Monday, 24 March 2014

FX and global macro Strategy - 24th March


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.
Given the move higher in US yields, especially on the short end of the curve, there is good reason to be supportive on the USD going forward. As such, dips could, and should be bought. Elsewhere, relatively neutral, with the AUD catching a bid on the back on lower US yields, and CNH recovering markedly.

Rates Overview: 

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
furthermore, given the worldwide drop in implied volatilty, we are likely to see money flow back into higher yielding currencies as any fears die down, while MXN doesn't offer the best yield, it is far more than most major pairs and as such a sustained move in risk appetite should support the MXN.

EURMXN 3m IV vs 1Y swap
As we can see, Implied volatilty, not only in Majors, but also in the MXN has dropped signnificantly. While implied yields (as per FX swaps) have stayed relatively higher. This should bode well for the MXN going forward however need to be mindful of any wayward spikes on various headline data. In which case managing the position would be advised.

Shorted 2 units EURMXN at 18.2470, targeting 17.80, stops 18.5

US 5s30s 

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)
The timing of the position is ideal, with US 30's trading on strong support. Considering the relative convexity of the generic 30's and 5's ideal positioning would be 5's notional exposure being 5.95x larger than the 30's to replicate the US5s30s curve the best, however taking this trade via futs a 1-6 ratio will be required.

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 highlighted in the opening, I see good opportunities for buying the DXY at 80 on the futures.

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

Looking forward, I feel the upside will be determined by Europe and not the US, yet the downside potential will be determined by the US.

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.

cheers.

Jeremy





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