Friday, October 31, 2008

Treat....or Trick?

The fix is in! No, Macro Man has not ordered a tin-foil hat and isn't quite prepared to believe that the Rosicrucians,et. al are running the show....yet. No, today is all about rebalancing flows for the month-end fixing in currency, bond, and equity markets.

While this is always an issue at month end, the sheer scale of the moves in equity markets this month make this the most widely-anticipated month end fixing that Macro Man can recall in his fifteen-plus year career. Stories are circulating that passive and active global equity funds will need to buy something like $35 - $50 billion USD at the 4 p.m. London fix today, and that pension funds will sell cartloads of government bonds to buy equities, as they are now overweight the former and underweight the latter.
Now, there is almost certainly something to this, because these sorts of flows do exist. So it would appear to be easy money to go long USD now, and lob them out to the poor slobs who will be buying later this afternoon. Call it an early Halloween treat!

Ah, but finance is rarely that straightforward. The DXY has already rallied 1.5% since the New York close, which strongly suggests that some punters are already short. What odds that there is a nasty short squeeze in EUR/USD between now and this afternoon to shake out some of the punters? And when exactly are you supposed to take profit on your dollar longs? EUR/USD sagged into the fix yesterday, but then rallied just before 4 pm, wiping out most of the profits from a fix-related short. While there may well be a treat from playing today's fix, so widely has it been discussed that Macro Man can't help but worry that Dr. Market is preparing a trick for unwary punters.

Ditto the equity/bond rotation, which looked like having legs earlier in the week but has frankly disappointed the last couple of days. As noted yesterday, while it is eminently reasonable to suggest that bear fatigue has set in, we do remain in a secular bear market. Should the expected pile-driver rebalancing not materialize today, what odds of a sharp drop in stocks into today's close? Macro Man has got nothing equities (having taken profits on his tiny tactical long on Wednesday), and remains leery of playing stocks 'til the dust settles on month end and the election.

Elsewhere, the news just gets better in Europe. Yesterday's Eurozone economic confidence indicator recorded its largest drop in the history of the survey (how often have we heard that phrase recently?), and UK flagship retailer John Lewis has seen sales fall 9.8% y/y.

More ominously, there is a serious gap opening up between core and peripheral government bond yields within the Eurozone...which is pricing in a serious chance of either default or a fracturing of the single currency zone. Ten year Italian government bonds now yield 1.25% more than their German counterparts. The 10 year CDS spread between the two is 75 at least some of this spread widening appears to be pricing in the chance of the Eurozone not reaching its 20th birthday.
And while that would be a nasty trick for a certain Monsieur Trichet (or his successor), is it churlish to speculate on what a treat that would be for macro punters?


cfarley said...

Are the fringe Eurozone countries specifically the ones with aging populations? Maybe we are seeing the long end of the govie CDS curve pricing in the ECB-handcuffing of fiscal spending as more of the 'Boomers retire. ("You mean I can't just print money to build more Italian hospitals?")

Anonymous said...

Yesterday's Eurozone economic confidence indicator recorded its largest drop in the history of the survey...And when was this particular statistic started? 1990? 1980? I suppose it has to be said but really so pointless.

At this moment the FTSE is down 66.66. That's a devilish number..

Anonymous said...

I have the feel that this bear mkt rally has legs. Bear mkt rally don't end just because someone (or everybody) calls them with this name. They end when shorts are covered, there is consensus or at least some debate that previous dawn was the bottom and fresh long are build. I agree with your arguments about macro numbers which will keep to be horrible (in line with mkt forecast though). But EMU collapse won't be a matter of weeks anyway, as BTP GGB are pricing. Some good news from libor, CP and credit short squeeze mustn't be disregarded in my view. We can get bearish on better levels from here in some weeks i think.
Of course, rumors about asset allocation flows are disturbing, as it was CNBC calling BOTTOM? on equity last friday. This didn't prevented a handsome bounce.

sick trader

fajensen said...

Halloween is the night of the dead:

"AIG used billions from Fed but hasn't said for what"

The internal auditor resigned and is now in seclusion, according to a former colleague.

What would scare an accountant to join an monastery?

Hubert said...


I understand Equity/bond flows.
But where exactly come the FX flows from?

Macro Man said...

Rebalancing currency hedges on international equity the value of the constituents changes, the amount of currency hedge needs to be adjusted at month end. The magnitude of this month's changes is enormous...hence the rumoured size of flow..

Hubert said...


sorry I still do not get it.

If SocGen moves from US bond exposure to US equity exposure, they do not move currencies.
But wait: If their portfolio loses f.e. 10 bn market cap in US equities, they have to reduce fx hedges by the same amout and buy in dollars. Is it that what you mean?

OTOH when Morgan Stanley loses 10 bn on its EUROSTOXX portfolio - does that not counteract the flow?

Anonymous said...

It was choppy but not what one might call a huge day for EUR, carry trade got trashed abit as dow fell but all recovered ok....

so now what happens on monday morning?

EUR does not seem to want to go below 1.2650 even with lack of decent liquidity, are we going to see a consolidation in EUR here, yen looks solid, the specter of intervention will stop anyone seriously shorting to far below here, NIKKEI may well have up day monday as dow up 1.5% is great for a month end like this....

trade well and watch ya stops.

Anonymous said...


I guess I've some idea how it works.

Suppose I, a European, have a US equity portfolio of 100. I hedge my currency risk by shorting the dollar.
When my portfolio has lost 40 % of its value, I will have to rebalance my hedge cause I don't want to be net short. I will cover my dollar risk by hedging 60 and I will buy US dollars on the sport market for 40 (unwinding my old hedge).


Hubert said...

Anon of 6:06,

thanks but I had got that.
What about counterveiling flows?
I do not have a BB screen in fron of me but European stock went down as hard as US stocks.

If we assume they performed nearly equally bad then is only a question if more FX hedged European money is invested in US equities as FX hedged US money in European equities. That must be MM´s implicit assumption.

And it looks plausible as the US ran a CA deficit for so many years.
Where do I find those estimates? Anybody any ideas?

Macro Man said...

Hubert, it's not just about percentages, it's about market cap. The US lost a lot more market cap in October than Europe, et al did, because the US has a higher overall weighting- and thus an equivalent percentage loss equates to a much bigger real dollar (or euro loss)....and its the relative shifts in those real money weights that dictate the hedging requirements.

Please trust me that this is not something that I have made up; it is very, very real.

Anonymous said...

Hey MM,

My impression is that your skepticism regarding this risk-rally is consensus right now. The pain trade is on the way up as market is short stocks and carry.

Another take on the situation: it's war between 1) the terrible confidence/growth indicators (consumer conf, ISM and new orders, IFO exp) - which will continue to be bad, but probably will have a hard time disappointing and 2) the stimulus package (existing and to come).

Now, the stimulus is of extraordinary proportions: rate cutting, fiscal boost to come and Fed swaps+facilities. Just look at the monetary base (ARDIMBNY Index), it's jumped as the Fed is pumping money through its facilities. Now look at lending (total bank credit, ALCBBKCR Index), the 13-week rate of change is highest in the past couple of years.

The point is that private funding is replaced by the FED and the economy will not come crashing down due to a sharp adjustment in credit. The economy will go into a deep recession, but the market is pricing Armageddon, and this will not occur in the US - even though the consumers are becoming savers.

I am long risk via stocks, credit, EUR$ and AUDJPY.

I wish you good luck,


Anonymous said...

...but the funniest bit is that, apparently, a fracture of the single currency and a return to old currencies by some countries, wouldn't be considered a credit event relevant for CDS triggering... Now that would be something protection buyers via CDS should consider.