Monday, April 30, 2007
Another week, another reason to worry. Macro Man is beginning to feel like the teacher in the old Charlie Brown television specials: an annoying background noise as the stars of the show (in this case, risky assets) carry on their conversation.
The latest brick in the wall of worry comes from Turkey, where the presidential elections were disrupted by a statement from the military on Friday evening and mass demonstrations on the streets of Istanbul over the weekend.
The situation presents an odd cocktail of gripes: while the average Turk on the street agrees with the military about the importance of maintaining a secular government, no one particularly wants to see the generals get involved with determining the outcome of democratic elections. Regardless, the market outcome has been predictable- gaps lower in the Turkish equity, bond, and currency markets, followed by almost immediate dip-buying from investors eager to purchase riskey assets "on sale."
The complacency implicit in the dip buying is particularly telling given the horrible seasonality of EM assets in May. And if Iceland could trigger an EM meltdown last year, why not Turkey, a much bigger market, this year?
That the Dow has risen in 19 out of 21 days for the first time since 1929 underscores both the favourability of the recent market environment and the potential danger posed by a deterioration of conditions. Not that Macro Man is forecasting a 1929, 1987, or even a February 27 outcome for equities; however, it continues to seem prudent to maitain a relatively defensive posture and have plenty of room to add risk on dips.
Macro Man has to shake his head, though. His sale of SPM7 calls has to date been undone by what is literally a once-in-a-lifetime straightline rally in equities.
Friday, April 27, 2007
In Curb Your Enthusiasm, Larry David often finds himself in trouble when he shrugs his shoulders and makes a noncomital noise when asked his opinion on something. Were he a finanical market economist, Macro Man suspects that he'd be making that noise in response to the GDP figs.
Spending was strong, but everything else was pretty tepid. The only real notable feature of the data was the high print on the deflator, which registered 4.0% q/q saar, the highest reading since the original George Bush was in the White House. The core PCE delfator was up 2.2%.
While bonds have taken their cues from the price data, this may be something of a headfake. Energy was the prime contributor to price gains, and the government deflator was 5.9%- recalling memories of the $500 wrenches purchased by the military during the Reagan years. However, bootstrapping the core PCE data suggests that the y/y rate for March (released on Monday) will be 2.1%- lower than expected and close to the Fed's comfort zone. Macro Man will therefore sit tight with his long bond position, though he may look to pitch it in the mid 108's.
UPDATE: So blah was this report, and inded the aftermath, that Macro Man neglected that your all time-high in EUR/USD is now 1.3684. The silence, however, is deafening. The slow-motion crash continues apace....
Will today be a Freaky Friday? Markets feel nervous, though far from panicky. Today's US GDP release could be a catalyst for a bit more market volatility than we've recently observed. A legitimately weak number (i.e., one where negative contributions come from sources other than housing and inventories), coming on top of a skein of poor Japanese data overnight, could prove to be a tipping point for risky assets.
Macro Man senses nerves in a range of markets, an small wonder. Everything is the same trade. One would struggle to come up with a strong macroeconomic relationship between Spanish equities and the foreign exchange value of the New Zealand dollar versus the yen, but for the last year, they've been the same trade.
It is interesting to note that housing markets in bubblicious areas like Spain and Ireland are showing signs of rolling over; meanwhile, rumours abound that Ecofin poobah Jean-Claude Juncker wants to resign his post in protest over the ECB's acquiescence of a strong euro. Maybe, just maybe, things are about to get interesting. Such developments will come none too soon; Macro Man has been mullahed on his short risky asset position in the alpha portfolio.
As a housekeeping note, he exercised his 1.3550 €/$ calls yesterday and was filled on his sale of 100k XHB at 35.50. Roll on 8:30 EDT!
Macro Man’s email box has been polluted on several occasions recently with solicitations for and explanations of a range of “exciting new financial derivative products.” Specifically, investment banks are sending out an increasing amount of drivel about things called CCOs and CFXOs: collateralized commodity obligations and collateralized foreign exchange obligations. If ever there was a solution for a problem that didn’t exist, this crap is it.
To quote a recent solicitation: “while this is a modification of CDS translated into FX space, we can see that this actually closely resembles a well-defined FX product, namely a one-touch option.”
In other words, there is already a liquid and easy-to-understand product where the market and credit risks are transparent. These banks wish to replace this product with an illiquid, opaque structure where the market risk is similar but the credit risk is an additional variable. This begs the question of why end users do not simply replicate the payout profile of this junk by combining traditional one touch options with conventional credit default swaps.
Macro Man has generally pooh-poohed those worry warts who view derivatives as the paving stones on the road to Financial Armageddon, but this rubbish certainly gives him pause for thought. A word of warning to anyone considering buying this junk: in all likelihood, the people who structure this stuff get paid more than you. Before buying, ask yourself where that money comes from!
Thursday, April 26, 2007
Well, the champagne corks have popped. Of course, it was equity people doing most the partying, as the Dow Jones (why does anyone follow this index?) broke 13,000 for the first time ever yesterday. The currency folks’ champers went flat pretty quickly, as EUR/USD could only manage to hit the previous all time high to the very pip. Six months after the euro’s previous foray to 1.3667 against the dollar, it was trading below 1.20. Sadly for EUR/USD longs like Macro Man, the same trend has unfolded in the hours since EUR/USD traded above 1.3660 yesterday.
The last twenty four hours have seen some interesting facts emerge. First, the global growth story remains fairly intact and upbeat. In addition to solid sentiment readings in Germany and France, the US saw much better than expected durable goods data for March. Equities predictably had a ball.
However, signs of unease amongst beneficiaries of global activity appear to be growing. The Norgesbank surprisingly left rates on hold yesterday. While the attached statement suggested that the trajectory of monetary policy has actually not changed, that the bank failed to deliver a widely anticipated tightening perhaps indicates that they don’t want tightening financial conditions to bind too tightly while uncertainty remains.
