Haven't written for a week. Last week saw a fairly persistent supportive stance and then a rally on Friday night when European concerns about structured credit surfaced with some warnings from credit agencies.
It was pretty much perfect for me and I stayed fairly long the whole time waiting for the break to the upside I had been calling for for a while.
Monday saw PPI surprise strongly to the upside (1.0% QoQ against 0.8%) but that only made our market shiver and shake before bouncing back to pretty much where it was before the number. That wasn't encouraging. I am always nervous when the market resists news because ultimately, the interest rate market is about economic data and the interpretation of this data. Data cannot be shoved aside because eventually the data will shove back.
It is pretty clear to me that some complacency may have set into the market about the CPI number tomorrow. If forecasts of core CPI range basically from 0.6 to 0.9 with the vast majority at 0.7-0.8, then a surprise to either side seems to me uncomfortably likely. With the market positioned basically as it was prior to the big shake-up in June, I see all the potential for a big move on the down-side. A print of 0.5-0.7 or even 0.8 may provoke little or a moderate move in the market but 0.9 or higher will cause a big sell-off and shake us all up again.
All the burns and scars I suffered in June prevent me from piling into this but I am still convinced the likely outcome is going to be under 0.9. A sell-off in the US tonight can allow me to load-up a little but if I get a chance to take some off the table at a profit prior to the number, I most certainly will.
Position: Long across the curve in futures. Slightly short in the long end overall.
Best case: Very low print CPI or big rally overnight in the US, allowing me to square it up.
Worst Case: Sell off in US (maybe a big rally in equities), followed by 0.9 or higher in CPI.....ughh
Tuesday, July 24, 2007
Saturday, July 14, 2007
The First Hurdle
The employment (and unemployment) number is usually the monthly domestic number which is the biggest market mover. June's employment/unemployment number was a 2 standard deviation surprise to the upside with the unemployment number hitting a 33 year low at 4.2%. At the time, pretty much the whole desk was long. It absolutely killed us.
This time around, the expectation was for a low employment number. Blythe was calling for a correction of the 2 std deviation move and expected the employment number to be flat and the unemployment figure to bounce back to 4.3%. I was happy to go along with a low number (Blythe and CBA have good cause to be trusted on these forecasts), the question, however, was how far could the market move on this number?
With CPI on 25 July being the main game with regard to determining if the RBA was going to hike, I could not see the curve out to 3 years moving more than 5-6 points either way, regardless of the result. However, it was greatly due to the strong domestic data in June that the market had sold off as much as it had and if that result were now negated (or at least countered) by July's data, shouldn't we be roughly where we were before June? The spanner in the works was that foreign (in particular, US) bond markets had sold off considerably in that period, with US 10 Yr yields going from 4.888% at the end of May to 5.086% on Wednesday's close.
I was modestly short going into Thursday morning, looking for a little sell-off overnight to go long again and at least square up my futures in the long end. I got that sell-off late in the New York session with 3's going from 62.5 on Wed's close to the mid 50s and 10s going from 84 to 77 or so. I bought 100 3s at 56.5 and ended up crossing the spread (unusual for me) at 11:15-20 to buy 280 10s at 77. I could have gotten set half to a full point better, as it turns out, but I was frightened of not getting set at all or at much worse levels as liquidity dried up prior to the number.
It turned out fine, as it transpires, because employment printed at 2,500 (against expectations of 15,000), with full-time falling by 34,300 and unemployment retracing to 4.3%. As expected, the market rallied 2-3 points or so in the 3s and 10s, the curve steepened a little, and then the market traded back and forth, almost unsure what exactly that should be worth. Stronger buying came later in the day and the short-end rallied very nicely, with Sep bills rallying 3-4 and Dec/Mar bills even more.
This was all great for me but left me feeling as if I should have been a bit longer going in. That's a little revisionist, I guess, because I was still a little gun shy after all the strong data in May/June. A lot like betting on a string of losing horses, cutting back a bit on my bets and then saying I should have bet the farm on the horse that does finally come in.
I resisted the urge to replace my short position in 10s because I still see the major risks in the US to the upside (shaky credit markets and the possibility of correction in the equity markets). I still think that when the range finally breaks, it'll be more likely to the upside.
