Analysis: Investors see risks increase, fear a liquidity crisis at the market level

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Analysis: Investors see risks increase, fear a liquidity crisis at the market level

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A man wearing a protective mask, amid the coronavirus (COVID-19) epidemic, walks past an electronic card showing the Shanghai Composite Index, Nikkei Index, and Dow Jones Industrial Average outside a brokerage agency in Tokyo, Japan, March 7, 2022. REUTERS / Kim Kyung Hoon

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NEW YORK, March 15 (Reuters) – The violent swings in asset prices following the Russian invasion of Ukraine are driving some investors to reduce risk in their portfolios, fearing the kind of commodity volatility in recent weeks could hit other markets.

The problem is liquidity, or the ease with which investors can buy or sell an asset without affecting its price. While episodes of low liquidity have contributed to sharp swings between markets over the past decade, signs of stress have become more abundant in recent weeks, exacerbated by everything from sanctions against Russia to the anticipated tightening of the central bank. to know more

Should liquidity continue to deteriorate across markets, investors fear other assets could be subject to the kind of violent price swings that rocked commodities this month, which included a one-day doubling in nickel prices and an increase in oil to 14 years. tall.

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“It’s not always clear where the contagion risks lie,” said Frances Donald, Global Chief Economist of Manulife Investment Management. “This is why liquidity needs to be monitored, not just daily, but hourly at this point, for signs of challenge.”

Financial indicators are showing increasing signs of stress across all markets.

The so-called FRA-OIS spread, which measures the gap between the US three-month forward rate agreement and the overnight index swap rate recently hit its highest level since May 2020, while another stress indicator on closely monitored short-term borrowing, the spread between the three-month US Libor and the overnight rate on the swap index was at a similar level. The volatility of stocks (.VIX), currencies (.DBCVIX) and US Treasury yields (.MOVE) also increased. to know more

In another potential red flag, Barclays (BARC.L) on Monday suspended sales of two products related to crude oil and market volatility, which some saw as a sign of lack of liquidity. to know more

Among the assets investors cut were emerging market bonds, which last week recorded net outflows of $ 3.54 billion, the largest decline since April 2020. Treasuries, meanwhile, recorded inflows of about $ 5.4 billion in the past nine weeks, according to BofA Global Research.

Mike Vogelzang, CAPTRUST’s Chief Investment Officer in Boston, said his firm took “aggressive action” in response to the Ukrainian crisis to reduce the risk profile of its portfolios. This included cutting equity exposure and selling mortgages and a number of corporate bonds, replacing them with highly liquid short-term US Treasuries.

“We are concerned about a potential global liquidity risk,” he said. “We’ve been significantly underweight US Treasuries relative to our benchmarks for years now, so we’ve really filled that bucket and reduced the potential for illiquidity in our portfolios.”

Vogelzang said events such as last week’s nickel price spike – which occurred when a major global producer bought large quantities of nickel to cover falling price bets and cover expensive margin calls – indicate the potential for “panic”. from liquidity “in the markets. to know more

Investors also highlighted the counterparty risk, referring to the probability of non-fulfillment of contractual obligations linked, in this case, to an underlying commodity. In a rare notice on Monday, the Securities and Exchange Commission said the concentrated positions of prime brokerage counterparties pose particular concern. to know more

Bill Campbell, DoubleLine’s Global Bond Portfolio Manager, is concerned about the impact the Ukrainian crisis is having on a “systematically important” part of global supply chains that affects not only energy prices but also vital commodities such as wheat, of which both Ukraine and Russia are the largest producers.

Campbell has reduced exposure to Eastern European countries in its portfolios and is seeking to differentiate investments between commodity-importing and commodity-exporting countries to reduce risk.

“We need to feel more comfortable that this crisis will be contained in the region,” he said.

Ryan O’Malley, a fixed income portfolio manager at Sage Advisory, said the conflict accelerated liquidity problems in the corporate credit market, prompting him to increasingly shift his portfolio towards more liquid assets like Treasuries.

“We’re trying to get more liquid,” O’Malley said.

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Reportage by Davide Barbuscia; editing by Ira Iosebashvili, Megan Davies and Richard Pullin

Our Standards: Thomson Reuters Trust Principles.

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