The deepest, most-liquid debt market in the world is much more shallow than it looks, especially on the most volatile days.
While the U.S. Treasury market consists of about 300 different securities, almost 70 percent of all daily activity takes place in the six or so most recently sold bonds and notes, according to Federal Reserve research. The other securities account for about 30 percent of the volume.
That’s on a good day. When volatility picks up, the market becomes even more concentrated in the most-active notes, New York Fed researcher Michael Fleming wrote in a report this week.
So in a week like this one, when Treasury yields plunged close to their all-time lows, it was probably just a handful of bonds pushing around the entire $13 trillion market, wreaking havoc on benchmark borrowing costs on everything from mortgages to auto loans.
For proof of this, just look at recent history: Trading was most concentrated on days around Oct. 15 2014, when bond yields experienced sudden and extreme moves on seemingly little news, and during the 2013 selloff in fixed-income markets.
It seems “that trading concentration is positively correlated with volatility,” Fleming wrote in the report.
This week, yields on 10-year Treasuries dipped as low as 1.5 percent at one point from 2.3 percent at the end of December, according to data compiled by Bloomberg. The declines sent ripples through global markets that were already jumping at the smallest provocation. Selling of risky assets beget more selling, and buying of haven securities beget more buying. Oil and stocks plunged. Gold surged. Many human traders hid.
But computers didn’t hide. In fact, they got to work. This was a moment for them to shine. Algorithms could respond with lightning speed to any news nugget. (Just note the quick revival in stocks after a Twitter post by one journalist having to do with oil. Just a few words posted on social media moved markets by billions of dollars.)
These algorithms were at work in the Treasury market, too. In fact, when it comes to U.S. government bonds, rapid-fire traders are increasingly making their presence felt, with Chicago-based firms including Jump Trading, Citadel Securities and Teza Technologies gaining an increasingly dominant share of the action.
This computer-dependent set relies on securities that trade frequently to execute fast arbitrage bets. This explains why traders focus on the most popular bonds during times of stress; it’s the algorithms jumping in while everyone else jumps out.
The result is that the Treasury market is becoming less predictable and more prone for wild gyrations. There’s an increasing absence of a level-headed influence on volatile days. And in the meantime, just a few bonds increasingly influence one of the world's most important borrowing rates.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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