Wednesday, January 28, 2015

The Federales arrive

It's Federales ride into town today, and while it seems as if Macro Man should be tense/excited/worried, somehow he just cannot envisage a likely scenario where the apple cart gets upset too much.   Call it the first few minutes of Once Upon a Time in The West rather than the Gunfight at the OK Corral.

To be sure, the data has not been uniformly on the Fed's side since the pow-wow last month; if anything, it's been the opposite.     It's difficult to see them getting too alarmed, however, given that the economy grew at a pace of roughly 4% for the final three quarters of 2014.  A little pullback is not altogether unexpected.

Indeed, 'twould be more worrisome if confidence were starting to fracture.   If anything, however, the opposite is the case.  Most measures of consumer confidence are at their highest levels since before the crisis, so it's hard to see the Fed (over) reacting to a few weeks of soft patch.  Indeed, the only thing rising faster than the Gallup consumer confidence index, pictured below, is the US dollar.

To be sure, people are long dollars, and positions are always at risk when there are shocks; just ask some erstwhile longs in EUR/CHF!  That having been said, while the position may be broad, Macro Man doesn't have the sense -yet- that is is especially deep.   That may be hard to credit given the 30-figure move in EUR/USD over the last few quarters, but long-time FX punters will know that short euros has generally been a difficult position to carry.   Now that we are finally seeing a secular change in the trend, good opportunities to sell have been few and far between.

Perhaps the greatest near-term risk is if the FOMC mentions the strength of the dollar in any light but one that emphasizes the boost to consumer purchasing power.  It's possible, to be sure, but somehow Macro Man just doesn't see it yet.  Yes, they may well acknowledge the further downward pressure on headline inflation, but generally speaking they still believe that this is a net positive (and your author is inclined to agree.)

So while some commentators may expect a few fireworks today, the best that Macro Man can foresee is a few strains from a lonely harmonica.

Monday, January 26, 2015

Bullet points while preparing for SNOWMAGEDDON

* When Macro Man checked the weather forecast last Friday, early this week was supposed to be cold and sunny.  Over the weekend, it changed to a bit of snow.   Yesterday, as he was riding his bike on the turbo trainer, Macro Boy the Elder burst in to tell him that the forecast had changed to 20 to 30 inches (50 to 75 cm) of snow from Monday morning to Tuesday midnight.  You know it's bad when they cannot specify the amount of snow you'll receive within 10 inches.

* A year ago, March '14 heating oil was priced at just over $3.00.   Today, March '15 is at $1.62.   With plenty of the stuff set to be burned in the Northeast this week, the strong dollar will demonstrate a palpable benefit to the economy.

* Syriza duly "won" the Greek elections while falling short of an outright majority.  Meanwhile, anti-austerity party Podemos is the hottest new thing in Spanish politics.   It's all very well for Draghi and the Germans to harp on about structural reform and fiscal rectitude, but what happens when those goals happen to conflict with the will of the people?  The risk/reward from owning peripheral debt at these levels looks very poor indeed.

* Some degree of consolidation in the euro is probably to be expected after the recent downdraft.  Anyone who wanted to be short but wasn't probably had to reach and hit a bid that he'd rather not have.   That having been said, it doesn't seem as if many are positioned for a "proper" move to parity, so any bounces should probably be seen as a gift and an opportunity to add to shorts at better levels.

* For another take on central banks and risk, peruse friend-of-the-blog Neil Azous's piece at Finalternatives.

* Good luck and stay warm!

Friday, January 23, 2015


It's the oldest trick in the policymakers' manual: Under-promise, over-deliver.  In fairness, Super Mario never really under-promised; Wednesday's 50b per month leak certainly suggested a program that was larger than the prevailing consensus.  But by comfortably exceeding that figure just 24 hours later and laying out a roadmap for at least 18 months' of purchases, Mario Draghi once again demonstrated that he is not to be trifled with.

To be sure, the Germans got their wish and segregated the vast bulk of the buying from the ECB's balance sheet; Macro Man couldn't help but notice Draghi's mention that the Bundesbank were the beneficiaries of full risk sharing (had it been required) in the depths of the maelstrom in 2008.   Whether this was a subtle dig or a history lesson is unclear; perhaps it was a little of both.

