ECB: The Force Re-Awakens

If you're reading this, you probably don't need Macro Man to tell you what happened at Draghi's press conference yesterday, nor how markets reacted.  The ECB president left little room for interpretation; the only way he could have been more dovish is if the ECB had actually eased policy.  In fact, he was probably even more dovish that that; in many cases, the anticipation and build-up resonate more than the event itself.    Consider yesterday's press conference as a trailer for ECB: The Force Re-Awakens.

One comment that Macro Man would like to make is to commend Mr. Draghi's manner of communication.  Throughout his tenure at the ECB, he has generally taken pains to speak fairly clearly and with the impact he has upon markets at the forefront of his mind.   He has clearly not always liked the message that he's had to convey, but in general he's endeavoured to leave the market with a  clear picture of the institutional mindset.

In this, the Italian is far superior to his native English speaking colleagues in Washington and London.   While they waffle and flip-flop, Draghi will admit that he has changed his mind and clearly enunciate the factors that drove him to that decision.   Macro Man cannot ever recall his taking recourse in the word "model", which is such a favorite of the current Eccles Building incumbent.  The ECB is "working and assessing".....the Fed and Old Lady are "waiting and seeing."   'Nuff said.

So.....the zillion dollar question is "what now"?  The euro, which was referenced by Draghi on several occasions, predictably fell out of bed at the prospect of more QE and/or a deposit rate cut in December, taking it down to fairly critical support.

So....do we chase or do we wait for a pullback to sell?  Back in the good old days, the answer would be easy.   You'd sell every day for a week, usually at lower prices each time, and then pause to assess the state of play.  In fact, that strategy worked very well during ECBQE1, where the market clearly didn't have enough of a short position and had to chase it down.  That move, however, was notable for two things:

* It actually bottomed at the same time the ECB actually started enacting the QE program announced in January

* The Fed was still in the "teaser trailer" mode for Liftoff, leaving markets almost rabid with anticipation (remember when some people thought they might go in June?!?!)

With the power of hope working on both sides of the trade, small wonder that it worked so well in the first couple months of the year.  Since then, however, trying to momentum trade the euro (or most other non-EM currency pairs, for that matter) has been an exercise in futility.   Not that that can't change, of course, but one also needs to consider the Fed's reaction function in all of this.

To be fair, there isn't that much priced for December...just a 30% chance.  However, given that the Fed seems to take its cues from the market rather than giving them, and with the small likelihood of meaningful progress emerging on the inflation front in the next couple of months, there still remains room for Fed expectations to ratchet down...potentially undermining the dollar.

This is admittedly a tricky one because it seems likely that different measures of the threefold mandate will be delivering different signals.   The Fed, like the ECB today, has noted the strength of the currency and its impact upon inflation.   Given the likely trajectory of ECB policy, will this Fed have the cojones to deliver a liftoff in the same month that the ECB throws more gas on the monetary fire?  It seems dubious.

On the other hand, it now seems possible that with favorable seasonality approaching swiftly, we could see equities make a bid to ramp into year end, which would assuage some of the concerns that emerged (whether they'd admit it or not) when equities dumped in August/September.   Stocks on both sides of the Atlantic have breached their September highs, suggesting that we've put in a double bottom.

Macro Man would note that European stocks dramatically outperformed their US counterparts in the first quarter of the year when QE fever was rampant; given his views on the relative values of the two markets (even with US technology having it off, apparently), readers will be unsurprised to hear him bang the drum once again for European stocks.

Finally, it's perhaps worth putting into context the scale that the ECB (and BOJ) could ease to bring them into line with other central banks.  The chart below normalizes CB balance sheets (denominated in USD) to 100 in January 2007; observe that the two CBs currently engaged in QE lag far behind the Anglo-Saxons who've finished with it.   (The PBOC balance sheet largely reflects FX reserves, which is a form of quasi-QE insofar as the money is deployed into foreign asset markets.)

So the Force is re-awakening (not that's it's been asleep this year), equities are breaking out, and the euro is right on support courtesy of the second highest volume day on EBS over the last four years.  Macro Man reckons you have to have at least a small EUR/USD short on (say 20% of desired), just in case it dumps with no let-up.  Hope for a bounce to sell more but be prepared to watch it go straight down, particularly if real money and macro throw their weight behind the position.

