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.

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.


Summary:

-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)


.

Tuesday, 2 August 2016

August FX & Rates outlook

It's been a while since I last posted here, having spent the past 3 months taking exams and travelling around Asia. It's been a relatively quiet period in markets with this thing called Brexit happening, but just over a month later, it seems like its been mostly forgotten.. and its hardly been the apocalyptic world ending mess that some predicted in the mean time.

In other markets, the broad USD is still painfully boring in a very tight range, credit has been crazy strong (both HY and EM) as investors have flocked to carry on any dip, Vol is  low, as of writing the past 10 days in SPX has realized an incredible 4.5 points, and commodities have been mixed with oil tanking (lol) and gold/silver rallying somewhat. Lots to talk about then.

BoE and GBP markets

First section, I want to look at the BoE. We've got the MPC meeting and accompanying inflation report on Thursday morning. a 25bp rate cut is fully priced into front end GBP markets - Aug OIS trading at about 22bps so more than a full cut is priced into markets as we stand. Cable has been rather resilient, helped by mild $ weakness the past few weeks and is seemingly trading comfortably above 1.30 - sentiment is obviously quite bearish but the price action doesn't seem to agree quite yet. Cable would be a clear sell on rallies up towards 1.40, but also to me quite a nice buy on dips /if/ we traded below 1.30 again. We're clearly being led around by rate spreads, and so this meeting could be rather important with some nice asymmetry.

GBPUSD vs 2y2y rate spread

Going into the meeting, GBP vols are fairly low all things considered, partly due to recent realized vols being very low (traded in a few hundred pip range for weeks) and given that there is a full expectation for action. My concern here is that if the BoE doesn't cut at all, cable would likely rally along with rate differentials and the latent short position being squeezed out. 1.35 area would seem fair before it started getting trickier to rally.

Regarding the decision from the MPC, the way I see it is as follows; The BoE doesn't need to cut, the BoE doesn't want to cut, /but/ the BoE might cut for the sake of action and response. In this aftermath of Brexit, there has been no clear panic (heck, even thought gbp dropped 10%, it never got close to panic trading especially given calls for 1.15 area), other financial markets remained very solid (looking at equity markets here) and vol is low and contained. The BoE has been for a long time, in my eyes, heavily data dependent... where much like the Fed, the data is equity and vol.

GBP1M and FTSE vol

Now actual data was poor, sentiment and PMI data fell off a cliff, implying some contraction in H2 GDP, which is very ungood. The main argument for the BoE to cut, is that they are now focusing more on maintaining growth as opposed to targeting inflation, at least in the immediate term, which frankly to me is total rubbish. Since 2008 we had (the now revised away) triple dip recession, and the BoE did a bit of QE, a bit of other nonsense, but nothing in base rate. And the way I see this, is how is this different? Now Brexit is unequivocally bad for our H2, but its not seemingly been /that/ bad.  Core, hard data remains stable in the UK, labour markets are doing well with no anecdotal signs off mass layoffs post-Brexit. Inflation is/was starting to turn, and swaps have moved higher on the weaker GBP.

UK curve (from Citi)

GBP 3M OIS

So with all that said, and how I don't think they should cut, but, they probably will, because we've seen in the past how CBs don't like to shock markets and their precious expectations. This doesn't mean however we shouldn't position for a surprise. The risk:reward looks compelling to call bs on all this rate cut talk. Firstly just by paying front end rates, at 22bps you make a small amount on a 25bps cut, you make 25bps on no cut, and ur risking 22bps for a balls deep move to 0%. So for a 1:1 payoff, you're leaning against what is a very small chance of 50%, and in my eyes a moderate, non zero chance of no action (lets say maybe 30-40% of no cut).

Paying later dated stuff isn't a terrible idea either (tho less compelling), negative rates seem out of the question (for now) in the UK given the backlash that has had in Japan and Europe on Banks... banks are too important in the UK to put them under that sort of pressure and the negative feedback loop there will be far worse than any brexit stuff. Whilst UK bank shares haven't done well, it would be unwise to put them under more pressure much like Japan and Europe below.

TOPIX banks, and SX7E
So to summarise in trade ideas, given my view on the asymmetry of this meeting, 1:1 risk reward on 50bp cut to no cut, small gain on 25bp and a ~30% of no cut, I like paying front end here.

