Do Markets Top on Good News?

Friday, April 25, 2014

It's a good thing that Macro Man still has a full head of hair, because with the amount he's been scratching it recently he'd have some awful marks without it.  Equities have once again nudged close to the highs of the year, the level where they've failed time and time again in 2014.     For most of the last few months, Macro Man's taken it almost as an article of faith that stocks would roll over come May, both because of the poor historical performance and the persistently weak seasonality in recent years.

In that vein, he's taken some length off the table, because there's no point having a well-thought out plan if you aren't going to stick to it.   By the same token, however, it behooves him to stress-test the view periodically; it's still a bit cold and windy to be a lazy sunbather.

How bad is the seasonality in May, actually?   Does it depend on the prior four months of the year?  First, to get a sense of perspective, Macro Man checked the performance of the SPX in every month since 1980.  He was surprised to see that the average return is actually pretty solid: +0.93%.   What's also interesting is that pockets of weakness in May tend to cluster, as can be seen in '81-'84, '98-'02, and of course 2010-12.   Frankly, he is a little embarrassed to admit that he forgot that the SPX actually rallied in May of last year, so swept up was he in Tapergeddon and its impact upon the Japan trade.  Anyhow, last year's 2% rally in May was atypically large to be in a middle of one of these clusters.

What if we go further back?  Macro Man parsed data going back to 1929.  Unsurprisingly, the well-known historical pattern emerges, with the average return for the month coming in at -0.06%.   How much of this was down to bear-market performance, however?   Macro Man created a simple study to test.

Using both the full dataset since 1929, as well as the "modern" dataset since 1980, Macro Man tested to see what May's performance was like depending on the first four months' returns.  Specifically, he checked the average return in May when the index ended April down on the year, the average return when it was up more than 5%, and the average return for everything in between.  The results are summarized in the table below.

As you can see, when the index is modestly up on the year through April, May has historically been a very strong month.  Indeed, the 1.88% return since 1980 is higher than the average full-sample return for any individual month, even December.   As of Thursday's close, the SPX is up 1.64% year to date.   Hmmmmm.......

All of thiscertainly merits a pause for thought.  However, Macro Man cannot get the favourite saying of one of his mates out of his head: "markets top on good news."  To be honest, he hasn't studied this in any great depth, so he doesn't actually know if it's true.   It certainly sounds like one of those aphorisms that ought to be true, even if it isn't.

Regardless, the news has certainly been fairly decent recently, on both the macro side (a solid durables report) and the micro side (some of those earnings look great, and golly, Apple's gonna split!)  Moreover, the ECB looks like it has pushed all of its chips to the centre of the table (using another tired poker anaolgy),  as the recent rhetoric on both rates and the currency have been deafening.  Next Wednesday's CPI is not to be missed, and with excess liquidity breaking below the magic 100 bio barrier, if the ECB is going to act, it should come next month.

Of course, a cynic might suggest that absent a QE program for which there is currently insufficient infrastructure, a refi/depo rate cut will be the last throw of the dice, the bluff that the market will call.  (Yet another card analogy!)  Moreover, it is not altogether clear to Macro Man that charging banks for holding cash, thereby cutting into their NIM, is an unalloyed positive.   He could therefore have some sympathy that that "good news" could be sold.

At the same time, next week's US payroll figure also looms large.   If we ever do get a bang-up employment print, Janet Yellen will no doubt throw a party (to which she'd wear a polka-dot dress?)  to celebrate the good news.  Fixed income markets, on the other hand, might throw a public execution of the front end and belly.   5s-30s already looks like flattening long before 2s-10s follow?   And how will equities react?   "Not well" would appear to be a sensible guess.

As such, Macro Man finds himself in sympathy with his friend's aphorism, whether it be spurious or no.  His gut tells him that a top is close and that good news will in fact be bad news...potentially very much so.   His head, on the other hand, tells him that the boogie man in the seasonality closet may not actually exist.

In the end, he is left with higher conviction....that he doesn't currently possess an edge.  As such, he will stick to the process, follow the plan, and retreat further to the sidelines, awaiting further clarity one way or another.  When it comes, in whichever direction.....well, that really will be good news.

