Events to watch this week…

1. The ECB meets on Thursday and we don’t expect much from policymakers despite low inflation and ECB M3 figures this morning. We saw that Flash inflation remained poor and steady in June (0.5% YoY), and ECB data on M3 Annual growth and Private Loan continue to disappoint. EURUSD recovered from its May losses and is now trading around 1.3650. The next resistance on the topside stands at 1.3672 (which corresponds to its 200-day SMA), followed by 1.3700. We would try to play the 1.3550 – 1.3670 range for the coming days, with a stop loss 50 Below/Above the range.

2. Tonight, the Reserve Bank of Australia is expected to keep its cash rate at a historical low level of 2.5%. We don’t see anything new; perhaps policymakers will try some more jawboning in order to push the Aussie down a bit. AUDUSD has remained pretty much rangy for the past few weeks, trading between 0.9330 and 0.9440. There seems to be a strong resistance zone at 0.9440/60 on the topside and it may be worth trying to sell some if the Aussie gets back to those levels for a test back towards 0.9330 (tight stop loss above 0.9480).

3. The Swedish Krona may continue to be under pressure this week ahead of the Riksbank meeting on July 3. The market is expecting the central bank to cut its benchmark rate by 25bps to 0.5% after CPI contracted by 0.2% YoY in May. Deflation is a drag and economists see it as a concern as it would only add to Sweden’s record household indebtedness. Even if the market is pretty bearish at the moment, we wouldn’t consider entering now as there is little room left. The SEK has depreciated 4.5% approximately against the Euro and the Dollar, and it may enter in an oversold area.

Review on the FPC’s report

The table below shows that the cost of an average house in the UK (and its regions) is ten times bigger than the average Salary based on ONS House price index. London comes first of the league with a House-price-to-salary ratio of 14.18, which is not surprising after ONS showed earlier this year that London property market is 25% above the 2007-2008 peak.

image001

(Source: ONS)

This morning, Bank of England Governor Mark Carney announced new measures on mortgages in order to ‘control’ the potential bubble in the housing market that UK is experiencing at the moment. Even if he mentioned that the threat ‘is not imminent’, the BoE is still concerned about the level of debt of UK households. Therefore, he came up with a couple of measures:
1. The BoE introduced a cap on mortgages: banks cannot hold more than 15% [in their portfolios] of the number of new residential mortgages that equal or exceed 4.5 times the borrower’s annual income. The Treasury will ban all applicants that are asking for a loan superior to 4.5 times their annual income through the Help to Buy Scheme.

2. The committee also suggested that lenders should stress test if borrowers can cope with a three percentage point rise in interest rates within the first five years of the loan.

Cable rose significantly after the announcement and reached a high of 1.7039 during London trading session. It was quite a surprise as the market was expecting the British pound to ease against the US Dollar (and the Euro) after Carney’s (kinda) dovish tone before the Treasury Select Committee a couple of days ago. The 2-year UK yield is down 10 bps to 0.837% (compare to 10 days ago), and the implied rate on the short-Sterling March 15 contracts eased 3-4 bps.
EURGBP is trading back below its 0.8000 level as EURUSD keeps fluctuating between 1.3600 and 1.3650. The next support on EURGBP stands at 0.7980, followed by 0.7960.

Watch the Yen

USDJPY is flirting with its 200-day SMA at 101.67 after US GDP disaster… US GDP printed at -2.9% Ann. QoQ (far from the -1.8% expected and well below the first economists’ ‘projection’ of +2.6%).
A break on the downside could bring us to the next strong support at 100.75.

JPY-25June

(Source: Reuters)

If we have a quick look at EURJPY, we can see that since the pair closed below its 200-day on June 11, it has been unable to resurface above it. The 200MA stands now at 139.00 and EURJPY trades within a tight range 138.57 – 138.90 today.

EURJPY

(Source: Reuters)

The VIX/VXV Ratio

Last time, we talked about the convergence and divergence between the VIX and SKEW and what sort of information we could get from that. Today, let me introduce you to the VIX/VXV ratio combined with an application on the US Stock market.
But first, let’s start with the definitions of all the indexes:

– As a reminder, the ‘SKEW’ is an indicator that computes the implied volatility of the S&P500 from OTM the options and therefore ‘measures fat tails’ and investors fear.

