FxWirePro: Carry trades in 3m INR and KRW NDFs eyeing on global risk sentiments and potential rate cut by Korean central bank

A confluence of factors ranging from US growth being not too hot or too cold to spur large dollar gains, a lower-for-longer bias setting in for global monetary policy, RMB depreciation not creating a negative feedback loop to global sentiment, and resurgence in portfolio inflows should support EM carry trades over the short term.

Currently, the US dollar index is trading at 97.16, appreciating notably in yesterday's trade. The surge in the US dollar was driven by the weakness in the trading partners rather than the strength of the US dollar.

You have heard the word Brexit many times by now and you will continue to hear it for some time to come as comic debates in the British Parliament make our local Parliament look good. It is this Brexit that makes the IMF, like many other think tanks, say will result in increased uncertainty and a slowdown in investment in the UK and, to a lesser extent, continental Europe. 

German investor sentiment and the ECB’s lending surveys released yesterday showed sharp declines in June. The UK growth forecast was downgraded by 0.2% to 1.7% in 2016 and close to a full percentage point for 2017 at 1.3%.

We foresee long INR-KRW has favourable carry trade characteristics along with an attractive entry point at the bottom of the three-year range.

We are neutral on INR over one year relative to the forwards but its low vol and high carry characteristics will keep the rupee as a constructive long position when foreign demand for EM assets is strong and risk conditions favourable.

The move lower in USDKRW might be running out of steam as the pair is the 1120-1140 range that has provided support in the past year.

Expectations for further policy easing (we expect BoK to cut rates another 75bp in the cycle) will hurt the interest-sensitive won as would a renewed deterioration in China’s growth outlook.

The trade mechanism: Long INR-KRW 3m NDF Long INR-KRW 3m NDF at 16.76 (short USD-INR 3m NDF 68.03 and long USD-KRW 3m NDF at 1140.20) with a target at 17.76 (+6%: top end of recent range) and a stop at 16.42 (- 2% and 1.7% below the bottom of the recent range). The trade horizon is three months and positive carry is 43bp/month.

Potential Risks: GST, deposit outflows, RBI's governor Rajan’s successor are the major concerns for INR strength.

Failure to pass GST legislation in the upper house of Indian parliament could result in negative sentiment towards INR, while Rajan transitions out of the RBI and foreign currency deposit outflows pick up starting in September to add extra pressures. A cyclical pick up in Korea’s economic growth alongside a longer period of stabilization in Chinese activity could improve sentiment toward the KRW.t