Originally posted on August 20, 2020
By Mikhail Bezroukov, analytics product manager and Yu Zou, director, quantitative analysis
The COVID-19 crisis has impacted nearly all asset classes, and USD corporate bonds have not been spared. As the mid-March 2020 market volatility affected USD corporate bond prices, it also compromised their liquidity. While these spikes in liquidity costs occurred across the USD corporate bond asset class, we found the level of impact-and the path to returning to pre-crisis levels-varied across credit rating and sectors.
As the onset of the pandemic roiled US markets the second week of March 2020, USD investment grade corporate bonds saw a dramatic increase in liquidity costs. A useful metric for gauging liquidity costs is price liquidity ratio (PLR)- which looks at market impact and measures the movement in price of a security for an executed trade of a given size. A higher PLR represents a larger movement in price for a given trade size and therefore shows lower liquidity. By this metric, the PLR for the corporate sectors of the FTSE US Broad Investment-Grade Index (USBIG®) rose from 0.02% at the end of February to 0.10% at the start of April-representing a significant spike in liquidity costs.
This dramatic rise in investment grade bond liquidity costs can be tied to a timeline of events. As shown below, the World Health Organization’s official declaration of a pandemic coincided with the initial rise, which sharply fell when the Fed began its bond buying program.
While the rise in investment grade bond liquidity costs in mid-March was dramatic, it was dwarfed by the illiquidity spike in USD high yield bonds. As shown below, during the same time period, the corporate sectors of the FTSE US Broad Investment-Grade Index (USBIG®)” PLR surged from 0.03% to 0.17%.
We also see some divergence when comparing how price and liquidity metrics have since fared. While high yield bonds experienced greater volatility in both prices and liquidity costs, investment grade bonds have since followed a smoother path. And while both have seen liquidity costs come down considerably from their early April highs, they remain above pre-crisis levels, with investment grade bonds only slightly exceeding them and high yield bonds remaining above pre-crisis levels by a wider margin.
We can also observe uneven pandemic impact if we look at liquidity costs across corporate bond subsectors. For example, the Financial-Bank subsector remained relatively liquid throughout the market volatility, likely reflecting lower operational disruptions compared to other sectors. However, as shown below, areas of the market facing higher operational challenges as a result of the crisis-such as the Industrials-Transportation and Utilities-Electric subsectors-saw higher jumps in transaction costs.
While each of these corporate bond subsectors felt the impact of the COVID-19 crisis, the above charts indicate that their liquidity costs have since retreated to pre-crisis levels. However, as the length of the crisis and the depth of its impacts still remain to be seen, a smoother ride ahead is anything but certain.
© 2020 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) MTSNext Limited (“MTSNext”), (5) Mergent, Inc. (“Mergent”), (6) FTSE Fixed Income LLC (“FTSE FI”), (7) The Yield Book Inc (“YB”) and (8) Beyond Ratings S.A.S. (“BR”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, MTSNext, Mergent, FTSE FI, YB and BR. “FTSE®”, “Russell®”, “FTSE Russell®”, “MTS®”, “FTSE4Good®”, “ICB®”, “Mergent®”, “The Yield Book®”, “Beyond Ratings®” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, MTSNext, FTSE Canada, Mergent, FTSE FI, YB or BR. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided “as is” without warranty of any kind. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of FTSE Russell products, including but not limited to indexes, data and analytics, or the fitness or suitability of the FTSE Russell products for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell products is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing contained in this document or accessible through FTSE Russell Indexes, including statistical data and industry reports, should be taken as constituting financial or investment advice or a financial promotion.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back- tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.
This publication may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group data requires a licence from FTSE, Russell, FTSE Canada, MTSNext, Mergent, FTSE FI, YB and/or their respective licensors.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.