Thursday, September 18, 2014

The Hadrian Partition

Dramatis Personae

David Cameron......................................Captain James T. Kirk
Menzies 'Ming' Campbell.....................Mr. Spock
George Osborne...................................Dr. Leonard 'Bones' McCoy
Alistair Campbell..................................Lt. Cdr. Montgomery Scott
Alex Salmond.......................................Captain Bruce of the USS Hadrian
Nick Clegg.............................................A redshirt security man #1
Ed Milliband.........................................A redshirt security man #2
Moira Stewart......................................Lt. Uhura
Vladimir Putin......................................Ensign Pavel Chekov


Kirk:   Stardate 2014.18.9.  The Enterprise has been called to the Albion quadrant to investigate the status of the USS Hadrian.   The Hadrian has not responded to subspace communications from Starfleet Command for several weeks.  A possible mutiny is feared.

(Cut to the bridge of the Enterprise)

Chekov:   Approaching the Hadrian, Captain She appears to drifting aimlessly in space.   Recommend we lock her in with NX-ray tractor beam, sir.

Kirk: Thank you, Mr. Chekov.  Hold off on the NX-ray for now.  Mr. Spock, can I get a visual?

Spock: Yes, captain.

(Cut to image of the Hadrian floating in space.   A faint shimmering is observable around a quarter of the way from the stern.)

Kirk: Spock, magnify image.

(Cut to larger image of the Hadrian.  A blue curtain of shimmering light has intersected the ship where the engines connect to the main body of the ship.)

Spock: Fascinating.

Kirk:  What do you make of it, Spock?   Is there anyone on board the Hadrian?

Spock: (checking instruments):  Affirmative, Captain.  The instruments read 112 life-forms on board- a full crew.

Kirk:  And the wall of light?

Spock: It appears to be a negative energy field, Captain, that's locked onto the Hadrian.  Given that the crew are all still alive, it would be logical to conclude that it has not caused any harm...yet.

Kirk:  Uhura, try to raise the captain of the Hadrian on subspace radio.  Who is it these days?  William Wallace?

Spock: I believe it is Captain Robert D. Bruce, Captain.

Uhura:  Hadrian, this is the Enterprise.   Come in, please.   This is the USS Enterprise calling the USS Hadrian.   Come in, please.   (pause) No answer, Captain.

Kirk:  We'd better go check it out.  Spock, Chekov, come with me.  (Walks to the door of the bridge, then speaks into intercom.)  McCoy and Scotty to the transporter room at once.  Prepare to beam aboard the Hadrian.

(Cut to Kirk, Spock, McCoy, Scotty, Chekov, and two redshirts beaming aboard the bridge of the Hadrian.  In contrast to the Enterprise, the interior of the Hadrian is painted a pleasant green colour.  A number of uniformed crew-members are silently milling about, aimlessly.  There is no sign of Captain Bruce or any of the Hadrian's other officers.)

Kirk (grabbing a gold-shirted Hadrian crewman):  You there!  I'm Capatin James T. Kirk of the USS Enterprise.  Where are your captain and the other officers?   What's going on here?

(The crewman looks at Kirk silently, then resumes milling about when Kirk releases his tunic.)

Kirk:  Bones, what's wrong with them?

McCoy:  Impossible to say, Jim, without a thorough examination in the infirmary.  I'll take the one you spoke to and give him a complete physical.  (He starts to leave the bridge, guiding Kirk's crewman by the arm.)

Spock (scanning the crewman with his tricorder): All neural and physical activity are normal, Captain.

McCoy:  Dammit, Spock, something is wrong with them!  Maybe they've had an emotional trauma...that can be deeply disturbing!  Can't you get that through your logical Vulcan mind?

(Spock raises one eyebrow and says nothing.)

Kirk: Bones, leave him be.  Get to the infirmary and find out what's wrong with this crew!   We need to find Captain Bruce and figure out what that energy field is!  Scotty, can you go to the engine room and see if the energy field's having any effect?

