4 sentences explain why investors remain forever worried about bond market liquidity

Stop me if you’ve heard this before: people are worried about bond market liquidity.

In their latest multi-asset essay, John Tierney and the strategy team at Deutsche Bank address (what else?) the problems posed by bond market liquidity.

And the opening of their essay, in my view, sort of summarises why this whole issue has gotten so much steam in the first place.

In short: lots of investors think they are great and how dare the market not given them the prices they’d prepared for.

Here’s DB:

You are a brilliant investor blessed with exceptional foresight. Having figured out future economic trends, deciphered central bank responses to them, identified the investments set to gain the most, you even picked the best time/level to open a position in these chosen assets. What can possibly go wrong? A lack of market liquidity makes exiting your trade prohibitively expensive or worse, scuppers your ability to execute it altogether.

Now, DB’s report on the issue takes problems posed by liquidity very seriously. (More to come on that.)

And what the firm eventually argues is that liquidity has now become a binary thing in markets: there either is liquidity or there isn’t.

This is problematic because it necessarily sets up scenarios in which liquidity is needed and doesn’t exist.

All it takes is one moment of outsized stress in markets for the stability of the thing to fall apart.

Look at events like the Treasury “flash crash” of October 2014 and it’s obvious this is a danger lurking out there.

But I think so much of the reason this issue which is frankly quite arcane and, at this point, mostly just fun to self-referentially talk about, still has legs is because so much of the idea owes a lot to the belief that there are true prices out there in the market.

If you know you own risky debt that even in good times was probably going to be hard to unload in volatile markets, then is your worry about bond market liquidity really about the market or just about your portfolio? Probably depends how smart you think you are.

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