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 15 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  

The Mystery of the Dots, Part II

Tuesday, April 15, 2014

A continuation from Part I

I returned to 221B Baker Street with an FT, an Economist, and a large bag of wine gums.  I recalled that while confronting a particularly vexing problem, Holmes had often taken to chewing the latter between puffs of his pipe.

"Anything else I can do for you, Holmes?" I asked as I handed over the items.

"Be a good chap and get me that copy of Who's Who in Finance, will you?" he replied, pointing his finger to the bookshelf behind me.  I retrieved the slim volume and wordlessly handed it over to him.  He placed it on the desk, then immediately bent over the two diagrams that Ms. Yellen had left him, immersing himself in their decryption.

While I struggled with the solution to the Times Su Doku and simple crossword, for the next several hours Holmes remained seated silently at his desk, stirring only to suck on his pipe or pop a wine gum in his mouth.

Finally, at dusk he yawned, stretched his arms to the ceiling, and stood up.   "Watson, we're making progress, my boy!" he said, with the slightest hint of a smile creasing his features.   "Still, there's more to be done. "

"What can I do to assist?"

"Run down to London Library and fetch a copy of the latest IMF World Economic Outlook, the proceedings from the 2003 Brookings Panel on Economic Activity, and every Federal Reserve Open Market Committee statement since February 1994." 

"With pleasure, Holmes."

"Watson, I've missed you, truly I have.   As an assistant and a foil you are peerless.  Oh, and while you're out, drop by the Yard and invite friend Lestrade round for an early lunch tomorrow."

Flushed by the praise from the world's preeminent detective, I caught a hansom cab to the library, where with the help of a consulting librarian I managed to procure the documents that Holmes required.   Carrying them in a large rucksack, I walked through St. James's Park to Scotland Yard.   Lestrade was out arresting a few LIBOR traders, so I left the message from Holmes and caught another cab back to Baker Street.

Holmes was in no mood to dine, and I was in no mood to go hungry, so after handing him the bag of documents  I went to the Royal China Club for a dinner of chili lobster and a rather decent bottle of Nuits-Saint-Georges.  I returned to his chambers to find him in almost a frenzy, a pile of documents strewn over his desk.   He consulted one sheaf of papers, and after making an annotation in a small, leather-bound notebook, tossed it aside to examine another.  It was clear that Holmes would be working for many hours to come, so I left the room as silently as possible, descended the stairs onto Baker Street and made my way back to my own quarters.

The next day dawned unusually warm for an early spring morning, with the sun making its first appearance in the London sky for what seemed like months.  It was therefore a pleasure to walk from my chambers to those of my friend, all the more so because of the sense of anticipation that gripped me.  Although I could not fathom the meaning of those bizarre diagrams, it was a comfort to know that if anyone in the world could unlock their secret, it was Mr. Sherlock Holmes.  

Mrs. Hudson extended her usual welcome when I arrived mid-morning, and allowed me to make my own way up to Holmes's sitting room.    Although it was just past ten, he was finishing up a plate of scrambled eggs and toast, topped up with appreciative sips of a large mug of tea.  Long experience told me that he had not slept; my friend's iron constitution and force of will allowed him to make demands of himself while working on a case that would overwhelm a lesser man.

"Good morning, Watson, a very good morning to you indeed!"  Holmes clapped me on the shoulder as I sat next to him at the table.

"You've found a solution, then, Holmes?  What do those dots signify?"

It was a frequent habit of my friend to wait for a particular moment of his own choosing to divulge the results of his inquiries.  Although he often chided me over the years for my sensational accounts of his adventures, he nevertheless had an uncanny knack for revealing his solutions in a manner that enhanced their dramatic impact.  Today, it appeared, would be no different.

"Now, now Watson!  "'Twould be rude of me to unlock the mystery of the dots before our guests are here, would it not?  Now, please allow me to freshen up before they arrive.   Please, make yourself comfortable, won't you?   No, try the seat by the door, and do keep your service revolver handy if you have brought it with you."

