Tuesday, September 16, 2008
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?