Vincent seems considerably more active and vocal now. He came over to talk about how he believed that the upcoming CPI figure (prob headline) would be negative. I wanted especially John to see how he thought things through by asking Vincent why he believed so. He didn't disappoint, bringing up figures, anecdotes and citations to back up his opinion. It is great and uplifting to see that he is still in the game.
Thursday night saw 10s sell-off down again to the mid-70s on the back of a massive rally in equity markets (damn, forgot to switch my super back into equities). I really had no strong intraday conviction about the direction the markets were going so I stayed where I was, and stayed with the same range play bias.
Went to lunch at Malaya with Boyd, Channy and Johnny. Great food but those guys are hard-core soccer nuts and I'm not sure I fit in under that umbrella. Nonetheless, I enjoyed it.
I must admit, at the moment, to having trouble with getting all routine tasks that I have to take up with Darius' absence done as well as planning for and executing trades in my book and also getting work done on my project of pricing the fixed rate home loan swaptions.
Luckily for me, my book is making money at the moment so I don't feel too bad about it all. Must lift my game a bit though.
Position: Moderately long out to 3 years (including futures), moderately short thereafter with no futures position.
Best case: Bull steepening.
Worst case: Bear flattening. The curve has steepened a fair bit already (things are going well all over right now). This situation could develop if equity markets overseas rampage onwards.
Looking to square up my long and curve position a bit next week. Good time for it, seeing as we're top of range again. Might even put on a modest flattener.
This time around, the expectation was for a low employment number. Blythe was calling for a correction of the 2 std deviation move and expected the employment number to be flat and the unemployment figure to bounce back to 4.3%. I was happy to go along with a low number (Blythe and CBA have good cause to be trusted on these forecasts), the question, however, was how far could the market move on this number?
With CPI on 25 July being the main game with regard to determining if the RBA was going to hike, I could not see the curve out to 3 years moving more than 5-6 points either way, regardless of the result. However, it was greatly due to the strong domestic data in June that the market had sold off as much as it had and if that result were now negated (or at least countered) by July's data, shouldn't we be roughly where we were before June? The spanner in the works was that foreign (in particular, US) bond markets had sold off considerably in that period, with US 10 Yr yields going from 4.888% at the end of May to 5.086% on Wednesday's close.
I was modestly short going into Thursday morning, looking for a little sell-off overnight to go long again and at least square up my futures in the long end. I got that sell-off late in the New York session with 3's going from 62.5 on Wed's close to the mid 50s and 10s going from 84 to 77 or so. I bought 100 3s at 56.5 and ended up crossing the spread (unusual for me) at 11:15-20 to buy 280 10s at 77. I could have gotten set half to a full point better, as it turns out, but I was frightened of not getting set at all or at much worse levels as liquidity dried up prior to the number.
It turned out fine, as it transpires, because employment printed at 2,500 (against expectations of 15,000), with full-time falling by 34,300 and unemployment retracing to 4.3%. As expected, the market rallied 2-3 points or so in the 3s and 10s, the curve steepened a little, and then the market traded back and forth, almost unsure what exactly that should be worth. Stronger buying came later in the day and the short-end rallied very nicely, with Sep bills rallying 3-4 and Dec/Mar bills even more.
This was all great for me but left me feeling as if I should have been a bit longer going in. That's a little revisionist, I guess, because I was still a little gun shy after all the strong data in May/June. A lot like betting on a string of losing horses, cutting back a bit on my bets and then saying I should have bet the farm on the horse that does finally come in.
I resisted the urge to replace my short position in 10s because I still see the major risks in the US to the upside (shaky credit markets and the possibility of correction in the equity markets). I still think that when the range finally breaks, it'll be more likely to the upside.
Vincent seems considerably more active and vocal now. He came over to talk about how he believed that the upcoming CPI figure (prob headline) would be negative. I wanted especially John to see how he thought things through by asking Vincent why he believed so. He didn't disappoint, bringing up figures, anecdotes and citations to back up his opinion. It is great and uplifting to see that he is still in the game.
Thursday night saw 10s sell-off down again to the mid-70s on the back of a massive rally in equity markets (damn, forgot to switch my super back into equities). I really had no strong intraday conviction about the direction the markets were going so I stayed where I was, and stayed with the same range play bias.
Went to lunch at Malaya with Boyd, Channy and Johnny. Great food but those guys are hard-core soccer nuts and I'm not sure I fit in under that umbrella. Nonetheless, I enjoyed it.