I picked up a copy of the Illustrated London Gazette and perused the sporting pages while Holmes readied himself.   He emerged from his dressing-room at five minutes to eleven, then went to his desk and opened a small dossier of papers as if double checking them.   Apparently satisfied, he closed the folder with a small, satisfied nod and sat upon the settee.   "Well, Watson," he said, rubbing his hands eagerly, "this promises to be very interesting indeed."

At the appointed hour the bell rang, and we could hear Mrs. Hudson usher our client up the stairs.   The door opened, and the elfin Ms. Yellen walked nervously into the room.  As we stood to greet her, Holmes gestured to the seat opposite me, saying, "Please sit, Ms. Yellen.  I believe you prefer the chair?"

"I do, thank you."   She walked over, made herself comfortable, and then looked at Holmes expectantly.   "Well, Mr. Holmes, have you got any answers for me?  Do you know what the dots mean?"

"I do, madam."    Our client exhaled deeply, as if a great weight had been lifted from her shoulders.  'However, before I share the results of my investigations, I must ask you a few questions."

Ms. Yellen nodded her assent.

"Tell me, madam, in your telegram to me you mentioned something about the case being 'vital to the world economy', yet when you were here yesterday there was no explanation of how or why?  Similarly, you referred to a big project that was winding down at your office, but refused to elaborate.   Why was that?"

Our client flushed.   "Well, Mr. Holmes, I...I...I just didn't think they were that important."

Holmes looked at her archly.  "Madam, might I suggest to you that your judgment of what is important or not leaves rather a great deal to be desired.   Facts are important, Ms. Yellen....such as the fact that you are the head of the US Federal Reserve."

Our client and I gasped simultaneously.   "But how did you kn-know..." she stammered.

"I know it all!" Holmes thundered.  "I know who you are, and I know what you've done!   Here, look at this!"  Holmes thrust a small piece of paper at our client's face.    "This was the very first Fed statement explicitly announcing interest rate policy!"

"It was short, concise, and to the point!   But look what you've done to it!" continued Holmes.   "Twisted it, stretched it, and pulled it all out of recognition.  You've destroyed it!"  He showed her another sheet of paper, upon which was printed dense blocks of text that required a font so small to fit on one page that it was illegible.  As our client squinted to read it, I heard a heavy footstep running up the stairs.

"Scotland Yard has wasted countless hours pursuing LIBOR setters and FX spot guys.  They are merely the unwitting foot soldiers of a campaign to distort and disrupt the financial system.  Ms. Yellen, the greatest manipulator of financial markets is....YOU!"

As Holmes stood and pointed at our client, Chief Inspector Lestrade appeared at the sitting room door.   Ms. Yellen appeared stunned for a moment, then a crafty glint appeared in her eye.    She feinted running behind the sofa, throwing Holmes off his guard, then charged past him and rushed at me.    As I fumbled with my revolver, she head-butted me on the hip, sending me sprawling.   Lestrade proved one obstacle too far, however, as he wrestled her to the ground and clapped restraining handcuffs upon her.

As Lestrade hauled Ms. Yellen to her feet, Holmes gazed at her with a look that almost resembled pity.  "There is a black thread of manipulation running through the colourless skein of the market, and our duty is to unravel it, and isolate it, and expose every inch of it."

"But what about the dots?" our erstwhile client screeched.  "I really was concerned about them."

"You can blame your friend the professor for that," replied Holmes.

"Faugh!" she said with visible disgust.   "And how long am I going to go down for?"

"Oh, I'd say for a considerable period," said Lestrade.  Ms. Janet Yellen blanched and gave an audible whimper as he led her down the stairs.

I sat down, shaking my head.  "For the life of me, Holmes, I cannot figure out what just happened, let alone the business with the dots.   And who is this professor?"   

