Wednesday, October 07, 2015

Crude breaks the pincers

Yesterday went just about as planned.    European equities enjoyed another solid day while the S&P took a breather and a little dip, justifying calls for Turnaround Tuesday.   Meanwhile, it looks like the pincers were broken in crude oil, which put in a very nice day to break through the little downtrend line...and unlike last week, it sustained a nice close above it.  If crude can break above the late-August highs (about a buck and a half away), expect CTAs to get stuck in to close their positions, which could be fun to watch.

By the time you read this, the BOJ will have announced policy, with relatively little expected for this meeting (but something like a 50/50 perceived chance of more easing at the month-end meeting.)   Recall that it was last October that Kuroda supplied the market with ammunition to drive the rip in USD/JPY and the Nikkei; both they and Japanese CPI have stalled, largely for reasons outside of the BOJ's control.  While Kuroda is undoubtedly clever enough to understand this, by the same token he faces pressures to keep the ball rolling; his press conference will be interesting in terms of any hints given as to the near-term prospects for policy shifts.

Readers will recall that Macro Man suggested selling the Nikkei just as the wheels were starting to come off of global equities; while obviously a shock easing is a risk to that view, other than that Macro Man finds the Japan trade to be really quite uninspiring at the moment.  If you feel like USD/JPY is stuck in the mud, you're not wrong; it's traded on both sides of 120 every day but four since the beginning of September.   Zzzzzzz.

Now, on to China.   YUM brands is reportedly considering a name change to YUK, not only because of the dismal quality of their culinary offerings, but also because of its tepid growth and disappointing earnings...which they laid squarely at the door of the Chinese consumer, as Chinese revenues only increased 2% y/y.   Given the contradictory message from this report and Nike's, it's hard to know how much this says about the consumer's spending power and how much of it is disenchantment with the Colonel's chicken.

Meanwhile, there was an interesting paper recently published by the SF Fed on China.   The ostensible purpose of the paper was to determine if China has a history of fudging its GDP figures via looking at other countries' export figures.  (The conclusion was that it used to, but the data is more reliable since the crisis....perhaps less pressure to grow at breakneck speed implies less pressure to lie.)

In any event, the authors identify a range of ancillary indicators, and various combinations of them, that offer a good (and reliable) proxy for Chinese activity.  Macro Man used an amended version to create a little indicator of his own (if anyone has access to a time series of the 5000 enterprises diffusion index of raw materials supply, by all means share!)  In any event, the indicator seems to track the recent trend of published GDP fairly well...

...albeit showing lower growth than the official number.   Then again, that's the widespread view the true state of Chinese growth, so it's no bad thing.  Interestingly, the high-frequency version of the indicator suggests a flat trajectory of growth over the past few months, which jives nicely with Macro Man's general view that China has slowed but isn't collapsing.

We're due to get the report on September's FX reserve data in the next day or so (EDIT: It was released last night, and showed a smaller than expected decline of $43 bio; while not sustainable ad infinitum, it certainly doesn't convey any sense of a rapidly deteriorating situation.)   this should be closely watched for clues to the severity of capital flight and the degree to which the current account is mitigating its impact.

Tuesday, October 06, 2015

97 handles, 2 days

Whew.   97 handles is two days is potent stuff, and that's what the Spooz put in from the post-payroll lows on Friday through the high print on Monday (which wasn't that far off the close.)  This was the biggest two-day rally off the lows since all the way back on....August 27, and my didn't that turn out well?

It seems safe to say that the market has experienced quite a bit of psychological trauma over the past few weeks, no matter bull nor bear.  Obviously, sticky money is going to stay invested regardless of what market beta is doing, but you really have to wonder how much more of this the fast money crowd is prepared to take.  Yes, there is ample opportunity if you're a scalper...but if you're not quick (and good), by the same token there is plenty of opportunity to get scalped.

When equities are in freefall, one often hears the hopeful mutter of "turnaround Tuesday."  Now, alliteration is no way to run any kind of investment process, but it does seem to be the case that outsized moves either side of the weekend tend to reverse themselves come Tuesday.  You'd have to think that chances favor at least a bit of consolidation today after the furious price action of the last week.

