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Deutsche Bank: "No One Knows How To Hedge Or Price Liquidity In This World"

Tyler Durden's picture




 

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:

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.

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.

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.

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

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.

 

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Fri, 05/15/2015 - 10:00 | 6096962 Dr. Engali
Dr. Engali's picture

When the time comes to sell, selling will be banned and the "markets" will be closed. Any selling needs to be done before the markets turn, if you wait it will be too late.

Fri, 05/15/2015 - 10:52 | 6097203 prefan4200
prefan4200's picture

If selling is banned and the markets are closed, it will already be too late, no matter whether one has sold or not.  There will be a revolution, blood in the streets, and the only precious metal worth having will be lead, and even that lead you will have to "give" to others in order to protect your life and belongings.  The value of our investment portfolios will be the least of our concerns.

Fri, 05/15/2015 - 11:22 | 6097372 KnuckleDragger-X
KnuckleDragger-X's picture

Liquid assets that aren't really liquid is the cool thing nowadays I guess....

Fri, 05/15/2015 - 11:47 | 6097478 NotApplicable
NotApplicable's picture

There's only one way to hedge/price a ponzi, and that is to stay completely OUT of it.

Fri, 05/15/2015 - 15:08 | 6098286 MonetaryApostate
MonetaryApostate's picture

On a long enough timeline, nothing really matters anymore...

https://youtu.be/fJ9rUzIMcZQ

Fri, 05/15/2015 - 09:57 | 6096963 Haus-Targaryen
Haus-Targaryen's picture

Looking for the credit squeeze in cash and the liquification of AG and AU.  

Looking at a castle right now.  (No shit).

For those of us in the know when this goes south, we are going to preserve our wealth while the rest of the world's wealth evaporates instantly.  Expect the media to make demons out of us, for capitalizing on other people's distress.  

I hope you all have appropriate plans in place.  

Fri, 05/15/2015 - 10:06 | 6097000 LawsofPhysics
LawsofPhysics's picture

Of course, and a dependable tribe.  Probably the most important thing.

Fri, 05/15/2015 - 10:33 | 6097128 TrustbutVerify
TrustbutVerify's picture

Please, elaborate on the AG/AU comment. 

Fri, 05/15/2015 - 10:43 | 6097167 Haus-Targaryen
Haus-Targaryen's picture

If you try and purchase a house/car/goods & services with AG or AU right now -- hardly anyone will take it.  

When cash stops flowing people will start bartering, and the best object to barter with for high-ticket items is AG and AU.  

Fri, 05/15/2015 - 11:10 | 6097308 LawsofPhysics
LawsofPhysics's picture

Bingo. This has been the case after every major depression and world war since the dawn of recorded hsitory.  In fact, any real collateral that is in your possession or the possession of your tribe.  Same goes for any productive capacity that you control.

Fri, 05/15/2015 - 14:36 | 6098138 TrustbutVerify
TrustbutVerify's picture

Danke.

Fri, 05/15/2015 - 09:57 | 6096964 HonkyShogun
HonkyShogun's picture

Oh, I'm pretty sure Goldmensch Sacks does.

Fri, 05/15/2015 - 10:18 | 6097048 gafgroocK
gafgroocK's picture

 

 

 

Be Long 9mm Ammo

Fri, 05/15/2015 - 09:57 | 6096965 HedgeAccordingly
HedgeAccordingly's picture

perhaps this is why their Fixed income trading head left to walk the earth.. 

http://hedgeaccordingly.com/2015/05/deutsche-banks-head-of-fixed-income-...

Fri, 05/15/2015 - 09:59 | 6096971 Dumgoy
Dumgoy's picture

Golden Sacks do

Fri, 05/15/2015 - 10:03 | 6096988 madbraz
madbraz's picture

"hedge"???  these fckng a$$holes pretend that by buying derivatives and other synthetic BS from other gamblers they are "protected".  wake up 

Fri, 05/15/2015 - 10:09 | 6097011 sodbuster
sodbuster's picture

Yeah, and what is the current definition of an "investor"? Someone who puts in a fake bid for a millisecond?

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.

Fri, 05/15/2015 - 10:05 | 6096996 LawsofPhysics
LawsofPhysics's picture

No shit sherlock.  What did everyone expect once money creation was allowed to become complete detached from reality and collateral?!?!?!

This is completely expected.

Fri, 05/15/2015 - 10:05 | 6096997 madbraz
madbraz's picture

i get the feeling the next 3 months we will see the NY FED fighting tooth and nails to defend the SP500 from heavy selling pressure and keep their charade alive.  funny feeling that this time it will be for naught and they will gently step aside...  been wrong before tho

Fri, 05/15/2015 - 10:16 | 6097037 Chuck Knoblauch
Chuck Knoblauch's picture

Liquidity is determined by the state.

Fri, 05/15/2015 - 10:17 | 6097044 DontFollowMyAdv...
DontFollowMyAdviceImaDummy's picture

This is why I sold most of my "fruit stawk" at the mid-132s recently... just got the fiat for it where I'm now actually buying grams and ounces of various stuff that should be exchangable for almost anything should things really implode this time.  Self-insurance is awesome when you make a plan (buy low sell and then sell before the rest of the sheep discover fleeceOmatic) and stick to it!

Fri, 05/15/2015 - 10:21 | 6097063 chomu
chomu's picture

Howard Marks schooled the Street over a month ago about this. Old news and Jimmy Reid is late to this party again..

 

http://www.oaktreecapital.com/memotree/liquidity.pdf

Sat, 05/16/2015 - 01:20 | 6099814 rex-lacrymarum
rex-lacrymarum's picture

It's not as if it had been great news when Marks got around to discussing it either. This debate is by now at least two years old, if not more. Not that this is any consolation, on the contrary. One of the conclusions offered above, namely that it will get worse the longer this surreal state of affairs continues is quite correct. 

Fri, 05/15/2015 - 10:37 | 6097139 medium giraffe
medium giraffe's picture

Long tulips, pussies.

Fri, 05/15/2015 - 10:42 | 6097159 Osmium
Osmium's picture

Why would you need to hedge?  Just buy Stawks, they always go up!

Fri, 05/15/2015 - 11:11 | 6097317 I Write Code
I Write Code's picture

Gibberish.  Hedge or price volatility?  Volitality is already a derivative.  And a derivative of a largely random function.  The idea that one can or should hedge it is perverse.

But a *lot* of the "fundamentals" of modern markets, leverage and derivatives, is GARBAGE, it's all privatized gains and socialized losses, you just run it under-priced until it collapses and the Fed helicopters in free money to save your bankster ass.  Paul Volker said as much in 2008, he blamed the whole collapse on the Chinese, "They should have demanded higher returns!" he said, meaning on the junior tranches of the garbage CDOs and MBOs.  Yes they should have.  We shaved some Chinese muppets.  If those tranches were priced honestly they'd have yielded 20% or higher - and that would have cut the market by 90% or more because the (false) profit would have gone out of the whole exercise.

That folks is the 2008 crash in a nutshell.

Here's how you price volatility:  (1) Pay me a billion dollar consulting fee, (2) Buy four trillion dollars worth of my hedging derivatives that I make 5% on, (3) when they crash, go cry to the Fed.  Have a nice day.

Sat, 05/16/2015 - 07:21 | 6099983 Fire Angel
Fire Angel's picture

Absolutely perfect article. Here's my favorite part: 

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.

Thanks for all your hard work, Tyler(s). You're quite right to boast about your achievements.  Fire Angel 
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