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Friday 5 January 2024

2024 FX & Rates thoughts

 


Hey all... its been a very very long time without a post... I was never allowed too... but that's changed... so I'm going to quickly share some thoughts on some markets as we start 2024... as always with these things, dont take it too seriously and do ur own work before you make a trade..

Anyway,

2023 brought us narrative cycles that changed from extreme to extreme, every alternate month. And all that was left at the end of it was a 30yr Yield aggressively unchanged, Stock markets at record highs, credit spreads close to tights and uncertainty (VIX) seemingly a thing of the past. 


Many explanations given as to why 2023 didn't go as many predicted, and theories to rationalize the resilience; be it the Fiscal Deficit, Slower monetary lags, accumulated savings or even just the recovery from the pandemic shock. 

In this post, I am not going to dwell on explaining what has happened, nor am I going to try and predict what will happen next… You have plenty of Bank strategists who will get it wrong instead!

I am just going to work through some thoughts on what the markets are telling me now, what scenarios are in the price, and where there may be trades to take for those that disagree on which path 2024 takes.

So starting off with Monetary policy, and firstly, the path for the Fed. With Powell’s Pivot coming in the December FOMC the market has rushed to price in close to 150bps of cuts in the coming year, bringing policy from 5.30% down to 3.8% by Dec24, before settling at 3.25% out the curve. With this, the conversation has drastically shifted since Q3 ‘23 from “will the fed cut”, to “when will the fed cuts'' and then into ‘24, “how far will the fed cut”.


Here we have the path for the SOFR, plotted with the option implied breakeven. Without trying to get too cute about it, it's going to be hard to properly monetize a view that sits within these bounds. When we think about what this shows us, it's clear the market has finally removed the tail to further hikes from the Fed. It’s almost a *certainty* that rates will not be sustained at >5% for any meaningful time. On the other end of the distribution, we see that the market is unwilling to meaningfully price sub 2% rates, or a return to the “old new world” (ZIRP). 

Removing the tail to >5% FF is clearly a positive for markets and risk assets, and with recent Fed commentary, it seems the hurdle to bring this back into the discussion is extremely high.

This is all well and good, nothing I am saying here is at all controversial. Not least because this is now how the Fed is guiding us. They are now communicating that, with the sustained drop in inflation, keeping policy rates unchanged will be considered marginal tightening. With the running rate of PCE (3-6mma they love to quote) currently at 2%, and the continued “vibescession” in the air (asurvey data), the FOMC has correctly determined that it's the end of its 2yr long program of tightening. 

As such, a normalisation in policy will be required to keep the Real fed funds curve stable, (at the current level of tightness) If measured using FF - Core PCE, then the current stance of policy is set at 2.25-2.5% Real. As we look into 2024, and if the forecasts play out for PCE , then if the Fed do not act, the real FF in 1yrs time will be nearer 3%, somewhere between 2-3 additional hikes. It’s now clear why the Fed are forecasting 3 cuts next year, this is with the view to keep real FF broadly stable. And as such, barring any drastic changes on the price outlook, the ceiling for rate cuts is sensibly 75bps. 



With 150bps of cuts priced into the curve however.. We not only a see normalisation of nominal FF, but a loosening in real terms... to the tune of about 75bps (ie the 6 priced vs 3 from the dots) 

This can be argued as approximately fair, as of now, depending on where your expectations for the US and Recession's this year land. If you do believe that the Fed will be placed into a scenario later this year, where growth has slowed substantially and the labour markets have meaningfully weakened, the Fed will clearly need looser policy. You will certainly require more than 75bps of “real easing”.. Likely needing a Real FF south of 1%.. And thus you will see closer to 250bps of cuts needed to get us there.

(However we note that a FF around 2.75% by Dec24 still falls within the bounds of what our option probability fan chart shows us.)

But there is a time decay associated with this view... a steady economy/labour market, will see us continuously can-kick both the timing and depth of the cutting cycle as we traverse the year.

Data remains far too resilient to be currently expecting a recession, and as we pull to par and take out those cuts, the negative carry of being long the front end will start to seriously burn. Dragging the curve higher, with the market questioning at times (tho likely to no avail) that policy is not tight enough. (replaced with just longer at current levels).

Put simply, if we assume 3 cuts to be the minimum (its not), and circa 10cuts needed to respond to a <meaningful> slow down (tho it'll be 4-5 bigger cuts to bring us 250bps lower).. To receive the front end here with 6cuts priced you need to be just shy of 50% confident that the US will experience a severe enough recession that forces the Fed to actively loosen policy.

Now again, I'm not gonna sit here and say one way or another whether that's gonna happen… but economic momentum is still broadly strong, and with global regions (Europe/China) likely near their own nadirs, it’s neither an easy, nor cheap bet on this outcome.

Whilst there has been a slowing in Labour markets, if there is one lesson corporates will have learnt post Covid, is that letting go of staff may cause even more problems when you need to re-hire later on… perhaps the bar for that major labour market weakness is likely higher than a “typical” downturn…

AND we will still need to deal with the balance sheet in this outcome. In the past, the Fed has used this as the first lever, but its recent experience with starting the tightening cycle contingent on the ending of QE in '21 cost the Fed valuable time in responding to the inflation wave, and they know this. It's definitely possible to see normalisation cuts, whilst QT continues (or at least slows).


A quick look at market implied forward real yields and we have settled with 1.5/1.75% across the entire spectrum as the appropriate real yield.. if/when the Fed really needs to respond to the data, these will be meaningfully lower... and in the meantime, the fed told us they are capped at ~2.5?

            So whats the trade?

Steepeners are clearly the most popular macro expression.. And to be honest, they seem inviting.. The Fed will cut… The Fiscal is fucked… Curves should steepen!

