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Forex Weekly Analysis – Anchored volatility doesn’t make FX “safe”
It will take a Fed policy shock to drive a marked move higher in global volatility and the FOMC is working overtime to make sure that whatever they do in their next two meetings, it won’t be a surprise when/if it happens. The EUR/USD looks all bottled up in its range unless they make a mistake. The GBP/USD, by contrast, looks like an accident waiting to happen. We like being short AUD and NZD too.
■ Diving into tail risk space. We use our Quant team research about volatility of volatility to group currencies according the market implied tail risk and identify relative value opportunities. The ‘low tail risk group’ includes EUR/USD, AUD/USD, USD/CAD and USD/CHF. EUR/GBP and JPY crosses comprise the ‘moderate tail risk group’, while cable unsurprisingly presents the highest tail risk. Our analysis suggests Buying USD/CHF 3m butterfly against EUR/USD, and Buying USD/JPY 3m butterfly against EUR/JPY.
■ Dissecting EM FX total returns. We find the relationship between real rates and FX total returns to be asymmetric; a widening US-EM rate differential has been a good signal for being long USD-EM on a total return basis, whereas a narrowing US-EM rate differential has been becoming increasingly weaker and less reliable in recent years. Meanwhile, coordinating with broader rationales such as external balances, growth performance and volatility can be a better platform to assess inter-EM investment opportunities.
■ Technicals. Only a move below 0.7560/0.75 will lead to a continuation in the EUR/GBP down move. In the short term, a pullback can be expected. A USD/JPY move beyond 110.40/111 will be needed to signal an extension of the recovery.
■ Quant. The quant portfolio has increased the long GBP position and the risk on board remains limited. The biggest longs are in NOK, CAD, GBP and USD. The most sizeable shorts are in EUR, AUD and SEK.
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