Saturday, March 31, 2007

Weekend Quiz

The answer to last weekend's quiz was as follows:

Sydney 8.50
London metro 8.30
Perth 8.00
Vancouver 7.70
NY metro 7.20
Auckland 6.90
Dublin 5.70
Liverpool 5.30
Chicago 4.50
Dallas/Ft. Worth 2.70

Congratulations to winner barreb, who got them all right. As barreb likely knows, all data comes from the latest Demographia survey on household affordability, available at Demographia defines a housing market as 'affordable' if the price/income ratio is 3.0 or below.

The survey is really worth reading. It suggests that in aggregate, US house prices are not particularly high, relative to incomes, in comparison with the rest of the world. That having been said, the survey does reveal the US as a land of extremes. Some US markets are the most expensive in the survey (which comprises the Anglo-Saxon countries) , while others are the cheapest. The survey appears to confirm Macro Man's prior view that there is no single homogeneous US housing market.

That being said, the survey also provides an object lesson the pitfalls of statistics. The survey rates countries on the basis of the median market house/price income ratio. The US rates as the second most affordable market in the survey:

However, that 3.7 reading for the US can be misleading. The average ratio for the US was actually 4.2. And if markets were weighted by population, the average was 5.2! While this reading would keep the US in "second place", it nevertheless catapults the country as a whole from 'moderately unaffordable' to 'seriously unaffordable.' The two takeaways from this are that you can prove anything with statistics, and that if you live in the United States, it's best to live in a small town!

Anyhow, on to this weekend's quiz. If you have a Bloomberg, don't cheat. Answers in the comments section for anyone who wants to play.

Rank the following ten markets from highest to lowest P/E ratio, as of yesterday's close:

* Bovespa (Brazil)
* DAX (Germany)
* Hang Seng (Hong Kong)
* ISE 100 (Turkey)
* Nikkei (Japan)
* S&P 500 (USA)
* Sensex (India)
* Shanghai A shares (China)
* TSE (Canada)

Good luck!

Friday, March 30, 2007

Protectionism = bad

...unless you're the Commerce Department or a US manufacturer of coated paper. The announcement of the imminent imposition of tariffs against China in the coated paper market has sent the dollar, equities, EM, and bond yields sharply lower. Perhaps wave 'C' stands for China.....

Tradin' around

Macro Man is long some 108 TYM7 puts expiring in 3 weeks. With the future close to strike and plenty of potentially market moving data today, it makes sense to start delta hedging. He buys 50 futures at 108-05, and bids 107-30 for another 50. He'll reassess should the data prove hawkish/strong and 10 year yields climb back towards 4.70 or above.

Three myths

It is month and quarter end (and indeed year end, if you're Japanese) today, which should provide all sorts of fun and games for markets. Expect plenty of volatility around fixing/closing periods as fund managers scramble to hedge/window dress their portfolios to appear as attrative as possible for their monthly/quarterly reporting requirements.

Macro Man can only hope that he holds on to his remaining profits for the month; it would be nice to register positive performance for each of the first three months of the year. A window dressing rally in the SPX would be just the ticket...

Financial markets are home to a number of myths and legends. Some of these refer to specific traders or trades (George Soros' sale of sterling in 1992, for example.) Others refer to apparent market phenomena. The last business day of March, for example, used to regarded with a mixture of awe and dread, such was the supposed influence that Japanese fiscal year end flow was purported to have on asset markets. Fortunately, a combination of regulatory adjustments and time have reduced the resonance of the fiscal year end myth, though it is still believed in some quarters.

Today, Macro Man would like to address three market myths and (briefly) attempt to debunk them.

Myth 1: The Fed is flooding the money market with liquidity to prop up the stock market.

This appears to be a popular theory among certain segments of the retail market, and message boards on popular blogs are frequently littered with references to Fed repo actions as "proof" of market manipulation by the Fed. While Macro Man holds no great love for Ben Bernanke, accusations of corrution, et al are well wide of the mark.

Daily Fed repos are not evidence of propping up the stock market; they are the instrument that the Fed uses to keep short term rates around the Fed funds target. Moreover, the ratio of repo awards to submissions has been relatively constant over a long period of time, except on the rae occasions that the Fed does wish to flood the market with liquidity. See, for example, if you can find September 11 and its immediate aftermath on the chart below. Suggestions that the Fed is propping of equities via the repo market are a myth.
Myth 2: Higher oil = lower dollar; lower dollar = higher oil

There is a popular theory that the dollar and the oil price are inextricably linked and highly negatively correlated. The naive version of the theory implies a high foreign price elasticity of oil demand, and that as the dollar weakens non-US entities will susbtantially increase the volume of their oil consumption, thus dramatically increasing the price in dollar terms. In fact, there is a large body of evidence suggesting that the opposite is true, and that demand for oil is highly price inelastic.

The more subtle version of the theory is that the owners of crude receive (primarily) dollars for their exports, but consume and invest in a currency basket that has a substantially lower dollar weight. This is clearly a factor at the moment, as certain oil exporters are among the most enthusiastic sellers of dollars/buyers of euros in the market today. The question left unanswered, of course, is who is buying the oil, and where do they get the dollars to pay for it?

It wasn't that long ago, for example, that European dollar demand to pay for oil was being blamed for a trend decline in the EUR/USD rate- how times have changed! Looked at from a longer term perspective, however, there has been very little stable correlation between the dollar and oil. The 2 year rolling correlation between the dollar's real effectiuve exchange rate and oil has been both strongly positive and strongly negative over the past 20+ years, and the long term average is -0.07: hardly evidence of a strong causal relationship.

