The release of a new plan in the Euro-zone to prevent a liquidity crunch notwithstanding, we have been surprised by the extent of the rally in equity markets. In our opinion, the magnitude of the rebound was most certainly exacerbated by movements in currency markets. By allowing foreign countries to participate in the EFSF or its SIV, the Euro zone is in essence becoming one of the very few jurisdictions actually willing to allow an appreciation of its currency. There is news today that China could potentially be willing to invest up to €100bn in the Euro zone if conditions are right. This potential foreign bid is a big deal as it implies that the massive build-up in long U.S. dollar positions is no longer warranted. As today’s Hot Chart shows, long USD positions last week were almost as large as the height of the 2008-2009 global credit crisis. From a tactical standpoint, further unwinding of long-USD positions could buoy the S&P500 higher given the current inter-market correlations. The risk-on trade is on for now.
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