1st June - FX & Rates thoughts

Pretty much finished my exams now, 1st year all but over and now a long boring summer awaits.. But hopefully the markets will be interesting enough to provide us with plentiful opportunities to take.

I've been looking at the $ returns in European assets. Below shows normalized returns of both the DAX and a basket of 10y+ EGB sovvies.

DAX and EGB $ returns

Returns in both have been rather stagnant of late, and this is hardly surprising given the EURs fall in line with the DAX's and Bunds rally. I'm still in the mindset that the EURUSD has "relatively" limited downside, at least compared to analyst prediction, which have recently stirred up again. I'm still of the opinion that the reaction function of a higher USD will ultimately impact the US enough (and benefit the RoW) to the point where monetary policy expectations start to converge again... whether this means later Fed hikes or earlier RoW is yet to be seen.



DAX (inverted) vs. EURUSD

Looking at this chart, we can see the strong correlation between EURUSD and the DAX recently, this was highlighted before in one of the last blog posts - but in the past week, maybe through heightened greek fears, maybe not. We've seen a large-ish divergence in the two. Friday was the first time since just over a month ago we've seen a sizeable DAX sell off with little EUR movement. However of course, there are plenty of risks to the bullish European equity theme, but I think ultimately the majority of factors are supportive, ranging from my positive outlook on the Eurozone to the of course accommodative ECB.

Because of this I'd like to look at selling DAX puts, and using the premium to fund a EURUSD call. In an ideal world, I think I would look to structure this in a slightly more exotic way, maybe with some sort of x-asset KO or the such, but alas I can't. So simply selling dax put and buying a EURUSD call will make the most of both these ideas. As we looked at before, Vol In the DAX is at record levels relative to the SPX, so its potentially a wise idea to buy some deep OTM puts in SPX as a global equity hedge for this idea, but I'm not sure I'll need to pay the premium for this.

Ultimately I've been really rather happy with the EURUSD recently, buying it back in April towards 1.06, and then just 2 weeks ago in my last blog post getting bearish just shy of 1.14 - we stand pretty much at 1.10 now which seems reasonably "fair" right now, but with an upward drift bias.

That's my current play in this space, not too interesting, not much going on. NFP next week should be interesting, ultimately I don't think even if it was 300k+ we'll see a June Hike so reactions (bullish USD) could be fade potential.

In the bund space, I've only gone and recreated this stupid chart that the sell-side have adored the past few weeks..

Bunds vs JGB

I mean it is compelling isn't it? well kinda.. but if anyone was to believe this then Bund puts are quite cheap. I was looking at a sept 151 put in FGBL, which is approximately the low we put in back in early May, and it costs a mere 50cents. If this does occur, which is a big if, the option would have an intrinsic value of ~200 cents on expiration in sept and probably worth much more before than, offering a decent risk reward set-up. Of course, we have the ECB meeting this week, and I'm sure some concern about this movement in rates will be addressed, and draghi will waffle on about the QE program and people will go back to remembering that there is only one direction for Bunds... maybe. I mean, if the stronger H2 EZ plays out, and inflation ticks higher then they must surely accept higher nominal rates, after all we are only at levels seen at the beginning of the year.

Thinking more about the longer end - it does seem rather capped. We had all this excitement last month about the "taper Tantrum" part two, but that has died down rather rapidly. I like this chart which shows US 30 year swap rates overlayed with Copper. Maybe its a nice correlation, or maybe its more important that global growth prospects are the clear and present danger for higher rates, regardless of US growth. I mean after all, global rates are fairly well anchored to each other, and in think back to two weeks ago when the USD was pretty weak. Global asset managers loved picking up USD debt with the USD at such a discount especially vis a vis the EUR.

We also see Global PMIs trending lower on this chart and while I am optimistic on global growth (mostly due to higher USD / lower Oil) this downward trend will most certainly keep the long end pinned lower, especially in our low realized inflation world.

However on the shorter end, divergence is still reflected clearly. Here is a CIX of a DXY weighted 2yr swap spread of the US against the RoW. It's been a clear driver, and understandably, but its been trending lower as Fed hikes have been pushed back and back. But to me, broadly the USDs strength will be limited, and even if the spread rises, it won't support the USD as much as it has in the past. I think as we move into the hike cycle, the raw spread in support of the USD won't be as important, even now I think its importance has been overstated. At every stage, the US rates market has outperformed forwards (mostly) and we'll merely be moving along an upward sloping curve which the forwards (as calculated from the curve) see. so we could simply plug in the forwards to this and we could see a DXY 2y spread upward of 0.7% next year... but that's not to say the DXY is going to be 105+..

