EFTA01459711.pdf

12 January 2016 FX Blueprint: Forever Young Theme #14: Volte-face - buy 6m EUR/EM-USD/EM vol spreads, sell EUR vs TRY, MXN, INR • Options markets assume the dollar will drive price !Figure 1: Eurozone fixed income outflows dominate the action but the euro is now the "risk off" currency (financial account • "Euroglut" outflows into the US and EMFX reverse as risk appetite sours and carry trades squeeze 1,400 • Curnolftive. EUR bn 930 EUR be a=eValLedon gargaa 1.200 ImoHaws 400 • EUR/EM crosses have been realizing well above USD/EM but implied volatilities are quite similar 1.00) - M1IIP 903 800 4,ICO • We recommend buying 6m EUR/EM - USD/EM 900 • .1.900 volatility spreads in TRY, MXN. INR 400 -1,500 • For a directional view, express our EM 2016 200 -1.700 Outlook short EUR v. TRY, MXN and INR trade as a 4m 97.5% worst-of put, a 2/3rd discount v. vanillas 0 -1.900 .200 -2,100 UM is the nevz risk appetite barometer 40D -7.300 Our FX strategy team has written extensively about 2038 Ace zoio 2011 wiz 2013 2014 2015 "Euroglut" outflows into the U.S. and emerging Totter AnneAs Sr* Ittembevg Mom LP markets (see FX Special Report 9-Dec-14 and 1-Dec-15). EUR increasingly adapts the hallmarks of safe haven currencies such as CHF and JPY; fixed income Figure 2: Positive vol premium in USDIEM, negative vol outflows (Figure 1) followed by sudden repatriation premium in FUR/hi as flight to EIJR safety not priced during positioning squeezes. Consequently, correlation between equities (a risk proxy) and EUR/USD has SPX EUR TWI ly corr flipped since the Fed-driven USD rally (and ECB QE- driven EUR sell-off) last year. The EUR TWI is now SPX-USD TWI 1y corr negatively correlated to the S&P 500 while the USD TWI is positively correlated to equities (Figure 2). We can also infer forward-looking market expectations of dollar-equities correlation by comparing implied volatility for USD-hedged and un-hedged international equity ETFs. In recent months fun-hedged) EFA volatility has traded 1-2% below both iShares hedged EFA (HEFA) and DB X-trackers hedged EFA (DBEF), suggesting the market expects the dollar will be 2013 2014 2015 2016 positively correlated to global equities in the future Sarno Oadiscar 0a* Illeamlarg Fenno, LP (principally with respect to EUR, CHF and JPY). j We should expect a similar result when looking for Figure 3: Positive vol premium in USD/EM, negative vol volatility in EMFX. Since EUR/USD is negatively !premium in EUR/EM as flight to EUR safety not priced correlated to equities (acting as risk proxy), we would expect EUR to be negative correlated with EMFX as well, making EUR/EM more volatile than USD/EM. ■ EURTRY • EURMXN ■ EURINR Buy EUFflEkl volatility not USDIEM for an added fool. Of Indeed, EUR/EM is realizing higher, but implied ■ USDTRY volatility is not reflecting this at all. Figure 3 illustrates ■ USDMXN that EUR/EM and USD/EM 6-month implied volatility is ■ USDINR priced roughly equal for much of EMFX, and where it is not (such as INR), the premium on EUR-cross volatility relative to USD-cross volatility is too low. As a result, while USDTRY, USDMXN and USDINR exhibit typically positive volatility risk premiums, EURTRY, EURMXN and EURINR volatility premiums are negative. 6M Implied Vol 6M Realized Vol 6M Vol Premium Saga O6CO Deutsche Bank AG/London Page 29 CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0120349 CONFIDENTIAL SDNY_GM_00266533 EFTA01459711