What do you do when the ugly get uglier and you are looking for a profit in the currency markets?
The answer according to David Bloom, a foreign exchange strategist at HSBC in London is pick a winner for the wrong reasons.
"The problem with FX is when the ugly get uglier it becomes harder to differentiate between the dollar, euro, pound and yen," Bloom wrote in a note to clients.
With the four major currencies all looking ugly, people are turning to Asian currencies through lack of choice, he added.
"The unintended consequences are that the market is bullish emerging market and other high yielding currencies, perhaps for the wrong reasons," Bloom wrote.
But he warned that once the second round of quantitative easing comes to an end, how we define ugly could change very quickly.
"We still maintain that any change in perceptions surrounding US monetary policy will cause the biggest shockwaves to the FX market. Particularly, if investors are short the ugly and long emerging market and other high yielding currencies through lack of choice," he explained.
Who Is Ugliest?
Interest rate expectations have underpinned the euro in recent weeks despite all the doom and gloom surrounding the euro zone's periphery.
Bloom said he had been predicting dollar gains when the Fed signaled an end to QE2 but now has cold feet following so poor US data.
"The market seems to believe that the euro looks slightly prettier than the other currencies in the ugly contest," Bloom wrote.
"The recent US housing data makes for appalling reading. In a pre-crisis world the market would be looking to sell dollars; however, the situation in Portugal and Ireland means it is difficult to automatically buy euro."
Bloom is bearish on the pound and says the yen is out of action due to the G7's coordinated action and has had to look elsewhere.
"The unintended consequences are that the market is bullish emerging and other high yielding currencies, perhaps for the wrong reasons," he said.
You Can't Buy Ugly
Can the euro really be the prettiest of the ugly sisters as Trichet begins to raise rates?
"We would argue that higher interest rates in the euro zone could very well lead to higher borrowing costs in the periphery, which in turn should be bad for the euro," he wrote.
"But what the market seems to believe is that the euro is a harder and prettier currency than the other big four currencies purely because the ECB is poised to raise interest rates" he added.
The Norwegian Krone or the Swedish Kroner are an alternative to buying the euro, according to Bloom.
With the Japanese yen off the market due to G7 action Bloom says the Swiss Franc is now at the mercy of the risk-on, risk-off trade.
"If the market turns risk-averse the yen no longer offers a safety valve.
This leaves the much less liquid Swiss Franc at the mercy of those looking for safety," he warned.
"So in essence the G7 co-ordination will lead to unintended consequences of a strong Swiss Franc in a 'risk-off' environment and a stronger Aussie dollar, South African Rand, Brazilian real and Turkish lira in a 'risk on' environment," said Bloom.
"However, in the ugly contest world one would not be buying or selling the yen against the dollar, euro or pound. In fact the G7 has encouraged the market to buy carry against the yen," he added.