And im sure they eventually will, but the carry to hold these will be painful for many and almost certainly a chop fest (as has been the case in Q4 ‘23).. Timing is critical, and chances are you can be patient to get into these.

So as we stand right now:

-even if the data tells you there are no more hikes.. 

-even if the Fed is telling you it sees 75bps of normalisation… 

-the market is still asking 150bps as the hurdle for the year for your steepeners to perform... 

I’m not sure the data is anywhere close to leaping that just yet…

To play a similar idea (fwds in the belly are too high) + that they should be pricing a normalisation to the 2-3% range rather than 3-4%, I have preferred the front end flatteners… leaning against the cuts in the H1’24, and playing for deeper cuts into 2025+, this has been the core risk in my book since the summer of last year..

** quick note here... many smarter people than I tend to push back and tell me that the Fed only has a window to cut in ‘H1 as the US election starts to muddy the waters.. And yes I’ve seen the historical analogues, yes I understand the arguments but no I do not think this is a strong enough reason to be in on imminent Fed loosening of real rates.**

The benefit of this position is the carry profile it offers, especially in lieu of the current data that we see.. But of course, the true distinction between the two choices (which ultimately both playing for the same end result of Receiving the belly) is that one is Long Vol (steepener).. the other is Short vol… And the risks that come with those two distinct profiles.. (ie if the Fed truly needs to cut, no reason they can't be 75/100bp steps..)

If we run a little thought experiment and try to value the different points on the curve in this eventual recession scenario.. How is it going to look? lets consider the 10yr point having a real yield somewhere close or lower than 0.5%...and breakevens likely around 2%.. puts our 10y yield somewhere 2-2.5%.

Ok... so... for our 2s10s (at -40bp, but crucially +15bp 1yr fwd) to be performing, we are needing the fed to cut well past 2%.. meaningfully more than priced..and even outside the realm of the option distribution... at this point, if this is the outcome you need its probably just better to own sofr call spreads...

The steepener is long vol.. It's not just owning the tail of the sooner/deeper recession… But also *could* perform if we see a re-acceleration of growth, sticky wages and potentially any topside risks to input prices (geopol etc)..  so whilst i've hated on steepeners.. they *can* still work in this world only if we assume the fed never hikes again and that there only possible response to data is chanting "higher 4 Longer"... This is the boogeyman of the bear steepener that we saw last summer. 

To hedge my core flattener against the risk of a bear steepener type move, i've re-engaged with puts in US long end at the turn of the year... the market seems incredibly overweight fixed income again, and with the data not cracking, too much priced, and a ton of issuance coming, it seems too rich.


Global Rates

So how does the rest of the world look? Below we chart (somewhat messily) the main Global CBs, and the quantity of rate cuts priced into ‘24 and ‘25…



Of course, they all have very different starting points, and many EM’s (much like the tightening cycle) have begun their journey before the fed. But the broad slope remains the same for all, 2024 is where the majority of cuts are, and 2025 flattens off dramatically. 

Looking at these from the same perspective as the fed, lets see how spot Real rates, and the market implied (vs fcast) 1yr fwd real rates compare. 

We see a very mixed picture , the US, EZ price the somewhat “fair” probabilistic loosening over 2024, with Real yields dropping 75bps or so, but even across the G10 landscape, the view is very different. The UK, Aus, Norway all stand out with marginal tightening in real terms… (with only 100, 75, 120bps of nominal cuts priced respectively)..



Emerging Markets are very mixed, with the Latam CBs drastically normalising their (arguably) way too high real rates, and the typically prudent CBs of the CNB and BOK see a slight relative tightening. 

There is a lot of nuance here though… all these CBs here have different mandates, different reaction functions and different asynchronies along their own cycles.

The point is, when looking into front ends as a tool to play for the worlds 2024 may turn into, we should be careful with which curve to pick. You might end up getting the call right for the US, and not monetising it at all.

My quick thoughts to these curves, without elaborating further, are that HUF/ CLP price a bit too much, and that KRW/BRL/CZK price too little.. (many reasons for this, wont get into it here..)

Global rates correlation has only increased in the post covid world, something that as the impacts wash away, should diminish.. But for now, if one agrees that US Front end are a touch rich, patience will be rewarded, and there will be far better entry opportunities for the fundamental receivers into Q2/3..


Interestingly, while the Rates market suggests a ~50% likelihood of a meaningful recession, this sentiment is not as evident in the credit market with CDX in $ HY merely ~360bps and IG ~60bps. . This divergence is noteworthy as it indicates wildly differing perceptions about the economic outlook.

Following the initial shock caused by last year's banking crisis, there was a notable decrease in cross-asset volatility as we climbed the wall of worry (ex a minor Long end hiccup in sept/oct).. This sucked money into the credit spectrum, baited by the prospect of high total returns.. Culminating with spreads ending the year basically at the tights since the tightening cycle began. Combined with a large rally in UST, we saw a considerable re-pricing lower of costs associated with corporate and sovereign funding.


HY & select EM Sovs have been presented with a golden opportunity to refinance. in Jan24 we should expect them to make the most of it with sizable amount of issuance among the crappiest of names.. (turkey CDS traded sub 300 guys... come on now..)

IG does looks very different.. With many stronger balance sheets than countries, IG treasury departments did a superb job of terming out debt at low yields/spreads post Covid (much like the household balance sheet did)... and whilst there will of course be a beta, I don't have too much concern over IG even in the more meaningful recession scenario…

One major trend we’ve seen also, and something that just feels like a car crash waiting to happen is “Private Credit”... not sure I’ve gone a day without hearing about it.. It's incessant.. and after Blackstones/Apollo’s shocking Xmas videos, I think we can all join together and pray that there is some form of Karma in the world..

