Bought EUR/USD call option
We have planned for some time to change our research service, with the intention of implementation at the beginning of this year. As such this will be the last Real-Time briefing where I share our specific trading strategy. Real-Time briefings will continue, but will be used to provide more frequent updates on our views and analysis of events between AmpGFX reports.
It is also coincidently the first time I have traded using options over standard spot transactions. Using options is something that I have mulled for some time, and perhaps more abruptly, today, I have decided to bite the bullet and implement.
Perhaps a shift in market conditions in recent years have weakened my capacity to time markets, and using options may provide a more effective way for me to manage risk.
For the record, I bought a three-month EUR/USD call; strike at 1.1600, spot ref 1.1414. There are other details I could share on size, price etc, but this is my last specific trade notification so will leave it at that.
I will send a separate email discussing more details about changes to our research service, including Real-Time Briefings.
We have held a view for some months that the USD should weaken. This reflects the fact that global market turmoil has been more prominent and largely led by US asset markets in recent months, reflecting increased risks for the US economy emanating from various sources, such as feedback from a weaker global economy, concerns over blowback from trade policy, exposure to the energy and tech sectors.
We thought the Fed might not raise rates in December. In fact, we thought hiking was a central-banking A01 error and were surprised as an institution the Fed made it. We can’t pin the blame solely on Powell; the staff should have advised him more forcefully, which raises questions about the structure of the institution and the force of will of Powell, which is a whole other topic of discussion.
But in any case, we think the risk is now that the Fed does more sole-searching and adopts a more flexible stance. It might struggle to convince the market of newfound flexibility, and indeed it might continue to resist changing style and course. But the potential surprise for the market is that it decides to pause its QT and suggests a willingness to cut rates if required. I don’t necessarily think the Fed needs to panic just yet and ease policy, but it should at least make a clearer statement of the risks that policy may be more restrictive that need be in the context of broader global uncertainty.
There were reports that Trump was trying to arrange a sit-down with Powell. Trump’s credibility on central-bank policy is obviously low, and many might conclude that such a meeting might in fact be counter-productive. But the Fed can be rightly criticised, in my view, and the Administration has a case for asking the Fed to do some sole-searching on their conduct. If the message is delivered in the right way, it could contribute to some changes to the style and substance to decision making at the Fed. Perhaps Powell has already been counselled by his peer group accordingly. Powell speaks soon in a joint interview with Bernanke and Yellen. They would never openly say they disagreed with the rate hike last month, but I doubt their Fed would have hiked.
Before the Dec rate hike, Powell announced that the Fed, this year, planned a comprehensive review of how it conducts monetary policy. And he also moved the Fed to including a press conference after each FOMC meeting. The review may provide the catalyst for making and presenting a case for re-introducing more policy flexibility.
On the other hand, we expect the ECB to stick with its current policy stance, that has already seen it end QE in January. It may tweak policy a bit, if required, but, by and large, we expect little adjustment and an underlying desire to get rates up at some point.
Policy at the ECB is still clearly accommodative. Unlike the Fed, it probably does not risk derailing its and the global economy, by tightening policy. If conditions deteriorate, it is just more likely to stay the course, as opposed to the Fed that might ease policy.
The EUR has, it seems, in recent months, under-performed the narrowing in yield spreads (short, long, and real). This under-performance has intensified in the last week. As such, we see a higher risk of a catch-up rise in EUR.
As mentioned, timing FX markets has appeared to get harder. The rapid rise in JPY in recent weeks makes sense in the context of lower US yields and weaker equities, but was quite delayed in showing up.
EUR might now appear more correlated with financial markets in China, and many are pinning the weaker Eurozone economy on the slowdown in China. This may account for a lack of rise in EUR – it may appear more high-beta than safe haven than it has in the past. But even on this account, there are reasons to see a strategic, even if not long term, recovery in Chinese asset markets as Chinese policymakers become more focused on shoring up its equity market and economic confidence.
Credit risk metrics also have improved for the EUR in recent months, relative to the USA. This includes some narrowing in Italian bond yield spreads.
There are still clear down-side risks for the EUR, including Brexit uncertainty, and we are uncertain on how EUR might perform near term, hence our decision to use an option to express a long view, allowing us to run this trade without a stop loss and conduct some spot-trading around the option in consideration of changes in the option delta (and take advantage of the positive gamma).