A dramatic shift is taking place in bond trading

Flickr / Casey Fleser

People are worried about bond-market liquidity.

Yes, yes, I know. You know that already.

Barely a day goes by without someone adding to the chorus complaining about difficult trading conditions. There have even been TV adverts addressing the topic.

The comments are so common that Matt Levine has a section in his daily email dedicated to detailing Wall Street’s concerns with liquidity.

A part of the reason this keeps coming up is because liquidity is really difficult to define, and a lot of the traditional metrics for liquidity don’t seem to capture the difficulty many traders and investors seem to have when trading big positions.

Barclays analysts led by Jeffrey Meli had a big note out on Wednesday touching on some of these issues, and it is one of the best pieces of analysis we’ve seen on this topic.

In particular, it showcases how trading behavior has changed, and uses charts to show how the bond market is shifting away from principal trading toward agency-like trading.

Barclays uses TRACE data to focus its research on block trades, or trades of more than $5 million, with an offsetting trade, or a trade in the same bond in the opposite direction, in a five-day period. The idea here is to track bonds on to and off bank dealer balance sheets.

And with that, let’s dive in to the charts:

Trading is focused on the newest bonds


Basically, bonds see a lot of trading right after they are issued, and this trading deteriorates sharply over time.

“First, volumes have become increasingly concentrated: bonds issued in the past year accounted for 41% of block trades in 2015, compared with only 34% in 2010,” the Barclays note said.

Deutsche Bank touched on this in a recent note, pointing out that this has severe implications.

“Between days one and five, average volume drops by 80% in high yield, and by 65% in investment grade, at which point it continues to decelerate going forward, but at a much slower pace,” the bank said.

Banks are taking less risk, with agency-like trades becoming more popular.


Agency trading is where a bank is sitting in the middle of two counterparties that are ready to trade, whereas principal trading is where the bank takes a bond on to its own balance sheet for an extended period.

In short, the former is becoming more popular, and the latter less popular.

Here is Barclays:

There has been a meaningful shift in the composition of agent versus principal trades since 2010, with a clear shift toward the former. While about 16% of block trades had an almost immediate (within 15 minutes) offsetting transaction in 2010, those trades comprised 23% of total block trades in 2015, an increase of almost 50%. Similarly, the fraction of trades with an offsetting transaction between 15 minutes and one day has also increased, likely also representing some increase in order taking. On the other hand, the fraction of block trades without an offset in five days – ie, the risk stays on dealer inventories for a longer time – has declined significantly, from 47% to 36%.

Agency trading is especially prevalent in older bonds.


The agency trading is especially popular for older bonds, likely because banks are less willing to take these bonds on to their balance sheet, as they’re less certain that there will be an unidentified buyer right around the corner.

Here is Barclays:

In general, a higher proportion of block trades in older securities happen on order; in 2015, 28% of block trades in bonds issued more than five years ago had an offsetting trade within 15 minutes. More important, while agent trades have generally become more prevalent across all bonds since 2010, the effect has been clearly more apparent in bonds issued more than a year ago, suggesting a shift toward more agency trades for less liquid bonds.

And the cost of trading is much higher for old bonds too.


To recap, the bid-ask spread is the difference the price at which dealers are willing to buy (bid) and the price at which dealers are willing to sell (ask).

This spread is much wider for principal-type trades, and for older, less liquid bonds.

Here is Barclays:

Not surprisingly, bid/offer costs are higher for block trades where the offsetting trade occurs in 1-5 days. Further, the difference in cost is much higher across vintages: the realized bid/ask cost is 4bp higher for bonds issued five years ago than for recently issued securities. Given that the inventory sits on dealers’ balance sheet for a slightly longer time (1-5 days), the liquidity premium charged by dealers is higher.


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