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"Turn Those Machines Back On" - The Day The Bond Market Died (If Only For A Few Minutes)

Tyler Durden's picture




 

The first hint that Skynet was self-aware took place on May 6, 2010, when the DJIA crashed over 1000 points in minutes, a move we warned would take place in April of 2009 with "The Incredibly Shrinking Market Liquidity, Or The Upcoming Black Swan Of Black Swans" merely extrapolating the ubiquitous and pervasive presence of HFTs in all parts of the market, leading to terminal instability and illiquidity. Four years later, on October 15 2014, the HFT hammer struck again, only this time it wiped out liquidity in the world's supposedly biggest and most liquidi market: the US bond market.

We showed the unprecedented, multiple sigma moves at the time as follows:

However, while the algos would have been delighted to let October 15 slide into the collective memory made obsolete by a constantly rising market (because investors are only truly angry when the market plunges not when it surges) just as the regulators made a mockery of their fiduciary responsibilities in the aftermath of May 6, and now markets are more fragile than ever as HFTs comprise the vast majority of all trades, some appear to be complaining and even, gasp, asking questions how it is possible that the $12 trillion US Treasury market traded like an illiquid Pink Sheets pennystock, or worse, the Nikkei.

Here is the WSJ with some of the complaints: “It starts moving faster and faster, and you can’t point to anything,” recalled Mark Cernicky, managing director at Principal Global Investors , which oversees $78 billion.

The WSJ cites JPM which notes that "during the plunge in bond yields, trading volumes exploded in the futures market and in Treasury bonds. But, according to J.P. Morgan data, that morning the average amount of Treasury 10-year notes available to be bought or sold near current market prices was 54% below the average for the prior two weeks. For two-year notes, the available stock of notes was 75% below the two-week average."

Now, investors and regulators are burrowing into the causes of the plunge in yields to try to understand whether electronic trading and new regulations are fueling sudden price swings in a market that acts as a key benchmark for interest rates, investments and U.S. home loans.

 

Regulators and other experts are examining deep-seated shifts in trading since the financial crisis, which could help explain the unusual size of the move in a market many investors rely on for its relative stability.

 

“What happened on Oct. 15 is the result of things that had been building for a while,” said Alex Roever, a strategist at J.P. Morgan Chase & Co. who follows the government-bond market.

Well, yes. They have also been extensively previewed here, most recently in Phantom Markets: Why The TBAC Is Suddenly Very Worried About Market Liquidity. And sure enough, with the usual year and a half delay, the regulators are finally on the scene.

The Federal Reserve, Treasury and Commodity Futures Trading Commission are looking at that day’s trading activity, according to people familiar with the situation. One focus is the role of high-speed electronic trading in the bond market, although regulators haven’t yet drawn any conclusions, these people said.

 

Market supervisors at the Fed and Treasury have pored over the day’s trading data and reached out to big banks to better understand what caused the sudden drop in yields, said people familiar with the matter.

What caused it? Simple: first and foremost thank the Fed, whose relentless purchases up of Treasurys from the private market has led to a historic shortage of the most popular CUSIPs, and a daily update where Treasurys trade negative in repo land, meaning an constant inability to procure the underlying bonds.

Capital rules have also led to a shrinking of the “repo” market. Short for repurchase agreements, repos are short-term loans crucial to the smooth functioning of the market by enabling bondholders to lend out securities to investors who want to sell and bet on price declines. “The net effect of regulation has been to lower liquidity,” said Ashish Shah who heads credit at $473 billion asset manager AllianceBernstein LP. “So you get short-term dislocations that are larger than what we used to get—even in Treasurys.”

Odd, that, because we warned about precisely this in July: 'The Current Repo Fails Issue Rebukes Any Notion That The Fed Is In Control."

And then there are the algos. The WSJ's take is the following:

Potentially amplifying swings, banks have become wedded to risk measures that mandate traders pull back from the market when volatility spikes.While these models help manage risk, by forcing dealers out of the market when prices get volatile, “at times like mid-October they can in a way be self-fueling,” said William O’Donnell, head Treasury strategist at RBS Americas.

