Thursday, June 28, 2007
So has this been another short-lived crisis? The S&P 500 tested and rejected a break of the neckline yesterday, while FX carry, which looked so horrible 24 hours ago, has roared back with a vengeance. It appears to be yet another 2007-style mini-crisis, that dip that you're supposed to buy over and over again.
Perhaps. It's true that risk assets shrugged off a poor durable goods report yesterday, which easily could have been used as an excuse for further weakness in equities, EM, credit, and FX carry. By the same token, however, the elements of recent risk asset weakness have not been about the economic cycle per se; they've been, first and foremost, about liquidity. And there was no real news, good or bad, to emerge on that front yesterday.
The greatest threat facing risk assets is a withdrawal (or possible reversal) of the financial market "liquidity multiplier" in the event of a re-pricing, re-rating, and widespread dumping of toxic credit structures. There is some suggestion that the greatest threat will actually come next week, after hedge funds in particular mark their portfolios to market (though there may well be some foot-dragging in the subprime CDO space) and prime brokers adjust margin and credit settings.
Of course, the Fed also has some say about liquidity conditions. Macro Man has been rather interested (and pleasantly surprised) by recent press rumblings that the FOMC may switch focus away from core inflation to headline. It would be somewhat ironic, of course, given that the preferred core measure is finally likely to enter the comfort zone tomorrow. However, if the Fed (justifiably) switches the goal posts, it could finally focus attention on the fact that headline inflation is rising rather sharply indeed. This in turn should raise risk premia and support Macro man's TIPS position.
Macro Man recalls that the Fed closed the book on last spring's financial market turbulence by signaling an end to the tightening cycle at the equivalent to tonight's meeting in 2006. Might the FOMC actually kickstart market turbulence by demonstrating that inflation remains a problem and that any Bernanke put is struck so far away that it doesn't even appear on a screen?
Note: Severe network problems have rendered the P/L inaccessible today.