Interdealer trading has been on the rise recently, extending what has been a year-long streak of higher par value and total number of trades into 2013.
The increase in interdealer trading volume comes as overall trading volume has been on the decline, including customer buy and costumer sell trades.
And many market participants believe higher interdealer trading volume is a function of low nominal yields, which is reducing the attraction to retail buyers.
"We believe that retail is not as involved in the markets directly because absolute yields are too low," a New York trader said. "The cash is instead flowing into the mutual funds. The funds have to invest the money so that is where the increase in institutional buying is coming from."
Others agreed direct retail participation has dropped significantly. "There is a drop in retail direct buys because of an aversion to low nominal yields," said Matt Fabian, managing director at Municipal Market Advisors. "Direct retail is done with a commission fee structure so as yields compressed, there was not a lot of space to charge a commission with an individual trade."
A loss of bond insurance has also pushed retail buyers into institutionalization of management, like mutual funds, Fabian noted.
The Municipal Securities Rulemaking Board noted in a recent report that interdealer trades jumped to $630.5 billion in 2012, up from $526.3 billion in 2011. Total number of trades also rose to 3.44 million in 2012, up from 3.28 million in 2011.
That comes as customer buy trades were down at $1.62 trillion in 2012 from $1.67 trillion in 2011. Total number of trades was down to 4.14 million from 4.96 million. Customer sell trades in par value fell to $957.5 billion in 2012 from $1.09 billion in 2011. Total trades dropped to 2.13 million from 2.16 million in 2011.
While interdealer trading was up, overall trading volume fell in 2012, and market participants also pointed to bond funds for an explanation. “That dynamic is a result of consistent inflows into muni bond funds,” said Tom Boylen director of trading at Performance Trust. “Therefore selling volume from funds was probably hindered by the fact that they didn’t need to raise cash. Trading volume was lower because funds are purchasing new issues and didn’t have to sell.”
Into 2013, that trend continued, according to Municipal Market Advisors.
MMA reports that interdealer trades have climbed to as much as 30% of all trades on a single day. Most recently, interdealer trades accounted for 29.6% of all trades on Jan. 7 followed by 29.9% of all trades on Jan. 8, and 28.2% of all trades on Jan. 9.
A week later, 26% of all trades were between dealers on Jan. 14, followed by 26.6% on Jan. 15. The following day, 25.4% of all trades were between dealers.
On Feb. 6, 26.2% of trades were interdealer followed by 23.2% on Feb. 7. On Feb. 8 22.3% of trades were between dealers and 25.9% of trades on Feb. 11.
Later in February, 30.9% of all trades were between dealers on Feb. 25, followed by 29.4% of trades on Feb. 26. And indeed, Feb. 25 marked the sixth highest daily interdealer market share day since May 2006.
An increase in interdealer trading on an absolute level also shows that secondary trade chains are lengthening, Fabian said. The longer the chain, the more dealers are moving bonds between themselves. It's harder for dealers to find those going-away customers and dealers are more reliant on primary market activity."
And without those direct retail buyers, dealers are turning to each other to make money. "Traders turn trades over to make money," a New York trader said. "You just give up and turn it to the street."