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The Topping Process Part II: Selling TLT Trade Update

Conclusion: From a fundamental perspective, the Treasury bond market offers limited upside.


Position: Closed our long position in the long-end of the U.S. Treasury bond market (TLT).


Concurrent with our recent sale of the Treasury curve flattener (FLAT), we’ve decided to also part ways with the long bond by selling our iShares Barclays 20yr-plus Treasury Bond Fund (TLT). Simply put, we think the topping process is underway in both securities, meaning that there is a meaningful amount of asymmetry to the downside from a risk/reward perspective.


From a fundamental perspective, the Treasury bond market offers limited upside – especially given our call for the slope of U.S. economic growth to bottom out in 1Q. Moreover, we think our dovish intermediate-term outlook for inflation is largely priced into the long end of the Treasury yield curve. Recall that in late 2010, long-maturity Treasury yields ripped ahead of the 1Q11 jump in reported inflation. A similar lead time in this cycle supports our view that lower-highs in CPI over the intermediate term is largely priced in at current yield levels.


The Topping Process Part II: Selling TLT Trade Update - 1


Using 10yr yields as a proxy, a quantitative breakout above TREND resistance at 2.03% would be incremental confirmation of the intermediate-term growth scenario we have laid out in recent months. That would likely coincide with a breakdown of the TLT ETF through TREND support at $117.07. In the event we receive the aforementioned quantitative signals in the coming weeks, our next step(s) would be to consider a Treasury curve steepener and/or shorting long bonds. 


For now, we are content to wait and watch.


Darius Dale

Senior Analyst


The Topping Process Part II: Selling TLT Trade Update - 2


The Topping Process Part II: Selling TLT Trade Update - 3

The Week Ahead

The Economic Data calendar for the week of the 9th of January through the 13th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - 1. calendar

The Week Ahead - 2. calendar


Today’s employment data was a positive for restaurants, in particular QSR.


With the exception of the 45-54 YOA cohort, which saw a sequential deterioration in employment trends in December, the age groups we monitor saw a sequential improvement in employment trends last month.  The chart below illustrates the national employment trends by age bracket.  For QSR, in particular, the sustained strength in employment trends among 20-24 year olds is encouraging for 4Q11 sales.  The restaurant industry is a prime beneficiary of improving employment trends as our macro team’s KING DOLLAR theme (strong dollar = strong consumption = strong America) continues to play out.





The restaurant industry is still hiring but there is a notable divergence forming between quick service and casual dining employment growth trends in November, as the chart below shows (this data set is released on a lag).  Casual dining employment growth seems to have stalled at just under 2% while QSR employment growth continues to accelerate. 





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The Topping Process: Short TIP Trade Update

Conclusion: Our soon-to-be released 1Q12 macro theme of Deflating the Inflation II portends negatively for the price of Treasury Inflation-Protected Securities.


Position: Short Treasury Inflation-Protected Securities (TIP). 


If there’s one thing Old Wall St. fails to understand it’s that being perma-anything in the Macro arena will get you carted out the back door over a long enough duration. Mean reversion and spread risk remain arguably the two most dominant drivers of price within, and across, asset classes.


Having authored the Inflation Accelerating call late in the summer of 2010 – a time when “deflation” and “double-dip” were the #1 and #2 topics de jour  on the Street – we are in a unique position that should help our clients prepare for what’s next.


Specifically, we understood that Burning the Buck to near-record lows would fuel a reflation rally in commodities that would eventually become corporate margin pressure that was ultimately passed through to end-consumers as higher price points/less discounting on a YoY basis.


Meanwhile, the consensus storytelling of “no wage growth = no inflation” has evolved into: “transitory supply-side shocks as a result of geo-political tension (crude oil) and ‘rapid’ emerging market demand”. Emerging market demand? The MSCI Emerging Market Index crashed -20.4% in 2011 as “rapid” emerging market demand slowed dramatically. The “BRIC” markets all finished down in a range of -18% to -25% as their demand for materials, like bricks, slowed alongside their domestic economic growth.


As Keith suggested on in the live Q&A segment of our daily Morning Macro call, “In Macro, your best short ideas are usually borne out of the realization of your best long ideas – of course after ceding the appropriate amount of time to the topping process.” Looking at TIPS/inflation hedges specifically, we think that topping process is beginning to draw to a close – appropriately well after we initially authored the bearish call on commodities in 2Q11.


