Macro and Vol Commentary
The Fed is committed to hiking rates until inflation is cooled, but the ECB has indicated they will hike rates in July. What will this mean for the currency pair?
European Economic Data
- Confidence in Europe has declined across the board; economic, industrial, services, and consumer confidence are all falling, outlining the deteriorating economic outlook, with the data at 105,7.9,13.5, and -22, respectively. This trend will continue as inflationary pressures persist. Consumers will be particularly impacted in the coming quarters, as has been for this year.
- European manufacturing was marginally weaker for May at 54.4, down from 55.5 in April; higher input costs, tightening financial conditions, squeezed purchasing power, and weak consumer confidence could cap manufacturing. New orders were the lowest since November 2020, and outstanding business increased at the slowest rate since August 2020, indicating that we could see weaker production in the coming months.
- Input and output costs eased, and confidence also fell to the lowest since the 1st wave of the pandemic. The trend of declining activity is firmly intact, and we have seen weaker month on month data since June 2021.
- Services are still performing well, as the sector profits from fading pandemic restrictions. This growth will continue to fade with the data set slowing from 57.7 to 56.3 for May.
- Construction and industrial output are growing slower, at 3.3% Y/Y in March and -0.8% Y/Y, respectively. This, in conjunction with waning growth from the manufacturing sector, will lead to weaker growth in GDP Q2. Indeed, weakening data in Q2 will certainly drag confidence down further, but Q1 data will likely be in line with initial expectations at 5.1%, although Germany experienced weak growth in Q1 at 0.2%, but was still positive. While this is a backwards-looking data set, it provides a platform of expectation for Q2, and there is a significant downside to the economy in Q2.
- Inflationary pressures will remain high in the coming months, but price growth will slow and plateau, prompting lower inflationary growth in Q4 2022. April’s CPI figures were 7.4% Y/Y, with M/M data 0.6%, in line with the previous month’s data. Core inflation was 3.5% Y/Y in April, highlighting where the inflationary pressure is. Energy and food pressures are likely to remain high in the near term due to the Ukrainian crisis and supply chain blockages in China.
- PPI for March was 36.8%, and the M/M data was 5.3%. The input costs in the PMI have shown signs of slower growth, and this could be passed onto PPI.
- Wages are starting to rise, reaching 2.8% Y/Y; a tight labour market and high inflation give employees a vital bargaining tool. Real wage growth is still profoundly negative, and this dynamic will stay. Wage growth and a strong labour market will provide the ECB with more room to hike rates as the consumer will be in a stronger position, but with real wages still negative, consumers are still very much on the backfoot.
- Employment is rising at 2.6% Y/Y in Q1, up 0.5% Q/Q. This has caused unemployment to decline to 6.8%, strengthening the ECB’s hand, but rates are still negative, and data is weakening.
- The probability of rate hikes for the remainder of 2022 is high at 316.5%, 316.7%, 177.4%, and 194.3% in July, September, October, and December, respectively.
- The APP is declining as April was €40 billion, €30 billion in May, and €20bn in June, which leaves the door open for a rate hike in July.
- Christine Lagarde has indicated that rates will be positive by October 2022, which was slightly faster than some anticipated.
- 10yr bonds in Europe are all firmly positive, but credit spreads are still negative when you compare against the U.S. 10yr yield.
The credit spread between 10yr European bonds and the U.S. 10yr is negative except Greece and Italy. While positive interest rates are bullish for the Euro, we expect this rally to be capped by a negative credit spread for many European countries. Economic data in the U.S. is deteriorating, and growth fears have prompted some moderate softness in the USD. The U.S. is more isolated from Europe, and the European economy will struggle due to the energy crisis in the coming years; as there is no quick fix, the U.S. could export LNG to Europe and greatly benefit. A recession in the U.S. is avoidable; consumer demand is still relatively strong, and if the supply chain shortages are resolved, this will reduce the chance of a recession. If inflationary pressures persist to the current extreme, the probability of a recession will increase, and the Fed needs to get interest rates above 3% to curb inflation. While wages have increased and the labour market is tight, a change in this dynamic would bring the housing market into ‘turmoil’, according to Jeremy Siegel of Wharton. We are not bearish on the USD but expect EURUSD to reach 1.10 U.S. data weakens, and the ECB becomes more hawkish. We believe resistance at the 50 DMA will hold firm in the immediate term, but if credit spreads between the U.S. 10yr and European 10yr yields.
