Tuesday, November 30, 2010

Nightmare before Christmas

You know that dream where you find yourself back at school about to go into your finals and you have done NO revision and what’s more for some reason you aren’t wearing your trousers? No? Well we bet some Eurocrats are wishing that was their reality compared to their current “Nightmare before Christmas”.

But say we were to wake up and find ourselves in their nightmare. What would We do?

TMM notes that our path from here is not exactly clear but there are options for which we have invented code names used by the leaker in Merkel’s office***:

  1. Increase the size of the EFSF (“Big Bertha”).
  2. Create a pan-European bank recapitalization fund and new stress-test round (“Groundhog Day”).
  3. Explicitly rule out the SDRM (“Horatio Nelson”). Burying head in sand optional.
  4. Instruct the ECB to go nuclear and buy bonds unsterilized (“Dr Strangelove”). Utter loss of credibility counseling to be provided by the Fed.
  5. Require Sov CDS to be 100% margined (“The Little Bighorn”). Watch Euro dive some more as all those “down with Europe” flows go into the one remaining market they can.
  6. Immediately stick Portugal and Spain into the EFSF (“2 tons of you-know-what in a 1 ton bag”). Have you ever had your shopping bags rip breaking all your eggs on the way home from the grocery store? We have.

We would view (2) as the most positive development. In terms of finance, we would imagine that the Euromandarins are looking at the pre-funded EUR60bn EFSM as a potential source of bank recapitalization funds, supplemented by another draw to take us to, say ~EUR100bn which we would say is enough for the system. If the Euro-banks are capitalized properly (and credibly) this time, then there will be nothing to stop them scooping up all this peripheral debt and thus the sovereign-bank feedback mechanism will work in reverse.

At least, that's what we would do it was our nightmare. However, the Eurocrats have shown themselves to be utterly clueless and comments such as:

show that they are obviously suffering from sleep paralysis. Which as anyone who has suffered it will know is very frightening indeed.

But back to reality.

Another day, another 1.x% down on the Spanish 10yr and the Euro, though TMM notes that equities are doing OK all things considered. Maybe it’s that the supranational sector equities are actually becoming a sanctuary away from sovereigns, FX and bonds. Even the Ibex index is rapidly turning into the “Telefonica and Banco Santander” index, both of which have big businesses outside of Europe.

Telefonica got $6.4bn of its $15bn of Q3 revenues and $5.4bn of its $7.3bn of operating profit from Latin America. At 8% dividend yield and 8.5x PE it appears that the largest index constituent has reached, as pointed out by our friend, Charles, in the comments yesterday, the point of "compelling un-leveraged cash yield" from whence few things can trade down without any of the complexities of having a heavily debt financed balance sheet like Banco Santander. Though that is looking pretty ridiculous too. Take earnings from Latin America at 12.5x (Banco Itau's level) and the rest of the bank comes at 4.6x PE. That does look pretty cheap and with those two comprising 41% of the Ibex TMM wonders whether mindlessly selling Ibex futures might have had its day.

We are thinking of donning the Kevlar knife catching gloves as we cannot believe there isn’t a "surprise" change around the corner as the Eurostriches wake up and pull their heads out of the sand.

Monday, November 29, 2010

A Line In The Sand

Well we have the bailout plan, cue the usual items from your chosen bailout drama:

  • Protests (check)
  • Breakdown of government consensus (check)
  • Inevitable question of who’s next.

TMM are coming to the conclusion that the drama in Europe is getting fairly predictable and the big question – Spain – is only just starting to be asked by the market. In a cruel twist of fate, Iceland – (Remember that one? Mid-Atlantic Lehman-on-volcano?) – now trades about 30-40bps tighter for 5 year sovereign CDS than Spain. Let it never be said that the gods don’t have a sense of humor, it’s just that they are as cruel and capricious as they were in the Iliad.
But TMM at this point are looking for slightly more nuanced trades than the obvious “it’s all gonna end innit?” ones and this has caused us to turn to none other than CDS indices. The chart below is of the Itraxx financials senior and sub indices which have diverged more than a bit recently.

The reasons are pretty clear: the EU and any bailout packages now expect junior creditors to take the pain along with equityholders whereas decisions have been made by the great and the good that senior lenders should be made whole so that banks don’t get into a collective crisis due to a ramp in funding costs. The objective here is clearly to force the weak to dilute and cram down junior creditors while keeping senior whole and not pushing a wholesale exodus of the bank paper market.
So, is this what the market is pricing right now? Not much, and frankly, not even close. TMM are feeling lazy and thought we’d take a snap of both a 5 year deal on European senior financials vs sub financials and equalize the default probabilities (assuming cross default provisions, naturally) and see what we got.

As can be seen its abundantly clear that you have to set recoveries on senior really low to get these spreads to line up assuming the kind of sub haircuts we are looking at here (0-25%). Now, maybe European financial leaders are joking and maybe this will get so bad that senior will get impaired but right now TMM can’t help but feel the senior/sub trade has more than a bit of a way to go.

While we're onto nuanced trades, it seems to TMM that it's worth having a punt on 10yr Ireland. A quick back-of-the-envelope job suggests that at 71.89c on the Euro, if you assume that Ireland restructures with a 30% haircut when the EFSF runs out in 2013, then you get a loss-adjusted yield of 5.3% - or 255bps above Bunds. Now TMM reckon that once Ireland has a "Number Two" of 30% it will be on a sustainable debt path and that 255bps above Germany *post-restructuring* in such a scenario comfortably prices the risk premium. In fact, that looks like fantastic loss-adjusted real yield with the added bonus of the wildcard option that they manage to pull this beast off. As with all the subprime trades, the key to finding support in prices of toxic waste under-priced illiquid assets, is for there to be a decent enough unleveraged yield. Well in the New Normal world, this looks to be a key candidate.

And finally, a happy announcement to make . With the increase of local denials of any peripheral problems, it would appear that the the Eurostrich has spawned lots of baby peripheral Eurostriches. Aren't they sweet! arrrrhhh

Going "cheep" to a good home .. ( groan)

Wednesday, November 24, 2010

The Beginning of the END

The situation in Europe has hardly improved over the past 24 hours. A raft of stronger European PMIs and German IFO figures that all outperformed expectations did little to lift mood and go to emphasise that the problems are sovereign-based rather than in the private sector. This morning has seen further blow outs in Eurozone peripherals and associated liquidity trades used by the market to hedge the periphery meltdown tail risk. Specifically, things like EURIBOR/EONIA basis and EUR/USD Cross-Currency basis have been moving sharply, bring back bad memories of May (not 2008, as some are trying to suggest).

Of course this has all added fuel to the "End of the Euro" Army who are being wheeled back out into Media space. More elderly occupants of FX dealing rooms are reminiscing over the old cries such as "Get me Mark/Spain calls", pondering if they might just return one day, raising a glimmer of hope for the drivers of "FX Taxis" where many old EMS FX-Cross traders ended up in the late 1990s. Of course, the 12yr old French quants in the room haven't a clue what they are talking about but smile politely.

TMM have had a think about this and the processes involved in moving from a single Euro to separately tradable sovereign currencies, should it happen. Whilst Euro-Apocalypstas seem to suggest that the move would be a step change, we would like to suggest that the process will mirror the evolution of other emerging markets. In these cases, the markets develop their own products to facilitate speculation hedging before they become officially freely tradable. Namely, the Non-Deliverable Forward (NDF) market. And so it should be with Europe.

So TMM would like to present the launch of a new product to facilitate such "hedging" called The END (European Non-Deliverable) market.

