Tuesday, May 15, 2007

Tuesday morning bullet points

It's been a while since the last bullet point post, so without further ado...

* It seems quite clear now that China has replaced the US as the global economy's Typhoid Mary. While the rest of the world has famously decoupled from the US slowdown and the March SPX hiccup, the slightest hint of a little trouble in big China seems to send risk trades off the boil. That today's 3.6% decline in Shanghai, a move which literally fails to register on any chart of more than a year, has been used as an excuse for the retreat of risky asset favourites this morning is an ample demonstration of how Sinocentric markets have become.

* That having been said, there is an interesting dynamic developing in US markets. The VIX is famously negatively correlated with stock prices, as equity indices tend to ride the escalator up but take the lift (that's the elevator to you in the US) down. Although the SPX has stalled over the last week or so, the 2 month rate of change remains near its strongest level in at least two and a half years (note the right hand scale of the chart below is inverted.) Yet the VIX is nowhere near recent lows, opening up quite a substantial gap on the overlay. This divergence may suggest that the SPX is about to roll over more aggressively. Alternatively, it could mean that longs are scrambling for hedges, which would then mitigate the extent of any subsequent losses, the dynamic that seemed to play out in March. Either way, it's worth keeping an eye on.
* Yesterday, Macro Man alluded to the poor performance of a notional SAFE reserve basket that would include yen, but didn't include a graphical representation. The chart below demonstrates just how much a reasonably sized yen position would have cost SAFE, which is presumably why they haven't had one.
* The BOJ's lack of urgency in prosectuing the tightening cycle recieved another fillip overnight with the release of weak machinery orders, a series which correlates fairly well with capex. The orders series has now been flat or negative y/y since July of last year; with CPI also negative, Macro Man has a fair amount of sympathy for how the BOJ has conducted policy. Tomorrow's BOJ meeting is unlikely to produce an interesting outcome; Wedneday evening's Q1 GDP figures, on the other hand, could easily generate a surprise in either direction.
* The situation in Europe is really quite interesting. It appears that the Eurzone is beginning to fracture into 'haves' and 'have nots', in terms of capability of living with a strong euro. Romano Prodi hit the tape yesterday having a moan; it should come as little surprise that Italy is among the countries struggling to cope with an overvalued exchange rate, given the historical usage of ITL currency devaluation as a monetary policy tool. But the Q1 national account figures in Europe were quite striking. Germany, which has indicated a capability of living with current levels of the euro, delivered first quarter growth of 0.5%, better than expected and a highly creditable result after the new year's VAT increase. France, on the other hand, also delivered 0.5% growth, lower than the expected 0.7%. Of course, France didn't have the VAT base effect to deal with, so the outturn was actually substantially weaker than the German figure. Macro Man reckons that net exports will end up contributing nicely to German growth and negatively to that in France.
* April inflation in the UK came out in line with expectations at 2.8% y/y. While this was something of a relief, sterling has reacted more than the strip. At this point, the market seems happy with what is priced, and doesn't show an inclination to change things much in either direction. While Macro Man expects the BOE to reiteate its confidence in the 2% inflation forecast tomorrow, he concedes that the market may not care in the short term, particularly if the earnigns data are solid. He therefore trims half his short sterling position at 94.07 to avoid getting blindsided.
* As feared, the attempt to leg out of the crude spread is going badly, and has cost Macro Man all of his month's profits and more. Tolerance for further slippage will be minimal, as risk management dictates not allowing a non-core view to completely overwhelm positions carrying more conviction.


Charles Butler said...

What an enviable position Germany finds itself in, sitting astride the great historical chasm separating Rome from the Slavic world. How well France will fare, given its somewhat natural propensity to actively impede European integration, is perhaps being seen already however. The other great beneficiary of the euro(zone) would be Spain, the tremendous success of whose infrastructure companies stems from the Iberian skill as court machinator.

Plus ├ža change.

tmcgee said...

interesting on the VIX/SPX discrepancy. i suppose that's similar to the discrepancy between somewhat elevated USDJPY risk reversals and the subdued realised and implied vols. maybe the feb/march sell-off finally prompted a little insurance buying, as you say.

Macro Man said...

Yeah, yen riskies have lagged, but at least they've moved in as spot has gone up. Adjusted for the absolute level of vol, however, you're probably right, in that they are wider than we should expect given where spot and vol is.

