Central Bank Hoedown, Part II

A 45 minute span around the European lunchtime sees the announcement of policy rates in the UK and Euroland, with the ECB press conference a further 45 minutes later. The broad expectation is for no change from the BOE and a further 25 from the ECB , and Macro Man finds it difficult to argue with that.

The real interest will come in the ECB press conference, where the market will wait with bated breath to hear if Trichet declares and end to the tightening cycle, or at the very least suggests that rates are no longer accommodative. While there is certainly a chance of the latter, Macro Man sees virtually zero chance of the former.

Yet in looking at the strip, the market is pricing in little more than a 50% chance of a further tightening beyond today’s. Some of this may be a reflection that European policy rates are swiftly approaching neutrality, and some of it reflecting the rally at the short end of most curves during the spate of US economic weakness over the past month. Either way, Macro Man reckons that the chance of another ECB rate hike beyond today is a heck of a lot closer to 100% than it is to 50%.

This spells opportunity. Macro Man therefore sells 1000 ERU7 contracts at 95.955. There is a useful risk level at 96.05 which can serve as soft mental stop level. An obvious hedge would be to sell EUR/USD, but Macro Man is nervous of doing so into tomorrow’s payroll data and the concomitant gap risk.

Elsewhere, Macro Man was amused to see the release of Iceland’s Q4 current account data, which revealed a deficit amounting to 31% of GDP (annualized.) For 2006 as a whole, the deficit was something like 27.5% of GDP. Of course, the day after the data was released, EUR/ISK went down. If there is one oversubscribed carry trade that is worth worrying about, it’s this one. Unless, of course, you ask Moody’s, who in their wisdom have decided that the major Icelandic banks now merit a Aaa rating. Right......




Finally, Macro Man was amused by the explanatory pass-the-parcel conducted by the panoply of sell side brokers this morning. On inquiring why USD/JPY had rallied so sharply from its 115.55 overnight lows, he was told that it was because of the sharp Nikkei rally. Fair enough. On inquiring further as to the source of the Nikkei rally, Macro Man was informed that it was because USD/JPY had gone up. Gee, thanks. Of course, these are the same guys that always claim that their clients are ‘doing OK’, regardless of market condition. This begs the question of who are the poor brokers that are stuck covering the funds comprising the HFR Macro Hedge Fund Index? Poor buggers...








Previous
Next Post »

13 comments

Click here for comments
Anonymous
admin
March 8, 2007 at 11:00 AM ×

exactly, the whole euro rate curve is too low, its doing exactly as the dollar curve did during 2004-2006 and not pricing in a long enough or high enough cycle. massive opportunity right now.

fyi you have a typo, should be 95.955 not 96.955.

Reply
avatar
Macro Man
admin
March 8, 2007 at 12:03 PM ×

Damn, you figured out my plot to artificially inflate my P/L! ;) Thanks for the catch...but this seems like such an obvious trade that it almost beggars belief.

Reply
avatar
infd
admin
March 8, 2007 at 1:22 PM ×

Regarding EURISK.
ISK weakend for 4 minutes and reversed and got stronger from 89.5 to 88.20, and today even 87.60
The reason, apparently, interest rate differential is too tempting for some.
Now let see if it will last for a month more or until rates go down....
As per Moody's, even locals were surprised and started selling bank shares :)

Reply
avatar
Macro Man
admin
March 8, 2007 at 1:36 PM ×

What I cannot understand is who/what/where keeps buying ISK. I understand the attraction- the highest rates this side of Istanbul- but the abject failure of the market to liquidity-adjust its ISK views astounds me.

Broadly speaking, the ISK has been relatively immune to the slings and arrows of outrageous fortune, and I cannot figure out why.

But I cannot help but think that it will end in tears at some point-probably when 'external imbalances' becomes a driving theme of currency markets, whenever that may be.

Reply
avatar
infd
admin
March 8, 2007 at 2:02 PM ×

Just a day before yesterday Austria issued few yards of Glacier ISK bonds.
It is beyond logic, I agree.

Reply
avatar
Macro Man
admin
March 8, 2007 at 2:08 PM ×

What is the world coming to when people issue debt in a very high yielding, very illiquid currency like the ISK? I would love to emet the guy that decided to issue just to ask him what he was thinking. Macro Man is no financial Calvinist, despising carry for carry's sake, but he (hopes he) is no fool, either....

Reply
avatar
Anonymous
admin
March 8, 2007 at 2:55 PM ×

The guy who issued the Glacier Bonds got a commission? :)

Reply
avatar
Anonymous
admin
March 8, 2007 at 3:05 PM ×

love your comments referencing brokerage sales ..... in my opinion , talking to sell-side coverage is like giving a machine gun to a monkey

Reply
avatar
Damian
admin
March 8, 2007 at 3:07 PM ×

A stupid question - what is the ERU7?

Reply
avatar
Macro Man
admin
March 8, 2007 at 3:18 PM ×

Good sell-side coverage can be a very valuable resource. The only problem is that good sell-side coverage often turns into a good buy-side or prop competitor/colleague!

There was an extremely droll website making the rounds last year which featured a talking chimp in various guises (all including sunglasses, if I recall correctly) providing various flavours of sellside patter. Very amusing, and if anyone knows the website and what the link is, by all means post it here.

Damian, ERU7 is the September Euribor contract (the European equivalent to the US eurodolalr contract) on 3 month interest rates.

Reply
avatar
Damian
admin
March 8, 2007 at 3:31 PM ×

A stupid follow-on question: why did you choose that instrument? In other words, why not just use the Eurodollar contract?

Reply
avatar
Macro Man
admin
March 8, 2007 at 3:45 PM ×

Because it was based on a view about European, rather than US, interest rates!

Reply
avatar
Capt. Marvel
admin
March 8, 2007 at 4:58 PM ×

My thought is that your “Central Bank Hoedown” posts themselves contain the answer to the questions why did the USDJPY and the Nikkei rise last night. I think their rise is a reflection of the bets placed on Trichet’s comments, namely his specific comment on whether or not he would still call ECB policy “accommodative”. That he did call policy accommodative, signaling the probability of further ECB tightening, removes a perceived threat to a low JPY and related carries. It is the EURJPY that is a primary driver here. As we got closer to the ECB announcement, bets firmed that an end to ECB tightening would not be announced. This produced the EURJPY bounce, and removed the major, immediate-term threat to the low JPY, allowing it to fall and the Nikkei to bounce vigorously.

Reply
avatar