Thin Trading: Fed Fund Futures and Antique Watches

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

Print Friendly, PDF & Email

What's been said:

Discussions found on the web:
  1. Philippe commented on Oct 10

    They are two parts of these stories

    The derivatives as a support to prices

    When looking at the net position of the speculative funds, they have as August resolutely read few fed rates cut (they are long Fed funds and long ten years TB). When looking at the fundamental data as published in September (ISM, factory orders, leading indicators) they are weak enough to sustain their views.

    The cash component as a support to the real needs the Balance of payment

    When looking at the speed at which foreign investors (latest ones Vietnam, Qatar) are shifting their assets away from the USA, the level of interest of indirect bidders in the TB auctions, the needs arising in many countries to support their banking industries (From Kazaktan to Russia, Central Banks are increasingly supplying additional funds to their banking system through repo’s 10 Billion USD a day)
    One may wonder how much flexibility the Fed may have with the Fed funds even though they are not a driving force on the long-term interest rates.

    Cronos is more pressing and more demanding.

  2. Winston Munn commented on Oct 10

    If I understand this post correctly, we must “watch” the Federal Reserve to make sure they don’t “auction” off on us a bill of goods worth much less than advertised?

  3. XON commented on Oct 10

    I know how annoying it can be when non-financial people ask what are probably dumb questions here, but I’ll try this one: Is there a technical manner to judge whether in a given market, there is enough information to deem it transparent enough to function as a market?

    When I look at the article, and try to generalize the concept, it seems that every market is susceptible to this. If it is, have the technician figured out how to measure that?

  4. Philippe commented on Oct 10

    “Is there a technical manner to judge whether in a given market, there is enough information to deem it transparent enough to function as a market?”
    After many years I have the same question,why in some cases legal cases are instigated, market manipulation,insider information,misrepresentation of truth, document fraud, and for years one may see that happen with no legal action.
    The only answer is market sanction

  5. michael schumacher commented on Oct 10

    Not surprised by the watch thing as it’s been going on in the classic car auction arena for many years…..the names are usually published a few weeks after the event has happened, by then people have forgotten……quite a unique parable to our own stock market ….LOL

    Fed Funds futures are just another tool in the self fulfilling prophecy of an economy we are led to believe occurs. If you say it or demonstrate it enough times it becomes part of the vernacular and it only becomes relevant if it occurs as predicted….but since the % changes so often it is of no use to me.

    Tell me again how rate cuts are supposedly a sign that all is well??? that’s rhetorical in case you did’nt realize.

    Back to your friendly (if you are long) Chinese supported ATM, sorry, STOCK MARKET…


  6. David Merkel commented on Oct 10

    So long as the watchmaker has cash, they can fix prices. But think of all the money De Beers blew in protecting their “monopoly,” as it crumbled around them.

    Bubbles pop when cash flow is insufficient to pay the cost of financing them. That eventually happens in all significantly rigged markets.

  7. Justin commented on Oct 10

    That being said, it is amazing the credibility that the media seems to garner it, especially if and when the Fed Funds Futures are indicating a rate lowering. Connotated language should not be allowed in the business media. Just facts man…just facts!

  8. Estragon commented on Oct 10

    David Merkel – “Bubbles pop when cash flow is insufficient to pay the cost of financing them. That eventually happens in all significantly rigged markets.”

    Quite true, however in the case of the fed funds rate, aren’t we talking about the creation of cash itself ;-)

  9. michael schumacher commented on Oct 10

    We’ve on;y seen a glimpse of what can happen when there is not enough cash. If only the Fed and Treasurey would stop printing it up and serving it straight to the market would we really see the effect of Merkel’s statement.

    ANd that is all it is….just a statement that is rooted in book theory……It does not factor in cheating and “fuzzy math” that has ceremoniously trumped any and all reality simply because the Goldman’s of the world refuse to take a loss.


  10. SINGER commented on Oct 10


    “Phillipe Stern, owner of Patek Phillipe maker of fine Swiss timepieces announces a
    $10 million dollar share buyback due to excess cash and belief in the future of his industry…”

    just a thought…I wonder what the next highest bids were in those auctions???

  11. Justin commented on Oct 10

    So what is it? Isn’t it the fact that they use the fed funds futures market as a hedge and not as a predictor of future prices. Therefore, it in no way should be construed as having any predictive power as to what direction the FOMC needs to take. Afterall, they don’t even get it right!

  12. michael schumacher commented on Oct 10

    taken from the recent GS filing

    Houston…there is a language problem….

    DJ Goldman Level 3 Assets Exposure at Aug $50.9B

    followed by

    DJ Goldman Aug Level 3 Fair Value $72.05B, 7% of total assets

    You can’t make this shit up………

    Fair Value????????..then why is it placed in La La Land valuations at level 3??

    What a scam……


  13. bucky katt commented on Oct 10

    Price is a function of LIQUIDITY, having nothing to do with value

  14. Philippe commented on Oct 10

    A bank potential loss is to be assessed from its capital and earnings base or potential capital gain through assets disposal as opposed to its assets, which are financed from borrowings, and capital.
    GS gearing is 25.
    If level 3 is a potential loss GS has to generate assets capital gain of the same amount.

  15. michael schumacher commented on Oct 10

    I totally disagree with you Phillipe, there is nothing that will make GS (or any other brokerage FTM) have to make it up in other places. Level 3 was designed to park declining assets in a place that will most likely never see real valuations assigned to them ever. They can park whatever they like for whatever time period they see fit.

    There is no tit for tat in that world……only ours.. since most of the things that effect us can’t be allowed to affect the elites.


  16. Philippe commented on Oct 10


    It could be that indulgence will be so far streched but that means that the financing will have to be found for a large pool of non performing assets, they may escape the Banks supervision, auditors but they may not borrow for free.

  17. michael schumacher commented on Oct 10

    You are speaking from a standpoint of fiscal responsibility-what SHOULD occur. You’re argument falls at that point since what we are dealing with is so far from that. What is stopping them from having a fake valuation assigned to them for a long period of time? so that said non-performing assets are really not and are performing to a level that they say they are??? therefore you have eliminated most of the problems associated with a non-performing asset. It’s quite the bullshit way to do business…

    BTW……the message from the administration put out today would do well if it were directed at the brokerages….

    Hope Now? is what the title should be..


  18. Philippe commented on Oct 10


    The financial world is aware since long and questions are raised as soon as financing is asked.
    Financing is the private sector (it is not derivatives it is CASH)

  19. Justin commented on Oct 10

    So it is the banks that “know the price of everything, and the value of nothing.” Or is it, “the value of everything and the price of nothing?” Oh! who the hell cares they’ll do what they want to anyway.

  20. michael schumacher commented on Oct 10

    in this case the question(s) were never asked as long as the money appeared……it is continuing as we speak. Monday’s coming debt sale will occur as if none of the previous “issues” were of any concern.

    We do not live in a world that takes it’s economic rules from a textbook…….you are arguing (covertly) that it does. I could’nt disagree more.

    justin has the idea…..


  21. stanleyb commented on Oct 10

    Reading the auction announcements this week, the volume of the 4 week T-bill was cut from 18B to 8B being auctioned this week, but they increasing the volume of 13 and 26 week bills from 28B to 31B and even more the number of 2 year and 5 year bonds for sale on sept 27th.

    Why is the Fed reducing the 4-week T-bill volume by so much?

    It might be from having a lot of sudden short term cash at the end of a tax quarter …but it also could be the Fed purposely shifting their debt pool more into mid and long term bonds to lock in low interest rates on its debt into longer period vehicles, before it’s forced to pay higher interest rates again.

Read this next.

Posted Under