Short-Dated IV/AV Spreads

Event risk in the terms of upcoming NFP and Powell testimony the short dates are understandably bid. In our view, the best odds of extracting value from this environment remain in short-dated calendar spreads. The AUD stands out both with respect to spread between the two weeks and the one month both in terms of the implied vols and with regard to the actuals as seen in the chart above.

With the BoC ending QE and moving forward the expected first rate hike to April next year, many domestic fixed income pundits were expecting a more dovish BoC testimony, particularly following the weaker than expected domestic growth number reported ahead of the BoC announcement. The market's expectations were not met, and the dollar CAD rose vs the USD testing the 1.2300 but there was not any follow-through buying. There are two reasons for this 1) the BoC is following the tightening moves seen elsewhere (AUD and NZ in particular) and at the same time, the BoC statement came on the day in which the commodity complex started to show early signs of rolling over. Another clear sign of this larger international trend can be seen in the weakness in the CAD vs AUD, with CAD AUD falling off the 1.10 level back to 1.07. Traditional price action vs. news analysis would draw the conclusion that CAD is weak if it cannot rally on the back of the BoC hawkish stance. That ignores the more generalized rise in rates globally. If the Fed turns out to be much less hawkish in removing QE, and the global reflation trade gains a second wind then the Canadian dollar will ramp up very quickly. We remain sceptical about the durability of the commodity price rally largely because of the weaker Chinese macro backdrop, but we have to admit a re-test of the previous cyclical high or USD low of around 1.2010 looks likely.

Our hourly longer-term dispersion indicator is showing signs of rolling over suggesting that for the short-term at least the CADJPY move higher is due to at least a period of price consolidation. We are not yet seeing the kind of short-term momentum divergence that we need to see prior to initiating a counter-trend trade.

EURCAD also showing clear signs of trend exhaustion but here too we need to see some clear signs of divergence to suggest the move is over. All we can conclude is that the existing trend is due for a pause.

EURCAD actuals spike on the sharp down move on Friday. EURCAD risk reversals are losing their premium for EUR calls over and the longer-dated EUR calls are looking cheap on a percentile rank basis.

Potential divergence developing between spot EUR and the risk reversals. It will be interesting to see if the premium for EUR puts increases if the EUR is able to make a new short-term low.

Also, potential divergence developing between EURCAD momentum and spot as you can see in the chart above.

EURCHF breaks lower and EURCHF AV shows clear signs of rising.

Both short and longer-term EURCHF momentum remains bearish.

EURCHF LT momentum above.

More clear signs that GBPJPY topside momentum is waining but still no clear evidence of divergence. That is the missing ingredient needed to imply a short term top.

The spread between two-week JPY implied vols and actuals remain wide as seen in the chart above. At the same time, the spot is facing important top-side resistance at the 114.30 level. With the BoJ leaving its monetary policy unchanged, the major event risk next week is the Fed on Wednesday and the NFA at the end of the week. If we had to guess we would opine that the likely Fed stance while slightly more hawkish is not going to come to as much of a "shock" as the Bank of Canada's volte-face. The China credit story is still very much in the background and the markets are rightly or wrongly ignoring it for now but it could come back to the foreground easily. What is a bit unusual in the chart above is the positive IV/AV spread that is associated with a period of dollar strength not dollar weakness and this is still a sign that the market does not want to let the short-dated options go out the door cheaply.

Despite the bearish momentum picture in EURCHF, dollar CHF long term momentum remains positive for now. While marginally off their highs CHF risk reversal still is still in the top Quartile for topside protection. Only in the one-year is the risk reversal in favour of CHF calls over, but here too the premium is small in percentile terms. Long term readers will remember our positive stance on EURCHF was based on the view that Biden's win would lower geopolitical tensions. We were right in that view, but only for a brief period following the US election and we now have to admit the decline in EURCHF represents a reversal of that trend with US-China and US-Russia tensions rising.

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