Macro Man

It's the last day of the month and it's all to play for. Macro Man's monthly P/L is still negative, but only just. It won't take much at all for him to sneak in another positive month (albeit a less impressive one than it looked a week or so ago.)

Typically, the small mammal that powers Macro Man's IT systems appears to have caught a terminal disease, so he appears set to spend much of his morning battling his computer.

Suffice to say, however, that the DOTW are having their say...for the time being. While it's easy to say ex-post, the risk asset market did look set up for a bounce yesterday, and duly delivered. When even Chicken Little Asset Management ("where the sky is always falling") thinks we're oversold, you know it's time for a bounce.

However, the 3 wave correction set up that Macro Man sketched out in February/March applies here as well, in all likelihood. The hedge fund community is even experiencing the same sort of drawdowns, if the relevant indices are to be believed. There remains ample potential for a further bounce up to 1500-1510 on the SPX before further weakness ensues. Such a squeeze will no doubt feel very painful indeed for risky asset shorts and could well suck the DOTW into re-adding risk at lousy levels.

If Wave C delivers the sort of bone-crunching drawdown that it failed to in March, the DOTW may be left singing a different Smiths tune in desperation :

Please please please let me let me let me get what I want this 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?

1. Are we now at the point where good = bad? In other words, might a strong US GDP figure, chock full of real final demand, actually be a bad thing for risky assets? Such a number could suggest to the Fed that its forecast of moderately below trend GDP remains on track, there's no need for a growth scare, and thus no need to ease rates (as the Cramers of the world hope.) A bad number, with below expected growth concentrated in inventory accumulation and weak final sales, could perhaps kindle further hopes of a monetary balm and deliver a "don't fight the Fed" rally, however temporary it might be.

2) Is there a double entrendre more compelling that "redemption" right now? On the one hand, a redemption for the market means a normalization of the credit market and a recovery in risk assets- hurrah! On the other hand, the single greatest threat to market stabilization is the forced sale of illiquid securities by funds to raise cash to meet month-end redemptions. Some hedge funds may unilaterally choose to susend redemptions, but there is plenty of toxic dross held by mutual funds that don't have that option. As end users read their FTs, WSJs, Economists, and the like, the risk must be that they decide over the weekend to raise a little cash...which could mean price-insensitive selling next week. Consider yourself warned!

A long time ago, Willie Nelson sang "turn out the lights...the party's over." While the failure of the DOTW to step in immediately makes it tempting to conclude that the party really is over for equities and risk assets, it does of course remain premature to conclude that with any degree of conviction.

Neverthless, it's also important to respect the fact that markets are starting to seize up and that equities are rapidly approaching some very interesting levels. Interesting levels to buy? Perhaps. But, Rudyard Kipling's admonition notwithstanding, in times of financial distress keeping your head (or at least using value as a short term investment criterion) isn't always the right thing to do. The FTSE, for example, is already perched right on its uptrend line of the entire five year bull market.
A break could produce a fair amount of pain (and further asset allocation shifts from the UK pension fund industry.) It makes sense to position for the tail risk event, which would then provide a platform for selective purchases on weakness. Macro Man therefore buys 400 FTSE Dec 5525 puts at 80.

Poor Henry Kravis. One day he snaps up AllianceBoots, operator of the UK's hegemonic chain of pharmacies, and is feted with an appearance on the cover of this month's Bloomberg Markets and a panegyric within the pages of the magazine. The next thing you know, he's actually being asked to improve the terms of his financing (in the lenders' favour, of all things!) while his debt underwriters get stuffed with the bulk of the Boots debt. Meanwhile, Cerberus Capital has been caught in the crossfire and failed to dispense with another $10 billion worth of debt required to finance its Chrysler purchase.

Left holding the bag, of course, are the underwriting syndicates, which now have billions and billion of dollars of undesirable debt on their books. Should such an environment persist, we will eventually see what economists refer to as an "inventory unwind". And when that happens, we'll finally get the dip that you don't want to buy immediately. On a more medium term horizon, meanwhile, it could be that the PE bid for equities is more price sensitive than has been the case; of course, the PE bid could well be replaced with a healthy dose of VIG (a.k.a. the Voldemort Investment Group, a.k.a. sovereign wealth funds.)

Another example of an institution assuming the risk of unhappy clients is AXA, proprietor of the horribly-performing cash-plus fund highlighted in this space on Tuesday. Macro Man's industry spies suggest that AXA is now meeting redemptions out of its own capital base, such is their aversion to selling more securities and embarking upon another unpleasant voyage of price discovery. When institutions begin to warehouse substantial amounts of dodgy inventory, as is happening now, the "systemic risk" warning signal begins flashing amber.

