28th - RBNZ and stuff.

Last weeks big event was clearly the RBNZ... hiking the OCR to 3.5% (+25bps), yet in the statement saying how they will pause any further hikes and look to see the impacts of this 100bps hiking cycle. Furthermore, the RBNZ really changed their tone with regard to the NZD... even suggesting intervention (but that worked so well to weaken the NZD every other time....)

Looking at the specific times of each headline, and a tick chart of the NZD during the RBNZ, the major drop came after the stronger language regarding the NZD. However, while this language was a little stronger than usual, its nothing new... Wheeler has bitched and moaned about the strength of the NZD throughout the entire hiking cycle, but only now does the market listen.

Looking ahead, the NZD is sat an important cross road, with a confluence of support at current spot prices

NZD technical chart

There was heavy selling via leveraged players as recorded by Citi, and on the Reuters Matching engine there was 5-10x normal volumes post RBNZ. So clearly a lot of money behind the recent leg lower, however what I am concerned about is how uber-bearish everyone has become all of a sudden. Because, frankly, nothing has really changed. Most people expected a pause in hikes, we got that. Most people expected Wheeler to express concern wrt NZD, we got that (and a little more). So really, to me the continued weakness is on fear of intervention. Something which the RBNZ has done multiple times (last May namely) and failed.

The overall environment is still very carry positive, being gauged two ways, firstly :

NZD (red) vs G10 implied volatilty (white)

The relationship between the NZD and G10 implied volatility is still strong, albeit a marginal divergence in the last week. Without implied volatility ticking up meaningfully (scale inverted btw) I struggle to see *too* much downside in the NZD, as managers will look to pick up carry (with NZD offering better rates than some EM).

Another way to look at this, is Carry/Vol:

NZD (red) vs Carry/vol (white) 

I'm looking at 1Y swap spreads over G10 implieds here, and its a good theoretical (and practical) reason as to why the NZD is where it is... However, since the RBNZ the two have diverged substantially, because carry didn't exactly drop much (2yr swaps dropped what, 4bps) and implied volatility certainly hasn't picked up.

NZ 90-day bank bill 3rd contact out (continuous, currently M5s)

NZD 90-day bank bill curve last week (purple) and spot (yellow)

Here we can gauge the impact of the RBNZ on the short end rates. With the NZ M5s dropping the odd tick, but still much, much higher. Secondly the futures curve dropped the odd basis point, i.e. the pause in hikes, was no surprise to the rates markets as it was mostly priced in.

However, don't get me wrong here, I am bearish the NZD in the longer term. What I am saying is, don't chase it lower here, because in the short term there will probably be better prices to load up short. As we move into September and beyond, implied volatility is likely to turn higher and US short end rates are likely to pick up further, and this is when we could see a larger decline in the NZD. But for the meantime, carry remains attractive, and the NZD appears "cheap" for carry traders. So holding off shorts may be the more tactical play now as we could see some short covering from leveraged players, and some carry related demand.

On the theme of carry, the Grandpa of twitter (Mr. Morski) sent me this chart last week

TRY, BRL, ARS total return since 1995

It really goes to show the power of carry in the long run (TRY spot price has dropped some 98%, yet return is 1600%) and is a stark reminder not to be on the paying side of carry for too long... Timing, as with options, is critical with being short carry.

I spent a lot of the duller moments last week reading back over the 2014 outlook pieces from various sell-siders, and even though we give then a lot of stick, in general they've done reasonably well on their recommendations and predictions.

Now there are some clear areas that they have got wrong, volatility definitely didn't tick upwards on diverging monetary policy, however this hasn't actually meant their ideas have failed.

Playing this monetary policy divergence was how we were told to position this year, and when we hear about the terrible performance of Global macro funds, especially in the FX markets it seems weird.

Pct Change (vis a vis USD) YTD [y] vs bps change in 2yr swap YTD [x]

*"the line" +r^2 is on purpose :)

As we can see, there is a strong relationship between a currencies performance, and the move in its short end rates, as we'd expect. The only outlier, is the AUD which, even though their rates have dropped this year, remains the strongest ccy YTD.

However, going into this year, it didn't take a rocket scientist to realize where rates were going in these countries. It was obvious that with disinflation/deflation in Europe/Sweden that rates would be cut, likewise with the RBNZ hiking, the UK economy on the verge of hiking and the improving US it comes as no surprise to see their currencies stronger on the year.

For this reason, I find it odd that FX macro traders have struggled so much this year... as playing this move has paid off as below.

Basket playing the divergence b/w rates YTD.

