Thursday, March 26, 2015

Running in place

A 1.5% downday, and the SPX is basically unchanged on the year.   There's a reason that Macro Man hasn't written too much about equities recently, and that's it in a nutshell.  For the first three months of the year, US equities have been a bloke on a treadmill, running at a brisk pace simply to stay in place.

Not that this has come as any great surprise.  In October, Macro Man noted that liquidity factors were the primary explanatory variable for the S&P's stellar run of performance over the past few years, and with the tap being turned off (in the US at least) there was naturally some reason for concern over future returns.

Indeed, more than a year ago Macro Man performed an analysis of the SPX's return and vol by Fed policy regime; he thought that he had published it here at some point over the summer, but he's deuced if he can find it.  Regardless, the analysis suggested a very bullish outlook for US equities as long as the Fed was a net purchaser of assets, and a dim prognosis whilst the Fed did nothing.   He's taken the liberty of updating the study for the full body of the Fed's QE Era (Dec 2008- Oct 2014); a summary of the results are below.

As you can see, based on this study, the right question for US equities is not "why aren't they going anywhere?", but "why are they doing so well?"  Since the end of October, the SPX has generated an annualized price return of 5.4%, with a vol of just over 13%.  Of course, a number of ancillary factors have also impacted the price- ECB QE, the collapse in energy prices (bad for producers, good for energy consumers), and of course, the shifting sands of Fed policy expectations.

There are, of course, limits to this type of analysis, given the paucity of truly independent samples.  Even going back several decades delivers little more than a handful of policy cycles, which is really an insufficient number from which to draw strong statistical inferences.  For what it's worth, a year ago Macro Man also performed a study on SPX performance by orthodox Fed policy regime, splitting the cohort into the first 6 months of tightening/easing, subsequent tightening/easing, and on hold (defined as no policy moves for the last 6 months.)  The results are set out below.

On the face of it, this might suggest that a rate hike might be the best thing to ever happen to the US equity market, but correlation does not of course imply causality.  One might posit, for example, that early-stage and subsequent tightening cycles are driven by robust economic activity, which would naturally prove supportive of stock prices.  The lower returns from on hold and easing, meanwhile, would reflect the weak underlying economic conditions justifying those policy stances.

In the current environment, the expansion is already somewhat long in the tooth when measured by the calendar (though not by the credit cycle), and earnings have had a lot of "unnatural" support baked into the cake thanks to uber-accommodative policy over the last six years.  This is unlike any of the scenarios captured in the data set above.

Current and future financial conditions in the US look set to be tighter than those of the past several years, so it seems natural to expect equity performance to be worse (and, cough cough, macro performance to be better.)  That being said, Macro Man's model is still somewhat bullish of the SPX, which informs a moderately long strategic position even as he is agnostic tactically.  He is following developments in the model and the market from afar, however, and is ready to change his stance when and if circumstances warrant.

In the meantime, there's always the DAX, though it certainly looks like at least a good chunk of the easy money's been made in that one for the time being....

Tuesday, March 24, 2015

Not much to say

Apologies for the radio silence over the last few days, but Macro Man hasn't really got a lot to say.  Illiquid market churn is not "macro"; your author has historically performed best while looking through the noise, so that's what he's trying to do at the moment.

One interesting observation is that this little correction in EUR/USD, some 6 big figures peak to trough, represents the largest retracement of the entire downdraft off of the peak.  Classic Fibonacci retracement levels remain quite far away.

That the Fed now feels comfortable talking about the dollar is certainly interesting to note, though at this juncture Macro Man remains of the view that they view it as an input to the decision-making process rather than a policy goal in and of itself.  Nevertheless, he will keep a close eye on both the data and the rhetoric; it may end up being the case that either the dollar trade or the rates trade will work, but not both.  

In fairness, that's been the story of the year so far; the only reason that Macro Man had both working was his spectacular entry points on his eurodollar trades.  Of course, the future matters more than the past, so at some point a hard decision may have to be taken.  At this juncture, however, he has the luxury of time to watch and for the time being, that's what he intends to do.

Wednesday, March 18, 2015

Dot-dot-dot, dash-dash-dash, dot-dot-dot

Well, that was....intense.

The Fed dropped the word "patient" and explicitly left the door ajar for a move in June should circumstances warrant.   However, the real sting in the tail was in the SEP, where the infamous dot-plot ratcheted lower in response to downgrades to the growth and inflation forecasts.

