Back in the saddle

It is a bit of a cliché that markets are always most interesting when one is away on holidays, but last week lived up to the old saw. Macro Man and the dollar spent most of the week going downhill, while global stocks and bonds keyed off of Ben Bernanke’s relatively neutral testimony to roar higher.

The moves were not terribly difficult to understand. The dollar suffered as US data turned down and Europe and Japan registered stellar growth figures for Q4 of 2006. The combination of trade and TIC data was all it took to put the nail in the dollar’s coffin and bring the perma-bears out of the woodwork. Poor activity data and a relaxed Bernanke, meanwhile, proved sufficient to spur a cheeky 10 bp rally in both 10 year Treasuries and Dec 07 eurodollars. This was all the stock market needed to generate a liquidity fueled rally which took the SPX to another multi-year high.

Macro Man is still digesting everything that happened last week. He does, however, have a few thoughts based on what he heard on the slopes and what he’s read so far this morning:

* Last week was not a carry unwind story. Sure, the yen rallied against both the USD and the EUR. However, some of this was likely related to Treasury coupon payments, while macro discretionary traders have scrambled to go long yen in the hopes that they will be able to earn a couple bps more carry on Wednesday. Color Macro Man unimpressed. In a real carry unwind story, stuff like AUD and NZD and TRY and BRL would get caned, not lifted up on wings of eagles. That’s not to say it cannot happen, but it is highly unlikely with the SPX at its highs.

* The TIC data is like watching a traffic accident in your rear view mirror. It might tell you something about driving conditions in general, but says little about the direction of the road ahead. Lost in the kerfuffle over the TIC data was the fact that the dollar actually rose against the euro, the yen, and the ADXY last December. If this data were of any use in market timing, surely there would be at least some modicum of contemporaneous correlation between capital flows and the performance of the currency market.

* That having been said, there is a clear trend towards the erosion of the home bias amongst US investors. December set a record for net purchases of foreign equities. Given the disproportionately large market cap of the US equity market, as well as return-dampening factors such as Sarbanes-Oxley, a steady flow of equity capital out of the US is likely to continue. Ultimately, this probably means that a given level of interest rates will be less supportive in the future than it has been in the past.
* Macro Man expects Q1 growth in the US to be quite poor, perhaps 1.5% (finger in the air estimate.) However, he also expects that to be the low water mark for US growth in 2007. Much of the weakness should be concentrated in manufacturing, where inventories remain high relative to shipments. December/January has seen the onset of inventory liquidation; Macro Man reckons it should be over by March. This should set up some interesting trading opportunities over the next few months.

* The portfolio fared OK during last week’s mayhem, despite the premature profit take on the short sterling position and the unsuccessful option hedges on SPH7 and EUR/JPY. The short NZD/USD position in the alpha portfolio was stopped at 0.6922 (two pips slippage off of the 0.6920 level). Macro Man will start to think about selling US bonds around the 109 area in TYHY, and may think about buying JGBs around 1.80 on the benchmark yield.

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Click here for comments
February 19, 2007 at 1:15 PM ×

Welcome Back!

I should have stopped myself in the Nzd. Didn't Still short and Caught. Good Luck.

Macro Man
February 19, 2007 at 1:36 PM ×

Thanks. If you're short kiwi, then your biggest hope is probably my biggest fear; namely, that a BOJ rate hike DOES matter and that there is a deeper correction in the yen against all things carry-ish. There is a rather ugly-looking potential head and shoulders in NZD/JPY which I am keeping an eye on. While I've been around long enough to know not to prem-empt breaks of these types of patterns, it does suggest potential vulnrability there. After all, it was a break of a EUR/NZD H&S at 1.99 that helped kick-start the kiwi rally over the summer.