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"Profound Shift In Liquidity Risk" May Imperil Market Function, New Report Says
Over the past several weeks we’ve said quite a bit about the lack of liquidity in both corporate and government bond markets. In a nutshell, QE is taking its toll on Treasury and JGB markets, with both traders and officials in Japan voicing concerns about liquidity while new regulations have made it more onerous for banks to hold inventories of corporate bonds, imperiling the secondary market at a time when new issuance is high thanks to record low borrowing costs. Here’s more:
- Illiquid Corporate Bond Market Will End In “Very Unpleasant Fashion”
- Drowning In Liquidity But None In The Bond Market
- More Flash Crashes To Come As Shadow Banking Liquidity Collapses
- BoJ Conducts Survey, Promptly Ignores Results
Now, Oliver Wyman and Morgan Stanley are out with a new report that takes an in depth look at the issue.
From the note, on market conditions in general...
There's a liquidity conundrum in fixed income markets facing policy makers and investors: how it’s resolved will have long term investment implications across banks, asset managers and infrastructure players.
At its heart is the huge shift in liquidity risks to the buyside and asset owners as the twin forces of financial regulation and QE have played out. New rules have driven a severe reduction in sell-side balance sheet and banks’ liquidity provision. Wholesale banking balance sheets supporting traded markets have decreased by 40% in risk weighted assets terms and 20% in total balance sheet since 2010. At the same time, credit markets have boomed as companies turn more to bond finance and investors are hungry for income. Credit market issuance is 2.4 times larger today than 2005. Within this, AuM in daily redeemable funds have grown 10% per annum and are now 76% above 2008 levels…
This comes at a time when we think the liquidity of secondary fixed income markets is likely to get materially worse. As regulatory costs continue to drag on returns, we expect another 10-15% shrinkage of fixed income balance sheet from the largest wholesale banks in the next 2 years. As much as 15-25% could be taken out of flow rates, we think, given the huge returns pressure on that business…
There is a growing urgency to tackle this debate by policy makers. The impact of less liquidity has been masked by a benign, ultra low interest-rate environment, but this is set to reverse in the US in the next 12 months, and could also reveal the side effects of QE pushing investors to less liquid securities.
...and on the impact of regulation…
We think the market underestimates how much more constrained market making will become in rates, credit markets and security financing. Wholesale banks’ risk weighted assets have already shrunk 40% since 2010 and balance sheet is down ~20%. Yet more is still to come – we expect a further 7-15% reduction in balance sheet over the next 3 years, focused in flow fixed income products…
Capital and funding requirements continue to ratchet up as banks deal with additional RWA and leverage pressures. We estimate that by 2017 capital consumption per unit of revenue generated in rates and credit intermediation will have increased 4-6x since pre-crisis levels.
...and here’s a heat map…
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The report also contains quite a bit more in the way of policy reccommendations and implications for other market participants which we'll cover in a subsequent post.
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Banks are starting to experience the problems that grandma has known for 8 years now, capital produces less and less income.
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Let's get real. At the true market price, supply is equal to demand. If some extraordinary power, e.g. central bank, artifically pushes prices way above the market price, sellers come out of the woodwork and buyers disappear. In other words, there is an imbalance between supply and demand. It's Econ 101.
In all likelihood, central bank intervention has pushed us to the point where there are simply no buyers at current prices. And the moment central banks exit the market, prices will plummet. There is an old saying to describe the situation in which central banks find themselves. They have a tiger by the tail, and while they dare not let go neither can they hold on forever.
https://www.youtube.com/watch?v=CVy8eJuk0gM
Old Chinese proverb "Stock prices go up like escalator, go down like elevator!"
According to Oliver Wyman and Morgan Stanley:
March 19, 2015
Wholesale & Investment Banking Outlook
Liquidity Conundrum: Shifting risks, what it means
Financial regulation and QE are at the heart of a huge shift in liquidity risk from banks to the buy-side, which is increasingly a concern for policy makers. This shift is far from over: we expect liquidity in sell-side markets to deteriorate further, as regulation shrinks banks’ capacity another 10-15% over the next two years. Our interviews with asset managers highlighted their concerns over scarcer secondary market liquidity, particularly in credit and in Europe.
Regulatory risks are rising for asset managers, as policy makers worry about the risks to financial stability from US QE exit and market structure changes. Our base case is the initial set of reforms follow an incremental approach that involves stress testing of select funds and a range of micro reforms. This could add an extra cost of 1-5% to asset managers, albeit the largest firms are already well placed on this.
To calibrate possible stress tests, we’ve analysed the periods of worst fund redemptions in the last 35 years. For instance, fixed income mutual fund outflows in 1994 were on average ~5% in the worst 3 months vs 4-7% fund cash holdings today, which gives us some reassurance. However regulators may wish to test for an even tougher scenario at a fund level. Our bear case is for a more profound longer-term change in regulation that would hit profits and investment flexibility.
For the banks, diminishing returns on capital from market making demand even greater efficiency, dexterity and scale to achieve 10-12% returns. More firms will trim this business, ultimately leaving a potentially attractive prize for those able to endure.
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You can download the complete report at the following link:
http://www.oliverwyman.com/content/dam/oliver-wyman/global/en/2015/mar/2...
hey one hundred, go shoot yourself you POS. you're asking people to give access to their bank accounts over the internet to strangers? Va fungu
It's all fun and games until there's no bid.