Friday, September 29, 2006

Hung, drawn, and quartered

As the quarter mercifully comes to an end, a few things have become obvious. Sometimes, the simplest strategy actually works. The SPX is up nearly 6% including dividends this quarter, a performance record that most hedge funds and prop guys would dearly love to match. Sometimes the macro theme is that there IS no macro theme, other than position squaring and/or distress. It appears that Q3 was just such a period.

One of the great dangers on investing, particularly macro investing, is attempting to see patterns or themes when none actually exists. Macro Man is as guilty of this as anyone else, and has struggled over the last few weeks as a result. There are times to trade tactically, and the past few weeks been one of them. Little surprise, then, that strategic positions have been taken behind the woodshed and caned.

How long will it continue? This, of course, is (literally) the million dollar question. October is a month that typically sees rising volatility and financial accidents, which should provide some tradable opportunities. Then again, the same could be said of September, which turned out to be an absolutely dire month. One source of hope is that it is difficult for non commodity vols to get much lower. The Q3 range in EUR/USD, for example, was the smallest since Q1 1979 (thanks, dodgy central banks!) The ‘opportunity’ in USD/JPY was only modestly better; it was the smallest quarterly range since Q1 1996. A once in a decade crap quarter versus once in a career crap quarter- what a result!

Commodities, obviously, sustained substantially greater volatility. But given the embedded long ‘buy and hold’ positions of many funds and investors, this was clearly the wrong kind of volatility. Macro Man is clearly betting that the weak hands have been shaken out there. The initial crude reaction to the OPEC production was encouraging, and the DIA/OIH spread was looking diamond (ho ho ho.) But the late day sell-off in crude was discouraging both psychologically and p/l wise, taking the spread from a tasty profit to a modest loss in the span of a couple of hours. Energy bears watching to make sure that there isn’t more distressed selling in the pipeline (OK, I’ll stop.) Meanwhile, SPZ6 is nearly and the topside strike of the long strangle. It is time to start hedging some gamma. Macro Man offers 3 SPZ6 @ 1350, 3 more @ 1355, and 3 more @ 1360. Today’s quarter end mark up should give Macro Man a fill in one or two of the gamma orders, and the CNBC crowd a record high in the Dow over which to crow. Come Monday, though, the QTD and MTD get wiped clean and it’s nose to the grindstone time. We’ll strap on the crash helmet and try not to get crushed by falling vols.

Thursday, September 28, 2006

Ten Thursday One-liners

1) So Vega is in the process of imploding. This explains the shocking performance of their (large) positions: short bonds, short NZD, short EUR/JPY. Nothing like a forced exodus to cause a little consternation.
2) The short NZD trade makes sense now. NZ officials are upping the ante on talking down the currency, and October is seasonally a poor month for carry trades. Now that Vega has puked their short, Macro Man looks to establish his. Sell 15m NZD/USD 1 month forward at 0.6550
3) The bid-only price action in bonds now makes a bit more sense as well. Macro Man will try again with the short bond trade, selling 100 TYZ6 at 108-08.
4) Europeans and Japanese are becoming increasingly vocal on EUR/JPY, with no discernible impact. Perhaps they need to quit telling newswires, and start telling China, Russia, SAMA, and the other assorted sovereign names who keep buying EUR (and GBP, for that matter) come hell or high water.
5) The Dow is within a rounding error of its all time high. Macro Man wishes his equity p.a. could ay the same. With oil finally looking like putting in a bottom, Macro Man wonders if US equities are now fadeable. He sells DIA/buys OIH in $10 million/leg @ .9090 on the ratio.
6) It seems like only a matter of time before Eastern Europe explodes. There seems to be too much corruption for there not to be a blowout.
7) Isn’t it amusing that despite all the focus on China and its manipulation of the CNY, that USD/CNY is the only Asian cross that is moving lower?
8) Why is it that the US has a capitalist economy but a socialist sports system (revenue sharing, etc.), while Europe has a socialist economic system but a laissez-faire sports system (cowboy capitalism in European soccer)?
9) The economic bureaucrats in the UK must be calculating export prices using the same formulae that their American counterparts use to calculate unit labour costs, if recent revisions are any indication....
10) This month we’ve had Amaranth and Vega blowing up. When will option Vega quit performing like Vega Asset management’s recent investment performance?

Monday, September 25, 2006


Consider the following:

1) US fixed income trading well through funds/cash rate, pricing in 2.5 rate cuts for next year. This is a pseudo-recessionary outcome.

