US risk watchdog: Selloff in U.S. and European bond markets are a mystery

The Office of Financial Research - the U.S. institution that watches risks in the financial sector in the wake of the Great Recession - said it still does not understand why there has been an increasing number of sharp selloffs in the U.S. and European bond markets.

“We don’t have all the answers for the causes of this decline in market liquidity and I think until we do have a better grasp of what some of those causes are, it would be untoward to try to suggest remedies,” Richard Berner, the director of the body, said.

In a speech to the Brookings Institution, he said that liquidity seems to have become “increasingly brittle” in these markets, appearing adequate during normal conditions but disappearing abruptly during times of stress

These periods include sharp moves in euro-area government bonds that have occurred over the past two months as well as the U.S. bond market’s “taper tantrum” in the summer of 2013, and flash crash in October 2014.

While those episodes did not disrupt U.S. financial stability, analysts cannot sufficiently understand their causes.

“But together they highlight a potential weakness in markets that could amplify the impact of financial shocks,” Berner said.

It was too soon to discuss regulatory measures, he added.

As MarketWatch reports citing Berner, while the so-called Volcker rule, which restricts banks from making proprietary bets, often gets blamed for the lack of liquidity, the structure of markets has changed and needs to be examined before blame is pinned on any one cause.

One change that high-frequency and algorithmic trading has spread to fixed-income markets from equity markets. Cyclical changes in the supply and demand of collateral, regulation, and changes in the investor base also weigh, he said.