Well, Macro Man knew it was going to happen. His vacation saw more market fireworks than the 4th of July, Chinese New Year, and the Millennium put together. His return has seen those pyrotechnics extinguished by a steady stream of volatility-dampening drizzle (and alas, he is speaking literally.)

For those who endured the first half of August, the current respite must be welcome. Indeed, this morning's recovery in erstwhile favourites such as the Turkish lira suggests that risk appetite has not been completely eradicated. Anecdotals suggest that volumes are fairly low, however, which is hardly a firm foundation for a sustainable recovery.

Yesterday's meeting between Senate Banking Chairman (and would-be US president) Chris Dodd, Ben Bernanke, and Hank Paulson has helped to calm things as well. Markets appear to have interpreted Dodd's press conference as indicating that the Fed could cut rates should conditions deteriorate further. How this is near-term bullish (rates cuts should things get worse) is a bit of a puzzle to Macro Man, but then again so was the risk asset rally after the last Fed meeting. And we know how that turned out!

While Dodd stopped short of promising rate action (or publicly requesting it), the implication was pretty clear that he'd like some relief. He did his part as well, of course, providing viewers of the press conference with a phone number (1-800-999-HOPE) to ring if their teaser rates are about to reset. Now, Macro Man would guess that the sort of people who watch or read about press conferences from the Senate Banking Committee chairman are generally not the sort of people that need to dial a financial literacy hotline. Nevertheless, it is probably a good thing that SOMEONE is doing something to increase the financial nous of Mr. and Mrs. Joseph Sixpack.

Imagine, though, what the world would be like if our buddy Jim Cramer held political office. Macro Man can just imagine Cramer on CNBC, in full Crazy Eddie-style rant mode:

Mr. Bernanke! The market is broken! My guys are puking stocks at prices so low, they're practically GIVING them away!

Hedge funds! Struggling to shift unwanted inventory? Do you HAVE NO IDEA how you're gonna trim risk and meet redemptions? Prime broker playing hardball and asking for more margin?

Shop around, see what terms they're offering, then call me up and I'll beat 'em!

That's right, dial 1-800-BAIL-OUT and Crazy Cramer will sort you out, pronto! That's 1-800-BAIL-OUT for the finest prices on government prop-ups! 1-800-BAIL-OUT! Call today!

That, we can all be thankful, resides in alternative universe that none of us currently inhabit.

In any event, Macro Man retains the view that the medium-term prognosis for risky assets remains broadly constructive, even if neither economic growth nor market Sharpe ratios can match the pace of the past four years. A key caveat to the view is that the US avoids recession, even if consumers spend at a below trend pace. The rationale for this view is that corporations have not exhibited the type of excesses (in terms of hiring, capital investment, or inventory accumulation) that has almost always foreshadowed periods of negative growth in the United States. Those conditions may be met in the fullness of time, but for now Macro Man believes that 'muddle through' economic growth remains the most likely outcome.

The rationale for the generally upbeat view of risk assets, meanwhile, rests on one word: liquidity. While asset markets have clearly seen a sharp reduction in the amount of micreconomic liquidity available (in other words, the amount of trading that can be done in asset markets without producing catastrophically expensive transaction costs), on a macroeconomic basis, liquidity remains ample.

Now, to demonstrate this fully would require more time and space than Macro Man has at his disposal. So his explanation will be necessarily brief. Suffice to say, however, that a primary tenant of his view is that most market participants and commentators underestimate the impact of the developing world in providing liquidty.

Take, for example, the global monetary policy setting indicator that Macro Man posted yesterday. It showed that global (actually, Macro Man uses the ten largest economies in the world as a proxy for the globe) monetary policy is still slightly accommodative, albeit much less so than it was a few years ago. If we break that down by source (developed markets versus emerging markets), however, we see an interesting disparity. Developed markets (which comprise 82% of the GDP weight in the world's ten largest economies) appear to have a monetary policy setting which is broadly neutral, a conclusion that does not seem unreasonable. The 5 EM countries in the world's top ten largest economies (China, Brazil, Russia, South Korea, and India), while comprising only 18% of the GDP weight, nonetheless contribute 80 bps of policy accommodation to the global economy. (Note that this measure is GDP-weighted.)

Focusing primarily or exclusively on developed market central banks, as many in the market tend to, would lead one to underestimate the degree of policy accommodation left in the global economy, and perhaps by extension the potential for growth and asset returns.

