ORLANDO, Fla., Nov 11 (Reuters) – Hopes for a Fed “pivot” exploded on Thursday after soft U.S. inflation data sparked one of the biggest rallies in U.S. stocks, bonds and interest rates markets in years.
Fine. But while the notion of a potential shift in Federal Reserve policy is perfectly reasonable and logical, the word “pivot” – like “transitory” and others before it – should be binned.
The hold these words has over markets is remarkable. This is understandable, they are useful, especially if they are new additions to the financial lexicon.
They are simple, they cut through nuance, and they are a good crutch for investors, economists, traders, bankers, fund managers – and yes, journalists – to sound intelligent.
These buzzwords are not new. From G7 references to “excessive” FX market volatility to former ECB president Jean-Claude Trichet’s pledges to stay “vigilant” on inflation, they have long been interpreted by traders as policy signposts.
They may be becoming more ubiquitous, however, due to technology – artificial intelligence (AI), machine learning (ML), and algorithmic (algo) trading in large part owe their success to them.
In the insta age of skimming, scanning and nanosecond attention spans – when music is “consumed” by the song rather than by the album – they are ideal. They reflect the times.
But they outlive their usefulness, and their meaning can get blurred. Shorthand can easily morph into broad-brushed assumptions, leaving traders tied in knots over particular words without really understanding their meaning.
Entire investment strategies are built around what may be poorly misunderstood concepts, and they are even prone to fueling herd-like trading, which can distort market liquidity and prices.
Meir Statman, professor of finance at Santa Clara University and an expert on behavioral finance, notes that this is not a new phenomenon, but could be having a more profound impact due to technology.
“If you have facts coming in at a rapid clip, and you have to digest or explain these moves second by second, you are forced to use shorthand to explain what’s going on,” he said. “That makes it more difficult for our brains to keep track of it. So people are looking for help wherever they can get it.”
STUCK IN A MOMENT
In August last year the OECD published a report called “Artificial Intelligence, Machine Learning and Big Data in Finance – Opportunities, Challenges, and Implications for Policy Makers”.
The authors noted that traders have for decades trawled news reports and corporate statements for information that they hope will give their investment decisions an edge.
But AI, ML and algos can now do this in an instant. When everyone’s models are programmed to grab the same word, phrase, or signal, herding behavior and one-way markets can ensue.
“Convergence of trading strategies creates the risk of self-reinforcing feedback loops that can, in turn, trigger sharp price moves,” they wrote.
Policymakers are aware of the problems, at least from a messaging perspective. This time last year, Fed Chair Jerome Powell and Treasury Secretary Janet Yellen said “transitory,” the adjective they had used to describe the nature of post-COVID inflation, should be retired.
According to Yellen, it wasn’t an “apt” description of what was unfolding before their eyes.
It had become a rod for their own backs and markets did not let them forget it. But how long is “transitory” anyway? Does it refer to inflation rising, or merely staying high? It is highly subjective.
Similarly, the current obsession on when the Fed will “pivot” away from its most aggressive rate-hiking campaign in 40 years has been perhaps the single biggest driver of financial markets in recent months.
Until Thursday, traders had been sorely disappointed.
Perhaps Powell has learned his lesson – he has only referenced a pivot twice in his post-meeting press conferences this year, both times to the Fed’s pivot toward hiking rates earlier this year, not the eagerly-awaited downshift.
Avoiding talk of a pivot will reduce the risk of damaging the Fed’s credibility in the eyes of some sections of the public and financial markets, as happened with “transitory.”
Dario Perkins, a managing director at TS Lombard and a former Bank of England economist, says markets have always gravitated toward these buzzwords.
“They run on themes and ideas, and these words are basically shortened, hyphenated versions of complicated themes and ideas. They capture a moment, capture a mood,” he said.
(The opinions expressed here are those of the author, a columnist for Reuters.)
By Jamie McGeever; Editing by Leslie Adler
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