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During monetary policy season, the major central banks have been quite predictable, except ECB and RBNZ, central banks of all G10 countries have stood pat in this easing season, so does the Federal Reserve.
The Fed was no different and somehow conspired to under-deliver even relative to the underwhelming level of market expectations. The Fed cut its rate projections substantially again this week, again undermining the dollar versus every currency.
It matters not that the market was priced for only one-third the amount of tightening the Fed had formerly projected –in lowering its ambitions from four to two rate hikes this year the Fed sent a powerful signal about its reaction function which now appears a bit more accommodative of higher inflation and less tolerant of still mediocre growth.
USD skews drifted lower for the best part of the past 18 months, gradually repricing a softer path of Fed tightening, and reflecting the consensus in long USD FX positioning vs both emerging markets and low beta funding currencies.
However, it is difficult to disagree with the conclusion that a more benign Fed opens up additional downside for the dollar, and on a broader basis than characterised the earlier phase of this correction.
The issue that confronts us from a trade perspective is that the dollar correction is already relatively mature in terms of duration (two-months, the same as that which followed the FOMC in this month).
Hence, any longs of USD against TWD should be squared-off after the FOMC and the first step is to neutralize these positions -we don't mind taking losses on a 3-month USD/TWD NDF (3.7%) and close the legacy bearish USD options.
USD risk-reversals should be pressured further to align with the impulsive retracement in spot.
Sell USD/SEK skews in calendar form, and enter USD/INR put spreads that offer pre-taper tantrum levels of vol-adjusted carry. Capitalizing on risk reversal numbers and correlate that with bearish environment surrounding dollar, we continue to stay short in USD/JPY, GBP/USD and EUR/USD.