Even more interesting was the RBNZ, which ratcheted rates to 7.75% but noted that kiwi strength was both “excessive” and “unjustified.” Leaving aside the obvious correlation between New Zealand’s nominal rates and currency strength, the language in the statement was significant because it repeats the criteria that the RBNZ has previously set for intervening in the currency market. As such, the statement must surely be taken as a shot across the bows of the market that further kiwi strength might see the RBNZ taking the other side of the trade. This morning, the NZD has broken an uptrend line against the dollar- could the little old kiwi be the catalyst for a correction in risk assets? Stranger things have happened. (Macro Man cannot help but note the irony of the RBNZ complaining about currency strength on the same day that news of a trade SURPLUS for March was released.)
Another central bank peeved at domestic currency strength is that of Brazil. As USD/BRL approaches its own version of “the deuce”, Bacen has stepped up its presence in the currency market and threatened to ease rates more aggressively. This prompted Macro Man to wonder about the degree of legitimate BRL overvaluation, which will ultimately dictate the success of Bacen’s intervention campaign.
A few years ago, Macro Man had played around with some PPP-style valuation models for Brazil, saved them into a spreadsheet, and then promptly forgot them. Essentially, he calculated a basic purchasing power parity for USD/BRL. Unsurprisingly, this simple model did not do terribly well in identifying an ex-post equilibrium for USD/BRL, and currently pegs fair value for the pair at 2.73. However, he also adjusted this basic calculation to account for terms of trade shocks; this model appeared to do a somewhat better job of identifying ex-post equilibrium levels for USD/BRL.
This work was carried out in late 2004; at the time, this adjusted model pegged fair value for USD/BRL at 2.66, modestly below the prevailing spot level of 2.90. Imagine Macro Man’s surprise, therefore, when he updated the work and found the TOT adjusted model had more or less tracked the USD/BRL spot rate over the past couple of years, currently assessing fair value at 2.07.
Doh! Although Macro Man has done fairly well out of Brazil (in his real job) over the past couple of years, he generally assume that the real was growing more overvalued below 2.40 and sized positions accordingly. Even more intriguingly, the size of the over/undervaluation according to the adjusted PPP model seems to bear a pretty reasonable relationship to the delta of Brazil’s trade balance. For the past year, the model has suggested that the real has been more or less fairly valued- and the trade balance has flatlined.
What are the implications for Bacen and its intervention policy? Well, for the last couple of years, they have been leaning into the wind, trying to stem a fundamentally justified appreciation of the real. However, barring a further positive terms of trade shock, a move in USD/BRL below the deuce will finally bring the real into overvalued territory. Not only should this begin to impact the trade account, but it also raises the likelihood that Bacen intervention tactics could finally gain some traction. Coupled with its evident resolve to accelerate rate cuts and go for growth, this suggests to Macro Man that fixed income and particularly equities are likely to be superior Brazil plays than the real. He will therefore trudge to the back of the queue of those waiting for a dip to enter these trades.
Wednesday, April 25, 2007
Macro Man has the champagne on ice, reading to pop the cork when, as seems inevitable, EUR/USD makes a new post-1999 high. Perhaps another rubbish reading on durable goods or housing will do the trick. For the time being, profit taking seems to be the order of the day, taking the other side of demand caused by Voldemort and yet another strong ifo reading in Germany.
In Japan, the trade surplus surged to a record high on an unadjusted basis in March, providing some suggestion that the yen is, indeed, undervalued. Macro Man has never disputed that the yen is undervalued; rather, he has claimed that the yen is not terribly undervalued against the US dollar. It was interesting to see that exports to the US were up only 2.4% y/y, while those to Asia and the EU rose 10% and 13.7% respectively. Yes, Virginia, exchange rates do eventually matter!
Tuesday, April 24, 2007
Markets feel strangely nervous today, and it's hard to pinpoint why. Sure, Target admitted that they'll miss their April sales forecasts, and of course, S&P noted that the subprime mess hasn't exactly improved recently. But still, those factors don't really explain the jitters being felt across asset markets today.
Take the FX carry trade (no, really- please take it!) The Aussie dollar in particular has been hit hard overnight on the release of much lower than expected CPI (0.1% q/q instead of the expected 0.6%.) This has obliterated any hopes for a near term rate hike, so investors will need to content themselves with the 6.4% they are currently earning on 3 month cash. Clear, a reason to abandon ship!
There's been some suggestion that the low print in Aussie CPI was all down to bananas, and that stripping out the monkey food would yield a quarterly reading more in line with the consensus. Perhaps...but it does appear that Aussie inflation, both with and without food, has peaked and is heading lower. That the AUD has been smashed on this stands in stark contrast with the NZD's reaction to a lowball print in New Zealand inflation last week. That the dip in AUD has not been gratefully scooped up as the dip in kiwi was last week may indicate that the carry trade is overdue for a dip.
In Spain, meanwhile, the IBEX has been pummelled lower, with property company Astroc leabing the charge lower. The shares of the Valencia-based developer have cratered in recent days with little apparent catalyst. Could it be ECB policy tightening is finally starting to bite? Or is it just that balmy weather in the UK has encouraged sun-loving Brits to abandon Spanish property in favour of the North Atlantic Riviera? Perhaps Charles Butler, proprietor of the excellent IBEX Salad, could shed some light on the issue....
Elsewhere, Macro Man has won a beer from a colleague as Abdullah Gul was announced as the AKP presidential candidate in Turkey. The solid performance of the TRY this morning in light of the news offers some suggesiton that today's jitters are just that- jitters.
Monday, April 23, 2007
It’s been a fairly dull start to the morning, with equities slightly lower, bonds slightly higher, and EUR/JPY down about half a percent. News headlines include an S&P upgrade to Japan’s long-term local currency rating (AA- to AA), and two stories that were subsequently denied:
* The FT carries a story that Japan is mulling the establishment of a sovereign wealth fund, a story that percolates every so often. While the MOF denied it, such a fund seems inevitable, given the state of the country’s demographics. Such a fund would almost certainly have negative consequences for the dollar, given that a high proportion of Japan’s reserves are kept in the greenback.