Myth 3: My clients are making money

Macro Man occasionally enquires with sales people across various asset classes how their customers are doing. When market conditions are favourable, most clients appear to shoot the lights out by being limit long. Whan conditions turn turbulent, clients are generally a bit bummed because they take profits on their net shorts a little prematurely, thus limiting their gains. Remarkable! If brokers are to be believed, their clients switch from limit long to net short at virtually the high tick of any market.

The reality, it would seem, is somewhat different. Macro Man recently became aware of an index that measures the performance of 60-70 currency managers to whom Deutsche Bank allocates some capital. The index measures just their trading performance, not the returns from holding cash. Macro Man isn't sure how many currency managers exist, but he has to believe that 60-70 represents a statistically significant sample size of the universe. The performance over the last year suggests that investment performance is rather different from that suggested by brokers.

Hopefully, Macro Man's March P/L won't look similar by the end of the day....

Thursday, March 29, 2007

You don't know what you're doing

Confused yet? Macro Man is and, judging by the schizophrenic behaviour of risky assets, bonds, and currencies over the past 24 hours, he isn’t alone. Stocks and carry currencies have roared higher overnight, while bonds (except for JGBs, naturally) have sagged. Damn the torpedoes, full speed ahead, Cap’n!

Former Princeton professor Ben Bernanke’s recent performance reminds Macro Man of the old saw that “those who can’t do, teach.” Macro Man isn’t really sure what BB and the Fed are trying to do, but it doesn’t appear to be working.

Evidently, the recent change to the FOMC statement was a change in the communication strategy rather than an underlying change of view. For a guy who claims to believe in clear communication, BB certainly seems to confuse a lot of people. Ultimately, that should lead to an increased risk premium for longer duration assets and a steepening of the yield curve. Unsurprisingly, this is exactly what has happened since the FOMC statement, and the 2-10 curve is now at its steepest since last May (when BB chose to communicate Fed policy through the Money Honey.)
Even if one accepts as correct that the Fed is right to be focusing on inflation, Bernanke does little to inspire confidence. In the Q&A yesterday, he expressed the hope that core inflation would come down courtesy of the notorious owner’s equivalent rent. Now, the problems with OER are well-documented, and there is no need to rehash the argument in its entirety here. But it is perhaps worthwhile to graphically demonstrate exactly how poor this measure is in capturing changes in the price of shelter:

Macro Man’s major beef is twofold: BB is a) targeting a price measure that is utterly irrelevant to reality, which is surely not the Fed’s mandate, and b) more than occasionally guilty of cognitive dissonance, only trotting out facts or wishcasts when they appear to support his view, and conveniently ignoring them when they do not. Now, he’s clearly not alone in this regard; a number of prominent Wall Street economists and strategists make a very good living doing exactly that. Surely, however, markets can and should expect more from the chairman of the FOMC.

This man does not know what he is doing. Do you?
As a housekeeping note: due to a busier than expected week, the answers to last weekend’s quiz will be unveiled this coming weekend.

Wednesday, March 28, 2007

Not-so-gentle Ben

Early comments to hit the tape from BB throw no liquidity bones to risk assets.
- Inflation remains predominant concern
- Incoming data support Fed's policy stance

Macro Man agrees that fears on the economy are overblown, but concedes that he would like to see some improved data pretty soon to support that view.

Stocks should suffer on this, as the cyclical data evidently needs to get considerably worse before BB changes his tune; perhaps the Bernanke put is struck at lottery ticket levels after all!

Macro Man takes his lumps on the MXN, stopping out at 11.0850 spot basis, 11.0970 to April 4.

A Raisin in the Sun

“What happens to a dream deferred? Does it dry up like a raisin in the sun?”
- Langston Hughes

Just when you thought it was safe to get back into the water, risky assets start rolling over. Typical! Today may well prove to be some sort of watershed (to borrow a phrase from Dennis Gartman) with the release of durable goods data in the US. And oh yeah, Ben Bernanke is testifying before Congress this afternoon as well.

Readers with memories longer than a few days may recall that both of these items- durable goods and Ben Bernanke opening his trap- have coincided with stock market meltdowns over the past twelve months. That is, in and of itself, sufficient to make Macro Man nervous.

Moreover, while Macro Man had thought that the A-B-C correction may have played itself out in double time, he is now no longer sure. Perhaps it is time to revive the withered remains of Wave C. Consider that last spring, the first day of the Wave C meltdown occurred just under four weeks after the first lurch lower.
Yesterday’s stock market weakness occurred four weeks to the day after the gut-wrenching lurch lower at the end of February...
Now, maybe durable goods will be stellar- it wouldn’t come as a massive surprise. And maybe Ben will be dovish- after all, some of the housing data really has been execrable, and he won’t be too chuffed to see consumer confidence off its highs.

By the same token, however, the market is already expecting a healthy bounce from durables- it won’t take much to disappoint. Moreover, Bernanke may well go to pains to ensure the JEC that inflation remains his paramount concern- note that breakevens are near their recent highs and inflation expectations ticked up in yesterday’s confidence report- and that rate cuts remain far, far away. It doesn’t take a genius to figure out that the market probably wouldn’t like that.

The risk indicator that Macro Man follows ejected him from his carry trade this morning. However, he remains long risk assets as a result of the beta plus portfolio. He will therefore do two option trades this morning to benefit from the expected volatility: one defensive trade, an one offensive trade.

He buys 600 DAX April 6800 puts at 99. This is quite a costly investment in terms of premium (nearly $400k), so if durables are good and Bernanke is Gentle Ben, it may be quickly jettisoned.

He also takes a punt on dollar upside, buying EUR 75 million 1 week 1.3250 puts for 0.10%. Premium outlay is only $100k and it could present some nice gamma scalping opportunities over the next few days. Macro Man will look to buy 20 million EUR at 1.3260 as a delta hedge, should we get down there.

