Thursday, May 31, 2007

Hang On, Sloopy

Continuing a theme, the cheerful 60's ditty "Hang on, Sloopy" keeps running through Macro Man's head (though not his Ipod.) It's month end, and Macro Man is set for a very solid month's performance if his portfolio can just hang on another day.

Yesterday's gains were helped, of course, by the Lazarus-like recovery in US equities, which generated a new all-time closing high in the S&P 500. It is quite a testament to how bubblicous the dot-come era was that the Dow and SPX ae now at all time highs, but yesterday's Nasdaq close was at an index level that is only 50% of the all-time high (reached in Marh 2000.)

So with equities recovering sharply, the dreaded carry trade has once more come back with a vengeance, providing Macro Man's beta portfolio with yet another boost. Of course, any mention of currencies these days is apparently forced by law to discuss China. The Strategic Economic Dialogue has come and gone, and it appears that the protectionist element in Congress was less than convinced by Madam Wu. Today's FT carries a rather droll article suggesting that the Senate is close to finalizing a bill that would compel the Treasury to intervene in markets that are 'misaligned'. Quite how the Treasury would intervene to buy a nondeliverable currency (such as that of, oh.....China) doesn't appear to have crossed anyone's mind, but then again economic and market literacy has never been a particular hallmark of protectionists.

Meanwhile, Brad Setser has another post addressing the impact of exchange rates on global (im)balances. The problem with much of the punditry addressing the impact of exchange rates is that it uses too small a sample size. Quartely current account releases do not provide a lot of datapoints, particularly for series as autocorrelated as external balances. Moreover, Macro Man would argue that improved hedging techniques has extended the lag with which FX moves are passed through and thus impact the real economy.

To gauge whether FX rates appear to drive external balances over longer, more statistically significant perods of time, Macro Man performed a simple study using the G10 currencies. He simply looked at the deviation of the Q4 2006 OECD real effective exchange rate from its 20 year average, and compared it with the deviation of the Q4 2006 current account balance as a percentage of GDP from its 20 year average. If there were an impact, we would expect to see weaker-than-normal exchange rates producing better-than-normal curent accounts, and stronger-than-normal currencies producing worse-than-normal current accounts.
By and large, that's exactly what we get. Of the ten countries in the study, eight produce the "right" relationship (including the US, whose FX rate is very slightly stronger than its long term average.) The two outliers were Canada and Norway, whose current accounts and currencies are both higher than average. Of course, these countries are both large producers of energy in the midst of a rampant bull market.

It would appear, therefore, that exchange rates do matter, if one waits sufficiently long for the impact to materialize. Macro Man would be very surprised indeed if The Economist is still whistling the same tune in a few years' time.


Anonymous said...

MM ,
Why do you have long positions in SPY in both your alpha and beta blotters ,,, is it due to the option ( strangle ) position ?

Thanks in advance

Anonymous said...

macro-man -- love the support on "exchanges do matter", but for the sake of honesty, i have to point out that looking at the $ v. its 20 year average from 86-06 does leave out the period of $ strength in the early 80s while picking out the period of $ weakness post plaza. but the broader point still stands -- the broad $ isn't that weak v. most historical trends. the standard econometrics on the us also suggests a trend deterioration in the US trade balance over time absent $ depreciation (as a result of higher income elasticities for imports than exports ... ) which also is relevant for thinking about the $ in a long-term equilibrium sense, so such elasticities can and do change.


Anonymous said...

I say Peak-A-Boo(by Devo) Macro Man!

It seems you've been "Singing in the Rain (or Kaching)," so perhaps it's a sign that you need to take a little break and go on a nice vacation with your family and enjoy your fruits of daily meticulous labor since Sept 2006.

Yeah, I'm also curious why you have SPY if both your Alpha and Beta portfolio, and also why is the bottom 3 items in you Beta (-20 million)? Is it sell "Put" options?

Thanks for writing your daily blog for I'm learning daily but slowly.

Asian Man

Macro Man said...

The long SPY position in the beta portfolio is part of an RV trade: short the homebuilders (XHB) and long SPY, which is simply a bet that there is more pain to come for housing and that the homeys should underperform the broad market. At the time of trade it was volatility-weighted, but then in April I added to the XHB short so the VAR risk of that leg is greater than that of the SPY leg. Nevetheless, the trade broke even last month despite a tremendous rally in stocks, which I think bodes well for future returns.

Brad, you're right, data is a bit cherry-picked (though not intentionally.) Nevertheless, one could argue that a weak dollar/ large c/a deficit makes a nice counterpoint to the strong ccy/high c/a surpluses of the oil exporters, and that everyone else still remains "in line".