The signs of
the risk off are seen in everywhere. US economic indicators are deteriorating
rapidly, signaling weaker growth rate this year due to sluggish domestic
consumption as repo market shows significantly odd signs recording the highest
level of failure of settlement since 2008. When FOMC suggested dovish step for
policy rate, we or many market participants recognized that as an agreement of
G20 in Shanghai. Right after G20 meeting, PBOC reduced required reserve ratio,
RRR, and this was somewhat surprising as market had woes about possibility of
RRR hike rather than cut in light of covering capital outflow. But, if there
was an agreement about weak US dollar, as FOMC led depreciation, PBOC had to
move renminbi toward appreciation rather than additional devalue. When US
dollar turn strong a little bit last week, however, PBOC raised CNY fixing rate
in line with that. This proved that there wasn’t the agreement, but China
wanted renminbi to be weaker although the pressure of strengthening US dollar
decreased. Albeit HSBC noted currency war ended for now, we don’t think so.
China is set to start. And as you know, continuing global currency war means
worse equilibrium, not optimal equilibrium in global economy.
On the other
hand, how about Euro area? Many argue Draghi hopes to end weakening Euro as he
does not signal additional rate cut for now. But we should consider asset
purchasement, especially Euro corporate bonds of investment grade. This policy
must lead offshore companies to issue their bonds in Euro area rather than own
country. And then this should cause weakening Euro in contrary of current
market recognization. However, we face the bigger problem now. We saw depreciation
of GBP in line with terror in Belgium last week. Yes, it is the risk named as
BREXIT ahead of only 3 months. Unless BREXIT is realized, many countries in EU
could start to pursue special status like United Kingdom. This means systematic
risk in Euro area. Risk off caused by EU could lead strong US dollar.
In these
environments, US dollar could be stronger rather than weaker despite US Fed
turns dovish. This reaction could cause weak oil price as well. Deflation fear
is not faded.
So then, why US
Fed turns dovish surprisingly? They want weak US dollar and strong oil price
and these mean reflationary policy. But, why? I think they realize strong US
dollar could not spur domestic consumption any more. So they should adopt
opposite strategy so called currency war. Domestic consumption started to
deteriorate from start of this year and labor market seems to be weak in line
with sluggish sentiment in nonmanufacturing sector seen in sharply falling ISM
employment index and mid- and small corporations’. Furthermore, ahead of
earnings season for 1st quarter, we should throw out hopes. Market
forecast of earnings are too high. We should prepare crush in stock markets as
soon as possible.
We should add
duration in main developed countries especially United States. I prefer United
Kingdom for higher yield than Euro area as well. Yield curve seems not clear.
With the relative value analysis, short belly of butterfly in 5s10s30s tenor of
government bonds, but when treasury market restart bull movement, 10 year
treasury could be outperformed. I am somewhat cautious to overweight corporate
bonds even though ECB will start to purchase soon. Next step risk off could be
led by financial sectors, so I think slightly underweight position in credit
bonds despite some corporate bonds provide attractive spreads and yields. In
FX, I recommend short USD/JPY and GBP/USD. I want to short EUR against USD as
well, but this strategy is not priority.
