Mnuchin Blames Volcker Rule, High-Speed Trading for Volatility

(Bloomberg) -- U.S. Treasury Secretary Steven Mnuchin blamed volatility in equity markets partly on high-speed trading and the effect of the Volcker Rule, adding that he planned to conduct an inter-agency review of market structure.

“Over a longer period of time the market reflects various different economic components but a normal trading day now is a 500-point range. A lot of that has to do with market structure, and that’s something we’re going to take a look at,” Mnuchin said in a roundtable interview Tuesday at Bloomberg’s Washington office.

Mnuchin Blames Volcker Rule, High-Speed Trading for Volatility

Mnuchin declined to comment on other possible reasons for stock turmoil, saying that he didn’t want to make remarks on the economy or broader markets during the Federal Reserve’s policy meeting Tuesday and Wednesday in Washington.

Mnuchin said he will ask the Financial Stability Oversight Council, which he heads, to study stock market volatility. While he has not “pre-judged” what exactly is behind the sharp moves before a review is complete, Mnuchin said problems with market structure “may be one of the reasons.”

U.S. stocks have fluctuated drastically during President Donald Trump’s tenure, at times reversing course on his comments about the Federal Reserve’s interest rate hikes, the ongoing trade dispute with China or the possibility of a government shutdown.

“In my opinion, market structure has led to a lot more volatility,” Mnuchin said. “Part of this is a combination of the market presence of high-frequency traders combined with the Volcker Rule.”

Yet, the ascent of high-frequency traders was more than a decade ago, and the Volcker Rule has been in place since 2013. And while daily swings have been violent in 2018, last year was the calmest since at least 1990, according to the CBOE Volatility Index, and each of the last six years was below the historical average.

Mnuchin’s promise of a market-structure review was enough to drag down exchange stocks, including high-speed trader Virtu Financial Inc. -- which closed 4.4 percent down -- as well as platforms Intercontinental Exchange, Nasdaq and CME.

Volcker Rule

The Volcker Rule, named after former Federal Reserve Chairman Paul Volcker, was one of Washington’s most significant, and controversial, responses to the 2008 financial crisis. It prohibited banks from using their own money to make speculative bets on markets, and restricted them from investing in hedge funds and private-equity firms.

But Wall Street has long argued that the rule is unnecessarily complex, almost impossible to adhere to and prevents banks from executing trades on behalf of clients. Partly in response to those concerns, the Federal Reserve and other regulators are working on an overhaul of Volcker.

In the past decade, high-frequency trading morphed from an obscure market-structure issue to a highly charged debate over whether traders armed with computer algorithms were exacerbating volatility.


High-Frequency Trading

When regulators have sought to boost oversight, they’ve faced intense pushback from industry. After calling for a crackdown on aggressive high-frequency trading in 2014, former Securities and Exchange Commission Chair Mary Jo White conceded before leaving office in 2016 that a fix had proved difficult. Wall Street’s main regulator still hasn’t passed a significant rule to curb the practice.

One reason the SEC has done little to rein in the practice is that it’s concerned that making any changes to modern, electronic markets will cause more harm than good.

Mnuchin added that FSOC also would “probably” look into the potential risk posed by the $1.3 trillion market for leveraged loans that often backs mergers and acquisitions of highly-indebted companies. Mnuchin, though, said he doesn’t “have the same concern at the moment” about the market, which has been the subject of warnings from the Fed and the Office of the Comptroller of the Currency.

“I have heard a lot of people express that concern. I don’t have the same concern at the moment, but having said that it is an area that given people have expressed concern we will probably want to take a look at,” he said.

Trading Whiplash

While regulatory officials had already acknowledged that leveraged lending has been the subject of low-level discussions at FSOC, there’s been little public evidence that the market poses an immediate threat to the financial system.

Stocks rose during the first year of the Trump administration amid historic corporate tax cuts, low unemployment and deregulation. In recent months, markets have pared their gains. Echoing comments made by Trump, White House trade adviser Peter Navarro on Monday blamed recent market volatility on the Fed’s rate increases.

Equity investors have suffered from whiplash as traders debate the fast-shifting narratives on interest rates and U.S.-China trade. So far, there have been six days this quarter when stocks completely reversed an intraday move of at least 1 percent, the most since 2011, when Standard & Poor’s downgraded the U.S. sovereign debt rating.

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