Back to the Starting Line Investor risk appetite has returned with a vengeance since the start of the month, as some of the most maligned asset classes have recouped some, if not all, of their January losses. For instance, U.S. equities, which were off to a weak start, particularly when compared to global bourses, have come full circle and most of the major indices are back in the black. Currencies have been the center of the storm, with at least eight central banks issuing dovish proclamations since the start of the year. This led to the strong dollar thesis that has been widely embraced by investors, resulting in the 5% gain in the DXY and the 6.7% decline in the EUR/USD during January. While February has offered more of a truce for these currency trends, with volatilities lower as the USD and EUR are mostly flat for the month, we continue to believe that there are more chapters to be written for this trade. The blowout U.S. employment report last week highlights the economic divergences between the U.S. and other developed markets, which will undoubtedly continue to cause the monetary policy divergence that has created volatility over the past few quarters. With this as a backdrop, we find the risk rally as constructive, particularly for asset classes that should benefit from domestic growth, but are cautious given the next round of central bank meetings set to begin in March, which should continue to highlight the growing disparity between U.S. economic growth and much of the rest of the DM. As we shall discuss in our upcoming Friday summary, the employment picture is making the Fed’s lift-off decision challenging, with primary and ancillary indicators moving towards pre-recessionary levels. While wage growth, or the lack thereof, remains an area of concern, macro-prudential issues may arise as the flip side of this coin as recently pointed out by a WSJ article penned by Jon Hilsenrath. As such, while we have seen a complete retracement in equity markets, the rates market has only returned some if its gains, although the curve remains flatter as the short end is mostly unchanged since the start of the year, while the longer end is still 20 bps tighter than the start of the year. We would also be amiss if we did not mention the continued turmoil in Greece and Ukraine, which should provide a safety bid if these situations devolve more than anticipated. Given that yield differentials (i.e. 10-year treasury vs bunds) remain at post common currency wides, we envision that we have moved from the extreme overbought portion of the U.S. trading range to one where relative value exists for at least foreign buyers. Recent auctions support this though, with both the three-year and 10-year stopping through their pre-auction levels. We had thought that 1.70%-2.0% was a good trading range, and now have to move it to 1.7%-2.2%, although the theses of continued global demand for treasuries remains intact.
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