(Bloomberg) – Wall Street’s skeptical mind may be forgiven for seeing all the features of a liquid beer-market trap on Tuesday’s stock rebound.
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The trading situation in equities and bonds has worsened in recent months as money managers struggle to buy and sell in size without moving prices, with echoes of the 2020 epidemic disruption.
Concerns over liquidity in the S&P 500 futures, or ease of doing business, and even the value of covid-stimulated liquidity more than two years ago, market depth in the US Treasury has reached this historically alarming level, according to JPMorgan Chase & Co. Goldman Sachs Group Inc. Data.
Although trading problems in 2020 began to ease within a few weeks, for many Wall Street participants it seems that the problem will not end this year as the Federal Reserve emerges from the easy-money era against the backdrop of strong economic data – a recipe for cross-asset volatility. .
“The market depth is not much better than it was in March 2020,” Nicolaos Panigirtzoglo, a strategist at JPMorgan, wrote in an email. “This means that the market’s ability to absorb relatively large orders without significantly affecting prices is very low at the moment.”
This is a warning word for deep buyers who returned across the board with the S&P 500 up 1.57% in Tuesday’s trading when the Treasury retreated.
Everything from US stocks and global bonds to corporate credit has sunk together this year. This reflects fears that the Fed’s campaign to tighten policy to cool inflation will hurt the US economy. Last week the major stock gauge came within 30 points of a bear market, or 20% sinking, this is often the precursor to a recession.
With improved cross-asset volatility, market makers are becoming more risk averse. The result is a wide discrepancy between the value of their offloaded assets by sellers and the clearing levels that dealers offer them.
One wonders whether the volatility of stocks and bonds is causing less liquidity or not, and hard-to-trade markets are a known bogeyman that is quoted by many investors whenever their returns break. But things are clearly so bad now that the Fed warned last week about the systematic risks posed by the deteriorating trading conditions.
Vincent Mortier, Chief Investment Officer of Amundi SA, has fond memories of the March 2020 liquidity crunch. Things almost came to a standstill, where the firm had trouble selling high-quality, short-term corporate securities.
“Since that incident, I’ve told myself we need to be serious about understanding why and when bonds shifted from liquid to liquid,” Mortier said in an interview. “For a day, you can deal with such a challenge without any problems, but when it does not last for a while.”
Under its new model, Amundi determines what it will cost to liquidate 5% of a fund’s assets in a market downturn. Based on the answer, the firm provides a stress profile for each fund and a corresponding cash buffer to offset losses from redemption.
The liquidity problem in the world’s largest bond market is particularly acute because the Fed’s volatile turn increases volatility.
The investment banks that once kept the market afloat have left the MIA due to costly restrictions on taking risks imposed after the financial crisis. Their participation has shrunk as the credit market has grown. Now, the Fed, the biggest sponsor of the treasury market, is also stepping back because it aims to jetty billion from its balance sheet.
While the plumbing of the bond market is in better shape than the 2020 route, Treasury traders are securing fewer transactions in tight bid-ask spreads.
“The depth of the market and the price effect matrix are close to the last level seen in Covid Shock, suggesting a fairly high risk of volatile price action,” said Avisha Thakkar, a rate strategist at Goldman Sachs. “One of the side effects of the Fed’s absence as a backstop buyer is that the risk of market volatility is higher when a push occurs.”
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