Scotty:   Aye-aye, Cap'n!

Chekov:  I think we should use the NX-ray now, Captain.

Kirk:  Yes, thank you for sharing your opinion Chekov, but right now it's not needed.  You stay here in the bridge.   Spock, let's explore the ship.

(He and Spock leave the bridge, followed by the two redshirts.  Cut to the Captain and his party exploring a random corridor of the Hadrian, passed occasionally by an indifferent crewman.)

Spock:  Captain, I was thinking....(He is interrupted by the beeping of Kirk's communicator.)

Kirk:  This is Kirk.

(Voice of McCoy):  McCoy here.   Jim, I've never seen anything like it.  This crewman is perfectly healthy in every way, but he simply has nothing to say!

Kirk:  Bones, we need more than that.  Stay there.  Spock and I will come have a look.

(Cut to the infirmary.  Kirk and Spock walk in as McCoy is bent over the prone body of the blinking Hadrian crewman.)

Kirk:  Bones, we need this crewman to talk!  You've got to do more!

McCoy:  Dammit Jim, I'm a doctor, not a miracle-worker!  We need to get inside the head of this man, and I just cannot do it!

Spock:  Captain, might I suggest that I employ the Vulcan mind-meld technique.  If there's anything in this man's mind, I may be able to draw it out.

Kirk:  Good idea, Spock.  Do what you need to do.

(Cut to image of Spock locked in a mind-meld with the silent crewman as Kirk and McCoy look on.   Kirk's communicator beeps.)

Kirk:  Kirk here.

(Voice of Scotty):  Cap'n, it's Scotty here.  I dinna want to alarm ye, but that there negative energy cairtain is tryin' tae break the ship apairt!  We have anaither few houairs, and the Hadrian will be splet in two!

Kirk:  Is there anything you can do, Scotty?

(Voice of Scotty):  Och aye, Cap'n, I'm wairkin' as hard as I can.   Come on you beauties, ye know what tae do!

Kirk: Keep me posted, Scotty.

(Voice of Chekov): We could use NX-ray to keep ship together, Captain!

Kirk:  Yes, I know your view, Chekov.   That will be all.   Kirk out.

(Spock stirs and separates from the crewman, shaking his head somewhat groggily.)

Kirk:  Spock!  Are you alright?

Spock:  Yes of course, Captain.   Getting inside this man's mind was a fascinating example of scientific...

McCoy:   Come on, Spock, enough of your dithering!  What was inside the man's brain?

Spock:  The spectre of the dividing wall of negative energy first descended upon the ship a few weeks ago, separating the ship in two.   Those to the south of the wall, which comprise the majority of the ship, were left with an overwhelming compulsion to remain silent, as if they have nothing to say.  Those caught on the other side of the wall, which include the captain and his officers, have seen some of their number actively trying to break the ship apart, while others attempt to stop them.   It's quite fascinating...of course, if the ship were to break apart, many of the crew, including those under the compulsion of this strange negative energy, will likely perish.   This crewman seems to think that among those caught on the other side of the energy wall, it's evenly splity between those who want to sunder the ship and those who are trying to keep it together.

(Voice of Scotty over the intercom):  Cap'n, it's gettin' wairse!  This ship could break apart in just a few short houairs!

Kirk:  Do your best, Scotty!  Bones, Spock, we'd best investigate this wall of negative energy.

(Kirk, McCoy, and Spock walk out of the infirmary and down the hallway, where they are followed by the two redshirts.  Cut to an image of a large room which is bisected by the shimmering blue curtain of negative energy.   Perhaps it is a trick of the light, but there appears to be a faint outline of a white 'X' on the curtain.   On the far side of the curtain, crew members of the Hadrian can be seen and heard arguing.)

Kirk:   Crew of the Hadrian!  What's going on here?

