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DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, LEGAL ENTITY
DISCLOSURE AND ANALYST CERTIFICATIONS.
22 March 2017
Figure 2: Both EURUSD and USDJPY are near Figure 3: EURUSD 2m skews are still elevated in
important technical levels favour of EUR puts
1.14 120 14 EURUSD 2m implied vol 1.00
EURUSD USDJPY (right)
118 13 EURUSD 2m risk reversal skew (RHS) 0.50
1.12
116 12
114 11 0.00
1.10
112 10
-0.50
1.08 110 9
108 -1.00
8
1.06
106 7 -1.50
104 6
1.04
-2.00
102 5
1.02 100 4 -2.50
Jul-16 Nov-16 Mar-17 Jan-16 May-16 Sep-16 Jan-17
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
Where do we stand on this? Given that our 3m forecast has for some time been 1.0300,
we should be approaching levels that are a sell level for EURUSD. And with the market in
mean-reversionary mode in G10 space (as per GBPUSD, USDJPY among others in the
past week following periods where breakouts looked possible), fading the impulsive move
higher in EURUSD should be in our thoughts. Despite this, we do not see the stars as
aligned for such a trade. As we have discussed at length in recent weeks, 2m EUR implied
volatility remains high vs. both realised volatility and other FX vols, suggesting that French
election risk remains priced in. This takes on added force from the fact that the 25-delta
risk reversal skew in the 2m tenor remains well bid for EUR puts, despite the rally in spot
(Figure 3). To us, this means EURUSD has room to run still higher, and ideally we would
like to see these metrics soften up before looking to short it. As for EURJPY, we have
been sellers for choice in the 120-125 range. The pair has been trendless, but we suspect
any move higher in realised FX volatility would see JPY outperform.
From the opposite perspective, why are we not jumping to raise our EUR forecasts? On
the European side, we remember how Donald Trump was also perceived to have
performed badly in televised debates, yet emerged victorious. On the US side, we are still
waiting for more colour on the likelihood of tax reform, which could come as soon as
Thursday when the House of Representatives is likely to vote on healthcare reform.
Market bullishness on US equities, the USD and higher US rates since Trump's November
election win has been based above all else on the idea that meaningful pro-market tax and
regulatory reform would materialize in the US, together with substantial fiscal stimulus and
infrastructure spending. The Trump administration has suggested it wants to have the
blueprint for this plan ready within its first 200 days, and healthcare reform has been top of
the agenda.
The House healthcare vote is critical in that a) it is the first Congressional vote on a key
policy issue and b) the wider tax reform agenda requires healthcare to pass before other
aspects can follow. If healthcare reform does pass the House this week, the market will
likely have higher expectations for the wider agenda being activated too, which should in
principle boost the USD (especially if expectations increase regarding the implementation
of border-adjusted taxation). The Senate leadership wants to vote on any House bill before
its recess on April 10-21, so the agenda could speed up materially in coming weeks. We
accept though that if a) healthcare reform passes the House and b) the USD still gets no
lift or weakens further, we may need to think again with respect to our current modestly
bullish forecast profile.
Figure 4: Equity and rates vol is near the lows Figure 5: G10 ad EM vols have fallen aggressively
US Swaption Vol, 1m10y normalised bp/yr 17.5%
Average G10 3m vol
140 Vix Index (RHS) 45
130 Average EM 3m vol
40 15.0%
120
35
110
30 12.5%
100
90 25
10.0%
80 20
70
15
60 7.5%
50 10
40 5 5.0%
2010 2011 2012 2013 2014 2015 2016 2017 2011 2012 2013 2014 2015 2016
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
Turning to developments down under, the RBAs March minutes underscored how recent
growth in investor housing credit demand (albeit concentrated in eastern cities), combined
with weak wage growth and investment demand, is likely to keep rates on hold over the
foreseeable future (disappointing traders who had begun pricing in hikes). Instead, the
policy focus will shift to enhanced macro-prudential measures, which have the support of
the Australian Treasury and financial regulators, and have already begun being proactively
implemented by major banks through targeted rate hikes and more stringent lending
standards. While the development is marginally negative for the AUD as it cools the
property market and loosens constraints on monetary policy, we expect its effect will be
limited by the RBAs noted reluctance to cut rates from these historically low levels.