So how would they work and what would be the underlying hedge?

It turns out that the re-denomination clause in Sovereign CDS for G7 countries allows these guys to re-denominate their debt without triggering the CDS. This is particularly interesting in the case of Italy (coincidentally, a G7 member) and provides us with a way to get long Mark/Lira without paying away copious amounts of carry. So, think about doing the following set of trades:

  1. Short 5yr Italian Bond funded on reverse repo (currently, 5yr yield is 3.488%).
  2. Sell protection on 5yr Italy CDS (currently 206bps).
  3. Buy 5yr German Bond funded on repo (currently, 5yr yield is 1.626%).
  4. Buy protection on 5y Germany CDS (currently, 43bps).

If you add (1) and (2) together, you effectively have a short position in a risk-free Italian bond (usual CDS/basis caveats apply) that has the interesting characteristic that if everyone's favourite Italian, Uncle Ber-lech-sconi, decides to readopt the Lira, you are short an ITL-denominated bond and the CDS doesn't trigger. On the other hand, if they keep the Euro and restructure then you are hedged (again, usual CDS/basis caveats apply). The opposite is true of (3) and (4) - if Germany readopted the Deutschmark then you are left holding a DEM-denominated bond with credit risk hedged (although I'm sure no-one would bother buying protection on Germany). [As an aside, although most iPIGS CDS trade with the re-denomination clause, TMM is sure that variant contracts will eventually appear].

OK, so how do we price a DEM/ITL END ? Back in Finance 101 TMM remember learning how to price FX Forwards (Covered Interest Rate Parity and all that bollox). Without going into too much detail, and again with all the usual caveats, the 5yr Italy risk free rate is going to be something like 1.43% (=3.488%-206bps) and that of Germany is going to be about 1.2% (1.626%-43bps). Now DEM/ITL was pegged at 989.99, so plugging all the numbers into the FX Forward formula chucks out an outright 5yr forward rate for DEM/ITL of about 992.46. And that seems ridiculously low to TMM.

The first chart below shows the history of the 5yr END and the second shows the FX Forward Points.

Of course there is no guarantee that, upon leaving, either country would readopt their old currency at the levels they entered the Euro (they could have the NuovoLira, or NeuMark or whatever). But the above is illustrative that the market could very easily start trading contracts based upon Euro-exit as the hedge does not depend at all upon the new currencies or rates that they re-denominate at (these are, after all, purely arbitrary). TMM reckon that it would be pretty easy to trade their ENDs purely as the implied interest rate spread with a contract clause to add in the appropriate new Mark/Lira exchange rate upon exit, given its arbitrary nature.

So, who's going to be first to trade their ENDs in Euro ?

Tuesday, November 23, 2010

Gangsta Style- North Korea

One member of TMM has been to North Korea and noted that amongst the very, very few goods you could buy there was music. Though even worse than K-Pop TMM have to give the world's craziest despot an A for effort for ripping of none other than Nas. Bravo. 

Armchair Generals

A large component of the populace of Financial Markets is made up of commentators, advisors, strategists and so called "experts" and they are all there to "help" you make the right decision in your investment process. Whilst their existence can be poo-pooed as unnecessary and a drain on the efficiencies of the market, the very fact that they can survive in one of the most efficient and cut throat of arenas means that someone thinks their services are worth paying for. And for an analyst or strategist his reputation and hence livelihood, is just as much influenced by the success of his calls as is the actual fund manger by his investment performance. Therefore he will try at his utmost to retain that air of authority and "turn to" knowledge.

So today, with the markets attention being blindsided from the Euroblx and China Squeeze by some North Korean fireworks, we predict that every salesperson or broker you speak to will have suddenly transformed overnight into a 5 star Armchair General, trying to sound like WestPoint trained Asian strategic defence experts. But don't be puffed in, remember that these are the same people that only yesterday were Armchair Irish Budget experts and the day before they were Armchair Geologists re: rare earth metals and only a few weeks ago they were Armchair Meteorologists re: Hurricanes in the Gulf and previous to that they were Armchair Seismologists, Vulcanologists, Jet Engine Engineers, and even Epidemiologists when disease is involved. For this is the way it is.

A US Ex-Investment Bank Sales Desk near you awaits your calls:

To be honest it is the fun of the job, the financial markets do broaden your worldly knowledge dramatically and you do get led into studying the workings of things you wouldnt have imagined yourself getting dragged into, but lets just keep a reality check on the pomposity of some of the analysis we are offered up and offer up. Do we know what will happen in Korea? No. To be frank we don't, and our expertise on the subject is so low that it is insulting to offer it up for consumption. All we know is that there are e few outcomes ranging from "all out war" to "will be forgotten about in a few days". And our limited experience would suggest that if we had to make a choice we would plump for the latter.

But of course that doesnt mean that the market cant spend an awful lot of time spewing reams of worthless analysis. And this headline from the ultimate market-lagging arse coverer is winning so far.


No shit, Sherlock! Whatever next? Perhaps:


We will therefore try not to be distracted by the analysis but will note what has happeneed to prices. Of course the knee jerk reaction was worthy of Private Fraser in Dad's Army, "We are doomed" but though China stocks were all headed lower during the day interestingly when the news broke Shanghai rallied. HK however continued south, though we would like to believe the points we raised yesterday are just as much a factor.

Finally, on a different subject, one reader wisely suggested that we add a glossary of some of the terms we often refer to in this space. So we are happy to oblige - the glossary can now be found in the sidebar and will be updated when necessary or you can find it immediately here: Glossary of TMMisms. If we have forgotten any please feel free to jog our memories.

Monday, November 22, 2010

QE Bomb Ground Zero

This weekend saw another Eurorevelation - Ireland is/has/will approach the EU/IMF for some money to bail it out. Now whilst this may not be be a surprise to anyone with half a brainstem, it is being presented as a Eurorevelation - when a piece of blindingly obvious euroblx is finally admitted to by the Eurostriches, accompanied, of course, with shock , dismay, resignation and cries of unity and future controls. Of course conjuring 80 gigaeuros out of fresh air is easy these days and even the debt strapped UK is managing to magic up an extra 7 or 8 gigapounds to help (would they mind taking payment in aircraft carriers)? But the real interest is how fast the markets can pack up their field artillery and retrain it from Ireland onto Iberia. With, we imagine, more that a few buying Ireland and selling countries southwest of France today.

The only other news of note was the market's reaction to an S+P downgrade in outlook for New Zealand, which looks a little over-aggressive.

But it is last week’s news in Hong Kong that we want to focus on. Over the past week China and HK engaged in a lot of “micro measures” to counteract the effects of all those QE dollars rushing into emerging markets. For HK property markets these include:
- Punitive tax rates for properties bought and sold in less than 2 years.
- A max loan to value ratio of 50% for properties worth over $12mm HKD (down from 60%, which was down from 70% six months ago).
- Moves to release more land.

TMM are of the view that this is all well and good and likely to work as well as those sandbag barriers and the like erected before hurricane Katrina. The reason is that HK property is an object lesson in the problems of having a pegged or quasi-pegged currency.

When TMM were sitting around in finance classes in their respective universities they were taught that property markets really should come down to purchasing power on the demand side (wages, mortgage rates, credit availability), as well as supply side factors (zoning and land use regulations, etc). As zoning tends not to change that much from year to year and credit policies shouldn’t change much from year to year what you really look for are mortgage rates and wages. All that talk of “rent equivalent housing costs” in inflation data is largely driven by this idea: if you didn’t own a house but rented it how much would your costs move around? On the blackboard that should be some proxy for how much it costs to build a house and how much people can pay for it. Pretty simple right?

