The Real Reason Why There Is No Bond Market Liquidity Left

Tyler Durden's picture

Back in the summer of 2013, we first commented on what we called "Phantom Markets" - displayed quotes and prices, in not only equities, FX and commodities but increasingly in government bonds, without any underlying liquidity. The problem, which we first addressed in 2012, had gotten so bad, even the all important Treasury Borrowing Advisory Committee to the US Treasury had just sounded an alarm on the topic.

Since then we have sat back and watched as our prediction was borne out, as bond market liquidity slowly devolved then sharply and dramatically collapsed recently to a level that is so unprecedented, not even we though possible, leading first to the October 15 bond flash crash and countless "VaR shock" events ever since.

And while we urge those few carbon-based life forms who still trade for a living to catch up on our numerous posts on market "liquidity" and lack thereof, here is a quick and dirty primer on just why there is virtually no bond market left, courtesy of the man who, weeks ahead of the Lehman collapse when nobody had any idea what is going on, laid out precisely what happens in 2008 and onward in his seminal note "Are the Brokers Broken?", Citigroup's Matt King.

Here is the gist of his recent note on the liquidity paradox which is a must read for everyone who trades anything and certainly bonds, while for the TL/DR crowd here is the 5 word summary: blame central bankers and HFTs.

* * *

The more liquidity central banks add, the less there is in markets

  • Water, water, everywhere — On many metrics, liquidity across markets seems abundant. Bid-offers are tight, if not always  back to pre-crisis levels. Notional traded volumes in credit and rates have reached all-time highs. The rise of e-trading is helping to match buyers and sellers of securities more efficiently than ever before.
  • Nor any drop to drink — And yet almost every institutional investor, in almost every market, seems worried about liquidity. Even if it’s here today, they fear it will be gone tomorrow. They say that e-trading contributes much volume, but little depth for those who need to trade in size. The growing frequency of “flash crashes” and “air pockets” – often without obvious cause – adds weight to their fears.
  • Yes, street regulation has played a role — The most frequently cited explanation is that increased regulation has driven up the cost of balance sheet and reduced the street’s appetite for risk, and hence ability to act as a warehouser between  buyers and sellers.
  • But so too have the central banks — And yet this fails to explain why even markets like FX and equities, which do not consume dealers’ balance sheets, have been subject to problems. We argue that in addition to regulations, central banks’ distortion of markets has reduced the heterogeneity of the investor base, forcing them to be the “same way round” over the past four years to a greater extent than ever previously. This creates markets which trend strongly, but are then prone to sudden corrections. It also leaves investors more focused on central banks than ever before – and is liable to make it impossible for the central banks to make a smooth exit.

How Bad Is Liquidity Reall?

From the BIS to BlackRock, and Jamie Dimon to Jose Vinals, everyone seems to be talking about market liquidity. Chiefly they seem to be fretting about a lack of it. Primary markets might be wide open, thanks in large part to the largesse of central banks, but the very same investors who are buying today seem deeply concerned about their ability to get out tomorrow.

Liquidity as a concept is notoriously difficult to pin down. It has a reputation for being very much in evidence when not required, and then disappearing without trace the moment you need it. For strategists – and regulators – this represents a challenge: conventional metrics like bid-offer and traded volume can go only so far towards capturing what investors mean by liquidity. And yet because investors’ concept of liquidity tends very much to be focused on tail events, by definition, data to help monitor it are scarce.

This paper tries to assess the evidence across markets, and evaluate what is driving it.

Some observers have argued that even if liquidity is disappearing from some markets, it is being maintained – or even concentrated – in others. We argue in contrast that the risk of illiquidity is spreading from markets where it is a traditionally a problem, like credit, to traditionally more liquid ones like rates, equities, and FX. There is a bifurcation – but it is between decent liquidity much of the time and then sudden vacuums when it is really required, not across markets.

We likewise take issue with the widespread notion that the problem is solely due to regulators having raised the cost of dealer balance sheet, and could be ameliorated if only there were greater investment in e-trading or a rise in non-dealer-to-non dealer activity. To be sure, we see the growth in regulation – leverage ratio and net stable funding ratio (NSFR) in particular – as one of the main reasons why rates markets are now starting to be afflicted, and indeed we expect further declines in repo volumes to add to such pressures. But illiquidity is a growing concern even in markets like equities and FX, which use barely any balance sheet at all, and where e-trading is the already the norm rather than the exception.

Instead, we argue that in addition to bank regulations, there is a broad-based problem insofar as the investor base across markets has developed a greater tendency to crowd into the same trades, to be the same way round at the same time. This “herding” effect leads to markets which trend strongly, often with low day-to-day volatility, but are prone to air pockets, and ultimately to abrupt corrections. Etrading if anything reinforces this tendency, by creating the illusion of lliquidity which
evaporates under stress.

Such herding implies a reduction in the heterogeneity of the investor base. One potential cause is the way steadily more investor types having become subject to procyclical accounting and capital requirements in recent years, most obviously for insurance companies and pension funds.

