Wednesday, September 23, 2009


Well, the big day is finally here, and it's not begun terribly auspiciously. Macro Man is desperately trying to fend off a headache, as the brackets supporting his six computer screens have completely packed in this morning. The rather cubist array of monitor angles is eerily reminiscent of a Picasso painting; while that's fine for the Museu Picasso, Prado, or some other repository of the artist's work, it's not really what you want when you're attempting to track the progress of hundreds of small, flashing numbers.

The larger question, of course, is whether this evening's Fed announcement will generate headaches of an altogether more substantive sort. For choice, Macro Man suspects not; while there is some talk of the Fed starting to look at using reverse repos to drain liquidity from the system, this appears to be laying the groundwork for such a development next year rather than a sign of imminent draining. After all, there'd be little point in draining the SFB roll-off in the next couple of months when the MBS purchase program will be simultaneously increasing bank reserves.

That having been said, the FOMC will be looking at a headache of its own before too long. The deflationary impact of commodity prices, particularly energy, is already waning; by the end of the year, unchanged oil prices will generate a similar magnitude of yearly gains that a) lured the ECB into its ill-fated July 2008 policy tightening, and b) immediately preceded last autumn's global meltdown.
While it's certainly not axiomatic that a similar outcome will ensue, particularly in the absence of further marginal oil price rises, the impact of base effects on reported CPI and PPI inflation should be fairly substantial. Those Fed voters who interact with actual businesses who pay actual energy bills may eventually prove to be a headache for the more academically-inclined Fed governors who tend to rely on output gap models and measures of "core" inflation.

And that could prove to be a headache for those managers reliant on short-vol or coupon-clipping strategies. To be fair, "risk on" and carry trades have been the nonpareil money-spinners of the past few months. Anecdotally, Macro Man's sense is that just about every macro manager out there has some of the latter, even if they have disbelieved or attempted to fade the former.

For what it's worth, however, the HFR macro index has registered a pretty poor performance thus far this month. While Macro Man has certainly scuffled, there's been enough juice in the carry trades, some of his long-risk equity trades, and the dollar to avoid a shocker. He'd have thought others were in a similar boat, but on the evidence of the chart below, perhaps not.

Macro Man has long thought that the last few months of the year would prove volatile and topsy-turvy as the risk rally comes under the threat of its own success (via the implied policy tightening that it would produce.) Thus far, it's been fairly plain sailing. And while Macro Man is still positioned for the good times to continue, he's started to rein in his horns a little so as to avoid the mother of all migraines if the Fed does change its tune.


Nemo Incognito said...

Other things to add to your base effects:

- metals
- Agriculture in 6-8 months once the flop in demand for potash filters through in the form of reduced crop yields.

dblwyo said...

A couple of others: reduced growth in China, reduce oil demand. "Last" time inflation was exogenous and driven by oil supply-demand imbalances.
Here's the two really fun parts. As savings worldwide re-balance (US/UK down, China up)trade re-balances and is likely to slow the rapidly developing economies. Less demand on oil.
Fun fact two - oil comes in two categories. Old and in front of political barrier fields running out and under-invested. New, under/un-developed behind political barriers and almost non-invested. Oil demand will grow more slowly but will S>D or still D>S next year? NB: non of the alternate energy options are breakeven much below $80. It's the '70s all over again.

Anonymous said...

Can someone please explain how a carry trade is helping US equities? And how sustainable is this? Thanks.

Steve said...

MM to what extent do you think (if at all) rising oil acts as a tax and slows the rise of other prices? It seems to me with the New Frugality that that effect could be more pronounced than it was just a couple of years ago.

I am focusing more on rent equivalents. By far the most active residential RE sector is the low end, units above $500k are barely moving. That means foreclosures and first time buyers. The specs are buying distressed stuff and renting it out; the first timers are moving out of their rentals. Huge pressure on rents, and I think the impact should be fairly rapid. Here in NYC I guesstimate that rents have come down about 10% so far this year, on the back of a healthy drop last year as well.

