Wednesday, July 23, 2008

Turning point?

Macro Man forwarded yesterday's modest proposal to the Congressional Budget Office, where it received an enthusiastic response. He also contacted the major networks as well; expect to see the Macro Man Plan feature prominently in the autumn McCain-Obama presidential debates.

Moving back to the more prosaic world of financial markets, we seem to be at a critical juncture. One market that shows signs of reversal is interesting; two might be a coincidence. But when a whole host of markets break supports/resistances simultaneously, Macro Man sits up and takes notice, because such behaviour is characteristic of thematic turning points (even when the theme switch is from "everyone makes money" to "everyone loses money".)

Let's start with the obvious: banking stocks. The sea change there is best exemplified by Wachovia, which posted shocking results yesterday, delivering a much larger-than-expected loss....and rallied 27%. Would that have happened a week or two ago? Nope. Over the past six days, the BKX has rallied 45%. Holy cow! For any basket of stocks to move that far, that fast is truly stunning, and almost certainly represents a (very) painful scramble to cover shorts.
A short-covering break of resistance is occurring in broader indices as well. Yesterday's SPX recovery was truly impressive, and has fed through into the Eurostoxx, which has broken the resistance created during the consolidation period that registered so strongly on Macro Man's chop-o-meter a few weeks ago. You'd have to think that there's a decent chance of follow-through as shorts scramble to cover.
The dollar is also poised to confound the bearish consensus. Yesterday, EUR/USD broke through the support of the uptrend from mid-June. The move has followed through today.
Similarly, USD/JPY has broken the downtrend line off the mid-June highs, as well as the widely-watched 200 day moving average.
Slightly further off the beaten track, you can find even more stunning reversals. Yesterday, Czech CB governor Tuma suggested that the CNB could trim rates next month in response to CZK strength, even though inflation's shown little sign of moderating. There is little more bearish for a currency these days than abandoning the inflation fight in a pursuit of growth; this is particularly the case when the market is heavily positioned the other way. Yesterday was reportedly the largest one-day move in EUR/CZK of all time; while Macro Man has not confirmed that statistic, there's little doubt that the reversal has exposed a very small exit door in long CZK positions.
Two other central banks who are straddling the growth/inflation divide are the BOE and RBNZ. The former released the minutes of the July meeting this morning, and treated the market to the odd spectacle of one member voting for a cut, another voting for a hike, and the remainder sitting on their hands. This has prompted another nasty reversal (yes, there's that word again) in short sterling, which one would have to presume has not been a profitable one for market punters.

The RBNZ, meanwhile, announces rates tonight (or tomorrow, depending on your time zone), with the market split 50/50 as to whether they'll cut rates. Really, it's only a matter of time before they do go, but with NZD positioning extraordinarily heavy relative to the size of New Zealand's GDP, expect fireworks no matter what the outcome.

Whether this week turns out to be an intermediate (1 month) or even longer term turning point, or just another head fake, will only be known in the fullness of time. But after the length and scale of many market moves in June and July, there'd appear to be worse market strategies than betting on a position squeeze and reversal of recent market fortunes. If the CTAs are going to engage in a stop-loss feeding frenzy, it's best to let them have at it.


Anonymous said...

basically this is THE inflexion point. Fake bottom or not? The fact that everyone is calling for it means most likely we will not get it.....but then again we may be having this conversation in a couple of months after 15% worth of gains across the board.....

Macro Man said...

Anon, that's sort of my base case...a painful squeeze that sets up a nice shorting opportunity when the next penny/shoe/whatever drops

Quarrel said...

AUDUSD is breaking down. The commodities fun could be over for a good while ..


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XX said...

Would appreciate your thoughts on the following:

There is currently a big dichotomy in US inflation expectations. On the one hand, US inflation break evens have been cratering over the past month. 5 year expectations have fallen 45bps to around 2.25%. 2 year inflation expectations have fallen 80bps from the highs to about 2.1% today. If this is achieved over the next 2 years, this would imply that the Core PCE Deflator falls back to 1.6%, based on the median headline CPI and Core PCE spread over the past 20 years. (Mean: -72bps, std dev: 85bps) This would be well within the inflation comfort zone for the Fed. However, at the same time, the Fed has become increasingly vocal about containing inflation and inflation expectations. Based on speeches, there is an increasing likelihood that 3 FOMC members will be voting for a rate hike in the next meeting, and the Fed Funds market is now pricing in 100bps in hikes by June next year, down from 50bps a week ago. So who’s right? Fight the Fed or fight the market?