Lest you think that AXA was the only institution impacted by subprime, or that only dollar-based investors are taking the hit, consider the fund below. The chart, Macro Man is sure you'll agree, bears an uncanny resemblance to that of the AXA fund. However, the chart below shows the price of the Oddo Cash Arbitrage Fund, a euro-denominated cash-plus fund domiciled in France. It would certainly appear as if the 'cash arbitrage' in question involves buying short-term subrpime paper in the US, hedging the currency back into euros, and collecting the yield difference between LIBOR (used in the currency hedge) and the subprime notes. It looks like the fund might need to be re-christened as the "Oh-no Cash Abritrage Fund"...
Elsewhere, Macro Man was blown away by a piece written by Jim Cramer yesterday comparing the current environment to October 3, 1998, a scant few days before the Fed engineered an emergency rate cut in the midst of the LTCM crisis. Although Cramer does state that he expects things to get worse (and specifically suggests sectors to short), the underlying theme of the piece appears to we are entering the sphere where Fed easing enters the equation, and boy you don't wanna be short when they do cut rates.

Macro Man had to shake his head when he read this. Has volatility really fallen so low that the current blip prompts comparisons to October '98? Not that that scenario couldn't eventually unfold, but there would have to be a lot (and Macro Man means a LOT) more pain before the environment resembles October of '98. Let's take a ride in the way-back machine:

Equities

THEN: On October 2, 1998, the S&P 500 closed 17.1% below its closing high of a few months before.

NOW: Yesterday's SPX close was a scant 2.25% below its prior closing high.

Investment Grade Credit

THEN: The spread between Moody's BAA index and 30 year Treasury yields widened from 1.43% in July to 2.07% on October 2. Swap spreads widened to 0.89%.

NOW: The Moody's BAA spread has widened from 1.43% to 1.56%, and swap spreads, while wider, are still at 0.72%.

Emerging Markets

THEN: A year after the Asian crisis, Russia took the unprecedented step of defaulting on local currency debt; the rouble got crushed.

NOW: EM central banks are flush with FX reserves and many, many currencies are at their strongest level versus the dollar since 1998-99.

Yen Carry

THEN: USD/JPY had already fallen 9.6% from its high, vols were at 18%. The 17.8% peak-to-trough crash in USD/JPY the following week was part of the rate cut calculus.

NOW: USD/JPY has fallen 3.5% from its peak and vols are at 7.5%. If positions were as large as they were in 1998, both implied and realized volatility would be higher.

Real Economy

THEN: The NAPM fell from 52.2 to 48.7 in the six months leading up to October 2.

NOW: The ISM has risen from 51.4 to 56 over the last six months

None of this means that a crisis cannot unfold, of course. Indeed, it looks increasingly likely that the resolve of the DOTW will be tested in equities. Bear in mind, though, that it will need to get a lot worse before an emergency rate cut balm can make it better.

To paraphrase Winston Churchill: we're not at the beginning of the end; if anything, this is only the end of the beginning. Macro Man will therefore write a check to protect against disaster:

He buys 1200 August DAX 7600 puts at 135.

1) Why was it such a surprise that Countrywide earnings were disappointing: given the underlying state of its market, surely the confidence interval around the consensus forecast must have been pretty wide?

2) Aussie hedge fund Basis Capital has hired Blackstone to dispose of its subprime turds: could it be that they want to flog their ropy assets to Voldemort?

3) Who will with the battle for ABN Amro: the RBS consortium, or Barclays, backed by financing from Voldemort and Temasek? And if the latter, does this mean that Voldemort will eventually morph into Vinny the loan shark, the place to go for financial institutions who need cash, and quickly?

4) How soon can one refer to the plotline of the final Harry Potter book without being called out as a spoiler? (Hint: not yet, as Macro Man will be reading the book on his August holiday.)

5) What is the best way to play the ongoing secular boom in food prices?

6) How much of the current bout of yen strength is down to uncertainties surrounding the LDP’s forthcoming trouncing in Sunday’s Upper House elections?

7) Why has the service on Japanese railways remained superb after privatization while the UK railway network is in a diabolical state after the breakup of British Rail?

8) How much do equities need to sell off before the DOTW (non-housewife branch) scurries for cover?

9) Where is risk positioning the biggest, relative to one’s ability to exit at a non-knee trembling rate?

10) Did you realize that the BRICs are all in the list of the world’s top 10 largest economies if one counts the Eurozone as a single economy?

11) How does one measure the strength or weakness of a currency? Macro Man could not help but observe that a new Porsche 911 turbo advertised on Yahoo (for $107,800) appears very substantially cheaper than the same car in Germany (€137k), UK (£97.8k), Japan (Y18.79 mio), or even China (R1.95 mio). (Disclaimer: Macro Man drives a late 90’s VW, but Macro Boy’s consuming interest in all things automotive forces him to know things like the cost of a 911 turbo.)

12) Why is the coffee machine in Macro Man’s office always broken?

13) What level of GDP growth will encourage the ECB to stop tightening rates?

14) Is there anything more annoying for a commuter than the moment you realize that you’ve left your iPod at home?

15) Kuwait’s currency revalued again (by 1.7% this time) while the Argentine peso is getting shellacked: is the emerging market wheat finally getting separated from the chaff?

16) Did you know that Wednesdays are the best day of the week for US stocks: over the last two years, the cumulative price return for the S&P 500 on Wednesdays has been an impressive 23.1%? (Monday is the next best day, at 7.7%, although Monday returns are actually negative since 1950!)

17) How can last year’s hot, dry summer in the UK and this year’s cool, wet summer in the UK both be down to “climate change”?

