Thursday, November 30, 2006

Treasury short stopped out

The sub 50 Chicago PMI has prompted the 109 stop loss on the short Treasury position to get filled at 109-01.

Fortunately, short equities and short the dollar are more than compensating....

'Tis the season

December 1 is always a significant day chez Macro Man, as it marks the first day that holiday music is played on the stereo. Macro Man fully expects to return home tomorrow evening to the smooth sounds of Bing Crosby or the Rat Pack crooning about what a great month December is. At the office, however, he is already deluged with the electronic equivalent of Crosby or Sinatra.

The Macro Man email inbox is crammed full of research telling him how to benefit from December seasonality in financial markets. According to the conclusions of these various studies, December is a great time to be:

Long stocks
Long bonds
Long EUR
Long GBP
Short USD
Short CAD
Short AUD

The historical persistence and Sharpe ratio of these strategies is impressive. However, Macro Man wonders if the seasonality issue has gone a bit ‘tabloid.’ If everyone knows about seasonality, surely they load up on the seasonal trades beforehand and telescope the opportunity? The equity market is perhaps the best example of this, where the ‘January effect’ now takes place in November-December (kind of like Oktoberfest takes place in September.....)

Elsewhere, all three tidy-up orders were filled yesterday. The TYH7 straddle was sold at 2 22/64, while GG and the DIA/OIH spread were offloaded at the limit levels of 29.00 and 0.86, respectively. The last of those was clearly premature, as a surprising drawdown in crude inventories sent oil rocking higher. The OIH decisively broke through resistance and now targets 150 as the next stop. Fortunately, the Jan 145 calls are now in the money and should ensure at least some degree of further participation to the upside. Overall, the portfolio looks set for a reasonable month’s profit which should take the since-inception numbers into the black. The main thrust of the portfolio is short equities, short bonds, short the dollar, and long energy. It will be vital to keep a watchful eye on these themes, as it is unlikely that all will come off at once.

Wednesday, November 29, 2006

Tidy up time

Well, the good news is that the bond short avoided being stopped out by one tick, as the TYZ6 high yesterday was 108-31. The bad news is that the recovery in global stock markets looks to have scuppered Macro Man’s chances of notching a monthly profit in excess of 1%, as the recovery in the ASX and DAX have put an unsightly dent in the P/L this morning. As the end of the month approaches, it is time to review the portfolio and tidy up a few trades that have outlived their usefulness or reached relative extremes:

* Close the long TYHY107 straddle/short Bund 117.50 straddle position. The Bund straddle is bought back at 2.04. While the US market isn’t open yet, the Treasury straddle should fetch something like 2 28/64 by hitting bids. The position has been a positive, if low vol, performer, thanks to the long bond beta that it has at current levels. However, with the TYZ6 position so close to getting stopped, it makes sense to take off what has become a hedge, rather than go long US bonds at a yield level below 4.50.

* Sell the Goldcorp position at $29 or the opening price, whichever is higher. Gold has reached its near term target of $640, where it seems to be stalling. A near term reversal would provide a welcome flush of weak longs, and provide an opportunity to re-establish a long gold (actual or proxy) position. A 14% return in less than two months is not to be sniffed at, and at these levels Macro Man is happy to take it.

* Take profit on $2.5 million of the DIA/OIH spread at 0.8600 or the US opening, whichever is lower. The January WTI future is approaching levels that have served as formidable resistance over the last couple of months, and Macro Man would be remiss in not lightening up ahead of these levels. If this order is filled, the 145 offer in OIH will be cancelled.

The overall tone of yesterday’s US data was undeniably weak. The failure of the bond market to maintain its rally below 4.50 in 10yr yield is perhaps instructive, however. Maybe there was an offer ahead of 109 in the futures, or maybe there were simply no fresh buyers of bonds at levels more consistent with recession than soft landing. Regardless, we have perhaps reached an inflection point and should now expect stocks and bonds to trade with a negative correlation, rather than the positive correlation of the past several months.

While there was a good deal of spilled ink over the existing home sales data, including more attention paid to the decline in the median sale price, relatively little attention was paid to the Case/Schiller house price index, which provides a more complete picture of trends in the price of US housing. This data showed a 3.7% y/y rise in house prices. While this still represents a significant slowdown from the prior pace of house price growth, that fact should come as no surprise to anyone possessing a functioning set of eyes or ears, given the hype attached to the housing bust.

In digging around, Macro Man came across a rather curious set of data. Housing is the classic non-tradable good, whose price is dictated by local supply and demand dynamics. As such, one would expect a relatively low correlation between house prices in different countries. Macro Man was astonished, therefore, to see a relatively strong correlation (both in terms of direction and magnitude) between the Case/Schiller index in the US and the Halifax house price data in the UK. The correlation comes with a caveat, however; the Halifax data is lagged by twelve months (i.e., it is a leading indicator.)

Macro Man is not sure what to make of this data. The relationship could be spurious, or could simply reflect broad swings in the global interest rate cycle. However, the vastly different structures of the US and UK mortgage markets make it difficult to believe that the global rates cycle by itself can explain a) why the UK should lead, and b) the strength of the relationship (r-squared of 0.65, t-statistic of 20.) While Macro Man is fairly agnostic on the US housing market over the next six months, the chart will provide at least a crumb of comfort to those looking for a surprisingly early rebound in US activity.

Tuesday, November 28, 2006

Adding to $ short

Macro Man buys another 10 million EUR at 1.3144. Voldemort is reportedly bidding below that level, and barriers at 1.32 beckon....

Awaiting confirmation

Yesterday saw the S&P halt an impressive winning streak, as the index registered a decline of more than 1% for the first time in 95 trading sessions. This not only mirrored weakness already registered elsewhere in the world, but it also triggered Macro Man into his long SPX/short DAX position via the March futures. The knock on effect to risky assets was immediate, with Latin American currencies in particular selling off while Treasuries caught a safe haven bid.

This morning, however, there has been relatively little follow through, and markets await confirmation that yesterday’s sell-off was real. While yesterday’s equity market weakness was superficially similar to some of that observed in late spring, it was actually substantially different. Weakness in May-June was accompanied by bond market weakness and concerns over inflation and Fed tightening. This time around, bonds are at their highs, so further weakness in the absence of a bond market sell-off will be construed as a hard-landing trade. That’s not to say that it won’t happen, as there is plenty of data this week to encourage equity and economy bears if the chips land right. Moreover, after a stunning run, supports have finally been broken (see DAX chart below), which should naturally encourage a bit of profit-taking from longs who participated in much of the summer and autumn rally.

However, this morning has been characterized by the relative resilience of risk assets. The Nikkei and DAX haven’t really moved, and Turkish fixed income and the lira haven’t really sold off, despite the weakness of Latam in late New York. Meanwhile, the NZD, poster child for naked carry and current account risk, has been uber-bid in London. Can this persist? Obviously, anything is possible, and Kiwi strength doesn’t come as a total surprise given the broad-based weakness in the JPY and CHF this morning. However, if the recent rise in equity volatility is maintained, the NZD is almost surely headed for a fall, along with other G10 (and possibly EM) carry trades. A naïve overlay would suggest that NZD/JPY should already be at 76 or lower, rather than the current 78.30!

While it is too early to pull the trigger (we’ll need to see another session of equity weakness/higher vol to confirm the trend), Macro Man is on high alert to sell NZD and go long JPY, CHF, or possibly EUR as and if the carry trade unwind finally becomes a reality.

Monday, November 27, 2006

DAX/SPX ratio spread filled

Macro Man bought 100 SPH7 at 1400 and sold 170 GXH7 at 6384.

Judgment Week

The importance of this week in guiding financial market trends for the rest of the year and possibly beyond cannot be overstated. The raft of US data should go some ways in determining the character of the US ‘landing’, whether hard or soft, especially in the hyper-sensitive housing market, which sees new and existing home sales figures for October. This should, by extension, provide us with significant information as to whether the dollar’s sell-off will continue, and to a lesser degree whether the bond market can rally any further.

