Fairly Interesting

The next couple of days should be fairly interesting. The SPX did indeed close above its 200 day moving average, as did the Eurostoxx....but of course, this came after what's already been a super-strong rally. Immediate follow-through has been tepid, to say the least, for what it's worth (i.e., not much.)

Similarly, the dollar looked like it was really on the rack yesterday, only to catch a magical bid against the yen late in the London morning, which has since filtered through into other stuff today. It's no biggie if you've been along for the ride, of course, but if you're trying to re-immerse yourself like Macro Man is, it just makes things a bit trickier.

On the surface, the macro data out of the US yesterday had everything that a risk-asset bull could ask for. The ISM was strong, particularly in the details, with new orders breaching 50 for the first time since late 2006. Meanwhile, the personal income data seemed to be just perfect: stronger-than expected income and spending, and a tasty bump in the savings rate to a new fourteen-year high of 5.7%.

The details of the latter report were somewhat less serendipitous, however. A closer look at the source of income revealed that most of the surprising increase in income was actually government handouts, e.g. transfer payments. Although one data point is hardly sufficient to confirm a trend, the fact that Uncle Sam's largesse was largely tucked away rather than spent was a tick in favour of Macro Man's core view- e.g. that the "recovery" will disappoint as household savings are rebuilt. It's Ricardian equivalence before your very eyes!
Moreover, the recent rise in oil prices, if sustained and continued, will take a significant bite out of households' disposable income. If it also pressures nominal rates higher, as has seemed to be the case over the last month, that will at some point provide a headwind to further equity strength.

The recovery in US 10-year inflation breakevens this year has been nothing short of stunning, as they've retraced nearly 80% of their H2 2008 collapse. Much of this adjustment has come via higher nominal rates; TIPS yields haven't done a whole lot over the last couple of months.
While it's well-known that TIPS don't really represent any sort of market-implied inflation forecast, they do represent some sort of measure of market dysfunction; during times of stress, no hedge fund wants illiquid, capital-sapping stuff like TIPS on their books. That TIPS have held in there recently suggests that market liquidity is returning...just as you'd expect from the equity rally.

Hey, Macro Man even managed to trade an FX option yesterday without incurring the immediate mark-to-market hit that characterized all of his trades in Q1. While the directional timing is a bit tricky, that he can once again access the option market to take bigger bets makes it a good time to get stuck in once again.
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Anonymous
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June 2, 2009 at 10:40 AM ×

I can understand the source of income (tranfer payments) and the tucking away of it (increased savins) but they add stronger than expected spending.
I just cannot fit in the latter.
Geert

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Macro Man
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June 2, 2009 at 10:56 AM ×

Geert, it was stronger than expected (by 0.1% m/m), but still negative. That spending still fell in a month where aggregate incomes rose half a percent is, I think, the telling thing.

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But What do I Know?
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June 2, 2009 at 12:20 PM ×

"While it's well-known that TIPS don't really represent any sort of market-implied inflation forecast"

Thanks for that MM, but someone really ought to tell that to the PM's traipsing before the cameras on Bloomberg and CNBC. The inflation "predicting" calculations for TIPS always remind me of the gyrations involving the worth of a POS tech company that happened to own shares in a flavor-of-the-week darling--invariably with the conclusion the one could buy the favorite "at a discount." How'd that work out?

Anyway, I've been trying to think of a good way to say what you said about TIPS for some time. Thanks!

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Anonymous
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June 2, 2009 at 4:21 PM ×

Just wondering what makes fx options attractive right
now as there is currently sub par liquidity in terms of open interest? Yet people seem to bet more on the currency etfs such as FXA or FXC via the options market. Thoughts?

Regards,
Rick

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vlade
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June 2, 2009 at 4:54 PM ×

@rick,
I suspect MM is not buying ETOs, but an OTC one via his friendly broker...

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Professional Gringo
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June 2, 2009 at 5:32 PM ×

I caught that $/yen move yesterday. A reverse technical magical thing of beauty and then went to the beach.

Then screwed up my aud/usd long this morning and now feel like an idiot. You're only as good as what you did yesterday right?

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Professional Gringo
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June 2, 2009 at 7:04 PM ×

I almost forgot, if you guys haven't seen the video on the new 2012 Pelosi GTxi SS/RT Sport Edition from Congressional Motors do yourself a favor and have a look. Google:

http://www.youtube.com/watch?v=rAqPMJFaEdY&feature=player_embedded

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Anonymous
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June 2, 2009 at 11:05 PM ×

First, I doubt consumers are saving in anticipation of higher future taxes so I don't think we can call this Ricardian equivalence (if we ever can).
Second, and please pardon my ignorance, could you briefly explain why TIPS don't really represent a market inflation forecast? And also your sentence regarding the adjustment coming via higher nominal rates? Which nominal rates?

Love your blog, thanks.

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Anonymous
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June 3, 2009 at 1:17 AM ×

Anon @ 10:40,

My guess (and its ONLY a guess) might be that the spending increase reflected rising gas and food prices. I haven't really dug through any numbers...

old trader

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Mike
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June 3, 2009 at 4:27 PM ×

I just can't find my rhythm. Last year I was in the groove but all this year I feel clumsy.

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