Stability-Liquidity Tradeoffs in Post-Crisis Bond Markets

Darrell Duffie

Graduate School of Business, Stanford University

Brookings, November 17, 2015

P R E - S E T T E M P L AT E S & U S A G E T I P S

A  stability-­‐liquidity  tradeoff  

•  Capital  and  ac6vity  rules  have  improved  bank  stability  and  reduced  commitments  of  bank-­‐affiliated  balance  sheets  to  financial  market  intermedia6on.  

•  This  raises  incen6ves  for  agency  intermedia6on,  CCPs,  all-­‐to-­‐all  trade,  shadow-­‐bank  intermedia6on,  and  a  shiD  by  banks  away  from  low-­‐risk  standardized  (low-­‐margin)  products.  

•  The  net  impacts  on  market  efficiency  are  s6ll  playing  out,  and  depend  on  other  factors,  including  monetary  policy.    

 

   

 

Treasuries  bid-­‐ask  spreads  are  stable  

0  

1  

2  

3  

4  

5  

6  

7  

8  

9  

1/1/2005   1/1/2007   1/1/2009   1/1/2011   1/1/2013   1/1/2015  

256ths  

2-­‐year   5-­‐year   10-­‐year  

Source:  Adrian,  Fleming,  Stackman,  and  Vogt  (2015)  (BrokerTec  data)  

Treasury  note  trade  price  impacts  

Source:  Adrian,  Fleming,  Stackman,  and  Vogt  (2015)  (from  BrokerTec  data)  

0  

3  

6  

9  

12  

15  

18  

1/1/2005   1/1/2007   1/1/2009   1/1/2011   1/1/2013   1/1/2015  

256ths  per  $100  million  

2-­‐year   5-­‐year   10-­‐year  

Symptoms  of  changing  liquidity  •  Tradi6onal  liquidity  measures  such  as  price  impact  and  bid-­‐

ask  spread  look  fine.  

•  Turnover  and  trade  sizes  are  generally  down.    

•  Single-­‐name  CDS  and  matched-­‐book  repo  markets  are  withering.    

•  The  10-­‐year  Treasury  note  “yield  crash”  of  October  15,  2014  is  a  symptom  of  changes  in  the  mix  of  intermediaries,  including  HFT.    

 

   

 

Trade  size  has  declined    

Source:  Adrian,  Fleming,  Stackman,  and  Vogt  (2015)  (BrokerTec  data)  

0  

5  

10  

15  

20  

25  

1/1/2005   1/1/2007   1/1/2009   1/1/2011   1/1/2013   1/1/2015  

Millions  of  D

ollars  

2-­‐year   5-­‐year   10-­‐year  

Treasury  market  turnover  

0  

0.02  

0.04  

0.06  

0.08  

0.1  

0.12  

0.14  

Data  source:  SIFMA  

Daily  volum

e/ou

tstand

ing      

Figure 4.13: Benchmark Price Impact (Cash)   Figure 4.14: Benchmark Trade Size (Cash) 

 

 Figure 4.15: Treasury Active Contract Trade Size

(Futures)  

 

 

 

 

   

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2004 2006 2008 2010 2012 2014

32nds per $100

million

2 Year 5 Year 10 Year

Note: Slope coefficients from weekly regressions of 5” price changes on 5” net order flow for the on-the-run notesSource: Staff calculations, based on data from BrokerTec.

0

5

10

15

20

25

30

2004 2006 2008 2010 2012 2014

$ millions 2 Year 5 Year 10 Year

Note: 21-day moving average; Average trade size; On-the-run notesSource: Staff calculations, based on data from BrokerTec.

0

1

2

3

4

5

6

7

8

9

2004 2006 2008 2010 2012 2014

$ millions 2 Year 5 Year 10 Year

Note: 21-day moving average; 8:20 - 15:00 ETSource: Staff calculations, based on data from CME Group.

