A Unique Look at Fixed Income Trading

Paul Daley, Managing Director of BondWave, talks fixed income trading in 2021 and looks at what may be in store for municipal bond trading this year. Chip Barnett hosts. (12 mins)

Transcript below

Barnett Chip: (00:03)
Hello and welcome to another Bond Buyer podcast. I am Chip Barnett. My guest is Paul Daley and he is the managing director of BondWave. And he’s going to share his research and insights with us today.

Barnett Chip: (00:18)
You know, I think we’re talking about a wide range of topics of interest to the municipal bond market. So let’s start with 2022 by taking a look at 2021. What kind of year was it last for fixed income trading?

Paul Daley: (00:38)
I would describe 2021 as kind of back to normal, Chip. Obviously, 2020 has been a weird year. It was a year of outliers. If you look at it in contrast to 2021, if you look at things like supply spreads, a typical measure of trading in a market, we’ve seen some really crazy stuff in 2020 for obvious reasons. But for example, at the end of March, when bid-to-bid spreads reached 2.5% for five- to ten-year municipal bonds, we saw a sharp increase in volume. Lots of motivated news, obviously lots of volume trading spikes related to COVID. And so 2021 was really the contrast where we saw things like bid spreads return to very normal type levels. We’ve seen volumes go down and yet liquidity hasn’t necessarily gone down.

Paul Daley: (01:36)
The other thing that we saw that I think was a bit unusual, surprisingly on the bright side, is that the new schedule was very, very strong in 2021. 2020 was kind of a banner year for the new issuance in the municipal market – and 2021 was only 1% less – so still the second highest level of new issuance we had seen in our data. Thus, the combination of the shrinking of this secondary market and the increase of the primary market suggests that much of the new money that entered the municipal market was absorbed by the primary volume. And we didn’t necessarily see it sink into the secondary volume.

Barnett Chip: (02:19)
Specifically, how did municipal commerce work?

Paul Daley: (02:22)
It worked out pretty well, actually, you know, I just described the scenario where you have fresh money coming into the market that gets sucked into the primary issuance and doesn’t necessarily show up in the secondary volumes . In this scenario, you would therefore think that trading costs would increase, right? It’s usually a description of a low liquidity environment when you don’t have a lot of side trades. But what we saw instead is that slippage costs, for example, came back to the levels we saw in 2019, supply gap costs also came back to the levels we saw in 2019 significantly lower than what we were seeing in 2020 And that’s also a very favorable comparison for a second reason – 2019 was kind of the lowest trading cost year we have in our data history . So we’ve seen kind of a continuing trend of lower and lower transaction costs, and it’s a pretty opaque market.

Paul Daley: (03:26)
So it’s something unusual to see, but trading costs have seen this secular decline. You have 2020, which is, you know, the outlier driven by, you know, a world-changing event, but 2021 has returned to this trend of lower and lower transaction costs. So despite secondary trading volumes not being robust at all, we saw a continuation of the trend of good supply spreads, tightening, slippage, relative to other trades, so may result in a decrease in trading volatility and overall I think it’s just an expression of how the market is moving. Even though we have a very opaque market structure for fixed income trading, we’ve still only seen this continued decline in trading costs, which is a very, very positive trend, obviously.

Barnett Chip: (04:22)
Well, for this year, what do you see for fixed income trading in 2022?

Paul Daley: (04:27)
So I think I see a continuation of the trend. I think we are going to see a further decline in trading costs. The only exception that I think we will have is that I assume that all of these new issues that have absorbed new capital entering the market will now be expressed as secondary transactions. So you have more dollars, there were more bonds, so you didn’t see as many side trades. Now, I guess secondary trading will cool down a bit with an increase in the fed funds rate. You know, if interest rates go up, we’ll calm down a bit in the primary market, but we’ll see an increase in activity in the secondary market. And again, this age-old trend will continue where we see a decrease in trading costs. And that’s probably about all I’m willing to make predictions – I’m not much of a predictor, but I’ll also add, I have hope for what will happen in 2022.

