Yesterday, we publish a series of quick notes on the balance of companies that are reporting this week looking specifically at inflation expectations.  A common theme for this earnings season is that top line sales trends remain strong, but nearly every management team has underestimated the impact of inflation on margins and earnings.  This has led to guidance being reduced, as we saw last night with TXRH, PEET and last week with CAKE.


CPKI, BAGL and CBOU all stand out as companies that will need to raise guidance for inflation expectations for the balance of this year.  Interestingly, if you search CPKI’s most recent quarterly earnings transcript for the word inflation, you will not find it even once.  This alone is an indication that the company may be underestimating the impact of inflation on the P&L, at least publicly. More importantly, the most recent guidance from the company, of 2.5% inflation for the year, was not even in the ballpark of reality, putting CPKI at risk of having to guide down. 


For BAGL, I believe that 2-3% overall commodity inflation guidance is more than likely conservative and will probably be revised higher.  Given surging coffee costs (not to mention that SBUX and PEET both increasing inflation expectations), CBOU will bring down guidance; it will be interesting to see by how much. 


Below is a run-through of the news from the restaurant space along with the price action from yesterday and our fundamental view on select names.

  • GMCR announced earnings post-close yesterday, beating the Street’s expectation of $0.39 in EPS by three cents. 
  • GMCR announced a 7.1m shares secondary offering (an additional 404k shares is for holders) through BofA.
  • GMCR’s price target was raised to $85 from $55 at KeyBanc.
  • DNKN filed a $400m IPO through JPMorgan, Barclays, Morgan Stanley, BofA, and Goldman Sachs.  Prior speculation was for the deal to be in the range of $500-750m.  
  • PEET reported a strong EPS beat of $0.41 versus consensus $0.34.  A cautious tone was struck by management regarding coffee costs and management lowered guidance by 10 cents.  The new guidance is for EPS in the range of $1.43-1.50 versus prior guidance of $1.53-1.60 and Reuters $1.56.
  • PEET was cut from “Outperform” to “Neutral” at Robert Baird.  The twelve-month price target is $48.
  • PZZA reported Q1 EPS $0.64 versus consensus $0.60.  Domestic SSS were +6.1% vs consensus +1.8% (company +6.7% vs consensus +2.4%; Franchise +5.9% vs SA +1.7%) and International SSS grew +5.6%.
  • DIN gained 5.7% on accelerating volume on the back of strong earnings released yesterday morning. 
  • YUM and Little Sheep have not yet reached a deal according to Business China, citing a Little Sheep spokesperson speaking yesterday.
  • CMG is far from in the clear with Immigration officials.  A Chipotle attorney has confirmed to the WSJ that ICE officials have visited 20-25 restaurants and the government intends to interview Chipotle employees. A former ICE lawyer says that the government's behavior suggests it is looking for something that goes beyond its investigation of the company's I-9 forms, which has already led to Chipotle's dismissing hundreds of workers.




Howard Penney

Managing Director


It’s important to take into account the fact that hold was low but we differ with management on the impact.



LVS was trading below $40 last night after hours following a disappointing earnings release.  If you trade at 14x EBITDA, your margin for error is slight.  We haven’t exactly been a cheerleader for this stock but we have to admit that a 15% total decline yesterday was a bit excessive.  April is off to a great start in Singapore and while LVS’s Macau market share was substandard in April, the market was off the charts.


To be clear, however, the stock should be down.  While hold was low in Singapore and Vegas, management’s estimate of a $40 million negative impact looks very aggressive to us.  In fact, we estimate the total impact across the properties was only $13 million.  Thus, this was a genuine miss due to Vegas and Singapore.




  • We don’t believe the negative hold impact across LVS’s portfolio was nearly as severe as management presented.  We estimate that net revenues actually would have been $3MM LOWER and EBITDA would have only been $13MM higher had hold been normal across their portfolio.  Here are our estimates by property.
    • Low hold only impacted Vegas EBITDA by $5MM and net revenue by $20MM
    • In Macau, high hold helped net revenues to the tune of $52MM and EBITDA by $18MM
    • At MBS, we estimate that hold impacted revenues by $29MM and EBITDA by $26MM
  • Costs were tightly controlled if not reduced everywhere but at MBS
  • Promotional expenditures were cut across the entire portfolio with good results everywhere but Vegas
  • While we can’t confirm that LVS is making much progress on growing its junket share in Macau, direct play as a percentage of RC certainly took a dive this quarter




LVS reported $305MM of net revenues and $65MM of EBITDA, missing our estimates by 15% and 44%, respectively and missing the consensus by 9% and 34%, respectively.


