Old Rates for New Zealand

It's month end and there are going to be all sorts of associated wobbles but, overall, stresses are lifting and there appears to be a reversal of Middle East inspired moves, perhaps as punters look to strap risk on ahead of expected equity inflows for the new month. It would appear that 80% of Libyan oil fields are in "rebel" hands and that they are starting to export from Tobruk again and we are pretty sure that Saudi could replace any Libyan shortfalls. So really Tripoli could look like Baghdad in 2004 and it really shouldn't do anything to oil. But a quick question - when does the "rebel" title get exchanged for "authorities"? Because "rebel" always seems to imply minority and it appears that the rebels are now the authorities of most of the country.

So, metals are moving up, equities had a good close in NY followed by a reasonable response in Asia and it's only Europe that has had a shot at trading the down side. In fact equities have done really well considering how much bad news has been thrown at them. Just like AUD/USD, which despite all sorts of normally negative muck is trading only just below its highs. We have also been pondering the price action in Ags, with Cotton tracing out the sort of chart that is gappier than Mike Tyson's teeth at A GAP conference in Bank Tube station, with shortages by textile manufactures causing the latest squeeze. TMM are hoping that fresh supply relieves any pressures to use recycled cotton before we are forced to wear belly-button-lint blue/grey shirts.

But today we would like to have a look in more detail at what is going on in NZ where the debate is raging about the impact of the Christchurch Earthquake...

Readers will recall that TMM were strongly of the view that the Queensland floods in Australia were, if anything, net growth positive due to the fact that infrastructure rebuilds usually entail the replacement of older plant machinery etc with more modern and more productive versions. Furthermore, they represented an inflationary supply shock to an economy already growing above trend, with a likely looser fiscal stance adding to underlying inflationary pressure. Although, for childish political reasons, the Australian government decided to introduce a tax to help pay for the cost of rebuild, along with redistributing current expenditures, it remains the case that a fiscal policy response to natural disasters is the appropriate one given the ability for such policy to be (a) targeted centrally and more directly, and (b) more immediate in terms of action than monetary policy which, beyond an immediate impact upon confidence (in demonstrating that policymakers are on the ball), works with a longer lag via credit creation and is more dependent upon individual businesses exhibiting demand for loans.

But what about if the economy is *not* already growing above trend? It's certainly possible to argue that a second earthquake in 5 months could be a body blow to the economy via the consumer confidence channel. To date, the recovery in New Zealand has been somewhat, err, tepid, joining the UK in putting in a negative quarter of GDP. Perhaps, then, punters are correct in pricing in 32bps of easing over the next two RBNZ meetings, with 30bps for March alone? It's hard not to draw parallels with the Fed's rate cuts in the aftermath of 9/11, rather than with their hikes in the aftermath of Hurricane Katrina. But even before September 2001, the front-end had priced out a great deal of tightening and was beginning to price in an extension of the Fed's cutting cycle as it was clear that the economy was falling into recession, so TMM is not sure that is necessarily the perfect analogy.

But what is clear is that the RBNZ decision is very much a function of the economy's underlying state. Today's Business Confidence survey provides some grounds for optimism that after the recent "soft patch" that activity was beginning to pick up. The below chart shows the 3month moving average of the NBNZ Activity Outlook (white line) vs. the 4-quarter lagged YoY GDP data (orange line), and suggests that prior to the earthquake that GDP was likely to accelerate to around 4% or even higher over the coming months. Similarly, the surge in Milk prices and Ags in general underline the significant strength in the Agriculture sector on the back of external demand.

To date, one of the weaker areas of the economy has been consumption - primarily, TMM presume, due to September's earthquake. TMM's model of Retail Sales based upon Consumer Confidence, Consumer Credit growth, Wage growth and the RBNZ's survey of expected wages 1yr ahead (see chart below - orange line; actual Retail Sales - white line) suggests that sales should have been running at around 3.75-4% YoY. The divergence in Q4 of last year is presumably a combination of the effects of last September's earthquake and general statistical noise. Certainly, one would expect consumer confidence to fall and drag the model projection lower, but it's not obvious that it would plumb the lows at the high of the financial crisis. Even if it did, the other inputs to the model aren't flashing warning signals which would lead TMM to worry about a complete collapse in consumption...

...And TMM's Inflation-Expectations augmented Taylor Rule (see chart below, white line; RBNZ cash rate - orange line) for the RBNZ seems to imply that policy is already exceptionally loose. While it's certainly possible to argue that the RBNZ could hold off tightening in the face of the disaster, it's not necessarily obvious that easing would be a particularly sensible thing to do.

However, TMM recognise that the RBNZ have been walked into a corner given that the market has priced in such a great deal of easing, with the press and local economists calling for as much as a 50bps cut. Given that central banks generally do not like to surprise markets to the downside, especially during crises, TMM are forced to conclude that even though the underlying economy actually looks as though it was in the process of reaccelerating, that the most likely outcome in March is a 25bps cut. However, with a good deal more priced in (see chart below: OIS forwards - red line; 3m Bank Bill forwards - purple line; spot OIS - blue line), for the brave, a pay position in the March RBNZ OIS or a long NZD position might be worth a punt. TMM are too chicken to do the former, and instead elect to sell their old nemesis AUDNZD.