When considering valuations.. Realised default rates are broadly speaking low, albeit slowly rising. Perhaps currently around 4%. Forecasts for this are set to rise modestly to around 5-5.5% for 2024, which (given a range of fair recovery assumptions) does not make HY spreads at 350-400bps mispriced in any meaningful way… However in a typical recession (whatever typical is) , default rates are historically observed to realise more like ~8-14%… if what the rates markets are pushing for comes true, there are a lot of accumulated credit positions that may start to sweat and CDS hedges needing to be placed… 

I could talk now about equities at all time highs, valuations blah blah, but I won’t.. I'll spare you your time.. But I know that Credit won't sell off if Equities don't... what i do know is that I will lose less if I'm wrong. 

As always, using CDS as a macro instrument is functionally just SPX puts in disguise.


Ok so what about FX

2023 was, on the surface, a pretty dull year for FX.. EUR traded in a 7 fig range.. Generally speaking monetary policy cycles were synchronised, and with no major economic divergences, we saw a distinct lack of vol!

Under the hood however, we saw a major dispersion. And Whilst G10 was fairly bounded, the low vol year saw a substantial drift in relative performance as the year progressed.


So what do you do if vol is low in FX? The FX carry trade! 

If you came into 2023, and just sorted by Yield, you did pretty amazing just in spot terms alone... Add in Carry and boom, what a year!

Probably one of the best in history (at least my career) for the monkey brain FX carry strategy. 



Whilst there are a few anomalies (Switzerland: SNB FX flow / Safe haven.. South Africa: Reg28 Pension flow/ garbage), the high yielders really did outperform!

Another defining factor for FX returns in 2023 was the normalisation of Current accounts post the Ukraine War shock in 2022 on trade balances.. Unfortunately it seems in 2024 there is no clear story here, or any (+/-2%) shifts in CA expected.. And hence will not dwell on this.


Looking ahead, the current narrative for 2024, which I have no doubt will be heavily questioned, is that as the Fed Cuts, you sell DXY… this falls apart in two major ways.

  1. If the fed is cutting, so are other CBs (as is priced)... Interest rate differentials will remain somewhat constant.

  2. IF the fed is cutting <meaningfully>... something is likely ungood.. And I’m not sure that's a world I want to be limit short DXY.. 

Now of course, a caveat to 1) is that, perhaps we do see some divergence between US / EU / Asian growth in ‘24, in which case you have an economic vol dampener alongside a normalising Fed, and you have a green light to play the FX carry trade.. 

to 2) its of course more dependent on the risk charateristic, CHF and JPY can easily rally vs USD, but its hard to argue that many others will..

As such I find the arguments for a meaningful USD weakness in 2024 to be somewhat poor, and as such not something I'm currently positioning for... Preferring to think and act like DXY is in a range, and that we are closer to the bottom than the top right now.

So let's look at the current rankings of Global FX, measured by their Carry/Vol ratios. The Usual suspects are clear, much like in 2023… And you can bet the accumulated position in those CCYs is chunky. 


(INR a standout, but purely a function that Vol is non-existent and so the denominator really skews things)

Here’s a messy chart again, highlighting how these ratios (for some select ccys) have evolved over the past few years.. And its clear why 2023 was a record year for Carry.. You had not only decade highs in yields, but vols declining too!.. 



But they have peaked. And looking forward, it's clear that the Carry component will drop, the question will then be how the Volatility side of the equation will develop. 

you can easily get a double whammy here, and mostly felt in EMFX..If you get a normalisation in policy rates (see Latam) AND an increase in Vol! Then things will get spicy.

A few expanded observations would suggest that; if 2024 goes south.. Then CEE FX and Latam will be most vulnerable.. MXN and HUF especially. (I will caveat here that the story in MXN is just so powerful (Remittances, Reshoring, Rates) that it will require a <really meaningful> recession to truly whack MXN, but it will be spectacular if it occurs)..

An unwind of the FX carry trade would benefit Asian FX vs CEEMEA/Latam, and will see CNY,  JPY outperform.. I suspect 2024 will be continue to be a good year to trade Factor FX models, especially between regions within EM...

One final observation is that the depressed implied vols across FX, and wide interest rate differentials across many pairs, make for very cheap options... If you are inclined to be bullish USD, USDCHF, USDCNH, USDTWD (and USDJPY to lesser extent) calls are cheaper than the forwards ! positive carry / Long vol is a nice combo to have... and within the Bearish USD camp, some HYers (MXN, BRL, INR) offer cheap ways to get long risk.. (ATMF-20df spreads listed)


As we look ahead to 2024, it's evident that one of the defining features of the year will be the series of elections taking place globally. This is not just a series of isolated events, but a significant occurrence where like 4 billion people voting in many of the major economies.  This is set to be a major influence on individual countries, and potentially shapes the course of geopolitics and economic trends for a long time ahead..

In EM, elections always take center stage. Investors will be closely watching, waiting for the wave of sell-side analysts promoting narratives of game changing structural reforms and pivotal economic turning points. A more cynical view suggests that while these stories are often surrounded by excitement, they often lead to unrealistic expectations which cannot be met by the flows. Nonetheless, for the spivvy traders, these periods can offer a plethora of trading opportunities, particularly as the RM world get caught up in the whirlpool.

Finally, the US election cycle is gonna start reallly kicking off.. its not as clear as prior elections with regard to the USD / Risk assets (2016, 2020 both clear+binary)... with both sides fiscally irresponsible, its hard to make a strong case either way for now... of course tho, this will change into the election as the market takes sides.

Anyway,

I think that's enough for now... I'm excited for 2024.. markets are a little confused, and that always brings good trading opportunities.. so long as you aren't too stubborn.. 

Much like 2023, I don't expect a clear narrative to last >2 months (unlike 2021/22). The Market will be desperate to jump again and again into Recession trades at the first moment they can, but perhaps like last year, it just never comes?