* Bank of Greece governor Garganas was quoted in a newspaper story as stating that further euro strength may preclude additional tightening from the ECB. This was partially responsible for the early stop loss run in EUR/USD and EUR/JPY. No doubt after an angry phone call from M. Trichet, the Bank of Greece subsequently denied the comments. It’s unlikely that the French elections have had much impact, though the outcome (Sarkozy and Royal making it past the first round) may increase the chance of the odd moan about euro strength over the next couple of weeks.
There was an interesting post in All About Alpha the other day linking to a Bridgewater piece on hedge fund beta masquerading as alpha. This calls to mind Macro Man’s recently-dormant research agenda on beta strategies. Remarkably, it didn’t take long to come up with a reasonable proxy for emerging market exposure that matches the Tremont emerging index, net of fees.
Per the Bridgewater note, emerging market returns can be thought of as ½ equity and ½ fixed income. Even within the fixed income space, currency and carry explain most of the returns. So a simple strategy of ½ EM equities and ½ EM carry basket would appear to capture the flavour of EM investing. Could it really be that simple?
As it turns out, it can. Macro Man constructed a simple index of ½ MSCI Emerging equities, ½ a carry basket of popular EM currencies plus the G3. While there is undoubtedly some ex-post selection bias here- THB is not included in the carry basket because it is fairly unfeasible to trade it offshore in size at the moment- the basket does capture most of the EM currencies that have been popular to trade over the past fifteen years.
He calculated returns on both a gross and net of performance fee (20%) basis. While he did not include a management fee in his calculation, by the same token he also did not include any return on cash deposits, either. The results are set out in the chart below.
The question is whether he can tweak the replication with a market-time element to turn it from a pure beta play to a beta-plus. A bit more research is required here. While there are undoubtedly superstar EM managers who trounce the index on a regular basis, it would appear quite clear that one can capture the bulk of the asset class’s returns with relatively little effort and at a cost substantially lower than two and twenty.
Friday, April 20, 2007
The ancillary implication of the slow motion crisis is that European firms are probably in better shape with the euro here than previously. It seems dubious that this is because hedge rates have improved from 2004- that would seem virtually impossible- but rather that productivity has improved and that domestic demand is firmer. Moreover, Eastern Europe is growing like gangbusters, and the euro is not strong against PLN, HUF, CZK, etc.
Today's comment from the German exporters' association that they can live with EUR/USD at 1.40 was telling. As an aside, a 10% rally from the low of the year, which would make this move comparable to prior moves, would put EUR/USD at 1.4150....
Have you got your bottle of champagne of ice? Or, if you live in the United States, your bottle of California sparkling wine, since true champagne is now unaffordable. This morning EUR/USD has traded up to 1.3638, a scant 32 pips away from matching its all time (post euro launch) high. With such an obvious target so close, a new all time high could literally come at any minute.
Aussie through 0.80, cable through the deuce, and a new all-time high in EUR/USD. What more could you want to signal a dollar crisis? Heck, even The Economist has had the decency to keep the dollar off its front cover, thereby permitting further downside. A funny thing happened on the way to the currency crisis, however. If the dollar really is in the process of crashing, it seems to be happening in high definition, super slow-motion. And if it’s happening in super slow-mo, can we really characterize it as a “crash” or a “crisis”?
How can we define a crash or crisis? Well, a reasonable shorthand definition, it seems to Macro Man, is the attainment of a new price extreme accompanied by a large rate of change (say, over a three month period) and high/rising volatility. And by this measure, the recent spate of dollar weakness (against the euro) bears little resemblance to episodes in the recent past.
EUR/USD has only rallied about 5% over the last three months, which is hardly a signal of impending Armageddon. In the good old days, that could have been a daily range! At the same time, implied volatility has barely moved, remaining close to all time lows. And with good reason- realized vol has also been remarkably low! So while the dollar has weakened fairly steadily, there is absolutely nothing to suggest in the currency episode that global investors are panicking or fleeing the dollar wholesale.
The last two episodes of dollar weakness, on the other hand, tell a different story. In late 2004 the dollar’s three month rate of change comfortably exceeded 10%, one month implied vols traded around 10% (in contrast to the current 5.8%), and there was a sharp uptick in realized volatility.
Similarly, when EUR/USD breached 1.20 for the first time in late 2003 and traded as high as 1.29 in early 2004, there was considerably more sound and fury than we currently observe. The three month rate of change reached 10% (twice!), one month implieds traded comfortably above 10%, and one month realized vol moved substantially as well…
Whatever the reason, the lack of volatility in the current bout of dollar weakness suggests that doomcasts of a US financial market implosion on the basis the dollar remain well wide of the mark. If foreign investors really were preparing to ditch US assets wholesale, surely we’d expect the currency market to exhibit more thunder and lightning than is currently the case.
Thursday, April 19, 2007
Macro Man’s yen concerns proved to be sadly prophetic yesterday, as the JPY has rallied strongly overnight before he could take remedial action. The prime mover here, as seems to be the case with many currency and bond moves, was of course China. Leaks of strong data prompted a sharp sell off in risk assets in Asia; those risks proved to be well-founded, as China’s GDP, industrial production, and CPI all proved to be substantially stronger than expected. The y/y growth rate of Chinese GDP accelerated to 11.1%; one would have to believe that, absent draconian lending restrictions from on high, borrowing rates in China would be comfortably higher. While the best China-watchers in the business are characterizing all this data as ‘temporary spikes’, it strikes Macro Man that there was a remarkable confluence of such spikes in China during Q1- except, of course, in the value of the RMB.
Over the course of the session the Shangai market fell sharply, taking the rest of regional equities with it. The rationale for the decline was that yet another upside surprise for nominal GDP (real growth and inflation) will force a legitimate policy tightening and send Chinese shares lower. Even in today’s short-attention-span market, many traders seem to vaguely recall that they were Shanghai’ed a couple of months ago. The memories are fuzzy, mind you, but it was enough to take some money off the table.
