Friday, January 30, 2009

Micro vs Macro

It's been a bit of a weird month, hasn't it?

For Macro Man, the last couple of weeks have really dragged by (including the always-crushing error of mistaking Wednesday for Thursday)....and yet he is shocked that we're at the end of January already. Talk of loving risk and a the five-day rule seem like a long, long time ago.

Such is the difference between micro and macro....quite often, when focusing on the one, it's easy to lose sight of the other. Macro Man, as the name implies, typically focuses more on the macro side of the equation; as the saying goes, the name does exactly what it says on the tin.

But if it seems as if his macro musings are less interesting than usual- and judging from the relatively low number of comments this month, you have- he is not surprised to hear it. While Macro Man has focused a bit on macro issues this month- the collapse in global trade and the potential onset of protectionism (a long-held theme for him), in his real world book he has become much more of a micro man this month.

To be sure, he has allocated capital to his favourite thematic trades and done OK by them. But there has been quite a bit of noise in these trades, relative to the net directional signal. And there have been good, fairly directional macro trades that he either missed (long the front end of Europe early in the month) or got wrong (the equity dump into the inauguration.) So Macro Man has found imself doing an unusually large amount of shorter-term trading to pay the bills, so to speak, while his longer-term macro bets percolate on the stove. It's not his core methodology, but if markets are going to be noisy than it behooves him to try and trade the noise.

One of the other reasons for his stronger emphasis on micro, rather than macro, is the relatively unattractive pricing of options. Macro Man typically likes to articulate his views via options becasue a) they offer significant leverage, b) the strategies that he employs allow him to articulate a defined loss parameter, and c) they allow him to play for the signal rather than getting shaken out by the noise.

So in the current environment, they should be ideal, given how noisy things are; in the past week, for example, AUD/USD has traded from 0.6425 to 0.6725 and then back again. And on the face of it, options on "risky assets" might look cheap. A simple overlay of the SPX and VIX, for example, would suggest that implied index vol should be closer to 70 than 40.

However, this ignores the fact that options decay, and the longer you remain in the same range, the more unprofitable owning options ata given volatility will become. Given that the SPX first traded at yesterday's closing level on the 10th of October, it's not surprising that implied vols have come lower.

Digging deeper confirms Macro Man's suspicions that options have been expensive, not cheap. Plotting the VIX against realized 20-day annualized vol in the SPX yields some pretty interesting results. If we look at the gap between realized vol and VIX, we can see that implied vols were actually lower than historical vol throughout the teeth of the crisis in September-November. This year, despite the lower level of VIX, implieds have still traded at a premium to the actual volatility in the market. So Macro Man's intuitive sense that optins have seemed expensive looks to have been correct; small wonder he's found difficulty in structuring attractive looking trades, in contrast to Q3 and Q4.
A similar development is evident in the currency space, where AUD/USD vols, for example, now trade above the level of historical vol after trading at a substantial discount late last year. While it is of course future, rather than historical, vol that is the real basis of comparison to implieds, it's difficult to extrapolate an uptick in realized vol while so many asset prices remain within the ranges established over the past few months.
An obvious alternative strategy is to sell vol. However, Macro Man has found that bid/ask spreads on bounded-risk short vol strategies (butterflies, barrrier ptions) have rendered those unattractive as well. There's no point buying a barrier option if you are effectively selling vol at 19% rather than the 24% mid-market vanilla implied.

Given his gloomy worldview, Macro Man has little interest in unbounded-risk strategies like selling straddles and strangles. So he's left keeping some risk in his favourite macro trades (while remaining poised and ready to add aggressively when they come into play)....but for the most part, spending his time on the micro, trying to use the noise to his advantage.

Thursday, January 29, 2009

The Alternative Universe Newswire

There is a theory in particle physics, known as the many-worlds hypothesis, which posits that there are an inifinite number of universes, with a new one created whenever a particle's qunatum wave function "collapses." Readers of Philip Pullman's His Dark Materials trilogy will be familiar with one "practical" interpretation of the hypothesis, wherein similar but slightly different universes overlap each other.

Macro Man can confirm that this is in fact the case, as he possesses a rather unique newswire that feeds in from one of the alternative universes. He usually keeps it under wraps in the bottom of a drawer, but sometimes feels compelled to have a look at it when real-world news headlines leave him scratching his head. He finds that the alternative universe newswire sometimes offers a fresh, more truthful perspective on events than his everyday sources of news.

Recently, he's taken to looking at the alternative newswire with depressing frequency. Consider the following real-world headlines that have crossed his screen recently, and compare them with the alternative-universe newsfeed:

Our world newsfeed(OWN): Russia, China blame woes on capitalism

Alternative world newswire (AWN): Wen, Putin admit Martingale forex strategies "misguided".

In gambling, a Martingale strategy is one in which one's stake is doubled after every losing bet until he finally wins (or loses all his money.) If one possesses infinite wealth, this strategy will deliver a profit of the original stake when one finally wins; in the real world, however, its practitioners usually bust before finally winning.

In markets, the term refers to adding to a losing trade to "improve your average". Unsurprisingly, market punters usually achieve similar results to roulette players in using the strategy.

And in macroeconomics, it has come to mean an endless cycle of buying foreign exchange reserves to maintain an artificially weak exchange rate, regardless of the negative externalities of such a policy. To be sure, the US is culpable for a great deal of the current global economic stress, but this does not absolve either China or Russia for pursuing their own misguided policies which have generated a collosal misallocation of resources.

That the ongoing travails of the rouble has impaired the kleptocrats' financial standing in some small degree provides at least one small rainbow in an otherwise never-ending torrent of doom and gloom.