Now we are in beginning to enter a sweet spot where our bottom-up view (our models point to lower-highs in CPI over the intermediate term) is supported by our top-down, quantitative view (King Dollar breakout; CRB Index breakdown). Together, those signals suggest that investors are likely to start to demand a lower premium for inflation protection over the intermediate term.


Where could we be wrong on the slope of U.S. CPI? While QE3 is always a possibility, we interpret the U.S. dollar’s quantitative setup (Bullish Formation) as: whatever the Fed does (if anything during this pivotal election year amid strengthening U.S. economic data) is likely to be trumped by the ECB, the BOE, the BOJ and other foreign central banks. That spread risk is bullish for the USD, as no currency is priced in a vacuum of itself.


The Topping Process: Short TIP Trade Update - 1


Additionally, the potential for geo-political risk to create another oil price shock is a factor we must consider. It is, however, rather difficult to interpret how much of that is already baked into the current prices of crude oil and TIPS. Moreover, just like with long-term TAIL growth and inflation forecasting, we have no edge on what is coming down the pike next from the unstable EMEA region. In either scenario, anyone who tells you otherwise is sacrificing analytical integrity for the sake of compensation.


For now, we are short TIP for a trade and will look manage the immediate-term risk.  A breakdown through the TREND line would give us further conviction in this thesis.


Darius Dale

Senior Analyst


The Topping Process: Short TIP Trade Update - 2

Weekly European Monitor: The EUR Drifts Lower Ahead of ECB Meeting

Positions in Europe: Short France (EWQ)


Asset Class Performance:

  • Equities: European indices were up with a negative divergence from the periphery week-over-week. Top performers: Finland 4.1%; Austria 5.0%; Russia (MICEX) 3.8%; Germany 2.7%; Sweden 2.5%. Bottom performers: Cyprus -10.4%; Hungary -5.1%; Spain -3.2%; Greece -3%; Italy -2.9%
  • FX: The EUR/USD fell -1.87% week-over-week. Divergences: RUB/EUR +2.36%; CZK/EUR -1.20%, Romanian LEU/EUR -0.66%
  • Fixed Income: 10YR sovereign yields broadly increased w/w, led by Spain +66bps to 5.69%; Belgium +51bps to 4.60%; and Greece +47bps to 35.43%. Italy’s 10YR is now up to 7.14%! 

Weekly European Monitor: The EUR Drifts Lower Ahead of ECB Meeting - 1. yields



Call Outs:

  • Overnight deposits at the ECB continue to make higher highs (€455.3 Billion).
  • Unicredit fell -38% this week, and its market cap has now dropped by €8 billion since the announcement of a €7.5 billion capital increase. 
  • Major bond auctions from Germany and France proved successful. Germany issued €4B of 10YR bonds at 1.93%, with strong demand, and France issued €8B of 10-30 year maturities with the 10YR average yield at 3.29% vs 3.18% on December 1. Yet, Italian 10YR yields closed Friday at 7.14%!
  • A downgrade of France’s AAA credit rating should be priced in at this point. That said, a downgrade will force Eurocrats to answer questions on the EFSF as a AAA rated facility, and push up yields on further EFSF issuance.
  • France re-engages in Financial Transaction Tax talks. Expected to make a decision by the end of January, France does not have the backing of the EU but some support from Germany and Italy, while Britain is vehemently against it. We think approval could be a huge headwind for France’s already ailing banking industry.


Charts of the Week: 

-Below we show the charts of Eurozone confidence and Manufacturing and Services PMIs for the month of December.  As forward looking indicators they present a mixed outlook for the region. Eurozone Confidence was largely flat to negative and the PMIs, despite a notable positive inflection month-over-month, have yet to confirm a trend.  We think the shortcomings of a “fiscal union” and the lack of an adequate bazooka to ring fence sovereign and banking issues should weigh on confidence to the downside in the coming months and mute any improvements we may see in the employment and inflation picture.