The end-2015 median is now at its lowest level since before the Taper Tantrum.

Market reaction was swift, and Yellen's press conference did little to dissuade the participants from buying securities and selling the dollar.  For today at least, score this one in favour of the monetary heroin addicts.

Probably unsurprisingly, the most vicious price action took place in the most-positioned market, EUR/USD.  Pre-Fed short covering evolved into post-Fed stop-lossing, which itself became a full-blown rout in the gray zone after 4 pm NY time.  Not since Bernanke pulled a volte-face in July 2013 have dollar longs been punished so swiftly, with so little liquidity.

From Macro Man's perch, price action in eurodollars was disappointing but not altogether surprising given the magnitude of the dot-plot downgrades.   They key question here is whether the market chooses to maintain a 10-20 bp "easing risk premium" in the ED market versus the dot-plot, or whether it's now happy to let the market price converge now that the Fed has apparently capitulated.

Macro Man has to confess that the dot-plot forecasts moved a bit lower than he had envisaged; such is life when ruled by a central bank that forecasts with a rearview mirror.  It's just as well that he had a last-minute bout of jitters and sold a few dollars and cut a little bit of rates risk before the announcement.

From his perch, he still expects a handsome snap-back in the data for April and March; while he doesn't think that will generate a hike in June, it could well be enough to swing the dot-plot pendulum the other way for 2016 and beyond.  Although he is tempted to add to some of his ED bets given this sharp rally, prudence suggests that it's better to be a day late than a day early, particularly if the market decides that it wants to price perma-ZIRP to feed the jones of all the asset-market junkies.

As for the euro, meanwhile, let's not forget that even at the peak of the gray zone squeeze, it was still down some 1.5% from February's close.   Scant consolation if you were the poor bugger selling in the low 1.04's last week, but less of a worry for more strategically-inclined investors such as your author.

Thus, from Macro Man's perspective, the SOS that you heard after Wednesday's trading was not a plea of "save our shorts" from underwater euro bears, but rather a weary, resigned "same old sh--" that we've had from the Fed (and BOE) over the last couple of years.

(As an aside, did anyone else find irony in Yellen's response to the chap from American Banker magazine?   Y'know, the bit about getting rid of incentives for excessive risk-taking....)

Banishing the ghost of 1937

So the big day is finally here.   Will patience be a virtue, or won't it?   Macro Man's hunch is that the Fed will keep the door ajar for a midyear rate increase, but maintain a pretty high bar for doing so.  Judging by yesterday's survey results, he has plenty of company.  Fully half of you opted for answer C, "Indicate that a June hike is possible but unlikely."   Only a third of you thought that the market's perceived probability of a rate hike in three months' time will increase as a result of today's Fedapalooza.

In terms of his portfolio, Macro Man has decided to more or less sit tight.  As discussed yesterday, he has a bit of a barbell on, with positions in those assets most and least priced for a hawkish outcome. Judging by both the poll result and yesterday's little short-covering flurry in EUR/USD, a bit of a damp squib today would not come as any real surprise.  Macro Man's positions are pretty modest at the moment, so he's willing to wear a little bit of short term pain if it means getting better entry levels to reload.

Your author was intrigued to see the flurry of press attention paid to Ray Dalio's warning on a 1937 repeat from the Fed.   Only a few miles separate Macro Man's office from Mr. Dalio's, though the distance between their respective places in the financial universe is obviously substantially greater.  Still, Mr. Dalio is a famous adherent of brutal honesty, so Macro Man can't help but observe that he thinks Mr. Bridgewater, a man who's been known to hold the odd bond or ten billion, is talking his book a bit.

Although Macro Man has not read the verbatim text of Dalio's missive, based on press reports it seems to him that Dalio is falling prey to the fallacy of the false dichotomy discussed last week.   The Fed can raise rates modestly and still maintain easy financial conditions, even if the feedback loop between the policy rate and overall financial conditions is swifter and stronger than it was in the past.

Moreover, "we can't raise rates because it might precipitate another crisis" is a counterfactual that can neither be proven or disproven  unless someone's willing to give rate hikes a go.   What we can say, however, is that there is no room for orthodox policy easing should the need arise from current policy settings.   And of course, if unorthodox measures were all that effective, Mr. Dalio wouldn't be sitting here in 2015 fretting about the economy's ability to withstand any tightening whatsoever!

