Liquidity Is Bad Even by August Standards, JPMorgan Shows

(Bloomberg) — A familiar bogeyman is lurking alongside the gut-wrenching swings across assets of all stripes: illiquidity. It’s problematic even by the dire standards of August, according to JPMorgan Chase & Co.
Measures of market depth in U.S. equities, Treasuries and currencies relative to the rest of the year have fallen below the average since 2010, the bank’s research shows. It’s a sign that market players have diminished capacity to absorb the trade-driven mania sweeping assets.
“Even by August standards, when market depth tends to decline and volatility to rise, this month is delivering numerous unusual events and milestones,” strategists led by John Normand wrote in an Aug. 9 note.
After opening in the red Tuesday, the S&P 500 Index surged as much as 2% after the Trump administration granted a grace period before fresh China tariffs take effect.
Last week saw U.S. equities plunge 3% after China let its currency weaken to the lowest in 11 years, before a turnaround so furious it’s been seen only a half dozen times during the bull run. Accompanying that was a blinding rally in sovereign bonds, sinking Treasury yields to multi-year lows.
S&P futures “liquidity fell sharply again starting last Wednesday as the market sold off post the FOMC meeting and rose only modestly” the next day, Deutsche Bank AG strategists led by Bankim Chadha wrote in a Friday note.
While volumes in the contracts climbed, the number available at the best bid-offer price — the bank’s measure of market depth — slumped, they wrote.
The ways in which dramas play out via liquidity have been the subject of several JPMorgan missives, with strategist Marko Kolanovic blaming a “negative feedback loop between volatility and liquidity” for topsy-turvy markets in April. As volatility rises, market depth declines exponentially, exacerbating price moves, he said.
Still, by another measure, liquidity in S&P 500 futures “could have been worse than it was over the last two weeks,” strategists Rocky Fishman and John Marshall at Goldman Sachs Group Inc. wrote in an Aug. 13 note.
“Top-of-book depth has been materially better than it was at the depths of December’s volatility, which is to be expected given a more mild sell-off,” they said.
Another factor at play in sharp swings over the past week may be selling by systematic strategies that use volatility as an input.