Holidays and flu have kept me busy in the beginning of this year, so this is my first post in 2009. All the central themes I discussed with you all last year remain, with Global growth (or lack of it) at the forefront of our thinking. However, a couple of positives have recently surfaced albeit in a stormy environment: global PMI data has just started to rally off its lows, and the volatility on equities has fallen considerably with the VIX now around 40 and far away from the double top in the 80s of October and November of last year.

If we take a look at equities, then since October, in most cases we have seen a 20% rally in most of the indices worldwide. This is interesting as analysts tell us that the demand in bonds is due to capitulation of funds in equities over bonds. Certainly the rally in bonds looks like a bubble in the making but the balloon looks like it still has room to inflate as governments and treasuries agree that rates will remain low is essential. It is crucial for governments to install this belief, as they need to issue tons of bonds in coming months to build up an armoury for fiscal stimuli. If they don’t keep this view alive then returns of 1 or 2% will see a mass exodus and leave major governments without the funds they need. This is why the commitment to cut rates will remain strong, especially in the UK and the US.

As we see unemployment in Germany tick up for the first time since 2006, I foresee the ECB having to play catch up so expect rate cuts and possibly 75bp next week. This should see the EUR take the hit it deserves, as the ECB is way behind the curve here as inflation is NOT an issue anymore for now at least. A central bank cannot afford to wait until the data is in front of them before acting as even Trichet admits that monetary policy takes about 6 months to take hold. They are playing with fire here and basically ‘fiddling whilst Rome burns’* and we all know what happened to that empire. On the other hand, anything less than a 75bp cut next week will be met with derision, a lack of confidence and a lower EUR, so I believe the week ahead is going to be hard for the EUR no matter what. The fall to the 1.35 area on Friday suggest many agree.

Based on the interest rates convergence and Japan’s creditor nation status, the Yen is still my favourite currency, and whilst the authorities are concerned about a stronger Yen, I feel they will only be able to slow this move. I see further interest for central banks to use the JPY as part of their diversification process and although this will take some time to enact, I see investors jumping ahead and piling into JPY as the carry trade is a thing of the past and any risk appetite will not manifest itself in buying JPY crosses this year. Hence, I still bet for the EURJPY breaking all the lows towards the level of 100. I have also shorted the GBPJPY pair at the level of 140 and will do the same with the USDJPY if it rallies up to the 95.00 level.

With all that said the major concerns on the health of the economy remain, and we must not take our eye off China and Global recession issues. Add to this the big fall I expect in corporate earnings and failures, and my view is that this rally in equities could be close to an end. I still believe that this is an excellent opportunity to buy into equities, and that is what I maintained when discussing with friends and family this Christmas. However, the fact that equities are cheap today, doesn’t mean that they can’t get cheaper in a few months, so trying to play the market timing game, there are 3 main indicators I will be looking following. Two of them are the ones common to all economic cycles: interest rates ceasing to go down and a stop in the sharp increase in unemployment. The third one is directly related to the origin of this crisis, and it’s the fact that we are yet to see any signs of recovery in the US housing market.

* “Fiddling whilst Rome burns” is a phrase which means to occupy oneself with unimportant matters and neglect priorities during a crisis.

Its orgin is the story that Nero played the fiddle (violin) while Rome burned, during the great fire in AD 64, but there are two major flaws with the story. Firstly, there was no such instrument as the fiddle (violin) in first century Rome. There’s no definitive date for the invention of the violin, or of its synonym as fiddle, but it certainly wasn’t until at least the 16th century. If Nero played anything during the Rome fire, it was probably the lyre.

Secondly, the story may be completely false and Nero may very well not have neglected his duty at all. Nero died four years later, and we should remember that history is written by the victors. The historian Suetonius records the Nero was responsible for the fire and that he watched it from a tower while playing an instrument and singing about the destruction of Troy. Others record this story merely as a rumour.

By modern-day standards Nero certainly appears a bizarre character, but that doesn’t make this story true. Roman scholars differ over interpretations of events surrounding the fire. The rivalries and conflicting accounts, even those in contemporary reports, make the ‘fiddling’ story uncertain.