Wednesday, February 27, 2008

What's going on with wheat?

What's going on with wheat? Macro Man generally tends to avoid mention of the soft commodities, because he frankly has no specialist knowledge and only the most basic of general knowledge- which isn't exactly a formula for investment success.

But still- the recent price action in wheat deserves mention. The CBOT contract for May delivery has risen from $900 /bushel at the end of 2007 to $12.50/bushel as of yesterday's close- a pretty stunning rally by any measure.

But even beyond that, yesterday's price action was pretty stunning. The chart below may not look particularly unusual until one observes the price scale on the right- the intraday range was more than 20%!!!!

At first, wheat was ground up by the forces of profit-taking....until someone or something added yeast, at which point it began rising nicely.
All joking aside, the scale of the year-to-date price move, and particularly yesterday's intraday volatility, suggests that something is going on. So Macro Man puts the question out to those who know more than him about wheat, i.e. those that know something:

What the hell is going on with wheat?

Don't you hate it when that happens?

Macro Man isn't going to write about equities this morning, because it seems quite clear that he doesn't understand what's going on there. Whether it was his time off skiing, the slight illness that he's currently nursing, or the fact that it's a leap year, this newfound dynamic of "equities rally on all business days ending in 'y'" is certainly peculiar.

No, there are other fish to fry this morning, as the dollar is once again getting beaten like a rented mule. EUR/USD, for example, has finally and decisively breached the psychologically significant 1.50 barrier; while there are some intermediate targets at 1.52 and 1.53, the longterm goal is 1.63, still nearly 10% away.
While Macro Man has spent the last five months decrying the dollar and telling anyone who will listen (and many who won't) that it is toast, he finds himself in an unusual (and irritating) position. At an investor rountable a couple of weeks ago, he was bemused to find that the majority of the attendees were bullish dollars (or at least bearish EUR/USD), a circumstance that he found difficult to reconcile with negative real rates in the US and a hawkish ECB. At the time, EUR/USD was 1.45, towards the bottom of the range of the prior few months.

Clearly, this appeared to be a set-up for a nice move lower in the greenback, which in fact is what has occured, against things as diverse as oil, the euro, the New Zealand dollar, and the Taiwan dollar. And did Macro Man slap on a position and reap the profits that his view deserved? NO!

Even worse, he has found himself actually LONG dollars, courtesy of a) the Powerball strip b) the sterling basket trade, and c) the USD/JPY option hedge, which expires today. Macro Man had toyed with hedging the last of these earlier in the week at 108, and missed the he sold $25 million at 106.93 earlier this morning.

Ay caramba! Is there anything worse than having the right view and not making money? In Macro Man's defense, he has been away from the market, both due to his skiing holiday and for other personal reasons, for much of February. Still, it's galling to be, in the words of Trent from Swingers, "so money" and yet end up with "no money." Don't you hate it when that happens?

Today sees everyone's favourite Jim Henson character, Ben Bernanke, step up to the mic today to freestyle on the state of the economy. It's hard to imagine him saying anything other than "we're buggered", particularly if durable goods orders come out in line with the rather bearish consensus expectation.

Consider yesterday's data. The house price data was better than expected, but still pretty awful. Given continued high levels of supply, it seems likely that time, rather than interest rates, is the only thing that can resolve the situation.

Meanwhile, consumer confidence cratered, a decline caused in no small part by increased pessimism on the job front. As discussed in this space before, the jobs hard to get component is one of Macro Man's favourite tells on the labour market data....and as the chart below inidcates, it's suggesting another very weak number next week. Meanwhile, the "business outlook will be better in 6 months" component registered its lowest reading since April 1980.
So surely the Fed needs to cuts rates more, right? Not so fast, my friend. PPI inflation registered its highest reading since 1981, consistent with the high level of import prices, which are at a similar extreme. With oil at record highs and global food prices continuing to surge, it's hard to see this trend coming to an end any time soon.
As Macro Man has mused on previous occasions, what makes the current environment so tricky for the Fed is that for the first time in 30 years, the US is not a price setter for global's a price taker. In the 1980's and 90's, when there was slack in global commodity supplies, the price was set on the basis of marginal demand....and more often than not, that demand came from the US.

These days, however, there are genuine supply shortages, which means that lower US demand has little impact on the price...particularly when it is other countries that are showing the largest demand growth for energy and other industrial commodities.

All of this hearkens back to the 1970's, which was a terrible time for bonds and, if anything, an even worse time for equities. All of which makes the recent resilience of stocks that much more puzzling. Perhaps if today's unconfirmed rumour of a UK bank in trouble proves true, equities can finally reverse course. In any event, Macro Man cannot help but think that near term equity risks remain to the downside...not only because of the toxic data mix noted above, but also because of the horrible March seasonals which kick in next week.

Damn. Macro Man's ended up writing about equities after all. Don't you hate it when that happens?

Tuesday, February 26, 2008

I'll HUF and I'll puff and I'll blow your peg down

Oh, those crazy Magyars! While the attention of the financial world has been focused on the currency pegs in China, Russia, and the Middle East, the latest shoe (or should that be peg?) to drop was in Hungary, where the National Bank announced yesterday that the forint band was to be dropped with immediate effect, and that henceforth the HUF would be permitted to float freely.

