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After the dovish Fed statement, the greenback staged a surprise recovery yesterday, which was not necessarily backed by a visible improvement in fundamentals. We think that the pullback will be short-lived, especially because the market has priced out any further rate hikes by the Fed for the remainder of 2017. Fed funds futures are pricing the probability of a hike at the 20 September, 1 November, and 13 December meetings at 8%, 2%, and 42% respectively.
The bearish turn in the dollar of late has been pronounced and broad-based, and shaken front-end vols out of their stupor. The knee-jerk spike in 1M ATMs this week alongside the dip in the greenback – most pronounced in AUDUSD (+1.3) following the RBA neutral rate and in Euro-bloc currencies after the ECB meeting (CHF + 1.0, SEK +0.8, NOK + 0.75, EUR +0.7) – runs counter to the grain of generally positive spot-vol directionality for USD pairs and is suggestive of a cash market caught wrong-footed and/or under-positioned on dollar shorts.
Gamma out-performance is likely to continue in our view since central bank policy re-thinks can be sticky affairs lasting weeks as positions and valuations adjust; CAD 1M ATM vol, for instance, printed its cycle low in early June before the BoC shifted gears and has been on an upswing for more than a month since JPM sources say.
From a gamma trader’s standpoint, AUD is of particular interest since this week’s RBA story is new, is less likely to be fully discounted in vols yet, and additional gyrations are in the pipeline as markets test the bank’s tolerance for higher rates/stronger FX.
It is a common myth that water drains in the opposite direction in the Antipodes from that prevailing in the Northern Hemisphere. The Antipodes have similarly shared in the weak inflation phenomenon, and subdued inflation allows both the RBA and RBNZ to be patient.
