What is Going On?

The behaviour of currencies has been confused by JPY. JPY weakened sharply after the BoJ announced its inflation goal and asset purchases, although as US 2-year rates started to increase shortly afterwards, it is not clear whether the connection between the two would have been broken or not. Certainly, the historic relationship has held and USD/JPY has recently fallen with 2-year rates, although JPY is now at the weaker end of the historic range. The fall in JPY in February and March translated into a rally in USD in that period. But is that the right explanation, or was it that falling expectations for QE led to rising US short-term rates and hence a rally in USD? Why did USD/JPY seem to lead rates upwards? Did it just start to move, and then get pushed on by an increase in 2-year rates? That is the most coherent explanation, given that 2-year rates have now fallen and USD/JPY has done the same, and given that USD actually fell against EUR and GBP in February and March during the risk-on phase for US equities. A further distortion of the picture comes from the behaviour of AUD, which has been falling as the market has started to price in the continuation of the loosening cycle in Australia. That is an AUD-driven move, but it looks like a weakening of USD.

So I think what is happening is this. USD continues to be negatively correlated with risk assets, but AUD is increasingly decoupling from global risk, JPY has been swinging around with US short-term rates, and those factors have made it seem as if USD’s negative risk correlation was being broken. I suppose this is an argument that risk-on/risk-off is still with us, but is no longer the main influence on each and every market. EUR remains correlated with global risk (as does GBP, which rather falls out as being the currency that dances to the others’ tunes), perhaps because global risk-off phases have been driven by European concerns — i.e. the moves of EUR and risk assets may be co-determined by European conditions (in terms of whether there is a crisis episode and whether the ECB is sounding tight or loose).

In equities, the trend of the past few months has persisted, which has been for global markets to move in tandem around differing central tendencies that have been determined by local conditions. So, for example, China-related equities have been weak, as have European equities, not because their daily moves have decoupled from global risk but because their broad directions on a weekly and monthly basis have diverged. Thus there are two games to play in equities: prediction of the short-term (say, month-long) risk-on or risk-off tendency, and prediction of the broad trend.

In commodities, Brent crude has started to fall, having reached a high plateau in March. It is tempting to think that this is because the Iranian situation is calming down — but then, why does the copper chart look exactly the same? A better explanation would seem to be that global growth looked less exciting in March (especially for China) and hence copper and Brent stalled and then fell, while the US, because it is the global leader in terms of growth prospects at present, saw its equity market power ahead. Thus there may still be quite a lot of risk premium to fall out of Brent — but the market could rally if the Spanish situation abates and we see another risk-on phase.

Well, this is all very nice, but what is going to happen next? I really think that the latest Spanish fears are overdone. The ECB will not allow a deteriorating liquidity spiral, and Spain’s solvency is not really in question. That means that credit spreads should come in again. US economic — and hence, earnings — expectations should continue to rise because the prospects are good whether the economy is strong or weak. If that sounds paradoxical, the reason is that the Fed appears highly willing to act if the pace of improvement deteriorates. Without any serious danger on the horizon, US equities could well continue to grind upwards. I seem to go over this ground again and again; but the fact is, the latest round of Spanish concerns has caused a pullback, and I have no argument that that should end today rathern than next week or next month. In the meantime, the market would have plenty of time to take out my stop. That is what has held me back. One of my trading rules is: only trade when you can make an argument that your stop should not get hit. Does “concerns about Spain are already overdone” count as such an argument?

What about other markets? I would like to be short AUD, but was slow to get in, because I am disinclined to bet on the breaking of relationships. Actually, that disinclination kept me from shorting AUD much too early — I did not do so in January or February, when some were keen on the trade, because I expected a risk-on phase in which AUD would rise. But AUD has now managed to fall in a risk-on phase, and I think I have enough evidence that it has started dancing to its own tune. The question is whether the market will give me an entry point — it has not recently been kind.

A logical extension of my view on Spain, I suppose, is that I should be long EUR/USD. If US equities rise, and Spain is not the problem that the market presently fears, then USD should fall and EUR/USD should rise. The danger here, as with the equity trade I discuss above, is that my view is predicated on the idea that the ECB will not allow a liquidity crisis to push Spain into a bailout. This idea does not mean that the ECB will not wait until the market fears it is not going to act before acting. If Spanish bond yields continue to rise, there may be time for a mini-crisis episode before EUR and SPX rise (and the problem with sequential views is that things can happen in the interim, such that the second part of the expected sequence never happens).

I must admit I am feeling very frustrated at present. I made the right call on equity markets in late January but made no money. I made the right call on USD/JPY and short-term US rates (i.e. I expected the relationship to hold and US rates to stay low), but entered too early and lost money. I said at a meeting in late March that I thought fears over an attack on Iran were priced in and that the fact that sanctions were biting might well force Iran to the negotiating table, but failed to develop enough conviction to do a trade. My views are not translating into action. The problem, I think, is that I am being too demanding of my arguments, looking for too much certainty. The fact that the market has moved one way, and all the opinion seems to be that way, and further that the market has stalled and that the slightest hint of change is in the air, is perhaps enough of an argument that a stop beyond the current range will not get hit and a contrarian trade is therefore in the offing. I was not demanding enough with USD/JPY, but had I held off a little longer, I would have got a suitable entry point (it was a mistake to catch a falling knife without an argument that it was about to hit the chopping board). My trading has been best when it has been opportunity led — i.e. when I have been looking for chances to trade, and grabbed the ones that seemed most promising.

My trading has also been best when I have had most conviction. At the moment I don’t feel I have a lot. For example, I found it difficult to argue that expectations for Fed rates should stay low, because the Fed has not, in fact, committed to keeping rates low. Part of the reason for my confusion is that I have yet fully to grasp the effects of the Fed’s new monetary policy (and, especially, the effect of the forward guidance). This area definitely needs more thought.


  • Eurozone trade surplus fell for 2nd month, d.e., Feb, but remains well into positive territory. Imports rose 3.5% MOM s.a., while exports rose 2.4% MOM s.a.
  • US retail sales and core retail sales both rose 0.8%, b.e., Mar.
  • Empire State manufacturing index fell to 6.6 d.e. Quite a big drop, and another indication of a slowdown from a leading economic indicator.
  • China FDI -2.8& ytd/y Mar. An effect of the Chinese slowdown, not a cause.
  • UK CPI 3.5% a.e. Mar. Core 2.5%, near lows for the past two years.

Coming Up

  • US building permits and housing starts
  • US IP and capacity utilisation
  • Draghi speaks