Nothing like being trapped in a tin can 10,000 metres above sea level to get a little perspective on things.  Couple that with the a month long break, and here’s hoping that it’ll be a little easier to ignore the trees…

When we last looked (here), the stage was set for a relief rally into July.  For mine, we are at least a couple weeks short of completing this rally – more time spent filibustering around 1150 (Jan10 highs) would see this consolidation out.

From there, I’m favouring the downside.  The playbook that makes most sense to me is the one that says follow the ebbs and flows of government stimulus, and the leading indicators are suggesting that the ebbs hold the floor.  With a softening macroeconomic picture, now being reflected in drifting earnings expectations, a move substantially higher would require something else – something that could kickstart a contraction in risk pricing. While not out of the realms of possibility, the odds are against it.

Consider US credit spreads – looks suspiciously like they are trading towards the lower end of a ‘new world order’ trading range – 100 to 150 bps rather than the 50 to 100 bps that prevailed during the credit boom years.

In this environment, the insouciant recovery in equity markets is likely to trip up.  Sovereign risk in its many guises will resurface periodically – and will act as a catalyst for such risk aversion trades. If credit spreads are widening, then the risk curve will be getting a whole lot steeper – and equities will trade lower.

In this respect, keeping an eye on those currencies that rise and fall with the wash of liquidity may prove useful – as we’ve noted before the Asian Dollar index is useful in this regard, it’s rallied consistently over the last 8 weeks…