With Bernanke speaking on the economic outlook tomorrow and the Beige Book released on Wednesday, the volatility surrounding Fed expectations should be extremely high, particularly given recent hints from Poole and Warsh that they think the strip might be mispriced. Forget judgment day: this is judgment week!

Price action in the dollar has been relatively muted in Europe after Asia gapped it lower. The gap in EUR/USD was closed thanks to more moaning from the French, but Macro Man suspects that the marginal impact of this bleating will swindle until and unless the Germans join the chorus. Comments from the German exporters’ association on Friday suggested that currency complaints will not be forthcoming; indeed, they sounded almost smug in suggesting that EUR/USD could rally to 1.40 and not affect them. It sounds very much like the German carmakers and Siemens may have locked in tasty hedges while their French counterparts have not! As noted this morning, Macro Man stepped up to the plate and bought 10 million EUR/USD at 1.3110 on a spot basis. Further dollar sales may well be made on an opportunistic basis. EM, meanwhile, has shaken off the election of 'bad guy' Rafael Correa in Ecuador, providing furthe evidence that the prevailing theme is not one of 'carry unwinding.'

Elsewhere, bonds have retreated from their highs, with the yield backing up this morning to nearly 4.58%. Continued heavy intervention from Asian central banks suggests that a bond bid will likely persist, and in the absence of absolutely cracking US data, 4.70-4.75% may now be the top of the yield range; indeed, it might take cracking US data to get us there! Macro Man will consider taking off some of the bond short below 108 on the Dec future, as the trade has frankly become a bit boring. Will Macro Man have a chance? Depending on whom you ask, Black Friday either went very well or horribly, so the jury remains out. One potential source of encouragement has been the recent uptick in the weekly leading indicator, which has surged in the last two months. Could this be a sign that the data in the US is about to improve, thereby squeezing dollar shorts and bond longs? We’ll see.

Finally, and despite the comments above re: German exporters, Macro Man cannot help but think that a surge in EUR/USD will really benefit US corporates at the expense of their European competitors. Anecdotal evidence suggests that US exporters are coming out of the woodwork to lock in attractive hedge ratios, which should, all being equal, spur US equity outperformance moving forwards. As the chart below indicates, the last time EUR/USD was around these levels, the ratio of the DAX to the SPX was around 3.5, well below its current level of 4.54. Given that the recent high was around 4.60, the risk/reward looks compelling. Macro Man therefore looks to buy 100 SPH7 and sell 170 GXH7 at a ratio of 4.56: 1. The stop will be set just above 4.60 if and when the trade is executed.

Mind the gap

The USD gapped sharply lower in the Asian opening, a relative rarity in foreign exchange. Although the buck has retraced much of its loss against the EUR (and indeed all of it against the yen), Macro Man believes this is highly suggestive of which way the wind is blowing.

It therefore makes sense not to be too greedy in hoping for a retracement; therefore, Macro Man buys 10 million EUR/USD at the curent offer of 1.3110.

He may look to sell out his $ call against the yen over the next 24 hours; more to come later.

Friday, November 24, 2006

Whither the dollar? Reply to a poster

Is this the big dollar downmove?

Well, that is what I am wrestling with. While the dollar's price has changed, that is a necessary but not sufficient condition for the market environment to change. After all, it was less than two months ago that the dollar had evidently broken HIGHER and many commentators and traders were calling for a big dollar up move.

That having been said, volumes have been quite large today, and central banks do seem to have changed their behaviour (chasing EUR/USD higher above 1.30 rather than trading the range.)
I am still trying to figure out what is driving this, because you need to know the driver/theme before you can project the price action. I don't think it's a carry unwind, else EUR/JPY wouldn't have made new highs today.

Is it a diversification story? A current account story? A relative growth story? I/we/the market needs more data points to be convinced.

For the time being, one has to favour EUR/USD higher from a purely technical perspective, hence the cheeky attempt to buy the dip. That having been said, EUR/USD is already overbought on the we need something more compelling than 'technicals' to drive us higher. At this point, the balance of risk favours that central bank and private sector actors will continue to sell USD over the next few days...but whether it is a 5% move or a 0.5% move will depends on whether or not a tangible theme emerges that justifies a de-rating of the dollar.

So for now, the jury is still I am happy to buy the dip, but reticient to pay the offer until I have more and better information. If, however, this is a 5% move, it will demand a high risk allocation.

FX explosion!

Ranges have finally broken in FX, with EUR/USD surging above 1.30. Macro Man was filled at 1.3005 on his 10 million stop loss. He will now bid 1.3070 for another 10 million.

More updates as time permits....

Thursday, November 23, 2006

Turkey Day

As Americans prepare to settle into their annual orgy of food and televised sport, financial markets are surprisingly (and irritatingly) volatile. The portfolio has suffered substantially over the past 24 hours, largely as a result of the continued resilience of Aussie equities. Whether this is the result of commodities, liquidity, or a good start to the Ashes, Macro Man is not sure. Nevertheless, the strong performance of the ASX while the S&P 500 remains stuck in the mud has proven to be relatively costly.

It leads Macro Man to once again question the themes that are driving markets. It is difficult to find a grand unified theory, given the cross market price action that has emerged over the past few days. Consider the following:

* Bonds are bid, with 10 years displaying a 70 bp inversion to Fed Funds. Macro Man continues to believe that official and pension flows are the primary driver of higher bond prices, but surely at some point (10 y yields < 4.50%?) one has to suggest that the market is pricing in a sever economic slwodown.

* The dollar is also reacting, trading to its lowest levels against the euro since the spring. The catalyst for yesterday's move was not terribly obvious. Some have suggested the White House downgrade to its 2007 growth forecast, but c'mon. Virtually every private sector forecaster in the world has downgraded its US growth forecast at some point in the last six months, and in any case, the WH forecast for next year still puts US activity around trend. This morning, another strong ifo survey provided a more obvious catalyst for euro strength. However, given the singular failure of the euro to react to the poor French data the other week, it is not obvious that relative growth is a key driver of currencies. Perhaps it is just down to CBs and models....

* 'Risky markets' such as Mexico, Brazil, and Turkey have underperformed dramtically. This morning has seen both the Turkish lira and domestic T Bills sell off hard; feel free to insert your own joke here about another Turkey getting roasted on Thanksgiving. Yet Asian markets and currencies have performed strongly. Is it a carry trade unwind? If so, why have currencies like the Aussie and New Zealnd dollars and sterling not suffered more? Is it because the CBs are buying those, too?

* And if growth, particularly US growth, is slowing, why haven't equities shown any signs of weakness? Is it because the stock market is smoking crack, or is it because the growth slowdown isn't actually the prevailing theme?

These are the issues that Macro Man is dealing with. If the growth slowdown theme catches fire, than the short equity bias should do well, and offset losses in bonds and commodity stocks. Moreover, Macro Man will be out of the legged EUR/USD short at 1.30, thus giving him some upside. Nevertheless, this isn't the first time that markets have displayed such inconsistencies. Two months ago, Macro Man wrote about the lack of thematic unity across markets. Curiously, not much has changed, except stocks and bonds are higher, while the dollar and oil or lower. Perhaps it just means that liquidity remains ample, while currencies and commodities are just range trading until the US re-accelerates. At this point, though, it's hard not to see the market taking a few more potshots at the dollar in particular....

Wednesday, November 22, 2006

Dollar downtrend?

Currencyland has risen from its long slumber today as the dollar has gotten creamed against most of its G10 counterparts. While most currency traders have probably given up for the year, next week sees a new fiscal year for many hedge funds and investment banks. As such, the emergence of a dollar trend in late November would be quite handy, and provide these folks with a tailwind for 2007.

Is this the real deal? At this point, it is too early to say. Most major currencies remain within (albeit at the edge of) established ranges, and most of the private sector volume has come from CTAs and trend followers, a client base that has demonstrated a stunning lack of profitability over the past few years.

