Tuesday, September 30, 2008

Tenor Madness

Regular readers will know that Macro Man is a bit of a music aficionado. While he sadly possesses no musical ability (other than possibly as a lyricist), he nevertheless finds it useful on occasion to draw on musical analogies to distill market insights.

He often selects the iPod music for his commute on the basis of his mood or the prevailing market environment. Given the stressful conditions of the past few weeks, he's been listening to an exclusive diet of 1950's and 60's post-bop jazz. After all, The Clash and Run-DMC, linked above, are a bit shouty for the current environment. And if he wants to hear someone moan about the miseries of life, he doesn't need the Smiths- he'll just call up one of his brokers.

In any event, Macro Man's been listening to a lot of Sonny Rollins this month. While Saxophone Colussus is his favourite Rollins record, Tenor Madness isn't too far behind. The latter seems particularly apt for the current state of finance, as fixed income and money markets are caught in the throes of a bit of tenor madness.

With the end of the quarter and the three month date about to rollover into the new year, the dash for cash has generated substantial distortions, despite the recent central bank dollar swap announcements. First quote of the day for overnight dollars was 13.5%, and yesterday's ICAP 3 month quote was 4.375%. The last time 3 month LIBOR was that high, Fed funds were 4.25%. The ruptures in the market can be seen in the chart below, which shows the 2-10 US government yield curve and the 2-30 US swap curve. Unsurprisingly, they are normally very highly correlated. However, recent front-end stress have driven a very significant wedge between government and swap curves.
Quarter-end also brings about the usual mechanistic rebalancing flows from pension funds and other long-term real money investors. It appears that such flows are already going through in Europe, helping to generate a vicious intraday bounce in stocks. Well, it's either that or the news of another Benelux bailout or an Irish government bank guarantee.

Or perhaps the market has decided that news which apparently ushered in a new Great Depression last night is actually pretty meaningless this morning. Macro Man and the chap next to him, both of whom are short stocks, have just been left shaking their heads this morning.

With respect to the TARP's failure to pass Congress, Macro Man touched on the political aspect of it last night (at least with respect to his opinion of the politicians involved), and doesn't intend to go there again.

After an evening's thought, however, it struck him that last night's vote was a Fort Sumter-esque shot in a modern class war. Macro Man has long thought the the negative aspects of globalization would eventually manifest themselves; however, he suspected that the primary mechanism would be protectionism. While there's nothing to say that that still won't be the case, he nevertheless views last night's failed vote through the prism of Joe Sixpack desiring to claw back some living standard away from modern plutocrats.

If the rationale for the TARP's failure could be distilled in one chart, it would be the one below, which shows a surge in corporate profits (at the apparent expense of wages) as a share of national income. It is the divergent fortunes of these two series that has fueled Main Street anger and turned "no" voting Congressmen into class warriors.
Of course, laying the blame for the current state of the world exclusively at the foot of Wall Street is badly misplaced. The US savings rate has been steadily declining since long before the invention of CDOs, SIVs, and subprime. It will have to rise, particularly as society ages. A large part of the rationale for government intervention in the current crisis is to ensure that this occurs in a gradual, orderly fashion, rather than abruptly via the wholesale withdrawal of credit throughout the economy.
Last weekend, Macro Man exhumed some laid-back tunes from his university days in a further effort to remain chilled. The lyrics from one song in particular are remarkably pertinent to the current situation, despite having been written forty years ago:

The percentage you're paying is too high priced
While you're living beyond all your means
And the man in the suit has just bought a new car
From the profit he's made on your dreams
But today you just read that the man was shot dead
By a gun that didn't make any noise
But it wasn't the bullet that laid him to rest was
The low spark of high-heeled boys

Month-end flows and poor liquidity have thus far enabled equity markets to defy the Low Spark; however, thanks to tenor madness Macro Man continues to expect the High Heeled Boys to win out in the end.

Monday, September 29, 2008

Main Street > Wall Street

Clearly there are more voters on Main Street than Wall Street, and we all know that the first job of a Congressman in October is to make sure that he is a Congressman in January.

Regardless of whether "the package" was a good idea or not, it doesn't exactly paint the US political system in good light that an apparently palatable deal has been shot down (with defectors on both sides.)

Particularly heart-warming was the individual who rescinded their "yes" vote, taking the yes tally from 207 down to 206, once he saw that the deal was going to fail.

So the question now is....how low do equities have to go, and how many banks have to fail, before Main Street decides that bailing out Wall Street might not be such a bad idea, after all?

Barring a volte-face from the House, we may be about to find out....

UPDATE: Macro Man is shocked, shocked to see Democrats blame Republicans and Republicans blame Democrats for the failure of the bailout bill. The problem with modern democracy is that only professional politicians seem to want the job of governing....

(As an aside, how does Vikram "we only have $42 billion of downside on Wachovia" Pandit feel right now?)

What's the German Word for Schadenfreude?

Clink. Clink. Clink.

That sound you hear is the pennies dropping in Europe. While yesterday saw what appears to be an anticlimactic agreement in Congress on the format for the TARP, the real weekend news came from this side of the pond. What's the German word for "schadenfreude"*?

Where to begin? How about with Fortis, which last year decided it was a good idea to issue stock, which traded at a P/E of 9, to help finance its partial purchase of ABN Amro (a virtually identical company), at a P/E of 17. The remainder of the purchase was funded by short-term debt....not exactly the best idea at the beginning of a credit crunch. The outcome? A problem so big that it takes not one, not two, but three governments to bail it out. So after Friday's nasty squeeze higher, Eurostoxx is on the back foot once again. The feel-good factor from the TARP already feels like a long time ago.
Meanwhile in Germany, the country's second-biggest commercial property lender has been supported by a shadowy cabal of other German institutions. It's a very European solution to financial crisis; it seems as if most institutions here don't bother to tell you what the crap they own is worth, so it shouldn't surprise that they don't bother to tell you who is saving their bacon. Hypo Real Estate's losses are being blamed on Ireland-based Depfa Bank; one wonders how the German Finance Minister will manage to blame this one on the Yanks. The market is voting with its feet; the front end of Europe, typified by the Schatz below, appears to be breaking out. And here in the UK, the Gordon and Alistair show has added another property to its portfolio. The demise of Bradford and Bingley as a private sector concern is one of the least-surprising in recent memory. The UK government is acquiring quite a tasty portfolio....one wonders if they are trying to match George and Hank in the "my portfolio of nationalized turds is bigger than yours" competition.

Regardless, last Monday's surge in EUR/USD seems like a long, long time ago. Would it really surprise to see it back near recent lows by the end of the week? (For that matter, would anything surprise in this crazy market?)
Lest readers think that Macro Man is picking on Europe, Sunday's New York Times carries an interesting article on American-style kleptocracy. While the chicanery of AIG FP is unsurprising to those familiar with them, the real talking point in the story was confirmation that Goldman (alone among financial institutions) was at the table when the AIG bailout was crafted. No wonder Warren Buffett is happy to invest in GS; where's your downside when they get to bail themselves out?