Regardless, it was a fairly assured performance from the ECB President, and when Mr. Draghi is assured, he normally gets what he wants.  So it was yesterday; although the euro took a little while to make up its mind, by the end of the day the sellers poured in, the buyers backed off, and the SNB no doubt congratulated themselves on how little they managed to lose on their 175 billion of euro denominated assets (or B.)

Looking at a monthly chart, there appears to be quite a bit of fresh air below current levels in EUR/USD.

While nothing moves forever in a straight line, of course, it certainly doesn't feel as if euro weakness has gone tabloid, as the Dollar Going Down Forever was wont to do quite frequently over the last decade and a half.  EGDF might well become over-crowded, but that will likely require more time and lower prices.

As for equities, they were all swept up by the excitement on Thursday; one can easily imagine European equity managers chairing Signor Draghi out of the village square, as the SX5E reached a post-crisis high.  That having been said, liquidity can only carry you so far in the absence of any discernible demand; everything you need to know about European equities is probably summarized in the chart below of the IBEX and DAX; no promises for guessing which is which.

And fixed income?  Let's just say that when you can be long 10 year UST versus BTPs and pick up 30 bps of positive carry, you're supposed to do that until your (appendage of your choice) falls off, aren't you?  The ECB hasn't even bought bonds yet, and those BTPs are yielding roughly 10 bps above the all time low in Treasuries.

No wonder the SNB wanted no part of buying any more.....

Thursday, January 22, 2015

When doves fly

The ECB's thunder was stolen a bit on Wednesday, as three other central banks hit the tape with dovish developments.   The BOJ downgraded their inflation outlook, the BOE minutes revealed that the MPC lost its 2 hawkish voters, and of course the Bank of Canada cut rates, a mere twelvemonth after it first emerged as a tradeable macro theme.  

Lower oil prices were a common thread running  through these announcements; to paraphrase Prince, this is what it sounds like when doves fly.

Speaking of which, today is the day when we (almost certainly) finally get ECB QE.   The WSJ ran a story yesterday suggesting EUR50 billion per month of purchases, which while sizable was a bit less than the Fed bought when QE3 was in its pomp.  Of course, an open-ended commitment to continue these purchases for as long as necessary could render the ultimate size to be quite large indeed.

Of course, questions still remain, even if the WSJ leak is correct.   What bonds will be bought, from which countries?  Will the ECB buy them, or will the national CBs simply buy their own countries' bonds, per last week's report?  Will they touch the depo rate tomorrow, or indeed ever again?

At the time of writing (7 pm EST on Wednesday), the survey has generated 100 responses, roughly half of which occurred before the Journal story.

The results are summarized in the table below:

As you can see, the average respondent expected a total QE size of approximately 733 bio, with a median of 600 bio.  As you can see from the standard deviation, there were a few rather large outliers.   This is broadly in line with the prevailing consensus, and consistent with a year's worth of purchases per the leak.  An open-ended commitment that allows for a potential increase in size could be construed as a dovish surprise.

Roughly 1 in 5 respondents expected a 25 bp depo rate cut, so any move on rates would also be taken as a surprise.   That having been said, punters seem to feel that it's all in the price.   The EUR/USD expectation skews slightly to the high side, albeit with a pretty wide distribution (as seen by the more than 7 big figure SD!)  Curiously, 1.18 was the most common of the 100 responses.

On aggregate, readers expected a modest rally in the Eurostoxx 50, though again, with a wide distribution of responses.  Ironically, one of the tightest forecast distributions was EUR/CHF, where the SD of responses was "just" 3-and-a-bit percent.  On balance, there's not a whole lot here to sway Macro man one way or the other.  He's retaining a very modest euro short that offers plenty of room to add should either news or price offer an attractive opportunity.

Finally, it's perhaps worth noting that readers seem to expect the first Fed hike this September, with that meeting representing both the median and the mode of respondents.   The average response was for December 2016, but was heavily skewed by a few wags inputting 2020, 2038, and 2065 as the dates for lift-off.

One can only hope that these joking forecasts do not come to pass.  If they did, there would no longer be any macro hawks or doves....we'd all be dodos.

Wednesday, January 21, 2015

Survey says!

It's obviously a big week for financial markets still smarting from the sting of the SNB.   The apparent raison d'etre for the Swiss volte-face is coming to town on Thursday, in the form of a much-anticipated ECB QE announcement.