In recent history we’ve since learned that the availability of credit is not necessarily stable and that interest rates really don’t follow much of an inflation targeting regime in many places. Nowhere is this more true than in places that pursue either an implicit or explicit dollar peg. To wit look at HK property below with the Hang Seng in Red and Hong Kong Real Rates in Orange. It’s pretty clear that what drives HK property is exactly the same thing as the Hang Seng: real rates.

Now, TMM aren’t calling HK property investors spivvy fools who are investing in something vastly less liquid than HSI futures but... wait... yes, we are! To wit you could just about trade HK property names on Fed funds – it’s abundantly clear that property yields are driven by borrowing costs in HK dollars more than by anything else.

Rents are a little better and do seem to track wages pretty well – if you’re bullish Asian wages longer term then owning these assets at the right point in the real rates cycle isn’t halfway bad, though that time is probably not now.

It is no small wonder to TMM how and why HK locals continue to plow their cash into property and property companies having had a 60% peak to trough decline in property prices only 12 years ago. At least regulators are limiting leverage this time; though that doesn’t stop people destroying their life savings, it may prevent another full blown Asian crisis.

Given where HK property and the relevant equities have run to its worth taking stock of just what you are buying when you buy HK property:
1) Long TUA (2 year notes)/rates. If USD rates increase then this trade looks messy.
2) You’re long the HKD peg staying in place (one would presume an unpegged HK would have higher rates in line with those of China, though that isn’t saying much from a real rates point of view)
3) Financial services in Asia.
4) China capital controls: let’s not kid here, HK is only relevant so long as China’s capital markets remain restricted to foreigners. With China now developing futures, credit default swaps and the like the hissing sound as HK loses its place in Asian capital markets will be all louder if and when China opens up some more.
5) China wage competitiveness: maybe this says something of the company TMM keeps, but if you’re not a broker, trader, banker, capital markets lawyer or auditor in HK, chances are you are involved in manufacturing in Guangdong. The raison d’etre of Guangdong is making it cheaper, and with all the news of Chinese wage rises that’s hard to see that being here to stay.

To that end, TMM would like call HK as ground zero of all that is wrong with global monetary arrangements right now and maybe the most compelling short around. It is TMM’s opinion that the slide in the likes of Sun Hung Kai, Cheung Kong and the like is technically overdone in the short term but here to stay longer term.

After all, what does a sly $3mm USD or $10000 per month buy you here versus here? Purchasing power parity has often been a widowmaker in macro but TMM thinks that the time has come to call it.

Friday, November 19, 2010

CapEx, Capisch?!

Another Friday, another Reuters screw up. Team Macro Man found the misreporting of China's Reserve Ratio Hike as an actual rate hike by the newswires somewhat farcical. We are sure there was no sub-plot in announcing it at the same time as The Beard was trying to explain to the Germans why he is trashing the Dollar! Perhaps it's time to go Long AUD vs. short Thomson-Reuters. But for now, it certainly feels as though "that is it" for the day, with no US data this afternoon and expiries likely to see us pinned around current levels.

So TMM thought they'd take a look at something they've been following for the past year as an indicator of when (or if) the corporate investment story is likely to ramp up and morph into a private sector hiring cycle.

Over the years, we have found that the 6m ahead CapEx expectations component of the Philly Fed survey to be a pretty good predictor of non-residential investment. The trouble with survey data is that it is pretty noisy, as sentiment whips around with the equity market. But on a 6m moving average basis, it is a little clearer. The below chart shows the 6m moving average of the said CapEx component (blue line, lagged 6m), non-residential investment growth (YoY, red line, lagged 3m) and year-on-year Non-Farm Payroll growth (green line). From what TMM can tell, corporates appear to have undergone a similar sort of CapEx plan as the early-1990s, when it fell sharply, then recovered, and then looked as though it would double dip (in late-1993), before re-accelerating in 1994 as the outlook became more certain. And it looks like they have done pretty much the same thing this time around, just over a shorter time scale. Their CapEx expectations have recovered back to their post-recessionary highs with it looking like the double-dip danger over.

One of TMM's strongly-held theories is that most trading desks are staffed with guys that, prior to 2008/9, had only experienced one recession - that of the early 2000s, and that this is their playbook for how recoveries develop. But that recession was followed by a very atypical recovery, driven by credit growth, interest cuts and housing-financed consumption.

The early-1990s recovery was very different - it was slow to start with as the output gap was pretty large, but eventually, corporates began to invest and private employment growth followed with a lag (as can be seen in the chart above), and gradually the unemployment rate came down (see chart below: white line - YoY employment growth, orange line - unemployment rate, lagged 6m). Back in the 1990s, Japanese Households and Corporates both had to repair their balance sheets, but in the US today, Corporate balance sheets have never been in such great shape. For this reason, while we buy into the idea that things are going to be slow, we certainly don't think we are turning Japanese. With US employment growth having finally turned positive and the recent upward revisions to private hiring over the past six months, TMM are starting to find themselves itching to get long of equities.

Indeed, it surprises many to find that earnings have nearly recovered their fall since peaking in August 2007 (see chart below), only 9.5% below, and are expected to breach their peak mid-next year. It seems to us that absent a double dip these expectations are very likely to be realised given the position Corporates are in. As far as TMM can see, this has never been a better time for corporates to invest:

  • With a split House, there is more clarity on regulation.
  • QE2 is keeping real rates very low.
  • They have been terming their debt out at record low yields, and not bothering to swap it to floating, resulting in lower funding costs for the years to come.
  • Free Cash Flow yields are sitting above the cost of debt.
  • The recent economic data has suggested a double dip is not on the cards.

Given all the above, it is pretty hard for management to justify to shareholders either not investing that cash in new enterprises or returning it to shareholders. As we've seen over the past few months, the return of multi-billion Dollar M&A and share-buybacks has ramped up significantly. We expect organic growth through investment to follow...

...and with the S&P500 trading at just 12.4x 2011's earnings, and looking nearly as cheap as it has done since Spring-2009 (see chart below, trailing earnings yield minus 10yr real yields - although, admittedly, this is as much a result of real bond yields being so low as anything) it seems to us that both the valuation and newsflow has turned for the better.

Finally, given the post-QE2 positioning washout and falls in bullish sentiment it appears that positioning is not an obstacle. If yesterday's renewed optimism can hold, then there appears little to stop a melt-up into year-end.

Thursday, November 18, 2010

And relax

Aaaand relax. Ok guys that was a good workout, well done. Now do some stretches, cool down and take a break.


DXY failure at top of downtrend from June.
The Fed model still very cheap.
CPI yesterday shows fundamentals haven't changed - it's just been positioning.


The news-fires in the boilers of euro-gloom need more fuel, and it isn't coming today.
Spanish auctions have gone very well, although it seems that local banks are the main buyers. The Irish trade we suppose. It makes sense if you are a local bank as the only way the sovereign goes down is because you have gone under first.


Bullish oil data yesterday with a massive draw.
Gold - made of rubber today.


Fidelity's junk bond king allocating out of High Yield into equities.
GM IPO out of the way so less equity supply.


China is toning down the possibility of higher rates as it looks like they are applying supply side measures rather than monetary tightening.
Korea capital controls are less than expected and, as the Won is the macro darling, its rally has handed out some decent profit to the street.


Open interest falls (5yr note future down 9% since QE2 day) suggest CTAs have by and large cut their positions now.
Volatilties are off in most option markets.
The market feels a lot more clean - last few days were serious pain for the kermit and momentum money.