This action was taken in lieu of the widely expected interest rate hike, and prompted a sharp short-term rally in the HUF (i.e., a sell-off in EUR/HUF), as depicted below. By way of background, the HUF has been pegged against the euro since 2001, and since 2003 that peg has been centered at 282.36. However, the NBH has allowed the HUF to fluctuate 15% either side of its parity, which meant that it maintained a commitment to prevent EUR/HUF from falling below 240.
So in a sense, yesterday's sharp sell-off in EUR/HUF made a bit of sense- after all, the downside of the expected return distribution has been fundamentally altered. On the other hand, it's only the very left-hand side of that distribution- surely not enough to merit a 1.5% sell-off in EUR/HUF? After all, recent levels in spot have been comfortably removed from knocking on the door of the edge of the forint band, so Macro Man struggled to see why yesterday's announcement was so bullish HUF.
After all, wanting a strong(er) currency is one thing, but getting one is something else. Of course, that may miss the point. Perhaps the authorities don't want a stronger currency....and have simply waited until the forint peg was irrelevant to the market's calculus before scrapping it. If so, then it's a job well done, particularly as it should now allow the NBH to maintain a more consistent monetary policy, rather than threatening to cut rates every time EUR/HUF dips below 250.

Perhaps the GCC are waiting for a similiar opportunity to scrap or adjust their pegs. Unfortunately for them, the inflationary opportunity cost of waiting is much higher than it ever was for Hungary. With oil just under $100/bbl and OPEC muttering about production cuts, it's hard to see that changing any time soon.

Elsewhere, equities enjoyed another late-session melt up courtesy of more monoline news. Is it just Macro Man, or does there seem to be a conspiracy to spin good news about these guys every day or two, simply to ensure that they are not the straw the breaks the market's back? While your humble scribe is admittedly not a credit analyst, he struggles to see how S&P could have concluded that everything is hunky-dory at MBIA and that the firm no longer merits being on credit review. Isn't closing their eyes to obvious turds how we got into this mess to begin with?!?!?!

Monday, February 25, 2008

Has anything changed (except the weather?)

Macro Man is back in the saddle after a week on the slopes, and to be honest it's difficult to see much that's changed.

Equities going nowhere fast? Check.

A monoline rescue plan in the works? Check.

Inflation uncomfortably high in the US and elsewhere? Check.

Banks still taking underperforming, unsaleable assets onto their balance sheets? Check.

OK, a few things have changed. The dollar's a bit weaker on a broad basis, but surely that's what you'd expect given the negative interest rates at the short end? Similarly, the continued weakness at the back end of the yield curve couldn't have been much of a surprise given last week's horrible CPI number. And frankly, $100 oil and gold within spitting distance of a grand don't exactly suggest that that dynamic is going to roll over any time soon, are they?

Macro Man often finds that time away from the market provides an opportunity to reflect on longer term themes. This year, he found himself musing on the impact of climate change more often than not.

Perhaps it was the cost of the flight, boosted by taxes and rising fuel costs.

Perhaps it was the fact that he was skiing with a friend who runs a large energy fund and remains rampantly bullish on oil.

Perhaps it was the fact that as a winter holiday comes to a close, one's thoughts naturally drift towards making plans for the summer.

Regardless, as Macro Man practiced his telemark technique high up in the Alps (pictured, left), he found himself thinking about global warming a lot.

OK, the snow wasn't THAT bad. But it's been more than two weeks since the last snowfall, so things did get a bit slushy over the last couple of days.

Hmmm....perhaps it's just a case of UBS's future overlords wanting to make themselves at home?

Saturday, February 16, 2008

Quiz answers

In order of MOST to LEAST affordable, the list is as follows:

1) Dallas/Ft. Worth (median house price of 2.5 times local median income)

2) Sarasota, FL (5.7)

3) Leicester, UK (6.0)

4) Christchurch, NZ (6.6)

5) New York (7.0)

6) London (7.7)

7) Sydney (8.6)

8) Belfast (8.8)

9) Bournemouth (8.9)

10) Los Angeles (11.5)

Source: Demographia

All but the Metroplex, which is characterized as "affordable", are listed as "severely unaffordable." What's that about de-coupling?

An analysis that may interest only me

It's a fairly well-established phenomenon that financial website traffic goes through the roof when markets go to hell in a handbasket. So when Macro Man decided to perform a little analysis last week, even he was surprised by the close link between traffic and equity market activity.

The chart below sets out daily volume in the SPX, depicted in red and shown on the left-hand axis. The blue shows shows daily traffic on this very site, calculated in terms of deviation from trend. In other words, traffic has generally increased since the inauguration of this space a year and a half ago, and that traffic is measured against that upward-sloping traffic trend.
What's interesting is how closely the two series appear to match up; one could even argue that web traffic is less volatile that daily equity trading volume. How long, then, til someone calculates an indicator for financial web traffic that can either confirm a large equity move or show divergences?

Regardless, both traffic and trading volumes suggest that the recent equity gyrations have occured in the context of decreasing interest from the public at large. 'Twill be interesting to see when the next traffic volume spike occurs...

A Quiz For While I'm Gone

Place the following cities in order from MOST to LEAST affordable housing markets, relative to local incomes:

* Belfast

* Bournemouth, UK

* Christchurch, NZ

* Dallas/Ft. Worth

* Leicester

* London

* Los Angeles

* New York

* Sarasota, Florida

Answers later in the week. First correct response posted in the comments section wins a free annual subscription to this site, which normally retails at £0.00.

