“This is the most well telegraphed rate rise in the history of rate rises. So, if you’re not ready for it, you sure as hell have been warned. You’ve got no excuse.”
Guy Debelle told traders and investors to prepare for a new bond market order where volatility is almost certain to rise in times of stress. Giving a speech at an Actuaries Institute Seminar in Sydney, the Reserve Bank’s assistant governor said the emergence of algorithmic trading and the fall in liquidity which has arisen from stricter compliance regimes meant the market would be more volatile in times of stress.
He said the “flash crash” in the US highlighted the prevalence of algorithmic traders, otherwise known as high frequency traders, who now account for approximately one third of the Australian bond market trading activity and more than half of the US market. High frequency traders provided plenty of liquidity to buy small parcels of bonds at prices close to the market but the depth of liquidity was poor as there were few buyers prepared to take larger parcels. Liquidity could be “both good and bad simultaneously.”
Fund managers needed to recognise the bond market had changed, adapt the way they trade in bond markets and possibly have “a higher liquidity buffer” than in the past to handle unexpected redemptions. Liquidity had never been all that good during financial market crises but now it was worse as banks “are less able to be nimble buyers of assets whose prices they believe have overshot.” The change had arisen because of regulatory changes and internal risk tolerances”. He posed the question: “Has regulation increased the cost of liquidity provision too far with the result that liquidity in the bond market is now too low?”