FX Markets Weekly: Sell over-owned currencies

FX Markets Weekly: Sell over-owned, expensive currencies

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FX Outlook: Sell over-owned, expensive currencies

None of the three systemic issues which converged in January – European sovereign risk, Chinese tightening and US data undershoots – have been resolved, nor will they be for a few months. Expect deleveraging to continue. Aggregate USD shorts have fallen substantially but this reading belies position skews in particular currencies. The most over-owned and expensive currencies (commodity FX) should fall the most. Sell AUD and NZD vs. USD and sell Scandinavian currencies vs. USD and CHF. Stay short cable.

FX Derivatives

On the back of continued concern around European sovereign credits and a sharp sell-off in risk markets, vols ended the week on a bid tone. The RBA's rate hold decision has put AUD and AUD-cross vols into play, and investors positioning for further downside in AUD should consider AUD/JPY puts, where the skew has outperformed. Front-end AUD/USD vol looks cheap to USD/BRL vol, which looks rich on an outright basis as well -- sell a 3M USD/BRL vol swap

Trade Recommendations

Investors are facing a wall of worry, warranting a more overtly defensive portfolio. Close out the remaining recovery trades (medium-term USD shorts in options) and concentrate on selling high-beta currencies which are over-owned and not yet oversold. Avoid the yen crosses, as these are already too cheap, but sell AUD and NZD vs. USD instead. Also sell AUD vs. CAD. Scandinavian currencies have proven unusually resilient to a move away from risk. We do not expect this to last – sell NOK vs. USD and CHF in cash and sell SEK vs. USD and CHF in cash and options (put spreads). Stay short GBP vs. USD and CHF.

Technical Strategy

Risk markets remain vulnerable. The USD is the main profiteer – EUR/USD could extend to 1.3100, cable to 1.5275. JPY is more mixed. CE3 currencies have come under increased pressure and indicate a much stronger decline against USD. While equivalent breaks are looming against EUR, these have not yet been triggered. Hold shorts in EUR/USD, Cable, EUR/MXN and NZD/NOK.

FX Alpha Strategies

G10 carry is down more than 2% on the week, and EM carry is roughly flat. The forward carry strategies are long the USD vs. most of the majors except SEK and CHF. The strategies are up 1% to 1.4% YTD.

ENDS

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