Friday, February 15, 2008

Bonds Get Kervieled

What a weird day. Everyone's favourite helicopter pilot regales the market with stories of his whirlybird exploits, including an implicit promise to fly again soon....and the long end of the US curve gets whacked. The chart below doesn't really do the move justice, but that was a big sell-off at the long end yesterday; a glance at Macro Man's sadly in-the-red P/L reveals that 10 year swap yields have risen more than 30 bps so far in February, with nearly half of that move occuring yesterday.
What made the move so perverse was that Bernanke's commentary was pretty dovish. Sure, he paid lip service to keeping an eye on inflation, but no one really believes that any more, now do they? In any event, it's hard to conclude that the long end was building in any sort of inflationary risk premium, given that TIPS sadly sold off even more than nominals, taking the breakeven several bps lower yesterday. Oh, and all of this happened while stocks sold off as well. What gives?
Macro Man heard some mumbling about switches in the deliverable bonds for futures, and it is true that futures held in rather better than cash. But ultimately what this looks like was that there was a motivated seller with large size to put through the market at the long end. Some are suggesting that this is mortgage convexity selling. While it seems off for that to be kicking in at such low yield levels, stranger things have happened. In any case, what we know is that bonds have gotten whacked by a large unidirectional seller; in other words, they've gotten Kervieled!

While Macro Man is of course watching this market very closely, he also has one eye on the Alpine snow reports. He'll be on the slopes next week for a spot of sunshine and exercise....and perhaps the odd glass of vin chaud. While he plans to keep an eye on markets, and perhaps contribute the odd poem or two to this space, he'll obviously be occupied with things other than actively trading in and out of positions.

He therefore leaves the following risk management orders:

*Buy $25 millon USD/JPY at 110.25 on a stop loss basis

*If the OEX/Russell 2000 ratio closes below 0.8650, exit the position on the opening the following day.

Given the noise and skittishness of all asset markets, there's relatively little that would surprise Macro Man about the next week's worth of trading. In times like this, being away from the market for a few days can often yield a new and profitable perspective. Will it happen this time? Let's see....

Thursday, February 14, 2008

Should We Love Equities?

Ah, Valentine's day. Lovers walk hand-in-hand in the park, early spring flowers bloom, birds sing sweetly in the air, and the greeting card and florist industries make money hand over fist. Macro Man's plans for the day are fairly modest- another trip to Croydon (hardly a center of romance!) to take care of some admin, and then a nice dinner at home with Mrs. Macro and a good bottle of wine.

Not that romance is dead, mind you. Macro Man is wondering how to manage another relationship, one which has occasionally yielded a bounty of joy but recently has turned distinctly frosty and distant. He refers, of course, to his relationship with equities.

Having remained broadly constructive on stocks through the end of last year, courtesy of the "muddle through" view on the US economy (which, depending on how you interpret the January retail sales data, was either strengthened or weakened yesterday), Macro Man was forced to abandon stocks last month, as the diastrous price action mandated a lovers' quarrel. His positioning ever since has retained a bearish tilt, or at least a tilt that has lost money this month- the large cap/small cap spread seems to drift lower no matter what the broad market does, and is rapidly approaching Macro Man's review level.

In any event, the apparent recovery in equities, combined with daily missives from a raging equity bull who holds forth on the culinary delights of bear steak, have encouraged Macro Man to at least review the premise of his bearish tilt.

As far as he can make out, the relationship between three things is currently skewed and will need to adjust. At this juncture it is too early to say in which way they'll shift, but he's confident that over the course of 2008 something will have to change. These three factors are the price of equities, the level of interest rates, and the expected level of corporate earnings in 2008.

In Macro Man's world, it's not that difficult to come up with a price forecast for the S&P 500. Figure out where you think earnings will be, come up with a multiple (which is at least partially driven by interest rates), multiply the two, and voila! There's your price target.

If we look at bottom-up earnings expectations for the SPX, the rationale behind the late 2007 swoon is fairly evident. Index-level earnings expectations were marked down from over 95 in the summer to 89 by the end of the year. The data has subsequently taken a jump, which Macro Man fears simply represents the turning of the calendar page from 2007 to 2008. (His usual datasource for this stuff is unavailable, so he's forced to back it out from Bloomberg data, which is about as elegant as Stone Age cutlery.) In any event, these figures appear to be confirmed by Standard and Poor's themselves, so Macro Man will take 97 as a reasonable level for current bottom-up estimated operating EPS.
Now obviously, bottom up estimates are generally overly optimistic, particularly early in the year. But that doesn't mean that they won't move the price of the index as they adjust througout 2008- just look at what happened last year! In any event, if SPX earnings really are 97 in 2008, then under most reasonable assumptions, the SPX is underpriced.

For most of the last couple of years, trailing P/E ratios for the SPX have averaged around 17. Put a 17 multiple on index level earnings of 97, and you get a year-end price target of 1649. Zowie! No wonder Macro Man's correspondent is so bullish! Now, it's obviously possible that multiples can shrink, and perhaps they will do so given the high levels of uncertainty over the economic cycle and the credit market. Yet with interest rates low and tumbling, the opportunity cost of not holding stocks is high and rising....assuming that underlying earnings don't plummet.

In any event, Macro Man constructed a simple "cheat sheet" to help him think about these things. The table below sets out the three variables mentioned above: index level earnings, assumed P/E ratio, and the resultant SPX price target. He rean simple scenarios for index level earnings ranging from 100 (modest upside surprise from current estimates) to 75 (earnings recession) and using two multiple assumptions- 17 and 14.
As you can see, the current price of the SPX is consistent with a modest earnings recession- a 10% decline in 2008 earnings vis-a-vis 2007, assuming a trailing multiple for the year of 17. What's interesting is that even if one assumes a more pronounced downdraft in earnings, you still only get to levels observed when the market was getting Kervieled.

So unless one is willing to forecast a bone-crushing recession or a multiple compression with low interest rates, which Macro Man presently is not, then one sort of has to conclude that equities are at least a bit on the cheap side....and perhaps quite a bit so. So does that mean that we should all fly back into equities for a lovers' reunion, spouting cliches about how "making up is the best part" of our relationship?

