Macro and Vol Commentary
The move by the SNB to raise rates this week has provided headwinds to EURCHF and backed the ECB into a corner.
- European GDP for Q1 was 5.4% Y/Y and 0.6% M/M, higher than expectations, but growth is slowing, and we are seeing this in the data. GDP in Q2 could contract on a Q/Q basis as inflationary pressures curb consumer and business sentiment.
- Industrial production is declining, falling to -2% Y/Y in April after a revised -0.5% Y/Y in March, but was up 0.4% M/M. We expect this to continue to contract along with industrial confidence, which stood at 6.3 in May, due to high energy, raw material and labour costs, not to mention weak end-user demand.
- The manufacturing PMI from S&P global was revised higher for May to 54.6, but this is still lower than April's figure of 55.5.
- Output growth improved marginally from April's low; however, business confidence continues to fall at an alarming rate as prices are expected to rise.
- Supply chains remain congested, demand is softening, printing a bleak outlook for the manufacturing sector, and we expect the current trend to persist.
- Construction output for Europe is contractionary, with the S&P Global construction PMI at 49.2 for May and output M/M at 0%, but from a Y/Y perspective, growth will fall in the coming months, down from May's figure at 3.8%.
- Household consumption was negative for Q1 at -0.7% Q/Q, down from a revised figure of -0.3% Q/Q. Despite employment data continuing to be strong, household consumption will decline further.
- Retail sales are falling on an M/M basis at -1.3%, down from -0.4% in March, the Y/Y figures are still positive, but growth is waning as expected. This is in line with falling consumer confidence which stood at -21.1.
- Employment stands at 2.9% Y/Y, marginally higher than the previous month at 2.6%. Unemployment stands at 6.8% in April, and there are still jobs available, and this will cause unemployment to decline. The strong employment outlook gives the ECB room to raise rates. However, the bond market for Italy, Spain, and Greece is a worry.
- CPI data is rising and an alarming rate at 8.1% Y/Y in May, with core CPI at 3.8% Y/Y. The ECB are behind the curve and will need to raise rates, especially as the SNB increased by 50bps this week, and their inflation is lower.
- After the emergency meeting failed to captivate the market, the fears over Italian and Spanish yields continued to grow. This will cause the ECB to act, Italian, Spanish and Greek 10yr yields are above 3%, and Portugal is at 2.97% at the time of writing. This presents funding issues for the economies; however, the stress is being managed at this point.
- The spreads between these countries' 10yr yield and the German 10yr bond continue to widen and are essential.
- All major central banks have hiked rates except the ECB; the market is pricing in 25bps in July and then 50bps in September, with rates expected to be 1.2% by December.
- This slightly backed the ECB into a corner, and we could see the language change regarding a 50bp.
- The bank is firmly behind the curve; after their ad-hoc meeting, the ECB decided it would apply flexibility in reinvesting redemptions coming due in the PEPP portfolio to transition into tighter monetary policy while keeping price stability.
- The SNB raised rates this week by 50bps, shocking the market and causing CHF to strengthen.
- A stronger currency is not bad at this time, especially when inflation is imported, but it does increase the propensity to import goods and services.
- The SNB see supply chain bottlenecks decline in the medium term; however, China's COVID policy will remain problematic.
- The bank is adjusting the threshold rate used to calculate the level of banks' sight deposits. This will ensure that the secured short-term Swiss franc money market rates are close to the SNB policy rate.
- We expect the bank to increase rates in future meetings to curb inflation and to move away from capping FX levels.
Both CBs have negative rates, but Switzerland have moved first, breaking tradition; this has fuelled CHF strength this week. However, we expect the higher rates in the U.S. and the future rate hikes will prompt the dollar to the firm. The ECB needs to raise rates to help strengthen the euro, but 10yr yields remain an issue. They are nervous about peripheral countries' yields increasing, causing funding issues. The spread between the German 10yr and these countries is integral. With the SNB moving first, we expect EURCHF to weaken in the near term, but inflation is higher in the euro area, and the ECB will have to start moving quickly; the implied rate for European rates is 1.2% in December with 1.9% expected by March 2022. This will give rise to EURCHF and other currencies, but given the lower global growth environment, EURUSD will struggle given U.S. rates. We are turning more bullish on the EUR; however, we expect further downside to EURCHF in the near term towards 1.00 but favour building a long position around 1.050 as the ECB start raising rates.
