Thursday, June 21, 2007
As the more scientifically aware reader will no doubt already know, today is the summer solstice and the longest day of the year in the Northern Hemisphere. Given the systems problems and other assorted mishaps encountered in the real job so far this morning, it already feels like the longest day of the year and it's only 10 am!
The NFL has a charming tradition of calling the last man selected in the annual new player draft "Mr. Irrelevant." While some Mr. Irrelevants actually stick with a team and go on to have meaningful careers, most live up to the name and quickly fade into obscurity. It's a little-known fact, however, that financial markets also have a Mr. Irrelevant. He currently goes by the name of Rodrigo de Rato, Managing Director of the IMF.
Any doubts as to whether Rato deserves the nickname have been dispelled over the last few days. Many readers will no doubt recall the furore that resulted from the IMF announcing that it intended to take a more prominent role in exchange rate surveillance in April of last year. Global imbalances were all the rage, and there was nary a carry trade to be seen.
Now fast forward to this week. On Monday, Rato made a speech where he announced that the IMF has taken the decision to overhaul its exchange rate surveillance framework for the first time in thirty years, adding the proviso that "a member should avoid exchange rate policies that result in external instability." To say that the market was underwhelmed is an understatement. So irrelevant has the IMF become that none of the currency specialists that Macro Man talks to on a daily basis have even mentioned it at all. One can almost hear coupon clippers everywhere bellowing "Mr. Irrelevant, we who are about to put on the carry trade salute you!"
One byproduct of global imbalances and mercantilist exchange rate policies has of course been the accumulation of FX reserves and a concomitant price-insensitive bid for US Treasury securities. It looks as if that may be changing. One popular explanation for the recent rise in yields is that China, et al had stepped away from the market just as traders and investors were expecting them to step up to the plate in size. The removal of the 'PBOC put' helped catalyze the move through 5% on the 10 year Treasury, after which stop loss and convexity selling tacked on another 30 bps. Macro Man has quite a bit of sympathy for this view.
Brad Setser has an interesting post on T Bills, which more or less suggests that CBs have been piling into the short end and eschewing notes and bonds. It's an interesting idea, so Macro Man decided to have a look at a graph comparing 10 year yields with that of 3 month T Bills. He was stunned by the result. The implication couldn't be clearer; somebody with significant size to shift has been market-timing the yield curve. As Macro Man wrote on Brad's blog, if SAFE et al start treating government bond markets like they do currencies, then expect to see a lot of unhappy bond managers out there over the next few years....
Elsewhere, US equities put in a surpisingly soft performance yesterday as concerns over suprime continue to swirl. The ABX indices continue to head lower, and stories about disposals from badly-underwater Bear Stearns hedge funds are circulating everywhere. The problem is that the market's risks and exposures are fairly opaque, much as they were in the autumn of 1998. Now, Macro Man is not suggesting that the current situation poses as serious a threat to markets as the double whammy of Russian default and LTCM implosion did nine years ago. Still, it's pretty unsettling, as there are a lot of badly underwater structured credit positions out there that have not been marked to market.
A forced disposal from the Bear fund could establish a new market price for some of the more odious instruments; if risk managers elsewhere are on the ball, this could force others to mark their toxic waste to market. At the same time, the SPX looks to be forming a classic double top formation, with the neckline at 1486. A break would target 1430.
The portfolio got bushwacked yesterday as both beta (of course) and alpha (unusally) portfolios have a long equity bias, despite the recent purchase of XHB puts. It's time to remedy this. Macro Man will buy 1000 July E Mini 1520 puts and sell 1000 1555 calls. Net premium outlay will be roughly $462k, a small price to pay for avoiding disaster.
Elsewhere, the CBC (Taiwan's central bank) raised rates by a higher than expected 25 bps and surprised the market by raising the FX reserve requirement. The TWD has strengthened as a result.
Are you listening, SNB?