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11 ноября, 19:15

Case Study: Can Gold Rally Along With Inflation?

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So I woke up a few days ago and saw this WSJ piece.Yes, world; letting real rates stay negative for so long was probably going to do that.I thought it would be a good excuse to compose another thought piece. Like the kids say: here goes nothing.Now we've detailed potential drivers for inflation in the past - with oil ripping towards new highs (Saudi-corruption-purge-driven or not), nominal rates ripping higher, and stocks falling, I was curious to also see gold also down. I am a strong believer that gold trades like a currency rather than a commodity. Commodities for the most part trade based on supply and demand. The demand function is usually the result of end-use products that during special situations may be propelled further by speculative fervor.Oil gets turned into gasoline and put into vehicles, grains, softs, meats get eaten, metals get thrown together to make cool stuff, etc. etc.The supply function, in many aspects, behaves in accordance with price. Price goes higher, people invest in getting more of that high price "stuff" whatever it may be and vice versa.Gold is a bit different. Why? Like all commodities, it can store some value. But the key difference here is the fact that global central banks, those crazy economic professor types, deem it as a viable form of storer of value and medium of exchange so much that they accumulate it as reserves.As a result, gold more than any other precious metal trades like a currency based on the rates of the country that it's denominated in.So here we are at the focal investigation of the post. Hypothetically, if inflation rises (let's not argue this right now and just assume such is the case), will gold be a good hedge? Let's go to the charts first, since I'm lazy.Yes, yes I know - I didn't get the chance to run the regression on returns vs returns - I have a very finite window to use BBG and the files I build I cannot keep. On top of that, without a BBG API, it takes a horrific amount of time to manually extrapolate the real yield (before the existence of TIPS) by interpolating the CPI.With my whining in mind, even with an "incorrect" price vs price regression - you can observe the directional relationship between gold and those rates. Also, the relative relationship between the different rate products vs gold should be valid as well (the base effect from the regression of price vs price as a result of the level differences should be somewhat negated as all the rate products are roughly on the same base level).Spot gold px vs real yield shows the tightest connection here. So we'll focus in on that one for a sec.From the above, it is evident that gold goes down when real yields go up in a semi-lockstep fashion. (I assume the economic driver here is: holding gold which yields vs holding a currency which in some situations can yield a lot in real terms and in other situations can yield very little or even negative in real terms)Conclusion 1 - Gold trades rather closely with real yields. Although there are sure to be other factors influencing the gold price, it is roughly over the long term a function of real yields.Moving along. Assuming the answered found in Conclusion 1. Can gold always be a good hedge for inflation? Or better yet, can real vs nominal yields diverge (widening of breakevens and thus the emergence of "inflation") without real yields actually going up significantly (real yields going up would theoretically put significant downward pressure on gold)Let's look at some different yield regimes. The two main interests that occupy my focus for this experiment. They are the high inflation periods of the 70's and 80's as well as the periods of shock post the dot-com bubble and the GFC.Now I'm going to add some events to shed some qualitative light on the various worldly happens which caused individual reactions to rates. FYI, for those with a short attention span - this will be a very long table. I will highlight in red those times when real rates were likely zero or negative (higher inflation vs fed funds rate) and I will also provide a summary at the bottom.Disclaimers: The inflation prints were averaged out for entire years while the Fed Funds rate is printed on the table only when a change occurs. Basically, this analysis is far from perfect. However, assuming that those highlighted periods were times when real rates were either negative or close to zero is probably semi-safe. Besides what's life without the right amount of danger, eh?Those with the curiosity of a cat and armed with a Bloomberg terminal can hopefully use this as a launch pad for additional analysis.DateFed Funds Rate EventFed Chair Arthur Burns (January 1970 - March 1978)1971: GDP = 3.3%, Unemployment = 6.0%, Inflation = 3.3% Jan4.5% - 4.0%Expansion.Feb3.5%Jul5.5%Fed raised rate to fight inflation.Aug5.75%Wage-price controls.Nov5.0%Lowered rate to stimulate growth. 1972: GDP = 5.2%, Unemployment = 5.2%, Inflation = 3.4% Mar5.5%Raised rate to combat inflation. Confused markets.Dec5.75%1973: GDP = 5.6%, Unemployment = 4.9%, Inflation = 8.7% Jan6.0%Raised four times that month.Feb6.75%Lowered to 6.5%, then raised to 6.75%.Apr7.25%Raised for next five months.Aug11.0%OPEC embargo created inflation in October.1974: GDP = -0.5%, Unemployment = 7.2%, Inflation = 12.3% Feb9%Jul13%Raised from March to mid-July.Dec8.0%Lowered gradually from July to December.1975: GDP = -0.2%, Unemployment = 8.2%, Inflation = 6.9%Jan6.5%Lowered four times in January.May5.0%Lowered five times in five months.Sep6.5%Raised from June through September.1976: GDP = 5.4%, Unemployment = 7.8%%, Inflation = 4.9%Jan4.75%Lowered from October through January.Apr5.5%Raised in April and May.Nov4.75%Lowered from July - November.1977: GDP = 4.6%, Unemployment = 6.4%, Inflation = 6.7%Aug6.0%Raised from December through AugustOct6.5%Raised again in September and October.Fed Chair William Miller (March 1978 - August 1979)1978: GDP = 5.6%, Unemployment = 6.0%, Inflation = 9.0%Jan6.75%Dec10.0%Raised each month from April through December.Fed Chair Paul Volcker (August 1979 - August, 1987)1979: GDP = 3.2%, Unemployment = 6.0%, Inflation = 13.3% Apr10.25%Oct15.5%Raised rates 4 points.Dec12.0%Gradual decline through the month.1980: GDP = -0.2%, Unemployment = 7.2%, Inflation = 12.5%Jan14.0%Increased rapidly that month.Mar20.0%Raised rates in February and March.Jun8.5%Lowered to 9.5% in May and 8.5% in June. Sep12.0%Rates increased to 10.0% in August and 12.0% in SeptemberDec20.0%Raised steadily until mid-December.Dec 2918.0%Lowered two points.1981: GDP = 2.6%, Unemployment = 8.5%, Inflation = 8.9%Jan20.0%Reagan took office. Volcker raised rates again.Apr16.0%Lowered 4 points.May20.0%Raised 4 points.Dec12%Lowered 8 points.1982: GDP = -1.9%, Unemployment = 10.8%, Inflation = 3.8%Apr15.0%Raised 3 points.Dec8.5%Lowered nine times over nine months.1983: GDP = 4.6%, Unemployment = 8.3%, Inflation = 3.8%Aug9.66%Raised from May to August.Oct9.25%Lowered from August to October1984: GDP = 7.3%, Unemployment = 7.3%, Inflation = 3.9%Aug11.75%Raised from March to August.Dec8.25%Lowered from September to December.1985: GDP = 4.2%, Unemployment = 7.0%, Inflation = 3.8%Mar9.0%Raised from February to mid-March.Dec7.75%Lowered from April to December.1986: GDP = 3.5%, Unemployment = 6.6%, Inflation = 1.1%Aug5.66%Lowered from March to August.Dec6.0%Fed Chair Alan Greenspan (August 1987 - January 2006)1987: GDP = 3.5%, Unemployment = 5.7%, Inflation = 4.4%  Sep7.25%Raised rates from April to September.Nov6.75%Lowered after October 19 stock market crash.1988: GDP = 4.2%, Unemployment = 5.3%, Inflation = 4.4%Feb6.5%Lowered in January and February.Dec9.75%Raised rates to fight inflation.1989: GDP = 3.7%, Unemployment = 5.4%, Inflation = 4.6%Dec8.25%S&L crisis. Fed lowered rates.1990: GDP = 1.9%, Unemployment = 6.3%, Inflation = 6.1%Dec7.0%Recession began in July.1991: GDP = -0.1%, Unemployment = 7.3%, Inflation = 3.1%Dec4.0%Recession ended in March.1992: GDP = 3.6%, Unemployment = 7.4%, Inflation = 2.9%Apr 93.75%Expansion.Jul 23.25%Sep 43.0%Clinton took office in 1993. Fed made no changes.1994: GDP = 4.0%, Unemployment = 5.5%, Inflation = 2.7%Feb 43.25%Mar 223.5%Apr 183.75%May 174.25%Aug 164.75%Nov 155.5%Raised rates.1995: GDP = 2.7%, Unemployment = 5.6%, Inflation = 2.5%Feb 