Bond market liquidity will get worse, not better: industry experts

LONDON (Reuters) - The problem of thin liquidity fueling volatility across global fixed income markets is going to get worse over the next few years, not better, an industry conference in London was told on Tuesday.

The combination of tighter regulation with banks reducing their borrowing capabilities and changing their business models has contributed to a loss of liquidity. That has exacerbated price moves in many fixed income markets, even the generally safe and steady areas such as top-rated government bonds.

“The liquidity situation is extremely tight,” Marc Hellingrath, head of financials at Union Investment, told the Euromoney Global Borrowers & Investment Forum in central London. “We see regulatory headwinds coming further and further down the road, so we expect liquidity to get even worse.”

Hellingrath was on a five-strong panel which included investors, regulatory experts and trading platform and technology providers.

A wave of post-crisis regulation has forced banks to hold more capital and trade on their own account less. That has made them less able to hold large inventories of bonds on their books and act as market makers.

Reflecting how critical the issue of liquidity is to financial markets right now, the audience approached 200, more than double the turnout for other panels earlier in the day.

Lack of liquidity - the ability to trade large volumes of an asset without significantly moving the price - was one of the main factors behind the sharp decline in German government bond prices earlier this year.

The yield on benchmark 10-year German Bunds soared a full percentage point in just two months after trading at a record low close to zero in mid-April. German bank Commerzbank called the selloff a “flash crash”.

The problem may be even more acute in corporate bond markets, where liquidity is often lower anyway.

Hellingrath said that 80 percent of trading volume in the U.S. corporate bond market takes place in just 20 percent of bonds. The situation is even worse in Europe, he said.

“We’re never going to go back to the good old days. The regulators are here to stay, the market structure is here to stay,” said Tsai Li Renn, head of fixed income trading at Singapore Exchange.

Reporting by Jamie McGeever; Editing by Larry King