Is that a Pink Flamingo I See?

TMM are reminded of Macro Man’s words regarding Pink Flamingo’s at this point in time:

Recent market price action has started to remind Macro Man of an episode from his distant youth, nearly 30 years ago. People did strange things in the 1970's, and he remembers a "game" played by various households in his neighbourhood in what must have been 1979 or so. One family bought a pink lawn flamingo, such as that pictured to the left, and stuck in the lawn of a neighbour. There followed several months of "pass the parcel", wherein the flamingo would magically appear on the front lawn of a different house every few days or so.

And it seems to have been for macro thematic trades, where the "pink flamingo" of position unwinding has been passed from market to market.

With Libya looking increasingly like it is descending into a tribal civil war TMM have come to the conclusion that recent events in the markets have moved so fast and so unexpectedly that the thematic trade unwind - Qaddafi assassination/SPR rumours and equity bounce notwithstanding - is likely to continue into the weekend and month end, and arguably the next few weeks. Long oil and the EM/DM thing were arguably quite “owned” by the fast money set but the massive blow in front end crude vol and decline in E-minis these last few days are indicative of the “get me a chopper and get me out of risk fast” trade.

In the E-minis TMM note that over the last few days the JBTFD crew has been out in force only to see them fade into the afternoon. Indeed, they find it remarkable that despite Oil trading ten Bucks or so off its highs that equities have not really managed to bounce in any material way. To that end we are expecting a lot of very crowded thematic trades to start unwinding if they have not done so already including – but not limited to the following.

1) Super Growthy Tech Names: For this TMM can give no better example than Baidu. It trades at about 78x trailing earnings and aside from being expensive it has also had two very, very bad things happen to it for those who know much about China: a government sponsored entity has become a competitor to it, and it has started to receive a number of anti-monopoly suits that are being reported in the media. TMM know that this is not Baidu’s first day in court but the play these cases are getting in state media may be indicative of something more sinister. The whole street assumes Baidu keeps its 80% stake in search going forward so there is plenty of room to disappoint and with 7%+ of the company owned by hedge funds thoughts of disorderly exits from burning theaters have crossed TMMs minds. Netflix, with the launch of Amazon Prime video streaming is probably in this bucket too – catalyst + prospect of oil shock recession = not a whole lot is going to trade at >50x PE.

2) Japan Equities are About to Get Slugged by Oil: Japan is incredibly dependent upon oil and it imports most of it from the Middle East. The BP Statistical review has this snappy chart you can see below.

Much of Japan’s recent recovery has been driven by consumption and unusually low savings rates – one can safely assume that if oil stays high more of that income is going to get spent on oil and general economic conditions will deteriorate. It also does the trade balance now good, which makes TMM think that the JPY rally is more panic driven – once the panic subsides and people realize that Japan is a major importer with a lot of other structural issues the buying should abate. The rest of Asia will be affected too but they are likely to respond by revaluing their currencies up. The recent outperformance in the Nikkei is likely over until further notice and the JPY is likely not far behind it. NOKJPY is the usual way this one is played though it was doing well before Gaddafi turned out the lights on Silvio’s court proceedings by shutting off the gas to Italy. The recent rally JPY on the back of this is further proof of TMM’s prediction that trading JPY this year was not going to be easy.

3) MXNZAR: Somewhat obscure cross but basically long a US growth proxy and short a basket case country with a central bank that is dovish. Sadly aforementioned basket case is the world’s largest gold producer, Mexico’s oil reserves are depleting and US growth isn’t looking so great here. Unwind well underway.

4) Long Ags: A crowded trade that has likely seen its best – front end contracts in wheat are already taking a pummeling and cotton is ending the only way it could – badly. The one to watch of course is corn which can, using a combination of wastefulness, human stupidity and enormous subsidies into a combustible fuel.

TMM have no doubt that there are others and we would like to hear from you. One thing is for sure – with a lot of crowded consensus trade and lot of unwinding to do it is going to be a very ugly month and likely quarter end for a lot of people.

The WereSurvey - Vote for Bank TMM

It appears to be that time of year again when every FX bank, broker and bureaux de change starts hounding their clients to complete the Euromoney FX survey showing said institution in a glowing light. TMM are completely baffled by it.

We imagine that once upon a time, in the primordial financial ooze of FX, a Euromoney virus inserted its genetic matter into the DNA of the first progenitor "Head of Sales" and it has survived through the generations ever since. For once a year this recessive gene kicks in and, rather than pursuing the normal aspirations of a financial institution, such as growing a sustainable highly profitable business, the Heads of Sales across the world transform into slavering demented beasts craving to dine on fresh votes. All because they have tethered themselves to a benchmark that is bollox and persuaded the boards of their banks that high rankings in the Euromoney survey are synonymous with a highly successful cost to income ratio and hence bottom-line for the bank.

