Wall Street never thought it would be this bad.
Over the last two months, and particularly over the last two weeks, investors have been exiting their bond investments with unexpected ferocity, moves that continued through Monday.
A bond sell-off has been anticipated for years, given the long run of popularity that corporate and government bonds have enjoyed. But most strategists expected that investors would slowly transfer out of bonds, allowing interest rates to slowly drift up.
Instead, since the Federal Reserve chairman, Ben S. Bernanke, recently suggested that the strength of the economic recovery might allow the Fed to slow down its bond-buying program, waves of selling have convulsed the markets.
The SPDR Barclays High Yield Bond exchange-traded fund has declined 5 percent over the past month, though it rose in Tuesday trading. The fund has seen $2.7 billion in outflows year to date, according to IndexUniverse.
Another popular junk ETF, the iShares iBoxx $ High Yield Corporate Bond, has seen nearly $2 billion in outflows this year and is off 3.4 percent over the past five days alone.
Investors pulled $333 million from high-yield funds last week, according to Lipper.
While correlating to the general trend in fixed income, the slowdown in the junk bond business bodes especially troubling signs for investment banks, which have relied on the debt markets for fully one-third of their business this year, the highest percentage in 10 years.
With yields on the U.S. municipal bond market rising, local issuers on Monday postponed another six bond sales, totaling $331 million, that were originally scheduled to price later this week.
Since mid-June, on the prospect that the Federal Reserve could change course on its easy monetary policy as the economy improves, the municipal bond market has seen a total of $2.6 billion in sales either canceled or delayed.
Thus, there is only one direction for rates: UP, with muni bonds leading the decline, given that the financial structures of many municipalities are teetering. There is absolutely no good reason to be in municipal bonds now. And muni ETFs will be a worse place to be, given this is relatively HOT money that will try to get out of the exit door all at once.
Please understand how many of these interest rate derivatives work. When the rates go against you, “margin” must be posted. By “margin” I mean collateral. Collateral must be shifted from the losing institution to the one on the winning side. When the loser “runs out” of collateral…that is when you get a situation similar to MF Global or Lehman Bros., they are forced to shut down and the vultures then come in and pick the bones clean…normally. Now it is no longer “normal,” now a Lehman Bros will take the whole tent down.
The Basel-based BIS - known as the central bank of central banks - said in its annual report that using current monetary policy employed in the euro zone, the U.K., Japan and the U.S. will not bring about much-needed labor and product market reforms and is a recipe for failure.
"Central banks cannot do more without compounding the risks they have already created," it said in its latest annual report released on Sunday. "[They must] encourage needed adjustments rather than retard them with near-zero interest rates and purchases of ever-larger quantities of government securities."