The Macro Take: Ten days to Fed lift off but the market must hold
- The Fed doves can coo all they want, but the trend is 221,000 on NFPs
- This is trend over past three months, with jobless down to 5.1% (best in 7 years)
- With 10 days to go, the Fed will move if the markets can stay above 1,800
- It needs to keep above that until September 16 (-6% move from Fri’s 1,921 close)
- Should be an action-packed week with China back in and central bank meetings
- Meetings happening in New Zealand, Canada, Russia, Malaysia, UK, South Korea
By Kay Van-Petersen (KVP)
Live from the Asia Pacific!
A very good morning to everyone and wishing you all a positive, uplifting and most importantly profitable week.
We will only cover three things today:
- US non-farm payrolls and the Federal Reserve Bank
- The potential of portfolio volatility (as a directional play and/or portfolio hedge)
- The emerging Markets melt-down
All these points are revisits from some of the key big picture investment themes that were originally sent out on July 31 and later published on TradingFloor.com in three segments. Found here: Part One, Part Two and Part Three.
Ten days to September 16 – the Fed decision
The headline number missed massively - it was 173,000 against 217,000, but there are the upwards revisions of 44,000 coupled with the fact that the average three month nonfarm payroll number is over 220,000 (and that August is traditionally a weak initial print before bigger than normal upward revisions).
Add to this unemployment now at 5.1%, it leaves me feeling very confident about a September 16 lift off. Inflation will feed through, core inflation is stable and by the time we see 2% headline inflation, it is way too late to start hiking.
US Citi Economic Surprise Index clearly on an uptrend
However, the S&P has to hold. We closed on Friday at 1,921, down only 10% from an all-time high of 2,135 on May 20. I think Fed chair Janet Yellen can stomach a move to 1,800, a further 6.3% fall from Friday’s close and a total drop of around 16% from all-time highs. However a deeper fall than that and she may not have the political capital to bring everyone on board for a hike.
SPX must hold above 1,800 for lift-off
Can the market hold enough so as not to startle the Fed from not hiking?
The 2014 October correction low was 1,820.66, a 5.2% drop from here?
Yes, it’s a bit crazy to think that the first hike from the lowest of bases, after so long is being spooked by a correction from all-time highs. After all, we pretty much went up in a straight line of 200% move upwards since the inception of QE 1 in 2008.
The doves and central bank babies out there (hush hush, you want some more printing with that milk?) are saying the Fed should not hike given market turmoil, China slowdown, USD strengthening, etc. All ludicrous, the Fed has to do what is right for the US and put the horse (the economy) back in front of the carriage (the capital markets).
see more serious falls in emerging markets. Photo: iStock
What people fail to realise is the reason we are in this mess of “weakest recovery on record” and politicisation of the Fed – it is because we have not let things run their natural course. The US market/economy has been like a child nursed for too long from protective parents and people are complaining that this child is not growing up into a strong person. This was what I was trying to get across from my recent piece in the New York Times.
It is better that the market is on its toes – VIX elevated at around 28, US 10 yr treasuries at 2.12% – for the Fed hike, than to be asleep at the wheel when it happens. With the Fed implied probability of rate hike being 30% for September, I am clearly in the minority.
I also think a lot of the nervousness is around the uncertainty. The sooner we hike – whether it's one and done, or a gradual wait and see – the sooner we can move onto the next thing (watching emerging markets fall in the vacuum of space)
Theme 5: Volatility – a mark-to-market review
So volatility was investment theme 5 that was advocated at the end of July as part of KVP’s Macro Rosetta stone. Either as a directional play and/or hedge to the portfolio.
It is also something I have been banging on and on about for months, ie the VIX levels were too complacent. The table below is meant to capture the potential returns that one would have made picking up 12 and 13 strike ATM calls on the VIX over a number of maturities.
Oh and in case you were wondering, you could have picked up the VIX calls at even better level, we got under 11 at one point. Remember everything should be approached from a portfolio context, in this case not only would this have provided a handsome hedge, but in some portfolios it would have even added to the underlying profit.
So let’s assume a super savvy client came across KVP’s July 31 note, did their own further due diligence and based on a portfolio of $2m, decided to allocate 5% ($100,000) of that to going long volatility through the 12 strike October 21 expiry calls. That client’s call position would have returned $230,000 in profit (3.3 times the premium) as of Friday’s close.
If one had been more aggressive and focused around the September 16 Fed date, the 13 strike September 16 expiry call would have netted one $460,000 in profit. I am not sure where you are from, but where KVP comes from, $460,000 can buy a few rounds.
The point here is, being long volatility is the most obvious trade now, but it was out of fashion for a very long time. Used from a portfolio context and around key events that the market could be mispricing volatility, is how you pick your spots. And of course, this theme can still be played through puts on various securities.