Hmmmm. What's the German for "crooked market"?

* This is a joke.

Friday, September 26, 2008

O Package Where Art Thou?

This market just gets more and more surreal. Yesterday saw the release of not one, not two, but three pieces of abjectly awful US economic data. So naturally, equities surged higher and government bonds tanked....because of more hopeful noises over the passage of the TARP.

The orders data was wretched on both a headline and core basis. The core shipments figures, which get plugged straight into the GDP calculation, were also awful, prompting at least a couple of immediate Q3 forecast downgrades.

Meanwhile, just when you thought that the housing data had lost its capacity to shock, the new homes sales figures dropped 11.5% month-on-month. The way things are going, they'll soon be able to publish housing data by name, e.g. "This month Fred and Mavis Smithers bought 687 Walnut Lane in Pig's Knuckle, Arkansas." The one housing figure that Macro Man follows is the supply data; as the chart below illustrates, there is no real improvement in sight.
Finally, the jobless claims data were also poor, registering a new cyclical high. The continuing claims data, which provide a smoother series, suggest that we should unsurprisingly expect the unemployment rate to continue rising.
All of this helps to explain why Macro Man remains medium-term bearish on global equities, particularly as both the real-economy and financial-system pennies are about to drop in Europe.

In the near-term however, the Paulson Package is dominating both the headlines and market sentiment. Yesterday, markets rallied on hopes that the package would be passed imminently; today, the collapse of Wamu (is it just a coincidence that this happened during the TARP debate?) and Congressional intransigence have sent equities careening back down. Amongst Macro Man's colleagues, the US Congress is starting to look like a bunch of hapless yokels such as one finds in a Coen Brothers film. In fact, if you listen closely enough, you can hear the market shouting "O Package Where Art Thou?"

Indeed, the whole sordid situation of the past several years resembles the entire Coen Brothers ouevre. The duo's filmography offers a number of insights into the financial crisis. Consider:

Blood Simple (1984): It's bloody simple. The US economy and financial system are completely buggered, and Europe ain't far behind.

Raising Arizona (1987): The aim of the TARP and every other measure taken by Team 1250 is to raise house prices in Arizona, Alabama, and each of the other 48 states.

Miller's Crossing (1990): Somewhere, there must be a back-office clerk named Miller who is involved in trying to cross-net Lehman-facing trades.

Barton Fink (1991): "Fink" is probably among the more innocuous of the four-letter words being used to describe Mr. Fuld and others.

The Hudsucker Proxy (1994): Let's see....a group of businessmen attempt to manipulate their stock price so they can make a killing. The characters are all either deeply cynical or hopelessly simple. Hmmm....Macro Man can't find any possible correlation to the current situation, can you?

Fargo (1996): Unfortunately, Jerry Lundegaard's financial distress may soon be echoed throughout the United States. His snowballing of GMAC (obtaining a loan for a car that didn't exist) is a microcosm of this entire crisis.

The Big Lebowski (1998): A number of erstwhile financial market participants will soon be adopting the lifestyle of The Dude.

O Brother Where Art Thou? (2000): As above.

The Man Who Wasn't There (2001): Two words: Jimmy Cayne.

Intolerable Cruelty (2003): A pretty apt description of how Macro Man's mates at Lehman London were treated by Lehman New York over the past couple of weeks.

The Ladykillers (2004): Scottish Widows' parent company, Lloyds TSB, is down 35% so far this year. The outlook for UK financials remains grim.

No Country For Old Men (2007): As noted a few weeks ago, this is no market for young men.

The Coens' next film is going to be called Burn After Reading. It's hardly a stretch to believe that that is exactly what's being done to the hard evidence of various parties' misdeeds over the past few years.

Thursday, September 25, 2008


"When a man is tired of London, he is tired of life."

-Samuel Johnson

Macro Man is tired of London. Frankly, he was tired of Madrid. And he's also tired of his little enclave in Surrey to which he retires each evening and weekend.

Have no fears, gentle readers. Your scribe is not perched on the ledge of a tall building, prepared to commit a gruesome kind of hari-kiri (for one thing, he is acrophobic.) He is far from tired of life. He is, however, tired of these markets, which seem to require 24-hour attention, seven days a week.

Perhaps it is the dark mornings; without sunshine and birdsong streaming through his window, Macro Man is naturally a bit groggier when the alarm goes off. However, his fatigue is more of an existential ennui; how many crises, miracle cures, and Sunday nights on the Bloomberg can one man take before the brain starts Operation Shutdown?

Not that he's begging for mercy, of course; attention to detail in stressful times is part of the job description. And stress remains highly evident in this market. The LIBOR/ICAP rates both surged higher yesterday; below is yesterday's chart updated with the latest fixes. Observe how ICAP 3 month rates are nearly 4% now!

The same sort of stress is evident further out the curve as well; 2 year swap spreads reached another record high yesterday, and are on another planet compared to any levels in Bloomberg's 20 year dataset. That Banesto is now giving away free motor vehicles with every large time deposit would appear to confirm Macro Man's suspicions that all is not quite right with European banks; one wonders what Miguel Indurain thought of the idea?
With markets moving as quickly as they are, traders (or at least Macro Man) feel like they must keep a closer eye than usual on both price action and their P/Ls. Of course, the downside to doing so is an all-to-frequent negative message resulting from downswings in the P/L. This month, for example, Macro Man has had twelve losing days and seven winning days. While he has managed to scrounge together a profitable month (knock on wood), thanks to the optionality in his book, it is still psychologically tiring to go home starting at a red number nearly twice as often as a black one.

By his count, he's only had two sleepless nights this month; he can only imagine how exhausted, mentally and physically, less fortunate market punters must feel. Readership figures also suggests that you, too, are feeling the strain. After surging last week, weekday visitor figures have retreated this week to more "normal" levels.
Sod's law suggests that the SCREW-U package will be voted on Saturday or Sunday, thereby depriving punters of yet another relaxing weekend. However, with quarter end rapidly approaching and the market evidently as fatigued as Macro Man, perhaps the surprising outcome of the next week would be that everything goes gentle into that good night.

Wednesday, September 24, 2008

Time for a new multi-national program?

Another day, another stunning piece of news that will save the global financial system for sure, this time. Yes, folks, the irresistable force has joined with the immovable object, and Warren Buffett has invested $5 billion into Goldman Sachs, thereby providing incontrovertible proof that history at least rhymes.

Macro Man will leave the in-depth analysis of the deal to others, and confine himself to the following three observations:

1) The deal says a lot more about Goldman than it does about Warren. The last time Macro Man checked, GS was not in the habit of writing $500 million annual checks (the yearly interest on the preferred stock) and giving away free in-the-money options out of the goodness of their hearts. If they are doing this deal, it suggests that (perhaps unsurprisingly) there was more than meets the eye to the last batch of Goldman results

2) When Warren last did a deal like this, in 1987, it clearly did not mark the bottom of credit-related equity distress, which occurred several years later.

3) Lehman Brothers conducted a similar offering at the end of March, which was over-subscribed. That went well, didn't it...

