EM Asia FX strategic framework – When investors project higher rates and equity-linked FX pairs, trade war morphs from tail risk to base-case scenario

The trade war has returned as a key USD driver and, in our view, further escalation, which remains our base case, will tend to be USD supportive due to the less open US economy, which is set to lose less than those of its peers on a decrease in global trade. This said, recent Fed worries should keep a lid on USD strength but will also tend to make, notably, the ECB reluctant to commit to a tightening cycle.

Emerging market currencies are set to remain challenged by the risk of an escalating trade war, lower commodity prices and a stronger USD near-term and rising US rates and tighter US liquidity over the medium term. While the global trade tensions have shifted the major Asian asset allocation. At the beginning of 2018, many EM Asia strategic frameworks were intended for  

- projecting higher USTs rates on rising CPI and dial back on pro-risk GBI-EM trades, and

- upholding longs in strong current account surplus and-equity linked currencies (SGD, KRW, TWD) on the assumption stocks would hold up well because the P/E multiple compression on higher real rates would be offset by the higher EPS outlook.

However, as global trade war tensions morphed from a “tail risk” toward a “baseline scenario,” shorts in USDKRW, USDTWD, and long in SGD TWI positions are squared-off and activated a short CNY/TWI position by the third week of June.

In rates, we added receivers in 5y5y TWD NDIRS to our long 3yr CDB and receive SGD 5y5y IRS trades, while trimming further our UW in THAIGBs.

It is likely that China will respond to escalating trade tensions and to the prior tightening in aggregate fund support for the domestic economy by easing policy settings on the fiscal, monetary, FX, and regulatory/property fronts. Early indications are the greater preference for easier liquidity/monetary policy, together with a more limited, targeted, fiscal/infrastructure easing.

The 2H’18 working assumption for the 7-day repo rate now stands at 2.80% versus 3.20% a month ago and the 1H’18 outturn of 3.04%. Observed in the context of the US’s looser fiscal and tighter monetary stance, China’s evolving policy mix would seem incompatible with a stronger CNY. Consequently, we are lowering our CNY TWI (CFETS basket) target for the end of the year from 95.50 to 93.50 and versus the Dec2017 close of 94.85. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly USD spot index is inching towards 63 levels (which is bullish) while articulating at (14:37 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex