Trade Idea Generation. the process of writing and thinking..LETS DO IT

[DcifrThs]

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PPP is horribly horribly off when looking at Canada vs USA (canadian prices 10-30% higer across the board). But of course it takes a few years for these things to work, hence my opinion that there has been a real interest rate hike of 3-4% in canada during the last year.

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how elastic is our demand for canadian goods?

Barron

[DcifrThs]

this process has been going verrrrrry slowly for a few reasons, the main one is the pain in the ass getting even monthly data.

despite the problems, i've accumulated some very good data from 1960 and now have built a respectable (nonupdated unfortunately) database fromw hich to make pretty pictures to go along w/ my anaylsis.

be that as it may, i wanted to throw out the main positions i'm looking at now and hoepfully get some feedback.

1) long EM credit default swaps. these have fallen (i.e. spreads jumped) recently as more negative news from the US comes in. i think this is overdone since many of the major EM countries in the index depend far more on china/euro area than the US

2) long ~10yr BEI. this one is one of my highest conviction and most thought out trades. it is long 10yr TIPS short 10yr nominal bonds (duration adjusted obviously). the rational is as follows: right now, we are in a precarious economic position. growth is at risk and capacity pressures/still relatively tight (but easing slightly) labor market, high commodity prices, and a weak (and likely weakening) dollar are all contributing to an inflationary environment. the break even inflation rate though hasn't adjusted significantly. it should and it isn't. it apparantly seems to adjust more in retrospect and thus appears to be not a great predictor of future (or expected) inflation. i.e. during the last 3 years, the BEI rate adjusted more in retrospect and didn't even predict the moderate inflation we saw until it already happened.

a rate cut now will only stoke inflationary fires and thus push the 10yr nominal yield even higher and increase demand for inflation protected securities.

further, the fed has shown a high bias for low rates and is likely to cut even when not 100% necessary to hold up growth since inflation expectations appear to be anchored (i.e. the 50bp cut in sept. and the previously low rate era etc.). this is a risk as the faith in the fed's ability/will to control inflation will be tested when the economy slows AND inflation pressures persist.

add to that the liquidity premium (not liquid TIPS vs. very liquid 10yr) which perenially depresses TIPS yields and this position looks highly attractive. this is a longer term position though since, as noted, the BEI rate won't likely adjust immediately.

3) long 2yr, short 10yr. right now, as stated above, a rate cut is likely to push up yields for the 10yr (more inflationary expectations) while obviously pushing down yields for the 2yr. this isn't priced in sufficiently at this point.

4) short USD vs. JPY, Yuan, and asian emerging markets. this is a fairly straightforward trade. despite global imbalances starting to correct themselves, the falling off of demand for US treasuries by these countries combined with their ever growing CA surpluses and US interest rate direction spell tough times for the dollar vs. these countries (while the dollar might even be overpriced vs. the EURO at this piont)

5) on a similar note, the pound now looks expensive vs. the Yen and Yuan.

6) this one i'd wait until the short rates adjust after the coming likely fed cut (as noted the fed apparantly likes lower rates). i'd bet that after the coming rate cut, UK rates and US rates will converge. the UK economy is showing weakening signs and the housign bubble there will likely eventually put some downward pressure on growth as well (though not as much as in the US). so i'd go long UK short rates and short US short rates (1-2yrs) and use that diff bet to capture the narrowing of the interest rate diff. this could also be a signal for going long the USD/GBP as that might be a bit expensive after the coming fed cut.

7) finally, i think that the gumming up of the credit markets is likely to come to a halt in 3-6 months. but i think it will improve in the coming weeks/month so i'd start putting on a euribor spread narrowing bet. i'd go long 3mo euribor futures 1mo out and short 1mo euribor futures 1 mo out.

i'd love to hear some feedback or questions on these 7 bets that i'm writing up right now so let's hear it.

thanks,
Barron

[CrushinFelt]

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3) long 2yr, short 10yr. right now, as stated above, a rate cut is likely to push up yields for the 10yr (more inflationary expectations) while obviously pushing down yields for the 2yr. this isn't priced in sufficiently at this point.


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You're already missed some HUGE movement in the 2 yr. Though, I do like anything that deals with the steepening of the yield curve.