What's notable is that- stop me if you've heard this one before- Europe appears to have quite a bit more upside on the charts than the SPX.  Spooz, for example, are roughly 1.5% off the highs of last month's Fed day....but Eurostoxx are nearly 4% lower.  The DAX is nearly 7% lower, but obviously there are some extenuating circumstances there.

When it comes to European equities, Macro Man feels like he's not only beating a dead horse, but cremating it, burying the ashes, and then proceeding to beat those.  Still, it's helpful to remind oneself that proper macro themes don't always come fruition a few days or weeks after you've made your mind up; some, like fine wine, need to age before they are ready.  Of course, in this game being early often equates to being wrong, so it's important to know when to pull the trigger and manage risk.

From Macro Man's perch, the best way to play the theme at the moment is with toe in the water type sizing; he generally prefers to ratchet up risk with a tailwind, so to speak....and right now, European equities still don't really have that.

Elsewhere, the headline non-manufacturing  ISM was a little weaker than expected, but still quite strong.   Interestingly, the employment component registered its joint 4th highest reading in the 18-year history of the survey.  Curiously, 2 of the other top 4 readings have also come within the last year.  While there's not much month-to-month correlation between this indicator and payrolls, a trend basis they tend to match up quite closely.  As such, the ongoing resilience of the ISM figure is telling.

The upshot of yesterday's frenzy is that eurodollars sold off and steepened; the 2nd vs 10th spread highlighted here yesterday steepened by 3.5 ticks.  It's only a drop in the bucket, of course, but every reversal has to start somewhere.  Whether the reversals can sustain, of course, is another question, as  investors these days know all too well.

Monday, October 05, 2015


So what now?   Friday's price action was as stunning as the employment data was disappointing, and punters could be excused for wanting to take some time off to gain some perspective and clear their heads.   Unfortunately, that option probably isn't available to many; we're entering the sharp end of the year with many, many YTD P/L's in uncomfortable territory- while it's not quite "find the trade to bet your year on" time, it's not far off.

In perusing a few charts over the weekend, Macro Man was struck by a number of them that appear to be caught in the middle of pincer-like narrowing trendlines.   Some, like gold, still offer a little room to maneuver:

Others, like the euro, look like a resolution will happen soon.  The irony is that there is relatively little on tap data- or policy-wise this week to give it a jolt....then again, large moves often happen in the absence of an obvious catalyst.  The pincers are currently 200 pips wide and narrowing fast.
The tell on which direction goes might come from oil, where the pincers are tightest of all.  There was admittedly a false break higher last week- was this a bull trap or a prelude to the next leg of the reversal?   Either way, it seems likely that the environment of high volatility is like to remain with us.

Last Friday, you could almost hear the market pining for a hint of QE4 when Spooz were on their lows.  It's nonsensical, of course, but such is the outcome of the modern day "every asset owner's a winner" Lake Wobegon financial markets.

In that vein, Macro Man was intrigued to see that after Friday's number most eurodollar curve spreads collapsed to their lowest levels in nearly 2 years.   The generic 2nd vs 10th contract spread, for example, is now at just 99 bps, pricing LIBOR less than 1% higher between March 2016 and March 2018.  By way of comparison, the median dots in the infamous SEP plot rise 225 bps between the end of 2015 and the end of '17 (not an exact match on time frame, but close enough.)  Fading this now is a bit of a falling-knife play, but the pre-taper low of 81 bps will look nice as a stop-loss risk parameter if we get another 5-10 bps lower.

If the flattening continues, though, pretty soon the Fed is going to run out of room to maneuver, because the market will be pricing nothing at all.  Between now and then, they're going to have to make a choice: do they continue to kow-tow to the whims of the market and its propensity to throw the toys out of the pram, or do they start delivering a tough-love type of lecture that market pricing doesn't reflect the Fed's intentions?

