Sacred Cows

Although Macro Man has focused largely on equity pain trades over the last few days, stock markets are from from the only place where the consensus has come a-cropper.   Indeed, the recent strength in fixed income is an obvious source of pain, particularly given that US 10 year yields have retraced more or less all of their rise since last month's Fed meeting.  Today, however, Macro Man wishes to address foreign exchange, where a number of sacred cows have recently been ushered into the abattoir.

Ever since Ben Bernanke first mused about a possible tapering of asset purchases last May, markets have erred on the bullish side of the dollar trade.  Ironically, of course, the immediate impact of the "taper tantrum" was to send USD/JPY hurtling lower as both the Nikkei and consensus positioning were taken to the woodshed.

If at first you don't succeed, however, try try again, and the ensuing quarters have seen the market layer long-dollar trades against an array of currencies- notably the JPY, CAD, AUD, and selected EM.

To be sure, towards the end of last year these trades worked brilliantly as the market began to price in the beginning of the end of QE3.  While there was clearly the occasional hiccup to start 2014, after Yellen dropped her "six month" bomb, it seemed like only a matter of time before George Washington would once again be the baddest man in the market.  Indeed, Macro Man noted last Friday that USD/JPY was closing in on its highs and wondered how much risk the market still had.

Well, thanks to the analytical powers of his partner Harold H. Hindsight, it seems as if the answer was "too much."   Too much, at least, to hold up in the face of what seemed like a startlingly upbeat Kuroda after Tuesday's BOJ meeting:

"I don't want to give the impression that we are stubbornly against stimulus, however given that macro fundamentals are on track, we are not considering additional easing at the moment...."  (translation courtesy of BAML)

Ouch.   Unsurprisingly, USD/JPY has taken a swift journey to an important layer of support.....



What's particularly troubling in this instance is that it's removed one of the few obvious catalysts for USD/JPY to power higher (higher US yields being another, missing, catalyst.)   What's interesting about the whole Abenomics trade is how much of it has been predicated on expectation rather than deliverance.  For all of the anticipation over the past eighteen months, the BOJ has only forcefully delivered once.   Since late last year, the prospect of further easing has tempted USD/JPY longs like a will-o-the-wisp, dragging them further into the boggy marsh of consensus positioning.  The timing of the hoped-for next easing has been pushed from January....to April.....now to July or beyond.  Hey, there's always the GPIF....

Meanwhile, we have now exited the favourable seasonal period for USD/JPY  and have entered the long, cold Antarctic winter of yen-short discontent:



Another pink flamingo popular trade this year as been long USD/CAD as markets have fixated upon Canada's twin worries of persistently low inflation and weak export performance.   Not without cause, mind you; the Poloz BOC, while careful to mind its p's and q's, has offered a knowing "nudge nudge, wink wink" to those who've concluded that a weaker CAD could offer a handy solution to both problems.

Alas, while the trade was a prized heifer in January as USD/CAD ripped more than 5%, it has spent much of the subsequent period in the queue to become steaks at Farmer Market's next dinner party.  Simply put, the data simply hasn't cooperated.   The last two core CPI readings have both exceeded expectations, which is bad enough.  So have the last two trade balances, to make things worse.   To top it off, the prior data was revised, which lopped a third off of the average trade deficit of the prior six months.

Far from ascending the giddy heights of the mid to high teens, as was widely expected, USD/CAD now rests on critical support around the 1.09 -1.0910 region.   A break below and there's little but fresh air (or is that methane gas?) until a 1.06 handle.



Unfortunately for CAD shorts, loonies tend to fly in April:



But perhaps this is largely a USD story?   What if we were to take the dollar out of the equation?  Sadly, the story is little better.  Imagine you have an cross trade in two countries, A and B, with the following characteristics:

Country A
* Has the lowest current account deficit/GDP in its regional trading bloc
* Recently enacted sweeping reforms of its resource sector to enhance productivity and spur FDI
* Has seen seen market interest rates decline this year on demand for its paper

Country B
* Has a current account deficit/GDP of more than 5%, three times as large as Country A
* Has seen rolling strikes and violence cripple the productivity of its resource sector
* Has seen market and official interest rates rise this year on concerns about the currency

Knowing that, you'd feel pretty good about your trade, wouldn't you?  In truth, in January you should have, for ZAR/MXN (Countries B and A, respectively) dropped nearly 5%.   Since then, alas, it's been a steady grind higher, to the point where the cross is actually higher on the year (and that doesn't even include the carry!)   It's the class clown making the speech on graduation day while the valedictorian sits in detention....



Unfortunately for holders of dollar longs against sundry EM currencies, the seasonality is no better this month than it is for JPY or CAD shorts.  Indeed, over the past dozen years, April is the single best month for USD shorts against ZAR, TRY, and BRL:
















A colleague of Macro Man once characterized the market as possessing two personas: The Buddha and the Thief.   When the market is a Buddha, errors are forgiven, things are calm, there is time for contemplation, and if you're lucky you find Nirvana.   When the market is a Thief, however, you must jealously guard your capital, as profit proves to be elusive, loss comes easily, and before you know it your P/L has been stripped bare.    No prizes for guessing which kind of market we've had in 2014!

Perhaps today's Fed minutes can stop the rot and restore a degree of normalcy to market conditions.  It's possible, though probably not likely, that they banish the Thief and return the Buddha to the market arena.

If Macro Man had his druthers, however, he'd prefer to see the market reincarnated as Vishnu.  At least then you could be sure it would take good care of the sacred cows...