The Market Changes Lanes

The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates.

Life in the fast lane
Surely make you lose your mind
Life in the fast lane
Everything.  All the time
- The Eagles  

As a daily commuter who sometimes travels to two or three different locations each week, I feel I am fairly well informed about the major roads in the Bay Area. 

For example, just south of the Walnut Creek exit on I-680, I like to be in the slow lane in preparation for exiting onto Highway 24.  However, there is an asphalt patch there that has been eroding over the last four years which has created a significant divot.  I know exactly where, within the lane, the worst of the divot resides and I instinctually move to the far right-hand side of the lane to avoid the worst of it.

In addition to knowing where the various bumps and holes are, it’s easy to recall lane variations, exit-only exits, and even short-term construction areas where workers may be perilously close to traffic.

Traffic in the Bay Area can be awful at times, but it is also quite volatile; meaning it doesn’t always depend on the time of day or day of the week.  Sometimes, you have to just go with the flow.

One thing that has always amazed me is that an additional lane doesn’t always relieve the flow of traffic in the way one might first expect. At first glance, it seems that if you know an additional lane is coming up on the left-hand side, the left-most lane should move quicker than the others.  As you get near the new lane, only the cars in the current left-most lane have access and that additional space should feed back far into the slow traffic causing this lane to move quicker.

My empirical, but anecdotal, evidence does not confirm this hypothesis*. Instead, it seems, all lanes move at the same grudgingly slow pace until the new lane is added when they all seem to feel some relief at the same time.

Why is this? Well, it’s likely that I am not the only person who knows the new lane is coming up and so the left-most lane gets overcrowded as more people “bet” it will move quicker.  The added burden of this traffic causes a slowdown to a point of equilibrium where all lanes move at the same pace. This is a good illustration of the efficient markets theory. Last week, we experienced another.

For months now, markets have been made well aware that the Fed would end QE2 on June 30.  During the same period, we’ve heard from all kinds of pundits that rates will have to rise once such a large buyer of Treasuries is taken out of the markets.  We were told that without the Fed buying Treasuries, yields would rise considerably — all else being equal.

In the time leading up to the end of QE2, investors have had plenty of time to change lanes  and I’m certain they did.  But demand continued to outweigh supply in the Treasury markets and yields remained depressed.

In fact, during the last month news about Greece dominated the bond market, first driving yields down in a flight to quality bid and then releasing them upward (just a bit) after the austerity package was approved.

But overall Treasury rates did not move in conjunction with the argument that losing the Fed as the largest buyer would leave the market without customers.  The reason for this is simple:  the market still believes the U.S. (and global) economy is sluggish and will take a long time before inflation becomes an issue, driving action by the Fed. The Fed confirmed as much in last month’s FOMC statement as well as Chairman Bernanke’s press conference. 

As the Fed exited the freeway, markets adjusted — or really, they adjusted once the Fed moved into the exit only lane — and whatever effect this had on rates was built into prices long before the end of the quarter.

*- If you’ve seen any academic articles on traffic patterns that might confirm this theory, please forward them.  I’m always looking for an advantage during the commute!