1/5/2017 0 Comments
The Federal Reserve has published a paper on the Volcker Rule's impact on corporate bond liquidity.
The paper quantifies a fact most have know to be true: liquidity provided by dealers in the corporate bond market has decreased due to the Volcker Rule. The methodology of the research is to quantify price changes for corporate bonds which have been down graded from investment grade to junk. These downgrade events provide a consistent stream of stress events to measure corporate bond market liquidity.
The conclusion of the paper is that corporate bond liquidity has decreased subsequent to the implementation of the Volcker rule to levels seen during the financial crisis.
"Indeed, we find the disturbing result that illiquidity in stress periods is now approaching levels see(n) during the financial crisis."
So is this significant for financial markets as a whole? Will the next market stress event throw the corporate bond market into a tailspin? Corporate bonds should trade at a liquidity discount compared to its previous, high-liquidity price level. On the margin, this will make the Fed more cautious with regards to tightening financial conditions.
Michael Grove, CFA