Re-Engaging

It's hard to believe that it's June already. Perhaps it's because he's had the whole knee saga to distract him, perhaps it's because he's another year closer to the dreaded "four-oh", but man, Macro Man has found that time has really flown this year.

The good news, from Macro Man's perspective, is that he feels like he's finally starting to make some progress on rehabbing the knee. This, in turn, will hopefully make it easier mentally to become fully re-engaged with the market. Taking a look back at the last couple of months, Macro Man feels as if he's spent much of that time trading defensively. While it may have seemed like a good idea at the time (given that Macro Man's preferred themes were not in play), much like the "prevent defense" in the NFL, defensive trading rarely if ever works.

In any event, having the intent to trade off the front foot is one thing.....having the ability to construct attractive trades at current levels is something else. Despite the orgy of positive vibes from asset markets, there is still something a bit broken with markets. Simply put, there remain significant liquidity vacuums in which prices gap on next to no volume. Take Spoos on Friday for example, which were meandering slowly into the close before they were ramped 15 points in the last half an hour. As the e-mini VWAP chart below suggests, it didn't take make capital to push stocks a lot higher.
And if it doesn't take much to gap it higher, presumably it wouldn't take much to gap it lower, either. Still, it's hard to ignore the fact the the SPX is knockin' on heaven's door...the 200 day moving average. The index hasn't closed above that level since December 2007; while it traded above it almost exactly a year ago, the failure to close above was a great sell signal. Given that most other assets have roared after breaking the 200d MA, it wouldn't be a complete to see the risk-asset love-in soar to new heights should the SPX close above 929 today.
Elsewhere.....they're baaaaccckkkkk. One of the most pleasant aspects of the whole "global financial crisis/economy going back to the stone age" thing was that emerging market central banks and SWFs pissed off for a couple of quarters and by and large allowed the exchange rates of other countries to be set by private sector supply and demand.

But the poltergeist of Voldemort and chums has returned with a vengeance, drilling the USD against the euro, sterling, Aussie, et al. Part of this is down to a recent increase in FX reserves as these countries slow the pace of hot money inflows (CBC, Bacen), enjoy the bounty of higher petro-revenues (Middle East and, to a degree, CBR), or try to maintain a static currency peg despite large trade surpluses and a much-ballyhooed economic recovery (China.)
That said, the recent noise surrounding these guys would appear to be somewhat louder than recent reserve accumulation would appear to suggest. So Macro Man wonders if these guys haven't actually decided to legitimately diversify a bit more away from the USD....certainly there have been suggestions of such a decision in, for example, Russia.

And like equities, to a degree it doesn't matter what the fundamentals really are. If these guys all think the others are diversifying away from the buck, then they will step up and start doing it themselves. And in a market where liquidity has still not returned to normal, that can have a disproportionate impact upon price.

So the question is....does one tag along and hope that he can buy back a short $ position when the music stops? Stay out until the situation becomes a bit clearer? Or start buying $ upside because the private sector market is now getting short dollars, whichy usually means a reversal is aroudn the corner? That's among the many questions that Macro Man needs to answer over the coming days.
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June 1, 2009 at 10:27 AM ×

You mention central bank reserves activity Macro Man. Given that the UK seems to be in a similar economic situation to, if not worse than, the US, with greater political uncertainty, I have been mystified by the recent rally in sterling. I wonder whether it is being driven by Chinese diversification away from the dollar. After all, I dare say that sterling is one of the few reserve currencies that the Chinese could buy at the moment without bothering the issuing authorities.

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Macro Man
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June 1, 2009 at 10:30 AM ×

RE, sterling is typically most beloved of the oil producers.....Russia to an extent, but most notably the Middle East. So I don't think it's a coincidence that sterling's renaissance has coincided with that of crude.

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Anonymous
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June 1, 2009 at 10:35 AM ×

MM - how do you get a sense of the "private sector market" getting short $$? Rudimentary question, but i'll connect the dots if you can provide a few...

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Macro Man
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June 1, 2009 at 10:38 AM ×

It's pretty purely a function of anecdotal evidence from the banks that see the flow.

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DWL
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June 1, 2009 at 10:47 AM ×

MM, What are the data sources for your "required purchases" chart, i.e. how do you construct those estimates? (Many thanks if you'd care to discuss it.)

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Anonymous
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June 1, 2009 at 11:04 AM ×

GBP is rallying given the levels it was trading at......UK ALREADY saw ccy devaluation......is the American's turn to devalue their ccy

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June 1, 2009 at 11:05 AM ×

Interesting, MM. I knew about Russia's penchant for sterling, but not the Arabs'. One would have thought that it would make more sense for them to invest in the currency of a resource-user like the yen, but then I suppose that if sterling depreciates, there are always London houses and football teams here to spend your pounds on.

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June 1, 2009 at 11:23 AM ×

Anon at 11.04,

True, but sterling has rallied against the euro and yen, not just the depreciating dollar.

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Minty
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June 1, 2009 at 2:12 PM ×

Hi macro thanks for your post again, would you mind sharing your thoughts on Ichimoku clouds from a technical perspective please? They seem rather handy to me.

Thanks!

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Anonymous
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June 1, 2009 at 3:42 PM ×

large component of FTSE is resources and oil ... UK still produces a tiny ... and yes middle east petro-dollars get re-circulated through teh City.

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Macro Man
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June 1, 2009 at 3:49 PM ×

DWL, I basically aggregate the total reserves, assume a given portfolio benchmark, and adjust each month for the interest income and exchange rate effects. This leaves two numbers....the desired amount of euros and the 'actual amount'. the difference is the required trade. It's not exact, but I have found it to be pretty useful over the past few years.


