A riyal pain in the...

Question:   If a market falls and there is no one there to panic, does it make a sound?

Yesterday's price action was notable for a) unwinding the vast chunk of Friday's euphoric price action in equities and crude b) the fact that other markets just didn't seem to care.   Sure, fixed income rallied, but in Europe it was going up anyways and in the US a sense of "just get me into something safe" was palpably absent.   USD/JPY, meanwhile, which lost no opportunity to drop last week, couldn't be bothered to lift a finger yesterday.  Finally, even the comments section in this space was relatively subdued compared to the activity of recent weeks.

Maybe it's just Macro Man trying to fit a narrative to the apparent lack of interest from his market interlocutors, but it really just felt like many people were content to sit back and watch.   Stories are already rumbling of the biggest pension fund re-balance in three and a half years  come the end of the week/month, so perhaps that will dissuade some of the friskier shorts from pressing their bets.  To be honest, Macro Man isn't sure whether all of this is a reassuring sign of a more balanced market...or a sign of complacency heralding further blood on the street down the line.  Either way, he is bemused by those that can have strong convictions in this environment on time frames that are dominated by noise, rather than signal.

And now for something completely different.

One of the more interesting features of the global economy and markets over the past couple of years is the way that they have exposed fault lines in weak economies and institutions.  China is an obvious example, as are Brazil and Russia.  The latter of these, of course, has been hit not only by economic sanctions, but also more viscerally by the collapse in oil prices.   In this, they are far from alone; just look at high yield and USD/CAD, last week's price action notwithstanding.

Of course, the entity most obviously affected by the decline in oil prices is Saudi Arabia, one of the world's largest oil producers with a decidedly non-diversified economy (energy represents something just shy of 75% of total tax revenues, down from more than 90% a few years ago.)  The deterioration in the country's external and internal finances has led to speculation of an official devaluation of the riyal.


Of course it wasn't that long ago that markets were pushing for a revaluation of the SAR and other GCC currencies, thanks to double digit inflation pressures at the height of the oil boom:


Those pressures, of course, petered out, both because of the refusal of the GCC authorities to address the issue, and the small matter of the global financial crisis doing away with any inflation problems in these countries.

Now, of course, there is a different set of issues, most namely a gaping hole in the Kingdom's finances, and a resulting erosion in the country's FX reserves.   Government revenues have fallen by more than 50% since 2012, and the budget balance has collapsed from a 13% surplus that year to what looks like a 15% deficit this year.  Of course, such volatility in the Saudi budget is not without precedent; following the oil glut of the mid-80's, the Kingdom's budget deficit reached 25% of GDP in 1987.  It should be noted at this juncture that having devalued the SAR to 3.7450 in June of 1986, the authorities did not touch it again during the final budget blowout...or the subsequent recovery in oil or the country's finances.   This was in direct contrast to their behaviour in the 1970's when the SAR was first revalued against the USD and then pegged to the SDR, which was tantamount to the same thing.


At the same time, it should be noted that while Saudi Arabia's external balances have obviously deteriorated sharply, the deficit remains fairly modest in comparison with prior surpluses.  Indeed, it could probably be financed through the sale of citizens' holdings of property in Mayfair alone!


In any event, there is one regional currency that does float (a bit) with the ebb and tide of the GCC's favorite export: Kuwait.   Unlike the SAR or AED, it did strengthen in 2007 in response to domestic inflation pressures.   Now, it's weakening in line with the decline in oil revenues.   To date, everything looks pretty much consistent with historical precedent.  If there were evidence from KWD were to weaken substantially further, that could be a signal that legitimate pressure is likely to mount upon the SAR.   As of now, however, the canary is alive and well.


Ultimately, the SAR is a political trade much more than it is an economic one.   In this, it resembles Hong Kong much more than it does Russia or Brazil.   To be sure, economics can exert pressure on the politics (viz. 1997 in HK the oil price dumps of the mid 80's and late 90's in the KSA), but then again, the reverse is also true: last week the Saudi authorities basically banned local banks from quoting SAR options.

