Friday, September 28, 2007
Macro Man breathed a sigh of relief this morning when he saw the cover of The Economist. It would appear that the trend of dollar weakness has at least another week to go; more importantly, it's nice to see the magazine focus on a life and death type issue that has unfortunately been ongoing for the better part of two decades.
The dollar continues to trade on the back foot, meanwhile, as markets slide into the end of the quarter. Word on the street is that take-up for recently launched investment trusts in Japan has been paltry, thus giving the yen a small boost this morning. Meanwhile, even erstwhile whipping-boy the Taiwan dollar has gotten into the act, with USD/TWD now trading at its lowest level since mid-January. If the greenback starts losing ground against the Zim dollar, however, then you'll know it's probably time to start covering.
Macro Man wonders what is more unpleasant: the chart of US new home sales, now down 40% + from its peak, or the frustration of housing market bears that their favourite issue has not resulted in lower stock prices, as measured by the indices, in the US? That the SPX is up this week despite a pretty unambiguously poor set of macro data (yesterday's jobless claims notwithstanding) is a testament to the importance of liquidity and globalization in driving asset prices.
Macro Man wonders if there won't be plenty more juice in the emerging theme of large caps (many of whom derive income from foreign operations) outperforming small caps (which tend to have a more domestic focus.) He intends to do some more thinking and investigation, and may establish a position next week.
For now, it's hold onto your hats (and hopefully, your P/L) time; only a few hours left to make (or keep) money this month and quarter. Good luck.
Thursday, September 27, 2007
After last week's eventful developments, market interest and activity appears to be pausing for breath, at least until tomorrow's quarter-end. While certain enterprising retail establishments may already be gearing up for the Christmas/holiday season, one can only hope that financial markets are not sliding into their usual late-year lethargy.
Given the strong October seasonality and continued uncertainty over America's economic and monetary trajectory, there would appear to be little danger of market stagnation over the next few months. Indeed, a few interesting nuggets have emerged over the last day or so that warrant mention, as they once again suggest that de-coupling, at least financial de-coupling, does not appear to be happening:
* Warren Buffett to buy a stake in Bear Stearns? Rumour has it that the Oracle of Omaha and some Chinese banks, among others, are looking at taking a chunk of Bear. Such a transaction could ignite a rally in the financials, which have badly lagged the SPX recovery to date. (Disclaimer: Macro Man owns a bit of BSC p.a.)
* UK house prices have risen 0.7% this month, according to Nationwide Building Society. This was more than expected and should help calm, at least temporarily, fears that the UK housing market is set for a lemming-like leap off the white cliffs of Dover. Meanwhile, nobody took the BOE up on its recent offer to lend £10 billion at the penalty 6.75% rate.
* On the flip side, yesterday the ECB lent €3.9 billion to an unnamed bank at a punitive rate, suggesting that turbulent undercurrents continue to swirl below the apparent calm in money markets. Month end could provide a few fireworks as banks try to tart up their balance sheets...then again, maybe it won't . We'll know soon enough, however.
Given the relative quiet, Macro Man thought it might be interesting to review the situation in a country where he has significant market risk but has, alas, taken a rather laissez-faire attitude towards his positions. The clue is in the title of the post, as he is of course referring to Japan.
This week saw the annointment of Yasuo Fukuda as prime minister, an event which, by all accounts, places the reforming vigour of Junichiro Koizumi more firmly into the rearview mirror. While Fukuda has retained a majority of Abe's Cabinet ministers, that is not necessarily any great thing. And his appointment represents, from everything Macro Man can tell, a return to the factional, behind-closed-doors dealmaking politcal environment that dominated Japan in the decades prior to Koizumi's election.
In any event, Macro Man has sigificant alpha portfolio risk in short JGBs, with a bit of long yen and long vol risk as well. Of course, the beta portfolio is short yen, so all-in directional FX risk is a moveable feast. That being said, it's worth reviewing the macro situation.
BOJ governor Fukui's term ends next spring, and it is widely believed that he would like to hike rates at least one more time before his departure. To date, CPI inflation has prevented him from doing so, as both headline and core CPI have been negative y/y for most of the year. However, as energy price base effects recede, it is perhaps possible that we see CPI back positive soon. This could be all a trigger-happy Fukui requires to hike another 25 beeps.
Certainly underlying price pressures would appear to be greater than suggested by CPI. Wholesale prices and corporate services prices are both rising, with the rate of change steadily increasing over the past several years.
Elsewhere, the nominal P/L has eked back into positive territory on the month, though there's still a crucial period of trading to come. USD/GCC appears to be undergoing a bit of short-covering after yesterday's SAMA non-event, and it seems reasonable to expect that that may continue until next week. Macro Man will look at layering shorts then. Markets still need something to talk about, though, so revaluation focus as switched to Hong Kong. Plus ca change...
Wednesday, September 26, 2007
So will this be the week that The Economist slaps the dollar on the front cover? Macro Man certainly hopes not, as he is positioned for further dollar weakness and would prefer not to face such a formidable obstacle to further profits. The euro-centric DXY came within tickling distance of its all-time lows yesterday, though it has subsequently backed off a smidge.
Some market technicians are now calling for a respite, given that the buck appears "oversold." And while a pause in dollar weakness, particularly one that keeps The Economist focused on other things, may certainly be refreshing, it would appear unlikely if Macro Man's reading of the current market environment is correct.
Simply put, he does not feel that the market has the short dollar trade on in meaningful size-certainly not in the same magnitude that existed in 2003-04. Part of that is a result of current low-volatility environment, which encourages relatively rapid profit-taking. Indeed, there has been plenty of evidence that some euro longs have been taking money off the table this week. More strategically, however, dollar weakness hasn't really resonated as a thematic macro trade, other than in brief pockets, for the past couple of years.
