FxWirePro: Shift in Bullish Vols Among Asian and High-Beta EMFX-Bloc

The brutal late-summer bullish seasonality of FX vol (refer 1stchart) has re-asserted itself following an eventful FOMC meeting and a rather more dramatic turn of events on US/China trade towards the fag end of the week. Before being overshadowed by the Presidential tweets that upended any lingering hopes of quiet late summer markets, the “hawkish” Fed cut at the July FOMC could reasonably have been expected to be the marquee event catalyst of the week likely to produce durable market impact over the next few weeks.

A consensus had begun to emerge around soft US exceptionalism and contained dollar strength in the lead-up to the September ECB, as uber-dovish Fed expectations were revised to reflect a more reasonable assessment of concurrent US activity data, and the old strong-US-weak- Europe cyclical/policy divergence narrative revived. 

The latest tariff threat from Trump emphatically reinforces this notion of dollar bullishness; the crucial difference for FX volatility is the potential for greater velocity and urgency to dollar rallies than might have been previously anticipated. The net result is a sharp re-pricing higher of front-end implied vols across the board, with the largest increases focused on Asian currencies in the eye of the storm and China-linked high-beta EMs such as ZAR (refer 2ndchart).

In light of the further escalation in the US-China trade conflict, we are revising our USDCNY forecast profile higher. As we have noted in recent research (see China FX focus: Life after 7.00) the risks around a break of 7.00 have arguably never been greater. With tariffs likely to be applied to the remaining set of Chinese exports to the US, upside pressure on USDCNY should only increase, as a weaker currency should be part of the first-order response to such a loss of competitiveness. This has been evident in 2018 and in May of this year after the US raised tariff rates on Chinese exports. Courtesy: JPM