Friday, May 28, 2010
While we are still dominated by the maddening cacophony of month-end flow, let's drill down on the inflation/deflation debate that has been at the core of most of our recent pieces. This time at a specific issue brewing beneath the surface. The Bank of England is allowing an inflation problem to develop in the UK as Merv' the Swerv' has repeatedly attempted to talk down Sterling and interest rate expectations in order to keep monetary conditions exceptionally loose to support the recovery. He argues that there is a very large output gap and that the imminent fiscal tightening and Eurozone austerity plans will weigh heavily on growth. Maybe you're right Merv, but targeting growth alone is not your job. As David Cameron reminded us, this morning, the rise in inflation in recent months is worrying and "rates will be set to control it" and that we "need to make sure that CPI is under control". As some have rightly pointed out, politicians should not meddle with independent central banks. But given the BoE isn't carrying out its mandate properly, perhaps the PM is right to raise the issue. The BoE argue that much of the jump in inflation is FX-related and VAT-related, and yes to some extent this has had an impact, but cannot explain a significant chunk of increase.
Spot the difference: UK core CPI (white), US core CPI (brown), Eurozone core CPI (green)
There is a material risk of inflation expectations de-anchoring, especially given that the BoE appears to be the most dovish major central bank. Earlier in the year when market-based measures of inflation expectations spiked, the BoE toned down its rhetoric. Interestingly, the 5y5y Breakeven (first chart, white line) is back to the highs of the year and looking precarious. Survey measures of inflation expectations have also drifted higher towards 2007-levels, though not yet to the highs of 2008, but with 5%+ RPI prints it is likely that these will continue to move higher, especially given that rates are so low. Sorry Merv, don't think this is sustainable...
It's funny that this time around, there are no calls for the World economy or Emerging Markets to decouple from the Eurozone train crash, in sharp contrast to the consensus view around the US housing market. Given this, rates markets have pushed out tightening cycles globally as economic contagion has been priced in as the Eurozone demand is expected to collapse (hold on a minute, it wasn't that strong to start with...). Anyway, whether or not this view is legitimate or not is irrelevant, the UK looks like it has an inflation problem and the BoE is going to have to do something about it. The below chart shows forward rates for the BoE Base Rate (red), 3m Libor (purple) and spot SONIA swaps (blue). At the 2yr horizon, there is a good chunk of hikes priced in, but still the Bank is only priced at about 1.7%. In reality, there is also a lot of risk premia in the curve so, if anything, market expectations for the Bank rate look very low, and those at the 1yr horizon virtually non-existent. With carry at the front-end now so low, Short Sterling looks like a "yours"...
As Dr Bubacles put it:
"Hanetos, en quilla cobitos, ben neth neck obfeta penetos quentaniqa, heth eth eth eth eth eth eth. F****d inseta inflayshun"
Thursday, May 27, 2010
Following on from the inflation/ deflation debate we had better have a look at gold which appears to be denying the deflation leg of the argument and is leaping directly to the "inflation somewhere down the line anyway, only currency they aren't printing and so store of value etc etc " argument. Yup all of that makes sense but I can't quite get to grips with buying the stuff here as I have just had my TDI (Taxi Driver Indicator) triggered on the way home last night "you gotta be long gold innit". And that follows the DPI (Dinner Party Indicator) being triggered a month ago. Now running both indicators through my Polemic MDI Model (Moist Digit Indicator - involves licking your finger and sticking it in the air) and calibrating it via the BLSH algorithm (Buy Low Sell High), I can't help but thinking we aren't far off a large amount of hoopy earings hitting the market and effectively doing to specs what the GA ( Grannies Attic) function did to Mssrs Hunt in the Silver market in the '80s.
The extrapolationists all have their rulers out and are calling for it to head somewhere just outside the orbit of Pluto by 20"insert year here". Meanwhile, the Austrians were dredging the lakes as fast as they could and smelting and selling tons of gold coinage. 'Demand was strong enough to constitute “panic buying,” Austrian mint Muenze Oesterreich AG said on May 12.' but 'Gold demand, down 11 percent in the first quarter from the prior three months' , HOWEVER the World "talk it up" Gold Council said it will be “strong” this year on increased investment and higher jewellery usage and more elaborate Indian weddings.
Open Interest is screamingly high. And if you are buying gold on a disaster scenario play then having it stashed in a warehouse a long walk away and your counterpart now defunct may not be the wisest way to do it.
But let's look at some other stuff...
Against World Real Rates (first chart below, yellow line - EU, US, Japan & UK 10yr Inflation Swaps, GDP-weighted as a proxy for World Real Rates), Gold doesn't really look out of whack. To what extent this is market pricing of easier global policy to deal with the potential deflationary shock from Europe is not clear. But looking at the 10yr World Breakeven (second chart below) clearly shows that the Deflationistas are winning the debate... Perhaps given that both real rates and inflation expectations are now so low, the really overvalued assets are bonds?
Short term, though, we have a ratcheting relationship with the risk-on/risk-off trade. As gold is a loaded position, stress = gold falling. So, if we are seeing a bounce in risk assets ( now a bit more discernable through the month-end fixing cacophony) then gold should drift up again short term giving the taxi drivers one more hurrah. But I am wary... gold may be going to the Moon, if not Pluto, but we need to see a few taxi crashes and dinner party pregnant pauses when gold is mentioned, before we really take off....
And finally, a late foot(ball) note... Hope this TV network's roving reporter isn't using the same map as his colleague to get to the World Cup!
Wednesday, May 26, 2010
Due to the restrictions of a monster hangover and the ability to only be able to focus by closing one eye, this is being rationed to bullet points.
Reasons to be cheerful 1, 2, 3...
- Libor destressing - EDM0 has bounced, Whites-Reds steepening, EURUSD basis sharply tighter.
- $5.4bn taken in ECB's USD FX Swap lines, by just three bidders. Clearly yesterday's rumours about a certain Mediterranean bank were untrue.
