The EURUSD vols have been belligerently sold off in the aftermath of the French presidential election. The markets hailed the election of Macron, shielding a very pro-European programme. The majority of the risk was factored in at the front end of the curve, and the 1m implied returned to lows not seen since 2015 (refer above charts), which marks the start of the current vol regime.

Nonetheless, the longer EURUSD expiries like 3m and 1y vols fell significantly below their lows. This seems intriguing as volatility moves tend to be larger at the front-end. But the 1m vol did not break its lows because it is now pricing the next 8 June ECB meeting.

The last time the low vol regime lasted a certain amount of time coincided with a period when central bank policies were more accommodative than today. This depressed the volatility of short rates, which is powerfully driving FX volatility (refer above charts).

However, we now observe a correlation break between FX and rates volatility, with EURUSD vol under pressure while rates vol remains supported. In our view, relative rates volatility currently better captures the central bank stances than EURUSD volatility.

Lastly, FX vol has been extremely focused on short-term political risk, and its valuation diverged from the medium fundamental background. As the market is now freed from political fears and refocuses on the modalities of ECB tightening, the case for more euro bullishness and more volatility resurfaces.

Thus, we advocated buying EURUSD topside volatility – EURUSD vol sold off aggressively after Frexit fears receded. – The market will now focus on the ECB’s 8 June meeting. FX vol has disconnected from rates vol, which has been less impacted by political risk but still resiliently discounts ECB risk.

We recommend going long an EURUSD 1y volatility swap, paying-off volatility realized above 1.05. This condition discounts the entry level via the negative skew. The currency swaps are for exchanging an amount of real cash in one currency for the same amount in another.

EURUSD vol sold off aggressively to its low regime area as political fears vanished.

Is it heading towards a softer regime, or is it a great opportunity to load longs?

The market would now be cautious in the ECB’s stance that is scheduled on 8th June.

However, FX vol disconnected from rates vol, which has been less impacted by political risk, but still resiliently discounts ECB risk.

The material has been provided by InstaForex Company – www.instaforex.com

  • AUD/JPY is struggling to extend gains beyond 84 handle, the pair is hovering around 5-DMA at 83.89.
  • Demand for the Yen remains muted, mildly cautious to negative sentiment seen surrounding Asian equity markets on Friday.
  • AUD/JPY saw multiple failures at 50-DMA currently at 84.30 which weighs heavily on the upside.
  • Technical studies are neutral to mildly bullish. Break above 50-DMA will see further upside in the pair.

Support levels – 84.04 (38.2% Fib of 88.176 to 81.486 fall), 84.30 (50-DMA), 84.83 (50% Fib)

Resistance levels – 83.89 (5-DMA), 83.27 (20-DMA), 83.06 (23.6% Fib)

Recommendation: Watch for break above 50-DMA to go long.

FxWirePro Currency Strength Index: FxWirePro’s Hourly AUD Spot Index was at 142.132 (Bullish), while Hourly JPY Spot Index was at -44.6845 (Neutral) at 0620 GMT. For more details on FxWirePro’s Currency Strength Index, visit http://www.fxwirepro.com/currencyindex.

The material has been provided by InstaForex Company – www.instaforex.com