69

21

Decline in GCF net lending volume

-100

-80

-60

-40

-20

0

20

40

60

80

100

$ bi

llion

s

Mar 11 Sep 11 Mar 12 Sep 12 Mar 13 Sep 13 Mar 14 Sep 14 Mar 15 Sep 15month

Non-BHC Dealers Small BHC dealers Large BHC Dealers

Monthly AverageDaily Net Cash Positions by Dealer Group

Copyright 2014 FINRA

Corporate bond – average bid-ask spreads

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

2002 2004 2006 2008 2010 2012 2014 2016

$ pe

r uni

t par

Investment Grade

High Yield

Copyright 2014 FINRA

Corporate bond – average trade size

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

2002 2004 2006 2008 2010 2012 2014 2016

$ mill

ion

1,000 Most Active BondsLess Active Bonds

Turnover  of  corporate  and  municipal  bonds  

0  

0.001  

0.002  

0.003  

0.004  

0.005  

0.006  

0.007  

0.008  

Municipal  bonds   Corporate  bonds  

Daily  volum

e/ou

tstand

ing      

Data  source:  SIFMA  

When  more  dealers  compete,  corporate  bond  trade  costs  go  down  

-­‐10  

0  

10  

20  

30  

40  

50  

60  

1   2   3   4   5   6   7   8   9   10   11   12   13   14   15   16   17   18   19   20  

Cost  in  Basis  Points  

Number  of  dealers  responding  

Investment  Grade  

High  Yield  

Source:  Hendersho`  and  Madhavan  (2014)  

Number  of  CDS  trades  per  quarter      

0  

50,000  

100,000  

150,000  

200,000  

250,000  

300,000  

350,000  

400,000  Single-­‐Name   Index  

Data  source:  DTCC  

Who  handles  U.S.  bonds?  

0  

500  

1000  

1500  

2000  

2500  

3000  

3500  

4000  

2001  2002  2003  2004  2005  2006  2007  2008  2009  2010  2011  2012  2013  2014  

Bond  Fund+ETF   Dealer  Bonds  Financed  

Data  sources.  ICI:  AUM,  bond  mutual  funds  +  ETFs.  FRBNY:  primary  dealer  daily  financing  (securi6es  out)  of  UST  +  agencies  +  MBS  +  corporate  bonds.    

Assets  (b

illion  USD

)  

Net  monthly  cash  inflows  to  bond  funds  

-­‐80  

-­‐60  

-­‐40  

-­‐20  

0  

20  

40  1/1/13  

3/1/13  

5/1/13  

7/1/13  

9/1/13  

11/1/13  

1/1/14  

3/1/14  

5/1/14  

7/1/14  

9/1/14  

11/1/14  

1/1/15  

3/1/15  

5/1/15  

7/1/15  

9/1/15  

Billion

s  of  d

ollars  

Data  source:  Investment  Company  Ins6tute  

Section 4 Figures

Figure 4.1: Financial Assets of Security Brokers and Dealers

  Figure 4.2: Net Treasury Positions of Primary Dealers 

 

 Figure 4.3: Gross Treasury Positions of Primary

Dealers   Figure 4.4: Estimated Treasury Market-Making

Positions of Primary Dealers

 

 

 Figure 4.5: Ownership of Treasury Debt by Investor

Group  

Figure 4.6: Government Bond Fund Flows 

 

0

1

2

3

4

5

6

1990 1994 1998 2002 2006 2010 2014

$ trillions

Note: Quarterly observations; Total financial assets of security brokers and dealers as reported in the financial accounts of the United StatesSource: Staff calculations, based on data from Federal Reserve Board.

-200

-150

-100

-50

0

50

100

150

2002 2004 2006 2008 2010 2012 2014

$ billions

Note: 4-week moving averageSource: Staff calculations, based on data from FRBNY.

0

1

2

3

4

5

6

7

8

9

0

100

200

300

400

500

600

2002 2004 2006 2008 2010 2012 2014

%$ billions

Position

Position as % of Debt Outstanding,ex-Fed (RHS)

Note: 4-week moving average; Sum of dealers’ short and long positions Source: Staff calculations, based on data from FRBNY.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0

50

100

150

200

250

2002 2004 2006 2008 2010 2012 2014

%$ billions

Position

Position as % of Debt Outstanding, ex-Fed (RHS)

Note: 4-week moving average; Smaller of each dealer’s short and long position in each reporting bucket, aggregated across dealers and buckets Source: Staff calculations, based on data from FRBNY.

0

10

20

30

40

50

60

2004 2006 2008 2010 2012 2014

%

Mutual funds Pension fundsHouseholds State and local governmentsDepository institutions Money market fundsInsurance companies Other financial institutionsNonfinancial businesses Federal Reserve

Note: Mutual funds includes closed-end funds and exchange-traded funds; Pension funds includes government retirement fundsSource: Staff calculations, based on data from Federal Reserve Board.