In cable, downside seems limited unless the BoE goes big (but unlikely for aforementioned backlash). Taking advantage of negative skew and cheap vols could sell 1.30 puts to buy a 1.33/1.35 call spread. (pretty much zero cost as i type with spot at 1.3230)


US markets and Fed


 So plenty to talk about here too - we have an important data release on friday in the form of NFP and then Jackson hole before the "live" September meeting.

The problems I have when discussing or thinking about the fed is my tendency to care about global occurrences, perhaps too much. Stemming from the way I view the Fed funds rate, which is not as a number that I see on my screens, but all relative to other central banks, think of the FF as more like FF-G3 base rates.. and that every time europe/japan or whoever cuts, its tightening from the Fed. Some pass through from this obviously occurs in FX, having seen the USD rally 25% over the past 2 years, to a large extent on rate differentials, but more so going forward it limits the fed greatly. Probably capping us at max 2 hikes per year (if everything was perfect) and more likely just 1, in Dec.

This doesn't however mean its not a bad play to be short US rates here. The fed loves to tee up meetings, and looking at domestic data there is all the reason to be talking hikes right about now.. in fact if it wasn't for that whole brexit thing, june would have been a viable option too. I ask myself, why not Sept? well, there are no massive known risks like with the brexit vote, the FOMC has made it clear that more hikes are coming, data (equity and hard data) is good (tbc this friday too). So why not? well, they might still, but with trump coming more into view, 9 CBs easing post Brexit, and a slowly looming issue in oil, patience might be used.. plus, Yellen is just so December

8th vs 12h continious ED vs 2yr $ swap
The above is an interesting chart I've been looking at and pondering, the curve(orange) is at the lows where as outright front end is middle of the range.. typically the two move together but steepeners have clearly not been popular. I think at a rate of 14bps (far less than 1 hike per year) is low from a macro view and also on short term metrics vs outright. So I look to pay the curve a bit going into NFP / JH and Sept meeting.

In USD, I'm actually neutral to bearish. Take USDJPY, it seems inevitbale at this point we trade below 100, and its hard to put a number on when the BoJ cares again, because we could have thought it was 115/110/105 and now 100.. but who knows after that, 95?.. or maybe they dont care like they used too. EURUSD im fractionally bullish due to negative feedback loops that occur with a higher USD or wider rate spread to Europe which should cap any DXY advance. FX is certainly not the space I want to play the Fed in, I dont think its at all clean enough right now to do so with, hence looking at rates for now.

EM / Carry bid to infinity

well, what a 6 months its been for certain carry positions. BRL up hugely, CDS trading on par with Turkey (from well over double at xmas).. heck, even ZAR is rallying a ton, and you know when that happens people are sifting through the excrement just for any hint of yield. Domestic fundamentals in the two aforementioned countries, as well as many other EMs hasn't drastically improved.. so its one of two things to me, either we were grossly undervalued beforehand or low inflation, negative rates is just continuing to push investors into anything that yields. In reality its probably a nice mix of the two.

For a select few, here we see Carry/vol (using 3m rates and IV)

3m Carry/vol, Brazil, Turkey, SA and mexico

Brazil has performed very well here, so no surprise assets there have performed so very well.., turkey has somewhat deteriorated recently given political shenanigans (read: sh*tshow)

Mexico the worst, and hasn't really improved to the same degree as others, hence not being sweeped up as much as others and seeing some under-performance there (oh and Trump). Other assets such as HY CDX have a carry/realized vol of around 1, and have been performing very well too. So the question needs to be asked, will this continue / when do we call bs on the rally ? probably not soon, with no major risks that could seemingly derail, and never-ending low rates and inflation it would take a lot to not want to own stuff at 5+%.. neverthless, we've seen crazy inflows into EM, like record crazy this year.. so the boats getting awfully lopsided and the exit door getting smaller and smaller.. If oil were to kick off again (once again unlikely), then it could get messy fast but not a huge concern on the radar just yet. Perhaps look to trade within EM and just pick up the better names (or higher vol adjusted yielders). Say being long INR/TRY/BRL/IDR etc whilst selling a basket of beta weighted lower carry (and arguably higher risk EM) such as MXN/KRW/AUD could work well to bring in a bit of carry and not risk a massive turn lower in EMFX broadly.