Carried away

Macro Man's signal for his FX carry basket was triggered, so he has exited the carry basket first thing this morning. It looks like he has some company....

Tuesday, March 27, 2007

Proxy battle

It’s been another fairly quiet day so far as markets digest yesterday’s impressive mid session rally in US equities. Although the Nikkei had a bit of a shocker overnight, submarining Macro Man’s JGB profits, European equities have traded on the front foot thus far. Hawkish comments from the ECB and a robust ifo report have sent European fixed income lower; sadly, Macro Man never added to his profitable Euribor trade. At this juncture, it is probably too late to add until the ECB suggests the possibility of 4.25%. The keynote event of the week, however, will be Bernanke’s Congressional testimony tomorrow.

A quiet day like this allows Macro Man to reflect on trading methodology. Regular reader wcw asked yesterday why Macro Man did not sell a synthetic RUF index as opposed to the XHB trade that he actually executed. Setting aside the prosaic rationale of not being familiar with the RUF (Macro Man typically tracks the HBS index to monitor

In this case, it appears that it does. XHB and the RUF index appear very highly correlated, as indicated by the chart below. While the RUF has fallen in (pardon the pun) somewhat more than XHB, this is simply a function of volatility: 40 day historical vol for RUF is 33, while it’s only 27 for the XHB. Given that the actual trade was constructed on a fairly volatility neutral basis (short $5 million XHB at 27.3 vol; long $10 million SPX at 14.5 vol), it appears to Macro Man that XHB was in fact an acceptable substitute for the underlying index, whether RUF or HBS.

However, Macro Man has come unstuck using less perfect proxies in the past. His recent experience with AUD/CHF and EUR/HUF ‘hedges’ on the long SPY beta position still sticks in the craw. Indeed, he is still suffering from a proxy battle: his long Goldcorp position has lagged bullion very badly indeed.

So allow Macro Man’s pain to be your gain. Next time you have a strong view on an asset and are tempted to trade a proxy as a Heinz position (ketchup- get it?!?), be wary. Today’s great proxy trade- like USD/ZAR and the SPX...

...could well be yesterday’s, and indeed tomorrow’s, lesson that correlation does not imply causality.Indeed, Macro Man would not suggest trying to proxy trade Series 1 below with Series 2. An ancillary quiz for those interested: anyone who can correctly identify the apparently correlated series in the chart below will win an actual prize (to be determined.)

Elsewhere, the 660 puts expire today, likely worthless. Macro Man sells out his futures hedge at 665.50, locking in a modest profit for the trade since inception.

Monday, March 26, 2007


Ouch. That new home sales data was bloody way to sugar coat that. Macro Man still believes that this is a 1994/5 story rathe than a 1990 story, but concedes that the thesis is coming under a bit of strain. The worst part of today's data was the supply figure, which shows a supply of new homes totalling 8.1 months times the most recent sales data- and that's with the notorious exclusion of cancellations.

The trade here is so obvious that Macro Man could hardly bring himself to do it. He sold 150,000 XHB @ 33.85 and bought 70,000 SPY at 142.75. This should be roughly beta-neutral and is simply a play that homebuilders will underperform the broad market- hardly rocket science given today's data!

Monday, Monday

Well, it’s been a quiet start to the week, to say the least. Equities are doing little, bonds are drifting lower (including JGBs, taking Macro Man’s new short into early profitability), and the dollar’s a bit higher, largely on short covering. Macro Man is frankly struggling to get terribly enthused so far, though perhaps the new home sales data in the US will provide a bit more excitement.

As housing remains an issue of paramount interest to many, Macro Man would encourage readers to have a go at the weekend quiz. To date, the prospect of a non-existent T shirt and Macro Man’s eternal respect has enticed only one respondent to have a go, and even he only managed to mention two cities.

Elsewhere in housing:

* Macro Man believes that the UK housing market is a lot like the US, except without a publicist. Apparently, last year was the first time since the 1950’s that the home ownership ratio fell in the UK.

* At the same time, a 102 year Sussex pensioner was granted a 25 year interest only mortgage for a buy-to-let property. Hmm, no problems here, no sirree

* There’s an interesting discussion on housing over at Econbrowser, with charts suggesting that mortgage defaults are linked to local unemployment rates much more closely than they are recent house price gains. This jives with Macro Man’s own view that housing alone is unlikely to ring the death knell of the US consumer; that will come from an income shock from job losses deriving from non-housing related circumstances.

Answers to the quiz will be revealed later in the week...

Sunday, March 25, 2007

Weekend quiz

Given the ongoing obsession with the US housing market, Macro Man thought it would be fun to have a quiz on housing. List the following 10 markets in order of least to most affordable housing (as defined by median house price/ median household income.) Anyone getting all 10 correct wins a Macro Man T-shirt (or, should such T shirts not exist, Macro Man's eternal respect.)

* Auckland (New Zealand)
* Chicago (USA)
* Dallas/Ft. Worth (USA)
* Dublin (Ireland)
* Liverpool (UK)
* London Metro (UK)
* New York Metro (USA)
* Perth (Australia)
* Sydney (Australia)
* Vancouver (Canada)

Answers later in the week!

Friday, March 23, 2007

A piece of history

Yesterday saw the release of an historic piece of data. For the first time since the bubble burst, Japanese land prices rose on the year. If ever there was a sign that the dark days may finally have passed, this is probably it. Naturally, as the article linked above suggests, the very act of land price recovery has already raised fears of an incipient property bubble. Indeed, word on the street is that such fears were one of the reasons for the BOJ’s abandonment of quantitative easing last year. Regardless, the recovery in activity and asset prices is prompting an increasing clamor for a more aggressive normalization of BOJ rates.