- Hammer in candlestick on US stocks (compare with 5th feb low) and failure to breach and hold the year's lows.
- 89% of stocks in the S&P500 being more than one standard deviation below their 50day moving average.
- Island reversal in Eurostoxx against the May 7th lows.
- Even Marc Faber saying its a buy.
- EURNOK falling.
- USDSEK soothsayer technical sell, GBPJPY soothsayer technical buy.
- Corporates returning to put on long term hedges in non-USDs.
- Relative silence on the European front (Mangler been bound and gagged).
- The US is clearly pissed off with EU policy incompetence.
- Geithner called for a Eurozone bank stress test (swearing on the phone call between Obama & Mangler?!). Important as Fed/Treasury think US Stress Tests were point at which they "won the war" re: market confidence.
- Joint US/German press conference announced for tomorrow - policymaking is finally being internationally coordinated.
- Italy followed Spain, Portugal & Greece in enacting a deeper fiscal austerity plan.
- Barney Frank has killed the Swap Desk provisions in the Financial Regulation Bill.
- Background data continues to be good (although no effect from the recent panic has fed through yet).
- Consumer Expectations component of US Consumer Confidence points to robust growth in PCE(chart below, PCE yoy lagged 6months).
Reasons to be miserable 1, 2, 3...
- The bounces in risky-FX have been tepid.
- Read any recent press piece.
- Europe is still a complete mess.
- Credit/Equity pipeline a potential supply overhang.
- Someone has handed German regulators a loaded machine gun.
- Going to ban people with "fat fingers" next?
- Monster hangover from last night.
- Living in the UK.
Care to add your own reasons to be cheerful or miserable in the comments?
Tuesday, May 25, 2010
After yesterdays look at the micro workings of the money markets lets stand back during this interlude in Nightmare on Elm Street and have another look at the really Big Picture. To make sure we're still heading in the right direction, let's have a look around...
The US banks with a large dose of help from the accountants and regulators rebranded debt as assets, switched the money in their vaults with IOUs, lent the real money to Joe Public who gave it to China in exchange for expensive plastic chattels, who in turn spent a load of it in Australia and put the rest in a big pile. Then someone noticed the worthless promises in the bank vaults and the need to replace them with some real money. Which was a bit of a shock. So the UK and US governments kindly printed a shed load of new money and borrowed oil tanker-like ship loads of it to refill the bank coffers. Job done, "I thang yow and goodnight". Please don't call for an encore and please leave the theatre quietly.
Meanwhile, in Europe, they had found a cunning way around all that worrying middle bank bit by just lending directly from the governments to Joe Public via enormously profligate social policies. The nice up side being for Joe, or Juan or Guiseppe or Georgiou Public is that it isn't even a loan so they aren't even expected to pay it back, unlike Mr and Mrs Foreclosed on Main Street and Mr and Mrs Bust of Acacia Avenue. Instead, it's the governments who are directly left holding the can with no-one else to really blame. In the UK and US, the politicians were adept enough to pin the blame on the banks, leading the rabble on the march against the City/Wall Street. Despite Mangler Merkels late "It was 'im sir" short-selling swipe at the banks, the blame game seems weak and it is the Governments that are in the firing line. Riots in Greece, general strikes threatened in Spain (buy shares in plywood manufacturers in Madrid?). It's hard to believe that Italy is going to stay quiet through this, despite Berlesconi's apparent dash into hiding. 629,000 official government cars in Italy? (watch Fiat's next numbers!)
Where are we
So much dire gloom has been published about the state of the EU that you'd almost believe that the US and UK debt monsters have evaporated. They haven't, they just have new bedfellows. It would appear that the money that Europe is now "not" printing to help out its domestic brethren is fast leaking fast into USDs and even GBP (and, of course, CHF), giving the illusion of comfort for the US and UK. Yes, GDP may be running at a reasonable lick in the US, but how much of that is still on the back of borrowing and public spending? In fact, you have to wonder whether GDP measures are the next accounting con to unravel. Should they really ever contain public spending figures funded by increases in debt? If I borrow money and give it to the kids to buy sweets does that mean we as a family have a higher GDP and so should be lent more? Seems daft....
This European shake-up is only drawing clearer battle lines between New East and Old West. The Old West have been playing so hard for the past decade that they have ended up kicking the football over the fence into New East and are now desperately shouting over the fence to get it back "Hey Mister, can we have our ball (trillions of Dollars/Sterling/Euros/Commodities) back, please?", and the answer appears to be "No sorry, I'm going to keep it till you have learned to behave", and rather more quietly "and I'm even going to play with it myself".
Where are we going?
So where are the West going to replenish their meagre coffers? The argument of deflation appears to now be on everyone's lips but the end game cannot be. The US, UK et al. are not Japan. Japan has savings and the Yen is effectively a pension currency constantly being recycled, so a devaluation never occurs to help them inflate their way to growth (through a dodgy GDP reading again). In the West, it is hard to see the ball being returned from the East without a huge bout of inflation to alleviate the debt burden and revalue the competitive manufacturing/IP base. In the past, the West has either had a steep Intellectual Property-gradient (and weapons-gradient if you go further back) to earn (or threaten) its way to higher relative wealth. But the world is levelling out on all fronts (apart from debt where it's tipped the other way) and if there is someone willing and able to do your job for less than you, you are toast. Or on strike and toast (listen up BA crew). Western expectations of a 4 bed house, car and good education in exchange for basic jobs have to be tempered against the tidal wave of exceedingly well-educated and unemployed people out there at your ankles willing to do it for less. And if Western relative wealth has to diminish then, psychologically, folks would always rather see it eroded by inflation (blame someone else) than take a pay cut, which is a direct admission of personal failure. So having your own currency to devalue to help you on this course is of great advantage.