(A jowly man in a Starfleet Captain's uniform stops arguing and looks through the curtain at Kirk in surprise.)

Bruce:  Who the daivil are ye?

Kirk:  Captain James T. Kirk, USS Enterprise.   And you, I presume, are Captain Bruce?

Bruce:  Captain Robert T. Bruce.  (Bruce executes a florid little bow.)  What are ye doin' on mah ship?

Kirk:  We've been sent by Starfleet Command because you've not been responding to their communications.

Bruce:  Wail, it's hard tae respond when ye're stuck in the arse-end of the ship, ain't it, laddie?  Run along, now, Kairk, and tell Starfleet everything's just fine aboard the Hadrian...or will be soon enough.

(Voice of Scotty):  I cannae hold her much longer, Cap'n!   She's on the vairge of breakin' up!

(Voice of Chekov):  Use the NX-ray, Captain!

Kirk (into communicator):  Scotty, you must keep her together!   Chekov, one more peep out of you and I'll have to sanction you.  Now Captain Bruce, suppose you tell me about this energy field and about the ship breaking up?

Bruce:  Och aye, that's nae concairn of yours, lad, nor of anyone else's!

McCoy:  But this is a Starfleet ship!  You can't just tear it apart on a whim!  There are lives at stake!  You've been brainwashed by this negative energy field!

Bruce:  Nonsense lad, I couldn't be thinking more clearly.  This part of the ship is tired of being under the yoke of Starfleet, and we're aiming to do something about it!

Anonymous Hadrian crewman:  You've got to stop him! He's mad!

(Bruce turns and casually fires his phaser at the crewman, who slumps to the ground.  The two heretofore irrelevant redshirts hoist their phasers and attempt to fire through the curtain.   The beam rebounds and hits the men, who collapse in a heap.  McCoy rushes over and checks them with his scanner.)

McCoy: Jim, they're dead.

Kirk:  Now look here, Bruce, you've killed two of my men.

Bruce:  Typical Starfleet oppressor,  blaming us for their own mishaps.   Let me tell ye laddie....this ship waill break up, we waill escape the Hadrian, we waill colonize a new planet and we waill join the United Federation of Planets...on our own terms.

Spock:  You're being most illogical, Captain Bruce.  Even if you manage to separate this ship and leave it somewhat structurally sound, your remnant will be too small to travel very far in space.  Even if you manage to find a habitable planet, in all likelihood the journey will be an unpleasant one.   You should consider the benefits that you get from being a part of Starfleet before deciding to leave.   Finally, even if you do manage to colonize a planet, you'll have no chance of joining the Federation.  Its current members, including Starfleet, will simply not allow it.

(Bruce looks at Spock and laughs maniacally.)

Bruce:  Liar!  We waill join the Federation.   As for our our survival, naiver you worry.   We have a wee nest egg of Federation credits saved up that we'll use until we join.

Kirk:  And what makes you think that anyone in the Federation will accept those credits?   Good god, think man!   You're endangering a hundred lives simply to satisfy a schoolboy's grudge!  How can you be so irresponsible?

Bruce:  Och, I'll show you irresponsible!

(Bruce opens a console on the wall and starts manipulating some of the controls within it.  The blue curtain appears to flicker, then reappear with an even stronger intensity.  The ship lurches violently, throwing Kirk and his colleagues onto the floor.)

(Voice of Scotty):  Cap'n, she's strating to fracture!  Oh my bonny lass, hang togaither!  No one loves you more than your Scotty!

Will Kirk, Scotty and the crew of the Enterprise manage to combat the negative energy field and keep the Hadrian intact?  Or will Captain Robert D. Bruce success in his plot to sunder his ship and start a new society?

Tune into BBC1 Thursday night (or Friday morning?) to watch the exciting conclusion to The Hadrian Partition!


How watching Yellen is like watching a football match

(This gag was first sent out on Twitter yesterday.  For reasons that will soon become apparent, this succinct summation of the Fed will have to suffice.)

