EFTA01464418.pdf

Deutsche Bank Markets Research Global Foreign Exchange FX Spot Date 16 May 2013 FX Blueprint Dashing Buck Theme #1: Green Back: Buy USD TWI: Sell EUR/USD Theme #2: USD/JPY to Step Up Again: Buy USD/JPY Theme #3: Swiss Cheese Pounded: Sell GBP and CHF vs. USD and EUR Theme #4: Solid Bloc: Sell NZD/CAD, Buy low delta AUD/USD call Theme #5: NOK o'Clock: Buy NOK/SEK Theme #6: No Chinese Quick Fix: Buy USD/CNH calls Theme #7: Japanese Takeaway: Buy USD/KRW, USD/SGD, buy MYR/JPY Theme #8: EMEA Reality Check: Buy PLN/CZK, buy EUR/HUF and USD/ZAR calls, buy USD/TRY put Theme #9: Mexican Siesta: Take profit on short USD/MXN, sell EUR/BRL and EUR/CLP Theme #10: Turning Up the Volume: Buy USD/GBP variance swap and AUD/USD variance swap Research Team London Bilal Hafeez James Malcolm Henrik Gullberg George Saravelos Caio Natividade Siddharth Kapoor Oliver Harvey Nicholas Weng New York Alan Ruskin Daniel Brehon Drausio Giacomelli Guilherme Marone Mauro Roca Singapore Sameer Goel Mallika Sachdeva Sydney John Horner Tokyo Taisuke Tanaka Head of FX Strategy Bilal Hafeez Deutsche Bank AG/London DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) EFTA01464418 054/04/2013. EFTA01464419 16 May 2813 FX Blueprint: Dashing Buck Overview Asia, not the US, has provided the biggest surprises of 2013 so far. Chinese FX reserve accumulation has grown at a pace not seen since 2010. Much seems to be due to speculative dollar sales, but whatever the reason, the likely rebalancing has provided support for non-dollar reserve currencies such as the euro and Australian dollar. The other surprise has been the scale of the Japan "shock" with Abenomics proving to be the most radical set of policies since the depression-era. The yen has fallen markedly; competitor nations such as Korea have seen their currencies weaken, while suppliers to Japan such as Thailand and Malaysia have seen their currencies strengthen. Through all of this the dollar has marched higher even with the market wavering over an early move to tapering by the Fed and still absent equity re-allocations to the US. Dollar Break-Out Time The resilience of the dollar should be taken as a signal that the dollar is in the midst of a major uptrend. Over the coming months, economic data will likely improve after a soft patch, which should keep real yields well supported. More importantly, despite continued US equity market outperformance, international investors have still favoured the Euro-area, Japan and EM Asia over the US in terms of flows. This is unlikely to continue. Chinese reserve accumulation should also slow down, not least because of measures by authorities to clamp down on speculative inflows. The euro will no doubt lose out with such a backdrop. Additionally, the ECB has re-opened discussions of easing, while the Fed is contemplating how to wind down easing. On the flow side, lower euro risk premia should see much less repatriation, and if anything a greater allocation to foreign assets by Euro-area investors. We go long the dollar trade-weighted index and short EUR/USD. Japan Shock Though many want to fight the trend, we continue to stick resolutely to a bearish yen view. The next three to four months should see a wave of events and announcements that will reinforce the potency of Abenomics, whether through elections, structural reforms or monetary policy. Expectations will remain one of the key channels through which Abenomics will influence the direction of the economy. The flow picture also remains negative for the yen thanks to M&A outflows and the potential for further unwinds in EFTA01464420 past inflows to short-term Japanese instruments. We stay short the yen against the dollar. GBP, CHF: Nowhere To Hide Two other currencies should lose out to an unwind of safe-haven inflows: sterling and the Swiss franc. The negative sterling picture is aggravated by the fact that recent strong data will not change BoE policy, while the negative net investment income balance points to Page 2 How We Did Turning to how our trades performed from January's blueprint, it is clear that our weaker yen and stronger euro calls were key factors behind our overall return of +3.8%. Carry trades also performed well. Our biggest winner was long USD/JPY (up 17%) while our biggest loser was short a 1 year USD/PHP NDF (-1.5%). The trades made 3.8% on average with a hit ratio of 78%.1 Bilal Hafeez London, +44 (20) 7547 1489 an extremely negative current account deficit dynamic. The franc meanwhile will suffer from a resumption of portfolio outflows from Swiss-based investors. We sell both GBP and CHF (vs EUR and USD). Rest of G10 Swedish disinflation and Norwegian household debt issues should lead to central bank biases that support a long NOK/SEK trade. Finally in G10, we like to go long CAD against the JPY and NZD on the back of Canadian growth catching up to US growth, a stabilisation in the housing market and an upturn in natural gas prices. We are neutral on the Australian dollar, but given the recent sharp decline would consider buying AUD upside options, which appear cheap making the riskreturn look attractive. Asia = China+ Japan The yen-centric Asia FX trade, short Korean won and long Malaysian ringitt, should continue to perform well. As well as competition from Japanese companies, Korea will likely suffer from portfolio re-allocations to Japan. Malaysia meanwhile should benefit from a pickup in bond and equity inflows after the recent election. As for CNY, at annualized appreciation pace of 12%, we are concerned. The state of the economy does not justify that, and measures to clamp down on speculative inflows should reduce the appreciation pressure. Moreover, a band-widening should, if anything, lead to CNY weakness. We like to sell CNY via options. Rest of EM Of the remaining currencies, we find the Brazilian real attractive thanks to its carry and policy support for a range in the currency. We go tactically neutral on the EFTA01464421 Mexican peso. Big picture the currency looks attractive, but positioning is crowded. In EMEA, we look for additional strength in the Israeli shekel after its recent sell-off on the back of a strong economy. We remain negative on the Hungarian forint and South African rand, and positive on the Turkish lira. We enter optionbased trades to express those views. 