Analysis: Investors see rising risks and fear a market-wide liquidity crunch

NEW YORK, March 15 (Reuters) – Sharp swings in asset prices in the wake of Russia’s invasion of Ukraine are prompting some investors to reduce risk in their portfolios, fearing that the kind of volatility seen in commodities in recent weeks does not hit other markets.

The issue is liquidity – or how easily investors can buy or sell an asset without affecting its price. While episodes of low liquidity have contributed to sharp swings in markets over the past decade, signs of stress have grown in recent weeks, exacerbated by everything from sanctions on Russia to the expected tightening of the central bank. Read more

If liquidity continues to deteriorate in the markets, investors fear that other assets could be subject to the kind of violent price swings that have ravaged commodities this month – which have included a doubling in nickel prices in a day and a surge in oil to 14-year highs.

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“You don’t always know where the risks of contagion lie,” said Frances Donald, chief global economist at Manulife Investment Management. “That’s why liquidity needs to be monitored, not just daily, but hourly at this point, for signs of trouble.”

Financial indicators show growing signs of market stress.

The so-called FRA-OIS spread, which measures the spread between the US three-month forward rate agreement and the overnight indexed swap rate, recently hit its highest level since May 2020, while Another closely watched indicator of short-term funding stress, the spread between the US three-month Libor and the overnight index swap rate was at a similar level. Volatility in stocks (.VIX), currencies (.DBCVIX) and US Treasury yields (.MOVE) also increased. Read more

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

Among the assets investors cut were emerging market bonds, which saw net outflows of $3.54 billion last week, the biggest reduction since April 2020. Treasuries, meanwhile, fell. saw inflows of some $5.4 billion over the past nine weeks, according to BofA Global Research. .

Mike Vogelzang, chief investment officer at CAPTRUST in Boston, said his firm had taken “aggressive action” in response to the Ukraine crisis to reduce the risk profile of its portfolios. This included reducing equity exposure and selling mortgages and a number of corporate bonds, replacing them with highly liquid, short-term US Treasuries.

“We are worried about a possible liquidity crisis on the world stage,” he said. “We’ve been significantly underweight US Treasuries relative to our benchmarks for years, so we’ve really filled that bucket and reduced the potential for illiquidity in our portfolios.”

Vogelzang said events like the spike in nickel prices last week – which came as one of the world’s major producers bought large amounts of nickel to hedge bets on falling prices and cover calls from expensive margin – indicate the potential for “liquidity panic” in the markets. Read more

Investors also highlighted counterparty risk, referring to the probability of default of contractual obligations linked, in this case, to an underlying commodity. In a rare warning Monday, the Securities and Exchange Commission said the concentrated positions of prime brokerage counterparties pose particular problems. Read more

Bill Campbell, global bond portfolio manager at DoubleLine, worries about the impact of the Ukraine crisis on a “systemically important” part of global supply chains that not only affects energy prices, but also vital raw materials such as wheat, of which Ukraine and Russia are major producers.

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

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

Ryan O’Malley, fixed income portfolio manager at Sage Advisory, said the conflict had accelerated liquidity problems in the corporate credit market, prompting him to increasingly shift his portfolio towards more liquid assets such as goods of treasure.

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

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Reporting by Davide Barbuscia; edited by Ira Iosebashvili, Megan Davies and Richard Pullin

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