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Declining cost of FX hedges creates opportunities to raise hedge ratios

Mallika Sachdeva
+656423 8947
Bryant Xu

Deutsche Bank Research has launched a new series of Asia Corporate Strategy Notes for our corporate clients, focusing on risk management recommendations in currency and rates markets. The first report in this series argues that corporations should take advantage of declining Asia FX hedging costs to raise USD and EUR hedge ratios.

As Mallika Sachdeva and Bryant Xu argue in the report, we expect the cost of USD/Asia and EUR/Asia forward hedges to continue to decline sharply in the next 1-2 years driven by a differing pace of central bank policy rate changes. The Fed and ECB are expected to hike rates over the next 1-2 years to regain control over inflation. While Asian central banks will also be tightening, Deutsche Bank forecasts policy rates in Asia rising only half as much on average.
A slower pace of rate hikes in Asia, and the sharp compression in the policy rate differentials against the US and Europe implies a forthcoming collapse in USD/Asia and EUR/Asia forward points, driven by covered interest rate parity. The cost of hedging Asian FX exposure against the USD and EUR is thus set to fall sharply, potentially into negative territory for many markets. The natural question for corporates is: should this impact my hedging choices?
In the report, Mallika Sachdeva and Bryant Xu conduct a historical analysis to study the hedged returns of USD/Asia and EUR/Asia crosses conditional on the level of hedging costs, and identify statistical relationships which might help inform hedging choices for firms.
They find the strongest opportunity to raise USD/Asia hedges comes in CNY, where declining FX forward points have tended to be associated with a higher USD/CNY spot, and positive hedged returns. Our negative view on the currency adds to the case. They also find opportunities to raise USD hedges against TWD, KRW and PHP for the more medium-term, and IDR in the short-term.
More broadly, they see EUR/Asia hedging opportunities becoming much more compelling. The ECB exit from negative rates will not only see EUR rates rise, but also the cross currency basis narrow as capital reverses back, leading to an even sharper compression in EUR/Asia hedging costs. Our EUR/USD forecasts also paint a bullish profile over the coming years, with Asian currencies likely to underperform this recovery.

The full “Asia Corporate Strategy Notes –Declining cost of FX hedges creates opportunities to raise hedge ratios” is available here for clients of Deutsche Bank Research.
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