In an article for the Financial Times, Henry Timmons discussed the positive effects on bond market liquidity due to the increased proliferation and use of fixed income ETFs. 

In essence, the innovations that have already led to more liquid and transparent markets in stocks and commodities are now happening in the fixed income markets. Despite waves of financial innovation, the bond market has been slow to adapt until recently. 

Some reasons for this are capital requirements at large banks leading to less inventory of corporate bonds on dealer balance sheets, central banks vacuuming up massive swathes of government and mortgage debt, and market participants who were resistant to change.

However, this state of affairs is being disrupted by ETFs which trade on exchanges and have tighter bid-ask spreads than what is found in individual bonds. In fact, many now look at fixed income ETFs for price discovery due to these factors. 

Of course, there are some detractors who contend that liquid fixed income ETFs which hold illiquid bonds could lead to financial instability in the event of a market downturn. Yet, fixed income ETFs were resilient in 2022 which was the worst year for bonds in decades.

Finsum: Fixed income ETFs are rapidly growing and having positive effects on bond market liquidity even if the underlying bonds remain illiquid.