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An Angry Paul Volcker Responds To Accusations He Caused The Bond Liquidity Crunch

Paraphrasing Jean-Claude Juncker, "when it gets serious, you have to lie (or deny)" and sure enough in just 30 seconds, the vehement anger Volcker shows in the following clip when 'accused' of creating illiquidity in markets due to his rule suggests the former Fed head is more than a little 'fed' up... and he should be, as we have pointed out previously - while Fink et al. are happy to blame his rule, it is HFT and Central Bank distortions that have created the illiquid disaster that so many call 'markets' today.

 

"look, I've told you... why do we keep repeating ourselves... I am not worried about the lac of liquidity in markets.. period!"

 

 

As we noted previously,

Central bank distortions have forced investors into positions they would not have held otherwise, and forced them to be the ‘same way round’ to a much greater extent than previously. The post-crisis increase in correlations, which has been visible both within credit and equities and across asset classes (Figure 35), stems directly from the fact that investors now increasingly find themselves focused on the same thing: central bank liquidity. Every so often, when they start to doubt their convictions, they find that the clearing price for risk as they try to reverse positions is nowhere near where they’d expected.

 

This explains why the air pockets have not just been in markets where the street acts as a warehouser of risk. It explains why they have occurred not only in the form of sell-offs which could have caused multiple market participants to suffer from procyclical capital squeezes. It also explains why the catalysts have often, while often trivially small, have nevertheless been macro in nature, since they have boosted expectations of a change in central banks’ support for markets.

 

Unfortunately, it leads to a rather ominous conclusion. The bouts of illiquidity will continue until central banks stop distorting markets. If anything, they seem likely to intensify: unless fundamentals move so as to justify current valuations, when central banks move towards the exit, investors will too.

 

To sum up, we are left with a paradox. Markets are liquid when they work both ways. Market participants, though, find themselves increasingly needing to move the same way. This is not only because of procyclical regulation; it is also because central banks have become a far larger driver of markets than was true in the past. The more liquidity the central banks add, the more they disrupt the natural heterogeneity of the market. On the way in, it has mostly proved possible to accommodate this, as investors have moved gradually, and their purchases have been offset by new issuance. The way out may not prove so easy; indeed, we are not sure there is any way out at all.

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To which all we can add is: Good luck with the "exit"