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|
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|
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|
|RX ATM vols|
Final chart on this whole thing, is the EUR M1KE from MS..
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.
Was spot ref at 0.91, bought at 23% cos ma spreads are a bitch... but here's is the trade from OVML pic.twitter.com/gW5ysW213C— Jere Wilkinson-Smith (@JeremyWS) May 7, 2015
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.
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.