I must be the only muppet in the market who doesn't feel fully investd in short yen, and I can tell you, it hurts....

Dale said...


The other day you said that you thought that a fair value for the Euro was $1.10. What do you think a fair value for the Swiss franc is?

Anonymous said...

I think the VIX/SPX dynamic is telling us that something much deeper is happening in financial markets than meets the eye. First, I don't think the VIX developments are similar to the dynamics in JPY-cross risk reversals. The JPY option markets have reacted in typical fashion, with vol selling off with the JPY and risk reversals coming back into the range.

The SPX dynamic is totally different and surprisingly similar to the dynamic we saw at the end of 1995. The interesting thing is that the macro environment is also quite similar. My theory is that the VIX/SPX decoupling represents a re-leveraging of equities after a mid-cycle slowdown.

This development, coupled with a move into CPI base-effect nirvana for the next quarter, suggests that we could be in for a nice ride in risk assets. MM, you're not alone in feeling that your not short enough JPY... But it doesn't pay long term to be greedy in JPY, better to buy high yielding EM.

Macro Man said...

Dale, I have it at roughly 1.35, though the OECD has it at 1.68. My estimate of EUR/CHF fair value is clearly below theirs....

Charles Butler said...


The chart similarities between '95 and now are more than evident - and very notable. But the macro environment? The 2003 slowdown was not comparable to the very bad early 90's recession. There is no event corresponding to the 1994 jump in interest rates or the long term lowering of rates beginning in '82. And the trigger provided by tech stocks from 1996 on? EM's don't do it for me in that regard, but I might be wrong.

This is only to say that I don't see 2007 converting itself into 1996, if that was what was implied. I've got no problem with continuation of the current scheme, frustrating as it is in its refusal to confirm any belief with conviction.

Dale said...


I find it strange that some consider the Swiss franc to be overvalued, given that there is supposedly a carry trade going on with the Swiss franc, and they have an enormous trade surplus, and Swiss salaries are high in relation to the cost of living. (Unlike the British pound, where UK salaries are low in relation to the cost of living.) I am still trying to get a handle on this. Since I sold my Delphi shares in December, I have been in foreign currencies and cash, waiting for the Great Unwind. I have about half of my portfolio in Japanese yen, and a smaller position in Swiss franc. I am sure the yen is undervalued, but I am wavering on the franc.

Dale said...

@anonymous + Charles:

Perhaps you are not going back far enough. I have read comparisons of the current situation to the Panic of 1837, for example.

Macro Man said...

A couple of points: while the current floating-on-air environment feels superficially like 1995, it seems to me that the backdrop is rather different. In '95, the Fed cut rates and bonds actually put in a nice rally. Now, cuts aren't obviously forthcoming, and the extent of the rally in the 10yr has been very, very modest in comparison. Instead, we now have Voldemort and co. injecting hundreds of billions of dollars a quarter into the US and global financial system.

Buying risk assets and EM is the obvious call, but at what point does the good news get fully priced. USD/BRL shorts were enormous before today; no doubt the break of the deuce has increased those positions by another couple of yards. If Bacen does an RBI or BI and pulls the bid, then great, that trade will work. If not, then the real will continue to grind higher and attract more $ shorts who will want to get out (eventually.) If EM 2007 = NASDAQ 1997, then maybe the party has a ways further to go. The endgame, however, will be the same; even the good stuff will be massively overvalued, and the crap will eventually get found out as such.

Dale, it is possible for the Swiss to be overvalued against the dollar and still undervalued overall. The vast, vast majority of Switzerland's trade is with Europe, so the EUR/CHF rate is really the one that matters. I see fair value in the high 1.40's. It's a similar story to the yen, really: not particularly out of whack versus the USD, but ludicrously undervalued vis a vis the euro.

Dale said...


OK, thanks.

Charles Butler said...


'but at what point does the good news get fully priced.'

The rise of the blogoshpere makes that an even harder question to answer, what with every piece of positive evidence deconstructed instantly. You know of whom I mostly speak - and how immense is his reader base. But he's far from alone. Until fairly recently, Alan Abelson was the only guy doing that for public consumption and, as much as you wouldn't want to miss an instalment, you traded very few pennies on his angle.

Everybody now gets to take the other side of his own opinion and most markets show it, as if buying one share has been morphed into long ten/short nine - volatility being maybe no more than difficulties with the execution.