I must admit, at the moment, to having trouble with getting all routine tasks that I have to take up with Darius' absence done as well as planning for and executing trades in my book and also getting work done on my project of pricing the fixed rate home loan swaptions.
Luckily for me, my book is making money at the moment so I don't feel too bad about it all. Must lift my game a bit though.
Position: Moderately long out to 3 years (including futures), moderately short thereafter with no futures position.
Best case: Bull steepening.
Worst case: Bear flattening. The curve has steepened a fair bit already (things are going well all over right now). This situation could develop if equity markets overseas rampage onwards.
Looking to square up my long and curve position a bit next week. Good time for it, seeing as we're top of range again. Might even put on a modest flattener.
Wednesday, July 11, 2007
Credit Jitters
Leading into last night, the market seemed to have found and bounced off the bottom of the 50/70 range again and there waiting for a night of no significant data (Business Inventories) but in which Bernanke was going to speak on inflation to some academics. I was set up moderately long from buying at the bottom of the range.
Of course, I had no idea that the ratings agencies were going to decide to put a range of MBSs and CDOs (involving the subprime sector) on notice for downgrades. This caused a big rally in UST and dragged our 3s and 10s to the top of the range again only 2 days after it had pretty much toughed the bottom.
This is a concern and I think the market is reasonably likely to break the range this time in the US and subsequently drag our 10s along with it. Of course, our 3s and especially our Bills will be restrained due to domestic issues (employment figure on Thursday and CPI later in the month determining whether the RBA will hike) but in the meantime, our 10s will basically be free to swing and in the event of a large and/or sustained move, the rest of the curve will follow to some extent.
The consensus seems that the employment number will be low this time around and I'm ok with that but for the fact that I am now a bit shorter in the long end (sold 10s into the rally) and, as I type, 10s are testing the top of the range again. If the number does print low, then, seeing as we are presently positioned at the top of the range, it is likely to extend the move.
I would be much more comfortable if the long end in the US sells off tonight, taking 10s back to the mid-high 70s and then we had a low employment print. I'm happy to stick with what I have though because I can't see the market pricing in too much from tomorrow's number with CPI looming in 2 weeks. I also reckon that, even with the sub-prime woes and the credit events of yesterday, the next wave of news on that issue will come further down the track and the market will have a chance to bounce around the range again.
If I'm wrong, then I'll buy back the tens and square up that side as the market finds a new range. That'll probably be somewhere up near 90 though.
Still no news about the management situation at work. I doubt anything concrete will come to light until the bonuses are announced and probably paid out.
Position: Slightly short, mostly in the long end.
Best case: Steepening rally, such that 10s sell off. Employment prints low, credit woes in US abate.
Worst case: Flattening sell off. Employment prints very high (people regain some confidence in 2nd hike) and 10s actually rally finding a new range or worse, trending upward (people start believing in a US easing on maybe the back of credit jitters).
Of course, I had no idea that the ratings agencies were going to decide to put a range of MBSs and CDOs (involving the subprime sector) on notice for downgrades. This caused a big rally in UST and dragged our 3s and 10s to the top of the range again only 2 days after it had pretty much toughed the bottom.
This is a concern and I think the market is reasonably likely to break the range this time in the US and subsequently drag our 10s along with it. Of course, our 3s and especially our Bills will be restrained due to domestic issues (employment figure on Thursday and CPI later in the month determining whether the RBA will hike) but in the meantime, our 10s will basically be free to swing and in the event of a large and/or sustained move, the rest of the curve will follow to some extent.
The consensus seems that the employment number will be low this time around and I'm ok with that but for the fact that I am now a bit shorter in the long end (sold 10s into the rally) and, as I type, 10s are testing the top of the range again. If the number does print low, then, seeing as we are presently positioned at the top of the range, it is likely to extend the move.
I would be much more comfortable if the long end in the US sells off tonight, taking 10s back to the mid-high 70s and then we had a low employment print. I'm happy to stick with what I have though because I can't see the market pricing in too much from tomorrow's number with CPI looming in 2 weeks. I also reckon that, even with the sub-prime woes and the credit events of yesterday, the next wave of news on that issue will come further down the track and the market will have a chance to bounce around the range again.