1 Past performance is not indicative of future performance. Deutsche Bank AG/London EFTA01464422 16 May 2013 FX Blueprint: Dashing Buck Theme #1: Green Back The dollar is the top performing currency in G10 so far this year, and not far from the top if emerging market currencies are included. Therefore, dollar strength has not been confined to just the yen (see first chart), which suggests a broader dollar uptrend is unfolding. The fact that the consensus of analysts is only looking for moderate dollar strength against the majors and weakness against the rest of G10 and EM add to the case that we are only at the early stages of dollar strength. Equity Flows Still Not Supportive Ironically, dollar strength has so far not been supported by foreign inflows into US equity markets, despite US outperformance. The US saw negligible equity inflows in 01, with the Euro-area seeing by far the largest. Both Japan, and the rest of Asia also saw larger inflows (see second chart). Flows often lag performance, so one would not necessarily expect flows to immediately pick up into the US with stronger US markets, but the resilience of the dollar does augur well for a dollar uptrend. China Wildcard Yet the equity flow picture has not been the most surprising flow story of 2013. Instead, the significant increase in Chinese FX reserves takes that prize. Reserve accumulation has been at the highest pace since 2011, and undoubtedly has provided much support to currencies such as the euro and Australian dollar through a rebalancing effect. The backdrop of weak growth and strong credit expansion has provided an unusual mix for such a pace of accumulation. It would appear that some inflows to China have occurred through over-invoicing of exports and onshore entities taking advantage of the carry offered by borrowing in dollars and lending in Chinese rates However, over the past week, new measures have been introduced to clamp on these practices. This should slow the pace of reserve accumulation. Moreover, the sharp decline in the USD/CNY fix over April has also likely added to inflows. USD/CNY continues to trade at the bottom of the band around the fix, which implies still significant CNY demand. However, this state-of-affairs is unlikely to continue not least because the much anticipated band widening may actually occur over the coming months, and bring to an end anticipatory inflows. Dollar Mispricing Stepping back, what is evident is that US equity EFTA01464423 markets have been outperforming since 2009, but the dollar has only started to gain traction since late 2011. The 1995 dollar turn also saw US equity Deutsche Bank AG/London Figure 1: Dollar Trending Higher In 2013 65 67 69 71 73 75 77 79 Fed USD TWI USD basket vs G10 ex-JPY (equal-weighted) Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Source: Deutsche Bank Figure 2: Equity Flows To Everywhere But US 10 20 30 40 50 60 70 80 -20 -10 0 12Q1 12Q2 12Q3 12Q4 13Q1 Source: Deutsche Bank $bn, estimated for Q1 for Euro-area Euro Japan Asia ex-Ch US Figure 3: China Reserves Have Surged In 2013 100 150 200 250 300 350 50 (100) (50) 09Q1 09Q3 10Q1 10Q3 11Q1 11Q3 12Q1 12Q3 13Q1 Source: Deutsche Bank China ($bn) EFTA01464424 Asia incl China ($bn) Page 3 EFTA01464425 16 May 2813 FX Blueprint: Dashing Buck outperformance precede dollar strength. The swing factor for a more pronounced dollar move, though, appears to be real interest rates. Their relentless decline since late 2808 did weigh on the dollar, but the picture has started to improve as real rates appear to be turning up (see first chart on this page). Earlier tapering by the Fed would likely cause a sharper move up in real yields, but even a further delay in tapering would unlikely cause real yields to reach new lows. Therefore, markets have entered an important new phase for the USD: real yields moving higher in tandem with stronger equity markets. Such a combination should be very supportive for the dollar. We therefore like to go long the dollar trade-weighted index. What about the euro? We turned bearish EUR/USD at the beginning of March, and beyond our broad bullish dollar view we see two factors as driving us towards our 1.20 end-year target. First, we see divergence in conventional policy expectations (rates) returning. For all the unconventional measures since 2088, the remarkably consistent pricing of 2-year ahead rates paths from the Fed and ECB post Lehman is what stands out (see second chart). We think this year will mark the beginning of renewed divergence. On the Fed side, mid-2015 guidance is soon coming into view for 2-yr rates making the entire US yield curve "live". In contrast, the ECB is re-opening a discussion around negative rates and strengthening its verbal guidance on "low for long" via multi-year liquidity commitments. For how long can the market be pricing identical rates paths for the ECB and Fed over the next decade? Second, and more importantly, we see the reduction of Eurozone risk premia as negative, not positive for the EUR. On the one hand, our models suggest there is little redenomination risk priced into the EUR anymore. This has seen the correlation with Euro peripheral bond spreads and EUR/USD drop to close to zero, and makes the potential (negative) EUR/USD reaction to a return of tail risk very asymmetric. Most importantly, the big story over the last five years has not been a lack of inflows into the Euro-area, which have remained remarkably steady. It has been domestic risk aversion. This has seen large waves of repatriation and the building of more than EUR ltrillion worth