Waiting with bated breath…

It seems as if every market is at a critical juncture and just waiting with bated breath. Which ones? Well, there are the important ones: currencies and bonds. Equities aren’t on the list of important ones right now, because they are just following the moves in other markets. The trade has been short USD, long equities – a reflation trade. The 10/30 spread has been blowing up as rates on the long end jump and rates on 10 years and shorter have been locked down. Great if you want to start a bank, not great if you’re poor and milk prices are rising at the supermarket.

Let’s start with the USD:

If the USD bounces here, it will generate an unwinding process where equities will have to be sold. It will be a domino effect that will cause one big Wall Street margin call. I’m positioned for this scenario. Many, if not most, investors are positioned for the USD to continue falling, believing the Fed can re-inflate the economy and seeking safety in equity earnings that they believe will rise with inflation.

If the USD doesn’t bounce here, then we can get some inflationary pressures. Equities might benefit, but the real beneficiaries will be the commodities and related companies. DBA certainly looks strong and has had a very nice move recently:

DBA, while a follower of the currency moves, also has something else going for it: geopolitics. With some freak draughts and weather related incidents causing additional strain to the already tense political maneuvering, DBA could benefit from increased protectionism as countries move to protect their domestic supplies. It could provide a good support, but this, again, is a critical juncture.

Meanwhile, the 10/30 spread, while off it’s historic lows is still at incredibly low levels:

In the meantime, EEM is possibly rolling over. I say possibly, because it hasn’t broken it’s uptrend, but with continuous inflows on the one hand, but emerging economies trying to dissuade those same inflows on the other, it can go either way – depending on the market’s view on the USD.

And on and on we go. The financials have been significant underperformers this year, and at some point (I think in the very near future), the large hedge funds holding the financials might be squeezed out. They’ll have to either liquidate their positions in BAC, WFC and the like, or they’ll have to liquidate in other markets (gold? USD? treasuries?). And let’s be real – can the equity market have a sustainable rally without the banks? I think not.

Every market I track is waiting to see what happens with the USD. I have been calling for a reversal day for a while, but I think it’s coming (maybe today is the day), which will signify the need to unwind the risk trade. That unwinding will involve USD getting stronger, equities and commodities getting hit hard. The real problem with that scenario is that there will be no place to park and hide.

Last 5 posts by Yaron Sadan

• Portugal, and Yields, and Iran . . . - January 30th, 2012
• The Hunt for Yield - January 26th, 2012
• All eyes should be on Iran - January 23rd, 2012
• Quick note - January 19th, 2012
• Our monkey mind - January 17th, 2012

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