Wednesday, December 29, 2010
Tuesday, December 28, 2010
A peek at Outlook 2011
2010 has been an year of turbulence and 2011 is no different. Main themes of 2011 are
Equity markets: 10% rising S&P 500 market
US 10y rates: Rising rates to higher levels but not far from 2010 closing levels
Gold: Gold might see a cap to its further rising
EUR: Euro will be embroiled in core vs peripheral debate
Now my favorite part, volatility markets. Underlying economy is still recovering and turbulent events are anticipated in Europe and China. From this perspective volatility will be slightly higher.
US housing: Forclosures are still happening, Housing starts and new home sales are indicating double dip ahead. Persistent unemployment and dimming of prospects for brighter future is sapping confidence from people. This is not allowing the prices to rise.
EM: Emerging markets are currently battling with inflation, Hot money flows. Inflation rise in emerging markets needs to be treated on a per country basis. Because, Inflation arises due to various factors, structural problems (institutional), overheating of economies due to unbridiled growth. Ofcourse, most of the policy makers are very much aware of the outright misery caused by Hot money inflows. They are acting on these aspects very well. Brazil has increased IOF tax to 6 percent. This means higher rates, probably lower equity markets and Stronger currencies.
Gold: Today Gold has achieved the highest currency status driven by fear of falling dollar. But this has created newer problems in demand side. People from India are slowly staying away from this highly expensive commodity.this structural factor can break the back of Gold price rise.Another factor that can play into this is awareness among investors. 2010 has been an year when investors were scarred by QE and Euro crisis. Most importantly this reminds me of one thing, In India, in remote villages illiterate people are fooled by quack saints. These impostors take money to pray to rain gods to bring rain into their fields and bring them prosperity. Similarly, in highly educated western world, i see economic bloggers (some impostors) fool the ordinary investors into various investments by telling ghostly stories based on their half knowledge. I strongly beleive this is one of the drivers of the Gold speculation. 2011, gold might see 1500 but might not stay there for long. Gold option trading will be a promising area.
OiL: OPEC controls the spigots of global oil supply. As long as no geo political shocks due to some terrorism related activity, EM countries should be driving the rise of oil prices.
I am going to write more and more on the macro factors and expressing my trading strategies.
Equity markets: 10% rising S&P 500 market
US 10y rates: Rising rates to higher levels but not far from 2010 closing levels
Gold: Gold might see a cap to its further rising
EUR: Euro will be embroiled in core vs peripheral debate
Now my favorite part, volatility markets. Underlying economy is still recovering and turbulent events are anticipated in Europe and China. From this perspective volatility will be slightly higher.
US housing: Forclosures are still happening, Housing starts and new home sales are indicating double dip ahead. Persistent unemployment and dimming of prospects for brighter future is sapping confidence from people. This is not allowing the prices to rise.
EM: Emerging markets are currently battling with inflation, Hot money flows. Inflation rise in emerging markets needs to be treated on a per country basis. Because, Inflation arises due to various factors, structural problems (institutional), overheating of economies due to unbridiled growth. Ofcourse, most of the policy makers are very much aware of the outright misery caused by Hot money inflows. They are acting on these aspects very well. Brazil has increased IOF tax to 6 percent. This means higher rates, probably lower equity markets and Stronger currencies.
Gold: Today Gold has achieved the highest currency status driven by fear of falling dollar. But this has created newer problems in demand side. People from India are slowly staying away from this highly expensive commodity.this structural factor can break the back of Gold price rise.Another factor that can play into this is awareness among investors. 2010 has been an year when investors were scarred by QE and Euro crisis. Most importantly this reminds me of one thing, In India, in remote villages illiterate people are fooled by quack saints. These impostors take money to pray to rain gods to bring rain into their fields and bring them prosperity. Similarly, in highly educated western world, i see economic bloggers (some impostors) fool the ordinary investors into various investments by telling ghostly stories based on their half knowledge. I strongly beleive this is one of the drivers of the Gold speculation. 2011, gold might see 1500 but might not stay there for long. Gold option trading will be a promising area.
OiL: OPEC controls the spigots of global oil supply. As long as no geo political shocks due to some terrorism related activity, EM countries should be driving the rise of oil prices.
I am going to write more and more on the macro factors and expressing my trading strategies.
Monday, December 27, 2010
USD swaption skew
Skew in 2010
2010 year dollar fixed income markets weathered various events ranging from hopes in recovery of housing market, Euro currency crisis, Federal reserve’s unconventional methods to handle the crisis of 2008 and geo political events. USD yield curve responds to these events accordingly and rises up when inflation talk takes precedence and falls when safe haven mentality seeps in. Changes in swaption skew reflect these scenarios.
Spot Yield curve is broken down into short dated, 2y, intermediate 5y, medium term long dated 10y and long dated 30y.
Skew is broken down into structures trading 1y and less as short dated, more than 1y and less than 5y medium term and 5y and beyond is long dated.
Players in swaption markets trade options on interest rate swaps to express views on swap rates. In this market Payer swaption and Receiver swaption are akin to call and put on Libor interest rates. Treasury yield curve along with swap spreads will represent the Swap curve on which options are traded. Implied volatility is a measure of dispersion of swap rates at some point in future. High Implied volatility suggests higher dispersion and higher cost of options. Swaption market volatility is depicted more aptly by Normalized volatility. Forward rate times Log normal implied volatility is equal to Normalized volatility.
Normal Volatility = Forward Rate X Log Implied Volatility
Rising Normalized volatility suggests bid for volatility and converse is true for falling normalized volatility.
Interest rates are correlated to Normalized vols. This correlation varies from 1 to -1. In general rising rates will have falling Normalized vols and vice versa. This means a positive correlation. But other factors can weigh in to amplify and depress the correlations. For instance normalized vols for 30y tails are at -0.3.
These factors give a framework of measure to estimate the value in an ATM option.
1) Correlation with rates
2) Volatility ranking
3) Volatility Roll down
4) Carry
5) Implied and realized volatility ratio
6) Implied and realized premium
Skew: Market players attach volatility different from at the money options to Out of the money options. This difference in implied volatility is called skew. Existence of skew is due to demand and supply factors, view of players on the speed of rise and fall in interest rates. Skew dynamics can be abstracted into different kinds of shapes. These shapes are termed as Normal, lognormal, square root, quarter power, super normal and super lognormal skews. These skew shapes are not arbitrary but capture the underlying rates distribution phenomenon.
Log normal skew: level of Interest rates is directly proportional to normalized volatilities. When interest rates are closer to zero, due to zero lower bound rate changes will be lognormal distributed. In this skew, we tend to see, higher normalized volatilities for Out of the money payer swaptions proportional to interest rate level.
Normal skew: level of Interest rates is independent of normalized volatilities. When interest rates are away from zero rate changes will be normal distributed. In this skew, we tend to see, higher flat to similar normalized volatilities for Out of the money payer swaptions and at the money options.
Interest rates move up and down so do normalized volatilities. Swaption skew moves can be traced to moves from one skew level to another skew level. This can be termed as skew migration. Log normal skew can become super lognormal skew that is normalized vols rise fast as interest rates are rising. Similarly, skew can lower to Square root and quarter power. In these two regimes, Normalized volatilities don’t rise as fast as they rise in lognormal regime. After quarter power regime we can think of normal skew level where normalized vols are independent of rate moves. Finally beyond normal skew regime we can think of normalized vols falling when rates are rising.
Spot and forward yield curves tell us about what market is thinking today with current set of information. Volatility players take one step further by trying to guess the range of the yield curve moves with current set of information. This guessing game involves attaching equal probabilities to various rate changes. But reality is far different from ideal state. Some players think rates will go up, others think go down and another group think rates will remain range bound. Markets do what they want and winners and losers are declared accordingly. Due to this kind of market environment, its not accurate to attach equal probabilities when thinking of range of outcomes centered away from the forward curve. Systematic way of attaching higher and lower probabilities to distributions centered on rates other than forward curve is called skew.
Skew arising due to change in market sentiment towards rise or fall of rates can be captured by risk reversal transactions. Risk reversal is defined as buying and selling OTM call and put with same moneyness. For instance, buy ATM + 25 call and sell ATM - 25 put will translate to buying a risk reversal. This strategy is employed to sell rich put skew and buy cheaper call skew and position for rise in rates. This risk reversal price can be compared against price for a normal, log normal skew to identify traded skew.
Skew also arises due to demand and supply in the markets. This factor can be traced by comparing current skew level to historical skew and rate moves and sentiment in the market. Normally flow traders are privy to this kind of information but in no time this information will become public.
