Monday, July 30, 2007

Shoulder-tap time

We've all been there. You're at your desk, working hard and concentrating, when someone taps you on the shoulder and says "Uh, Bob, can I have a word?" The conversation that follows such a shoulder tap is rarely pleasant and, in Macro Man's experience, normally results in either the conveyance of bad news, the performance of an unpleasant task, or both.

As Macro Man surveys the rocky landscape of global financial markets, he sees a number of people for whom the shoulder tap is coming:

* Leveraged risky asset longs: these poor souls are receiving taps on the shoulder from two different sources. Internal risk managers, noting that market volatilities have risen sharply, are encouraging their charges to trim risk as VAR usage has increased markedly for unchanged nominal position sizes. Meanwhile, margin clerks are out in force making margin calls, which probably partially explains the late session swoons that the SPX has put in the last few days- swoons that are reminiscent of last May/June. In both cases, risk positions are getting sold because portfolio managers have to, not necessarily because they want to.

* Japanese housewives: As long as Mrs. Watanabe is punting NZD/JPY profitably, her husband is no doubt pleased as punch with her hobby. But when she loses as much in a week as she'd made all year, her salaryman husband cannot be too happy. Japanese retail aggregators suggest that the yen positioning remains at record short levels; how much more can poor Mrs. Watanabe lose before her husband leaves her for a younger, better-looking woman who knows how to take profits?

* Shinzo Abe: This tap on the shoulder came from the Japanese electorate, who delivered a crushing defeat to Abe's LDP in the Upper House elections. The ultimate result is likely to be legislative gridlock, which should further divert the Abe train from the 'Koizumi redux' route that many observers had hoped and expected from him.

* Investment bank credit market makers: These well paid souls are getting a tap on the shoulder from their bosses telling them either a) "you cannot spend all day in the toilet!", when the market seems to be stabilizing, or b) "get back into the toilet!" when the market craters again. For those not in the know, "dealer in the toilet" is a common rationale for not quoting a price in something especially toxic.

* The management of American Home Mortgage: Last week the accountants must have tapped senior management on the shoulder and said "remember that dividend we're supposed to be paying..."? (Thanks to the Ape Man for pointing this one out.)

* VIG and other sovereign wealth funds: Slightly earlier than even Macro Man expected, the US and Europe are reminding the soverign wealth funds that participation in their domestic asset markets is a privilege, not a right.

It appears as if the market has recovered some modicum of risk appetite over the weekend, as equities and carry trades are both putting in a reasonable performance so far. This has delivered a bit of a blow to Macro Man's p/l, which suffered from the late-session collapse in US equities in the beta portfolio but has not made any of the losses back in the alpha portfolio.

The bounce is not entirely unexpected, as the magnitude of the SPX sell-off has more than matched that of prior A wave declines over the past few years. Nevertheless, Macro Man cannot believe that there isn't more pain in the pipeline, particularly with an ugly month end approaching for those with large long equity or credit betas.

Friday's GDP data was probably as benign as it could have been for risky assets. Although growth was solid, the composition did not suggest durability, what with large portions of the gains from government spending.

Of particular interest to Macro Man was the fact that net exports were the single largest contributor to GDP growth, adding 0.3% to non-annualized quarterly growth- despite the huge run-up in energy prices. The data was a bit of a milestone, actually; it took the three year rolling cumulative contribution of net exports into positive territory for the first time since the early 90's.

The improvement is particularly impressive given the rise in oil prices over the last several years, and is a testament to the fact that weaker than "normal" consumption isn't an unambiguous negative.

Remind me again why the dollar needs to fall forever?


Charles Butler said...

This morning's DOTW (and they were out in force early) got their fingers singed nicely. Considering that it is taking place on the 'new' news of a credit crunch rather than the coming to pass of old predictions, it probably merits taking more seriously... at least from this balcony.

Macro Man said...

I tend to agree, Charles, hence the much vigorous purchases of index puts in this episode than in prior periods of equity weakness.

