FxWirePro: BoK shifting down gears on trade tariff mechanism – Uphold DNTs on central bank’s status quo

Among the most susceptible economies owing to trade tensions, South Korea has slowed its pace of rate hikes. Yes, Bank of Korea (BOK) maintained its rate policy unchanged at 1.50% this morning, which was widely anticipated. There are strong headwinds in the economy, due to not only trade war concerns but also to the structural weakness related to aging population and falling productivity.

The robustness of KRW is yet another factor for the South Korean central bank to slow the tightening perceptibly. As a country running a current account surplus above 5% of GDP, KRW is naturally under appreciation pressure. However, an overly strong currency is not in the favor of policymakers, as the external trade is crucial for the country.

Facing the mounting pressure from the US, the BOK is considering disclosing its market intervention records, which implicitly means that the KRW could be stronger than what market expected in the future. All these indicate that the growth is poised to slow down, and BOK is likely to stay on hold for now.

Not surprisingly, the combination of high implied/realized vol ratios and a relatively tight 1055-1095 spot range this year also marks it out as one of the better range plays on our double no-touch (DNT) screens. The vanilla expression of the KRW calendar is a short 3M vs. long 6M vega-neutral vanilla structure.

For investors constrained from assuming uncapped downside risk in vanilla KRW options on geopolitical risk considerations, one-touch calendars are a viable alternative; for instance, short 2M vs. long 4M 1050 strike calendar spreads cost 19% at inception (spot ref: 1069) and roll up statically to 38% in unchanged markets (2X gearing), potentially even a fair bit more if spot were to slip lower towards the middle of its YTD range around 1070; the 1050 strike is also below the 1060 floor that official jawboning has placed under spot this year.

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