2) The SPX is barely 1% off its high of the year set last week. The market has rallied in virtually a straight line since July 18, the day before Bernanke’s latter-day Humphrey-Hawkins testimony. This appears to be a purely liquidity-driven rally; the entire US yield curve has shifted down by 55-60 bps over the last two months. If the bond market is right about a near-recessionary outcome, then stock prices should be much lower than they are.

3) Commodity prices have come sharply lower. This, too, is a pseudo-recessionary outcome, albeit exacerbated by the Amaranth fiasco and the general exodus of long commodity index positions. Of course, base metals have fared rather better, though this is partially a function of the virtual absence of deliverable inventories in stuff like nickel at the LME.

4) EM wobbles but hasn’t yet fallen down. EM assets and currencies have finally started to lurch a bit lower, albeit in sporadic, non-contagion fashion. About time, too, some would say. Between a Thai coup, possible Ecuadorian default, Hungarian corruption, and Polish electoral uncertainty, the asset class has been buffeted by strong headwinds over the last week or so. All in all, however, emerging markets have traded relatively well (with the exception of the ZAR.) This is particularly the case in Asia, the most growth-sensitive of the EM regions. Now, this is perhaps simply a reflection of the soft landing being priced into US/developed market equities. Still, it doesn’t suggest that the global economy is hitting the proverbial wall.

5) Growth sensitive G10 currencies are trading well. The dollar bloc complex (AUD/NZD/CAD) have all traded rather better than expected given how the bond market has reacted to US growth data. Perhaps they are tracking the Baltic Dry Index instead of US macro data; the BDIY is showing an acceleration of shipping activity, which of course is hardly consistent with the sort of slowdown required to produce a $20 fall in oil.

So what are we left with? Bonds and oil say 1.5% US growth, US equities and most EM say 2.5% US growth, while the BDIY and dollar bloc currencies are saying 3.5% growth. There must be a trade here, but after recent mishaps Macro Man needs more time to reflect. At some point, though, these various asset markets will converge, and there will be money to be made when they do.

Thursday, September 21, 2006

Carry me home....

Talk about an anticlimax. The FOMC statement could be summarized in three sentences:

1) Growth is slowing; we think inflation will too.
2) We might have to hike a bit more; then again, we might not.
3) Jeff Lacker wanted to hike today; the rest of us voted him down.

The outcome is ‘as you were’, the both the Fed and the market waiting to see if housing kills the US consumer. If it does, the bond market is probably cheap at these levels. If it doesn’t, the bond market is pretty expensive. Given that terror, wars, $3 gasoline and a stock market meltdown have yet to kill the consumer this decade, Macro Man is skeptical that housing is the proverbial straw that broke the camel’s back, particularly with the corporate sector in robust health.

However, it will be a while before anyone knows the true outcome. In the meantime, it’s a waiting game. And when markets know they have to wait, they like to get paid. This explains the popularity of the carry trade over the last two weeks, and at this juncture it’s hard to see that affinity not continuing for a while longer. Sure, Brazilian politics are heating up and Hungary is a mess. But hey, Thailand isn’t exactly the Garden of Eden, and the THB has already re-traced virtually all of its coup move. The resilience of antipodean currencies in the face of bad data/weak commodities and the market’s headlong rush into sterling at sky-high levels suggest that carry is alive and well.

Given that Macro Man’s current positions are essentially long volatility, anti carry strategies, it is time to slap on a hedge. Therefore, Macro Man sells $10 million USD/TRY 1 month forward at 1.4920. He sets the initial s/l at 1.50 spot basis.

Macro Man is at an offsite tomorrow and over the weekend- an excellent use of his time. He'll be back, perhaps bloodied but always unbowed, on Monday.

Wednesday, September 20, 2006


Well, it’s all going horribly wrong. Macro Man took a loss on his one position that would currently be in the money (long EUR/JPY put), and was stopped out of long oil a few hours after putting the trade on. Even equities are looking OK, which spells trouble for the long volatility position. As for the short bond position- ugh. At 108, it is time to get out and think again. There have been some rumblings that the Fed was unhappy with the dovish reaction to the August statement/minutes, so perhaps we could get a hawkish surprise today – unit labor costs anyone? Failing that, it looks lie more trouble awaits the short bond position.

Tuesday, September 19, 2006

Ten Tuesday one-liners

1) So Hungary’s prime minister admits to a ‘deluge of lies’, and the HUF rallies from the London open yesterday. Anyone wearing losses in that swine today probably deserves what they get.

