March FX & Rates outlook

Global markets have seemingly shrugged off the start of the year, and if we are all in agreement then the year can start now... There is a fair amount to consider, we've an imminent ECB meeting, the FOMC towards the end of the month and a lot of action in the HY/commodity space.

Firstly, a quick primer on the ECB this week: what I see baked into these markets is similar to last Decemeber in terms of a move in the Depo rate, which currently stands at -0.30%.. 3m3m EONIA forwards trade at a 10bps discount to this (from 15 a few sessions ago), and this works as a decent proxy for expectations but speaking to a few people 15 or 20bps is what they are looking for as they believe the ECB will deliver.

ECB Depo - EONIA 3m3m forward

I'm less sure about the rate, but there is a definite expectation on non-rate action; such as a new tiering for negative rates (in some sense similar to Japan/Swiss etc) which would be welcomed by the market, and lastly an increase of €10/15bn EUR on the QE program. Now this is a lot, but I believe after the disappointment felt in December, and the sharp asset moves (especially on front end rates) the ECB would be keen to avoid this.

Whilst I am not sure how they will surprise, I think they will. One possible caveat to this is that there has been a decent move higher in inflation expectations (5y zc swaps up 20+bps in the past 2 weeks) and the strong bounce in oil, however with headline inflation taking another dip its hard to see anything else other than dovishness. Another possible headwind is the rhetoric surrounding negative rates that all kicked off last month, specifically around Financials (and those CoCos).. but personally I think that was a narrative fitted to price action and not an overly large concern - but worth considering.

EUR TWI is positive y/y and since the inception of negative rates/ QE, which whilst not a massive problem its something I feel the ECB would like to change.

EUR y/y

Some form of downside in EUR looks good to me especially with front-end skew being bid to 0. With EURUSD at 1.10, and given my bearish US rates theme (later on in this), I think being short is a good tactical play, however given the potential risk of disappointment like last time I'm preferring options to spot, given the crazy moves in EUR back in dec.

eurusd 25d riskies

10s30s is also interesting to me, its been steepening quite a fair chunk. In my last post I recommended 5s10s flattener, and looking at 10s30s at 80bps, I am keen to look to extend this out the curve, especially given a surprise from the ECB and the very tiny chance of any upward revisions to inflation (or continued increase in market inflation expectations).

German 10s30s

I am less sure there is any juice left in BTPs, the spread has dropped to 122bps from 150 a few weeks ago which is where i was a buyer.. but here, not for me.


Now on to the Commodity spectrum, and today / this week, we've seen an almighty squeeze (and thats what it is) in a lot of commods.. true, however that metals bottomed a long while back, and this is an important tell to me. With Chinese peak pessimism occurring at this time, one has to wonder if the EM collapse story is gone now, especially as we look to any upside in growth. EM credit / FX / equity has been an incredible story YTD, outperforming in the midst of G10 markets blowing up. Brazil CDS trading back below 400 (from 500), even ZAR is up (after carry) YTD.. and thats quite something.

Oil has been a big driver of many markets, and somewhat fairly, but we have to step back after a move like today and re-evaluate.. Personally, I've been long inflation (which is by-proxy long oil) but I'm starting to look and think we've potentially squeezed enough.

Front month CL

 Now I know there isn't much in a line, or a moving average, but given the move we've had I would start to consider that we've approached a stronger resistance area around $40/bbl. There are still many issues that haven't been resolved in the last $10 rally, albeit I think we did see the low, I think we could trade lower in the immediate future. Owning puts isn't the worst idea to me, implied vol gets hammered on a rally and cheapens downside and we now stand at 50, being long vega here isn't bad either with 100d realized vol sat closer to 60.

Copper is similar, now trading close to 2.30, up from sub 2 not long ago. But we stand at resistance, and would be concerned of a pullback which could put the brakes on global risk, so owning hedges now is a) a cheap time b) a good price.

One other way I'm playing this is in USDCAD, I like the $ exposure given what I'll write about next. the CAD side, its a fairly simple 2 factor model that seems to run it; Oil, and rates spreads (which themselves are autocorrelated to oil).

By the looks of it, it seems a cheaper way to play Oil downside and as such USDCAD calls are attractive to me.

CADUSD, Oil, and 2y rate spread

A simple regression would indicate FV for USDCAD to be around 1.36/1.37, contingent on the variables being steady. For indicative purpose, a 1 month 1.36 call costs 32 pips.

SPX over 2000 is good. Good for risk generally, and interesting for the Fed, which remembering back to Sep-No-hike, played an key role. This makes for potential hawkish trades into the FOMC

Looking at the ED curve, its still well-below where we started the year, and has some catching up to do with other markets in my opinion.

This is an index of the average contract-contract roll in EDs, I.e. 3 month slope for the first 10 contracts. we started the year at 15bps, implying a rate of 60bps per year (or just over 2 hikes), we recently traded as low as 4bps, or less than one hike.. I think curve steepeners in this sense offer a good risk:reward with limited downside (cos realistically it'll really take something to go negative) and a look back towards 15bps+.

Elsewhere, the 10s look expensive on the 5s10s30s fly, and whilst being outright short is one way to play, selling 10s here looks good for a reversion of another 10bps or so.

US 5s10s30s

With Core inflation in the US looking strong, employment growth good and broader macro risks disappearing I see no reason why the Fed would not continue to hike this year - however March is unlikely, its too soon after the shockwaves that hit around the beginning of the year, so I see this setting up very very much like last year.. with March = Sept, April = October, and most importantly June being like December.. a Hike! of course, of course, the usual data dependent bollox applies here, but as things are going now, I see 2 more hikes this year. which makes fed funds and Eurodollar curves remain attractive.

So remain bearish US fixed income vs. everywhere else, though stick to the front end if playing outright as global anchoring of longer end rates will probably keep a cap on 10s+

As with the GBP curve, the idiocy that occurred there was just quite something with the talk of negative rates and at one point the GBP curve being flatter than EURs courtesy of Barclays here.

Months to hike index was also greater in UK, and still stands at ~40months.. but Brexit innit. Oh well. Markets gonna market.

All in all, should be an interesting month but I'm positioned for a shorter term dip in risk, whilst seeing the next 3 months in $ rates very attractive to short.

Thanks for reading.