Waiting For Clowns To Join The Gaming Of Contained Bailouts

Asian risk markets started the week with losses, but rebounded sharply on singular event of Dubai, after Abu-Dhabi provided a sticking plaster to Nakheel's bond. Markets may indeed assume that the plaster is the right cure for headache? Despite the claims that Austrians should be held responsible for various financial crisis and even World Wars, the nationalization of Hypo Group Alpe Adria is a clear positive for financial markets? All those Greek musings, Spanish tango ...

Well, financial markets may have other issues in the focus. Nomura's Mr Macro sums up today:

Since the NFP report, the Citigroup Economic Surprise Index (CESIUSD) has ripped 55 points higher. Stocks are unchanged, IG is tighter by almost 8bp, Gold is down 7.6%, and EUR/USD is down 0.78%. One of the more interesting aspects is the breakdown of real yield and inflation expectation components. All the increase in yields since the NFP report is accounted for by real yields. Inflation expectations hardly budged. In the context of Fed rhetoric, that acknowledges better growth but insists this is not a trigger for rate hikes, this market response is a curious one. The Fed is inviting inflation, but inflation has not sent an RSVP. There are three possible interpretations:

1. Higher real yields and a steeper curve are affirmations of better growth prospects at a time when wide output gaps dampen down inflation expectations.
2. Markets do not trust the Fed to keep rates lower for longer. Following a period of stronger data, the Fed may conclude the economic expansion is sustainable and signal higher rates. Markets are building in risk premium against that outcome rather than discounting higher inflation expectations of a Fed perpetually behind the curve.
3. A more benign explanation is how higher real yields threaten commodity prices. Breakevens are tied to oil prices. If oil declines it is difficult for inflation expectations to increase.

Ironically, the bond market moves on Friday were just the opposite. All of the change in yields came on the back of the inflation component. At this juncture it is still too hard to be conclusive whether the biggest risk in 2010 is the Fed scare or an inflation scare. Stay tuned.

The Japanese candlestick charting technicians at Citigroup Global Markets conclude on Euro today:

Euro weakening — Buying back of dollars versus the euro appears to be intensifying, with US long-term interest rates rising and the euro having fallen below support at $1.463. On the other hand, the dollar/yen could not make a break above ¥90.78 (12/4) and has been pushed back down. The recent prevailing trend on the forex market has not been dollar strength but rather euro weakness, in our view. If we are right, this could be negative for the equity markets.

And add on on equities:

Impact on the equity market — The correlation between overseas equity markets and the euro/dollar rate and between the Nikkei 225 and the euro/yen rate has intensified since March. Even if the dollar stages something of a comeback against the yen, if the euro loses ground against the yen this would be negative, not positive, for Japanese equities.

It is no wonder that Citi strategist Tobias Levkovich was asking late Friday: "Why Might Someone Buy Stocks?" The quest for answer somehow missed the favourable economic backdrop, but focused instead on relative value gaming:

• Equity allocation seems light and may need some adjustment.
• Pension funds could boost their stock portfolios.
• Extreme flows into bond funds argue for some shift.
• Poor yields on cash may force some money into dividend yielding stocks.
• Sidelined cash contentions are not that indicative of new buying.

However, Steven Wieting, the US economist at Citigroup, sees the route "from financial recovery to real recovery":

• A solid gain in real output is evident in 4Q 2009 without the help of substantial one-off stimulus. Consumption, trade and (less favorably) inventories have all surprised to the upside in recent reports.
• Employment data could show outright gains, if mild, before long.
• Inflation expectations receded meaningfully in early December and consumers noted a highly favorable pricing backdrop in the latest Michigan survey.

Yea, the adoration of equities comes difficult this time, so expect a digital outcome ...

Jan Bylov of Nordea Markets is also trying to look past the US job market schizophrenia today:

Stocks – The US job report schizophrenia

Exposed by the US job report “economic surprises” from USA have rebounded strongly during December. Apparently, this is igniting a schizophrenia between the potential consequences: 1) Fed to tighten and remove liquidity sooner rather than later and 2) will stronger data but potentially less liquidity kill the stock market recovery? With the cardinal proponents of a healthy stock market centred on valuations, growth and liquidity investors’ concerns are understandable – not least with global bonds losing upside price momentum and US dollar recovering. Clearly, the US job report is raising questions about the assurances from Fed about low rates for an extended period and the continuation of “Goldilocks” (bond yields low and ranging, a weak US dollar suggesting amble global liquidity, commodity prices not soaring, leading stock indices recovering and major central banks erring on the side of dovishness). In a low-liquidity environment the parameters driving the post March recovery appear to be questioned by investors. Consequently, while we are structurally bullish it appears increasingly important to focus on tactics to protect the 2009 profits.

Bonds – US & UK taking a big hit

For different reasons long bonds in US and UK have taken a hit while continental European equivalents continue range trading near levels seen at the fear peak of “systemic breakdown” back in early 2009. Most likely, the sell-off in long US bonds and the halt of hoarding US short duration bonds are related to the sudden change and return back to more US economic strength surprises seen during December and in particular the strong US job report. It now appears that investors are questioning the consequences of the strong US job report – will more strong data follow and will it speed up the timetable of when Fed will begin tightening and removing liquidity? With an absence of new Fed rhetoric we believe that bonds still receive a tailwind from dovish statements from Fed, Bank of England, ECB and the IMF… centred on the timing of “exits” which should err on the side of further supporting demand and financial repair. Consequently, we maintain that the yield direction will continue to oscillate/range between the popularity of two transient investment themes: 1) “supply fear and political discipline” and 2) “hesitating central bankers”. The overall market action still backs theme #2.

Commodities – Gold and oil squeezed lower

The setback in gold and oil comes from a situation with very high speculative commitments – also evident in US dollar – suggesting that a further exit by speculative traders is at risk of pressuring prices further down for now. Elsewhere, industrial metals continue to show overall strength, and with the traded $-index still not signalling a reversal (>77.50) underlying commodity strength is favoured.

Currencies – Unwinding the crowded short USD trade

Lead by the US job report investors appear to be questioning the dovish statements by Fed and what the consequences of less liquidity might mean to the Goldilocks scenario! Nowhere is the question raised harder than among currency traders whom are faced with an enormous load of short USD positions. Technical USD resistance levels are under pressure everywhere (EUR 1.46 & USD index at 77.50) and “the line of least expectation” surely is up for USD. So far we consider the situation as a risk management issue, and our May -09 carry basket strategy of long BRL, TRY, RUB funded by CHF and CAD has a protective stop (profit) close to spot.

Nomura made a defensive rotation call in telecoms and utilities even for Asia last week ... It is a digital world today!