Steven Englander, global head of G10 FX strategy at Citi, says that in recent conversations with clients, four big “uncertainties in asset markets” stand out.
In an emailed note, Englander offers some colour surrounding each debate:
How much slack in the U.S. economy? — This subject continues to come up in client discussions, with many investors remaining sceptical that the slack that Fed Chair Yellen sees in labour markets exists in reality. The impact of last week’s minutes was so powerful because it was the first indication that Fed officials might be wavering in their commitment. Fed Chair Yellen’s testimony on Thursday will be a focal point. We think early innings will go to the Fed doves, but that the dovish view will be harder to maintain as time goes on.
Weather — Everyone talks about the weather but does nothing about it. In financial markets, investors are staying on the sidelines until the impact is resolved. We think that weather effects are likely above 50% of the perceived slowing. The impact is most visible on housing, but housing data were weak through most of the 2013, so while housing may be most affected by the weather, it may not be indicative of the overall impact on the economy.
China — Davos-like China optimism coming out of G20 and surprisingly good January data are paling against concerns that commodity stockpiles are out of line with production prospects. There is also considerable scepticism that the credit surge will continue. It makes commodity currencies look increasingly vulnerable, with AUD high on this list.
EUR — The mystery wrapped in an enigma. Surprising encounters with non-leveraged clients, who are very EUR positive. The argument is that both sides of the current account identity are now EUR positive. The current account surplus is there, and the EUR-positive camp argues that the relevant asset prices for the financial account are those of euro zone banks — up 22% since end-September, +8% year YTD — and Spanish and Italian yields, which offer the highest yield for the lowest risk (the worm has turned). This is hardly a majority view, but the novelty is that it is well-argued view. The counterargument is that euro zone inflation is far below target in core as well as peripheral countries, so the ECB will act to make euro zone assets less attractive, but the counter-counter argument is that the pros are the bird in the hand and the cons are deeply in the bush.
All of these debates are likely to dominate for a while, as the weather issue likely won’t be resolved until April, when March economic data are released. The labour market picture will probably be obscured until then as well.
In China, the big question is how long the sell-off in the Chinese yuan — which appears to be engineered by the PBoC in order to shake leveraged investors out of carry trades — will continue. In the euro zone, the advance estimate of February inflation out on Friday is the next piece of the puzzle. Evidence of stabilisation may keep the ECB from moving to ease further for now.
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