Of Europe, some tigers, and a coffin

Tuesday, January 18, 2011

As we have mentioned the 3rd week of Jan is when a turn to the start of year favourite trades often occurs and tying in a US holiday adds greater weight. We were looking for the Euro negative consensus trade to start to unwind after the auctions and so far so good, but more on that later. The equity story isn’t quiet so clear though. Our ideal scenario would have been for a flat lining for the first two weeks that would now accelerate, but the steady climb we have seen so far means that any turn to further strength would have to be stratospheric to effectively mark a change. But as things are currently set technically, it is more likely we see a dip. We have strong soothsayer turn signals that matured on Friday’s close and we have even had a perfect catalyst added to the mixture in Steve Jobs taking medical leave- This has not been received well by the market or holders of AAPL but TMM wish Steve all the best and a speedy recovery – not least of all because he appears to have orphaned a number of hedge funds. In the interim we are taking out an ad in the local paper:

5 Tiger Cubs Available For Adoption

Recently orphaned in tragic circumstances from their favorite trade. Looking for a loving home. Cute, cuddly and good at visiting companies, doing fundamental research and finding cheap stocks.

So there are two big antagonists in our short term view on equities. The techs and AAPL vs our background beliefs and a relief rally in Europe.

Now, more on that Europe function. As we have often mentioned this year, the desperation to stay short of Europe is palpable through the interpretations and biases applied to any Euro related headlines with the negatives lept upon and any positives gently put to one side. The core issues the market has been focusing on up until now have been the auctions and the expansion and scope of the EFSF. Well it looks as though Spain have already managed to complete 60% of their funding needs ‘til April and that any EFSF decision will not come before March. That means we have 6 weeks of waiting and we can’t believe the market can sit still on their hands, or shorts, for that long without looking for other functions to trade in the interim, similarly to last summer when the European STFU policy shifted attention away to the US.

So TMM have spent the weekend thinking a bit more about the Euro and are increasingly of the opinion that even after the fluffy bunny took a bite out of the shorts last week, that the Drachmark has a great deal more upside, and wouldn't be surprised to see it pushing 1.40 over the coming weeks. And here is why...

While the recent talks related to expanding the EFSF and changing its remit aren't necessarily game-changers, it seems that sentiment is still very much in the camp of "they'll never come out with anything" or "the Germans won't agree to it" etc etc. Indeed, the tone of many of the trader wraps and IBs TMM received towards the end of last week and the beginning of this week was one of little expectation of any anything concrete materialising. The interesting thing is that despite early attempts to trash the currency and bonds this week that we've actually moved sideways, perhaps helped by the A-Team reassessing their issuance and bank strategy. TMM was impressed to see the ECB rip the faces off bond shorts in the days before last week's Portuguese, Spanish and Italian auctions, resulting in the Portuguese getting away paper at lower yields than last November. While used to then seeing them say something utterly stupid, or pull back from a policy, this week the Spanish (and today, the Belgians) decided to cancel auctions and replace them with syndications. This is an interesting strategy that, if managed well (i.e. - unlike Greece's syndication attempts last year), results in certainty of yield for both the sovereign and for investors - yesterday's Spanish syndication, while paying a slight yield premium, is clear evidence of the success of such a policy. Additionally, one of the chief Eurostriches, Zorro (a.k.a. Zapatero) began to talk about a renewed recapitalisation of the unlisted banking sector in Spain and as we have already mentioned, Spain has now already covered 60% of the debt maturing in April (the chart below shows the upcoming debt maturities, courtesy of the nice folk at Deutsche Bank):

But there are other reasons why TMM like the Euro. Last Thursday, Baron Von Trichet (presumably as a result of the Bundeathstar being aimed squarely at him) did his best to warn the market that inflation, while not yet alarming, was increasingly inconsistent with the ECB's mandate and, notably, reminded European rates traders of the July 2008 hike. Now, TMM remembers the preannouncement of that July 2008 hike very vividly, mainly as a result of the P&L decimation that arose as Non-Inversion Notes blew up the European rates market, and feel that many European rates traders will have similarly remembered that standing in the way of the train is not a particularly pleasant thing to do. As a result, Euribor has taken something of a hit, and TMM reckon it will remain a sell on rallies for the reason that if the ECB is starting to talk about rate hikes, we have a long way to move given that the extraordinary liquidity provision has only just been priced out (i.e. - EONIA to rise to the 1% refinancing rate) by July (see below chart of forward EONIA, courtesy of TMM's mates at Nomura).