Going on to weight the components according to the size of the move in 2yr swaps (which makes sense as we aren't going to equally rank a currency whose rate dropped 5bps, as one whose dropped 25 etc)

Weighted basket YTD

Basically, no excuse to be doing poorly is you're a "macro" trader expressing views through FX so far...

In other things, a few charts just to keep an eye on.

EUR real money selling continues, and we trade pretty much on par with the 1Y swap spread. However look for short covering into the data fest on wednesday and beyond. However, I still feel Yellen will likely surprise to the hawkish side, and I am also bullish on US macro.. hence I do not want to be short USD in any size, and particularly not past wednesday. So playing any short covering will have to be quick and tight.

EUR vs 1Y swap spread

Large 1.35s going off this week, mostly towards the back end.

EURUSD DTCC

USDCAD trade highlighted a few weeks ago doing v.well indeed, and I especially like being long USD into the second half.

USDCAD vs model (+techs)

USDJPY still range bound, looking to buy vol very soon. 3M straddle shows good value (as per blog as few weeks back) and Ideally I'd like to get long sometime this week.

USDJPY daily

US 2 year rates likely to head to 0.75% by year end. Supporting the USD against G10.

US 2 year bond yield

US5s30s still flattening...  now nearly 150bps. Keep an eye on it.

Us 5s30s

This week is likely the most exciting of the summer months, with Wed/Thu/Fri filled with plenty of tier 1 data releases from US GDP/FOMC, EZ CPI, CNH PMI, US NFP and more.


In completely unrelated things, only 17 more days ... FUCKKKK :s

21st July...

Last week was truly sad for humanity ranging from the Malaysian plane to the escalation on the gaza strip, it saw a quick sharp move lower in risk assets, with USDJPY heading back towards the low end of the 101-102 range which we find ourselves in. However, strong bids kept the hefty sub-101 stops safe for now. Likewise Gold saw a quick roundtrip from 1300 -> 1325 -> 1300. EMFX took a bit of a hit, but like the others, we saw a sizeable reversal.

The EURUSD was interesting last week, as the market headed lower to test very important weekly support areas.

EURUSD daily tech chart

1.35 really seems to be the line in the sand for the meantime, with a quick test of this area last Friday afternoon. However the market reversed to post a close above the rising trendline and critically above 1.35. Given the outlook for the summer (as discussed before), I don't see us leaving this range trading dynamic any time soon, hence still looking to fade these levels.

The fundamental outlook for the EUR looks bleak at best, while peripheral markets remain relatively strong, current account surplus is still v.healthy and risk appetite is very high, the EUR will struggle to fall meaninfully. But the divergence of monetary policy will soon become too much and the EUR will weaken. Here we see the 1y1y swaps for EUR and USD.

EUR-USD 1y1y swaps

It is expected that in 1Y's time the 1Y rate spread is around 75bps, far more than the current 21bps. As discussed in my last blog post, taking these values and assumptions into account, the EURUSD should weaken to below 1.30 in the next 12 months.

Furthermore, inflation has been diverging quite a bit recently, and expectations are also diverging. This is of course benefital for the EUR in terms of real rates, yet should weigh on the market as it will cause a further divide in monetary policy.

EZ vs US 2yr inflation swaps

I am, as suggested, a fan of the USD in any medium term outlook (given my belief that US rates pick up in H2, but i'll get onto that later). But the short term technical support in the EUR, makes me think selling AUD or CAD will be better played vis a vis the EUR.

Such as when looking at these two set-ups below.

EURCAD vs 2yr spread

I've tweeted a lot about the USDCAD and respective divergence with interest rates, yet throughout this time the EURCAD has stayed interlocked with 2yr spreads, until now. We are starting to see a divergence, and as such, I'm rotating my CAD shorts from USDCAD longs to EURCAD longs.

EURAUD vs 2yr spread

Here we see the EURAUD... it has diverged from rate spreads for a while. Mostly because the low volatility environment has supported the AUD in general (like with EMFX or NZD) as can be shown by the carry/vol chart below

AUD vs carry/vol

So while I am bearish the AUD in general, we have to respect the fact that it is up in this area for good reasons, and as such betting against right now is probably not the best plan, that is, until volatiltiy rises. Furthermore, there has been a lot of international demand for the AUD, and in particular Aussie debt... a triple A rated nation with a 10Y yield 3.4% is very attractive, especially given that it was ~100bps higher just a few months ago.