So we get back to the inflation vs. deflation argument. It would appear that the deflationary function we are currently seeing in various European countries is a short term adjustment as the consumer stops spending. This reduction in spending should swiftly impact the currency via the debt servicing load and result in it falling RELATIVE TO THOSE with the savings and hence an increase in imported inflation. The trouble is, years of promises to public sector workers have resulted in very large (in some cases, larger than the "official" national debt numbers) inflation-indexed pension liabilities being run up, neutering the inflation argument somewhat. But there are plenty of examples of debtor countries treating external creditors in a different way to those domestically. We must stop focussing on EUR/USD, EUR/GBP and start looking instead at EUR/USD/GBP block vs. savers. Once this massive deleveraging event has run its course, it will be back to plan A: buy things of limited availability that other people want.
And that won't be EUR, GBP or USD. The USD and GBP have all had their turn as a funding currency... now it's the Euro s turn....
...right, interlude over. Back to our seats for the main billing...
Monday, May 24, 2010
Since the money markets imploded in August 2007, players have paid close attention to the Libor-OIS spread, the EUR/USD Basis Swap and associated flattening of Whites-Reds as potential warning signs of stresses in the inter-bank market. In recent weeks, these stresses have become elevated, much to the confusion of many money market traders. Most FX Forward guys report that the minute White Eurodollars get hit, the offer for Dollars in term disappears, as bad memories of late-2008 surface, but simultaneously the Overnight and Tom/Next market is awash with Dollars. It's pretty easy to see that since Ben, Merv and Trichet fired up the printing presses, the global monetary base has exploded. Remember the chart below? That was the one showing that banks are hoarding money rather than lending it out (much to the irritation of many politicians), and that the Monetary Transmission mechanism was broken. Well, maybe it is, but it's hard to argue that banks are having trouble funding when they are sitting on this cash, the day-to-day funding markets have plenty of Dollars and, so far, interest in the Fed/ECB FX Swap lines has been virtually non-existent. Some argue that the rate is uneconomic, but 10-15bps is neither here nor there - if you want USD, you will pay up for them. The lack of participation here is telling...
So is this just fear then? Most of the widening in Libor-OIS has been futures-led in forward space. The below chart shows the Sep10 US FRA/OIS spread having widened 50bps since mid-April. Now, Libor has risen significantly as fears of a European banking crisis, triggered by one or more of the PIGS defaulting, but only by about 30bps. The EUR/USD 3m Cross-Currency Basis Spread has also similarly widened, as players have been reluctant to make markets in term. To some extent, the widening has probably also been driven by unwinds of "Fed on hold" trades, expressed mainly in Eurodollars. Another reason with which to beat them has been a noted US bank research piece suggesting that the financial reforms could add 25bps to the "fair value" for Libor, plus another 100-150bps if EMU breaks up, triggering a European banking crisis. The logic behind the financial reform premia is related to the spreads between CP rates for Financials & those for Industrials, and to some extent, reduced implicit support for the financial system should lead this to rise, but let's face it, whatever the government insist, when the shit hits the fan, they are going to stand behind Citi, BoA etc. So this isn't really likely to have much of an effect on the "fair value" of Libor. And now that the Germans have passed the EU/IMF bailout package, the probability of an EMU break-up-led crisis is very low, at least for the next year or two. So the fear in Libor-OIS looks well-overdone here...
Friday, May 21, 2010
When it's time to delever, discipline suggests cutting the losers and keeping the winners. Except it rarely works out like that - the winners bail-out the losers until the pain gets too ball-crunching and then a wholesale dump of everything in the book is inevitable. A lot of the moves yesterday, overnight and this morning are very suggestive of this capitulation point being reached as even the market's favourite whipping boy, the Euro has rallied 4% from the lows on Wednesday. There aren't any Pink Flamingos left.
Yesterday had the feel of "throwing out the baby with the bath water". A few metrics in particular seem to point to many portfolio managers and traders getting the "tap on the shoulder" from superiors telling them to cut their losses. A 20bp move in TIPS breakevens and $7 collapse in Oil are all symptoms of Inflationistas throwing in the towel and converting to the religion of European deflation. Oh dear.
Baby and bath water indeed...
Thursday, May 20, 2010
Events necessitate that today's post is somewhat brief...
Although liquidity in the German bond market returned after a couple of hours of confusion and discussions with legal teams, the damage was done. The unpredictable behaviour of politicians in the face of financial crisis evoked memories of the failed TARP vote in September 2008 and the associated deleveraging that followed. Those that had managed to just about hold onto their favoured risky asset trades suddenly felt that the tickling feeling in their posteriors perhaps was developing into the feeling Edward the Second of England had in his last moments. Short EUR/AUD and short Euro vs. Asian FX has been one of the favoured trades of both levered and real money since the beginning of the year when the Greece crisis began to materialise, having so far bailed them out to some extent on other trades gone wrong.
So... here is the only chart you need today:
In other news, the Paris Museum of Modern Art appears to have fallen victim to the biggest heist in history .
*5 WORKS BY MODERN MASTERS STOLEN FROM PARIS MUSEUM
*STOLEN PARIS PAINTINGS WORTH EUR500 MLN - OFFICIALS
Well they say that addicts turn to crime to fund their habits. Perhaps the British Museum should up its security around the Elgin Marbles?
A lot of these markets feel very thin. Eurostoxx volaility break, Spooz already gappy and EMFX looks like its anorexic. Not really a sense of panic yet, apart from a few cases of favourite trades getting hosed (AUD, XAUEUR, Platinum), or starting to get hosed (EURAsia). There have been a lot of shocks to P&L this month and it is hard to see appetite appearing to do anything other than cut risk ahead of month-end, especially with the vote tomorrow. If it passes, then yes, it's a different story. But this is somewhat reminiscent of the "three day rule" (which reader RightField wisely applied on the day of the "flash crash"). Things haven't bounced after a couple of days, if anything the newsflow is getting worse, and there is significant event risk and no policy response (OK, technically there was the German howler) to a worsening financial crisis. The weakness of the Jobless Claims numbers will only exacerbate this. The risk remains a -3% day in Spooz.
