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Macro Update [07/01/15]

Some items to consider.


Euro-zone:
As much as market participants may be tired of a recurring headline issue since 2010,
the success of holding together the EMU at its peak participation have rolled further out
of the money, with escalating complications for the single currency experiment. Thus,
EZ debt impasse issues have no place to be tucked away by market participants, and
ultimately dominates their trading psychology in the interim, as seen once again with the
myopia on London session activity in currency and futures markets.
The policy events are out there, the details have been touched upon by many, and the
unknowns are at the forefront. As participants sift through data feeds and analysis, its
important to think twice before believing on what intuitively seems sensible, as well as
adequately adjusting for positioning biases that often lead to painful curve-fitting
rationalization.
During crisis management, the objective policy measures are not always ironclad, and
the resulting subjective trajectory is heavily determined by psychological equilibria, and
not from fundamental concepts or break-fix procedures. If Euro-zone is an uncontrolled
experiment, then resolving downside risks means implementing a template that is
designed on-the-fly. This is where things get interesting in terms of handicapping policy
events, and trading the shifting odds.
Simply stating doom and gloom contagion from a Grexit is a false blanket statement.
The polar opposite yields equally false pretenses, as its naive to think that a Euro
reconfiguration can only mean a larger EMU. Just because there is no concrete
procedure on decreasing the size of the EMU, that doesnt mean template legislation
(that is likely underway) wont take a precedence in resolving special circumstances.
(Special as in we didnt think this would happen) Its this notion in crisis management,
that makes a Grexit possible, though, timing this with objective odds will require a lot of
luck. Has Greeces recent fight with its official sector creditors advanced the delta of a
reduction in EZ member states? Yes. But, concluding the end-game is likely to involve
many surprises, due to the nature of template legislation during crisis management,
which diminishes the payout of gaming event-driven scenarios.
During negotiations, hard deadlines can become soft deadlines, and final voting
quorums can lead to subsequent voting quorums, which puts doubt into timing what
final or end-game really means. It is also key to consider the human nature tendency of

reappraisal (a cognitive one), given the emotional and social unrest the Greek impasse
has spewed, as negative consequences become real, they get revisited and then
framed by policy leaders to reconsider a constructive approach, regardless of how futile.
So, despite Greece initially defaulting on the IMF repayment, currently with no further
EZ rescue funds, a creditor/debtor agreement still ways apart, and a ECB ELA enigma
with Greek banks, the break in the bend is not just policy action, but a matter of how
much pain Greece can take on a socially unrest and financial & economic scale.
Unfortunately, staying with the Euro on their terms is not going to happen, despite what
any time is bought. After each round of failed rescue measures, the social, financial, and
economic consequences push the Greek people further towards the upper pain
threshold. Devaluing internally is proving unsustainable despite the faults of both
creditors and debtor when assessing the impact of rescue mechanism liabilities. Human
nature tends to avoid such necessary external devaluation in this specific case, thus it
wouldn't be a surprise that pendulum of pain swings again, though ultimately enough
will be enough (like closing out a losing position). This sequence can take a form of a
consistent creditor rejection of extension proposals, an ECB stalemate on ELA funding
to Greek banks until further action, an initial no on the July 5th referendum to avoid fear
of political suicide, and then further emergency policy meetings as the Greek banking
system deteriorates, and a compromise is born out of chaos, which will breed rise to
new (ineffective) leadership. This sequence seems to fit the psychological tendency of
avoiding immediate necessary pain to ultimately face a larger pain the future, the further
the decision come to an agreement (or externally devalue) is put off.
In other words, another iteration of the Greek tragedy before the Grexit scenario
reaches fruition is still in the cards, despite increased Grexit odds near-term. The
counter-scenario is that given the Grexit ball has already been in motion for years, that
this is the dawn of the drachma (which equally many seem to think). So one has to ask
themselves, how would a Grexit look like? The recent events certainly portray the latter
scenario, but the former scenario can still happen, just with more intensity if so, as the
end result remains the same. So timing the final iteration of the downsized Euro
reconfiguration depends not on the details of systemic Grexit complications and the
scenarios that will result, but the pain threshold of a very proud country. With great
hubris, comes a high tolerance for pain. So these are some things to consider before
placing or while managing Grexit trades.
Meanwhile for the rest of Europe, at least the ECB has, intentionally and unintentionally,
created a contagion firewall thus far, with its various intervention policies outside the
scope of traditional monetary policy which began with the tactical use of their balance
sheet, and there has also been a light at the end of the tunnel for some of the PIIGS.