So, while I like the set-up in EURAUD, I'm holding off a bit to see how things play out. Especially with the NZD... Going into next week, here we can see the RBNZ probabilities

implied probability of OCR

 Given last weeks poor CPI print, the NZD got hit hard as there is a growing chance we don't see a hike this week. However, if we do, expect a lot of the move to be reversed. On the other hand, a temporary pause in OCR hikes will most certainly lead to NZD weakness.

Looking now at the GBP, I'm still rather bearish, and this sentiment is growing day-by-day. The market is pricing in a 2014 rate hike, something I see very unlikely given the persisting weakness in real earnings (BoE target for nominal wage growth is ~2.5% by year end, lol no chance)

We've started to see some smaller data prints start to disappoint (not just estimates, but overall) and a few more will really kick the overbought market a little, causing a more sizeable shake out of the longs

BNP Paribas' positioning indicator

GBP daily

The 1.70 is a really important level, and with the longs rather saturated, risk:reward is definitely with selling these areas for a move lower to support areas. Especially combining the idea that I feel a 2015 rate hike from the BoE is much more likely we could very well see general weakness, not just in the shorter term but throughout H2.

Another look at positioning is via 3 month 25-delta risk reversals as per below.

GBP vs 3MRR

My preferred indicator for "smart money" not CoT. Demand for downside puts has picked up a fair amount in the past week.

Anyway, the GBPUSD has two components, the GBP and the USD. Going into the last part of the year, I certainly see US rates picking up, and am still expecting to see 75bps on the 2yr by xmas.

In fun bonus charts, here is 1Y realized vol for the GBPUSD

GBP1Y realized vol

Here's the fun part... the all time low in realized is approximately exactly 1Y after I was born... So this past 1Y has been about as exciting as my first year on the planet, for the GBP at least.

With regard to the 10Y now, the recent drop-off due to geo-political tensions presented a good selling opportunity to me.

CESIUSD vs USTs

Looking at the simple driver of the 10Y, economic surprise. We would expect to see US10yrs head higher with a pick-up in US macro. Everything I see when looking at the US economy suggests we do see a much stronger H2, and as such paying US rates now is good (as talked about here)

Using the USDJPY as a proxy would work, however, how I am going to play it is short USTs (2.45% on 10Y)

Instead of buying USDJPY, I want to take the current opportnuity to enter into a 3M long volatiltiy trade.

Even though the current 3 month implieds are much lower than 2007, one critical factor to remember is that the Curve is still rather steep (as demonstrated by the 1Y-3M)

JPY 1Y-3M implieds

JPY vol termstructure, now and 7yrs ago

When comparing current term structure with that off Summer of 2007, we see that while short dated vols are much lower, there is far less complacency on longer dated vols. Unlike in 2007 when the curve was almost flat.

So it is still reasonably expensive to buy volatility, so now more than ever timing is critical.

USDJPY daily

I don't think, much like with EURUSD, we break this week, or even next. But it is eventually coming.. As I have mentioned, topside calls are very cheap, and frankly I think we see a break upwards, however being short USTs covers that thesis comfortably, as such I want to treat this as a volatility trade. So a 3 month straddle (ATM) costs 230 pips. Each day I put off entering the trade I save around $120 of theta, so I don't want to rush into buying this straddle and timing is as always key. I will also delta hedge with discretion throughout the live of the trade, however I will try to keep it relatively delta neutral, however depending on my short term views I may use the delta to hedge against my UST trade or even alongside it. Lets see.

Either way... in summary.

• I like EUR short term
• I dislike GBP short/medium term vs USD (short term vs EUR)
• Paying US rates here is great
• Tactically waiting to get long USDJPY vol... will not wait more than 2 weeks though.
• CAD and AUD expensive, NZD at risk next week
• Earth is a depressingly sad place.

Models and things.

Just going to post some of my model charts in the 1st part here, there is not *too* much to read into, especially as some go against my short term positions. Anyway;

EURUSD

EUR vs model (spread in P2)

My go-to EURUSD medium term model. A concoction of relative equity performance, Short term swap spreads and also peripheral spreads.

Observation period was 2012 -> end of 2013. So far YTD, the EURUSD has been within 200 pips of my model (but given the YTD range is tiny, not that impressive) - Right now, it seems fairly priced against the cross asset components.

Using my 1Y forecasts for my components are calculating where my model would be, given that risk premia is likely plateauing, and short end US-EU rates are diverging, my model sees 1.2982 (range of 1.32/1.278)

AUDUSD

AUD vs model (spread in P2)

Unlike many, I don't actually include Copper prices (or other commodities) into my model, instead I stick with, at least in our current dynamic, having short end rate spreads, EM credit spreads, US 10 year yield and implied volatility.

Observation period was 2013, and while quite divergent at the beginning of this year, they've finally come together.

