The volume of tradable corporate bonds in Europe is shrinking for the first time since 2005, according to Bloomberg news agency.

Despite a large number of high-quality company issues outside the financial sector, Bloomberg calculates an effective decrease in the sum of euro-denominated tradable bonds of 21 billion euros.

The reason for the decline is in payment claims, buybacks, pending repayments and bond purchases by the European Central Bank (ECB).

Declining supply typically limits liquidity in credit markets, making it difficult to price risks.

This is already the case on the European government bond market.

The dominance of the ECB has contained volatility, reduced trading volumes and displaced investors.

Such a process is also called "Japanization".

Central bank purchases reduce supply

"We are nearing a state where the credit market is near stalling," said James Vokins, director of high-credit loans at Aviva Investors.

"It won't work with current liquidity needs and that could be a problem for the following year if the trend continues."

The declining supply minus all apparent factors is the result of ongoing central bank aid in times when companies are low on capital, after taking on more debt in 2020 and now with record balances.

The gross supply of euro-denominated bonds outside the financial sector fell 42 percent year-on-year.

The ECB decided last week to reduce the speed of its bond purchases under the Pandemic Emergency Purchasing Program (PEPP).

But the majority of the purchases are under the Corporate Sector Purchase Program (CSPP), which began in 2016.

The real emissions volume in the euro zone is expected to remain in negative territory for most of the autumn.

Barclays strategists Zoso Davies and Jenny Avdoi predict a decline in net supply minus ECB purchases for three of the four remaining months in 2021.

Even after an expected offer of 32 billion euros in September.

The exception is November.

Example Japan

The Japanese government bond market is an example of a further progression of this situation.

Liquidity there is so low that there was no trading in 10-year bonds even during a bond auction last month.

Supply could normalize if sales pick up again over the long term as companies reduce their saved funds. At the moment, the declining supply enables investors rich in cash to take out new issues and keep risk premiums for corporate debt at historic lows. Based on index data from Bloomberg, spreads have been holding at 83 basis points since mid-April.

In the face of intense competition in the bond market, portfolio managers are forced to either buy up everything they have or risk leaving resources unused. "The situation on the new issue market makes it difficult to get papers with acceptable interest rates," comments Thomas Neuhold, portfolio manager at Gutmann Kapitalanlage. "When you try to limit interest rate premiums, you are ultimately left with your money."