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Asia: short JPY/KRW Positioning surveys generally indicate that the most consensus Asia FX trades at current juncture are short KRW and SGD against USD through and short SGD against the NEER basket and short CNH against a narrow version of CFETS basket. Not surprisingly, these two basket trades also form a part of our trade recommendations. In fact, these shorts might have increased after US election outcome due to fears of protectionism. As a result, we believe that contrarian investors should be long KRW, CNY and SGD against USD or JPY. Amongst these, our favourite contrarian trade is long KRW vs JPY. Three triggers Three reasons why the current developments may ironically be positive for Korean Won: « After a brief period of outflows from the equity markets, we believe inflows are set to resume. A sustained rally in S&P Index due to the anticipated de-regulation and fiscal push will undoubtedly be positive for KOSPI (given the high positive correlation) and as a result for KRW. Moreover, history suggests that the current sell off in rates and KRW is unlikely to spur considerable outflows from the debt market. ¢ It is still not very clear if the outcome of this US election is going to be negative for foreign trade. Should these concerns decrease, positive impact from looser US fiscal policy could push Asia growth higher. « The recent sell off in KRW vs USD from 1100 to 1150 is indicative that domestic concerns around politics, Hanjin shipping troubles and Samsung related issues seems to have been largely priced in. As a result, we believe that any additional domestic negative news is unlikely to adversely impact KRW materially. Additionally, in terms of valuation, our long term COMPASS model indicates that the Korean Won is one of the most undervalued currencies in Asia. JPY better than USD as funder We believe it makes sense to express this contrarian view by short JPY instead of USD. Currently JPY/KRW is at 10.9 and our forecasts indicate it to be at 10.6 by Q4 2017. In the case of a stronger USD, we expect BOK to sound cautious with the pace of KRW depreciation and smooth the move higher in USD/KRW. Moreover, USD/JPY has greater sensitivity to USD rates than KRW. Chart 46: KRW, KOSPI, SPX highly correlated Chart 47: KRW more influenced by equity flows than bond flows 1.5 7 ——=3m correl SPX and KOSP| 3000 =m correl KOSPI and KRW/USD { 6000 05 4000 2000 0 0 tn -2000 1 -4000 * & & &% <> & %& © % N N N BS \ N N N FS SS KX FF WP KF KF WD AK -6000 a \ > S- SS & & & © we we mBond flows sm Equity flows © © © e © © FF VW FT of w Source: BofA Merrill Lynch Global Research Source: BofA Merrill Lynch Global Research Bankof America Merrill Lynch Global Rates, FX & EM 2017 Year Ahead | 16 November 2016 25 HOUSE_OVERSIGHT_014755