abob's fundies journal

It's excellent seeing more traders with a macro interest out there : )

I'll be posting a few more bits over the coming days.

Merlin has convinced me I need to become more proficient at the fundies... So I am reading your posts with interest also... thanks for your analysis..

Scott

Looking behing the headlines, here are some institutional analyst quotes of interest. What's important here is not the Philly number in itself, but that it has really reinforced the recent batch of soft data and has acted as somewhat of a tipping point in creating a wholesale shift in the mkts view on the US growth trajectory. (NAB is cautiously pessimistic, Briefing.com make some interesting points and retain their bullish growth outlook, but the major houses have an outright negative view of the data).

I believe this type of material is the kind of stuff that provides a real understanding for global macro traders. Compared to the standard stories one finds in the financial press and general media, this content should be far more valuable in furthering one's knowledge. I hope you find it useful.

HSBC - The detail of the report was genuinely weak, with a number of key indicators falling into negative territory.

The question is whether today's report represents a true deterioration or if it just a "rogue" number, but both the headline index and the average of the components suggests an ISM manufacturing of 50. This in turn would be consistent with manufacturing output growth at 2%, versus current growth still running at over 5%

National Australia Bank - This is the lowest level for this series since early 2003, as shown in the first chart below, although the implications of this decline are diminished by the volatility in recent months.

The Fed is likely to be a little more circumspect about the release, waiting to see if the decline is reflected in the broader ISM Manufacturing survey.

http://i33.photobucket.com/albums/d5...lyfedsep22.jpg

Briefing.com - Our outlook sides with the fundamentals of strong underlying business capital investment and manufacturing production given strong corporate balance sheets. The Philly index is independent of its components so can provide a misleading read and is especially volatile given the small region covered. The manufacturing sector moves in mini-cycles compared to the overall economy and the regional measures move in even shorter cycles with far more month to month volatility.

Merril Lynch - Bottom line, just as with the weaker Chicago Fed NAI index (earlier this morning, plus 0.05) the Philly Fed reading suggests that the moderation within the manufacturing sector continued through the end of the third quarter.

In contrast the Empire index showed a slight bounce in Sep to 55.7 from 55.1. It's unusual for the two surveys to diverge this sharply and the signals for the September ISM report are now mixed but that said, our early take on ISM is for a near flat reading for September (final forecast to come).

...in this light, Bernanke's leanings in our view are shifting toward a neutral to easing bias rather than the de jure "tightening bias" of yesterday's FOMC statement. Overall risks appear more balanced now than at any time in 2006 and the data must be watched very closely for a shift to an easing bias.
...the FOMC consensus appears to believe that: 1) an easing of energy prices 2) the lagged impact of rate hikes 3) the slowing in housing 4) cash hoarding by business, are all contributing to moderate the economy going fwd, which in turn should moderate the inflation outlook going fwd as well.

The view held by some on the street that the Fed hikes rate of Q1 of 2007 is increasingly narrow and based upon a view that employment costs reaccelerate in Q4 of 2006 and Q1 2007.

To that factor, we add the potential risks of beginning of year new pricing increases - the last "lingering" inflation risk. That said, such a narrowly defined forecast of a Fed rate hike is controversial and the more likely outcome may be that the Fed's easing cycle is simply postponed for a month or two in 2007.

Dresdner - Employment index defies trend: While the shipments and new orders indices dropped sharply and showed their first negative readings in over three years, the employment index actually edged higher to +10.7 from +8.2. Obviously, labor market conditions lag economic cycles and recent business surveys showed a similar divergence between sales expectations and current hiring intentions. However, the forward looking part of the Philadelphia survey showed hiring intentions six moths from now were markedly lower in September at 5.7 from 17.7 last month. With some lag, employment growth is likely to follow GDP growth lower.

By the beginning of next year, we expect the unemployment rate to be back up at 5.0% (from 4.7% currently). We are now expecting just 1.7% GDP growth in Q3 and 1.5% in Q4. That is a marked deceleration from the 4.2% average of the first half of the year and should help reign in inflation pressures. The Fed is likely to stay on hold through the end of the year. By early 2007, we expect the Fed to start lowering the fed funds rate.
http://i33.photobucket.com/albums/d5...rphillySep.jpg

BNP - The index would be consistent with a manufacturing ISM index down to 52.5 in September from 54.5 in August (due for publication on 1 October). The situation will worsen further in the next few months, despite falling oil prices. We are maintaining our forecasts of lower Fed rates and bond yields.

