FxWirePro: The Major FX Derivatives and Macro Themes For 2020

What are the ‘key take aways’ from 2019, what does that mean for 2020, and what are the implications of the UK election result, where are the risks in emerging markets, how could the trade war and other geopolitical issues develop, is a currency war already in full swing, and what are the long-term issues for the foreign exchange markets, all of which are the cause of concerns for 2020.

The year-2019 was not only the time in which we began to establish ourselves in a permanent low-interest world. 2019 was also a year of exceptionally low exchange rate volatility. VXY Global heads into next year with the deepest cyclical undershoot on record, in excess of 3 % pts. Ultra-cheap vol valuations however need to be set in the context of less stressful global economic conditions next year. JPM baseline expectations of lukewarm moves from the big G3 FX, and the drip feed of USD strength in 2019 of the kind that erodes speculative interest in FX carry are other reasons to curb one's enthusiasm for a V-shaped vol rebound.

The path of least resistance to higher FX vol next year runs through politics (US/China, US elections), not economics. 

The major option themes for 2020 are: 

i) Favoring EM vol over DM vol; 

ii) Betting on Euro strength through contained upside structures / RVs; 

iii) 2020 US elections: long USDCHF forward volatility over the Democratic primaries; 

iv) The systematic shorts in AUD and JPY risk- reversals as their risk-sensitivities have regime-shifted lower; 

v) Long GBPUSD 1Y1Y forward volatility for renewed back-ended Brexit disruption; and 

vi) The model- based mean-reversion pair selections (NOK vs. SEK, PLN vs. HUF).

In the special section, we introduce a novel framework for trading mean reversion on FX volatility spreads, by providing plain vanillas, vol swaps and FVAs backtests for G10 and EM pairs. 

In the financial markets, the major lesson from 2019 is that "normalisation" most unlikely to happen in the foreseeable future. We will have to set ourselves up in a world of low interest rates, low inflation and permanently expansionary monetary policy. Central banks will be less active, so FX volatilities will remain low, even if the EURUSD sideways movement is unlikely to last. The best news from the ECB is that it will do nothing while the Fed will have to fight for its independence in 2020. Courtesy: JPM & Commerzbank