2) If everyone in Singapore was so worried about EUR/JPY, why didn’t they mention it in the statement?

3) The high of the year in the S&P 500 at 1326.70 came the week of the May Fed meeting. This week’s high has been 1324.87, and the Fed meets tomorrow....

4) How could Amaranth let one guy take so much risk?

5) Given the collapse in gold, why isn’t the AUD lower?

6) Other than the Mexican Bolsa, other major EM equity markets have failed to re-test their yearly highs a la the SPX. Could this be a sign of distress in the pipeline?

7) The CBI called for a rate hike for the first time in its 41 year history yesterday. What’s next- UK mice calling for more cats in the household?

8) Shhh....don’t look, but USDCNY closed at a new low today. Macro Man may have been a bit premature in puking his EURJPY puts.

9) With the VIX below 12, equity vol looks cheap, and Macro Man cannot resist. He buys 20 October 1300/1355 strangles at 13.

10) Oil looks like it’s putting in a bottom. Macro Man Buys 50 CLZ6 at 65.25 with a stop loss at 63.25.

Monday, September 18, 2006

BOND-gy Jumping

Record longs in the 10yr are beginning to tell, and there is no more room at the fixed income inn. The bond market looks set to do a bit of BASE jumping, and Macro Man is stopped into doubling his short at 106-23. The wretched rear view TICs data may have given the market the push it needed; all we need now is a surprising rise in the NAHB to snip the bungy cord and allow the bond market to plummet off a cliff a la Wile E. Coyote.

G7 snoozer

Well, the IMF reclaimed the mantle of irrelevancy that it has proudly borne for sixty years, as little of substance emerged from the weekend’s meetings in Singapore. Sure, China saw its quota bumped and the G7 agreed that greater yuan ‘flexibility’ sure would be swell. But other than a few token sideline whinges about EURJPY, there was relatively little to interest Macro Man, or anyone else for that matter.

Unless the G7 are prepared to take China, Russia, and the Middle East to task for their obliteration of free floating G7 exchange rates, there is little other than exporters or a position unwind standing in the way of a weaker yen. At the moment, neither appears to be particularly potent obstacles. As a result, Macro Man will sell out his 149 EURJPY puts purchased on Friday, recouping 37 pips. An 18k loss is not difficult to take on what was after all a lottery ticket bet on a G7 surprise.

Elsewhere, US Treasuries are refreshingly limp, perhaps spurred by CFTC reports of yet another record long in 10yr futures. Macro Man remains a stop loss seller through 106-24. Although the Fed meets on Wednesday, the key for Treasuries this week is probably the housing data- NAHB tonight, with starts released tomorrow. In this vein, it is interesting to note that the homebuilders’ stock prices have ceased their sickening plummet and seem to be putting in a base, for example Toll Brothers as seen below. Given that the implosion of US housing has now gone tabloid, the chances are rising of an unexpected sign of improvement, if not this month than perhaps next.

Friday, September 15, 2006

RICkety Reserve Policy

This weekend sees the semi-annual confabulation of IMF grandees, G7 finance officials, and lucky boondoggle recipients convene on Singapore. The last time this band of Merry Pranksters got together in April, something quite extraordinary happened. The IMF shrugged off 60 years of lethargy and seized for itself an apparent mandate of worldwide importance: the correction of the much-dreaded global imbalances. The initial manifestation of the IMF’s new hobby was, of course, the G7 finance ministers’ statement, which rapped China and the rest of the emerging current account surplus world for fiddling with their currencies (or, more to the point, not allowing us to fiddle with them as much as we’d like.)

In the intervening six months, of course, China has allowed the CNY to fizz around a bit more; 3 month historical vol has risen steadily from 0.8% in April to a whopping 1.35% today. And thanks to the softly-softly approach of ‘Hammerless Hank’ Paulson, USD/CNY has finally and decisively traded through ‘The Ocho.’ However, the focus on the level of emerging currencies is misplaced; what should be of much greater concern to the conventioneers are the distortions caused by emerging countries’ FX reserve management.

Simply put, EM FX reserves are now so big that their activities are setting the price of exchange rates, crowding out the private sector and pushing a number of pairs well beyond equilibrium. Looking just at the RICs (Russia, India, and China; Macro Man couldn’t find good data for Brazil), their FX reserves went from a combined $268 billion in June 1998 to $489 billion in June 2002 to $1.6 trillion in June 2006. The recent parabolic rise in reserve levels has accompanied a period of remarkably low market interest rates: the infamous Greenspan conundrum. Now, some of the blame for persistently low bond yields must accrue to Easy Al; after all, if you tell the market exactly what you’re going to do, you shouldn’t be surprised if there is no reaction when you do it. Nevertheless, the abject failure of Western bond yields to rise in line with historical norms suggests that at least a degree of monetary policy sovereignty has been ceded to the EM reserve accumulators.

