As demand for safety subsides, both the U.S. dollar and the Japanese yen began April weaker vs. their major counterparts. This is thanks to Angela Merkel. Since her conversation last week with Vladimir Putin, when he told her that he’d order a partial withdrawal of Russian troops from his county’s border area with Ukraine, FX markets have taken comfort as non-haven currencies have strengthened and implied volatilities have softened. Earlier, Obama’s fiery comments regarding the Russian troop built up had rekindled worries and stirred markets. But for now due to the ‘Freundschaft’ (Friendship) between Merkel and Putin, it appears that the world is a safer place, and the market’s appetite for risk has returned.
Russian Note: The most obvious impact of the crisis has been Russia’s difficulty selling its sovereign bonds. According to Bloomberg, four auctions have failed. As a result the Russian government sold notes directly to pension funds and banks sidestepping the bond market. Half of these non-tradable securities are due in March 2015 at a 7.73% and the rest mature in February 2016 at 8.25%. Yield on government ruble bonds due January 2016 have risen 190 basis points since the start of the year.
Fed Chair Janet Yellen said the U.S. economy will need support for “some time’’ after a regional measure of manufacturing decreased. She rejected as ‘‘tremendously premature’’ the conclusion that the Fed should disregard long-term unemployment in adjusting its stimulus campaign. (Translation: we can expect the same old same old from the Fed). And she said again that she did not see ‘clear indications’ that long-term unemployment would, by itself, prevent people from finding new jobs. She said she expected that as the economy improved, many people who had stopped looking for work would return to the labor market. (Translation: she supports the same old same old coming from the White House.)
Americans were less hopeful about the overall economy in March as indicated by a dip in consumer confidence to a four month low. But, there was some positive data released in the fortnight:
- Private sector payrolls jumped 191,000 in March. While February’s payroll figures were revised to 178,000 from 139,000, which is still short of the consensus estimate of 195,000.
- U.S. durables rose more than forecast, 2.2%, led by autos. Non-defense capital goods ex-aircraft, however, fell 1.3% and this is the one that counts.
- The Conference Board consumer confidence index rose to the highest level since January 2008.
- U.S. retail sales rose 0.3% in Feb after -0.6% in Jan.
- The Fed says 29 of 30 big banks passed the stress test (Zions fell short).
- Fitch affirmed the U.S. triple-A rating and removed Oct’s “negative watch.”
China announced the “seize the moment” campaign to accelerate work on investment projects. Analysts have already cut their growth estimates to 7.3%. The official Chinese PMI rose to 50.3 in March from 50.2, while the HSBC version fell. The official sub-index for large firms was even better, 51, while the medium and small sub-indices were under 50. Some analysts say the data shows weakness; I think it shows some ‘stability’; it’s a positive sign on a negative trend line.
On Tuesday the EUR hit a high of 1.3820, before sliding back below 1.3800. Implied volatility in both EUR/USD and EUR/JPY parings are moderately higher. Despite suggestions that the move is simply a short-squeeze, reports out of Germany suggest another interesting idea—that the EUR is getting support as Russia diversifies out of U.S. dollar. Analysts say “Russia’s footprints are in the market.” The single currency’s strong start in April has also been support by positive data.
Today Reuters reported that Eurozone businesses logged their busiest quarter in three years at the start of 2014, but did so by slashing prices. President Draghi predicts that the recovery will eventually push inflation back toward the target of just below 2 %, and today he stated if necessary policy maker could turn to asset purchases to combat persistent low inflation.
- The ECB left its rate at 0.25%.
- Markit’s Eurozone Composite PMI dipped to 53.1 in March from 53.3 in Feb.
- The European Commission flash consumer confidence was less-bad at -9.3 in March from the very bad -12.7 in February. Reuters reported a forecast of -12.5.
- Spain CPI fell 0.2% y/y in March.
- 6 German states reported March CPI for an average rise translating to 1% y/y, vs. a forecast of 1.1% y/y.
- Eurozone manufacturing PMI fell in Feb but French PMI hit a 33-month high and Spain and Ireland remained good. Germany and Greece both had indices under 50.
- Eurozone unemployment was the same 11.9% in Feb as in Jan. But in Germany unemployment fell 20% more than forecast.
- Current EUR/USD rate is 1.3711.
- Mid implied volatility is 6.04%.
