By Pam Martens and Russ Martens: April 9, 2015
You know times are weird on Wall Street when JPMorgan CEO Jamie Dimon devotes a good chunk of his shareholder letter, released yesterday, to fretting about whether there will be enough Treasury notes to go around in a safe haven stampede during the next crisis.
Dimon writes that “In a crisis, everyone rushes into Treasuries to protect themselves. In the last crisis, many investors sold risky assets and added more than $2 trillion to their ownership of Treasuries (by buying Treasuries or government money market funds). This will be even more true in the next crisis. But it seems to us that there is a greatly reduced supply of Treasuries to go around – in effect, there may be a shortage of all forms of good collateral.”
To underscore his point, Dimon invoked the tumult in the Treasury market on October 15, 2014, writing that on that day “Treasury securities moved 40 basis points, statistically 7 to 8 standard deviations – an unprecedented move – an event that is supposed to happen only once in every 3 billion years or so….”
Not to put too fine a point on it but the Homo sapiens species to which most of us belong (we can’t be positive about some traders on Wall Street) has only existed for about 100,000 years, making the “3 billion year” reference a bit over the top. Nonetheless, the move in the 10-year U.S. Treasury note on October 15, 2014 was extraordinary and has been dubbed a Flash Crash in Treasury yields by those who have taken a serious look at the day’s trading.
The day began with a lot of crowded trades betting on an improving economy and a stronger dollar. Then came the economic data releases showing a less than rosy picture. The Commerce Department reported a decline in retail sales of 0.3 percent for September; the Producer Price Index came in at a decline of 0.1 percent and the Empire State Manufacturing Survey reported that the “general business conditions index fell twenty-one points to 6.2, signaling that the pace of growth slowed significantly from last month.”
Market data firm, Nanex, reported that between 9:33 and 9:45 a.m. on the morning of October 15, 2014, “liquidity evaporated in Treasury futures and prices skyrocketed (causing yields to plummet). Five minutes later, prices returned to 9:33 [a.m.] levels.” Nanex goes on to say that “Trading activity was enormous, sending trade counts for the entire day to record highs — exceeding that of the Lehman collapse, the financial crisis and the August 2011 downgrade of U.S. debt.”
According to an analysis by Bloomberg News, “Yields on the 10-year note tumbled 0.34 percentage points to a low of 1.86 percent that day, with most of that drop occurring in a 10-minute span from 9:30 a.m. in New York, before ending the day at 2.14 percent.” Bloomberg reports that “Adjusted for current yield levels, which are close to historical lows, the magnitude of the intraday decline that day has been exceeded only once in the past half-century…”
The New York Fed has a Treasury Market Practices Group (TMPG) composed of personnel from the financial industry and the New York Fed. Minutes from its meeting on October 16, 2014, the day after the Flash Crash in Treasury yields, revealed the following:
“Regarding the events of October 15, members discussed a number of possible drivers that may have contributed to the large price swings and heightened volatility observed that day. Possible drivers discussed included large scale repositioning by leveraged investors, activities of electronic trading algorithms, and dealer balance sheet and risk management constraints. Members concluded that more time would be needed to fully understand the day’s events.
“The TMPG then received an update from a working group formed to conduct a review of high-speed electronic trading in TMPG covered markets. Working group members discussed potential risks of high-speed electronic trading identified by the group, such as operational risks to market participants and risks to broader market function. The TMPG suggested that the working group aim to better understand the events of October 15 and evaluate whether the events would be an appropriate case study for the TMPG’s potential white paper on high-speed electronic trading in TMPG covered markets.”
One of the key concerns floating around Wall Street is that the Federal Reserve itself may be a source of liquidity stresses in the Treasury market place. As a result of its previous, massive Quantitative Easing (QE) programs, it’s sitting with $2.4 trillion in Treasury securities on its balance sheet as of its report dated April 2, 2015. Keeping that supply out of the marketplace is part of the Fed’s monetary policy strategy to keep interest rates low and boost economic activity. However, in times of stress when trillion dollar banks and billion dollar hedge funds want to instantly flip out of junk bond ETFs, stocks and other riskier assets and into the safe haven of U.S. Treasuries, there may not be enough supply to go around given the trillions of dollars in high risk assets that now dominate the globe.
As of 9:55 a.m. this morning, the 10-year Treasury note is trading at a yield of 1.91 percent. From the date of the 1929 crash throughout the Great Depression years of the 1930s, the 10-year Treasury note never dropped below 2 percent. In July of 2012, the 10-year Treasury set an all-time historic low of 1.38 percent during intense worries over Europe’s sovereign debt problems. Should there be a future panic in the next few years that pushes investors out of risky trades, we could easily set a new record low below 1 percent.