Not so fast. There remains considerable volatility around the current view, and just because Macro Man is not forecasting a recession now does not mean that he cannot contemplate doing so in the future. Moreover, while day-to-day price action is highly untrustworthy, we probably need to respect the underlying trend.
The chart above overays Wilder's Directional Movement Indicator onto the SPX. The cloud at the bottom of the page purports to show the underlying directional trend. You can probably guess for yourself that red equates to a bear market trend. Macro Man ran the same chart for the monthlies, and January saw the first reversion into a bear trend since 2003.

The current uptick may breach the trendline drawn, and may perhaps even breach the 1400 level that stopped the index a couple of weeks ago. But until the index can at leat start breaching some key moving averages, such as the 40 day shown on the chart, then all of this could just be a bear market rally. Until that is accomplished, Macro Man will probably follow the paraphrased advice of Stephen Stills: "if you can't be with the bull you love, love the bear you're with!"

Wednesday, February 13, 2008

At least the hangnail won't kill ya!

Whew! Macro Man sure is glad the whole credit crisis thingy is over. Now that Warren Buffet is on the scene, everything's gonna be just peachy, don'tcha think? That seemed to be the market reaction to Warren's revelation on CNBC that he is looking to reinsure all the munis currently covered by the unholy trinity of AMBAC, MBIA, and FGIC.

Indeed, the sentiment shift appeared to recall nothing so much as the old Mighty Mouse cartoons, with the Oracle of Omaha in the starring role. See if you can spot him in the clip below, bellowing in a surprisingly robust tenor "Here I coomeeee to saavvveee thee daaayyyyyyyy!"

Unfortunately, upon further reflection Warren is not, in fact, here to save the day. The muni market remains in pretty good shape with low default rates. So while Buffett's offer may head off some tail risk in that market, it shouldn't really do much to lift the prices, given that AAA muni yields are already pretty much at par with Treasuries.

No, the real distress is in structured-credit land, and Macro Man couldn't help but notice that Warren said nothing about bidding to reinsure the veritable Everest of structured credit turds which are currently stinking up financial markets. That's where the accidents have been, that's where the pain is, and that's a place that Mr. Buffett clearly (and justifiably) has no interest in stepping.

So far from saving the day, Warren's offer yesterday was the equivalent of a paramedic coming upon the victim of a horrific automobile accident and saying "Ooh! That hangnail looks really painful! Let me snip that off for you!" It might make a minor irritation feel better, but in the grand scheme of things it doesn't improve the lot of the victim very much at all.

Speaking of "not helping the victim", markets received further evidence this morning that helicopters cannot fly across the Atlantic. In a move forecast by precisely no one (or at least no one that provides forecasts to Bloomberg), Sweden's Riksbank tightened rates by 0.25%, citing high inflation and an erosion of inflation expectations. Gee, don't they know that there's a crisis going on? If their mindset is mirrored in the halls of Frankfurt, waiting for the "imminent" ECB rate cut could be like waiting for Godot....

Tuesday, February 12, 2008

Mixed signals

On the face of it. the world would appear to remain a distinctly unpleasant place. AIG announced yesterday that it was the latest "winner" of the dodgy accounting sweepstakes. The market reaction was swift and predictable, as AIG dropped sharply on volume of 100 million shares. One might posit that there is some signal there.
Meanwhile, the ECB seem to be going out of their way to quash market hopes of near term rate cuts; while it makes Macro Man feel a touch better about his option overlay from last week, it should not, on the face of it, be a positive for risk assets. And indeed it has not, for many. Credit continues to get smoked, EUR/ISK has traded up to 100 today, and even the TRY has weakened so far this week. Everywhere you look, it seems like someone is putting out a fire. So why the heck did the SPX closer higher yesterday?

Given that credit in its many guises has paved the road to perdition on which equities appear to be travelling, it is instructive to observe the relationship between the two. The chart below shows the SPX with the Itraxx Euro Crossover Index, a useful proxy for all things credit. (Note to professional readers: this is the "57" index, rather than the current "58", which is used to provide a longer history.) Unsurprisingly, the correlation has been pretty high for the last year, particularly since the credit crisis kicked off properly in July-August.
What's curious to note is that while crossover spreads have made a new high (i.e., a new low as pictured on the chart above, as the scale on the crossover chart has been reversed), the SPX has failed to do so. Might this, along with the resilience of equities in the face of yesterday's AIG news, represent some sort of "positive divergence" from equities, and thus foreshadow future gains?

Peut-etre. But it's unwise to read to much into a breakdown in the correlation between equities and credit. For fun, Macro Man ran a 1 month rolling correlation study betwen the SPX and crossover series depicted on the chart above. Unsurprisingly, since the crisis kicked off the relationship has been very strongly negative, on balance. However, as you can see below, the correlation has fallen (that is, trended closer to zero) between the two series over the last week or so. Again, might this not suggest that equities have gotten "credit crisis fatigue" and become immune to marginal bad news?
Perhaps. But look at the chart again. The last episode of breakdown between the two markets took the correlation almost to zero. That was at the end of last year- indeed, the spike high on that chart ocurred on Janaury 1. You probably don't need Macro Man to tell you what happened to equities in January.

Ultimately, this seems to confirm Macro Man's belief that the signals one receives from market pricing in this environment are unusually unhelpful in determining the state of play. Reminiscences of a Stock Market Operator is a wonderful book and almost always touted as essential reading for traders. Predicated as it it is, however, on discerning signals from market price action, the book and its lessons are probably best locked away in a cupboard somewhere until conditions normalize- whenever that may be.

