Fixed Income Research http://www.credit-suisse.com/researchandanalytics Asia Macro Strategy EM Fixed Income Strategy Research Analysts ASIA MACRO STRATEGY Ray Farris Managing Director +65 6212 3412 ray.farris@credit-suisse.com Trang Thuy Le 65 6212 426 trangthuy.le@credit-suisse.com FOREIGN EXCHANGE STRATEGY Puay Yeong Goh Associate +65 6212 4694 puayyeong.goh@credit-suisse.com INTEREST RATE STRATEGY Jarrod Kerr Director 65 6212 278 jarrod.kerr@credit-suisse.com Kenro Kawano Director +81 3 455 9498 kenro.kawano@credit-suisse.com EMERGING MARKETS STRATEGY Ashish Agrawal Director +65 6212 345 ashish.agrawal@credit-suisse.com What s good for the US is good for Recent news flow has shifted markets to something akin to a unipolar world focused on the better-than-expected US recovery. This is pushing the USD stronger, yields higher, and is shifting the structure of correlation among equities, rates, and FX. What is good for the US is good for the USD describes recent price action and can probably run further. Positioning long the USD does not yet seem excessive, in our view, and we think compelling evidence of stronger growth in Asia is probably still a few months away. Historically, Asian currencies have weakened against the USD when the USD has strengthened meaningfully against the G1. We have nudged our shortterm USD-Asia higher, flattening our USDCNY outlook and stressing risk in the INR and IDR in the current environment. Our directional bias for higher Asian yields and steeper curves has played out with a vengeance. We think this has further to run, and maintain our current recommendation set. We continue to recommend 2s5s swaps steepeners trades in India following the Reserve Bank of India s policy meeting. We have cut our short USDINR trade recommendation. Our review of the BoJ meeting leads us to continue paying swaps in the super-long sectors. We recommend wider-band synthetic short trades, asset swap longs, and a combination of paying 2yr swaps and buying 3yr JGBs. Down under, AUD and NZD curves have bear steepened. We recommend holding on to our paid AUD 1y1y, versus a received NZD 1y1y trade recommendation (now 1bps in profit), targeting a move to 115bps. ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ARE IN THE DISCLOSURE APPENDIX. FOR OTHER IMPORTANT DISCLOSURES, PLEASE REFER TO https://firesearchdisclosure.credit-suisse.com.
Exhibit 1: Asia macro view summary Country FX Rates Australia Bearish: Targeting 1.3 in three months. Maintain mild short duration. We prefer to express front end paid positions in AUD against received position in NZD. China Indonesia India Korea Malaysia Philippines Singapore Taiwan Thailand Neutral: Broad USD strength is leading the government to fix USDCNY gradually higher to manage CNY strength on a trade-weighted basis. Bearish: We continue to be cautious on the IDR as early signs of overheating emerge. Possible fuel price hikes add to inflation risks and run counter to Bank Indonesia s dovish policy stance. Neutral: RBI s failure to cut creates near-term risk to Indian equities and so financing for the INR. Neutral: The KRW faces temporary pressure to rise given broad USD strength and lingering government caution about Korea s growth outlook. Neutral: Strong BoP, but we expect the central bank to resist appreciation now that the MYR is stronger relative to the THB and PHP. Neutral: The BSP has cut rates and appears resistant to PHP strength until the electronics sector recovers. Neutral: The MAS is likely to maintain appreciation of the SGD TWI, but with the TWI hugging the middle of the bands, risk-return to longs is weak.. Neutral: The central bank is likely to resist TWD strength until the electronics sector recovers. Modestly bearish: Widening trade deficit likely to weigh on the THB until exports recover more significantly in H2. Neutral: PBoC s liquidity actions have had the desired impact and liquidity conditions have stabilized. The IRS curve is likely to be range bound in the near term. We remain neutral for now. Bearish: Expectations that fuel price increases could trigger a breach of the 212 inflation target should keep sentiment weak and limit gains in bonds. We see little incentive to add duration at this point and recommend reducing duration into any rally. Steeper: RBI is closer to starting what could be an aggressive easing cycle. The curve is too flat and we recommend 2s5s OIS steepeners. We retain our long 5y bond against 5y OIS recommendation too. Bearish: BoK has turned more constructive on the growth outlook and stressed that they would endeavor to lower inflation expectations. A combination of factors, both global and domestic, will likely push yields out of recent ranges. We recommend positioning with payers in 5y IRS. Tactically bearish: We retain 5s1s IRS steepeners to hedge against risks of weaker demand for long bonds and much better growth prospects. Neutral: The bond curve will likely stay supported on easy liquidity and low inflation. Neutral: A constructive outlook on USTs, coupled with supportive demand supply dynamics and easy liquidity, should support relative outperformance of SGS. Neutral. Steeper: We retain 3s1s IRS steepeners to position for increased hedging interest as markets absorb record supply. Asia Macro Strategy 2
