Close position to receive 4Y5Y USD versus paying 4Y5Y EUR swaps USD/EUR.
We record a 37.5bp loss on a ½ position opened on 23 December.
Right view, wrong implementation
Unfortunately, this trade will be recorded under the category of having the right view but the wrong implementation.
Late last year and early this year, two of our main views were that (1) the USD curve was likely to flatten and (2) the ECB would be able to anchor rates, so in a scenario of higher US rates, we would expect a steeper EUR curve. This made the case for a 5-10 box trade, i.e. flatter USD, steeper EUR.
However, given the uncertainty about US growth and a very short based market positioning in US fixed income at that time, we wanted to insure against a fall in global rates driven by the US. Based on multi-year correlations, this let us implement the box view as a 4Y5Y spread trade (see charts below).
As the accompanying charts show, the correlation to both outright US rates and the box broke down this year. Despite the ongoing downward pressure on US rates, the correlation was unfortunately never re-established and today we hit our stop.
On the back of the recent rally in US fixed income, the improving US data (including yesterday’s GDP data) and the Fed starting to become less dovish, we now believe that the risk is leaning towards higher US rates. For the EUR markets, this should imply steeper curves and higher long-end forwards.
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