MBS MID-DAY: Illiquidity Arrives on Schedule, But Bearing Lousy Gifts

If illiquidity shows up for the start of the holiday trading season and says "I come bearing gifts!" you do not want those gifts.  They typically consist of negative reprices and blood pressure medication.  The former is due to the quick market movements that illiquidity can create while the latter is due to the frustratingly random nature of the move.

But that's how illiquidity works: fewer buyers and sellers at any given price, regardless of volume.  Look at it this way: if there are 10 traders trading--let's say 5 buyers, 5 sellers-- and 7 of them go home, one side is now outnumbered 2 to 1.  If there were twice as many traders to begin with and the same proportion went home, we could be left with an even 3 vs 3.  While these examples are definitely oversimplified, the point is that imbalances become bigger as participation dwindles.

And guess what dwindles starting on the Friday before Thanksgiving week!

Today's imbalance happens to be in favor of bond sellers.  It's not necessarily a massive imbalance, but it's enough to make for a pronounced move heading into the afternoon hours.  The timing isn't much of a coincidence either.  European bond markets add to the overall liquidity.  When they closed at noon, it didn't take long for domestic markets to see that there were more sellers than buyers.  Several lenders have already repriced and more should follow unless we get a big bounce fairly quickly.