FxWirePro: Activate USD longs vs JPY via cash and NZD optionality

The market overreacted when it heard the comments by Fed chair Jay Powell which means that the US dollar weakness is unjustified, is what many experts are claiming right now. After all Powell did not provide any new information. It is generally known that the FOMC estimates the neutral level of interest rate to be around 2.5-3.5%, so that the current interest rate level of 2-2.25% is obviously not that far off this range any longer. 

In addition, it is understandable and normal for a central bank to act more cautiously and data-dependent at the start and end of a rate hike cycle. 

However, if all that really was foreseeable, why did the market react so sensitively to Powell’s comments? 

This is due to the fact that the uncertainty surrounding the Fed’s approach was higher right from the outset of this cycle. This is due to the fact that inflation dynamics have changed, and that everyone remains puzzled by how weak price pressure continues to be despite a very tight situation on the labour market. While wages have started to rise more rapidly, as should be expected when unemployment rates are as low as this, and inflation has stabilised at the central bank target of 2%, many are likely to be of the view that the inflation development of the past few years is still not sufficiently explainable. And as a result, the central bank’s projections for its neutral interest rates are uncertain, as the bankers themselves have admitted frequently enough. It could always still emerge that their estimate of 3% is completely incorrect. There is high uncertainty also as regards the economy, which is partially due to the unclear political agenda Washington is pursuing. 

Trade recommendations:

The long USDJPY trade was motivated by the prospect for a further adjustment higher in yields (USDJPY continues to have the highest sensitivity of any major currency to US yields), while the re-initiation of NZD shorts last week was a hedge for poor risk sentiment, ongoing CNY weakening and China tail risks to growth. Over the past week, the performance of these trades has been mixed. 

USDJPY trade has recouped some of its losses given the rebound in equities while the NZDUSD trade is underwater following positive news reports on a US-China agreement. The erratic nature of news flow is one reason why we had suggested NZDUSD shorts via options last week. The trade is now deep out of the money but we maintain exposure given tail risks to high beta FX as noted earlier. 

Long 3m at-expiry digital NZD put/USD call (strike: 0.6195) for 15%.

Activated longs in USDJPY in September. Courtesy: JPM, commerzbank

Currency Strength Index: FxWirePro's hourly USD spot index is inching towards 39 levels (which is bullish), while hourly NZD spot index was at 83 (bullish) and JPY is at 3 (which is absolutely neutral), while articulating (at 11:15 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex