, convulsions in bond markets can cause unforeseen and unpleasant consequences. That crisis, sparked by an unfunded spending spree announced by the former UK prime minister and her chancellor, almost blew up the UK pension fund sector.investigating the claims of unusual illiquidity and volatility in the Treasury securities market.
“Moreover, lower-than-usual liquidity implies that a liquidity shock will have larger-than-usual effects on prices and perhaps be more likely to precipitate a negative feedback loop between security sales, volatility and liquidity,” the paper warned.While the bank seems relatively sanguine, albeit cautious, about the current state of the bond market, there is detail in the paper that perhaps validates the traders’ concerns.
Market depth for those notes – the amounts of securities available for sale at the best bid and offer prices – has been similar to that in March 2020 and measures reflecting the price impact of trades were notably higher for the two-year notes relative to March 2020. Now, rates are rising rapidly, and that liquidity is being withdrawn. The pandemic and, more recently, the war in Ukraine ignited inflation and have caused central banks to halt their purchases of bonds and other securities – the policies known as quantitative easing – and reverse course.
Other central banks, most notably Japan’s are also selling US dollar assets to defend their currencies because US monetary policy is moving faster and more aggressively than their own and threatening currency depreciation, increased inflation and a higher cost for buying commodities or servicing US dollar-denominated debt.
They have been replaced by high-frequency traders and hedge funds, whose activity is inherently more volatile and leveraged, which would tend to amplify movements in yields and in the depth of the liquidity available during any moment of stress.
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