16.0%Raised rates.Jul 65.75%Lowered rates.Dec5.5%1996: GDP = 3.8%, Unemployment = 5.4%, Inflation = 3.3% Jan 315.25%Kept rates low despite inflation.1997: GDP = 4.5%, Unemployment = 4.7%, Inflation = 1.7% Mar 255.5%1998: GDP = 4.5%, Unemployment = 6%, Inflation = 1.6%Sep 295.25%LTCM crisis.Oct 155.0%Nov4.75%1999: GDP = 4.7%, Unemployment = 6%, Inflation = 2.7%Jun 305.0%Raised ratesAug 245.25%Nov 165.5%2000: GDP = 4.1%, Unemployment = 6%, Inflation = 3.4%Feb 25.75%Raised rates despite stock market decline in March.Mar 216.0%May6.5%2001: GDP = 1.0%, Unemployment = 6%, Inflation = 1.6% Jan 36.0%Bush took office. Jan 315.5%Mar 205.0%Recession began. Fed lowered rates to fight it.Apr 184.5%May 154.0%Jun 273.75%EGTTRA tax rebate enacted.Aug 213.5%Sep 173.0%9/11 attacks.Oct 22.5%Afghanistan War.Nov 62.0%Dec 111.75%2002: GDP = 1.8%, Unemployment = 6%, Inflation = 2.4%Nov 61.25%2003: GDP = 2.8%, Unemployment = 6%, Inflation = 1.9%Jun 251.00%JGTRRA tax cuts enacted.2004: GDP = 3.8%, Unemployment = 6%, Inflation = 3.3%Jun 301.25%Low rates pushed interest-only loans. Helped cause Subprime Mortgage Crisis.Aug 101.5%Sep 211.75%Nov 102.0%Dec 142.25%2005: GDP = 3.3%, Unemployment = 6%, Inflation = 3.4%Feb 22.5%Borrowers could not afford mortgages when rates reset in 3rd year. Mar 222.75%May 33.0%Jun 303.25%Aug 93.5%Sep 203.75%Nov 14.0%Dec 134.25%Fed Chair Ben Bernanke (February 2006 - January 2014)2006: GDP = 2.7%, Unemployment = 6%, Inflation = 2.5% Jan 314.5%Raised to cool housing market bubble. More homeowners default.Mar 284.75%May 105.0%Jun 295.25%2007: GDP = 1.8%, Unemployment = 6%, Inflation = 4.1%Sep 184.75%Home sales fell.Oct 314.5%Dec 114.25%LIBOR rose.2008: GDP = -0.3%, Unemployment = 6%, Inflation = 0.1%Jan 223.5%Jan 30 3.0%Tax rebate.Mar 182.25%Bear Stearns bailout.Apr 302.0%Lehman fails. Bank bailoutapproved. AIG bailout.Oct 81.5%Oct 291.0%Dec 160.25%Effectively zero. The lowest fed funds rate possible.Fed Chair Janet Yellen (February 2014 - January 2018)2015: GDP = 2.6%, Unemployment = 6%, Inflation = 0.7% Dec 170.5%Growth stabilized.2016: GDP = 3.2%, Unemployment = 4.6%, Inflation = 0.4% (as of December, 19 2016)Dec 140.75%2017: GDP, Unemployment and Inflation TBDMar 151.0%Fed projects steady growth.Jun 141.25%Whoa, that was a lot of blog space. If you want a descriptive version of what happened - here's an NY Times article.So to summarize some of the events in the table, we have a few periods of interest. You have 1973 - 1979 where there were often times when real rates were either negative or close to being negative. Same can be said about 2004 - 2005 and then 2008 where real rates were negative at the end of the year. - 2016.I believe monetary stimulus is much more effective (perhaps, only effective) when there is fiscal stimulus implemented in a concurrent fashion.Here is a chart of long-term government spending.If you carefully look, I saw spikes in government spending relative to government receipts in 1975-1977, what looks to be around 1987, 1992, 2001, and then 2009. Therefore, I expect those times, if combined with low/negative rates to create a sizable amount of inflation.The opposite trend could be said from the mid 1990's to 2000. I would expect low inflation during this period especially if real rates were positive.Now tying it all together with the gold price. I have three screenshots. Rates: Nominal vs Real in different "regimes"Corresponding gold in corresponding regimesMy weekly data for gold doesn't go back that far - so here is the chart for the first "regime (1975 to 1985) in monthly spot gold prices.1975 - 1985As you can see from the above: our data starts with gold falling close to ~50% (from 180 to below 100) from 1975 to late 1976 as real yields rose against steady nominals (a closing of the breakeven inflation). Then, we experienced something extraordinarily scary - a rise in nominal yields with a falling real yield from 1978 to 1980. This development of inflation along with real yields actually trading lower led to an explosion in gold prices (trough to peak move of ~400% in one year) - proving that gold was indeed a good inflation hedge in this scenario. Finally, real yields marched higher along with nominals and gold went into a huge bear market.So yes, there could be a bond bear market (nominal rates rising) while there is a breakout in inflation - during which gold would be a great hedge. However, interestingly, even with low rates and inflation during the early and mid-1970's, gold actually fell ~50%. Remember, 1975 we had the increase in government spending as noted above. In addition, we had close to negative real rates.It seems that the direction of the real yield and the general direction of inflation actually caused gold prices to fall despite the absolute level of inflation was still high. 1985 - 1996 Moving on to the next time bucket. 1985-1996 saw a rally in gold from 1985 to 1988 coming out of the bear market. 1986 - 1987 saw a small pocket of breakeven inflation going higher, potentially triggering gold higher as well. Interestingly as nominal rates continue to fall in the beginning of the 1990's - real rates roughly stay the same. Gold did not trade closely with real rates in this scenario and instead tracked breakeven inflation as both kept getting squeezed lower. Lastly, you had meaningful moves in nominals and real yield first higher, then lower in 1994 to 1996. Gold ultimately did not care as it stayed tightly range bound.1996 - 2009A quick side note: of the 4 rates charts in the real vs nominal screenshot above, this regime's chart actually has the red line as the real yield and blue as the nominal - sorry for any confusion.Continuing with the decrease in government spending and generally low inflation of the mid-1990's - gold continues to slide, goes nowhere.Then, when we hit the 2000's, we started to see both nominals and real yield go lower. This move was roughly in tandem so I don't think breakevens were moving much. With a slight expansion of breakevens and inflation itself not really trading directionally despite lower rates and increased government spending, gold's reaction was to steadily build into a bull market.In my opinion, this move in gold in the 2000's could be explained by persistently lower real yield. Inflation had risen slightly but it was nothing significant and definitely dwarfed by the move in gold.Lastly, we have 2008 - 2009. Real yields spiked higher while inflation collapsed - gold subsequently sold off, tracking both inflation and real yields pretty well.2009 - PresentPost GFC, the most interesting period of time was late 2011 to 2013. Nominals started to bottom out while real yield continued to march lower. We began building higher lows in breakevens as inflation looked poised to go higher. This actually proved to be the peak in gold. As real yields spiked higher in what was later deemed the taper tantrum with gold going into bear market ever since.Conclusion 2: After all that rambling, here's to summarize: I think gold is probably less of an inflation hedge than some might think. Although it does follow inflation to an extent - gold also seems to be very sensitive to real yield moves. If you believe real yields are set to rise along with inflation - then gold might not necessarily do very well - for example, 1981-1982, gold kind of topped out despite the fact that there was still pretty high inflation simply because real yields were rising.But then, you have scenarios such as the early/mid-2000's with low and steady inflation, with a consistently lower real yield, where we also witnessed the foundation of a huge gold bull market.And ultimately, there are scenarios of higher nominal yield and lower real yield - usually, they are ephemeral, lasting only a few months. However, we saw a meaningful one that lasted from 1978 to 1980. Keep in mind as with many things in the market, it seemed that direction mattered more often than level. For example, when the widening of real and nominal rates in 1980 hit its zenith, gold was already peaking. Other miscellaneous charts for your musings:Here's FED and ECB assets vs. spot gold priceHere's gold vs the VIXI think our own Macro Man did a little bit of analysis on that one as well. I'm sure all the readers have seen that one, but in case you haven't, here it is - linked here.And that's all I got this go-round, guys.Hope everyone has a wonderful day and weekend. Stay warm out there!

