EFTA01459006.pdf

6 December 2015 Update: China Monthly: Rising challenges will trigger more policy easing in 2016 months. We expect RMB asset volatilities in HI to narrow only after positioning in the offshore RMB remain subdued when most of these temporary FX market becomes more balanced. Offshore RMB market stabilization measures will be liquidity renormalization is the key in reviving relaxed/removed over the next one to two quarters, financing activities in the offshore RMB bond and asset volatilities to renormalize in H2. market. We forecast net issuance in the offshore RMB bond market to be modest at RMB50-100bn • Balanced allocation between fired income and in 2016. equity market While the asset allocation shift between equity and fixed income market should be find€ng ,Nrazegy. largely driven by valuation, investment flows at We forecast 10Y CGB yield to trade between 2.7-3.2%, domestic fund houses and banks (wealth 10Y CDBs between 3.1%-3.6% in 2016 and 5Y NDIRS management products) were quite volatile and to range between 2.2-2.8%. Our curve risk is neutral to extreme in 2015 with sizeable inflows to bond slight steepening considering liquidity and growth risk. funds in Q3, however, the lesson from the equity We recommend trade the cash CGBs and rates in these market turmoil in July 2015 is that asset allocation ranges with a long bias. We expect cash bond market by both institutional and retail investors needs to demand to be supported mainly by commercial be more balanced between the equity and fixed banks/policy banks, fund houses and insurance income assets. In addition, considering growth companies. On onshore credit, we expect IG sector to fundamentals will remain sluggish, we expect both outperform and recommend add allocation of liquid IG equity and fixed income market to benefit from names. flush liquidity and asset allocation demand. Furthermore, we expect the basis between the repo rates in the Stock Exchanges and the RMEi ii.reeildiess to cuntintio into 2016 interbank market to narrow as the new IPO funding Following the 11 August devaluation, the PBoC has rules will be implemented in 2016 which reduces resisted currency depreciation via various measures the risk of liquidity squeeze in the money market. ranging from FX interventions to the introduction of As such, even in the event of equity market rally, macro-prudential measures to limit outflows. In we believe we are unlikely to see large outflows addition, various SAFE and PBoC officials have mooted from the fixed income market into the equity the idea of introducing a "Tobin Tax" to discourage market in 2016, which is supportive to demand in speculative trading. All are strong signals of the the fixed income market. intensified official efforts to dampen speculation on the currency and slow capital outflows which have indeed • Reserve diversification inflows to MB bond been effective in the onshore market. Net FX purchases rriarket. With RMB inclusion into the SDR basket by financial institutions (including the PBoC) and net FX effective on October 1 2016, and China having settlements and sales by Chinese banks on behalf of liberalized access to the interbank bond and FX clients show that capital outflows have been market by foreign monetary authorities, decreasing. In October, net FX purchases by Fls supranational agencies and foreign governments, increased by $2bn during the month. Adjusting this we are likely to see growing reserve diversification series for"fundamental" flows (October net trade inflows to the RMB fixed income market. We also balance and net FDI transacted in foreign currencies) expect inflows by foreign institutional investors as suggests China's FX outflow in October was $49.3bn. RMB OFII program continues to expand. We This represents a third of the outflow during September forecast about RMB500bn bond market inflows and is the smallest outflow since July. from foreign investors in 2016. ▪ Credit risk remains high amid supply risk in 2016. Despite the slowdown in outflows in the onshore We believe the ongoing pressure of capacity market, USD/CNH continues to trade weaker than reduction in certain sectors makes credit events in onshore spot CNY, particularly in recent weeks. In the bond market, the trust market and the bank addition, CNH volatility and risk reversal skew remain loan market inevitable in 2016. On the other hand, high. This is because the market continues to believe measures to simplify issuance procedures and the authorities' resistance to CNY depreciation is promoting direct financing (recently by the NDRC) inconsistent with the country's weak underlying in the corporate bond market allow more fundamentals, monetary easing bias and capital corporations to access the corporate bond market account liberalization plan for financing. In our view, the combination of credit event risks and supply risk will keep investors Hence, into 2016, we believe RMB depreciation will highly selective in credit exposures. persist, albeit on a gradual basis. Why? First, despite the government efforts to slow outflows, we do believe ▪ Offshore MB CCS market. We expect the onshore corporates will continue to remain active in tightness in offshore RMB liquidity to persist for repaying their external debt. This is due to (1) worry some time and we expect the basis between that RMB depreciation will persist and (2) ongoing onshore and offshore money market rates to Deutsche Bank AG/Hong Kong Page 5 CONFIDENTIAL — PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0119195 CONFIDENTIAL SDNY_GM_00265379 EFTA01459006