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.
Section 1 of the report provides an overview of the U.S. Treasury market, applicable regulations, and data used in the report. The report relies on nonpublic transaction data from the most liquid parts of the Treasury market, including the interdealer market for benchmark securities (the “cash” market) and the tightly linked Treasury futures market (the “futures” market).
Section 2 puts the market turbulence of October 15 in context. The 37-basis-point trading range in the ten-year Treasury note on October 15 was highly unusual, particularly since the only notable news (the release of somewhat weaker-than-expected U.S. retail sales data at 8:30 a.m. ET) came well before the rapid round trip in prices. Liquidity conditions were strained, but volumes reached record highs, and trading took place in a continuous manner. Contributing to the general level of volatility were global macroeconomic concerns and an unwind of short positions in U.S. interest rates in the days leading up to and including October 15.
Section 3 of the report discusses the key findings from the analysis, focusing on the period leading up to and including the volatile 9:33 a.m. to 9:45 a.m. ET “event window.” It discusses a number of factors that may help explain the volatility:
- Market depth declined and trading volume surged following the retail sales data release, as bank-dealers and principal trading firms (PTFs) changed their behavior in response to the high volatility.
- PTFs’ share of trading volume—more than half in the futures and interdealer cash markets on October 15 and control days—increased significantly during the event window. Moreover, trading activity of PTFs and bank-dealers in the cash and futures markets is highly concentrated.
- Only modest changes in net positions occurred during the event window, but there were more buyer-initiated trades as prices rose, and more seller-initiated trades as prices fell.
- Several large transactions occurred between the retail sales release and the start of the event window, but the analysis does not suggest a direct causal relationship with the subsequent volatility.
- The time required to process incoming futures orders increased just ahead of the event window, with significantly increased message traffic due to order cancellations.
- “Self-trading” (where the same entity takes both sides of a trade) increased during the event window.
Section 4 then reviews broad changes to the structure of the Treasury market over the past two decades, including the growth in high-speed electronic trading, the growing presence of PTFs, the declining market share of bank-dealers, and potential changes in liquidity demand by many investors. Despite these changes, the report shows that by some metrics the liquidity and efficiency of trading in the Treasury market are as robust as they have ever been. But the changes in market structure raise questions about evolving risks, such as whether an improvement in average liquidity conditions may come at the cost of rare but severe bouts of volatility and strained liquidity.
The final section provides an important discussion of next steps toward a fuller understanding of the implications of the evolving Treasury market structure to support the goal of maintaining a highly liquid and resilient market.
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
Alain Chaboud is a senior economist at the Board of Governors of the Federal Reserve System.
Dobrislav Dobrev is an economist at the Board of Governors of the Federal Reserve System.
Michael Fleming is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.