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Fixed Income & FX Research
FX - Strategy
UBS Investment Research
FX Morning Adviser
Don’t Misread Equities
10 December 2013
One of the biggest talking points in the tapering story is how equity markets will
respond to the marginal decline in liquidity provision. Views differ on this matter,
and if the dollar is, as we expect, on the way to growth status then greenback longs
(especially in USDJPY) will need to be more sensitive to any post-tapering
reaction which hurts equities more than it ‘helps’ US yields. Even without an early
Fed move in the mix, investors may already be cautious about the potential for a
correction and the cross-border flow implications. Heading into year-end,
adjustment risks are high, but the FX market should not over-interpret the signals.
Firstly, US markets have been the outperformer in G10 (Chart 1) from the
perspective of a dollar-based investors and, hedges notwithstanding, net
rebalancing flows would likely materialise to the dollar’s detriment. In addition,
our Asset Allocation team has halved their global equity overweight due to tactical
concerns, and the overweights favour Europe and the UK over US and Japan, with
relative valuations a key factor here. These are already strong enough headwinds
for US equity markets, but the FX reaction through the correction would be a good
litmus test of how overseas positioning ranks in the US already. If such crossborder liquidation is enough to offset the ‘anticipated’ reaction function, whereby
the dollar strengthens in major equity correction phases, then the interaction should
be welcomed. The adjustment can be healthily transmitted towards a correction in
US economic expectations, allowing data to begin outperforming over time –
which is flow positive – and keep the Fed on track. Whether initial data
disappointments trigger an equity move or the other way around is irrelevant: the
signals are cyclical and secondary to structural changes.
Secondly, our asset allocation favours developed markets over emerging markets
due to higher rate of growth acceleration in the former, and this pattern of
growth/recovery translates into a large allocation to developed market equity. This
is the structural rotation that we expect, and the biggest scope for a surprise on this
level is actually US investors, who need to start unwinding nearly half a decade’s
worth of ‘equity carry’. When QE1 was first launched in 2009, so ran the
assumption that US investors would fund cheaply in domestic currency to earn
carry overseas, largely in EM. Indeed, despite US policy volatility and growth,
asset manager flow data from the Investment Company Institute show shat US
investors consistently liquidated domestic equity portfolios in favour of overseas
investment (both equities and fixed income). This year, however, the US’ outright
inflow picture is far stronger, and without marginal growth to maintain total return
expectations, EM will struggle to maintain pace. If US equities correct EM
liquidation may follow, but this time don’t count on a reversal of repatriation.
Chart 1: Index performance in USD terms (ytd, 2013)
Chart 2: US interest rising (ICI equity flows, 8w MA)
This report has been prepared by UBS Limited
Sources: Investment Company Institute (as of 27th Nov 2013)
FX Morning Adviser 10 December 2013
The pair extended its strength, and there is no major resistance until 1.3833. A
close above which would be an important bullish event opening the way to
1.4037. Support is at 1.3694 ahead of 1.3621.
As bullish conditions persist, there’s scope for further upside in the near-term to
test the resistance at 103.74 and then the critical 105.75. Support is at 101.63.
The strength seen this morning indicates there’s potential for extension of the
pattern of higher highs/lows to the important resistance at 1.6618. Support is at
Further selling this morning saw the test of the major support range at 0.8891/64.
While the latter holds, there’s risk for a short-term recovery to unwind the sharp
sell-off. Resistance is at 0.8934 ahead of 0.8984.
With the MACD below its zero line, there’s potential for more downside over the
coming days to test the support at 0.8893. Resistance is at 0.9168.
Any downside will be corrective and limited to support at 1.0596. Resistance is at
1.0708, a break above which would open 1.0804.
Having tested the critical support at 1.2215 last week, the cross is consolidating.
A close below which would be an outright bearish development, triggering a selloff to 1.2130. Resistance is at 1.2274.
The latest recovery does not change the bearish trend. Look for rejections from
higher resistance levels at 0.8419 and 0.8458. Support is at 0.8324 ahead of
The cross extended its strength and is trading within striking distance of the
resistance at 142.63. The immediate risk appears to be for a short-term setback
to unwind the overextended upside conditions. Support is at 138.43.
*NOTE: The trend for each currency pair as defined in the table is determined by our proprietary model and is independent of our discretionary interpretation
of price action
Source: UBS FX Strategy
Money Stock M2 (Nov)
Money Stock M3 (Nov)
Tertiary Industry Index (Oct)
BSI Large All Industry QoQ (Q4)
RICS House Price Balance (Nov)
Home Loans (Oct)
Investment Lending (Oct)
NAB Business Conditions (Nov)
NAB Business Confidence (Nov)
Consumer Confidence index (Nov)
Industrial Production (Nov)
Retail Sales (Nov)
Euro-Area Finance Ministers Meet
Industrial Production (Oct)
Industrial Production (Oct)
Industrial Production (Oct)
Visible Trade Balance (Oct)
Trade Balance (Oct)
ECB's Draghi Speaks
NFIB Small Business Optimism (Nov)
NIESR GDP Estimate (Nov)
Wholesale Inventories (Oct)
New Yuan Loans (Nov)
Aggregate Financing (Nov)
Source: UBS Global Economics, Bloomberg LP, Reuters LP, Reuters, Market News International