Meanwhile, the news just gets better and better in Europe. The French INSEE printed a new, below-expectation cyclical low....

...as did the ifo....
....leading the latter's chief economist to express a view that, at the risk of beating a dead horse, sounds oddly familiar.

Meanwhile, the FT carries a story today that echoes Macro Man's concerns about the European banking system. Given that every large, leveraged debtor has been punished in one way or another over the past year, it seems only a matter of time before European banks come under the cosh.

And indeed, that time might come sooner than you think. With the end of the quarter swiftly approaching, money markets are tightening notably as the three month date rapidly approaches the turn of the year. Despite the recent dollar swap arrangements, there is some suggestion that European banks in particular (and global banks generally) are desperate for dollar funding. It's worth noting that LIBOR funding levels are looking increasingly fictional.

The chart below shows three month dollar LIBOR versus the 3 month ICAP dollar fixing rate. When ICAP launched its fixing rates to great fanfare a few months ago, interest swiftly waned after they turned out to be very close to existing LIBOR fixings. Observe, however, how ICAP has recently started fixing much higher than LIBOR; the true cost of unsecured dollar funding is now close to 4%.
Money market pressures are not confined to the US, of course. Dec Euribor contracts are implying a rate of 5.30%, a premium of more than 1% to the ECB's refi rate. And despite now-consensus expectations of a BOE rate cut before year end, observe how the December short sterling contract has plummeted in recent days.
So clearly, the TARP has yet to save the day, following the the TAF, TSLF, and PDCF on the list of ineffective acronyms (though in fairness the TARP has yet to be enacted.)

Given the troubles in Europe, it would seem that a new, multinational taxpayer-funded program is required to enable ALL banks to de-lever and recapitalize. Macro Man has already devised a rough sketch of how such a program could work, and is available to consult with the G7 to make it happen.

Taxpayers around the world may be curious to learn what such a program might be called: Macro Man would suggest the Special Capital Raising/Extended Writedown Undertaking.

Tuesday, September 23, 2008

Pain cave

Back from Madrid (which was not so much of a romantic getaway as an exercise in Blackberry watching), Macro Man has arrived back at his desk to find financial markets as one big pain cave.
Anecdotal stories of September's carnage are already beginning to filter through...and that's from before the roller-coaster ride of the last few days.

In any event, stress remains highly visible in short-term funding markets, which suggests that the Paulson Plan, even if approved, is far from a panacea. Other highly visible signs of stress include the following:

1) SPX. Here's a remarkable statistic for you: the SPX fell 3.82% yesterday.....and had its smallest daily range since September 12. Ouch!
2) Oil. Rarely will you see a purer short squeeze than what was observed in October crude oil futures yesterday. Monday was the last day that these futures were not assignable; i.e., from today onwards, longs can demand delivery of 1000 bbl per future at the depot in Cushing, Oklahoma. It seems quite clear that some short out there badly underestimated the market's willingness to let them roll their exposure to November; nothing like a 25% intraday rally in something that you're short. Ouch!
3) The dollar. Macro Man observed yesterday that he thought that the dollar might come in for a spot of bother; little did he know that EUR/USD would put in its strongest daily rally since the inception of the single currency! Based on the experience of last month, it was natural to expect the euro's rally to continue this morning; however, thanks to a new cyclical low in various European PMI surveys, EUR/USD is down more than a percent from last night's high. Ouch!
Within his own book, Macro Man has seen some of his erstwhile star performers turn sour this week; while he managed to dodge the bullet of last week's uber-squeeze, he feels like he's running as fast as he can just to stay still.

Not that still is an altogether bad result, particularly if it keeps you out fo the pain cave.

Monday, September 22, 2008

Thoughts from Madrid

Macro Man has spent the weekend in Madrid, which is salubrious an environ as any other in which to digest the momentous developments of the past week. While things do seem to be changing at the speed of light, he does have a few thoughts about where markets go from here.

The first and perhaps most important of these is that global equities remain in a bear market. Global growth continues to slow and earnings expectations continue to look overambitious in many markets. One little note that flew around the market on Friday night highlighted that the stunning turnaround on Thursday and Friday simply took many assets back to their closing levels of the previous week.
While Macro Man has long thought that some sort of fiscal solution was necessary to end the current crisis, it is by no means a sufficient solution to kickstart a new bull run. Ultimately, the market needs that greatest of all healers, time, to do its thing before Macro Man will be ready to contemplate strategic longs in stocks.

Between now and then rests what is likely to be a hard slog of treacherous trading conditions. Fortunately, we're all get used to trading those kinds of markets, as "treacherous conditions" is a pretty apt description of the last year or so.

That having been said, there remains ample scope for a further tactical rally within the broader bear market. Whether such a rally actually materializes is, of course, another question; frankly, Macro Man isn't sure. His portfolio risk has been reduced accordingly, as he wouldn't be surprised to see equities end the coming week up five eprcent or down five percent.

Such short equity risk that he does retain remains concentrated in Europe. While the ECB's intransigence in the face of changing circumstances drew a surprising number of defenders in the comment section of Friday's post, Macro Man is frankly happy for it to continue; equity shorts are always easier to run in the face of unforgiving monetary policy.

To be sure, the rising tumult of regulatory backlash against short-sellers and hedge funds, which resembles nothing so much as a cartoon mob armed with torches and pitchforks, makes Macro Man glad that he does not deal in single name securities. The squeeze potential in single names, both from regulatory diktat and ongoing issues surrounding Lehman-facing trades, appears to be substantial.

It looks increasingly likely that the market will have another go at the dollar. It is pretty hard to construe the implosion of the US financial system and socialization of the associated costs as anything but a negative for the dollar. With central bank swap agreements in place, foreign banks may now be able to borrow dollars again, rather than being forced to purchase them in the open market. Moreover, the market may retain a desire to price in a small chance of additional Fed cuts, though if the SPX rallies another 100 points then hikes will likely re-emerge in short-end pricing.

You'd have to think that the Paulson Plan should eventually steepen the US yield curve, though perhaps not as much as in previous cycles. A steeper curve is clearly beneficial for banks, but if the US wants to kick-start prudent mortgage borrowing again, having long-term rates at too high a level will be a negative. In any event, Macro Man lives in hope that markets re-introduce a term premium into the US government and swap curves.

Ultimately, the market's mision is to get through the end of the year alive. While last week saw the price of many major financial indicators largely unchanged, Macro Man wouldn't be surprised if there was a large pile of money lost in the process. Although circumstances can obviously change, from Macro Man's perch the next few months are likely to be all about opportunistic trading, taking the other side of panicked pricing a la the RMB one year forwards last week. This naturally lends itself to a lower risk budget than normal; and hey, if last week is anything to judge by, you're likely to be taking more risk than you think when you put on a position.

Saturday, September 20, 2008

Weekend Special: Financial Poetry by Popular Demand

By request of a reader, a re-working of A.E. Houseman:

To a Trader Retiring Young

The year you made forty percent,
Investors thought you heaven-sent.
By leaps and bounds your assets grew,
To fifteen yards from under two.