My friend chuckled as he reclined on the sofa.  "These were deep waters, Watson, substantially deeper than I first supposed upon receiving the telegram.  It was obvious, of course, as I pointed out to you yesterday, that our Ms. Yellen held a senior position at the US Federal Reserve.   A quick check of the FT and Economist revealed that she had recently replaced a certain Ben Bernanke as chairman of the Open Market Committee.  Further research suggested that she had previously chaired the subcommittee on Communications.

"Her stated goal was 'transparency' of communications, but that was obviously a red herring.   Observe how poorly she was able to judge which information to emphasize in describing her case to us.  Note also how shifts in policy were communicated 20 years ago: short, succinct sentences.  Over the past few years, however, Fed policy has become a virtual Babel of messages, some of which conflict with each other.   Look at how long their last statement was, and how little it actually said.  Consider also that this statement and its guidance is just one plank of the policy platform.   Asset purchases and forecasting are also presented as policy tools.

"What I discovered is that the Federal Reserve, and indeed similar institutions like our very own Old Lady, are claiming to back efforts to enhance financial stability and do away with manipulation.   They support crackdowns in the LIBOR and FX scandals.   And yet these are the very same institutions that have suppressed volatility and risk premia more than a universe of bank traders could ever hope to do."

"But the dots, Holmes?"

"Ah yes, the dots.   In sifting through the literature, I found that that Ms. Yellen and her institution are not the mastermind of this nefarious campaign to manipulate markets.   The dots were placed there by the man at the centre of it all."

"And who is this?"

"In my study of global monetary policy over the last four years, Watson, I have become conscious of some sort of power over the manipulator, some agent who casts a veneer of academic credibility to the patently absurd.  Again and again in policies of the most varying sorts- qualitative guidance, state-contingent threshold guidance, target and policy forecasting- I have felt the presence of this force, and deduced its influence in other policies in which I have not personally been consulted.  In the end, my investigations led me to Professor Michael Woodford.

"He is the Napoleon of manipulation, Watson.   He is the organizer of half that is published and nearly all of what provides the intellectual underpinning of this trend in policy.   He is a genius, a philosopher, an abstract thinker.  He has a brain of the first order.  He sits, motionless, in the centre of a great web, but that web has a thousand radiations, and he knows very well the quiver of each of them.

"It was Woodford that convinced the FOMC that they could present explicit policy forecast guidance (for that, my dear Watson, is what those dots were), written qualitative guidance, and verbal guidance, all of which contradict each other, and still maintain the illusion of credibility."

"If it hadn't been for you, Holmes, it might have worked!"

"For a while longer, Watson.  But the agents of financial repression usually slip up in the end, and when they do, the market is there waiting for them.   Like Lestrade, the market is not always the quickest to catch on, but once it does it's like a bulldog with a bit between its teeth.  For now, we must keep a wary eye on our friend the Professor and catch him out whenever we can."


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

The Mystery of the Dots

Monday, April 14, 2014

In the spring of 201- I had not seen Mr. Sherlock Holmes for more than four years.  My medical practice, which had been booming a few short years previously, was somewhat lacklustre since the epidemic of pecunia refrenata had driven so many out of the City.  Although my small roster of regular patients was sufficient to keep me in modest comfort, I often cast a wistful thought back to the days when I shared Baker Street rooms and the occasional adventure with my friend.

Holmes, meanwhile, had won global renown for his ingenious solution to that infamous affair with the QE2 and QE3.  The crowned heads of Europe regularly consulted him on matters of international importance, and he had even become something of a sensation in the gutter press.  I thought that some day he might come to call on me between cases, but sadly he never seemed to have the time.

One Wednesday afternoon in late March I had an appointment with one of my occasional patients, an elderly fellow named Mr. Jartholomew Axgrind.  This gentleman  possessed a shock of white hair and walked with a stoop, but boasted a wiry physique that would have flattered a man two decades his junior.   Cantankerous at the best of times, he was in a particularly foul mood that afternoon for someone so well-preserved as he, refusing to even let me apply a stethoscope to his surprisingly muscular chest.

