The Dow Jones Industrial Average stormed back from a nearly 800-point decline to end Thursday slightly lower, the latest in a series of wild swings rattling investors who worry that ongoing volatility could crimp liquidity among stocks, bonds and other assets.
Stocks surged in the late afternoon after The Wall Street Journal reported that Federal Reserve officials were considering stepping back from their predictable pace of quarterly interest-rate increases, reassuring investors who worried the central bank was on an overly aggressive path.
An imbalance of buyers and sellers disrupted trading among bonds and other assets early in the session, traders said, spurring larger-than-average price fluctuations. The diminished liquidity is making it harder to buy and sell stocks, bonds and oil futures and exacerbating swings in the year’s final weeks, when markets are typically more subdued. That is putting investors and analysts on edge, as many rush to lock in any scant returns for what is shaping up to be the worst year for stocks since 2015.
Traders said Thursday that it is becoming harder and taking longer to match buyers and sellers in a variety of markets. An onslaught of orders in the equity-futures market triggered trading halts by the
overnight to prevent further steep drops.
Multiple exchange-traded funds that track bonds have lately been trading at discounts to the net asset value of their bondholdings. That is unusual because any ETF may be exchanged at any time for a basket of its component securities, a mechanism that aims to keep market values in alignment.
These ETFs ranged from corporate-bond funds, such as
SPDR Portfolio Intermediate Term Corporate Bond ETF
to high-yield ETFs, including
iShares iBoxx $ High Yield Corporate Bond ETF
The SPDR intermediate-term fund, which on Thursday had a net-asset value of $33.01, traded as low as $32.70
“We don’t have a good idea of what buyers will pay for these bonds,” said Mohit Bajaj, director of ETF trading solutions at broker WallachBeth Capital LLC. “It’s a sign the market is having a hard time keeping up.”
Some analysts and portfolio managers believe the gap signals that some trades aren’t being fully executed as prices swing, creating unusual dislocations.
Mohamed El-Erian, chief economic adviser at Allianz and former chief executive at Pacific Investment Management Co., said in a Thursday interview in Hong Kong that low liquidity is one of his top concerns in the market right now.
“If you’re looking for a potential black swan, one area you could look at is what happens when people realize they don’t have the underlying liquidity that they thought they had,” he said.
The Dow Jones Industrial Average dropped as much as 785 points Thursday, before paring its decline to 79.40 points, or 0.3%, to end at 24947.67. The index is on course for a 2.3% weekly drop. Meanwhile, 471 S&P 500 stocks—94% of the index—were down 1% or more from their trailing-year highs through Thursday’s close, while 68% of the broad index was off 10% or more, according to FactSet data.
Bond prices jumped, pushing bond yields down sharply. The yield on the 10-year Treasury note fell to 2.872% from 2.921% on Tuesday, the last open session for the bond market. U.S. markets were closed Wednesday for a national day of mourning for President George H.W. Bush.
“People are pouring into bonds,” said Larry Peruzzi, managing director of international equity trading at Mischler Financial. That has put strain on liquidity among fixed-income assets and contributed to some trading issues. Stock investors are calling traders, saying, “Just get me out,” he said.
“Nothing is orderly. It’s making for a stressful week,” he added.
Some investors said the Fed’s decision to reduce the size of its bond portfolio was contributing to the erosion of liquidity across financial markets as much as the central bank’s rate increases. By reversing the Fed’s earlier stimulus efforts, officials have been pulling money out of the financial system at a rate of roughly $50 billion a month. The Fed now holds $3.91 trillion of Treasury and mortgage bonds, down from $4.24 trillion when the decision to pare the balance sheet was made in September 2017.
“The shrinking of the balance sheet is putting pressure on financial markets,” said Doug Peebles, chief investment officer for fixed income at AllianceBernstein Holding LP. “Can I prove it to you? No, I can’t. But I can feel it, and it isn’t good.”
Year-end pressures have made bond dealers increasingly reluctant to trade corporate bonds as they seek to minimize the risk to their balance sheets and financial performance. Some investors said they are being asked to break sell orders into smaller chunks to make them easier to trade, while the cost to execute them has risen by as much as $1 per $1,000 bond for $10 million trades, according to Zachary Chavis, a trader at Sage Advisory Services in Austin, Texas.
Zhiwei Ren, a portfolio manager at Penn Mutual Asset Management, said that he has had trouble trading bonds and stock futures in recent days. Earlier this week he had trouble selling a
corporate bond. The prices on the screen didn’t match what people were willing to pay for it, he said.
“It looks like there’s liquidity, but once you try to catch it, it goes away,” he said.
Liquidity in typically easy-to-trade securities such as Treasurys and mortgages appeared diminished. Traders said platforms were taking longer to execute buy and sell orders, with fewer offers and requests visible on their screens. Some said the delays suggested dealers were turning off automated price quotes, which firms do to minimize the risk of losing money in volatile markets.
“From platform to platform, I’m getting mixed results, and also from dealer to dealer,” said Michael Lorizio, who trades Treasurys and mortgages at Manulife Asset Management. “When you have increased volatility, you can’t blame counterparties for wanting to be more hands on,” he said. “It’s not a normal trading environment.”
Oil traders also have noted lower volumes and liquidity on days of major price moves in recent weeks.
“If you need to buy 1,000 lots of crude, it’s a lot harder now than it was six months ago,” said Scott Shelton, a broker at ICAP PLC.
—Steven Russolillo, Gunjan Banerji and Stephanie Yang contributed to this article.
Write to Corrie Driebusch at email@example.com, Daniel Kruger at Daniel.Kruger@wsj.com and Michael Wursthorn at Michael.Wursthorn@wsj.com