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04 December 2012 Written by
A top government economist has concluded that the high-speed trading firms that have come to dominate the nation’s financial markets are taking significant profits from traditional investors. The chief economist at the Commodity Futures Trading Commission, Andrei Kirilenko, reports in a coming study that high-frequency traders make an average profit of as much as $5.05 each time they go up against small traders buying and selling one of the most widely used financial contracts. The agency has not endorsed Mr. Kirilenko’s findings, which are still being reviewed by peers, and they are already encountering some resistance from academics. But Bart Chilton, one of five C.F.T.C. commissioners, said on Monday that “what the study shows is that high-frequency traders are really the new middleman in exchange trading, and they’re taking some of the cream off the top.” Mr. Kirilenko’s work stands in contrast to several statements from government officials who have expressed uncertainty about whether high-speed traders are earning profits at the expense of ordinary investors. The study comes as a council of the nation’s top financial regulators is showing increasing concern that the accelerating automation and speed of the financial markets may represent a threat both to other investors and to the stability of the financial system. The Financial Stability Oversight Council, an organization formed after the recent financial crisis to deal with systemic risks, took up the issue at a meeting in November that was closed to the public, according to minutes that were released Monday. The gathering of top regulators, including Treasury Secretary Timothy F. Geithner and Ben S. Bernanke, the Federal Reserve chairman, said in its annual report this summer that recent developments “could lead to unintended errors cascading through the financial system.” The C.F.T.C. is a member of the oversight council. The issue of high-frequency trading has generated anxiety among investors in the stock market, where computerized trading first took hold. But the minutes from the oversight council, and the council’s annual report released this year, indicate that top regulators are viewing the automation of trading as a broader concern as high-speed traders move into an array of financial markets, including bond and foreign currency trading. Mr. Kirilenko’s study focused on one corner of the financial markets that the C.F.T.C. oversees, contracts that are settled based on the future value of the Standard & Poor’s 500-stock index. He and his co-authors, professors at Princeton and the University of Washington, chose the contract because it is one of the most heavily traded financial assets in any market and is popular with a broad array of investors. Using previously private data, Mr. Kirilenko’s team found that from August 2010 to August 2012, high-frequency trading firms were able to reliably capture profits by buying and selling futures contracts from several types of traditional investors. The study notes that there are different types of high-frequency traders, some of which are more aggressive in initiating trades and some of which are passive, simply taking the other side of existing offers in the market. The researchers found that more aggressive traders accounted for the largest share of trading volume and made the biggest profits. The most aggressive scored an average profit of $1.92 for every futures contract they traded with big institutional investors, and made an average $3.49 with a smaller, retail investor. Passive traders, on the other hand, saw a small loss on each contract traded with institutional investors, but they made a bigger profit against retail investors, of $5.05 a contract. Large investors can trade thousands of contracts at once to bet on future shifts in the S.& P. 500 index. The average aggressive high-speed trader made a daily profit of $45,267 in a month in 2010 analyzed by the study. Industry profits have been falling, however, as overall stock trading volume has dropped and the race for the latest technological advances has increased costs. Mr. Kirilenko, who is about to leave the C.F.T.C. for an academic position at the Massachusetts Institute of Technology, presented a draft of the paper at a C.F.T.C. conference last week. He said that the markets were a “zero sum game” in which the high-speed profits came at the expense of other traders. Mr. Kirilenko warned that the smaller traders might leave the futures markets if their profits were drained away, opting instead to operate in less transparent markets where high-speed traders would not get in the way. “They will go someplace that’s darker,” Mr. Kirilenko said at the conference. That could destabilize futures markets long used by traders to hedge risk. A spokesman for the C.F.T.C. said the agency had no comment on the study. But the paper was immediately hailed by Mr. Chilton, who is a Democrat and a critic of recent shifts in the markets. Mr. Chilton said that the study would make it easier for regulators “to put forth regulations in a streamlined fashion. It’s a key step in the process and it should fuel-inject the regulatory effort going forward.” Terrence Hendershott, a professor at the University of California, Berkeley, said there was a limit to the importance of Mr. Kirilenko’s work because it focused on profits and did not address the benefits high-speed traders bring. Mr. Hendershott and many other academics have found that the competition between high-speed traders has helped lower the cost of trading for ordinary investors. But Mr. Hendershott said that limited data available to researchers had made it hard to determine whether the benefits outweighed the costs. The speed and complexity of the financial markets jumped onto the agenda of regulators after the so-called flash crash of 2010, when leading stock indexes fell almost 10 percent in less than half an hour, before quickly making up most of the losses. In its first annual report, in 2011, the Financial Stability Oversight Council noted the concerns raised by the flash crash, but not in great detail. This year’s report included a much fuller discussion of the risks posed by the increasing speed and complexity of the financial markets and called for regulators to look for more ways to limit the risks. Regulators have said that devising new rules has been hard, in part because the trading world has become so complex, making it difficult to determine the total effect that all the innovations have had on traditional investors. Mr. Kirilenko said in an interview Monday that his study was intended to address that. “We’re not estimating,” he said. “Our data is excellent.”