Somehow (and he cannot believe he's saying this), Macro Man finds a European equity long easier to stomach psychologically, both outright and against the SPX.  If the Fed jellies, the outright will perform well, and if they somehow actually do put rates up, one would posit the spread will do well...in fact, the spread should do just fine even if they don't go.

One can only hope that the sequel to the current episode isn't Return of the Screw-Job....
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Polemic
admin
October 23, 2015 at 10:06 AM ×

Draghi really exuded confidence in his position.Was open and intelligent and cam up with one of the best quotes ever from a CB press conference.

"political uncertainty is part of democracy"

Notable absence of anything 'Weidmann' including the man himself.

Has Draghi, hammer of the Euro, cast the German into the pit of academic whining?

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Henning
admin
October 23, 2015 at 10:35 AM ×

excellent post, thanks

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Anonymous
admin
October 23, 2015 at 10:52 AM ×

Equity shorts getting hammered again. Folks, do you notice a pattern?

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Anonymous
admin
October 23, 2015 at 11:06 AM ×

FT: surprisingly, and interestingly, with the EUR/USD having been clubbed like a baby seal and USD/JPY solidly north of 120 we awoke this morning to see XAU and XAG stronger. I haven't seen this kind of correlation breakdown for a long time(I believe the last time we saw serious PM AND USD strength was during the first greek scare an eternity back in time).
Could it be that some people are hedging a global currency debasement risk with something else than equity?
That would be the start of a serious trend but it's too early to call it such.

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Purple Haz
admin
October 23, 2015 at 11:08 AM ×

Thank you, MM, for the latest in a string of really good posts lately.

Interesting few days coming up, with the BoJ at the end of next week and the Fed just before - even if no-one expects anything from the latter. In terms of events to derail the current melt-up, the debt ceiling springs to mind but I'm struggling to gauge the likelihood of an agreement not being reached (maybe not helped by being in the UK, rather than across the pond). Any thoughts? Seems the market is pretty comfortable/complacent about it.

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Anonymous
admin
October 23, 2015 at 11:10 AM ×

Dax up +350pts yesterday, gaps up +100 today, just popped another +100 in the last 30 mins.

Nico & Nick have gone awfully quiet lol...

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Anonymous
admin
October 23, 2015 at 11:12 AM ×

Why do all the posters here think that this melt-up will be derailed? What is wrong with you all? Equities are going up because every central bank making them go up. Why do you want to throw your money away???

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Polemic
admin
October 23, 2015 at 11:13 AM ×

I suggest that some people, instead of gazing out across the seas in the hope of a rogue wave upsetting the current rallies, examine the Kubler-Ross model.

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Purple Haz
admin
October 23, 2015 at 11:18 AM ×

Fairly comfortable with the current market action in terms of positions, but trying to be alert to possible 'derailing' events - not hoping for them. Hence my question about the debt ceiling, as I don't have a strong grasp of the situation.

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Anonymous
admin
October 23, 2015 at 11:30 AM ×

Until yesterday's ECB, finance twitter has been full of "experts" saying how this equity upswing would "bounce-off" some MA or another, how this was the "top of the up-move" and we'd then witness a crash that would rival 2008. Idiots. This is the perfect opportunity for central banks to cause the shorts max pain, and it's in full effect. Mark my words, equities will take out their all-time highs before the snows come.

Winter is coming.

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Anonymous
admin
October 23, 2015 at 11:37 AM ×

Does anyonw know the protocol for calling a presser if the FED were going to raise rates next week? Yellen said she could call a presser if they were moving at last one. How much notice would they give journo's? The weekend, a day, hours? More a general question than an expectation of them moving. I don't need a smart response from FM or one of his buddies, thanks.

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Anonymous
admin
October 23, 2015 at 11:42 AM ×

All this talk of shorts getting carried out like there is no risk management. I'd argue shorts have tighter risk management as they are generally fighting the tide, waiting for it to go out.

Seems to me like it's the Hedge funds with their big long positions that are getting carried out. Hedge Fund Hotel has been taken over by Mr.Basil Fawlty.

Wonder if they will have to liquidate other positions if Valeant gets much worse.

