An Extra Helping of Volatility?

Revisiting the curious case of October 15th.

Like HFT arguments, Tim prefers his cranberry sauce cheap, gelatinous and canned.

Popular wisdom seems to be building that a Flash Crash actually occurred in the treasuries market as capital flew to safe havens a little more than a month ago. Tim considers the arguments.

It's Thanksgiving!

That means turkey, stuffing and gravy, cranberry sauce in at least three varieties, people camping out in front of Walmart, football ... and on the east coast of the US, a very unfortunately-timed mess of snowy weather. Indeed, the notorious day of bad travel beforehand always seems to sneak up, only to leave you marooned for hours in your car slamming the steering wheel, or stuck with a bunch of friends you never wanted on a train and wondering why.

Some messes just seem inevitable, given all their elements coming together in just the wrong way, and this would describe the US government bond market on October 15th, too.

That week, of course, witnessed a bout of severe volatility unseen in several years, which taxed the treasuries market especially—a focal point for electronification throughout 2014—when investors finally spooked, hedging strategies began to tilt sideways, and everyone headed for safer ground.

Just what happened has, since then, been a topic of increasing interest and lively disagreement.

In a not-particularly-bold observation at the time, I wrote that the return of volatility would provide a real test for treasuries' market infrastructure and buy-side risk management systems alike, in many cases for the first time.

What I didn't expect is that the phrase "flash crash" would be tossed around as the event was dissected a month later.

Too Much Flash
The numbers bear this description out. On the 15th, the 10-year treasury yield dropped almost 35 points in little more than an hour before recovering during the rest of the day.

But discursively, "flash crash" takes us back to equities in 2010, when aggressive selling by high-frequency traders caused a 600 point drop on the Dow Jones Industrial Average in five minutes. And here the comparison gets fuzzy.

That may have been the day the still-smoldering HFT debate began in earnest. But four years later, the parlance doesn't prove very helpful to those of us who actually want to know what happened in October, with offensive and defensive positions now being taken over the early morning of the 15th, just as they were when Flash Boys was published. HFT lobbying organization Modern Markets Initiative—now featuring the help of former critic and CFTC commissioner Bart Chilton—even popped into my inbox on Tuesday. Probably not a coincidence.

There can be no denying that treasuries trading is faster and, as a portion of the whole, more electronic than it once was; however, other than the rapidity of the two events in question and their temporary nature, there is little to compare them.

As Gregg Berman's joint SEC-CFTC investigation found in 2010, equities were "so fragmented and fragile that a single large trade could send stocks into a sudden spiral." The stimuli on October 15 were multiple and macroeconomic, and in terms of executing venues and liquidity provision, treasuries are still governed more closely than stocks.

Alternative Theories
That's why it seems like a stretch, even mildly opportunistic, for certain quarters to now cry, "we knew this would happen eventually in bonds; HFT is evil, etc.", and why alternative culprits—whether conceptual, such as the flimsiness of a principle-based liquidity risk management model, or specific theories about a few large hedge funds getting caught out on one of their greeks—make more sense to explain what happened.

Figuring out where technology played its part in that process is important, and October 15th could well provide a view into tech's evolution in treasuries as more information comes to light about what was executed where, and how. The exercise is certainly worthwhile.

But in this case, the most important question is probably the original one: Why? And high-speed market-making can't completely explain that, even if some of us would like it to.

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