Is this the market that will blow up the global economy?

A few tidbits on the US corporate bond market from BofAML:

 Summer 2019 snapshot of the US HG market. The US high grade (HG) corporate credit market has expanded to an $8.293tn asset class, including $7.959tn of bonds and $0.334tn of derivatives notional outstanding.

 Supply. HG new issuance volumes have averaged $1.258tn per year since 2014, peaking at $1.396tn in 2017 with $1.187tr expected in 2019.

 Trading volumes. Overall HG credit trading volumes have averaged $62bn per day so far this year. CDX IG indices offer the highest liquidity with daily trading volumes averaging $35bn, while HG cash corporate bonds averaged $23.3bn per day. Larger transactions are increasingly executed through single-dealer portfolio trades – we estimate $595mn daily, or 3% of trading. Also, a higher share of bond trading is shifting into the more liquid bond ETFs. So far this year, trading in ETFs has averaged 11% of the cash bond trading volumes. This included $1.9bn of HG corporate ETF trading and $0.6bn of corporate bonds in broader high grade fixed income ETFs. Finally, single-name CDS trading has averaged $1.0bn per day.

 Spreads. Since 1997 HG index spreads averaged 153bps, ranging between 53bps in October of 1997 and 622bps in December of 2008. The current spread is 125bps. The median 5s/10s corporate spread curve for HG issuers has been about 30bps since 1997 compared with 38bps for 10s/30s. Currently curves are relatively steep.

 Spread drivers. From a big-picture perspective, high grade credit spreads follow the general business cycle and price in line with the other broad markets, such as equity volatility. In addition to the broad macro market environment, credit-specific fundamental and technical demand-supply factors impact spreads. Credit spreads compensate investors for two types of risk: mark-to-market-risk (including liquidity and downgrade – such as Fallen Angel – risks) and default (credit) risk.

 Default risk in HG. Historically HG defaults have been relatively rare and far between. The average annual issuer-weighted HG default rate was just 0.14%.

And this:

With the post-financial crisis collapse in dealer inventories of HG corporate bonds (Figure 65), and the fact that only about 0.3% of outstanding bond notional is traded on a daily basis (Figure 66), liquidity risk in HG is very high – especially for older bonds. This is a nice attraction for buy-and-hold investors, but a big concern that warrants compensation for the vast majority of investors subject to market-to-market.

A lot of that debt has gone into share buybacks. But if stocks come unstuck on a crashing global economy then all bets are off for tight spreads, illiquid markets and declining credit quality.

David Llewellyn-Smith
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