Wednesday, December 17, 2014

How the Market Stole Christmas!

A trader's lament, with apologies to Dr. Seuss:



You’re a mean one, Mr. Market
You really are a heel
It is your common practice
Bloody awful’s how we feel
Mr. Market
You make the whole strasse trade like an imbecile!

You’re a monster, Mr. Market
My book’s a giant hole
I added dollar/ruble
Any my money you then stole, Mr. Market.
Why didn’t I trade with a
Czech, Turk, Hungarian or Pole?

You’re a vile one, Mr. Market
Lower oil’s good for stocks
But now energy high yield’s
Cracking underneath your shocks
Mr. Market
Given the way you make me trade I feel
Dumb as a big ol’ box of rocks!

You’re a foul one, Mr. Market
You’re as nasty as a skunk.
My payroll buy of dollar/yen
Is now a bunch of junk,
Mr. Market.

The three words that best describe you
Are as follows, and I quote
Stink!
Stank!
Stunk!

You’re a rotter
Mr. Market.
You’re the king of stupid grinds
Buy and hold just seems much better
Than trying to use our minds
Mr. Market

My book is an appalling dump heap
Overflowing with the most disgraceful
Assortment of deplorable rubbish imaginable
Mushed and crushed in this unwind.

You nauseate me, Mr. Market
Central banks all had my back
ECB is nice and easy and
Abe’s selling market crack
Mr Market!

Even if the Fed’s just “patient”
Spooz must rally hard
To get me on track!

Will the Market make away with everyone's holiday goodies, or can someone, anyone bring joy to the Whos of Whoville?

Tune in this afternoon to find out!



 


Tuesday, December 16, 2014

Out

As of yesterday, your author is out of all his macro positions, buying back the last of the EDZ5 he was assigned from Friday afternoon's silly expiry squeeze.  It's been a good run for him, largely as the result of a successful "pin the tail on the donkey" exercise in the aforementioned eurodollar contract.

From here, he is happy to sit tight and watch to see if prices move to any sort of overbought/oversold extreme.  Bitter experience in  2011-12 taught him that expecting rational market responses to what can only be called more nonsense in Greece is a fool's errand, and there's no point playing if he doesn't have to.

He doesn't trade Russia, as he makes it a policy not to trade the asset markets of countries that invade other sovereign states, unless they speak English.  Nevertheless, last night's panic rate hikes may introduce some more two-way volatility into markets, even if they ultimately prove unsuccessful.  Macro Man cannot shake the image of Putin as the little Dutch boy trying to plug a dike with his (middle) finger.

And of course, we have the case of the Federal Reserve and the game of "will they or won't they" with respect to the "considerable time" language.  Ordinarily a 300k+ payroll and an unemployment rate damned close to what used to be NAIRU would make a mockery of the question (let along current levels of Spooz, Treasuries, credit, etc.), but obviously we no longer live in ordinary times.

The collapse in oil prices clearly will have an impact on headline inflation, and while the Fed has spent much of the post-crisis period arguing that core is really what matters, one cannot help but worry that they will execute another "cherry pick the factor supporting ZIRP" pirouette.

One factor that does not argue for ongoing ZIRP is the level of capacity utilization, which is nearly back at the highs of the previous cycle.  True, prior cycles enjoyed much higher levels of CapU, but for reasons that Macro Man will detail in a future post it is probably unreasonable to expect those levels to return any time soon.  As the chart below illustrates, there is a solid general relationship between the Fed's monetary stance and CapU; suffice to say that we're well past the threshold that typically spurs the onset of monetary tightening.



How will the Fed play it?  Macro Man reckons they'll jettison considerable time and replace it with "patient", probably this month.   How will markets react?  Not  much of a clue.  Last year's December tapering helped "spur" a rampant equity and dollar rally into year end.   On Monday's evidence, neither of those is in the offing this time around.  Throw in the Greek mularkey and what still seems to be heavy USD positioning, and Macro Man feels like he doesn't have an edge.  And when he has no edge, he has no position.  So he's out....for the time being at least.

Wednesday, December 10, 2014

Ruh-roh Raggy, or I Love It When a Plan Comes Together

Price action since last Friday's stonking payroll figure has been rather telling, wouldn't you say?  Two trades that have worked a treat in recent months- long Spooz and long USD/JPY- have come under the first threat of any kind since that gut-wrenching roller coaster ride in mid-October.

