Friday, October 09, 2015


Another day, another equity rally.   If this continues any longer, the S&P might actually be up on the year!  Yesterday's catalyst was a familiar one, i.e. a Federal Reserve that yet again passed on the chance to demonstrate that they actually do intend to lift rates off of zero this year decade century millennium.

Curiously, the minutes appeared to pooh-pooh the impact of the recent bout of global market volatility; whether the FOMC thinks they're fooling the market, or if they're just fooling themselves, is a question left for the reader to consider.  Nevertheless, they conveniently noticed that inflation (as they measure it) has yet to start approaching its appropriate level (as they define it) better wait a little longer, because gosh darn it, the model says inflation should go up eventually!

In an obscure academic at Bo Diddley Tech, such faith in poorly performing models would be touching if a trifle pathetic.  For the so-called best and brightest to continually misunderstand the situation they confront is just plain concerning.  Macro Man has written about all of this before and doesn't feel like digging too deeply into it again.

Suffice to say that even short term inflation expectations show zero signs of becoming unanchored...

...the trimmed mean CPI has trended lower, but is hardly pointing to anything like corrosive deflation....

....while the median CPI has been very steady above 2% for 3 years.  If you're looking for signs of broad-based, corrosive deflation/disinflation, you won't find them here.  Apparently, though, the Fed doesn't distinguish between corrosive deflation and cheaper consumer goods, even though there's a veritable Everest of evidence to suggest that most of what we see is the latter rather than the former.

All the moaning in the world won't help you make money, however.   It seems as if it might be time to implement a "Carney" strategy for the Fed- i.e., whenever they communicate, simply assume that they're either bad economists or lying.  In that vein, the yesterday's minutes would suggest playing for a hawkish outcome.  Conveniently, the SPX has bellied up to the bar at the Last Chance Saloon  for would be shorts, with last month's high offering a clear risk parameter against which to sell.

If we somehow end up making new highs by year with the Fed sitting on its hands, it will be worth questioning who are the bigger pack of fools: the Fed, for leading us on this merry dance, or those of us who followed along like rats behind he Pied Piper?

Thursday, October 08, 2015

Partiers and party poopers

Another day, another equity party.  While any one week rally of this magnitude inevitably brings out the equity cheer-leading squad, more macro driven investors are facing a crossroads.   Specifically, anyone who tried risky asset shorts has been forced to cover; the question now facing them is whether to stand pat and await another level to sell, or to rent some long beta and see what happens.

USD/MYR is a perfect example (though this chart will be dated by the time you read this.)  Having gone up in more or less a straight line between May and August, the price action has become increasingly erratic and overlapping, and punctuated yesterday with a sharp downmove.   True, if you were long the whole way up you still have the psychological cushion of being onside; however, as anyone who's ever taken risk will tell you, once you've banked some P/L in a prior month's return, you are loathe to give it back in a new month.  Even within the boundaries of a normal correction, USD/MYR can drop another 5% and still remain well within its secular uptrend.  That's a tradeable do you stop and reverse, or merely stop?   To a large degree, it's a function of trading style and time horizon.

How markets choose to navigate the current crossroads will likely dictate the next few days' or weeks' price action.  Macro Man isn't really a short-term punter, but to him it looks like there's more to go, particularly if China re-opens today and joins the party rather than raining on the parade.  Of course, the longer the party rages, the more likely it is that the cops get called in the person of the Federales...the prospect of which could easily tip the whole thing over again and send us back to square one.

However, even yesterday there were a few turds in the punchbowl, to extend the analogy.  Oil looked set to build on breaking out of the market's pincers but was undone by a much larger than expected inventory build; while the correction was swift, crude remains comfortably above yesterday's breakout point so technically there was little damage done.

Rather more damage was announced by Deutsche Bank after the close, which disclosed an expected 6.2 billion euro loss for Q3 thanks to what owners of the stock hope is a kitchen sink goodwill impairment.  (Remember the kitchen sink write-downs of 2007-08?  You could have fed millions with the contents of those sinks.)  Significantly, the bank also suggested that it dividend would be slashed or even eliminated altogether.

Cynics can and have pointed to DB as a repository for much of the murky detritus that flows through the global and European financial systems, and its hard to argue with that assessment.   For several years after the crisis DB's balance sheet remained as bloated as it was before 2008, though over the past couple of years they've managed to shrink it a bit.  Nevertheless, slashing the dividend is not exactly what equity holders were hoping for, and served as a timely reminder that Eurostoxx dividends and banks trade cheap for a reason.   Remember, kids, you can't spell "SX7E sucks" without "SX7E"!

