“There are fewer market-makers out there and way more investment grade and sovereign bonds,” Stokes says. Even in Treasuries, the most-liquid market in times of heightened volatility, she says the ability to transact without moving prices has declined.
To be sure, you could make the case that dealers were never in the business of taking losses for their clients, and that you’d rather have investors take it on the chin than have banks freewheeling in the markets, which almost brought down the entire financial system in 2008. Or that reduced liquidity is a feature, rather than a bug. Plus, you rarely hear investors complaining that people aren’t willing to part with their bonds when prices are rising — only that they can’t unload their positions when they’re falling.
There’s evidence market depth predictably drops during bouts of high volatility, but the question rests on whether the situation is materially worse than it’s been in the past. An analysis by JPMorgan suggests that while liquidity in the Treasury market has actually improved from its lows, it’s still well below pre-crisis levels. In December, when investors sought out haven assets as equities sank, the bank’s analysis showed end-of-year market depth for Treasuries fell twice as much as the average in the previous five years.
That doesn’t bode well for less liquid, risk assets.
“The issue is whether there will be enough liquidity in asset markets when everybody wants to redeem funds at the same time,” says Nellie Liang, a former Fed staff economist, who’s now a researcher at the Brookings Institution. She sees the biggest risks in funds and ETFs for less liquid assets, like certain corporate bonds, leveraged loans and emerging-market debt.
Concerns about liquidity aren’t confined to debt. Even in the $5.1 trillion-a-day market for foreign exchange, illiquidity has manifested itself in a series of mini-flash crashes. Most recently, traders were blindsided by a seven-minute surge in the yen versus the dollar, which took place during the witching hour — a period between New York’s market close and the opening of trading in Tokyo when volumes tend to thin out.
Andrew Maack, head of foreign-exchange trading at Vanguard, says flash events have become more common as algorithmic trading programs begin to outnumber humans. According to JPMorgan’s annual survey, currency traders said liquidity will be the biggest daily challenge of 2019. To JPMorgan’s Chinedum Nzelu, concerns about liquidity really come down to being able to get in and out of trades “when it counts.”
Bianco Research’s Jim Bianco says extraordinarily loose monetary policies have buoyed financial markets for so long that investors might be lulled into a false sense of security.
“Right now, there’s a lot of support for these debt markets from the central banks,” he said. “But what happens when economies get stronger and the central banks want to get out, and so does everybody else? Then you really will have a problem on your hands.”
This article was provided by Bloomberg News.