Market Liquidity Strains Signal Heightened Global Financial Stability Risk
IMF Blog, October 27, 2022
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Bibliographic details
- Authors: Fabio Cortes, Glenn Gottselig, Shoko Ikarashi, Aki Yokoyama
- Published: October 27, 2022
Chart of the Week / Overview
- Title: Market Liquidity Strains Signal Heightened Global Financial Stability Risk
- Authors: Fabio Cortes, Glenn Gottselig, Shoko Ikarashi, Aki Yokoyama
- Date: October 27, 2022
- Label: Chart of the Week
- Core point: "A deterioration in market liquidity has amplified price swings."
Definition and significance of liquidity
- Liquidity refers to "how easily assets can be bought or sold—and when it dries up, it can be disruptive."
- Liquidity is described as "a key measure of how well financial markets are working."
Recent developments and drivers
- After "more than a decade of abundant liquidity and relative calm in markets," central bank interest-rate increases to contain inflation have been accompanied by elevated market volatility.
- Measures of market liquidity "have worsened across asset classes, especially in recent weeks, as heightened uncertainty about the economic outlook and monetary policy left investors with much less risk appetite."
Financial stability implications
- Worsening liquidity "may pose risks to financial stability," as outlined in the Global Financial Stability Report referenced in the text.
- The piece notes that "sudden price moves combined with forced selling and deleveraging can lead to disorderly conditions in asset markets that could threaten broader market functioning and stability."
- Spillover channel highlighted: "Spillovers from disorderly asset markets could also increase borrowing costs for governments and corporations, worsening financial conditions."
Illustrative episode
- The stress in the United Kingdom’s government bond market required the Bank of England to intervene.
- This episode is used to underscore how liquidity deterioration can produce market stress and require central bank action.
Key takeaways
- Market liquidity has deteriorated across asset classes amid rising interest rates and heightened uncertainty.
- Reduced risk appetite has amplified price swings and market volatility.
- Liquidity strains can produce disorderly market conditions via forced selling and deleveraging, with potential spillovers to borrowing costs and broader financial conditions.
Source: Market Liquidity Strains Signal Heightened Global Financial Stability Risk, Chart of the Week, Fabio Cortes; Glenn Gottselig; Shoko Ikarashi; Aki Yokoyama; October 27, 2022.