– The VIX index, introduced in 1993 by the Chicago Board Options Exchange (CBOE), measures the 30-day volatility implied by the ATM S&P500 option prices. The components of the VIX are basically near/next – term put and call options.

– The VXV index (that you can also find in Bloomberg) is designed to be a constant measure of 3-month implied volatility of the S&P 500. It uses the same methodology and generalized formula as the VIX index.

If you are familiar with the term structure, investors and traders can use the historical data of the last two indexes (VIX and VXV) in order to gain a better understanding of the market’s expectations of the future volatility. As you can see it on the graph below, for the past few years (December 11 – June 14), the VIX/VXV ratio (in green) has been oscillating around 0.85 – 0.90 with a low of 0.71 (16-Mar-12) and a high of 1.0645 (02-Mar-14). The ratio has remained most of its time below 1.00, which is logical as the term structure should have an increasing concave shape (in theory). Basically, a ratio superior to one would mean that investors are more concerned about the near term fluctuations (usually a correction) of the S&P500 and often comes from an appreciation of the VIX due to market events such as FOMC meetings or companies’ earnings.

image001

(Source: Bloomberg)

In the graph, we drew a white line which has (‘kinda’) acted as a support for the VIX-to-VXV ratio (around 0.82). However, when we look at the S&P500 chart (white/blue), we can see that most of the times that we hit this ‘imaginary’ resistance, the ratio rebounded and we either saw a stagnation or correction in the stock market.

For those who don’t agree with us concerning the application, they just to have to remember that the VXV provides a valuable tool for traders to identify the term structure of S&P 500 implied volatility and that a single value of the (SPX option) implied volatility is not enough.

Quick Overall update…

This week has started with limited risk appetite as situations in Iraq and Ukraine both remain intense. US yields still struggle to take off in the middle of this QE Taper environment (10-year is trading below the 2.60% level), while Gold and Silver both continue to soar and are now trading above 1,300 and 21.00 levels respectively. The US Dollar remains offered against most of the G10 / EM currencies; as you can see it on the chart below, the USD index continues its bearish momentum and is now trading at 80.23 between its lower Bollinger Bands (20, 2.0) and its 200-day MA.

usdiNDEX

(Source: Reuters)

Dollar Bloc: Low vols sustain demand for Dollar Bloc currencies and especially the Canadian Dollar. Since its high of 1.1278 on March, USDCAD has entered into a bearish momentum as the Loonie continues to benefit from higher than expected CPI figures. As a reminder, annual inflation came in at 2.3% in May (vs 2.0% consensus) and stands now above the BoC 2-percent target. USDCAD broke its 200-day (1.0783) last week and visited its 5-month low at 1.0710 earlier this morning. The next support on the downside stands at the psychological 1.0700, followed by 1.0650 (Jan 7).

Yen: Low US yields in addition to a quite Japanese overnight session add pressure on USDJPY, still trading below 102.00. The pair has been stuck within a 70-pip range for the past couple of weeks, trading above its 200-day MA (101.65) and below its 100-day MA (102.20). The pair’s vols stands at their lowest level; the 1-month ATM volatility decreased to 5.02% (from 10.2% in the beginning of February). USDJPY looks vulnerable and we would carefully watch the downside at the moment; a break of the 200 MA would push the pair back to its strong support at 100.75. On Friday, we will get an update on inflation and household spending figures in Japan; Core Nationwide CPI is expected to increase to 3.4% in May (up from 3.2% the previous month) and could continue to disappoint investors on the easing measures (no signs of urgency from BoJ policymakers).

Euro: We expect the single currency to come back under pressure in the medium term as it seems that the ECB is not done with easing. Final Inflation came in at 0.5% YoY in May a couple f weeks ago and flash EZ Mfg. PMI printed below expectations of 53.5 at 52.8 (French Mfg. PMI was miserable at 47.8). Traders will watch closely updates on Inflation (flash) and ECB figures (Private loans and Money Supply) next week on Monday. EURUSD is trading back above 1.3600; the next resistance zone is seen between 1.3660 (higher Bollinger Band) and 1.3670 (200-day SMA).

