Originally posted on August 20, 2020

By Mikhail Bezroukov, analytics product manager and Yu Zou, director, quantitative analysis

The COVID-19 crisis has impacted nearly all asset classes, and USD corporate bonds have not been spared. As the mid-March 2020 market volatility affected USD corporate bond prices, it also compromised their liquidity. While these spikes in liquidity costs occurred across the USD corporate bond asset class, we found the level of impact-and the path to returning to pre-crisis levels-varied across credit rating and sectors.

As the onset of the pandemic roiled US markets the second week of March 2020, USD investment grade corporate bonds saw a dramatic increase in liquidity costs. A useful metric for gauging liquidity costs is price liquidity ratio (PLR)- which looks at market impact and measures the movement in price of a security for an executed trade of a given size. A higher PLR represents a larger movement in price for a given trade size and therefore shows lower liquidity. By this metric, the PLR for the corporate sectors of the FTSE US Broad Investment-Grade Index (USBIG®) rose from 0.02% at the end of February to 0.10% at the start of April-representing a significant spike in liquidity costs.

This dramatic rise in investment grade bond liquidity costs can be tied to a timeline of events. As shown below, the World Health Organization’s official declaration of a pandemic coincided with the initial rise, which sharply fell when the Fed began its bond buying program.

While the rise in investment grade bond liquidity costs in mid-March was dramatic, it was dwarfed by the illiquidity spike in USD high yield bonds. As shown below, during the same time period, the corporate sectors of the FTSE US Broad Investment-Grade Index (USBIG®)” PLR surged from 0.03% to 0.17%.

We also see some divergence when comparing how price and liquidity metrics have since fared. While high yield bonds experienced greater volatility in both prices and liquidity costs, investment grade bonds have since followed a smoother path. And while both have seen liquidity costs come down considerably from their early April highs, they remain above pre-crisis levels, with investment grade bonds only slightly exceeding them and high yield bonds remaining above pre-crisis levels by a wider margin.

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We can also observe uneven pandemic impact if we look at liquidity costs across corporate bond subsectors. For example, the Financial-Bank subsector remained relatively liquid throughout the market volatility, likely reflecting lower operational disruptions compared to other sectors. However, as shown below, areas of the market facing higher operational challenges as a result of the crisis-such as the Industrials-Transportation and Utilities-Electric subsectors-saw higher jumps in transaction costs.

While each of these corporate bond subsectors felt the impact of the COVID-19 crisis, the above charts indicate that their liquidity costs have since retreated to pre-crisis levels. However, as the length of the crisis and the depth of its impacts still remain to be seen, a smoother ride ahead is anything but certain.

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