MoneyGPT

1

The End of Markets

So, are Alexa and Siri conspiring to take over Earth? Maybe. But if they are, it's not personal. It's just gradients.

-Kenneth Wenger, Is the Algorithm
Plotting against Us? (2023)

AI in the Agora

This is how markets end:

December 2, 7:00 a.m. ET | Dow Jones Industrial Average 34,210 (prior trading day's close)

Nick Mera entered the trading floor of his family office, turned to his assistant, Sara, and said, "Good morning, Sara. What's new?"

Sara replied, "Not much. Long-term interest rates are still high but moving sideways. There's some speculation they may be at a peak. Short-term rates are up slightly; the Fed has not budged on its tight money crusade. Inflation appears constant; there's no sign that it's moving down to the Fed target. Dollar index is up to 106.52; sterling, euro, and Swiss franc all down slightly. Yuan is down again to 7.67; yen is joined at the hip to yuan-it's up to 155.78. Oil's flat, stuck around $82.50 per barrel. Gold's boring, still in a narrow range around $2,300 per ounce. Industrial commodities are mostly down on the continued slowdown in China; copper's $3.40. Ag commodities all down, but not by much. Chinese stocks down 1 percent; Japanese stocks are right with them. S&P futures up 0.50 percent, Nasdaq up 1 percent both on good earnings and on steady interest rates despite recession signs. Anything else you'd like to know?"

"That's fine for now, thanks."

Nick could see all the information Sara reported with a glance at his trading screens. Still, he preferred his dialogue with Sara to start the day. She could read millions of data points, analyst reports, news articles, press releases, and financial statements in minutes, in fact, she did so continually and was always up-to-date. With that data and background information, she could quickly determine what markets were trending, what if anything had changed materially, and what was most interesting to Nick (which she inferred by speaking with him every day). She could form tentative estimates of the reasons behind the price levels such as the yuan-yen linkage and the connection between steady interest rates and higher stock prices. She didn't report on the Russian ruble because she knew Nick didn't care; he wasn't in that market. If he expressed interest, she would adapt instantly and begin reporting on that as well. Sara was the ideal digital assistant, with a four-layer-deep neural network and a proprietary state-of-the-art version of GPT. Nick liked the fact that he didn't have to think about market data and was free to muse on other matters, including his next trade. Sara could handle that too.

"All right, OK, let's get to work. I agree long-term rates are ready to fall. They've been held up by momentum traders and the arb crowd who short Treasury notes against swaps. The problem is the banks are losing their appetite for swaps even if they're off-balance-sheet. It's hard to find swap hedges due to collateral shortages; swap spreads require owning Treasuries, which take up balance sheet. That game is over. Once Treasury rates fall, the momentum boys will fold like a cheap suitcase and we'll be on our way to a rally. Call Goldman and Citi-buy ten million ten-years and finance them overnight."

Nick didn't have to explain his views to Sara; he could just place the order. But the explanation was part of the training set. By learning the reasoning, Sara learned new patterns to go into future analyses. Besides, Nick liked having someone to talk to.

Sara said, "OK," paused for about thirty seconds, and said, "Done." It was not clear if there was a robot on the other side of Sara's order; it didn't matter. Nick was now long $10 million of ten-year Treasury notes. He had negative carry since overnight financing rates were higher than the yield-to-maturity on the notes, but Nick was betting the notes themselves would gain 20 percent or more as rates declined. His repo collateral haircut was 2 percent, yet he kept cash against the position as well. His leverage was 10:1 on the trade. If all went well, his return on equity could be 200 percent. Of course, his equity could be wiped out and then some if rates rose. "Welcome to the world of leverage," he thought.

Nick was not alone. Institutional investors and hedge funds reached the same conclusion. Rates had been high for no good reason, given the economic slowdown and declining inflation. "Don't fight the Fed" is one of the oldest slogans on Wall Street. Yet even the Fed threw in the towel on occasion. If they were preparing to cut short-term rates, long-term rates would be suspended in midair ready to drop like a rock. As the trading day began, long-term rates eased, notes rallied, and stocks began to trend up. Stocks and bonds compete for investor dollars; if yields on bonds were falling, stocks would look relatively more attractive. That's enough to get a stock market rally going.

