What are bond dealers doing with their inventory? Tracking inventory is a helpful tool for getting flow sentiment on markets. If there is an increase in dealer inventories, it is a sign that the dealer community may believe that prices are going higher; otherwise, the dealers will not hold the bonds in their portfolio. If hedged with Treasuries, there is the expectation that spreads will tighten. Dealers may be stuck with inventory they cannot get rid of which will lead to excesses in their inventory levels but since bond dealers, especially for corporates, are not required to make markets, we generally find that bond inventories tell us something about the direction in prices.
The chart above is from weekly inventory information collected by the NY Fed from primary dealers. Like the futures commitment of traders, it may not provide useful information every week, but it does confirm and provide insight at extremes. The chart shows a combination of both investment grade and high yield bonds held in inventory. All bond exposures have fallen from January highs. Long exposures have especially fallen while shorter maturities have increased slightly.
The inventory changes are consistent with the spread widening we have seen in both investment and high yield bonds. Given the current market uncertainty, we expect that the current inventory trends to continue.
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