Minty, ichimoku charts are moderately useful for anything the Japanese trade in size, since they use them. I don't really look at them for anything else.

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Anonymous
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June 1, 2009 at 6:00 PM ×

I find it a bit interesting that you have a bias to buy USD based primarily on positioning/sentiment rather than on a macro view.

The short USD view lines up the 2 key policy/macro themes currently in play 1) the Fed is determined to prevent deflation, the easiest way to do this in the context of a rising US savings rate is via a lower dollar/higher commodities and 2) Fed actions in the money and credit markets are bringing the internal plumbing of the financial markets back to a semblance of normal (e.g. libor/ois narrowing, back-end swap spreads less negative, etc...), if Q4 USD appreciation was a function of deleveraging as markets broke down, shouldn't the USD then depreciate as markets put themselves back together?

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Mike
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June 2, 2009 at 1:54 AM ×

But why should a cup of coffee cost twice as much in London as it does in New York?

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June 2, 2009 at 6:57 AM ×

Macroman, I wonder if China might dump their currency regime soon. Would have a couple of interesting effects:

1) Improve purchasing power, especially in rural areas that are the center of dissent now vs the cities in the late 80s.
2) Make it easier to buy offshore assets like, say, mining companies.
3) Would wack exporters but they're already down and developed world demand isn't coming back.
4) Could spend their money on domestic stimulus some more - which appears to be the only thing that is plausibly working policy wise right now aside from Bernanke putting on the worlds greatest convergence trade between crossover and treasuries.


Thoughts?


Nemo

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Anonymous
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June 2, 2009 at 9:04 AM ×

It doesn't make much sense for Russia, the Mid-East or China to hold dollars when the biggest trading partner for their imports is Europe.

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Macro Man
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June 2, 2009 at 9:12 AM ×

Nemo, I think all of those are valid points. Of course, they've all been valid points for some time, and yet the Chinese have decided to pursue a different, suboptimal strategy....so I think it's safe to say that the carrots/sticks are not strong enough to budge them.

Anon, two points. One, for better or for worse, the dollar is the currency against which their respective currencies are traded, so in the name of finanical stability they need to have a disproportionate amount of dollars in their reserve holdings should they need to intervene. Second, a disproportionate amount of those countries' exports to Europe are invoiced in dollars, eg oil. Whether that will will continue, or for how long, is of course open to debate...but for now that's the way it is.

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Anonymous
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June 2, 2009 at 9:16 AM ×

Nemo - currency appreciation and stoking Chinese domestic is not necessarily the same thing. The Chinese govt is interested in stoking domestic demand to take up domestically produced goods. Chinese are much more interested in spending for investment and reducing rural / urban gap than for money to flow back to buying Western products (especially consumer products).

My bet is that China will maintain it's "peg", stimulate spending on necessities and coordinate spending in Western countries through purchasing missions.

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June 2, 2009 at 9:22 AM ×

Macro Man, I guess the reason why things should change now is that China has been through an interesting experiment - can it keep the economy humming with cash splashes if the world burns and they now know they can. They were probably terrified of doing anything adverse to exports but now that has already happened they may be looking at things differently.

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Macro Man
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June 2, 2009 at 9:34 AM ×

Nemo, I think the fundamental problem/challenge with China is its sheer size. If we take it as read that the paramount goal of the CCP is to stay in power, we have to consider the various constituencies that they must satisfy:

* Middle Class. China has what I assume is the largest middle class in the world. They are skilled workers who are internationally competitive, and would surely benefit from the appreciation of the RMB.

* The poor. China's poor comfortably exceed by a multiple of two the population of any other country in the world except India. A stronger currency brings no tangible benefits to this cohort, while a weak currency allows China to remain in low value added, labour-intensive industries that keeps the urban poor in jobs.

* The rich. They can already buy whatever they want, and those that own low-end exporters would probably be hurt by a stronger currency.

While this is simplistic, I do think it is the case that the CCP is pandering to the demographic that would be most likely to rebel...namely the poor if they could not find work in low-end industries.

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Anonymous
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June 2, 2009 at 9:34 AM ×

Forgive my ignorance but isn't the sterling starting to become less relevant to crude,
So why the rally?

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Macro Man
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June 2, 2009 at 9:49 AM ×

Well, for one thing because the oil exporters love to own it. Also, some of the private sector has been buying either to close out stale shorts or to go long on a valuation bet.

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June 2, 2009 at 9:51 AM ×

Macro Man, I think you're missing an additional "class": farmers. China is still heavily rural and these guys would benefit from having cheaper inputs (Fertilizer, consumer goods, etc). They are also way, way more numerous than their urban cousins. Assuming exports have taken their lumps already and that the low margin / downmarket exports have taken their lumps that wager to back farmers may be appealing.

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Macro Man
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June 2, 2009 at 9:57 AM ×

Nemo, I think you are underestimating what would happen to oil if the Chinese decided to "let the dollar go." As we observed last year, and indeed are observing today, when the market gets a sniff that the $ might be going down, there is a disproportionate impact on commodity prices. Indeed, China might well have learned the lesson that allowing the RMB to strengthen too much is associated with higher oil prices (and thus higher prices for fertilizer, etc.). I am not saying that this would necessarily happen again....but it might. And from the CCp's perseptive, a stable status quo is preferable to the sorts of riots we had early last year when inflation was zooming.

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Anonymous
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June 2, 2009 at 9:59 AM ×

Perhaps, but I wonder how the sterling dynamics will change once
The North sea oil is almost gone.

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June 2, 2009 at 11:39 AM ×

I agree inflation would be a huge issue but not in CNY terms which is all that matters. I think it would actually be GOOD for social stability in China (would be a total circus everywhere else though).

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