At least vs. our estimates, the revenue miss was entirely on the casino side.  Non-gaming revenues net of promotions and discounts were actually $3MM ahead of our estimate as lower room revenue was offset by a material reduction of comps.  While management tried to promote the success of their strategy of sharp reductions in promotional allowances, the results clearly speak for themselves… and frankly, they stink.

  • Net Casino revenues came in $58MM below our estimate
    • The average hold in Las Vegas for LVS has been 18.1% over the last 8 quarters.  If we use the 8 quarter average, table win would have been $23MM higher. If we use last year’s hold rate of 18.9%, table win would have been $26MM better. Either way to get to the $45MM impact LVS claims that hold had on the quarter, we’d have to assume 22.75% which is far from the 3 year average.  In fact, there have only been 2 quarters since 2008 that the company has seen a hold rate north of 22%.  We estimate that the EBITDA impact was about $6-7MM (gross table win – Nevada gaming tax – drop * rebate rate)
    • Drop fell 13% YoY but to be fair, 1Q2010 was a difficult comp as table drop grew 23% YoY.
    • Slot drop was clearly negatively impacted by the cut in promotional spending, plummeting  36% YoY on an easy -10% comp.  Slot results would have been even worse if not for high hold of 8.5% which benefited slot win by $2.6MM.
    • On the net, we think that low hold only hurt LVS by the tune of $20MM in gross gaming win and by less than $5MM on EBITDA
  • Total operating expenses increased by 9% YoY or $20MM in Las Vegas to $240MM



  • We’re not sure how much traction LVS is making on the junket front, but direct play as a % of RC declined to 19% of RC vs. 24.4% in 2010.
  • Fixed costs/commissions were lower than we expected and down YoY, despite last year being a year of cost cuts.
  • As in Vegas, LVS took a knife to promotional spending – although with clearly better results



Sands Macao’s revenues came in $9MM below our estimate.  However, property reported EBITDA of $92.6MM was $5MM above our estimate due to a combination of lower fixed expenses, lower taxes on lower win, and higher table win rate due to lower mix of direct play.

  • Gross and net VIP table win were $9MM lower than our estimate due to $500MM lower RC volume than our estimate
    • Direct play was only 10% of total RC in the quarter vs. an average of 14% over the last 3 quarters
    • Hold was 6 bps better than we estimated
    • The rebate rate was 91bps vs our estimate of 86bps (or 33% of hold)
    • Low hold impacted gross and net VIP win by $8MM and $6MM respectively and EBITDA by about $3MM.
  • Mass table win was $3MM below our estimate due to drop being $100MM less than we estimated. Drop grew 13% YoY.
  • Slot win was $2.5MM above our estimate due to higher handle and a higher win rate
  • Non-gaming revenue net of promotional expense was in-line with our estimate
  • Implied fixed expenses declined $6M or 7% YoY to $42MM

Venetian Macau

Venetian’s net revenue of $638MM was 2% below our estimate but a combination of lower commissions and lower fixed costs led to the property reporting EBITDA that was 9% better than we projected.  If table hold for both Mass and VIP was ‘normal,’ we estimate that net revenues would have been $14MM lower and EBITDA would have been $5MM lower.

