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The three challenges for risk markets have been predominantly observed for the months of September/October: the risk of a disappointment at the September FOMC meeting; quarterly rebalancing flows; and the US election. The trios are engulfed all asset-classes though, the first two are now largely behind us. We continue to believe the challenge for the overall direction of risk assets from the US election is less about who wins, and more about how close the result would be, given the risk of a contested election and legislative paralysis.
Risk sentiment has turned back to positive after month and quarter-end, buoyed by hopes that a US stimulus package is getting closer. This has seen the USD remain under pressure, along with curve steepening in the bond markets.
Global equities continue to experience their deepest correction since bottoming in March, but focusing only on stock market declines misses the equally-important erosion in cross-asset correlations that has emerged this month.
Few of the safe assets are moving in the expected direction: USD is up 2% versus EMFX and 10Y German yields are down 10bp, but US 10Y & 30Y yields, USDJPY and EURCHF are almost unchanged.
Gold is off 6%. So, a typical basket of defensives is functioning about as well as fire insurance that covers just one bedroom in the house. This risk-management problem is one we have been writing about for over a year, and will return to in this week's View after an update on how negatively to judge what is going wrong in the global economy and US politics.
Among FX-bloc, scale up defensiveness. Rotate into short EURUSD and GBPUSD in cash. Add long USDNOK optionality and hold a core long JPY position.
FX options have begun re-allocating greater event risk premium from US Election Day to the 1-3 weeks period after to account for the possibility of a contested outcome and/or delay in ballot counting. GBPCHF puts continue to be the cheapest no-deal Brexit hedge. Flies are generally cheap vs. ATM vols across GBP-cross surfaces as low-delta GBP call vols are depressed. 25D GBP puts in EURGBP are rich across the curve, consider spreads vs. 10D strangles to earn smile theta with defined risk. Courtesy: JPM
