Analysis: Traders ready for wilder swings as rate rises stoke volatility

　　div classBodysc17zpet90 cdBBJodivpBy Dhara Ranasinghe, Saikat Chatterjee and Davide Barbusciap

　　pLONDONNEW YORK Reuters – Traders in the worlds largest markets are having to navigate wild intraday swings and shrinking deal sizes as central banks rapidly withdraw stimulus measures, in a smallscale reminder of a pandemicdriven financial seizeup just two years ago.pdivdivdiv classBodysc17zpet90 cdBBJodiv

　　pThe U.S. Federal Reserve said in a report this week that liquidity had “deteriorated” further than what might be expected at current levels of volatility, with noticeably poor conditions in treasury, commodity and equity markets. p

　　pThe onset of the coronavirus pandemic triggered a market crisis in March 2020 as investors dumped riskier assets, prompting global policymakers to pump in a total of 15 trillion, the equivalent of more than a sixth of the world economy, to help them regain stability.p

　　pIf markets are too unstable, the ability of central banks to transmit their monetary policy effectively is reduced and the Feds wording is being read as a warning by some.p

　　pLiquidity had already been progressively more constrained after post2008 regulations curbed the marketmaking and risktaking ability of the worlds biggest banks. p

　　pBut this years pinch is down to rapid interest rate rises by central banks and their efforts to cut balance sheets swollen by huge bondbuying programmes, with liquidity shortfalls now particularly acute in bond markets.p

　　pIt is also evident in the Cboe Volatility Index, known as Wall Streets “fear gauge” which is up 14 this week alone. But at just over 34 points, the VIX remains below peaks of almost 90 hit during the outbreak of the COVID19 crisis in 2020 and the global financial crisis in 2008.p

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　　ppCentral bank balance sheets set to get smaller https:fingfx.thomsonreuters.comgfxmktakpezybwgvrcbanks1205.PNGp

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　　ppDEPTH DEPRESSEDp

　　pAs of next month the Fed will start selling down its bond holdings, which is likely to mean even thinner trading volumes.p

　　pBethany Payne, bond portfolio manager at Janus Henderson Investors, said “the risk of hitting bond market airpockets has increased” of the possibility of big sudden price swings. p

　　p“Bond market depth remains depressed year to date, as liquidity is withdrawn from the system,” she said, citing the combination of monetary tightening, inflation, Russia‘s invasion of Ukraine, and the Fed’s bond sale plans. p

　　pOne indicator of the scale of the volatility are German 10year bond futures, which are showing an average daily gap between the highest and lowest prices that is higher than any year in the past five, Refinitiv data shows, while Bund volatility in March was the highest since 2020.p

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　　ppVolatility in German Bund futures has jumped https:graphics.reuters.comGLOBALBONDSzjvqkjqyxvxchart.pngp

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　　ppThe picture is similar in the 20 trillion U.S. Treasury market, which Steven Abrahams at brokerage Amherst Pierpont said results from the Feds “withdrawal of liquidity by design”.p

　　p“There are more investors that just arent sure where the curve is going to go next, that has taken some of the capital out of the market, and traders are seeing it in kind of jumpier moves in yields during the day as well,” Abrahams said.p

　　pVarious indexes illustrate the shape market liquidity is in, with Abrahams analysis showing Treasury liquidity at its tightest since March 2020.p

　　pAnd a Goldman Sachs indicator based on inputs from over 30 different markets shows Treasuries leading recent liquidity tightening. p

　　pAnother from CrossBorder Capital, which the consultancy says leads markets by 612 months, is at a threeyear low.p

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　　ppBond volatility https:fingfx.thomsonreuters.comgfxmktakpezybrqvrbond20volatility.JPG p

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　　pp‘BE MORE CAREFUL’p

　　pGreater volatility appears to be filtering into currency markets, where average daily turnover on the worlds mosttraded exchange rate pair, eurodollar, is down to 4,500 trades on the EBS multidealer platform, from nearly 6000 in March.p

　　pLower turnover can increase volatility, with a gauge of expected swings in the euro on a onemonth horizon recently hitting twoyear highs above 12, Refinitiv data shows. p

　　pThat often leaves traders struggling to execute larger trades and can cause a small number of trades to move prices.p

　　p“If you look at the screens, they are relatively normal. But we know that if anyone wants to trade a big size, that market depth will be challenged,” Chris Huddleston, CEO at brokerage FXD Capital in London, said, adding trading would get harder as interest rate hikes gather pace.p

　　pSuhail Shaikh, CIO at Fulcrum Asset Management in London, estimates volatility is already between the 90th and 95th percentile in the context of asset classes own history.p

　　pBut market nervousness is partly because “risk officers are pointing out the Fed has been making loud noises about liquidity, which is not common for the Fed to do,” Shaikh said.p

　　p“So we are just moving on from there being no worries to be more careful,” he added. p

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　　pp Reporting by Dhara Ranasinghe, Sujata Rao, Danilo Masoni and Saikat Chatterjee and Davide Barbuscia Editing by Sujata Rao and Alexander Smithp

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