It is increasingly about the functioning of markets
While attention is understandably focused on last week's market selloffs, some investors are also looking elsewhere - and rightly so.
For them, another unsettling aspect of the past few days relates to the manner in which the markets have functioned.
Liquidity is patchy, volumes are down, some bid-offer spreads are gapping, and there is little appetite among Wall Street intermediaries to warehouse risk - all pointing to some clogging in the pipes that allow for the normal and efficient functioning of markets.
Not surprisingly, signals of market stress are increasing, with a growing number of measures now flashing yellow and some on the verge of flashing red. The longer this persists, the greater the risk of very large market moves - in either direction, depending on the economic and financial catalysts.
Three factors are impacting today's functioning of markets.
First, a growing number of European institutions appear to have stepped up their de-leveraging. The driver is the deepening European sovereign crisis.
In the absence of proper policy responses, the dislocations have decisively breached the Italian firewall and have now spread to the core of the euro zone. The result is an across-the-board disposal of assets on the part of increasingly-stressed institutions.
Second, healthy balance sheets - and there are quite a few of them around the world - are refusing to engage fully. Indeed, some are going the other direction and opting for additional de-risking in response to an unusually cloudy economic and policy outlook.
Moreover, even healthy banks are now pursuing the 2011 version of the 1980s phenomenon of "macho provisioning" - namely, disposing of certain European assets in a very loud fashion in order to signal to investors that they are in better shape than some competitors.
Third, market technicals are acting as amplifiers. A number of examples come immediately to mind.
Regulatory and traditional year-end considerations are influencing the way certain financial institutions are managing their balance sheets.
Greece-related developments have narrowed the range of credible risk-hedging instruments, encouraging banks and hedge funds to reduce gross exposures and not just net exposures. And the expanding role of official entities - as both buyers and sellers in daily markets, and not just regulators and supervisors - is diverting some balance sheets away from normal market activities.
Left to their own, these factors will continue to eat away at liquidity and sideline a larger number of market participants. They can only be reversed by substantial actions in Europe, thus adding to the pressure being placed on the European Central Bank to be more aggressive.
The ECB will not, and should not, engage more of its balance sheet without greater re-assurances from European governments - those that have fallen behind over the years in implementing economic reforms that promote growth, jobs and medium-term debt sustainability (such as Greece, Italy, Portugal, Spain etc...), as well as the stronger economies that can provide significant financial support to their struggling neighbors (primarily, and critically, Germany).
Today's market outlook does not depend just on the wellbeing of companies and the stance of our policymakers (including the outcome of the Super Committee that will report in a few days). Increasingly, it is also impacted by the state of the pipes that determine the manner in which markets function.
For this reason alone, and whether we like it or not, we must all now be avid watchers of the ECB and of the range of required actions by other Europeans to enable this institution to be more engaged in solving the crisis.
Dr. Mohamed El-Erian is CEO and co-CIO of PIMCO