As for this blog, I can't imagine it will be consistent or active... Just wanted to write a lil something as I haven't been allowed too for the past 7 years or so.. GLHF




Ok... coming back a few days later to finish this off...I wrote too much and feel sorry for anyone who has made it this far… I’m just gonna write a little one liner with an outlandish prediction for the markets I think about.. not to be taken too seriously

  • US: Steepeners at risk… Equity pain trade is still for it too just roof higher and higher… The election goes somewhat smoothly but with a Red win but not trump (don't ask me who)

  • Europe: Multiple Greenshoot narratives keep getting trampled on as the year progresses until Italy just sends it over the cliff… ECB QE restarts here ahead of everywhere else.

  • UK: Fucked, but at least the Tories will be gone this year.

  • Japan: The BoJ Hike… but will be guiding cuts by the end of the year again as 25bp base rates kill their economy.

  • China: Xi bought some time.. Mid cycle rebound, maybe more interesting in 2025 but boy will people try the Long China Short US trade many times this year.

  • Korea: zzz maybe rates a bit high

  • India: The Wildcard for a Geopol flare up… But the RBI will manage the FX on both sides.. Can INR print 0 vol??

  • Czech: CNB will be the first CB to stop cutting, having been slow to start.. when or where that is, idk

  • Poland : The Tusk hype will disappoint.. Whilst it's the one good political development to occur in ‘23, the flows wont match the story.

  • Hungary : Hungary just deserves to get punished  I’m not even sure why its in the EU at this point..(#HUNGEXIT?), Too many cuts are priced into the curve and the Currency will become vulnerable to something nasty as they make one step too far.

  • SA: They need to be very careful what side they choose on the global stage.. deep down the election I’m most excited about… ANC to print sub 50% but with no strong oppo, gonna be a fun one.

  • Israel: Expect the GeoPol to calm down, and the Shekel is structurally cheap!

  • Turkey: If you’ve been brok’d into TRY or Turkish Assets, I wish you good luck.. I just want to remind you that the windows are normally 6months long before the Erdo Rug .. Its been 3months already.

  • Egypt: maybe 1yr NDFs >50 a bit high… 

  • Brazil: USDBRL just one big coil.. Should be fun when it breaks but could be a long time away… maybe some spivvy short vol structure (WDKO anyone??) kinda think selic fwds too high too but we know how that usually ends...

  • Mexico : best fx fundamentals out there… most vulnerable to the downside… is Vol cheap?. .. Banxico can cut a lot more than priced and MXN can get destroyed if the US consumer does crack. Steepeners here look much better than in $..

  • Chile : quite dull tbh.. Not sure I like the FX tho.

  • Argentina : I’m just not quite sure how global finance has fallen in love with Millei, has anyone actually listened to him?! This won’t end well..




Monday 17 July 2017

Summer 2017 FX & Rates thoughts

Hi guys,

Quick scan across some markets and some associated thoughts, have been mostly away with exams and travels.. so relatively brief thoughts.

Interesting few months since I last posted here, mostly led by a re-shifting in rate expectations led by Canada and UK, with the Central banks priming the market for a removal of recent surplus accommodation. BoC has already realised a 25bp hike, and has another 25 to go to remove the 'one-off' adjustments seen in response to oil price declines. The BoE is also, inconsistently, trying to prime for a removal of the post-brexit 25bp cut... This as well as the ECB bringing forward removal of QE and potential rate hikes into the equation has led to some sizeable moves in rates markets, and by derivation FX.


A chart we've all seen a thousand times now, Bunds breaking the 50bp level! opening up room for a continued weakening.. Overlayed we see ERz7z8 (Euribor futures spread for 2018). Pricing in 22bps of moves, with consensus talk for a move by ECB at earliest of Q4'18, its hard to see this curve price too much more than 25bps (aside from perhaps positioning led moves).. This broadly limits my expectations for 10y yields especially given already steep 2s10s, and unlikely major major shifts in terminal EUR rates projections... This being said, with current depo rates, and a slightly sooner taper, can see bunds ticking to 1% before looking to consider fading.

50 days later, and a BoC hike has caused USDCAD to drop by over 8%.. not long ago the macro theme was worried about housing crisis, and now sell-siders (GS) looking for 1.15s... quite the shift in sentiment.. Traders been trying to fade a long the way, further being squeezed by a hawkish BoC... The main discussion needs to be around whether its the start of a prolonged hiking cycle or merely just a removal...

June 2018 STIR spreads between BAs and EDs trade flat.. having traded 60bps wide at the start of the BoC move... A tactical fade here might work better in rates than buying USDCAD into 1.25 support.

CADNOK my prefered FX set up to trade CAD from the downside here as trading into significant resistance with well defined levels to lean off for options structures or stops.

CADNOK daily ranges
For indic purposes, 6.7/6.25 DNT mid marked at 25% (5months) as a way to play the range.. put spreads also attractive.. or just short spot.


EURUSD has also continued its trudge higher as both EUR supported and USD has been sold off in this global convergence of rates.

EURUSD daily trend-line
So... here we are again.. at the top end of this multi-year channel... make or break time. EUR Futures CFTC positioning is at extreme longs which makes the challenge harder, but by no means out of the question.

Having little conviction on EURUSD here about this break, I'd rather lean on the possibility of a fakeout and return to range.. This can be done with a 1x2 put spread 1.13/1.10 for zero cost. downside breakeven 1.07 for a year end position..

1x2 ps
EURUSD still trades cleanly off rate differentials (as it tends too) and a popular trade here is Long UST / Short Bunds ( a proxy for long effectively).. Broadly I think the pressure is on tightening but momentum will be hard to continue from here, especially as we are currently leaning on overly optimistic ECB and dovish Fed... the needle can move back quickly and take a 20bps of the spread (or couple hundred pips in eurusd).

In Latam / EM FX.. I've been looking at USDBRL downside here.