Looking at money supply produces a similar picture. Macro Man has constructed a measure for dollar-terms global money growth, measuring the growth in dollar-term M2 in each of the world's ten largest economies. The picture there also looks constructive for risk assets, and for similar reasons. Dollar money growth, while not at the levels seen in 2003, neverthless remains extremely firm at 12%. And again, the 5 EM countries punch above their weight in contributing; by Macro Man's calculation, the five aforementioned countries have contributed 40% of the dollar-term money growth recently.
Now to some extent, the growth in this measure is symptomatic of dollar weakness. But if we look at local-currency term money growth and GDP weight it, we still get a y/y increase of more than 9%, the highest reading in four years. And again, the EM countries contribute something like 38% of that growth.
Now, Augustin Mackinlay at the Global Liquidity Blog will tell you that broad money growth doesn't tell the whole story, and he is of course correct. You often see episodes of large money growth during periods of economic duress, during which the investment prospects of risky assets may be very bleak indeed. Moreover, one also sees a spurt in broad money growth during periods of market distress, as funds exit securities markets and enter money market funds (and thus, the broader monetary aggregates.)
However, the past few years have hardly been characterized by global economic duress. And the EM countries who have contributed most to money growth, China and Russia, don't exactly have the sort of financial systems characterized by rapid switches between securities and money market funds/cash deposits. So Macro Man is willing to conclude (and, at the right price, to bet) that this liqudity is in fact real and waiting on the sidelines to be invested. Who needs FIG when you have VIG, RIG, and BIG waiting in the wings?
In any event, the utility of the $ money growth measure as a proxy for risk asset market conditions can perhaps be demonstrated by the chart below. Even Macro Man was surprised by the very high degree of correlation between y/y global $ money growth and y/y changes in outstanding financial derivatives (data via the BIS). To be sure, there is probably a small currency translation effect here dependent on moves in the dollar. But that effect should be linear and relatively small, and certainly does not explain the dramatic shift in derivatives trading as dollar money growth ebbs and flows.

Needless to say, the current macroeconomic liquidity environment would appear to remain relatively sanguine for financial risk-taking. A final piece of the puzzle, at least when it comes to the United States, is the level of cash sitting on the sidelines. According to ICI (via Bloomberg), US money market fund assets have risen more than $300 billion so far this year. If you're scoring at home, that's more than twice the amount taken out of conumers' pockets in a year if $500 billion of ARMS reset 3% higher.

That money market fund assets have grown more than $100 billion since the last week in July underscores Mr. Mackinlay's point that broad money aggregates can jump during times of distress. But you have to wonder how long that money will be content to sit on the sidelines in the event of a non-recession outcome for the US economy, particularly if and as some quality assets start to look cheap. A few months, perhaps, but Macro Man is willing to bet that it's not much longer than that.
All of this, therefore, suggests that the dip should, in fact, be bought. However, from a tactical perspective, it's also important to remember that another noisy dip is very likely indeed. And one will hardly be in the mood or position to go shopping for bargains if too much money has been lost on the way down. In these markets, it's important to position yourself so that you can trade because you want to, not because you have to.
Macro Man will therefore lower his EWZ offer to 55 and perhaps lower as circumstances warrant. That, he hopes, will prove sufficient to avoid the need to dial Cramer's hotline in this or any other universe.

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August 22, 2007 at 2:22 PM ×

Point of the day goes to you Macro Man ...

Macroeconomic liquidity remains ample. This is indeed the point. Of course, this could be mistaken for complacancy and I also guess that this won't de-facto bail out what is clearly now an unwind/unravelling of the most risky positions/instruments (Setser's last note is good on this).

Turning to the general global liquidity stance which in this case is proxied by CB short term interest rates we are now looking at the three major CB's all more likely to go South than North although I do expect the ECB to nudge it up to 4.25% but there is clearly downside risks to this call.

The thing is that the discourse on global excess liquidity has not suddenly gone away but of course the eye of the storm has tilted now towards securing an orderly end to the rollercoaster ride now seen in financial markets. In fact, if the BOJ does not raise come Thursday (and I would bet that they won't) we are right smack back into this idea of the current tightening cycle (how ever so slow it is) which was initiated as a 'joint' move to police excess global liquidity. I mean, it did not really turn out as everybody expected did it?