Previewing the upcoming RBNZ meeting, we do not anticipate any major innovations in
Governor Wheelers messaging. He is likely to continue enforcing a dovish tone, especially
in light of disappointing 4Q16 GDP data, but this is already largely priced by NZD falling
~4% from its Feb highs (on a trade weighted basis). No doubt that outcome is giving the
RBNZ some relief, and they will take care not to distract from their prior messaging.
Meanwhile in Norway, the Norges Bank delivered a dovish monetary policy meeting
(relative to market expectations) by pushing back their longer term rate hike assumptions
by two quarters. This came in recognition of the severe disappointments in inflation
readings over recent months, which spilled over into their forecast inflation path. However,
their short term rate outlook was largely balanced out by financial stability concerns and a
more positive growth forecast, cushioning the impact on NOK.
More importantly for the longer term, NOK outlook was that the Norges Bank downgraded
its forecast for fiscal spending and the structural non-oil budget deficit in response to the
revised fiscal rule (restricting withdrawals from the GPFG to 3% of assets). As we stated
last week, the new fiscal rule will begin binding this year, raising the likelihood that fiscal
policy may become capped in a downturn, and shift more of the burden of a policy
response to monetary policy and currency depreciation. Under such circumstances, NOK
should reasonably be expected to depreciate even more than usual, and is one factor that
underpins our bullish 12m EURNOK forecast of 9.50.
With oil stuck in a range, markets have lacked a catalyst for adjustment. Todays
budget announcement could change that
We are long USDCAD via call RKOs, and we think outright vanilla calls are
starting to look attractive
The Canadian dollar has been relatively unaffected by the broad wave of USD weakness
that has dominated FX price action in 2017 so far, ranking as the worst performing G10
currency against the USD on a year-to-date basis. This weakness has however been very
gradual affair, lacking a specific catalyst. The outcome has been a steady decline in
implied volatility. We see potential for the latter to change in the near-term.
1.40 0.50
1.35 0.30
1.30 0.10
1.25 -0.10
1.20 -0.30
Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
In this piece we restate our case for a weaker Canadian dollar, and highlight
potential catalysts for a fresh move higher in USDCAD. Specifically, we look at
potential risks associated with todays budget release, and evaluate their expected impact
on CAD price action. The announcement of a tax on foreign buyers of housing in particular
could in our view lead to a repricing of BOC expectations.
We are long USDCAD via an 11 April 2017 expiry 1.35 call RKO 1.40 (link), and while
we hold on to the position, we think exposure to USDCAD upside via outright vanilla calls
is attractive at current levels for the first time in several months.
Figure 7: The recovery in non-energy exports Figure 8: Manufacturing sales have rebounded, but
remains totally elusive the gap from pre-crisis levels remains large
15% Exports ex oil & mining, 2007 C$, y/y 53.0
Imports ex oil & mining, 2007 C$, y/y Sales of manufactured goods
51.0
(Constant 2007 C$ bn)
10%
49.0
5% 47.0
45.0
0% 43.0
41.0
-5%
39.0
-10% 37.0
Jan-11 Feb-12 Mar-13 Apr-14 May-15 Jun-16 2005 2006 2007 2009 2010 2012 2013 2014 2016
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
As a result, the divergence between leading indicators of US demand and demand for
Canadian exports has widened sharply over the past few months (Figure 9). Expectations
of changes to the NAFTA framework and the looming threat of border adjustment taxes,
as we highlighted in the macro section, likely represent an additional motive for
underperformance.
65 15%
60 10%
5%
55
0%
50
-5%
45
-10%
40 US ISM New Orders
-15%
35 Canadian Exports (RHS, SA, YoY %)
-20%
30 -25%
Jan-08 Feb-09 Mar-10 Apr-11 May-12 Jun-13 Jul-14 Aug-15 Sep-16
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
This challenge means that recent stronger data prints are likely to be overlooked at the
Bank of Canada. As per its latest statement, the BOC views the recent pickup in inflation
as temporary, and is unlikely in our view to be swayed in the opposite direction by this
Fridays CPI data as long as underlying data about wages and earnings remains poor. The
latest set of employment data failed to assuage concerns on this front (Figure 11).
