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Shortage of bond buyers may be squeezing sellers

A sign outside the headquarters of JP Morgan Chase & Co in New York. Concerns that diminishing liquidity can cause gyrations in bond markets – flagged by JPMorgan Chase & Co. chief Jamie Dimon – came to a head this week.

Mike Segar/REUTERS

Concerns that diminishing liquidity can cause gyrations in bond markets – flagged by JPMorgan Chase & Co. chief Jamie Dimon – came to a head this week.

As bonds tumbled across Europe, the bid-ask spread, a gauge of the market's depth derived from the difference in prices or yields between buyers and sellers, widened. It reached 0.27 basis point for German 10-year bunds on Thursday, up from as low as 0.1 in March and an average of 0.2 this year, data compiled by Bloomberg show.

That means sellers may be getting squeezed by a shortage of buyers. Adding to the risk of holding bonds, implied option volatility on German 10-year bund futures contracts surged in the past week to the highest since August 2012.

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"It's very easy to enter the market but difficult to get out when liquidity is thin," said Richard McGuire, head of European rates strategy at Rabobank International in London. "Investors go in through the door, but in a selloff they have to come out through a keyhole."

In a letter to shareholders last month, Mr. Dimon called a roller-coaster day in Treasuries on Oct. 15 a "warning shot" to investors, and said the next financial crisis could be exacerbated by a shortage of the securities. His view was echoed by Tidjane Thiam, who will take over as chief executive officer of Credit Suisse Group AG next month.

"Regulation has structurally reduced liquidity in many key markets," Mr. Thiam said in an interview on Bloomberg Television on Wednesday. "You can expect liquidity incidents. I think Jamie Dimon was right to underline that in his letter. That's a structural issue in the new world we live in."

Bonds have sold off in a global rout that wiped more than $430-billion (U.S.) from the market in the past week. A capitulation on long positions, or bets that prices will rise, was triggered by a shift in sentiment as improving economic data and rising oil prices prompted investors to revolt against record-low yields.

Yet the magnitude of the decline wasn't justified by those economic numbers, none of which points to a big jump in inflation or interest rates, according to Rabobank's Mr. McGuire.

The yield on Germany's 10-year bund, the benchmark euro-zone security, has surged 43 basis points since the start of last week to a high for 2015. A basis point is 0.01 percentage point.

The jump suggests that increased regulation may be hampering dealers' ability to make markets and that bond-purchase programs such as the European Central Bank's quantitative-easing plan have cut the amount of securities in circulation.

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"The ECB's demand caused a huge imbalance," said Steven Major, global head of fixed-income research at HSBC Holdings Plc in London. "It doesn't help that the selloff took place when market positioning was extreme. But the sky's not falling in – just a bit of long-overdue realism."

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