Morning Report: Liquidity Issues Ahead? 7/21/15

Markets are lower this morning as earning pile in. Bonds and MBS are down small.

Dodd-Frank has severely neutered the market-making function of the banking system. When the Fed starts tightening and bonds sell off, the natural buyers of bonds (primary dealer banks) will no longer be able to dampen the moves by standing on the other side of the trade. The Fed is unconcerned about this, but we shall see what happens when rates start going up and the bond market starts falling faster than they are comfortable with.

Incidentally, Hillary will probably be forced to support a financial transactions tax, which is a tax on market-making as well. Basically it would slap a  tax on every stock trade, currency trade, and bond trade. Narrowing bid / ask spreads and a 90% drop in commission rates has basically eliminated the market-making functions (NASDAQ market makers, the specialists on the NYSE floor, block trading at banks) in the stock market. Machines are all that is left, and even they are not in the market-stabilization business. The next crash, they are going to suspend trading until things stabilize and there will be nothing but GTC (good till cancelled) buy orders for people to sell to. Washington should be careful what it wishes for.

As China’s economy cools off, and the US dollar rallies, we have seen commodities get absolutely slammed. Oil has been cut in half over the past year. Gold is in free-fall. Natural Gas is down big. This will keep a lid on inflation, and allow the Fed to keep rates lower longer.

Everyone knows that Chinese money has been behind the building boom in many large cities. This is actually driven by policy. Chinese investors who invest $500,000 and can prove that their investment created at least 10 jobs (not hard to do on a construction project) get permanent green cards. These are typically wealthy Chinese investors who are trying to get green cards for their kids and are not all that concerned about return on investment, which means dirt cheap financing for developers. Now, the government is thinking of making some changes. Obama would like these investors to put money in low-income housing, not luxury condos. Also, abuses in the program have led other to question it altogether. The program has bipartisan support so it probably isn’t going anywhere, but when you use policy as an economic lever you invariably create dislocations and marginal projects that don’t make economic sense. Something to watch.

19 Responses

  1. A one basis point FTT would put enough friction into the system to eliminate some the abuses of HST (front running, bids designed only to bait algorithms, etc.) without adversely affecting liquidity.

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  2. don’t know how you are going to separate the wheat from the chaff in HFT…

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  3. When there’s pee in the punch, I suggest dumping out the bowl. Seriously, what is the justification for HFT? We slready know that it’s used to screw investors.

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    • FB:

      Seriously, what is the justification for HFT?

      Tighter bid/offer spreads, greater liquidity, and lowered transaction costs. See this and this.

      We slready know that it’s used to screw investors.

      It can be, but that doesn’t mean it is only, or even primarily, used in such a way.

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  4. So, what is the justification for offering early information to certain participants?

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    • FB:

      So, what is the justification for offering early information to certain participants?

      There is no justification for an exchange offering early information to certain participants, but that is a different thing than someone gaining a technological advantage over others. And besides, neither of those are a necessary characteristic of HFT.

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    • McWing (from the link):

      So, all of these Obamacare advocates who told us last month during the King v. Burwell debate that Obamacare would collapse if millions of people didn’t have subsidies but still had guaranteed issue access to insurance now think it’s a good idea to do just that for millions of poor illegals in California.

      So, all of these people who told us during the 2012 NFIB v. Sebelius debate that the combination of the individual mandate and subsidies was key to a functioning Obamacare don’t think that’s necessary when covering a new class of people through Covered California—millions of poor illegal immigrants in the state.

      Just more evidence that the left has no principles and is incapable of making a sincere, consistent argument.

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    • McWing:

      Noble Lies.

      Kevin Williamson had a good article in the most recent issue of NR (need subscription) about exactly that. One of the examples he used was Elena Kagan’s confirmation hearings.

      Somewhere between her bat mitzvah and her Senate confirmation hearings, Elena Kagan, a nice Jewish girl from the Upper West Side, must have browsed the works of the 14th-century Islamic scholar Ibn al-Munir: “War is deceit,” he wrote, “and the most complete and perfect war waged by a holy warrior is a war of deception, not confrontation, due to the latter’s inherent danger and the fact that one can attain victory through treachery.” How else to explain how she went from her 2009 declaration — “There is no federal constitutional right to same-sex marriage,” words she put in writing and revisited to assure senators that that was in fact her view — to precisely the opposite position — discovering a national fundamental right to same-sex marriage lurking about the Constitution — in only a few years?

