As the sudden spells of activity grip the market’s volatility, it has become a common phenomenon in recent weeks. As the tendency of the investors to buy off assets during the low period is quite strong, the real test would be when the Federal Reserve withdraws asset price support.
As of now, the overall liquidity is relatively high in the market. Even though the central bank is tapering, its asset-buying plans are still huge. As sharp swings have been seen in the market recently, we will experience Gramercy’s founder Robert Koenigsberge’s phrase “illiquidity in the middle of liquidity. It seems absurd that one can find illiquidity within liquidity.
In recent years, investors have been well equipped to navigate the storms of volatility for further future gains by using market drops as a basis. But, if this was not enough, two factors have now complicated matters: first the inflation, and second the investability of China and Russia.
Investors now need to be extra careful about not just illiquidity in the middle of generalized liquidity but consider overall liquidity.
Global bonds and equity investors have recently seen a considerable surge and slump in recent days. Last week’s falling of the stocks, then recovering for two days and then again pitching low.
Health, economic and financial grounds were the immediate concerns of this volatility. The new and more infectious coronavirus variant, Omicron, and the fashion in which chair of Federal Reserves Jay Powell chose to withdraw the gross wrongly characterization of inflation as transitory.
Due to lack of sufficient risk-absorbing capital, the volatility caused by chaotic closing of the pain trades was magnified by a well-established structural imbalance while facing a sudden shift in ordinary market knowledge.
It was all due to the extended Federal Reserve market distortion, which reflected uniformity of portfolio positioning and not just the intermediaries (broker-dealers) to act counter-cyclically. Until now, the fear of missing out on an investment opportunity was the driving force that kept the illiquidity in liquidity in check.
With strong confidence in the Federal Reserve, every spell of localized illiquidity encouraged the private sector to extend their leverage to take advantage of the situation. Due to this, more and more people got pulled into a similar situation. Consequently, the risk of systemic financial instability shifted from banks that have robust regulatory oversight to non-bank participants in the market who are under-supervised and poorly regulated.
So inflation and the investability of major emerging economies are setting up the stage for the two new global themes.
Persistent inflation restricts the ability of the Federal Reserve to inject liquidity into the market. This ensures that the central banks are not dovish, resulting in global monetary policy tightening.
There would be a greater risk to the markets’ own leverage and debt which will threaten internal global financial conditions to tighten as more of this reality sinks in. Omicron magnifies the risk of stagflation tendencies making it more prominent by the unintended effects of well-aimed deterrent health measures. This week’s clear imposing of a vaccine mandate by Bill de Blasio, New York’s mayor, on the private sector is just one example.
The question regarding China and Russian is even more complicated. The uncertainties regarding the Chinese government’s involvement in the market are greater. Greater the scale and the scope of the Chinese government’s involvement, the higher is the risk to global capital. Mostly those involved in so-called tourist flows have ended far from their natural habitat, being pushed due to highly subdued yields at home. This can result in the tightening of global financial conditions.
There are greater possibilities for destabilization rounds of sanctions and counter-sanctions as the west is concerned about Ukraine. The desire in market volatility is simply to repeat the past incident involving reversible illiquidity, between persistent general liquidity. But the risk that would grow with regards to highly persistent inflation and uncertainties of the emerging market is one of the most generalized and more permanent dwindles of overall liquidity.