Austerity Weddings

Remember that all of this is due to the announcement that the future King, Prince William, will be marrying Kate Middleton. If you read the UK press you would believe that UK GDP will exceed that of China due to a "feel good factor" the nation is about to enjoy that will make the consumption of recreational drugs redundant. We are buying tressle table and bunting manufacturers as the UK turns into one great street party, although we recommend the royal couple take advantage of the current half price champagne offer at Morrison and gets the wedding dress order sent before the real inflationary pain kicks in in January.

So... It’s a pause, maybe with Thanksgiving coming up next week this "pause" may stretch to a "respite" amongst the usual risk suspects. However there might be a new game developing ready to bite Mr Market on the bum.

A confluence of news has led to some ugly moves in Munis, but so far there has been limited contagion. However, TMM are watching the Muni->Notes->EM bonds-> mess linkage carefully

Wednesday, November 17, 2010

The Book of Eurorevelation

Chapter Six, Verses 1-17:
6:1 And I saw when the Investor opened one of the seven debt structures, and I heard one of the four living creatures saying as with a voice of thunder, Come.
6:2 And I saw, and behold, a white horse, and she that sat thereon had a bow in her hair; and there was given unto her a great Current Account surplus and she came forth conquering, and to conquer, for she was Mangler Merkel.
6:3 And when he opened the second debt structure I heard the second living creature saying, Come.
6:4 And another horse came forth, with red hair: and to him that sat thereon it was given to take peace from the Eurozone, and that they should slay one another: and there was given unto him a great budget deficit. His name was Ireland.
6:5 And when he opened the third debt structure, I heard the third living creature saying, Come. And I saw, and behold, a black horse; and he that sat thereon had the balance of Greece in his hand. His name was Austria.
6:6 And I heard as it were a voice in the midst of the four living creatures saying, A measure of a Dollar for a Euro, and three measures of peripheral debt for a Euro; and the Oil and the Gold hurt thou not.
6:7 And when he opened the fourth debt structure, I heard the voice of the fourth living creature saying, Come.
6:8 And I saw, and behold, a pale horse: and he that sat upon him, his name was Trichet; and Weber followed with him. And there was given unto them authority over the fourth part of Europe, to kill with rates, and with FX, and with haircuts, and by the wild policies of the zone.
6:9 And when he opened the fifth debt structure, I saw underneath the altar of the European Parliament the souls of them that had been slain for the undemocratic word of The Euro, and for the testimony which they held:
6:10 And they cried with a great voice, saying, How long, O Eurosceptic, the Holy and true, dost thou not judge and avenge our blood on them that dwell in Brussels?
6:11 And there was given them to each one a vote; and it was said unto them, that they should rest yet for a little time, until their fellow civil servants also and their unelected brethren, who should be killed even as they were, should have fulfilled their course.
6:12 And I saw when he opened the sixth debt structure and there was a great crisis; and the markets became black as Wednesdays, and the whole balance sheet became as blood;
6:13 And the stars of bond portfolios fell unto the earth, as a fig tree casteth her unripe figs when she is shaken of a great wind.
6:14 And the heaven of non-mark-to-market was removed as a scroll when it is rolled up; and every central banker and reserve manager were moved out of their places.
6:15 And the Kings of the banks, and the Princes of finance, and the chief executives, and the rich, and the strong, and every bondholder hid themselves in the caves and in the regulator and the media
6:16 And they say to the media and to the regulator, Fall on us, and hide us from the face of him that sitteth on the throne, and from the wrath of the Investor:
6:17 For the great day of their wrath is come; and who is able to stand?

Blessed be the Name of The Euro.

Tuesday, November 16, 2010

Policy Lending May Not be Your Friend

TMM notes that while the Ring Cycle continues to play out in Europe (with a likely Wagnerian ending long term, but a plug short term) things are looking progressively worse for risk assets in Asia. Today more rumors came of monetary tightening in China across the board as well as a rate rise in Korea. If that wasn't enough, the State Reserve Board, that wonderful Chinese entity that imported hundreds of thousands of tons of copper concentrate in early 09 and single-handedly engineered a Lazarus-like rise in the base metal complex, seems to now have gone all offered with auctions of aluminum ingots amongst other metals. Chalco and other metal names in Asia have suffered pretty horribly as a result of this as has the entire index: combined with property curbs (they just keep coming, don't they?) and insane rises in food prices, it is quite clear the Wizards of Beijing who pull the levers on China are in a full-fledged inflation panic and are doing anything within their grasp to get it under control. TMM can't help but feel with some good news in the offing in Europe and pain in Asia that buying EURAUD is not an idea without its merits.

One story that did catch TMM's eye was the Bloomberg one on the pending Solar Panel glut. TMM have followed the rise and fall of this sector for some time and consider it a good object lesson in the perils of policy lending. You see, circa 2004-2005 solar was really taking off due to subsidies in some sunny places (Spain) and not so sunny places (Germany). Some astute folks decided that given low manufacturing costs, economies of scale and whatnot that they would move their production to China like Suntech or move into truly massive scales of production like Q-Cells. As you can see from the chart below (white - Suntech; orange - Yingli Green Energy; yellow - Q-Cells; green - Canadian Solar), things were pretty good until 2007, but have been dreadful since. Why?

The answer is that margins absolutely collapsed due to an insane number of new entrants and growth really, really slowed down. Here is Suntech vs their margins and revenue growth:

And here is Q-Cells which is a pretty ugly story:

All in all there really weren't any winners in this sector as you can see below: the Chinese producers got canned just as hard as the Europeans:

The reason is that around 2005-2006 China decided that solar and particularly polysilicon was a great industry and they wanted to get big in it - real big. Even during late 2007 and early 08 when aggregate bank lending was tightening you could still get loans for solar companies to expand production into the teeth of an ugly downturn at the same time as China real estate CDS widened out horribly because that sector was cut off from lending onshore. The result was that *a lot* of solar capacity got built and margins in the industry went down. Capital intensive projects underwritten on 25% EBITDA margins realized 15% margins and the equity in many cases has not seen daylight since.

Its important to note here that policy lending ain't all bad: in Japan during its period of rapid growth from the 60s to the early 80s lending "window guidance" existed but was more organized: a lot of loans got printed but only to a select few who would duly create oligopolistic pricing and not cannibalize one another. Not bad for investors though really bad for consumers. Princes of the Yen has more. Ultimately policy lending impact on your book comes down to more how it gets done than anything else - it's always a form of redistribution one way or another.

So it caught TMM's ear recently when at a lunch they heard two friends in the special situations and PE business complain at length about how many battery company deals they were seeing.
- "How is it that all these guys already have half their cash lined up from state banks?"
- "Look at the margins - this stuff will be fine no matter how much of a muppet the promoter is."
Which makes TMM wonder: can the likes of BYD in Hong Kong survive the onslaught of a bunch of hyper-subsidized competitors? Sage of Omaha beware: the PBOC are not your friends.

Monday, November 15, 2010

The European Pantomime

As we enter the new week with recent trends having stalled or reversed, the news-wires are fully lit up with commentary about whether or not Ireland will restructure/trigger the EFSF or not ("Oh yes they will!"..."Oh no they won't!"). All the while, the Eurozone debt problems bubble below the surface ("It's behind you!"). TMM cannot help but get the feeling that the situation in Europe has become even more ridiculous than a Pantomime, and in fact can only be described as a Farce. Over the years, TMM have noticed that when in trouble, CEOs (and Finance Ministers) upon realising just how bad the situation is, but still in something of a form of "denial", often take to "fiddling around the edges" in attempting to solve their problems. In Greece, there was the "Tarpaulin Tax" on swimming pools and the Irish have just come up with the idea of reviewing the tax on online betting. We bet that won't help very much.

