Hi, Mr. Chief Financial Officer of Generic China Corp. This is John Doe from sales at Solidly Second-Tier Bank. How are you? Listen, I think I have something that might interest you. Ever heard of a Target Redemption Forward? No? Let me explain. It’s a structured product, kind of like a series of exotic options that pay a monthly income as long as the spot yuan exchange rate remains above the strike price. Now, I hate to mention this, but I want to be up front with you, because you know I value your business. The risk here is that if the yuan falls below a certain level—say, 6.2 against the dollar—the option gets knocked out and you have to pay out double the amount. I personally don’t see that happening any time soon. I mean, with USD/CNH trading in this kind of range, we’re talking practically no-risk money.
You’re in? Great!
You already know how this ends (in tears and delta hedging).
Read about the latest slaughter in structured product land over here.
The backlash to the bond market liquidity theme in full-swing. That’s fine and expected though I do think some people are taking it a bit far. The problem with the liquidity story is not the story itself but simplistic bandwagon reporting that does not advance the narrative at all. I’ve said before on Twitter, it’s not enough to simply say that dealer holdings of fixed income have fallen X percent over the past X years, or that bond market liquidity is “a concern.” Many people, myself included, were talking about that theme and writing that story years ago and we need move on from that.
With that in mind, here’s a fresh angle to a stale story. In my opinion, it strikes at the heart of the issue – which is that the liquidity story is simply the flipside of what has been an intense scramble for corporate bonds in recent years.
What no one ever says about corporate bond market liquidity
Everyone’s worried about bond market liquidity. That much we know. Whether it’s high-yield corporate bonds sold by junk-rated companies or the ultra-safe Treasuriessold by the U.S. government, investors’ ability to buy and sell these securities without “overly” affecting prices has moved to front and center of the proverbial market concerns.
The causes, we hear, are myriad. Regulation that has curbed banks’ ability to hold vast sums of bonds on their balance sheets is often blamed. We are also told that years of low interest rates have herded investors to the same positions, spurring billions of dollars worth of inflows into global bond funds. The worry is that should those inflows reverse, bond prices could hit an air pocket and face a rapid descent.
There’s a long list of potential solutions to the problem. A shift toward electronic trading was once supposed to save a corporate bond market in which many trades are still done over the phone (although so-called electronification has apparently impeded liquidity in the U.S. Treasury market). Exchange-traded funds that give investors the ability to instantly dart in and out of positions are promoted as a quick fix for a longer-term problem. BlackRock, the world’s biggest asset manager, is pushing standardized bond issuance and wants to delay trade reporting for corporate debt.
All these solutions miss the point, however. None focus on the real reason behind deteriorating liquidity, which is that vast swaths of the corporate bond market have simply been cornered …
Read the rest over here.