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Goldman Releases Top Trade Recommendation #9: Long USDZAR And USDKRW (Again)

It took less than 2 months for Goldman's Top Trade Recommendation #6: i.e., going short the CHFSEK, to implode in truly spectacular fashion, in the process bankrupting any number of levered FX investors, who suffered an unlevered loss of 16.5% (add leverage, annualize, and you end up with the worst trade "Top" reco perhaps in history). Less than three weeks later, Goldman feels the urge to take the flow on the other side of its clients' trades, and sure enough, here is Goldman's brand spanking new Top Trade, this time #9, one which recommends going long the USD against an "equally weighted basket of ZAR and KRW for a target of 110."

From Goldman:

Trade Update: Top Trade recommendation #9: Long USD against an equally weighted basket of ZAR and KRW for a target of 110

 

We recommend going long USD against an equally-weighted basket of ZAR and KRW, for a spot target of 110 and a stop at 95. Total annual cost of carry is approximately 3%, which we will account for in terms of our stop-loss through the year.

 

As we discussed when we closed out our Top Trade recommendation to be long a basket of $/HUF and $/ZAR after approaching our total return target of 9% (see Closing our Top Trade recommendation #8 to be long USD vs ZAR and HUF after reaching total return target, January 21, 2015), we continue to expect further USD strength vs EM currencies. We see two main buckets of EM FX weakness vs the USD: i) the EMs where internal and external balances put pressure on the currency to act as a mechanism of adjustment, and ii) the ‘lowflation’ EMs for which currency weakness will be an integral part of combatting below-target inflation. Moreover, with a backdrop of a stronger USD, we continue to expect these themes to be reflected in the market. To express this view, we initiate a new EM FX Top Trade, recommending an equally weighted basket of short ZAR and KRW vs USD. The ZAR and KRW have been among the stronger-performing EM currencies over the past month, so they offer better entry points for short EM FX positions.

 

As one of the clearest examples of the first bucket of EMs, we continue to expect further weakness in the ZAR vs the USD. Ongoing imbalances in the domestic economy and a still wide current account deficit, compounded by eventual pressure from higher US rates, are likely to send this cross higher. Moreover, the decline in inflation is likely to give pause to the SARB as it contemplates the next move in the rate cycle. Our latest forecasts revised our view of $/ZAR higher to 12.70 in 12 months.

 

The KRW is another low-inflation EM currency that we think will depreciate vs the USD. Domestically, headline inflation remains well below the central bank's target and activity is subdued – at the latest monetary policy meeting, the BoK downgraded both its growth and inflation outlook by around 50bp to 3.4% and 1.9%. Following substantial weakness in both the JPY and EUR since September last year, the KRW on a trade-weighted basis is near post-crisis highs. Given the importance of export competitiveness to the Korean economy, we think ongoing pressure from JPY and EUR weakness – both of which face further downside in our forecasts (JPY at 130 and EUR at 1.08 in 12 months) – will put pressure on the KRW. Moreover, due to the downside risks to the inflation outlook, we now expect a rate cut from the BoK in April, which should help drive the currency weaker vs the USD.

 

We forecast $/KRW at 1150 in 12 months, around 5% higher than current spot. But there is scope for overshooting relative to this, especially if recent pressures on the CNY extend. The latest China PMI data suggest that activity in Q1 is on a weak footing. With the anti-corruption campaign also typically in focus in the first quarter of the year, there is some scope for policy easing measures to support growth. Moving rates lower is likely to be the primary focus of such policy measures, although it also raises the risk that policymakers allow some degree of RMB depreciation through a shift in the fix, a possible band-widening, and that the CNH continues its recent move in a weakening direction. Any such move is likely to further pressure the KRW to depreciate, and long $/KRW provides some exposure to such a move

Our suggestion: do what Goldman does, not what Goldman says.