Figure 10: This BOC views the uptick in inflation as Figure 11: Average earnings have failed to rebound
temporary, Fridays data likely inconsequential from all-time lows
5.00 CPI headline y/y % 6.00
Average hourly earnings of
CPI core common y/y %
permanent workers % yoy
CPI core trim y/y %
4.00 5.00
3.00 4.00
2.00 3.00
1.00 2.00
0.00 1.00
-1.00 0.00
2005 2006 2007 2009 2010 2012 2013 2014 2016 2005 2006 2007 2009 2010 2012 2013 2014 2016
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
In the meanwhile, markets have shifted back to pricing a small probability of a hike by the
Bank of Canada this year, with OIS markets pricing in a ~40% likelihood of a hike by year
end. The local swap curve has steepened considerably (Figure 13), and yields in the belly
of the curve have moved higher in line with the global sell off in rates of the past few
months (Figure 12). We would be inclined to fade this move in policy expectations, in line
with our call for USDCAD to trade at 1.35 in 3 months.
Figure 12: The global sell off in yields has pushed Figure 13: The market has started to price in a
Canadian yields higher tighter policy outlook for the BOC
Swap curves
2.50 1.00
Canada 5yr yield (%) 3m2y
0.80 2y5y
BoC Overnight Target Rate (%)
2.00
0.60
1.50
0.40
0.20
1.00
0.00
0.50
-0.20
0.00 -0.40
Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 2011 2012 2013 2014 2015 2016 2017
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
Fiscal and external developments present in our view a more likely potential source of
negative surprises for the Canadian dollar. At the external level, we already highlighted in the
macro section the possibility that early progress on ACA repeal might pave the way for a
more open debate about tax reform in the US, potentially with references to border
adjustment taxes. We think the initial reaction would likely be negative for Canadian assets.
At the domestic level, we will be paying close attention to todays national budget
announcement. We see scope for negative surprises on the following points:
1. A potential increase in capital gains tax would likely prove negative for sentiment in
the near-term. The net long-term impact of an increase in capital gains tax rates would
of course need to be gauged against the potential improvements in growth
expectations created by the likely increase in fiscal spending. As such, beyond the
immediate likely negative risk response to the measure, we would expect limited near-
term impact.
2. The possibility of a national tax on foreign buyers of real estate, along the lines of
the 15% levy introduced in British Columbia, has also been the matter of speculation
in national media after Ontario Finance Minister Sousa explicitly called for such a
measure in a letter to national Finance Minister Tourneau. In this case, we would
expect a mixed near-term impact, but with potential for a meaningful long-term impact,
as tighter macro prudential standards would likely give the Bank of Canada leeway to
remain accommodative despite financial stability risks.
How to trade it
We are long USDCAD via a 11 April 2017 expiry 1.35 call RKO 1.40. The short vol bias of
the trade was the main driver behind our decision to express the view via RKOs.
Since then, however, implied vols have collapsed and are trading below delivered vols for
the first time since December 2016 (Figure 14) and the risk reversal skew has moved
aggressively in favor of USDCAD puts (Figure 15), with calls still priced at a premium to
puts. The move in implied vols and in the riskie suggests, in our view, that outright vanilla
calls are becoming an attractive expression of the view for the first time in several months.
We recommend buying a 1-month USDRUB 59.4 call for 0.61% of notional (spot
ref 57.6), maximum loss of this trade is limited to the premium paid
Figure 16: Rouble has outperformed oil prices Figure 17: and most oil currencies
$ per barrel Spot performance (31/12/2016=100)
70 35 108
106
40
67
104
45
64 102
50 100
61
98
55
USDRUB RUBNOK
96
58 RUBCAD
60
Oil, Brent (RHS and inverted) 94 RUBCOP
55 65 RUBKZT
92
Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 01/01/2017 01/02/2017 01/03/2017
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
We see emerging upside risks to USDRUB over the coming weeks. While we overall
remain constructive on the rouble due to strong fundamentals, and by extension on
Russian assets, we think that a combination of factors are likely to push USDRUB
tactically higher in the near-term:
First, the decoupling from oil prices does not seem sustainable. As Figure 16 shows,
the rouble and oil prices tend to converge quite quickly after periods of divergence. We do
not see any special reason to think this time is different. In fact, the setup of the ministry of
finances FX intervention scheme makes such convergence more likely (intervention
volumes decline when oil prices fall). To put in other words, unless oil prices rebound to
their pre-selloff levels (i.e. around $55/bbl for Brent) we would expect the natural direction
of USDRUB to be higher.
Second, downside risks to oil prices have increased. Recent signals from the oil
market have been mixed. For example, Saudi Arabia increased its production in February
but it made clear that it is committed to the OPEC deal. Without taking a view on the
directionality of oil prices in the very near-term, we argue that the downside risk to oil
prices has increased partly because investors are much more vigilant following the abrupt
re-pricing earlier this month. Furthermore, we are concerned about market dynamics
under which a potential downward move in oil feeds expectations for a break-down of the
OPEC deal. This could lead to a vicious self-fulfilling bearish price action.
