FxWirePro: Re-pricing of USD/JPY vs USD/high-beta implied correlations on improved US-China trade surface and puzzling Brexit

Carry and positioning unwinds have been the two primary drivers of FX returns over the past month. Stabilization in growth momentum and a restart of US-China trade talks are encouraging, but both are nascent and fragile in our view. While the defensive views haven’t changed much, but the overall risk appears to be subsidized.

While sterling has accelerated higher last night extending the recovery after setting new 3-year lows at the beginning of this month, now up 5%. The move triggered by comments from outgoing EU Commission President Juncker (his term finishes on 31st October) commented that a no-deal Brexit would have “catastrophic consequences”, that he was doing “everything to get a deal” and "if the objectives are met, all of them, then we don't need the backstop".

Even though the concerns linger over US-China trade friction, Brexit and global economic recession, Japanese investors probably re-confirmed that 105 is the bottom of the range for USDJPY and started increasing overseas investment. Indeed, Japanese investors increased their foreign bonds investment in the last week of August (refer 1st chart) and probably partly because of that, USDJPY started deviating upward from the correlation with the US-JP yield gap (refer 2nd chart). Such investors’ view on USDJPY is understandable given USDJPY has stayed mostly within the range of 105 and 115 since the beginning of 2017. 

USDSGD vs USDJPY: Yen-cross gamma has performed like a charm over the past few weeks, most notably during the rush for exit doors on risk sparked by the break of USDCNY through 7.0, followed by the equally volatile retracement shortly after the announcement of delayed/split tariffs.

Options markets have accordingly re-priced USDJPY vs USD/high-beta implied correlations lower / high-beta cross-yen vols higher e.g. even after this week’s partial retracement, AUD vs. JPY 1M implied corrs (+12%) are more than 20% pts. below their late-July high. One yen-cross that defies this general rule is SGD/JPY. While the broad contours of the cross have tracked those of the rest of the JPY bloc, absolute levels of corr. are much higher (refer above chart) that make them ripe for option structures that benefit from de-coupling. Arguably, no JPY cross-correlation should be priced in positive territory in the current climate of recessionary fears, let alone in the mid-30s, and certainly not when trailing realized corrs are deeply negative (hourly 1-wk -9%, 4-wk -40%). The case for a stronger Yen in a falling US real yield, jittery risk climate is obvious; the case for a weaker SGD rests on Singapore’s high degree of exposure to the US/China trade conflict and expectations of impending MAS easing in October that informs the Asia team’s short SGD NEER stance. Consider the following dual digital structure: 

3M (USDSGD > 1% OTMS, USDJPY < 1% OTMS) costs 10% (individual digitals 26% and 37.3% respectively). Courtesy: JPM