Tuesday, September 01, 2015

Death, taxes, and bank holiday rain

It's nice to know that like death and taxes, there are certain immutable features of modern life- such as rain on a UK August bank holiday.  One thing that does change, however, is the trend in financial markets.   These days, if you don't like the price of your favourite financial asset, just wait a few hours- it's bound to be radically different.

Yesterday's post noted a favourable set-up to fade the recent rally in equities, and so it's turned out to be thus far.   Once again Asia has sent equity futures sharply lower (Spooz down 20 at the time of writing) after giving them a battering Sunday night as well; interestingly, New York didn't do much of anything with equities during its trading hours.

While yesterday's UK holiday may have had a little to do with that, volatility fatigue is perhaps a more likely culprit- either that, or equity punters were staring slack-jawed at the oil market to worry too much about trading their own books.  Yesterday's rip carried on the price action of late last week; the correction has been so substantial that WTI futures actually closed up on the month of August after apparently teetering on the brink of the abyss a week ago.

The monthly candle looks to be delivering a classic reversal signal, with prices rejecting the move below $40 in the strongest possible way.  Yesterday's catalyst was of course the rumbling that OPEC may finally be ready to act; 'twould be poetic justice if a collapse that was kick-started by OPEC's standing pat were to be ended by a (long overdue?) supply response.

Whatever the long-term fundamentals dictate as an equilibrium price (and there are a lot of moving parts there, both on the supply and the demand side), in the shorter term obviously tactical considerations such as positioning come into play.   One has to assume that the CTA complex has not enjoyed this little turnaround any more than they enjoyed last week's volte-face in the dollar or US equities.  It would be logical to assume that the market generally and CTAs in particular will continue to cut positions as VaR models scream "no mas!"

Finally, it's worth noting that USD/HKD is now locked at the bottom of the band at 7.7500.   After the ruptures caused by the SNB and PBOC this year, it may be difficult to find too many people willing to fade this one, even if the HKD peg has a much more substantial history of stability than the other two.  One would hope, at least, that markets have learnt a little better to trade off of expected return rather than probability of positive return.

That having been said, there's usually a bit of opportunity in HKD FRAs as the HKMA floods the domestic money market with Honkie as they defend the peg by bidding USD at 7.7500.  Sadly it's tough for Macro Man to get prices without a a Bloomberg terminal, but it's perhaps worth looking at receiving some 3 x 6 HKD versus selling, say, December eurodollars if the current pricing looks good.

The HKD peg is not an immutable fact of life...but as pegs go it's closer to death, taxes, and bank holiday rain than it is to the Swissie or RMB.

Monday, August 31, 2015

Thoughts on tactics and an historical milestone

It's a bank holiday in the UK today, so at least British chiropractors and osteopaths can look forward to a day of relief from treating market-related whiplash.   Not so their US counterparts, as futures are trading on the back foot Sunday night in New York.  Sunday night market moves are, of course, notoriously unreliable and prone to overshooting then reversing- it's almost as if someone has a vested interest in spooking the market!  (As opposed to spoofing, which anyone living in their Mum's spare room can tell you is a one-way ticket to perdition.)

Macro Man was interested to see Li Kequiang reassure the public that the RMB would not continue depreciating....(at least not til after the parade, he whispered.)  Of course, the SNB has already provided ample evidence this year that official reassurances about the stability of pegged exchange rates are worth about about as much as a child's fistful of Monopoly money.

Woe betide those engaging in rumor-mongering or other unsavory activities, however.   News over the weekend suggesting that the Chinese authorities had rounded up nearly 200 miscreants for spreading disinformation.  Woe betide Mr. Li should he fall out of favour!

Macro Man corresponded over the weekend with his former assistant, who is living out his own personal version of On the Road  by meandering throughout Asia for much of the year.  Having spent much of the time in China, where he has family, Jimbo noted that the average Chinese doesn't really care about the stock market, which is only for the select few.  Of course, if the select few represents only 10% of the population, that's still 130 million frenzied punters....which naturally is a major part of the problem.

Elsewhere, it's been a tumultuous month for investors across a number of different strategies, and it would come as little surprise to see a lot of rather large absolute values in the monthly readings- both positive and negative depending on strategy and nimbleness.  On balance, however, the market has recently selected heavily towards strategies that benefit from rising assets and low vol,  so on balance the reading is probably not too pretty.