Macro Man is joking, of course; or is he? The chart below shows the performance of the Shanghai index on a logarithmic scale. While you can just about make out last night’s wobble and February’s jitters, to call them “blips” is almost overemphasizing their importance. While Macro Man would feel queasy about going long at these elevated levels, particularly with Chinese margins on the wane, that’s not to say that yet another round of policy tightening will send shares spiraling lower. The most likely outcome is sideways action such as that observed in January-February. Low delta wingnut downside might make some sense as a punt, but Macro Man needs to dig a little deeper.
Wednesday, April 18, 2007
“When the facts change, I change my mind. What do you do, sir?”
- John Maynard Keynes
The above quotation is one of Keynes’ most famous, and is a maxim that Macro Man tries to live by. While it is important not to flip-flop with every incoming piece of information, it is nevertheless vital to investment success not to remain wedded to a preconceived notion when the underlying circumstances change. Many a successful trade has been ruined by failing to recognize a change in circumstance and therefore staying in too long.
A couple of months ago, Macro Man wrote a series of articles on the yen carry trade, or lack thereof. He maintained then, and maintains now, that the size of the yen carry trade is nothing like it was in 1998, and that doomcasts of a similar catastrophic drop are wide of the mark.
That having been said, Macro Man is starting to get a little concerned. While the period immediately after the February G7 saw a flush out of what few legitimate carry trades were out there, the last six or seven weeks has seen a sharp sell-off in the yen against a broad range of currencies. Looking at the yen versus 4 popular carry currencies (USD, NZD, AUD, TRY), it is now weaker in nominal terms against all but the dollar when compared to the point when Macro Man first addressed the subject. In carry-adjusted terms, of course, the yen’s weakness has been even more pronounced.
What is different now, compared to a couple of months ago, is that ownership of the carry position seems to be deeper amongst the fund management community. Yen weakness at the end of 2006 and early 2007 was driven, in Macro Man’s view, by Japanese household demand for foreign currency assets. Macro Man would characterize this as an asset allocation shift rather than a carry trade, per se. What’s curious to note is that investment trust sales over the past couple of months have been heavily skewed towards equities rather than foreign bonds/cash plus type products. It seems as if the NZD/JPY uridashi with spot at 88.50 is not terribly appealing to Mrs. Kobayashi. Similarly, one of Macro Man’s favoured flow measures suggests that Japanese institutional selling of yen has yet to re-accelerate in the new fiscal year.
So who or what has driven the yen so weak against high yielding foreign currencies? The answer, it would appear, is that gaijin fund managers have finally and aggressively been sucked into the trade. Macro Man was fairly startled to see the latest Russell/Mellon survey from Deutsche Bank: the median yen position has moved aggressively short over the last couple of months, taking the yen short to its largest in four years.
Macro Man is currently short yen in the beta portfolio and more or less flat equity delta, given the short SPM7 calls in the alpha portfolio. On the basis of positioning, at least, he appears to be exposed where he needs protection and flat where the chances of a short covering rally remain. While this doesn’t necessarily require immediate action, Macro Man is now thinking about shifting his hedge profile to fit the evident market positioning.
Tuesday, April 17, 2007
Taken at face value, today's US data hasn't done too much to threaten the market's view of a stagflationary outcome fo the US economy. Industrial production fell 0.2%, which was a weaker than expected out-turn. While manufacturing was actually quite solid, up 0.7%, the substantial revisions to the back data lowered the estimated capacity utilization by roughly half a percent. In other words, the economy has more slack than previously thought.
Core inflation, meanwhile, was closer to zero than it was to the expected 0.2% monthly rise. Nevertheless, the headline came in at the expected 0.6 m/m and 2.8% y/y. And soon after, Chuck Plosser hit the tapes that the Fed is still worried about inflation, blah blah blah. Either way, it looks like a recipe for continued underperformance of $ assets and, by extension, the USD. Macro Man therefore buys £15 million 2 week 2.02 cable calls for 0.26% of face, a small premium outlay of about $78 k. Should sterling remain uber bid and the dollar broadly offered, this trade could offer a reasonable amout of leverage.
The major financial news of the day is that UK CPI printed a surprisingly high 3.1% y/y this morning, forcing Mervyn King to write a letter to Gordon Brown explaining himself. This news has not been welcome to Macro Man, as he’s taken alpha portfolio hits on the long short sterling and long cable one touch positions. Beta portfolio gains have not fully compensated for these losses, unfortunately. Numerologists will be pleased to see that cable has broken through “the deuce”, though has yet to breach its pre-Black Wednesday high of 2.0115. Should such a breach ensue, there is fairly clear sailing to the topside, technically.
The Dec short sterling contract, meanwhile, is fully pricing in two more rate hikes. In Macro man’s view, this means it’s too late to sell out the position, though he is not quite brave enough to add. In the letter, King noted that today’s CPI report didn’t materially change the Bank’s view from its February inflation report, and that they are prepared to look through the short term volatility in the data. If the data hasn’t altered the Bank’s view, therefore, it would appear unlikely to alter their behaviour- so Macro Man doesn’t think it realistic that they will hike more than twice for the rest of the year, and that the balance of risk remains tilted towards an economic deceleration and only one further tightening. Thus, he sits tight on short sterling.
Inflation data in the US is unlikely to have a similar impact, barring an equally extreme miss. That being said, the continued failure of core CPI to turn meaningfully lower may continue to provide headaches for the Fed. Perversely, the recent rise in US yields has been largely real-yield driven, as breakevens have edged from 2.48% to 2.45%. Fortunately, TIPS are priced off of headline inflation, which looks as if it is now accelerating on a monthly basis while turning higher on a y/y basis. Macro Man is sorely tempted to add a long breakeven spread to his beta portfolio, though that’s more or less what he will have once exercising the TYM7 put options this Friday
Particularly galling is the ease with which firearms may be purchased. At Wal-Mart you cannot buy music that uses the F-word too frequently or makes fun of Jesus, but you can buy a gun with virtually no questions asked. This seems perverse. True, the second amendment guarantees the right to bear arms- but then again, the first amendment guarantees freedom of speech. Somehow, the potential consequences of blasphemy are deemed more undesirable than the potential consequences of gunplay. Hmm....where have we heard this before?
