A Riddle Wrapped in a Price Swing: ‘Weird Stuff Happens’ in Treasuries
On Oct. 15, 2014, officials at the U.S. Department of the Treasury were spooked by a burst of rapid-fire trading in the $13 trillion market for U.S. government debt. Over a 12-minute span that morning, the yield on the benchmark 10-year Treasury note plunged from 2.02 percent to 1.86 percent, then just as quickly shot back up to within a few ticks of where it started.
The nosedive and rapid recovery were a rare episode of volatility for the Treasury market, which helps finance the U.S. government and, with $500 billion in securities traded every day, is the largest and most active debt market in the world. Treasury yields have fluctuated that much only three other times since 1998, including the day central banks announced a coordinated cut in global interest rates during the height of the financial crisis in October 2008 and in August 2011, when Standard & Poor’s lowered its credit rating on the U.S. This time, there was no apparent cause, leaving bankers, traders, and regulators mystified. Jamie Dimon, chief executive officer of JPMorgan Chase, called it “an event that is supposed to happen only once in every 3 billion years or so.”
A year later, the Treasury Department still doesn’t fully understand what happened during those 12 minutes. In a report released in July and produced in coordination with four other agencies, Treasury laid out a reconstruction that included enough analysis to impress even some high-frequency traders who had spent months on their own trying to piece together the events of the day. But the government couldn’t come up with a full explanation of who or what triggered the price swings. More troubling, the report laid bare just how little regulators understand about the daily workings of the Treasury market, which has changed drastically over the past decade through technological innovation and the rise of electronic speed traders.
“The Treasury market has not been fully reviewed in over 15 years,” says Antonio Weiss, a former investment banking executive who is leading the Treasury Department’s deep dive into the mechanics of the market. “We are in the early stages of conducting such a review in light of the very significant changes that have occurred.”
Weiss is playing a pivotal role just nine months after his nomination for a top Treasury post caused a rift between the Obama administration and Democratic lawmakers seeking a tougher line against Wall Street. Senator Elizabeth Warren led a populist campaign against Weiss, whom she portrayed as a symbol of government coziness with the financial sector. Weiss withdrew his name, took a job as a counselor to Treasury Secretary Jack Lew, and stepped out of the limelight.
Now the ex-Lazard dealmaker is the point man on one of the most pressing financial concerns for the government: understanding the day-to-day trading in Treasuries and why it seems to have become more turbulent than at any time since at least the 1970s. By one measure, outsize swings are occurring almost twice as often as statisticians would normally expect, according to data compiled by TD Securities.
The ups and downs are so prevalent that Treasuries have been more volatile than U.S. stocks this year. “This isn’t your grandfather’s market anymore,” says Steven Meier, an executive vice president at State Street, a top investor in the Treasury market.
Uncertainty over when the Federal Reserve will raise interest rates is feeding some of the recent volatility, but regulators are also examining the impact of high-frequency traders, who use algorithms to buy and sell Treasuries in microseconds. Speed traders now account for about half the electronic trading in the Treasury cash market, up from 25 percent in 2008, according to research firm Tabb Group. During the most frenzied moments last year on Oct. 15, speed traders were responsible for about three-quarters of all trading. “We need to consider whether the race for speed, at this already advanced stage, helps or hurts market functioning,” Weiss said in an August speech at the Brookings Institution in Washington.
Speed-trading firms, based mostly in New York and Chicago, got access to the electronic platforms to trade government bonds about a decade ago. Now 10 high-frequency firms regularly account for about half of all electronic trading in cash Treasuries, according to the government’s report. The entry of speed traders has added competition and reduced the amount big banks charge clients that buy Treasuries. Also making the business less profitable are new financial regulations that require banks to hold more capital and use less leverage.
Wall Street’s big bond dealers say they are now less willing to facilitate trades in Treasuries. In theory, that can exaggerate price swings and lead to brief periods of illiquidity. In truth, the biggest banks are simply filling more buy and sell orders internally, rather than on interdealer platforms, reducing the visibility that regulators have into the market.
On Oct. 9, researchers from the Federal Reserve Bank of New York said they found evidence that the swarm of orders placed by speed traders may be making the market appear more liquid than it really is, especially when investors look to move large blocks of Treasuries. When markets are running smoothly, speed traders provide efficient pricing and a steady supply of buyers and sellers, says Larry Tabb, chief executive officer of Tabb Group. “But when weird stuff happens, and it’s happening in microseconds or milliseconds,” he says, “it’s kind of hard to take a pause and figure out what’s going on.”
While pieces of the Treasury market have raced into the Digital Age, a lot of trades are still made over the phone between dealers and clients. Regulators have “virtually no visibility” into those deals, says Weiss. “That has to change.” In an Oct. 13 research note, Kevin McPartland, head of research at consulting firm Greenwich Associates, wrote that “the level of opacity that still exists in the market for the debt issued by the largest economy in the world is stunning.”
One obvious solution is to improve the system for tracking trades. Unlike in the stock and corporate bond markets, there is no real-time database for government bonds. While regulators can get access to data from private exchanges, the information isn’t stitched together to provide a complete picture of market moves, and it’s not disclosed to the public as it happens.
Weiss has spent much of his time talking to banks, hedge funds, exchanges, and speed-trading firms about potential fixes. In July he ran a closed-door meeting at Columbia University to discuss market structure. Weiss told the group, which included more than a dozen finance executives and academics, that Treasury was still looking into changes in the market and was wary of the potential for future risks, according to people in attendance. Part of Weiss’s mission has been to counter complaints from the financial industry that regulations are the primary cause of less liquidity. “We’ve pushed back against some pretty simplistic arguments,” he says.
The bottom line: Treasury officials are looking at ways to make the $13 trillion market for U.S. government debt less of a mystery.