Fed

The Fed Raises Rates, Explained by the Rube Goldberg Machine

readingbyeugene Leave a comment

Today, the Federal Reserve raised interest rates for the first time in more than half a decade. I cheered a little bit when the announcement came to pass, I admit. For the last two to three years, the question of when the Fed will raise rates has been an ongoing topic of discussion in my line of work.

The New York Times has put together a very clever explainer of the impact of the Fed raising rates via the Rube Goldberg Machine.

The short-term interest rates vs. long-term interest rates is something worth considering:

When the Fed raised rates in the mid-2000s, long-term rates didn’t go up. This puzzled a lot of economists, including the Fed chairman at the time, Alan Greenspan. The culprit, according to a theory put forward by his successor, Ben Bernanke, may have been savers in countries like China. They were sitting on piles of cash and had few reliable places to park it, so they chose the safest vehicle they could find: United States government debt. Whether that analysis is correct or not, the key idea is that while the Fed has a great deal of control over interest rates in the short run, it has a good deal less in the long run.

I also liked this explainer on the notion of the increase in rates being “priced in”:

The Fed must change beliefs in a way that doesn’t surprise anyone, or it risks putting the economy in shock. This is why, for the last few weeks, the Fed has been loudly (by central bank standards, at least) telling markets and consumers that it’s going to raise rates in December. It wants people to be able to prepare for that announcement and for markets to price in their reaction ahead of time. So there’s a strong possibility that the Fed’s decision on Wednesday to raise rates will not cause much of anything to happen. And if indeed this is the case, the Fed will have actually succeeded in running its machine.

As the article correctly points out, rate increases make life a little bit harder for borrowers and a little bit easier for savers. Are you cheering this move?

What Happened in the Markets on September 18, 2013 at 2PM?

readingbyeugene Leave a comment

This is an intriguing analysis at Nanex of what happened in the financial markets (equities and futures) on September 18, 2013 milliseconds before the FED announcement of “no taper” at precisely 2:00PM.

One of Einstein’s great contributions to mankind was the theory of relativity, which is based on the fact that there is a real limit on the speed of light. Information doesn’t travel instantly, it is limited by the speed of light, which in a perfect setting is 186 miles (300km) per millisecond. This has been proven in countless scientific experiments over nearly a century of time. Light, or anything else, has never been found to go faster than 186 miles per millisecond. It is simply impossible to transmit information faster.

Too bad that the bad guys on Wall Street who pulled off The Great Fed Robbery didn’t pay attention in science class. Because hard evidence, along with the speed of light, proves that someone got the Fed announcement news before everyone else. There is simply no way for Wall Street to squirm its way out of this one.

Before 2pm, the Fed news was given to a group of reporters under embargo – which means in a secured lock-up room. This is done so reporters have time to write their stories and publish when the Fed releases its statement at 2pm. The lock-up room is in Washington DC. Stocks are traded in New York (New Jersey really), and many financial futures are traded in Chicago. The distances between these 3 cities and the speed of light is key to proving the theft of public information (early, tradeable access to Fed news).

We’ve learned that the speed of light (information), takes 1 millisecond to travel 186 miles (300km). Therefore, the amount of time it takes to transmit information between two points is limited by distance and how fast computers can encode and decode the information on both sides.

Our experience analyzing the impact of hundreds of news events at the millisecond level tells us that it takes at least 5 milliseconds for information to travel between Chicago and New York. Even though Chicago is closer to Washington DC than New York, the path between the two cities is not straight or optimized: so it takes information a bit longer, about 7 milliseconds, to travel between Chicago and Washington. It takes little under 2 milliseconds between Washington and New York.

Therefore, when the information was officially released in Washington, New York should see it 2 milliseconds later, and Chicago should see it 7 milliseconds later. Which means we should see a reaction in stocks (which trade in New York) about 5 milliseconds before a reaction in financial futures (which trade in Chicago). And this is in fact what we normally see when news is released from Washington.

However, upon close analysis of millisecond time-stamps of trades in stocks and futures (and options, and futures options, and anything else publicly traded), we find that activity in stocks and futures exploded in the same millisecond. This is a physical impossibility. Also, the reaction was within 1 millisecond, meaning it couldn’t have reached Chicago (or New York): another physical possibility. Then there is the case that the information on the Fed Website was not readily understandable for a machine – less than a thousandth of a second is not enough time for someone to commit well over a billion dollars that effectively bought all stocks, futures and options.

The conclusions the authors draw? The announcement was leaked:

The Fed news was leaked to, or known by, a large Wall Street Firm who made the decision to pre-program their trading machines in both New York and Chicago and wait until precisely 2pm when they would buy everything available. It is somewhat fascinating that they tried to be “honest” by waiting until 2pm, but not a thousandth of a second longer. What makes this a more likely explanation is this: we’ve found that news organizations providing timed release services aren’t so good about synchronizing their master clock – and often release plus or minus 15 milliseconds from actual time. Their news machines in New York and Chicago still release the data at the exact same millisecond, but with the same drift in time as the master clock. That is, we’ll see an immediate market reaction at say, 15 milliseconds before the official scheduled time, but in the same millisecond of time in both New York and Chicago. Historically, these news services have shown a time drift of about 30 milliseconds (+/- 15ms), which places the odds that this event was from a timed news service at about 10%. 

Something does sound fishy based on the charts provided by Nanex. I’ve read some of their analyses before and they have been overwhelmingly convincing. We’ll see how this one unfolds pretty soon, I think.

The Super Mario of Finance

readingbyeugene Leave a comment

Today’s quote of the day comes courtesy of Felix Salmon, who thinks we need Super Mario to come in and clean some financial pipes:

It seems we don’t need Ben Bernanke any more, we need Super Mario to come in and unclog those pipes. It’s a hugely important job, but the problem is that no one knows how to do it, especially insofar as the clogs look like rational market pricing more than crisis-related market inefficiency. (Remember, the prepayable fixed-rate 30-year mortgage itself is something which is never found in a laissez-faire capitalist system: only government intervention can ever persuade banks to issue such things.)

So who will be this Super Mario of finance? Click through the post to see a startling long-term trend in mortgage originations vs. FICO scores.