The Fed’s Price Keep­ing Op­er­a­tion

Financial Mirror (Cyprus) - - FRONT PAGE - By Charles Gave

The US equity mar­ket is a con­stant source of sur­prise, but what re­ally amazes me is any sug­ges­tion that it is “try­ing to tell us some­thing”. Be­tween al­go­rithms, in­dex­a­tion, closet in­dex­a­tion, reg­u­la­tions, ex­change traded funds, struc­tured prod­ucts, track­ers, neg­a­tive in­ter­est rates and of course mas­sive cen­tral bank in­ter­ven­tion, “Mr. Mar­ket” prob­a­bly has very lit­tle to say, save that he is hope­lessly lost. Put an­other way, the no­tion of the mar­ket be­ing a fo­rum for “price dis­cov­ery” seems like a shib­bo­leth from an­other era, at least dur­ing the last five years.

The only dis­cov­ery process which now seems to mat­ter is the likely ac­tion of the cen­tral bank(s) this week or next. The rest is just con­ver­sa­tion. In­deed, it is moot whether this strange new crea­ture can cred­i­bly even be called “a mar­ket”. At best it is a pol­icy tool to be ma­nip­u­lated, just like in­ter­est rates or the ex­change rate. And, of course, the only price which mat­ters is that which the cen­tral bank deems to be the right one.

To il­lus­trate the point, con­sider the chart which shows a con­fig­u­ra­tion that I have never seen in 40 years of study­ing mar­kets. Three times in the last 15 months the S&P 500 started to run out of steam with the sub­se­quent de­scent be­ing pre­cip­i­tous as it quickly hit over­sold ter­ri­tory. The im­pres­sion was of a big buyer tak­ing a rest.

As a re­sult, the stock mar­ket started to look de­cid­edly “sick”. Yet on all three oc­ca­sions when the S&P 500 fell below the 1870 level, it not only re­bounded, but pow­ered higher to a point that it was as over­bought as it had been over­sold just a few weeks pre­vi­ously. Mov­ing from over­sold to over­bought in a few weeks is pretty un­com­mon; do­ing it three times in a row, in just 15 months, to my knowl­edge has not hap­pened be­fore.

The im­pli­ca­tion is that some­one or some­thing has de­cided that the S&P 500 is not au­tho­rised to fall below the 1900 level and, hence, that en­tity needs to be tested as to the strength of its hand. Al­ter­na­tively, it could just be that silly al­go­rithms con­tinue to make a mock­ery of mar­kets, in which case the best thing would be for the au­thor­i­ties to sim­ply close down the light-speed trad­ing desks. Or there is per­haps a third ex­pla­na­tion:

Con­sider the no­tion that in our new world of high level “price keep­ing op­er­a­tions”, Wall-Street equity prices have two com­po­nents; namely a “fair” value around which shares should trade if this were a “nor­mal” world, and also a “pre­mium” above that fair value level, which re­flects in­vestors’ con­fi­dence in the eq­ui­ties fall­ing.

The worry must be that, if at some point, the be­lief co­a­lesces that the Fed­eral Re­serve’s “put” is no longer work­ing, a crash may fol­low in short or­der, just as in 1987 when in­vestors re­alised that much hyped port­fo­lio in­sur­ance was bo­gus. And this is per­haps why the last 15 months has (likely) seen the ar­range­ment of three PKOs.

The bad news is that I can­not iden­tify one case in 4,000 years of eco­nomic his­tory when any en­tity has been able to sta­bilise a price, any price. And I find the cur­rent at­tempt by cen­tral bankers to achieve such a re­sult about as promis­ing as King Canute’s ef­fort to turn back the waves. Of course, Canute was mak­ing the point to his courtiers that there were lim­its to his mag­is­te­rial pow­ers. There seems to be no such self-aware­ness in the cor­ri­dors of power within our cen­tral banks.

cen­tral bank’s

abil­ity to stop

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