Monday, 27 February 2017

FX & Rates thoughts - March 2017

I've been rather absent from writing (here or on twitter), so thought I would post again broadly following up from my post in early Jan.

To me, very little has changed in the global outlook that I see in the ~3 weeks I spent on a beach.. Nicely portrayed by rather sideways markets - US 10y trading the 2.3%-2.5% as shown here.. In what is a highly documented flag formation, suggesting that in the not too distant future we see a breakout in some direction, and maybe some accompanying vol.



With most of the discussion it seems around Trump policy still, and how that will eventually filter through to the economy (and thus fed policy). One of the big rates moves that we've seen, and probably the most important to me, is the acceptance that Trump is not going to create the large impulse in real GDP growth / productivity etc that was hoped end of last year.

US 5 year real yield
All this does lead me to wonder if the trumpflation trade might never result in any real progress for the US, we discussed in the last post that expected real GDP boost through Trump was a mere 1.1pp / year, but perhaps it may be even less.

Now of course, I am writing in this tone because fixed income has rallied, and TY is at the top of its range.. attaching a narrative to price action... If we were at 2.5/2.6% im sure all the narrative would be on the other side.. It seems leveraged money / CTAs are still decently short US rates and thus I can envisage a potential break lower in yields towards 2%, especially if the fed dial back any hawkish tone (or geopol risks, le pen, rise).



Broadly, and without going into too much detail, US economy is still strong, and Fed rhetoric remains hawkish to keep leaning on paying 2 hikes per year (currently priced 2 1/4).. Most likely imo starting in June, but there is certainly a non-0 chance of March. I would suggest the Fed likes to keep the option alive (with ~35% priced in), but as highlighted many times would prefer not to shock the markets and thus will not hike and clearly present June (~80% priced) (barring any major turns in outlook). If they stay true to course, I can still envisage US 10y at 3% throughout the course of this year.

Looking elsewhere, specifically the antipodean markets, some sense has finally returned! FX markets (no strong view either way from me on them) continue to rally with broadly strong EM sentiment and supportive data, but in rates CBs have regained control of the front end and moves have normalised significantly.





Firstly, the RBNZ said they would be on hold for 2017, and most of 2018 and those 2 hikes priced in quickly retraced, with now just under 1 hike priced, which is probably closer to fair given the rather decent domestic macro.

AUD rates also did as expected and IRZ7 has come back towards fix, with now just 5bps priced. Our trade from last post to Rec AUD vs US has worked nicely, selling the spread at 50bps, it now stands at 29bps (+21bps) and I like to lighten up my long AUD leg here, whilst leaving a bit of Short $

EDZ7 vs IRZ7

In my other rates trades, SEK 1y1y vs EUR 10s30s has performed nicely too.

SEK 1y1y vs EUR 10s30s
Rec SEK 1y1y at -20bps and paying eur 10s30s at 58bps were the entry points, a 10m1y SEK swap currently trades at -25bps (+5bps) and 10s30s is 64bps (+6bps), so the idea of trading riksbank policy (which they were ratrher dovish, and hit the fx a bit) with a global steepener hedge in EUR worked nicely for +11bps so far (+17bps if beta weighted EUR against SEK in 2:1 DV01 ratio).

I look to hold SEK recievers a bit longer as the carry is still decent and have protection on it until mid-year given recent Riksbank rhetoric. On the EUR leg, I still would favour having the hedge on ( as it also pays small carry, 1bp/month) but look to cover if we move much more..

A strong recommendation to read this blog on longer term rates if you have time - https://globalmacrotrading.wordpress.com/2017/02/24/a-view-on-long-term-global-rates/

And building on that, and looking for more recievers, I like the look and roll in the ILS curve. 1y5y trades at 1.50% vs 5y spot 1%, around 4bp of carry per month. Hedging global risks with an EDZ7EDZ9 steepener looks attractive here. Beta ~1 so can roughly keep DV01 same.

ILS 1y5y vs EDz7z9
ILS spot fx has rallied significantly YTD (chart below, REER) putting any potential shift in BoI narrative on hold for the immediate future. Inflation is slowly ticking higher along with global inflation, but I question how long this lasts with base effects from oil rolling off fast. BoI address this by saying the primary cause of the uptick to 0.1% y/y is through oil and small domestic administrative price changes.


oil y/y % change

ILS REER
With BoI decision to keep rates on hold today (http://www.boi.org.il/en/NewsAndPublications/PressReleases/Pages/InterestRate27-2-17.aspx) and a very neutral tone, I believe ILS rec work well with a global hedge in a similar set-up to SEK vs EUR rates. Noted ILS strength to dampen tradables inflation and whilst domestic data is solid, the BoI are in limbo where cuts are v unlikely, but hikes remain off the table for 2017, and even then the path will be v slow. Unless of course global inflation and other rates markets move, hence the ED$ hedge.

