Monday, January 22, 2007

Toe in the water

It is time.

Judgement week for carry has come and gone, the carry trade remains intact, and Macro Man still has nothing on. The RBNZ meets on Thursday, and Macro Man sees little chance that they can do anything but stand pat. Given that there is still roughly a 25% chance of a rate hike price in, that would presumably lead to a sell off in NZD.

However, the reaction of kiwi is in the face of uniformly dovish data last week ( below consensus CPI and retail sales readings) suggests that it is the level, rather than the change, in interest rates that is keeping the NZD afloat. The kiwi might be a flightless bird, but it can still hitch a ride on a 747, which seems to be the case at the moment.

Nevertheless, it seems silly to gamble on the RBNZ. Similarly, Macro Man thinks sterling has been driven higher by a one-off shift out of dollars and into pounds, and he has little appetite to the the last guest at that particular party.

He therefore will dip his toe in the beta plus G10 carry trade by selling $20 million versus the AUD ( 0.7889 to 02 Feb) and buying $20 million versus the CHF (1.2485 to 02 Feb.) AUD/CHF itself is at levels that seem extraordinarily high by the standards of history, but at least there is relatively little event risk on the horizon.

At the same time, it looks like oil is finally bouncing. Macro Man had to scrape his windscreen for the first time all year this morning, so the weather is turning more supportive. Meanwhile, $50 is clearly a key psychological level on crude. Macro Man will therefore book profits on his June 53 puts at 2.75 today, and perhaps look to buy some calls on a dip in crude.


Anonymous said...

Seems the players formerly in positions of authority like Lawrence Summers and Willem Buiter are warning but no one is listening

``Current risks are ludicrously underpriced,’‘ says Buiter, a former member of the Bank of England’s Monetary Policy Committee. “At some point, someone is going to get an extremely nasty surprise.'’

Macro Man said...

The problem, of course, is that the people currently in a position of authority don't care. To wit, the people providing loads of liquidity for the West to buy up risky assets- China, Russia, the ME, etc.- have yet to significantly alter their behaviour.

If anything, the problem will be exacerbated by the creation of a Chinese government investment authority, which presumably will purchase assets riskier than Treasuries, Bunds, Gilts, and Agencies.

I personally think that the angst over the US housing market is, if not quite Chicken Little, certainly well discounted. I have yet to hear an adequate explanation as to why the US is any different to markets in the Antipodes and UK, all of which have experienced significant slowdowns this decade.

The blow-up, when it comes, will likely be something out of left field. Will it be an Ecuadorian default that triggers a run on EM? Bernanke performing the monetary equivalent of the fiscal doom-mongering he espoused last week in next month's Congressional testimony? Fundamentalists winning the Turkish presidency?

It's hard to say. What is clear, however, is that liquidity remains ample, and that tightening in high yield currencies is rewarded with inflows (essentially doubling the impact of the tightening) and "unched" decisions in funding countries is rewarded with a shellacking.

I remain of the view that stocks are broadly attractive for 2007, albeit with the potential for hiccups. The problem is that the FX carry trade is reaching a critical juncture, in terms of technical levels. Either we are perched on the edge of euphoria or on the edge of a cliff, and currency options are cheap as chips. I have been dragged into implementing the least painful of the carry trade legs (naturally, the wrong one.)

The risks are evident, and valuations are stretched. But the question that we must ask ourselves is whether we can afford to underperform, potentially for an extended period, out of hazy, general concerns rather than specific ones. I, and I suspect many others, have found it difficult to resist; being permanently bearish is fine if you are a strategist, but when there's P/L to generate each month opportunity cost is as bad (and in some instances, worse) than actual cost. The best we can do is go in with our eyes open and try to be more cognizant of potential SPECIFIC risks than the next guy.