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Market Voice: The new drivers of price formation in U.S. Treasury securities

Chris Amen
Chris Amen
Managing Director, Head of OTR Treasury Trading at Dealerweb

The U.S. Treasury securities market is rapidly modernizing. The emergence of non-traditional liquidity providers and introduction of new trading protocols are providing market participants with additional options when seeking best execution. In the process, pricing data today is arguably more indicative of the true market from moment to moment than ever before. What are the new drivers of price formation in U.S. Treasury securities though?

U.S. Treasury securities and the fixed income market

Treasuries represent the largest segment of the fixed income market. Average daily notional volume in Treasuries of more than half a trillion dollars exceeds that of the markets for mortgage-backed securities, corporate debt and municipal bonds combined. Prices on industry benchmark Reuters Capital Markets (RCM) 19901 update more than one million times per day.

Figure 1 – ADV Traded in Fixed Income (Year-to-date through July)

Source: SIFMA – Click on chart to request a free Eikon trial

Less appreciated, however, are the market dynamics that influence price formation in Treasuries.

Influencing price formation in Treasuries

The primary market participants in Treasuries include broker dealers, institutions, central banks, market makers and proprietary trading firms (PTFs). The majority of all transactions, historically, occurred through requests-for-quotes (RFQs), central limit order books (CLOBs) and traders interacting by telephone and chat.

In recent years, PTFs are accounting for an increasing percentage of transactions in on-the-run Treasuries.

The shift began following the financial crisis. Increased capital requirements on banks acting as broker dealers and restrictions on proprietary trading created a need for supplemental liquidity in the Treasury market. In response, non-traditional liquidity providers including market makers and PTFs progressively increased activity. In order to trade directly with market participants, PTFs built connectivity to broker dealers and institutions possessing the requisite trading and technological capabilities to receive streaming bids and offers.

Direct streaming transactions

Direct streaming liquidity on a one-to-one basis allows both providers and consumers to create data-driven, customized trading relationships. The relationships allow for larger top of book quantities in Treasuries at tighter prices with minimal information leakage.

Prices generated from RFQs and CLOBs are generally correlated. Pricing data from direct streaming transactions provide new constructive context on movements in the U.S. Treasury securities market.

Data furnished to RCM 19901 by Dealerweb, a division of Tradeweb, is anonymously aggregated from markets involving broker dealers, institutions, central banks, market makers and PTFs across the different trading protocols.

Figure 2 – RCM 19901 page

Source: Eikon – Click on chart to request a free trial

Prices from direct streams, similar to disclosed trading between broker dealers and institutions, can be indicative of market moves. While the prices and sizes offered by PTFs are designed for the specific counterparty, price changes in multiple streams provide additional data points that can evidence pattern shifts.

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In addition to enhancing trading for liquidity providers and consumers in all market conditions, direct streaming liquidity is improving pricing data that radiates to the overall market to the benefit of market participants.

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