I’ve recently been digging deeper into possible correlation trades, mathematical modeling approaches, and some other “meatier” stuff – hopefully that should tide you over while just enjoying the previous analysis I’ve given on the HSI and the Japanese situation regarding both the yen and the Nikkei 225.
Today kicks off the “event playoff” season in the US and Japan [and don’t forget the Eurozone meetings today and tomorrow – After-edit], with the year’s last FOMC meeting. Later on this week we get the Japanese election, and from there on out it’s all fiscal cliff and final year window dressing. Staying on Twist for a while, here are my thoughts. Main Recommendation under different scenarios:
- If they only de-sterilize Op Twist 2, sell immediately. I believe that the only incremental change under this scenario is the degree of absorption of risk, not the magnitude. There simply is no additional asset to buy into that would lift markets and cause asset allocation somewhere else. Given the ramp up into the meeting, the market is more likely overstretched than anything.
- They top off Op Twist to stave off the fiscal cliff adverse effects. I do believe this will be the choice of method, and together with OT I suppose net new buying would come in around $70 billion per month in long-end bonds. It still cuts below my back-of-the-envelope calculation of how big buying would need to be to stave off the fiscal cliff deflation chance, but given uncertainty over these decisions it would make sense. Alternatively, they could include a contingent language, saying “if X isn’t met, we’ll buy Y extra” or “extra buying will only come into effect if sequestration is adopted”. The asset mix forecasting problem becomes somewhat more complicated here, and I don’t think a “naked” recommendation is good here: watch the number and try to sense the fiscal cliff negotiations.
- Blowout buying commences where there is a total of $100+ billion being bought in excess of QE3’s MBS’s, split between normal- and aggressive buying, represented by long bonds and MBS’s respectively. The thinking behind this effective $1.7 trillion is largely that no matter what the US politicians do, calculations based on the total fiscal gap (or budget deficit under actual corporate accounting rules) warrants all possible efforts now while inflation is subdued and bonds are extremely richly priced. In this scenario, I guess buy foreign equities at all costs and try to take some profits on your long Nikkei225 or USD/JPY trades. On the latter, shifting to EUR/JPY or AUD/JPY could be a better alternative on the expectation for risk- or commodity rallies respectively.
What do I mainly expect to do tomorrow? Sell probably. The market is so primed right now and every indicator save gold has been flashing “ALERT – marginal easing expectations are excessive” throughout the week. Will we see a repeat of the Japanese unmet expectations when their last incremental easing failed to satisfy currency markets and the yen actually rose after dilution as happened earlier this quarter? Only a few more hours until we know!
Edit: Quick post-mortem.
Well, check box 1, we “met” expectations, so I am fairly interested in selling into any US strength that comes around on a lull-day. But then again, you probably won’t get those for a while with the fiscal cliff discussions.
What I fear is that the Fed can’t do more easing now under this scenario, given that they have already modified QE3 after about 90 days of life. If the fiscal cliff isn’t resolved, can they really go out again after 45 days and do something meaningful? Can they do it without looking like the laughing-stock BOJ when they did two consecutive purchase rounds in October and November? I don’t want to find out.
Markets are sanguine, partially because this is lunch break at Wall St. presumably. There was a little jump as the “More QE!” part was grasped, a little drop as the actual number probably sank in, and now a slow, methodical rise as there seems to be a greater understanding of what the “Evans Rule” (of not raising interest rates/tightening monetary conditions until 6.5% and falling unemployment has been ensured, as long as inflation isn’t seen at 2.5% or more) actually is. Slow momentum seems to be building, and the EUR/USD is perky, but the overnight winner seems to be Nikkei 225 futures which are jumping by half a percent despite atrocious liquidity and currency gains. OK, that’s it for tonight, wake me up at Dow 12 000…