My view - The ISM is a national manufacturing survey. It is a diffusion index - anything above 50 indicates net growth, anything below points to a contraction. What's so important about these regional surveys and the ISM is that they are at least a month ahead of the official data, which explains why the official manufacturing data doesn't usually impact the market to any great extent.

A hat tip to James Montier (an excellent equity analyst at Dresdner). In a recent research paper, he had a stab at the poor forecasting record of economists, saying that a very simple Fed model pointed to a sharp slowdown in growth in H2 (below 2%) but the majority of economists were still forecasting well above that. Simplicity wins again!

Back to the data, what are we to make of it? Well, I believe the market has sufficiently bought in to the sharp slowdown story and that to adopt this hypothesis now could be too late in the game. Indeed given the extent of move across markets (especially fixed income), I think the greater risk is that we have a batch of good data (at least better than the now downgraded expectations) and that could produce a short-term bout of USD strength. It's a very close call, one that is not related so much to my absolute view on the US economy as it is to where I think market sentiment presently stands.

On my side, there is the fact that prices have already moved quite significantly, that there is a divergence between the NY Empire survey and the Philly Fed (though the NY survey is younger and less reliable), and that risks still remain from the prices/inflationary perspective (see survey components and unit labour costs). It isn't a strong view and I would jettison it on a sub-50 ISM release or on a EUR/USD break-out above the highs of the past few months.

That is my interpretation of events. Whether you agree with it or not is not really the purpose of this post. It's about being sufficiently informed with valuable information that you can genuinely make up your own decisions.

PS - I've tried to be selective in my cutting and pasting so I hope I haven't egregiously breached any copyright.

Yesterday, I said I liked GBP/USD from the short side. Developing the idea that pound is overvalued, I think it would make sense to add a long EUR/GBP position of equal size.

Because of the strong correlation between EUR/USD and cable, cable is not the ideal vehicle with which to express a short sterling view. By adding a long EUR/GBP I hope to effectively sterilise my sterling view from exposure to EUR/USD, which I see at serious risk of break-out (see chart below). Even though I am modestly bullish the USD, I have far less confidence in a short EUR/USD trade than I do in a pure short sterling trade.

http://i33.photobucket.com/albums/d5...Sept222006.jpg

In terms of exposure, I am approximately trading the BoE trade-weighted index (it has a super high correlation to a 50/50 basket of cable and EUR/GBP). The trade-weighted index today hit a 15-month high, with expectating a rate hike in November from the BoE. I also expect a hike, but between now and then I see greater risk of data pointing to no hike than to pointing to an additional hike (ie perhaps there is a skewed return profile). In addition, a strong pound has a monetary tightening effect in itself, and the housing market has picked up steam once again but I believe this will be relatively short-lived and see more risk to the downside.

(So we have: GBP/USD short at 1.9010 (stop at 1.94) and long EUR/GBP at 0.6732 (stop at 0.6550).

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Data sidebar - Today's euro area data came in on the firmer side of expectations. July new orders rose 1.8% m/m (consensus 1.2%), suggesting industrial activity is firming up a little, while French consumer spending rose 3.3% in August, though July was just -0.9% and the June number was revised down to 0.9% from 1.7% previously). A little bullish for the euro, though the mkt doesn't really pay attention to this data on an intraday basis.

I have a little time on my hands so I am writing on the broader topic of global macro investing to give newbies an idea of what its all about.

I'm guessing most macro investors follow a similar method to myself; before they do any investing they do research, lots and lots of research. We formulate a hypothesis on where the economy is (yes, we are not even sure about this!), where it is going, and what the implications are for the financial markets. Myself, I take a cross-market approach, where my outlook for currencies depends not only on the real economy, but also on developments in other financial markets (commodities, bonds, and equities). Everything is related in this approach. This style of investing is totally discretionary, involving a lot of 'what-ifs', and it is often quite vague (a lot of of feeling around in the darkness). It can also be filled with self-doubt as there are few explicit signals to show you the way. On the flip side, of course, there is that feeling of joy and confidence when your thesis proves true and events play out broadly to your plan.

