Liquidity risk in bonds may not be the top risk in investors’ minds, but with the sharp sell-off in bonds underway, it’s garnering greater attention. The Bank of Canada is also prepared to mitigate the risk.
In Canada over the last three weeks, the 10-year government bond yield has spiked nearly 0.50 percent. The five-year government bond yield has shot up 0.35 percent. The corresponding move in U.S. Treasury bond yields is 0.35 percent and 0.25 percent. The German 10-year government bond yield is up nearly 0.50 percent since mid-April.
The moves signal a number of things, from an improving economy in Europe, to deflationary fears rapidly disappearing as oil prices hit their highest levels since late last year, to investors positioning themselves for higher rates.
But, to some extent, the trend higher in bond yields is magnified by the reduced liquidity in government bond markets.
Market Liquidity
Markets for any asset are liquid if an investor can buy or sell large quantities of it quickly at a predictable price. In bond markets, the most liquid markets are those of sovereign government bonds, which benefit from many firms willing to buy and sell (market makers), large amounts of bonds issued (typically several billion dollars), and many other factors.
