Societe Generale is out with its top FX trades for 2016. The following is the list of these trades along with SocGen’s rationale behind them.
1. Buy USD on dips in Q1: We remain bullish on the USD in 2016, albeit not as strongly as in 2014 and 2015. As valuations become more stretched, we expect more volatility and frequent consolidation (e.g. in Q1 as the Fed takes a pause). We expect CAD and SEK to be most resilient in 2016, while NZD and CHF will be the biggest losers.
2. Long CAD/CNH: The CAD is the only G10 currency we expect to outperform the USD in 2016. We are looking for 6% CNH depreciation vs the USD as the authorities’ more flexible FX regime allows it to correct overvaluation vs trading partners. The trade carries negatively; trades 15 and 16 look at cheaper bearish CNH structures.
3. Short GBP/USD: Less volatile than EUR/USD, normally, but with a much bigger (Brexit-related) tail risk. EU exit could see GBP/USD at 1.30.
4. Timely Brexit hedge: Buy EUR/GBP 1Y call strike at 0.80, Sell 7M call strike at 0.80: GBP/USD would fall more than EUR/GBP would rise in a Brexit scenario. But a hedging solution via options is more optimal in EUR/GBP due to the complacency in forward volatility and skew, while cable puts are already expensive. Our forward hedge would be profitable in seven months between 0.75 and 0.87; if EUR/GBP is below 0.80 at end-June, investors would be left long a 5M call paid at a lower premium with full topside and vega exposure. Indicative offer: 0.65% (spot ref: 0.7070)
5. Short NZD/CAD or… Long an eventual oil recovery + short Kiwi, as RBNZ still has scope to cut rates and NZD remains vulnerable to China weakness.
6. Long JPY and CAD vs CHF and NZD: We recommended this long-term trade six months ago, and it remains relevant after minor gains in H2 2015. NZD and CHF are still richly valued, while JPY and CAD are cheap. The basket is well balanced from a risk perspective, with one funding currency and one investment currency on each side.
7. Long NOK and SEK vs GBP and EUR: Long NOK (oil) and SEK (undervalued, strong growth, huge current account surplus); short EUR (QE, negative rates) and GBP (slowing growth, slow-moving BOE and ‘Brexit’ tail risk). Very cheap basket on a long-term valuation basis.
8. Short select EM currencies through a cheap basket. A set of bearish EM outcomes (Fed tightening, Chinese growth, yuan depreciation and a rise in EM corporate defaults) suggests that correlations in the EM space will stay elevated and could rise further in 2016. Taiwan and Chile have the biggest export exposure to China. In G10, our bullish USD/JPY view is moderate, but a disorderly CNY fall would revive fears of an Asian currency war and support a larger move. Markets are still pricing these joint macro risks as diversified, offering the opportunity of a cheap worst-of option. Buy 6M worst-of CNH, JPY, TWD, CLP ATMS puts / USD calls.
9. Monetize high odds at zero cost: The AUD and CAD are very tightly correlated, while higher AUD volatility since 1999 strongly suggests that any AUD fall should exceed a CAD fall. We recommend buying an AUD/USD 3M ATMS put financed by a USD/CAD 3M ATMS call. Setting a knock-out at 0.6450 on the AUD put makes the trade costless, securing potential extra gains on the AUD side. Over the decade, AUD/USD did not lose more than 12% over a quarter, apart from the 2008-09 crisis. Buy AUD/USD 3M ATMS put with RKO 12% lower / Sell USD/CAD 3M ATMS call. Zero cost (Indicative. Strikes at 0.7320 and 1.3315).
10. Regional EM: Short Asia against EMEA and LATAM: Against the backdrop of growing concerns about EM corporate credit quality and higher US rates, downside risks to Chinese growth (SGe 6.0% vs consensus 6.5%) coupled with RMB depreciation (USD/CNY moving at 6.80 by year end) will see Asia underperform EMEA and LATAM on a total return basis. Buy RUB, BRL vs sell KRW, MYR.
11. Short EM exposure: Long USD vs TWD & KRW: Korea and Taiwan are both highly exposed to weaker Chinese growth through the direct export channel and from RMB depreciation through the indirect channel by having relatively high export similarity. Both currencies could be increasingly used as proxy trades for the China story given more favourable carry characteristics.
12. Long EM exposure (against EUR): Short EUR vs PLN and CZK Despite a challenging environment for EM FX, the CEE currencies will do well against the EUR on strong basic balances, robust domestically generated growth dynamics, and suppressed inflation. The CNB is expected to abandon the floor in EUR-CZK in Q3, though the risks of a later exit have increased.
13. Long EM exposure (against USD): Short USD vs RUB and INR: The RUB is expected to do well next year as domestic factors coupled with modestly higher oil prices proves beneficial. For a second year in a row, the INR is attractive on a carry-adjusted basis due to improvement in external balances, higher FII limits and the RBI limiting large movements in either direction.
14. EM relative value: Short TWD-INR, long RUB-MYR: Two positive carry structures with appealing qualities related to China and commodity exposure. India has the lowest direct export exposure to China in the region, while Taiwan has the highest, and for the sizeable positive carry (6.5%) to be eroded, it would probably require a sustained risk-on rally. Stable to higher oil prices would be beneficial for long RUB-MYR, and if oil prices fall, further the positive carry (approximately 9% per annum) provides a significant downside buffer.
15. Bearish China trade I: Long USD-CNH call spread: A gradual and controlled depreciation in USD-CNY toward 6.80 is our baseline scenario, but there are risks of a larger move if trade-weighted appreciation is too much for policymakers to bear relative to growth and employment objectives. Substantial negative carry (-3.8% over 12M) and unfavourable breakeven levels in plain vanilla call options leaves a USDCNH call spread as the most attractive structure to position for either orderly or disorderly depreciation.
16. Bearish China trade II: Long CNH vs TWD and KRW: Given the unfavourable risk-return characteristics of being long USD-CNH, relative value structures against regional low yielders has some appealing qualities. First, long CNH against KRW and TWD has decent positive carry (+3.7% on an equally weighted basket). Second, these crosses have been positively correlated to higher USD-EM. Third, investors are likely to seek proxy trades for gaining exposure to the RMB depreciation story, and as such, KRW and TWD depreciation should at least match, or more likely exceed, that of CNH at different points throughout the year.