The 2017 outlook envisions emerging market currencies coming under further downward pressure through to the end of Q1 (tough harmonizing task). The KRW is in the crosshairs from a perfect storm of Fed tightening, higher US 10yr yields, protectionist and geopolitical risk premium, and a Chinese H1 growth slowdown coupled with ongoing RMB depreciation.

The worst case for emerging markets would be investors throwing in the towel on the secular bond bull market or severe strains developing in corporate credit. Domestic political risks and the ongoing deterioration in rate differentials should also hurt the Korean won.

The entry point for long USDKRW is particularly attractive. The 200-day moving average and 38.2% Fibonacci retracement level (from the February high) both come in around the 1146-48 area. Additionally, trend line support from the September lows is around 1157.

Risk-reward is favorable given the technical set up, macro backdrop, and the likelihood that short-term positioning has been squeezed out after the move lower from the November 21 high.

Recommendation:

Bank of Korea likely to remain on hold next week, inflation in 2017 to reach bank's target band, we continue to favor shorting regional low yielders against the USD, and long USDKRW adds to our existing recommendations of long USDTWD and owning a USDSGD 3m one-touch knock-in 1.4950.

Korean authorities did note that they were closely monitoring KRW FX volatility, which is likely to stem the pace of USDKRW appreciation but is unlikely to change the trend move higher in the pair.

In addition, the added uncertainty on corporate earnings has the potential to slowdown equity inflows from offshore investors. As a result, we come up with the more conducive hedging vehicles as to keep any USDKRW FX exposures on the check.

So, USDKRW longs are encouraged at 1165.43 via 2m NDFs ahead of Fed’s rate hiking speculations.

Alternatively, one can also look in for buying USDKRW 1m/2W call spread with strikes of 1,165-1,210 for a net debit, this position to address puzzling swings on both barriers. Call spreads are preferred to vanilla structures given elevated skew and favorable cost reduction.