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2011: don't look back in anger!

The list of risks for 2011 mentioned in his blog is tremendous but none of them seems to be strong enough to restrain the overall optimism that prevails for 2011. Yet a quick snapshot at 2010 (chart below) shows that the acceleration of the momentum strategy over the last few months is likely to be unsustainable. In the meantime, in spite of stable monetary policies in the G3 throughout the year, the heightened volatility in the FX world played havoc on our carry index return.

One of the reasons why 2011 may be different is the return of the cycle. The US economy is poised to grow above potential for the first time in years. This should entail a (limited) fall in the unemployment ratio, some early tightening expectations by the Fed (or at least no QE3) that should be dollar positive. How could it be consistent with the over-bullish view that prevails on oil? First, our forecast stands well below consensus as supply/demand and inventories pattern point to lower equilibrium prices. Second, as the chart below shows, the correlation between USD and oil has turned positive over the last few weeks. As history shows it could last a while before mean-reverting. As a result our bullish DXY forecast is not at odds with the consensus view of rising oil prices (our main scenario remains a sharp reversal of the correlation yet).

One barely mentioned “risk” is the appointment of the new ECB President (who may not be Weber…) at the end of the year. It could be a huge test for the euro stability. Before that several institutional milestones might affect the EUR/USD: the third Banking sector stress test should be carried out in February; the European Council may agree on a Treaty amendment on a permanent bailout facility in March while the Commission will provide some proposals on EU budget and tax in June…
Lastly, cross assets signals are somewhat puzzling as the last chart highlights: a good proxy of carry trade the AUD/USD failed to follow both the S&P 500 and copper prices over the last few months. This may suggest that risky assets are poised to show some retrenchment very soon in spite of still positive backdrop. This should be the big picture of this year: overall positive trend for risky assets but sharp/volatile intermediary moves. Good luck and happy new year!