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Anonymous
admin
October 23, 2015 at 12:17 PM ×

CHINA CUTS RATES

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Leftback
admin
October 23, 2015 at 12:22 PM ×

LB arrives home after a day on the road to find he has missed the big blowout party. The last lines of Charlie are being snorted through $100 bills and a few nice young Ukrainian ladies are asleep in the bedrooms. "What happened?" he inquires, "Dr Aghi threw a spontaneous house party at your place" was the reply. "Nice", LB replies, "wait, what happened to Mister Shorty? Did he...?". A shake of the head and a finger drawn across the neck indicated that it wasn't pretty. LB nodded sagely. Sometimes it's not the smart things you do that contribute to the P/L, but the dumb things you don't do....

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Anonymous
admin
October 23, 2015 at 12:26 PM ×

It's almost as if global central banks want equities to go up...

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Leftback
admin
October 23, 2015 at 12:29 PM ×

So, the ECB jawboning provided cover for the PBoC. Another example of what are clearly co-ordinated moves by global CBs. Assume nobody was short China ahead of that lot....? [look away, look away]

Absolutely no point trying to enter anything here [except possibly a rehabilitation facility] until after Monday's close. Let's allow the dust to settle and then see where we are. Happy weekend to all.

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Leftback
admin
October 23, 2015 at 12:29 PM ×

Anon @ 12:26. Nice. Short and snarky.

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Anonymous
admin
October 23, 2015 at 12:33 PM ×

LB - Thx, all part of the service. Well done on yr equity length btw. (Although I'm thinking it would be cheaper if the shorts here just mailed you their funds direct, that way everyone could cut out the trading costs and save a few bps).

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Nick
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October 23, 2015 at 12:34 PM ×

Better long and wrong than short and cought? To be fair one would have to be pretty senseless to be short in front of Mr. Draghi. And something tells me that Nico knows this as well as me.

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Anonymous
admin
October 23, 2015 at 12:38 PM ×

Nick - I see. Only I saw your & Nico's short entries clearly posted here about 9% lower down, but no exits/stops etc. Anyway glad you magically avoided losing your accounts. Maybe you stopped & reversed and caught the up-move too?

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Anonymous
admin
October 23, 2015 at 12:54 PM ×

SNB removed peg before QE. Ecb and Pboc acting before FED rate rise?

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Nick
admin
October 23, 2015 at 1:10 PM ×

Anon @12:38, sorry I forgot to tell you how to trade. But since you are asking now, I closed the short in SX5E sometime ago for a small loss. Did not do anything else in equity since then, not my main asset class.

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Booger
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October 23, 2015 at 1:10 PM ×

Hmmm...There is only one thing to do here with that Draghi surprise and that is to start a eur.usd short position and add to that.

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Macro Man
admin
October 23, 2015 at 1:12 PM ×

I neither need nor want people littering this space with the quotidian details of their short-term trading, nor of rampant cheerleading every time stocks go up a few percent. As someone posted above, people do tend to use risk management...and my observsation is that there tends to be a lot less 'sell and hold' than there is 'buy and hold.'

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Polemic
admin
October 23, 2015 at 1:24 PM ×

The ripper in bonds and equities as not been accompanied by oil which is reaffirms that this is indeed a post Draghi rates adjustment rather than growth adjustment price move. Would be nice to see a bit more of a commodity rally to confirm a general move from worry. But then we have to consider why Draghi is strongly hinting at further adjustments and that is BECAUSE growth and inflation is forecast to be weak.

Energy is still a major input into expectations as Draghi himself kept alluding to and still the lynch pin for a lot of leverage.

I was thinking this morning.. A wild speculation of course.. But I wonder if Putins ultimate objective in the middle east is to put the squeeze on Saudi Arabia. It is the Western puppet in the region, so would be nice for him to politically poke the West via Saudi, but it is also a huge financial contributor to the West. But the other ambition to add to wobbling the west's Saudi financial and political benefits is to somehow 'persuade' them to decrease oil output which would see prices rise. Triple win for him.

Oh and as we are all talking short term trading to MM's chagrin. I've just taken profit on all my longs as I feel that trading is not about trading on what we know, but what we don't know. At the moment we areal pretty convinced we know what the ECB's next move will be and if there is one thing we really should have learned over the past few years is that expecting CB action is like expecting the Spanish Inquisition.