- Current EUR/JPY rate is 142.61.
- Mid implied volatility is 8.96%.
Recommended Enhanced Yield structure: Continue Long EUR/JPY structure.
Australian Dollar (AUD)
The Australian dollar is headed for its best quarterly performance since 2011 against the USD. On Wednesday the RBA left rates on hold as expected, and 27 of 33 economists surveyed by Bloomberg predicted the central bank will refrain from cutting interest rates through 2014 year. Despite RBA Governor Steven’s jawboning that the recent rise will reduce the stimulus provided to the economy by low rates, the AUD is hanging on to its gains.
- House prices are up 2.3% m/m in March for 10.6% y/y.
- Q4 GDP firmed to 0.8% q/q and firmed to 2.8% y/y.
- Final domestic demand edge up just 0.1% q/q.
- Current AUD/USD rate is 0.9231.
- Mid implied volatility is 8.72%.
- Recommended Enhanced Yield structure: Long AUD forward.
- Long AUD/USD forward at 0.9235 for 2-Weeks.
- Sell 2-Week AUD Call / USD Put with 0.9295 Strike (34 Delta).
- Forward’s implicit deposit rate is 2.20%.
- Yield from US dollar cash position 0.24%.
- Yield from option premium 7.92% annualized.
- Structure’s yield is 10.36% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium) plus potential capital gain from AUD appreciation to 0.9295.
Great British Pound (GBP)
The pound remains stable. The GBP is headed for a fourth quarterly gain versus the dollar. Analysts forecast future reports will show that the U.K. recovery is strengthening. UK house prices are up for the 15th month in a row y/y, with London up 18%. Minutes from the last Monetary Policy Committee (MPC) showed a unanimous vote to keep an even keel and to support a strong pound as a tool to hold inflation down.
UK Q4 GDP is confirmed at 2.7%, in line with forecasts, but the current account deficit of 5.4% of GDP is too high for comfort. The cause is not trade but rather falling income from overseas assets as the GBP strengthens.
- UK service sector PMI was 57.6 in March decelerating from 58.2 in Feb.
- CPI is up 1.7% y/y, down from 1.7% in Jan and meeting forecasts.
- PPI has output prices up only 0.5% (from 0.7%) and input prices down 5.7%.
- House prices are up 0.6% m/m and 6.8% y/y. And to no one’s surprise, mortgage lending was up in January.
- UK Q4 GDP is confirmed at 2.7%, in line with forecasts, but the current account deficit (£22.4 billion) is too high at 5.4% of GDP. The cause is not trade but rather falling income from overseas assets.
- Average earnings rose 1.4% in the 3 months to Jan, better than 1.2% in the Oct-Dec period.
- Current GBP/USD rate is 1.6574.
- Mid implied volatility is 5.56%.
Recommended Enhanced Yield structure: Long GBP Forward
- Long GBP/USD forward at 1.6580 for 3-Weeks.
- Sell 3-Week GBP Call / USD Put with 1.6705 Strike (30 Delta).
- Forward’s implicit deposit rate is 0.28%.
- Yield from US dollar cash position 0.24%.
- Yield from option premium is 5.43% annualized.
- Structure’s yield is 5.95% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from GBP appreciation to 1.6705.
Canadian Dollar (CAD)
Aided by short covering and profit taking, some improved data, and fading global fears the CAD is up over 2.0% vs. the USD. But caution, substantial risk exist with the release of international merchandise trade and employment on Friday. Technically, the failure to break back above the 50-day moving average of 1.1086, points to modest CAD strength.
- February industrial product prices rose by 1% m/m.
- January GDP rose a bit more than expected, by 0.5% m/m and 2.5% y/y.
- January manufacturing sales recovered to a gain of 1.5% m/m.
- February CPI eased to 1.1% y/y and the core CPI slowed to 1.2% y/y, while January retail sales recovered with an increase of 1.3% m/m.
- USD/CAD rate is 1.1013.
- Mid implied volatility is 7.54%.
Recommended Enhanced Yield structure: Long CAD forward
- Short USD/CAD forward at 1.1005 for 2-Weeks.
- Sell 2-Week USD Put / CAD Call with 1.0930 Strike (32 Delta).
- Forward’s implicit deposit rate is 0.00%.
- Yield from US dollar cash position 0.24%.
