Extreme markets need extreme measures

These are crazy markets by any standards. I have been in the market directly and indirectly since I was 17-years old – ergo thirty odd years. Never before have I seen a more overvalued currency than the Swiss Franc. This Swiss need to go abroad and spend all their savings while the currency is cheap. (There is actually already huge arbitrage of buying groceries et al across the border at half-price! Imagine the damage that does to domestic driven companies and stores in Switzerland.) No country can deal easily with 40 per cent revaluation!

Chinese rate flexibility
Meanwhile, China has allowed the USD/CNY rates to appreciate below 6.4000 for the first time since 1994. This is a major indication that, unlike the 1998 Asian Crisis, this time China will allow some flexibility on rates to help reset global imbalances. Less intervention will also mean less recycling of capital hence a reduction in the need for US Dollar assets. As far as China, or for that matter Asia goes, I expect Asian currencies will be boosted in value on this, and SGD was up almost one per cent this morning.

Source: Bloomberg LLP

China also somewhat surprisingly made it known through the China Security Journal that it could do some targeted easing in H2 2011 – which is a major change as we have just seen +6.5% print in Chinese inflation. Basically, this could be China again trying to lead the way like it did back in the autumn of 2008.

A pegged Swiss currency?
There's no doubt that CHF is the most overvalued currency but is Switzerland really looking to peg the CHF vs. the EUR? This would be highly surprising as the peg would have to happen way above the present exchange rate level, but Swiss National Bank Vice-President Jordan actually indicated this last night and today he is getting support from the Swiss Business Lobby.

Social tensions amass - still waiting for politicians to move
The risk of increased social tension is surely tempting policy makers to introduce emergency laws to counter this. On that note I find this piece interesting.

The Gordian Knot remains: We are sitting and waiting for a political move towards sanity, while knowing politicians have done nothing but buy time in the last three years since the financial crisis. That's why we are in Crisis 2.0. That’s why we moving to Quantitative Easing everywhere - in Europe, the U.K. and the U.S. and are now also seeing it in Switzerland and Japan. When you don’t want to deal with the root of the problem of debt you need to inflate away the burden. Watch how central banks will slowly move this way….

Forced austerity
In Italy there is “breaking news” concerning the demand for forcing austerity through by using "an emergency decree”. This seems now confirmed in a Reuters report.

Strategy
If one was sitting on an island observing all of this I think the preferred strategy would be as follows:

Wear a tin hat, buy Gold, buy 1 year CHF put (betting CHF weakens), and find some cheap way to get upside when and if the Euro moves to being a Euro-Mark. Meanwhile, here back in the land of reality, or lack of it, the theme remains:

Political risk, event risk and discontinuous pricing – the market has lost its bearing.

In order to get direction we, I am sorry to say, need Germany to commit one way or the other. Amid this lack of constructive action from Germany we continue to see pressure on the French rating (CDS continues up – now at five day high of 174.50), increased interbank market tension and continued stop loss action.

I am still in neutral mode on risk – awaiting some sort of clarity on risk.