But the tendency towards illiquidity pockets even in markets where insurance and pension money is not dominant suggests a deeper cause. We think the most likely candidate is central banks’ increasing hold over markets. Over the past four years, it is expectations of central bank liquidity, not economic or corporate fundamentals, which have become the main driver of everything from €/$ to credit spreads to BTP yields.

While central banks have always been significant market participants, their role has obviously grown since 2008. Most obviously, their global asset purchases have drastically reduced the net supply of securities available to be bought by investors. At the same time, we have seen a breakdown in a number of fundamental relationships which had previously correlated well with markets – and their replacement with metrics directly linked to central bank QE. Because the herding is not directly backed by leverage, it is unlikely to be reduced by macroprudential regulation.

To date, the air pockets and flash crashes represent little more than a curiosity, having mostly been resolved very quickly, and having had little or no obvious feedthrough to longer-term market dynamics, never mind to the real economy.

But we think ignoring them would be a mistake. Each has occurred against a largely benign economic backdrop, with little by way of a fundamental driver. And yet with each one, investors’ nervousness about the risk of illiquidity is likely to have been reinforced. When the time comes that investors do see a fundamental reason all to sell – most obviously because they start to doubt the extent of central banks’ support – their desire to be first through the exit is liable to be even greater.

There when it’s not needed

First, let us consider the evidence that all the fuss about liquidity is much ado about nothing. In many markets, under normal conditions, it is now possible to trade on more platforms, with more counterparties, and with tighter bid-offer, than ever before. While some market developments may perhaps point to the potential for problems, day-to-day liquidity remains remarkably good.

Plenty of notional volume, with tight bid-offer

The most obvious data point in this respect is that notional traded volumes in many markets are at or close to all-time highs.

US credit, for example, saw nearly $27 trillion in secondary trading last year; HY volumes have doubled since the crisis (Figure 1). In government bonds, the increase was typically pre-crisis, but volumes have typically remained flat even in the face of a growing proportion of bonds being absorbed by the central banks (Figure 2). German Bunds are a notable  exception. Notional volumes in equities have fallen from precrisis peaks, but remain close to them in the US and Japan (Figure 3).

Likewise, data on bid-offer across markets mostly paints a healthy picture. The BIS shows that bid-offer in govies has largely fallen back towards pre-crisis levels. Equity bid-offer is likewise close to pre-crisis lows, and seems to suggest that even quite large portfolios could be transacted at tight spread levels – provided volumes were split quite broadly across a large number of stocks (Figure 4). Bid-offer in credit remains wide to pre-crisis levels, as far as we can tell4, but is the tightest it has been since then (Figure 5). For small investors not correlated with the broader herd, these gains in notional volume and tight bid-offers will represent a very real ability to transact.

Turnover in decline

Admittedly, the positive message in these notional data is considerably mitigated when the growth in many markets – and in many investors’ portfolios, especially in rates and credit – is taken into consideration. Once transaction volumes are adjusted to show the difficulty an investor is likely to have moving a given percentage of the market, a very different picture emerges – and one which is much more consistent across markets.

In credit, rates, and equities alike, turnover relative to market outstandings has fallen considerably. Corporate turnover has almost halved since the crisis (Figure 6). The decline in government bond turnover has been more protracted, but is just as drastic, especially in US Treasuries (Figure 7). Equity turnover is more obviously influenced by the rise and fall in outstandings with market movements, but has also suffered a post-crisis decline (Figure 8).

For most investors, turnover is probably a more useful metric than straight traded volume. Monthly mutual fund inflows and outflows have generally grown as fund sizes have increased; for high-yield bond funds, net outflows seem to have been growing even in percentage terms, never mind in notional ones (Figure 9). Given that their share of the market has also been growing, the capacity to move a given percentage of the market is a much better guide than the ability to move a  given notional volume. The same tendency is not quite as pronounced in other long-term fund types, but seems also to be true for money market funds (Figure 10).

And yet despite declining turnover, the fact remains that outflows to date have not led to obvious liquidity problems.

ETFs, futures and indices – can they be more liquid than their underlying?

If the mutual funds’ role in contributing to market liquidity risks has been exaggerated, then we think ETFs have been more maligned still. They may well be responsible for some of the reason “day-to-day” liquidity has held up so well, but we struggle to see that they can be blamed for any increase in its tendency to disappear under stress.

The rise in ETFs has certainly been striking; in equities, in particular, net ETF sales have outstripped regular mutual fund sales in recent years (Figure 16), though in fixed income their rise has been slower. More striking still is that ETF trading now constitutes just under 30% of all US equity dollar volume. The rise of ETFs is probably one reason why, also in Europe, a growing proportion of daily volume is shifting away from intraday trades and towards end-of-day auctions (Figure 17).

There may well be a positive feedback loop in which other large trades are increasingly executed at end-of-day auctions, precisely because investors know that liquidity is becoming concentrated there, and to avoid being seen for reporting purposes to have dealt away from the daily closing price.

But what is striking in Figure 17 is that non-auction equity volumes have also been rising in recent years. Rather than ETFs subtracting from cash traded volume, they seem to have added to it. The same might be said for the rise of traded volume  in dark pools.

