Soft vs Hard data - Mind the Gap

The gap between survey based indicators (Consumer confidence, small business optimism...) and hard data indicators (Investments, Retail sales, Loans...) is at the widest levels we've seen in a while, indicating some emotional overreaction to future "Trump policies".

Couple of banks: Credit Suisse, Nordea, Morgan Stanley have recently voiced their concern along with Atlanta Fed economists

The Atlanta Fed and the NY Fed's GDP forecasts for Q1 2017 have also diverged significantly (respectively 1% vs 3%).

The Fed of Atlanta focus is on hard data while the Fed of NY model incorporates soft data.

I rebuilt two quick time series as well, for hard data I used the Atlanta Fed GDPnow as a proxy and for the softdata I used an average of the yearly changes for : Consumer confidence, Small businesses optimism and ISM.

The right graph shows a mean reverting time series, testing close to 0 for Hurst exponent* and Dickey-Fuller test *.

As observed, when the spread is above 8 the series tend to mean revert pretty fast, within 2 to 3 months.

So expect surprise indices and soft indicators to print lower in the next quarter.

Finally, for the anecdote, a friend of mine highlighted that most of the enthusiasm is coming from...Republican voters!

* Note that sample is small

The simplest Value graphs

"All else equal"  France equities offer more value than US equities

CAC vs GDP

S&P vs GDP

Well, well, well it gets more complicated from here for this administration. Health care is put to bed for now and the focus is on tax reform and tax cuts. Problem is...how to finance it ? Tariffs on trade ? maybe magically tax cuts will finance themselves as the economy roars back?...anyhow health care savings (350bn) are gone for now and it should hurt the trump trade, stick to flatteners and prepare for some sector rotations, so far the market is...confused if you look at the S&P closes!

Equities RV plays, Cash reserves on the move and debt ceiling looming

Interesting patterns into quarter end, the week was not shy of events : a terrorist attack, a big piece of legislation (health care bill), Japanese repatriation flow and first signs of Chinese defaults.

The Trump bull trade is slowly taking a back seat.
It is pretty evident in FX with DXY weaker, in rates (20bps rally) and inflation land with 5yr Break-evens taking a hit.
That said equities continue to be resilient, caution required.

Fast money is in selling mode (US equities) if we trust the SMART index

S&P 200 Moving Average distance to its index is getting stretched (lower graph)

S&P vs Credit (Surprisingly Europe Itraxx is the most correlated of the credit indices to S&P and has best mean reverting properties),  showing S&P too high

Not to mention the biggest US equity fund outflow (from the FT and EFPR)

Commercial bank lending
 First couple of stories are appearing about weak commercial bank lending.
As seen in the graph below yoy changes are turning bearish again

The deeper story might be linked to the debt ceiling which will start haunting congress before the April 28th deadline. Remember debt ceiling episodes are high volatility events for stock markets.

The treasury has already started withdrawing cash reserves from the FED and the pace is quite dramatic (300bn so far - white and orange lines)

The opposite side of the coin and linked to the reduction in commercial bank lending is the commercial bank cash reserve increasing at the FED (green line)

All in all caution in your US equity allocation! Europe and Next 11 EMG countries are a better bet.

Tactical trades suggestions: 

Long Cocoa

JPY stronger into Japanese year end, note that the xccy basis continues to correct as the system is flush in USD. Move USDJPY into GBPJPY longs.

Long BRLUSD, highest conviction trade

US 2/10 flattener, momentum is trying to turn but still carries -6bps a quarter

Short 5yr BE short (see previous post)

Watching 5y SEK BE, or receivers as some component of inflation turning lower

Favor Carry trades, long EM equities and FX.

Short Spoos, for the braves only

US FI carry

3yr is best carry+roll down on the curve but balance sheet expensive, 10s still hard to hold on curve from a carry standpoint

In the news...

Repo clearing finally a reality, cash lenders only.

"The Depository Trust and Clearing Corp., which processes securities transactions in the U.S., plans to expand central clearing of repurchase agreements in coming months to include cash lenders, in a move that may reduce risk in a key funding market for Treasuries trading."

Let's see if it motivates the CME to offer their own version of it, all to all.

Regulations, market structure changes and impacts on liquidity

This is a piece on how regulations, unconventional monetary policies and the dominance of both algorithmic trading and systematic strategies  have influenced the trading landscape.
Written in 2016 so a little aged but some relevant themes still shaping todays market structure.

Fixed Income market structure changes

Thoughts on US inflation trends - March 2017

Seven years of unconventional monetary policies finally gave way to higher inflation expectations.

CPI is printing above the 2% FED target and 10yr break-even crawling back above the 200 mark.

Nominal rates are marching higher mostly as a re-pricing of term premiums. Real rates if higher in 2016 remain pretty contained with 5yr rates still in negative territories.

Let's look at various value measures and some of the new dynamics affecting break-evens.

TIPS Liquidity Premium = Bloomberg inflation forecast – 10y BE

Using Professional forcasters survey instead of BBG forecast

 Measures of 5y5y forward BE inflation

5yr Break-evens vs CLA, retail gas (a smoother version of CLA) and Commodity index

Some de-correlation becoming apparent, other reflationary factors weighting more on BE besides commodities and energy (Fiscal policy, wage growth…)

Interestingly 5/30 nominal and real curves are diverging as 5yr real yield staying anchored in negative territory…suggesting 5/30 nominal too flat or 5/10 real too steep

2-5-10 nominal and real butterfly as a value indicator

5yr real yield repricing hard (white line) since early march compared to nominal yields. Are 5y nominal treasuries too cheap on the term structure, they are certainly good value on a cross sectional vs Europe, CAD or cross assets MBS, credit…

At this point 5y real yields look expensive both on term structure or vs commodities complex as BE shows.

To be fair, longer time frame show both markets fair, what’s interesting is that 5y real yield are more volatile due probably to real money positioning and liquidity constraints but a good mean reverting vehicle.

Term premiums have stabilized helping treasuries take a breather but might just build a flag pattern before resuming higher

Two measures of risk premiums

PCE vs CPI spread, stable for the last 2yrs but high vs 5y average

For a quick and dirty understanding of the differences between the two baskets http://www.businessinsider.com/pce-vs-cpi-weight-comparisons-2014-6

CPI fixed weights while PCE incorporates revisions

Shelter is a big component of CPI

Health care and financial services better represented in PCE

Recently Shelter measures have been more subdued but core goods elevated, higher oil prices may be having an impact. We are also entering a period when seasonality impact carry and support Tips prices.

The graph below shows CPI seasonality and how core prices tend to be higher from March to September. That said, Core CPI despite being adjusted for seasonality tend to be higher in the first half of the year vs second half of the year. This explains idiosyncratic relative expensiveness of Tips in one period vs the other, as carry becomes a differentiating factor. Might explains 5y richness on the curve that started early march.

Overall long term model shows 10 Real Yield too low by 25bps vs fair value at the end of February

Model is based on Real short rate (SR), 1y Momentum in real SR, changes in core CPI, Changes in GDP