Let's get ready to rumble!

Fresh off the successful passage of his Life in the UK exam, Macro Man is now ready to get stuck into the rest of the week. He suspects he's not alone in that regard, as the preliminaries of the first two days of the week now give way to more heavyweight event risk: GDP, ADP (OK, that's more of a welterweight), and the Fed today, PCE and the Chicago PMI tomorrow, and of course unenjoyment/ISM day on Friday. You can almost hear Michael Buffer stepping up to the the mic and bellowing "Let's get ready to rumble!"

The most obvious event risk of the day is the Fed, though by now a further 50 bp cut is widely discounted. Macro Man's take is that another half-pointer would ignite at least a bit more upside in equities and other risk assets, weigh on the dollar, and naturally steepen the curve. However, these moves could easily be short lived, particularly in equities, in the event of unfavourable developments on Thursday and Friday. It would apprear prudent to not bet the ranch on a single datapoint, such is the potential for these markets to turn on a dime over the next few days.

In the last few months of 2007, Macro Man took the view that the Fed was perhaps making too much use of macroeconomic tools like Fed funds, and insufficient use of microeconomic tools to address the ruptures in the money market. Well, in mid-December they announced the TAF, and six weeks later we can assess the initial impact of the program. The chart below shows the 3 month TED spread, and as you can see it has narrowed sharply since the TAF announcement was made.
It begs the question of "what took them so long?", but being late is still probably better than doing nothing at all. Observe that the spread has been relatively sticky around 1%, well above the levels prevailing before the crisis kicked off in mid-2007. That's not necessarily the end of the world, mind you; the world's central bankers (and, it must be said, many market participants) bleated for a long time about the low level of risk premia embedded in financial asset prices, so swinging the other way for a while is no bad thing. And given that we're still firmly in the world of writedowns and bailouts , you can hardly say it's not justified.

Macro Man's "muddle through" view on the US economy received something of a fillip yesterday with the release of much-stronger-than-expected durable goods data orders data. Mechanically, the strong core shipments data (+2%) and inventory data (+0.8%) should buoy the Q4 GDP figure released today, as they are plugged straight into the GDP model equation. Incidentally, the latter figure conforms to Macro Man's view that much of the recent softness in the data has been down to an undesired inventory build-up late in the year, which will take a couple of months to work out- just as it did this time last year.

However, Macro Man is not yet prepared to dislocate his shoulder in patting himself on the back for his prescience. The orders data is extremely volatile, and on a 3m/3m basis the trend is still negative. If not matched off with final sales, heavy orders can generate an even larger inventory build...and that is the stuff of which recessions are made. So while the inventory figures are not terribly timely, and not sexy at all, if you want to know where the US economy is going you could do much worse than to follow inventory trends- either via the official data or through surveys such as the ISM.
Elsewhere, in Macro Man's soon-to-be adopted "homeland", Swervin' Mervyn has been re-upped for another 5 years in the Threadneedle Street hot seat, while mortgage approvals sank to their lowest level in a dozen years. Several readers have asked about whether Macro Man has the inclination to add to his sterling short at current levels. For the time being, he does not; the time to add will be when Merv throws in the towel and starts slashing rates more aggressively. And for that, he'll need to see a more pronounced drop in either inflation or activity. Macro Man is prepared to wait.

Finally, as noted yesterday, recent quant fund ruptures seem to have generated a small pullback in Macro Man's large cap/small cap strategy. The OEX/RUT spread is now approaching the uptrend line of the past year, and now would appear to be a reasonable time to add risk to a position that Macro Man would expect to carry for a long time.
Macro Man will therefore up the nominal position size to $15 million per leg, buying 99,000 OEF and selling 93,250 IWM half an hour after the market opens today.
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15 comments

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Quarrel
admin
January 30, 2008 at 1:51 PM ×

GDP @ 0.6 Ouch.

