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16 Dec 2015
EM in 2016: Deeper into the vortex - SocGen
FXStreet (Delhi) – Research Team at Societe Generale, suggests their top trading recommendations from emerging markets in 2016.
Key Quotes
“Short select EM currencies through a cheap basket: A set of bearish EM outcomes (Fed tightening, Chinese growth, yuan depreciation and a rise in EM corporate defaults) suggests that correlations in the EM space will stay elevated and could rise further in 2016. Taiwan and Chile have the biggest export exposure to China. In G10, our bullish USD/JPY view is moderate, but a disorderly CNY fall would revive fears of an Asian currency war and support a larger move. Markets are still pricing these joint macro risks as diversified, offering the opportunity of a cheap worst-of option. Buy 6M worst-of CNH, JPY, TWD, CLP ATMS puts / USD calls.
Regional EM: Short Asia against EMEA and LATAM: Against the backdrop of growing concerns about EM corporate credit quality and higher US rates, downside risks to Chinese growth (SGe 6.0% vs consensus 6.5%) coupled with RMB depreciation (USD/CNY moving at 6.80 by year end) will see Asia underperform EMEA and LATAM on a total return basis. Buy RUB, BRL vs sell KRW, MYR.
Short EM exposure: Long USD vs TWD & KRW: Korea and Taiwan are both highly exposed to weaker Chinese growth through the direct export channel and from RMB depreciation through the indirect channel by having relatively high export similarity. Both currencies could be increasingly used as proxy trades for the China story given more favourable carry characteristics.
Long EM exposure (against EUR): Short EUR vs PLN and CZK: Despite a challenging environment for EM FX, the CEE currencies will do well against the EUR on strong basic balances, robust domestically generated growth dynamics, and suppressed inflation. The CNB is expected to abandon the floor in EUR-CZK in Q3, though the risks of a later exit have increased.
Long EM exposure (against USD): Short USD vs RUB and INR: The RUB is expected to do well next year as domestic factors coupled with modestly higher oil prices proves beneficial. For a second year in a row, the INR is attractive on a carry-adjusted basis due to improvement in external balances, higher FII limits and the RBI limiting large movements in either direction.
EM relative value: Short TWD-INR, long RUB-MYR: Two positive carry structures with appealing qualities related to China and commodity exposure. India has the lowest direct export exposure to China in the region, while Taiwan has the highest, and for the sizeable positive carry (6.5%) to be eroded, it would probably require a sustained risk-on rally. Stable to higher oil prices would be beneficial for long RUB-MYR, and if oil prices fall, further the positive carry (approximately 9% per annum) provides a significant downside buffer.
Bearish China trade I: Long USD-CNH call spread: A gradual and controlled depreciation in USD-CNY toward 6.80 is our baseline scenario, but there are risks of a larger move if trade-weighted appreciation is too much for policymakers to bear relative to growth and employment objectives. Substantial negative carry (-3.8% over 12M) and unfavourable breakeven levels in plain vanilla call options leaves a USDCNH call spread as the most attractive structure to position for either orderly or disorderly depreciation.
Bearish China trade II: Long CNH vs TWD and KRW: Given the unfavourable risk-return characteristics of being long USD-CNH, relative value structures against regional low yielders has some appealing qualities. First, long CNH against KRW and TWD has decent positive carry (+3.7% on an equally weighted basket). Second, these crosses have been positively correlated to higher USD-EM. Third, investors are likely to seek proxy trades for gaining exposure to the RMB depreciation story, and as such, KRW and TWD depreciation should at least match, or more likely exceed, that of CNH at different points throughout the year.”
Key Quotes
“Short select EM currencies through a cheap basket: A set of bearish EM outcomes (Fed tightening, Chinese growth, yuan depreciation and a rise in EM corporate defaults) suggests that correlations in the EM space will stay elevated and could rise further in 2016. Taiwan and Chile have the biggest export exposure to China. In G10, our bullish USD/JPY view is moderate, but a disorderly CNY fall would revive fears of an Asian currency war and support a larger move. Markets are still pricing these joint macro risks as diversified, offering the opportunity of a cheap worst-of option. Buy 6M worst-of CNH, JPY, TWD, CLP ATMS puts / USD calls.
Regional EM: Short Asia against EMEA and LATAM: Against the backdrop of growing concerns about EM corporate credit quality and higher US rates, downside risks to Chinese growth (SGe 6.0% vs consensus 6.5%) coupled with RMB depreciation (USD/CNY moving at 6.80 by year end) will see Asia underperform EMEA and LATAM on a total return basis. Buy RUB, BRL vs sell KRW, MYR.
Short EM exposure: Long USD vs TWD & KRW: Korea and Taiwan are both highly exposed to weaker Chinese growth through the direct export channel and from RMB depreciation through the indirect channel by having relatively high export similarity. Both currencies could be increasingly used as proxy trades for the China story given more favourable carry characteristics.
Long EM exposure (against EUR): Short EUR vs PLN and CZK: Despite a challenging environment for EM FX, the CEE currencies will do well against the EUR on strong basic balances, robust domestically generated growth dynamics, and suppressed inflation. The CNB is expected to abandon the floor in EUR-CZK in Q3, though the risks of a later exit have increased.
Long EM exposure (against USD): Short USD vs RUB and INR: The RUB is expected to do well next year as domestic factors coupled with modestly higher oil prices proves beneficial. For a second year in a row, the INR is attractive on a carry-adjusted basis due to improvement in external balances, higher FII limits and the RBI limiting large movements in either direction.
EM relative value: Short TWD-INR, long RUB-MYR: Two positive carry structures with appealing qualities related to China and commodity exposure. India has the lowest direct export exposure to China in the region, while Taiwan has the highest, and for the sizeable positive carry (6.5%) to be eroded, it would probably require a sustained risk-on rally. Stable to higher oil prices would be beneficial for long RUB-MYR, and if oil prices fall, further the positive carry (approximately 9% per annum) provides a significant downside buffer.
Bearish China trade I: Long USD-CNH call spread: A gradual and controlled depreciation in USD-CNY toward 6.80 is our baseline scenario, but there are risks of a larger move if trade-weighted appreciation is too much for policymakers to bear relative to growth and employment objectives. Substantial negative carry (-3.8% over 12M) and unfavourable breakeven levels in plain vanilla call options leaves a USDCNH call spread as the most attractive structure to position for either orderly or disorderly depreciation.
Bearish China trade II: Long CNH vs TWD and KRW: Given the unfavourable risk-return characteristics of being long USD-CNH, relative value structures against regional low yielders has some appealing qualities. First, long CNH against KRW and TWD has decent positive carry (+3.7% on an equally weighted basket). Second, these crosses have been positively correlated to higher USD-EM. Third, investors are likely to seek proxy trades for gaining exposure to the RMB depreciation story, and as such, KRW and TWD depreciation should at least match, or more likely exceed, that of CNH at different points throughout the year.”