G3 Recap 4-15-11

Main Items:

  • US Core CPI rose 1.2% YoY in March as expected vs 1.1% previously. Headline Inflation rose 2.7% YoY vs 2.6% expected and 2.1% previously.
  • U Michigan Confidence improved to 69.6 in April vs 68.8 expected and 67.5 previously. While 1yr inflation expectations were stable at 4.6%, 5yr expectations fell to 2.9 from 3.2.
  • Empire Manufacturing rose to 21.7 vs 17 expected and 17.5 previously. In particular, the employment index surged to 23.08 in April from 9.09 in March, the highest level since May 2004
  • Moody’s downgraded Ireland’s rating by two notches, taking the country down to Baa3 and just at the brink of junk status. Moody’s says steep austerity measures risk hurting economic growth. Moody’s said the downgrade to BAA3 from BAA1 — which puts its rating two notches below both Fitch and Standard and Poor’s — was also due to uncertainty around solvency tests required by the European Stabilization Mechanism
  • The Greek Finance Ministry said that it will adopt further EUR26bn in new austerity measures and EUR50bn in state-asset sales through 2015 to meet goals to reduce the deficit and debt. The government is still aiming for a deficit of 7.4 percent of GDP this year, even as first-quarter revenue missed the target by 1.4 billion euros.
  • Glencore disclosed that it controls 45 percent of the third-party lead market, 38 percent in alumina, and between 30 and 20 percent for aluminium, cobalt and thermal coal. Glencore says that its copper production in Africa will jump to 370,000 tonnes this year, up by nearly a half from just less than 250,000 tonnes in 2009. By the middle of the decade, the trading house expects to mine more than 650,000 tonnes. On coal, Glencore told potential investors that its production would jump to 15.6 milliom tonnes this year, up more than 56 percent from 10m in 2010. By 2015, the trader hopes to mine 20.7 million tonnes. CNBC

Overseas:

  • EU March CPI rose 2.7% YoY in March vs 2.6% expected and previously. Core Inflation unexpectedly jumped 1.3% YoY vs 1.1% expected and 1.0% previously, although additional tax measures in the periphery may have been a contributor.
  • China’s economic data was basically the same as the ones leaked yesterday:
    Expected Actual

CPI +5.2% +5.4%

PPI +7.2% +7.3%

IP +14.0% +14.8%

Retail Sales +16.5% +17.4%

GDP YoY +9.4% +9.7%

  • India WPI rose 9.0% YoY in March vs 8.4% expected.

Commentary:

  • The Vix index touched the lowest levels seen since late 2007 today, breaking below the 15 handle:

    This will probably bring the permabears out of the woodwork again, decrying complacency and warning of an imminent equity sell off. However, what they continue to miss is the importance of the availability of credit on both equity returns as well as equity implied volatility. A model using various credit measures as well as trailing S&P P/E suggests that the Vix can fall to 13 in the coming months:

    This model’s error terms support the idea that implied volatility was underpriced starting from late 2005, but then overpriced since the sell off last year. The latter observation is further supported by a simple comparison of S&P implied vs realized volatility since the 2009 lows in the chart below. Except for 2Q2010, being short vol has been a very profitable strategy, with the 3m implied – realized differential averaging over 5 vol pts over this period. As I have noted in prior posts, this mispricing means that being short S&P variance swaps will likely continue to have excellent risk reward characteristics over the subsequent months.

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2 thoughts on “G3 Recap 4-15-11

    1. Hi Sid –
      You are right. However, it is the magnitude of the differential that we are concerned with. The Vix has averaged just north of 20 over the past year. An average IV-RV differential of 5 vol pts suggest that vol arbitrageurs have been able to generate nice returns over the past year.

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