In watching Yellen's press conference yesterday, particularly her waffling about over the dots and the meaning of 'considerable time', it struck Macro Man that much of the Fed's communication strategy (authored by Yellen) is predicated upon a sad misapprehension that verbosity is equivalent to insight.  Sadly, in the case of the modern Fed, the latter is altogether true.  Watching reminded Macro Man of his days going to the footy.....

Wednesday, September 17, 2014

The big day arrives

The big day that's been on the calendars of Fed-watchers everywhere has finally arrived, and with it a signpost to some of the trends of the last few weeks.   Will the Fed signal "Full Speed Ahead" by articulating a detailed set of exit principles (a necessary prerequisite for ending ZIRP) and perhaps even dropping the "considerable period" language?  Or will it announce "U-turn" by waffling on any concrete timeline for exodus and maintaining the current forward guidance as-is?

For choice, Macro Man would probably lean towards the latter, though a third option "Something for Everyone" could well be the most plausible outcome- announcing a general set of principles (without articulating specifics such as the IOER/RRP  rate spread) while maintaining the "considerable period" language.

Indeed, Macro Man feels relatively confident that "considerable period" will be maintained.   Although there is of course no guarantee that the previous tightening cycle a decade ago will be followed to the letter, it does provide a precedent and a timeline with respect to guidance language that the Fed may well believe can guide markets.

For those of you under the age of 32 or so who have never seen the onset of a Fed tightening cycle, consider the timeline below and possible analogue to the current environment:

June 2003 (September 2014): Fed eases policy   (rate cut in 2003, last announcement with QE in 2014.)

August 2003 (October 2014): "In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period."

September 2003 (December 2014):  "In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period."

October 2003 (January 2015) : "In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period."

December 2003 (March 2015): "However, with inflation quite low and resource use slack, the Committee believes that policy accommodation can be maintained for a considerable period."

January 2014 (April 2015):  "With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation."

March 2004 (June 2015):  "With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation."

May 2004 (July 2015): "At this juncture, with inflation low and resource use slack, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured."

June 2004 (September 2015): Rate hike.

The analogue above is far from gospel, and if you wanted to suggest that because of the extraordinary easing put in place over the last six years that the current year should be shifted forward by a few months (leading to a rate hike in, say, June of next year), Macro Man wouldn't argue too vociferously.

The over-arching point, however, is that the Yellen Fed is likely going to walk on eggshells in tightening policy, providing as much gentle early warning as possible.    What better way to do so than repeat the mind-numbing semaphore of the Greenspan era?

Anyhow, as Macro Man sees it, once the "considerable period" gets ditched we're in for two "patients" and a "measured" before the tightening proper commences.    He feels pretty sure that the first hike will come in a quarterly SEP month, which would provide forecast cover as well as give Yellen a chance to explain herself to the public.   Certainly we see a similar dynamic at play with the ECB and BOE, where policy moves often occur during quarterly forecast months.

From Macro Man's perch, this will be the first serious test of the dollar trade of the past few weeks.   Sure, payrolls were poor but the market has had a funny way of ignoring Le Chiffre when it suits.  Insofar as much of the USD trade has been about policy divergence between America and the rest of the world, evidence that the US leg may come a bit later than desired could throw a right cross at George Washington's jaw.  (Suggestions that the ECB is struggling to muster demand for TLTROs won't help, either.)

As for rates, Macro Man bought a few red eurodollars yesterday, as trading the range still seems to make sense- particularly if Yellen sticks to her colours and downplays the imminence of tightening.

As for stocks?  You'd have to think a scenario with a somewhat weaker dollar and lower rates would be taken positively; no doubt that's what yesterday's rally was front-running.  Although Macro Man continues to trim length on strength, he cannot yet bring himself to go short, as neither the price action nor a catalyst suggest it's time.

