Smaller spreads was supposed to make things better, but it took regulators some 10 years to understand that by decreasing the spread, the market would get less efficient, at least if you trade more than 100 shares. We have always argued that by decreasing the spread, many functions of the “natural” market maker would dissapear, as there is no spread to motivate the trader being in the market, providing the nescessary liquidity. We are not arguing for the old times to return. Technological advances are great, but only if the market benefits. The development over the past years, with Broken Markets, is now slowly being acknowledged by the regulators. Irrespective of what the academics tell you, liquidity is not better, trading impact is higher etc. One of our suggestions is starting off by applying a spread in relations to the company market cap. There are many more suggestions, but first let’s see if the SEC finally starts realising the market is broken. From WSJ.
For some stock prices, the new math might look a lot like the old math: Regulators are thinking about bringing back the fraction.
The move would at least partly undo an 11-year-old rule that replaced fractions of a dollar in stock prices, like 1/8 and 1/16, with pennies. The idea of that change was to trim investors’ trading costs: One-cent increments can lead to narrower gaps between the prices at which brokers buy and sell shares—potentially reducing their opportunity to shave off profits.
Guest post by Azizonomics.
In attempting to stimulate risk appetite by taking “safe” assets out of the market, the Fed has actually achieved precisely the opposite of stimulating productive investment. First, it has turned bond markets into a race to the bottom as bond flippers end up piling into the very assets that the Fed is trying to discourage ownership of — because what’s the point of holding bonds to their maturity when the Fed will jump in at an even lower price floor, thus assuring the bond flippers of a profit? Second it has energised other safe asset markets (such as gold) as longer term investors look for alternatives to preserve their purchasing power in the context of a global economic depression.
The Fed is firing at the wrong target; the real problem — the thing that is causing investors to scramble for safe assets — is an economic depression brought on by (among other non-monetary causes) the deleveraging costs of an unsustainable debt bubble. Without addressing the problem of excess total debt, the Fed is firing blanks.
However, there seems little prospect that the Fed will listen to the debt-watchers who actually predicted the crisis. The likelihood is that the Fed will continue to attempt to take safe assets out of the market. And after treasuries, what will the Fed try to take out of the market?
Guest post by Azizonomics.
John Cochrane thinks that central banks can attain the price-stability of the gold standard without actually having a gold standard:
While many people believe the United States should adopt a gold standard to guard against inflation or deflation, and stabilize the economy, there are several reasons why this reform would not work. However, there is a modern adaptation of the gold standard that could achieve a stable price level and avoid the many disruptions brought upon the economy by monetary instability.
The solution is pretty simple. A gold standard is ultimately a commitment to exchange each dollar for something real. An inflation-indexed bond also has a constant, real value. If the Consumer Price Index (CPI) rises to 120 from 100, the bond pays 20% more, so your real purchasing power is protected. CPI futures work in much the same way. In place of gold, the Fed or the Treasury could freely buy and sell such inflation-linked securities at fixed prices. This policy would protect against deflation as well as inflation, automatically providing more money when there is a true demand for it, as in the financial crisis.
The obvious point is that the CPI is a relatively poor indicator of inflation and bubbles. During Greenspan’s tenure in charge of the Federal Reserve, huge quantities of new liquidity were created, much of which poured into housing and stock bubbles. CPI doesn’t include stock prices, and it doesn’t include housing prices; a monetary policy that is fixed to CPI wouldn’t be able to respond to growing bubbles in either sector. Cochrane is not really advocating for anything like the gold standard, just another form of Greenspanesque (mis)management.
Guest post by Peter Tchir.
Mind Boggling Performance in Spanish and Italian Bonds
Spanish 2 year yields are at 3.39%, or 50 bps better on the day. There is ZERO liquidity, but even then it is almost unbelievable that on July 24th, these bonds were yielding 6.77%. That is a massive change. It is completely dependent on Draghi supporting them. Without clear indications that Spain will ask for help and the ECB will provide the help, this won’t last. But so far, all indications are that Europe has had a change of heart. Even in Germany, the dissent, while still there, is coming more and more from second and third tier players, rather than key figures.
Even the 5 year point is interesting. Italy and Ireland (yes Ireland is back) have stopped gapping tighter, but are grinding away and now yield 4.87% and 5.50% respectively. Spain remains a star with the yield down to 5.39% which is 36 bps better on the day, and Portugal, of all places, is now yielding “only” 9.4%.
