Fixed Income Markets in the New Year: Ring in the Changes

By Colby Jenkins, TABB Group

Originally published on TABB Forum

Empirical data make it clear that over the past eight years, over-the-counter fixed income markets have continued to expand. But the data may belie the fact that this growth has been built on a fractured foundation, as increasing regulatory scrutiny and electronification and growing liquidity concerns continue to transform business models.

If last year is any indication, 2016 is poised to be another year of major change for the fixed income OTC markets. Empirical data continues to tell a compelling story: The numbers make it clear that over the past eight years, over-the-counter fixed income markets have continued to expand. But the data may belie the fact that this growth has been built on a fractured foundation.

Outstanding notional sizes of global debt markets surged – both the U.S. corporate bond and U.S. Treasury market continue to break annual records in notional outstanding (see Exhibit 1, below), growing by 77% and 207%, respectively, since 2005. But the debate as to whether liquidity in OTC fixed income markets is waning is certain to be carried on in 2016, as the effects of Basel III and other regulatory changes combine with shareholder demand for increased return on capital to alter business models.

Exhibit 1: U.S. Corporate Bond and U.S. Treasury Security Markets Notional Outstanding

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Source: TABB Group, SIFMA

Efficiency needs and cost concerns are fueling an increased use of technology across the marketplace, irrespective of asset class. As a result, a new breed of market-maker is emerging. In some arenas where products are suited, electronic trading is surging, while in others, growing illiquidity is causing participants to rely more heavily on relationships as the search for assets becomes an archeological dig (see Exhibit 2, below).

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Source: TABB Group

Meanwhile, the list of provocative, thought-provoking business drivers in today’s OTC fixed income markets also continues to grow – potential problems in search of solutions. Among these, aggressive regulatory reform, accommodative central bank monetary policies, the consolidation of assets under management, the proliferation of electronic trading, weakening credit fundamentals, and declining bid/ask spreads coupled with increased liquidity premiums are perennial challenges keeping the market off an even keel.