Thursday, May 05, 2011

Was that the "Gong"?

TMM "Note to self": USD/JPY will remain difficult. DO NOT TOUCH. We are out of that one as the mood turned "carry off" in general. The EUR/GBP we will hang on to.

TMM must admit that, as optimists on the US economy and having taken a constructive view of equities this year, they have found today's post very difficult to write. This is because after a pretty good earnings season (where revenues posted their largest upside surprise since Q4 2004) equities still look pretty cheap on their valuation models and have been remarkably resilient in the face of several idiosyncratic shocks this year. While Q1 growth data disappointed to the downside, certain survey and supply side data were suggesting a reacceleration to around 3.6% annualised GDP going into H2. Indeed, today's post was - until yesterday - going to be about how TMM were coming around to the view that the bond market was overpricing the risks to growth (based upon a combination of arithmetic and forward real rates) and that they were getting to close to pulling the trigger and going short Treasuries. But yesterday's Non-Manufacturing ISM data have them wondering if the "Gong" has just been rung...

In an eerily similar manner to 2010, the US data has begun to roll over, with Non-Manufacturing ISM adding to the list of Philly Fed, the Global PMI and Jobless Claims. As above, TMM's GDP model (see chart below, white line vs. actual GDP - pink line) had been, until recently, pointing to growth in the 3.6-3.7% annualised region. However, the most recent survey data have led to a dramatic reversal, with the model now consistent with annualised growth of just 1.6%. Now, the model not even close to perfect (it does not include household or government consumption inputs, for simplicity), and certainly, it is possible to argue that the most recent data may be the product of statistical factors related to a late Easter, but it is hard to ignore the fact that a trend in the data has emerged and it is increasingly looking like the US is once again growing sub-trend, widening the output gap further.

Regular readers will be familiar with the below chart of Economist 2011 GDP consensus expectations lagged two weeks (white line) vs. the 5y5y forward real rate (orange). Obviously, both have been moving lower over the past month, with the bond market seemingly settling at just below 2.8%, while analysts have settled on 2.9%. Plugging in 1.8% for Q1, that would suggest in order to match the economists' yearly 2.9% figure, that GDP would need to be growing at an annualised 3.2% for the rest of year and a mere 3% under the bond market's pricing of growth. Until yesterday, TMM thought that was not a big hurdle and that the time to short Treasuries was near. However, if the model prediction of 1.6% is plugged in, that would require H2 annualised growth of around 4% (or 3.9% under the bond market metric), which is a significantly higher hurdle. TMM are increasingly concerned that markets may be sleepwalking into a growth scare...

...particularly ahead of tomorrow's Payroll report, about which TMM's model (see chart below, orange line) reckons economists are overly optimistic in looking for a 200k private jobs increase vs. 110k on our model.

The trouble for markets, and growth expectations, is that real rates have fallen a great deal in past couple of months, such that the 5y5y forward real rate is now plumbing levels usually seen prior to a Fed easing. Under this prism, it is hard for nominal yields to fall much further unless either inflation breakevens fall and/or the Fed eases further...

Oh dear... we said it... could this be the time that the "Gong" rang for QE3?

Or rather, the time the "Bell Tolled" for Equities and risk assets more broadly?

The below chart shows 10yr yields (white line), 5y5y breakevens (orange line) and 5y5y real rates (yellow line). In 2010, real rates initially fell in response to slowing data but then gradually dragged breakevens lower as well to the point that a growth scare morphed into a deflation scare. Sure, real rates can go a little lower, but TMM suspect that with commodities being given the short shrift that it will be breakevens that take leadership.

In short, TMM have found this a very difficult post to write upon the backdrop of their, up to now, optimistic views of growth. However, given positioning in EMFX and equities, a demonstrable turn in the macro data and little room for the bond market to cushion these growth downgrades that we are at an important inflexion point. TMM believe that either the data has to rebound sharpish, or else talk of QE3 is likely to intensify in the coming months. TMM are struggling to believe that they are writing these words...

It is a shame, as we had hoped that the US would tough it through to the point where they became competitive enough to re-compete against the new world, which is all the more frustrating as that cavalry may well be coming to the rescue in the shape of the stories in the FT today on US competitiveness re: China and Siemens' concerns re: Brazil hint that that structurally the way companies think may be changing. But will they be in time to make it a Waterloo rather than an Alamo.

25 comments:

Anonymous said...

As I said yesterday's post this does not add up to any overcomplex expanation. It simply appears to be a overplayed growth story on rpicing leading to a risk off readjustment of a depth I don't know.I wouldn't however be shorting treasuries. Indeed either sitting on cash ,or just balancing income strategically across bonds and defensive bluechips all look preferable to continuin to ride the inflation risk on trade which can we not agree has been priced to perfection?

