FX & Global Macro Strategy - March 31st

G10 FX overview

We've seen a bit of a reversal in some FX pairs recently, with crosses like EURAUD, GBPAUD etc pulling back significantly as the AUD faced some short covering last week. However later in the week, there is the RBA where we could see further rhetoric towards the strength of the AUD, furthermore we have manufacturing PMIs for China which should see some volatility in the AUD. On top of this, we need to be vigilant for end of year JPY flows which should play some part in the USDJPY movement - however if we see Us equity rally and rates head higher - the corporate flow becomes irrelevant.The EZ CPI just hit the wires, coming in at 0.5% vs. 0.6% meaning the ECB later on in the week will be critical.

EZ CPI Y/Y - ECB still sees no deflation risk...

Most importantly we await the NFP at the end of the week, with estimates currently in and around the 200k range... however estimates tend to be very inaccurate. However given the move in short term US rates, I struggle not to be constructive on the USD over the coming few weeks. This, potentially mixed with stronger data could see the DXY trade back towards 81.

NZD - leaning off the highs, looking for downside

The NZD is still storming higher vs. the USD with it recently trading 0.87 matching the 2013 high meaning we are trading just 130 points below the 2011 high (which represents a generational high, only higher seen in the early 80's). However this represents some decent trading opportunities for leaning off these levels.

From a fundamental perspective, I see the RBNZ continuing their rate hiking program, however at a vastly slower pace than the market expects. I see another 25bps likely before a pause to assess the impacts with the OCR rate sitting at 3.00% for a short period of time. This is because the NZD is far above the high end estimates from the RBNZ and this will most certainly weigh on the minds of the governor and fellow voters. With the rate path being pushed back, we should see the NZD give back some of its gains that we've seen year-to-date. The OIS markets have priced in the aggressive rate hikes for some time, and this had fed through to the NZD, but we are still seeing an underlying bid emerge. Most likely as implied volatilty has dropped off significantly and therefore with growing carry, the attractiveness of the NZD keeps increasing as uncertainty (and cost to hedge) decreases.

NZD 3 month Implied volatility

The chart below shows the NZD with various resistance levels, the 3M implied yield (LHS), daily stochastics (P2) and the spread from 200DMA (P3). The latter indicator shows the spot is above thr 200DMA by about 5-6%, which is relatively quite high.

Stochastics show momentum is certainly slowing as we trade up towards the 2013 high. All in all, I'm short leaning on these levels for my stops, targeting a swing lower back to, at first, 0.8550

NZD overview chart

EUR and the ECB

So, we've just literally had the EZ CPI print hit the wires, and the EUR has dropped off a cliff (albeit a small one)

EURUSD

This is because it came in at 0.5% (0.49% to 2dp) vs. Estimates of 0.6%. This puts pressure on the ECB to act later on in the week. However I don't expect anything;

"Short term, only QE (GDP-weighted bond buying) would be a real game changer with enough force to meaningfully reverse the rising trend of EUR/$." - GS

For the EURUSD to meaningfully depreciate we need QE, however, given the fall in CPI is a lot to do with energy prices dropping and seeing the impact on CPI that the Feds QE program had, I find it unlikely that the ECB follow that route.

Furthermore a rate cut is possible, but given the already low yields, 10bps or so won't do anything - both to the markets and the economy. Therefore, lower inflation boosts the real yield spreads between the US and Eurozone, and even though nominal rates are lower in EZ, once adjusted for inflation, EZ rates are higher.

As we can see, EURUSD has been led quite well by real yields, and frankly there seems no change to this relationship going forward. This is why, a lower CPI can in fact be bullish for the EUR, but only as long as the ECB doesn't act on it (QE etc). Since writing, the EURUSD has rebounded 50 points back towards 1.3775 for this very reason.

As such, certain crosses such as EURNZD, EURAUD and EURCAD (less so CAD) look quite attractive at these levels.

NFP preview

We have the monthly Non-Farm payroll reading this Friday, its far from the most important. Given the recent Fed moves, the print seems almost irrelevant, as only a negative value would trigger some real thought about ending the taper program.

Currently estimates sit around 200k, which seems fair given other economic indicators. However I'd argue, as the weather has improved we could see upside surprises to the number. Thus supportive of the USD, and also US rates.