Sterling: After Carney’s hawkish comments at the Mansion House that the BoE will consider raising its Official Bank Rate (currently at a historical low of 0.5%) sooner that the market expects (which meant Q1 instead of Q2 previously), today’s testimony before the Treasury Select Committee sounded a bit dovish. BoE Governor said that the ‘exact timing’ if a rate increase will be ‘driven by the data’ and will be ‘limited and gradual’ based on the central bank’s estimation. The 2-year UK-US yield spread shifted lower to 41.1bps this morning (down 4bps), bringing Cable below the 1.7000 level. There has been a large build of long Sterling positions for the past few weeks based on monetary policy divergence (long GBPCHF, GBPJPY or short EURGBP are popular positions to hold at the moment), and the dovish stance of this morning may be another good opportunity to enter (buy on dips / sell on rally) for traders or investors.

Quick market update…

Geopolitical tensions in Iraq, with militants taking control of a strategic Shi’ite town – Tal Afar – located in the North of the country, continue to drive US yields lower. The US-year yield is down 7bps from Friday’s high of 2.644%, pushing USDJPY below the 102.00 level. The next resistance on the pair stands at 101.70, followed by 101.55 (last week’s low). Last week, Bank of Japan decided to keep its monetary policy steady and seemed quite confident that the economy will meet its 2–percent inflation target without additional stimulus. Vols on USDJPY are now back to historical levels (for instance 1W ATM is trading at 5.47%), and the pair seems now stuck in the 100.75 – 103.00 range as we reported last time in our Update on Japan.
The Nikkei index dropped below the 15,000 (closing at 14,933) as geopolitical tensions kept investors on edge, a red session that continues now in Europe with the DAX down 1.6% since last week all-time-high of 10,033.74.

The British pound hit a high of 1.7010 against the greenback this morning before it started to be sold. A support zone is seen between 1.6900 and 1.6920 where we could potentially find new ‘buyers on dips’. In the UK, there are the Financial Policy Committee at the Bank of England and inflation figures tomorrow, BoE minutes on Wednesday and Retail sales on Thursday. On the US side, the Fed meets this week and there is little doubt on a update on its monetary policy; it will continue its Taper ‘auto-pilot’ strategy by cutting purchases by another $10bn bringing down the APP to $35bn.

The Euro remains week against the major crosses, trading below 138.00 against the Yen, at 1.2175 against the Swiss Franc and at 0.7980 against Sterling. We wouldn’t play the single currency for the moment especially after the sharp fluctuations we saw in the last couple of weeks; perhaps we will try to be long EURGBP (intraday position) based on a technical view (RSI is showing an oversold signal at 21) with a ST target at 0.7990.

Watch the 2-year yield spreads!

Yesterday evening, while most of the people were watching the World Cup first game’s kick-off, BoE Governor Carney and UK’s Chancellor of the Exchequer George Osborne both gave a speech at the Mansion House. The topic on the table was their concerns about the UK housing market as a rate hike would stress mortgage debt and therefore threaten the recovery. Until now, investors and traders were pricing in a rate increase somewhere in Q2 next year; however, Carney surprised the market by stating the Official Bank rate hike ‘could happen sooner than markets currently expect’. It immediately shifted the UK rate curve higher, with the 2-year now trading at a 3-year high of 0.852%. If we have a look at the chart below, we can see that the UK-US 2-year spread (in red) rose 10bps sending Cable (in yellow) to the roof. After it nearly reached its strong psychological resistance at 1.7000 on May 6, the British pound had entered into a bearish momentum against the greenback until it test its support at 1.6680 (mid-April lows) a few times. Despite strong UK fundamentals, the market is more concerned about the rate ‘neutrality’ debate and which central bank will consider starting raising its benchmark rate early next year.

Cable-2Y

(Source: Reuters)

However, this week’s strong employment data in addition to Carney’s hawkish speech played in favour of the pound which hit its psychological 1.7000 resistance against the US Dollar yesterday. We reached our target on EURGBP at 0.8000 based on our previous article (Some overnight developments), which has also been driven by the 2-year UK-EU yield spread (in orange, reversed scale RHS) as you can see it below.