In this respect, we see ETFs as very much akin to the CDS indices in credit, or futures in equities and rates. It is not that there is a fixed quantity of trading to be done, and that the arrival of a new instrument necessarily removes trades which would have been done elsewhere. If anything, we see the opposite phenomenon. Liquidity begets liquidity: when investors have new instruments with which to express views and refine their positions, it tends to encourage still more trading.

In addition, in contrast with open-ended mutual funds, ETFs – like closed-end investment trusts – offer the possibility for prices to diverge from net asset values. This affords an additional cushion, especially during periods of market stress. The fact that ETF volumes have a tendency to increase relative to cash volumes during periods of stress – even though they then are likely to be trading at a discount – suggests that this cushion works well, and may even act to boost liquidity during stressed conditions. We have much sympathy for the way one ETF provider put it: “Everyone complains when they see our prices deviating from the underlying. But what they fail to realize is that at least people can and do actually trade at those prices: in troubled times, the prices shown on broker screens for underlying instruments are often a fiction.”

So while we would agree with the statement that “no investment vehicle should promise greater liquidity than is afforded by its underlying assets”5, we think there is something for an exception for vehicles which are themselves tradable, and can trade with a basis relative to their underlyings. ETFs, CDS indices and futures can and do provide much more liquidity than their underlyings. This, though, is not so much because they “promise” more liquidity, as that they facilitate additional activity, much of which is crossed at the index level, and only a fraction of which is transmitted through to the underlying. While investors are periodically surprised and frustrated by these vehicles’ failure to perfectly track movements in their underlyings, this failure is in some ways the secret of their liquidity. Rather than stealing liquidity from the underlyings, we think their growth has added to it.

Missing when required

But if neither ETFs nor mutual funds can be held responsible for perceptions of reduced liquidity across markets, what can? The finger is most often pointed at the street. Many buysiders feel that dealers’ willingness to act as a liquidity provider even during good times has waned; might such reduced willingness also help explain an increased tendency of liquidity to evaporate altogether? We think this is much closer to the truth – but even so, we doubt it is the full story.

Are the brokers broken?

Such arguments have been voiced most persuasively in Jamie Dimon’s recent letter to JPM shareholders. He cited three factors: higher cost of balance sheet, explicit constraints for US banks as a result of the Volcker Rule, and in extremis the fact that the rescues of the likes of Bear Stearns, WaMu and Countrywide/Merrill have led not to gratitude but to heavy fines for JPMorgan and Bank of America, in at least one case following the abnegation of ex ante assurances otherwise.

The effects of the latter two factors are hard to observe, and would probably become visible only in a proper crisis. Even then, they might in principle be offset by “Rainy Day” funds. These are pools of money being set up by asset managers precisely so as to take advantage of liquidity-related distortions. But it seems doubtful that these will ever reach the scale required to take 2008-style rescues, at least without large amounts of leverage.

The effects of reduced dealer balance sheet, however, are visible already, and are contributing directly to the perception of illiquidity in fixed income. Unlike equities or FX, fixed income trading is fragmented across an extremely large number of outstanding securities. Only rarely can a willing buyer and seller of the same security be found at the same instant. As such, liquidity, particularly for larger trades, relies heavily on dealers’ ability to act as a warehouse, temporarily hedging a long position in one security with a short position in another. This requires both the availability of balance sheet, and the ability to borrow securities freely through repo. Both of these are now under threat from regulation.

Why e-trading is no panacea

E-trading works extremely well as an efficient means of uniting buyers and sellers of a given security – provided those buyers and sellers exist in the first place.

That is, a buyer can probably find a seller faster now than they could a few years ago, when they had to rely solely on email and phone calls. In indices, in equities and in on-the-run govies, where many investors are ready and willing to trade the same security on either side of the market multiple times in an hour, this can bring about significant improvements (Figure 24).

But in much of fixed income (and especially credit), liquidity is intrinsically fragmented. End investors’ willingness to buy and sell a large notional volume of a given security is simply not there in the first place (Figure 25). Even if investors could be persuaded to concentrate their positions in a given issuer on a smaller number of outstanding “benchmark” securities, as BlackRock has called for, issuers could never be persuaded to do so, since it would add to their refinancing risks. Issuers like the diversification that a multitude of outstanding securities brings.

As such, it is no use efficiently putting together buyers and sellers when those buyers and sellers do not exist in the first place. This is why many traders report that – even when they have on occasions been able to offer ‘choice’ markets with zero bid-offer for a while, these have not necessarily resulted in any trading. End user liquidity remains fundamentally dependent on a counterparty’s willingness to act as a warehouse: to buy the security the seller wants to sell, to offer the security the buyer wants to buy, find a hedge of some sort and then move to unwind the position later. This is also why so many bond market participants – buyside and sellside – are opposed to efforts to copy-paste equity-inspired regulations into a fixed income framework in the interest of increased transparency.

Nor is it obvious that there is an easy alternative to the existing broker-dealer model when it comes to warehouses. Bid-offers are tight enough that the market-making model relies upon leverage in order to generate a reasonable return on equity. Even if, say, asset managers or hedge funds are prepared to act as warehouses, for them to make money on the operation they will want to operate with leverage. But – as the clearing houses are now starting to find out, and banks discovered some time ago – such leverage represents precisely the sort of systemic risk that regulators are now keen to limit.

