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..

Sunday, 9 April 2017

FX & Rates thoughts - April 2017

Hi guys! 

So another blog post, once again starting by showing the very well defined range in US 10s.. This seems to be driving markets and narratives, and will likely to continue doing so. Since the last blog post, when US 10s were also at 2.35% we have had a nice round trip to the top of the range, and back to the bottom. Mostly because the fed really ran against market expectations and hiked in March.. but then positioning, a debate between hard and soft data and a topping off of inflation has brought these expectations back down to earth.

In the immediate term, it seems Friday's price action has put a floor in yields for now. This seems to line up with other rates markets - Bunds look to have found support against the lower trend-line (charts below).

US 10y yield daily chart
Bunds daily chart

Friday's NFP had a bit of everything for everyone.. weak headline and mediocre wage growth coupled with decent u/e rates - it seems the market has spun the narrative that lower NFPs are signalling we are reaching full employment, and that a running 3m avg of 150k+ is still very strong. I can't massively argue with this logic and am still leaning on the opinion that market is now under-pricing fed activity.

Comments from Dudley and other fed-speakers has shifted the conversation away from Fed funds and towards Balance sheet in the past month or so... So I suppose we start here for this blog.

UST holding by the fed against maturity, and cumulative (taken from NYFed SOMA page)
Above shows the breakdown of UST ownership by the fed. n.b. not MBS, just USTs. (average holding somewhere in the 2021s/22s)

With the Fed balance sheet at 4.475tr $ (FARBAST INDEX), we can see see just from the cumulative graph that this unwind of the balance sheet is going to be a *slow* process. Arguments can be made that they unwind MBS related stuff first as less direct secondary market impact, but aside from the detail, the raw amount to unwind is massive. A purely passive rolloff of this ownership will take 5 years at least to have a substantial impact on the fed's balance sheet to bring it down to more neutral $2-3tr, levels.

I for one cannot, and will not, try to make a prediction of what the direct impact on monetary conditions will be from BS reduction.. is 1tr equivalent to 25bps of FF?? I have no clue.. I dont think anyone is really going to be able to make a concrete guess at that, including the FOMC.

So with the discussion around pausing the FF hikes to start the reduction, I don't think this is an overly viable option to take, rather the fomc should clearly signal the pace, timing and size of the BS reduction (whether its through selling or just rolling off) and be tepid to begin with, ramping up the pace if necessary, but not using it as a replacement for FF rate.

Ultimately however, the balance sheet will be massive for a very long time, probably well into the next down cycle, and so the cynic in me would suggest that it won't ever fully normalise as the chances of not having a recession in the next 5-7yrs in US macro is so slight.

All this being said, we will be having much greater conversations in the coming months than what I've just said, and I have no doubt that towards sept the Fed will start being a bit clearer with what this involves.

On trade ideas, I think with the marginal buyer of long end US paper disappearing there is arguments to be made for a steeper curve. One that I look too is US 5s30s (in swaps charted)

US 5s30s daily
We trade in a nicely defined range, and has been flattening for the past few years, and rightly so. The reason I like this trade however is that if we get a serious discussion around BS reduction in the next few months, and the fed do, for whatever reason, deem it as a replacement for FF hikes being long the belly will perform nicely as there is a lot of roll built into it, and short the long end should continue to work.

It also carries nicely as a trade (2bp per month) which relative to the volatility of the underlying curve offers decent Carry/Vol. The technicals line up to allow for a clear defined stop and breakout (if the theme gets momentum).

The only things that make me uncertain, primarily come from the growing concerns around the pick up in inflation.

Looking at Oil y/y, it continues to drop and will be around 0 some time this summer..

This chart from Nordea above is perfect in summing this up, and is not just a phenomenon in europe, but for global inflation.. Core CPI globally remains meh at best. Further, the upside surprise this has caused will soon fade, and as we see below in the Citi Inflation suprise index, we have perhaps topped out on inflation "suprises" (fwiw this chart correlated v nicely with Oil y/y % change, which suggests this surprise index will be back below 10, and 0 by the summer).