Another factor that plays into skew development is when rates move up and down without any particular direction. In other words if high realized volatility persists out of the money option should have higher value than what they normally have. This price can be captured by Butterfly quotes or straddle and strangle swaps. Straddle provides market level for ATM volatility. Strangle will provide indication of Out of the money options. These two quotes combined provide value of the skew for out of the money options.
Demand & supply, Risk reversals and Butterfly quotes together measure the shape of the skew. Indirectly describing how investors expect the volatility to rise. This view is captured by normalized volatility thus resulting in various skew shapes.
SABR Model interpretation of swaption skew.
Skew can be analyzed using SABR model. For detailed discussion of SABR model I will refer to a presentation I put together. SABR model has Rho and nu parameters to capture the Smile and skew of the swaption skews. I looked at NU and Rho parameter for 10y tails from Totem monthly data. Interestingly Vol of vol remained very stable. Month over month yield curve changes had minute effect across most of the maturities. This suggests very low levels of realized volatility in the market. Rho parameter showed changes by becoming positive when rates are rising and negative in falling yield curve scenario. This doesn’t give any predictability to market vols direction but describes the dynamics reasonably.
Short dated skew for 10y tails for different option expiries, 1m, 3m, 6m and 1y expiries manifest skew that is Lognormal to less log normal. As of November month end skew levels are more lognormal.
Does understanding of these skew shapes give us any understanding of how to trade swaptions markets? I think it does. When we clearly understand what has happened we can predict the future outcome with a reasonable confidence. This requires proper description of past and current states and future expected states of market levels.
Short dated skew
1y 10y, 1y 5y, 1y 2y
1y 10y
In January, 10y Rates at 3.74 and 2s 10s at 261 bps. By end of November, 10y swaps are trading at 2.95. 2s10s at 220 bps.
As Spread between 2s 10s widens spread between spot and forward rate increases.
ATM straddles were trading at 830 bps. From here market premium has fallen down to 742 bps by end of November.
Normal vols have fallen down from 126 to 108.
Skew shape remained more or less log normal. 200 low receivers are trading at 56 and 200 high payers are trading at 175 normal vols.
1y 5y
In January, 5y Rates at 2.66 and 2s 10s at 261 bps. By end of November, 5y swaps are trading at 1.74. 2s10s at 220 bps.
ATM straddles were trading at 471 bps. From here market premium has fallen down to 392 bps by end of November.
Normal vols have fallen down from 129 to 104.
Skew shape remained more or less log normal. 200 low receivers are trading at 47 and 200 high payers are trading at 197 normal vols.
1y 30y
In January, 30y Rates at 4.41 and 2s 10s at 261 bps. By end of November, 30y swaps are trading at 3.81 2s10s at 220 bps.
ATM straddles were trading at 1448 bps. From here market premium has fallen down to 1429 bps by end of November.
Normal vols have fallen down from 111 to 101.
Skew shape remained less log normal and more square root. 200 low receivers are trading at 70 and 200 high payers are trading at 142 normal vols.
2010 year dollar fixed income markets weathered various events ranging from hopes in recovery of housing market, Euro currency crisis, Federal reserve’s unconventional methods to handle the crisis of 2008 and geo political events. USD yield curve responds to these events accordingly and rises up when inflation talk takes precedence and falls when safe haven mentality seeps in. Changes in swaption skew reflect these scenarios.
Spot Yield curve is broken down into short dated, 2y, intermediate 5y, medium term long dated 10y and long dated 30y.
Skew is broken down into structures trading 1y and less as short dated, more than 1y and less than 5y medium term and 5y and beyond is long dated.
Players in swaption markets trade options on interest rate swaps to express views on swap rates. In this market Payer swaption and Receiver swaption are akin to call and put on Libor interest rates. Treasury yield curve along with swap spreads will represent the Swap curve on which options are traded. Implied volatility is a measure of dispersion of swap rates at some point in future. High Implied volatility suggests higher dispersion and higher cost of options. Swaption market volatility is depicted more aptly by Normalized volatility. Forward rate times Log normal implied volatility is equal to Normalized volatility.
Normal Volatility = Forward Rate X Log Implied Volatility
Rising Normalized volatility suggests bid for volatility and converse is true for falling normalized volatility.
Interest rates are correlated to Normalized vols. This correlation varies from 1 to -1. In general rising rates will have falling Normalized vols and vice versa. This means a positive correlation. But other factors can weigh in to amplify and depress the correlations. For instance normalized vols for 30y tails are at -0.3.
These factors give a framework of measure to estimate the value in an ATM option.
1) Correlation with rates
2) Volatility ranking
3) Volatility Roll down
4) Carry
5) Implied and realized volatility ratio
6) Implied and realized premium
Skew: Market players attach volatility different from at the money options to Out of the money options. This difference in implied volatility is called skew. Existence of skew is due to demand and supply factors, view of players on the speed of rise and fall in interest rates. Skew dynamics can be abstracted into different kinds of shapes. These shapes are termed as Normal, lognormal, square root, quarter power, super normal and super lognormal skews. These skew shapes are not arbitrary but capture the underlying rates distribution phenomenon.
Log normal skew: level of Interest rates is directly proportional to normalized volatilities. When interest rates are closer to zero, due to zero lower bound rate changes will be lognormal distributed. In this skew, we tend to see, higher normalized volatilities for Out of the money payer swaptions proportional to interest rate level.
Normal skew: level of Interest rates is independent of normalized volatilities. When interest rates are away from zero rate changes will be normal distributed. In this skew, we tend to see, higher flat to similar normalized volatilities for Out of the money payer swaptions and at the money options.
Interest rates move up and down so do normalized volatilities. Swaption skew moves can be traced to moves from one skew level to another skew level. This can be termed as skew migration. Log normal skew can become super lognormal skew that is normalized vols rise fast as interest rates are rising. Similarly, skew can lower to Square root and quarter power. In these two regimes, Normalized volatilities don’t rise as fast as they rise in lognormal regime. After quarter power regime we can think of normal skew level where normalized vols are independent of rate moves. Finally beyond normal skew regime we can think of normalized vols falling when rates are rising.
Spot and forward yield curves tell us about what market is thinking today with current set of information. Volatility players take one step further by trying to guess the range of the yield curve moves with current set of information. This guessing game involves attaching equal probabilities to various rate changes. But reality is far different from ideal state. Some players think rates will go up, others think go down and another group think rates will remain range bound. Markets do what they want and winners and losers are declared accordingly. Due to this kind of market environment, its not accurate to attach equal probabilities when thinking of range of outcomes centered away from the forward curve. Systematic way of attaching higher and lower probabilities to distributions centered on rates other than forward curve is called skew.
Skew arising due to change in market sentiment towards rise or fall of rates can be captured by risk reversal transactions. Risk reversal is defined as buying and selling OTM call and put with same moneyness. For instance, buy ATM + 25 call and sell ATM - 25 put will translate to buying a risk reversal. This strategy is employed to sell rich put skew and buy cheaper call skew and position for rise in rates. This risk reversal price can be compared against price for a normal, log normal skew to identify traded skew.
Skew also arises due to demand and supply in the markets. This factor can be traced by comparing current skew level to historical skew and rate moves and sentiment in the market. Normally flow traders are privy to this kind of information but in no time this information will become public.
Another factor that plays into skew development is when rates move up and down without any particular direction. In other words if high realized volatility persists out of the money option should have higher value than what they normally have. This price can be captured by Butterfly quotes or straddle and strangle swaps. Straddle provides market level for ATM volatility. Strangle will provide indication of Out of the money options. These two quotes combined provide value of the skew for out of the money options.
Demand & supply, Risk reversals and Butterfly quotes together measure the shape of the skew. Indirectly describing how investors expect the volatility to rise. This view is captured by normalized volatility thus resulting in various skew shapes.
SABR Model interpretation of swaption skew.
Skew can be analyzed using SABR model. For detailed discussion of SABR model I will refer to a presentation I put together. SABR model has Rho and nu parameters to capture the Smile and skew of the swaption skews. I looked at NU and Rho parameter for 10y tails from Totem monthly data. Interestingly Vol of vol remained very stable. Month over month yield curve changes had minute effect across most of the maturities. This suggests very low levels of realized volatility in the market. Rho parameter showed changes by becoming positive when rates are rising and negative in falling yield curve scenario. This doesn’t give any predictability to market vols direction but describes the dynamics reasonably.
Short dated skew for 10y tails for different option expiries, 1m, 3m, 6m and 1y expiries manifest skew that is Lognormal to less log normal. As of November month end skew levels are more lognormal.
Does understanding of these skew shapes give us any understanding of how to trade swaptions markets? I think it does. When we clearly understand what has happened we can predict the future outcome with a reasonable confidence. This requires proper description of past and current states and future expected states of market levels.