Finally, Brazil.   The BRL was off to the races on Wednesday, trading 1% stronger against the dollar even when Spooz briefly dipped into negative territory.   And then....bad news from Congress, which couldn't muster a quorum to vote on giving Dilma some budgetary veto powers.  When your friends not only don't support you, but can't be bothered to show up, it's not a good sign.  In any event, USD/BRL performed a volte-face, rallying even as equities came roaring back.

In the grand scheme, of course, the magnitude of the move was nothing special- certainly not in comparison with what we've observed over the past few months.  Then again, the abrupt reversal was a timely reminder that idiosyncratic factors can play a large role in EM valuation, and that Brazil has very few that aren't a headwind at the moment.

For fun, Macro Man dug up an old Brazil PPP spreadsheet that he first wrote in 2005.  The base period was 1994, the date of Brazil's last mega-devaluation (as opposed to the much more garden variety "large scale" devaluations!)

In any event, imagine his surprise when he found that the spreadsheet, this iteration of which actually hadn't been updated since 2007, spat out a PPP for USD/BRL of 3.91.   Way hey!  Of course, looking at it historically, it's kind of hard to suggest that the modeled PPP bears much resemblance to where the BRL has traded in the past.

The original piece of work actually made an adjustment to the PPP to account for shifts in the terms of trade.   As you can see, it worked very well indeed up until the currency wars/Fed forward guidance period from 2011 onwards.  It has identified that the BRL's equilibrium level has gotten weaker, but not to the magnitude of that observed in the marketplace.  That Brazil continues to run trade surpluses would appear to underline that fact.

Of course, the overall current account is well into deficit, thanks to the large and growing income deficit that Brazil runs.  Moreover, the capital account balance doesn't look particularly rosy with corporate indebtedness and foreigners fleeing Brazilian assets.   The PPP tells a story, but not the whole story, and when you add the other factors in (including Bacen perhaps playing along with the government's program) Macro Man continues to see a good old fashioned EM crisis bubbling away.  As such, this remains one market that he expects to remain a party pooper.

Wednesday, October 07, 2015

Crude breaks the pincers

Yesterday went just about as planned.    European equities enjoyed another solid day while the S&P took a breather and a little dip, justifying calls for Turnaround Tuesday.   Meanwhile, it looks like the pincers were broken in crude oil, which put in a very nice day to break through the little downtrend line...and unlike last week, it sustained a nice close above it.  If crude can break above the late-August highs (about a buck and a half away), expect CTAs to get stuck in to close their positions, which could be fun to watch.

By the time you read this, the BOJ will have announced policy, with relatively little expected for this meeting (but something like a 50/50 perceived chance of more easing at the month-end meeting.)   Recall that it was last October that Kuroda supplied the market with ammunition to drive the rip in USD/JPY and the Nikkei; both they and Japanese CPI have stalled, largely for reasons outside of the BOJ's control.  While Kuroda is undoubtedly clever enough to understand this, by the same token he faces pressures to keep the ball rolling; his press conference will be interesting in terms of any hints given as to the near-term prospects for policy shifts.

Readers will recall that Macro Man suggested selling the Nikkei just as the wheels were starting to come off of global equities; while obviously a shock easing is a risk to that view, other than that Macro Man finds the Japan trade to be really quite uninspiring at the moment.  If you feel like USD/JPY is stuck in the mud, you're not wrong; it's traded on both sides of 120 every day but four since the beginning of September.   Zzzzzzz.

Now, on to China.   YUM brands is reportedly considering a name change to YUK, not only because of the dismal quality of their culinary offerings, but also because of its tepid growth and disappointing earnings...which they laid squarely at the door of the Chinese consumer, as Chinese revenues only increased 2% y/y.   Given the contradictory message from this report and Nike's, it's hard to know how much this says about the consumer's spending power and how much of it is disenchantment with the Colonel's chicken.

Meanwhile, there was an interesting paper recently published by the SF Fed on China.   The ostensible purpose of the paper was to determine if China has a history of fudging its GDP figures via looking at other countries' export figures.  (The conclusion was that it used to, but the data is more reliable since the crisis....perhaps less pressure to grow at breakneck speed implies less pressure to lie.)