Once I have a thesis I then decide the following: how much to invest in the proposition (based on my stregth of belief), how market sentiment stands at the time, whether to scale in to the position or take an outright stance, and when I will bail on the trade - entry and exit can be helped by technicals (there is no downside in applying a little technical knowledge to your trade even if you are not a believer). Regarding exits, I tend to have a very wide pain threshold because I want the leeway to add to a trade if the price is cheaper and macro conditions remain stable - this is not averaging down per se because if conditions move to invalidate my thesis I will bail and reassess. A big risk for macro traders is that they put so much effort in to formulating an opinion that they become married to their trades, reluctant to junk their thesis in the face of mounting evidence telling them they need to reassess.

Timing the trade is a very important aspect of the process, particularly if you are trading extreme market conditions. For example, there are bound to be many funds who called the top in the commodity market way too early, who would have got caught with their pants down when oil and other commodities rose at an ever steeper trajectory, and on the flip side imagine the pain of those fund managers who went long oil at $76. Calling turning points is a big part of many macro trading strategies, but it is also where a great many fortunes are made lost. Sticking to the the commodities example, it seems crazy to be long crude oil at $76, but this is only the case in retrospect - in the futures market there is a buyer and a seller at every price (it is a zero sum gain), so there most likely will have be some funds who bought right at the top and who are still be holding on, hoping for a return to new highs. Timing and risk management are paramount, just as they are with any trading strategy.

Related to the issue of timing is the idea that moves in the financial markets can seem out proportion to the underlying fundamentals. Since a disconnect between price and reason can last for a long long time, it is important not to take the view that the market is wrong and that it must correct the moment you put the trade on. It's about asking yourself what could trigger a turnaround in sentiment and timing your trades accordingly.

Lastly, it's worth noting a key differentiator between macro investors and macro analysts/strategists - some individuals in the the latter group can become so heavily invested in their views that they become known as perma-bulls or perma-bears, whatever the economic weather. As an example, chief strategist Stephen Roach of Morgan Stanley was a perma-bear for many years and he has only recently switched his view to a more optimistic outlook (a contrarian signal perhaps?). These strategists believe steadfastly in their outlook, and perhaps rightly so - given that the economy is cyclical they will, in all likelihood, eventually be proven right (the adage of a broken clock being right twice a day comes to mind). However, the investor does not have this luxury and he may have lost his capital a long time before reaching this point.

I'm sure some smart alec's out there have managed to automate a global macro trading strategy but I am not one of them - I just could not bring myself to rely on econometric models. For most, macro investing is subjective and discretionary.

Thanks for taking the time to write this primer. I know it was for our benefit, not yours as you already know this. I have read thru it twice and will keep reading until I understand it... If not anything else I am persistent.

One question, though with all the talk of lowering interest rates here in the USA and a bearish dollar, Why would you be short on the pound. Would not the weaker dollar inversely lift the pound... you see, I am still learning..
Thanks for your patience.

Scott

This section is all about charts and relationships between economic variables. A macro investor is always asking questions and looking to the data to provide the answers (or at least to provide clues as to what the answers might be).

http://i33.photobucket.com/albums/d5...ngtriangle.jpg

The Big Picture - The ING presentation where I snatched the above diagram from is a general presentation on the economy and it said that each of the above 'poses a risk to stability'. I believe it is also important to consider the natural self-corrective mechanisms at play in the triangle, not just the risk. For example, concerns over the US housing market losing steam and a potential sharp slowdown in growth are reflected in lower bond yields, which in turn reduce mortgage costs and make houses more affordable. So an inverted yield curve is not just a sign of a possible upcoming recession but can also provide part of the solution to the problem. And asset prices, economic policy and the real economy of course have their own sub-components, which also have feedback mechanisms (eg: monetary policy is affected by fiscal policy, and bond yields affect exchange rates and vice versa).

I believe the triangle is a great way to frame your macro thinking.

http://i33.photobucket.com/albums/d5...arketrates.jpg

The Consensus - We must always compare our views to the market view because if there is no difference, you probably don't have a trade worth making. The above chart shows the market's best guess of policy rates going forward. If I think interest rate differentials are the main determinant of exchange rates and that differentials are going to evolve exactly as the market is pricing in, then there is no rationale for me to place a currency trade.

When you have a choice, the consensus is best determined from financial variables (eg futures contracts) than from Bloomberg or Reuters surveys, because analysts don't have hard cash on the line. That said, the good thing about Bloomberg surveys is that you can see the degree of divergence or convergence of views in the market.

