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Market tensions remained elevated during the Asian session, with initial declines in China’s equity markets and the yuan breaking through 6.70 against the US dollar for the first time in nearly a year. That said, markets recovered some poise in late trading. China’s central bank (PBoC) Governor Yi Gang made a first verbal intervention, saying that the currency will be kept stable at an equilibrium level. The FX market has reacted mildly to the increased US-China trade tensions which weighed on Equity indices this week, triggering a 4 vol points rise in the VIX on Monday, and to the renewed concerns on Italian fiscal budget, with 10yr BTP/Bund spreads widening up to 25 bps during the week.
One could argue that the most recent FX price dynamics, with USD and JPY rising and EMFX dropping, was already incorporating all trade tension news, at least if compared to the relative complacency as manifested by Equity markets; therefore, the violent price action we have witnessed this week could be interpreted as a necessary adjustment on Equities rather than anticipating further corrections to materialize for currencies. The latter thesis could be supported by the massive early-February Equity sell-off which failed to impact significantly FX vols, beyond a short-lived, although sharp, move.
We like focusing on the Asian vol space instead, which, despite being at the epicentre of the trade war tensions between US and China, offers attractive pricing for entering tactical plays. We highlight two opportunities, one being more defensive in nature and the other more tilted towards positive Carry generation.
We consider two trades in the Asian vol space for navigating the current landscape, characterized by multiple elements of uncertainty. A 3M worst-of call on a (KRW-CNH-AUD) USD basket offers cheap protection in case of a further escalation on the trade war front.
Prudent USDSGD vs USDTWD 3M vol spread rewards investors with a positive vol Carry and a contained downside risk profile. Courtesy: JPM
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