In any event, the authors identify a range of ancillary indicators, and various combinations of them, that offer a good (and reliable) proxy for Chinese activity.  Macro Man used an amended version to create a little indicator of his own (if anyone has access to a time series of the 5000 enterprises diffusion index of raw materials supply, by all means share!)  In any event, the indicator seems to track the recent trend of published GDP fairly well...

...albeit showing lower growth than the official number.   Then again, that's the widespread view the true state of Chinese growth, so it's no bad thing.  Interestingly, the high-frequency version of the indicator suggests a flat trajectory of growth over the past few months, which jives nicely with Macro Man's general view that China has slowed but isn't collapsing.

We're due to get the report on September's FX reserve data in the next day or so (EDIT: It was released last night, and showed a smaller than expected decline of $43 bio; while not sustainable ad infinitum, it certainly doesn't convey any sense of a rapidly deteriorating situation.)   this should be closely watched for clues to the severity of capital flight and the degree to which the current account is mitigating its impact.

Tuesday, October 06, 2015

97 handles, 2 days

Whew.   97 handles is two days is potent stuff, and that's what the Spooz put in from the post-payroll lows on Friday through the high print on Monday (which wasn't that far off the close.)  This was the biggest two-day rally off the lows since all the way back on....August 27, and my didn't that turn out well?

It seems safe to say that the market has experienced quite a bit of psychological trauma over the past few weeks, no matter bull nor bear.  Obviously, sticky money is going to stay invested regardless of what market beta is doing, but you really have to wonder how much more of this the fast money crowd is prepared to take.  Yes, there is ample opportunity if you're a scalper...but if you're not quick (and good), by the same token there is plenty of opportunity to get scalped.

When equities are in freefall, one often hears the hopeful mutter of "turnaround Tuesday."  Now, alliteration is no way to run any kind of investment process, but it does seem to be the case that outsized moves either side of the weekend tend to reverse themselves come Tuesday.  You'd have to think that chances favor at least a bit of consolidation today after the furious price action of the last week.

What's notable is that- stop me if you've heard this one before- Europe appears to have quite a bit more upside on the charts than the SPX.  Spooz, for example, are roughly 1.5% off the highs of last month's Fed day....but Eurostoxx are nearly 4% lower.  The DAX is nearly 7% lower, but obviously there are some extenuating circumstances there.

When it comes to European equities, Macro Man feels like he's not only beating a dead horse, but cremating it, burying the ashes, and then proceeding to beat those.  Still, it's helpful to remind oneself that proper macro themes don't always come fruition a few days or weeks after you've made your mind up; some, like fine wine, need to age before they are ready.  Of course, in this game being early often equates to being wrong, so it's important to know when to pull the trigger and manage risk.

From Macro Man's perch, the best way to play the theme at the moment is with toe in the water type sizing; he generally prefers to ratchet up risk with a tailwind, so to speak....and right now, European equities still don't really have that.

Elsewhere, the headline non-manufacturing  ISM was a little weaker than expected, but still quite strong.   Interestingly, the employment component registered its joint 4th highest reading in the 18-year history of the survey.  Curiously, 2 of the other top 4 readings have also come within the last year.  While there's not much month-to-month correlation between this indicator and payrolls, a trend basis they tend to match up quite closely.  As such, the ongoing resilience of the ISM figure is telling.

The upshot of yesterday's frenzy is that eurodollars sold off and steepened; the 2nd vs 10th spread highlighted here yesterday steepened by 3.5 ticks.  It's only a drop in the bucket, of course, but every reversal has to start somewhere.  Whether the reversals can sustain, of course, is another question, as  investors these days know all too well.

Monday, October 05, 2015


So what now?   Friday's price action was as stunning as the employment data was disappointing, and punters could be excused for wanting to take some time off to gain some perspective and clear their heads.   Unfortunately, that option probably isn't available to many; we're entering the sharp end of the year with many, many YTD P/L's in uncomfortable territory- while it's not quite "find the trade to bet your year on" time, it's not far off.

In perusing a few charts over the weekend, Macro Man was struck by a number of them that appear to be caught in the middle of pincer-like narrowing trendlines.   Some, like gold, still offer a little room to maneuver:

Others, like the euro, look like a resolution will happen soon.  The irony is that there is relatively little on tap data- or policy-wise this week to give it a jolt....then again, large moves often happen in the absence of an obvious catalyst.  The pincers are currently 200 pips wide and narrowing fast.
The tell on which direction goes might come from oil, where the pincers are tightest of all.  There was admittedly a false break higher last week- was this a bull trap or a prelude to the next leg of the reversal?   Either way, it seems likely that the environment of high volatility is like to remain with us.

