Contracting Inflation Crushes the Dollar
The US Dollar has been thriving on borrowed time. Time has run out. The US Dollar plunged to its lowest in 15-months in what many experts see as the beginning of a secular decline.
Till now, A hawkish Fed served as a solid tail wind. A Fed pause will take the wind out of USD sails. The USD peak is behind us. Leveraged funds have repositioned their portfolios to go net short over the last month. Rising demand for FX gamma in the options market forebodes rising volatility in FX markets and a precursor to sharp out of the range price moves.
Currency opportunities abound in developed markets (DM) and emerging markets (EM). Each of the G10 currencies have strengthened against the US Dollar over the last one month. High yield from double digit carry will position EM currencies to outperform the US Dollar in second half this year.
Not all gloom and doom for King Dollar though. A resurgence in US inflation, onset of recession, and any further geo-political shocks will strengthen the US dollar as the world’s only global FX reserve.
In this paper, we will explore two specific opportunities in the Euro and the Pound. Central Bank policy divergence and equity portfolio repositioning will drive Euro and Pound to significantly outperform the US Dollar.
This paper posits two potential opportunities with long position in CME Micro FX Futures. First, a long position in CME Micro EUR/USD Futures with an entry at 1.128, target of 1.196 and hedged by a stop loss at 1.09 to deliver a reward to risk ratio of 1.8x. Second, a long position in CME Micro GBP/USD Futures with an entry at 1.31, exit at 1.399 and hedged by a stop loss at 1.265, delivering a reward to risk ratio of 2x.
THE US FED APPEARS TO TAME INFLATION DOWN
The US Fed has been fiercely fighting a raging inflationary environment. Its relentless battle is yielding results. Latest CPI reading shows that annual inflation is losing steam and now stands at 3% YoY. Both inflation and core inflation are now receding faster.
Market expectations is for a final rate hike on July 26th marking the end of an unprecedented hiking cycle.
The Fed seems to have tamed down inflation. Market anticipation of a Fed pause is taking winds off US Dollar sails.
A clutch of DM and EM currencies have sharply outperformed the dollar over the last one month as seen from the chart below.
Across the Atlantic, inflation remains stubbornly high in the EU and UK. The European Central Bank (ECB) and the Bank of England (BoE) have indicated that their hiking cycles are far from over. More fire power is required to tame inflation down.
TAKING THE WIND OUT OF DOLLAR SAILS
Policy Divergence: Exchange rates are all about interest rates. Central bank policy divergence plays a massive role in charting the forward path of FX-pairs. Combining Hawkish BoE and ECB with a US Fed that is expected to “pause for good” has led to a sharply weaker USD and strong Euro and Sterling.
Equity Portfolio Repositioning: Besides policy divergence, it is the hedge funds fuelling rally in Euro and Sterling. These funds have been ramping up their equity positions in European stocks while slashing down the weighting in US equities as per prime brokerage data from Goldman Sachs.
Portfolio repositioning by the hedge funds should come as no surprise. The Nasdaq recorded its best first half year in 40 years and is up >31% YTD. European stocks have been more subdued. Stoxx 600 is up merely 5% while the FTSE100 is down YTD. Lower valuations in Europe appear compelling for some hedge fund managers.
FX Options Market Forebodes Sharp FX Moves: Time now is ripe for large moves in the FX market. FX option dealers have been witnessing rising demand for gamma in G10s. Gamma in FX options represents the sensitivity of FX options' delta to underlying FX rate. Typically, rising demand for gamma is a precursor to sharp FX moves.
TRADE SETUP
CME Micro FX Futures enable affordable access into the deeply liquid FX Futures market. Each lot of CME Micro EUR/USD provides exposure to 12,500 euros with each tick delivering a P&L of USD 1.25 per lot for every pip (0.0001) move in EUR.
Similarly, each lot of CME Micro GBP/USD provides exposure to 6,250 pounds delivering USD 0.625 per lot in P&L for every pip (0.0001) move in GBP.
LONG EURO FX FUTURES
• Entry Level: 1.1280
• Target Level: 1.1960
• Stop Level: 1.0900
• Profit at Target: 680 pips x USD 1.25 = USD 850
• Loss at Stop: 380 pips x USD 1.25 = USD 475
• Reward/Risk: 1.8x
LONG GBP/USD FUTURES
• Entry Level: 1.3100
• Target Level: 1.3990
• Stop Level: 1.2650
• Profit at Target: 890 pips x USD 0.625 = USD 556.25
• Loss at Stop: 450 pips x USD 0.625 USD 281.25
• Reward/Risk: 2x
Please note that the above P&L illustrations do not consider transactional costs and the cost of capital required for placing margins with CME clearing members and service providers which varies across brokers. CME clearing & trading fees can be found on CME Group's website.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Till now, A hawkish Fed served as a solid tail wind. A Fed pause will take the wind out of USD sails. The USD peak is behind us. Leveraged funds have repositioned their portfolios to go net short over the last month. Rising demand for FX gamma in the options market forebodes rising volatility in FX markets and a precursor to sharp out of the range price moves.
