Subject: Treasury Market..
From: "Daniel McHale" <[email-masked]>
To: "Eric Schwerin" <[email-masked]>, "Hunter Biden" <[email-masked]>, "Arlene Busch" <[email-masked]>, "Mike Mathis" <[email-masked]>, "Chuck Harple" <[email-masked]>
Date: Wed, 19 Nov 2014 16:54:25 -0500

…This is a very interesting read from Bloomberg that came out yesterday
that highlights how electronic trading, coupled with unintended
consequences of new banking regulations and capital requirements, are
causing shockwaves to the Treasury market.  I have a close friend who works
on the US Treasuries sales deck at Deutsch Bank, and he has been talking
about this canary in the coal mine for a while.  Considering every consumer
and commercial loan is tied to Treasuries and/or Libor, it's worth the
quick read.

Flash Boys Invade Treasury Bond Market In New Era Of Volatility
<http://www.finalternatives.com/node/29039>

Nov 18 2014 | 6:50am ET

By Susanne Walker and Lisa Abramowicz (Bloomberg) -- In a flash, the bond
market went wild.

What began on Oct. 15 as another sleepy day in the U.S. Treasury market
suddenly turned into the biggest jump in volatility in a quarter century,
leaving investors worrying there will be turbulence ahead.

The episode exposed a collision of powerful forces -- the rise of
high-frequency trading and the decline of Wall Street dealers -- that are
reshaping the world’s biggest and most important bond market. Money
managers say the $12.4 trillion Treasury market is becoming less liquid,
meaning securities can no longer be traded as quickly and easily as they
used to be, thanks in part to the Federal Reserve’s bond-buying program.

“The way the market is set up right now, we’ll see instances like we did on
that day,” said Michael Lorizio, senior trader at Boston-based Manulife
Asset Management US LLC, which oversees $281 billion. “There’s going to be
a learning curve as to how to handle that.”

The development reflects unintended consequences of new financial
regulation, as well as steps the Fed has taken to breath life into the U.S.
economy. The implications, however, extend far beyond Wall Street, because
the Treasury market determines borrowing costs for governments, companies
and consumers around the world.

When the day began on Oct. 15, an unprecedented number of investors were
betting that interest rates would rise and U.S. government debt would lose
value. The news that morning seemed ominous. Ebola was spreading. So was
war in the Middle East. At 8:30 a.m. in Washington, the Commerce Department
announced a decline in retail sales.

*Buy Quickly*

The shift came all at once. The sentiment that the Fed would raise rates
reversed. Traders who’d bet against, or shorted, Treasury bonds had to buy
as many as they could as quickly as they could to limit their losses. By
9:38 a.m., 10- year Treasury yields plunged 0.34 percentage point, the most
in five years.

Analysts such as Jim Bianco, president of Bianco Research LLC in Chicago,
blame the herd mentality of electronic traders.

“A lot of these guys are focused on speed,” Bianco said. “They’re all
uncreative and write the same program. When the stimulus comes in a certain
way, every one of them comes to the same conclusion at exactly the same
moment.”

The influence of high-frequency traders in the Treasury market is growing.
About 60 percent of Treasury securities trades are expected to be
transacted on electronic platforms by the end of next year, an increase
from 40 percent in 2013, according to Tabb Group LLC, a New York-based
research firm. Of those trades, 10 percent were executed by robots in 2010,
a share that will probably grow to 20 percent next year, according to Tabb.

*More Volatile*

“As the markets become more electronic, they become more volatile,” said
Larry Tabb, Tabb’s chief executive officer. “It’s the new normal.”

At least one electronic trader, Charles Comiskey, the head Treasury dealer
at Bank of Nova Scotia, said he unplugged his computer for half an hour
during the height of the frenzy. That may help explain why yields plummeted
so fast without sellers to stem the fall.

It may also explain why an unprecedented $946 billion of U.S. government
debt ended up changing hands on ICAP’s BrokerTec trading platform on Oct.
15, breaking the record by 43 percent. Once sellers stepped in and the
plunge was arrested, there was plenty of liquidity.

Bloomberg LP, the parent company of Bloomberg News, competes with BrokerTec
and other bond-trading platforms.

*Cash Reserve*

New rules adopted after the 2008 credit crunch are also part of the new
normal. Global guidelines called Basel III, instituted by the Bank for
International Settlements in Basel, Switzerland, require banks to hold more
cash in reserve for assets such as bonds they keep on their balance sheets.

Partly in compliance with the regulations, the 22 primary dealers
authorized to trade directly with the Fed reduced their U.S. government
debt holdings to $46.3 billion at the end of October from a record high
$146 billion in October 2013, Fed data show. While they still hold
inventory, they’re allocating less to opportunistically buying big clumps
of bonds and then slowly selling them, a process known as market-making.