Third, Russian authorities are not pleased with the current levels of the rouble. Two
recent official comments highlight that. First, finance minister Siluanov said on Monday
(20 March) that the rouble is overvalued by 10%-12%. Second, CBR officials said that the
CBR could resume FX intervention (on top of the ministry of finance scheme) if inflation
continues to fall towards the CBRs 4.0% inflation target. Although we do not think that the
government or the CBR would deliver a game-changer policy any time soon on that front,
investors should expect verbal intervention to intensify if USDRUB falls further.
Fourth, geopolitics have become a two-way risk. A potential removal of the US (or the
EU) sanctions has become very unlikely scenario. That is no news. However, as the
Russia-US relationship cools down again, we suspect that the risk of an actual escalation
in tension has increased. Specifically, we think that Russian assets underprice a scenario
where Russia, for example, recognizes the independence of the Donbass territory in
eastern Ukraine. Although this is not a base case or necessarily a near-term risk it does
poses an upside risk to USDRUB, which is arguably not in the price.
Figure 18: Current account flows to become less Figure 19: The Russian government sees risks to
rouble supportive in 2Q non-energy exports from strong rouble
Average current account surplus 2007-2016 ($bn) Energy includes crude, petroleum products and natural gas
30
500 Exports (12-month rolling, $bn) 250
25
400 200
20
300 150
15
200 100
10
0 0 0
1Q 2Q 3Q 4Q Jan-11 Jan-13 Jan-15 Jan-17
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, Haver
Policy rate, however, is likely to stay supportive despite of a potential cut on Friday
(24 March). Our economist is calling for a 50bp cut (to 9.50%) against consensus call for
no change. Yet, our base case is that the CBRs post-meeting communication is unlikely to
guide markets to price more aggressive easing cycle in a meaningful way. We expect this
combination would be marginally negative for the rouble but not a game-changer.
Against these risks, we think it makes sense to take advantage of low vols to buy
1m USDRUB upside. Relatively low vols suggest to us that buying 1-month options offers
a better risk-reward than short rouble via forwards currently. We think that markets
currently underprice the upside asymmetry in USDRUB. This is evident from the decline in
1m risk reversals over the past two weeks at a time when the rouble outperformed oil
prices significantly (Figure 21). We specifically like buying 1-month USDRUB 25 delta call
(strike: 59.4; spot ref 57.6, forward ref: 58.0). The downside of this trade is limited to the
upfront premium which is 0.61% of the notional. We like the 1-month contract given that
we expect USDRUB to converge with oil prices over a relatively short period of time, and
given that it is much cheaper than the 2-month and the 3-month contracts on an implied
volatility basis (Figure 20). The 1-month tenor is probably cheaper also because the 2-
month tenor also includes the French election risk (23 April and 7 May) while the 3-month
tenor also includes the OPEC meeting (25 May).
15.0 12.0
10.0
14.0
USDRUB 1m RR
8.0
13.0 USDRUB 3m RR
6.0
12.0
21/03/2017 4.0
1-week ago
11.0
1-month ago 2.0
10.0 0.0
1w 2w 1m 2m 3m 6m 9m 1y Mar-15 Sep-15 Mar-16 Sep-16 Mar-17
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
Lastly, we also revise our 12-month USDRUB forecast higher to 60.00 (from 58.00
previously). This new forecast is still bullish against forwards. The rationale behind our
upward revision is as follows:
The forecast revision largely reflects a change in the balance of risks around oil
prices. We previously were more confident about the bullish outlook to oil. However,
we have become more concerned about supply-demand rebalancing given the
abrupt increase in production from the US. We still expect oil prices to rise in 2H as a
base case, but downside risks to this outlook have arguably increased. Our new
USDRUB reflects this.
The forecast revision also reflects, to a lesser extent, the risk that Russian authorities
will increase their FX intervention in a meaningful way.
Figure 22: GBPUSD has followed rate spreads Figure 23: GBP is typically supported in low vol periods
-0.90 10yr GBP-USD Gvmt Bond Spread (LHS) 1.28 18 G10 FX vol (CVIX, rhs) 95
-1.40 1.20 4 65
1-Jan 16-Jan 31-Jan 15-Feb 2-Mar 17-Mar 2010 2011 2012 2013 2014 2015 2016 2017
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
2. Markets are still wedded to the notion of a rangebound cable. Stubborn thinking
on this front is not only evident through spot price action, but also in GBPUSD risk
reversals approaching post-referendum highs (Figure 24), just as spot reached
recent lows. Whether such logic holds to the upside remains to be tested at the
post-October high of 1.27, but both technical and fundamental factors seem to
underpin such thinking.