(Sources: ECB, SNB, Eurostat, S&P Global)
As per the above with macro inflation remaining stubborn CBs are increasing rates further than originally expected with the ECB’s hand likely to be forced by actions taken by other CBs (ie the Fed raising 75bps vs the originally forecasted 50bpsand the SNB’s surprise hike). With Governments and Central Banks struggling to fight Stagflation and rate action becoming unpredictable (as we’ve seen with the Fed/SNB) and not following previously stated forward guidance and rate telegraphing as closely as we’ve seen in recent years we favour being long Macro FX Gamma with EURCHF being no exception. Below we put a trade idea benefitting from EURCHF vols increasing and spot moving lower in the immediate term but reverting higher with likely ECB rate hike action.
EURCHF 1-month Realised and Implied Volatility
EURCHF Trade Idea
- Buy KI EURCHF Call Option
- Strike 1.0500, KI Barrier 0.9950
- Expiry 3 months
- Premium cost for 10m EUR notional circa 7k EUR
- For reference vanilla equivalent premium cost circa 38k EUR
USDBRL NDO Positioning Data 02/06/2022 - 09/06/2022
This week for the USDBRL there was less volumes and the options that were traded had a lower notional value suggesting reduced conviction. The range was similar to the week prior, although slightly narrower, with no option traded at 4.40. The trend is still in favour of USD weakness with very few call options traded above stop. Call option volume was minor and traders are expecting the USD to weaken.
USDBRL NDO Positioning Data 09/06/2022 - 16/06/2022
USDCNY Vanilla Positioning Data 02/05/2022 - 09/06/2022
The options market for USDCNY shows a preference to USD strength, in chart 2 we can clearly see more call options traded. The range for options due to expire in the near term show a slight shift higher, upside cover reaches 6.95. Towards the end of August there is a large number of call options traded between 6.80-7.10 with a strong notional value. The options market suggest we will continue to see USD strength.
USDCNY Vanilla Positioning Data 09/06/2022 - 16/06/2022
EURCHF Vanilla Positioning Data 16/04/2022 - 16/05/2022
There is a strong difference between the two charts below, in the month to 16 May traders saw upside with call options traded up to 1.08. These options are due to expire before the beginning of July. In the month to 16 June, there are considerable put options traded with a range down to 0.97. The put option have a strong notional value suggesting conviction, and we expect to see EURCHF downside in the immediate term before the ECB meeting next month.
EURCHF Vanilla Positioning Data 16/05/2022 - 16/06/2022
Charts and Tables
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Key Events & Releases
JP Morgan Global FX Volatility
The index rallied sharply in June, breaching resistance at 11.00 and 11.18, but resistance at 11.90 caused the index to come down to trade at 11.70. The stochastics are converging but continuing to fall, and the MACD is negative and converging. To confirm the outlook of higher prices, the index needs to break above the robust resistance of 11.90 and then resistance at 12.00. Alternatively, if the index finds resistance at that level, the recent trend can reverse down to 850 MA at 11.13 and 38.2% fib level at 10.73. The appetite seems to have softened around the near-term resistance, and we could see a change of trend, but indicators point to further upside pressures in the meantime.
The dollar index has been softening in recent sessions after finding resistance at 105.78 and has been trading mostly sideways today, supported by 50 MA. The stochastics have, however, converged on the downside, confirming a strong selling pressure, but the MACD is negative and has struggled to point out an outlook. If weakness prevails, we could see prices break below the 50 MA at 104.23 level to test 104.04. On the upside, if support above this level holds firm, this could trigger gains through 105 and target 105.78. The most recent indicators suggest we could see the index fall further in the near term, but the index needs to breach the near-term support to confirm this.
The pair gained ground in the first week of June, breaching 1.045 levels to find resistance at 1.0471. In the last couple of days, however, this level has been robust, and the pair sold off down to find support at parity. The stochastics are rising, but %K is showing signs of tailing off. The MACD diff is negative and continues to converge. The gains have not been well bid, and the most recent candles struggled to recover after the sell-off, indicating momentum on the downside. If support at 1.01 is broken, we could see the pair edge lower down to the 1.00 level. On the upside, if support at these levels holds firm, it could trigger gains back to 1.023 and 1.03. The indicators and support at 1.00 could point to a change of momentum in the near term, but the lack of appetite could cause the pair to edge sideways in the meantime.