OWN: Brown says UK was right to sell gold in 1999, says UK bought euros by selling gold

AWN: Brown admits selling XAU/EUR below 300 was "collossally stupid"

The high print in XAU/EUR in 1999 was 270. It is now 632. Macro Man isn't sure what is worse: that Gordon Brown is too stupid to understand that that is a bad trade, or that he thinks that YOU are too stupid to understand that that is a bad trade.
OWN: "We foresaw economic downturn," Trichet says.

AWN: Trichet reveals ECB forecast model (pictured, below.)
OWN: Brown defends economic record, blames global crisis for downturn

AWN: Brown admits that UK is buggered

OK, maybe it's not fair to pick on Gordon twice. But the gold headline above was literally unbelievable, and the graphic below (which amde the rounds yesterday) is too good not to share.

Wednesday, January 28, 2009

Will They or Won't They?

Will they or won't they? That's the question du jour, at least with respect to today's FOMC announcement. There's obviously nothing they can do on rates, so the big issue is whether the Fed takes the leap and announces a program to buy longer-dated Treasuries.

Such an outcome would hardly be unprecedented; the BOJ, for example, has purchased JGBs in the secondary market for more than a decade via its rinban program. For the Fed, it would seem to be more a matter of "when", rather than "if", they pursue such a policy; after all, buying government duration is part of the "Bernanke QE playbook" that he's been following to a tee so far.

Regardless, the Fed will probably not be best pleased to see 30 year Treasury yields some 50 bps higher than at the time of their last meeting. More to the point, the uptick in 30 year mortgage rates is an unwelcome development for BB and co., given the perceived target of 4.5% and the recent signs that refinancing demand was responding to lower rates.Regardless, equities are once again threatening a more interesting bounce, helped on by the mooted meeting between Obama and the bank CEOs. Good bank/bad bank is swiftly materializing as the preferred next attempt at a solution, thus validating Macro Man's long-held view that a "turd-buying repository" would be created before all is said and done.

Of course, an exact replica of RTC is not on the cards; that agency took assets off of bankrupt institutions, whereas today the object is to stop everyone from going bankrupt. How the bad bank would work is currently uncertain; what price would they pay, what incentive would banks have to offload their turds, etc. Simply having the FDIC standing on a street corner, Salvation Army-style, with a big bucket marked "turds" wouldn't appear to be an ideal solution.

Whatever the solution, it seems likely to originate from someone with connections to Goldman Sachs. Yesterday's scuttlebutt was that yet another GS alum, Bill Dudley, is the front-runner to replace Geithner at the New York Fed. This provides further fodder for the chattering classes to mutter about GS in the same terms as the Rosicrucians et, al.

It would be refreshing if the Adminsitration appointed someone to a position of economic responsibility who has demonstrated an ability to anticipate economic developments and to accurately forecast the market impact. Someone like Mr. Paulson. (That's John, not Hank.)

Somehow, however, Macro Man thinks this one probably won't happen.

Tuesday, January 27, 2009


For some reason, the world seems to be a somewhat less awful place today. Sure, there's plenty of violence all over the globe, the airwaves are still polluted by the brain-suck that is reality TV, and today's front page trumpeted that 70,000 people around the world lost their jobs yesterday (while Gordon Brown still has his.)

Nevertheless, markets are percolating as a faint whiff of recovery drifts through the air. Stocks are well off their lows and global fixed income markets suddenly look vulnerable. The newsflow would appear to encourage the view that the worst has been priced and that, on the margin, things will start to get better. Take Europe, for example, where Macro Man has offered the occasional gentle criticism of the ECB's reading of the economy.

This morning's ifo exceeded the consensus forecast, led by an uptick in the expectations component. Jean-Claude Trichet 1, Macro Man 0?

Markets seem to be pricing something like that. After rallying for four straight months in virtually a straight line, the front end of Europe has sold off sharply over the last couple of days, tacking 27bp onto 2 year German yields sicne Friday's close.
There are reasons for scepticism, however. While the io exeeeded expectations, this doesn't obscure the fact the current conditions component fell to a fresh all-time low, nor that the headline index barely moved. Moreover, the very people who compile the survey suggested that there remains no change in the economic downtrend and that the ECB has room to cut rates quite a bit more. Finally, it is worth noting that a well-known fund preumed to operate with non-public information was rumoured to be taking profits and/or hedging its European front end longs over the past few days.

Is it true? Who knows. But if you get into a trade because someone else is doing it, and then you think they might be cashing out, what would you do?

In the US, meanwhile, we can all rejoice that the financial crisis is over. After all, what other conclusion are we to take from the fact that Pfizer has been able to secure $22.5 bio in bank loans to finance its acquisition of Wyeth? If the M&A pipeline is open, baby, then let the good times roll!

As always, the small print matters. The rate at which they are borrowing (7% or so over one-year swaps) wouldn't look out of place in Vinny the Loan Shark's book of business. For the time being, PFE is a AAA-rated company; what does this borrowing rate suggest about the availability of credit for large universe of firms with less shiny ratings?

Meanwhile, the conference board's leading indicator unexpectedly rose 0.3% yesterday, offering further hope that the worst is past- at least according to the anecdotes provided by macro Man's counterparty banks. Again, colour Macro Man sceptical. Money growth added a full percent to the monthly change; given the collapse in monetary velocity, money growth will have a much lower-than-usual impact on actual growth. Moreover, the 3m/3m rate of change is still sharply negative (5.5% annualized.)

Macro Man likes to track the level of the ECRI weekly leading indicator; as the chart below illustrates, while it has quit collapsing, there is no real observable bounce.
To be clear, Macro Man isn't suggesting that the data isn't going to improve; given the mooted size of the Obama stimulus package, the real surprise would be if it didn't at some point in Q2. But as Macro Man has said on a number of occasions, the most important component of any enduring recovery is time. So you'll have to pardon him if he doesn't run after the light at the end of the tunnel; he has a funny feeling that it might be an oncoming train.