It's kind of ironic, really.  For years, the market has assumed a kind of omnipotence that central banks have over asset prices, whereas latterly, it is the market itself that seems to hold all the power over the Fed's lift-off decision.  In reality, of course, neither is all-powerful or all-knowing, and the longer that each side attributes these traits to the other, the nastier the surprise will be when reality bites.

Friday, October 02, 2015

The Fed put is real, and it's spectacular

It's payroll day today, and while the number of course is very important, somehow it feels a bit less so given that the Fed is almost certainly out of play this month.  Yesterday's ISM was worse than expected and better than feared, judging by the published consensus and the word on the strasse.  Markets seemed uncertain of how to digest things, even though the annualized vehicle sales numbers were a blowout, registering their highest reading in 15 years.

Also released yesterday was a very interesting paper authored by Boston Fed president Eric Rosengren and two others, arguing that the Fed acts as if it had a treble mandate, with financial stability joining inflation and (un)employment as explanatory variables in determining Fed monetary policy.  The authors identified a number of buzzwords that reflect concern over financial stability in Fed meeting transcripts, and then included their frequency of use in a regression to explain changes in Fed policy.

If Macro Man were to summarize the findings of the paper in one sentence, it would be this:  The Fed put is real, and it's spectacular.

Cynics will be unsurprised to see that the Fed's use of "downside" financial stability words like "volatility" and  "bust" occur much more frequently than "bubble" during the 1987-2009 sample period.   Perhaps not coincidentally, the FOMC's use of the buzzwords has trended noticeably higher since the 1990's.


What is somewhat surprising, however, is how much of an impact the buzzwords (or, more accurately, the concerns conveyed by them) have had in explaining Fed policy.  Over the sample period, each 100 buzzwords included in the transcripts equated to a 45 bp move in the Fed funds rate.  Believe it or not, that's a stronger impact than a 1% change in the forecast for inflation or the unemployment rate had over the same period.

Perhaps most telling is the skew in the Fed's reaction function.  The paper broke the sample down into quintiles using credit spreads, with the widest spreads representing a "bust" and the tightest spreads a "boom."  During the "bust periods", each 100 words of moaning about financial stability explained nearly 67 bps of easing, while a similar volume of concern during booms (which we've already established doesn't happen anyways) would only explain 36 bps of tightening.  In fact, the explanatory power of the financial stability buzzwords during "busts" is stronger than any reading for inflation or unemployment, the Fed's ostensible policy targets.  As many have suggested, the Fed not only doesn't take away the punch bowl these days, it spikes it with Everclear.   A simplified summary of the findings is set out below.

Based on these findings, perhaps the appropriate question is not "does the Fed make policy based on financial stability", but "does the Fed make policy based on anything else"?   

Elsewhere, the Atlanta Fed slashed its GDPNow Q3 forecast to just 0.9% yesterday, which raised eyebrows (and more doubts that the FOMC will ever pull the trigger.)  The basis of the downgrade was preliminary goods trade data for August, which showed sharp declines in both exports and imports and a widening of the deficit.   Forecasting the impact of trade on GDP is sketchy at the best of times, using preliminary data even more so.

One counterpoint to the notion that trade collapsed in August is the Long Beach Port data, which showed quite a substantial surge in traffic in that month.  Obviously the port data can be quite sloppy, but as a sense check it certainly doesn't confirm the basis of the GDPNow downgrade or suggest undue cause for concern.  After all, if the economy's going into the tank, why are Americans buying so many cars?

Finally, today's number.  The consensus forecast is rather unimaginative at 201k for the headline number, but Macro Man is hard pressed to argue against it; his own model looks for a rise of 209k.  Ordinarily, one might say that the unemployment would be of interest, given that it's approaching the NAIRU identified by the FOMC in the latest SEP last month.   The again, that NAIRU projection itself has come down by 0.3% since the end of last year, so it's pretty clear that the Fed is willing to lower it as much as necessary based on the spot unemployment rate reading.

Moreover, the table posted above suggests that it doesn't really matter anyways; during the good times, the Fed doesn't give a monkey's about the unemployment rate.   Indeed, based on all available evidence, they don't give a monkey's about anything but keeping the market supplied with (virtual) puts, thus blowing up the next (unmentioned) bubble.  The problem is that when the bubble bursts, that tends to be pretty spectacular, too.

