Rec USDCNH 3m fwd, Pay USDCNH 1y fwd
Last: 850 pts
Flat carry until 3m rolls off (calculated as pts/day from both 1y and 3m legs)
Could be an interesting, carry-efficient China hedge, with fwd curve in USDCNH flattening to 2015 tights, if taking a defensive view in light of recent fall in Chinese Credit impulse, LKQ index (composite of rail freight, electricity consumption, loan volume) and fall in PMI. Fall in PMI although seasonally attributed to CNY effects, - still something to consider with broader move lower in Chinese macro data.
A stylized look at PMI's vs risk-proxy ccy-pair vols (e.g. JPY crosses), shows that FX vol term structure tends to steepen into periods of economic expansion and flatten when peaks of economic momentum occur as front-end vols get more bid during risk-selloffs than longer-dated. 6m ATM on EURJPY at the moment is at 9.4, however curve is flat with 1y ATM converging on the 6m two weeks ago, which seems out of step with current economic momentum. The current convergence is rare, as inversions tend to occur around exhaustions in vol spikes up, and that curve usually still is steep around bottoms in vol. This can be taken as an opportunistic entry to long 6m6m FVA's at 9.60 with the view that vol at settlement will trade around 12 (8-year historical average). Given the tightness of the FVA vol to the spot vol, being long 6m6m FVA could be a carry efficient expression compared to paying theta on a spot-straddle.
I think the arguments for a higher vol environment for the next 6m is compelling. Excess liquidity is declining with the Fed continuing to tighten, the ECB exiting QE as well as the BoJ adding less to liquidity creation. Geopolitical backdrop of 'trade-wars' is also likely to be vol-expansionary. Trump's post election vol spike was faded because markets saw the unlikelihood of extreme policies on the Trump to be realized in the near-term; we are currently seeing otherwise.