Macro Man is therefore reluctant to hop on board the dollar down train in any meaningful way at current levels, and indeed is currently legged short EUR/USD.

Nevertheless, it would be nice to have at least something on. Macro Man therefore spends a bit of premium to buy 20 million EUR worth of 1.32 euro calls expiring 22 January for 0.42% of face, or 84,000 euros.

It is tempting to sell some USD/CAD, but the poor performance of oil after the lofty inventory data has scared him off that one for the time being.

Limp out of EUR/JPY

Macro Man will attempt to leg, rather than limp, out of the EUR/JPY 'hedge' by buying $12.5 million USD/JPY at 116.80 and then bidding 1.2885 for 10 million EUR/USD, with a 1.30 stop loss o/c/o. It appears that Voldemort has decided that enough is enough and is capping EUR/USD at 1.2920....

Chinese whispers

As the holiday season moves swiftly towards us, the noise-to-signal ratio in financial markets approaches infinity. The level of frustration in markets is palpable, virtually regardless of what positions one chooses to hold at any particular point in time. The resource complex has saved Macro Man’s bacon, as gains in GG and OIH have made up for losses in bonds and the short Aussie equity trade. Net-net, the portfolio has lost a smidge overnight, though again there has been quite a bit of volatility amongst the constituent positions.

The holidays also bring us to the rumor-mongering silly season, where a good imagination is more important than good analysis when it comes to getting the markets right. If you can conjure up the right kind of nonsense, you can move markets your way, if only for a few minutes. Still, sometimes that’s all it takes. Among the rumors and Chinese whispers that Macro Man has heard recently are the following:

*The BLS is going to adjust the October unemployment rate from 4.4% to 4.6%
*Iceland is going to see its sovereign debt rating downgraded
*Voldemort is buying EUR/USD
*Voldemort is selling EUR/USD
*Voldemort is buying EUR/JPY
*Voldemort is selling USD/JPY
*China will limit CNY appreciation against the dollar to 3% next year
*MOF has told Japanese exporters to sell USD/JPY
*The Fed is flooding the US economy with liquidity which would have been picked up in the now-discontinued M3 data but somehow is not captured in narrower monetary aggregates
*A platinum ETF will be launched
*Risk trades are on the brink of a massive liquidation
*The central banks of many if not most Asia ex Japan countries have been intervening to buy dollars heavily this week
*Tom Cruise wore six inch platform shoes to his wedding to disguise the fact that he is closer in stature to Mini-me than Dr. Evil
*And of course........there are ‘huge’ stop losses on either side of the market! (Pick any market- the rumor works well for everything from TYZ6 to Malaysian palm oil.)

Needless to say, most of it is rubbish. However, if you were long platinum and looking for a tasty exit level, yesterday’s ETF story served one up on a silver platter. The moral of that particular story, evidently, is caveat auditor!

And if you haven't voted....

Tuesday, November 21, 2006

Random shots

What would you rather be: a financial market trader or an American turkey? The lack of action in these markets is so dire, Macro Man is swiftly moving to favour the latter; at least turkeys will be put out of their misery in the near future. Portfolio performance has remained solid over the last 24 hours; what the recovery in Aussie stocks took away, the out-performance of energy stocks and NYMEX crude gave back. Given how quiet everything has been, it would be relatively surprising to see much change in the P/L.

Jeff Currie, the energy analyst at Goldman Sachs, put out an excellent piece last week discussing the underperformance of WTI. Essentially, WTI has faced a headwind caused by the fact that the delivery depot in Oklahoma is landlocked and oversupplied; Macro Man was aware of the former factor but did not realize the significance of the latter. The upshot is that WTI is underperforming and not reflecting the global supply/demand dynamic, and anomalous spreads have emerged with not only Brent, but also with crudes of similar quality such as Louisiana light. It also explains the relative outperformance of the OIH versus WTI. Assuming the conditions at Cushing are mitigated (and Currie believes the fundamentals are already turning), WTI discounts should ebb, and the Dec 07 WTI/Brent spread should continue to widen out back towards its longer term average of $1.50-$2.50.

A less compelling research missive from Goldman is the introductory piece from their global economics monthly, wherein they declare partial for their ‘global decoupling’ thesis. While acknowledging that Japan seems to have hit a rocky patch, they state that Europe appears to be decoupling from the US. Perhaps, but maybe not in the way that they expected!

Platinum has gone bid today on news that an ETF might be launched. While the move has generated a small p.a. profit (his and Mrs. Macro’s wedding rings are platinum), there is little to suggest that this is anything other than noise. If there were a liquid platinum option market, he’d be tempted to buy puts. Sadly, there isn’t, and the recent history of copper and nickel suggest that fading squeeze-y moves in illiquid metals can be a relatively costly exercise. Macro Man might be tempted to fade any sell-off in USD/ZAR resulting from the platinum move, but he’s need to see levels closer to 7.00 before pulling the trigger.

Finally, Macro Man encourages you to vote in the equity market poll posted yesterday. The results will feed into a much larger poll (which is the source of the response options), but Macro Man might be too embarrassed to forward his results if he cannot notch a double-digit response figure!

Monday, November 20, 2006

Macro Man wants your view

At the risk of embarrassing himself by displaying the dearth of readership of this (admittedly young) project, Macro Man would like to solicit your opinion on the US equity market. The results will then feed into a poll-of-polls, the results of which will be revealed on Friday.

Please respond, and encourage your (astute) friends and colleagues to do so as well. Disclosure: Macro Man voted for the 'bubble talk is irrelevant' option.

Macro Man humbly thanks you.

An honest man’s assessment of US equities

It’s hard to believe that we are almost at Thanksgiving already. For such an irritating year (in terms of the collapse of volatility, May excepted), 2006 has passed relatively quickly. Only a few weeks to go until YTD P/L’s flip back to zero (indeed, for many hedge funds and investment banks, only a few days!), which hopefully will bring increased risk appetite and volatility back to financial markets.

The portfolio has fared pretty well over the weekend, with a sharp decline in Aussie stocks offsetting the rallies in Treasuries and EUR/JPY. Macro Man is disgusted with himself for losing money in the latter, as the short EUR/JPY trade has been one of the costliest in foreign exchange over the past three years. He will bid 1.2785 to cover the short EUR leg, then perhaps look to sell out the yen on a decline in USD/JPY. Currencies remain a wretched market, and perhaps Macro Man would be advised to abandon them altogether for the time being.

In trawling the web over the weekend, Macro Man was startled to see one well-known hedge fund manager call the current US equity market environment “one of the best shorting opportunities in years.” Is this really the case? A bearish argument, it seems, would hinge on three key planks: valuation, positioning, and future earnings. Macro Man attempted to examine each of these arguments from an honest and hopefully unbiased perspective to determine whether we really are perched at the edge of a precipice.

Valuation does not appear to be a significant obstacle to future equity gains. The current S&P500 trailing P/E ratio of 17.6 is relatively low by the standards of the last 20 years, coming in at just the 25th percentile. Meanwhile, both Treasury and corporate yields are near their lows of the same period, suggesting a relatively attractive valuation for equities on the basis of the so-called “Fed model.” Skeptics about the quality of SPX trailing earnings must reconcile their views with the persistent strength of NIPA earnings, which are tax-based and cover the entirety of corporate America. To put things in perspective, the chart below illustrates S&P 500 earnings per share and price over the past several years: observe how much higher EPS is than the last time the index was at 1400! Macro Man is forced to conclude that while US equity valuations may not be especially attractive relative to the rest of the world, the US market actually looks cheap relative to its own history.