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04 December 2012 Written by
Yesterday I sat in on a conference call with one of the most influential and most involved Washington insiders on US fiscal issues, Erskine Bowles. Mr. Bowles (Democrat) was one of the two chief architects of Pres. Obama’s bi-partisan commission on debt reduction (National Commission on Fiscal Responsibility and Reform) in 2010 along with Alan Simpson (Republican). This commission produced the bi-partisan Simpson-Bowles plan on deficit reduction, which included both increases in revenues and cuts in spending, but was ultimately rejected by the Obama administration. Both Simpson and Bowles are now out of the political arena and therefore speak very candidly, as Bowles did today. Mr. Bowles launched the conference discussing the long term trends in the US, calling deficit and debt trends the main threat to the United States over the long term specifically stating that entitlements are the main cause of deficit trends. He noted that increases in revenue are meaningless without real spending reduction specifically to healthcare. He put a 2/3 chance US avoids full execution of the debt ceiling (either getting a deal done by year-end or the first 10 days of January) and a 1/3 chance of “going over” the fiscal cliff, which would bring about another US recession. He says taxes will go higher and a likely compromise on revenues will be $1.2 trillion over 10 years. What you hear of ups and downs “collapse” and “progress” and fighting is political “theater”. The crux of the issues are understood by the parties. We concur as we have stated for years, that the gravest long term threat to the US is the rising deficit spending driven by unwieldy and unsustainable government transfer programs. The fiscal cliff is truly only the very short term threat. A likely ultimate “deal” will likely end up as some $1.2 trillion in revenue increases and $400 billion in spending cuts for a total $1.6 trillion adjustment, far less than what is necessary, $4 - $5 trillion over ten years). We add to what Bowles stated, asserting that despite a likely lack of change to entitlements, the resolution that comes in the near term (combo of revenue and spending) will be enough to avoid 2013 rating downgrades. Fundamental reform to curb the exponential Other Revenues and Spending Changes, 17%Payroll Tax Cut Expiration, 16%Budget Control Act Automatic Cuts, 11%Other Expiring Provisions, 11%Unemployment Benefits Expiration, 4%Affordable Care Act Tax Increase, 3%Medicare "Doc Fix" Expiration, 2%2001/2004/ 2010 Tax Cuts & AMT Patch Expiration, 36%US: Federal Deficit Reduction in FY2013 growth of entitlements and guarantee their longevity is not a priority and will not be an achievement of this administration. However, fiscal cliff will be avoided, economy will continue recovery, growing around 2% next year, monetary policy will remain loose indefinitely and markets push higher. According to Bowles, the main challenges to the US fiscal situation are: 1) HEALTHCARE a. “Far and away the biggest problem”. The US spends two times as much as any other developed market as both a percent of GDP and on a per capita basis but the results are not commensurate with the expenditures. Accounts for 10% of GDP and 1/3 of US budget and is growing fast. 2) DEFENSE a. US spends more than next 17 countries combined. 3) TAX CODE a. Inefficient and ineffective. Simpson Bowles recommended wiping out “backdoor spending” meaning eliminate deductions and tax credits primarily enjoyed by the wealthier. Broaden base in addition to higher taxes. 4) SOCIAL SECURITY a. President Roosevelt designed program average life expectancy then was 63, today it’s 78. The Simpson-Bowles recommendation was for incremental increases in eligibility with the first increase, by one year, to come 40 years from now. 5) INTEREST PAYMENTS a. $240 Billion/year even at today’s low rates. By 2022 US will spend more than $1 trillion on interest spending Fiscal Cliff “Catastrophic economic effects” if allowed to occur: $7.7 trillion over 10 years, $607 billion in 2013 alone. 2 million new unemployed and rate will go back to 9.0%. We will go over the fiscal cliff if Republicans do not agree to increase taxes. Mr.Obama's proposal: •$350 Billion of healthcare cuts in Obama proposal, but not enough. Need at least $650 B in healthcare alone to slow the rate of growth of healthcare spending. •Nothing in proposal on SS. •Obama proposal does have some additional spending – Bowles says more recommendable is to set up infrastructure bank for additional spending get more bang for your buck. Sticking points as defined by Mr. Bowles between the two parties: 1) REVENUES a. Problem is with the source of the revenue increases. Republicans ok with $800 billion, and prefer to broaden tax case, simplify code, and eliminate loopholes and deductions. Democrats $1.6 trillion by raising taxes on top 2% to 36% and 39.6% in top two tiers. 