Front-Running the Fed Pivot Might Not Work Next Time, by Charles Hugh Smith

Nothing lasts forever. From Charles Hugh Smith at

The Fed has trained the trading-rats all too well, and there is no way to avoid the unintended consequences of the Fed’s large-scale human behavioral experiment.

The Federal Reserve has been running a large-scale human behavioral experiment since 2008. The results are now in. Let’s start by stipulating that trading-bots are programmed to trade on human behavioral flows, i.e. trends and reactions to policy announcements and other “news” (earnings beats. etc.). As a result, the robot-trading-rats are responding to the same stimuli as the human-trading-rats in the Fed’s experiment.

Here’s the experiment set-up. When the trading rats hit the red button, the stock market swoons, and the Fed leaps into action to “save the market” by injecting trillions of dollars in stimulus and liquidity through various programs such as buying Treasury bonds. The trading-rats who “buy the dip” are rewarded with hefty gains as the market soars once the Fed “pivots” from “hawkish” to “dovish.”

Trading-rats are smart and so they realized they didn’t need to wait for the Fed to act to reap big gains. Since everyone playing the trading game knows the Fed will pivot dovish once the market swoons, then the trading-rats started front-running the Fed’s pivot, buying every swoon based on their supreme confidence that the Fed would soon “save the market” from crashing.

The Fed is now trapped by the success of its mass-scale behavioral experiment. The trading-rats have such total confidence in the Fed Put, i.e. the Fed “saving the market” once it swoons, because every time they’ve hit the red button the Fed has leaped into action and released a tsunami of stimulus and liquidity that reverses the swoon and pushes risk assets to new highs.

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