Be Afraid

From this morning   WSJ

Bond Swings Draw Scrutiny

Focus Is on Oct. 15 Plunge in Treasury Yield

By Tom Lauricella and Katy Burne

Nov. 9, 2014 7:59 p.m. ET

The day’s trading was just hitting its stride in New York on the morning of Oct. 15 when bond investors, traders and strategists were stunned by an unusual move in the $12 trillion U.S. Treasury market playing out on their computer screens.

The yield on the 10-year Treasury note took a sharp dive below 2% within minutes, and few could understand exactly why. Some dealers immediately pulled the plug on automated trading systems that provided price quotes to customers. Fund managers rushed to convene meetings. Many investors scrambled to pinpoint the reason behind the accelerating decline.

“It starts moving faster and faster, and you can’t point to anything,” recalled Mark Cernicky, managing director at  Principal Global Investors , which oversees $78 billion.

Now, investors and regulators are burrowing into the causes of the plunge in yields to try to understand whether electronic trading and new regulations are fueling sudden price swings in a market that acts as a key benchmark for interest rates, investments and U.S. home loans.

At the time, bond-market analysts attributed the fall in yields to weak U.S. economic data, shaky European markets and hedge funds scrambling to cover wrong-way bets. But many investors felt that didn’t fully explain why the yield on the 10-year Treasury note tumbled to its biggest one-day decline since 2009. When yields fall, prices rise.

Regulators and other experts are examining deep-seated shifts in trading since the financial crisis, which could help explain the unusual size of the move in a market many investors rely on for its relative stability.

“What happened on Oct. 15 is the result of things that had been building for a while,” said Alex Roever, a strategist at  J.P. Morgan Chase  & Co. who follows the government-bond market.

The Federal Reserve, Treasury and Commodity Futures Trading Commission are looking at that day’s trading activity, according to people familiar with the situation. One focus is the role of high-speed electronic trading in the bond market, although regulators haven’t yet drawn any conclusions, these people said.

Market supervisors at the Fed and Treasury have pored over the day’s trading data and reached out to big banks to better understand what caused the sudden drop in yields, said people familiar with the matter.

Last Monday, CFTC officials briefed the federal government’s Financial Stability Oversight Council on activity in Treasury-futures trading on Oct. 15. The amount of Treasury futures traded at  CME Group  Inc. doubled from the prior day’s levels.

The moves also dominated recent discussions with the Treasury Borrowing Advisory Committee, but the group said “no firm conclusions could be drawn without further analysis” about who and what was driving it.

Some officials see parallels in the stock-market shifts that paved the way for the May 2010 Flash Crash that sent the Dow Jones Industrial Average down almost 900 points in a few minutes before recovering.

Regulatory changes have made bond dealers less willing to hold even relatively safe government bonds on their books, especially in times of wild price swings. At the same time, government bond trading—where not long ago most trading was done over the phone—is becoming more electronic, attracting high-speed computer-driven traders.

Some of these changes have made it faster and easier for professional investors such as mutual funds to trade. But another result, traders and investors say, is that there is less cushion in the bond market when news prompts a herd of buying or selling.

During the plunge in bond yields, trading volumes exploded in the futures market and in Treasury bonds. But, according to J.P. Morgan data, that morning the average amount of Treasury 10-year notes available to be bought or sold near current market prices was 54% below the average for the prior two weeks. For two-year notes, the available stock of notes was 75% below the two-week average.

Global banking rules adopted since the financial crisis require firms to hold more capital in reserve against securities held on their books. Although Treasurys are considered to be safe investments, banks still must count them when determining how much capital to hold as part of new regulations.

The impact can be seen in Treasury holdings by primary dealers—firms, mostly large global banks, that trade directly with the Fed. Their monthly average holdings of Treasurys have fallen 69% to $33.3 billion over the past year, according to a  MarketAxess Holdings  analysis of data from the Federal Reserve Bank of New York.

Potentially amplifying swings, banks have become wedded to risk measures that mandate traders pull back from the market when volatility spikes.

While these models help manage risk, by forcing dealers out of the market when prices get volatile, “at times like mid-October they can in a way be self-fueling,” said William O’Donnell, head Treasury strategist at RBS Americas.

Capital rules have also led to a shrinking of the “repo” market. Short for repurchase agreements, repos are short-term loans crucial to the smooth functioning of the market by enabling bondholders to lend out securities to investors who want to sell and bet on price declines. “The net effect of regulation has been to lower liquidity,” said Ashish Shah who heads credit at $473 billion asset manager  AllianceBernstein  LP. “So you get short-term dislocations that are larger than what we used to get—even in Treasurys.”

At the same time, traders are increasingly shifting to electronic venues.

CME Group has said about 35% of its volume is attributable to high-frequency traders, and some bond-market participants say much of the electronic trading is concentrated in roughly a dozen speedy-trading firms.

Researcher Tabb Group estimates that electronic trading in Treasury securities will rise to 60% of overall market volume by 2015 from 37% in 2013.

A decade ago, a trader at a fund company would have to pick up a phone to call a salesperson at a bank for a quote on bonds they want to buy or sell. Today, dealers have computer programs that automatically spit out quotes to clients on a screen.

This change has meant firms can process information and trade much faster. But where dealers used to have a closed network of brokers through which to set prices, in the last few years fast-trading hedge funds and proprietary-trading firms have been allowed to trade in this network.

The presence of high-frequency traders has help offset some of the decline in trading by dealers. But in times of market tumult, those speedy traders often seek to avoid losses by pulling back from the market, while dealers tend to seek to help clients get trades completed.

What’s more, virtually all major dealers have shifted to using computers to automate Treasury prices quoted to clients. While that has generally helped make trading faster, on Oct. 15, several traders shut down these systems.

Among them was Guggenheim Securities. A spokesman for the firm said it does so “at time of great it cannot keep up with the extreme volatility of the market.”

He said shutting such automated systems off “protects the firm from giving erroneous prices,” and allows it to continue quoting clients—albeit at a slower pace—over the telephone.

—Ryan Tracy contributed to this article.

Write to Tom Lauricella at and Katy Burne at

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