As such, e-trading to date has done a great deal to boost what the IMF calls “flow”, or day-to-day liquidity, for small-sized trades. But when it comes to larger transactions, they can seldom be cleared (Figure 26).

‘Phantom liquidity’ – is the problem getting worse?

There is an argument that the liquidity provided by e-trading seems to be more fleeting than that stemming from voice trades and personal relationships. When markets become volatile, e-trading operators tend to pull the plug – or, at best, reduce the size they are willing to trade. A recent IMF analysis concluded that it was precisely such a reduction in the depth of order books which seems to have led to the ‘flash rally’ in US Treasuries on October 15th 2014. A high dependence on electronic trading also seems to have contributed to the flash crash in equities on May 6th 2010.

It is this phenomenon that is known as “phantom liquidity”, or the “liquidity illusion” – a tendency to evaporate when really needed. It does seem possible that e-trading may have added to such a tendency, by improving the appearance of liquidity under normal conditions, and then withdrawing it in periods of stress. This could help explain why some of the most obvious instances of recent illiquidity have occurred in markets which already have high proportions of trades conducted electronically.

And yet beyond the anecdotal, quantitative data demonstrating an increased tendency towards “phantom liquidity” is extremely hard to pin down. After all, it makes predictions not about day-to-day circumstances but about tail events, which by definition are few and far between.

The best evidence is probably some increase in bifurcation in day-to-day trading conditions, visible in daily volatility levels across markets. Rather than there being a steady stream of moderately volatile days (and liquidity conditions), volatility seems to be becoming more clustered than it used to be: there are many days with tight ranges and good liquidity, and then occasional days of extreme intraday volatility and reportedly poor liquidity – even though (as in the flash crash and flash rally) volumes on such days can actually remain quite high.

Often, the volatility is thought to occur intraday, and therefore may not be captured by the net daily changes implicit in volatility metrics. Looking at intraday high-low ranges in markets paints a slightly clearer picture – but not decisively so. It does in general seem to us that intraday ranges have become more bifurcated since around 2005, most obviously with a period of low volatility prior to the financial crisis being followed by the extremely high ranges during the crisis itself, but also with post-crisis daily trading ranges being more bifurcated than prior to 2005.

Low day-to-day volatility, punctuated by occasional sharp corrections, are exactly what we might anticipate if markets were becoming less liquid. In credit, for example, they are one of the features which distinguishes the cash market relative to the continual bouncing around of the CDS indices. And we have argued previously that markets seem to be becoming more subject to positive feedback loops, which see them trending steadily upward only to fall back suddenly and often unexpectedly.

And yet the limited number of observations, and the variations across markets, make it hard to make confident statistical statements about any change in the shape of distributions. We are left with the unsatisfying conclusion that evaporating liquidity is as much a feeling voiced by many market participants as to what might happen under stress, illustrated by a few idiosyncratic examples, as it is a statistically demonstrable phenomenon.

The evidence of increased herding

A recipe for a perfectly liquid market would be one with a small number of homogeneous securities being traded by a much larger number of heterogeneous participants. This would do a great deal to improve the likelihood of a buyer and seller both wanting to transact in the same security at the same time, and hence being able to agree upon an appropriate price. Indeed, it has even been suggested that we might quantify markets’ potential for liquidity along such lines, taking the number of distinct market participants and dividing by the number of securities traded.15 This is one reason why liquidity in indices and futures is often so good, as they concentrate a large amount of activity in a small place.

One potential explanation for growing illiquidity is that markets have been evolving in an exactly opposite direction. Not only has the number of securities traded been growing (in credit in particular), but the heterogeneity of market participants seems to have been reducing as well. Here too, the regulations are partly to blame, with more and more investors being forced both to mark to market and to hold capital or cover pension deficits on the basis of such mark to market calculations. In addition, though, it feels to us as though market participants are increasingly looking at the same factors when they make their investment decisions.

For the last few years, valuations in more and more markets seem to have stopped following traditional relationships and instead followed global QE. Likewise in meetings with investors, we have been struck by how little time anyone spends discussing fundamentals these days, and how much revolves around central banks. Record-high proportions of investors think fixed income is expensive and think equities are expensive.  A growing number of property market participants seem to think real estate is expensive. And yet almost all have had to remain long, as each of these markets has rallied. Could it be that central bank liquidity has forced investors to be the same way round more so than previously, and that this is  making markets prone to sudden corrections.

While it is hard to demonstrate conclusively, a growing weight of evidence would seem to point in such a direction. CFTC data on net speculative positioning in futures and options markets has become more extreme in recent years, and abrupt falls in net positioning have often coincided with sharp market movements. Net shorts in Treasuries reached record levels immediately prior to the flash rally, for example (Figure 29); net longs in commodities contracts preceded the sharp fall in commodities indices in the second half of last year, and record net euro shorts (Figure 30) and dollar longs are being squeezed at the moment. However, it could be argued that growth in notional contracts outstanding is a normal part of financial market deepening; normalizing by the net open interest would (at least in some cases) suggest recent positioning is not too far out of line with history.

