Monday, 17 July 2017

Summer 2017 FX & Rates thoughts

Hi guys,

Quick scan across some markets and some associated thoughts, have been mostly away with exams and travels.. so relatively brief thoughts.

Interesting few months since I last posted here, mostly led by a re-shifting in rate expectations led by Canada and UK, with the Central banks priming the market for a removal of recent surplus accommodation. BoC has already realised a 25bp hike, and has another 25 to go to remove the 'one-off' adjustments seen in response to oil price declines. The BoE is also, inconsistently, trying to prime for a removal of the post-brexit 25bp cut... This as well as the ECB bringing forward removal of QE and potential rate hikes into the equation has led to some sizeable moves in rates markets, and by derivation FX.

A chart we've all seen a thousand times now, Bunds breaking the 50bp level! opening up room for a continued weakening.. Overlayed we see ERz7z8 (Euribor futures spread for 2018). Pricing in 22bps of moves, with consensus talk for a move by ECB at earliest of Q4'18, its hard to see this curve price too much more than 25bps (aside from perhaps positioning led moves).. This broadly limits my expectations for 10y yields especially given already steep 2s10s, and unlikely major major shifts in terminal EUR rates projections... This being said, with current depo rates, and a slightly sooner taper, can see bunds ticking to 1% before looking to consider fading.

50 days later, and a BoC hike has caused USDCAD to drop by over 8%.. not long ago the macro theme was worried about housing crisis, and now sell-siders (GS) looking for 1.15s... quite the shift in sentiment.. Traders been trying to fade a long the way, further being squeezed by a hawkish BoC... The main discussion needs to be around whether its the start of a prolonged hiking cycle or merely just a removal...

June 2018 STIR spreads between BAs and EDs trade flat.. having traded 60bps wide at the start of the BoC move... A tactical fade here might work better in rates than buying USDCAD into 1.25 support.

CADNOK my prefered FX set up to trade CAD from the downside here as trading into significant resistance with well defined levels to lean off for options structures or stops.

CADNOK daily ranges
For indic purposes, 6.7/6.25 DNT mid marked at 25% (5months) as a way to play the range.. put spreads also attractive.. or just short spot.

EURUSD has also continued its trudge higher as both EUR supported and USD has been sold off in this global convergence of rates.

EURUSD daily trend-line
So... here we are again.. at the top end of this multi-year channel... make or break time. EUR Futures CFTC positioning is at extreme longs which makes the challenge harder, but by no means out of the question.

Having little conviction on EURUSD here about this break, I'd rather lean on the possibility of a fakeout and return to range.. This can be done with a 1x2 put spread 1.13/1.10 for zero cost. downside breakeven 1.07 for a year end position..

1x2 ps
EURUSD still trades cleanly off rate differentials (as it tends too) and a popular trade here is Long UST / Short Bunds ( a proxy for long effectively).. Broadly I think the pressure is on tightening but momentum will be hard to continue from here, especially as we are currently leaning on overly optimistic ECB and dovish Fed... the needle can move back quickly and take a 20bps of the spread (or couple hundred pips in eurusd).

In Latam / EM FX.. I've been looking at USDBRL downside here.

USDBRL put spread levels
EM FX should be in a strong condition to rally vs the USD going forward, especially across the summer doldrums and slowly performing macro data. Neutral Fed, weaker USD, low x-asset volatility and tight credit spreads should allow for continued appreciation broadly.

A 4 month 3.10/3.00 put spread is mid at 0.53%, offering a 5:1 payout for a further 5% rally in BRL towards year end. A cheap way to participate in a further EM rally.. Similar pictures in ZAR and TRY. Favouring limited loss structures given the potential political incidents (as we saw earlier this year), and taking advantage of low vol / high carry to get higher payouts on these put spreads.

Popular positioning is to have short AUD as a Long EM hedge here.. All things considered, if it wasn't for the technical picture I would argue it would be a nice (and cheap risk off hedge) to have on. Instead, I'd prefer once again to look at front end Aussie rates.

