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FxWirePro: Identify mixed bag of sentiments in EM Asia FX universe and hedge wisely

In Asia, we retain a bullish stance on trade oriented FX universe where the policy makers are expected to withstand 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. 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.

China’s central bank announced yesterday to reduce the reserve requirement ratio by 100bps for most of the commercial banks, effective from 25 April, in order to replace the maturing medium-term lending facility (MLF). The central bank said this move is to lower the cost of funds for the real economy, and the replacement will only increase the money supply incrementally.

Theoretically speaking, banks will get 1.62% interest from required reserves, but have to pay 3.30% for one-year tenor MLF. That said the replacement will lower the funding costs for the commercial banks, reflecting an easing bias to the monetary policy stance. The timing of the RRR cut was a surprise as the PBoC normally takes action on Friday, and the cut arrived right after the Q1 GDP report.

It seems that China’s authorities see that the economy is not doing as well as expected. The housing prices, released this morning, still illustrated a downward trend on a year-on-year basis. All in all, this is not positive for CNY.

The bar for outright vol selling is considerably higher this year, but that does not preclude exploiting pockets of receding of dollar momentum to tactically harvest theta when curve shapes and realized vols co-operate. USDKRW is one of the best candidates to do so currently. 

First, the 3M-6M segment of the KRW vol curve is flat (refer 1st chart), so naturally lends itself to short front vs. long back curve steepeners.

Secondly, KRW is one of the notable laggards in the normalization of FX vols from their VIX spike highs as discussed earlier, hence there is room for the front-end of the curve to sag.

Thirdly, realized vols in USDKRW have cratered over the past two weeks, and are now running a substantial 2-3 pts. under 3M ATMs (refer 2nd chart). Absent another SPX shock, subdued KRW realized vols can persist given tailwinds from equity inflows, the won’s trade-related appreciation bias and a more symmetric policy lean against bouts of sharp FX rallies and sell-offs.

AUDUSD - USDCNH 2M straddle spreads, 100:125 vega ratio.

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