But other data also point to an increase in investor crowding. Our own credit survey shows that investors’ positions in credit since the crisis have not only been longer on average than ever previously, but also less mean reverting, and exhibiting less dispersion and less mean reversion (Figure 31). Fully 83% of those surveyed were long credit in December last year – a sizeable imbalance for any market. Similarly, the BAML global investor survey shows that investors have been long in equities for a longer period than would historically have been normal.

Research specifically designed to detect investor herding has reached the same conclusion. An IMF analysis of the correlation between individual securities transactions by US mutual funds, using the vast CRSP database, shows a clear pickup in herding with the crisis, and then another one in late 2011. The herding seems to have occurred consistently across markets, but was more intense in credit and especially EM than in equities. It also occurred both among retail and among institutional investors. The IMF were unable to test for herding in government bonds and FX because of the much more limited number of securities.

What we find striking about the herding numbers is the way they correlate with the metrics we use to track the scale of central bank interventions: rolling global asset purchases by DM central banks, and global net issuance of securities once central bank purchases (and, in this case, also LTROs) have been subtracted out. Over the past four years, we have had to use these metrics to help explain market movements when traditional fundamental relationships have broken down.

Investors likewise agree on the dominance of central banks: in a survey of global credit derivatives investors we conducted in January this year, fully two thirds thought “central bank actions” would be the main driver of spreads this year, well ahead of “credit fundamentals”, “global growth trends” or “geopolitical risks”. Even if the central banks are only having to intervene because the systemic risks they are confronting have become bigger, the effect remains the same.

This, then, would seem to be the final piece of the puzzle as to what is making markets prone to pockets of illiquidity. Central bank distortions have forced investors into positions they would not have held otherwise, and forced them to be the ‘same way round’ to a much greater extent than previously. The post-crisis increase in correlations, which has been visible both within credit and equities and across asset classes (Figure 35), stems directly from the fact that investors now increasingly find themselves focused on the same thing: central bank liquidity. Every so often, when they start to doubt their convictions, they find that the clearing price for risk as they try to reverse positions is nowhere near where they’d expected.

This explains why the air pockets have not just been in markets where the street acts as a warehouser of risk. It explains why they have occurred not only in the form of sell-offs which could have caused multiple market participants to suffer from procyclical capital squeezes. It also explains why the catalysts have often, while often trivially small, have nevertheless been macro in nature, since they have boosted expectations of a change in central banks’ support for markets.

Unfortunately, it leads to a rather ominous conclusion. The bouts of illiquidity will continue until central banks stop distorting markets. If anything, they seem likely to intensify: unless fundamentals move so as to justify current valuations, when central banks move towards the exit, investors will too.

Rather than dismissing recent episodes as relatively harmless, then, we are supposed to worry how much larger a move could occur in response to a more obvious stimulus. While financial sector leverage has fallen, debt across the nonfinancial   sectors of almost every economy remains close to record highs, meaning that the potential for negative wealth effects in the real economy is very much there.

In principle, markets could gap to a point where they went from being absurdly expensive to being absurdly cheap, and then – as investors stepped in again – gap tighter, perhaps even without very much trading. But the existence of the feedback loop to the real economy means that the fundamentals tend also to be affected by extreme market moves: “cheap” may be a moving target. This in turn could force central banks to step back in again.

To sum up, we are left with a paradox. Markets are liquid when they work both ways. Market participants, though, find themselves increasingly needing to move the same way. This is not only because of procyclical regulation; it is also because central banks have become a far larger driver of markets than was true in the past. The more liquidity the central banks add, the more they disrupt the natural heterogeneity of the market. On the way in, it has mostly proved possible to accommodate this, as investors have moved gradually, and their purchases have been offset by new issuance. The way out may not prove so easy; indeed, we are not sure there is any way out at all.

* * *  

To which all we can add is: Good luck with the "exit"

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Stoploss's picture

"The beatings will continue until morale is improved!!!"

BandGap's picture

Who will buy my junk when I need it, then?

Headbanger's picture

Less liquidity = INCREASE RATES


asteroids's picture

Don't overthink liquidity. It's directly related to the number of people involved in a market. People leave the market, "liquidity" dries up. Everyone now nows the casino is rigged, so why play? Hence, liquidity dries up. Blame the FED and the "boyz" for rigging the game.

MonetaryApostate's picture

What difference does it make?  (Hitlary quote not intended)

Collapse the markets already, I for one am tired of the whining....

When are the damn solution(s) coming?  (If ever?)

Oh that's right, they aren't, and the 1%ers will get more wealthy, control more, and take everything they want anyway...

(Just like they've done for centuries now, yes?)


Judgment is coming, bank on it....


Hippocratic Oaf's picture

I'm in the business.

There is never a bad bond, only a bad price.

JRobby's picture

laugh track deafening

Pummeling commencing in 3,2,1......

max2205's picture

Since I read this when do I get my 3 credits in distorted markets 401?

LawsofPhysics's picture

Yes, but again, in the absence of any real price discovery, who the fuck knows what that price should be...?

I don't think people really understand the consequences of a lack of faith in fiat...

