TRP - Investment Viewpoint: Navigating a Liquidity-Constrained Fixed Income Environment

Executive Summary
„„- Credit markets have seen a significant decline in liquidity in the wake of the 2008 financial crisis, as new government regulations have limited Wall Street banks’ proprietary trading activities. This has occurred alongside strong investor demand for fixed income assets and heavy corporate debt issuance.

-„„ As the Federal Reserve prepares to unwind unprecedented monetary accommodation, regulators have expressed concerns that if rates rise and investors aggressively sell their fixed income holdings, dealers’ constrained capacity to absorb supply has the potential to fuel financial market volatility.

-„„ In the view of T. Rowe Price’s Fixed Income division, liquidity conditions are unlikely to improve meaningfully anytime soon. With that in mind, this paper discusses our holistic approach to managing liquidity risk in client portfolios. Portfolio managers, traders, and analysts continually collaborate to assess liquidity conditions at both the market and security level. Quantitative tools provide additional insights into the liquidity profiles of portfolios and prospective performance under different market scenarios.

-„„ A shortage of liquidity could worsen market dislocations if rates rise markedly. But there are several factors that should temper the impact of increasing rates, and demand for fixed income seems unlikely to falter for long.

-„„ In the current environment, global trading and fundamental research capabilities, along with a long-term investment horizon, are essential for meeting clients’ investment objectives.