Amazing scenes

Well, that was an eventful night. No, not the Fed cut and the concomitant risk asset orgy that followed; Macro Man covered that in his last post. Rather, he's referring to some of the things he saw and heard when he went out to party afterwards.

It's a bit of a tradition that after staying late to follow markets during periods of extreme importance, one goes out to paint the town. You know, to decompress, let off some steam, and hopefully celebrate a profitable evening's trading.

So Macro Man and a few buddies made their way to a karaoke bar in Soho, looking for an evening's entertainment of firewater and off-key vocalizing. Imagine our shock and surprise when we got there and found Alistair Darling and Barney Frank knocking back tequila shots and monopolizing the mic! Who knew that those two were such rowdy friends.

In any case, neither one is much of a singer, especially after emptying the better part of a bottle of Cuervo Conmemorativo. Most of their singing was pretty garbled, but Macro Man did manage to understand one Rolling Stones song that they performed. Perhaps due to their consumption of tequila, though, they altered the lyrics. Here's what they were singing:

Under my thumb
The bank that once had me down
Under my thumb
The bank that once pushed me around

It's down to me
The difference in liquidity
Down to me, the change has come
It's under my thumb

Ain't it the truth man?

Under my thumb
The hard-ass bank that's just had its day
Under my thumb
Now they've cut rates and so changed their ways

It's down to me, yes it is
The way it just does what it's told
Down to me, the change has come,
It's under my thumb
Ah, ah say it's alright

Under my thumb
An inflation-fighting man
Under my thumb
I've just made him throw down his hand

It's down to me
The way it cuts when it's spoken to
Down to me, the change has come
It's under my thumb
Ah, money's easy babe
Yeah

It's down to me, oh yeah
The way it cuts when it's spoken to
Down to me, the change has come
It's under my thumb
Yeah it feels alright

Under my thumb
Its views are just kept to itself
Under my thumb
I can make it bail out someone else

It's down to me, oh that's what I said
The way it cuts when it's spoken to
Down to me, the change has come
It's under my thumb

Say, SPUs are up 40 now...

Says it all...
Says it all...

Money's easy babe
Money's easy babe
Feels alright
Keep it, keep it easy babe

As if that wasn't shocking enough, imagine Macro Man's surprise when he encountered the Deputy Governor of one of the regional Feds. This gentleman, kitted out in some rather natty casual threads, seemed rather emotional about the aggressive Fed move.

Macro Man managed to corner him and ask him if the Fed viewed saving the leveraged buyers of crappy credit as the rationale for easing. Did they realize who they were saving via this provision of liquidity? Here's how he responded:



All this is in good fun, of course, but the reality is that the aggressive Fed easing, with a veiled promise for more, ignites the "kick the dollar" scenario that Macro Man has been contemplating. Why buy US financial assets? Other stock markets are cheaper. Other bond markets offer superior real yields and safer credit. Other central banks provide a clearer commitment to protect the puchasing power of the currency.

Global investors largely shunned the US market in July as the recent crisis was beginning to percolate. With CIC coming into existence at the end of this month, what odds that the formerly reliable inflow of capital from China becomes a little more selective? Such is the stuff of dollar shellackings.

What's interesting is that the back end of the US yield curve actually sold off after the rate cut. Part of this may have been due to the placement of curve steepening trades, but some of the rise in yield must surely represent a risk premium against the Fed throwing gas on the inflationary fire. For headline CPI, base effect Nirvana will morph into base effect Hades in Q4, and it is eminently possible that we'll see a 4 handle before the year is out. Negative real yields on two year notes, anyone?

Macro Man finds it very interesting indeed that the Fed has cut rates and eased its inflation concern even as 5y/5y inflation breakevens have shot higher. This measure will probably provide a good barometer of Fed credibility (or lack thereof) moving forwards; a continued rise will be bullish for gold and very, very bad indeed for the dollar.


Unsurprisingly, the FX carry basket was triggered back into existence, sadly after most of the moves have already occurred. These trades were placed this morning. Elsewhere, Macro Man neglected to input the roll on his JGB position; that has now been done.

The collapse in FX vol has kept the portfolio in the red thus far this month, but the overall loss is manageable and there should be plenty of opportunity to make it up as Helicopter Ben's dollars drift down to earth.



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Anonymous
admin
September 19, 2007 at 2:11 PM ×

If you saw Barney Frank at a bar , you should rethink hanging out with those friends who took you there .... not that there's anything wrong with that :)

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Anonymous
admin
September 19, 2007 at 3:08 PM ×

MM,

There appears to be a strange technical related to the short part of the BE curve, that explains why the 5y5yBE is so high relative to a 10yr BE or 2032BE, and so it may not be the best indicator for inflation expectations right now. DB explains it quite well in their recent Global Linkers update, with a few graphs.

Regards,

FR

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Macro Man
admin
September 19, 2007 at 3:52 PM ×

Hmm.....I'l have a butcher's, thanks FR.

