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FxWirePro: Hedging European political risk - Buy EUR/JPY 3m one-touch vanilla

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).

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.

The likely victory of a market-friendly candidate would redirect attention to ECB tightening, propelling the euro gradually higher.

On the contrary, a Le Pen victory would imply an immediate and significant bearish impact.

FX/bond correlations elect a short EURJPY as the best hedge. A scenario with the OAT Bund widening to 150bp would send the EURJPY to 108 and the EURUSD to 0.99.

A one-touch option takes advantage of the complacent relief in skew, benefits from a rise in downside vol and is the best way to catch a short-lived bottom in spot.

Buy EURJPY 3m one-touch knock-in 108 @ 13% (7 times leverage).

Rationale: The likely victory of a market-friendly candidate would redirect attention to the modalities of ECB tightening, propelling the euro gradually higher.

In contrast, a Le Pen victory would have an immediate and significant bearish impact.

FX/bond correlations elect a short EURJPY as the best hedge.

A scenario with the OAT-Bund widening to 150bp would likely send it to 109.

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August 20 23:00 UTC Released

JPReuters Tankan DI

Actual

27 %

Forecast

Previous

26 %

August 20 21:00 UTC Released

KRPPI Growth MM*

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0.1 %

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Previous

-0.4 %

August 21 08:30 UTC 345345m

ID7-Day Reverse Repo*

Actual

Forecast

Previous

6.278 %

August 21 08:30 UTC 345345m

IDDeposit Facility Rate*

Actual

Forecast

Previous

18.283 %

August 21 12:30 UTC 585585m

IDLending Facility Rate*

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Forecast

Previous

0.9 %

August 21 12:30 UTC 585585m

DEZEW Economic Sentiment*

Actual

Forecast

Previous

0.13 %

August 21 12:30 UTC 585585m

USNational Activity Index*

Actual

Forecast

Previous

0.13 %

August 21 12:30 UTC 585585m

CAWholesale Trade MM

Actual

Forecast

-0.4 %

Previous

0.9 %

August 21 14:30 UTC 705705m

TRReuters Tankan DI

Actual

Forecast

Previous

811.8 Bln TRY

August 21 14:30 UTC 705705m

DEZEW Current Conditions*

Actual

Forecast

Previous

811.8 Bln TRY

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