Risk on related USD declines should resume this week. The more mixed pattern of G3 economic data is not, we think, sufficient to sustain a â€œrisk offâ€ related USD rally. Rather global markets are simply retreating deeper into â€œmiddle-wayâ€ territory where growth (most especially in EM) improves but the risk of policy tightening is low.
What stands out this week?
ô€‚„ Momentum (page 5): The retracement in the USD downtrend flipped some â€œfast engineâ€ trend following models from short to long USD â€“ with the likely effect of lightening positioning â€“ but the long-term trend remains intact. Moving average based models also signal a strong downtrend in sterling
ô€‚„ Positioning: TFE based margin traders (page 6) increased their EUR position but started to capitulate on their long GBP positions over the week.
ô€‚„ Positioning: Latest IMM data (page 7) show EUR long positions are relatively modest (60th percentile) with the overall net short USD position moderated by a significant long USD, short GBP position. Macro hedge fund exposure to the USD index also seems neutral (page 8). IMM accounts are maintaining sizeable long JPY, CHF, AUD and NZD positions.
ô€‚„ FX volatility: the risk off/event risk related vol. spike at the start of last week is gradually subsiding. We expect implied vol. to ease lower as â€œmiddle-wayâ€ trading conditions re-assert. Interestingly EUR-USD risk reversals have now inverted in favor of EUR puts instead of EUR calls out to 6-months (page 12), this may reflect hedging of either outright long EUR or short vega positions via the accumulation of EUR puts. Either way it mitigates the positioning risk to the uptrend.
ô€‚„ FX correlations: G10 and EM FX correlation with oil is steadily declining but correlation with equity markets remains intact with the exception of GBP-USD (page 18, 19). EM FX is still strongly correlated with EUR-USD (page 20).
ô€‚„ Flow of funds (page 21): September saw some of the largest inflows of capital into EM during the year so far. Our high frequency sample of equity portfolio capital flows shows some moderation over the last week but inflows to the EM local debt market remain very strong. A sustained weakening of capital flows to EM is required before it feeds through to more modest levels of EM central bank EURUSD diversification demand.
ô€‚„ Japan flows (page 25): Portfolio capital flows â€“ both equity and equity and FI combined â€“ remain JPY negative. This suggests recent JPY demand is either speculative or related to the FX hedging of existing FX exposures, a development encouraged by the convergence in USD-JPY forward points toward par.
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