Monday, February 11, 2008

Is there anything more irrelevant than G7?

Well, the big event of the weekend has come and gone, and lo and behold not much has changed. Yes, the G7 group of finance ministers and central bankers gathered for a spot of sushi and karaoke in Tokyo over the weekend, a confabulation that appeared to generate little of interest other than perhaps a few sore heads among the attendees.

Sure, they issued a statement, and golly, wasn't it swell. Here's a brief summary in the rhetorical style of Boris Johnson:

"Blimey, things are going a bit wobbly, aren't they? It's a jolly good thing each of us is 'Tis a pity that a few bad eggs are spoiling the party for everyone. Do let's have a chat and see if we can't put things right. That quango we set up in October has been frightfully busy quangoing. It'll be brilliant when they can tell us all about their adventure.

Those pesky exchange rates really oughtn't to move around too much. China's been a real trooper, and if they could do even more, we'd all be chuffed to bits. Crikey, a tank of petrol's a bit dear nowadays, isn't it? Someone really ought to have a look into that and see what can be done. But really, everyone should just be a good chap and not be so selfish.

Oh, have you seen that the daffs have started blooming already? Perhaps there's something to this global warming mularkey after all. Sadly, those lucky folk who live where it's warm all year seem to be in a spot of bother. We really must do something about that one of those days. Unless we get blown up first."

Meanwhile, in a sign of the deep regard in which 20th century institutions are held by the world's emerging economic powerhouses, CIC's Lou Jiwei flicked a rhetorical V-sign at the IMF recently. Blimey!

All of this posturing, with the attendant issuance of pompous, self-referential communiques by grandees unable to meaningfully impact the environment they inhabit, led Macro Man to wonder over the weekend: is there anything more irrelevant in today's world than the G7?

He thought about it over the weekend, and came up with the following brief list of entities whose irrelevance, if not eclipsing that of the G7, nevertheless gives it a run for its money:

* Organizing Committee for the New England Patriots 2008 Super Bowl Parade

* Voting Panel for 2007-08 "Best Screenplay" award

* Broker Joe

* The Bank of Japan (OK, maybe this is double-counting them)

* The IMF (As Brad Setser has noted, SWFs are organizing bigger bailouts than the IMF ever did)

* Quant funds?

* The US Congress (it's good to know that investigating steroids in baseball and secret taping in the NFL is more important than investigating WTF is going on in Iraq and Guantanamo.)

* The UK Border and Immigration Agency. On second thought, they are fine, upstanding people who are dedicated to securing the borders of this wonderful country. Now, please can I have indefinite leave to remain?

Reader suggestions to add to this list are welcome; answers on a postcard, or failing that, the comments section.

Friday, February 08, 2008

Macro Man isn't sure...

...but he reckons that the waiting room scene from the film Beetlejuice (in which the eponymous ghost has ticket number 3,765,945 or some such) may have been filmed at the Lunar House, the Home Office building in Croydon.

Actually, it wasn't quite that bad, though he could have down without the Carpenters karaoke performance from the woman selling overpriced and underbrewed coffee.

In any event, he has a shiny new stamp in his passport and two shiny new positions for his portfolio. The 3 month TRY calls were purchased for 0.677% of face, leading to an overall premium outlay of just over $200k. Meanwhile, the 96.625 ERM8 calls were sold for 5.5 ticks, while the 96 puts were purchased for 9 ticks. June and September Euribor contracts have both rallied another 4-5 ticks today, and the risk/reward of taking the other side continues to look quite good.

It's now time to look forward to the weekend; here's hoping that this evening's activities don't make generate a hangover that makes you feel like either of the two chaps pictured above look.

Thursday, February 07, 2008

A couple of apparent mispricings

This post is being written on Thursday evening, as Macro Man has gradually revived throughout the day. There may be a worse feeling that that caused by dodgy tapas and indifferent rioja, but if so it's been a while since Macro Man has had the misfortune of encountering it. In any event, your humble scribe is at least feeling human again, and given that he is spending much of Friday in an immigration office in Croydon, he thought it might be useful to scribble down a few thoughts while he has the time.

While Macro Man was wishing he was dead earlier today (Thursday), he missed out on some developments in Europe. Specifically, the Bank of England fulfilled the expectation of all bar two of the 61 economists surveyed by Bloomberg and cut rates by 0.25%. The accompnaying statement was, if anything, hawkish, highlighting upside risks to inflation caused by food, energy, and sterling. While the recent decline in the pound has been fairly dramatic, the £ TWI is still within a well-established long-term range, so it seems somewhat perverse for the Bank to be wringing its hands over it. Surely it's nowhere near the biggest problem on their plate at the moment?

In the Eurozone, meanwhile, Jean-Claude Trichet signalled an immediate about face and proclaimed that the next move in rates will be a cut. At least that's how the market seems to have interpreted the press conference, as the strip has rallied while the euro's been caned. Frankly, reading through the comments, Macro Man really can't see what is so uber-dovish in Trichet's remarks. Tellingly, he started off by focusing on continued upside risks to inflation- which is a pretty good indication of where the ECB's primary worries lie- and didn't introduce any cute new code words for the market to use in timing a forthcoming ease. Markets appeared to fixate on the comment that market turmoil is generating am "unusually high" amount of uncertainty , and Trichet's acknowledgement that a US slowdown will have an impact on Europe. Well, duh!