Figure 24: GBPUSD 3m risk reversals are at highs Figure 25: The MPCs narritive has oscillated
GBPUSD
1.34 GBPUSD 3m risk reversal skew (RHS) -0.50
-0.70
1.32
-0.90
1.30 -1.10
-1.30
1.28
-1.50
1.26
-1.70
1.24 -1.90
-2.10
1.22
-2.30
1.20 -2.50
Jul-16 Oct-16 Jan-17 Apr-17
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
Figure 26: UK data surprises may now be stretched Figure 27: Bellwether UK assets continue to rally
20% UK retail sales ex fuel, sa, %3mma ann. 150 650 UK Homebuilders Index
UK Economic Data Surprises RHS
15%
600
100
10%
550
50
5%
500
0%
0
450
-5%
-50
-10% 400
3. Recent Scottish headlines have been difficult to decipher. As for politics, matters
have been complicated one notch further by louder calls for another Scottish
independence referendum. Two factors may explain why GBPUSD price action hasnt
been forceful on this front as many might have initially expected.
Firstly, the potential date for a Scottish referendum seems so far away right now that
markets may only be keeping one eye on the issue. Both Sturgeon and May appear
to have reluctantly agreed to wait until the completion of Brexit talks in Spring 2019.
This could fall as far as the 3 year implied volatility tenor before which EU/UK
Brexit negotiations will provide ample entertainment for the pound. Moreover,
markets have also traditionally waited as close to six months before political events
before pricing kinks for such events let alone two years. A lot can change over
such long periods of time.
Secondly, markets may be divided about how the risk of Scottish exit feeds through
into the pound conventionally or indeed how the issue intertwines with Brexit. We
present just some of the wide schools of thought on this matter.
For some, the scenario of a UK breakup is an even more worrying prospect than the
small print about Brexit. Firms may find the added uncertainty associated with both
risks too difficult to weather.
For others, the jury is still out about whether independence necessarily needs to be a
net bearish force for GBP, at least in the long run. A fiscally stronger and less politically
divided nation may be the only sustainable way forwards.
Some believe the risk of Union breakup would be so damaging for PM Mays legacy
that she may be shaken from initial vision about Brexit. Perhaps Scottish cries have
succeeded in decreasing the odds of a very hard Brexit a net positive for GBP.
Polls would suggest Sturgeon faces a crucial problem winning a second referendum -
Euroscepticism in Scotland. As shown by Exhibit 4, many believe the SNP would not
win another referendum despite current polling.
Some believe the cards are now in Europes hands, irrespective of noise generated by
headlines at home. But opinions are just as scattered between those in this camp too.
Pessimists argue that the EU has gained bargaining power with UK fearing breakup.
Optimists believe the G3 leaders wouldnt see it in their personal interests to
encourage a precedent for regional independence. Rationalists see no material
difference between the situation now and before as Sturgeon had already ignited the
fires of Scottish independence last June. For all the talk of the EU welcoming Scotland
with open arms, rationalists may believe the EU simply distances itself any Scottish
controversy until it receives a formal ascension request. After all, why should Scotland
receive favourable treatment compared to the long list of countries that are in
ascension talks already including bigger politically heavyweights like Turkey.
Figure 28: Asian FX is recoupling with stronger Figure 29: Net foreign buying of Asian equities has
Asian equities risen strongly this year
Cumulative net foreign buying, US$bn year-to-date for the sum of
India, Indonesia, Korea, Malaysia, the Philippines, Taiwan, and
Thailand
96 15
625
MSCI Asia ex-Japan 94 2016
10
Asia vs. USD (RHS) 2017
575 92
5
90
525
0
88
475 -5
86
425 84 -10
Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 1 6 11 16 21 26 31 36 41 46 51 56
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service.
These flows seem likely to continue somewhat longer. Our technical analysts are bullish
on EM equities and particularly Asian equities (see EM Update: Still Bullish). Our global
equity strategists also argue that equities can rally further, in part given that they believe
that retail participation is in its early stages (see Global Equity Strategy). Low volatility
levels are also encouraging flows into carry and fixed income plays.