18) As an adjunct, why is carbon the only emission that people try to offset when it is only a small part of the greenhouse gas issue (and why does no one offset particulate emissions, i.e. pollution)?

19) Was last month’s impulsive move above the long term trend line at 5% the mother of all false breaks in the US bond market?

20) Why is it that counties with high private sector savings rates are scrambling to set up sovereign wealth funds, while in counrties like the US with low private sector savings, the concept of a nationalized equity investment scheme can get no traction (despite the long term funding gap of the social security program)?

and a bonus question .....

21) WHY OH WHY DIDN’T MACRO MAN SLAP ON THAT EQUITY OPTION HEDGE YESTERDAY?

Cloudy
The sky is gray and white and cloudy,
Sometimes dollar-yen is selling off on me
And the brokers, they start to yell
They think yen strength's really swell
And that shorts are goin' to hell
But here's Mrs. Watanabe, now I'm felling pretty well...

- Simon and Garfunkel, "Cloudy" (alternative universe version)

Ichimoku-mania has continued unabated this morning after USD/JPY broke the key cloud support at 120.68 in Tokyo trading. As forecast yesterday, the sell side brokerage community is all in a stir, and for the first time all summer Macro Man now sees more clouds in his Bloomberg message box than he does in the sky.

What does it mean? Is this the end of yen carry, a development which could kick another leg of support out from under the global risk trade? Probably not. Noted carry currencies such as the AUD and NZD, favourites with Japanese retail, aren't exactly rolling over today. And lest we forget, the last break of the cloud support (highlighted below with the arrow) was a superb buying opportunity for USD/JPY.

Elsewhere, a milestone piece of data was released today, but naturally no one cares. The Eurozone current account for May posted a monthly deficit of €14.6 billion, well wider than the expected deficit of €4.2 billion. This deficit was the widest monthly reading on record. Of course, no one cares, because the US deficit is so much bigger in absolute magnitude and, don'tcha know, the dollar is going down forever. Yet the EMU figure, despite the inherent noisiness of the data, is emblematic of something that Macro Man believes very strongly: that an artificially strong exchange rate (the usual outcome for a reserve currency) will ultimately beget uncomfortably large external deficits. It may be years before such a development comes to pass (outside of France, naturally), but come to pass it will.

One somewhat frightening chart is making the rounds this morning that appears to exemplify the dangers of subprime to even "safe" investments. The chart below shows the price of a Luxembourg-based USD money-market fund that is designed to deliver one month LIBOR plus 0.50% per annum. Now as we all know, you cannot get something for nothing, so one way to pick up that yield premium is to take credit risk. The problem, of course, is if your "AAA rated" security is really a piece of subprime junk wearing Groucho glasses. If the price data furnished by Bloomberg is accurate, it suggests that there must be a few unhappy investors out there whose safe cash-plus fund has turned into a 14% monthly loss.

And if that can happen to a money market fund, one wonders what the portfolios of leveraged credit longs must look like. Macro Man is kicking himself for never putting on the long equity/short credit trade, as neither has seen the correction that he'd been waiting for.

Finally, Macro Man was talking with one of his counterparties this morning, who wondered allowed how deleterious the impact of US ARM resets and generalized housing weakness will be. Macro Man's answer was "not very", as the amount of extra mortgage payments from resets is trivial from a macroeconomic perspective, while household net wealth has remained pretty resilient despite the weakness in housing. Were the equity market to follow the housing market lower in the context of rising unemployment, then Macro Man would feel more comfortable in beginning to contemplate rate cuts and a possible recession. That having been said, it always makes sense to hedge when the market lets you, so Macro Man might slap on another low/zero cost option overlay should equities have another nice day.

Oh, dipbuyers of the world
Unite and take over
Dipbuyers of the world
The sell-off's over
Sell-off's over
Sell-off's over

- The Smiths (alternative universe version)

Although a few more cracks are appearing in the risky-asset space, the dipbuyers of the world continue to selectively exercise their mojo to keep various risk trades alive. While Friday's price action in equities, credit, and the yen was somewhat gut-wrenching, collateral damage this morning has been relatively minimal. Stock markets in Asia and Europe aren't showing much signs of distress, and risky currencies like the Aussie and Kiwi dollars are making new highs (against the greenback, at least.)

Turkey is more popular today than during Thanksgiving and Christmas combined, judging by early market reactions. The favourable result from the weekend's elections has produced a strong rally in Turkish equities, bonds, and the lira, which has helped assuage any fears of a spillover from Friday's ugliness. Naturally, Macro Man was triggered out of his FX carry basket, which was executed before the DOTW really got stuck in this morning. C'est la vie....

Of course, it's not all sweetness and light. Credit is still looking ropy, with the Euro crossover spread index punching up towards 350 bps this morning. However, the market's attitude towards the impact of credit distress is somewhat curious. Despite the fact that S&P downgraded some European credits on Friday (the alarm must have gone off!) , markets were happy to sell the dollar pretty aggressively.
It seems to Macro Man that selling dollars may work during mini-periods of risk aversion, or when concerns are not too deeply entrenched. If it really hits the fan, however, Macro Man would expect the dollar to rally as USD-funded trades (long €, long EM, etc.) are closed. One exception, of course, could be USD/JPY, where most participants with a position are long. It's amusing that whenever the yen starts to boogie, London brokers begin sending out ichimoku charts to anticipate how Japanese accounts will react.

