Fed, Treasury Officials, U.S. May Need to Rethink Treasury-Market-Structure

 

        By Ryan Tracy
        WASHINGTON--Senior officials at the Treasury Department and Federal Reserve questioned the benefits of high-frequency trading in U.S. Treasury markets, suggesting market overseers are building the case for new rules targeting the firms.
        Fed governor Jerome Powell and Antonio Weiss, a senior counselor to U.S. Treasury Secretary Jacob Lew, said Monday that the government should re-evaluate the structure of U.S. Treasury markets in light of recent events that suggest they are more prone to swings.
        The remarks, made at an event hosted by the Brookings Institution think tank, were the latest evidence that Washington is growing more concerned about signs that financial markets have grown more volatile with the growth of fast trading. Officials have lately focused on a huge 12-minute swing in the yield of a key U.S. Treasury bond on Oct. 15--the Treasury market's version of the 2010 stock price dive known as the "Flash Crash."
        Buying and selling Treasurys, as well as financial products tied to them, is central to how global financial markets operate on a daily basis. In recent years, superfast, electronic trading has expanded to account for about half of volume in the most active parts of the Treasury market on a typical day.
        Messrs. Powell and Weiss said that development, along with other changes, warrant a re-evaluation of how the Treasury markets are structured.
        "We need to consider whether the race for speed, at this already advanced stage, helps or hurts market functioning," Mr. Weiss said.
        He said the Treasury Department and financial regulators should consider new rules, including requirements for Treasury-market participants to register with authorities and hold more cash on the margin against each trade. He said activities like self-trading, in which a fast-trading firm takes both sides of the same trade, raise questions about fairness. "Automated trading may provide traders with additional tools to beat the system," Mr. Weiss said.
        Mr. Powell, who has an influential voice as a member of a Fed board that sets rules for large banks, didn't endorse any specific rule changes, but said the current market structure, which encourages superfast trading, could be less resilient than in the past. "One can certainly question how socially useful it is to build optic fiber or microwave networks just to trade at microseconds or nanoseconds rather than milliseconds," he said.
        Bill Harts, chief executive of the Modern Markets Initiative, an advocacy group for high-frequency trading firms, said those firms support "a data-driven analysis of how additional regulation could make the markets more efficient."
        "It is because of those high-speed tools that investors have never had it better in terms of" being able to buy and sell at their desired price, Mr. Harts said.
        The Oct. 15 event has focused the government on the issue of Treasury-market volatility, which is a concern because a lower appetite for the bonds during a crisis could drive up borrowing costs for the government, corporations and consumers.
        A report in July from staff at the Fed, Treasury, Securities and Exchange Commission, and Commodity Futures Trading Commission found the events of Oct. 15 had no single cause. The report said fast traders accounted for the majority of trading volume that day and noted they can be part of independent firms, like hedge funds, but are also part of large Wall Street banks.
        The Treasury Department has always been concerned that the bonds it issues are regarded as safe and easy for investors to buy and sell. But today's debate is unusual in that it takes place amid a rapidly evolving market with new regulations and participants, said Lou Crandall, chief economist for the research firm Wrightson ICAP. "Important parts of the environment have changed and there is no way to predict exactly how the system will respond."
        Some on Wall Street say new regulations are to blame for more fragile markets because they have made it harder for big banks to act as middlemen between buyers and sellers.
        U.S. officials don't appear convinced their rules are the problem. Mr. Powell said regulations "may be one factor driving recent changes in market making," but added "these same regulations have also materially lowered banks' probabilities of default and the chances of another financial crisis."
        Another significant change in Treasury markets: The Federal Reserve now is holding far more Treasury bonds as part of its programs to stimulate the economy.
        U.S. officials are expected to further discuss the issue of Treasury-market structure during a conference this fall at the Federal Reserve Bank of New York.
        Write to Ryan Tracy at ryan.tracy@wsj.com
        (END) Dow Jones Newswires
        August 03, 2015 16:01 ET (20:01 GMT)

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