The Committee on the Global Financial System (CGFS) and the Markets Committee today released two reports on the structure and liquidity of fixed income markets.
The CGFS report, Fixed income market liquidity, finds signs of greater fragility, with liquidity conditions being more susceptible to disruptions, such as sudden stops of liquidity in key segments of the market and a deterioration of market depth metrics.
“Fixed income markets are in a state of transition,” said CGFS Chairman William Dudley, President of the Federal Reserve Bank of New York. He added: “So far, the effects of ongoing regulatory, technology and market structure changes do not appear to have had large, persistent effects on the price of liquidity services for most major asset classes, but rather have been reflected in increasingly fragile liquidity conditions.”
The report identifies the key drivers of the change as:
the rise of algorithmic trading in fixed income markets, which may accelerate the rate at which seemingly ample liquidity can evaporate after the first signs of stress;
banks’ trimming of trading-related exposures in response to lower risk appetite in the wake of the financial crisis and to more demanding regulatory requirements; and
unconventional monetary policies, which can give rise to crowded trades and one-sided risk expectations on the part of market participants.
The Markets Committee report, Electronic trading in fixed income markets, focuses on the first driver and finds that the rise of electronic trading in fixed income markets tends to facilitate the matching of buyers and sellers. This improves market quality in normal times, but may also mean less robust liquidity conditions in times of stress.
“Electronic trading is transforming market structure, the process of price discovery and the nature of liquidity provision in fixed income markets, as it has done for other asset classes,” said Committee Chairman Guy Debelle, Assistant Governor of the Reserve Bank of Australia. He added: “It also poses challenges to policymakers, including the need to monitor its effects on market quality and to ensure appropriate governance of algorithmic trading.”
A survey of more than 30 electronic trading platform providers across the world shows a 40% increase in average daily trading volume between 2010 and 2014. Findings in the report also suggest that automated trading has picked up, although it remains less prominent than in other asset classes.
