Michael J. Fleming

Measuring Treasury Market Liquidity

This paper examines a comprehensive set of liquidity measures for the U.S. Treasury market. The measures are analyzed relative to one another, across securities, and over time. I find highly significant price impact coefficients, such that a simple model that explains price changes with net order flow produces an R 2 statistic above 30% for the two-year note. The price impact coefficients are highly correlated with bid-ask spreads and with episodes of reported poor liquidity (such as the fall 1998 financial markets turmoil). Quote and trade sizes correlate modestly with these episodes and with the other liquidity measures, as do yield spreads between on-the-run and off-the-run securities. In contrast, trading volume and trading frequency are only weakly correlated with these other measures, suggesting that they are poor liquidity proxies. The various measures are positively correlated across securities, almost without exception, especially for Treasury notes.

The Term Structure of Announcement Effects

We analyze high-frequency responses of U.S. Treasury yields across the maturity spectrum to macroeconomic announcements. We find that surprises in the announcements evoke the sharpest reactions from the intermediate maturities, thus forming striking hump-shaped curves of announcement effects. We then fit an affine-yield model to the yield changes using the announcement surprises as GMM instruments. The model estimates imply that the announcements elicit larger shocks to an expected future target interest rate than to the current short-term interest rate and that different types of announcements generate different expectations about this target rate, how rapidly it will be approached, and how long it will be maintained.

What Moves Bond Prices

This article takes a close look at a year in the U.S. Treasury securities market and tries to explain the sharpest price changes. The authors attribute each of the twenty-five largest price shocks during August of 1993 to August 1994 period to a just-released macro-economic announcement. They also measure the bond markets average reaction to various announcements and the reactions to surprise in the announcements headline numbers. The strongest responses are found to come from the employment, producer price index, and fed funds target rate announcements. Significant responses to U.S. Treasury security auctions results are documented for the first time.

An analysis of CDS transactions: implications for public reporting

Ongoing regulatory reform efforts aim to make the over-the-counter derivatives market more transparent by introducing public reporting of transaction-level information, including price and volume of trades. However, to date there has been a scarcity of data on the structure of trading in this market. This paper analyzes three months of global credit default swap (CDS) transactions and presents findings on the market composition, trading dynamics, and level of standardization. We find that trading activity in the CDS market is relatively low, with a majority of reference entities for single-name CDS trading less than once a day. We also find that a high proportion of CDS transactions conform to standardized contractual and trading conventions. Examining the dealer’s role as market maker, we find that large trades with customers are generally not rapidly offset by further trades in the same reference entity, suggesting that hedging of large positions, if taking place, occurs over a longer time horizon. Through our analysis, we provide a framework for regulators and policymakers to consider the design of the public reporting regime and the necessary improvements to data collection to facilitate meaningful price reporting for credit derivatives.

Financial Market Implications of the Federal Debt Paydown

U.S. Treasury securities fill several crucial roles in financial markets: they are a risk-free benchmark, a reference and hedging benchmark, and a reserve asset to the Federal Reserve and other financial institutions. Many of the features that make the Treasury market an attractive benchmark and reserve asset are likely to be adversely affected by the paydown of the federal debt, and recent developments suggest that this may be happening already. Market participants are responding by moving away from Treasuries as a reference and hedging benchmark toward agency debt securities, corporate debt securities, and interest rate swaps. The Federal Reserve is taking steps to adjust its portfolio and should be able to do so with minimal implications for monetary policy.

Repo market effects of the Term Securities Lending Facility

The Term Securities Lending Facility (TSLF) was introduced by the Federal Reserve to promote liquidity in the financing markets for Treasury and other collateral. We evaluate one aspect of the program--the extent to which it has narrowed repo spreads between Treasury collateral and less liquid collateral. We find that TSLF operations have precipitated a significant narrowing of repo spreads. More refined tests indicate the market conditions and types of operations associated with the programs effectiveness. Various additional tests, including a split-sample test, suggest that our findings are robust.

The Microstructure of the TIPS Market

The potential advantages from the introduction of Treasury inflation-protected securities (TIPS) in 1997 have not been fully realized, mainly because TIPS are less liquid than nominal Treasury securities. The lack of liquidity is thought to adversely affect TIPS prices relative to prices of nominal securities, offsetting the benefits that come from TIPS having no inflation risk. Despite the importance of TIPS liquidity and the market’s large size, there is virtually no quantitative evidence on the securities’ liquidity. This article sheds light on this phenomenon using novel tick data from the interdealer market. The authors identify several features of the TIPS market also present in the nominal securities market, but some unique features as well. As in the nominal market, there is a marked difference in trading activity between the most recently issued (“on-the-run”) and previously issued (“off-the-run”) securities, as trading drops sharply when securities go off the run. In contrast to the nominal market, there is little difference in bid-ask spreads or quoted depth between these securities, but there is a difference in the incidence of posted quotes. These results suggest that trading activity and quote incidence may be better cross-sectional measures of liquidity in the TIPS market than bid-ask spreads or quoted depth. Intraday patterns of trading activity are broadly similar in both markets, but TIPS activity peaks somewhat later, likely reflecting differences in the use and ownership of these securities. Announcement effects also differ between markets, with TIPS auction results and CPI releases eliciting particularly strong increases in trading activity, likely indicating these announcements’ special importance to TIPS valuation.

How do Treasury Dealers Manage their Positions

Using data on U.S. Treasury dealer positions from 1990 to 2006, we find evidence of a significant role for dealers in the intertemporal intermediation of new Treasury security supply. Dealers regularly take into inventory a large share of Treasury issuance so that dealer positions increase during auction weeks. These inventory increases are only partially offset in adjacent weeks and are not significantly hedged with futures. Dealers seem to be compensated for the risk associated with these inventory changes by means of price appreciation in the subsequent week.

Heat Waves, Meteor Showers, and Trading Volume: An Analysis of Volatility Spillovers in the U.S. Treasury Market *

The market for U.S. Treasury securities operates around-the-clock from the three main trading centers of Tokyo, London, and New York. We examine this market for volatility spillovers using the methodology employed by Engle, Ito, and Lin (1990) for the foreign exchange market. We find meteor showers in Tokyo and London but not New York; i.e., volatility spills over into Tokyo and London from the other trading centers, but not into New York. We also find that lagged trading volume significantly impacts U.S. Treasury yield volatility for the overseas trading centers, although it does not change the basic meteor shower findings.

Price Formation and Liquidity in the U.S. Treasury Market: Evidence from Intraday Patterns Around Announcements

We identify striking adjustment patterns for price volatility, trading volume, and bid-ask spreads in the U.S. Treasury market when public information arrives. Using newly available high-frequency data, we find a notable lack of trading volume upon a major announcement when prices are most volatile. The bid-ask spread widens dramatically with price volatility and narrows just as dramatically with trading volume. Trading volume surges only after an appreciable lag following the announcement. High levels of price volatility and trading volume then persist, with volume persisting somewhat longer.