New bank rules and automated trading could be sapping U.S. Treasury market liquidity and may spur more volatility like the flash rally of Oct. 15, said Federal Reserve Bank of New York Executive Vice President Simon Potter.
“There could be unintended consequences of these regulatory changes, including the possibility that sharp intraday price moves become more common,” Potter, who leads the team at the New York Fed in charge of implementing U.S. monetary policy decisions, said in a speech on Monday in New York.
On Oct. 15, benchmark Treasury yields swung the most relative to overall yields since at least 2000, scarring debt investors who say they’re still trying to figure out why it happened.
“There does not yet appear to be consensus by market participants around a single cause of the volatility” that day, Potter said in the text of his remarks. “A number of factors likely contributed, including concerns about the global macroeconomic outlook and the unwinding of positions by leveraged investors.”
He also said the “dominance of electronic and automated trading and the changing composition of participants in the Treasury market” could make such episodes “more probable.”
JPMorgan Chase & Co. chief Jamie Dimon called the episode a “warning shot” last week, blaming it on central-bank hoarding of bonds along with regulations that have led dealers to retreat from making markets.
“Liquidity was challenged, and frequent periods of strained liquidity would be undesirable for the most liquid sovereign debt market in the world,” Potter said. Given the importance of the Treasury market “and the risks posed by periods of sharp volatility, understanding the manner in which the evolving market structure is affecting market liquidity, efficiency, and price dynamics is of the utmost importance, and something we plan to study further,” he said.