Fundamental risks exist, of course, but we think the most likely case is that these will not
challenge the momentum trade in the next month or so. Specifically:
Opinion polls continue to suggest that Marie Le Pen is unlikely to win the French
elections.
US protectionism seems less likely soon. The tone of US rhetoric about imposing tariffs
on China and Asia more generally has softened. Equally important, we think that
Chinese President Xi Jinpings willingness to meet recently with US Secretary of State
Rex Tillerson suggests to us that Xi will play his meeting with US President Trump in
April cautiously rather than confrontationally.
The recent US manufacturing data and the rise in metals prices suggest that the
slowing in global growth momentum we expect over the next few months is likely to
be modest.
Korea, Taiwan, and Thailand run very large current account surpluses which their
private sectors struggle to recycle effectively. All have also experienced some
improvement in growth that has encouraged capital inflows.
In India and Indonesia, hawkish monetary policy shifts in January have defended
historically high real yields. These have discouraged resident flight to dollars and
encouraged foreign portfolio inflows.
Singapores inflation cycle currently implies that the SGD nominal effective exchange
rate should trade in the upper half of its policy bands and that the Monetary Authority of
Singapore will keep policy unchanged in April (see here).
Chinas successful defense of the CNY earlier this year is also helping Asian FX by taking
away what was a driver of long USD-Asia proxy trades (see China capital flow monitor:
February too good to be true?). Ironically, Chinas choice over the past few days to
respond to USD weakness by holding up the USDCNY fix in order to weaken the CNY
against its basket probably implies a constraint on the potential for USD-Asia to fall at
some point. However, we think that Chinas government will reverse some of this recent
CNY fall vs. its basket if the USD recovers later this year as we forecast. We are
maintaining the CNY outlook we discuss in our 8 March FX Compass.
Figure 30: Opportunistic depreciation of the CNY vs. its basket should
constrain USD-Asia at some point
USDCNY fix CNY CFETS basket (RHS)
6.95 97.5
6.85 96.5
6.75 95.5
6.65 94.5
6.55 93.5
6.45 92.5
May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
Yet, the recent outperformance of most Asian countries exports against Chinese
exports and levels of real effective exchange rates shown in Figures 31 and 32 suggest
that most Asian currencies can probably appreciate more against the CNY before it
becomes a hard constraint.
Figure 31: But most Asian countries exports are Figure 32: And only Koreas REER looks like it is
growing robustly relative to Chinas exports beginning to become rich to its history vs. China
15.0%
130
Exports, USD, seasonally adjusted, 3m avg,
REER deviation from 10y average, %
4Q 2015 = 100
120 10.0%
110 5.0%
100 0.0%
90
-5.0%
80
-10.0%
70
MYR
TWD
IDR
INR
KRW
THB
PHP
SGD
CNY -15.0%
CNY KRW TWD PHP INR IDR SGD THB MYR
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
Putting it all together, we have cut our USD-Asia forecasts as we show in Figure 33. Our
message is that for short term of the next few months USD rallies should be sold. We are
relatively more bullish IDR and INR near term, while we maintain a bearish outlook on
CNY and PHP. We have also incorporated a stronger profile for the SGDNEER in
3 months, forecasting the NEER to trade around 1% above the midpoint, before
weakening to mid in 12 months.
Looking beyond the early summer, we maintain an outlook for a USD recovery over the
next year. One reason is that our Global FX Strategy team continues to forecast a USD
recovery led by EUR weakness over the next year. Fed hikes combined with ECB
dovishness should gradually give the USD traction. Another is that we expect US trade
policy toward Asia to turn more protectionist, even if this is difficult to quantify, and we see
the potential for US protectionism and a shift to border tax adjustment in US corporate tax
remaining high.
50 50
0
0
-50
-50
-100
-150 -100
From FX reserves Capital flows, $bn
-200
From PBoC foreign assets -150 Trade balance, $bn
-250 From PBoC FX assets
Net change in PBoC FX assets, $bn
From FX settlement
-200
-300
Jun-13 Apr-14 Feb-15 Dec-15 Oct-16
Jan-13 May-14 Sep-15 Jan-17
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service, CEIC Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service, CEIC
Figure 35 shows Chinese New Year seasonality likely explains some of this change in
flows. The swing in the trade balance during the month reduced funding for capital
outflows and the shortened working days in the month restricted the time that the public
could access banks to engage in flows.