A Head of Sales at a full Euromoney.
"beware the 'Moony lads, and stay on the roads".


Two of team macro man's favourite aphorisms are "Benchmarks are Bollox" and "Correlation does not imply causality". The Euromoney Survey encompasses both.

As far as a Head of Sales is concerned, the argument goes like this.

- the higher clients rate you, the more business they do with you.
- the more business they do with you, the more money you make.

Which is all well and good - but completely flawed. As anyone who has ever worked in an FX dealing room will tell you.

As the FX wars are basically being fought on the battlefields of credit and technology, it's easy to get clients to do more business with you. You just extend credit lines to every subhuman rated entity out there and then provide them all with an e-platform streaming suicidally tight prices in every product under the sun for them to deal on. The business will flood in and no doubt you will get a stunningly high ratings in the Euromoney Survey. But does this mean you have a flourishing, sustainable and profitable business? As the constantly raging battles on the shop floors of FX rooms between sales and trading will attest, no, and they will continue to attest to it as long as either side's benchmarks are misaligned.

One bank we know had a fantastic franchise that they tried to enhance through the introduction of an algorithmic pricing platform. It was a roaring success as the clients loved it and volumes soared. Unfortunately, revenues didn't. As clients, of course this is just great as we keep getting handed more and more mid market pricing. In fact the banks are now at the point where their fantastic services are being rewarded by being allowed to make a price in competition with all the other banks, which, if won, means by definition they were off market. We wonder how long its going to be before someone on the sell side says enough is enough. Or indeed the regulators... wouldn't any company with an alleged market share of 20%+ attract the attention of the competition authorities?

As a client you do business with a bank for a variety of reasons, but they basically fall into two pots. Doing business with them either decreases your costs (e.g. best price, cheapest prime brokerage, e-processes, outsourced functionalities) or it increases your revenue (great research, information, trade ideas, advice or introductions). But when all other choices are marginal, picking who you actually pull the trigger with depends on whether you like the guy on the end of the phone. Who you pick to do $50m of "at best" will be completely different to who you give $100m, as part of larger, on a price in a "help get me out of here" market. Greater volumes in the second case but the happier bunny won't be the one that just saw twice as much business.

Whatever the business argument is above, TMM are most surprised at how banks think that increasing the Euromoney rank has a direct bearing on profitably rather than the other way round. You are what you are to your clients whether they fill in the survey or not. Wining and dining, cajoling and schmoozing for the extra votes for that extra place on the survey does not increase your profitability. It will only increase the bonus of the Head of Sales who has had the Euromoney survey outcome tied into his performance measures. In fact if you are like us, you will find this fawning for votes positively negative and award less business to those that appear to really care about their rankings. Take heed WereSurvey.

Though we may not have the silver bullet to rid us of this menace, we suggest a little fun. If you are like us poor folks currently being plagued, begged, bribed, induced, beaten, blackmailed or otherwise curmudgeoned into filling in the form of the WereSurvey, please cast your protest vote for TMM.

We promise that, should we win any category and Euromoney track us down, we will send a Werewolf on stage to collect it at the Euromoney presentation dinner and publish the photos thereof on the blog.

Flatulent dictators and the Fed

While TMM's usual policy is not to wear their Armchair General's uniform in the office , they cannot resist passing a brief comment. Libya is now the third country in as many weeks to be brought to its knees by the Twatterati, and we are beginning to wonder whether or not markets will be able to shrug off the deepening regional crisis. The pictures of Gaddaffi waving an umbrella from a van to show he was not in Venezuela reminded us of a book we once read by the BBC's John Simpson who recalled that while being interviewed, said dictator spent the entire time loudly breaking wind while waving a fly swatter around. And regardless of the UK's somewhat, err, poorly-timed diplomatic overtures toward the country, Gaddaffi is not your run of the mill dictator, sitting a little closer to Kim Jong Il than to Mubarak.

So why do we bring this up? Well, aside from the fact that Libya is the 17th largest producer of crude oil (see chart below, courtesy of TMM's mates at Nomura), the presence of mercenaries, the Air force firing at protesters (OK, some are now abandoning the guy), runways destroyed, squabbling Gaddaffi brothers each commanding various regiments of the army and opposition forces reported to be in control of the East of the country that, to TMM, this starting to look a hell of a lot like a civil war. With protests picking up again in Yemen, and a demonstration planned for Thursday in Saudi Arabia, TMM wonders where this ends. It is worth noting that WTI is now just under 10% higher than where it was last Friday when the US went home for the long weekend and, as TMM's sharp mate RightField pointed out, the contract roll to April will have the front month trading $98 tomorrow and the mainstream media talking about $100 oil and the potential hit to consumption. TMM read a few pieces this morning pointing out that each $1 jump in crude wipes out $100bn in annualised GDP when fully processed through the economy.