For those fortunate enough not to be familiar with ichimoku, it is a rather bizarre and convoluted charting technique apparently popular in Japan. Western brokers without the foggiest idea of how the chart is calculated are particularly fond of referring to the significance of the cloud and the potentially catastrophic effects of a downside breach. Now, Macro Man is as fond of technical analysis as the next man, but he prefers to understand what he his looking at- how it's calculated, why it can be expected to work, etc. When brokers send out ichimoku or DeMark charts without the slightest idea of how they are calculated, he can only shake his head and understand why technical analysis enjoys an unsavoury reputation in some circles.

Elsewhere, in honour of the release of the last installment of the Harry Potter series (no plot spoiling please!), Macro Man has finally gotten around to updating his Voldemort and co. FX reserve spreadsheet to include Brazil, making it well and truly a BRICs analysis. While he was aware that Brazil's FX reserves have been growing quite strongly, it was only when he saw the chart that he truly realized the extent of Bacen's accumulation- FX reserves have more than doubled since this time last year.

When he replaced Taiwan with Brazil in his calculation of required euro purchases to maintain benchmark, he got another jolt- the Q2 figure rose by nearly €10 billion. Now, this is an approximation, and Macro Man doesn't have a good grasp of Brazil's portfolio- for all he knows, it could be entirely in $. By the same token, of course, the above does not include any of the Middle Eastern monetary authorities, who are likely accruing reserves and assets even more quickly (in absolute dollar terms) than Brazil, and some of whom clearly keep a relatively low dollar proportion of their assets.

With a tailwind like that, is it any surprise that the risk trade is to buy Europe/USD, even at the current lofty levels?

1) In 1975, China’s urban population comprised just 17% of the total. By 2004, that figure had reached 40%. In India, by contrast, that figure rose from 21% to 29%. Belgium has the highest percentage of urban population of any non city-state in the world at 94%.

2) China’s emergence as an economic power is remarkable when looked at over longer periods of time. In 1975, the country’s per capita income was only 76% of that of Burkina Faso. Today’s it’s 5 times as high.

3) In 1989, the fertility rate in Vietnam was 3.8 children per woman. By 2004, that was down to 1.8- comparable to the fertility rate in the US (1.77).

4) New Zealand has the highest rate of internet usage in the world, at 788 users per 1000 population. The lowest rate of internet penetration is in Tajikistan, with usage of 0.78 per 1000 population.

5) Life expectancy in South Africa has fallen from 63 in 1992 to 45 in 2004, which demonstrates the magnitude of the public health problem in sub-Saharan Africa posed by HIV.

6) The country with the most sexually-liberated workforce is Mozambique, where women comprise 54% of the total labour force. The most male-dominated workforce is in the UAE, where just 13% of the workforce are women. There is little to no correlation between women as a percentage of the workforce and wealth/income; rather, it appears to be a function of cultural preferences.

7) The nation with the world’s largest per capita carbon emissions is Trinidad and Tobago (32 tons per capita); the country with the fewest emissions is Chad (0.015 tons per capita).

8) The country with the largest military budget as a percentage of total fiscal spending in the world is....Singapore, at 30%. The largest big-country military spend as a percentage of total is Pakistan, with 28%. In the US, 19% of the budget spend is allocated to the military- that’s up from 16% in 2001. The lowest military spend in the world is by Mauritius, with just 0.91% of fiscal expenditure going towards the military.

All data courtesy of www.gapminder.org, where you can see all this data and more presented in a unique graphical format using the Gapminder World tool.

So yesterday's big event risk was, at the end of the day, pretty bland. US core CPI was modestly higher than expected, but no one cared as they were waiting for Bernanke. The Fed chair's testimony was, to Macro Man's reading, relatively balanced, offering something for just about everyone to use to justify their preconceived viewpoints.

Predictably, hawks focused on the failure to downgrade the 2007 inflation forecast and the observation that the headline PCE deflator is running at a pace that's much too high for comfort. Doves, meanwhile, anchored on the surprising modest downgrade to 2008 growth expectations. To Macro Man, the most interesting bits of the whole farrago dealt with issues away from the economic cycle. That BB devoted 1/5 of his testimony to discussing the Fed's brand new regulatory vigour on subprime smacks of horse-already-bolted ass-covering of the first order. And Barney Frank's grandstanding on income inequality (a valid and pressing political issue, but surely one outside of the remit of the testimony) only serve to increase Macro Man's conviction that protectionism is a legitimate and pressing threat, and one that will get an increasing amount of airplay over the next sixteen months.