Monday, January 26, 2009

What's Worth Buying?

Another weekend, another attention-grabbing headline in the UK Sunday press. Outgoing BOE Cassandra David Blanchflower observed that unemployment in Britain is likely to reach 3 million (from the current 1.92 million) and that rates are "obviously" going to zero. This is the same chap that forecast UK unemployment of 2 million by year-end 2008 months before Merv the Swerve claimed that the severity of the economic and financial downdraft was unforeseeable. Cassandra, indeed.

In any event, running the latest UK labour figures through Macro Man's single-factor BOE model does indeed generate a forecast of sub-zero base rates. This is obviosuly an overly simplistic methodology for dealing with a lognormally-distributed (i.e., cannot go below zero) macro-economic variable, but it nevertheless suggests that further rate cuts wouldbe consistent with the MPC's historical reaction function. So sterling predictably got splattered in Asian trading, though as last week demonstrated, early gaps are not always reliable. In any event, welcome all and sundry to the year of the Ox- a castrated bull. Is the Chinese zodiac offering a glimpse into what to expect for 2009 (i.e., more fo the same as 2008)?

While there are no shortage of talking heads willing to appear on CNBC pimping the view that stocks are "cheap" and "a screaming buy", Macro Man is reminded of the old market aphorism that "those who say don't know, and those who know don't say." (Quite where this leaves him, an anonymous purveyor of general investment thoughts and the occasional dodgy poem, is a consideration for another day!)

In any event, those who have been forced to mark-to-market have learned that holding most non-government bond or short-end instruments has been a decidedly losing proposition. Macro Man has updated his simple pension fund performance model for the end of 2008, and unsurprisingly the three-year return has turned negative in each of the G3 markets. Those confidently predicting a nearby bottom for financial markets might wish to consider that despite much worse global macroeconomic fundamentals, rolling risk-adjusted returns of pension portfolios remain well above the early-Noughties nadir. From Macro Man's perch, more downside lurks.
While Macro Man traditionally been sceptical of the gold bug argument, he has to concede that it is more attractive now than at any other point in his career. If one takes the not-outlandish view that global short rates will converge at zero, give or take, then the opportunity cost of holding gold becomes very low indeed- particularly in the absence of any other higher-return asset that does not run a susbtantial risk of default.

While Macro Man does not necesssarily subscribe to the view that hyper-inflation is an axiomatic outcome of global QE, he does concede that inflation is an eventual risk should global monetary velocity stage a quicker-than-expected recovery. At the same time, he is amply aware of a small but highly-convicted cadre of punters that believe that global fiat currencies will ultimately be discredited by the time the current financial and economic crisis is resolved.

Just as the Bretton Woods system of fixed exchange rates was the outcome of the Depresssion/WWII, what odds that the outcome of a global effort to beggar-thy-neighbour is a return to the gold standard for major currencies (including the RMB)? Pretty small, in Macro Man's view, but not zero.

More prosaically, if this is a view that is being articulated in the market, then there may be a profitable trading opportunity. It is quite remarkable that gold has completely divorced itself from EUR/USD; after exhibiting an r-squared of 0.32 in 2007 and 2008, gold and the euro have exhibited zero correlation so far this year.

Indeed, the chart of EUR/Gold looks pretty bullish, as it last week closed above the prebious all-time high. While Macro Man has yet to be convinced that gold is a buy and hold from current levels for the long term, he will readily concede that it looks worth buying for at least a tactical punt.

Friday, January 23, 2009

The Golden Bog Award

Britain has gone Oscar-crazy. Macro Man is utterly oblivious to "celebrity culture", and while he once memorized every winner of the Heisman Trophy whilst in high school, he couldn't tell you a single Oscar winner last year other than that for Best Song. Regardless, the papers are full of pictures of Kate Winslet, trumpeting a forthcoming "Brit cleanup" at the Academy Awards, whenever they may be.

In any event, Macro Man is proud to unveil the finalists for the first annual Golden Bog awards, honouring the assets and people that have exhibited the most turd-like behaviour. As you can probably imagine, the list of semi-finalists was exhaustive, and the gnomes at Macro Man Industries have been working overtime to winnow it down to three finalists.

And now welcome to the stage a member of the Golden Bog Awards official auditors, Friehling and Horowitz, with the three nominees:

1) The Financials! (cue a rousing cheer....) Eighteen months into to the market and economic crisis, we are still seeing writedowns, the emergence of hidden losses, and accelerating government bailouts. Single digit stock prices (or sub £1 in the UK) are now virtually de rigeur, and finding credit at a reasonable price is only slightly easier than finding Eldorado.

2) The Russian Rouble! (a smattering of applause....) After preventing currency strength for years, accruing massive reserves, and telling foreigners that you intend to screw invade another country for no obvious reason, sustain a massive negative terms of trade shock, and spend a load of your reserves in a futile attempt to defend your currency from achieving uber-turd status. (Yesterday's announcement of a regime change has not noticably slowed the pressure on the RUB.)
3) John Thain! (cue a round of catcalls and hissing....) Mr. Thain took over at Merrill Lynch in late 2007 armed with a golden reputation and a promise to "kitchen sink" the bad assets on the ML balance sheet. The ensuing fourteen months saw aggregate losses of $34.58 per share, a shotgun wedding to Bank of America, and, yesterday, an ignominious departure.

Putting aside his failure to staunch the losses at Mother Merrill, the suspicious decision to expedite the payment of bonuses just before year end carries with it more than a faint whiff of sulphur- not least because the troops on the ground got stiffed pretty badly, by all accounts. From the outside, the decision to pay himself and his cronies just before the BOA merger looks to be bordering on criminal.
But what really cements Thain as the winner of the first annual Golden Bog Award was his decision to spend $1.2 million doing up his office last year, including spending $35k on what Macro Man can only posit was literally a golden bog.

