FxWirePro: A bird’s eye-view on EM Asian rates and FX derivatives

Two years on from China’s melodramatic currency regime (devaluation mechanism of its currency) in August 2015, the event prolongs to cast a long shadow over the foreign exchange market since then. The considerable downward move, driven by the central bank to reinforce economic growth.

At the same time in recent months, our proxy of FX positioning data indicates that Chinese corporate USD selling interest has risen noticeably.

To the extent that this positioning adjustment is not yet complete suggests we could still further downside pressure in USDCNY in the near term.

We’ve already stated in our recent post that the implied volatility has bounced off the recent lows, the richness of implied versus realized vols has eroded; risk reversals and skew-to-vol are falling, term premiums have compressed while the vol smile has moved higher. 

The base case scenario envisions CNH outperforming the forwards to year end.

While the interest rate swaps and FX spreads offer varying degrees of carry opportunities across Asia.

Selling HKD FX spreads (i.e. 3x12) and TWD FX spreads seem to offer a durable source of carry. With no catalyst apparent for a reversal, they should continue to attract interest from the yield hunting community.

HKMA's issuance of HK$40 billion of Exchange Funds bills announced in the recent times not to have significant impact on liquidity conditions and interest rates, sources say. 

Receiving HKD or SGD rates offer the highest carry in swaps across the region; though these are more risky if US yields melt up.

On a spread basis to US yields, the carry is significantly diminished, but non-zero, though provides more protection given domestic liquidity considerations. We continue to like paying 5yr NDOIS, though carry is small (1bp/month).