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Sunday 10 August 2014

week of the 11th August - BoE/UK economy and the GBP.

A year ago, at the August inflation report, the BoE effectively enacted forward guidance, the GBP had an incredibly choppy session trading from 1.52 to 1.55 in the space of a few hours. I recall it well, as I'd just got back from holiday and was playing Dead Island 2 on one screen, while having twitter and my terminal open on the others. I was glad to stay out of the markets that day as I was getting myself re-acquainted with the markets. This week, we have the BoE once again, and it provides Carney with a perfect opportunity to provide a little more certainty with regard to the 1st rate hike... which is now seen by many in 2014. Renewed CPI projections could be a big mover for the market - a shift higher in the baseline estimate would most certainly bring forward expectations to November time.

UK CPI -Next release for CPI is Aug 19th, however the projections are likely going to be more important.

However, I sit on the camp that sees a 2015 rate hike, one of the key indicators which the BoE have been telling us to watch is Average earnings growth, which they expected to rise to 2.5% by year end (GLWT). Given its persistent weakness, I think the BoE are going to be extremely cautious during the hiking cycle, and will try and put it off as long as possible.

The UK labour market has been incredibly strong, with consistent -30k prints on the claimant count, and the headline rate of unemployment dropping far faster than anyone expected... So we /should/ see a pick-up in wage inflation as we get closer and closer to the NAIRU.

Looking to the markets now, it's clear that the GBP is trading rather weak going into the BoE, presumably with the growing fear that they may confirm (by means of forecasts and language use) a spring 2015 rate hike... With the recent GBP drop, we've also seen STIRs (specifically Short sterling Z4s) rise back into their 2014 range.

Dec '14 Short sterling
For the meantime, the GBP is trading incredibly closely to relative interest rates, most notably the implied yield spread from M5 STIR contracts (Short sterling - Eurodollar)

GBP vs M5 spread

This does make a lot sense too, both central banks are not too far away from hiking cycles, and both economies look to be performing well in my opinion, as such the smallest changes in rate path expectations affect the GBP. Essentially, the US hiking cycle is supposedly to start later but is going to be a tad more aggressive (using 5y5y rates as a rough proxy for terminal rates, we can see US rates are 50+bps higher than UK ones)

UK 5y5y (white) US 5y5y (red)

However, it seems that the GBP is far more sensitive to what is happening on the (very) short end, so essentially for the time being, the GBPUSD is a rather simple bet on the distance between 1st hikes. Which puts the current cable rate equivalent to a 6 month gap... it was closer to 9 months when we traded at 1.72, but we've seen short sterlings weaken, and US rates move higher so we've dropped back to 6 months.


GBPUSD rolling quarterly change vs CESI spread
Also, data has turned against the cable in the past few months, and this will be a defining factor in determining that time gap between hikes, and thus the Cable itself

Morgan Stanley's M1KE (month to the 1st hike) recently went under 12 months for the US... reinforcing the Summer '15 view that many have (tho this will be very data dependent, especially if wage inflation ticks up in the US). However, this all seems pretty fair to me, so right now the GBP is in a wait and see mode regarding the BoE, until then cable will mostly be a USD story.

A trade idea from a few weeks ago was selling GBP vs EUR (about 1/2 way down here)

However, given that I'm winding up my positions for my summer holiday, I've decided to very closely watch the EURGBP next week and look to cover around where we are (preferably 0.8020) 

EURGBP model
Still trading a little cheap to my model, but its close enough now to not mean much, hence my willingness to take profits here.

The EUR should be interesting next week too, in my opinion. We saw a hint of what maybe to come on Friday, with a sizeable short covering rally taking us back above 1.34. However I still think there is scope for a move back closer to 1.35 (which would be ideal to load up with Long term shorts)

Model (white) vs EURUSD (red) and the spread
So we could see a bit of short covering, which would also serve to help the EURGBP pre-BoE, which is what I'm looking for so that I can exit that trade.

For the EUR, we also have German GDP... but something is telling me that I won't give a toss about it (as its Thursday) - however a negative print, which is slowly starting to be expected really does throw a spanner in the works of this eurozone recovery...

We have seen the DAX trim a good thousand points or so since they won the World cup, but finally looks "cheapish" relative to basic valuation methods, but also against US equity. Even though we have seen a pick up in risk (as per my controversial posting of RU CDS' vs. DAX) European assets are looking like good value, especially on the periphery. If the markets really are in some short term risk on/risk off mode, then ceterus paribus, we should see some demand for EUR equity into the beginning of next week especially after the rebound in US equity on Friday, Also given that (on technical metrics) we are oversold and trade at better values this could also serve well to boost the EUR.

relative EU/US equity vs EURUSD

Also, on this "risk off" move in the markets last week... the EURCHF traded down to 1.2130, while 1M vols spiked higher (ok, ok, they are still crazy low, but its quite a move)

EURCHF 1 month ATM vol
Using this spike in vol and lower spot price, I sold 1.2125 puts for expiration at year end... merely 45 points tho.

