U.S. Federal Reserve officials are concerned that an investor panic, perhaps triggered by a surprise interest rate hike, could cause a liquidity crisis in parts of the financial system, according to Reuters.
The Fed has been indicating for some time that it will raise interest rates sometime this year, but Reuters reports that officials are “particularly worried about whether the booming asset management industry can withstand a run of redemptions” in the event of a financial crisis.
If certain funds held by individuals and institutions do not have the underlying assets sufficient to back investors cashing out in a panic, the lack of liquidity would expose investors and the economy to sharp price swings.
“Some open-ended mutual funds offer daily withdrawal privileges but invest in assets that take longer to sell and settle,” Fed Vice Chair Stanley Fischer said in a speech last month. Fed Governor Daniel Tarullo and Atlanta Fed President Dennis Lockhart have issued similar warnings about liquidity in the last few months.
Asset managers have said they are systemically safe. But according to Reuters, Fed officials have noted a surge in asset management inflows and concentration. Fixed-income exchange traded fund assets reached $246 billion in 2013 from their inception in 2002, according to Greenwich Associates.
The economy’s weak winter performance has pushed expectations of an interest rate hike more toward September. Futures traders are betting on a move as late as December.
“Part of what’s going on is [investors are] not being convinced that we’re going to raise interest rates,” Loretta Mester, president of the Cleveland Fed, told economists last week.
Reuters said bond markets “are still susceptible to another ‘taper tantrum’ such as the one that happened in 2013 when then Fed Chairman Ben Bernanke caught investors off guard by suggesting the central bank could trim bond purchases earlier than the market expected.”
“Liquid markets could quickly turn illiquid in response to a shift in Fed policy or some other shock, which could amplify any adverse market response, as occurred during the taper tantrum,” Deutsche Bank said in an April note.