The literal text of the (poorly worded) Second Amendment is as follows: “A well regulated militia, being necessary to the security of a free state, the right of the people to keep and bear arms, shall not be infringed.”
Macro Man reckons he’s hit upon the solution. Require all gun owners and buyers to sign up for the militia, today’s National Guard. If state laws cannot dissuade easy access to firearms, perhaps the prospect of a tour of duty in Iraq can.
Monday, April 16, 2007
The G7 statement was limp, as expected. There was no real change from February, and surprisingly little moaning on the sidelines: a classic non-event.
The IMF statement was limp. Sure, they provided a list of policy targets for the multilateral participants (US, Europe, Japan, China, and Saudi Arabia.) And sure, Hank Paulson said he really, really, really wants the IMF to strengthen its oversight capabilities on exchange rates. But as Brad Setser discusses, the policy goals are generally nebulous and toothless.
The problem, as it has been, is that the IMF has no “stick” with which to encourage cooperation. China, the Middle East, et al. have no need for the Fund’s monetary IV- quite the contrary! So if pleas like Macro Man’s have not fallen on deaf ears, they seem to have fallen on relatively powerless ears.
That China couldn’t give a hoot what the IMF had to say was evident by the fact that they sent jubbs to the meetings while the Finance Minister and PBOC Governor stayed at home. It’s hard to take China’s lip-service towards rebalancing its economy seriously when the relevant officials cannot even be bothered to give up their weekend barbecues.
A comment from one of the jubbs, PBOC deputy governor Hu Xiaolian, afforded Macro Man some modicum of amusement. She told the IMF steering committee that "Given the limitations of various exchange rate analytical tools, it is well known that the concept of exchange rate misalignment is subject to theoretical weakness, their estimates highly unreliable, and therefore could not serve as criteria or premises for surveillance."
Perhaps, but suggesting that the shortcomings of various models prevents one from identifying the RMB as undervalued given the trade surplus/reserve accumulation is like a birdwatcher stating that the absence of a DNA sample prevents one from correctly identifying a waterfowl that looks like a duck and quacks like a duck.
Anyhow, it looks very much like an “as you were.” The dollar should trade poorly against most things that pay 3% or more, and decently against the other stuff. It was amusing yet predictable to see PBOC ensure that USD/CNY closed higher on the day- Zhous must have had a nice giggle over that at his weekend barbie.
The entry signal on the FX carry beta plus portfolio was finally triggered; fills are in the P/L below. This week could prove interesting for equities; US earnings season picks up steam, and the data slate is chock full of important releases, starting with retail sales today. Ultimately, though, the world continues to look like a pretty happy place, especially if you work at PBOC and you’re holding all the cards.
Friday, April 13, 2007
Macro ManNow, today's open letter was written tongue-in-cheek: but only just. The drumbeat of tit-for-tat protectionist/mercantilist/beggar-thy-neighbour economic policymaking is growing louder by the day. Reserve managers buy unfathomable amounts of dollars and in response, Congressmen rush to join the Smoot-Hawley International Tariffs Help Extend the American Dream Society (see if you can figure out what the abbreviated name is....)
Someone has to be an adult, and as painful as it is for Macro Man to admit it (given his general aversion to "official" intervention in markets), the IMF is the obvious candidate. The alternative- that recent trends accelerate in a parabolic fashion- would almost certainly have unpleasant consequences.
Yesterday, Macro Man had a pop at China, a favourite target in these e-pages. Many others had a similar response to China's enormous reserve growth in Q1. One interesting explanation that's been bandied about is that the parabolic increase in Q1 reserves reflects the maturation of some swaps that were traded a few years ago. Now maybe this is the case and maybe it isn't- we won't really know until we see more data. Regardless, Macro Man isn't sure that it matters. Either PBOC was playing silly buggers last quarter, or they were playing silly buggers a couple of years ago. Either way, it is difficult to avoid the conclusion that they are playing silly buggers.Moreover, China's reserve growth stands out only because the existing stock is so darned big. On a rate of change basis, China doesn't particularly stand out from its peers. Since the middle of 2006, FX reserves in China, Russia, and India have all grown by more than 20%. So even if the jump in Chinese reserves has a logical explanation...then what the hell are Russia and India playing at?
Intriguingly, today sees the release of US trade data for February. An absolute shocker would provide an interesting backdrop for this weekend's IMG/G7 discussion, to say the least. Macro Man originally thought that there was a reasonable chance of a large widening due to higher oil prices. However, a glance at the the import price data reveals that America's terms of trade actually improved slightly in February. So any blowout would have to come from volumes rather than prices, which would appear rather unlikely given the softness of domestic demand during the month.
Nevertheless, interesting trends are emerging in US trade prices. It looks increasingly like the great goods price deflation trend, which has helped keep core inflation relatively low, has come to an end. The chart below shows the y/y change in the price of imported manufactured goods- the last couple of years certainly look like a change in trend from the late nineties/early noughties! Even import prices from China rose last month! This is one of the reasons why Macro Man loves keeping TIPS in the portfolio.
Elsewhere, M. Trichet performed as expected, signalling in ECB semaphore that a June rate hike remains on the cards. When the euro failed to come off on any 'sell the fact' action, that set the stage for the next leg of the squeeze higher. We're now barely a percent away from the all time high of EUR/USD. If the IMF doesn't do its thing (which would shift the focus away from the € and towards the yen, RMB, etc.), then we could be popping champagne corks on Monday afternoon.
