Complacency halts USD, JPY rise

Late last week, the spectacular comeback in asset markets from their late-December lows finally appeared to be rolling over – conveniently so, as the major US indices were testing their 200-day moving averages. But Friday’s session was a harsh rejection of that notion as the US equity market came roaring back.

US-China trade talks don’t appear perched on the verge of a breakthrough (and any likely deal seems mostly priced in) and there were no sufficiently impactful data points to drive the comeback. The one clear positive fillip for equities was the European Central Bank's Coeure on Friday airing the idea that there is scope for the ECB to do another TLTRO operation, but the price action seemed to suggest a squeeze on short positions as the major US indices pulled to new highs since early December.

We struggle to understand how the current market ramp, which almost impossibly coincides with a persistent bid in safe-haven assets like core EU bonds and US Treasuries, can extend much longer. Sure, one last flurry of strength on a positive trade deal headline might offer an additional modest, one-off boost. Eventually, however, with global liquidity tightening on the US Treasury’s issuance blitz and the Fed’s QT, it is simply not possible to maintain a simultaneous bid in risky assets and US Treasuries – either bonds falter and eventually provide their own headwinds for risk appetite or risk appetite rolls over again.

This week, we focus on the Federal Open Market Committee and ECB minutes up Wednesday and Thursday in particular and on the Eurozone flash February PMIs on Thursday. Meanwhile, equity market technical and animal spirits remain firmly in focus all week, particularly our notion that either Treasuries or equities must soon fall steeply. Note that US markets are closed today for a holiday.

Trading interest

Short EURUSD: still prefer the downside in EURUSD, perhaps given the tactically frustrating price action, with exposure via put options – 1.10 for four months takes us to the other side of EU parliamentary elections.

Short AUDUSD: given the lack of momentum, either patience is required for a fresh sell-off wave to arrive or the expression of a view in two-month or longer put options.

Short EURJPY: trade here via options (put spreads for one month or longer in case price action lower is halting) as the local price action has proven impossibly choppy and rangebound and the timing of a return of weak risk appetite difficult to discern. 

Chart: EURUSD

The latest downside break attempt through 1.1300 was corralled on Friday , but the downside remains the focus, given the weak Eurozone outlook as we await a close below the range low of 1.1216 for signs of mounting downside momentum. Downside exposure via options still attractive as implied volatilities are quite low relative to historic averages – currently just above 6.5% for three-month options.