So congratulations to John Thain, winner of the Golden Bog Award! Mr. Thain is pictured below accepting his award.

Thursday, January 22, 2009

The First Shots

For some time, Macro Man has held the view that one of the primary second-order risks of the current financial crisis and the concomitant recession would be a broad-based rise in protectionism and beggar-thy-neighbour policies.

To be sure, for the likes of China and other Asian mercantilist nations, such activities are meat and drink for economic policymakers. But yesterday saw the first shots fired in the West, whre there were not one, not two, but three separate currency comments from policymakers. It reminded Macro Man of nothing so much as a fight scene from the old Adam West Batman series:

WHAM! Phiipp Hildebrand of the SNB said that with the zero-interest bound rapidly approaching, the bank would consider "unlimited" currency intervenion to weaken the CHF. Cue a predictable rally in EUR/CHF:

POW! It seems as if France has moaned about currencies every year since the late 1960's Bretton Woods balance of payments crisis. They continued the streak in style yesterday, as FinMin Christine Lagarde rapped the BOE on the knuckles for doing nothing to defend sterling. (The UK Treasury issued a swift two-word rejoinder, the second word being "off".)

"Separately", a G7 source (codename: Fer a Cheval Bleu), mentioned that G7 would dicsuss sterling weakness at next month's meeting.

BAM! Yesterday was quite an interesting exercise in game theory, as there was an enormous ($6 billion) option expiry in USD/JPY at 10 am New York time. The strike price was 90.00, and and expiry USD/JPY was trading at.....90.05. The thinking in the market was that the option short would need to buy $6 billion after expiry, and were leaning long as a result. When the institution in question pulled the bid at 10.01, a 3% plunge down the elevator shaft swiftly ensued, taking USD/JPY down to its previous low of 87.10.

Intervention rumours swiftly ensued, though USD/JPY subsequently squeezed higher along with US equities. But still, it would be quite a statement for Japan to intervene in currency markets in week one of the Obama administration. Such a statement, in fact, that the presumptive Treasury Secretary Geithener made a comment yesterday (admittedly not targeted at Japan specifically) reiterating the US preference (or demand, depending on your perspective) for flexible, market-determined exchange rate regimes for major trading economies.
The list of countries that prefer a "competititve" (economist-speak for weak) exchange rate is a long and growing one, while the list of those wishing for a stronger local currency is rather short indeed. Something tells Macro Man that we haven't seen the last of this issue....

Elsewhere, bond bears now have their chance to shine. Equities have quite going down in a straight line (the SPX has rallied on 75% of the last 4 trading days!!!), and long bonds have broken a fairly key support line. If the bond bubble is gonna burst (say that five times quickly after a few beers!), the ducks are lining up for the first shot to happen now.

Wednesday, January 21, 2009


The bad news: On Barack Obama's first day in office, the S&P 500 registered a decline virtually identical to the average annual return during George W. Bush's eight years in office...a tenure that included not one but two bear market declines of 44% or more.

The good news: Obama has another 1,460 days (and perhaps 2,921) to improve his average.

Whether it was more fo the same (ongoing concerns over the financial system) or the relatively uninspiring oration from the new president, yesterday's price action was far from an Obama-rama; it was much more of an Obama-nation. (thanks, Bobby D.)

Technically speaking, there is basically nothing between yesterday's closing price and last November's 741 lows. Fibonacci-ists might hang their hats on 789 retracement support, but from Macro Man's perch that looks decidedly flimsy.

This has been a pretty frustrating move for Macro Man; while he is/was extraordinarily bearish on stocks for the medium term, his tape-reading abilities have deserted him this month, and he's completely whiffed on this move. Fortunately, he's done OK elsewhere, but grates.

How bad are the financials? Reams and reams can and have been written about them, and still we are all collectively amazed by each fresh casulaty in the sector. Consider this; through Q3 of last year, one of the most popular (and populated) equity trades was the spread that Macro Man labeled "equity market crack"- long energy and short financials. This spread got absolutely mullahed in Q3, even making new lows in October at the height of the funding scare. Since that point, oil has fallen by a further 50%....and energy stocks have outperformed financials by 95%. Yowsah!
Elsewhere, there was a raft of data released in Singapore last night, including the worst quarterly GDP print (-16.9% annualized) sine the Bloomberg data series begin (1975.) CPI and industrial production data were also lower than expected, and the government slashed its forecasts for 2009, looking for weaker growth and a chance of deflation this year. Despite this, the MAS announced that they saw no reason to adjust policy between meetings and no reason for the SGD to be weak. Hmmm...perhaps they've borrowed JCT's glasses?
Other than Brazil (which will cut rates this week), Singapore is just about the last economy out there that hasn't eased monetary policy. This may be a pushback to avoid "rewarding" speculators; if so, Macro Man is perhaps doing himself a disservice by drawing attention to the issue.

Finally, it's worth observing that Mervyn King has essentially declared open season on sterling, noting in a speech that a sustainably weak £ offers a number of benefits (without citing any potential demerits.) Meanwhile, the public sector borrowing requirement for December obliterated expectations, coming in at a tidy £44.2 billion. The pound has peen pummelled (again) as a result.

A rather interesting (if possibly apocryphal) quote has been making the rounds today:

"A weak currency arises from a weak economy, which in turn is the result of a weak government"

The speaker? Why, Gordon Brown, of course, in 1992.

Hmmm. While the new president lowered expectations for immediate (or is that intermediate) relief yesterday, at this point Macro Man would lean towards the Obama-nation emerging from this crisis before Brown's Britain.

Tuesday, January 20, 2009


Yesterday, Macro Man offered up a view that a bearish sterling conclusion from the banking crisis in the UK and the aoption of QE by the Bank of England was misplaced.

