European investors have thrown their weight behind comments by Jamie Dimon, the CEO of JPMorgan, this week who warned of the risks that reduced liquidity was having on global asset markets.
William de Vijlder, the group chief economist at BNP Paribas, called this the main issue that markets were currently facing and was relieved that the problem was now coming to the fore.
"The concern I have is the following, that markets go up based on monetary liquidity - central bank injections - and they go down based on a reduction in market liquidity ," he said.
He added that a lack of market liquidity could be highlighted during the "final phase" of a bubble in a particular asset class. He explained that a number of traders could be stung making short term moves as the clock runs down before a steep correction.
"All of a sudden, the music changes," he said.
Both Dimon and Larry Summers, the former U.S. treasury secretary, have warned about the volatility in currency and Treasury markets this week and how a lack of market liquidity can spark wild intraday swings. Dimon implied that another economic crisis was inevitable and focused on the "multiple new rules" from regulators since the 2008 financial crisis that was affecting the market-making capabilities of banks.
"The banking system is far safer than it has been in the past, but we need to be mindful of the consequences of the myriad new regulations and current monetary policy on the money markets and liquidity in the marketplace—particularly if we enter a highly stressed environment," Dimon said in the newsletter on Wednesday.
Bill Blain, a fixed income strategist at Mint Partners, waded in on the debate in his daily research note on Friday. Incredulous at the seemingly never-ending rally in European sovereign bond markets he said "what goes up must come down."
"If you thought the bond-spike liquidity-vanishing moments we saw last year were extraordinary…you ain't seen nothing yet," he said.
Global management consulting firm Oliver Wyman and Morgan Stanley released detailed report on the subject in March, highlighting that global banks have shrunk their balance sheets by some 20 percent since 2010 which has "significantly" reduced the liquidity in secondary asset markets.
"Liquidity has decreased sharply, creating new risks for investors and issuers, but there are no easy answers. Policymakers face a difficult set of trade-offs and how they and the industry responds will have profound implications on traded markets and investors." Christian Edelmann, the partner and head of corporate and institutional banking practice at Oliver Wyman, said in the report released on March 19.
The research involved interviews with asset managers, with portfolios totaling around $10 trillion, who indicated that liquidity in fixed income markets was one of their top concerns.
The Governor of the Bank of England, Mark Carney, has previously highlighted that liquidity could evaporate as the U.S. Federal Reserve tightens its main benchmark interest rate. The Bank of International Settlements also warned in March that market liquidity in the bond markets may increasingly be dependent on the portfolio decisions of only a few large institutions.
Meanwhile in November, a report by the International Capital Market Association (ICMA) looked at the European corporate bond market and concluded that its liquidity was "rapidly evaporating" mainly due to financial regulation and extraordinary monetary stimulus. Regulation, rather than reducing systemic risk, has simply transferred that risk from the banks to investors, it said.