USDBRL put spread levels
EM FX should be in a strong condition to rally vs the USD going forward, especially across the summer doldrums and slowly performing macro data. Neutral Fed, weaker USD, low x-asset volatility and tight credit spreads should allow for continued appreciation broadly.

A 4 month 3.10/3.00 put spread is mid at 0.53%, offering a 5:1 payout for a further 5% rally in BRL towards year end. A cheap way to participate in a further EM rally.. Similar pictures in ZAR and TRY. Favouring limited loss structures given the potential political incidents (as we saw earlier this year), and taking advantage of low vol / high carry to get higher payouts on these put spreads.

Popular positioning is to have short AUD as a Long EM hedge here.. All things considered, if it wasn't for the technical picture I would argue it would be a nice (and cheap risk off hedge) to have on. Instead, I'd prefer once again to look at front end Aussie rates.

1y1y OIS rolls about 25bps over 1yr, as the market has started to price in hikes in both RBA / RBNZ (just because of the BoC? probably) ... but the RBA will likely continue to stay dovish. and so either at these levels, or marginally higher, it should work to put receivers back on.

AUD 1y fwd rate change expectations.

 Having momentarily priced cuts in early June, market is quickly back to recent years extreme in pricing. (using 90 day bank bill futs).. Favour using OIS vs IBOR to receive as housing market concerns and bank concerns could worsen.. sacrificing a few bps of roll to remove probability of a housing blow up to MtM pnl is perhaps worth it.

AUD 1y1y OIS 


Perhaps thankfully, local mortgage providers have been hiking rates, which take any pressure off the RBA.. the market may be getting ahead of itself equating Canadian macro with Australian and with a decent sell-off that we've seen, fading is worthwhile.

Another Interesting market to be hit by this rates sell off is CHF.. A notably boring market until recently.

EUR and CHF hikes priced over time
CHF has followed EUR in pricing hikes going forward (arnd 15bps in 1y), in fact pricing in marginally more up to 3 years out. The SNB is not under the same pressure as the ECB to bring normalisation on the table (as I still see most of the hawkishness is around tapering rather than hiking outright, thus SNB has time to be stable) as such if we are to look to fade this European front end sell-off receive CHF.. 6m3y rolls 12bps into year end which is attractive Carry/vol, and more so than fading EUR rates.

Perhaps hedging out global rates risk and rec CHF / pay EUR.. With marginally more priced in the belly for CHF (as above) can structure a positive carry position to play the divergence (or separation between the two)...

CHF 1y rate change expectations

Or can more simply be done buying ESZ8 (euroswissys) vs ERZ8...

In other rates markets, without going into much details.. I still favour belly/curve receivers in ILS (5y etc).. hefty roll, and a CB thats still neutral as hell... not too mention shocking recent CPI data and a continued strong ILS.. BoI ain't going anywhere anytime soon and ILS rates will continue to outperform, as well as pay double/triple the roll as it costs to put on a rates hedge (Favoured a TY risk reversal here for close to ZC).

ILS rolls (columns are fwd start dates, rows are swap tenor)

In Latam, Chile has likely close to finished its cutting cycle, but domestic data is still really struggling and with CPI plummeting, growth waning, commodity prices not overly supportive and CLP doing nothing in their favour, BCCh will not be moving upwards anytime soon either.

2y spot trades at 2.6, yet curves have steepened (2s5s gone from 25 -> 75) offering very attractive rolls, with potential for further cuts if data continues to worsen.. In the Latam space, with Brazil cutting and Mexico closely following in 2018, I see it unlikely for the BCCh to change tone soon, as such receiving is good.

So where are we left?? Hmm, mostly received globally.. Israel, Swiss, Aus and Chile... and arguably waiting to recieve EUR rates if they sell off more.

Overly concerning to be left this one sided, so look to pay some $ steepeners and outright option structures to neutralise this global rates risk... Bund 160/162.5 risk reversal pays u 5 ticks where spot is now, so a bit of this, something similar in TY and then positive roll steepeners to balance the book.

So having highlighting some FX/Rates trades... The main themes out there continue to be the extremely low volatility environment... x-asset vol is close (if not at) all time lows, and like with all the previous times, it does eventually blow out, but with no catalysts being the spark, we may just trundle along with our 6 vol times... sigh.

Another interesting development is the increasing real rates, and sell off in TIPS.

5 year real swap US
Trading against significant resistance, and little to suggest a realistic shift in productivity or economic activity, i struggle to see a much higher real rate in the US than 0%.. as such receiving this might be ok as a trade.

But with Credit spreads this tight, maybe some subtle risk off trades might be worthwhile... just in case..

Sunday 9 April 2017

FX & Rates thoughts - April 2017


Hi guys! 

So another blog post, once again starting by showing the very well defined range in US 10s.. This seems to be driving markets and narratives, and will likely to continue doing so. Since the last blog post, when US 10s were also at 2.35% we have had a nice round trip to the top of the range, and back to the bottom. Mostly because the fed really ran against market expectations and hiked in March.. but then positioning, a debate between hard and soft data and a topping off of inflation has brought these expectations back down to earth.

In the immediate term, it seems Friday's price action has put a floor in yields for now. This seems to line up with other rates markets - Bunds look to have found support against the lower trend-line (charts below).




US 10y yield daily chart
Bunds daily chart

Friday's NFP had a bit of everything for everyone.. weak headline and mediocre wage growth coupled with decent u/e rates - it seems the market has spun the narrative that lower NFPs are signalling we are reaching full employment, and that a running 3m avg of 150k+ is still very strong. I can't massively argue with this logic and am still leaning on the opinion that market is now under-pricing fed activity.

Comments from Dudley and other fed-speakers has shifted the conversation away from Fed funds and towards Balance sheet in the past month or so... So I suppose we start here for this blog.