Macro Man owes the Central Bank of Russia an apology. Comrades, I never should have doubted your commitment to revalue the rouble. After the Rosneft fiasco of a couple weeks ago, the RUB has surged back (and indeed, through) the reval level against the EUR + USD basket. Now, about that James Bond style foreign policy....
Plenty of news from China as well, with the stats bureau releasing a torrent of statistics last night. Most significantly, GDP growth surged 11.9% y/y, the highest reading since 1995. Although China does not release quarterly expenditure-based breakdowns, ancillary data suggests that consumption, investment, and of course net exports all contributed to the strong reading. Retail sales growth of 16% y/y is impressive, though in comparison to per capita income growth of 18%, it's less so. Indeed, despite the strong growth of nominal and real incomes (and the paltry return on bank deposits), Chinese consumers continue to build savings.Slightly more troubling was the news that CPI rose 4.4% y/y, substantially higher than the forecast of 3.6% and the highest since September 2004. Macro Man is always amused by commentaries on Chinese inflation. Many of the same people who note the regime's desire to minimize social unrest by creating 10-15 million jobs per annum cheerfully dismiss the impact of sharply rising food prices (8.3% y/y in May.)

Now, Macro Man is au courant with the strong rise in Chinese labour productivity, but as far as he is aware that has not yet extended to workers being able to function for extended periods of time without victuals. Moreover, a "let them eat cake" response towards food price inflation has not historically been conducive to socio-political stability. And lest we think that food price inflation in China is a localized phenomenon attributable to temporary distortions, consider the remarkable correlation of food inflation in China and the US over the last few years, despite the obvious differences in their food consumption baskets.

Finally, an interesting survey out of Japan, where 44% of the firms surveyed by Reuters expect the MOF to intervene if USD/JPY rises further. Of those expecting intervention, more than half expect it to occur at or below 128. As Macro Man has noted previously, things seem to be changing in Japan. While there is likely still money to be made from shorting the yen, Macro Man (in what's becoming a theme) would expect the risk adjusted return to be less attractive in the future than it's been in the recent past.

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.

When the weather's getting you down, there's nothing like bolting town to escape....unless you happen to go to Scotland on business, where it gets even colder (and, if possible, wetter.) Golf fans 'round the world need only tune into this week's Open at Carnoustie to get a flavour for what Macro Man and other denizens of the appropriately-named Blighty have put up with this "summer."

A day out of the office also affords one the opportunity to reflect on markets without the pressure of a screen and brokers providing, during environments like these, plenty of noise but lamentably little signal. Macro Man has been giving plenty of thought to volatility and risk premia after the latest victory of DOTW (Dipbuyers Of The World). And upon further review, he still expects both realized volatility and risk premia to rise, even if the absolute return of risky assets remains quite strong. Consider the following:

1) The credit issue isn't going away. Not only is the turd-calibre BBB- ABX index plumbing new depths (left hand chart below), but ominously even the AAA rated tranche is starting to roll over (right hand chart.) And you heard it here first: the US is indeed asking China to buy more mortgage backed debt!

2) The quality of economic data remains poor, to say the least. It now appears that that some of the missing construction job losses in the US may not be missing after all. Per the usual, we'll probably have to wait for the benchmark revisions in Q1 2008 to tell us how horrible the construction job market was in Q1 2007.

3) Will the strength of the euro fracture Europe? The strength of the euro exchange rate is probably close to the level where it will start to impact ECB monetary decisions, if we're not there already. Of course, attempted intervention by Nicolas Sarkozy could well encourage the ECB to stay the tightening course when they otherwise might be tempted to stand pat. Such suboptimal policymaking should ultimately deliver suboptimal economic outcomes, which should drive financial market volatility.

The UK press is already cackling at the prospect; yesterday saw columns in both the Telegraph and the Times discussing Europe's currency problems. Neither mentioned the role of FX reserve managers in driving euro strength, which is one of the reasons why Macro Man chooses to highlight the subject so often. Those unfortunate enough to trade foreign exchange know, by and large, that SAFE, CBR, the Gulf monetary/investment authorities, et. al. are hegemonic participants in the EUR/USD and GBP/USD rates; the mainstream media remains blissfully ignorant, for some reason.

4) Don't look now, but energy prices could/should become a concern again. Goldman's excellent oil analyst Jeff Currie recently suggested that crude prices could reach $90/bbl without OPEC production increases; tellingly, oil curves have moved from steady contago into backwardation recently. The chart below shows the first minus the fifth Brent contract, for example.

This should both increase the attraction of oil longs (despite the recent rise in spec length) and increase the inflationary impulse from energy should the prices be sustained beyond September (due to base effects.) Macro Man has tangential exposure through his TIPS position (which recently paid its coupon) , but may consider adding some calls on a dip.

5) Currency complaints aren't just the province of Europe. New Zealand finance minister Cullen suggested that the government could change the RBNZ's mandate to prevent further rate increases , which in turn strengthen the kiwi dollar. Killing the inflation-targetting goose that laid the golden economic egg would probably be a case of the cure being worse than the disease, but it once again suggests that policymakers the world over are being tempted by suboptimal policy options.

And that, at the end of the day, should help promote a secular rise in financial market volatility once one cuts through the day to day noise. Even if the DOTW remain profitable moving forwards, Macro Man cannot help but expect that their Sharpe ratios will decline. He has to admit, however, that such a development doesn't appear imminent; then again, it never does.

