Thursday, June 26, 2008


So, Vizzini said his piece last night, observing that growth risks, while mitigated, remained to the downside, while inflation risks were somewhat more acute than previously thought. And hey- Fezzik voted for a rate hike! Macro Man thought that on balance, the statement was a tad more hawkish than he'd feared, but clearly the market didn't agree. To be sure, Macro Man doesn't think that the Fed will hike rates any time soon, but the reaction of markets appeared to suggest that such an outcome is, to quote the original Vizzini, "inconceivable!"

Macro Man was frankly surprised at the reaction of equity and currency markets to the statement. After the SPX bounced above 1330 and came back to 1325, Macro Man seriously contemplated an aggressive sale of ESU8 with a stop loss at 1335, just above the high of the day. Having taken back his SPX short earlier in the week, he didn't want to miss out on the downside party. Fortunately, he stayed his hand, as the trade would have produced the worst possible outcome: a stop-loss purchase near the highs, followed by the subsequent expected decline. This market really isn't getting any easier, is it?

Fortunately, Macro Man retains reasonable short risk in European equities, which have followed on from the limp US close. Stock market weakness has been exacerbated by yet another bearish report on Citigroup- Goldman expects a cheeky $8.9 billion writedown and has put C on their "sale of the century" list. In Europe, Fortis is feeling the hangover from its share of last year's ABN purchase; it's raising additional capital and has suspended its dividend.

Moving on to currencies, Macro Man is wondering whether it's time to resurrect the Rule of Four Point Two. Long-time readers may recall last spring's thesis that the EUR/USD tends to meander in a range that is roughly 4.2% wide for several months before embarking on an explosive move in the direction of the trend. Since the sharp rally of January/February, EUR/USD has spent three months in a range that's been 4.5% wide- a range close enough to qualify for the Rule, in Macro Man's view. Notably, Voldemort and co. have been observed selling at the top and buying at the bottom, just as they did during prior applications of the Rule.

How best to play this? Tough as it may feel, the profitable strategy is to buy weakness and sell strength while spot is constrained within the range. However, once the range breaks, run with it, because it should be good for a 3%-5% move. For the past several years, these breaks have come to the topside of the range, and yesterday's price action would suggest that the same will happen this time around.

And yet....Macro Man can't help but think that EUR/USD has run its course, and that the next big macro change will be the European economy finally slowing enough over the next few months to change the ECB's view. We've already had the first rise in German unemployment since early 2006, and the ECB's hawkish rhetoric appears to have crushed business confidence. G3 FX has been a P/L morass over the past few months, and Macro Man has little inclination to jump the gun whilst the market's in the middle of the range.

He can't help but think, though, that his worldview, combined with the Rule of Four Point Two, will make EUR/USD an attractive sale in a percent or two. While a large EUR/USD decline might seem inconceivable at the moment, as Inigo Montoya observed, that word doesn't always mean what you think it does.


Charles Butler said...

On the trade-weighted front, 20 foot cans Cadiz-New York seem to be shipping for about 40% of a year ago. The change is apparently even more exaggerated from Buenos Aires. Many are reported to be going back empty to satisfy US demand.

GermanGuy writing from Germany said...

A rise in German unemployment since 2006? Looks like I missed something over here...

Apart from that, thanks for your informations on macro trade issues. Keep up the excellent work.

Greetings from Germany

GermanGuy writing from Germany

Macro Man said...

Mein Herr,

Mein apologies. What I meant to say is that we've had the first (monthly) rise in Germany unemployment since early '06....

Anonymous said...

My first good day in forever (stubbornly sticking with risk reduction trades) today (a thirty dollar rise in gold certainly didn't hurt). While waiting for the Euro to do something against the dollar, I have shorted the GBP against it (just trying to keep the risk low). I also have AUD/NZD - New Zealand will report a (probably) negative first quarter GDP number in a few hours, and CHF/JPY (call me lucky on that one, but it has worked reasonably well). My biggest currency position though, is short USD/MXN. With about half the volatility of EUR/USD, that has been the carry trade of the year (so far).

Macro Man said...

Well done, Anon. Kiwi GDP should be interesting; will it do an Aussie, and shock to the upside, or a Canada, and shock to the downside? Seems to me that the street is short kiwi, but has room to get shorter...we shall see.

USD/MXN is one of those trades that I don't understand, and thus don't believe in and don't have. Been a bit frustrating to see it move like this in a straight line (EUR/CEE4 are similar.)

Fortunately, I took about 60 bps out of the 10yr TIIE swap in a week and a half earlier this month, so I feel like I've done alright out of Mex in this run.

Anonymous said...

I live in New Zealand, and I can tell you the mood here is pretty grim, so I didn't see a big chance of a positive surprise (the GDP number came in on target at -0.3 - though the trade balance was horrible at -196 MM NZD versus +150 MM NZD expected). I don't want to put all my faith on the mood of the people, though - I read a quote yesterday from a woman in the United States (with still positive GDP growth and a relatively low 5.5 percent unemployment) - "now I know how my grandfather felt during the Great Depression." With only two mild recessions in twenty-six years, a relatively bad downturn will bring much worse than what has happened so far (and an enlightening reassesment of what bad economic times really mean).

I must confess I don't understand every trade I make (but I can always find reasons to justify them :) ). And I certaninly make short term trades against my long term beliefs. I don't believe too much in Mexico long term (they will become an oil IMPORTER in a few years due to lack of investment in that industry), but for now, they have a policy rate 575 basis points above Fed Funds Target Rate, so I piled in with the usual hope that I can get out quickly enough when things turn :) ).

Japan also falls into that category for me. While the yen could appreciate smartly in the near term as carry trades unwind (plus the possibility that interest rates will increase some day), the yen seems to me (despite Japan's currency reserves) the major currency most likely to go to zero. They have the oldest population in the history of the world, horrible demographics (like Russia, forecasts call for one-third fewer people there by the middle of the century), the highest government debt (percentage of GDP) of any major country ever, and almost no resources. Anything they can do, other Asian countries will soon be able to do better (and cheaper).