  • Net gaming revenues were $5M below our estimate
    • Gross VIP revenue was $5MM below our estimate and net was $8MM lower than our estimate
    • RC was $400MM or 1.5% lower than we estimated
    • Direct play was 19% of RC
    • Hold was 3bps below our estimate
    • The rebate rate was 84bps or 31% of hold
    • Low hold negatively impacted gross VIP revenues by $20MM (net by $14MM) and EBITDA by approximately $10MM
  • Mass table win was $5MM above our estimate
    • Mass drop only grew 6% YoY however, table hold was a ‘healthy’ 27.9%
    • The 8 quarter average hold for Venetian is 25%.  Assuming a 25% hold rate, Mass win would have been $28MM lower and we estimate that EBITDA would have been negatively impacted by approximately $15MM
    • Slot win was $2MM below our estimate due to a lower win rate
  • Net non-gaming revenues was $8MM lower than we projected primarily due to lower room and retail & other revenue, partly offset by lower promotional spending
  • It appears that junket commissions were lower this quarter and that fixed expenses decreased to $85MM from a run rate of approximately $100MM
  • Non-gaming, net of promotional expenditures were $8MM below our estimate

Four Seasons


Four Seasons net revenues beat our estimate by $4MM and EBITDA by $8MM.  Direct play declined materially, and hence hold was a lot a better than we expected and fixed costs were lower.  High hold across Mass and VIP tables benefitted FS to the tune of $50MM and $16MM, respectively.

  • Net gaming revenues were $13.5MM above our estimate
    • Gross VIP table revenues were $1MM above our estimate and net revenues were $13MM better
      • Drop was $900MM below our estimate due to a much lower mix of direct play- 40% vs. our estimate of 50% (compared to 54% in 4Q10)
      • As a result of lower drop, we underestimated the win rate by 73bps
      • Despite the high win rate, the rebate rate was only 97bps
      • We estimate that high hold benefited revenues by $41MM and EBITDA by $11MM
    • Mass table revenues were in-line with our estimate but the win rate was much higher and drop was disappointing
      • Mass drop actually fell 17% YoY
      • Even if we use the property's high 12 month trailing average hold of 29.1%, we still get to a benefit of $9MM on net revenue and $5MM on EBITDA.
  • Net non-gaming revenue was $10MM lower
  • Implied fixed expenses declined 3% YoY to $19MM



MBS net revenues were in-line with our estimate but EBITDA was 11% lower than we projected due to higher costs as new amenities opened and had yet to fully ramp and higher receivable reserves. 

  • Net VIP revenue was $3MM better than we estimated due to better RC volume and lower rebates
    • RC grew a whopping 24.5% QoQ
    • Rebates were 1.24% in the quarter compared to 1.31% in 2H2010
    • Assuming 2.85% hold for MBS, we estimate that low hold negatively impacted revenue by $29MM and EBITDA $26MM (close to LVS’s estimate).  We would argue that 2.8% is a better ‘normal’ rate to use given the different mix of games and the lower average hold experienced by the property thus far.  Under this scenario the negative hold impact would have been $24MM and $22MM on revenues and EBITDA, respectively.    
  • Slot revenues were $3MM below our estimate due to lower hold – probably due to a higher mix of EGT machines
    • MBS added 333 slots QoQ
    • Slot handle increased 11% QoQ
  • Mass revenue was $7MM lower than we estimated due to lower drop growth, somewhat offset by better hold
    • Table drop grew 5% QoQ
  • Net non-gaming revenue was $6MM above our estimate due to lower promotional expenditures
  • Even after taking into account higher doubtful accounts, we estimate that implied fixed expenses increased to $182MM from $153MM.


Other stuff:

  • Sands Bethlehem was spot in-line with our revenue and EBITDA estimate
  • Other Asia ops are losing less money
  • D&A was $5MM higher vs. our estimate
  • Rental expense was $2MM higher vs. our estimate
  • Corporate & stock comp jumped to $46MM, up $6MM QoQ and 58% YoY
  • Net interest expense was $7MM below our estimate


TODAY’S S&P 500 SET-UP - May 4, 2011

The mechanism driving most Correlation Risk across asset classes in the market remains the USD. So watching where the USD might stop crashing is a critical risk management exercise in play yesterday (USD flat on day = XLE (Energy stocks) down -2.5%; Brazil down -1.8%, etc…).


The Hedgeye immediate-term TRADE line of resistance in the USD developing at $73.52 – watching that very closely as resistance becoming support could easily trigger a much larger move in the hedge fund community’s largest net long position since 2007 - long the Inflation trade.  As we look at today’s set up for the S&P 500, the range is 24 points or -0.56% downside to 1349 and 1.21% upside to 1373.



