Be kind, unwind
Since the beginning of the month we have had failed BOBL auction and Mr Bill Gross’ piece about how the bond markets are offering the sale of the century Bund yields have exploded 41 B.P. while US 10yr yields by 28 B.P., accompanied with a large spike in implied volatility across the curve. Although some of this has been viewed as just a position unwind the speed and herding mentality of the markets has given me a major cause of concern……

There are reasons to believe that the worst phase of the sell off may be ending as inflation expectations are adjusted as the curve bear steepened may make sense ,be it with the rally in the crude market or adjustments due to the fact that the curve flattening bought on by QE had gone too far....but it is the voracity of the pain trade unwind which ,in turn has caused a massive increase in volatility that has shown that it has the potential to upset the apple cart.
ITS A TRAP!

Water, water, everywhere
On many metrics, liquidity across markets seems abundant. Bid-offers are tight, if not always back to pre-crisis levels. Exchange traded volumes have reached all-time highs. The rise of electronic trading is helping to match buyers and sellers of securities more efficiently than ever before.
But not a drop to drink
And yet almost everyone, in almost every market, seems worried about liquidity. Even if it’s here today, they fear it will be gone tomorrow. HFT and electronic trading contributes to most of the increased volume however the growing frequency of “flash crashes” and “market gaps” – often without obvious cause – adds weight to their fears.
Run away, run away….
One explanation is that increased regulation has driven up the cost of balance sheet and reduced the bank’s appetite for risk, and hence ability to act as a middleman between buyers and sellers.This leaves the propieatry trading firms as the only sourse of liquidation by the funds.
But in addition to regulations, central banks’ distortion of markets has reduced the mix of views in the market, forcing investors 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.
Liquidity is very much in evidence when not required, and then disappears without trace the moment you need it....There is an argument that the liquidity provided by electronic trading are less substantial than that stemming from voice trades, floor trades (where it still exists) and personal relationships. When markets become volatile, firms tend to pull the plug – or, at best, reduce the size they are willing to trade.
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 abrupt corrections. Electronic trading reinforces this tendency, by creating the illusion of liquidity which evaporates under stress.
Unlike the trading floors, which had the advantage that there was always someone is there to make a price. In the current environment it is easy enough to “turn the machine off” and not answer the phones.
Up to now, the flash crashes have been little more than a curiosity, having mostly been resolved very quickly, and having had little or no obvious follow through to longer-term market dynamics, never mind to the real economy.
But 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.

“The more liquidity the central banks add, the more they disrupt the natural order of the market.”
For the last few years it has mostly proved possible to accommodate this; however the way out may not prove so easy; indeed, I ‘am not sure there is any way out at all.
