Market turbulence reveals price of liquidity in fixed income ETFs says Moody’s

A break in the clouds

The latest report from Moody’s Investors Service finds that the March 2020 spate of financial markets volatility demonstrated that ETF performance is governed by its underlying markets. The gap between the price of a fixed income ETF and its net asset value (NAV), which widens during a crisis, is the price of liquidity, the firm says.

“Leading up to the coronavirus-driven market volatility, assets invested in ETFs soared, especially in fixed income products. This rapid growth raised a number of questions: chief among them how resilient ETF liquidity would be in tumultuous markets,” says Moody’s Assistant Vice President Fadi Abdel Massih. “The first quarter of 2020 has been a test of our answer: that credit ETFs track not only the performance of their underlying assets but also the liquidity of these assets.”

The late February confluence of the spread of the coronavirus pandemic, deteriorating global economic outlook, vacillating oil prices, and asset price declines created a severe and extensive credit shock across many sectors, regions and markets, Moody’s writes. ETF outflows began to reverse the inflows seen earlier in 2020, with equity ETFs experiencing the first wave, but quickly followed by fixed income ETF outflows. Further, the dislocations between fixed income ETF prices and NAVs have revealed not only the price discovery role of ETFs but also the price of liquidity.

Subsequently, the Federal Reserve stepped in and bolstered marketplace liquidity by launching a set of tools to support the economy. Among them, primary and secondary market corporate credit facilities which are designed to alleviate pressure in the corporate debt and ETF markets. The Fed has expanded the definition to include corporate bonds as well as a portion of ETFs with exposure to high yield corporate bonds.

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Beverly Chandler
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