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EM Strategy Plus Summary - 11 October 2013

Core Content

This document outlines the key views and asset allocation strategy for emerging market (EM) currencies and bonds for the coming weeks and months. It highlights the potential for certain EM currencies to appreciate, the risks associated with others, and the overall market sentiment influenced by global economic conditions and central bank policies.

Main Views and Asset Allocation

• PICKS (Poland, Israel, the Czech Republic, Korea, and Singapore) are expected to appreciate by 5–6% against the 60:40 USD:EUR basket over the next 3–6 months. The low historical correlation among PICKS currencies supports a good risk-return profile for long positions.
• The EM focus is on appreciating currencies and differentiating in rates, suggesting a strategic approach to carry trades and interest rate differentials.
• Risk appetite is expected to remain well supported in the coming weeks, with specific recommendations to sell USDKRW and USDPHP, stay short USDINR, and tactically long USDSGD ahead of the MAS policy review.
• Receive front-end swaps in THB and steepeners in MYR, while looking to pay dips in INR OIS.
• Malaysia remains underweight due to limited scope for real reform and vulnerability to capital outflows.
• Poland is the most bullish in the portfolio, with a recommendation to sell EURPLN and expect it to drop below 4.00 in the first half of next year.
• Russia is underweight, with a recommendation to switch out of RUSSIA'20 into TURKEY'11/19 due to cyclical and structural growth issues.
• Brazil is slightly overweight, as the CBR's hawkish stance is seen as positive for the economy.
• The US government shutdown and debt ceiling deadline are highlighted as key risks for the coming week.

Key Recommendations

FX Trades

• Sell 3m USDKRW at 1081, targeting 1060.
• Sell 1m USDPHP at 43.13, targeting 42.20.
• Buy USDSGD at 1.25, targeting 1.26.
• Sell EURPLN at 4.23, targeting 4.10.
• Sell EURON at 4.48, targeting 4.35.
• Sell USDINR NDF at 63.0, targeting 60.8.
• Switch out of RUSSIA'20 into TURKEY'11/19, targeting a z spread narrowing from 90bp to 30bp.
• Buy CZKHUF at 11.67, targeting 12.00 (but position was stopped out).
• Sell USDCOP at 1883, targeting 1830 (but position was stopped out).

Credit Trades

• Sell Croatia'23 CDS basis at 58, targeting 18.
• Switch out of SOAF'41 into SOAF'25, targeting 50.
• Buy 3m3m USDTRY FVA vs. 3m3m USDBRL FVA at 0.10%.

Options

• Buy 3m3m USDTRY FVA vs. 3m3m USDBRL FVA as a hedge against potential volatility.

EM Focus: Appreciating PICKS

• The PICKS currencies (PLN, CZK, ILS, KRW, SGD) are expected to appreciate 5–6% against the 60:40 USD:EUR basket.
• These currencies have low correlation, suggesting a good risk-adjusted return for long positions.
• The PICKS countries are expected to outperform high-yielding but higher-risk countries due to Fed liquidity concerns.

Fundamentals and Correlations

• PICKS countries have strong fundamentals, with low government debt and positive current account balances.
• The realised volatility of the equally weighted basket of PICKS currencies is 5%, with low correlations between the currency pairs, enhancing the risk-return profile.

Key Risk Events

• The US government shutdown and debt ceiling deadline on 17 October pose significant risks.
• The MPC meeting in Thailand on 25 October is a key event, with expectations of no rate cuts and no change in monetary stance.
• The MAS policy review is expected to maintain tightening policy, with a possible band widening or slope easing.

Portfolio Adjustments

• Poland has been increased in allocation, with a reiteration of EURPLN short.
• Russia has been reduced in allocation by two notches.
• Brazil has been increased from neutral to slightly overweight.
• Malaysia remains the largest underweight due to limited reform potential and vulnerability to capital outflows.

Summary of Key Indicators for PICKS Countries

Conclusion

The strategy emphasizes long positions in PICKS currencies, short positions in high-yield EM currencies, and a shift from Russia to Turkey in credit. It also highlights key macroeconomic events and central bank policy reviews as pivotal for the coming weeks, with a focus on volatility management and risk appetite. The overall outlook remains bullish on carry and risk assets, with a decline in volatility expected.