2) SPENDING CUTS a. Mr. Obama is looking for $4.5 trillion over 10 years but $850 Billion of which comes from drawdown of troops from Middle East. “Not enough”. Mr. Obama’s plan needs $750 billion in more cuts. 3) DEBT CEILING Probabilities for Fiscal Cliff Execution as seen by Bowles: •1/3 Getting deal done •1/3 Technically “go over cliff” but get done in first 10 days of January. Technical issue. If Bush tax cuts expire (worth $3.9 trillion over 10 years), then Republicans can agree to cut taxes in 2013 (rather than agree to increase then in 2012), •1/3 Full execution of fiscal cliff On the European front, news flow came from Spain’s banking bailout and Greece’s debt buyback, Spain formally requested aid not for the full sovereign bailout as hotly awaited for by the market, but for its banking sector, which will come in the form 36.5 billion Euros including 2.5 billion euros for the "bad bank" on December 12. Four nationalized Spanish banks will be the recipients of the funds: 18 billion will go to Bankia 9 billion to CatalunyaBanc, 5 billion to Nova Caixa Galicia; 4.5 billion to Banco de Valencia. Greece’s announcement of its debt buyback is consistent with the ongoing nature of combined European efforts to maintain the integrity of the European Union, with Germany “all-in” on the rescue of Greece, the less costly (to Germany) option that disintegration of the EMU. The change in tone and leniency of the German positioning symbolized by Chancellor Merkel’s travelling to Greece in early October to meet with Samaras for the first time since the crisis erupted.
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13 November 2012 Written by
16 October 2012 Written by
Soros Fund Management Chairman George Soros waits to deliver a speech at the Central European University in Budapest, November 3, 2011. REUTERS/Bernadett Szabo     (Reuters) - The European Union could be destroyed by the "nightmare" euro crisis, and Germany needs to take the responsibility to save the common currency, billionaire fund manager George Soros said on Monday Soros, who made his mark as an investor on a big bet against the British pound in 1992, said the other alternative is for Germany -- the euro zone's biggest economy -- to simply leave the 17-member currency bloc. The crisis "is pushing the EU into a lasting depression, and it is entirely self-created," said Soros, chairman of Soros Fund Management. "There is a real danger of the euro destroying the European Union," he said. "The way to escape it is for Germany to accept ... greater commitment to helping not only its interests but the interests of the debtor countries, and playing the role of the benevolent hegemon." Germany should act as the leader of the union in the same that the United States did for the free world after World War Two, Soros said at a luncheon hosted by the National Association for Business Economics. Soros, founder of the Open Society Foundations and a founding sponsor of the Institute for New Economic Thinking, said Germany needs to step up to save the euro and the euro bond plan because "if it successful, it would cost very little, but if it fails, it would drag down Germany." Issuing euro bonds would be a way to share risk across the euro zone. Soros floated another solution to the more than two-year-old crisis: let Germany leave the euro. "The problem would disappear in thin air," as the value of the euro declines and yields on the bonds of debtor countries adjust, he said. The International Monetary Fund and the finance ministers of some outside countries have put pressure on Germany to do what is needed to save the euro and solve a crisis that has hamstrung the global economy. Germany is at the forefront of the euro zone's northern creditor countries that are locked in a clash with the bloc's heavily indebted southern states over the future shape of the bloc. Germany again said it was too soon to say that Greece - the most troubled of the euro zone's members - needed more time to meet deficit-cutting goals, keeping fears alive that the smaller country could ultimately leave the currency bloc in what would be a messy exit. A key problem is the uncertainty over whether Spain will ask for financial aid from the euro zone and whether Greece can agree on new austerity measures with its lenders. Public opinion in Germany, as well as in Finland and the Netherlands, has grown increasingly opposed to bailouts of euro zone governments. The notion that governments are "riskless" is the main false assumption underlying the euro zone, said Soros, adding it could be corrected by the introduction of euro bonds. "But that has become politically unacceptable by Germany," he added.
