Forex Market Outlook June 19th 2014



In the last fortnight we’ve seen a cacophony of developments: continued dovish central bank policies, negative rates in the Eurozone, a downward World Bank revision on world growth forecasts (from 3.2% to 2.8% for the 2014), fears of emerging market financial crisis, a top Republican in the U.S. losing his primary re-election, oil price spikes, and of course, terrorists on a rampage in Iraq again. Currently, the mood is one of caution rather than outright fear, but the indicators are getting louder. This should all be very bullish for the safe havens; that’s, if times were ‘normal’, and rates were rising. But these aren’t ‘normal times’.


Fundamentals are taking a back seat to other developments. The situation in Iraq is unsettling for the U.S., and is being reflected in oil prices. Even though the broader financial market mood is cautious, the U.S. dollar benefits from its safe haven status. With the Fed inching toward policy normalization, U.S. bond rates are likely to move up. If it happens, expect a significant decoupling between the USD vs. most major currencies. Why “if it happens”? Because the International Monetary Fund on Monday cut its growth forecast for the U.S. economy and said that the Federal Reserve may have scope to keep interest rates at zero for longer than investors expect.

If Iraq implodes, expect USD strength; and when the crisis subsides, the USD should continue its recent slip against commodity currencies.

  • Payrolls grew by 217,000, more than forecast.
  • Unemployment rate is at 6.3%, the same as May. The U.S. unemployment rate is now back to where it was before the Great Recession.
  • May retail sales rose 0.3% m/m, import prices firmed to 0.4% y/y.
  • Initial claims increased slightly to 317,000.
  • Mortgage applications rose 10.3% in the latest week, breaking a 2-week drop.
  • Q1 GDP contracted 1% from the initial estimate of +0.01% and against forecasts of -0.5%
  • Pending home sales from NAR rose 0.4% in April, but is down 9.2% y/y.
  • April personal income rose 0.3% m/m, while spending fell 0.1% m/m.

Russia / Emerging Markets

In spite of an armored Russian column crossing the border into eastern Ukraine according to Ukraine’s interior minister, market concerns seemed to have eased. Implied volatility in the USD/RUB is off 1.5% to 8.15%. Perhaps, Russian involvement in Ukraine is gradually being accepted, or at a minimum condoned. G7 countries did not adopt specific sanctions against Russia if it continues to interfere in Ukraine, and Putin was even in attendance at D-Day commemoration ceremonies.

Geopolitical and market concerns have shifted to Iraq, where Islamists have captured city after city. Russia by the way has stepped in with a familiar refrain: “We told you so.” Russian Foreign Minister Sergei Lavrov said “We warned long ago that the affair that the Americans and the Britons stirred up there wouldn’t end well. “

  • Russia’s central bank kept the policy rate unchanged at 7.50%

Oil extended gains on speculation that an escalation of violence in Iraq would threaten output from OPEC’s second-biggest crude producer. Will increased volatility in oil prices spill over into higher volatility the FX markets? So far, actual volatility has increased, but implied volatilities haven’t for Turkish lira (TRY) and the Israeli Shekel (ILS), which are the only two currencies in the region in which I’d considering holding positions. Although both currencies are at multi – month lows vs. the USD, their 1-month at-the-money implied volatilities vs. USD are 10.36% and 4.28%, respectively. This is slightly lower than their 1-year historic levels. But that said, if the insurgents continue to stir things up, expect much higher implied volatility and historic volatilities for both.

  • Current USD/TRY rate is 2.1428
  • Mid implied volatility is 10.81%.

Long TRY forward and Long USD Call/TRY Put, which is a long synthetic straddle. The structure benefits from a discount in the forward rate of the long TRY forward.

  • Sell USD/TRY 1-Month forward at 2.1575 for (Get long TRY, which is at a 0.69 % discount to the spot rate).
  • Buy 1-Month USD Call / TRY Put with 2.1428 Strike (54.60 Delta).
  • Forward’s implicit deposit rate is 8.23% annualized, or .69% per month.
  • Yield from US dollar cash position 0.23%.
  • Downside Breakeven (if the TRY appreciates) is USD/RUB 2.1326.
  • Upside Breakeven (if the TRY depreciates) is USD/TRY 2.1825.
  • Maximum Gain: Unlimited through TRY appreciation or depreciation vs. the USD.
  • Maximum Downside: 1.17% of invested USD amount.