of underweights in foreign assets. Lower tail risks and a gradually improving business cycle should see a return of these outflows - so we think EUR/USD is fully EFTA01464426 capable of participating in a USD rally, even if it lags the move lower in many other crosses. Bilal Hafeez George Sarav Page 4 Figure 4: USD Drivers Turning Up -3 -2 -1 0 2 3 normalised units USD Real yields* S&P:world 91 93 95 97 99 01 03 05 07 09 11 13 Source: Deutsche Bank, * pre-1997 nominal ley minus CPI used, rather than TIPs Figure 5: ECB To Diverge From Fed 0 1 2 3 4 5 6 7 US 2y2y rates Market has been pricing identical Fed/ECB rates path since 2008, divergence coming Euro 2y2y fwd rates 05 06 07 08 09 10 11 12 13 Source: Deutsche Bank Figure 6: Euro-Area Repatriation To End -6 -4 -2 0 4 6 Cumulative debt and equity flows, trio EUR inflows outflows 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Source: Deutsche Bank EFTA01464427 Deutsche Bank AG/London EFTA01464428 16 May 2013 FX Blueprint: Dashing Buck Theme #2 USD/JPY to Step Up Again After a 14 big figure rally in the fourth quarter, our January Blueprint piece was called 'Don't wait for USD/JPY to dip.' It argued that the move had great scope to run because yen trends are multiyear affairs which in the early stages tend to see few pullbacks. Another 12 big figures later, we feel the same way. We envisage spot Japan's narrow basic balance remains under pressure continually ratcheting up in steps following the new BoJ's landmark shift to Quantitative and Qualitative Easing (QQE) in early April. Our latest forecasts are 110 by December and 120 next year. The prospect of overshoot is also very real. Unwinds before outflows The case that we made earlier from BoP and flow drivers is still relevant. Japan's current account may be starting to stabilize but the capital flows picture continues to deteriorate and matters more (first and second charts). Outbound M&A is accelerating judging by the take-up of JBIC loans under MOF's USD100bio cheap bridge financing facility. And massive short-term hedge trades and safe-haven inflows from the time of the European Crisis have only just begun to get unwound. The latter that probably accounts for the strong underlying bid which the spot market found after exploding higher on April 4/5. It might also imply that another leg higher in the market through, say, 102 would induce a rash of 'stop-loss' buying. By contrast, consensus had put more focus on the prospect of fresh capital outflows, which are so far disappointing. And short-term offshore positioning dissipated accordingly: Just before the recent breach of 100 the weekly IMM report, for example, had leveraged funds' yen short at less than 40% of open interest, versus 60-80% when historically stretched. This made little sense when divergent monetary policy continues to be a source of ongoing support, and left the market susceptible to seemingly innocuous triggers like a low weekly US jobless claims number. Regardless, on the institutional side, we have consistently pointed out that significant new Japanese real money outflows are likely to evolve only gradually, and even then for the most part will be FX hedged. Retail investors, too, should be slow starters in terms of foreign asset demand. A key difference with America's experience during QE1 & QE2 is that Japan's relative growth prospects have improved rapidly. And the fact that local investors' starting point EFTA01464429 is a heavy underweight in the domestic stock market. Expect more! Abenomics is a departure from past reformist agendas, in that it relies heavily on the lever of expectations (apparently in part generated by yen weakness per the 1930s). Thus, the BoJ's latest Outlook Report Deutsche Bank AG/London Source: Ecowin; US Commodity futures trading commission (CFTC) Source: Deutsche Bank Significant short-term unwinds have yet to ensue Source: Deutsche Bank Offshore positions cut when spot stalled in 97-99 range Page 5 EFTA01464430 16 May 2013 FX Blueprint: Dashing Buck anticipates a 'virtuous cycle among production, income and spending triggered by increases in public investment and exports.' At the risk of caricature, Hayami had been all about gritting one's teeth and holding out for the eventual benefits of (Schumpeterian) creative destruction, while Shirakawa was resigned to the structural drag from demographics. Kuroda has taken a leaf out of the Fed's much more activist playbook, raising the stakes (promising almost three times as much QE) and taking a lead in talking up the economy's reflationary prospects. Policy board members' core forecasts are that the economy will exceed its potential by a factor of 5-6 times this fiscal year (2.4-3.0% versus 'around 0.5%,' albeit with the caveat that this includes frontloaded demand ahead of the April '14 consumption tax hike)! Measures of progress will come over the summer, with investors able to gauge the reaction to: (i) Abe's grand deregulation and competition plan, to be unveiled midJune; (ii) the Tokyo metropolitan and Upper House elections, in June and July respectively; plus (iii) final social security reform and fiscal reconstruction plans in August and September. Positive domestic sentiment could well exaggerate risk-seeking outflows just as the Fed discussion about tapering down asset purchases is progressing. Déjà vu and then some So how does the current backdrop stack up against previous periods of significant yen weakness? We examined seven episodes since the breakdown of Bretton Woods. They were characterized by trade shocks (mid- and late-70s, late-'80s, mid-'90s); valuation overshoots and intervention (mid-'90s); capital outflows, be they deregulation-, risk seeking- or 'sell-Japan'-driven (early and late-'80s, mid -'90s, early and mid-'00s). Clearly, today shares many of these features, with the added kicker of an unprecedented monetary backdrop. This is what raises the prospect of overshoot. But that's unlikely to