Thoughts on volatility and a few trades

Wednesday, May 23, 2007

Ever so slightly, things are starting to look a bit more interesting. As Macro Man wavers, the US and China chat, and global rates continue to edge higher, signs are emerging that markets may start to jiggle around a bit more. Consider the following:

* The euro has failed for the time being and looks set to trace out a deeper correction. As of last Tuesday, CTAs had record long positions on the IMM. While the positions are likely smaller now, we are starting to approach levels where some of the more medium term sell signals are likely to be triggered.

* At the same time, very long term EUR/USD implied vol seems to have found a bottom. Macro Man didn’t quite bottom tick 10 year vol, but he wasn’t far off (knock on wood.) When his one touches are revalued at month end, they should provide a nice boost to his FX alpha.

* USD/JPY is approaching levels where it has failed earlier in the year. Technically, it should either bounce hard off the low 122’s or accelerate higher through the level, providing a nice opportunity either way.

* Intriguingly, there has been a surge in the US equity put/call ratio. Macro Man (and a couple of posters) has opined that the SPX/VIX divergence suggests that introducing optionality into the portfolio makes a lot of sense. Apparently, the market agrees with him. What makes this development so curious is that the prior spike in the P/C ratio resembling this one occurred immediately before the February 27 China scare and subsequent risky asset correction.

* Both the ECB and BOE continue to sound hawkish despite the recent rise in official and market rates. Unrelenting Fed hawkishness this time last year kicked risk assets in the head with an iron boot. Could Europe deliver a similar punishment this year?

Macro Man has decided to clean up the alpha portfolio by closing the short end positions in euribor and short sterling. While there may be some upside to holding onto both positions, any significant increase in market volatility could encourage him to do something stupid. Far better, therefore, to clear the decks and watch the market with a clear head. He hangs onto the long TYM7 as a synthetic equity market put but will probably be forced to exit on a break below the year’s lows.
He adds a trade in Singapore, however. The recent strength of the SGD against its NEER basket has led the MAS to pump liquidity into the system, putting substantial pressure on short term interest rates. Indeed, for offshore investors, Sing short rates are now below those in Taiwan (as implied by NDF curves.) However, the recent underperformance of the SGD, combined with ongoing strength in much of the rest of Asia, has now pushed the Sing dollar to the weak side of its NEER basket peg. This should therefore encourage a normalization of rates in Singapore.
The one year swap rate was in the mid 3.50’s as recently as three months ago but recently traded as low as 2.5%. Macro Man is willing to bet that SGD weakness will produce a normalization of the Sing short end. He therefore pays the one year swap at 2.65 in S$40k per basis point. He’ll review the position at 2.50, but ultimately looks for the yield to rise back above 3.00 and towards 3.50. The relatively flat curve at the short end makes carry a minimal consideration.

Posted by Macro Man at 10:33 AM  


Macro Man. Are you sure that "global rate continue to edge higher"? That certainly seems to be the case with Treasury yields. But take a look at high-yield bonds, CDS spreads, etc. Both rates and spreads are falling. Regards, A.M. (

Agustin said...
2:51 PM  

By rates, I'm generally referring to "risk free rates"- i.e government bond yields and the strip. When the risk free rate goes high enough, it should (eventually) require a higher yield for risky assets to prevent investors from switching into govvys or cash. Clearly, we're not there yet.

Macro Man said...
2:56 PM  

Macro Man,

Do you think that perhaps the stock index futures are being manipulated upwards in the morning, which causes the entire market to rise, only to fall back down as the day progresses?

Dale said...
8:27 PM  

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