Lower Rates for Longer

Today we had a shocker of a AUD CPI number, AUD YoY CPI came in at 2.2% versus a 1.8%. This has caused AUDUSD to rally as the market believes that rates cuts are to be priced out as the AUD-USD interest rate diffrential increases. In interest rate space, the market initially reacted by pricing the AUD 1yr1yr fwd rate higher by 10bps, but the market has subsequently retraced most of the initial increase.
This increases my conviction that “long carry/long roll” trades in the short run is the way to go as tapering expectations decrease and get pushed further out the lure of making daily carry income will be too hard for many to resist…

 

Outlook (3)

NFP – tapering tapering expections

Sept payrolls were out today (they usually come out on the first Friday of every month, but the government shut down got that delayed).

They came in at 148K, much lower than the Bloomberg economist survey (180K).

As we speak 10yr US treasury rates have dropped more than 10bps. Credit is rallying further and AUDUSD is has rallied all the way back to 0.9717, credit is pushing (again!) at its all time tights and US equities is pushing at its all time highs.

Market is clearly focused on a delayed tapering (come on guys, usually a low NFP print is a bad economy!).  Whilst, the short term economy is hard to predict, I think “risk on” strategies that have a high carry/long roll or short rate volatility, in the near term will be the way to play the market.

So thinking going long credit, long divi stocks, long rates, short payor swaptions or long cheap (or high roll down) receivor swaptions makes sense as by the time of the Fed meeting after next there will not be enough data to significantly bring forward tapering expectations.

MS vs GS

Sorry been busy for a while, will try to spend more time on the website. But here is what is on my mind today:

Finally MS CDS is trading tighter that of GS’s. Buoyed by the latest set of results where more emphasis was places on annuity income such as PWM and a slow de-emphasis on fickle fixed income trading income has made MS, in the eyes of CDS traders, a stronger credit than GS.

This has never happened before and due to the structural nature of the change in the business mix, it would seem that would be the sign of things to come.

sg20131021117 (2)

Take advantage of the current turmoil in Indonesia

As Bernanke talks more about tapering the more EM assets have been selling off as years of hot money tries to come out of various EM countries mostly through a small (and illiquid) exit. Indonesia is no exception:

Indo

The above graph shows that since mid May the amount of foreign held Indonesia government bonds has decreased substantially. However there is still some more selling to go to even reach levels seen at the beginning of 2012 and therefore there is still more downside potential. This rush to the exit has created some interesting opportunities.

Getting the currency out of Indonesia is a problem. Should a foreign investor want to sell its Indonesian Government bonds it has previously bought it can sell the bond (and receive IDR onshore), but it will need to transfer the IDR into USD before it can take the USD out of the country.

This can be quite difficult in times when local banks do not have much USD cash to pay for the IDR. Instead, what offshore players have been doing is that they sell IDR through NDF. This has pushed the NDF to levels that may not make economical sense.

For example, the 2-month NDF is trading at 265 points above USDIDR spot. This currently implies and interest rate of nearly 16%!

However, if local corps and/or PWM have the ability to sell IDR (in return for USD) and hedge the currency risk with NDF they can lock in this 16%. Here is an example on how the trade would work on an USD1mm notional:

Step 1:

The investor sells IDR9,938,000,000 and buys USD1,000,000 at 9,938 (this is the current spot).

Step 2:

The investor enters into a 2month NDF contract and sells USD1mm USDIDR at 9,938 + 265 = 10,203, this means that the investor has to pay back USD1mm in 2months time in return for IDR10,203,000,000.

After the two months the investor would pocket 2.66%, which is around 16% annualized. There is no FX risk. The trick of course is to get an investor who can actually sell IDR in the first place as foreign investors do not have the ability to freely sell IDR. This is the reason why international players have not been doing this trade. The reason why local Indonesian banks have not been doing this is because the Bank of Indonesia (BI) does not local banks to speculate on IDR. We have heard of corporate clients and PWM clients doing this trade.

What’s an NDF?

A NDF stands for non-deliverable forward. It is the same thing as a normal FX forward except that for currencies which are regulated it is used as a way for foreign investors take views on a currency (as they cannot buy or sell the spot FX). Otherwise, it works the same was as a USD settled FX forward.

AUDUSD Short Squeeze?

