Sunday, November 28, 2010

FX market update And Strategy update : Short TRY/BRL - Long USD/ZAR

FX market update
The end of the week has seen a great deal of nervousness in the CEE markets. As our EMEA Scorecard has now turned decisively negative, with all the scorecard member countries respective readings on the negative side and given the external pressure factors as discussed above, the pressure felt in the central European countries and in Hungary in particular, is hardly surprising.

Hungary, with higher debt levels than its peer members is more vulnerable to debt crises elsewhere and this has been once again proven in the context of the Irish debt situation and the fears of contagion to other PIIGS countries. Exacerbating these external factors is the newest development in Hungary, where the Hungarian government’s plans to funnel private pension funds worth about 3 trillion forints back into the state funds has dealt a severe blow to investor confidence, taking the five-year government yields to one-year highs.

The move in yields was followed by the slide in Hungarian equities on Thursday, with the Hungarian BUX index closing the day with near 3% losses. CHF/HUF, a pair of particular interest due to Hungarian Swiss franc-denominated debts, moved aggressively above the 100-day moving average on Friday’s trading. The move has also seen the cross break the resistance at 211.00 mark, which marks the 50% retracement level on the big wave from 195.584-226.415. The next big resistance is seen at 214.64, which in turn marks the 61.8% retracement level on the same wave.

Strategy update
As in the case of European debt jitters, the global anxiety that was set in motion by the skirmish between the two Koreas earlier this week, has taken its toll on risk appetite in Emerging Markets. And again, on margins, we have observed our TRY/BRL short positioning to be a relative gainer on the back of diminished risk appetite.

The sell-offs experienced this week in many of the high yielding EM currencies have also allowed us the initiation of the USD/ZAR long strategy, with the break of key resistance 7.0855 on Tuesday, November 23.

The past week has seen little change in the fundamentals of either Turkey or Brazil. It is, however, the rapid change in the external factors, as highlighted by the events in South Korea and the continued nervousness in Europe over the fears of contagion in debt troubles that have had the most impact on positive carry favourites such as the Turkish lira. In particular, USD/TRY has on Friday’s trading moved aggressively above the 100- day moving average, with the up move chasing the 1.50 handle in the pair. As we have noted in past publications, the sharp risk deloading turns in the markets have shown the tendency of benefiting our strategy on the margins and this week has been yet another illustration of this particular dynamics in TRY/BRL.

Having twice rejected at the upper end of the channel formation, this week’s sharp move down has set the pair for a test of the channel support that comes in just below the 1.1500. mark. We continue to be moderate carry earners in our strategy, with the current indicative one-month carry gains of about 20 pips for holding the Brazilian real longs against the Turkish lira.

This week, the South African rand has suffered a twin blow, as the combined external pressure from the European debt troubles and the Korean situation – both of which take their toll on emerging market investment appetite – has been combined with domestic growth pains with Q3 GDP at 2.6% disappointing markedly wider market expectations.

The contraction experienced in the manufacturing sector has, at least partially, been attributed to the strong rand and this setback in the growth, if repeated in the subsequent quarter, can be expected to keep the pressure on the South African central bank (SARB) to continue the path of monetary easing, even though the bank has stated that its last round of easing in the amount of 50 basis points was not with the aim of rand-weakening. The inflation is at the same time seen inching higher and in and out of itself places a limitation on the degree of easing SARB will be able to engage, but given that price increases are still hovering around a fairly moderate 3.5%, we believe the bank will maintain dovish rhetoric in the near future.

Given the above conditions, we feel the timing of our USD/ZAR long strategy is fitting and one that complements the technical picture in the cross: Having broken the peak of the double-bottom formation, the gains in USD/ZAR have propelled the pair to above the 100-day moving average at 7.1375. A close above this level would pave the way for further gains, with the next technical resistance seen at around the 7.1790-1800 range, where 61.8% retracement level on the 6.7603-7.4388 wave comes in. With lower rates in South Africa, the carry cost of the strategy is also somewhat lower and the current indicative one-week cost is around 76 pips.
Full report: FX market update And Strategy update : Short TRY/BRL - Long USD/ZAR

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