Short dated skew
1y 10y, 1y 5y, 1y 2y
1y 10y
In January, 10y Rates at 3.74 and 2s 10s at 261 bps. By end of November, 10y swaps are trading at 2.95. 2s10s at 220 bps.
As Spread between 2s 10s widens spread between spot and forward rate increases.
ATM straddles were trading at 830 bps. From here market premium has fallen down to 742 bps by end of November.
Normal vols have fallen down from 126 to 108.
Skew shape remained more or less log normal. 200 low receivers are trading at 56 and 200 high payers are trading at 175 normal vols.
1y 5y
In January, 5y Rates at 2.66 and 2s 10s at 261 bps. By end of November, 5y swaps are trading at 1.74. 2s10s at 220 bps.
ATM straddles were trading at 471 bps. From here market premium has fallen down to 392 bps by end of November.
Normal vols have fallen down from 129 to 104.
Skew shape remained more or less log normal. 200 low receivers are trading at 47 and 200 high payers are trading at 197 normal vols.
1y 30y
In January, 30y Rates at 4.41 and 2s 10s at 261 bps. By end of November, 30y swaps are trading at 3.81 2s10s at 220 bps.
ATM straddles were trading at 1448 bps. From here market premium has fallen down to 1429 bps by end of November.
Normal vols have fallen down from 111 to 101.
Skew shape remained less log normal and more square root. 200 low receivers are trading at 70 and 200 high payers are trading at 142 normal vols.
Yield curve movements-2010
I was doing some research to record the movements in the yield curve in 2010. Therefore i have put together a yield curve graph as of january, june and november month ends. 2010 has witnessed many events. Mainly pertaining to US recovery, Euro core vs peripherals and china and other emerging markets displaying signs of vigorous growth. Of all most important is rise of Gold prices to historical highs. Each of these events played into the changes in the shape of yield curve. Weaker US recovery has been bullish to treasury yields, similarly intensification of Euro crisis led to a safe haven bid. These two factors played into the fall of yield curve. But as we came close to year end, there is a shift in sentiment of the market players. Yields started rising swiftly. does it mean people are buying into stronger recovery. What has triggered this change. US fiscal deficit widens but the extension of tax cuts is getting greater attention as economists are thinking GDP growth will be boosted by a percentage point.
My prediction for yield curve movements is hinged on same above factors. Weaker US recovery means lower rates. I attach less probability to this so rates have to go higher. Euro will not break up in 2011. We all should remember one thing. Euro project came to genesis from the ashes of second world war. Europe has been under constant conflagaration through out this millenium. Last 50 years were peaceful years for this continent. Its not that easy to give up this peace. Germany will become stronger by helping the peripheral countries. So any Euro related safe haven bid should be treated as an opportunity to position for higher rates. Another factor that can play into this is how Emerging markets manage their economies. if any crisis erupts here, this will throw a spanner into rates from rising. I forgot two of the main players, Fed QEII and housing recovery. I beleive housing recovery is going to be anemic and slow and will have influence to impede rates fall to rise of rates. Fed QEII will be there as a trump card that can tip all the possibilities in its favor.
Net i beleive we will see higher rates next year compared to 2010.
My prediction for yield curve movements is hinged on same above factors. Weaker US recovery means lower rates. I attach less probability to this so rates have to go higher. Euro will not break up in 2011. We all should remember one thing. Euro project came to genesis from the ashes of second world war. Europe has been under constant conflagaration through out this millenium. Last 50 years were peaceful years for this continent. Its not that easy to give up this peace. Germany will become stronger by helping the peripheral countries. So any Euro related safe haven bid should be treated as an opportunity to position for higher rates. Another factor that can play into this is how Emerging markets manage their economies. if any crisis erupts here, this will throw a spanner into rates from rising. I forgot two of the main players, Fed QEII and housing recovery. I beleive housing recovery is going to be anemic and slow and will have influence to impede rates fall to rise of rates. Fed QEII will be there as a trump card that can tip all the possibilities in its favor.
Net i beleive we will see higher rates next year compared to 2010.
Monday, June 28, 2010
June 28, 2010 market thoughts
Monday june 28th 2010, a very funny start to the markets. FRB Richmond researcher has published an article stating macro economics is too arcane for people without any formal training. He went on to say people with Phd’s are best suited to render their expertise on the formidable area of macroeconomics. His main intention looks like bashing at blogging world that is bringing transparency to the incomprehensible activities of various stake holders ( fed, politicians and market leaders). Bloggers came back with their rebuttals. All these rebuttals are very much fun to read.
Search for fed economist calling stupid bloggers.
Okay now let us talk some money matters. What happened today in the markets? Bonds staged another rally on the concerns of deflation and stringent measures of austerity talk from G20, Euro came down because of concerns related to Spanish banks, equities staged selloff at the behest of depression kind of feeling in the market.
Bonds: 10 year treasuries have closed at 3.02 %. Rates are in the mode of rally for a while. Entire may rates went down due to the concerns related to sovereign contagion. In june this rally got reversed initially but talk of weaker economic reports is pushing the yields lower and lower. There is a possibility of rates going lower further. Right now market sentiment is very very bullish on rates. Last week we have seen very weak housing report. One thing can put a damper into this rally is change in sentiment, this can be in the form of strong economic reports, ISM and unemployment report. Chances are less likely that a stronger report will emerge.
Now, GDP is driven by consumption and there are no signs of improvement in this factor. Financial crisis of 2008 has altered people’s mind sets from borrow and spend to save and save. Economists say this is not good for the economy. This will lead to deflation. Unofficial Unemployment rate is hovering in double digits. In such a scenario, no one wants to spend the money. Housing is ready to fall to the ground once the crutches of tax credit are expired. Market fundamentals are not at all strong. Every indicator is showing signs of weakness. In this scenario, trade of the day would be bearish trade on equities, bullish trade on bonds and a range bound to down ward bias trade in commodities. In this kind of scenario, European economies suffering from the contagion risk of peripheral countries debt problems are posing another first order risk to growth.
Emerging economies are struggling to break the ugly inflation. I think world is getting into more interesting situations.
US cannot improve its consumption by giving money to consumers. It can improve this by few ways
1) Reducing taxes
2) Building a stronger manufacturing economy
3) Reducing the cost of entitlements.
Reduction of taxes has an amplifying effect on the GDP. I think researchers like Christina romer have contributed their fine minds and effort in analyzing this fact. I don’t want to muddle their well received thoughts with my interpretations. On second and third point I would like to offer my thinking. US has started loosing its grip on manufacturing economy due to increased cost pressures. It takes more dollars to build a car in US than in a developing country. So capital went to these low cost areas and hence US became an economy more dependent on services. Demographics are changing every day. Not every human being wants to become a Harvard law graduate. Some like to live a life of mechanic and some want to become a ice cream maker. These kind of people find jobs with small business owners. Main concern for these small business owners is health care costs. If governments tackle this issue deftly (not sure if Obama care can do this) then people in this sector will get to keep their jobs and they will become bearers of consumption and economy will get kick started. I would implore every leader to work towards an amicable solution to entitlement costs to bring the lower end of society to survive and live life. In the post 2008 crisis recovery, people with good education have gotten improvements faster than the low income groups.
Search for fed economist calling stupid bloggers.
Okay now let us talk some money matters. What happened today in the markets? Bonds staged another rally on the concerns of deflation and stringent measures of austerity talk from G20, Euro came down because of concerns related to Spanish banks, equities staged selloff at the behest of depression kind of feeling in the market.
Bonds: 10 year treasuries have closed at 3.02 %. Rates are in the mode of rally for a while. Entire may rates went down due to the concerns related to sovereign contagion. In june this rally got reversed initially but talk of weaker economic reports is pushing the yields lower and lower. There is a possibility of rates going lower further. Right now market sentiment is very very bullish on rates. Last week we have seen very weak housing report. One thing can put a damper into this rally is change in sentiment, this can be in the form of strong economic reports, ISM and unemployment report. Chances are less likely that a stronger report will emerge.
Now, GDP is driven by consumption and there are no signs of improvement in this factor. Financial crisis of 2008 has altered people’s mind sets from borrow and spend to save and save. Economists say this is not good for the economy. This will lead to deflation. Unofficial Unemployment rate is hovering in double digits. In such a scenario, no one wants to spend the money. Housing is ready to fall to the ground once the crutches of tax credit are expired. Market fundamentals are not at all strong. Every indicator is showing signs of weakness. In this scenario, trade of the day would be bearish trade on equities, bullish trade on bonds and a range bound to down ward bias trade in commodities. In this kind of scenario, European economies suffering from the contagion risk of peripheral countries debt problems are posing another first order risk to growth.
Emerging economies are struggling to break the ugly inflation. I think world is getting into more interesting situations.
US cannot improve its consumption by giving money to consumers. It can improve this by few ways
1) Reducing taxes
2) Building a stronger manufacturing economy
3) Reducing the cost of entitlements.
