Friday, March 06, 2015

A perfect mix

Well, Super Mario looked happier and more relaxed yesterday than he had in quite some time, n'est-ce pas?  Obviously, there were no fresh policy initiatives to unveil given that the ECB has yet to commence the implementation of the QE purchase program previously announced.

Nevertheless, Mario had a twinkle in his eye, perhaps because he had some forecast upgrades to deliver on growth this year and next.  Indeed, in aggregate the ECB now expects the Eurozone economy to be nearly 1% larger by the end of  next year than they did just three months ago.  The evolution of the forecast profile is nicely sketched out in the table below, from Jefferies:

Of course, some of that upgrade is a function of the ECB itself, and the announcement of the QE policy.   The assumption of "we have done something, ergo it will work" is often a dangerous one that begets complacency, as we have seen all too often over the past few years.  In fairness, though, things do seem to be ticking over a little more.   As Draghi proudly noted, the credit impulse is sparking to life a wee bit, and basic measures of sentiment are now pointing higher.

From a currency punter's perspective, meanwhile, the policy and economic mix appears to be a perfect one to engender currency weakness.   Tight fiscal policy?   Check.   Loose monetary policy, with a commitment to remain that way for a (ahem) considerable period?   Check.   The growth outlook improving, and with it the prospects for C/A surplus-dampening domestic demand?   Check.

Who knows, we might even see a reduced private sector demand for some segments of the EZ bond market.   After all, Draghi noted that the ECB would not buy bonds through the deposit rate (currently -0.20%, and likely to stay there if the forecast profile materializes.)  By a stunning coincidence, Schatz (i.e German 2 years) closed yesterday at...wait for it....-0.20%!

Of course, as Swiss franc traders will attest, just because a CB puts an implicit (or explicit!) floor under something doesn't mean that the floor will hold ad infinitum.   That having been said, holding bonds offering negative yields is a position that costs money to carry, so the at the very least reducing the prospect of capital appreciation surely diminishes their allure for some holders.   Bobl (5 years) at -0.07% in many ways looks even worse!

Regardless, the chart of these things would appear to suggest that the party is over, for the time being at least.

While it would be nice to focus on the medium term prospects for the euro given the perfect policy mix for shorts, the realpolitik of modern macro for many punters is that today's payroll figure is now more important, for the time being of course.   Given the intense focus on the Fed's "patience", a misstep on the data front could shift the market's timetable presumptions, perhaps engendering the sort of short squeeze that we haven't seen all year.

Macro Man has often scuffled in March, and he isn't alone.   An analysis of the CS macro hedge fund index reveals that since 2000, March has been the worst month of them all for the industry.  Now, that in and of itself is not a reason to slash risk...but assuming that the market has not become exclusively populated by 30-year old "know-it-alls", it might be reasonable to posit that punters with as much gray hair as your author might be somewhat sensitive to signs of a trend reversal at this time of the year.

For what it's worth (admittedly not much, given the noise in the data), Macro Man's model yet again looks for a somewhat lower than consensus reading for payrolls, forecasting a print of just over 200k.   In the unlikely event that his forecast were to prove to be spot on, it's hard to envisage too strong of a market reaction, unless there was disturbing news on the unemployment rate or wage front.  To be sure, any sane central bank wouldn't be troubled by a 200k print.....and most crazy ones wouldn't, either.

In any event, Macro Man's little PA portfolio has had a nice start to the year, so as noted previously he has trimmed some of his short euros.  He also took a little profit in fixed income as well, just enough to feel emboldened to add if there is a silly rally after tomorrow's figures.

These are merely tactical adjustments, however.     After all, the perfect policy mix doesn't come around too when it does, you really don't want to spend too much time on the sidelines.

Thursday, March 05, 2015


Tomorrow sees the release of US nonfarm payrolls, financial markets' monthly paean to the fetishization of statistical noise around a slow-moving signal.  Although Macro Man has not dug terribly deeply into this, on the surface there would appear to be some downside risk to the number, given the appalling weather that the country has "enjoyed" for the last six weeks.  Heck, even the diligent professionals of the Chicago construction industry have fallen behind in their renovation of Wrigley Field because of the weather.

Generally speaking, however, the labor market has improved so substantially that it would normally merit a tightening of policy.   Indeed, the degree of improvement is starkly illustrated by the scatter plot below, which shows unemployment and the corresponding Fed funds rate.  Other than the current ZIRP, the next-lowest level of Fed funds with unemployment at these levels was 0.8%, in the mid-1950's.