If I'm wrong, then I'll buy back the tens and square up that side as the market finds a new range. That'll probably be somewhere up near 90 though.
Still no news about the management situation at work. I doubt anything concrete will come to light until the bonuses are announced and probably paid out.
Position: Slightly short, mostly in the long end.
Best case: Steepening rally, such that 10s sell off. Employment prints low, credit woes in US abate.
Worst case: Flattening sell off. Employment prints very high (people regain some confidence in 2nd hike) and 10s actually rally finding a new range or worse, trending upward (people start believing in a US easing on maybe the back of credit jitters).
Sunday, July 8, 2007
Payrolls Redemption
The market has been fairly well behaved in the lead up to and into the first week of the new budget year. 3s have broadly been oscillating from the high 40s to the low 60s and the 10s have also seen a 15 or so point range from 70 to the mid 80s. I have been playing this fairly well by shifting and rebalancing my 3s10s curve but ,at the same time, I've also been occasionally kicking myself for not going all-in by playing those ranges outright.
The very low retail sales and building approvals figures which sprung forth on 3 July were a bit of pleasant surprise for me, because I had really been fearing more strong data but I held on because of the core view that the RBA would not hike and that the data (and especially the CPI figure) would eventually prove this, at least out to August.
Low wages, the high AUD, the high hurdle set by the previous CPI, home lenders raising fixed rates, the rumours of excess domestic inventories and the fall in bond prices all gave good reasons to believe that the RBA would more than likely not go so soon. The election might also put some political pressure on the RBA not to hike, so I figured, on the balance of risks, being long, at least out to 3 years was the right move for now.
Leading into payrolls, I did something I don't usually do. I printed out a copy of my blotter and took it home with me. I figured that I wanted to give it the same attention that I would if I was on the desk. My view was that the surprises were probably going to be to the upside (on the number) and I had various orders at the bottom of the ranges to buy since I was thinking that any sell-off would be short-lived because our market was had limited space to move until the July CPI and also because I couldn't see any significant further lowering of unemployment in the US (ie. massively high payrolls number).
At 10pm or so, I pried myself away from my girlfriend and set up Bloomberg and made a call to Boyd at UBS to place a few bids in ambush positions below. After that, all there was to do was wait.
As it happens, it pretty much turned out exactly as I guessed.
Payrolls comes out 132k against 125 expectation and the June figure is revised from 157k to 190k. The unemployment rate remains at 4.5%. Strong result but not overwhelming. The market buzzes around a little and then sells down with the 3s down from 54 to 50 and the 10s from 74 to 69.5. I get filled paying 50 for 100 and 70 and 69.5 for 100 each. The market drifts back up again, 3s back to 55 within an hour and ending at 51.5; 10s back to 75 before closing at 72.
I was tempted to sell at least these new positions back as the market rallied back but my book was short and this is the bottom of the range so I'd rather build up my longs, hoping to ride it back up to the top of the range again at least one more time before it breaks out to find a new range again.
The feeling that these small successes in July has given me has been just the tonic I've been yearning for. Despite the pain endured in May/June, it has been a fantastic learning experience, at least for me. Even better because I seem to have survived it (from an employment perspective).
The problem I see with labelling a market as range-bound or trending, and further to that, defining a range or piling into a trend, is that it is fundamentally a generalising and complacent view. The market will always ultimately punish complacency and I've learned that no forward-looking view is completely correct at the time because a view ultimately only expresses a balance of risks based on present information on a non-deterministic outcome. John gave me a great piece of wisdom saying:
"The only thing that is always right is the market"
It is very easy to fall into a lazy, complacent position when you trade a low volatility market like Aussie bonds. I can't imagine the same situation forming in my mind trading Hang Seng index futures. Getting stung early into my career is the best thing that's ever happened to me and now it's up to me to apply the lessons taught.
Retail trade and payrolls and playing the range have given me a nice start to this year but I'm ready for anything to happen.
Position: Overall small short/square.
Futures: Very long short end. 3/10s curve looking for a bull steepening move.
Best case: Weak domestic data. US long end weakening without taking the short end with it (bull steepening preferred). Equity market correction would be good.
Worst case: Very strong domestic data. High CPI number. Bear flattener caused by maybe strong data (domestic or US) plus flight to quality in the long end perhaps.