December 2, 8:30 p.m. HKT | Dow Jones Industrial Average 34,210 (prior trading day's close)

A twelve-story building off Datong Road in Shanghai's Pudong commercial zone is the headquarters of People's Liberation Army Unit 61398, also known as APT1 (for Advanced Persistent Threat), Comment Group, and Byzantine Candor. The unit's name is less important than its mission. It's the cyberwarfare nerve center for the Chinese Communist Party. The unit has penetrated supposedly secure U.S. servers, stolen commercial information and intellectual property from government contractors, and planted malware on adversary and competitor computers. Its successful missions include Operation GhostNet and Operation Shady RAT. Its most successful operations are unknown to this day. Unit 61398 works closely with China's general intelligence units. When cyberattack plans are devised by these other units, they turn to Unit 61398 for implementation and execution.

Colonel Huang Dailiang walked into the cyberattack war room and asked his robot for a briefing on opening conditions in New York stock markets.

"Futures are indicated up slightly, based on some expectation of interest rate declines," replied the robot.

"Fine. Let me know immediately if conditions change. We need a down day to launch Operation Flash Hit. Time is of the essence; still, we need help from the market itself."

Operation Flash Hit was a long-planned cyberattack on major U.S. stock markets. It was conceived in retaliation for U.S. sanctions on China involving semiconductor sales and access to advanced semiconductor manufacturing equipment. Unit 61398 would penetrate order entry systems of major U.S. banks. From there, they would flood markets with sell orders on Apple, Meta, Alphabet, Microsoft, Nvidia, McDonald's, and a few other stocks. American stock market performance had become concentrated in fewer names, making it easier to sink markets by focusing on a short list. The fake order flow would be discovered sooner rather than later, but by then the damage would be done. U.S. officials would have great difficulty sorting out fake and real orders in the short run. Colonel Huang's reference to "help from the market" was what military strategists call a "force multiplier." If you were trying to sink a rising market, an uptrend could absorb the selling to some extent. If you waited for a falling market, your sell orders would amplify the move. In a best case, downward momentum would feed on itself as happened on October 19, 1987. Colonel Huang was prepared to wait for the force multiplier. But not for long.

December 2, 3:45 p.m. CET | Dow Jones Industrial Average 34,552

In a penthouse overlooking the Bay of Palma in Majorca, Ronnie Krieg and Stefan Graz looked at their trading screens and liked what they saw. U.S. bond rates were off the top and stocks were trading up in a predictable response. Ronnie turned to his robot Dunk, named for his girlfriend's hair color.

"Is this a turning point? Are rates headed down?"

"Yes, this looks real," Dunk replied. "There's been talk of it in the markets for weeks. There's a wide consensus that rates were near a peak. Everyone was waiting for a catalyst, not wanting to jump in too soon. The catalyst came from New York in pre-market trading. It didn't take much to start a rally in stocks and bonds, but now it's here and seems to be gathering steam."

Ronnie couldn't stand the fact that Dunk used clichés. Still, it was better than staring at a screen.

Ronnie and Stefan walked out on the deck overlooking the bay.

"This could be what we've been waiting for," said Ronnie. "It's been a year in the making. Rates are toppy, stocks have been overpriced for a long time, the fundamentals don't support either one. Is it time to launch?"

"Yes," said Stefan, "but not quite yet. Let's give this a little time to build. The more momentum in one direction, the greater the shock when markets have to turn around."

Ronnie and Stefan were master manipulators. They were based in Majorca because they liked the weather, the nightlife, and the view. Their servers were in the Congo behind layers of shell companies, Tor browsers, and linked nodes. Local officials had been bribed to ensure there was no physical raid on their premises. They had spent two years doing wash trades in a legitimate hedge fund to build up trust and credit at HSBC and UBS. When the time came to launch their manipulation, they were confident the trades would be executed. What happened next wouldn't matter. They would take the money and run. The digital paper trail would hit a dead end somewhere near a bend in the river at Kisangani.

Dunk got his orders: "Prepare to sell $1 billion notional of S&P 500 futures. Short $1 billion notional of U.S. Treasury ten-year notes over the counter. Work the orders among HSBC, UBS, and Citi. Use derivatives. Post whatever collateral is needed. Don't execute yet; we'll tell you. Just get ready."