Hedge funds have filled the vacuum created by the retreat of the big banks.
On the morning of Oct. 15, the turmoil in Treasuries echoed in the trading
of junk bonds. As $8 billion was being wiped out in that global market,
Toronto hedge-fund manager Philip Mesman fielded e-mails from U.S. bankers
clamoring for him to buy their customers’ holdings.

*Shock Absorber*

Investors were unloading the debt of the riskiest companies, forcing
exchange-traded funds and mutual funds to sell. Before Basel III and the
Volcker Rule, which limits the ability of U.S. banks to trade on their own
accounts, dealers would’ve bought the bonds themselves and held them until
finding someone to take them. Instead they were forwarding the “sell”
messages to firms they knew had quick access to cash.

“In the old days, the dealers could carry inventory and it acted like a
shock absorber,” said David Breazzano, who manages $8.2 billion in
high-yield bonds and loans as Waltham, Massachusetts-based DDJ Capital
Management LLC’s chief investment officer. New regulations create
“opportunities for other institutions to fill the gap,” he said.

One result is a narrowing of the market. Average daily turnover in the U.S.
bond market shrank to $809 billion last year from $1.04 trillion in 2008,
according to Securities Industry & Financial Markets Association data.

The Fed has bought so many bonds -- $3.5 trillion worth since 2008,
including $1.86 trillion of Treasuries -- that big individual trades matter
more now. The amount of U.S. debt available to trade at one time without
moving prices as of October has plunged 48 percent to $150 million since
April, according to JPMorgan Chase & Co.

*Possible Drivers*

That phenomenon hasn’t been confined to the U.S. The size of German bund
futures that can go through the market at one time without moving the price
has fallen 46 percent to 784 contracts as of Oct. 17, from this year’s peak
of 1,450 contracts in April, according to JPMorgan. The average over the
past four years was 920 contracts.

Regulators are searching for an explanation. The Federal Reserve Bank of
New York’s Treasury Market Practices Group, a gathering of finance
executives and New York Fed officials, met Oct. 16. It identified “possible
drivers” of what happened as changes in the direction of trades by
investors with a lot of borrowed money -- “repositioning by leveraged
investors” is how they put it -- algorithm-driven robot traders and the
regulatory restrictions that limit the participation of big banks,
according to minutes of the meeting.

“Members concluded that more time would be needed to fully understand the
day’s events,” the minutes said.

*Liquidity Break*

Timothy Massad, chairman of the Commodity Futures Trading Commission, which
oversees the Treasury futures market, told reporters in Chicago Nov. 5 that
his agency “took a look at” the price fluctuations of Oct. 15.

“Basically we didn’t see any break in liquidity,” Massad said. “I think it
was just a high volume day. But let me just add that’s based on our
preliminary look. New evidence might come to our attention that suggests
otherwise.”

CME Group Inc., the Chicago-based derivatives exchange, saw record trading
that day with 39.6 million contracts changing hands, including all-time
highs for interest-rate futures and options at 25.1 million.

Terrence Duffy, CME’s executive chairman, said one of the most active days
in the history of futures trading went off without a hitch.

*Market Turbulence*

“The systems were really rocking and rolling,” he said in a Nov. 6
interview in his office. “All of a sudden we saw a tremendous amount of
volatility enter the marketplace at once.”

The U.S. Securities and Exchange Commission is pushing mutual funds to test
whether they could satisfy customer redemptions during periods of financial
stress, said people with knowledge of the plans.

The Treasury Department heard concerns about high-frequency firms in
fixed-income at a November 2013 meeting of the Treasury Borrowing Advisory
Committee, a group of executives who represent banks and investment funds.

Members “suggested that the liquidity provided in the market through
electronic trading was small on a relative basis and unlikely to persist
during periods of market turbulence,” according to the minutes of the
meeting.

In certain markets, “there’s a facade of liquidity,” said Jon Duensing, a
money manager at Amundi Smith Breeden, the U.S. unit of the French
asset-manager Amundi that oversees about $1 trillion. “It’s possible that
the mechanisms that investors thought were in place to facilitate capital
flow may break down.”

*--With assistance from Matthew Leising, Matthew Boesler and Alexandra
Harris in New York, Cecile Gutscher and Ari Altstedter in Toronto, Anchalee
Worrachate in London and Silla Brush and Dave Michaels in Washington.*

*Copyright 2014 Bloomberg. All rights reserved. This material may not be
published, broadcast, rewritten, or redistributed.*

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