New technology and regulation in fixed income markets have made it harder to gauge levels of liquidity for Treasuries and corporate debt, and have brought new investment risks, U.S. Federal Reserve Governor Jerome Powell said on Thursday.
In recent years markets have contended with a series of revolutions in borrowing, market structure and federal regulations enacted after the 2008 financial crisis.
These developments have fueled concerns that liquidity is drying up across fixed-income markets, Powell said in testimony before a United States Senate panel adding "although many recent studies have found it difficult to identify such a broad reduction."
"It may be that liquidity has deteriorated only in certain market segments," he said in remarks before the economic policy subcommittee of the Senate's banking committee.
"It may also be that, even if liquidity is adequate in normal conditions, it has become more fragile, or prone to disappearing under stress," he said.
Powell cautioned mutual funds and other investors in the corporate bond market about recent record levels of borrowing. With dealer balance sheets shrinking, he said, buyers now bear greater liquidity risk.
There are signs that liquidity is improving in corporate debt, such as declines in estimated bid-ask spreads, but "there is some evidence that liquidity has deteriorated for the lowest-rated bonds," he also said.
In the Treasuries market, changes in technology have allowed trading to move "at extreme speed," and may have "led to greater liquidity risk, or sudden declines in liquidity." At the same time, changes in the market structure have led to smaller average trades, making it hard to see "the effect of trading on prices" and measure liquidity.
The post-crisis regulations have affected liquidity, leading both to increases and decreases, Powell said.
"Some reduction in market liquidity is a cost worth paying in helping to make the overall financial system significantly safer," he said.
Separately, Atlanta Federal Reserve Bank President Dennis Lockhart on Thursday said a potential British exit from the European Union would be a "big event" although it should not "stop the music" on a potential interest rate hike in June. Lockhart also said he no longer would advocate an interest rate hike in April, citing slower-than-expected U.S. economic growth and inflation that is not yet clearly firming.
Lockhart, speaking with reporters after a symposium sponsored by the CFA Institute in Chicago, said he would not rule out a June rate hike but would need to see faster economic growth, continued monthly job gains of more than 200,000, and firming inflation before he could support it.
The British June 23 referendum on whether to exit the European Union, a move dubbed "Brexit," takes place after the Fed's June meeting.