G3 Recap 1-10-11

Main Items:

  • Piigs CDS widened further today as Portugal, Spain and Italy are all auctioning debt this week.
  • Kocherlakota, a new 2011 voting FOMC member, said in an interview that “The bar for dissent from the committee is going to be pretty high for me.” Fisher, also a new 2011 voter, said in an interview that “I expected that program [of Treasury purchases] to be carried through.” These comments were both dovish relative to market expectations, as Fisher had been expected by some to actively dissent.
  • Oil markets were braced today for the impact of the loss of up to 15% of US crude after a pipeline leak forced BP to shut down 95% of production from North America’s biggest field – FT.
  • Alcoa earned 21c vs 19c expected in 4Q. Sales missed: 5.65bn vs 5.75bn.

Overseas Data:

  • Chinese Trade balance dropped to 13.1bn in Dec vs 20.75bn expected and 22.9bn previously. Export growth slowed sharply to 17.9% YoY from 34.9% previously, while Import growth was steadier at 25.6% YoY vs 27.7% previously. This series has historically been pretty choppy with regular seasonal effects, but the surprise this time is that the seasonal downturn that usually occurs around February may have hit earlier.

  • Italian Budget Deficit in 3Q printed 5.1% of GDP in 3Q vs 6.1% previously

Commentary:

  • There is a lot of fixed income issuance this week, from EU sovereigns, (Wed, Thurs) corporates, as well as the US Treasury (Tues-Thurs). The EU debt is spooking the markets, pushing PIIGS CDS up along with European financial CDS. The Itraxx 5yr Senior Financials CDS index hit a new high today:

    The interesting part is what didn’t happen: EURUSD didn’t fall, but actually rallied on the day.
    Let’s put this into a context. Over the past 500 trading days, a regression of EURUSD vs 5y rate spreads, log(Senior European Financial 5yr CDSI), and the 3rd WTI contract had a correlation coefficient of 85%. The T stats are -42, 12, and 5, respectively, indicating that the CDS was by far the biggest driver for the cross over this time period. Furthermore, according to this model, EURUSD should be trading at 1.23 by now:

    But instead, the cross is trading 5 figures higher, and despite a higher CDS and lower rate spreads, EURUSD rallied on the day. The last time that the model broke down this badly was in March and August of last year, which were both short term inflection points for the cross. This strongly suggests at the possibility of a short term reversal. ()
    Judging by the correlation of risk assets to the EUR recently, such a reversal is also likely to be risk positive.

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3 thoughts on “G3 Recap 1-10-11

  1. Be careful to focus entirely on WTI when you ‘talk’ crude. The Brent contract is now far more important to setting price levels in the daily phys crude market than the WTI contract. WTI is now really only a benchmark for US destined crude.
    On a different note, here some stats on 2010: ICE Brent volumes increased by 34% after an 8% increase in 2009. CME WTI volumes increased by 21% after a year of no increase in 2009. On average last year 1.25bn bpd of WTI and Brent traded on the oil futures markets, 15 times daily global physical oil demand. Brent increased its share of crude futures volumes by 1.4% to 31% and, with extra weightings this year in the key passive oil indices, its clear international price lead over WTI, its non-US nature and its seaborne as opposed to landlocked status, will increase further in 2011. It is early days but note that 2011 has started with storming futures volumes. January 2011 ICE Brent volumes to date are +38% on Jan 2010 and +57% on Jan 2009. CME WTI volumes on the same basis are +62% and +63%.
    (source of this data: PVM Brokers-London)

  2. Thanks for your comments, PPK. You are right, but fortunately the regression results were almost identical using brent futures. By using the 3rd WTI contract, the effects of the delivery differential appears to be negated.

  3. Fair point: correlation WTI to Brent is very high. And 3d month makes sense. Prompt month diff Brent over WTI now $6,50 /bbl ( 97 versus 90.50 ) whereas diff in 3d mnth smaller at around $3.80.
    Looks as if we the market wants to break the $100 very soon on Brent ! OPEC is not in the driver’s seat since the recent rally in crude seems demand driven. And growth numbers for 2011 in crude look very healthy.

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