Wednesday, February 27, 2008

Don't you hate it when that happens?

Macro Man isn't going to write about equities this morning, because it seems quite clear that he doesn't understand what's going on there. Whether it was his time off skiing, the slight illness that he's currently nursing, or the fact that it's a leap year, this newfound dynamic of "equities rally on all business days ending in 'y'" is certainly peculiar.

No, there are other fish to fry this morning, as the dollar is once again getting beaten like a rented mule. EUR/USD, for example, has finally and decisively breached the psychologically significant 1.50 barrier; while there are some intermediate targets at 1.52 and 1.53, the longterm goal is 1.63, still nearly 10% away.
While Macro Man has spent the last five months decrying the dollar and telling anyone who will listen (and many who won't) that it is toast, he finds himself in an unusual (and irritating) position. At an investor rountable a couple of weeks ago, he was bemused to find that the majority of the attendees were bullish dollars (or at least bearish EUR/USD), a circumstance that he found difficult to reconcile with negative real rates in the US and a hawkish ECB. At the time, EUR/USD was 1.45, towards the bottom of the range of the prior few months.

Clearly, this appeared to be a set-up for a nice move lower in the greenback, which in fact is what has occured, against things as diverse as oil, the euro, the New Zealand dollar, and the Taiwan dollar. And did Macro Man slap on a position and reap the profits that his view deserved? NO!

Even worse, he has found himself actually LONG dollars, courtesy of a) the Powerball strip b) the sterling basket trade, and c) the USD/JPY option hedge, which expires today. Macro Man had toyed with hedging the last of these earlier in the week at 108, and missed the he sold $25 million at 106.93 earlier this morning.

Ay caramba! Is there anything worse than having the right view and not making money? In Macro Man's defense, he has been away from the market, both due to his skiing holiday and for other personal reasons, for much of February. Still, it's galling to be, in the words of Trent from Swingers, "so money" and yet end up with "no money." Don't you hate it when that happens?

Today sees everyone's favourite Jim Henson character, Ben Bernanke, step up to the mic today to freestyle on the state of the economy. It's hard to imagine him saying anything other than "we're buggered", particularly if durable goods orders come out in line with the rather bearish consensus expectation.

Consider yesterday's data. The house price data was better than expected, but still pretty awful. Given continued high levels of supply, it seems likely that time, rather than interest rates, is the only thing that can resolve the situation.

Meanwhile, consumer confidence cratered, a decline caused in no small part by increased pessimism on the job front. As discussed in this space before, the jobs hard to get component is one of Macro Man's favourite tells on the labour market data....and as the chart below inidcates, it's suggesting another very weak number next week. Meanwhile, the "business outlook will be better in 6 months" component registered its lowest reading since April 1980.
So surely the Fed needs to cuts rates more, right? Not so fast, my friend. PPI inflation registered its highest reading since 1981, consistent with the high level of import prices, which are at a similar extreme. With oil at record highs and global food prices continuing to surge, it's hard to see this trend coming to an end any time soon.
As Macro Man has mused on previous occasions, what makes the current environment so tricky for the Fed is that for the first time in 30 years, the US is not a price setter for global's a price taker. In the 1980's and 90's, when there was slack in global commodity supplies, the price was set on the basis of marginal demand....and more often than not, that demand came from the US.

These days, however, there are genuine supply shortages, which means that lower US demand has little impact on the price...particularly when it is other countries that are showing the largest demand growth for energy and other industrial commodities.

All of this hearkens back to the 1970's, which was a terrible time for bonds and, if anything, an even worse time for equities. All of which makes the recent resilience of stocks that much more puzzling. Perhaps if today's unconfirmed rumour of a UK bank in trouble proves true, equities can finally reverse course. In any event, Macro Man cannot help but think that near term equity risks remain to the downside...not only because of the toxic data mix noted above, but also because of the horrible March seasonals which kick in next week.

Damn. Macro Man's ended up writing about equities after all. Don't you hate it when that happens?


CV said...

Wow, you long on the USD MM; I did not see that coming :).

What is most interesting for me is what really cracked it to put it past the 1.50 mark. Was it the German investor confidence? The small increase in the services index (manufacturing was down if I remember)? Of course, we also had the plunge in French consumer spending and the crash of Italian investor confidence.

Or perhaps it just was the prospect of the Fed lowering another 50 bps come March.

Especially Italy is toast (if anything) in this environment. Now, nobody says that the ECB is in a particular nice spot. Inflation is stubbornly high and oh dear, was that second round effects we saw from the German wage deal?! I think it was.

So, where does it go from here? Well, don't listen to me :). I have been persistently calling this one falsely from the beginning of 2008.
What puzzles me I guess is the ECB's complete reluctance to look at the incoming slowdown just as I am also puzzled by the extent to which the Fed is ready to trade on the expectation that inflation is NOT above and beyond a monetary phenomenon.

In the end of course, I persist that if there is one thing we can say for certain it is that de-coupling will hurt much more in Europe than it will in the US. Apparently, it seems as if it will take a notable slowdown in Germany before we see action from the ECB.

So, there is a market perspective here and a more structural perspective. On the former the Euro, for better or worse, now needs to bear the burden of de-coupling and re-balancing. However, in a structural perspective this is simply impossible, at least if we want Italy, Portugal or Greece to stay in the Eurozone.

Finally, on the ECB? Well, we won't see a move in March that is for sure I think. Will we see one in the first half of 2008? That I think is the main question. I still think we will but the odd positive reading here and there could bolster the ECB's vigilance. Those windmills, if you remember, looked very real for a certain Spanish knight too.


Macro Man said...

CV, I didn't really, I've been busy with stuff other than the blog portfolio!

