Summer "Meh"

Seasonal trading in London. A few days of hot weather and the media are trotting out spurious statistics on the number of deaths caused by the heat and looming water shortages. The authorities, to be seen to be "doing something" and avoid corporate culpability, are issuing warnings that boil down to  "Heat is hot" and "Don't do anything that sane people wouldn't do anyway"  such as  "If you can't swim - don't". 

With the average number of deaths per day in the UK at about 2,000 (so 28,000 over the past 2 weeks) TMM think the additional 700 being panickly reported as caused by heat is pretty insignificant. But the "Something must be done" media mentality has taken grip. TMM are looking forward to Government edicts that statistical blips (and the sun) are morally wrong and that those with fridges should do their "fair share" by leaving their fridge doors open (forgetting the 1st law of thermodynamics). TMM however say "Enjoy it while it lasts, you'll be moaning about rain within the month". 

So why mention this apart from TMM's running ire with UK press and politicians? Well, there is another reason why these stories are on the front page - There isn't any worse news to replace it. The UK is doing OK. Retail sales this morning confirm the recovering trend in data that has been in place since May and things really are looking up despite the BBC's continued attempts to blame government cuts, this time benefit caps, for our "disastrous" living conditions. They really are the Zero Hedge of UK economics. 

Moving on, yesterday's headline event saw The Beard manage to hold a central line and, despite our hopes of a market seeing him as more hawkish than they thought, it appears they have finally got the message. Policy will be responsive to economic conditions. Yes folks it's called nuance and as we learned during the European problems of 2012, the markets aren't very good at nuance preferring the black and white of either boom or bust.    

So if BB was, as many reported, dovish relative to market expectations we wonder why the performance of equities has been particularly lacklustre and any softening in USD vs EM we might have expected hasn't happened. In fact the reverse in INR with USDINR pressing on and Indonesia appearing to have chucked in the towel. US10y has dipped 7 bp to just below our mental anchor point of 2.50% but all in all not a ballistic response to a "dovish" Humphrey Hawkins statement. 

The Carneyage resulting from the 9-0 BoE vote was kneejerk as further examination of the minutes showed that things weren't all one way and that further QE could be useful (Para 28). But the BoE is generally adopting the new Monetary Policy fashion of forward guidance over action. Watching these central bankers get to grips with forward guidance is like watching a 4 year old's first attempts at riding a bike without the stabilisers. Exceedingly wobbly and prone to reckless deviation from the desired course, though Ben appears to finally be getting the hang of it. 

So, what are TMM doing? We are still holding out for a corrective turn in markets. EM hasn't calmed down post Ben and equities have not ripped higher so despite this "Meh" response, we would suggest that the market set up is vulnerable to a small bit of bad news tipping things lower pretty quickly. A correction is in order. But as for what that cause may be, well, as with the best bits of unexpecteds we don't know, but a friendly bet on some stupid comment from a European is top of the list.

Until we get it,  Meh = carry creep

Beware the Humphrey-Hawkish of July

We have mentioned in past years that we have clouded memories in the back of our minds of this week in July being significant for market turns. It was something we used to watch when trading equities in the late 90s in the heady bull run of that period and, just eyeballing the chart below (vertical lines indicating this week) we can see it working well nailing some dramatic turns since.



Ok, not every year (last year being a damp squib) but enough for us to be looking out for a turn this week. But why this week of the year and why the response? Well, it's almost as though some chairman of a Federal Reserve somewhere was saying something significant enough to turn markets! Indeed yes, back through the years these are the dates of the summer Humphrey-Hawkins testimonies. No spooky planetary alignment involved, just Al or BB doing their stuff to sound stimulatory or restraining.

We can effectively see this as during down waves in markets and any emergent recoveries, HH has tended to produce up swings  as policy was aimed to be stimulatory. During periods of excess, when policy was swinging the other way, we saw turns lower, though 2006 is a clear example of the Fed not seeing what it was getting itself into and effecting policy that just made things worse in the end.

As for tomorrow's impact, we run into this July's HH at full steam ahead for equities (at all time highs in SPX) leading us to feel that a turn obviously will be to the downside. Against that though we really can't see BB being anything other than "balanced" and not wishing to rock the boat.

