Don't Look Here! Look Over There!


COMICAL ACTIVITY - Although the lack of market volatility has been frustrating, I still believe there are some excellent opportunities out there, if you look in the right places. Sometimes it just requires looking away from the major markets and digging deeper into less traveled country (more on this in a moment). Indeed, I continue to look for the onset of that much needed correction in US equities (that feels like it is never going to come), and I constantly check to see if that forever contracting range in USD/JPY has broken out. When you look at these two major markets, it is almost comical.

ALTERNATE UNIVERSE - One market is afraid to fall (whatever that phobia is), while the other defies geometric law, with the price having been near the apex of the triangle for several months now. Of course, all of this is a function of a one dimensional market controlled by the forces of government and central bank proponomics. There have however been signs of a slow move from Fed Yellen and other dovish Fed officials in recent days towards the hawkish side (still miles away but at least a step in that direction), and this could be warning of an eventual shift in the trajectory of markets. But at this point, it is too soon to leap to any conclusions. Key levels to watch in these markets are SPX 1950 and USD/JPY 100.75. A break below either of these levels would be a major development.

BACK TO "OTHER" MARKETS - I will say that while most of the focus should ultimately be on Fed monetary policy and the US Dollar ( and US yields), there are other markets we should be keeping an eye on. I have argued for some time now that the EUR/CHF cross rate could potentially act as the Baltic Spark that opens the door for global macro volatility. Why? If the entire system is being supported through easy monetary policy and central bank intervention, perhaps the clearest line in the sand is the place to look. The SNB has set the 1.2000 barrier as the level that will be defended at all costs, and yet, the market hasn't been able to muster any significant gains beyond 1.2000, and has in fact been gravitating back towards the level in recent weeks.

AN IMPORTANT BARRIER - The correlations between the Franc and safe haven flows are still highly relevant, and if we see any pullback in equities or a broad capitulation in risk assets, the SNB may have a tough battle on its hands. A violation of 1.2000 could call into question the effectiveness of other central bank efforts to prop the economy. And when I say other, the Fed is the primary candidate. I don't see any compelling trade in EUR/CHF at the moment, but would love the idea of buying once stop losses are cleared below 1.2000, if that ever does play out.

NOT SO SPECIAL - Ok Joel, so EUR/CHF is another market to watch, but what should we be trading right now? As I have highlighted in recent commentary, I love the idea of short exposure in the New Zealand Dollar at current levels. I have chosen to play this trade through the US Dollar, and despite the negative carry, I believe there is plenty of upside (more appropriately downside) at current levels. Over the past few sessions we have begun to see the market roll just a bit, with softer inflation data and falling dairy prices offering a good excuse for offers. But for me, the catalyst is more about longer-term cyclicals and the fact that you have a currency that has been showing an abnormal divergence from its peers in the commodity bloc. While both Aussie and Cad have fallen off a good deal from cyclical highs against the buck, Kiwi is still trading at post float record highs.

REMEBER WHEN - I remember a time when everything was great in Australia and Canada and both currencies could do no wrong. The thought of weakness was a thought for fools. And now, there are very few out there who can even remember how aggressively in demand these currencies were. So here we are with the New Zealand Dollar. No one thinks this currency will drop, and everyone is drawn to the attractive yield differentials and robust local economy. But the impact of the RBNZ is starting to show and with the central bank quite vocal in its view that the currency is well overvalued at current levels, it really should only be a matter of time before Kiwi goes from relative outperformer to relative underperformer. I would also argue that from this point forward, we should see a general narrowing in yield differentials back in favor of the Buck.

WRITING ON THE WALL - Moving on to the more exotic, I also really like the idea of building a significant short Shekel position at current levels. I am not arguing the case for a weaker Shekel on the merit of the current escalation, and simply believe that just as is the case with the New Zealand Dollar, the Israeli Shekel is cyclically overvalued and due for a major reversal. There is some formidable USD/ILS support in the 3.40 area, with plenty of additional longer-term support towards 3.30. For any of you wondering how the Shekel can retain such a bid tone even in the face of the current strife, this is not an unfamiliar or uncommon phenomenon. The currency has built up an strong immunity to domestic crisis involving national security. It really takes a lot for the currency to weaken in the face of such risk.

THE TIMING MAKE SENSE - However, with the Shekel strength diminishing the bottom line of the export economy, there is plenty of good reason for the Bank of Israel to be looking to intervene at current levels. Perhaps the current escalation could be used as a potential catalyst for Shekel weakness. Yet ultimately, the currency is due for reversal and I suspect we will see something materialize in the days and weeks ahead. We already saw a nice bullish reversal in USD/ILS on Wednesday, so technically, I really like the idea of the long position at current levels (3.4150). I am looking at a potential double bottom around 3.4000, with the neckline coming in at 3.4500 and a measured move objective of 3.5000. This definitely presents itself as a compelling risk/reward play.

TALKING BOUT MY GENERATION - Finally, one of the major catchwords in markets right now is "complacency." The area where I feel complacency is the most interesting over the past 12-18 months is the area of geopolitical risk. There have been some decent blowups around the globe over the past several months, and yet, the reaction from markets to these risks have been relatively muted. The obvious argument for complacency goes back to what was highlighted above, in that everyone is only focused on free money incentive to buy risk on the back of current monetary policy. But I would also argue that we live in a generation that has never really felt the severity of real war (thankfully), and as a result, does not really believe that anything bad will ever actually happen. I think this has also contributed to the lack of volatility resulting from various geopolitical risks in recent months.

COMFORTABLY NUMB - So while the US has imposed these most recent sanctions on Russia, and while tensions may intensify between the two countries, nobody actually believes anything will happen. No one is concerned that the turmoil in the Middle East will spill over into the global economy. And as much as I don't wish anything to happen, I do fear this type of complacency. Tactically, and in consideration of the above, I recommend against exposure to EM on the whole, as these currencies could be facing a double whammy assault in the form of favorable US yield differentials and a spike in geopolitical risk that markets start to take more seriously.

Complacency can be dangerous when mixed with geopolitical risk. Via @joelkruger

Currency Pairs

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Euro Battles around 1.1700

The Euro keeps dipping below 1.1700 but has refused to breakdown thus far. 

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