That being said TMM are not sure that our non-prediction and subsequent commentary about the cheapness of WTI vol applies in any way, shape or form right now. Looking at the vol skew in listed WTI calls you really have to wonder what that person bidding up June silly is thinking:

Though we are thinking that we could well get an "Oil Shock Nuevo" where appropriate price levels are determined by Islamic clerics, or production is shut down whilst internal conflict extends, that type of price impact would last longer than June and more likely extend well past next December. So, for something more fancy that just shouting MINE oil, then we are thinking of rolling out option exposure as we are of the opinion that short dated crude vol is something you can happily put a fork in – it’s done. If we are going to $120 the really scary news is that we probably are not going to be coming back any time prior to early 2012.

OK, TMM are now changing out of their uniforms and back into their regular clothes...

Before the most recent surge in Middle Eastern/North African unrest, TMM had been struck by just how bearish punters seemed to be getting of the US rates market, mainly on the back of worries about EM inflation and the recent acceleration of US growth data. However, TMM would note that the Fed do not actually particularly care about headline inflation, instead focusing on core inflation, as seen in their recent commentaries. And, unlike in the UK, there is very little evidence of headline price pressures feeding into the core. In fact, TMM's model of core CPI, based upon the 1yr lagged output gap (see chart below - orange line; actual core-CPI - white line), seems to do a pretty good job of explaining the broad trend. On this model, core CPI is only projected to reach 1.4% by the end of 2012, a level well-below what the Fed believe to be "mandate consistent".

Plugging the above model for 1yr ahead core-CPI into a Taylor-type Rule provides a forward-looking version of what would be considered "appropriate" policy under this framework (chart below, white line; actual Fed Funds Target - orange line). Policy is still way too tight on this metric and expected to be so for the next couple of years.

Ah, you say, but doesn't the QE2 stance indicate looser policy? Yes, of course, it is much more difficult to quantify this, but one "guess" as to how stimulative the Fed is might be to look at the growth in narrow measures of money. The chart below is identical to the above but also includes YoY M1 money supply growth (green line, inverse scale) which by and large appears to expand/contract at changing rates depending on the Fed's stance (something that will, no doubt, be reassuring to Monetarists). Ignoring the base effects related to Y2K and 9/11, there is close enough relationship to make this a believable proxy for the stance of monetary policy. On this basis, monetary policy became too tight throughout the course of 2010 until the Fed began to reinvest MBS proceeds and announced QE2. However, even under the assumed path of QE2, M1 growth would not be growing quickly enough to be consistent with a very negative Fed Funds rate and also suggests that rather than being a "stock" variable, QE impacts the monetary stance as a "flow" variable. While this may look as though we are using the MDI (Moist Digit Indicator, "finger in air" and lacking intellectual rigor, as a rough rule of thumb, TMM find it hard to believe that a Fed run by the World's most prominent monetary economist is going to be hiking rates any time in the next year and probably not even in the next two years.

On that basis, TMM have to conclude that the market is overpricing the probability of rate hikes (see chart below - 3mL forwards - purple, Fed Fund forwards - red, spot OIS - blue line), and that the front-end looks ripe for a purchase...

...especially given that the net speculative position as a percentage of Open Interest is sitting at its lowest since 2007:

And finally, with everything that is booting off today, TMM are back delving in their dressing up box for their 5* General Tin Hats.

Once more unto the breach, dear friends, once more...

Yawn and stretch... Mmmwoahh. That’s better. Now then, what's been going on?

Middle East Soccer has seen the revolution ball passed from Egypt to Bahrain and it is now in Libya, all in a week. At this rate we will have seen the formation of the “New People’s Ottoman Empire” completed by teatime. But today’s TV is coming live from Libya and you have to think that the Gadaffis have politically gone “all in”. You can hardly shoot 300 - 500 of your own people and then back down and expect a healthy retirement that doesn’t involve lampposts and 1 inch 3-ply.

BoE – ho hum. We almost give up on commenting on the Swerve and his Mervynflation, but at least the rest of the market is waking up to what has to happen.

G20 – zzzzzzzzzzzz

We have a fair amount of catching up to do, but let's start by having a look at Europe.

The STFU policy has managed to gag most bad news and dissent so far this year, but over the last week we have been picking up more odd rumbles on our seismometers.

- Hamburg has said “Nein” to Mangler and the incoming party is expected to be less euro-friendly
- Portugal borrowing levels hit new highs and the ECB jumped in again (though Portuguese Jan budget deficit fell 58.6% y/y)
- Concerns over the German banking system raised its head again with WestLB back in the limelight
- A large exodus from North African turmoil is not exactly what Spain and Italy need at the moment
- And finally the ongoing debate about what is going on in the Euro funding markets

It is this last point we are actually going to take a look at, as this weekend the latest great mystery plaguing the European money mkts was finally resolved.


According to some knowledgeable insiders, the €16 yards borrowed from the ECB marginal lending facility (see above for a historical perspective) was a by-product of the ongoing wind-down of the two particularly nasty pieces of the Irish toxic waste pile, namely ANGIRI and IRNWID. In TMM’s view, this invites all sorts of puzzlement and questions, like a) couldn’t this all have been coordinated just a tiny bit better; b) who foots the roughly €3mm/week bill. However, TMM have resolved to stop sweating the small stuff in 2011 and want to use this opportunity to dwell on the big picture, namely the state of affairs in Euroland.