be an issue in the next 3-6 months. James Malcolm, London, Taisuke Tanaka, Tokyo, Abe's delivery scheudul Source: Deutsche Bank Periods of yen weakness in the 70's and early 80's Source: Deutsche Bank Periods of yen weakness since the late 80's Source: Deutsche Bank EFTA01464431 Page 6 Deutsche Bank AG/London EFTA01464432 16 May 2813 FX Blueprint: Dashing Buck Theme #3: Swiss Cheese Pounded EI Swiss investors have significant underweights in foreign assets and "safe havens" globally are turning. Sell CHF vs USD and EUR. El The GBP bear story is not over, in our view: basic balance dynamics remain explosive, Carney will stay dovish and market positioning is cleaner. Sell GBP vs USD and EUR. Don't Underestimate Swiss Investor The market has been very focused on "safe-haven" inflows into Switzerland in recent years. While these have been big, the bigger story is the lack of outflows. Up to 2088, bond and equity flows by Swiss investors had been running at a 50bn CHF annual pace, mostly recycling savings from Switzerland's large current account surplus. The main destination has been US and European assets, accounting for more than two thirds of Swiss net foreign assets. This abruptly ended after Lehman: the Eurozone crisis, narrow rate differentials, CHF strength and very volatile equity markets all played their part. On all these fronts, we think things are changing however. Eurozone risk premia have been unwound to pre-2018 levels. Riskadjusted equity returns are booming. The Swiss franc has stabilized at extremely overvalued levels, and both European and US yields have likely bottomed. We therefore see conditions ripe for a return of the Swiss investor to international capital markets, and believe this will be a major driver behind Swiss franc weakness. All Other Safe Havens Have Turned Aside from domestic-led portfolio outflows, we don't think the signals from the unwind of other "safe haven" trades can be underestimated. Of all the "tail risk" trades, we see gold as holding the most similar properties to the Swiss franc: zero yielding, but perceived to hold value at times of stress. With the economy entering an environment of asset price inflation but goods price deflation, gold has proved a poor hedge, and we think the same holds for the Swiss franc. Indeed, medium-term trends between the two are similar, and combined with the huge decline in Eurozone risk premia, we see the risks as skewed towards an unwind of the more than 150bn of safehaven inflow that went into Switzerland over 2010-12. CHF Should Participate in Dollar Turn Finally, USD/CHF historically turns to lag turns in the dollar cycle. Back in the 1990s, it turned together with USD/JPY and USD/DEM. With our confidence on the dollar outlook building and no change from the SNB on EFTA01464433 the back of a very benign inflation outlook, we see conditions as ripe for a breakout in both USD/CHF and EUR/CHF targeting 1.00 and 1.27 respectively over the rest of the year. Deutsche Bank AG/London Page 7 It's Not the Inflows, But the Swiss Outflows That Matter cumulative fportfolio lows, bn Sfr -900 -700 -500 -300 -100 100 99 inflows outflows 250bn u/weight 02 05 Source: Deutsche Bank, Bloomberg Finance LP 08 11 Swiss Franc Is Last "Safe Haven" To Turn 200 400 600 800 1000 1200 1400 1600 1800 0 90 93 96 99 02 05 08 11 Source: Deutsche Bank, Bloomberg Finance LP Gold in EUR terms (lhs) CHF effective exchange rate (rhs) 70 80 90 100 110 120 130 CHF Is Last To Weaken Around Dollar Turns Months since currency topped against USD in 1990s 10 EFTA01464434 20 30 40 50 60 70 80 90 0 NZD AUD CAD GBP NOK SEK DEM CHF JPY Jun 1988: NZD/USD hits cycle high, year when DXY range begins April 1995: USD/JPY hits cycle low, DXY uptrend begins Source: Deutsche Bank, Bloomberg Finance LP EFTA01464435 16 May 2813 FX Blueprint: Dashing Buck Staying Bearish GBP We've been bearish sterling since the start of the year and stick with the view, despite the last few months' squeeze. First, the recent run of positive UK data surprises versus the US and Euro-area appears to have reached extremes. Even if the run of positive UK data continues, it is difficult not seeing a greater catch-up from the country's two main trading partners. Second, outside of its recent potential to squeeze GBP shorts, we don't think the moderate improvement in the data outlook matters much anyway. Unlike the Fed, the BoE won't shift to less easing anytime this year, so the market can't price much in terms of relative monetary policy tightening. In contrast, GBP correlations with risk appetite (eg. the FTSE) have shifted to negative over the last two years. Improved risk appetite is associated with higher outflows from the UK given the extremely low level of real yields - the lowest in the world. Third, we believe that flow, not data, will be the dominant driver behind GBP. On that front, we think it is fair to say that sterling has the worst flow dynamics in the world. Portfolio inflows remain exceptionally weak due to very negative real yields. The trade balance remains stuck in deficit due to the high share of services, the big rise in ULCs in recent years, as well as persistent negative J-curve effects. Perhaps even more worrying, the investment income balance is deteriorating rapidly. This, not trade, has been the biggest drag on the UK current account and has small potential to improve in coming months. For any EM country, this deterioration would flash warning lights on the sustainability of the external position. This is very negative in the UK and growing. On top of this, it stands in sharp contrast to the US. Even though both have current account deficits, the UK appears to be suffering from a more structural decline in the relative profitability of its foreign investments - pointing to a more permanent decline in the UK financial system's capacity to transform foreign "safe haven" inflows into higher-yielding foreign assets. Finally, the risks are skewed