By Scott DiMaggio and Alison Martier
We laud US regulators' announcement on Monday that they will increase oversight of the Treasury market. Unfortunately, merely assuring investors additional price transparency in trading won't be sufficient to stem the kind of volatility that has apparently compelled officials to take action.
The US Department of the Treasury and the Securities and Exchange Commission have joined forces, asking the Financial Industry Regulatory Authority (FINRA) to collect Treasury cash market trade data - similar to tracking conducted by FINRA for the corporate and municipal markets - presumably with the goal of sharing that information with investors.
That US regulators see a need to create additional transparency in trading is good news. It will help investors make better investment decisions. If only the solution to volatile Treasury markets were so simple.
The Heart of the Problem
Unfortunately, liquidity, not transparency, is the heart of the volatility problem. The fact remains that market trading has not kept pace with market growth. This has led to significantly more volatility in the world's go-to "risk-free" market.
The US Treasury market ballooned - from $4.2 billion in 2007 to $12.5 billion in 2015 - during a period when average daily trading volume declined - from $570 billion to $515 billion. As a result, the number of days for a security to turn over increased from eight to 24.
It's hard to describe a market as liquid under these conditions. And it becomes easier to understand why even a market that is expected to be "liquid" occasionally freezes up, as the Treasury market now famously did in the Flash Crash of October 15, 2014.
Navigating to Calmer Waters
We think investors should take steps to safeguard against such unwanted volatility.
A better solution lies in globalizing fixed-income portfolios. Global portfolios diversify across multiple yield curves, economic cycles, monetary cycles and business cycles. This helps dampen volatility in a more volatile world. In addition, when US Treasuries are volatile, global government bonds provide pockets of liquidity elsewhere.
Investors seeking to maintain a core bond profile should hedge currency exposure. Over the past two decades, currency-hedged global bonds have been less volatile than US bonds, thanks to the benefits of economic diversification. And over the same period, they've slightly bested US bonds as well.
So while we applaud regulators for wanting to enhance the transparency of trading information, we don't think they've gone far enough. US Treasury markets are likely to remain choppy. It's time for investors to take action, and go global.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
Scott DiMaggio, CFA, Director - Global Fixed Income and Canada Fixed Income
Alison M. Martier, CFA, Senior Managing Director - Global Fixed Income Business Development