Ah, but it has rallied since June in virtually a straight line. Surely the market is long and soon to be wrong? Macro Man would concur that the speculative market is now long US equities, but positions look relatively light. As far as he can make out, the over-arching story of the past five months has been short-covering. Anecdotal and survey evidence suggest that active global index fund managers have underweighted the US for several years, with corresponding overweights in Europe, Japan, and EM. Moreover, the chart below illustrates the net long S&P 500 speculative futures positions as a percentage of the outstanding spec positions. It is interesting to note that the market has been persistently short for most of the past four years, with most of the long positions during that time coming during the annual Q4 rally. Perhaps the current modest long will meet the fate of prior longs since 2002, and quickly unwind. Nevertheless, any long that exists is, as far as Macro Man can see, very modest by the standards of history. As such, he cannot see that positioning can credibly be used as a rationale for the US market being an outstanding short, especially when other markets exhibit (anecdotally, at least) greater length and a higher beta.

What about future earnings? It is here that the bear argument makes its strongest case. Although Macro Man does not believe that the housing market necessarily leads to recession, he is concerned by other, more persistent drivers of corporate profits- namely wage growth and the inventory cycle. A simple macroeconomic model which has proven to be remarkably successful in modeling annual profit growth is flashing a bright red warning light. The model, which displays a correlation of 0.82 with actual NIPA y/y profit growth since 1953, suggests that economy-wide profit growth should slow to 0% y/y in the relatively near future. The model is not yet pricing recession, but rather a period of stagnation. Macro Man is not positive what the price implications for equities would be is profit growth flatlines for a few quarters, but something plus or minus 10% or so seems reasonable. Such an outcome would imply that equities are a relatively unattractive long, but by no means the sale of the century.

One caveat to note is one of the few prior notable misses of the macro profits model. In 1995, after a period of prolonged Fed tightening, the model suggested a deceleration to zero profit growth. In fact, profit growth showed surprising resilience, and the US stock market put in a straight-line rally of fairly memorable proportions. This is the bull case: that 2006 = 1995. As yet, Macro Man is unconvinced by this argument, as we need to see how resilient profits prove to be during this period of low nominal GDP growth. In the end, he is left more or less where he started. He is suspicious of the resilience in profits to date, but cognizant that neither positioning nor current valuation are gale-force headwinds. Indeed, he suspects that the “melt-up” scenario would be relatively painful for quite a few smart investors, which is why he slapped on the risk reversal hedge on Friday.

Friday, November 17, 2006

S&P riskie

Bought 50 Dec SPZ6 1425 calls at 4.45
Sold 50 Dec SPZ6 1375 puts at 6.3

Strange things are afoot when housing starts collapse and bonds barely budge....

The good, the bad, and the ugly

Yesterday saw a little bit of good (bonds cratering despite an incredibly dovish CPI figure), a fair amount of bad (the broad equity melt-up continued), and a whole lot of ugly (catastrophic declines in crude, the OIH, and a curiously delayed collapse in Goldcorp.) The net result was a roughly 0.50% drop in P/L, taking November back towards flat and the since inception bottom line back into the red.

Macro Man is not afraid to admit that he understood very little of the price action observed yesterday. Why, after floating on air since payrolls, did the bond market abruptly reverse course in the face of such dovish price data? Sure, Moskow was hawkish, capacity utilization was higher than expected, and the NAHB registered another monthly rise. But was that really sufficient to produce a 10 bp peak-to-trough sell-off in bonds? Similarly, why did crude prices collapse starting at 10 a.m. New York time? Macro Man has heard explanations ranging from a consultant report on OPEC shipments to distortions caused by the futures roll, but none seem terrible compelling. Why, also, did USD/MXN rally in a straight line from 9 a.m. NY time onwards? ‘Profit-taking’ seems to be the default explanation, though it is a fairly uncompelling one.

What all of these moves have in common is that they appear to be flow driven, where motivated buyers and/or sellers push prices, regardless of any fundamental rationale. Such markets are inherently difficult to trade, particularly if one cannot see, let alone anticipate, the flow. Caution is therefore warranted, and perhaps a more tactical approach is required. Macro Man is kicking himself for not lightening up on the OIH at 142, when the DIA/OIH ratio was comfortably on a 0.86 handle.

A few random thoughts as we head into the weekend:

*The usually useless TIC data provided one interesting insight, which supported Macro Man’s thesis that the predictive value of the yield curve has declined. Although foreign official authorities were (surprisingly) tiny net sellers of Treasuries in September, there was an interesting yield curve dynamic in their flows. Foreign official sources sold $9.1 billion worth of Treasury bills and bought $7.7 billion worth of Treasury bonds. So despite an-already inverted yield curve, central banks are putting on flatteners. This, on top of the pension perma-bid, is one of the big reasons that Macro Man is willing to bet against the signals sent by curve inversion.

*Macro Man alluded to the growth in CB reserves equaling that of US money supply growth over the last few years. The chart below illustrates that fact, illustrating the cumulative rise in MZM and the FX reserves of China, India, Russia, and Taiwan since the start of 2003. Is it any wonder that central banks are losing control of monetary policy?

*CBs have reportedly been all over the foreign exchange market this morning, both intervening in USD/Asia and selling dollars against a panoply of G10 currencies. Meanwhile, President Chirac moaned about the strength of the euro again yesterday. Although Macro Man doesn’t expect too much from the G20 meeting this weekend, he will be very keen to observe over the coming weeks whether the Germans join the French in muttering about euro strength, or whether the original thesis of electoral posturing is proven to be the correct one.

*A poster to the site alluded to the poor performance of currency traders in recent years as a result of central bank meddling in currency markets. Macro Man decided to investigate to see if the theory, which Macro Man shares, is borne out by facts. His view is that the dollar should have strengthened dramatically and consistently since US short rates went above those of Europe in December of 2004, and would have done so had it not been for central bank euro purchases. If he were correct, then we should see a notable drop-off in currency trading performance once Voldemort became a head-wind, rather than tail-wind, to private sector trading strategies. In fact, this is exactly what happened, using three different return indices (Stark currency trader, Barclays currency trader, Deutsche Bank currency trader) as a measure of currency fund performance. Hmmm.....

*The danger of an equity melt-up remains a key one for the portfolio. Macro Man will look to overlay this risk by slapping on a risk reversal. He will buy 50 Dec 1425 calls/ sell 50 Dec 1375 puts at the option opening later today.

*It is perhaps fitting that as the economics world mourns the passing of Milton Friedman, national money supply data are becoming increasingly irrelevant with the distortions caused by FX reserve allocators.

Thursday, November 16, 2006

Harry Potter and the FX reserve managers (Why is there no volatility? Part II)

The portfolio had a good day yesterday, almost in spite of itself. Goldcorp had a glaring earnings miss and metals traded on the back foot, yet the stock clawed back early losses to close unchanged on the day. Meanwhile, a build in crude inventories was more than offset by sharp declines in product inventories, which provided a bit to crude and a pleasant upward jolt to the oil service stocks. OIH is now within shouting distance of Macro Man’s second offer at 145. EUR/JPY has come off its highs overnight, with a PBOC official noting that China does buy some yen for their FX reserves. That they then sell the yen 24 hours later was, strangely enough, left unsaid. Meanwhile, the stronger than expected Empire survey provided a jolt to bonds, taking the 10 year yield back north of 4.60. Finally, the Fed was hawkish enough in the October minutes to keep Treasuries on the back foot through the close and in the overnight session.

Of course, the real test for bonds will come via the CPI and housing data released today and tomorrow. The TIC data is also released, with a new ‘improved’ methodology that accounts for short term flows, thus making the series even more erratic. The appropriate reaction to the number, whatever the result, should be a yawn. In terms of portfolio tactics, Macro Man has a net short equity bias which will be increased should profits be taken on another slug of the OIH position. This position will bear watching, as stocks could very well be in the melt-up mode that so often accompanies the end of the year generally and the third year of the presidential cycle specifically. If this proves to be the case, then some adjustment will be required. For now, however, Aussie equities are underperforming, which might lend itself to a long SPZ6/short XPZ6 spread trade.

