FxWirePro: Polls and monetary policy surprise in CEEMEA - ZAR vols to intensify on results and RUB to reverse gains but encourage bullish exposure in ruble versus euro

The South African rand has been the top performer in the recent past by a large margin as the market grew increasingly confident that Ramaphosa and his allies will win the ANC elective conference election.

For all those who hold ZAR positions, today's motto is: please fasten your seatbelts! The expected outcome of the vote at the ANC Congress is likely to create volatility in ZAR exchange rates. The decision on the ANC presidency (and thus on the ANC candidate for the country's presidency and likely next president of South Africa) is of considerable importance for the rand. On Friday, South Africa's currency has already risen sharply,

The ruble gained on December tax payment flows and despite the Bank of Russia cutting its key rate by more than expected.

On Friday the Russian central bank (NBR) decided to cut the key rate by 50 rather than 25bp to now 7.75%. As the reason for the bigger step, it stated the extension of the agreement on production cuts for oil that reduces the upside risks for inflation over a one-year horizon. At year-end 2017 the NBR expect the inflation to reach 3%, it will only approach its inflation target of 4% in late 2018.

However, the NBR is of the view that medium term the upside risks in inflation will dominate. That is why it will continue to only cut its key rate gradually and will thus move from a restrictive towards a neutral monetary policy at a slow pace.

Due to the central bank’s cautious approach, the RUB will continue to depreciate only moderately against USD, which is benefitting from rising interest rates.

As a positive current account oil exporter, RUB is the cleanest FX beneficiary of a bullish shift in oil prices and has added tailwinds of high rate carry and cleaner positions/cheaper valuations than earlier in the year that prompted our EMEA team to turn OW last month.

We like expressing leveraged bullish RUB views via EURRUB instead of USDRUB for three reasons:

a) The better insulation to higher Treasury yields / stronger dollar;

b) the dovish tinge to the October ECB may have trimmed upside risks to the Euro, and Italian elections next year could potentially even generate some alpha on short EUR crosses in 1H’18 by refocusing investor attention on European sovereign risks; and

c) The carry / vol ratios of EURRUB options significantly outstrip those in USDRUB.

RUB call spreads / at-expiry digitals are ideal formats to express leveraged views in given the weight of existing positions that is likely to sponsor a low volatility grind higher in the currency.

In addition, RUB risk reversals have been chronic underperformers this year, which is likely to continue in an environment of contained volatility and potentially stronger oil prices than we are budgeting for (hence outperformance of RUB calls on skews), so there is value in net earning premium by selling RUB puts for financing purposes even with highly asymmetric strike selections (refer above chart).

For instance, 6M 67 strike (1%OTMS) EUR put/RUB call at expiry digitals can be purchased vs. selling 6M 72 strike EUR call/RUB put at expiry digitals (6.4% OTMS, above 1-yr spot highs) @ - 6.2% / -4.2% (i.e. net premium intake) of equal EUR notional/leg (forward ref. 70.49).