Steve said...

Anon the carry trade is just a way of saying low borrowing costs. Historically it goes back to the 90s when Japan had 0% interest rates while the rest of the world's were around 5%. So you could borrow (short) yen and pay 0% finance costs, and invest the non-yen proceeds at 5%--or in stocks.

Interest rates are pretty much zero across the board, so money is "finding its way" into stocks.

Macro Man said...

Steve, I think another $20 on oil would indeed act as a tax....the consumer feels the marginal changes, not the y/y changes as depicted on my chart.

As for rents, they may well be falling sharply across the land...but they only represent 6% of the CPI basket. OER is 24%, and while that may follow, I frankly have forgotten how to anticipate changes in that most execrable of inbdicators.

Shelter will certainly offset a goodly portion of energy priuce rise observed to date....but not enough, I think, to prevent a fairly sharp swing in yearly comps back to positive. And that, I suspect, will ultimately be fodder for the regional presidents...

Anonymous said...

GS wrote soemthing about OERtoday and the implication was that lower rents would drice core CPI to 0 next year.

Macro Man said...

Sure, but that excludes the price of everything that goes up....the issue for the regionals is, i think, that the true cost of lving/doing business isn't going down.

Anonymous said...

Steve - thank you for the excellent explanation.

Bob_in_MA said...

Calculated Risk had an excellent post on the relationship of OER, REIT rents, and some other indicators. The early warning indicators on the graph seem to indicate OER is headed down, probably sharply.

Some amazing percentage of recent home sales, 30+% I believe, are by cash-flow investors who will be looking to rent.

You make a good point about the YoY change in oil, but I'm not sure the Fed will be fooled into raising rates.

I'm betting firmly on deflation. Commodities are in a mini-bubble. Take a look at the 6-month price and inventory moves in Aluminum:'s absurd. LME inventories are 450% higher than a year ago, and any time in the last five years, and the price has been rising for six months.

Bob_in_MA said...

Sorry, here's the Calculated Risk link: OER and rents...

and Aluminum stats

leftback said...

Anon @ 2.13: Further to Steve's excellent précis, the major funding currency for the carry trade is now the dollar, which has contributed to the dollar's weakness. Now consider the leverage that is employed, and you will see the vulnerability of the equity markets worldwide if (and when) this carry trade unwinds.

Anonymous said...


Is HFRXM an accurate reflection of how discretionary macro does? Think there are a lot of systematic funds / pure commodity discretionary also included which muddies the water.

Also is it that relevant when the vast majority of assets are managed by 5-10 funds.

Everyone I know is long Dec & Mar in size and adding in June a la the euro$ 96/7/8 fly printing today.

Does seem very consensus now that risk assets go higher on the tide of liquidity because the only thing that people think could ruin the party is tightening which seems far from the minds of those who control the levers of monetary and fiscal policy.

What could derail this apart from a change in tone from above?

Swine flu - unlikely unless more virulent mutation
Iran - the assumption is that America will restrain Israel if Iran continues to play games, is this correct? Interesting Stratfor piece this week.
Protectionism - bubbling away

Anyone else care to throw a white swan into the mixer?

Macro Monkey said...

Great chart on oil. It has been in the back of my monkey mind for a while.

One cautionary note: last time headline inflation spiked (summer of 2008) and everyone thought it was a monetary phenomenon--despite declining core inflation--it was the Fed that was right and the market that was wrong. In the event we found out that it was much more about a speculative ramp in commodities than it was any pernicious inflationary process.

I am mindful that the underlying dynamic is a little different this time in that the output gap is probably wide and narrowing, whereas then it was starting to widen, but the broader point is that however tempting it is to dismiss officialdom and say things like "But I don't eat core inflation", core matters. It is not the only thing we should look at, but it is a key diagnostic tool.

This does not mean that monkeys won't react to superficial headlines. Of course we will. It is what we do. But it does mean we shouldn't necessary take headline inflation at full face value.

