FxWirePro: spot divergence between emfx, EMEA FX and DXY – outright trades ahead of Eurozone elections
Source: FxWire Pro - Treasury / 03 Mar 2017 06:10:27 America/New_York
The strong price actions in higher yielding currencies are chased and stay neutral on ZAR, TRY and RUB. EM local markets have staged an impressive rally in the past three months. The question for investors is whether or not to chase the strong price action in higher yielding currencies.
In EMEA EM local markets, we think the answer is ‘no’. Stretched risk premia, unattractive valuations and upcoming event risks (Fed, European politics) suggest the momentum of the rally has peaked for now.
We, therefore, stay neutral in high yielding currencies. The conviction in bearish CEE FX positions is reinforced on underpriced European political risks in EM.
A number of indicators suggest the EM FX rally is running out of steam, in our view:
First, our EM FX risk appetite index looks increasingly stretched. The above diagrams show that our EM FX risk appetite index, based on a number of risk, flow and positioning metrics, is heading towards stretched levels.
Historically, changes in this index have co-moved closely with EM FX. Admittedly, we have underestimated the extent to which risk appetite would recover from the lows in December, and have successively closed bearish EM FX positions (taking profits on UW TRY, and being stopped out of long USDRUB) in response.
Second, the performance of EM currencies has significantly diverged from the Dollar Index. This is illustrated in the above diagram, which shows the deviation the JPM’s GBI-EM FX spot index against its fitted value from a regression on DXY and 2-year UST yields. The bulk of this outperformance can be explained by the strong performance of commodities despite rising UST yields.
In outright trades, amid above stated fundamental event risks it is advisable a new EURPLN 2m call to position for underpriced European political risks. We let EURILS put spread expire in the money, and do not roll the bullish ILS exposure given expensive valuations. While we stay short EURCZK forward contracts.© FxWire Pro 2018. All rights reserved. The FxWire Pro content received through this service is the intellectual property of FxWire Pro or its third party suppliers. Republication or redistribution of content provided by FxWire Pro is expressly prohibited without the prior written consent of FxWire Pro, except for personal and non-commercial use. Neither FxWire Pro nor its third party suppliers shall be liable for any errors, omissions or delays in content, or for any actions taken in reliance thereon.