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.