FX volatility is easing off following the March Fed hike and the reduction in political risk, following the defeat of the populist candidate in the Netherlands and a wider bookmakers’ spread between Macron and Le Pen (refer above graph).

In our view, the FX euro vol market is complacent compared to the bond market, seeing the resilient 10y OAT-Bund spread. This relief offers an attractive entry point to hedge a large euro downside move via options.

The 3m downside skew in euro crosses retraced sharply, and almost fell to last year levels in the EURUSD and EURGBP (see above graphs for risk reversals and vols).

The EURJPY and EURCHF skew are also materially less expensive, with, in particular, the EURJPY 3m risk reversal returning below -3 from -5. Indeed, the 3m ATM vol is not that high compared to the spot level, further suggesting designing a long vega hedge.

EURJPY implied volatility is already high compared to realized volatility but would spike much higher if the spot were to collapse (negative vol/spot correlation – see top chart). Indeed, the 3m ATM vol is not that high compared to the spot level, further suggesting designing a long vega hedge.

In addition, an effective hedge must not be conditional but delivers anyway if the feared market scenario becomes reality. Also, euro spot market liquidity is very likely to deteriorate sharply if Le Pen wins, prompting large intraday moves. In these conditions, the most appropriate strategy is buying a one-touch option: it takes advantage of the recent skew cheapening, would highly benefit from a rise in downside vol and is the best way to catch a short-lived bottom in the spot.