It's another vote for the big fed cut I guess.

and another random ADP number. Who knows what to think of them.


--Q

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Macro Man
admin
January 30, 2008 at 2:17 PM ×

yes, headline gdp was rubbish, but inventories subtracted 1.25% from growth. Ultimately, that bodes better for the future than a higher headline print showing a hefty inventory build.

As for adp, yeah a bit better than expected but to date its track record doesn't warrant much excitement.

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Anonymous
admin
January 30, 2008 at 2:53 PM ×

Hi MM,

I like the big/small cap trade, as well (using the Dow instead of the OEX, though).

Can you tell me the command you used to generate that graph on Bloomberg? Thanks.

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Macro Man
admin
January 30, 2008 at 3:14 PM ×

anon, it's custom index i made myself. Hit cix go, and then follow the instructions. Many of the bbg charts posted here are cix's that i've created over the years.

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2and20
admin
January 30, 2008 at 4:43 PM ×

CIX is the best function on bloomberg.

i think you're right on waiting to increase the GBP short, it's exactly what i'm doing. I have on a small short position, and was going to increase it, but the US seems to have so many issues just now, plus the Fed slashing rates deep and fast, looks like it means a weaker dollar in the near term whilst we wait for the sh*t to hit the fan in the UK. I've no doubt that's coming, but UK crash is unfolding at a much slower pace than the US.

oh, and ADP is a joke. wait for negative non-farm payrolls to really take the market down (on that note...10y treasuries look ok at 3.70%, could easily see them 50bps lower as Fed cuts then signals more to come).

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RebelEconomist
admin
January 30, 2008 at 6:12 PM ×

Congratulations on your new status, but doesn't that make it unpatriotic for you to short sterling now?

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Anonymous
admin
January 30, 2008 at 6:45 PM ×

Could buy half the amt TWM rather than shorting IWM. Cash management?

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January 30, 2008 at 7:42 PM ×

Go helicopter ben go go!!!
goobye dollar!! goodbye long bonds!!
Ben is Greenspan squared!!!

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vlade
admin
January 30, 2008 at 8:42 PM ×

There's only one thing that could save Ben from being a heli-Ben forever. That is, if he's willing to raise as fast as he's willing to cut. I have not seen or heard any evidence that would even remotely point to that.

At least when BoE cut in Dec they (effectively) in their release indicated that if things get out of hand with inflation they will raise as fast as they cut.

Real yield on sterling (measured as 30y ZC RPI vs 30Y swap) is lowest in years, but at least it's still positive.

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Anonymous
admin
January 30, 2008 at 9:15 PM ×

50 bps cut saves U.S. paper economy, for 2 hours...

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Quarrel
admin
January 31, 2008 at 2:34 AM ×

2and20,

I agree on the negative non-farm employment numbers. It'll be the big wake up call. (of course its a market mover at the best of times, and this isn't the best of times)

Was the fed signalling this in their statement:

"
Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets.
"

But, I don't think we have yet seen the softening in the labor markets - at least in official figures. Does the fed know fridays number (or a better proxy than ADP)?


--Q

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Caprica
admin
January 31, 2008 at 2:45 AM ×

I wonder how low Ben's rate cutting spree will go. We are now at 3%. It got as low as 1% back in 2004. Any thoughts?

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Caprica
admin
January 31, 2008 at 4:07 AM ×

Quarrel asks: "Does the fed know fridays number"

I believe that the Fed and the White House is only informed of the number in advance if the figure vastly different than expected. Otherwise they see the result about 24 hours before the rest of us.

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Peter
admin
January 31, 2008 at 8:09 AM ×

its a good day to sell (USD)GBP again ..

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Anonymous
admin
January 31, 2008 at 10:58 AM ×

"Could buy half the amt TWM rather than shorting IWM. Cash management?"

Only if you want lousy performance:

http://seekingalpha.com/article/35789-the-case-against-leveraged-etfs

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