CB Day

Now you know why Macro Man is attemping to exercise patience rather than impetuosity. It looked for all the world like US equities were plunging down the abyss (and they may, of course, still do so.) The head and shoulders neckline was broken, MBIA cut its dividend and received a downgrade, and yet another positive opening had withered into a sea of red.

With less than two hours left in the session, the S&P 500 was down nearly yet a percent....and then executed an August 15-style comeback to close up nearly a percent and a half. Was it Warren Buffett? The plunge protection team? The Rosicrucians? Who knows. What yesterday's price action demonstrated, however, is that caution remains warranted, especially when it comes to pre-empting key technical breaks.

One financial price that seems to have broken just about every technical level possible is sterling. The pound would appear to have few redeeming qualities, and seems to be in the same place as the dollar was in September/October: the market is extremely bearish but not extremely short. Or are they? Macro Man is struggling to come to grips with exactly how the market is positioned in sterling.

Today sees the Bank of England announce its rate decision, an event for which Macro Man has waited before going short sterling. Caution in this market has proved to be costly, as the pound has plummeted in virtually a straight line. In many ways, Macro Man hopes that the BOE will remain on hold today; we all know that they're going to cut quite a bit more, but an unched outcome today might squeeze a few latecomers to the sterling-going-down party.

What's clear is that despite its recent caning, sterling is nowhere near cheap, as anyone walking the streets of London can surely attest. Even against the euro, another eye-wateringly expensive currency, Macro Man estimates that the pound is only now returning to "fair value" as estimated by PPP. Macro Man is interested in selling sterling after the BOE; initially he will sell £20 million against a 50/50 basket of euros and dollars. In the event of no change, he will offer the basket (GBP/USD and GBP/EUR) at 1.6560; in the event of a cut, he will close his eyes and sell at best.
Of course, the ECB also meets today, and the market will eagerly parse M. Trichet's comments for signs that the Bank is prepared to reverse course. It would seem as if this might be a few months too early; surely the ECB will need to see more definitive signs of a slowdown in activity (rather than merely sentiment) and/or a reversal of the inflation hump? The latter, at least, would appear unlikely until Q2.

A hawkish outcome would likely pressure Macro Man's 2 year receiver position, though could support the euro (assuming he gets his EUR/GBP in.) One idea to keep in the bottom of the drawer until March or April, which was suggested in the comments section yesterday, is a European steepener. Such a trade will make a lot of sense once the market begins to price ECB easing...and of course one could argue the downside risks to the trade are fairly minimal, given that the ECB is highly unlikely to tighten further from here.
It's one to keep an eye on, for sure; prior steepenings have pushed the swap curve to 150 bps, versus the current 17. Probably the greatest near-term risk is a strong recovery in equities, which would pressure back ends around the world. For now, Macro Man will wait and watch. After all, even the best-laid plans can be foiled by factors coming out of left field. And coincidentally, Ben Bernanke speaks this afternoon....

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Click here for comments
Manc Trader
January 10, 2008 at 11:30 AM ×

FT columnist seems to be in the short
sterling is a safe bet camp.

January 10, 2008 at 12:11 PM ×

i think the Cable pullback will be short lived.. just a feeling

Macro Man
January 10, 2008 at 12:19 PM ×

Me too...hence the toe-dipping in the basket at market.

January 10, 2008 at 1:27 PM ×

...given that the ECB is highly unlikely to tighten further from here.

i'm not so sure...the ECB is so hawkish, i get the feeling it would love to get rates higher to get m3 down, it just can't at the moment given the credit/liquidity issues out there just now. a strong equity recovery and a subsidence of tight credit conditions could easily see hikes get priced back in, and even without that i think they will be incredibly reluctant to cut.

10y Bunds ~ 4.08% seem a low risk short, but so does anything in the short-end below 4%. IMHO.

January 11, 2008 at 11:12 AM ×

Excuse me,
Interensting your graph with ADJ PPP.
Could you say me how do you estimated the ADJ PPP
on this chart ?
thanks !!!