After all, if you're a macro hedge fund, why screw around with a currency that trades on a 5% or 6% annualized volatility when Turkish or Brazilian equities can move that much in a day? Macro Man's sense is that that may be changing, and that once month- and quarter-end passes on Friday, these funds may be prepared to expend more of their risk budgets on giving George Washington a smack.
And while history may not repeat, it quite often rhymes. Macro Man has observed an interesting phenomenon in EUR/USD which suggests that any near-term pullbacks may be very shallow indeed.
In 2003, when EUR/USD posted its first weekly close above 1.10, it rallied 9 figures in more or less a straight line before stalling.
Later that year, when it registered its first weekly close above 1.20, it ended up rallying another 9 figures in a straight line before losing ground.
Focus this morning is on an announcement from SAMA. To say that Western analysts and fund managers, including Macro Man, have no special insight on this would be an understatement. Indeed, the banks that Macro Man speaks to cannot even agree whether this is a regularly scheduled announcement or something extraordinary.
Tuesday, September 25, 2007
Every so often, Macro Man is accused (often by friends and family) of being a know-it-all. As regular readers will have no doubt deduced, he does tend to have strongly-held opinions, and is often less than subtle in his manner of expressing them. But one thing that he takes special care to avoid is overconfidence, and a willingness to admit that he does not know something has saved him from loss and embarrassment on a number of occasions.
As Macro Man scans the world around him, he sees plenty of cause for confusion and head-scratching. Among the things that he does not understand are the following:
1) What, if anything, is the C&I loan data saying? Amidst the "worst crisis in 25 years", commercial and industrial loan growth has soared. Some of this no doubt represents a substitution effect (i.e, bank borrowing rather than CP or bond issuance), but the very fact that banks have been willing to lend suggests the fears of a financial system implosion were overstated. Indeed, current y/y C&I loan growth is the highest in-you guessed it-25 years.
Given the braodly cyclical nature of loan growth, that would appear to suggest that the US economy is as far from recession as you could get. Yet the indicator appears to be a lagging one; in the last economic downturn, for example, loan growth didn't turn negative until July 2001. So is the C&I telling us about the cycle, liquidity, or just the substitution of bank borrowing for issuance?
2) In the aftermath of the first bank run since the 19th century, how can the UK Government be so popular? Regardless of where one sits on the political spectrum, it is hard to escape the notion that the Northern Rock fiasco could have been handled better. Normally, scenes of lengthy queues outside of banks would spell disaster for the current government. Yet Labour, led by the heretofore intensely uncharismatic Gordon Brown has, if anything, seen its approvals ratings rise, to the degree that Gordo is contemplating an early election. How has this happened?
3) How has the Ireland rugby team become so bad, so quickly?
4) Why, on the day that Goldman Sachs reported blow-out earnings ($6.13 versus $4.35 expected) and Bear Stearns reported awful earnings ($1.16 versus $1.71 expected) did GS stock fall $1.97 while Bear stock only declined by 18 cents?
5) What are GCC countries waiting for? Kuwait has revalued the dinar by another negligble amount this morning, yet other Gulf countries have remained steadfast in their dollar pegs. What are they waiting for before they float/revalue? The current policy regime is pretty clearly highly suboptimal, and as things now stand the macroeconomic impact is only going to get worse. With oil at 80 bucks, it's not exactly like the Gulf countries are going to run out of cash any time soon, so why wait? Is it because they wish to avoid speculation on their domestic currencies?
If so, the permit Macro Man a derisory snort, given that Middle Eastern institutions are among the more predatory speculators in the G4 currency markets.
6) Why are short-dated inflation breakevens in the US so low? In case you hadn't noticed, commodity prices are en fuego recently. And these tend to be the primary driver of changes in headline CPI. The weak dollar has attracted a bit of attention as well., and we know that China is no longer exporting deflation. So why are short-term breakevens (proxied below by the 1 year inflation swap) near their lows of the last six months?
Monday, September 24, 2007
Sigh. And so the long dark winter is upon us. When Macro Man left the house this morning, it was absolutely pitch black for the first time since last March. Although the weather remains reasonably mild (it's warmer in late September than it was in late July), the onset of autumn is well and truly here. Once daylight savings is reversed in October, daylight will be for lunchtimes and weekends only.
Whether the winter proves to be one of happiness or discontent remains to be seen, of course. Financial markets are busy developing historical analogies to the current environment. Is it the aggressive asset price reflation of 1998? The recession/stock market rally of 1991? Or perhaps even the 'Fed behind the inflation curve' episode of April 2006?
At this juncture it is difficult to say, for of course history may rhyme but it rarely repeats verbatim. What does seem clear, however, is that there is currently a disconnect in financial markets. Now, disconnects are strange animals. They can occasionally be sources of rich opportunity in what Macro Man jokingly refers to as Heinz trades (Heinz--> ketchup-->catch up, in which an outlier eventually returns to 'correct' pricing.) But they can equally be a source of intense frustration, because there is no guarantee that the ketchup comes out of the bottle, so to speak.
What is striking now is the degree of easing priced into the eurodollar curve, and by extension that short end of the Treasury curve, with the "gas on the fire" response of risk asset markets both before and since the Bubble Boy's 50-beep gift last week.
If we compare the eurodollar strip with last Friday's three month LIBOR fixing, we see that the strip is discounting three month interbank rates more than 0.75% lower by the middle of next year. Some of that no doubt represents a compression in the spread between LIBOR and Fed Funds, but some of it undoubtedly is pricing in further rate cuts.
Now, if you believe that the housing market is a black hole at the centre of the universe which is
Friday, September 21, 2007
All of a sudden, markets feel like they've had enough. The dollar has tried and failed to extend losses this morning, and equities are drifting higher after yesterday's weakness. 10 year bonds across markets remain on the back foot, though a set of execrable PMI data from Europe have arrested the decline for the time being. After an enormously eventful week, it seems as if Macro Man isn't the only one content to go quietly into that good (hopefully, should Ireland beat France tonight) weekend.
