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The narrative is beginning to rise about liquidity issues within the fixed income market, the result of Dodd Frank. These new rules imposed in the wake of the financial crisis made it more expensive and more difficult for banks to hold corporate bonds on their balance sheets at exactly the same time that the market has ballooned in size.
Moreover because of deteriorating revenues from fixed income trading—a major result of Dodd Frank—many firms including a high profile layoff of 25% of its traders by Morgan Stanley have eliminated positions/infrastructure.
A combination of complexity of fixed income trading and the inability of technology to replicate people in the fixed income market and coupled with the above regulatory changes is wreaking havoc.
And there are exchange trading funds complicating the matter. ETFs “promise” investors the ability to quickly dip in and out of the corporate bonds at NAV, a promise that is consistently being broken for even in the best of times of one way heavy selling there is a major mismatch between expectations and realities of trading the market.
Because of the razor thin market, the result of low liquidity, year-end pressures including tax related selling and limited risk appetite many non-investment grade bond indices have collapsed to levels last experienced in 2009.
Some are making analogies to the subprime market of 2008. I do not share this view for the simplistic reason the market is microscopic as compared to the mortgage market. I will argue however because of HFT where everything is cross correlated, volatility in equities may significantly increase.
Commenting upon yesterday’s market action, equities were volatile; trading that I believe was entirely influenced by HFTs. Treasuries declined
Today is the commencement of the two day FOMC meeting where majority believe the Fed will boost the overnight rate, the first increase since 2006. I will continue to argue that if an increase does not occur, prices will fall as most will believe the Fed is seeing something that most don’t see.
Last night the foreign markets were mixed. London was up 1.75%, Paris up 2.29% and Frankfurt up 2.33%. China was down 0.29%, Japan down 1.68% and Hang Sang down 0.17%.
The Dow should open moderately higher as the selloff in the credit markets and crude has abated. Emerging markets rallied against the dollar. The 10-year is off 6/32 to yield 2.24%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.