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The interdealer market for Treasury securities shares many features with other highly liquid markets that trade electronically using anonymous central limit order books. The interdealer Treasury market, however, contains a unique trading protocol, the so-called workup, that accounts for the majority of interdealer trading volume. While the workup is designed to enhance liquidity in a market with diverse participation, it may also delay certain price-improving order book adjustments and therefore affect price discovery. In this post, we exploit the tight relationship between the ten-year Treasury note traded on the BrokerTec platform and the corresponding Treasury futures contract to explore how the workup protocol affects trading in the interdealer market and to highlight the impact of technological changes on observed trading behaviors.
Michael Fleming, Frank Keane, and Ernst Schaumburg
The recent Joint Staff Report on October 15, 2014, exploring an episode of unprecedented volatility in the U.S. Treasury market, revealed that primary dealers no longer account for most trading volume on the interdealer brokerage (IDB) platforms. This shift is noteworthy because dealers contribute to long-term liquidity provision via their willingness to hold positions across days. However, a large share of Treasury security trading occurs elsewhere, in the dealer-to-customer (DtC) market. In this post, we show that primary dealers maintain a majority share of secondary market trading volume when DtC trading is taken into account. We also use survey data on large dealers to characterize activity in the DtC market and discuss some of the gaps in the available Treasury trading volume data.
In an earlier post, we showed that Treasury market liquidity appears reasonably good by historical standards. That analysis focused on the most liquid benchmark securities, largely because data availability is best for those securities. However, some studies, such as this one and this one, report that market liquidity is concentrating in the most liquid securities at the expense of the less liquid, so that looking only at the benchmark securities gives a misleading impression. In this post, I look at trading volume information reported by the Federal Reserve to test whether liquidity is becoming more concentrated.
Note: Updated versions of the charts in this post showing data through March 31, 2016, can be viewed here.
In a 2014 post, we described what settlement fails are, why they arise and matter, and how they can be measured. A subsequent post explored the determinants of the increased volume of U.S. Treasury security settlement fails in June 2014. Part of that episode reflected a steady increase in settlement fails of seasoned securities. In this post, we explore the characteristics of seasoned fails in recent years, in order to better understand the risks associated with such fails.
Securities broker-dealers (dealers) trade securities on behalf of their customers and themselves. Recently, analysts have pointed to the decline in U.S. dealers’ corporate bond inventories as evidence that dealers’ market making capacity is impaired. However, historically such inventories also reflect dealers’ risk management and proprietary trading activities. In this post, we take a long-term perspective on the evolution of dealers’ inventories of corporate bonds, Treasuries, and other debt securities and relate those inventories to expected returns in fixed-income markets in an effort to better understand the drivers of dealer positioning.
Michael Fleming, Frank Keane, Michael McMorrow, Ernst Schaumburg, and Nathaniel Wuerffel
The New York Fed recently hosted a two-day conference on the evolving structure of the U.S. Treasury market, co-sponsored with the U.S. Department of the Treasury, the Federal Reserve Board, the U.S. Securities and Exchange Commission, and the U.S. Commodity Futures Trading Commission. The events of October 15, 2014, when yields experienced an unusually high level of volatility and a rapid round-trip in prices without a clear cause, underscored the need to better understand the factors that affect the liquidity and functioning of this important market.
The market for benchmark U.S. Treasury securities is one of the deepest and most liquid in the world. Although trading in the interdealer market for these securities is over-the-counter, it features a central limit order book (CLOB) similar to that found in exchange-traded instruments, such as equities and futures. A distinctive feature of this market is the “workup” protocol, whereby the execution of a marketable order opens a short time window during which market participants can transact additional volume at the same price. With the broadening of the interdealer market to include hedge funds and proprietary trading firms, and the increase in trading activity, some market participants consider the workup to be somewhat of an anachronism that is destined to lose its relevance relative to the CLOB. Contrary to this notion, we document the continued important role played by the workup, show some ways in which trading behavior in the workup has evolved, and explain some of the observed changes.
The U.S. Treasury market is one of the deepest and most liquid markets in the world, with significant trading in both Treasury futures and benchmark securities. In this post, we examine the pattern of trading activity in these instruments and document the substantial increase in cross-market trading (simultaneous order placement and execution in multiple markets) in recent years, highlighting the impact of technological advancements that allow nearly instantaneous trading across assets and trading platforms. Identifying the growing role played by high-frequency trading in U.S. Treasury markets is important for understanding the price discovery process. Our findings suggest that price discovery takes place on both futures and cash markets and that cross-market trading helps maintain the tight link between the two.
Tobias Adrian, Michael Fleming, Daniel Stackman, and Erik Vogt
First in a five-part series
The issue of financial market liquidity has received tremendous attention lately. This partly arises from market participants' concerns that regulatory and structural changes have reduced dealers' market making abilities, but also from events such as the taper tantrum and the flash rally, in which Treasury prices fluctuated sharply amid seemingly little news. But is there really evidence of a sustained reduction in Treasury market liquidity?
Nashrah Ahmed, Alain Chaboud, Dobrislav Dobrev, Joseph Fiorica, Michael Fleming, Frank Keane, Michael McMorrow, Suraj Prasanna, Ernst Schaumburg, Nathaniel Wuerffel, and Ron Yang
The $12.7 trillion U.S. Treasury market plays a critical role in the global economy, serving as the primary means of financing the U.S. government, a risk-free benchmark for other financial instruments, and a key venue for the Federal Reserve’s implementation of monetary policy. On October 15, 2014, the market experienced unusually high volatility, record trading volume, and a rapid “round-trip” in prices without a clear cause. In a recently released report, staff of the U.S. Treasury, the Federal Reserve Board, the New York Fed, the SEC, and the CFTC examine the events of that day. This preliminary report provides the most thorough analysis to date of the events that day and serves as a foundation for future analysis of Treasury market functioning and structure.
Liberty Street Economics features insight and analysis from economists working at the intersection of research and policy. The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Donald Morgan.
The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.
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