Currency opportunities abound in developed markets (DM) and emerging markets (EM). Each of the G10 currencies have strengthened against the US Dollar over the last one month. High yield from double digit carry will position EM currencies to outperform the US Dollar in second half this year.
Not all gloom and doom for King Dollar though. A resurgence in US inflation, onset of recession, and any further geo-political shocks will strengthen the US dollar as the world’s only global FX reserve.
In this paper, we will explore two specific opportunities in the Euro and the Pound. Central Bank policy divergence and equity portfolio repositioning will drive Euro and Pound to significantly outperform the US Dollar.
This paper posits two potential opportunities with long position in CME Micro FX Futures. First, a long position in CME Micro EUR/USD Futures with an entry at 1.128, target of 1.196 and hedged by a stop loss at 1.09 to deliver a reward to risk ratio of 1.8x. Second, a long position in CME Micro GBP/USD Futures with an entry at 1.31, exit at 1.399 and hedged by a stop loss at 1.265, delivering a reward to risk ratio of 2x.
THE US FED APPEARS TO TAME INFLATION DOWN
The US Fed has been fiercely fighting a raging inflationary environment. Its relentless battle is yielding results. Latest CPI reading shows that annual inflation is losing steam and now stands at 3% YoY. Both inflation and core inflation are now receding faster.
Market expectations is for a final rate hike on July 26th marking the end of an unprecedented hiking cycle.
The Fed seems to have tamed down inflation. Market anticipation of a Fed pause is taking winds off US Dollar sails.
A clutch of DM and EM currencies have sharply outperformed the dollar over the last one month as seen from the chart below.
Across the Atlantic, inflation remains stubbornly high in the EU and UK. The European Central Bank (ECB) and the Bank of England (BoE) have indicated that their hiking cycles are far from over. More fire power is required to tame inflation down.
TAKING THE WIND OUT OF DOLLAR SAILS
Policy Divergence: Exchange rates are all about interest rates. Central bank policy divergence plays a massive role in charting the forward path of FX-pairs. Combining Hawkish BoE and ECB with a US Fed that is expected to “pause for good” has led to a sharply weaker USD and strong Euro and Sterling.
Equity Portfolio Repositioning: Besides policy divergence, it is the hedge funds fuelling rally in Euro and Sterling. These funds have been ramping up their equity positions in European stocks while slashing down the weighting in US equities as per prime brokerage data from Goldman Sachs.
Portfolio repositioning by the hedge funds should come as no surprise. The Nasdaq recorded its best first half year in 40 years and is up >31% YTD. European stocks have been more subdued. Stoxx 600 is up merely 5% while the FTSE100 is down YTD. Lower valuations in Europe appear compelling for some hedge fund managers.
FX Options Market Forebodes Sharp FX Moves: Time now is ripe for large moves in the FX market. FX option dealers have been witnessing rising demand for gamma in G10s. Gamma in FX options represents the sensitivity of FX options' delta to underlying FX rate. Typically, rising demand for gamma is a precursor to sharp FX moves.
TRADE SETUP
CME Micro FX Futures enable affordable access into the deeply liquid FX Futures market. Each lot of CME Micro EUR/USD provides exposure to 12,500 euros with each tick delivering a P&L of USD 1.25 per lot for every pip (0.0001) move in EUR.
Similarly, each lot of CME Micro GBP/USD provides exposure to 6,250 pounds delivering USD 0.625 per lot in P&L for every pip (0.0001) move in GBP.
LONG EURO FX FUTURES
• Entry Level: 1.1280
• Target Level: 1.1960
• Stop Level: 1.0900
• Profit at Target: 680 pips x USD 1.25 = USD 850
• Loss at Stop: 380 pips x USD 1.25 = USD 475
• Reward/Risk: 1.8x
LONG GBP/USD FUTURES
• Entry Level: 1.3100
• Target Level: 1.3990
• Stop Level: 1.2650
• Profit at Target: 890 pips x USD 0.625 = USD 556.25
• Loss at Stop: 450 pips x USD 0.625 USD 281.25
• Reward/Risk: 2x
Please note that the above P&L illustrations do not consider transactional costs and the cost of capital required for placing margins with CME clearing members and service providers which varies across brokers. CME clearing & trading fees can be found on CME Group's website.
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Full Disclaimer - linktr.ee/mintfinance
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