Traders are getting more anxious about a lack of market liquidity

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Last week Citibank analyst Matt King released research showing that central bank liquidity was causing markets to become dangerously unbalanced.

It’s a theme picked up by ANZ’s global head of market research Richard Yetsenga who has just sent a fascinating note to clients after a recent marketing trip to Europe to visit clients of the bank.

Following on from discussions about recent market moves in commodities, the US dollar, Euro and interest rates Yetsenga said that market participants were worried about liquidity – or rather, the lack of it.

Discussions, as such, were dominated by the broader issues of liquidity, positioning, market dynamics, and fundamentals. And in fact fundamentals at present seem to be taking a back seat for most. Market liquidity has unambiguously shifted up investors’ hierarchy of issues. While it seems that large investors have already been managing a larger share of their portfolios with an eye on market liquidity than was the case pre-crisis, the range of clients factoring liquidity into their investment decisions has broadened further.”

That’s not how it is supposed to be, given that central banks have been injecting liquidity into markets for years.

Equally if, as clients have told Yetsenga, they are already positioning for a lack of liquidity, this can further exacerbate that very lack of liquidity. That is, as traders and investors shrink position sizes, become move tentative, and less certain of their conviction in their positions, they are likely to hold them for shorter periods and exit more quickly.

They may even step aside completely for a time.

This puts further pressure on liquidity, indeed it can plunge it into a downward spiral.

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