towards higher "political" and "policy" premia on GBP. The continued dramatic decline in Eurozone risk premia should hurt GBP the most given that sterling has been one of the biggest beneficiaries of "safe haven" inflows from the Eurozone. On a more medium-term basis, the ongoing domestic political debate around an EU membership referendum EFTA01464436 on top of EU initiatives towards increasing regulatory burdens on the financial sector (financial transaction tax, among others), will do little to provide a mediumterm uplift to UK structural competitiveness. George Saravelos, London, portfolio UK vs Avrg US & Euro Data Surprises At Extremes 0.2 0.4 0.6 0.8 1 -0.8 -0.6 -0.4 -0.2 0 -1 04 Source: Deutsche Bank 06 08 10 12 UK and Canada Have Worse Basic Balance In World Narrow C/A + FDI SGD NOK TWD HUF MYR CNY SEK CHF ILS RUB PHP KRW CZK THB CLP BRL EUR AUD JPY IDR PLN MXN NZD TRY EFTA01464437 USD GBP INR CAD ZAR Source: Bloomberg Finance LP. *Average of 3M rolling correlations over the past 5 years. Rank of basic balance Broad C/A + FDI + Portfolio HUF SGD MYR 26 CNY MXN SEK PHP TRY 21 RUB THB KRW CZK PLN 16 EUR CHF BRL USD AUD 11 IDR ILS CLP NOK TWD 6 NZD INR JPY CAD ZAR 1 GBP Page 8 Deutsche Bank AG/London EFTA01464438 16 May 2013 FX Blueprint: Dashing Buck Theme #4: Solid Bloc T. The key US data suggest CAD's external backdrop remains supportive, as do Canada's commodity prices, and fears on Canadian housing are likely overdone. We maintain our recently entered CAD/JPY long. Having recently exited our long -held bullish AUD/CAD and NZD/CAD views from our previous Blueprint, we now also go short NZD/CAD. T. With AUD looking to have clearly overshot to the downside we do not enter AUD/CAD shorts at this point. Indeed we are more inclined to take advantage of the skew in AUD/USD options to buy a vanilla AUD/USD 1.01 3-month call for around 100 pips. We have in the past noted how US data surprises tend to lead Canadian data surprises, showing the influence trends in Canada's largest trading partner have on its economy. CAD then tends to follows US data surprises. CAD has been surprisingly resilient to weakness in the broader US data flow in recent weeks - a period where our US Macro Pulse Index of data surprises has largely run in negative territory. As can be seen in Figure 1, however, the key parts of the US recovery story — the recovering housing and labour markets — have been more encouraging than the broader US data flow recently, and are providing greater support for CAD. Canadian commodity prices also remain supportive, with US natural gas prices having climbed solidly in 2013 Even in the weakest part of the Canadian outlook — the weakening building sector — the recent news is more encouraging, with overall building permits at a 5-month high in March (albeit driven by non-residential permits). While it is by no means a bullish factor yet, it may be that market participants are too negative on how much further this sector is likely to weigh on CAD (Figure 2). Given our ongoing bearishness on JPY, we expressed this CAD bullishness by going long CAD/JPY on 9 May when it rallied through 99 (see Trade Recommendation: Long CAD/JPY, 10 May) and we maintain this long. This improving macro backdrop for CAD is being reflected in the financial variables that drive our shortterm models of CAD crosses. Our AUD/CAD model has clearly rolled over, while our NZD/CAD model is starting to roll over as well (Figure 4). So we recently exited our long-held AUD/CAD and NZD/CAD Blueprint views (see FX Daily: Changing the Call on CAD Crosses, 6 May 2013). EFTA01464439 Figure 1: Signals from US housing and labour market support CAD... CAD TWI 12wk-12wk% (LHS) 10 15 -15 -10 -5 0 5 97 99 01 03 05 07 09 11 13 Combined Mortgage Apps and Jobless Claims 12wk-12wk% Pulse (RHS) 10 15 -15 -10 -5 0 Source: Deutsche Bank, Bloomberg Finance LP Figure 2: Canadian building outlook starting to turn? 10 20 30 -40 -30 -20 -10 0 Jan-03 10 20 30 Canadian. Building Permits 3m3m%, (LHS) CAD TWI 3m-3m% (RHS) Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 -40 -30 EFTA01464440 -20 -10 0 Source: Deutsche Bank, Bloomberg Finance LP Figure 3: NZD/CAD model is rolling over — even though spot has overshot near-term, we target a move to 0.80 0.87 0.85 0.83 0.81 0.79 0.77 0.75 May 12 Aug 12 Source: Deutsche Bank, Bloomberg Finance LP Nov 12 Feb 13 May 13 NZD/CAD Model - uses Dairy Futures, NatGas, Crude, CRB, rate differential, USD TWI, VIX Deutsche Bank AG/London Page 9 EFTA01464441 16 May 2813 FX Blueprint: Dashing Buck While both crosses have now fallen a long way relative to our models, we would now expect these models to keep trending lower. Given the respective levels of the two crosses (and our AUD view below), we prefer to go short NZD/CAD. Indeed we are now more cautious on NZD more widely, as most of the good news appears priced in following its rally in recent months (see Figure 4). In terms of AUD, our view remains that the global monetary environment argues against looking for anything more than short-term weakness. Reinforcing this were the Chinese monetary data for April, which showed a further pickup in M2 Money growth — this has generally been bullish for AUD in recent years. Moreover, our Chinese team remains more bullish on the Chinese growth outlook than the market consensus, looking for 8.2% growth in 2013 and 8.9% growth in 2014, against a market consensus of 8.8% growth in both years. It is notable then that other "China plays" such as Hang Seng H-shares and copper prices have started to trend higher recently, indicating a greater confidence in the outlook for Chinese demand (see Figure 5). This should soon start to bolster AUD. One of the other key drivers of our resilient-AUD view has been the expectation of ongoing mining-related FDI inflows (see for instance FX Daily: On-Hold RBA Lifts AUD, But FDI Inflows And G3 Policy Remain Key Supports, 5 March 2013). Despite recent negativity on the