Opinion

Breaking the fixed income feedback loop

David Everson, head of markets, EMEA at RealQ, writes that the fixed income market’s growing reliance on data and liquidity tools risks eroding the quality of trading signals through negative feedback loops, making the next priority smarter, more discreet matching of genuine buyers and sellers rather than simply distributing more information.
By David Everson

The fixed income market has never had more data. Composite mids, dealer axes, smart dealer selection tools, best execution analytics and now, finally, the consolidated tape.

We’ve become masters at collecting, analysing and distributing information. In some cases, we’re probably drowning in it.

In recent years, a range of workflows have emerged to help participants navigate this growing pool of data. But in our pursuit of better liquidity discovery, have some of these tools started to dilute the very signals they were designed to uncover?

The industry has made huge progress in making bond markets more transparent and liquidity more accessible. But every time we consume, analyse and build workflows around a liquidity signal, we risk changing the behaviour of participants that generated it, leading to the emergence of negative feedback loops that weaken trading signals.

Weak signal

Sell-side traders frequently refer to the butterfly effect created by every axe, inventory signal or streamed price that leaves the trading desk. All have the potential to be consumed, analysed, repackaged and redistributed across the market. By the time the original signal finds its way into a data product, the impact is often far greater than the trader intended.

Imagine a scenario where a dealer is short a bond and raises their streamed price to attract liquidity and cover the risk. Almost instantly, that adjustment is incorporated into a market data product, such as a composite mid, and redistributed back into the market. As a result, the market moves against the dealer before they’ve had a chance to cover the short.

As dealers increasingly adopt central risk book models, this challenge becomes even more apparent. Anyone responsible for pricing thousands of ISINs across a large risk book will recognise the problem immediately. Expressing genuine interest risks moving the market away from you and making contra liquidity more costly to access. Over time, participants adapt. Streams become more defensive and less meaningful, gradually eroding the market’s ability to signal where risk is genuinely available to trade.

Interested or not?

Another feedback loop is emerging. Historically, axes were designed to communicate genuine areas of dealer interest. If a dealer was long or short a position and wanted to trade, the axe provided a useful signal to the market. Today, however, axes are also an important input into smart dealer selection models, meaning that if a dealer has shown interest in a bond, they’re more likely to respond to an enquiry relating to it.

The problem is that if visibility within dealer selection tools is influenced by the number of axes a dealer distributes, the market risks rewarding the presence rather than the quality of an axe. By creating an incentive to show as many axes as possible, axes become less representative of genuine trading interest and more indicative of participants seeking workflow visibility.

Different feedback loop. Same outcome. The more the market consumes a particular signal, the greater the incentive to optimise for that signal and the less valuable it becomes.

Smarter matching

The industry needs to shift its focus. For years, we’ve concentrated on displaying more liquidity and distributing more information. The next phase is identifying genuine intent and matching it more intelligently.

Natural liquidity occurs when real buyers and sellers, with genuine contra trading objectives, find each other at the right moment. Technology should help facilitate that process, but not at the expense of signal quality.

There’s a reason Damien Hirsts aren’t sold on eBay. High-value assets benefit from context, curation and discretion. Fixed income liquidity is no different. The future isn’t about broadcasting every signal to every participant. It’s about connecting the right participants when meaningful liquidity is most likely to intersect.

Platforms should act as filters, not amplifiers. Breaking the fixed income feedback loop requires a market structure where participants can express risk safely and liquidity signals can retain their value. The goal is not to distribute more information, but to create better outcomes by connecting genuine buyers and sellers at the right moment.

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