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Fed's dovishness has already decoded into softer USD skews.
The only dollar potency that was expected during Q1 2016 was to come against the commodity currencies given excess supply in oil, metals and bulk commodities; and versus emerging markets currencies where imbalances were greater (subtrend growth, current account deficits, commodity exposure high), widely followed index like DXY (lower in 2016) would diverge from a proper trade-weighted one like USD nominal effective index (slightly higher in 2016).
We look ahead for SEK, where nominal valuations aren’t excessive but the projections of appreciation against dollar are convincing.
Fade risk premia further and take advantage of steeper vols to enter calendar risk-reversals in USD/SEK.
Cross currency effects: The currency is correlated with EUR and thus benefits from the shift in sentiment brought forth last week by ECB Draghi’s comment that further EUR rate cuts were not warranted.
The pair has been the beneficiary from a Swedish economy that enjoy strong fundamentals in terms of growth, current account position and inflation, makes the justification for medium-term appreciation incontrovertible, and the threat of further Riksbank policy action less acute.
In order to boost the value in selling USD/SEK risk-reversals, we take advantage of the welcome steepening in the curve across European currencies and leg a short dated put with a longer dated short call position, making this a calendar risk reversal trade.
We buy a 2M 3W USD/SEK put funded by shorting 3M 3W USD/SEK call in model portfolio.
It is advisable to be on the long side of gamma position in SEK, while we are rationally certain with the short vega (and vol of vol) stance.
