When the levee breaks

THE ALPHA THAT WASN'T - Though I can't complain about my overall performance this year, I can say that currencies have been a frustrating asset class. There has been little volatility in this market in recent months, and the opportunities have been few and far between. Most currencies have resigned to relatively quiet consolidation, and it almost seems as though everyone is waiting for some big event to get things going again. I am not sure what that event will be, but the likely candidates are the Fed, China, and geopolitics. It seems to me that the first of these three (the Fed) is the most sensible, and very well could be factoring in right now. The latest minor pullback in US equities is definitely worth attention, as this is the market that will need to see some form of capitulation to ignite other less active asset classes like currencies. Perhaps market participants are finally starting to price in the start to a less accommodative central bank. This would be what is needed to take the cash out of stocks and rotate it into other anemic markets. We are in desperate need of a rebalancing, as it can't all just be about equity markets. Yet despite the lack of volatility in the currency markets, I am always watching and always waiting for opportunity. At the moment, here are some of my observations in FX. The ability for USD/JPY and EUR/CHF to remain so well capped on rallies, despite some very strong demand in both markets, is something that should not be ignored, and should warn that there are deeper stresses in the global economy than many perceive.

WHEN THE LEVEE BREAKS - I am not sure how it all plays out, and while I agree both of these markets should ultimately trade a good deal higher over the medium-term, I also wouldn't be surprised if we saw one more sharp pullback in each of these markets before heading higher. I think USD/JPY could still make a new yearly low below 100.75 and I think EUR/CHF could take out some sell stops below 1.2100 and threaten the all important 1.2000 SNB barrier. At the same time, I have also been very focused on the commodity bloc and emerging market currencies. In recent days, despite any equity weakness, these correlated markets have been less responsive, and have in fact shown signs of strength, which is somewhat counterintuitive. While it is entirely possible that money is flowing out of equities and into other potential attractive risk investments, I don't expect this trend will manage for any extended period of time. As a contrarian, this has left me with a particular fixation on the New Zealand Dollar. At the moment, everything looks great for the currency. The local economy is seemingly immune to external pressures, and the RBNZ has retained an upbeat and hawkish tone. And yet, with the currency tracking near cyclical highs, despite some significant weakness in recent months with its cousins (Aussie, Cad), I don't believe there is any reason to expect things will be different here. Things have a way of turning around rather quickly in these markets and traders can be quite fickle. As per earlier in this commentary, I believe the themes of the Fed, China and geopolitics are all quite relevant, and all of these themes could weigh quite heavily on the New Zealand Dollar going forward. At the moment, the currency looks as strong as ever, but I am betting that if these pressures in correlated markets continue to build, it won't be long before Kiwi relents. The key level to watch below comes in at 0.8500. Look for a break below 0.8500 over the coming days to open the floodgates.