Traditional broker-dealers generally carry net long or short positions in Treasury securities from one day to another, an activity that requires capital. Dealers hold Treasuries for a variety of reasons, including to support the liquidity needs of their customers, to hedge exposure in other fixed-income products, and to meet their obligations as primary dealers to participate in U.S. Treasury auctions and the Federal Reserve’s open market operations. Many argue that the ability and willingness of dealers to  7  A CLOB protocol aggregates all executable bids and offers across participating liquidity providers in a single order book that is available to all market participants. In a liquid market, the continuous visibility of quotes and the interaction of multiple bids and offers are likely to enhance the price discovery process and market transparency. In contrast, a request-for-quote protocol, where a request for liquidity typically is submitted to only a limited set of providers, by its nature imposes a degree of market segmentation that may impede the price discovery process as compared with a CLOB protocol, but is arguably better suited to handle large block trades and illiquid securities. 8  Momentum detection is a strategy that attempts to predict short-run price changes based on patterns in realtime market data. Statistical arbitrage is a trading strategy that typically relies on identifying mean reversion from historical relative pricing relationships between correlated assets. Spread trading seeks to profit from a simultaneous purchase and sale of two closely related fixed-income assets.
BIS central bankers’ speeches  7  October 15 also raises questions about the nature of liquidity in the Treasury market today. As I mentioned earlier, market liquidity is a difficult concept to pin down, and if one asks how liquidity evolved on October 15, the answer will differ depending on the measure of market liquidity you have in mind. It is certainly the case that some frequently-cited metrics of liquidity, such as the quantity of orders available for execution in the CLOB at a given point in time, often referred to as “market depth,” showed significant signs of strain that morning. But volatility was also elevated, so a coincident reduction in market depth may be unsurprising. Indeed, an increase in volatility and reduction in depth can work in a self-reinforcing manner, in which reduced depth causes trades to have a greater price impact, while the resultant volatility causes market depth to shrink further. This dynamic has always existed in markets, but it is possible that automated trading serves to exacerbate it in certain situations. But even if a sharp reduction in market depth makes sense given an increase in volatility, a trade of reasonable size would have been more expensive for a customer to execute in the event window, and would have had a greater price impact, than in more normal conditions. In this sense, liquidity was challenged, and frequent periods of strained liquidity would be undesirable for the most liquid sovereign debt market in the world.