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The global economy has been surfing a cyclical upturn, and financial markets are bolting on central bank accommodation, but as post-crisis policies are dismantled, the appearance of calm in FX-land risks being deceptive.
The Fed was first out of the blocks with a strong policy response to the global financial crisis, prompting the Brazilian finance minister to bemoan ‘currency wars’. The election of Shinzo Abe as Prime Minister of Japan brought the BoJ into the fray, and by the start of 2015, the ECB had joined in and a significant dollar rally was underway. As the ECB edges towards normalization, an undervalued euro has room to rise further.
A glimpse at Euro area economics -
Very strong PMI confirmed for December, suggesting 3.3% growth at the end of 2017
PMI details strongly across sectors and countries
Euro-area retail sales bounced back (MoM 1.5% from previous -1.1%); and so is IP, has also rebound from holiday-distorted October (MoM 1% from previous 0.4%)
Euro area inflation remains low, despite strong growth and rapidly falling unemployment
Euro rates derivatives:
The EONIA curve is now pricing cumulative rate hikes by Dec19 broadly in line with our view (35bp versus our call of 40bp)
We stay neutral at the very front end of the curve but expect more steepening further out the curve
Keep blues/golds EONIA curve steepener as carry efficient bearish duration proxy which is also supported by RV but also favour greens/blues
Favour receiving greens EONIA in the reds/greens/blues curve-and-level neutral EONIA fly on RV considerations
Stay long Jun19 in Dec18/Jun19/Dec19 50:50 Euribor fly
Bearish trades: initiate Mar18 Schatz/Bund weighted bear steepener and 2s/10s weighted bear steepener using 3M payers
Investors wishing to position for an eventual flattening of the swap curve should consider 5s/15s bear flatteners via 1Y payers
Bullish hedges: we favour 2s/5s/10s and 5s/10s/30s bull belly richeners implemented via 3M receivers
Swap spreads narrowed aggressively across the curve taking Schatz and Bobl spreads to the narrowest levels since the ECB started to buy bonds below the deposit rate
RFR German repo rate specialness is expected to increase further on the back of asset purchases and widespread between RFR and GC
JPM faded the recent move and tactically initiate Mar18 Schatz OIS swap spread widener.
