EFTA01459698.pdf

12 January 2016 FX Blueprint: Forever Young Theme #3: Monkey business - Buy USD/CNH, buy USD/TWD RMB weakness is not over yet We see three reasons why it should continue; 1) further unwind of carry- ICNY depreciation against the USD will likely be lagoon modated as long as CNY is stable vs. the basket sensitive trades, driven by widening interest rate differentials; 2) hedging of FX liabilities due to poor 107 615 underlying fundamentals and rising credit risk and 3) 6.20 106 higher tolerance for currency depreciation by the 625 Chinese authorities. They would result not only in a 103 • 630 higher USD/RMB but also inevitably higher vol We see 6.35 value in buying USD/CNN call spreads We are also 101 • 6.40 buyers of USD/7VVD as a relatively cheap proxy for RMB. 99 6.45 6.50 The latest round of FX reforms from the Chinese 97 31 Dee 2014 .100 16.55 authorities has had two key features: (1) a change to 95 6.60 the USD/CNY fixing methodology in August, with an Jan-16 64Y-15 May-16 Jul-I5 Sep-15 Nos-15 Jtel-l6 intent to align the spot and fix rates (although this — City basket based an CFETS —CNY basket based on 61$ resulted in CNY devaluation); and 2) introduction of a — an basket based on WA —USO/CNY spot IftleS/ CNY effective exchange rate basket (in December) to Sane Devessin Sent Saw Frew LP. CSPC HOW /ISMS shift market perception of FX management from bilateral USD/CNY to a trade-weighted focus. Although these are positive steps towards making CNY a more The real cost of funding in China remains too high and international and market-driven currency in the policy easing has not been quite as effective medium term, the short-term consequence we feel is a weaker RMB accompanied by higher volatility. 16% % YDY 14% One, with China encouraging the market to shift its 12% focus to a trade-weighted basket of currencies, the 10% authorities are sending a clear message that should 9% USD strengthen against its trade-partner currencies, 6% they would be willing to accommodate USD strength 4% against CNY as well, and the same should not be seen 2% as a devaluation tactic. In other words, CNY weakness 16% 0% against the USD canewill be tolerated as long as CNY -2% % YoY, 18% vs. the basket is "basically stable'. Recent price action -4% 31AMA 20% (see chart) supports this thesis. We believe USD/CNY Jen-00 Jan-03 Jan-06 Jan-09 Jan-12 Jark115 — Real coat of fuming (eµusted by PM) has potential to reach 7.0 this year without the - (Instinct 3811.1A. RISSi authorities getting overly concerned. Using DB's 2016 sane Rants &.i, Bleembetv f wino U.. CEIC Hew *lain. global FX forecasts, the CNY CFETS index would remain -100 even if USD/CNY reached 7 by the end of the year, as China's trade partner currencies are likely Narrowing in US-China rate spreads will add to upside to weaken even more. pressure on USD/CNY... Two, given the various challenges of rebalancing the 5.0% r 59 economy, the Chinese policymakers. we feel, are 40% shifting priority to growth as against currency stability. 30% 63 In 2015, the authorities undertook monetary and fiscal 2.0% easing, while attempting simultaneously to keep 6.8 1.0% USD/CNY stable through intervention and various macro-prudential measures. It's a tenuous strategy, as 00% 7.3 China came face-to-face with an impossible trinity - -1 0% monetary easing and a gradual opening of the capital -2 0% 78 account were in direct conflict with its desire to keep -30% USD/CNY stable. As the focus shifts to stabilizing -40% growth, the authorities are likely to ease monetary 06 07 09 09 10 II 12 13 14 15 16 policy more actively, even at the expense of a weaker 2Y bond spread between US & Chin —uSO/CNY spot downed, RN& currency. DB Economics expects the Fed to hike rates Sang sae„ Cent. lOcanbep !nen:, LP. WC Herr Andeittcs by 75bp this year, versus 50bp of cuts by the PBoC. Deutsche Bank AG/London Page 7 CONFIDENTIAL — PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0120327 CONFIDENTIAL SDNY_GM_00266511 EFTA01459698