"My dear sir!" I exclaimed, "if you do not wish me to examine you, perhaps you should find another doctor to consult!"

"Harrumph," he muttered, seizing his battered greatcoat and striding towards the exit, "perhaps I will.  But Watson," he said, pausing at the doorway as his voice strengthened into a familiar tone, "do you think he'd be interested in helping me with a case?"

"Holmes!" I cried, as Axgrind's stooped figure straightened to form the familiar rigid bearing of my friend.  "My dear fellow!  How have you been?  But do you mean to tell me you've been Axgrind all along?"

"I see the last few years have not dulled your powers of observation, Watson," he replied, shaking my hand warmly.  "Indeed, I took on the character of the ill-tempered Mr. Axgrind to afford me the opportunity of looking in on you every so often."

"But Holmes, why the ruse?   You know you were always welcome here!"

"Of course, Watson, but would Mr. Axgrind's fee have been as welcome if offered as charity?"  It was true that Axgrind's pecuniary generosity had always seemed a stark contrast to his irascible character, and that the income from his quarterly visits had been vital in maintaining the practice as a going concern. 

"Ah, yes Holmes, well I am very thankful indeed.  But what's this you say of a case?"

"Watson, my friend,  I received a very interesting telegram this morning that reminded me of a few all of our old adventures.   Tell me, what do you make of it?" he said, handing over a folded slip of paper.   I took it and read the message:

"Deuced if I know, Holmes.   What's this nonsense about moving dots?  I can make nothing of it, I'm afraid."

"Capital, Watson!" exclaimed Holmes.  "Scintillating!  Every single item of importance has eluded your observation."

"How so?" I inquired, wondering what even so brilliant a detective as Mr. Sherlock Holmes could make of such a cryptic message.

"As I mentioned, I received this cable this morning.  Observe, Watson, that it has been sent from Washington, DC in America.   It was, composed, therefore, in the middle of the night by the sender, this Yellen.  Who sends a transatlantic message at that hour?   Someone who is agitated in the extreme and cannot sleep, and finally resolves to consult a higher authority.   Note also that Western Union offices are closed at that time of night, and yet this person was able to access a telegraph.  That, combined with the sender's location, is suggestive of somebody that is highly placed within official circles in America.  Finally, the mention of the importance to the world economy implies that the sender is involved with business or finance of some kind.  I can think of eleven possibilities, but the one that seems most likely by far is that the sender is an official with the Federal Reserve, America's central bank."

"Genius, Holmes!  Now that you mention those things, they seem obvious."

"They are, if you know how to look."

"But what of the dots?" I asked, stroking my moustache. "You haven't mentioned them."

"Facts, Watson, we need facts!  Speculation without them is a sure path to error.  Fortunately, this Yellen has arranged transport to London and will be at 221B Baker Street at 11 am sharp tomorrow.  If you'd do me the honour of sitting in on the meeting, I am sure that we'll both find the experience stimulating."

"Naturally, Holmes!   Nothing would delight me more!"

"And now, what do you say to a nice side of mutton and a glass of claret at Rules?"

I awoke the next morning with something of a sore head.  Holmes had regaled me over dinner with stories of his adventures since I had last accompanied him, and also described the contents of his latest monograph- volatility forecasting in the context of a zero lower bound.  A glass of claret became a bottle, and one bottle became three before we stumbled out onto Maiden Lane and made our way to our respective quarters.

Mrs. Hudson welcomed me warmly when I rang the bell at Holmes' Baker Street chambers and ushered me into the sitting room at five minutes to eleven.   The famous detective appeared lost in thought and silently gestured at me to take a seat, which I did in one of the comfortable easy chairs that flanked either side of the settee.   I knew from long experience not to disturb my friend's reverie; such was the intensity of his concentration that any attempt at conversation on my part would have proven fruitless.

At 11 am sharp, the bell rang and Mrs. Hudson ushered our visitor up the stair.

