It turns out the corporate bond market still needs traders.
The algorithms that dealers use to buy and sell bonds with their customers failed in March at the height of extreme volatility from the coronavirus pandemic, according to investors and price data. The nimble analysis of flesh-and-blood traders was suddenly needed to price bonds, edging out machines that normally can trade large portions of the market without any human input.
The bond market has been one of the last corners of finance to move into the digital age, slowly modernizing from the rise of electronic trading to new venues that will remove much of the interpersonal communication from the process of selling company debt. Yet even as digital platforms set record volumes in the first quarter, market watchers said the bots failed a test when Treasuries and credit spreads were so disorderly.
“Good old-fashioned blocking and tackling is still very much a part of the business,”said Chris Coccoluto, head of investment-grade bond trading at Manulife Investment Management. “It was almost nice to see in a way you had to rely on your relationships.”
The virus-related disruptions were profound. At the height of the volatility, Treasuries rallied to record low yields and corporate bond spreads gapped out to levels last seen in 2009. The securities are linked as the vast majority of investment-grade bonds trade at a premium to Treasuries, adding an extra layer of complexity when neither market was fully functional.
While humans were able to spot the new patterns quickly, the bots couldn’t adapt because algorithms are built on historical data, said Chris White, founder of advisory firm ViableMkts LLC.
“This is a reminder to a lot of people who may have been vilifying human interaction in the bond-buying process,” said White, a former fixed-income executive at Goldman Sachs Group Inc. “When things get really volatile, people become extremely valuable to the process.”
Cutting Risk
For decades, banks have stepped back when prices are unpredictable and buying too much from a customer could trigger multimillion-dollar losses in just days. At the end of March, dealers cut risk-taking mainly by shutting off algorithms that were spitting out incorrect prices left and right.
With Wall Street pulling back, asset managers stepped up to fill the void, according to MarketAxess Holdings Inc. data. Voice trades -- in which counterparties agree to a price over the phone, but process and hedge digitally -- rose to a record, according to Tradeweb Markets Inc.
Roughly 70% of the investment-grade corporate bond market still trades with some element of human interaction, especially larger transactions over $2 million. The record credit trading volumes handled on MarketAxess, Tradeweb and Trumid Financial LLC show how traders took advantage of platforms to execute smaller, simpler transactions electronically, which in turn allowed them to focus their attention on more difficult deals that require complex analysis, said Chris Bruner, head of U.S. credit at Tradeweb.