Due to the China slowdown story for a long time I have not liked AUD.

However it seems that plenty of other people have this view (see graph) therefore today I have flattened out my position in case any substantial coming out of FOMC.

I will be looking to go long AUDUSD as a short term technical trade at high levels to catch the short squeeze as I believe AUDUSD has the potential to gap up when people take profit or cut losses.

cftc

Credit Spreads hitting a floor

What is obvious is that due to factors such as potential fed tapering is that credit spreads have hit a floor and further “risk-on” sessions won’t have a significant impact on lowering credit spreads:

pic1

 

Basically, what the above graph is saying is that throughout 2012, there seems to be a -ve relationship between the SPX Index is and the YTM of the JACI index (an Asian bond index).

But ever since the start of this year, the YTM of the JACI seems to have hit a floor and further increases in the SPX didn’t show mean a lower YTM of the JACI index (in fact there is a slight +ve relationship between SPX and JACI YTM in 2013). This shows that further improvements in risk assets (measured by the SPX here) will not have any impact on lower yields as they have had through out 2012.

Furthermore, taking a look at a regression between the YTM of the JACI Index vs 10yr US swaps, we can see that at low levels of bond yields there is traditionally a strong correlation between them.

It is only at high yields where this relationship breaks down:

pic2

In fact here is the same data as above with the same data points as above but stripping out the data when the yield to maturity is greater than 6.5%.

pic3

 

It seems that outright levels of the JACI YTM can be well explained by outright levels of rates as shown by the high R^2. (0.7732).

What have the Japanese been buying?

With the recent USDJPY rally and rise in the risk markets due to “Abenomics” some in the markets have anticipated an increase of EM demand from Japanese based investors.

According to Bloomberg, retail investors in Japan have bought an annualized USD16Bln in the Uridashi primary market, which is USD3.5bln or around 20% lower than what they bought in the whole of 2012.

In contrast, Japanese investors have seem to have been focusing on their own equity market, where issuance in JPY denominated paper (largely linked to equities) has increase from 2012’s USD23.2bln to USD28.12bln.

This has been reflected in the recent euphoric performance of the Nikkei (the 75.46% increase represents the performance of the Nikkei since Abe’s 2012 election victory).

NKY

Where in HK is safe to buy?

Due to lack of new supply and high demand for residential properties on HK Island, in a scenario where residential prices are decreasing, HK Island residential prices may decrease less than its Kowloon, East New Territories and West Territories counterparts.

Below is graph of YoY growth Hong Kong house prices by different areas in Hong Kong (source: Centa line index).

One can observe that during the crash of late 2008 HK Island prices dropped faster than other places areas. However, this was also preceded by above average house price growth in this market segment.

During the latest house price boom, West New Territories has outperformed the other indices, therefore, during a market downturn this index may under perform the others.

This coupled with the fact that (according to SCMP) 70% of new homes available for sale in the first half of the year are located in the New Territories this market segment may face market pressure should a downturn realize. This may only be exacerbated by the fact that during the coming year over 90% of the Land Sale Programme supply will be in the New Territories (Lands Department).

Centaline

Gold as a store of value?‏

The argument for gold as a store of value has been put into question recently as there was a large market sell of on the 15th April with no clear immediate cause.

But has it ever been the case that gold has been a store of value? and if so, what exactly is it a store of value of?

Should gold be a true “store of value” YoY performances of gold should go up and down together with real life goods, i.e. they should be correlated.

Below are graphs of the YoY return of gold vs the YoY Inflation index, House Prices YoY Returns vs the YoY Inflation index, and Oil Prices Returns vs the YoY Inflation Index.

In each of these cases, the argument for correlation seems to be far stretched.

For example, inflation has far under performed the return of gold for most of the past decade, which would had made it a great investment, but not as a “store of value” as inflation has been fairly tame. This may be an important distinction because it shows that inflation is not a major factor in gold prices. So gold prices may fall even if inflation goes higher. This has been the case in the past year where gold prices have dropped but inflation has been stable.

Therefore it seems that buying gold because it is a good “store of value” may be flawed.

USDCPI vs YoY Gold Returns

GoldCaseShiller

House Prices YoY Returns vs YoY Gold Returns

GoldYoYCPI
Oil Price Returns vs YoY Gold Returns

GoldCL1