Just How Illiquid Is the Market Right Now?
In her speech at the Salzburg Global Forum on Finance in a Changing World, Federal Reserve Governor Lael Brainard pushed back against the notion that the bond market faces a dearth of liquidity. She acknowledged that a true lack of liquidity would be damaging but notes that the concerns cannot be not seen in available evidence, such as bid-ask spreads or turnover. Besides determining the specific level of liquidity, Brainard highlights the importance of ascertaining the factors impacting this level:
- Regulation: Some reduction in liquidity might result from regulation, but broker-dealer inventories were being reduced before Dodd-Frank, and not all inventories are used for market making
- Electronic execution: High frequency trading fits well with Treasury trading and might mean greater market concentration in the future, leading to less flexibility in periods of greater volatility, and fewer firms might have necessary technology to keep up
- Risk: The financial crisis may have caused firms to reassess their risk tolerance for some market-making activities
- Asset managers: Daily redemptions could increase significantly during times of market stress, intensifying liquidity constraints, and not enough is known about how bond bunds will react during a crisis
Brainard closes by stating that conditions warrant further research and the Federal Reserve Board will be monitoring the situation accordingly.
Her full speech can be accessed here.