Play the USD with an Edge

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Markets are doing absolutely nothing as we await the Fed. There are many people “guessing” what the Fed will do, but one thing is sure, nobody knows. Guessing about market direction without much edge is not trades we like taking on, we leave that to others.

We like to trade events with a possible edge, or a kink to a possible scenario that has attractive probabilities.

Recently we have had some major moves in oil with exploding volatilities. Oil is a huge driver of the “fundamental” economy. Emerging markets is another big driver of global risks, and where oil is a big input to.

Below is a chart showing the EEM US vs oil since 2017. There is a lag, but these two tend to move in tandem (while EEM US, orange oil).

The USD is a big factor driving oil as well as driving the EM space. We don´t have a strong view on the USD and the Fed this time around, but since oil and EM are both “priced” in USD, the divergence in volatilities aof late could be providing an interesting trading opportunity.

Whatever the Fed decides upon, the USD will follow, hence affecting both the price of oil and the EM space. Which way they will go we leave to the “smart” guys.

EEM US implied volatility is down from recent highs, but still well above the lows we saw in late May.

Below is a chart showing oil volatility, OIV vs emerging market vol index, VXEEM. The relationship has skyrocketed. OIV has skyrocketed against most vols, but since the EM space is very USD sensitive, we find it interesting to look into strategies of selling oil volatility versus buying EM volatility.

It is basically a take on a mean reversion approach of two different volatilities, but both sensitive to the USD, that will move on the Fed.

Source, Charts by Bloomberg