Forex and Capital Markets Overview, April 15, 2016
By Huddleston Capital Management.
It was the deeply righteous William Shakespeare who wrote, “As soon go kindle fire with snow, as seek to quench the fire of love with words.” Though the bard is renowned more for his observations of human foibles than his economic analysis, his line would have been a spot on prediction for U.S. dollar performance in the first quarter of 2016, as the fire of love for the USD was quenched by the Fed’s scaled back expectations for rate increases.
Since the beginning of the year the greenback is off 4.70% vs. the Euro, has slipped 7.8% vs. the Australian dollar (AUD) and has lost a staggering 11% vs. the Japanese yen (JPY). Bullish hopes for the U.S. dollar have been dashed as the Fed took a stand to halt the pace of interest-rate increases. Current focus is now on “emphasizing downside risks to the US economy originating from abroad.” Translation: the plan is to keep supporting lower rates. The results will not be kind to USD bulls.
Two factors have contributed to its stellar performance. First, the market’s reaction to the Bank of Japan’s monetary easing was brief and underwhelming, and secondly, the ‘safe haven’ and ‘funding currency’ status of the Yen provided an appealing haven from global unrest and equity market uncertainties.
Implied volatilities remain firm. Concerns generated from uneven global economic conditions within the developed world, along with signs of intervention and commodity price moves, have pushed implied volatilities in risk reversals in most major pairings above historic levels. Harbinger or opportunity? Perhaps both.
Inflation and confidence surveys have firmed, and job growth remains steady. But, don’t expect rising yields to offer dollar support in the near future. The Fed is clearly on hold. Chair Yellen told Congress in February that volatility in financial markets could set back US growth, then the FOMC March statement reiterated the dovishness, and in late March Chair Yellen reminded us how the central bank needed to ‘proceed cautiously’ in lifting rates. So, for now, the market expects the dollar to fall, regardless of anything else going on, including yield differentials.
US consumer data fueled fears of a slowdown in domestic activity. Despite continued strong non-farm payrolls, the Conference Board’s forward-looking consumer confidence index fell 5.6 points to 92.2 in February while the Institute for Supply Management’s nonmanufacturing index slipped to 53.4 in February from January’s 53.5, to cap off five consecutive monthly declines. Meanwhile, the Department of Commerce revised January’s core retail sales growth downward, to 0.2% from 0.6%.
Market positioning offers scope for the greenback gains, and eventual rate hikes should see U.S. dollar strength against the G10 and emerging currencies, but for now the USD is in a bearish mode. Expect further U.S. dollar consolidation. Adjust positions for USD strength in the medium term.
- March nonfarm payrolls rose by 215,000, the jobless rate rose to 5.0%.
- Average hourly earnings rose 2.3% y/y.
- March ISM manufacturing index rose to 51.8.
Another apt Shakespearian line notes “There is nothing either good or bad but thinking makes it so.” So far in 2016, the most notable ‘good’ has been the significant strength of the JPY.
- ISM non-manufacturing index rose to 54.5
- March retail sales dropped 0.3% m/m.
- February industrial output fell 0.5% m/m.
- February core CPI firmed to 2.3% y/y
- Core PCE prices were steady at 1.7% y/y.
- Federal Reserve kept its fed funds target range at 0.25% to 0.50%.Implied VolatilitiesEUR/USD: 1 Month At-the-Money Volatility 8.50 % USD/CAD: 1 Month At-the-Money Volatility 11.14% USD/JPY: 3 Month At-the-Money Volatility 10.98%Euro (EUR)The recovery in the euro zone is continuing, but it is nothing to write home about. Growth is modest and confidence surveys are mixed. Inflation is contained and disinflationary pressures persist. The sluggish pace of the recovery has been especially surprising given the fact that the euro area has benefited from the fall in energy prices and ECB’s quantitative easing. Net results have been negative interest rates and continued weak growth. With further European Central Bank easing not likely in the near term, Fed hikes could be a more important driver, pointing to a relatively stable euro for now but euro weakness over time.Technicals hint at slowing upside momentum for the euro, while modest short positions suggest scope for euro declines.Expect renewed softness in the euro over the medium term.
- Eurozone March manufacturing PMI rose to 51.6
- PMI fell to 53.1. Eurozone March economic sentiment fell to 103.0.
- Germany’s IFO business confidence rose to 106.7.
- February retail sales rose 0.2% m/m.
- Industrial output fell 0.8% m/m
- February unemployment fell by 39,000.
- March CPI fell 0.1% y/y, while the core CPI quickened to 1% y/y.
- February PPI fell 4.2% y/y.
- Q4 employment rose by 0.3% q/q and 1.2% y/y.
- Q4 labor costs firmed slightly to 1.3% y/y.