      He points out how this is SOP in the way the left has achieved its goals. And the deception is all acceptable in the service of a noble cause.

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  5. ScottC: ““There is no federal constitutional right to same-sex marriage,” words she put in writing and revisited to assure senators that that was in fact her view — to precisely the opposite position — discovering a national fundamental right to same-sex marriage lurking about the Constitution — in only a few years?”

    She didn’t, but I think the confirmation process lets such people squirm out of such things rather easily, since we can’t ask them specifically how they’ll vote on issues. There is no constitutional right to same sex-marriage in any constructionist or originalist sense, and the only way to find that right is to open the pandora’s box to finding *any* right that is sufficiently popular among liberals and the intelligentsia.

    And I think she could probably, candidly, say there is no right to same sex marriage in the constitution, but the natural and obvious good of federally recognizing same sex marriages outweighs any explicit or implicit right conferred by the constitution, and thus she felt morally obligated to vote for SSM, whether or not the text could be seen to encompass such a right or not.

    That being said, I would guess the British considered the rebellious colonists deceitful as well, and treacherous, engaged in the dishonorable activities that allowed a relatively small collection of colonist to defeat the British empire. An expectation of clarity and honesty about end-goals and strategy on the part of those who are, or are likely to be in, the position to effective cultural and legal change on behalf of “moral goods” is probably not reasonable. And ultimately, one can critique Ibn al-Munir for his dishonesty, and his advocacy of treachery, but when politicians are upfront about extreme opinions or Big Goals and instead choose direct confrontation the ultimately tend to lose the battle.

    To whit, I shall quote Jorah Mormont from the the Game of Thrones books:

    “Rhaegar fought valiantly, Rhaegar fought nobly, Rhaegar fought honorably. And Rhaegar died.”

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    • KW:

      That being said, I would guess the British considered the rebellious colonists deceitful as well, and treacherous, engaged in the dishonorable activities…

      Undoubtedly, but the two sides were at war. Literally. If the American left is literally at war with the American right (and I am certainly open to such a claim, believe me), then let’s face up to the fact honestly and behave accordingly, and cease telling ourselves that we ultimately share some common goal. If the left is our enemy, literally, then we should treat it as such.

      An expectation of clarity and honesty about end-goals and strategy on the part of those who are, or are likely to be in, the position to effective cultural and legal change on behalf of “moral goods” is probably not reasonable.

      I don’t “expect” the political left to be honest about its goals at all. But I do view its dishonesty as a vice, and one that the vast majority of non-political Americans should be aware of. An understanding of why politicians and political activists are dishonest does not turn that dishonesty into a virtue. I don’t quite understand the purpose of responding to an instance of political dishonesty with an explanation of why such dishonesty should be expected.

      I attribute that, ultimately, to individuals.

      I don’t. Certainly individuals of any political stripe can be illogical or cavalier about the internal consistency of the arguments they make. But that doesn’t mean that it isn’t more inherent to certain ideologies as opposed to others.

      Progressivism as an ideology is much more driven by sentiment and emotion than is conservatism or libertarianism. (Hence the standard progressive critique of cons/liertarians as “heartless” or “uncaring”.) I think this makes progressives much less concerned with the logical consistency of their arguments than adherents to other ideologies, and more prone to self-contradiction when they do attempt to present arguments on behalf of their policy preferences. We see it pretty routinely, even here. Some progressives even seem to view their contradictions as a virtue. (I’ll look for the link in the archives to demonstrate this later…I’m a little tied up at the moment.)

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  6. @ScottC: “Just more evidence that the left has no principles and is incapable of making a sincere, consistent argument.”

