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Goldman Sachs: Thoughts On Our Tactical FX Stance In Volatile Markets

Fuseworks Media
Fuseworks Media
Goldman Sachs: Thoughts On Our Tactical FX Stance In Volatile Markets

1. Overview: It was another ugly day for global markets, dominated by continued fiscal worries, rumours and public denials. Southern European markets were particularly hard hit, again, with notably underperformance of exposed equity and bonds markets. In FX, EUR/$ crossed the line of 1.30 but EM currencies in the European periphery, including PLN and HUF sold off hard as well.

Yesterday's macro data was mixed with weak German retail sales, a strong UK manufacturing PMI and better than expected US factory orders.

Today's data schedule will be dominated by global services PMI/ISM indices and labour market data in the US in the form of the ADP report and the Challenger survey.

As markets remain volatile, we briefly review how our tactical FX recommendations are performing; discuss some key risks and potential opportunities.

2. Broadly Neutral on Risk Sentiment

After having been heavily exposed to pro-cyclical trades with a high beta to broader risk sentiment, we reduced much of this exposure since late-March to shift towards a more neutral stance. Our main concern was that much of the good cyclical news had been priced at the time. Without further additional upside surprises relative to already high expectations, there appeared to be a risk that many cyclical assets may run out of momentum.

The only areas where we have clear pro-cyclical exposure are parts of the world that should be relatively more insulated from the euro-area worries - the US consumer exposure in equities (recommended yesterday through our WF US Consumer Growth basket), and Asian FX exposure through short $/TWD. One of the reasons we want to remain long Asia is because of the combination of strong growth and rising inflationary pressure, as well as the rising likelihood of a CNY move anytime soon. Given the small positive beta to broader risk sentiment, we are not surprised to see this cross move slightly against us in the last few days, though it continues to trade about 0.8% better than where it was recommended.

Given the strong Asia specific factors and very limited direct contagion risks from Europe to Asia we remain quite convinced of this TWD exposure. With the exchange rate being a main policy tool to address emerging inflationary pressures, it would also make sense if the authorities attempted to contain volatility in both directions and continue to keep the currency on an appreciating path.

The two other current trade recommendations - short EUR/GBP and long TRY/BRL - have been explicitly chosen as risk-neutral implementations of our growth differentiation themes and specifically the core-periphery and leaders-laggards variants of the broader theme. So far this non-correlation to broader risk sentiment does seem to hold and we have experienced small potential p/l swings. Even the short TRY/BRL idea, which is slightly under water currently, remains far from the stop.

The main risk to the TRY/BRL recommendation is the more hawkish BACEN than initially expected, although the Brazilian authorities also appear very committed to blocking further FX appreciation of an already very overvalued currency. On the long side of the cross, we think that TRY appreciation will be a critical element during the initial phase of monetary policy tightening in Turkey, which has just started.

3. Exposure to the Euro

While neutral to broader risk sentiment, our tactical trades do have some exposure to the Euro. Obviously short EUR/GBP directly benefits from the latest round of contagion fears affecting European assets. On the negative side and given tighter trade links to the Eurozone, the TRY has shown some moderate underperformance relative to BRL. One tactical risk therefore remains that an outsized down move in EUR/$ pushes the short TRY/BRL beyond our stop.

There is also a small but significant negative beta between $/TWD and EUR/$. An outsized EUR decline would therefore be a risk.

Overall, the exposure to further EUR declines, which we do not anticipate, is relatively small but notable across our tactical ideas.

4. Potential Opportunities

Though we carry little direct exposure currently, we have been saying for some time that a more pronounced pro-cyclical FX stance will be attractive at some stage again. This still holds and the latest round of cyclical data, in particular the manufacturing ISM and PMI surveys globally, further support this view.

However, we also need to see a reduction in fiscal contagion fears before we can pull the trigger. Obviously the situation remains fluid and the actions of European policymakers will likely remain a critical factor but we are already looking for ideas with a stronger positive pro-cyclical and pro-risk beta than currently.

