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FxWirePro: New Year trade resolutions for EMFX baskets

We reckon bullish USD/EM baskets, spot rates should be upwardly biased, and the bulk of total return performance in 2018, if any, should come via carry – similar to the past two years. The risk to our forecasts is a stronger performance in 1H and a weaker outturn in 2H. While we are most bullish on MXN and ZAR as contrarian trades, and willing to buy the TRY once the diplomatic scoreboard has been tallied. The CNH has good carry trade properties (for now) while KRW, TWD, and CLP could be sensitive to weaker China growth.

Owning protection on BRL is preferred given positioning and political risks. From a dispersion perspective, the TRY, ZAR, MXN, and BRL could show the highest level of dissimilarly compared with the rest of the EM currency universe.

Strong bond inflows: the Foreign appetite for EM bonds has been strong, with equity flows severely lagging. Even with the pressure on EM currencies between September-November, bond investments remained sticky, suggesting positions were FX-hedged. When EM currencies are depreciating, the gap between actual bonds yields and fair value tends to increase. The opposite happens when currencies are appreciating.

EM FX volatility: Similar to movements in spot rates, when volatility is increasing (typically occurs when EM currencies are depreciating) the gap between actual bond yields and fair value tends to increase. When volatility is falling the gap between actual and predicted yields tend to decline.

Trade recommendations:

Stay short in EURCZK via 2m forwards

RV trade - 3m USDTRY put up-and-in Short USDTRY (post fall-out from Reza Zarrab trial)

Short USDZAR (post-February 2018 budget announcement)

RV trade - Long INR and IDR vs short KRW and TWD

Long CNHTWD

6m USDMXN digital put

6m USDBRL topside seagull.

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2018-01-16 14:32:49
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