Extract from Morgan Stanley Global Economic Forum Analysis by Stephen Jen :
A good trading rule to deal with sharp changes in risk
In any case, I believe that this is a great trading rule investors can use to handle sharp shifts in general risk-appetite, though it is not a good rule for tracking changing economic fundamentals. (Also, I am not sure if this rule applies to the EM currencies.) If risk-taking recovers, which is what I believe will happen, sooner rather than later, then USD/JPY, EUR/USD, GBP/USD, EUR/JPY, AUD/USD and NZD/USD should all head higher, reversing much of the correction we witnessed in the past week. USD/CAD should head lower. If, however, I am wrong, and risk-aversion deepens, then we should continue to expect these crosses to move toward their fair values.
Risk-taking to recover sooner rather than later
While I wouldn’t be surprised if I turn out to be premature on this, I think that several months from now, we will look back and realise that this was a buy-on-dip opportunity for risky assets and investors will, after learning from the experience of February/March, be quick to re-accumulate their exposure to high-quality assets at discount prices. I think that we will see a recovery in risk-taking sooner rather than later. In terms of the total world’s equity market capitalisation, it took six months for the world to recover from the bout of risk-retrenchment last May/June. But it took only six weeks for the market to recover from the February/March shock. This time, I am guessing that a full recovery will be as quick as the one in March.
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