U.S. authorities called out banks for pulling out of the Treasury market last October during a period of extreme volatility and said high-frequency trading firms contributed to wild price swings by submitting a number of orders that canceled each other out.
In a six-minute window on the morning of Oct. 15, 2014, banks reduced their market making and for a period of time provided no, or very few, buy offers, the U.S. Treasury and other agencies said in a report released Monday. At the same time, high-frequency traders were the “dominant participant” in the market with individual firms accounting for both sides of the same transactions.
The trades caused Treasury yields to plunge and then rise, covering a 37 basis point range during a 12-minute period starting at 9:33 a.m. Intraday changes of greater magnitude have only happened on three occasions since 1998 and unlike October’s movement, were driven by significant policy announcements.
“The changes in market structure also raise questions about evolving risks, such as whether an improvement in average liquidity conditions may come at the cost of rare but severe bouts of volatility that coincide with significant strains in liquidity,” the report said.
The findings will probably spark debate on Wall Street as financial firms have complained that a series of rules implemented under the 2010 Dodd-Frank Act have reduced liquidity in the bond market and exacerbated price swings. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon has said what happened in October should serve as a “warning shot” to investors. Blackstone Group LP CEO Stephen Schwarzman added that new regulations may fuel the next financial crisis.
Treasury and the financial regulators will keep studying the “evolution of the U.S. Treasury market” and will continue assessing trading practices and regulatory demands, the report said. The document calls for studying “the implications of a registration requirement” for firms engaged in automated trading in these markets.
Treasury Secretary Jacob J. Lew said last week that regulation from Dodd-Frank shouldn’t be blamed for reduced liquidity and increased volatility. Monday’s report deflects the bulk of the blame from recent regulations.
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