Yesterday, Energy broke the TRADE duration leaving 7/9 sectors broken on TRADE and 8/9 broken on TREND.




THE HEDGEYE DAILY OUTLOOK - daily sector view








  • ADVANCE/DECLINE LINE: -911 (-400)  
  • VOLUME: NYSE 1003.11 (+7.26%)
  • VIX:  16.70 +4.44% YTD PERFORMANCE: -5.92%
  • SPX PUT/CALL RATIO: 1.84 from 1.38 (+33.87%)



  • TED SPREAD: 25.00 -0.200 (-0.794%)
  • 3-MONTH T-BILL YIELD: 0.03% -0.02%
  • 10-Year: 3.28 from 3.31
  • YIELD CURVE: 2.67 from 2.70 



  • Quarterly Treasury debt sales announcement
  • 7 a.m.: MBA Mortgage Applications, prior (-5.6%)
  • 7:30 a.m.: Challenger job cuts, prior (-38.6%)
  • 8:15 a.m.: ADP employment, est. 198k, prior 201k
  • 10 a.m.: ISM non-manufacturing, est. 57.5, prior 57.3
  • 10:30 a.m.: DoE inventories
  • 3:30 p.m.: SF Fed President John Williams makes first policy speech
  • 4 p.m.: Fed’s Fisher speaks in New Mexico
  • 4:15 p.m.: Geithner speech on economy in Washington
  • 7 p.m.: Fed’s Lockhart speaks in Atlanta


  • Treasury Secretary Tim Geithner speaks in Washington on the economy.
  • Conagra makes a $86/share cash bid for Ralcorp for a takeover that would acquire $2.5b of debt.
  • Applied Materials agrees to buy Varian Semi for 55% premium at $63/share.
  • Richard Branson says no deadline for decision on whether to sell airline.


THE HEDGEYE DAILY OUTLOOK - daily commodity view




  • Silver Slumps on Higher Margins; Gold Drops on Report of Soros Fund Sales
  • Rice May Drop on ‘Abundant’ Thai Supply, Aiding World’s Poor as Corn Gains
  • Cocoa Poised to Tumble as Maersk Cargo Signals Price Peak: Freight Markets
  • Glencore Seeks $61 Billion Value in London, Hong Kong Initial Share Offer
  • Crude Oil Halts Two-Day Decline in London Before U.S. Employment Report
  • Copper Drops to Seven-Week Low on Concern China May Tighten Credit Further
  • Corn, Soybeans Drop for a Third Day as Price Rallies May Cut Into Demand
  • Sugar Falls for a Fifth Day on Thai Output, China Inflation; Coffee Drops
  • Cash-Copper Premium in China Signals Demand May Increase: Chart of the Day
  • Gasoline ‘Bubble’ May Grow Past 2008 Record on Supply Drop: Energy Markets
  • Palm Oil Drops to Two-Week Low as Demand for Soybeans Weakens, Crude Falls
  • Coal Stocks ‘Alarming Low’ in China, ‘Critical’ in India: Chart of the Day
  • Cocoa Arrivals From Bahia Boost Brazilian Production to Most in 16 Years





THE HEDGEYE DAILY OUTLOOK - daily currency view




  • Euro approaches 18-month high versus dollar before interest-rate decision
  • Portugal financial rescue medicine may be just a first taste - euro credit
  • German 2-year notes drop on ECB tightening bets; Portuguese bonds advance
  • Spain’s thousands of illegal homes sour development minister’s sales pitch
  • BMW profit advances more than estimated on demand for 5-series, x3 models
  • new deutsche bank CEO turns on Krause vying with Weber for power with Jain
  • European stocks fluctuate; Holcim drops while shares of Actelion advance
  • Europe retail sales drop most in 11 months on rising oil, government cuts
  • UK house prices drop for first time in three months as cuts deter buyers
  • UK Mar mortgage approvals 47.6k vs consensus 48.0k and prior revised to 46.7k from 47.0k
  • Uk Apr Construction PMI 53.3 vs consensus 55.5 and prior 56.4
  • Eurozone April Services PMI 56.7 vs consensus 56.9 and prior 56.9
  • Germany April Services PMI 56.8 vs consensus 57.7 and prior 57.7







