A new paper by Quantitative Brokers’ research team, led by Shankar Narayanan has found that the average quote size of many interest rate futures are almost 70% below 3-year averages, leading the firm to warn that “traders and asset managers are recommended to exercise caution as shallow quote sizes indicate markets are vulnerable.”
In its report the firm analysed recent month averages of quote sizes, liquidity – measures as the inverse volatility in volume time – volatility and bid-ask spreads for rates futures. It then compared those to the deviations from the previous three months, one year and three years of those microstructure variables
“The average quote size of all the futures, except the US 30-year (ZB) and the US Ultra 10-year (TN), is significantly lower than the 3-years’ averages,” Narayanan wrote. “The pattern is somewhat consistent across exchanges. The 2-Year futures quote size average of November is almost 98% lower than the 3-year averages. The ZB and TN quote sizes have been relatively unchanged in the last three months. The drop in quote size is attributable to a confluence of several macro conditions”
It also found volatility averages in November were 10-30% higher than the three-year average. Although quote size corrections were noted in February 2018, December 2018, and March 2020 as previous period of market volatility, the team wrote, “However, the recent drop is steep and intriguing as it is more concentrated in the quote size than the volatility and other microstructure variables.”
The paper’s assertion is that shallow quote sizes can indicate market vulnerability to bad news as information and liquidity shocks are more pronounced.
“Traders need to exercise caution in execution as the cost of trading big sizes and targeting specific benchmarks will prove challenging; the algos are customized to “normal” environments,” note the team. “The extreme drops in quote sizes make limit order placement harder. Similarly, asset managers need to be careful with their portfolio allocation.”
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