Thursday, October 01, 2015

Dudley to market: remain calm, all is well

Where to begin?  How about with Bill Dudley, who gave a speech yesterday essentially saying "nothing to see here, please disperse" when it comes to bond market liquidity (or lack thereof.)  To say that the argument was uncompelling and smacked of complacency is an understatement; for example, Dudley's analysis focused on dealer-to-dealer transactions in the Treasury market while ignoring client-to-dealer transactions.  Moreover, by focusing on measures (such as deviation from fitted yield curve) that he himself admits were distorted by the Fed's zillion dollars worth of asset purchases, Dudley essentially rendered his argument tautological.

Unsurprisingly, other analysis comes to a different conclusion such as the chart displayed in this article showing how daily yield moves in excess of 1 standard deviation are at historic highs since the implementation of Dodd-Frank.

Dudley wrapped up his argument with the usual "even if liquidity has declined, it's a small price to pay for financial stability."  That's easy to say, but there is of course no guarantee that the deterioration of liquidity has conferred (or coincided) with overall financial stability...and that's without pointing out the logical fallacy that maintaining ample market liquidity and financial stability are somehow mutually exclusive.

As for those who've been bulldozed in the least liquid segment of the corporate sector, where price becomes news, here's a succinct summation of Dudley's message to you:

Moving along, focus today is on the ISM, where despite the published consensus forecast of 50.7 the whisper number is below 50.  Yesterday's execrable Chicago PMI number has surely fed the tide of negativity.  Given the weakness in other regional surveys, the market's pessimism would appear justified, though the historical correlation between the regional reports and the national figure are relatively modest.

While it would appear unlikely that the Fed would move policy with the ISM below 50, no one actually expects a move in October anyways, given the S&P 500's audacious failure to rally.  Putting things into context, however, it's important to recall that manufacturing is a relatively small (if visible) portion of the US economy.   A composite measure of the manufacturing and services ISMs, weighted 30/70 to reflect their relative importance, suggest things are nowhere near as bad as the usual prophets of doom might suggest.

Obviously, things can change....but right now Macro Man isn't seeing the sort of deterioration that would serve as a legitimate cause for alarm.

Speaking of which, there have been some fairly bearish viewpoints espoused in the comments section recently, and Macro Man was amused to see Carl Icahn star in a video expressing a similar sentiment.  Your author was shocked, SHOCKED to see Mr. Icahn, who owns many billion dollars worth of corporate equity, recommend steep corporate tax cuts as a solution to the current malaise.

The fact is, however, that corporate profits are generally doing just fine, thanks to a whole host of advantages that companies enjoy which Joe Sixpack does not.  Macro Man has touched on this before, but profits (and market expectation of future profit streams) do an excellent job of defining the secular cycle in US equities.  The current state of play, quite simply, does not suggest an imminent collapse, nor that this is 'the Big One'.  If anything, the time to make that argument was 6-9 months ago, which was exactly the point when Macro Man was fuming about the lack of volatility in the market.

History suggests that when earnings expectations are pointing up and the market's pointing down, it's the market, not expectations, that tends to correct.  Perhaps this time really will be different.  Macro Man cannot shake the view, however, that while we have moved into a higher volatility regime for the foreseeable future (thereby reducing the ex ante Sharpe ratio of holding risky assets), the ultimate resolution will be higher, demonstrating this to have been a correction rather than the start of a new bear market.

Wednesday, September 30, 2015

3 charts, 3 stories

The chart:  German harmonized inflation


The story:  The flash estimate of German HICP surprised to the downside yesterday, dipping into negative territory once again.   The risks to today's Eurozone figure therefore look comfortably skewed to the downside of the consensus expectation of flat y/y.  Now, a lot of this reading still captures the base effects of oil; it's easy to forget that Brent (in dollar terms, at least) is down 50% from its levels of a year ago.  Come the beginning of next year, the bulk of that base effect will drop out and German/European inflation will gradually trend higher (excepting a further 50% collapse in oil, of course.)