Finally, we have noticed that the recent posts have pushed Macro Man's "last request" down out of sight, so it is only fair that we raise it again. So incase you missed it:
Wednesday, May 19, 2010
So that's why the European policy makers were so quiet... They were coming up with a cunning plan so cunning that their foot has fallen off. Yes indeed, the Germans appear to have followed Nursie's brother's plan and decided to trim their toenails with a scythe.
*TWO-YEAR GERMAN GOVERNMENT BOND YIELD HITS RECORD LOW OF 0.422 PCT,
*TRADERS SAY LIQUIDITY DRYING UP IN BUND CASH MKT
Whether the ban is only naked or not doesn't matter. The reality is that desks have stopped making markets in Euro government bonds. The Repo market is already skittish and desk risk limits will inevitably have been cut. The inability of fixed income arbitrage funds to trade without first arranging repo is a big hit to liquidity. Stand by to hear of the next HF blow up...
It seems like the London response was to fade the sell-off: "seems overdone", "it's been done for domestic consumption, not the market" etc etc, and risk was put on. But the German bond market is the world's 2nd largest (the Bund, the world's most liquid future ) and it is hard to see how breaking it can be seen as anything but a deleveraging event. If we see Bunds start to be dumped then the last floating ship of european stability has just been torpedoed.
FRANCE NOT CONSIDERING BAN ON NAKED SHORT SELLING IN EUROPEAN DEBT, UNLIKE GERMANY
Tuesday, May 18, 2010
Last weekend we saw the press hit the nitro-boost on the Europhobic stories:
- Sunday Times: "Euro heads for parity with dollar".
- FT: Germans lead gold rush frenzy - Greece considering legal action against US banks (for shorting CDS etc).
- Merkel: "Bailout has bought only time, not a solution".
And though it is not in the class of the ultimate Tabloidometer, the Economist, last week's Newsweek front cover was a Euro splash:
And despite all of this the Euro rallied yesterday. And it did so of its own accord as well. Even against its normal high beta risk buddy the Aussie Dollar. But then, the AUD itself is looking sick on many cross measures, with the worries of a China slowdown, the RBA in the 8th innings of its hiking cycle and the Henry tax making life difficult if you dig for a living. And of course, most of the good news is in the price. Lets sprinkle in a couple of other ingredients to the cauldron - a ZEW that was nowhere near as bad as the market had started guessing just before its release based on the Sentix correlations. A Doji on the SPX. Soothsayer technicals, daily and weekly, in EUR/USD. Record IMM shorts in the EUR, as well as seemingly everybody in every type of investor class, using the Single Currency as a hedge (and as we all know, if you want a hedge, go to a garden centre). The ECB's USD 84-day Open-Market Operation only attracting $1bn of demand (hold on a minute, wasn't there supposed to be a liquidity crisis?!). And finally, the most worrying indicator of all is that European officials have gone eerily quiet. Either they have finally learnt that "Silence is Golden" or they have some cunning plan. Hopefully more cunning than Baldrick's Bullet...
The other alternative is that of course they have absolutely no plan whatsoever and they have run away. Which is what the Knights may have to do if the Euro Rabbit turns out to be a killer.
If, however, the Knights have their way and slip past the rabbit we may have a new version of OMD's anthem "Enola Gay" to sing...
Mister Trichet , you should have stayed at home yesterday.
A-ha words can't describe, the feeling and the way you lied.
These games you play, they're gonna end it more than tears someday,
A-ha Mister Trichet , it shouldn't ever have to end this way.
It's 12:45, and that's the time that you've always tried.
We got your message on the radio , things abnormal and extending the loan.
Mister Trichet , is Europe proud of ECB today?
A-ha these cuts you give, they never ever gonna fade away,
Mister Trichet , it shouldn't ever have to end this way,
A-ha Mister Trichet, Euro fades in our dreams away?
It's 1.30, and that's the time you will deny QE .
We got your message on the radio, things abnormal , there's some way to go.
Mister Trichet , is Europe proud of ECB today ?
A-ha Liquidity, it ain't ever ever gonna drain away………………………………
(London times apply)
Monday, May 17, 2010
In financial markets, very often the question is "who's next?". We saw that with the banks in 2008 and, most recently, with the peripherals in Europe. The obvious candidate here is the UK.
Sentiment on the UK is generally pretty poor, not without reason, and short GBP was one of the big consensus trades of 2009 (with repeated head-scratching from many punters when January 2009 proved to be the low - note, never listen to Jim Rogers!). Spot traders need little encouragement to sell Sterling, as "bashing Betty" is one of their favourite pastimes. Gold priced in Sterling looks well on its way to hitting the 1000-mark, following the USD and EUR both hitting that "prestigious" level. Good job Gordon.
And since the election, Gilts have started to cheapen vs. SONIA (green line), but as seen with the GDP-weighted average EMU spread (vs. EONIA, orange line), they can potentially widen a lot further. It is also interesting that USTs (vs. OIS, white line) and Bunds (vs. EONIA, pink line) have not materially moved, the latter is somewhat surprising given that the Germans are going to pick up the tab for all those Greek swimming pools. Indeed, the Greeks seem to have misunderstood what the market meant when it said that Europe needed its very own TARP programme (http://wealth.net/2010/05/greek-tax-avoidance-101-cover-your-swimming-pool-with-a-tarp-fool-a-satellite/).
Speaking of Development Economics, today we got a taste of fiscal consolidation UK-style, with the Times reporting that the DfID (The Department for International Development) has announced that it is to cancel a £146,000 project for "a Brazilian-style dance troupe with percussion in Hackney". Err... not sure that's going to help, guys.
The currently announced fiscal policies amount to a £10bn fiscal ease. (Shouldn't the UK be cutting its deficit, not increasing it?!) The IMF reckons removing VAT exemptions would go 3.5% of the way to the 9% they think is needed to stabilise the UK's debt-GDP ratio, and hiking VAT to 20% should provide another 1%. But removing the VAT exemptions (such as children's clothes) is probably not going to go down well with the LibDems who are essentially an un-reconstituted socialist party. And VAT needed to go up anyway, even without enacting a stimulus. The numbers just don't add up. Unless they get significantly more credible by the June 22nd Emergency Budget, the UK is going to get Fitch-slapped.
