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- The UK has dominated markets again in recent weeks, but despite the political shifts, hedge funds have increased their net-longs in GBP according to CME Group data.
- USD/JPY has been quietly marching to new highs for the year. CME Group options data reveals significant interest in USD/JPY calls around the 159 level.
- The FX volatility curve has started to flatten, suggesting less panic than before.
The UK has continued to dominate FX markets in recent weeks with a new chancellor announcing a major U-turn in fiscal policy. CFTC data on investor positioning in CME FX futures and options contracts can provide unique insights on investor behaviour during this period. We find that despite the volatility in UK bond markets, hedge funds have steadily increased their net-long positions in GBP (Chart 1). Meanwhile, asset managers have reduced their net GBP shorts. Therefore, investors appear to be less nervous about GBP than it would first appear. Here are the details of this and other positioning:
- Over the past month, hedge funds increased their net-long GBP positions and it remains their only long among the major G10 currencies.
- Hedge funds reduced their net-shorts in JPY and EUR.
- They increased their net-shorts in CAD and NZD, suggesting bearishness towards commodity currencies.
- Asset managers cut back their net-shorts in GBP and JPY. They stayed net-short CHF, AUD and NZD (Chart 2).
- Their main net-long remains EUR.
Comparing hedge fund and asset manager positioning, we find both are net-short JPY, net-short AUD, and net-short NZD. But they notably disagree on GBP – hedge funds are net-long, while asset managers are net-short.
Macro Hive take: With the U-turn in UK fiscal policy, we think much of the good news on the UK has likely been priced. We would consequently side with asset managers in being bearish GBP. We continue to think the Euro-area faces downside risks as we enter the winter months and so agree with hedge funds in being bearish EUR.
Although the market has been focusing on the UK, USD/JPY is marching to new highs for the year and is close to breaching 150. We can use CME Group data to determine the most popular strikes in FX options trading and assess the levels on which investors are most focused. We find the following:
- There is large (net) open interest with option strikes at around 154 and 159 – all with more demand for USD calls than puts (Chart 3).
- The largest open interest is around the 159 strike, suggesting investors could be positioning for an extreme overshoot in USD/JPY higher.
- On the bearish side for USD/JPY (yen strength), we find net-demand for USD/JPY puts at around 144 and below.
What to watch: MoF intervention is the big risk for USD/JPY, so investors must be wary of any sharp intraday moves lower, which could signal intervention. The next BoJ meeting is on 28 October, which could see a more hawkish turn by the central bank, though speeches by BoJ members have so far been quite dovish. Then Fed policy remains key for USD/JPY as U.S. rates have been a big driver. The next Fed meeting is on 2 November.
FX investor risk appetite
The CME Group has a range of FX volatility data to help investors track the level of volatility. We can also use FX volatility data to determine investor risk appetite. We find the shape of the FX volatility curve useful in this regard. When shorter-dated FX implied volatility is higher than longer-dated volatility, this suggests investors are worried or in panic mode. In contrast, when shorter-dated FX volatility is lower than longer-dated volatility, this suggests investors expect calm markets. The latest data finds:
- In recent weeks, the FX volatility curve has started to flatten but remains in ‘fear’ territory (Chart 4). The flattening has been driven by shorter-dated implied volatility falling by more than longer-dated volatility.
- The CME Group’s CVOL volatility indices confirm this development. The CME Group G5 aggregate FX has fallen from 15% to 14% over the past week.
- We also find that equity volatility and rates volatility have also started to fall.
- It appears the worst of the recent panic has abated, but volatility remains high, so markets may remain nervous in the weeks ahead.
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