Friday, January 25, 2008
If you ever needed a reminder that most short term price action is noise, rather than signal, this week has provided a timely reminder. Taken at face value, this week's moves suggested imminent US recession and asset price deflation on Monday, Tuesday, and the first half of Wednesday, while price action since then has had "soft landing" written all over it.
In retrospect, of course, much of the volatility in stock index prices has been down to the work of one or more unfortunate Frenchmen; Macro Man assumes that he is not alone in concluding that the short term price swings caused by the worst trader in history (judging by the size of his loss) have little insight to offer as to the medium term trajectory for economic growth and financial prices.
Macro Man also assumes that he's not alone in scratching his head and thinking "what now?" Next week's Fed meeting is set up to be an extraordinarily interesting one. It has emerged that despite the Banque de France knowing about SocGen's travails over the weekend, the Fed had no clue when they hit the panic button on Tuesday.
Grep Ip seems to suggest that the SocGen revelation won't impact the Fed's decision next week, but come on! If, before the equity market meltdown, the Fed was planning on doing 50.....why should they cut any more next week, thereby at least doubling the amount of their originally intended easing?
Yet to the market, it's not a question of whether the Fed eases, but by how much. The OIS market is currently pricing in 40 bps of easing. Of course, if the Fed doesn't ease, markets could then puke, delivering the kind of price action that prompted the emergency cut in the first place. The problem with allowing the market to lead you, Mr. Bernanke, is that it inevitably leads you into an uncomfortable corner.
What seems evident is that volatility is set to remain pretty high. If the Fed doesn't cut next week, equities should tank and bonds soar. If they do cut....well, let's just say that the dollar will be (French) toast.
In the meantime, Macro Man's recently-minted short risk asset delta has taken something of a beating as the market piles back into the "risk trade." While he made a gesture at hedging with his SPX calls, the size of the position was relatively small, and as such has only mitigated a small portion of the last 36 hours' losses. Macro Man originally targeted a re-test of prior support at 1360; futures are suggest a breach of that level at the opening. Retracement targets are located at 1385 and 1412; each of those could be seen without threatening the underlying bear market, if that is indeed what we are in. Discretion being the better part of valour in this environment, Macro Man therefore cuts half of his short DAX future position at 7020, locking in at least a portion of tasty profits.
USD/JPY has also had a vicious bounce and requires some attention. While an Armageddon option stop loss scenario continues to beckon in the event of further weakness, it might require price action below 102 or even 100 to prompt it. In the meantime, the DOTW have every excuse to pile back in. A similar retracement chart suggests scope to 110, and Macro Man really wouldn't want to see it breach that level.