Citi inflation suprise index

So what does this mean? Well, basically a few central banks (looking at you, ECB) got a bit too excited, and frankly with Core CPI going nowhere, the discussion about a tightening cycle is frankly ridiculous at this stage. Not something that should be realistically discussed for a good year at best imo. However this doesn't mean that we should be receiving EUR to me.. There will be a time not too far where we hit the serious discussion of tapering, and then perhaps curves can start to price in a realistic hiking cycle.. for the meantime, EUR 2s5s at 30bps probably is fair for a neutral upward sloping curve, but much like the US 2s5s did, it has serious potential to move steeper as we get into the cycle (in perhaps 1y time).. Buying dips in EUR 2s5s could be a fantastic trade in the next 6m-1y, but probably not right yet.

US 2s5s during taper tantrum

Ok, so there were a few rates thoughts, currently my book is set up with two trades from previous blogs

-- ILS 1y5y reciever at 1.50% vs EDz7z9 at 69 bps

-- SEK 1y1y reciever at -0.185% vs EUR 10s30s steepener at 59bps

On the ILS trade, the long/short rates trade idea has performed very well so far, Recieving ILS argument was made before, and still holds very valid today. BoI very sensitive to tradables and energy inflation, both of which are going against them as ILS rallies and oil y/y fades. the 4bp roll per month provides a nice buffer, and the ED curve steepeners hedge out global rates risk.

ILS 1y5y vs ED

A 10 month fwd 5yr ILS now trades at 1.31%, representing a PnL of 19bps from that leg.. On the ED, it is the same level as entry so 0 pnl.. Right now, given the correlations that ILS has to outright US rates, I look to cover here for +19bps and re-enter in a few weeks/months time when US 10s are back towards 2.5%, thus i am left long EDz7z9 at 69bps. Which fits well for a move back towards 75/80 towards June.

Onto SEK, managed to whether the volatility in EUR rates and maintain the reciever, a 9m1y is still marked at -0.25%, so a PnL of just 6bps.

The hedging leg here in EUR 10s30s trades at basically flat again off 61bps, but rolls the odd bp per month and provides coverage.. Stops at B/E for the 10s30s.

So along with these two pair trades, I like adding that US 5s30s steepener, otherwise nothing really new to me in Rates as shown by the chart below which show how much is priced into dec 2017 front ends... i.e. nothing, nowhere.

fix-z7 spreads
So, onwards and upwards to FX.. and the EURUSD is just.... ahh, Rate differentials. Sigh.

EUR vs 10y spread
A very strong relationship continuing here. As such its rather boring, EURUSD does appear to be leaning on a rather strong upward trendline here coming in at 1.0550s, so i expect a big of a fight around these levels from the bulls.

JPY vs US 5s
USDJPY is a bit more interesting, trading "cheap" to US rates.. balancing precariously above 110 it does provide, imo a nice level to lean off for tactical longs. Especially if US rates return to the range. USDJPY might be a more asymmetric, and carry positive expression of Short US rates here, especially considering the story from japan is quite quiet now the year-end stuff has passed.

perhaps eurjpy then looks quite cheap to own some topside in? if EURUSD is battling against support, and so is USDJPY, then double whammy in eurjpy!


As documented by many, Le Pen risk premium is being placed into EUR right now, but the risk still seems limited to me. EURJPY skew is chunky so could fund upside by selling downside here. Tight stops at 117 for spot trades makes sense for a move to ~120. 

One potential FX trade I like here, primarily leaning on Le Pen being a non-event for markets is buying some very tight EURCHF DNTs

a 1 month (may 10th), 1.0575/1.0825 double-no-touch is priced at ~10% given that spot vols are being marked higher for the risk event.. 

eurchf range
Vols are priced about 0.5 wide in 1 month EURCHF, so I would imagine the DNT isn't traded far away from BBG mids, perhaps 12-14%.. offering a decent 7+:1 risk reward for eurchf continuing to be boring (and no le pen).. decent pay-off to me and locked in loss for a significant tail risk (if le pen does win).

