The motivation for the recent deterioration in the performance of underlying risk asset markets and the ensuing USD bounce from its early June lows appears to be concern over the prospect of an early end to the liquidity fuelled boom in China. Unsurprisingly those markets and currencies most popular as China plays – oil, AUD etc – have corrected the most. While the China market was unable to stage a bounce overnight, it nevertheless appears that the mooted policy moves are minor. The PBoC has simply stated that it will use market tools to control lending growth and affirmed a “moderately loose” monetary policy. This seems a far cry from the sort of policy tightening that would mark an exit from “middle-way” and a genuine near-term threat to the risk asset rally.It looks like people simply love the momentum trade ...
From a top-down perspective we believe there are two environments in which the USD can rally. One is that the economic data relapse as we reach the mid-peak of the W and spark a major correction in risky assets (left of middle-way). The second (right of middle-way) is that the strength of the recovery is such that fear of policy tightening saps the performance of risk assets as greater differentiation between excess liquidity and genuine growth plays emerges. In this environment – essentially what we are forecasting for 2010 - the USD is also supported, in G3 at least, by a favourable shift in interest rate differentials. An economic relapse may still follow. In the right of middle-way world there is also a high risk that sharp rises in the automatic stabilisers – oil and long-term yields - spark a relapse. We have already has a mini version of this. In early June the USD actually started to rally amid rising yields – i.e. we had moved right of middle-way. What happened next, however, was that risk assets started to correct on fears that higher oil and yields would derail the recovery. This pulled us back into middle-way and saw the USD recovery fail despite weakness in risk assets, sparking talk of a “correlation break”. Context is more important than correlation. ...
However, the colleagues at the Technical Research of BAS-ML published a report on short interest in equity markets yesterday, with a following key message:
ASI readings remain elevated- a contrarian positiveWell, let it be! However, the chart of "adjusted short-interest ratio" may be sending signals that contradict the findings of analysts. Click on chart to enlarge, courtesy of BAS-ML.
Adjusted short interest (ASI) for the S&P 1500 rose in early July by 1.4%, with ASI increasing across all market caps. The increases were most evident in the mega caps and small caps, where ASI rose by 2.2% and 5.4% respectively ..., led by Energy, Materials and Consumer Staples. Overall ASI still remains elevated, especially within the mega caps space and among Financials ... High short levels can provide a floor on equity prices, and current readings may still be viewed as a contrarian positive for the market. Additionally, ASIR or days-cover-ratio (a measure of potential buying pressure) also continued to rise in early July on persistently weak trading volume; levels are now back near the historical average ... Short interest is reported semi-monthly with current data from 01July09 to 15July09. Our data is adjusted for the estimated effects of convertible arbitrage.
ASI rises across sectors in early July led by Energy
Aggregate ASI in the S&P 1500 rose modestly by 1.4% in early July, led by increases in Energy (8.7%), Materials (4.4%) and Consumer Staples (4.3%). ASI in Financials also rose overall in early July by 3% after falling in June by -5.4% (reflecting the unwinding of the preferred arbitrage trade in the large Diversified Financials). ASI in the sector still remains very elevated and accounts for 26% of all shorts in the S&P 1500. The large level of shorts in Financials is a contrarian positive for the sector.
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