The benefit of quiet days, of course, is that they allow us to take stock of big picture views and developments. Over the last couple of days and weeks, Macro Man has articulated his growing disillusionment with the dollar and expressed fears that the next bubble will be one of dollar weakness.
While the current shellacking of the buck does not yet represent anything like a bubble, it has certainly taken a number of exchange rates to interesting levels. Yesterday, Macro Man noted that the EUR/USD rate is now "bigger" than the USD/DEM rate. Soon after, another historical threshold was reached. For the first time since America's bicentennial year, a Canadian dollar is now worth more than its US counterpart.
The chart above doees not include the current quarter, else you'd see the last candle below 1.00. How sustainable the uber-loony is remains to be seen, though Canadian policymakers have, to date, played down the impact on domestic manufacturing. The recent recommendation of a commission in Alberta to raise the royalty taxes on tar sands developments has attracted some attention, but the sort of extra revenues expected to be raised (some $2 billon per year), while non-trivial, are hardly on a scale that will dissuade investment, particularly if oil continues its march on $100/bbl. The next obvious target is the post-Bretton Woods low of 0.96.
Another financial market price at historical levels is of course gold. Macro Man has highlighted the importance of the $730 level on a couple of occasions, and the chart below offers a belated demonstration of why. The first gold future bounced hard off of $730/oz in both 1980 and 2006. It has now breached this level, and technically it's clear sailing from here to $870. Given sentiment, the pace of the move could prove to be quite explosive.
Thursday, September 20, 2007
Nothing like a complete breakfast of cereal and toast.....
Toast. Not only is it a wonderful breakfast food- tasty with honey, jam, marmalade, butter, or even dry-but it is also a pretty accurate description of the current parlous state of the US dollar.
Macro Man has long been more favourably disposed to the buck than many. His disavowal of the "dollar must go down forever" thesis is one of the reasons that he (unfortunately) didn't delta hedge his powerball strip. However, even his patience has its limits. A few weeks ago, he noted that any aggressive gesture from the Fed to bail out turd-holders and reflate asset markets would force him to turn structurally bearish.
That has now come to pass, and in what Dennis Gartman might refer to as a "Watershed" moment, Macro Man has lost faith in George Washington. Simply put, if the Fed doesn't give a crap about protecting the purchasing power of the dollar, why should anyone hold it?
We've reached a rather interesting juncture in EUR/USD, at least if you are a fan of arcana like Macro Man. Not only has EUR/USD breached 1.40 for the first time, but it is now trading "above" its implied USD/DEM equivalent (on the basis of the EUR/DEM conversion rate of 1.95583) for the first time. This might only interest a finance geek like Macro Man, but he still thinks it's telling.
Impetus for the dollar's latest downturn has come from panic-monger extraordinaire Ambrose Pritchard-Evans, who highlights in this morning's Torygraph the growing risk that Middle Eastern countries abandon their dollar peg. While the headline might be straight out of the Sun or New York Post (the author must be short dollars p.a.), the theme is a very real one.
Inflation in the Middle East is rising due to three factors: "Dutch disease" oil revenues, artificially low rates resulting from the dollar peg, and the weakness of the buck in foreign exchange markets, particularly against those regions from which the Middle East imports most of its goods. The trend in UAE inflation, while perhaps more dramatic than in other countries, is neverthless emblematic of the problem at hand.
They had 9% inflation last year, which will almost certainly print double digits this year. Why, then, are rates at 4.7% and the dirham allowed to slide down the toilet? The obvious solution is to break the peg....which, in the case of Saudi Arabia, could disrupt a source of large price-insensitive capital flows into the US.
The trend seems clear, therefore-at least until The Economist puts the dollar on its cover. Rallies should be used as an oppurtunity to add to dollar shorts. In the meantime, however, gold may offer the best risk/reward opportunity. $730 is a massive level in bullion; a break should target $850 in fairly short order. Macro Man will therefore stop into longs at $742 in the Dec futures contract, adding to the exposure he has from options.
Finally, Swervin' Mervyn has testified before the Treasury Select Committee today. In a shocking, SHOCKING development, King has defended the bank's actions and blames the apparent inconsistencies on other people/organizations. Sorry, Merv: you've blown it.
And for what reason? NRK continues to head lower, and rumours are swirling that HBOS and Alliance and Leicester are preapring to step up to the BOE's liquidity milk-teat. Please, everyone....form an orderly queue.
Finally, today's equity action is likely to be driven by Goldman and Bear Stearns earnings. So far Lehman has beaten estimates whil Morgan Stanley missed. But the real action should be today: Bear was at the epicenter of the subprime earthquake, while GS has both a superior reputation and more proprietary exposure. Still- things are unlikely to be that bad. A Goldman friend of Macro Man's mentioned on the train this morning that he hopes GS misses earnings...so that his bonus allocation (paid in GS stock) will be at a lower price level...
Wednesday, September 19, 2007
Well, that was an eventful night. No, not the Fed cut and the concomitant risk asset orgy that followed; Macro Man covered that in his last post. Rather, he's referring to some of the things he saw and heard when he went out to party afterwards.
It's a bit of a tradition that after staying late to follow markets during periods of extreme importance, one goes out to paint the town. You know, to decompress, let off some steam, and hopefully celebrate a profitable evening's trading.
So Macro Man and a few buddies made their way to a karaoke bar in Soho, looking for an evening's entertainment of firewater and off-key vocalizing. Imagine our shock and surprise when we got there and found Alistair Darling and Barney Frank knocking back tequila shots and monopolizing the mic! Who knew that those two were such rowdy friends.
In any case, neither one is much of a singer, especially after emptying the better part of a bottle of Cuervo Conmemorativo. Most of their singing was pretty garbled, but Macro Man did manage to understand one Rolling Stones song that they performed. Perhaps due to their consumption of tequila, though, they altered the lyrics. Here's what they were singing:
Under my thumb
The bank that once had me down
Under my thumb
The bank that once pushed me around
It's down to me
The difference in liquidity
Down to me, the change has come
It's under my thumb
Ain't it the truth man?