One trade that is not causing Macro Man to sip champagne is the WTI/Brent spread. Continued inventory overhang at Cushing has caused WTI to lag badly in the latest run up in oil, and the Dec 07 contract now trades at a discount to its lower quality counterpart. The trade is singlehandedly responsible for losses in the alpha portfolio this month and has knocked half a percent off of overall performance. Macro Man will want to see an improvement soon, or it might be time for remedial action.
Thursday, April 12, 2007
Yesterday, Macro Man wrote that he had a bigger beef with China’s FX reserve policies than he did with the level of the RMB per se. Now, the two issues are intimately related, of course, as a change in the prosecution of the former would indubitably result in a change in the value of the latter. Nevertheless, it is the distortions caused by reserve growth that pose the larger structural threat, in Macro Man’s view, because of the artificial compression of risk premia that result.
Well, China released Q1 FX reserve data last night...and it really makes Macro Man wonder what the hell they are playing at. The stock of reserves increased by a whopping $136 billion in the first quarter alone, a growth rate that is looking decidedly parabolic.
What makes the reserve growth particularly galling is that the have authorities dramatically slowed the pace of RMB appreciation since mid February. Now, maybe this has been in preparation for a large one-off step revaluation of the RMB....but probably not. And obviously, ex-post, it’s difficult to reconcile RMB stagnation with any myths about capital xportation when Q1 reserve growth exceeded the reported trade balance by almost $90 billion. The only reasonable explanation is that Q1 saw a deliberate attempt to slow the pace of RMB appreciation and/or accrue FX reserves. And while Macro Man is certainly no fan of protectionism, he does think that China (and indeed Russia) needs to be called onto the carpet. Perhaps the G7/IMF will do so this weekend. Failing that, maybe the US Treasury report on currencies will finally name and shame China for taking the piss.
In any event, the upshot is that China, Russia, India, and the rest of their brethren have a lot of wood to chop in terms of their reserve management. Macro Man estimates that those three plus Taiwan, just by themselves, needed to buy €35 billion in Q1 just to maintain portfolio benchmarks. While these guys have certainly been active so far this year, Macro Man does not have the sense that they have shifted this sort of size- otherwise, the euro would be even stronger. And the higher the euro goes, the larger the performance lag against benchmark will- and thus the greater the pressure to come to market. It is for this reason that Macro Man fears that USD/Europe could be perched on the edge of a precipice, near term.
Relatively hawkish Fed minutes, and EUR/USD is 40 pips higher than when London went home yesterday, with rumours abounding that the Russian central bank is buying like it's going out of style.
Macro Man hears the theme tune from Jaws playing in his head...so he buys €20 million of a 2 week (April 26) 1.3550 euro call for 0.255% of euro face, our about $70k worth of premium. It's a small ticket bet, but if EUR/USD explodes like Macro Man thinks it might, the payoff could be quite large...
Wednesday, April 11, 2007
Macro Man has largely stayed away from currencies recently. Not only has the FX carry component of the beta plus portfolio been neutral for most of the last six weeks (though it is perilously close to re-entering the carry trade at nosebleed levels), but the occasional foray into FX alpha trading has proven unsuccessful since early in the year.
Part of this has been the breakdown in the effectiveness of proxy trades, which was a costly feature of March. Part of it has been the lack of volatility- G3 FX vols remain at or near all time lows. Part of it has been the stretched valuations of many of the more popular EM currency trades (TRY and BRL, I’m lookin’ at you) combined with a seasonal tendency towards underperformance. And part of it has been the degree to which central banks continue to dominate the landscape, whether via reserve accumulation or via diversification/maintenance of reserve portfolio benchmarks. It’s difficult to get terribly excited about throwing loads of risk at a market whose hegemonic participants have a tendency to push things away from where the private sector would prefer to take them.
Nevertheless, the currency market is throwing up a couple of interesting talking points. A number of currency pairs are at, near, or just through critical long-term technical levels:
* GBP/USD 2.00
* AUD/USD 0.80
* AUD/JPY 100
* AUD/CHF 1.00
* USD/NOK 6.00
* EUR/USD 1.3670
The obvious features here are dollar weakness and carry currency strength. Carry currency strength is largely down to low volatilities, benign global asset market conditions, and ample liquidity. If gold were at $620, the SPX at 1400, and US 10 year yields at 5%, Macro Man suspects that the Aussie dollar, for example, would be a heckuva lot lower than it is now. Failing those developments, however, there may not be much to stand in the way of further strength.
The dollar, of course, is the real issue that could provoke renewed interest in currency markets. It’s remarkable how little fanfare has accompanied the dollar’s descent towards multiyear/multi-decade lows against a number of non-funding currencies. Part of the lack of clamour is simply a function of the fact that the greenback spent all of Q1 tracing out a range against, say, the euro. Indeed, EUR/USD is only 1.5% above where it closed 2006.
However, EUR/USD has shown a remarkable tendency over the past few years to consolidate within a fairly narrow range before exploding higher. Granted, there has been a declining marginal return from each range breakout, but the repetitive pattern is nevertheless instructive. Macro Man has dubbed this behavioural pattern the “Rule of Four Point Two.”
Consider the following:
* In the summer of 2004, EUR/USD traded in a 4.2% range before central bank buying helped drive a breakout which extended 12 big figures
* In Q1 2006, EUR/USD traded in a 4.5% range before central bank buying helped drive a breakout which extended 6 big figures
* In summer 2006, EUR/USD traded in a 4.2% range before central bank buying helped drive a breakout which extended 4 big figures
* In Q1 2007, the range in EUR/USD was 4.2%, which we’ve now breached, with reports suggesting increased central bank activity
Now, a glance at the chart above will suggest that Macro Man is to some extent fitting his facts to the story. In the first two instances mentioned, EUR/USD had made a prior, lower, low before settling into the 4.2% +- range for a few months. But let’s face it: “The Rule of Four Point Two” sounds better than “The Rule of Four to Six Percent”. In any event, those narrower ranges were actively felt and traded by the market, so it’s a liberty that Macro Man feels justified in taking.