That it is much anticipated, of course, raises the ante on having a view; given the ongoing strength in European rates and weakness in the euro, it would appear that there's a lot baked into this particular cake.  Of course, Mario Draghi has shown an almost Svengali-like ability to bend markets to his will; he's certainly had more success convincing punters to sell euros and buy BTPS than he has convincing the Germans of...well...anything.

In any event, Macro Man can see arguments in favour of following Draghi's lead once again, and others in favour of "selling the fact."  Certainly last week should give punters pause about slavishly following the apparent dictates of any central bank.  He thought it would be useful and informative to conduct a brief survey about expectations for ECB policy and market reactions.  Insofar as the audience in this space is well-informed about these issues, the results should provide an interesting snapshot of what "smart money" expects.  Readers can of course then follow through with their own interpretation of these results.

Kindly fill in the form below:  a results posting will follow before the ECB renders its decision.

Sunday, January 18, 2015

Weekend interlude: The curse of the Hammers

Longtime readers may recall that Macro Man is partial to the footballing stylings of West Ham United.  The story behind his support of West Ham is a convoluted one; suffice to say that when he first moved to Europe more than two decades ago, the allure of East End pie'n'mash and jellied eels proved stronger than the fancy-Dan surroundings of certain other London clubs more generally popular with his fellow expatriates.  And hey- if the Hammers are good enough for Frodo Baggins, they're good enough for him.

Anyhow, as your author was enjoying the 3-0 thrashing of Hull City this morning, he was struck by the ongoing blandishments of erstwhile club sponsor Alpari FX on the advertising hoardings around the pitch.  Alpari, as you may have heard, was one of the casualties of the SNB this week; like many FX bucket shops, it was unable to recoup the losses from short CHF customers trading on razor-thin margins, and has gone bust.

Curiously, this was not the first firm associated with West Ham that has run into a spot of bother.  Although the club is currently owned by a couple of East End boys done good (if becoming a porn magnate can be described as "done good"), its previous owner was an Icelandic sugar-daddy named Björgólfur Guðmundsson.   Mr. Guðmundsson, who alas no longer qualifies for sugar-daddy status, was also the majority owner of highly levered Icelandic bank Landsbanki, proprietor of such too-good-to-true financial schemes as Icesave.   As readers may recall, Iceland did not exactly enjoy smooth sailing during the financial crisis, and both Landsbanki and Mr. Guðmundsson declared insolvency in 2008-09.

Prior to that, West Ham was sponsored by a no-frills airline called XL Airways, which catered to the package holiday customer more interested in the size of the ticket price than the comfort of the travel or the convenience of the embarkation/debarkation locales and times.   The business model was a familiar one in the airline industry:

1) Borrow money
2) Lease aged planes and slap a new logo on them
3) Charge punters little enough to fill the planes but just enough to turn a profit

Such a business is inherently leveraged, and as you may recall leveraged businesses did not fare so well in 2008.  XL, however, was almost prescient in the timing of its failure; it ceased operations the Friday before Lehman Brothers went bust.

Let this little history lesson be a word of warning.  It seems unlikely that the demand for pornographic materials is going to wane in the near future, so the core business of West Ham's owners would appear secure.   If you happen to own stock in the club's next sponsor, however, you might be advised to sell...or at least take out a cheeky hedge in case the curse of the Hammers strikes once again.

Friday, January 16, 2015

A few thoughts about yesterday's bombshell

For many punters, yesterday was either the most fun they've had in ages or a potential one-way trip to the unemployment line- depending, of course, upon their perspective and (more importantly) their positioning.  Either way, it certainly re-ignited interest in macro, if the blog-o-meter is to be believed:

Judging by the reaction of the IMF and corporate Switzerland, it was not just lazy longs in EUR/CHF who were sideswiped by the SNB's decision.  It's hard to know whether the SNB misjudged the likely market reaction or whether they just didn't care.   Ignorance or apathy- which is a more cardinal sin for a central banker?

Regardless, yesterday served as a reminder that while old-school macro has seemed dead it was, to quote Billy Crystal in The Princess Bride, only "mostly dead."  That there was damage reflects how our markets have changed; in the old days, pegged exchange rates were targets to be taken on and wiped out if they deviated too far from fair value.   The ERM, Asia, Latin America; in the 90's breaking pegs was a great source of macro return.

