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Bond Market Structure

By Michael Decker

Bonding Time Podcast on US Bond Market Structure – a Discussion with Dan Kelly of MarketAxess.

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User 631176803 · Bonding Time with MarketAxess on US Bond Market Structure

Michael Decker:

Welcome to another edition of Bonding Time, BDA's periodic podcast on US fixed income, market structure and market conditions. We are thrilled today to welcome Dan Kelly as our guest. Dan is Head of Municipals at MarketAxess. And Dan, you joined MarketAxess about a year ago after a long career on the municipal desk at Morgan Stanley. And before that, PaineWebber. And we're thrilled you're here, and thank you for joining us today.

Dan Kelly :

Michael, it's a pleasure to be here. Thank you for having me.

Michael Decker:

So let's talk about last year first. 2023 saw a relatively steady trading volume in the municipal market despite weak origination. What drove trading activity last year and what were the highs and low spots for the year in the market?

Dan Kelly :

Looking back at 2023, the way I describe it is it was a wild ride. You had a number of different catalysts in the market driving both trading and rates. And looking back, it was a market that no one has seen in quite some time. From some regional bank failures in the early part of the year to a Fed pivot and pause in the... Call it middle of the year, to some contraction in the market toward the end of the year, we saw over 100 basis points from trough to peak as far as yields were concerned. And through all of that, you saw investors increase their exposure to munis, some decrease their exposure to munis, but overall, a pretty robust trading environment.

Michael Decker:

Absolutely. And how did liquidity hold up during that time and how are liquidity conditions currently in the market?

Dan Kelly :

Well, I can speak for what we see on our platform here at MarketAxess, but liquidity held up quite well. In fact, as yields hit their peaks in October, you saw retail investors swoop in to capture yields that had not been available in our market in almost a decade. And as far as the market's ability to deal with these different shocks that we saw throughout 2023, liquidity held up quite well. Looking back at 2023, secondary market volumes were down about 10% on a year-over-year basis, but it certainly didn't feel like that going into the fourth quarter as volumes in the fourth quarter were significantly higher than what you saw in quarters two and three. And looking at 2024, the market looks to be setting up quite well with respect to the depth of liquidity available to investors.

Michael Decker:

Terrific. And where's the demand coming from? Are we still seeing a big spike in retail interest or is it coming from other directions?

Dan Kelly :

Well, demand is broad-based. Retail certainly seems actively engaged, at least from what we're seeing at MarketAxess. I would think that the volume of retail has fallen a bit given the massive rally in rates we've seen since November. But the strength in both the SMA and ETF asset classes, which are at the end of the day, retail investors, tells me that retail is certainly engaged in our market currently.

Additionally, bond funds and other asset managers are actively putting money to work in munis. So as far as investors are concerned, it looks like it's a deep pool of investors.

Michael Decker:

Yep. So we saw a bit of shakeup last year in terms of liquidity providers in the market. What are the implications of that and does it raise any concerns?

Dan Kelly :

Yeah, Michael, we spent and do spend a lot of time thinking about that dynamic, notwithstanding the headlines over the past couple of months. The market over the past couple of years has seen less traditional liquidity providers in the market on a daily basis. That said, the resiliency of the muni market continues to be impressive, whether it's alternative liquidity providers coming in, relative value players coming in, or what we see with respect to regional dealers stepping up and increasing their footprint into the market. Although it's never nice to see participants exit the market, the fact that liquidity remains very deep in the market to me is an encouraging sign going forward.

Michael Decker:

Yep. I know some of BDA's members are predominantly mid-size and regional firms, and they view the market definitely as an opportunity going forward. And when you're talking about non-traditional buyers, you're thinking about crossover buyers that come into the market when yield levels hit a certain point?

Dan Kelly :

Sure. Yeah. And we saw, at least... Again, I could speak for what we saw on the platform, September and October and going into November, certainly the depth and the breadth of liquidity providers was very impressive. Going into January with relative value where it is, although I'm no longer in a trading seat, which I kind of miss from time to time, I think relative value players are less likely going to be price makers in this market and more passive participants than the real money accounts that need to put money to work as a result of January reinvestment. But those relative value players certainly can step in quickly and with a lot of influence when markets begin to show signs of dislocation or inefficiency.

Michael Decker:

Yep. Okay. Let's talk about 2024. What are your thoughts on yield levels and volume for this year?

Dan Kelly :

I'm not smart enough to answer that question, but I've done a lot of research and a lot of reading. And if you take a step back and just see what's going on, it's going to be a very interesting year, 2024. There are a lot of crosscurrents, whether it's the Fed, okay? And the expectations that the pause continues or they're higher for longer or they begin to ease. And then you look toward the end of the summer and then the presidential elections certainly will be heating up. So how will that impact our market, its levels and in volume?

And I look back to the last two presidential election years, 2016 and 2020, and you saw a lot of activity almost front loaded, whether it's issuers wanting to get their debt sold and placed into the market well before the election influence kicks in, or whether it's portfolio managers and traders wanting to ensure that they're properly positioned going into what could be a hotly contested election.

So I look at 2024 as one that will be multi-tiered. I think you'll have issuance, again, reading a number of different publications, supplies expected to pick up slightly. What does that mean? Does that mean that the first nine months of the year is going to see much more supply than the last three months? Maybe, that could be because issuers are trying to avoid the election. You may see some lumpy weeks of supply as issuers may want to avoid Fed weeks or Fed decision weeks. But I do expect volume to be slightly higher than in years past. But again, I'm standing on the shoulders of others who've actually done the work.

