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We expect a hawkish tone from the ECB at the meeting in June after it was perceived as slightly dovish at the latest meeting.
A lot of speculation among market participants has been on whether the ECB will change its forward guidance and remove the 'or lower levels' phrase from its guidance on policy rates. However, in our view, sticking to this guidance and instead delivering another hawkish twist to the introductory statement is most likely. We expect the ECB to argue that the options provided for further accommodation are less likely to be used.
For active delta-hedgers, EURUSD gamma looks worth owning standalone heading into a crucial ECB meeting next week with the cash market decently long on IMMs and spot premium to short-term fair value models not significant; any hint of disappointment or stubborn dovishness from Draghi and co. therefore carries the risk of a painful washout that will reward gamma longs, particularly given the low bar of multi-year lows on 1M ATMs at 6.9 that carry virtually no cushion over trailing realized vols.
This baseline suggests to us that the premium for Italian elections should not exceed that for the French, and will count as a strong fade if their relative ratio starts approaching towards 1. The forward vol priced between 22 Sep –23 Oct (the two dates mentioned in the press) in EURUSD is currently 8.9, a good 2 vols over spot ATM, but only 50% of the peak absolute forward vol spanning the two French election rounds reached in late February (refer above table).
On the whole, Euro-bloc FX options discount close to 60% of the high in French election risk, and it would not surprise to see this fraction inch higher over coming weeks as certainty around the event crystallizes. It is too early in the event calendar cycle to mull fading the first uptick in risk premium; if anything, we are biased to be long of the relatively underpriced camp in table – the top 3 per the last column would constitute EURCHF, EURJPY, and EURUSD, of which we are currently running EURUSD longs via 1M1M FVAs outright and in long/short format via EURUSD – EURSEK vol spreads.