How will that inform punters' decisions for the rest of the week?   Obviously, with payrolls on Friday the will they/won't they for the Fed will receive either a small wedge in the door to keep it ajar....or a large iron nail hammering it shut.  Rightly or wrongly, it now feels like financial markets rather than economics will dictate whether the Fed pulls the trigger next month- and markets have a funny way of throwing their toys out of the pram to get what they want.

Macro Man was intrigued to observe that the SPY stopped at the 61.8% retracement level of the "down the lift shaft" drop, almost to the penny.  The thing about Fib lines is that if you draw enough, of course you're bound to find some that appear to define the price action.   That having said, it's a useful rule of thumb that most corrections retrace roughly half of the original move, give or take an eighth or so.

In that vein, it looks like if equities are going to stop and have another look lower, it should happen from here.  (Easy enough to write when futures are already down a percent and a bit!)  The risk/reward from selling with a stop above last week's high looks pretty good, though holding such a position through payrolls (or even Draghi on Thursday) is probably unwise.  Similarly, anyone who bought the break in oil referred to on Friday might do well to set a stop at levels that lock in at least a modest profit.  The good news is that volatility is sufficiently high that you don;t have to wait long to see some pretty sharp movement.

Finally, it's worth noting a bit of a milestone that occurred over the weekend.  West Ham United won at Anfield, home of Liverpool FC, for the first time since 1963.  To put that in perspective, the day before that match in 1963, the SPX closed at 73 (erroneously reported on Twitter over the weekend as 65.  Mea culpa.)

It's left for the reader to decide whether that says more about the Spooz or the Hammers....

Friday, August 28, 2015


All of a sudden, the world looks pretty good, doesn't it?  Spooz are up on the week (raise your hand if you saw that one coming 48 hours ago), Q2 GDP was revised waaaaay up, and even crude oil broke its steep downtrend with its best day in about 6 years.   The good news is positively gushing!

The GDP figures will no doubt come as a comfort to the Fed, and take some of the edge off of the recent worries about a corrosive deflationary episode.   Not only did the quarterly real growth figure come in at a handsome 3.7%, but the deflator also spiked above 2%.  As it is now, the Q2 figure is shaping up as one of the better ones of the post-crisis era.

Of course, we'll still have the usual hand-wringing about underused labour, a remaining output gap, etc.   To get a sense of what the models are saying about this, Macro Man plotted the CBO's estimate of potential nominal GDP with the actual readings from the BEA.  Sure enough, you can see the wide gap emerge over the crisis and slowly close in the ensuing years.

But how useful are these estimates of potential GDP, anyways?   Common sense would suggest that the trajectory of growth before the crisis was unsustainable with most inputs at equilibrium- otherwise we wouldn't have had a crisis.  Macro Man plotted the historical difference between the level of nominal GDP and the CBO estimate of potential to get a sense of the historical trends of this implicit output gap.

As you can see, since the mid-70's the CBO's estimate of potential GDP has generally outstripped the actual level of GDP, in many cases by a sizable margin.  While there is no guarantee that the Fed employs similar estimates of potential growth, such a systematic error would appear to cast a few doubts on the whole output gap framework.  At the very least, the overoptimistic GDP assumptions explain the generally execrable state of US public finances for most of the last 40 years.

In any event, some combination of the number, the rally in equities, and oversold technical conditions have finally breathed a spot of life into the oil market.   The trajectory of the crude price since midyear has resembled nothing so much as a cliff diver in Acapulco (like you used to get on weekend TV thirty-some odd years ago); yesterday, however, saw a decisive rejection of the last-gasp move below 40.

There's been some quality discussion of the fundamental dynamics of crude in the comments section over the last couple of days, and Macro Man doesn't have a whole lot of fresh insight to add to that particular debate.  From a technical perspective, however, the downmove looked a little tired earlier this week, so it didn't come as a complete shock to see the reversal.  Although CTAs are nowhere near being challenged on their positions, it would still be reasonable to expect a further correction higher.  Even a 38% correction would take October crude (pictured above) to $47 or so; a 50% retracement would have the price pushing $50.