What does it all mean? Macro Man senses a growing risk that the dollar could be susceptible to one of its periodic step shifts lower against the euro. He feels that central banks are behaving like sharks circling a dying whale...as soon as one commits, they will all pounce and the result will be a frenzy. Whether this should happen is almost beside the point, though rate spreads suggest that most of the dollar’s recent weakness has been justified. Perhaps a shocking trade figure on Friday could energize the market?
While Macro Man is leery of buying euros at the current nosebleed levels, and particularly ahead of Thursday’s ECB meeting and the weekend G7, he nevertheless feels that a potential run on the dollar is an opportunity that should not be missed. He therefore executes an initial purchase of €10 million at 1.3425 spot basis, 1.3436 to May 3. If the trade pans out, risk will likely be added on top. 1.3250 will serve as an initial review level. Although GBP offers superior carry, Macro Man is reticent about buying ahead of “the deuce”, particularly as cable has been paid up today on the potential non-story of a “UK HIA.”
Elsewhere in currency land, Brad Setser had an interesting post yesterday on the RMB and China’s trade surplus. Brad suggests that shifts in the USD/RMB rate overstate the degree of RMB appreciation, and that burgeoning exports to Europe suggest a reasonable sensitivity to the EUR/CNY rate.
Macro Man decided to do a little digging to discover the extent of the difference between USD/RMB and an export-weighted currency index. The results are set out in the charts below.
Tuesday, April 10, 2007
The week has heated up a bit, with plenty of data points to digest. In no particular order, the following items are catching Macro Man’s eye this morning:
* If the word on the street is to be believed, Voldemort and co. have been active in selling USD/Europe overnight. In 2006, they started ramping it on Easter Monday. This year, they’ve evidently decided to wait until liquidity improves on Tuesday. Regardless, they’ve driven a small wedge between EUR/USD and relative rate expectations: the chart below illustrates EUR/USD and the expected 3 month cash spread this December. If maintained, the breakdown could be telling.
* The AUD is on fire: it’s broken parity against the CHF and is now at its highest level against the dollar since 1990. The next obvious technical barrier is 100 in AUD/JPY. M&A flow appears to be a primary driver here, and the technical picture is suggesting a risk of broad-based Aussie strength.
* On the other hand, the G7/IMF/World Bank meetings this coming weekend have prompted little more than a yawn. This is somewhat surprising, given it was these very meetings last year the caused the market to go long yen and short all things with current account deficits. The market’s complacency, combined with relative price extremes, is worrisome. Of course, they may be taking their cues from policmakers; the MAS has intervened vigorously today to weaken the SGD against its NEER basket.
* Like a dog with a chew-toy, Europe refuses to let go of the US mortgage loan story. The employment data has been written off as weather-related (where was the dismissal of the February data for the same reason?), while the recent American Home Mortgage announcement has provided further encouragement to the “hell in a handbasket” crowd. Nevertheless, European equities have opened strongly today, suggesting a reasonable degree of comfort that any economic fallout will be ring-fenced.
* China’s trade data for March revealed a remarkable contraction in the surplus, from $23.8 billion in February to just $6.9 billion in March. Yearly export growth plummeted from 51.7% to 6.9%. Now, either the global economy has hit a brick wall, or there is some funny business going on with the data. Macro Man votes funny business, with the likely culprit being firms’ desire to shift merchandise ahead of government-imposed export quotas. On a smoothed basis, the data suggests some moderation of the surplus but continued strength in exports.
* Inflation in Norway hit its highest level since spring 2003. This should validate further aggressive tightening from the Norgesbank and spur the NOK a bit higher on a broad basis. There may well be a trade here. This latest in a broad series of upside inflation surprises do little to alter Macro Man’s belief that inflation, rather than recession, is the biggest threat facing risky assets at the moment. It will be interesting to see whether or not Jean-Claude Trichet begins positioning the market for a further tightening of ECB rates; if he does, both the euro and Macro Man’s short euribor position should benefit.
Monday, April 09, 2007
Markets ar easing in to the post-Easter/post-payroll week, with most of Europe out for Easter Monday today. Thus, it will be tomorrow before one can say that whatever impact last Friday's employment figures might have is truly in the price. If Asian markets are anything to go by, then equities will put in a good performance today and tomorrow. Of course, earnings season lurks like the proverbial 800 pound gorilla, and a series of disappointing out-turns could easily reverse favourable developments on the macro front.
Macro Man took the weekend off, and so didn't post the answers to the previous weekend's quiz on P/E ratios. Congratulations to Sandy, the winner.
The answers were as follows:
Hang Seng 15.6
ISE 100 13.1
Friday, April 06, 2007
Insofar as it can be trusted (i.e., not very), today's employment situation report in the US was pretty good all round. Thus far, the bond-currency square has been circled via a stronger dollar, as expected. Whether that sticks is another question entirely, of course. Londoners are fleeing their desks a scant 15 minutes after the release; New Yorkers may not be far behind. Thus, if someone wanted to jam things later today, they could. Whether they choose to do so remains to be seen...
Time to put it all on black and spin the wheel. Yes, it's payroll day again today, with the added kicker that there is zero liquidity in those few markets that remain open. A usually noisy (as opposed to signal-y) event will likely be even noisier today, and traders could do worse than to hit the golf course today and worry about the consequences of the report on Monday.
For those that retain an interest, however, some interesting gaps are emerging. Yesterday saw a poor performance from the US bond market, with the future sliding back below 108. Yet higher yields provided little succor the the dollar, as EUR/USD traded up to its highest level since the spring of 2005.
Recent correlations suggest that this combination may not be durable, and one of the two (either US bonds or the dollar) will snap back after payrolls. For choice, Macro man would favour the dollar, as it has seemed to trade well on each of the last several payroll days. Yet that strength has proved ephemeral, as current weakness of the buck against everything but the yen would attest.
If today's payroll figure is as profitable as yesterday's BOE non-hike, Macro Man will be more than satisfied.