 

CME Group has said about 35% of its volume is attributable to high-frequency traders, and some bond-market participants say much of the electronic trading is concentrated in roughly a dozen speedy-trading firms.

 

Researcher Tabb Group estimates that electronic trading in Treasury securities will rise to 60% of overall market volume by 2015 from 37% in 2013.

 

A decade ago, a trader at a fund company would have to pick up a phone to call a salesperson at a bank for a quote on bonds they want to buy or sell. Today, dealers have computer programs that automatically spit out quotes to clients on a screen.

 

This change has meant firms can process information and trade much faster. But where dealers used to have a closed network of brokers through which to set prices, in the last few years fast-trading hedge funds and proprietary-trading firms have been allowed to trade in this network.

We have written so much about the takeover of the capital markets by various assorted algos and electronic trading modalities that we won't even link back to any of the thousands of Zero Hedge articlescovering this topic.

However, we will provide a glimpse of how all this relentless artificial zero volume levitation will finally end. One day, when everything is about to crash and exchange are flooded with sell orders, all the machines - the algos, the exchanges, the Mahwah and Chicago servers - will simply be shut off:

The presence of high-frequency traders has help offset some of the decline in trading by dealers. But in times of market tumult, those speedy traders often seek to avoid losses by pulling back from the market, while dealers tend to seek to help clients get trades completed.

 

What’s more, virtually all major dealers have shifted to using computers to automate Treasury prices quoted to clients. While that has generally helped make trading faster, on Oct. 15, several traders shut down these systems.

 

Among them was Guggenheim Securities. A spokesman for the firm said it does so “at time of great volatility...as it cannot keep up with the extreme volatility of the market.”

 

He said shutting such automated systems off “protects the firm from giving erroneous prices,” and allows it to continue quoting clients—albeit at a slower pace—over the telephone.

Which considering that virtually every time there is a sharp drop in stocks, some exchange - be it BATS, Nasdaq or NYSE - breaks, is all one needs to know of the coming capital market future: please join the rest of the cat herd, courtesy of the Fed's ZIRP policies, and deposit your money into the pyramid scheme stock "market", just don't hope to be able to withdraw any of it out when the music finally stops.

 

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Mon, 11/10/2014 - 11:37 | 5432370 InjectTheVenom
InjectTheVenom's picture

maybe we need a bond market czar ?

Mon, 11/10/2014 - 11:52 | 5432406 Ghordius
Ghordius's picture

no. what "we need" is an insight. like that those markets used to be "liquid" and "deep", like a big dark lake

but then algos started to stretch it. and so it's an immense shallow puddle. stretching through time dilation. and of course, as hinted in the article, throwing overboard every pretense of a healthy market, including the existence of good, honest market makers willing to buy at a certain price and sell at another

all in all, a result of a relentless propaganda action for utter market fundamentalism. wake up, that "invisible hand"? it's people. it was always people. stop believing in voodoo policies or using the "casino mentality"

markets ain't magic per se. they need structure and order to work "their magic". you can break them. by too much, too wrong but even by too little regulation

Mon, 11/10/2014 - 11:58 | 5432435 Divided States ...
Divided States of America's picture

I dont think anybody outside of the investment industry knows or gives a shit about these occurences.....that will of course change when the gas prices on the gas station moves up or down AND the prices at our local supermarket becomes digital and moves up and down constantly...actually to clarify, the prices moves in only one direction....UP.

Mon, 11/10/2014 - 12:13 | 5432493 ShorTed
ShorTed's picture

Oh god, please, no more czars!  The 'mkt' is fucked up enough, why would we want to add more central planning?

