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Finally, USDKRW took a break from the streaks of bearish swings today. Entering the new week, USDKRW stabilized at 1087 level with a gap up opening today.
The Bank of Korea raised its base rate by 25 basis points this morning, from a record-low of 1.25 pct to 1.5 pct as widely anticipated. It has been the first adjustment in benchmark rate since May 2016 and the bank's first rate hike since June 2011 amid clear signs of a solid economic recovery. Since 2014, there hadn’t been a hike of a benchmark rate by a major central bank in Asia.
This is deemed as a potential “buy the rumor, sell the fact” event for the Korean Won. The won had already appreciated to a new year’s high of 1077 against the US dollar yesterday from 1150 in late September. With the won stronger by more than 11% this year, the Ministry of Finance is monitoring for speculative activities.
Korea’s headline and core inflation have retreated sharply below the BOK’s 2% inflation target. CPI inflation peaked at 2.6% YoY in August and retreated sharply to 1.8% in October while core inflation fell to 1.3% from 1.8% for the comparable period. This morning, industrial production contracted 5.9% YoY in October, its worst performance since 2013. Korea’s 3-year treasury yield retreated from its peak of 2.21% on 14 November to 2.11% yesterday; 10-year was lower to 2.48% from 2.61% for the same period. With USDJPY also looking to rise above 112 on a steeper US yield curve, USDKRW has risen back above 1085 this morning. The press conference later would be thoroughly viewed to foresee if this is a one-off affair or the start of a rate hike cycle.
So far, however, the market in the region still appears to be a bit quiet, one reason most likely being that nobody wants to lose a big one before the year-end.
Bidding USDKRW call ratio spread of Christmas expiries:
We could foresee bullish risks in the dollar on account of: a) Inflation convincingly bounces back, further validating the dots; b) Feds’ hiking cycle most likely to continue c) Rest of world normalization is depriced.
Hence, at any cost, the pair may bounce back, especially, on the eve of Christmas. Subsequently, we emphasize buying Dec-22 USDKRW 1x1.5 call ratio spreads in this write-up, using strikes at 1090 /1110, indicative offer: 0.28% (vs 0.65% for the 1090 strike, spot ref: 1088).
Max leverage: 5 times of shorting the topside strike in 1.5 times the notional of the near leg provides a 55% discount on the 1090 call strike. A full reversal of the past two-month performance is required before there would be negative P&L.
Investors could also consider a 1x2 call ratio: the discount to 1090 call strike rises to around 70% and maximum leverage to 8.5x but the level at which the trade starts experiencing negative P&L is much lower (1128).
Low vol and moderately high skew Short-dated volatility parameters are conducive to position for a limited (2-4%) correction.
Vol: One-month implied volatility is at the lowest level since 2014 while the premium implied over realized is at its two-year average.
Skew: Risk reversals have compressed alongside easing in North Korea tensions and the move lower in the spot, but selling topside is still the most advantageous versus regional peers.
The maximum loss is limited to the extent of the premium paid below 1090 and unlimited above 1144.
