Rate Traders Watch Fed

Terry Flanagan

Interest-rate traders and risk managers may be in for an intense few months ahead, as the U.S. Federal Reserve considers when and how to taper quantitative easing, and a new Fed Chairman is lined up.

Such catalysts will spark increased market volatility, CME Group Chief Economist Blu Putnam said.

Before year-end, President Obama must nominate a replacement for Ben Bernanke, whose second term as Fed Chairman ends on January 31, 2014. Current Fed Vice Chair Janet Yellen and the President’s Chief Economic Advisor Larry Summers are said to be main contenders.

A wildcard third choice may come to bear if the President thinks neither could get approved, Putnam told Markets Media.  TIAA-Cref top executive Roger Ferguson, a former Fed vice chairman, could be on Obama’s short list, some say.

Putnam will be focused on the Senate confirmation hearings for the Fed nominee. “These are likely to be the most contentions and divisive ever,” he said. “It will cause volatility in markets regardless of who is nominated.”

The approval process for the Fed leadership role is especially important in light of how active and influential the central bank has been in recent years. “These unelected officials have such a huge impact on the U.S. economy,” said Putnam.

Meanwhile, the September 6 U.S. jobs report is anticipated to be one of the more important economic headlines of the year, as the data may shape Fed policy outlook through year-end. The critical nature of the jobs report is underscored by the calendar events closely following, Putnam said.

Decisions emanating from the Federal Open Market Committee meeting on September 17-18 will factor in the Labor Department’s August data. “They’ll tell us something about QE after that,” Putnam noted.

While he does not expect the Fed to tip its hand as to how fast tapering will be applied to QE, asset purchases will be indicated in the September 18 minutes.  “Today’s consensus is they will reduce their activity starting in October,” he said.

“People are totally focused on what the Fed is going to do,” Putnam said. For yield metrics, “traders will look to futures. But to express risk management concerns associated with volatility, they will turn to options pricing.”

“I look at volumes to tell me what people are thinking by their actions,” Putnam continued. “In May through July, we saw nearly two times as much activity in CME Treasury put options as call options, indicating risk managers are worried about rates rising and how much volatility that will cause.”

While put buying demonstrates those concerns, hedge funds may buy calls if they believe rate increases and inflation pressures will take longer to play out, he noted. Such differences are illuminating as risk managers consider direction, volatility, and timing.

Other topics that are front and center currently for Putnam and CME stakeholders are assessments about the U.S. budget, China’s role in financial and commodity markets, gold supply and demand, and energy data. Internal and external presentations frame the issues that risk managers face.

“Debt-ceiling legislation needs to be passed again, or there will be government shutdowns,” the economist said. Congress returns from its summer hiatus on September 9 and must reach some consensus on the nation’s legal debt ceiling, with a deadline of midnight September 30.

Putnam’s analysis has featured long-term demographic changes in China.  People disagreed with his earlier prognosis on how China will factor into markets.  “My projection was that China’s growth rate would be decreasing through this decade,” Putnam said. “People are aging, the economy is more mature — the easy gains are done.”

Putnam, who focuses on Bayesian analysis, said ‘Big Data’ has swung in favor of that sort of dynamic economic research. “Thirty years ago, market intelligence meant what do you know that others don’t, and who told you?” he said.

The longer-term perspective “makes for a lot more trading activity using quantitative analysis,” Putnam said, as storage cost of big data is no longer a constraint, and there is limitless machine power to analyze. “It’s open season on data — people can run programs, real time, in the nanosecond space, in the cloud.”


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