(Sources: Eurostat, ECB, S&P Global)
The hawkish remarks from the ECB halted the recent EUR downtrend, with the ECB expected to raise rates as early as July, and eventually exit from the negative rates environment by the end of 2022. Volatility-wise, a more hawkish FED and the appeal of USD as safe haven propped EURUSD 1-month realised Vol up when compared to the implied, and in addition to this, the change in ECB’s monetary policy stance could still help volatility realising higher than implied. Markets are also expecting the FED to raise rates by 50-bp over the next two meetings, which could lead to further strength for USD in the short term. Thus, we favour a structure net buying volatility, to benefit from a rally in USD and a further uptick in Vol.
EURUSD 1-month Implied vs Realised Volatility
EURUSD Trade Idea
- Trade idea in 1-month
- Buy EKI EURUSD Put, 1.0745 Strike, 1.05 Barrier in EUR 5mio – Pay EUR 41K circa.
- Sell EURUSD Put, 1.04 Strike in EUR 10mio – Rec EUR 20K circa
- Total structure premium net Pay EUR 21K circa.
USDBRL NDO Positioning Data 12/05/2022 - 19/05/2022
Option positioning suggests that traders do not believe in the rally in the BRL, the put options are now trading down to 4.30. The notional values of the options is high suggesting that conviction in the market. There are call options traded above spot but have low notional value suggesting little conviction. We expect further downside in the BRL with the options trading lower strikes.
USDBRL NDO Positioning Data 19/05/2022 - 26/05/2022
USDCNY Vanilla Positioning Data 12/05/2022 - 19/05/2022
Once again there is little pattern in the options market, spot has moved higher and we saw a moderate increase in upside cover in chart two. Near term sentiment is slightly mixed, with a large volume of puts traded between 6.53 and then a strip expiring in June, these puts have a large notional value with strikes between 6.30-6.50. Options traded become more sparse as we move through Q3 with no real pattern at this time, the range is in the same range suggesting some consolidation.
USDCNY Vanilla Positioning Data 19/05/2022 - 26/05/2022
EURUSD Vanilla Positioning Data 26/03/2022 - 26/04/2022
Options traded in May show that sentiment was weak with traders betting on lower prices with some below 0.95. The majority of options traded in the near term favour the downside but there are a number of call options with strikes up to 1.15, which we see as optimistic at this time. Longer dated options are more split, with few options traded above 1.15. We expect prices to consolidate between 1.05 and 1.10 in the near term.
EURUSD Vanilla Positioning Data 26/04/2022 - 26/05/2022
Charts and Tables
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Key Events & Releases
JP Morgan Global FX Volatility
The index has weakened in recent sessions after failing into resistance at 11.54. The stochastics are in oversold territory, but we could have a buy signal on the horizon. The MACD diff just converged on the upside, both of which help to confirm the improving sentiment as the index reaffirms support at the 200 DMA at 10.17. If prices continue to hold this level, we could see the index push higher towards the 50 DMA at 10.52. In the long run, the index needs to take out 10.50 to confirm the trend. On the downside, to confirm the head and shoulders, the index needs to take out support at the 200 DMA at 10.17 and then the 61.8% fib level at 9.87.
The dollar index has contracted sharply in the last couple of sessions, breaching the 200 MA level of 102.45. The stochastics are rising out of the oversold, and MACD diff suggests higher prices; we could see the breakthrough of resistance at the 102 to 200 MA level at 102.45. The index struggled to break above that level in recent sessions, and if it breaks above this level, this could trigger gains back above 50 MA towards the 100 MA at 102.58 and 103.27. In order to regain upside conviction, the index needs to gain a footing above the 200 MA, a robust resistance level.
The pair has improved in recent sessions but found resistance at 1.0765 and now stands at 1.0701. The stochastics are converging on the downside out overbought as the MACD diff converged on the downside, suggesting we could see the pair push lower in the near term. The index needs to hold above trend support at 1.0695 before targeting 1.0765. The reaffirmation of support at that level would suggest strong upside potential. On the downside, rejection above 1.07 could trigger a break of support at 200 MA at 1.0628 and then 1.06. We expect the pair to gain footing in the near term, and if it breaks above the near term resistance, this would confirm the ascending triangle formation.