In currencies, the effect is if anything more pronounced. Since May 2002, when the EUR broke out of a multi-year consolidation pattern, the level of EM FX reserves has exploded ($1.1 trillion just for the RICs!) Given that in many cases these are the very countries that are diversifying most aggressively out of USD (note that most of them don’t tell the BIS/IMF what they’re up to), the consequences for the currency market should be obvious.

EM CBs are, on aggregate, consistently large buyers of EUR and GBP, and more moderate buyers (though not on a liquidity-adjusted basis) of commodity currencies like the CAD. They are sellers of USD, of course, have ignored the CHF, and largely stayed away from the JPY, particularly in relation to Japan’s importance in the global economy. If Macro Man is correct rather than paranoid, we would expect to see that the stuff they buy goes up, and the stuff that they sell or ignore goes down. As the table below suggests, that is exactly what has happened.

So while they enjoy munching on chili crabs in Singapore, perhaps French Finance Minister Breton and BOJ Governor Fukui, both of whom have recently commented on the rather high level of EUR/JPY, will spare a thought for the EM central banks. The reason that EUR/JPY is at 150 not because the Japanese are fiddling with the yen. Rather, it is simply that the EM nations that have accrued the most reserves over the past few years have bought an absolute truckload of euros but relatively few yen. Given that FX reserve levels in many of these countries can be comfortably described as ‘excessive’, perhaps instead of moaning about the level of the CNY they’ll encourage the likes of China to buy a few less bunds and a few more hospitals.

Is there a trade for G7? Macro Man’s preferred strategy would be to go short the FX market as a whole. Performance this year has been poor, and there is little to suggest that things will improve in the near term. This morning’s little yen rally on the back of yet another China band rumor smacks of desperation. Ultimately, things are setting up for some nice trades in the months ahead, but the market needs to endure more short term pain to bring those opportunities to fruition. For choice there appears to be little chance of a market moving outcome over the weekend. That having been said, there is nothing priced in, either. So risks must be skewed towards a constructive development taking the market by surprise. Given the recent focus on EUR/JPY, it’s worth taking a punt on: Macro Man buys 10m face worth of 1w 149 EUR puts versus JPY for 58 JPY pips.

Macro Man remains a stop loss seller of TYZ6 on a break of 106-24 to double the current hundred-contract short.

Thursday, September 14, 2006

How can there be a recession when everyone's making so much money?

One of the more entrenched and hackneyed themes in financial markets today is that the implosion of the US housing market will be the final nail in the coffin of the bloated US consumer, thereby condemning America to a significant slowdown or a recession even as the rest of the world ticks merrily along. As noted yesterday, the bond market appears to be pricing in a worst-case outcome, as it is clearly ignoring the inflation story. But what the Nattering Nabobs (or is it the Nattering Nouriels?) of Negativity can’t seem to answer is the question posed above: how can there be a recession when both the corporate and household sector are making so much money?

Now we can choose to believe the NIPA profits data, or we can choose to disbelieve it; Macro Man suspects that the NIPA data may be overstated given the recent income revisions, but only modestly so. Certainly the relatively robust earnings growth reported by the S&P 500 for the last 3 years suggests that the trend, if not the level, of the NIPA profits data is spot on. And what the trend says is that things have never been better for the US corporate sector. Margins are good, gearing is light, and on an economy wide basis there has been relatively little inventory buildup relative to sales. Bluntly put, the US economy has never been anywhere close to recession when the corporate sector has had it so good. The chart below illustrates profits as a % of nominal GDP, with recessions in the shaded areas. Typically, profit growth has slowed considerably before the onset of recession, with the nadir in profits coming with the onset of recovery. As things now stand, profit data suggests that a recession isn’t even on the radar.

