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Julian D. A. Wiseman
Publication history: this was written for, but then not wanted by, the London Review of Books, so only here. Usual disclaimer and copyright terms apply.
At twenty-five past one, on the first Friday of the month, I am standing in an investment bank’s London dealing room. This happens to be in London’s docklands, but the scene would be much the same in any dealing room owned by any other ‘bulge-bracket’ bank.
Why here? Why now? The reader has been invited to witness vicariously the events in a dealing room at this time for a reason. At 08:30 in the Washington morning, on the first Friday of the month, the US Bureau of Labor Statistics releases the Employment Report. This is a regular seismic event in the world’s financial markets: not the Richter-big of a Russian default (which occurs with random timing a few times each century), but rather a periodic tremor, a small Californian shaker that throws the books from the shelves and reshuffles some few tens of billions of wealth between borrowers and lenders.
The dealing room in which I stand has the same colour scheme as every other dealing room, and the dominant colour is grey. Walls: pale grey; computers and monitors and printers: light grey; carpet-tiles: mottled-grey-and-something, except where spilt coffee and dropped lunches have darkened this to pure dingy grey. These matt greys are just interrupted by the luminescent grey of flickering computer screens. Not a place for the aesthetically sensitive.
Amidst this field of grey are people. Even five years ago suits, either pinstripe or plain, would have been the norm, but ‘casual Fridays’ have crossed the Atlantic, subject only to a woefully unsuccessful attempt by every bank’s management to prohibit scruffiness and jeans. Non-casual days in London still bring strong pinstripes, though never checks. In Europe the reverse: checks but never strong pinstripes. These people include traders, sales, researchers (such as the author), managers, and quite possibly the photocopy boy. Some sit, replete with lunch, coffee to hand, awaiting the show. Other stand in small groups, perhaps discussing how the markets might react, or perhaps the forthcoming weekend.
Those sitting, sit at a ‘desk’. A desk is an island of furniture midst the narrow canals of carpet tiles. It typically seats eight, four facing four, separated by a mountain ridge of screens and piled paperwork. Embedded in this furniture, along with all the other computers and sundry electronics, are speakers and microphones. One can push a button to choose a channel, speak, and be heard at every desk at which the speaker is set to hear that channel. When these speakers first arrived on dealing floors, they were mounted in small boxes that sat above the screens — the current parlance seems to be “box” in British English, and “squawk” in US English, though both use “hoot ’n’ holler”.
An economist is “on the box”. He is sitting in an office in Manhattan, therefore devoid of pinstripes, five hours earlier in the day, the dealing room greyly indistinguishable from any other, talking into a microphone. My box isn’t working properly, so I can only hear vague mumbling. However, the morning strategy comment is still in my email: we (my employer, and therefore I) expect the ‘headline number’ to be plus 250,000 (“+250K”), slightly larger than the previous month’s +246K. This “headline number” is the change in the number of people in the US in non-agricultural employment. Non-farm payrolls: jobs. Is America at work? Typically one or two hundreds of thousands of jobs are created each month in the US (euroland can only dream of such things, but it actually happens in the US). We are about to know how many. And, at this instant in the early London afternoon, the vital question for financial markets is whether the number of jobs created is more or less than “market consensus”.
Before each important economic release, a number of economists from the major banks and brokerages are polled, and their forecasts averaged. This is the “market consensus”. Obviously, individual forecasters will differ, some expecting a stronger and others a weaker number. If consensus for “headline non-farm” is (say) +150K, and it “prints” +160K, that would be described as “on consensus” or “as expected”: ±10K doesn’t matter. The reader might notice that an additional ten thousand Americans have the dignity of earning a daily crust. The reader might even hope that some have the dignity of earning a daily loaf, and perhaps the pleasure of sharing it with a loved one and children. The reader might ponder ten thousand intensely personal stories of a search, a search at last successful, for an ecological niche in which, if not to prosper, at least to survive. But financial markets wouldn’t care: ten thousand people is small change and they wouldn’t be missed. Go back to sleep.
But if headline non-farm is materially away from the consensus, then prices might really move. Materially? Fifty thousand people is material, and two hundred thousand (half the population of Luxembourg) is huge.
The crucial issue is how payrolls (or its reverse, unemployment) will influence interest rates. “Fed Funds”, the US version of that which the UK used to call the “base rate”, is set by the High Priest and Delphic Oracle of 1990s Capitalism, also known as Alan Greenspan. Financial markets worship Alan Greenspan. (Perversely, this makes his job much more difficult, but that is his problem and very much another story.)