Posted by Macro Man at 7:00 AM 0 comments Links to this post  

A Trip to the Cinema

Thursday, April 24, 2014

Macro Man recently finished reading Flash Boys, which was certainly entertaining if somewhat incomplete.  While some of the other explorations of high-frequency trading are evidently more thorough, Michael Lewis is close to unparalleled in his ability to craft a storyline from specialist arcana that can appeal to the layman.  Who could have imagined, for example, that Moneyball (a book about quantitative analysis in baseball) would turn into a film featuring Brad Pitt?

As his mind wandered the other day, Macro Man found himself wondering who might play the relevant characters in a film version of Flash Boys.  Lost in thought, it occurred to him that in some ways, the film had already been made.   For what better description of Lewis's book could you come up with than Terminator 3: Rise of the Machines?

At the same time, the very best-selling book on Amazon is the English translation of a 700 page book by French economist Thomas Piketty: Capital in the Twenty-First Century.  The book has become something of a phenomenon, generating reams of lavish praise or opprobrium, generally depending on the existing views of the reviewer.   Either way, it struck your author that the crux of Piketty's tome, with its focus on income inequality, could be summarized in the title of the old Bogart/Bacall vehicle: To Have and Have Not

This naturally set Macro Man off to thinking what other notable economic and financial books may already have been "inadvertently" made into films already.

A couple of years ago, Daniel Kahneman wrote an excellent book that explores the insights gained from his academic career in Thinking, Fast and Slow.   The description of the two modes of thought resonated with Macro Man, and he thoroughly enjoyed the book.   The title, meanwhile, recalls the story of Charly (itself taken from Flowers for Algernon), a mentally handicapped man who undergoes a procedure that renders him a genius.

One of the most prominent financial commentators of the last decade is, like him or loathe him, Nicholas Nassim Taleb.  In Fooled by Randomness he popularized the notion of the "Black Swan", and then followed up by writing a book with that very name.  Following the financial crisis, of course, the Fed and other central banks have done their utmost (a little bit of regulation and lot of  financial repression) to stave off further market volatility.  For the time being, therefore, the most appropriate film adaptation of the Taleb corpus would be Bye-Bye Blackbird.  (Macro Man can't wait to see the sequel, though...)


Finally, one of the great debates of the post-crisis era has been the appropriate role of fiscal policy.  In the Eurozone, for example, economic recovery has been stayed by Calvinist fiscal austerity...but the prior economic crisis was the result of market rejection of Dionysian fiscal profligacy.   Regrettably but unsurprisingly, demagogues on both sides of the fiscal debate have tended to employ less-than-nuanced arguments in favour of their viewpoint.  One prominent example is of course Paul Krugman, a persistent advocate for fiscal spending who appears unwilling to acknowledge the potential downsides of such a strategy (viz. the Eurozone.)  As such, Macro Man wonders if his Economics textbook could not be cast as a remake of Brewster's Millions, the film in which Richard Pryor must spend absurd amounts of someone's else's money on unproductive services as a means of enriching himself....

Readers are of course invited (nay, encouraged) to come up with their own film adaptations in the comments section.   As for those hoping for a sober analysis of corporate earnings or the RBNZ...sorry, better luck tomorrow!

Posted by Macro Man at 7:00 AM 10 comments Links to this post  

Testing Tuesdays

Wednesday, April 23, 2014

Bob Geldof famously doesn't like Mondays, a sentiment which is likely shared amongst wide swathes of the population.    He presumably has no beef with Tuesdays, and if the populace at large is fairly neutral on the second day of the workweek, the same can probably not be said for equity punters.  For as Citi's Brent Donnelly pointed out yesterday, the stock market's performance on Tuesday has been nothing short of spectacular.

Perhaps it's mere coincidence or a statistical quirk.   Maybe it's the sign of dark forces at work.  Frankly, Macro Man doesn't know.  All he can say is that thus far in 2014, the SPX has rallied an impressive 8.75% on Tuesdays....and dropped a cumulative 6% on the other four days of the week.

Now, when Macro Man was reminded of this phenomenon, he thought it sounded a little familiar, so he did a little digging.  Sure enough, just last year, the cumulative week 17 performance on Tuesdays was 7.89% versus just 2.71% for the other four days.  In fact, the SPX started the year by rallying on 19 of the first 22 Tuesdays, a not dissimilar hit rate to 2014's 15 out of 17.  So what happened next?

