Earlier this year in his letter to shareholders, Jamie Dimon jumped [7] on the bond market liquidity warning bandwagon.
As you may recall, Dimon spoke out not only about the lack of liquidity in corporate credit markets (something which is always fun for sellsiders because it provides a nice “told you so moment” with regard to the Volcker Rule’s attempt to deter “evil” prop trading), but also about Treasury market depth and the rather disconcerting fact that six sigma events are happening in rapid succession. As a refresher, here are the notable excerpts:
The likely explanation for the lower depth in almost all bond markets is that inventories of market-makers’ positions are dramatically lower than in the past. Dealer positions in corporate securities are down by about 75% from their 2007 peak, while the amount of corporate bonds outstanding has grown by 50% since then.
Recent activity in the Treasury markets and the currency markets is a warning shot across the bow
Treasury markets were quite turbulent in the spring and summer of 2013, when the Fed hinted that it soon would slow its asset purchases. Then on one day, October 15, 2014, Treasury securities moved 40 basis points, statistically 7 to 8 standard deviations – an unprecedented move – an event that is supposed to happen only once in every 3 billion years or so (the Treasury market has only been around for 200 years or so – of course, this should make you question statistics to begin with). Some currencies recently have had similar large moves. Importantly, Treasuries and major country currencies are considered the most standardized and liquid financial instruments in the world.
Indeed, last October’s Treasury flash crash was a wake up call to quite a few market participants and served to validate two concerns we’ve been pounding the table on for years: 1) the presence of nefarious algos across markets means flash crashes are no longer anomalous but in fact part and parcel of today’s broken markets, and 2) the Fed’s move to suck every last vestige of high quality collateral out of the market has led to an acute lack of liquidity.
Or, visually:
Now, Dimon is back at it, warning that when (or maybe “if” is more appropriate) rates start to rise, Treasurys could sell off “violently”. Here’s more, via Bloomberg [8]:
Jamie Dimon, JPMorgan Chase & Co.’s chief executive officer, said the bank will be prepared for the possibility that Treasury prices move violently when interest rates rise.
“The one thing I do worry a little bit about, by the way, is Treasuries,” Dimon said Friday at a conference in New York sponsored by Barclays Plc. “Interest rates have been so low, for so long,” he said, adding that some traders and their managers have never experienced a rising interest-rate environment.
“So I wouldn’t be shocked to see 10-year Treasuries, when rates are going up, people change their mind, they change direction, that they will be violently volatile and go up much faster than people think,” Dimon said. “I’m not predicting that. I’m simply saying in the back of my mind, I think that’s a possibility.”
So while Dimon is worried that "some traders and their managers" have never seen a rate hike - something we warned about [9] back in May - we're sure no one at JP Morgan falls into that category, and besides, the bank is great at hedging tail risk [10]...
