Treasury Trading Down as Black Box Traders Withdraw

Users of computer-driven strategies of all sorts have been taking it on the chin. Bloomberg tells us that the latest casualties are Treasury bond traders using quantitatively driven strategies hit by a sudden increase in volatility.

The failure of the models is producing more collateral damage than one might expect. Trading volumes in what is the biggest and most liquid market in the world have fallen by as much as 80%, according to interbroker dealers. This in turn has produced some dramatic responses. As Bloomberg reports:

Securities firms increased commissions as much as nine-fold to avoid losses should offers to buy or sell bonds suddenly disappear, according to Mark MacQueen, a partner at Austin, Texas-based Sage Advisory Services Ltd., which oversees $5 billion….

“There’s no question that even the most liquid market in the world, the Treasury market, has been facing bouts of illiquidity, occasional discontinuous pricing, and more anomalies than you normally get,” said Paul Yablon, head of global macro proprietary trading at RBS Greenwich Capital in Greenwich, Connecticut. `It’s typical of a financial crisis environment.”

The price swings showed up most in the market for Treasury bills, the safest securities with the shortest maturities. There were 15 days last month when yields on three-month bills swung by 10 or more basis points, according to data compiled by Bloomberg. That happened only six days from the start of 2002 through July. There were only five such swings in the aftermath of the September 2001 terror attacks.

“Volatility’s going to lead to wider spreads, less liquidity and more risk,” Sage Advisory’s MacQueen said. “You’re paying a little more to get transactions done.”

The difference brokers charge to buy and sell Treasury bills widened to 20 basis points last month from the typical 1 basis point, he said. That means commissions on a $1 million order swelled to $185, from about $20….

Until a month ago, the interdealer market where firms trade anonymously typically had bids and offers for at least $500 million of two-year notes at the quoted market price, said ESpeed’s Ficke. Last week, the amounts were about $100 million, he said. New York-based ESpeed operates one of the two largest interdealer broker systems behind ICAP Plc….

“We’re still in very volatile markets, and as a trader I appreciate volatility,” said Theodore Ake, head of U.S. government bond trading at primary dealer Mizuho Securities USA Inc. in New York. “I just want liquidity with my volatility.”’

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