February 14, 2011

Naufal Sanaullah

naufalsanaullah@gmail.comwww.shadowcapitalism.com

Mubarak steps down while Canadian trade figures blow pastestimates and US consumer confidence helps S&P rally tonew highs

Good day for risk to end the week on Friday, as Mubarak’s re

signation helped alleviate fears of geopolitical contagion in the Middle East. A small beat in the Univ of Mich consumer confidencesurvey for February (75.1 vs 75.0 expected) helped propel US stocks to new highs. EM also got abid on Friday, as both Indian and Chinese indices posted strong reversal candles, though it remainsto be seen if it can be sustained in any way. December Canadian merchandise trade figuresshowed a huge beat past expectations of a $300m deficit, printing at a $3.0b surplus. This helpedpropel CAD to big gains in FX land on Friday, and leading to some breakouts in CAD pairs.The S&P rallied another 0.60% on Friday as the DM bull trade continues to be on. I am getting a bitless outright bullish at these levels, and given my large net-long weighting in US equities (whichgrew quite a bit on Friday), I bought some protection in the form of bear ETFs, for a trade. Summer

2008 highs in the SPY ETF come in at around 2% from current levels, and I’m expecting some selling

around there. I remain constructive US equity in the intermediate term.US yields are on the rise and this is weighing down on EURUSD and Friday was no different, with abig fig drop in the cross. EURUSD has spent the last month or so consolidating its rally sinceJanuary lows, and for now, I am more biased to a downside resolution, with 1.35 being the biglevel to watch. USD and US equity could both rally together here, as the US recovery becomes

Shadow Capitalism

Market Commentary by Naufal Sanaullah

February 14, 2011

more self-sustaining, and as Fed Tsy purchases enter their final stages without any furtheriterations of QE in the pipeline, as of yet at least. Also, it is important to remember that Irishelections are next month and that Portuguese yields still remain above 700bps in the 10yr tenor. Iremain short EURUSD and will be looking to add on a breakdown below the 1.35 level. I continueto believe that Portugal will have to tap the EFSF and that Spain will be spared from needing abailout only due to unsterilized monetization from the ECB.After bouncing hard off of the support trendline I have drawn in, AUDUSD is back above parity and

I’m out of the quick tech

-driven short I had on. As of 1015pm EST, AUDUSD is up another 60 pipsabove parity and not looking too bearish at all. Interesting to note that AUS-US swap spreads aresuggesting quite rich valuations for AUDUSD at prevailing rates, with an implied gap of about 650pips. Also interesting is that AUD is trading with a higher correlation to the Kospi than KRW isshowing, and with EM seeing massive foreign capital outflows and risin

g “bad” inflation, perhaps

this is another harbinger of an extended sell off in Aussie. RBA Governor Glenn Stevens out withsome dovish comments that weighed down on AUD on Friday, but the reaction appears a bitexcessive. I am hesitant to get outright short AUDUSD unless I see some technical breakdown, andfor now I sit agnostic. Chinese CPI print tomorrow should move the pair, particularly if it comes inon the higher end, suggesting more tightening in store.

February 14, 2011

Below is a chart showing the high correlation between the Aussie (in blue) and Korean equity (in

red), as well as a nice chart from GS’s John Noyce highlighting the overvaluation of AUDUSDrelative to swap spreads. Apologies for the “fuzziness” of the Noyce chart.

US 5yr TIPS inflation compensation is now back to 200bps (orange line, LHS), while short(er)-endrates look to be on the rise for the first time in a while (blue, LHS), and 2s10s (red, RHS) aresteepening in tandem. With the economy strong, EM underperforming, US yields rising, and nosignal of QE2 being extended, USD could be poised to rally here. The recent breakout in USDJPYcould signal a shift of carry funding back to the JPY, as the summer 2010 double-dip fear-inducedUSDJPY plunge is unwound. US growth risks + Fed bid for USTs led to a big selloff in USDJPY fromlast summer; with the opposite in effect now, the shift in carry funding thesis looks sound.