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    RESEARCH  |  MACRO SHIFTS

    Five forces reshaping fixed income markets

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    Contributors: Jeff Meli, Anshul Pradhan, Joseph Abate & Zornitsa Todorova

    30 Apr 2024

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    The world of fixed income is undergoing rapid and profound changes. New technologies are transforming the landscape of trading, at a time when record issuance of US Treasuries – the bedrock of global debt markets – is posing new risks to financial stability. Our Research analysts explore five seismic shifts affecting fixed income assets and markets in the next five years.

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    Contributors: Jeff Meli, Anshul Pradhan, Joseph Abate & Zornitsa Todorova

    30 Apr 2024

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    GO TO SECTION

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    Treasury tsunami

    America’s government bond market is braced for a deluge of issuance. Budget deficits are very wide and are likely to remain so, no matter what political configuration emerges from the elections in November. That has significant consequences for fixed income markets, and not just in the US.

    For one thing, it means long-term yields in the US are likely to remain elevated, even if the Fed embarks on a rate-cutting cycle. Studies suggest that a 1 percentage-point increase in the projected deficit/GDP ratio leads to an increase of about 20 basis points in the 10-year Treasury yield, as investors demand compensation for an inferior fiscal profile.

    Our Research team also notes big shifts in the composition of Treasury buyers. Foreign central banks used to be the backbone of the market, but their appetite for US debt has faded as their pools of foreign-exchange reserves have shrunk or flatlined over the past decade. The US Federal Reserve has retreated from the market too, as it sought to shrink its balance sheet to fight inflation. In short, the baton has passed from those who need to buy to those who choose to buy, such as mutual funds and hedge funds.

    Line chart showing buyers of US Treasuries from 2000-2020

    That implies higher yields, and higher volatility, in the future.

    When the US sneezes …

    What does this mean for debt markets globally? The omens are not necessarily encouraging.

    Major bond markets around the world often move in sync. Common characteristics of those markets – such as openness and reasonably free flows of capital across borders – mean that a sharp movement in interest rates in one jurisdiction can get transmitted quickly across others, even if the sizes of those markets are very different. In this context, the US has tended to matter more than fundamental links between markets and economies might imply. Spillovers appear to be amplified by the dominance of the US dollar and the enormous influence of the US Treasury market, where prices serve as benchmarks for trillions of financial assets.

    Barchart showing effects of a 100bp rise in 10-year US bond yields on 10-year swap rates across countries

    However, the degree of this synchronicity is not constant. Our analysts find that it varies across geographies and points on the yield curve. Specifically, domestic factors can either soften or exacerbate the response of a specific bond market to gyrations in US Treasuries. Levels of sensitivity also vary over time, changing as macro conditions evolve.

    But one thing is clear: any tremor in US Treasuries is likely to be felt far and wide.

    A more fragile future

    For regulators, watching over these rapidly changing fixed income markets will not be easy. Our analysts see something of a “trilemma”: authorities can try to create systems that function well, are low-risk and are free of moral hazard. But they probably cannot achieve all three aims at once.

    The huge extra supply of US Treasuries set to wash over the market is likely to create new strains on intermediaries such as dealers. And vulnerabilities may not be obvious until they are exposed by events. Recent episodes such as the 2019 blow-up in repos, a market for interbank lending, and the COVID-induced “dash for cash” in early 2020 suggest that markets are increasingly prone to instability.

    New regulatory constraints could exacerbate frictions. Take the central-clearing mandate from the Securities and Exchange Commission, due to be phased in from 2025. This looks set to relieve some strains on intermediaries but will likely introduce new ones in their place, which could add new costs as the size of the Treasury market increases. Each new requirement like this has the potential to add complexity and subtract flexibility, raising the chances of severe dislocations. Those, in turn, would require interventions from policymakers to restore stability – which could remove incentives for market participants to guard against risk.

    The result: fixed-income markets are likely to become more fragile, subject to more regular bouts of illiquidity and heightened volatility.