To a large extent, the outperformance evened out.   Indeed, from week 22 onwards, the SPX was down nearly a percent on Tuesdays, versus a cumulative rally of nearly 13% on other days.  While the index still punched above its weight for the year as a whole, the discrepancy wasn't nearly as notable as it is today (or indeed was a year ago.)  If anyone has a rational explanation for why Tuesdays have been so great for the first 4-5 months over the last couple of years, Macro Man would love to hear it.   Failing that, he'd suggest that anyone betting on a sustained continuation of this outperformance trend might find themselves tweaking the Boomntown Rats song before too long.

Elsewhere, sterling has been rather notable for its strength in recent days, with cable pushing to its highest level since 2009.  To be sure, some of this strength reflects the relative resilience of the UK data, which itself has filtered through into rate markets.  Nevertheless, it does look like sterling might be a little ahead of itself, even if one accepts that current rate differentials are justified.

That in and of itself is an open question.   While economic activity is clearly quite brisk (and house prices in the Southeast downright rampant), CPI inflation is at its lowest level in 5 years.   Given that Woodfordite central banks pursue a function wherein Policy target = min( employment, CPI, GDP), this should provide ample opportunity for Mark Carney to contrive excuses to keep policy unchanged, perhaps up until the election.

Indeed, Macro Man's own work suggests that appropriate rates based on the post-crisis, pre-Carney reaction function of the BOE are already quite a bit lower than they were a few months ago given the drop in inflation.  As such, it would appear that the in the near term at least, the prospect of UK rate rises might be close to fully priced...

Moreover, the Scottish referendum is now less than six months away, and the polls seem to be swinging ever closer to a dead heat.  History suggests that constitutional referenda  tend to exact an ex ante risk premium in currency markets (viz. the euro in 2005 and the CAD in 1995) which at the moment is absent from sterling.  As such, from Macro Man's perch, sterling should carry a large 'caveat emptor' sign at current levels.

Finally, it will be interesting to see if UKIP follows through on its plans to make the newly-available David Moyes its Head of Strategy.   After all, if he can keep Manchester United out of Europe.....

Posted by Macro Man at 7:00 AM 9 comments Links to this post  

A Market Vignette

Tuesday, April 22, 2014

In the absence of anything interesting to say about a drearily dull start to the week, Macro Man thought he would share a small vignette of what the market was like two decades ago.

Macro Man's very first job upon graduation from university was in Chicago, working for a very well-known option market-making firm.  Having acquired an interest in foreign exchange while studying abroad during the '92 ERM crisis, he was assigned to work at the currency options pit of the Chicago Mercantile Exchange as a trading assistant.

Before arriving in Chicago in July of 1993, he wasn't really sure what to expect.  Having attended a liberal arts university, he had taken no finance courses; as such, the only options knowledge he possessed was what he'd crammed for the interview to get the job in the first place.

From what he could tell, however, it was pretty complicated stuff.  The firm he was joining had a reputation for being staffed with really smart people (naturally- they'd hired Macro Man!), so he assumed that the business generally was populated by the types of guys who broke the bell curve in collegiate math courses.  After all, the chaps on TV who talked about the stock market all sounded pretty clever, and anyone who'd read Liars Poker knew that they were bottom of the intellectual heap, right?

The job, as it was explained to Macro Man during the offer, was to assist the firm's option traders in the CME pits while slowly acquiring sufficient practical and classroom knowledge to eventually become a trader himself.  All in all, it promised to be intellectually stimulating while serving up the odd jolt of adrenaline when things got a little crazy.

Upon starting the job, your author found that (unsurprisingly, in retrospect) the quotidian aspects of the job were somewhat more mundane than anticipated.  Perhaps he should have been warned when he found that all the traders referred to his yellow-coated brethren as mere "clerks" rather than the more elevated "trading assistants," though given that most of his early-career tasks were indeed clerical, the shoe fit (and he wore it.)

What was really shocking, however, is when he actually went to the exchange floor to work during trading hours.  The roar of the floor, particularly during a data release, was startling but hardly surprising.   No,what really opened his eyes was the people.

Contrary to expectation, the floor was not primarily populated calculus curve-breakers.   Oh sure, some of the options guys were really smart, both in an academic and street sense.  The futures traders and brokers, on the other hand, while hard workers and good at their jobs, were more notable for the size of their beer guts than their IQs.   These were salt-of-the-earth guys, many of whom might be digging ditches if they weren't on the floor.