Under my thumb
The hard-ass bank that's just had its day
Under my thumb
Now they've cut rates and so changed their ways
It's down to me, yes it is
The way it just does what it's told
Down to me, the change has come,
It's under my thumb
Ah, ah say it's alright
Under my thumb
An inflation-fighting man
Under my thumb
I've just made him throw down his hand
It's down to me
The way it cuts when it's spoken to
Down to me, the change has come
It's under my thumb
Ah, money's easy babe
It's down to me, oh yeah
The way it cuts when it's spoken to
Down to me, the change has come
It's under my thumb
Yeah it feels alright
Under my thumb
Its views are just kept to itself
Under my thumb
I can make it bail out someone else
It's down to me, oh that's what I said
The way it cuts when it's spoken to
Down to me, the change has come
It's under my thumb
Say, SPUs are up 40 now...
Says it all...
Says it all...
Money's easy babe
Money's easy babe
Keep it, keep it easy babe
As if that wasn't shocking enough, imagine Macro Man's surprise when he encountered the Deputy Governor of one of the regional Feds. This gentleman, kitted out in some rather natty casual threads, seemed rather emotional about the aggressive Fed move.
Macro Man managed to corner him and ask him if the Fed viewed saving the leveraged buyers of crappy credit as the rationale for easing. Did they realize who they were saving via this provision of liquidity? Here's how he responded:
All this is in good fun, of course, but the reality is that the aggressive Fed easing, with a veiled promise for more, ignites the "kick the dollar" scenario that Macro Man has been contemplating. Why buy US financial assets? Other stock markets are cheaper. Other bond markets offer superior real yields and safer credit. Other central banks provide a clearer commitment to protect the puchasing power of the currency.
Global investors largely shunned the US market in July as the recent crisis was beginning to percolate. With CIC coming into existence at the end of this month, what odds that the formerly reliable inflow of capital from China becomes a little more selective? Such is the stuff of dollar shellackings.
What's interesting is that the back end of the US yield curve actually sold off after the rate cut. Part of this may have been due to the placement of curve steepening trades, but some of the rise in yield must surely represent a risk premium against the Fed throwing gas on the inflationary fire. For headline CPI, base effect Nirvana will morph into base effect Hades in Q4, and it is eminently possible that we'll see a 4 handle before the year is out. Negative real yields on two year notes, anyone?
Macro Man finds it very interesting indeed that the Fed has cut rates and eased its inflation concern even as 5y/5y inflation breakevens have shot higher. This measure will probably provide a good barometer of Fed credibility (or lack thereof) moving forwards; a continued rise will be bullish for gold and very, very bad indeed for the dollar.
Unsurprisingly, the FX carry basket was triggered back into existence, sadly after most of the moves have already occurred. These trades were placed this morning. Elsewhere, Macro Man neglected to input the roll on his JGB position; that has now been done.
The collapse in FX vol has kept the portfolio in the red thus far this month, but the overall loss is manageable and there should be plenty of opportunity to make it up as Helicopter Ben's dollars drift down to earth.
Tuesday, September 18, 2007
That's what it is.
Macro Man covers his ESU7 short at 1501 and buys another €20 million at 1.3925 spot basis.
Let the good times roll.......hangovers are for suckers, worriers, and the sad bastards who don 't live under the warm embrace of friendly central banks.
Damn the torpedoes, full speed ahead!
At last, the waiting's over and the big day is here. Investment bank reporting season kicks off with Lehman Brothers before the New York open, and the most eagerly-awaited Fed announcement in years hits the tape this afternoon (EDT)/evening (BST.) So after a month of biding time, shuffling positions, and waiting, it's time for financial markets to enter the crucible. In the words of the legendary Bocephus, it feels like all my rowdy friends are coming over tonight.
As an appetizer, however, we have the rather unedifying spectacle of Bank of England independence and credibility withering before our very eyes. The market is rife with rumours that the section of Mervyn King's statement on the Bank's potential Lender of Last Resort status-quoted in this space on Friday-was shoehorned in at the last minute after the Treasury notified the Bank of the problems with Northern Rock.
That the Treasury has taken the unprecedented step of guaranteeing all Northern Rock deposits raises the moral hazard stakes even further, and asks the question of what the end game will be. While there is clearly a utility to be had in shoring up depositor confidence throughout the banking system, Northern Rock has surely lost its right to exist as an independent entity. Its business model was essentially identical to that of an SIV-type vehicle: it funded long-term assets (its mortgage book) via short-term liabilities (interbank borrowing.)
Yesterday, other UK building societies saw their share prices collapse late in the session (the chart below shows the intraday price action of Alliance and Leicester.) It was probably this panic that encouraged Alistair Darling to create the emergency guarantees for Northern Rock.
Macro Man was amused to see Goldman Sachs and HSBC reduce their price targets for Northern Rock from somewhere around 1000p to somewhere around 300p (yesterday's close was 282.) Uh, thanks fellas. Macro Man hereby offers a price target of his own: zero.
In the meantime, Mervyn King has remained silent since his statement last week. The BOE has offered an emergency repo this morning, while the FT reports that the penalty rate on the Northern Rock credit line will be 7.25%, assuaging some of Macro Man's moral hazard fears. Yet the market is now focusing on the fact that Mervyn King's term as BOE governor ends next summer, and wondering if he was strong-armed into the NRK bailout under threat of non-renewal. Either way, it's a sordid situation that can only damage the credibility of the Bank. On the plus side, Newcastle United, the football team formerly sponsored by Northern Rock, has managed to secure a new sponsorship deal:
At the end of the day, NRK's business model, financing long-term assets (its mortgage book) with short-tem liabilities (interbank borrowing) is indistinguishable from that of a number of exploded hedge funds and insolvent SIV-type vehicles. While it may be appropriate to disintermediate depositors from this mess, there should surely be no question that NRK and its shareholders should be left holding the (empty) bag. Other banks may have a similar asset-liability mismatch, but it appears that NRK was particularly egregious in inflating its balance sheet.