IMO, the breakeven market has gotten it wrong. We just saw a CPI print of 5%. Inflation tends to be sticky. Inflation is still high in many EM's across the world. We are in the middle of hurricane season.

In any case, there's potentially another 60bps of downside or so in 2yBE's. Carry in Aug is 45bps. Risk seems pretty skewed to me.

fxquant said...

Forex markets, like banks, have been so one-sided for so long with carry trades, "risk aversion" plays (hah) and EUR linking to CL, SPX, EUR/JPY, GBP or whatever suits fx players fancy any given day it has become something of a farce. Negative Euro`Zone data has been downplayed or ignored while even minot, third tier US data such as Milwaukee PMI or Richmond Fed are played up. Beware when the end comes Euro-bulls.

Kevin said...

Trading on a feeling is rarely wise, but this just doesn't have the feel of a major market bottom...are freddie and fannie really going to be okay? Will Lehman survive? Even if Crude oil sold off another $25, it would still be where it was earlier this year when demand started to get hit. While stocks precede an economic recovery, I doubt there will be any such recovery for quite some time. If you can stomach pain for a month or two, it's a short opportunity. I'm scaling in.

Macro Man said...

XX, I'm long TIPS pa, and have been since Jan 2007, as a hedge against high inflation killing equities. But I am under no illusions that TIPS breakevens represent some sort of forecast of future inflation, particularly in an environment where doing a cash long break/short nominal bond trade is very difficult for a hedge fund. So really, TIPS prices are set by supply and demand of real money investors. The "inflation swap" available to the leveraged investor is, alas, a more disadvantageous price than the cash bond breakeven, further dissuading leveraged types from going long inflation. SO, I think your comment on the breakeven market is right.

Fxquant, now all we have to do is get China , Russia, and the Middle East to pay attention to Eurozone data, and maybe they'll bugger off for a few lifetimes and let the private sector set the price!

Kevin, I don't think we necessarily disagree...but April/May was very, very painful for a whole host of punters, and it seems reasonable to expect more pain ahead- enough pain, IMHO, to warrant a stab at the "long risk asset" trade before going back into short mode again.

Brian said...

"but with NZD positioning extraordinarily heavy relative to the size of New Zealand's GDP"


How are you able to determine the level of NZD positioning? thanks

Macro Man said...

Well, it's more of a sense than anything else. But I know it's my biggest position in VAR terms, and it's a trade that has real macro appeal (capitulating CB, overvalued ccy, et al), and most of the brokers I speak to have lots of clients that are I think it's a reasonable assumption. Net positioning amongst all participants might be much smaller, as macro shorts are balanced by longs from Mrs. Watanabe and co.

Flash Rabbit said...

Thanks v much for the tip on NZD - another big jump down exactly as predicted! Very nice indeed.

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Anonymous said...

I'm a new reader of your wonderful blog. Thanks for the time and effort it must take. Put the posts together for a book-- sort of an updated Memos from the Chairman by Ace Greenberg (no other comparisons to the Bear are appropriate!) Loved the Dead Bank poll. How do the markets view the dollar in light of a new, uber liberal Prez in the US who will up spending and taxes?

Macro Man said...

Anon, thanks for your kind comments. I thoink there's a chance that Obama could be quite good for the dollar, insofar as the rest of the world would look more favourably on the US without a GOP-er in the White House. I'm not saying that that's the correct view, but the love-in that Obama received in Europe recently is telling, I think.

In the fullness of time, a President Obama's agenda would help shape the trajectory of the dollar more than any warm'n'fuzzies that he might give the the near term, though, I could see an Obama victory leading to a dollar rally...especially if the ECB shows signs of caving in as well.

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