06 ноября, 20:30

Venezuela: A Bondholder Nightmare, A Market Failure. Where Was Macro?

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This post was written in collaboration with Caracas Chronicles. Check them out! “The time between the “outrageous” and “yeah, you didn’t know that?” can be incredibly short.”This tweet was about the Hollywood harassment scandal, but it applies to markets on a regular basis – and it certainly did in Venezuela last week.  Intrigue surrounded the amortization and maturity of two PDVSA bonds, which required roughly $2 billion for bondholders. Sanctions preventing US dollar transactions and new US dollar funding for the regime complicated the already difficult task of cobbling together payments with an absolutely broke government.And yet... it paid. PDVSA somehow bundled the October 28th amortization payment across the line, and promised, with some credibility, that the check would be in the mail for the maturity of the PDVSA bond of November 2nd. Then, one of the more surreal events in the history of sovereign defaults happened: after market hours on Thursday evening, Maduro announced that the government will stop paying principal and interest on the current debt load, the same day they pledged to pay back a bond at par. And what had been a tumultuous but profitable week for Venezuela bondholders, turned into a total nightmare. The 7% December 2018 bond saw its value cut in half from the high 60s Thursday afternoon, to the mid 30s on Friday, just above what many people use as assumption of what defaulted sovereign debt is worth in a restructuring. With the wave of Maduro's magic wand, “Venezuelan default” went from “outrageous” to “yeah, you didn't know that?” Here's where “macro” comes in. Those who’ve been following me for the last few months know that I have a healthy skepticism of macro trading strategies. There are traders out there who are constantly ahead of the curve, who see opportunities more quickly and accurately than the rest of the crowd, even in markets they don't trade in every day. But for the vast majority of the universe, there has to be a definable edge when you are doing something the rest isn't, whether it's a different type of analysis, or taking advantage of some market breakdown or regulatory change. The different pools of capital in financial markets should produce enough diversity to keep markets “honest” in the same way Leo Messi keeps defenders “honest” because they have to protect against him charging to the goal or threading a brilliant pass to a teammate. You can’t “cheat” towards one or the other because you'll pay for it. How did markets miss that Venezuela could default any day? Did they miss out on this chart, which shows nearly $4bn in payments going out the door in Q4 2017, for a country with stated foreign reserves of $10bn?  A few months ago, I talked to some EM managers on the subject. One suspects that “(debt holders) are going to start bailing when it's too late, ourselves included. Anyone that has anything to do with an index gets burned by being underweight, so they inevitably come back. To step out of the position, you would have to compensate, and there isn't enough risk-adjusted yield to do so elsewhere.”That's the “cheat”; for bondholders, Venny debt was a case study of game theory in Emerging Markets. The market structure is set up in such a way that the biggest foreign investors were afraid to sell and afraid to buy. Macro investors should step in and say “Look, the market is pricing a greater than ever chance 2018 bonds will be paid at par.  There's nearly $4bn in bond payments this year, another $10bn next year, versus $10bn in foreign reserves at best, for a country under sanctions that prevent access to new dollar funding.”Why didn’t they? There's a few reasons: The capacity of repo markets to lend bonds has been greatly curtailed. After the post- Global Financial Crisis reforms, banks don't want the risk of lending bonds in a credit on the edge of default. This situation leads to a lot of difficulty in trying to establish a sizable short position in the bonds, and when you can, it can be prohibitively expensive;  The size and risk appetite of global macro has been overwhelmed by the size of real money investors. The days of George Soros pushing around markets and central banks are over; enter the era of the multi-trillion-dollar passive asset managers such as Blackrock, Vanguard, Fidelity, etc.The liquidity provided by Wall Street banks seized up further when the US imposed sanctions on USD transactions with the regime. A couple key players in the interdealer “wholesale” market stepped out after the August round of sanctions, worsening market liquidity and amplifying the wild swings Venny Bonds are known for.Call it what you will, self-preservation, or the Bachaquero on Wall Street trade, but guessing the date of the Venezuelan default has been a trader parlor game for over three years now — more than one hedge fund trader got carried out on the short Venny theme. Traders were lulled into complacency that Maduro would simply find a way. He didn’t.With macro traders sidelined and real money investors petrified, liquidity dried up and the market became hostage of local brokers and regime insiders, rather than economics and risk. A break that macro traders were unable to exploit… and Venezuelans couldn't prepare against. It is yet another testament to the power of market efficiency, and the consequences when it breaks down.The losers in this game? Not the regime, the fixed income investors or even the hedge fund guys that shorted Venny too early: the real losers were the Venezuelans who died because there weren’t enough dollars to service the debt and import food and medicine.  

30 октября, 07:39

EMFX And USD, The World's Newest Petro Currency

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Well, even the St. Louis Fed has caught wind of this reversal in USD: Indeed, it has been a nice run. Speaking of which, has anyone seen Abee? The guy splendidly calls the bottom in the USD trade and then does his best impression of J.D. Salinger. Come on man, take a victory lap...What I find interesting about this move is not so much the fact USD has bounced back--as noted the long USD trade had a lot going for it, including way too sanguine FOMC expectations relative to the state of the economy and underlying inflation drivers. But during this move high beta EMFX has gotten decimated. Take a look at the chart below, which is normalized spot currency performance vs. USD back to the end of June: At the top you have low beta names, those leveraged to China and the global growth cycle: KRW, INR and CNH. At the bottom you have three high-beta EM currencies: ARS, TRY and ZAR, all with their own political and/or economic problems and low real interest rates.  What else do you notice about those bottom feeders? They’re all oil importers. Take a look at three more high beta EM currencies, but this time oil exporters: COP, RUB and BRL:  They’ve all appreciated 1-2%, not counting carry that would add up to roughly 3-5% running. All during a time in which the USD trade weighted basket has appreciated roughly 6%. So lets dig out ye olde Brent chart...Another one that a peanut gallery regular (IPA, take a bow) nailed square in the chops a month or two ago: This leads me to a couple of conclusions for what is driving this move, and what may be next: Don’t forget this chart: Demand has been the major driver of this move higher in crude.  The supply side has been a snoozer. As such, an economy that is growing aggregate demand, increasing interest rates, and exporting energy (if not crude, than the sum of coal, crude, LNG, and products) should do well, and so should its currency. Don’t discount the increasing correlation of USD to crude--a correlation I remember being close to -1 in the not so distant past.   Indeed, this is a relatively new phenomenon as US production has steadily increased. When I sat next to a nest of energy traders in the early part of this decade, they batted around the term “tight oil” a lot. I had to ask under my breath one day, “um, what is tight oil?”  Shale. It means shale. Note the steady rise throughout this year.So we have a situation where global growth is good ( +China), demand for consumer goods is strong ( +Asian exporters), which has led to higher commodity prices. Interest rates, if not quite buried in a the sandpit of a couple of months or a year ago, are still not getting out of hand. In sum, that's a pretty attractive scenario for EMFX. Where does that leave the high beta energy importers? Well, I think in pretty good shape, because of that last chart. Oil prices are still well off their highs... terms of trade haven’t taken that bad of a hit, especially when offset against gains in other commodities (copper, etc.) or export demand at large. The total whitewash in some of these currencies looks more like positioning getting too heavy in carry trades and getting a bit overdone here- a view I have some confidence in for a couple of reasons: Risk markets elsewhere are taking out new highsNo material change in interest rates (yet) that would change the economics of carry tradesBTD mentality doesn’t stop at FANG stocks…ZAR certainly is a strange animal and has been hammered for reasons well beyond terms of trade. But the combination of political noise and higher oil prices has supercharged this move--not unlike what we have seen in MXN over the past few weeks as the NAFTA spitting contest heated up. Where will politics take these currencies? Plenty of opinions out there on that--I have my views which are beyond the scope here; the point is USD is more highly correlated to global growth than any time in the past, and “risk-on” currencies are poised for a come back if the underlying dynamics remain intact.

