Explanation for Recent Run-up

Discussion in 'Economics' started by jbusse, Oct 15, 2011.

  1. jbusse


    Over the past two weeks, there is one simple thing that has been bugging skeptical macro observers: namely the paradox of i) just how ugly the European funding and liquidity situations have gotten, on the one hand, confirmed by the blow out in French bond yields (the French-Bund 10 year spread just hit an all time record yesterday) as well as continuing deterioration in credit spreads across core European nations, yet, on the other, ii) the euro, especially in that critical pair the EURUSD, has seen one of its most explosive rises in recent history, which as Zero Hedge pointed out yesterday, has totally decorrelated with the French-Bund spread, to which it had been firmly 'pegged' previously. As a result of ii), equity markets have surged due to legacy correlation arbs, which see Euro strength, and hence dollar weakness, as an empirical signal of equity "cheapness", which in turn leads all algos to treat a rise in the EURUSD as a buying signal. So how is it that even with the interbank liquidity situation in Europe frozen and getting worse, further keeping in mind that European banks are now expected to (or have already commenced - see yesterday's move in PrimeX) engage in widespread asset liquidations, that broad market risk is perceived as cheap? Simple. As the following note by Deutsche Bank's Alan Ruskin explains, the sole reason for the EUR (and hence S&P and global 100% correlated equity risk) surge in the past 9 days is not driven by any latent "optimism" that Europe will fix itself, but simply due to the previously discussed wholesale asset liquidations (as none other than the FT already noted), which on the margin are explicitly EUR positive due to FX repatriation, courtesy of the post-sale conversion of USDs to EURs. Which means that the ever so gullible equity market has just experienced one of the biggest headfakes in history, and has misinterpreted a pervasive European, though mostly French, scramble to procure liquidity at any cost by dumping various USD-denominated assets, as a risk on signal!

    In other words, an internal bank run has somehow been interpreted to be stock positive... And there is your explanation for not only the paradoxical surge in the EURUSD and S&P, but why the correlation between the EURUSD and the Bund-France spread has completely broken down. Expect all of this to promptly, and very violently, correct once the market understand what an idiot it has been in the past two weeks.