FxWirePro: FX correlations and cheap hedges for escalating trade tensions

FX markets continue to consolidatewhile news headlines with regards to a Brexit deal last to emerge, marginal reflections on the pound is observed in the recent past after the reasonable recovery off the recent lows in the last week or so. 

While a step-forward in negotiations between the US and Canada gave the CAD a boost, with oil prices pushing back towards range highs perhaps helping this currency and the NOK, which has also rallied the last few days. However, the majority of G10 remains wrapped up in well-defined ranges, with AUD and NZD clearly bearing the brunt of the trade issues between the US and China, although both are at important support regions. There is little in the day ahead that suggests we will move out of the current ranges, with Thursday and Friday providing more risks.

The latest divide between EM and DM in terms of FX dynamics has widened further. While Turkish Lira woes and escalation of US-China trade tensions have gradually impacted the whole EM complex, including assets (like EUR/Asia-FX crosses) which at first had remained insulated, G7 currencies and vols were left roughly unscathed. 

Unsurprisingly, a look at a dislocation analysis in the vol space would now identify EM vols (especially BRL, IDR, TRY, RUB vs both USD and EUR) as overvalued by up to 5 standard deviations. 

Still, we highlight a number of trades that, rather than playing an inversion of the latest market trend looking for large payouts, offer attractive hedge and carry opportunities in the current market environment. 

We look for laggards in the Asia-FX vol space for hedging an extension of the weakness in the region, in the form of long vol plays on select currencies/baskets, in the latter case playing for a rise of FX correlations. When looking for positive carry in the FX vol space, we identify a low-risk short-correlation trade on USDJPY vs USDCHF which, positioned for the long- USD trend to lose steam against G7 peers, and allowing different possible implementations, would generally display an attractive risk-to-reward profile. 


We find value in owning optionality on USDJPY and 50.5 USDKRW, as cheap hedges for escalating trade tensions and intensifying EM turmoil. Courtesy: JPM

FxWirePro’s Currency Strength Index: Hourly USD spot index is flashing 31 (which is bullish), while hourly GBP spot index was at shy above 48 (bullish) and EUR at -31 (bearish) at 09:23 GMT.

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