Our best-fit scenario would be if BB tries to be central in message but (having had a market response that first read him as hawkish at the June statement with respect to tapering, that then swung to reading him as dovish in the post-minute speech) the markets once again over react and this time swing back to reading him as hawkish. That would catalyse our "3rd week in July" turn.

However there is also an extreme version of this "market misreading him as uber-hawkish" risk. If BB were to be asked a question along the lines of "Aren't you worried about equities becoming a bubble?". he may slip on his words enough to create a headline storm along the lines of Greenspan's "irrational exuberance" speech. Stocks would dump in a display of short term fireworks, but no serious long term harm would be done. Meanwhile policy could stay accommodative.

Nice idea, but a dangerous play. But hey, it is his last testimony so why not celebrate it with fireworks.

US Economic Ballistics

Now that the dust has settled somewhat from Taper-mania, it probably makes sense to take a step back and reassess the US macro landscape over a longer time frame.

The market consensus seems to be that everything will be fine. Consensus equity forecasts remain fairly bullish. Expectations for GDP growth the rest of the year hasn’t really budged. In fact, since 10y Treasury yields began moving higher in early May, 3Q growth expectations have actually ticked higher. (Q2 expectations have fallen, but appears to have been driven by yesterday’s weak retail sales figure rather than anticipated effects of higher rates)



A simple gut check, however, suggests that it is too early to signal the all clear. First, the pace of the move was substantial. On a 3 month basis, nominal yields moved over 90bps, which puts this recent episode as amongst the 6 worst periods for Treasuries over the past 20 years. (Chart below shows 10y nominal yields and the rolling 3m change in the bottom panel. Note that with the exception of 1994, all those episodes resulted in a stabilization in yields over the subsequent months)



As some of our astute readers have noted, these types of moves have historically had a significant impact on interest rate sensitive sectors such as homebuilding. The chart below highlights this, as well as the fact that this recent episode is essentially on par with the 1994 experience, albeit the pace is much faster this time. Note that we express the mortgage rate in percentage terms, since a $100 / month increase in mortgage payments is a much bigger deal if the original payments were $800 as compared to $1600.



There are, however, a number of offsetting factors that mitigates these worries. Homebuilding remains a smaller driver of US growth than in the past. The ratio of debt service payments to income are at multi decade lows. And the current mortgage rate of ~4.5%, remains BELOW the 4.74% to existing mortgages, unlike the prior instances when yields jumped.



However, TMM notes that personal expenditures growth has exceeded real income growth for some time – and TMM suspects that the refinancing activity was likely a key driver. I.e. even though real income growth has been broadly flat since 2009, (first chart below, bottom panel) consumers have been able to refinance their mortgages with a ~5% rate to ~3.5% and used to cash flow for consumption, which has grown at a fairly steady rate of 2% YoY in real terms. (Second chart below, bottom panel) If true, this tail wind is likely to weaken.





As a result, TMM thinks that a continuation of recent growth trends will require a successful growth handoff. The improving employment picture is a positive, but TMM thinks that ultimately, improvements in real wage growth will be needed. That could happen on its own as the unemployment rate continues to decline – i.e. the US economy may have already achieved ‘escape velocity,’ albeit at a slower pace than historically. However, the jury is certainly still out on this. The San Francisco Federal Reserve, for example, recently noted that the reluctance of employees to accept wage reductions meant that there may be a substantial amount of “pent up” wage reductions that are getting reduced via frozen wages that are gradually eroded away by inflation. The authors calculated that the number of people with frozen wages remains a substantial portion of the labor force:
http://www.frbsf.org/economic-research/publications/economic-letter/2013/july/wages-unemployment-rate/

On net, the balance of risks for consensus growth expectations after the recent move appears to be on the downside. This suggests US yields are likely to stabilize around current levels, at least for a while. Equity prices, however, are likely to be less affected, even if there is a slowdown. The chart below shows SPX performance in the months following historical yield spikes of comparable magnitude. All instances showed positive returns 5 months later.



As a result, equities we expect to carry on gently into outer space. (new highs)

Meanwhile something unexpected may happen to the Dollar. There is a strong belief, certainly positionally, that the USD is on a steady ride upwards too, but if we look at USD performances during the events above (BoE’s USD index used below) we see that it has actually come off:



So in the case of the dollar there is a fair chance that it may well not make it into orbit and fall down to earth.