Exhibit 2: Asia macro portfolio Active trade recommendations As of 15 Mar 212 FX Entry date Asset Entry level Current P&L (% of P&L (USD) Target Stop loss notional) 29/2/12 3m USDINR 1x2x1 put butterflies.36%.13% -.23% -226, 23/2/12 3m JPYKRW 1x2x1 put butterflies.43%.59%.16% 153,795 19/1/12 3m EURINR 1x1.5 RKI put spreads.5%.% -.5% -54,83 Rates Entry date Asset DV1 Entry level Current P&L (in bps) P&L (USD) Target Stop loss 9/3/12 Pay 5yr KRW IRS USD1K 3.56% 3.66% 1bps 11,5 3.85% 3.4% 1/3/12 Pay AU NZ 1y1y swap spread AUD/NZD15K.8%.9% 1bps 224,594 115bps 7bps 15/2/12 Pay 3m forward INR 2s5s OIS USD2K.%.12% 12bps 24,395 5bps -25bps 2/1/12 Pay AUD 2s3s4s swap butterfly AUD25K -.19% -.16% 3bps 78,616-13bps -22bps 12/12/11 Buy India 7.99 217 bond, sell 5y OIS swap USD1K -1.1% -.58% 43bps 428,94-5bps -125bps Pay 5y OIS swap 7.38% 7.82% 43bps Receive India 7.99 217 bond 8.39% 8.4% -1bps 12/12/11 Pay 5s1s MYR IRS USD1K.47%.39% -8bps -8, 8bps 3bps Exhibit 3: Asia macro portfolio Closed trades FX Entry date Asset Entry level Closed level P&L (% of notional) P&L (USD) Comment 23/2/12 Short USDINR 5.24 5.97-1.45% -143,222 Closed on Mar 15 3/1/212 3m USDJPY put, USDSGD put, USDCHF call worst of.23%.1% -.13% -13, Closed on Feb 23 2/1/212 Short USDKRW 114 1134.56% 559,989 Took profit on Feb 16 12/1/212 3m USDKRW 1x2x1 put butterfly.44%.7%.26% 262,7 Took profit on Mar 2 Rates Entry date Asset DV1 Entry level Closed level P&L (in bps) P&L (USD) Comment 27/1/212 Pay 6m1yr AUD swap AUD25K 3.85% 4.5% 2bps 537,88 Took profit on Feb 16 3/2/212 Pay 1y2y AUD swap AUD25K 3.84% 4.13% 29bps 773,829 Took profit on Feb 1 31/1/212 Pay 2y CNY IRS USD1K 2.75% 3.25% 5bps 5, Took profit on Feb 1 2/1/212 Receive 5y1y AUD swap AUD25K 5.25% 5.3% -5bps -13,972 Stopped out on Jan 24 Asia Macro Strategy 3
What s good for the US is good for... Market dynamics have clearly shifted over the past week to a focus on a more persistent-thanexpected US recovery. Combined with the Fed s failure to hint at new quantitative easing, markets are being forced to price better growth with higher yields, but centered on the US given news flow from Europe and China more confusing, both in terms of growth and policy. Price action has supported our long-standing bias for higher Asian yields and steeper curves, but moved against our forecasts for stronger Asian currencies. The rise in yields can extend further and persist into the remainder of the year, in our view. Exhibit 4: Asian local currency yields are on the move Changes in swap rates since 1 March, bps 3 25 2 15 1 5-5 -1-15 1s 5s 1s5s IN CH ID TA HK KR PH MA SI TH US, the BLOOMBERG PROFESSIONAL service USD-Asia is highly dependent on how the USD trades vs. the majors The outlook for USD-Asia is more dependant on the extent of USD strength against the major currencies. Exhibits 5 and 6 show that when the DXY rallies significantly, Asian currencies have tended to weaken against the dollar 1. Exceptions to the rule exist, but they have tended to be relatively brief, implying that risk-return favors being flat or short Asian FX if you think the US dollar is going to rally meaningfully against the major currencies. Exhibit 5: DXY strength implies ADXY weakness Exhibit 6: DXY strength implies ADXY weakness 1 95 9 85 8 75 DXY, left scale Asia basket vs USD 145 147 149 151 153 155 157 159 161 163 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 13 DXY, left scale Asia basket vs USD 12 11 1 9 8 7 6 Jan-99 May-1 Sep-3 Jan-6 May-8 Sep-1 8 85 9 95 1 15 11 115 Note: Asia basket is an equally weighted index of IDR, INR, KRW, MYR, PHP, SGD, THB, and TWD vs. the USD. Note: Asia basket is an equally weighted index of IDR, INR, KRW, MYR, PHP, SGD, THB, and TWD vs. the USD. 1 The charts do not show the 1997/98 Asian Crisis period both because it was idiosyncratic to Asia and the extent of volatility in the period impedes ability to see the relationship between DXY and Asian FX in other periods. Asia Macro Strategy 4
