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Why You Should Prepare For a Big Risk Rally

Falcon 9 Rocket
Photo: spacex.com
Falcon 9 Rocket

If Europe can just shore up its banks, this strategist sees a potentially major move in risk-on currencies.

No doubt, it's a mess in Europe right now. But Steven Englander, head of G10 currency strategy for Citigroup , is looking past that, and he likes what he sees.

"If you can ringfence Europe," and at least develop a plan that prevents financial-sector problems from spreading, "the fact that they don't have a deal won't matter that much outside," he told me. "The reason Asian FX was selling off wasn't because of Portugal, but because of the fear that European banks would take such a big hit."

Don't expect a Europe plan to help the major currencies, though. Englander's view is that once investors' frantic worry eases, they will realize that the dollar, the euro, the Japanese yen and the British pound, which account for about 78% of FX trading volume, all have fundamental underlying problems - high debt to GDP, loose monetary policy, and so on. "In terms of long term investments in these currencies, there are real concerns," he says.

This is where it gets interesting. If investors shift just 10% of their assets out of these dominant but not-so-healthy currencies into smaller ones, that represents an 8% drop in volume in the big four - but a nearly 40% increase in volume in the rest. "A modest withdrawal from the impaired 80% becomes a massive injection into the healthy 22%," Englander explains. And if that happens, well, hold onto your hats.

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Learn more: The essential vocabulary for currency trading is on Key Currency Terms. Top currency strategies are broken down for you in Currency Class.

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