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The yield of 10-year US Treasuries flirted with the 3% mark again yesterday and immediately all the usual suspects (BRL, MXN, RUB, INR, ZAR and TRY) came under depreciation pressure again.
However, a part of the recent depreciation of EM currencies is also likely to be due to the excessive optimism is seen over the past few months: in view of a lack of other alternatives, EM investments were in high demand.
Most notably, we expect ZAR to continue benefitting from strong inflows. On the other hand, the currency remains overvalued vs its terms of trade. We expect the current account deficit to widen and SARB's easing to gradually decrease carry. The benign inflation outlook supports asset valuations and suggests SARB may ease further.
We recommend a 3m 12.00/11.60 USDZAR 1x1 put spread (roughly equivalent to 25d/10d strikes, spot ref: 12.5605), indicatively priced at 0.65% of the USD notional.
We believe the structure is appropriate for the outlook for a contained USDZAR downside and taking into account the positive correlation between lower USDZAR spot levels and lower implied volatility.
ZAR is currently, on a relative basis, the more attractive high yielder in our region, and we would expect it to be able to attract a higher share of portfolio inflows – both bonds and equity. The FX score in our client survey also remains relatively low compared to other high yielders.
However, at the same time, we would expect only a contained ZAR recovery given the currency continues to screen overvalued in our models.
The contained outlook also motivates us to favor cheap option exposure rather than any OW position in the GBI-EM model portfolio. An alternative structure would be a three-month 11.69 digital put, at 15% premium (spot ref: 12.5605). Courtesy: JPM
Currency Strength Index: FxWirePro's hourly USD spot index has shown 109 (which is bullish) while articulating at 12:45 GMT. For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex.
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