One thing we are clearly not inclined to do is actively position for further fiscal contagion in the Eurozone. Our views are quite clear in that respect. Greece is in a different league compared to Spain, Portugal, Ireland and the others. While restructuring remains a possibility for Greece as highlighted by Erik Nielsen and team, fiscal consolidation and a sustainable debt trajectory remain the most likely outcome for the others.

5. Current Trading Views

The following trading ideas from the Global Markets Group reflect shorter-term views, which may differ from the longer-term "structural" positions included in our "Top Trades" list further below.

In FX:

1. Stay short USD/TWD, opened at 31.74 on 31 Mar 2010, with a target of 31.0, and a stop on a close above 32.10, now at 31.50.

2. Stay long TRY/BRL, opened at 1.18 on 14 Apr 2010, with a target of 1.26, and a stop on a close below 1.14, now at 1.1647.

3. Stay short EUR/GBP, opened at 0.8695 on 21 Apr 2010, with a target of 0.83, and a one-day stop on a close above 0.8850, now at 0.8561.

On rates:

1. Stay short 5yr credit protection in Mexico vs. long 5yr credit protection in Colombia, opened at a spread of -3bp on 16 Nov 2009, with a target of -150 bp, and a stop of 75 bp, now at -29.24 bp. 2. Stay short 5yr credit protection in Argentina vs. long 5yr credit protection in Venezuela, opened at a spread of 75 bp on 19 Jan 2010, with a target of -200 bp, and a stop at 250 bp, now at -77.66 bp. 3. Stay long 10yr Gilts vs. short SONIA (3.75% Sep-19 Gilt vs. 10yr spot Sonia), opened at 60 bp on 25 Feb 2010, with a target of 35 bp, and a stop on a close above 70 bp, now at 47.22 bp. 4.

Stay short Dec-10 3m EONIA, opened at 84.5bp on 04 March 2010, with a target of 110bp, and a stop at 70bp, now at 71.84 bp. 5. Position for 2s5s flatteners in Indian swaps, opened at 119 bp on 22 Mar 2010, with a target of 70 bp, and a stop on a close above 135 bp, now at 131.5 bp. 6. Position for 2s-10s flatteners in USTs, opened at 272 bp on 24 Mar 2010, with a target of 240, and a stop above 285 bp, now at 269.37 bp. 7. Stay short 5-yr JPY swaps vs. a combination of 2s and 10s, opened at -41 bp on 24 Mar 2010, with a target of -20 bp, and a stop on a close below -50 bp, now at -43.80 bp. 8. Go long 10-yr US Treasuries vs. 10-yr Bunds, opened at 75 bp on 26 Apr 2010, with a target of 40-50 bp, and a stop on a close above 85 bp, now at 67.2 bp.

Equity Trading Strategies:

1. Go long Wavefront US Consumer Growth (GSWBCOGA), opened at 109.37, with a target of 120.00, and a stop of 106.00, now at 108.52.

6. Recommended Top Trades for 2010 (opened on 02 Dec 2009 unless otherwise stated) 1. Stay short S&P 500 Dec10/Dec11 Forward Starting Variance Swap, opened at 28.20, with a target of 21, now at 26.9254. 2. Stay long Russian Equities (RDXUSD), opened at 1645.9 for a target of 2050, now at 1698.81. 3. Stay long GBP/NZD, opened at 2.29, with a target of 2.60, now at 2.1030. 4. Close short 2yr GBP swap rates vs. long 2yr AUD swap rates on a 1yr forward basis, opened at -268.5 bp, for a potential loss of 24 bp (inclusive of carry). 5. Stay short 2yr TRY rates through cross-currency swaps, opened at 8.77%, with a target of 12.0%, now at 9.11%. 6. Close long 5yr credit protection in Spain vs. short 5yr credit protection in Ireland at 13 bp, opened at 70 bp, with a target of 20 bp, for a potential profit of 2.9% (inclusive of carry). 7. Stay long the GS FX Growth Current, opened at 103.5, with a target of 111.8, now at 106.3151. 8. Stay long PLN/JPY, opened at 32.1, with a target of 37.5, now at 30.6660. 9. Long Chinese Equities (HSCEI), opened at 12616.01 on 01 Apr 2010, with a target of 15000, now at 11618.58.

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