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HK Diaries part 4 – Singularity?

Buried in the sprawling, nightmarishly complex and totally pointless landslide of petty interference that is Mifid2 – there is a very interesting provision. I know, right – I was as surprised as you! Sitting in yet another interminable briefing on the topic, drawing spirals on my notepad, I suddenly heard this intriguing provision. From next year,  Algorithms involved in electronic market making must carry a unique identifier – and the trades they do will be reported to the regulator with that identifier attached.  This to me is absolutely momentous. For years, regulators and banks have effectively conspired to create a system of individual monitoring – individual bank employees now assume a huge amount of personal risk as they are responsible for upholding countless daft regulations, and what might be market practice one day is considered illegal the next. But this new provision effectively extends that kind of supervision of individuals to include individual algorithms. The next flash crash, at least in Europe where Mifid2 applied, will be analysed on the level of which individual bundles of code were trading, and presumably why. To me – the implication is clear. Algorithms are now being treated as participants in markets – not just tools that banks use.

When people talk about the “Singularity” in technology, they typically mean that some kind of AI will become intelligent enough to start creating and propagating other, even better AI’s, which is presumed to lead to some kind of either glorious utopia or terrifying robot world domination. But there’s a very crucial flaw in this scenario – namely the idea of “intelligence”. It’s very easy as human beings to go around using this concept, because we have a shared experience rooted in our biology of wanting certain outcomes, and so intelligence is  easily understood in terms of how we overcome obstacles to get those outcomes. For machines, there is no such goal/obstacle relationship. Of course, one can program an algorithm to contain a utility function, something to maximise or minimise depending on a set of constraints. It’s possible to imagine that at a sufficient level of complexity, these utility functions and algorithms maximising behaviour might lead to something that looks a bit like human intelligence. But that’s hardly the point. The algorithms already have a perfectly serviceable provider of obstacles and goals – us!

Seen like this, humans have largely been working in the service of algorithms for a lot longer than computers have been around. After all, a publicly listed company is a kind of algorithm – with a utility function (profits) to maximise, and a set of constraints imposed by law, physics etc. The humans who work for this algorithm provide it with a kind of mapping – interpreting the world into inputs that the algorithm understands. The humans here are giving the algorithm its goals, but the algorithm is providing the muscle to achieve them – sometimes literally in the case of a big company, sometimes computationally in the case of a modern trading algorithm – but the relationship between us and our technology is more complex now than that of tools. It is a two way street. Once a company or a trading algorithm starts, it becomes a part of creating the world that we live in. No human being ever decided that we should spend the majority of our time in offices, but the logic of the machines we created interact with our understanding of the world to make that decision for us. Computers like to be in air conditioned buildings. They like lots of humans in the same place to maximise network effects, and specialisation. In financial markets, they don’t like heterogeneity, and have no regard to the actual needs of investors. That’s why we have triple leveraged ETF’s on broad stock market indices, but no nominal GDP futures – the machines are configured to maximise profit, not fulfil the proper function of markets of allowing firms and households to reduce risk plan for the future.

In this context, the Mifid 2 insistence that Algorithms be identified, rather than firms, is quite radical stuff. But the substitution of firms for algorithms gives us a clue for how the AI alarmists could be very wrong. Ultimately, firms have nothing driving them but the goals set for them by people. Granted its  a two way street where people’s thinking can be driven by the conditions set by the firm they work for, but the willpower comes only from the people themselves. No matter how smart AI gets, and how much computational might it can muster, the involvement of human beings, with our single minded focus on  serving our own best interests, means that there’s no reason to expect machines to take over from us in the realm of setting goals in some sort of sudden revolution. Like public companies have affected the material conditions of the world, ever more advanced computers are doing the same – but its a gradual crawl as humans get used to being the thinking appendage of the systems we’ve built. Rather than a singularity, and an AI taking over the world, the machinery we’ve built is gradually assimilating us – as we become ever more inseparable.

