FED Media Leak and High-Frequency Hedge Funds?

An article yesterday, (FT: ‘Fed probes for leaks ahead of policy news,’ September 24, 2013) brought up a possible serious allegation that the FMOC decision on monetary policy last week might have been leaked by someone in the media. The FMOC decision is made known to the media from 1:50 pm ET in a locked room in Washington and all parties are prohibited from making any information public before 2:00 pm ET.

High-frequency hedge funds trade in very short time frames of milliseconds.  The article quoting Eric Hunsader, founder of Nanex, implies that it takes 5 to 7 milliseconds for the information to travel from Washington to New York and Chicago, where data showed unusual asset price trading and movement at exactly 2 pm ET.

Thus, someone leaked the information internally and gave high-frequency hedge funds an unfair advantage.   This will no doubt add to the political debate about high-frequency hedge funds on regulation.  In fact, the article mentions that the New York attorney general under the Martin Art has agreed with Thomson Reuters to stop the practice of selling access to the University of Michigan Survey of Consumer Sentiment two seconds prior to the release.  Of course, high-frequency trading firms benefited from front-running releases.

The profit potential for high-frequency hedge funds is very large since they take advantage of very small price differences that happen in milliseconds.  Since the FMOC decision resulted in a large move of asset prices, these hedge funds which use high amounts of leverage would have made a substantial return in a few milliseconds.

Note that the time scale here is in milliseconds and the information leak time interval could only benefit high-frequency hedge funds.  The question posed then is that could there be other types of leaks internally but of much longer time intervals to other market players. This would have to come from the staff of central banks, not the media as in this particular case.  An additional question would lead us to consider the possibility that different types of leaks could occur in other markets globally.

Anyways, let’s wait to see the outcome of the investigation.

Impact on Your Trading

1. Regarding trading, this is an additional risk to consider.  We can call this the ‘front-running release risk’ and the magnitude of the risk will depend on the importance of the information and the time interval. As an individual trader this would mostly affect you indirectly since you might have accounts with institutions, such as mutual funds and alternative investments such as other types of hedge funds.
2. The direct affect will be that the dynamics and progress of the trading patterns will now be different.  But this is probably a small affect since the time scale is in milliseconds.
3. The main issue here is the potential implications of different types of leaks, as discussed above, which could originate from the staff of central banks either in the US or globally. These types of leaks would occur during a larger interval and pose a much greater risk for markets and the credibility of central banks.

Source: FT (Financial Times): Robin Harding, Kara Scannell and Arash Massoudi, ‘Fed probes for leaks ahead of policy news,’ September 24, 2013