Anonymous said...

"why dollar fall forever" -- hmmm, let's see, the trade deficit is still 6% of US GDP, and while the deficit is improving against europe, it is still rising v asia (and it must be rising again in nominal terms v the oil exporters). w/o a weak $, net exports wouldn't be contributing to growth --

that said, it need not fall v the euro forever -- it already is weak v europe.

I am not sure i understand your point about oil. presumably the gdp data is in real not nominal terms, so strong real exports and higher oil prices (which lower imported oil volumes) would help lower the real but not the nominal deficit (unless I have something wrong ...).

and what prompted looking at a rolling three contribution? it produces an interesting graph, but it is a bit unusual ...

brad setser

Corey said...

Because there hasn't been a proportionate spike in short term credit spreads (e.g. six month paper over six month t-bills), I personally believe this latest round of selling is completely a risk aversion/re-pricing event, compounded by extremely tight spreads and triggered by overbought conditions. That being said, the event that seems to be getting little attention is the coming spike in YOY inflation figures in the US. As I've noted before, there is going to be substantial pressures on prices (note raise in minimum wage by 70 cents last week, a nice 13.6% increase), and by November the YOY CPI will be likely north of four get there with minimal assumptions. I'm scaling back into gold in anticipation of these events, and historically gold makes moves of 20%-30% in these environments from July - October...and this move historically precedes the "big" move that many are expecting in the gold market, but that is likely to happen during the strongest seasonal period of Nov.-Feb.

I think the stock markets of the world will be competing with much higher interest rates a few months down the line, not simply risk aversion, re-pricing, or profit taking. I also think the housing market in the US will be much worse than other countries with inflated home prices, thus the pressure on the dollar.

Near term I'm in the camp of a bounce, and maybe a bigger bounce than some would like.

Macro Man said...

I'll admit that the 3 year chart was a bit of blatant data-mining, Brad. When I went through the data on Friday, I observed that net exports had contributed positively over a 1 year horizon. So I checked again and found that NX had added over the last two years.

So I checked again and saw that not only had it added over the last three years as well, but that the 3 year rolling sum had just turned positive. When I ran the chart I was surprised at how dramatic it looked, so I decided to include it.

As for "dollar going down forever", I have sat in meetings with people who told me that net exports could never sustainably add to US growth given the differences in size between exports and imports. I don't know if three years is "sustainable", but it must be getting close.

Anyhow, my impression is that there are a lot of lazy $ shorts out there who buy EUR/USD and cite external balances. While I'd concur that the dollar should go down against the usual suspects, I remain of the view that EUR/USD has more than done its part and but for the grace of Voldemort and co. would be a lot lower.

Anonymous said...

There appears very little left in US to loan against that does not carry some default risk.

Anonymous said...

July 30 (Bloomberg) -- The U.S., France and Germany are racing to draw up rules to govern developing nations' secretive state-controlled investment funds, spurred in part by Barclays Plc's use of Chinese and Singaporean money in its takeover bid for ABN Amro Holding NV.

shankar said...

I got 2 questions for you:

1. It appears that the US Treasury is hitting the market for another $23B (in addition to $22 last week). Is it possible that the Fed is sitting on the sidelines fully knowing that this will result in market decline and due to 'flight-to-quality' - will actually reduce rates as opposed to an increase? At some point in future, the fed can then flood the market again with liquidity to prop the market?

2. Treasury Secretary Paulson is asking the Congress to increase the US debt limit to accomodate higher outlays. Due to the turmoil in the mortgage markets, isn't it in the interest of US to keep the borrowing costs low - even at the expense of markets? The only way to achieve it would be to make sure that 'flight-to-quality' persists. (In the face of increased borrowing, if the Fed increases money supply then it would actually depreciate dollar and lead to increase in inflation and rates? Perhaps Mr. Bernanke did hide M3 figures to make sure that no one can see these once he starts reducing the money supply M3.)