"Ha!" muttered Holmes.   "A small person, as the fourth stair barely made a creak!"

This deduction was proven correct when our client entered the room.   Standing barely over five feet in height, a bowl of white hair surrounded a jovial-looking, red-nosed visage.   She (for our visitor was indeed a woman) looked much as one might picture the wife of Father Christmas, barring the fact that her attire was drab and gray rather than merry and red.

"Please have a seat, Ms. Yellen," said Holmes, gesturing to the sofa.

"Thank you, but I prefer the chair," she replied in a voice that sounded more appropriate to a Brooklyn deli than a London sitting room, and installed herself on the seat facing mine.

"Now madam, what can we do for you?"

"Well, Mr. Holmes, in December I received a strange diagram on my desk at work.  I didn't know what to make of it, for it seemed like something a child might draw as a doodle while talking on the telephone.  In speaking with my colleagues, it seems as if they all received a similar image at the same time as I did.   It was quite a sensitive period at the office as we were focused on- well, the details are not important, but starting to wind down a big project that had been an important part of our working lives for more than a year.

"No one paid much attention to these diagrams, which seemed quite meaningless.  Indeed, our target customers seemed thrilled that we were winding down our project, and things couldn't have gone much better...."

"Do you by any chance have a copy of this diagram, madam?" interjected Holmes.

"Certainly, Mr. Holmes.   I know how particular you are about evidence, and I can swear to you that this diagram is exactly as it was when it appeared on my desk."   She took a small sheet of paper from her handbag and passed it over to Holmes.   He studied it silence for a minute then handed it to me.  It looked like this:

As I handed it back to Holmes, Ms. Yellen resumed her story.  "A couple of weeks after we received the diagram, however, things started to go a bit wrong.  My boss become agitated, and the value of our most important product started to decline against those of Japanese and European competitors.   Our stock price fell sharply in early January for no reason at all.  Worst of all, our Chairman abruptly left his post at the end of that month, leaving me in charge.

"For a while after I assumed control, things seemed to return to normal.  The value of both our products and our share price rose again, and everyone seemed fairly happy despite the fact that snow had disrupted a lot of production over the first few months of the year.  While this meant that I couldn't hire as many people as I might have, on the whole things were looking pretty rosy as recently as a few days ago.

"Then, I received this on my desk."   She fished into her handbag once more, retrieving a half-eaten knish and putting it on the end table.   She then plucked a second piece of paper from the bag and handed it to Holmes.

He peered at this paper for a full ninety seconds, then compared it with the first one for another minute or so.  "What do you think, Watson?"

"Frankly, Holmes, it borders on the grotesque.  I confess I can make heads nor tails of these little dots, save that they appear to be a bit higher in the second diagram than in the first.  If anything, it reminds me of the adventure of the dancing men, which if memory serves also involved America."

"Yes, and with tragic consequences, if you'll recall, Doctor.  Tell me, Ms. Yellen, has anything untoward happened since you received this second diagram?"

Our client sighed and slumped in her chair.   "I'm sorry to say that it has, Mr. Holmes.   Although my colleagues have once again claimed that these dots can mean nothing, and that there is no significance in their movement, as soon as we got the diagrams, things have started turning south again.  This time, it's the value of our bonds that have plummeted.  I mulled over the problem for a considerable period but could come up with nothing to do, so thought I had better consult an expert- you."

"Very interesting, very interesting indeed, Ms. Yellen.  I am much obliged to you for bringing this  curious matter to my attention.   Allow me to think on it for while, so I suggest you return here at the same time tomorrow.    In the meantime, you might wish to see the sights of London.    I hear Threadneedle Street is very interesting these days."

As Mrs. Hudson ushered our guest downstairs, Sherlock Holmes looked at me with a glint in his eye.   "This is a real corker, Watson, at least a two pipe problem.  Be a good chap and fetch me a copy of the Financial Times and The Economist  from the corner shop, will you?"

