Currencies and Interest Rates (CitiFXs view)

A Little Perspective on What Lies Ahead

http://www.investlogic.ch

Forever and Ever ?

The worlds economies have been fostered and sustained since 2008 by the central banks of the planet working in tandem to make sure that the entire globe did not slide into the hellhole of Depression. To that extent the concept has worked but we are still on the lifeline to date and no one seems to want to get off of it. It is similar to a person being hooked on heroin with the inability to withdraw and so the habit continues. There are consequences of this behavior of course including irrational behavior, overblown promises and the increase of the risk that when withdrawal comes that the patient slips into convulsions. Those, however, are long term and systemic problems that will continue to haunt us but in the meantime more mundane issues abound.

What Do We Believe For 2013 ?

follow similar path to that Initial claims willThis willabe the first indicationseen in the 1970s and begin to move2s higher in 2013. that further trouble lies ahead. The have one push down towards U.S. 10 year yields will beach ballfinal go underwater. 1%-1.2% at which point they could bounce up like a let 1.20 in Q1 parity EURUSD will2fall towardsalso expect 2013 and possibly even 1.10-15 with about a real possibility in years. We a rally on the USD Index this year of 15% move higher interest rate dynamic kicks in and we USDJPY will eventuallyto see a moveas thethe low 90s over the course of the year. would not be surprised into to move to $2,055 We expect Gold$2,400 in 2013. -$2,060 in the first quarter of 2013 a and ultimately a rally towards Oil Crudetime (Brent)inshould rally to the 2011/2012 highs around $125 and possibly move to all highs 2013. The DJIA will drop over 20% towards the 10,000-10,500 area. which suggests that this move will be predominately driven by EURUSD (57.6% of the USD-Index). Banking crises and collapses were not uncommon during the period. 5s curve will eventually move higher also but not before posting one last move down.

The dynamic in this cycle is similar to 1973-1978 albeit at higher nominal levels. In 1978 this was a turning point which then saw these numbers head significantly higher again. However that, as well as a deterioration in economic activity and housing, was partially induced by a tightening Fed which given the present debt/ housing/employment dynamic is highly unlikely even if we see some inflation in the system. However we think there is a real danger that higher yields (Bond markets) and a tighter fiscal dynamic could induce this move. Bottom line we think the best may be behind us for now on this chart and expect renewed deterioration in 2013

This chart has been in our view, the best interest rate chart in the World for the last quarter century. Our bias is that we have limited downside left here before we pop

Where initial claims go... the yield curve will follow.

We did not quite reach this base in late 2008 when it stood at 1.89%. It now stands at 1.05%. As yet we have not regained any levels of importance on the topside. While we do not for a moment suspect that we would stay down there for long, we do think a danger remains for one last move lower as seen in previous trends. IF so, that low could be subject thereafter to a sharp bounce as seen in prior instances. There are currently many scenarios at play which could be the catalyst to such a move. Candidates? 1. Fiscal Cliff and/or debt ceiling negotiations; 2. Europes sovereign debt crisis; 3. Middle East turmoil; 4. China slowdown

A little lower then a lot higher - for Treasury yields.

EURUSD set to weaken

USD strength is on its way

The trend is clearly higher.

The present dynamic in Crude continues to remind us of the 1970s when we got 2 supply shock moves. The first came in 1973-1974 at the same time as we had a collapse in the Equity market (1973-1974); a collapse in housing activity (1973-1975) and a sharp fall in economic activity (1973-1974). During the 1973-1974 period Crude pretty much tripled in price (low to high) over 18 months. Then about 5 years after the 1973-1974 surge it did it again and once again virtually tripled in price in 1978-1979 over 18 months (backdrop here was the Iranian revolution and the Iran-Iraq war). In 2007-2008 Crude virtually tripled in price over 18 months and we saw an equity, housing and economic dynamic very reminiscent of 1973-1975. Now as we head towards 2013 could we be setting up for another tripling in price over 18 months to 2 years? We hope not as that would put Crude close to $200.

Stay Far Away From Equities...

Every bounce off this trend line on the VIX since 2007 has been followed by a sharp move lower in the S&P (average 23% over 4 months)

"History does not repeat, but it does rhyme" Mark Twain

The current price action in the S&P 500 is eerily similar to the movement leading up to the collapse in 1987... (via Bloomberg)

The Dow is also tracking this move almost perfectly over the last two years...

It's not just 1987... Here is the Dow analog again the 1977-78 period and 1905-1910 period... (via Citi)

And a Bonus Chart - for those who prefer to look at Bond Analogs... Here is the current move in 10Y US Treasury yields overlaid on 1992's movement... spooky no? and somewhat fits with a view of weakness into year-end, downgrade on debt-ceiling and collapse... (via Citi)

http://www.investlogic.ch

"The idea is there, locked inside. All you have to do is to remove the excess stone." Michelangelo.

Thank you