FX Update: Contrarian EURUSD thoughts for the longer term

Trading interest

• Taking profit on USDJPY
• Buying long term (Nov 6 – days after election) EURUSD calls

Yesterday our bandwidth was  entirely occupied by the recent JPY sell-off move that was historic in “sudden volatility” terms as we watch whether the USDJPY rally can proceed now that we have both of the traditional cylinders of yen support firing: risk off in equities and safe haven bond strength. Arguably, a third cylinder is EM carry trades, which are under more considerable pressure since yesterday than they have been in some time – USDMXN finally catching up with some of its peers in rather violent fashion, in particular. This is important to watch on the risk that USDJPY is underdoing some sort of regime shift, perhaps a flight of capital or other.

Today we zoom out and have a look at EURUSD, which we see as very undervalued for the longer term.  As the US yield curve flattens toward inversion as US 30-year yields poke at historic lows today (and the curve is already inverted for the 3-month-10-year portion of the curve), it is clear that the Fed is behind the curve and will eventually have to chop rates further and ratchet QE higher, its declared intention to eventually taper the “Not QE” notwithstanding. Looking at EURUSD upside potential through options and with expiries on the other side of the US election in November is one to begin establishing a position, as we discuss below.

The US Philly Fed was absurdly strong yesterday – not sure whether to take anything away from that number – and given its history of extreme spikes, we need another strong reading to begin arguing that US manufacturing is picking up. Also of concern in the US is a data point like the US Cass Freight Index (a measure of freight shipment by road, rail, air and barge), which, as the wolfstreet.com website points out was down some 9.4% year-on-year in January, it’s worst level since 2009.

Chart: EURUSD, implied volatility and risk reversals
(Source: Bloomberg) This is a chart I sent out  with today’s Market Call podcast (discussion specifically on EURUSD starts around 14:30 – supporting on the first slide of today’s Market Call slide deck), talking about the still very low implied volatilities for EURUSD. From these levels in spot combined with the low implied volatility, we see compelling risk/reward in being long EURUSD upside via options for the other side of the  US election, with a further position to be added in the event a technical reversal materializes in the weeks ahead.