-10-8-6-4-202468

10

2004 2006 2008 2010 2012 2014

$ billions

Note: Total net monthly flows; Some funds own agency debt securities and MBS in addition to Treasury securitiesSource: Staff calculations, based on data from Morningstar.

67

Asset  management  stability  issues  •  Comments  on  the  risk  of  a  crisis  arising  from  sudden  bond  

fund  redemp6ons  seem  exaggerated.  •  A  rush  for  the  exits  would  impact  prices,  but  bids  will  likely  

arrive  before  a  crisis  is  triggered.  Who  exactly  would  “fail”?  •  Large  hedge  funds  present  a  poten6al  for  unwind  risk,  given  

their  reliance  on  leverage  and  expert  porkolio  managers.  •  Large  agency-­‐based  managers  seem  more  benign,  and  have  

not  been  designated  as  SIFIs.  •  Regulators  also  focus  on  insurance  firms  that  are  ac6ve  in  

financial  markets.  Some  have  been  designated.  •  Money-­‐market  funds  are  migra6ng  to  government  securi6es    

   

 

Supplementary  content  

Depth  has  declined  from  recent  highs  

Source:  Adrian,  Fleming,  Stackman,  and  Vogt  (2015)  (from  BrokerTec  data)  

0  

500  

1000  

1500  

2000  

2500  

1/1/2005   1/1/2007   1/1/2009   1/1/2011   1/1/2013   1/1/2015  

Millions  of  D

ollars  

2-­‐year   5-­‐year   10-­‐year  

T-­‐note  mul6lateral  plakorm  volumes  

0  

10  

20  

30  

40  

50  

60  

2001   2002   2003   2004   2005   2006   2007   2008   2009   2010   2011  

10-­‐year   5-­‐year     2-­‐year  

Source:  Fleming  (2014)  (BrokerTec  data)  

Daily  volum

e  (billions  of  d

ollars)  

FX  dealer  versus  non-­‐dealer  volumes  

0  

500  

1000  

1500  

2000  

2500  

3000  

3500  

1995   1998   2001   2004   2007   2010   2013  

Dealers   Non-­‐dealers  

Source:  Rime  and  Schrimpf  (2014)  (BIS  data)  

Daily  trade  volume  (billions  of  U

SD)  

Some  remaining  system  vulnerabili6es  

•  Improving  but  s6ll  fragile  design  of  tri-­‐party  repo  leaves  the  poten6al  for  repo  fire  sales.  

•  Lending  of  last  resort  is  overly  limited  by  Dodd-­‐Frank.    

•  Poten6al  for  pro-­‐cyclical  margins,  pending  new  FSB  standards  (more  research  needed).  

 

 

                                                                                                                                 Type  (90th  percen6le  haircut)  

Treasuries  (2.0%)  

Agency  MBS  (3.0%)  

Agencies  (3.0%)  

Money  market  (5.0%)  

Agency  CMO  (11%)  

IG  Corporate  (9.0%)  

Equi6es  (15.0%)  

HY  Corporate  (15%)  

CMO  (Private)  (20%)  

Other  

Treasuries  

Agency  MBS  

Agencies  

Agency  CMO  

CMO  

U.S.  tri-­‐party  repo  collateral  and  liquidity  

Data  source:  FRBNY,  November,  2015  h`p://newyorkfed.org/data-­‐and-­‐sta6s6cs/data-­‐visualiza6on/tri-­‐party-­‐repo/#interac6ve/volume  

US  GSIFI  FHC  

U.S.  Bank  U.S.  Broker  Dealer    

     Counterparty  

U.K.  Broker  Dealer    

Zone  of  stays  on  failure  terminaNon  of  swaps,  repos,  sec-­‐lending  

Daily  average  volume  of  interest  rate  deriva6ves    

0  

200  

400  

600  

800  

1000  

1200  

1400  

1600  

1995   1998   2001   2004   2007   2010   2013  

US-­‐OTC   US-­‐EXCH   UK-­‐OTC  

Daily  average  volum

e  (  $

 billions)  

Data  sources.  BIS:  OTC  Triennial  (April),    U.S.  exchanges  Table  23A  (March).