It's all about inflation

So.  Today's the day when markets will, presumably, be freed from the yoke of Fed QE for the first time in two years.  After the judders of a couple of weeks ago, equities now seem relatively sanguine about the prospect; could you have envisaged 10 trading days ago that the VIX would be below 15?

What's interesting to note is that while Spooz have roared back nearly to their highs, US fixed income has trod a decidedly more careful path.  Indeed, overlaying a chart of SPX futures with EDZ5 illustrates how resilient rates have been; simply eyeballing the chart suggests that EDZ5 "should" be 30 ticks lower.


Of course, a few things have changed in the interim.   James "5 Minute Macro" Bullard suggested during the equity sell-off that the Fed could defer ending QE.   In the realm of adult analysis, the ongoing weakness in commodity prices could certainly be taken as a deflationary signal.   Well, it could if the Fed were ever prepared to take rising commodity prices as an inflationary signal, which they seemingly aren't.   But hey, what's a little hypocrisy between friends?

As such, the market will pretty clearly focus on the inflationary language in the statement for clues as to where the Fed stands.  The September statement that "the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year" may well be altered in the wake of the commodity downdraft and the slightly below expectations September CPI.

The magnitude of any change will set the tone for trading over the next couple of days- the larger the magnitude of the change, the more dovish it is likely to be taken.   Of course, given current pricing, one could argue that a dovish outcome is already priced- in certain segments of the market, at least.   Looking at Macro Man's usual-suspect EDZ5, a purchase of the 99.25/12/00 put fly at 2.5 does not look like a terrible way to bet on an outcome that's not quite as dovish as hoped.

Of course,  the phrases "not quite as dovish as hoped", "Yellen", and "profit" are rarely spotted in the same room together.  Given that punters seem to have abandoned all interest in bearish rates plays, however, if fading a dovish consensus were ever going to work, a day like today could well be the time.
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Polemic
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October 29, 2014 at 2:32 PM ×

YEs it all seems to be back to neutrality in equities. Rates as far as i can see are a crap shoot and I still hang by the opinion that what ever you finely assess and trade on will be swamped by some form of unexpected noise taking you out and making any precise analysis worthless.

But I like the risk reward on the fade the expected dovishness you talk about. I'm still interested in the great return to 'meh' from extremes on both sides carries through to oil and we see the spring bounce back to more 'meh' on that too $90 bounce levels? You could argue that oil started all this and so may be the sat to normalise a bit ..

And the other great indicator of normalisation ? The 'commentometer' has fallen off a cliff in the last 24 hrs .. ( especially if you strip out the yes it will , no it won't' banter)

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Leftback
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October 29, 2014 at 3:08 PM ×

NO it didn't! Oh yes, it DID...

Peanut gallery are spectators today. Opportunities will present themselves - after the clown show.

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Nico G
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October 29, 2014 at 3:24 PM ×

i will QE your commentometer with one more comment on the fantastic divergence of Europe vs. US throughout that V thing and wish good luck for the long stoxx short spoo crowd. That long short like most long short thingies is still directional, and you will lose big if global equities fall so choose your timeframe well

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Nico G
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October 29, 2014 at 3:28 PM ×

PS: to put it another way and reach 4 comments

there is no way US equities will fall faster than European. Ever.

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CV
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October 29, 2014 at 4:06 PM ×

Yeah, it has all gone a bit too quiet. Happy times for Italian banks today; someone needs to arrange a shotgun wedding with MPS.

Oh and this;

"there is no way US equities will fall faster than European. Ever."

I'll hold you to it Nico ;), but a flush in Spoos would not do anyone in Europe any favors. Meanwhile of course, the ECB is actually ramping up purchases just as the Fed is winding them down. What was it LB said about wonders the other day ;)

Claus

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Leftback
admin
October 29, 2014 at 4:09 PM ×

It all depends on FX and leverage, really. Some of us are guessing that the US equity market is more highly leveraged than Europe, and that EURUSD will rise in Q4. Nico takes the opposite point of view.

Although I do like Mr T's pair trade, LB prefers for now to stay long his patented US low rate portfolio [= REITs, preferreds, munis and 30y], long EM equities [Brazil and Russia] and long peripheral/Eastern Europe [Portugal, Greece, Hungary, Austria, Spain], while shorting the US small craps [IWM] from time to time when market exuberance is at its most irrational. At its core, a great deal of this is based on a mean reversion trade in USD.

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Nico G
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October 29, 2014 at 4:34 PM ×

it is all about timeframe - if spoos sink to 1500 then yes you may find (relative) support in Europe, since they won't be dropping from sky high

on a multi weeks timeframe for example Europe signaled a higher low when spoos tested 1180 a while back and the pair trade worked

but then again have you talked to Iberica friends? it is ok to visit Spanish and Algarve golf courses, they kinda look nice but Iberica fundamentals are abysmal

+ all the clever skilled workforce migrated to London, Sweden and the US those last years. Terrible labour demographics.

and there is no way in hell Dr. Aghi will be allowed to match Abe or the Bernank feats in nominal terms. It is never gonna happen.

They might find a choux de Bruxelles way to cut some slack to Iberica pigs for Germany will not pay for it.

If big money had really bet on (believed) a Draghi/Yellen balance sheet spread you would have EURUSED under 1.18 by now

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Leftback
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October 29, 2014 at 5:20 PM ×

Indeed I have, Nico, my friend. Everyone knows the fundamentals are bad, and the exit of hot money is often the very best time to buy.

Sell hope, buy despair.

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abee crombie
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October 29, 2014 at 6:16 PM ×

Nice call MM, indeed edz5 has sold off. But the better play would have been the DXY...

lets see if 10 and 30 year follow the lead, which I doubt

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rossco
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October 29, 2014 at 10:40 PM ×

If qe has been all about asset class correlation then the spooz v ez chart seems to be showing pretty clearly that that tradeAy be over.

Looking for risk parity to take a bath. There's only so much reward to be had in doing nothing

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