FxWirePro: Bullish/bearish scenarios and risk events that linger around dollar – EM gamma to spike off on USD puts offloading

The US dollar has been crawling ahead in recent days, with the market-implied probability of a December Fed hike inching to around 80%. The FOMC minutes and US CPI data this week will be in focus. Fed Chair Yellen is also scheduled to speak on monetary policy this weekend, while ECB President Draghi will be part of a panel on “Rethinking Macro Policy” on the sidelines of the IMF-World Bank meetings.

EURUSD bullish targets are unchanged at 1.20 for year-end and 1.25 for September 2018. Other G10 forecasts are left unchanged.

Bearish scenarios:

1) Tax reform efforts fail to deliver a passable bill and is dropped ahead of mid-term elections

2) Ongoing inflation undershoots finally cause the Fed to capitulate on the ’18 dots;

3) Trump support sharply falls among republicans

Bullish scenarios:

1) Inflation convincingly bounces back, further validating the dots;

2) Congress rallies and breaks ground in delivering progress in tax reform;

3) Rest of world normalization is depriced.

The list of key market events this week includes:

Oct 10: Norway CPI, UK trade balance, and UK industrial production.

Oct 11: FOMC minutes.

Oct 12: France CPI, EA industrial production, Sweden CPI, and US PPI.

Oct 13: Germany CPI, US CPI, US retail sales, and US UMich consumer sentiment survey.

The FOMC minutes, US CPI and Yellen speech will provide crucial signposts for the ongoing dollar rally.

We stay positive on USD in the near-term, given our view that the market continues to underprice the probability of a December Fed hike.

USD options market:

EM gamma spiked sharply as the shakeout in dollar shorts played out most violently in heavily-positioned in carry trades in EM and lifted delivered vol, but G10 vols fell as the sapping of bearish USD momentum prompted liquidation of USD puts, especially versus European currencies (refer above chart).

USDCHF stands out as decay positive candidate to buy USD calls in on risk-reversals. Buy USDCHF vs. USDSGD risk-reversal spreads to earn the dollar-neutral skew risk premium. Benchmarking ZAR, MXN and BRL vol curves to historical precedents of the election.