And what of US investment bank shareholders? Lehman reports today, which will be our first real taste of how this summer's fireworks have impacted Wall Street. Ominously, Bank of America issued a statement yesterday suggesting that the credit market dislocation will have a "meaningful impact" on earnings. Many, however, expect the IB's to window-dress earnings via non-recurring cashflows and/or mark-to-model valuations.
Macro Man is not an equity analyst and doesn't plan to sift through the minutae of the statements. But he cannot shake the notion that the better the announcements sound on a headline level, the worse things may well be under the surface. We all know July and especially August were crap; the more transparent the banks are about this, thequicker we can all move on without fear of ex-post revelations of hidden turds.
And of course, we have the Fed. Much can and has been written about today's decision elsewhere, so Macro Man will keep his comments relatively brief. While he thinks that the Fed should do nothing, he does live in the real world and acknowledges that that ain't gonna happen.
His impression is that bond and currency markets are expecting 25 bps from the Fed funds rate and similar on the discount rate. That is, his expectation is that the people involved in those markets expect 25/25. Looking at where the US yield curve and some high-yielding currencies are currently trading, one could argue that 50/50 is actually priced.
Equities, meanwhile, look set for 50/50 all the way. One would have to suspect that a 25/25 would be construed as a disappointment, unless it was accompanied by a (highly unlikely) promise of much more.
So it would appear that "risk trades" are vulnerable in the event of a 25/25 or perhaps even a 25/50 outcome. This was the very rationale that encouraged Macro Man to sell 1500 calls in the first place. Of course, it's a touch simplistic to look at the actual rate decision in isolation. What if the Fed does 50/50, but then says that they view the action as sufficient to support the economy, and thus that their primary concern has reverted to inflation?
One would suspect that risk assets would perform poorly. Macro Man's base case expectation is 25 on the Fed funds rate, though he has a sneaky suspicion that they might do 50 on the discount rate. The statement, he believes, will offer some vague assurance that the Fed will take appropriate action on the basis of new developments.
Ultimately, this should stoke another downleg in risk assets, if for no other reason than that expectations need to be re-set. While Macro Man still holds the view that the dip is meant to be bought, he reserves the right to change his mind in the event of fresh developments.
Monday, September 17, 2007
Markets have opened up the new week in edgy fashion this morning, spurred on by weekend scenes of the UK's first bank run in more than a generation. The news makes fairly grim reading, with some £2 billion of Northern Rock's £12 billion deposit base withdrawn since Friday morning. London dealers are asking themselves this morning whose fortunes have collapsed more swiftly: those of Northern Rock or the England rugby team?
Regardless, the chart of Northen Rock is beginning to resmble that of another mortgage lender that suddenly found it difficult to obtain market financing for their loan book. Although many expect a white knight buyer to emerge for Northern Rock, would it really come as much of a surprise if they went the way of New Century?
This week should prove to be very tumultuous indeed, what with the Fed announcement tomorrow and Lehman, Morgan Stanley, Goldman, and Bear all reporting Q3 earnings. There is clearly scope for plenty of volatility, particularly with the S&P 500 perched just a few points from its high since the "crisis" began. Macro Man would not be suprised to see fairly quiet trade today as markets wait nervously for the newsflow to begin in earnest tomorrow.
Those tempted to do a bit of reading in the meantime may turn to Alan Greenspan's new book, The Age of Turbulence, which is published today. The Maestro's legacy has become a bit tarnished recently, with many laying the blame for the subprime debacle squarely on his shoulders. There has been some suggestion that The Age of Turbulence was prompted by Greenspan's desire to engage in a little historical revisionism to preserve his legacy as the Maestro.
Is this in fact the case? Judge for yourself. Macro Man 's contacts in the publishing industry have provided him with access to an initial version of the galleys, reprinted here on an EXCLUSIVE* basis. Enjoy!
the housing crisis: In the spring of 2003, it started to become clear to me that the US housing market could begin to start suffering significant distress in 2006, with a concomitant decline in the price of mortgage derivative securities in 2007. I therefore acted promptly, authorizing a 0.25% cut in the Fed funds target rate to 1%. While many on the Committee did not agree with this move, my argument in favour of pre-emptive action against an economic downturn in four years' time eventually carried the day.
irrational exuberance: It is a widely-held fallacy that I used the phrase "irrational exuberance" in reference to stock markets in late 1996, just as they were set to register stunning gains for the next three years. In fact, what I said to the American Enterprise Institute that night was "But how do we know when irrational antipathy has unduly depressed asset values, which then become subject to prolonged and justified appreciation over the next several years?"
In March 2000, I determined that equity markets had, at last, become irrationally exuberant, and described them as such in meetings with the Administration and Congress.
fiscal policy: I was occasionally stunned by the inability of politicians from both sides of the aisle to understand the appropriate use of fiscal policy. Although I eventually developed a working relationship with the Clinton and G.W. Bush administrations, it came only after the painstaking effort of lecturing the executive and legislative branches on how to use fiscal policy.
I recall a meeting that I had with Gene Sperling in early 1993. Sperling articulated the new Clinton administration's intended economic program, which included a substantial increase in spending along with targeted tax cuts. Given that the Fed funds rate was set at an already-accomodative 3%, this was a clearly inappropriate setting for fiscal policy.
"Gene," I said, "let me explain to you what the role of fiscal policy is. When monetary policy is easy and I do not wish to be blamed for taking away the punch bowl, it is the job of fiscal policy to begin tightening the strings on the economy. Only after it is clear that the economy is resilient enough to absorb policy tightening is it appropriate for the Fed to adjust its monetary stance.