Of course central banks, particularly those with dual mandates, do not make policy for unemployment alone.  Inflation is obviously a clear determinant of Fed policy and preferences, especially given that it has remained persistently low in the aftermath of the crisis.  Now, Macro Man has opined on this topic on a number of occasions, but hopes readers will excuse him if he addresses it once again.

As you know, the Fed has chosen a reference target of 2% for the PCE price index, excluding food and energy, for inflation.  This is all well and good, except that the target looks unattainable- and not just because of the lingering impact of the crisis.   If we take a 5 year moving average of the core PCE deflator to smooth out noise, we should get a decent idea of what trend levels of inflation (as defined by the Fed) look like.  And what we find is that with the exception of mid-2008 to mid-2009 (oh, the irony!), the long-run average for the deflator has been well below 2% for nearly 20 years. 

(It is at his juncture that the uncharitable reader might choose to regard the Fed's long-term forecast for 2% inflation as the triumph of hope over expectation.)

Now, as your author observed a few months ago, a primary culprit for this shortfall in inflation has been the secular decline in the durable goods deflator.   Simply put, the price of manufactured durable goods started going down 20 years ago and has kept doing so, regardless of financial conditions, the economic cycle, sunspots, or any other variable that you might choose to measure.  For your convenience, the chart of the deflator index is reproduced below.

Unsurprisingly, Macro Man has not changed his view that there is nothing that the Federal Reserve (or any other central bank, really) can do to offset the secular decline in durable goods prices, nor should they try- the forces driving these declines are well beyond the sphere of monetary policy.  Attempting to do so, on the other hand, will impact the price of things that are responsive to central bank policy, such as many of the securities, futures, and exchange rates flickering on your screens.

Recently, it occurred to Macro Man that it might be interesting to craft an alternative measure of consumer inflation, something that Janet Yellen might think of as 'TICC' inflation, e.g. 'things I can control.'  Such a measure would not only strip out food and energy, the prices of which are driven by idiosyncratic factors that do not necessarily respond to monetary policy, but also of durable goods, which don't either.

To calculate this 'TICC' inflation measure, Macro Man calculated traditional core PCE inflation and that for durable goods.   Using the monthly weight of durable goods in total core PCE expenditures, he was then able to back out a figure for core PCE inflation, ex-durables.  Given that the weighting to durable goods in the overall basket is fairly modest  (12% currently, down from 15% a couple of decades ago, though these were nominal rather than real figures), the overall impact to the 'controllable' inflation measure is evolutionary, not revolutionary.  Nevertheless, the results are interesting, and set out below.

It is interesting to note that the average 'TICC' inflation rate since the announcement of QE2 has been 1.92%- more or less bang on the Fed's ostensible target, though the current rate is very slightly lower.  If you believe that the shape of the line matters more than the level, then you can still ascribe a level of deflationary concern to the Fed, insofar as both measures (core and TICC) are not hugely off of their post-crisis lows.

On the other hand, if you believe the level does matter, well then there is more breathing space for the Fed between the price of things that they can influence and deflation.   By the same token, this measure would have picked up that monetary conditions were too easy in the middle of the last decade in a way that core PCE did not.

Naturally, none of this is to suggest that the Fed will take this type of analysis into account.   One could argue, furthermore, that the fallout from the secular decline in durable goods prices (lower wages in the manufacturing and related sectors, for example) is something that the Fed should try to counteract with monetary policy, futile though it may be.

Nevertheless, as the debate about lift-off intensifies over the coming weeks and months, some observers will no doubt wring their hands about the low level of inflation and claim that the Fed couldn't possibly raise rates with core PCE so low, or the economy will tip into deflation.   Macro Man at least plans to keep tracking this TICC inflation so that he'll have an idea of how low it really is in things that the Fed can actually control.

Tuesday, March 03, 2015


A song in honor of the Nasdaq Composite reaching 5000 again, a mere 3,907 weekdays after it first achieved that lofty perch, with apologies to Prince....

I was dreaming when I bought this
Forgive me if it goes astray
But when it comes to Fed tightening
You can wait until Judgement Day
The screen was all flashing
There were people buying everywhere
Trying to run from cash destruction
You know they didn't even care

Two thousand zero zero rally over,
Oops out of time
So today I'm gonna buy 'em like it's 1999

I was dreaming when I bought this
So sue me if it goes up fast
But markets just rally, and rallies aren't meant to last
War is all around us, my mind says it just ain't right
So if I gotta buy I'm gonna listen to my chartist tonight

Yeah they say two thousand zero zero rally over
Oops out of time
So today I'm gonna buy 'em like it's 1999

Lemme tell ya something
If you didn't come to buy 'em
Don't come knocking on my door
Got funny money in my pocket
And the market's just ready to roar
Yeah, everybody's got a bomb
We could all die any day
But before I let that happen
I'll leverage my blues away

Two thousand zero zero party's over
Oops out of time
So today I'm gonna buy 'em like it's 1999

Author's note:   While stocks and other risky assets have undoubtedly been pushed up by the panoply of uber-aggressive montary policies around the globe (as discussed ad nauseum in this and other spaces), the current market doesn't really resemble 1999 very much at all.  The current trailing P/E is roughly 17.5- in 1999 it was pushing triple digits.  And lest we forget, the pace of the rally in the bubble era was truly eye-watering.....