Yesterday, Macro Man provided some macroeconomic and financial rationales for why market volatility has been so low: namely, that the performance of major economies and asset markets are virtually indistinguishable at the moment. However, there are other forces at work, namely You-Know-Who, a.k.a. He-Who-Shall-Not-Be-Named, a.k.a. Lord Voldemort. In other words, the currency reserve managers of Asian and oil exporting monetary/investment authorities. Why does Macro Man collectivize these institutions into the catch-all phrase Lord Voldemort? For two reasons. The first is that these institutions tend to be very sensitive about their flow, and apply pressure to their counterparty brokers not to reveal what they are up to, as is customary with private sector flow. As such, brokers are generally afraid to report the source of their flow as ‘sovereign’, instead using rather tortured euphemisms when referring to what’s driving the market. This strikes Macro Man as similar to the euphemisms applied to Voldemort in the Harry Potter books. The more sinister parallel, of course, is that the influence of these institutions is everywhere in bond and currency markets, and threatens to overwhelm the smooth functioning of market pricing heretofore performed by private sector profit-maximizers.

The sums that we are dealing with here are very considerable indeed. The rate of reserve accumulation of the key players has been virtually parabolic in recent years. The chart below shows the combined currency reserves of just four countries- China, India, Russia, and Taiwan. Note the absence of countries like Korean and Malaysia, as well as the assets that have accrued to Middle Eastern investment authorities. Observe the scale on the left hand side of the chart. At the beginning of 1996, these countries had $235 billion in currency reserves. As recently as January 2002, their combined reserves were $452 billion. As of this September, their combined reserves totaled $1.65 trillion.

In less than five years, therefore, these four countries have essentially pumped $1.2 trillion into global fixed income markets. To put that number in perspective, it is essentially identical to the entire growth of US M2 during the same period!!!! Even if the bulk of the money is put on deposit or enters the 2-5 year sector of the curve, it is very difficult to believe that this does not have a knock-on impact at the back end as well. This is especially the case given that a growing number of reserve assets are being farmed out to private sector asset managers with a benchmark duration that might well be higher than those of the central banks’ direct bond purchases. This, Macro Man believes, is one of the principal solutions to the bond market conundrum and the concomitant lack of volatility.
Their impact on the currency market is, if anything, more acutely felt. It is Macro Man’s firm belief that EUR/USD would have traded close to parity over the last couple of years had its price been determined solely by the private sector. A 100 bp cash premium has traditionally sufficed to drive the dollar stronger against the EUR/DEM. For the last year and bit, the dollar’s cash premium has been at least double that, with no discernible impact upon the EUR/USD spot rate. Why? Well, as monetary and investment authorities accrue dollar reserves through either FX intervention or oil revenues, the money is virtually all in dollars. To maintain a portfolio benchmark of, say, 25% euros, a portion of these dollars must be sold in exchange for euros (or sterling, or Canadian or Aussie dollars) every month. The chart below illustrates how many euros per quarter China, Russia, India, and Taiwan would need to buy under two scenarios: a constant 25% benchmark weighting, or a gradually rising benchmark weight from 15% in 1999 to 27.5% today. Small wonder the private sector bias to be long dollars at these levels of carry has not had much impact!!!

What is the end game? Macro Man wishes he knew. Two things he is watching out for, however, are a European slowdown and a rise in protectionism. In the event of the former, Macro Man suspects that European politicians would seriously countenance intervention to weaken the euro. Such an outcome is unlikely while the ECB remains in tightening mode. However, with presidential elections in France next year, the current government will be acutely aware of the need to maintain sufficient economic momentum to foster a robust labour market. De Villepin’s comments earlier this week, therefore, should be observed through the prism of electoral posturing. The second possible endgame is a rise in concrete protectionism in the west. If the US were to tell China ‘neither your dollars nor your goods are welcome here anymore’, that would likely catalyze a more pronounced sell-off in the dollar, with the private sector happy to coat-tail central bank dollar selling.

In the meantime, Macro Man is desperately trying to find a magic wand sufficiently powerful to combat the likes of Voldemort. Being clever, he fears, is not enough. After all, Dumbledore was a pretty smart bloke, and look what happened to him....

Wednesday, November 15, 2006

Why is there no volatility? Part I

Macro Man is back in the saddle and pleased tHat the resource bets have compensated for the execrable performance of the bond short. The post-payroll bond short was stopped at the highs of 108-14 on Monday, which looked like a bit of a mug’s trade until yesterday’s data. The remaining 200 lot short is maintained, with a stop at 109. While Macro Man remains a believer that the market is underestimating the trajectory of US nominal GDP growth, he has to concede that the timing to allocate risk to the view may not be right. 10 year yields below 4.50 are not something that he wishes to see for any duration of time. The Fed minutes, CPI, and housing data this week will determine whether being short bonds makes Macro Man a hero or a villain.

Elsewhere, equity markets continue to price a soft landing. Macro Man is impressed with the strength of the SPX and considers himself fortunate that his short equity bias has not been particularly painful. Certainly picking the right market is key, and the continued weakness in copper suggests that the Aussie equity short remains the appropriate trade. Less appropriate is the position in DAX puts, and Macro Man sells out the position at 6.5 before they expire worthless. He remains 145 offer for another $2.5 million worth of OIH.

Long option positions have not worked for most of the year as actual and implied volatilities have remained extraordinarily low by historical standards, across asset classes? Why is this? Macro Man has done some investigating. One of the first requirements for asset market volatility is macroeconomic volatility, or a divergence in the macroeconomic fortunes of major economies. Not only is this not happening, one could argue that because of globalization major economies have never been so synchronous. Consider that most major economies seem to be growing at roughly 2%, give or take, with core inflation at the upper end of comfort levels and every G10 central bank bar New Zealand’s raising rates this year. Using industrial production as a proxy for growth, we can see below that the difference in y/y industrial production between the highest and lowest in the G3 has never been lower in the last 25 years.

Synchronicity of the cycle is all well and good, but if there is a large disparity in asset market returns and/or volatility across countries/currency blocs, investors will be rewarded for making country bets and currency volatility should ensue. One of the more remarkable financial market phenomena over the last six years has been the remarkable convergence of risk-adjusted returns across the US, Eurozone, and Japan on an apples-for-apples basis. If we look at a basic asset allocation strategy- 60% equities (MSCI total return), 35% bonds (7-10 year total return), and 5% cash, we see that the rolling three year return to risk ratios amongst the G3- which had showed a large degree of variation in the 1980’s and 90’s- have been virtually identical across the G3 for the entire decade.

The implication is that investors are in fact NOT rewarded for taking country and currency bets, because they generate a virtually identical return for each unit of risk that they place in each country/bloc. Because the capital account is by far the most dominant driver of currency moves, the fact that there has been a convergence of capital market returns has been absolutely vital in explaining why there’s been so little volatility in currency markets.

The obvious conclusion is that when we observe a decoupling of the economic cycle and/or asset market returns, currency volatility should return with a bang. At the current juncture, however, there is little indication that this will happen any time soon.

Later this week: Part 2: the rise of Lord Voldemort

Tuesday, November 14, 2006


Macro Man isn't sure what feels worse: the first flu bug of the winter season, or financial markets. The flu bug laid him up for Monday and most of Tuesday, while the market has provided relatively little solace. The retail sales and PPI disingenuous to suggest that the data actually fit the core view; in fact, they do not, and the post-payroll bond short was chucked overboard as a result. More thoughts will hopefully be forthcoming tomorrow. While Macro Man was away from the trenches for most of the last couple days, it seems quite clear that Voldemort has once again been despoiling the foreign exchange market by stepping into to sell EUR/USD and stopping the post-data rally on a dime. Perhaps the flu was a blessing in disguise....

Voldemort was aided, of course, by an unexpected moan from French PM de Villepin, who (admittedly playing to his Airbus audience) suggested that the politicos need to get more involved in setting EUR exchange rate policy because, by implication, the ECB weren't doing a good job. If only Macro Man had put on the Boeing/EADS spread discussed a couple of weeks ago... Tomorrow should see Macro Man fighting fit, with a portfolio update and some preliminary results from a recent research project...

Friday, November 10, 2006

It's elementary!