What about energy equities?  Obviously there is a lot of idiosyncratic risk based on debt profile, cost of production, etc., so for any specific stock it is probably unwise to generalize.  To get a sense of the "beta" for energy stocks, however, Macro Man decided to have a little fun with ExxonMobil (XOM.) He plotted the ratio of that stock price to the SPX going back to the early 80s; unsurprisingly, the last few years have been pretty darned rough on XOM, taking it back close to its average relative price in the 1990's.

Obviously, this is a simple measure that does not capture the total return of the two series.  Nevertheless, as a simple proxy for what the market is willing to pay for non-idiosyncratic energy exposure (XOM is about as non-idiosyncatic as it gets!) relative to the index as a whole, it has some utility.

"But surely," Macro Man can hear you saying, "this ratio simply reflects the oil price?"   Well, yes and no.   In broad strokes, yes, of course it does, but there can certainly be periods when XOM can out- or under-perform crude on a relative basis.   In late 2008, for example, XOM handily outperformed the SPX even as crude was taking another swan dive, as it was first part of the "equity market crack" trade, and then seen as a safe haven with a nice dividend cushion when it was all going to hell in a handbasket.

What's interesting about this chart is that XOM led the weakness in crude over the past few years, rather than vice versa, and if anything still looks a little "cheap" by this measure.  With a dividend yield nearly twice that of the 10y Treasury, it pays OK, as well!  Obviously this is a pretty shallow analysis, but it does lead Macro Man to wonder when it would make sense to don the Kevlar gloves and have a look at equities in the energy sector.  It's been a long, hard road for them...but at some point they'll be priced where a gusher of their own looks close to inevitable.

(As an aside, Macro Man had to laugh at the advert that popped up when he looked at a dividnd yield history of XOM.  Talk about quick on the draw- one upday in crude and it's already pimping 'The oil boom'!  Somehow, the cowboy hat/goatee/cheesy half smile is what makes it click.)

Thursday, August 27, 2015

The best-laid plans

But Mousie, thou art no they lane,
In proving foresight may be vain;
The best-laid schemes o' mice an' men
Gang aft agley.

-Robert Burns, To a Mouse

Well, Macro Man had the right idea to get long yesterday, but apparently so did everyone else, as equities were bid when he woke up and only briefly threatened to tickle negative territory in the morning before ripping in the afternoon.   You know what they say about the best-laid plans...well, you do if you can read Scots, at least.

That's alright, at least his short-end trade came good, right?   Err....no.   The Dudley comments that the case for a September lift-off being less compelling than a few weeks ago were not particularly surprising- one might have thought that the recent 14-tick rally in EDZ5 was pricing just that- but that didn't stop the short end from ticking up further, because hey- PermaZIRP!

The long end received no such succor, however, as stories of Chinese selling similar to that reported here yesterday vis-a-vis Bunds began to percolate.   The data was pretty solid, too; the 3m/3m rate of change in core durable goods turned positive for the first time all year.

Interestingly, spot VIX remained stubborn, closing at 30.32 despite Spooz going out more or less on their highs.  Of course, the curve is sharply downward-sloping, which eliminates one of the prime attractions of selling vol (i.e., the roll-down of the VIX curve.)

While Macro Man is of the view that the fractured micro-structure of the market is a clear reason for implied and realized volatilities to be higher than those observed for much of the summer, he is not yet convinced that current levels in any way represent the new normal.  As such, he will continue to use the 30 level as a touchstone for the sustainability (or lack thereof) of any market correction; with VIX here, he is happy to wait for his price (or price pattern.)

Interestingly, the FX market more or less disregarded the Dudley comments that the short end apparently took so deeply to heart.  USD/JPY's back north of 120, the euro sub 1.14, and cable got shunted down the lift shaft some 370 pips below Tuesday's high.  Macro Man frankly isn't sure what drove that weakness, as sterling performed comfortably worse than even the euro.  While it's tempting to suggest the ongoing rise of left-wing loony Jeremy Corbyn has something to do with it, positioning is a much more likely culprit (what's new?)

In any event, the surge in the big dollar yesterday in spite of the Dudley comments would suggest that there was a lot of clearing out done earlier in the week, and that perhaps a few babies were chucked out with the bathwater.   Now, the last week of August isn't normally the time to start rebuilding positions, but then again this has been a pretty unorthodox last week of the summer, so it seems likely that there was at least some real buying going on.