Nonetheless, we see several other drivers of capital flow improvement that are likely to
remain intact in the coming months:
1. The government is likely to maintain its recently stricter implementation of capital
controls and restrictions on cross border yuan flows that we outlined in reports CNY:
tightening policy to stay in control and China tightened its checks on personal forex
2.8
2.7
2.6
2.5
2.4
2.3
2.2
Jun-16 Aug-16 Oct-16 Dec-16 Feb-17
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service, CEIC
We continue to expect Chinas balance of payments to remain in deficit in the sense that
the PBoCs reserves fall on a trend basis. We believe that monetary policy is too easy for
trend stability of the CNY, even after the recent rise in interest rates. However, the factors
above suggest that the pace of capital outflows and reserve losses should remain at
modest levels that allow the government to continue to dictate the path the CNY takes.
The broad USD remains the main risk we see to our outlook. A sharp USD rally, perhaps
because of a Fed shift to a faster pace of rate hikes or passage of the Destination Based,
Cash Flow Tax proposal, would create new incentives for larger capital outflows from
China (see US Economy Notes: Dont be a border adjustment loser).
China publishes four main indicators from which one could estimate the monthly change in
FX reserves, and hence capital flows:
1. SAFE's FX reserves. SAFE's FX reserve is the most direct measure, and tends to be
released first in the month, usually in the first week around the 6th or 7th. However,
several problems exist with using the headline change in the value of FX reserves as
a guide to capital flows. One is that assumptions about the currency and asset
structure of reserves need to be made in order to adjust for valuation effects. Another
is that the PBOC engages in intervention in forward markets, but releases data on this
with a lag. We note that the correlation of changes in FX reserves to changes in
balance of payments flow has been falling (Figure 38).
2. PBoC total foreign assets position. Foreign assets on the PBoC's balance sheet are
valued at cost, in RMB. The monthly change can be understood as the PBoC's RMB
cost of acquiring new foreign assets. The total foreign assets position covers all PBoC
foreign assets, including FX, gold and "other" foreign assets. It captures PBoC
intervention as well as other activity in foreign assets. Unlike FX reserves data, the
change in PBoC foreign assets position is not subject to valuation effect. PBoC
balance sheet data are typically released around the 14th to 17th of the month.
3. PBoC foreign assets position FX component. Changes in the FX component of
PBoC's foreign assets above (excluding gold, or "other foreign assets") are the
balance sheet item most directly related to PBoC FX intervention. This indicator has
historically had the highest correlation to change in reserves asset in BoP, although its
correlation has fallen slightly more recently (Figure 38).
4. Commercial banks' net FX settlement. FX settlement refers to the exchange
transactions between RMB and foreign currencies that banks conduct for their clients.
The time of conversion between the RMB and the foreign currency is regarded as the
time-point for the statistics. Unlike the three indicators above, FX settlement includes
both spot and forward transactions. We view this as a more timely and broader
measure of FX market pressure.
FX settlement is closely related to the change in reserves. A settlement deficit would
usually be offset by a fall in PBoC FX reserves. However, commercial banks can also
manage their own FX position in the short term. For instance, in the case of net demand
for FX from clients, banks may cut their own FX positions and become a direct source of
FX provision to clients, eliminating the need for PBoC FX reserves to fall to clear the
market at the prevailing exchange rate. In August 2015, the FX settlement deficit was
much larger than implied by the change in PBoC balance sheet or FX reserves, partly due
to the combination of commercial banks running down on their own FX position and PBoC
forward intervention.
FX settlement statistics are not prepared based on the principle for transactions between
residents and non-residents that governs Balance of Payment statistics. In addition, FX
settlement data are not subject to the accrual accounting basis required in the preparation
of the BoP statistics. As such, its correlation to BoP reserves asset is high, but still not
quite as high as PBoC foreign assets.
FX settlement data are usually released on the third week of the month.
Figure 37: China's capital flow indicators tracking Figure 38: PBoC foreign FX assets generally have
BoP flows high and stable correlations to BoP flows
Monthly change in USD, minus trade balance. FX reserves are Monthly change in USD, minus trade balance. FX reserves are
adjusted for valuation effect adjusted for valuation effect
Correlation to BoP flows excluding goods trade balance
300 Monthly non trade flows vs. BoP flows, $bn
and reserves assets
200 PBoC
foreign PBoC foreign Net FX FX
100
assets FX assets settlement reserves
0 From 2006 97.5% 97.7% 95.4% 94.8%
From 2010 98.1% 98.5% 95.9% 95.1%
-100
From 2012 98.0% 98.1% 94.9% 93.2%
-200 From 2014 97.6% 97.5% 92.8% 85.4%
-300
Net change in reserves adjusted
-400 From PBoC foreign assets
PBoC foreign FX assets
-500
FX settlement
-600 BoP non trade flows, $bn
Mar-10 Nov-14
Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service
Figure 39: Vanilla portfolio cumulative percent returns (Since 1 Sep 2014)
Indicative Vanilla portfolio return based on a starting notional capital of $10mn on 01 Sep 14,
$11.3mn on 1/1/15, $12.5mm on 1/1/16, $13.0mm on 1/1/17 .