'Twill come soon enough, no doubt; when it does, much better not to have the burden of a stale, money-losing short to overcome (mentally and financially.)

Bonne chance a tout!

Monday, September 15, 2014

A little sport to start a big week

It's obviously a massive week for macro punters, what with the Fed and the Scottish vote and the first TLTRO auction.  Why not ease into it buy watching a little sport, like a high dive competition?

Our first competitor, "80s man", is diving off a platform 52.4 meters high....

Very impressive!   Can our second athlete, "China Industrial Production", top it?

Ooooh, the judges like that one, Jim!   Much like in the Olympic events, the Chinese diver takes the lead!  Can our third and final contestant, "AUD", possibly unseat the Chinese champion?

The crowd is on its feet, roaring with approval!    Jim, I think the AUD has won the diving competition!   It has!  A stunning upset!   Let's go to Mesa Jones, our sideline reporter.  What can you tell us, Mesa?

"Well Gary, the Australian team is clearly jubilant that their athlete, the AUD, has performed so well in a diving competition.  Just a couple of weeks ago it was unclear whether the AUD would be able to dive at all, so this is a real upset and the Aussies are over the moon at their victory.

"When I spoke to the Chinese coaches, they were very disappointed with their performance, which nobody saw coming.   Although Chinese IP has been competing naturally for some time now, the coaches suggested to me that they may soon put IP back on a course of performance-enhancing drugs.   Back to you in the studio, Gary."

There you have it, folks, a superb diving competition to start your week.   Stay tuned for more great sport later this week, including Connect-the-Dots from Washington DC,  the British Tug-of-War Championships over Hadrian's Wall, and target-shooting from Frankfurt.

Thanks for watching CNBC8, the Ocho!

Thursday, September 11, 2014

When will the profit-taking come?

One of the sad realities that Neil highlighted in his recent guest piece was the propensity of markets to take profits swiftly whenever there is a decent move.  Part of this is of course a function of the aimless nature of macro in a zero interest rate world; part of it is also a function of the "five minute macro" mentality that so many punters embrace (willingly or unwillingly) as a function of their risk management framework.  No doubt some of it is also the various "puts" sold by central banks which tend to push assets back towards some mean.

Regardless, at a charity golf outing on Monday Macro Man heard several anecdotes of profits being taken in the euro after a whopping 3.5 big figure move.  Of course, 3 days is a full market cycle in 5minutemacroland, and positions have no doubt been subsequently re-added.  Yet with major event risks looming, Macro Man cannot shake the sad idea that a deeper bout of profit-taking might be in the offing.

Sterling, for example, is following the precedent of CAD in 1995 almost to a T, weakening to its lowest level several days before the referendum, then drifting slowly higher.  Yesterday's poll result obviously gave cable a kickstart higher;  with that weekend gap looming at the time of writing, what odds that we close it before the referendum just to screw everyone who sold last weekend's poll result?

Eurodollars, meanwhile, continue to dribble lower on the back of the SF Fed research paper released the other day.  Macro Man regards that as little more than doublespeak- a regional Fed research department doesn't necessarily speak for its regional President, let alone the FOMC as a whole.   Just ask the freshwater economists in Minnesota, who were eventually sacked by that notorious monetary smackhead Kocherlakota for disagreeing with him!

Anyhow, the usual-suspect contracts are now at levels that have generally held over the summer.  EDZ5, for example, has much liked it below 98.90, except for one brief foray that ended with the Fed's blase policy announcement on July 30.

In the "good old days" of 5 years ago, of course, when you saw a trend emerging you hopped on it and added as it went your way.  Obviously, in a mean reverting world that's not the greatest idea...especially when everyone else is taking profits.  Of course, there's the rare exception to the rule (USD/JPY in 2012-13, for example), which perhaps unsurprisingly have been prime sources of macro returns when they occur.

