FxWirePro: Attain euro’s optimism through EUR/JPY but deploy delta-hedge as ECB to conclude QE in 2019

JPY underperformance has been the highlight as well as USD softness. Consequently, USDJPY remained in a roughly three yen range while yen’s NEER marked the lowest level since February 2016 on January 5 this year though it has rebounded this week. Meanwhile, JPY crosses extended the upside; EURJPY reached 136-handle for the first time in more than two years.

ECB is likely to conclude QE program as a run-up to tightening in 2019; EUR bond yields should rise by more than in other DM countries as they are more overvalued; balance of payments trends should remain strong and counter a further deterioration in front-end rate differentials; and political risks should be laid to rest for the next 1-1/2 years if Italy elects a mainstream government as seems probable based on the trend in the opinion polls (we attach only a 5% probability to a non-mainstream government.

For now, EUR optimism is more safely expressed through EURJPY, this pair is a safer vehicle to position for stronger European growth and the risks that this could persuade the ECB to dispense with an additional taper and end QE already in September.

EURJPY PPP and FEER valuations are the yen bear’s arch-enemies, but they apply far more to the USDJPY than to the EURJPY, given that the euro, too, is significantly undervalued on a PPP basis. The PIIE puts a FEER-consistent EURJPY rate at 121. More important perhaps than the valuations, however, is our confidence that the ECB is further along the road to policy normalization than the BOJ.

Hence, keeping the both OTC and technical factors in mind, it is advisable to initiate below relative value trades.

Sell 6M EURJPY 25D risk-reversal (buy EUR calls - sell EUR puts), delta-hedged for risk-averse traders.

Buy 3M EUR puts/JPY calls vs. sell 3M 28D EUR puts/KRW calls for directional traders.

Buy 3m EURJPY ATM -0.49 delta puts for aggressive bears on hedging grounds. Courtesy: SG JPM

Currency Strength Index: FxWirePro's hourly EUR spot index is inching towards 80 levels (which is bullish), while hourly JPY spot index was at -18 (mildly bearish) while articulating (at 06:03 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex.

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