UST holding by the fed against maturity, and cumulative (taken from NYFed SOMA page)
Above shows the breakdown of UST ownership by the fed. n.b. not MBS, just USTs. (average holding somewhere in the 2021s/22s)

With the Fed balance sheet at 4.475tr $ (FARBAST INDEX), we can see see just from the cumulative graph that this unwind of the balance sheet is going to be a *slow* process. Arguments can be made that they unwind MBS related stuff first as less direct secondary market impact, but aside from the detail, the raw amount to unwind is massive. A purely passive rolloff of this ownership will take 5 years at least to have a substantial impact on the fed's balance sheet to bring it down to more neutral $2-3tr, levels.

I for one cannot, and will not, try to make a prediction of what the direct impact on monetary conditions will be from BS reduction.. is 1tr equivalent to 25bps of FF?? I have no clue.. I dont think anyone is really going to be able to make a concrete guess at that, including the FOMC.

So with the discussion around pausing the FF hikes to start the reduction, I don't think this is an overly viable option to take, rather the fomc should clearly signal the pace, timing and size of the BS reduction (whether its through selling or just rolling off) and be tepid to begin with, ramping up the pace if necessary, but not using it as a replacement for FF rate.

Ultimately however, the balance sheet will be massive for a very long time, probably well into the next down cycle, and so the cynic in me would suggest that it won't ever fully normalise as the chances of not having a recession in the next 5-7yrs in US macro is so slight.

All this being said, we will be having much greater conversations in the coming months than what I've just said, and I have no doubt that towards sept the Fed will start being a bit clearer with what this involves.

On trade ideas, I think with the marginal buyer of long end US paper disappearing there is arguments to be made for a steeper curve. One that I look too is US 5s30s (in swaps charted)

US 5s30s daily
We trade in a nicely defined range, and has been flattening for the past few years, and rightly so. The reason I like this trade however is that if we get a serious discussion around BS reduction in the next few months, and the fed do, for whatever reason, deem it as a replacement for FF hikes being long the belly will perform nicely as there is a lot of roll built into it, and short the long end should continue to work.

It also carries nicely as a trade (2bp per month) which relative to the volatility of the underlying curve offers decent Carry/Vol. The technicals line up to allow for a clear defined stop and breakout (if the theme gets momentum).

The only things that make me uncertain, primarily come from the growing concerns around the pick up in inflation.

Looking at Oil y/y, it continues to drop and will be around 0 some time this summer..




This chart from Nordea above is perfect in summing this up, and is not just a phenomenon in europe, but for global inflation.. Core CPI globally remains meh at best. Further, the upside surprise this has caused will soon fade, and as we see below in the Citi Inflation suprise index, we have perhaps topped out on inflation "suprises" (fwiw this chart correlated v nicely with Oil y/y % change, which suggests this surprise index will be back below 10, and 0 by the summer).

Citi inflation suprise index

So what does this mean? Well, basically a few central banks (looking at you, ECB) got a bit too excited, and frankly with Core CPI going nowhere, the discussion about a tightening cycle is frankly ridiculous at this stage. Not something that should be realistically discussed for a good year at best imo. However this doesn't mean that we should be receiving EUR to me.. There will be a time not too far where we hit the serious discussion of tapering, and then perhaps curves can start to price in a realistic hiking cycle.. for the meantime, EUR 2s5s at 30bps probably is fair for a neutral upward sloping curve, but much like the US 2s5s did, it has serious potential to move steeper as we get into the cycle (in perhaps 1y time).. Buying dips in EUR 2s5s could be a fantastic trade in the next 6m-1y, but probably not right yet.


US 2s5s during taper tantrum

Ok, so there were a few rates thoughts, currently my book is set up with two trades from previous blogs

-- ILS 1y5y reciever at 1.50% vs EDz7z9 at 69 bps

-- SEK 1y1y reciever at -0.185% vs EUR 10s30s steepener at 59bps


On the ILS trade, the long/short rates trade idea has performed very well so far, Recieving ILS argument was made before, and still holds very valid today. BoI very sensitive to tradables and energy inflation, both of which are going against them as ILS rallies and oil y/y fades. the 4bp roll per month provides a nice buffer, and the ED curve steepeners hedge out global rates risk.

ILS 1y5y vs ED

A 10 month fwd 5yr ILS now trades at 1.31%, representing a PnL of 19bps from that leg.. On the ED, it is the same level as entry so 0 pnl.. Right now, given the correlations that ILS has to outright US rates, I look to cover here for +19bps and re-enter in a few weeks/months time when US 10s are back towards 2.5%, thus i am left long EDz7z9 at 69bps. Which fits well for a move back towards 75/80 towards June.



Onto SEK, managed to whether the volatility in EUR rates and maintain the reciever, a 9m1y is still marked at -0.25%, so a PnL of just 6bps.


The hedging leg here in EUR 10s30s trades at basically flat again off 61bps, but rolls the odd bp per month and provides coverage.. Stops at B/E for the 10s30s.

So along with these two pair trades, I like adding that US 5s30s steepener, otherwise nothing really new to me in Rates as shown by the chart below which show how much is priced into dec 2017 front ends... i.e. nothing, nowhere.

fix-z7 spreads
So, onwards and upwards to FX.. and the EURUSD is just.... ahh, Rate differentials. Sigh.


EUR vs 10y spread
A very strong relationship continuing here. As such its rather boring, EURUSD does appear to be leaning on a rather strong upward trendline here coming in at 1.0550s, so i expect a big of a fight around these levels from the bulls.

JPY vs US 5s
USDJPY is a bit more interesting, trading "cheap" to US rates.. balancing precariously above 110 it does provide, imo a nice level to lean off for tactical longs. Especially if US rates return to the range. USDJPY might be a more asymmetric, and carry positive expression of Short US rates here, especially considering the story from japan is quite quiet now the year-end stuff has passed.

perhaps eurjpy then looks quite cheap to own some topside in? if EURUSD is battling against support, and so is USDJPY, then double whammy in eurjpy!