In other FX markets. USDZAR has been attracting a lot of headlines, with the FX heavily selling off, CDS widening as ratings agencies look to force IG selling (2-4bn of SOAF paper), so one can easily argue that FX will remained pressured, but with a neutral and supportive global environment, and the terrible macro becoming marginally less terrible, it seems it may be a nice currency to own, and now at a discount.. 

Technicals see us at a crossroad, so I steer away from spot trades as I dont want to be washed out on any news that could really hurt.

Instead 3 month 13/12.5 put spreads cost about 0.7% of notional, offering a 7:1 payoff to expiry.

Not a great deal of other things are interesting me right now.. Tho I do stress, this is me taking a "break" from markets, had an amazing holiday to Morocco, and planning my 3 month long summer holiday, so expect things to remain quiet from me, both here and twitter.

In summary

-- Covered ILS 1y5y for +19bps, left EDz7z9 steepener to trade the US 10y range.

-- Maintaining SEK 1y1y vs EUR 10s30s for now with a +8bps running pnl

-- Entered into a US 5s30s steepener at 58bps, stops at 50bps for a BS related trade

-- 1 month EURCHF 1.0575/1.0825 DNT, bbg mid at 10% (likely offers 12-14% tho haven't checked) for a good r:r Le pen snooze-fest

-- 3 month USDZAR 13/12.5 put spread at 0.7% of notional, as a way to cheaply participate in any continued EM rally

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 -

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

With BoI decision to keep rates on hold today ( 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.

Thursday, 5 January 2017

January 2017 FX & Rates thoughts

It's been a while since I've last posted as have been busy working / with uni / travelling, but I thought as we come into a new year, I will share some of the trades that I currently like the look of, and more broadly my views on current markets.

Starting off with addressing the main points quickly - Trump is to take office in the US in around 2 weeks from now, whilst there is still little concrete evidence of what exactly he will do, regarding fiscal policy the consensus is for a large impulse. Given how little detail is still known, its hard to determine the impact but banks have given a stab at it, and the table below shows the consensus shift that has occurred to stronger growth/inflation/activity. SG were admittedly rather bearish before trump, with '19 GDP effectively forecast at flat, though the introduction of Trump's policies is seen to raise GDP by 1.1pp y.y through 2018/19. Ranges of estimates from various banks sit somewhere around this, with some as low as +0.4pp.

Pre/Post Trump forecasts, from SocGEn
As such, the impact on markets has been clear, US curves now price in 2.25 hikes from the Federal reserve in 2017, vs less than 1 just a few months ago.  A solid fade if 3 gets priced in, given globally how difficult this will be to realize. On the other hand, the Fed were already keen on hiking - With only Brexit/Election delaying >1 in 2016, so pent up hikes remain in Yellens mind, so likewise paying Fed hikes at 2 seems attractive as seemingly this will be the minimum we see, unless we get a 20% correction in the SPX of course ;)

Number of hikes priced into Fed Funds curve for 2017

The first main concern is how realistic this is to occur, markets have flipped and people are now paying global rates as the perceived benefit from trump meaningfully changes things...

Firstly, it still feels rather presumptuous that the benefits from the changes in policy will outweigh the costs. It's true that the world has been relying on monetary policy for too long as this panacea of growth and its a good thing that governments will be shifting more towards fiscal policy, hopefully a similar thing can be done in Europe. But going back to Trump, and his outright protectionist measures, clear disdain for China and Mexico is surely going to be negative for Emerging markets, the very areas that have done lots of the heavy lifting post 2008.  

Thus far EM has remained robust. FX took an immediate hit of a few %, but credit (CDX EM, inverted) has remained very strong, trading just shy of tightest levels of 2016. Room for further weakness when/if the full extent of Trump policies are known.

