Deutsche Bank: "No One Knows How To Hedge Or Price Liquidity In This World"
Deutsche Bank's Jim Reid was recently visiting clients in the US, where he listened to their gripes, concerns and market fears. At the very top: buying is easy, but when the selling starts it's all over.
To wit:
As for the bad news, while central bank liquidity is "pushing this problem out", it is also causing it as we showed in Why There Is No Treasury Liquidity In One Chart. So ironically the longer Central Banks delay the inevitable day of reckoning, the worse it will be. Incidentally, while we have been saying precisely that for almost 7 years, here is Bloomberg's Simon Ballard who sounds a tad tinfoil hattish and conspiracy bloggish.
To wit:
Don't worry about the selling: once it does begin, it will be so furious exchanges will simply shut down for the day (or week, or month, or good) and nobody will be allowed to leave the biggest Hotel California ever created by central banks for market participants. The truth is that nobody is getting out of this alive, or at least with profits, when the central planners lose control. There is zero hedge to what is coming.Whilst I was [in the US] everyone wanted to talk about trading liquidity and rates. In terms of liquidity some stressed more than others about it but all concluded that the last few weeks in rates were eye-opening. No-one really knew how to hedge or price for it in a world where you need to hit short-term performance targets. This supports my view that liquidity premiums will never be properly priced in this cycle and investors will stay in assets too long in order to maximise short-term performance. This is completely understandable though given the nature of the industry. But when this cycle does end there is likely to be savage moves in markets where either investors need to sell or where they are able to sell. The good news is that central bank liquidity should continue to push this problem out for a good while yet but we're likely to get regular reminders of the problems that will occur when the fundamentals change.
As for the bad news, while central bank liquidity is "pushing this problem out", it is also causing it as we showed in Why There Is No Treasury Liquidity In One Chart. So ironically the longer Central Banks delay the inevitable day of reckoning, the worse it will be. Incidentally, while we have been saying precisely that for almost 7 years, here is Bloomberg's Simon Ballard who sounds a tad tinfoil hattish and conspiracy bloggish.
Sadly at the rate the mainstream media is agreeing with everything we have said from day 1, soon there will soon be no "conspiracy theories" left.Liquidity, or lack thereof, is increasingly seen as a potential central element to the next credit market correction
- QE, paradoxically, may actually be curtailing the very liquidity that it is designed to reignite, through bank lending and consumption
- QE absorbed fixed income financial assets’ liquidity from market in recent months and tightened bid/offer spreads across asset base
- Poor credit mkt trading liquidity now likely to contribute to greater bouts of volatility and corp bond price action
- Velocity of recent bond selloff may have been accentuated by the lack of underlying market liquidity
- Investors see current lack of bid-side liquidity when they want to sell, lack of offer-side liquidity when want to buy
- ZIRP world underpins investor demand for incremental yield
- Focus on fixed income (spread product) creates strong demand/supply dynamic, reduces liquidity
- Meanwhile, QE encourages investors to buy what the central banks are buying
- Secondary credit market liquidity now minimal as primary market remains main conduit for investing
- Lead managers unwillingness to bid for benchmark bonds post-syndication, even in small nominal, raises question as to strength of credit market foundations if tested
- Regulatory changes and capital constraints hamper banks’ ability to take bonds and risk onto balance sheets, further reducing market trading liquidity profile
- Absence of marginal buyers of risk may exacerbate volatility and negative price action during periods of risk aversion
- Consolidation among sell-side investment banks and buy-side fund managers has shrunk number of market participants, ’killing’ off market transition mechanism
- Concentration risk means large proportion of market tends to be positioned in same direction, i.e. all better buyers or better sellers; such alignment tends to intensify price moves
- Evolution of electronic trading platforms and HFT programs further reduces true market liquidity
- Trading may be driven by model rather than underlying real money strategy
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