This begs the question of how much more the USD is likely to rally against the majors. Our FX strategists currently forecast about 2% with most of that coming in the next several months as markets adjust to higher US yields. Given the USD has so far rallied about 8% off its recent bottom, our forecasts would be consistent with past patterns of USD rallies in the 1985-95 dollar bear market of about 12% and the roughly 1% rallies in this bear market other than the 28 crisis-driven surge (Exhibits 7 and 8). Exhibit 7: USD rallies in bear markets 1987-95 Exhibit 8: USD rallies in bear markets 22-present 12 13 115 11 13.68% USD TWI 98 93 11.4% 17.51% 15 1 12.35% 12.37% 5.46% 88 1.49% 95 83 7.8% 9 78 USD TWI 85 Jan-87 Oct-88 Aug-9 May-92 Mar-94 73 Jan-4 Aug-5 Apr-7 Nov-8 Jul-1 Mar-12, the BLOOMBERG PROFESSIONAL service Further DXY strength implies a period of temporary Asian FX weakness This implies a temporary period of weakness in Asian currencies over the next month or so. However, we remain constructive on Asian growth and think that once the USD stabilizes against the majors, USD-Asia should resume drifting down. Our economists detail in their new Emerging Markets Quarterly that they estimate Asian growth bottomed in Q4 and has begun to recover. Exhibit 9 from our new Quarterly shows Asian industrial production growth has already accelerated sharply. If global PMIs continue to recover, Asian export growth should be clearly accelerating by late Q2, in our view (Exhibits 1). Exhibit 9: Asian industrial growth is accelerating Annualized % change in the industrial production level (sa) over the past three months preceding each observation point in the chart. Exhibit 1: Asian export growth should rise into Q2 4 3 2 1-1 LatAm -1 EMEA -2 NJA -2 NJA ex-china NJA ex-china, Singapore & Thailand -3-3 Jan-1 Jul-1 Jan-11 Jul-11 Jan-12 4 3 2 1 7 65 6 55 5 45 4 35 3 US ISM & euro zone PMI* (LHS) NJA ex. China & India real exports, %qoq 99 1 2 3 4 5 6 7 8 9 1 11 12 1 5-5 -1 Source: Haver Analytics, the BLOOMBERG PROFESSIONAL service, CEIC Asia Macro Strategy 5
For all of the concern about China s weak exports and trade deficit in February, Exhibit 11 shows that it is typical for China s export growth to lag recoveries in its core markets by several months following major troughs. We remain confident that Chinese export growth will be rising smartly by mid-year, if not earlier, supporting Chinese growth. Exhibit 11: China s export growth should recover by mid-year, if not earlier 7 65 6 55 5 45 4 35 3 25 2 Global PMI new orders*, 3m lead Exports, yoy%, 3m avg (RHS) Jan- Jan-2 Jan-4 Jan-6 Jan-8 Jan-1 Jan-12 5 4 3 2 1-1 -2-3, CEIC Where does this leave us in Asian FX? We have nudged our three-month forecasts for USD-Asia higher to account for the likelihood that further strength in DXY remains the dominant market theme over the next couple of months (Exhibit 12). This view recognizes that more compelling evidence of recovery in Asian growth and trade balances is only likely in the April and May data, to be reported in May and June respectively. We have kept most of our 12-month forecasts pointing toward Asian recovery, however, and stress that Asian FX is best traded at the extremes rather than as momentum plays. Exhibit 12: Credit Suisse Asian FX forecasts Exhibit 13: Forecasts vs. forwards %, positive numbers represent Asian FX appreciation vs. the USD 3 months 12 months New Old New Old USDCNY 6.39 6.25 6.27 6.2 USDINR 51.5 48. 48. 47. USDIDR 935 925 91 9 USDKRW 1135 11 19 17 USDMYR 3.1 2.94 2.98 2.9 USDPHP 43.4 42.6 42.3 42.3 12 1 8 6 4 2 3m vs fwd 12m vs fwd USDSGD 1.27 1.24 1.24 1.22 USDTWD 29.8 29.25 28.75 28.75 USDTHB 31.25 31. 29.75 29.5-2 CNY INR IDR KRW MYR PHP SGD TWD THB, the BLOOMBERG PROFESSIONAL service In the short term, our greatest concern is about the IDR and the TWD vs. the forwards. We expect overheating in Indonesia to continue to push USDIDR higher. In India, the RBI s recent failure to cut policy rates threatens the strength of inflows into equities in the short term. We today recommended stopping out of our short USDINR position in our model portfolio at a 1.5% loss. Asia Macro Strategy 6
