My assessment last night on what the FED was likely to do was off the mark. I assessed a 67% probability that it would cut the Fed Fund Rate by .25 and the Discount Rate by .50. Instead it cut both by .25.

I always do a post analysis assessment especially if it proves off the mark. I review the decision components to see what I may have done differently, being careful to avoid hindsight bias.

The Decision Tree I constructed rated the probability of rates being raised and remaining unchanged as being so low that I did not spend much time on them. I focused instead on the various scenarios (branches) for a cut in the rates. I pruned the scenarios to three:

  • a) One of the rates would remain unchanged and the other cut by .25
  • b) Both would be cut by .25
  • c) One of the rates would be cut by .25 and the other by .50

The inputs to the branches were:

  1. The state of the US economy;
  2. The need to protect the US $ and
  3. Bernanke’s view of the cause of the 1929 depression.

Reviewing my inputs, it’s clear that I placed too much weight on (3). Given what has been said today about the FED alternative tool box, I was relatively spot on (1) and (2). But where I went wrong was thinking that given Bernanke’s theory of the causes of the 1929 slow down, he would seek to solve the liquidity problem through the Discount Rate. Instead the FED will be seeking alternative means.

What I did get right was the first part of the scenario I had crafted: what would happen if (b) took place. I reasoned that the ES would tank and that this would be followed by two inside days ahead of the CPI on Friday. This is subject to the PPI and Retail Sales not being greatly outside expectations. Once Friday is over, I’ll review the Tree again and see where improvements could have been made.

I do the reviews because I feel it’s important to review one’s decision-making processes. Making decisions that accord closely with reality is as important as reviewing your trading plan etc. Revision of decisions is an important rule for constant and never-ending improvement. And, I feel the review ought to be done not only when we get it wrong but also when we get it right. That way we may identify enabling patterns and limiting ones.

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