EARLY LOOK: Discounting The Obvious

• keith
• February 19th, 2010

“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.”
-George Soros

Soros’ track record calling macro market moves speaks for itself. He was born in Budapest, Hungary. He went to school in London. He has worked against New York City’s traffic jams of consensus for most of his career. When it comes to betting on the unexpected, he’s no stranger to Discounting The Obvious.

For real-time risk managers, our daily task is to reveal consensus for what it is, then to capitalize on it when the timing is right. Sometimes consensus is right. Sometimes it isn’t. For the last 3 months, consensus has had the pace of global monetary tightening dead wrong.

Rather than get into an academic debate about whether the Fed’s move to raise the Discount Rate last night is an explicit tightening signal or not, we market practitioners will simply refer investors who are marked-to-market to the charts of the US Dollar and US Treasury Bond Yields. Markets don’t lie; people do.

You can pull up a 3-day or 3-month chart of either and the take-away is the same. Both the US Currency and Bond markets have been Discounting The Obvious now for 3-months.

The last holdout in the US Bond market has been the short end of the yield curve. That’s because it was being politicized and held artificially low. This morning, that’s changed. Short term yields (2-month US Treasuries) are shooting straight up, breaking-out above my intermediate term TREND line of 0.88% to 0.94%.

Taking a step back to consider where global market moves are versus our out-of-consensus expectations, we kicked off 2010 with 3 Macro Investment Themes:

1.      Buck Breakout (bullish on the USD, bearish on gold)

2.      Chinese Ox In a Box (bearish on Chinese equities, bullish on Chinese currency)

3.      Rate Run-up (bearish on Treasuries, bullish on Global Bond Yields)

Altogether, given the economic data coming out of both the US and China, these calls weren’t that difficult to make. Both countries continue to reveal higher than expected growth and inflation data. In the face of these facts, an assumption of an “extended and exceptional” US monetary policy of ZERO percent interest rates is both unsustainable and unreasonable.

In terms of the Buck Breakout call, a lot of consensus strategists in America started to justify US Dollar strength by virtue of Europe’s sovereign debt problems. While that may be a convenient explanation, it’s not the entire explanation. Since we called it the “Bombed Out Buck” in Q4, the US Dollar Index has had a +9.3% melt-up from its Burning Buck lows. There is a lot more to a monster currency move like that than just Greek and Spanish CDS.

I don’t think I have been too critical of Ben Bernanke. I simply had an inflation forecast that didn’t line up with his. This morning I am going to pat the man on the back for seeing the inflation data for what it is – inflationary. He Who Sees No Inflation is seeing the light. This is progress.

Inflation? Yes, it’s out there. The US Producer Price report (PPI) for January was reported well ahead of consensus expectations yesterday at +4.6% year-over-year growth. Now a man making CDO’s on Park Avenue in New York might not feel that in his cost of goods sold, but I can assure you that a Hungarian carpenter who uses anything with metal does, particularly versus this time last year.

In terms of consumer prices (CPI), it’s both hypocritical and political to call last year’s deflationary low of -2.1% CPI (July 2009) the Great Depression Part Deux, and at the same time not recognize that the year-over-year inflation report you are going to see at 830AM this morning as inflationary. Fortuitously, we had this reported inflation catalyst in our assumptions when we made both our Buck Breakout and Rate Run-up calls.

So what do this morning? Well, I’d actually sell some of your hard earned US Dollars to the consensus beaters as they clamor for them. The US Dollar Index is trading up almost a full percent. That’s a lot in a day, and as they say on a cold winter day on Simpson Street in Thunder Bay, ‘if you gottem’, sellem’!

At $81.19 this morning and $1.34, respectively, the US Dollar Index is finally going to be immediate term overbought and the Euro oversold. I am not making a call that we are no long bullish on a Buck Breakout. I am simply telling you to ring the register as consensus is finally starting to Discount The Obvious.

My immediate term support and resistance lines for the SP500 are now 1079 and 1111, respectively.

Best of luck out there today and have a solid weekend,
KM

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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