FX Markets Weekly: Euro’s risk premium too high

FX Markets Weekly: The euro’s risk premium is too high

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FX Outlook: The euro’s risk premium is too high

Despite predictions that sovereign risk would doom the euro even if Greece stabilised, March is proving that the old rules still apply. Stronger data and higher stocks still prompt broad USD weakness, even against the euro. But even as the euro tracks stocks higher, it still carries a risk premium. EUR/USD and EUR/JPY should be 4% stronger (1.42 and 130) to catch up to the improvement in underlying fundamentals. To exploit this mispricing, buy EUR/USD (cash, call spreads), sell USD/CHF or own CHF/JPY for greater leverage.

FX Derivatives

Front-end implieds remain under pressure as realized vol stays low – keep short 3M3M USD/JPY FVAs. EUR/USD skews look rich in favor of EUR puts, while EUR/JPY skews look rich in favor of EUR calls – sell 1M 25D EUR calls/ JPY puts. Calls on CHF against a basket of GBP and USD offer a correlation-efficient way to position for the SNB’s eventual normalization of FX policy.

Trade Recommendations

Bond markets have been quicker than FX to re-price sovereign risk. Own currencies which still carry a risk premium: buy EUR/USD in cash and options (1.39/1.42 call spread), sell USD/CHF in cash and options (1.05/1.02 put spread), or buy CHF/JPY (cash) for greater leverage. Keep most risk in the crossrates, however. Add long AUD/NZD and NOK/SEK (both in cash and options) to existing CAD longs vs GBP, NZD and AUD (all cash). Take profits on long EUR/GBP. Add a bearish EUR/CHF seagull to cash short. Stay short GBP/CHF and long PLN/CZK.

Technical Strategy

The focus is on the crosses as the USD consolidation continues to develop. The setup for commodity currencies is mixed, with CAD expected to outperform while NZD should lag. Another shift for JPY points to additional short term underperformance against the USD and on the crosses as the broad consolidation phase remains intact; corrective pullbacks are buying opportunities for the crosses. Asia FX retests critical resistance levels while suggesting some pause, but corrective retracements are buying opportunities. Stay short GBP/CHF, NZD/CAD, EUR/USD and EUR/MXN, and long EUR/GBP.

FX Alpha Strategies

G-10 and EM carry continues to grind higher, and forward carry is now short the USD across the board except against JPY Forward momentum overlay remains short the USD across the board as well.

ENDS

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