Eulogy For The Treasury Market

by: John Jansen

I have posted numerous articles here on the decline of liquidity in the US Treasury market. This one from a WSJ story strikes at the roots of the Treasury market, a market in which I have participated for thirty six years. The story reports that ICAP (one of the largest bond brokers) is considering instituting circuit breakers such as those applied in the equity market when the market has a huge moves.

The Treasury market has always been viewed as the safest most liquid market in the world. Investors around the globe flock to the Treasury market because they believed that they could always effortlessly move large blocks of bonds without disrupting the marketplace. In the multitude of financial crisis over the last several decades the Treasury market has always functioned even when other markets were impaired.

The Treasury market functioned through the Latin American debt crisis of the early 80s and the horrific stock crash of 1987. The Treasury market provided safety as Long Term Capital crumbled in 1998 and hobbled through the events of 2007 through 2009 more efficiently than any other asset class. Dealers were always prepared to trade and customers had instant access to liquidity.

If this idea to close markets when they become overly volatile becomes part of the fabric of the Treasury market I think the market will lose some of its luster. We deal at the margin and that will make the market less attractive to investors and will motivate investors (at the margin) to find other places to park their funds. I think it would mark the beginning of the end of an era and would be an historical marker as the dominance of America fades.

Via the WSJ:

ICAP Weighs Treasurys-Trading Controls
Turbulent government-bond markets are prompting one large brokerage firm to consider installing circuit breakers
By Katy Burne
Updated June 2, 2015 7:00 p.m. ET

Turbulent government-bond markets are prompting one large brokerage firm to take a cue from the stock-trading world and consider installing circuit breakers.

ICAP PLC is studying the possibility of temporarily halting Treasurys trading following large price moves, according to people familiar with the matter.

Such a program would mark the first use of such safeguards in the $12.5 trillion U.S. Treasury market. Circuit breakers are routinely used to halt trading in stocks when price fluctuations exceed predetermined ranges.

London-based ICAP is raising the idea with some of its customers, one of the people said, and weighing the pros and cons of adopting such controls, which already are commonplace in equity markets in the U.S. and elsewhere. According to Sandler O'Neill + Partners estimates, ICAP's BrokerTec unit handles about 60% of Treasurys trading activity between banks and high-speed trading firms, which account for a large share of overall trading.

Some traders worry that timeout periods in the world's most liquid securities market would reduce investors' access to the perceived safety of Treasurys when other markets are declining, and could raise the possibility of distorted prices in related markets like derivatives that are closely tied to government bonds.

Even so, the development is the latest sign that price gyrations sweeping financial markets are unnerving traders and pushing participants to consider unprecedented steps

Some market participants have discussed the idea of circuit breakers in bonds with officials at the U.S. Treasury Department, a person familiar with the talks said.

"Given the recent extreme swings in bond prices, safeguards to prevent the market going into free fall are worth exploring," said Kevin McPartland, head of market-structure research at Greenwich Associates.

A spokesman for Nasdaq OMX Group Inc., which runs a Treasurys trading platform, declined to comment on any new controls under discussion. A spokesman for Tradeweb Markets LLC, which also has a Treasurys platform, declined to comment.

ICAP's discussions come on the heels of large one-day price swings in Treasurys and German bunds, two of the largest, most liquid markets in the world, over a period of months. The events touched off a debate about whether electronic bond venues need heightened risk controls.

Implemented in the U.S. after the 2010 "flash crash" that sent the Dow Jones Industrial Average tumbling more than 700 points in a matter of minutes before largely recovering, circuit breakers essentially put trading in a stock on hold if prices move up or down by a preset amount intraday. Exchanges coordinate with one another to issue a marketwide halt in trading.

In December, Chicago futures-exchange operator CME Group Inc. said it would implement circuit breakers for Treasury futures, currency futures and metals futures, expanding existing controls it already had in place for equity and energy futures. Those controls have been put in place.

Such procedures would be vastly more difficult to apply to bonds, observers say. While much of the bond markets are traded electronically today, trading doesn't take place on exchanges and the handful of platforms catering to bonds don't coordinate with each other on how to handle extreme price moves.

"In a world where liquidity can move so quickly from one venue to the next, the absence of an industrywide agreement on when to halt trading poses a risk to the bond market," said Adam Sussman, head of market structure at institutional equities-trading platform Liquidnet.

Traders have attributed the heightened volatility in government bonds in part to structural factors, including the rise of electronic trading and prevalence of high-speed computer algorithms that were long prevalent in the equity, futures and foreign-exchange markets.

The Treasury Market Practices Group, an expert panel convened by the Federal Reserve Bank of New York, in April wrote that automated trading strategies now account for more than half of Treasury trading on some platforms, and that its increasing adoption would lead to "the risk of sharp, short-term disruptions to the Treasury securities market of the kind experienced in the equities and futures markets."

Others finger a decline in liquidity, or the ease of trading at given prices, as a result of new rules in the wake of the financial crisis targeting bank risk-taking.

In April, Treasurys traded by banks that act as primary dealers of U.S. government securities hit their lowest monthly volume seen since 2009, according to Haver Analytics.

The concerns come as equity and currency markets have experienced exaggerated price swings, raising concerns about the role of electronic trading.

"Pricing may adjust quickly and unexpectedly, even in the absence of significant market events," said authors of a report last month by the Financial Stability Oversight Council, a panel of top U.S. regulators created after the financial crisis to oversee the financial system.

On Oct. 15, traders scrambled to react to a stunning rally in Treasurys that sent yields on the 10-year note plummeting to an intraday low of 1.87% within minutes, their biggest one-day decline since 2009.

The episode, in which some dealers turned off their automatic price-quoting systems, prompted scrutiny from the highest levels in Washington and on Wall Street.

"You started seeing gaps because dealers were getting full," said Scott DiMaggio, fixed-income portfolio manager at AllianceBernstein, which oversees $499 billion in assets.