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Euro is bid on its crosses and well placed for further gains but that seems momentary.
EURJPY rallied sharply higher yesterday and is again probing the 20 day moving average at 121.20. We look for the market to stabilise here and may resume bearish business at any time. Prior to which the pair constantly plummeted price from the highs of 124.120 levels to the recent lows of 119.311 levels amid minor upswings (refer daily chart).
Geopolitics also remain a concern as China lawmakers approved a landmark national security law for Hong Kong.
Bearish EURJPY Scenarios:
1) A second Covid-19 wave undermines risk markets and does further damage to EUR
2) Dilution of the EU recovery fund to favour more loans/fewer transfers.
3) UK leaves the EU at year-end with no trade deal.
4) GCC blocks Bundesbank participation in QE.
5) Assessments for the prospect of a V-shaped global growth recovery are significantly tested;
6) Trade tensions between the US and China re-intensify with negative spillovers to Japan’s supply chain.
Bullish EURJPY Scenarios:
1) EU agrees the current recovery fund proposals.
2) All countries tap the ESM facility and the ECB stands ready to activate OMT.
3) The UK extends the Brexit transition period.
4) The outlook for the global economy recovers more sharply than expected and risk sentiment firms;
5) Momentum in JPY selling flows related to outward portfolio investment and FDI repeats on a similar exceptionally large scale as seen in 1Q’20.
OTC Updates & Options Strategy:
Contemplating above macroeconomic and geopolitical factors, at spot reference: 120.750 levels, we uphold 3m EURJPY (1%) ITM -0.79 delta puts for aggressive bears on hedging as well as trading grounds as the mild abrupt upswings were contemplated earlier.
Rationale: The positively skewed EURJPY IVs of 2m tenors are signifying the bearish risks in the underlying spot (refer 1st exhibit). The bids for OTM puts indicates that the hedgers expect the underlying spot FX to show further dips so that OTM instruments would expire in-the-money (bids up to 118 levels) but skews have stretched higher a bit which is why we’d chosen ITM strikes.
To substantiate the above EURJPY OTC indications, we could see fresh positive bids to the existing bearish risk reversal (RR) set-up that indicates the long-term hedging sentiments for longer tenors that are still substantiating bearish risks amid minor upswings (refer 2nd exhibit). Courtesy: Sentry, JPM & Saxo