A senior Federal Reserve official has warned that last autumn's "flash crash" in US Treasurys could happen again due to the changing nature of the US government debt market, and urged banks, investors and exchanges to adopt a revised set of guidelines in response to the turmoil.
The US Treasury market is the biggest and most liquid in the world, and forms the bedrock for the global financial system. Its steadiness and the solid creditworthiness of the US government is a large reason why it constitutes a mainstay of global central banking reserves and the default haven asset in times of crisis.
However, last October, Treasurys see-sawed dramatically, seemingly on little news. The yield on the benchmark 10-year US government bond, which moves inversely to price, slid as much as 33 basis points to 1.86 per cent before rising to settle at 2.13 per cent. Mathematically this move was so sharp it would only be expected to occur once every 1.6bn years.
However, Simon Potter, executive vice-president of the Federal Reserve Bank of New York, warned in a speech on Monday that the unintended consequences of regulatory and market changes could mean that "that sharp intraday price moves become more common" in the future.
The volatility of the US Treasury market that day has been pored over by regulators, traders and exchanges, but no definitive reason has been found for the wild fluctuations.
Jamie Dimon, the head of JPMorgan, also highlighted the October 15 "flash crash" in his annual letter to his shareholders, and said that it constituted a "warning shot across the bow", attributing the sharpness of the moves to regulatory changes that encourage the hoarding of Treasurys and discourage banks from helping to cushion sharp moves in bond markets.
In a recent white paper on the increasing automation of trading in US Treasurys, the New York Fed highlighted explanations including computer-driven high-frequency trading; poor economic news leading to investors swiftly reversing bets against Treasurys; and changing structures in the bond market. But it said that experts "have generally been unable to attribute the price action to any single factor".
This was echoed by Mr Potter in his speech to big banks that are the primary dealers of the Treasury market, but the Fed official attributed the speed of the moves at least partly to the rise of electronic, high-frequency trading in the US government bond market.
"It is possible that changes in the participation or behavior of firms employing automated strategies — including broker-dealers and proprietary trading firms — had an effect on market liquidity and price movements that day," he said according to a text of the speech.
Although the October 15 crash has had little lasting impact on prices in the US Treasury market, with the 10-year yield now only modestly higher than where it ended that day, the ferociousness of the moves is leading to a revamping of guidelines for the Treasury market.
The Fed's white paper has already updated a list of best practices for investors, dealers, traders and exchanges, and Mr Potter said that once a consultative period was over everyone active in the US Treasury market should adopt these new measures.