FxWirePro: Chinese effects on Germany, EURO weighs on ECB – EUR/AUD options straps to hedge

Despite the economic stimulus package, China's economy is showing scant signs of accelerating. We took this as an opportunity to fundamentally revise our view of China. We no longer expect the Chinese government to significantly increase its economic stimulus package. Instead, it will accept the loss of growth caused by the trade war. The Chinese economy is unlikely to pick up significantly.

The more cautious picture of China naturally has implications for the growth forecasts for the rest of the world. This applies in particular to the export-oriented German economy, for which we expect economic growth of only 0.8% in 2020 (previously: 1.3%). We are thus much more cautious than most other economists. Germany remains in the grey zone between lean growth and recession. For the eurozone, we have lowered our forecast for 2020 from 1.1% to 0.7%. The looming protracted economic slowdown suggests more than ever that the ECB will adopt a comprehensive easing package at its next meeting in September. The ECB should lower its deposit rate from -0.4% to -0.6%, introduce a tiered interest rate system to relieve banks of the penalty interest rate and resume net purchases of bonds.

The euro is likely to suffer from the fact that the ECB will resume its net purchases of bonds. We have therefore lowered our year-end forecast for EURAUD from 1.68 to 1.6550.

OTC Indications and Options Strategy: Please be noted that IV skews of EURAUD are stretched on either side, the positively skewed IVs of 2m tenors are signifying more hedging interests in bullish than bearish risks. More bids for OTM calls of this tenor indicate that the underlying spot FX likely to spike up to 1.68 levels and bids for OTM puts show 1.59 levels.

Contemplating fundamental and OTC factors as explained above, although it is sensed that all chances of Aussie dollar looking superior over Euro in the near term and vice versa in the medium-term future; accordingly, we advise to hedge the puzzling swings through below options recommendations.

The execution: Spot reference: 1.6363 levels, buy 2 lots of at the money 0.51 delta call option of 3m tenor and simultaneously, buy at the money put option of 1m tenors. The option strap is more customized version of straddles but instruments slightly biased bullish risks. Courtesy: Sentrix & Commerzbank