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Out of Control Mathematical Algorithms
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 of 2009.

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


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