Insights on the US Treasury Market by Giancarlo

CFTC LogoThe 10-year US Treasury futures contract is the most liquid US Treasury contract, the US Treasury market is going through a “liquidity hierarchy”, and as volatility increases in US Treasuries, liquidity migrates from less liquid cash securities to more liquid futures contracts.

Those were just three of numerous bits of insight given by the Commodities Futures Trading Commission (CFTC) Chairman Christopher Giancarlo in New York about the US Treasury Market; he made the remarks in front of the fourth annual Conference on Evolving Structures of the US Treasury market.

Earlier this year the CFTC released a study by its Office of the Chief Economist; the study was authored by Lee Baker, LIhong McPhail and CFTC’s Chief Economist, Professor Bruce Tuckman and called “The Liquidity Hierarchy in the U.S. Treasury Market Summary Statistics from CBOT Futures and TRACE Bond Data.

Giancarlo summarized the findings in the speech.

The US Treasury Market and Technology

Giancarlo has been in the securities industry for thirty-four years and he described how technology has shaped his years in the business.

“Then, the provision of trading liquidity was entirely a human activity, analog and personal, conducted by market specialists who crowded into the financial district and its trading pits and dealing floors each day from ferries, buses and subways.  Today, liquidity is increasingly machine conducted, digital and anonymous, from all parts of the country and all corners of the globe.


“But what of that change?  What difference, if any, does it make?  That is part of what this New York Fed conference and the three that proceeded it are designed to explore – the evolving structure of the market for US Treasury securities.  That evolving structure has direct parallels, not only in markets for other government debt, but also in those for corporate debt and, for us at the CFTC, in the range of exchange traded and over-the-counter derivatives.”


Giancarlo on the liquidity hierarchy?

The idea that the US Treasury market was going through liquidity hierarchy was among the most interesting ideas while US Treasuries are traded over the counter, most if not all US Treasury futures products are exchange traded.

“The study portrays a highly complex and dynamic ‘liquidity hierarchy’ in the US Treasury Market.  It shows that, while overall risk volume is greater across all cash securities than across all futures contracts, the liquidity hierarchy is more complex, with certain futures contracts more liquid than certain cash securities, and vice versa.” Giancarlo said.

He expanded later.

“The sophisticated liquidity hierarchy of the US Treasury market is well served by the diversity of new and traditional market makers and liquidity providers.  Trading cash treasuries in this complex hierarchy is also appropriately conducted by the varied methods of trade execution that Governor Brainard reviewed for us this morning, from electronic trading and batch auction-based systems to traditional voice execution.

“This dynamic and complex liquidity hierarchy is also present in financial and other swaps markets overseen by the CFTC.  Regulated swaps markets require the same diversity and flexibility in execution methods that continue to provide a robust and resilient foundation for cash markets for US Treasury securities.”

Parallels in The US Treasury and SWAPs markets

Giancarlo continued making comparisons between the US Treasury Market and the SWAPs market.

“In fact, we observe quite similar developments in US and global derivatives markets, where both broker-dealers and proprietary trading firms play important, often complementary, roles in liquidity provision.  In swaps, we also see the growing use of electronic trading, including batch auction-based systems. “ Giancarlo said. “Yet, those more automated trading systems continue to operate alongside more traditional, ‘squawk box’ voice execution, just as Governor Brainard (Brainard also spoke at the conference) confirmed remain active in less liquid segments of cash Treasuries.

“What makes all of those methods of swaps execution continually viable is the complex and dynamic hierarchy of swaps liquidity.  It is the reason why the CFTC recently put forward a proposal to sanction within our swaps trading mandate a wider scope of trading methodologies similar to what is available in US cash treasuries.  Our new proposal is designed to encourage greater flexibility, competition and innovation in methods of swaps trade execution without impacting larger financial stability goals.  The dynamic and complex liquidity hierarchy of financial swaps requires the same diversity and flexibility in execution methods that are widely used in cash markets for US Treasury securities.”

Other Conclusions

Giancarlo also noted these trends between the US Treasury cash securities and futures.

  • Futures contracts play a dynamic role in liquidity-challenged environments.  The relative amount of risk traded through futures contracts is higher on days with large price movements and at times outside of U.S. trading hours.
  • Average trade size, in risk terms, is much higher for cash securities than for futures contracts.  This is likely due to the higher prevalence of automated trading in futures markets and execution on electronic exchanges, which in turn results in futures trades being broken down into smaller orders for execution.”


Giancarlo, Thomas Jefferson, Alexander Hamilton and James Madison


Giancarlo also recalled an interesting anecdote describing how New York and Washington D.C. became financial and government hubs.

“It is good to be on Maiden Lane, where in 1790, at a house just down the block, Number 57, Thomas Jefferson, Alexander Hamilton and James Madison produced the compromise of 1790.  Under that agreement the national capital would move out of New York (satisfying the two Virginians, Jefferson and Madison) and the new Federal government would undertake and settle the Revolutionary War indebtedness of the thirteen states (satisfying Hamilton).  This compromise assured that the new District of Columbia would be America’s political capital and New York City would be its financial centre.”

Jeffersonian Vs Hamiltonian

Both Jefferson and Hamilton have been previously noted in stories in The Industry Spread.

Their philosophies are the centre of the most important politically philosophical debate for the American- and maybe even global- financial services industry.

Hamilton was a believer in a strong federal government, while Jefferson feared that a strong federal government would simply replace the monarchy in tyranny.

As George Washington’s first US Treasury Secretary, Hamilton’s vision of a central banking system won out; Jefferson, as Washington’s first Secretary of State, argued against it but Washington sided with Hamilton.

The Bank of the United States was chartered under Hamilton’s watchful eye in 1790 with an initial investment of $10 million; it was an early pre-cursor to what is now the Federal Reserve and the national banking system.

The argument is fought over today on the tenth amendment, which grants the states anything not enumerated in the US Constitution, and the commerce clause which grants the federal government  power to regulate interstate commerce.

The Dodd/Frank bill was one example of the Hamiltonian philosophy winning out; Fintech has recently started being approved for federal charters under the OCC in another Hamiltonian victory.

Jeffersonianism has suffered numerous setbacks; while all out tyranny has never formed, Jefferson would consider income tax rates as high as nearly forty percent a form of tyranny.

The federal income tax wasn’t even first instituted until 1861.

Ironically, Jefferson had the same distaste of big banks as Massachusetts Democratic Senator Elizabeth Warren- specifically their distaste for the power they wield- their solutions to limiting this power would vary vastly.

Hamilton’s vision has largely been realised. The Federal Reserve and the Office of Comptroller and Currency, which created a national banking system by making the OCC a single regulator for member banks, are both manifestations of his vision.

Jefferson favoured a state banking system then; today, there is a parallel state banking system, with banks being chartered in a single state and operating in that state.

He, like Republicans, would oppose anything like Dodd/Frank and like Republicans favour any law which would help those banks be free of any federal burden.

He would likely concur with Republican complaints that the Volcker rule applies unnecessarily to state banks which occasionally trade in SWAPs repos, and other fancy instruments,  even though the effect on the system is negligible.

Hamiltonians believe that financial services are inherently interstate commerce and require one set of rules while Jeffersonians believe that states are the incubators of ideas and good ideas are standardised across states over time while bad ideas serve as warnings to other states.