Yesterday, Macro Man was wrong.

Flash Gordon's peso has been the subject of a beating last endured by opponents of Mike Tyson in his prime. Cable has plumbed to its lowest levels since mid-2001 (a time in which EUR/USD was in the mid-80's) , EUR/GBP is up 5% in less than two days, and GBP/JPY has reached new all time lows. Ouch!

Cable is down a big figure even since Macro Man printed out his charts this morning.

Allow him to wipe the egg off his face....

Anyhow, the big news of the day is of course the inauguration of Barack Obama. As an indication of the anticipation, the UK media has been heavily advertising its coverage of the inauguration and speech; Macro Man can only imagine the fervour in the United States.

The world looks grim at the moment, and for good reason; the current financial crisis and the concomitant global recession is shaping up as a once in a generation, if not lifetime, event. Regardless of one's political affiliations, it is in everyone's best interests that Mr. Obama can live up to the lofty expectations for him. In the near term, it appears unlikely.

Nevertheless, from a market perspective Mr. Obama has a relatively easy comparison; the SPX declined an annualized 5.5% during GWB's eight-year term.
An Obama bounce, an Obama-rama if you will, has been conspicuous in its absence. Macro Man has been wary of such a squeeze (to his detriment, given the performance of his early year tactical buy) ever since election day. At the risk of sounding tautological, it seems likely that if an Obama-rama doesn't materialize soon, equities could be in (even more) trouble.

Monday, January 19, 2009


Another day, another bailout. This time it's on the east side of the Atlantic, where the UK authorities have organized another capital injection/loan guarantee program for (some of) Britain's troubled banks.

Last Friday, the feel-good rally in equities and sterling was rudely interrupted by a late-session swoon by some of the UK banks deemed most vulnerable, a turn of events sufficiently troubling that "Flash" Gordon Brown and his Darling sidekick have organized another bailout.

Flash Gordon may have saved the world with his earlier bailout, but he didn't manage to save RBS, still reeling from its catastrophic acquisition of ABN Amro little more than a year ago. Not even Ming the Merciless could lose £28 billion in a single year, but RBS managed the trick. The good news for RBS longs is that there is good long-term support on the chart 28p below the current price.
At the same time, the Bank of England has been given the power to buy turds...err...assets from banks to help them shore up their balance sheets. Roll on quantitative easing, UK style! The question is how low Merv and co. might want to take rates in conjunciton with any asset purchases. Macro Man has a sneaky suspicion that they'll be reticent to trim below 1%, though that hasn't stopped the short sterling strip from rallying a bit this morning.

Sterling the currency has come under a bit of pressure, however, as the market engages in a knee-jerk "sell the quant easing currency" Pavlovian response. EUR/GBP has traded up 2p from Friday's lows, and GBP/USD has shrugged off early-session strength.

But surely we've seen this movie before? The market had a pop at the dollar (for whatever reason) in December as the Fed moved to quatitative easing....and the buck has subsequently retraced most of those losses.

While Macro Man comes second to no man in his disdain for Flash Gordon, in his view the UK's troubles are pretty fully priced into the currency markets. Macro Man calculates fair value for EUR/GBP at roughly .75, making the pound some 20% undervalued against its European neighbours. While that is not necessarily a catalyst for an immediate sterling rally, EUR/USD in 2008 demonstrated what can happen when the valuation rubber band stretches too far.

So Macro Man is shockingly somewhat constructive on sterling in the medium term, though there can of course be plnety of short-term setbacks.

In the meantime, Macro Man looks forward to Flash Gordon claiming victory with his latest initiative. There is, however, no word yet on whether he will change the national anthem from "God Save the Queen" to something more up-top-date from Queen:

Friday, January 16, 2009

Event Risk

Every time the ECB meets, you can count on two things:

1) Jean-Claude Trichet will come close to dislocating his shoulder as he pats himself on the back, and

2) A cohort of Macro Man's readers will spring to his defense.

Yesterday proved to be no exception. Macro Man is finding it difficult to escape the notion that Trichet is a spectacularly poor economist; what other explanation could there be for his apparent ongoing concern about wage pressures in Europe? And given everything we've seen over the past year and a half, Trichet's casual dismissal of the possibility of European deflation (as well as a European government default) was intellectually cavalier. A good rule of thumb in finance is that when someone says that something "cannot happen", they don't know what they're doing.

In any event, the major defense of Trichet appears to be "well, he's not Bernanke." Talk about damning with faint praise! There is no shortage of commentators, including your scribe, who have taken the Fed to task over the past year and a half. Googling "Fed" and "incompetent" yields neary 900,000 results. The ECB has been relatively unscathed from public criticism, however; the same Google search yields only 30,000 results, and most of them are about cricket. They certainly don't deserve a free pass, hence Macro Man's criticism.

Moving along, Macro Man's trade theme received further support last night with another piece of abysmal data, in this case Singaporean exports, which registered a worse-than-expected 20% y/y decline. Apparently, things are so bad in Singapore that the government is encouraging people to shower less; not exactly what you want to hear in a country where it's the middle of summer 365 days a year! Macro Man remains bearish of the S$ and other trade-sensitive currencies.

Meanwhile, equities and other risk assets finally put in a decent show yesterday after the straight-line drubbing of the previous week. We are entering a potentially treacherous few days in global markets, with event risk in adundance.

This morning sees the release of Citigorup earnings; given that they were teetering on the brink yesterday, the release could be a key driver of sentiment today. Then, of course, we have option expiry on today's opening, followed by a long US weekend for MLK day. And finally, Barack Obama is inaugurated next week. FDR's inauguration speech still resonated today; given Obama's undoubted rhetorical ability, would you be willing to bet against him delivering a speech that provides at least a short-term bump to sentiment? Macro Man wouldn't.