TMM has also noticed that many financial participants are having problems understanding the new European alphabet soup, so armed with our trusty Eurodictionary, we'll attempt to translate:

SDRM (Sovereign Debt Restructuring Mechanism): A brand of barbers particularly popular in Latin America about 10 years ago. As fashions changed over the years, this hairdressing label has struggled. But recently branches have been spotted opening in Dublin, Athens, Lisbon and Madrid, offering "A free Number Two for new customers". Goldman Sachs reported to be preparing a road show for an IPO.

EFSF (Eu Fequin' Serious, Fergal?! How Much?!): Repair bill for the EDP (European Pandora's Box, formerly European Partnership for Democracy). To be paid by German taxpayer as punishment for opening said box and discovering that the Greeks had run off with all the money.

IPN (Irish Promissory Note): Magic currency with the face of a Leprechaun on it, backed by the pot of gold at the end of the rainbow. Also popular in California, backed by Toyota Priuses.

SMP (Stop My Pain): Tap on shoulder from management: "Hit the bid on those bonds now".

LCH (London Clearing House): Evil Anglo-Saxon attempt to break the Euro Govvie market by whacking large haircuts (free from SDRM, see above) on iPIGS bonds.

MRO (Money Replacement Operation): ECB open market operation in which newly printed money is exchanged for IPNs (see above) and other bits of paper originating from Club Med. See also: "Quantitative Easing".

EBRD (European Bank for Reconstructing the Deutschmark): Secretive operation run by Darth Weber of the Bundeathstar with the aim of reintroducing the Deutschmark and the Mediterranean coast as a German tourist destination rather than a financial black hole.

And now, a message on how not to trade Foreign Exchange that has been doing the rounds this morning that tickled TMM's funny bone. We would like to give credit where due, so if anyone knows the creator, please let us know:

Friday, November 12, 2010

In Case of Global Consensus Break Glass

TMM were somewhat cynical about the G20 but some of the headlines hitting the news today have given us pause for, ooh, a few seconds before we started tipping out our gold. Much of the wealth generated over the past few years has been based upon the thesis of “more of the same” – more trade imbalances, more carry trades (now supercharged with QE2), more monetary debasement and therefore higher commodity prices. So, at this time TMM have broken the glass on their macro playbook for a global consensus apocalypse. Needless to say it’s a little different to the other one we have which is reserved for a zombie apocalypse, the other tail risk event TMM worries about.

EM FX Carry Trades: Higher FX rates generally mean lower inflation which means that what you make on your FX upside you are likely to lose on rates. TMM mentioned this a while ago but really long duration trades in Southeast Asia and India look a lot less appealing than they did in the middle of the Euro Crisis. The front end and cash do look interesting though since some hikes are priced in there for some of SE Asia.

Equities: All things good for the USD are generally negativeve equities but in the medium term the picture is not uniformly clear. People in the low margin exporter business will get smoked (Li & Fung comes to mind at TMM), not to mention any other number of lower end clothing brands and outsourcing driven businesses in China. A lot depends on how these countries respond to the challenge of higher currencies: responsible policy would suggest fiscal stimulus but monetary easing is entirely possible too despite the fact it would exacerbate investment bubbles in much of Asia. To that end, its hard to argue for shorting property names, incredibly overcooked as they are, until you see what the domestic policy play is. The only braindead move may be Japan exporters which will now face a vaguely competitive position on the macro front, something they haven’t seen in a long time.

Rates: Let’s be honest – one way ticket, up. Less demand from the FX bodily fluids taking community means demand goes down just as improved competitiveness would wreck the case for QE. Rates are one of the more overcooked trades out there in TMM’s view and have the capacity to move hard and fast. Similarly, more carry driven FX pairs (USDJPY) would move quickly too and JGBs might be ground zero for the mess. Shorting these would get leverage to some very heavily over owned bonds in a ridiculously misaligned currency.

Commodities: If the world realigns, the case for an alternative currency doesn’t really check out and Gold will get brutally, horribly beaten down. TMM finds it hard to see it any other way but is open to suggestions. Industrial complex and the like will be hit hard too, though there is light at the end of the tunnel: while China fixed asset investment would take a backseat those countries with serious infrastructure and housing shortages that would now be buying iron ore, coal and the like with more valuable currencies could pick up the slack once the dust has settled.

Eurozone: TMM would normally exclude the EU from any discussion on consensus thinking, but even they seem to be coming to the realisation that something needs to be done about Ireland.

Thursday, November 11, 2010

The Adventures of Baron Von Trichet

As you have probably gathered, Team Macro Man have been somewhat bemused for a while at the extraordinary tall tales coming out of Europe associated with the past and ongoing processes employed to wallpaper over the cracks in the fabric of the Eurobuilding. This telling of unbelievable stories reminds us of the marvelous books we read as children of the Baron Munchausen and his extraordinary adventures. Indeed, Munchausen Syndrome is a medical term for an extreme form hypochondria where the patient makes up all sorts of symptoms when none exist. However, we are convinced that the form of Munchausans that Europe displays are reversed where the tall tales are used to belie the dreadfulness of the underlying disease.

During our research on the subject we found some extraordinary similarities with the dear Baron's life, as depicted in the 1988 film The adventures of Baron Munchausen (1988), and some of the current main European protagonists. We took reference from the Synopsis of the film found here . We recommend you having a quick look at the original synopsis as then you will appreciate how with a few substitutions we easily ended up with our own film plan:

The Adventures of Baron Von Trichet

The film begins in an unnamed and war-torn European city in the early 21st century (dubbed "The Age of Reason" in an opening caption), where, amidst explosions and gunfire from a large Investor army outside the city gates, a fanciful touring stage production of Baron von Trichet's life and adventures is taking place. Backstage, city official "The Right Ordinary Weber" reinforces the city's commitment to reason (here meaning uniformity and unexceptionably) by ordering the execution of a bank who had just accomplished a near-superhuman feat of bravery (Anglo Irish, in a cameo), claiming that Ireland's bravery was demoralizing to others. Not far into the play, an elderly man claiming to be the real governor of the ECB interrupts the show, protesting its many inaccuracies. Over the complaints of the audience, the theater company and Trichet , the "real" Trichet gains the house's attention and narrates through flashback an account of one of his adventures, of a life-or-death wager with the Great Investor, where the younger Trichet's life is saved only by his amazing luck plus the assistance of his remarkable associates: Sarko, the world's fastest talker; Papapapa, a man with remarkable talent for making up numbers; Mangler, who possesses extraordinary wealth, and sufficient lung power to knock down an army by exhaling; and Zap a fantastically deluded man.

When gunfire from the investors disrupts the elderly Trichet's story, the importance of saving the city eclipses the show. Trichet wanders backstage intending to die, until the exuberantly enthusiastic questioning of Sally Salt, the young lady who always asks question at ECB conferences, persuades him to remain living.

Insisting that he alone can save the city, Trichet escapes the city's walls in a hot air balloon constructed of women's underwear, accompanied by Sally as a stowaway. The balloon expedition proceeds to the Moon, where Trichet , rejuvenated by the escape, finds his old associate Sarko. but angers the Mervyn King of the Moon, who resents the Baron for his romantic past with the Queen of the Moon (Gordon Brown) . A bungled escape from the Moon brings the trio back to (and beneath) the Earth, where the God Voldemort hosts his guests with courtesy and Papapapa is found. Trichet and Voldemort's wife, Australia, attempt a romantic interlude by waltzing in air, but this cuts short the hospitality and Voldemort expels the now-foursome from his kingdom into the South China Seas.