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4) short USD vs. JPY, Yuan, and asian emerging markets. this is a fairly straightforward trade. despite global imbalances starting to correct themselves, the falling off of demand for US treasuries by these countries combined with their ever growing CA surpluses and US interest rate direction spell tough times for the dollar vs. these countries (while the dollar might even be overpriced vs. the EURO at this piont)

5) on a similar note, the pound now looks expensive vs. the Yen and Yuan.


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Agree with both. See John Kane's Leverage thread.

I'd like to comment on #2 but I'm not familiar with those products.

I feel like this is an awesome time to be investing and really envy John for putting some $ to use and you (assuming you go through with some of these ;p). I don't have the capital yet to do anything other than feed my Roth and make a few option and/or bond plays.

[spider]

Well, I really have no opinion in terms of pro/con, you are getting into some pretty hairy stuff. But I would mention a couple of things to keep in mind wrt the Fed:

1) Bernanke establishing reputation as inflation fighter -- You always hear that the new guy at the Fed needs to prove to the markets that he is serious about inflation early on so he'll be credible down the road. To the extent this is true, the Fed might exhibit a short term bias for a higher fed funds rate than otherwise. I think this is pretty plausible although I'm not sure if there is any real evidence of this. Also, Bernanke came into the job w/ a strong reputation as an inflation fighter so he probably has less need to establish the reputation than, say, Greenspan when he first took over.

2) Liquidity -- I don't really know what is going on wrt to these SIVs, CDOs, etc. Which is not surprising or significant. But I'm also not sure ANYONE knows what is going on here and that is a little scary. Wrt the Fed, it makes it harder to predict how they will act in the future since they might be considering a lot more than the usual inflation/growth tradeoff. For example, some have said the Fed needs to cut not so much to stimulate growth, but to increase liquidity.


Bottom line: Good chance to kill or be killed if making financial bets in the near term.

[DcifrThs]

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Well, I really have no opinion in terms of pro/con, you are getting into some pretty hairy stuff. But I would mention a couple of things to keep in mind wrt the Fed:

1) Bernanke establishing reputation as inflation fighter -- You always hear that the new guy at the Fed needs to prove to the markets that he is serious about inflation early on so he'll be credible down the road. To the extent this is true, the Fed might exhibit a short term bias for a higher fed funds rate than otherwise. I think this is pretty plausible although I'm not sure if there is any real evidence of this. Also, Bernanke came into the job w/ a strong reputation as an inflation fighter so he probably has less need to establish the reputation than, say, Greenspan when he first took over.

2) Liquidity -- I don't really know what is going on wrt to these SIVs, CDOs, etc. Which is not surprising or significant. But I'm also not sure ANYONE knows what is going on here and that is a little scary. Wrt the Fed, it makes it harder to predict how they will act in the future since they might be considering a lot more than the usual inflation/growth tradeoff. For example, some have said the Fed needs to cut not so much to stimulate growth, but to increase liquidity.


Bottom line: Good chance to kill or be killed if making financial bets in the near term.

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right, and that is all good in a vacuum, but bernanke has to make the growth/inflation tradeoff during times of high stress. he does have leeway for this since the past generation is so used to anchored inflation expectations that lower rates won't drive up near term inflation expectations anywhere near what they would be longer term (i.e. 2yr inflation expectations are probably pretty well anchored so the fed can lower rates without driving the expectations up too much...but inflation is volatile on a longer timeline than growth so longer term inflation expectations are likely to jump up steepening the yield curve. i.e. the last fed cut saw a rise in 10yr yields, not a fall)

your points are good though. the problem for bernanke will be in determining whether he has enough leeway w/ anchored expectations to help stave off serious downward pressure on growth.

i think that looking at the fed's (and his) history, he'll err on the side of propping up growth vs. fighting inflation until we see some improvement in the economy.

in terms of the liquidity thing, that is the bet i'm taking in the euribor market since that is seeing the most dislocations. within the next few months i thinkw e'll see these rates settling down to longer term relationships rather than the liquidity scared (oh noes, i be needing dem funds now since i don't know where dem losses will be) super steep 1 vs. 3mo euribor futrues contracts.

keep the comments coming [img]/images/graemlins/smile.gif[/img]

thanks,
Barron