Jumping on the bandwagon now seems unwise, but many still will as FOMO is just too big these days, I mentioned KRW earlier as a potential to sell, mostly looking at two factors.

CDX HY vs $KRW
$KRW often trades like a vol product (one that is cheap to buy) but has recently overshot some other x-asset moves.. secondly, China is still a concern to me, and just as no one is talking about it (and CNH vols/skew is back to nothing) is precisely when they'll come out and do something, with KRW highly exposed to this.

Anyway, just a quick update on some market dynamics from me, and if you're foolish enough to still be reading, here is a bonus chart that everyone seems to love right now..

totally not a concern... yet...


Thursday, 21 April 2016

April/May FX&Rates thoughts

So it's near the End of April, and it seems we can "now" start 2016, and thus subsequently ignore the first 3 months of hectic volatility in every asset and US recession calling. A broad outlook to me is positive still, at least in the US. Some slow down in growth momentum, highlighted by calls for a bad Q1 GDP, but the remaining data remains stable, especially inflation.

What is key for the Fed is not data, as much as they say so, its the SPX, its the VIX, its HY... Where each of these has seen a significant improvement. The S&P is back to 2100, the VIX is clearly sub 20, and chilling down in the low teens and HY spreads have improved dramatically, with CDX HY trading close to 400!

CDX HY and VIX back to lows


These combined, put the financial conditions in a better situation than last October, this generally feels like a repost of this article I wrote back in Oct.(http://macrocreditfx.blogspot.co.uk/2015/10/27th-october-fed-and-rbnz.html)

And once again, it definitely means that on the margin we should expect the Fed to surprise with a hawkish tilt going forward. Thus I look to position for a sell-off into next weeks FOMC.

Another factor that is seemingly now "bullish" is higher oil.. whilst a year ago, and according to the textbooks lower was better - but a goldilocks range for oil (and notably low volatility) is the most ideal situation here, especially for the HY/Shale types. This also takes pressure from declining inflation readings which once again on the margin should prove beneficial for US rate hikes this year.

For me now, the only main risk against a June Hike (excluding some unforeseen madness) would be Brexit... which could take place a week after the June meeting. Whilst I, and the market, sees a low (less than 25%) chance of a leave vote winning, it's a tail risk that the would hate to tighten into as it potentially causes political and economic issues in the worlds second largest economy. So this is what niggles at the back of mind as someone paying rates here.

Trade 1: 5s30s flattener at 135bps, targeting 120, risking a move above 140.



Here we can see the set-up, leaning on this downward trend, we can establish a flattener. Most of the leg work likely to be achieved from the 5s, which have seemingly rejected another move lower to 1% and have quickly headed towards the middle of the large 1-2% range. On the 30s, global anchorage of longer end rates remain to support duration and with the USD weakening a tad recently, there could be an increase in demand for longer end paper that pays some 2.7% in $s. When comparing against japan or europe, there is a significant yield pick up even after swapping out the ccy, and so real money flows from these would likely keep a lid on longer end rates. Alternatively, sell payers in 30s whilst selling recievers in 5s with a delta that is equivalent to a 5s30s flattener but gives us more optionality on the outcome, albeit with limited returns.

The main risk to this trade, aside from an overly dovish Yellen is a continued pickup in inflation expectations which put a greater pressure on term premium and the longer end of the curve. However inflation expectations have moved a lot which Oils leg higher so it may struggle to keep heading higher.

Trade 2: Buy $ 3m2y straddle against 3m10y

Grey - 2s vol, Orange 10s, Blue 5s
As we saw in October, the shift from a dovish fed to a hawkish one, sparked a pickup in volatilty in the front end more than the belly or longer end. As such, I would take the opportunity whilst x-asset vol flows weigh on Rates vol, to get long 3 month 2year vol looking for a repeat of November. Either outright, or as I prefer against selling 10y vol which whilst will move, should be contained by more global factors.

Trade 3: Buy Peripheral Debt vs Corporate HY

European HY markets have performed very well, with 5y Crossover trading at a mere 300bps, this compares to a comparatively wide levels for BTPs at 120bps.


The rationale for this trade is a normalization of BTPs as a risk proxy, but hedging out any potential market weakness by paying Xover. some causes for this divergence include a continued under performance of European Financials, specifically Italian and the inclusion of IG rate corporate credit into the ECBs buying program which has supported (indirectly) HY debt markets. This is a relatively low conviction, but lower risk trade.