Swallowed by an enormous sea creature called Deflation, the travelers locate Mangler and Zap, and the Baron's trusty horse ECBucephelius. The Baron Von Trichet (who again appears elderly after being "expelled from a state of bliss", in his words) struggles with the conflicting goals of heroism and a peaceful death, before deciding to escape by blowing "a modicum of QE snuff" out into the sea creature's cavernous interior, which causes the sea creature to "sneeze" the heroes out through its whale-like blowhole.

Back ashore, the Investor Army is located but the Baron Von Trichet's associates are now too elderly and tired to fight the Investor as in the old days. The Baron Von Trichet lectures them firmly but to no avail, and he storms off intending to surrender to the Investor and to Weber; his cohorts rally to save both the Baron and the city.

During the city's celebratory parade, Trichet is shot dead by Weber. An emotional public funeral takes place, but the denouement reveals that this is merely the final scene of yet another story the Baron Von Trichet is telling to the same theater-goers who were attending the theater in the beginning of the film. The Baron Von Trichet calls the foregoing "only one of the many occasions on which I met my death" and closes his tale by saying "everyone who had a talent for it lived happily ever after."

An ambiguous finale reveals that the city has indeed been saved, even though the events of the battle apparently occurred in a story rather than the film's reality. Trichet rides off on ECBucephalus. As Trichet and ECBucephalus are bathed in the light of the sun parting through the clouds, they apparently disappear, and the credits roll over a triumphant blast of music.

Wednesday, November 10, 2010


Drowning in it today. We are a smidge buried in our own little Worlds. Earning a crust coming before the hobby. So a brief one.

If you imagine that dealing in the markets is a bit like beekeeping, where you are managing lots of small independent bits of information (the bees) and if you do it well you are rewarded with Honey, then we feel that today the little buggers have swarmed. Lots of little headlines all hitting the wires which individually would be just fine but they are coming in thick and fast on all the current themes.

Last night we had US yields picking up after the 10yr auction and it that uber rate sensitive pair USD/JPY has responded in style. Is it the start of something bigger?

Dunno because we are trying to work out what the Aussie data + Chinese data + reserve requirement hikes means.Is this significant?

Dunno because we are now trying to swipe away a swarm of stories on Ireland (IMF bailout speculation the latest). Do we think that’s likely?

Dunno we are now being harassed by an attack from the Mervynflation headlines. Argentine Economics. Have to say BoE Quants on fire there. Chances of inflation being at or above 2% or below 2%? Remember, only 2 outcomes possible... 50/50... Well done chaps. Do we care?

Dunno because the Portuguese auctions are out. Are they good or bad?

Dunno because someone has just placed all the soothsayer "turn" indicators in USD in front of us... Should we follow them?

Dunno because now a load of pre-G20 whining is hitting the wires. Are they going to hold it in a boxing ring? Or one of those cage-fight things?

We know that mastery of the market would look like this:

But today we just feel more like this:

So basically, sorry, we are just too busy to try and strip the swarm, find the Queen and get them back in the box. (Though for some reason, selling AUD/CAD is singing out to us).

Tuesday, November 09, 2010

No Man's Land

The weekend has brought us little new. APEC members have once again promised not to do what they are currently doing and most likely won't stop doing, effectively turning the current FX Wars into the FX Cold Wars. Expect bags of used notes to be exchanged in shady Vienna bars, and billions of USDs to be found in bushes in lonely city parks. Smiley's people indeed.

What is interesting is the market's spin on the US jobless figures. The number of blogs and commentators downplaying any excitement of a growing upward trend in US data adds weight to our suspicions that there are an awful lot of people in denial of anything that may damage their short USD possies or their short Equity dreams or their US down the Swannee ideals. This is all looking like a perfect set up for another explosive equity up move.

The Euro data continues to look like a roll over (see chart below, Citi Economic Surprise indices: orange - Eurozone, white - US), while the US data is re-accelerating and the market is happily kicking the Euro's butt around the yard on the peripheral concerns But the move in Euro related to the post-QE unveiling of the peripheral mess feels as though it is now priced in. In other words, we will need new bad news to get this moving again...

...We are all watching for the hair line cracks in Spain to open up again as the Zapetero denial policy cant hold it together for ever but so far Spain has only leaked wider, but it's not trading like Ireland or Portugal (see chart below, 10yr Bund-spreads: white - Greece, orange - Ireland, yellow - Portugal, pink - Spain).

But the other function for Euro is what happens in Asia. China appears to have added 5bp to its 1 yr bills today, but what if they do another small pseudo move in FX to appease G20? We think that differential competitiveness matters more to Asia than purely vs US as they are frightened of losing export market share to their regional neighbours. So where China leads, the rest will follow. And less USD/Asia "Cold War" buying means less EUR/USD buying. So really, putting it all together, as we sit here in no man's land between APEC and G20, it looks like short Euro vs long risk assets is the trade for now. Looking back to the first few months of this year, that was pretty much how the market traded the Eurozone crisis to start with: growth in the US was beating expectations and Asia was going gangbusters. In response, punters used Euros to fund their long-EM carry trades. It was only when the moves in Peripherals got very ugly and spilled over to Spain that markets got ugly. So, if Spain does crack, and it morphs into a general "risk off" move, we buy USD and sell those Risk Assets effectively leaving us short EUR/USD... Phew...

Oh and one final point, we have lifted the "comments" restrictions to allow anonymous non registered contributors to return to the fun. We are hoping that US health care issues are far enough behind not to have it descend into chaos again.

Friday, November 05, 2010

Peripheral Vision

Why oh why did they allow red wine to go on general sale before they found an antidote.

Dr Market Q.E. E.C.B. BoJ. BoE. RBA. has sat a few tough exams this week but its not yet over. Today it's going to sit its NFPs. A breeze compared to Wednesday's ordeal and we kick off with expectations of a "better than expected" expected, expected loop. In true Gone With the Wind style, "Frankly my dear I don’t give a damn" but we are guessing that there is a fair asymmetry of risk with them much more likely to stimulate USD buying rather than selling. And that is only if one other function doesn’t beat it to it...

Because today... TARA!!! (trumpet noise, not a play on the name of the house in Gone with the Wind) someone has noticed the Euro peripherals. We have had this brewing for some time yet nearly everyone has dismissed the theme as "no-one cares anymore". Funny thing is you don’t care as long as the price hasn’t moved. But as soon as the price starts to move and you need to blame something you suddenly do care and, bosh, you all jump together. Yet the story hasn’t changed, just the price.

So back to those prices, Irish CDS new highs (ok, there is debate as to whether CDS is actually a good measure of anything "real" or not) and FRA/EONIA is "all bid, no lid". Euro FX-crosses have taken a beating (thank you, EUR/CHF, you are a welcome green number on the P/L), our old fave the MIB index is not going up and the IBEX is positively negative with its trend line truly bust. And in gossip-land we even have the old favourite rumour of "a Spanish bank with liquidity problems" being dug out of last May's dusty notes and being recycled, though we think this unlikely as the ECB appears to have taken on the mantle of "lender of last resort but don’t tell anyone we are doing it" and the latest talk is that it was confusion with a FunRun the bank was organising. As we type, the first punchy call "*UBS ADVISES INVESTORS TO BET EURO WILL WEAKEN TO 1.29 FRANCS". We note they are invoking the old Ex-US investment bank rule of "Never combine a price target and time frame in the same forecast". A classic "Get out of Jail free".