24 октября, 17:27

European Inflation Breakevens Show...US Tax Reform Not Priced In?

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Amidst the noise this week, there has been some chatter about increasing inflation expectations in Europe. This is certainly relevant given the continued run of good economic data, from output, employment, and consumer confidence. The WSJ highlighted 5y5y breaks--which have purportedly increased--although given the brave new world of suppressed vol, the orders of magnitude are ridiculous. Is this increase supposed to catch Draghi’s attention in the press conference this week when it has increased a big 15bps?  Moreover, it is debatable how much information is embedded in breaks when correlation to US breaks looks like this. I’m not going to bother you with an overlay of oil prices, but I think you get the picture.  Looking at the residuals of 5y5y us breakeven vs. 5y5y eu HICP breakeven, it is such a quiet dataset that you can pick out each relevant macro event. A positive residual indicates high US breaks relative to EU breaks.  Nov 11, European Debt CrisisMid-2012, Taper tantrum2015, Falling oil prices/EM stress/EU deflation fearNov 2016: Trump/April 2017: Fed Hiking/ECB sitting on hands Today? The residual is zero, and has been stuck in a roughly 5bps range since May. Yet the lack of any movement in this chart is illustrative in the context of the recent rise in interest rates. A substantive tax reform that juices US growth, eases fiscal policy, and/or increases long-term budget deficits isn’t in the price. Or to the extent that it is, the impact has been offset by increasing expectations for global growth in general and European growth in particular. And quickly on another of my favorite subjects: if you read one piece about foreign exchange this week, make it Brad Sester’s most recent post on “Follow the Money”. It’s a great breakdown on how and by which channels countries with significant current account surpluses are intervening to keep their currencies weak (and worth noting that while my long usd/krw trade was a dud, it didn’t not work because the BoK was on the bid). While not relevant to the US, it is an interesting thought process to apply to Hungary in the context of our recent discussion about their C/A surplus, export competitiveness, HUF and local [email protected]

23 октября, 08:27

Czech and Hungary Monetary Policy--Distant Cousins?

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In one of last week’s post, I made some off-handed remarks about what makes a good macro trade, or in that case, what doesn't. Yes, you need a big picture view. You need complacency, stupidity, regulatory dislocation, misaligned incentives, or some combination, to generate the market mis-pricing necessary to score big when there is a catalyst to set the tinder ablaze. Reading the newspaper over the weekend, I got thinking about the Czech Republic after the anti-establishment ANO party won big, putting their pseudo-Perot type figure Andrej Babis in line to be the next prime minister. I thought the big story would be the large share of the vote won by anti-establishment candidates in this election and last week’s election in Austria. If you look at the type of candidates that are winning elections in Central Europe, it is consistent with the global trend towards liquidating the establishment, more so than necessarily far-left or far-right movements. Look at recent history: the United States, France, South Korea (sort of, by South Korean standards anyway), and Czech Republic have elected decidedly anti-establishment figures, while non-traditional and/or radical parties or candidates have done well in the UK, the Netherlands (Wilders and the Greens still gained seats at the expense of the establishment, even if not as many as predicted), Czech (again) and Germany. Indeed this is the story of 2017, and will continue to be later this year and into 2018 when we will get potentially market moving elections in Mexico, Brazil, and Italy--with an election in Hungary already in the bag for their nationalist prime minister, Viktor Orban--who arguably kicked off this trend in EMEA back in 2010.Yet after kicking the tires on Czech assets over the weekend, there doesn’t seem to be much stress about politics. The far bigger story this year has been the decision by the CNB to float the koruna, allowing it to appreciate versus the euro.  And as so often happens, the really juicy macro trade may be a layer beyond the current potential for policy tightening in the Czech Republic.First, getting an award like this is always a little awkward. It is like winning coach of the year in the SEC West. Sure, great job...but come on...look at the neighborhood. Yet the CNB is a strong, highly credible organization. Their chief economist hit the tape with this hatchet job on the rates market late last week: Doesn’t get much more explicit than that. Listen to the game masters. This type of verbal intervention, or forward guidance if you prefer, has pressed rates and CZK higher. If rate hikes are coming, is there still more upside in CZK? The currency has continued to well over the last couple of months...note the break higher from high levels And interestingly, duration has gotten pummeled. A big element here is that foreign investors piled into the country recently, and now are getting barbequed by rate hike expectations. CZK REER has only broken away from its CE peers since the break higher in rates over the past couple of months. Yet the move in the currency is totally uninteresting when compared to the Teutonic juggernaut to the west: That leads me to believe that unless there is some weird softness in the inflation data, the CNB will have to deliver on the rate hikes priced into the curve, which should continue to support CZK over the next few months. Perhaps lost in the din is why CNB is tightening policy in the first place. Inflation!! I found it Margaret! But what is the first thing you notice in this chart? Hungary and Czech HICP have been pinned to each other for most of the past four years. So we might expect the HNB to be following a similar course to the CNB? No, quite the opposite. I have to admit, this is one of my favorite charts of the year. The 2y rates crossed only days before the CNB allowed the CZK to float and the two trends barely took a breath, despite inflation following in lockstep!    I’ll have to go a few more rounds in the EMEA ring to build out this idea, but that inflation chart and the cross in 2y HUF and CZK rates is what a breakdown in central bank credibility looks like. We have some dry tinder here: higher inflation, a very tight labor market, a government that has to borrow tons of money every year to finance itself, and inflows from the EUWill that cause inflation expectations get out of hand in Hungary, leading to a panic among the notable number of foreign investors, and force the HNB to tighten policy, despite a questionable record of independence and a parliamentary election coming next year? For now I think the answer is still “no”, the prior REER charts don’t illustrate a big dislocation in competitiveness, and the chart below argues the currency side might be more of a “single” than a homer. But rates...yes….carry/risk vs. reward ratio could be very appealing. Rates in Hungary should be higher. But nobody makes money on should. Will it actually happen? Place your bets, folks. Macro at its finest.  [email protected]

20 октября, 18:53

Friday Roundup: CNY Internationaliztion (not), Another FOMC One-Off Excuse, and Oil Demand

