Yesterday, Traders embraced the release of the FOMC minutes. Indices were flat up until just before the 2:00pm release, and then took off, with the Dow gaining near 1%.
The thinking behind the Fed action was clearly revealed in that release. The emphasis was on the subsequent impact of credit on the entire system. The WSJ reported:
"Federal Reserve officials worried that credit-market
turmoil could reinforce slower growth at a time of "particularly high
uncertainty," leading to their half-point interest-rate cut last month,
minutes from the meeting show.
Without a cut, there was concern that "tightening
credit conditions and an intensifying housing correction would lead to
significant broader weakness in output and employment," the
rate-setting Federal Open Market Committee said. The minutes, released
yesterday, also showed members worried that market turmoil "might
persist for some time or possibly worsen."
They offered no clues about
the direction or timing of the Fed’s next move."
That last sentence is quite intriguing. Understanding whether or not a rate cut is forthcoming impacts yields, stocks prices, etc.
Given the significance of the Fed’s action, one would suppose that the markets which trade the Fed Futures would be, if not prescient, than at least telling about their future price action. One of the more fascinating aspects about this, however, has been the way the Fed Fund Futures have functioned over this time. They have been wildly wrong, forecasting an imminent rate cut since January 2006. I thought it might be instructive to look at why this maybe so, and what it might mean . . .
First off, Fed Fund Futures could be used to hedge positions,
especially fixed income holdings. Given the traditional impact any
change in rates has on a bond portfolio it makes some sense to think of
the buying and selling of futures as hedges. Rather than forecasting
future price action, they are offsetting risk to a given set of
Next, consider that not all markets are alike. The currency market
is broad and deep, with enormous amounts of cash exchanged every day.
(Note how much faster the greenback responded to the NFP report last
week, than the Fed futures did). So too are the Fixed Income markets,
Equity markets, and the Commodity markets, with trillions upon
trillions of dollars allocated to these asset classes. Options are some
what thinner, depending upon the specific issue — but still amount to
substantial amounts of capital.
Beyond this group, markets get thinner and thinner, with less
dollars changing hands, less diversity of thought about the subject
matter amongst the traders. This makes these markets less reliable as
"Tells" as to the future price action of their subjects. Professor Robin Hanson has noted these (amongst other issues) as elements which make markets less efficient as future discounting mechanisms. For those of you interested in these sorts of things, Chris Masse’s site has all the info you could ever want on Prediction markets.
Which brings us to a fascinating article in Monday’s WSJ on a subject near and dear to my heart:
How Top Watchmakers Intervene in Auctions.
It seems that many of the large watch houses — Patek Philippe,
Rolex, Omega — were anonymously bidding on their own antique and
collectible watches at auctions. For these manufacturers and marketers
of expensive timepieces, spending a few $100,000 to a few million on a
watch was a minor advertising and marketing expense. It served a larger
purpose than the actual ownership of the watches — it made their
current watches for sale seem much more valuable.
Alas, my own modest collection of antique timepieces contain no
Pateks — they never seemed to be good values, relative to the actual
watches themselves . . . Now I understand why.
Sayeth the Journal: "This
is a technique of which Patek Philippe and other famous brands, as
well, have availed themselves. "It’s an entirely different approach to
promoting a brand," says the cofounder of Antiquorum, Osvaldo Patrizzi,
"Auctions are much stronger than advertising."
Which brings us back to the Fed Fund Futures. As they get closer and
closer to Fed meetings, they become more accurate. They have now been
adjusting to the prospect that more rate cuts this year may not be as
imminent as previously believed: Prior to the the release of
yesterday’s minutes, the futures were downgrading the odds of another
cut by the Fed at the
Oct meeting. Two weeks ago, they had put the odds at almost 90%; that
slid to 48% on
Friday, and down to a 44% chance of a 25 bps cut as of 1:55pm yesterday.
As of the most recent reading: The fed funds futures now expect only
a 36% chance of an Oct cut, down from 88% 2 weeks ago (although if they
don’t go in Oct, they have priced in a 92% chance of Dec cut vs 100%
Miller Tabak’s Peter Bookvar noted that "for the 1st time
since mid Sept, the fed funds futures aren’t pricing in a fed funds
below 4.5% but implying a 100% chance of one more cut by year’s end."
Markets are mostly efficient — usually correct, but occasionally not. Markets have even set new highs as recessions were beginning: 1990, 1980, 1929; In 2000, the Nasdaq market doubled less than a year prior to the recession beginning.
This all suggests that an ongoing series of Fed cuts is far less likely to occur than has been recently expected . . .
Behind Rate Cut, a Shift in Concern
Fed Worried Credit Woes Could Fuel Broader Pain; ‘Some Inflation Risks’
WSJ, October 10, 2007; Page A3
How Top Watchmakers Intervene in Auctions
Luxury Timepieces Get Pumped Up in Bidding;
WSJ, October 8, 2007; Page A1
Auctions’ Role in Watch Prices Raises Ethical Questions
WSJ, October 8, 2007