Dec 28, 2004

Thoughts for the New Year

Some analysts are joining me in noticing the bullish pattern in Japan's Nikkei. Japan will probably be the story of the year in several ways next year. If their economy is indeed turned around they will no longer be motivated to sell Yen but will instead begin looking at raising interest rates. This in itself will shake up currency markets as Japanese intervention has kept the dollar artificially weak against floating currencies (the Euro in particular).

The biggest effect though will probably be in interest rate markets. Japanese O/N rates have been at zero for the better part of a decade and in my mind have been pulling global interest rates lower. The world has essentially struggled with the deflationary effects of negative growth in the second largest economy. That struggle may be over. This sort of shift in rates should cause some real pressure on peripheral borrowers and I would expect some spread widening in emerging market and high yield bonds. Many people looked at 1994 to see what might happen when the Fed began raising rates in early 2004 but this year's rate hikes were met with spread tightening. I don't think the same thing will be true when/if Japan begins moving rates up.

I would guess that all this and the development in emerging markets is setting up a pretty strong resurgence in macro trading.

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