Fixed income market liquidity

Report submitted by a Study Group established by the Committee on the Global Financial System. The Group was chaired by Denis Beau (Bank of France).

Fixed income markets are in a state of transition. Dealers have continued to cut back their market-making capacity in many jurisdictions. Demand for market-making services, in turn, continues to grow. This report - prepared by a Study Group chaired by Denis Beau (Bank of France) - explores recent trends in fixed income market liquidity, following up on earlier analysis by the CGFS (see CGFS Publications, no 52).

Thus far, the effects of diverging trends in the supply of and the demand for liquidity services have not manifested themselves in the price of immediacy services but rather they are reflected in possibly increasingly fragile liquidity conditions. Key drivers of current trends in liquidity include the expansion of electronic trading, dealer deleveraging, possibly reinforced by regulatory reform, and unconventional monetary policies. Given the transitional state of fixed income markets, regulators appear to be facing a short-term trade-off between less risk-taking by banks and more resilient market liquidity. Yet, in the medium term, measures to bolster market intermediaries' risk-absorption capacity will strengthen systemic stability, including through a more sustainable supply of immediacy services. Overall, the report underscores the need for a close monitoring of liquidity conditions as well as an ongoing assessment of how new liquidity providers and trading platforms are affecting the distribution of risks among market participants.

JEL classification: D47, G12, G15

Keywords: bond markets, immediacy services, market robustness, dealer inventory