The very low retail sales and building approvals figures which sprung forth on 3 July were a bit of pleasant surprise for me, because I had really been fearing more strong data but I held on because of the core view that the RBA would not hike and that the data (and especially the CPI figure) would eventually prove this, at least out to August.
Low wages, the high AUD, the high hurdle set by the previous CPI, home lenders raising fixed rates, the rumours of excess domestic inventories and the fall in bond prices all gave good reasons to believe that the RBA would more than likely not go so soon. The election might also put some political pressure on the RBA not to hike, so I figured, on the balance of risks, being long, at least out to 3 years was the right move for now.
Leading into payrolls, I did something I don't usually do. I printed out a copy of my blotter and took it home with me. I figured that I wanted to give it the same attention that I would if I was on the desk. My view was that the surprises were probably going to be to the upside (on the number) and I had various orders at the bottom of the ranges to buy since I was thinking that any sell-off would be short-lived because our market was had limited space to move until the July CPI and also because I couldn't see any significant further lowering of unemployment in the US (ie. massively high payrolls number).
At 10pm or so, I pried myself away from my girlfriend and set up Bloomberg and made a call to Boyd at UBS to place a few bids in ambush positions below. After that, all there was to do was wait.
As it happens, it pretty much turned out exactly as I guessed.
Payrolls comes out 132k against 125 expectation and the June figure is revised from 157k to 190k. The unemployment rate remains at 4.5%. Strong result but not overwhelming. The market buzzes around a little and then sells down with the 3s down from 54 to 50 and the 10s from 74 to 69.5. I get filled paying 50 for 100 and 70 and 69.5 for 100 each. The market drifts back up again, 3s back to 55 within an hour and ending at 51.5; 10s back to 75 before closing at 72.
I was tempted to sell at least these new positions back as the market rallied back but my book was short and this is the bottom of the range so I'd rather build up my longs, hoping to ride it back up to the top of the range again at least one more time before it breaks out to find a new range again.
The feeling that these small successes in July has given me has been just the tonic I've been yearning for. Despite the pain endured in May/June, it has been a fantastic learning experience, at least for me. Even better because I seem to have survived it (from an employment perspective).
The problem I see with labelling a market as range-bound or trending, and further to that, defining a range or piling into a trend, is that it is fundamentally a generalising and complacent view. The market will always ultimately punish complacency and I've learned that no forward-looking view is completely correct at the time because a view ultimately only expresses a balance of risks based on present information on a non-deterministic outcome. John gave me a great piece of wisdom saying:
"The only thing that is always right is the market"
It is very easy to fall into a lazy, complacent position when you trade a low volatility market like Aussie bonds. I can't imagine the same situation forming in my mind trading Hang Seng index futures. Getting stung early into my career is the best thing that's ever happened to me and now it's up to me to apply the lessons taught.
Retail trade and payrolls and playing the range have given me a nice start to this year but I'm ready for anything to happen.
Position: Overall small short/square.
Futures: Very long short end. 3/10s curve looking for a bull steepening move.
Best case: Weak domestic data. US long end weakening without taking the short end with it (bull steepening preferred). Equity market correction would be good.
Worst case: Very strong domestic data. High CPI number. Bear flattener caused by maybe strong data (domestic or US) plus flight to quality in the long end perhaps.
The Setup
After the slow, continual sell-off of May and the implosion of GDP and the employment figure in early June, the long end in the US completely crapped-out on 7 June. The results were like a tsunami on our desk. Every day was like a funeral.
I spent virtually all of May fighting off an urge to close out my long futures position and go short. On multiple occasions, I stopped myself from doing so because of the wiser voices on the desk and my own greed. Approaching the data in the first week of June, I was incredibly nervous about the strength in the Aust economy showing through again. My inertia and inability to switch it around caused a blow-up of proportions that I could barely fathom. I spent the next couple of weeks wondering each day when and if the axe might fall on me. I found myself glad to be involved in peripheral activities for the desk as a whole because it at least felt as if I was adding something.
Then the end of June rolled up, some communication came out that confirmed there were some serious issues with our senior management and, most importantly, that Vincent wasn't trading until they were resolved. Suddenly, I realised that my issues and my performance, were in the grand scheme of things, insignificant. If it was just me that had blown-up, or if I was by far the biggest, then I'd have good reason to be worried; but it as it stood, the new year was going to wash my sins clean.