To be sure, some emerging markets with an excess of dollar funding may be vulnerable.   Of course, many of the countries moaning about potential Fed tightening since the taper tantrum were the very same ones that whinged when the Fed was doing QE!   There's just no pleasing some people....

As for the state of the economy, summoning the ghost of 1937 really misrepresents where we are and where we have been.  It's true that industrial production is roughly 5% above its pre-crisis peak, the same level as it was when the Fed started tightening in 1937.  However, the paths to that level were very different indeed....

While growth in the rest of the world has clearly been anemic since the onset of the crisis, it's worth reminding ourselves that anemic is a damned far way from catastrophic.   In 1937, US exports of goods and services were only 2/3 of their pre crisis peak.  Last year they exceeded 2008's levels by 26%.

Finally, let us note that the Fed tightened policy in 1937 as the unemployment rate tumbled from a Depression high....all the way down to 11%!    Lest you have forgotten, the peak unemployment rate during the Great Recession was 10%.   It's true that U6 was as high as 17% a few years ago....but we also don't know what the equivalent would have been in the 1930's.  Regardless, in 1937 the unemployment rate had only retraced slightly more than 50% of its rise from the pre-crisis trough, substantially less than it has done over the past five years.

None of this is to say that tightening won't have some negative repercussions- after all, you can't make an omelet without breaking a few eggs.  On the other hand, Japan offers a salutary lesson that perma-ZIRP is no buffer against economic downturn or financial crisis.  Unlike Japan, the United States has returned to solidly positive nominal GDP growth (albeit lower than pre-crisis trends.)  Perhaps the question that Mr. Dalio really should be asking is what he'd like the Fed to do when the next downturn comes (and come it will, ZIRP or no ZIRP): cut rates from  2.50%, or push on a string?

Tuesday, March 17, 2015

What's in the price?

The FOMC announcement is rapidly approaching, an event at which push will presumably come to shove.  Macro Man retains his (reduced) short euro position and downside positioning in  EDZ5.  However, with crunch time rapidly approaching, he is wondering if a little adjustment might not be in order.

His approach to analyzing the event and its impact is twofold.  The first is to assess the likely range of outcomes and estimate the market's perceived probability distribution for them.   The second is to determine, relatively speaking, what is in the price for major asset markets.

In terms of the FOMC, the market fetishization of the word "patient" strikes Macro Man as overly simplistic.  On the face of it, of course, the market would read the removal of "patient" as a hawkish  development and its inclusion as a dovish one.   However, what if the FOMC were to remove "patient" but indicate that policy is highly unlikely to move until and unless inflation is clearly moving back towards the 2% target?  Is that really a hawkish outcome?  By the same token, what if "patient" remains but the bottom quartile of the dot plot moves higher for 2015 and 2016, suggesting a greater conviction across the committee that rates will move this year?  Is that really dovish?

Macro Man chooses to focus instead on how the totality of Wednesday's policy announcement- statement, SEP, and press conference- will impact the market's perceived probability of a June rate hike.   At the time of writing, June eurodollars are pricing LIBOR at 0.385%, versus a spot fixing of 0.27%.  July Fed funds futures are pricing an effective rate of 0.22%, versus 0.12% for the current month.   These would suggest that the market is ascribing somewhere between 40%-50% for the probability of a June hike.

Macro Man is curious to know what readers expect the outcome of this week's meeting to be.  The easiest way to find out is to conduct a survey; your author would be grateful if you would respond to the one-question survey below.

Edit: Responses are here.

Edit #2: Whoever screwed around with the response graph, please cut it out.

As for what's in the relative price of major assets, one quick and dirty way of assessing pricing is to merely consult charts of price action year to date.

Let's consider the SPX:

It had a rough time after payrolls (reflecting increased expectations of monetary tightening) but is still up roughly 1% on the year in price terms.

The DXY:

As Thierry Henry might say: Va-Va Voom!  Clearly there's a lot of something in this price.  While some of it is no doubt the Fed and expectations of a tightening, a large chunk of it is also the aggression of the ECB.  USD/JPY, which is historically more sensitive than the euro to US rate moves, is up "just" 1.5% year-to-date.  Nevertheless, the explosion in price since payrolls a couple of weeks ago suggests a lot of latecomers to the party.

