“1. Stay long the USD in 2017, at least in 1H
Nowhere will policy rotation be as evident as in the US in 2017. The Fed path will continue to re-price higher as incoming US President Donald Trump delivers fiscal stimulus. Rising rates and USD will make it harder for non-US borrowers to refinance a wall of USD-denominated debt. Scarcity will push the USD to new cycle highs, further away from fair value.
2. EUR/USD below parity? Two option structures
We see EUR/USD heading to parity into spring. With general USD strength combining with European political uncertainty, a temporary overshoot is a distinct possibility. We recommend two risk profiles: 1) EUR/USD 6m European digital put strike 0.97 costing 13% and 2) zero-cost 6m downside seagull strikes 0.97/0.99/1.17.
3. Stay short the yen: Buy USD/JPY 6m call spread 1×1.5 strikes 118/120.5
The BoJ has its timing right. With global yields likely to rise further in 2017 (see SG FI Outlook 2017: The big hangover) and 10y JGBs credibly pegged around 0%, the yen can get much weaker still. The above structure is cost-free (indicative, spot ref: 114.30). It starts losing money only when USD/JPY breaks above 125, at which point the BoJ might struggle to defend the JGB peg (speculation about an adjustment of the long-term rate target would rise).
4. Brexit vote dust settles: selling cable volatility safely
After the post-Brexit-vote jitters, cable has reconnected with short-term rates. Sterling positioning has cleaned out its extreme shorts. The Brexit process will not be smooth, but is unlikely to deliver large surprises over the next six months. The settling dust and cable’s likely future range make GBP volatility a Sell. A naked short is much too risky, while the euro moving down and then up is likely to generate EUR/GBP volatility. So we suggest directional and volatility RV implementations circumventing the issue: 1) Buy GBP/USD 6m double no-touch 1.19/1.30 for only 13% and 2) go long EUR/GBP 1y volatility swap against GBP/USD 1y volatility swap.
5. Buy SEK and NOK vs AUD and NZD…
The SEK and NOK are best positioned to benefit from the reflation theme. The NOK has some significant catching up to do in the light of the rising oil price and local forward interest rates. With SEK inflation breakevens finally recovering, the Riksbank should turn less dovish. The AUD and NZD have had a relatively good 2016 so far as investors have climbed a wall of Chinese worries – we see little upside from here. The trade costs 0.6% per quarter, an acceptable cost given the excellent entry level.
6. … or Buy SEK and CHF vs NZD and JPY
In a rising yield environment, we prefer the CHF to JPY as a safe haven, as the JGB peg will remain a drag on the JPY. The SEK is our favourite G10 currency for 2017, while the NZD is our least preferred.
7. Kiwi weakest G10 currency against USD
We expect the NZD to fall the most against the USD in 2017, reaching 0.64 by year-end. New Zealand remains highly exposed to a slowdown in Chinese demand, and the RBNZ won’t stay neutral in front of revived currency strength. Short rates already point toward a much lower NZD/USD. Downside medium-term kiwi volatility is expensive, suggesting RKO puts. Buy NZD/USD 1y put strike 0.68 RKO 0.59 for 0.98% (spot ref: 0.7135), which compares with 3.85% for the vanilla.
8. Trading more frequent intraday volatility spikes
The amplitude and frequency of black swan events in FX have increased in 2015-2016, suggesting a deep change in the nature of currency risk. Our findings (using extreme value theory), falling spot volumes, growth in electronic trading and tighter regulations point towards a durable transformation. A volatility regime with more frequent intraday volatility spikes improves the profit odds of rolling long gamma positions financed by short vega positions, especially when curves are steep. Variance/volatility swaps circumvent the spot execution risks involved in dynamic delta-hedging.
9. Regional EM: Short EMEA and LatAm against Asia (through to 1Q)
Regionally, EMEA (USD crosses) and LatAm will likely suffer more than Asia through to 1Q. While Asia is more sensitive via trade linkages, higher-beta regions with less favourable external positions (EMEA dollar crosses and LatAm) should do worse when overall risk sentiment is deteriorating. Long INR, IDR vs Sell TRY, MXN (6m carry -0.4%).
10. Short EM exposure: Long USD vs TWD and MXN Long USD-MXN:
The MXN looks to be on a downward track through to 1Q due to generalised pressure on EM currencies coupled with uncertainty regarding Trump’s trade and immigration policies. Brexit and NAFTA are different animals, but price action in GBP could be instructive in terms of understanding how the peso might trade – GBP rallies have been limited and short positions have been very sticky. Long USD-TWD: This offers neutral carry and is appealing against a backdrop of EM currency weakness, Chinese growth expected to print at 6.1% in 2Q, ongoing CNY depreciation and the risk premium related to Trump’s policy biases.
11. EM relative value: Short TRY-RUB, long INR-KRW, short SGD-INR
Owning positive carry relative value structures that are directional to a weaker USD are appealing. Short TRY-RUB on relative sensitivities to Trump’s policies, growth and external balances, and capital outflow risks. Long INR-KRW on political risks in Korea, sensitivity to Trump’s policies, and exposure to Chinese growth and FX depreciation. Short SGD-INR provides attractive vol-adjusted carry; SGD will likely underperform as long as expectations of MAS easing remain in place.
12. EM Trump basket: Short MXN, TWD, KRW vs long RUB, INR, CLP
Currencies sensitive to Trump’s policies and a deterioration in risk sentiment are expected to underperform (MXN, BRL, ZAR, TRY, KRW, TWD, PHP), while those more insulated (INR, IDR, THB, RUB, CLP) should outperform. Long RUB, INR, CLP vs Sell MXN, TWD, KRW (6m carry +1.2%).
13. CNY depreciation: Own 1y CNH seagull structure (6.80/7.13/7.50 strikes)
Our base-case scenario envisions USD/CNY rising to 7.30 by the end of 2017. The structural richness of implied volatility over realised argues for short volatility structures. Additionally, short downside volatility is appealing because there are few fundamental reasons for the CNH to trade meaningfully stronger over the next year. Owning a 1yr USD/CNH zero-cost seagull structure (6.80/7.18/7.50 strikes) offers a maximum gain of 4.2%. With no digital risk involved and limited convexity, the position can be conveniently delta-hedged. Losses are unlimited if USD/CNH trades below the 6.80 strike in one year.
14. CNY – escalating probability of free float: Buy 2yr USD-CNH call spread (7.80/8.40 strikes)
The probability of a free-floating RMB will likely rise steeply over the course of the next three years and become almost a nearcertainty by the end of 2019. We assign a 20% probability to a free float in 2017 but a 50% one if the US took major trade actions against China. In 2018, we see a 50% probability of a free float, rising to 80% by 2019. Selling topside optionality significantly reduces the cost of vanilla call options and the term premium is not high. Maximum leverage is close to 6x beyond 8.40 in two years and losses are capped at the premium paid.
15. Buy USD-SGD one-touch to position for EUR-USD parity
In 1Q17, we expect EUR/USD to break through the technical support at 1.05 and reach parity. If the pair does indeed test 1.00, USD/SGD should rise towards 1.50. The SGD has one of lowest implied vols in EM (3m implied volatility at 6.7%, against 10.0% for the EUR/USD), making it relatively cheap to express a directional USD view through options. Buy USD-SGD 3m one-touch knock-in 1.4950. The maximum leverage is 5x, while the maximum loss is the premium paid”.
Copyright © 2016 Societe Generale, eFXnews™
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