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Can Wall Street Addicts Front-Run the Fed to Get Their Fix?

Goldman Sachs gets lucky by front-running the Fed on mortgage-backed securities.

It was no secret that Jerome Powell and Associates were firing up the printing presses in the basement of the Marriner S. Eccles Federal Reserve Board Building before the pandemiconomy, bailing out Wall Street in the repo market madness. Now that “quantitative easing forever” has become official central bank policy, and the Fed is willing to buy anything and everything at any price, anything goes. It turns out that parking your money in an investment you believe in has become passé. The real money-making schemes consist of placing bets on what the Fed will do next. Just ask Goldman Sachs.

That’s Gold, Jerry!

Like any patriarch in a family of five betting this week’s paycheck on the New York Knicks going over the Chicago Bulls, the Wall Street titan was praying to the heavens for some good luck.

In the days leading up to the Fed announcing QE infinity, the investment banking juggernaut was scooping up mortgage-backed securities like nobody’s business. As the central bank intervened in financial markets to support every industry and market, Goldman Sachs was buying highly leveraged mortgage bonds from deleveraging funds being forced to liquidate.

During the market mayhem in March, Goldman charged distressed banks and funds a fee to exit their positions, allowing them to receive a cash injection and escape those pesky daily margin calls in a collapsing marketplace. The smartest men and women in the room filled up the financial giant’s reserves by taking advantage of desperate parties.

Then, on March 20, the U.S. central bank confirmed unlimited purchases of mortgage bonds. This sparked a 3% rally in the Bloomberg Barclays Mortgage-Backed Securities Total Return index of the agency mortgage bonds and a 14% boost in Markit iBoxx benchmark of non-agency securities. Therefore, Goldman made money through what it charged its clients and a spike in bond prices. Or, as Bloomberg wrote, the transaction was “a bet that’s almost certainly made money since the Federal Reserve unveiled massive stimulus turning a crash into a rally.”

Did Goldman Sachs do anything wrong? It insists that it was only a stroke of luck because it was unaware how the Fed would act, noting in a statement:

“Making markets — buying from or selling to our clients — is the core activity of our Global Markets division, and we do it regardless of market conditions. We had no advance knowledge of any of the facilities the Fed announced and assumed risk when we bought securities from clients during this period.”

Even if the Dolce and Gabbana of The Street bought these bonds expecting Fed action without any direct information, Goldman did not behave in an odious manner. If the Fed were already adding to its positions in these types of securities, why would the central bank refrain from stockpiling more when the Coronacrisis is making us watch the world burn? Goldman experts may have had an inkling that the Eccles Building was about to do something drastic, which is now a prevalent problem in financial markets. The power players hang on the Fed’s every word, wheeling and dealing based on the institution – remember the interest rate drama in the good old days of summer 2019?

Running at the Front

In stock trading, front-running is when you execute a trade with the intent of being ahead of the curve of other market players. There are variants of front-running – legal and illegal. For instance, there is an unlawful method of capitalizing on advanced information that has not been released to the public. Another example of front-running is just paying attention to what is happening in front of our eyes, using excellent judgment and foresight skills.

If you noticed the potential fallout from COVID-19 in January and expected the outbreak to lock down the United States, you could have bought shares in Clorox, Slack, and Netflix stocks. Or, if you thought a market meltdown was imminent, you could have piled up bearish exchange-traded funds (ETFs). When you are front-running, you are the first on the platform at the station, not hopping on a moving train.

Goldman Sachs denies possessing advanced knowledge of the Fed’s QE4ever endeavors. Cynics who see the revolving door between Wall Street and the Fed will not believe it. Since there is zero evidence to contradict its statement, the public can chalk it up to Goldman having enviable timing and unbridled faith in an institution that has come to its rescue multiple times over the years.

Feeding Your Addiction

Junkies will tell you that their sole purpose in life is to get the next fix. Anything will be done to achieve another high, even if it fails to compare to the initial experience. Wall Street is a more dignified addict, relying on easy money from the Fed to survive and thrive in a bear or bull market. If the Fed appears to hold out on a fresh supply of dollars, hedge funds and money managers will employ a diverse array of tactics to ensure they scratch that monkey on their back. Street junkies will break into pharmaceutical labs or enter prostitution. The Street will petition Congress for bailout funds or front-run the Fed (legally, of course!). In the end, what is the difference? The patient still overdoses.


Read more from Andrew Moran.

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