Bond market illiquidity: a sign of the times (read: deflation threat)

Nearly three weeks ago Bloomberg reported on a study trumpeting that there really hasn't been a liquidity crisis in the corporate bond market, after all. Unfortunately, the headline, "It's Official: There's No Bond Liquidity Crisis", is a lot rosier than the actual assessment laid out in the article. The concluding sentence really sums it all up:

The bond market may be deeply troubled, and may face a rocky road ahead. But the problems have less to do with the mechanics of each debt trade and more with years and years of monetary stimulus and the ensuing lopsided demand to buy credit.

This is pretty much saying, "Yeah, things are really just fine and dandy, because aside from the fact that the whole world has changed what with all the QE and money printing since 2009, everything's still pretty normal and as expected."

Now everyone knows that abnormally low interest rates and multiple rounds of QE in the G-7 since the financial crisis has led to an explosion of debt issuance worldwide; this past summer, the shockwaves emanating from China's stock market crash, economic slowdown, and currency devaluation exacerbated the tensions in the debt (i.e. credit) markets, which since at least mid-2014 had been grappling with a steady hemorrhaging of liquidity owing to the sheer supply glut of bond instruments.

This is a sign of the times: in recent months, Western regulators have begun resorting to rather extraordinary measures to keep the bond bubble from nastily popping. I can't seem to find the articles via Google now, but not too long ago I saw some headline about new limits on bond trading; earlier this year I read about proposals to restrict traders' access to daily bond quotes to reduce volatility.

Bloomberg notes from the study in question:

Their findings show credit markets are actually evolving. And everything seems fine. Maybe even better than it was before the 2008 financial Armageddon, which prompted Wall Street banks to shrink and stop acting like hedge funds.

Now, actual hedge funds and others are stepping in and making markets, even as big banks pull back. Yes, companies can’t seem to sell enough corporate debt and yes, this means trading has failed to keep pace with debt issuance.

As a counterpoint, the banks aren't terribly happy about their reduced role. Just two and a half months ago they were complaining that much of the bond market's liquidity squeeze can be blamed on post-crisis regulation which has constrained their traditional market-making function.

As usual, it's most likely there is a good deal of truth to both sides of the issue.

Back to China, the big elephant in the room...the present state of the global bond market goes a very long way to explaining just how grave is the fear of deflation of asset values in the rich developed nations. It's why, as the cartoon in my last post showed, Xi Jinping could leave the UK with Dave Cameron and George Osborne ecstatic about losing their underwear.

So my next post, hopefully before the markets open Monday, will touch the issue of China's latest interest rate and reserve ratio cuts, the removal of the cap on deposit rates, and consequent likely inclusion in the IMF's reserve currency basket, the SDR (Special Drawing Rights).