Going forward, markets (regardless of how volatile) have accepted the reality of a Euro
reconfiguration, and lets not forget, that every year of the futile kick the can is another
year of a global recovery (though very uneven), thus would help cushion any ripple
effects of the inevitable (whenever that may be). Its important to be reminded that, as
usual, people tend to misconstrue a negative situation to a degree that stretches
beyond reality, and eventually come to their senses, and their actions (whether policy or
market positioning) reflects that over time.
China:
Theres a difference between an economy overheating and an equity market
overheating. Sure, A-shares and red chips have seen their light of day this year, as GDP
is number one globally on paper, but the resulting bear market correction shouldnt be
coupled with the assigned stories of hard landings, shadow banking collapse, corruption
justice, and anything else that would spook risk participants, especially after the recent
rate cut stirred those fears. Needless to say, economic rebalancing does coincide with
the long-term growth rates being paired down, but it is too easy (and wrong) for market
participants to cling to the various negative biases toward China when assessing asset
price movements with economic trajectory, as they act on intuitively compelling
reasoning at the moment. The economy and markets often diverge, and the excessive
financial and economic blanket statements on China undermine the reality of position
shakeouts, thus markets again overstate the impact of reverting prices on long-term
trend strength.
Puerto Rico:
What a better time to bring up lingering debt obligations with the Greek impasse leading
the way. Citing high debt-to-GDP levels and debt servicing agendas is rather amateur
considering how credit events have been dealt with in recent years. The lesson here is
to not overreact, as weve seen this in the municipal and local bond space in recent
memory, and for the time being. This time is different doesn't seem to carry much
weight when assessing market positioning in the near-future.
Japan:
The beauty of stabilization appearance and effective goals for the BOJ/Abe still drive
market psychology in the land of the rising sun. A brief return of inflation (though under
target), FX depreciation, and a three-arrow medicine for growth seemed promising, but
reality points to continued challenges peddling uphill, despite trader psychology (ie. Yen
positioning on moral suasion).The recent light economic data dampens the runaway
USD/JPY positioning, though there are global influences to consider, the experiment is

still underway, and without toppled expectations, the Yen continues to move in
expressively tighter ranges as it squanders off the highs. The night owl trade of volatility
seems a distant past, until further notice. But, would certainly ignore the flawed US is
Japan crowds, which also seem to be the ones that confuse/ignore export % of GDP
with services % of GDP. And meanwhile, reforms tend to be more theoretical than
applicable, in terms of desired resolutions, thus wouldnt count on any policy-driven
culture shift anytime soon.

Russia:
Exhaustion of Russian geopolitics has aged considerably from the state of market
emotions last year. Energy seems to have found an equilibrium after the wheels-fall-off
momo of late last year screeched to a grinding halt. Tying in fundamental and derivative
stories related to the price of oil and the many biases that ensue, may have comforted
position traders, but ultimately, one cannot stray away from the fact that, causation
biases aside, collateralization and finalization of crude contracts exacerbates a premium
that succumbs to excessive speculation and volatility. Thus, would trade positioning
frameworks coupled with psychological awareness (for right and wrong reasons), and
not so much the energy derivatives, geopolitics, and supply/demand data.
Emerging Markets:
Punt to the US. (Follow the leader, absorb market headwinds, and revisit).
United States:
The positioning volley based on Fed recalibrations at the turn of every data release and
every FOMC meeting continues to dominate speculation. The main crowds seem to be
polar opposites, as in too much faith in the Fed vs. not enough faith in the Fed. Its
apparent that policy bears move goalposts in terms of disagreeing with every Fed
indication of policy adjustments against their beliefs, and the systemic bets have proven
(and will continue to be) the wrong move, regardless of initial reaction, as profiting off a
correction doesnt justify consistently shorting new highs on a risk-adjusted basis. Upon
recovery recognition, many people were quick to undermine the CB policy efforts, and
upon economic traction, crowds tend to overshoot the recovery. But, if a recovery is a
recovery, regardless of how slow (psychological factors have the most potent effect on
pace, regardless of what is deemed structural), then the doves slowly get taken by the
hawks despite how USTs have consistently supported them. The timing remains an
enigma, and the bond liquidity does wonders on sustainable pricing, but the US still
remains on a path in the right (but slow) recovery trajectory. However, the economic

cycle is still ways away from the excessive greed it takes to chase mutiple rate hikes to
ultimately risk a substantial downturn, as there are many developments that need to
happen first before worries of overheated credit cycles and the resulting risks from that,
can come to fruition. Betting on the blowout in spreads requires patience, and the
rewards have been brief. It still seems curve prices are never at a level most market
participants are content with, as there always has to be a pending disaster, thus this
skewed perception of the Fed still exists, and will likely pass-through with stronger data,
a more confident/aggressive Fed, and an accelerated demise of gold bugs. Until these
events happen, the ebb and flow of muddle-through recovery (post-disaster myopia
psychology) keeps a lid on long-term expectations.
The small window of EM liquidity on US accommodative exits are something to consider
when sustainable curve buying ensues, but the degree is not as extreme during the
taper tantrum days, due to markets being more psychologically prepared from every
year of recovery and subsequent policy changes. Positioning shifts cannot be ignored,
but shouldnt be overrated too.
In terms of FX, the USD is still the long-term winner, regardless of subsequent
positioning shakeouts from the global liquidity rush becoming overzealous from time to
time, and the mostly completed unwind of policy bear dollar shorts. Long-term Euro
reconfiguration uncertainty is adds a USD tailwind, despite any near-term Euro tailwinds
if a Grexit (whenever that happens) is aligned with thoughts of a stronger Europe, thus
stronger Euro psychology. There still exists upward forces to the greenback in the longterm before traditional correlations come back, and globalization with finalization amidst
contagious CB policy ideas give rise to the strength of abroad market forces, thus
impacting trader psychology and their appreciation/depreciation trading decisions.
Final Note:
Policy makers make mistakes, and debt restructurings are too often skewed too negative.
Political theater and the unfortunate cultural uprising overseas will make an interesting stage for
pricing this month, but nonetheless, chaos breeds momo, and momo is good for trading.