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The euro had no difficulties breaking the 1.13 mark yesterday as the dollar simply had nothing to oppose this move. The FX market for euro interpreted the information ECB President Mario Draghi provided at the opening of the ECB forum in Portugal as completely new information and used that as a reason to raise rate expectations which had been lowered following the last ECB meeting. Everything all told Draghi pointed out that the ECB was prepared to consider a slow exit from its expansionary monetary policy, which is nothing completely new.
A softer vols environment for EUR-pairs should also fetch weaker EUR-correlations (of the form EUR/CCY1 vs. EUR/CCY2). Implied EUR-corrs are no longer at their lofty pre-French election levels, but realized EUR-based correlations have plummeted (refer above chart).
The market has interpreted this as tapering the QE programme next year, driving German yields higher and EURUSD up through recent 1.1300 highs.
The impulsive rally through 1.1300, combined with German 2-year yields pushing through the key -0.60/0.58 region suggests there is real upside potential. However, we still have significant resistance in the 1.1450 region.
Hence there is a case for exploring decoupling plays. At a granular pair-by-pair level, most of that collapse owes to the divergence between Scandinavian and antipodean FX –another manifestation of H1’s long Europe vs. short China wave –which is difficult to monetize via delta-hedged pure vol constructs due to limited option market liquidity in those crosses.
Non delta-hedged constructs that rely minimally on implied vol re-marks are more realistic; we like selling EURNOK vs. EURSEK correlations in the mid-50s (realized - 20) via short EUR put/NOK call – short EUR call/SEK put – long NOK call/SEK put triangles with carefully chosen strikes and tenors that ‘close the delta loop1'.
The above chart explains that Sharpe ratios of return streams of the triangle are impressively high, and though it does not entirely sidestep the crisis-era drawdowns typical of naked vol selling, European-crisis era spikes appear to have dampened drawdowns appreciably thanks to the protection of the long leg.