Nevertheless, it's been a good run over the past six weeks, and with the Scottish vote and the Fed in the pipeline, it would be surprising to see those with profits not cash in at least a few of their chips. As always, the trick is to figure which trends have been noise and which are set to continue.  For choice, Macro Man likes Z5/Z6 steepeners in EDs, and prefers USD/JPY to cable....

Tuesday, September 09, 2014

Ending the cult of loss aversion in global macro

With macro markets finally starting to percolate nicely, the following is a guest post by friend-of-the-blog Neil Azous of Rareview Macro.  Neil's piece reflects many of the conversations that Macro Man has had with friends the industry, and was originally published here.

The 2008 financial crisis exposed institutional money managers to a range of risks for which they were not prepared. Some of these were market risks, in which the value of their investments declined more than they had previously imagined possible. Some of these were liquidity risks, in which still-viable strategies gated their funds, thereby preventing investors from getting their money out. Finally, some of these were operational risks, in which the demise of Lehman Brothers and the Madoff scandal highlighted the importance of factors such as accounting, compliance, and infrastructure, as well as just performance when it came to choosing a fund.

In the wake of a traumatic loss, whether it is financial or personal, it is just human nature to overcompensate to make sure the experience is not repeated. But while that is understandable, it is rarely the best response. And so it has proved for many hedge fund investors over the past few years. While one could argue that each of the investor responses highlighted above has damaged investment performance, this article will focus on one specific issue:  the cult of loss aversion in global macro investing.

Although some global macro funds performed strongly during the financial crisis, others were caught up in the maelstrom.  As a result, while the strategy attracted strong inflows in 2009-2010, enthusiasm was tempered to a degree by the realization that an idiosyncratic macro investment would not automatically guarantee a hedge against generalized market stress. At the same time, the recipients of these inflows were keen to maintain their larger asset bases and the fees associated with them. This has become a particularly important factor over the last several years as conventional strategies have performed strongly, and with investors demanding positive returns in macro regardless of the underlying market and policy dynamics.

The result has been a concentration of assets under management (AUM) amongst a few very large funds, many of which fetishize loss avoidance over all other factors in trade selection and risk management. Of course, risk management is an important part of any robust investment process.  However, in modern macro investing the cult of loss aversion is becoming counterproductive given the fundamental and market outlook.

These days, most macro managers can be more accurately described as ‘hedged’ than ‘absolutely discretionary return’ investors. When legendary traders such as George Soros or Stanley Druckenmiller were making a name for themselves in the British Pound or Equities (yes, he was long a lot of them) they did not have a “hedge” against those positions because they truly believed in them. Sadly, very few macro managers have this level of conviction these days. They are too worried about taking a loss rather than a making huge profit.

In a world of many independent opportunities and a widely-dispersed asset base, it is completely rational for firms to use tight trade- and portfolio-level stop losses, because with rare exceptions (such as during times of acute market volatility) each stop loss decision has little bearing on the behavior of the market as a whole. Unfortunately, this does not describe the current state of the market.

Thanks to the static monetary policies operating in many major economies, there are relatively few independent investment opportunities with sufficient market liquidity to absorb a thematic allocation from a large global macro fund. As a result, the few such trades that do exist very quickly become over-crowded, particularly by the few large funds that dominate the AUM base of the strategy. Unfortunately, this leads to paranoia and a fear of loss rather than a healthy balance between risk taking and risk management.

When the markets do move, portfolio managers are incentivized to take profits or reduce risk very quickly. Why? Because macro investing has become a game of musical chairs, where investors need to make sure they are not the one caught out when the music stops. Those on the right side of the market, aware that most of the past five years have been characterized by range trading in foreign exchange and fixed income, move to ensure that they do not drawdown their investment gains. Those with losing positions, on the other hand, do not feel able to view markets through a value prism, and instead worry about the possibility of hitting their modest loss thresholds, and thus closing out positions at disadvantageous levels. Consequently, the de facto “macro” time horizon has been compressed into a few hours to a few weeks, leaving relatively few able to capitalize on the thematic gains that have traditionally characterized the strategy.

