“Usually, just as a holder’s desire to sell an asset increases (because he has become afraid to hold it), his ability to sell it decreases (because everyone else has also become afraid to hold it) … Just when you need liquidity most, it tends not to be there,” Marks added.
Looking ahead, with the Federal Reserve eying a possible interest rate hike, bond market participants are growing more concerned.
“There seems to be a conflict between low liquidity in markets requiring more and more predictability and the Fed wanting to have more flexibility,” Deutsche Bank economist Torsten Slok said in a Wall Street Journal article. The “lack of liquidity could trigger a volatile reaction in fixed income markets as investors re-position for whatever decision the FOMC takes.”
Nevertheless, regulators are aware of the problem and are taking steps to help obviate the risks. For instance, the Securities and Exchange Commission is working on rule changes to the creation and redemption process of ETFs, allowing ETF sponsors to use similar debt securities as an alternative when creating ETF shares made up of difficult-to-find or less liquid securities. [SEC Could Amend Rules, Bolster Bond ETF Liquidity]
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.