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10 October 2012 Written by
  Fears on the outlook for global growth got more fuel today, sending US markets lower for the fourth consecutive trading day, after yesterday's publication of the IMF's World Economic Outlook report where the Fund downgraded its global growth outlook for 2012 and 2013. The IMF downwardly revised its growth forecast for China 7.8% from 8.2% y/y, seeing a soft landing in that economy with a gradual pickup in growth driven by recent policy easing. Today, Alcoa's assertion that a Chinese economic slowdown will cut global demand for aluminium fuelled increased fears of a slowing Chinese economy. Rather, Chinese economic expansion of 8.0% down from 9.2% y/y in 2011 and the +10.4% y/y in 2010 is a soft landing, manoeuvred in part by government machinations on the stimulus front. Despite the low probability we assign to a hard landing, fuelling pessimism on that front was data released earlier this month; China showed its 11th straight month of manufacturing decline, dropping to 47.9 from 47.6 in August. A result of this bearish sentiment, at mid-day the MSCI World was 0.7% lower, S&P 500 -0.7%, aluminum -2%, and oil -0.5% to $91.79. Ten-year UST yields fell two basis points to less than 1.69%. We remain more positive on the global growth scenario with China to expand 8.0% y/y in 2012 and global growth expansion of 3.8% and in 2013 to +4.1% y/y. I expect trend appreciation in US equities over the next 12 months fuelled by the Fed's monthly liquidity injections. We view QE3 as bullish for equity markets and consistent with an equity market rally through year-end of another 6.4% from current levels to an S&P 500 target to 1525. This S&P year-end target is consistent with a price-to-earnings ratio of 14.8 by year-end, on par with current PE ratio and consistent with 13.2x next year's consensus estimates. In our view, the Fed's move promotes increased risk-taking and search for higher-yielding instruments.
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10 October 2012 Written by
Goldman Sachs says there’s gold to be struck in going long the euro against the Aussie dollar, which could prove a ‘trade of the century.’

  “One of the best long term trades out there at the moment is long euro versus short Aussie,”  Thomas Stolper, chief currency strategist at the U.S. investment bank told Deal Journal Australia. At the genesis of his thinking is that much of Europe’s bad news is priced in whereas the headwinds for the Australian dollar are only now building from slower Chinese growth, interest rate cuts by the Reserve Bank of Australia and tighter fiscal policy.