Trade 4: Buy Canada STIR vs US at 6.5bps

M7 STIR spread
Canadian rates have moved a lot, especially versus the US, and while fundamentals in both are broadly in line, Canada has sold off mostly in part to Oil's rally so there is some embedded risks to oil in this trade, however it's setting up as a good risk:reward to pay the spread at 6.5bps, risking a move to 0 whilst targeting a possible 25bps move higher. Once again a play that the US moves first and that the BoC remain cautious which pushes down the curve somewhat.. the strengthening CAD should hel p with that as the BoC (as hinted last night) is starting to be concerned with it and its impact on exports.


In FX, I have very little conviction anywhere. The EURUSD keeps flipping up and down in its range, whilst I am Bearish US rates, I am less bullish on the USD, and wouldnt be overly surprised to see us take out 1.15. In JPY, thats had a wild ride, where the market has called out the BoJ to a large degree of success so far, but one has to question with the improving risk backdrop / commodity price increase / BoJ that USDJPY downside is limited here.

AUDUSD remains bid with commodities (notably Chinese domestic metals are rocketting!) however as we approach 0.8 I start to see limited upside and the risk:reward is skewed to downside. EMFX and other EM assets have been very well supported by general risk sentiment and the recent Argy offering highlights the demand that is out there.

GBP is purely a brexit sentiment trade for the next two months as we hear more and more on polls, whilst staging a relief rally now (partly USD weakness), cable looks keen to burst higher through 1.44/1.45 however I'd expect to see hedgers and sellers re emerge and the upside on GBP is limited until we get *much* more clarity on what could happen.

Cross-asset vols broadly seem cheap to me, given the potential shocks and risks we see in the next 3 months, but very selectively will I buy vol. In US equity, it seems very cheap but the fed will try not to spook the markets here and whilst earnings are relatively lame, the market is shrugging it off.



Monday, 7 March 2016

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.

Tuesday, 26 January 2016

February Rates & FX outlook

The start to 2016 has been very volatile to say the least, to the ~10% decline in Equity markets, ~25% decline in oil prices and a chunky widening in credit spreads.

What both frustrates me, but provides opportunities, is that during this sell-off, much like last August cross market correlations have jumped rapidly to 1. Whether you load up a chart of E-Minis, US10s, CDX HY, USDJPY, AUDUSD, Oil.. they are all tracking tick for tick. Rightly or wrongly, they will probably do this for a while as they did through September, whilst markets digested everything, volatility subsided and underlying drivers of each asset eventually came through.

Going back to the start of this weakness, it was sparked by China.. no one really doubts this, the rapid move in CNY triggered 1% candles in US equity futures at 1:15am UK.. It was both good fun to see everyone become a china expert and a royal ballache to wake up to drastically different prices, but for the past 2 weeks now, China has remained quiet where as markets have remained impressively weak. The narratives have switched from China driving the markets to Oil, and who knows what is next (my money is on HY, but we'll see).

Going back to the point of this, I think that the jump in correlations is a clear and present opportunity to express some better underlying macro trades that two weeks ago made sense to a lot, but under current sentiment wouldn't be nicely welcomed. Think, just general sentiment is now for Equity to close the year negative, even US 10s have been called to end at 1.5%. Whilst I understand there are some concerns out there, the fact we are *so* sure of this bearishness now we are down 10% solidifies the view that its people panicking. This doesn't mean I will be right, I am just saying people are reading the tape as gospel and ignoring the underlying fundamentals which funnily enough haven't really changed in the past 3 weeks. (at least equivalent to the size of the market move)

Firstly, TIPS.. The trade everyone loves, but everyone loses on... I really think tips offer some great value here. US 10 year break-even inflation stands at 1.33% down from around 1.55% at xmas as shown below. As per, it correlates well with oil.. which of course is ES, which is US 10s, which is CXD HY which is Oil etc etc.

With Inflation broadly, its mostly reliant on core domestic trends rather than "transitory" oil moves, and domestic trends remain  on balance positive to the US with my personal expectation of CPI to continue to tick upwards.

As such, the market noise that we've had YTD and over the past 6 months offers good entry points into BEs

US 10 year breakeven vs. Oil 
With correlations, it is clear that this (along with many trades) is sensitive to movements in oil for the immediate term, but it is a trade I really fancy here.


