Capitol Report: Regulators probe whether high-speed trading exacerbates swings in bond market
WASHINGTON (MarketWatch) — The impact of algorithmic and high frequency traders is mostly thought to be an issue surrounding the U.S. stock market.
But now federal regulators are concerned they may be behind the curve as these firms move into the bond market.
Specifically, the watchdog agencies are reviewing the sharp swing in Treasury yields last Oct. 15 , Federal Reserve Governor Jerome Powell said Tuesday.
“We are working with other regulators to understand exactly what happened that day and to determine whether there are implications for regulatory or supervisory policy,” Powell said in a speech to the Brookings Institution discussing the aftermath of the scandal of financial institutions manipulating key benchmark interest rates such as the London Interbank Offered Rate.
On the morning of Oct. 15, the 10-year yield briefly plummeted to around 1.8% from about 2.2% after U.S. retail sales data came in lower than economists forecast. The sharp swing drew comparisons to a ‘mini-flash crash’ seen in stock markets.
At the time, authorities blamed the short-lived price move on a lack of liquidity in the market.
The conventional wisdom is that regulatory changes in the wake of the financial crisis have led some broker-dealers to pull back their market-making activities and their appetite for providing liquidity.
But Powell noted that issues that a few years ago “concerned only equity markets” could now be at play in fixed-income, currency and commodities markets.
“Other players, such as mutual funds, exchanged traded funds, algorithmic and high-frequency traders and electronic exchanges are taking more prominent roles,” he said.
“These changes will affect market liquidity and functioning in ways that are difficult to foresee” and “it is possible that some of these factors played a role in the sharp swing in Treasury yields last Oct. 15,” he added.
The U.S. Treasury market remains much more lightly regulated than the stock market. Treasury securities are exempt from Securities and Exchange Commission oversight.
James Angel, an associate professor at Georgetown University, said that Oct. 15 was a “long overdue wake up call to the Treasury and the Fed” that more oversight of the Treasury market is needed.
“Electronic trading for the most part makes markets better, but it brings up market stability issues that need to be addressed,” Angel said.
But given the “unregulated, almost freewheeling nature” of the Treasury market, setting up protections like circuit breakers bring up a hornet’s nest of issues, he said.