Italian bonds gain strength, European stocks up on the news
Yen has been finding some bids, perhaps influenced by US Treasury
Oil stands out as relative outperformer aided by geopolitics
Obama asks for more borrowing power
Economic calendar extremely light today
For any of you trading the markets this week, things have picked up a tad into Wednesday, with volume getting to as about as high as it will get until after the New Year in this very light holiday trade. The key focus for today has been the Italian bond auction which will be going on into tomorrow with the more important results being released tomorrow. The auction due will total up to Eur20B and is the first big test of the European Central Bank’s latest three year LTRO liquidity program. To this point however, it seems as though the newly modified central bank policy tool has not done anything major to bolster sentiment. But the Italian bond auction does take on added meaning given the country’s use as a barometer for the broader European debt crisis. Today’s auction is the less important of the two, with the longer term debt due on Thursday.
undoubtedly be the Italian bond auction results, with the economic calendar basically empty.
Moving on, from an FX standpoint, we have been seeing some mild risk off price action, with currencies tracking lower against the safe havens. More interesting is the price action in the Yen, with USD/JPY slowly moving lower and away from the 78.00 area. Also of note has been the price action in oil, with the commodity very well bid over the past week and standing out as a relative outperformer as the price rallies back over $100. Iran's threat to block oil shipments from moving through the Strait of Hormuz if foreign sanctions are imposed have certainly factored into the supported oil market.
Elsewhere, the US Treasury has released its semi-annual FX report, and while there was no specific mention of China as a currency manipulator, this did not dissuade the Treasury from coming down hard on Japan’s recent intervention actions. The report said that it “did not support” Japan’s FX market interventions in August and October given the fact that FX movements during that period were orderly. The report contrasted the interventions from August and October to the earlier post earthquake intervention from March where the official Japanese action was more justified. However, a Japanese government official has since been on the wires saying that the US criticism will do nothing to change the country’s stance on FX. Also, President Obama today announced he will ask Congress for an extra $1.2tn borrowing authority this week. This would raise the Federal debt limit to $16.4tn & therefore avoid the need to ask for more increases before the 2012 elections are held.
Foreign Investment in US Equities
While on the surface, the recommendation appears to be non-currency specific, we view this as an extremely attractive opportunity for a portfolio hedge in 2012 and potential arbitrage strategy. Currencies have been broadly outperforming against the US Dollar in recent years and it finally appears as though this trend could be on the verge of some form of a reversal back in favor of the buck. However, long USD positions have also been quite risky and exposure to the Greenback might bring with it some unwelcome stress. As such, our recommendation is foreign investment in US equities. What does this mean?
Here is how we see this playing out. Should current correlations stand, if US equities are to head higher, then the investor will benefit from the US equity return, but at the same time, likely have his/her investment offset by the sell-off in the US Dollar and appreciation in his/her local currency on the resurgence in risk appetite and outflow from the safe-haven US Dollar. If on the other hand US equities head lower, then the risk off market environment will allow the investor to offset his/her loss in US stocks through the appreciation in the US Dollar on its safe-haven flows (remember – the investor in invested in US equities and thereby has USD exposure).
So if this is the case, then where is the benefit in this trade, and why even do it? Well, what if we see a break down in familiar correlations where the US equity market rallies and the US Dollar also rallies at the same time? What if we see a situation where US equities and the US Dollar become positively correlated? In this scenario, the investor stands to benefit a great deal and will not only make money from his investment in US equities, but will also enhance his/her returns on the appreciation in the US Dollar.
The global recession appears to be moving in phases, and with the markets now dealing with phase two of the crisis in Europe, we can start to anticipate the transition to phase three, where we believe that China, the commodity bloc economies and emerging markets will all be exposed. At the same time, we see a first in and first out type of situation, with the US economy the first to emerge from the global recession which should translate into a more upbeat outlook on low valuation US equities and the US Dollar as well, on a narrowing of yield differentials back in favor of the Greenback as the Fed begins to signal a reversal of ultra accommodative monetary policy.
Relative performance versus the USD on Friday (as of 10:00GMT)
NZD +0.57%
AUD +0.31%
CAD +0.29%
JPY +0.23%
CHF +0.17%
EUR 0.00%
GBP -0.03%