Today, your trading floor is dim,
Stripped of furniture and trim.
No more, the telephone’s shrill cry
Or buying low and selling high.

Smart lad, to turn the other cheek
And hide as regulators seek,
A culprit for the tempest’s wind
And those that profited and sinned

By selling as the tide went out,
Revealing who was left with nowt.
No more, your selling of the banks
Neither the Brits’, nor else the Yanks’:

Now you will not swell the rout
Of long investors getting out.
The emperor’s new clothes can stand
Unmolested by your hand.

So fly to islands, seas, and sands
Knowing your track record stands,
A monument to bygone days
Before the market changed its ways.

And in some future market craze
We’ll shake our heads, recall the days
When shorting Icarus was done
By you, just ere he reached the sun.

Friday, September 19, 2008

A Message In Bold...And Another To M. Trichet

There's not much that Macro Man can write that you probably don't already know: markets are completely, utterly broken. Liquidity is nonexistent, in some cases literally, which naturally exacerbates the volatility which we are all observing.

While an RTC II is a welcome and obvious solution to many of the current problems, blaming short sellers and engaging in witch hunts are not. That policymakers seem to be opting for both reduces the integrity of the market.

Macro Man isn't able to write any more this morning, so below he leaves you with the post he wrote yesterday afternoon when it looked like the financial world was going to end (though in many ways, it looks even more so today.)

While it may not carry the immediacy that it had when he wrote it, its basic premise nevertheless applies. It's short and sweet. Enjoy....

"The ECB is a credible anchor of stability and confidence for 320 million citizens of the euro area."
Jean-Claude Trichet, 18 July 2008

"We have only one needle in our compass. That needle is price stability, our definition of price stability."
- Jean-Claude Trichet, 7 August 2008

Monsieur Trichet: 320 million Europeans say, "Look at the ****ing compass, you arrogant git!"

Thursday, September 18, 2008

You know it makes sense

Given that the Russians seem to own most of the UK (or at least London), it makes sense for the British authorities to adopt certain practices of their new uber-lords. And given that the Russkies, upon reaping the harvest of their serial unpleasantness towards foreigners, have simply shut their stock markets down until further notice, you know it makes sense for the FSA to simply ban all short selling of financial stocks for the next eight years.

Pretty soon, the authorities will simply delete the "sell" key off of all electronic and broker trading systems, and appropriate all red paper sell tickets that may have survived from the 1980's. Only one way for stocks to go then, baby.

Yep, all is good with the world. BUY BUY BUY!

Addendum: Apparently the NY attorney general will use the Martin Act to deal with short-sellers, er fraudsters. (Might Macro Man suggest he start with the slippery characters at Lehman NY who drained all the cash out of Lehman London on Friday night, leaving his buddies there with nothing but a pile of stationery and $80 billion worth of turds.)

Big Brother is now truly watching you.

Remember, folks...you heard it here first.

Faster Than the Speed of Light

Although Macro Boy the Elder is only six years old, he knows that nothing (other than certain properties of subatomic particles) moves faster than the speed of light. Nothing, that is, except financial market sentiment and pricing, which is changing at literally unbelievable speed.

News so far this morning is that the world's central banks have cobbled together a plan to provide localized overnight dollar funding. While this alleviates the worst of the near-term funding pressures, it does little to solve the more medium issues surrounding uncollateralized interbank lending.

The craziness can be observed in the price of the December 2008 eurodollar contracts, which have had a cheeky 80 bp range over the last three days. That is not a properly functioning market.
The panic is equally evident in gold, which has rallied $110 in a week. This is a market that is stocking up on shotguns, candles, and tinned beans, and is looking to place its fiat money in a hard, tangible asset. Macro Man is normally a "barbarous relic" man when it comes to gold, but given banking sector concerns he can sort of understand the appeal of gold at the moment.

Even the most sacred of cows has been taken to the abattoir. One year USD/CNY NDFs have traded as high as 7.18 (!!!!), pricing in a 4.7% depreciation in the RMB over the next year. Macro Man asked a couple of banks for some downside spreads to try and take the other side; while he received a nice price from one bank, the price from the other was literally unbelievable- he was being asked to pay out regardless of which side he traded.
European equities and short sterling have bounced strongly after CNBC aired a rumour that the BOE will cut rates today at 9.30 local time (20 minutes from when this post is being written.)

If they do, stocks will fly. If they don't, stocks should dump. In either case, prices could move at faster than the speed of light.

Wednesday, September 17, 2008


Merv ain't got no alibi
It's ugly! Hey, hey it's ugly!

If traders were prone to chanting, the above ditty is probably pretty close to what they'd be singing. Respite from the "good news" of AIG's nationalization (or whatever you want to call it) has ebbed pretty quickly as markets come to grips with crippling cash shortages in a range of currencies. December short sterling, for example, has traded down as low as 18.5 ticks from last night's close...quite a stunning reversal from recent price action.

Having wiped out a number of US firms, markets now seem to be focusing on taking down UK banks. Macro Man has replaced AIG with HBOS on his screens....sure enough, the share price is down 50% at the time of writing (and 25% since he started writing this post, when the chart below was posted.)
The rapture from last night's eurphoric US action was dispelled pretty quickly in early European trading, with something of a "witch's hat" formation at the open.
Not that action in other markets has been particularly pleasurable; price action in December eurodollars has been, and there's really no other word for it, ugly.
Macro Man is naturally busy managing his book. In normal circumstances, running a book is like playing quarterback- you take the ball and scan the field for opportunities to strike. This month, he's been playing left tackle on the offensive line: his job is to provide a pocket of protection so that his quarterback doesn't get killed.

It's not a glamorous job, but as any NFL aficionado will tell you, it's among the most important (and best-paid on the team.) It's just a coincidence that most of the guys who fill the role are u-g-l-y.

Tuesday, September 16, 2008

Snake eyes

So Team 1250 rolled snake eyes and did nothing with interest rates. From an economic perspective it's not such a bad decision- as noted this morning, previous cuts haven't exactly been a panacea for this market.

In any event, AIG is now the main event, and even as Macro Man writes this post, the Fed is on the tape saying that they may lend money to AIG. Cue the obligatory 20 point bounce in the SPX from the levels prevailing when the chart below was printed.
Far be it from Macro Man to point out that the emperor has no clothes...but didn't the Fed also lend money to Lehman Brothers via the various TAF/PDCF/TSLF programs? How did that work out for everybody?

In any event, given that AIG management has refused capital that would require their own departure (known forever more as "Fulding 'em"), any infusion of public money should require immediate hari-kiri for the AIG management team.

While the market is starting to feel a bit squeezy, it does feel like it needs a final cathartic flush ; price action similar to yesterday's would probably do the trick. Macro Man reduced some of his short deltas earlier today , and at this point isn't sure whether his next equity trade will be a buy or a sale.

In this market, best to stay nimble so that you don't crap out.

The Last Throw of the Dice?

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?