While Macro Man certainly understands the idea of being long USD/SAR as an asymmetric bet, he's gotta believe that there are better trades out there driven by more transparent factors than Saudi politics (what with the dog-fight for the succession, etc.)  Hell, if Saudi Arabia really were planning to flog off part of Aramco, that could also enter the equation.  In any event, a history lesson is also probably useful; the 1 year forwards have been quoted around 900-1000 pips over the last couple of weeks;  in the 1980's, the biggest annual depreciation that Macro Man could find for the SAR was....1000 pips.  Granted, most of those decision-makers are probably now dead, but it does give you an idea of the gradualism that has traditionally characterized the Saudi currency regime.  Paying current levels looks very likely to produce a riyal, sorry royal, pain in the P/L.

And hey, if you absolutely must play a currency peg, why not look at Hong Kong?  You can buy a 1 year 7.85/7.75 1 x 2 put spread (ie, owning the entirety of the peg range) for a modest credit.    Sure, 1 x 2's carry risk...but in the highly unlikely event of a peg break, do you really think it would be to the downside?  Pricing that strike at roughly the same vol as the 7.85's is just wrong wrong wrong; anyone with the cojones to take the other side will almost certainly be glad they did.


Note: It's been brought to Macro Man's attention that his new email distributor may be hitting some spam filters.   If you have signed up to receive this piece on email but not gotten it, please check your spam or promotions folder and add your author to the list of "trusted senders".







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Bruce in Tennessee
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January 26, 2016 at 12:50 PM ×

Keep in mind that no one is right all the time. I come here to read the stories and the theories, but I would never make a bet unless I had thought it through myself, and that is what all of us should do. Some here are, ummmm, not doing well. The question you should ask yourself is Why?

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Bruce in Tennessee
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January 26, 2016 at 1:10 PM ×

One other thought comes to mind. You know, when you don't have much money, sometimes you go shopping and the clerk in the store may ask you what you're interested in. In those times you might reply,"Oh, nothing...just looking."

I wonder if that is what this bubba is doing or if he's planning on selling a lot of something to pay for his new shopping spree....

http://finance.yahoo.com/video/irans-rouhani-shops-cars-jets-124730159.html

Iran's Rouhani Shops for Cars, Jets on European Visit

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Anonymous
admin
January 26, 2016 at 1:24 PM ×

As I mentioned yesterday, Central Banks are in the market quietly putting a bid under equities every time they sell off too much.

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Anonymous
admin
January 26, 2016 at 1:25 PM ×

The Fed will also announce that they have put rate increases "on hold" in tomorrow's FOMC. Simultaneously, the BOJ, ECB etc will bid equities - we will see a large rise.

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Anonymous
admin
January 26, 2016 at 1:32 PM ×

@Anon - 1:24 PM

And you know this, how? And telling us, why?

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Macro Man
admin
January 26, 2016 at 1:33 PM ×

What does that statement even mean? Every time stocks go up, it's because of CBs? Where have they been all year then? The BOJ's purchases are a matter of public record. Thus far they've purchased just under $3bio in ETFs and REITs. In technical terms, that's known as "not enough to touch the sides"

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amplitudeinthehouse
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January 26, 2016 at 1:57 PM ×

Macro Man, not sure about the pegs, but I think the US dollar goes up from here.
As for Boj purchases along with other CB, let's not kid ourselves , their Yennish rhetoric is about to break out of its range. Casino and American Express stocks are having a laugh. And we should laugh along in the other direction, as we have for quite awhile. You do know you can't make a horse drink water , not even at these levels. Don't worry about it, I know these Peking punters, it'll bottom out soon. Believe or not , this market hasn't drop far enough out there yet.

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Bruce in Tennessee
admin
January 26, 2016 at 2:17 PM ×

http://www.bloomberg.com/news/articles/2016-01-25/trader-who-made-6-200-on-china-futures-says-go-short-or-get-out

"Huang Weimin, the hedge fund manager whose Chinese stock-index futures wagers returned more than 6,200 percent last year, has some advice for investors in 2016: Sell your shares now, before it’s too late.

