Another One Bites the Dust

Macro Man sure is glad that he finally got on the distribution list for "the memo." Yesterday's memo about the breakdown of correlations and the underperformance of carry and EM proved to be timely; the Illuminati have done their job well over the past twenty-four hours.

Currency de-leveraging has had a particularly strong impact on EUR/USD; given that the euro was directly or indirectly the beneficiary of speculative flows funded by dollar borrowing for much of the past six years, the unwinding of these trades has been nothing short of spectacular. Macro Man's post-holiday expectation that the USD would range-trade has proven to be spectacularly incorrect; fortunately he did not follow up with any sort of nonsensical vol-selling strategy. Was it really two years ago that he was moaning about the lack of volatility? EUR/USD has fallen 20% in 3 months!
From a long-term perspective, the rally in the dollar has actually been pretty modest; the chart below shows USD/DEM monthly candlesticks since 1980. EUR/USD could sell off quite a bit further and the dollar bear market remain intact. Yet the buck seems to move in seven year cycles, and the current bear seems to be at or past its sell-by date. With the situation in Europe no better than the US-and one could argue the future newsflow will be worse- might the current unwind represent the genesis of some sort of deflation-driven dollar bull? (Think JPY in the first half of the 90's.)
In any event, it looks like FX carry is the latest strategy to blow up, following a distinguished line that includes high-yielding structured credit turds, equity long/short, fixed income RV, and energy/commodities. The chart below show the performance of a simple G10 carry basket as of last night- it should lurch down again on today's close.
The real pain, however, is being felt in EM. The Turkish lira has taken a beating, and anecdotal evidence suggests that local corporates are short USD. Latan America looks ugly, as does Eastern Europe. And Asian sovereign CDS blew up last night, including China (owner of the odd $2 trillion or so in cash), which rose 70 bps.

And of course, it wouldn't be any sort of crisis if Argentina didn't default, a development that now looks imminent. So after FX carry and the EM miracle have been taken behind the woodshed for a beating, Macro Man is left to wonder: where are the remaining sacred cows to be taken to the abattoir, the pink flamingos that have yet to be hunted? Because Macro Man has little doubt that another strategy will, like those before it, bite the dust.
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Anonymous
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October 22, 2008 at 9:38 AM ×

MM-GBPUSD unwind in the past 24 hours has been as, if not more, spectacular in the last 24 hours...1.71ish to 1.625 or thereabouts...Time for all the US expats to close out their long UK work visa positions and move home...

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Lemmiwinks
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October 22, 2008 at 10:37 AM ×

300 bp hike by Hungary central bank from 8.5 to 11.5.
Without any effect at all on EURHUF.

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Sean Maher
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October 22, 2008 at 11:09 AM ×

It seems that although EM central banks are awash in dollars, their corporates are massively short, partly because of reckless hedging activity, partly because of difficulty refinancing aggressive overseas expansion; we've had huge hedging blow-ups in Brazil and China (that Citic Pacific open-ended Aussie Dollar swap is probably the first of many similarly reckless bets) and rumours of lots more to come in Russia and elsewhere...it's a very painful US$ short squeeze which will inevitably overshoot.

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Anonymous
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October 22, 2008 at 12:14 PM ×

EUR/RON. The NBR cannot defend this much longer, the MM rates are in the sky 20/200 for O/N. So, from the current spot of 3.57 there is a nice return to cash at 4.2 or 4.5 once MM rates move lower. This should happen very soon as the economy is starting to feel the pain.

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Anonymous
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October 22, 2008 at 12:49 PM ×

or for the americans to move over to london and low ball bid for some of those US expats' flats.

the hungary CB cant be happy with this reaction after unprecedented 300 bps hike.

MM, USD SGD vol is VERY cheap and looks to be breaking out. 1.6000 target for the next 2 months.

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Anonymous
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October 22, 2008 at 12:53 PM ×

…might the current unwind represent the genesis of some sort of deflation-driven dollar bull? (Think JPY in the first half of the 90's.)

Hi MM,

as far as I know the JPY’s bullish market in the first half of the 1990s was the result of an expansionary fiscal policy combined with a relatively tight monetary policy by Bank of Japan, at least as measured by real interest rates spreads vs. USD (a policy mix then fiercely criticized by Nobel Prize Paul Krugman, at least in its monetary component...). In a Mundell-Fleming world such a mix is set to ignite a rally in the domestic currency via growing real domestic rates but without any significant impact on output.

US fiscal policy is surely going to be accommodative in the years ahead, thanks to T-notes and T-bonds due to be issued to finance the bailout package recently approved, but the monetary policy is certainly not going to be tighter. I think USD is set to continue appreciating vs. EUR, but the main reason is that markets are now rewarding those countries and CBs more growth-oriented rather than inflation-oriented.

Read you later, AT

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Anonymous
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October 22, 2008 at 1:51 PM ×

One very strange thing is that the UBS G10 carry trade strategy has lost money this year. It currently does reverse carry-trade with 3 long and 3 short currencies. USD, CHF and JPY should be the longs.

http://www.ariva.de/chart/index.m?ind_volume=ON&secu=100086529&boerse_id=47&go=upper&zoom.x=0&zeitvon=0&t=year

The switch between normal/reverse CT is determined by UBS's risk index:
http://www.bloomberg.com/apps/quote?ticker=ULTAFXRI:IND

The rules are:
>+1: reverse
<-1: normal
-1 to +1: don't change strategy

Johan

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D
admin
October 22, 2008 at 1:59 PM ×

The capo di capi pink flamingo:

Long treasuries after the short treasuries are squeezed out.

:)

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Anonymous
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October 22, 2008 at 4:18 PM ×

Forget about catching a falling knife, it's raining knife's so either get under your desk or just spend more time on the golf course.

This ain't no market for sane men.

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Anonymous
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October 22, 2008 at 7:30 PM ×

"Macro Man is left to wonder: where are the remaining sacred cows to be taken to the abattoir,"


How about equities that never return any real earning to shareholders in the form of cash and who's return is the hope that on a greater fool coming along to pay more then you did. Hummmmmmm

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Cortex12
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October 23, 2008 at 4:27 AM ×

HUF
Seriously, have measures like the Hungarian 300 bp hike ever worked in real life (during turbulent circumstances)? My knowledge of interest-rate-measure-history is limited but it seems to me that this action is more likely to attract coordinated attacks than fend of the attackers. Besides, the side effects on the economic activity of a 3% rate hike are not great.

Feel free to prove me wrong by example!

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