Tuesday, June 10, 2008

Red Eye

One of the perils of macro trading is that markets move 24 hours a day, and newsworthy events are not confined to the normal trading day in any particular time zone. When market-moving events occur in the middle of the night, one occasionally (or, depending on one's proclivities, nightly) receives a phone call to say that something's going on. Macro Man generally tries to manage his book in a way that minimizes the need for late night phone calls and trading, but on occasion such outcomes are unavoidable.

Such was the case last night, when Ben Bernanke brought his own version of Hammer time to financial markets. The impact was instantaneous, especially in fixed income, with both directional and RV strategies gapping on virtually no liquidity. Such environments are not exactly conducive to going quickly back to sleep, and in retrospect Macro Man feels like the picture above left- like a rabbit caught in the headlights, with a case of red eye to boot.

There's not much you can do except sell what you can, a strategy apparently pursued by more (and bigger) punters than Macro Man. As noted yesterday, the moves in some of these short term interest rate contracts are historic, and has led to such perverse situations as the following:

*Between Thursday's close and Monday's close, December short sterling fell 34 bps

* Between Thursday's close and Monday's close, 94.50 calls on that Dec short sterling calls were unchanged in value.

Ay caramba! The rise in implied vol completely offset the delta loss of the option. That, Macro Man would suggest, is a market that is close to ungameable.

And that, ultimately, is a decision that each of us have to make. What is cheaper: the opportunity cost of missing a "lay up" trade at current levels, or the actual cost of putting on the lay up trade, misjudging your market liquidity, and losing more money than you thought possible?

Given that Macro Man already accomplished the latter on certain positions this week (thankfully, at least partially offset by other, more successful trades) , he's happy to opt for the former.

And make no mistake- market pricing is currently pretty aggressive. The market is now pricing in more than 2 Fed rate hikes by the end of the year; this time last week, 14 bps were priced. The one week shift in the Fed funds curve, pictured below, has been substantial.Somewhat amusingly, Macro Man's good buddies the Russkies have chosen this moment of maximum market distress/minimum market risk appetite to finally allow the rouble to strengthen. In what appears to be a reval of the currency, the RUB has broken through the erstwhile support of its 55c US/ 45c EUR basket.
These markets are hard enough as it is. But when the world's third largest holder of FX reserves is actively trying to screw you over, Macro Man has to believe that he's not the only macro man suffering from a bit of red eye this morning


Anonymous said...

think there still many players left in short sterling or too many 'burnt once too often and bitter' types sitting on the sidelines?

Macro Man said...

I really dunno. Then again, vol is so high that you can do some pretty optically attractive butterflies at pretty low cost. So that's what I've tried to do today, succumbing to the siren call of short sterling for the first time....

Corey said...

After participating in a great gold run into March, I've shifted my focus to foreign currencies with little luck thus far. My analysis of the currencies tells me the yen should be the biggest winner over the coming months, but clearly the last few weeks have tested that thesis. I'm wondering if the Ben Bernanke jawboning is little more than an attempt to say "we care about inflation enough to talk dirty, but in the end we don't know about raising rates b/c we have no idea how the data will play out."

Clearly the Euro currencies have been outperforming relative to the yen (Trichet), however today I notice a *small* outperformance by the yen. I find it interesting that the 2-10 moves in Europe, the Shanghai index crash, and the other dislocations in the market haven't caused a greater amount of distress in the US equity indices - notably the R2K.

Things kinda feel pretty good, like you're comfortable b/c your head is in boiling water and your feet are on ice - huge disparities but the temperature is about right.

I'm still looking at the yen right here and have added more at these levels today...if we're not out of the woods and things go crazy, I'd expect a 1200-1700 tick move up in the yen futures within a short amount of time. If not, I expect the S&P to shoot back to 1440 right quick.

Good luck out there. Any thoughts appreciated.

Macro Man said...

Corey, I think there's a lot of people trying to run long yen, with less than zero success. At the same time, the japanese themselves seem to be on a bit of a yen selling program...the DOTW have lived to fight another day.

Insofar as the market theme of the last month has been spelled P-A-I-N, I'd suggest that the pain trade in USD/JPY is to the topside (viz, the IMM positions are still net long yen.)

Meanwhile, US officials are all starting to try and jawbone the $ higher. Anyone buying USD will find themselves paying negative carry...unless they buy em against the yen. I also wonder if some equity/EM guys are short USD/JPY as a hedge against their core market longs...and are being hurt as well.

In sum, I'd suggest treading carefully and be miserly with your risk budget. Over the past few hours/days/weeks I've seen too many "never gonna happen" moves to believe that this market is fully rewarding rational analysis.

Adrem said...

Light crude has gone contango out to July 2009 today. High oil px expectations becoming embedded?

D said...

I don't believe any of the rate hike yapping going on right now. A move as sharp as the one we have seen is caused by too many people on the same side of the trade.

kihei said...

I am feeling some pain being short USD/JPY. I am in this trade simply because I believe the BOJ will blink first before the FED does in raising rates. I am holding out for food inflation to hit Japan as it has other Asian countries and for them to raise rates sometime this fall. With the banking situation in the US I do not see the FED raising rates this year. So far I am wrong on this trade.