Friday, February 27, 2015

A simple model

So the US economy is not, in fact, falling off a cliff...just yet.  Although durable goods orders are notoriously noisy, yesterday's solid print should assuage at least a few fears about the recent soft tone to some of the data.  That core CPI managed to beat expectations was icing on the cake, as the dollar and US yields both jumped smartly after the releases.   As Hannibal Smith used to say, "I love it when a plan comes together!"

Of course, it wasn't all pony rides and lemonade.  Weekly claims were quite a bit higher than expected, albeit in the context of seemingly interminable snowy, nasty weather for much of the country.  Still, the decline in claims seems to have stalled a bit recently; although it's probably too early to read too much into it, it nevertheless remains a development worth watching.

Every so often, Macro Man likes to take a step back and look at data in its unadulterated form- no rates of change, moving averages, or anything like that, just the level of the underlying data.  When looking at the level of durable goods orders, ex-transport, you can see the recent soft patch; put into context, it doesn't yet look particularly abnormal or worrisome.  Certainly the loss of momentum is nowhere as severe as it was in 2012.

Perceptive readers will note that durables are basically at the peak level of the last cycle, whereas the SPX is comfortably above it.  How, then, do these orders figures compare with other data?   Macro Man assembled a chart showing nominal retail sales, the ex transport orders noted above, and industrial production, scaling each series to 100 as of February 1992.  As you can see, the relative fortunes of the 3 data sets vary starkly.

As the title of the chart suggests, these three series capture the changes in the economy quite well.  Consumers have continued to spend (note that retail sales are substantially above the level of the pre-crisis peak), but not, it would appear, on goods made in the US.  This is hardly a stunning revelation, of course, but it's nice to see it demonstrated so sharply in a single chart.

This got Macro Man to thinking.   Retail sales, like the SPX, are very comfortably above pre-crisis highs, IP is marginally so, and orders are basically at the level.   What would happen if we regressed these 3 series against the SPX?  The results are set out in the chart below.

As you can see, the relationship is generally quite good, with an r-squared of .88.   Note that to some extent that should be expected, insofar as the entire time period was in-sample and your author regressed levels rather than changes.  Nevertheless, it's interesting to note that the divergence between the current level of the SPX and that suggested by sales, orders, and IP is larger than  it has ever been over the past couple of decades.

To a large degree, of course, that is a function of QE/easy monetary policy/low bond yields/low discount rates.   One would naturally expect, ex ante, that stocks should look a touch rich to exclusively growth-based indicators given that global policymakers have begged investors to move out the risk curve for more than half a decade.

Naturally, equities also benefit (and suffer) from leverage, both on a corporate and investor level.  Indeed, generally speaking the amplitude of changes in stock prices dwarfs that of changes in the underlying data, so it may well be the case that a simple linear regression is a decidedly imperfect tool.

To mitigate the impact of leverage, Macro Man ran the same regression, but on the natural log of the SPX to smooth the swings in stocks relative to the economy.  Upon obtaining model output, it was a trivial matter to reconvert the data back into SPX terms.  The results of this study are below.

This model suggests a closer fit between the current level of stocks and that implied by growth data (and a closer overall fit, with an r-squared of 0.93), though it still views equities as nearly 10% too high (when using current stock prices.)  However, "mispricings" of this magnitude are fairly ordinary; indeed, the same model suggests that stocks were undervalued by a greater amount in the run-up to the crisis.  That very fact should tell you everything you need to know about relying exclusively on growth-based indicators that take no account of financial conditions.

So what have we learned?  A very simple growth-based model suggests that US stocks should indeed be at all time highs, albeit at levels lower than those currently prevailing.  Introducing a liquidity term would indubitably close that perceived valuation gap; indeed, in Macro Man's own, more robust equity model, liquidity factors explain almost all of the ex ante expected return of the SPX.

As long as liquidity remains ample, growth doesn't necessarily need to roar to justify current if not higher prices.   If and when the tap gets closed off, on the other hand, simple indicators like these can provide a rough and ready guide to how deep the correction might be if we were to revert to using growth rather than easy financial conditions as the primary valuation metric.

