Recap 2015-04-22: My Take


The weak US data in 1Q has been unusually surprising. The Bloomberg measure of surprises, for example, is at the most negative level since the Lehman recession:

The drivers seem to be a result of both the data as well as the resilience of analyst estimates. Clearly, the US economy is feeling the front loaded effects of the move in oil and the dollar. However, analyst estimates has remained broadly sanguine, with many expecting a bounce back in 2Q. The chart below illustrates how despite the sharp drop off in 1Q growth estimates (white line) 2Q estimates has actually ticked up. (orange)

The wide spread consensus expectation of a strong rebound means that the data needs to hit expectations. And given where we are in 2Q, that needs to start happening soon.

Asset prices have already moved in response to the weak 1Q data. As economic surprises (orange) fell in late Dec and accelerated in Feb and March, treasury yields (white) fell, and equities (yellow) and the dollar (green) consolidated.

In other words, data over the next few weeks are likely to be quite important. If the recent string of data disappointments continue, analysts as well as the Fed are likely to need to reassess their growth projections. In particular, they are likely to need to reassess the impact of the dollar. The US economy is actually relatively closed, but its exposure to global trade has been increasing over the years, just like those of other DM countries. Dudley on Monday said that

While I am relatively optimistic about the growth outlook for 2015, I also must acknowledge that there are some significant downside risks. In particular, the roughly 15 percent appreciation of the exchange value of the dollar since mid-2014 is making U.S. exports more expensive and imports more competitive. My staff’s analysis concludes that an appreciation of this magnitude would, all else equal, reduce growth of real GDP by about 0.6 percentage point over this year. Some of the recent softness in indicators of manufacturing activity is likely a reflection of this development.

Given that US growth has been averaging 2.3%, the 0.6% figure is quite substantive. In addition, an upward revision of the ‘beta’ of the dollar on US growth is important because expectations for further dollar strength are widespread. Such a revision would thus have a compounded effect on expectations for US growth & monetary policy.

Furthermore, note that there is probably a reasonable basis for such a revision. All macro models use historical data as a basis for estimates. GMO recently published a white paper noting that domestic sales of EAFE (non-US developed market) country corporations have continued to fall since the recession, also that trend may have stabilized as of 2012:

In other words, it is quite possible that the continued globalization of corporate profits (which leads investment & hiring intentions) has not yet been fully incorporated into analyst models.

Having said that, however, most of the charts support analyst optimism. The S&P is in the middle of a textbook bullish wedge that looks likely to be resolved soon. The last such occurrence was a year ago:

US 30y yields’ downward momentum appears to be flagging, with yields unable to re-break support at 2.5%. Like the S&P chart, we are likely to get some sort of formation break soon, either up or down. There are some similarities to 2012 here also.

The Dollar is consolidating above long term support / resistance.

Finally, Gold appears to be consolidating before a push lower. If yields and the dollar move higher, such a move would not be surprising.

In fact, short gold may be one of the better proxies to express a short interest rate view. Since the curve is in contango, carry is positive. (rather than negative in most expressions) In addition, an end to global central bank easing is in sight. Finally, the sharp drop in commodity prices globally the past few quarters means the marginal cost of production has likely fallen dramatically.

Recap 2015-04-07: S&P Returns Decomposition


Trailing S&P returns has slowed sharply from the end of 2013. I thought it would be worthwhile to break down the sources and see if it there was anything worth extrapolating.

First, as most folks know, S&P price returns are driven by either an increase in earnings expectations, or an increase in the multiple of earnings that the market is willing to pay for those earnings. Bloomberg has a historical series of consensus expectations for EPS, so we can use that to back out the historical price change due to each part. Historically and unsurprisingly, the PE component has been much more volatile than the earnings component as a driver of prices:

What’s interesting here is the weakness in earnings growth since 2012, but especially in the past 6 months. That is, of course, the result of the combination of lower oil, a stronger dollar, and weaker growth globally. Unsurprisingly, the change in consensus estimated EPS can be reasonably approximated using economic data. The regression (subject to all the caveats on regression results) and consensus forecasts over the next few quarters all point to a decent bounce in EPS estimates by year end. Barring unexpected strength, however, EPS growth estimates are likely to remain below those from mid 2014:

That shouldn’t be too surprising… gradual revenue and productivity growth is the norm for corporate profits.

