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This write-up is just an attempt of routing trade flows in the right direction rather than having speculative moves that blow-out-of-the proportion due to the recent significant data flows from the central banks.
The Fed played out to the hawkish end of our scenarios, and the USD has repriced appropriately in the past two weeks. But further pricing in of the 2018 dots and cyclical outperformance will require time and rely on inflation and Washington outcomes.
The deeply negative basis spread makes it unprofitable for a yen-based investor to buy US Treasury securities despite the apparent yield pickup on offer because of the cost of hedging dollars.
The directional demand/supply outlook for options tilts in favor of higher FX vols, but the 2-vol+ cyclical undershoot on VXY from earlier in the year has corrected to a large extent. These offsets argue for a milder, more balanced bullish vol bias in Q4. VXY Global has ticked higher more than 1% pt since a 1-sigma plus undervaluation on the index was flagged.
A savage rebound in bond yields, led by the US, has delivered a strong bounce for the dollar. We like buying the USD and CAD versus the JPY. Otherwise, though we’re not inclined to chase it, we will be looking for opportunities to buy EURUSD and sell GBPCAD as current trends slow. We think we’ll be at EURUSD 1.25 by next September.
Although sterling is undervalued, there is no fundamental catalyst for us to expect an appreciation trend from here. On the contrary, UK growth momentum is slowing and we are doubtful that the two rate hikes priced in by end-2018 will be realized.
The yen has long been seen as the global risk proxy par excellence, yet it has failed to weaken in the face of buoyant risk sentiment and rising equity markets in recent quarters. It is clear that the yen is not trading primarily as a funding currency anymore. One important development that might explain this is the persistent and sizeable yen-dollar negative cross-currency basis spread since mid-2015.
