Monday, November 1, 2010

FX market update And Strategy update

FX market update
In the past week, we have observed increasing talk and speculation surrounding a potential rate cut by the South African Reserve Bank (SARB) on 18 November by 50bp on the reference rate that currently stands at 6%, following the previous cut of the same amount in September. The markets can be seen both on the yields that have seen a weekly drop of about 20bp and 1%, in the 2yr South African swaps and ZAR/USD, respectively.

Earlier in October we established a long USD/ZAR positioning, valuing the rand gains against the dollar as excessive. We welcome the turn in the spot rates and with the cross now headed for a second consecutive weekly positive closing, we remain more sceptical of rate cut speculation. While the continued capital inflows to South Africa, as now clearly seen in the bulging South African gross reserve accumulation, standing at a record USD44.07bn, continues to propel rand gains to a level no longer seen as competitive from a South African exporting point of view, we do not believe in SARB breaking ranks with its peer countries, such as Turkey or Brazil and engaging in further rate cuts.

Rather, we see the key development in the alternative liquidity and capital flow management measures. These measures - examples of which have already been seen in Poland and Turkey this week - have been freshly outlined in the South African Minister of Finance, Pravin Gordhan’s, Medium Term Budget Policy Statement, released on 27 October. Accordingly, South Africa is looking to sterilise foreign investments by using FX swaps and adding to its existing reserves; to ease regulations that pertain to offshore investments and exchange controls and expatriation of assets held by emigrants. The one intention of these measures is to reduce the volatility of short-term foreign capital inflows, while solidifying the longer-term, fixed foreign direct investments.

What we take from these policy proposals and intended regulatory measures is a South African policy line where alternative measures to rate cuts, which arguably have done little to ease the rand gains in 2010, will be sought out for implementation. We continue to look for unchanged rates in South Africa for the remainder of the year; we also continue to scan the rand universe for new entry levels in establishing new rand-short
strategies looking to take advantage of the fair value vs market rate discrepancy.

Strategy update
We continue to maintain positive exposure to both the Hungarian forint and the Brazilian real on the spot markets while looking for a correction lower in the Turkish lira and Polish yields. Our overall positioning continues to be supported by the latest scorecard strength readings.

While the past week has seen the Brazilian Current Account Deficit widening by an additional USD3.85B to a record high of USD47.3B, the country continues to enjoy steadfast investments, with the Foreign Direct Investments now at a 21-month high at near $5.4B. While we are observing signs of boom-like credit expansion, with Brazilian bank lending showing fast growth especially in the mortgage area, we continue to see room for real appreciation against the Turkish lira, where, in turn, the central bank’s quarterly inflation report (read further comments here) has further strengthened our view that there will not be any Turkish hikes before end-2011.

Technically, the cross remains capped by the channel resistance as seen on the weekly charts. The same time horizon is also indicative of a bear flag formation, with channel support seen around the 1.15 handle. We are moderate carry gainers in this strategy as with indicative 3-month cross Turkish/Brazilian forwards (as priced through USD) giving us an indicative carry of about 0.10%.

With the Polish central bank remaining on hold for the rates against a minority view of a 25bp hike (see here for commentary on Polish rate decision), our strategy has seen accelerated forint gains with the pair now making a decisive close above the trend line resistance.

Technically, the cross has completed a close above the 200-day moving average, propelling HUF gains toward the resistance zone of 1.4690-1.4710. Similarly, on the weekly charts, the cross is making a second weekly close above the trend line resistance. The above mentioned zone will also see the cross attaining a 38.2% retracement level on the big wave (1.3645-1.6430) to 2009 highs and pushing onto the 50-week moving average.

Receiving Polish 2yr IRS
After the volatility that was experienced in the short end of the Polish yield curve, the rate decision has been followed by steadily lower yields, a fact that has been further aided by general risk appetite for the emerging markets bond investments.

However, the news on Fitch warning of a potential credit rating cut on Poland, which came out on Friday, 29 October, 2010 on Bloomberg, has created such a level of anxiety and volatility in this particular strategy that we have decided to take moderate profits of 2bp.
However, we continue to maintain our view that the markets are too aggressively positioned for a rate hike and we will be looking for fresh levels to re-enter this strategy.

Full report: FX market update And Strategy update

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