Viewing the world from the perspective of a Fed-dominated financial market has been a struggle for most of the second quarter. The mental market map becomes much clearer when instead we consider the possibility that the ECB has (at least temporarily) rested control from the Fed. Its success in depressing domestic rates amidst the promise of long-term funding has encouraged risk extension into higher-yielding assets both in its immediate satellites and more broadly around the financial system.
From an FX standpoint, the opportunity set is limited by the degree of convergence, but of greatest interest where the ECB-driven pricing of the rates term structure provides additional stimulus beyond what the domestic economy requires and thereby opens up the scope for policy divergence.
Interest rate spread divergence between those dominated by the ECB and those breaking away points to medium-term opportunities in, for example, long GBPAUD or GBPSEK. As a candidate to migrate out of the low term structure bloc based on rising inflation and support from asymmetric oil price risk, we continue to focus on opportunities in long CADJPY or short EURCAD.