    I attribute that, ultimately, to individuals. I do not think either the left or the right is capable of making a sincere, consistent argument, only individuals within the group that we classify (or self-classifies) as left or right. If we take the speeches of George W. Bush together with the speeches of George H. W. Bush and Ronald Reagan and Donald Trump and through in some Rush Limbaugh and Sean Hannity, you’ll get some inconsistent arguments. Even individuals (I’m thinking of listening to Rush) can argue inconsistently when the context changes. Elections and opportunities change the nature and sometimes the specifics of arguments . . . it’s easy to not be for gay marriage when you don’t think there’s a chance in hell of becoming law. Inconsistency, especially in arguments presented for public consumption, could simply be explained as political pragmatism. Why argue for a moral good at a time and place where that argument will make it more difficult to bring that moral good about, and may in fact work against that moral good?

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  7. Given the costs (market instability & information arbitrage), one can reasonably conclude that a slightly smaller bid/ask spread does not offer enough offsetting value. Mind you, it does reduce profits of those doing the trading, but that is not of significant value to investors.

    Incidentally, Scott, do you ever read Alex? It is a wonderful comic run by the Telegraph (UK) that is set in The a City (the UK reference to their center of financial services for the non Anglophiles).

    BB

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    • FB:

      Given the costs (market instability & information arbitrage), one can reasonably conclude that a slightly smaller bid/ask spread does not offer enough offsetting value.

      The costs of what exactly? You seem to have beeen conflating HFT with other things like speed arbitrage, so I am not sure what exactly you are talking about now. Besides, just because a decrease in b/o spread isn’t valuable to you doesn’t mean it isn’t valuable to others, or the market as a whole. Let the market players and the exchanges decide for themselves what is or is not worth the cost. If it isn’t worth it to you, then it is easy enough not to involve yourself.

      Incidentally, Scott, do you ever read Alex?

      Nope, never seen it.

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  8. @ScottC: “Undoubtedly, but the two sides were at war. Literally. If the American left is literally at war with the American right (and I am certainly open to such a claim, believe me)”

    I think that’s true, especially at the more “extreme” latitudes.

    Left and right and middle all share a common goal of wanting a better world. The war is more or less about what that means and (to a lesser degree) how to get there. On the one hand, to the left part of a “better world” means same-sex marriage and accepting all stripes of gender differentiation or confusion as normal and laudable and perhaps even courageous, where as the right is more prone to argue such things should be seen as pathologies to be treated or remediated. So there, we have an argument about what “a better world” means. On the other hand, both right and left (except for the extreme far left) want a robust national/world economy and high employment and so on, but one side tends to believe that is achieved through government micromanagement and higher taxes and government spending and efforts at job creation and efforts to reduce the income gap, whereas the right is more prone to see less regulation and getting the government out of the way and letting individuals and businesses keep the money they earn as the path to a robust economy.

    But I these differences of opinions end up in something that I believe would be best described as political and strategic war. Yet as in any war, those engaged in the battle have varying degrees of commitment. Some politicians are more interested in protecting their own lifestyle and political power than advancing the cause, and some pundits as well. Others are true-believers and whatever they think advances their cause is justified—because it is war.

    “I don’t quite understand the purpose of responding to an instance of political dishonesty with an explanation of why such dishonesty should be expected.”

    Because I’m pedantic? Or, such responses are a peculiar vice of mine?

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  9. The 2010 “flash crash” was directly linked to a British HF trader. It is a dubious assertion to delink HFT from arbitrage.
    Here’s a rather interesting link.

    http://www.chicagobooth.edu/capideas/magazine/fall-2013/high-frequency-trading

    I’ll post on Alex separately. Quite entertaining.

    BB

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    • FB:

      It is a dubious assertion to delink HFT from arbitrage.

      Again, you have to be more specific about what you are talking about. To be sure, HFT is linked to arbitrage opportunities, but there are different kinds of arbitrages. The kind you originally seemed to be decrying was information/speed arbitrage. That is, people who have the technology to “see” orders, and hence act on that info, microseconds before anyone else can. But HFT is not just, or even primarily, engaged in that kind of arbitrage. You might want to read this:

      http://www.investopedia.com/articles/active-trading/092114/strategies-and-secrets-high-frequency-trading-hft-firms.asp

      BTW, if an exchange wanted to go to minute-by-minute batch auctions as described in your link, I wouldn’t object. I just think it is an issue for exchanges, investors, and traders to manage and work out for themselves, not something that should be mandated by regulation.

      Like

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