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Scale back EUR longs and increase USD longs: Rotate long EURCHF into long USDCHF via risk reversal; keep EURUSD call spread The much-awaited ECB meeting was modestly dovish and with it, Draghi was able to deliver euro weakening alongside a QE “taper” announcement for the second time in a year.
The halving of the monthly purchases to €30bn for nine months was only slightly more dovish than our base case of €20bn, but the signal of an even slower exit was more relevant and has resulted in our economists pushing back the call for the first rate hike by a quarter to in June 2019, in addition to a third taper in 4Q’18.
Even if this outcome hadn’t been as dovish, it would be fair to say that the ECB monetary policy will be on autopilot in the near future and thus diminish in importance as a driver for the euro in the coming weeks, leaving the currency open to vagaries of other factors such as US-dynamics, which are more dollar bullish at the moment (a substantially better-than-expected US GDP outcome this week reinforces strong growth momentum for the dollar), and Euro area political risks which will likely become more negative into Q1 given Italian elections. The longer-term view is still euro bullish since the focus will eventually shift to ECB rate hikes (Sep’18 EURUSD target is at 1.25).
We thus scale back EUR longs by unwinding long EURCHF outright and rotating it into long USDCHF via a risk-reversal (CHF shorts are still preferred tactically given expectations of an unchanged SNB policy).
Our derivative strategists note that USDCHF risk-reversals are an attractive way to hedge pro-risk portfolios at current low vol levels.
The structure we recommend expires on December 15th, so just past the FOMC meeting, and has a spot-to-strike distance ratio of 1:2.9 on the upside vs. downside.
Notably, the carry is not that onerous—flat over a 1-month horizon—so will not overly be penalized if USD does happen to consolidate.
Separately, the EURUSD call spread is near worthless and thus we maintain that position.
Long USDCHF, in conjunction with a pre-existing spot long in USDJPY, initiated post-Japan elections intra-week, positions the portfolio for an ongoing improvement in the US economy. Courtesy: JPM