There is perhaps no other job in the world where flatulence is as much of an asset as it is on an exchange floor.  Have you been squeezed out of a good location in the pit?  Drop a little "bomb" and the crowd will part like the Red Sea, allowing you to occupy your preferred spot.  Certain traders developed a knack for letting fly right before a large order came into the pit, thus ensuring that they could occupy the prime real estate in front of the broker and do a large portion of the trade.

In  Macro Man's second week of work, the senior trader he was clerking for got into a fistfight with a rival trader.   This was not a typical baseball fight with lots of milling around and little actual violence; this was a proper punch up.   Macro Man happened to be on the edge of the pit to pick up some trading cards from said trader (nicknamed 'Johnny Ya-ya') and saw the whole thing unfold before him.   He instinctively grabbed Ya-ya's opponent but was ordered instantly to let him go and leave the pit.

After the fracas broke up, Ya-ya stormed off of the trading floor.   With one brief exception a few months later, he never returned, having transitioned to an "upstairs" job trading OTC options.

One aspect of the floor that Macro Man remembers fondly was the prevalence of ridiculous bets.   Traders, clerks, and  brokers would have a flutter on everything, from the first day of snow (it was Halloween 1993, if memory serves) to the height of the trading floor (architectural plans were consulted) to who would win a fight between a killer whale and a great white shark (Macro Man rang the Chicago aquarium to get an expert answer on this one, perhaps inspiring this show.)

There were three bets, however, that still resonate with your author to this day.   The superstitious might even suggest that they offered foreshadowing of the financial crisis and its aftermath.

A foot of cockroaches.   There was a broker in the Deutsche mark option pit called Chris who was a bit different from a lot of the guys- he seemed older and he wore a pony tail, which wasn't a common barnet on the CME in the early 90's.  Oh, and he claimed he could eat a foot of cockroaches (i.e., twelve inches' worth of cockroaches laid end to end.)

Naturally, this inspired a modicum of skepticism from other denizens of the DEM pit, so a few friendly wagers were offered...and then a few more....and a few more.  Brokers bet with brokers, traders with traders, clerks with clerks.  Eventually, after work one day, the cockroaches were somehow procured, laid end to end.....and duly consumed.  Bettors on Chris were paid out, and Macro Man learned very early on that not only is there never only one cockroach, but that even the most foul of (financial) fare will usually find a consumer.

The NCAA tournament.  Betting on the NCAA college basketball tournament was rife, unsurprisingly.   Unlike the relative tedium of filling in brackets and tracking overall accuracy, NCAA betting CME-style was devastatingly simple.    The winner of the tourney was worth $100; everyone else was worth nothing.  Markets were made in each of the teams, and you were obligated to keep track of which teams you bought and sold, in which quantity, with whom, on the free trading cards that that were a staple of the CME.

This was all well and good, provided that one sized their positions correctly and managed risk.   In many ways, this sort of trading taught neophytes like your author as much about risk management as his professional activities, given that it was our own wealth on the line.  Unfortunately, not everyone learned his lesson.   A clerk for a rival trading company owned by a French bank fared rather poorly, losing some $15,000 in the process to all manner of floor personnel.  (Remember, this was more than two decades ago, so the sum was almost certainly in excess of half of his annual salary.)

This proved to be quite a thorny problem, as the kid couldn't pay, which irritated his creditors rather considerably.   Eventually, a compromise of sorts was reached:  the clerk was sacked and the bank made good on his debts to avoid the stigma of having stitched up the rest of the floor.   This was quite an early indoctrination into the concept of "if you lose enough money, eventually somebody will bail you out for 'the common good.'"

Fifty Reese's Cups.    On the wall of the exchange, surrounding every pit, there were rows of little boxes with phone turrets where clerks would accept orders from "upstairs" and signal them into the pit.   There was a guy who assisted one of these phone clerks who was big.  Not Big Ten football lineman big, Augustus Gloop big.   As memory serves, he took a bit of ribbing about his size, but was generally good-natured about it.

Somehow, one day the phone guys started talking about Reese's peanut butter cups, and how many one could eat at a single sitting.   One thing led to another, and the gauntlet was thrown down as to whether Augustus could eat 50 Reese's cups.   Call it a financial version of Cool Hand Luke.

