I realise the above chart is a bit chaotic, so let me just explain what line is what and what is going on.
Orange - ADXY (Asian FX Index vs USD)
Dark Blue - SPX
Yellow - GOLD
Light Blue - EUR
Green - 3m EURUSD Xccy Basis Spread
Purple - 10yr US Real Rates
3m EURUSD Xccy Basis is the additional premium vs pure interest rates (which are essentially zero in both US & EU) that market participants have to pay in order to borrow USD through the FX Forward market. Importantly, it is a means of keeping track of the attractiveness and participation in the FX Carry Trade (because it provides a measure of the OTC market, which straight IMM positioning data do not).
It is well known that the Fed have been pushing the "rates on hold forever" story over tte past six months, and accordingly, US 10yr Real Rates collapsed to as low as 1% a week ago. There has been much speculation about the USD carry trade (i.e. - borrowing in USD to buy anything with any sort of yield) as rates have fallen and the Dollar has been under pressure.
The above chart illustrates this - the EURUSD Xccy Basis Spread and US Real Rate are measures related to both the financing of the carry trade, and also of the attractiveness of owning it. Interestly, over the past week or so, these measures have begun to turnaround somewhat (Green Line & Purple line). Coming after yesterday's surprise ECB announcement with respect to the LTRO, it appears that the liquidity cycle may well have peaked.
This does not necessarily mean that growth-related assets look vulnerable (after all, much of this move comes on the back of stronger US data), but it does signal that the cross-asset correlation that we have seen this year may be about to break down. Specifically, if the moves in the Basis & Real Rates continue, the USD could rally very strongly.
Given that a year-end sell-off in the USD has been a clearly-highlighted seasonal trade, the risk is that the market finds itself in some pain.