Perhaps next month's staff forecast revisions will give the ECB an opportunity to exchange their hawks' talons for the gentle cooing of doves. But from the sound of it, M. Trichet still sounds several months away from beginning to seriously contemplate trimming rates. Unsurprisingly, that's pretty much what's embedded in cash markets at the moment. Three month Euribor fixed at 4.35% today, which is much lower than December's panic highs but still represents an unusually large basis for a central bank firmly on hold. The June Euribor contract, however, rallied 17 bps today, closing at an implied rate of 3.765%. Will three month cash rates really fall 60 bps in the next four and a half months? Perhaps, but it would take both an ECB easing and a normalization of the basis to the degree that Euribor could trade flat with the refi rate. It might happen, but it seems slightly dubious to Macro Man.

Given that Macro Man is long the front end of the euro curve through his receiver position, this is a cause for concern. However, there is an option startegy available that looks to be an appealing overlay to his current position and what is in the price. Friday morning, Macro Man will look to buy 500 June 96.00 Euribor puts, which are 23 bps out of the money versus the future but 35 bps in the money versus current cash rates. He will sell 1000 96.625 calls, which are 40 bps out of the money versus the future and nearly 100 bps out of the money versus cash. Based on closing bid/ask spreads, he should earn a credit of 2 ticks per spread to do this trade. Maybe 3 month Euribor really will fall 100 bps by the end of June...but if it does, Macro Man likes his chances of making money with his receiver and short DAX positions!

The other thing that Macro Man finds odd is encapsulated in the chart below. The chart shows the fortunes of the currencies (measured against the euro for convenience) of five countries, each of which has a large current account deficit as a percentage of GDP and relatively high inflation. In other words, currencies that are classically vulnerable to global risk aversion. As you can see below, most of them have been so far in 2008, with the South African rand performing particularly execrably.
Yet one of these currencies has weathered the storm remarkably well; it's the only one that is closer to its highs of the past six months than its lows, and the only one that is stronger in nominal terms (i.e. has a lower reading on the chart) than at the beginning of last year. It's the Turkish lira.

Now granted, Turkey's fundamentals are stonger than those in, say, Romania, given the high level of nominal interest rates and high levels of FDI cover for the current account. But it's not like Turkey has always been bulletproof; it got hit pretty hard in August, and of course it got massacred in 2006. Granted, there probably isn't an Israeli bloke almost singlehandedly blowing up the market this time, but still- its resilience is startling, all the more so when you consider that local equities are down 25% year-to-date already!

One possible explanation is that many TRY longs are held against the ZAR, and as such are actually making money hand over fist. That might explain the behaviour of some currency and fixed income punters, but not the broader market as a whole. And let's face it; if a spread as innocuous as Macro Man's large cap/small cap is causing pain, shouldn't the same hold true for a market like Turkey?

A useful rule of thumb is that crises typically don't end until even the best trades go sour. In that vein, it should be a question of when, rather than if, the TRY endures a trying time. Macro Man has been musing about this for a while, but was beaten to the publishing punch by the dodgy tapas and by Goldman, which advocated long EUR/TRY on Thursday morning.

Macro Man prefers a cheap lottery ticket, because if this sucker's gonna blow, it will REALLY blow. And chances are that it will be relatively soon. So Macro Man will spend $200k or so on some upside; 3 month 1.40 $ calls cost about 66 bps (on a 21 vol), so Macro Man will buy $30 million at the market opening tomorrow. And hey- if it all comes to naught, maybe those 96 Euribor puts will finish in the money!

Top 10 most difficult things to do when you feel like Death

1) Write an intelligent blog post

2) Think of nine other entries for a list like this


Wednesday, February 06, 2008

Very ugly, very quickly

Yesterday's off-topic rant was certainly an eye-opener, as it generated a record level of comment (by a comfortable margin) for any post in this space. While Macro Man could take this as a comment on the relative paucity of insight offered up by his daily market musings, he prefers to regard it as a measure of the universality of disdain in which the general public holds bureaucratic institutions.

In any event, it's time time to put the nose back to the grindstone and focus on markets, where things appear to have gotten very ugly, very quickly. Where to start? How about with yesterday's jaw-dropper, the horrific service sector ISM in the US. There was more than a faint whiff of sulphur from the very get-go, as the Institute of Supply Management released the figures early, citing probable "security breaches", i.e. leaks. When the subsequent release showed a multi-standard deviation miss, and indeed the second worst reading in the survey's decade-long history, the reason for the apparent leak became clear, as the data was clearly of a market-moving nature.
While the data was so bad as to be scarcely believable, move the market it did. While fixed income received something of a bid, particularly at the short end, the back of the curve is still well, well off its lows in yield. No, the real impact was felt in equities, where the warm and fuzzy, "kumbayah" feeling of the past couple of weeks was replaced by a down 3% day in the SPX, which conveniently (or not, depending on your position) broke through the recent uptrend, apparently confirming it as a correction.

How ugly was yesterday's price action? So ugly that even erstwhile intramarket "hedges", such as Macro Man's large cap/small cap trade, relocated to Texas. That position, which was doubled at the end of last month, has cost Macro Man $460k in less than a week. Ouch! As the chart below indicates, that spread (long OEX/short Russell 2000) has also gotten very ugly, very quickly. The deterioration in the spread probably speaks volumes about distress in the quant space, and it is beyond the capacity of mere mortals like Macro Man to determine precisely when the downdraft will end. He still believes in the funadamental rationale for the trade, and so will hold tight for the time being. However, price action below 0.87 on the ratio will force a rethink; Macro Man may take his losses on the cash position and look to implement a lower-risk option strategy instead.
There is some ugliness developing in currency markets as well. In the developed space, the euro has taken a bit of a dump after German G7 sherpas warned that the single currency should not bear the burden of adjustments in the foreign exchange market. It's sentiments like these that encourage Macro Man in his belief that Japan will find it politically tricky to intervene to weaken the yen this side of 100. A break of prior lows in EUR/JPY would confirm an impulsive five wave sequence, suggesting that the underlying trend is now bearish.

