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We’ve already highlighted in our recent write ups on the concerted rise in the dollar against currencies of all stripes since US Election Day has elevated USD correlations to near historical highs.
Subsequently, the large thematic move in USD-correlations is lower, likely led by a de-coupling of JPY-(and possibly EUR-) crosses in response to a worsening risk backdrop brought about by trade tensions. We view this as probably a mid Q1/early Q2 event that is worth keeping a close eye on for signs of a realized correlation breakdown.
On the watch list are a handful of relative value dislocations within the EUR and JPY-cross complex that have begun to open up as a result of stretched USD-correlations. The most compelling of these is BRLJPY – USDBRL vol spreads that have historically acted as a reliable proxy for USDJPY vol but currently screen too cheap relative to the latter.
This requires one to agree with the fundamental notion of owning yen vol of course, which we do not mind because our perception is that tails on USDJPY are especially fat this year: either trade tensions generate the sort of risk-aversion that mean-reverts JPY REER from extremely cheap levels and validates our starkly non-consensus bullish end-2017 call on the currency, or upward surprises on US growth and inflation push up Treasury yields towards Fed dots and send USDJPY spiraling higher towards and beyond last year's highs. Either ways, spot moves are unlikely to be timid, hence yen and cross-yen vols should prove to be a decent hold.
