Muddling through

Yesterday was the least interesting day that Macro Man can recall in quite some time.  To be sure, it was Columbus Day in the US, which is kind of a holiday (and kind of isn't), and a number of other countries were also closed.  Still, given the OMG China/Fed/Oil/Payrolls/Spooz! whirlwind of the last couple of months, it felt like a typical quiet summer's day got lost in the space/time continuum and emerged, blinking, on October 12th.

What's moderately interesting is that lost in all the sturm und drang of Battleground SPX, other asset prices that are typically useful signposts for either financial stress or euphoria could not seem less engaged with the great economic debates of the day.  USD/JPY, for example, rinsed everyone who was involved in the span of a few days in August, and since then has done quite literally nothing.   Macro Man calculates the 1 month realized vol as 4.5%, but even that seems high given that the price seems stuck at 120 give or take a few pips.

To be sure, this could merely reflect a lack of positioning and more interesting (or painful) trading conditions elsewhere.  The euro, for example, has broken out of the pincers observed last week, as has gold.  On the surface, that might suggest a further bout of USD weakness, particularly in light of the ongoing renaissance in EMFX.  On the other hand, oil got severely rejected in its first go at the 100 and 200 day moving averages yesterday, so it's difficult to call this a can't miss opportunity to play dollar weakness.

Indeed, if anything Macro Man would generally characterize this as an abeyance of the broader theme of dollar strength.  How one wishes to trade this clearly depends on time horizon, intellectual flexibility, etc.   Personally, when it comes to secular themes (where the default position would be long dollars in this case), he tends to view being flat as equivalent to being limit short, a moderate position as being flat, and a limit long position as being...well...limit long.   At the moment he has a very small long dollar position that is the equivalent of a modest short in this framework.  More nimble punters may well be tempted into outright dollar shorts as the Fed flip-flopping continues.  (There is, however, no truth to the rumor that a popular breakfast food chain has purchased the Eccles Building and plans to rechristen it as the Waffle House.)

Speaking of the Fed (because it seems a necessity to do so on a daily basis), Macro Man had a little fun poring through some data yesterday.   A number of Fed speakers, including Yellen, have made a bit of a song and dance about inflation expectations and concerns that there could be some erosion of the public's long-term view on future price rises.  One would normally expect that expectations, particularly those in the long run, would match either the central bank's target, or at least resemble the trajectory of realized inflation.

Macro Man plotted the 1- and 5-year forward inflation expectation series from the University of Michigan alongside the core PCE deflator, which the Fed believes is the most accurate measure of inflation.   Quelle surprise: did you know that the last time that core PCE inflation was the same level as either inflation expectation series was 1992?

While it is true that current 5-year expectations are at the lower end of the range of the past few years, it's also the case that the highest level of expectations came in early 2008...which wasn't exactly a harbringer of any type of spiral, and was largely looked through (except by a certain European central bank).  Moreover, the trend in expectations over the past couple of decades pretty much defines "stability."

As a citizen, what's more troubling is that the central bank seems to think inflation is a lot lower than the populace does, assuming that expectations tend to at least loosely anchor around observed inflation.  That's an argument that's been fought and lost, however, so there's not much point getting worked up about it.   As it is, any further erosion of any measure of the public's inflation expectations can and will be taken as the next excuse for FOMC inaction.

Switching gears briefly, at the time of writing China has released RMB-denominated trade data, which show yet another larger-than-expected surplus in September- indeed, a record month surplus of Y376.2 billion.  Although imports were slightly weaker than expected, the large beat of the consensus was driven by stronger-than-expected exports.

Perhaps uncoincidentally, the PBOC fixed the RMB at its strongest level since the deval, with the strongest daily rise in nearly a year.  Thus far, Macro Man's base case on China appears to be playing out, i.e. a muddling-through as the market's worst fears slowly defuse. Muddling through is never a sexy forecast, but quite often it's a correct one....