ECB Signals Steady Interest Rates as Fed Risks Loom Over Outlook 
New York Fed President John Williams Signals Rate Hold as Economy Seen Strong in 2026 
Stock Futures Dip as Investors Await Key Payrolls Data 
Gold Prices Fall Amid Rate Jitters; Copper Steady as China Stimulus Eyed 
BOJ Rate Decision in Focus as Yen Weakness and Inflation Shape Market Outlook 
US Futures Rise as Investors Eye Earnings, Inflation Data, and Wildfire Impacts 
Bank of America Posts Strong Q4 2024 Results, Shares Rise 
China Holds Loan Prime Rates Steady in January as Market Expectations Align 
U.S. Banks Report Strong Q4 Profits Amid Investment Banking Surge 
Global Markets React to Strong U.S. Jobs Data and Rising Yields 
ECB’s Cipollone Backs Digital Euro as Europe Pushes for Payment System Independence 
U.S. Stocks vs. Bonds: Are Diverging Valuations Signaling a Shift? 
In this write-up, contemplating monetary policy outlook and geopolitical surface, we refer to JP Morgan’s analytical piece and emphasize on the long vega exposure - 6M6M/+1Y6M FVA 1*2 spreads for hedging the simmering broad-based risk sentiments.
BoC maintains status quo in yesterday’s monetary policy, left the key interest rates unchanged at 1.75%.
Their reaction function, especially relative to the Fed, will likely remain one of the biggest uncertainties around CAD’s relative performance. CAD 2y OIS has declined 11bps in the past month, and now is pricing in up to three cuts by end-2020, starting in December. Our economists are forecasting the BoC to deliver insurance cuts in Oct and Dec, although uncertainty around this is higher for BoC than perhaps elsewhere where central bank rate cuts are being priced in.
While the US-China trade developments remain very fluid and we are bound to see a few more adverse episodes.
The Cheap vega ownership could be deployed in anticipation of the vega tenors receiving more attention with the spot now under the watchful PBoC hand, we recommend using the favorable vol entry levels to add vega.
Utilizing attractive pricing and positive rolldown, 1x2 FVA spreads are time passage friendly and low maintenance long vega positions that struck us as a solid buy in the current environment where low decay vega is well sought after. The basic construct involves selling shorter-dated FVA along upward sloping segment of the vol curve to partially fund the purchase of a longer-dated FVA that sits on a flatter part of the term structure. The roll-down of the short leg then compensates (or even eliminates, as is the case for CADJPY) the slide of the long position, all the while preserving the overall structure’s net long vol characteristic. The short leg is not large enough to disrupt the net positive sensitivity of the package to vol upturns. Consequently, the structure is a carry efficient risk-off hedge.
We screen for the FVA spread candidates based on their pricing (in form of a 1-y z-score) and the sensitivity to the ongoing market turbulence (in form of 2-week change in pricing of the package) (refer 1st chart).
In the case of CADJPY, the current levels are still a bargain by historical standards, even after the recent bounce. The net 6-month static vol slide (at the expiry of the short leg) deteriorated as the front vols spiked on the back of the recent spot gyrations but is still positive thus making the long/short structure superior to holding a similar long-dated straddle (refer 2nd chart).
Consider: short 6M6M CAD/JPY @8.7ch vs long 1Y6M @8.55/9.05, in 1:2 vega weights or short 6M6M USDJPY @7.6ch vs 1Y6M @7.55/7.95 indic, in 1:2 vega weights. Courtesy: JPM
