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In longer dated vols, this week indicated that Taiwanese life insurance companies were actively extending the maturity of their FX hedges, Bloomberg reports.
Whereas in the past they had focused primarily on 3-month swaps—the vast majority of which are executed onshore — anecdotal evidence from the region indicated a growing preference for 1-year and potentially longer tenors.
We can see evidence of this in FX forward pricing, where the term structure of both onshore and NDF cross-currency basis recently inverted (refer 1st chart).
Though not a regime shift by any means, such a change in hedging strategy is likely intended to mitigate the potential impact of Fed hikes on FX hedging costs. It is important to note, however, that with nearly 75% of our forecast for four hikes over the next year priced into the curve, barring a significant acceleration in Fed tightening we think 1-year maturities are unlikely to offer meaningful savings over rolling shorter-dated hedges.
Further, given more limited onshore liquidity in these points, they are exposed to the noticeably higher volatility exhibited by NDFs. In the meantime, given the relative slopes of the USD and TWD swap curves, carry on hedged foreign assets is likely to deteriorate as a greater fraction of their hedge book is pushed into longer tenors (refer 2nd chart). In fact, such a shift will likely make EUR-denominated assets—which already offer better relative value— look that more attractive by comparison. Courtesy: JPM
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