Monday, December 17, 2007

Tie Me Up! Tie Me Down!

Well, well well. Macro Man was offline on Friday afternoon, engaged in one of those "rich food and expensive claret" luncheons, but it looks like he missed a doozy. He's now the proud owner of a new £20 pound note, courtesy of the high CPI inflation print. The reaction of risk asset markets was pretty apt, given that the price rise was pretty broad-based. Headline, core, food, energy....it's all going up. And not just in the US of course! Just this month, Macro Man has already highlighted multi-year highs in CPI inflation in both Europe and China. The same, it almost need not be said, holds true in countries as diverse as Singapore and South Africa. Indeed, it seems as if there's only two kinds of countries that aren't experiencing multiyear highs in inflation: erstwhile hyperinflationary economies (Brazil, Russia, Turkey) who have a recent legacy of maxi-devaluation of the currency, and Japan. The question of what ails Japan is worthy of its own post, or indeed its own blog; suffice to say that the country is back in the doldrums. More interesting is the implication for other markets.

This week, for example, sees a round of liquidity auctions from the "Gang of Five"- the Fed, ECB, BOE, BOC, and SNB. This is the first shot in the banks' attempt at a microeconomic solution to the money market crisis. Yet the Fed, BOE, and BOC have already begun pursuing macroeconomic solutions via cuts in the benchmark interest rate.

The question which was always going to arise from such an effort is now pushing to the forefront of markets' agendas: how much can CBs ease when inflation appears to be a legitimate problem? One answer is "as much as they want", but that of course ignores the lessons of the 1970's. It seems pretty clear that the Fed's been dragged kicking and screaming into the last two easings, and it's not an unreasonable assumption to say that the bar will be set even higher for further monetary stimulus int he near-term. If, indeed, one can even think of the near-term; the next Fed meeting isn't until the end of January.

In the near term, then, adverse price may well have tied the hands of the Fed (and pretty clearly, the ECB), if not other central banks. There would appear to be little chance of CBs getting "ahead of the curve" as envisaged by most market participants. The upshot, then, is that risky assets are unliely to be on the receiving end of the warm bath of liquidity that has prompted the last couple of forays to the topside.

From a tactical perpective, therefore, the outlook for risky assets would appear to be somewhat unfavourable. Yet nominal bonds are not exactly screaming "buy me!" either. True, 10 year yields have risen almost 0.40% over the last couple of weeks. Yet they've failed to keep up with y/y CPI, and on that basis yields are now negative. Errr......no thanks.

So what to do? Risk assets look set to at least explore further downside, yet nominal bonds currently pay you nowt in real terms. Perhaps it's time to look at Macro man's old friend, TIPS. Not only do they provide the safety of government securities, but they also insure one's portfolio against further adverse price moves. Moreover, there is a seasonal component to TIPS that is worth considering, as the inflation compensation is calculated off of the non-seasonally adjusted CPI index.

Basically, Q1 generally sees a sharp rise in the NSA index, presumably due to new year's mark ups and administered price rises. The table below sets out the seasonality; the NSA index has never failed to rise at least 1% in Q1 this decade, with the rise exceeding 1.5% in each of the last four years. Indeed, in six of the last 11 years, the Q1 rise in the NSA index exceeded that of the subsequent three quarters combined! Put it all together and, for the next couple of months, TIPS look like just about the best long-side bet going. Macro Man will therefore bid 104 for another $25 million of the issue that he already owns. If done, he may well look to sell a bit of crude oil to hedge against a commodity price implosion.

Elsewhere, another piece of evidence on the myth of decoupling emerged in Australia overnight. Centro Properties is an Australian company that owns retail space in the Antipodes and the US. Sadly for them, they are dependent on the interbank loan market for financing, which has gone about as well as you might expect over the past few months. The firm today suspended its dividend and announced that its creditors have given it until Februay 15 to roll over its debt. Cue a 76% decline in the share price in today's trading. Ouch!


Finally, we're approaching levels in EUR/USD where it is safe to conclude that The Economist cover curse has struck again. Macro Man is trying very hard not to read too much into price action. While the rally in the dollar could well reflect a repricing of the Fed, a downgrade of expectations elsewhere, a repatriation of USD by American firms looking to shore up balance sheets, or a bet of valuation, the reality is that currency markets appear to be following the script observed elsewhere, e.g. he who plays, loses.
While central banks may have their hands tied up, active participants in these markets look more like they've been tied down on the railroad tracks, with the Orient Express coming 'round the mountain. It's not a pleasant feeling.



2 comments:

Peter said...

at least short term, it proved to be a geTAF' jail card

what i notice in my humble efforts to read the markets, is that its sentiment thats taking a hit

a clever bloomberg header reads:

"2008 resolution idea: kick the hope habit"

"Cassandra" said...

There were meaningful interludes during the 1970s - and I believe that the present bears similarities in terms of this being BOTH a monetary/credit phenom AND a demand-pull phenom - when not just risk assets, but most assets (gold & NFMs included) were simultaneously whalloped, leaving cash and but a few equity outliers as the preferred allocation destination, the relative performance pick-up of a sufficiently large magntiude to rearrange wealth-rankings to those who got it wrong. And this was while both the stag and the flation in stagflation were still emerging,

Presently, we are at that point where equity investors look around and realize that BOTH deflationary and inflationary scenarios are inimical to growth or margins/earnings, and that the stagflationary one, too, is loooking increasing ropey for BOTH growth AND earnings. It is one of the few times when "Disinvestment" is superior to investment.