Tuesday, September 16, 2008

The Last Throw of the Dice?

Is today the last throw of the dice for Team 1250? Yesterday's equity market price action, particularly the late-session, high-volume collapse in the SPX, are providing a grave test to Team 1250, and indeed policymakers around the world.

Macro Man's decision on Friday to replace LEH with AIG on his screen as the vulnerable stock to watch proved prescient, as the price of the latter has collapsed over the past couple of sessions and now appears headed to zero. Given AIG's role in the structured credit and CDS maelstrom, they are possibly more likely to receive aid than Lehman was. If the Federales do bail out AIG, as a US taxpayer Macro Man would like to receive some sort of compensation; say, the transfer of Cristiano Ronaldo from Man United to West Ham for £1.

Joking aside, significant stress is now entering the system. The SPX put in its worst day since September 2001, and the squeeze in cash money markets is enormous; Macro Man is hearing stories of overnight USD cash being as quoted as high as 20%.
So suddenly, today's FOMC meeting is in play. As recently as last Friday, the market was pricing in zero chance of a move from the Federal Reserve; yesterday, October Fed funds was pricing in 22 bps of easing.
Some banks are now forecasting a 50bp rate cut today; others are forecasting zero. Should market distress continue along recent trajectories, policymakers will be forced to do something. Macro Man's take? An isolated Fed rate cut will provide very short-term relief, but will ultimately lead to lower prices. After all, if the previous 3.25% of easing hasn't supported equities, why should another 25 or 50 bps?

However, Macro Man would ascribe a 1/4 chance of a global coordinated policy easing today, which would be announced early in the European afternoon. A signal of global coordination could have a more lasting impact on markets, as it would suggest that the ECB and BOE have abandoned their monetary hair-shirts and re-entered the world of common sense, where a 2 month 38% decline in the oil price reduces forward inflation pressures.

Recent datapoints are not encouraging. The ECB's Mersch has painted the tape over the past twelve hours with the usual commentary that they are concerned about second-round effects and that inflation is the only point on their compass. Should the ECB care to consult said compass, they might observe that it is pointing due south- for economic growth, for equity prices, and yes, for inflation as well.

In the UK, meanwhile, August CPI printed a new high of 4.7%, thanks to the ongoing rapacity of rip-off Britain energy markets. The Bank has provided a special 2 day repo today to "fine tune" money markets; should that take the place of a policy easing, further downside beckons for the FTSE.

However, should the markets fall further and produce a coordinated response, the squeeze could be fearsome indeed. VIX already closed yesterday at levels which have typically indicated bottoms; a sell-off ended by a policy response would feel climactic and could generate the classic "tradable bounce"..USD/JPY , an absolute widow-maker for the past six months, is also perched on the edge of a precipice. Should current conditions not resolve themselves swiftly, we could easily be knocking on the door of 100 in short order.
Add in Goldman earnings, where we'll see the obligatory EPS beat of a buck a share, which could provide prove nano-term bullish for risk assets but micro-term bearish if it somehow precludes a global policy response.

And on top of all this, we have the noise generated by the market repercussions of Lehman's demise; to wit, people who had positions on with Lehman (both customers and other banks) now find that they may no longer have those positions. This is generating all manner of erratic price action as dealers and custys scramble to cover; 4 o'clocks may be verrryyyy interesting for the next few days.

And what it introduces into markets is yet another element of chance, driving a further wedge between "price" and "fundamentals." While this may ultimately introduce some fantastic mispricings and trading opportunities, in this market return of capital is far more important than return on capital. Would you want to bet the ranch on a roll of the dice?


Macro Trading Ideas said...

now according to me we can't exit from cash credit position, market makers don't pay for size, or at least at incredible levels..
but about our preferred trade long S&p500/short russel2000 (i can't believe that it goes always in the same direction, also today on electronic...), now i can't roll on december because cme has sold the contract, do you know where to trade or a good substitute (spmid400??).
I don't feel me good if i haven't this trade on my book..
now MS and GS spread are at crazy level this morning, aig at 20..my god!!!
is a US interest rate cut any economically helpful here?? NO!
JCT, King, where they are? who can fire them?

Anonymous said...

MacroMan - you mention 4 o'clock. It did move a lot yesterday in money markets around that time. What happens @ 4:00 exactly?

t said...

anon - london close (local time)

Anonymous said...

Sir Gianfranco Zola and Cristiano Ronaldo... not properly two of a kind!

JPY and (to a lesser degree) CHF are set to gain further, but safe-haven-USD is not going to crumble, even though FOMC was to cut 25 bps... EUR and GBP seem to be in worse position. Any news from SEK or NOK, recently? Risk aversion is a sort of nuclear meltdown maechanism...


Macro Man said...

Anon @ 11.23- it's the time of FX fixing in London, and the presumption is that other Lehman -related trades will be put through at the same time.

Anonymous said...

Interesting thing with PIMCO's exposure to CDS on AIG and Bill Gross' comment two days ago on Bloomberg that AIG is not going to fail..

Anonymous said...

The CME didn't "sell" the Russell futures contracts. ICE coughed up more money to license them (exclusively), so they trade there now. It remains uncertain how much of the volume will migrate there, but what is wrong with trading it on ICE?

eq said...

mini russell on ICE. Dec traded>250k contracts yesterday

mikarsky said...

My bet: No Fed rate cut and no strong indication that it would consider a cut anytime soon.

Anonymous said...

Sentment calls for an AIG resolution today. I don't think that a Fed rate cut, should it occur, will impact the AIG problem. MM correctly says that there is a divergence between fundamentals and price in the markets, but for AIG price reflects fundamentals. Other weaker players-- Wachovia, UBS, WM and now MS have obviously been caught up in this liquidity/ fundamentals black hole per macro trading ideas at 11:05. I am curious about the number of firms who will ultimately succumb. Surprisingly, there seems to be little talk about increased short regulation in US markets as a result of these meltdowns. However, I feel that such reform is likely to be part of an ultimate new regulation package.

Anonymous said...

Moscow trading suspended for 1 hour after being down more than 15%, Oslo down 10%

dblwyo said...

Partly coincidence but Meredith Whitney gave her usual blunt but insightful assessment of things and was analytically negative ~ 3p.m. US time. Market's turned over then.

MM - what about LEH and it's CDS exposures ? While that may be cleared out won't that ripple thru the credit markets ?

Ditto for AIG who's apparently an even bigger player.

Macro Man said...

Looks like AIG's getting bailed out, so Dr. Market is giving the market the finger.

Anonymous said...

Barron's cites counterparites' their crude contracts with LEH as a major reason for the price decline in crude. Anyone have insight on this issue?

Basti said...


You are concentrating on the short run. Macro Man should focus on the macros. =D

US money supply is being drained away with the deleveraging. Currency supply (as provided by credit) is being reduced at a much higher rate than money is being printed out, so the net result is a strong appreciation of the dollar within a the mid-term.

Short term I could expect a lot of hedge funds to bet against the dollar thinking they will outsmart the Fed. There should be a lot of volatile lateral movement as hedge funds lack the funds to move the forex market for too long.


Disclosure: All major holdings are in dollars.