Price action in the latter has been particularly troubling, as the first two trading days of the week saw a breathtaking 4-figure swoon before recovering, albeit modestly.  Having lived through, as the Prince of Frankfurt might say, the slings and arrows of outrageous markets for most of the year only to end on an apparent high, tolerance for further drawdowns must be miniscule indeed.



Macro Man noted last month that some of the recent price action in  Japan reminded him of 2005-06.   Punters of a certain vintage may recall that after a solid rally in 2005, USD/JPY cracked back brutally in December that year before eventually resuming its upward trajectory in spring 2006.

 As noted risk manager Scooby-doo might say, "Ruh-roh, Raggy!"

On a somewhat happier note, US rates- particularly your author's favored EDZ5 contract- have behaved rather more as expected in the wake of the payroll number.  Macro Man has not written about many specific trades during his renewed tenure at the helm of the good ship MM, but he has noted 3 specific opportunities with respect to EDZ5:

* Selling the EDM5/Z5/M6 futures fly at -8

* Buying the EDZ5 99.00/99.12/99.25 call ladder for a 3 tick credit

* Buying the EDZ5 99.25/12/00 put fl for 3

Of these, the first has drifted slightly against him after an initial flurry in his favour, currently sitting at a 2.5 tick loss.

The option structures both have optimal payouts with the future at 99.125; after flailing about in a range all year, at the time of writing we're at 99.09, a mere 3.5 ticks from the haven of max profits.


Unsurprisingly, the option strategies have performed very well indeed; the call ladder's currently valued at 8, with the fly at 6.5.  Thus far, Macro Man's view that a strong payroll would be more accurately reflected in rates rather than FX thanks to positioning has proved correct.

As noted punter Hannibal Smith might say, "I love it when a plan comes together!"

Discretion is, of course, the better part of valour, and while the last few months have been a fun (ahem) ride, we're now at the stage where noise trumps signal in determining price action.   Your author has therefore started cashing out this week, and anticipates finishing the job before the options expire on Friday afternoon.

Call it a triumph of proper macro; the call ladders sat on his book for 8 months untouched, and have ended up delivering a handsome reward.  It made a welcome change from "OMG have you seen the last 30 pips?!?!?!" that characterizes so much of today's 5-minute macro world.


Friday, December 05, 2014

The last but two

Well, yesterday's ECB meeting proved to be more Titus Andronicus than Hamlet or Romeo and Juliet, with Draghi performing his usual trick of doing nothing but promising reaallllyyyyy hard to do something really quite impressive if the governing council makes up its mind.

To be fair, opening the possibility of purchasing a broad range of assets could be quite powerful; of course, even if the ECB were "only" to do standard sovereign QE, they would be purchasing a much broader range of assets than the Fed, BOE, or BOJ.  After all, didn't the entire Eurocrisis revolve around the fact that a BTP (or Bono, or GGB, or OAT, etc.) is a completely different animal from a Bund?

Of course, a number of questions remain.   Perhaps the thorniest is what exactly QE in Europe could hope to accomplish.   Draghi trotted out the usual song and dance about lowering risk premia, the portfolio channel effect, etc. etc.  Certainly it seems difficult to credit that the level of sovereign yields is proving an impediment to growth, given that they're at record lows across vast swathes of the Eurozone, erstwhile crisis countries included.

The portfolio channel effect could prove to be a more effective one, but then again, there are reasons to expect it to work less well than in other countries.   The fragmented nature of Eurozone asset markets across national borders make it less likely, it would seem, that certain assets would be seen as acceptable substitutes than in other countries.   If the ECB buys Bunds, are the holders really going to run out and purchase shares in Santander or Intesa?  It seems dubious.  Credit easing is what's really needed, but alas that's much easier said than done.

Draghi's anchoring on the oil price was also curious, insofar as there would appear little that the ECB could do to alter the trajectory of crude;  the prior president of the ECB, a certain M. Trichet, demonstrated how foolhardy it is to chase the in- or de-flationary will-o-the-wisps caused by the oil market.  In this case, perhaps Mario was simply using energy prices to add a little zest to his warnings over lover prices; from Macro Man's perch, however, it weakened rather than strengthened his credibility.

For the time being, market focus may shift back to the dollar side of the equation and the US, what with payrolls and what not today.  Macro Man's model remains relatively upbeat, looking for an out-turn of  257k; he would note, however, that it has tended to be somewhat over-optimistic for the last few months.

