Bond liquidity fears hit asset managers

Fears over poor liquidity in the bond market are leading asset managers to hoard more cash than they need, according to the head of one of the largest US custodian banks.

Jay Hooley, chief executive of State Street, said asset managers were under pressure from regulators to "stress test" their portfolios against a bond market rout, and managers were building up excess deposits with the bank as a result.

State Street's excess deposits rose to $54bn in the first quarter, from $52bn in the final months of 2014, even though the bank tried to discourage their growth, including by introducing fees on some deposits.

The bank earns little on such deposits, which have been dragging down its results as they have swelled over the past year.

"The irony is that an asset manager's excess liquidity ends up being our excess deposits," Mr Hooley said.

Regulatory demands for stress testing of bond funds is an "appropriate" response to the fears of a market crunch, should interest rate rises cause a rush out of the bond market, Mr Hooley said.

But State Street - which itself also owns one of the world's largest asset managers - is urging managers to minimise their cash holdings by optimising liquidity across different portfolios.

"It is early days and the stress testing process is maturing," Mr Hooley said. "The more sophisticated the process, the more refined the outcomes."

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While low interest rates continued to be a headwind, pushing down State Street's net interest revenues by 1.3 per cent to $546m in the first quarter, a spike in foreign exchange market volatility helped the bank beat analysts' earnings forecasts.

It reported a 5.9 per cent rise in net income to $377m, on quarterly revenues of $2.6bn, up 4.8 per cent, but the bank left full-year guidance unchanged and its shares reversed three days of gains and were down 2.6 per cent in early afternoon trading.

A surge in the value of the US dollar against the euro, and the sudden end to Swiss central bank intervention to hold down the franc, boosted foreign exchange trading in the first part of the year.

Mr Hooley said volatility was set to continue, albeit at a more modest level, because of "the divergence in interest rate expectations for the US relative to most other major economies and the actions taken by several central banks around the world to increase their quantitative easing."

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