Last Friday, you could almost hear the market pining for a hint of QE4 when Spooz were on their lows.  It's nonsensical, of course, but such is the outcome of the modern day "every asset owner's a winner" Lake Wobegon financial markets.

In that vein, Macro Man was intrigued to see that after Friday's number most eurodollar curve spreads collapsed to their lowest levels in nearly 2 years.   The generic 2nd vs 10th contract spread, for example, is now at just 99 bps, pricing LIBOR less than 1% higher between March 2016 and March 2018.  By way of comparison, the median dots in the infamous SEP plot rise 225 bps between the end of 2015 and the end of '17 (not an exact match on time frame, but close enough.)  Fading this now is a bit of a falling-knife play, but the pre-taper low of 81 bps will look nice as a stop-loss risk parameter if we get another 5-10 bps lower.

If the flattening continues, though, pretty soon the Fed is going to run out of room to maneuver, because the market will be pricing nothing at all.  Between now and then, they're going to have to make a choice: do they continue to kow-tow to the whims of the market and its propensity to throw the toys out of the pram, or do they start delivering a tough-love type of lecture that market pricing doesn't reflect the Fed's intentions?

It's kind of ironic, really.  For years, the market has assumed a kind of omnipotence that central banks have over asset prices, whereas latterly, it is the market itself that seems to hold all the power over the Fed's lift-off decision.  In reality, of course, neither is all-powerful or all-knowing, and the longer that each side attributes these traits to the other, the nastier the surprise will be when reality bites.

Friday, October 02, 2015

The Fed put is real, and it's spectacular

It's payroll day today, and while the number of course is very important, somehow it feels a bit less so given that the Fed is almost certainly out of play this month.  Yesterday's ISM was worse than expected and better than feared, judging by the published consensus and the word on the strasse.  Markets seemed uncertain of how to digest things, even though the annualized vehicle sales numbers were a blowout, registering their highest reading in 15 years.

Also released yesterday was a very interesting paper authored by Boston Fed president Eric Rosengren and two others, arguing that the Fed acts as if it had a treble mandate, with financial stability joining inflation and (un)employment as explanatory variables in determining Fed monetary policy.  The authors identified a number of buzzwords that reflect concern over financial stability in Fed meeting transcripts, and then included their frequency of use in a regression to explain changes in Fed policy.

If Macro Man were to summarize the findings of the paper in one sentence, it would be this:  The Fed put is real, and it's spectacular.

Cynics will be unsurprised to see that the Fed's use of "downside" financial stability words like "volatility" and  "bust" occur much more frequently than "bubble" during the 1987-2009 sample period.   Perhaps not coincidentally, the FOMC's use of the buzzwords has trended noticeably higher since the 1990's.


What is somewhat surprising, however, is how much of an impact the buzzwords (or, more accurately, the concerns conveyed by them) have had in explaining Fed policy.  Over the sample period, each 100 buzzwords included in the transcripts equated to a 45 bp move in the Fed funds rate.  Believe it or not, that's a stronger impact than a 1% change in the forecast for inflation or the unemployment rate had over the same period.

Perhaps most telling is the skew in the Fed's reaction function.  The paper broke the sample down into quintiles using credit spreads, with the widest spreads representing a "bust" and the tightest spreads a "boom."  During the "bust periods", each 100 words of moaning about financial stability explained nearly 67 bps of easing, while a similar volume of concern during booms (which we've already established doesn't happen anyways) would only explain 36 bps of tightening.  In fact, the explanatory power of the financial stability buzzwords during "busts" is stronger than any reading for inflation or unemployment, the Fed's ostensible policy targets.  As many have suggested, the Fed not only doesn't take away the punch bowl these days, it spikes it with Everclear.   A simplified summary of the findings is set out below.

Based on these findings, perhaps the appropriate question is not "does the Fed make policy based on financial stability", but "does the Fed make policy based on anything else"?   

Elsewhere, the Atlanta Fed slashed its GDPNow Q3 forecast to just 0.9% yesterday, which raised eyebrows (and more doubts that the FOMC will ever pull the trigger.)  The basis of the downgrade was preliminary goods trade data for August, which showed sharp declines in both exports and imports and a widening of the deficit.   Forecasting the impact of trade on GDP is sketchy at the best of times, using preliminary data even more so.