Pol

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abee crombie
admin
October 23, 2015 at 1:50 PM ×

Great post MM, thanks for making me re-think the EURUSD...not that I am involved. This is also a nice conundrum for EM FX (Aud & Cad as well), and oil and Pol just stated. Nasdaq earnings shouldnt be much of a surprise given that part of the economy is still doing well. Agreed with mr T yesterday, it seems so obvious. Sometimes its not supposed to be easy (mr oaktree) but for the past 4 years all you had to do was be long tech.

As for EUR, it interesting to see that BOBL hasnt broken the may low

My gut tell me Nasdaq will make new highs and then we see an equity market roll over

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washedup
admin
October 23, 2015 at 1:55 PM ×

Pol - Putin is probably a lot more tactical (and a lot less strategic chess grandmaster) than he seems to be given credit for.

As for "as I feel that trading is not about trading on what we know, but what we don't know", truer words were never spoken. With the right risk stops, I think we have been in a market environment, starting early this year and gaining force, where consensus just needs to be faded, period.

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Anonymous
admin
October 23, 2015 at 2:57 PM ×

Santa rally started early this year innit???

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wcw
admin
October 23, 2015 at 3:42 PM ×

In re Russia, the simple answer is the right answer: Russia does not want its only real client left in the ME replaced by the jihadis. It is the right move for Russia. Oddly, it is also better for the US than addlepated statebuilding fantasies.

In re trading, second the motion. Talking about your trades is like talking about your fantasy sports team. Nobody else cares, literally nobody.

In re markets, CBs are targeting asset prices because governments refuse to spend. It is disappointing.

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Anonymous
admin
October 23, 2015 at 3:45 PM ×

Saw this on finance twitter: "$SPX started the year at 2059. Now 2072. It's never been up 7 years in a row." V true, saying that, we've never had every major bank easing at once and buying equities either... forgive me but I'll not fade this.

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Booger
admin
October 23, 2015 at 4:06 PM ×

I agree, it would not be wise to fade Draghi and Euro QE2 here. Perhaps in a few months. The obvious and highest probability trade that I can see is short eur.usd. It is overcrowded, but that is the beauty of it. When a CB says QE it is a siren call to all forex traders who can still hear. Everyone understands what it means so you have to get on board. It does get overdone, so you have to get off at some point, but my guess is we are closer to the start than the end.

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washedup
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October 23, 2015 at 5:14 PM ×

anon 3:45/boog - as long as u guys were also 'not fading it' when we were down at 18 handle and its therefore part of your core view that central banks will keep pushing equities up till they get engulfed by the Sun, I will say a)hats off and b)good luck. My opinion happens to be that european equities are cheap but will offer a better entry point (repeatedly), and spoos are asking for it especially if this dollar move starts to gain traction and puts pressure on commodities.

Put differently - in what sense was what draghi said, a surprise? I read about 4 sell side pieces that forecasted specifically what he said - so the market took that as an excuse and decided to wedge the less careful shorts, i.e. the ones who were short from 2000-2020- happens.

This is patently NOT the time to get wedded to opinions - that era lasted from 2011 to 2014 and is over - there will be plenty of hiding under the table for both bulls and bears in the next few months.

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Booger
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October 23, 2015 at 5:47 PM ×

Washed: I wouldn't be long equities here either. What I was saying was that Draghi's announcement is a big deal for eur.usd once he has made it. Arguably the announcement was not a surprise but the timing surprised me.

Perhaps there is too much focus about when it will be announced or whether it was a surprise. If you pick that, then you get a bonus 200 pips, but if you didn't there is still the other ?600 pips in this potential move. Here the CB call has a very clear signaling function and everyone knows it. Every man and his dog will be shorting eur.usd and virtually everyone knows what the signal means. You don't want to be the last one to get on the train (before it heads in the other direction), but it is arguably very worth getting on. In fact I am hopeful eur.usd will make my quarter and have pared the other positions and gone all in on that. Thank you Mr. Draghi, you made my week !

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hipper
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October 23, 2015 at 6:57 PM ×

Whether Draghi was or wasn't a surprise to the market... the first two days it certainly did act surprised. But I've been thinking all the time that EZ data would improve toward the year end but that it will eventually start to flatten out if EM and China get softer? EZ needs them, domestic consumption alone won't do it. So that's why this might be better regarded as QEhopium, the beginning of the climaxing phase from previous oversold positions, which actually ended in late September. So some of that fuel has already been burned up. And after the first QEhopium in January the run on DAX lasted only 3 months or so. Part of the run through late 2014 was probably because of the teaser leading up to that, again already front ran when the event actually occured.

