It isn’t 2008 but there has been a lot of talk in the markets about a coming liquidity crisis. Part of the problem stems from new regulations that have made it more difficult for banks to hold proprietary positions and therefore harder to offer prices. This means that when an institutional investor needs to exit an investment in bonds.
Nor has volatility in in the junk bond market helped. Also, a big mutual fund closing — Third Avenue Management — in December of 2015 created a shock to the system when it announced it would block investors from redeeming money from its Third Avenue Focused Credit Fund.
The liquidity crunch has been long noted in several NeuGroup peer group meetings. As noted in the “The Year’s Top Takeaways” in the December/January issue of iTreasurer, members of The NeuGroup’s Treasury Investment Managers’ Peer Groups (TIMPG1 and 2), were told to get ready for higher costs of liquidity:
“As a result of the Dodd-Frank and Volker rules, brokers are carrying lower inventories, partly due to new regulations paring down market makers’ interest in maintaining large inventories from an economic standpoint, and because brokers recall the excesses leading up to the financial crisis and don’t want to return there. A consequence of these inventory levels is wider bid/ask spreads. Also thinner volumes will mean higher volatility.
Electronic trading is picking up steam, similar to the equity market a decade ago, and this type of trading could improve liquidity, as it will allow buyers and sellers to bypass the dealers and conduct peer to peer trading. Although it is still too early to understand what the future of short-term cash investing will bring, one thing is for sure: liquidity risk is becoming an increasing risk concern.”
Of course looming large in the background is the Federal Reserve and whether it will really start getting hawkish with rates. So far Fed Chairman Janet Yellen is keeping up a dovish tone and said the ramp up in rates will be slow. But if market conditions change and, say, inflation suddenly makes and appearance (not likely soon), liquidity could dry up even more as companies look to sell increasing worthless fixed rate paper and no one steps up to buy. This means portfolio risks should be continually addressed to avoid future crunches.