Pearl Harbor 2007
Bloomberg described the instant reaction Friday morning, only an hour before stock trading opened, to the Fed’s sudden and unannounced-in-advance cut in the discount rate, which we discussed at some length yesterday:
When the Fed announced the rate reduction at 8:15 a.m. New York time, S&P 500 futures soared 3.6 percent in 46 seconds. Within 15 minutes, Europe’s Dow Jones Stoxx 600 Index was up 2.4 percent. Credit-default swaps on the CDX North America Investment-Grade Index dropped 6 basis points to 72 basis points as the perception of U.S. corporate-bond risk declined.
“I thought “Holy cow,’ I had to look at my screen twice to make sure I was reading it right,” said Walter “Bucky” Hellwig, who helps oversee $30 billion in stocks and bonds at Morgan Asset Management in Birmingham, Alabama. “They’re going to use everything they’ve got in their arsenal of weapons to make sure there is not chaos in the markets,” he said, referring to the Fed.
It is important to understand that the timing of this move was meaningful. Bear funds had been enjoying a field day in this market. Many had become bold and took risky actions. Instead of buying puts, they they might sell uncovered calls, for example, as well as creating some really arcane structures. A marvelous thing when it works, and potentially deadly when it doesn’t.
Friday morning marked the expiry of certain options contracts, and pricing would be based on the first trade of the day. By acting at 8:15 in the morning, the Fed conducted its own version of December 7, 1941 on some of the bears. They were sitting ducks, often with no way to recover from their complacency of just an hour before. Suddenly they had to cover naked stock option positions by buying stock that had suddenly become much more expensive. It would be interesting to know just how many fortunes were wiped out on Friday morning; quite a few, we’d guess.
The Fed certainly acted to restore liquidity and confidence to the market. It would appear from the timing of the move that there was also a subtext to the Fed’s actions. Some of the wise guys learned yesterday an expensive personal lesson about Ben Bernanke and Henry Paulson.
August 18th, 2007 at 1:38 pm
It is important to understand that the timing of this move was meaningful. Bear funds had been enjoying a field day in this market. Many had become bold and took risky actions. Instead of buying puts, they they might short calls, for example. A marvelous thing when it works, and potentially deadly when it doesn’t. (p)Friday morning marked the expiry of certain options contracts, and pricing would be based on the first trade of the day. By acting at 8:15 in the morning, the Fed conducted its own version of December 7, 1941 on some of the bears. They were sitting ducks, often with no way to recover from their complacency of just an hour before.
That makes sense. The Dow opened essentially at its previous close and within 15 minutes it was up 320. In the 100 minutes thereafter it gave back over 250 points. For the rest of the day it worked its way back up to a net gain of 230. The S&P500 and Nasdaq behaved similarly.
As 10:45 approached the bears seemed implacable but, as you say, the market was probably relaxing back to the whereabouts from which they had covered their shorts.
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It’s a good thing that the current Treasury Secretary is a hardened Goldman Sachs capo.