Par Contre's picture

Precisely! It's not an issue of liquidity but rather of price. When central banks inflate the value of financial assets through excessive credit creation, the result is an inbalance of supply and demand. So long as the market is confident in central banks' ability to support inflated prices, the market will appear to function normally. But the moment that doubt arises, the market is flooded with sellers and the buy side disappears.


The solution: quit manipulating the markets and allow prices to find their natural equilibrium.

Uber Vandal's picture

I never had a bad meal, but I puked for what felt like a day when I undercooked the food once.

AGuy's picture

"There is never a bad bond, only a bad price."

What about a Bond in default?

PTR's picture

That correction to the mean is gonna be nasty.

NoDebt's picture

At the first sign of significant selling into illiquidity (i.e. the next serious crash):  Casino's closed.  Go home.

And that's how it will end.

kaiserhoff's picture

Why god made puts,

  because when the house is on fire, no one will sell you insurance.

Dr. Engali's picture

Good luck collecting when there is nobody left standing. Counter party risk is a bitch.

NoDebt's picture

Yeah, I think Doc and I have been in violent agreement over this for some time.  Puts won't help.  Nothing will help because there won't be a market, nor any market clearing.

This is a subset of my theory that "They're going to take this whole damned thing private."  Public markets will cease to exist (at least in anything like their current form) and "trading" will be limited to large institutional players in private deals or on private exchanges.

stant's picture

No minky hammer lic for the pleps . Just the club

gatorengineer's picture

Gee they could call these private exchanges something scary, like say.... I dunno "Dark Pools"......  NoDebt, you are supersharp you havent realized this already happened?

funthea's picture

You need only try to envision the truth...

There are no markets.

The_Dude's picture

You can check out anytime you like, but you can never leave

Fun Facts's picture

There are no markets left either.

Mercury's picture

ETFs, futures and indices – can they be more liquid than their underlying?

I've been thinking about this for a while and I'm pretty sure the answer is: No, they can't - at least not when the market is actually moving. And don't confuse volume with liquidity.

Arguably the whole purpose of ETPs is to create arb opportunities for those in the priveledged position to create/redeem units. That's not you.

Like Facebook and  'Ladies Night', ETPs are a two sided, platform market:

if it's free/close to free YOU ARE THE PRODUCT:

Trick Shroadé's picture

Too many words. Tell me more about Greece.

youngman's picture

me too...I just read the headline and that was enough for me....exit...yeah right....

GRDguy's picture

What??? We're actually running out of greater fools??? 

thinair's picture

There are ten people and resources to feed only nine. What happens to the tenth and why? O’ Humanity, Why are you running and for what?

For full context, please visit my blog

Read the post titled “No one saw it coming”


Thanks zerohedge for all the good work you do!

I will not put anymore comments zero hedge, because you deleted my last post. Either you do not agree with me or you are doing this work for credit or for some other reason... You could have sent a simple email and I would have stopped. 

Thanks for letting me post here.. for the last time. People from 25 countries came to know about The Plan B.

thinair's picture

There are ten people and resources to feed only nine. What happens to the tenth and why? O’ Humanity, Why are you running and for what?

For full context, please visit my blog

Read the post titled “No one saw it coming”


Thanks zerohedge for all the good work you do!

I will not put anymore comments zero hedge, because you deleted my last post. Either you do not agree with me or you are doing this work for credit or for some other reason... You could have sent a simple email and I would have stopped. 

Thanks for letting me post here.. for the last time. People from 25 countries came to know about The Plan B.

LawsofPhysics's picture

"investors"...  "markets"...  LMFAO!!!    stop it... you are killing us...  no really.... Stop it!

TeethVillage88s's picture

OT except for the ship sinking, TPP & TTIP


"Among the text leaked on Wednesday are Tisa’s annex on telecommunications services, an amendment that would standardize regulation of telecoms across member countries, according to WikiLeaks."

- US Will give up any future attempt at Anti-Trust if it signs more Trade agreements
- Normalization of laws being necessary, Oligopolies are the Rule in former Hacienda Nations in Latin America, Asia, South Korea, Japan, China

- Plus censorship, you can't have free press in the future even if you want it, can't criticize government officials or King or Queen... who knows maybe we lose ability to criticize diplomats

youngman's picture

There is no way out now.....any mention of the word markets contain the words Central Banks now...and will from now on......they are the market now....and we are just those birds on the back eating the bugs off of the water makes me laugh now...rules too..they will just change them when they need to....

Government needs you to pay taxes's picture

At least in equtiies, those POS market maker 'specialists' on the NYSE were nowhere to be found when the market was crashing (87/01) and liquidity was needed.  Ain't skeered.

Dr. Engali's picture

Of course there is no liquidity. Everything is overpriced and the world's largest hedge fund (the fed for those who can't keep up) is the largest potential seller. This is why if there is ever any real selling the "market"will vaporize in a nano-second.

...out of space's picture

really fensi post but it really  sound like a economic gibrish.