The dip-buyers of the world have certainly united, to the extent that "dips" soon look like "blips" on the chart. Once again, traders have been rewarded for closing their eyes and buying weakness, a turn of events which has left many of Macro Man's more seasoned amigos in the market scratching their chins and shaking their heads.

Macro Man himself has locked in a rather costly round-trip on the FX carry trade, as the indicator he follows unsurprisingly swept back into risk-seeking mode overnight. Three days and $700k later, he's back where he started.

Today's retail sales figures in the US will almost certainly show another tepid reading, but that probably won't come as a substantial shock to many people. Thanks to trade, inventories, and business investment, Q2 growth in the US looks set to post its highest reading for some time; Morgan Stanley, for example, is forecasting growth at a 3.9% saar clip.

While that pace is virtually certain to slow in H2, it's still not exactly suggestive of an economy on the ropes, is it? It's difficult, therefore, to construct a secular bear case for risk assets unless one believes that the entire financial system is built on a rickety foundation funded by subprime loans.

Those of us old enough to remember when the Friday the 13th movies went on cinematic release are perhaps scarred by the lurking menace of Jason, and tend to see him around every corner (or dip/blip) in markets. It calls to mind the old Stanley Druckenmiller anecdote of how he was elevated to a senior research position very early in his career because he hadn't been scarred by the 70's bear market. Perhaps Macro Man should just hire an army of 22 year old and Japanese housewives to trade the market for him, as they evidently aren't troubled by the same nightmares as him.

Macro Man will be away on business Monday; normal service should resume on Tuesday.

If those legendary 80's musical mopers The Smiths were still actively recording, they would probably reconsider remaking one of their hit songs as "Dip-buyers of the World Unite." No doubt such a tune would be the theme song of Generation-Y financial market particpants, as yet again a risk event has (thus far) morphed into a buying opportunity. Whether that remains the case in the fullness of time remains to be seen, but for now we can evidently chalk up another victory to the dip-buyers of the world, perhaps masterminded by the nefarious Mrs. Watanabe.

Anatole Kaletsky had an interesting column in The Times this morning discussing the weak dollar and what it actually means. His brief discussion of the reasons for dollar weakness were woefully incomplete- not a single mention of Voldemort and friends!- but the contemplation of the weak dollar's implication is worth considering.

While modern hedging techniques can help delay and partially reduce the impact of exchange-rate pass through, over long periods of time the piper must eventually get paid, as Airbus is learning to its chagrin. That the US trade deficit has stabilized and even improved in the face of firm energy prices is, Macro Man believes, a testament to the impact of dollar weakness against European currencies in particular. We'll find out at 8.30 am New York time today whether this development continued in May.

Macro Man has mused before that the market is ignoring the cyclical dynamic in G4 currencies, potentially at its peril. The OECD recently updated its leading indicator series, and what do you know? Economic momentum is now stronger in the US (subprime and all!) than in Europe for the first time in a year and a half. If this trend extends over the next several months- and Macro Man sees no reason why it won't, given that Europe is just now feeling the bite of non-accomodative interest rates- this should, in the fullness of time, be reflected in currency prices.

News that CBs have perhaps filled their boots full of EUR for the time being is tempting Macro Man to sell some EUR/USD or GBP/USD here. However, he has toyed with the idea that the 'new range' for EUR/USD may have shifted to 1.35/1.39; therefore, it probably makes sense to wait and sell as close to 1.39 as possible.

Morever, it's not as if CB reserves are staying static. BOK was evidently in the market after hiking rates last night, and RBI ramped USD/INR higher early in the London session. Actions such as RBI's leave Macro Man shaking his head when he reads analyses suggesting that the US is somehow addicted to CB financing of the current account deficit. Deficits will always be financed at the appropriate price. As India has found, delaying that appropriate price from being reached can have unintended and unpleasant consequences (e.g., inflation.) At market-clearing exchange and interest rates, the private sector will be happy to finance the US current account- which, incidentally, would almost certainly be smaller (and thus easier to finance) at market-clearing prices that it is today.

After all, it's important to remember that there's more to the US economy than a fast-food nation of SUV drivers!

1) FX reserve growth continues at a ridiculous pace. China released its Q2 reserve data today, and Jon Anderson of UBS was right- reserve growth did slow in Q2. Instead of growing $135 billion, as it did in Q1, China's pile of FX reserves grew by a miniscule $130 billion in Q2. The chart below illustrates the reserve growth of China, India, Russia, and Taiwan.
2) The pace of growth really has been parabolic. Consider the rates of change of China, Inida, and especially Russia over the last year. All of these countries are active particpants in diversifying/maintaining portfolio benchmarks for their currency reserves.

3) Adjusting for valuation, the TRIC central banks (RIC, really, since CBC has actually sold a few dollars recently) had to buy €39 billion in Q2 just to maintain portfolio benchmarks. When one considers that Russia's reserve growth is almost certainly mirrored in the Gulf, and that some Gulf states have much lower dollar weightings in the their portfolios than China or even Russia, the official demand for euros in Q2 could easily have exceeded €50 billion.

It looks like the CBs and investment authorities were hoping to buy euros on the dip, but failed- hence the recent scramble to pay offers at nosebleed levels. Looks like they've been using a ratings agency toolkit of their own!

