Saturday, 9 May 2015

May FX & Rates thoughts

Gotta start with the big events of the past few weeks... the large repricing in the European rates space.

Looking at RX1, or the 10Y bund future we've seen a massive sell-off. No matter how we look at it really, its a big and important move. However I think its key to note that this has mostly been a parallel shift up in EGB rates, as in, looking at peripheral spreads (Italian-German for ex) are still near cycle lows, and in fact they were a little tighter on the week.

RX1 daily chart
RX1 tick chart
Thursday saw some crazy vol in Bunds, which may be seen as capitulation. Flow talk suggests this is mostly CTA/speculator led (as per someone i know at JPM) where as the real money flow still underpins the fixed income markets. However this episode, like the Flash crash in UST yields last october just goes to show vulnerabilities in the market.

As I know everyone loves, we can try and fit a narrative to this move... of course whatever we say won't capture the whole picture, but we can try and justify it somewhat.

 First off is of course the stops/liquidity idea, which is often the sales reps "go to" excuse for any inexplicable move.. but of course, this does play a part. The market was noticeably thin, and even in my size I was struggling to get good fills in the Bund option space...

Secondly, and a theme that I've talked about as recently as beginning of April here where I looked at inflation swaps are questioned the likelihood that the long end of European rates could stay low... or my march piece where I looked at a comparison to Japan and thought it was getting ridiculous here

The common theme I talked about in those, was the idea that even if overall the Eurozone economy was rather weak, the rate of change in data and direction is certainly picking up... and this was seen in leading indicators, CESIEUR and inflation swaps.

I did question a few blogs ago why nominals hadn't responded clearly to a sharp rebound in inflation expectations.

EZ ZC 2y inflation vs German 10 year
But of course, one of the goals of ECB is to lower EUR real rates, and for sure this works, definitely on the short end of the curve. But further out, you have to wonder whether the impacts are truly market related or will they become realized? doubtful tbh.

The only issue I have with this is that this wasn't exactly "new" last week... inflation swaps had been shooting higher since Jan, but its the most logical reason for higher EUR rates, just not describing the catalyst behind it. Of course we'll never know, and as an update, my short bund / long UST trade from prior blog here is still open and doing fine. Entered at 161bps (i know right, nailed the high!) and currently sat at 139bps.

EUR/US 10 year swap spread
Looking forward however, whilst I am getting a flurry of sell-side ideas on Bunds et al. I think I am going to steer a little clear of it for a while, looking in the options space, there has been a significant (if understandable) pick up in implied vols

RX ATM vols
ATM vols traded as high as 11, but now done to 6 or so.. but still commanding quite the premium over the average. Obviously there is quite a skew in the vol, with puts quite a chunk higher than calls, but even still with the kind of moves we've seen I don't particularly want to be selling OTM puts. However what maybe some of the specialists might want to look into is that the skew in UST futures is far more slight, and going on the idea that long end rates are reasonably anchored within each other then there may be some hedged plays taking advantage of the differing implieds... however I'm too lazy to think about that too much and already in a tightener so got enough exposure for now.

Final chart on this whole thing, is the EUR M1KE from MS..

down to 30 months, from 55 months, just a few weeks ago... now I would probably look to fade this move in euribor futures.

Okay I lied, one last chart on this, ERA curve vs a few weeks ago. Its steepened a bit, and shifted higher, but lets be real, yes I think that the Eurozone economy is doing better than most out there, but no I don't think we see hikes for a long time. The Taper talk may come and go, but I suspect we follow a similar path to the US, where we have to wait a very extended period after the end of QE before hikes come into play.

And oh well, lets have a bonus chart :)

US 2s10s vs Bund 2s10s analog
In terms of monetary policy, the ECB is a good many years behind the Fed, in terms of an implemented open-ended QE program etc, and sitting on the supposed lower bound. To me, its entirely possible we see a similar path in EUR rates, as we saw in US rates over the past few years. First we see steepening, which maybe just starting, as growth and momentum pickup, all is good, yay! but the realization that hikes are way off means that any EUR rate taper tantrum will be short lived and eventually we start to see flattening as a few years later the short end looks to pick up. Now of course, this is very, very, very iffy, but plausible imho. Hence why I am still positioned for higher EUR rates. Nevertheless, anymore illiquidity in the long end will undoubtedly push ERZ8 (the one I watch) around, and last week it was tick-for-tick the 10Y bund, so that could be the best place to trade the overriding macro theme of no hikes. 

Okok onto something else. Can't obviously cover everything, but in my last piece here I put forward what is apparently a somewhat controversial idea, on the possibility of RBNZ rate cuts, and when we last looked at the NZD we traded new all time highs (Trade weighted) and I suggested the RBNZ would be less than happy.. and they were. since then, the TWI is down ~4%

Very good for my EURNZD longs from last week ;) up 10 big figures, but covered it now - tho still like the idea. Since last time, there has been growing talk of a rate cut, with some local banks predicting a 25bps cut this year! so maybe my call won't be soo outlandish. Afterall I got the hike cycle right, calling for a much a lower terminal rate vs the almost 5% that was expected :)

I bought a USDCHF 0.97 digi call the other day (spot ref 0.91) for 23%, idea based on a hedge against my overall book which is generally short USD, or has been, and takes advantage of a potentially dovish/supportive SNB and cheap cheap price. a 4:1 risk reward ratio for USDCHF  trading where it was just a few weeks ago, in 9 months. Yes please.

Ok, one last segment I promise, I've been looking into EMFX a bit these past few days, not that I really trade them, but I was asked on building a carry portfolio, specifically in EM. 

AUD vs JPM EMFX index
It is no shock to anyone, that the AUD trades like EMFX, it has done so for a long time. However what I didn't really realize, is that versus the JPM EMFX basket, the beta is very close to 1. As in, Long EMFX/short AUDUSD would in spot terms be rather flat over the past few years, but up a ton in carry. 

EMFX yield

Here is a somewhat crude and crappy CIX of the yield on that EMFX index. (I don't know currency weightings, so assumed they were all the same lol), but its around 6%. Now if we adjust this yield for paying AUD swaps then.

EMFX carry funded in AUD
Now of course, I'm not specifically looking to buy all EM just versus AUD. I do of course have my biases for funding ccys, such as CHF as well. And at the same time, there are some relative basket cases in EM, such as possible pressures on TRY and ZAR, but generally speaking I'd much rather fund in AUD right now, as it should alleviate risks from a stronger USD (directly ofc, obvs there are indirect impacts on EM from this, due to USD liabilities esp in TUR etc)

On a carry/vol basis, it also looks good. Using the simple AUD funded carry, we see carry/vol sat near its highs. 

All I'm saying is that I don't think its the worst time to be overweight EMFX, just look to fund it in AUD and CHF, and be selective in EM by being underweight Turkey/SA etc. 


  1. How would expect fx/rates to react if my mildly-semi-bullish Oil call is correct in the next few months? Secondly, would fx/rates react reversly if my call is incorrect and prices go down to say $45?

  2. firstly I think it depends on the reasons for oil price rises/declines... if its a global reflation story then I think we'll see the correlations that have been present in the past 6months to maintain... that is to say outright levels on the long end of the curve will probably rise, the curve will get steeper, inflation expectations will rise, the USD may weaken, Indian swap rates will rise blah blah...

    however if its a purely supply side reason for oil moves, i think the cross market correlations will be more subdued aside from the inflation impacts, which at most is very tenous in its link through to realized inflations.