The 45-year-old former worker at a state-owned company, a virtual unknown until last year, has become a star of the Chinese futures market after timely bets on the direction of share prices propelled his Yourong Fund to the top of the country’s performance rankings. He’s carried the winning streak into 2016, returning 35 percent through Jan. 22 after selling stock-index futures just days before the market’s worst-ever start to a year. The Shanghai Composite Index plunged 6.4 percent on Tuesday, bringing losses this year to 22 percent."


...?

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Anonymous
admin
January 26, 2016 at 2:23 PM ×

MM - another random anon here.

CBs are in the business of manufacturing expectations. Lifting asset prices - any asset - at selective/arbitrary times to achieve that goal is not far from the imagination. Global money printing has surged since 2009 - what would be the risk of all their efforts reversing?

I agree - there is no hard/concrete evidence. But it doesn't mean that it should be eliminated from one's trading calculus.

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Macro Man
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January 26, 2016 at 2:24 PM ×

Well, the guys is either a good trader or an example of the principle that if you take 1.3 billion punters, at least a couple will look like geniuses over relatively small sample period.

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Macro Man
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January 26, 2016 at 2:31 PM ×

Anon @9.23 I would certainly not dispute the notion that in general, CBs want risky assets to rise and put policies in place that hope to achieve that. I would dispute, however, the all-too-common assertion here and, presumably, elsewhere, that CBs are "in the market" buying equities and that that is why they have risen on days x, y, and z.

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Anonymous
admin
January 26, 2016 at 2:31 PM ×

I understand that many here are reluctant to believe that Central Banks and their associated entities are directly bidding equities and the like, and that's fine. You can choose to ignore these 'pointers' and lose money, or you can take it on board and make money. Your choice.

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Anonymous
admin
January 26, 2016 at 2:57 PM ×

@ANon - the Central Bank Whisperer - It's difficult to disprove your theory, and I won't try. But, there are other indicators of the price action to look at.

1. Europe gaps up or down (usually down) depending on Asia recently. It then proceeds to do sweet FA and, eventually, close the gap in a low, holiday style move. Pure grind, even when you get Siemens up nearly 8%.

2. The possible reason we rally in Europe is there are no sellers at these levels. Not being smart here but there's nobody in the Level 2 price action selling. So, when the lack of sellers selling is exhausted, we move up in search of more. And they ain't there. At least not until the US opens and gets its Sell on. Will we continue to rally into Apple without fear of a bad number?

3. THe correlation levels with oil and equities right now is the highest in +20 years. Tick for tick. HFT must be loving it, another couple of products that move in tandum. It can't be good for market structure long term. Oil is wagging the equity dogs tail though, of that there is no doubt. So, maybe, the CB's are in there trading oil too. Get those inflation numbers right where they want 'em.

3.

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washedup
admin
January 26, 2016 at 3:00 PM ×

"You can choose to ignore these 'pointers' and lose money"

Which pointers anon 2:31? I am genuinely curious what reagents you use to discern the smell of central bank sulphur? I don't want to disparage the idea, just have seen no evidence in the last 20 odd years I have been watching these markets. If there are specific metrics to look at please let me know.

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Anonymous
admin
January 26, 2016 at 3:08 PM ×

Signs of Central Bank involvement can be ascertained via patterns in dark pool & algorithmic trading. DOM and L2 alone are insufficient due to hidden/iceberg orders, spoofing and HFT continually posting/pulling orders. I'm not saying it's easy or 100% accurate to see these patterns, but they are there ;)

Watch equities now to see what I mean...

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Macro Man
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January 26, 2016 at 3:27 PM ×

I have run some numbers: see the new post.

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Anonymous
admin
January 26, 2016 at 3:31 PM ×

Here's some other numbers: Dow Jones up +200 points since my 'pointer' post, up a total of +400 so far today... coincidence? Either way there was money to be made.

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January 26, 2016 at 4:45 PM ×

some believers around....
@anon 3.31: you have to be hugely rich because you can predict market prices.. please let us become so rich like you... give us another "pointer" please :)

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