Fed's Brainard says Fed examining possible drop in market liquidity

[July 01, 2015]  WASHINGTON (Reuters) - The U.S. Federal Reserve has launched a study to see if U.S. Treasury markets are being hampered by a lack of liquidity, an issue some investors and others have cited as a potential risk to financial stability, Fed board member Lael Brainard said on Wednesday.

Brainard, speaking at a financial conference in Austria, said events like the sharp swing in U.S. bond prices last October and earlier this year in the market for German bonds added to anecdotal evidence that markets for the world's safest assets are less deep and less liquid than they had been.

If true, she said, that could cause trouble in times of financial stress if investors cannot freely buy and sell safe haven bonds at other than fire-sale prices.

However, so far "there is relatively little evidence of any deterioration in day-to-day liquidity," Brainard said in a prepared text. "Anecdotes of diminished liquidity abound, statistical evidence is harder to come by."

Traditional measures of market liquidity do not seem to have changed since the 2007 financial crisis, she said, while episodes of market volatility could have explanations other than a lack of liquidity.

"We are in the early stages of data-based analysis," she said, with Fed researchers focused on the events of last October and whether that pointed to changes in the market for U.S. Treasury securities.

The possible loss of liquidity in the U.S. Treasury market in particular could pose risks to a variety of funds and investment vehicles that might, in a stressed environment, need to liquidate bond holdings to raise cash.

A lack of liquidity in bond and other markets "could be significant if it acted as an amplification mechanism," for financial stress, Brainard said.

Some investors have pointed to regulatory changes as a source of the problem, with new restrictions on what large institutions can hold on their books. The spread of high-frequency trading could also be involved, since the companies that use those strategies often hold smaller inventories of bonds and have smaller cash buffers.

But Brainard, in remarks similar to those of other Fed officials, said those are not necessarily the full explanation. Companies and investors may be changing their investing strategies and choices for other reasons that are still to be understood.

(Reporting by Howard Schneider; Editing by Chizu Nomiyama)

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