Traders may have gotten last week’s Fed news 7 milliseconds early

September 24, 2013

But what about frozen orange juice futures? (Spencer Platt/Getty Images)

Reporting from CNBC and Quartz points to strong circumstantial evidence that one or more traders received an early leak of the Federal Reserve's surprise decision last week not to slow down its bond purchases.

Markets swung rapidly on the 2 p.m. announcement last Wednesday, with stocks, bonds, and the price of gold all skyrocketing. Somebody placed massive orders for gold futures contracts betting on exactly that outcome within a millisecond or two of 2 p.m. that day -- before the seven milliseconds had passed that would allow the transmission of the information from the Fed's "lock-up" of media organizations who get an early look at the data and the arrival of that information at Chicago's futures markets (that's the time it takes the data to travel at the speed of light. A millisecond is a thousandth of a second). CNBC's Eamon Javers, citing market analysis firm Nanex, estimates that $600 million in assets could have changed hands in that fleeting moment.

There would seem to be three possibilities: 1) Some trader was extraordinarily lucky, placing a massive bet just before a major announcement that would make that bet highly profitable. 2) There was a leak, either by a media organization with early access to the data or even someone at the Fed. Or 3) The laws of physics have been violated as the information traveled from Washington to Chicago faster than the speed of light.

You can see why Option 2 looks the most plausible.

Presumably there will be a hard look into what exactly happened, and in particular whether some technical glitch allowed some high frequency trading firm to get the data a few milliseconds early, or some unethical behavior. But in the meantime, there's another useful lesson out of the whole episode.

It is the reality of how much trading activity, particularly of the ultra-high-frequency variety is really a dead weight loss for society.

Capital markets exist to serve the real economy: Stock and bond markets exist to allow companies to raise the funds they need and savers to invest for the future. Futures and options markets exist to let companies and individuals hedge against potential losses, smoothing out the risks of fluctuations in currencies, commodity prices, or whatever.

There is a role in these markets for traders whose work is more speculative. Having opportunistic traders in the markets always watching for mispricings can be beneficial to the real companies and individuals looking to save or invest because it means they are more likely to be able to get a fair price and carry out the transaction whenever they want. (The traders ensure, to use the formal terms, liquidity and efficient price discovery).

But when taken to its logical extremes, such as computers exploiting five millisecond advantages in the transfer of market-moving information, it's much less clear that society gains anything. Five milliseconds, Wikipedia tells me, is about the time it takes a honeybee to flap its wings. Once.

In the high-frequency trading business, billions of dollars are spent on high-speed lines, programming talent, and advanced computers by funds looking to capitalize on the smallest and most fleeting of mispricings. Those are computing resources and insanely intelligent people who could instead be put to work making the Internet run faster for everyone, or figuring out how to distribute electricity more efficiently, or really anything other than trying to figure out how to trade gold futures on the latest Fed announcement faster than the speed of light.

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