Thursday, November 06, 2008


Oh dear. The expected feel-good rally ran into a juddering halt, and instead morphed into a "sell the fact" on the Obama victory. Of course, pundits being what they are, they could obviously claim that yesterday's sell-off was "always" going to happen. The market rallies? An obvious result of the Obama feel-good factor! The market tanks? Having bought the rumour of an Obama victory (and its presumed beneficent impact on consumer confidence), markets were always going to sell the fact once he was elected.

Of course, such Harry Hindsight analysis is utterly useless, particularly when you're running risk. Your P/L tells you whether you had the right call. From Macro Man's perspective, he has completely disengaged from positioning in equities. For choice, he would have expected the feel-good rally to continue, so being flat was the right choice.

In any event, it seems like the grim reality of the global recession is swiftly intruding into the recent rally. The notion of "value" is a movable feast, and overnight news suggests that the earnings target is moving swiftly.....lower.

After last night's close Cisco guided down forward revenue expectations to levels well below prior expectation. Perhaps even more significantly, Toyota slashed its profit forecasts after japan's close this morning; the e-coupling dream seems a long time ago, doesn't it? While analysts are forecasting relatively little earnings growth in Japan over the next year, it nevertheless seems likely that earnings will fall quite a bit more than currently expected. Sound familiar?
Of course, central banks globally are trying to address the dramatic economic slowdown. Of course, trying to do something and actually doing it are two different things, and it is now probably time to exhume a word last heard in 2003: "traction." Specifically, the ability (or lack thereof) of policymakers' actions to gain traction, to have an impact.

So far, the Fed's policy actions have had mixed results. Bernanke and co. made a big deal about paying interest on reserves, as it would theoretically allow them to quantitatively ease while maintaining a nonzero funds rate. So far, that effort appears to be failing, despite repeated announcements from the Fed raising the level of interest (aka, the "floor" on the effective funds rate) that they will pay institutions depositing reserves at the central bank.

So far, it's not working. For the last few days, the effective funds rate has traded well through the floor, at 0.23% (versus a floor of 0.65%.) There are a couple of esoteric technical factors driving this (relating to insurance and the exclusion of the GSEs), but it confirms that the devil with saving the world is in the details.
Today in Europe is, of course, central bank day, with both the Old Lady and the ECB poised to trim rates. While markets are demanding 100 and 50, respectively, Macro Man can't shake a sneaky belief that the BOE will do a compromise 75 bps, which would disappoint both markets and mortgage holders.

A number of UK institutions have already announced that they will not pass through all of the cuts and/or pre-emptively raised their base-rate tracker spreads on new business. So unfortunately for Macro Man, it will take a 50 bp cut just to get him levels for his new mortgage that he could have achieved last week! Alas, the margin between joy and pain is often very thin indeed.

More broadly, he is bemused by the aggressive pricing in short sterling. December 2008 is currently pricing 3 month LIBOR at 4.10%, more than 1.50% above yesterday's fix. Macro Man would rankly be rather surprised if the BOE cuts more than 1.5% this month and next. And given that we've already heard from mortgage lenders that not all of the base rate cuts will be passed on, why is the market expecting all of them to be passed on in the unsecured interbank lending market? Oh, and let's nor quarter/year end, banks tend to hoard cash. Observe how 3 month sterling LIBOR has ticked up at each of the quarter ends this year.

Surely it's not unreasonable to expect the same to happen at year end?
So even if Macro Man is wrong and the Bank does ease rates very aggressively in November and December....he still reckons the market is overoptimistic that the Old Lady gets traction.


Anonymous said...

150 !! That was some cut. MM: your mortgage should be fixing a tad lower tha you expected.... Now let's see if even the ECB gets to 3.00%

Damcanu said...

Seeing as I am on C&G tracker tied to BoE base rate I'll be a good few quid better off next month :-)

BUT my monthly electric & gas direct debit bills are shooting up :-(

Swings and roundabouts .......

Macro Man said...

Zowie! I've told Mrs. Macro to get the mortgage broker on the dog ASAP...we'll see what comes back.

I, too, am on a C&G tracker (until January at least.) That they have lowered standard variable rate to 5% gives me quite a bit more breathing room should I want to wait and see what's out there...

Hats off to Merve the Swerve and co....didn;t think they had it in them. Does JCT?

Anonymous said...

And JCT is the usual bluff.....

vlade said...

One way to look at this would be "What do they know we don't that forced the conservative BoE cut like this????"

Gustavo said...

way to go ECB...another 6.5 meetings to ZIRP.

Anonymous said...

ukx dividend yeild covers mortgage rate and we can all create SIVs!

D said...

Clank! Fortunately the BOE 75bps wasn't a buzzer shot. It appears they are more bearish than you.

Macro, what are you trading these days or are you still just tending the legacy positions?


Macro Man said...