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Today is the morning prices had to find me...from my wi-fi resistant hovel in the rural midwest I hear the treasury curve is bear steepening...can it be?!? The rhetoric behind the Senate bill looks like “we can all have a unicorn” type stuff...tax cuts for all!!  I’d hazard a guess that nobody has made a buck this year going long on Trump’s ability to execute--so I’m still skeptical. Notable moves in Canada as well...driven in part by lousy data but also moves by the local regulator to tighten mortgage standards. This gets back to an issue about local versus national housing price increases I addressed over the summer--stay tuned for an update next week.  And a little housekeeping here-- I couldn’t post this chart in the comment section of the previous post, but I thought it was worth highlighting.  CNY is 2% of international payments, and (arguably) falling. Beijing and the PBoC are dragging their feet on the internationalization of the currency--they simply don’t want it...yet. They prefer (capital) control and stability. While there have been some signs that Chinese local debt will gain greater acceptance in real money circles or (gasp) EM local market indices, we’re not there yet either. I’d like to quickly circle back to “Fed speak”, which will become more important as we finally get a answer from Trump on the next chair of the FOMC, and more data over the next couple of weeks.  In a speech in early October, San Francisco Fed chief John Williams gave another hypothesis on the “one-offs” that might be sandbagging inflation: “An even bigger contribution to low inflation has been coming from the healthcare sector. Mandated cuts to Medicare payment growth, which also tend to be incorporated into payments for nongovernment health services, have kept inflation in overall health-care services unusually low for several years. These legislated changes have been a key factor holding inflation below the Fed’s 2 percent target, despite a strengthening economy.”He reiterated this stance in a breezy Q&A with the New York Times earlier this week. Does Williams’ health care hypothesis have any more efficacy than Yellen’s targeting of telecom prices? Let’s look at the numbers.Indeed, Medical care CPI has cratered and currently stands below core CPI for the first time since “Who Let the Dogs Out” topped the charts. But there’s a strong correlation there--the NY Times article implies medical care CPI is unrelated to headline--but this chart would argue otherwise. The contribution of medical care CPI is at the lows--but off of very high levels that single handedly drove core CPI above the 2% threshold around the beginning of the hiking cycle. Now that has normalized. And as much as I hate stripping every inconvenient item out of CPI, if you look at this chart you don’t see anything too different than the plain vanilla core CPI, or the fed's trimmed mean and median CPI measures. Add back 10-15bps for trend medical expenses CPI if you prefer. It just doesn’t matter. While I would agree with Williams this is a bit of an outlier, it is also one that is highly correlated with underlying CPI trends. Skilled labor is a significant portion of medical expenses and thus will increase somewhat in line with nominal GDP.  Look for a mean reversion bounce back here which will drag core CPI higher, but not enough to really be a game changer for monetary policy. But thanks Dr. Williams...keep those theories coming!!Lastly I quickly want to touch on oil prices. WTI is still top of the range, and while Brent (below) has finally broken the 56 level, it simply refuses to take a run at 60. Supply has been a two way street here, with continuing OPEC chatter, issues in Iraq, and continued free flowing wells in the US. I have inside source on the supply demand picture in the oil industry.  Ok, it’s the New York Fed. Check out how demand has been growing as a contributor to the oil price since the recent lows in early July: Demand isn’t dead!! Keep a close eye on tightening supplies because any OPEC resolution or supply disruptions could have a much bigger beta on oil prices than they have in the past, especially with US production much closer to full capacity than it was a year ago. Have a good weekend and stay safe out there!! [email protected]

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19 октября, 09:23

"The Macro Renaissance" or "The Dollar is Dead, Long Live Macro"

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Think about history’s great entrepreneurs: the people that set out to change the world, and did just that. Today’s best example is Elon Musk. Take a couple minutes out of your busy day and watch a bit of his presentation of the Tesla Powerwall. What do you notice first, other than entry music fit for the reigning WWE Intercontinental Champion? Elon has a great hook. Fossil fuels are going to destroy humanity. Now think about your last powerpoint presentation to an investor, client, or boss. Yeah, you used some generic corporate-approved background theme and loaded it down with bullet points and charts. Me? “Guilty.” Good grief, the evidence is probably out there on the interwebs somewhere. I bring this up after reading an article in last weekend’s edition of Barron’s, “The Coming Renaissance of Macro Investing” by macro superstar John Curran. He opens with a story about Nixon’s Treasury Secretary William Simon cutting a deal with the Saudis in mid-1974 to buy their oil in exchange for recycling those dollars into US treasuries. Curran claims this set the stage for two generations of US opulence because USD “demand” from petrodollar states underpinned the strength of the dollar as a reserve currency and allowed the US economy to grow amidst low and relatively stable interest rates. That sounds be a good hook--not quite Musk’s threat to global humanity, but one that appears to show a courageous Treasury secretary that stepped into the crucible and saved America from inflationary doom. We could sit here all day and argue about the economic history of the United States and the role of the dollar’s reserve currency status in the development and maintenance of a global hegemon. Let’s look at the facts.  Source: St. Louis Federal Reserve and Energy Institute of AmericaThis chart shows the gap between the current account deficit and net oil imports as a percentage of GDP. In the early 70s, this was a significant issue. America had a strong manufacturing and export base, so when the Arab oil embargo put those imported barrels at risk, and the price of oil skyrocketed, exports suffered, and US consumers were squeezed. Curran correctly notes that the deal between the US and the Saudis was about neutralizing oil as an economic weapon. But it was far more about national security and guaranteeing energy supplies than it was about recycling petrodollars and establishing the USD as a reserve currency in a post-Bretton Woods world.  That didn’t come until several years later, when President Reagan declared “morning in America”. By the 1980s, Europe was still a fractured, socialistic mess, while relative prosperity in the United States, unsurpassed financial markets, the Cold War and strong property rights conspired to give Reagan the ammunition he needed to up the ante on the Soviets: bonds. The key ingredient: Foreigners wanted US assets. They bought treasury bonds. They bought Michael Milken’s junk bonds. They bought Louie Raneri's mortgage-backed securities. They bought corporations. They bought golf courses. They bought movie studios. Anyone remember the press squealing about the Japanese buying up the entire United States? Help me out here...is Japan a big oil exporter? No. The world wanted our assets because we were buying their oil AND their stuff--and we had the best assets and rule of law on offer. The demand for US assets to finance the current account deficit was MUCH bigger and deeper than Curran claims. That’s important because he uses the petrodollar argument as the foundation for his claim that the Chinese are due to seize the dollar’s global reserve status.There is certainly some appeal to his argument: he details the ways in which the Chinese are seeking to rotate away from the dollar as a medium of exchange in oil markets. To understand that to be a threat to the dollar’s status as a reserve currency ignores the last points in the above chart: net oil imports as a percentage of GDP are approaching zero...and adding in the trade surplus in petroleum products leaves energy as a positive or immaterial force in US financial flows.Curran notes that the increase in domestic production has led to lower oil prices and lower revenues for Gulf states--but he pushes that argument too far when he says that leads to lower demand for Treasuries and dollars. If we are exporting oil, won’t we receive dollars in return? Won’t US exporters than invest that money either in expanding domestic production….or in US treasuries, corporates, or equities? The last plank in this piece circles back to macro at large, which can be summarized as MACRO IS DEAD. LONG LIVE MACRO.  Everyone says macro is dead. Must be a contrary indicator. What’s the evidence here? The Fed “normalization” will lead to diminished support for the US Treasury market. ...The US will need to finance enormous and growing entitlement programs, and our historical international sources will no longer support us.The key here, as is central bank credibility. Say what you want about the Fed, the flat curve and (relatively) resilient USD is telling you the market believes they will strangle inflation behind the metaphorical dive bar of global financial markets. That’s another plank in the arsenal of a global reserve currency and one that isn’t going away soon.  There is little evidence that global investors are on the verge of abandoning their faith in the US in favor of China. China exports goods (their trade surplus) which leaves them a BUYER of foreign assets.  What are they going to buy? Russian corruption?  Until the Chinese consumer becomes even close to the rabid, voracious, insatiable animal known as the American consumer, this trend isn’t changing.  And lastly, despite our president’s best efforts, the US is still a destination for capital the world over when people want to put their money in a safer place. That’s not about to change either--not for people in Latin America, the Gulf States, Africa or even China.  We all like to think of ourselves as contrarian investors, or smarter than the average bear. But this one just doesn’t hold water to be the “paradigm shift” that blows us out of the current malaise of low volatility and rings in a new era of macro investing. [email protected]

16 октября, 19:16

The FOMC and "Surprising" Low Inflation: Careful Analysis or Willful Ignorance?

