Nouriel Roubini, one of the few prominent economists credited with predicting the 2008 financial crisis, thinks there could be another one just around the corner.
Roubini’s latest piece in the Guardian is a warning particularly about the low levels of market liquidity:
A paradox has emerged in the financial markets of the advanced economies since the 2008 global financial crisis. Unconventional monetary policies have created a massive overhang of liquidity. But a series of recent shocks suggests that macro liquidity has become linked with severe market illiquidity.
That’s a slightly wonkish way of saying that there’s just not enough money moving in markets at any one time. That means that small changes in positions can have much bigger changes on asset prices — small corrections become big corrections, and big corrections can become crashes.
Here’s Roubini again:
And yet investors have reason to be concerned. Their fears started with the “flash crash” of May 2010, when, in a matter of 30 minutes, major US stock indices fell by almost 10%, before recovering rapidly. Then came the “taper tantrum” in the spring of 2013, when US long-term interest rates shot up by 100 basis points after then-Fed chairman Ben Bernanke hinted at an end to the Fed’s monthly purchases of long-term securities.
Roubini calls this a “combination of macro liquidity and market illiquidity” — global interest rates have been cut and cut again, and monetary policy in general remains extremely supportive.
With little liquidity, popular or seemingly sure-bet trades become crowded — until they’re not a sure bet any more. When everyone rushes for the exits at once, it can make things extremely volatile:
As a result, when surprises occur — for example, the Fed signals an earlier-than-expected exit from zero interest rates, oil prices spike, or eurozone growth starts to pick up — the re-rating of stocks and especially bonds can be abrupt and dramatic: everyone caught in the same crowded trades needs to get out fast. Herding in the opposite direction occurs, but, because many investments are in illiquid funds and the traditional market makers who smoothed volatility are nowhere to be found, the sellers are forced into fire sales.
Roubini thinks that’s a recipe for disaster: “Macro liquidity is feeding booms and bubbles; but market illiquidity will eventually trigger a bust and collapse.”
He’s not the first person to make this point. Accumen Management director Ken Veksler wrote a couple of months ago about how liquidity has been drying up, particularly in FX. Former US Treasury Secretary Larry Summers and JP Morgan boss Jamie Dimon both agree.
European Central Bank board member Benoit Couere has also expressed concern about the lack of liquidity driving volatile movements in bond markets recently.