After its sharp downdraft, the SPX is perched just against trendline resistance, a break of which could spur a nice pop higher.
Treasuries provide some confirmation of the easing of "risk off" pressures, as TYH9 has broken trendline support.
It seems quite clear that macro punters at least have been positioned firmly for "risk off"- lower equities and bond yields. The correlation of the HFR global macro index with the SPX has been pretty close to -1 over the past month.
So with these punters having made a good start to the year, Macro Man wouldn't be surprised in the least to see profit taking and risk reduction into the event risk of the next few days.

Thursday, January 15, 2009

What does it say...

...about ECB credibility that with 300 respondents in the poll, the joke response (hike 100 bps) was the third most popular answer?

-50 53%

-75 17%

+100 11%

-25 11%

0 4%

-100 4%

Wednesday, January 14, 2009

ECB Open Thread

Macro Man is likely to be tied up for much of Thursday morning in meetings. Suffice to say that this week's poor equity market price action was not part of the game plan (Macro Man thought we'd see a squeeze up to 1000+ in the SPX by mid-February) and has sent him back to the drawing board. It's hard to believe that he wrote a post entitled "I love risk" little more than a week ago.

The main event for Thursday is, of course, the ECB; readers and punters should feel free to use this post as an open thread over the course of the day. To get the ball rolling, here's another poll on what the ECB will do: Macro Man's own vote is for a boring 50 bps from Kermit and co.

results are here

Thoughts on Europe

Well, Macro Man highlighted the issue of trade yesterday, but even he was surprised by the US trade number for November. The $40.4 billion deficit was much better than expected, and indeed the narrowest in nearly 5 years. While Macro Man had been troubled by the October report and its implication for his constructive dollar view, yesterday's data boosted his confidence in his economic analysis (though as observed yesterday, that does not necessarily translate into market success!)

What was particularly striking about yesterday's figures was the sharp decline in both imports and exports, providing further support for yesterday's theme. Macro Man received some pushback on his claim that the Baltic index represents true supply and demand for shipping (though why the unavailability of trade finance somehow doesn't count as a determinant of shipping demand eludes him), so he was curious to see an article in today's Torygraph suggesting that container rates on same routes have hit zero due to- you guessed it- falling demand.

Another source of curiosity yesterday came from a Market News story about tomorrow's ECB meeting. It must have been a slow day chez MNI, as they evidently had the luxury of time to ring around a few different ECB moles. The divisions within the ECB were pretty much laid out for all to see; one guy pretty much said "we're buggered", 50 bps is a done deal, and we'll push for more. Another was quoted as saying that the bottom may already be in and that they have to worry about eventual inflation.

Now Macro Man has had a go at the ECB before, and frankly been surprised at the amount of reader support for JCT and co. But frankly, he's left wondering if we will need to create a new species for the ECB; traditionally, central bankers are divided into "hawks" and "doves". Perhaps we'll need to include "frogs" on the in in Muppets. Where was this concern about the forward outlook in August, as oil was already on the way down? As things now stand, the ECB looks set to miss its inflation targt on the downside by as much as blew it on the topside. Good work, lads!
At the same time, there are more insidious structural headlines beginning to hit the tape. S&P, for all their many faults, have been conducting one of their periodic reviews of sovereign credit ratings over the past few days. Nations like the US and UK have had their ratings affirmed, while the PIGS are on negative watch (Ireland doesn't show in the chart below for some reason.)
Now, Macro Man isn't a Bernard Connolly type character who hates Europe for the sake of it. But he cannot help but wonder if the last year or so hasn't put a dent in the attraction of the euro as a store of value. After all, many FX reserve holders in Asia and the Middle East have belatedly come to realize that holding euros isn;t any good iff you need dollars to defend your currency. That in and of itself would argue for a higher dollar weight than a purely markowitz approach would dictate.

Moreover, insofar as the current crisis has been all about the small print, the Eurozone has small print in adbundance. Less than half of the countries in the Eurozone enjoy a AAA rating (though obviously a bigger percentage of Euroland GDP is AAA), and recent market developments have confirmed that EMU assets, including government bonds, are not, in fact, perfectly fungible. BTPs are not a government trade these days, they are a credit trade.

And while Ireland may not call in the IMF, a worst-case outcome for the economy and the banking system could raise serious questions about some countries' ability to pay their liabilities. Not exactly what you want to see in a reserve currency!

And try as he might, Macro Man cannot find the mechanism or gameplan within Europe should, say, Greece decide to withdraw from th single currency becuase they cannot afford their euro liabilities. The standard European respeonse seems to be "we don't need a plan because that cannot happen."

Funnily enough, that sounds an awful lot like S&P's comments on their subprime housing model should house prices decline in the recent Michael Lewis article (page 5, to be precise). And didn't that end well.....

Tuesday, January 13, 2009

A Tradeable Theme

One of the challenges and pleasures of being a (lower case) macro man is the intellectual challenge of finding tradeable themes. Sometimes they fall into your lap, such as last year's "implosion of the world financial system" theme. In other environments, things can become a bit trickier, not least because timing is just as important as direction in implementing a trade.

One of Macro Man's core views for the past several months has been that following the gradual waning of the financial crisis, there remains a bone-crushing recession to cope with in 2009. One of the direct outcomes of the hit to global domestic demand is, unsurprisingly, sharply falling trade volumes.

Last summer, the Baltic Dry Freight Index collapsed, a move which at the time was characterized as somewhat overdone. Since making a low late last autumn, the index has essentially flat-lined, implying that there is little to no fresh marginal demand for shipping.

Trade data around the world has subsequently confirmed the message from the BDIY. Taiwanese exports fell 41% (!!!!) y/y in December, while trade figures throughout the rest of Asia have shown similar weakness (if not quite of the same magnitude.)