As such I still like being positioned long USD across the board (vis a vis, JPY/GBP/AUD/NZD etc)

Overall however, looking at the rollover on weekly vols, the market doesn't add to much of a volatility premium to the NFP

FX and global macro Strategy - 24th March

G10 FX overview:

Having mentioned, I've covered most of my GBP shorts at 1.65, giving the headline risk going into tomorrows CPI readings. However I don't see it being to important in the medium term with the GBP likely heading lower as it remains elevated relative to interest rates. On the EURUSD front - following a stop run spike during the middle of the US session, we see the USD futures pushed back below 80.  However going through this week, I can't help but remain constructive over the USD in the medium term. As we can see, the vast majority of bullish weekly engulfing have been succeeded by another bullish week.

DXY weekly chart.

Given the move higher in US yields, especially on the short end of the curve, there is good reason to be supportive on the USD going forward. As such, dips could, and should be bought. Elsewhere, relatively neutral, with the AUD catching a bid on the back on lower US yields, and CNH recovering markedly.

Rates Overview: 

Last week, Yellen really shock the markets - suggesting that the first rate hike could be just over 12 months away, as such, this suggests that given this rate path expectations we could see US 2yr yields above 0.6% in the coming few months. However, the entire US yield curve marked higher last week (with 5yr dropping the most - 18bps), yet the most interesting aspect is the actual shape of the yield curve with 2s10s looking like it could drop further, and also the5s30s at the most shallowest level since Q2 2012. However more on this later.

EURMXN - buying into EM weakness

The EURMXN is trading about 18.25 while I write, and at this level we can see that it is ranging in an ascending triangle. Given the geopolitical risks that have come and passed the MXN has stayed relatively strong. Perhaps, an EM FX recovery could be better played through a higher Beta CCY, this being said higher risks are involved and relatively speaking, Mexico is in a better place than say Turkey or Russia.

EURMXN Daily chart

furthermore, given the worldwide drop in implied volatilty, we are likely to see money flow back into higher yielding currencies as any fears die down, while MXN doesn't offer the best yield, it is far more than most major pairs and as such a sustained move in risk appetite should support the MXN.

EURMXN 3m IV vs 1Y swap

As we can see, Implied volatilty, not only in Majors, but also in the MXN has dropped signnificantly. While implied yields (as per FX swaps) have stayed relatively higher. This should bode well for the MXN going forward however need to be mindful of any wayward spikes on various headline data. In which case managing the position would be advised.

Shorted 2 units EURMXN at 18.2470, targeting 17.80, stops 18.5

US 5s30s 

We've seen the US 5s30s come off very sharply post FOMC, in part to duration being very sought after, and also the belly of the curve has been seen as the most vulnerable maturity as we head into a rate hike cycle.

However I don't see the Fed raising rates next June, in fact - I think it will be much more likely to be Q3/Q4 2015, as such I think the belly has sold off too much relative to the long end, especially considering CESI indications are for US macro to start picking up in the short term as we move away from the "bad weather".

For this reason Selling 30's and buying 5's (i.e. steepener on the 5s30s) seems like a decent idea to me

US 30 year yield (top) US 5s30s (bottom)

The timing of the position is ideal, with US 30's trading on strong support. Considering the relative convexity of the generic 30's and 5's ideal positioning would be 5's notional exposure being 5.95x larger than the 30's to replicate the US5s30s curve the best, however taking this trade via futs a 1-6 ratio will be required.

Also, I do expect US long ends rates to continue rising, with the 10's trading above 2.85% in the not too distant future, this should also see increased volatilty come back into the market, as shown by the MOVE index below.

MOVE vs US 10 yr

Steepener of the US5s30s at 183.53bps. looking for 200bps, stop discretionary somewhere ~160

Long USD after Yellen

As highlighted in the opening, I see good opportunities for buying the DXY at 80 on the futures.

As we can see, and its not just against the EUR, but the USD is trading quite cheap to interest rate spreads (1Y implied yield)... While only one factor of many, it has been a key driver in the past.

EUR vs EUR 1Y model, spread in bars below

Looking forward, I feel the upside will be determined by Europe and not the US, yet the downside potential will be determined by the US.

The reason for this is, with EUR forward rates anchored lower, with little hope of falling the only reason they will meaningfully rise is if US rates rise, which will of course happen at a faster rate, hence widening the US-EU yield spread. So with EUR rates staying flat any movement in the yield spread will be determined by the rate of change of US rates. Conversely, EZ growth could well keep surprising to the upside, with a growing CA surplus and basis swaps now 0 EURUSD appreciation would come most meaningfully from the EZ aspect. As we saw in the first 2 months of 2014, with the US economy being hit "hard" by the weather, the EUR was broadly unchanged... As such I don't see the US macro picture actually being a driver for the USD (apart from the relationship between growth and rates, and then rates and USD).

