Investors might be about to find out what happens after a “Golden Age” of consumer credit.
Following a period of “explosive growth” in consumer credit, the nearly $1.6 trillion U.S. bond market tied to car loans, credit cards, student debt and even cellphones has begun to see liquidity deteriorate, according to Joseph Kalish, chief global macro strategist at Ned Davis Research.
During volatile stretches, like the start of 2022, liquidity in parts of debt markets have been prone to drying up.
Issuance of new “asset-backed securities” exploded last year after a brief pandemic pullback, and so did trading volumes, according to Kalish. But the tone recently has shifted, including with Wall Street dealers becoming less willing to commit capital to the sector (see chart).
Take the credit-card ABS. “Primary” dealers, or the brokerage arms of big investment banks, had more than $1 billion in average daily positions in this type of short-term debt in 2018, but their scope since has dwindled to about $200 million, according to a Ned Davis report Thursday.
Dealer positions also dropped in student loans and other consumer-debt sectors in the same stretch, but increased in auto bonds.
Wall Street dealers historically have been a key artery of liquidity for buyers or sellers looking to transact, once bonds are first sold into the market.
BofA Global pegged trading volumes in the U.S. ABS market at $59.5 billion in the first quarter, the lowest first quarter in the past 10 years, or the entire history since reforms took hold requiring public reporting of such trades.
“Moreover, delinquency rates appear to have bottomed,” Kalish wrote. “That will likely lead to tighter lending standards.”
All this comes as the ABS market enters the “seasonally unfavorable” second half of the year, when performance tends to slump, he said, which is part of his downgrade of the sector to market-weight to overweight.
In 2008, illiquid subprime mortgage bonds were at the heart of the troubles for major global banks that required government bailouts.
While asset-backed bonds didn’t similarly implode back then, the Federal Reserve did create a 2020 emergency lending facility for the sector at the onset of the pandemic to keep credit flowing — a version of its 2008 program — underscoring the role the sector plays in the U.S. economy.
Earlier in June, JPMorgan Chase & Co.
CEO Jamie Dimon said a storm likely was on the horizon for the U.S. economy, as the Federal Reserve plans to aggressively raise interest rates this year to fight inflation near 40-year highs.
However, Brian Moynihan, the chairman and chief executive of Bank of America
offered a much less pessimistic view of the economy, due to a strong labor market and solid consumer spending.
Stocks tumbled on Thursday ahead of a key U.S. update on inflation, with the Dow Jones Industrial Average
S&P 500 index
and Nasdaq Composite Index
all booking their worst daily declines in about three weeks.
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