A previously undiscovered scientific experiment

Well, well, well. It looks like we have a new entry for the hedge fund lexicon:

"the Cioffi machine is broken" - So sorry, but all your money is gone.

That the NAV of the riskier Bear Stearns credit fund is zero should come to a surprise to nobody bar a few Buhhist hermits living in the upper reaches of the Himalayas. On the margin, perhaps the fact that the "good" fund is only returning 9 cents on the dollar has disappointed a few people (namely, the unlucky investors), but let's face it- the difference between the 9 cent reality and the 15-20 cent expectation is really just different shades of red.

That the dollar, equities, and credit should have sold off so sharply after the BSC announcement belies a market that is acting on instinct to sell whenever they hear bad news from subprime. One could almost call it a Pavlovian response.

Regular readers will recall that Macro Man takes an occasional interest in science and attempts to pattern his investment decisions around the scientific method insofar as possible. They will no doubt appreciate his gratification when, in the course of his scientific reading, Macro Man discovered the findings of some of Dr. Ivan Pavlov's unpublished experiments. The results are set out below:

Moving on to more serious matters, the newsflow is coming fast and furious this week. Yesterday saw higher-than-expected inflation in the UK, and while today's earnings data were soft the unemployment rate was lower than expected. Glenn Stevens made an interesting speech overnight which appeared to accept the high level of the Aussie dollar; this comes in sharp contrast to the dismay expressed by Kiwi policymakers, which explains why long AUD/NZD is such a popular (though, to date, underperforming) position amongst macro punters.

Yesterday also saw the release of a rather fascinating set of TIC data from the US. While Macro Man generally disdains high frequency analysis of this data, as it resembles rearview driving, there is occasionally an interesting explanatory nugget to be found. The May data was such a case. That the inflow was a record $126 billion is of passing interest, though given the rise in the DXY during the month it probably shouldn't come as a big surprise.

The real interest is in the details. Basically, central banks are completely absent from the data- according to the Treasury, the US managed to fund its external deficit just fine thanks to private sector financing. Now, there are no doubt some holes in the data- Brad Setser, who follows this data much more closely than Macro Man does or cares to, has some suspicions that CB purchases came through the secondary market in London. And there may be an element to that.

However, given the 27 bp rise in 10 year yields during May, an Occam's Razor approach would probably yield the conclusion that the price-insensitive buyer took a break in May, which is exactly what the TIC data suggests. Moreover, despite the ongoing concerns over US growth and credit, the inflow into US corporate securities was MASSIVE. There was a net $72 billion invested into corporate bonds, and a further $42 billion invested into US equities. Both were records, with the equity inflow being 50% higher than the previous monthly record.

Quite frankly, Macro Man isn't really sure what to make of that. It seems a bit premature for the soverign wealth funds to be stepping up to the plate, but would certainly represent the sort of size that those institutions could shift. It is premature to conclude that the rest of the world has begun to see value in US equities on the basis of one month worth of data. However, if the June TIC shows a similarly large inflow, it would provide a useful explanation of how and why the US equity market has managed to shrug off the seemingly endless torrent of bad news on subprime and housing generally (another horrible NAHB last night, incidentally.)

Today, of course, sees the rel;ease of CPI in the US (and Canada) and, more significantly, Big Ben's semiannual testimony before Congress. While he will almost certainly mark down the growth and inflation forecasts for 2007, Macro Man does not expect him to alter the outlook for 2008.

More significantly, Macro Man does not expect BB to turn more dovish on inflation. To do so would prompt the obvious rejoinder from the committee: "Then, given subprime and housing, why the *&$@ don't you cut rates?" Moreover, to play down the cost of living would fly in the face of common sense, given that US households have to pay for food and energy.

Macro Man is alo wary of the equivalent testimony last year, when Bernanke disappointed those looking for hawkish testimony by throwing a bone to the doves. This served to reverse the prevailing market trend of the past couple of months, as the DXY chart above illustrates. With the dollar index at a similar (though opposite) extreme today, Macro Man is wary that Big Ben could sound relatively hawkish, leading to a sell-off in bonds and a short squeeze in the dollar. While this won't necessarily represent an end to the trend of dollar weakness against Europe and the dollar bloc, it is enough to encourage Macro Man in his prior posture of staying away from the weak dollar train. After all, the TIC data appears to demonstrate that contrary to popular belief, in the absence of central bank bids the dollar needn't fall forever.