From Marc to Market:
The US dollar lost momentum yesterday
but has regained it today. The euro has been pushed through last week's lows near $1.1180. The next
immediate target is $1.1145, which corresponds to the lower Bollinger
Band today, though the intraday technical readings suggest some modest upticks
are likely first. The $1.1200-$1.1220 area may cap upticks.
The greenback held above JPY109 and bounced to recoup 38.2% of its
decline since the pre-weekend high near JPY110.60. A move above this
retracement (~JPY109.70) may yield minor gains and still struggle to sustain
gains above JPY110.
The dollar-bloc currencies have been led lower by the Australian dollar.
When the US dollar momentum faltered yesterday, the Australian dollar
resurfaced above $0.7200. Unable to get above $0.7230 today, RBA Governor
Stevens comments helped push it new lows since early March (~$0.7155).
Stevens noted that the Australian dollar, which has been falling since
late-April, was moving in the right direction. His observation that
inflation was low and below target encourages speculation of an additional rate
cut in the coming months.
Sterling is recouping nearly everything it lost in the past two sessions
and is back knocking on last week's high above $1.46. It appears to
have been helped by a poll out late yesterday that found that not
only are the undecideds in the UK referendum breaking toward the remain camp
but that some of those that had favored leaving and reversing.
However, we are not fully satisfied with that explanation. After all, sterling
has been trending higher against the US dollar
like many currencies did in the first part of the year. Sterling rallied
6.7% from the late-February low through the May 3 high. The polls only
showed a shift in the last two weeks or so.
Also, the options market is still reflecting anxiety, and given that the
referendum poses contingent risk, the
options market is where it ought to be
expressed. The referendum is within a month now so one-month
volatility should be the focus. It is firm today at around 11.2%. This is the upper end of where it has traded
since early-March. It finished last week near 10.4%.
The increase in implied volatility suggests options are being bought. The spread between the
pricing of puts and calls equidistant out of the money (25 delta) can help determine what options are being bought. The premium for puts over
calls is the largest since last May. This
suggests that despite sterling's gains in the spot market, some
participants are still seeking protection in the options market by buying
one-month sterling puts.
The broader dollar gains have been driven
by the shift in expectations of Fed policy. For medium-term
investors, it does not make much of a difference whether the Fed hikes in June
or July. The August Fed funds futures contract implies a yield of 54
bp. We know that currently Fed funds have been averaging 37 bp. If
the Fed were to raise rates 25 bp at either the June or July meetings, fair
value for the August contract is 62 bp. The market is pricing in a 68%
chance of a hike at one of the next two meetings ( (54-37)/25)....
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