quinta-feira, 8 de setembro de 2016


BRL and other brazilian assets have run quite a wild path last 4 years. From the “country of the future” to most hated EM and now to some “OK back to business”. No intention to tell the whole story again now once most know it very well. What calls my attention now is that perhaps once the excesses of the downside relative to other currencies has worked out it seems now for me that the optimism has also run its course in relative value to other EM's. Important to notice the “relative” because I still believe commodities has a way to go up so BRL will still benefit from it but Im concerned the “very cheap” is behind, both in relative value and also in fundamental terms.

Currency is probably one of the worst markets to predict. Besides many factors acting at the the same time they also change in importance during the time. Not to say that sometimes it seems no fundamental factor works at all. But sure tones of models can be made and at least we are not in the middle of nowhere without a compass.

Built this simple one below using only commodities and CDS. Chart is YoY % 

Not only not cheap but also a bit expensive.

On relative value against an equal weighted EM basket it also doesn't look very cheap anymore. 

Again, because I believe commodities still has a way up BRL should benefit, but the main point here its not a bargain it used to be at the beginning of the year, specially compared to other EM currencies.

segunda-feira, 1 de agosto de 2016

Yield curve flattening and the recession

A lot attention has been paid to the yield curve recently, specially the 10 years minus 2 years US treasure spread (spread). In fact many papers have been written on the subject and the important prediction function that the spread has on US economic cycles and recession. However since the introduction of the ZIRP the nature of the spread seems to have changed. Looking through the data since 1978 until ZIRP its possible to notice that the most important driver of the spread has been the short term interest rate, more specifically the Fed funds, and not the long tail. But after ZIRP things changed and because the short term is anchored by the Fed funds the spread has been driven by the long tail. So, looking for the spread nowadays could be misleading in terms of recession prediction. Sure a recession is always possible but this time it wont be caused by the usual driver of the spread, what reduces its importance in my view.

Fed Funds, curve flattening and recessions:



the flattening of the curve and FED funds hiking cycle is very similar. But to measure better the effect of Fed Funds and the 10 Years UST on the spread I ran a couple o simple regressions below.

First the impact of FED Funds on the spread since 1978:


and from 1978 until 2007 just before the crisis...


things are pretty much different for the UST 10Y: 


However, since 2010 things changed and UST is the main driver of the spread now, not surprisingly once the 2Y has been anchored by the Fed funds.

What can be seen here also...


If the the spread is important because most of it is driven by the short term rates it must be important to question its meaning now that the driver has changed. NBER has a paper that through a much deeper analyzes also finds more prediction power on the short term rates instead (http://www.nber.org/papers/w10672.pdf).