How the Fed screwed up the bond market

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Trouble brewing in bonds?

Live by central bank liquidity, die by central bank liquidity.

That could well become the mantra for a bond market that, after years of support by the Federal Reserve and its global counterparts, now finds itself suffering under the unintended consequences of the trillions in easing distributed to allay the fears of a market in crisis.

"Liquidity," in fact, is THE watchword now in bond trading—ironic, considering that the U.S. central bank's primary intention has been to boost the flow of cash through financial markets, drive a push toward riskier assets like stocks and corporate credit, and thus generate a wealth effect that would spread through the economy.

Indeed, stock prices have soared and high-yield aka junk has been one of the best places to be in fixed income, even if comparable U.S. and global economic growth has been absent. Companies already have issued more than half a trillion dollars in debt during a record 2015, convinced that investors will still have an appetite and rates will stay low.

But with the Fed looking for a spot where it can start tightening policy even as others are loosening and deflation fears dropping while inflation concerns grow, investors are getting the jitters.

What if, they wonder, rising rates make all that corporate debt look less attractive and spur a selloff? The scary answer, according to an increasing number of market experts, is a potential scenario where there's a rush to a door that is nailed shut. A huge number of sellers would be pouring into a market with a dearth of buyers, setting up a scenario where bond prices cascade and yields explode.