Some good data interspersed within the negative have provided hope that the trend is improving. Among the positive pieces of news were strong production figures, which bolstered confidence that the so-called mini-stimulus woiuld prevent a deeper economic slowdown. Data confirms stabilization of activity and even a modest improvement on the manufacturing side. May industrial output matched the median estimate in a Bloomberg News survey. Ministry of Finance data released showed May fiscal expenditure rose. In the words of the Ministry of Finance “We have great evidence that infrastructure projects have increased.” I just love the phase from a government official that, “ We have great evidence.” Just imagine Obama saying that without the data to support it.

Expect further central bank easing in the months to come. The Peoples’ Bank of China released its 2014 outlook and promised continued “fine-tuning” of policy to achieve goals like liberalization of interest rates, and it also promised that it would research deposit insurance. The central bank has strengthened the daily reference rate against the dollar by 0.2 %; the biggest weekly advance this year. Peoples’ Bank of China cut its reserve requirements for rural banks became effective today, June 16th.

  • Reported May factory output up 8.8% y/y, better than 8.7% in Aril.
  • Retails sales rose 12.5%, beating forecast.
  • Fixed asset rose “only” 17.2% y/y, the weakest since data began in 2011.
  • New construction was down 18.6% y/y in the first 5 months.
  • May trade surplus rose to US$35.9B, with exports rising 7% y/y.
  • New home prices fell 0.3% m/m in May for the first drop since June 2012, although still up 7.8% y/y (the 5th month of deceleration).
  • May CPI quickened to 2.5% y/y.
  • May PPI fell 1.4% y/y.
  • Property investment in the January-to-May period rose 14.7 %, down from a 16.4 % pace in the first four months.
  • Manufacturing PMI for May rose to 50.8 from 50.4 in April, a little more than the 50.6 forecast; the first gain of 2014.

Euro (EUR)

The ECB cut deposits rates down into negative territory, maintained their dovish tone, and announced a series of measures to encourage bank lending. But exactly what did they do, Ron? Well, they…

  • Cut the refi rate to 0.15%,
  • Cut the margin lending facility rate to 0.40%,
  • Cut the deposit facility rate to -0.10%.
  • Announced the ending of SMP sterilization, the process that ensures that individual actions by the central bank don’t result in an overall increase in the money supply.
  • Announced a “Targeted Long Term Repo Operation.”

Note: The ECB didn’t announce QE in any form.

Last week taxi drivers illustrated just how difficult any structural reform in Europe would be. A U.S. company named Uber allows passengers to use cellphones to call up independent car services and book rides. Basically, it’s a for people looking for rides. Taxi-drivers protested in Berlin, Paris, London and Madrid. They say Uber is not fair because the car services don’t have the same regulatory costs, knowledge, and training as taxi drivers. Everyone calls for structural reform, fewer government regulations, and smaller government bureaucracies, but somehow everyone doesn’t really want it. This is a clash of new-tech vs. established method. It’s a small moment of truth with all the factors that need to be in the larger debate.

As dust continues to settle from the ECB’s efforts to boost inflation and growth, the EUR now acts as a funding currency. Interest rate differentials between the EUR and its major counterparties are now noticeable and resulting in downward pressure for the single currency. In medium term for USD to appreciate against the EUR, the U.S. economy needs to show growth, but in the case of the GBP, evidence of economic strength is apparent, and it will serve to strengthen the GBP/EUR. Technicals point to short term EUR strength vs. USD.


  • May CPI was unrevised at 0.5% y/y.
  • Core CPI estimate was unchanged at 0.7% y/y.
  • Eurozone job growth in Q1 was 0.1% q/q and 0.2% y/y; the first since Q3 2011.
  • Total EU unemployment is 18.7 million persons.
  • Eurozone industrial production rose 0.8% m/m in April vs. a forecast of 0.3% and -0.4% in March (rev), or 1.4% y/y (vs. 0.2% in March revised).
  • Q1 GDP was unrevised at 0.9% y/y.
  • April PPI fell 1.2% y/y.
  • Eurozone PMI fell to 52.2 from 53.4 in April, according to Markit.
  • April retail sales rose 2.4% y/y.


  • The Bundesbank says Q2 growth will slow from 0.8% in Q1.
  • German added rose 0.3% q/q and /0.8% y/y.
  • PMI fell 52.3 vs. 52.90 in April
  • Industrial production rose 0.2% m/m.
  • Germany’s retail sales unexpectedly dropped 0.9% m/m in April.
  • April industrial output recovered to 0.2% m/m.
  • Germany’s April factory orders firmed to 6.3% y/y.
  • Trade surplus unexpectedly widened to €17.4B.
  • The Bundesbank raised its GDP forecasts for Germany from 1.7% to 1.9%.