Although generating a 10%-12% gross return should not be a particularly hard target in an environment where risk parity funds have produced 20%+ annualized gains over the last few years, the current focus on loss avoidance above all else has condemned the macro strategy to a performance that is mediocre at best.  If a portfolio manager is unable to weather a 5% drawdown without having his risk allocation cut or eliminated, how is he to participate in the type of trades that generate double digit returns? The answer is he cannot. Unfortunately, what is individually rational (i.e. cutting risk quickly to avoid hitting drawdown limits) has proven to be collectively irrational as the industry careens from stop-loss to stop-loss.

This negative feedback loop has provided even more incentive for investors to allocate elsewhere, and very often to managers dedicated solely to one asset class, including funds that are far less focused on loss aversion or a metric like a Sharpe Ratio. Remember, investors can market returns. They cannot market a Sharpe Ratio.

It is ironic that the macro strategy has lost its way considering the opportunity for out-performance from some of the big themes of the last four years – long Equities (yes that is a macro investment), long Interest Rates, long Credit, and short Volatility – was very large. These were strategies that in previous cycles made big profits for the macro managers who got them right.

They can do so again. That is why the call right now should be to re-think how investors look at risk. What investors should demand from their managers is a return to old-school macro investing, where themes are given time to play out, portfolio turnover is significantly reduced, and more focus is placed on absolute returns at the expense of fetishizing drawdown limitation.

At the very least, investors should take a look at the macro managers that have evolved post the Global Financial Crisis. A new breed of portfolio managers are emerging who  are “risk conscious” and use their expertise in derivative products to add both edge and control to concentrated investing. True, their absolute AUM pales in comparison, and certain strategies may have liquidity constraints in terms of scale, but it is becoming easy to identify this group of “risk conscious" managers from those simply focused on loss aversion.

Additionally, the sector needs another George Soros, who generated 25%+ returns year after year, with a Sharpe Ratio lower than a diversified US 60/40 benchmark. How was that done? By believing in his themes and betting big. Otherwise, it is just a matter of time before investors realize their collective actions have squeezed the risk appetite out of managers and left the global macro landscape without an edge.

Should such a change occur, there are plenty of thoughtful managers who will again reap significant benefits for investors.  Recall that the so-called golden age of macro investing featured concentrated positions, higher volatility, and a somewhat lower Sharpe ratio.  However, it also offered excellent diversification against a portfolio of risky assets and generated large absolute returns.

Until then, we can only hope that current circumstances are not merely incentivizing those with the best marketing pitch  and the quickest trigger finger, but instead rewarding the truly talented while weaning out the less skilled….the way Darwin meant it.

Monday, September 08, 2014

Sweating Scotland

Way back in April,  when Macro Man mused about the then-distant Scottish independence referendum, he suggested that sterling should eventually be priced with a risk premium in the run-up to the vote.

At the time, of course, it seemed like the issue was largely a talking point for FX salesfolk to drum up business, given that market focus was squarely upon other issues such as Carney, the Fed, Europe, etc etc.  To be sure, sterling has fallen quite sharply against the dollar, though given the relative stability in EUR/GBP much of that was a dollar issue rather than a sterling one.

Today, however, there can be no doubt that markets have noticed the Scottish issue, as weekend polls put the independence supporters in the lead, with now a scant ten days to go before the vote.  A quick glance at 1 month cable vols suggests that the market was not prepared for this at all:

 (chart courtesy of BAML)

From Macro Man's perch, this is the panic that you are probably supposed to start fading, if only in dribs and drabs.   Short sterling has rallied back to levels not seen in nearly a year, and the vol chart above tells you that people have panicked a wee bit.

Perhaps you don't want to do your full ticket now, but providing a bit of liquidity in times of uncertainty can often reap handsome rewards.

