Corporate Liquidity Pool Shrinks

Barclays Capital published a research piece last week thatcaught our eye discussing the declining bond inventory held at broker dealers.  Citing data from the New York Federal Reserve, Barclays points out that primary dealer net corporate inventory (long minus short positions) has dropped to approximately $75B as of March from nearly $300B in 2008.  Part of this decline is attributed to non-agency mortgage backed securities (think subprime), which until recently were included in the corporate category, but part of the drop can also be attributed to investment grade corporates.  This lack of inventory can reduce overall liquidity and widen bid/ask spreads in times of market stress.  The reduced willingness to hold inventory can be attributed to new capital rules put in place that make it expensive for banks to hold these securities.  This new market dynamic puts a premium on the electronic trading platforms we use for most of our corporate trading.  As broker dealers continue to position their balance sheets in a risk averse manner, having numerous trading counterparties along with an efficient trading tool is critical.  We believe this to be the case in both good markets like today and bad ones similar to 2008.