The Depth of Shallow Markets

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Markets can deceive. In periods of calm, they appear liquid, robust, even reassuring. Order books look full, spreads remain tight, and transactions flow without friction.

The evidence has been mounting quietly. In mid-October, U.S. banks borrowed $6.5 billion from the Federal Reserve's Standing Repo Facility in a single day, the largest such draw since the COVID-19 crisis.

At the same time, the International Monetary Fund issued a stark warning: global markets are "too comfortable" with mounting risks, and asset prices sit "well above fundamentals," raising the odds of a "disorderly" correction. The IMF's semi-annual Global Financial Stability Report pointed to a dangerous complacency among investors, who have largely shrugged off trade tensions, fiscal deficits, and concentrated equity valuations.

The appearance of depth is no guarantee of resilience. Modern market liquidity depends heavily on high-frequency traders and algorithmic market makers, whose presence can flatter order books during quiet periods but whose participation is conditional and fleeting. These participants now account for roughly 45% of consolidated U.S. equity volume, thriving on volatility and wider spreads.

Stress reveals the illusion. The surge in borrowing from the Fed's repo facility in mid-October was not an isolated incident but a symptom of broader liquidity tightening. Repo rates spiked as Treasury settlements drained cash from the private sector, reducing available reserves and pushing banks to tap emergency facilities.

Jan Nevruzi, U.S. rates strategist at TD Securities, observed that "liquidity is slowly, but surely, decreasing," adding that if the repo facility is continuously tapped, "the Fed should pay even more attention".​

The IMF's warnings underscore the systemic nature of this fragility. The Fund noted that equity valuations are "fairly stretched," with the Magnificent Seven tech stocks now accounting for 33% of the S&P 500's market capitalization, creating concentration risk that amplifies the potential for sharp corrections. If these companies fail to deliver the outsized earnings growth that justifies their valuations, the risk of a "sudden, sharp correction" increases dramatically.

These conditions demand a reassessment. Portfolio construction cannot rely on the assumption that liquidity will be available when needed. Instead, investors must build buffers—holding more cash, favoring assets with genuine market depth, and avoiding the illusion of safety.

Liquidity is most seductive when least reliable. When markets feel steady, when spreads are tight and trades execute smoothly, the temptation is to assume these conditions will persist. But real depth is tested not in tranquility, but in turbulence—when others flee, when order books thin, and when the cost of immediacy reveals itself. The recent strain in repo markets, the IMF's cautionary tone, and the persistent elevation in trading costs all point to the same underlying truth: what feels deep may be shallow, and what appears stable may be brittle. The prudent course is not to trust the calm, but to prepare for the storm that reveals which markets truly have depth, and which were merely performing liquidity until tested.​

Deniss Slinkins,
Global Financial Journal