However, today EUR 1y ATM vol reached a new cycle low at just above 7.2 points. Implying a break even +/- 775 pips from the market value at 1.3850

EUR 1Y ATM vol

Risk reversal skews over the 1Y still show a 1.25 points premium to puts, however this is the tightest they've been in a long time. Suggesting that the market is relatively flat the EURUSD. (n.b. this can be backed up by MS and BNP P positioning data)

As we can see from the Vol surface, Implied volatility smiles are pretty symmetrical out to about 9M, suggesting range trading is likely. however, the long USD idea is a relatively short term trade targeting 81 area, with stops below 79. entry 80.

cheers.

Jeremy

FX Strategy - March 17th

Global Macro / FX strategy

G10 FX Overview:

The USD is still going to be key going forward, with the Dollar index (DXY) perched on the edge of a potentially large breakdown. FX volumes across major ECNs and interbank dealing platforms are still a little low – but we are seeing with the uptick in emerging market volatility a slowly rising level of volume across the G10 spectrum. As it stands, the NZD and JPY are still the best performers YTD vis a vis the USD, with the former up 3.6%. Looking forward it is clear to see that geopolitical risks from the Crimea will play a big part of the overall risk sentiment. EURCHF will be the best at gauging this risk, this being said we will potentially see the SNB firmly reassure the 1.20 floor and as such could change the dynamic of the pair.

In other news, the PBoC raised the trading band for the CNY to 2% from the daily fix (from 1%), this will undoubtedly lead to higher realized volatility in the CNY/CNH markets. Even though short term Implied volatility may appear stretched, it may not drop lower and we could see a permanent (unattractive) shift in the carry/vol aspect of the CNH. If we see spot CNH start to weaken, other Asian CCY’s are at risk (such as KRW or TWD), in this case the SGD could be seen as a local safe haven, on top of the USD and JPY which will act accordingly under the heightened risk. The pain will be felt above 6.20, were corps may have to hedge their short topside calls, which would involve buying spot USDCNH. USDJPY would likely test the very critical 100 level in this case.

G10 Rates Overview:

On the back of the Rate hike from the RBNZ, NZD swap markets will remain interesting. There is still expected to be >100bps of rate hikes in the next 12 months. This idea will be tested with the upcoming NZD GDP number, a significant hit here could see NZD 1Y swaps shed more than 10bps and questions would be asked about the timing of the most recent rate hike.

Other than this, I still have a bearish bias on US treasuries going forward, especially with the US10Y being around 265bps (shorted 1 unit). We saw the yield premium of the US 10’s over the German counterparts reach 115bps last week, and with disinflation/low growth/potential QE in Europe, coupled with potentially faster than expected US macro performance over the coming months I don’t see this spread tightening significantly. As such, I favour selling USTs over bunds in any bond market sell-off. Selling Eurodollar 2015 contracts and buying short sterling of the same expiration offers good relative value, and tracks GBPUSD well.

GBPUSD – starting to top out?

Somewhat surprisingly, the GBPUSD is hardly up YTD (spot 1.6645 when writing), however this is mostly because there has been significant resistance for the GBP to attempt to overcome.  We are trading at the top end of a 5 year trading range, with 1.70 being the critical bull/bear line in the sand. It can be seen that shorts are comfortable building ahead of 1.70, but on the topside of this, it will be a very different scenario. As it is now, the market seems stretched still, with most indications suggesting significant GBP longs. CFTC CoT data shows significant longs, 1M and 3M risk reversals with the 3m tenor only seeing puts trade at a 0.7vol premium to calls, finally Bank positional indicators (BNP P and Citi) show that the GBP is still the most longed Currency among the G10.

Going into this week, we have plenty tier 1 data, with the UK unemployment rate being the most critical for the GBP.  Any downside misses would almost definitely see the weak longs in the market look to cover and we could see the GBP trade south of 1.65. Productivity indictors will also be closely watched and once again downside surprise would really push back the BoE rate path.

GBP vs 1y1y GBP-USD spread

Furthermore, building on previous points, Interest rate spreads – which are very dependent on US and UK data – have seemed to flatten off as has the spot rate. However while tracking well, its starting to diverge.

As we can see, the GBP has closely tracked the 1y1y forward yield spread, but with GBP 1y1y having an apparent ceiling in place (as BoE rate path can’t feasibly come any closer). As such the risks for the forward yield spread come from the USD aspect.

With the US 1y1y trading at 0.68%, I see that the recent bad weather has been priced into the rate market, but given the sturdy NFP, and the almost guaranteed taper, we should see US rates tick upwards with the highs around 0.80 definitely in view. This would imply a 1y1y spread at around 40bps which could see us trade in the low 1.60’s in GBPUSD.