Sadly, the post-crisis era has changed macro markets in a number of ways, none of them desirable:

* The myth of central bank omnipotence and credibility.  Although a lot us us here moan about "CB X is a fraud with no credibility", the fact is that the vast, vast majority of market participants believe in aphorisms like "don't fight the Fed."   Small wonder, too, since CBs did a generally excellent job of crushing vol, lowering the term structure of rates, and emasculating anyone who presumed to bet too heavily on an eventual change in the policy regime.   Europe has been the notable exception, but even there Draghi managed to extinguish the sovereign crisis throughout most of the Eurozone without buying a single bond (to date.)  

Of course, the problem with this myth is that no central banker is either omniscient or infallible, and policy error will occur eventually.   At the very least, policy shifts will occur unlike any that many market participants have ever seen before.   The last Fed rate hike, for example, was in 2006- meaning that no market participant under the age of 30 has ever seen one on a professional basis, and no one much younger than 35 has seen one whilst in a position of substantial responsibility.  Perhaps it's OK for such a significant cohort of the market population to be entering such uncharted territory...but you'd damned well better be prepared if they aren't. 

* Natural selection away from buyers of vol and risk premia in favour of sellers of vol and risk premia.  For intellectual and temperamental reasons, Macro Man has traditionally been a buyer of optionality.  He had a very good 2008-09 and a poor 2012, and for the last 9 months he's been sitting at home, cycling and doing some PA punting.  He knows another of other PMs and traders with similar profiles who've been spending their time in similar ways.  At the same time, some strategies focused on clipping coupons/selling vol/trading mean reversion in rates + FX have performed quite strongly.  Unfortunately (and your author will try not to sound bitter here), allocators and funds do not have the appetite to warehouse macro guys who merely pay for themselves during the lean years when the coupon clippers are having it off.

EUR/CHF has been a nonsense trade for the better part of a year, and it was pretty clear that a) the SNB wasn't going to raise the floor, and b) that EUR/CHF wasn't interested in rising by itself as the drumbeat of ECB QE grew louder.  If you really believed that it was going to rally, you could have been long calls with plenty of embedded leverage and modest (and pre-identified) downside.  Unfortunately, many punters who think like that have been naturally selected away, leaving those (not exclusively, of course) who have been rewarded for picking up the pennies.   However, if you never look for the steamroller, you won't see it as it's about to flatten you.

* Market liquidity has deteriorated very sharply.  It seems to be en vogue amongst a cadre of never-traded-professionally policymakers and regulators to state that a decline in market liquidity from pre-crisis levels is a good thing, as it will discourage excessive risk taking.   Be careful what you wish for, because you just might get it.  Lower liquidity, higher vol, and larger risk premium are certainly a recipe for substantially smaller nominal positions.  Unfortunately, lower liquidity, low vol, and low risk premia are a ticking time bomb, as VaR frameworks allow for large nominal position sizes.

However, low market liquidity warps the return distribution to a more non-normal shape, as witnessed by the EUR/CHF debacle.   Comments that the move was a "33 SD" event are nonsensical;   price action below 1.20 was never going to be normally distributed, so it is worse than useless to compare volatility there with that pre-peg break.  That EUR/CHF could trade down 30% (!!!) intraday should tell policymakers something about markets' ability to synthesize new news in an orderly fashion- it's evaporated.   OK, EUR/CHF impacts FX punters and Swiss corporates, but it's not an A-list financial price, is it?  Fine, but what happens when the same thing occurs in credit?   Hell, the same thing has kind of already happened in slow motion in crude oil, but because it helps consumers and screws Russia no one's complaining too much except a few holders of wildcatters' bonds.

Putting it simplistically, there are three classes of traders:

1)  Those that size trades based on current (low) levels of vol
2)  Those that size trades based on a perceived normal level of vol, and thus run 'low risk' in the current environment
3)  Those that do #1, but tell investors/CIOs/themselves that they'll switch to #2 when the time is just right.

In many ways, getting the sizing correct is just as important as getting the market direction right.   For the last several years, trader #1 has reigned supreme, but the rumblings over the last several months strongly suggest that you might want to think about switching gears to #2 earlier rather than later.  As for #3, they are like a (literal) black swan:  Macro Man knows they exist, but he's never seen one in the flesh.