Thursday, March 19, 2009

March Madness

For basketball fans, the sweetest two weeks of the year-the NCAA tournament, aka March Madness-begins today.

Those of us in financial markets, of course, have been living with March Madness for a bit longer, ever since the Bank of England kicked off an orgy of quantitative easing just two weeks ago. Macro Man can now report, on an exclusive basis, on some of the deliberations that took place amongst central bankers at last weekend's G20 meeting:

QE or not QE? That is the question.
Whether tis nobler in the mind to suffer
The slings and arrows of a vanished fortune,
Or to buy bonds against a sea of troubles,
And by inflating end them?

At this juncture a PM has to make a couple of decisions. What does he think the world will look like in, say, three to six months? And what does he think the market will think the world will look like, which is another way of saying what trades will the market do?

Contrary to some, Macro Man doesn't think last night's shock and awe necessarily spells a catastrophic descent into the abyss for the US dollar. On the contrary, last night's actions will merely go some ways to filling an abyss that represents a lack of dollars in the shadow banking system.

However, it seems quit clear that tactically, the market will wish to push the greenback lower. A brief stroll down memory lane to see what happened to sterling after the BOE decision may prove instructive. After an initial 48 hours of uncertainty, the market has pummeled the pound, and EUR/GBP is now up more than 5% in two weeks.

A similar short-term spanking of the dollar seems eminently possible, if for no other reason than there seems likely to be a disproportionate supply of dollars from people who like to make bets on currencies: hedge funds, real money managers, etc.

And while Macro Man is no fan of the euro-quite the contrary!- the fact that intra-European tensions are easing somewhat (BTP/Bunds spreads have narrowed some 25 bps this month) have restored some of the, ahem, "allure" of the single currency.
One view that seems to be overwhelmingly consensus is the bullish case for gold. Having sustained a Satan's finger-style reversal yesterday, the yellow metal is left near its highs of the last couple of weeks with positioning a fair bit cleaner.
Macro Man accepts this, and acknowledges that the bull case looks solid. But consider the uber-bull case. In a world where gold trades at $2000, where is the oil price? Last year's oil rally was largely a demand phenomenon, some of which was real and some of which was speculative.

But gold at $2k will pretty clearly be a monetary phenomenon, one which should impact all hard assets fairly similarly. When you throw in the multipliers that work in the oil market, via the monetary impact on the factors of production, Macro Man would submit that you should see a disporportionately large rise in energy prices. If you throw in the market pricing in an eventual recovery in demand volumes, the price impact could be explosive.

Gold may well be the superior trade for a 20% move. But Macro Man reckons that mid-curve oil is a far, far better trade for a 200% move.

And in a world of March Madness, that's the way he's thinking right now.


dismale said...

You can't hide a barrel of oil under your bed, well you could if you really wanted to. Just because gold oil have been correlated in the past doesn't mean they will be now. Oil will be driven by the economy so its going to fall, not even $20 would surprise. Gold is as you say a monetary phenomenon, anything could happen. I'm short gold but when I think the fan is about to be hit, I'll be long.

RebelEconomist said...

How about defence stocks? I like anything real, but the US actions are so at odds with their reassuring words to China last week that one can imagine that they feel betrayed. No doubt Macroman would say that the Chinese have largely brought this upon themselves, and I would disagree, but what really matters is their perception.

Macro Man said...

RE, the obvious US rejoinder is that the Fed has now adopted the same monetary policy as PBOC, e.g. selling shedloads of local currency to buy US bonds. Not sure how that constitutes a betrayal...

In any event, by all accounts China has shortened its duration so that virtually all of its holdings are two years and shorter. As these notes and bills roll off, they can always invest the proceeds elsewhere.....say, in securing a long-term energy supply?

The camel that broke the Greenback? said...

In a longer term perspective -- isn't it time for the dollar to take a more permanent hit in regards to safe haven status?

What will be the reasoning in ten years for resorting to a currency that lacks all marks of quality and that represents a market whose importance in trade-weighted terms is losing pondus constantly?
Why would the Chinese keep pumping every dime they make into US Treasuries when their own market is overtaking the US' in size and the US yield is zilch. Why should OPEC keep buying >60% USD?

I know the death of the dollar has been proposed, and wrong, before, but: why oh why?

Macro Man said...

For the dollar to lose its hegemony, China needs to be willing to allow its currency to become internationalized and occupy the same role in the financial sphere that China does in the sphere of international trade.

Politically, that is a non-starter domestically. As I have been saying privately for more than five years, and in this space for two and a half, it would be better for everyone concerned if China quit buying dollars and quit buying US Treasuries.

That they have not quit is down to their decision.

Anonymous said...

Hi MM..

In the last 2 weeks, you said that you would be looking for a higher USD/KRW and USD/INR over the next 3 off months. Do you continue to hold the view?

Reflation Trade: IF one should do a reflation trade, then would not the USD/ASIA (Except KRW and JPY) be a good sell, as the Asian currencies appreciate?
Aso, in that case would EM Equities attract yu any which way.

btw..$-INR closed at 50.39, down 90 paise or 1.8%.

From India...

CV said...

Well MM,

This is one time that I am happy to have your writings and this commentary sections to lean on.

One question which I want to pass on because I really could not answer it when asked;

"Incidentally, do you know about these Treasury purchases, are they to be in the primary market, or simply secondary purchases?"

Can anyone help me here or did I just not read the FOMC statement well enough. Clearly, it matters since secondary purchases would NOT be QE as we understand it traditionally no?

As for the USD hegemony, well this is the same old discussion. Who will step up to the fore?

Clearly, China does not have this inclination let alone ability and Europe ... forget it! This leaves I think a conglomerate of countries such as India, Brazil, Turkey, and other emerging markets, but at the current juncture nobody would bet money on this.

