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The weak US dollar was the chief driver of the bounce, accounting for almost three-quarters of the rise in the value of global reserves. Beyond dollar weakness, global imbalances remain persistent and have been another important contributor to the reserves revival.
The weak US dollar was the chief driver of the recovery. Over a third of global reserves are allocated into non-USD currencies, but the overall holdings are valued in dollars. Of the non-USD allocation, more than half are invested in euro-denominated assets. The currency allocation also tends to be rather stable over time.
BRLJPY vs USDBRL vega spread as a low-cost defensive play: USDBRL vs USDJPY correlations at near 30 corr pts (in 3M tenor) are near recent highs, in part due to the beta effect of the dollar downtrend lifting all USD-corrs, and partly because of idiosyncratic BRLJPY vol supply from yield-seeking Japanese retail structures.
The extreme setup is supportive of a long cross-vol vs short USD vol RV that can hedge against an abrupt reversal of the current euphoria in risk markets. Per 1st chart, the BRLJPY – USDBRL vol spread has hit a multi-year low near zero, which ought to be something of a line in the sand for any high-beta JPY-x vs. USD-vol pair. Cross-sectionally, BRLJPY – USDBRL is one of the most attractive RVs within the x JPY vol – USD vol spread complex (refer above diagram).
Crucially, the historical performance of delta-hedged 3M BRLJPY-USDBRL straddles (refer above diagram) shows the vol spread generates its biggest returns during major market downturns, rendering the spread a cost-efficient low bleed blow-up hedge from entry levels that are rarely witnessed.
At current markets, OTM BRL calls offer about 0.5 vol edge over ATM strikes prompting us to favor 6M 25 delta long BRL calls /JPY puts @ 11.6/12.2 vs. short USD puts / BRL calls @11.65 choice, in equal vega notionals; the choice of longer (6M) expiry is intended to buy more time for a potential vol eruption to materialize. Courtesy: JPM