Now, there is a popular view that while current data is poor, the stimulus packages in China will bail out the Asian region if not the world. Macro Man is sceptical. Indeed, the greatest risk to asset prices is that the Chinese stimulus is a damp squib. And if you need any reminders of what that means for the world, check out the chart below, which shows China's trade balance with the rest of Asia. China usually runs a tasty deficit with Asia, as they import components for onshore assembly and re-export. Observe how China has managed to shift demand abruptly lower with Wal-Mart style ruthlessness.Even Japan has started to suffer, as its trade balance has moved into deficit for the first time since the late 70's. The difference between now and then, of course, is that over the past few months Japan's terms of trade have improved sharply, whereas they were awful in the late 70's.

Continued weakness in global trade is one of Macro Man's favourite themes. The question then becomes how to play it. He likes being short SGD as a proxy for pan-Asian trade volumes, plus there's a kicker from a possible devaluation in April (the MAS policy easing mechanism.)

He also likes being short the Australian dollar, which in a sense is more of a pure China play via the commodity channel. Of course, Australia has its own domestic recessionand collapsing housing bubble to deal with, which should further erode whatever erstwhile yield support that the Aussie has enjoyed.

Of course, one of the occasional frustrations about this industry is getting the economics spot on but failing to realzie that via the trade that one implements. However, both of the trades above appear to be gaining market traction this weak. In honesty, Macro Man isn't quite sure what to hope for with today's release of November trade figures in the US....well, other than lower volumes all round, which is after all at the core of his view.

Monday, January 12, 2009

Perched On A Precipice


Was it really less than a week ago that the market and Macro Man were saying "I ♥ risk" ? Suffice to say that the enthusiasm has petered out pretty darned quickly, and everything now looks quite ugly.

Friday's payroll number was execrable, though perhaps not as execrable as it might have been. Karma dictated that having moaned about never winning a sweep, Macro Man triumphed last week with a cheeky -575 guess. The worse-than-expected unemployment was not particularly surprising, given that it looks likely to eventually exceed 9%.

Regardless, the uninspired price action following the figure has left equities looking vulnerable. Not only did Friday's close leave the SPX down on the year for the first time, but it also left the index perched bang on both the 55 day moving average and the uptrend from the lows.
Not that the vulnerability is confined to US equities, mind you. Technically, the picture is virtually identical for the Eurostoxx....the price is perched on both the moving average and the uptrend line. Given ancillary price action in other "risk tells" such as the yen, at the current juncture risks appear skewed towards a deeper "risk off" environment. Macro Man has adjusted his portfolio in a way that will hopefully de-sensitize him from such slings and arrows of outrageous fortune.

Elsewhere, at least one punter seems to be allocating a significant amount of premium to the notion that the ECB will see the light and slash rates this quarter. A literally unbelievable amount of option strategies have traded in March euribor over the past several days, with the end user doing a dazzling array of spreads that essentially look for euribor to settle at 1.75% in March, give or take. That would require fairly aggressive ECB easing, down to somewhere around 1.25% - 1.00%, depending on your basis assumptions.
Now, perhaps the end user has had the proverbial tap on the shoulder from moles within the ECB; to be sure, the airwaves have been dominated by dovish comments from ECB voters so far this year.

But it begs the question; if the ECB really does take rates down that low, shouldn't the euro be a bit lower?

Friday, January 09, 2009

A History Lesson

Having grown up in the United States but spent virtually all of his adult life outside the land of his birth, Macro Man has had the opportunity to observe different theories of education at close quarters. Indeed, with two children in school, he is now at the coal-face, so to speak; in the UK his kids have been taught cursive handwriting at an age when he himself was doing colouring in pre-school.

What has always struck him as peculiar about the UK educational system is the degree of specialization that it instills at a farcically early age; by their mid-teens, secondary school students have to tailor their studies to ensure acceptance to university for a pre-destined course of study. While this generates a very high degree of ability at the secondary and university level, it leaves a lot of gaps. The American system, on the other hand, tends to be broader and shallower...spending less time studying more things. There is also a great deal more flexibility in the US system of higher education, where students don't have to finalize a course of study until the end of their second year.

Macro Man himself is a graduate of a fine liberal arts university, where he was required to take courses in a broad range of subjects. In doing so, he discovered a passion for history, which he adopted as a second major to ensure entry into interesting-looking courses. To this day, much of his leisure reading tends to be about historical arcana.

In any event, his passion for history is coming in useful these days, as market and macro headlines offer up a history lesson virtually every day. One story circulating recently, for example, suggested that yesterday's equity price action was vital, because the market direction in the first five days of Janury almost always dictates the direction for the entire year. Thus, the fortunes of the next 11.8 months were dependent on whether or not the SPX could hold 903.25 or not. Macro Man decided to check on this; while there does appear to be a decent relationship, it is far from infallible. Since 1951, the direction of the first five days mirror the returns for the year as a whole 69% of the time; a decent strike rate, but close to random than infallible. A quick glance at the chart below suggests that as recently as 2002, a decent start to the year was followed by a shocker.
Meanwhile, macro data and policy decisions are reaching historical extremes with eye-raising regularity. German manufacturing orders have collapsed to easily their worst rate of change since unification. The outlook for industrial production is correspondingly grim. Meanwhile, the German government announced yesterday that is taking over part of Commerzbank, which itself is trying to digest Dresdner. Good thing there's no credit crisis, eh?

