LONDON/NEW YORK/SINGAPORE, March 30 (Reuters): The war in Iran has sparked chaos across financial markets, leaving some investors and market makers reluctant to take on risk, making trading harder and costlier - a scenario regulators watch closely.
None of the world's biggest markets, from US Treasuries, to gold, to currencies have been spared, investors and traders said. In Europe, hedge funds, which now dominate bond trading, added to those dynamics as they rapidly unwound a number of bets this month.
Investors say they have at times struggled to get prices, or execute trades over the past four weeks, as market makers fear being stuck with large positions that could quickly become unprofitable.
"When we try to trade, it takes longer to trade. (The market makers) want us to be more patient, cut the trades into smaller sizes," Rajeev De Mello, chief investment officer at GAMA Asset Management, said, adding gaps had widened between the price at which market makers would buy an asset and at which they would sell it. "What that has as a consequence is that everybody's reduced the sizes of their positions."
Various measures of volatility have soared to levels seen in previous market crises, including those for stocks, bonds, oil and gold.
Cracks have emerged even in the usually deep and liquid government bond markets, a cornerstone of global finance that has been hit hard as inflation risks spook investors.
The difference between bid and ask prices on newly issued two-year US Treasuries, a key measure of market depth and transaction cost for the most widely traded securities, has meanwhile widened roughly 27 per cent in March, compared with February levels, according to Morgan Stanley, suggesting dealers are charging a higher premium to take on risk.
To be sure, the latest symptoms of market stress are not uncommon during bouts of market turmoil, such as during US President Donald Trump's "Liberation Day" tariffs last April and the 2020 COVID pandemic.
But this round of volatility has arrived at a time when markets had been in an expansive mood, as investors rode a runaway rally across asset classes, suggesting a deeper correction may materialise if the war drags on and liquidity evaporates.
In Europe, the pain has been particularly stark in the futures market for short-term interest rates, where traders rapidly priced steep central bank rate hikes.
Liquidity became "severely diminished" at one point, operating at 10 per cent of usual levels, Morgan Stanley's co-head of EMEA rates Daniel Aksan said. "The (illiquidity, price moves) reminded me of the COVID days," he said.
Three European financial regulators on Friday said ongoing geopolitical tensions, namely the war in the Middle East, pose significant risks to the global financial landscape, opens new tab through higher energy prices, potential inflationary pressures and weaker economic growth. They reiterated their warning about the impact of volatility on liquidity and the risk of sudden price swings.
Trading has thus far remained orderly, but buyers are becoming increasingly scarce as investors rush to de-risk and move into cash, leaving dealers hesitant in turn.
"Firms have lost so much money - whether it's sell-side or buy-side - that liquidity is suffering because you don't have the players," said Tom di Galoma, managing director of global rates trading at broker-dealer Mischler Financial, referring to the US Treasury market. While trading volumes in Treasuries have surged, analysts say some of these trades have been done out of necessity, not by choice.
"With a wider bid-ask spread, it is more expensive to put on a trade and would be less attractive for people to enter into trades, but the fact that you still see really high volumes suggest that some of these trades were unwinds, or stop-outs," said Morgan Stanley US rates strategist Eli Carter.
