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ECB seems to be limiting the tractability: ECB President Draghi hinted at the last press conference, that the central bank had by in no manner casted-off all its missiles yet. He referred repeatedly to flexibility with regard to the bond purchase program, although he didn't go into any detail. We have shed some light on the matter by listing the various legal limits and pressure points at which the Bank could still act. On balance, the limitations to the purchase program are probably more binding than Draghi has been suggesting.
Consequently, the influential beta-forces of euro-strength/dollar weakness continue to preserve prevailing vol themes of gamma strength, vol curve flattening and risk-reversal underperformance.
We advocate maintaining the bullish exposure in EURJPY via a call RKO as JPY weakening is likely to be a slow grind rather than explosive.
The macro theme of euro area leading outperformance remains dominant; maintain core EUR or proxy longs as growth and inflation data continue to be supportive. Accordingly, encourage long EUR vs in cash (vs USD) and through options in EURJPY (133 calls, RKO 137).
Any spot holdings, wise to book returns in long EURJPY cash; but stay long EURJPY in options structure.
A key judgment call in G10 is to separate those central banks that have the potential to change policy in the near term from those that are unlikely to do so. The BoJ is firmly in the latter bucket and its yield targeting framework have left JPY as having the highest beta of any other currency to DM yields, as per JPM’s sources.
The short JPY leg of these trades has thus been motivated by its sensitivity to higher yields. We still recommend keeping exposure to long EURJPY trades but think that the move will likely be a grind higher rather than an explosive move that one might expect if the Fed weren’t on the side lines and US yields were moving higher as well. Thus we take profits on the cash version and keep exposure through the EURJPY call RKO.
Take profits on long EURJPY from 128.50. Marked at 1.38%. Bought a 2m EUR call/JPY put, strike of 133 RKO 137 for 21bp on July 7. Worth 14bp.