While strolling on the familiar stone of the Baker Street pavement, I found myself wondering what meaning Holmes could possibly find in those bizarre, and quite possibly sinister, dots.


To be continued.....

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

Oh Dear

Friday, April 11, 2014

Oh dear.   It isn't terribly easy at the moment, is it, no matter which side of the bull/bear divide you happen to inhabit.  Indeed, a quick glance at a 30 day chart of the SPX reveals a lot of slop with relatively little impulse and a lot of overlap.

That having been said, price action  over the last week or so does seem to be a little more serially correlated and purposeful.  Yesterday's Fed rally retraced nearly 61.8% of the decline from the ding-dong highs, then promptly gave it all up and more yesterday.  So is that an A/B/C , or a 1/2/getting started on 3?  Enquiring minds want to know.

(As an aside, it is surely a coincidence, as one of Macro Man's mates pointed out, that this more directional price action started right after Flash Boys was published....innit?)

Meanwhile, the proprietors of Trendlines 'R' Us are doing a roaring trade, given the demand for their products to contain weakness in the NDX...

...and the Russell 2000.

Unfortunately, at the time of writing, some of the merchandise appears to be of dubious quality and easily broken:

(Sod's law suggests that the Nikkei will stage a furious rally before this post is published, thus rendering it obsolete before the pixels hit your screen.)

Quite frankly, Macro Man isn't quite sure what to make of this whole setup.   The first chart above suggests that chasing extremes is a lousy idea, and while the SPX and Nikkei charts have broken, the NDX and RTY are holding on...barely.  Some confirmation from those would be a nice way to increase confidence.  Then again, USD/CAD broke the key support level highlighted here the other day....and then decided to rip back up above it.

All in all, it's a pretty low quality trading environment, given the erratic price action, mixed signals, and general unwillingness of punters to warehouse any more pain.   The Eurostoxx puts highlighted a few days ago would appear a sensible way of playing a bear trade without loading up too much risk at bad levels, thus allowing the picture to clarify a bit.


Posted by Macro Man at 7:00 AM 18 comments Links to this post  

Spot the Difference!

Thursday, April 10, 2014

Try to spot the difference between the texts below:

FT today: 

Greece has raised €3bn in a five-year bond deal after attracting in excess of €20bn in orders for its eagerly anticipated return to the bond market.  The yield on the deal was confirmed at 4.95 per cent – much lower than most analysts expected.
FT January 25, 2010 :  

International alarm over Greece’s debt crisis abated on Monday when investors flocked to buy the government’s first bond issue of the year, an indication that it may run into less trouble than anticipated in meeting its short-term financing needs.  Investors placed about €20bn ($28bn, £17bn) in orders for the five-year, fixed-rate bond, four times more than the government had reckoned on.
Could you find it?  Astute readers will have noticed that at the time of the earlier bond auction, the paper cleared a little under 6% with CDS at ~320 bps, whereas yesterday the bonds fetched 4.95% with CDS at 425 bps.

Nothing to see here, folks, please disperse.

Posted by Macro Man at 2:14 PM 6 comments Links to this post  

Minute Bubbles

The Fed minutes proved just the tonic for equity longs, as the magic red headline stating that SEVERAL FED OFFICIALS SAID FORECASTS OVERSTATED RATE RISE PACE sent stocks ripping higher.  The news was less comforting for USD longs and fixed income shorts, however.   Eurodollars have now corrected much of the sell-off from last month's Fed meeting, and while USD/JPY remained remarkably stable, USD/CAD crashed through the support highlighted yesterday.

A more thorough read of the minutes provided a slightly more balanced view than the all-powerful red headline.   For while a few of the market-savvy participants did indeed voice concern over the message sent by the shift higher of the infamous dots, some others apparently suggested that the move was warranted.  The solution to the problem of the dots was, of course, the insertion of the flimsy final paragraph in the statement, which was roundly ignored by the market.  It certainly feels as if the more the FOMC writes, the less they say.  (Readers who recognize a certain parallel with your author will be gratified at the relative brevity of today's offering.)

