How do you judge liquidity in a bond for which there's no price?

Another day, another hopeful rumor that takes equity prices back from the brink.   This time, it was a hint of a suggestion that oil producers might coalesce around a production cut, though amusingly the person who broke the "story" didn't seem to interpret her quotes that way.   In some ways, it feels like the old days of Team 1250, though in fairness this week Yellen hasn't sounded particularly sympathetic to the occasional whinges from Congress that the stock market's had the temerity to go down.

Yesterday's Coco post prompted some readers to share anecdotal colour, little of which was encouraging.   Simply put, liquidity is non-existent for these bonds at the moment, which is one of the reasons why ancillary instruments are being used as a hedge; owners simply cannot get shot of their inventory.  At least they can sleep soundly at night knowing that the New York Fed has decided that corporate bond liquidity is just fine, thank you.

Somehow, the idea of using bid/ask spreads during a time of easy financial conditions and generally rising prices to judge market liquidity when the market turns seems very, very wrong.   Macro Man is reminded of his days trading USD/CNH in the early part of this decade, when the market was decidedly smaller than it is now.   It was 30 pips wide in $50 million to get in, but 3 big figures wide in $10 million to get out.  For better or for worse, there are a couple of candles on the chart that he can point to and say "that was me."

How do you judge liquidity in a bond for which there's no price?  By the volume of tears shed when the owners realize that they are stuffed.   One thing the NY Fed did pick up on, at least, is that trading volumes for corporate bonds has gone down, as has the average ticket size.   It's a good thing that the overall size of the corporate bond market has shrunk, then, isn't it?

Anyhow, the situation with the Cocos would be amusing if it weren't so sad (and dangerous).  Consider that policymakers and regulators have:

a) Eviscerated the low-risk yields available to investors,
b) Generated rules to allow, nay encourage, the issuance of arcane and hard to value securities that offer the yield that's now missing in government bonds, but at the cost of short gamma and negative convexity to the owners, and
c) Mandated that traditional intermediaries cannot participate in the market as principals, thus ensuring illiquidity and a treacherous voyage of price discovery.

If you were trying to design the perfect mechanism for a financial meltdown, you'd have to work pretty hard to beat this perfect storm of moronicity.  Macro Man half-expects some regulator to blame gravitational waves for the ruptures going on in markets at the moment.

There were a few moments yesterday, particularly in the morning, that had more than a faint whiff of climax about them.  When USD/JPY dipped back to 111, the greens were up 20, and Spooz were this close to 1800, there was definitely a sense of panic in the air.   The only thing missing was a proper rip in the VIX, which rallied, but seemingly half-heartedly.  Indeed, price action in the VIX has generally suggested that a final flush is not in the offing.

Or has it?   It's easy to forget, given that we're close to lows that have been tested several times, but the net change in US equities on an index level hasn't been that great recently.   Macro Man plotted daily VIX levels with the one month change in the SPX over the past year; he was surprised to see that the VIX actually looks pretty rich at the moment.

Perhaps the market is panicking, after all.   For sure, all of the rates trades that Macro Man's tried this year have been blown out of the water, because money market curves don't want to do anything but flatten, for reasons that are clear to all.   Beyond the obvious issue of equity price action, that the Riksbank cut rates to a more negative level than expected yesterday with GDP growth of nearly 4% says it all.  (Incidentally, after this week's testimony Macro Man wouldn't be totally surprised to see a bill emerge from Congress banning negative rates from the Fed.)

Two themes that have worked, however, are USD/JPY and GDX.     Gold had its best day in about five years yesterday, as equity negativity and the (pardon the pun) penny dropping over negative rates has lent a bid to precious metals the likes of which haven't been seen for some time.  More broadly, of course, the dollar has weakened against many things other than oil, which doesn't hurt, either.

One of the reasons that Macro Man has liked GDX is that it is "cheap" to gold.   Part of this is a currency effect; many of the companies in the underlying index are domiciled and listed in Australia and Canada, with clear implications for the US dollar value of their stocks.  However, that doesn't explain all of the discrepancy.   There are no doubt some idiosyncratic corporate issues to boot, but still; underperforming gold by 50% since the beginning of 2012 is pretty stunning.   All the more so given what oil services stocks have done in relationship to crude over the same period.

The day after an 8% gain probably isn't the ideal time to buy GDX (or anything else for the matter.)  Still, as a strategic hedge against NIRP and general policy-making idiocy, you could probably do a lot worse.

Finally, Macro Man would be remiss if he didn't post the (actual) follow-up to I Should Coco, which is fitting on so many levels that he doesn't know where to begin....