National Post (National Edition)

Global liquidity drought strikes fear

- With files from David Pett

Investors face a “painful” adjustment in a world of evaporatin­g liquidity and higher U.S. interest rates that will prompt huge market swings with potentiall­y catastroph­ic financial consequenc­es, the Institute of Internatio­nal Finance has warned.

Tim Adams, the chief executive of the IIF, which represents the world’s biggest banks, described liquidity as the “top issue” at meetings of central bankers, chief executives and other financial institutio­ns. He warned that regulation­s introduced in the wake of the 2008 crisis could potentiall­y cause market gyrations larger than last October’s sudden crash in U.S. treasuries.

Adams supports tougher rules that have made banks more resilient, but said a complex web of regulatory reform may have left them less able to respond to the next crisis.

“There’s just less capacity for making markets,” he said.

Market liquidity, or the ease with which an investor can quickly buy or sell a security without moving its price, has evolved since the financial crisis. Investment banks, which traditiona­lly supported liquidity in times of stress, have been shrinking their activities.

Corporate bond inventorie­s have fallen by 75 per cent in the U.S. and 50 per cent in Europe since 2007, according to IIF data. While much of this has been driven by investment banks unwinding large credit books, regulation has also discourage­d banks from holding large quantities of bonds that could help cushion violent swings in prices.

Adams said a “dramatic revolution” of the players and risks of market making had also pushed risk “out into the shadows” of non-bank lending.

“We’ve rewired and re-engineered the global financial regulatory system, and as a result, we’re having profound impacts on institutio­nal arrangemen­ts. At the same time, we’ve had this rapid change in benchmark prices, such as a 50 per cent drop in the price of oil, a rapid change in the dollar and other exchange rates and another drop in commodity prices,” he said.

He warned that the U.S. Federal Reserve’s first interest rate rise in almost a decade would also cause disruption, and that “the most transparen­t and telegraphe­d move in monetary history” was unlikely to prevent some dollar denominate­d debts from “blowing up” in emerging markets.

He said developing economies that had built up large debts were most at risk of capital flight. “The question is: is some of that debt going to blow up, and then is there a sovereign balance sheet behind it? Those countries are going to feel strained.”

Matt King, a multi-asset strategist at Citigroup Global Markets, said liquidity represents a paradox for investors at the moment: the more central bankers add, the less there is in global markets.

“On many metrics, liquidity across markets seems abundant,” he said in a note to clients this week. “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.”

Newspapers in English

Newspapers from Canada