EMFX was well supported on Friday, and likely to be supported even more if we see the DXY topple over and head to 81. We saw relative implieds volatility spike higher in EM land, but hardly anywhere to be concerned, trading at an average 3.3 vol points higher than a G10 composite on 1month tenors (however mean is 2.5, so only really 0.8vols) I opted on Friday morning to sell some topside USDRUB and USDTRY 25D calls (2.25 on $TRY) 1 month expiration, as we saw quite the spike higher in risk reversals (from 0.5 to almost 2.5 on 1m 25D for USDTRY)

USDTRY 25 delta 1 month risk reversal
However, given the attractiveness to fund EM carry (and DM to some extent) with EURs recently, an EM rally could serve to weigh on the EURUSD, however I don't expect it to be a hugely significant factor.

In other news -- *BREAKING: JEREMYWS' Aaa RATING PLACED ON REVIEW FOR DOWNGRADE AT EDEXCEL

Rumours are strong that we'll see a downgrade to Baa1 on Thursday... but We'll see. 

Monday 4 August 2014

4th August - RBA rhetoric et cetera

The most exciting week of the summer turned out to be not that exciting... US labour data came in a little light, but still strong. Strong enough for it to not affect the Fed decision making process in my opinion. However, it did successfully manage to crush volatility, and given the calendar for the next week, while there are occasional interesting points, overall it should be rather dull.

However, one of the more interesting releases will be the RBA (tomorrow (5th) morning). Rate movement are highly unlikely, and like the BoC the RBA is in a neutral stance where they see equal chance of the next move being a hike as well as a cut.

(N.B.Using OIS markets, there is around a 15% chance of a rate cut)

However, given the uptick in CPI I see no real chance of a rate cut, yet the RBA are still going to be trying to verbally intervening wrt the AUD.

AUD daily chart
The 0.95 area has been important for the RBA, as they've noticeably picked up their tone when the AUDUSD has traded here, and even though he are 0.9320, we are still close. So I'd fully expect the RBA to mention strongly the AUD. Especially since their neighbours (RBNZ) did so the other week, and the sell of there has been exactly what the RBA has been looking for.

AUD vs OIS rate (next meeting)
Australian data (and Chinese data) has been so-so and looking forward, neither look to be explosive or terrible, so I'm still part of the camp that thinks that the majority of the moves in AUDUSD are going to come from developments in the US rate markets.

AUD vs US 10s (inverted)
More specifically, the area with which the US 10 year note trades will be key... the intr-day correlation isn't huge, but with RBA policy in neutral and data their just chugging along, and sustained move higher in US 10 year yields through the latter half of this year should see the AUDUSD underperform and weaken back towards the 0.90 area.

Much like with the NZD, the AUD is incredibly sensitive to the levels of volatility, and without a meaningful uptick there, its hard to see AUD weakness frankly, as carry traders will look to the AUD and NZD.

AUD vs 3M implieds (inverted)
Overall, I am bearish the AUD going into the second half of the year across the board, as the AUD is more sensitive to the longer end of the yield curve than say the EUR or GBP, and so with rising 10s, the AUD should underperform. Regarding the RBA, there is no doubt they gonna bitch and moan, but the RBNZ had done so everytime, and only recently did the NZD listen. Maybe the same for the AUD.

Next onto a chart that was highlight from @gmactrading on twitter, which shows the EURUSD vs generic 2 year swap spread. Simple enough.

EUR vs 2 year spread
What is interesting about this, is how the relationship is not really "relative" as one would expect, but the actual level of the 2yr spread was key. It had traded at 0 +/- since "whatever it takes" yet the EURUSD continued to rise, as other factors (peripheral spreads, relative equity, current account growth) became more important.

But it is important to note, that now the rate spread has moved lower (currently 28bps wide) the EURUSDs correlation has picked up significantly. And while correlation =/= causation, given the move from 0 -> 28bps coincides with the ECB cutting, I think it is very significant and will be very key into year end.

However, shorter term, it may have over-run a little bit, especially as the DXY has run into resistance... So with the EURUSD market quite short, and running out of momentum - a short squeeze to 1.35 is on the cards for this week.

Finally, This chart I quickly made in Excel shows on the x-axis the Long/short positioning in the FX markets as a composite indicator of desk prop flows / risk reversals / IMM / real money flow etc etc

The Y-axis shows % deviation (overvalued vs undervalued) of the currencies against my own models (of which some can be found here)


My ideas would be to fade the extreme moves in the upper-right and lower-left quadrants. For example, a week ago, the GBP was trading 1.5% above my model and also had positioning value of 40 (where 50 is most extreme long and -50 is short). Shorting with a set-up like that is how I look to trade based upon this, likewise, short term, the EUR is "undervalued" and also the market is short, so there is potential for a short squeeze higher and hence I would buy. However, I need to do some more work on this idea, just thought I'd share what I've got so far (which admittedly is not much).


Not much else going on, expect 10 days 'til judgement day. fuck.