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HK Diaries part 3: propaganda

Finance is widely considered to be a highly mathematical profession, indeed it’s the most common question I’m asked by people considering applying for a job in finance or wondering how I came to be involved. Well it’s certainly true that the day today grunt work of finance is highly mathematical – it’s essence for me is the stories we tell ourselves about what constitutes value, about what other people want, and about how people conduct themselves in exchange. If that sounds awfully high-minded to you and you consider your role within finance to be a simple numbers game then to be honest I don’t think you’re doing it right. Great traders, fund managers and market commentators understand the power of narratives as well as being able to crunch the numbers. 

I certainly don’t consider myself great in any sense, but being a humble student of the market I take a lot of interest in the construction of narratives and their propagation. I often like to say that last many people believe a great many intelligent things and have much original thought, it’s often the stupid and naive thoughts that we all carry around with us that have the power to really move markets. An intelligent or nuanced idea typically struggles to make it far past the mind of its originator – but catchy if daft idea can spread far and wide. Given that finances offer a game of second guessing, an idea does not even have to be believed for it to have an impact, so long is enough people believe that it is important in the minds of others it can and will drive price action. One elegant expression of this is the aphorism the technical analysis works because technical analysis works! 

What’s fascinating about the process of watching market participants get an idea stuck in their head is the fact that the ideas totally emergent and almost random, get a tremendously effective in the sense of generating large impacts. Because I have not yet moved into my new flat and am languishing a serviced apartment (I know Poor Me Right…) With a TV Hooked Up to cable news, I’ve been taking the opportunity, quite rare for me, to catch up on the kind of viral that are spreading outside of the financial world. Propaganda is distinct from this kind of emergent persuasive nonsense in the sense that it is deliberately contrived with clear objectives in mind. Propagandist deliberately set out to create content that influences the Minds of others in ways they feel they can predict. However, watching clearly partisan news channels such as Russia today it seems like a strange hybrid is springing up in The Propaganda space. Whilst the institution of Russia Today very clearly exists to further the interests of Russia’s kleptocratic government, it’s very clear that many of those contributing content do not share that objective. It’s a very strange spectacle to observe supposedly free thinking people being drafted into servant obviously political end. I remember when I was a teenager frequenting various forums discussing religion and politics, it would often be said the trying to co-ordinate Internet users was like herding cats. Somehow contemporary Russian propagandist seem to have solved this problem. 

When you really think about it though this is been the defining feature of every successful political movement. Truly successful ideas are those able to propagate themselves buy inculcating in those hearing them a need to spread them further. Often they can trump and take advantage of and trump ideas that appear in Direct contradiction. During the Cold War, American counter spies were baffled by Soviet agents Who, in the wake of the Kennedy assassination, variously claim that Harvey Lee Oswald was and was not a KGB agent or a lone wolf. American intelligent agents who believed Soviet defectors who told them that he was acting alone was suddenly subject to suspicion because of rampant paranoia about Soviet infiltration of the secret services, so despite the clear unimportance of his motivations, enormous amount of Manpower and stress were devoted to a kind of internal Civil War. This tactic of sowing confusion and doubt, and taking advantage of their enemies otherwise advantageous belief that they should be circumspect about intelligence they received has obvious parallels in the way that modern Russian propaganda merely seeks to sow division and doubt rather than to push a particular agenda. Of course it does do that too in another ways, but the principal purpose is to change the rules of the game of common knowledge from one where it’s possible to know the truth the one where truth is a relative concept, dependant simply on power. It’s obvious to see why a state whose advantages, such as they are, lie in tight hierarchical control and military aggression would benefit from pushing this view of the world. 

However if we’re talking about who has managed to set up the best self-propagating and self-sustaining propaganda operation, recent Russian efforts are quite pathetic compared to what has been achieved by the Western media. Despite its focus, it’s difficult to imagine how the limited resources of Russian propagandists will ever compare to Hollywood and the Western press. Russia Today’s commentators are proud of being called for useful idiots by the Western media, and I have some sympathy with that. At least they appear to be having fun and are able to put across their controversial opinions and compared to the hand ringing moral certitude and piety of many Western commentators they must feel they had it pretty good. Of course the fact that their number include George Galloway and Nigel Farage mean that the Western characterization is pretty much bang on. That doesn’t change the fact however the Hollywood actors whose movies promote American values around the world and journalists at The Economist who promote a highly America centric pseudo internationalism can probably be characterised in similar ways. They may not be idiots, but unbeknownst to them, they are certainly useful. 