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On Sunday, in a speech to the IIF, Janet Yellen again expressed her “surprise” at low inflation figures: “Inflation readings over the past several months have been surprisingly soft….”Our friend Polemic nailed it on Twitter: Indeed...the Chairwoman goes on to detail just what was so surprising: “...The recent softness seems to have been exaggerated by what look like one-off reductions in some categories of prices, especially a large decline in quality-adjusted prices for wireless telephone services.” And the September minutes didn’t mention wireless prices by name, but it is tough to believe that wasn’t under the hood here: “In addition, many judged that at least part of the softening in inflation this year was the result of idiosyncratic or one-time factors, and, thus, their effects were likely to fade over time.”Same script back in July: "idiosyncratic factors, including sharp declines in prices of wireless telephone services and prescription drugs, and expected these developments to have little bearing on inflation over the medium run."As most of you know I am outside the orbit of most sell side research. I find US economic research particularly vexing. Have you read any economists take apart these talking points and evaluate if their veracity?  This is a chart of the NY Fed’s underlying inflation gauge “prices-only” index, which I dug into a while back in this post. It doesn’t take into account financial conditions and other non-price measures. It continues to rise, despite the fall in core CPI, Core PCE (through August) Adding in financial conditions, the UIG index is getting into some frothy territory similar to what the US experienced in the late 90s and mid 00s. The break with PCE measures is stunning.So yes, perhaps some one-off idiosyncratic factors at work in the low headline readings. If you look at the Fed speak, Yellen isn’t the only one that has cited wireless prices….The FOMC leadership  clearly has established this as their explanatory variable workhorse. And indeed, prices gapped lower earlier this year: But this begs the question, is Janet Yellen a millennial? Is she one of those people that is constantly texting and snapchatting but cut the cord on cable long ago?  Cable and satellite companies are picking up the slack and definitely doing their part to help the FMOC meet their beloved 2% inflation mandate....prices in this category are up 6.8% YoY. On behalf of the Fed, thank you Comcast. You are true patriotic Americans. Please continue to hike prices so we can fight those deflationista bolsheviks over at Verizon.  It is worth noting that wireless service and cable/satellite components started breaking in opposite directions around the same time….The right axis in this chart shows the contribution of Cable/Sat and Telephone to the overall CPI index (Inflation nerds: I cheated a little when I calculated this because I didn’t want it to consume my whole day...ping me if you want to get deep in the weeds). Don’t look now, but Cable/Sat prices’ contribution to the headline index is at all time highs!  Here’s what we get if we sum up the two incidence components. Net -6bps contribution in the September CPI and +/-12bps for the past twenty years...Thanks for flagging this, Janet.This leads you to one of two conclusions: 1 ) the FOMC is clueless, and is blaming irrelevant factors for low inflation when something else is really at work, or 2) the FOMC--as an institution...not just Yellen--will continue to “look through” recent low inflation readings, and they are citing certain components as examples for what is giving them the confidence to do so. The data in the underlying inflation gauge and the drumbeat from Dudley backs that theory. Yet this chart might argue in favor of the former--is the Fed willfully clueless about the drivers of low inflation readings? The Trimmed Mean PCE and Median CPI figures, which are constructed specifically to exclude noisy data, are in a persuasive downturn. Yet that is not what FOMC leadership is choosing to focus on. Instead we get “Idiosyncratic. wireless prices.” Bottom line: Yellen and Dudley are looking at the underlying inflation gauge, where prices are rising and already above 2%.  They are looking at financial conditions, they are looking at wages--and while they are too smart to take the punch bowl away, they are going to continue to drain it slowly until economic data tells them they should be doing otherwise, or until the underlying gauges start to converge with headline price data.Perhaps it is what Polemic said, which has a certain Occum’s Razor appeal to it. Maybe they just don’t know why the UIG and financial conditions are diverging so dramatically from trimmed mean PCE and median CPI...and that’s why the curve relentlessly [email protected]

13 октября, 07:40

QE Unwind and Charge of the Horsemen

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This is one of those times I am glad I am not paid by the word. I was in the car on a long drive this evening and heard the soporific tones of NPR’s Kai Risdahl going through the day’s financial results.  “Down day for the Dow today, closing off one-tenth of a percent.”“Down day for the Nasdaq as well, closing one-tenth of a percent lower”“The S&P 500 fared no better, closing down four points, just under two-tenths of a percent.” Really? I mean...really NPR? Couldn’t you have just saved us all a little time and said, “everything basically unch...again.”  There was a time earlier this year (and for the prior decade, I guess) when I would wake up, fire up my laptop to get the overnight price action. For the past three months I just hit snooze, read the Wall Street Journal, and figure prices will come to me if they are worth looking at. Today I spent some time thinking back to 2006 as a part of a piece I am working on about the potential downside of a victory by the populist candidate in the upcoming Mexican presidential election. Turns out markets were hustling pretty good back then! There was a fare degree of vol….but that had done nothing to shake the complacency of years of monetary quaaludes and financial accumulation. There was vol….and there was the BTD mentality...but it took until at least 2007, arguably right into the weeks just prior to the Lehman bankruptcy in 2008, before it was really all over. Investors had to have their throats slashed. There was no possibility of a soft landing.  “We are at a wonderful ball where the champagne sparkles in every glass and soft laughter falls upon the summer air. We know at some moment the black horsemen will come shattering through the terrace doors wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no one wants to leave while there is still time. So everybody keeps asking--what time is it? But none of the clocks have hands.”  In late 2006 my boss taped to the wall above his desk. In an act of part-mockery, part-admiration, we found a clock with the company logo on it, broke off the hands, and nailed it to the wall above his terminal. Both the quote and the clock sat in that same place in 2008 when colleagues were literally stopping at the bank on their way home to withdraw cash in case it wouldn’t be open the next day.Right, so “The Great Unwind”. This chart caught my eye in the financial paper of record earlier this week:  I would have lost a nickel on this one--I was a little shocked that the ratio of the change in central bank assets to GDP was at the highest levels of the decade early this year...and is only just not starting to come down. But look at the slope of that line...steep. We all remember back in 2012 when the Fed was ready to sound the all clear….only to see the growth and inflation go down the chute again in 2013. Perhaps the steep negative slope of monetary accomidation and the wheezing of the global economy weren’t uncorrelated events..but it is also self-evident that correlatin was not forecasted by the monetary authorities in charge of the printing press at the time.So while it is boiler plate Fed-speak, it came as a mild surprise to hear the Atlanta Fed Governor Rafael Bostic say this yesterday in a speech on the subject of balance sheet “normalization”: “On balance, the limited market reaction to the rollout of the Fed's new balance-sheet policy leads me to conclude that financial market participants do not view it as a significant tightening of conditions or a hindrance to economic growth….I don't expect financial market conditions to be significantly affected in the coming months by balance-sheet reductions.”  There’s so much wrong with that statement I don’t really know how to approach it. In the interest of journalistic integrity, let's stick to the facts.  Or failing any facts, let’s stick to what the Fed has told us already about the impact of QE on long-term rates. Back in April, a gang of economic pirates at the Federal Reserve said, “Avast, ye scurvy dogs, ye olde term premium rests at the bottom of the sea in Davy Jones’ Locker, 100 basis points below the point where Captain Ben skewered the hull of the wee ships sailed by risk-averse landlubbers.”  Ok, maybe not just like that, they were economics PhDs...but they did highlight how balance sheet normalization will cause an unwind of their estimated 100bps in compressed term premium wrought by the Fed’s QE programs, which doesn’t even count knock-on impact from the ECB, BoJ, and BoE asset purchase programs that may or may not be wound down over the same period of time. I think the steam in the economy and increased supply effect from balance sheet normalization will eventually steepen the curve--right now the market has voted in favor of a repeat of 2013, where tighter conditions will lead to a slowdown in growth that will force a reversal to more accommodation.The same economic wonks (the nerds, not the governors) at the Federal Reserve are forecasting a  fed funds path that looks like this...The Fed governors decided to split the difference with those forecasts and those of the market in the September SEP.  Given the growth and wages data I noted earlier this week, and some good reasons to believe that inflation is being sandbagged by some one-off effects, I think there is good reason to price in a path close to the “dots”...say nothing of the nerds’ “dots”! So yeah, I can hear Al Edwards laughing already….ice age, I get it…but his latest piece did mention that a more hawkish Fed led by Warsh would be his choice to try and defuse this credit driven time bomb. I still believe as my old boss did...you can’t defuse it...people won’t leave the party until the black horsemen crash through the window, slash the throats of the guests, and pillage the house.But maybe, just maybe….a steeper curve would convince a few party-goers to call it a night.