On the other hand, I do think that USD bearishness is limited without a major drop in this carry you now get in the dollar - its sometimes like this that I wish forwards were a predictor of price. All this time I've been bearish the USD, but its really relative to everyone's bullishness and more of a sideways drift lower in DXY.. and so I wish we could have a 1Y fwd in EURUSD under parity as per forecasts.. this would make sell-side forecasts so much more interesting :P alas, fwds are just a bit of fun maths and nothing more.

On the NZD.. since I last looked at it here where I presented the idea that the RBNZ could cut rates. Since then some smaller banks have agreed with me, and more recently HSBC have thought this is possible. More importantly the NZD TWI has dropped from 160 to 149, and the crucial cross with AUD has pulled back a lot, but still high.

NZDAUD

The NZD OIS market sees around a 50% chance of a cut in the next 3 months or so, from pretty much 0 a few months ago, this is a primary factor on the lower NZD. But its also fallen out of favour from the momentum/tech guys, with us trading yearly lows under 0.71

Carry/vol is also a great indicator for NZD - and both don't paint a pretty picture. Carry has dropped remarkably as the market has seen the turnaround in the RBNZ rhetoric.

Carry/vol vs NZDUSD

As I've suggested, against a lot of critiques, is the idea of an easing RBNZ... many simply suggest they won't cut and will just use FX and words to achieve their goal, but I think serious risks in China, domestic inflation (yes, yes I know housing blah blah) and declining Terms of Trade will see the RBNZ react, especially in a world of cutting CBs - they'll hardly be out of place!

Taylor Rule for New Zealand

Here we can see the Taylor rule for NZ.. now I know all the arguments for/against this.. but we can see quantitatively the justification for lower rates, maybe not 0.75% of course, but lower - lets say 3%. Still we'll see, I'm not 100% sure they'll cut at the next meeting, and I'm not even short the NZD anymore, I've taken it for its ride and am happy, but the concern for us is the positioning is heavily short and we appear to be quite overextended, so by no means would I want to short here, bounces, maybe...

Still not too many idea, Exams probably have a part to play in that, but im nearly done and I'm sure the twitter/blog flow will pick up :)

Thanks for reading y'all

17th May 2015 - FX/Rates thoughts

So I'm about to enter my exam season, which will pretty much keep me pre-occupied for the next 3 weeks - its crazy how quickly this year has gone, regular readers and friends on twitter can surely remember me panicking about my A-Levels last year, and some even as far back as GCSEs I'm sure.

But I just want to write a shorter piece for whilst at exams. Generally speaking, and maybe its because i'm arguably more focused on exams, I'm struggling more bigger thematic/directional ideas in the FX and Rates markets. However this maybe the dynamic we are in until the elusive rate hike.. which is now priced for Dec/Jan, and as such the markets are just in a "wait-and-see" mode. Either way, I'm not completely out of thoughts, just not as many as normal. The first thing to look at is obviously the EUR and bunds etc. Because they are still very much in the forefront of everyone's thinking.

EUR/USD vs US-EUR 10 year swap

10 year swap spread has tightened to 130bps, down from the 160bps a while back.

If you remember back a while, I positioned for a tighter spread, but now I think we've come in enough for that view to have diminished in the short run. I still think EUR long end rates should be higher, but I'm of course wary of the large QE flows etc.

Normally, the EURUSD rate is not too sensitive to the longer end spreads, but it seems clear from this overlay that it has been. Much the same reason i'm sure as to why the EUR is well correlated to the DAX for example. A lot of flows, both real money and CTA flow has been "hedged". Well this isn't new to anyone, we've all been talking about it for months, but it just still seems to be around, not sure for how long though, would expect this to diminish as markets settle down... (I'm not one for correlation trading lol, but would expect lower correlations going forward, and it intuitively makes sense)

EURUSD vs DAX inverted

Looking ahead however, I am still constructive on European equity, the conditions are still rather strong, and of course we have this minor greek issue in our way, and maybe the tail risk is somewhat under-priced (as it always is) but I'm not expecting doomsday there. So at least in this market we can potentially build some ideas.

DAX vs 2 year EUR real rates, a bit iffy, but its a supportive factor, that and euroarea growth accelerating this year and QE etc etc

Looking at ATM implieds in DAX and SPX, we can see the premium in VDAX is crazy high.

Infact so high  we gotta zoom out the chart into the monthlies before we find a time when Dax vols were 80% higher than SPX

The skew is equally interesting, if you follow me on twitter, you would have seen my long SPX risk reversal trade, which is doing nicely, but I think that DAX is probably even more interesting. selling downside in the DAX is obviously risky, but probably worth it. I mean those of you that know me, know I'm a bit of a theta whore, but this does seem like good value especially going into the summer doldrums.

Furthermore, we see that Bund futures, have set-up, at least from a tech perspective, a bit of a base.

Potentially we could see a pop in RX which would likely be construed as EUR bearish assuming USTs are like meh.