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HK Diaries part 2 – leverage!

Hopefully there is some crossover between the people I know professionally, and the people reading this, such that some of you will have received my weekly email. For those that are interested this contains some broad brush thoughts about macro trading, and some much more specific thoughts about local rates markets in Asia, where the majority of my focus will be. If you’re more interested in that then these ramblings, please let me know and I’ll sign you up for. 

For those interest in the ramblings, I wanted to share a few thoughts this week on the problem of leverage. Not the normal problem people talk about, Ie being scared by there being too much of, but the thorny problem of what exactly people talking about when they’re worrying. The problem is that like many macroeconomic ideas, leverage as applied to whole economies takes a sensible and well-defined accounting concept and seeks to generalise it into a tool to understanding a whole system of economic actors. When talking about firms or individuals leverage is simple to compute and the consequences are simple to understand. You can objectively say that one firm or one person is more leveraged than another by comparing the ratio of their borrowings to their equity. When are  look at firms it can be a little complex to compute their equity, but fortunately for most complicated firms there exists a lively secondary market in their equity which enables us to say sensible things about which firm is going to be considered more leveraged than another.

However already there are difficulties here. We know that because of biases that prevail in financial markets, certain kinds of companies trade at higher valuations than others. This means that without private information, it’s difficult to compute objectively how relatively leveraged each company might be. But whatever difficulties there are in measuring the equity of firms, those difficulties and multiplied in every dimension by trying to measure the equity of an entire economy. In fact, in most discussions of leverage in economies people don’t even try, rather they seek to compute leverage as a ratio of debt to income. That’s not because it’s more correct to compute leverage as a ratio of debt to income rather than as a ratio of debt to equity, but simply because this is what is possible. No matter how hard they may try, no index fund yet conceived constitutes a representative slice of an economies assets!

This is of particular concern when it comes to discussions of leverage in China. Not so long ago, the Chinese central government was issuing edicts to its entire population on the subject of how many common pests each household should be responsible for eradicating. There were quotas for rats, flies, mosquitoes and aparrows- indeed we observed in eerie Echo of this campaign in more modern times with the nomenclature used in Xi Jinping’s campaign against corrupt officials. Although a very low and dubious utility, this did result in large provision of services by the population to the Central government. It can be said with certainty that these were not included in any sensible national accounting. Neither should they have been. This is a trivial example but the point generalises. In a command economy when much of the economic activity is not based around transactions, national income statistics that are based exclusively on transactions are likely to be a poor estimator of economic activity. 

There can be little doubt based on their actions and public pronouncements that the Chinese authorities recognise the efficiency of Markets as a mechanism to allocate resources, yet their can be equally little doubt that the phenomenon of those markets generating the kind of messy and unpredictable outcomes that we observe in capitalist economies is of great concern to  a technocratic and authoritarian government whose first principle is to retain control. Money markets are fast, agile and forward looking. Transaction and sunk costs are low, and absent regulation, barriers to entry are minimal. It should come as no surprise that money and debt markets have grown so rapidly in response to liberalisation. Indeed the forms the growth has taken, with burgeoning shadow banking and wealth management products, as well as highly questionable practices by corporates whose main business is not in the financial markets but whose use of inventory and access to cross border financing can look very bank like in nature, should come as no surprise given that the authorities are reluctant to permit financial innovation by banks. If it is physically possible to make a buck, someone will give it a go. However much of the economy, the real economy that is, remains subject to central planning and state control. You therefore have a transaction based financial market that exists to serve a mixed economy. Such a market composed as it is of transactions that can be measured, should look big by construction compared to economies where are the financial markets are not developed like much of the developing world, or economies both financial and real markets a highly developed and almost entirely based on transactions as in the West.

