Attack the Week (ATW)
July 24, 2023
I hope you all had a blessed weekend. I published two articles over the past few days, which I hope you find useful. Not to worry if you have missed it; see the links below.
#3 of stories from the institutional past deals with the concept and illusion of free lunches. Some fun memories of the unlimited pre-GFC world should hopefully give you a good glimpse into the “good old days”. Speedboats and all.
The Essence of Paper Alfa is really a summary and mission statement as to what this is all about. Paper + Alfa.
One of my nephews works for a large media company and has asked me to talk to their development team in regard to what professional readers would seek when it comes down to a more in-depth analysis of monetary policy debates. The field is vast, and competition is fierce. I opined that “facts” are less relevant and that journalist opinions, with all due respect, also don’t offer value to a professional reader who receives timely sell-side research on those very topics.
Real value, I argued, is found in their proprietary data in terms of media reaction itself through the analysis of what subject triggers heightened discussion amongst their readership.
Most media companies sell their data in today’s age, where advancements in Natural Language Processing (NLP) and the surge in digital data have prompted the investment world to look into this information in order to gain actionable insights from the vast and intricate labyrinth of user-generated content. Heck, there are hedge funds real-time analysing language tone and facial expressions when our esteemed monetary leaders speak.
If you sit in the middle of the vast array of information or sentiment flow, you have an edge, I would think. The question, however, is how good of a representation of opinion that data offers and how it’s subject to change. It sure is not easy. As in all data things, there will be tons of noise relative to concrete signals.
With that in mind, Paper Alfa is also thinking of ways to analyse data, especially from Twitter (X), and to attribute the current market sentiment to an investment framework. If you have any views or even experience in this field, do please hit me up.
As we are gearing up for a very busy central bank week, below are my thoughts on what I think is most likely to transpire. As usual, people’s discussion about the event heats up just a day or two before the event, while markets have already pretty much settled as to what’s likely to come. I don’t put on any trades in the days before those meetings; it’s frankly irrelevant to my thinking. What I am mostly interested in is a) any clues as to a change to their current way of thinking and b) the market reaction to those events, which should give a good insight into current positioning across markets.
A 25bp policy rate increase is pretty much baked in. “Dots” from the Fed’s June projections imply a subsequent 25bp hike delivered later this year, whereas the market only shows a small probability attached to such a scenario. Too little in my view.
Jay, however, will most likely give no strong guidance as to when, if at all, another rate hike is coming. Recently softer core inflation will be welcomed by the committee, but they will want to see several more months of softer inflation data before calling an end to the hiking cycle.
One interesting aspect I always ponder is the optionality he has when giving his views. This time around, I would argue, he can lean either way, depending on what his current focus might be. This optionality was somewhat weakened in pretty much all recent meetings, as he had to continue pressing on with the hawkish rhetoric.
A hawkish optionality would be if Jay emphasizes the resilience of activity and highlights the topic of a potentially higher neutral real interest rate. He could also downplay the slowing in core inflation, given the potential for non-shelter services inflation to remain structurally more elevated.
Dovishly optionality could come in the form of guiding away from a rate hike in September or the remainder of the year and linking any further policy tightening now firmly on data dependency and the accumulation of policy tightening already enacted.
I don’t think JPOW will lean much against pricing and will generally be interpreted as hitting more dovish tapes. Once you link your monetary policy to data outcomes, the market will sniff out (as it has already done) your relative change in reaction function. Talking about reaction function, I will be publishing a note on the “inverse optimal control” monetary policy function. This will look back at Yellen’s adjusted Taylor Rule reasoning and argue how it can be adapted to today’s monetary policy path. Stay tuned.
As for the ECB and BOJ, our weekly focus charts and other important market events this week, read on …