Anonymous said...

the consumption based US economic model is broken and had been for a while. higher commodity prices with gas closing in on 4$ just kills average folks spending power.

break-evens should narrow as QE only supports price levels whilst switched on (flow) versus other measures ... plus lower real estate values imply higher tax rates applied by municipalities. the curve should continue to flatten as tightening proceeds domestically (and globally).

the rotation towards defensive stocks is real money reducing risk in advance of on the end of QE. as to whether we will see QE3 ... well that's a function of how low oil prices go over the next few months.

CV said...

Don't be so sure about the USD/JPY TMM. I think long the USD index (or long the USD/JPY) and long Japanese beta is a good bet here on the idea that the BOJ is going to "out-QE" the Fed and thus that the JPY becomes the new carry funder.

I mean, we have seen this before and it was a joyride :).

As for the general growth scare, it is definitely coming, but in the second half. Q2 US GDP should be quite strong. I am not however completely foreign to LB's idea that the US will be in a recession by the end of the year, but we need to see serious deterioration in the data for that to become the main scenario.



Claus

Anonymous said...

One Nobel laureate I think did think through to the point where the US becomes competitive enough to re-compete. It is thought that this point lies somewhere on the back of an envelope...

...in the mid 60 s






I however have some trouble seeing the EURO at that point.

CV said...

Right Anon @ 3.05, this is all well and good, but Japan will be printing 3-4% of annual deflation at that point and thus before that happens the fiscal doves will take over the board room of the BOJ and we will get QE Nipponaise.

Now, they might try to fiddle with a hike in the consumption tax which we know will be DEFLATIONARY over time as it was in Germany. Anyways, this is just my own pet idea on Japan.

Obviously if the USD rocks towards ever new lows from here, I will be long stopped out and gone.

Yet, I do note that the Euro longs are taking a crap today since JCT did not feed the Eurotriches with a hike.

Claus

Leftback said...

One of the few things yours truly got right these last two weeks was that we would see a sharp reversal in EURJPY. The claims data today were shocking really, even worse than my own fears and other people's "soft patch" forecasts. So given the accuracy of the TMM model we may well see a weak number tomorrow, but that would seem to have been thoroughly priced in by the Treasury market now.

What was shocking today was to see DXY rise on the weak data (plus JCT comments, obviously). Weakness in crude and other commodities is probably forcing some unwinding by dollar shorts, and yes, that argument is obviously circular!

I am strongly in agreement with Claus on a rotation here from USD to JPY as funding currency for carry trades. That means the party isn't quite over, but all of the weak dollar trades are largely done. Big industrials, exporters, miners, oil companies will all take a back seat when the next phase of the equity rally begins.

Nobody and I mean NOBODY likes Japan, valuations are cheap, and the BoJ simply has to sell the yen sooner or later. Long Nikkei, long USDJPY looks to me like a really good trade for Q2. If you want a pair then long Japan:short (choose a BRIC) would probably deliver.

Nemo Incognito said...

LB, have been eating some significant (though not too bad) pain on SGDJPY. Still a believer though and do think JPY is it now.

Ok, so I just sold all my silver puts as of a few minutes ago. So - I think I have a new car to order. That 100bps of the book turned into 800 rather nicely.

I think this unwind of the mining names and industrial metals trade is long overdue and likley to continue. For a lot of perma commods bulls this has been a lot of pain very very quickly. I can't help but feel that what has made it all the worse is silly season CTA inflows.

Leftback said...

Nice work on the silver short, Nemo.

Look at the CLAVADISTA D'OLIO ... amazing.... but, but what happened to those "Nigerian incidents", "Libya" and "Chinese drivers"...? Does anyone here remember the bloke who ripped my head off for suggesting crude was massively leveraged to the dollar? Krugman, of course, will tell us this is just "supply and demand"...

Did 7% of drivers just drive their cars off a cliff before lunch, Paul? Come on....

mw said...

Nemo

Seems like a no brainer now but nobody wanted to touch those puts a week ago, very nicely done.

I agree about base metalsand the perma commods bulls experiencing lots of pain. Funny though I still hear from many of them that this move down is time to buy more. Talks of 'demand inelasticity' and the like. Just makes me wonder how long they'll try to keep the party going before throwing in the towel.

Anonymous said...

Am I the only one thinking that this is only a 'sell in May and go away' play?

Leftback said...

Bloody hell, look at crude.... this is epic....

There is surely no way that the market can hold up here with major sectors surely about to crater in an absolutely massive way (mining and drilling).

Just when you think you've seen it all in this crazy insane casino.

