05.16.2012
By Terry Flanagan

Electronification Presents Risks for Treasury Market

With the benchmark 10-year U.S. Treasury near historical lows of 1.75%, the risks to the downside have been well-publicized. An uptick in inflation or a change of course at a large foreign buyer of U.S. government debt are just two possibilities that could propel yields sharply higher.

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Speakers at the May 15 Treasury-focused panel at Markets Media’s Future of Electronic Fixed-Income Trading conference were colorful in their descriptions of the situation. One panelist said Treasury market is like having thousands of people in a room with only one three-foot door, while another conference participant said a market “puking” of Treasuries can be expected in the short to medium term.

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One aspect of the market that has changed since past Treasury selloffs is the increasingly electronic nature of government-bond trading, and the emergence of algorithmic and high-speed strategies. Market participants say the changed landscape is generally for the better, but it also has the potential to accelerate declines.

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“High-frequency trading is the X-factor” when considering a potential market rout, said George Gonclaves, managing director and head of U.S. rates strategy at Nomura. “If there’s one thing that electronic trading is doing, it’s speeding things up.”

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An increase in high-frequency trading of Treasuries can be expected to continue, and as more Treasuries are issued, liquidity can be expected to deepen, one panelist noted. However, another panelist noted the emergence of a bifurcated market in which algo traders find liquidity while traditional institutional investors such as pension funds find more friction and costs in their trading.

 

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