If the Fed fails to deliver before the end of the year then the anti-dollar trades might be still be the way to go. Negative dot plots and the "tight" 9-1 vote against the hike were already very ominous signs. The majority of the dollar run has been based on improving data and liftoff expectations which now seem to be much more questionable. But since it's a game of relativity and still even if they hold and present more disappointments there's probably not very much reason to say dollar should "crash" either, especially against EUR.

Even if they remain a stalemate there must be other ways for that pressure to get out. If everybody tries to race to the bottom, no one might actually ever get there and things might suprisingly stand relatively still. Perhaps commodities that pressure relief valve? Re equities the fact that QE has failed them before in a relatively short time is worrying, and even this EZ rally is based on data momentum which might begin to flatten out at any moment. I'll just probably stick with the REITs and some commodity stuff.

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Mr. T
admin
October 23, 2015 at 8:06 PM ×

I dunno guys, I'm long the "right" assets but none of this makes sense. AMZN @ 70x dubious FCF is not all that different than portgual 2yr @ 20bp. I have the gnawing feeling that a portfolio thats using best practices to control factor exposures is really just taking bets on something thats not properly modeled. For example barra has AMZN yield exposure modestly negative, a simple HRA shows an r^2 of .001 between AMZN and USGG10YR, but at the same time there is simply no way there would be such a wide swath of the market trading on 5 year estimates if there was higher risk free rates.

A rolling over seems unlikely, but all the same when the bus gets to your stop you get off. I'm more interested in looking for opportunities that are based on real growth than chasing multiple compression. If we don't see real growth, then I don't see a need to be in.

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Anonymous
admin
October 23, 2015 at 8:31 PM ×

http://www.marketwatch.com/story/fed-should-hike-rates-due-to-asset-market-frothiness-oecd-chief-economist-says-2015-10-23?link=MW_home_latest_news

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washedup
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October 23, 2015 at 9:38 PM ×

"a portfolio thats using best practices to control factor exposures is really just taking bets on something thats not properly modeled"

Si seƱor - look no further than the positive correlation between USD/JPY and US equities - there is a not a planet that exists where a surging buck makes everything hunky dory in risk-land, but thats how this market has been trading it.

As for AMZN, its now a cloud services company with a cash flow sucking 'we retail everything' business attached - I am by no means an expert in cloud services, but I am somewhat uncomfortable with the idea that profits coming from that line of business are rock solid and stable.

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Polemic
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October 23, 2015 at 10:19 PM ×

I had guessed that Usd/Jpy was tracking eqs because they were both tracking US rates. In my FX days USD/JPY was all interest rate diffs in the curve, mostly 2 yr. so with Jpy rates steady ( at the moment pre Abe next move) it's all US rate swings. But as I say that was only my guess. Add to that the in/out of jpy carry trades in risk environments that see jpy fall and look for carry in ok times and come home out of carry in rough times. Hence it all ties in with the same drivers for SPX. So I really don't think there is any causality.

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October 24, 2015 at 6:31 PM ×

It will be interesting to see how the EURUSD acts if the Fed strongly hints, in October, of a possible hike in December. It seems there are growing probabilities of a strong hint of a hike. The US stock market has indeed exploded, employment still fine, China more mixed than altogether bad, and US corporate earnings largely solid.

Although a hawkish Fed in light of Europe/Japan/China policy actions will push USD higher testing markets in the form of crude, commodities, EM, and US earnings growth for multinationals...

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Anonymous
admin
October 24, 2015 at 6:44 PM ×

Anyone care to offer their view about the best risk/reward situations in European equity ETFs?
Thanks

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Anonymous
admin
October 25, 2015 at 11:14 AM ×

I would love to hear MM comment on the impact of recent immigration to eurozone's growth, inflation and debt dynamics.

Could it lead to ECB tapering earlier than generally thought? Germany issues more bonds...more for ECB to buy..perhaps increasing the size of QE only to quit early due to sudden demand shock 2nd half next year?