As far as volume is concerned, I think that it's going to be hard-pressed or we're going to be hard-pressed to replicate the amount of volume both in our amount and number of trades that we saw in the fourth quarter of 2023. But I do think volume should remain healthy for most of 2024 as. Even with the massive rally that we saw in rates in November and into December, we're still at yield levels that we haven't seen in quite some time, and I think there's a value proposition in owning munis.

Michael Decker:

Sure. So at BDA, we spend a lot of time on regulation and compliance and enforcement issues, and maybe the biggest issue that's on our plate right now is this proposal from the MSRB, and there's a corresponding proposal from FINRA, to shorten the time that firms will have to report trades to the real-time trade reporting system from 15 minutes to one minute. So what are the implications of that for your dealer customers?

Dan Kelly :

That's a great question, Michael. I look at this question from both sides because this was first proposed before I came to MarketAxess and I was on the dealer side. And now I look at it through a different lens from the electronic trading and platform side. I see a number of benefits to it, whether it's price transparency, whether it's liquidity, but I also see that there's some significant challenges in adopting this. I think the MSRB has done an excellent job in reaching out to the community, asking for feedback with respect to what's actually reasonable and what can be accomplished in the timeframe that they're suggesting. The fact that they're looking at different aspects of the market and identifying which trades are relatively easily reportable within one minute and some trades that may need to have an exception, I think shows that the MSRB wants to work with the dealer community and not put them in a position where they're unable to achieve what the MSRB is looking to implement.

So I think there's going to be some work to do, but I go back to when I first started in this market and we had to quickly move to a 15-minute reporting requirement, and boy was that a heavy lift. I think a lot of the leg work's been done, but there is still much work to be done. But I think that at the end of the day, the MSRB is just looking to make this market much more efficient and much more transparent, and I think moving to T+1, among other considerations that they're looking at, certainly at the end of the day will be a good thing.

Michael Decker:

Yep. The devil will be in the details, but the rumor is we're going to see the next version of the proposal very soon, so we'll have some answers maybe. What's new at MarketAxess in the world of municipals these days and any plans for 2024?

Dan Kelly :

Well, I don't want to turn this into a MarketAxess commercial, but certainly we'll spend a couple of minutes talking about what's going on on the platform. Looking back at my first year, it was certainly a year of learning for me. I've said this before and I'll repeat it here. When MarketAxess had come into my prior firm, I would be the person that would pick up the phone and pretend to be on the phone so as not to talk to them because I was so intimidated by what was going on around me with respect to the electronification of the market and just the innovations that were available to the market. I look at 2023, our volumes were up significantly on a year-over-year basis. We eclipsed over $110 billion in par trade on the platform for 2023, and that is just a significant number to me as a newcomer here.

We have really aggressive goals and some high hopes for 2024. I'm not really going to get into much detail because I don't want to spoil the surprise, but I do think that both in the second quarter and fourth quarter of 2024, we'll have a lot more to talk about, whether it's tools we're looking to develop and introduce into the market or just more innovation that we're looking to build upon. I do think '24 is going to be a really exciting year for MarketAxess, and I'm certainly happy to come back in a future date, Michael, and give you some more details, but at this time, I'm going to keep them pretty close to home.

Michael Decker:

Well, I'm going to take you up on that, so plan on another appearance in the second and fourth quarters. We'll learn more details then. Let's just finish with a couple of questions I'd like to ask of our podcast guests. What about the market current conditions keeps you up at night, and what helps you sleep soundly?

Dan Kelly :

Well, what keeps me up at night? I have a new 16-year-old at home who just got his driver's license, so him on 95 certainly keeps me up at night. But as far as the market is concerned, Michael, I think what really... I spent a lot of time thinking about is regulation. And again, having come from the dealer side and now on the vendor side, I always get concerned about overregulation or whether we're regulating things that really don't need to be regulated.

We always had this joke that the MSRB and other regulators in our market are the undisputed, undefeated champions of the world because they don't take no for an answer. That said, both are willing to work with the community to make sure that the market is much more transparent, the market's much more liquid and certainly builds confidence in our market. But if there was one thing that keeps me up at night is just regulation, certainly it seems like there's another challenge or another potential enhancement that regulators are looking to bring to the muni market. And how do we get there and how do we ensure that the regulation that is being implemented actually helps the market and doesn't hinder the market?

Another thing that I worry about, and again, I'm not smart enough to know what the answer is here, but especially in election year, there's always talk about tax change and what the impact of any legislative bill would be to the media market.

I think years ago when I was down in Washington advocating for the return of advanced refunding and advocating for the return of a Babs like product. I read these days now that the tax exemption may be on the table in the next couple of years. That always is a concern for me, how this market will react to that, how liquidity will be going into these proposals, certainly are certain aspects of the market that keep you up at night.

Michael Decker:

Definitely for us too, preserving the tax exemption is our far and away number one legislative goal and something that we pay a great deal of attention to. Well, Dan, this has been interesting and enlightening. Thank you so much for your perspective on the issues that we've discussed. We'll definitely have you back later in the year to talk about what's coming up at MarketAxess, and thank you for your time.

Dan Kelly :

Yeah, looking forward to a great 2024 Michael, thank you very much for having me.