Steve said...

MMonkey that's why I am focusing on rents and equivalent, it is core and it is big.

Bob thanks for the link, I was about to dig for something like that.

Anon my pleasure. The issue is, it's like money supply, great concept, hard to measure. I consider myself to be a monetarist in the Friedman sense but who the hell can measure it.

leftback said...

Thought experiment: If FOMC announces extension of QE programs and MBS purchases, the dollar caves in, Euro flies into empty space between 1.48 and heads for 1.60. Equities and commodities soar. What does that do to oil ($100? Higher?) and is $gaso then a de facto tax on consumption that begins a double-dip recession?

This is why LB thinks that there will be a slight tap on the brakes here before the reflation train really leaves the station.

Anonymous said...

re: oil demand


US has similar statistics for vehicle miles.

spagetti said...

agree with the necessity for the tap on the brakes. the fed probably knows that their aactions have helped restore confidence somewhat, but the picture is very lopsided. the marginal improvement they can achieve at this stage will not be worth the cost ($ collapse, yields higher..etc)

Anonymous said...

LB + Spaghetti: Echo your sentiments, but feel it might be too early to start pressing on the pedal; safest thing for FOMC to do is nothing - yet. opinion seems to be skewed on the tightening side with talk of reverse repos; if the incoming data continues to come in positive, repos etc will be anticipated and the market will make the first move; USD carry starts to slow up, and greater demand for commods into 09-10 from OECD might just play off against one another.

spagetti said...

tap on the breaks should be verbal only at this stage in my opinion

i think they should do nothing, and talk slightly hawkish.

Macro Man said...

ANon@ 3.41: agreed re: HFR clearly seems to capture a small and, judging by its trajectory, not particularly talented, subset of the AUM out there.

Re: always, they're hard to predict. What I will say, though, is that macro guys have listed "Iran" in the top 2 or 3 biggest risks in just about every roundtable I have been to over the last 6-7 years.

Bob_in_MA...agreed re LME inventories, but as we know the hegemonic buyer in this crap doesn;t trade predominantly in London. Ally is the poster child for this seeming irrationality.

Anon @ 5.26, the pushback from energy bulls would obviously be, how do those stats look in China, where there are only 3 cars per 100 people (opposed to something like 85 in the US) and sales are, to my chagrin, growing strongly?

Macro Man said...

Well, that was as dovish as it feasibly could have been....and the whites make a new high. The boy who cried wolf, indeed.....

Crisis Management said...

Something for almost everybody in this one, stocks, bonds, gold, euro, yen are all reacting up 15 minutes after the statement.

The oil bulls must be scratching their heads, weak dollar was supposed to be moving oil tick for tick. I for one enjoy seeing oil get put on time out, if only for the day.

barbadkatte said...

The problem with the hawkish tone is how stock markets might react. Quite a bit of the restoration of the confidence traces directly or indirectly to the stock markets. If the hawkish tone spooks the market, all the confidence gained may be lost, and we are back in the deflationary spiral. So it is likely that the Fed will give enough fodder to both the hawks & the doves to score points without reaching any consensus

Skippy said...

Great Blog as always MM. On commodities, growth always wins in the end (assuming that supply is not at the pinch point). The lesson from oil in mid 2008 was that underlying demand was not that inelastic afterall and falling demand eventually caused the oil price to fall. Commodity prices can only suspend disbelief for so long - if underlying demand does not recover sufficiently oil and other commodity prices will probably fall again. In my view, end demand is still not sufficiently strong enough to sustain the rebound in growth beyond the inventory cycle. But the base effects from the falls last year may well be a problem for the headline CPI.

Skippy (from London)

Crisis Management said...

Wow euro has certainly come off after that "Asian sovereign" appeared around 1.4830. Voldemort, was that you?

Anonymous said...

Hi MM,
Can you explain what long risk trades you have kept on in terms of earning carry pls?