USD-EU-JPY economies

US recovery drivers are Fiscal stimulus, Exports…. Headwinds will come from stimulus withdrawing.


Most desirable thing here is improvements in housing, employment and foreclosures

EU/ECB sovereign Risk: Greek bailout, stabilization fund are just starters in the fuzzy space of EU zone sovereign risk.

Germany/France banks together have major exposure to PIIGS debt.

Most desirable thing here is transparency and political will to work together.

Emerging Markets

China, India still plagued by property bubble and inflation. Will European slowdown impact export sectors if these roaring tigers.

US recovery happened on the heels of huge doses of monetary and fiscal stimulus. Fed is slowly withdrawing stimulus programs. We are still not out of woods yet, unemployment is stubbornly over 9 %, housing market shows no signs of recovery, and manufacturing is showing a bit of activity.

Will USA and Europe morph into Japan?

I can think of Europe rather than US turning into Japan. Why? Demographics. Europe has a decling trajectory of young population compared to US. Deflation is might take its life but will be smothered by inflation.

EURO Zone Sovereign problems will play out for long time. All politicians expect problems to get resolved on their own. But this is not going to happen. Europe fundamentals are not that sound. Especially, debt laden PIIGS. There will be a decline in the living standards because of austerity measures taken by the peripheral nations. Europe is more vulnerable to deflation due to systematic deleveraging. This will have indirect impact on China and EM nations.

In this kind of macro scenario what kind of action will play out in various asset markets?

Interest rates: Treasury and Bund yields are trading at their lowest levels of 2010 due to sovereign risk and recovery problems. Since April 10y treasuries have fallen almost close to 75 bps. Bond futures traded in CBOT are pricing 124. How low can yields can go from here? I think if Japan stands an example, rates have further room to go down. US debt levels are rising, recovery is not yet on tracks. What can stall yield curve flattening? FED is on perma hold policy. This means short end curve remains very much anchored to low levels. Inflation shows no sign of coming and therefore 10y rates are falling lower. One interesting thing I can see is from option skew markets. Markets are pricing more of falling rates compared to rising rates. What this means to rest of the markets? Housing loan rates will be low but of no use as long as banks are not willing to lend. Then what is the purpose of these low levels. What are treasury investors looking for? I can think of only one thing, central banks are getting richer for their UST holdings and getting more money for strong dollar.

I can think of another 50 bps rally before any sell off to occur.

Yield curves to flatten further instead of steepening

Fundamentals in rates markets, High level of treasury debt and expected US growth are pointing towards bearish view in the market. But sovereign risk is playing dominant role. So markets need to reach a stage where sovereign risk is no longer threat but the unsustainable debt is bigger threat.

In Forex markets, USD will be crowned as king not because of its best traits but better traits when compared to other currencies. Dollar is benefiting from better growth and removal of liquidity measures.

EURO will attain its nirvana by attaining parity to dollar.

JPY might fall further due to increased purchasing of non JPY assets and further QE