It's interesting to note that October seems to be getting a bit of play now as a "compromise date" for the Fed's lift-off.   Like a lot of people, Macro Man has been running with the idea that the Fed would want to lift off in a quarterly meeting, with the full panoply of support via the SEP/press conference, etc.  He still holds that view, but acknowledges that the Fed has stated pretty explicitly that every meeting is a live one, and they could in theory call a press conference to explain something after a non-quarterly meeting.  The narrative emerging from this week's Jackson Hole conference will be particularly interesting in this regard.

At 3 ticks, the Oct/Nov Fed funds spread offers better than 7-1 odds of an October lift-off.  It's not like betting on the Houston Astros to win the World Series (100-1) before the season starts, but it's pretty darned good as a cheap punt if and as a narrative over a possible October lift-off builds.

After all, cheap bets offering high potential payouts are a cornerstone of the best-laid plans of building a macro portfolio.

Wednesday, August 26, 2015

Achtung, Kapitan!

Just when you thought the good ship S.S. Spoo had righted itself after a couple of nasty rogue waves, it went and hit a bit of uncharted reef late in Tuesday's session.  Morning ecstasy turned to afternoon despair, and you can just envisage a scene similar to that from a black and white WWII movie in which the German seaman shouts "Achtung, Kapitan!" when spotting Allied torpedoes approaching.

Let's get one thing clear: this is not 2008 redux, for the simple reason that the underlying stress in the real economy of most of the world is not nearly as significant as it was 8 years ago.  That having been said, there are pockets in which the current environment is worse than the GFC:

* China's real economy and shadow banking system are in worse shape.   Without delving into too many specifics, the authorities went all-out on stimulus in 08/09, not only borrowing from future growth but also encouraging an even more extreme misallocation of capital than was the case previously.

* Commodities have been hit by the twin storms of previous capex coming on line and reduced demand thanks to China and shifting demand patterns elsewhere.   Remember that a key plank in China's stimulus platform in response to the GFC was to engage in strategic purchases of key commodities.  It seems safe to say that that ain't happening this time around, and China's natural rate of demand is also ebbing with the economy downshifting to a lower growth profile.  In the US, the capex into oil extraction from alternative sources has naturally made the sector (and its debt) more vulnerable to sustained lower prices, given the relatively higher breakevens from extraction.

* Market microstructure.   At the risk of belaboring this point ad nauseum, it cannot be re-iterated enough how ephemeral the price on your screen is.  In many cases, there are no real market makers any more, only "liquidity providers" who can come and go as they please.  Brokers act on an agency basis, which means if you want to sell, the price you get is one that another punter (or "liquidity provider") wants to buy.  Unfortunately, that's not always the price at which you want to sell!

Of course, regulators have made noises in the past that less market liquidity is not necessarily a bad thing, as it exacts divine retribution on punters with the temerity to get their size and direction wrong. File this one under "be careful what you wish for, because you just might get it."

Macro Man was somewhat disgusted to see HFT shop Virtu trumpeting in the WSJ that Monday was one of its best ever days.   (This from the firm that famously never loses money.)   "We were there to catch the falling knives," they claimed, neglecting to mention that they also helped tip the knives off of the edge of the table to begin with!   One wonders what the regulatory reaction would have been had a bank or a bloke living over his Mum's garage had made a similar claim.

In terms of markets, yesterday's price action was obviously pretty poor- giving up a 70 point rally in the SPX is not a good thing, producing the dreaded "Satan's middle finger" candlestick formation.

The 30 level in the VIX remains a useful touchstone; although it was breached with Spooz at their ding-dong highs, the break could not hold, which was a significant warning signal.

It seems likely that the equity market will have another look at the downside today; at the time of writing 10 pm NY, Chinese equities aren't exactly blowing anyone away with their reaction to yesterday's policy easing- which itself was fairly close to the bare minimum that one could reasonably have expected.

For choice, however, Macro Man will be inclined to buy this dip (assuming it has materialized), as he would expect some sellers with weak hands to materialize, especially after Tuesday's price action.  It's not a particularly high conviction view, however, so the size will be very social indeed until some ancillary indicators give him a bit more confidence.

