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EM Strategy Plus Summary - 13 June 2014

Core Content Overview

This document provides a weekly summary of investment strategies and trade recommendations for emerging market (EM) assets, including FX, local debt, credit, and options. The analysis is based on market conditions, economic fundamentals, and central bank policies.

Key Views and Asset Allocation

CNH (RMB)

• The RMB is in a range market, not a new appreciation trend.
• Investors are overly bullish now, similar to how they were overly bearish when it was weak.
• Recommendation: Remain short 3m USDCNH, targeting 6.20. Consider going long USD slightly lower.

South Korea

• Korean front-end swaps have rallied, but correlation with USD rates has broken down.
• Rate hike expectations are nearly gone, and rate cuts are possible.
• Recommendation: Maintain receiver in the front end, expect limited back-ups, and price in the chance of a rate cut. Buy 1y1y KRW at 2.9%, targeting 2.85% on a hawkish FOMC.

Brazil

• Break-even inflation (BEI) is edging down, but repressed administered prices will prevent headline inflation from easing.
• Inflation risk remains tilted to the upside.
• Recommendation: Buy 1y Brazil BEI (May 2015), targeting 6.50%. Entry level: 6.13%. Stop loss: 5.85%. Recommended allocation: USD 5k DV01.

Turkey

• Political risks and a worsening current account deficit make the TRY a poor long candidate.
• Recommendation: Sell TRYBRL, targeting parity. Also, short TRY via USDTRY RKOs.

Russia

• EM debt: Sell Russian CDS, buy Turkish protection.
• Credit fundamentals: EM default rate is expected to peak in Q3 2014 and fall toward DM levels.
• EM growth cycle is bottoming out, leading to a net rise in ratings.

Regional Asset Allocations

Malaysia

• FX: Neutral. Long MYR vs TWD as a carry trade.
• Local debt: Neutral.
• Local rates: Neutral.
• External debt: Neutral.

Indonesia

• FX: Bullish. Entry levels are attractive after recent depreciation.
• Local debt: Neutral on IDR bonds, looking for 10y yields to rise to 8.5%.
• Local rates: Neutral.
• External debt: Buy 5y Indonesia CDS at 146bp, targeting 180bp.

Thailand

• FX: Neutral. Political uncertainty remains a headwind.
• Local debt: Neutral.
• Local rates: Front-end steepeners (1y3y), back-end flatteners (2y10y).
• External debt: Neutral.

Poland

• FX: Long PLN vs HUF, targeting 76.50.
• Local debt: Buy POLGB Jul'18s.
• Local rates: Receive the belly.
• External debt: Overweight.

Hungary

• FX: Long HUF, targeting 5y5y FWD.
• Local debt: 2y5y outperformed 5y10y.
• Local rates: Bullish back end.
• External debt: Overweight.

South Africa

• FX: Bearish. Short ZAR via USDZAR call spreads.
• Local debt: Short duration.
• Local rates: Receive FRA 2x5.
• External debt: Buy 5y South African CDS.

Mexico

• FX: Neutral. Positive on long-term outlook.
• Local debt: Buy 2y Mexico BEI.
• Local rates: Trade tactically in 1y-5y tenors, go long UIDs 2y and TIIE 2y.
• External debt: Neutral.

Trade Review

New Recommendations

• Sell TRYBRL: Target parity, entry at 1.052, stop at 1.085.
• Buy 1y Brazil BEI: Entry at 6.13%, target 6.50%, stop at 5.85%.
• Buy 2m USDIDR ATMF put: Entry at 160bp.

Summary of Key Points

• RMB (CNH): Range-bound, not a new appreciation trend. Maintain short position, target 6.20.
• KRW: Rates have rallied, but expect a lower-for-longer scenario. Buy 1y1y KRW at 2.9%, target 2.85%.
• Brazil: Buy BEI due to repressed inflation and inflation risk. Target 6.50%.
• Turkey: Sell TRYBRL due to political risks and current account deficit. Target parity.
• EM Debt: Sell Russian CDS, buy Turkish protection. EM default rate is expected to peak in Q3 2014.
• FX: Long PLN vs HUF, short ZAR via USDZAR call spreads, short TRYBRL.
• Credit: Buy 5y Indon CDS at 146bp, target 180bp.
• Options: Buy 2m USDIDR ATMF put, buy 3m USDTRY RKO, sell 3m USDCLP, sell 3m NZDCLP.

Conclusion

The document highlights a cautiously optimistic outlook for EM assets, with a focus on relative value trades, inflation-linked instruments, and FX strategies. It advises against overexposure to certain currencies like the RMB and TRY due to market volatility and structural risks, while suggesting opportunities in Brazil, Poland, and Hungary. The overall strategy remains focused on balancing risk and reward in a market environment marked by uncertainty and diverging central bank policies.