The government, as all incoming governments do, has accused the Labour Party of a "scorched-Earth policy" of leaving several of Brown's turds around Whitehall in the form of unpublished spending commitments. And Liam Byrne, Labour's outgoing Chief Secretary to the Treasury is reported to have written a note to his successor that reads "Dear Chief Secretary, I'm afraid to tell you there's no money left". Well, I guess at least he's honest... While this is obvious politicking, it all seems a bit deja vu to last October and the restatement of Greece's budget deficit.
- Private Finance Initiatives (Broon's off-balance sheet accounting trick) - £139bn.
- The un-funded public sector pension liability (Broon's great Baby-boomer giveaway) - £1,104bn.
- Contingent liabilities - e.g. Network Rail (so privatisation didn't work after all, huh?) - £22bn.
- Financial sector interventions (Broon saving the world and Fred Goodwin's pension) - £130bn.
...which comes to a startling total of £1395bn + the official debt number (£890bn), a grand total of £2,285bn or 162% of GDP. Perhaps it's a bit unfair to include the pension liability (which most Western countries have) or the financial sector interventions (which, provided RBS hasn't done its cods on European bonds as well as everything else, will probably post a profit one day), but the others are fair game. That comes to 96% of GDP and could potentially be announced as part of "opening up the books" and discovering Brown couldn't add up all. Beware of Scotsmen bearing Red Briefcases...?
Merv' the Swerve keeps a'swervin', being about as dovish as he possibly could at last week's Inflation Report. Osborne talks about tighter fiscal policy meaning rates will be lower for longer. That's a textbook "sell the currency" scenario. But does the market actually already price in this tightening? So the logic goes, as the government increases its share of the economy, it forces up the Real Exchange Rate as the government spends money on domestic "stuff" and employs more people (thereby pushing up the relative prices and relative wages). And the flip-side, is that as it reduces its share of the economy, it removes demand for those goods and the associated job cuts push down unit labour costs, weakening the Real Exchange Rate. The below chart shows UK General Government Consumption (white line) vs. the BoE's Effective Exchange Rate (brown/green series). Obviously the banking sector interventions have artificially pushed up the Government's share of the economy, but even excluding those, it looks as though the currency is already anticipating a sharp fiscal contraction.
Friday, May 14, 2010
Just when it looked as though Team Europe had finally got its act together and addressed both Liquidity (via the "How Much?!" IMF/EU/ECB package of last weekend) and Solvency (via renewed fiscal tightening in Spain & Portugal and new EU rules), economic data conspires to compound Spain's problems as Core CPI just turned negative. With many governments' fiscal plans being centred around Nominal GDP, this makes an horrendous problem worse.
Cue, a return to last week's financial crisis price action with STIR Strips flattening, EUR/USD Basis widening, Bubble CDS widening, risk assets selling off and the Euro looking more offered than a night out with Gordon Brown. The news reports claiming that the only reason the bail-out happened was because Sarkozy threatened to take France out of the Euro confirm many punters' suspicions that EU policymakers are utterly incompetent and utterly un-united.
But like it or not, there IS a package and fiscal tightening is being pushed through even at the expense of growth. And though the ECB has been politicised, despite the desperate protestations of Darth Weber of the Bundeathstar, it is clearly relaxing its monetary policy and its inflation-fighting determination. So despite the fact that the Euro has fallen a long way this year, on most traditional measures it is still over-valued. Any economic textbook will tell you that this combination means the currency needs to weaken. And clearly it is. But what does that mean for risk assets?. On a basic level, the transmission mechanism is via lower European growth and lower demand from Europe, but the ECB's "no it's not QE, you are wrong" version of QE, the Fed's unsterilised FX swaps as well as lower yields and monetary tightening being pushed out further, globally, mean that at least some of this effect will be offset. And yesterday's "Mibometer" chart showed European equities decoupling from EURUSD.
The point is that Euro-weakening is not inconsistent with risk asset-strengthening. EU policy incompetence since late-last year has created a Pavlovian-dog approach to moves in the Euro being transmitted to risky assets. Provided the Euro only grinds lower, it does not provide a particularly big risk to global growth. But if the moves become disorderly then you know what to do...
...which brings us to another point. Short Euro is the "trade du l' annee" and its inability to sustain any rally have encouraged positioning to grow significantly. The other helping hand has been Macroman's beloved currency piss-takers taking a bath on all those Euros they bought above 1.50 and now selling Euros on any bounce. Without the worry of fighting FX Reserve Managers, players have felt confident both in selling rallies and selling weakness - "I ain't short enuff" is the common cry. (But then you never are are you? Right up to the point when you ARE and wished you weren't). One thing is for sure, there are some very large positions out there. And while the Euro is not significantly undervalued, policymakers purport to take a dim view of disorderly moves in exchange rates as they "pose a risk to global growth". (Right Oh). Today we see the Mibometer link is creeping back in as the speed of the sinking of the good ship Euro drags other otherwise buoyant assets down with it. This spread closing shows that we are back to a purer asset-linked panic mode and it is hard to see policymakers just sitting tight. Somewhat amusingly, Voldemort and his Death Eaters now have an interest in the EUR *not* collapsing and it may be the case that it is the G20, not the G7 that intervene. Seems eerily reminiscent of October 1998 when Macro Hedge Funds really really wished they weren't short Yen...
So as this is posted and the city echoes to the cries of "NEW LOW EURO!!!" emanating from the windows and voice boxes of FX trading rooms, the mighty currency looks like it has been relegated to a bio-fuel substitute. However, there may be a glimmer of light at the end of its tunnel: the theory that the gene pool of the "last Euro" will be preserved as a lonely specimen in a basement in Brussels, is perhaps not to be. There may be two other genetic variants to breed from in the future:
- The Euro stash to be found one day mutating in the basements of the SNB.