One counterpoint to the notion that trade collapsed in August is the Long Beach Port data, which showed quite a substantial surge in traffic in that month.  Obviously the port data can be quite sloppy, but as a sense check it certainly doesn't confirm the basis of the GDPNow downgrade or suggest undue cause for concern.  After all, if the economy's going into the tank, why are Americans buying so many cars?

Finally, today's number.  The consensus forecast is rather unimaginative at 201k for the headline number, but Macro Man is hard pressed to argue against it; his own model looks for a rise of 209k.  Ordinarily, one might say that the unemployment would be of interest, given that it's approaching the NAIRU identified by the FOMC in the latest SEP last month.   The again, that NAIRU projection itself has come down by 0.3% since the end of last year, so it's pretty clear that the Fed is willing to lower it as much as necessary based on the spot unemployment rate reading.

Moreover, the table posted above suggests that it doesn't really matter anyways; during the good times, the Fed doesn't give a monkey's about the unemployment rate.   Indeed, based on all available evidence, they don't give a monkey's about anything but keeping the market supplied with (virtual) puts, thus blowing up the next (unmentioned) bubble.  The problem is that when the bubble bursts, that tends to be pretty spectacular, too.

Thursday, October 01, 2015

Dudley to market: remain calm, all is well

Where to begin?  How about with Bill Dudley, who gave a speech yesterday essentially saying "nothing to see here, please disperse" when it comes to bond market liquidity (or lack thereof.)  To say that the argument was uncompelling and smacked of complacency is an understatement; for example, Dudley's analysis focused on dealer-to-dealer transactions in the Treasury market while ignoring client-to-dealer transactions.  Moreover, by focusing on measures (such as deviation from fitted yield curve) that he himself admits were distorted by the Fed's zillion dollars worth of asset purchases, Dudley essentially rendered his argument tautological.

Unsurprisingly, other analysis comes to a different conclusion such as the chart displayed in this article showing how daily yield moves in excess of 1 standard deviation are at historic highs since the implementation of Dodd-Frank.

Dudley wrapped up his argument with the usual "even if liquidity has declined, it's a small price to pay for financial stability."  That's easy to say, but there is of course no guarantee that the deterioration of liquidity has conferred (or coincided) with overall financial stability...and that's without pointing out the logical fallacy that maintaining ample market liquidity and financial stability are somehow mutually exclusive.

As for those who've been bulldozed in the least liquid segment of the corporate sector, where price becomes news, here's a succinct summation of Dudley's message to you:

Moving along, focus today is on the ISM, where despite the published consensus forecast of 50.7 the whisper number is below 50.  Yesterday's execrable Chicago PMI number has surely fed the tide of negativity.  Given the weakness in other regional surveys, the market's pessimism would appear justified, though the historical correlation between the regional reports and the national figure are relatively modest.

While it would appear unlikely that the Fed would move policy with the ISM below 50, no one actually expects a move in October anyways, given the S&P 500's audacious failure to rally.  Putting things into context, however, it's important to recall that manufacturing is a relatively small (if visible) portion of the US economy.   A composite measure of the manufacturing and services ISMs, weighted 30/70 to reflect their relative importance, suggest things are nowhere near as bad as the usual prophets of doom might suggest.

Obviously, things can change....but right now Macro Man isn't seeing the sort of deterioration that would serve as a legitimate cause for alarm.

Speaking of which, there have been some fairly bearish viewpoints espoused in the comments section recently, and Macro Man was amused to see Carl Icahn star in a video expressing a similar sentiment.  Your author was shocked, SHOCKED to see Mr. Icahn, who owns many billion dollars worth of corporate equity, recommend steep corporate tax cuts as a solution to the current malaise.

The fact is, however, that corporate profits are generally doing just fine, thanks to a whole host of advantages that companies enjoy which Joe Sixpack does not.  Macro Man has touched on this before, but profits (and market expectation of future profit streams) do an excellent job of defining the secular cycle in US equities.  The current state of play, quite simply, does not suggest an imminent collapse, nor that this is 'the Big One'.  If anything, the time to make that argument was 6-9 months ago, which was exactly the point when Macro Man was fuming about the lack of volatility in the market.

History suggests that when earnings expectations are pointing up and the market's pointing down, it's the market, not expectations, that tends to correct.  Perhaps this time really will be different.  Macro Man cannot shake the view, however, that while we have moved into a higher volatility regime for the foreseeable future (thereby reducing the ex ante Sharpe ratio of holding risky assets), the ultimate resolution will be higher, demonstrating this to have been a correction rather than the start of a new bear market.