A liquidity crisis in credit is inevitable


The liquidity on the markets follows a series of ups and downs that represents the fear-greed cycle of investors.

Markets are usually more liquid in greed and more illiquid in those where fear prevails. This is because if greedy behavior prevails, managers' fear of losing opportunities by being cut off is high, so don't ask too many questions to decide to invest. On the contrary, in the phases in which fear prevails, investors will ask themselves more questions, becoming reluctant to invest.

Essentially, if the demand and supply price gap is too high, no transaction will close.

Liquidity and central banks

If there is someone who has filled the liquidity markets, these are certainly the central banks. This means that for companies willing to borrow at low cost there are no special conditions: "consequently, not only have debt markets swelled, but growth is disproportionately derived from those segments where disclosure is poorer", declares Tad Rivelle, Chief Investment Officer Fixed Income of TCW.

For the expert, the deficiencies of disclosure are particularly important in liquidity crises in bear markets, as "human beings are led to fear – if not panic – when they fail to obtain information they consider essential".

Liquidity and passive funds

The assets managed by the passive funds have increased enormously during the current economic cycle. For Rivelle, the problem will occur when these funds become net credit risk sellers. What could happen is that buyers, having become very selective, do not make themselves available to act as counterparts. "Liquidity could therefore become very problematic for the passive universe and for credit markets in general".

How to move?

TCW's Chief Investment Officer Fixed Income argues that as long as financial markets are populated by humans, there will always be an alternation between fear and greed and between liquidity and illiquidity.

A solution could be found in the Treasury or cash investments: "History suggests that this could be one of the most important allocation choices in an end-of-cycle context", stresses Tad Rivelle

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