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For the past three months the EURUSD exchange rate has been moving in a range of roughly 2 cents. Only in 2014 did the cross temporarily move even less than that. At the same time the market increasingly expects the low volatility to become a permanent feature which is reflected in the falling implied exchange rate volatilities. And this sad state of affairs is by no means limited to EURUSD, but can be observed across the entire G10 universe.
Since the start of the year our G10 volatility index has been falling to new historical lows on an almost daily basis. In the following we will explain the reasons for this trend as well as give an outlook.
Activity data has stabilized in the Eurozone but not yet improving. The much-awaited PMIs hardly delivered any satisfaction to EUR bulls — while the manufacturing components did indeed tick up, the services were weaker leaving the composite unchanged on the month. The ECB meeting this week didn’t deliver much new information, but the underlying message was of policy accommodation for as long as the eye can see.
Last week, we noted that the failure of the data to improve in a decisive manner (let’s say the composite PMI towards the upper-end of the one-year range in the 51.5-52 region), would subject the euro to the drag from negative rate spreads for at least another month, and probably leave these options facing terminal decay.
Hence, we unwind part exposure to bullish EURUSD trades. The EURUSD call spreads was part financed by selling EURNOK topside; we take profits on this structure this week. The view is still NOK- bullish within G10 high beta FX, but the pairing vs. EUR amid signs of renewed global growth uncertainty and weak Norwegian developments lead us to tactically unwind exposure to this trade. Partially unwind bullish EURUSD trades; keep bullish exposure via a digital call.
Long a 4M 1.15 digital EUR call/USD put. Paid 11.5% on Nov 26th, marked at 3.24%.
Long 4M EURUSD 1.12/1.15 call spread vs. short 4M EURNOK 10.25/10. 50 call spread. Cost 15.5bp in November, marked at 11bp. Courtesy: JPM & Commerzbank
