Why is the liquidity of the US stock market decreasing
Sergey Gurov
Apr 2, 2025Liquidity in the American market has been declining for many years, including due to tighter regulation and the growth of automated trading, notes Bloomberg. But now the uncertainty with Trump's trade policy has further worsened the situation.
After the 2008–2009 crisis, the US and Europe (and beyond) began to adopt laws, particularly in the area of banking regulation. Rules requiring financial organizations to increase capital buffers and restrictions on proprietary trading have led banks to sharply reduce their market-making activities. The introduction of electronic trading platforms and the growing use of automated calculations for computerized trading have also made market liquidity less predictable.
Since the beginning of 2025, the issue of declining trading liquidity in the US stock market has become even more relevant for institutional and retail investors. The increase in expected transaction costs for buying or selling American stocks and derivatives is related not only to increased volatility but also to the decline in trading activity by active market participants. Among the main reasons for the fall in market depth and the rise in volatility, most often mentioned in recent analytical materials, are investors' concerns about the negative impact of tariff wars on the profits of American companies. Also, the growing uncertainty regarding the state of the global economy and the impact of trading programs that tend to further increase market volatility when it rises.
This phenomenon can be observed in the example of a couple of widely tracked liquidity indicators. Liquidity in S&P 500 index futures at the end of March was at a two-year low, according to Deutsche Bank data. The five-day moving average of the Citigroup liquidity index, which is calculated based on the trading volume of S&P 500 futures, is also near the lowest level in the past two years.
There is also another important factor — the lack of active market participants willing to provide liquidity during times of market stress. This is largely due to the continued popularity of passive investment funds, which have a number of restrictions on when and how they can trade. Amid falling liquidity of individual stocks, investors have become more active in buying US exchange-traded funds, many of which follow passive strategies in the stock market. In the first two months of 2025, the net inflow into ETFs registered in the US, amounted to $114.8 billion. We discussed how the rise of passive investing affects markets here.
Why it matters
As uncertainty in the stock market persists, it is important to consider the various factors that affect market liquidity dynamics. Investors with significant exposure to mid and small-cap company stocks should remember that a potential exit from positions may be accompanied by substantial monetary and time costs.