That having been said, it does look increasingly likely that Draghi will have another go at the tide of disinflation, ordering it to recede.  Perhaps we'll need to wait for December's forecast round or even early next year, but more easing (be it a further depo rate cut or more QE) looks to be in the pipeline at sometime, even if its difficult to have any confidence whatsoever that it will work.

In any event, the euribor market is willing to buy into the story, even if Eurozone equities are not.  (Though it may be the case that the latter has been suborned by too much length and more stories of automotive malfeasance.)  Yesterday saw a roaring trade in upside euribor option strategies; even though ERM6 has just a 17 tick range over the last six months, a large number of call flies went through yesterday requiring a further 17 tick move to hit max payout (and a 7 tick move to hit the at expiry breakeven.)  OK, at 2 ticks these structures aren't going to break the bank, but Macro Man does find it interesting to see the sudden uptick in volume in a market that he's kind of had on auto-ignore for some time now.

The chart:  USD/CNH

The story:  Remember that time 6-7 weeks ago when USD/CNH was going straight to the moon and taking USD/CNY with it, etc.?   Well, a funny thing happened on the way to the didn't happen, at least not yet.   While Macro Man has had a more constructive (or at least, less destructive) view on the RMB in its various guises than most commentators, he doesn't think the resilience of the CNH represents any sort of vindication other than a very short term one.

Much of the price action on the way down in USD/CNH over recent weeks has been characteristic of official selling; as a general rule of thumb, it's not very surprising that something goes down when a seller with a $3.5 trillion war chest lets a few go.  Then again, recent scuttlebutt is that the last few days' weakness is due to month-end flows rather than PBOC selling.  That, of course, serves as a timely reminder that China manages to generate a hell of a lot of foreign exchange revenues through international trade; this is a prime example of how it can offset capital account outflows. 

All this having been said, now that the CNH and CNY have come together (CNH is actually trading slightly stronger than CNY for the first time in a while), things could get interesting.  There has been a school of thought that the Chinese authorities wanted to harmonize the market pricing of on- and off-shore RMB before unleashing the full fury of the market mechanism (what with its 2% daily trading band.)  Well, now they've done it, so if the RMB were going to become more of a float than a peg, it could and should happen soon.   Stay tuned.

The chart:  The S&P 500 in 2003-2004

The story:  Observe how in the run-up to the first rate hike of the previous cycle (marked by the black arrow for you under-30's), the SPX whipped around in a range for 6 months after the Fed first hinted that something was rumbling.  Granted, that range was a lot tighter than the one we've been mapping out over the past few weeks...but then again, it wasn't as tight as the one the SPX had traced out for the six months prior to the August swoon.

In any event, equities actually rallied towards their highs in the run-up to the first rate hike...only to sell off to fresh lows immediately afterwards.   At the time, there was plenty of commentary that the Fed would only be able to manage a few hikes before having to pause and possibly reverse.  In any event, once it became apparent that the US economy was not, in fact, going to collapse, Spooz recovered...before going on a rip-snorting rally into year end.

Now obviously, the analogue is not perfect.   There is no housing bubble to spur (unsustainable) consumption growth, and today's credit cycle is much more mature, as holders of Glencore and other commodity-based paper can ruefully attest.  Nonetheless, from a market psychology point of view, the precedent of the last cycle may prove to be a useful one.  After all, history may not repeat, but it often rhymes. As such, from current levels Macro Man finds prognostications of an imminent meltdown  or melt-up equally unconvincing.   Once the rate hike happens (if it does) and a month or two pass without the data rolling will be a lot easier to argue a bull case for reasons other than short-term mean reversion.

Tuesday, September 29, 2015

Core meltdown

Well, that got ugly in a hurry.  Curiously, however, yesterday's risky asset selling never really seemed to reach a panicked crescendo; it was more of a drip-feed of supply into the market all day.  In that sense, it wasn't like a disaster movie or a Bond flick where the infuriatingly calm female voice intones "core meltdown in 30 seconds".   No, this was more of a Glencore meltdown, a slow descent into the void.