mining investment outlook, the ABS's 01 Capex survey suggested an increase in mining investment would be seen in 2013/14, with a lift in building and structures investment offsetting an expected decline in machinery and equipment investment. While this may prove too optimistic, it suggests mining investment is hardly about to fall off a "cliff". In terms of what this means for AUD, even if there is little growth in mining investment, it is likely to remain at an extremely elevated level for some quarters to come. Additionally, as mining investment rotates from an import-heavy machinery and equipment focus to a local-expenditureheavy building and structures focus, the AUD-intensity of this spending may well increase. This argues that the need for resource firms to continue to generate substantial FDI inflows will likely remain intact. As to how we prefer to express this AUD view, one relatively consistent dynamic in FX options markets is the tendency of AUD/USD options to skew towards puts on AUD/USD declines (see Figure 6). We would EFTA01464442 take advantage of this dynamic by buying a vanilla AUD/USD 1.02 call (around 70 pips at time of writing), expecting it to resume trading in the 1.02-1.06 range that had until very recently held for most of 2013. John Horner, Sydney, +61 (2) 8258 2130 Page 10 Deutsche Bank AG/London Figure 4: The good news in NZ is more than fully priced 10 15 -15 -10 -5 0 5 04 05 06 07 08 09 10 11 12 13 Source: Deutsche Bank, Bloomberg Finance LP NZD TWI 3m% ch (LHS) ANZ Survey Employment Intentions 3mth change (RHS) -25.0 -20.0 -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 20.0 25.0 Figure 5: Many China plays are now getting a boost 10 15 20 25 30 35 5 1999 2001 2003 2005 2007 2009 2011 2013 Chinese M2 money supply growth yoy% (LHS) H-Shares yoy% (RHS) 100 150 200 50 -100 -50 0 Source: Deutsche Bank, Bloomberg Finance LP Figure 6: Taking advantage of option market dynamics to buy a vanilla AUD/USD 1.01 3-month call on this dip EFTA01464443 0.55 0.65 0.75 0.85 0.95 1.05 1.15 AUD/USD (LHS) AUD/USD 25-delta risk reversal (RHS) -8 -7 -6 -5 -4 -3 -2 -1 0 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Source: Deutsche Bank, Bloomberg Finance LP EFTA01464444 16 May 2013 FX Blueprint: Dashing Buck Theme #5: NOK o'Clock The Norwegian krone has weakened somewhat vs. the EUR since the last FX Blueprint on Jan 10 th , reflecting weaker crude primarily but also a Norges Bank that has struggled to make its mind up on what the main focus of monetary policy should be, headline CPI or household debt/house prices. The latest policy meeting would suggest household debt and house prices now have the upper hand again, although with the caveat this could change if the krone appreciates significantly. However, to be fair to Norges it is a nigh impossible job for any inflation targeting central bank to balance the dilemma of pockets of domestic overheating with external deflation. Add a solid C/A surplus and a triple-A rating and Norges Bank is stuck between a rock and a hard place. What this means for our outlook for the NOK is that the Norges Bank's NOK TWI projections matter more than ever. Deviations of around 2-3% or more are likely to be crucial over the next couple of rate meetings. Other factors/variables that will be monitored closely at Norges Bank are: a) total credit as % of GDP; b) house prices as % of disposable income, c) real commercial property prices; d) the share of money market funding in Norwegian financial institutions. These four variables have previously been identified as the key indicators the Bank monitors on an ongoing basis for guidance on longer-term financial stability, and also the main variables that will determine the additional capital requirements for the counter-cyclical capital buffer. Taken together, the dilemma of balancing the risk of domestic overheating versus excessive currency appreciation and subdued spot inflation is something Norway shares with a number of EM economies and also to a lesser extent with neighboring Sweden. However, Norway's dilemma is further reinforced by the lack of an output gap, Norway's accumulated oil wealth, booming oil & gas investments, extremely low unemployment, and large external surpluses. The bottom line, with Norwegian monetary policy likely to continue to be a compromise over the next couple of meetings, the best Norges Bank can hope for currently is that the correction in Brent crude lower will extend and weigh the NOK down. Near-term, and dependent on crude consolidating above/around $100/barrel, the re-assessment of the Norges policy outlook favour a higher NOK/SEK. Look for a return to the highs from EFTA01464445 late last year. Target 1.1775, with a stop @ 11.90 (1.1440 at the time of writing). Source: Deutsche Bank Source: Deutsche Bank Figure 1: NOK I-44 slightly weaker than NB's latest projection Figure 2: CPI below target, but slightly above NB's projected inflation path Source: Deutsche Bank Figure 3: Household debt is increasing again Deutsche Bank AG/London Page 11 EFTA01464446 16 May 2013 FX Blueprint: Dashing Buck Meanwhile in Sweden imported deflation is dragging headline CPI further below the Riksbank's projection (in April -0.5% YoY vs the -0.2% projection). For the inflation targeting Riksbank this should mean further policy easing, and it might result in further cuts. However, as the majority on the board has made clear, they are not entirely comfortable reducing rates further in response to external disinflation when house prices are edging higher and households take on more debt. Also, further rate reductions would not necessarily support demand since the slowdown was/is due to weak sentiment and a poor external environment. Meanwhile in the real economy, data is generally a mixed bag, with a few very early indications of a turnaround. Retail sales are largely stable, and consumer sentiment is back in the positives, backed up by higher property prices and