Well, I have drastically reduced risk and am left with some strategic options which aren't really doing much except decaying.... ;)

My bets are basically fourfold:

1) Options on selling stuff that gets hurt by global recession

2) Options on receiving some EM rates where I think there is room to cut

3) Some small bets on the US curve and swap spreads

4) Some bets on currency pegs that might get challenged

Anonymous said...

#4 - Smart - Ultimate convexity - but if you win, we are in big big trouble

#2 - Stay small - brazil and mex have been widowmakers

Macro Man said...

Anon, I am involved with Brazil. Mostly through swaptions, where the loss is defined, and very briefly (and expensively) through the DI curve, where my 'small' position cost me quite a bit before I cut it out two days later.

On #4, not necessarily. USD/HKD forwards are now priced below the bottom end of the band.

Anonymous said...

Ft said HKD's strength comes from the unwinding of the carry trade. So it would not last long. What is your opinion, MM?

Macro Man said...

I think it has a lot more to do with people taking losses on Hang Seng positions and having to fund the losses by buying HKD!

richie rich said...

mm...are you suggesting that we could see another raid on HK currency peg ala '98?
seems to me gulf states more susceptible

Anonymous said...

UK rate cut effect consumer sector
mortgage balances 535.1
33% market on trackers 133.78
Assume -1.25% rate 1.67

Personal deposits 568.2
1.5% reduction 8.52
Net income effect -6.85

For Banks
Interest on Mortgages -1.67
Interest on deposits -8.52

Net interest income 6.85

Nice one Merv (Brown/Darling?)

Anonymous said...

BoE and ECB ... still trying to fight the last war

Solvent borrowers all want (and need) to delever. Lower rates won't encourage new loans, and if anything will just free up a small amount of cashflow to pay off additional principal

Lenders obviously have no interest in lending to insolvent borrowers

So in the end, the central banks are shooting themselves in the foot

Anonymous said...

appears to be a flight to money market on this side of the pond today ahead of a supposedly horrible non farm friday...the buzz from mfglobal: 'Lots of talk in fixed income on widening MBS spreads. Also selling of treasuries and buying bunds. Real money and Asian accounts have also sold 10s today.'
we study seasonals over here, with mrci dot com considered the best...with march '09 US futs, the seasonal is to go long around 11/6-12 and hold until the end of the year, a strong seasonal up in bonds...we also study the cot reports, open interest in futures, with the small speculators considered the wrong way corrigans, and the commercials considered the smart money: cot reports come out friday after close, last week had the commercials long TY US CL and short SP...the small specs were short TY US CL and long a whopping 350k contracts of SP emini

Anonymous said...

Think that now the funding costs for putting reval positions in the middle east have now declined massively compared to earlier this year. Whereas running a 20 USDAED position would cost you 5k a week, it is now almost nil. And it's not like SAR and AED will see depreciating pressure! Basically, it is almost a risk free bet on going short 1yr USDAED and 1yr USDSAR....yes given the weakness in the global economy these countrie will NOT want a stronger ccy but nevertheless we have seen a complete unwind of these positions. So if they are intent on letting go of the pegs without the "speculators" making a bundle of cash, now is an adequate time......


Macro Man said...

Deacon, with respect to the CFTC data, how do you distinguish between outright duration bets and curve plays? That's the trouble I've always had with that dataset. Certainly solid bond performance could be expected via horrible economic data and crumbling stock market...check and check. I still wonder about the Supersized menu of supply on the docket, however, especially with a slower pace of FX reserve piss-taking demand to explain the "conundrum".

Anon, with respect to the GCC stuff....I hear you. Unfortunately in a mark-to-market world, if the points keep going, that entails real pain...I'd prefer to get paid more for my trouble. (We had some short USD/GCC and closed it at flat points.) Putting it another a world of counterpatry risk and Superman trades encountering kryptonite- do you want to lend the UAE money at 3.5% for a year (the equivalent of selling the 1y fwd in USD/AED)? Frankly, at this juncture, China looks like a better trade to me. AT least there's a prayer that you might get some ccy appreciation there.

Anonymous said...

With regard to the GCC peg and its prospects for longevity, I think its clear that the financial crisis has given it an extended lease on life. Earlier this year when oil was rising and dollar falling it seemed only a matter of time before the Gulf CBs would have to revalue to fight inflation. But given what has happened since mid- July I think its clear why they didn't; it doesn't take much imagination to see what would have happened to GCC currencies in a free float when oil falls by 60%.
This illustrates the conundrum facing the GCC CBs: in a free float they would be the ultimate commodity currencies, as the region's economies are almost entirely backed by oil. Given that the volatility of oil prices would feed into their exchange rates, they almost have to have a peg of some sort in order to avoid wild fluctuations in their currencies.
That said, now would be an opportune time for them to shift into a better composed peg (i.e. less dollars, more euros and maybe some yen and CHF). This would devalue their currencies somewhat in the short term (and put any short USD/GCC bets under water for the foreseeable future), but leave them better off in the long run because they would no longer be tied so tightly to the dollar's fortunes.