The Macro Take: Sitting on the sidelines...for now

• Given the tight and very light volumes last week, we really need everyone back in their trading seats to get a lay of the land.

• Key question still remains, is this USD bounce the real thing? Or a head fake to another move lower?

• Being neither too smart nor too foolish, KVP is doing one of the hardest things a trader/portfolio manager can do, sitting on the side lines and waiting.

• Let the currents of probability dictate when it's time to act.

• Apart from some downside exposure through equity puts or VIX calls for the portfolio (equity volatility is too low), things are looking neither here nor there.

By Kay Van-Petersen

Week 13: End of Q1 2016: US PCE and NFP due, plus PMIs in full swing and liquidity should be returning to the markets post the holidays.

Overview

On the sidelines this week, given the very short and volume light week 12 – which in hindsight was no surprise given the big weeks of the European Central Bank and the Federal Reserve, as well as the quadruple witching from two Fridays back - and of course, Good Friday. Hope those with holidays had an excellent break.

The only thing that is really screaming out at me is equity volatility index, the VIX, is too low – unless of course the world is fixed.

1. Week 13.

2. Side-lines,

3. Reflections of a global macro neophyte.

Up ahead is week 13.

AU, NZ, HK, UK, GE, FR, DK still not back in until Tuesday after a long Easter weekend. But the US will be out the gates today, looking to set the trend.

There is nothing major on the central bank scheduled meetings agenda. We do have five different Fed speakers, including San Francisco Fed's John Williams who will be speaking in my adopted home of Singapore today.

On the economic side, it is purchasing managers index week galore – with the heavily watched countries being the US, the Eurozone, China and the UK. We also have final GDP prints out of the UK and Canada.

Apart from the PMIs, the key attention will be on the US PCE deflator out today and a well-known Fed favourite. In addition to super Friday US nonfarm payrolls, there will be the keenest ever focus on average hourly earnings to gauge if inflation is going up (trust me, reach out to any family member/friends you have in the US and they will tell you inflation is going up).

What KVP is watching this week:

Central banks.

Speakers/other: March 28 – April 3.

Fed speakers: Williams (29), Kaplan (29), Evans (30), Dudley (31), Mester (1).

Other speakers: No other major central bank governors scheduled to speak.

Meeting/minutes this week: Mon Mar 28 – Sun Apr 3.

BoK minutes (3).

Meetings/Minutes next week: April 4 – April 10.

RBA 2.0%e 2.0%p (5), RBI 4.0%p (5), Fed minutes (6).

On the sidelines.

So my thinking of a potential continuation of USD liquidation seems to be dead wrong judging by last week. Yet even those moves were odd, in the sense that it seemed primarily against the majors and less so against commodities and emerging markets forex. And again, the lack of volume makes me wary to read too much into the significance.

Key thing this week is really what trend (if any) gets set. Are we going to see a continuation of the strong bounce we got in DXY? It was up every day last week, closing up 1.3%. Or will we pullback & head to new lows on the DXY potentially targeting that 92.50 point?

DXY $96.273 was up strongly in week 12, around 1.3% for the week, moving up every day.

I am not sure – it’s an on the sidelines week (potentially period) for me, one to catch up on research, dig into some numbers, think, strategise and then press repeat. I need to really rethink everything, because if there is one thing we’ve seen from these markets, its that everything is possible. Currently my big picture structural views are intact, but tactically I am struggling.

Part of trading/investing, is not trading/investing. But we are always trading/investing, if you know what I mean. Everything is a trade, its just a question of whether you are:

• Cognisant of it (ie, you know that you have risk on and factors associated with it)

• Are aware of the skew (payoff/risk, benefit/cost)

• Are aware of the skew to time ratio

Again - context here is essential, i.e. Ten times may sound great, but ten times in 20 years versus two times in one year? Hmmm… currently I’ll take twice a year.

Now when I have eight digits in the bank account in a grown up currency, I’d probably take the 10 times in 20 years investment (context is key).

Are you aligned with the trade? (ie you want to make the Rio Olympics but you are eating your fourth cheeseburger for a midnight snack).

Week 12's potential INIL for a USD liquidation theme:

Overall the INIL trades I put out last week are doing poorly, whilst three of the trades stopped out in the money (First profit targets hit on both oil and MIB, two out of three of the targets on Daxhit).

Remember I roll up my stops to the entry price if the first target is hit and so on. The pros of this are that I protect PNL generation; the cons, you need the momentum to continue and noise after the first profit target can stop you out.

At the end of the day, whilst it was 11 separate trade ideas, it's really one big dollar play and a stronger dollar is crushing the USD shorts.

One thing is for sure, the Brussels bombings, Brexit fears (increased post the event) and the comment of Bundesbank president Jens Weidmann comment (not supportive of ECB move, “decisions went to far") are all very structurally bearish factors for Eurozone equities, the EURUSD and of course the Eurozone as a whole – economically and politically.