Even if the BOJ continues to take its time, an argument could be made that JGB yields should rise. Real activity remains robust, confidence remains firm, and, from a longer term perspective, government bond yields have tracked land prices fairly well over the past 20 years, albeit with a modest lag. Benchmark yields have already spiked 7 bps on yesterday’s release.
An obvious and interesting question is whether a further rise in yields would provide succor to the yen. The answer, as far as Macro Man can see, is possibly but not definitely. The problem is that life insurance companies have guaranteed returns to their policyholders, and for most of them the hurdle rate is substantially (0.70% - 1.00%) above the current JGB yield. As such, a rise from 1.60% to 1.80% is unlikely to prompt a change in behavior. Should yields rise close to 2.00%, on the other hand, some lifers will probably increase their domestic bond weightings at the expense of partially hedged foreign bonds. Over the past year, for example, the yen appears to have been positively correlated to yields with yields above 1.80% and negatively correlated to yields below that rate.

As a result, Macro Man is not particularly concerned with his short yen beta position at the moment. If anything, he reckons the yen is probably a sale on rallies given the anecdotal increase in Japanese demand for foreign assets over the past week or so. This doesn’t mean that there is no trade, however. JGBs have been confined in a narrow range for more than six months, with 135 on the continuous future proving to be a tough nut to crack.

The recent sell-off has broken a short term uptrend line and threatens the 55 day moving average, a breach of which should get CTA sellers involved. This looks like a nice set up from both a fundamental and technical perspective, a confluence of factors that suggests a relatively aggressive risk budget. Macro Man will therefore risk slightly in excess of $500k by selling 50 futures at Monday’s open should the open be greater than 134.25; if it is below that level he will be 134.25 offer. If executed, he will place a stop at 135.50.

Thursday, March 22, 2007

The most valuable sentence in the world

"Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information."

It's been a while since a single sentence created that much wealth in the span of a few hours. Macro Man's email box is full of nanoanalysis on yesterday's Fed statement, with guest literature PhD's poring over each single word in agonizing detail. Macro Man finds this periodic foray into textual analysis to be nearly as tiresome as Trichet's monthly verbal striptease around the word 'vigilant.'

However, the naive, simple explanation is probably the best in this case. The statement has changed, ergo the Fed's viewpoint must have changed. By no longer suggesting that the next move on rates will necessarily be a tightening, they have therefore opened the possibility that the next move could be an easing. It's all down to the data.

In this, the Bernanke Fed has proven to be more prescient than its Greenspan predecessor, which went from a tightening bias in December 2000 to cutting rates in January 2001 without passing Go or collecting $200.

In any event, the reaction has been predictable. Liquidity is the oil that greases financial market rallies, and yesterday afternoon was no exception. However, it's probably wise to remember the outcome of a similar rally in January 2001, when the Fed actually started easing. Sure, the SPX had a super day (indicated by the arrow), but it all ended in tears.

Nevertheless, the near term technical picture is fairly positive for risk assets. The DAX, for example, has both closed a gap and put in a technical double bottom, targeting new highs on the index. In the near term, and perhaps in the intermediate term if Macro Man's relatively constructive view on the US economy is correct, risk assets will perform well.

And while Macro Man has covered his shorts, he is not yet prepared to go aggressively long all things risky. The Fed has raised a small risk of letting an inflation cat out of the bag; while this is not as significant a danger as it was last April/May, Macro Man believes it was telling that the curve steepened and breakevens widened yesterday.

Indeed, breakevens (below) are near recent highs. Regular readers will know that Macro Man views a blowout in breakevens as the single largest threat of a major correction in risky assets, the kind of correction that throws the Brazil out with the bathwater.

We just may find that if (and yes, it's a big if) breakevens widen to, say, 2.65%, Helicopter Ben may land the aircraft without dispensing any largesse.

Maco Man was fortunate in the timing of his trades this morning, as the FX carry basket opened on the back foot but has subsequently rebounded, thanks in part to robust UK retail sales. Macro Man has implemented every leg of the trade, including the long GBP; despite his aversion to sterling, he fears that the market might have a go at the dollar over the next few days. All fills for the morning's trade are listed below.

I heart risk

The market loves risk, courtesy of yesterday's Fed shift. If seems one needs an adavanced degree in semiotics to decode the subtleties of the Fed's communication strategy, but yeterday's indubitable softening of tone induced a zowie-worthy reaction from risk assets.

While today has started somewhat slowly, there probably remains more joy in the pipeline. Macro Man has therefore:

* Cut the short Turkish equity position
* Cut long EUR/HUF
* Re-established the FX carry basket, given that the indicator he follows has moved back into risk-loving after several weeks' hiatus.

Wednesday, March 21, 2007


Well, the Fed slammed the door on the tightening bias, somewhat to Macro Man's surprise. Perhaps you can take Ben out of the helicopter, but you can't take the helicopter out of Ben. Regardless, we are now getting the requisite risky-asset lovefest that generally ensues when the Fed finally takes its foot off of the monetary brake.

The repurchase of the puts was obviously the wrong decision, and now some other hedges will likely be jettisoned, starting with the short Turkish equity position tomorrow morning. In the meantime, Macro Man sells $20 million USD/MXN at 11.0350 spot basis, 11.0420 to 04 April. CTAs are long USD/MXN and likely to exit very, very soon.

Fed up with these trades

In advance of the Fed announcement tonight, Macro Man has filled on his sale of 15 million EUR/HUF at 248 spot basis (248.33 to 04 April.)

Separately, he has bought back his short June 1310 puts at makes sense, given that VIX is all the way back down to 13.5.

