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Matthew Tucker is head of investment strategy for fixed income at Barclays Global Investors in San Francisco. IndexUniverse.com caught up with the busy bond executive on Thursday to find out how the ongoing credit crunch is impacting iShares' exchange-traded funds focusing on fixed-income markets.
IndexUniverse (IU): How is today's volatility impacting spreads between short- and long-term Treasuries?
Matthew Tucker (Tucker): As a result of the credit crunch and the significant flight to quality in Treasuries, we've seen a steepening of the yield curve as investors have moved towards safer, short-term securities. The spread difference between 2- and 10-year Treasuries has gone from about 150 basis points at the beginning of September to around 200 basis points. This type of yield curve flattening is fairly common during economic disruptions.
In terms of bid/ask spreads, it's important to note a general decline in liquidity across the fixed-income market sectors. This has been driven by the removal of significant fixed-income counterparties as well as general credit concerns about other counterparties. In addition, as a result of the general crisis in credit markets, participants are less willing to commit capital at this time. We've seen a significant drop in volume as well as available liquidity across fixed-income markets.
Since fixed-income ETFs trade on exchanges, it should be noted that they're providing an additional source of liquidity for some investors who now have limited access to bond markets. ETFs are serving as price-discovery vehicles in these markets.
IU: Can you explain how that's working given increased market volatility?
Tucker: In the current bond market, we're seeing a reduction in the frequency with which individual securities are being traded. This means that some securities which are normally very liquid are experiencing a reduced number of observable trades in the market. As a result, market participants trying to access the value of those securities are finding a lack of data.
Intraday ETF prices are helping to fill that gap. These are actionable prices where all market participants can buy or sell a basket of bonds. So even though there may not be individual securities trades available at the moment, you can see how a basket trades through an ETF. And these baskets are very specific. For example, look at the iShares iBoxx Investment Grade Corporate Bond Index (NYSEArca: LQD). It's comprised of 100 liquid corporate bonds. In the current market environment, we're seeing a reduced number of trades in the fund's underlying bonds. In general, that reduction in number of daily trades has averaged roughly 25-30% in the past few weeks. So when the ETF is trading, it's providing the market information.
IU: Is LQD experiencing higher bid/ask spreads as a result?
Tucker: The bid/ask spreads have actually been fairly stable. In June, LQD was trading with bid/ask spreads of around 8 basis points. Today, that's up to 11 basis points. So there has been some impact on spreads, but it's a reflection of how the underlying markets have been trading.
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