G20 looks like its going to be a bundle of laughs. With headlines such as "*SCHAEUBLE COMPARES QE2 WITH CHINESE CURRENCY POLICY" you really have to wonder if its worth revisiting our "Nineteen-Eighty-Four" theory.

We hate to say it but the USD may meander on QE fallout vs Euro-woe, however, you would have to think that both functions are god for gold... Sorry "good" for Gold... The god Gold. In fact, we were wondering yesterday what God's number plate on his little car (a Honda Pious we assume) would be. And we started looking through the reg plates available on the UK sites. Though GOD 1 was unavailable, having been bought by Gordon Brown we assume, we did find a useful set of XAU numbers available. The best being G20 XAU, which can currently be purchased here for £310. Unfortunately we haven't got time to trawl for all suitable market plates available so we invite you to use that site to come up with suggestions matching available plates and who you would give them to.

Happy NFP day...

Thursday, November 04, 2010

iPIGS + CBs = GSEs Redux

That's QE behind us and if yesterday was Xmas eve then today feels like Christmas afternoon, with the parents on the sofa having eaten too much QE and sold even MORE dollars. But the ADHD market kids having unwrapped their pressies, broken most, lost the rest and will be looking for something else to play with. TMM have been waiting for Europe to fill the role for some time.

As regular readers will know, we have taken a somewhat negative view of the European situation. But even we have been surprised by just how quickly the situation has deteriorated further in Greece and especially Ireland. When the Eurocrats finally cobbled together the EFSF multi-GigaEuro bailout fund, we kind of expected that Europe would manage to muddle through somehow, but present TMM with plenty of opportunities to laugh at them. We've not been disappointed on the latter, but it is increasingly looking like we were wrong on the "muddle through" bit. Mangler Merkel, attempting to ward off those nasty German Law Professors who want to ruin the European Project for everyone, has come up with a proposal presumably drawn up by Darth Vader in the Ministry of Defence Bundeathstar that essentially aims to make the lending programme permanent, but impose burden-sharing on bondholders. In terms of making the Euro more sustainable (as far as the fiscal side goes), this is much more like the standard IMF bailouts seen in the past, but there is a clear separation of fiscal authority and thus no single Euro bond. In the medium term that means that bond yields amongst the group will have to trade like EM Sovereign's external debt. Credit risk is now explicitly back on the table.

In the short term, however, TMM reckon this has an even more worrying impact. Readers might recall TMM wrote about the similarities between peripheral debt and the GSEs and the behaviour of Official FX Reserve managers back in 2008. As a quick refresher, these guys had been buying Agency debt as if it were a UST substitute, and in July 2008 when Paulson was forced to load his "Bazooka" by authorising an equity injection should it be needed, but stopped short of "explicitly" guaranteeing the GSEs. In response, reserve managers quickly came to the conclusion that they had credit risk that they didn't like and started selling in short order (see chart below: custody holdings of USTs - white line, custody holdings of Agencies - orange line). By the time they were done, they'd sold about 25% of their ~$1trn Agency holdings and replaced them with USTs.

The reason we bring this up is that the EU restructuring mechanism essentially *explicitly* says that peripheral debt is *not* guaranteed by the rest of Europe, and that if fiscal sustainability is a problem, there'll be a restructuring. Now, at the risk of causing controversy, TMM would point out at in a lot of the regimes that employ FX piss-taking intervention and reserve management, human rights aren't really too high up the priority list. And the guys deciding the allocations are running the risk of getting thrown in jail (or worse) if they take a bath on this stuff. The incentive to dump anything that is starting to look a bit too risky is clearly there. And so, when Russia came out yesterday and removed Irish and Spanish debt from the list of securities in which its SWF can invest in, our ears pricked up.

Updating our ball park model for official holdings of USTs (see chart below, green line) and EGBs (orange line), we were struck by how reserve managers stuck with Europe through the crisis, presumably the EFSF etc have given them piece of mind. But, that looks to be changing. The model estimates that something like $1.23trn of EGBs are held by these guys, probably bought at an average FX rate of something like 1.25, which gives around EUR1trn. Extending this finger-in-the-air guesstimate a bit further, if we assume that the bond allocations were by GDP weight that gives about EUR 730bn non-German holdings. Following their GSE behaviour, that would imply a sale of about EUR 180bn of peripheral debt...

Now, China has been playing the nice guy, buying Greek & Irish paper & the like, but TMM doesn't think that they included the possibility that the EU would let them sink. Funnily enough, we are reminded of Rio Tinto's jilting of Chinalco who in return labeled them "a dishonourable woman". Stern words... we wonder if they'll be used again.

But more specifically, the news-flow from Ireland just gets worse and worse, with dealers reporting huge selling (some, up to 40% of their total sovereign flow yesterday!) with only the ECB buying. This clearly isn't a sustainable situation, certainly not if Darth Weber has anything to say about the matter. The chart of the 10yr bond (see below) increasingly reminds us of the price action in a bankrupt company: long-only selling. We are increasingly of the opinion that a dash to the EFSF is imminent for Ireland...

With this in mind we are we are pulling the trigger on EUR/CHF shorts ( bypassing the USD noise) with planned stop through the 200 day moving average.

Wednesday, November 03, 2010

Was it Good for You?

Well, its only 15 minutes post but TMM can lay claim to a few things:

1) Our non-prediction was not wrong. Not bad.
2) Now that the alcohol and post-QEtal glow are wearing off, it might be time to get back to business and some actual themes aside from the dong-measuring contest that has been the last few weeks.

Europe is still an utter mess and while everyone was waiting for the Bearded Magician to pull the rabbit out of the hat peripheral spreads have gone all sorts of terrible. Hard to love the Euro here.

Asia: No kidding folks, we have an inflation problem out east. $600bn may make things cool off a bit tomorrow but borrowing at ~0% to buy stuff that has a ROE of 25%+ and get into carry trades is still compelling for the vast majority. Asset inflating we go.

Food: See above, no rest for the wicked especially in sugar, rice and just about anything else.

Bedtime for now but more tomorrow.

Fed up of waiting

This year the Xmas decorations appear to have gone up earlier than ever leaving the wait for Xmas inexorably long. And so it has been with the wait for Santa Ben. But at last it is FOMC Eve and we are sure we are not alone in feeling jubilation that finally Santa is about to come down the chimney and leave all of us market participants the presents we've been waiting patiently for. He always gives good presents. Let's just hope that he doesn't forget to include the batteries.

In terms of anticipation, the FX option market is pricing the highest overnight volatility (see chart below) since the depths of the EMU-crisis in May. And for good reason. We are unsure exactly what market expectations are, although it seems something in the region of $500-600 Gigadollars over six months is the consensus, at least from the surveys we have seen from economists and traders. But even if we knew the outcome of today's meeting, we have no idea how markets will react, with contradicting anecdotes about positioning and reactions leading them to conclude that sitting on the sidelines seems like the best strategy.

