The stern US dollar has been strengthening fails to drive gamma performance: fade rich USD vols and skews.

This week saw a sharp acceleration in the global sovereign rates bearish steepening, on improved global data activity, central bank shifts from ultra-dovish policies, and prospects of fiscal stimulus.

The backup in yields is consistent with a readjustment to the recovery in Oil prices, but surprise upticks in inflation or signs of ECB/BoJ tapering would leave them with room to cheapen further in the medium term (Unlike in May, $50/bbl oil is now obvious almost everywhere).

The docility in realised vols even as the USD is firming up is upsetting the long vega positions we entered throughout the summer. The revival of the carry trades post-Brexit referendum were seen and the accompanying softening in FX vols as an opportunity to lock in attractively low levels of forward vols. In particular, it seemed unlikely that vols would soften dramatically while US election risk and central bank meetings would keep day weights elevated.

Thus we bought 1Y EURINR ATM and 6M ATM and lower delta strikes in USDSGD, USDCHF, and AUDUSD, all of which are incurring negative carry even as 6M to 1Y vols have broadly remained flat since inception. The reason is that realized vols in USD pairs have dropped since Aug as sharply as they had rallied in Jun, and USD skews kept underperforming.

The underperformance of gamma is pervasive among USD, JPY, and EUR pairs, and is actually the broadest and most acute it has been since the SNB de-peg rattled FX markets and ushered in an era of liquidity-constrained gamma firmness

FX vol markets are experiencing their longest stretch of negative gamma performance since Q4 2014.

We hedge our long vega exposure by selling short-dated vols in USDINR and USDSGD.

This weakness in realized vols even as the USD is correcting its undervaluation gap is a marker of USD skew richness.

Short 3M USDPLN 25D RR and consider 1x2 USD ratio call spreads in USD/Asia.