FxWirePro: A Snapshot On Asian FX-Bloc And Zero-Cost Conditional Hedges

EM Asian currencies were mixed versus the dollar during Wednesday’s Asian session. The SGD slid 0.3%, while the JPY gained slightly amid a 7 bp drop in the 10Y UST yield. The CNH closed flat. Zhang Ming, an economist at the Chinese Academy of Social Sciences that is a top government think tank, said in remarks published on Wednesday that China's economic growth may drop to 5% or even lower due to the coronavirus outbreak. He added it will possibly push policymakers to introduce more stimulus measures. 

While the KRW dipped somewhat Wednesday after tumbling 0.7% the previous session. USDKRW could consolidate at around 1,180 for now, following future movements in USDCNH. South Korea’s finance minister Hong Nam-ki on Wednesday told reporters that the government has no plan to draft extra budget related to the 2019 novel coronavirus. USDTWD is expected to rise towards 30.2 when onshore markets reopen Thursday after the Lunar New Year holidays.

It is worth considering USD calls/KRW puts vs. USD puts/JPY calls as a zero-cost conditionally bearish risk structure (equal USD notionals). Equally out-of-the-money (vis-à-vis spot) KRW puts and JPY calls in 1M – 3M expiries are near-identically priced at present, which strikes us as somewhat anomalous given:

1) KRW's heightened sensitivity to the SARS and MERS epsiodes in the past;

2) substantial addition to KRW length in recent months – highest positioning since mid- 2014 on our EM investor survey – that is vulnerable to unwinds; and 

3) the seemingly bulletproof price action in the Yen amid large swings in risk appetite in recent times, most memorably during the EM crash of 2Q/2Q’18 and the subsequent equity carnage in 4Q’18. 

The structural yield-seeking outflows from Japan appear to have semi-permanently altered the Yen’s risk sensitivity even as risk-reversals are priced at an exorbitant premium for JPY calls thanks to sustained corporate and institutional Japanese hedging of US investments via options instead of forwards in recent years. 

The net result is that JPY calls and KRW puts are priced to be equally sensitive to bouts of risk aversion; we think ex-post realized beta of KRW w.r.t. JPY will be a fair bit higher than 1. Along similar lines, SGD puts/JPY calls vs. USD puts/JPY calls, while a whisker above pure zero- cost, are also worth considering as a tiny premium proxy for a long USDSGD call position that should deliver in the event of broad-based panic in Asian markets. Should the virus scare fizzle out in coming weeks, both legs of either of the above long/short option spreads should expire worthless, leaving almost no P/L impact. Courtesy: JPM