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A glimpse: The USD rally caused by Donald Trump’s election victory and based on rising inflation and interest rate expectations continued again yesterday. That means the market is pricing in acceleration in Fed rate hikes next year and in turn more dollar strength. This is visible in EURUSD as the pair failed at the test of the annual low at 1.0711 yesterday though.
In the event, Trump delivered the first of what may be many surprises of this Administration: he was conciliatory. Since we expect trade conflict to emerge soon, there are no changes in core views around reserve currencies.
With the risks to EM growth getting skewed to the downside and the risks to Fed hikes becoming more two-sided, risks to high carry currencies have gone up as well.
These are especially vulnerable given that positioning in high beta/ EM currencies is at its longest in three years. Our preferred view to express the bearish China is via long USDKRW, but are neutral on high-yielders/commodity currencies for now since commodity prices have the potential to remain well-bid in the event Trump chooses to emphasize infrastructure spending.
Our views on EM vol shorts have undergone a 180-degree about turn. Before this week, a benign view of EM growth and capital flows had prompted us to sell options in select EM currencies such as CNH (basket driven, steady managed depreciation) and BRL (a genuine macro turnaround story) for harvesting still-rich risk premium.
But with a structural break in EM economic prospects in the offing under the new administration, that stance is no longer tenable, and we will be looking for opportunities to buy still cheap EM vol, with a bias towards low-quality EMEA (ZAR, TRY) and trade-afflicted Asians.
We are long SGD and AUD (as an EM contagion proxy) vega in this bucket, and are eyeing the following as good value risk premium to buy when a modicum of sanity and liquidity returns to option markets:
SGD risk-reversals as flagged last week;
CNH risk-reversals that we have remarked on a few occasions as being cheap vis-à-vis the implied yield in forwards;
USD call/CNH put – USD call/CNY put option spreads as RMB disorder hedges;
EURINR risk-reversals, a better hold than ATM vols as outlined here; and
Long JPYKRW and EURKRW vs. short USDJPY and EURJPY vol spreads.
