By: Andrea Cohen
Considering the current trends in the major economies we would like to point out a couple of our observations and the conclusion we draw from them.
First we look at the US economy. The Fiscal Cliff aside, there is no doubt that the US is the driver of economic recovery in the world in the last quarter or so. The Fiscal Cliff situation is more about uncertainty than about actual activity, at the moment. With the resolution of the tax part of the dispute between Republicans and Democrats, we learn that Consumption should ne be as adversely affected as initially feared (because the vast majority of households will pay the same taxes as before and for those who are about to pay more, the change in consumption patterns shouldn’t be significant at all).
The budgetary issues have been postponed by a couple of months, but we speculate that they too will be resolved in a manner that will avoid a slide into recession. We therefore see the US continuing to demonstrate persistent recovery.
Venturing a bit to the north, we encounter Canada. Canada is obviously highly correlated to the US in terms of economic activity, yet gets less attention and therefore the CAD can sometimes lag behind the USD. For example, unemployment in Canada had shown an impressive improvement in the most recent report, yet little reaction has been registered in light of this news. Stable, almost boring, for us Canada is a preferable proxy to the US for placing bets.
In Europe on the other hand, there is no good news. The ECB discussing negative rates is proof of how desperate things are there. With the saga with Greece and Spain still not resolved and activity slowing (or shrinking) practically everywhere, including the largest economies of Germany and France, there is little room for optimism there.
We don’t think that political risk is a major one in Europe at the moment, but fundamentals of economics dictate that there is a vicious cycle of slow activity that depresses consumption and raises unemployment. Every time we see somewhat good news coming out of Europe (for example, the famous “trust me” from Draghi a few months ago), the market tends to overreact with optimism, just to reverse the trend shortly thereafter when the dust settles and reality reemerges.
Combining these insights lead us to favorably consider a short position in EUR-CAD.
There are two trades here, really. One is to go into this short position now (at about 1.2953) and wait for a drop to the 1.23 area within three months. In this case, we are comfortable with a 1.32 stop-loss level.
Another option is to “ambush” the EUR-CAD in case good news comes out of Europe. Waiting for a spike in EUR-CAD, we will then short the cross in anticipation of a reversal to pre-spike levels. This is more of an opportunistic trade, with a shorter time horizon. It therefore requires closer attention to the markets and quick reflexes.