Tuesday, May 04, 2010

Bread and Butter

After a weekend spent thinking about a) Greece (that's a lot of dough, but they've somehow still managed to disappoint), b) the weather (temperatures plummeted for the long weekend), and c) estate agents (a more villainous, less industrious profession is difficult to find), Macro Man is now ready to think about something else.

So how about fixed income pricing in the US? No, not the back end of the Treasury curve, which rises and falls for a whole host of reasons, not all of which are obvious beforehand. No, Macro Man is looking at the short end, the bread-and-butter of a macro punter's book.

Yesterday's ISM was pretty impressive. True, a lot of the strength was "in the price" via the consensus forecast, but even that was exceeded. New orders moved back towards their highs of the cycle, while the headline is now approaching the highs of the last few cycles. Indeed, the only reading of the last 20 years to register higher than yesterday's 60.4 was observed in May 2004: ironically enough, the month before the Fed started hiking rates last time.

As of yet, of course, there is no serious mention of actually putting the funds rate higher- though Macro Man does know one or two guys who expect a rate hike relatively imminently. And while the FOMC minutes indicated that the committee is not yet prepared to countenance (or even really mention) asset sales, the groundwork for policy normalization is clearly underway.

How else to describe last week's twin announcements paving the way for a term deposit facility (note to Fed: please come up with more interesting names for your programs! All these acronyms are really starting to run together. Why not name one "Bob"?)

In any event, 3m LIBOR has now risen 10 bps over the last few weeks and at this juncture shows no signs of stopping. If we regress the last month's fixings and extrapolate them over the course of the year, we can see that LIBOR will approach 0.80% by year end.

Note that while a continuation of the recent trend may not be a reasonable assumption in the absence of any new policy developments, such an extrapolation would, on the other hand, be entirely consistent with both a gradual move towards normalization and, importantly, real-world borrowing and lending rates via the FX forward market.

In any event, if we compare the extrapolation with the June, Sep, and Dec eurodollar contracts, something funny happens. Each of the contracts is priced within a few bps of the line.
Sadly absent is the juice that was present in the strip throughout much of last year. Macro Man has bemoaned the lack of a risk premium in the strip on several occasions thus far this year, and this is just another example of that.

Small wonder, then, that despite the classic "macro trade" of Greece blowing up, many macro punters are suffering through indifferent returns thus far this year. There just ain't any jam on the bread and butter.


Nemo Incognito said...

Certainly feels like liquidity draining out mm. Check relative performance of small bs large caps in Asian markets.

Right Field said...

MM - like the analogy of ISM level in 2004 and rate hike a month before. However, I would note that unemployment at that time was closer to 5.5% vs. 9.7% now...

Either way, I believe that rate normalization in the US needs to accelerate. Been looking at mid-curve Eurodollars (broken butterfly's) to express the view.

Red June 2011 Eurodollars (EDM1 CMDTY CT) are last 1.44% vs. Red June 2011 Fed Funds (FFM1 CMDTY CT) are last .98. There is a 46 bps rate differential between the two measurements and my view is that needs to expand to 100 bps.

If anyone holds the view that the uptick in data will remain, either 200-300k+ in positive NFP or a change in FOMC language or asset sales then you need to have exposure for a re-pricing of growth back into a 1-year time bucket.

I think a lot of positions in these underlying have been unwound or too many investors are tired of bleeding theta on this view...

wcw said...

Me, I just think you two are both early. Things are much, much better: the recession is over and even job growth is coming back, probably as we write. That said, compared to potential things remain completely punk, so I don't expect a Fed raise this calendar year. My L-bottom thesis may have been somewhat gloomy, but that doesn't make this an old-fashioned V-bottom, either.

Skippy said...

It is an obvious point (often made here) but the strength in manufacturing has been aided and abetted by policy (fiscal and monetary). In order to achieve the rebound in production, private excess was swapped to public stress - now clearly evident in the huge sucking sound coming from Europe.

If this was a typical post war cycle, policy rates should be a lot higher. However, it was a banking panic which is rapidly becoming a sovereign panic and sovereign crises rarely end well.

Leftback said...

It certainly feels like the front end is the most likely place for investors to be run over by a steamroller. At least, that is the short term view, with another jobs number up ahead that will be stronger and also goosed by census hiring.

The longer term view is still cloudy. There is definitely weakness in Shanghai equities and it seems like the RBA wants to pop the Aussie housing bubble, where house prices have reached 7 x median earnings.

deke said...

SPX opening session of the month green did the 7th straight month, so will be interesting to see if money gets put to work after today's dip under the theme of 'tired of zero money market funds return'...SPX 89 month MA at 1172, the number that was the final hurrah in January 2002, the headfake in 2004 with final breakout in May 2005, retested in October of the same year, and resistance in October 2008

equity bulls would be helped if euro 'stick save' is finally initiated, and the 5MA is now setup for it (still near 132)

Leftback said...

2s10s at 268, and 30y mortgage rates sticking tight to 5%. Looks like those calling for >300 in the poll are going to be out a few bucks.

wcw said...

In re house prices at 7x median earnings, house prices in my PUMA (Public Use Microdata Area) were at 12.4x in 2008, using ACS median value versus ACS median family income.

A free golf clap to the first one to ask what percentage here rent.

econobserver said...

It is time for the UK election post? Will the result have any real impact on UK fiscal and monetary policies? thoughts?

Deniz said...


re: monetary policy, there is some empirical evidence that in open economies fiscal multiplier is close to zero and adjustment takes place via real exchange rate and shift in composition of aggregate demand. that means that consolidation might not have an impact assuming that UK is still a functioning economy.


mythoughts said...

RF, why should the spread between Fed Funds and Eurodollars be 100 basis points? Isn't it usually (historically) about 20?