Tuesday, 9 September 2014

G10 overview - Sept 9th

A quick look at some G10 currencies, and some of my thoughts on them, especially as we have started to see the markets liven up a little bit, broadly speaking, Central bank divergences is still the main factor, but we've got plenty more noise around now.

Some generic charts to start with, firstly, 1y1y swap rates for UK, USA and Europe. These (and their inter-relationship) do pretty well to sum up where the FX markets have gone in the past few weeks/months and why.

USD, GBP and EUR 1y1y swaps
Next up, is G10 vol, which will be touched on throughout, but generally speaking we can see how it has bottomed and finally heading higher with some decent traction.

G10 1 month implied volatility composite
Anyway, on to the EUR, which has been very very weak whilst I was away on my travels. ECB cutting rates and looking to boost the balance sheet some €1tn a very good reason for the weakness we've seen, but it seems to a large extent that now the ECB can do little else to weaken the EUR more (which is what they've been doing since 1.40 anyway). As such we need to maintain positive US economic momentum for any further EURUSD weakness.

However, Positioning is now a huge hurdle in the way of sustained weakness... possibly the only realistic one as well. Whether you look at IMM or proprietary data, everyone is balls-deep short the EUR and looking at the charts, the market seems very extended.

A quick look at EURUSD 28 day (1m) RSI shows its at its lowest level since... well before the EUR existed.

EUR RSI extreme
However, its low for a very good reason, and versus my models, there is little in it between fair value and the current spot rate. With diverging rates its no surprise to see this pressure on the EURUSD.

EURUSD vs fair value model
This being said, rates are still likely to continue diverging, the Eurozone economy continues to lag behind the US by a substantial amount and real money flows are strongly biased towards the USD, so while a bounce is likely, expect it to be relatively short lived. We will probably trade the topside of 1.30 again soon, however we may be in for a period of range trading as the market clears out all of the shorts before the fundamentals take over and we head lower again.

My trade (which I don't think that you should follow) is Long 1.3050 2m call, short 1.27 2m put. If we go sideways (as I mostly expect) we are pretty much zero cost. Downside is going to get harder with positioning and techs in the way so we hopefully won't see 1.27 go. On the other hand, if we do see shocks to the current status quo (where-ever they may come from) we may see a short cover rally which we would benefit from.

On to the GBP... one poll suggesting "yes" to be the outcome of the Scottish independence vote on the 18th has certainly stirred up the markets. GBP has *plummeted* (kinda) implied vols have gone nuts and the skew has slammed lower as investors are desperate to buy downside protection, or else they going to look like fools if "yes".

As such, we can see that the premium on GBP 1 month options has risen to a high not seen since the 2010 general election.

GBP - G10 1 month vols
But its not just the very front end (which has inverted out to 4 years), but even 3 month risk reversals have slammed wider, with investors paying a hefty premium for downside strikes

GBP 3 month 25D risk reversal
looking to trade on the back of this might be a good idea, especially on the longer dated tenors, which will more than likely see the referendum effect pass, so downside puts (deep OTM) be pretty attractive to sell... however I would rather wait a few more days for the "yes" hype to build.

As personally I don't see "yes" happening, nor the impact being *huge*... numbers like -5% or -10% are thrown about on the sell-side, but no-one really knows. Uncertainty and the likely push-back from the BoE are sure to weaken the GBP, and right now it still feels like a mass exodus from hefty GBP longs rather than pure speculative shorts, hence, while downside is likely it might not be massive. but a sub 1.60 handle will occur on yes.

On the other hand, there may not be that much upside to a "no" vote. Much of the downside move can be explained from UK rates dropping and "no" doesn't do much to change that.

GBP vs M5 STIR spread
Maybe another way to look at this is the EURGBP, because really, the GBP hasn't been that weak... the USD has just been really strong.

The EURGBP has weakened to levels from two weeks ago... wow.

EURGBP daily

Currently ATM options expiring the 19th trade at 11.5/13.1 vol, with spot at 0.80 (give or take) we have a few options, ideally positioned short vol and also short GBP. As such 0.8150/0.79 sep 19th double no touches currently priced at ~25% of notional.

As such this offers decent risk:reward for the referendum to be a relative non-event, and at the same time see little upside potential for the GBP. Gotta watch that gamma tho.

On to NZD and AUD

The AUD has been performing well, with positioning currently standing at multi-year highs and staying surprisingly robust against the recent DXY rally

from BNPP
The AUD however is vulnerable to a pick up in US rates still, however it seems more sensitive to the longer end of the curve, and need to see US 10's to meaningfully pick up in order to see any sustained weakness from the AUDUSD.

However its neighbour, the NZD, is much more vulnerable in my opinion (not that I'd short here)

With one of the largest net external liability positions, New zealand is at risk from higher funding costs. While that is a way away still, we start to see short end rates pick up as we get closer to this fabled Fed Hike. On the other hand, moving into a hiking cycle should lead to structurally higher levels of volatility, as such carry/vol from NZD should retreat somewhat weighing on the NZD more so.

We can plainly see the importance of g10 vol on the NZD from this daily chart

NZD vs 1 month vol (inv)
So longer out, NZD is tres tres vulnerable, but shorter term it suffers from the same problems that EUR bears face... that positioning is rather short. However selling rallies is definitely something I like. 

With AUD, I think patience is the key.

I've looked at 1/2 of the G10, but thats probably enough as this is getting quite long now... To finish, just some bonus charts that I've got my eye on.

US 2s5s10s
5's looking cheapish here... and work well as hedge against selling EDs. However I don't particularly want to be long 5s into year end by themselves. would rather play the curve, so maybe 5s10s at 75bps

But considering this chart of CESIUSD vs chg in US 10s, I'm starting to think once again that bonds are a tad expensive here

cesiusd vs 70day change in US  10s
US 10 years
Here we have US 10s and QE highlighted... now just a thought regarding Core/peripheral Eurozone rates... do they start to rise on the back of the ECB starting to do something?!?

In other news, off to uni in 3 weeks, unsure as of yet how that affects my twitter/blog flow.

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