 BJF explane in his vid

spigot off

and about volatiliti in the market

Naomi Prins people dont have any money

( for some reason i cant put link on , but you can see on youtube)

Keltner Channel Surf's picture

TINA becomes TENA:  Timely Exit Not Available

Dr. Engali's picture

Oh, I thought you were talking about another sex change.

Keltner Channel Surf's picture

Ha!  You doctors are always thinking about anatomy. 

TINA:  There Is No Androgen

jump_mutha_fukah's picture

How's the trading going? You have to love days like today, up down, up down....I was waiting all day for the last drop...and I knew it would not come until I made a trade. So I waited as long as I could till around 12:58 or so and sold some TNA puts...and like majic, IWM capitulated about 5 minutes later. I was also short the calls so it worked out. Been working a calendar strattle all week and hedging out each side on the wild swings as well as rolling to next week...thats all I feel good with given the BS movement we have been seeing. After next week, any moves over 125.50 on IWM I plan on naked call selling TNA weekly. They want to relentlessly press forward, then I'll take the other side of that for the premium...this is getting long in the tooth. 


Keltner Channel Surf's picture

Been a tough week, but did OK today, albeit with a half-sized position in SQQQ, got out already.  In the future, I might sit out pre-JOBS weeks, unless the fixed space is rocked.

Been thinking about you, assumed you might have gotten squeezed by the odd IWM action, looks like it has the most positive Daily technicals, still not good, but all indices have been ramping against normally reliable measures above the 20 MAs until today.  If this marks the beginning of the end of the TINA crap that messes with trend trading. we can begin to rejoice.  Because the FED is everything, seems too little volume in between  big econ reports for anything to work.

jump_mutha_fukah's picture

I cant wait for this TINA BS to end. Can't wait till they raise rates just so people quit squawking about it....I mean now that all the wealth has been concentrated, lets at least give these bastards some usury on all they have stolen. /s

Got a little squeezed yesterday only in that I missed an opportunity to sell some puts a bit more pricy that morning before the moon shot...once I saw that, I walked away from the idiot box and went to work on my yard....checked the market at 3:30 and said to hell with stopping, I got another shot at it today thankfully and wasn't so spastic about pulling the trigger. I hadn't planned on trading the next two weeks but looks like I may at least next week...bit nervous about what the RUT rebalance will bring...already enough unknowns lurking out there on a daily basis this just adds another to be blind sided by.

Think whatever upside is left to this in the short term is not going to be very spectacular...we may have a blow off top coming at some point, but this just doesn't feel like it yet...feels more like a weary market ready for a reprieve than one ready to rocket sustainably higher. Next big drop we get may sucker in enough shorts to give a blow off the booster fuel needed. Just my guess, but seems like that is about as good as anything these days in Bizzaro World...I mean who would have ever thought we would ever see the multiples currently being traded and rationalized away, the all bad news is good news, a market at nosebleed levels while its homeland is in the depths of depression....unreal...a reckoning must not be far off. 

Good luck and stay nimble

Keltner Channel Surf's picture

Same to you.  It'll take a while for nearly 10 yrs of craziness to be worked through, but at least the odds a typically dull trading summer are lower than usual can give us hope for a little warm weather profit.

Kickaha's picture

Let me rephrase this painfully long article.

When the Fed and all of the world's central banks pump so much fiat unbacked by anything tangible into the system, the pricing of all financial assets gets distorted upwards to the point where the current prices bear virtually no relationship to the real world.   The actual fair market value of the securities no longer is relevant.  When that happens, any tendency of the ask and the bid to hover around both sides of the true price and then resolve into actual sales disappears.  Yes, there are still bids and asks, but both have actually become bids in the sense that they are both way above the true price.  It is a contest among traders unconcerned with holding a security long-term.  In essence they are competing in an auction to see who will hold the asset for a limited time in the hopes of flipping it for a profit later on at the next auction.

 In an auction, everybody submits bids.  Nobody submits asks.

One day, the easy money and the auctions will stop, and at that moment the absence of any asks will become more noticeable, indeed, and it will be very hard to sell whatever you were hoping to flip. Sic semper bubbles.



scubapro's picture



this whole article seems to whine on and on at how there 'could' be a decline in liquidity.  funny thing is lack of liquidity can cut both ways, depending on if people want in or the mis-described tsy 'flash crash' in october, where tsys were bid UP dramatically b/c everyone wanted in, but few would sell.    junk will be the opposite, no buyers all sellers.   to assume the bond market is homogenous is way off base.   

yes etf's can be more liquid than the underlying, one will see a divergence from nav.   

In.Sip.ient's picture

Notice how everyone is crying for more liquidity???


That would be code for more QE for those of you that missed the obvious.


And more QE is exactly what the FEDs now do at their own risk!!!


In the competition to maintain reserve currency status, the US$

sinks on QE and swims on NO QE and higher interest rates.


Those who you see whining in the above article would be the

cronies who will lose out in the US$ desperate bid to maintain

the status quo...


scaleindependent's picture

Honest question.

What would force the market and central banks to make an exit?

What are the consequences of not exiting?

They may just state that an exit is not necessary. 

chomu's picture

Most of the paper issued over the year resembles the giant turds that my dog drops on my pristine sod avery day...