EURJPY

As documented by many, Le Pen risk premium is being placed into EUR right now, but the risk still seems limited to me. EURJPY skew is chunky so could fund upside by selling downside here. Tight stops at 117 for spot trades makes sense for a move to ~120. 

One potential FX trade I like here, primarily leaning on Le Pen being a non-event for markets is buying some very tight EURCHF DNTs

a 1 month (may 10th), 1.0575/1.0825 double-no-touch is priced at ~10% given that spot vols are being marked higher for the risk event.. 

eurchf range
Vols are priced about 0.5 wide in 1 month EURCHF, so I would imagine the DNT isn't traded far away from BBG mids, perhaps 12-14%.. offering a decent 7+:1 risk reward for eurchf continuing to be boring (and no le pen).. decent pay-off to me and locked in loss for a significant tail risk (if le pen does win).

In other FX markets. USDZAR has been attracting a lot of headlines, with the FX heavily selling off, CDS widening as ratings agencies look to force IG selling (2-4bn of SOAF paper), so one can easily argue that FX will remained pressured, but with a neutral and supportive global environment, and the terrible macro becoming marginally less terrible, it seems it may be a nice currency to own, and now at a discount.. 

Technicals see us at a crossroad, so I steer away from spot trades as I dont want to be washed out on any news that could really hurt.

Instead 3 month 13/12.5 put spreads cost about 0.7% of notional, offering a 7:1 payoff to expiry.



Not a great deal of other things are interesting me right now.. Tho I do stress, this is me taking a "break" from markets, had an amazing holiday to Morocco, and planning my 3 month long summer holiday, so expect things to remain quiet from me, both here and twitter.

In summary

-- Covered ILS 1y5y for +19bps, left EDz7z9 steepener to trade the US 10y range.

-- Maintaining SEK 1y1y vs EUR 10s30s for now with a +8bps running pnl

-- Entered into a US 5s30s steepener at 58bps, stops at 50bps for a BS related trade

-- 1 month EURCHF 1.0575/1.0825 DNT, bbg mid at 10% (likely offers 12-14% tho haven't checked) for a good r:r Le pen snooze-fest

-- 3 month USDZAR 13/12.5 put spread at 0.7% of notional, as a way to cheaply participate in any continued EM rally


Monday 27 February 2017

FX & Rates thoughts - March 2017

I've been rather absent from writing (here or on twitter), so thought I would post again broadly following up from my post in early Jan.

To me, very little has changed in the global outlook that I see in the ~3 weeks I spent on a beach.. Nicely portrayed by rather sideways markets - US 10y trading the 2.3%-2.5% as shown here.. In what is a highly documented flag formation, suggesting that in the not too distant future we see a breakout in some direction, and maybe some accompanying vol.



With most of the discussion it seems around Trump policy still, and how that will eventually filter through to the economy (and thus fed policy). One of the big rates moves that we've seen, and probably the most important to me, is the acceptance that Trump is not going to create the large impulse in real GDP growth / productivity etc that was hoped end of last year.

US 5 year real yield
All this does lead me to wonder if the trumpflation trade might never result in any real progress for the US, we discussed in the last post that expected real GDP boost through Trump was a mere 1.1pp / year, but perhaps it may be even less.

Now of course, I am writing in this tone because fixed income has rallied, and TY is at the top of its range.. attaching a narrative to price action... If we were at 2.5/2.6% im sure all the narrative would be on the other side.. It seems leveraged money / CTAs are still decently short US rates and thus I can envisage a potential break lower in yields towards 2%, especially if the fed dial back any hawkish tone (or geopol risks, le pen, rise).



Broadly, and without going into too much detail, US economy is still strong, and Fed rhetoric remains hawkish to keep leaning on paying 2 hikes per year (currently priced 2 1/4).. Most likely imo starting in June, but there is certainly a non-0 chance of March. I would suggest the Fed likes to keep the option alive (with ~35% priced in), but as highlighted many times would prefer not to shock the markets and thus will not hike and clearly present June (~80% priced) (barring any major turns in outlook). If they stay true to course, I can still envisage US 10y at 3% throughout the course of this year.

Looking elsewhere, specifically the antipodean markets, some sense has finally returned! FX markets (no strong view either way from me on them) continue to rally with broadly strong EM sentiment and supportive data, but in rates CBs have regained control of the front end and moves have normalised significantly.





Firstly, the RBNZ said they would be on hold for 2017, and most of 2018 and those 2 hikes priced in quickly retraced, with now just under 1 hike priced, which is probably closer to fair given the rather decent domestic macro.

AUD rates also did as expected and IRZ7 has come back towards fix, with now just 5bps priced. Our trade from last post to Rec AUD vs US has worked nicely, selling the spread at 50bps, it now stands at 29bps (+21bps) and I like to lighten up my long AUD leg here, whilst leaving a bit of Short $

EDZ7 vs IRZ7

In my other rates trades, SEK 1y1y vs EUR 10s30s has performed nicely too.

SEK 1y1y vs EUR 10s30s
Rec SEK 1y1y at -20bps and paying eur 10s30s at 58bps were the entry points, a 10m1y SEK swap currently trades at -25bps (+5bps) and 10s30s is 64bps (+6bps), so the idea of trading riksbank policy (which they were ratrher dovish, and hit the fx a bit) with a global steepener hedge in EUR worked nicely for +11bps so far (+17bps if beta weighted EUR against SEK in 2:1 DV01 ratio).

I look to hold SEK recievers a bit longer as the carry is still decent and have protection on it until mid-year given recent Riksbank rhetoric. On the EUR leg, I still would favour having the hedge on ( as it also pays small carry, 1bp/month) but look to cover if we move much more..

