Quick overview

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These days, there are various economic announcements and changes that you need to think of. Such events will help define the future of monetary policies, the economy as a whole, not to mention they could also trigger movements in currencies, commodities, stocks, bonds and so on. That’s why it’s imperative to learn why the liquidity conditions are important during these major economic announcements, and if they can affect the economy in any way.

Learning more about market liquidity

Market liquidity is a major part of the financial markets. It usually consists of different dimensions. First, we have the market depth, which refers to the volume of buy and sell orders that are available. Generally, a deep market is able to absorb the large transactions without dealing with any major price changes.

Then, there are bid-ask spreads. The bid price is the highest price that buyers are going to pay, and the asking price is the lowest one that sellers are going to accept. If there is a narrow spread here, that indicates a high liquidity, but a wider spread will be showing lower liquidity, which is a thing to keep in mind here.

Market resilience is referring to the market’s ability to recover fast after a large transaction or maybe a shock. If the market is highly resilient, it will return to an equilibrium a lot faster, so keep that in mind. Immediate also measures how quickly the transactions can be executed. A higher liquidity will bring fast trade execution. But on the other hand, if there are major economic announcements, all the liquidity dimensions can drastically change, so you have to keep that in mind.

Major economic announcements and the market expectations

If there are any major announcements, then those will influence markets because the info they share might affect the economic expectations of a country. For example, those can be the GDP growth figures, retail sales data, inflation statistics, employment reports, trade balance reports, central bank policy changes and so on.

A lot of these major announcements will be shared by the FDS, European Central Bank, Bank of Japan and others similar to them. The market will always form expectations before the announcements, and we can see price reactions based on the outcome of the expectations, which is an extremely important part of the process here.

How does liquidity change before announcements?

As a trader using the best Forex brokers, your focus is always on finding the best info and figuring out when and how to act. With that in mind, the reduction in market participation can appear, because some traders will focus on reducing exposure before major announcements. The trading activity will decline, order book depth is decreasing, and the available liquidity is falling. This can lead to a fragile market environment.

Plus, you can see wider bid-ask spreads here. The market makers are dealing with increased uncertainty before the important releases. And in order to compensate that risk, they are quoting wider spreads, reducing the order sizes and limiting the market exposure. The transaction cost is increasing because of that.

Another thing to note is that electronic market makers and the algorithmic trader are frequently canceling resting orders before they do a major announcement. That is going to reduce the visible liquidity, and the liquidity appearing on the trading screens is not going to represent the executable liquidity with very good accuracy, which is a thing to keep in mind.

Liquidity during the announcement

Naturally, those things are taking place before the announcement. But what happens during the announcement? It will be a normal information shock, and participants have to reassess the interest rate expectations, inflation outlook, corporate earning projections and economic growth forecast. All of that will create a very intense trading activity, which is something to consider here.

And on top of that, you will also have temporary liquidity withdrawal. Some liquidity providers are withdrawing from the market. And that’s mostly due to the uncertainty regarding the price direction, the higher volatility risk and the difficulty when it comes to managing inventory positions as well. Having such a withdrawal could lead to some sharp price movements, which is something to consider here.

Moreover, there’s also a rapid price discovery. Markets will try to figure out an equilibrium price and the price discovery comes with a few things. That is accompanied by large trading volumes, large volatility, temporary liquidity shortages and so on. The adjustment can take quite a bit of time or it can be short, that mostly depends on how important the news is in the first place.

Is there a relationship between liquidity and volatility?

Of course, they are interconnected. In the case of high liquidity environments, when the liquidity is abundant, orders are absorbed with great efficiency and the price changes are remaining smooth. On top of that, the volatility is lower. However, if there is a low liquidity environment, that means the liquidity is lower and smaller orders are moving prices more significantly, the volatility is higher and depth of the market is deteriorating, which can prove to be very problematic.

Algorithmic trading is playing a major role in these situations, mainly because it can assess the news and figure out the best course of action accordingly. It can help with news-based algorithms, liquidity provision, liquidity withdrawal and other factors. All of that is super important, and it’s exactly why you have to take it into consideration. There are natural challenges that appear in these use cases, but addressing that wisely can be super important.

Conclusion

It’s clear the liquidity conditions will always play a major role when it comes to major economic announcements. There will be reactions before, but also during and right after the announcements. You can see volatility, liquidity withdrawals and so on. In general, the higher liquidity will deliver better price discovery, more market stability and event the transaction costs are lower. But if the liquidity is low, that leads to volatility, a higher execution risk and many others. It’s imperative for traders to assess all these news, use the right brokers and take advantage of the changes.