  • China and Hong Kong fell on fears of further monetary tightening in china.
  • Most Asian stocks decline as raw material producers, Australian banks retreat
  • Hong Kong home sales fall to two-year low on government curbs, loan rates
  • Shinhan profit little changed as Korea property slump drives up bad loans
  • Vietnam raises repurchase rate for fifth time this year in inflation fight
  • Philippines, Malaysia will consider rate rises as oil fuels Asia inflation
  • Asia seeks to boost use of local currencies in trade, reduce dollar’s role.
  • Japan was closed for Greenery Day and will remain closed until 6-May.












Howard Penney

Managing Director

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Correlation Risk

“We are willing to accept almost any explanation of the present crisis of our civilization except one.”

-F.A. Hayek


That’s an important quote from page 65 of a chapter that Hayek wrote in “The Road To Serfdom” titled, “The Abandoned Road.” As I take a step back and think about what a tremendous opportunity our profession has had to learn about real-time risk management and the interconnectedness of Global Macro markets in the last 3 years, it’s somewhat sad to realize that consensus hasn’t been paid to learn much.


What we get paid to do is chase short-term returns. The Bernank perpetuates this performance pressure by marking the short-term “risk free” rate to model (or the ZERO bound) and, as a result, this gargantuan experiment of starving savers of returns imputes 3D Risk (3 D’s) into markets:

  1. The Dare – zero percent rates dare you to chase yield across asset classes where you can justify it
  2. The Delay – zero percent short-term financing for banks delays the financial restructurings that free market prices would impose
  3. The Disguise – zero percent expectations disguise the interconnected risks associated with carry trading, correlation risk, etc

The Disguise is the one that can really nip a perma-bull in the butt. That’s the one that, allegedly, “no one can see coming.” That’s the one that is being revealed real-time. In terms of making excuses for being willfully blind to it, this time is different because we have a modern day technological innovation in financial market transparency – it’s called Twitter.


Going back to Hayek’s aforementioned point, I think that’s the one thing our professional politicians do not get paid to understand. That would be called accountability. The Disguise in financial markets is The Correlation Risk – and while his original text was addressing a different kind of socialism and Big Government Intervention in 1944, I still think what Hayek goes on to say about explaining our perpetual financial “crisis” is very appropriate:


“… that the present state of the world may be the result of genuine error on our own part… and that the pursuit of some of our most cherished ideals has apparently produced results utterly different from those which we expected.”


With another 78 Billion Bailout Euros being extended to the government of Portugal this morning, Spain seeing unemployment spike to 21.3% (new all-time highs), and Americans staring down $5/gas at the pump with jobless claims re-accelerating, wasn’t that some advice our “independent central bankers” and fiscal spenders should have considered?


Independent research? Should we just never mind silly old school things like the American Constitution or what John Locke wrote On Liberty 80 years before Hayek penned his original counter-points to Keynes? Just buy-the-damn-dips, chase yield, and believe that it’s going to end well this time?


Back to The Correlation Risk and playing the game that’s in front of you…


Given that the US Dollar is the #1 factor we are talking about when we say Global Macro Correlation Risk (say it central planners -“who –ho-wns de Campaigner-in-Chief?”), let’s  get a real-time price check on how that looks on our intermediate-term TREND duration (3 months or more):

  1. Crude Oil = -0.92
  2. Gold = 0.94
  3. Silver = -0.94
  4. Coffee = -0.84
  5. Pork Bellies = -0.92
  6. CRB Commodities Index = -0.87

I know, I know – The Bernank calls this commodity stuff that you put in your cars, stomachs, and teeth “transitory”…


How about the intermediate-term TREND inverse-correlations between the US Dollar Index and relatively larger matters like countries?

  1. USA (SP500) = -0.82
  2. Brazil = -0.88
  3. Mexico = -0.82
  4. Germany = -0.93
  5. Spain = 0.94
  6. Russia = -0.85
  7. China -0.85
  8. South Korea = -0.90
  9. Australia = -0.91

How about the obvious, the intermediate-term TREND inverse correlations between the USD spot price and the world’s currencies?

