Share Prices & Company Research


08 October 2020

How Liquid are Government Bonds?

While financial markets continue to move unpredictably and are disconnected, relatively, from the global economy, investors are opting for more risk-averse and liquid securities. One asset class that has been gaining attention is Government Bonds – the ultimate safe-haven asset class – which have continued to rally since January. So, what makes Government Bonds so liquid?
First, global government bonds have a significantly larger issue size than any other asset class. For example, the US government has US$18tn nominal amount outstanding in treasuries - implying that there is a lot of availability for investors to purchase. On the flipside, the largest buyers of these securities are financial institutions – such as pension funds and insurers – who use these securities to match cashflow payments for clients and policy holders. Therefore, with significant supply and demand forces at play, there have always been both buyers and sellers for these securities. One may argue that the mass government issuance seen in most Western economies may disrupt the original supply and demand powers, with supply overshooting demand. However, the second largest buyer of these securities – investors – often gravitate towards these securities in times of market volatility. Often enough, we see that when the CBOE VIX – which is a leading indicator of volatility in US equity markets – rises, the US 10Y treasury often falls in tandem. Additionally, investors use government bonds as a key allocation in portfolios for capital preservation.
However, government bonds are not always liquid. Earlier this year, Argentina entered negotiations with key creditors over restructuring US$65bn of debt. The proposed terms included suspending coupon payments for three years, reducing the coupon rate by 62% and a 5.4% cut on the nominal value. Given the sour terms, or even worse prospects if the bonds default, sellers have significantly outnumbered buyers and hence liquidity has dried up. If investors are adamant on selling a security, often they will attempt to mark their price below the market value in a bid to sweeten the deal and attract buyers. This is why illiquid securities often have higher yields or trade at a deep discount to compensate for the additional risk. In the Argentinian example, yields have skyrocketed over the past few years – with their overnight rate reaching 60% while the US has a much lower 0.06%. However, such events only usually occur in highly-troubled economies that have an inability to pay their debts and countries with high credit ratings, such as Japan, the US and the UK, have rarely experienced said issues. With bond issuance at all-time highs, and government debt piles inflating into unprecedented waters, we are comforted to see the appetite for safety is still there for investors.

Please note that investments and income arising from them can fall as well as rise in value. The payment of income and the return of capital could be in jeopardy in the event that the parent company has problems meeting its financial obligations.
How Liquid are Government Bonds?
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