surging equities. In the manufacturing sector the PMI remains just below the 50 benchmark line, but hard industrial data has improved significantly of late, with industrial output up 0.8% on the month in March for a flat YoY reading, while the more forward looking new orders component rose a sharp 10.5% MoM and 11.2% YoY, the highest YoY outturn for 2 years. So where does this leave the krona? On the back of the CPI report the rates market is almost fully priced for a further 25bp rate cut over the next two meetings. This to us seems about right, as even given the reluctance of the Riksbank neutrals to solely focus on the CPI, they can also not ignore headline CPI when it is running so much below target. However, at current levels (8.65) we also see limited downside in the SEK vs the EUR. In the current environment and at current policy rate levels, policy expectations can only impact on the SEK to a degree, with positive flows dynamics (C/A surplus a solid/steady 7-7.5% of GDP), attractive valuations (see DB's BEER, FEER and PPPs), and more near-term a lack of positioning (SEK a net short on dbSelect, investors have not been this short the krone for almost a year). Therefore we believe the probability of further rate reductions in the SEK is best captured in short SEK vs the NOK, where the CPI gap will continue to underpin expectations for a wider policy rate gap. Look for a return to the highs from late last year. Our initial target is 1.1775, with a sto 'ust below 1.12. Henrik Gullberg, London, Figure 4: Inflation is running below Riksbank fcsts Source: Deutsche Bank Figure 5: Domestic inflation stable - imports hugely EFTA01464447 deflationary Source: Deutsche Bank Figure 6: Household debt as % of disposable income Source: Deutsche Bank Page 12 Deutsche Bank AG/London EFTA01464448 16 May 2813 FX Blueprint: Dashing Buck Theme #6: No Chinese Quick Fix We believe the risk-reward to USD/CNY has shifted in favor of topside exposure for a few reasons. First, Fixings have diverged from the trend in macro data 108 the fixing has become increasingly misaligned from domestic macro data and the USD's gains against China's trade partners. China is losing competitiveness, at the very time when returns to its growth model are being tested. To us, this appears unsustainable. The motivations behind stronger fixings — whether RMB internationalization or an attempt to "catch-down" to spot — are unlikely to compel a continued disconnect from fundamentals and regional FX trends. The pace of fixing gains in April — at a 12% annualized pace — is not only unlikely to continue, but may well reverse to fulfill the policy promise of greater two-way volatility. Second, one-way USD selling pressure onshore should begin to normalize. Authorities are clamping down on sources of speculative USD sales. Trade invoicing irregularities used to disguise capital inflows will now be scrutinized. Foreign currency lending is likely to slow, as regulators discourage imbalanced FX loan-todeposit ratios by tying them to higher long USD NOP limits for banks. Importer buying is thus likely to return to the market. Should USD deposit rates begin to rise in response to the regulation, incentives to sell USD may begin to shift. Seasonal buying should also rise in the summer with a pick-up in MNC repatriation. Third, the widely expected band widening is not necessarily a positive for CNY. In fact, the April 2012 band-widening was first followed by spot trading to the upper extreme of the band. We see a narrowing of the spot-fixing basis as a key precondition for the move, and are wary of a downshift in growth expectations. Thus, spot could be facing upside — not downside — pressure at the time of band-widening. Fourth, market signals may be foreshadowing a turn. Volatility markets are becoming less complacent. CNH implied volatility has been moving higher since midApril with realized volatility picking up sharply this month. CNH spot has begun to trade at a discount to CNY, after trading at an average premium of 125 pips in Ql. Offshore positioning in the RMB complex is stretched and strongly consensus, and is thus vulnerable to abrupt shifts in expectations. Timing remains the key risk to our view. Policy intent for lower fixings and/or early band widening could keep EFTA01464449 the lid on for longer. But we believe risk-reward is now more compelling for topside. We recommend going long USD/CNH via short-dated vanilla calls. Indicatively, a 3M 6.22 call costs 27bps. We also maintain our long 3M USD/CNH versus USD/CNY NDF spread trade to position for an initial move higher in spot within the bands, with a view to squaring the NDF leg at par. Deutsche Bank AG/London 20 40 60 80 -100 -80 -60 -40 -20 0 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Source: Deutsche Bank, Bloomberg Finance LP USD selling should normalize as regulations reduce FX lending relative to deposits onshore 100 20 40 60 80 -40 -20 0 USD bn 10 20 30 40 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Net FX sales by onshore clients to banks, monthly (LHS) New FX loans - FX deposits, monthly (RHS) Source: Deutsche Bank, CEIC, SAFE -30 -20 -10 0 Citi China Data Surprise Index USD/CNY Fixing (RHS, reversed) 6.24 6.29 6.34 6.39 6.19 Spot traded to the top band last time it was widened EFTA01464450 6.00 6.10 6.20 6.30 6.40 6.50 Jun-11 Spot Max Intraday Deviation from Fix (RHS) CNY Spot CNY Fixing April 2012: Intraday trading band widened to +/-1% from +/-0.5% Dec-11 Jun-12 Source: Deutsche Bank, Bloomberg Finance LP Sameer Goel, Singapore, Mallika Sachdeva, Singa Page 13 Dec-12 -2% -1% 0% 1% 2% 3% 4% 5% Jun-13 EFTA01464451 16 May 2813 FX Blueprint: Dashing Buck Theme #7: Japanese Takeaway 3E We expect sensitivity to the JPY and offshore portfolio allocation preferences will continue to drive Asian FX. We are long USD/KRW, USD/SGD & MYR/JPY. Asian FX returns this year have largely been driven by varying sensitivities to the JPY. Correlations