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Corporate Bond ETFs and Liquidity: A Looming Black Swan or Extended Contango?

MarketsMuse update inspired by yesterday’s column by Tom Lydon/ETFtrends.com and smacks at the heart of what certain “bomb throwers” believe could be a Black Swan event, albeit an event that may not be driven by a global crisis or surprise economic event. The event in question will, in theory, take place when interest rates start ticking up (and underlying corporate bond prices tick down) and institutional bond fund managers find themselves trying to figure out whether to simply suffer from mark-downs (and performance) or to continue collecting coupons until the issues they hold mature.

MM Editor Note: Since most folks know that bond managers are akin to lemmings (no disrespect intended!) and typically follow each other like blind mice, given the massive size of the corporate market place, a potential avalanche could take place when everyone runs for the exit if rates tick up and simultaneously, the economy starts to slow. Wall Street dealers are certainly not going to be available to catch those falling knives, simply because new regulations have put a crimp in the capital they can commit to warehousing positions. Worse still, its easy to envision one very long contango event, where the cash ETF trades at a discount to the value of the underlying bonds, simply because one won’t be able to sell those underlying bonds in any type of material size.

Here’s an opening extract from Tom Lydon’s piece “Liquidity Concerns In Corporate Bond ETFs”: Continue reading