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Here's what's behind the high-yield bond crisis

A trader works on the floor of the New York Stock Exchange.
Adam Jeffery | CNBC
A trader works on the floor of the New York Stock Exchange.

Heavy volume in bond ETFs today. Not just Pimco (BOND), but also High-Yield (HYG, JNK), Corporates (LQD) and interest-sensitive Utilities (VPU).

It's the high-yield space everyone is watching. The biggest high-yield ETF, iShares High Yield Corporate (HYG), is down 0.3 percent today, over two percent this week., near a 12-month low.

Some of these declines are clearly due to fundamental factors...principally a concern about higher rates.

But some of these issues are likely tied to liquidity. It's been well-known that bond dealers have pulled back on inventories of bonds. This process has been going on for several years.

A tighter inventory means that if someone wants to pull back and sell something, prices will have to drop.

That leads to a desire by some to try to second guess the market by selling ahead of perceived heavier volumes.

Why are inventories tighter?

First, the banks had big losses during and after the financial crisis. You lose a couple billion dollars in bonds and you get more cautious.

Second, regulatory restrictions have gotten much tighter (Dodd-Frank) around risk-taking and capital levels.

Finally, large sections of natural buyers and sellers--proprietary trading desks run by large brokerage operations--have been mostly shut down due to Dodd-Frank. That is a lot of trading capacity that has been taken out of the market. That can make a smooth functioning of the market much more difficult.

Finally, you don't have to be an investment genius to realize that valuations have been stretched by the desperate "reach for yield."

Let's be honest: There has been a lot of "tourist investors" in the high-yield space in the last few years. These are investors who just want higher yield, no matter what. In the past, investors who needed high yield would have hired a bond manager or carefully looked at a company's prospects before buying a junk bond. Today, you can just invest in an ETF. You don't need to know much.

So what? These "tourists" are much quicker to pull money from an ETF. And that leads to others trying to front-run those concerns, as described above.

  • Bob Pisani

    A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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