Monday, September 15, 2008

A Financial Requiem

With apologies to Kenny Rogers

On a warm summer’s evening in a bar in the City

I met up with the banker; we were both too tired to weep.

So we took turns starin’ out the window at the darkness

‘Til boredom overtook us , and he began to speak.

He said, “Son I’ve made a life out of readin’ people’s faces,

And knowin’ what their trades were by the way they held their eyes.

So if you don’t mind my sayin’, I can see you’re out of winners

For a taste of your drink I’ll give you some advice.”

So I gave him my mojito and he drank down my last swallow.

Then he bummed a Montecristo and asked me for a light.

And the bar got deathly quiet, and his face lost all expression.

He said, “If you’re gonna play the game, boy, ya gotta learn to play it right.

“You gotta know when to hold ‘em, know when to Fuld ‘em*

Know when to walk away** and know when to run

You never count your money when you’re sittin’ at the table

There’ll be time enough for countin’ when the deal is done.***

“Now every trader knows that the secret to survivin’

Is knowin’ when to hit the bid when the market is a rout.

‘Cause every trade’s a winner and every trade’s a loser

And if it all goes wrong just hope the Feds will sort you out.”

So when he’d finished speakin’, he turned back towards the window,

Stubbed out his fat cigar and walked out through the door.

And somewhere in the darkness, the banker he broke even.

But he gave me a position that I’ve kept forever more.

You gotta know when to hold ‘em, know when to Fuld ‘em

Know when to walk away and know when to run

You never count your money when you’re sittin’ at the table

There’ll be time enough for countin’ when the deal is done.

* Memo to AIG: Now is probably not the time to to refuse an equity injection because you'd have to give up control

**Not when some Koreans offer you $26/share for a quarter of your company

*** Unless you're Jimmy Cayne and emerge from yet another bridge tournament to find that your firm is insolvent

Macro Man extends his best wishes to all of his friends and counterparts at Lehman Brothers.

Sunday, September 14, 2008

Lehman Goes to the Wall

Unfortunately for all at Lehman Brothers, it looks like the King's English Defence has failed to avoid checkmate. Latest reports suggest that the street is preparing for a Lehman bankruptcy as Team 1250 has said "no mas."

As always in these cases, Macro Man now feels badly under-exposed to the short risk trade, having put on some EM FX option structures last week when he felt badly overexposed to Team 1250's machinations.

With much of Asia out on holiday on Monday, liquidity will be just fantastic overnight. What's more than a little frightening is that Lehman may soon have company, if AIG's share price (which shed 30% on Friday and is overlaid with Lehman's on the chart below) is anything to go by.

Strap in, boys and girls: it looks like the roller-coaster ride is just getting started.

Friday, September 12, 2008

A Damned Shame

Well, what can we say? Another day, another US government intervention- this time to broker a buyer for Lehman Brothers. Per the usual, someone got wind of it beforehand, leading to the by-now de rigeur spike in the SPX before the news hits the tape.

It's a damned shame that LEH has gone to the wall, but being a damned shame isn't necessarily a good criterion for government intervention. Readers across the world can no doubt think of domestic issues that are a damned shame but have yet have yielded no government response.

Still, there appears to be an ever-lengthening list of items in the United States which are a damned shame and which are generating a policy response. Consider:

* It's a damned shame that the hegemonic mortgage lenders/guarantors have run out of capital. We need to give homebuyers the ability to maintain mortgages, so let's put Fannie and Freddie into conservatorship.

* It's a damned shame that Bear Stearns has run out of liquidity. Given their role as a clearer and prime broker, we need to organize an orderly sale of Bear to stabilize the financial system.

* It's a damned shame that Lehman Brothers' share price is at 4. Clearly the market is pricing in a failure. In the name of financial stability (again), let's work the phones and broker a sale.

* It's a damned shame that bank stocks are going down. Hey, here's an idea: let's start tinkering with the regulations regarding short sales and rumour-mongering.

* It's a damned shame that American automakers make poorly-built, expensive cars that require way too much fuel to run. Ford and GM can clearly see which way the wind is blowing; they are demanding $50 billion from the government's liquidity milk-teat.

Allow Macro Man to add one more to the list; hopefully someone from the US Treasury reads this and sorts him out.

*It's a damned shame that Macro Man has an enormous TV cabinet taking up space in his garage. This situation appears to tick all the boxes for a government bailout:

- Is it big? Yes- the cabinet is 1.5m tall, 2m wide, and weighs at least 300 kg. It's about as easy to shift as 2007 vintage BBB-rated ABX

-Is there a market for it? Not really. A quick perusal of Ebay reveals a lot of supply of big TV cabinets, with very little demand. Kind of like the asset side of Lehman's balance sheet, really.

- Is it impairing? Yes. It takes up a lot of space in the garage- Macro Man would like to stick the lawnmower in there, but this bloody cabinet takes up all the space.

So come on, Secretary Paulson: sort Macro Man out. (Alternatively, anyone in SE England who wants a handsome oak TV cabinet and is willing to arrange for some strong blokes to take it away should contact Macro Man at the email address on the right.)

So anyways, equities everywhere are roaring higher today, as no one wants to go home short. While market scuttlebutt is that LEH will make an announcement at noon London time, it's pretty clear that something will be done by Sunday.

Still, the fundamental backdrop is awful. Macro Man has had enough of the short-term roller coaster, and is now trying to fixate on the things that he thinks matter. Consider the following:

Economic growth looks bad. Looking at the OECD leading indicator, growth prospects in much of the world look dreadful- particularly in Europe. Not coincidentally, Macro Man's equity shorts are concentrated there.
Earnings expectations are still coming lower. Macro Man's research suggests that bear markets don't end until analysts start looking for accelerating nominal forward earnings per share. So far, that ain't happening. And Macro Man doesn't expect it to for a while, because....
Earnings expectations are still too high. Macro Man isn't sure which is more remarkable about the chart below: the fact that 12m earnings growth expectations have never turned negative during this crisis, or the fact that they are accelerating higher (other than in Japan, where ironically the OECD indicator above is the best of the bunch.)
So Macro Man has taken the deliberate decision to disintermediate himself from the intraday highs and lows of running an equity index short. He's paid his money and he's made his bet. While he runs the risk of being flattened by Team 1250, the increasingly dead cat nature of the index bounces, combined with the lousy fundamentals, will hopefully help him fixate on the horizon a few weeks ahead, rather than the noise of the intraday waves.

And if they don't...well, that would be a damned shame.

Thursday, September 11, 2008

Team 1250 Strikes Back

So BOA is the white knight who will save Lehman (ed. note: with whose money?). It looks like Team 1250 let a few friendly folks know beforehand. Macro Man hopes they remembered to ring Bill Gross so he could sell protection on Lehman and ring up another record day.
Does anyone know the code for Romanian stock index futures? Macro Man needs to find a less corrupt market....

Free fallin'

Another day, another disappointing lack of collapse in European equity markets. While Macro Man is trying not to tick watch and remains firmly committed to the bear trade on a medium term basis, he has to concede that the lack of instant gratification has been frustrating in an environment where mistakes are swiftly punished.