Consider the following:

1) Global bonds are once again strongly bid. Is it central bank liquidity, growth fears, or a short-killing cocktail fo the two?

2) US Q3 growth all of a sudden doesn't look so bad. Sure, the number will likely be revised up, but the French and (likely) the Japanese would trade their Q3 growth for America's 'awful' number.

3) Equities appear to be trying to roll over.

4) The Aussie dollar is underperforming on a cross basis.

5) Although precious metals are doing well, copper is taking a bath.

6) The resource stocks have had a nice run, and Macro Man remains heavily exposed as a percentage of the portfolio. Price action in stocks like Phelps Dodge is ugly today, and the OIH ain't looking too hot, either.

What should we conclude from this? It's elementary! Time to sell Aussie stocks. Macro Man sells 200 XPZ6 futures at 5420, stopping out at 5500. Futures were at 5000 less than six weeks ago, so the risk/reward of the trade is exceedingly compelling- hence the relatively hefty risk allocation.

Friday morning joke

Q. What do you get when you invite a bunch of central bankers together in Frankfurt?


Macro Man's buddies are at it again. PBOC governor Zhou decided yesterday afternoon to yank the market's chain by stating that China has a 'clear plan to diversify reserves.' The dollar predictably tanked. This morning, meanwhile, Asian central banks (no naming names, of course) have reportedly been buyers of dollars as the private sector scrambles to sell the buck given the Chinese tailwind.

And lo and behold! Look what Mr. Zhou has to say for himself this morning. He claims that China has 'No plans to speed up diversification' and 'no plans to sell dollars.' Hmm. Nice trading, guys. Macro Man is not a conspiracy theorist by nature, and is not sure if this sort of behaviour qualifies as a conspiracy so much as naked and blatant market manipulation. Either way, the whiff of sulphur has strengthened to a stench. Where's Harry Potter when you need him? Lord Voldemort is trading foreign exchange!

In actuality, the shenanigans of the CBs have impacted the portfolio only tangentially. Although there are a few FX trades, the net exposure is essentially short EUR/long TWD. If the market is going to ramp EUR/USD above 1.30, obviously this position will need some adjusting. However, having sold EUR/JPY at 150, Macro Man wants to give it a couple of days to see how it enjoys the rarified air of being closer to 200 than 100.

Elsewhere, the commodity plays are peforming strongly. Goldcorp benefitted from an anaylst upgrade and the underlying strength in gold to rise roughly 8% yesterday. Macro Man will be keen to see if it can keep running higher as gold approaches the tecnhical target of $650. Perhaps writing some calls will be worthwhile. The OIH, meanwhile, sank into the close despite the underlying strength of oil. The partial profit take at 140.40 is therefore slightly in the money. Although Macro Man does not believe that a Democratic Congress will be able to pass a windfall tax on energy companies, the possibility thereof will create some noise. This, in turn, could provide an opportunity to trade around the core position. Macro Man will offer out another $2.5 million of his cash OIH position at 145.

Bonds, meanwhile, continue to squeeze higher. The Michigan number was disappointing, of course, but Macro Man thought that the resultant bond rally was outsized, particularly given the correction lower in claims and the implications of the trade data for GDP growth (Q3 likely to be revised to a 2 handle.)

Macro Man cannot help but observe, meanwhile, that the 'global decoupling' pipe that the market likes to smoke is giving off a rather acrid smoke. Japan saw the release of yet another disappointing figure last night, as machinery orders revealed a further retrenchment in capex spending. There is a decent chance we see a negative print for Q3 next week.

In France, meanwhile, GDP stagnated in Q3, showing zero growth from Q2. This contrasts sharply with expectations for 0.5% nonannualized quarterly growth. Seperately, IP registered a surpising decline and is now down on a year-on-year basis. It may be difficult for the ECB to sound too hawkish with data like this in the background. By the same token, however, the European bond market isn't exactly priced for a substantial extension of the tightening cycle, either. Nevertheless, it is curious to see how happy the FX markt is to ignore poor data in Europe and Japan in their lust to follow Lord Voldemort, the Pied Piper of foreign exchange.

Thursday, November 09, 2006

Sell $2.5 million OIH at 140.40

The 142 offer looks out of bounds, so might as well take the windfall gain while it still exisits.

Thursday bullet points

* The OIH looks set to open through the 140 offer for $2.5 million. Macro Man moves the offer to 142, but will go to market an hour after the NYSE opens if the retail crowd haven't paid up. Macro Man has been interested to observe comments that 'big oil' might be in trouble with a Democrat-controlled Congress. Clearly, the market does not share his dim view on the abaility of mixed party government to accomplish anything, good or bad.

* Macro Man has also heard conspiracy theories that the Bush/Cheney cabal engineered the decline in energy prices over the late summer in an attempt to bolster the Republicans' electoral fortunes. This, of course, begs the queston of which sinister entitity pushed crude from $60 to $78 during the spring and early summer?

* US trade figures were, surprise surprise, better than expected as lower oil imports spurred a decline in imports. The ex-petroleum trade balance has now flatlined for two and a half years.

* Elsewhere, Japanese bank lending disappointed, with the y/y chart starting to look an awful lot like it has peaked. Macro man is starting to really like the idea of buying JGBs on dips. Watch this space.

* The market has once again tried to sell the AUD hard, but the 'invisible hand' of you-know-who is reportedly still on the bid.

* From the 'You wanna see a housing bubble? I'll show you a housing bubble, mate' file: over the last two weeks, the UK press has been filled with stories such as:

- Dramatic rise in requets for aid in dealing with debt from the Citizens' advice bureau
- High street banks and building societies advertising their willingness to lend five times joint income on mortgages
- The highest level of repossessions since 1993, both in absolute terms and as a percentage of oustanding mortgages
- Grocery stores offering 52 year mortgages

The BOE hiked as expected today, but at some point buying short sterling upside is gonna look awfully attractive, if the last six months' price action in eurodollars are anything to go by.

Wednesday, November 08, 2006

Whip it real good

The soundtrack of the day in financial markets is being supplied by Devo, singing 'Whip it.' The bond market continued yesterday's rally early this morning but has subsequently reversed course. Maybe it's because of the mortgage applications (up strongly), maybe it's because the short term market got caught long, or maybe it's because yesterday's buyers bought too much. Regardless, the market has retraced about half of yesterday's rally, peak to trough.

FX, meanwhile, has degenerated into a farce. Today, Macro Man has heard the following:

1) A report that China has $5 billion a day to sell between now and the end of the year.
2) A denial of the report by the purported author
3) A report that 'Asian CBs' were sellers of EUR/USD above 1.28.
4) A report that 'Asian CBs' were buyers of EUR/USD below 1.2750
5) A report that SAFE will begin transacting foreign exchange via the CME.
6) A report that CBs are selling USD/JPY
7) A report that CBs are buying AUD as the market sells the fact of the RBA tightening.

Equities, meanwhile, appear to be 'selling the girdlock fact'. Macro Man is unsure at this jucnture if there is anything to do there but sit tight.

In summary, all that Macro Man can hear at the moment is 'Whip it......whip it real good" played at a very high volume. The noise, it goes without saying, is deafening.

Tuesday, November 07, 2006

A faint whiff of sulphur

So bond markets across the world go super bid (-5 bps in US and Europe, -6 in UK) on no news as the dollar mysteriously sells off. This comes after a period of persistent Asian currency strength and, if anecdotal news is correct, substantial USD buying by central banks in North, Middle, and Southeast Asia. It looks like Macro Man's favourite market players may be up to their usual tricks today. If they don't get you in one market, they'll get you in another....

A confederacy of dunces

Well, today is the day that the US electorate will (delete as appropriate) throw the bastards out/let the bastards in and bring sense to Washington/bring nonsense to Washington. In reality, the policy differences between Democrats and Republicans are not terribly large; indeed, the policy that each party seems to stand for most strongly is the desire to seem themselves elected. Although Macro Man is not a political scientist and does not pretend to have the energy or desire to sift through the minutiae of the various parties/candidates, it appears to his inexpert view that both of the US parties remain aligned to the right of, say, David Cameron’s Tory Party on the political spectrum.

