The U.S. Treasury market is the deepest and most liquid government securities market in the world. However, it lags far behind the equities market in terms of informational transparency. There is little access to data around such basic metrics as which treasuries are trading and when they are trading, for example. Despite the challenges, high frequency traders (HFT) have been able to improve on the traditional and less automated ways of trading treasuries. HFT, working on razor thin margins and serving as nimble and responsive intermediaries, now represent eight of the top ten dealers in the market according to a recently published BrokerTec list.
The beneficial role of HFT in the government debt market was brought into sharp focus in the aftermath of chaotic trading in the treasuries market on October 15, 2014. On that day, extreme volatility produced a statistical deviation so severe, TABB Group Analyst Anthony Perrotta said such a move should occur once “every 1.6 billion years.” Initially, many people blamed the role of proprietary trading firms (PTFs) using HFT tools for the “Flash Rally.” But a multi-agency report analyzing the event looked separately at the actions of banks and PTFs on that day and discovered these market participants were both using HFT tools completely differently.
The report found that banks, the traditional dealers in treasuries “tended to widen their bid-ask spreads, and for a period of time provided no, or very few, offers in the order book in the cash Treasury market.” Contrast this with PTFs using HFT tools who “… continued to provide the majority of order book depth and a tight spread between bid and ask prices throughout the day, even during the event window.”
A supplemental finding of the report, unveiled at the conference hosted by the Federal Reserve Bank of NY in October 2015, found that while HFT was providing bid and ask quotes, banks were ignoring customer orders.
We believe that PTFs are better at automating trading than others, despite using similar trading tools. In fact, PTFs using HFT tend to become the dominant intermediaries in the asset classes in which they participate. This has been a great outcome for investors, as it introduces competition that drives down costs and fuels innovation that creates further money saving efficiencies.
Industry Support for the Role of HFT in the Treasury Market
“(HFT) as a group continued to provide the majority of order book depth and a tight spread between bid and ask prices throughout the day, even during the event window.”
– Joint Government Agency Report: The U.S. Treasury Market on October 15, 2014
“Automated trading has come to play a crucial role in fostering liquidity and the efficiency of the price discovery process in inter-dealer U.S. Treasury markets.”
– Automated Trading in Treasury Markets White Paper: Federal Reserve Bank of New York’s Treasury Market Practices Group
July 13, 2015: Joint Staff Report: The U.S. Treasury Market on October 15, 2014
On October 15, 2014, the market for U.S. Treasury securities, futures, and other closely related financial markets experienced an unusually high level of volatility and a very rapid round-trip in prices. Although trading volumes were high and the market continued to function, liquidity conditions became significantly strained. Strong evidence suggests that PTFs, as a group, also remained engaged as liquidity providers throughout the event window, implying that more than one type of PTF strategy was at work.
October 20, 2015: A Preliminary Look at Dealer-to-Customer Markets on October 15, 2014
Presentation by the New York Federal Reserve Bank at its Evolving Structure of the U.S. Treasury Market Slide 8 details episodes of dealer non-responsiveness during the unusual volatility in the market for U.S. Treasury securities, futures, and other closely related financial markets on October 15, 2014.
September 29, 2015: MMI Blog – There’s HFT in Treasuries Trading? What’s Next, Computers in Phones?
The use of high frequency trading tools by the top firms dealing in U.S. Treasuries – banks and non-banks alike – has been prevalent for a long time. But you would think HFT in treasuries is “Breaking News” after the release of a confidential BrokerTec list generated media coverage reporting “HFT Dominance.” The BrokerTec list of top interdealer firms for treasuries by volume had just two banks listed among eight proprietary trading firms. While it is true that HFT is the trading platform of choice in treasuries, it is also true that it has been the case for a very long time regardless of who is on the list.
September 23, 2015: Business Insider – High-frequency traders are now dominating another huge market
Risk.net just published a confidential list ranking the top 10 firms by volume traded on BrokerTec, an ICAP-owned trading platform for US Treasurys that is believed to make up 65% to 70% of interdealer market volumes.
September 23, 2015: Risk Magazine – Client list reveals HFT dominance on BrokerTec
The list – obtained by Risk – shows eight of the top 10 firms ranked by volume on BrokerTec over May and June were non-banks, with a big contingent of HFT specialists. These firms racked up trades with a notional volume of almost $7 trillion during the period, or 85% of the volume executed by the top 10 firms. Topping the list (see below) are three Chicago-based firms – Jump Trading, Citadel Securities and Teza Technologies – which between them accounted for 51% of the volume executed by the top 10 firms.
September 1, 2015: Financial Times – High-frequency traders: bond market scourge or savior?
Principal Trading Firms say their role was vindicated during the wild price swings on October 15 after a report by five US regulators showed that during a crucial 15-minute window — in which the 10-year Treasury yield plummeted 33 basis points before bouncing back up — PTFs were responsible for the majority of trading, amounting to more than 70 per cent of all activity.
July 17, 2015: MMI Blog – Dwarf Planets and Real Liquidity
This week, the New Horizons space probe capped a nearly decade-long mission to explore Pluto up-close. Back on Earth, five government agencies concluded their up-close look at the U.S. Treasury market event last October. Separately, these news events prompted those who still see Pluto as a planet, and those who still see principal trading firms (PTFs) as erratic market participants, to take interesting views of the facts presented.
FRED TOMCZYK, CEO TD Ameritrade
Bloomberg News, April 24, 2014