Tuesday, 24 January 2012

Risk rally arrives on time

Since November we have been adamant that we were heading into a situation where a tendency to “risk-on” could accelerate into a real risk rally. We are there now. Financial stocks are moving up (phew, they will not go under). Spanish, Italian, Belgian government bond yields are falling quickly (phew, they will not go under). Commodities are about to join in (phew, the world is not going under).

Dollar is (unfortunately for Europe) weakening under a combination of a short-squeeze and a stronger belief that the euro will not fall apart in 2012. HY bonds are doing very well, thank you, as corporate earnings do not really reflect the apocalypse vision of early December. Will this positive sentiment ever end? Of course it will. But just like nobody knew how far the risk-off collapse could take us down in August, nobody knows how far this rally will carry us upwards.

If anybody claims to know, we will question their credentials. But for now, all indications are that we can continue for a while. Until then, enjoy the party. You will be joined by more and more consensus thinkers. UBS and Citi have joined us in the past two days.

The last shoe to drop
Just like we have been keeping tab on the Euro bond auctions, as a sign we are moving away from the pits of the risk-off downdraft, we are now eyeing the T-bonds/Bunds. If the revaluation of risk assets continues, we will eventually see a major calamity in those two types of assets. Once we get there, the risk-on rally will probably on its last legs.

And on the sidelines
We have a lot of rumours going on. Germany and France should be ready to accept a slower implementation of the 9% Tier 1 capital requirement in order not to put too much pressure on the credit market. Germany should be ready to accept “solidarity” with the problem countries and “long term solutions” in order to solve the underlying problems in the euro-zone. Germany suggests to move the ESM forward and let EFSF and ESM operate in parallel for a while. Lagarde from IMF wants more money in order to have bigger reserves if needed. The policy rules in the Euro-17 will be more flexible.

Why am I not surprised about all this? If there is some truth to any of the rumours it appears that a healthy dose of pragmatism is now being brought in. But only after Germany managed to get her way in forcing a deeply destabilising set of long-term upon Europe. Quid pro quo.

Finally it feels as if the ideology is beginning to take back seat to some practical action. There is still a long way to go before anybody can declare “mission accomplished”. But there is no doubt that now is the right time to be pragmatic. It always works best when the market is in a mood to believe that things are heading in the right direction. It seems to be now.

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