1y1y OIS rolls about 25bps over 1yr, as the market has started to price in hikes in both RBA / RBNZ (just because of the BoC? probably) ... but the RBA will likely continue to stay dovish. and so either at these levels, or marginally higher, it should work to put receivers back on.

AUD 1y fwd rate change expectations.

 Having momentarily priced cuts in early June, market is quickly back to recent years extreme in pricing. (using 90 day bank bill futs).. Favour using OIS vs IBOR to receive as housing market concerns and bank concerns could worsen.. sacrificing a few bps of roll to remove probability of a housing blow up to MtM pnl is perhaps worth it.

AUD 1y1y OIS 

Perhaps thankfully, local mortgage providers have been hiking rates, which take any pressure off the RBA.. the market may be getting ahead of itself equating Canadian macro with Australian and with a decent sell-off that we've seen, fading is worthwhile.

Another Interesting market to be hit by this rates sell off is CHF.. A notably boring market until recently.

EUR and CHF hikes priced over time
CHF has followed EUR in pricing hikes going forward (arnd 15bps in 1y), in fact pricing in marginally more up to 3 years out. The SNB is not under the same pressure as the ECB to bring normalisation on the table (as I still see most of the hawkishness is around tapering rather than hiking outright, thus SNB has time to be stable) as such if we are to look to fade this European front end sell-off receive CHF.. 6m3y rolls 12bps into year end which is attractive Carry/vol, and more so than fading EUR rates.

Perhaps hedging out global rates risk and rec CHF / pay EUR.. With marginally more priced in the belly for CHF (as above) can structure a positive carry position to play the divergence (or separation between the two)...

CHF 1y rate change expectations

Or can more simply be done buying ESZ8 (euroswissys) vs ERZ8...

In other rates markets, without going into much details.. I still favour belly/curve receivers in ILS (5y etc).. hefty roll, and a CB thats still neutral as hell... not too mention shocking recent CPI data and a continued strong ILS.. BoI ain't going anywhere anytime soon and ILS rates will continue to outperform, as well as pay double/triple the roll as it costs to put on a rates hedge (Favoured a TY risk reversal here for close to ZC).

ILS rolls (columns are fwd start dates, rows are swap tenor)

In Latam, Chile has likely close to finished its cutting cycle, but domestic data is still really struggling and with CPI plummeting, growth waning, commodity prices not overly supportive and CLP doing nothing in their favour, BCCh will not be moving upwards anytime soon either.

2y spot trades at 2.6, yet curves have steepened (2s5s gone from 25 -> 75) offering very attractive rolls, with potential for further cuts if data continues to worsen.. In the Latam space, with Brazil cutting and Mexico closely following in 2018, I see it unlikely for the BCCh to change tone soon, as such receiving is good.

So where are we left?? Hmm, mostly received globally.. Israel, Swiss, Aus and Chile... and arguably waiting to recieve EUR rates if they sell off more.

Overly concerning to be left this one sided, so look to pay some $ steepeners and outright option structures to neutralise this global rates risk... Bund 160/162.5 risk reversal pays u 5 ticks where spot is now, so a bit of this, something similar in TY and then positive roll steepeners to balance the book.

So having highlighting some FX/Rates trades... The main themes out there continue to be the extremely low volatility environment... x-asset vol is close (if not at) all time lows, and like with all the previous times, it does eventually blow out, but with no catalysts being the spark, we may just trundle along with our 6 vol times... sigh.

Another interesting development is the increasing real rates, and sell off in TIPS.

5 year real swap US
Trading against significant resistance, and little to suggest a realistic shift in productivity or economic activity, i struggle to see a much higher real rate in the US than 0%.. as such receiving this might be ok as a trade.

But with Credit spreads this tight, maybe some subtle risk off trades might be worthwhile... just in case..


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