All this made for a strange situation with Vincent. He was, at his heart, a trader and a risk taker. Without this, I really wasn't sure what he was. We were like a pack of wolves, hunting together, sharing our kills and revelling in the communal excitement of it. Sometimes we killed, other times, the prey got away but regardless of the result, we lived and shared the life of the pack. Vincent was like the alpha dog of the pack. He was the big wolf, who we (especially me) would look to for guidance and inspiration. Now he was muzzled and we all regarded him curiously, because he was still alpha dog yet he wasn't, for now, one of us.
The new year rolled around and I went into the first week of July and the data season with a couple of key thoughts regarding our market:
1. The RBA was not likely to hike in 2007. The 'hurdle rate' for core inflation had been raised considerably by the low CPI figure in May. I figured (correctly, as it turned out) that the RBA would at least wait until the July CPI figure before acting (meaning a July hike was out of the question). Also, that core CPI figure would probably have to be 0.8 or above for the RBA to go in August. I didn't think that was likely and I figure that the market's reaction to the strong data in June was overdone. Stevens hosed some of that down in his speech in Brisbane in mid-June and the very low retail sales figure last week took some further wind out of those hawkish sails.
2. The dangers for large moves remain in the following areas:
a) Equity market correction/nervousness
b) Further credit market nervousness
c) Further correction in Bunds/Treasuries due to repositioning of forecasts.
a) has yet to be seen since late February 2007 and that move, caused by the 9% correction in Chinese equities and the sub-prime nervousness had mostly been erased within a month or so later. Many commentators (I'm looking at you, CitiFX) have been calling for the apocalypse in Equities for a while.
b) was really the story of the later part of June 2007. Complacency in pricing of risky assets had been called out by many observers for a long time. This move caused some pain for us despite futures trading a fairly narrow channel during this period. I still contend that this move has a fair way to go. A credit crisis could easily see a massive correction across the credit spectrum. Maybe not soon but I reckon when it happens, it'll happen in size and rebalance asset allocations across the asset risk spectrum.
c) is interesting because many people think that this move is basically done. I'm not so sure. With every investment bank in the world calling for multiple easings in the US this calendar year on the back of forecasts of rapid slowing in the US economy, the data was not co-operating. Unemployment, in particular was especially stubborn. In Europe, Bunds were bleeding a slow dance of death, seemingly drifting every night from 4.14 at the start of May to 4.44 by the end of May. When a bunch of houses, and especially Goldman so publicly gave up on these views in the first week of June, the market crapped out, with US 10s going from 4.86 on 31 May to 5.24 on 8 June. The easing bias had basically left the market and the US had gotten a defacto tightening-and a half.
I think that, in the shorter term and on an incremental basis, the US could drift any which way (leaving aside the factors discussed in a) and b)) but the independent bias for large moves in the long end could be found in an increase in non-tradeable inflation as the labour market arbitrage presently found between the developed economies and especially China and India dissipates. That move in non-tradeable inflation can only go in one direction and is completely inexorable. When this becomes expressed in longer term rates, to what extent and for how long, I'm not sure but there is a distinct possibility that the tightening cycle in the US, Europe and most of the world could have quite a way further to run. Even if the US takes a pause (which it currently has), the longer term trend could still be hawkish.
Putting this all together, I have kept a large long position in Bills and have been trading various different weightings in the 3s10s curve. I figure that being long out to 3 years will be helped if:
1. The RBA doesn't hike this year.
2. The equity market gets the jitters/craps itself.
3. Flight to quality occurs, probably being dragged along by the long end.
Being short the long end helps if:
1. The tail of the curve continues to even out.
This position could go wrong if:
1. The RBA hikes.
2. We get some extremely strong data (esp domestic).
3. The curve (from belly to tail) flattens in a bearish move (the strong domestic data, coupled with a big continued rally in the US would do that).
I spent virtually all of May fighting off an urge to close out my long futures position and go short. On multiple occasions, I stopped myself from doing so because of the wiser voices on the desk and my own greed. Approaching the data in the first week of June, I was incredibly nervous about the strength in the Aust economy showing through again. My inertia and inability to switch it around caused a blow-up of proportions that I could barely fathom. I spent the next couple of weeks wondering each day when and if the axe might fall on me. I found myself glad to be involved in peripheral activities for the desk as a whole because it at least felt as if I was adding something.
