Australian central bank (RBA) is scheduled for its monetary policy next week wherein it announces cash rates. With the RBA expected to be on hold for the foreseeable future short-maturity interest rates are well anchored. While 3y swap rates have been in a 2.10 – 2.35% range throughout 2018.
The Aussie’s mid-August slide to 0.72 on Turkey-inspired global risk aversion left it quite oversold when judged by our short-term fair value estimate, which remains near 0.75. AU-US yield differentials have continued to drift in the US dollar’s favour in recent weeks but Australia’s key commodity prices have been mixed, overall a little higher since mid-August and a long way above March lows. Still, AUD risks probably remain to the downside in September (0.70 handle), given the confluence of FOMC meeting, US review of China tariffs and EUR/Italy budget risks. By year-end we see AUDUSD back to 0.73.
AUDUSD risk-reversals (RRs): AUDUSD RRs have been bullish neutral (refer above nutshell). It is disingenuous to include AUD in an EM list, but its China / commodity linkages have resulted in a price response this year not too dissimilar from other EMs, hence this (questionable) stretch.
With spec AUD positions fairly short on IMMs, there is room for a short squeeze higher in the currency that can dampen the elevated negative spot-vol correlation of recent weeks.
Thus, we intend shorting 3M 25D AUD puts vs 6M 25D AUD calls, vega-neutral in a box risk-reversal structure. This construct is net short gamma and skew, and can be construed as a moderately RV efficient way of selling AUD vol (refer 2nddiagram).
Currency Strength Index: FxWirePro's hourly AUD is flashing -26 (mildly bearish), hourly USD spot index is inching towards 84 levels (which is bullish), while articulating at (12:19 GMT). Courtesy: JPM
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