Mr. Irrelevant

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?

Posted by Macro Man at 10:04 AM  


the SNB rumours have already been floating around, if nothing but rumours at this point...

on the PBOC/Treasuries. i've heard that there's been some funky things going on in TED spreads. don't know how well versed you are in these. i'm no expert and would like to know more. basically it's a reflection of the same thing, if true -- Voldemort has shifted some serious dough into the very short-end of the curve...

tmcgee said...
12:53 PM  

oops. should have looked at your posting setser's way first...

tmcgee said...
12:56 PM  

Yeah, the SNB rumours have been floating around for a few days. What's particularly amusing is that I heard the denial before I actually heard the rumour.

Yeah, on PBOC, that's the exact point I am making...they went on buyer's strike at long end and stuffed all their intervention proceed into bills...then let the market puke and hoovered up the back end at 5.30%.

Technical name for that is "playing silly buggers", which is a sport they've mastered in the currency market the last three years.

Macro Man said...
1:12 PM  

Rodrigo Rato's ascension to the throne of the IMF was just part of the prize package awarded to Aznar for his signing on to the 'coalition of the appearing to be willing', at the same time taking a heavyweight out of the running for the post-Aznar leadership of the PP.

You get what you pay for.


Henry Mackay said...
1:46 PM  

It's really the IMF as an institution that I'm poking a stick at, but obviously it's hardly surprising that there have been Machiavellian shenanigans behind the appointment of a senior figure at a multilateral organization. Those institutions are Machiocracies almost be definition.

Macro Man said...
1:58 PM  

The meaning is apparent, but have you just coined a new word? Google seems to think so...

avinash goldfish

Anonymous said...
3:11 PM  

I'd never heard it before I wrote it, so I suppose it is a new word. Please, spread it so at least I'll have one lasting legacy...

Macro Man said...
3:20 PM  

In light of these goings ons with CHF, TWD and SEK, I am left pondering the potential for the yen to head even lower (it is quickly becoming the funding currency of first resort). Until we start to hear big noises from the Japanese authorities, or unless rates notch significantly higher, the carry trade looks like it will continue to hold centre stage. I can almost hear Ms Watanabe laughing in the background as analysts keep arguing the case for a stronger yen.

Econocator said...
3:30 PM  

True enough about the IMF (and others of the ilk), but Rato's tenure there has been characterized by serious disatisfaction within the ranks over his seeming absolute refusal to, well, do anything.

Just what is expected of a multilateral institution in a bellic environment.


Henry Mackay said...
3:49 PM  

With regards to the yen, the most plausible outcome seems to be status quo - sell it. Just an observation, but gold in yen terms has been getting little or no attention, i.e. gold has been strongest in yen terms recently. The Japanese have shown in the past they can drive TOCOM gold higher with a failing yen...add to that the global inflation and unfavorable CPI comps coming up in the US (on top of spiking food and energy), and you might have a recipe for a gold pop. Disclosure: I am a gold trader and I'm positioned for a 2-step move in gold - up this summer, then pause (as yen strengthens), then spike in USD terms late '07 early '08. I haven't seen a better set-up in gold as I've seen today since November 2005.

Corey said...
2:49 AM  

Out of curiosity, Corey, what reminds you of late 2005 in the gold market? Clearly the parabolic rise in yen crosses is highly reminiscent of November 2005, but looking at gold (in yen and $ terms), I don't see much there. Of course, I don't really follow the itnernal dynamics of the gold market that closely, so there could easily be loads of interesting things bubbling beneath the surface- hence the query.

Macro Man said...
1:30 PM  

I don't portend to know more than the next guy in the gold market, nor do I think gold trading is enigmatic. What you've got in gold right now is a situation when everything lines up 1) A failing currency (yen) that can drive gold, 2) Commercial traders holding their largest long contract position during the entire five year bull market, which means 3) Funds and specs have been slowly shedding their long positions during an extended eight week correction that is somewhat shallow (50% retrace), 4) Lots of bogeys out there, including media reports on how gold falls when interest rates rise (hardly the case), and 5) A precarious situation in the rate complex where the long end is being sold for the "safe" short end of the yield curve. The last point is the most interesting, as it typically is followed by continued USD weakness that indicates economic softening six to nine months ahead.

Today's situation is a bit different than Nov. 2005, and I can't point to many similarities (other than the yen)...but I could go on about all the higher lows in the mining stocks and how gold usually bottoms in a small ABC formation. Most importantly, when things fall into place (kind of geometrically in my head), I like to get long.

Corey said...
2:34 PM  

OK, thanks. Has there been an uptick in the volume/open interest in TOCOM? I remember very clearly how the Japanese got gold fever at the end of '05. These days, it seems like they have 'anythingthat ain't the yen' fever.

Macro Man said...
3:10 PM  

Post a Comment