FX Markets Weekly: FX targets for the endgame

FX Markets Weekly: FX targets for the endgame

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FX Outlook: FX targets for the endgame

The ECB’s refusal to extend liquidity has put markets in endgame mode, where a local funding issue morphs into a global leverage crisis due to a succession of policy missteps. Four scenarios are plausible – status quo, additional ECB/Fed liquidity, ECB quantitative easing and additional IMF lending. We propose FX targets under each. The first and second look most likely, which in turn will drive additional deleveraging. Close longs in cyclical FX, sell more GBP and buy more CHF.

FX Derivatives

Front-end implied vols are at highs of the past twelve months on the back of massive market swings. EUR/high-beta currency vols now look rich relative to USD/high-beta vols and should benefit from a potential extension of the risk aversion move. A resumed correlation in USD/JPY spot versus US interest rates makes longer-dated USD/JPY vol an attractive sell versus AUD/USD. A relatively flat EUR/GBP vol curve makes EUR/GBP 6M implieds an attractive buy versus either EUR/USD or GBP/USD implieds.

Trade Recommendations

Policy inertia creates a low-liquidity/high-volatility environment. Cut longs in cyclical currencies and confine risk to currencies where fiscal risk is understated or where policy misalignments remain (CHF). In cash, sell GBP vs USD and CHF. Take profits on short EUR vs CAD, IDR and INR, but stay short EUR vs CHF. Take losses on short USD/CAD and JPY/KRW, and long CAD/JPY. Take profits on short 3-mo EUR/USD vol vs USD/CAD vol.

Technical Strategy

Extreme volatility provides evidence that risk markets have entered a transition phase which could lead to a broader consolidation of several months. A break of neckline support at 1160 in the S&P500 would confirm it and would give the already launched commodity currency consolidation an extra boost. EUR and GBP are expected to remain under pressure. Stay short EUR/USD and GBP/USD.

FX Alpha Strategies & Manager Performance

G-10 and EM carry are down 3% and 1% respectively this week. Forward carry has now turned long the USD across the board.

ENDS

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