Sidebar - A relatively new development is in the field of 'economic derivatives', where the market actually puts a price on the likelihood of an outcome of certain economic data (eg non-farm payrolls, retail sales, cpi) through the use of auctions. These derivative prices can be used to determine the market view instead of using the Bloomberg consensus, though the improvement over Bloomies is not that great; this just goes to show how random individual data releases are. For more on economic derivatives see here and here.

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I didn't even get on to the chart making! Its getting a little late here, so I have made this little guide in to four parts. If I don't finish it tonight, I will definitely have it wrapped up by tomorrow morning. All the best.

Hi smjones. Thanks re the comments, and I hear you loud and clear re the GBP/USD trade. That is why I added a long EUR/GBP leg to the position. This way, EUR/USD can move and the sterling trade should remain intact (ie if EUR/USD does down, cable goes up, but EUR/GBP should offset this). Note, adding EUR/GBP to the trade is not a hedge (I don't believe in hedges) but is a purer expression of a negative sterling view.

Re the USD, I'll admit I am marginally USD bullish, but this is partly because there is 'all the talk' that is USD-ive. From this position I believe the market is more likely short than long the USD and there is greater risk of USD appreciation on a string of positive data surprises than vice-versa. I'm trying to figure out where the market is going, now that we have a good handle on where it is.....it's all a bit convoluted, I know.

Thanks for the explanation. the indepth on the EURGBP helps me understand your position.... If I understand you, it is not a hedge. It is a correlated pair trade combination to negate the effects of the correlation between the EUR and GBP... Thus Isolating the pound. Thanks again for your time... Scott

Yup (I think). In an ideal world if EUR/USD is up 1% then cable and EUR/GBP should both be up 1% so your sterling position has effective protection against moves in EUR/USD and you are indeed left with an isolated pound trade. It isn't 100% perfect but its a pretty nifty simple solution to the EUR/USD correlation problem.

The 50-50 sterling basket comes with the added benefit of moving closely in line with the BoE trade-weighted index.

What follows is a hotch-potch of interesting charts and questions I have thought about recently. These are the kinds of things I look at before formulating a hypothesis. Whether I agree with what analysts are saying or not, at least I am able to visualise the data and draw up my own conclusions. There is a significant difference between economic analyst reports and general stories on the financial markets that are churned out by the likes of CNBC and Bloomberg - the latter contain more subjective content and spin and less pure informational content, which you need to form an unbiased independent opinion. I'm not saying the media is a waste of time - far from it - but for me it's all about making the best use of your time and seeing the bigger picture.

Chart Hotch-Potch:

http://i33.photobucket.com/albums/d5...blechartsI.jpg
(Source: ING Global Economy Presentation, September)

- The <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" /><st1:country-region><st1lace>US</st1lace></st1:country-region> housing market is clearly softening. Will it stabilise or keep heading lower? Charting helps tells us about the speed of the move. What will it mean for consumption? Perhaps we can look to the <st1:country-region><st1lace>UK</st1lace></st1:country-region> and <st1:country-region><st1lace>Australia</st1lace></st1:country-region> to give us a heads up? <?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" /><o></o>

- There appears to be a good inverted relationship between gasoline and US retail sales. This makes sense from a logical perspective. I am bearish gasoline, so this may help in cushioning consumption from the housing market slowdown.
<o></o>
<o>http://i33.photobucket.com/albums/d5...ingdouble2.jpg</o>
<o>(Source: ING Global Economy Presentation, September)</o>
<o></o>
<o>- US labour costs are still a concern from an inflationary perspective. Does the data support the idea that inflation lags the economic cycle hold up? The above chart confirms this common view, telling us that wages should not move much higher against a backdrop of a softer labour market, and should start moving lower shortly. The relationship is not so reliable however - see the first half of the chart! Thought - if next week's PCE inflation data (a Fed favourite) is much weaker than expected then the collective evidence on prices pointing to easing inflationary pressure may be sufficient for me revise my USD view to a more bearish view.