Once again looking forward, I expect to see 10Y US rates edge higher toward 3%, US 2's to pick up another 30-50bps, and implied volatility to tick up marginally (mean reversion). While EM credit spreads staying constant (measured via CDX 5Y EM - CDX 5Y IG)

Therefore, an approximate value of around 0.865 is seen. Which given other factors does seem reasonably fair to me.


GBPUSD

GBP vs model (spread in P2)

This model focuses a little but more on forward interest rates spreads, with a greater importance on the 1y1y spread. But also positioning (as per a option skew indicator) plays a big part. Arguably the GBP is becoming (as crazy as this sounds) a carry currency and so volatility becomes a big factor, and we've seen the strong inverse relationship between GBP and GBP Implieds this year.

All in all, this is quite a different model, but still working well. A slight divergence in the past two weeks as UK short end rates have given back some of their gains. The observation period was again 2013.

Given the path for the majority of these factors, I don't see *that* much upside in the GBP vs the USD. It might continue higher in the shorter term, but in 1Y time, I would be surprised to see us above 1.70.

USDCAD

CAD vs model (spread in P2)

This model is much like EURs, strongly reliant on shorter term spreads, but unlike the others, we've seen an actionable trade (bought USDCAD the other week) which is going well (+100 now)

So with regard to my current trade, I am looking for a move back into the 1.09s eventually.

_____________________________________________________________________________

So that was a look at some of my models, now for some of my thoughts for the next week and ahead.

This next section involves looking at the USDJPY and UST's, something I have done many times before.

I'm definitely on the side of wanting to pay US rates at these levels, the US 10Y is at 2.52% and I still do think we head higher. One negative however is the carry one has to pay. A 3 month fwd, 10Y swap trades at around 2.7% (or +15bps), and so one way I am looking at avoiding paying this cost is to use the USDJPY as a proxy long for US rates.

On top of this, you would recieve 6pips from being long the USDJPY over a similar 3 month period, so instead of negative carry, its positive!

Now this is not at all a new theme, could have interchangeably used them all year, but I am very much liking the fundamentals behind paying rates, so the timing seems right for me now.

USDJPY vs US10's (red)

However, this may all be too good to be true. One major risk, and it is quite major, is the positioning in USDJPY and the enormous vacuum that lay just below market.

USDJPY, daily.

While there are noted bids doted between 101.2 and 100.8, there are plentiful stops all the way down to 100 and beyond. One bad US data piece could be the trigger to set the domino's falling, so maybe looking into options could be a good idea, so as we limit downside, and reduce risks of a "fake" breakout under 101 / 100 for example.

A 3 month USDJPY 102 (40 delta) call costs about 88 pips right now, and given historically low levels of vol this maybe the most attractive play to me. But maybe if you ask BNP Paribas they could suggest something a little bit more exotic :)

USDJPY 40 delta call volatility

Anyway, we've got a busy week ahead of us in the G10 space;

• The odd Draghi speech
• RBA + BoJ on Tuesday morning (probably same old boring rhetoric)
• UK CPI, est for 1.6% vs 1.5% prior. Quite an important print imo. carney speaks aswell
• ZEW (I pronounce it Zoo in my head...) but frankly meh
• BOC statement / conference. (poloz language wrt CAD is key, likely dovish still)
• UK employment data, my only concern is can it live up to expectations...
• US CPI / Consumer sentiment on friday, but frankly meh.

Some Charts - 7th July.

Just going to post some charts that may/may not be interesting or at all useful. Mostly they look nice.

First of looking at some FX vs rates charts. The short end of the US rate curve has pushed quite a bit higher recently. Frankly, this hasn't really transferred into any USD strength yet, most likely with market participants still quiet, and volatility really low.

EURUSD vs 1Y swap spread

pretty self explanatory chart, recent policy divergence will definitely push the yield spread wider, but will it transform into EURUSD weakness? well only if flows into euro-assets stop, risk premium picks up, or the Fed really goes for it. All of which quite unlikely in today's environment,

AUD vs 2y swap spread

Similar thing here, the US component of the rate spread has pushed the red line lower in both instances. However the AUD has a few more factors involved, namely trading as an EM/risk proxy (which it does from time to time)

AUD vs CDX EM-IG spread

Looking at CDX EM minus IG spread, strong correlation over the past few years, and since EM has recovered considerably YTD, the AUD has lagged, but there most likely is a reason for this over the past few weeks as US rates have risen. 

Posted this next one last week, but its still striking in my opinion. USDCAD;

USDCAD vs 5 year spread

pretty clear this one, and I still like looking for long USDCAD down here

This one seemingly lost me a few followers on twitter, but heck, I still think its interesting.

