March FX & Rates outlook

There has been a lot of discussion in the past few months all about negative rates in Europe/Denmark/Switzerland, however I think what is more interesting is to consider the impacts on the Bund curve, against say, JGBs. Japan has obviously struggled with deflation for many decades now, whilst its a relatively recent wave hitting the European area. Tho this being said, every bund trades through JGBs across the entire curve!

JGB vs Bund sovereign curve

There are a lot of issues in the Eurozone, from growing Grexit concerns to structural fiscal issues, however I don't believe that we are going into a period like Japan.

This chart from Martin is one of many that show optimism in Europe:

#EUR: how about 3% EMU GDP growth? What a difference a month makes in sentiment, e.g. https://t.co/T6tYNnL2qT pic.twitter.com/WewvAnX08r
— Martin Enlund (@enlundm) March 9, 2015

It is of course worthy of note that the wave of disinflation/deflation has been exacerbated by commodity prices, in particular oil price declines, however the basing factor will mean that the impact will disappear from the headline figures over time. And whilst we may not see massive inflation, we may see a definitive pickup.

This might have quite the impact on Bund yields (and other zero-bound rates), primarily those in CEE.

HUF / PLN / EUR 5 year swaps

There has been a sizable uptick in Hungarian and Polish rates in the past few session, and it feels like there may be more pain to come, as even though there may be a global hunt for yields, what we may see is a re-convergence of longer maturity rates.

What I mean by this is that if large global flows are going to be looking for yield, the clearly you'd look straight to USTs. One would much rather own a 10y UST at 2.2%, than polish rates at 2.1% as per above for example, and these flows may act to re-converge all DM rates.

While at the same time the idea that bund yields (and other zero-bound 10s) could actually pick up.. Thus when we see the 10 year USD/EUR swap rate at 160+ bps I think that the upside is rather limited and we are approaching the ultimate highs.. its possible that Fed hikes and upside data surprise may shock this higher, but I don't think we trade too much higher, and considering carry and roll would not hate Long USTs vs short Bunds here.

USD-EUR 10y swap

Looking to FX now, the EUR has been really hit, currently tradig firmly under 1.10, with the DXY storming towards 100. On a technical picture there isn't much support until this channel as per below, around 1.04/05

EURUSD weekly

From a gut-feeling perspective it certainly feels like the EURUSD is situated at a worst case for Europe/ best case for US kinda area, especially given the pace of decline, and while fundamentally the USD is strong, we are way ahead of ourselves - but this isn't new and fading the USD is still too risky. But with the EUR side, positive surprises in the macro picture might start sparking inflows, thus far any flows into Equity/Debt (which are large) have mostly, if not all, been FX hedged. From a managers perspective owning the USD makes sense. Especially given the yield pickup as per earlier, and the "expected" appreciation. But these are flows that are unlikely to capitulate and reverse, so we need new flow into EURs, but from where? don't know. we'll see.

But I think EURAUD could pose a decent short term opportunity at current levels, trading the range of 1.40/1.50

EURAUD vs 5y spread

A potential double bottom here offers good value to get in and play this range, Both via a spot trade for a short term move, and a 1x2 call spread (3 month, strikes ATMF and 1.45)

EURAUD 1x2 call spread

Receives small premium if there is a break lower, and is starts to lose at 1.49 at expiry.

On to the GBP a little...

I posted this trade on twitter last week:

and a 1x2 put spread looks good (1.54 and 2x at 1.50), receive premium and protect down to 1.45 handle pic.twitter.com/4opphN7GLn
— Jere Wilkinson-Smith (@JeremyWS) March 2, 2015

Doing well thus far, with cable dropping towards 1.51, but obviously with this structure my delta flips from short to long if we drop much further so I need to be careful, but its a decent start and I don't think that we see the market getting too ahead of itself into the General election.

GBPUSD daily

Still quite a fair amount of protection being bought into the election (tho I would love to see a riskies composite against many currencies, because obvs GBPUSD is hugely skewed due to USD call demand, and EURGBP riskies skewed due to EUR put demand, so ya know, if anyone wants too then that'd be great :D )

GBP vol premium vs Global

GBP vol premium is fairly minimal, but on a z-score its quite extended against its mean going into the election (this is 3 month vols). But its not at the super panicky Scottish Ref levels yet.

Lastly, I am going skiing next week (yay!) and its a fab time to buy EURs... almost 1.40!

GBPEUR