NEWS / Foreign Exchange

A strange decoupling evolving

These days, we are witnessing a discrepancy between the level of activity in the broad US economy and the housing related sectors. As our proprietary Index of Weekly Economic Indicators shows, we are currently at the strongest level of economic activity in since the stock bubble years. But the housing sector deteriorates by the day and since the housing market activity has been one of the strongest drivers behind construction and mortgage components in real GDP growth, we expect GDP to weaken from here.

This is apparently not the view taken by the bond market. 10-Year Treasury Notes have been declining in the last two weeks, taking the 10- year yield to 4.64% (the highest since February. The bond traders have been inspired by the Bernanke??™s comments on Wednesday where he emphasized that the Fed had kept an inflation bias even after having changed the FOMC statement wording at the last rate decision meeting. Bernanke is opting to create a data-will-tell-you-as-we-go approach to monetary policy ??“ very unlike that of Greenspan who would usually indicate the general direction of the Fed managed part of the yield curve.

We think that Treasuries will be rangebound in the next quarter or so. The market is waiting for either the deteriorating housing sector or the strong overall economy to win the battle over inflation/disinflation. We have a modestly bullish stance on Treasuries at this level, since the historical experiences dictate that the negative (disinflationary) effects from the faltering housing market will be stronger than the overall economy.

This picture is the same, but the stakes are higher in Japan. JGB??™s have been rangebound since September last year and the last streak of inflation figures was again lower than expected. Yet, JGB??™s are now trading at the lower end of the range (near 134) and 6-month rates have fallen back from their 10-year highs from the end of February. We have still not seen a convincing streak of figures from Japan and despite the turnaround in land and property prices, the Bank of Japan is not likely to hike rates any time soon with CPI figures still runningbelow 0% YoY.

We intend to buy JGB??™s on Monday when the futures market starts trading them. We would like to buy around 134 and have a stop offer at 133.80. Target at 135.40.

The Euro-Zone continues to expand, but at a more moderate and stable pace than the US economy. We are still convinced that the EUR might be supported in the mid-term by the tensions in the Middle East and the deteriorating US housing market, but we are beginning to see stories about the European equivalent of a US housing and construction bubble. Especially Spain looks red-hot in this regard with the number of new construction units higher than the sum of new construction in Italy, France and Germany combined. Does Spain = Florida? It is still our impression that the overall Euro-Zone housing market is in better shape than the US housing market ??“ especially since rates are lower in Europe and since the financing part has been a lot more aggressive in the US than in the Europe.