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EURUSD levels of 1.2250 suggest that the euro is seen as an attractive alternative to the US dollar by the market. But in this context let us refer to Thursday’s ECB meeting. Even if the trade-weighted euro has risen far less than EURUSD, concerns as to how ECB President Mario Draghi sees the recent EUR reaction is likely to keep EURUSD under control until Thursday.
That having been said, our forecasts were set at relatively conservative levels – a peak of 1.23 on EURUSD -to take account of the fact that the euro is no longer undervalued from a structural perspective (the REER is within a percent of its 20Y average) and indeed is materially overvalued compared to any cyclical interest rate model (EURUSD is overshooting fair value from 5Y rate differentials by between 8-12% depending on the lookback period).
In addition, we were cautious about the potential for US corporate profit repatriation together with a more assertive Fed and positioning to weigh on EURUSD in 1Q (we set out a low-conviction forecast for a dip to 1.14 in 1Q’18).
Trade recommendations:
Buy EURUSD (cash) at 1.2244, stop at 1.1966.
Long EURJPY (cash) from 136.23 in the recent times as BoJ maintains status quo in its monetary policy. Marked at-0.62%.
Long a 9m 1.80 EURNZD digital call with a 3mo 1.80 window KO. Paid 17.5% on November 21. Marked at 18.3%.
Prefer a call ladder spread in GBPAUD as we expect limited spot appreciation and topside volatility, we recommend buying a call ladder of diagonal tenors. Buy 1 ITM Call of 1m tenor, simultaneously stay short in 2w 1 lot of ATM Call and Sell 1 lot of OTM Call of positive thetas (strikes 1.5260/spot/1.5610).
That structure improves the odds compared to a call spread ratio as the maximum and constant profit zone is reached over a range instead of a single spot level.
However, the risk is potentially unlimited above 1.5610, and investors would have to delta-hedge dynamically the trade in the event of fast upside.
Buy-and-hold structure and Greeks’ behavior: The above profile sells convexity. Being short gamma implies a buy-and-hold profile, as the full leverage can only be monetized at the expiry.
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