Around the world, stock markets have been rallying today, while EURUSD has barely risen above the 1.30 mark, which may prove to be a major test of its resilience. We, on the other hand, suspect that the rally is approaching its end.

China continues to appreciate the Yuan, if only by words

The PBOC fixed USDCNY slightly lower today. Meanwhile the deputy governor of the PBOC, Hu XiaoLian was quoting Milton Freeman on the dangers of inflation. The governor focused on the damage wrought by inflation on society and in general the lower income strata, adding that Yuan appreciation is in China's best interest, as it will reduce the need for sterilization which remains one of the major contributers to the overflowing of liquidity in China's financial market.

The comments are in line with the general tone of the government since 2007, if not earlier, that asset bubbles should be prevented at all costs as their consequences can be destructive on the long term, stable growth of the country. We have seen and heard countless declarations of the intent to clamp down on bubbles, with very little action taken. Indeed, the stock market bubble was destroyed not by extremely timid and pointless Chinese measures, but by the bursting and collapse of the global commodity and finance bubbles in 2007-2008, which were then mirrored in China itself. The comments, then, only confirm the tendency of the Chinese to speak tough, but do nothing or little when a problem demands decisive action. On the other hand, one must question the extent to which they can hinder the bubbles at this point, since they are so gigantic that it is hard to believe that it would politically feasible to take the necessary actions to stop them, except through an involuntary policy error. Such seems to be the case at the moment to us.

They do not seem to very concerned about the imbalances in their economic model, and its lack of an alternative in the short-term due to the length of time necessary for engineering a shift of attitude among Chinese consumers. There is also the crucial, but much neglected fact that China has in fact worked against the emergence of an overspending consumer society over the years through its measures aimed at curbing population growth. It is true that the one-child policy applies to cities only, but that is also where shopping malls and the greatest spenders tend to live. Akin to the situation of Germany and Japan, where the elderly are dominating the demography for different reasons, any expectation of a rapid, sustainable jump in domestic Chinese consumption is misplaced.

Where will the EURUSD go from here?

Traders seem to be encouraged by stress test results, and they appear to be interested in driving the EURUSD to above 1.30. Still, we remain highly skeptical that the long-term trend of the EURUSD can be changed at this stage, and would be very surprised if that would turn out to be the case.

The ECB, and other Euro area governments have failed to address their problems squarely. The E750 billion bailout fund was apparently created on the basis of similar notions that led the Fed to take over Bear Sterns, AIG, and much of the bad debt in the finance sector. The idea is that markets are wrong, and that the despised assets do have intrinsic value that would be realized if held to maturity. It is like advising a child that, if you close your eyes for long enough, all your problems will be gone, regardless of what others are telling you.

As such, it remains to be seen that when real action is demanded, they will be able to show solidarity, and be able to maintain their seats while doing so. The electorate is quiet, but it is not stupid. We find that it is exceedingly brave to bet on the fortunes of the Euro when it is supported by such an immature, misformed, and inadequate political structure. Let's once agains recall that this currency was created during the first decade of 21^st century, a time of exceptional optimism and bullishness, and the structures backing it are not at all prepared for the kind of tests that it will have to undergo quite soon.

Fed worried about credibility and deflation

The Fed's Janet Yellen was quoted as speaking against raising the inflation target to 4%, as demanded by some to boost growth, saying that this would jeopardise the central bank's credibility. Also, Peter Diamond, a Fed nominee awaiting confirmation, has made comments to the effect that deflation is the bigger danger facing the U.S. economy.

In fact, one constant word in comments by Fed officials these days is uncertainty. It seems like they are as confused as most speculators are with respect to the where the global economy is headed.

On the one hand, assuming that what we are going through is just a phase in the cycle, one must argue that uncertainty among analysts is a strong confirmation for the bull case. After all, that is what a recovery is all about. Recession is ending, the economy is turning around, and only because it is beginning to happen, people are worried and the outlook seems to be uncertain. That would imply, of course, that one should invest heavily in carry trades and stocks, since the return to the good, old days is just around the corner. But on the other hand, if this is not an ordinary recession and crisis, the solidity of this common argument is up for question. There appears to be a consensus among names like Soros, Greenspan, and even Barton Biggs, that this is a real black swan invent, one that is likely to have a long-term impact on economic growth for many years to come. If this is the case, to analyze the situation, we must reverse our general bullish outlook, and see matters in an overarching bear context that will last for many years.

Between 1980 and 2010, we had one large bull market, which kept the bullish scenario on the foreground in spite of all kinds of temporary reversals and shocks. We argue that the events beginning in Autumn 2007 have created such conditions that this time the main trend is a downtrend for a while, and other factors must be evaluated in its context.

Of course, how you see this is up to you, and it must be admitted that one could make a convincing case for a bull market with sufficient intellectual exertion. But we don't like to have lawyers throw dust in our eyes. A straightforward analysis is always better, and that surely backs the bear case, the wider once scope of examination gets.