Tuesday, 21 April 2015

FX & Rates thoughts - April 22nd

Markets are all very interesting right now, we are living in interesting times and there is a lot that we could look at. However, I am going to focus mainly on the UK election, the GBP and related assets. Although there are certainly some ideas that we are going to look at in EUR rates markets and ultimately the EUR fx rate.

Firstly, the UK election is now just 2 weeks away and its all starting to get very exciting... or maybe not, I'm not too bothered.. I am finally old enough to vote, however I don't have the best political knowledge and while I have a rough idea on how the election is going to play out, there are plenty of uncertain outcomes that are entirely possible.

We have already seen the markets react to varying polls, just like with the Scottish referendum. After one poll from the Guardian suggesting the Tories had taken a bit of lead we saw an immediate bid in the GBP. This acted as a good sign to me as to where we stand going into May 7th... However currently the bookies (paddy power) favourite is a for Labour Minority. All this uncertainty is what has led to heightened implied volatility in the GBP relative to other currencies as shown below.

GBP-FX composite 1-month implied vol
We can see 3 distinct peaks in this chart.. 2010, Sept 2014 and right now, and these all coincide with election risks, and just like before this heightened risk premium will most certainly fade in a few days after the election.

GBP riskies vs basket
However conversely to ATM implieds, the skew is much tighter than the prior two spikes (on a basket weighted basis, i.e. not just GBPUSD riskies).

So far this year, the GBP has performed well, so long as we don't fund it in USDs or CHF. One of my trades of the year for 2015, was buying a basket against varying currencies and as we can see below that it is up around 10% against 3 of the funding currencies and down 5% against the CHF, so as an update it is all going rather well.

Looking forward, I think we do have a sizeable chunk of election risk premium priced into the GBP, I would argue a good few percent. I think the market learnt its lesson from the Scottish vote and more efficiently priced in the risk.

GBP vs Z5 STIR spread
Short term interest rate spreads have diverged meaningfully from Spot FX in the past few weeks. Here we chart L Z5 - ED Z5, or Dec 2015 LIBOR futures. This simple overlay would suggest the GBP is around 1.55 and of course its a huge simplification however its clear hedging election risks is most straightforward in FX and this is represented above.

Whilst there is uncertainty in this election, and I don't think anyone would disagree with this, its hardly as if there wasn't in 2010. The 1st time we had a coalition must've come at a shock to many, and rightly so the GBP was vulnerable, however only for a day or two.

GBPUSD May 2010 and DXY

TWI GBP May 2010
What I hope these two charts demonstrate is that, yes, the GBP was weak for the odd day, but most people (looking at you Sell-side) have been charting cable mostly, but we can see from the top chart that this was mostly dictated from USD moves. If my memory serves me, the US flash crash was very close to the UK election and this of course impacted USD pairs hugely. The TWI GBP is far more useful and we saw merely a flesh wound on the day within a strong up-trend.

Now of course I'm not looking to make a prediction of who is going to win... I really don't have a clue, however to me its clear that a fair chunk of risk premium is priced into options markets and spot FX although the past has shown us that even a shock result is necessarily doomsday for the GBP. We have these (imo) outlandish forecasts from the likes of MS, BNPP and barclays seeing the GBPUSD at about 1.4 by Q2 end, not something I really see as too likely unless the USD really gets a kick. In honesty I think the election will most surely result in stupid intra-day vol but in the grand scheme of the GBP (and related to its key drivers) I don't actually see it as too important.

Looking at the BoE/UK economy, sure, we can easily argue that the BoE missed the hike window and now we are pricing in another 14 months (MSM1KE) till we have that elusive 1st hike.


GBP 5y5y inflation swap
Looking at most UK macro data pieces, the situation certainly isn't atrocious. PMIs are strong, the Labor market is not bad at all, real GDP at a steady 3% looking forward, Europe possibly turning the corner... all is good, right? well there are still some niggling issues, such as 0% CPI and wage growth, but ultimately I think the UK economy is still strong and has a strong outlook. I do apologise for the 5y5y chart, but if Mr Draghi uses it, there is enough reason to think that it may appear as one of the inflation indicators for Mr Carney, and well it sits fairly comfortably at 3.2%, far more anchored than say the Europe equivalent.

The last time I wrote about the GBP was a couple of month ago and I suggested a 1x2 put spread with spot around 1.54, and the max payout at 1.5... today we stand with spot pretty much at 1.50 and expiration in just over a week I've decided to cover this for a very nice return.

And from here, I'm looking to rotate into a long GBP risk reversal. Long 1.54 calls and short 1.42 puts. The rationale is that if the election passes and the result is acceptable we should see a bid across the GBP and the gap highlighted earlier will likely close. On the other side, even a shock (like 2010 was) may jolt the GBP lower, but it doesn't change the raw fundamental drivers for the GBP at least in the 3 month horizon and given the skew in implied, this structure is pretty much zero cost after fees/spreads.