EG-2Y

(Source: Reuters)

With the FOMC meeting next week, we assume that the volatility will remain low and especially in the FX market. Carry trade currencies (especially the Kiwi) should continue to outperform in this market. We saw yesterday that a currency that will remain under pressure will be the Swedish Krona (SEK) after the CPI came in at -0.20% YoY in May. If deflation continues to stagnate at around 0%, the Riksbank will have to intervene later this year but cutting its benchmark by another 25bps (it currently stands at 25bps), therefore impacting the currency.

Some overnight developments (Kiwi, Aussie…)

Yesterday evening, the Reserve Bank of New Zealand raised its official cash rate by another 25bps for the third time this year to 3.25%, at a time when most of the central banks have kept their base rates at or near zero. If we have a quick look at the statement, it said that inflationary pressures are expected to increase (as a reminder, CPI came in at 1.5% in the first quarter) and the central bank would like to see interest rates back to a more ‘neutral’ level as it is important that ‘inflation expectations remain contained’. The next meeting will hold on July 25th and some economists already expect another 25 bps rate hike.

With FX volatility at very low levels since the beginning of the week, we have played the typical classical carry trade strategy since Monday by holding a long position on NZDJPY ahead of the RBNZ meeting. If you have a look at the graph below, we thought that it was interesting to buy the pair between 86.80 and 87.00 for a test back towards 88.80 (s/l below 85.80). NZDJPY was helped by the spike in the 10-year yield from 4.22% (end of May) to 4.47%.

NZD-12-06

(Source: Reuters)

We think it is still interesting to play the Kiwi in the short term, potentially against the AUD or the EUR. AUDNZD is now approaching an interesting level, trading around its 50-day MA at 1.0844, and seems to be on its way to retest its support at 1.0800 (second one stands at 1.0780, 100-day MA). We suggest that new joiners should wait for a slight ‘bull’ correction after yesterday losses. In Australia, jobs data were a bit disappointing in May with total employment falling 4.8K (vs +10K consensus) from an upward revised 10.3K the precious month. However, full-time employment rose 22K (vs part time fell 27K) and could explain why the Aussie remains well supported against the yen (trading around 96.00) and the US Dollar (0.9400).

For the Euro, we would continue to keep a bearish view against the British pound in the days to come based on the monetary policy divergence, with a next target at 0.8030 (followed by the psychological 0.8000 level).

Update on UK and Cable…

The storm on the Euro also impacted the value of the British pound after Draghi’s speech in Brussels last month. Cable is now approaching its strong psychological support level at 1.6700 where there could potentially be some ‘buyers on dip’.

On the UK side, the BoE MPC met on Thursday but as expected nothing new concerning its monetary policy was released. The BoE is still seen as the first major bank to start raising rates in early 2015 (probably Q2); therefore investors are still interested in playing the monetary policies divergence between the major central banks (short EUR/GBP is a popular medium term position to hold at the moment). In addition, the National Institute of Economic and Social Research (NIESR) estimated today that the UK economy have eventually surpassed the pre-recession peak it reached in January 2008 after more than 6 years. NIESR are forecasting a 0.9% growth in the March-May period (tight slowdown compared to the 1.1% estimated between February and April), which would mean that the level of UK GDP stands 0.2% above where it was in January 2008. With an economy that almost faced a triple-dip recession in 2013, Britain has taken much longer time to recover compare to other ‘strong’ economies such as Germany or the US (both returned to pre-cisis level in 2010).

If we have a quick look at the economic indicators, we saw last week that Manufacturing, Construction and Services PMIs all stood well above the 50 (expansion / contraction) level at 57.0, 60.0 and 58.6 respectively. Moreover, industrial and manufacturing output both came in higher-than-expected at 3.0% YoY (vs 2.8% expected) and 4.4% YoY (vs 4.0% consensus) in April.

The rebound we have since in the US yields since the lows reached in the end of May helped the greenback recover against the major currencies this week. The graph below shows you one of Cable’s main drivers, the 2-year UK-US spread (in red). As you can see it, the spread narrowed by 10 bps since the end of May and now sits at 0.291%, which pushed Cable (in Yellow) down by 120 pips to 1.6750.

Cable-Spread

(Source: Reuters)

Based on this analysis, we will try to buy Cable at around 1.6720/30 for a test back towards 1.6800 (at first) with a stop loss at 1.6680 (below its 100-day MA at 1.6688).