Wednesday, February 25, 2015

Something for everyone

Janet Yellen's testimony yesterday had something for everyone (except owners of puts, natch.)  Of course, these days 'balanced' outcomes seem to mean 'dovish', as markets are clearly placing the burden of proof upon hawkish developments to justify market pricing.   Given that we're closing in on 9 years since the last rate hike in the United States, that is probably a justified posture.

To be sure, there were some things that did sound outright dovish.   The familiar mantra that there is room for further improvement in the labour market was trotted out; at times, one wonders if Yellen would be saying that if the unemployment rate were 0.5% ("when we say full employment, we mean full!")

The comments vis-a-vis inflation and foreign risks were not particularly surprising, given that they echoed the tenor of the minutes.  While some might paint as dovish her emphasis that the removal of 'patient' does not necessitate a tightening within the next couple of meetings, from Macro Man's perch it makes a lot of sense.  The more options they give themselves, and the freer they are from the tyranny of this silly forward guidance, no doubt the more comfortable they will be.

On the other hand, Yellen sounded quite confident that the net impact of lower oil is solidly positive, a point that seems to be in dispute in some quarters.  Moreover, she offered a gentle reminder that the risks posed by Johnny Foreigner are not all to the downside. 

All told, Macro Man saw absolutely nothing to dissuade him from the view that the first tightening will come in September.  Indeed, if anything some of his concerns about an earlier June tightening were mollified somewhat.  While it is perhaps not a surprise that ED's have rallied and flattened as a result,  they remain too high, in your author's view.   Should the rally continue, he will look to add to shorts.

One thing that Macro Man is mindful of is that March often has a nasty way of reversing the trades that have worked in the early part of the year.   The dollar and equities are both obvious candidates to exact harm on the marketplace.   A sell off in both coinciding with the start of ECB would be knowingly explained as a "sell the fact" phenomenon (ex post, of course) by the usual armchair savants.

Per Monday's post, your author is still sitting tight, for the time being.  However, if ED's continue to rally, it would appear to him that they would offer a superior near term return than the dollar.  Put another way, if they were 'right', then the USD value would likely be quite 'wrong.'

Markets generally do offer something for everyone; you just have to know when and where to take it.

Monday, February 23, 2015

How ya left?

So Greece is not, after all, leaving the euro....yet.  The recent agreement was as uninspiring as it was unsurprising, a classic example of the type of can-kicking that has led us to this point, some 5 years after Greece first descended into chaos.

That both the arguments and the solutions have not moved on tells us quite a bit about the situation; the interests of the Greeks on the one hand, and the Troika (or, to cut to the chase, ze Germans) on the other, are implacably opposed.   Neither can credibly give ground on the areas of fundamental dispute: the Greeks, because they literally cannot afford to pay and there is no realistic hope of changing that dynamic, and the Troika, because to forgive debt would open a Pandora's box that would likely result in the end of a few political careers.

Perhaps justifiably, the euro has essentially yawned at the news of the agreement; after all, Greece seems to go through showdowns quicker than some people go through bottles of shampoo.  And so how are we left?

* The dollar remains off of its highs...but not very much so

* The SPX and DAX are at all time highs

* Indices in Madrid and Milan, on the other hand, are at or below levels prevailing last June

* The US economy seems to be in a bit of a soft patch after several quarters of stellar growth

* The recent spate of horrible weather in the northeast doesn't seem likely to improve that in the near term

* The US short end is too low to add to shorts but too high to take profit on existing ones

* Crude oil seems to have stabilized, for the time being

* The ECB cranks up the QE machine soon

* The Fed seems unwilling to cause pain to anyone except owners of volatility

For Macro Man, it's a bit of an uninspiring confluence of factors- for the time being at least.  To be sure, it's always easy to find reasons for equities to go down...but then again, it's also easy to find reasons for them to go up- at the moment, it's hard to find much conviction.

As such, your author could easily see himself sticking with his positions- a modest EUR short, owning some downside and small steepeners in ED's- without doing much by way of adjustment this week.  It's one of the more refreshing aspects of trading for one's self- there is no implicit pressure to do something for the sake of doing it, such as one often finds on a professional trading floor.

More thinking, less doing.  That's the power of the home office!

Thursday, February 19, 2015

A multiple choice quiz

Yesterday's minutes reveal that the Fed is:

a) Justifiably concerned about the lack of global demand

b) Ignoring nascent signs of recovery in Europe, so get ready for another U turn

c)  Tick watching the dollar TWI

d) Proving that when push comes to shove, they don't have what it takes to leave ZIRP

e) Clueless

f) Actually "Funny Money" from the comments section, so JBTFD; heck, JPTFO!