  1. Euro = -0.99 (not a typo)
  2. Swiss Franc = -0.96
  3. British Pounds = -0.95
  4. Chinese Yuan = -0.92
  5. Japanese Yen = -0.87
  6. Singapore Dollar = -0.96
  7. Aussi Dollar = -0.94
  8. Brazil’s Real = -0.92
  9. Canadian Dollar = -0.85

Really? Yes, President Obama – really. This Correlation Risk math checks out from Hawaii to Havana. We get it. Anyone gaming Geithner and The Bernank get it. The Chinese get it.


In the Peoples Bank of China’s Q1 Monetary Policy Statement last night (published on China’s website – not to be politically pandered to on 60 Minutes this Sunday or at a US Federal Reserve Presser), this is what the Chinese had to say about all of the aforementioned real-time prices:


“Stabilizing prices and managing inflation expectations are critical… given the loose monetary policies of major economies and gradual recovery of the global economy, commodity prices and global inflation expectations are rising significantly.”


“Significantly” versus “transitory.” Academic dogma versus independent analysis. Government storytelling versus Correlation Risk. It’s all out there folks. It always has been – and, sadly, when it comes to US policy, so has Hayek’s “Abandoned Road.”


My immediate-term support and resistance lines for Gold are now 1525 and 1565, respectively. For oil I’m at $109.39 and $114.21 – and for the SP500, my immediate-term support and resistance lines are now 1349 and 1373, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Correlation Risk - Chart of the Day


Correlation Risk - Virtual Portfolio

Royal Awareness

This note was originally published at 8am on April 29, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“It’s choice not chance that determines your destiny.”

-Jean Nidetch


Interestingly this quote comes from a one-time overweight housewife with a self-confessed obsession for eating cookies—a woman who eventually kicked her weight and went on to start a peer group to support her overweight friends, which expanded and in 1963 was incorporated as the Weight Watchers organization.


The quote also seemed appropriate for it reminded me of the vaulted status of global central bankers and their choice (along with a committee vote) to act or not (in what sometimes seems like chance) to direct a country’s monetary policy, and therefore economic health. In the recent era, central bankers have attained a sort of rockstar status typically reserved for celebrities and athletes, and just this week Ben Bernanke joined the club of celebrated central bankers (notably the ECB’s Jean-Claude Trichet) with a live press conference following his policy announcement—trappings that must clearly enhance his “cult” status.


Yet, with today being the Royal wedding day, and with my role being European analyst on the Macro Team, we thought we’d give The Bernank a needed rest and focus on the actions across the pond at the Bank of England, namely the hefty choice that CB Governor Mervyn King faces with the UK stuck between stagnant growth as inflation accelerates.


In particular, we’d like to call out the strength of the British Pound versus the USD, in our opinion an out-of-consensus call that we’ve been long of via the etf FXB in the Hedgeye Virtual Portfolio since 3/23 due to the following positive factors:

  1. The BoE’s increasingly hawkish lean on inflation and evidence that suggests the positive currency impact of an interest rate hike (examples include ECB and Riksbank decisions)
  2. The announcement of austerity by the UK Government in the fall of last year to proactively cut public spending and boost revenue, versus the US’s passiveness in addressing its rising debt and deficits, a position that has perpetuating a weak USD versus most major currencies (US Dollar Index down for 14 of last 18 weeks)
  3. Bernanke’s commitment to keep rates near zero percent and his  indication that some form of QE-lite will follow QE2’s expiration in June = continued USD weakness
  4. The flight to safety of Sterling as Eurozone debt contagion remains at large (also bullish for the CHF and SEK)


The Proof is in the Pudding

While the above points have been supportive of the GBP-USD trade to some degree this year, the prospect of high inflation with slow growth in the UK is the pressing threat facing policy makers. And while there are numerous ways to spin the headline data out of the island nation, in our mind it’s hard to argue against the  inflation data, which has charged higher for the last 18-22 months. The current inflation readings include:

  • Consumer Price Index (CPI)   +4.0% in March Y/Y
  • Producer Price Index (PPI) for Input   +14.6% in March Y/Y
  • PPI Output   +5.4% in March Y/Y

While the BoE drew a sigh of relief with the March CPI number 40bps below the February reading, current levels are a full 2% higher than the BoE’s target, and 1.5-2.5% above European peers, as rising energy costs continue to fuel high readings this year.