As readers know, we don't do predictions . We do "non predictions". So in line with tradition, TMM predict that the Fed will NOT announce more than $700bn and will NOT announce less than $400bn over a six month period (or equivalent). Now this is something of a cop out, but not for good reason. Experience suggests that the Fed will try their damnedest to avoid surprising the market in a bad way, and the recent leaks and furore about the Primary Dealer questionnaire illustrate that they have a pretty good handle on things. That suggests the downside floor is pretty high. On the upside, we are sure that the FOMC will be utterly delighted by the increase in inflation expectations since Jackson Hole, with 5y5y TIPS Breakevens (see chart below, white line) surging 1.17% to 3.09%, essentially equaling the highs back in April. Now this would suggest that the Fed would be cautious in terms of driving breakevens even higher for fear of deanchoring inflation expectations. The truth, as always, is somewhat more nuanced, as the Fed's own model for deriving inflation expectations from TIPS (attempting to strip out the usual caveats: funding, inflation risk premia and valuation of the deflation floor) has not risen quite as much, by 68bps (see chart below, orange line). Unsurprisingly, a good portion of this is inflation risk premia: QE2 is essentially the last roll of the Dice - there is nothing left after this. A more careful look at the chart shows that while 5y5y Breakevens did not reach March 2009 lows, the Fed's measure *did*, and was within a whisper of the levels reached in late-2008. Anyway, the point here is that the 5y5y breakeven is more followed by market participants and thus the Fed is left with a difficult balancing act between that, which argues caution, and their own model, which suggests there is more scope. In TMM's book, that argues that the upside surprise is also capped.

That being said, if you want the upside on the EM bubble and QE look no further than Hong Kong as the team a large US ex-investment bank have pointed out. Hong Kong is an odd market because thanks to the USD peg it is basically a China fundamentals story powered by USD liquidity dynamics. Whereas the Shanghai Composite tends to move in line with mainland fundamentals and liquidity conditions HK tends to be driven by what is going on in the markets more broadly. The best way to demonstrate this is looking at the premium/discount between companies with both a Shanghai and Hong Kong listing. As can be seen here, Chalco, one of our least favorite companies traded at a truly bizarre premium onshore in China in 2007 as liquidity was flush onshore, rates were high in the USD market and there was something of a property investment crackdown underway. That collapsed into mid-08 as aggressive China monetary tightening came through and loosening went on in the US. The difference this time of course is that now liquidity is flush everywhere and if anything China is cracking down on property again and talking about tighter loan quotas. For those not brave enough to play the “limit long HK, damn the torpedoes” game buying the H share premium does look fairly sensible as EM countries including China have to brace for impact from the QE Tsunami.

The other side effect of the QE announcement is to lift the veil on everything else that has been ticking on in the background for the past 3 weeks. European news as been completely shrouded and as the market has been holding its collective breath. Actually the analogy we would prefer is it has been gagging with its hand over its mouth on a bad Irish/Greek prawn waiting for the speeches to be over before it legs it to the toilets and chucks its Euro guts up. Six months ago Irish spreads going to where they are now together with bombs going off in Athens' Embassies as someone tries to incite revolution may just have seen EUR/CHF FALL. Not Rally. We are are pretty close to reloading EUR/CHF shorts just in case (we also like the soothsayer signals in it). We cant be that far off SNB relief exit levels either. It also ties in with our view on Euro rates.

Ooooooo.. is it Christmas yet? Pleeeaaase can it be. We are just SO excited, can we open it now please? Or just peak inside the paper ???

Tuesday, November 02, 2010

Food For Thought

So the RBA decided to stick it to the market once again, this time by hiking, accompanied by a pretty hawkish statement highlighting in particular that the slowdown in China looks to be less severe than previously thought. Indeed, TMM cannot help but think that yesterday's PMI data out of both the US and China have firmly moved the RBA back into hiking mode more broadly. A re-acceleration of the industrial cycle in the US is clearly bullish for its export partners (we're looking at you Mexico...), and what appears to have merely been a mid-cycle slowdown in China means that there is unlikely to be much let up in demand for things in "God's Country". But the increasing meme of Asian inflation which was added to by the Reserve Bank of India citing food prices for its own hike overnight and the possibility of QE-leakage is all adding to our previously mentioned fears of asset bubbles in Emerging Markets.

About a year ago, TMM heard a bit of shoe-phone that at a meeting of Chinese Mandarins, after one such mandarin gave a presentation upon the risks to the economy from the stock market and other potential asset bubbles within China, Premier Wen simply replied something along the following lines: "I've seen the stock market go from 2000 to 6000 and then back to 2000 and now back up to 3000... I know how to deal about that... What I want to know about is food inflation". And so, with China's Food CPI running at 8% YoY (see chart below), and slightly-less-manipulated data that TMM look at suggesting it is running far higher, the alarm bells are ringing.

But it's not just Asia. Turkey printed an upside surprise in CPI last week, with Food price inflation running at an eye-watering 15.33%, and headline CPI now running at 9.24% vs a low of 7.6% in July. Yet 5yr Xccy Swaps (see chart below) are sub-8%...

...And India, with Wholesale Prices rising at just shy of 17% (see first chart below), the 5yr OIS is hovering around 7% (see second chart below).

Now TMM totally get the QE-leakage story in terms of capital flows into Emerging Markets, but the idea that EM rates markets will be bulletproof in the face of an inflation scare seems baloney to them. The flip side of the QE-leakage story is that inflation is fueled by attempted FX intervention and domestic money supply expansion. The RBI's, and the PBoC's, recent rate hikes merely signal further moves in this respect. It seems to us that the trade here is to pay rates in EM vs being long the currencies, rather than just sitting long of both the currency and the bonds on the "search for yield" argument.

It's all looking a bit too much like 2006 in EM for TMM.

Elsewhere TMM are somewhat bemused by the Anglo/French defense deal. Would it not save a lot of time, money and angst if the UK went direct to doing a defense deal with the Chinese? Apart from the obvious benefits of making a pact with the biggest bully in the playground, we are unaware of any large national monuments in the UK dedicated to famous triumphs over the Chinese that will obviously need renaming. Unlike Trafalgar Square and Waterloo Station and surrounding environs. Of course we would happily rename the British Boxer dog in case they felt it was anything to do with a rebellion.

Monday, November 01, 2010

What a Load of Central Bankers

Here we are, the roar of finely tuned trading machines on the grid, waiting for the green lights from the central banks, is deafening. Well we wish it was. Its actually pretty dead as every feasible permutation of QE has been discussed ad nauseam (today's lucky winner is ex-Fed member Meyer with 5 Terabucks). In fact looking back at a chart of anything just shows what an un-October month October really was. I suppose the "surprise" this October was in the "no surprise". Which makes for an exciting end of year as the pressure to perform has now been compressed into the last 2 months.

But before we kick off we have to get through this week's CB-fest. So we have been doing our own spying on them, looking for clues. We didn’t really find anything of great surprise.

Fed - Have just been lent the "Euro-millions" lotto machine to use in deciding how much QE to do. Awaiting for the game show style announcement on Wednesday... "And the first number tonight is 15, the second is...

BoJ - We heard singing from their windows of an ironic version of the Vapours classic. Only this time it is "We are turning USA".

RBA - Lots of giggling and herbal smells - "you know what? We are in such a wonderful place why don't we let you lot decide on rates? We are just so high on commodities we really don’t care about the odd 0.25% anymore. In fact just leave it to that journo in a mac, you all seem to pay more attention to him than us anyway".

ECB - Saw Paul McKenna enter the building with a large watch on a long chain muttering "look into my eyes, not around my eyes, into my eyes .. Europe is just fine and those blow outs today in euro-peripheries are just the market's way of saying how wonderful your policies are. Oh and don’t forget to say Viiigiiiilent".

BoE - Saw a large package arrived marked The Gaucho Grill with Argentina postmarks. We suspect it was bought from the Kirchner estate having previously been used to incinerate all traces of inflation contaminants from your otherwise tenderest of data.

Back to sleep.