G3 volatility i.e. that of the world's three leading economic blocs – the US, Japan and EU – has been in free fall since the start of the year plunging to multi-year lows, but forex carry trade is nonetheless taking a breather, according to a leading market analyst.
In a note to clients, Kit Juckes, Head of FX at Société Générale, said risk sentiment is more vulnerable when the global economy is sailing in less predictable late-cycle seas. “For the moment, we prefer taking advantage of exceptionally low implied volatilities to implement directional trades via options rather than buying volatility per se. Short USD/CHF is an attractive hedge, and we recommend a costless put spread ratio strategy.”
Juckes also said US equities are showing toppish signs, and European financials are selling off in the aftermath of the ECB dovish package revealed overnight, as low rates are anchored for longer.
“Forward guidance has been prolonged to December 2019, and the mention of discussions about extending it to March 2020 makes the statement sound even more dovish. EUR/USD should therefore remain prisoner of its 1.12-1.16 range but is currently trading in the lower bound,” the SocGen expert added.
The volatility market remains however the least bearish it has been since June, and tactical longs appeal if the 1.12 support holds, as the market could “unwind” some of its accumulated shorts.
Juckes also said EUR/CHF is tracking EUR/USD so tightly that USD/CHF is “now paralysed at close to parity” thereby pressing its volatility at a multiyear low. However, the persisting positive volatility premium does not suggest buying this volatility outright, but rather trading the spot future direction via cheap options.
“We expect the overvalued dollar to gradually reverse its gains as the FX market's focus turns to end-cycle risks and slower US global growth. Risk aversion is likely to resurface in 3Q, and the CHF to benefit from it. The bearish dollar skew allows to build costless USD/CHF ratio put spreads,” Juckes concluded.
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Gaurav S.
