Wednesday, October 1, 2014

Bond Market Liquidity

We typically think of Treasuries as being very liquid - by which we mean that an investor can buy and sell a large quantity of the asset with little impact on the price.  We're also implicitly assuming that there is no new information about the asset's fundamental value.

So look what happened recently for TIPS (Treasury Inflation Protected Securities) when Bill Gross, Chairman of PIMCO (one of the biggest fixed income management shops) quit.  

The day Gross left Pimco to join Janus Capital Group Inc. (JNS), Mexican government bonds declined 0.3 percent, inflation-protected U.S. bonds lost 0.4 percent and debt of Verizon Communications Inc. (VZ) -- one of his bigger company holdings -- dropped 0.3 percent. That compares with a 0.05 percent decline on the Bank of America Merrill Lynch Global Broad Market Index.
and

“Less liquid sectors such as TIPS continued to weaken as a result of Pimco concerns,” Leduc wrote in a Sept. 30 note. “There has not been measurable impact in most liquid sectors.”


Article here;  http://www.bloomberg.com/news/2014-10-01/gross-exposes-42-trillion-bond-market-s-key-flaw-in-pimco-exit.html


If we look at the real rate of return on TIPS since they were first issued, we can see that the real return has declined over the years.   This could be due to a secular decline in real rates, but is also, at least in part, consistent with some liquidity premium being present in the TIPS yield.