This is definitely not to say that China has no problem with leverage. Clearly some exceptionally dodgy things are going on. Bonds  did not sell off this week, despite the new two month Repo operation, in a vacuum, and whether you want to blame concerns about supposedly hawkish new members of the politburo, alarmism in the financial blogosphere about the inclusion of shadow banking assets in overall leverage calculations by the pboc, or just some unspecified and difficult to evidence cash call going on in the shadow banking sector – it’s clear that markets are easily spooked. At the same time, at least one major Chinese conglomerate, hainan airlines, is very clearly facing financial stress – taking a one-year dollar loan at rates of almost 9%, which in a yield starved world definitely seems an act of desperation. But there are more interesting points to be made here about the difficulties of a hybrid economy than banging on about how levered they are. Chinese conglomerates have been on a state-sanctioned foreign acquisition spree, taking advantage of extremely loose funding conditions and a lack of willing takers of loans. As financial conditions tighten, and non-performing assets need to be financed none the less, it’s likely that some of these conglomerates will run into problems – but equally likely that the authorities will do their utmost to prevent these problems from spilling over into the domestic economy. Whereas the Western conglomerate facing problems abroad might choose to cut jobs at home or decrease domestic investment, Chinese conglomerates as all major actors in the Chinese economy are stuffed with communist party members to prevent them taking actions that are in their interests but don’t align with policy goals even on the sly. 

Given my left wing leanings, if you’ve made it this far into the post, perhaps you think I’m engaging in romantic exceptionalism because I’m just so happy to see a communist country doing well. You’ll have to trust me this is not the case. I may not have the kind of reflexive Ill Will towards the Chinese Communist Party that most in financial markets have, but I’m no lover of authoritarian regimes regardless of what they call themselves. It’s always tempting to doomsay. It’s always tempting to be a seller of new highs. Witness the gnashing of teeth bitcoins rise this week. Understanding the underlying mechanisms for why things are the way they are is much more rewarding I hope you would agree!

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HK Diaries part 1: New prices, old problems

Slightly peculiarly, one of my chief joys in travelling and moving around is being a kind of economic tourist – examining and unpicking the weird and wonderful ways in which we exchange and trade with our fellows under different conditions and contexts. Recently, I’ve been lucky enough to have the opportunity to relocate to a new city – and I’m looking forward to sharing my experiences through the lens of a left wing armchair economist, puzzled and intrigued by what I see!

Hong kong is a deeply strange city – firmly rooted in its British colonial traditions, equally firmly under the heel of a one party state antithetical in values to much of those, but with its own distinct and proud identity and customs. Its financial system is utterly different to that of the UK, a big, old and heavily institutionalised economy with complex and contingent links to the outside world. Whereas the UK can rely on the economic credibility of a centuries old currency and government, and manage its domestic economy through storied institutions – Hong Kongs setup is faster, more flexible and rooted in globalism. Its currency is pegged to the US dollar by active intervention in markets for domestic financial assets – and banknotes are issued by 3 private institutions (with the exception of HKD10 notes, which are too burdensome for them to bother with) under conditions (of provable $ reserves) monitored by the central bank. The HKMA’s credibility derives from its relative success in managing the capital outflow problems inherent in a small open economy, and of course a substantial reserve of $ reserves and $ denominated liquid assets that it can use to buy or sell financial assets.

Relative prices are therefore different to the UK in some pretty predictable ways. Being a small open economy, internationally traded goods are relatively more expensive compared to labour – whose price is determined by nearby, less wealthy countries. An hours work in hong kong buys less cheese from abroad than an hours work in the UK, even at equivalent wages post tax because unlike the UK, Hong Kong does not have the luxury of selling financial assets to the rest of the world (i.e. borrowing purchasing power) in aggregate. What’s kind of delightful is to see this abstract bit of economics trickle down to the price of a lump of Tesco’s Cheddar in a partner local supermarket – my friends in the proper sciences will doubtless know the feeling of satisfaction at an experiment, even a thought experiment, yielding the expected result! Slightly less gratifying to have to pay so much for the essentials of life – but whilst I’m sure I’ll integrate with gusto, going without cheese is just a bridge too far for now.

