FxWirePro: Chinese equities and commodity prices make graveyard for high beta FX space

FX markets are processing a messy combination of falling commodities, higher core yields, and isolated weakness in Chinese equity markets that fuels a sense something may be up in China.

May is living up to its reputation as a graveyard for high-beta FX.

The portfolio has benefited from these dynamics insofar as it is long EURJPY and long TRYZAR. The former was helped by higher core yields and deleveraging of euro-funded positions in high-beta currencies; the latter by Turkey's status as an oil importer. We hold these trades.

We caution against indiscriminately chasing the commodity sell-off as this has been exacerbated by valuations and leverage and may not indicate a systemic China downturn.

Investors should focus instead on FX that have lagged commodities (EM more than G10) or which are most sensitive to China.

It’s probably too early to be confident about the broader economic and market prognosis from weaker commodity prices, but we’re inclined to agree with the sanguine message from both bond and equity markets that this is not a systemic event that reflects upon the health of the global economy or indeed even the overall strength of the Chinese economy.

The fall in commodities is more likely to be caused by technical factors (commodities overshot in 1Q and attracted a fair degree of leverage) overlaid with the delayed effects of the targeted measures taken by Chinese policymakers in 1Q to take the steam out of the property market and which are now being reflected in weaker credit growth and a noteworthy underperformance from the Chinese equity market.

AUD is the currency most directly tied to Chinese equities. In addition, investors remain long and the RBA has more work to do to lift growth and inflation.

We sell AUD vs EUR as political risk will be laid to rest this weekend (the Italian election is too distant to command a risk premium).