Thursday, July 03, 2008

Shift F9

(Shift F9)

This market just doesn't get any easier, does it? Consider that in the last day and a half, we've observed the following:

a) A stunning intraday rally on Tuesday off the S&P 500 Maginot line, apparently based on GM sales figures, the flimsiest of possible justifications

b) A late session collapse in European equities on Wednesday, led by erstwhile market leaders the miners. The basis for the sell-off appeared to be a modest correction in traded coal prices

c) A follow-through- and more- from US equities, which took erstwhile positive catalyst GM to its lowest level since the first Eisenhower Administration and the SPX right back to the Maginot line.

d) A hugely weak opening in Europe, which suddenly reversed after the release of weaker-than-expected PMI data. After the release of the worst UK services PMI in history (which admittedly only goes back to 1996) , the FTSE surged into positive territory and short sterling got clumped.

WTF? On issue #4, that's literally like some sort of Bizarro world.

Well, if you expected it to get any easier today, think again. 1:30 London time (8:30 NY time) today will be one of the most influential moments in time that Macro Man can remember. For it is then that the US releases (a day early thanks to tomorrow's July 4 holiday) its monthly employment report and that Jean-Claude Trichet begins his press conference to explain today's rate action (widely expected to be a hike.)

The market broadly expects a hawkish Trichet, and normally, that's a pretty good bet. But Macro Man cannot help but think that the risk could be skewed the other way. Markets are discounting another 30-35 bps of tightening after today's 25-er. Yet the EUR/USD exchange rate is back towards its all-time high, even as forward looking indicators of economic activity have turned south. The chart below shows Germany's ifo survey with the ECB refi rate; as you can see, the ifo leads by a healthy margin and has turned sharply lower in recent months. Might the ECB throw a bone towards growth at 1.30 and suggest that policy is now neutral? Inquiring minds want to know.
In the US, meanwhile, the consensus expects correction of last month's "rogue" 5.5% print on the unemployment rate. Yet Macro Man's preferred indicator points to a further rise in the U-rate , so he reckons the risk is towards a weak number. The employment component of the ISm is also at levels that are consistent with a higher unemployment rate. Even if Macro Man is right about unemployment, the juxtaposition with Trichet means that today's EUR/USD price action is anyone's guess.

Perhaps a cleaner trade is in the yen, which tracks US yields very closely- see the chart of 2y yields and USD/JPY below. Macro Man has joined the ranks of frustrated traders with a long yen position (EUR/CHF shorts must feel the same way)....if he is right on today's figures, he should get some joy.
If he isn't, then he'll be happy to jettison and avoid the cardinal investment sin of turning a trade into an investment.


Anonymous said...

"Markets are discounting another 30-35 bps of easing after today's 25-er."

I think you meant tightening. An easing by the ECB today certainly would make the day memorable. :)

spagetti said...

MM dont you feel that he 'has' to hike because of his previous hawkish comments ?

im btw putting my money on a doveish surprise, and i've got the EUR version of your int.rate diff. chart + EURJPY in front of me..
but my conviction rate is curbed by Trichet sounding obsessed with hiking rates

oh, and another thing; so many themes on which history rhymes:
1930's with its deflationary theme BUT more interestingly the 1992 episode of the hawkish Buba leading to a crisis; do you think the ERM parallel is valid ? do you think Trichet is as devoted a student of history as Ben the Deflation Buster ?

good luck for today !!!

Adrem said...

Re: Pulling back because of German ifo data.
MM surely the graph covers a period when inflation was benignly on the back seat. Now its unbenignly upfront so Trichet breaks the pattern because his priority is now inflation not employment.

Adrem said...

Just a thought. As we know, markets often test central bank/government resolve. Is the oil market doing that to Bernanke? Oil says: let's see if you have the gumption to raise rates?

Macro Man said...

Anon, fixed- thanks!

Spags, one issue that no one ever talks about vis a vis the Depression comparison is the fact that in the 1930's the world was in a fixed exchange rate regime anchored by the gold standard. That is a very different scenario from today's, where many exchange rates are floating and those that are fixed are anchored by the Turd standard. Those curencies to which the dollar is pegged have something very important than an inot of gold does not: a printing press, and they ain't afraid to use it.

Re the ERM parallels, yes I do believe they are apt. The obvious differnce is that without the flexibility of a currency/interest rate adjustment, the real economy takes the strain.

Adrem, in 2000 inflation peaked at more than 3% in May 2001...coincidentally, the month the ECB started cutting.

On the "gumption" bit, how bout this: what odds a coordinated intervention to support the dollar tomorrow in illiquid holiday markets?

spagetti said...

thanks for the reply

re intervention; i hate conspiracy theories, but to me it would make sense that the ECB agreed with the Fed/Paulson that they hike today; deliver a less hawkish press.conf and if needed step in to defend 1.60
or intervene in the EURJPY ;)

Anonymous said...

Frustratingly good call MM re neutrality from Trichet, he seems overly cautious, probably given difficulty of sole price stability focus whilst real economy continues to suffer. € off 130 pips and equities rally, usual nonsense!
Best, JL

Macro Trading Ideas said...