As many readers will no doubt be aware, there's been a bit of market volatility over the past twenty four hours. The dollar is weaker, equities are lower, credit is wider, and govvys are bid. While these developments had been percolating for a few days, they received fresh impetus yesterday on the new that Moody's has downgraded a small pile of subprime rubbish and that S&P has put another, slightly larger pile of subprime garbage in the queue to be downgraded.

This, combined with heavy private and public sector activity yesterday, helped propel EUR/USD to new all-time highs and taken the DXY within a whisker of 15 year lows. When Big Ben failed to offer out a rate cut lifeline in yesterday's speech, US equities extended the early-session losses to finish sharply lower. This morning, credit has continued its recent rout, with the European crossover index briefly touching a spread of 300, a significant widening from the 197 level posted just 3 weeks ago.

Unsurprisingly, Macro Man's FX carry filter flashed red this morning, and he jettisoned the basket on the opening. While many of the carry crosses have actually come back so far today (the dip-buyers cannot be crushed so easily!) , one would have to believe that another day or two like yesterday could finally generate the dip that you don't want to buy. Insofar as ratings agency action may force liquidation from funds constrained by investment guidelines, yesterday's downgrade action does represent a new factor in the risky asset equation.

Macro Man has been around long enough that he has developed a network of contacts throughout the financial industry. One of his moles in the ratings agencies was kind enough to pass along his firm's "Subprime Analyst Toolkit" in response to Macro Man's query on their rating methodology.

Macro Man was actually quite impressed by the three-pronged approach taken by the agencies, as well as the degree of sophistication embedded in the technology. Fortunately, he received permission to share the contents of the toolkit with his readers:

1)
The most important piece of technology is the pillow. This part of the toolkit is the most actively used by analysts, as they tend to spend most of their time asleep. Some agencies apparently prefer violins (allowing the analysts to fiddle while the market burns), but a pillow is clearly state-of-the-art technology and is now industry standard.

2)

Of course, analysts cannot spend all of their time asleep. At some point, they need to wake up and actually study the merits of various subprime issues and credit structures. Fortunately, they are provided with this alarm clock that rouses them from their slumber. The alarm has a built-in link to credit speads and ABX indices, and triggers when the market has almost fully discounted agency ratings downgrades. For the comfort and convenience of the analysts, the alarm clock is equipped with a handy 'Snooz' button that allows them to catch an extra few weeks of sleep should they so desire.

Once the analysts are finally awake, however, they still must perform an evaluation of the merits of the various securities and structures within their bailiwick. Fortunately, the agencies equip their analysts with a rearview mirror so that they can see for themselves what has already passed and act accordingly. The rearview mirrors got a particularly heavy workout in late 2001 and 2002, for example, with the debt of firms like Enron and Worldcom.

宏觀人崗位現在可接受對中華人民共和國的檢查員

"You want the truth.....you can 't handle the truth!"

- Col. Nathan Jessep, A Few Good Men

Imagine Macro Man's surprise when he read a comment on Brad Setser's blog suggesting that access to his humble journal has now been blocked in China. He has no idea if this is true or not, and isn't sure what his reaction would be if it is. Surprise, for sure, tinged with perhaps a touch of pride (clearly he is hitting a nerve!) and more than a little sadness (does Col. Jessep really live in Beijing now?) Somehow, however, Macro Man suspects that his little hobby probably doesn't register on the radar of anyone who really matters. Still, if any of Macro Man's Chinese readers (there have been a few) happen to see this post, by all means let him know that he's not blocked!

Perhaps any web access shenanigans were conducted with a foreknowledge of China's June trade data, which was a whopper. The surplus registered at a massive $26.9 billion, a new record and well above the consensus expectation. Some of the surplus may well have been a product of frontloaded activity resulting from the July 1 withdrawal of some export tax rebates (i.e., subsidies), though in that case it was strange to see exports fall from 28.7% y/y to 27.1%. The real driver behind China's surging surpluses, however, remains tepid imports, which in June rose just 14.2% y/y, well below the expected 20%. Could it be that PBOC has actually managed to tighten and that the economy is slowing?
Trends in China's trade with the US are particularly interesting, as we now have data through May (the month of Madame Wu's visit to Washington, you may recall.) There is a clear seasonality to US/China trade, with a peak in the run-up the Christmas season and a nadir around the lunar New Year. Through the first two months of Q2, China's trade surplus seems to have clawed back less of its Q1 drop than has been the case in recent years. Some of this may well represent the inventory adjustment that the US economy has sustained in the first half of this year. Nevertheless, it is remarkable to see that the growth in China's exports to the US has fallen sharply and is now at its lowest level since the last recession.

Eagle-eyed politicians might also observe that the recent peak in China's export growth to the US occurred just before the Chinese revaluation in July 2005 and that the recent deceleration has come as the pace of RMB strengthening has intensified. Indeed, recent trends in import/export growth are likely to reinforce the notion that the China's undervalued exchange rate is exerting a meaningful influence on trade, and thus maintain US political pressure on China for further action.

