New Trade $FXE – All About the ECB

by Enis May 22, 2013 10:34 am • Commentary

My favorite trade that I have been pounding the table about is long U.S. dollars.  In case you missed it last week, here’s my macro wrap detailing why I liked that trade.  Three key points that I also mentioned as justification for my long USD / short Canadian dollar trade last week:

  1.  Rates Have Converged to 0.  Would you rather earn 3-4% with your money in Malaysia, the Philippines, or Thailand, or 2% with your money in the U.S.?  Would you rather earn 1.6% with your money in the Eurozone, or 2% in the U.S.?  Would you rather earn 1% with your money in Japan, or 2% in the U.S.?All of a sudden, the U.S. dollar is not looking too shabby.
  2. The Federal Reserve’s next step is more likely to be taking the foot off the gas rather than pushing further down on the pedal.   But most importantly, the U.S. dollar has been able to rally this year even with the Fed in full QE mode.  In my mind, any hints at reducing QE by the Fed would just add rocket boosters to a trend that is already in force
  3. Outperformance of U.S. assets.   In the past couple years, we have seen the pendulum swing back towards the developed world, as emerging market stocks and commodities have underperformed as investments.  That has significantly reduced the appeal of emerging market assets, and is leading to a shift back into growth investments in the U.S. (which is still the envy of the developed world in terms of financial market depth and performance).

Today’s focus on Bernanke’s QE comments provides the right entry to initiate another long dollar trade, this time against the Euro.  While the dollar is selling off today based on Bernanke’s comments that there are no immediate plans to taper QE, the real driver of the dollar in the past 3 years has been rate differentials.  In fact, the dollar is higher against almost all major currencies in the past 2 years, in a time that included QE2, Operation Twist, and QE-Infinity, so QE is clearly not a major driver of the dollar.

Along those lines, today’s selloff in the dollar vs. the Euro is a good entry point to initiate a longer-dated short Euro position, particularly since I expect the ECB to fight currency strength even more in the coming months, since European exports are looking more and more expensive vs. their Japanese counterparts.  Here’s the trade:  

TRADE: FXE ($128.10) Bought the Sept 128 put for $2.60

-Bought 1 Sept 128 put for 2.60

Break evens on Sept Expiration:

-Losses of up to 2.60 between 125.40 and 128, max loss of 2.60 at 128 or above

-Profits below 125.40

Trade Rationale:   The FXE is the Euro ETF.  I expect a 5-10% move over the next 3 months, in which case volatility is too cheap.