Going forward, taken from the above I expect the upside to be limited in the GBPUSD, most importantly because of the divergence between the cable and rate spreads, but when factoring in the heavy GBP longs the risks are to the downside going into this week’s macro numbers. The claimant count has seen one of the strongest periods of decline in history and maintaining a -20k print will be hard.

Throughout this week, downside support levels can be seen at 1.6540, 1.6474, 1.6275.

Upside resistance can be found at 1.6710, 1.6820 and 1.70.

GBP Spot week implied volatility trades at 6.85 implying a breakeven range of about 126 pips either side of spot. This is historically quite low, but in the short term, most G10 FX vol is very low, and while it can be good to look towards opportunities of buying vol, now is not quite the right time.

GBP 3 month 25 delta risk reversal

I shorted GBPUSD at market (1.6643) at 2x leverage, looking for 1.65, then 1.63, stops above 1.68

USDCAD – dovishness fully priced in?

It is no secret that the new BoC governor (being an ex-export minister) takes kindly to a weak CAD. After all, it will boost their exports, and as so much trade is with the US, the USDCAD is critical to their potential growth plans. Oddly enough, USDCAD is one of the only consensus trades that has performed this year, Ever since Goldman put out their “trade of the year” recommendation to buy USDCAD spot there has been a flurry of sell-side recommendations to short CAD, targeting as far out as 1.18 by year end.

However, a large reason for the bearishness was the relative divergence between the two central banks and their respective plans going forward (figure2). We’ve seen the respective spread between the 2 year government debt tighten from about 90bps in September to around 67bps now (was 60 in Jan). Relatively speaking, the CAD looks quite cheap to rate spreads, and their respective forward paths with spot USDCAD at 1.11.

USDCAD vs 2yr sov spread

Much like the GBP is heavily longed; the CAD is the most shorted currency as per the composite indicator from BNP Paribas, meaning that we could see shorts look to cover if we fail to see further downside in the CAD.

On top of this, traditionally, the CAD is seen as a commodity currency. And historically there has been a very strong correlation with commodity prices; however since the beginning of the year, the CRB index has completely diverged from the USDCAD (figure 3). While commodity prices are starting to look vulnerable across the board, especially considering Copper and Iron prices recently sold off hard.

USDCAD vs CRB (inverted)

However, even though I am constructive on the CAD in the short term, I look to the options market to structure a trade. Given the expected weakness in the CAD, and taking the prior points into consideration, buying puts could be a way to profit from the potential downside while limiting losses. At the same time, the trade would benefit from rising implied volatility by being long vega. However, short USDCAD could work just as well in the short term.

  

EURCHF – SNB will protect the 1.20 floor

Given the recent uncertainty in the Crimea as mentioned in the G10 overview, the CHF has received a moderate safe haven bid. Now, yes Switzerland is running a 10% of GDP current account surplus, which is of benefit to the CHF, yet I do firmly believe the SNB will defend the 1.20 floor. As such, I believe the recent discount the EURCHF is trading at on the back of the Crimea shenanigans to be good timing to look to buy. There are a few options though, I like holding EURCHF as a core position in the medium term. As such, one could position long EURCHF, and if traded via forwards you can receive some yield for holding long EURCHF, you can buy time sensitive upside calls, but the critical aspect is the time aspect (theta decay). With uncertainty around the geopolitical risk, getting the timing right is indeed tricky, finally one could sell downside puts, which are both equivalent  to be long (via delta) and also bring in yield in the form of theta decay.

EUR model

For this reason, I favour the last choice. But either way, the EURCHF looks like decent value at 1.2130, however in the short term, is the EUR the best way to trade potential CHF weakness.

 When modelling the EURUSD vs short term rate spreads, we can see that the EUR is approximately 2% rich to where the fixed income markets would expect to see the EUR. It is true to say that this is merely a two variable regression, but even still there has been a very strong relationship over time and as such the USD can be seen as relatively cheap to the EUR (relative to rate spreads) and maybe it’s best to position via USDCHF as vol will be higher.

I've sold Aug 2014 EURCHF 1.21 puts at 3.5%, delta ~52%

Thanks!

FX Strategy going forward

NFPs were stronger-than-expected, but by no means fantastic at 175k, just below the mean (188k) for the last year. The ECB came out, not concerned about EUR strength, and while not hawkish, just less dovish. With the STIR future still implying a yield of less than 0.5% out to December 2015, there is not really a chance for the rate path to be pushed out in time.

(This being said, the BIS had a nice chart in the quarterly survey suggesting rate paths as per Central bank projections are pretty rubbish, and if they can't get it right... who knows?)

Black - Actual, dotted lines = expected.