Moving forward, however, the US may not be a lone voice in criticizing China's currency policy. China's trade surplus with Europe has trended higher on an even more parabolic path than that with the US, and on current trends may even exceed that with the US in a couple of quarters. There's quite a bit of noise in the data, however, and it will be interesting to see how export growth is distributed when the full set of June data is released next month.

A common defense when China is charged with mercantilism is that the country only runs a surplus with noted consumers, and tends to run a large deficit with other current account surplus countries. That argument may be fading. The May deficit with the rest of Asia registered its smallest reading since the last recession and is only a hair from switching into surplus. Observe the remarkable trend decline in import growth from Asia over the past half-decade; it's hard to avoid the conclusion that China has taken quite a bit of market share from its neighbours over the past few years.

One country which still enjoys a trade surplus with China, however, is Japan. Part of this may be attributable to the relative growth of domestic demand in the two countries, and some of it may suggest that the yen is just as weak as the RMB!

Key focus for the day will be Big Ben's afternoon speech on inflation; might he offer some hints on a switch of focus to headline? Inquiring minds (and TIPS holders) want to know!

Macro Man was stunned to discover over the weekend that the sun has not, in fact, spontaneously extinguished itself. It had been so long since our local star had appeared in the sky that Macro Man had to explain to his children what that bright thing up above was. No doubt its sporadic appearances for the remainder of the summer will be timed around Macro Man's holidays; such is the nature of British weather.

There are a few things that have grabbed Macro Man's eye this morning, including the following:

* As expected, an enterprising pubic figure has decided to have a go at the ratings agencies. Ohio attorney general Marc Dann is investigating the agencies for aiding and abetting subprime mortgage fraud. Readers will be shocked to learn that prominent Ohio pension funds are long MBS and ABS out the wazoo...

* It's official: the name of China's soverign wealth fund will be China Investment Co. , Ltd. (CIC for short.) Central Huijin will be folded into the CIC but evidently maintain some investment autonomy. PBOC will apparently broker (but not underwrite) the sale of CIC's bonds, likely to be timed with the maturity of PBOC's own sterlization bills. Replacing short term bills with CIC's long term debt should serve to steepen China's already-steep yield curve; this is a trade that may merit some consideration in the future. CIC plans to open its door for business in September.

* The policymaker backlash against carry continues apace. The FX market is abuzz with talk that Nicolas Sarkozy will have a proper moan about the strength of the euro (particularly EUR/JPY) at this week's Ecofin meetings. Today, Taiwan's central bank sold USD/TWD into the close, getting maximum bang for their buck and sending USD/TWD sharply lower. Do you think the closing pip price was some sort of editorial comment about the carry trade from CBC?

* Another piece of propaganda has appeared in today's Nikkei newspaper: Weak Yen Threatens Japan's Global Stature (subscription required.) Is this a pre-emptive strike by the MOF to counter Sarkozy-esque complaints, or a legitimate change of opinion within Japan? Perhaps a bit of both. Regardless, the steady stream of yen propaganda is certainly interesting and suggests to Macro Man that USD/JPY is very, very unlikely to go above 130 for the foreseeable future.

* The RUB has appreciated slightly against its basket today, suggesting that last week's shellacking may well have been a flow-driven phenomenon. What's interesting is that NDFs are still pricing the forward basket at the reval level. Is this a change in regime towards a more flexible basket peg or a one-off discrepancy? What is certain is that Russia should have a stronger exchange rate on both a terms of trade and monetary policy basis.

* Those with access to the hard copy of The Times of London can obtain a firsthand view of how manipulated/manipulative the mainstream media really is. Page 9 offers up a pseudo-panegyric to Boeing's new 787 Dreamliner, as does the editorial page. Imagine Macro Man's shock when he turned to page 15 and saw a full page ad from Boeing (the first he has ever observed in The Times) declaiming the eco-merits of the latest iteration of the 747. Yet another timely reminder of the importance of filtering media reports through a critical lens....

While the headline payroll report was as close to consensus as you'll ever see, sure enough there were some revisions that suggested a stronger US labour market that previously thought. Quelle surprise! Perversely, construction payrolls showed another modest 12k gain. Macro Man was actually pleased to see that, as it implies that either

a) the payroll data is as useless as he thinks it is
b) Homebuilders still don't get it, meaning more pain to come
c) Both of the above

Either b or c would suit the portfolio, naturally.
Markets clearly are trading on the basis of pain or flow, however. While this week's US data has, in aggregate, been somewhat better than expected, it surely didn't merit tacking on 20 bps to the ten year yield. It seems likely that the market has been caught long and wrong and is now paying the price.

In FX, meanwhile, the market (or, more specifically, central banks) have decided that they are buyers of EUR/USD at current levels no matter what. So after payrolls produced a run of stop losses down to 1.3568, Macro Man's best buddies the central banks have helped drive it up to a high of 1.3642. The moral of the story is that when swimming in financial market waters, you should know who and where the sharks may be.

Nowhere is this more true than in Russia, where the recent revaluation of the rouble has been compltely unwound. Is this a temproary quirk, or did the CBR just pull the bid to let Russian corporates buy some cheap dollars? We'll only know if the fullness of time, but it is interesting to note that Rosneft paid US-based UniTex today for its share in Yukos gas stations. Hmmmmm.....