Financial markets here have a different set of relative prices also – but not just the stuff you can look up on Bloomberg! The chief activity of the markets in currencies, interest rate derivatives and government bonds which I participate in is to price ever more difficult to imagine kinds of risk, and the more that is agreed upon, the more esoteric the trades and kinds of risk become. Markets for interest rate derivatives are nowhere near as developed out here, and move a lot quicker – thanks to the diversity of regimes and currencies that are traded, and the relative lack of transparency of the markets in those things. For better or for worse, the huge participation by public bodies in bond markets in Europe, the US and the UK has lead to muted volatility and stable prices for money at different times – another way to say that the term structure of interest rates doesn’t change very much. The set of things that “everyone knows” is much smaller. In the so called developed markets, it’s easy to play the common knowledge game and hard to think outside of it, especially as your job probably depends on it.  Common knowledge here is harder to come by – and much more lucrative to those who can acquire it. I’m looking forward to spending time doing so, and I am very keen to hear from anyone based in Hong Kong or the surrounds who’d be interested in discussing it over a beer. For my friends in the UK, I hope you enjoy these updates, and if you’re interested in the gory details of market moves, flows, trades and themes – please do comment or DM me so that we can work out a way to get those to you in a manner that suits.

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Monetary policy at Glastonbury

Glastonbury festival is a truly wonderful thing and you should go if you have the chance. I showcases the very best of humanity on every level. If you like making an effort to have fun, and have other people have fun, it is the place for you! This year however, one particularly odd incident occurred. I noticed several of the food stalls with signs saying that fake £20 notes were circulating, and that if one they found one, they would confiscate it there and then. I didn’t think much of it as I was meandering across the site to see “First Aid Kit” – who you should go and listen to right now for the remainder of the time it takes you to read this post! Later on, a friend told me that having handed what he thought was a perfectly good £20 to one of these stalls, they told him they had to take if from him. I was shocked! It is of course totally against the law to do this without providing a customer with a a receipt, and subsequently having the police examine the note before destroying it if it does prove to be fake. You cannot simply take money from people on the basis that you say it’s fake. As an aside, if you know anyone to whom this happened who might have a photo, or a name of a vendor that was participating in the scam, please let me know. I am discussing this with the festival organisers. Later on, the same thing happened to me, but as you can imagine, they had picked the wrong guy. I told them that they had two choices. Either destroy the note in front of my eyes by burning it or tearing it into little pieces, or I would call the police. They gave me back the note. The BoE carries a good page on what one should do in this situation: 

Now, Forgery is clearly a problem for a monetary system. But why? Most people would say something like “it is stealing from the government” or “it will reduce trust in the system” but actually this isn’t quite right. In fact, the only dis-benefit of a good forgery is that the original forger and his friends will, arbitrarily, be able to command a bit more of societies resources. In extremis I suppose one could argue that it could cause inflation, but given that materially less than half of all tansactions are carried out in cash, and these tend to be of lower value, and cash constitutes only £73bio of our £2.3trio money supply (3%), it would have to be very extreme indeed! Now, obviously it is important that cash be made hard to forge, otherwise forgery could become ubiquitous enough that the above problems poses serious challenges. But having made cash uniquely hard to produce, and having robust laws to punish forgers, there really is no issue with a few well forged notes circulating. Quite apart from the moral issue of jacking festival goers, who speaking from personal experience may not have 100% of their mental faculties to call on in that situation, it’s very clearly economically illiterate to worry about.

It also jars with the normal process of money creation in a modern economy. It’s now widely accepted that the Bank of England does not control the quantity of money. This is left to commercial banks, who create new deposit money when they extend loans. This is something that whilst widely accepted by those who take an interest in such things, is totally against everyday intuition and still rather baffles professionals in the financial industry who don’t spend a lot of time thinking about the nuts and bolts of retail banking. I absolutely blame economics teaching for this – and applaud organisations like Positive Money who are seeking to promote mass public understanding of this key aspect of the financial system.

