Time to share the pain?

The year is barely two weeks old, but there have really been some extraordinary developments in financial markets already. The abject performance of developed market equities is striking, to say the least, as is the concomitant rally in fixed income. What makes each of these especially peculiar is the generally robust performance of undeniably risky EM currencies, at least until today.

The Turkish lira, for example, has traded at its cyclcial high against the $ in each of the three sessions before today. If, however, the world economy really is in bad shape, it's difficult to see how those countries that have enjoyed a substantial amount of capital inflow over the past year(s) can avoid a more pronounced correction.

Yesterday's US retail sales data shouldn't have been terribly surprising given the inventory readings from the ISM, but it gives Mr. Bernanke another excuse to take his helicopter for a spin. A 0.1% monthly print on core CPI would surely cement expectations of a 0.50% easing at the end of the month and, in all probability, drive US fixed income to even more eye-watering levels. Macro Man's foray into paying various points on the US curve has been little short of a disaster; in the event of a 0.1% reading on core this afternoon, he will close the 10 year leg and lick his wounds.

It's interesting to observe more and more evidence that the pain which originated with US subprime borrowers is being shared by an increasing number of people worldwide. While the cause and effect relationship are debatable, it is still striking to see charts like the one below, which plots the year-on-year change in New Zealand housing sales. (The equivalent figure for US existing home sales is -20%.)
Tonight sees the release of Q4 CPI in Kiwi-land, where base effects are expected to push the y/y figure to 3%, the top of the RBNZ's tolerance band. However, should the figure undershoot by any great degree, what odds that the market once again begins romancing the notion of future RBNZ rate cuts, and buys the front end of the NZ curve while whacking the NZ dollar?

Another place that could start sharing more in the pain is Europe. Looked at from a broader term perspective, Europe has growth that is almost certain to slow in 2008, combined with high inflation and, to date, a hawkish central bank. It seems as if the market has thus far tried to play this view through the euro, but surely that is a lethal combination for equities? Especially so when one considers that the DAX, for example, has broken a couple of key technical supports.
Macro Man's short-bias equity alpha trades have been spectacular winners so far this month, but have not fully compensated for the execrable performance of the beta plus portfolio. Given that risky EM is finally showing signs of cracking today, it looks like the time is ripe to add to the short equity bias in the alpha portfolio. Macro Man therefore sells 100 Dax futures (GXH8) at 7560.
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vlade
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January 16, 2008 at 9:25 AM ×

Yes, I was quite a bit surprised by the performance of some of the EM currencies. I have followed CZK a bit, which appreciated around 15% agains just about anything.
Give that:
- about 10%+ of the purchases in the real estate there has been driven by foreigners
- the main drivers of the economy are exporting manufacturers (mostly car and car parts) owned by foreigners, with the factories estabilished to use the relatively cheap and skilled labour (which is now becaming scarce - even without appreciating local currency which also makes it not so cheap anymore)

Yes, there's the fact it has the lowest interest rates in EU, and that the high inflation will drive the rates higher - but, you could have said a similar thing about US a few years ago. So was it a good thing long run?

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Anonymous
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January 16, 2008 at 11:50 AM ×

NZ CPI is tipped to be a shocker..does not bode well for inflation in Oz either correlation is about 70% over 10yrs...living here i can vouch for the fact that yes things are more expensive BUT mortgage rates are hurting alot of people...my core thoughts are to own both nz and aud curves but wait till after both cpi's and then short ccys as well...

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Anonymous
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January 16, 2008 at 9:04 PM ×

Speculation one or more big hedge funds have blown up and are liquidating equities in Asia - see Tokyo/HK yesterday. May drive FX markets wonky with cross currents for a while?

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Macro Man
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January 16, 2008 at 9:10 PM ×

Vlade, the CZK has been a puzzle to me for most of the last year; while there has undoubtedly been a solid story in the Czech Republic, I have struggled to see that it justifies the strength of the koruna.

As to a HF going bust and screwing up currency markets, it wouldn't be the first time...and it won't be the last. Not heard the story myself, but wouldn't be surprised if it were true (or, for that matter, false.)

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