Reduction of taxes has an amplifying effect on the GDP. I think researchers like Christina romer have contributed their fine minds and effort in analyzing this fact. I don’t want to muddle their well received thoughts with my interpretations. On second and third point I would like to offer my thinking. US has started loosing its grip on manufacturing economy due to increased cost pressures. It takes more dollars to build a car in US than in a developing country. So capital went to these low cost areas and hence US became an economy more dependent on services. Demographics are changing every day. Not every human being wants to become a Harvard law graduate. Some like to live a life of mechanic and some want to become a ice cream maker. These kind of people find jobs with small business owners. Main concern for these small business owners is health care costs. If governments tackle this issue deftly (not sure if Obama care can do this) then people in this sector will get to keep their jobs and they will become bearers of consumption and economy will get kick started. I would implore every leader to work towards an amicable solution to entitlement costs to bring the lower end of society to survive and live life. In the post 2008 crisis recovery, people with good education have gotten improvements faster than the low income groups.
Wednesday, June 23, 2010
June 23 2010 Highlights
1) Obama named David Petreaus by ordering down McChrystal as his war General
2) Fed came up with cautious outlook for economy.
3) Rates are to stay low forever
4) Long end rates will grind down lower
5) Swaption Skew changes will be favoring receivers
6) Equities will be looking range bound to lower
7) Oil will be range bound
May month has been sovereign crisis issue for Europe, BP gulf crisis for US and inflation global growth problems for Asia. June has been mostly aggravating Gulf crisis in US and equanimity in Europe and currency appreciation in Asia. Towards the end of month new twist came to this drama in the form of replacement of war general in Afghanistan. I think this is more of a political change rather than a strategic change. This act proves obama is very serious about what he means. Okay now what next, is everything all right? NO. Housing sales came low yesterday. Fed came up with cautious outlook and reading same FOMC statement for last 1 year. What does it mean. I can also read the same stuff every month. Why should fed be given such high respect for their acts? It means Fed is viewing the economy through those old rusty indicator lens. Markets are evolved, we have high frequency trading, exotic derivatives, large public sector deficits, persistently high unemployment and huge health care costs. Cocktail of all this well give a hazy picture of some thing being right all the time . This is sufficient for fed to keep rates low etc. Anyway even fed hikes rate nothing is going to happen bank lending. As they have stopped their sacred money long time ago. This means no inflation. This means long end rates have further room to fall or rise slightly.
Swaption skews for receivers are very rich.
2) Fed came up with cautious outlook for economy.
3) Rates are to stay low forever
4) Long end rates will grind down lower
5) Swaption Skew changes will be favoring receivers
6) Equities will be looking range bound to lower
7) Oil will be range bound
May month has been sovereign crisis issue for Europe, BP gulf crisis for US and inflation global growth problems for Asia. June has been mostly aggravating Gulf crisis in US and equanimity in Europe and currency appreciation in Asia. Towards the end of month new twist came to this drama in the form of replacement of war general in Afghanistan. I think this is more of a political change rather than a strategic change. This act proves obama is very serious about what he means. Okay now what next, is everything all right? NO. Housing sales came low yesterday. Fed came up with cautious outlook and reading same FOMC statement for last 1 year. What does it mean. I can also read the same stuff every month. Why should fed be given such high respect for their acts? It means Fed is viewing the economy through those old rusty indicator lens. Markets are evolved, we have high frequency trading, exotic derivatives, large public sector deficits, persistently high unemployment and huge health care costs. Cocktail of all this well give a hazy picture of some thing being right all the time . This is sufficient for fed to keep rates low etc. Anyway even fed hikes rate nothing is going to happen bank lending. As they have stopped their sacred money long time ago. This means no inflation. This means long end rates have further room to fall or rise slightly.
Swaption skews for receivers are very rich.
Tuesday, June 22, 2010
Will yuan rise imapacts?
China is running huge surplus against developed countries. China became shop floor of the world. This was made possible by increase in entitlement costs and therefore erosion of competitiveness, improvements in communications and transportation technology, hard work of Chinese labor and political planners. Industries in western countries matured and started providing their workers with huge benefits. Cost of these benefits started tipping the balance of value generated from these industries. Corporate leaders judged for creating shareholders wealth had to scour new ways of reducing costs. Improvements in technology in global shipping and internet have allowed companies to move operations to places where cost of production is cheapest. This resulted in drying up of jobs in manufacturing sector (Middle America) and these jobs moved to eastern side of the globe. This resulted in huge trade surplus. There is one important factor that played role in the de-manufacturing of western countries. It is financial engineering. Western economies have created gigantic consumer societies. These consumers access to credit have gone on binge to finance their purchases of appliances, houses, education, cars and everything. This all was made possible by financial alchemy. Western politicians are asking china to allow their currency to rise. I would say reduce the health care and pension costs. This will tilt the balance of economies. This will reduce unemployment and allow harmony to prevail in the society. Even if china allows yuan to rise to 5 RMB to dollar it is not going to solve problems.
Thursday, June 17, 2010
invisible hand-Greece
Economies around world grow, decay and stagnate throughout the time like eco systems. Macro economic theorists and practitioners study why certain economies grow and some ruin. Adam Smith developed his theories on capitalism, Karl Marx devoted his life in explaining destructive forces inbuilt in capitalism, modern day economists like Keynes supported fiscal activism, and Freidman popularized monetarism. Despite these theories standing as shield against severe crisis, we are seeing economic crisis happening repeatedly. Each crisis is succeeded by a new explanation from new wave of economists. My question is can we indentify the factors that are underlying the crisis. My answer is yes. So how can we achieve this? An economy whose growth accompanies with minimum stress prevails and anything else is bound to fail.
In this article, I would like to think about some economies that have risen into stronger economies like US, UK, Japan, Germany, some economies that have fallen from top like soviet bloc, some Latin American countries and some struggle to survive like Pakistan, Zimbabwe and some African nations.
Civilizations have thrived and destroyed in last two millenniums. We have horde of historians describing rise and fall of Roman Empire, Persian Empire, Chinese civilization, Hindu kingdoms, British Empire, Spanish Empire and so on. As Tolstoy mentioned, “all happy families are alike and each unhappy family is unlike in its own way” the story of rise of all empires is same but fall is different in its own way. Every civilization starts small. Depending on the strength of the people from the civilization, it will start growing. This growth is constantly under check from opposing forces. These forces can be like Barbarians for Roman civilization, Muslim invasions in India, Mongols invasion in China etc. In Modern days, we do not see Empires but Countries, no monarchs but elected or self-appointed leaders to govern. These leaders can safely govern their kingdoms without any fear from barbarian invasions. Therefore, some countries in Europe and Japan have preferred to outsource their defense needs. If so what is the balancing force that ensures each country allocate capital and resources efficiently lest it will ensure its ruin. This force I call as Adam Smith’s invisible hand. This invisible hand takes many forms, activist investor who will punish financially mismanaged countries by limiting its access to capital markets, active public activist who will purge system of mismanagement and so on. Invisible hand is absent most of the time, will manifest itself when system attains deep disequilibrium. So how do we know when system has attained disequilibrium? How long system can remain in disequilibrium. Markets can remain in disequilibrium for longer time than we can ever imagine.
Greece: Greece is a Mediterranean country with great history. This country produced historians like Aristotle and leaders like Alexander. In modern days it has joined European union as a member country by subordinating its currency Drachma to Euro. In return, it enjoyed superior access to global capital markets. This wonderful gift made its politicians to become lax towards fiscal policy. Consequently, country became deeply indebted. As world, growth is increasing so Greece fiscal expenditure is increasing. This expenditure did not help towards developing growth rate of the nation. Therefore, invisible hand turned up in the form of active investors and brought the nation to its waking state.
In this article, I would like to think about some economies that have risen into stronger economies like US, UK, Japan, Germany, some economies that have fallen from top like soviet bloc, some Latin American countries and some struggle to survive like Pakistan, Zimbabwe and some African nations.
Civilizations have thrived and destroyed in last two millenniums. We have horde of historians describing rise and fall of Roman Empire, Persian Empire, Chinese civilization, Hindu kingdoms, British Empire, Spanish Empire and so on. As Tolstoy mentioned, “all happy families are alike and each unhappy family is unlike in its own way” the story of rise of all empires is same but fall is different in its own way. Every civilization starts small. Depending on the strength of the people from the civilization, it will start growing. This growth is constantly under check from opposing forces. These forces can be like Barbarians for Roman civilization, Muslim invasions in India, Mongols invasion in China etc. In Modern days, we do not see Empires but Countries, no monarchs but elected or self-appointed leaders to govern. These leaders can safely govern their kingdoms without any fear from barbarian invasions. Therefore, some countries in Europe and Japan have preferred to outsource their defense needs. If so what is the balancing force that ensures each country allocate capital and resources efficiently lest it will ensure its ruin. This force I call as Adam Smith’s invisible hand. This invisible hand takes many forms, activist investor who will punish financially mismanaged countries by limiting its access to capital markets, active public activist who will purge system of mismanagement and so on. Invisible hand is absent most of the time, will manifest itself when system attains deep disequilibrium. So how do we know when system has attained disequilibrium? How long system can remain in disequilibrium. Markets can remain in disequilibrium for longer time than we can ever imagine.
