The EURUSD was interesting last week, as the market headed lower to test very important weekly support areas.
|EURUSD daily tech chart|
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|
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|
Such as when looking at these two set-ups below.
|EURCAD vs 2yr spread|
|EURAUD vs 2yr spread|
|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|
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|
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|
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|
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|
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|
So it is still reasonably expensive to buy volatility, so now more than ever timing is critical.
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.