Paul Daley, managing director at BondWave, talks about fixed-income trading in 2021 and looks ahead to what may be in store for trading in municipal bonds this year. Chip Barnett hosts. (12 minutes)
Transcription below
Chip Barnett: (
Hi, and welcome to another Bond Buyer podcast. I'm Chip Barnett. My guest is Paul Daley and he's the managing director at BondWave. And he's going to share his research and insights with us today.
Chip Barnett: (
You know, I think we be talking about a wide range of subjects of interest to the municipal bond market. So let's start off with 2022 by taking a look back at 2021. What kind of year was it last year for fixed income trading?
Paul Daley: (
I would describe 2021 as a kind of a return to normal, Chip. Obviously 2020 was a strange year. It was a year of outliers. If you look at it in contrast of 2021, if you look at things like bid offer spreads, a typical measure of trading in a market, we saw some really crazy stuff in 2020 for the obvious reasons. But for example, at the end of March, bid offer spreads were as high as two and a half percent for five- to 10-year municipal bonds, we saw big spike in volume. A lot of news driven, obviously a lot of COVID driven, volume trading spikes. And so 2021 was very much the contrast where we saw things like bid offer spreads returning to very normal type levels. We saw volumes decreasing and yet liquidity did not necessarily decrease.
Paul Daley: (
The other thing that we saw, I think that was a little unusual, surprisingly so on a good side, is that the new calendar was very, very strong in 2021. 2020 was kind of a record year for new issuance in the municipal marketplace — and 2021 was only 1% less — so still the second highest level of new issuance that we'd seen in our data. So combining the shrinking of that secondary market, with the increase in the primary market, suggests that a lot of the new money that came into the municipal marketplace was absorbed by the primary volume. And we didn't see it necessarily flow into the secondary volume.
Chip Barnett: (
Specifically, how did municipal trading perform?
Paul Daley: (
It performed quite well, actually, you know, I just described the scenario where you've got new money coming into the market and it's being absorbed by primary issuance and not necessarily showing up in secondary volumes. So you would think in that scenario, that trading costs would be increased, right? That's typically a description of a low liquidity environment when you don't have a lot of secondary trading. But what we saw instead was that slippage costs, for example, came back to levels that we had seen in in 2019, bid offer spread costs also came back to levels that we had seen 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 level of trading cost year that we have in our data history. So we've seen kind of this continual trend of lower and lower trading costs, and this is a fairly opaque market.
Paul Daley: (
So that's kind of an unusual thing to see, but trading costs have been on this secular decline. You've got 2020, which is, you know, the outlier driven by, you know, a world changing event, but 2021 very much returned back to that trend of lower and lower trading costs. So in spite of the fact that secondary trading volumes were not robust at all, we saw a continuation of the trend of good offer spreads, tightening, slippage, relative to other trades, so can into the volatility of trading decreasing and overall, I think it's just an expression of the evolution of the marketplace. Even though we have a very opaque market structure for fixed income trading, we still have seen just this continual decrease in trading costs, which is a very, very positive trend, obviously.
Chip Barnett: (
Well, looking ahead to this year, what do you see for fixed income trading in 2022?
Paul Daley: (
So I think I see a continuation of the trend. I think what we're going to see is a continuation of lower trading costs. The one exception I think we'll have is, my guess is that all of that new issuance that absorbed new capital coming into the marketplace will now be expressed in secondary trading. So you've got more dollars, there were more bonds, so you didn't see as much secondary trading. Now my guess is secondary trading will cool off a little bit with an increase in the federal funds rate. You know, so interest rates going higher, we'll cool off a little bit in the primary market, but we'll see an increase of activity in the secondary market. And again, that secular trend will continue where we see decreased trading costs. And that's probably about as far as I'm willing to go on predictions — I'm not much of a predictor, but I will also add in, I have a hope for what will happen in 2022.