France recommended banks stop using the dollar for international transactions as BNP faces a $10 billion fine from the US for trading with forbidden counterparties (mostly Iran).
France unveiled part of a new budget that will cut €4 billion in public spending and €1.1 billion in household taxes.

Portugal, Ireland, Greece and Spain

  • Portugal lost -0.3% jobs quarter/quarter, but gained 1.8% jobs y/y.
  • Industrial production rose 6.7% m/m in Portugal.
  • Industrial Production decreased in Spain and Ireland, with Finland and Malta.
  • Spain and the Netherlands had rising PMI’s.
  • Current EUR/USD rate is 1.3554
  • Mid implied volatility is 5.23%.
  • Current EUR/JPY rate is 138.36
  • Mid implied volatility is 5.71%.

Recommended Enhanced Yield structure: Buy EUR forward.

  • Long EUR/USD forward at 1.3576 for 3-Weeks.
  • Sell 3-Week EUR Call/ USD Put with 136.00 Strike (45 Delta).
  • Forward’s implicit deposit rate is -1.43%.
  • Yield from US dollar cash position 0.24%.
  • Yield from option premium is 7.67% annualized.
  • Structure’s yield is 6.48% (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from EUR appreciation to 136.00.

Australian dollar (AUD)

The Australian dollar exceeded my favorable outlook. It approached the year’s high set in April. Monetary conditions in Australia are set to remain accommodative in the coming months. The benchmark cash target rate is likely to be kept unchanged at 2.50%. Consumer price inflation has continued to pick up gradually; price gains reached 2.9% y/y in the first quarter of 2014 compared with a 2.7% advance at the end of 2013. Note of caution – naming Australia, the IMF issued a dire warning about a global housing bubble, saying house prices are over the historical average vis-a-vis incomes and rents. Weakness in employment growth has pushed the employment to population ratio to 60.8%, near record lows. Expect the AUD to stand its ground in longer term, if not slip a little first, on some near term jawboning from the RBA.

  • June consumer confidence edged up 0.2% m/m.
  • Building approvals fell 5.6% in April when a gain of 2% was expected.
  • Unemployment is steady at 5.8%.
  • Employment fell by 4,800 in May; the first negative number 2014.
  • May business conditions eased to -1 and business confidence was steady at +7,
  • April home loans were flat m/m.
  • April private sector credit rose to 4.6% y/y.
  • Q1 GDP firmed to 3.5% y/y.
  • April trade balance swung to a deficit of A$122M.
  • Current AUD/USD rate is 0.9389.
  • Mid implied volatility is 5.53%.

Recommended Enhanced Yield structure: Short AUD forward.

  • Short AUD/USD forward at 0.9300 for 2-Weeks.
  • Sell 2-Week AUD Put / USD Call with 0.9325 Strike (28 Delta).
  • Forward’s implicit deposit rate is 1.20%.
  • Yield from US dollar cash position 0.23%.
  • Yield from option premium 5.82% annualized.
  • Structure’s yield is 7.25% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium) plus potential capital gain from AUD depreciation to 0.9300.

Great British Pound (GBP)

In a speech the Canadian BoE Governor Carney warned that rates in the UK could rise sooner rather than later. He said that the UK economy is recovering a fast pace, and there are risks that labor market slack will be eroded faster than expected. His suggestion means that the BoE will be the first major central bank to normalize monetary policy since the global melt down. The divergent policies between the ECB and the BoE have pushed Yields between British and German 10-year government bonds to their widest since 1997. Expect continued GBP strength vs. its European counterpart. The GBP continued its bullish run nearing a 5 year high against the USD.

In what can be described as micromanaging of the good sort, the BoE will regulate banks to ensure mortgages are commensurate with incomes and property values, and the UK will also open old industrial sites for housing. They’re working hard to prevent a housing bust.

  • U.K. May claimant count unemployment fell by 27,400.
  • April trend earnings growth slowed to 0.7% y/y.
  • The April jobless rate dropped to 6.6%.
  • Construction rose 1.2% in April (from -0.2% in March) and Q1 was revised from 0.6$ to 1.5%.
  • Industrial output increased to 0.4% m/m and 3% y/y,
  • Manufacturing output was up 0.4% m/m and 4.4% y/y.
  • U.K. May consumer confidence improved to zero.
  • May Halifax house prices firmed to 8.7% y/y.
  • April trade deficit widened to £9.62B.
  • Current GBP/USD rate is 1.6940.
  • Mid implied volatility is 5.21%.

Recommended Enhanced Yield structure: Buy GBP Forward

  • Long GBP/USD forward at 1.6968 for 3-Weeks.
  • Sell 3-Week GBP Call/ USD Put with 1.7025 Strike (36 Delta).
  • Forward’s implicit deposit rate is 0.00%.
  • Yield from US dollar cash position 0.24%.
  • Yield from option premium is 5.62% annualized.
  • Structure’s yield is 5.86% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from GBP appreciate to 1.7025.

