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FX Market Update

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Recent moves in EUR/USD and EUR/CHF are out of sync with our short−term models

Wed, Nov 26 2008, 16:42 GMT
by Danske Research Team

Danske Bank A/S

• Spot moves since last week: On Thursday, the Swiss National Bank (SNB) took markets by surprise as it cut its target rate by 100 bps, causing EUR/CHF to appreciate 2%. Also, with equity markets tumbling, EUR/SEK reached all-time highs on Friday. Monday's agreement to bail-out Citigroup contributed to a general improvement in risk appetite, causing EUR/USD to appreciate to levels not seen since the beginning of November.

• Recent moves in EUR/USD and EUR/CHF are out of sync with our short-term models: Although the estimate has moved slightly upwards since last week, EUR/USD and EUR/CHF are now trading nearly four standard deviations above our short-term financial model. This potentially reflects that the currencies are not aligned with movements in other asset classes and that we could see a correction in the short term. Our forecasts are 1.21 and 1.46 respectively on a 3-month horizon.

• Skewed option-implied distribution in Scandies: Following last week's violent moves, particularly in EUR/SEK, and the accompanying rise in implied volatility, risk reversals in EUR/SEK and EUR/NOK have reached the highest levels since the introduction of the single currency. This translates into wide and skewed option implied distributions. For example, on a 3-month horizon the option implied 90% confidence region in EUR/SEK spans the interval [9.06; 11.74] with the spot at 10.27.

• Strategy: Although AUD/USD has fallen somewhat during the past week, it continues to mark one of the largest deviations from our short-term financial models (STFM). While we acknowledge the large depreciation already seen in AUD against USD (35% since mid-July), we believe that the cocktail of a global recession and continued financial distress could send the pair somewhat lower. For example, one way to position for a limited fall in AUD/USD would be through a 1-month reverse knock-out put-option (spot reference 0.635, strike 0.64, barrier 0.565). Given the very negative risk reversal, this comes at a low price of 110 AUD pips; a comparable vanilla put costs around 310 AUD pips (indicative prices only).

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Published on  Wed, Nov 26 2008, 17:12 GMT