EMFX index and CDX EM

Secondly, global rates still remain rather anchored to or below 0. Both the ECB and BoJ have moderately shifted their viewpoint to negative rates throughout 2016 as the backlash on banks and the upward pressure from US rates leading to "tapering" from the ECB (which was hardly tapering but ok) and yield curve control from the BoJ. But these have been small shifts and will keep a lid on JGBs and Bunds going forward, so one does continue to question how far US yields can diverge before the pressure becomes too great. Bearing this in mind, historical spreads between US and Japanese 10 years have reached close to 5% (4.93 in 2000), and currently only stand at 2.4% where as Bund/UST spread stands at its widest in history. The first issue with these continuing to widen is the feedback loop to the USD... 

The FOMC in their Dec meeting minutes started to express concern for a strong USD, however one can infer the pressure is not great enough for concern just yet. But it will build. Secondly, global flows will inevitably favour owning US rates, either FX hedged or not. If the consensus builds that the USD will certainly rally (which is the consensus) there will be less pressure to hedge fx and will keep global rates anchored still as international investors pick up USTs.

Yield spread vs EURUSD (inverted to show USD strength)
A 10y UST fx hedged to a Japanese investor offers yields 55bps higher than a JGB

With these considered, I think longer end rates remained somewhat anchored together, but still believe there is room for this trump narrative to play out much more, easily to 3% on 10s before the feedback loops and negative impacts on RoW are felt. 

With this also, EURUSD does seem like it will finally crack parity this year, something which I hate to jump on as those that have followed my previous EURUSD trades, I have faded below 1.07 for the past 2 years, and hate to be with consensus here.. but feel that the momentum behind the trump narrative can run further into his reign whilst risks politically in europe are only getting louder in 2017, with Le Pen a sizable concern at the back of my mind right now. As such, I do like owning 3/6month parity options. 

As writing with spot at 1.0520, a 6 month 1.00 Digi put costs 20%, offering up a 4:1 risk/reward, which seems worth owning. Other ideas could be put ladders, as skew has cheapened in the past month. 

EURUSD 6m 25delta RR

In the meantime, the pressure that US rates have had on other markets certainly has created good opportunities. Looking to markets such as Swedish front end rates. 

Global curve steepening has meant forward rates trade at quite a premium, with hefty rolldown. Sweden very notably with SEK 1y1y trading at the higher end of its yearly range at -0.2%  and vs a 1y swap at -0.5%, offering 30bp of roll down all else equal. 

SEK 1y1y
The Riksbank remain extremely dovish, and with a strong dislike for a strong SEK, in recent weeks however TWI SEK has rallied >3% as EURSEK rejected 10. Whilst only back to levels earlier on in the year, the direction of travel is against their plan and expect to see murmurs to suggest against a continued rally. Unfortunately the riksbank are quite reactionary to the ECB with regard to policy, and frankly will continue to do this almost as if they were pegged to the EUR. 

Sweden CPIF forecasts
Domestic data however is strong in Sweden, with upward pressures to inflation and steady growth, declining u/e, however the pull factors from the ECB will outweigh any potential domestic out-peformance for the foreseeable future, and the repo rate is not expected to rise until 2018 at the very earliest based on the Riksbank's on estimates. Something they will not want to bring forward as impacts on the FX will be detrimental. 

One trade to pair this with, which creates a well balanced European rates long/short. 

Paying EUR 10s30s at 58bps here, offers 15bps of carry/roll in a year, for a curve which typically has an annual range of 50bps.. thus a strong curve steepener with great carry/vol. 

SEK 1y1y vs EUR 10s30s

Based on this historical beta, could also weight each leg roughly 1:2. Receiving 5k dv01 of SEK for every 10k of paying EUR.

Historical returns of those sizes, before carry/roll (which should all else equal be $300k/yr) and correlated VaR

Elsewhere, and another cheap area to receive rates is AUD/NZD and whilst is a similar set-up to SEK, has different associated risks, namely more commodity and EM related.