Paul Daley: (05:30)
And it is that there will be greater adoption of transaction cost analysis. Transaction cost analysis is not well adopted in fixed income markets. And that’s mainly because fixed income trade data is very difficult to consume. It’s not necessarily easily formatted. You have different types of trade mixed in the strip published by the MSRB or the strip published by the FINRA. What you really need are tools and calculations designed to increase the usability of existing data. And this leads to a kind of virtuous circle. You have greater transparency with the new tools and calculations you have, a better understanding of the market which reduces the fear of investing in the market, which leads to more investments, which reduces trading costs. So I think, and I hope, we’ll see more adoption of technology and types of calculations designed to better understand the market so that people are more comfortable investing in the market. So those are my, those are my hopes and my dreams.

Barnett Chip: (06:47)
You know, your research shows that the number of exchanges has gone down. What does it mean?

Paul Daley: (07:03)
Well, I don’t mean that means something we should be too concerned about. Admittedly, the number of exchanges decreased in 2021 compared to 2020, but 2020 was very difficult, volumes saw peaks which were significantly due to the events of the COVID crisis. People did not flee the market in 2020, it was very actively traded. And I think that’s a direct result of proposed or announced government intervention. One of the things we’ve learned in the markets in 2020 is that in times of crisis you don’t necessarily need the government, the Fed, to step in and spend a ton of money. What you need is for them to announce that they will. And that brings confidence back to the market, doesn’t it? There’s a kind of innuendo there. I always sell to the buyer of last resort who I can sell to.

Paul Daley: (08:03)
So now I don’t have to worry about owning things anymore. And so we saw a huge volume of transactions in 2020, we saw a lot less volume of transactions in 2021. Again, because it was difficult, comparable to 2020, but also because of the other phenomena that I described earlier, that the new show schedule was just very, very robust. And so the new money entering the municipalities was absorbed by this new issuance schedule. Now that I think the new issuance schedule will take hold, we will see some sort of return to normal trading volumes. So I guess these decreases in the number of trades, these decreases in coins traded on the secondary market, that will reverse in 2022.

Barnett Chip: (08:49)
Can you tell us a bit about the four asset classes you cover in the different BondWave dashboards?

Paul Daley: (08:56)
Absoutely. So, for now, we cover all PMP-specific asset classes. Thus, in the current market price mark-up disclosure rule, certain asset classes were covered, namely corporate bonds, municipal bonds, agency bonds and 144A, which is not in reality only a subset of companies. So we are producing dashboards for these four asset classes, but there are other assets with trades being broadcast for which we will be rolling out dashboards as we roll out cost analysis products of transactions. So specifically, structured products, these include asset-backed securities, mortgage-backed securities, whether it’s the versions, to be announced, mortgage-backed securities, or specified pools . We will therefore produce data for all of these elements in addition to the four dashboards that we currently produce.

Barnett Chip: (09:58)
Do you have a final thought for our listeners?

Paul Daley: (10:00)
My final thoughts are as follows. I encourage everyone to research new technologies and techniques to understand trading costs and fixed income securities. I come from the equity side of the world myself, where fixed income or trading cost analysis is old, right? It has been around for decades, it is well accepted and well understood. Everyone uses it from the buy side to the sell side and even retail investors use it. When it comes to the world of fixed income, where there’s a lot less data and less transparency, I think there’s also a kind of fundamental jaded attitude towards cross-trade analysis. The data is not solid, the data is difficult to process, it is difficult to draw conclusions. But there’s BondWave and other companies that are making strides in how you take that data and interpret it using advanced data science techniques to make the data more consumable. I therefore encourage auditors to pursue a number of new technologies and calculation techniques to help them better understand trading costs and with better understanding, better results. So it’s a virtuous circle in that regard.

Barnett Chip: (11:24)
Paul Daley from BondWave, thank you very much for being here.

Paul Daley: (11:27)
Today. Chip. My pleasure. Thank you very much for inviting me.

Barnett Chip: (11:31)
Thanks to Wen-Wyst Jeanmary, who did the audio production for this episode, and don’t forget to rate, review and subscribe at www.bonder.com/subscribe. From the bond buyer, I’m Chip Barnett. And thank you for listening.

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