FX Markets Weekly

FX Markets Weekly: As Undershoots Go, This Is No Lehman

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FX Outlook: As undershoots go, this is no Lehman

Europe’s sovereign crisis spawns daily references to Lehman, but one analogy which doesn’t apply concerns valuation. Despite collapses in EUR/USD, commodity currencies and the yen crosses, few currencies have undershot short-term value as dramatically as they did post-Lehman. Since risk premia are not yet extreme, there is no urgency to re-enter cyclical currencies until policy risks fade. The June G-20 meeting is the next hurdle. Stay largely flat until then.

FX Derivatives

VXY is at the highest level of the past year as week-on-week changes in front end vols are near levels not seen since the Lehman. Front-end EUR/NOK vol looks cheap and is an attractive switch for investors who have been long front-end EUR/USD options. Further out the curve, USD/SEK 1Y implieds look relatively cheap, especially as a spread versus USD/CAD.

Trade Recommendations

An average-sized stock market correction has triggered a disproportionate position squeeze in FX. Currency performance mirrors positions and is the inverse of fundamentals. Avoid the temptation to chase or fade the position squeeze. Take losses on stopped trades (short EUR vs. INR, IDR and CHF) and close short EUR/USD. Keep low residual risk (long CHF vs EUR in options and vs GBP in cash and options; stay short GBP/USD vs USD/CHF vol).

Technical Strategy

Spill over effects from the European sovereign debt crisis have pushed risk markets to the brink of a major sell-off. Commodity currencies have in this process confirmed the start of an overdue broad consolidation-phase. EUR has reached its first major target at 1.2134 but is structurally still missing a minor new low to complete the full bear-cycle whereas the latest signals in GBP are indicating a strong GBP underperformance yet to come. We are short GBP/USD.

FX Forecasts

AUD/USD forecasts lowered to 0.82 in Q2 and 0.87 in Q3. Forecasts for NZD and CAD lowered in Q2 and Q3 but raised in Q4 and Q1 2011

ENDS

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