Weekly European Monitor: The EUR Drifts Lower Ahead of ECB Meeting - 2. confidence


Weekly European Monitor: The EUR Drifts Lower Ahead of ECB Meeting - 3. pmi


Weekly European Monitor: The EUR Drifts Lower Ahead of ECB Meeting - 4. pmi


Germany (EWG) - We’re getting more constructive on Germany on recent data, however are very aware that despite Germany’s strong fiscal position and employment base, the country’s capital markets are not immune to the region’s sovereign and banking contagion risk. After all, German equities were down last year -20% despite a similar strong fiscal and employment position. DAX is holding TRADE and TREND lines of support.



Key Regional Data This Week:

Positives (+)

Eurozone CPI 2.8% DEC Y/Y vs 2.9% NOV

Eurozone PPI 5.3% NOV Y/Y vs 5.5% OCT

Germany Retail Sales 0.8% NOV Y/Y (exp. 0.7%) vs -0.6% OCT

Eurozone Unemployment Rate 10.3% NOV (inline) vs 10.3% OCT


Negatives (-)

Germany Factory Orders -4.3% NOV Y/Y (exp. -1.2%) vs 5.2% OCT  [-4.8% NOV M/M (exp. -1.8%) vs 5.0% OCT]

Eurozone Retail Sales -2.5% NOV Y/Y (exp. -0.9%) vs -0.7% OCT  [-0.8% NOV M/M (exp. -0.4%) vs 0.1% OCT]


ECB Meeting Preview: On Hold

On Thursday January 12th the ECB convenes to announce its main interest rates. We expect the ECB to be on pause given the actions it took at the last meeting in December, namely the 25bps cut to the main interest rate to 1.00%, issuance of the 36 month LTRO, and reduction in the required reserve ratio from 2% to 1%.


We do expect macro fundamentals to deteriorate in 2012, which will warrant further cuts, however we expect the committee to give pause to review the impact of the measures taken in December. Headline inflation has moderated, which is favorable to the committee’s 2% target in 2012. We expect the ECB’s SMP facility to remain critical to fill sovereign demand and dampen yields and funding conditions to remain tight across banks.



Interest Rate Decisions:

(1/5) Romania Interest Rate CUT 25bps to 5.75%



CDS Risk Monitor:

-On a w/w basis, CDS was largely up across the Europe, with a positive divergence from the periphery.  Spain saw the largest gain at +55bps to 448bps, followed by Italy +26bps to 529bps, and Portugal +23bps to 1,113bps.


Weekly European Monitor: The EUR Drifts Lower Ahead of ECB Meeting - 5. CDS


Weekly European Monitor: The EUR Drifts Lower Ahead of ECB Meeting - 6. CDS




-We’d short the cross at $1.31 for an immediate term TRADE. The EUR/USD remains broken long term TAIL ($1.40) and intermediate term TREND ($1.42) in our models and we think the lack of resolve from the newest proposals for a fiscal union will encourage greater downside. 



The European Week Ahead:


Monday:  Franco-German Summit in Berlin.  Jan. Eurozone Sentix Investor Confidence; Nov. Germany Current Account, Trade Balance and Industrial Production; Dec. UK House Prices (Jan 9-13)


Tuesday:  Dec. UK BRC Shop Price Index; Dec. France Business Sentiment; Nov. France Manufacturing and Industrial Production; Q4 Russia Consumer Confidence (Jan 10-13)


Wednesday:  Hungarian President meets with the IMF in Washington to discuss loans. 2011 Germany Budget and GDP; Dec. Germany Consumer Price Index; Q3 Italy Deficit to GDP; Jan. Russia Weekly CPI; Nov. UK Trade Balance


Thursday:  Eurozone Announces Rates; Nov. Eurozone Industrial Production; Dec. Germany Consumer Price Index – Final; UK Announces Rates; Dec. UK NIESR GDP Estimate; Nov. UK Industrial and Manufacturing Production; Dec. France Consumer Price Index


Friday:  Nov. Eurozone Trade Balance; Dec. UK PPI Input and Output; Dec. Spain Consumer Price Index – Final; Jan. Russia Money Supply



Matthew Hedrick

Senior Analyst


Join us in welcoming another winning New Year on January 12th from 6:00 to 9:00 PM. The celebration will take place at the Sake & Shochu Lounge at Zengo Restaurant, located on 622 Third Avenue at 40th Street, New York NY.


For furthers questions and RSVPs please contact us at .


Best Wishes,

The Hedgeye Macro Team

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