So let’s start with the first piece of the puzzle. The rolling off of the €16 yard Irish technicality (probably some time next week) is likely to reduce excess liquidity in the Eurosystem to around €20bn (please treat this number with caution, as there’s a lot of room for interpretation). In itself, this isn’t likely to cause a repeat of the sharp EONIA squeeze we saw in January (see below), which was, at least partly, due to a variety of technical factors. However, it’s entirely clear which way the wind is blowing. Barring any unforeseen calamities, EONIA is likely to continue its gradual move higher, towards the main refi rate of 1%. This is a culmination of painstaking efforts on behalf of the ECB, designed to “cleanse” its interbank mkt and wean the addicted banks off the mother’s milk of ECB liquidity (of course, all it means is that the little buggers are now firmly latched on the teat conveniently provided by their respective national govts).


The second piece of the puzzle is, of course, the ongoing saber-rattling rhetoric of the ECB Big Cheeses, who continue to threaten hikes (e.g. Bini-Smaghi on Friday; Trichet in his French radio interview this past w/e; Darth Weber at the G20). While it’s not clear just how much of this is intended for the specific ears of the union leaders in Germany, the mkt has certainly been reading the message loud and clear. Consider, for example, that new bold ECB call from Barclays, who now expect the first hike in Sep 2011, rather than Jun 2012.

The net result of both developments (i.e. tighter liquidity conditions and expectations of monetary policy actions) is the move in 1y EONIA rate seen this year (below).


So the main question for TMM is what all this “sturm und drang” actually means. Assuming that the ECB rhetoric is reflective of their actual thinking and, more importantly, translates into action, it is TMM’s considered opinion that the Eurozone is heading for a painful accident. Allow us to look at this in a bit more detail.

It’s abundantly clear that the EMU is experiencing a “many-speed recovery” (see below for a comparison of industrial production YoY averages), in the face of which the ECB is resorting yet again to their favorite Eurostrich policy framework.


Specifically, they claim, with much ardor, that it’s simply not their problem and that the national governments should just get their acts together and sort things out (the fact that the national govts can’t seem to be able to do just that is, yet again, not the ECB’s problem). While such a view is undoubtedly justified as far as the letter of the law goes, it clearly doesn’t contribute to a long-term solution.

The issue that’s been raised by a number of pessimistic pundits is that the Eurozone, with its multitude of disjoint policies and regimes, isn’t a viable construct in the long run. Efforts at strengthening the fiscal union, while ongoing, have so far yielded no meaningful results. At any rate, such herculean harmonization effort is likely to take years, if not decades. While this is ongoing, the Eurozone remains stuck with divergent growth rates and a central bank that’s unwilling to make allowances for this. Will it survive such an ordeal? The last time the ECB closed its eyes to peripheral developments during the 90s (focusing on Germany which was in the throes of re-unification), we all know what happened. Now, in the aftermath of the bursting of the peripheral bubble of partly their own creation, the ECB is facing a divergent dynamic of a different sort and getting ready to commit the same grave error. Plus ça change, plus c'est la même chose, indeed.

While thinking about all these weighty matters, TMM did a wee bit of scenario analyzing. The idea has some merit, in spite of some rather aggressive simplifying assumptions. Let’s take a hypothetical Eurozone sovereign with a lot of public and banking sector debt, a moderate GDP growth rate (held constant) and a healthy desire to get its fiscal house in order, reflected in a negative primary budget balance. We look at the trajectory of the said sovereign’s debt/GDP ratio under different rate regimes (each 100 basis points higher).


Now, quite clearly, this is not rocket engineering and is precisely the sort of thing the pundits look at when talking about countries not able to deal with unsustainable refinancing rates. We invite readers to consider that tighter ECB policy, accompanied by low growth in the periphery, has PRECISELY the same effect on peripheral debt sustainability as soaring mkt yields. And all this before we even take the effective exchange rates into account.

We have had March billed in our diaries for the showing of “Eurowoes 3” since December. Are we being shown the trailers?

EDIT: apologies for the miscalculation of the cost of the Irish debacle in the original. It's been corrected (thanks to the peeps who caught this).

Back soon

As expressing short term views doesn't seem to enamour anyone and as bigger macro ideas require time-consuming research and as TMM have neither the time nor inclination at the moment, TMM have decided to have a week off.

The Doubt Point

You have to wonder if Obama's career has kept him too far away from rearing his kids, because the first thing you learn as a parent is that the worst way to get a kid to do what you want them to is by telling them to do it and, worse still, by doing it publicly. Of course they are going to dig in their heels. We do wonder if things might have been different if yesterdays newswires weren't full of lines such as "CIA says Mubarak will step down". In a way we quite admire him, but the unfortunate result is that it's another Friday TV viewing day as the markets trade oil, equities, fx and bonds directly proportionally to the number of stones in the air over Tahrir Square. It looks as though Mubarak's truculence will be greeted by a firm smack from the back of his populace's hand.

