The U.S. Treasury market is the deepest and most liquid government securities market in the world. However, it lags far behind the equities market in terms of informational transparency. There is little access to data around such basic metrics as which treasuries are trading and when they are trading, for example. Despite the challenges, high frequency traders (HFT) have been able to improve on the traditional and less automated ways of trading treasuries. HFT, working on razor thin margins and serving as nimble and responsive intermediaries, now represent eight of the top ten dealers in the market according to a recently published BrokerTec list.
The beneficial role of HFT in the government debt market was brought into sharp focus in the aftermath of chaotic trading in the treasuries market on October 15, 2014. On that day, extreme volatility produced a statistical deviation so severe, TABB Group Analyst Anthony Perrotta said such a move should occur once “every 1.6 billion years.” Initially, many people blamed the role of proprietary trading firms (PTFs) using HFT tools for the “Flash Rally.” But a multi-agency report analyzing the event looked separately at the actions of banks and PTFs on that day and discovered these market participants were both using HFT tools completely differently.
The report found that banks, the traditional dealers in treasuries “tended to widen their bid-ask spreads, and for a period of time provided no, or very few, offers in the order book in the cash Treasury market.” Contrast this with PTFs using HFT tools who “… continued to provide the majority of order book depth and a tight spread between bid and ask prices throughout the day, even during the event window.”
A supplemental finding of the report, unveiled at the conference hosted by the Federal Reserve Bank of NY in October 2015, found that while HFT was providing bid and ask quotes, banks were ignoring customer orders.
We believe that PTFs are better at automating trading than others, despite using similar trading tools. In fact, PTFs using HFT tend to become the dominant intermediaries in the asset classes in which they participate. This has been a great outcome for investors, as it introduces competition that drives down costs and fuels innovation that creates further money saving efficiencies.
Industry Support for the Role of HFT in the Treasury Market
“(HFT) as a group continued to provide the majority of order book depth and a tight spread between bid and ask prices throughout the day, even during the event window.”
– Joint Government Agency Report: The U.S. Treasury Market on October 15, 2014
“Automated trading has come to play a crucial role in fostering liquidity and the efficiency of the price discovery process in inter-dealer U.S. Treasury markets.”
– Automated Trading in Treasury Markets White Paper: Federal Reserve Bank of New York’s Treasury Market Practices Group