Out Patient

fed policy

Jerusalem Post

March 20

fed policy

In a sense, it’s all more of the same. In a world in which financial markets no longer function as a mechanism for price discovery, by enabling the free interplay of willing buyers and willing sellers of financial instruments, the prices displayed in these dysfunctional markets no longer represent ‘value’ in any traditional meaning of that term.

Instead, prices in the markets represent estimates of what the participants in the markets think the entities who control the markets intend to do. These entities are, in the first case, the central banks of the world’s largest economies, as well as the central bank of the specific country in which the market is located.

For instance, in Tel-Aviv, the markets react to global developments, but also to the decisions — or speculation as to the likely decisions — taken by the Israeli central bank. Sometimes, when there is a functioning government in Israel, the Israeli financial markets respond to decisions taken by the government. Other times, only governmental agencies run by appointed technocrats are at work and it is these which move the local markets.

What is true for Israel is, in principle, valid for all developed countries, where quasi-independent governmental agencies exist and function. In countries such as Russia, Turkey and Argentina, the local dictators or autocrats — all of whom are ‘elected’, of course — impose their wills on the central banks and other agencies.

But, although from a socio-political perspective there is still an enormous difference between democratic and autocratic systems of government, from a market perspective, there is less and less — and often none at all. The prices reflect the known, expected or suspected intentions of ‘the authorities’ — and nothing else.

Thus it is that in the land of the formerly free markets, prices no longer represent willing buyers or sellers, but rather the assessment of the ‘traders’ — most of which are now computers programmed with sophisticated algorithms to conduct buying and selling operations — as to which way the wind is blowing. These robots can be manipulated by feeding them the code words that they look for in news headlines, because they will respond to these words by executing purchases or sales in various markets, along the lines defined by the programmers.

Let’s take a concrete example — or, to say the same thing in Newspeak, let’s concretize that concept. The most important market in the world is the US Treasury bond market and the largest market in the world is that for foreign exchange, with the euro/dollar exchange rate as its center-piece. The most important institution in the world is the Federal Reserve Bank, the central bank of the United States — which is still perceived, at least in the US, as the most important country in the world.

The Fed is the primary arbiter of prices in the US market and, by extension, the entire global financial system. What is says is therefore of critical importance, as is clear from the impact that official Fed pronouncements have on the markets. The periodic meetings of the Fed’s Open Market Committee (FOMC), every six weeks or so, are the most important of all, because these enunciate Fed policy in the present and outline policy in the future.

The communication of Fed policy is considered essential and every word or phrase used has enormous significance. Last year, Fed chair Janet Yellen introduced a new key word — ‘patient’ — into Fed policy making. In the context of a possible rise in short-term interest rates — which have been at near-zero for six years — Yellen said that the Fed would be patient in deciding to raise rates and defined ‘patient’ as two Fed meetings. In other words, so long as the code word ‘patient’ appeared in the statement issued after a FOMC meeting, there was no chance of a rate hike for at least the next two meetings.

This Wednesday’s FOMC meeting removed the word ‘patient’, opening the way for a possible rate hike any time from June. But this dramatic, earth-shattering change in the human condition came only after the Fed had assiduously prepared the markets for this eventuality, so that they would not — God forbid — suffer a shock. Furthermore, the excision of ‘patient’ was accompanied by the application of other, soothing, words to the effect that the economy is not doing very well lately, and so the first rate hike may be delayed some time.

This message was further expounded by Ms. Yellen at the post-FOMC press conference. The net result was that instead of plunging, as might have been feared by the implications of the demise of ‘patient’, the markets soared. That is, stock and bond prices soared. The dollar, on the other hand, fell by the most in a single day since March 2009.

Millions of words of analysis were written over a few hours following the patient-less announcement, explaining what had happened and how the Fed had compensated — or over-compensated — for the erasure of that word. But, come morning in Europe, the markets abruptly changed direction — apparently because of new bad news about Greece, and the use of words-with-negative-connotations-for-computerised-trading-systems caused a near reversal of everything that had happened in the US markets the day/ night before.

In short, it’s hard to be a trading algorithm when the humans can’t get their acts together. Time to replace the Greek Finance Minister, Ms. Yellen, the ECB, IMF et al with reliable, clear-thinking machines. Then the world will run smoothly and sensibly.

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