Greece: Greece is a Mediterranean country with great history. This country produced historians like Aristotle and leaders like Alexander. In modern days it has joined European union as a member country by subordinating its currency Drachma to Euro. In return, it enjoyed superior access to global capital markets. This wonderful gift made its politicians to become lax towards fiscal policy. Consequently, country became deeply indebted. As world, growth is increasing so Greece fiscal expenditure is increasing. This expenditure did not help towards developing growth rate of the nation. Therefore, invisible hand turned up in the form of active investors and brought the nation to its waking state.
USD-EU-JPY economies
US recovery drivers are Fiscal stimulus, Exports…. Headwinds will come from stimulus withdrawing.
Most desirable thing here is improvements in housing, employment and foreclosures
EU/ECB sovereign Risk: Greek bailout, stabilization fund are just starters in the fuzzy space of EU zone sovereign risk.
Germany/France banks together have major exposure to PIIGS debt.
Most desirable thing here is transparency and political will to work together.
Emerging Markets
China, India still plagued by property bubble and inflation. Will European slowdown impact export sectors if these roaring tigers.
US recovery happened on the heels of huge doses of monetary and fiscal stimulus. Fed is slowly withdrawing stimulus programs. We are still not out of woods yet, unemployment is stubbornly over 9 %, housing market shows no signs of recovery, and manufacturing is showing a bit of activity.
Will USA and Europe morph into Japan?
I can think of Europe rather than US turning into Japan. Why? Demographics. Europe has a decling trajectory of young population compared to US. Deflation is might take its life but will be smothered by inflation.
EURO Zone Sovereign problems will play out for long time. All politicians expect problems to get resolved on their own. But this is not going to happen. Europe fundamentals are not that sound. Especially, debt laden PIIGS. There will be a decline in the living standards because of austerity measures taken by the peripheral nations. Europe is more vulnerable to deflation due to systematic deleveraging. This will have indirect impact on China and EM nations.
In this kind of macro scenario what kind of action will play out in various asset markets?
Interest rates: Treasury and Bund yields are trading at their lowest levels of 2010 due to sovereign risk and recovery problems. Since April 10y treasuries have fallen almost close to 75 bps. Bond futures traded in CBOT are pricing 124. How low can yields can go from here? I think if Japan stands an example, rates have further room to go down. US debt levels are rising, recovery is not yet on tracks. What can stall yield curve flattening? FED is on perma hold policy. This means short end curve remains very much anchored to low levels. Inflation shows no sign of coming and therefore 10y rates are falling lower. One interesting thing I can see is from option skew markets. Markets are pricing more of falling rates compared to rising rates. What this means to rest of the markets? Housing loan rates will be low but of no use as long as banks are not willing to lend. Then what is the purpose of these low levels. What are treasury investors looking for? I can think of only one thing, central banks are getting richer for their UST holdings and getting more money for strong dollar.
I can think of another 50 bps rally before any sell off to occur.
Yield curves to flatten further instead of steepening
Fundamentals in rates markets, High level of treasury debt and expected US growth are pointing towards bearish view in the market. But sovereign risk is playing dominant role. So markets need to reach a stage where sovereign risk is no longer threat but the unsustainable debt is bigger threat.
In Forex markets, USD will be crowned as king not because of its best traits but better traits when compared to other currencies. Dollar is benefiting from better growth and removal of liquidity measures.
EURO will attain its nirvana by attaining parity to dollar.
JPY might fall further due to increased purchasing of non JPY assets and further QE
Most desirable thing here is improvements in housing, employment and foreclosures
EU/ECB sovereign Risk: Greek bailout, stabilization fund are just starters in the fuzzy space of EU zone sovereign risk.
Germany/France banks together have major exposure to PIIGS debt.
Most desirable thing here is transparency and political will to work together.
Emerging Markets
China, India still plagued by property bubble and inflation. Will European slowdown impact export sectors if these roaring tigers.
US recovery happened on the heels of huge doses of monetary and fiscal stimulus. Fed is slowly withdrawing stimulus programs. We are still not out of woods yet, unemployment is stubbornly over 9 %, housing market shows no signs of recovery, and manufacturing is showing a bit of activity.
Will USA and Europe morph into Japan?
I can think of Europe rather than US turning into Japan. Why? Demographics. Europe has a decling trajectory of young population compared to US. Deflation is might take its life but will be smothered by inflation.
EURO Zone Sovereign problems will play out for long time. All politicians expect problems to get resolved on their own. But this is not going to happen. Europe fundamentals are not that sound. Especially, debt laden PIIGS. There will be a decline in the living standards because of austerity measures taken by the peripheral nations. Europe is more vulnerable to deflation due to systematic deleveraging. This will have indirect impact on China and EM nations.
In this kind of macro scenario what kind of action will play out in various asset markets?
Interest rates: Treasury and Bund yields are trading at their lowest levels of 2010 due to sovereign risk and recovery problems. Since April 10y treasuries have fallen almost close to 75 bps. Bond futures traded in CBOT are pricing 124. How low can yields can go from here? I think if Japan stands an example, rates have further room to go down. US debt levels are rising, recovery is not yet on tracks. What can stall yield curve flattening? FED is on perma hold policy. This means short end curve remains very much anchored to low levels. Inflation shows no sign of coming and therefore 10y rates are falling lower. One interesting thing I can see is from option skew markets. Markets are pricing more of falling rates compared to rising rates. What this means to rest of the markets? Housing loan rates will be low but of no use as long as banks are not willing to lend. Then what is the purpose of these low levels. What are treasury investors looking for? I can think of only one thing, central banks are getting richer for their UST holdings and getting more money for strong dollar.
I can think of another 50 bps rally before any sell off to occur.
Yield curves to flatten further instead of steepening
Fundamentals in rates markets, High level of treasury debt and expected US growth are pointing towards bearish view in the market. But sovereign risk is playing dominant role. So markets need to reach a stage where sovereign risk is no longer threat but the unsustainable debt is bigger threat.
In Forex markets, USD will be crowned as king not because of its best traits but better traits when compared to other currencies. Dollar is benefiting from better growth and removal of liquidity measures.
EURO will attain its nirvana by attaining parity to dollar.
JPY might fall further due to increased purchasing of non JPY assets and further QE
Wednesday, June 16, 2010
Buy SPY,FXE puts
Everywhere talk of recovery and at the same time talk of stalling market rally happening. Folks like Jim Cramer are questioning the sharp rally happening in risk markets. Market is shrugging of bad reports and inching forward on small good reports. Turmoil in Europe, Housing doldrums in US and unimagined impact in emerging markets are forming the main events of the current act. Back drop is still peppered by deep sovereign deficits in developed economies and surplus in developing economies.
Today housing starts report printed 593,000 units. This is a 10% drop from month of April 2010. Starts of single family homes fell 17.2%. This number vindicates the fact that government’s tax rebate of 8000 dollars effect started fading. Construction industry folks are saying housing industry is still in dire straits. Lack of financing new projects is main bottleneck. Banks are not interested in getting into this high risky business in current environment due to expected losses. Housing starts normally acts as leading indicator of economic growth. Since this indicator is flashing red, economic recovery looks not a feasible outcome. My recommendation would be to buy SPY OTM puts.
Spaniards are occupied with world cup foot ball games although the country is sinking due to crisis in public finances similar to Greece. So what is really going on here? Euro zone governments came together and pooled together 950 billion dollars as a stability fund to bailout nations that are having difficulty in accessing capital markets. In May, Greece managed to get the funding issues resolved temporarily. Although, Greece is not out of woods yet. Now Spain came along with its problem of debt problems. In fact Spain took austere measure to bring the deficit down. These measures will not only bring the debt burden but also bring down the prospective tax revenue. In this situation only thing can help not in short term is to improve the competitiveness in the market. Spain is not alone in the world. If Spain goes down then along with it many other economies have to go down. First order effect will be on Euro. Euro has to depreciate further against dollar. Along with Europe its primary trading partners in emerging markets (India and china) will face a slow down. This means a contagion effect will kick start and economies around the world will again face show down. This time central banks that have already flooded market with liquidity need to employ financial engineering to bootstrap the economies from the brink of disaster. Can they? I think they might get lucky again. In the mean time I will recommend FXE puts to monetize the euro dollar parity.