"By the same token, when it becomes clear the the economy is slowing, it is appropriate for the Fed to slash interest rates quickly so as to provide a needed boost to activity. Only after monetary policy fails to engender an economic recovery (no doubt because the government ovecooked the fiscal tightening previously) is it appropriate to cut taxes or raise spending.
"In a very real sense, monetary and fiscal policy must work together as a 'good cop' and 'bad cop.' Because of the nature of transmission mechanisms, it is imperative that the Federal Reserve, as an unelected agent, fulfll the role of the good cop."
his recommendation that mortgagees take out adjustable-rate mortgages (ARMs) during the early stages of the tightening cycle in2005: In early 2005, the Economic Club of Cheyenne invited me to Wyoming to make a few remarks. Knowing the local predilection for hunting, I made a casual reference to the forthcoming end of deer season and called on the attendees to "go take out arms" to try and bag one last large-antlered buck before the season ended. This was subsequently misinterpreted in the financial press as a recommendation that homebuyers use exotic and dangerous mortgage products. In reality, nothing could be further from the truth.
the stock market crash of 1987: Half an hour after after the opening of the New York Stock Exchange on October 19, 1987, it became clear that the stock market was in significant distress. Two months into my tenure as Chairman of the Federal Reserve, I was about to meet my first great challenge.
At approximately 10.30 a.m., I took a phone call from Treasury Secretary James Baker. The Secretary asked me what I planned to do about the stock market decline.
I replied that I planned to do nothing, as my Objectivist background had taught me that government agencies should not play a role in private markets and in no way should save "looters" from the consequences of their own economic decisions. I told him that I did not wish to grant markets a "put option" to insulate them from price declines.
Mr. Baker was not impressed. In his inimitable Texas drawl, he said, "Boy, I don't know much about them there put options. But if you don't do something quick, I'll give you another kind: you can have the option of whether I put my left boot or my right boot up your be-hind."
After deliberating for a few minutes, I concluded that shoring up confidence in the financial system was, after all, a worthwhile goal, and thus provided liquidity to markets. And that was the genesis of the policy tool that eventually became known and loved as the "Greenspan put."
Bob Woodward's biography, Maestro: A number of friends and colleagues told me that I should be flattered by my portrayal in Woodward's book, but frankly I found it all to be a bit embarrassing. Woodward left out numerous examples of my policy-making genius, and left the reader in doubt as to whether the entirety of world economic growth was down to my decisions, which of course it was.
Macro Man is sure you'll agree that Greenspan has outdone himself....
* these galleys fell off the back of a truck
Friday, September 14, 2007
Well, it didn't take long for the governor of the Bank of England to remind us why he is known is some quarters as "Swervin' Mervyn." A day after Merv appeared to drop the hammer on bail-outs and "the world owes me a living" financial risk-takers, news has hit the tape that Northern Rock, a prominent UK building society, has borrowed "a substantial amount" from the Bank in an emergency operation.
As of yet, official details- the amount and the rate- have yet to be officially confirmed. That hasn't stopped the press from characterizing the operation as exactly what King stated would not be forthcoming: a bail-out.
Now, in his TSC statement, King did suggest that the Bank has a role to play as lender of last resort to ensure financial stability:
"In addition, central banks, in their traditional lender of last resort (LOLR) role, can lend “against good collateral at a penalty rate” to an individual bank facing temporary liquidity problems, but that is otherwise regarded as solvent. The rationale would be that the failure of such a bank would lead to serious economic damage, including to the customers of the bank. The moral hazard of an increase in risk-taking resulting from the provision of LOLR lending is reduced by making liquidity available only at a penalty rate."
The problem, of course, is that the current standard BOE "penalty rate", 6.75%, is actually lower than the current interbank borrowing rate. So conceivably, Northern Rock could borrow from the BOE and lend in the open market and lock in a small profit- exactly the sort of behaviour that King decried in his statement.
Macro Man is willing to withhold final judgement until the details emerge. But if NR really did borrow at the standard "penalty" rate just before announcing that a) they expect to earn £500-540 million this year, and b) they expect new lending volumes to increase, it will be difficult to avoid the conclusion that Swervin' Mervyn has committed the grossest hypocrisy. (Interestingly, there are a number of anecdotal reports of large queues outside of Northern Rock branches, so perhaps NR's cure was worse than the disease!)
Of course, puzzling behaviour is not confined to the BOE. Serial whingers the Swiss National Bank have provided numerous reasons to scratch one's head over the past few years, and this week is no exception. The SNB hiked its LIBOR target rate by 0.25%, surprising some observers but earning a hearty "Bravo!" from Macro Man. Yet this morning the SNB set the 1 week repo at 2.08%, a whopping 0.21% lower than yesterday. So on Thursday, they hike rates (fully justified, given their currency concerns), but on Friday they cut rates?!?!?! SNB: WTF?
The continued strength of equities, carry currencies, and other non-CP risk assets is also prompting Macro Man to ask WTF. We are swiftly moving towards a scenario wherein a 0.25% Fed easing will be seen not as as a disappointment, and thus a reason to sell stocks, but as a provision of unneccesary liquidity, and thus a reason to buy. Macro Man was filled on his sale of ESU7 at 1490, so if this scenario plays out he may be stuffed. That the central bank of Turkey felt sufficiently confident to surprise markets with a rate cut yesterday- which was followed by a rally in TRY- is pretty clear evidence that contagion risks have, for the time being, subsided. It's just another brick in the wall of Macro Man's view that a Fed easing would be a mistake.
Today sees the release of a really interesting piece of data in the US. No, not retail sales, industrial production, current account, or even consumer confidence figures. All of these will be interesting, to be sure, but the cyclical data is less significant than usual, as Big Ben noted last week, while the confidence data is, in the short term, little more than a proxy for the stock market. No, the figure that Macro Man is really looking forward to is the import price number.
