I might be wrong – I usually am – but I sense a developing sea-change in markets’ behaviour as good news ceases to be bad news and bad news becomes good.
For months the response to positive economic news has seen the screaming hordes stampeding towards the doors in fear of central banks reducing the flow of money for nothing. Gradually, however, during the past few weeks, and I really mean just the last few weeks, better news is being received by investors with good grace.
The US and the UK might have been closed on Monday, for Memorial Day and for the spring bank holiday, respectively, but the rest of the world was not asleep and better than expected first-quarter preliminary GDP figures for the eurozone and a raft of not-as-bad-as-expected releases out of Japan have been well received. The well-entrenched trend towards rising oil prices also does not seem to be treated as negatively as it might be and all of a sudden risk-asset markets have a spring in their step despite the next Fed move very clearly creeping closer.
Demand side
After the hiatus, today brings a slew of US data which, apart from the Chicago PMI and the Dallas Fed manufacturing activity index, are very much focused on the demand side of the economy. At the centre will stand the personal consumption and expenditure figures, which in a way measure the US economy at street level. It is here that the buck is made and spent and therefore the numbers are truly relevant to the Fed, not that I can see anything specific to stop the impending rate move.
The income and spending numbers are then followed at 9:00am New York time by the Case-Shiller house price index, a key driver of the much-vaunted “wealth effect”. Two decent sets of numbers today and it becomes, in terms of monetary policy, simply a matter of lighting the blue touch paper and retreating. My old friend Alex Moffatt of Joseph Palmer & Sons in Melbourne wisely pointed at the US two-year note yield which has risen from 70.5bp on May 9 to 93bp now, which tells us that the front end of the curve now has the tightening pretty much fully priced in. During the same period, the yield on the 10-year has “only” risen from 1.70% to 1.87%, which represents something of a bear flattening. At 92bp I’d think the yield curve in the medium to long term to be too flat given the forward risks and I would feel prone to run either short duration or a steepening bias. Do I really want to locking in sub-2% 10-year yields? Watch the PCE deflator, which is possibly, were Janet Yellen and her merry men limited to seeing only one single economic statistic per month, the one they would choose as it is the most concentrated of distilled essences of the real economy.
Blast from the past
I spent the last couple of days last week touring the City and Canary Wharf where I met plenty of low friends in high places but it was here in the Oxfordshire Cotswolds that the past caught up with me. I received a visit from a dear chum from the heady days of structured products before the global financial crisis. The person in question was Frankfurt-based and sold credit structures for ABN AMRO into the German market. Old hands will remember the way in which ABN AMRO knocked the cover off the ball with its invention of the constant proportion debt obligation (CPDO). It was a highly complex index-based product that stole a march on all the fancy structures being pumped out by the US investment banks – think Bear Stearns and Merrill Lynch – by being both technically more advanced and, as it was credit default swap index-based, not susceptible to much of the deliberately toxic content of some of the “bespoke” synthetic CDO tranches that significantly contributed to bringing the house down in 2008.
We spoke about how those investors who were allowed to keep their iTraxx index-based CPDOs got their money back in spades. I was reminded of the same situation in the reverse FRN market in 1992 where investors who were squeezed out by wild and random marks to market when the market was in head-long panic and who lost their shirts, their shorts and often their jobs. Those who had the temerity and, not least of all, management permission to hang on ended up making out like bandits. The relative stability of today’s uncertain markets points towards some lessons having been learnt, among them that diving headlong into the sea without a life jacket as soon as the first rat has left the ship might not be the wisest of long-term investment strategies.
The race for minute-by-minute mark to market might satisfy some needs but certainly not all. Diminishing market liquidity makes a mockery of second-by-second mark to market and hence we have another case proving that transparency and liquidity are nothing more than second cousins who don’t really like each other that much. We were taught as children that patience is a virtue and that good things come to those who wait. Fed or no Fed, I’d be a small long for choice.
Meanwhile, more French transport workers are going on strike as the country’s trade unions demand the cancellation of the 21st century and the reintroduction of the 20th. In Greece the impossible remains impossible and self-deception continues to reign supreme, especially among the creditor nations’ politicians if not among the humble Greek and Northern European taxpayers,, who have to fund the charade. Maybe they should take a few minutes and listen to Donald Tusk who suggested that “the spectre of a breakup is haunting Europe” and that EU leaders promoting utopian “illusions” of a united Europe have lost touch with their peoples.
Finally the FT reported this morning that, horror of horrors, some hedge funds are commissioning exit polls on Brexit Day to make money from knowing the probable outcome before the official results are announced. Yeah? And don’t football teams spend money on better players in order to score more goals than the opposition?
Have a good albeit foreshortened week.