Moreover, there was discrete attention paid to financial stability concerns, with credit and equity valuations coming under scrutiny.  The departure of Jeremy Stein will no doubt quell and least some of those rumblings, though it seems unlikely to banish them altogether.   Coincidentally, a helpful reader pointed out the latest report from the Financial Crisis Observatory at Einstein's alma mater, which highlighted a strong tendency towards bubble-like behaviour in credit:

Source: http://www.er.ethz.ch/fco/FCO_Cockpit_1April2014.pdf

Also meriting a headline, of course, was the lack of specific discussion of the infamous "six months" definition of "considerable period", no doubt because the phrase was intended to be deliberately vague.  While some committee members were probably not terribly put out by the hawkish tint that the comment lent to the proceedings, it did little to calm the waters already muddied by the Fed's increasingly Byzantine communications strategy.   Perhaps someone should give Yellen a KISS?

In any event, the equity beta pain was forestalled as the 1830 level in Spooz has held like a champ yet again.   Macro Man's concern has thus far proven unwarranted, though of course two rallies do not a safe market make.  Hey, at least Polemic called this one right.

Fixed income, on the other hand, has reacted more along the lines that Macro Man envisaged.  The M5/Z5/M6 eurodollar fly, highlighted in this space last week, has broken down nicely having offered up an attractive entry point late last week.

From here, however, Macro Man reckons that the short end will have a trickier time of it.   EDZ5 is now closer to its highs of the year than its lows, and will quite possibly oscillate between the two for some time.   One strategy that Macro Man quite likes as an overlay on the fly is buying call ladders on 0EZ5 (options on the Dec 15 contract expiring in Dec 14.)  Something like the 99.00/99.12/99.37 can probably be had for a tick, which provides an at-expiry breakeven of 99.49.  Tasty!   The brave at heart could even roll the top strike down to 99.25 and earn a 3.5 or maybe even 4 tick credit with a breakeven that's well north of the all time high in the underlying.

Because for all the soothing words from these minutes, something tells Macro Man that we're not about to have a bubble in eurodollars any time soon.

Posted by Macro Man at 2:57 AM 3 comments Links to this post  

Sacred Cows

Wednesday, April 09, 2014

Although Macro Man has focused largely on equity pain trades over the last few days, stock markets are from from the only place where the consensus has come a-cropper.   Indeed, the recent strength in fixed income is an obvious source of pain, particularly given that US 10 year yields have retraced more or less all of their rise since last month's Fed meeting.  Today, however, Macro Man wishes to address foreign exchange, where a number of sacred cows have recently been ushered into the abattoir.

Ever since Ben Bernanke first mused about a possible tapering of asset purchases last May, markets have erred on the bullish side of the dollar trade.  Ironically, of course, the immediate impact of the "taper tantrum" was to send USD/JPY hurtling lower as both the Nikkei and consensus positioning were taken to the woodshed.

If at first you don't succeed, however, try try again, and the ensuing quarters have seen the market layer long-dollar trades against an array of currencies- notably the JPY, CAD, AUD, and selected EM.

To be sure, towards the end of last year these trades worked brilliantly as the market began to price in the beginning of the end of QE3.  While there was clearly the occasional hiccup to start 2014, after Yellen dropped her "six month" bomb, it seemed like only a matter of time before George Washington would once again be the baddest man in the market.  Indeed, Macro Man noted last Friday that USD/JPY was closing in on its highs and wondered how much risk the market still had.

Well, thanks to the analytical powers of his partner Harold H. Hindsight, it seems as if the answer was "too much."   Too much, at least, to hold up in the face of what seemed like a startlingly upbeat Kuroda after Tuesday's BOJ meeting:

"I don't want to give the impression that we are stubbornly against stimulus, however given that macro fundamentals are on track, we are not considering additional easing at the moment...."  (translation courtesy of BAML)

Ouch.   Unsurprisingly, USD/JPY has taken a swift journey to an important layer of support.....

