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Where's the liquidity?

Happy Friday, friends! Another wild week in the markets is coming to a close, but monthly options expiration is just starting. With that said, I think it's a great time to review what's going on with liquidity in these markets, or the lack thereof.

S&P 500 e-mini futures: a dry spell

Liquidity in the spoos has all but evaporated since late 2021. While we're seeing some return, and bid/ask spreads narrow, the situation remains one of leptokurtic risk distribution, especially considering the significant amount of volume in options (approximately $1 trillion per day traded in the index options and ETF options for indices, such as SPY).

Crude remains constrained

Liquidity in crude was absolutely obliterated when the Russia-Ukraine war started. We saw prices surge, the bid/ask spread widen to nearly $4.5, and order book depth crumble. While prices have come down, and the bid/ask spread narrowed to some degree, we still see wider spreads and significantly constrained liquidity in this pivotal commodity's futures contracts.

Treasuries aren't treasured

Treasuries, shown above using the 10-year T-note futures as a proxy, remain extremely illiquid since the Russia-Ukraine war kicked off. The bid ask spread hasn't been too wide, but price action has seen much greater volatility in 2022, which had the worst first half for bonds in about four decades.

The 30-year bond futures contracts aren't much more liquid than the 10-year T-note futures, showing a similar pattern of reduced liquidity after the Russia-Ukraine conflict began.

Euro: better, but not by much

Liquidity in the Euro FX futures contracts is certainly better than what we see in the above examples, but not significantly better. We saw a similar pattern of low liquidity, widening spreads, and greater volatility after the Russia-Ukraine war started, and while we've seen spreads normalize and liquidity return, it is still well below levels we saw the middle of 2021.

Gold: a curious outlier

The precious metal seems to have had a healthy resumption of liquidity and narrowing in its spread after it neared an all-time high during the Russia-Ukraine war's initial stages

In conclusion

Monetary policy tightening, especially via QT, is likely to continue to dampen market participation, and as a result liquidity. The less liquidity there is (as shown by order book depth), the more likely it is that we have greater volatility. While volatility in equities has been dampened of late, I expect that to change after today's options expiration due to dealer positioning changes, as well as powerful event volatility catalysts coming up, like Jackson Hole and PCE data.

This lack of liquidity amplifies the leptokurtic distribution of potential price outcomes, because it takes less money to move the market more. Sizable options-driven participation, particularly in at the index level in the S&P 500, further fattens tails.

To me this means being careful about position sizing and having any strong bias. This market can potentially burn both bulls and bears alike. Be careful out there, my friends.


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