FX Commentary: Dollar Floundering, GBP Outlook Still Rosy


In the second instalment of his FX Commentary series, HCM’s Ron Huddleston casts his eye over the currency markets to evaluate recent trends and ponder where the market will be headed in the week ahead.


Since you last heard from me the U.S. dollar is lower across the board. News and bad weather have driven the markets. We’ve seen a cut in Chinese liquidity, a decline in U.S. retail sales, flat GDP growth in Japan, slightly stronger than expected GDP figures in the Eurozone, the UK unemployment ticked up to 7.2% from 7.1%, unemployment rise to a 10-year high in Australia, a drop in Mexican industrial production, and we had 6 major snowstorms in the New York region in the last 6 weeks. Weather may sound a bit like the dog ate my homework excuse, but the reality is, it’s unprecedented, and it has affected productivity.

Under the heading overlooked positive news for the greenback, the U.S. Congressional Budget Office (CBO) stated that “The U.S. budget deficit narrowed by 37 percent in the first four months of the fiscal year compared with a year earlier as spending declined and a stronger economy helped increase revenue. “ According to CBO projections this means America’s deficit as a share of its economy will shrink to a seven-year low in the 12 months ending Sept. 30. Although the percentage of the population in the labor force is at historic lows, the decline in unemployment to 6.6 % and constrained spending is helping to boost government revenue. If my limited Macroeconomics 101 recollections serve me correctly, I believe this surely is a positive indicator.

Fed Chairwoman Yellen made her first public comments last week. She promised continuity and suggested that there is a high hurdle to deviate from the current path of gradually reducing monthly bond purchases. Yadda yadda yadda. Same old, same old…

Euro (EUR)

On mixed news the Euro went on a tear. Bad news included a story that the ECB is considering negative interest rates and the German ZEW (Remember them? Gesellschaft für Konsumforschung, Germany’s largest market research institute) index of investor confidence falling from 7-year high. The Euro found strength from data showing a stronger-than-forecast recovery, Germany’s gross domestic product rising above expectations, and France avoiding falling back into a recession, this while the USD has come under pressure from weak data. Technical indicators point to a bullish EUR. In the absence of strong data out of the U.S., expect continued EUR strength in the near term. Implied volatilities are lower.

Current EUR/USD rate is 1.3756
Mid implied volatility is 6.17%.
Current EUR/JPY rate is 140.65
Mid implied volatility is 9.90%.

Recommended Enhanced Yield structure: Long EUR vs. JPY (As opposed to Long EUR vs. USD due to the higher implied volatility of the EUR/JPY pairing).
Long EUR/JPY forward at 140.70 for 2-Weeks.
Sell 2-Week EUR Call / JPY Put with 142.30 Strike (28 Delta).
Forward’s implicit deposit rate is -0.10 %.
Yield from US dollar cash position 0.24%.
Yield from option premium is 7.39% annualized.
Structure’s yield is 7.53% (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from EUR appreciation vs. the JPY to 139.50. Additionally, this structure benefits from either JPY or EUR appreciation vs. USD.

Australian Dollar (AUD)

As is often the case for the ‘land down under’, Chinese news has largely motivated trading in the AUD. Chinese imports and exports grew twice as fast as forecast, which eased concern about a slowdown and sent the Australian dollar to a four-week high versus the greenback. Commodity currencies were also supported after Chinese lending data suggested the world’s second-biggest economy may not be cooling as much as feared. The positive news helped erase earlier AUD declines, after notes from Reserve Bank of Australia the February meeting reiterated that the most prudent course would likely be a period of stability in interest rates. With Australia’s unemployment rate at a 10-year high and today’s announcement that Q4 wages rose at the slowest rate on record, don’t expect the recent AUD strength to continue for too long, domestic concerns could force the RBA’s hand. That said, technicals suggested moderate short term strength.

Current AUD/USD rate is 0.9023
Mid implied volatility is 8.70%.

Recommended Enhanced Yield structure: Long AUD forward.

Long AUD/USD forward at 0.9031 for 2-Weeks.
Sell 2-Week AUD Put / USD Call with 0.9115 Strike (28 Delta).
Forward’s implicit deposit rate is 2.25%.
Yield from US dollar cash position 0.24%.
Yield from option premium 6.48% annualized.
Structure’s yield is 8.97% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium) plus potential capital gain from AUD appreciation to 0.9115.

Great British Pound (GBP)

Although today U.K. unemployment unexpectedly ticked up to 7.2%, the pound has been firm since the release of the Bank of England’s quarterly Inflation Report. Inflation surprised at 1.9% in January from 2% in December for the first time under 2% since November 2009. Growth is projected at 3.4%. The BOE outlined the next phase of its guidance, which is focused on absorbing all of the spare capacity in the economy over the next few years, while monitoring a broader range of indicators, even once the jobless rate reaches 7%. Additionally, the central bank raised its growth forecasts, noting that the recovery has been gaining momentum. Also, the statistics office reported house prices are up. So the bottom line is that the GBP still has rosy outlook, but the rate of further improvement will likely slowdown.

