Central Bankers and their Big Brass Balls.


A couple of weeks ago the world seemed pretty sure of how Ben, Abe and Dr. Aghi were playing their hands.

Ben's crowd were going to be tapering off on QE whilst Abe was going to do the heavy lifting from here on out and Dr. Aghi, having surgically removed the tail risk, was on look out and even preparing the ground for further easing and potentially negative interest rates to counter a dire European outlook. To that effect the obvious trades were to be long USD/JPY and Nikkei, gently short Euro, be long Euro Equities and to be starting to lighten up on US equities.

Then things started to go a little off course. US data become steadily poor enough for tapering of QE to be reconsidered and see the dreadful term "detapering" introduced - Here we would like to remind you of TMM's rule of ISMs - "Every time the ISM dips below 50, the Fed follows with an ease (rates or QE) "



To this end equities stopped sliding (temporarily) and started to respond inversely to bad US economic news and the Usd started to drift off, most noticeably in that most QE of crosses, Usd/Jpy.

But hope was at hand as the market waited for Abe to come to the rescue with Arrow 3, which was becoming all the more important because shake-downs in everything "Abish", though still being termed "healthy and corrective profit taking", were just starting to introduce elements of doubt as to the immediacy and uni-directionality of Jpy and Nikkei. If this slippage hadn't started occurring probably less necessity would have been attached to the potency of his 3rd arrow comments but as it was, the market didn't get a speech worthy of a Churchill or Eisenhower and as TMM alluded to in the last post, have started to worry that the all powerful Wizard may just be a small man playing around with levers, smoke and mirrors. So down we went again in Nikkei and USd/Jpy, already weak, was given another kicking.

But on the sidelines something else was happening. Carry trades in general had started to catch fire and the lack of guaranteed Japanese action set that nightclub without adequate fire exits that TMM have been warning about for a while, High Yield Emerging Market, alight and the few exits were getting more than a little busy.

So it now fell to the ECB where Dr Aghi's reputation for cool creativity has remained at "David Bowie" levels.

However expectations for a dovish ECB were smashed today. In particular, Draghi’s statement that “price developments should remain in line with price stability” sounded neutral and this sent EUR carry trades, especially Euribor contracts, south sharply, with a concurrent rally in the EUR. Meanwhile this was like a bucket of petrol over EM Bonds and the slits of exits couldn't cope. Italy and Spain were caught in the ECB / EM crossfire and both 10yrs put on 20+bp.

With it now looking as though the QE baton has been passed back to the US, Usd/Jpy and associated NKY then melted in the flames.

No wonder we have had such large movements with perception of CB policy in all three major areas changing within the space of a few days, leaving people worrying that Abe might not be Superman, Dr Aghi might not be Super Mario and Popeye Bernanke may have to go back on the Spinach.

But lets look at them one by one, first the ECB.

Now, TMM is puzzled by Draghi’s statement. Because despite Draghi’s proclamations, EU Inflation expectations are NOT close to the ECB mandate. Below is a chart of 5y EU inflation expectations. We are now at levels from last summer, and before that 2010. At 1.5% for 5 years, TMM thinks any rational observer would conclude that the ECB is missing its inflation target of ‘close to, but below 2%’ by a sizable margin.



A possible explanation is that the ECB is trying to exert pressure on EU politicians to continue fiscal reform efforts, which has eased of late. In the final paragraph of Draghi’s statement, he said: “the Governing Council considers it very important that decisions by the European Council to extend the time frame for the correction of excessive fiscal deficits should remain reserved for exceptional circumstances”. Whilst TMM remain comfortable that data in Europe IS bottoming and that tail risk is not there (despite the sudden resurgence in European periphery yields), perhaps we should be concerned that the ECB, without immediate emergencies (tail risk) to deal with could be back to operating within their normal confines of inflation targeting and, comparatively to OMT swift action, may be perceived to be becoming sluggish in response.

As one wit posted to us.. "*S+P DOWNGRADES DRAGHI BAZOOKA TO WATER PISTOL"

But TMM think that the usual oscillation in expectation and outcome for ECB meetings will result in a swing at the next event with Draghi producing a "more Dovish than expected" result.

So what about Abe? It's all about confidence and TMM have been wondering just how much of the past few months rallies in Nikkei and USD/JPY have been the result of expectation and how much due to real action. Because if he lets this one slip and confidence of success vanishes, then so will the expectation and we will retrace all of that component. Which we feel is most of it. So with that in mind TMM really don' t think he will drop the ball right now and he will put on a show next week.

And the US? We have been throwing around all sorts of arguments and analogies, most of them medical ranging from tearing off the plaster of QE as quickly and painlessly as possible, to continued methadone prescription, to amputation and stem cell therapy. Once again, as with Japan, it all rests on continued confidence and here we have a balance between confidence in the continued supply of liquidity if the economy needs it against confidence in long term Fed policy, the two being slightly different. The other point of confidence is who follows whom. the market the fed, the fed the data, the market the data or the Fed the market. We would prefer to think that the Fed will, as they keep stating "do what is necessary" (as the ECB also keep saying) to which point they will try and play the Goldilocks scenario of just the right amount for any situation.

We would like to remain confident that despite the wild oscillations in central bank expectations the central bank Governors are indeed Governors - Those big Brass Balled governors on the steam engine of the World's economy and they can’t afford to choke off what confidence may finally have emerged.



One could argue that if this is the case then the medium term outlook for equities is pretty flat as the governor functions operate, so selling 1650 straddles in S+P, particularly during this recent high vol may not be as mad as it may currently appear.

