Cash pile mitigates liquidity worries in US bond market

The record US$3.5 trillion stockpiled in United States fixed-income funds is raising the spectre that the bond market will buckle under the strain of redemptions once interest rates rise. Simple mathematics suggests there is little need to worry.

While fund assets have almost doubled since the financial crisis, their size as a portion of US mutual funds is still in line with the 21 per cent average over the past three decades, according to the Washington-based Investment Company Institute. Debt fund managers also hold almost 9 per cent of assets in cash, close to the highest in 25 years and more than the maximum rate of outflows in 1994, one of the worst years for bonds.

With St Louis Fed president James Bullard saying that markets were probably mistaken if they expected interest rate increases to occur more slowly than policymakers forecast, money managers such as BlackRock have called on regulators to forestall a potential liquidity crisis that may deepen a sell-off if too many investors try to get out at once. While a fall in bonds that economists have predicted all year may finally materialise, JP Morgan Chase says withdrawals are unlikely to unleash a flood of selling that upends debt markets.

"The worries are overblown," said Nikolaos Panigirtzoglou, a London-based global market strategist at JP Morgan. "If you look at history, it's clear investors aren't over-invested and bond funds are well positioned."

The stakes have never been higher for the Federal Reserve to engineer a soft landing from almost six years of near-zero benchmark rates as the amount of outstanding public debt in the US hits a record US$17.7 trillion.

Debt securities of all types, from treasuries to junk bonds, have rallied this year and confounded forecasters who foresaw losses as the Fed scaled back the extraordinary stimulus that has supported the economy since 2008.