Reviewing the ABC's

While Macro Man's progeny are now old enough to read, he finds himself reliving old times, going through the A-B-C's in his quest for an accurate risky asset forecast. He has made much in recent weeks of the A-B-C technical set up, and until a few days ago all was proceeding according to plan. However since then, a few unforeseen events have occurred. To Macro Man's consternation, the correlations between the SPX and other risk trades have swiftly broken down, taking his alpha P/L from +$700k to flat month to date. Moreover, the A-B-C pattern in the SPX is not proceeding according to plan.

The correction seems to have played out at supersonic speed- what should have taken a couple of weeks has instead taken a couple of days. Looking at other charts of risk assets, Macro Man is slightly worried that we are in fact still in the Wave B corrective bounce. The Bovespa, for example, failed to make a new low last week, suggesting the current bounce is not the end of Wave C, as Macro Man had originally thought, but rather still part of the B Wave. In that case, a less-than-dovish Fed could perhaps be the trigger for a renewed downdraft in risk assets. Macro Man will therefore look to buy back his short June 1310 puts on SPM7 for 10 or lower in today's trading. By the same token, he wants to start extricating himself from one of the malfunctioning hedges. He will therefore look to sell 15 million EUR/HUF at 248 spot basis.Macro Man's obsession with the alphabet is not confined to technical teal-leaf reading, however. Last night saw the ABC weekly consumer confidence survey registered the joint largest weekly drop (from +2 to -5) in the history of the survey. Now, some commentators are suggesting that this somehow represents the subprime chickens coming home to roost. Macro Man takes a more prosaic view, and reckons that the decline of the (lagged, smoothed) confidence index simply reflects the prior decline in equities. The recent past would appear to support this view.

Elsewhere, a few other items of interest:

* Yesterday, Macro Man observed the strange dissonance between INR strength and SENSEX weakness. A poster was kind enough to point out the technical distortions caused by the tax season and the absence of available government paper in comparison with banks' statutory liquidity ratio. Today, the whole market is talking about it, as Indian short rates squeezed as high as 70% overnight and the INR enjoyed another solid rally as a result. Should the usual happen and the squeeze unwind in April, the INR might make for a nice tactical short. However, the timing will have to be spot on.

* Inflation still matters! Higher-than-expected CPI readings in the UK and Canada yesterday sent both the loony and the pound soaring. The latter was particularly amusing, a a rumour had circulated in the minutes prior to the release of a weak figure. However, some of the the wind was taken out of sterling's sails today by the release of the March MPC minutes, where one member voted for a cut. Mr. Blanchflower, you're my kinda guy! Macro Man is actually hoping for a bit more of a squeeze in sterling so he can apply larger, broad-based shorts.

* In Malaysia, Bank Negara said they were happen for the ringgit to strengthen. Macro Man can't remember the last time he heard that kind of talk from an Asian central bank, especially one as historically activist as Negara. He will look to sell $30 million versus MYR on a pop back to 3.50 spot basis.

Tuesday, March 20, 2007

Far out!

Interesting news from the murky world of subprime. Evidently, with great danger comes great opportunity:

NEW YORK -(Dow Jones)- Accredited Home Lenders Inc. (LEND) said Tuesday that it obtained a $200 million loan from hedge fund Farallon Capital Management LLC, bolstering hopes that the subprime mortgage lender would survive a funding crisis that has been pinching the entire sector.
The San Diego lender said the proceeds can be used to fund mortgage loans, enhance its liquidity and for other corporate needs. The loan has a five-year term and an interest rate of 13% a year. Farallon, in San Francisco, will also get 3.3 million warrants - or options to buy shares - from Accredited, with an exercise price of $10 a share.

The warrants are actually 10 year options (no disclosure whether European or American) ...and are already in the money. This deal is pretty reminiscent of the deal that Warren Buffet struck with Salomon 15 years ago, and a pretty good indication that risk taking is far from dead.

Taking the other side of US trade deficits

Q: What do you get when you dress a pig in a prom dress?

A: A pig.

Macro Man has been trousered by one of the fundamental errors in macro investing- the dreaded proxy trade. His calls on the US equity market, while not perfect, have been pretty good, yesterday’s rally notwithstanding. However, by trying to hedge via proxies (particularly currencies) and being cute with a calendar spread instead of straight puts on the S&P 500, he has borne all the losses incurred by US equity weakness (via the beta plus portfolio) while losing money on his hedges at the same time. Memo to self: if you want to dance with the prom queen, it’s best to avoid the barnyard.

Macro Man has stopped himself out of the short AUD/CHF position at 0.9705 spot basis (0.9690 to 04 April.) While equities remain firmly ensconced in the danger zone, risk/carry currencies have broken all manner of resistances. The Indian rupee, for example, is now trading at its strongest level against the dollar since late 2005, despite the fact that the SENSEX chart continues to look awful. India is one of those weird stories that people either love or hate. Macro Man wants to hate it (current account deficit, lots of hot money inflows, unionized workforce, etc.) but concedes that the price action is more love-worthy. As such, he stays away. Meanwhile, current losses on the SPY position are somewhat exaggerated as the ETF went ex-div last Friday, knocking $0.55 off the price. The dividend will be reinvested back into the portfolio when it’s paid on April 30.

Switching gears, there was an interesting discussion over at Brad Setser’s blog the other day about whether exchange rates matter for external balances or not. Now, Macro Man has previously contended the modest nature of Japan’s trade surplus (by historical standards) suggests that the yen is not as undervalued as many commentators appear to believe. Macro Man decided to dig a little deeper. The chart below illustrates the one year moving average of the US bilateral trade deficit with five unnamed countries. They can best be described as follows:

Country 1: 15 year deterioration that is finally showing signs of improvement
Country 2: Broadly stable trend with a tilt towards slight deterioration
Country 3: The world’s most populous country
Country 4: Steady trend of deterioration over the past 15 years
Country 5: Trends around zero, deficit appears to be improving

Now what might you say about the currencies of those five countries?