One final note, this time one bonds.  Yesterday's price action stank worse than a day-old kebab, particularly in Bunds, which couldn't get out of their own way.  One narrative circulating was that a sovereign that had spent some of its FX reserves defending its currency was ditching its lowest-yielding bonds to brings its portfolio back in line.   The story is eminently plausible, as there are plenty of candidates for FX reserve burn, and would you keep the bonds yielding less than 1%?

That Bunds could not manage to outperform BTPs this week is another indication of some fairly persistent selling pressure in the former.

Macro Man remains of the view alluded to yesterday that fixed income is not a bad way to fade the current rout in risk; sure, there is downside, but if the CBs are selling there is at least something of a backstop.  Either way, they didn't really rally when stocks were getting crushed and they got crushed when stocks rallied.   In the short run, at least, that divergence is telling you something; that the usual suspect owners of zillions of bonds have blanketed the press talking down Fed hikes (and up Fed easing) sends a similar message.

It would be nice, for once, if the beneficiaries of the most egregious misallocation of capital were forced to shout "Achtung, Kapitan!"

Tuesday, August 25, 2015

A few thoughts from Monday night NY time

Well, that was interesting.   Macro Man wishes to extend apologies to all readers for not informing them of his presence at a beach yesterday; the short trip to Rhode Island was a spur-of-the-moment thing, and your author didn't think that the "world goes to hell while he's on holiday" rule applied.  Mea culpa.

That having been said, those souls portraying yesterday as some sort of "Black Monday" were well wide of the mark.  Macro Man can only assume that they were literally playing with black crayons in 2000, and figuratively in 2008-09.

To be sure, the market liquidity environment was execrable, from the Chinese meltdown to the Nikkei meltdown to the DAX meltdown to the Spooz meltdown to the ETF meltdown to the USD/JPY meltdown to the subsequent meltups....and back down again.

Yesterday's hastily scribbled assertion that the time might be nigh to don the kevlar gloves proved wide of the mark; that having been said, the 30 level in the VIX did serve its purpose to a tee.  Spot VIX obviously gapped through the level (when it could be bothered to print at all!), but notice how the 30 level held almost to the tick on the equity uptrade before Spooz rolled over again and VIX rebounded.

If anything, this strengthens Macro Man's conviction of the utility of the 30 level as a tell.  While it is obviously nice to use massively oversold conditions to cover profitable shorts, Macro Man would be leery of running even the most tactical of longs until the VIX breaks that 30 level and heads lower.  Otherwise, that's not a knife you're catching with those kevlar gloves, it's a neutron bomb.

Still, it's been a while since Macro Man's been able to suggest a trade on Friday (short Nikkei) and have it some go nearly some 15% in the money on an intraday basis on Monday.   For choice, he would cover half of it here (17910 at the time of writing) and run a stop at the entry level on the balance- while being prepared to roll that down if and as the index makes new lows.

The reaction to yesterday was quite telling.  The closer you are to a P/L, the more interested you were to keeping your head down and figuring out what would happen next.   The closer you are to political office (current or desired), the more interested you were in casting blame for the unspeakable fact that markets went down.  Such is the realpolitik of markets in the brave new world of the modern regulatory environment.

What does make the current environment different from 2000 or 2008, of course, is the prevalence of algos in the market and the lack of presence of banks as risk-warehousing intermediaries.  Macro Man saw an interesting stat suggesting that while there were a record number of trades in S&P minis yesterday, there was not a record volume because the average ticket size was a mere 2.57 lots.  That's fairly astonishing, given that the minimum size is obviously..err....1.  Whether that meager size was down to the algos doing the trading in intentionally small sizes, an abject lack of liquidity, or both is of course an interesting subject for debate.

Macro Man looks forward to the report in 5 years' time damning some poor bugger living over his Mum's garage for causing today's meltdown.

In seriousness, however, the air pockets observed in so many of Monday's markets do not speak well of the micro-structure.  While China is of course a source of duress, imagine how bad it would/could be if the locus of distress was in the domestic real economy rather than speculative foreign financial markets.  It's high-hanging fruit, but regulators would do well do address issues related to "liquidity providers" and their movable feast of participation, even if they can't raise the sort of cash generated by LIBOR and FX fixings.