If there are materially fewer people in work than consensus, then Fed Funds are more likely to be lowered or less likely to be increased (at least relative to the previous perception of these likelihoods). If more people are at work, then official interest rates are more likely to go up than the market was previously anticipating. But the timing is vital: financial markets trade interest rates in many ways and for many different maturities. Financial markets trade interest-rate futures: in June, at what rate will banks in London be able to borrow US dollars for 3-months? In July? In September? In March 2001? End of 2008? Financial markets trade US Government Debt (known as Treasuries or USTs), that mature in 2 years, in 5 years, in 10 and in 30, and many maturities in between. Financial markets care lots about timing. If employment is surprisingly high, then how should that affect interest rates over the next 30 years?
This trading is not idle gambling. Financial markets exist for a genuine reason: governments and companies like to borrow. The US government is massively in debt: traded US Treasury debt totals (depending on how it is measured) over five trillion dollars, of which over three trillion is tradeable debt. That is over $750 for every second that has elapsed since the Declaration of Independence (or, perhaps less meaningfully, a dollar for every day that the Universe is old). And we British have no claim to excessive piety: our government debt is now £400 billion. (Though we and the Americans can very smugly throw rocks at the Europeans, whose official national debts are just as large, but who also have unofficial ‘hidden’ debts, in the form of pension liabilities, which are unbelievably cosmic in magnitude.)
Those who have been kind enough to lend money to the world’s governments, companies and households may wish to reduce their substantial risks. If a pension fund has bought $1 billion of a 30-year US Treasury Bond (ie., has lent money to the US government for 30 years), then that asset might change in value on any day by multiples of $10 million. That’s a noticeable profit or loss, and the holder of the bond might want to hedge some of that risk. If a retail bank in the US is borrowing money from its depositors one day or one week at a time, and is lending that money in the form of 30-year fixed-rate mortgages, it may wish to hedge some of its (complicated) financial risks. Hence financial markets. Hence speculators. And this speculation is not even new: when speculators in British government debt were roundly denounced in 1719, a trader apparently replied “there is one way to get rid of us: pay off the national debt”. Indeed so.
And what about the rest of the forthcoming employment report? What are we or the rest of the street looking for? (The “street” being another trans-atlantic import, with the suppressed word being the nineteenth century “Wall” rather than the fourteenth century “Lombard”.) Perhaps Manufacturing Hours Worked will give us an insight into an issue that we believe is of particular importance to the Federal Open Market Committee (chaired by Alan Greenspan). As it is, we expect unemployment to remain at 4.3% and hourly earnings to moderate to 3.9% from 4.0% the previous month (year-on-year increase).
The trading floor is quiet, waiting. A few voices comment on market prices just before the number: a trader’s voice on the box says “a lot of people looking for 121, an equal number of people looking for three-quarters to be taken out on the bond”. Thanks: up or down, who can tell? When asked about the street view, a strategist sitting near me says that “the consensus is low 200s, but the market is priced for mid-300s I guess”. In other words, the economists believe one thing (a headline figure of mid two-hundred thousands), but the street’s bond traders’ collective wisdom is uncertain but centred around a stronger economy (three-hundred and something thousand). Eyes are on the screens, waiting for the print. It might be that a mischievous trader will shout a spoof (“SIX HUNDRED THOUSAND”), but such faking is rightly frowned upon by both management and others.
Just before the number the June long-bond future is 119 20/32, the long bond itself (maturing February 2029) yields 5.67%; in Germany the 10-year Bund future is at 112.68, and the Jan 2009 Bund yields 4.13%; and in the UK these numbers are 116.01 and 4.63%.
So we wait attentively for this periodic news. The first such periodic news known to this author originated with the Bank Act of 1833: “That an Account of the amount of Bullion and Securities in the Bank of England belonging to the said Governor and Company, and of Notes in Circulation and of Deposits in the said Bank, shall be transmitted weekly to the Chancellor of the Exchequer for the time being, and such accounts shall be consolidated at the end of every month, and an average state of the Bank Accounts of the preceding three months, made from such consolidated accounts as aforesaid, shall be published every month in the next succeeding London Gazette.” Underneath the 1833-Act returns published in the London Gazette appeared the address “11, Downing-street”. The 1844 Act followed, and it specified a more detailed weekly return, copies of which were available free to the public soon after 2pm on Thursdays from the Chief Cashier’s office (perhaps an early pre-echo of the Old Lady’s 1997 independence). A 1930s guide to the London money-markets remarked that “representatives of the banks … walk into the Chief Cashier’s office, help themselves to copies of the Return … then quickly pass out through the gloomy portals of the Bank”. How little changes: this article happens to be about the US Employment Report, but another financial news release to which markets are currently very sensitive is the Balance Sheet of the Bank of Japan — to what extent is it supporting what remains of the Japan’s financial system?