- The Euro DNA from EUR500 notes still being used by lost tribes in Colombia in the years to come.
Thursday, May 13, 2010
As can be seen below the Italian stock index has cleanly departed company form EUR/USD down the road to ruin and it is hard to see the high road of equities crossing the low road of the currency until we are really convinced that Mr. T and the Single A+ Team can get their act together and claw back their money from the system.
Wednesday, May 12, 2010
Thanks to all for the amazing feedback, both in the comments and offline, to the last post. It's left Macro Man overwhelmed and Mrs. Macro shaking her head in disgust.
Your very kind gestures of appreciation have kick-started a couple of ideas that Macro Man has had knocking around in the back of his head for some time. He hopes that you'll like them.
Those of you who just can't get enough of your author's frequent bemusement and bad poetry, rejoice! The task of relocating himself and his family to the USA is sufficiently daunting that he feels unable to cope without a forum for public venting. He will therefore be keeping a Diary of an Impatriate, though be warned: no market or financial topics will be addressed in any way, shape, or form. Macro Man has retired from financial blogging, and he means it.
Secondly, and most importantly, is the idea of giving something back. Macro Man would like to give something back to his adopted homeland, and he hopes that you can help him. He has therefore created a Just Giving page for Great Ormond Street Hospital for Children.
Over the last three and half years, he has spent hundreds of hours writing hundreds of thousands of words. He hopes that some of them have made you laugh, made you think, and maybe, just maybe, even helped you make a bit of money.
If so, please consider giving a little something back by making a donation to GOSH. You can do so by clicking here, or on the appropriate space on the sidebar (once Macro Man's replacements start posting.) The people at Great Ormond Street do amazing things for sick children; please consider making a small contribution to help them and make life a little better for kids who have more important things to worry about than disappearing financial bloggers.
Thank you all once again.
And now, I really am going...for good.
Monday, May 10, 2010
Today marks an important end....but also a new beginning.
This will be the last post that "Macro Man" makes in this space, the 1,024th step on a journey that began on September 13, 2006. It's been an incredibly fun ride, and I have been gratified at the response and readership that the site has generated.
Being Macro Man has helped me navigate the most fascinating market environment of my or anyone else's lifetime. Last year, it helped me deal with the stress of overcoming a serious knee injury. It's enabled me to meet people, both in person and online, that I hope to count as friends for years to come.
But now it's time to move on.
It's been a frustrating year, both professionally and on the blog. Although the past few years have provided ample proof, I have become a firsthand witness to the inefficiency of capital allocation in 2010. Despite excellent performance in 2008-09, particularly on a risk-adjusted basis, the fund with which I have traded had most of its assets pulled in Q1.
It's a shame, though of course it's part of the business, so there's no tears. Still, the upshot has been that I haven't been trading for four months, and haven't been going into the office for six weeks. So if you thought I sounded detached, now you know why.
When, at the same time, an almighty palaver erupted in the comments section over health care and other issues, it was frankly tempting to pack it in right there. There can be few things more frustrating than providing a forum by dint of one's own labour- unpaid, and with no other sources of income- only to receive a barrage of abuse from a horde of ungrateful commenters.
Fortunately, revising the comment policy eliminated the trolls, though at the cost of sacrificing a few regular contributors who were unwilling/unable to register. And so we've soldiered on, and fortunately in recent weeks there's been plenty to engage our collective interest.
But now I'm moving on.
On Friday, volcanic ash permitting, I will board a plane bound for JFK, from which I will decamp to the great hedge fund ghetto in Fairfield County, Connecticut. Next Monday, I'll be starting as a PM at a Tier 1 fund that shall remain nameless. It's a cracking opportunity, and I'm excited to get stuck in.
But you can't move on without leaving a few things behind. While my passport tells me that I'm going "home", in reality I'm leaving it. I have spent almost all of my adult life outside of the United States, and for the last 13 years I've lived in the UK and Ireland. It's ironic, really; I arrived two months after New Labour swept into power, spent most of the last decade complaining about Gordon Brown, and now I'm leaving just a matter of hours after they (hopefully) get the heave-ho from Number Ten.
And while I've had plenty of moans about British bureaucracy over the years, I am under no illusion that things are any different or better in the US. Certainly the regulatory environment is utterly bereft of what one might term, for lack of a better phrase, a "sense of humor."
Those of you who have seen my lamentable attempts at poetry over the years know that a sense of humour is a pretty important prerequisite for reading my stuff. Given that I have zero interest in landing either myself or my new shop in hot water, it is therefore with great sadness that I hang up my keyboard with today's final post.
I did, however, mention a "new beginning" in my opening sentence. Like the Terminator, you can't kill the Macro Man blog with just one shot. I am pleased to announce that I've assembled a small panel of guys that have agreed to contribute periodically and keep the space alive. I think you'll enjoy reading their stuff; indeed, all of them have commented from time to time over the years.
The updates, particularly initially, are unlikely to be daily; not everyone has as much free time as the original Macro Man! I'd also like to invite any other readers who think that they might have something to offer by way of semi-regular contributions to get in touch at email@example.com.
At this point in a valedictory farewell message, it is usual to thank a laundry list of people who have helped the author along the way. Frankly, there are too many people to thank by name, especially as I would assuredly leave somebody out and offend them. So allow me to offer a blanket "thanks" to everyone who's read the blog over the years, and especially to those who have commented or gotten in touch offline. You have (trolls excepted) made this an incredibly rewarding experience.
Finally, and before I fade into the distance, I would like to extend a hearty invitation to readers to keep in touch offline (that's firstname.lastname@example.org. Operators are standing by.) This particularly applies to my fellow travellers in global macro portfolio management, and even more particularly to those located in NYC and especially Fairfield County. While I certainly plan to keep in touch with my old muckers in the London market, it would be nice to build a network in the US relatively quickly. The Macro Boys will face the angst of being the new kid in school come September; 'twould be nice if their old man didn't have to go through the same thing.
