FxWirePro: Spotlight on relative value cheap hedges among commodity FX against JPY

Yen-crosses reliably reprised their usual positive beta to risk markets in 1Q’18 and fell sharply alongside the 10% sell-off in stocks. Unsurprisingly, commodity FX/JPY crosses bore the brunt of the pain, none more so than BRLJPY (YTD -9%). 

Yet persistent supply of BRLJPY vol from Uridashi structures meant that implied vols never really took off in a way that the outsized spot move might have justified ex-ante; for instance, a 3M 9% OTMS strike on January 26th –the SPX peak for the year –was priced at a 3 vol premium over the ATM strike, yet 3M ATM vol is nearly unchanged since then barring a short-lived 2.5 vol spike around the VIX shock.

Compared to G7 commodity FX/JPY crosses in particular, BRL vs JPY correlations look too high i.e. BRLJPY vol too low despite the larger reaction in the underlying (refer 3rd chart); for comparison, AUDJPY, NZDJPY, and CADJPY 3M ATMs have all gained around 1vol since the S&P high even as BRLJPY vol has floundered. BRL vs JPY 1M – 3M implied corrs via USD @ 25% are also solidly rich on a standalone basis relative to trailing realized correlation between-15% to 25% depending on the lookback window.

This is both a source of frustration and an opportunity for vol owners. We have been carrying a long BRLJPY vs short USDBRL 6M vol spread for a couple of months now with admittedly not much P/L to show for it despite timing entry just before the VIX shock; nonetheless, we believe this vol spread is the most parsimonious, transaction cost-effective expression of selling USDJPY vs USDBRL correlation and is a position we continue to like holding since technicals are still just as attractive as when we first recommended it.

2nd chart shows that the implied vol spread at present is low both historically and compared to the general demeanor of realized vols in less orderly FX markets. This is the case almost irrespective of strikes on the two surfaces, though for choice, we have a slight preference for OTM BRL call strikes (i.e. the weak side of the risk-reversal for both pairs) where the vol differential is marginally tighter.

For instance, the vol differential for 6M 25D BRL call strikes is marked at 0.15 vol (mid) in referring 1st chart. For active / intra-day delta-hedgers, 1M ATMs should also be of interest where the vol spread is marked below zero, and where recent realized vol outperformance has been in excess of 2 vols (1-wk 2.2, 4-wk 2.5 based on hourly NDF samples). Courtesy: JPM

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