*U.S. FEB. NON-FARM JOBS ROSE 275,000; RATE 4.4%
And they’re off. Boxes spring to life across the trading floor, shouting numbers: “TWENTY-THREE TRADES TWENTY-EIGHT BID TWENTY-EIGHT BID FIGURE OFFERED TWENTY-EIGHT TRADES MARKET FAST ONE-TWENTY THE FIGURE ONE-TWENTY OH FIVE BID ALL OVER SEVEN THE OFFER SIX TRADES TWO HUNDRED TIMES SIX TRADES AGAIN SIX STILL BID…”.
This chorus comes from the futures trading floor. Trading still happens face-to-face on such a floor, in what seem to be enormous volumes. A hand signal and a shout (trades must be shouted) and an obligation to buy tens or hundreds of millions of pounds (or dollars or euros) of government debt can change hands. A visual treat of loud jackets in ridiculous stripes (adored by the press as a source of pictures) worn by some astonishingly wealthy loud personalities (adored by the press as a source of stories) shouting at each other with simultaneous and strangely precise hand signals.
But face to face trading is coming to an end. Europe’s most important bond future (which, much to the chagrin of the French, has German government debt as the underlying instrument), used to trade on such a floor, but now (to some mild annoyance in London) has migrated to an electronic exchange that is at least notionally German. Other futures contracts will also become electronic: face-to-face trading is in its last death-throes. In 67 BC, the market in play was grain. Rome’s grain supply originated, in large part, in Egypt and Libya; but pirates had disrupted the supply. A law was passed appointing Pompey to a supreme command over all the seas, and giving him the tools to re-establish control — numerous ships, money, access to both available revenue and to allies. “On the mere announcement of his appointment the price of goods fell in the markets of Rome.” They traded face-to-face then, as did those trading oil futures during the Gulf War: when it became clear that Saudi refineries were not at risk, oil futures collapsed. In February 1814, as Napoleon was in the field against so many of his accumulated enemies, he received a dispatch from Paris saying, inter alia, that the funds had fallen 5 points to 47.75 (down 10%! The situation was dire indeed). As one bought and another sold at that price, they could see the frightened whites of each other’s eyes. By 1992, with George Soros proving that you can’t buck the market, trading in currencies, bonds, equities, interest-rate swaps and much else was by telephone (a contraption not admitted to the Bank of England until 1902), but futures (and options on them) were still traded face-to-face by men — and a few women — in those brightly coloured outfits. Now, in early 1999, deals in most assets traded in the wholesale markets are matched by a computer: my bid and your offer are joined together in the unreality of cyberspace. Face-to-face trading and the chorus of live commentary thereon are threatened species: silicon mine, copper yours.
We are now three or four minutes past ‘the number’, and the chorus of commentary is quietening, partly because the futures pits are less frantic, and partly because most of the boxes have been turned down. Last autumn, as Russia defaulted and devalued, as a very famous hedge fund spectacularly collapsed — taking with it 20% or so of the US equity market — the Federal Reserve cut official interest rates three times, by a total of 0.75%. But none of these financial market events has greatly affected ‘Main Street’ (rather than Wall Street). Yes, there was a huge effect on the real economies of South-East Asia, of South America and elsewhere, and to some extent the US acts as both a domestic and a global central bank. But US households are saving less than nothing, and a rise in interest rates would divert some of this abundant consumption to saving. US financial markets had been reasoning that the right time for rates to rise might be quite soon.
But we have just learnt that the unemployment rate has risen, albeit only marginally. With no signs of inflation anywhere in the system, and unemployment rising, Alan Greenspan is much more likely to stay his hand: rates will rise less, or later, or both. Whilst we can know nothing for sure, the balance of probabilities has shifted that way. Hence the rise in price and fall in the yield of the US long-bond, and likewise in the German and UK government debt markets, and elsewhere. So, our perception of the real economy has changed, albeit slightly, and that has changed our view of the environment in which the central banks will take their next and subsequent interest rate decisions, and thus the price at which we are willing to lend and borrow has altered. Maybe only slightly, but there are enough billions and trillions of debt for slightly to matter.
Julian D. A. Wiseman, March 1999
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