The USD has continued to make fresh highs as the combination of ongoing global cyclical disappointment, and relative US cyclical outperformance adds fuel to the unwind of USD shorts. 63% of the extreme short dollar base seen earlier this year has unwound, similar to the proportion of the extreme dollar discount unwind, which now shows the USD only 4.7% cheap versus 5y rate spreads, from near 13% in mid-February.
Watching for cracks in the USD correlation wall: The re-syncing of US rates and the dollar has spurred across- the board USD strength over the past month, and there are few signs yet that indiscriminate dollar buying is giving way to greater differentiation (80% -100% of G10 and EM currencies have weakened vs the greenback over 1-wk, 2wk and 1-mo trailing windows).
The natural corollary of a universal dollar rally is that USD-based implied correlations have climbed to near range highs (refer 1st chart), and are worth watching for cracks as a gauge of whether risk sentiment is worsening.
One oft-repeated FX pattern during risk-off episodes is an initially broad USD surge, followed by an even more intense bout of deleveraging characterized by a cratering of yen-crosses and breakdown in JPY/high-beta correlations that mean-reverts a USD-correlation index to its local lows –see shaded bars in (refer 1st chart) for examples; notably, this was also the experience of the taper tantrum episode that the current bout of Treasury weakness is being increasingly likened to, when the Abenomics/QQE-I fueled uptrend in USDJPY was rudely interrupted by a serious bout of cross-yen selling.
We have been running GBPJPY vs USDJPY and BRLJPY vs USDBRL vega spreads in our model portfolio for a while now as protection against such disorderly price action. At current levels, directional investors could consider JPY put/KRW call spreads or digitals that are well-priced within the subset of defensive cross-yen plays (refer 2nd chart) e.g. 3M 10.20 strike digital JPY calls offer 5.5 times gearing (spot ref. 9.72). Courtesy: JPM
Currency Strength Index: FxWirePro's hourly JPY spot index has shown 158 (which is highly bullish), while hourly USD spot index was at 2 (absolutely neutral) while articulating at 09:17 GMT. For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex.
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