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09 октября, 07:38

AWE Wages Picture is Worse Than It Looks; Why Is The Curve Still So Flat?

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“Down Goes Frazier! Down Goes Frazier! Down Goes Frazier!” --Howard CosellI used to have a colleague that would giddily exclaim, “Down Goes Frazier!” anytime he was short a bond that flashed, “HIT” on the broker screens. Since he was pretty good at his job, it became so ubiquitous on the desk that it was easy to forget where it originated.  Those of us that grew up in the 90s remember George Foreman as a lovable middle aged man that made a living beating up mediocre boxers and selling indoor grilling equipment. But in the 70s, he was a total badass. Foreman pummelled the champ into virtual submission, knocking him down six times before the ref stopped the fight midway through the second round.   So that was the phrase that went through my head when I saw that negative NFP print. The unthinkable has come true….A seven year streak of positive prints is over. An awful number, even looking through the noise from the hurricane? Not by a long shot. UE continued lower, indicating there was no easing of labor market conditions. More importantly, average hourly earnings grew faster than expected, and continued a trend higher that has been intact since early this year.I’m always a little suspect of YoY numbers since they are by definition dependent on what happened a year ago--a look at annualized AHE over the last three months, seasonally adjusted paints a rather surprising picture: .Pretty clear picture there. Three periods of recent history--2010 to 2015, when wages bumbled around 2%....2015 to early 2017, when they bounced around 2.5%. Now one could reasonably infer wages are set to find a new range at or above 3%. And yes, the Fed has hiked interest rates, and has the torpedoes armed and ready to deploy in December. Yet the curve remains amazingly flat--no doubt in part because of this year’s low headline inflation prints implying we may be near the end of the economic cycle. But with the recent prints in payrolls/wages and some good arguments for why headline CPI is understating financial conditions, seems like 2/5s should be a little closer to the steeps than the flats, when there is little evidence the Fed is going to waterboard the economic recovery with an aggressive hiking cycle.And we all know what USD has done this year--until the past few weeks anyway. Why does the curve refuse to steepen?  This chart is from Kashkari’s diatribe last week. The FOMC’s most dovish voice says, “I believe the most likely causes of persistently low inflation are additional domestic labor market slack and falling inflation expectations…..I will argue that the FOMC’s policy to remove monetary accommodation over the past few years is likely an important factor driving inflation expectations lower.”I think the above evidence takes an ax to the first leg of Kashkari’s labor market argument. And the second? The clear implication is that the combination of tapering asset purchases, hiking rates, and eliminating SOMA re-investments (that is, reducing the balance sheet) has over-tightened monetary conditions.  I think Kashkari has misidentified the source of lower inflation expectations. Market-implied inflation expectations fall by definition when there are buyers of nominal rate bonds relative to inflation linkers.  Without kicking the hornet’s nest of term premium arguments, the NY Fed’s ACM term premium model shows a steady if unspectacular increase in short-term forward rates with the term premium still solidly in negative territory.  Source: New York FedThe bottom line is that there is a ton of demand for assets relative to the marginal propensity to consume. Global investors want to buy more long-duration assets relative to the quantity being issued by either the government, or corporate borrowers, forcing down future returns.  That doesn't foreshadow lower inflation. It illustrates easy financial conditions.That demand for assets extends not only to foreign corporations and individuals, but also to central banks. Remember a year ago when smart people we saying there was a floor below which the PBOC’s foreign reserves could not sustainably fall? If it ever existed, it is nearly $100 billion in the rear-view mirror now. And the Chinese aren’t the only ones--the US current account deficit combined with resurgent manufacturing demand has put foreign central banks into overdrive to limit the appreciation of their domestic currencies. Foreign central banks have purchased roughly $200 billion of treasuries this year.One might think that reflected a global interest in buying US Treasuries--but foreign private investors have added a modest $24 billion this year. Any chance that money is going into spread product??? Which brings us nicely back to this: The Economist gives us about one of these per year. It just shouts out “contrary indicator”. Twitter practically had kittens. Take the time to read through the article, it’s actually pretty good. They go through a number of arguments for how we got here and what might happen next. Only one did I find rather dubious--the suggestion that we are near the endgame because there are more people in developed markets starting to retire, and as they burn off assets real interest rates will be forced to rise. That ignores billions of people in emerging markets. Not only are they in a better demographic situation--they are living longer as their standard of living increases. A recent paper by the San Francisco Fed shows that it is actually life expectancy rather than demographics that has driven real rates lower over the past thirty years.That means as people in EM countries increase their living standards, they are not only making more money, they are hoarding more of it in anticipation of living a long and fruitful life, which pushes global real interest rates lower. More on this subject later this week. We can parse this market in practically any way we like--bemoaning the lust for cov-lite, sub-investment grade bonds,  Argentine bonds with comically long times to maturity,  levered short vol positions, or private equity, but at the end of the day there is a ton of money chasing assets, and not enough scary stuff happening in the world to convince them to change course. History tells us these trends don’t end well. But we don’t know when the music stops. The Fed doesn’t want to be the villain that breaks the market--but there’s a ton of evidence I’ve noted here that argue financial conditions are too loose, and even by its own measures, core inflation isn’t telling the whole story.  I just can’t get away from the memory of 2004-2006, when the fed hiked 25bps every meeting for three years and still armed the greatest financial weapon of mass destruction history has ever seen.To the Fed Governors...I know you guys love your jobs but look at your own numbers...to borrow from Reagan…”Doctor Yellen, Steepen this Curve!”