Country 1: Has historically been cheap, might now be expensive as deficit is turning
Country 2: Doesn’t look out of whack as deficit is steady
Country 3: Dirt cheap
Country 4: Pretty cheap
Country 5: Ebbs and flows between cheap and expensive; had been cheap, now might be expensive

What if we present the data another way? The chart below shows the five countries’ share of the US trade deficit, because after all, a $5 billion deficit in 1987 ain’t the same as a $5 billion deficit in 2007.
Hmmm. The most interesting change here is country 2, which has seen a steady and steep deterioration in its share of the US trade deficit for 15 years. While it has lost most of its share to country 3, on a trend basis it has lost ground versus each of the other four countries for the past 10-15 years. It’s not exactly a compelling argument that the currency of this country is fundamentally super-cheap, is it? Yet that is an argument that is taken as practically gospel amongst most of the analytical community, for country 2 is of course Japan. The full roster is as follows:

Country 1: Eurozone
Country 2: Japan
Country 3: China
Country 4: Mexico
Country 5: Brazil

Of all the arguments in favour of ‘global decoupling’ and Japan, this one is probably the most powerful...but it’s one that nobody makes because it contradicts the conventional wisdom that the JPY is uber-cheap!

Monday, March 19, 2007

Just one of those days

Have you ever had one of those days where nothing seems to work? Macro Man has seen an irritating drawdown over the past 24 trading hours as his risky asset longs have gone down and his risky asset shorts have rallied strongly. What gives?

The A-B-C correction in US equities appears to be proceeding in line with expectations. The low to date has been above the ideal target range, and as recently as, uh, the last trading day, price action was looking ropy.

Where Macro Man has come-a-cropper is the short risky asset overlay. The currency trades have performed abysmally, thanks in part to the gap in CEE-4 caused by the Slovak reval. Yet the Aussie dollar is near decade highs again, having gone up 3c in (literally) a straight line.

Similarly, the Nikkei could have posted some devastating price action last night. Instead, it rebounded strongly, adding fuel to the "carry is back, baby!" fire. Macro Man had thought that the combination of SPX price action and another China rate hike might have been sufficient to send Japanese stocks lower, but clearly this has not been the case.

Is Macro Man missing something? Can risk-asset underperformance really be ringfenced to only impact the US? Clearly the recent price action is suggesting that this is a possibility. However, given the very strong correlation of risk asset returns over the past several years, Macro Man remains wary.

He'll leave a stop loss in AUD/CHF at 0.9760 for risk management purposes, but he still thinks that the expected further weakness in US equities should reverberate cross other asset classes. If tonight's NAHB release doesn't do the trick, perhaps a hawkish Fed tomorrow will get the job done.

Morning headache

Slovakia has revalued its currency by 8.5% within the ERM system over the weekend, sending all Eastern European currencies, including Macro Man's HUF short, screaming higher. Ugh.

The market's reaction seems somewhat exaggerated in other central Europeans; Macro Man views a similar shift in the HUF ERM parity as unlikely.

As such, he buys another 10 EUR/HUF at 244.80 spot basis, 245.21 to 04 April.

UPDATE: Moody's has apparently released a report saying that while Eastern Europe is not like Asia in 1997, "inflammability" is rising. It can't come soon enough!

Friday, March 16, 2007

Double, double

Double, double, toil and trouble. Fire burn and cauldron bubble! Actually, perhaps we should say triple. triple, prices ripple, as it's triple witching on US equity exchanges today. It's also CPI day, with risky assets not yet out of the Wave C woods. Macro Man expected those factors to dominate markets today, but Asia had other ideas.

The dollar has sold off sharply, equities have rolled over slightly, and gold is looking perky. Yesterday Macro Man sketched out a worldview suggesting an eventual buying opportunity in the dollar. So what's going on?

The market is behaving rationally, within its current belief system. The limp tone of US data carried over yesterday, and subprime continues to attract loads of attention. As such, the market is now pricing in 50 bps of Fed easing, give or take, by year end.

In Europe, meanwhile, the ECB has engaged in a full-on verbal assault, with a seemingly endless wave of hawkish comments hitting the tape. Somewhat oddly, the strip hasn't budged, perhaps as a result of ongoing equity turbulence. So it's the euro that's borne the brunt of the monetary repricing. And if one takes what's currently priced in the strip at face value, it's hard to argue with the EUR/USD move.
Now ultimately, Macro Man suspects that the relative strips are mispriced- more likely the Eurodollar strip. However, that doesn't mean that a) it cannot get more mispriced, or b) that the mispricing will correct any time soon.

As such, Macro Man has to concede that there potentially remains more downside for the dollar in the near term. He is not yet prepared to throw risk at the trade...playing the strip looks much more attractive, as that arena is more Voldemort-free.

Finally, Macro Man is clearly losing his mind. He wanted to hedge his gold puts a little more than 60 delta...but forgot that his position is 275 contracts, not 200. Ay caramba! He will therefore bid 650 for another 50 lot of GCJ7.

Dollar cracking?

It seems as if the market is grasping the dollar bear story with both hands this morning. While Macro Man does not necessarily agree with some of the basic premises of the argument, he has to concede that said premises are unlikely to be disproven in the near term.

He finds himself long dollars synthetically via his gold puts. He therefore buys 125 GCJ7 @ 647.50 to turn his gold position from directional to long vol.

Thursday, March 15, 2007

Fitch downgrades Iceland!

Here's what happened last year, which eventually fed through into weakness in all currencies with large/deteriorating current accounts. It certainly doesn't feel like the same will happen this time around, though EUR/ISK a percent or so higher (Bloomberg screen not updating)

A modern fairytale

Time for a game. Which of the following is not like the others?