But maybe he is being guided by a greater force? Read this.

The Euro Bunny has stuck its furry nose out of its burrow again too, with a surprise re-appearance from Portuguese yields. The ECB were swift to act, chasing off the predators and covering up the evidence, but the damage has been done and Mr Market is sniffing around the burrows again. So together with the other ingredients in the titration burette we have precipitated a fairly dense cloud of worry. We haven't reached the full tipping point, but we think all it will take today is one well-aimed flaming rag-topped bottle of octane in a Cairo square.

So what for now? Well, we have completely toned back our EUR/USD view... That last retrace to 1.3750 was enough and returned us to agnostic, which is the way we will remain until we get some resolution from this turn we are so expecting across risk in general. The same applies to rates. The gloves are off and we are grasping a Sebatier carving knife of USTs. As mentioned yesterday, the IBEX/DAX cross is off the table waiting for better re-entry levels and the EM/DM trade sees reducing of the shorts on the EM side as it's getting so much cheaper. As for DM Equities, we are just soooooo wanting them to fall over, having been on the bull bandwagon for so long, it's time to switch alegiance and play for a move down... How far? Not sure yet and we'll play that by ear, but new highs will have us out.

What else? AUD/NZD? The Bird has been crucified recently on weak data and recessionary comments to the point where AUD/NZD has actually gone UP even as stresses in the rest of the world have increased. The overnight rate moves after Stevens's comments make us think that it has gone a little too far. On top of that, the Copper/Milk ratio looks to be a Kiwi in a Coal Mine (sorry...). Add to that our usual theory that when things get stressy folks get out of their hobby trades (AUD/NZD being one of them, and it's always on the long side); and a very low VIX primed for a spike... So while we are busy shouting "YOOURS" in general on risk we'll shout "YOOOURS" in that too...

How to Catch Knives and Weekend at Abdullah's

Well TMM are not sure whether the king of Saudi is dead or not but one thing is for sure: he's really old and apparently not that well. Which leads TMM to think - if he were to die would they even tell us? TMM would like to see a remake of one of their favorite films - weekend at Bernie's.

TMM were hardly surprised that EM equities had a rough start to the year but having provided our readers our thoughts on the matter along these lines:

We have to ask ourselves just when we decide to fade these moves. As can be seen in the snap below, some very big moves have been seen out there in SE Asia.

As most macro-folk know, value is a relative thing and when looking at equities it often helps to compare earnings yields (the inverse of a PE ratio) and what the yield is on the local currency 10 year bond. It’s a simplistic measure on some level but it does get to the core of a lot of actors’ decisions: whether to hold bonds or equities, whether as a corporate to issue debt or equity. It doesn’t do much for relative FX valuations and what the yield spread should be between different markets but it does provide some anchor for equity valuations. So, what does it tell us?

With respect to India below it does seem to pick a few big turns and by that metric equities should be getting cheap sometime around 16000 on the Sensex. But cheap to what?

Well, cheap to local rates but how good value are they in historical context? To that end TMM have plotted the spread between Indian local FX 10 years and the US 10 year treasury and the inflation differential between India and the US. As can be seen below Indian bonds tend to be great value when the inflation differential isn’t so bad and they arguably are at this point in time as the CPI differential is falling. However – there are two ways these series can converge on inflation – either US picks up or India gets under control. Given what we are seeing in agricultural markets we can rule out the latter in the short term but a peak in CPI later in the year could not be far off and is plenty in local FX bonds at this point in time. TMM are holding off on equities but as we said before, dabbling in local FX bonds does not look completely insane except in a full-blown risk off panic which we aren’t ruling out. 

To that end, TMM are thinking that one of two things are possible - we see a bounce within the next few weeks in EM, likely after some more bloodshed OR we move into a generalized risk off. DM vs EM may have seen its best days this year (after 8% or so of alpha in 6 weeks, depending upon your reference indices) but things that have taken an absolute pasting this year - US rates, bearish bets in DM, etc etc may not be dead just yet. TMM are looking at a few other favorites like IBEX/DAX and thinking that though this is probably not the end as we know it, its likely time for a turn. 

Titration of a Bullish Solution

We kicked off today thinking we had scored our first goal in the TMM 2011 non-predictions with Darth Weber NOT getting Trichet's post at the ECB. But it appears that the decision has gone to the 3rd umpire. We are praying for a goal and, by the time you read this, it will most probably have been announced, one way or another, whether he is not joining the ECB, not joining a large European Bank or not joining a Hedge fund. Or is.