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Anonymous
admin
September 19, 2007 at 4:53 PM ×

Macro,

I can't believe $USD hasn't tanked amidst 50 bps cut. Can you help us understand what is going on ?

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Macro Man
admin
September 19, 2007 at 5:01 PM ×

Well, it has tanked against EM and commodity currencies. It was never going to tan k against the yen, given that EUR/JPY is the turbo anti-dollar. So the mystery is the euro and sterling.

On the former, 1.40 is a huge psychological level, and for better or worse there are rumoured barriers being defended there. I am not concerned yet, though I'd like to see it go before the weekend.

Sterling is its own animal, with similar problems to the US (lots of debt, dodgy finan cial institutions, housing looking a bit ropy, CB has lost creidiblity, so the failure of the dollar to tank against sterling isn 't a total surprise. If I am right about the buck, GBP/USD should drift higher, though perhaps EUR/GBP will go up more.

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Anantha
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September 22, 2007 at 6:13 AM ×

Financial Times

Crisis in S Korean building industry

By Anna Fifield in Seoul

Published: September 21 2007 03:00 | Last updated: September 21 2007 03:00

http://www.ft.com/cms/s/0/4271e4a0-67db-11dc-8906-0000779fd2ac.html
-----------------------------------------------------------------
As though a magic wand has been waved, price of credit has improved
markedly. ABCP yield in the US is now 5.2%!! The spread between LIBOR
and BASE rate in the US is down to slightly under 60 basis points!

If things were really as bad as the financial industry claimed - with
beating of breasts about conditions being the toughest they had seen
in their life times, etc., - it is unlikely that they could have
improved so dramatically and so quickly. I conclude that it was a
SHOW. It was drama and it was staged to blackmail the central banks into continuing to feed them with the junk food of low interest rates.

For now, this blackmail has succeeded.

The world's biggest imbalance is now to be found in the anatomy of
central bankers - too much of rubber and too little bone.

The reason why the financial industry put on a show of distress and pain is simple: the amount of leverage that the system had built up was so much that they could not tolerate any incremental tightening of the cost of capital as the UK, Australia, Canada, the ECB, the RBNZ and the SNB were undertaking this year. The Fed had its hand on the trigger too. These guys had to be stopped in their tracks and hence the drama.

The industry had built such a vast castle of debt - or more precisely, castles upon castles - on a base of low interest rates - that there was no other choice for them. They had to bring the cost of capital down and they have succeeded.

For the rest of us, this drama and its success would have profound
implications - some positive and short-term and some negative,
long-term and long-lasting.

It is naive to argue that this "needless" easing of monetary
conditions would not have inflationary consequences in a world marked by high capacity utilisation in the US and in China, in India and elsewhere. Tight "resource utilization" is more precise for it includes labour.

Regardless of whether it is immediately inflationary in the US or it comes about with a lag would depend on whether consumer spending
retrenches at all. If the pain was for real, there would be retrenchment and there would be household de-leveraging. In that case,this rally in stock markets would be short-lived because it will have been established aggregate demand was going to get weaker regardless of interest rates.

If household de-leveraging does not occur, then inflation would follow
in the US too in short order. 5-year and 10-year breakeven inflation rates have risen this week rather markedly in the US.

In any case, most other countries in the developing world - China and
India, in particular - would face the inflation problem. In China, it
is going to set the economy up there for a spectacular bust down the road and in India, the successful "soft-landing" is going to be disrupted.

Their central banks have been placed under tremendous pressure and brought under some heavy conflicting priorities now.

I am just using these two as examples. I am sure that the problems - in varying degrees and colours - apply to New Zealand, Indonesia and Korea, etc.

As the article in FT on Korea says - inventory of unsold apartments
has risen because of high prices and the efforts of the BoK and the
government to cool demand. That has, for now, exacerbated
unaffordability.

The risks are two-fold:

(a) either reflation does not succeed - that is deflationary and bad for corporate profits, etc., rates go down further, bonds rally, etc. central banks fight with one another to stem currency appreciation.

This might become evident in three to four months.

(b) reflation succeeds too well: after about six to nine months, there are inflationary consequences evident everywhere. central banks
tighten. asset bubbles would be bigger at that time. more mayhem would result, then, simply because the problems would have become bigger than they were in July 2007.

The only certainty I have is of a super-bull market in gold and silver that is about to unfold over the coming years.

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Macro Man
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September 22, 2007 at 1:49 PM ×

Reflation is unlikely to work where is it "needed" most- in housing. Simply supply/demand dynamics dictate that either time or lower prices will be required to plow through the excess supply of housing. Lowering Fed funds is unlikely to speed either of these processes notably.

What it will do, of course, is allocate funds to those sectors of the economy/financial markets that least need it- equities, commodities, etc.

I suspect that your outcome (b) is where we are headed, and would merely add the observation that 'emergency liquidity' is rarely withdrawn as speedily as it is provided, which naturally creates another bubble in the stead of the prior one.

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