Putting Holmes on the Hunt for Cheap Gamma

Market reaction to the G7 statement has been refreshingly rational, as the dollar's grey-zone attempts to surge have been body-slammed so far, taking both the EUR and the JPY to levels virtually identical to Friday's New York close.

Tellingly, reserve managers have been reported as buying up EUR/USD throughout the Asian and European sessions, re-inforcing Macro Man's view that it's more important to pay attention to the people with the money than he people with the microphone.

Indeed, one could easily argue that the "G" that is most influencing markets this morning remains GE, as equities have traded on the back foot following Friday's late-session melt away in the US. Sadly, it remains premature to state that the correction higher is over and the down trend back in force, for the simple reason that volume remains pretty modest. Sure, there was a slight uptick over the 4 days of sideways SPX action, but volumes remain well, well below the levels of February-March.
Still, with a number of bank earnings out this week, it's not hard to construct an argument that the catalyst for fireworks is now in place. After all, the G7 failed to deliver any concrete steps on improving market conditions, banks that demanded more liquidity with no concomitant increase in regulation were told to get back in their box, and the newspapers are full of rumoured rights issues and write-downs.

Macro Man has sent Holmes, Watson, and the Baker Street irregulars out onto the streets in search of some cheap gamma. Sadly, they've drawn a blank thus far, beaten to the punch by the infamous Moriarty. Should anyone encounter any, by all means pass the word. Lestrade of the Yard is offering a shiny gold sovereign as a reward.
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Anonymous
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April 14, 2008 at 11:18 AM ×

Gamma is quite cheap in RXM... implied breakeven below current realized gamma and RXM is going up, which is usually vol bull. Should move with US equities as well.

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Anonymous
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April 14, 2008 at 1:54 PM ×

mxn is super cheap (but maybe cheap for a reason) still if end of world comming that 1 month 11 ot pays out pretty good (ive lost more money in mxn this year than i should admit too)

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Anonymous
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April 14, 2008 at 1:58 PM ×

i have been watching mxn vol from the sidelines for a while and shaking my head. what will bevthe catalyst?

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Macro Man
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April 14, 2008 at 1:59 PM ×

Yeah, I'd file MXN under 'cheap for a reason'.

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tmcgee
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April 14, 2008 at 2:11 PM ×

i just wonder: do you ever hear of reserve managers selling the EUR? on occasion of course, but less frequently than common sense or market playing would expect. i don't doubt their purchases today but do think it becomes the overly easy rationale ... anyway, some semi-contrarian thinking.

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Macro Man
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April 14, 2008 at 2:26 PM ×

They do occasionally sell EUR and GBP, etc....but broadly speaking, only for the "punting" account, which is a helluva lot smaller than the "reserves" account...so net/net, the net volume is very large to the buy side.

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Anonymous
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April 14, 2008 at 2:38 PM ×

most intervention is conducted (still) in the dollar market, so CBs that are intervening heavily but have a portfolio target below the basket they buy through intervention are natural USD sellers. Macroman's take doesn't surprise me much as the pickup in CB intervention last year implied very large sales of USD for EUR and GBP on net over the course of the year just to keep the USD share of reserve portfolios from rising. You see this with the emerging market central banks that report data to the IMF -- and that is 1/2 the flow at best. If a big central bank was trying to lower its USD reserve share while intervening heavily, the required sales would be massive indeed.

Macroman -- do you have any view on whether or not Voldemort is diversifying at the margins? The upward revisions to Voldemort's USD holdings in the survey were smaller than expected, which opens the door. But Voldemort's diversification of fund managers (the growth in the USD assets of the state banks) and assets (more corporate bonds?) may have reduced the share of Voldemort's holdings that appear in the US data.

bsetser

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Macro Man
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April 14, 2008 at 2:51 PM ×

Brad, I would be surprised if SAFE were divrsifying (i.e., reducing the percentage) out of dollars at thse levels. For an ostensible long-term investor, going longer EUR at 1.58 would seem a very sill trade indeed.

Rather, and per prior comments from the Chinese, I suspect that they are diversifying by asset class....not only via CIC, but via SAFE's rather surprising purchase of its Total stake which you picked up on.

It's obviously difficult to tell on my side of the fence, but my impression is that the most active players have been the Middle Eastern guys.

Moreover, when Russia accrues a lot of FX reserves, they typically flip into a portion of euros within a matter of days. Recently, their pace of reserve accrual has tailed off quite sharply.

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tmcgee
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April 14, 2008 at 3:06 PM ×

muy interessante. i'm still amazed at the sheer pace of chinese reserve accumulation, though as brad details it is increasingly returns on reserves. much like japan's $1 trln-plus now. i understand the aspect of reserve-ratio targets leading to inevitable accumulation of EUR and GBP. but as macroman says, maybe they are starting to balk. but i'm not sure what the endgame is in terms of reducing dollar selling. it doesn't seem to be a short-term rates story anymore per se. but perhaps once the ecb changes tune on rates so will the EUR. but that seems awfully simplistic...

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OldVet
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April 14, 2008 at 4:45 PM ×

There may be more to China reval than before, see pretty well educated guess at: http://piaohaoreport.sampasite.com/blog/

Apparently the gradual reval regime is not helping slow hot money inflows.

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