FxWirePro: Extra caution on Asian FX vols on US-China trade tormentor – Find defensive and positive carry opportunities

Another bad day for commodity prices yesterday, but while industrial metals remain under pressure, oil prices picked up the baton, falling c. 7%. Commodity currencies followed. The FX market has reacted considerably to the mounting the US-China trade tensions which weighed on Equity indices this week, triggering a 4 vol points rise in the VIX on Monday, and to the renewed concerns on Italian fiscal budget, with 10yr BTP/Bund spreads widening up to 25 bps during the week.

One could argue that the most recent FX price dynamics, with USD and JPY rising and EMFX dropping amid expectations that China would retaliate for the latest tariffs the US has announced on Chinese imports, which has weighed on prices of commodities and commodity-linked currencies, at least if compared to the relative complacency as manifested by Equity markets; therefore, the violent price action we have witnessed in the recent past could be interpreted as a necessary adjustment on Equities rather than anticipating further corrections to materialize for currencies that were already incorporating all trade tension news.

The latter thesis could be supported by the massive early-February Equity sell-off which failed to impact significantly FX vols, beyond a short-lived, although sharp, move. Still, cautious in such markets is advocated and it is reckoned that balanced portfolios are likely to fetch constant yields in an uncertain mid-summer landscape, as indicated in last week’s 2H’18 outlook.

We prefer staying away at the moment from the LatAm space, given the large event premium priced in by the options market for the incoming election in Mexico on 1 July (around 3% implied daily move on USDMXN, although steadily declining over the past few weeks, 1% on USDBRL).

We like focusing on the Asian vol space instead, which, despite being at the epicentre of the trade war tensions between the US and China, offers attractive pricing for entering tactical plays. We highlight some chances, one being more defensive in nature and the other more tilted towards positive Carry generation.

We consider the second idea in the Asian vol space, this time aimed at harvesting a positive Carry and to offer some protection in case that the trade dispute between the US and China were to intensify. We were recommending entering a long 6M USDKRW vol/short 6M USDTWD vol idea for benefitting from the relative cheapness of KRW vol compared to regional peers. One month and a half on, it is SGD vol which catches our attention as a possible laggard in the Asian space, if ever as a cheap hedge for the short-vol leg rather than as a conviction trade for hedging an extended risk-off scenario in the region. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly USD spot index has shown 86 (which is bullish) while articulating at 10:12 GMT.

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