- February M3 money growth was steady at 5% y/y.
- Private sector loans firmed to 0.9% y/y.
- January current account surplus eased to €25.4B (sa).Current EUR RatesEUR/USD: 1.1308 EUR/CAD: 1.4574 EUR/JPY: 122.93
EUR/USD: 1 Month At-the-Money Volatility 8.50 % EUR/CAD: 1 Month At-the-Money Volatility 11.45% EUR/JPY: 1 Month At-the-Money Volatility 10.96%
Recommended Enhanced Yield Structure: Short EUR/USD Forward.
o Short EUR/USD forward at 1.1309 for 2-Weeks.
o Sell 2-Week EUR Put/USD Call with 1.1255 Strike (39 Delta). o Forward’s implicit deposit rate is – 0.91%.
o Yield from US dollar cash position 0.63%.
o Yield from option premium is 14.32% annualized.
Structure’s yield is 14.04% annualized from deposit rates and the option’s premium plus potential capital gain from EUR depreciation to 1.1255.
Australian Dollar (AUD)
Australian economic trends are steady, although mildly subdued. The central bank maintains a modest easing bias. It’s not clear if or when it will act on that bias. The economy grew at a relatively healthy pace as evidence that non-mining sectors were recovering, despite the large drag on economic growth from falling mining investment. The unemployment rate fell from a peak of 6.3% in July to 5.8% in February.
Challenges remain for the Australian economy, and could become more apparent in upcoming data. Eventual Fed rate hikes should lead to a weaker Australian dollar over time. All said, expect modest near-term gains in the Australian dollar.
- March business conditions rose to +12.
- Business confidence rose to +6.
- March manufacturing PMI rose to 58.1.
- Services PMI fell to 49.5.
- February retail sales were flat for the month.
- April consumer confidence fell 4% m/m.
- The February trade deficit widened to A$3.41B.
- Q4 house prices slowed to 0.2% q/q and 8.7% y/y.
- The central bank kept its Cash Rate at 2.00.Current AUD RatesAUD/USD: 0.7706 EUR/AUD: 1.4673 AUD/NZD: 1.1150 AUD/JPY: 83.77Implied VolatilitiesAUD/USD: 1 Month At-the-Money Volatility 12.33 %
EUR/AUD: 1 Month At-the-Money Volatility 11.80% AUD/NZD: 1 Month At-the-Money Volatility 9.82% AUD/JPY: 1 Month At-the-Money Volatility 14.95%
Recommended Enhanced Yield structure: Long AUD/USD forward.
- Long AUD/USD forward at 0.7710 for 3-Weeks.
- Sell 2-Week AUD Call /USD Put with 0.7800 Strike (36 Delta). o Forward’s implicit deposit rate is 1.80%.
- Yield from US dollar cash position 0.63%.
- Yield from option 12.88% annualized.
Structure’s yield is 15.31% annualized from deposit rates and the option’s premium plus the potential capital gain from AUD appreciation vs. USD to 0.7800.
Great British Pound (GBP)
In the land of Shakespeare expect the pound to weaken modestly over the medium term. Economic activity worsened in February. But there is good news: survey data points to some improvement going forward. Inflation remains benign despite some recent firming. Bank of England is on hold for now. The June referendum on the U.K’s membership in the European Union could weigh on the pound.
Technicals hint at further GBP/USD downside movement, although existing short FX positions could limit the extent of the U.K. currency’s decline.
I really should have a Shakespearean quote here, but I can’t think of one. Any suggestions?
- Q4 GDP growth was revised up to 0.6% q/q and 2.1% y/y.
- February industrial output declined 0.3% m/m.
- Retail sales fell 0.4% m/m.
- Sentiment surveys improved in March.
- Manufacturing PMI rose to 51.0.
- Services PMI rose to 53.7.
- February trade deficit narrowed to £11.96B.
- January jobless rate remained at 5.1%.
- Trend earnings growth firmed to 2.1% y/y.
- March CPI inflation firmed to 0.5% y/y.
- Core CPI firmed to 1.5% y/y.Some Current GBP RatesGBP/JPY: 154.30 GBP/USD: 1.4186 GBP/EUR: 1.2558 GBP/CAD: 1.8260Implied VolatilitiesGBP/JPY: 1 Month At-the-Money Volatility 12.96% GBP/USD: 1 Month At-the-Money Volatility 10.42 %
EUR/GBP: 1 Month At-the-Money Volatility 9.50% GBP/CAD: 1 Month At-the-Money Volatility 10.40%
Recommended Enhanced Yield structure: Short GBP/ JPY 2 Forward.
o Short GBP/JPY forward at 154.42 for 2 Weeks.
o Sell 3-Week GBP Put/JPY Call with 152.85 Strike (33 Delta). o Forward’s implicit deposit rate is -0.84%.
o Yield from US dollar cash position 0.63%.
o Yield from option premium is 18.71% annualized.