Combining these, I can't help but end up with a shorter term EURUSD bearish bias. And this is strange coming from me, as I've been calling for it to pick up every since we dropped around 1.08 (just see older blog posts).. but we trade now, just shy of 1.14 and we may getting a bit ahead of ourselves, and if the lazy correlations remain then a move back towards 1.10 is on the cards for now.

In other FX markets, We've had time for the GBP to settle down, if you read back to my election piece here you'll see that I bought a zero-cost GBPUSD risk reversal, we currently sit ~800 points higher then when I recommended that and I've now covered.

GBP vs STIR rates

We were ultimately taking a view that the election risk premium was too much (inferred fom the divergence from rate spreads), and now that risk is passed we've joined back up together and the outlook for cable is pretty clear... its all about relative monetary policy, as it always has been, and not some pointless election (pietro ;) )

So that trade has done well, I have leaned on the more hawkish side in both the US and UK for some time, still expecting a 2015 hike, and the BoE to be not too far behind at all, but right now I don't see anything particularly interesting in GBP rates, I mean I'll probably moan about the proxy (5y5y) terminal rate being too low (especially vis a vis USD rates) as I have done on twitter many times in the past, but ultimately its not huge, and its probably the macro economic textbooks telling me this and not what the current economy is saying.

Silver

 In other markets, Silver continues to push higher, after breaking out of this range, my long straddle idea is working well with Silver moving quite a bit quite quickly. Needs to clear 18.25 really.

Looking into possible long Silver vol trade.. spot in a tight range, and implieds cheap to FX composite. pic.twitter.com/htUcLhtFoM

— Jere Wilkinson-Smith (@JeremyWS) May 11, 2015

USDJPY is similarly a one which we should look to position long vol in... but as I said, the summer markets may be slow so we don't want to burn premium on this just yet. 

However that being said, because realized is so low, the USDJPY implied discount to the overall FX market is quite large, so premiums are cheap-ish, but still I think I'll wait till after exams

And broader Vol themes, especially in the rates market (3m5y) is heading lower, even after some larger moves in the FI space recently, and FX vols will likely track lower into the summer, assuming we don't have that June Hike, which is very very unlikely.

FX vs rates vol

The move we have seen in rates is clearly a mix between a few factors, higher inflation expectations I'm sure plays its part as I have looked at many times before, but we can't forget term premium which has moved higher, likely pushing nominal yields with them, and ya know at the same time burning a few CTAs fingers.

10Y ACM  term premium

Yup so that's pretty much it from me.. no shocking ideas or themes, which I'm glad about, hopefully I won't miss much whilst on exams :) 

May FX & Rates thoughts

Gotta start with the big events of the past few weeks... the large repricing in the European rates space.

Looking at RX1, or the 10Y bund future we've seen a massive sell-off. No matter how we look at it really, its a big and important move. However I think its key to note that this has mostly been a parallel shift up in EGB rates, as in, looking at peripheral spreads (Italian-German for ex) are still near cycle lows, and in fact they were a little tighter on the week.

RX1 daily chart

RX1 tick chart

Thursday saw some crazy vol in Bunds, which may be seen as capitulation. Flow talk suggests this is mostly CTA/speculator led (as per someone i know at JPM) where as the real money flow still underpins the fixed income markets. However this episode, like the Flash crash in UST yields last october just goes to show vulnerabilities in the market.

As I know everyone loves, we can try and fit a narrative to this move... of course whatever we say won't capture the whole picture, but we can try and justify it somewhat.

 First off is of course the stops/liquidity idea, which is often the sales reps "go to" excuse for any inexplicable move.. but of course, this does play a part. The market was noticeably thin, and even in my size I was struggling to get good fills in the Bund option space...

Secondly, and a theme that I've talked about as recently as beginning of April here where I looked at inflation swaps are questioned the likelihood that the long end of European rates could stay low... or my march piece where I looked at a comparison to Japan and thought it was getting ridiculous here

The common theme I talked about in those, was the idea that even if overall the Eurozone economy was rather weak, the rate of change in data and direction is certainly picking up... and this was seen in leading indicators, CESIEUR and inflation swaps.

I did question a few blogs ago why nominals hadn't responded clearly to a sharp rebound in inflation expectations.

EZ ZC 2y inflation vs German 10 year

But of course, one of the goals of ECB is to lower EUR real rates, and for sure this works, definitely on the short end of the curve. But further out, you have to wonder whether the impacts are truly market related or will they become realized? doubtful tbh.

The only issue I have with this is that this wasn't exactly "new" last week... inflation swaps had been shooting higher since Jan, but its the most logical reason for higher EUR rates, just not describing the catalyst behind it. Of course we'll never know, and as an update, my short bund / long UST trade from prior blog here is still open and doing fine. Entered at 161bps (i know right, nailed the high!) and currently sat at 139bps.

