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Shorter term USDKRW sentiment remains driven by geopolitical gyrations. The past month has seen in excess of USD3bn in net equity outflows. Still, the stock of foreign ownership in the Kospi is still around USD100bn higher than where it was in Dec-16.
Such a rapid rise has been one reason for us not chasing the more equity sensitive currencies (KRW and TWD) higher in recent months. Weaker global equities can also create a further negative feedback loop for EM Asia currencies, particularly those where local residents own large amounts of offshore equities and hedge back the currency risk. The won is a good example of this.
Risk markets lurched lower this week amid thin summer liquidity as geopolitics took center stage. Without any edge in calling the outcome of the latest flare-up, our instinctive reaction is that this too shall pass as many other false alarms involving North Korea have before, and that investors can do worse than to position for an eventual retracement lower in USDKRW spot via net vol-selling option structures such as USD put/KRW call ratio spreads that earn decay while awaiting normalization and do no P/L damage if tensions escalate.
We are reluctant however to translate an (admittedly simplistic) benign political view into a broader bearish take on vol: near-historic low levels of volatility do not offer that luxury; geopolitics has been known to sustain volatility for longer than just a day or two; many investors may hold more alarmist views on North Korea than us, and to the extent that overvalued equity markets are destabilized, the risk of a deeper correction cannot be ruled out.
Foreign ownership-heavy North Asian equity markets have already seen sizeable outflows in recent weeks, and the risk of a negative feedback loop to weaker regional FX is one to closely watch.
At the very least, complacent risk markets have once again have been taught a lesson in the value of gamma ownership, and we suspect this episode will focus minds on buying cheap gamma heading into an event heavy stretch between late August and mid-September. Courtesy: JP Morgan