Macro Man fails to see a substantial real impact from the Democrats winning control of the House or even the Senate, though he concedes that the market may conclude differently. Certainly the historical performance of equities is much higher under gridlock than under single-party rule, which may explain at least part of the recent run up in US stocks. This, at least, would appear to fit in with Macro Man’s general attitude towards politicians, namely that those most desirous of political power are generally amongst the least qualified to wield it effectively.

The one political item that Macro Man keeps on the radar is that of protectionism. The tide in the US seems to have tilted decisively towards more rather than less; insofar as there ever will be a ‘dollar crisis’ (and Macro Man has serious reservations that there will be), it will likely be spurred by the US government telling foreigners that either their dollars or their goods are no longer welcome. Macro Man remembers how acrimonious trade negotiations were among the spurs for the very sharp rally in the yen in the mid 90’s.

Elsewhere, it’s been a quiet start to the week on the data front, with central banks comments grabbing most of the headlines. Janet Yellen grabbed headlines with some fairly innocuous comments on foreigners potentially buying fewer US assets in the future. Well, when Asian and oil exporting countries quit buying so many dollars, they’ll be less need for them to purchase US assets, won’t there? That the dollar sold off on the back of Yellen’s comments is probably more reflective of short term positioning than the expectation that she will catalyze a substantial downtrend in the dollar as she did in September of 2004.

BOJ governor Fukui, meanwhile, promised to act pre-emptively in adjusting monetary policy and promised that policy normalization won’t take longer than five years. To a market for whom five days now represents the ‘medium term’, Macro Man cannot see that this promise should have a definitive impact. Not even the observation that the yen’s real effective exchange rate is the weakest since 1985 prompted much in the way of yen buying, else EUR/JPY would not remain comfortably north of 150. The problem, it seems to Macro Man, is much more to do with yen crosses than USD/JPY. Indeed, with US finished goods price inflation substantially below that of Japan at the moment, the equilibrium PPP rate for USD/JPY is actually drifting higher. No, the real problem is that there are motivated buyers of Asian, European, and Antipodean currencies who do not share the same enthusiasm for the yen. Macro Man leaves you to decide who these motivated buyers might be.

The portfolio remains solidly in the black this month, though the pullback in Treasuries and Goldcorp has taken a bit of the shine off. On the plus side, oil and energy stocks are performing well, with the OIH trades delivering a nice fillip to the P/L. Macro Man remains 140 offer in $2.5 million worth of OIH, allowing the options to take a greater delta burden. The 107 bid in Treasuries remains unfilled, and it will likely remain so until at least Thursday, when the Michigan sentiment is released. The continued softness of retail energy prices should maintain the recent recovery.

Monday, November 06, 2006

Is the yield curve forecasting a recession?

Macro Man was unsurprised to see a substantial discounting of Friday’s employment data on the basis of a) the loss of employment in the manufacturing and construction sectors, b) the fact that the bulk of the revisions were in education, c) the bulk of the job gains were of either the governmental or the burger-flipping variety, and d) the numbers are so volatile that they don’t mean anything anymore. Of these, Macro Man has substantial sympathy for the fourth objection but very little for the first three.

After all, isn’t it a good sign that firms are adjusting to weaker demand by shedding labour? That US companies have the flexibility to do so is an underlying strength of the American economy versus Europe or Japan, and one of the reasons why trend growth in the US is higher than in most other developed economies (even with the recent downward revision to trend growth estimates.) And why should teachers not count? They comprise a substantial portion of the workforce, and it is unsurprising that August/September data looked anemic if school districts did not supply payroll data in a timely fashion. And if all jobs were of the burger flipping variety, why is the unemployment rate amongst college graduates 1.9%, while the rate for non-high school graduates 5.8% (admittedly down from 7.1% in July.) That firms are now forced to hire workers with relatively low qualifications is suggestive of the tightness of the labour market, not its imminent implosion.

As noted on Friday, the bond market was priced for yields to rise on any non-horrible news, and Macro Man was pleased to see the losses extended after the non-manufacturing ISM figure. However, the market remains in tactical mode, and Macro/Micro Man remains bid at 107 to take back 200 of his 300 short Treasury contracts. If the March 95 eurodollar calls go offered at a tick any time soon, meanwhile, Macro Man will likely add to the position in a lottery ticket bet.

One notable aspect of the bond market selloff on Friday is that it was essentially a parallel shift higher in the yield curve. 2’s -10’s remains inverted by 10 bps, and cash- 10’s by substantially more. According to a number of commentators, including the Fed, this is suggestive of an imminent recession. Indeed, many of the more bearish economic commentators are hanging part of their argument on the signals provided by the yield curve.

However, should we believe what the yield curve is saying? After all, it’s not as if many of the people buying bonds are doing so in an attempt to predict the trajectory of the US economy. Central banks have appeared happy to buy Treasuries at a level shunned by the private sector- hence the persistent real money short position revealed in survey such as the Merrill Lynch or Russell/Mellon. Moreover, central banks have consistently demonstrated the willingness to pay way over the odds for assets over the past few years. Anyone who has bought EUR/USD and GBP/USD at currently levels on a consistent basis, as central banks have, is clearly not motivated by such trifles as ‘valuation.’

An even stronger case against relying on the US yield curve as a signal of recession is the abject failure of yield curves in the UK


and New Zealand

to predict recessions over the past few years. Of the three countries, only the UK has even seen rate cuts, which will be fully reversed on Thursday. Macro Man wants to hear an adequate explanation for the lack of predictive power in these countries’ yield curves before he relies on a slight inversion of the US curve as an augury of doom.

Elsewhere, the EUR/JPY offer was filled and bid on, at least partially on EURUSD buying from our old friends the Asian central banks. Macro Man looks forward to the day when these fine fellows find out what exactly it is that they’ve been buying. Overall, however, Macro Man has little room for complaint, with November starting off on a fine footing. A few more ticks lower on TYZ6 and he can start banking some of the profits.

Friday, November 03, 2006

Four is a magic number

Four was a magic number in today's employment situation report. The household survey reported employment growth of roughly four hundred thousand, average hourly earnings (you know, the burger flippers and auto makers getting killed by the housing market) rose a higher than expected zero point four percent month on month, and the unemployment rate came in at a much lower than expected four point four percent.

Now, the 'playa haters' will no doubt say that employment is a lagging indicator, and that even if it isn't, golly gee wasn't manufacturing employment weak. The obvious rejoinder is that the prior data was revised up (again), with the August-September employment figures revised up by a total of 139,000 jobs. The tin foil hat brigade may cry 'electoral conspiracy', but if you think the game is rigged then there is no point even playing. Macro Man is more than willing to bet that, in a year's time, the Q3 GDP figure will end up being revised to show growth higher than 1.6%. Any takers?

The bond market has obviously fallen through the stop level, and a fresh 100 lots was sold at 107-30. The stop for this poisition is set at 108-15, just above the prevailing level at the time of the NFP release. The EURJPY offer has missed getting filled by 2 pips so far...such is foreign exchange. Macro Man is tempted to sell out his DAX puts but wants to see the US market actually put in a recovery before doing so. A weekend's worth of decay is the price he pays for a higher degree of conviction.

Balancing Act

Markets are now finely balanced between pricing a soft versus hard landing in the US and, by extension, the world. As yet, no decisive conclusion has emerged, though a substantial out of consensus out-turn on today’s payroll data may be the trigger for more thematic market price action.

