Liquidity – Feature
warns that “the risk of a sudden significant deterioration [in li- quidity] appears higher than normal”. This is despite the US central bank sitting on a record high balance sheet of almost $9trn (£7.3trn). “Declining depth at times of rising uncertainty and volatility could result in a negative feedback loop, as lower liquidity in turn may cause prices to be more volatile,” the Fed warns. Across equities, bonds and commodities, market depth – the ability to absorb large orders without significant price fluctua- tions – has deteriorated. The number of futures contracts for equities and oil has fallen to a low last seen in early 2020, when the outbreak of the pandemic caused an initial liquidity crunch, according to Refinitiv. Similarly, depth has deteriorated for bonds with shorter matur- ities as investors anticipate the effects of further rate hikes. Moreover, US and European initial public offerings (IPOs) have fallen by more than 90%, year to date, an indication that
firms are finding it harder to raise cash from public markets. But the Fed also notes that while market depth has worsened, bid/ask spreads remain relatively stable in the liquid segments of financial markets, which suggests that liquidity providers are moving towards executing larger trades in multiple smaller transactions, the central bank says. Across the pond, the Bank of England is keen to reduce the size of its balance sheet, which is close to £1trn. But widening bid- offer spreads in the short-term gilt market is leading some commentators to suggest it should slow down the process of monetary tightening.
High-frequency hosepipes But the problems with market liquidity go beyond monetary tightening, says Richard Tomlinson, chief investment officer at Local Pensions Partnership Investments. He believes that the retreat of banks from some trading and market making activi-
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