Current GBP/USD rate is 1.6712.
Mid implied volatility is 7.73%.

Recommended Enhanced Yield structure: Long GBP forward.

Long GBP/USD forward at 1.6720 for 3-Weeks.
Sell 3-Week GBP Call / USD Put with 1.6800 Strike (38 Delta).
Forward’s implicit deposit rate is 0.28%.
Yield from US dollar cash position 0.24%.
Yield from option premium is 8.19% annualized.
Structure’s yield is 8.19% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from GBP appreciation to 1.6800.

Canadian Dollar (CAD)

The Loonie posted modest gains in the fortnight. Some suggest the strength is largely on the basis of the decline in the greenback. But, there were some fundamental bright spots for the CAD: Canada’s January house prices firmed to 0.4% m/m, the Canadian economy gained 29,400 jobs, and commodity prices (especially oil for Canada’s benefit) climbed. The major question for the BoC (Which incidentally, I recently learned is ultimately owned by ‘Her Majesty in Right of Canada’) still remains. How it will handle extremely low inflation? Against the backdrop of U.S. Fed policy, this remains bearish for the CAD in mid-term. In the very short term expect some CAD strength.

USD/CAD rate is 1.1043
Mid implied volatility is 7.66%

Recommended Enhanced Yield structure: Long CAD forward.

Short USD/CAD forward at 1.1035 for 2-Weeks.
Sell 2-Week USD Call / CAD Put with 1.0975 Strike (32 Delta).
Forward’s implicit deposit rate is 0.00%.
Yield from US dollar cash position 0.24%.
Yield from option premium is 9.72% annualized.
Structure’s yield is 9.96% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from CAD appreciation to 1.0975.

Japanese Yen (JPY)

The Yen is only major currency to underperform the U.S. dollar since our last commentary. Real GDP growth in Japan finished the year on a decidedly disappointing note, far short of what the consensus had expected. This may reignited opposition to an April increase in the sales tax and put the effectiveness of Abenomics (The economic policies of Shinzo Abe designed to jolt the economy out of its suspended malaise). The BoJ kept QE at the same ¥7 trillion but boosted the enhanced lending program to banks. In the long term expect more JPY weakness. JPY growth will continue to disappoint. The country is a demographic time bomb. In the short term technicals signal weaker JPY. Implied volatility vs. the EUR is above historic levels.

Current USD/JPY rate is 102.35
Mid implied volatility 8.93%.
Current EUR/JPY rate is 140.77
Mid implied volatility is 9.90%.

Recommended Enhanced Yield structure: Long EUR/JPY forward. Please see the recommendation for the EUR.

Mexican Peso (MXN)

Growth-driven embrace of risk has been the theme of last week as equities, commodities, and emerging market currencies have strengthened. The USD/MXN is getting its mojo back. Mexico’s sovereign debt rating was upgraded by Moody’s in early February, bringing the country to A3 from Baa1. The peso continues to outperform its Latin counterparts, but challenges to the continued resumption of risk for emerging markets remain, and this will weigh on MXN in the near term. Implied volatility is firm.
Current USD/MXN rate is 13.2663
Mid implied volatility is 10.05%.

Recommended Enhanced Yield structure: Sell MXN Put against U.S. deposit, not a forward.

Sell 3-Week USD Call / MXN Put with 13.45 Strike (35 Delta).
Yield from US dollar deposit 0.24%.
Yield from option premium is 13.84% annualized.
Structure’s yield is 14.08% annualized (from deposit and option’s premium). If option is assigned, result will be long MXN at 13.45.

About the author

Ron Huddleston of Huddleston Capital Management (HCM)
Ron Huddleston of Huddleston Capital Management (HCM)

Mr. Huddleston has nearly 20 years of financial services experience, with primary expertise in the conceptual and structural development and trading of derivatives. He has also held a range of senior advisory positions working with high net worth and institutional clients, with his most recent role at Wells Fargo focused on the development of customized foreign exchange derivatives for the firm’s ultra high net worth clients. Mr. Huddleston has also held a range of management and trading positions at Capital Markets Trading (Frankfurt), Dresdner Bank (Frankfurt) and Citibank (Frankfurt and Hong Kong). Mr. Huddleston was a member of the Pacific Stock Exchange, where he was an options market maker on Microsoft listed stock options.

Huddleston Capital Management (HCM) is the managing member and investment manager of the Enhanced Yield Currency Fund (EYC). The managing partner is Ron Huddleston, me. HCM is registered in the United States as a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) with the NFA and CFTC. In addition to the fund, HCM offers managed accounts using OTC options and forwards. HCM is looking to partner with a U.S. bank to introduce foreign exchange managed accounts and investment products that will allow clients to gain alpha, diversify, and hedge currency exposure.
The EYC fund strategy uses OTC options and forwards in a covered call approach; short call options corresponding to the long side of forwards are held. The short calls are covered by the long side of the corresponding forward contract. The option positions match the expiration, notional amount, and the currency of the long side of the forward contract. The positions’ terms range from 2-Weeks to 6-Months.