One market where gratification has been instant is New Zealand, where yesterday's surprisingly aggressive 0.50% rate cut has sent NZD/USD 2 cents lower in fairly short order. Not that there hasn't been a sting in the tail; as noted at the end of yesterday's running diary, Bloomberg misreported the move as a 0.25% cut, in line with market expectation. Misreported central bank activities happen with surprising frequency on Bloomberg; Macro Man is coming perilously close to purchasing a tin foil hat with respect to Bloomberg News. In any event, he has been dragged back into the short NZD trade; one of his most profitable analytical frameworks has been to sell those currencies where CBs go for growth, which the RBNZ has.

There are, of course, other markets in free fall. While Macro Man doesn't really trade a number of these, it is still interesting to observe the value destruction that's going on.

Remember when precious metals were the only "real" store of value left? How much retail money poured into metals ETFs? Silver is down 50% (!) from its highs in March. 50%! That's truly impressive.

Oil is now back to last year's closing levels; if it doesn't bounce soon, the base effect on inflation data will lead to a significant reducton in CPI prints globally. To a degree, it's already happening; Chinese CPI is already surprising to the downside. While Macro Man was happy to trade an inflationary theme earlier in the year, it's pretty obviously been the wrong way to look at the world for the last few months. Fortunately, he hasn't thrown much, if any, money down that particular sinkhole, though the bid for US 30's might reflect something of a deflationary trend.

One market where the collateral damage has been significant is Russia, where the equity market is down nearly 45% over the past few months. It just goes to show that if you actively seek to screw over investors and stick up two fingers at the rest of the world, your markets will eventually get punished. This begs the question, of course, of why the SPX isn't 20% lower.
EUR/USD, meanwhile, remains in free fall as well. This has been something of a source on consternation to Macro Man, as he's felt a significant opportunity cost from not really participating. On the other hand, his expectations for the dollar have so far been wrong: it hasn't settled into a range trade like he thought. So from that perspective, not making money in a move that he didn't expect is no reason to beat himself up. Regardless, we are approaching pretty critical levels in the dollar. EUR/USD is now back at the level prevailing when the Fed first cut rates a year ago; the year on year change in the pair looks set to turn negative for the first time in two and a half years.
On a longer term basis, 80 was a critical long-term support for the DXY for 20 years; when it finally broke last autumn, the follow-through was swift and dramatic. The DXY is now retesting the 80 level, which should act as staunch resistance. If the USD is going to fail, it should start very soon. If it keeps going and closes this month above 80, it will be a powerful signal that the seven year dollar bear market is over.
At this point, Macro Man is trying to remain flexible on the dollar while retaining conviction on higher quality trades. Hopefully, this modus operandi will keep the most important number on his screen, the P/L, from free fallin'.

Wednesday, September 10, 2008

D-day for Lehman: A running diary

Macro Man is going to try something new today, an occasional running diary of his thoughts, fears , joys, and frustrations on what looks set to be a momentous day. It might prove useful ex post in helping him to evaluate how he deals with noisy days. Scroll down to see updates....

8:58 am: The LHC has been turned on, and we're all still here. Lehman's trading over 10 in Germany, despite DKB apparently pulling its bid. European equities aren't nearly as weak as bears (including MM) might have hoped...this market really is quite frustrating. I'd certainly expect to have been better than flat on the day at 9 am.

9:20 am: Today is one of the few days that physics jokes are all the rage: A neutron walked into a bar and asked, "How much for a drink?" The bartender replied, "For you, no charge."

9:49 am: And the FTSE goes briefly positive on the day. The drawer labeled "Things I Understand" is rapidly emptying.

10:23 am: The EU downgrades its 2008 Eurozone growth forecast and warns of serious downside risks to its 1.5% 2009 forecast. At the same time, Trichet pops up on the wires yet again railing against higher inflation expectations. Eurostoxx futures now back at 3240, IBEX down close to 1.5% on the day. I love it when a plan comes together....

11:23 am: Back from a spot of exercise (Macro Man is a firm believer in sound body, sound mind), and the market seems to have settled into a pre-Lehman lull. LEH still up a couple of bucks in European trade, so it seems like someone is betting on good news. There could be an interesting dichotomy of outcomes here. A spin-off scenario, wherein Lehman divides itself into Goodbank and Turdbank, is pretty good for shareholders. Turdbank shares will probably go to zero, but Goodbank shares could eventually recoup all those losses and mroe through price appreciation. If bondholders are left with bonds of each company, however, they're looking at a possibly significant haircut on principal repayment.

On the other hand, if Lehman is undertaken or bailed out a la Bear and the Agencies, shareholders will be S.O.L. but bond-holders yet again made good. Macro Man votes for the bondholders to get stiffed this time....

12:23 Seven minutes to go and equity indices and USD/JPY have firmed. Team 1250 spreading the rumour of good LEH news through the Japanese walls? Hmmmmm

12:34 pm Come on, where are these results? This is worse than waiting for payrolls.

12:45 OK, I'm no equity analyst, but this looks pretty bad. $5.92 per share loss, selling off the crown jewel of the asset management business, spinning off some (but by no means all) of their bad assets. Why the heck are they still paying ANY dividend if they are bleeding money out of every orifice?

European equities are coming back off, but I have to say I am a bit disappointed with the reaction so far. Come on, get stuck in!

13:00 Patience is a virtue, apparently.....having spiked above $10/share LEH now trading at yesterday's closing price, Spoos are negative, USD/JPY below 107 the figure

13:43 The market seems to lie the conference call, and some of the marks do seem quite conservative. Still, Macro Man is left to wonder if LEH isn't going to turn into something of a zombie bank: an institution with lots of illiquid crappy assets on their balance sheet, funded via a central bank liquidity milk-teat, and an eroded client base, that jumps limps along interminably. He hopes that isn't the case, but cannot rule out the possibility.

14:00 At last, some lunch. Macro Man has a bad feeling that we're going to see a horrible squeeze higher at the US equity open. Ugh.

14:26: Viva la squeeze! Spoos and USD/JPY bid no lid, and European equities are about to turn green. It feels like there are a lot of electrons in my book right now, giving it a negative charge...

14:56: LEH has traded back to yesterday's closing price and bounced, taking broader indices with it. All in all, it's been a frustrating day so far.

15:35: Macro Man is a tad surprised at how much disintermediation there appears to be between LEH and broad indices. It's as if indices in the US and Europe are saying that the buck (or perhaps more to the point, the crisis) stops with Lehman. In reality, it would appear likely that after Lehman recedes as in issue, another bank in trouble will immediately crop up in its place, just as Lehman replaced Fannie and Freddie on Monday.

Crude inventories look pretty bullish; if WTI and Brent cannot rally on that and the OPEC cut, you'd have to think that it will go quite a bit lower. Good for the consumer, eventually; bad for energy stocks fairly immediately, one would think.

And yes, Macro Man is blatantly talking his own book there.

