‘Liquidity is terrible’: Poor trading conditions fuel Wall Street uproar
The ability of traders to transparently buy and sell stocks, bonds and other financial products on Wall Street has deteriorated sharply this year, fueling wide swings in the world’s largest and deepest capital markets. world.
Liquidity in US markets is now at its worst level since the early days of the pandemic in 2020, according to investors and major US banks who say fund managers are struggling to execute trades without affecting prices.
Relatively small trades worth just $50 million could drive the price down or cause a rally in exchange-traded funds and index futures that typically trade without causing major ripples, says Michael Edwards , deputy chief investment officer of hedge fund Weiss Multi-Strategy Advisers.
He added: “Liquidity is terrible.”
The challenging conditions were met with a significant shift in the global economy that caught many portfolio managers off guard: slowing growth, rising interest rates and intense inflation. Unprepared for the shift in sentiment, traders abruptly repositioned their portfolios.
The shortage of liquidity also affects the vital markets that companies use to finance themselves and that governments exploit to fund public spending. Minutes from the U.S. central bank’s latest policy meeting released last month showed officials were concerned about problems created in the Treasury and the commodity market by weak liquidity.
The business landscape changed dramatically after policymakers in Washington and Brussels sought to shield Main Street from Wall Street in the wake of the 2008 financial crisis. banks are now required to hold larger capital buffers to protect their balance sheets against major fluctuations.
This means that banks now hold far fewer assets, such as stocks and bonds, making them less nimble in responding to investor buy or sell requests and clogging the channels that connect buyers and sellers.
“People [banks] are unwilling to commit capital,” Edwards said.
In debt markets, holdings of corporate bonds among primary traders who underwrite U.S. government debt have steadily declined over the past decade, according to data from the New York Federal Reserve, taking another leg longer. low this year.
In particular, banks have moved away from holding debt that is more vulnerable to rising interest rates, reducing their net positions in high-quality bonds with maturities of 10 years or more into negative territory. Meanwhile, the health of the US government bond market – a benchmark for trillions of dollars in assets worldwide – is at its worst since the March 2020 market crash, according to a Bloomberg index.
“It’s frustrating,” Jordan Sinclair, research director at the Capstone hedge fund, said of the cash crunch. “The global financial crisis was a failure of the banking sector. They took too many risks and gave too much weight and it only made sense for regulators to make sure it didn’t happen again. But there are consequences.
This manifested itself in more heated exchanges. Sinclair estimated that the Vix index, an indicator of US stock market volatility, jumped more than 5 points in a single trading day nine times in the 15 years before the financial crisis. In the 15 years since the crisis, this has happened 68 times.
And yet, during this period, the business losses suffered by major US banks have been manageable and have not threatened the entire financial system. This is a fact not lost on traders and investors, especially after the fallout from the collapse of the Archegos family office last year was largely contained.
High-frequency trading firms like Citadel Securities and Jump Trading have filled some of the void left by the big Wall Street banks, but investors said the algorithms that help execute trades through these types of traders often mean that trading capacity was automatically reduced when stocks began to swing violently.
In May, investors hoping to trade e-mini futures on the S&P 500 – one of the most important contracts that big fund managers use to bet on the direction of the market – saw tiny offers to buy and sell by looking at their trading screens. Goldman Sachs recorded that on some days less than $2 million worth of contracts could be bought or sold at the actively quoted market price, the lowest level since March 2020.
Separate data from JPMorgan Chase underscores the fragility of the system. The bank measured the order imbalance — the difference between buy and sell orders in S&P 500 e-mini futures — it took to move the futures 1% in five minutes.
It took an order of about $900 million to move futures contracts that amount in May, about 67% less than the size of a trade imbalance that would have been needed from 2017 to 2019. Strategists at the bank found that a similar phenomenon occurred in futures contracts. followed by US government bonds, warning that “liquidity has recently started to decline again and market depth over the past three months is now the lowest since March 2020.”
Low liquidity has amplified stock market volatility, investors said. In back-to-back trading sessions last month, Walmart and Target suffered their biggest declines since 1987 after each warned of intensifying cost pressures. The slides erased $71 billion from the pair’s market valuation.
Outsized daily stock moves were also recorded at Meta, Amazon and Facebook-owner Netflix, while metrics show volatility in blue-chip companies like Apple, Microsoft, Visa and Coca-Cola increased.
“There are a lot of transactions, but in terms of order size, they’ve been smaller in recent months,” said Mary Phillips, head of Dimensional. “I think if you’re the kind of asset manager who tries to do big block trades quickly and you’re really specific about what you want to trade, you might face some liquidity issues.”