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One Concerned Trader Asks: Is The Fed Prepared For Its New Role As "Head Trader?"

For the better part of six years, we’ve been saying that central banks are the only traders left in town.

Between the meltdown in 2008 (during which mom and pop got the illiterate Chinese housewive treatment when they were forced to watch as half of their paper profits were vaporized before their very eyes in the space of just a few months), the proliferation of sub-penny scalping algos, and revelations that everything from benchmark rates to FX has been rigged by big banks for years, real people no longer want anything to do with this casino. 

At a higher level, seven years of unconventional monetary policy has put the Fed and many other DM central banks in the position of being forever wedded not only to the preservation of ZIRP, NIRP, and QE, but also to capital markets which, far from playing their traditional role as an efficient price discovery mechanism for assets, are now merely another tool in the central planner toolbox. The Fed effectively admitted all of this last month when it cited market conditions in its decision to adopt the “clean relent”/ “dovish hold”, in the process tacitly suggesting that the FOMC has become aware of its vexing reflexivity problem. 

Against this backdrop we bring you the following from Bloomberg’s Richard Breslow, author of “Trader’s Notes”.

From Bloomberg's Richard Breslow

  • The Fed’s Dudley and Yellen, wisely, decided to take a pass on repeating earlier comments when they spoke yesterday. Markets were flying, why risk it? Tomorrow, however, after the dust has settled from the release of the non-farm payroll report, we will undoubtedly get the most interesting and important speech of the week. It most likely won’t be from Fischer, Dudley nor Mester, but from non-voter Eric Rosengren, when he presents a research report he co-authored entitled “Should U.S. Monetary Policy Have a Ternary Mandate?” It discusses whether the Fed should place financial stability on a par with employment and inflation in its deliberations. The bottom line of the analysis is that, dual mandate aside, the FOMC is very much aware of, and respondent to market conditions
  • Now it isn’t terribly surprising that in the big picture, financial stability conditions have been a consideration. Just think back to the Fed’s response to Black Monday or LTCM. As the paper argues, over time, the power of monetary policy to affect the economy became very evident and this realization was why the dual mandate was introduced explicitly in 1977. But the question remains whether financial condition concern should manifest itself through unemployment and inflation dual mandate forecasts or be a separate consideration all together? To me, the danger in the latter is it turns central bankers into traders and market timers and that is something they are unlikely to have trained for
  • Central banks have become much more ubiquitous in asset markets. Boy, that statement doesn’t break new ground. Quantitative easing, selecting which assets to buy or sell, managing the yield curve and selecting individual economic sectors to target make the central bank the major market player, dominating in every way traditional market actors. Throw in sovereign wealth funds and you have bankers sitting glued to their Bloomberg terminals rather than white boards. It is very seductive and addictive to “oversee” markets by actively managing them. But it is not healthy for the functioning of markets as we knew them. An ex-Fed governor told me back in 2009 that the central bank would be an active and growing presence in the markets, and I had just “better get used to it.” He was right
  • But as much of a presence in the markets central banks have become, this third mandate, de jure or de facto, raises the counterintuitive problem of who is actually in charge. Should the central bank be so manipulable every time investors get caught with positions they no longer want? It explains very much so the ’’ bad news is good news’’ phenomenon. You are a trader long equities, do you want a beat or a miss if the Fed’s reaction function is openly explicit? It is the ultimate central bank put whether investing in equities or emerging markets. The central banks have created the conditions for market turmoil by being so concerned with market turmoil
  • The paper is being presented and debated at tomorrow’s conference. Hearing how the discussion goes regarding the perceived efficacy of this third mandate and its permanence will be a big clue on how to invest going forward