Bond market liquidity has proved a fertile topic for discussion since the financial crisis. So much so that the cascade of articles, viewpoints and arguments has been mildly satirised by one financial newsletter’s daily “people are worried about bond market liquidity” segment.
Part of the reason for this debate is that liquidity is a nebulous concept – particularly for those who aren’t actually in the business of buying and selling securities directly.
The reasons for the purported decline have been outlined many times before: a fall in the number of market makers has lowered trading volumes – hurting investors’ ability to buy and sell without affecting prices, and leading to questions over what happens when the tide goes out.
The warnings have continued this year from firms such as ratings agency Fitch. But we’ve also begun to see a number of suggestions to the contrary, and they’ve all stemmed from similar sources.
First we had an occasional paper published by the FCA, in which researchers suggested there was “little evidence” of a decline in liquidity. That attracted criticism from some quarters, and a claim this was a “dangerous” line to take. But two other studies from regulatory bodies have made similar claims.
The snappily named International Organization of Securities Commissions said as much in August. Then the Federal Reserve Bank of New York suggested last month that it too had been unable to find evidence of a decline, this time when focusing on liquidity in US treasuries.
But a couple of these studies did acknowledge the lack of available evidence – and there is little doubt that regulators are taking the problem seriously, even if they can’t find proof of its existence.
Searching for concrete examples that everything’s fine, asset managers have highlighted both the departure of Bill Gross from Pimco – which accelerated outflows from the firm’s Total Return Bond fund to the tune of almost $100bn (£80bn) – as well as the suspension and liquidation of the Third Avenue credit fund in January.
Despite expectations to the contrary, neither of these episodes produced much in the way of market-moving trades.
This defence is important to fund firms, of course, because it represents a bulwark against a rising tide of regulation seeking to compensate for a drop in liquidity. At the moment, they do appear to be winning out.
One caveat still holds. It may not be as simple to say that funds such as Pimco Total Return simply sold assets into rising markets, but a look at bond market performance since then doesn’t suggest the most difficult environment in which to dispose of those positions. Academic research, and the available evidence, may suggest that bond market liquidity is a storm in a teacup. The real test may be yet to come.
Dan Jones is editor of Investment Adviser