As in the film, the entire proposition inspired a raft of betting, except in hundreds and thousands rather than twos and tens.   Consensus was probably tilted very slightly in Augustus's favour until someone thought to ask him if he liked Reese's cups.   "They're my favourite," he replied with a glint in his eye, thereby spurring a frenzy of betting on "Yes."

As with the cockroaches, the Reese's Bacchanalia was scheduled for after the close on some appointed day.   In the run-up to the eat-a-thon market anticipation built to a fever pitch, and even those benighted souls with nothing riding on it were eager to see if Augustus could emulate Paul Newman.

Alas, it was not to be.  On the morning of the appointed day, the news rippled through the trading floor: the bet was off.   Apparently Augustus, in a rare fit of concern over the state of his well-being, had taken the outlandish step of consulting a physician about the proceedings.   This worthy individual had warned him of the potentially disastrous consequences of scarfing that much candy in one sitting (presumably hyperglycemia.) 

The moral of the story, of course, is that it is possible to have too much of a good thing, even a favourite sweet.   Readers will no doubt have deduced by now where Macro Man stands on this issue vis-a-vis the raft of easing measures served up by Willy Wonka the Fed and BOE, among others.

'Tis a pity that the professors who run monetary policy these days never spent any time on the Merc floor.   Perhaps Chris, the wayward clerk, and Augustus could have taught them a thing or two...

Posted by Macro Man at 7:00 AM 10 comments Links to this post  


Monday, April 21, 2014

The past week has been notable for the victory laps taken by central banks currently residing under the thumb of Professor Moriarty Woodford.  In last week's speech to the Economic Club of New York, Janet Yellen noted that forecasts for unemployment were largely proven correct- but only with a healthy dose of QE to grease the wheels.   Latterly, Martin Weale at the Bank of England has performed an exhaustive study suggesting that QE worked even better than originally thought.

All of this is well and good, and the Weale paper is full of Bayesian vector autoregressive fun, if you're into that sort of thing.  The problem with these sentiments, of course, is that they are based in one way or another on the very types of econometric models that have failed so spectacularly over the past seven years.   The counterfactual ("what would have happened if there were no QE over the last few years?") is easily dismissed, because it is unprovable.

Perhaps Macro Man is the only one irritated by this casual dismissal of the counterfactual.  After all, irritation is not a particularly remunerative emotion, and what's done is done.  Nevertheless, it is perhaps worth pointing out a few holes in the logic.

In Yellen's speech, she noted that the unemployment came in just about where it had been forecast, but only with the aid of QE.  Observe how she was careful to use private sector forecasts rather than the Fed's own estimates.   Macro Man ran a little study, comparing the unemployment rate from 2012 onwards with where the Fed itself had forecast it 12 months earlier.  As it turns out, unsurprisingly, the unemployment rate has been consistently lower than the Fed had forecast 12 months earlier- by an average margin of 0.4%.

So in point of fact, if QE had an impact, perhaps the Fed didn't need to do it after all, as their unemployment rate forecasts might have been more accurate!

Of course, the real question for Ms. Yellen is "if QE was so great at keeping the unemployment rate below your forecast, why was it so lousy at keeping economic growth at your forecast, let alone above it?"

Were one to actually pose such a question to the Fed, the response would no doubt be full of phrases like "fiscal drag" and "participation rate" and "part time employment" and stuff like that.  (It would be churlish to ask why the econometric models did not forecast this stuff, too.)

Of course, with fiscal policy, there is another unprovable counterfactual that is blithely waved away.  The Fed's attitude towards the government has been one of an overindulgent parent towards a squalling infant or squabbling toddlers, the type that always seem to sit in close proximity to your author on airplanes.  Rather than using the stick of "shape up or else", the parent/Fed adopted the carrot strategy of "here's a little sweetie to keep you quiet for five minutes."  Of course, the lesson learned by the naughty children is that having a fit brings a it encourages more fits.  (The same holds true for the infants in the airplane example.)  For all his many faults, it's hard to imagine that Alan Greenspan in his pomp wouldn't have let off a few rockets in his Congressional testimonies to put an end to some of the nonsense.

Just once, it would be nice to see a headline that differs from the usual


Instead, it would be great to see something like


Sadly, that's one for the alternative universe newswire (or maybe a couple of the regional Fed presidents.)  It's too bad, really....that's a counterfactual that Macro Man could really get behind.