Specifically, the figure on import prices from China. When Macro Man talks to his colleagues about inflation, articulating his view that it is a large and growing problem for the US, he draws a lot of quizzical looks. One tenant of his view that real-world inflation (as opposed to the core PCE deflator, a measure that nobody pays) is that the deflationary impact of the BRICS has been replaced with an INflationary impact.
As has been documented previously, US import prices from China are now rising y/y: 0.9% at last count. On a more high-frequency basis, the 3 month annualized rate is up nearly 3%. What's particularly interesting is that both the y/y and high frequency import price data bear a startling resemblance to China's headline CPI. All the more reason, therefore, to take the recent acceleration seriously and disregard thos analysts who seem to think that food prices don't matter. All of this, of course, is an argument in favour of allowing the RMB to appreciate more quickly. To a degree, this is occuring- against the dollar. EUR/CNY, on the other hand, is back close to its post-reval highs.
Regardless, if an acceleration of non-oil import prices is met with Fed easing, it provides another reason to question why anyone would buy dollars any more. While EUR/USD remains near all-time highs on a spot basis, at longer maturities (such as those used by some sophisticated European exporters), this is not yet the case. Might they start getting sucked in to take advantage of current "value" before long?
Thursday, September 13, 2007
Calm continues to prevail as equities tread water, some CP is being rolled over (albeit at shorter maturities), and the dollar continues to tank. The buck has reached yet another significant low against both the euro and, somewhat more surprisingly, the Canadian dollar this morning. One might have thought that a severe dent to US economic growth expectations might negatively impact its neighbour to the Great White North, but for now strong energy prices, stretched resource utilization, and advantageous positioning have propelled the loony higher. It may not be long before USD/CAD shorts convene for a "parity party."
A refreshing breeze swept through financial markets yesterday, courtesy of the Bank of England. The Old Lady of Threadneedle Street has long prided itself on its market savvy and awareness, and like other major central banks it takes an active role in surveying the state of financial markets in real time.
In advance of next week's testimony before the Treasury Select Committee, BOE Governor Mervyn King released a statement setting out the Bank's views on the current state of play. The message contained therein was reminiscent of the Seinfeld Soup Nazi: "No bail-out for you!"
The entire statement, linked above, is well worth a read. But among the choicest quotes were the following:
"But the source of the problems lies not in the state of the world economy, but in a mis-pricing of risk in the financial system."
"If, in the wake of a shock to the financial system, the terms on which the financial system extends credit to the private sector become less favourable, then borrowing and overall demand would weaken. Other things being equal, that would lower the inflation outlook. Of course, other things are not equal. When the Monetary Policy Committee meets each month it reviews all the evidence on the outlook on inflation before reaching a judgment. The August Inflation Report implied that some slowdown from recent strong rates of economic growth was needed to meet the inflation target."
"the provision of such liquidity support undermines the efficient pricing of risk by providing ex post insurance for risky behaviour. That encourages excessive risk-taking, and sows the seeds of a future financial crisis. So central banks cannot sensibly entertain such operations merely to restore the status quo ante. Rather, there must be strong grounds for believing that the absence of ex post insurance would lead to economic costs on a scale sufficient to ignore the moral hazard in the future."
"If central banks underwrite any maturity transformation that threatens to damage the economy as a whole, it encourages the view that as long as a bank takes the same sort of risks that other banks are taking then it is more likely that their liquidity problems will be insured ex post by the central bank. The provision of large liquidity facilities penalises those financial institutions that sat out the dance, encourages herd behaviour and increases the intensity of future crises."
Strangely, short sterling continued its recent rally yesterday, with the March-June '08 contracts up 7-8 ticks. Markets keyed on one comment suggesting that the BOE would take the appropriate action; however, the above excerpts would strongly imply that the current mindset of the BOE is that the appropriate action is to do nothing!
What is ironic, of course, is that unlike in the US or Eurozone, monetary policy in the UK is pretty unambiguously restrictive. Markets are happily selling sterling this morning after the RICS house price balance tilted negative- could this be the real economy spillover required to prompt a BOE rate cut?
In the fullness of time, perhaps, but certainly not yet. The scope of the rollover has been modest in comparison with past episodes, and remember: it was just last month that the MPC judged that economic activity needed to slow to preclude further tightening. Now, Macro Man has disliked sterling all year, so he has sympathy for those selling it now.
But those doing so on the expectation of an imminent rate cut should be warned. The BOE is clearly not in the mood to provide a free lunch to banks and speculative turd-buyers; unlike the Fed, the Old Lady is not for turning.
Elsewhere, in the comments section to yesterday's post, reader Corey noted the confluence of factors that could produce an explosive move in gold. Now, Macro Man has avoided commodities since the disastrous GG and oil spread trades earlier this year, but has to admit that the idea has merit. Combine a weak dollar with an unneccesary provision of financial market liquidity (money markets might appear to need it, but it seems clear that other markets don't), and it would appear to be a perfect setup for a higher gold price.
Macro Man decided to run a simple study to see if these two factors have much of an explanatory power over gold, and sure enough, they do. A simple regression of y/y changes in gold with y/y changes in the DXY and global money growth yields a reasonable r^2 of 0.43. The t-stats of both factors are statistically significant.
Wednesday, September 12, 2007
Whether it's crisis fatigue, an Indian summer in the UK (during the daytime at least), or just plain myopia, markets are happy and risk assets are trading on the front foot this week. It's crunch time in terms of ABCP roll-overs, but markets seem to be taking the attitude that "that's for those money market blokes to worrry about; nothing to do with us." Nothing, that is, until bonus time, when a number of people may find themselves the recipient of a "Number 3 all over" haircut.
Both in the real world and in finance, the last few weeks and months have begun to seperate the wheat from the chaff. Consider the variant fortunes of the following persons. Who would you rather be?