As regular readers will recall, TMM still expect the Fed to remain on hold all year given the still large output gap, and therefore US rates markets still have room to rally, and over the past couple of weeks it is notable that the US vs. EU rates correlation has fallen sharply as RV trades have been put on between countries that are likely to see rate hikes and those that aren't. As a result, TMM expect the recent widening trend of 2yr EU vs. US rates to continue, providing support for EURUSD. Adding that to the calming in peripheral bond & CDS markets and falling financial volatility (see VIX), TMM's EURUSD model (based upon these variables - see chart below: white line - model, orange line EURUSD) which, while far from perfect, has provided a reasonably good guide to trading the Euro over the past 6months, reckons that the pair should be closer to 1.38 than 1.34.

Given that the underlying variables are all moving in the same direction, call us heretics if you like, but we like EURUSD higher yet...

Finally, before we go, a quick newsflash: After today’s UK CPI figures we have had this update on BoE monetary policy...

UPDATE: TMM think it is time that Mervyn King got the sack.


...compare and contrast with....


Posted by cpmppi at 11:35 AM  


Sorry but you have 2yr Eu at 1,21% and 2yr US at 0.59%, i REALLY like to buy a convergence trade, Schatz is pretty cheap.. core inflation is at the same level and we have disaster in EU periphery... commodity inflation is caused by fed policy, for ECB to hike rates is the wrong move, just as they did in 2008!


FdTriGuy said...
4:36 PM  

Euro looking a bit wobbly late in the day... The move from below 1.29 felt like a case of shorts caught offsides.

It would be most curious were the Euro debt crisis of 2010/2011 go out with a whimper instead of a bang, as might one might infer from TMM's prognostication.

Anonymous said...
5:03 PM  

looks like from nomura chart that paying nov or dec ecb dates still not a bad trade ... we should have 1 full hike priced in before year end ... hence shatz not cheap ... whether they hike or not is a different story that depends on data in q2.

Anonymous said...
5:14 PM  

Agreed with anon at 5.03. Certainly acted like a EURUSD short squeeze - interesting to see US equities not following on from Europe today.

Generally there is a lot more banging before the whimpering happens. Even if this isn't the way the world ends, Greece still looks a lot like an economic Waste Land.

Leftback said...
5:58 PM  

Anon 5,03 and LB,

Agreed yes it would be amazing if the European issues just went out with a whimper and I doubt they will. But they will probably come in waves. I think this could be similar to last summer when equally the problems hadn't gone away but the STFU policy managed to move the market on to worrying about other things and we saw eur/usd grind all the way back to 1.4000 as everything went QE.

Yes its a squeeze but its a squeeze we don't think is over and we will need to see a lot more +ve eur/usd commentaries circulating before we think it is.

Fabio - the ECB are blinkered by their mandate. And so however much Italy scream due to their correlated funding costs it might be like screaming in space.

ANON 5.14 I dunno .. year end is an awfully long way away event wise..


Polemic said...
8:41 PM  

Polemic, one of my lady friends agreed they will come in waves... hope we don't see 1.40, I would find that... disagreeable.

The US YC reached dizzy heights again today with 2s30s tickling 400 bps. Chances are, one of those ends is going to move, and LB is going to bet on the rear, since the front end is nailed down.


Leftback said...
10:17 PM  

PoLIMEC, fantastic short squeeze , I'm sure V placed bets before getting in the peripheral bond queue, though you'd have to check that one out ( bonds).....anyway I'm still in the bar waiting for my race.....

Whew..just finished reading an abundance of 11 forecasts, their all split in half.....first half this , second half that.....not a word what rates will be around when QE pumping starts to dissipate and the various perceptions proportionate to the background macro, see what happens anyway.

Don't like it,TMM, just don't like it.....

FX said...
11:59 AM  

Respect. Great call on the short squeeze. Having been on the receiving end it is a reminder that it is difficult to fight the dark forces of the Bundethstar and a central bank in this part of the world.

LB, great Ashes win for England. Very comprehensive. Respect there as well. Punter is gone...

Skippy said...
2:14 PM  

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