The natural rejoinder is that the crippling blow dealt to the consumer from housing has yet to hit the corporate sector, and once it does the retribution on profits will be terrible and swift. Naturally, this begs the question of what exactly encourages consumers to spend. Is it the tone of the articles in the real estate section of the local newspaper, or is it the amount of cash that breadwinners have left after paying Uncle Sam and the local utilities? History is strongly in favour of the latter. A simple two factor model of consumer spending suggests that disposable income growth is responsible for 85% of spending growth, with changes in household net worth explaining the other 15%. Now, the model suggests that if the consumer was going to get whacked, it should have already happened. In fact, the prospects for consumption are looking better than they did a few quarters ago, thanks to the strong growth in income. While today's retail sales data may have disappointed the consensus, forget not that it came on the heels of a bumper July; Q3 is tracking at 1.2% above Q2. That's a nearly 5% annualized rate it you're scoring at home- hardly a sign of impending doom.

Total personal income is growing 7.3% y/y, profit growth is strong, and inventories are relatively lean. Oh, and the recent decline in gas prices should provide a further boost to disposable income. While it is certainly possible to see a modest period of below trend growth, the risks to what’s currently priced are skewed squarely to the upside. And this doesn’t even take into consideration the likely upward revision to past GDP growth. There is a large discrepancy between the growth suggested by the (more reliable) income data and that in the expenditure figures. Typically, the expenditure data is revised to bring it in line with the income data, which in this case is suggesting real y/y growth of nearly 5% as of Q2.

Bonds yielding 4.75 are an opportunity on a silver platter; Macro Man will sell another 100 TYZ6 on a break of 106-24.

Wednesday, September 13, 2006

What is the bond market smoking, and where can I get some?

Where to start? Macro Man has spent more than an hour just figuring out how to title a post and upload a chart. At this rate, the only insights that I'll be able to offer will be of the Luddite/isn't technology tricky variety. Let's hope things improve. This blog is intended to serve as a forum for occasional observations, thoughts-out-loud, and trading ideas on the global economy. Now, Macro Man is not Superman, and his powers of insight and deduction are not bulletproof; hopefully, however, they'll be of interest to someone other than Macro Man and Mrs. Macro. And now, on with the show....

It seems quite clear that the US bond market is smoking something a touch more potent than a Marlboro or even a Gitane. The 10 year is trading 50 bps through the Fed funds rate, the strip is pricing 50 bps of easing next year, and 2's - 10's has been inverted on and off since early June. According to the Macro Man history book, this is pricing in either a full-blown recession for 2007 or a permanently fixed inflation rate of, say, 1.75% on the core PCE deflator, right in the sweet spot of Big Ben's preferred range. How likely are either of these outcomes? Let's examine the inflation argument first, and then tackle growth in a subsequent post.

I believe that the inflation outcome can be easily dispensed with. Yes, commodities are coming lower and yes, TIPS breakevens have collapsed. But can anyone seriously doubt by this point that we are in the midst of a secular bull market in commodities? Not only has infrastructure investment been inadequate over the past decade, but demand growth from the BRICs and their buddies has been very large indeed, and looks set to continue for the forecastable future. Surely this story must be known by now, and yet one still reads stories blaming $75 oil (or even $64 oil, for that matter) on CTAs or geopolitical risk premia. Look, if geopolitics were a big deal, why were both the Lebanese pound and the Israeli shekel stronger at the end of the recent unpleasantness than they were when it kicked off? No, put Macro Man in the camp of a secular bull market in commodities (albeit with the occasional cyclical price decline), which is inherently inflationary.

More intriguingly, after 17 Fed rate hikes, monetary conditions remain highly inflationary. The entire yield curve is now well below the level of nominal GDP growth, and has been for several years. The last time this circumstance persisted for more than a few months was in the 60's and 70's; as the chart below indicates, there has been a very strong relationship between the level of interest rates vis-à-vis nominal GDP growth and the secular inflation trend. Sure, globalization means that manufactured goods prices probably aren't going to rise very quickly. But as Mr. Euro himself, Jean-Claude Trichet, mentioned in an ECB pressie a few months ago, if commodity prices and services prices are being driven higher by the same factors that are depressing manufactured goods prices , why the hell would you strip them out to find 'true' inflation? If Ben persists in focusing just on what he wants to see (notice how the Fed hasn't said a dadgum thing about unit labour costs now that they convey the 'wrong' message?), at some point he's going to wake up to an enormous problem on his hands. The signs are not encouraging- just check out the trend in the median CPI from the Cleveland Fed.

So convinced is Macro Man that the bond market is smoking crack, he is a seller of 100 Dec 10yr futures at 107-08, the current price. Upside in the even of weak retail sales on Thursday or benign CPI on Friday is likely limited to 108. 105 and lower is far more likely in the weeks ahead.

Coming soon: How can there be a recession when everyone's making so much money?