Being long ARS is finally profitable, even after spot crashed 15% in one day earlier this year.

Rolling 1Y NDFs

1M NDF implied annual yield

but certainly helped by the fact you get >30% yield... (was >100% in Jan)

anyway, not much from me today, just some interesting charts. All mostly USD bullish.

I'm Back! 1st July

I'm back, and I have not missed much! (not sure if I am happy or sad about that), but the outlook for the summer doesn't look great, even JPY 1 month vols trade with a 4 handle ffs... oh and EUR 1 months trade lower and lower day-by-day. Now currently at 4.25 (an all time low of course!)

G10 and EM 3 month implied volatility.

So the future doesn't exactly look bright, and I can't see why we won't see a boring summer with things going like they are now.

However there are still some identifiable themes, that maybe if they play out, the summer won't be so bad.

1st one builds off my most recent post from back in April "long look at the CAD" here. I thought the CAD looked like a good buying opportunity. Now I think the complete opposite, but in fairness the CAD has risen just shy of 4% since then, which given today's slow environment, feels more like 10%

A lot of the rationale in April, was that the CAD was the most shorted currency (by most measures) and we have since seen a decent round of short covering, and some speculative buying (especially as inflation has ticked up, something I highlighted back in April).

But now we sit fairly neutral, and seemingly at a bit of a technical cross-road.

USDCAD daily chart

USDCAD is pretty much sat at what could be interpreted as strong support levels, not only this, but stochastics are lowest in many years, suggesting that at least in the short term, we could be due a pull back.

Another important factor is that off yield spreads, which can be seen below.

USDCAD vs 5 year rate spread

Here we can see a sizeable disconnect in the past few weeks between the USDCAD, and the 5 year rate spread. Given its incredibly strong relationship in the past, it could either be going the way of the once famous "EURUSD vs 2 year german/us spread" however I think this is less likely, and I do think that the USDCAD proves to be good value at its current levels.

The final chart for the CAD is that of the USDCAD versus implied volatilty. This is because, while a spot trade is easy and simple enough, maybe with volatility so low, this trade might be more favourable via options.

USDCAD vs 1 month vol 

we can that as Implieds have dropped off (around the world) there has been demand for CAD (and carry/risk in general), however, it is likely that a move higher in the USDCAD would be accompanied with a move higher in implieds, so being long vega is not the worst idea... Hence, with implieds this cheap, buying upside calls seems quite attractive.

A 3 month 1.065 call costs about 95 pips, with a KO at 1.04 about 87 pips (probably not worth the KO then)

Either way, I like Long USDCAD here

My next charts are to do with US yields, we still have the 10 year trading give or take at 2.5%, pretty much exactly where it was 365 days ago.

I still do think the US economy will recover well, and is seemingly lagging the UK's monster rebound by 6-9 months (if we forget that little -2.9% print on Q1 GDP) however there has yet to be a "shockingly" strong recovery, hence the US 10 year has gone sideways for nearly 4 months!

This next chart compares the CESI USD to the bp change in the US 10 year over a rolling 70 day period.

It is quite clear (to me at least) that we won't see higher yields without better US data, which is yet to come.

CESIUSD (white) vs. US 10 year 70 day change (red)

A major theme is that of rising inflation... which may be the shock story of H2 (shock maybe a strong word)

Next chart is that off USDJPY vs the US 10 year yield... closely tracking as per usual. Does suggest that if we do eventually see higher yields, that the USDJPY will follow suit higher

some other bonus charts just to finish this (sorry its long, been away for a looong time)

NZDUSD vs G10 3m IV (inverted)

Once again... We really aren't going to see the NZD drop until volatility picks up or carry drops... and given the current environment, neither seem too likely. For this reason, I am going to steer clear of the NZD, because frankly over the summer, with vol low... what reason is there for NZD to fall (milk?).

Sweden... SEK has been my favoured short ever since last December... it took its time, but is finally starting to drop a bit. Mostly because of that lingering deflation (no biggie tho) and we have seen a huge divergence in 1y1y fwd swaps, which as of the other day, the US rate is > than the SEK rate

USD vs SEK 1y1y and spread

This chart is striking, but I do not at all think USDSEK goes to 8... its just there may be some more pressure, especially if; 1) US rates rise, 2) Riksbank eases moar!

USDSEK vs US/SEK 5 year spread

A sizeable move, especially important is that the US 2 year rate is now > than the swedish 2 year rate for the 1st time in a while...but rates aren't everything.