Then, beyond that, we have the ever more crazed efforts by central banks to change the composition and size of the money supply using QE, special lending facilities, FX swap lines and all sorts of other gimmicks. Ultimately, all these are doing is using discretionary powers of central banks to “trade” their way to better economic outcomes. There is some evidence that it has helped, and some that it has made other problems worse. My personal belief is that by inflating financial asset prices in pursuit of consumer price stability and arbitrarily redistributing wealth, they are storing up huge problems. But this post is not for discussing that. It’s merely to point out that my friend handed over his £20 note because a pie shop at a festival told him it was fake. He was worried about the fake notes, but not about being robbed. The gulf between people’s ideas about money and reality is so vast that modern Central Bankers cannot possibly be said to have a mandate for what they are doing. The public needs to be told about what’s going on so they can hold them to account.

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Why I’m still not excited by Jeremy Corbyn

My political leanings are not a secret in my day job, so naturally as the resident Socialist on the dealing floor, I spent much of Friday being told that I was smug, a Corbyn Fanboy and a raving commie. At least 2 of those things are pretty true.

I was certainly delighted with the result. Whilst I voted for Owen Smith in the last leadership election, I am ever a labour loyalist. So long as the party remains functionally accountable to the working class through its union affiliations and membership structure, I’ll be a fan. Policy wise, I am not particularly discriminating. I don’t think governments can do all that much to encourage economic activity – though they can certainly make economic mistakes. Due to Labours commitments to raise government spending, at a time when real yields on gilts are sharply negative whilst inflation  and wage growth remain low, I thought that voting for them made good economic sense. Head and heart were both behind the Labour Party.

And indeed, I’m excited. I’m excited for the same reason I was in 2015 when the “Milifandom” lit up twitter with their irreverant fandom of Ed Milliband – although ultimately Labour did poorly. I was excited too when I met people canvassing who weren’t getting their news from the newspapers, and had formed some pretty eclectic opinions that were markedly to the left of where the media claim the “centre ground” in politics is. And I’m excited still by the dominance of left wing political ideas on social media, to which they seem very well suited. The enormous surge of people joining the labour party has been joyful to see – and at total odds with the prevailing narrative of political apathy pushed by most pundits, papers and media outlets. There is, following this result, quite a tangible feeling of a surge in support for the left that, frankly, feels fantastic after years of being told my ideas are irrelevant.

Compared to this, Jeremy is frankly a little uninspiring – in the sense that he is very much a product of these powerful forces, not a driver. The huge mandate with which he won the two leadership elections he has participated in seems to me more to do with the huge influx of new political engaged people joining the labour party than any great personal traits that he brought to the campaigns. His ideas are broadly consistent with left wing ideas, but they are not brilliant and novel. There is nothing whatsoever wrong with this. In my view, leaders should reflect the interests of their followers, and should channel their efforts effectively. This can be done perfectly well without the meglomiacal flair that many bring to leadership roles – humility, consistency and empathy are all wonderful traits that Jeremy appears to have in spades, but they are not the stuff history is made of.

Now my most fervent wish is for all those who joined the party for the sake of Jeremy’s leadership to remain engaged. The mass movement, the buzz, the feeling of progress is the real story here – and the sooner that message can be made to resonate with people the better. For we face trying times. The UK is likely to underperform economically as Brexit related uncertainty eats into demand from consumers who will want to save for troubles ahead, and firms who will hold off investing and building inventory for similar reasons. The fecklessness of Theresa May’s government will almost certainly exacerbate this – and the almost inevitable failure of our talks with the EU will likely lead to further political turmoil. It is the vital duty of the new labour joiners to form a movement capable of facing all of this down, winning the next election outright, and then governing well. It is all exceptionally exciting stuff. The sooner we can get over our fetishisation of the “dear leader” the better.