Posted by Macro Man at 7:00 AM 9 comments Links to this post  

Go on, you know you want to

Thursday, April 17, 2014

"Go on, you know you want to."

How many times over the last few years have macro punters contemplating a sale of the euro heard that voice inside their heads?  From the sovereign crisis to Cyprus, from Fed tapering to ECB QE,  there have been a myriad of (apparently very good) reasons to sell EUR/USD, and yet here we are, knocking on the door of 1.40.  Like the devil on Larry Kroger's shoulder, the voice looks at the chart and says it again.

"Go on, you know you want to."

It's a siren song that's hard to resist, particularly now that the ECB has joined the chorus.  In the absence of a ship-mast against which to lash themselves, punters would do well to examine some of the relevant narratives to determine whether it's a wise course to give in.

1) The 'Japanification' story.   A key argument against selling the euro has been the impressive rise in the Eurozone's basic balance over the last several years.    Not only has the emasculation of domestic demand in much of Europe pushed the current account into a tasty surplus, but Eurozone banks' unwinding of foreign assets has maintained a healthy capital inflow as well.  This combined demand for euros has gotta push it up, right?

The evidence is sketchy.   Macro Man can find no stable and sustained relationship between the basic balance and the euro.  That does not mean that there is no relationship, of course, merely that it does not appear to be a (let alone the) hegemonic driver of the euro exchange rate.  Indeed, at some points in recent history there appears to have been a negative correlation between the two.   The voice is getting louder....

2) Positioning.  With so many different actors participating in currency markets, it can be quit difficult to get a true read on accurate positioning.  Fortunately, the sector with the quickest trigger finger also happens to be the easiest to model positioning for, namely CTAs via the IMM data.  The story there is one of modest (and declining) length.   With the 50 and 100 day moving averages 50-120 pips lower from current spot, it wouldn't take much to trigger a flurry of stops, as that community exits longs and begins to go short.   The siren's song, it's so beautiful....

3) FX Reserve managers.  One of the earliest literary devices in this history of this space was the bequeathing of the sobriquet "Voldemort" upon the PBOC and SAFE.  The rationale was simple:  by accruing absurd levels of FX reserves to maintain artificially weak exchange rates (and artificially high current account surpluses), and then trading/investing these reserves aggressively, Voldemort and like-minded institutions were exerting a malevolent influence upon developed financial markets. Over the ensuing years, the influence of FX reserve managers has waxed and waned.  Recently, China appears to have been at least moderately active diversifying the $100 bio+ that they spent in Q1 to weaken the RMB.

However, how durable is this moving forwards?  The stated purpose of widening the RMB band and pushing the currency weaker was to discourage hot money speculation (both domestic and foreign.)   For the time being, at least, it certainly seems to have worked; moreover, it seems unlikely that the domestic corporate sector will play as many over-invoicing games as they have in the recent past.  At the same time, China's current account balance has shrunk back the level (as a % of GDP at least) of a dozen years ago, back when Voldemort was a mere Tom Riddle...

It therefore seems likely that reserve accumulation should slow, perhaps dramatically...and with less reserve accumulation comes less diversification demand for euros.   Hmmm, Macro Man is reaching for his red sell tickets....

4)   Interest rates.  Rate differentials are the bread and butter of any study of exchange rate determination.  Applying them to EUR/USD appears to support the conclusions above.   Based on the historical relationship with the 1y1y spread, for example, it looks like the euro should be closer to 1.20 than 1.40.   It's an open and shut case, right?

Not so fast.  Readers may recall that there were other interest rates than 1y1y swap spreads (themselves a proxy for monetary policy) that were driving the euro exchange rate in 2011 and 2012.   A proper rate model should include some sovereign spread component.   Macro Man ran two iterations of a very simple two factor model, using a measure of short term rate differentials and the 5 year Spain/Germany spread as the input factors.  One uses 2010-11 as the in-sample period (the Trichet model), and the other uses 2011-2014 as the in-sample period (the Draghi model.)

The Trichet model is not dissimilar to something that Macro Man ran in real time in 2011.   What's interesting to note is that the model broke lower relative to the actual market starting in July 2011- almost exactly the time that Italy and Spain got properly sucked into the sovereign crisis.  While the model has consistently suggested that the euro is too high since, it has retained a reasonable degree of correlation with movements in the FX rate, even in the out of sample period.   What is very interesting to note is the seemingly inexorable rise in the model since Draghi's "whatever it takes" speech in the summer of 2012.  How does it look if we use Draghi as the in-sample?