Gillian Tan for The Wall Street Journal
The euro’s long run average against the Aussie dollar is around A$1.70 compared with the A$1.250 being traded late Wednesday in Sydney.  “It’s great for Aussies going on holidays but I’m not sure how long it’s going to last,” he said. Talk of the Australian dollar being a safe haven should be put on ice too. The US investment bank believes it’s at least 20% overvalued against the greenback and vulnerable to a sharp correction amid a slowing domestic economy and downward pressure on commodity prices. “You can make the case now that the Aussie may have peaked out and may be heading south quite substantially,” said Mr Stolper. Goldman’s central expectation is for a gradual weakening over the medium term but if commodity prices fell substantially then a correction as low as US$0.6500 over the medium term could result, Mr Stolper said. The Aussie continues to trade above parity against the greenback and remains near historic highs versus other rivals even after a large fall in iron ore and coal prices. Prices for iron ore, Australia’s biggest export, have recovered to US$117.20 a ton from the three year lows of US$86.70 a ton struck on Sept. 5 but remain well below the US$135.50 a ton traded three months ago. Some of the currency’s ongoing strength is attributed to record central bank buying of Australia’s bonds to capture the high yields offered by the nation’s triple-A securities and to diversify away from the troubled euro zone. But that demand has now likely topped out, stripping away a key support plank, said Mr. Stolper. “It is almost certainly a clear slow down in terms of inflows coming from central banks particularly into the Australian dollar,” he said. And on that safe haven status:   “It has become a reserve currency without any doubt but that doesn’t mean it’s a safe haven currency,” Mr. Stolper said.
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10 October 2012 Written by
Trades apparently made in error on Tuesday raised questions once again about the complexities of the modern stock market. A spokeswoman for the Financial Industry Regulatory Authority said an unnamed firm was reviewing errant trades to determine whether it would seek to have them canceled Tuesday afternoon. A number of seemingly unrelated stocks–such as those of Web radio firmPandora Media Inc. P -3.53% (P), the U.S.-listed shares of Finnish phone maker NokiaCorp. NOK1V.HE -1.25% (NOK) and real-estate investment trust CYS Investments Inc. CYS -1.86% (CYS)–saw brief price spikes up or down before returning to their original ranges Tuesday morning. A review of a handful of the affected names showed one to four trades, of several hundred shares each, executed at prices well outside the prevailing rate for each stock. At least one exchange-traded fund also appeared to be affected The Financial Select Sector SPDR Fund XLF -0.62% (XLF), a fund tracking financial shares in the Standard & Poor’s 500-stock index, jumped to $16.49 from $16.06 shortly after 10:47 a.m. EST and reverted to the original price shortly afterward, according to FactSet. At least 258 trades in 146 stocks over the course of nearly an hour caused isolated price spikes starting at 10:02 a.m., according to Nanex, a market-data firm. “A firm reported trades to the FINRA/NASDAQ TRF today at prices away from the current market,” the FINRA spokeswoman said in an e-mailed statement, referring to a “trade reporting facility,” the mechanism used for reporting transactions executed off an exchange. Such trading venues, such as “dark pools”–which are privately run stock markets that match up trades electronically–have grown to represent a large share of U.S. equity-market volume. “The firm is reviewing the trades to determine whether corrections or cancellations of the trades are necessary,” the spokeswoman said. She wasn’t immediately able to say how many stocks were affected by the mishap and declined to give the name of the firm investigating the trades. The episode underlines how improved technology has increased traders’ awareness of trading mixups, said Christopher Nagy, a consultant focused on market regulation and operations. “It happens every day, all the time,” Mr. Nagy said. “Most of the time, unless you’re really paying attention to it, it just happens and goes away. Through information and through technology, it’s been highlighted much more than it had in the past.” Meanwhile, a series of high-profile technological mishaps this year have brought the structure of markets under greater public scrutiny. In August, software problems at Knight Capital Group Inc. KCG -2.35% (KCG), one of the country’s largest facilitators of stock trading, caused erratic trading in dozens of stocks and cost the firm $440 million. Since then, smaller incidents of unusual trading action have afflicted energy stocks and, notably, shares of Kraft Foods Group Inc. KRFT +0.88% (KRFT). Market overseers have acknowledged that, while they are working to improve their stock-market oversight and create systems to guard against large-scale trading snafus, individual stocks will likely continue to see erratic activity from time to time. U.S. stock-market operators and brokers last month proposed that exchanges develop a “kill switch” to clamp down on a firm’s trading if its positions grow too large. But Gregg Berman, senior policy adviser for the SEC’s division of trading and markets, said at an industry event last week such measures wouldn’t put an end to the “little blips” that occasionally affect trading. Mr. Berman, a former hedge-fund manager, said at the event that preventing such smaller issues would be extremely complex.
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