- In the <st1:country-region><st1lace>UK</st1lace></st1:country-region>, inflation is running well above the 2% target. Is the BoE going to act aggressively? The chart tells us that food and energy prices are a big driver and that core inflation is a lot lower. If energy prices continue to moderate and all else is constant, perhaps the BoE can relax a little. The market is already pricing in a rate hike in November and a good chance (around 40%) of another hike next year - but if energy prices moderate (petrol pump prices are down but gas retail prices have risen) then there is some prospect for the market to expect a less hawkish BoE, which would be GBP negative.

http://i33.photobucket.com/albums/d5...ouseprices.jpg

(Source: ING Global Economy Presentation, September)

- The <st1:country-region><st1lace>UK</st1lace></st1:country-region> housing market is vital to the economy and is stretched to the limit. Where will it go next? The chart shows how prices moderated to almost zero on a year on year basis, but have started to pick up again. What can we expect of the upturn? Well, mortgage approvals are a good leading indicator and point to much higher prices, but is it different this time ? By all measures, <st1:country-region><st1lace>UK</st1lace></st1:country-region> house prices are very expensive and the mortgage approvals data is a volatile series. With interest rates now at 4.75% and house prices already so high, it is cheaper to rent a property than it is to buy on an interest-only mortgage. Because of this I think scope for further gains in the housing market is restricted at best.


http://i33.photobucket.com/albums/d5...kecbktable.jpg
(Source: UBS Economics Weekly)

- Its imperative to keep in mind the target horizons of central banks (for both pure inflation targeters and the Fed). Even if inflation pops above the target/comfort levels in the short-term, if the drivers of the move are expected to be short-lived then the implications for policy may not be that significant. The more evidence there is of higher inflationary expectations becoming embedded in the system through so-called second round effects such as wage-bargaining, the greater is the likelihood of a policy response.

Reading FOMC statements and BoE minutes provides us with an excellent summary of the state of the economy. It also provides you with a great framework from you can start to assess the economy. How does their outlook compare with yours? Always remember, it is their thoughts and actions relative to the market that are key to rates. Where is the divergence in thought. Who is behind the curve - you, them or the market? Who is underestimating or overestimating certain risks.

...it's all food for thought eh. More charts to follow in the final part.
<o></o>
</o>

Hotch potch of interesting charts continued:

http://i33.photobucket.com/albums/d5...toricindex.jpg

(Source: UBS European Weekly)

- Analysts often design their own indices. Many banks have economic data 'surprise' indices, proprietary risk measures etc. The above is a measure of ECB rhetoric over time (I don't know how they went about calculating it but top marks for ingenuity!).<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" /><o></o>

http://i33.photobucket.com/albums/d5...bluecharts.jpg
(ING Prophet Global Summary)

- We had a very weak Philly Fed. What does this mean for the ISM? Bond yields are already pointing to a run of pretty soft numbers for the ISM (first chart). Using financial variables as an indicator for real economy variables can be a good idea because asset prices likely contain the best forward looking information available.
- What would are the implications for GDP (see second chart).<o></o>

http://i33.photobucket.com/albums/d5.../ZEWandIFO.jpg
(Source: Barclays Capital Euro Weekly)

- Turning to Europe, the German ZEW indicator may just be a survey of analysts but it gives us a surprisingly good handle on the German IFO. What is it saying about next week's IFO and what are the implications for the state of industrial activity?<o></o>
- The IFO survey is one of the few bits of European data that moves the Euro. Why is this? The chart shows a nice correlation with European industrial production data (which comes out a lot later than the IFO) and so doesn't move the market to any great extent when it is released.
- It is starting to look like world growth peaked in the first half of the year. If there is a global slowdown will it be as syncronised as the upswing? What would this mean for policy and rates?
http://i33.photobucket.com/albums/d5.../CADandoil.jpg
(Source: Barclays Capital FX Weekly)

- The strong correlation between USD/CAD and oil suggests we may do well to think of CAD as a commodity currency. I am bearish oil. How does this fit in with my view on the Canadian economy and BoC policy? Does it reinforce my existing view or does it run counter to it?


(All sources are publications over the past week or so)

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I hope the above has given you a flavour of the type of stuff that I look at as well as maybe giving you a few ideas of the types of things you can look on your own (you can access a lot of raw data from original sources eg: CBO, Fed, National Statistical Office). Before you get down and dirty on your here are a few tips: <o></o>
<o></o>

- Keep on researching until you have answered most of your questions (the 80/20 rule works well here, otherwise you risk trading paralysis by analysis). Try to figure out the themes in the market so your questions are relevant.
- I've always been weak on the econometrics side, but I'm the first to admit that statistically testing relationships can provide a lot of useful information. Just appreciate the weaknesses in statistical modeling and watch out for spurious correlations - they are everywhere!<o></o>
- Determining the causual relationship between variables can be very tricky. Before plotting variables together, try to formulate a logic for the relationship. Is it what you expect? If not why not? Are you missing another variable?<o></o>
- Relationships between variables change all the time. From experience, the relationship between economic variables tends to be somewhat more reliable than the relationship between an economic variable and a financial variable (eg growth and commodity prices/equity prices), or between two financial variables (say exchange rates and bond yields).<o></o>
- These days, I tend to look at other people's research to form a bigger picture outlook, but I can't emphasis enough the importance of making charts yourself - this provides you with a feel for the data and helps you appreciate the inherent weaknesses as well as the tricks used by analysts (eg: simple altering the axis on charts, or being selective in their time horizon to prove a particular point). If you are reliant on the research of others and read daily and weekly research notes, try to be proactive and skip through the backward looking reportage (it's generally of limited value).


