Updated Apr 18, 2010 12:00:00 AM
This past week has all the hallmarks of a market set to stall and undergo a correction lower for a few weeks at least. Before outlining those hallmarks, it's worth mentioning the main source of hesitation with this view, namely the proximate catalyst to Friday's sell-off: the US bank being charged with fraud by the SEC. (Oh, and also that it happened on a Friday.) While it makes sense that their own shares should be hammered, it's less than clear why oil, gold, JPY-crosses, not to mention the broader stock market, should collapse in tandem. After all, they're only one bank, and they'll be able to pay off any fine if found guilty, and then resume making billions again. But perhaps we're getting too caught up in the headlines of the moment. Taking a step back, there are plenty of other fundamental reasons why the rally in risky assets may take a breather for a while. China's President Hu indicated in a speech in Brazil on Thursday that China plans on reverting to a managed float of the Yuan, though the timing of that move is still open. China also raised mortgage lending requirements to take some air out of the growing real estate bubble, adding to earlier steps to rein in bank lending. Taken together, markets fear those moves will crimp Chinese growth and undermine the global recovery, hence the commodity and stock market sell-off. In terms of allowing the Yuan to potentially appreciate, we would argue that it would eventually be a positive for the global recovery outlook, after the initial knee-jerk risk averse reaction, which should last only a few days or weeks. If China allows the Yuan to strengthen, it will improve the export competitiveness of key export-driven economies like Japan and Germany,
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Updated Apr 11, 2010 12:00:00 AM
The 1Q earnings season kicks off next week and if the last reporting season is any indication, it should have significant implications for risk appetite. 4Q earnings were viewed as constructive for the markets as they showed the first semblance of organic growth. In other words, all of the earnings were not based on cost cutting alone but also a smart pickup in top-line activity. While cost cutting did dominate and helped overall earnings beat expectations by more than 5% in 4Q, sales figures also impressed to the upside by nearly 2%. We expect this pattern of organic growth to continue and show through in the 1Q reports. Estimates for overall earnings growth currently rest around 30% from a year ago. To be fair, very low comparable levels from last year make reaching this threshold quite easy. However, the evidence of late (especially from the retail space) suggests we could surpass these estimates in a big way. Should this come to fruition, there are a couple of plays in the currency space that should do quite well. In this vein, we like to look at the inter-market correlations and what has done well in tandem with equities this year thus far. The currency pairs best correlated with US equities in 2010 thus far have been – perhaps unsurprisingly – USD/CAD and AUD/USD. The former has seen a whopping -95% correlation while the latter has moved in concert with stocks 90% of the time this year. Should we see a similar rally in equities that we got in 1Q (roughly 7%) this would pin the S&P 500 near 1275. While not our base case, it is important to note that given the 2010 relationship this would place USD/CAD near 0.9530 and AUD/USD around the 0.9800 area by the end of
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Updated Apr 4, 2010 12:00:00 AM
Generally positive data streams this past week, culminating in Friday's positive US jobs report (more detail below), sent risky assets higher (stocks, commodities, JPY-crosses). In FX, USD/JPY continues to lead the way up, again following US Treasury yields higher, lending support to the JPY-crosses and even the beleaguered Euro and Sterling via EUR/JPY and GBP/JPY. Friday's NFP report saw the USD bounce slightly into the end of the week, potentially signaling the end of the EUR and GBP recovery. Credit default swaps for Greece, Portugal and Spain surged to recent highs this past week, just after the EU accord on Greece, which should serve as a reminder that EU credit concerns are still an issue. Overall, we continue to see the risk environment improving, and for further potential higher in USD/JPY and most JPY-crosses. We think EUR and GBP will continue to lag, while AUD and CAD are likely to continue to lead, leaving the USD with a bit of a mixed picture against the majors. Increasing speculation that China will soon revalue the Yuan is supportive for risk sentiment in the near term, at least until Chinese officials deny it. A Yuan revaluation would be seen as supporting the global recovery by improving the export competitiveness of mired developed economies (think Japan or Germany), effectively spreading the wealth away from China somewhat. While the near-term outlook is constructive for risk, many markets have reached potentially pivotal levels, so some consolidation seems likely. But many of the barriers to the upside are merely psychological, and could be surmounted relatively easily. In US stocks, for example, the DJIA and S&P 500 are likely to test key 12K and 1200 levels next week; a break above would be bullish for risk. In gold, prices stalled again below the 1125/30 recent
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Updated Mar 28, 2010 12:00:00 AM
(N. B.: This weekend, the UK will shift to British Summer Time (BST), which will move clocks in the UK one hour ahead of GMT. The difference between NY time and London will return to 5 hours.)
EU efforts to reach an accord on Greece captivated the market's attention for most of the week (more below), but the real mover was a sharp rise in US rates and a further steepening of the yield curve. Those moves sent the US 10-year credit swap spread into negative territory for the first time ever and triggered a position-driven sell-off in US Treasuries, sending yields higher. Treasury dumping increased after the pricey US Treasury auctions in subsequent days (see below), and 10-year US Treasury yields finished the week about +16 bps higher for the week, but lower from the +23 bp peak. The rise in US rates sent the USD sharply higher, aggravated by EUR weakness on Greek bailout concerns and breaks of key technical levels. USD/JPY experienced the largest move higher in line with its typical correlation with US rates. The directional move in US rates is not surprising, but the timing was, as the drop in credit swap spreads occurred before any of the US auctions, suggesting positioning played a key role.
To see whether the USD gains of the past week are sustainable, it helps to understand the reasons behind the run-up in US Treasury rates, as some are likely temporary while others are more durable. Among the temporary factors are potential Japanese asset managers' selling of US bonds for financial year-end accounting purposes. As they dispose of US bonds, they also buy back USD/JPY, which they originally sold to hedge their USD bond exposure. Those flows may be temporary and reverse after the March 31
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Updated Mar 21, 2010 12:00:00 AM
FX markets continue to fluctuate broadly in recent ranges, turning with every twist in the ongoing Greek drama. Risk saw higher in the beginning of the past week as EU leaders appeared to be in agreement on a plan to provide an aid package to Greece. Then the German government indicated it could not legally support such a plan and that Greece should seek aid from the IMF, sending EUR/USD and most other risk assets lower into the end of the week. Then on Friday, EU Commission President Barroso confused matters further by advocating a standby financial aid mechanism of coordinated bilateral loans from Euro-area countries. The immediate Greek drama may be entering the final act, though, as next week's EU summit is likely to see a definitive resolution one way or the other. If European leaders fail to reach an agreement, it will look very bad for Euro-area cohesion, exposing the fiscal vulnerabilities of other members now seen to be on their own, and likely see the Euro suffer as a result. In the end, Greece will be bailed out, whether by the EU, the IMF, or some combination of the two, and we think the risk of a Greek debt default remains remote. Even though its last bond auction was well oversubscribed, Greece is facing unsustainably high borrowing rates and a package is needed to lower Greece's borrowing costs and give the austerity plan time to work, otherwise a high cost debt-spiral would ensue. Once an aid package is resolved, we would expect some of the tempest to subside and for the EUR to stabilize and potentially recover. Given that EUR/USD has moved back to the lower end of the recent range, we would prefer to be buyers of EUR/USD while its holds above the key 1.3430/50 level.
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