Of course, none of this is carved in stone but since even real economic fundamentals are trending down in Japan, Europe, and the US it does leave the CBs with a very myopic focus on future pipeline inflation and M3s as a lever to justify a continuation of the battle against perceived excess liquidity.

A last point I think deserves wider circulation although of course one of the Economist's recent Economics Focus columns noted something similar (http://www.economist.com/finance/displaystory.cfm?story_id=9621595) is the point about how it is increasingly the developing economies (whatever that is anyway) which is adding to the global monetary growth, at least on the margin.

Ok, all for now ... hope you had a nice holiday and good to have you back. Keep it up.


Macro Man
August 22, 2007 at 3:59 PM ×

Thanks Claus. Risk assets are certainly enjoying a nice warm soak today in a comfortable tub full of liquidity, thereby releiving me of my EWZ position.

Interesting to note though that the ECB went out of its way to suggest that the rate outlook has not materially changed. At some point it will be interesting to take a bet against those thinking that a Fed cut next month is a done deal....

August 22, 2007 at 4:28 PM ×

Welcome back mm
In your chart "contributions to monetary setting", what is the meaning of monetary setting? Is this M1? Monetary base? And the % change on the y axis... is that the year over year % change?

Macro Man
August 22, 2007 at 4:31 PM ×

JP, the 'monetary setting' is where central bank policy rates are relative to neutral. So a reading below means that rates are below neutral. i.e accommodative. -1% means that the GDP-weighted policy rate is 1% below neutral.

August 22, 2007 at 4:52 PM ×

Macro Man, thanks for the mentions! The challenge, for us liquidity analysts, comes more from "market liquidity" than from "macroeconomic liquidity". How do we measure the former? Is it measurable? Cheers, Agustin.

August 22, 2007 at 8:16 PM ×


A memory from Brooklyn days: the Crazy Eddie chain went bankrupt following a fraud.

Deliberate choice by MM for his readership?

Macro Man
August 22, 2007 at 10:41 PM ×

I wouldn't say that Cramer is a complete fraud, but the whole "I just want Joe Sixpack to get rich like me" schtick does reek a tiny bit of snake oil.

In any event, his TV offering, much like Crazy Eddie's advertising, demonstrates the triumph of (in-your-face) style over substance.

August 23, 2007 at 5:33 AM ×

two quick comments:

I thought you were sarcastic about "the dip buyers of the world". Are you now one of them?

Agree with your comment that the EM world is still providing a cushion. But, what if the "market-liquidity" crowd has gotten so risk-averse that it freezes up, trumping EM central banks.

Third, did you notice that the ABC/Washington Post consumer comfort index is hurtling toward levels that we normally see in recession.

Lastly, which risky assets are really cheap? Carry-trade currencies? EM bonds?

I am a bit confused or even surrpised by your bullish undertone

Macro Man
August 23, 2007 at 8:34 AM ×

Anantha, good questions. The pejorative 'dipbuyers of the world' term was coined in reference to those who seemed to think that EVERY dip needed to be bought IMMEDIATELY. It seems pretty clear that they should now have been disabued of the notion that that is a good idea. The dip that I want to buy is the panic dip, the dip where people sell because they have to, not because they want to. Call it the 'margin clerks' dip.

Obviously, if no risk-takers step up to the plate, then risky assets can fall a long way. But experience has demonstrated to me at least that catastrophic market events overshoot, and then correct more quickly than one could have anticipated. My bet is that EM SWFs could and would function as a risk-taker of last resort.

As for what is 'cheap' , I would argue that in a non-recession outcome, the S&P 500 looks cheap from a top-down viewpoint below 1400. Certainly there are individual stocks that already look cheap, though of course there are individual stocks that still look expensive. At the wides, investment-grade credit looked cheap, and will do so again should we revisit those levels. FX carry is probably the least cheap of the risk assets, and if I am right should suffer the biggest deterioration in its future risk-adjusted return relative to the past.

I have seen the ABC consumer confidence figure, and it is a source of concern. Bear in mond, though, that a) the overall measure remains within the 'range' of the past four years, and b) sharp moves in that index are driven by equities. I'd expect a meaningful bounce should the curent period of relative calm endure for the rest of the week.

I am trying to wear two hats: tactical and strategic. From a strategic perspective, I think that SPX sub 1400 looks like a good bet, given my underlying economic view (which could of course be wrong.)

From a tactical perspective, however, I want to put myself in a position where I have the P/L and pyschological cushion to be able to fade any panic selling.