Morning Brief – 10, 9, 8…

10, 9, 8…

11 hours ahead of the London time zone is that of Sydney’s. That means that shortly after we conclude our shortened trading day this New Years Eve, the impressive fireworks display on the other side of the world will be underway. 16 hours (presumably less 10 seconds) from the start of Sydney’s fireworks, New York’s Times Square will count along with its renowned ball drop. In our respective time zones and in our respective ways we’ll be welcoming in the New month, year and decade. Ever early, the foreign exchange market has made their calls and thus its bed for 2020.

By looking at the cost of insuring against movements in certain currencies we can determine the relative interest on both sides of the market for one currency and therefore measure and infer the conviction the market holds for price movements over the duration of the observed contracts. For those of you versed in the options market, I’m talking about risk reversals. I shan’t go for the full Times Square from 10-0, rather a modest first second third.

In first place: Peak Dollar (again).

We’ve seen investors anticipate a weaker Dollar for the last couple of years as it continued to outlive the normal duration of its upward rallies. On the eve of 2020, however, the same concerns exist and Dollar strength is still somewhat pervasive. The Dollar’s demise is frequently attributable to investors’ acrimonious attacks on the US economy’s twin deficits in the current account and government budget. This phenomenon is a killer for currencies because questions of solvency and monetary action gather pace.

The threat is more credible this time around. On the eve of 2019 it cost nearly 3.5% to sell the US Dollar forward against the Euro making the cost of hedging and speculatively betting against the greenback’s fall very expensive indeed. Consequently, those without an immense conviction behind its fall would not take positions against it and given the geopolitics that has unfolded in the last 12 months, it did not take a discernible fall. Now, it costs well over 1% less to take out a comparable bet and therefore, with concerns of twin deficits, US peak growth and recession on the table, more players will and are taking out contracts for a bad 2020 for the Dollar.

Runner up: Sorry Sterling

With the passing of the General Election and the confirmation of Johnson’s majority, some pessimism in options and spot markets was withdrawn. Now, with the deadline of 31st December 2020 feeling like an even larger hurdle than January 31st of the Deal deadlines before it, investors have restocked the 12 month bias towards a weaker Pound Sterling. This pricing will reflect the relative expectations of downside versus upside hedging and therefore is not fully indicative of investors’ perspectives. At face value at least, short Sterling is a crowded and popular trade.

Last but certainly not least: Risk, risk and more risk!

JPY, CHF, Gold and Silver are all tipped by options markets to gain value in 2020. The conclusion? 2020 could be a bumpy ride and, perhaps, the record low FX volatility we’ve come accustomed to might be coming to a close. Either way, purchasing the right to buy defensive assets and currencies over a 1y time horizon at current prices attracts a premium over seeking the right to sell them. Therefore investors have shown that they would rather hold safety than risk at current prices.

The market’s call is clear and derived from trading activity and current pricing. It’s view is Dollar down, Pound down (even against the falling dollar!), and risk higher. Speak with you in 366 days (2020 is a leap year) to find out if they were right!

Discussion and Analysis by Charles Porter

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