In the EM space, the South African rand has gotten absolutely mullahed over the last week or two, and USD/ZAR is now within hailing distance of the panic highs of 2006. As Macro Man has mused before, South Africa is one of the few "old skool" EM countries left, with a large current account deficit, high inflation and interest rates, and a corrupt political leadership to boot. Recent power cuts have done little to alter this image. Macro Man has contemplated shorting the rand for some time; it looks like he may have missed the boat.
If Macro Man's trigger pulling in the ZAR has left something to be desired, his efforts in the US curve have left the RSPCA and PETA on his trail, so badly has he screwed the pooch. He's basically watched the 2-10 curve steepen from 50 bps to 160 in a straight line and not been able to pull the trigger. Ay caramba! In fairness, it's not quite that bad; Macro Man has had a sort of cross-market ratioed curve trade on, paying the back end of the US and receiving twice the bpv in 2 year Europe. That position's actually done quite well.

But if one takes the view that the economic slowdown is indeed global, and will hit Europe with sufficient force that either growth or inflation slow materially, than an ECB easing would appear to be in the bag at some point in late Q2 or Q3. And when that happens, the European curve should steepen nicely. As the chart below illustrates, the European curve has lagged the US by a few quarters for the last decade or so; if that's the case this time around, then the steepening party could just be getting started.
Of course, it's probably foolhardy to pull the trigger now, especially with an ECB meeting and press conference tomorrow. Have Trichet and co. seen enough to make them take their foot off the monetary break and press the accelerator? Almost certainly not. So Macro Man will bid his time, especially as he already has a highly-correlated trade on the books.

And as he discovered with the large cap/small cap trade, adding fresh risk at inopportune moments can turn very ugly, very quickly.

Tuesday, February 05, 2008

An Open Letter to Gordon Brown

Dear Gordon,

1. The weather in the UK is pretty awful.

2. The cost of living is very high.

3. The public services range from well-intentioned but poorly executed (NHS) to hell-on-earth (transport.)

4. Population growth in the UK is relatively low, and there is a large funding gap in the pension system.

5. There is also a large hole in the budget.

6. On and off for the last ten and a half years, I have paid more tax into HM Treasury than bears thinking about.

Given these points, but particularly 5 and 6 above, WHY THE F*&(^ DO YOU MAKE IT SO HARD TO GET PERMANENT RESIDENCY?!?!?!?!?!

Consider, Gordon, that your humble scribe is the spouse of a UK national and has resided (and paid tax) continuously in the UK since late 2003 (and from 1997 - 2000 before that.) The immigration rules state that the spouse of a UK national can obtain permanent residency after two years of living together in the UK, subject to certain proofs.

Although you are a politician, I am confident that even you can deduce that 2008 - 2003 > 2. Imagine my surprise, therefore, when upon calling for an appointment to obtain permanent residency I was informed that this would be impossible because I had the "wrong kind of residence permit."

Imagine my chagrin when I found that I now have to apply for a further temporary residence permit for another two years before obtaining permanent residency. I acknowledge that any sympathy you may feel is probably compromised given the prospect of charging me £595 this week, and then £950 (plus inflation) in two years' time, simply for the pleasure of being a host to your parasitic taxation policy.

Let's put this in perspective, Gordon. My ultimate intent is to obtain a UK passport, given that much of my family (hint: they are Guardian readers!), my friends, and my professional life are centred (note: I've spelled it wrong, just for you!) in the UK. I am doing so for all the "right reasons", and not to be a leech to society. Hell, I even passed the "Life in the UK" test in less than three minutes, which must be some sort of record.

Yet under the cackhanded policies of the Border and Immigration Agency, I cannot even obtain permanent residency by the time that someone else, who moved to the UK on the same day as me and with no familial ties to the UK whatsoever can obtain a full UK passport!

Even more bizarrely, I observe from the BIA website that by virtue of my being married to my wife for more than four years, were we to move to the UK today from foreign parts, I could obtain permanent residency immediately. Savour, if you will, the irony:


Tempting as it is to up sticks and relocate to a more welcoming country, as noted above my personal and professional lives are located firmly in the United Kingdom. So I beseech you Gordon: find the kindness in your cold, cold heart to turn your eye to the Border and Immigration Agency and hire somebody who has a triple-digit IQ and isn't in league with Satan.


Macro Man

P.S. Next time you see him, tell Mohamed al-Fayed that the reason he can't get a passport isn't down to racism, Diana, or his dealings with the Khashoggi family; most likely, it's down to bureaucratic incompetence.

P.P.S. To regular readers expecting market and economic musings, normal service will resume tomorrow. But what's the point of having a blog if you can't vent some steam every so often?

Monday, February 04, 2008

Snowed Under

Freak events and acts of nature are generally among the more difficult things to game from a financial market perspective. Even if you know that the long-term impact of event x is zero, if a sufficient number of people believe that event x will meaningfully alter the course of events, financial market prices will move. And as Lord Keynes famously remarked, "The market can stay irrational longer than you can remain solvent."

Prior to the last few weeks, the most recent example of a broad market-moving acto of nature was Hurricane Katrina. And what we observed with that undoubtedly tragic event was a short-term impact on activity, energy prices, and consumer confidence, but relatively little long term alteration of the course of financial asset prices. Stocks, bond yields, and the dollar all dipped in August 2005....and then ended the year considerably higher.

