am/FX: Based

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As European tail risks subside and equities enter a bullish window… Short USDNOK looks good.

by Brent Donnelly

October 17, 2022

Current Views

Short USDNOK @ 10.60

Stop 10.92

Take profit 9.88

Long a 3-month USDBRL 4.90 digital put at 20%

Spot ref. 5.1850 on 10OCT22

Expires 11JAN23

October 17, 2022

Based

Despite Friday’s dirtnap in stocks, I still think we have the makings of a potential relief rally into year end. It’s hard to concoct a straight-up bullish macro narrative but this could be more about things getting less bad than things being outright good.

Energy prices in Europe are making new four-month lows.

Dutch Natural Gas Futures

Gilts are finding a base after the fiscal U-turn in the UK

UK gilts since the start of September 2022: Based?

More micro and tenuous (but perhaps most important) are the short-term double tops in 2-year and 10-year US yields and the blowoff bottom in stocks. If we stay below 4.55% in 2s, 4.10% in 10s, and >3500 in SPX, bullish seasonal equity drift will kick in, as discussed in Friday’s am/FX. These are big “ifs” but they offer up a tradable scenario here that is easy to risk manage with clear exits and good risk/reward.

When you look at equity correlation to FX markets, CAD and NOK always pop up as two of the most tradable correlations. I don’t love long CAD because I am worried about the mortgage reset problem there and the risk that the Bank of Canada Outlook Survey today could be dour (10:30 am NY time). I don’t think we are far from a BoC pause, despite consistently hawkish words from Macklem, et al.

In contrast, there is nothing coming out in Norway until the 20th of October. USDNOK is forming a nice triangle on the hourly chart and 2022 has been marked by a consistent stream of great setups featuring either triangles or horizontal lines. Here’s the chart:

USDNOK hourly back to April 2022

I am pre-empting the breakdown by going short here, simply because I think the triangle offers close enough resistance that you can get short here (10.59) with a stop at 10.92, targeting 9.8800. A move back towards 9.80 would be a full round trip of the move up that started with the September 13 explosion higher on US CPI. The spike high after last week’s US CPI figure was 10.8600 and that is why I think a stop at 10.9200 makes sense. That is also above the quintuple top at 10.90 (start of October.)

Lower USDNOK is a higher SPX trade (~70% correlation), so if stocks collapse, this idea will not work. Why not just be long S&P futures? The risk/reward looks better to me in USDNOK because you can have a tighter stop and I would argue that NOK got more oversold than S&Ps. The high in the RSI for USDNOK was 80 while the SPX RSI never got much below 30. They are both similar trades, but I like short USDNOK better.

Yields

The trend higher in yields has lost a bit of steam, though we are less than 15bps from the highs and obviously nowhere close to being in the clear. This is a particularly interesting level, though. The last three highs in 2008, 2009, and 2010 were 4.10%, 3.95%, and 3.99% and we are trying to chop out a high in the 4.00%/4.10% area here.

Below, you can see we have made five efforts to find a peak just above 4%.

And here you can see a similar series of attempts to take out 4% eventually failed in the QE era.

To summarize: I think we may have based here in risky assets because:

We are past peak tail risk in the EU and the UK. The EU energy story continues to get less bad. The UK fiscal story is also less bad.
Blowoff bottom in SPX on CPI release creates a tradable low in stocks.
4% yields in the US creates a possible pivot for global rates, especially as gilts stabilize.
Very bullish seasonals for risky assets into year end.

Short USDNOK spot or put on a bearish options strategy that takes advantage of the high vol in USDNOK. For example, sell call spreads to buy put spreads or sell a 50% 2-month one touch (approximate strike is 11.02, which is perfect because it’s above the highs, but that’s ballpark please ask your salesperson for an accurate, live price).

Final Thoughts

This is a good article on parenting (HT SB): https://www.notboring.co/p/how-do-i-teach-these-kids.

My parenting advice, if you have more than one kid: Find ways to spend extended time with each child, on their own. My kids are different people when they are separate, vs. together. They are more calm, more zen, and I think they are more like their true selves. Some of my favorite memories of parenthood are the solo fishing trips I took with just me and one son. The interactions and depth of engagement are just different.

Have a rocking day.