Theme 4: EM meltdown, re-ringing the bell and breaking the drums on this
Ending with the biggest concern at the moment, by far! If we’ve spoken over the last few weeks you’ll note that KVP has gotten, more and more bearish on emerging markets, that it is almost scary. Ping the desk if you want the piece from August 24 or see From emerging markets selloff to stealth crisis.
The past week saw the Brazilian exchange traded fund (EWZ) down around 10%. Now where do you think the Brazilian ETF is, in regards to 2008?
Brazil’s ETF approaches 2008 level
So other emerging market-related ETFS like the main emerging market index (EMM), Malaysia (EWM), Turkey (TUR), Russia (RSX), South Korea (EWY) should be close to those 2008 levels right?
No, far from it - and winter is coming
Source: All charts, Bloomberg
How about those emerging market bond etfs, the likes of EMB and PCY, they must be in complete free fall right?
Source: Al charts, Bloomberg
No, even farther from it – they have held up remarkably well.
Remember, a credit book (unlike an equity book) is like a game of poker. Now that game works when things get bad, but not too bad. However when things go pear-shaped, there is a tipping point, called “I need liquidity and I am the mother of all price-takers”.
We are not there yet, but I think we will get there very soon. So these are interesting ETFs for those still looking for short exposure to hedge their ports or outright direction bets on emerging market and potential market contagion given:
- The Fed hike
- Stronger USD (regardless of Fed hike, everyone else is easing)
- Falling commodities (initially due to supply and stronger USD, and now demand waning)
- EM governments & corporates with huge USD denominated bond positions
- EMs with highly charged domestic issues (Corruption, political deadlock, autocracies)
- EMs with huge foreign ownerships
- EMs that have to price their trade goods through USD (regardless of being net exporters or importers)
- EMs whose largest trade partners are China, Japan and the Eurozone (all of whom have embarked on structural devaluations, with the former just getting started)
- Developed markets ill continue to outperform emerging markets
- Do you really need more?
It’s about to get even worse, don’t be surprised if we have capital controls coming to an emerging market close to you! Potentially one very close to Singapore, hmmm….
Lastly thanks to the savvy client (Mr. Global RE) that flagged EUM, it’s the reverse ETF of EEM for those that want to short the emerging markets ETF by going long the underlying.
At $16.6 million average daily volume for the year, it should be decent enough liquidity for most folks. Like EEM – where we have been recommending puts and short-side exposure – it is a US-listed and USD-denominated ETF.
Reflections, rants and other stuff
The blind G-20?
As I tweeted out over the weekend (@KVP_macro), I wish you could short headlines given the G20 forecast of growth to rise. Then after some thinking, maybe, just maybe it will be harder for the Fed to hike rates if the G20 admit that things are actually going to get worse. See article from the FT - G20 defies gloom to forecast rise in growth.
Awesome weekend spent most of it looking at a blank wall, drinking earl grey tea whilst eating cartloads of Kenny Roger’s corn cakes. Not to mention finally got our marathon session in for Game of Thrones Season 5 – that show is like the markets, you just never know who may get taken out! It’s just way too hard-core, cannot wait for the next season.
I’ll be in Shanghai this week for our official opening on September 10. For clients in town please give KVP a shout out if you are around.
Remember US not back in until Tuesday due to Labor day holidays – Happy Labor day!
Profitable positioning everyone.
Key macro data points to watch over next week*
Speakers/Other: Mon Sep 7 – Sun Sep 13
Fed Speak – Kocherlakota (9)
Meeting/minutes this week: Mon Sep 7 – Sun Sep 13
BoC 0.50%e 0.50%p (9), RBNZ 2.75%e 3.00%p (10), BoE 0.50%e 0.50%p (10), COPOM (BZ) minutes (10), BNM (Malaysia) 3.25%e 3.25%p (11), RU 11.00%e 11.00%p (11), BoK 1.50%p (11).
Meeting next week: Mon Sep 14 – Sun Sep 20
RBA minutes (15), BoJ (15), Thailand 1.5%p (16), Fed (16), SNB -1.25%p (17), ID 7.50%p, Fed (17)
Economic data flash
Lastly, life is very similar to investing/trading, you end up with what you put up with – so set your standards high, focus on the process and a profitable trading/investing to you all – be successful and don’t forget to enjoy the journey.
The effective use of our time is the most valuable commodity we have.
-- Edited by Adam Courtenay
Kay Van-Petersen (KVP) is Asia Macro Strategist at Saxo Bank, the home of social trading. In addition to TradingFloor.com, please follow him on twitter @KVP_Macro