February 9, 2011

Naufal Sanaullah

naufalsanaullah@gmail.comwww.shadowcapitalism.com

China hikes while German IP misses and gas price pressuresweigh on US ABC Consumer Comfort Index

Another positive day for risk today, although volumes in equity were low across the board. ThePBoC finally hiked its benchmark lending and deposit rates by 25bps to 606bps and 300bps,respectively. With CPI at 4.6% and January CPI rumored to have breached the 6% level,just about everyone was expecting a benchmark rates hike. The very tight interbank funding conditionsbefore the Chinese New Year (with SHIBOR surging at a pace unseen since the 2007 liquiditycrunch) likely was responsible for the delay of the expected hike to after the New Year. With a hikediscounted and real yields still in very negative territory, I expected a fade of any initially bearishreaction, which is what the market provided today.The S&P rallied 0.45% today, extending its rally since Egypt lows. As per McLellan Oscillators andother short-term trading OB/OS indicators, the market is still far from extremely overbought

territory. And with the AAII Sentiment Survey’s Bull/Bear ratio still below 2.0, sentiment is still far

from extreme.

Shadow Capitalism

Market Commentary by Naufal Sanaullah

February 9, 2011

The labor market has been consistently pointed to by bears as defense for their theses, but thereare definitely constructive signals from leading indicators that suggest the cyclical recovery in thelabor market may be underway, and perhaps underacknowledged due to the structuralemployment issues that may be masking or distorting much of the recovery.Both initial claims and wage & salary disbursements are seeing some serious divergences from theheadline unemployment rate, suggesting the headline rate may be on its way down soon, althoughas I mentioned the structural employment concerns remain and should keep jobless rates elevatedbeyond the implied cyclical levels. Still, this continues to strengthen the argument for US equities.

As I’ve stated many times, the biggest risks to US stocks are in higher interest ra

tes, implications of rising food & energy prices, and the continued drag on housing.

February 9, 2011

US yields continue to breakout as economic data improves and auction performance remains poor.

After a 62% PD takedown in today’s 3yr auction, the 10yr yield surged

to close about 70bps richfrom pre-

auction levels. Tomorrow’s $24b 10yr auction should provide more context to current

demand for issuance.The chart below of 10yr yields remains very bearish

US govys, after last week’s breakout. The

pattern suggests a move back to and above the significant 400bps level. With inflation rising and astill much-too-large output gap for the Fed to be hiking this year, I expect yields continue higherfrom here, particularly in the long-end of the curve. 2011 could shape up to be a rangebound yearin rates on the whole, given EM shock risks providing potential bids for Tsys, but I continue to be

bullish on curve steepeners and believe that the “new normal” of rates is here.

The Australian Dollar has been trading sideways since

last week’s economic outlook upgrade by

the RBA, but is sitting at the resistance level of its current triangle while approaching its apexconcurrently. Liquidity is ample globally and risk continues to be bid, so I am more inclined toexpect a breakout than failure in the next few trading sessions. Above 1.02, AUDUSD should takeoff, with the pattern implying a 600-650 pip surge, although I am a bit skeptical of a rally of thatmagnitude. Still, despite my fundamental concerns and bearishness regarding Aus

tralia’s property

sector, I will definitely be chasing AUD higher if it breaks out.