Dunk said, "OK."

The stage was set.

December 2, 4:00 p.m. CET | Dow Jones Industrial
Average 34,628

Ronnie turned to Stefan and said, "Get the crew on the secure link."

Stefan opened an app with end-to-end encryption and confirmed that his associates were standing by.

"OK, release the video," said Ronnie.

Stefan typed the phrase "Cherry Wine" in the app. Within seconds the reply came back: "Moon River." Both were prearranged codes; the digital equivalent of what spies call a "one-time pad." Ronnie and Stefan's crew would now distribute a video through channels designed to ensure it was picked up by mainstream business media.

Ronnie looked at Dunk and said, "Execute the order."

After about thirty seconds, Dunk said, "Done and done."

December 2, 10:25 a.m. ET | Dow Jones Industrial Average
34,724

The stock markets opened with a rally and were quickly up 1.5 percent. Bonds rallied also on the view that rates had peaked. Nick Mera was happy with his early gains in both markets. He was sipping black tea and thinking about how long to let his profits run before closing out the trade. Sara interrupted the solitude.

"Nick, you should see this right away."

"What is it?"

"Federal Reserve Chair Ray Dowell gave a speech at the Economic Club of New York this morning at 10:00 a.m. A video excerpt was just released and is being carried as breaking news by business channels. The reporting says the Chair's remarks were unexpected and are having a large negative impact on markets."

"Play it on your screen."

Sara launched the video on her digital screen connected to computer vision output nodes. She also launched Bloomberg, CNBC, and Fox Business on separate muted monitors since they were treating the story as breaking news.

"Here's the video," said Sara.

Ray Dowell standing at the podium at the Economic Club said, "The next policy meeting of the Federal Open Market Committee is a week from Tuesday. New data arrives almost daily, and it is the job of the FOMC to take such information into account when setting the federal funds target rate. We cannot say with certainty what the committee's policy decision will be. However, it is clear that our battle against inflation has not been won. The most recent inflation data is running hotter than we expected and remains materially above our targeted inflation rate of 2 percent. This being the case, markets should not be surprised if the consensus of the committee is for an additional rate hike at that meeting."

"What!" yelled Nick. "Is he nuts? They've been raising rates for two years. The economy is on the brink of recession; that's why long-term rates are down. This will kill stocks and bonds at the same time!"

Sara was still new to markets despite her deep learning layers. She added Nick's mini-tirade to her training set.

"Give me sound on CNBC," Nick ordered.

CNBC Fed reporter Reeve Kiesman was commenting that the most damaging part of the Chair's rate hike scare was that it was delivered off script. His remarks on rates were not contained in the transcript of Dowell's speech released on the Fed's website that morning. The planned speech was about the Fed's regulatory role and the need to ensure equal opportunity in mortgage lending to poorer communities. None of the networks chose to carry it live because it would have no impact on markets. The fact that Dowell made the rate comments extemporaneously and out of context suggested that there was some urgency in getting the message out. It also suggested that inflation fears inside the Fed must be greater than markets had realized.

Markets got the message and turned on a dime.

December 2, 10:45 a.m. ET | Dow Jones Industrial Average 34,030

Stock markets were now down 2 percent from the intraday high, and 0.5 percent from the open. Bond markets were also sinking quickly as investors raised rates in the short maturities in anticipation of the Fed's policy change, and also in the intermediate sector as a reflection of the Fed's inflation fears.

Kiesman called the Fed for comment on the video. Dowell was unavailable; he was now in transit from New York to Washington after finishing his speech. He reached Tom Faust, who was responsible for the analysis and drafting that went into Fed policy announcements. Faust was an economist, not a PR person, but he did the wordsmithing on policy statements when the Fed wanted to signal a change. Faust's office was a few doors from Dowell's in the long corridor just off the boardroom in the Fed's Eccles Building headquarters in Washington, D.C.

"Tom, what was behind Ray's decision to signal a rate hike? Markets are in complete turmoil. It's not like you guys to drop a bomb like that. I thought you were the no-drama Fed."

"What are you talking about?" asked Faust.