Out of Control Mathematical Algorithms|
A recent Chicago Federal Reserve study released Monday implies that regulators
must impose new restrictions on high-speed trading firms to limit
'out-of-control' mathematical algorithms after a number of technology-related
errors have hurt investor confidence. The report said that industry and
regulators have articulated 'best practices' for risk controls, but many trading
firms fail to implement all the recommendations or rely on other firms to catch
an 'out-of-control' algorithm or problem trades. The SEC is searching for limits
to the kind of volatile massive, mathematical algorithm trade that, according to
an October SEC report, helped drive the liquidity crisis and set in motion the
‘flash-crash’ of May 2010 that rattled the markets worldwide. Concerns that some
firms do not have 'stringent processes for the development, testing and
deployment of code used in their trading algorithms' and that 'out of control
algorithms' were more common than anticipated by the Chicago Fed, prior to the
study. The report from the Chicago Fed found a few trading firms interviewed,
deploy new trading strategies by 'tweaking' old code and placing it in
production in 'a matter of minutes'. One trading firm interviewed by the Chicago
Fed reported two incidents of out-of-control algorithms. “To address the first
occurrence, the firm added additional pre-trade risk checks. The second
out-of-control algorithm was caused by a software bug that was introduced as a
result of someone fixing the error code that caused the first situation,” per
the Fed report. The report suggested regulators impose limits on the number of
orders that can be sent to an exchange within a specified period of time.
Additionally, regulators want the creation of a 'kill switch' that could stop
trading activity, at one or more levels. The report suggests that regulators put
into play, intraday position limits that set the maximum positions a firm can
take, during any one trading day.
The Commerce Department Tuesday reported the U.S. current account deficit in Q2
narrowed to $117.4 billion from a revised $133.6 billion during Q1. A decline in
the goods deficit - with falling oil prices a key factor - plus a larger surplus
in income payments such as U.S. earnings on investments with a surplus abroad on
income which rose to $55.5 billion from $47.4 billion - played a key role in the
reduction. During Q1, net financial inflows fell to $88.5 billion from $164.7
billion and foreign acquisitions of U.S. assets increased by $83.0 billion after
rising $69.7 billion. As a percentage of GDP, the current-account deficit
dropped to 3.0% during Q2 from 3.5% during Q1. From the GDP peak in 2005 of
6.5%, the deficit is sharply lower during Q4 but, still off a low of 2.4% in Q2
Treasury Department data released Tuesday showed foreign investors bought a net
$60.2 billion of long-term U.S. securities in July, up sharply from the $5.5
billion purchased in June and the largest amount of purchases during any month
since January. Overseas investors were net buyers of $50 billion in July, up
from $32.5 billion in June and they purchased $4.5 billion of government agency
bonds in July after net sales of $600 million in June. Foreign investors
purchased a net $6.4 billion of U.S. equities in the month in the key Treasury
sector. Taking into account purchases by U.S. residents and overseas investors,
the net foreign purchases of long-term securities was $67.0 billion in July, up
sharply from $9.3 billion in June. China-based investors slightly increased
their holdings of U.S. Treasurys in July, according to Treasury Department data.
For the fifth straight month, optimism from home builders climbed during
September to reach the highest level seen in more than six years. The National
Association of Home Builders/Wells Fargo housing market index gained 3 points to
a seasonally adjusted reading of 40, marking the highest index since June 2006.
William Dudley, president of the New York Federal Reserve Bank, said Tuesday
that the Federal Reserve will "stay the course" of its easier monetary policy
until the economy is clearly rolling. "If you're trying to get a car moving that
is stuck in the mud, you don't stop pushing the moment the wheels start turning
- you keep pushing until the car is rolling and is clearly free," he remarked in
a speech to the Morris County Chamber of Commerce in Florham Park, N.J. Dudley
said the benefits of the Fed's third round of asset purchases, or QE3,
"substantially" exceeded the costs. While headline inflation may edge higher for
a few months on higher energy and grain prices, fundamentals are in line with
the central bank's 2% inflation target, he added. Dudley said that QE3 was
designed to increase confidence in the recovery and if successful, may lead to a
rise in long-term Treasury yields, a jump in expected returns on private assets
and a decline in risk premiums. "This matters because such shifts would provide
support to the economic recovery," he commented.
Charles Evans, the president of the Chicago Federal Reserve Bank on Tuesday that
the Federal Reserve needed to launch another round of asset purchases given the
problems facing the economy and the potential dangers lying ahead. "It is
essential to do as much as we can now to bolster the resiliency and vibrancy of
the economy," Evans said in a speech to a business group in Ann Arbor, Michigan.
The economy faces some "big risks" from the global slowdown and the U.S. fiscal
policy stalemate, he said. Evans has been a strong proponent of additional Fed
easing and wanted the Fed to say it wouldn't stop easing until the unemployment
rate fell below 7%. Evans said he supported the Fed action "wholeheartedly"
while the Fed stopped short of setting any specific target. Evans argued that
the Fed has taken "a strong step towards economic conditionality" by saying it
would continue to purchase assets until there was significant improvement in the
labor market. The central bank language would keep rates near zero even after
the economy strengthens should reassure investors and businesses that the Fed
will not tighten prematurely, he added.
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Sept 18, 2012