* Shinzo Abe, Prime Minister of Japan. Actually, not any more. Abe has committed political seppuku after the economic and reform momentum of Koizumi has ground to screeching halt. Indeed, the only thing that seems to have increased under his watch is political scandal. The likely replacement as PM would appear to be Taro Aso, LDP Secretary General. Cue the Dukes of Hazzard theme song ("Just a good old boy/Never meanin' no harm/Beats all you ever saw/Been in trouble with the law/Since the day he was born.") It seems safe to assume that Japanese politics is switching back towards the bad old days of pork barrel spending.
* The new graduate intake at Goldman Sachs. A vicious rumour is circulating around the City that the new grad intake at Goldman have all been funnelled into Operations. Imagine the ignominy: expecting to take their first steps towards becoming Masters of the Universe, these poor souls now find themselves chasing third-party valuations and sending SWIFT messages. It's almost bad enough to make them wish they'd taken that job at Lehman.....
*Mohammed El-Erian. After just two years at Harvard, Mr. El-Erian has returned to the fold at PIMCO. While Mr. El-Erian claims that he's left Harvard for family reasons, the fact that he's been named co-CEO and co-CIO is no doubt a coincidence. Not a bad round-trip, is it? Harvard, meanwhile, is now left looking for a CIO for the second time in two years. If anyone from Harvard's administration is reading, Macro Man would be happy to entertain any offers....
Elsewhere, the dollar bear market appears to coalescing even faster than Macro Man had envisaged. Everyone in the known investment universe now seems to be bearish, though Macro Man's investigations suggest that positioning (at least against non-EM currencies) remains light. If this is the case, then pullbacks should be relatively limited. 80 in the DXY is an obvious level that the market can key on.
If the "incipient dollar down-bubble" thesis is correct, the market will end up chasing it after failing to get filled on hopeful dollar sell orders over the next week or so. Stay tuned.
Yesterday's US trade data came out broadly in line and continued to suggest that prior dollar weakness is having an impact. In both nominal and real terms, exports continue to outstrip imports by a healthy margin. It may be a coincidence that Ben Bernanke spoke on global imbalances yesterday, but his comments on the US current account deficit ("unsustainable") are reminiscent of Fed comments in Q3/Q4 2004, a period which saw an aggressive weakening of the buck.While the "savings glut" explanation may have a degree of truth to it- FX reserve accumulators have clearly had an excess demand for dollar assets- one has to query whether the same will hold true in the future. The evolution of SWFs and shift towards a more proft-oriented investment strategy would certainly argue for an asset allocation with a lower dollar weighting than that currently held by China or even Russia; a clear renewal of the dollar downtrend may make VIG, RIG, et al. even less enthused about holding dollar assets. And if Japan ever does revamp its reserve management, as has been suggested recently, one would imgaine that they'd have a few bucks to go as well.
What's interesting to note is that China's trade with Europe is taking on an increasingly prominent role, which might argue in favour of upping the euro's weight in China's FX reserves. China now exports more to Europe than to the US, and the level of the trade surplus is now almost as high with Europe as with the US. At current levels, the monthly trade surplus with Europe ($13.7 billion) must be approaching the monthly allocation of FX reserves into European currencies.
Tuesday, September 11, 2007
Markets are remarkably subdued so far this week, perhaps suffering from "crisis exhaustion" after last Friday's payroll data. The investment bank earnings releases that had originally been scheduled for early this week (Bear and Lehman) have been pushed back into next week. Perhaps that's an ordinary occurrence, or perhaps it's a sign that they're struggling to fit the pieces together in a SarbOx-compatible fashion. If the latter, it's not exactly a ringing endorsement that the worst is over, is it?
As is generally the case, China marches to a somewhat different drumbeat to the rest of the world. So while the West has been snoozing, it's been all action in China with the release of a (yet another) higher-than-expected CPI report and a 4.5% decline in equities. While the latter is but a blip, the former has now reached its highest level in more than ten years, and thus merits some attention.
As has been the case throughout the year, food prices account for the bulk of the rise in CPI. Non-food-price inflation remains fairly steady at around 1%, which has encouraged many China watchers to presume that the current bout of inflation need not be met with aggressive policy tightening. Just as Clara Peller asked "Where's the beef?" in the 1980's, the question here appears to be "Where's the pass-though?"
Is that the right question, though? After all, a number of non-food items (energy, most conspicuously) fall under the aegis of price controls and thus should not be expected to show a price rise. And given the number of Chinese citizens living on a subsistence or quasi-subsistence basis, it is surely not in the best interests of a regime focused on stability to see food inflation (which has now hit 18.2%!) foment unrest in the hinterland.
And even relatively well-off urban workers must feel the pinch of food prices. Hell, the price of bread exceeding £1 per loaf made front page news in London! But the ease with which many seem to disregard food prices makes it seem as if Chinese workers don't have to eat. In fact, nothing could be further from the truth; food comprises a much higher proportion of living expenses in China and other developing economies than in the developed world. As such, food price inflation should be more likely to feed through into wage demands in these countries than one would expect in the US, Europe, or Japan. And higher wages could, ultimately, overwhelm productivity gains and generate higher unit labour costs from erstwhile disinflationary producers. Perhaps it's already happening, given recent trends in US import prices from China.
Further evidence that the inflationary dynamic in China may be more potent than commonly believed comes from the Baltic Dry Index, a well-known measure of freight costs. The rise of the last eighteen months has been little short of parabolic. In a sense, it doesn't matter how little it costs to produce something in China (or Vietnam, or India.) If it costs an arm and a leg to ship it, that's what the price will be in the destination market.
It may seem foolish to fixate on Chinese inflation when the Fed has finally ceased to care about US inflation. But if the Chinese authorities decide to meaningfully tighten macro policy after the October Party Congress, Asia might not be as bullet-proof as commonly supposed. And if Chinese unit labour costs do begin to rise in a meaningful way, the inflationary consequences of a weak dollar bubble could be that much more extreme.
Macro Man's systems have gone haywire, so no P/L today.