Going forward: looking at EUR forward swaps, there is honestly little room lower. the 3 month rate 1 year forward is at a mere 0.34%, and the USD equivalent at merely 0.44%. I see the short end of the yield curve being the main driver in G10 FX (ex JPY and AUD vis a vis the USD) for the foreseeable future, and as such, short end forwards give me a good guide as to current yield differentials and where they see monetary policy going in the next 12 months. Even though Eurodollars see hikes >1y away, there is still a clear and present divergence between monetary policy. This being said, in the shorter term as can be here, the possibility for a month through 1.40 and to 1.42 is quite likely. Longer term though, I see a reversion to historical relationships that we've seen (such as 2Y sov spread).

For now though, the EURUSD will be most sensitive to the very short end (3M OIS spreads etc) and as such I don't expect any serious downside for a longer period of time. >6M away.

1y forward 3 month swaps top pane, spread in red, EURUSD in green

As such, when the time comes that US data, and importantly data surprises start to pick up, I expect to see the EURUSD trade more akin to the spread (as seen above), but that is a while off, with meh NFPs and the .CESIUSD dropping like a stone (because the weather... right?)

CitiFX economic surprise index for the USA

Overall, still bearish USTs and happy to add shorts on the belly of the curve, but cautious on USD - there won't be any strength unless we see a significant pick up, its not like the ECB can do anything to weaken the EUR (if they even want too!), even a rate cut wouldn't do much. I think it would require QE...

RBNZ and the NZD: It is no secret the RBNZ don't like the height of the NZD. its the strongest currency YTD (+2.95 vis a vis the USD). Trading at 0.85, its definitely elavated, and importantly the current implied yield on a 1Y forward is about 3.21%, far above the 2.5% or so base rate spread. So basically the swaps market sees hikes, and plenty of them... in fact by my crappy calculation and composite chart I made I get about 123bps worth of hikes in the next 12 months.

Red (filled) RBNZ exp., RBA in white, Blue is spread, AUDNZD in red

 As we can, 123bps is priced in, and we can only assume that is in the NZD FX rate too... Where as the RBA expects about 1 hike in next 12 months, with rates expected 40bps higher next year.

All in all, I think there will be less than 125 bps of hikes in NZ and more than 40bps of hikes in Aus. So, one can only deduce in terms of FX exposure, being Long AUDNZD (and short NZDUSD in due time). Reason for the lack of hikes comes from my friends blog Here and many others, notably FX rate impact, "slowing" in some impactful EM, and Australia not much worse than NZ at all.

But broadly, I've made a point of downside vol in AUDNZD being too expensive given the pricing of rate hikes in the market, and I still firmly believe this however since posting it here, the risk reversal skew has come off a lot, with the 3M smile looking almost symmetrical.

GBP and why I see limited upside: I've summarized these points, multiple times recently on twitter, but here are my thoughts in one place.

1.) Forward rates, and spot rates have reached a ceiling, GBP 1y1y at 1.3%, GBP 1Y forward implied yield at 0.34%.

GBP vs 1Y implied yield, 1y1y on bottom

2.) Growing CA deficit - quite simple, likely to weigh on GBP over time, therefore medium term, I can't get too constructive GBPUSD

One worrying thing long term for GBP is the CA deficit. Just look at our neighbours on this... pic.twitter.com/7275fcAoJL
— Jere Wilkinson-Smith (@JeremyWS) January 21, 2014

'Nuff said on CA

3.) Positioning in the market - As per BNP Ps FX positioning indicator GBP is most longed. At threat of weak longs capitulating at the first sign of dovishness from BoE, or loss of momentum in UK macro. On the latter, PMIs very strong, hard to sustain that level, likely drift lower into 55's and could weigh.

BNP Paribas FX positioning - still heafty GBP longs, CHF flipped from short to long, growing CAD shorts too. pic.twitter.com/54zYHUFiNH
— Jere Wilkinson-Smith (@JeremyWS) February 27, 2014

I usually look at risk reversal as my positioning indicator, in fact my GBP fair value model is simply Risk reversals and interest rates, It has worked *very* well.

On top of this, IV has been very suppressed, and in fact the market seems short Vol, leading to an overall short gamma position. Thus if the newsflow is quiet, the hedging could dominate short term flow and a move lower will be pinned down by sellers of small rallies. Obviously the vice versa is true, with rallies being supported by dips buyers well.

4.) Techs, see previous post here - timing not fantastic, but added shorts and so avg, is 1.67 or so. More rationale behind GBP short there.


Either way - these are my thoughts going forward, hope you enjoyed. Thanks.

(originally planned on some EM, but getting late and school in the morning)