Festive mood hides danger: a sudden liquidity squeeze
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Festive mood hides danger: a sudden liquidity squeeze

TOKYO, Japan - An electronic signboard in central Tokyo's Yaesu district displays the Nikkei Stock Average (top C) and foreign stock indexes on the afternoon of June 25, 2013. Tokyo stocks ended lower as sentiment was dented by tumbling Chinese shares, am

The ebullient market conditions as 2023 ends are unlikely to last. Issuers must be ready for liquidity to ebb abruptly

January, usually the busiest month of the year for bond issuance, is appearing on the horizon as a sunny territory for borrowers to fund in. They should not be fooled — the present rosy sentiment could evaporate quickly.

The sustained tightening of bond and credit default swap spreads since US and European central banks showed they were done raising interest rates in mid-October has turned into a bigger rally than many had even wished for. But, even though the iTraxx Europe Main and Crossover indices touched fresh 12 month lows this week, this glide tighter is unlikely to last.

Interest rates in core markets have fallen some 100bp over the past two months, so it is no wonder some investors regret not having locked in more duration before that.

They remain eager to buy, and this will undoubtedly whet the appetite of eager borrowers, such as LBBW and Commerzbank, which this week made unprecedented early mandate announcements as they want to bring seven year covered bonds as soon as January 2.

This exuberance, however, is deceiving. Before issuers know it, January could turn into a fight for liquidity among credit and rates issuers.

For one thing, it will be the first year for a long time when no central bank, bar one, will be supporting deal demand from the very first day by buying bonds.

As the funding rush progresses and different types of issuers start competing for investors’ attention, the flow of investor money will be keenly watched.

The Bank of Japan is a wild card. The inventor of quantitative easing is still at it, and Japan's economy is weak, making a reversal risky. But the consensus is that the BoJ cannot continue easing indefinitely. When, rather than if, it ends its negative interest rates and bond buying operations, it could swiftly suck liquidity out of the global financial system.

With the BoJ having stood pat this month, one risk is that it might pivot as soon as its January policy meeting.

As one FIG syndicate head recently told GlobalCapital: “We are still living in a world where excess liquidity prevails.” That means, for all the talk of normalisation, financial conditions are still artificially supported.

Issuers of all calibres and types should be watchful. A policy tweak in the east could swiftly drain away liquidity in the west.

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