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The front-end CNH risk-reversals have shrunk to near zero (see chart) as the PBoC's tight FX management has smashed realized volatility.
CNH vol skews started softening in mid-Q1 when Chinese authorities instituted capital controls to curb capital outflows and have been on a steadily declining trend since alongside a general risk premium compression in China-linked assets.
China risk-reversals in free fall front-end CNH risk-reversals compressed to almost zero this week (see above chart), a rare occurrence in the EM FX world and a dramatic change of fortunes for a currency that was supposed to be spiralling out of control and into a 1990s style crisis only a few months ago.
The move picked up pace this week with 1M 25D riskies falling to 0.05 vols (-0.30 from intra-week highs), effectively signalling symmetric volatility risks in both RMB rallies and sell-offs over the next month.
The optics of nearly flat risk reversals is jarring given the long history of disruptive EM currency weakness that usually commands a healthy premia for USD calls over USD puts, and the more recent macro-narrative of declining growth, unsustainable leverage and capital flight around China that ought to have been priced into options via fatter right tail probabilities (i.e. higher USD call/CNH put prices).
Unsurprisingly, anecdotal accounts indicated investor interest in snapping up zero price CNH riskies purely on price grounds, even if catalysts for a volatile sell-off over the next month are not obvious.
Stay short 6M vol; USD puts/CNH calls are better shorts than ATMs to monetize RMB stasis given the skew set-up.