Structure’s yield is 18.50% annualized from deposit rates and the option’s premium plus the potential capital gain from JPY appreciation vs. GBP to 152.85.
Canadian Dollar (CAD)
The loonie has recovered nearly its entire late 2015/early 2016 sell-off versus the USD. A key driver of the CAD’s recovery has been the rebound in crude oil prices. One mustn’t forget that commodity prices are strongly correlated with the CAD.
Q1 GDP looks likely to come in above the Bank of Canada’s 0.8% estimate. U.S. /Canada short-term rate spreads have strengthened the CAD. The rate compression is the result of changes in the tone of Canada’s economic reports (relative to expectations), Ottawa’s fiscally expansive Federal budget, and reduced expectations of Fed policy tightening.
Central bank is on hold. A more benign global market backdrop and firmer oil prices will provide potential gain for the Canadian dollar. Technicals are providing important support for the CAD rebound, but eventually, Fed rate hikes will weigh on the Canadian currency. Expect further Canadian dollar strength in the near team, but also expect renewed downside pressure over the medium term.
- January GDP growth quickened to 0.6% m/m and 1.5% y/y.
- January retail sales rebounded 2.1% m/m/
- Manufacturing sales firmed to 2.3% m/m.
- March employment rose by 40,600.
- Jobless rate fell to 7.1%.
- March manufacturing PMI fell to 50.1.
- February trade deficit widened to C$1.91B.
- February CPI slowed to 1.4% y/y.
- Core CPI also eased slightly to 1.9% y/y.
- Q1 Business Outlook survey showed firms’ sales outlook steady at +16.
- Bank of Canada left its policy rate at 0.50%.Some Current CAD RatesUSD/CAD: 1.2865 GBP/CAD: 1.4195 CAD/JPY: 84.60
USD/CAD: 1 Month At-the-Money Volatility 11.37% GBP/CAD: 1 Month At-the-Money Volatility 10.29% CAD/JPY: 1 Month At-the-Money Volatility 14.90%
Recommended Enhanced Yield structure: Short USD/CAD forward.
o Short USD/CAD forward at 1.2855 for 2-Weeks.
o Sell 2-Week USD Put/CAD Call with 1.2800 Strike (43 Delta). o Forward’s implicit deposit rate is 0.01%.
o Yield from US dollar cash position 0.63%.
o Yield from option premium 19.09% annualized.
Structure’s yield is 19.73% annualized from deposit rates and the option’s premium plus the potential capital gain from CAD appreciation vs. USD to 1.2800.
Japanese Yen (JPY)
Despite the market’s 2016 Shakespearean love for the Japanese Yen (JPY is the best-performing G-10 currency year-to-date), Japan’s economic data has been
unimpressive, and there is little to suggest that JPY’s strength is fundamentally justified. The JPY gained in a typical safe-haven response to global turmoil and weaker global equity markets at the start of the year.
- In the Q1 Tanken survey, the large manufacturers’ index fell to 6.
- Large non-manufacturers’ index fell to 22.
- Capital spending plans showed a decline of 0.9%.
- Industrial output declined 6.2% m/m in February.
- Retail sales dipped 2.3% m/m.
- The February jobless rate ticked up to 3.3%.
- Labor cash earnings quickened to 0.9% y/y.
- The February current account surplus rose to ¥1734B.
- The national core CPI was flat year/year in February.
- CPI ex fresh food and energy firmed to 0.8% y/y.
- Tokyo’s March core CPI fell 0.3% y/y.Another possible explanation of the JPY’s surge might be found, at least partly, in nominal yields as a potential for currency drivers: In 10-year government yields, the U.S. enjoys a significant advantage to Japan with respect to nominal yields (+1.79% versus -0.08% respectively). However, allowing for expected inflation (Real yields), the U.S. dollar advantage is noticeably smaller. U.S. 10 Year rates are at +0.22% vs. -0.50% for Japan. Assumptions of a higher expected rate of inflation in the U.S. would explain why current yields would favor the Yen strength.Softening activity along with subdued sentiment surveys and underlying inflation trends could lead to further Bank of Japan easing. So, expect yen stability in the near term. FX positioning and stretched technicals suggest scope for the Japanese currency to fall.
“Love is blind, and lovers cannot see, the pretty follies that themselves commit,” another fitting quote from the deeply righteous Bill Shakespeare.