    The Equitification of credit

    Advances in technology, products and protocols are shaking up the traditionally rigid world of fixed income, affording investors greater flexibility and a wider scope of strategies to fit different investment styles.

    The rapid rise of exchange-traded funds, for example, has allowed investors to gain cheap exposure to benchmark corporate bond indices. In the US, the trading volumes of the largest investment-grade and high-yield ETFs are up by a factor of ten over the past decade and now account for about one-fifth of the total cash market.

    Bar chart with line showing ETF trading volumes and total cash volumes from 2013-2013

    The upshot is that credit markets are becoming much more like equity markets, where electronic trading and automated strategies took hold a long time ago. There will be limits, of course. Unlike the world of equities, where companies tend to be embodied by a single, fungible security, each issuer of bonds tends to have a variety of instruments that differ in ways that make them harder to trade and harder to track. Plenty of deals will still be struck the old-fashioned way, by calling up a broker-dealer.

    But the broader “equitification” trend looks well entrenched. Our analysts expect investors to continue to benefit, chiefly by having a much wider array of trading and investment options.

    A one-stop shop for Europe

    These changes are coming at a dramatic moment for markets in Europe, where regulators are soon to mandate much more rapid and uniform disclosures of trades in corporate bonds. The establishment of a so-called “consolidated tape” will provide a single source of reference for prices, volumes and timings across all venues.

    A centralised repository promises to bring Europe up to speed with the US, which has had a similar system for more than 20 years. Our analysts think the new framework will radically improve trade transparency on the continent, increasing the number of transactions reported without delay from about 8% to more than 80%.

    Their analysis suggests, however, that the effects on transaction costs will be mixed, cutting expenses for small trades and for newly issued bonds, but raising them for larger trades and older instruments. That’s the flip side of greater transparency: If the entire market can see the details of trades, dealers are likely to charge more for the risk that prices move against them.

    Chart showing effect of transparency by size buckets
    Chart showing effect of transparency by bond age

    These findings contrast with studies in the past, which have tended to conclude that extra transparency leads to quicker and cheaper trades across the board. But those studies were done mainly before the Global Financial Crisis made dealers much more wary of committing their balance sheets. The effects of Europe’s revolution in disclosure are likely to be more nuanced than previously thought.

    Note: The Equity Gilt Study is Barclays’ flagship annual research publication. Every year since 1956 Barclays Research has provided data, analysis and commentary on long-term asset returns in the UK and the US.

     

    Important content disclosures

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    About the analysts

    Jeff Meli

    Global Head of Research

    Jeff Meli is Global Head of Research at Barclays, based in New York. Jeff joined Barclays in 2005 as the Head of US Structured Credit Strategy and has held a number of other senior positions in the research department, including Head of Credit Research and co-Head of FICC Research. Jeff spearheaded the firm’s response to regulatory changes in research, including MiFID II, and has revamped the department’s approach to content monetisation. Jeff leads the development of the Research Data Science Platform, tasked with integrating new data sets and modern data techniques into investment research. He writes regularly about special topics in credit markets, liquidity, and financial market regulation and hosts The Flip Side, a podcast covering current events in finance and macroeconomics. Previously, he worked at Deutsche Bank and J.P. Morgan, with a focus on structured credit. Jeff has a PhD in Finance from the University of Chicago and an AB in Mathematics from Princeton.

    Brad Rogoff

    Head of FICC Research

    Brad Rogoff is a Managing Director and Head of FICC Research, based in New York. The FICC Research team covers corporate and sovereign bonds, securitized products, interest rates, FX and economics across developed and emerging markets globally. In addition to his leadership role, he largely focuses on the US high yield, leveraged loan and CLO markets. He and his team have consistently been ranked by Institutional Investor in the High Yield Credit Strategy category since 2009, and the US Credit Alpha has been voted one of the Best Weekly Credit Research Publications each year since. In 2016, Brad assumed management responsibility for the Emerging Market Corporate Credit Research team globally; in 2018, his role was expanded to include the Developed Market Credit Research team; and in 2022, he took on responsibility for FICC research. He joined Barclays from Lehman Brothers in September 2008, where he was a member of the Credit Strategy team focusing on high yield bonds and derivatives. He joined Lehman Brothers in 2002 as a member of the High Yield Research team focusing on the media sector and moved to the Credit Strategy team in 2005. Brad graduated from Harvard University, cum laude, in 2002 with an AB in economics. He is also a CFA charterholder.

