FI Analysis 21: New liquidity indicators for the fixed-income market

2020-06-30 | Reports Markets Bank

The Swedish fixed-income market – which consists of the bond market, the money market and interest rate derivatives – is important for the government, municipalities, banks and firms to be able to finance their operations and manage risks. It is therefore of central importance to understand how these markets function and, more specifically, how liquid they are. This FI Analysis presents a new method for measuring market liquidity that focuses on government bonds and covered bonds.

This new method captures more dimensions of market liquidity than the method that Finansinspektionen used previously (see FI Analysis 3, 2015). Thus, it describes how the market liquidity has changed over time in a deeper and more comprehensive manner than the previous method. We also construct an aggregate measure that summarises information from the individual indicators. The aim is to provide a general overview of market liquidity. The aggregate measure can be used to follow the development and analyse which factors are affecting market liquidity on the fixed-income market.

The aggregate liquidity measure shows that liquidity in government bonds improved after the sovereign debt crisis in 2012 and was then stable until 2018, with the exception of several temporary episodes in 2015 and 2016 when the market become more illiquid. In 2018, liquidity deteriorated significantly once again and has stayed at this lower level since then. For covered bonds, the historical pattern is not as clear even if it does show that liquidity improved until the end of 2019 and then deteriorated. The aggregate liquidity measure for both government and covered bonds, respectively, also shows a clear deterioration in liquidity on the market in conjunction with the outbreak of the coronavirus in March and April 2020.