Navigating a Rising Rate Environment Cafe Takeaways

Should you re-think how you source and engage with liquidity and trading protocols?

Buy side observations:

  • Volatility in the rates market has spiked this year which has led to a significant dip in liquidity, widened bid offer spreads and increased transaction cost, particularly in EM.

  • Members are seeing a ‘dial down’ in sell side risk appetite. This has been exacerbated by a number of high profile moves in seats around credit, making trades much more difficult to get done. It appears to them that there is a whole generation of sell side traders who have never seen rates go up.

  • The average trade size is smaller, bid offer is larger, and there are more ‘no offers’ than the buy side has seen in a long time.

  • Heightened cost of execution is the main concern, but it is worth noting that this cost is made up of: risk appetite, balance sheet provision and opportunity cost.

Buy side advice:

  • A few of our members note that they are needing to take more time on orders and consider implementation risk. However, the majority of the group stress a need to move quickly and efficiently in current conditions to reduce potential opportunity cost.
  • Buy side members must be more thoughtful around counterparty selection and trading protocols.
  • There is also a need to manage expectations internally around whether or not trades can get done.
  • Above all, this environment has proved that relationships are key and pay dividends when you do require some balance sheet provision. It is important to pick up the phone and focus on nurturing counterparty relationships.
  • It’s vital to be there for junior traders, avoid panic and ensure you have communication channels wide open with everyone, particularly analysts. Volatile conditions have resulted in increased communication amongst traders and PMs which has actually been very positive; discussions around alternative trading protocols helps trading but also trader development.
  • Buy side members must implement more imaginative ways to transact and ensure the desk has access to a variety of different liquidity providers, helping to move risk. Use the full suite of tools at your disposal to reduce opportunity cost.
  • Although it depends on the asset class and size of the trade, portfolio trading is undoubtedly on the rise.
  • All-to-all has proved useful for smaller sized trades; the buy side are seeing price takers become price makers. However, in the US treasury market, the buy side agreed that all-to-all is less useful.
  • Having the right algo streams and auto-execution in place enables you to pick and choose pockets of liquidity as they come up.
  • Trades are now a much smaller size, which is desirable when the market is moving around. The buy side advises that you minimize block orders and market impact where you can.
  • Flexibility is required as buy side members are forced to deviate from the benchmarks they are tracking and are finding it harder to manage the interest rate curve risk.
  • Be proactive not reactive!

We’ll be continuing this discussion in October during our FI East Coast Members Meeting:

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