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The mildly constructive EUR projection envisages a belated lessening in cyclical headwinds that should enable a modest EUR momentary recovery in line with the pull from cheap valuation (the REER is 7% cheap to a 20Y average) and record balance of payments support.
But one reason for the Yen’s appreciation when entering a global recession is that investors with speculative JPY short positions face increased volatility and buy back JPY to close their short positions; we note that there was a rapid reduction in speculative Yen shorts leading into the start of the 2008-09 recession in particular, as market recession expectations were re-aligned. From a fundamental point of view the market reaction is understandable.
OTC outlook: The positively skewed IVs of 3m tenors are signifying the hedging interests for the bearish risks (refer 1st exhibit). The bids for OTM puts expect that the underlying spot FX likely to show further dips so that OTM instruments would expire in-the-money (bids up to 120.50 levels).
Most importantly, to substantiate the above indications, we could see bearish neutral risk reversal (RR) set-up of EURJPY that indicates the long-term hedging sentiments across all tenors are still substantiating bearish risks amid minor abrupt upswings in the short-term (refer 2nd exhibit). Please be noted that 3m negative RRs suggest the overall OTC hedging sentiments for the further bearish risks. Hence, we advocate below hedging strategy contemplating the current OTC indications.
Options Strategy: Contemplating above factors and the prevailing underlying sentiments, we’ve advocated buying 3m EURJPY (1%) ITM -0.79 delta puts for aggressive bears on hedging as well as trading grounds as the mild abrupt upswings were contemplated earlier.
Short hedge: Alternatively, ahead of ECB and BoJ monetary policies that are scheduled for the next week, we advocated shorts in futures contracts of far-month tenors with a view to arresting potential dips, since further price dips are foreseen we would like to uphold the same strategy by rolling over these contracts for March month deliveries. Source: Sentry, Saxo & JPM