In summary, here is a modern artistic representation of TMM’s views on US Equities, Treasury Yields, and the USD:

Central banks. Three Heads Are Worse Than One.

Whilst we are talking about central bankers we have found a clip of the ECB in action. Three heads are worse than one.


 

Having heard Ben and the FOMC minutes it would appear that all central bankers are from the same genetic stock.

More Central Banker Brass Balls

It's interesting that the BoJ , ECB and now Fed policy adjustments are following similar patterns.

BoJ - We had the first mad rush after the first messages of policy change which pushed USD/JPY to 103 and the Nikkei to 16k. Then a couple of months later came an element of doubt as to the speeed or commitment to change and we saw a wash out. Then confidence returned and jpy renewed its general weakening.

ECB - Easing was on the cards until Draghi was "accidently" hawkish at the beginning of June seeing a  move driving euro higher until he came back in July with an overtly dovish statement with forward guidance as a strong affirmation.

US - Tapering has been on the cards for a while with the market spending the last couple of months adjusting to it. But then last night Bernanke and the minutes introduced the element of doubt into the timing. The response has been everything you would expect on throwing a hand grenade into a crowded room. It was definately a crowded room but was it really a hand grenade? The tapering trade is still in play, its just a matter of timing and the economy. As TMM have said many times, the central bankers are not going to undo any boost in confidence they have already achieved by choking off liquidity too early.  All that happened last night is that Ben gave guidance that the US10yr at 2.80% is too high after previously suggesting that 2.10% is too low. To that extent we expect him to sound hawkish or dovish at either extreme to maintain a range.

If we were to have learned from the ECB and BoJ and the oscillation of expectation around reality then the Bernanke event should not really have been a huge surprise. What was more of a surprise was just how fast market pricing in FX swung to "no tapering". There is blood down "Change Alley" this morning. But the one common theme of all these central bank steerings is the play in the market. On announcement short and medium and long term players all get on board. A full bus. Then comes the element of doubt and the short players are stopped out, the middle term are dubious leaving the long term better levels to get in on the big trade. This leaves the short term players behind and once again running after it. Basically, a positional wash of shorter term positions as "5 minute macro "get taken out of the 3 year macro trade. Don't you love enforced trading discipline?

With that in mind TMM fade the usd drop.

Back to the ECB. After the dovish Draghi was backed by the introduction of forward guidance suggesting no rate rises for a good while yet it looked finally as though we knew where we stood and we were going to have a July free of European issues . But then, in true "European Unity" style, Darth Weidmann came out with this

ECB WEIDMANN: FWD GUIDANCE WON'T STOP RTE HIKE IF INFL PRESSURES.

And with that the European wallpaper splits open again revealing thee huge cracks beneath. What is the point of issuing forward guidance that effectively says  "We won't raise rates" if then one of the schizophrenic voices in your head says "unless we do". They are still not speaking with one voice. The ECB cannot function as a single entity when the Bundeathstar constantly decides to go native - it needs to be castrated. We have suggested in the past that as a quid pro quo for the French signing up to fiscal rules should be that the Germans agree that the National Central Banks become mere branches of the ECB ie no longer have national ownership. That is one way to give the Bundethstar "the snip" it needs.

What do we do from here? As hinted at in yesterdays quiz, TMM were looking to lighten up their loads in equities having worn the dip and doffed their cap to Mr Bradleys Siderograph (which, however nutty, nailed the turn in equities and the USD). We have lightened more on this spike this morning. As for new trades we are buying USD/JPY again. looking for 103. It's Abe's turn to "do what's right".