And that, dear readers, is that. It's been a blast, and I hope that you've enjoyed it as much as I have. Enjoy the new Macro Man Blog, and best of luck with your trading endeavours.
If you went home happy and risked-up on Friday, you've probably seen a mushroom cloud rising over the ashes of your erstwhile-profitable portfolio, as the Europeans have engaged the nuclear option in response to the current crisis.
While the sums involved are not quite a match for those used by US authorities last year, they nevertheless reside in the same neighbourhood (assuming they can be fully deployed); the zillion dollar question is whether they'll have a similar impact.
How shall I help thee? Let me count the ways:
* €60 billion in cash from the European Commission, funded by bond sales
* €440 billion in loan guarantees, via pooled support of member governments
* Up to €220 billion from the IMF
* Outright bond purchases from the ECB, to be sterilized (this has evidently already started)
* 3m and 6m full-allotment LTROs
* Reactivation of FX swap lines
As always when it comes to Europe, Macro Man has to bite back scepticism. In this case, he finds himself switching from "show me the money!" to "wow, that's big...who's payin'?" with remarkable ease.
That is, of course, unfair...to a degree. But the remarkable ability of this situation to look hideous from every angle simply highlights the fundamental flaws in the Eurozone project (i.e., allowing any old country in, regardless of competitiveness, and the lack of a harmoinzed fiscal stance.)
Nonetheless, the immediate requirement for funding from European governments is not particularly high, which is probably a good thing given the spanking the CDU received in NRW over the weekend.
(One is also left to wonder how much a country like, oh, the US will be asked to contribute to IMF aid to Europe, and how well that will go down in a country with a gargantuan budget deficit and mid-term elections rapidly approaching. But I digress....)
Unsurprisingly, all of this has brought about another 180 degree turn in market sentiment, and everything that was cratering at the end of last week is doing its best Superman impression (up, up and away...)
That's a cheeky 6% in Eurostoxx...
...and FX swap points have come back...though not all the way.
It is certainly tempting to point at the bounce off the market low of last March and extrapolate forwards, given that Europe has unveiled its version of QE and bailouts. And in the near term, there is no telling how far stuff can run.
As always in the Eurozone, conditionality and enforcement are paramount issues that will be tricky to solve. No doubt Portugal, Spain, et al. will say the right things and appear to toe the line...but what happens when growth undershoots and so do fiscal revenues? Which will give way...living standards for civil servants, or fiscal rectitude? (This, as an aside, is the primary argument for IMF involvement: so the German's won't have to play "bad cop.")
So what we're left with is that a financial firestorm with its genesis in private sector off balance sheet SPVs is being solved at the sovereign level with a limited-funding SPV to guarantee to the periphery. Niiiiceeee....
In the meanwhile, as risk asset and euro shorts lick their wounds, there would appear to be one trade that makes loads of sense: short Schatz. The Germans will be on the hook for quite a bit of whatever cash is required, and with Schatz yields still under 0.70% it makes a whole lotta sense to fund early and often.
Sadly, Macro Man has a visit to the dentist this morning, so euro and equity shorts won't be the only ones in pain......
Friday, May 07, 2010
Where to begin? Let's forget the nonsense with P&G, or the supposed fat-fingered futures butchery at Citi ("your tax dollars at work!") Yesterday was a game-changer, a sea-change. Obviously, anyone who saw the SPX melt 60 points in 5 minutes probably doesn't need Macro Man to tell them this, but consider that:
* E mini futures posted their highest volume day (by a huge margin) since October 9, 2008.
* VIX soared higher and is now up on a y/y basis.
*The front end of the eurodollar strip got slammed in a long-overdue comeuppance for the "pennies in front of the steamroller" crowd. The chart below shows the continuous first eurodollar contract...ouch! At one point yesterday, EDM0/EDZ1 had flattened 45 ticks: the former was down 22 and the latter was up 23. Ouch, indeed.
* The day after posting its high print of the year, USD/JPY posted its low print of the year. Unless you're in the first week of January, that's normally not a good sign.
At the heart of everything, of course, is the ongoing implosion in Greece, and the European "response". It seems pretty clear that neither side (the Germans with the money, or the Greeks with the sense of entitlement) really wants to do a deal...and the fact that Greece has hired an investment banker to "advise" on its debt profile should raise a big 'ol red flag to any potential bottom-fishers in Greek debt.
The only centralized body in Europe with any sort of the authority is the ECB. And frankly, at this juncture, it looks like they are in over the heads. Now, perhaps we might wish to extend the benefit of the doubt to Trichet and company until after the Germans vote on the rescue package. Perhaps the governing council took the view that if the ECB acted pre-emptively, the necessary fiscal support would not be forthcoming.
Somehow, though, that doesn't ring true. A central bank that talks of being "inflexibly" wedded to price stability isn't one that sounds capable of quick, credible action. After everything that's happened over the last few years, how the hell can any Tier 1 central bank talk about "inflexibility"? It's asinine.
And if they really, truly didn't even discuss a bond-purchasing program, even in passing...well, then the single currency is going to deserve everything that it gets. Sticking your head in sand and hoping everything turns out OK isn't really an option if you're the custodian of a reserve currency in crisis...and yet that seems to be the policy response pursued by the ECB.
The natural result would be to strip the euro of its reserve currency status. OK, OK, the ECB isn't doing nothing. They're having a conference call, by gum, with some of Europe's largest banks to talk about the state of the money market! They'll presumably be told it's in bad shape...the scramble for dollars has sent EUR/USD forward points screaming to the right (i.e., pricing in higher USD rates than EUR rates.)
They've also publicized a conference call to be held amongst the G7. Leaking news of the call might not have been such a swell idea...because if it doesn't produce anything, what then? Sure, the Fed can re-open swap lines with European central banks, but both the US Congress and taxpayer may justifiably question as to why the Fed should lift a finger when the ECB itself doesn't seem prepared to do so. (And that's before Congress has gotten its teeth into the idea that they'll have to appropriate several billion dollars towards the IMF bailout of Greece.)