Some Current JPY Rates
AUD/JPY: 83.95 USD/JPY: 108.75 EUR/JPY: 122.80 GBP/JPY: 154.60
AUD/JPY: 1 Month At-the-Money Volatility 15.43% USD/JPY: 1 Month At-the-Money Volatility 12.52 % EUR/JPY: 1 Month At-the-Money Volatility 11.84% GBP/JPY: 1 Month At-the-Money Volatility 13.65%
Recommended Enhanced Yield structure: Short AUD/JPY forward.
o Short AUD/JPY forward at 83.84 for 2-Weeks.
o Sell 2-Week AUD Put / JPY Call with 83.05 Strike (35Delta). o Forward’s implicit deposit rate is -2.75%.
o Yield from US dollar cash position 0.63%.
o Yield from option premium 22.71% annualized.
Structure’s yield is 20.59% annualized from deposit rates and the option’s premium plus the potential capital gain from JPY appreciation vs. AUD to 83.05.
Mexican Peso (MXN)
Economic performance remains uneven and inconsistent. Firm inflation reinforces the central bank’s currency supportive tightening bias and discretionary FX intervention policy. In a move that raised eyebrows, the government proposed an additional MXN 175B of cuts to the 2017 budget after Moody’s lowered Mexico’s ratings.
More benign global markets and a further recovery in oil prices would be peso supportive. Expect moderate weakness in the Mexican peso in the near term, with more strength over the medium term.
- January retail sales firmed to 5.2% y/y.
- February industrial output also firmed to 2.6% y/y.
- January economic activity index eased to 2.3% y/y.
- March sentiment surveys were mixed – the services PMI rose to 50.8.
- Manufacturing PMI fell to 51.6.
- February trade deficit narrowed to US$725M.
- Unemployment rate rose slightly to 4.3% (sa).
- March consumer price inflation slowed to 2.6% y/y.
- Core CPI firmed to 2.8% y/y.USD/MXN rate is 17.38
USD/MXN: 1 Month At-the-Money Implied Volatility is 13.36 %Recommended Enhanced Yield structure: Short MXN forward
- Long USD/MXN forward at position 15.3722
- Sell 2-Week 15.4000 Strike USD Call / MXN Put (45 Deltas).
- Forward’s implicit deposit rate is – 2.52%.
- Yield from US dollar cash position 0.28%.
- Yield from option premium is 21.14% annualized.
- Structure’s yield is 18.90% annualized (from forward deposit rate, U.S. deposit rate, and the option’s premium), plus potential capital gain from MXN depreciation to 15.40.And because I’m often asked about them…Russian Ruble (RUB)The central bank held its policy rate at 11.00% in March, and said “moderately tight” policy might last longer than expected. 11.00%? Do I really need to say more?Calmer global markets and firmer oil prices have helped the ruble, but expect renewed weakness in the over time. The economy is still in recession and central bank easing from 11.00% remains possible.
- Q4 GDP fell 3.8% y/y, slightly less than expected.
- February real retail sales fell 5.9% y/y.
- Industrial output unexpectedly rose 1% y/y.
- March manufacturing PMI fell to 48.3
- PMI rose to 52.0.
- Q1 current account surplus fell to US$11.7B,
- Private capital outflow of US$7.0B during the Q1.
- March CPI slowed to 7.3% y/y.
- Core CPI rose 8% y/y.USD/RUB rate is 66.3665
USD/RUB: 1 Month At-the-Money Implied Volatility is 21.40 %Israeli Shekel (ILS)Disinflationary pressures have waned. Economic growth appears to be on an uptick. Central bank held its policy interest rate at 0.10% in February and March and rates are likely to remain on hold. Central bank also purchased US$700M in foreign exchange in March. Expect modest weakness over time.
- Q4 GDP growth was revised to show a larger 3.9% q/q annualized gain.
- February leading index rose 0.3% m/m, but eased to 3.5% y/y.
- January manufacturing output fell 3.7% m/m.
- Q4 current account surplus was held constant at US$3.57B.
- February CPI fell 0.2% y/y,
- Private sector 12-month CPI forecast firmed to 0.6% y/y in MarchUSD/ILS rate is 3.7835
USD/ILS: 1 Month At-the-Money Implied Volatility is 6.61 %
Mr. Huddleston has nearly 20 years of financial services experience, with primary expertise in the conceptual and structural development and trading of derivatives. He has also held a range of senior advisory positions working with high net worth and institutional clients, with his most recent role at Wells Fargo focused on the development of customized foreign exchange derivatives for the firm’s ultra high net worth clients. Mr. Huddleston has also held a range of management and trading positions at Capital Markets Trading (Frankfurt), Dresdner Bank (Frankfurt) and Citibank (Frankfurt and Hong Kong). Mr. Huddleston was a member of the Pacific Stock Exchange, where he was an options market maker on Microsoft listed stock options.