Then the end of June rolled up, some communication came out that confirmed there were some serious issues with our senior management and, most importantly, that Vincent wasn't trading until they were resolved. Suddenly, I realised that my issues and my performance, were in the grand scheme of things, insignificant. If it was just me that had blown-up, or if I was by far the biggest, then I'd have good reason to be worried; but it as it stood, the new year was going to wash my sins clean.
All this made for a strange situation with Vincent. He was, at his heart, a trader and a risk taker. Without this, I really wasn't sure what he was. We were like a pack of wolves, hunting together, sharing our kills and revelling in the communal excitement of it. Sometimes we killed, other times, the prey got away but regardless of the result, we lived and shared the life of the pack. Vincent was like the alpha dog of the pack. He was the big wolf, who we (especially me) would look to for guidance and inspiration. Now he was muzzled and we all regarded him curiously, because he was still alpha dog yet he wasn't, for now, one of us.
The new year rolled around and I went into the first week of July and the data season with a couple of key thoughts regarding our market:
1. The RBA was not likely to hike in 2007. The 'hurdle rate' for core inflation had been raised considerably by the low CPI figure in May. I figured (correctly, as it turned out) that the RBA would at least wait until the July CPI figure before acting (meaning a July hike was out of the question). Also, that core CPI figure would probably have to be 0.8 or above for the RBA to go in August. I didn't think that was likely and I figure that the market's reaction to the strong data in June was overdone. Stevens hosed some of that down in his speech in Brisbane in mid-June and the very low retail sales figure last week took some further wind out of those hawkish sails.
2. The dangers for large moves remain in the following areas:
a) Equity market correction/nervousness
b) Further credit market nervousness
c) Further correction in Bunds/Treasuries due to repositioning of forecasts.
a) has yet to be seen since late February 2007 and that move, caused by the 9% correction in Chinese equities and the sub-prime nervousness had mostly been erased within a month or so later. Many commentators (I'm looking at you, CitiFX) have been calling for the apocalypse in Equities for a while.
b) was really the story of the later part of June 2007. Complacency in pricing of risky assets had been called out by many observers for a long time. This move caused some pain for us despite futures trading a fairly narrow channel during this period. I still contend that this move has a fair way to go. A credit crisis could easily see a massive correction across the credit spectrum. Maybe not soon but I reckon when it happens, it'll happen in size and rebalance asset allocations across the asset risk spectrum.
c) is interesting because many people think that this move is basically done. I'm not so sure. With every investment bank in the world calling for multiple easings in the US this calendar year on the back of forecasts of rapid slowing in the US economy, the data was not co-operating. Unemployment, in particular was especially stubborn. In Europe, Bunds were bleeding a slow dance of death, seemingly drifting every night from 4.14 at the start of May to 4.44 by the end of May. When a bunch of houses, and especially Goldman so publicly gave up on these views in the first week of June, the market crapped out, with US 10s going from 4.86 on 31 May to 5.24 on 8 June. The easing bias had basically left the market and the US had gotten a defacto tightening-and a half.
I think that, in the shorter term and on an incremental basis, the US could drift any which way (leaving aside the factors discussed in a) and b)) but the independent bias for large moves in the long end could be found in an increase in non-tradeable inflation as the labour market arbitrage presently found between the developed economies and especially China and India dissipates. That move in non-tradeable inflation can only go in one direction and is completely inexorable. When this becomes expressed in longer term rates, to what extent and for how long, I'm not sure but there is a distinct possibility that the tightening cycle in the US, Europe and most of the world could have quite a way further to run. Even if the US takes a pause (which it currently has), the longer term trend could still be hawkish.
Putting this all together, I have kept a large long position in Bills and have been trading various different weightings in the 3s10s curve. I figure that being long out to 3 years will be helped if:
1. The RBA doesn't hike this year.
2. The equity market gets the jitters/craps itself.
3. Flight to quality occurs, probably being dragged along by the long end.
Being short the long end helps if:
1. The tail of the curve continues to even out.
This position could go wrong if:
1. The RBA hikes.
2. We get some extremely strong data (esp domestic).
3. The curve (from belly to tail) flattens in a bearish move (the strong domestic data, coupled with a big continued rally in the US would do that).
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