Bearish scenarios:
1) The unemployment rate moves back towards 6%, forcing the RBA to respond more aggressively to weak inflation;
2) China data weaken materially.
Bullish scenarios:
1) China eases policy and commodities rebound;
2) The RBA adopts a more hawkish tone to its communications.
So far, RBA outlook seems to be on hold for some time which is anchoring short-maturity interest rates and should keep 3yr swap rates in a 1.8% to 2.3% range, as long as core inflation remains below 2%.
While JP Morgan’s projections of AUDJPY at 81 by Dec’2017, 79 by Q1’2018.
Hedging framework (AUDJPY):
Please be noted that the IVs of ATM contracts are trading at 9.92%, 9.96% and 10.18% for 2m, 4m, and 6m tenors respectively.
On hedging grounds, risk-averse traders, capitalizing ongoing rallies of the underlying spot FX, we advocate shorting a 3M in premium-rebate notional and buying a 6M 84.250 AUDJPY one-touch put.
Those who wish to reduce the cost of hedging; we advocate buying 4M sell 2M AUDJPY OTM/ITM puts at 86/90.159 strike in 1:0.753 notionals.
Vols of 2m tenors are at the lower side which is conducive for option writers, hence, we’ve chosen ITM striking put as we agree with JP Morgan’s projections.


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