No week-end worries

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For once, markets are approaching the end of the week in a relative state of calm.  Oil prices have eased around 4% from the highs seen earlier in the month, global equities have more than recovered from the modest correction and the sell-off in higher yielding currencies (Brazil and Australia, among others) has stabilised, at least for the time being.

The other notable event was the further fall in the VIX index to levels not seen since mid-2007. In other words, investors are putting a much lower premium on uncertainty. Now, this can be seen as both a good thing and a bad thing, given that it was the under and mis-pricing of risk that was partly a factor in the financial crisis in the first place.

But for now, investors appear content to at least breathe a sigh of relief and not to worry about the latest twist and turn in Greece.  Enjoy it, as it won’t last forever.

Guest post by FxPro

Commentary

China’s growing pains. Notwithstanding the general mood of optimism apparent in risk assets these days, there is a growing school of considered opinion which believes that China is heading directly for a hard landing. Complicating the compilation of evidence to support this view is the fact that the Lunar New Year holidays were earlier than usual this year, distorting most series. Even so, there are enough signs to build a convincing case in support of this hard-landing contention. Car sales in the first two months of 2012 fell 6.5% in year-on-year terms; crude steel production is now barely positive, down from a growth rate of 40% in late 2009; and the growth of exports has slowed markedly, especially to Europe. House prices have dipped sharply in many major cities and construction has decelerated as well. Last week, departing Premier Wen Jiabao announced that the growth target for this year had been lowered to 7.5%, down from a previous estimate of 8%. Corporate earnings have softened markedly. As well, the Chinese equity market is under-performing in relative terms – the Shanghai Composite has shed more than 20% over the past year and is still down more than 60% from the late-2007 peak. China’s incredible growth story has been financially crippling for equity investors. Compounding the economic and financial uncertainty in China is the fact that this year marks a change in the political leadership of the country. Although policy officials still have numerous options at their disposal should the situation worsen further, nevertheless the drum-beat of warnings on the economy is getting louder. Even the exchange rate is taking notice – the renminbi has actually depreciated against the dollar so far this year. The challenges over the next couple of years are immense, not just financial but also structural, social and environmental. China will make for compelling viewing.

Rate race. One of the reasons we are seeing such notable shifts in FX is the changing interest rate picture that has emerged this month. Just this week, US 2Y yields have risen from 0.30% to 0.40%, which in a near zero-rate world is a fairly significant move.  We’ve seen a similar move in UK rates, with the equivalent rising from 0.42% to 0.52% over the same period.  The move has not been as pronounced in the eurozone (looking at 2Y swaps), but rates are nevertheless already higher there (2Y swap rate now 1.15%).  There are two further interesting points to note on this subject. First, and unsurprisingly, we are not seeing equivalent type moves in the traditional safe-havens of Switzerland and Japan, which has helped both currencies soften in recent days.  EUR/CHF is at 1.2074 this morning while USD/JPY is near an 11-month high. Both these moves will be more than welcomed by both countries, given the issues that sustained currency strength has caused over the past few years.  The other point to note is that emerging markets are bringing their rates down, something which has already undermined carry trades, and has the potential to do so more.  Brazil has already reduced rates by more than was expected and elsewhere it’s also worth noting that Australia is likely to cut in the coming months as well.  Even though official rates are likely to remain steady in the eurozone, UK and US, the prospect of rising market rates further down the curve (2Y rates having better correlations with FX) is likely to impact currency performance and, as we alluded to yesterday, many of the established correlations look set to be abandoned.      

Another bubble bursting – this time down under. It has been coming for quite some time but now it appears to be unfolding in earnest – the long-anticipated bursting of the Aussie housing bubble. Major cities such as Brisbane and Perth have experienced sharp declines in residential property prices over recent quarters, whereas prices in both Sydney and Melbourne have been more resilient.
However, the situation in Australia’s two biggest cities is definitely changing. In Sydney, property listings over recent weeks have soared, especially in those suburbs where the banker-belt is evident. Bonuses this year have been very poor, and over recent weeks there have been some very significant layoffs in the financial sector. At the same time as property listings are booming in Sydney and Melbourne, actual house sales are declining sharply. Not helping the situation is the incredibly expensive currency, which both inhibits potential offshore buyers and encourages the latter to sell if they already own. Unemployment is rising, household balance sheets are very highly leveraged – which has triggered a much-needed desire to raise saving – and mortgage rates are prohibitive. Second homes and holiday flats are increasingly being sold off and credit growth has slowed appreciably. The next few months will be very tough for Aussie property owners.        

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