Now looking at Rates, I've been reading much more on Swaptions, so I decided to look into a possible trade idea here.

EUR and NZD 1yf10Y rates
Global rates, as we've discussed plenty of times before are well anchored in this low inflation / high easing world we live in.. Here we see EUR and NZD swap rates (10 year 1 year fwd). With EUR rates, I get amazed day-by-day by the interesting world we live in, with negative Bund yields out to 9Y, and negative 3m EURIBORs etc etc, however I do think that the upward impulse in euroarea growth in the later half of the year will be enough to keep the 10Y rate from 0%, as such I am looking to sell 0% strike receivers with 1y expiration. I read an interesting piece from Soc Gen last week about the increase in implieds at the 0% strike and lower due to difficulties hedging and pricing these options, and so selling these looks good. The premium is around 4.4bps here.

Bill Gross came out today and suggested shorting 10Y bunds here, suggesting we could see a 10%-15% return from doing so.. a EUR 10 y swap currently costs about 2bps in carry/roll (mostly roll these days) per 3 months, so while I'm not overly keen on the exact timing its hardly an expensive short. On top of this, if we assume bunds won't go much lower than -0.2% for 10years, which is truly ridiculous given the whole macro situation in my opinion, then price appreciation is limited to a few % at most... so from a risk:reward its starting to make more sense. I've been in a long UST/ short bund trade for a while and its performing okay thus far, however I grow more confident in this, with EUR rates acting as an anchor and any EURUSD dip acting as demand for USTs.

USD -EUR 10s spread

With this premium, I look to buy receivers in NZD 10s. We currently trade at 3.775 and I think we have the potential to head much lower.

RBNZ 1 year expectations for OCR 
the market sees 25bps of cuts from the RBNZ over the next 12 months, however given the weakness in inflation, slowing growth, declining milk prices, very strong NZD we could see further dovishness from NZ. This makes me like the idea of receiving NZD rates, but buying a 3.42% receiver costs ~10bps.

the NZD TWI traded new highs just this week! RBNZ won't be very happy...

The one obvious concern for the RBNZ is house price growth, which would be further fuelled by a move lower in the OCR to say 3%, however I think that this would be worth the benefits.

House price index
Overall, selling 2x EUR 1y10y 0% recievers per NZD 3.42% reciever is zero cost (ex fees) and positions me well.

One final quick look is on CAD.

CAD vs Oil
As shown from the chart above, we are clearly still in dynamic whereby oil prices are determining the CAD for the most part. Oil is up some 20% from its lows a few weeks ago, however one would expect heavy offers on these rallies, producers that are losing around $50 will be frantically locking in these prices, and increasing capacity limiting Oil's gains. From a technical perspective there are arguements to be made for a run through 60, however generally speaking Oil will be pressured, and as such so will the CAD.

Given the rationale earlier for the EUR rates, and the recent discussions we've had on European macro and the potential for a strong year, long EUR exposure is something I have been building these past few weeks. EURCAD therefore looks attractive, alongside EURNZD (given the reasons above)


Anyway, its getting late (/ early...) so thanks for reading, feel free to discuss etc. and if you're in london, do come to the Thalesians talk on global macro next wednesday! should be great!


  1. neat stuff - give the state of new zealand's housing market i think the rbnz is far more likely to jawbone + intervene than cut rates substantially. so i think you'd get a better risk:reward via a simple short nzd fx trade opposed to a rates receiver.

    speaking of which, how did you get the 1y implied rbnz ocr chart? did you make a custom cix by taking the 1y3m nzd forward swap rate - 3m nzd spot swap rate?

  2. Hi! I see the point yore making, and yes at the end I suggest long EURNZD which is something I implemented too..

    And the index is produced by credit suisse, however a CIX looking at 1M NZD OIS and using 1m1yf to strip would work and show a very similar picture, but seeing as someone has made it for us there is no need for a CIX ;)

    " CS1YRBNZ Index DES
    < Menu > to Return
    Index Description: Notes
    RBNZ Chance of Priced Moves Next 12 Mths CS1YRBNZ NZD OIS
    The Index measures the number of basis points of rate hikes or cuts that are priced for the next 12 months.
    A positive number represents the markets implied pricing of rate hikes from the Reserve Bank of New
    Zealand in one year's time. A negative number implies rate cuts by the 1 year date. The index is a
    continually rolling series such that each day shows the number of basis points priced for the rolling 1 year
    ahead date. All pricing is derived from the Overnight Index Swap curve. If you have any questions,
    please contact Credit Suisse directly."

    1. impeccable timing on the long eurnzd trade...

      thx for the cs tip, will check it out.

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