According to BofAML, dealer inventories of investment grade corporate bonds are negative for the first time in history, a state of affairs the bank attributes to “excess demand” and should provide a potentially bullish technical for a market that’s been the subject of some debate all year long.
In the chart below, you’ll note that this actually appears to be the second such instance, but according to the bank’s Hans Mikkelsen, the other episode was due to an errant print.
“The only negative inventory number on record in the Fed’s data is for the week ended October 28, 2015, which was most likely an error due to well-known difficulties tracking long maturity bonds,” Mikkelsen writes, in a note dated Monday.
(BofAML)
For Mikkelsen, this portends a rally and if it’s all the same to you, he’d rather not get bogged down in a cart-horse debate.
“While here it is easy to become entangled in a chicken vs. egg discussion, as one could argue that that the causation runs in reverse with low dealer inventories the result of strong markets — and thus tighter spreads — we find strong statistical evidence that inventories lead spreads historically, not the other way around”, he writes. So unless you’ve conducted your own Granger Causality test, you’re probably not in a position to debate him on the subject.
Humor aside, investment grade credit will take whatever it can get when it comes to bullish technicals. After all, IG has been a terrible trade in 2018, suffering from jitters about duration risk and the prospect that high grade debt has become to a certain extent entangled with macro-systemic risk.
(Bloomberg)
Early last month, IG spreads hit their widest levels since December 2016.
“2018 is proving to be exactly the type of year you would expect as the Fed’s quantitative tightening is gradually kicking in and expectations for foreign monetary policy accommodation are reduced slowly”, Mikkelsen wrote, in a separate note out last week, before explaining that when it comes to high grade bonds, “this means declining demand for over time, deteriorating technicals, increasing volatility and eventually a spread widening environment, which we expect to begin next year (2019) and last through the next.”
One thing you want to note about the first chart shown above is that irrespective of whether it portends spread tightening in the short-term, it’s unlikely to do much in the way of allaying fears about liquidity in the corporate bond market. The post-crisis regulatory regime has made dealers less willing to lend their balance sheets in a pinch, and questions about what that would entail in an acute situation have dogged the market for years.
In a comprehensive assessment of liquidity in the high grade bond market dated July 25, BofAML described the picture as “mixed.”
