FxWirePro: Derivatives & Vols Perspectives For G10 FX-Bloc Amid Monetary Policy Season

The USD still appears to be robust, on a broader perspective, it is gaining traction against all of the majors among G10 FX-bloc and testing fresh highs vs both the EUR (highest since May 2017) and GBP (highest since January 2017). Wednesday’s widely anticipated Fed cut was delivered with a disappointingly dovish statement and a volatility-inducing press conference as Chair Powell struggled to clearly explain the FOMC’s reaction function. Rate expectations are firming and the outlook for relative central bank policy is delivering broad support to the dollar.

In a widely anticipated move, the US Federal Reserve lowered interest rates by 0.25% last night, taking the Fed Funds target range to 2.00-2.25% and announced an early end to its balance sheet run off. Moreover, Fed chair Powell suggested that further cuts could follow, noting that the Committee will “act as appropriate to sustain the expansion”. However, he also cautioned against expecting significant easing, signaling that the rate cut was a “mid-cycle adjustment” and not the beginning of a “lengthy cutting cycle”.

In contrast to the Fed, and indeed the ECB, the message from the Bank of England has for some time pointed to the need for gradually higher interest rates. 

But BoE kept the bank rate unchanged at 0.75% at today’s meeting. BoE acknowledged that uncertainty had risen and activity has weakened, but maintained the guidance of further limited and gradual tightening, based on a soft Brexit. The BoE voted unanimously to maintain the Bank Rate and the stock of bond purchases unchanged at today’s meeting. This was as expected beforehand. Data since the previous meeting had been volatile partly due to Brexit-related effects on markets and businesses.

The Bank of England is almost certain to vote unanimously to keep Bank Rate unchanged at 0.75% when it delivers its latest policy decision at midday. However, the minutes to the meeting and the accompanying quarterly Inflation Report are likely to talk of the likely need for limited and gradual increases over the forecast horizon, given that the BoE’s forecasts will remain conditioned on an orderly Brexit.

Well, upon the above fundamental developments, Short-Gamma/Long-Vega trades remain relevant in a subdued realized vols market. We show how the tactical filter has increased the allocation to short-Gamma trades as of late.

We tackle Vega ownership from the perspective of long-dated options where the interplay between carry, skew and vol grants benign time decay.

Despite a less dovish than expected ECB yesterday, we consider low premium, L/S directional structures for playing EUR-weakness over the weeks ahead. 

We run you through a tactical filter for timing FX short-Gamma trades (1M 25-delta strangles) or timing FX short-vol strategies suggested by JPM. EURUSD, USDCHF, USDMXN, and USDCNH are the sole four case where the latest trading signals by their model are below 100% (max short-vol capacity), when trade wars and monetary policy uncertainties were weighing on vol premia, suggesting a more cautious stance. Courtesy: JPM & DNB

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