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Risks to the rest of Asia are high. A number of Asian currencies with high correlation to CNY – notably TWD, SGD, and KRW have sold off during this period of CNY weakness. We had previously estimated these four economies had the most to lose from spill-over effects from deterioration in US-China trade ties, due to their integration into the global value chain.
It has to be stressed that, from a purely directional perspective, SGD might not be the optimal candidate for owning optionality and hedging a proper tail event in the region.
In an ideal world, despite not being a high-beta asset per se (if measured against moves in DXY or S&P Indices), the much higher betas of SGD relative to TWD support owning vol on the former rather than on the latter, putting aside idiosyncratic factors that could stimulate higher volatilities mostly on Taiwan denominated assets. Therefore, the carry-friendly nature of the trade combined with its modest downside risk offers an attractive risk-to-reward trade-off, thus supporting the choice of SGD as the long-vol leg, despite the relatively contained potential in a bearish market.
Also, given the idiosyncratic factors at play on TWD, suppressing directional sensitivities, the mean reversion potential of the trade is limited (as measured in terms of weak auto-regressive properties for the spread), which reduces the interest of adding Vega exposure via long-dated maturities.
For these reasons, compared to the earlier piece, we tend to favour the shorter (3M) end of the curve for increasing the sensitivity to the realized vol differentials, thus highlighting the carry-friendly nature of the vol trade rather than its pure hedge potential. This aspect of the USDSGD – USDTWD vol spread has been a potent P/L generator since 2016.
We recommend to Buy 3M ATM USDSGD straddles @ 5.025 choices vs sell 3M USDTWD straddles @ 5.55/5.95 indic, both legs delta-hedged, in vega neutral notionals. Courtesy: JPM
Currency Strength Index: FxWirePro's hourly USD spot index is inching towards -22 levels (which is bearish), while articulating at (08:39 GMT). For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex
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