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ECB Problems?
admin
October 25, 2015 at 11:28 AM ×

RBS analysis on the recent ECB press conference shows that in order to expand PSPP, the ECB could end up buying corporate bonds, munis, equities, and even individual bank loans. Expanding PSPP will likely lead to counter-moves by SNB, Riksbank (and others). Finally, expanding the range of assets on the ECB's books leaves the ECB vulnerable to a negative equity position in the event that those risk assets decline in value.

I am further hearing that NIRP may come to household deposits (NIRP already apply to many EU govt bonds).

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Booger
admin
October 25, 2015 at 11:34 AM ×

The move above the 200DMA for spoos has been astonishing and I would be surprised if it doesn't retest it (2060) and head at least back to 2000 (and then potentially 1600-1800). I had been quite wrong in shorting spoos earlier this month without respecting enough the gravitational pull of the 200DMA. One wonders how much good news surprise is left out there though with the best earnings out of the way, Draghi's surprise, China easing done for the meantime, positive data surprises last week. This has me thinking shorting spoos from here (2070) with a stoploss at 2120 and a timestop of 6/11/15 or earlier for 2060 or closing out.

EM FX is looking interesting to short again now that the china easing is out of the woodwork for at least the next month or 2. I was looking at the options and nzd.usd seems attractive. It might be a better shot due to the largish spec short positioning in aud.usd. AU might be a better short immediately after the next RBA rate decision if they do not ease. The only fly in the ointment is U.S GDP next week which might be a disappointment and usd negative. In which case the spoos short might do better.

So the general game plan for me is to move from eur.usd short to short spoos tomorrow then and then back to eur.usd and nzd.usd short after the U.S GDP print on Thursday. This might have to be radically altered by how reality pans out...

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Polemic
admin
October 25, 2015 at 12:50 PM ×

The ECB should bypass the current leaky QE process and if willing to buy individual debt then just issue their own credit card at superlow rates. Same as buying packaged debt but just unpackaged.

http://polemics-pains.blogspot.co.uk/2015/10/qe-card-thatll-do-nicely.html

The cheap credit goes straight to the bottom of the chain instead of creating asset distortions on the way.

A silly idea? These are silly times.

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washedup
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October 25, 2015 at 1:37 PM ×

I agree 100% Pol - the Martin Wolf FT interview of Bernanke was illuminating, in that it highlighted the 'we have no choice but to inflate asset valuations and hope for the best' problem the Fed has. In a perfect world where fiscal and monetary policy was co-optimized, the following 2 ideas would both perform way better than unlimited QE (aside from the QE credit card)

1. As the saudis embark on beggar thy neighbor overproduction strategies, OECD governments say thank you very much and quadruple the size of their SPR stockpiles - it backwar-dates the oil curve and reduces deflation - its essentially a permanent transfer of wealth from geopolitically hostile ME governments to american industry.
2. Give all american workers a payroll tax holiday - by definition its progressive given the cap on salaries subject to it - on the margin its paid for by mercantile CA surplus countries who are happy to own US treasuries at close to zero yields.

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abee crombie
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October 25, 2015 at 3:30 PM ×

Washed. The reason the Saudis are flooding the market is they they know electric cars are coming soon. Oil is doomed.

As for amzn, yeah the valuation is hard to model. But look at Google or Fb. Ppl pay up for growth. It's just at what price does it become silly. Nifty fifty again. Jump on GE bandwagon but sell tesla. It's a super hard momo game to play. Bc once you fall out of favor with the crowd you get killed. Just like last year aapl helped push up spoos this year it will probably be Nasdaq favs, but when u peel back the onion the leader list just gets smaller and smaller. No biotech, smaller tech isn't leading. Not to say they can't catch up, but it's not bullish yet.

If euro equites don't rally hard this week to catch up, it's a bad sign. Also HY kinda sticky here. Tax loss selling, hedge fund redemptions all setting up to make an interesting q4. More divergence i assume.

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washedup
admin
October 25, 2015 at 5:04 PM ×

i hear u abee - i guess the game is getting easier in a way - just e short everything and own google, apple, and amazon calls. I took profits 2 early on a variation of that idea earlier in the year. It's a winner takes all, increasingly zero sum profit pie in corporate america these days, especially tech.
What I find interesting is that even the outperformance of these so called leaders seems to be heavily concentrated into a few days around their earnings releases.

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