Automated Fed Analysis: Prattle’s Unique Approach

  • Wednesday, May 18, 2016

(“The Eccles Building”; by AgnosticPreachersKid )

On this FOMC Minutes day we see two stories unfolding.

  • The FOMC Minutes reveal that the Committee was less dovish at the April meeting than they were at the March Meeting.
  • Two Sigma made a splash by announcing its “artificial intelligence” analyzing Fed Minutes

Addressing the first point, we see this move as anticipated and, although our score is slightly more dovish than projected, it is more hawkish than the average Minutes over the last year. We see this as a clear signal from the FOMC that a June rate hike is still on the table. The key will be how speeches unfold over the next three weeks. With the market pricing in almost no chance of a rate hike in June, the FOMC is currently rather constrained. If upcoming speeches reveal increasingly hawkish sentiment, this signals a concerted effort to raise the probability of a June rate hike, thereby indicating either:

  • The FOMC wants to have options at its disposal in case the data warrant a rate hike in June, or…
  • The FOMC is already ready to go and just wants to signal that to the market.

These slightly more-hawkish-than-usual Minutes do not definitively point to the second option, so we see the first as more likely, but the sentiment scores on speeches over the next three weeks will reveal vital information.

Addressing the second point, we applaud this effort by Two Sigma to bring much-needed attention to the applications that technology has on “Fed watching.” We are also glad they’ve attempted to create their own limited version of central bank sentiment analysis.

It must be noted, however, there are significant differences in the technological sophistication of Prattle’s and Two Sigma’s methodologies:

  • Scope. Prattle uses a proprietary algorithm to analyze every communication from 20 central banks, not just Fed Minutes. We also provide metadata on every speaker and type of communication.
  • Speed. Prattle provides concrete, real-time sentiment scores for every communication we analyze.
  • Context. Prattle scores represent unique analyses of central bank texts based on the historical relationship between central bank communications and market reaction; Two Sigma’s “AI” aggregates analysis and generates a consensus score–one not unlike those found on media review aggregatorMetacritic.
  • Tradability. Prattle models the keywords and topics as a secondary feature to the more tradable implications of our comprehensive, unbiased, quantitative sentiment scores
  • Analysis. Prattle breaks down each of the these communications based on context and linguistic patterns to precisely identify how hawkish or dovish the entire document is; Two Sigma relies primarily on word counts.

Beyond the obvious investment implications of having a sentiment score for every communication from 20 central banks around the world, Prattle also pioneered the patent-pending methodology and literally wrote the book on it, How the Fed Moves Markets, published in December of 2015. Our book seems to have not only inspired their research and technology, but also the prose of their report.

An AI Approach to Fed Watching, page 2:

In Shakespeare’s Hamlet, chief counselor to the king Lord Polonius asked the protagonist what he was reading. Hamlet accurately, if imprecisely, replied, ‘words, words, words.’ Counselors to asset allocators might ask the same thing of so-called ‘Fed watchers,’ who dutifully interpret the US Federal Reserve’s Federal Open Market Committee’s (FOMC) meeting minutes.

How the Fed Moves Markets, page 59:

If an accurate assessment of central bank communication is important to understanding the market—and it undoubtedly is—analysts ought to stop treating central bank communications like poetry when attempting to zero in on policy: ‘close reading’ may be great for unlocking Shakespeare’s sonnets, but it’s not the best method of understanding essential, market-moving data.

As the original innovator in applying textual analysis to central bank communications, Prattle provides the most cutting-edge data products currently available. Two Sigma’s report may hint at the possibilities of central bank sentiment analysis, but we are proud to say that Prattle’s technologies realize that potential.

The Prattle Team

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Eccles Building photo by Agnostic Preachers Kid