What is amusing/bemusing is that with all the focus and questioning on how the US will finance its fiscal deficit, it was Germany that had a failed bond auction this week, as they were only bid on 87% of the offering size. Bid to cover on the US 10 year auction, meanwhile, was 2.5. Food for thought with respect to the euro, for sure.
The headliner today is of course the US employment report, the last to be released before the new president takes office. Wednesday's ADP report not only put an abrupt halt to the equity rally, but it also raised the spectre of a one-in-a-lifetime poor payroll figure. While consensus looks for job losses of 525k, Macro Man reckons that something close to 650-700k will be the average of all the office pools today. Indeed, some are mumbling about the chances of a million job losses! Anything close to that would be the second worst outcome in the history of the non-farm payroll report, with the worst coming in September 1945 after the US de-militarized following the war.
For choice, Macro Man would suggest that the number may not be as bad as feared in some quarters, though a seven handle on the unemployment rate seems like a given. But the random nature of the monthly payroll figure makes it anyone's guess- well, anyone's but Macro Man's; in a career that started in 1993, he has never won a monthly payroll sweep.

Finally, the Bank of England cut rates to an all time low of 1.50% yesterday. While it's true that Fed funds are also at an all time low, the BOE is a truly venerable institution, while there are plenty of people alive today who are older than the Federal Reserve.

The BOE was chartered during the reign of William and Mary, pictured wonders if they had a tracker mortgage?
In any event, the activism of the BOE is to be applauded; after all, this is an institution that once left rates unchanged for 103 years (1719-1822.) And you though Easy Al's "considerable period" was a long time.......

Thursday, January 08, 2009

Ten Non-Predictions for 2009: Part II

And now the second half of this year's non-predictions, following on from yesterday's first five:

6) EUR/GBP will NOT trade at par. This non-prediction is less controversial than it was a week ago, given the 5% sell-off in the cross. Macro Man must confess to feeling slightly bemused about sterling; having felt for years that it was bum-clenchingly overvalued (viz, last year's comment that cable would not reach a new high), it now looks farcically undervalued against other European currencies.

While this is clearly a result of the ongoing market and economic implosion, and the resultant easing policies pursued by the BOE, from Macro Man's perch it has overshot. After all, at least UK policymakers have (belatedly) realized the nature of the problems they are confronting. In the Eurozone, meanwhile, the economic pity party is just getting started. In December, Germany registered its first rise in unemployment of the cycle- something tells Macro Man it won't be the last. With the possible exception of the Swiss franc, the euro remains the most overvalued major currency in the world...and the lesson of the past year and a half is that that which is overvalued eventually gets nailed. Ultimately, EUR/GBP at 1.00 is just flat-out wrong, and Macro Man doesn't think it will happen.

7) The DXY will NOT make a new low in 2009. The DXY is mostly the euro, so this is really just another way of saying that EUR/USD will not trade meaningfully above 1.60 this year. From a technical perspective, the DXY rally has yet to reach meaningful retracement targets, so Macro Man would expect the buck to rally from here, taking the DXY to somewhere between 90 and 100, From a market perspective, Macro Man remains skeptical that years of dollar borrowing and leverage can be unwound over a few months, especially in an environment of impaired market liquidity. And from a monetary perspective, Macro Man believes that QE is an irrelevance for the dollar until the velocity of money starts to rise other words, until those dollars "dropped from Ben's helicopter" make their way back into the system. For now, they are merely going to shore up holes in balance sheets.
8) China will NOT stop taking the piss in currency markets. In Macro Man's ideal world, China pulls the bid in USD/RMB, slashes its FX reserves by 75% and uses the money to fund the beginnings of a domestic social safety net, and thus buggers off from trading EUR/USD. His ideal world also entails the Pittsburgh Pirates winning the World Series and West Ham the European a cursory glance at the sports pages will confirm that we are pretty damned far away from that ideal.

While there has been a bit of sturm und drang emanating from Beijing recently about the inutility of accruing more reserves and/or buying more Treasury bonds, there is also the small matter of the economic downturn and the desire to maximize net exports. Macro Man suspects that the latter consideration will prevail in domestic policy circles, which makes sense given his views on the dollar and US bonds. As the chart below demonstrates, the rise in FX reserves in China has been inexorable (if you don't already, tune in to Brad Setser for ongoing analysis of this issue.) So for better or for worse, we'll all have to continue living with Voldemort, the cockroach of global finance.
9) High grade credit spreads will NOT reach their wides of 2008. There are three dynamics at work here. First, dealers and punters had every incentive to mark this stuff as wide as possible to end 2008; after all, no one was getting paid last year, so it didn't really matter if it cost you more money. Whereas this year, there's at least a hope you get why not start the year with an extremely favourable mark? Second, the Fed is now targeting spread product, specifically MBS. As mortgage spreads tighten, yield-seekers will eventually be forced to move slightly out the credit curve. And finally, high grade credit generally bottoms first...certainly before the stock market. Observe how in the last cycle, AAA spreads made their wides in mid-2000, before the economy really went into recession. Sure, they remained elevated for a number of years afterwards.....but they didn't make new wides. Given the implied default rates in high-grade credit at current pricing, the asset class looks pretty cheap...especially in comparison to stocks. It can remain cheap for an extended period, of course....but Macro Man reckons that the chart below will not make a new high this year.
10) The approval rating of Gordon Brown and Barack Obama will NOT be as high as they are now at the end of 2009. The last yougov poll that Macro Man can find puts Gordon Brown's approval rating at 38%, substantially higher than its October lows. In Macro Man's view, the bounce has less to do with GB's "vision", "leadership", and "saving the world" than it does with the ineptitude of the Opposition. Given the likely trajectory of the UK economy in 2009, Brown's own ineptitude will eventually re-emerge as a factor in his ratings.

As for the president-elect, it strikes Macro Man that he would need to cure cancer, walk on Mars, and score the winning touchdown in the Super Bowl (all in addition to resolving the financial and economic crisis with the stroke of a pen) to meet expectations. So even if Obama does a good job (and it's in everyone's interest that he does), the grim reality of the 2009 recession is likely to reduce his approval rating from the the current 67%.