We like to sell EURJPY as what is initially a tactical trade and used as a Euroropean political risk hedge in our portfolio. There is an increasing risk that Japanese investors will reduce their holdings in semi core EMU bond markets. Japanese investors hold 12%
of outstanding OATs, adding to their holdings after the election of President Hollande. Japanese investors correctly assumed that the Franco-German relationship would stay intact allowing the 10-year OAT-Bund spread to come down from 51bp witnessed on the
day President Hollande was elected to 10bp last year. Most of the spread decline occurred within a globally deflationary trend which worked in favour of Japanese investors known for their deflation trade expertise. Now the spread is widening while global deflation risks have turned into reflation hopes. Hence there seems a double motivation for JPY based players liquidating positions, putting EURJPY under selling pressure.
Markets will watch efforts of the French left combining to bring one of its candidates into the 2nd round. A possible scenario of a second round vote between a hard left and a hard right candidate may increase the chance of the Front National’s Le Pen becoming
President. Her agenda to leave the EU and the EUR would require Parliamentary approval and hence represents an unlikely outcome. However, a potential scenario of a hard left or hard right future French President could perhaps reduce Franco-German cooperation which could disrupt EMU for years leaving the ECB in charge, which might win time by introducing a policy of a prolonged period of negative real rates and yields. The 15 March General Election in the Netherlands could increase jitters further should the outcome point towards increasing populism.
Widening economic inner EMU divergence seeing especially Italy lagging may potentially add momentum to this trade. Japan shifting its deflation focused portfolio into a carry emphasising strategy may help our bullish high yield EM strategy too. However, the projected EURJPY fall may delay the Anticipated USDJPY rally by a few weeks. The risk to this trade is investors perceive that Eurozone political risks are reduced. We like to sell EUR/JPY at market with a target of 117.50 and stop at 121.30
EM – Sell EUR/MXN
We believe risk/reward is skewed towards MXN strength on the crosses. While the currency has rallied a lot, and is unlikely to appreciate much more unless we get a benign outcome on Mexican trade, we also see only a 20% probability of large tariffs being implemented. As such, we believe MXN offers attractive carry plus scope for appreciation if we do get a benign outcome, and like to trade it on crosses.
We pivoted from trading long MXN against short CAD to short EUR last week. Strong commodity prices and good data continue to support CAD, while EUR should suffer from rising political risk and monetary policy divergence. While CAD/MXN is an attractive way to play the risk of a border adjustment tax, EURMXN would also move on this, as EUR is nearly 20% of the US’s TWI. The main risk to this trade is a worse than expected outcome on Mexican trade. This week will provide plenty of local data and information for the market to digest, with final Q4 GDP numbers, retail sales, bi-weekly CPI, minutes from the last Banxico meeting released and Q4 C/A data. We like to sell EUR/MXN at market with a target of 20.2 and stop at 22.2
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