Outside of that, the trend of gradual PE expansion that has prevailed since mid-2012 has broadly continued, though at a slower pace than before. Looking forward, the tailwind from higher PE is likely to continue given where yields are and the credit backdrop. If anything, they are likely to pick up a bit from here given central bank policies the past quarter.


  • Wed: Japan Eco Watchers, Dudley Speaks, FOMC Minutes
  • Thu: BoE, US Jobless Claims,
  • Fri: Canada Employment
  • Mon: BoJ Minutes, China Trade Balance, AU NAB Business Confidence
  • Tue: US PPI, NFIB Survey
  • Wed:

Recap 2015-04-01: The EUR & Reserve Managers, the Outlook for Risk Parity


One of the most interesting and unprecedented decisions the ECB has made recently was not to conduct QE, but rather to cut interest rates into negative territory. While it is true that other countries have experimented with negative rates prior to the ECB, the ECB’s decision to apply a negative interest rate to the second largest reserve currency in the world was without precedent. That may well be one reason the market has been surprised by the extent of the move in the EUR over the past few quarters.

It seems that the release of the latest COFER data has shed some light on one reason why the move has been so quick: the reserve managers. Now, reserve managers tend to act as a market stabilizing force; they tend to want to keep their allocations to various currencies broadly stable, so if one currency appreciates sharply vs another, the reserve managers tend to sell the one that strengthened, while buying the one that weaked – at least over the short run. However, in 2H 2014, they seem to have stepped away from the EUR. From JPM:

The proportion invested in EUR assets declined significantly in Q4, to 22.2%, the lowest percentage since 2Q2002. Further, the decline experienced over the last year was the sharpest witnessed since the EUR’s inception. Prior to 2009 the allocation to EUR assets was on the rise. However, during the last four years this trend has reversed, with the allocation falling by roughly 1ppt per year…

Currency depreciation during the quarter caused passive declines for everything except the USD. However, reserve managers swam against the strong USD tide, concerned that FX movements were driving non-USD allocations below target. Net of currency effects, they were significant buyers of CHF and JPY, and moderate buyers of GBP, CAD and AUD. However, they allowed the weaker EUR to drive that allocation lower, pretty much unresisted. This reflects medium-term concerns regarding their prodigious exposure to the common currency.

Here is are a couple tables showing the data in more detail. The US, EU, Japan, and UK all conducted QE from 2008 to 2014, yet the share of FX reserves in USD only fell 0.9%, the share in Yen actually rose by 0.5%, but the share in the EUR declined by a full 4.0%, with about half of that move occurring in the second half of 2014.

Per FTA & Deutsche Bank,

The IMF data excludes two of the world’s largest holders of FX reserves, holding as many assets as the rest of the world’s central banks combined. It is precisely these holders that have the largest ongoing potential to sell Euros:

(1) The Middle East. The region currently holds 1 trillion dollars in official FX reserves and another 2.5 trillion via large sovereign wealth holdings. It just so happens that this region is also running very large fiscal deficits due to the collapse in oil revenues. The most natural source of financing for these countries is to run down reserves: there is little reason to increase government borrowing or aggressively cut back spending until the oil market price war reaches a conclusion. We estimate that Middle East oil producers are running a combined fiscal deficit of more than 200bn in 2015, and low-yielding European assets seem like the primary candidates of assets to be sold.*

(2) China. The country may be the world’s largest holder of FX reserves, but it is also running these down at the fastest pace in history. Assets are dropping at an annualized pace of around 200bn USD, driven by central bank intervention to accommodate large-scale capital outflows. In turn, these have been caused by a reversal in the structural CNY appreciation pressure that has been in place over the last two decades: increased corporate hedging activity, an unwind of speculative “hot money” inflows and hedging of outstanding portfolio exposures. All look likely to stay for this year and beyond.

In conclusion, it does not take an active re-allocation of central banks away from euro reserves to prompt capital outflows from Europe. The Middle East and China stand out as two regions that are likely to face ongoing pressures to run down reserves over the next few years, with low-yielding European reserves likely to be the main casualties of the post-EM and commodity boom trends.

In aggregate, the behavior of FX reserve managers may be one of the transmission mechanisms of negative rates in particular. That may be one reason the power of negative rates has been so surprising – something that central banks globally are likely to remember the next time they face output gaps.

