Halister News

(Bloomberg) -- High-grade and liquid govt bonds such as those from the U.S., Japan and Europe are witnessing a significant drop in liquidity, and along with low rates, are posing heightened risks to financial stability, according to Bank for International Settlements.

• Less counterparties are quoting in $50m trades and are taking longer to come up with quotes, Miklos Endreffy, senior portfolio manager at BIS said at a conference in Hong Kong yday
• In Europe, players are defensive in offering high-grade credits, covered bonds where the ECB has a large footprint
• Monetary easing and persistently low rates also alter investor behavior with a lot more risk-seeking behavior seen
  • Investors including pension funds, life insurers are being pushed into risky asset class as traditional sovereign bonds are being purchased by central banks
• “So it really comes down to the risk of financial stability and how it can blow up very quickly,” Endreffy says, adding that “things can get ugly very quickly”
• Correlation between bonds and equities have changed and markets are now more affected by central bank purchases
  • Central banks may never actually exit from these policies
  • Balance sheets may be permanently elevated
• Money market reform, to be implemented in Oct., has led to rise in govt funds and fall in prime funds, which is depriving Japanese banks of a big source of dollar funding
  • Japanese banks are seeking alternative dollar funding by issuing commercial papers, a major reason why Libor has risen so fast
  • Investors may end up buying underlying Japanese govt bills, and swapping the FX proceeds for Libor plus 40-60 bps
  • Proportion of JGBs held by foreigners has risen due to activity from institutions such as SAFE, RBA and BIS
  • Money market reform has opened up a great outlet for dollar funds, provided investors are happy taking Japanese risk; this is also true for French CPs