* Cinderella
* Hansel and Gretel
* The Princess and the Pea
* The boy king who survived a coup attempt and then ruled for 72 years
* Global decoupling: if the US slows significantly, it won’t matter to the rest of the world

The answer? They are all fairly tales except for the one about the boy king, who was in fact Le Roi du Soleil.

What started out as a generalized risk aversion event seems to have morphed into something peculiar to the USA. US stocks are trading the worst, the dollar is getting hit, and carry trades of every description are being re-established. The view that a US slowdown need not affect the rest of the world is quickly evolving into market gospel.

In Macro Man’s view, this is utter rubbish. He is cognizant that Chinese domestic demand remains robust, thus providing a crutch to the global economy that wasn’t there in the 1990’s. But the notion that domestic demand in Europe and Japan is sufficiently strong to pick up the slack appears to be flat-out wrong.

Now, an essay tackling this subject can either be very long or very short. And if Macro Man were a professional researcher with no other responsibilities, he would write the long-from version of the argument. However, he isn’t, so he won’t.

The short form version of the argument is as follows. The “strong”, “self-sustaining” domestic demand growth in Europe and Japan recently has still been well below the level of US domestic demand growth, despite the acute impact of the housing crunch in the second half of last year.

The notion that Europe and Japan are somehow not reliant on exports rings equally false. For most of the past several years, net exports have added substantially more to growth in Europe and Japan than in the US. Even with the recent substantial improvement in the US trade account, this remains the case over the past few quarters.

Sure, both of these countries can export to China, but you have to ask yourself whether Chinese import demand will accelerate or decelerate if export growth to the US slows.

For the time being, the market appears to want to sell dollars against most other currencies, both risky and “risk-free.” Macro Man is content to step aside and let the market have its way. However, he suspects that this situation will ultimately morph into a buying opportunity for the dollar, probably against the euro. Either US activity will recover, as Macro Man expects...or growth in the rest of the world will slow, which the market apparently does not expect. The time is not ripe yet to go short...but eventually, it will be.

Assigning blame for subprime

There's an interesting piece from hedge fund manager Dour Kass over at on who's to blame for the subprime mess. A few thoughts:

* While it's easy to blame Wall Street for throwing together ever-more exotic (and toxic) structures comprised of low-quality mortgage pools, where is the criticism of Kass' hedge fund brethren for lapping this stuff up, stuffing it in portfolios, and then not marking it to market?

* Similarly, while the ratings agencies do not deserve to be totally absolved from blame for their tardiness in downgrading low-quality credits (a penny that has yet to drop in many quarters), one of the primary reasons for this is the pilfering of ratings staff by brokers and, you guessed it, hedge funds!

* Macro Man was also disappointed not to see blame apportioned to the many subprime mortgagees who committed fraud by misrepresenting their income, the value of the property to be mortgaged, or the reason for the loan. Yes, it is unfortunate that many people may be forced to lose their house, and the subprime lenders are correctly rapped on the knuckles in the piece for their largesse. Ultimately, however, people should be held responsible for their actions, else moral hazard increases and each bubble proves to be bigger than the last!

* The government probably opprobrium for dithering over Fannie and Freddie and allowing them to balloon their balance sheets to the degree they have while still maintaining the Federal guarantee.

Otherwise, an interesting piece- Macro Man concurs that criticism of Greenspan is this situation is probably warranted.

Wednesday, March 14, 2007

So the SPX makes a new low...

...and risky currencies are higher on the day!

Strange days, indeed. Most peculiar, mama....

Silly season

OK, so here's what we've ahd this morning:

* A story that the Massachussetts DA, William Galvin, is going after UBS and Bear Stearns over subprime lending and the banks' relatoinship with hedge funds. Pardon Macro Man's cynicism in a post-Spitzer world, but doesn't this look like an electioneering politico trying to lump as many negative-touchstone elements together as possible? Hedge funds! Investment banks! Subprime lending! I'm the guy that sorted it out!

In Macro Man's opinion, this is one of the biggest challenges facing US financial markets at the moment: as soon as somebody loses money, the lawsuits fly. What happened to the culture of individual responsibility? Perhaps instead of attacking AIM and other markets, US worthies should ask themselves why they are losing listings abroad? Macro Man suspects that the absence of potential lawsuits would figure fairly prominently on the list.

* A widely circulated story that Citigroup will need to raise its provisioning for subprime losses rom $300 million to $5.7 billion, a cheeky nineteen fold increase

* A widely circulated rebattal, with claims that the story was 'fabricated by traders.'

* The realization that Goldman's "stellar" earnings last quarter didn;t include the last three days of February. In case you hadn't heard, asset markets had a tiny wobble in those days. In other words, the Goldman results were pretty meaningless. Macro Man wishes he could report his results in the same way...if he strips out his two worst real-world trading days, for example, his since-inception Sharpe ratio goes from 0.7 to 1.0! Lehman's results have come out bang in word yet if there's been any 'selective disclosure.'

So how are we left? With the inclination to sell risky assets on rallies. Somewhat perversely, today's US current account data, showing a sharp improvement in Q4, is being taken as a signal to buy risky assets so far. If the US is buying less stuff from the rest of the world, how exactly is that positive for risk assets? And if we take the current account improvement at face value, why should the dollar need to go down at all?

'C' ya, Wave B

Well, well, well. Wave B did end, not with a whimper but a bang! After all the focus on macro data, investment bank earnings, ABS, and MBS, wave B ended courtesy of that most prosaic of factors: MSB (More Sellers than Buyers)!