Paul Daley: (
And that is that there'll be a greater adoption of transaction cost analysis. Transaction cost analysis is not well adopted in the fixed income marketplaces. And that's primarily because fixed income trade data is very difficult to consume. It's not necessarily formatted easily. You've got different trade types mixed together in the tape released by the MSRB or the tape released by FINRA. So what you really need are tools and calculations designed to increase the usability of the existing data. And that leads to something of a virtuous cycle. You've got greater transparency with the new tools and what the calculations you've got, more understanding of the marketplace that leads to less fear of investing in the marketplace, which leads to more investing, which leads to lower trading costs. So I think that, and I hope that, we'll see greater adoption of technology and calculation types designed to better understand the marketplace so that people will be more comfortable investing in the marketplace. So those are my, those are my hopes and my dreams.
Chip Barnett: (
You know, your research shows that trade counts have been falling. What does this mean?
Paul Daley: (
Well, I don't mean think it means anything that we should be too concerned about. Certainly trade counts have decreased in 2021 relative to 2020, but 2020 was very difficult, volumes had spikes that significantly because of the events of the COVID crisis. People did not run away from 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 that we learned about the markets in 2020 was that in the time of crisis, you don't necessarily need the government, the Fed, to step in and spend a ton of money. What you do need is them to announce that they're going to do that. And that brings confidence back to the marketplace, right? There's kind of this implied put there. I always have the sell the buyer of last resort that I can sell to.
Paul Daley: (
So now I don't have to be worried about owning things. And so we saw a tremendous amount of trading volume in 2020, we saw significantly less trading volume in 2021. Again, because it was difficult, comparable to 2020, but also because of the other phenomena that I described earlier, which is that the new issue calendar was just very, very robust. And so new money coming into municipals was being absorbed by that new issue calendar. Now that I think the new issue calendar will settle down, we'll see kind of a return to normal trading volumes. So my guess is those decreases in trade counts, those decreases in parts traded in the secondary market, that will reverse itself in 2022.
Chip Barnett: (
Can you talk a little bit about the four asset classes that you cover in the different dashboards BondWave has?
Paul Daley: (
Absolutely. So right now we are covering all of the asset classes that are PMP specific. So in the prevailing market price slash markup disclosure rule, they had certain asset classes that were covered, and those were corporate bonds, municipal bonds, agency bonds and 144A, which is really just a subset corporate. So we produce dashboards for all four of those asset classes, but there are other assets that have trades disseminated that we will be rolling out dashboards for as we roll out transaction cost analysis products. So specifically, the structured products, those include asset back securities, mortgage backed securities, whether those are the, to be announced, versions of mortgage back securities, or those are the specified pools. So we'll be producing data for all of those in addition to the four dashboards that we are currently producing.
Chip Barnett: (
Do you have any last thoughts for our listeners?
Paul Daley: (
My last thoughts are this. I would encourage everybody to pursue new technologies and new techniques to understand trading costs and fixed income. I've come from the equity side of the world myself, where fixed income or where trading cost analysis is old, right? It's been around for decades, it's well accepted and it's well understood. Everybody uses it from buy side to sell side and even retail investors use it. Coming over to the fixed income world where there's significantly less data and less transparency, I think there's also kind of a fundamental kind of jaded attitude towards transaction cross analysis. The data isn't robust, the data is difficult to deal with, it's difficult to draw conclusions from. But there are BondWave and other firms that are making advances in how you take that data and interpret it using advanced data science techniques to make the data more consumable. So I would encourage listeners to pursue any number of new technologies and new calculation techniques to help them better understand trading costs and with better understanding comes better outcomes. So it's a virtuous cycle in that regard.
Chip Barnett: (
Paul Daley of BondWave, thank you very much for being here.
Paul Daley: (
Today. Chip. It was my pleasure. Thank you very much for having me.
Chip Barnett: (
Thanks to Wen-Wyst Jeanmary, who did the audio production for this episode, and don't forget to rate us, review us and subscribe at www.bonder.com/subscribe. From the Bond Buyer I'm Chip Barnett. And thank you for listening.