At the end of the day, its all about using information to think for yourself.

Couldn't agree more.

I may be bearish the pound, but here is some more evidence going against my view. Sir John Gieve, deputy of the BoE and MPC member has given an interview with the FT, and his comments come across with a notably hawkish bias. This is new information, so I'm not sure why it hasn't given sterling a boost. Perhaps no one is awake and trading at this time? I joke, although the GBP tends not to move all that much in the opening session in Tokyo. The London traders will have the FT under their sleeves on the way to work in the morning, so I wouldn't be surprised if GBP jumped up a little around 7:00 UK time. It's all conjecture. (Side bar - I remember the Aussies sold the GBP a couple of years ago because their was a spoof documentary on the BBC showing a major terrorist attack in London - it was one of those scare your pants off documentaries, and it was made pretty well....but still, I mean, come on!).

Here are some excerpts from the FT piece:

Sir John Gieve has made clear that he seriously considered backing another interest rate rise at this month’s meeting of the monetary policy committee and came close to voting for a rise before the August increase was agreed.

In an interview with the Financial Times, the Bank of England’s deputy governor for financial stability also said recent oil price falls did not necessarily relieve global inflationary pressures.

Bank watchers are certain to scrutinise closely the comments by Sir John – in his first national newspaper interview since taking up his position in January – in an attempt to determine wheth-er he is a hawk or a dove.

Explaining that he had thought of voting for a rate rise before the August meeting, he added that the decision to raise rates last month had been “clear cut”, and said that at September’s MPC meeting “the issue was should we move again”. The disclosure will surprise some, since while the minutes of this month’s meeting made clear another rise had been touched on, it did not point to a long discussion.

His main concern, however, remained higher inflation, where he also saw pressure coming from higher import prices. “It may well be that we’re coming to the end of quite a long period where goods prices were being driven down by globalisation and the absorption of China and India,” he said.

Personally, I don't buy in to the idea that the disinflationary impulse from globalisation is fading out....not yet, anyway, and that last point is also countered by the fact that the pound is now pretty darn strong on a trade-weighted basis.
For the full interview go here: http://www.ft.com/cms/s/d5077f56-4c0...0779e2340.html

http://i33.photobucket.com/albums/d5...bppopsupFT.jpg

As Al Pacino would say, 'Woo hah!' It looks like the FT article had an effect. Of course, I was asleep at the time (Doh!). Note how cable is holding up quite well despite the move lower in EUR/USD - compared to the 7:00 (UK time) levels, cable is at the same level that it was at the open, while EUR/USD is some 40 pips lower. The market likes the pound this morning.

You can make a negative case for the pound from a structural perspective quite easily, but it is the cyclical drivers that the market cares about in the short and medium term. While these appear sterling positive from first glance, my inclination for a weaker pound remains intact. My thesis will surely be tested further.

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Elswhere, my stronger USD view receives a little support from a set of weak inflation data out of Germany for the states of Hesse and Brandenberg, and slightly softer consumer confidence out of France. It may not be enough to tell the mkt the USD is not a one-sided bet from the short side, but it is a start, and at least it has helped in bringing EUR/USD down off its recent highs.

Following the lower than expected inflation data out of Germany yesterday and the diverging components of today's IFO (current climate strong, future expectations deteriorating quite a bit), David Brown of Bear Stearns reiterated hiw view that:

"The recent slowdown in Eurozone inflation places a bigger burden on the ECB to get their skates on with tightening before they get caught short on timing. Eurozone inflation could hit as low as 1.5 percent-1.6 percent before the end of the year thanks to lower oil prices."