For clearly Glencore's travails have gone tabloid and are the new nexus of market weakness, with China's economic slowdown forgotten in a retail frenzy of Air Jordans and iPhone 6s's.  The company's swift descent into the maelstrom is the closest thing we've seen  seen to the financial crisis since crisis.  The familiar pattern...

Over-leverage during the good times -->  See underlying price of key asset(s) tumble  --> Share price comes under pressure as investors worry about leverage --> Devise plan to recapitalize and "sort everything out"  --> Market calls BS, equity and bond prices dump

....describes Glencore's downfall every bit as much as it did, say, Merrill Lynch's.  Certainly the price of Glencore bonds is reminiscent of crisis, be it the GFC or the biannual Greek meltdown/bailout.


On a positive note, it does not seem as if Glencore carries the same systemic risk that so many financial institutions did seven years ago, most notably AIG.   Macro Man was chatting with a mate yesterday who speculated that the company's notional derivative exposure must be "in the trillions."   Macro Man's philosophy is why guess when you can look, so he did, and was pleasantly surprised by what he found.   If the company's financial statements are to be believed, the company's gross and net derivative exposure is actually quite small, and they've actually unwound about half of their book since the end of last year.

                                                  source: Glencore

That will come as small comfort to those unfortunate souls long the bonds in the chart above, of course, nor those long the equity or bonds of other commodity players, large and small.  For better or for worse, Glencore can serve as something of a morality tale of the post-crisis era, and not just because they IPO'd at the ding-dong highs of the commodity market, joining others like GS (1999) and Blackstone/KKR (2007) to cash out at the best possible time.

No, Glencore's story is one of succumbing to the temptation of the luscious fruits on offer in ZIRP-world, and the doubling of the firm's gross and net debt profiles between the end of 2011 (its first year as a public company) and 2013.   Now, this probably says as much about how management's incentives were skewed as soon as somebody else was holding the equity bag as it does about the ultra-permissive borrowing climate that's prevailed in the world of QE, ZIRP, and central bank forward guidance.  But still- adding $27 billion of gross debt is pretty punchy no matter how you slice it.

The outcome leaves the Fed in exactly the type of conundrum that curmudgeons like your author have been concerned about vis-a-vis ultra-easy monetary policy and the misallocation of capital.   Does it react to market woes deriving from Glencore by delaying the policy shift that it's indicated it wishes to get on with?  If so, isn't that kind of like delegating the chairmanship of the FOMC to Ivan Glasenberg, which doesn't seem like such a hot idea given the performance of his firm?

On the other hand, there is some legitimate stress out there.  For many of us, credit market liquidity has been a primary concern in the brave new regulatory regime, with the inability of dealers to take any principal risk rendering the market considerably more volatile...and prone to over-shooting well beyond the apparent fundamentals of the market or an underlying security.   That's all well and good if you're a long-term investor with a multi-year horizon, but in the modern climate of five minute macro, it's properly frightening for those caught long (and wrong.)  Using HYG as a proxy, high yield isn;t in proper meltdown mode yet....but it's not too far off.

As equity-focused readers have noted, biotech has gotten slammed recently, even more so than in the 'rotation, rotation, rotation' shank-fest in the .  Obviously, this is a sector quite popular with a lot of equity guys, though their performance recently does raise the question of whether they actually generate any alpha, or simply buy the thing that goes up the fastest (and not sell it when it goes down the fastest!)

Regardless, the Fed really needs to sort out its communications strategy, which has descended into farce.   You know the stream of verbal diarrhea from governors and regional presidents has become counterproductive when two Fed-heads hit the tape an hour apart giving conflicting messages.  Yes, each person around the table is special and wonderful, etc.   At such a sensitive time, however, too many cooks spoil the broth (one used to be able to say there were too many chiefs and not enough Indians- is that still allowed?)

Either way, the Fed really ought to sort itself out sooner rather than later...or we might end up with a proper core meltdown, just like you see in the Bond movies.