Of course, looking ahead to French election, whilst we still have plenty of time for things to develop (not to mention market noise around 1st/2nd vote).

Eurostoxx Vol has been incredibly bid, and rightly so if the chance of Le Pen winning was strong. April Futures trade at 27 points, vs currently 1m realized of 11 and front month contract of 17.

The Curve, J7-M7 trades at extreme levels, and has continued to move well past what the OAT-Bund spread has been doing.


I would look to fade this extreme move in implieds as the probabilty of le Pen remains small in my eyes - tho am aware i am not french, and really don't know the situation there.. As such being short Vol outright is perhaps not best, and so selling J7, buying M7 would work well on a normalisation of the curve or a Le Pen victory.

But like I said, to me, its not a coin-toss like previous votes, however I am far less clued up about it, so regardless of what I do, I will keep it very small indeed.

Given the inverted Vol term structure in EURUSD you can get long a 3m3m Forward vol agreement at 9.1% vs spot 3m of 10.6%, which could act well if Le Pen does in fact win, or works well as a hedge if probability rises. From last post, I am still long a Mid-year digi put in EURUSD at parity, however with spot mostly unchanged, its worth 14% (from 20%, representing a small loss) and whilst we are on the topic of unsuccessful trades, my USDCAD call spread never got going regardless of a dovish BoC, but recieving their front end rates still seems somewhat attractive. With Oil at YTD highs its becoming harder to short CAD.

Lastly, a bit of faff around EUR and USD curves that I've been looking at recently

US-EUR 2s7s30s fly spread vs US 10s
With a lot of carry/roll built into the 5-10yr segment of the EUR swaps curve, I look at receiving 7yr on the 2s7s30s fly which offers attractive carry against the volatility of the underlying fly. Doing similar in US but paying the 7s, can be seen to correlate nicely with outright rates (as above) but offers significant carry as a Fixed income short.

The Fly spot trades at around 66bps as a spread, but 1y fwd trades at 33bps. Crudely comparing to a US 10s level of around 1.80%. Whilst there is no major macro underlying theme for trading the fly spread, trading the correlation with global fixed income offers a very good carry fixed income short (assuming correlation remains) rough beta of 0.5 on the basis point moves (if hedging out US 10s risk). Whilst ED$ curve steepeners offer decent roll, it is far less than this.. but at the same time much less faff, so I wouldn't recommend for a quick FI hedge, but perhaps in small size can work as a decent trade.

And well actually, one more wafer thin, idea. From on the ground research of Ecuador over the past month (well mostly sitting on a boat or a beach) I have concluded that the economy is strong and sound, with good local optimism and lots of faith in the new president (elected last week) I quite like the idea of owning Ecuadorean debt from a carry sense, offering 500z spread in the 2020s, Argentina (with a similar rating, B) trades at 350bps.. Now the story behind ECU is mostly history of screwing over investors and large oil exports. However with decent fiscal measures concerns of default seem overdone. The inability to devalue their fx may hinder when EMFX is going down, but whilst rallying should be supportive, not to mention plentiful supply of dollars within the economy. When I look at debt sustainabilty against similar levelled names (ghana etc) and first glance from bbg numbers I prefer ECU, especially after exploring Quito and the nearby forests and villages I do.

Ecuador vs average B rated HY spread. 

Anecdotally as well, you compare development levels in say ECU vs neighbouring Peru/Chile/Bolivia/Colombia and you'll see an on-par or in some cases better situation for many locals, strong (and publically free) healthcare, decent (and apparently v rapidly improving) mandatory education until uni level and good weather (tourism innit) that the z spread of 500bps against ~100bps for the other names offers good value to me. For front end low duration bonds, and in this environment, this pick up seems attractive as a small back of the book long. Outright it might not be the best yield, but have you seen CDX EM? nearly less than 200bps...

Should add for disclaimer sake here.. i spent a few weeks there and about 10mins on bbg looking at it.. total tourist so probably don't listen to that last bit ;)

cdx em

Summary -
- Rec ILS 1y5y at 1.5% vs paying EDz7z9 at 69bps
- short FVS J-M curve at 5.5
- Long US-EUR 2s7s30s fly 1yfwd
- and for the ballsy, some long ECU 2020 $ debt..

and as always, not spelt/grammar checked, sorry... Just quick and dirty thoughts.

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