Palliative care ordered by BIS for stressed global fixed income markets
Alarm bells and rescue missions often go hand in hand, and so it is with a key piece of work from the Bank for International Settlements. On this occasion, the emergency services promise more and better monitoring as the remedy for a precarious period in the fixed income market."Increasingly fragile liquidity" is the theme pervading a BIS report released on Friday."To the extent that rising costs and falling market shares have diminished the profitability of market-making, dealers may have fewer incentives to provide liquidity during periods of market stress," the BIS said."While this is an intended consequence of both market-based factors (such as the repricing of risks given reduced risk tolerance) and regulatory reforms to enhance dealers' resilience, market liquidity may become more dependent than before on the willingness and ability of other market participants to take contrarian views."Ongoing trends towards greater concentration and uniformity in the asset management industry cast some doubt on whether this is currently the case," the BIS said.Caution on the part of key market makers may only reinforce a bias unfavourable to system stability."While dealers' decisions to supply liquidity are driven by their individual cost-benefit analysis, market liquidity conditions reflect their collective stance and can give rise to feedback loops that can amplify trends," the BIS said.A cynicism toward algorithmic trading features in the BIS analysis."These alternative liquidity providers typically submit orders that result in tight bid-ask spreads but only for quantities of moderate size," the report said. "In such an environment, narrow spreads could result from trading strategies primarily geared towards attracting information on the order flow."Thus, "they could be a reflection of the ability of these firms to adjust their prices almost instantaneously to any market move, while carrying limited inventory risk, rather than an indication of ample liquidity conditions."