Nice avatar though

Mon, 11/10/2014 - 18:27 | 5434110 Clowns on Acid
Clowns on Acid's picture

Well the Bond market has a CheesePope ...  Lloyd Blankfiend at Goldman... he is "doing God's work" 

Mon, 11/10/2014 - 11:40 | 5432373 Ruffmuff
Ruffmuff's picture

Bill gross left so he could start the real company called "Pimped" ticker symbol "SOL".

Mon, 11/10/2014 - 11:45 | 5432390 Cognitive Dissonance
Cognitive Dissonance's picture

It all works great until it doesn't. Hope they are lining up scapegoats cus they're gonna need a bunch.

Mon, 11/10/2014 - 11:59 | 5432439 Dr. Engali
Dr. Engali's picture

Between, Ebola, Russia, Iran, Republicans, Fergerson,  the Simpsons I'd say they have plenty lined up.

Mon, 11/10/2014 - 11:47 | 5432399 frankTHE COIN
frankTHE COIN's picture

The real reason is because It's not a Bond Mkt. It's a Mkt full of Bonds.

Mon, 11/10/2014 - 11:49 | 5432405 JenkinsLane
JenkinsLane's picture

It's a shame Rollover was such a shit film - well past due for a remake/reboot.

Mon, 11/10/2014 - 11:51 | 5432411 madbraz
madbraz's picture

Electronic trading simply allows some of the big players (primary dealers and hedge funds) to manipulate rates higher (short treasuries), which is the objective of the NY FED.  When there is volume, it is buying volume from institutional investors.  This volume exposes the mispricing (rigging) that had occurred previously due to electronic trading - what occurred was simply a revertion to where price should be based on supply and demand.  That's why you don't see german or french or canadian long-term yields so high - there is no significant futures market for those bonds (futures markets = rigging). 

 

They shut it off on October 15 probably because it would have caused some big player(s) to collapse, so they went to phones and took prices down.  Think about it, you don't stop trading because prices are going up!  That's exactly what the primary dealers decided to do.  Do they stop trading an IPO because it goes up 10% in an hour?  Imagine the panic in the trading desk of a large primary dealer as they see their gigantic interest rate swap position collapse and they scream:  "stop that trading, it is killing me!  it can't go up in price any more, otherwise I'm done"!

Mon, 11/10/2014 - 11:50 | 5432413 alexcojones
alexcojones's picture

Terminator - Rise of the Machines?

Terminator 3: Rise of the Machines
Mon, 11/10/2014 - 11:59 | 5432438 Kaiser Sousa
Kaiser Sousa's picture

anybody observing the fucking Dow in the last hour of trading in London...
what a fucking farce.

Mon, 11/10/2014 - 12:06 | 5432464 JRobby
JRobby's picture

Mortimer! Your Brother is ill!

Fuck him!

Mon, 11/10/2014 - 12:09 | 5432474 ekm1
ekm1's picture

Finally even zerohedge is coming to grips with what I've been saying

 

As of 2006 when HFT started, the system is in INSTANT CENTRAL CONTROL.

 

Market = Suspended.

 

Central command chooses winners and losers upon Congress/WhiteHouse orders.

Mon, 11/10/2014 - 12:27 | 5432527 Dame Ednas Possum
Dame Ednas Possum's picture

Hear ye, hear ye...

Oh great numb-nuts has spoken.

Note: the clowns in congress and the WH are simply part of the marketing department. They most certainly are not in charge.

Mon, 11/10/2014 - 12:19 | 5432516 BellevueTrader
BellevueTrader's picture

HFT's run this show...If you understandd their creation and how they operate, you will never again step foot into this farce Edward Quince market. Dare to play? All you should know is this; They are turned ON!

