High-Speed Trading, Interest Rates Pose Risks, Treasury Says

The U.S. financial system’s vulnerabilities include a sudden spike in interest rates amid greater risk-taking and high-frequency trading, the Treasury Department said.

While threats to stability have “generally abated” from a year ago, they remain in markets for short-term funding and credit, interest rates and volatility, and in automated, high-speed trading that represents a significant portion of daily equity and foreign exchange volumes, the Treasury’s Office of Financial Research said in its annual report released today in Washington.

“Given these volumes, high-frequency trading poses several potential financial stability risks, suggesting that closer monitoring may be warranted,” the office said in the report. Under some scenarios, “high-frequency trading systems may obscure price discovery, exaggerate illiquidity, increase volatility, and contribute to extreme price changes.”

The office, set up as a part of the Dodd-Frank Act of 2010 and run by former Morgan Stanley chief U.S. economist Richard Berner, focuses on identifying and monitoring the stability of the U.S. financial system.

Pose Threats

Earlier this year, it said money managers could pose threats when reaching for higher returns, herding into popular asset classes or amplifying price movements with leverage.

Companies overseeing a combined $53 trillion in assets, led by BlackRock Inc. (BLK) and Vanguard Group Inc., can contribute to asset-price increases and magnify volatility during sudden shocks, the office reiterated today.

The Treasury also pointed to risks related to securities financing transactions in repurchase agreements, which it said is exposed to “the risk of runs and fire sales.”

Even as the U.S. budget deficit is declining and lawmakers have agreed on a spending plan for this fiscal year, the Office of Financial Research said uncertainty about the U.S. fiscal outlook could threaten markets.

Fiscal Brinkmanship

“Future episodes of fiscal brinkmanship could in the short run result in abrupt, destabilizing changes in government bond prices,” the report said. “Longer-term risks include the potential erosion of Treasury debt as a global benchmark and the U.S. dollar’s reserve currency status.”

Congress and the Obama administration clashed in October about government funding and a national health-care law. As a result, the U.S. government was partially shut for 16 days, and the Treasury was less than 24 hours from when it said it would exhaust borrowing authority.

Rates surged at the Treasury’s auctions of three- and six-month bills sold during the shutdown in October as investors shunned the shortest maturities. The rate to borrow and lend Treasuries for one day in the repurchase market reached the highest this year as money market funds stepped away amid concern they would hold as collateral securities that would be affected by a government default.

To contact the reporter on this story: Kasia Klimasinska in Washington at kklimasinska@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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