Liquidity in Fixed Income Markets

Fixed income markets in many jurisdictions have been going through a period of change, resulting in a debate as to whether they are continuing to function effectively, or will function effectively in times of stress. Changes in dealer business models and increased use of electronic trading platforms are influencing the nature of liquidity in bond markets. These changes are not as prevalent in Australia as they are in some overseas markets. For instance, while dealer inventories in US and European banks have fallen, in Australia they have been broadly steady, although they have undergone some substantial compositional shifts. Similarly, electronic trading and, in particular, high frequency trading (HFT), does not account for as large a share of trading in Australian financial markets as it does in US and some European markets. As these changes have occurred, market liquidity in some bond market segments in Australia has declined and is lower than it has been in the past. In contrast, market liquidity in derivative markets appears to have improved, such that overall market liquidity across bond and related derivative markets does not appear to have deteriorated. While this is a positive assessment, it is also likely that accommodative monetary policies in many major economies have supported market liquidity conditions in recent years and it is difficult to determine how robust market liquidity would be in the absence of these policies.