Charting Trader Stress By Economic Release Type
A recent study by J.M. Coates and J. Herbert analyzes "Endogenous steroids and financial risk taking on a London trading floor" confirms that risky activity tends to increase testosterone levels, and that high testosterone levels increase risky ventures. This is about as remarkable as a Federal Reserve "finding" commissioned using taxpayer dollars, and is pretty high up there on the Captain Obvious pyramid of scientific discoveries. One wonders how Vegas' multi-billion economy will adjust its business model now that it knows that gambling, arousal and testosterone are all related. Yes, that was rhetorical. Amusingly, the study discloses the following: "No subject consumed anything during the study that would interfere with his endocrine system." That also sounds very credible. Yet the most interesting discovery in the finding is the correlation of cortisol, or stress hormone, levels with various economic releases among which home sales, durable goods, jobless claims, Chicago PMI, ISM and NFP. What is curious is that cortisol peaks not on NFP, which has traditionally been seen as the most important macroeconomic metric and the one in which the BLS takes a most active expectations management role, but during ISM releases. Is it time for the Department of Truth to LBO the Institute of Supply Management?
The figure below shows a correlation between mean daily cortisol, implied bund volatility, and type of key economic data release:
The scientific secription of the chart:
Group cortisol plotted against implied volatility of German Bunds. Implied volatility in most bond markets follows the calendar of U.S. economic statistics, rising during the week of Chicago Purchasing Managers Index (PMI), peaking on or just before the Employment Report, and dropping after the information contained in these numbers has reduced uncertainty over the state of the economy. The upper line is the daily cortisol level averaged from the group of traders (left axis, pg/ml; mean SEM, n 11). The lower line is the implied volatility from German Bund (bond future) options with 1 month to expiration [right axis; Annualized standard deviation of the natural logs of daily price returns. Friday options (days 4 and 8) repriced to Sunday to eliminate the weekend effect. Bloomberg data]. Shaded bars display the importance of each economic release. The bars represent regression-derived day weights, i.e., the extra variance in Bund yields expected on that day due to the release of the U.S. economic statistic [lower left axis; basis points in yield change (12)]. The bars are for illustrative purposes only and do not enter into the statistical analysis. Implied volatility on day 5 was higher than expected, given the relative importance of the Chicago PMI, because the German market was surprised by the result of the French referendum.
Does this mean anything aside from the glaringly obvious? Probably. It may indicate that the specific weighting of the two most important economic releases, based at least on trader behavior is switched, and that the ISM is in fact a more important metric in determining market reaction and volatility than NFP.
Someone far smarts would likely be able to come up with a way to arb muted market reactions to the ISM.
Incidentally, the next ISM reading, due on November 1, and before the mid-terms and the QE2 announcement, may be thus even more important than the revised GDP read, which the Fed announced will be critical in determining whether QE2 is a go. Therefore, a strong GDP coupled with a weak ISM will almost certainly also validate the issuance of a few trillion in crisp dollar bills in just over a week.