With USD/JPY at its highest level since the financial world went 'bang', there must be at least an amber light of caution that a lot of good news is in the price.  Not to beat the same old tired drum, but there looks to be a lot less priced in to EDZ5 than USD/JPY; as such, in his personal trading, Macro Man has kept his option structures in the former while taking profits in the latter this week.

Macro Man cannot help but recall that last December's payroll was a strong one, keying a higher dollar and yields while allowing equities to keep rocking.  Virtually the entire street is probably hoping for a repeat, though much more on the dollar axis than rates these days.

Insofar as the year is drawing swiftly to a close, punters will likely have relatively little tolerance for a drawdown in the event of adverse data.  All the more reason to follow the road less traveled and keep the rates trades rather than the dollar for the time being.

After all, today's figure is the last really important release of the year but two (assuming the Japanese election is a foregone conclusion); other than this, we've got the second TLTRO tender and the Fed, after which the entire macro industry will probably heave a whopping sigh and look forward to the holidays.

Who knows?   If today's number doesn't play ball, that process might start a bit early.

Thursday, December 04, 2014

Mario and No-QE-yet

But soft!   What price through yonder support breaks?
It is the oil, and HICP is sub-one
Arise, oh price, and kill off deflation soon,
Which leaves us sick and pale with grief,
That thou hast left our price far below two:
Be not so low, since we are grievous
That headline price will be low through '16
And none but fools try to change it; have it off!

QE, or not QE?

King WEIDMANN and Lord SCHAUEBLE have arranged for DRAGHI to converse with ANGELA.   They withdraw to observe the conversation.

Exeunt WEIDMANN and SCHAUEBLE

Enter DRAGHI

DRAGHI

QE, or not QE: that is the question:
Whether 'tis nobler in the mind to suffer
The slings and arrows of outrageous markets,
Or to take arms against a sea of troubles,
And by easing end them?   To buy: to sleep
At last; and by a sleep to say we end
The heart-ache and the thousand natural shocks
That Europe's heir to, 'tis a consummation
Devoutly to be wish'd.   To buy, to sleep:
To sleep: perchance to dream: ay, there's the rub;
For in that balance sheet what dreams may come
When we have synthesized this fall in oil,
Must give you pause; there's the respect
That makes us act in economic strife:
For who would bear the whips and scorns this time,
The oppressor's wrong, the German's contumely,
The pangs of lower price, the law's delay,
The insolence of office and the spurns
That patient demerit of the unworthy takes,
When he himself his quietus make
With a buy ticket?  Who would Merkel bear
To grunt and sweat under a weary life,
But that dread of debt until death,
The undiscover'd country from whose bourn
No economy returns, puzzles the will
And makes us rather cure those ills we have
Then fly to others that we know not of?
Thus deflation does make radicals of us all;
And thus the native hue of resolution
Must triumph o'er the pale cast of thought
And enterprises of great pith and moment
With this regard the current turn awry,
All in the name of action--Soft you now!
The great Angela!  Frau, in they orisons
Be all my buys remember'd

ANGELA

Good lord, what are you on about, love?   Das ist nicht gut.  Karlsruhe, please pick up the white courtesy phone.  Karlsruhe....

Tuesday, December 02, 2014

Oil's getting drilled....

The major market development of the past few days has obviously been the ongoing decline in energy prices, spurred by the recent decision from OPEC to stand pat rather than cutting production. Oil's certainly not looking too slick these days, which naturally calls to mind a whole skein of commodity-related puns.   In the original iteration of your author's stewardship of this space, he wrote an entire post chronicling a list of them (aided admirable by numerous contributions in the comments section.)  Imagine his surprise to find that it was written six years ago to the day.  Plus ca change....

On a more serious note, a number of brain cells have no doubt been taxed attempting to assess the impact of the decline in energy prices.   In areas where taxes make up a large percentage of the retail price of petrol (like most of Europe and, it appears, Macro Man's home state of Connecticut), the impact is of course quite modest as the taxes don't change with the underlying fuel costs.  For the United States as a whole, of course, the price represents a fairly tasty windfall for consumers- some $75 billion over the past six months alone.


Of course, that needs to be balanced by the impact of lower oil on the ongoing development of alternative petroleum sources, which could perhaps shave off roughly half of the boost to consumption from overall growth.

