FxWirePro: Glimpse through geopolitical drivers of G10 FX space and OTC options

Another four notable political events are coming up this week. There is the EU summit that is expected to pronounce insufficient progress on the Brexit negotiations to warrant launching trade talks, but there remains the possibility of a constructive tone that leaves the door open to trade talks in a few months. There is also Japanese lower house election this weekend. With the latest polls cementing expectations of Abe being returned to power with a large majority, the big surprise for the yen would be a much-reduced majority, which would push USDJPY lower.

Over in New Zealand, the NZ First Party board and caucus are meeting to discuss whether to enter into a coalition government with either the National or Labour parties. To the north in China, the CCP’s 19th congress opens this Wednesday and will last about a week. The congress will provide important insights about Xi’s agenda in his second term. The most feverish speculation ahead of the meeting, however, is about the possibility of Xi laying the foundations of a precedent-busting third term.

There is, by contrast, no G10 central bank meeting this week to accompany this quintet of political events. A number of important UK data releases are in focus, plus parliamentary testimony by BoE Governor Carney and associates.

Speaking at this weekend’s G30 meeting, Fed Chair Yellen again showed her confidence that subdued inflation will pick-up in the coming year and re-affirmed that the US rate path is gradually higher as a result. The Fed does seem happy though to walk the market along one hike at a time. The bond markets are a little less convinced, with US yields sliding sharply lower Friday, flattening the curve. This, arguably, is more to do with position adjustment as a large short had been built up, but nevertheless is significant. ECB President Draghi said he was confident that they will achieve their inflation targets. We will get a better assessment at next week ECB meeting. Both he and BoJ Governor Kuroda believe assets prices are not stretched at this stage with the former stating markets aren’t "bubbly". This has all left the USD rates somewhat mixed around mid-points of ranges.

Select EMs with idiosyncratic issues aside, FX vols are reprising their typical seasonal weakness in October. It is too early in the mean-reversion cycle from 1H’17 lows to expect a V-shaped vol recovery given the supportive cyclical backdrop for risk markets. GBP is subject to substantial fundamental uncertainty around BoE policy, domestic politics and the Brexit process, very little, if any of which is priced into options. EURGBP 9M6M forward volatility and 1Y GBPJPY - USDJPY put spread switches are well priced to benefit from a renewed focus on UK's woes. Bullish BRL 1*2 structures screen favorably for a potentially sideways USD environment.