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The Liquidity Crunch Is Here

there is a major liquidity crunch now underway in the band market which will impact your asset values

By Joel Ross | Updated on June 14, 2015

It remains very unclear where rates may move over the next few months.  The Fed and Dodd Frank have created a dangerous and rapidly developing liquidity crunch in the Treasury and bond markets.  The Fed swept up $4 trillion of various bonds, and Dodd Frank regulations on the major banks trading desks and capital requirements has caused them to shed as much as 90% of the bond inventories. Due to the regs, once bond prices begin to move even lower than they recently have, the banks will be loathe to hold bonds and have these losses reflect on their capital and risk parameters. So Dodd Frank has managed to severely curtail the trading market to the extent that it is not really a market price for bonds that we see today. Not only is there very limited liquidity for large holders, but price moves are accentuated by the lack of liquidity.

The real problem will come when rates continue to rise even more than in the past few weeks and there is a flood of bonds hitting the market all at once. There will be few buyers thereby pushing bids down at an accelerating rate. There is a risk that the downward rush will be pushed further than a true market would have pushed them and rates will move up very fast. Then we need to look at the fact that the Fed has to dump several trillion of bonds on this limited market over the next few years. At some point the ECB will also need to dump all of the bonds it is now buying. Other central banks around the world will be doing the same. One assumes the Fed and ECB will be careful in their liquidation programs, but there will be this massive overhang to the market for years to come. Once the liquidation starts in earnest the overhang becomes real.

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