Expectations: A Market Time Machine

In H. G. Wells’ novel, The Time Machine, a traveler’s desire to find out what will happen to the human race ultimately leads him on a tremendous expedi- tion into a terrifying and perilous future. Metaphorically, the expectations of market participants also function like a time machine, as they allow partici- pants a glimpse into the market’s future. Foreign exchange traders stress that expectations play one, if not the, leading role in the dynamics of the market. ‘‘It is the expectation of the market which is most important,’’ says one trader regarding exchange rates. ‘‘Everything is expectation,’’ another trader concurs. Also market observers (i.e., financial journalists) underscore the vital role of expectations in the foreign exchange market. ‘‘Markets deal on expectations and the future. If you didn’t have news of expectations and expectations of the market then what would traders deal on?’’ one financial journalist asks. ‘‘When a market goes from being golden to being rotten, like Mexico [i.e., the Mexican peso] goes from one day to another, not because anything fundamental has changed, it’s because all of a sudden expectation went one way or the other,’’ another journalist adds in support of this view.

Similar to travel in a time machine, market expectations change not only the views but also the behavior of participants, both among individuals and on the level of the collective market. Indeed, the foreign exchange market may be the most rapid of all financial markets to translate and integrate expectations of the future into the present market behavior. One trader observes lucidly that, ‘‘Especially the currency markets tend to run ahead. We have seen that over the last few years, especially the currency markets tend to focus very much on the future. We often had discussions with our economist in which he said, ‘All the figures currently would point to such and such trend.’ And then all that was already priced in!’’ Thus, in their present evaluations of currencies and trading decisions, market participants include their expectations of future events and discount the probable effects of yet-to-come developments. Conse- quently, on the aggregate level of the market, collective expectations about future events are integrated into the current level of exchange rates. ‘‘The market is always expecting some events ... and the thing is before this event happens, the market moves in that way ... Everyone said, ‘OK, the dollar is coming up because there are interventions, there is some especially good big figure . . . and the market is expecting that and buying dollars, and of course dollar–mark is going higher’,’’ according to one trader. Thus the foreign exchange market creates an anticipatory reality that turns the expected future into the present in advance. ‘‘The market positions itself beforehand,’’ another trader declares. As expectations about future events are built into the market, a trader’s shrewd observation that, ‘‘If the news has come out, it is old for us: it is the past, it is already built into the prices,’’ is hardly surprising.

Like a time machine, market expectations allow individual participants to turn the wheel of time ahead, and the collective market to preempt the likely future of the market. This journey in time, however, transforms the meaning and impact of market news and information. Effective news is the difference between the market’s expectation and the actual published figure. Pointing to his massive, wooden trading desk, one trader explains that, ‘‘Information that comes out that is expected is not really information. It just confirms something you already know. You know, this table is made of wood. I don’t need to know that [news] comes out that this table is made of wood. Because we know that— fantastic. [However, news that] this table is made out of gold, that’s something different. If people don’t know it, it is going to move [the market]!’’ Expecta- tions thus determine the market’s reactions to news by turning news into a check of already acted-on expectations. ‘‘What makes the market move is the delta between the expectations and the news. It’s not the news itself,’’ one trader explains. Thus, news that merely confirms expectations does not change the already created status quo of the market, independent of how positive ornegative the intrinsic content of the news may be. Only unanticipated news, such as economic indicators deviating from what was expected, will move the market. Accordingly, as one trader observes, ‘‘Some figures are coming. If the figures are good or bad does not make any difference. [However], it makes a big difference if you expect a bad number and a good one comes.’’ Another trader echoes this sentiment, saying, ‘‘The final event gives just the conclusion and tells the people if their expectations were right or their positions were right. The expectations move the market, not the event.’’

According to traders, because expectations are already integrated into the market before the corresponding information confirms them, the arrival of anticipated news may even trigger a paradoxical move—in the opposite direction of what identical news would have triggered normally. ‘‘If the market has positioned itself beforehand, then you could get a totally adverse reaction to a certain event. You might get a positive number for the American economy, nevertheless the market reacts to the contrary because people were already long, and they are just going out of it,’’ one trader observes. Another trader explains this shift with a pertinent market example: ‘‘Five percent inflation is a bad figure, and that would under normal circumstances hurt any bond market. But if the market’s perception was the figure should be 5.5%, although 5% is still a bad figure the market could actually react the other way because what is expected is different from what the actual figure is.’’ Thus, traveling in the time machine of expectations, participants not only catch a glimpse of the foreign exchange market’s future; doing so actually changes the future they finally encounter. 

From the book "The Psychology Of The Foreign Exchange Market" by Thomas Oberlechner