The fly in our ointment is Emerging Market fixed income, where positions are being burned alive. Could this become contagious? Well the most encouraging sign we have is that the countries suffering bond grief, such as Mexico actually had positive out comes in equities as that was happening. We are positioned for more grief in the likes of Indonesia and other structurally worrisome emerging markets that have been recipients of blind yield hunting, but don't think that the developed markets, with their brass balled governors are going to fall. In fact European equities are tempting us again.

Finally, to cap off a week of mayhem, we have the NFP lottery today. TMM won't put in a prediction other than to suggest it will "surprise".





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Anonymous
admin
June 7, 2013 at 8:39 AM ×

C Says
It's sad that virtually all scenarios today are explained in terms of what central bankers will do.Apparently good macro analysis now requires us to be Mystic Meg and our chief weapon the crystal monetary policy ball. Free market,you have to be joking.

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amplitudeinthehouse
admin
June 7, 2013 at 8:54 AM ×

Thanks.

It hasn't been hard to find out who and where the market players are going with this one

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amplitudeinthehouse
admin
June 7, 2013 at 9:33 AM ×

I forgot, Shove the Qe market up your ass!

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Anonymous
admin
June 7, 2013 at 10:04 AM ×

Well, the Nikkei would have closed much lower today, had it not been for the surprise announcement during the market, that there will be a press conference at 3pm, to discuss the new investment guidelines of the government pension fund. This caused a 400 point up move.

The 3pm announcement was even worse than he third arrow. "The GPIF will increase the allocation to domestic stocks from 11% to 12%". Really ??

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abee crombie
admin
June 7, 2013 at 11:28 AM ×

As much as I agree tmm I am pondering the possibility of Japan being a harbinger for US. will have to see secondary reaction first. Many Japanese stocks were crazy over bought ( Mazda,fast retail,) and the 'bull' market in those type of stocks happened so fast. So it doesn't surprise me of a big pull back which I want to keep buying. But if yen can't get above 100 and Nikkei doesnt outperform I think filling ones boots may be a bad idea come October ..for now I'll buy the dip and watch the news. But the real tell will be in the strength of the reactionary move.

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Anonymous
admin
June 7, 2013 at 12:38 PM ×

Oh my. Those worthless June USDJPY puts came out handy yesterday.

Bit of a "50 quid in yesterday night's trousers pockets" feeling there.

Detapering Partners LLC did some more boot filling yesterday, hoping the "goldilocks of just the right amount" as TMM puts it will help us sell back to unsuspecting Great Rotationers the fixed income vehicles they sold to us in the past couple of weeks.

Now, if +400k comes up, this is probably going to hurt "a bit".

DD

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The Engineer
admin
June 7, 2013 at 12:43 PM ×

Through the graphic, is MM suggesting we should remember "the tragic bit/ There was no way of stopping it (QE)"?


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Polemic
admin
June 7, 2013 at 2:16 PM ×

Engineer. Like the film Speed

Actually factoid of the day.. the phrase " Going balls out", as in "flat out" is derived from the top speed spinning of the centrifugal governors on old engines...

Here endeth the lesson..

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intrinsic value
admin
June 7, 2013 at 2:44 PM ×

Suprise as in steady as she goes. the Aid did not like it as much

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intrinsic value
admin
June 7, 2013 at 2:46 PM ×

Aud

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Leftback
admin
June 7, 2013 at 2:50 PM ×

The surprise was there was no surprise. Very happy to have been on the sidelines watching the insanity for most of the last three sessions. In this context, being long fixed income and selected dividends and preferreds counts as "on the sidelines", as in no beta.

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Anonymous
admin
June 7, 2013 at 3:35 PM ×

c s'
"as in no beta"..ditto

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Leftback
admin
June 7, 2013 at 4:45 PM ×

A predictable squeeze yesterday and today. Probably didn't matter what the effing number was today. It was just time to sell vol, and that's a powerful force in these markets.

Today's trade? It is probably buy US fixed income and sell Euros. Monday we will have all this NFP in the rear view mirror and the US and European economy will still suck giant donkey d*ck.

Today is a good day to draw up a load of Fib retracements in your favorite instruments... if the VIX sticks at 15 then we are going to sell this bounce, but if it bleeds down to 12 again, then we are all going to be forced to go on another low volume trip to the stratosphere in our brand new Tesla. Probably depends on whether carry trades can be stabilized or not.

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Leftback
admin
June 7, 2013 at 5:30 PM ×

SPX 1650 is the 61.8% retrace of the move from 1687 to 1595. So for those who don't subscribe to the view we are in a 1999-like brand new paradigm, that's where this dead cat bounces to.

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Leftback
admin
June 7, 2013 at 7:11 PM ×

Nice graph here of USD v SPX correlation. Last year when we were in what we then called RORO world, these assets were anti-correlated and USD was only positively correlated with Mr Bond. That was before Abenomics, and Yen Carry, obviously.

Dollar Stock Correlation At Extreme Highs

With USD and SPX at extremes of correlation, the suggestion here is that this would at least revert to the mean, so we will see decreasing correlations between these two. So perhaps DXY strength will be negative for equities again in the coming months, and correlated with Mr Bond (Dollar Carry resumes). Again, whether this happens will depend on the fate of the current bout of Abenomics.

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June 10, 2013 at 6:34 AM ×

It all comes down to central bankers - who's printing and how much?

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June 11, 2013 at 7:18 PM ×

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