Today housing starts report printed 593,000 units. This is a 10% drop from month of April 2010. Starts of single family homes fell 17.2%. This number vindicates the fact that government’s tax rebate of 8000 dollars effect started fading. Construction industry folks are saying housing industry is still in dire straits. Lack of financing new projects is main bottleneck. Banks are not interested in getting into this high risky business in current environment due to expected losses. Housing starts normally acts as leading indicator of economic growth. Since this indicator is flashing red, economic recovery looks not a feasible outcome. My recommendation would be to buy SPY OTM puts.
Spaniards are occupied with world cup foot ball games although the country is sinking due to crisis in public finances similar to Greece. So what is really going on here? Euro zone governments came together and pooled together 950 billion dollars as a stability fund to bailout nations that are having difficulty in accessing capital markets. In May, Greece managed to get the funding issues resolved temporarily. Although, Greece is not out of woods yet. Now Spain came along with its problem of debt problems. In fact Spain took austere measure to bring the deficit down. These measures will not only bring the debt burden but also bring down the prospective tax revenue. In this situation only thing can help not in short term is to improve the competitiveness in the market. Spain is not alone in the world. If Spain goes down then along with it many other economies have to go down. First order effect will be on Euro. Euro has to depreciate further against dollar. Along with Europe its primary trading partners in emerging markets (India and china) will face a slow down. This means a contagion effect will kick start and economies around the world will again face show down. This time central banks that have already flooded market with liquidity need to employ financial engineering to bootstrap the economies from the brink of disaster. Can they? I think they might get lucky again. In the mean time I will recommend FXE puts to monetize the euro dollar parity.
Monday, June 14, 2010
invisible hand
Economic growth comprises developments in labor, housing, Manufacturing, service and consumer sectors. These sectors fluctuate in response to business cycles hence causing gyrations in GDP (gross domestic product). Some sectors grow and some lag behind. After housing sector bust contribution from this sector to GDP has been negative to lower. Again changes in each sector are monitored by sector specific indicators. Housing starts, existing home sales etc give an indication of expected growth in economy. Economic growth is most important to every human being that demands resources from another human being or institution.
Economic growth in each country exerts pressure on goods demand and supply. This pressure flows through international channels of goods and cash (credit). Demand and supply concerns determine the price of goods like OIL/GOLD/COPPER etc in global capital markets. Cash (credit) pricing is done similarly. In today’s world Goods, cash (credit) and growth are intertwined in such a way that change in each sector has reflexive effect on other market. Central banks and governments play role in directing economic growth through their policies by becoming a visible hand in regulating the welfare of society. Welfare of society is achieved by invisible hand that regulates responses of human beings to most optimal state and this is nothing but technology or innovation or financial crisis.
Why is credit important? Global economy is driven by buying assets today and paying for tomorrow. This can happen only when some have cash to lend and some are willing to borrow. US GDP in first decade of 21st century is driven by credit related purchases. People here owe everything to credit.
T
Economic growth in each country exerts pressure on goods demand and supply. This pressure flows through international channels of goods and cash (credit). Demand and supply concerns determine the price of goods like OIL/GOLD/COPPER etc in global capital markets. Cash (credit) pricing is done similarly. In today’s world Goods, cash (credit) and growth are intertwined in such a way that change in each sector has reflexive effect on other market. Central banks and governments play role in directing economic growth through their policies by becoming a visible hand in regulating the welfare of society. Welfare of society is achieved by invisible hand that regulates responses of human beings to most optimal state and this is nothing but technology or innovation or financial crisis.
Why is credit important? Global economy is driven by buying assets today and paying for tomorrow. This can happen only when some have cash to lend and some are willing to borrow. US GDP in first decade of 21st century is driven by credit related purchases. People here owe everything to credit.
T
Tuesday, April 27, 2010
Goldman senate hearing
GoldMan Sachs senate testimony:
This morning, star line from goldman descended to capitol hill and started firing at senators. It has clarified the meaning of market maker, complicated mortgage markets and its multifaceted relations with rating agencies. In the end what has happened senate helped goldman to explain their situation live on tv.
From Calculatedriskblog.com there is a wonderful summary of what has happened this morning
"You want the truth? You can't handle the truth. Son, we live in a country with an investment gap. And that gap needs to be filled by men with money. Who's gonna do it? You? You, Middle Class Consumer? Goldman Sachs has a greater responsibility than you can possibly fathom. You weep for Lehman and you curse derivatives. You have that luxury. You have the luxury of not knowing what we know: that Lehman's death, while tragic, probably saved the financial system. And that Goldman's existence, while grotesque and incomprehensible to you, saves pension funds. You don't want the truth. Because deep down, in places you don't talk about at parties, you want us to fill that investment gap. You need us to fill that gap. "We use words like credit default swaps, collateralized debt obligation, and securitization? We use these words as the backbone of a life spent investing in something. You use 'em as a punchline. We have neither the time nor the inclination to explain ourselves to a commoner who rises and sleeps under the blanket of the very credit we provide, and then questions the manner in which we provide it! We'd rather you just said thank you and paid your taxes on time. Otherwise, we suggest you get an account and start trading. Either way, we don't give a damn what you think you're entitled to!"
I have executed bear put spreads hoping senate will grill our famous ABACUS originators. At the end of day my trade went into red as senators got trained investing in CDOS. Most important irony today is Greek crisis tanked markets around the world. World took refuge in Gold (precious metal). Coincidentally, Goldman stock rose 2%/.
This proves Goldman is equivalent of Gold. Any doubts?
This morning, star line from goldman descended to capitol hill and started firing at senators. It has clarified the meaning of market maker, complicated mortgage markets and its multifaceted relations with rating agencies. In the end what has happened senate helped goldman to explain their situation live on tv.
From Calculatedriskblog.com there is a wonderful summary of what has happened this morning
"You want the truth? You can't handle the truth. Son, we live in a country with an investment gap. And that gap needs to be filled by men with money. Who's gonna do it? You? You, Middle Class Consumer? Goldman Sachs has a greater responsibility than you can possibly fathom. You weep for Lehman and you curse derivatives. You have that luxury. You have the luxury of not knowing what we know: that Lehman's death, while tragic, probably saved the financial system. And that Goldman's existence, while grotesque and incomprehensible to you, saves pension funds. You don't want the truth. Because deep down, in places you don't talk about at parties, you want us to fill that investment gap. You need us to fill that gap. "We use words like credit default swaps, collateralized debt obligation, and securitization? We use these words as the backbone of a life spent investing in something. You use 'em as a punchline. We have neither the time nor the inclination to explain ourselves to a commoner who rises and sleeps under the blanket of the very credit we provide, and then questions the manner in which we provide it! We'd rather you just said thank you and paid your taxes on time. Otherwise, we suggest you get an account and start trading. Either way, we don't give a damn what you think you're entitled to!"
I have executed bear put spreads hoping senate will grill our famous ABACUS originators. At the end of day my trade went into red as senators got trained investing in CDOS. Most important irony today is Greek crisis tanked markets around the world. World took refuge in Gold (precious metal). Coincidentally, Goldman stock rose 2%/.
This proves Goldman is equivalent of Gold. Any doubts?
Wednesday, April 21, 2010
Market Movements
Markets react to daily news like humans react to various events daily. For instance, we greet a person warmly if we like him and give a look of grin when we dislike a person. These are very natural reactions. Markets also react in the same way. If dollar strengthens oil goes down, good earnings follows good equity market response etc. These reactions are like explaining the market movements in terms of events happened on the day. But markets are like flowing river that musters its force from the under currents it is accumulating. This under current is determined by the fundamental demand and supply factors. For instance Gold Markets. Gold was trading at under 1000 dollars but today it is looking for direction at 1150 levels.
Great Recession has brought unprecedented crisis mitigating efforts by governments around the world. In this effort, huge fiscal stimulus has been pumped into the economy. This stimulus is due to creation of money by central banks. This binge printing made investors scared of loosing value of their paper assets. Investors felt may be world is heading towards the direction of Zimbabwe. So, everybody wanted to convert their assets to physical assets and Gold satiated their appetite. So the price shift that occurred in the Gold is due to this fear of loss of asset values. This did not happen in a day. This process took place over a period of few months. Some days when dollar is rising due to Greece crisis, Gold has risen and other days when Dollar was falling due to Fed’s FOMC statements gold has fallen due to lack of demand in Asia.
Therefore, Gold price movements needs to be viewed in a much higher window and analyzed in the light of both fundamental and technical factors that are driving the price. One thing is definitely sure, in the short run focus on technical movements and long run focus on fundamental factors. This short run and long run determination is an art not science.
