BofA Merrill Lynch investment strategist Michael Hartnett (of “Great Rotation” fame) identifies seven things that could be a dealbreaker for the never-ending risk rally in his latest note to clients:The biggest risk to investor positioning right now is any event that causes data, yields or volatility to break out of their recent trading ranges. The big 2013 risks remain a Bond Crash (in France or the US), a Currency War (between Japan, Europe and EM) or inflation. In coming weeks we would watch the following:
1. US labour market. The most likely reason for a big sell-off in US Treasuries would be acceleration in jobs growth to +250K in payrolls. Watch small business hiring intentions (SBOIHIRE Index) as a lead indicator (as was the case in late- 1993).
2. The 2.25-2.3% level on 10-year US Treasuries, which if breached could cause mortgage convexity to kick-in and send yields significantly and quickly higher, according to Rates Strategist Priya Misra.
3. Oil. Energy prices have quietly risen of late. A further $10/b rally in WTI to above $105/b & in Brent to above $125/b (note Brent in yen terms is at 4 year high) could dampen economic activity in Q2.
4. Inflation breakeven levels. With labour markets slack and output gaps large the likelihood of inflation is low. So why are breakeven levels close to 5-year highs? Should QE, FX devaluations and higher oil prices combine and cause a breakout in breakevens bonds would react negatively.
5. Chinese exports. Thus far Asian export growth has been resilient despite poor activity data and the Japanese yen devaluation. And China, ironically, has become one of the few major countries that is not manipulating its currency lower. That could change if Chinese export growth suddenly slows. And if China needs a weaker FX, the probability of a risk-negative currency war grows heralded by a sharp drop in ADXY.
6. Will France recover before Germany slows, or vice-versa? Their respective PMIs will tell the Q2 tale.
7. Bonds and Currencies. Sometimes it is the relationship between the two asset classes that matters. If the US fiscal tightening starts to bite look for for Treasury yields to fall and the dollar to rise. If the European story deteriorates once again, look for French yields to rise and the Euro to fall. If the Japanese are really to rid their economy of deflation, then look for the yen to fall until JGB yields start to rise.
BAML technical analyst Mary Ann Bartels wrote in a separate client note that calls for a correction in the market are becoming consensus, which could postpone the actual selloff. If it happens relatively soon, she says, it could be a 3-5 per cent correction.
If it gets pushed off for a few more weeks, however, Bartels sees a pullback on the order of 5-10 per cent.
For his part, Hartnett writes, “even assuming volatility stays low and the macro remains in a trading range, the best outcome is for equities and other risk assets is to grind higher in coming months.”
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