What's in the price?

The FOMC announcement is rapidly approaching, an event at which push will presumably come to shove.  Macro Man retains his (reduced) short euro position and downside positioning in  EDZ5.  However, with crunch time rapidly approaching, he is wondering if a little adjustment might not be in order.

His approach to analyzing the event and its impact is twofold.  The first is to assess the likely range of outcomes and estimate the market's perceived probability distribution for them.   The second is to determine, relatively speaking, what is in the price for major asset markets.

In terms of the FOMC, the market fetishization of the word "patient" strikes Macro Man as overly simplistic.  On the face of it, of course, the market would read the removal of "patient" as a hawkish  development and its inclusion as a dovish one.   However, what if the FOMC were to remove "patient" but indicate that policy is highly unlikely to move until and unless inflation is clearly moving back towards the 2% target?  Is that really a hawkish outcome?  By the same token, what if "patient" remains but the bottom quartile of the dot plot moves higher for 2015 and 2016, suggesting a greater conviction across the committee that rates will move this year?  Is that really dovish?

Macro Man chooses to focus instead on how the totality of Wednesday's policy announcement- statement, SEP, and press conference- will impact the market's perceived probability of a June rate hike.   At the time of writing, June eurodollars are pricing LIBOR at 0.385%, versus a spot fixing of 0.27%.  July Fed funds futures are pricing an effective rate of 0.22%, versus 0.12% for the current month.   These would suggest that the market is ascribing somewhere between 40%-50% for the probability of a June hike.

Macro Man is curious to know what readers expect the outcome of this week's meeting to be.  The easiest way to find out is to conduct a survey; your author would be grateful if you would respond to the one-question survey below.



Edit: Responses are here.

Edit #2: Whoever screwed around with the response graph, please cut it out.

As for what's in the relative price of major assets, one quick and dirty way of assessing pricing is to merely consult charts of price action year to date.

Let's consider the SPX:

It had a rough time after payrolls (reflecting increased expectations of monetary tightening) but is still up roughly 1% on the year in price terms.

The DXY:

As Thierry Henry might say: Va-Va Voom!  Clearly there's a lot of something in this price.  While some of it is no doubt the Fed and expectations of a tightening, a large chunk of it is also the aggression of the ECB.  USD/JPY, which is historically more sensitive than the euro to US rate moves, is up "just" 1.5% year-to-date.  Nevertheless, the explosion in price since payrolls a couple of weeks ago suggests a lot of latecomers to the party.

10y bonds:

They're marginally lower in yield on the year, which would suggests that there is less than nothing in the price.  Of course, there's a little thing called "ECB QE" which has had a bit of an impact on global bond prices, so one really needs to take the beta out of the equation in assessing 10 year notes.    Put another way, the Treasury/Bund spread has widened nearly 25 bps this year, which not only suggests that there is not "less than nothing" priced in, but also explains at least some of the DXY move to boot.

EDZ5:

A-ha.   Despite the fact that the short end of the US should be immune to ECB QE, this contract has fallen more in yield than the 10 year.  Some of this no doubt represents a decay function; two and a half months have passed since the start of the year, and there has been no obvious pressure, in aggregate, for the Fed to accelerate its timetable.   Indeed, the appalling weather and port strike have significantly dampened output in Q1; while the Fed might say that can look through it, everyone kind of knows that they'll want to see proof of an upswing before moving on rates.  The rule of thumb for ED's in 2015 is evidently "be short on payroll day and long every other day."    Hmmm.....

So, if one were to rank these assets by how much Fed tightening is in the price, from most to least, Macro Man would submit that the rank goes:

All of this presupposes that "YTD performance" is an accurate metric for judging what's in the price, which of course it may not be.   Still, Macro Man is intrigued to see his two main positions on opposite sides of this rubric.   On a portfolio basis, that's ideal, particularly as his entry points on both trades were very good so he has a decent accumulated P/L.

Still, it is tempting to tilt the axis a little more towards the asset with the least in the price, given the near-term price implications if the Fed is unequivocally (or as close as they can get to that) dovish.  More thought's required on this one, especially once the survey results are there to analyze...

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washedup
admin
March 17, 2015 at 11:06 AM ×

MM - my survey response is in, and I have a related question for you.
Do you treat the responses of MM surveys as a contrarian signal, or a true one?
Over the years, but especially in the last two with new management and a changed cast and crew at MM, I have noticed that unlike say the AAII surveys or CFTC position reports, punters here have a had a decent record at predicting 'actual' market moves over a 3 month period - needless to say that this is hardly a controlled experiment or a quality signal , but not sure why that is.

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Macro Man
admin
March 17, 2015 at 12:24 PM ×

Well, I kind of think it depends on the question and my perception of market positioning. This survey, which I believe was from last August, was obviously very prescient, as it indicated that the market wanted a $ position at a time when it didn't have it. Were the same result to emerge today, I would be mroe sceptical.

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washedup
admin
March 17, 2015 at 12:38 PM ×

thx - look fwd to seeing the results of this one. The response better be quick it has a short shelf life!

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Anonymous
admin
March 17, 2015 at 1:45 PM ×

http://www.irishtimes.com/news/politics/oireachtas/ireland-ignored-ec-advice-to-stop-economy-overheating-1.2108104

Former deputy director of the IMF Dónal Donovan said although the organisation noted some vulnerabilities in Ireland during the time leading up to the banking collapse, its assessments “gave no inkling” that a financial disaster was in the making. He said the IMF got it more badly wrong in Ireland than he had seen in any other country. “I cannot recall in my experience a situation where the rosy picture turned so negatively in such a short period of time(!).”

Happy St. Patty's to all. Got green?!

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Anonymous
admin
March 17, 2015 at 3:30 PM ×

I think out of all of those indicators Eurodollars are "closest" to the Feds actions, the others are affected by too many other factors to really be able to isolate expectations too closely. Given as you say they rally back so quickly after any strong data point says to me that they seriously doubt the Feds ability to hike and therefore the balance of risks is skewed heavily to a hawkish outcome rather than a dovish one.... For what it's worth I think the press conference will closely resemble yellens appearance before congress 3 weeks ago....

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Error403
admin
March 17, 2015 at 3:32 PM ×

Probably too long-term a consideration for this esteemed audience, but perhaps DXY outperformance owes as much to capital flows escaping EM and Europe in search of (perceived) safety ahead of the next blow-up rather than a few bps of extra yield.

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River
admin
March 18, 2015 at 1:31 AM ×

http://news.forexlive.com/!/new-way-of-pricing-gold-to-come-into-operation-on-friday-20-march-20150318

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