Early last month, three weeks prior to Russia’s invasion of Ukraine, Goldman called liquidity the bank’s “biggest technical concern.”
At the time, S&P futures liquidity was nearly as poor as it was during March of 2020, when the onset of the pandemic plunged markets (all markets) into abject chaos.
The bank’s Rocky Fishman cautioned that “low liquidity raises the stakes for systematic fund positioning,” increasing the odds that mechanistic flows “impact markets more than [they] would if liquidity were stronger.”
That’s part and parcel of the “doom loop,” wherein a lack of market depth exacerbates volatility (the two are negatively correlated), leading to even larger moves and higher vol in a not-at-all-virtuous circle that can easily pull in CTAs if trigger levels get taken out.
Needless to say, it’s been a rough ride since Goldman’s warning. For what it’s worth, the bank’s David Kostin cautioned again on liquidity in the course of cutting the bank’s S&P target for 2022. Buried nine pages into the rationale was a notable statistic: The median S&P stock’s bid-ask over the past month was the widest ever going back a decade if you don’t count 2020 (i.e., “ex-pandemic,” if you like). The figure (below) illustrates the point.
Once again, you’ll observe the relationship between liquidity and volatility. The more impaired the market, the higher volatility will invariably be. And higher volatility is conducive to even wider bid-asks. As JPMorgan’s Marko Kolanovic wrote years ago, “many market making algos (as well as business models) were calibrated during the years of low volatility, and as these programs don’t have an obligation to make markets and are optimized for profits, they likely adjust quotes and reduce size in order to maximize their own Sharpe ratio.”
Writing late last week, Goldman’s Kostin blamed poor liquidity for “exacerbat[ing] the impacts of shifting geopolitical risk and investor length on stock prices.” He continued, noting that “the combination of uncertainty, elevated volatility and widespread selling has also catalyzed a large drop in market liquidity.”
That underscores the chicken-egg dynamic that’s a fixture of these discussions. It’s never entirely clear which came first: Impaired market depth or elevated volatility. One thing we do know is that liquidity never recovered following the implosion of the VIX ETP complex on February 5, 2018, Jerome Powell’s first day on the job as Fed Chair (figure below).
I suppose this goes without saying, but the Ukraine conflict hasn’t done anything to help the situation. On-screen liquidity remains near the worst levels ever.
“S&P 500 futures average top-of-book size has declined [and] rival[s] Q4 2018 as the lowest level in 15 years outside of early 2020,” Kostin went on to say, noting that at 8bps, the median S&P 500 stock’s bid-ask over the past month rank[ed] in the 98th%ile of the past decade and the widest outside of 2020.”
Bid Ask spreads on SPY this morning we’re completely out of whack, something might break soon
Liquidity is literally what makes the world go round and risk adversity tends to wake up zombies that are in the speculation dance.
I was just reading about Russia adjusting the time component of currency pegs and thus the apparent strategy to literally buy time to arbitrage, as the rouble continues it’s spiral into hell, where hopefully it will be permanently buried.
Nonetheless, that sort of adaptive experimentation designed to slow defaults is a red flag for global liquidity links and chains. Russia will depend on triangular trading with partners that will cooperate with building a house of cards linked to real world global debt that probably makes Lehman look meek.
It’s a very ugly rabbit hole to explore, and the likelihood of ever getting out is slim, but the games between Russia, China, India and a chaotic chain of bad actors is very dark.
Random snip about chaotic banking in China which goes deeper than evergranse and crosses over to Russia oil and currency defaults:
“Due to the natural defects of receivables, the circulation of such credit certificates not only increases the vulnerability of the financial system but also aggravates the plight of small, medium and micro businesses, Kong said.
Such credit certificates are essentially illegal financing activities, which should be subject to unified supervision and regulation, a senior bill expert said…”
@oldbird spreads apocalyptic wings and lets his metaphors soar to heights I’ve never seen before! Not only that he sorta scared me with those supporting details! Cool.
Russian lawlessness knows no bounds on or off their battlefield of Imperial dreams. Just a couple of days ago I heard Russian elites announced patents, licensing agreements, trademarks, and so on, of non-aligned Western powers no longer had to be honored. That came on the heels of the confiscation of about “$10.6 billion” of leased commercial aircraft. What the totals for similar leased/’borrowed’ properties will amount to is something for Western business zombies to speculate on. One might think, the lessor’s will be able to repo the planes per long-standing norms between countries when lessees fail to make payments, but that would be wrong with Russia today. Access has been denied. One might also mistakenly think that the lessor’s will eventually get their assets back. The problem is these commercial aircraft must adhere to strict maintenance rules and schedules if they ever hope to maintain certification in the West. This means that ~$10.6 billion is rapidly coming in for a hard landing on runway 0.00. I’m writing from memory based on a days old Bloomberg.com article. But it fits in with a decades long trend for Putin and his allies with authoritarian bona fides and the others now displaying strongman proclivities. Treaties broken, formal and informal agreements of every sort turned against counter-parties to the detriment of the trust, international bodies of law followed only to the extent it suits. Consider the Hong Kong treaty and what is unfolding today is being in character. The Authoritarian Axis’s rapidly accelerating willingness to go beyond merely entertaining into enforcing increasingly fabricated narratives has now breached contract law that binds together economically profitable relationships. Business’s like MCD exiting Russia while promising to keep paying employees seems like a desperate ploy to buy protection for their stranded assets in the hopes the new Iron Curtain will be short lived. Good luck with that now that the legal basis for their grand dreams of world markets are imploding along with counter-party trust. Did these Western business zombies make the mistake of supposing “business law” was somehow sacrosanct while the rest of their authoritarian host’s civil legal system was essentially non-existent and/or hopelessly fragmented and/or corrupt and/or ultimately incompatible with lowercase “l” liberal, or even neoliberal, democracy values?
There seems to be some loose parallels with the 1930s Japan, Germany, Italy, etc resenting and then turning against the Western liberal democracy powers of sanction first imagined and acted upon in grand scale by Woodrow Wilson with the drive to form the League of Nations. It was only just a few days ago that Woodrow’s ambitious dream that war between large nations might be thwarted with “negative economic pressure” (if I remember the phrase used before “sanctions” correctly) got it’s first real trial run. Results to be announced. Woody’s initial threat of negative economic pressure may well have only exacerbated the Axis powers turn toward autarky and disengaging from the West’s liberal ideas. Autarky rather than playing by ‘rules’ to further integrate globally is certainly a common thread today’s authoritarian states share with the 1930s authoritarian states. Is it time to dust off the old phrase “Oriental Despotism” yet again? … Jeez, I weary of this for now.
H-Man, it would appear that capitulation is closer than we think.
It’ll be hard to miss when it does arrive. Once there are articles saying that people felt forced to sell their long term stock holdings to pay their mortgage or rent we’ll know capitulation is here.
Another indicator worth paying attention to is the chained collapse of a series of stablecoins.
Powell giveth, and Powell taketh away.