Sunday, 4 January 2015

FX weekly thoughts - Jan 5th

Over the Christmas period, maybe somewhat surprisingly, Investors still loved the USD, it felt as if as we changed over to 2015 speculators just had to own $s, and subsequently, the dollar had one of its best days in a long while (especially vis a vis CAD and GBP, +1.33% and 1.6% respectively)

More interestingly perhaps was the EUR, which traded as low as 1.2001, though this being said, with this much pressure it would seem probable for the (likely) hefty stops below 1.2000 to be tested.

EURUSD daily
We dropped through the 2012 "whatever it takes" low at 1.2043 without much difficulty, leaving the next obvious downside target at 1.1880 or so (2010 low).

We are seeing Record spreads between UST and bunds (or any EUR rate frankly), with the benchmark spread at over 160bps. While I know we shouldn't simply compare yields in different ccys, but its worth reminding that USTs are denominated in USD and Bunds in EURs.

US 10s vs German 10s
So with a hefty yield pickup over bunds, you also get to own USDs over EURs, which to many, given the divergent environment is rather attractive. Furthermore, Whilst this spread may widen further, bunds yields on a fast track to 0% will act as an anchor and will almost certainly drag US yields lower too, and with this continued theme of global disinflation (or at least expectations) the long end will still see plenty of demand.

However, I feel that perspective is certainly needed in the USD rally, while I do believe we head higher, its worth bearing in mind, we are already trading above the median Q1 '15 forecast for the DXY, and its only been one trading day!! On top of this, we are going into a year where it feels like  *everyone* is bullish to quite a large extent... so to be trading above Q1 f'casts and close to Q2s already seems like we may be getting a tad ahead of ourselves

DXY forecasts ranked from high to low for Q1

When we plot the USD against real 5 year rates, we are starting to see a bit of divergence occur, whilst not huge, and similar to what we saw in late sept/oct, it could put the brakes on the rally.

As opposed to looking at the broad dollar, the AUDUSD is seemingly the most sensitive currency to real 5 year rates, with an R^2 of 0.88 as we can see below

While small still, we are starting to see a touch of divergence in the past few weeks, suggesting the AUD could be supported, but when considering other factors (commodity prices, AUD rates) this is only one of a few key drivers, but nonetheless, it at leasts boosts conviction on the relative value AUDNZD, which down to 1.050 is once again at all time lows, which is cheap imo.

One last chart on FX and Real spreads... EURUSD vs. 2's real spread

EURUSD vs. real spread
Once again, it seems the USD may be getting a bit ahead of itself, when considering 2 year real spread.

I may be sounding like a bit of USD bear right now... but don't get me wrong, I can, and am, bullish but I do think that we could be in for some consolidation/pull back. Just think back 1 year, same sentiment as we have now, yet it took 6 months of consolidation before the consensus trade worked. Now I don't think we have 6 months, but until the ECB in late Jan, the USD may struggle to move much higher.

Looking for specifically at the GBP now, and wow its been weak. An illiquid friday in holidays saw a sizeable drop, trading through some large technical levels exacerbating the fall. Now I tweeted a chart like this one last week, and the GBP has been trading rich to rate spreads, and we still are, just less so...

When we look to play the US theme this year, paying the short end really doesn't seem like the best play, while it should work, the yield curve is so steep that a 1y1y fwd is 77bps higher than 1y swap so overcoming the carry will be tough, as such its far more intuitive to play the USD given the probable correlation.

However on the contrary in the UK, As I still am optimistic, shorting rates seems more attractive than trading the ccy. Even though the foot has been taken off the gas somewhat, the key metrics determining BoE policy aren't much different than the Fed. However looking at the short sterling curve you wouldn't have guessed...

Looking at Dec '15, there has been an entire 1 point rally, implying a 100bps lower LIBOR rate for this December, just since June...

A nice, although not totally reliable indicator, is the running sum of economic surprises (as per Citi's CESIs)

The top pane shows the clear slowing down of the UK economic surprise, whilst at the same time there has been a marked pick-up in US activity, a primary reason for the 1.72 -> 1.53 move in Cable, as the UK ticked lower as the US ticked up.

However, we are starting to slowly see a moderate pick up in UK data, and if there is any sort of Core inflation impulse higher, then I am sure we will start to see the hawks re-emerge. As such selling Z 15s here seems good.

A lot of big ticket releases this week from NFP, FOMC minutes, BoE statement, EZ CPI. However I have no clear biases on any of these, looking at some Dec data (globally) it was a tad weak, so maybe downward pressures on NFP (but consensus is only 240k), possibilty of a "deflation" print in EZ CPI after Spain's, but this is all in the estimates and thus shouldn't provoke *much* reaction. It might make for good trading, but is unlikely to change any of my macro biases or really matter.

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