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Although the fears of a recession have eased significantly, not least due to the recent agreement in the US-Chinese trade conflict, investors nonetheless remain sceptical towards the euro. And at present this scepticism is quite understandable. Neither the signing of the US-China Phase I deal, nor the passage of USMCA through Congress were meaningful market events: in the 48 hours surrounding the US-China deal signing USDCNY was net unchanged while the dollar was only marginally weaker in-line with recent trends. CAD and MXN were similarly indifferent yesterday morning to the US passage of USMCA. The fact that markets seemingly barely took notice of either event underscores how fully and long expected these events had become.
Meanwhile, reflation has been a dominant market theme since the end of last summer when talks of a US-China truce first emerged, and that theme has, in aggregate, sponsored a net 2.7% decline in the USD index and an average 2.4% rally across EM FX.
The focus will turn towards tracking how these market expectations of reflation are actually panning out. This will represent a more acute risk to markets should the data continue to disappoint. Put together there are several read- throughs from these present dynamics: While the portfolio is pro-risk, the exposure is selective. The team’s longs have been focused on a small number of European currencies, namely, CHF, NOK, and EUR. EMOWs are selective in MYR, CZK, RUB, BRL, and MXN.
After all, at present even the smallest shock can cause sentiment to deteriorate again and push the indices below their recent lows. Whereas the risk of renewed escalation in the conflict between the US and China is likely to be low in the immediate aftermath of the phase 1 agreement being signed, concerns in connection with Brexit seem more justifiable. The negotiations about a free trade agreement between the UK and the EU are meant to start next month and at present both sides are using a pretty tough tone which does not exactly point towards a rapid and easy agreement. Until such Europe-specific risks ease significantly the single currency is likely to struggle gaining any significant ground. However, we are optimistic that the economy in the euro zone will improve as of the spring - albeit very slowly - and that Brexit too will come to a happy end so that things are likely to become a little more relaxed for euro investors over the course of the year.
While the Asian FX strategists closed a downside USDCNH digital this week. The better opportunities are identified by idiosyncratic factors rather than generic beta exposure to global reflation. This has informed a concentration of long risk in CHF and JPY, for example. In the macro portfolio, the strategists added to CHF longs funded by GBP and JPY in cash, and today they took profit on a bullish CHFJPY seagull, while rotating into a 2m dual AED expressing lower USDCHF and higher USDJPY.
We advocate shorting GBPJPY via 2m (1%) OTM put option (position seems good even if the underlying spot goes either sideways or spikes mildly), simultaneously, go long in 2 lots of delta long in 2m ATM -0.49 delta put options (spot reference: 143.786 levels while articulating).
Elsewhere they remain long EURUSD through options, long NOKJPY in cash, and hedged through short AUD options structures.
AUDCHF is vulnerable to RBA QE, while AUDNZD will be supported by pressure on the RBNZ to match the RBA to maintain competitiveness.
Long a 6M AUDCHF 0.66 / 0.64 put spread, short a 6M AUDNZD 1.03 put. Paid 38bp AUD Nov 26th. Marked at 22 bps. Courtesy: JPM