Displaying items by tag: liqudity

While fixed-income ETFs are seeing strong inflows this year, academics from a trio of U.S. business schools suggest fixed-income ETFs can suck the liquidity out of corporate bonds during times of market stress. According to them, the potential problem stems from the creation and redemption baskets that ETF issuers trade with market makers, known as authorized participants (APs), to handle inflows or outflows from their ETFs. Unlike equity ETFs, bond funds’ creation and redemption baskets typically do not include every bond in the index they are tracking as this could include hundreds or even thousands of separate issues. In their paper, Steering a Ship in Illiquid Waters: Active Management of Passive Funds, the academics argue that in normal times a bond’s inclusion in an ETF basket makes the bond more liquid. This is due to a random mix of creations and redemptions increasing trading activity. But, during a crisis, when many investors are running for the exits, redemptions hugely outweigh creations. When that happens, if a bond is included in the basket, the APs “may then become reluctant to purchase more of the same bonds, reducing their liquidity,” according to the paper. However, other bond strategists disagree, including Dan Izzo, chief executive of GHCO, an ETF market maker. Izzo, who argues that the rise of ETFs had actually increased liquidity during periods of market stress, stated that “The causality ran in the opposite direction — it is because some bonds are illiquid that they increasingly feature in redemption baskets as sell-offs intensify, not vice versa.”

Finsum:While fixed-income ETFs continue to see strong inflows, a trio of academics argues that bond funds make the market less liquid during periods of stress.

(Washington)

Investors, be worried about the Fed, and not for the reasons you think. While all the market’s focus has been on how quickly the Fed will raise rates, what could really cause problems is the Fed’s unwinding of its balance sheet. According to the Indian central bank, this unwinding is sucking Dollars out of the system and causing a Dollar liquidity squeeze. According to Urjit Patel, the governor of India’s central bank, this Dollar-squeeze means “a crisis in the rest of the dollar bond markets is inevitable”, with a growing “possibility . . . a ‘sudden stop’ for the global economic recovery”.

FINSUM: It sounds like emerging markets are going to have increasing trouble issuing Dollar bonds, which could definitely throw a wrench into the recovery. Maybe this is how the Fed sparks a global recession and not just an American one.