So we start the new Year with another bout of risk aversion, rooted it seems mostly in China, though the US numbers have also not been great. But today’s European PMI data was fine, and Sweden’s was certainly good. The market is a bit overobsessed with China in my view, especially since we can’t really trust the data. In any case, if China is a problem for growth in the developed world it should be showing up in domestic data. So I like buying the European equity indices on this dip, and don’t see general risk aversion lasting.
From an FX perspective, the implications of risk aversion are less clear than they used to be. Yes the JPY has strengthened, but the CHF is still weak, especially against the EUR, and this may be a signal that the CHF is going to suffer this year. EUR/CHF has had every chance to go back below 1.07 but hasn’t managed it, and has surged lower over the New Year. With heavily negative yields and still very expensive valuation, there is little to recommend it except in extreme risk aversion when money may once again stop flowing out of CHF. For now, the CHF should be a core short.
The other currency which looks likely to be something of a focus early this year is GBP. Some are noting that the GBP sell off looks a bit overdone because yield spreads don’t suggest it should be this low. But even if you disregard all the concerns related to the potential EU referendum, the case for buying GBP on the basis of yield spreads is pretty weak. The big UK current account deficit and the relatively high UK inflation since 2008 (about 10% more than the US or Eurozone) mean GBP already looks very expensive. In fact, it’s just as expensive as the CHF in my models. So expect GBP to stay under pressure at least until the data shows a case for an early rate hike of the EU worries fade. I doubt either of these will happen before February at the earliest.