At a 65 bp inversion to Fed funds, one would think that the US bond market is priced for the worst. To a degree, that is true; it will take a run of poor economic data to keep yields from rising. On the other hand, we have to acknowledge that some of the purchasers of bonds are not profit-maximizing agents. Central banks buy Treasuries (and Bunds, and Gilts, etc.) because they have a veritable Everest of foreign exchange reserves to invest, and they need liquid securities in which to invest. Pension funds, meanwhile, are perpetually short gamma, forced to chase the market higher when declining yields increase the NPV of their liabilities. The recent run-up in equity prices also may be forcing some rebalancing trades (sales of equities, purchases of bonds) to ensure that strategic portfolio benchmarks are maintained. And let’s not forget the mortgage convexity guys either, another source of perpetual short gamma. The upshot is that yields may well remain lower than they ‘should’ be in the future, a fact touched on by Trichet yesterday.

Whither, then, the Macro Man bond short? At current levels, it remains the right trade, as bonds remain very close to the top of their range and far away from the Fed funds ‘anchor.’ Indeed, Macro Man will step a stop entry at 108 to sell another 100 in the event of a strong payroll figure. However, a change of tactics is required. When it comes to bonds, Macro Man has decided to become Micro Man until further notice. The stop for the current 200 lot position is set at 109. Moreover, Micro Man will book profits on 200 bond futures at 107 (leaving a remaining 100 stopped into as close to 108 as possible.) If the market is going to oscillate within a range, it is incumbent upon Macro Man to make some money trading around a (smallish) core position.

Elsewhere, the Taiwan dollar remains bid, shaking off six months of lethargic performance. Not even the indictment of President’s Chen’s wife on fraud charges has stopped the TWD juggernaut. The authorities would love to get their hands on Chen himself, but he enjoys immunity whilst in office. The CBC reportedly showed their hand today, but that is likely simply an attempt to smooth the pace of the TWD recovery. In any event, Macro Man suspects that more TWD shorts remain to be squeezed. Therefore, he sells $10 million USDTWD three months forward at 32.53. The stop is set at 33.20 on a spot basis and will be trailed lower as spot declines.

The EURJPY offer failed getting filled by 14 pips overnight but remains in place. Elsewhere, the portfolio has slipped a bit as oil prices have once again lurched lower, submarining the OIH position. Bond vol has also seems slipped back a bit, somewhat surprisingly, reducing the profits on the TY/RX straddle spread. It’s likely to be a tedious few hours until the payroll data; what happens afterwards depends on the figures.

Thursday, November 02, 2006

Pin the tail risk on the donkey

Markets appear to be approaching put up or shut up time. Bonds are trading close to top of the recent range, with a deep inversion to cash in the dollar bloc. To get a substantial further rally, we probably need to see the sort of data that would prompt the Fed to consider cutting interest rates. Cue tomorrow’s payroll data, an obvious source of a potential change in Fed view. Macro Man remains relatively upbeat, or else he wouldn’t be short 200 Treasury futures. Nevertheless, given that the standard error of the data is now greater than the underlying trend, there is ample chance of a statistical quirk that produces an outcome of zero or below. Moreover, the volatility surrounding the labor force statistics could easily prompt an unemployment rate uptick to 4.8.

Now, Macro Man would be willing to look through this data, but he suspects that the market would not. Moreover, fresh on the heels of today’s poor productivity data, there is every likelihood that the US economy ‘playa haters’ try and press their bets. Certainly, a downward revision to US potential GDP growth suggests the need for a more activist monetary policy (in both directions) moving forwards until the Fed feels a degree of comfort in ‘getting to know’ the lower-productivity (and thereby more inflation-prone) economy.

All of this, of course, is a recipe for higher volatility. As such, Macro Man has been interested to see a rise in the implied volatilities of equities, bonds, and currencies this week. Perhaps this is simply a reflection that vols have gotten too low to sell; however, it could also imply that market risk takers are finally getting fearful or greedy enough to act. Given that implieds remain extremely low by historical standards, low-delta lottery tickets provide strikes that are actually not terribly far away from current levels. With the SPX threatening to break support, Macro Man fancies some low-delta index puts. As noted earlier in the day, he bought some Dec DAX 5900 puts at 24.5. Why DAX? Well, the DAX is typically a higher volatility index than the SPX; since 1998, the 3m annualized historical volatility of the DAX has been 6.6% higher on average than that of the SPX (current observation is DAX vol higher by 3.3%). The VDAX, meanwhile, has averaged only a 3.3% premium over the VIX. Even adjusting for the slightly different maturity profiles of the two indices, it appears that DAX options are chronically underpriced vis-à-vis SPX options. With the VDAX currently pricing a scant 1.5% premium over the VIX, lottery tickets are cheapest on the German index.

Elsewhere, Macro Man won the office pool on today’s ECB press conference; he predicted that the word ‘vigilance’ would be the fifth word in the newswire headlines. That Trichet was hawkish should come as no surprise; nor should it shock even he is relatively balanced next month. The key signpost for ECB policy will likely be the January press conference, where the absence of the word ‘vigilant’ would be taken by the market as signaling a pause.

MOF currency guru Watanabe once again fired a shot over the bow of yen shorts by repeating that the yen should not be weak given Japan’s recovery (tell that to Mrs. Suzuki and co., Watanabe-san!) The comment was good for a half a percent in USDJPY and EURJPY. Macro Man was amused to see a few institutions note that he was ‘attacking’ USDJPY longs; curious, given that the yen is actually stronger versus the dollar on the year. Nevertheless, he has to acknowledge that the comments from the MOF are starting to appear with distressing regularity. Therefore, he looks to sell 10 million EUR/JPY one month forward at 150 spot basis. The yen long should partially hedge the $ calls, and with central banks reportedly offering EURUSD over the last 24 hours, perhaps euro upside is limited. Perhaps the greatest risk that the nascent rise in volatility peters out is that Asian CBs once again quash any potential trend in currencies and bonds. Truly, Macro Man would like to pin some tail risk on those donkeys....

Tail risk

As the weather gets colder, are markets heating up? The SPX looks like it is preparing to muster a reasonable test of support. Maybe it's just election jitters, maye it isn't. Either way, vol is still cheap but looks like it is set to bounce. The TWD has gone bid and vols have been paid as Taiwan dollar funded carry trades are closed. Meanwhile, bond vol has risen sharply this week, benefitting the Treasury/Bund vol spread.

If the risk case turns out to be the base case and the US lurches into recession, there should be significant moves in asset markets and rises in volatility. Macro Man buys 500 December 5900 puts on the DAX this morning @ 24.5 and 100 53.0 puts on June Brent @ $0.94. More details later.

Wednesday, November 01, 2006

Chicago (Economy) Bears?

Well, October didn’t finish too badly. A late rally in oil (and the OIH), plus an excellent performance from the new Goldcorp position kept the portfolio in the black to the tune of 0.16% on the month. Not stellar, but not awful given the (incorrect) bias to be short bonds and long the dollar. Indeed, the only Halloween horror that materialized was the Chicago PMI data, which sent bonds screaming higher and the dollar plumbing new (recent) depths against many major currencies.

A couple of Macro Man’s professional counterparties have reduced their ISM forecasts below the magical 50 level as a result. Now, Macro Man suspects that this is a bit of an over-reaction. The correlation between monthly changes in the Chicago PMI and the monthly survey over the past couple of years has only been 0.3, and as the chart below demonstrates, the recent relationship has been even weaker.

Nevertheless, Macro Man is cognizant that a sub 50 reading would be taking as clinching a Fed rate cut, perhaps as early as January. After all, the Fed ‘always’ cuts rates when the ISM dips below 50. As a result, some insurance is probably a good idea. Therefore, Macro Man buys 10,000 EDH7 95 calls for 5.5 ticks ($137,500.)

Elsewhere, the second leg of the bond short was implemented at 108, closing October marginally offside. Bonds are approaching the top edge of the range, so it’s put up or shut up time. Macro Man will stop out of yesterday’s sale at 109; the stop on the existing short will be reviewed after today. Meanwhile, Macro Man places his stop on the Goldcorp long at $22. This will be trailed up aggressively if/as the stock continues to perform. Elsewhere, Macro Man is hoping for an SPX rally so that he can buy some strangles as cheaply as possible.