Buybacks, QE, exuberint home flippers, impressive use of capital indeed

fremannx's picture

As yields rise, the liquidity problems can only get worse. The 10 YR UST is about to go ballistic...

Die Weiße Rose's picture

The Fed and other central bankers created a fake market that everyone else was frontrunning, to make a quick profit.

High frequency trading made it possible during the good OE times to make huge profits even from the smallest margins.

Now that the Fed has no more ammunition left after ZIRP and QE

(which had no real effect on the real ecconomy other than Equity-Markets, Bond market bubbles)

there is no other way to go but down.

Nobody wants to buy bonds in bubble territory that are based on ZIRP and QE fake valuations.

HFT only works if there is something to profit from.

Liquidity has gone and the Bond-Market bubble is about to burst.

I guess those fools holding the hot potatoes will be public pension funds,

and some unsuspecting loyal Goldman Sachs clients ?

just guessing.


polo007's picture

According to Voya Investment Management LLC:

The Outlook for Monetary Policy and Long-Term Interest Rates

Though there are many reasons for low long-term interest rates, it is useful to classify them into two sets: domestic factors and international factors. The main domestic factors are low short-term interest rates, low inflation and low inflation expectations, contained volatility in financial markets, tepid rates of economic activity and the increased size of the Fed’s balance sheet. The main international factors are low overseas interest rates, low inflation and deflationary expectations abroad, quantitative easing in major advanced economies and slow growth in the rest of the world. Domestic factors are the primary drivers of low interest rates in the U.S., while international factors have provided additional impetus.

It is well established that long-term interest rates are strongly correlated with short-term interest rates (Figure 9), a relationship that has been understood since at least the middle of the 20th century. Short-term interest rates are principally driven by the central bank’s policy rates and other monetary tools. The Fed has kept the fed funds rate below 25 basis points since December 2008, resulting in extremely low short-term interest rates, as indicated by the low yields of three-month and six-month U.S. Treasury bills.

Long-term interest rates are likely to stay low as long as short-term rates remain low. The recent, moderate selling trend in two-year U.S. Treasury securities implies that investors expect the Fed to hike its target rate. However, rates on three- and six-month T-bills have not risen much, suggesting that while an imminent rise in long-term rates is not yet priced, investors are pricing in a modest rate hikes afterward. Observed inflation and inflationary expectations also are important drivers of government bond yields. Low core inflation suggests that long-term rates will stay low.

Volatility in financial markets also affects long-term rates. The VIX and MOVE indices — measures of volatility for the stock market and the government bond market, respectively — have stayed fairly low. Volatility in the government bond market has increased a bit recently but is still low by historical standards. The size of the Fed’s balance sheet and Fed monetary policy actions can have substantial effects on long-term rates. While the large-scale asset purchase program has ended, the Fed will remain a large holder of U.S. Treasury and agency residential mortgage-backed securities even after it begins to hike (Figure 10). This large stock of Fed holdings is likely to restrain upward pressures on long-term rates by limiting the market supply of these securities.

International factors also have restrained long-term rates. Global price pressures are feeble. Inflationary pressures in the major advanced countries are subdued. Long-term rates are low in advanced countries such as Japan, the U.K. and Canada. Interest rates on short-term and intermediate-term government debt instruments are often negative in the euro zone and Switzerland. Japan has experienced long-term rates of less than 2% since the late 1990s. Compared to long-term rates in the major advanced countries, U.S. Treasury yields are markedly higher! What’s more, the European Central Bank and the Bank of Japan are likely to remain in quantitative easing mode at least for the rest of the year, if not beyond. Foreign demand for U.S. Treasury securities is extremely strong — China and Japan, for example, continue to hold large portfolios of U.S. Treasury securities for mercantilist and other purposes — and there is no reason to think that this will change anytime soon.


The combination of domestic factors and international factors supports our view that low long-term rates will persist. The U.S. economy continues to improve, albeit at a slow place. Job growth has been decent for the last few years and the unemployment rate has declined steadily. Auto sales have picked up. Crude oil prices have fallen dramatically from the elevated levels of recent years, to the benefit of consumers. Rising equity and house prices have enabled households to repair their balance sheets. Businesses have started to invest in equipment and software and building.

Nevertheless, the pace of growth is still disappointing. Labor productivity growth has been weak. Recovery in housing construction has been slow. Wage growth is tepid, as job growth has occurred in low-productivity sectors and industries in which wages tend to be low. Real median income for U.S. households is still below peak. Income inequality continues to increase. Labor’s share of national income is at a low point. Post-crisis income gains have been confined to the very top of the income distribution. Global conditions for growth are still unfavorable, which matters to the U.S. not only for trade but also for capital flows and migration. Slower growth abroad will diminish the prospects for exports.

The Fed, meanwhile, is likely to be cautious and gradual in raising the policy rate, and its balance sheet will stay expanded. The Fed has communicated that monetary policy will stay accommodative for a long time even after an initial rate hike and a few subsequent moves. The combination of tepid economic growth and low inflation domestically, weak global economic growth, strong demand for safe assets and the accommodative stance of the Fed could lead to the persistence of low long-term interest rates in the U.S. for much of this year.