35
30
25
20
15
10
5 Vanilla Portfolio YTD 2017: -0.3%
0
Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17
Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance.
Information, opinions and estimates contained in this report reflect a judgment at the original date of publication by CS and are subject to change without notice. The price, value of and income
from any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of securities and financial instruments may be subject to exchange rate fluctuation
that may have a positive or adverse effect on the price or income of such securities or financial instruments. The P&L results shown do not include relevant costs, such as commissions, interest
charges, or other applicable expenses.
Figure 41: Exotic portfolio cumulative percent returns (Since 1 Sep 2014)
Indicative portfolio return based on a starting notional capital of $10mn on 01 Sep 14, $10.8mn
on 1/1/15, $10.8mm on 1/1/16, $10.7mm on 1/1/17
12
10
8
6
4
2
0
-2
-4 Exotic Portfolio YTD 2017: -2.4%
-6
Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17
Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance.
Information, opinions and estimates contained in this report reflect a judgment at the original date of publication by CS and are subject to change without notice. The price, value of and income
from any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of securities and financial instruments may be subject to exchange rate fluctuation
that may have a positive or adverse effect on the price or income of such securities or financial instruments. The P&L results shown do not include relevant costs, such as commissions, interest
charges, or other applicable expenses.
Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance.
Information, opinions and estimates contained in this report reflect a judgment at the original date of publication by CS and are subject to change without notice. The price, value of and income
from any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of securities and financial instruments may be subject to exchange rate fluctuation
that may have a positive or adverse effect on the price or income of such securities or financial instruments. The P&L results shown do not include relevant costs, such as commissions, interest
charges, or other applicable expenses.
FX Forecast Recap
Figure 44: CS FX Forecasts
Major Currencies
vs. USD EURUSD USDJPY GBPUSD USDCHF USDCAD AUDUSD NZDUSD USDSEK USDNOK
3m 1.030 115.00 1.200 1.024 1.350 0.720 0.664 9.029 9.029
12m 1.000 112.00 1.200 1.060 1.370 0.700 0.673 9.150 9.500
vs. EUR EURJPY EURGBP EURCHF EURCAD EURAUD EURNZD EURSEK EURNOK
3m 118.45 0.858 1.055 1.391 1.431 1.552 9.300 9.300
12m 112.00 0.83 1.060 1.370 1.429 1.486 9.150 9.500
Emerging Currencies
vs. USD USDCNY USDHKD USDINR USDIDR USDKRW USDMYR USDPHP USDSGD USDTHB
3m 6.980 7.750 64.80 13100 1100 4.350 50.80 1.410 34.60
12m 7.180 7.750 67.00 13600 1170 4.500 51.80 1.445 35.50
vs. USD USDRUB USDTRY USDZAR EURHUF USDBRL USDMXN USDCLP USDCOP USDTWD
3m 58.00 3.800 13.50 313 3.200 19.00 670 3100 30.00
12m 60.00 4.100 14.25 313 3.500 22.00 680 3150 32.00
JAPAN ECONOMICS
Hiromichi Shirakawa
Head of Japan Economics Takashi Shiono
+81 3 4550 7117 +81 3 4550 7189
hiromichi.shirakawa@credit-suisse.com takashi.shiono@credit-suisse.com
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This research report is authored by:
Credit Suisse (Hong Kong) Limited ....................................................................................................................................................Trang Thuy Le
Credit Suisse Securities (USA) LLC .........................................................................................Shahab Jalinoos ; Alvise Marino ; Christopher Hine
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consequential loss arising from their use of this report or its content. Principal is not guaranteed. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that.
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Investment principal on bonds can be eroded depending on sale price or market price. In addition, there are bonds on which investment principal can
be eroded due to changes in redemption amounts. Care is required when investing in such instruments.
When you purchase non-listed Japanese fixed income securities (Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, Japanese corporate bonds) from CS as a seller, you will be requested to
pay the purchase price only.