Fed Guidance

Fed Guidance

TMM's Pre-Ben Quiz

Quiz time

1. You are approached by your boss over the issue of missing all your budgets for the past year. What forward guidance do you give him?

a) Explain that you intend to remain inactive for at least another year (in the style of the ECB)
b) Explain that you have done far too much work already and it's your colleagues turn (in the style of the Fed)
c) Explain that you are really really serious about getting productive and as soon as the holidays are over in July you'll get on with it (in the style of the BoJ)
d) Note that you colleagues' endeavours are resulting in a harder environment for you to do your job so it's their fault (in the style of the BoE)

2. You are a tennis player who has, thanks to your mother, had the sole lifelong ambition of winning Wimbledon. You finally succeed and in the process win an enormous amount of money so do you:-

a) Repay the support the populace has given you for free by donating a large chunk of the prize money to charity.
b) Turn down any offer of a knighthood as you were just doing your job and achieving your own personal ambition and anyway you have already been handsomely rewarded for your efforts.
c) Set up an academy to train thousands of school children in tennis, turning the UK into a tennis based economy having forgotten that as there can only be one winner all you are doing is increasing the number of losers.
d) None of the above.

3. You wish to legitimise fixings and benchmarks such as LIBOR. Do you hand responsibility for them to:-

a) Yourself
b) The regulatory body so they have only themselves to put in prison when it goes wrong.
c) The Dalai Lama
d) An outsourced offshore "for profit" institution that promised you they could do it "better and cheaper".

4. You are a central banker and are coming to the end of your press meeting and fancy ending on a light-hearted note so do you:-

a) Make a harmless quip involving an esoteric economist in order to enhance your academic aura and persona.
b) Call the Swiss reporter "Rupert" in reference to his red jacket and check trousers.
c) In dead-pan delivery suggest that it took a long long time to decide to keep rates on hold implying you are about to cut at the next meeting.
d) Break wind loudly.

5. You are a UK Royal Mail Postal employee who has been lucky enough to hang on to your job despite the decimation and automation of your industry when you are suddenly offered free shares in your soon to be privatised company. Do you:-

a) Say thank you and count your blessings as you are lucky just to have a job.
b) Say thank you but realise that it's a bribe from the government to counter Union objections.
c) Go into negotiations hoping for more.
d) Trust the instincts genetically encoded into you Jurassic DNA, resulting in you lighting braziers and chanting "Maggie Maggie Maggie, Out Out Out"

6. You are a BBC anchor person for their flagship news program and you have the whole world's news to choose from as a main story. Do you:-

a) Choose to cover Egypt.
b) Choose the decision by the EU court of human rights that not considering the release of the UK's most heinous murderers is demeaning to them and removes their self respect. (TMM are still choking on this one)
c) Choose, for a change, to educate the population with a new story from a far off land that is relatively much more important than local issues.
d) Having found that banks have learned from their past and are doing everything they can to prevent money laundering, spin the story to show that in closing the accounts of money payment agencies (who can't be policed) they have made in harder for Somali's to send money home and so people may be starving thus proving the bank is still evil. (hint - it was this one)

7. You are a US hedge fund manager who wants to go activist on a large publicly traded company but don't have enough AUM to purchase the requisite shares. Do you:-

a) Try to team up with another fund.
b) Raise more assets for your own fund so you can pursue this.
c) Buy some shares first for your own fund, then try to raise a separate fund solely for the purpose of doing this acquisition, with a 3 year lock up, and announcing the details with a vague press release.
d) Try something else.

8. You are a member of the Eurogroup and have found yourself in the unusual and enviable position of being in July without a crisis. Do you:-

a) Sneak off quietly to Antibes for an early start to your August break.
b) Issue a press statement lauding the success of your policies before doing (a)
c) Take advantage, while no one is watching, to put the boot into a minor periphery.
d) Prepare your robes for this month's meeting with the Lizard Gods in the hope of making a place on the mother ship back to planet Zarg having done their bidding in rending destruction upon the Zone.

9. You wish to invest in a very liquid product open to all. Do you:-

a) Go online, find the cheapest reliable broker and buy it.
b) Mess around trying to get best price so long you miss it and never get the trade on.
c) Find an ETF that does the same thing for a lot more risk and cost but will impress your neighbours more.
d) Go short because if you want to buy it,  probably everyone else has already.

10. If your are Team Macro Man and you expect equities to roll lower now. Do you:-

a) Sell and stay quiet.
b) Sell and tell everyone why involving lots of charts and tables.
c) Sell it and find yourself wrong after Bernanke speaks and yet have to wear the shame having told everyone.
d) Write a quiz instead.