As the pace of rate hikes by the Federal Reserve is revised downward by market participants, many of them remain convinced of the strength of recovery in the United States. The rise in the EUR/USD exchange rate could therefore convince Mario Draghi and the Governing Council to take a further step in their ultra-loose policy. Considering the above, it is critical to focus on the following elements: central bank liquidity, the Expanded Asset Purchase Programme and the market liquidity. In this environment, it is key for investors to get used to the fact that a minimal risk investment can no longer be considered without capital erosion. When it comes to investing excess liquidity, we should be aware that: • money market funds remain the most appropriate type of vehicle to park operational cash. They offer investors both safety and liquidity necessary for very short-term investment, with attractive returns compared to other alternatives. • enhanced treasury funds, in a context favourable to short-term bonds, can provide support adapted to the strategic treasury investment.
Figure 2: ECB Key rates, Eonia and excess liquidity
Source: Amundi
surprising to see asset managers and other fund managers assigning greater importance to liquidity, fund liabilities, et cetera. So how do you measure underlying liquidity? Research indicates that market liquidity is increasing in four different dimensions: • Market depth: the possibility of carrying out large-scale transactions without causing substantial price changes; • The tightening of the bid–offer spread;
THE ISSUE OF MARKET LIQUIDITY There are several factors that impact portfolio liquidity. Admittedly, central banks, led by the ECB and the BoJ are pumping liquidity into the economy through their asset purchasing programmes. However, while massive purchases of EUR 140bn in Bunds by the ECB aim to reduce market liquidity, Germany plans to issue ‘only’ EUR 1 billion in Bunds. In simpler terms, we must not confuse macroeconomic liquidity and portfolio liquidity. According to an estimate by the Bank of England, closing out a position or a portfolio now takes seven times longer than it did prior to the 2008 financial crisis. As you might expect, it is not
THE EXPANDED ASSET PURCHASE PROGRAMME (APP) Monthly purchases in public and private sector securities will amount to EUR 80bn (March 2015 March 2016 this figure was EUR 60bn). They should continue until the end of March 2017 and until the path of inflation is consistent with inflation rates below or around 2% over the medium term. At the end of April 2016, the purchases reached EUR 78bn and cumulatively from March 2015 - April 2016 the holdings represent a total of EUR 732bn with a remaining average maturity of 8.08 years.
• Speed of execution; • Price resilience: the ability of the market to return to the price levels that prevailed prior to a period of f inancial turbulence. Until now, analysis of the bid-offer spread was the simplest way of evaluating liquidity. In theory, narrowing spreads represent an improvement in liquidity. However, this is a particularly misleading indicator. In fact, two of the most important factors are the quantity that can be processed and the speed with which orders can be placed. In addition, the bid-offer spread must be viewed in conjunction with the level of interest rates. With interest rates approaching zero, the level of bid-offer spreads is not the same as when interest rates were at 4%. In other words, narrowing spreads is by no means a good measure of underlying liquidity. It should also be reiterated that when liquidity decreases, prices become less powerful in terms of information as they have drif ted away from their fundamentals. The risks of contagion and volatility also tend to intensify while less liquid markets lose their ability to withstand weaker shocks. Lower liquidity ultimately means greater room for manipulation. Overall, the issue of liquidity is clearly apparent. Central banks’ asset purchasing programmes are not the sole factors responsible for lower liquidity: regulation (which provides an incentive for buying and holding sovereign bonds) is another driver, as is the frantic search for yields and spreads. «
This article was written by Thierry Darmon, Co-Head of Treasury Business Line, Amundi, and Philippe Ithurbide, Global Head of Research, Strategy and Analysis, Amundi. NUMMER 4 / 2016
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