On US rates more broadly, they've been recieved lower as "risk off" or whatever we want to call it, has led to demand for bonds. It's been such a sharp, fast move that EDZ7 trades where Z6 did just 3 weeks ago.. The Curve has been pushed an entire year back! To me, this is just stupid given the underlying fundamentals have barely budged.

EDZ6 / EDZ7
Such a rally in bonds is something I am fading.. But it is once again linked to equity/oil/risk etc, which is frustrating but does offer a great price to fade the majority of this front end (and whole curve) move.

FFZ6 vs E minis
Moving tick for tick, the front end has tracked risk lower.. and here is my game plan for the FOMC this week... Thinking back to September last year firstly; We had seen a very similar move (sparked by china too) where front end rates were trading with Equity.. We can infer from this that we would see dovish behaviour from the fed sparking further fears (almost a realization of potential fears) and vice versa. So what we saw in Sept was the fed back tracking on what they had mostly told market participants was going to occur and this was a clear policy mistake - this meant the Oct meeting was used to tee up Dec. Looking to this meeting, I believe the Fed won't want to do that again, and thus will use this meeting to tee up march. Crushing vol, restoring a bit of confidence and ultimately resulting in the YTD moves giving back at least half of the move.

Now there was a lot of talk about how the Fed only goes when the hike probability is over 60% (or whatever it is), and as it stands FFZ6 sits at 60bps which is marginally more than 1 hike left this year. So I see this meeting (as I did in Oct here) to get short the US rates spectrum. Many ways to do this, Curve steepeners on front end, outright shorts, options trades.. but what I've opted for are Payer ladders on US 5s and short calls on EDZ6.

FVH6, or the 5 year future is currently trading in this well established range (something highlighted in my 2016 outlook piece where I am short a straddle on US 5s)

FVH6

Selling topside and buying a put spread offers a short vol, short rates and negative premium trade with the pay-off as such. I believe rates will drop throughout Feb as the Fed tees up more hikes, equity markets bounce and risk sentiment recovers somewhat. I am not sure we sell off enough to take out the lows but a move back to 119 works for me.

US 5 year options trade


On to FX.. I am positioned in rates for a hawkish fed, and I think the risk:reward in buying the USD is significantly less attractive here vis a vis rates. It also offers a decent hedge against a dovish fed on two accounts; firstly the USD should sell off but also considering EURUSD correlation to risk and its nature as a funding currency any further weakness sparked by a weak fed would lead EURUSD to take 1.10 in my opinion.

EURUSD
The charts see a consolidation / wedge forming, with heavy resistance towards 1.10, but its likely that we would see plenty of stops and a blow out through this on a dovish fed, trading as high as 1.12 in the following days.

EURUSD vs 10 spread
Here we can see why I prefer taking a rates trade for a hawkish fed, the divergence of EURUSD from rates gives us an equivalent 300 pip cheaper entry for short EURUSD (well for one way to look at it) but given the vol skew in EURUSD I would hedge my short rates with a 1.10 or 1.11 calls. As we are not only trading on the edge of the wedge but also its a cheap hedge right now.

EURUSD vs 2y real rate spread
Longer run Real rate spreads will be the key driver where we see little medium term dislocation between "fair value" and EURUSD.

One last trade, less related to FOMC, is EUR 5s10s flattener which I think is quite attractive here.

Trading towards the top end of its range at 70bps, This is quite steep when considering the rest of the curve.. More so, 5s are trading -0.25%, not far from the ECB depo rate (even if they cut again, which ftr I think they will, with an extension of QE)

EUR 5s
Much like with $ 5s, I've also got the same position in options on in € rates here.

EUR 5s10s
With less and less bonds eligible for QE purchases, extending along the yield curve will continue and demand will pick up for 10s and in this backdrop I would favour a flatter curve with the main risk coming from a sizeable bund sell off which doesn't seem too likely with the recent ECB rhetoric and oil backdrop supporting this.

In conclusion, my opinion is that right now, the fed will look to add confidence to the markets by staying firm to their plan and the hiking cycle by setting up the next meeting as a more likely than not situation, as such selling rates broadly should work as markets will start to decorrelate and trade back to fair levels. Buying EURUSD calls appears like a cheap hedge, and EUR 5s10s flattener looks like its at good levels.