FX Market Update: Week 15 – Positioning for lower oil-price

• The Greek bailout impact on EUR/USD compared to what we would expect: In order to evaluate the post-Friday bounce in EUR/USD we employ our short-term financial model (augmented by the 5Y Greek sovereign spread). These are our findings:

         (i) Despite the fairly modest 83bp Greek spread narrowing since Friday, the model would still predict a 4-5 big figure jump in EUR/USD. This is more than the 3 big figure move observed from 1.3350 to 1.3650.

         (ii) Should Greek spreads narrow to their pre-crisis levels (indicating a decline in the EUR risk premium), the model would indicate potential for EUR/USD to converge back above 1.40. This is, however, still well below the November 1.5144 high, as relative economic data has driven relative interest rates in the dollar’s favour.

         (iii) Combined with positioning, which still shows EUR shorts in place, the downside in EUR/USD appears more protected than the upside – should Euroland debt concerns ease further.

• Implied volatilities show mixed picture: Over the past week, implied volatility in the Scandies has edged higher, along with the spot and realised volatility. Additionally, the 1 Week expiry in EUR/SEK now covers the upcoming Riksbank meeting, which is exerting upwards pressure on short-dated EUR/SEK implied volatilities. This corresponds roughly to the usual pattern, which has seen the 1 Week implied volatility rising by 0.3-1.1 percentage point on the day which has the expiry covering the meeting on the three past occasions. As a result, the implied volatility curve has become inverted. Elsewhere, implied volatilities in EUR/CHF have continued lower towards the levels seen prior to the last signs of SNB intervention and the one month implied volatility is actually trading below that realised by our measure. With the skew also coming off, positioning for further EUR/CHF downside through out-of-the-money options has become more attractive (e.g, a 1M 1.43 EUR put).

• Strategy: Following a 20% rally since early February, the oil-price is currently under pressure and is likely to extend its losses below 80 USD/barrel over the next month, according to our commodities research team. This view presents FX trading opportunities worth considering: Looking at correlations, it appears that the closest link between the price of oil and the FX market is found in the currencies of the dollar-bloc (AUD, NZD, CAD). Furthermore, these currencies are vulnerable due to 1) crowded positioning – speculative investors are already ‘long’ and 2) stretched valuation by long-term measures (PPP). One idea to position in accordance with these arguments would be to enter a 1 Month USD/CAD 1.004:1.024 call-spread at an indicative price of 70 CAD pips (spot reference 1.04). By positioning through options, the downside risk due to the upcoming BoC meeting is also contained.
Explanatory notes can be found on page 20. Please refer to Technical appendix for FX Market Update for a detailed technical appendix. FX Markets Update is published every Tuesday. The next publication date will be 20 April 2010.