This should lend quite a bit of support towards overall USD strength and puts my tactical scenario of the Euro potentially squeezing to 1.15 in jeopardy (ie probably need another dovish Fed statement and EURUSD needs to hold above 1.12, ceteris paribus).

Overall though again, let's see how week 13 plays out with liquidity coming back into the market, Global PMIs and US PCE as well as nonfarm payrolls due.

Recent key franchise pieces.

KVP’s 2016 Global Macro View: Is this the year of the bear?

Gold/Silver: Probably the most important call that KVP has ever made and worth reviewing, given the pullback in some of the miners last week: Monday, January 25. The Macro Take: Get the picks out for gold and silver miners.

Reflections of a global macro neophyte.

Brazil politics is not a vacuum. The true global macro neophytes that pick up what KVP is putting down, will no doubt have heard about the epitome of drama that is going down in Brazil.

There is a deep, deep hole of a recession with one the nastiest politically fighting climates that I have ever seen. So recently Brazil's president Dilma Rousseff reinstated former president Lula to her cabinet to protect him from possible prosecution. There is a transcript of their phone conversation that was bugged, here is the link.

Now it's hilarious to read but not hilarious, as my Brazilian friends and clients will attest. Take a step back and note that these are two of the most prominent politicians in the seventh largest economy in the world.

The point here is not to single out Brazil (structurally it's still a short, it's in the cross hairs of EM/CMD not being fixed, added with the napalm of a burning need for political regime change).

The point is, this is politics and a problem with government structures (all structures really) where the incentives systems are not thought out well in advance (as opposed to say Singapore).

It's most likely happening in a country near you, in just a different shade and dance. It has nothing to do with being a “developed market” or “emerging market”, but the fact that people respond to incentives. If there are no good incentives/compensation structures then you end up with a combination of systems where there is:

1. Self-serving interests of a select few (those in the club).

2. Empire building and retrenched interests of those in the club.

3. Inefficiencies as those not “in the club” have no incentive to perform (in fact probably have an incentive to actively underperform) and those “out of the club” are running up a steep hill with the full force of the wind in their face.

4. Eventually these systems breakdown or blow up – this can take months, years, decades and sometimes centuries.

I am of course talking about governments and countries around the world - Europe and the US spring to mind. I am also talking about the central banks and central bankers around the world, including the Fed, ECB, BoJ, SNB, Riksbank, BoE.

I'll include in that company CEOs and senior management, take your pick of the sector space – it’s literally in more than 90% (if not 99%) of institutions out there be they schools, hospitals, charity organisations, religious groups, etc. I am of course talking about how to raise kids in society and interact with family and friends.

So what's my point here? What does this have to do with global macro?

Everything!

If you read The Big Short – they did not really cover this in the movie, but you tacitly get the idea when they go visit one of the ratings agencies – the author points out that most of the people that went to work at the SEC and the ratings agencies, i.e. the risk managers of Wall Street investment banks, were those who could not get into these same banks in the first place.

Implying that they are potentially not as smart, definitely not as incentivised to do as well on their job and probably also overworked and under resourced.

That is, how can the people who are supposed to be doing the policing, do so if they are vastly under resourced and under-incentivised? Or even as was in the case of the ratings agencies, have a direct conflict of interests – and of course they cannot and of course this has not changed.

It still boggles my mind: “So yes, you pay me and I will rate you. And yes, I appreciate if I don’t rate you A-, then you will not pay me XYZ…” Its like a fantasy fairy tale, set on planet Earth.

Think of Singapore, how can a country that is only 50 years old - that is, younger than a good portion of the human population, have gotten so far in so little time, with no natural commodities and in such a sustainable fashion?

They understood incentives, they understood that for government to be really as best of breed as it can (ie no system is perfect), it needs to attract best of breed people, so they pay their ministers very well.

Think about the firms that are always considered best of breed in their fields, GS, Point72, Apple, Google, FB.

Is it because they have smarter people than everyone else? Nope - but their cultures are built around understanding incentives and compensation, whether it's free yoga classes on-site, generous child support, to corporate retreats or to plain old forms of equity and cash, they get it. Culture is the only sustainable edge in any business.

So taking a step back globally, how human beings (politicians, central bankers, regulators, bankers, CEOs, senior managers) get incentivised has huge structural implications for how the geopolitical, economical and corporate currents develop for years/generations to come.

Yes, there will always be structural factors (young demographics, commodity rich in a commodity boom, high growth from a low base, first mover advantage), that can hide some of these ‘costs’ but it always comes back to bite whoever is left on deck at the time – and that’s the main problem.

What I mean is: “Hey it's someone else’s issue in 3/5/10 years time, I’ll be on my boat in Monaco then…” There is very little to no accountability, people over-promise and under-deliver all the time.

Understand that and you have yourself several trades for a lifetime.

-- Edited by Adam Courtenay