Debt Ceiling

Debt-Ceiling Brink Has Speed Traders Drooling


Debt-Ceiling Brink Has Speed Traders Drooling

Photograph by John Rensten/Getty Images

So the government’s shut down, and who knows how long it’ll be until it reopens? The real calamity is still a couple of weeks away: On Oct. 17, the Treasury Department will exhaust its borrowing limit. Unless Congress votes to raise the debt ceiling, the U.S. will default on its debt for the first time ever.

While investors are still yawning over another case of Congress turning a basic responsibility into a protracted hostage negotiation, the closer we get to a default, the more panicky the markets will get. There are lots of ways investors can try to take advantage of market chaos—using options and buying inverse indexes, for example—but there’s one sure-fire way to make money when things get hairy: speed. No one likes government-orchestrated chaos like high-frequency traders do.

While speed traders can make money in any number of ways, trading any number of assets, they thrive off of two things in particular: trading volume and market volatility. They like it when markets are deep and choppy, when there are lots of people trading, and when prices move around a whole bunch. This is exactly what happens when investors are in a panic, just as they were two years ago during the last debt-ceiling crisis.

In August 2011, as congressional Republicans and Democrats took their fight over the debt ceiling to the brink, the markets went into pure freak-out mode. On 16 of the 23 trading days in August that year, the Dow Jones industrial average moved by at least 100 points—including a week where the Dow moved at least 400 points for a record four consecutive days. Daily trading volumes spiked from around 7 million shares to 18 million shares during the second week of August. And while volumes calmed back down, the market chop lasted all the way into November.

August 2011 was the most profitable month for high-frequency traders since the financial crisis spun out of control in September 2008, but it also marked the end of an era of big profits for the industry. As the market has calmed over the past two years, steadily ticking upward while remaining less volatile, high-frequency traders have had a harder time making money. For one, it’s riskier to trade in and out of stocks when prices are higher. Trading volumes have also steadily decreased as volatility has flattened. The market is now a placid, shallow pool in which speed traders are drowning.

Which makes them all the more desperate for some action. Earlier this year, I spoke to dozens of high-frequency traders for a story about the decline of their industry. Most had fond memories of the frenzy the last debt-ceiling crisis spawned two years ago. A few of them remembered it as some of the best trading opportunities they’d ever seen.

“It’s hard to argue that they wouldn’t benefit from another debt crisis,” says Adam Sussman, the director of research at Tabb Group, a financial market consulting firm. There’s still a chance this will all get resolved in the next week and that another debt-ceiling crisis is averted. But the markets aren’t exactly betting that way. In the past week, the cost to buy protection against U.S. Treasuries, reflected in the price of credit-default swaps, has spiked, though prices are still nowhere near where they were heading into the debt-ceiling crisis two years ago.

Judging by Congress’s inability to avert a government shutdown, chances seem pretty good that we’re in for another protracted fight over the debt ceiling. “The longer they run out the clock, the more it benefits the HFT community,” says Dave Weiss, a senior market analyst at Aite Group. And this time, high-frequency traders are extra hungry. “It’s like binge trading for them,” says Sussman. “You gotta trade all you can, especially when you don’t know where your next meal is going to come from.”

Philips_190
Philips is an associate editor for Bloomberg Businessweek in Washington. Follow him on Twitter @matthewaphilips.

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