June 28, 2017 / 9:07 PM / 2 years ago

UPDATE 1-U.S. bond market liquidity may be more fragile -N.Y. Fed blog

(Adds analyst quote, context from blog post)

NEW YORK, June 28 (Reuters) - Some measures of U.S. bond market liquidity have deteriorated since the 2007-2009 global credit crisis due to a shrinkage of dealers’ balance sheets, the growth of electronic trading and other structural changes, according to a New York Federal Reserve blog published on Wednesday.

Nonetheless, the blog’s authors concluded that liquidity remained resilient after examining the effects of the 2013 “taper tantrum” in the Treasury market, the Oct. 15, 2014 “flash rally” in the Treasury market and the liquidation of the Third Avenue’s high-yield bond fund in December 2015.

A deterioration in liquidity, or how easily bonds are bought and sold, has concerned investors and regulators in the aftermath of those stress events.

Some market participants blamed the episodes on smaller dealer balance sheets due to regulations aimed at safeguarding the financial system.

“We find that dealer balance sheets have continued to stagnate and that various measures point to less abundant funding liquidity,” Tobias Adrian, an analyst at the International Monetary Fund, and New York Fed economists Michael Fleming and Or Shachar, wrote in their article, “Market Liquidity after the Financial Crisis.”

Dealers’ assets fell to $3.0 trillion at the end of 2016, down from a peak of about $5 trillion in early 2008 prior to the height of the financial crisis.

Tougher capital rules “have made it more expensive for bond dealers to carry bond inventory,” said Sharon Stark, fixed income strategist at Incapital LLC in Boca Raton, Florida.

Because of this, dealers have become more reluctant to stake big bond positions, the blog’s analysts said.

Possibly due to less dealer support, there has been a decline in the “depth” of the $14 trillion U.S. Treasury market, they said.

The average quantity of these government bonds that can be traded at the best bid and offer prices remained below levels seen before the crisis and 2013 “taper tantrum” but above levels during the crisis, they said.

In the $8.5 trillion U.S. corporate bond sector, the average bid-ask spreads on institutional-sized trades remained above pre-crisis levels, they noted.

While these measures signal some decline in liquidity, the deterioration was not widespread, they said.

“Although liquidity under normal market conditions may not have significantly worsened, it might be that it has become more fragile, or prone to disappearing under stress,” Adrian, Fleming and Shachar wrote.

Based on the market episodes examined in their blog, “the degree of deterioration in market liquidity was within historical norms, suggesting that liquidity remained resilient even during stress events,” they wrote.

Reporting by Richard Leong; Editing by Paul Simao and Meredith Mazzilli

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