16:05: If you'd told Macro Man at this time yesterday that the S&P 500 would close yesterday at 1224 and that LEH would lose $5.92 a share, he'd have told you that a) European equities would easily be more than a percent down from yesterday's closes, and that b) he'd be doing a damn sight better than flat on the day.

Exhibit 57 on why this is such a difficult market.

16:24: And as the SPX goes through the low of the day, USD/JPY goes through the high of the day. A frustrating end to what's frankly been an irritating day.

16:35: Grrr. Lehman now bouncing. Macro Man's book feels like he's experiencing all of the upside of equities (bearing in mind that he's short) and none of the downside. Time to go home and manage the rest of the day from the study.

18:07 Home, to find LEH small down on the day but Spoos up half a percent. Despite a reasonable amount of market volatility today and a nonzero (but in fairness, not massive) amount of risk on, Macro Man's daily p/l doesn't seem to have strayed too far from flat on the day. Hmmm, where was this lack of P/L volatility a couple of weeks ago when he could have used it?

19:22: So Spoos are now back to Friday's level, and Eurostoxx futures are up on the day. What an unpleasant market. At least tonight there's something else to look forward to: RBNZ announces rates at 10 pm London time. A 25bp cut will be a snooze, but a 50 could be an open invitation to start taking potshots again at the flightless bird.

20:34: So Macro Man ended up doing 4 trades today, all from the train on the way to work, and each pair locked in a small loss. That's why this blog is called "Macro" Man and not "Day-Trade" Man. Watching the US close will probably only wind Macro Man up; time to go downstairs and see if he can beat the Mrs. at chess.

21:45 The chess mirrored the market; Macro Man was had a big advantage and was sure he'd won, but allowed Mrs. Macro to escape through his fingers and snatch a draw. Not so poor Lehman; they need to sell valuable assets to raise capital, but if they do they'll face a ratings downgrade that will cripple their ability to conduct client business. Perhaps they should hire Mrs. Macro as a troubleshooter, given her ability to scape from checkmate. Oh well, roll on RBNZ.

22:05 Perfect end to a perfect day. RBNZ cuts 50, only Bloomberg reports it as 25, so as Macro Man sits there thinking "I could have sworn rates were at 8.25%, not 8%", NZD gets clumped. Just great. He needs to go to bed.

Good night.

Large Hadron Collider

Today is a momentous day for geeks around the world, from professional particle physicists to science amateurs like Macro Man. Yes, today is the day that the Large Hadron Collider in Switzerland is turned on, and with it mankind will attempt to replicate the conditions that existed at the time of the Big Bang.

Protons will be sent at virtually the speed of light to collide in mega-energy explosions. And with it, physicists hope to find all matter of esoterica: Higgs bosons, the so-called "God particle" that gives matter its mass; symmetric superparticles, massive counterparts to massless force particles; and, potentially, new dimensions in the fabric of spacetime.

One of the side effects may be the creation of microscopic black holes, which some prophets of doom are heralding as the end of the earth. A more apt forecast may involve Lehman Brothers, which appears to be travelling on the road to oblivion at close to the speed of light. Certainly financial markets appear to have created new forces and new dimensions in which to lose money; Macro Man himself has seen part of his portfolio disappear down a microscopic black hole thanks to a series of conflicting headlines about Lehman and KDB this morning.
Before his train pulled into its London terminus this morning, Macro Man had locked in losing round trips in USD/JPY and S&P futures. With Lehman set to announce its Q3 losses (as opposed to earnings) at 12.30 pm London time today, it will be all too easy to feel like one of the protons being sent around the Large Hadron Collider at 299,700 km per second.

The key is to make sure you exit the ride before the collision.

Tuesday, September 09, 2008

Another checkmate (guess who?)

As painful as it is to see Macro Man's friends at Lehman in personal financial distress, it's hard to escape the conclusion that the endgame is near. A record-volume slide into single digits and a current price that's 50% lower than Monday's opening suggests that checkmate is very, very near.

By all accounts, Lehman is considering releasing Q3 earnings after today's close to stop the speculation; the danger, of course, is that the release merely confirms the market's worst fears. Bear, Fannie, and Freddie provide recent evidence that a single-digit stock price is a death sentence; continuing with the chess theme, there doesn't appear to be a white knight on the horizon to swoop in to the rescue.
The obvious conclusion, barring a shocking development over the next ninety minutes, is that it's back to plan A for the equity bears and back to the drawing board for Team 1250. Strap yourselves in....this ride is about to get (even more) interesting.

It's tricky

It's tricky to rock a rhyme
To rock a rhyme that's right on time
It's tricky tricky tricky


Macro Man had to kick it old school on the iPod this morning to buck himself up after a bewildering day in financial markets. After all, if the Kings from Queens found it tricky to rock a rhyme in the mid-80's, when they were at the height of their powers, it's perhaps understandable that a (lower case) macro man might find it difficult to navigate the treacherous waters of the current stress-laden financial environment.

Where to begin? Yesterday's game plan proved as useful as a dodgy sat-nav, as Macro Man's road map left him off course, scratching his head, and wondering whether to ask for directions.

If the Agency bailout really were a panacea, it seemed reasonable to expect that equities would open high and rip higher throughout the day. In fact, yesterday's trading was enough to give Macro Man whiplash; while it may have been a day trader's paradise, it left Macro Man riding an emotional (and, to a much lesser degree, P/L) roller coaster. There were no fewer than 6 intraday moves of 1% in alternating directions....and that's not counting the opening gap higher. For those like Macro Man who went home Friday short equities and were forced to cover on Monday morning, watching the SPX oscillate was like walking a tightrope between fear and greed. It was all too easy to buy high and sell low yesterday in the name of "risk management" and "keeping some skin in the game."

Fixed income markets are equally confusing, at least to Macro Man. His position in US 30 years has gone all kinds of wrong....how the hell could USZ8 close yesterday at a higher level than it closed on Friday (and, incidentally, nearly 2 points above the levels prevailing when Macro Man woke up yesterday)? There's been some suggestion that the huge rally in MBS is forcing convexity buying of Treasuries; however, this convexity buying is, as far as Macro Man is aware, normally concentrated in the 5 and 10y sectors of the curve. Yet since Friday's close, 5 year yields are 1.5 bps higher while 30y yields are 3.5 bps lower. WTF?
As for FX carry, ugh. The good news is that Macro Man has largely reduced his FX positions and so avoided another source of heartburn yesterday. The bad news is because conviction is low, when he dabbled in selling a bit of carry yesterday, he dropped half a percent on his trade in five minutes and stopped out...only to see a two percent sell-off later in the day. The difficulties of trading FX are exemplified in the EUR/JPY chart below, which ends with yesterday's price action. While Macro Man understands the principles of candlestick charting, he doesn't know the name of lots of the patterns, including that in the red box below. What do you call a two-day pattern where prices extend sharply to the downside, then sharply to the upside, put in a 5% or so range, and then end unchanged?
If none exist, allow Macro Man to suggest the "Twisted Fork", the "Red Hot Poker", or "Satan's Finger" as alternatives.