The markets are a mixed bag and we continue to feel that there is a drip function of news around that may well end up turning sentiment generally negative. In fact, let's look at it as a schoolboy chemistry experiment

Titration of a bullish solution with negative news


Make up a solution of Bullishness

3g Bullish equity sentiment
5g US growth
2g of European Silence
6g of cheapness of EM equities to local fx bonds
10g of Trends
2g of Dovish Ben
7g of QE liquidity
in 1 litre of Kerosene

Make up a titrating solution (titrant) of bad news and fill a burette

5g of Egypt
1g of the Wikileaks story about the US government questioning whether Saudi oil reserves are for real
8g of China liquidity tightening
6g of Bond Yields
3g of P/E ratios
7g of threats of protected agricultural prices
2g Hawkish Ben
10g of General Surprises
in 300ml of Toluene

Clamp the burette over the flask and slowly drip the titrant into the flask until a cloudy precipitant of worry appears in the golden solution. This is known as the Doubt Point. Continued titration of the solution will see the cloud darken as the worry increases. Fumes will start to appear as the solution approaches its tipping point when it will instantaneously transform to a solution of pure bearishness. Which is green. This is known as the "What the F Just happened to my P+L" Point.

Your call as to where we are in the process. But we are really worried that instead of gold we end up with "pure green".

Demerging emerging, me old China

Nice to see Europe keeping things tight in the MRO/STRO allotments and nicer still to see EUR/USD rally (thank the Dark Lord's followers for their helping hands). But its really the Chinese news that has taken up today. You only need to look at Chinese forward curves (see chart below) to see how massively discounted the news was and the markets reaction, after knee-jerk reactions in the usual suspects, has been pretty muted. So far. As there is a school of thought one of us is entertaining that the news, however discounted, may be enough just to tip the western equity market over from its lofty linear climb we have been following for so long. But it’s a moot point. However it does lead us to consider our general Developed Markets vs. Emerging Markets trade we have had as one of our 2011 Non-Predictions.

A running theme of the past couple of weeks has been the stopping out of consensus trades. As mentioned, One of TMMs trades du l'annee has been the DM vs. EM out-performance trade and whilst perhaps not totally owned in the real money space, we know we are in the company of a fair chunk of fast money. As we have seen the sell-off in rates markets and general improvement to the US macro data, as well as a strong earnings season that showed a move from margin compression to sales beats has supported the foundations of the DM leg and we expect this to continue in the longer run. The EM under-performance bit has been supported by a reluctance to hike rates int he face of inflationary pressures, instead going for macro-prudential credit measures. But as food inflation and related issues have moved to the popular press, and rumours about 5.5% CPI prints out of China, higher than expected inflation prints in Indonesia etc have failed to produce any further sell-off. So just ass Asian CBs have begun to tighten, TMM wonder if we might be passing the peak of the EM inflation worries.

We are reminded of Spring/Summer 2006 when a seemingly dovish Fed and spike in inflation in EM resulted in a generalised risk aversion and EM panic which only ended when the CBs started to hike and get back ahead of the curve. As such we can't help wondering if we've reached this stage again, as the risk premia priced into these assets is ready to tighten.

But we also see that not all EM markets are made equal: India and the RBI still seem behind the curve and on a "Fed model" India still looks rich. Similarly, China does not seem to have anyone convinced at this time and a deluge of upcoming IPOs is likely to keep performance weak. Indonesia, however, is showing a lot more resistance and does look like good value in equities and not just their bonds (see chart below). The Philippines also. Brazil, much like China is suffering from political transition and a lack of muscular action on rates and has instead focused on whining about FX. While TMM supports this noble endeavor it is doing very little for risk assets.

Left for doom or right for normality?

Do we turn left and take the short thought path which takes us to the Middle East blowing up big time and a global energy winter that will make the 1970s look like nirvana? Or do we press ahead down our current path of analysing the normal diet of Eurowoes, US QE3/growth/Asia/inflation/trade etc? Because it just feels like a complete waste of time trying to micro-adjust our views on the world if within 3 months we have the Egyptian Eurovision song contest group, the Brotherhood of Man, doing an Ayatollah Khomeini and taking Egypt all Iranian. Have you seen the stock of weapons that Egypt has? 1000+ M1 Abrams's. And who knows how many jets etc. We hope the US remembered to fit them with some sort of remotely activated immobilisers. If they can do it with cars, it would make sense to do it with the weapons of death and destruction you hand out around the world.
- Hey Mo, call your Albanian mate to get me M1 goin', cos it's immobilised, innit
- Sure mate, as soon as he's finished on this AMG S65 in Chelsea, innit

The market appears to be in a similar position having got bored of the short term Egyptian story. TV pictures from Tahrir Square are showing crowds of friendly people waving at the cameras, which is more like a cross between a Live Aid concert and your local farmer's market than the path to Middle East Hell. So short term we are back to the basics.

The first thing we note is the MRSA like resistance of the equity markets. They appear to be thriving, unscathed by the recent anti-equities dousings of Egypt, the NFPs and bond yields. Which makes us think they will scream 2% higher today as the negative news flow pauses. And what of the UST yields? They are now looking a little bit toppy and though we are not donning the Kevlar hand protectors just yet, we are unlocking the glove box. The strangest pair to start motoring has been XAU/EUR. Of course, we could argue that the Middle East picture means that Gold goes up AND USD goes up on safe haven play, but these sorts of moves in Gold AND Euro, rather than being reserved for Eurowoes as normal, look more like a direct response to European rate moves. As for those Eurowoes, the STFU policy is working well and we still don’t see any specific worries appearing for at least another couple of weeks (apart from those German factory figures) and we hold on to our summer of 2010 theory. We have to say though, even though that model of ours says eur/usd looks cheap, recent moves in rate differentials and marginal credit widening make it less attractive. Darn...