EUR/US 10 year swap spread

Looking forward however, whilst I am getting a flurry of sell-side ideas on Bunds et al. I think I am going to steer a little clear of it for a while, looking in the options space, there has been a significant (if understandable) pick up in implied vols

RX ATM vols

ATM vols traded as high as 11, but now done to 6 or so.. but still commanding quite the premium over the average. Obviously there is quite a skew in the vol, with puts quite a chunk higher than calls, but even still with the kind of moves we've seen I don't particularly want to be selling OTM puts. However what maybe some of the specialists might want to look into is that the skew in UST futures is far more slight, and going on the idea that long end rates are reasonably anchored within each other then there may be some hedged plays taking advantage of the differing implieds... however I'm too lazy to think about that too much and already in a tightener so got enough exposure for now.

Final chart on this whole thing, is the EUR M1KE from MS..

down to 30 months, from 55 months, just a few weeks ago... now I would probably look to fade this move in euribor futures.

Okay I lied, one last chart on this, ERA curve vs a few weeks ago. Its steepened a bit, and shifted higher, but lets be real, yes I think that the Eurozone economy is doing better than most out there, but no I don't think we see hikes for a long time. The Taper talk may come and go, but I suspect we follow a similar path to the US, where we have to wait a very extended period after the end of QE before hikes come into play.

And oh well, lets have a bonus chart :)

US 2s10s vs Bund 2s10s analog

In terms of monetary policy, the ECB is a good many years behind the Fed, in terms of an implemented open-ended QE program etc, and sitting on the supposed lower bound. To me, its entirely possible we see a similar path in EUR rates, as we saw in US rates over the past few years. First we see steepening, which maybe just starting, as growth and momentum pickup, all is good, yay! but the realization that hikes are way off means that any EUR rate taper tantrum will be short lived and eventually we start to see flattening as a few years later the short end looks to pick up. Now of course, this is very, very, very iffy, but plausible imho. Hence why I am still positioned for higher EUR rates. Nevertheless, anymore illiquidity in the long end will undoubtedly push ERZ8 (the one I watch) around, and last week it was tick-for-tick the 10Y bund, so that could be the best place to trade the overriding macro theme of no hikes. 

Okok onto something else. Can't obviously cover everything, but in my last piece here I put forward what is apparently a somewhat controversial idea, on the possibility of RBNZ rate cuts, and when we last looked at the NZD we traded new all time highs (Trade weighted) and I suggested the RBNZ would be less than happy.. and they were. since then, the TWI is down ~4%

Very good for my EURNZD longs from last week ;) up 10 big figures, but covered it now - tho still like the idea. Since last time, there has been growing talk of a rate cut, with some local banks predicting a 25bps cut this year! so maybe my call won't be soo outlandish. Afterall I got the hike cycle right, calling for a much a lower terminal rate vs the almost 5% that was expected :)

I bought a USDCHF 0.97 digi call the other day (spot ref 0.91) for 23%, idea based on a hedge against my overall book which is generally short USD, or has been, and takes advantage of a potentially dovish/supportive SNB and cheap cheap price. a 4:1 risk reward ratio for USDCHF  trading where it was just a few weeks ago, in 9 months. Yes please.

Was spot ref at 0.91, bought at 23% cos ma spreads are a bitch... but here's is the trade from OVML pic.twitter.com/gW5ysW213C

— Jere Wilkinson-Smith (@JeremyWS) May 7, 2015

Ok, one last segment I promise, I've been looking into EMFX a bit these past few days, not that I really trade them, but I was asked on building a carry portfolio, specifically in EM. 

AUD vs JPM EMFX index

It is no shock to anyone, that the AUD trades like EMFX, it has done so for a long time. However what I didn't really realize, is that versus the JPM EMFX basket, the beta is very close to 1. As in, Long EMFX/short AUDUSD would in spot terms be rather flat over the past few years, but up a ton in carry. 

EMFX yield

Here is a somewhat crude and crappy CIX of the yield on that EMFX index. (I don't know currency weightings, so assumed they were all the same lol), but its around 6%. Now if we adjust this yield for paying AUD swaps then.

EMFX carry funded in AUD

Now of course, I'm not specifically looking to buy all EM just versus AUD. I do of course have my biases for funding ccys, such as CHF as well. And at the same time, there are some relative basket cases in EM, such as possible pressures on TRY and ZAR, but generally speaking I'd much rather fund in AUD right now, as it should alleviate risks from a stronger USD (directly ofc, obvs there are indirect impacts on EM from this, due to USD liabilities esp in TUR etc)

On a carry/vol basis, it also looks good. Using the simple AUD funded carry, we see carry/vol sat near its highs. 

All I'm saying is that I don't think its the worst time to be overweight EMFX, just look to fund it in AUD and CHF, and be selective in EM by being underweight Turkey/SA etc.