Recall the market turmoil related to events in Asian financial markets in 1997 and following the Russian bond default in the summer of 1998. Investors flocked to “on-the-run” Treasuries, and risk spreads for high-yield corporate and emerging market bonds spiked.
Chairman Greenspan described these episodes as an apparent collapse in investors’ understanding of possible future risks, despite what appeared to be mild imbalances, which led to “disengagement” by traders. 2 Therefore, I wish to advance a simple proposition: Liquidity is confidence. That is, powerful liquidity in the U.S. capital markets is evidenced when the economic outcomes are believed to be benign.