05 октября, 23:51

So What's The Trade, Ponch? Steepeners, Mi Amigo

Ponch...if we get there in time, we can put that hawkish central banker behind bars once and for all!So what's next for Mex rates? Can Ponch use his street smarts to subdue inflation, jail the hawkish central bankers and bring joy to the hedge fund world? Indeed, the next move for Banxico is a cut.  As discussed yesterday, there is probabilistic path for rate cut, with 50bps gradually priced by the end of 2018. 100bps is in the cards in 1H2018, but it won’t take much to convince the central bank to hold off or slow-play rate cuts to see how the election pans out.To complicate matters further, we don’t even know who will be running the central bank in 2018 (on either side of the border). The two leading candidates are Alejandro Díaz de León, who is currently on Banxico’s board of governors, and José Antonio Meade, the current finance minister. Both are eminently qualified--one could argue Meade is the more dovish of the two, but he may wind up running for president under the PRI banner.If Diaz de León is the choice, plenty of influence will be held by Manuel Ramos Francia, Banxico’s current vice-chairman and Mexico’s answer to Stanley Fischer. Ramos Francia places a high premium on financial stability, and together with Carstens can be credited with implementing a number of measures to backstop the Mexican currency and financial system over the past ten years--up to and including the aggressive hiking cycle that took rates 400bps higher since early 2016. That could keep rates higher for longer, especially if the Fed is still hiking in 2018.Lastly there’s NAFTA. I don’t have anything to add here. I still see little evidence Trump is going to blow up the system--if he were going to do it, he would have done so already. But this time bomb will only be defused by an agreement--one that doesn’t look on the horizon...and the Mexican election clock is ticking.Which segues nicely into the biggest risk in the market: Victory in next July’s presidential election for Andrés Manuel López Obrador, a leftist candidate that is a weird combination of Donald Trump, Lula and Jeremy Corbyn. AMLO has a small lead in a race that will be splintered between four candidates.The trouble is...I think he’s going to win. Sure, he could step on a political landmine as he has in past elections, but the recent global record of populist candidates versus either establishment or technocratic candidates is not good at all...Macron might be an exception, but even he was an outsider running against the establishment.  Mexico has all the ingredients for a populist/nationalist victory: a charismatic candidate, an external bully, a stagnant economy, a system rife with corruption, and a long history of poverty, inequality, and large segments of the population that feel “left behind”In 2006, Mexico had a long string of strong growth resulting from high oil prices and strong manufacturing demand. Felipe Calderon ran a technocratic “don’t mess this up” campaign, and still only beat AMLO by a whisker (and some think that is overstated by two whiskers). Today, from a political perspective (corruption, crime, education, etc.), pretty much everything Mexico had going for it in 2006 is worse. And AMLO is still here and ready to “drain the swamp”. How will the fractured establishment compete with that?       The market is underpricing the potential for inflation to come down...yet also underpricing AMLO risk. That points to good value in steepeners.2x10 TIIE is still really flat--and while that may be true of virtually any curve in the world, there aren’t many curves where one can make a convincing case for significant rate cuts in the next 1-2 years.  The flat curve is also a function of EM local flows at large--a portion of which can and will hit the exits if and when AMLO extends his lead in the polls. 2x10s is currently at 9bps--three months from now 40bps is much more likely than an inverted curve. In a directional or long-only book it is tough to ignore the risk-reward in buying the front end. At roughly 7.10 in 2y tiie vs. the 28d fixing at 7.36, you’re staking 20bps to make 50-60bps if Banxico cuts 100bps by mid-2018. Yet I can’t help but think there will be a better chance to build a structural position as the election campaign gets into full swing, which also allows you time to let some of that negative carry/roll burn off.  A decent compromise would be to receive in front of potentially positive hard data, while keeping dry powder on had to add on spikes driven by politics or USD strength.There you have it...Stay safe out there!

05 октября, 07:06

Inflation Is On Holiday in Mexico...But Set for a Big Hangover

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I loved watching the Six Million Dollar Man when I was a kid. On the playground we would make that cool sound he made when he ran really fast or lifted a truck off the chest of a helpless victim. We can rebuild him….We have the technology….the budget is limitless….six million dollars. Indeed, inflation is a thief in the night. Six million dollars certainly doesn’t go as far as it used to...and even less so in Mexico, where inflation is running well over 6%. Yet there is light at the end of the tunnel. The front end tightened 30bps early this summer when Banxico went on hold (gratuitous self-promo plug here, and here), which coincided with a most joyous period of EM enthusiasm--MXN strengthened about 8% from May to late June, which gave traders the ammo to price in cuts in the overnight rate. Since then, vol died and both MXN and front end rates have been largely range bound.  The market has agreed on a probabilistic path for the overnight rate--gradually lower rates consistent with the belief that Banxico will cut modestly sometime in 2018. Given risks around the election, this can be summarized as a roughly 50/50 chance of cutting 100bps or staying on hold. But inflation is 6.66%, higher than most people expected earlier this year (myself included). Year end expectations are still stuck at 6.3%.Yet several factors are foreshadowing a steep decrease in inflation in the coming months: #1: PPI is a leading indicator for lower headline CPI. PPI saw a dramatic increase earlier this year that was primarily driven by increases in energy prices and the depreciation of the currency in 2016 and early 2017. Those factors are mean reverting and will likely seep into consumer prices in the coming months. 2) Trimmed mean CPI is already falling from unspectacular levels, and the gap between the core/trimmed mean indices and headline has gotten even wider after the gasoline price hike in January.. Another positive leading indicator for headline CPI. 3) The recent price hikes in non-core products have not pressured wages higher.   These charts show the negotiated wage hikes (left) in the private, public sectors and overall (the red, blue, and green lines, respectively), and the average salary hikes in the formal sector (right). In each case, there is little to suggest there is any second round impact on wages due to high inflation, and real wages are well into negative territory.  Indeed, unit labor costs have been falling as well (although not as fast as they have in the past)4) There is still a negative output gap--while Banxico’s forecasts are more optimistic than they were earlier this year, there is still no positive slope that would portend demand driven inflation pressure.. Negative real wages, a sluggish economy, and a negative output gap gives the central bank scope to cut rates--if inflation allows. Banxico is more optimistic than the market--and their previous forecast-- about inflation falling quickly next year. 5) Product level analysis shows no evidence of second round effects--in fact, underlying inflation may be overstated at current levels. This is the YoY change in inflation and attribution of underlying sub-indices. Even a cursory look will show the brutal jump in perishable fruit/vegetable and energy prices. These two factors alone, which comprise only 12% of the index, contributed 30% of the increase in headline inflation. The top 20 products ranked by their incidence in the index over the last year shows just how large the impact is from one-off moves (gasoline, bus fares, “collective”, which is the subway) and crop-failure style food price hikes (tomatoes, potatoes, onions). Meanwhile, components that would indicate a frothy financial system like shelter (“own home”, in the literal Spanish translation) and rent are well below the 3% midpoint of the inflation target.6) Merchandise inflation is high--but driven by imported goods...and MXN fuerte!! Yet another component stands out in the data--non-food merchandise has moved up significantly as well despite the low underlying wage and growth data. Just as important, drilling into the data from Jan-Aug 2017 (thus, after the gasoline price hike) shows these prices have been sticky, moving up at an annualized rate of 5.6%. Is this evidence of second round effects? I continue to believe the answer is no--product level analysis argues this is being driven by the lagged impact of the depreciation of the peso. This is the ten highest contributors to non-food merchandise inflation in the Jan-Aug 2017 period: What do these products have in common? They are mostly imported goods. Given the rally back in the peso in the first half of this year, and the stability/low vol more recently, price increases in this group are set to mean revert and will likely settle in around 2-3%, which could lead to a 40-60bps negative contribution to the headline index. 7) Services inflation is high--but driven by food inflationServices inflation hasn’t blown out either, ending August at 3.7%. In fact it never cracked 4%--another indication that underlying inflation pressures are subdued. Services inflation has indeed increased, but it is coming off a low base.If we take a look at the top contributors to services inflation, a couple of things stand out. If we ignore the dreaded haircut inflation, the two big factors were are “taquerias” and restaurants, where prices have gone up over 6% and have contributed nearly 50bps to the headline number. What to take a crack at why restaurant prices have been going up? These are the 5 products with the highest YoY price increases: At risk of perpetuating a cultural stereotype, they use a lot of this stuff in Mexican restaurants... Mexico is in the midst of a Guacamole Crisis! If I were AMLO, I’d use that squeeze on small business owners to whack PRI like a….ah, I better not. And restaurant owners got no help from beef and chicken prices, which were up 5% and 10% respectively. The secondary impact of headline inflation is being felt in very transitory, competitive sectors--and underlying inflation is practically non-existent. These price increases are going to roll off, and competitive retailers  amidst tepid domestic demand will lower prices. These micro factors will combine with high interest rates, fiscal tightening and a stable peso bring further confidence in the credibility of the inflation regime. Putting all those factors together, inflation can fall below 4% in Q1 2018, well before what is currently built into sell side inflation surveys.Stay tuned for what is all means in part two tomorrow...along with a sweet CHiPs reference.