To date, most of the damage has been concentrated in equities. Credit, EM, and risky currencies are showing relatively little signs of distress, much to Macro Man’s chagrin. He is left in the uncomfortable position of having called the SPX more or less correctly but having nothing to show for it on a portfolio basis, as his alpha shorts have not moved as much as his beta longs. A perfect example of why so many portfolio managers are either bald, gray, or chain smokers....

Macro Man has been struck by the degree of complacency this morning. All things risky were marked wider/lower overnight and at the open, but the marginal flow appears to be buying rather than selling of risky assets. Irritating, to say the least....but Macro Man suspects it will end in tears.

Now that Wave C has begun, we can re-consult the roadmap sketched out a few days ago. If Macro Man’s analysis is correct, the bottom in the SPX should be roughly 1320-1330, as set out below.

Macro Man is unsurprisingly busy in his real job, so this morning’s post is brief. More colour will be added as circumstances dictate: suffice to say that today could well be a day on consolidation, but any small rally is meant to be sold until the end of next week, give or take. Good luck!

I love the smell of risk aversion in the morning

..and will add to it buy buying 15 million EUR/HUF 252 spot basis, 252.45 to 04 April. Macro Man will take profits at 256...just looking for a quick explosion here.

Tuesday, March 13, 2007

I hope it's not too late...

but if this really is the onset of Wave C, then it won't be. Macro Man sells 25 million AUD/CHF at 0.9560 sp0t basis (0.95385 to 04 April.)

The China Syndrome

If financial markets were a Hollywood movie, right about now a Z-list ham actor would be chewing on a toothpick and saying “it’s quiet out there....too quiet.” Risky assets continue to teeter on the brink between Wave C(orrection resumed) and Wave V(-shaped recovery.)

Yesterday’s “news” that New Century is on the brink of collapse tried and failed to catalyze a renewed downdraft in risky asset prices, which to a degree restores Macro Man’s faith in the rationality of markets. Stocks don’t go from 30 to 3 because they miss their quarter by a penny, and most that make that journey end the trip in bankruptcy. As an aside, Macro Man suggested in his office that throwing a tiny bit of p.a. capital at NEW might make for an interesting lottery ticket bet. He was roundly hooted down by all and sundry, suggesting that NEW’s descent into oblivion is fairly well discounted.

The recent spate of data releases in China has put everyone’s favourite talking point back in the headlines. Macro Man has observed a dissonance in things Chinese recently. See if you can spot it: which of the following three charts does not make sense?

So why, in a month when the trade balance and money growth both surged, comfortably exceeding expectations, did the Chinese take their feet off the RMB accelerator? A cynic might observe that with the safe passage of the G7 meeting, the authorities in Beijing decided to take a break from currency strength. A fatalist might posit that they’ve decided that $20 billion a month in fresh FX reserves just isn’t enough, and that they have decided to accrue $30 billion instead. A statistician would probably tell Macro Man that his sample size of flatlining $/CNY is too small to be statistically significant. And an optimist might suggest that foreign capital has seen the light and tired of throwing money at the will-o-the-wisp that is the “unlimited opportunity of Chinese markets.” Macro Man quite honestly does not know, but if China did indeed step up its intervention activity in February, it could perhaps explain a bit of the euro’s strength against the dollar last month.

Elsewhere, rumours abound that the central bank of Russia has been selling GBP/JPY for the last 24 hours. Perhaps they are simply following the advice of C. Fred (I’ve been short USD/JPY for 15 years) Bergsten, who advocates that China buy yen in today’s FT. (As an aside, Macro Man wonders if Marjorie Scardino, CEO of Pearson, is massively short USD/JPY p.a., such is the cheerleading for a stronger yen in the FT recently.) Perhaps this is a reserve switch out of sterling and into yen. Or perhaps it’s the sort of aggressive, market timing alpha trade by an ‘official’ entity that has made the FX market so treacherous in recent years.

So squaring the circle, markets are left to speculate what could push markets into either Wave C or Wave V. The macro data, if sufficiently stagflationary or benign, could do the trick. So, too, could the release of earnings from a triumvirate of US investment banks this week, starting with Goldman today. Now, maybe GS (and LEH, and BSC) will display immunity from recent market volatility, and maybe they won’t. Either way, it’s best to keep an eye on them as a potential driver of near term market direction.

Monday, March 12, 2007

Wave B(ye-bye?)

Well, we’re approaching crunch time for the Macro Man risky-asset scenario. Non-US equities have, by and large, reached ideal Wave B retracement targets- the DAX, Nikkei, and Bovespa have all reached their 55 day moving averages

Credit has also rallied strongly: even the toxic-waste ABX indices have bounced smartly.
Risky currencies such as AUD, NZD, meanwhile, have also reached/breached moving average resistance and are through their 50% Fib levels. EUR/USD, of course, never really sold off, de-railing Macro Man’s cheeky payroll punt.

It appears, therefore, that the time is rapidly approaching to wave goodbye to Wave B. The question is, are we about to usher in Wave C of the correction (new lows in all things risky), or are happy days here again?

Macro Man sees little reason to change his view at this juncture. While Friday’s employment data shut the door on near-term downside tail risk for the US economy, the lack of exuberance in stocks was telling. If we were in the early stages of a V shaped rebound, surely the S&P 500 could do better than a one point rally?

The beauty of Elliot-wave type analysis is that it allows one to project multidirectional price action moving forwards: A-B-C, corrections, etc. Its weakness is that it is often a bit fuzzy on how far things can go before the scenario must be discarded. For the time being, Macro Man is sticking to his guns, and looking for this week’s data (retail sales, Empire/Philly, PP/CPI) to perhaps provide a catalyst.

Failing that, it could be the good old fashioned ‘more sellers than buyers’ that send risky asset prices lower. And if that doesn’t emerge....well, then it’s probably back to the drawing board.