So while "risk" is currently enjoying a bounce, Macro Man wouldn't exactly be scurrying to build longs here. After a day like yesterday, he suspects that you're (finally) supposed to sell rallies now.
Alas, one place where a sea-change may not be in the offing is the benighted UK, where a hung parliament has now been confirmed (thereby putting paid to one of your author's non-predictions for the year.) While the Tories have a comfortable plurality of the vote, the vagaries of the UK electoral system (translation: Labour districts are the size of a postage stamp; everyone else's are the size of the Grand Canyon) mean that they are denied a majority.
Noted creature of the underworld Peter Mandelson was pimping the notion of Labour crawling into bed with the Lib Dems before the first result was announced last night, and it certainly sounds like Gordon Brown will need to be forcibly ejected from Downing Street (ed. note: now that, I'd pay to see.)
So even though the Tories will be the largest party in the house by a decent margin, we're looking at a few days of uncertainty at best and another 5 years of Gordon at worst. Ugh. Will the last one to leave Britain, please turn out the lights.....
Thursday, May 06, 2010
Man, today feels "old skool", doesn't it? First Macro Man's favourite 2008 whipping-boy Jean-Claude Trichet responds to Armageddon in the monetary union by sticking his head in the sand.....and then risk gets walloped in a beating worthy of a pre-Robin Givens Tyson. It's been a while since we've seen a red "-6%" next to EUR/JPY on the screens, or a day with so many loooooooong blue candles....
...how soon 'til we're waving bye-bye euro?
Wednesday, May 05, 2010
Ooooohhhh boy. That wasn't part of the rescue plan, was it?
The standard approach to crisis management is "UPOD": under-promise, over-deliver. This is the "shock and awe" approach to bailouts that we saw last spring (via huge QE programs and a Dr. Evil-esque allocation promise to the IMF, which hasn't done much good for Greece, it must be said!)
Sadly for holders of risk assets, the Europeans have taken the more treacherous "OPUD" strategy: after talking about sums as high as €130 billion last week, the Greek program underwhelmed that figure by €20 bio or so.
And so Greece came under the kibosh yesterday, dragging the rest of the world's risky assets with it. While there's no real trading in Greek 2yrs anymore, the best guess yield is now about 15%. That's not good.
The obvious question therefore becomes: what now? What happens when the authorities hit Greece with their best shot, and it just ain't good enough? Well, for starters, the rumour-mongers start hunting bigger game, like Spain. While yesterday's "Fitch downgrade" rumour proved to be unfounded, there are enough tendrils of smoke wafting up from Iberia to suggest the presence of fire. (Unless those are just ash clouds from Iceland.....)
While the SPX got a rather rude tap yesterday, 'twas little more than a peck on the cheek compared to what's been happening in the IBEX. The Spanish index is nearly 20% off of its January highs, has broken a previous low, and really needs to reclaim the technically significant 10,000 line quickly or else face risk of a splattering.
More ominously, the yields spread between Spanish bonds and Bunds has crept to a post EMU high. The chart below shows the yields spread in 5yrs, at nearly 150 bps....but the picture looks similar elsewhere along the curve as well. It's one thing for a little country like Greece to have a yield blow out.....it's quite another for one of the larger Club Med countries (and your next World Cup champions....) to go haywire.
Hmmmm. What's a poor policymaker to do? From Macro Man's perch, the eventual outcome is looking more and more inevitable. Remember last year, when J-C Trichet used to waggle his finger during press conferences and looked down his nose at the Anglo-Saxon money-printers?
Karma's a bitch, ain't it? For it's looking increasingly likely that the ECB will need to step in and buy Eurozone government bonds...particularly those at the periphery. They've already ejected the ratings agencies from the equation and torn up the collateral eligibility rulebook....why not go the whole hog into outright QE?
Sure, the Bundesbankers won't like it.....but the German exporters clearly will as the euro heads down the pan! Note how the € is losing serious ground against even sterling, the currency of a country with Moe, Larry, and Curly vying to be prime minister.
Tomorrow's press conference might be a bit to soon for the ECB to announce QE...but then again, maybe it won't.
Macro Man may not be in a position to post tomorrow...if not, enjoy your UK election and ECB presser!
Tuesday, May 04, 2010
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.
Monday, May 03, 2010
It's a bank holiday in the UK today, and you know what that means. With apologies to Frankie Valli....
I solve my problems and I see the light
A thirty hour week, you know it just ain't right
There ain't no danger we can go too far
We must start hoping now that we can change who they are
Greece is the word
They think our tough love's just a bleedin' pain
Why don't they understand, it's just a crying shame
They think we're lying that the danger's real
We start to find it's tough to make a credible deal
Greece is the word
Greece is the word, is the word that you heard
Their budget has no meaning
Greece got no time, it's the place that's in motion
Greece gives me a dodgy feeling...
We take the pressure and we throw away
A chance to sack civil servants, chuck 'em all away
There is our chance and if we make it that far
I do believe that they will stick a bomb in my car
Greece is the word
Greece is the word, is the word that you heard
Their budget has no meaning
Greece got no time, it's the place that's in motion
Greece gives me a dodgy feeling...
This whole thing's one big illusion
They'll get the dough, but all's in confusion
What are we doing here?
They'll take our money and we'll go away
And then their policy goes back to yesterday
Their tax collecting only makes it so far
Then the brown bags come back; they just can't change who they are.
Greece is the word
Greece is the word, is the word that you heard
Their budget has no meaning
Greece got no time, it's the place that's in motion
Greece gives me a dodgy feeling...
Greece is the word, is the word that you heard
Their budget has no meaning
Greece got no time, it's the place that's in motion
Greece gives me a dodgy feeling...
Greece is a turd
is a turd
is a turd
is a turd
is a turd
is a turd
is a turd