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With markets focused on tomorrow’s US Fed monetary policy announcement most major currencies were little changed yesterday.
The reduction of the Fed balance sheet that is likely to start tomorrow. This aspect that heavily drives FI analysts is hardly relevant for FX markets. The Fed has made it clear that it will implement it in a manner that takes consideration of the market. Of course, there may be some glitches at some stage or other. But the reduction of the balance sheet will not become a tool of everyday monetary policy – that much is clear already.
Sometimes monetary policy tools are used in such a manner that it hurts the market – if that is necessary to achieve a superior target. That is explicitly not the case with the balance sheet reduction. The Fed will implement it in such a manner that it produces as little market friction as possible. And as a result, it is not relevant for the FX market, which is not directly affected. We will have to focus on other aspects of tomorrow’s Fed communication. But more on that in tomorrow’s issue.
We nevertheless pare exposure versus a tactically more balanced dollar by closing longs in CHF and NOK and convert a short-dated EURUSD option into a cash long.
Stay short USDSEK in cash and take profits in options. The FOMC will determine whether it is safe to re-build exposures if the dots are dropped, or whether a selective USD recovery can extend.
The rally in 3M-6M ATM vols and compression of USD risk-reversals of the past 3 months is due a pause as the dollar consolidates.
Short dollar portfolios can consider selling USD puts as a yield-enhancing, delta reducing strategy that has historically improved risk-adjusted returns of cash USD shorts.
AUD and EUR calls are relatively rich within the USD-universe.
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