A strong recommendation to read this blog on longer term rates if you have time - https://globalmacrotrading.wordpress.com/2017/02/24/a-view-on-long-term-global-rates/

And building on that, and looking for more recievers, I like the look and roll in the ILS curve. 1y5y trades at 1.50% vs 5y spot 1%, around 4bp of carry per month. Hedging global risks with an EDZ7EDZ9 steepener looks attractive here. Beta ~1 so can roughly keep DV01 same.

ILS 1y5y vs EDz7z9
ILS spot fx has rallied significantly YTD (chart below, REER) putting any potential shift in BoI narrative on hold for the immediate future. Inflation is slowly ticking higher along with global inflation, but I question how long this lasts with base effects from oil rolling off fast. BoI address this by saying the primary cause of the uptick to 0.1% y/y is through oil and small domestic administrative price changes.


oil y/y % change

ILS REER
With BoI decision to keep rates on hold today (http://www.boi.org.il/en/NewsAndPublications/PressReleases/Pages/InterestRate27-2-17.aspx) and a very neutral tone, I believe ILS rec work well with a global hedge in a similar set-up to SEK vs EUR rates. Noted ILS strength to dampen tradables inflation and whilst domestic data is solid, the BoI are in limbo where cuts are v unlikely, but hikes remain off the table for 2017, and even then the path will be v slow. Unless of course global inflation and other rates markets move, hence the ED$ hedge.

Of course, looking ahead to French election, whilst we still have plenty of time for things to develop (not to mention market noise around 1st/2nd vote).

Eurostoxx Vol has been incredibly bid, and rightly so if the chance of Le Pen winning was strong. April Futures trade at 27 points, vs currently 1m realized of 11 and front month contract of 17.

The Curve, J7-M7 trades at extreme levels, and has continued to move well past what the OAT-Bund spread has been doing.


I would look to fade this extreme move in implieds as the probabilty of le Pen remains small in my eyes - tho am aware i am not french, and really don't know the situation there.. As such being short Vol outright is perhaps not best, and so selling J7, buying M7 would work well on a normalisation of the curve or a Le Pen victory.

But like I said, to me, its not a coin-toss like previous votes, however I am far less clued up about it, so regardless of what I do, I will keep it very small indeed.

Given the inverted Vol term structure in EURUSD you can get long a 3m3m Forward vol agreement at 9.1% vs spot 3m of 10.6%, which could act well if Le Pen does in fact win, or works well as a hedge if probability rises. From last post, I am still long a Mid-year digi put in EURUSD at parity, however with spot mostly unchanged, its worth 14% (from 20%, representing a small loss) and whilst we are on the topic of unsuccessful trades, my USDCAD call spread never got going regardless of a dovish BoC, but recieving their front end rates still seems somewhat attractive. With Oil at YTD highs its becoming harder to short CAD.

Lastly, a bit of faff around EUR and USD curves that I've been looking at recently

US-EUR 2s7s30s fly spread vs US 10s
With a lot of carry/roll built into the 5-10yr segment of the EUR swaps curve, I look at receiving 7yr on the 2s7s30s fly which offers attractive carry against the volatility of the underlying fly. Doing similar in US but paying the 7s, can be seen to correlate nicely with outright rates (as above) but offers significant carry as a Fixed income short.

The Fly spot trades at around 66bps as a spread, but 1y fwd trades at 33bps. Crudely comparing to a US 10s level of around 1.80%. Whilst there is no major macro underlying theme for trading the fly spread, trading the correlation with global fixed income offers a very good carry fixed income short (assuming correlation remains) rough beta of 0.5 on the basis point moves (if hedging out US 10s risk). Whilst ED$ curve steepeners offer decent roll, it is far less than this.. but at the same time much less faff, so I wouldn't recommend for a quick FI hedge, but perhaps in small size can work as a decent trade.

And well actually, one more wafer thin, idea. From on the ground research of Ecuador over the past month (well mostly sitting on a boat or a beach) I have concluded that the economy is strong and sound, with good local optimism and lots of faith in the new president (elected last week) I quite like the idea of owning Ecuadorean debt from a carry sense, offering 500z spread in the 2020s, Argentina (with a similar rating, B) trades at 350bps.. Now the story behind ECU is mostly history of screwing over investors and large oil exports. However with decent fiscal measures concerns of default seem overdone. The inability to devalue their fx may hinder when EMFX is going down, but whilst rallying should be supportive, not to mention plentiful supply of dollars within the economy. When I look at debt sustainabilty against similar levelled names (ghana etc) and first glance from bbg numbers I prefer ECU, especially after exploring Quito and the nearby forests and villages I do.

Ecuador vs average B rated HY spread. 

Anecdotally as well, you compare development levels in say ECU vs neighbouring Peru/Chile/Bolivia/Colombia and you'll see an on-par or in some cases better situation for many locals, strong (and publically free) healthcare, decent (and apparently v rapidly improving) mandatory education until uni level and good weather (tourism innit) that the z spread of 500bps against ~100bps for the other names offers good value to me. For front end low duration bonds, and in this environment, this pick up seems attractive as a small back of the book long. Outright it might not be the best yield, but have you seen CDX EM? nearly less than 200bps...

Should add for disclaimer sake here.. i spent a few weeks there and about 10mins on bbg looking at it.. total tourist so probably don't listen to that last bit ;)

cdx em

Summary -
- Rec ILS 1y5y at 1.5% vs paying EDz7z9 at 69bps
- short FVS J-M curve at 5.5
- Long US-EUR 2s7s30s fly 1yfwd
- and for the ballsy, some long ECU 2020 $ debt..

and as always, not spelt/grammar checked, sorry... Just quick and dirty thoughts.