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.
Monday, June 28, 2010
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
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