Separately, Risk Parity has been a pretty popular strategy the past few years. There are many flavors, but the high sharpe ratio over the past few years has resulted in a number of new funds that follow the strategy. Unsurprisingly, future returns are unlikely to match that of the recent past. That because the main reason for the performance of the strategy has been the decline in the discount rate for all financial assets. With that discount rate broadly stable over the past couple years, the discount rate tailwind for Risk Parity has eased.

The chart below highlights the idea. I calculated a rolling 5yr annualized return for a 10% vol Risk Parity portfolio consisting of only S&P and US long bond futures. Against that, I charted the 5 year change in the 10yr TIPS real yield. The rationale is that the TIPS yield was a proxy for the discount rate. A decline in the discount rate should result in higher risk parity returns; a rise should conversely result in lower returns. I plotted the yield change with a lead of 3 years because it has historically taken time for the lower discount rate to become reflected in asset prices.

In aggregate, the data appears to support that rationale. Risk parity strategies did not particularly shine in the final years of the last decade, as the Fed’s hiking cycle raised discount rates. With the Fed nearing hiking again, it seems quite likely that we see a repeat of that. And if history is any guide, Risk Parity returns over the next 5 years are likely to fall quite sharply from those of recent memory.


  • Thu: US Jobless Claims, Yellen Speaks
  • Fri: US Employment
  • Mon: US Markit Services PMI, ISM Non-Mfg,
  • Tue: RBA, EU Services PMI,
  • Wed: Dudley Speaks, FOMC Minutes

Recap 2015-03-23: On the EUR


I’ve been very busy with some research projects the past week. I am optimistic that those efforts will bear fruit, but in the meantime, future updates will likely be intermittent. On the other hand, I will hopefully have a bit more to say when I do write.

Market action the past week has been quite interesting. I wrote a few weeks ago that there appears to be a large ‘duration squeeze’ following the ECB’s start of the QE program. I was too early in anticipating stabilization; it appears the squeeze is continuing. The chart below shows the US 30y Treasury yield vs the average 30y EUR sovereign yield. (the 4 largest countries)

What’s new over the past week is that for the first time this year, the yield differential has tightened. While that certainly does not mean that the duration squeeze is over, it does suggest that the intensity of the squeeze is slowing.

The other new item is that for the first time in several quarters, oil prices appear unable to break to substantive new lows. (oil in green below, EUR in white, 30y spread from chart above in orange, and the SPX vs Eurostoxx ratio in purple) This is pertinent because despite the fact that US oil imports have fallen dramatically, the world continues to run a USD to EUR trade balance via the OPEC countries, which tends to invoice in USD and spend in EUR. As a result, the EURUSD cross continues to exhibit decent correlation to oil.

The combination of a stabilization of both oil prices and yield differentials is notable in that they occurred in conjunction – the first time they had done so in recent months except for a few days at the end of January.

In addition, it is quite likely that the bulk of the move in both these factors is over. Obviously oil can’t fall another $50, and with the ECB QE broadly priced in, a further 100bp widening in the US-EU 30y yield spread is improbable.

Given that this backdrop is occurring in the context of a historically extreme move in the currency cross, (see my 2/13 note) there is a significant possibility of a continuation of this recent corrective move. I’ve noted that historical corrections in the EURUSD with this technical backdrop have been roughly 10 figures over the course of a couple months or so. The pace of the move this time suggests that the correction may be both stronger and shorter. We are only a couple weeks and 5 figures in so far; historical precedents suggest another few weeks and another 5 figures or so.

Such a move is likely to be quite pertinent for the US vs EU equity performance differential. A large part of the EU equity outperformance YTD has been pinned to the EUR, and EU equity overweights are currently extremely popular, according to surveys from both BAML and Barclays, among others.

Separately, some interesting points from Goldman on lower expected Neutral Rates:

  • Since reaching a local high in early 2014 after the ‘taper tantrum’ of 2013, our estimates for the neutral level of short rates have been falling both in the US and the Euro area. They are now around 3.25% in the US (on the latest available survey, taken in December 2014, they stood at 3.50%, while in June 2014 they were at 3.70%) and 2.5% in the Euro area. The gap in neutral rates estimates between the US and the Euro area is at the highest level post the global financial crisis.
  • By these metrics, the market’s estimate of neutral rates in the US is around 50bp lower than both the FOMC’s median longer-run federal funds rate and our US economists’ forecast.