Thursday, April 05, 2007
Easter was one of Macro Man's favorite times of year as a boy, and he can still remember the pleasure that he used to feel as the holiday approached. Easter was a herald of spring, a sign that the long, cold winter had come to an end. It was a time when heavy jackets could be put away and windbreakers donned instead.
Then there were the Easter egg hunts, and of course, the candy on Easter morning. Macro Man always had a weakness for jelly beans, preferring them to chocolate. His mother used to stuff little plastic eggs with jelly beans and put them Macro Man's easter basket. Upon discovery, Macro Man would consume the parceled jelly beans with what in retrospect was alarming speed. The only downside to the whole experience (other than subsequent liabilities to dental professionals) was stuffing a handful of jelly bean into his mouth and sensing the sickly sweet taste of the dreaded black jelly bean.
As much as Macro Man loved most jelly beans, he loathed the licorice-y black ones. He'd normally pick them out and given them to his father, who loved 'em. However, during the occasional frenzied consumption binge, one would slip through. Rarely has he tasted disappointment more acutely than when a black bean would connive its way into a handful of fruity goodness.
So where are the black jelly beans now? Over the next thirty hours or so, there is plenty for the market to get its teeth stuck into, notably today's BOE meeting and tomorrow's payroll data from the US. Whether either will mean much in the fullness of time is up for debate. After all, if the BOE doesn't go today, they'll probably go next month. And US payrolls are notoriously noisy, with more information in the inevitable revisions than there is in the headline data.
Yet with many markets pricing perfection, either of these events could provide a black jelly bean to ruin the market's experience. Bank Indonesia has already surprised markets today by not cutting rates. Should the BOE surprise some in the market by not hiking, will it have an impact? There's been a lot of sterling bought (and a lot of fixed income sold) over the past week or two- could an innocuous decision to delay send markets scurrying for cover? Carry is almost ludicrously well bid....until it isn't. Macro Man will take a punt and buy 1000 Dec short sterling futures at 94.17, setting a stop loss at 94.09 (which would be a new low.)
Similarly, US payroll data could put a few black jelly beans in the market's Easter basket. Macro Man's Bloomberg message box is now filled with analysis on how the last three Good Friday payroll figures have seen an unusual amount of volatility. Perhaps tomorrow will be no different, particularly as yesterday's services ISM is being viewed as yet another nail in the US economy's coffin. Equities shrugged it off, but could they do the same with a low payroll print that for once doesn't benefit from revisions?
Macro Man doesn't know what the data will say, and neither do you (unless you work for the BLS). What he does know, however, is that the amount of volume required to shift a price, almost any price, is dwindling almost by the hour. Best to stay on guard, therefore, and try to pick out the black jelly beans as much as possible.
(And if you know FX and haven't filled in the Voldemort poll yet, please do so!)
Wednesday, April 04, 2007
The market’s risky asset love-in has seemingly reached fever pitch, as the travails of late February and early March appear to be little more than a distant memory. China famously regained new highs a couple of weeks ago, and the DAX has followed suit this morning. (We won’t mention the SENSEX, which is closer to its recent lows than it is the February high.) While the equity explosion has hurt Macro Man’s alpha portfolio hedges, the impact has clearly not all been bad. Not only is the beta plus portfolio off to a nice start to the month, but a Japanese asset allocation shift out of JGBs and into equities last night has helped the fixed income portion of the alpha portfolio.
A poster made an interesting point the other day about regional equity differentiation, suggesting that European equities are generating excess returns to the upside (compared to the SPX) while participating only partially on the downside. If true, this has implications for Macro Man’s portfolio, given that he has a short exposure to the DAX through his long put position.
In the very recent past, this has clearly been the case, otherwise the SPX would be at its highs just like the DAX. But from a longer term (last few years) perspective, is it the case that the returns from European equities are positively skewed vis-à-vis the US? Macro Man looked at the question in two different ways: examining the daily return profile of the SPX and DAX, to see if it has changed over time, as well as looking at longer term return-to-risk ratios, updating an earlier study.
The findings were quite interesting. Macro Man looked at the absolute value of daily movements in the SPX and DAX, splitting the results between up and down days, and then examining 2000-2003 and 2004-2007 as separate periods. In the former period, the SPX outperformed the DAX by about 18%; in the latter period, the DAX has outperformed by 44%. All told, the DAX has outperformed by 3% since the end of 1999 (these are nominal returns not including dividends.)
The data suggests two explanations for the reversal of (relative) fortunes between the SPX and DAX. The first one was surprising. In 2000-2003, the average up-day in the SPX was slightly larger than the average down-day. This was surprising, as the return profile of equities is famously skewed to the downside, and this period included a bum-clenching bear market. In fact, the data suggests that the SPX went down simply because there were more down days than up-days. The DAX, meanwhile, underperformed despite having a slightly higher “hit ratio”, simply because the average up-day made less than the average down-day lost.
In the more recent period, the DAX has maintained a skewed return profile. The average down-day still loses more than the average up-day makes. However, the hit ratio has improved from 49% to 57.2%, which explains the stellar performance of the index. The SPX has also seen its hit ratio improve; however, the lag versus the DAX has widened from 0.4% in the early period to 1.6% in the later period. This goes a long way to explaining DAX outperformance. Crucially, however, the SPX now loses more on down-days than it makes on up-days, just like the DAX. The S&P 500, therefore, has lost its “special” return profile and now looks like a normal market (that wins less often than the DAX.) So rather than Europe enjoying a put option that the US doesn’t have, the data suggests that the US has lost a put option that Europe never had. You don’t need Macro Man to suggest where that lost put may have come from!
On a total portfolio basis, meanwhile, the returns on European assets have almost never looked better. The 3 year return to risk ratio on a typical balanced European portfolio is now 2.26, just shy of the 25-year high set in the mid 1980’s. The equivalent ratios in the US and Japan are also high, but neither is close to its previous best, and both have started to lag Europe. If the trend continues, perhaps the euro won’t need the help of Voldemort and friends to set new record highs against the dollar and the yen!