Have fun.
Great Recession has brought unprecedented crisis mitigating efforts by governments around the world. In this effort, huge fiscal stimulus has been pumped into the economy. This stimulus is due to creation of money by central banks. This binge printing made investors scared of loosing value of their paper assets. Investors felt may be world is heading towards the direction of Zimbabwe. So, everybody wanted to convert their assets to physical assets and Gold satiated their appetite. So the price shift that occurred in the Gold is due to this fear of loss of asset values. This did not happen in a day. This process took place over a period of few months. Some days when dollar is rising due to Greece crisis, Gold has risen and other days when Dollar was falling due to Fed’s FOMC statements gold has fallen due to lack of demand in Asia.
Therefore, Gold price movements needs to be viewed in a much higher window and analyzed in the light of both fundamental and technical factors that are driving the price. One thing is definitely sure, in the short run focus on technical movements and long run focus on fundamental factors. This short run and long run determination is an art not science.
Have fun.
Tuesday, April 20, 2010
Market summary - April 20-2010
Today has been a tumultuous day in equity markets. Earnings reports are driving the market into positive territory. Technology sector is telling a recovery story in the markets. Financials are rising up driven by stronger earnings report by Goldman. Investor fraud case still looms over Goldman. Market legal experts are in the view that this legal battle will be adding another feather to Gold man’s cap.
S&P 500 traded above 1200. On Friday, it staged a decline in reaction to SEC accusation on the Goldman. I thought may be a pull back and this might persist probably for couple of days. But like a sprint runner who slipped down and picked up his pace, financial markets have resumed their march higher at the behest of strong earnings reports.
On economy front things are still the same,
Unemployment high, consumer sentiment sullen
But Retail sales are higher, personal consumption expenditures are higher
Housing still struggling to improve
Manufacturing is faring far better with PMI and ISM indicators signaling expansion phase.
So where will be end of April: MY bet S&P 500 will rise another 2%.
I forgot to mention one point, Greece I think will be forced to do some kind of default if not this year earlier it will be definitely next year. I think this way because, if I look at Greece and its debt needs, these needs are going higher than being offset by any kind of positive revenue growth. In such a scenario core pressure on Euro’s underperformance will disappear. So Euro can possibly go higher.
I will come up with some trades I think can help generate money on this tomorrow.
S&P 500 traded above 1200. On Friday, it staged a decline in reaction to SEC accusation on the Goldman. I thought may be a pull back and this might persist probably for couple of days. But like a sprint runner who slipped down and picked up his pace, financial markets have resumed their march higher at the behest of strong earnings reports.
On economy front things are still the same,
Unemployment high, consumer sentiment sullen
But Retail sales are higher, personal consumption expenditures are higher
Housing still struggling to improve
Manufacturing is faring far better with PMI and ISM indicators signaling expansion phase.
So where will be end of April: MY bet S&P 500 will rise another 2%.
I forgot to mention one point, Greece I think will be forced to do some kind of default if not this year earlier it will be definitely next year. I think this way because, if I look at Greece and its debt needs, these needs are going higher than being offset by any kind of positive revenue growth. In such a scenario core pressure on Euro’s underperformance will disappear. So Euro can possibly go higher.
I will come up with some trades I think can help generate money on this tomorrow.
Sunday, April 4, 2010
Week Ahead
Weekly Summary
ISM (Services): March ISM (S) index will be released on Monday and consensus forecast is at 54 compared to February.
Pending home sales: Pending home sales report suggesting slight decline will also be reported on Monday.
One important event of the day is Fed’s meeting to review the discount lending rate. Discount lending rate decision will have impact on the banks borrowing from the Fed’s discount window. I believe Fed is in the mode of burnishing its credentials to fight inflation by adjusting discount rate and at the same time keeping the Fed funds rate at current level so that it will not derail the growth process that is underway.
On Tuesday we will get FOMC meeting minutes. I think this still remain a low key event.
For Oil markets there is one release that can directly affect is crude Oil inventories.
Finally Wholesale inventories will be released on Friday.
Markets are closed in Europe for Easter. In US markets will open on Monday and it will be a testing day. In Equity markets, we will see a huge gains and will be a testing week if markets can hold on to the gains and trend higher.
Dollar is poised to get stronger at behest of strong growth theme in US.
Bond Markets will have to digest treasury supply and Fed meeting minutes. Last week Non Farm Payrolls have caused a selloff in treasuries. This week USM10 will be testing key support levels.
Oil has broken the 70-80 dollar range and currently trading at $85. Strong growth rate in US will drive oil higher. This week we will also have the oil inventory data that will weigh in. Last month WSJ carried an article suggesting that inventory measurement activity is prone to lot of inconsistencies. Need to see how market will react to inventory data from this perspective.
ISM (Services): March ISM (S) index will be released on Monday and consensus forecast is at 54 compared to February.
Pending home sales: Pending home sales report suggesting slight decline will also be reported on Monday.
One important event of the day is Fed’s meeting to review the discount lending rate. Discount lending rate decision will have impact on the banks borrowing from the Fed’s discount window. I believe Fed is in the mode of burnishing its credentials to fight inflation by adjusting discount rate and at the same time keeping the Fed funds rate at current level so that it will not derail the growth process that is underway.
On Tuesday we will get FOMC meeting minutes. I think this still remain a low key event.
For Oil markets there is one release that can directly affect is crude Oil inventories.
Finally Wholesale inventories will be released on Friday.
Markets are closed in Europe for Easter. In US markets will open on Monday and it will be a testing day. In Equity markets, we will see a huge gains and will be a testing week if markets can hold on to the gains and trend higher.
Dollar is poised to get stronger at behest of strong growth theme in US.
Bond Markets will have to digest treasury supply and Fed meeting minutes. Last week Non Farm Payrolls have caused a selloff in treasuries. This week USM10 will be testing key support levels.
Oil has broken the 70-80 dollar range and currently trading at $85. Strong growth rate in US will drive oil higher. This week we will also have the oil inventory data that will weigh in. Last month WSJ carried an article suggesting that inventory measurement activity is prone to lot of inconsistencies. Need to see how market will react to inventory data from this perspective.
Friday, April 2, 2010
Euro - Bear put spread trade
EURO: March unemployment report is moderately better report. It also provided some strong indications by revising up previous numbers. This means US economy recovery is breather and growth story is still intact. This fundamental news is strongly supportive of dollar and bearish to EURO. On the manufacturing front, ISM for manufacturing reported 59.6 a very strong number indicating expansion in manufacturing sector. This news might allow fed revising its stance on the ultra loose monetary policy. On Europe front, still Greece problems are not yet over. Greece is trying to roll its debt by issuing new bonds. This means there is still uncertainty in the direction of euro. Fundamental factors, growth is favoring strong dollar but sovereign debt issues are weighing in. Still we have Portugal, Italy, Ireland and spain to come up with stronger fiscal measures. In the light of these factors Euro looks vulnerable. So medium term the dollar is going to look strong.
Some recommended strategies are
1) Short Euro
2) Buy June futures put options
Buy 1.34 E6M0 june puts at 2450 and sell 1.30 E6M0 June put at 1150 for net debit of 1200.
This is a very nice way to monetize events strong recovery in US economy and sovereign crisis related issues in Europe.
Risk to this option is US economy hits a wrong note due to concerns of the Domestic fiscal crisis in various states and housing related drag has surprising negative impacts.
Some recommended strategies are
1) Short Euro
2) Buy June futures put options
Buy 1.34 E6M0 june puts at 2450 and sell 1.30 E6M0 June put at 1150 for net debit of 1200.
This is a very nice way to monetize events strong recovery in US economy and sovereign crisis related issues in Europe.
Risk to this option is US economy hits a wrong note due to concerns of the Domestic fiscal crisis in various states and housing related drag has surprising negative impacts.
ISM - Payroll -March -2010
ISM: Economic activity in manufacturing sector expanded in March and overall economy is expanding. Index stood at 59.6. An indication above 50 is considered to be expansionary.
17 manufacturing industries have shown growth.
Among the components, Inventories and Price paid have shown significant changes to the levels from February.
Inventories contribution looks a bit unsustainable at this level of 55.3
General commodity prices are also increasing and so the price paid component has increased.
PMI at a glance in last 12 months.
Month PMI Month PMI
Mar 2010 59.6 Sep 2009 52.4
Feb 2010 56.5 Aug 2009 52.8
Jan 2010 58.4 Jul 2009 49.1
Dec 2009 54.9 Jun 2009 45.3
Nov 2009 53.7 May 2009 43.2
Oct 2009 55.2 Apr 2009 40.4
Average for 12 months – 51.8
High – 59.6
Low – 40.4
Net this report suggests economic recovery is intact and markets are poised for a strong growth ahead of time.
