Positioning for a higher EUR Our trade of the week is to buy EURUSD at 1.16 with a target of 1.21 and stop of 1.15, with our USD scorecard suggesting weakness in USD in coming weeks (Exhibit 9). Below we highlight some of the dynamics in the options markets to find the best expression of our EUR view. The market has turned bullish on USD, particularly versus EUR, where the 3-month risk reversal is now two standard deviations below the average over the past year (Exhibit 4). USD expectations have been turning more bullish, with put volatility falling below that of calls. A survey of futures traders shows that 84% of them are bullish USD currently. The limited rise in the USD index (DXY) in the past month has diverged from the USD risk reversal (Exhibit 3). Since we expect USD to weaken in the coming weeks, we should see the EUR skew turn increasingly in favour of calls (Exhibit 4). SEK realised volatility is the highest within the G10 on an absolute and relative basis (versus last year's history), but we expect this to fade as the ECB moves towards ending its QE programme. The volatility carry, the difference between implied and realised volatility, is negative for EURSEK and USDSEK but we expect realised volatility to fall, pushing down the future-implied option market expectations. There are few upcoming local risk events over the coming months, making selling volatility more attractive. Some may see Exhibit 5 and expect that implied volatility now needs to catch up with realised, and we acknowledge this view, but our trade makes an assumption on the spot market move too. This is a short-term trade, as many volatility metrics on a 10-year horizon don't show SEK as diverged too much from other currencies. Exhibit 3:USD call volatility is rising more than the recent USD spot moves Source: Macrobond, Bloomberg, Morgan Stanley Research Exhibit 4:EUR risk reversal is now over two standard deviations below average Source: Macrobond, Bloomberg, Morgan Stanley Research2The SEK macro story: Real rates have turned increasingly negative as Swedish inflation rates pushed higher while bond yields were anchored due to quantitative easing, pushing foreigners out of the SEK bond market. The Riksbank justified its easy policy by saying that it was worried about SEK strengthening and that the larger neighbouring central bank, the ECB, was still doing QE. The ECB has confirmed that it wants to end QE this year and SEK is now 18% weaker than the high in 2013 and 5% weaker since the start of the year (Exhibit 7). Any moderating tone on SEK from the Riksbank could push SEK higher. Why not trade EUR calls It is possible to look at EUR, but we think that the SEK spot market is likely to react more to a stabilisation in USD, so we focus our analysis here. In the past month EURUSD at-the-money-implied volatility has fallen across all tenors, particularly in the shorter term (Exhibit 11) and hasn't diverged from other currencies as much as SEK has. The relationship between EURUSD implied volatility (ATM) and the Exhibit 5:EURSEK realised volatility now appears to be too high Source: Macrobond, Bloomberg, Morgan Stanley Research Exhibit 6:EURSEK risk reversal should come down Source: Macrobond, Bloomberg, Morgan Stanley Research Exhibit 7:SEK is weak, around levels last seen in 2010, making it more difficult for the central bank to be worried about currency strength Source: Macrobond, Bloomberg, Morgan Stanley Research Exhibit 8:SEK volatility is high versus the last year's history Source: Macrobond, Bloomberg, Morgan Stanley Research; Rank is the current level versus the low over thepast year as a % of range. Exhibit 9:Our USD scorecard is pointing towards USD weakness in the coming weeks -8% -6% -4% -2% 0% 2% 4% 6% 8% -1.6 -1.4 -1.2 -1.0 -0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4 Dec-16Mar-17Jul-17Oct-17Jan-18Apr-18Aug-18Nov-18 USD scorecard (4-factor average, 14 week lead) DXY 3m chg (rhs) Standard Deviation Source: Morgan Stanley Research3direction for EURUSD is in transition but recently the stronger EUR came along with lower volatility. 2m EURUSD forward at 1.177 is just above current levels, and with a 25 delta strike closer to 1.19 could still be profitable if the spot value reaches our 1.20/1.21 EURUSD target. Market levels: We expect the EURSEK upper level to be limited to the 10.50/10.60 area in the coming weeks. A big sell-off in global equity markets is required in the coming month for there to be a lot of weakness in SEK (to make new highs above 10.70). Exhibit 12 shows that EURSEK is currently sitting around the 61.8% retracement level of the 2009-12 downtrend and remains within a channel. The bottom end of the current channel is at 9.80, with a a move below 10.00 being likely in the next two months if EUR does rally to 1.21. Market positioning: According to the CFTC, futures traders are marginally long EUR (5.1% of open interest) but this is the least long they have been since March 2017 (Exhibit 13). Our own positioning tracker suggests that broader markets are short EUR. There isn't a good data source for SEK positioning but we would assume that investors are still short, particularly versus NOK. EURNOK volatility diverged from EURSEK in April (Exhibit 14), creating a rare situation where EURNOK volatility is trading below EURSEK, helped by rising oil prices. Exhibit 10:EURSEK volatility curve hasn't changed much in the past month Source: Macrobond, Bloomberg, Morgan Stanley Research Exhibit 11:EURUSD implied volatility has come down, mostly in shorter tenors Source: Macrobond, Bloomberg, Morgan Stanley Research Exhibit 12:EURSEK likely to trade to the bottom end of the channel 7.50 8.00 8.50 9.00 9.50 10.00 10.50 11.00 11.50 12.00 09101112131415161718 10.6956 9.7482 10.4096 (61.8% retracement) Source: Bloomberg, Morgan Stanley Research4。。。。。。