Now, of course, we have an unusually distorting, if no less tragic, force majeure hitting everyone's favourite engine of global growth, China. Not only is the lunar new year rapidly approaching, an annual even that severly distorts all manner of economic activity and data, but the counntry has been hit with the worst snowstorms in 50 years. This in turn has led to power cuts, fuel shortages, soaring food prices, and loss of life.

It's often difficult to know what exactly is going on in China at the best of times, but in a case like this it feels well-nigh impossible. Coming as it does at a time when the US economy seems to be on the ropes, could the snow be the tipping point for the global economic cycle? If so, why is a pro-cyclical currency like the AUD doing so well?

Judging by the Katrina experience, the long-term impact of the snowstorms will probably be relatively minimal. There may well be some short term distortions to the economic data, but heck- we were gonna get that anyway with the lunar new year. Michael Pettis had an interesting post over the weekend noting that the inflation prediction of the Director of the Office of the Central Leading Group on Rural Work (hint: you can tell that China is still Commuinist, because only Communists have job titles this long) is for January CPI to remain at 6.5%.

Now, such an outcome seems patently ludicrous, even if the government has released emergency stockpiles of food, etc. Moreover, we don't exactly have a long data series of this chap's inflation forecasting track record. Nevertheless, the authorities could easily conjure up an acceptable official figure, Argentina-style, and live with the family grumblings about the cost of living over the holidays.

Add in the fact that the G7 meeting is this weekend, wherein China will presumably be on the receiving end of a) commiseration over the snowstorms, and b) moans to keep going with the currency. China's usual response to b) is to stall the pace of acceleration. As the chart below indicates, the pace of the downtrend in USD/RMB appears to be slowing. Given the New Year, the snow, and the G7, it's not difficult to see a scenario wherein near-term downside virtually grounds to a halt. With NDFs pricing onshore rates at -6% at the front end, what odds that that market sees a short-covering rally? Macro Man is not brave (or, depending on your worldview, stupid) enough to go long USD/RMB, given the relatively modest upside and ever-present danger of the autorities "doing the right thing." But those who are short, particularly in long-term NDFs, could do worse than to partially hedge some of their exposure at the front end.

Elsewhere, cash rates are tightening again as the market anticipates the impact of massive rollovers. Certainly the last two quarterly refunding months, August and November, have seen significant distress in money markets while the prior one, May 2007, saw a rout in the govvy market. How much these concerns are justified remains to be seen, of course, but combined with events in China and US data, it would seem that volatility for the next few weeks is assured.

Not that Wall Street will care today, however. The Giants' shocking Super Bowl victory over the "Evil Empire" will probably leave the New York market with more than a few sore heads this morning. Macro Man is left to wonder: what did Vladimir Putin make of it?

Friday, February 01, 2008

After one day... doesn't appear as if February's getting much easier to play than January was. Stocks go crazy yesterday, and bonds barely budge. Employment data is horrible, and stocks nudge higher yet again...only to reverse as ISM is better than expected! Throw in the news that one bloated tech behemoth is buying another, and it's tempting to break out the monkey and having him start chucking darts at the FT.

The payroll data as reported was pretty unambigously weak, but that and £1.65 gets you a cup of black coffee at Starbucks. Macro Man was amused to read a wire story suggesting that "payrolls fall for the first time in five years." Actually, no; are memories so short that people don't remember the negative first print for August's data? Regardless, the trend is pretty clearly weakening, which of course is a big reason why Bernanke is taking his Sikorsky for a spin. Not that it did too many people on Wall Street (or, judging by today's data, Main Street) much good. The chart below illustrates the January returns for what might be termed "asset class benchmarks." Unfortunately, Macro Man couldn't dig up the total return for the Lehman Agg, which he has to believe would be the best performer of the lot. (Anyone who knows the Lehman Agg return, by all means share!) In any event, it was pretty grim for many equity and FX specialists, and commodities did nothing in particular. As noted throughout last month, macro was/is an attractive asset class in volatile environments. While Macro Man managed to claw out a 2.4% gain thanks to some fancy footwork intramonth, he actually underperformed the HFR macro index.
When Macro Man forecast at the end of last year that 2008 would be the "year of alpha", little did how know how true that would be, even from day one! While the final score for the beta portfolio was substantially better than it was at the depths of the abyss, all in it still notched an ugly 3.89% loss.

And while Macro Man's alpha portfolio left him (un)comfortably long risk assets in the first half of the month, he at least had the sense to add short equity risk and quit trying to sell US fixed income. Insofar as a vital element of successful trading is not losing too much money when you're wrong, he can at least breathe a sigh of relief that the remedial action taken in the second half of the month was successful
Particularly encouraging was that every aspect of the alpha portfolio was on song last month, combining to generate a tasty 6.30% return. The year of alpha, indeed! While he still managed to do some silly things (the diastrous attempts to sell US fixed income, cutting the silver long at the low, not stepping up to the plate and selling more dollars), at the end of the day he managed to recognize the bigger picture and salvage a good month for the portfolio as a whole.

On the basis of today's evidence, he'll need to stay on his toes if he wants to repeat the trick in February, particularly as he plans to hit the slopes for much of the second half of the month.

In the books

So January's in the books; suffice to say it wasn't too pleasnat for many people. (Though not, apparently, banks; Macro Man has heard a couple anecdotes of record Januaries for financials.) With payrolls and ISM today, February could start on equally treacherous footing.

The candlestick pattern (whatever it may be called) didn't work yesterday; whether that sets the stage for a more pronounced rally or an even more painful decline remains to be seen.

More later.