Unemployment: Much awaited unemployment report hit the electronic screens on an EASTER holiday. This report came at the heels of negative reports from ADP. Market has been looking at a range of -40,000 to 400,000. Final report indicated that employers have added 162,000 people. This number is a reasonably good number in the light of additions being expected of Census related hiring. Census hiring stood at 48,000 and will increase in the periods ahead of us.
Unemployment rate stood at 9.7%
March employment came from temporary help services , health care and Census hiring. Job reductions are still happening in Financial industry and information technology industry.
Non Farm payroll employment for January and February has been revised from -26000 to +14000 and -36000 to -14000 respectively.
17 manufacturing industries have shown growth.
Among the components, Inventories and Price paid have shown significant changes to the levels from February.
Inventories contribution looks a bit unsustainable at this level of 55.3
General commodity prices are also increasing and so the price paid component has increased.
PMI at a glance in last 12 months.
Month PMI Month PMI
Mar 2010 59.6 Sep 2009 52.4
Feb 2010 56.5 Aug 2009 52.8
Jan 2010 58.4 Jul 2009 49.1
Dec 2009 54.9 Jun 2009 45.3
Nov 2009 53.7 May 2009 43.2
Oct 2009 55.2 Apr 2009 40.4
Average for 12 months – 51.8
High – 59.6
Low – 40.4
Net this report suggests economic recovery is intact and markets are poised for a strong growth ahead of time.
Unemployment: Much awaited unemployment report hit the electronic screens on an EASTER holiday. This report came at the heels of negative reports from ADP. Market has been looking at a range of -40,000 to 400,000. Final report indicated that employers have added 162,000 people. This number is a reasonably good number in the light of additions being expected of Census related hiring. Census hiring stood at 48,000 and will increase in the periods ahead of us.
Unemployment rate stood at 9.7%
March employment came from temporary help services , health care and Census hiring. Job reductions are still happening in Financial industry and information technology industry.
Non Farm payroll employment for January and February has been revised from -26000 to +14000 and -36000 to -14000 respectively.
Wednesday, March 31, 2010
Market Decline is transient
Today markets staged small decline. This decline is mainly attributed to weak ADP employment report. This report suggested a reduction of 23000 heads for the month February to march. But I think this report result should not be considered as preface to the Friday’s unemployment report. As Friday’s report is more comprehensive and contains the new additions from the public sector. So it means last two days fall should not let bears to come out of their hibernation and declare their possibility of winning. I think eventually bears will be vindicated but they have to wait till markets have completely understood that economies cannot be driven by public or private debt for long time. Economies are driven by growth and quality earnings. So I will safely predict S&P 500 will rise above 1200 and may be 1300. Reason being clear, like Washington depends on daily polls every day people are depending for their well being on stock market performance. If stocks fall for few days media will go crazy about coming Armageddon. Typically if you have observed markets have become very resilient to bad news. They tend to fall less for bad news and rise more for good news. This asymmetric behavior is what driving markets crazily up.
On the Monetary policy front, Fed is on hold with regards to hiking fed funds rate. I think fed will raise the rate only after markets have priced in more than 100% probability. This has been the case for most of the previous hiking cycle. Fed is on hold not for any fancy reasons. It wants to be sure that its hikes are required to tame the inflation not growth. Fed has to face huge debt supply from the US treasury. So takeaway here is to play money market carry trades. This involves buying calls on EDZ0
On the Monetary policy front, Fed is on hold with regards to hiking fed funds rate. I think fed will raise the rate only after markets have priced in more than 100% probability. This has been the case for most of the previous hiking cycle. Fed is on hold not for any fancy reasons. It wants to be sure that its hikes are required to tame the inflation not growth. Fed has to face huge debt supply from the US treasury. So takeaway here is to play money market carry trades. This involves buying calls on EDZ0
Tuesday, March 30, 2010
US 30y Bond futures finds support (114)
USD 30y
US Govt 30y futures are trading in a tight range after last week big moves. At this point of time most of investor universe has assimilated some facts that have caused those spikes. These facts are, Weak 118 Billion treasury coupon securities auctions, unwinding of Swap spread positions, Pension fund buying activity and Corporate issuance glut. Don’t forget we have some market moving announcements within investment fraternity by Greenspan (canary on coal Mine), Bill Gross (Its good to move into stocks) and etc.
This week we have started with no big movements in the 30y yields. Economic news related to health of US economy remained stable to slightly positive. Market is waiting on the big news movers like Non-farm payrolls, ISM on first two days of April. Now a days economic indicators also started coming out neutral to slightly positive. This kind of scenario is making Equity markets to go bullish on positive news and stay muted to negative news. Bearish commentators are calling it top at every point market rising and feeling frustrated for not getting their call true. So where does this leave in terms of direction for treasuries. I think there will be a chance of yields moving higher is very plausible. But at this time it is very difficult to make this call because, technical analysis is suggesting the futures are heavily supported at 114. In addition, treasuries have been struggling to go beneath this low. Also even if it goes to this level such a move looks highly not sustaining. Another subtle fact that might come into play is new mortgage principal write downs by Banks will lead to spreads rising instead of falling. Another interesting thing will be treasury will be exiting from the MBS market.
My trade recommendation would be
1) Sell May 113 puts for a credit of $328 each
This trade has one major risk is market goes in a sell off
US Govt 30y futures are trading in a tight range after last week big moves. At this point of time most of investor universe has assimilated some facts that have caused those spikes. These facts are, Weak 118 Billion treasury coupon securities auctions, unwinding of Swap spread positions, Pension fund buying activity and Corporate issuance glut. Don’t forget we have some market moving announcements within investment fraternity by Greenspan (canary on coal Mine), Bill Gross (Its good to move into stocks) and etc.
This week we have started with no big movements in the 30y yields. Economic news related to health of US economy remained stable to slightly positive. Market is waiting on the big news movers like Non-farm payrolls, ISM on first two days of April. Now a days economic indicators also started coming out neutral to slightly positive. This kind of scenario is making Equity markets to go bullish on positive news and stay muted to negative news. Bearish commentators are calling it top at every point market rising and feeling frustrated for not getting their call true. So where does this leave in terms of direction for treasuries. I think there will be a chance of yields moving higher is very plausible. But at this time it is very difficult to make this call because, technical analysis is suggesting the futures are heavily supported at 114. In addition, treasuries have been struggling to go beneath this low. Also even if it goes to this level such a move looks highly not sustaining. Another subtle fact that might come into play is new mortgage principal write downs by Banks will lead to spreads rising instead of falling. Another interesting thing will be treasury will be exiting from the MBS market.
My trade recommendation would be
1) Sell May 113 puts for a credit of $328 each
This trade has one major risk is market goes in a sell off
Thursday, March 25, 2010
Market summary
March 25,2010
Market Summary
USD dollar index closed at 82.5
USD/Eur currency closed at 1.329.
Today Germany and france have reached a deal with regards to aid package to Greece. This involves IMF. ECB president has responded saying this kind of mechanism will hurt Euro. Consequently euro fell further. It looks it has further to go
30y futures: closed at 115.04. Last two days have been very damaging to treasuries. The following factors played into the weakness of the treasuries
1) Weak treasury auctions (markets are uncomfortable to impending treasury supply)
2) Swap market spread unwinding activity. Lots of players have crowded into spread wideners and this was not happening.
These two factors weighed heavily on the bond prices
Oil: oil is trading with in the ranges near $ 80
Gold has traced down to 1090 levels.
Equity markets had a volatile session. Markets rallied initially at the behest of good earnings from best buy, qualcomm and probable end to the woes of Greece. But towards the end of session markets shed all the gains that were obtained due to strengthening of the dollar
For tomorrow we will be awaiting GDP data and Michigan sentiment indicator.
Market Summary
USD dollar index closed at 82.5
USD/Eur currency closed at 1.329.
Today Germany and france have reached a deal with regards to aid package to Greece. This involves IMF. ECB president has responded saying this kind of mechanism will hurt Euro. Consequently euro fell further. It looks it has further to go
30y futures: closed at 115.04. Last two days have been very damaging to treasuries. The following factors played into the weakness of the treasuries
1) Weak treasury auctions (markets are uncomfortable to impending treasury supply)
2) Swap market spread unwinding activity. Lots of players have crowded into spread wideners and this was not happening.
These two factors weighed heavily on the bond prices
Oil: oil is trading with in the ranges near $ 80
Gold has traced down to 1090 levels.
Equity markets had a volatile session. Markets rallied initially at the behest of good earnings from best buy, qualcomm and probable end to the woes of Greece. But towards the end of session markets shed all the gains that were obtained due to strengthening of the dollar
For tomorrow we will be awaiting GDP data and Michigan sentiment indicator.
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