While the BoE has maintained its 0.50% benchmark rate since March ‘09, the lowest level in over 300 years of the history of the BoE, we’re of the camp of Andrew Sentance, one of the nine voting members of the BoE’s Monetary Policy Committee, and affectionately known as the ueber inflation hawk due to his very vocal stance for an interest rate hike since June 2010. We’re now seeing in the last few BoE meetings that fellow members Spencer Dale and Martin Weale have joined ranks for a rate rise of 25bps, while Sentance has upped his rate hike call from 25bps to 50bps, leaving the committee a 6-3 vote against interest rate action, but marginally more hawkish.


Below are a few key drivers that Sentance notes to justify a rate hike, which he’s included in this speaking tours:

  1. The UK’s need to strengthen its currency with its trading partners, particularly against the EUR as the Eurozone accounts for about half of total exports and half of total imports.
  2. A stronger domestic currency will help to combat imported inflation. The renewed surge of energy and commodity prices only adds to the imported inflation driven by a weak Sterling versus the EUR since 2007. 
  3.  The squeeze on disposable income is already a factor holding back the growth of consumer spending in the short term.
  4. Ergo, a rate hike is essential to boost the Sterling versus the EUR and other major trading partners to mitigate inflation and therefore improve consumer spending.

Not so Fast – Austerity’s Bite and Growth Fears

While Sentance makes some very convincing points supportive of a rate hike, others remain convinced that excess capacity in the economy will slow/drive down prices and that a rate hike would only create a further shock to the consumer.


Rightfully, this camp also points out the negative impact of the government’s austerity program, which broadly calls public job cuts of ~500K and ~£81 Billion in public spending cuts over the next 4 years, and an increase in VAT (from 17.5% to 20%) that began in the beginning of this year. Their position is that weaker consumer and business surveys are indicative of the strain of public sector deleveraging and expectations for slower growth. Additionally, it is argued that the negative impact on the housing mortgage market from a rate hike—with the housing sector mired in an anemic state—would be an additional blow to the consumer’s wallet.


Boiling it Down

As we’ve said from the outset, there are any number of ways to interpret the data. Arguably the BoE and UK government are left in a tough spot, trying to head off inflation while not pinching growth prospects. For reference real annual GDP was +1.4% last year, with the final quarter of 2010 showing a -0.5% hit Q/Q, while 1Q2011 rebounded to +0.5% Q/Q.


While the jury is still out on whether or not Q1 can be a sustained inflection, our call is focused on the implication of the Pound versus the USD, in particular, but also the EUR. We continue to applaud PM David Cameron’s forceful strategy to reduce fiscal debt and deficits, which according to the UK statistical office were 59.6% of GDP in 2010 and 10.4%, respectively (see chart below). Notably, the chart of cumulative public sector net borrowing shows improvement across annual compares, an indication that austerity may, in fact, be working.


Further, compared to the US administration, Obama and Company are just now coming to terms with the budget ceiling debate and the great issue on shaving down the budget deficit that is expected to rise well over 10% next year, according to our calculations, with the US debt as a % of GDP expected to reach 96% this year and over 100% next.


On these metrics, we think the UK’s proactive attention to reduce fiscal imbalance, coupled with the increased likelihood of an interest rate rise, should boost the GBP versus the USD. Should we get a rate hike, it should help alleviate inflation pressures, which will improve consumer and business optimism and therefore encourage growth prospects over the intermediate to longer term.  Given the likelihood that elevated input cost pressures are here (globally) to stay over at least the medium term, we think there’s prudence in a rate hike.


Increasingly we’re seeing the bifurcation in economic performance on the basis of policy decisions to cut fiscal imbalances and increase interest rates off historical lows. So long as the US continues to fuel its monetary policy of extend and pretend and promote the fiscal printing press, we’d expect the USD to suffer versus major currencies. Getting long the GBP-USD is but one way we’ve chosen to express this bifurcation.   


Matthew Hedrick



Royal Awareness - ME1


Royal Awareness - Virtual Portfolio

real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.