10y bonds:

They're marginally lower in yield on the year, which would suggests that there is less than nothing in the price.  Of course, there's a little thing called "ECB QE" which has had a bit of an impact on global bond prices, so one really needs to take the beta out of the equation in assessing 10 year notes.    Put another way, the Treasury/Bund spread has widened nearly 25 bps this year, which not only suggests that there is not "less than nothing" priced in, but also explains at least some of the DXY move to boot.


A-ha.   Despite the fact that the short end of the US should be immune to ECB QE, this contract has fallen more in yield than the 10 year.  Some of this no doubt represents a decay function; two and a half months have passed since the start of the year, and there has been no obvious pressure, in aggregate, for the Fed to accelerate its timetable.   Indeed, the appalling weather and port strike have significantly dampened output in Q1; while the Fed might say that can look through it, everyone kind of knows that they'll want to see proof of an upswing before moving on rates.  The rule of thumb for ED's in 2015 is evidently "be short on payroll day and long every other day."    Hmmm.....

So, if one were to rank these assets by how much Fed tightening is in the price, from most to least, Macro Man would submit that the rank goes:

All of this presupposes that "YTD performance" is an accurate metric for judging what's in the price, which of course it may not be.   Still, Macro Man is intrigued to see his two main positions on opposite sides of this rubric.   On a portfolio basis, that's ideal, particularly as his entry points on both trades were very good so he has a decent accumulated P/L.

Still, it is tempting to tilt the axis a little more towards the asset with the least in the price, given the near-term price implications if the Fed is unequivocally (or as close as they can get to that) dovish.  More thought's required on this one, especially once the survey results are there to analyze...

Friday, March 13, 2015

Why the DAX is outperforming

Macro Man was going to write a thousand-word post on the matter, but why bother when he can just show a picture (lifted from BAML's excellent Flow Show missive) instead?

Thursday, March 12, 2015

A case of big-figureitis

Oh dear, looks like the DXY has a case of big-figureitis....

One can only imagine the thoughts of the guy who paid 100.  Must be something like this...

A cold winter night; Greece still in debt
The euro's at its lowest yet
A rush of the blood to the head
Buy some dollars from my bed

Dollar, dollar, give me the news
I got a bad case of lovin' you
No squeeze, please I'm on my knees
I got a bad case of lovin' you

A pretty chart sends flutters to my heart
I learned that buddy from the start
Buying dollars is all I can do
'Cause the ECB's doin' QE, too

Dollar, dollar, tell me the news
I got a bad case of lovin' you
No squeeze, please I'm on my knees
I got a bad case of lovin' you

I know you like it, the dollar's on top
Tell me, Dixie, are you gonna stop?

Pay 100 on a tasty clip
Then I see Judas hangin' on my tip
Shake my fist as it starts to fall
My stop's been done, hear the broker call

Dollar, dollar, tell me the news
I got a bad case of lovin' you
No squeeze, please I'm on my knees
I got a bad case of lovin' you

With apologies to Robert Palmer.   Anyone too young to remember the original (released in 1978) has never seen a proper dollar bull move.....


Wednesday, March 11, 2015


With apologies to the Smiths...

Panic on the streets of London
Panic on the streets of Amsterdam
I wonder to myself
Could I ever be long again
The Bund rallies as yields slip down
I wonder to myself
Hopes may rise in the blogosphere
But Honey Pie, longs aren't safe here
So you abort
To the safety of a short
But there's panic on the streets of Moscow
Dublin, Beijing, Dusseldorf
I wonder to myself

Buy up the dollar
Sell the blessed euro
Because the QE they constantly play
It does nothing for me to shrink bond yields
Sell the blessed euro
Because the QE they constantly play

The Bund rallies as yields slip down
Voldemort nowhere to be found
Sell the euro, sell the euro, sell the euro
Sell the euro, sell the euro, sell the euro

Actually, Macro Man has covered a third of his short today, because it's come a long way and prudence dictates banking a little.    If form holds, he'll be selling it back out at lower prices.  It probably bears repeating that unless you're in your mid-30's or older, you have:

a) never seen a proper dollar bull market
b) never seen a free-floating EUR/USD  (i.e., absent the impact of FX reserve managers, who are currently dealing with their own issues instead of fannying about with other people's currencies.)

Believe it or not, this is what markets used to be like.