    Dominique Toublan

    Head of US Credit Strategy

    Dominique Toublan is a Managing Director and Head of US Credit Strategy, responsible for overseeing the team of US strategists who provide insights across investment grade, high yield, leveraged loans and credit derivatives. He also has a focus on the US Investment Grade market. Dominique brings more than 15 years of experience in the financial industry. Prior to Barclays, he was the Head of US Credit Strategy at BNP Paribas. Before that, he worked at J.P. Morgan within the High Grade Corporate Strategy and Credit Derivatives team. Dominique has been ranked the #2 US Investment Grade Credit Strategist in the Institutional Investor Fixed Income survey for the last two years. He was ranked #1 in US Credit Derivatives from 2011-2018. Dominique has a PhD from the University of Bern, Switzerland, and an MBA from the Wharton School.

    Zornitsa Todorova

    Head of Thematic Macro Research

    Zornitsa Todorova is a Vice President, based in London, leading the Thematic Macro Research group at Barclays. She covers topics such as the intersection between macroeconomics and financial markets, applying academic methods. Prior to joining Barclays in 2019, she taught risk management and investments at Bocconi University and Berlin School of Business and Innovation. Her work has been published in peer-reviewed academic outlets such as The Journal of Financial Markets, Institutions and Instruments, The Journal of Corporate Ownership and Control and The Review of Finance and Banking. Zornitsa holds a PhD Honors Degree in Economics and Finance from Bocconi University (Italy).

    Anshul Pradhan

    Head of US Rates Research

    Anshul Pradhan is a Managing Director and Head of US Rates Research. Based in New York, Anshul is responsible for interest rates research across cash and derivative products in the US. Prior to his current role, he was responsible for the firm’s US Treasuries research, and prior to joining Barclays in 2008, he was part of the Fixed Income Research Group at Lehman Brothers, where he focused on inflation-linked government securities. Anshul holds an MBA from the Indian Institute of Management and a Bachelor’s degree in Engineering from the Indian Institute of Technology.

    Themistoklis Fiotakis

    Global Head of FX and EM Macro Strategy

    Themistoklis (Themos) Fiotakis is the Global Head of FX and EM Macro Strategy at Barclays. In this capacity, he is responsible for FX forecasts and strategy views across DM and EM currencies as well as local EM rates. Over the last 20 years, Themos has held senior positions in sell-side and buy-side institutions. Before Barclays, Themos was the Head of Research at Glen Point Capital, a macro fund with an EM tilt. Prior to that, Themos ran FX and Rates research at UBS Investment Bank and before that he was responsible for EM FX Research at Goldman Sachs. Themos studied Finance and Economics at London School of Economics and Political Science at the University of Piraeus in Greece.

    Rohan Khanna

    Head of European Rates Research

    Rohan Khanna is a Director and Head of European Rates Research. Based in London, Rohan is responsible for interest rates research across cash, derivative and money markets in Europe. Prior to joining Barclays in June 2023, he held similar position at UBS AG and prior to that was a rates strategist at Goldman Sachs. Rohan holds a MSc in Economics from London School of Economics and a Bachelor in Engineering and MBA Finance specialisations from India.

    Joseph Abate

    US Rates Strategy

    Joseph Abate is a Managing Director in US Rates Strategy. Based in New York, Joseph is responsible for money market research specializing in repo, market liquidity, systemic risk and monetary policy. Joseph has been ranked for short-duration strategy in Institutional Investor’s Fixed Income Survey since 2010. Recently, he has also written extensively on central bank digital currencies and stablecoins. Prior to joining Barclays, Joseph was a senior economist at Lehman Brothers. He has a BA in Economics and French history from Vassar College and an MBA from New York University.

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