Tuesday, 1 September 2015

Fed (mountain) hikes

14:54 Posted by The Thalesians (@thalesians) No comments

The market has been awash with speculation about when the Fed might hike, continually watching for clues from Fed communications. The recent symposium of central bankers at Jackson Hole, organised by the Kansas Fed, presented the market with another opportunity to search for clues. Comments at Jackson Hole struck a hawkish tone. Fed vice chair Fischer suggested that inflation did not need to pick up for a Fed hike to happen. If we consider the start of previous Fed hiking cycles, whilst growth and employment levels might have been similar, for the most part, inflation was a lot higher than it is at present. For a wrap up of what happened at Jackson Hole, I'd recommend have a look at Sam Ro's write up at Business Insider. If you're interested in understanding central bank communications from a systematic viewpoint I'd have a look at my recent Thalesians quant paper on the topic for Prattle, where I show how patterns in central bank sentiment gauged from communications can be used to trade FX.

Whilst the market has been obsessing about when the Fed is likely to hike, perhaps a more pertinent question is what the market will do, when a hike actually happens? A recent tweet by Emanuel Derman got me thinking precisely about this point. (Incidentally if you don't follow him on Twitter you should do!). Derman suggested that:

Raising rates 25 bp is actually going to be a massive non-event. There will be a brief positive reaction by markets, then back to business - Emanuel Derman @EmanuelDerman

By the time the Fed actually does hike, the market will have had such a long lead time, that a considerable amount of market adjustment to the hike will have already occurred. Let's consider the dollar rally from July 2014 till just before January's ECB meeting. The Fed had not hiked during any of this period, nor had the ECB actually announced full blown QE. However, the market was primed to expect both these scenarios. The market was essentially adjusting to expectations, rather than significant changes in monetary policy.

Whilst the market were busy discussing Jackson Hole over the past few days, I was busy hiking in the Alps. The process of the mountain hike can very much be seen similar to the way the market is approaching the Fed hike. We're currently in that phase, getting closer and closer to the top. When the Fed finally does hike, it'll be like getting close to the mountain peak. Most of the hard work of climbing will be done by then, and the market will be moving on to other issues.

If you're on the US East Coast, I'll be in Washington DC 27 Sep, NYC 29 Sep-3 Oct and Boston 5 Oct if you'd like to meet me and hear more about systematic trading! If you're in mainland Europe, I'll be in Frankfurt 7 Sep, Zurich 8 Sep and Paris 6-9 Oct.

Like my writing? Have a look at my book Trading Thalesians - What the ancient world can teach us about trading today is on Palgrave Macmillan. You can order the book on Amazon. Drop me a message if you're interested in me writing something for you or creating a systematic trading strategy for you! Please also come to our regular finance talks in London, New York, Budapest, Prague, Frankfurt, Zurich & San Francisco - join our Meetup.com group for more details here (Thalesians calendar below)

07 Sep - Frankfurt - Saeed Amen/Jochen Papenbrock/Miguel Vaz/Adrian Zymolka - Quant Evening (Thalesians/Quant Finance Group Germany)
08 Sep - Zurich - Saeed Amen - How to build a CTA? / interactive Python demo
10 Sep - San Francisco - Steven Pav - Portfolio Inference and Portfolio Overfit
21 Sep - New York - Agostino Capponi - Arbitrage-Free Pricing of XVA (Thalesians/IAQF)
23 Sep - London - Stephen Pulman - Multi-Dimensional Sentiment Analysis
01 Oct - New York - Saeed Amen - How to build a CTA? / interactive Python demo
14 Oct - New York - Dan Pirjol - Can one price Eurodollar futures in Black-Derman-Toy? (Thalesians/IAQF)
21 Oct - London - Robert Carver - Lessons from systematic trading


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