Incidentally, I am with MM's argument on oil. Basically, when things start to heat up again, it will not be in the US or Europe but in some of the big EMs and, added the supply problems, oil will shoot back up I think.


RebelEconomist said...

I dare say you are right MM, that the Chinese have shortened duration and will look to buy commodities and commodity producers, but with the Fed supporting longer maturities anyway, their bigger problem is getting out of the dollar.

Provided that the US authorities maintain the internal value of the dollar, China has no grounds for complaint for any currency losses, but to me this looks increasingly like the US is pushing the reset button to validate US asset prices - a flood to lift all boats.

While this may present China with a short term problem, in the long term it will be a worse problem for America, because they will be forced to pay a distrust premium for years. The devaluation is moral as well as monetary.

SFOT said...

Hi MM, it's all about the USD this session, and the next, and the next 20, but as for oil, i remain a sceptic in it having a massive and sustainable rally. However, being short the front vs midcurve looks an interesting proposition if its 20% vs 200%!

Anonymous said...

I backed up the truck days ago on the DXO. I'm all set for the fun to come.


RebelEconomist said...

By the way, I think there are better real investments than oil. The GCC countries showed even less inclination to stop pegging to the dollar than China, so any significant oil price rise will automatically brake the dollar devaluation process.

Anonymous said...

i was wrong last time when i said gold was too thin to short into all you guys saying gold was a good short, and gold just completed a swift -$125 down yest.
as an alternative to the printing presses it does seem like the total global amount of investment in precious metals should be more than a few dow drug stocks

but, can you shave off of your gold bar and go buy something?

if the printing presses are just dealing with toxic debt it's not inflationary, and my gold bug friends are still saying that $400 trillion in derivatives will implode

from an old refco research guy:
"The capital flow into commodities is a risk to the global economic recovery. The world needs low commodity prices in line with weak demand, not an investment flow into commodities, which will raise the cost of production and make goods and services more expensive."

Anonymous said...

By rights oil prices should dip again. For some strange reason prices have jumped to 50 a barrel even though all I hear about is that the tanks are full in importing countries, that demand is still falling. Of course, never underestimate the foolishness of momentum traders.

Anonymous said...

from an old refco research guy:
"The capital flow into commodities is a risk to the global economic recovery. The world needs low commodity prices in line with weak demand, not an investment flow into commodities, which will raise the cost of production and make goods and services more expensive."

Strongly disagree. The 'recycling of money' is the problem right now. ie money velocity. The only way you turn on that hose is to buy stuff. Commodities is the sweet spot. Higher commodities, the faster the recovery. -mpm

Macro Man said...

SFOT, I have no real interest in front-end oil for the reasons you describe in your post. My earliest maturity point is Dec 9, and I have, in fairness, been nibbling very, very slowly. But to my mind, what the collapse in oil has done has been to halt the pace of exploration/investment in fresh supplies, which will mean when the next secular uptick in demand comes (and I am not clever enough to pinpoint it, other than to guess it will happen in the next year or two), there will be even less supply than there was last time. To me, that's bullish and always has been. The monetary phenomenon from QE is a different issue, but one that has kick-started me into taking the same position that i had intended to anyways.

RE, If you look closely at the world's largest c/a surplus countries, what do they have in common? Almost without exception, they intervene to artificially weaken their currency. Perhaps a US debasement is immoral/amoral, but I think you could credibly argue that one man's amorality is another man's realpolitik.

From the US/UK perspective, facing a banking system implosion and recession/quasi-depression, recent history offers two guideposts: Japan, which farted around on policy and sustained an exchange rate appreciation for five years after the bubble burst, or EM Asia, which endured shock therapy, vowed "never again", and has maintained a weak currency policy ever since?

The track record of the latter post-crisis is substantially superior to the former.

And so we are left with a situation that many of us have worried about for some time. Each country looks out for itself, enacting a set of policies that are individually rational but collectively irrational.

Anonymous said...


Macro Man said...

...says the erstwhile president of a country that had an average M2 growth of 43% during the first eight years of this decade!

Anonymous said...

I knew Putin' remarks would provoke a nasty comment

Macro Man said...

Hey, if anyone has a right to complain, it's the Canadians and the Europeans. The policies that China, Russia, et al seem worried about are the very policies that they themselves have pursued for most of this decade!

They thought that they were outsourcing monetary policy to the turns out, the Fed's now outsourced monetary policy to them.

Anonymous said...

90% tax on bonuses for employees of "TARP-ed" banks? That's going to be fun....

Shoeless said...


I, too, think that USD is going to be stronger (relatively) than people think. In terms of a "pain trade", what could be more painful than the world's largest hedge fund (the FED) seeing a rising dollar offsetting all the hard work they've done to reflate the economy. Poetic justice and a ball buster to boot!

SD said...

MM et al., do you guys see some value in the EURIBOR futures (esp. the reds)? Look somewhat cheap to me...

Anonymous said...

As I have said for the last couple of years, the U.S. dollar is toast - as soon as something else steps up to replace it. Absolutely no potential alternatives exist at the present time, and I can hardly imagine any scenario that produces a successor within the next decade. I do believe that the dollar will lose its status as the reserve currency - just nowhere near as quickly as many people think.

Anonymous said...

TALF fails?


gi said...

that why ben went nukular. and that why banks slumped. demand is deadly dead.

Gus said...

SD: methinks Euribor Reds have a decent the ECB will bring rates to near zero before starting any govies buying spree like BOE, BOJ or FED. It ain't going to be an easy task to decide and implement such a strategy. Look out for 50 bips at next ECB meeting and for low rates for longer than expected (as history suggests for past financial originated recessions).