Just a quick post updating my thoughts from earlier, spurred by overnight action last couple hours.
Rumors of a PBoC rate hike (after another 50bp RRR hike and 4.4% CPI both announced this week) is selling risk off, as Shanghai is down over 4%. AUD/USD is down almost a big fig from session close, breaking below parity as well as the support represented by October's breakout through around parity. Copper is posting a bearish engulfing, down 2.4% and back to pre-QE2 levels. US equity is also following suit, with the S&P down a percent and sitting precariously on the all-important 1200 level, although not breaking down in any sustained way as of yet. EUR/USD also down, selling off a good 60 pips to extend its 700 pip selloff since Nov 4, showing the "sell-the-news" trade post-Nov 2 FOMC meeting was a huge winner. Interestingly, USD/SGD is up a big fig as well, signifying the NJA/Chinese reval trade might be up, as hot money inflows and inflation risk become concerns to be addressed. CAD and NZD are positioned well to pick up some relative appreciation, especially as crude prices rally and the new hikers early in their hike cycle see some relative demand to the EM players hiking to stratospheric levels to stem the hot money tide. Long CAD & NZD vs AUD & SGD look like great plays if you want to stay out of being long USD.
But with DXY breaking out through 78.35, the next theme in FX for the following few months may be long dollar once again, especially as Eurozone periphery concerns heat back up. And the reflexivity of this issue is vital to its understanding; Ireland is not Greece in that it has no acute liquidity crisis (fully funded through July 2011, unlike Greece's situation in April of this year), but it still faces acute bailout risk because of its banks and the potential for them to be locked out of overnight/money market funding. This is why Irish govy yields are above the EFSF 800bps rate, but the reflexivity issue comes into play because of the USD rallying. USD TWI has a very strong inverse correlation with foreign financial commercial paper outstanding, so as USD rises, it makes interbank conditionals tighter globally, exacerbating the Irish bank liquidity crisis, and soon extending it into the sovereign. More Irish bank issues = more EUR selling = more USD rallying = more Irish bank issues. And of course, being funded through next summer is not at all sustainable and is "acute" as far as any long-term investor is concerned.
But the theme tonight is in the China-Australia risk complex. Australia has clearly hit trough inflation and although it's hiked quite a bit, the RBA still has a ways to go; meanwhile PBoC will be forced to start its rate hike cycle soon, and beyond just RRR hikes into actual benchmark rates. Both of these developments will be very bearish for their respective property markets, particularly Australia's, which is characterized by a 1.7x household debt/disposable income and a mortgage debt/GDP higher than even USA's at the height of its housing bubble. Australia's Commonwealth Bank responded to the RBA's 25bp hike earlier this month by hiking mortgage rates by 40bps. Banks are pressed for ways to keep margins high and the more the RBA tightens liquidity to fight inflation, the higher proportionate drag is felt on Aussie households with their mortgage payments. As per China's property market, which Andy Xie (who predicted/identified the 1980s Japanese asset bubble, 1990s SE Asia debt bubble, 1990s tech bubble, and 2000s US housing bubble, but has yet to cry wolf on any bubble calls) just claimed topped out this quarter and will begin declining sizably in mid-2011, its growth fueled the large copper demand from China that fueled the huge miner growth in Australia. The positive feedbacks and financial contagion are obvious. The real economy effects (and even in asset prices) are likely not going to be significant until mid-2011, but the new shift in policy trend and sentiment as a whole is very significant and important to watch for investors.
Short AUD/CAD is probably the best risk/reward trade in the FX market right now. Short AUD/CHF and long NZD/SGD aren't far behind.