There are so many issues still to be resolved, even if the Yes vote goes through, that it's difficult to trade on anything but emotion, such is the dearth of facts on such key issues as:

* What currency will Scotland use?  They seem to think sterling, the government seems to think not.   (Hint: if you have any Scottish fivers, best spend them this week while they're still legal tender.)

* Will Scotland be admitted to the EU?   Not if they use sterling, according to Olli Rehn.

* What portion of UK debt will Scotland assume?   None, if they don;t use sterling, according to Alex Salmond.

*  Will Scotland keep the queen as head of state, or dredge up some descendent of Bonny Prince Charlie to assume the throne?   Or will it become a republic?

* If Scotland votes Yes, what does this mean for the UK general election next May?   Will Scottish precincts vote/count?  What then happens when Scotland leaves the UK?  Do those MPs get ejected from Westminster, possibly bringing down a government?   Anything that keeps Mr. Bean Ed Milliband away from Downing Street will likely be taken positively be markets.

In the meantime, markets can merely watch the polls and sweat on the Jocks' decision.   Decisions taken in panic, however, are unlikely to be rewarded in the fullness of time.

Friday, September 05, 2014

0 for 1

Well, Macro Man whiffed on the ECB about as badly as he could have.  Not only did they announce an ABS program (the inevitable leak did occur right as yesterday's post went to press!), but for some reason they decided to cut the key rates by another 10 bps.

Now, you know as well as your author does that there is not a single individual or institution in Europe that would say, "Well, at 0.15% I wasn't sure if I could afford the loan, but now at 0.05% I am ready to rock'n'roll, baby!"  On the other hand, there may well be banks that would say, "Well, we could take out x in the TLTRO, and it will only cost us 10 bps to park it until we find someone to lend it to.   Wait, it now will cost us 20 bps?  Hmmm...maybe we should cut our bid by use paying more to sit on cash than we do to borrow it."

Of course, perhaps the real reason for the rate cut was to submarine the euro.  If so, Dr. Aghi's plan worked admirably, with EUR/USD evidently sustaining its largest single day decline in three years.  Now, there has been some querying as to whether the euro's decline might make the Fed uneasy, thereby altering the monetary policy outlook.  

Colour Macro Man sceptical.  Just yesterday, the US announced a trade deficit of $40 billion, which while being more than your author has in his sofa cushions, is pretty modest by the standards of the US.  The magnitude of the moves observed so far are pretty miniscule in the grand scheme of things (USD/JPY is unched since December 31); given that the US is still a relatively closed economy, the trade weighted exchange rate would have to move a hell of a lot more before it began to impact the models in any significant way. 

Obviously, for the US to cry foul at someone else's monetary policy undermining their exchange rate would be the height of hypocrisy, but somehow that doesn't feel like a particularly strong factor in favour of the argument.

Today of course is payroll day, with all the associated noise and fanfare.   For what it's worth, Macro Man's payroll model anticipates a slightly lower than expected result of 210k jobs, versus the consensus of 228k.   On the face of it, that might prove to be a slight disappointment.

However, yesterday's price action (as well as some of the macro returns for August) would appear to validate the poll result that punters are gunning for a stronger dollar.  As long as today's figure isn't abjectly weak (and with data of this dubious quality, that's by no means a given), one would have to think that the trend would continue- there would be strong arguments for a lower EUR/USD and higher USD/JPY on each side of the equation.  Insofar as FX over the last few years has largely been an exercise in sifting through turds to find the least repellant sample, finding a compelling fundamental support for a trend move in G10 FX is like a welcome breath of fresh air.

Price action will be key.  There are a lot of shops still underwater, and if this is the big trend for the end of the year, there shouldn't be much by way of pullbacks.  The Abenomics trade in 2012/early 2013 didn't let anyone in and punished the profit takers.   That's the way macro used to be, but the last few years have bred bad habits.   Macro Man is very curious indeed to see which way the pennydrops after this figure.