(As an aside, how do the regulators square the fines levied for those scandals with the paltry one levied on Citizens Bank, which was found guilty of literally stealing customer money?)

In the meanwhile, the structural failings of the market merely add to the volatility unleashed by the tightly coiled spring that has snapped back.   As Macro Man wrote on Twitter yesterday, Monday's price action was extraordinary- almost as extraordinary as the SPX remaining confined in a 5% range for 6 months.  You only need to observe one episode like this to learn that the longer that volatility is suppressed, the more violent the rupture when the low-vol environment breaks.

As for the Fed, obviously the deeper and longer any market correction, the less likely it is that they move this year.   That having been said, Macro Man does not agree that the chances have already telescoped to something approaching zero.  That the dollar took a bit of a beating yesterday- at least against the euro and yen- should give at least a little pause to the USD caveat expressed in the minutes, though of course on a TWI basis the dollar's weakening was less notable.

More to the point, while Macro Man has given the Fed plenty of stick over the years, even he doesn't think them so obtuse as to not recognize that this sort of reaction was at least somewhat possible in the run-up to any tightening.  As a result, he think that they'll play it by ear and not rush to judgment either way, a sentiment more or elss echoed by Dennis Lockhart's speech yesterday.

Your author can recall thinking in the immediate aftermath of Hurricane Katrina a decade ago that there was no way that the Fed wouldn't pause its tightening cycle to assess the (much more real) damage; two weeks later, and it was obvious that they were going to keep on truckin'.

Now obviously, that was Greenspan, not Bernanke (let alone Yellen!), and there's a massive psychological difference between continuing and starting a monetary cycle.  That being said, the point of the recollection was to illustrate how swiftly sentiment can change in a matter of a few days.  Intellectually, something close to a critical mass of the FOMC seems to have decided that they'd like to ditch ZIRP; as such, the news will have to remain bad for them to abandon that intent.

Maybe it will happen, maybe it won't, but with markets pricing only a 50% chance of any tightening by year end (versus 50% for September less than a week ago), the risk-reward is starting to look pretty good.  Macro Man sold a small initial clip of January Fed funds futures yesterday, and is hoping for a further rally so he can add to the position at even nicer odds.   It will take a hell of a lot in terms of news and price to push that totally to zero, so it should be an easy position to hold even if stocks take another downleg.

Finally, China.   A few minutes ago, Macro Man saw that USD/CNY fixed lower on the day, which surely illustrates the authorities' emphasis on FX stability as the rest of their world apparently crashes down around their ears.   There are some truly fantastic numbers being thrown about regarding intervention amounts, with the linked article suggesting $200 billion in the two weeks since the deval.

Simply put, PBOC could not extract that amount of RMB from the system without sterilizing (RRR cut/buying shedloads of T-bills) or causing a major money market rupture.  To date, neither has occurred, so Occam's razor suggests that the intervention size has been much smaller.  That having been said, the whole debate illustrates the opacity of the whole Chinese FX and monetary regime.   One thought that presents itself is that the next release of Chinese FX reserves will be very closely watched for clues as to how much firepower has been spent.

One cute trade would be to do a calendar spread, selling FX vol expiring before the release and buying some expiring soon after.  Bid/ask might be prohibitive, particularly in any sort of proper size; nevertheless, trying to figure out a way to game the idiosyncratic opportunity provided by a generally obscure piece of data is one way for the humans to kick the Matrix where it hurts.

Monday, August 24, 2015

Bullets from the road....to Armageddon?

Macro Man is traveling today so is forced to keep his observations brief:

* The Nikkei short suggested on Friday has worked a treat, and a testament to finding outliers when beta is trumping everything

* Alrhough Chinese equities are now down on the year, Macro Man remains unconvinced that CNY/CNH depreciation will become disorderly....at least not til we see a substantial chunk of China's FX reserves ebb away.  And if that were to happen, it's reasonable to ask what would happen to the Treasuries etc where those reserves are currently parked.

* Alrhough it feels like Armageddon, it's important to recall that these types of episodes are more normal than not.  The current one does not necessitate recession, though it has probably stayed the Fed's hand for September

* VIX will open above 30 today...that has historically been the point of exhaustion for non-crisis corrections.  Today's price action will therefore be quite telling, and owners of Kevlar gloves may wish to deploy them, if only gingerly, this morning