It’s a big week in the economic calendar as markets believe the Federal Reserve is primed to start cutting interest rates at this week’s FOMC meeting on Wednesday, September 18. Michael Warlan, global head of trading and operations at Third Avenue Management, discusses the significance of the mid-week Fed meeting and how the trading desks need to be cautious of how they react to the move. The global head of trading unpacks his strategy for the potentially volatile week ahead and covers what data signals he’ll be paying attention to.
Also, this week the Securities Exchange Commission will meet to discuss proposed amendments to the US equities market structure rules, Regulation National Markets System (Reg NMS). Warlan discusses what to expect from the update and to look out for any immediate reactions to the suggested reforms.
In this episode, the trading head also delves into the growth of retail trading and how to leverage that liquidity during market volatility. In wrapping up the show, Warlan offers one piece of advice to traders for the upcoming weeks and months.
Interview Transcript
Jo Gallagher Welcome to Trader TV This Week your insight into how trading desks prepare for the week ahead, I’m Jo Gallagher. Today I’m joined by Michael Warlan at Third Avenue Management to discuss the main topics and events meeting this week. Michael, welcome to the show.
Michael Warlan Thank you.
Jo Gallagher This is a big week in the economic calendar. Contextualize the trading environment right now and what’s in store for markets.
Michael Warlan While one would have expected things to have started to pick up, the summer holidays are further in the rearview mirror. We had a less-than-typical summer market activity that was elevated in July and August, where we saw volumes consistent with annual averages, and summer month volumes were in the high single-digit percentage points above the previous year’s activity. Now all eyes are fixed on Wednesday’s FOMC meeting and rate decision.
It’s no secret that the Fed and some investors have been eagerly awaiting the opportunity to make a cut and from the data and commentary these past few months, confidence around the consensus 25 basis point start Wednesday is growing. While many would assume that a cut will lead to a risk-on mentality, much could be learned from the commentary after the release. If there are additional changes in sentiment from the Fed, the market should be quick to react one way or the other. And if rate cuts were not enough this week we have a bonus with the SEC meeting Wednesday morning to address the long-awaited updates to market structure reform or to Reg NMS.
Jo Gallagher Given that backdrop, how do you adapt your trading strategy going into this week and make the most of these windows of short-term volatility?
Michael Warlan Well, historically, September has been a volatile month, often marked by rebalances, reallocations, and repositioning. We began to see signs of this starting in August with significant market swings both domestically and internationally. Such periods can present attractive opportunities for long-term investors. With increased volatility, it is crucial to pay close attention to significant moves and their underlying drivers, in a week like this. Equity trading should tend to be more passive and patient leading up to Wednesday’s decision with opportunistic trades deployed where appropriate. These opportunities might arise in non displayed or off-exchange venues where volume tends to be the choice for maintaining anonymity.
However, as fundamental active investors, we exercise patience, avoiding being driven solely by short-term macro changes. Instead, we react to attractive opportunities as they arise and aim to be a provider of liquidity whenever possible as well. Most of our algorithmic strategies will adjust volume curves around Wednesday’s decision, leading to a pickup in volume and activity immediately following the announcement and into the close. And for global markets will likely follow US leads. And as we enter Thursday’s trading sessions in Asia and Europe, currency markets do serve as a good indicator for what to expect in the session ahead.
Jo Gallagher As you mentioned, we have the SEC update on Reg NMS coming up on Wednesday. How significant is that and what are your expectations for immediate reactions.
Michael Warlan In December 2022 the SEC proposed some significant updates to the US equity market structure. Minimum price increments for quoting Reg NMS stocks, the reduction of access fee caps and enhanced transparency of better priced orders. The minimum pricing increments are adjusting the minimum price for ticks for quoting securities. The access fees are reducing the caps on access fees that exchanges can charge for executing trades, which would propose lowering trading costs for investors and finally, transparency or better price orders which enhance transparency of orders that are not priced at the MBBO, which has been called the round lot display size. And these reforms are part of the SEC’s ongoing efforts to modernize and improve U.S. equity market structure.
However, most of the focus will be on the tick size reform and access fee caps. These two proposals have seen extensive comments to moderate the Commission’s versions of the changes as they are key contributors to the equity landscape. Tick sizes are widely speculated to see the most compromise from regulators based on comments received and could likely see in tick-to-trade stocks, the tick size reduced to a half-a-penny increment to begin with. As for access fees, there was a significant proposed reduction from a cap of 30 mills to 10 mills. Pushback has been heavy from exchanges and concerns about the shifting of cost to other areas of the market, resulting in less efficiency and liquidity. However, a standardized fee schedule and less differentiation will reduce fragmentation and potentially result in consolidation, which one side argues will place a drag on market incentives for innovation, with another saying there will be increased liquidity in venues for others to trade against. These are longer-term issues. However, you could see some short-term reactions depending upon the final rules.
Jo Gallagher There’s been a major growth in retail participation over the last few years. How important is monitoring that retail flow to your trading strategy?
Michael Warlan Managing access to that liquidity has been a challenge that institutional traders have been looking for solutions for many, many years. So much so that the SEC, as part of those reforms that I just reviewed, had a proposal in there to address retail flow. However, I don’t believe that it’s going to make it to this Wednesday’s meeting, but that doesn’t negate its significance in the marketplace.
And in a week like this especially around something that could be leading to a significant or at least enhanced volatility on Wednesday, you need to have a strategy of how to participate with that liquidity, and that could be by identifying certain strategies, and tools that brokers offer which participate directly with that flow or at a minimum on your algorithmic strategies, whether they be participation or an over-the-day strategy, reducing that minimum execution quantity to make sure that you’re not missing out on a significant amount of that flow.
Jo Gallagher Finally, what’s one piece of advice that you would offer traders when thinking about the next few weeks and months?
Michael Warlan There is no secret that the US elections that are going to be occurring at the end of this year or the latter part of this year in November are on everyone’s minds. There’s undoubtedly going to be a change in administration, one form or another. And with that there is differentiation in what their policies are going to be. That could be on regulation, that could be on the investment style. There’s a host of issues that investors and investment managers are going to need to consider when they think about long-term planning. And in the short term, leading up to that, I’m sure that people will be paying close attention to the polls as well as a lot of the other information that comes out on a daily basis. The election markets will have an overhang, you know, taking up a tremendous amount of the headlines that are occurring in the markets for the foreseeable future.
Jo Gallagher Thank you, Michael, for your insight. And of course, you for watching. This has been Trader TV This Week.
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