On July 13, 2015, the U.S. Department of Treasury, the Board of Governors of the Federal Reserve System, the Federal Reserve Bank of New York, the SEC and the CFTC issued a Joint Staff Report analyzing the significant volatility in the U.S. Treasury market on October 15, 2014. The analysis, however, “did not reveal a clear, single cause of the price movement.”
During the course of trading on October 15, 2014, the market for U.S. Treasury securities, futures and other related financial markets experienced an unusually high level of volatility. The yield on the 10-year Treasury security fluctuated by 37 basis points, but closed only 6 basis points below its opening level. During the twelve-minute interval between 9:33 and 9:45 a.m., the 10-year Treasury yield dropped by 16 basis points and then rebounded. The Report stated that this high level of volatility, including the large round trip in prices to occur in such a short time with no obvious catalyst, is “unprecedented in the recent history of the Treasury market.”
Liquidity also became significantly strained, particularly during the twelve-minute window, and market depth – the dollar amount of standing quotes – fell dramatically. To reduce their risk, some market participants temporarily disengaged their automated price quoting systems, further contributing to the loss of liquidity. Trading volumes, however, remained high, even during the twelve-minute interval. The regulators were unable to explain why the volume was high, stating that the dynamics driving continued trading “remain an open question.”
Based on the Staff’s review of transaction and order book data, the Staff was able to identify a number of developments in the market on October 15, 2014, but the Report did not purport to provide a comprehensive explanation of the reason for those market developments. The Report cautioned that its findings were “preliminary” and “not comprehensive,” and that considerable more work is necessary to assess the risk of reoccurrence.
The Report also noted the changes in the Treasury market structure in recent years, principally an increase in electronic trading and the rise in firms engaged in principal transactions, which now account for more than half the trading volume in the Treasury market. Here too, however, the Report did not draw conclusions as to the effect of these changes in market structure, stating that: “The overall implications of these structural changes for Treasury market liquidity, and whether they suggest that events of October 15 are more likely, are unclear.”
The regulators’ analysis of these market events is continuing. The Report also urges a further review of the current regulatory environment applicable to the government securities market and, echoing proposals previously made by the SEC and FINRA, consideration of a registration requirement for firms conducting certain types of automated trading in the Treasury market.
The possibility of future market abnormalities presents risks for all market participants, across all markets. A better understanding of market dynamics is essential, and any additional regulation in this area should be based upon a more complete understanding of the sources of risk.
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