Sunday, 31 May 2015

1st June - FX & Rates thoughts

Pretty much finished my exams now, 1st year all but over and now a long boring summer awaits.. But hopefully the markets will be interesting enough to provide us with plentiful opportunities to take.

I've been looking at the $ returns in European assets. Below shows normalized returns of both the DAX and a basket of 10y+ EGB sovvies.

DAX and EGB $ returns
Returns in both have been rather stagnant of late, and this is hardly surprising given the EURs fall in line with the DAX's and Bunds rally. I'm still in the mindset that the EURUSD has "relatively" limited downside, at least compared to analyst prediction, which have recently stirred up again. I'm still of the opinion that the reaction function of a higher USD will ultimately impact the US enough (and benefit the RoW) to the point where monetary policy expectations start to converge again... whether this means later Fed hikes or earlier RoW is yet to be seen.

DAX (inverted) vs. EURUSD
Looking at this chart, we can see the strong correlation between EURUSD and the DAX recently, this was highlighted before in one of the last blog posts - but in the past week, maybe through heightened greek fears, maybe not. We've seen a large-ish divergence in the two. Friday was the first time since just over a month ago we've seen a sizeable DAX sell off with little EUR movement. However of course, there are plenty of risks to the bullish European equity theme, but I think ultimately the majority of factors are supportive, ranging from my positive outlook on the Eurozone to the of course accommodative ECB.

Because of this I'd like to look at selling DAX puts, and using the premium to fund a EURUSD call. In an ideal world, I think I would look to structure this in a slightly more exotic way, maybe with some sort of x-asset KO or the such, but alas I can't. So simply selling dax put and buying a EURUSD call will make the most of both these ideas. As we looked at before, Vol In the DAX is at record levels relative to the SPX, so its potentially a wise idea to buy some deep OTM puts in SPX as a global equity hedge for this idea, but I'm not sure I'll need to pay the premium for this.

Ultimately I've been really rather happy with the EURUSD recently, buying it back in April towards 1.06, and then just 2 weeks ago in my last blog post getting bearish just shy of 1.14 - we stand pretty much at 1.10 now which seems reasonably "fair" right now, but with an upward drift bias.

That's my current play in this space, not too interesting, not much going on. NFP next week should be interesting, ultimately I don't think even if it was 300k+ we'll see a June Hike so reactions (bullish USD) could be fade potential.

In the bund space, I've only gone and recreated this stupid chart that the sell-side have adored the past few weeks..

Bunds vs JGB
I mean it is compelling isn't it? well kinda.. but if anyone was to believe this then Bund puts are quite cheap. I was looking at a sept 151 put in FGBL, which is approximately the low we put in back in early May, and it costs a mere 50cents. If this does occur, which is a big if, the option would have an intrinsic value of ~200 cents on expiration in sept and probably worth much more before than, offering a decent risk reward set-up. Of course, we have the ECB meeting this week, and I'm sure some concern about this movement in rates will be addressed, and draghi will waffle on about the QE program and people will go back to remembering that there is only one direction for Bunds... maybe. I mean, if the stronger H2 EZ plays out, and inflation ticks higher then they must surely accept higher nominal rates, after all we are only at levels seen at the beginning of the year.

Thinking more about the longer end - it does seem rather capped. We had all this excitement last month about the "taper Tantrum" part two, but that has died down rather rapidly. I like this chart which shows US 30 year swap rates overlayed with Copper. Maybe its a nice correlation, or maybe its more important that global growth prospects are the clear and present danger for higher rates, regardless of US growth. I mean after all, global rates are fairly well anchored to each other, and in think back to two weeks ago when the USD was pretty weak. Global asset managers loved picking up USD debt with the USD at such a discount especially vis a vis the EUR.

We also see Global PMIs trending lower on this chart and while I am optimistic on global growth (mostly due to higher USD / lower Oil) this downward trend will most certainly keep the long end pinned lower, especially in our low realized inflation world.

However on the shorter end, divergence is still reflected clearly. Here is a CIX of a DXY weighted 2yr swap spread of the US against the RoW. It's been a clear driver, and understandably, but its been trending lower as Fed hikes have been pushed back and back. But to me, broadly the USDs strength will be limited, and even if the spread rises, it won't support the USD as much as it has in the past. I think as we move into the hike cycle, the raw spread in support of the USD won't be as important, even now I think its importance has been overstated. At every stage, the US rates market has outperformed forwards (mostly) and we'll merely be moving along an upward sloping curve which the forwards (as calculated from the curve) see. so we could simply plug in the forwards to this and we could see a DXY 2y spread upward of 0.7% next year... but that's not to say the DXY is going to be 105+..

On the other hand, I do think that USD bearishness is limited without a major drop in this carry you now get in the dollar - its sometimes like this that I wish forwards were a predictor of price. All this time I've been bearish the USD, but its really relative to everyone's bullishness and more of a sideways drift lower in DXY.. and so I wish we could have a 1Y fwd in EURUSD under parity as per forecasts.. this would make sell-side forecasts so much more interesting :P alas, fwds are just a bit of fun maths and nothing more.

On the NZD.. since I last looked at it here where I presented the idea that the RBNZ could cut rates. Since then some smaller banks have agreed with me, and more recently HSBC have thought this is possible. More importantly the NZD TWI has dropped from 160 to 149, and the crucial cross with AUD has pulled back a lot, but still high.

The NZD OIS market sees around a 50% chance of a cut in the next 3 months or so, from pretty much 0 a few months ago, this is a primary factor on the lower NZD. But its also fallen out of favour from the momentum/tech guys, with us trading yearly lows under 0.71

Carry/vol is also a great indicator for NZD - and both don't paint a pretty picture. Carry has dropped remarkably as the market has seen the turnaround in the RBNZ rhetoric.

Carry/vol vs NZDUSD
As I've suggested, against a lot of critiques, is the idea of an easing RBNZ... many simply suggest they won't cut and will just use FX and words to achieve their goal, but I think serious risks in China, domestic inflation (yes, yes I know housing blah blah) and declining Terms of Trade will see the RBNZ react, especially in a world of cutting CBs - they'll hardly be out of place!

Taylor Rule for New Zealand

Here we can see the Taylor rule for NZ.. now I know all the arguments for/against this.. but we can see quantitatively the justification for lower rates, maybe not 0.75% of course, but lower - lets say 3%. Still we'll see, I'm not 100% sure they'll cut at the next meeting, and I'm not even short the NZD anymore, I've taken it for its ride and am happy, but the concern for us is the positioning is heavily short and we appear to be quite overextended, so by no means would I want to short here, bounces, maybe...

Still not too many idea, Exams probably have a part to play in that, but im nearly done and I'm sure the twitter/blog flow will pick up :)

Thanks for reading y'all


  1. Hi Jeremy, I was wondering if you could explain how you created the Bund-JGB chart? No matter what I try I am finding it impossible to replicate! I have obv tried "Edit->Date Range" and changing the JGB curve dates but it will only accept either a start date OR an end date. I also tried the offset but no matter what I try, I cannot get the date range on your chart (07/23/98 - 01/23/04) overlaid on the bund curve! Bloomberg help are also struggling to explain how you managed this ha! Any info would be appreciated. Thanks Terry

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