Tuesday, June 05, 2007
Popular history has it that when General Cornwallis of the British Army surrendered to the combined American and French forces at Yorktown in 1781, the British Army band played a popular tune called "The World Turned Upside Down." The story has a nice historical resonance, as the world was indeed never the same after the emergence of the American nation-state.
Macro Man has no idea how the tune actually goes, but he can imagine that it's being played today as risk asset bears surrender to the combined forces of low volatility and ample liquidity. Here, too, the notion of the world turning upside down is an apt one. For the entirety of Macro Man's career, he has been accustomed to a return distribution featuring a large number of modestly positive daily returns for risk assets, punctuated by the occasional large negative return- the famous fat tails of the financial market distribution. Or, to use a more everyday metaphor, risk assets tend to go up the escalator but down the lift.
Not anymore, however. The apotheosis of the liquidity glut has evidently turned the world on its head, and altered risk asset return distributions beyond recognition. Consider, if you will, the New Zealand dollar. From early March to mid-April, NZD/USD rallied nearly 12%- very lift-like. The ensuing six weeks saw a corrective decline that totalled roughly 3.5% peak-to-trough. You can almost see the handrail on that escalator! As Chinese equities have tanked over the last few days, however, NZD/USD has clawed back all of the prior six weeks' losses and more. Once more into the lift, dear friends....
What is going on here? How can the correction be so modest, and the re-acceleration of the trend so vigorous? How and why have the fat tails upped and moved house from the left side of the distribution to the right? While there are admittedly factors that argue for NZD appreciation (a potential RBNZ tightening tomorrow night, the ongoing terms of trade boost from strong dairy prices), equally there are fpotential stumbling blocks that could/should constrain the flightless bird (RBNZ preference for a weaker currency, positioning, valuation.)
Clearly there are other forces at work here and the liquidity glut is driving everything. While Macro Man's portfolio is benefitting from the parabolic rise in the kiwi and other risky currencies, he can only shake his head and wonder how and where it will all end.