So when considering how the RBA reacts going forward will to a large degree depend on how China and global EM responds to trump, if there is more pain to come both through financial markets and economic data, then the balance of risk is skewed to cuts rather than hikes. Currently 18bps of hikes are priced in the AUD curve through to Dec '17, and 54bps by Dec '18. Whilst remaining issues such as housing, and consistent economic performance (more notably in NZ) suggest cuts are limited, rhetoric from the CBers as well as the balance of global risks suggests value here. Owning either IRz7 or ZBZ7 (illiquid af tho) acts well as a china tail risk hedge.

IR1 vs IR Dec 17

Outright though we still run the risk of a further sell off in US rates, as such playing this against EDs probably remains the best view, though starts to cost in roll.. Z7 ED/IR spread trades at 50bps, which could easily tighten towards 0 throughout the year if 2.5 hikes starts to materialize.

Moving onto talking about China, its hard to know where we stand, though I remain mostly skeptical about any sustained rebound there and do believe it will continue to struggle. Interestingly in recent days CFETS has re-balanced their basket (away from USD), arguably giving them more scope to deval against RoW, as we should more and more ignore what USDCNY does. Forward points and overnight rates have once again been massively squeezed in the start of this year, like last hurting the consensus long USDCNH positions. 

12m forward points remain extremely elevated at ~3500 points, (some 6% above spot), and would favour waiting for this to settle before shorting CNH as outflows are likely to remain strong.. I do question however if Trumps stance on China and the current 6% annual yield for buying CNH might actually make it a decent currency to own in 2017..  

Me, loving being the contrarian can easily convince myself to fade a lot of 2016 moves, namely the cheapness now occuring in TRY, MXN and even GBP.. each of which can be argued to provide decent value / carry but as of now I would prefer to not touch them, my most preferred outcome for these would be a quiet start to 2017, with trump being mild, global growth not surprising either way, and owning some upside via cheapening vols.

TRY REER vs Carry/vol
With regard to Turkey, the geopolitical risks, US curve steepening and stronger USD have weighed considerably. Carry/vol is leading REER lower, and whilst seems cheap, needs carry/vol to improve before stepping in (or having giant balls with which to fade it).. Lots of complicated factors in turkey, many of which i am clueless too. But another considerable wash out would certainly whet my appetite to getting long.

One consensus trade in FX is being short CAD, and for a multitude of reasons, weak economic data, a dovish BoC against rates that are pricing in tightening. On the other hand, oil prices remain strong supporting ToT and data on the margin. Charted below, we can see that the pull factor from widening rate differentials and downside with Oil leaves USDCAD slap bang in the middle. Personally my viewpoint on Oil is that it will mostly struggle to rally significantly as supply imbalances are slowly leaving the market and even the OPEC "cut" was not a huge game changer, especially when considering US supply that can come online towards 60, personally would prefer to lean on a 40/60 range for 2017, with OPEC supporting dips and the US (and even the USD) keeping a lid on it.

With spot leaning at the 100dma and bottom channel that has defined price action for the past 6 months, I would prefer to own upside, as a downward break could lead to a quick flush towards 1.300.  A 1.37/1.40 Call spread costs 0.45% and with vols fairly cheap (~9), acts well to lean on a catch up to rates and any further commentary to bring CAD rates back in line with reality.

In summary then, my ideas are fairly low conviction here (aside from SEK vs EUR which is med/high) but as we go through the early stage of a trump presidency, we can hope that the direction and size of any policy will become clearer and then can reassess, until then trying to stay relatively balanced with regard to outright global rates.


-Long 6m EURUSD digi put @ 20% (spot ref 1.0520)
-Rec Sek 1y1y at -0.2%
-Pay EUR 5s30s at 59bps
-Short EDz7 vs Irz7 at 50bps
- Long USDCAD call spread 1.37/1.40 (spot ref 1.3275)