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The European Central Bank (ECB) is scheduled for the monetary policy on July 25th. ECB’s readiness to cut its key rate next week. And there is no reason for the euro to appreciate considerably in the short run.
The currency differentiation and short correlation were laid out as one of the core vol alpha themes for H2 in the Mid-Year Outlook. One class of trades that were identified in there was selling GBP vs. commodity FX correlation on the view that GBP’s idiosyncratic political dynamics would lead to low / no correlation with other cyclically sensitive FX.
One such corr short that could be considered at current levels is EURGBP vs EURAUD: 3M implied corr is 26% vs. 2-wk realized corr -4%, 1-mo 16% and 3-mo 7% (refer 1stchart). The backtest in chart 2 shows favorable historical performance over the past 3-yrs since the Brexit vote.
A pushback is that if the ECB pivots towards re-starting QE later this year the EUR could fall against everything in sight and lift all EUR-x vs EUR-y realized correlations, as it happened when EURUSD fell from 1.40 to 1.05 during the ECB QE of 2014-16.
Two ways of guarding against this:
a) The limit expiry to pre-September ECB, when a 10bp rate cut is expected and when a potential QE announcement might come; and/or
b) Hold appropriately sized EURUSD put spreads against a short corr. swap, but sizing is a non-trivial problem.
With 2M EURGBP – EURAUD corr swap @24/35 indic we think vol spread is an attractive alternative to consider: 2M GBPAUD – EURGBP vol spread @0.95/1.45 indicative. Courtesy: JPM
