The coronavirus crisis has ushered in a “dramatic” shift in the world’s largest bond market away from traditional trading by phone towards electronic execution, according to a report produced by JPMorgan Chase.
The figures from the Wall Street bank, one of the biggest Treasury dealers, suggest that a gradual drift towards electronification of the market for US government bonds was accelerated by the impact of the pandemic as many of the bank’s clients — who found themselves suddenly working from home in a volatile market meltdown — preferred to transact based on prices quoted on a screen rather than picking up the phone to negotiate with a human trader.
Over the past two years, roughly 50 per cent of trading in the US Treasury market has been carried out electronically, according to the report by JPMorgan’s Treasury trading desk, seen by the Financial Times. That figure surged to 70 per cent in April and has continued to rise even as the most acute market stress eased, hitting 77 per cent in June. The data suggests that “the way these securities trade is starting to change dramatically”, the report said.
“A lot of people working remotely, both in terms of clients and trading floors, is definitely a factor in accelerating this trend,” said Thomas Pluta, co-head of North America rates at the bank. “Many clients now have a comfort level in trading these products electronically. You might see this trend reverse partly [as market participants return to the office] but I don’t think it will go back to where it was.”
The US Treasury market, the world’s most liquid bond market, has led the shift to electronic trading, but still lags behind other asset classes such as equities in the adoption of the technology. Typically, the most heavily traded “on-the-run” bonds are more likely to change hands electronically than more thinly traded “off-the-run” securities, which are older issues of the benchmark bonds and make up the majority of the market.
But starting in March, even off-the-run Treasuries — which saw the biggest price dislocations when liquidity cratered — have seen a “noteworthy” shift towards electronic execution of trades, according to the report.
During March’s market turmoil, a desperate dash for cash led foreign central banks and companies to dump their Treasury holdings. Many fund managers were also forced to sell in order to meet redemptions from investors. Further exacerbating the situation was the unwind of a popular and highly leveraged trade involving Treasury securities and their corresponding futures contracts.
Coupled with the fact that banks had limited capacity to absorb the deluge of selling hitting the market because of regulatory constraints, trading conditions quickly deteriorated. Volatility surged and traders complained brokers were at times not quoting prices.
The sudden evaporation of liquidity in what is supposedly the safest corner of financial markets prompted a preference for so-called firm quotes — offers to buy bonds that are not subject to cancellation — from these sellers. JPMorgan said this may have contributed to the shift toward electronic trading. For trades of above $100m, investors continued to show a preference to trade by phone, the report added.
Despite the scale of the shift, Mr Pluta said he does not expect electronic trading to supplant human traders. Some automated systems are overseen by traders, who also work with the programmers who build trading algorithms.
“This is not the machines taking over,” said Mr Pluta. “It’s more that the role of the trader has changed. Voice traders are very much involved in the electronic trading.”