to the JPY (first chart) differentiate the relative laggards — that compete for exports and portfolio flows with Japan — from the relative leaders — that are integrated into Japanese supply chains and should benefit from Japanese import demand, FDI, and potential QEinduced portfolio investment. With USD/JPY breaking into the triple-digit atmosphere, and a bulk of the "real" flow impact from Japanese policies yet to materialize, these divergent correlations remain the best guide to regional FX trends, in our view. In addition to the JPY, the outperformance of EM debt over EM equity fund flows has boosted debt-centric ASEAN FX over equitycentric North Asian FX. We believe this trend has legs but will become more selective. KRW has the most to lose from JPY weakness. Competitiveness metrics such as export similarity indices point to a trade channel vulnerability. But the real pressure point comes from the portfolio channel. Earnings expectation downgrades for Korean companies and upgrades in Japan are driving relative equity market performance, resulting in flows into Japan and away from Korea. Importantly, an identical trend unfolded during the JPY weakness of 2004-07 (second chart). Politicization of FX may also drive further monetary easing and FX intervention in Korea. By comparison, TWD losses should be more subdued from here given weaker export competition with Japan, stronger equity inflows and central bank USD supply. SGD is the purest USD beta in Asia. By virtue of its NEER framework, the USD TWI has consistently been the top driver of USD/SGD. Unsurprisingly then, the importance of the JPY to SGD has surged since the USD/JPY uptrend began in October. Importantly, a long USD/SGD view is predicated in principal on USD strength broadening across Singapore's trading partners. It is thus even compatible with S$NEER tracking near the top band, although this positioning makes the risk-reward that much more attractive. MYR should outperform, given good inflow potential and a growing trade surplus with Japan. The status EFTA01464452 quo election result should sponsor portfolio rebalancing towards Malaysia. Equities have considerable scope to catch up to ASEAN peers, where valuations are now unattractive. IPOs should resume in force and could attract offshore interest. Bond allocations should pick up as underweights are covered (third chart) and as Thailand considers penalizing bond market access for foreigners. Malaysia meanwhile is unlikely to consider capital controls or a line in the sand on FX. Page 14 JPY has been a key driver of Asian FX performance 0.1 0.2 0.3 0.4 -0.4 -0.3 -0.2 -0.1 0 Latest 6M Correlation to JPY (LHS) YTD performance vs. USD (RHS) Winners Losers -5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5% SGDKRW TWDCNY INR PHP IDR MYR THB Source: Deutsche Bank, Bloomberg Finance LP Equity flows move away from Korea and towards Japan during periods of JPY weakness 100 20 40 60 80 -100 -80 -60 -40 -20 0 USD bn EFTA01464453 6m sum 10 20 30 JPY/KRW downtrend begins 01 02 03 04 05 06 07 08 09 10 11 12 13 Japan Equity Inflows (LHS) Korea Equity Inflows (RHS) Source: Deutsche Bank, Bloomberg Finance LP -30 -20 -10 0 Portfolio reallocation to drive MYR outperformance 10 15 20 -10 -5 0 5 2009 USD bn Bond inflows (3m sum) Malaysia Other ASEAN (IDR, THB, PHP) 2010 2011 2012 2013 Source: Deutsche Bank, Bond flows data is collected from the respective country's official sources Sameer Goel, Singapore, Mallika Sachdeva, Singap Deutsche Bank AG/London EFTA01464454 16 May 2813 FX Blueprint: Dashing Buck Theme #8: EMEA Reality Check There are a number of sub-plots and potential themes currently in EMEA FX, but rather than impacting significantly on price action, they seem to have led to paralysis, with correlation patterns versus traditional drivers having converged to near zero in many cases. That is unlikely to last and over the next couple of months we are likely to see a mix of global themes and country-specific factors having much more of a significant impact on price action. In EMEA, the impact of the external backdrop is potentially very mixed. The subdued external inflation environment means that economies with large negative output gaps will be less sensitive to currency weakness, and more inclined to continue to push through rate cuts, if not regardless of FX, at least as long as FX depreciation is orderly. Hungary's NBH have made it very clear that the focus is on growth, and that inflation is taking the back-seat for now. Consequently, the NBH rate cutting cycle continues unabated, with the Bank now having reduced the base rate down to an all-time low of 4.75% from 7.00%. The poor domestic backdrop, the need for further fiscal austerity in order to secure EDP exit and headline CPI at a record lows suggest rate reductions will continue, with the rates market currently pricing in around 180-125bps of further easing. Indeed, weak data, the non-domestic PPI running at a mere 3.2% YoY, coupled with global disinflation and relative currency strength also lower the bar for 50bp rate cuts (during all NBH easing cycles since the turn of the century the bank has at some point reduced rates by more than 25bps) and/or a more prolonged easing cycle. Elsewhere, South Africa's SARB seems to be warming to the idea of rate cuts despite a relatively weak ZAR. Governor Marcus recently emphasized the importance of a free-floating exchange rate as a shock-absorber, and argued that a weaker currency would be crucial in dealing with the country's large trade and C/A deficits. She also pointed out that medium-term inflation expectations remain well anchored. These comments definitely appear more dovish than before, particularly with regard to the exchange rate and would suggest the Bank is ready/willing to accept a weaker currency as long as the sell-off does not become disorderly. The Czech National Bank (CNB), meanwhile, falls into the category of central banks not ju