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In today’s meeting, we now expect the ECB to announce a slower but longer taper, specifically a 9month QE extension at €20bn per month versus our earlier expectation of a 6-month extension.
Recent political developments in the Euro area have garnered attention. In Spain, the acrimonious standoff between the central and Catalan government has intensified uncertainty following the illegal referendum in which 90% of the voters voted for independence, resulted in a 20bp widening in Spain-Germany yield spreads intra-month.
Historical experience from valuation frameworks suggests that euro valuations are not yet a constraint for further strengthening. On long-term valuation metrics, even though the euro has strengthened by 15% in TWI terms since the post-QE bottom, historical experience from other major currencies where markets perceived an impending end of QE programs showed a larger, 26% strengthening in TWI on average.
Please be noted that the risk reversals are still indicating bearish risks, while positively skewed IVs of the same tenor signifies the hedgers’ interests in OTM put strikes.
On the flip side, if you look at the technical chart of this pair, the major trend has been rising higher. The technical indicators have also been substantiating the strength and momentum in this consolidation phase.
Hence, keeping both fundamental and technical factors in mind, it is advisable to initiate below relative value trades.
Sell 6M EUR/JPY 25D risk-reversal (buy EUR calls - sell EUR puts), delta-hedged.
Buy 3M 30D EUR puts/JPY calls vs. sell 3M 28D EUR puts/KRW calls.
Currency Strength Index: FxWirePro's hourly EUR spot index is inching towards 78 levels (which is bullish), while hourly JPY spot index was at shy above -51(bearish) at the time of articulating (at 07:01 GMT. For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex.
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