I should deliver a lecture on Disorderly Carry Trade Unwind to a class of one at Princeton (that's you PK, not BB). Surely the only Nobel Laureate ever who really should wear a dunce cap....

Leftback said...

The Champions of today's contest for totally inappropriate FX positioning are not, as one might suspect, ZAR longs or AUD longs, it's actually those who are long the mighty NOK. As a consequence all of the Scandies are as of this minute being taken behind the woodshed and soundly thrashed:

USD-SEK 6.2206 0.1233 2.0216%
USD-DKK 5.1343 0.1051 2.0894%
USD-NOK 5.4707 0.1494 2.8078%

That might finally mean a pint of Carlsberg for under $10 in København..

Leftback said...

I guess Silver was the piñata, this year.

This is almost painful to watch.
"The screens, nurse, the screens..."

Anonymous said...

"I should deliver a lecture on Disorderly Carry Trade Unwind to a class of one at Princeton (that's you PK, not BB). Surely the only Nobel Laureate ever who really should wear a dunce cap...."

There was a time, not in the too distant past, when a one-day 10% move in a given market was so rare, that when it did occur, it would lead to years of talk and analysis among academics and professionals. But these events are now common and routinely happen in different markets at least once month. Everyone wants to enter and exit at the same time. Risk management has been flushed down the toilet. Everyone is glued to their Bloomberg terminal/twitter feed/blog/etc, waiting to hit the enter/exit button at the same time.

Leftback said...

What else can happen? Max pain tomorrow would be a STRONGER than expected jobs number, then the new Treasury longs would also get hosed, DXY would rally again and the commodity longs would be hauled out from behind the woodshed where they are presently whimpering and be nailed to a cross.... this market has no mercy.

Anything you think can't happen, does.....

CV said...

Under 10$ ... that'll be the day LB. But it is all very beautiful. The local media made the point today that Danes should start planning a trip to the US as the USD/DKK was heading under 5. It makes sense though. The Scandies have been the recent, "under the radar", high beta play on a global recovery. All this while Danish banks are still going down the drain faster than the good ones can decide who should buy it this time.


...busted...

But yes, I feel for the commodity longs today. It is all extremely painful. Especially those long the grains ETF (which closed at mid day). It will probably open tomorrow morning well below many a stops. Don't you just hate to be taken out even without you have had the chance to fire back ...


Crude is pretty much in a spiral of death. Even natty is down 6 odd percent which is just plain unfair I think :).

Claus

Anonymous said...

You don't mean these markets don't have liquidity surely not!
Will people ever truly learn because it appears to me the answer is no.Time after time they pile into something and find reason after reason why it's the real deal.The only word that comes to mind is,morons.

Sid said...

My respects go to the stout and sturdy equity market. Hold on to it, man!

Anonymous said...

LB,
If you want to stand in front of this lot pinning hope on an as yet unknown number to make a winning trade please be my guest and go ahead. Numbers this week would only be offset I suspect by some suprise of unlikely magnitude. A littl better than expected would be like throwing pebbles under a steam roller.Persoanlly I do not care for the odds.This sounds like one of your less thought out posts coming on the back of whats been a giddy day for the markets.

CV said...

@ Anon 9:15:

Right, but I am not pointing fingers. A commodity bull losing the round today may still very well have won the preceeding 11 rounds and thus walk away with a nice profit.

And hey, didn't the Squid issue a bearish commodity call a week back. This is all going according to the plan folks. Have no fear.

Claus

Leftback said...

Anon @ 9:22

No, no, no, squire. You misunderstand my slightly tongue in cheek comment. I'm not in fact expecting a strong jobs number, mate, not at all. Simply examining the universe of possibilities within The Matrix, that's all, I'm not a pennies/steamroller merchant. Still, strange things have been known to happen....

Anonymous said...

LB
I would have been surprised if you had been actively recommending the actiontomorrow.You don't strike me as that sort of gambler.

No Donald Trump moment ..f..k u market I'm telling you what to do!

Leftback said...

A good day to just stand around and watch, eh?

Anonymous said...

LB
Yes I think so. The big question surely is how many portfolios are going to rethink where they want to be at the end of QE?It's been pose that there will be a buying problem for US debt unless yields rise as QE closes. Yet it appears to me that with uncertainty over whether econmic activity can actually stand up without QE we are going to see increased volatility and at least some protfolios will try to manage that by increasing their holdings treasuries which may find safe haven status again when it counts.
I'm simply not in the sell treasuries crowd yet.I think part of the markets been preparing for this moment since February or there abouts.It's a macro thing you know !!

Anonymous said...

There's still not much wrong with them Scandies. In a somewhat different way to Swiss, they somehow appear to have ended up in the right place at the right time and it's not just beta, methinks.