Wednesday, January 17, 2007

Rip-off Britain

The good news:

* NZ CPI was a smidge lower than expected overnight, declining 0.2% Q/Q and rising 2.6% y/y. This should keep the RBNZ from tightening next week, and has sent the kiwi dollar lower as a result (though naturally, not as much as Macro Man would like.) The short NZD alpha trade and the decision to delay the FX carry beta trade looks good from this perspective.

* UK wage data was lower than expected, as average earnings in December rose 4.1% y/y (3.7% ex bonuses.) This is well below the 4.5% region that has traditionally troubled the BOE, and the LM7 position has drifted back to the entry level as a result.

The bad news:

*The GG purchases were, shall we say, ill-timed. Although the financial cost has not been terribly onerous so far, Macro Man will have little patience to wear a loss in what is admittedly a speculative punt.

Depending on which newspaper you read, and when you read it, the BOJ is either a dead cert to tighten rates tomorrow or will wait til February. This has caused havoc in the short end of the yen curve, but it is not immediately clear to Macro Man why it need bother the foreign exchange market either way. 3 month yen LIBOR is currently 0.62%, and Macro Man cannot see that changing much no matter what happens tomorrow. He still retains an interest to sell yen on rallies.

After perusing yesterday's UK inflation data, Macro Man was struck by something quite remarkable. According to the ONS, utilities prices rose 15% y/y, which contributed significantly to the undesirable uptick in y/y inflation. Leave aside the issue of whether or not the BOE should be reacting to utilities inflation (because the demand for utilities is price and income inelastic in the short run, higher utility inflation actually represents a negative income shock)...what Macro Man wants to know is: how the %$*) can utility inflation be rising 15% year-on-year?

The bulk of the rise in utility inflation came from natural gas, the RPI price of which rose 40% y/y. Frankly, this beggars belief. Natural gas prices are a resounding 60% lower than they were last year (because of the shape of the nat gas curve, monthly changes are largely irrelevant)....yet for CPI purposes, they are up 40%!

Now, one of two things is happening here. Either the RPI measure is fundamentally flawed (and indeed, it does appear to lag spot prices by about twelve months), or the utility companies have taken up the mantle of ripping off consumers that the grocery stores and car dealers wore in the late 1990's. Given that the major gas companies have announced a price HIKE for next month despite a 60% decline in Feb natural gas since July, one can only conclude that the utility companies are absolutely nailing the UK consumer to the wall.

This should come as no surprise to those of us living in the UK. This is, after all, an island country, well-known for its damp weather, that had above-average rainfall last year, only for the major water companies in the south-east to proclaim a drought. The same water companies, which sustained substantial leakage problems (the real reason for the "drought"), reported profits in the range of £500 million - £1 billion. Rip-off Britain is back, only now you cannot dash to Calais to take advantage of cheap gas and water.

And for this, the BOE feels the need to raise rates. Hmmmm. Needless to say, Macro Man is talking his own book here, but he cannot help but think that the BOE is significantly underestimating the squeeze to UK consumers. After all, a vast majority of the UK does not earn City bonuses, and today's data demonstrates that annual real ex bonus wage growth is now -0.9%. Last week's rate rise will further squeeze homeowners already being stuffed by rip-off utility companies, rip-off petrol stations, rip-off Mayors of London (it now costs £4 to buy a one-way tube ticket- that's almost eight bucks to ride on a smelly, oft-delayed, non-air conditioned subway), and rip-off train companies.

Trading with your heart is generally a lousy way to earn a fortune, but Macro Man feels obliged to make a gesture in defiance of rip-off Britain. His short sterling position isn't sexy enough, he fears. He therefore spends $300k of premium (that's 30 bps of portfolio p/l) on a one year 1.70 one touch in GBP/USD. At a cost of 6% of the payout, he can buy $5 million worth of payout for that premium. It's a futile gesture, in all likelihood, but one that won't cost much.

But if the rip-off Britain/clueless BOE/shameless taxation by Gordon Brown chickens come home to roost? Well, the trade could be a home run, a slam dunk, a penalty shoot-out victory and a "six" all rolled into one.


Navin said...

Yes BOE sprung a surprise.

Dear MM,

I was waiting for a post from your on your outlook for 2007 ?

What are your thoughts on Emerginng market equities ?

david said...

let's not forget the impact a gordon brown victory will have on the GBP/USD.

Macro Man said...

That's the sad won't even be a Gordon Brown "victory" so much as a Gordon Brown coronation. UK democarcy, RIP

I am holding off on EM equities for the moment simply because resource companies are so heavily weighted in the indices. In Brazil, for example, seven of the top ten largest companies by market cap are commodity/resource companies. When I feel comfortable that commodities have bottomed and that the path of least resistance is for higher EM stocks, then I'll look to buy some of the indices.

Anonymous said...

With a BoJ increase likely , what happens to the carry-trade --will it be as ugly as last year's sell-off ? or has it been telegraphed enough that some unwinding has already occurred ?

thanks in advance

Macro Man said...

Well, the amusing thing is that suddenly, a BOJ incerase doesn;t seem that likely. Recent press leaks are suggesting they hold off, and JGBs surged last night as a result. Indeed, 3m yen LIBOR was fixed 7 bps lower than yesterday- it's unusual to see that big of a shift in cash rates, espeically in Japan!

If they hike, will it make a difference? Well, probably a bit more now than if we hadn't had the leaks. In the grand scheme of things, however, yen rates remain low in nominal terms, and any further rises will be extremely gentle. This shouldn;t really disrupt the carry trade from a 'denominator' point of view.

More threatening is probably tomorrow's US CPI data and earnings season. A sharp rise in inflation and/or a crackback in equities would reduce risk appetite and lead to some carry trades being unwound. It's one reason why I have played the yen through options...I get the benefit of the carry (which outstrips the option decay) , plus am long vol in case it goes horribly wrong.

Anonymous said...

This just showed up in my inbox. Any thoughts?

Great Analysis on Yen
Right now no one is even contemplating a yen meltdown but if they stay pat and the carry momo crowd takes out last year's highs in usdjpy and guns for 240 in gbpjpy you are going to see some serious yelps from EZ and US manufacturers. I wrote a piece on dailyfx regarding the fact that yuan just surpassed the HKD, so with yen continuing to weaken the imbalances are just becoming massive and markets aren't going to tolerate them forever. Carry has become the easiest trade in the world - akin to buying the intenets per NASDAQ crash and I have a feeling the correction will be just as vicious and may take down some big banks and hedgies with it.

Boris Schlossberg
Senior Currency Strategist
Forex Capital Markets LLC
Financial Square
32 Old Slip, 10th Floor
New York, New York 10005
Tel (212) 897-7660

Macro Man said...

I would take a slight issue that carry is either as easy or as widespread as people think. Most people with an opinion think that the yen and Swissie are undervalued, and that the Antipodeans and sterling are really very overvalued.

As such, most people would, I think, acknowledge that valuations are extremely stretched; but then again, they have been for some time, and the CBs of the carry triumvirate are all more hawkish than some would suggest is strictly necessary.

I would concur that a carry unwind will probably come from official sources at some point. However, it is a bit of a stretch to think that next month's G7 will prick the gonfalon bubble.

Meanwhile, the latest ML survey of fund managers suggests that real money managers are still overweight yen, which doesn't exactly suggest that it's the summer of 1998 all over again...