What's particularly troubling in this instance is that it's removed one of the few obvious catalysts for USD/JPY to power higher (higher US yields being another, missing, catalyst.)   What's interesting about the whole Abenomics trade is how much of it has been predicated on expectation rather than deliverance.  For all of the anticipation over the past eighteen months, the BOJ has only forcefully delivered once.   Since late last year, the prospect of further easing has tempted USD/JPY longs like a will-o-the-wisp, dragging them further into the boggy marsh of consensus positioning.  The timing of the hoped-for next easing has been pushed from January....to April.....now to July or beyond.  Hey, there's always the GPIF....

Meanwhile, we have now exited the favourable seasonal period for USD/JPY  and have entered the long, cold Antarctic winter of yen-short discontent:

Another pink flamingo popular trade this year as been long USD/CAD as markets have fixated upon Canada's twin worries of persistently low inflation and weak export performance.   Not without cause, mind you; the Poloz BOC, while careful to mind its p's and q's, has offered a knowing "nudge nudge, wink wink" to those who've concluded that a weaker CAD could offer a handy solution to both problems.

Alas, while the trade was a prized heifer in January as USD/CAD ripped more than 5%, it has spent much of the subsequent period in the queue to become steaks at Farmer Market's next dinner party.  Simply put, the data simply hasn't cooperated.   The last two core CPI readings have both exceeded expectations, which is bad enough.  So have the last two trade balances, to make things worse.   To top it off, the prior data was revised, which lopped a third off of the average trade deficit of the prior six months.

Far from ascending the giddy heights of the mid to high teens, as was widely expected, USD/CAD now rests on critical support around the 1.09 -1.0910 region.   A break below and there's little but fresh air (or is that methane gas?) until a 1.06 handle.

Unfortunately for CAD shorts, loonies tend to fly in April:

But perhaps this is largely a USD story?   What if we were to take the dollar out of the equation?  Sadly, the story is little better.  Imagine you have an cross trade in two countries, A and B, with the following characteristics:

Country A
* Has the lowest current account deficit/GDP in its regional trading bloc
* Recently enacted sweeping reforms of its resource sector to enhance productivity and spur FDI
* Has seen seen market interest rates decline this year on demand for its paper

Country B
* Has a current account deficit/GDP of more than 5%, three times as large as Country A
* Has seen rolling strikes and violence cripple the productivity of its resource sector
* Has seen market and official interest rates rise this year on concerns about the currency

Knowing that, you'd feel pretty good about your trade, wouldn't you?  In truth, in January you should have, for ZAR/MXN (Countries B and A, respectively) dropped nearly 5%.   Since then, alas, it's been a steady grind higher, to the point where the cross is actually higher on the year (and that doesn't even include the carry!)   It's the class clown making the speech on graduation day while the valedictorian sits in detention....

Unfortunately for holders of dollar longs against sundry EM currencies, the seasonality is no better this month than it is for JPY or CAD shorts.  Indeed, over the past dozen years, April is the single best month for USD shorts against ZAR, TRY, and BRL:

A colleague of Macro Man once characterized the market as possessing two personas: The Buddha and the Thief.   When the market is a Buddha, errors are forgiven, things are calm, there is time for contemplation, and if you're lucky you find Nirvana.   When the market is a Thief, however, you must jealously guard your capital, as profit proves to be elusive, loss comes easily, and before you know it your P/L has been stripped bare.    No prizes for guessing which kind of market we've had in 2014!

Perhaps today's Fed minutes can stop the rot and restore a degree of normalcy to market conditions.  It's possible, though probably not likely, that they banish the Thief and return the Buddha to the market arena.

If Macro Man had his druthers, however, he'd prefer to see the market reincarnated as Vishnu.  At least then you could be sure it would take good care of the sacred cows...

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