The US stimulus debate features two warring camps. The Obama administration insists that a failure to stimulate will open the door to a double-dip recession. Its foes retort that continued stimulus could scare investors into dumping US Treasuries. Team Obama invokes the recent run of poor economic data, which point to a risk of renewed slowdown. The critics recall that the Treasury market dipped unnervingly last year, and that foreign central banks were rumoured to be tired of funding US deficits.
Faced with finely balanced dilemmas, some Americans are wont to ask: “What would Jesus do?” In this case a variant may help: “What would hedge funds do?”
Hedge-fund traders typically consider not just the probability of alternative scenarios; they look at the magnitude of the consequences flowing from each of them. If a trader thinks a market has an equal chance of falling or rising – but that a fall, if it happens, will be larger than any potential rise – the trader will seize upon that asymmetrical pay-out. He will bet on the market falling, and his actions may be self-fulfilling.