So as for calls for today, we leave it up to you... Please pick a number form list A, a time frame from list B and an asset class from list C.

A - 1.3890, 3.7%, 12.98, 35bp, Parity, 8678, 3.1415, 0
B - Tonight, never, 3rd may, 4th July, St Swithins day, the 85th of Julember
C - EUR/USD, SPX, Indonesian palm oil, French spreads and pates, Pi

Of course you are welcome to add your own. Good luck and see you at the top.

Oh, and one last thing... It appears that our views on Zimbabwean Economics and The Merve's Gaucho Grill have been taken up by UK football

What can we say?

Today kicked off with TMM mulling over what to really say, whether it is just lugubriousness on returning from holidays or just because they haven't really anything to add to their previous stated views on the world we don’t know.

So far our expectations of the Euro story panning out in a similar fashion to last summer during a STFU respite in the run up to any EFSF announcements are holding true. The Euro news flow has turned vaguely positive re growth and it still feels like folks are fighting the tape yet our own model is still suggesting EURUSD has room to move above 1.4300 (See chart below: EURUSD - orange, model - white). We are not anticipating Mr T and the A Team deviating from the general message of last month. "Viiigiiiilence"...

The UK has been back in play with this morning's PMI (see chart below of Composite PMI - orange line vs q/q GDP - white line) completing a full set of bullish data that challenges the Q4 GDP readings to the point that we believe:

3PMI + Bob Crow + IDS wages - Q4 GDP = + I %

The BoE is likely to be faced with the prospect of inflation being above target at the two year horizon. They may try and wait for the Spring wage round, but we still think that 5bps priced in for a move next week is too little. A 25bp hike next week would do little to hurt the UK consumer, who hasn't been able to borrow anywhere near the Base Rate for years, and would alleviate some of the internal pressure the BoE is under. TMM bet that the Economics PhD community will start to come out over the next day or two changing their rate calls, making March 2011 Short Sterling look like a sell.

Meanwhile we have the Egypt function festering like an unburst boil in the background. Having totally screwed those playing the normal panic trades we are left with the short term market trying to play it like a live televised football match with every new skirmish producing short term responses depending on the direction of play. In normal conflict it's pretty clear which side is which, but the cunning plan to dress Mubarak supporters in the same strip as the away team has caused the casual observer some confusion.

Like all reality TV, the televising of running social unrest does seem to over hype the viewer's reactions and emotions. It would be interesting to know how Egyptian's responded to the recent images in London of the student riots when government buildings were occupied, the police attacked and the Royal Family being mobbed to the point where weapons were very nearly drawn. Did they think that England was going to turn to anarchy and hence trade on the consequences of UK Nukes falling into student hands? We, of course, just considered the whole event as student hijinks.

We feel that a solution cannot be far away when we see this headline that has just popped up:

*PAPANDREOU SAYS GREECE READY TO HELP EGYPT MOVE TO DEMOCRACY

What are they going to do? Send the Ptolemy family in again?

Twenty Riddles of the Sphinx

TMM are finding themselves scratching their heads and suddenly bereft of ideas. It's been a turbulent week or so if you've been a North African dictator, a Scottish Tennis player or a Short Sterling Long or Short. So while we collect our thoughts, we thought it was time for Twenty Riddles of the Sphinx.

1. Which trades first in SPX? 1350 or 1250?
2. Will contagion from Tunisia and Egypt spread to Saudi Arabia or Iran?
3. Will Brent Crude stay about $100 for long?
4. Is the Gold correction over?
5. Will EM central banks' reluctance to hike rates result in an EM panic?
6. Will the Bank of England hike in February, or has Q4's GDP shocker scared them off?
7. Were the shenanigans in Euro money markets a "one off", and will normal operations resume in the next reserve period?
8. Is the European peripheral bond market capable of standing on its own two feet now that the ECB isn't buying anymore?
9. Who will hike first? The ECB or the BoE?
10. How long will it be before Goldman Sachs get the blame for the North African & Middle Eastern social unrest as a result of its financial entanglement with Facebook?
11. Will Uncle Axel get the job?
12. Which trades first in EURUSD? 1.43 or 1.33?
13. Will Merv re-base his pension to CPI when the RPI-CPI basis goes negative?
14. Will the Fed complete QE2?
15. Will the AUD parity party last more than a few days this time?
16. When will S&P downgrade Moody's?
17. Is Spain's Caja plan enough?
18. Will anything ever happen in the Swiss front end?
19. When will risk assets have a more meaningful correction?
20. What particular variety of constitutional crisis awaits the new Irish government?