Pretty darned good.  Encouragingly, the basic shape of the model barely changes from the earlier version with a completely different in-sample data set. This version merely corrects for the structural break that occurred in July 2011.  The message, as you can see, is that the euro is pretty fairly valued, and that the recent rise is completely justified. 

Now, one can quibble about using a model like this to try to pin-the-tail on an exact currency valuation.  Indeed, Macro Man received a first-hand education on the dangers of such a practice three summers ago.  Nevertheless, to his eye at least these models do a pretty darned good job in explaining the underlying direction of the euro's trend.  And they both agree that it is up.

As such, from his perspective selling euros, while potentially profitable around event risks like ECB meetings, does not carry a terribly large (or even positive) expected value on a more strategic basis.  From his perch, therefore, it appears that punters' time could be more profitably spent finding a better trade.

Go on, you know you want to.

Posted by Macro Man at 7:00 AM 16 comments Links to this post  

Holy Whiplash, Batman!

Wednesday, April 16, 2014

Holmes and Watson have repaired to Baker Street for a well-earned break, leaving Macro Man to confront the rather more prosaic task of making sense of this week's price action.  With school holidays on either side of the Atlantic and Easter coming this weekend, it's probably safe to say that neither staffing levels nor market liquidity are particularly high at the moment.

Even with that qualification, Tuesday's price action was a little crazy.   The data, such as it were, was generally negative for liquidity (and therefore risk assets): a higher CPI and somewhat weaker Empire do not exactly scream "buy stocks!" do they, particularly when equities (and equity managers) have been on the back foot recently.   Yet buy stocks they did, at least until negative headlines about Ukraine hit the tape.

Now, at his old job Macro Man had a large placard taped to one of his monitors, imploring him "DO NOT TRADE ON HEADLINES."  There is a reason for this.    While the unraveling of eastern Ukraine is certainly a serious matter, as indeed is Russian intransigence, in February we learned that if Americans cannot find a place on the map, it doesn't matter.  And so sometime after lunch, the market came to its senses and rallied back through the intra-day highs.

All of this is one explanation for yesterday's price action.

An alternative, possibly more accurate, explanation is that this week is option expiry week, cash equities are closed on (Good) Friday, and there is a pretty decent slug of open interest in the 1825 strike (25,000 calls and 47,000 puts.)   Assuming that dealers are short this stuff, that's a lot of negative gamma to be hedging as Spooz cross the strike over...and over....and over again.   On an exclusive basis, Macro Man has procured some video footage of this hedging activity from yesterday:

Holy whiplash, Batman!

Not that other assets were immune.  Gold took a precipitous drop after breaking the 200 day, stopping just before the lows of early this month, before retracing to end the New York day just north of 1300.  For longs expecting a Ukraine-related boost, it must have felt a bit like hanging out with Kenny Bania.

Media reports suggest that Janet Yellen made a daring escape from Holloway Castle yesterday and has absconded back to the US, where she will today make a speech to the Economic Club of New York.  Time will tell if she is still in the service of the Professor or whether she has made a break from his nefarious schemes.  Going back to the SPX for a moment, one thing that caught Macro Man's eye in yesterday's tumult was the fact that yesterday's price action broke above last week's low, ensuring that the down trade is a 3 wave, corrective affair.  While it certainly doesn't jive with your author's base case view of weakness next month, it would certainly be consistent with the notion that Woodford still has his tentacles wrapped around monetary policy (i.e., a dovish speech tomorrow.)

Elsewhere, New Zealand's CPI printed a lower than expected 1.5% in Q1.  It seems highly dubious that this will dissuade Governor Wheeler from continuing to hike rates, though of course it does raise the odd question or two about the ultimate magnitude of the cycle.   To Macro Man's eye, AUD/NZD looks to have formed rather a nice bottom and has conclusively closed above the 100 day moving average for the first time in a year (when it was at 1.25.)   He will leave it to the reader (with the aid of Holmes, perhaps?) to explain why a level of CPI consistent with a tightening cycle in New Zealand requires angst and hand-wringing in the United States...

Posted by Macro Man at 7:00 AM 7 comments Links to this post