At this point I'm not sure if the Fed has any option but to go for growth...unlike the ECB.

The Frankfurters can point to their sole mandate of price stability, and how the various measures of such- CPI and money growth- far exceed their definition of the target.

In the near term, they're gonna need to see evidence that inflation is rolling over- unlikely over the next couple of months due to base effects and oil. It's rather a Buba-ish attitude, really....and as we know, the Buba presided over one of the world's consistently strong currencies...

Anonymous said...

Yes, I hate it when that happens (end up with positions containng something contrary to my view of the world when the world starts coming around to my view). I guess that doesn't happen often enough for me to expect it. :)

Somewhere today I read (sorry, can't find it now) that U.S. money supply has grown less than the nominal interest rate in recent months (as an argument that recent increases in commodity prices represent a change in relative prices and not true inflation).

Can you define "March seasonals," and point me to a place that quantifies them?


Macro Man said...


I don't have anything specific to refer you to, but it seems as if the last several Marches have seen pretty big sell-offs in "risky assets" at one point or another....and not in a straightforward manner either.

As for money growth, I observe that M2 grew 8.6% annualized in January, and indeed has accelerated in every month since October. Not sure how one concludes out of that the price rises are relative rathet than absolute...

Anonymous said...


Though Jean Claude's sole mandate is price stability, if that stability comes at the price of a functioning economy, then politicians all over Europe will call for his head. The ECB can talk hawkish all it wants, however when the going gets tough they'll have to scramble like chickens.

Anonymous said...

Equities rally on the hope of Fed's rate cut and government's bail out? Or it is just technical trap for bulls.

Peter said...

we r all whining (well ok, maybe not we, but I am for sure)
about the equity rally of the last few days

probably too many shorts and its Q end for many banks, prop desks..etc so maybe there is an unforesen bid in the mkt..

painful as it is, its the reality for now.

but i dont think there is a reason to change one's mind on equities for the time being

OldVet said...

Equities in US are getting some help from banks (subsidized by Fed cuts) and rating agencies. Insider baseball or call it what you will. It won't last more than a couple weeks IMHO. In meantime I (we?) suffer from short positions. I stubbornly kept JYN and CHF longs under stress in last month, but happy days are here again. Bulls are more like puppies in the window, leaping and yapping "take me, take me" to the SWF passersby.

jam said...

Thanks for the take on equities, Macro Man, a few weeks ago, Feb, 12you put up a chart of the SPX with the Itraxx Euro Crossover Index. If you got a couple minutes how is that looking these days after the recent equity upswing? Thanks for all the useful posts.

Anonymous said...

The longer term seasonal charts don't show anything bad in March (basically straight up through June, then flat until the end of October, then straight up again in November and December).

Sorry I can't remember that link about money supply growth. I just read too much to remember where things come from. If I come across it again, I will post it.

Oldvet, I stubbornly (and painfully) kept my Japanese Yen and Swiss Franc positions, too. I don't know if I would say "happy days are here again," but I have definitely enjoyed the last couple of days.


Bruce Chadwick said...

MM, you said "while there are some intermediate [EUR/USD] targets at 1.52 and 1.53, the longterm goal is 1.63, still nearly 10% away"

I assume that 1.52 and 1.53 are psychological targets. What method did you use to arrive at the 1.63 figure?

"Cassandra" said...

MM - I am most sympathetic to your equity concerns. Peter's assessment sounds reasonably plausible and accurate in the details, though it'll cost them an few extra bob to make it look better given Feb has 29 days this year.

But the difference with the 70s is that USD rates remain firmly "Shanghai''d", "PBoC'd", or smartly [temporarily] contained with an official purgatory policed by all manner of Official Flow and SWF "investment".

If (before these last six months), I'd asked you to play financial word association [football] a-la Monty Python whereby I chose the surrounding context and you, as financial MacroMan extraordinaire chose the associated market interest rate (without the benefit of revealing the associated year of our lord), and we began with.... " Oil + 25% & Gold +50% in last 3 months; Silver +100%; CRB +33%; NYC Bridge Tolls +30%; Briitish Rail annual pass +17%, US [actual] Budget deficit > 3.5% of GDP & US CA deficit > 5%, with less than 5% unemployment amidst two overseas military campaigns, and offical plastic-surgeonized inflation rates >4% (and rising), you might counter - even if you were being conservative - with "short rates at 6-1/2 and long bonds at 7-1/2*(or higher), much like they were in, say, the mid-70s.

Instead we (USDs) are at ~3 (and falling) and ~4-5/8, making rates highly negative on any non-doctored inflation rate. But given that this is eye-rubbingly so, one would be foregiven for considering "equities" not vastly unreasonable. So now the observer must ask the question whether bonds or equities will roll over first, for nirvana (somewhat) remains so long as real wage pressures remain muted due to globalization, and real (short) rates remain highly negative and the cavalry of offical buyers keeps the long-end safely in its box. My opinion that equities are vulnerable is virtually worthless that I've personally been waiting so long for USD bond rates to blow out that if I were any more wrong I'd be right....

But with the entire S&P500 on a 7.25% 1 year fwd est earnings yields, and JNJ, MSFT, ORCL, MMM, IBM, CVX, CSCO, PFE, AIG etc. all on 1yr Fwd Est earnings yields between 6.5% and 10%, this makes the carrying cost of waiting for a return of unfettered price discovery across all other associated markets excruciatingly painful, even if all concerned's shenanigans are merely pushing out the inevitable ugly to 2009 or 2010.

OldVet said...

OTOH, earnings for S&P for 2007 fell 4.2% YoY. And I'll bet good money they'll fall further in 2008. Bonds may go first, and recent upsurge in long bond corp yields may be signal?