Mon, 11/10/2014 - 12:21 | 5432522 nobodysfool
nobodysfool's picture

[Blue Star has gone from 24 to 16 1/2 in a very short time]
Gordon Gekko: Fox, where the hell are you? I am losing MILLIONS! You got me into this airline and you sure as hell better get me out or the only job you'll ever have on the Street is SWEEPING IT! You hear me, Fox?
Bud Fox: You once told me, don't get emotional about stock. Don't! The bid is 16 1/2 and going down. As your broker, I advise you to take it.
Gordon Gekko: Yeah. Well you TAKE IT!
[shouts]
Gordon Gekko: *Right in the ass you fucking scumbag cocksucker!*
Bud Fox: It's two minutes to closing, Gordon. What do you want to do? Decide.
Gordon Gekko: [calms down] Dump it.

ttp://www.imdb.com/character/ch0012282/quotes 

 

 

Mon, 11/10/2014 - 12:33 | 5432570 flow5
flow5's picture

" a move we warned would take place in April of 2009 "

 

That's not even a prediction.  I predicted the flash crash 6 months out and within 1 day.  9/11 been the only "black swan".

Mon, 11/10/2014 - 12:41 | 5432614 the grateful un...
the grateful unemployed's picture

isn't opening the bond market a good thing? isn't letting the market set the quote (and not some guy on the other end of the phone) a good thing? the fed buying all the product is not a good thing, even if the process is more open, the rub is, the fed will need REPO if they close off QE, REPO is what they did in the 90's. (now they even do reverse REPO in the MM markets) without QE REPO is essential, so change the capital rules, thats' all. the bond market was never meant to be that liquid, as long as the fed maintains incremental policy (provide stability for the markets, remember?) then everything is alright, uptight, clean out of sight. baby

Mon, 11/10/2014 - 12:50 | 5432629 Youri Carma
Youri Carma's picture

Is this really a market when it's permitted that HFTs are constantly sending and cancelling orders 'quote-stuffing' (Others call it 'liquidity') and front-running each other?

"It is certainly true that HFTs are constantly sending and cancelling orders." http://www.economist.com/node/21547988

The change of interacting algorithms forming a self feeding loop seems bigger than admitted. CFTC is only blaming it's circuit breakers. HF-Circuitbreakers?

Mon, 11/10/2014 - 13:08 | 5432758 TheBird
TheBird's picture

A couple comments.  First off, lets not tar and feather "electronic" trading.  The ability of individuals to trade via globex and other systems is a good thing.  Where the problem lies, just as in stocks, is with the HFT and short term algo trading systems and its knock on effect to market liquidity.  

Further, the continued consolidation in the trading "industry" - whether stocks, forex or now bonds, has resulted in far fewer players in the system. Now, when one big guy shuts his desk down, it hurts. 

Also, readers should keep in mind the ever changing nature of what "market maker" means.  Back in the day (read the 1990s, give or take) market makers in equities provided some degree of two sided price support, though rarely as a quote to any but their best clients.  Bonds have always been a one sided pricing affair (hence I never understood calling them anything other than dealers).  Forex was truly the only market where two way pricing was mandatory, not just to clients but to other market participants.

Fast foward to today.  Market makers in stocks? Where?  Forex has undergone such a consolidation in terms of players and the push to dealing exclusively through the machines has for all intents killed the two way market maker.  Bonds never really had it but now we read they run away from any notion of price support. 

Ignoring cash market bond systems for a moment, I do wonder if anyone has looked at the CME Globex system and considered the effects that this single futures platform has on the world.  When it first started and volumes were low it was not a big deal.  Now pretty much everything that is a future trades through that single point of failure.  That is decidedly not good.   I shudder to think what would happen if trading in ZN was offline.

 

 

Mon, 11/10/2014 - 14:22 | 5433051 hooligan2009
hooligan2009's picture

reminisces about having to make tight prices in 50m licks in any on the run bond, verbally, or suffer reputational risk and nasty names

Mon, 11/10/2014 - 14:36 | 5433108 Batman11
Batman11's picture

System crashes are one of the seven signs in Jim Rickard's "The death of money" indicating we are coming to the end of days.

 

Mon, 11/10/2014 - 19:07 | 5434317 RMolineaux
RMolineaux's picture

We need a quotation and transaction tax to shut down HFT

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