I just can't buy in to this logic. Is the bank logic's working backwards (ie - have they forecast aggressive hikes and are they are looking for ways to justify it?). Rate hikes may be easier to present to the public when headline inflation is high, but when there are question marks over the growth outlook, the euro is strong, and when oil prices have also pulled back, surely this data sends the signal of favouring a cautious approach in hiking rates rather than front-loading monetary tightening. Rates will go up, as signalled by Trichet, but the ECB surely isn't being pushed to acting quicker by the recent set of data.

I don't buy into it either. Granted the most recent CPI data showed a softening in inflation but the underlying figures for core inflation (CPI excl. energy) are still rising. Over the last 8 months the Core CPI exluding energy y/y are;

<table _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" bgcolor="white" border="3" bordercolor="white" cellpadding="0" cellspacing="0"><tbody _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/"><tr _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/"><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.4</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.5</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.5</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.4</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.4</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.4</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.3</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.6</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.5</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.6</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.7^(r)</td><td class="suiteCell" _base_href="http://epp.eurostat.ec.europa.eu/QueenPortletized/" align="right" bgcolor="white">1.7</td></tr></tbody></table>

Generally a rising trend. I still think we're on course for two increases of 0.25% before year end rather that one increase of 0.5% as the author of the quote above, imho, is implying. Unless next months y/y figure hits below 1.6% I don't think the central bank will be in any hurry to start cutting rates soon or even increase rates at a faster pace.

I have just pasted the charts below to highlight a simple but important point. EUR/USD and GBP/USD have a strong correlation (it is usually a case of EUR/USD driving GBP/USD rather than the other way around).

But, just because the correlation breaks down temporarily, this doesn't necessarily imply that one or the other currency pair will have to move up or down to make 'ammends' and 'catch up'.

For example, you can see in this morning's price action that EUR/USD dipped lower after the London open and has since retraced. GBP/USD, however, has floundered. Will it catch up? It may or it may not, but the strong correlation is not something to trade off alone. Even if correlations are mean reverting I believe this is an irrational basis for a trade.

The reason I say this is that the market is sterling negative today and this is reflected in the price action. If cable is lagging the upmoves relative to EUR/USD, or if the downmoves are outsized relative to EUR/USD, this simply means the market is a net buyers or seller of pounds. If a 1% move in EUR/USD is not exactly matched by a 1% move in cable, this means EUR/GBP is moving. This morning, cables failure to rally up with EUR/USD mean't that, by definition, EUR/GBP was rising. Further proof, then, of the GBP -ive sentiment in the market.

Here is the EUR/GBP to accompany the above two charts:

A little more GBP-ive grist for the mill from a late night Financial Times:

Error makes rate rise less likely

By Chris Giles, Economics Editor

Published: September 27 2006 22:34 | Last updated: September 27 2006 22:34


The Office for National Statistics on Wednesday admitted to an error that dramatically reduced the worry over inflation in the economy and makes a further interest rate rise less likely.

The ONS slashed its estimate of annual inflation in export prices from 3.8 to 0.6 per cent after it found it had introduced an error into the calculation.

After the change to export prices, the ONS’s estimate of overall inflation for goods and services produced by British companies and government went down from 3.4 to 2.2 per cent.
After correcting its mistake, the ONS now says the cash value of national income grew by an unsurprising 4.8 per cent annual rate in the second quarter rather than the unsustainable 6 per cent rate it estimated last month.

Policy makers often look more closely at the cash value of national output, since many believe it to be more reliable than the figures adjusted for inflation.

The Bank of England’s Monetary Policy Committee had expressed concern at the rapid growth of the nominal gross domestic product at its meeting this month. It said the 6 per cent growth rate was “consistent with consumer price inflation a little higher than its target”.

ONS officials explained they had been trying to eliminate a smaller problem related to VAT fraud from the national accounts. But a mistake crept into the computer programs, which artificially suggested that exporters were finding it easy to raise their prices in world markets.

Economists said on Wednesday night the lower growth rate in nominal GDP would remove one of the MPC’s concerns about inflation.

Danny Gabay of the Fathom consultancy said: “It looked as though inflation was rising more rapidly than growth – not any more.”


Copyright The Financial Times Limited 2006

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This probably isn't as important as say a revision in import prices or of course the CPI series, but once again this story came out very recently (in the late hours UK time) and it may not yet have been absorbed in to the market. I see no sign of it on Reuters. Don't know what Bloomberg is saying. Anyway, combined with arguably dovish comments from MPC member Blanchflower today, and a slight downward revision to GDP this morning, I think it could be tough going for the pound near-term.