FX Markets Weekly: Debt Restructuring, Devaluation

FX Markets Weekly: Debt Restructuring & Devaluation - Should Europe Be Different?

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FX Outlook: Debt restructuring & devaluation – should Europe be different?

The EU’s decision to partner with the IMF, and Greece’s likely decision to tap public markets rather than the Fund, are short-term positives for the euro. EUR/USD and EUR/JPY still appear to carry a 5% risk premium, which should decline if Greece progresses with fiscal tightening and avoids an IMF program. If Greece does tap the Fund, many will assume a repeat of some emerging markets’ experience – devaluation and debt restructuring. This template doesn’t fit Europe, however, since the periphery’s funding problem centers on domestic currency debt.

FX Derivatives

Front-end vols have rebounded sharply over the week, a copybook reversal from extremes in curve steepness. Stay long gamma as a spread to short vega positions. USD/JPY gamma surged in response to the spot rally this week, as the market was caught short topside strikes. Expect the front-end to remain bid. Owning EUR calls/USD puts over EUR puts/USD calls on a delta-hedged basis has been a profitable trade this year. With levels still historically cheap, owning delta-hedged risk-reversals is an efficient way to position for normalization in the EUR.

Trade Recommendations

Position for a gradual cooling in Greek anxieties by switching CHF longs into EUR longs. JPY looks short-term vulnerable as bond yields threaten range highs. Stay short but resist for now the urge to add. In cash, buy EUR/JPY (switching out of CHF/JPY), and buy EUR/GBP (switching out of GBP/CAD and GBP/CHF). Sell USD/CNY 12-mo NDF. Stay long EUR/USD, short USD/CHF, short GBP/CHF; long USD/JPY. Stay long CAD vs. NZD and AUD. Stopped out of AUD/NZD and NOK/SEK.

Technical Strategy

The USD rally has extended and broadened. The violation of key resistance for DXY and support at the range lows for EUR/USD suggests the medium term trends should continue. The advance in USD/JPY through critical 91/92 resistance confirms a bullish shift and another leg higher with targets near 97, as JPY looks increasingly vulnerable to further underperformance against the USD and on the crosses. Stay short EUR/USD, NZD/CAD and EUR/CZK, and long USD/JPY.

FX Alpha Strategies

Carry strategies are down on the week. Forward carry and overlay strategies, which are predominantly short the USD except against EUR, are also lower.

Research Notes

Corporate hedging recommendation: Hedging against a EUR/JPY rally (Kamal Sharma)

ENDS

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