- Yield from option premium is 7.79% annualized.
- Structure’s yield is 8.03% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from CAD appreciation to 1.0930.
Japanese Yen (JPY)
Japan’s sales tax increased from 5% to 8% on April 1st. (Just a reminder: the last time there was a similar rise in the sales tax, April 1997, it was a disaster.) The economic impact of the tax hike will be closely monitored over the coming months as policymakers decide whether further stimulus is required. The BoJ reported that the private sector corporate stash of cash and deposits rose 6.4% y/y. Is it just me? Or does it look like Abenomics is not convincing boardrooms to invest. Who was it that said Japan is a demographic time bomb?
- Retail sales surged by 3.6% y/y after 4.4% in Jan. (Not a surprise or particularly good news here. Consumers rushed to buy ahead of the sales tax increase.)
- Household spending fell 2.5% y/y in Feb.
- CPI is up 1.3% y/y as energy costs were up 5.8% due to weak JPY.
- Industrial production fell 2.3% m/m in Feb. A rise was forecast.
- Japan’s February corporate services prices were steady at 0.7% y/y.
- Q1 Tankan survey showed some improvement as the large manufacturers’ index rose to 17 and the large non-manufacturers’ index rose to 24, but capital spending plans eased to 0.1%.
- Japan’s March small business confidence rose to 53.5. (Someone please explain this to me).
- Current USD/JPY rate is 103.94.
- Mid implied volatility 8.49%.
- Current EUR/JPY rate is 142.47.
- Mid implied volatility is 9.24%.
Recommended Enhanced Yield Structure: Short JPY vs. EUR (As opposed to a JPY vs. USD, because EUR/JPY implied volatility is higher).
- Long EUR/JPY forward at 142.55 for 3-Weeks.
- Sell 3-Week EUR Call / JPY Put with 144.45 Strike (30 Delta).
- Forward’s implicit deposit rate is -0.10 %.
- Yield from US dollar cash position 0.24%.
- Yield from option premium is 10.58% annualized.
- Structure’s yield is 10.44% (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from EUR appreciation to 144.45. Additionally, structure benefits from potential appreciation vs. USD.
Mexican Peso (MXN)
Since the start of the Fed’s tapering in December, USD/MXN has been trading sideways. Foreign direct investment inflows derived from the 2013 reforms and rating upgrades have served as important as supports. Since our last commentary generally improving risk sentiment and firmer data, have provided MXN with technical and fundamental supports.
- 95.35% of the economically active population was employed in February 2014.
- Underemployment decreased, marginally, to 8.17% from 8.21 % y/y.
- Unemployment decreased to 4.65 percent in February of 2014 from 5.05 percent in January.
- Bank of Mexico left interbank rate steady at 3.5%.
- Consumer prices rose by 4.23 % y/y in February, down from 4.48 % y/y in January.
- Mexico posted a USD 976MM trade surplus, which comes on the heels’ of a record deficit in January.
- Current USD/MXN rate is 13.10.
- Mid implied volatility is 8.79%.
Recommended Enhanced Yield Structure: Sell MXN Put against U.S. deposit, not a forward.
- Sell 2-Weeks USD Call / MXN Put with 13.20 Strike (33 Delta).
- Yield from US dollar deposit 0.24%.
- Yield from option premium is 10.51% annualized.
- Structure’s yield is 10.75 % annualized (from deposit and option’s premium). If option is assigned, result will be long MXN at 13.20.
Guest post by Ronald G. Huddleston Managing Director of Huddleston Capital Management:
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.
Huddleston Capital Management (HCM) is the managing member and investment manager of the Enhanced Yield Currency Fund (EYC). The managing partner is Ron Huddleston, me. HCM is registered in the United States as a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) with the NFA and CFTC. In addition to the fund, HCM offers managed accounts using OTC options and forwards. HCM is looking to partner with a U.S. bank to introduce foreign exchange managed accounts and investment products that will allow clients to gain alpha, diversify, and hedge currency exposure.
The EYC fund strategy uses OTC options and forwards in a covered call approach; short call options corresponding to the long side of forwards are held. The short calls are covered by the long side of the corresponding forward contract. The option positions match the expiration, notional amount, and the currency of the long side of the forward contract. The positions’ terms range from 2-Weeks to 6-Months.
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