Meanwhile, the Law of Unintended Consequences may rear its ugly head as a result of the Agency bailout. Stories are circulating that bank MBS books have received a windfall profit of $20 billion from yesterday's furious GSE bond rally, which was surely an intended consequence of placing FNM an FRE into conservatorship.

FX reserve managers and PIMCO are also quids in, of course. Given how swiftly the bailout followed Bill Gross' pleas for the Treasury to deploy its checkbook, Macro Man is left to wonder: when Mr. Gross orders a pizza, does the CEO of Domino's deliver it personally?

In any event, there is likely to be some unintended downside from the bailout. Regional banks, who have been large holders of Fannie and Freddie preferred stock, have just seen those shares collapse in value. Word on the strasse is that at last a dozen will go under shortly.

More interesting is the fact that Agency credit default swaps are triggering, as the conservatorship is technically a default event. Now, no one knows exactly how many CDS have been traded on FNM and FRE paper, but the size appears to be very considerable indeed.

While the CDS will be cash settled, there could be some rather nasty P/L surprises for heretofore successful traders of these products. From poster "cds trader" yesterday:

I buy FRE sub CDS, 5y, at 50bps in $100mm, a while back. Nice trade, since it then widens to 250bps, where I sell it in $100mm. What's my profit? Well, its 200bps a year for the next 5 years, discounted at the risky rate. 200bps = 2%, and lets say 5 years worth of that is worth 8% (not 10%, as we're discounting those future cashflows).

SO...my P+L is showing up 8% of $100mm = $8mm. Great, nice trade. EXCEPT...along comes todays event, CDS triggers, but bonds are all above par. So the PAR - RECOVERY payout (ie. getting paid 100 in exchange for "defaulted" bonds) is zero, BUT all the CDS contracts stop paying the premiums.

So now I have received no payments, but my CDS trade where I was paying 50bps has gone away, AND the CDS trade where I was receiving 250bps has also gone away, so now my P+L is zero. Unfortunately, I'd already taken my $8mm P+L, so what this means to day is that I've just LOST $8mm, and that was from trading well apparently!!

Quite a few people will get surprised by the effects of this today I think.

While it seems unlikely that this impact will make or break many institutions, on an individual trader basis there could be a lot of unhappiness as this gets resolved. Moreover, the potential for back office error and out-trades would appear to be relatively high, if some of the anecdotals about back office technology and practice are correct.

In any event, Macro Man finds himself swiftly arriving at a high-conviction long term view. Anyone who finds themselves out of a job at year end should high-tail it to law school as swiftly as possible. The lawsuits resulting from this whole sordid era are likely to persist as far as the eye can see. Being one of the vultures picking at the financial system's carcass would appear to be an easier way to make money than trading, which today is once again proving to be very, very tricky.

Monday, September 08, 2008


Having recently re-read Arturo Perez-Reverte's excellent Flanders Panel, last night Macro Man played chess with Mrs. Macro for the first time in at least five years. He discovered to his chagrin that it is very difficult to play chess with one eye on a Blackberry; the missus dusted him twice with surprising swoops that caught him badly off guard.

This morning's parallel with financial markets is obvious, of course. The announcement of the Agency bailout/rescue package/whatever it is has wrong-footed risk asset shorts, and the early anecdotal reports suggest that a few punters may be facing checkmate. Macro Man will leave the in-depth breakdown of the mechanics of the rescue to others, and instead focus his thoughts on what it actually means for markets and his portfolio.

After Friday's appalling payroll data, it looked like we were all systems go for an equity and FX carry meltdown. It certainly seems like the market deployed a lot of risk shorting stocks, EM, and yen crosses, at least during European trading. In retrospect it certainly looks like someone had the heads-up about the GSE bailout, given the sharp bounce in equities into the close. With Paulson's close ties to Goldman Sachs and Morgan Stanley having advised the government on what to do with the Agencies, Macro Man is left to wonder if the Chinese walls are actually of the Japanese paper variety.
Regardless, now that Bill Gross and foreign CBs have been made good by the US taxpayer...err....Treasury, we need to figure out what happens from here. It seems almost axiomatic that financials (ex FNM and FRE common, naturally) and broader equity markets will continue to rally for a few days. However, in Macro Man's view today's action doesn't necessarily alter the medium term dynamic.

The greatest impact of the weekend announcement will be psychological; it will do relatively little in the near term to clear the inventory of unwanted houses in the US, it could put pressure on regional banks via a hit to their holdings of preferred Agency stock, and does nothing to assuage the weak US labour market. Further afield, of course, Europe is still in a world of hurt, particularly with the financial Calvinists running the policy show.

Next week sees GS, LEH, and MS release Q3 earnings, and none of them will be helped by yesterday's announcement. Perhaps there is room for good news if Lehman can find a buyer, and of course GS will beat estimates like they always do. But overall, Macro Man would expect a fairly dismal set of figures.

Moreover, there is plenty of precedent not to expect too much support over a three month time frame from the bailout. Consider some of the "substantial" policy actions taken last year: point A on the chart shows the first discount rate cut in August (also leaked to the market a day in advance), whereas point B shows the introduction of the TAF (which was supposed to fix all the funding problems.) While each of these prompted a knee-jerk rally in equities, ultimately the fundamentals and drove stocks lower.

Perhaps more relevant is the precedent of the Resolution Trust Corporation, formed in 1989 to be the buyer of last resort of assets held by the S&L industry. The RTC's formation occurred into a decelerating economy...but the SPX didn't bottom until October 1990. It wouldn't at all surprise Macro Man if the SPX didn't bottom until next year.

While Macro Man is still organizing his views, here is a simple summary list of his thoughts on the market implications of the GSE takeover:

1) The short European equity trade should be changed to a short Europe/long US equity trade, reflecting the different policy settings.

2) US Treasuries should sell off and spreads should tighten; the Treasury is selling government bonds to buy MBS.

3) FX carry should do pretty well. We've already had a gap higher in NZDJPY, and no doubt CTAs/carry models/Mrs. Watanabe have more demand in the pipeline.
4) Macro Man isn't really sure what it means for the dollar. While he can accept that a policy response can be construed as dollar-positive, he can't help but observe that the dollar did pretty well when everything looked horrible. A "heads I win/tails you lose" scenario always makes him uncomfortable, and he's frankly happy to be largely out of currencies at the moment.

5) It wouldn't surprise to see more pain in commodity equities, if there are any more stale long energy/short financial trades out there. Macro Man doesn't have a good feel for this one.

In any event, views are likely to evolve in real time, and for equity shorts like Macro Man today is all about damage limitation. His decision to put on some short long bond deltas on Friday hasn't saved his bacon entirely, but it has at least mitigated today's pain. Once again, his policy of "hedge when it looks like you least need it" has come in handy.

Having a back-up plan and protecting key assets are of vital importance in both markets and chess. And frankly, Macro Man will take a checkmate from Mrs. Macro every time if it means that he's mounted an appropriate defense of his portfolio and lives to fight again another day.