Outright shorts ARE getting killed. Whether you are short bonds or CDS the pain is palpable. The “smart trade” which was allegedly to play the curve from a flattener is also getting crushed as the rally is definitely steepening the curves.
Guest post by Themis Trading.
Bloomberg View published an op-ed today titled “High-Speed Trading Is Progress, Not Piracy” written by Professor Bernard Donefer of Baruch College. As expected, this is the typical HFT defense piece (why does Fred Mishkin come to mind every time we read an academic piece like this). We’ll save you the trouble of reading it and summarize Prof. Donefer’s main points:
- Criticism of HFT is overblown
- Information-timing asymmetries have always existed
- Automated market makers are liquidity providers
- There is some bad HFT (momentum ignition, layering) and this needs to be identified but don’t blame all HFT.
- Credit Suisse (the largest dark pool provider) published a study that shows volatility is down and spreads are tight.
Not even two years have passed, but majority have forgotten about the Flash Crash. With the markets having enjoyed a no volume melt up over the past months, it sure could get flashy if this market starts heading lower. The liquidity has just been drying up during this rally. With the low liquidity and depressed volatility levels, investors should recall what actually happened less than two years ago.
What’s to follow after the liquidity success? By Ambrose Evans via the Telegraph.
The global liquidity cycle has already rolled over. Assuming that no fresh action is taken, world economic growth will peak within a couple of months and then fade in the second half of the year – with grim implications for Europe’s Latin bloc.
Data collected by Simon Ward at Henderson Global Investors shows that M1 money supply growth in the big G7 economies and leading E7 emerging powers buckled over the winter.
The gauge – known as six-month real narrow money – peaked at 5.1pc in November. It dropped to 3.6pc in January, and to 2.1pc in February.
This is comparable to falls seen in mid-2008 in the months leading up to the Great Recession, and which caught central banks so badly off guard.
“The speed of the drop-off is worrying. This acts with a six months lag time so we can expect global growth to peak in May. There may be a sharp slowdown in the second half,” said Mr Ward.
If so, this may come as a nasty surprise to equity markets betting that America has reached “escape velocity” at long last, that Europe will scrape by with nothing worse than a light recession, and that China is safely rebounding after touching bottom over of the winter. Full article here.
Guest Post by Armo Trader.
We hear it all the time, High-Frequency Trading (HFT) provides liquidity to the markets. But they forget to mention one little caveat, that they only provide liquidity when it is convenient to them. We have a broken market structure, one that allows flash crashes (drops) and flash dashes (rips). If HFT was truly providing liquidity all the time, and not playing any games, we truly wouldn’t have these breakdowns in market liquidity.
On Wednesday, October 19, Juniper Networks, Inc. ($JNPR) was in-play as it had reported earnings, and because of that, the intraday volume was well above average. But as you will see in the video and charts below, that did not stop it from having a “flash dash” (flash crash to the upside). It ripped almost 90 cents in less the one second, which is utterly ridiculous, especially considering the fact that it was in-play.
(I doubt these were “bad/late” ticks because it was not just one abnormal tick, it was a continued series of abnormal ones-all under 1 second nontheless.)
Here is the video capturing the rip in $JNPR.
HFT provide Liquidity, narrow Spreads and decrease Volatility, or? Welcome to Algomania, once again.
Gold is trading at USD 1,836.60, EUR 1,330.90 , GBP 1,153.90, JPY 142,750 per ounce and reached a new record nominal high in Swiss francs at CHF 1,652.83. Gold was higher in all currencies prior to sharp selling was seen in the hour after the London AM fix.
Gold’s London AM fix this morning was USD 1,879.50, EUR 1,359.39, GBP 1,177.12 per ounce. Yesterday’s AM fix was USD 1,827.00, EUR 1,298.88, GBP 1,146.68 per ounce.
The speeches from Trichet, Bernanke and Obama were as expected and did not materially impact markets – but did belatedly confirm the extremely challenging macro environment.
Trichet’s angry outburst may lead to concerns about the long term health of euro. The outburst came after a question from a German reporter who asked what Trichet’s message was for German people who say their country should revert to the Deutsche mark.
Risk aversion has seen equity markets in the U.S., Asia and Europe fall again and peripheral European bond yields are edging up again, as are European CDS.