G10 FX overview:
Having mentioned, I've covered most of my GBP shorts at 1.65, giving the headline risk going into tomorrows CPI readings. However I don't see it being to important in the medium term with the GBP likely heading lower as it remains elevated relative to interest rates. On the EURUSD front - following a stop run spike during the middle of the US session, we see the USD futures pushed back below 80. However going through this week, I can't help but remain constructive over the USD in the medium term. As we can see, the vast majority of bullish weekly engulfing have been succeeded by another bullish week.
|DXY weekly chart.|
Last week, Yellen really shock the markets - suggesting that the first rate hike could be just over 12 months away, as such, this suggests that given this rate path expectations we could see US 2yr yields above 0.6% in the coming few months. However, the entire US yield curve marked higher last week (with 5yr dropping the most - 18bps), yet the most interesting aspect is the actual shape of the yield curve with 2s10s looking like it could drop further, and also the5s30s at the most shallowest level since Q2 2012. However more on this later.
EURMXN - buying into EM weakness
The EURMXN is trading about 18.25 while I write, and at this level we can see that it is ranging in an ascending triangle. Given the geopolitical risks that have come and passed the MXN has stayed relatively strong. Perhaps, an EM FX recovery could be better played through a higher Beta CCY, this being said higher risks are involved and relatively speaking, Mexico is in a better place than say Turkey or Russia.
|EURMXN Daily chart|
|EURMXN 3m IV vs 1Y swap|
Shorted 2 units EURMXN at 18.2470, targeting 17.80, stops 18.5
We've seen the US 5s30s come off very sharply post FOMC, in part to duration being very sought after, and also the belly of the curve has been seen as the most vulnerable maturity as we head into a rate hike cycle.
However I don't see the Fed raising rates next June, in fact - I think it will be much more likely to be Q3/Q4 2015, as such I think the belly has sold off too much relative to the long end, especially considering CESI indications are for US macro to start picking up in the short term as we move away from the "bad weather".
For this reason Selling 30's and buying 5's (i.e. steepener on the 5s30s) seems like a decent idea to me
|US 30 year yield (top) US 5s30s (bottom)|
Also, I do expect US long ends rates to continue rising, with the 10's trading above 2.85% in the not too distant future, this should also see increased volatilty come back into the market, as shown by the MOVE index below.
|MOVE vs US 10 yr|
Steepener of the US5s30s at 183.53bps. looking for 200bps, stop discretionary somewhere ~160
Long USD after Yellen
As we can see, and its not just against the EUR, but the USD is trading quite cheap to interest rate spreads (1Y implied yield)... While only one factor of many, it has been a key driver in the past.
|EUR vs EUR 1Y model, spread in bars below|
The reason for this is, with EUR forward rates anchored lower, with little hope of falling the only reason they will meaningfully rise is if US rates rise, which will of course happen at a faster rate, hence widening the US-EU yield spread. So with EUR rates staying flat any movement in the yield spread will be determined by the rate of change of US rates. Conversely, EZ growth could well keep surprising to the upside, with a growing CA surplus and basis swaps now 0 EURUSD appreciation would come most meaningfully from the EZ aspect. As we saw in the first 2 months of 2014, with the US economy being hit "hard" by the weather, the EUR was broadly unchanged... As such I don't see the US macro picture actually being a driver for the USD (apart from the relationship between growth and rates, and then rates and USD).
However, today EUR 1y ATM vol reached a new cycle low at just above 7.2 points. Implying a break even +/- 775 pips from the market value at 1.3850
|EUR 1Y ATM vol|
Risk reversal skews over the 1Y still show a 1.25 points premium to puts, however this is the tightest they've been in a long time. Suggesting that the market is relatively flat the EURUSD. (n.b. this can be backed up by MS and BNP P positioning data)
As we can see from the Vol surface, Implied volatility smiles are pretty symmetrical out to about 9M, suggesting range trading is likely. however, the long USD idea is a relatively short term trade targeting 81 area, with stops below 79. entry 80.