What a month after can mean!!!
Really a great day for me today.. trichet repaid me a lot.. one of my best day ever!!!

Anonymous said...

to quote the clash--im all lost (in the trading market place I can no longer trade happily)---wow the only thing that seems to work is flush out positions--really amazing how much pain there is and atleast in fx we are going nowhere over last month dxy pretty much unchanged yet the movement in stocks, rates and commodities would tell you otherwise but once again how do you put on a trade with good risk reward in these conditions--u don't happy 4th

Anonymous said...

great points, you anticipated the risk well...perhaps the reason for the late weakness in European stocks before today was the same which was inherent to the curve flattening- growing fears of not 25bp from Trichet et cie but 50 or the likelihood of another 25 next month (since they scheduled a full meeting too) such then the concerns and relief evident in the EUR curve ironically also helped equities recover as the fears of more hikes are off the table...bizarro world indeed...meanwhile the eur weakness and top which is apparently being at last confirmed, stands against your usd/jpy and 2yr correlation by posing the question, can one be bullish on the front end and bullish on the USD against EUR while USD/JPY drifts? Perhaps eur/jpy sells off hard too, mitigating such concerns while also historical precedent indicates that such a tight and positive correlation between stronger usd and higher treasury yields can reverse....what do you think? thanks, you are doing a great jpb by the way... Ed

Macro Man said...

Thanks anon and Ed, though all I can say is that my "good call" merely kept me out of the minefield that is EUR/USD. Fortunately I cut my yen long pretty sharpish after payrolls, so didn't get killed on that.

Ed, I'd say there's every chance that the joined-at-the-hip linkage between the yen and US bonds can break down; after all, the yen and equities used to trade in tandem, but today we've seen US stocks print 2 year lows (more or less) while EUR/JPY once again flirted with all-time highs.

As I noted a few weeks ago, that breakdown has cost a lot of people a lot of money. No doubt the yield/dollar breakdown will do so as well; it seems as if every RV trade out there gets smashed eventually, no matter how solid its foundations.

Anonymous said...

Great stuff MM...concerning the breakdown of equities and Eurjpy etc. The key seems to be FX Vol and the breakdown in correlation between FX Vol & VIX. Its FX vol picking up that will see carry get hurt..this used to occur when equities fell and Vix rose but now the link is not there... and why VIX and FX VOL no longer work, I would give quite a bit to find out... Its cost me a fair bit trying to argue against it! thanks for your thoughts

Laeeth said...

Good point about the breakdown of the link between fx vol and the VIX.

To complete the triangle, the other relationship that has broken down of late is that between equities and 10y yields. Possibly that is just one sign of powerful bond-bearish cyclical forces that may, over the years to come, unwind the entire post 1982 bond rally

Anonymous said...

we were trading the yen cross vs. sp500 correlation Manually from mid-july through august 2007. the black boxes took over and it made things a bit more difficult for the discretionary traders i manage. this correlation broke down AGES ago and i actually think it may come back soonish. the japanese houswives are loading up on JPY shorts again. have a close look at eurchf vs. sp's. a much better RV trade lately. and with a hawkish SNB today, an easier RV play with equities.

Macro Man said...

Anon, Laeth:

The breakdown between FX vol and VIX is really the same correlation breakdown that I've already observed, I think because both VIX and, say, USD/JPY (or NZD/USD)vol are highly inversely correlated with the price of the underlying.

So VIX has gone up as Spoos have gone down, but NZDJPY vol hasn't really done much because spot hasn't really done much.

Steve said...

Macro man,

I was intrigued by the IFO and repo rate graph and noticed that the IFO tended to lead by a considerable interval so I shifted them around and found a pretty good fit by leading the repo rate by 13 months. If that relationship holds, the repo rate should indeed peak here at 4.25%

Macro Man said...

Steve, I observed the same thing...which is why I figured there might be a chance that the ECB came out a bit dovish!

Steve said...

MM here's another one, if you can overlay the Shanghai index and crude it's an interesting one--not as is, but while shifting the Shanghai index forward 38 weeks, where the correlation is 97%! Interestingly, the Shanghai peaked 38 weeks ago. I am always wary of data mining but think there could be a certain causality at work here. Time will tell.

Steve said...

Not the best explanation I've ever written...if your e-mail is public I can send it to you, a picture is worth...well, you know.

Macro Man said...


Fire away!


Anonymous said...

Hey Steve,
not a big fan of technicals or anything, and I sure have not looked at the Shanghai on top of crude chart- but Crude oil rally from latter end of 2006 onward looks like a perfect rendition of infamous Elliot wave patterns, 12345- ABC, so as a coworker explained to me - we are 5, next step is ABC down to 105- who knows, I am looking to short crude at 150 for slightly different reasons, but we'll see-

Steve said...

Anonymous I'd be a happy camper, as would everyone in the "real world." I don't have the courage to tally how much I've lost on a short oil position.

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