To obtain a measure of term premium embedded in the curves, we subtract from the 5-year 5-year market yield the expectations of the 6-to-10 years short-term rates calculated as we described above. The latest numbers show that:

  • The term premium in the US is currently negative to the tune of around 70bp and is now at a historical low. For comparison, during 2012, it stood at around negative 50bp.
  • In the Euro area, the `blended’ term premium is at its historical minimum of negative 150bp.

My own estimate of the Neutral Rate is ~3% in the US and ~2% in Europe. As a result, I do not think yields are quite as mispriced as Goldman or the Fed, though still historically quite unusually low. The flow effects from the QE programs suggest that shorts should be placed at more extreme levels given that a full retracement is less likely.

Pretty funny:


  • EU Consumer Confidence improved to -3.7 vs -5.8 exp and -6.7 prev. This is the highest print since July 2007
  • US Existing Home Sales rose 1.2% MoM vs 1.7% exp
  • Tsipras has warned Angela Merkel that it will be “impossible” for Athens to service debt obligations due in the coming weeks if the EU fails to distribute any short-term financial assistance to the country. The warning, contained in a letter sent by Mr Tsipras to the German chancellor and obtained by the Financial Times, comes as concerns mount that Athens will struggle to make pension and wage payments at the end of this month and could run out of cash before the end of April.
  • the Syriza gov’t is ratcheting up an investigation into the head of the country’s statistics agency over charges he inflated Greece’s deficit figures to justify the current bailout. The action will likely draw the ire of troika officials who are demanding a politically neutral head of statistics to ensure accurate and transparent numbers. WSJ
  • 7.4% was the slowest expansion rate of the Chinese economy in 24 years according to Credit Suisse


  • Mon : Japan Markt PMI, China HSBC PMI
  • Tue: EU PMI, UKCPI, USCPI, US Markit PMI, New Home Sales
  • Wed: German IFO, US Durable Goods
  • Thu: German Consumer Confidence, EU Money Supply, UK Retail Sales, US Jobless Claims, US Markit Services PMI, Japan Jobless rate, CPI
  • Fri: UK House Prices

Recap 2015-03-16


Now that oil is back to making lows… are we likely to get a replace of Dec/Jan price action? In particular, are we likely to see the combination of widening credit spreads and falling bond yields? IMO, it’s possible but not probable. One reason why the effect of the decline in oil prices was so strong before was due to the speed of the decline. The pace of the decline was a multi-sigma event that was not priced into the risk premiums across markets. A similar decline from here would imply a $20 oil price – possible but not probable.

Separately, I was wondering how the ECB QE program compared to the first Japanese QE program back in 2002. I used the 2s30s curve as a point of comparison because front end EUR yields are negative now even as Japanese yields were not then. The price action analogue is clearly not meant to be compared literally, but may potentially be instructive as to how they may evolve going forward:

In any case, there isn’t much of a benefit to thinking too many moves ahead… just something to keep in mind.

Also, there has been a lot of press on “intelligent” portfolios recently. Most of these algorithms seem to be based primarily on some combination of historical price data rather than economic data. In particular, momentum seems to be an explicit part of the strategies involved. Now, momentum signals are successful when the trend to volatility ratio is strong. That is one major reason quant funds have performed well over the past several quarters – witness with trends across global fixed income, currency and equity markets over that time period. But what’s worth considering is that given the lower returned that are now priced into almost all asset prices here, future momentum to volatility ratios are likely to fall dramatically. As an example, consider an asset with a trend of zero, i.e. prices just exhibit volatility around its present level. It is likely that momentum based strategies are unlikely to perform especially well. It is probably not a coincidence that returns from momentum based strategies wane just as they become widely available.

Interesting Links:

Here is one very good reason not to use small email providers with security loopholes:


  • US Empire Mfg declined to 6.9 vs 8.0 exp and 7.8 prev
  • NAHB Housing Survey declined to 53 vs 56 exp and 55 prev


  • Tue: German ZEW, US Housing Starts
  • Wed: UK Employment, BoE Minutes, FOMC, NZ GDP
  • Thu: US Jobless Claims, Philly Fed
  • Fri: Quadruple Witching, Canada CPI, Retail Sales
  • Mon: US Existing Home Sales, EU Consumer Confidence, JapanMarkt PMI, China HSBC PMI