Canadian Dollar (CAD)

The CAD hasn’t benefitted from the rise in oil and gas prices stemming from the fresh Iraqi conflict. Safety concerns have dominated USD/CAD trading. Long term Iraqi oil supply interruptions will benefit the Loonie as Canada’s most lucrative export becomes more valuable. Like Australia, the IMF issued a dire warning about a Canadian’ housing bubble, saying house prices are over the historical average vis-a-vis incomes and rents. Foreign investors support Canada assets prices; they made the biggest purchase of Canadian securities in a year in April, buying stocks and selling government debt for an eighth straight month. External geopolitical risks increase CAD downside.

  • April manufacturing sales dipped 0.1% m/m; although new orders rose by 2.5% m/m.
  • Home prices rose 4.6% y/y.
  • April building permits recovered to 1.1% m/m.
  • May unemployment rate unexpectedly rose to 7%.
  • Employment rose by 25,800, with the gain coming from part-time jobs.
  • Canada’s Q1 GDP growth eased to 1.2% q/q annualized.
  • Final domestic demand declined 0.3% q/q.
  • USD/CAD rate is 1.0850.
  • Mid implied volatility is 4.26%.

Recommended Enhanced Yield structure: Long CAD forward

  • Short USD/CAD forward at 1.0855 for 2-Weeks.
  • Sell 2-Week USD Put / CAD Call with 1.0820 Strike (35 Delta).
  • Forward’s implicit deposit rate is 1.19%.
  • Yield from US dollar cash position 0.24%.
  • Yield from option premium is 4.55% annualized.
  • Structure’s yield is 5.95% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from CAD appreciation to 1.0820.

Japanese Yen (JPY)

Bolstered by the appeal of haven assets, the yen has risen against other majors reaching its strongest level in 4 months against the Euro.

Japanese monetary authorities reiterated that current easing is having the intended effect, and suggested that there is no need for more adjustment. Japan’s Government Pension Investment Fund (GPIF) will likely raise the amount allocated out of Japanese Government Bond Futures from 60% to 40% and into domestic equities, foreign bonds and foreign stocks by 5% each. Although technicals are neutral for the yen, the currency is trading outside the parameters of fundamentals and technicals. Risk aversion supports its recent strength. USD/JPY implied volatility is firm, while EUR/JPY implied volatility is off 1.0%.

  • May domestic corporate goods prices firmed to 4.4% y/y.
  • Q2 business confidence survey showed a decline in manufacturing and all-industry confidence.
  • April current account improved to a ¥131B surplus.
  • May consumer confidence index rose to 39.3.
  • Q1 GDP growth was revised up to 6.7% q/q.
  • April leading index eased to 106.6.
  • Japan’s April core CPI jumped to 3.2% y/y.
  • Jobless rate was steady at 3.6%.
  • Household spending fell 4.6% y/y.
  • Industrial output eased to 4.1% y/y.
  • Housing starts fell 3.3% y/y.
  • Current USD/JPY rate is 101.98.
  • Mid implied volatility 5.47%.
  • Current EUR/JPY rate is 1.3844.
  • Mid implied volatility is 5.23%.

No Position Recommended. Implied volatility too low to justify risk off/risk on Enhanced Yield Structure.

Mexican Peso (MXN)

Geo-political risk aversion and a surprise Bank of Mexico overnight rate cut of 50 bp cut to 3.00% spurred a quick drop in the peso and then a strong recovery. Technically, the USD/MXN is poised to gain moderately in the coming days. The 13.00 level is just over the 55-day moving average.

  • Industrial Production dropped to -0.6%; forecast was for 0.3%
  • CPI edged up to 3.51%.
  • Core CPI eased slightly to 3.0% y/y.
  • Consumer Confidence firmed to 90.7 from 90.3.
  • Current USD/MXN rate is 12.9867.
  • Mid implied volatility is 6.12%.

Recommended Enhanced Yield structure: Long MXN forward

  • Short USD/MXN position established from exercise of 12.95 Strike USD Call / MXN Put.
  • Swap spot position into 2-week forward.
  • Sell 2-Week USD Put / MXN Call with 13.00 Strike (35 Delta).
  • Forward’s implicit deposit rate is 1.20%.
  • Yield from US dollar cash position 0.23%.
  • Yield from option premium is 4.02% annualized.
  • Structure’s yield is 5.45% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from MXN appreciation to 13.00.