A number have commenters in recent days have noted the potential impact upon the high yield market, given that much of the exploration boom was financed by junk bonds.  To be sure, on an individual security basis it is difficult to state with any certainty how and when the lower price point for crude will either change development plans or disrupt cash flows.  This naturally depends on the extent duration of the current swoon, the breakeven for a given project, the hedging practices of the firm in question, and a myriad of other factors.

We can however get a broad sense of the scale of the issue.  Macro Man got a list of every security in the IBOXX high yield index (hat tip: AC) and broke them down by industry.  If one included just about every business related to hard commodities and energy, we get 26.5% of the index- approximately $137 billion worth of securities.



Winnowing it down to just oil exploration, services, and pipelines, we get 14.16%- still a quite tasty sampling.  One JP Morgan analyst seems to think that 40% of "energy" names could default in a few years should crude remain pinned below $65/bbl.   It's not clear, however, what industries he's including in that total:  coal?  utilities?   It's hard to see why the local power company, for example, should go bust just because crude is back to where it was in 2006.

However, if we take the analyst's figures at face value, what are we left with?  A worst-case scenario in which 40% of energy names, which comprise 18% of the index, default: in other words, a default by 7.2% of the index over a multi-year horizon.   Given that the yield on the ETF version of the index is currently 5.8% and the price has adjusted downwards by 5.85% since oil prices peaked in July, one might reasonably believe that a lot of bad news is already priced in.

If all we had to worry about were fundamentals, that argument might hold water.

Unfortunately, the new regulatory landscape is one that will amplify, rather than mitigate, the shock waves from events like energy sector defaults in the high yield sector.  Now, the people who have designed the current regulatory regime might tell you that it's a good thing that people who own the bonds of defaulting companies should take a haircut.   It's hard to disagree in principle.   They might also tell you that banks should not use taxpayers' money as a put to speculate on things like high yield bonds.  This is fine, although it is not immediately obvious that the solution is to ban 'speculation' or 'prop trading' altogether; if it were, why were these activities not also banned for the one financial asset that the United States Government happens to manufacture?

However, by forcing market-makers to act as brokers for products like high-yield credit (i.e., to act as an agent rather than a principal), the authorities have left a gap as wide as the Grand Canyon:  What if there are no buyers?

As we saw in 2008, price declines do not occur in a vacuum; they inform the intentions of other investors, potentially creating a snowball effect.   In such a circumstance, price really is news, and a crescendo of price declines ostensibly unjustified by underlying economic fundamentals is the result.  

Hopefully such a catastrophe is avoided, there is no mass wave of defaults, and everyone lives happily ever after.   Of course, hope is not a strategy.  It would be a shame, however, if an ostensibly net positive externality like lower oil prices in an oil-importing country were to impair the road to energy independence (and perhaps a few other roads, too) because the real economy was starved of capital as a result of an unnecessary high-yield crisis.

Friday, November 28, 2014

So Sell Some Vol and Buy the Spoos

If you're bored of eating turkey and/or watching crude collapse, enjoy the lyrical stylings of friend-of-the-blog Leftback, who sends his apologies to Modern English....

Punting Forwards, Placing all our Bets
The Team of Macro Man was never Second Best
But after ZIRP it's a Devaluation Race
and Central Bankers are Always
In Your Face

I'll Stop The World and Buy The Spoos
You've seen the earnings and they're
Getting Better All the Time
There's nothing Central Banks Can't Do
So Sell Some Vol and Buy the Spoos

Dream of Real Markets, In a Normal State
Free from Constraints of Imaginary Rates
We may be smarter than a lot of Momo Tools
But these Bazookas make the Smart Guys
Look Like Fools

I'll Stop The World and Buy The Spoos
You've seen the earnings and they're
Getting Better All the Time
There's nothing Central Banks Can't Do
So Sell Some Vol and Buy the Spoos

We had a year or two of Divis and The Reds
But then we woke to find the PIIGS had Shat the Bed
You bought some Credit Swaps to Mitigate your Risk
Never comprehending that Risk
Had Long Gone By.

I'll Stop The World and Buy The Spoos
You've seen the earnings and they're
Getting Better All the Time
There's nothing Central Banks Can't Do
So Sell Some Vol and Buy the Spoos

The Spigot's Open Wide....

Hmm hmm hmm
Hmm hmm hmm QE
Hmm hmm hmm
Hmm hmm hmm QE (humming)

I'll Stop The World and Buy The Spoos
You've seen the Earnings and they're
Getting Better All the Time
There's nothing Central Banks Won't Do
So Sell Some Vol and Buy the Spoos