Switzerland
The 1990s mid-cycle slowdown is an appropriate analogue to current market conditions. A lower dollar was the key ingredient the easing in monetary conditions that resolved this episode. This suggests that today, as the sole economic lever left, the greenback has further downside. Go short USD/SEK. Go long a basket of NOK, CAD, AUD and NZD against the USD.
The RMB has been steadily depreciating versus the U.S. dollar and has dropped to a new cyclical low versus its trade-weighted basket. All the while, Chinese domestic interest rates have lately drifted higher. When global investors wake up to these dynamics, global share prices and EM risk assets will likely sell off anew. In Mexico, initiate a new yield curve trade: receive 10-year / pay 1-year swap rates.
The latest conclusions from the sector-based (right) way to pick stock markets. Plus some important conclusions for credit markets.
As the sole shock absorber left in the global economy, FX markets will grow more volatile. The currency market's reaction to the recent Fed minutes exemplifies this phenomenon. Despite its sores and blisters, the U.S. economy wins the global beauty contest. Caught between those forces, the USD will continue to weaken over the next quarter or two before resuming its broader bull market.
The Fed is accentuating bearish dynamics for the dollar over the next three to six months. The upcoming National Congress of the Communist Party of China provides Chinese authorities with an incentive to ramp up stimulus this year. The new Treasury semi-annual report pre-empts meaningful direct interventions to soften the yen. More than just Brexit risk is weighing on the pound.
Reflation continues to dictate short-term market moves. Behind this sugar-high, the global economic backdrop remains poor. Commodity currencies can rally for a few more weeks, but once markets refocus on Chinese and EM core weaknesses, commodity currencies will make new lows. Within the complex, favor the NOK and the CAD over the AUD and the NZD. Our portfolio remains positioned for additional yen strength.
The dollar countertrend move has more downside, but beyond the next few months, the dollar remains in a cyclical bull market. Improvements in global growth, even if temporary, are likely to lift non-U.S. rates more than U.S. ones. The euro will benefit from that move as investors still have deep negative feelings toward EUR/USD, exactly as economic momentum has moved in favor of Europe. The SEK should outperform.
Japan is in a liquidity trap: bad economic news is good for the yen while good economic news is bad for the yen. Chinese reflation could help risk assets in the months ahead, but poor EM fundamentals will reassert themselves later this year. The yen bull market is not over yet. The BoC was more positive on growth than anticipated. The BoE's Super Thursday was a non-event.
No significant change in allocation was made. Direction wise, weights in Spain and Switzerland were increased slightly at the expense of Netherland and Sweden.
Fed dovishness is weakening the U.S. dollar. As the ECB and BoJ move to the sidelines and the Fed remains reluctant to hike rates, the euro and Japanese yen should continue to recover versus the greenback.