Recap 2015-03-11




  • Japan Machine Orders slowed to 1.9% YoY vs -1.0% exp and 11.4% prev


  • Wed: RBNZ, UK RICS House Prices Balance, AU Employment
  • Thu: French CPI, US Retail Sales, Jobless Claims,
  • Fri: Canada Employment, US PPI, UMichigan Sentiment
  • Mon: US Empire Mfg, NAHB Housing Survey
  • Tue: German ZEW, US Housing Starts
  • Wed: UK Employment, BoE Minutes, FOMC, NZ GDP

Recap 2015-03-10


Over the past week or so, strength in the USD is not longer occurring in conjunction with higher EU equity prices. The net result seems to be that the negative effects of a stronger USD is no longer being mitigated. The correlation between equities and FX is notoriously unstable, but it is quite strong of late and that seems to be the mantra of the day.

Also, the fact that EPS is expected to decline for the first time since early 2009 may itself be causing some portfolio adjustments, though the downgrades may be over for now:

In addition, despite the new EUR debt issuance the past few days, clearly supply not responding quickly enough to demand. The price action in EUR debt continues to drive longer term yields globally. At some point, either via more supply (over time) or lower demand (via prices) EUR yields will stabilize, but we are not there yet. Well… not in any place except Japan! Take a look at the far right column of this table of global 30y yield changes over the past 3 months:

The move in Japanese yields is the only DM market to have a positive print, and in fact the only country with a bigger move up in yields is Brazil! Quite surprising in the context of both the ongoing massive QE program … something for those long EUR sovereign debt to be mindful of. Perhaps the Japanese are selling JGBs to buy EU debt – specifically periphery debt, given that French and German 30y yields are now well below JGB levels. On that note… the 30y German yield traded at the same level as US 2y yields at one point today.

The upcoming Fed hike in addition to weak growth and lots of debt has resulted in a significant amount of credit tightening in EM. The 5y CDX is about to break the highest levels since 2009:

Separately, the NFIB small business survey was pretty interesting. The response to ‘Positions not able to fill’ hit the highest level since a random spike 10 years ago. However, the response to ‘compensation plans’ remain subdued. The differential between the two series is actually at the highest levels ever, a level last seen in 2000. This may reinforce Fed beliefs that they can let the employment data run a bit more before becoming concerned about inflation. In any case, the data is not weak by any means, and may be one reason why the US front end continues to move higher.

On a technical note, the Eurostoxx outperformance has taken the S&P / Eurostoxx ratio to the bottom of its 3.5 year range. There will probably be some profit taking here in the interim, but the chart is likely to provide a clue for the next move.


  • US NFIB Survey was broadly stable at 98 vs 97.9 exp and 98.9 prev
  • Australia Business Confidence declined to 0 vs 3 prev
  • China CPI improved to 1.4% vs 1.0% exp and 0.8% prev
  • Draghi Urged Greece to Allow Officials Back Before It’s Too Late. Draghi told Greek officials they face a critical situation and must let euro-area representatives return to Athens if they are ever going to obtain more aid. "Little has been done since the last Eurogroup (meeting two weeks ago) in terms of talks, in terms of implementation," Eurogroup chairman Jeroen Dijsselbloem said. "We have to stop wasting time and really start talks seriously," he said.
  • Japan: Interesting that as ECB enter’s it’s second day of QE, and German 10 years sup 30bp, Japanese rates are spiking, JGB yields up another 4bp at new multi-month highs. The Market is extremely illiquid owing to BOJ crowding-out effects but the sell-off is garnering a lot of attention
  • Yves Mersch: One way for banks to raise profits without shirking on investment is through genuine efficiency gains. And in this context I see a large “low hanging fruit” in Europe that is ripe to be picked – consolidation within the sector. According to most indicators there are too many banks in Europe relative to the size of the market. [3] This implies that there is significant scope to benefit from rationalisation, and without exacerbating the problem of “too big to fail”. Moreover, these benefits have become easier to realise now that we have a Banking Union and an end to supervisory divergence.


  • Tue: AU Home Loans
  • Wed: ChinaData, US Oil Data, RBNZ, UK RICS House Prices Balance, AU Employment
  • Thu: French CPI, US Retail Sales, Jobless Claims,
  • Fri: Canada Employment, US PPI, UMichigan Sentiment
  • Mon: US Empire Mfg, NAHB Housing Survey
  • Tue: