(July 10 – 10:45 ET) – The liquidity crunch may only get worse, according to an article in the current issue of The Economist.

The venerable news magazine reports that despite the recent surges in equity trading, and massive bond issuances, such as last week’s US$13.8 billion Deutsche Telekom issue, liquidity is draining from all sides of the world’s capital markets.

It points to rising bid-offer spreads in world currency markets as evidence that the most liquid of all markets is becoming tighter. As for bond markets, a rash of government buybacks has obviously hit the fixed-income market. Spreads on 10-year British paper have more than doubled from three basis points to seven.

It argues that the corporate bond market is struggling for liquidity too, although the evidence is more qualitative. Stocks are suffering, it says, because the worldwide flood of assets into equity markets has come at a much faster rate than increased trading.

The Economist puts the blame for the liquidity crunch on the world’s brokerage firms. It says that securities firms, particularly those burned in the global financial crisis of 1998, have become less willing to commit their own capital trading. The combination of increased volatility and more risk averse brokerages has meant that there’s less broker capital acting as lubricant to the financial markets. It argues that this becomes a vicious circle as less liquidity means more volatility, which means less broker capital and even less liquidity, and so on.

At the Investment Dealers Association’s recent annual conference it was argued that capital-intensive businesses have been poor performers for the Canadian brokerages over the past couple of years, so it is not surprising that they are willing to do less to grease the wheels.

Liquidity has always been more of a struggle for Canadian markets simply because of their limited size. Brokers here have had to do undertake activities, such as large bought deals, that are virtually unheard of in the U.S. just to keep markets moving. No longer. With their banking parents focusing ever more intently on returns, brokers are becoming more and more reluctant to put large chunks of capital at risk for minimal payoffs.
-IE Staff