FX Markets Weekly: Policy Remains Too Murky

FX Markets Weekly: Policy Remains Too Murky – Stay Long USD

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FX Outlook: Policy remains too murky – stay long USD
In markets which have become almost entirely policy-driven, this week’s developments have injected more doubt than confidence. Europe needs a liquidity fund with conditionality, but EcoFin is unlikely to deliver one next week. China’s tightening despite weak CPI suggests that housing remains an unresolved issue. Positions have moved quickly from short USD to small long, but the policy environment is too murky to reverse dollar strength. Stay long vs commodity FX and Europe, but neutral vs JPY.

FX Derivatives
During the past month, European and JPY cross vols have rallied, while USD/JPY implieds have declined. Continue to sell longer-dated USD/JPY vol. AUD/JPY vol curves are at historically steep levels: buy longer-dated AUD/USD rather than AUD/JPY vol. NZD/USD implied vol appears as a good buy among shorter-dated tenors, both outright and on a relative basis versus USD/NOK vol.

Trade Recommendations

Keep a moderately anti-cyclical portfolio: risks persist but news flow is random. Stay long USD vs AUD, NZD, NOK (all cash) and SEK (cash and options). Stay short AUD/CAD (cash). Stay short GBP vs EUR (cash) and CHF (cash and options), as the sovereign risk spotlight rotates around the G-4. Stay short EUR vs PLN and SEK, and long NOK vs NZD. Keep CAD/JPY as a long-term valuation trade.

Technical Strategy

Despite the hold of key levels, European currencies remain vulnerable to new lows amid the broader deleveraging process. EUR/USD targets 1.31 and GBP/USD seeks the 1.53 area. The commodity currencies staged a short term bullish shift over the past week led by AUD and CAD while suggesting additional outperformance on the crosses. Latam FX finally shifts into a consolidation phase following the test of critical resistance levels for USD/BRL and USD/CLP. Stay short EUR/USD, GBP/USD, NZD/NOK and EUR/MXN. Use corrective retracements in AUD and CAD to establish long positions on the crosses.

FX Alpha Strategies

Rate momentum strategies (forward carry) remain long USD across the board. The strategy is down 0.5% on the week but up 1% YTD.

ENDS

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