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Q1 in Review, trades for Q2

 

Price action in Q1 has lead to complaints in financial markets. It’s always the same – there weren’t enough trends! I got topped and tailed! Where’s the theme? Why is there no conviction? One way to work out the degree of buy side angst is to look at whether it’s been profitable recently to buy out of the money options – ie – highly leveraged bets in favour of large price moves. Broadly speaking, when it has been, discretionary macro hedge funds (ie, punters) are happy – because at least some of them made good money, some will have taken a slice of the trend at some point, and even if they didn’t make much themselves, they know investors will be excited by the performance of the leading funds and more money can come their way. Q1 saw ranges mostly hold, and popular positions (short bonds, long $) stopped out.

I can understand this carping, but nevertheless it can be a little wearing! Just because the most vanilla, liquid FX pairs or government bonds or stock indices haven’t gone in a big straight line this quarter doesn’t mean it was impossible to make money. I didn’t recommend my full suite of ideas for 2017 here on the blog as they’re a bit distinctive and one shouldn’t mix day job with pleasure – but a good number worked. I’ve been fortunate as well in my PA trading to be long stocks and the Euro – as well as even more fortunately perhaps purchasing some cryptocurrencies that are doing their best to act like a breakout tech stock rather than a spooky alternative investment. Before the cynics of twitter jump down my throat and remind me I’m but a sell side spiv writing puff pieces online etc, just relax chaps. I’m being open and honest about my positions, successes and failures, and it’s all small beans anyway!

Anyhow. what to do as we move into Q2? Close on most people’s minds is the French elections. It  would take exceptionally low turnout for there to be any realistic chance that LePen actually has a shot in the 2nd round, but she will probably get the largest vote share in the 1st round. US retail flows into European equities make me feel that this could result in quite a dramatic selloff in stocks – as investors who are *ahem* not used to dealing European stocks and may not be able to find France on a map decide that it may have been a bit rash to invest in a country where the principal opposition is promising to devalue the currency and default on debt. Sure, there are plenty of constitutional impediments to this, and smart people tell me that it won’t be that big of a deal if she wins, but I seriously doubt that many holders of equities and French bonds will figure that out on the day.  I therefore join the crowd of macro funds salivating over the potential opportunity to load up on risk at the point of the election for my PA!

Some trades that I like before then are, broadly, to be short in European front end rates. Yes I know the data has become weaker and various speeches have confirmed that they’re going to be ponderous about removing low rates, but 2y1y OIS (EONIA) swaps are -14bp – so the market is pricing no exit from 0 rates for over 2y! I’d pay this here after the recent rally. The strength of UK fixed income this quarter makes me highly circumspect about the cross market trade that everyone likes to do of paying £ long end rates vs EUR – but I’m also happy to have a paid £5y2y position on the book. At that maturity, you roll relatively flat, and don’t really have to fight the LDI flow as much as if you pay in the long end – and with historically low entry, I would load small size and tough it out. On the 2y1y EONIA i would bet the farm. The ECB’s ability to whipsaw the markets based on communication via leak is legendary, but they’ve shot a lot of bullets trying to talk rates and the Euro lower- so I say take advantage of their largesse.

With two shorts in my imaginary book I need a long! My Q1 recommendations were all either fwd steeepeners or selling vol so I needed the same then and recommended going long UK ASW, which I lucked out on – I was just picking an ASW trade that’d benefit from excess liquidity in the system, or a sudden return to looser policy, and the UK having been smacked on ASW post brexit and being on historical lows looked the right answer. It’s done well so I’d take it off, and enter instead some conditional bullish steepeners on the US curve – buying receivers on the front part and selling them on long end. The inconsistency and hollowness of white house foreign policy is beginning to scare me a little. War is a massive curve steepener  – you can’t put up front end rates but you sure as hell need to issue bonds to fund it. With the Fed no longer there to fund the US’s bond issues, the long end should be vulnerable while all the steepness currently residing in fronts and reds would come out. 1y2y 1y15y or similar did the trick for me in Q1 – so i’d re initiate here.

The macro investing community has  had a rough time in Q1 – but it needn’t. The narratives of ECB tightening, Brexit, Trumpaggedon etc are all on the table for Q2 this year – and buying them cheap now whilst conviction is low seems the way forward to me!

 

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