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The EM risk scorecard appears to be mixed, and at this juncture, most values in idiosyncratic opportunities are foreseen. For now, the focus on the following key risk factors for EMFX.
US trade tensions have not played out as an EM-negative factor so far, as markets seem to have a base-case that all will be negotiated in the end. This looks a reasonable base-case but there was not much risk premia built-in EM against a more adverse outcome or noisy journey, given markets have not sold off much of this risk.
In Asia, we retain a bullish stance on trade-oriented currencies where we expect policymakers to tolerate strength. The main question in our minds is how the risks are skewed in 2Q, and right now we acknowledge trade tensions could also add to the headwinds. So far, this has yet to manifest broadly but any material drop in the PMI surveys this quarter bears watching.
In terms of recommendations, we are retaining our bullish stance on Asia’s trade-oriented currencies, currently with active positions in KRW, TWD, and SGD. The starting point of current account surpluses/Net International Investment positions in Korea, Taiwan, and Singapore remains elevated/strong and the current cyclical posture for policymakers would be to tolerate currency strength.
Chinese banks bought USD434.2bn of foreign currency and sold USD452.5bn from January to March, resulting in net sales of USD18.3bn. This represented a 55% drop compared with net forex sales volume in the same period last year, thanks to the capital control measures. In other words, the Chinese corporates and individuals are not in a rush to convert their CNY to other currencies.
As there is little selling CNY pressure in the FX market, China’s authorities have restarted its opening-up process – a spokesman from State Administration of Foreign Exchange (SAFE) said that China will increase the quota for qualified domestic limited partners (QDLP) and qualified domestic investment enterprises (QDIE).
Both schemes allow licensed companies to raise funds from investors in China for investment overseas. There is no official timeline of these two schemes, but some big asset managers have reportedly received new quota recently.
We are currently not advocating longs in CNY because to the extent the trade tensions deliver a stronger CNY exchange rate on a tariff adjusted basis, the scope for Renminbi appreciation in the nominal space stands curtailed.
The reasonable option premium can be collected from shorting EUR calls/CNH puts due to negative points carry on both the EUR-and CNH-legs, which offsets some of the disadvantages of depressed EURCNH vols relative to USDCNH vols in an elevated USD-correlation environment.
A potential pushback against shorting EURCNH calls is that a Euro surge of the kind seen in 3Q’17 could drag EURCNH higher even absent a USD revival; it is a fair critique, but one we judge is low probability at the moment since the unique initial conditions associated with that Euro move.
On hedging grounds, AUDUSD - USDCNH 2M straddle spreads, 100:125 vega ratio.
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