Japan: BoJ to drive further curve steepening Although some expected additional easing by the BoJ at its Monetary Policy Board meeting this week, there were no particularly surprising policy moves, outside of the decision to expand the liquidity-supplying operations aimed at helping to strengthen foundations for growth. In its statement, the BoJ mentioned that the global economy has recently been recovering, and also raised its assessment of production. Additional easing is still expected At his press conference, Governor Shirakawa referred to a two-pronged package of strengthened monetary easing in February and an enhancement of liquidity-supplying operations for strengthening growth foundations in March, stopping short of referring to that enhancement of operations as additional easing, although he also did not specifically make any statements as negative as the one he made at the February press conference. In February s press conference he said that the BoJ had not changed the way it manages policy. In fact, his comment that the BoJ's policy stance has been a contributing factor in the recent strength of the stock market could be seen as evidence that the BoJ is amenable to future easing. He said he wanted the BoJ to "continue doing as much as it can as a central bank." We think the market probably interpreted this as indicating the possibility of additional easing, as suggested by the subsequent reaction of the yen-dollar rate. The market continues to be conscious of the possibility of further easing, and we expect the yen to continue to weaken, the flipside of dollar strength supported by favorable economic data in the US. Assuming the strength of the real economy does not cause a shortening of the expected policy commitment, we think shorter maturities are likely to maintain a degree of relative stability, strongly supported by the expectation for additional easing, but expect longer maturities to be subject to upward yield pressure. These moves are likely to become more pronounced moving forward. We expect a fairly extreme steepening of the JGB yield curve. Exhibit 14: 2y JGB yield and JGB 5y/1y and 1y/2y spreads 2y yield (%) 2.3 2.2 2.1 2. 1.9 1.8 1.7 1.6 9 85 8 75 7 65 spread (bp) 1.5 6 3/31/1 6/3/1 9/29/1 12/3/1 3/31/11 7/1/11 9/3/11 12/3/11 3/31/12 JGB 2y yield (lhs) 5y /1y spd (rhs) 1y /2y spd (rhs) In the swaps curve, the steepening pressures in the long end of the curve should remain intact, given the impact from PRDC structured notes hedge paying in response to weaker yen. Considering the JGB and swap curve developments, we like trades involving paying swaps in the super-long sectors, specifically, we like (1) wider-band synthetic short trades, (2) asset swap long trades, and (3) a combination of paying 2-year swaps and buying 3- year JGBs. See details in Japan Interest Rate Strategy Weekly dated 15 March 212. Asia Macro Strategy 7
Antipodean rates: Sharp US-led bear steepening In last week s Asia Macro Strategy we reiterated our paid AUD 1y1y (A$15kDV1) versus a received NZD 1y1y (NZD$15kDV1, so net paid on weights, given our risk on bias. Over the week, the significant sell-off in rates, lead by USTs, has seen both AUD and NZD curves bear steepen. Arguably the most interesting move in the AUD market over the week has been the disinversion of the 1s2s swap spread from -7bps to +2bps at the time of writing. The curve is finally starting to normalize and has further to go in our opinion. Frustrated longs and the unwinding of 1y1y receivers have pushed the AUD 1y1y rate from around 4.1% to 4.3% in two days. A similar yet less aggressive move was seen in Kiwi rates and the spread between the AUD 1y1y and NZD 1y1y has widened as anticipated (currently ~9bps). We recommend holding the position to the initial target of 115bps. Exhibit 15: AUD-NZD 1y1y P&L Exhibit 16: AUD 1s2s IRS spread A$ % Bps P & L 2, 5..3 15, 1, 4.5.2.1 5, 4.. 29-Feb-12 3-Mar-12 6-Mar-12 9-Mar-12 12-Mar-12 P & L Locus 3.5 4/11 7/11 9/11 12/11 Spot x 1Y Spot x 2Y Spread -.1 RBI keeps markets waiting as markets lose patience India: Stay in steepeners post-rbi RBI s mid quarter review of monetary policy today had a few surprises. RBI left key rates unchanged as widely expected but details indicated continued concern over inflation (Reserve Bank of India Meeting: If not now, when?). Even though most market participants were discounting the possibility that RBI stays on hold, they were unwilling to be positioned for that outcome. As a result we saw a sell-off in bonds and swaps were well bid. The marginal flattening in the OIS curve has been largely in the front end, reflecting the negative carry for yet another month. Even though there were no easing moves today, the RBI has surprised markets (in terms of timing) by their liquidity measures this year. Most recently, RBI cut the CRR (cash reserve ratio) by 75bp adding Rs48bn of liquidity and their open market bond purchases have aggregated Rs1.1tn. Markets have scaled back easing expectations in recent months, just when the RBI started to deliver (Exhibit 17). We have always (for many months at least) thought that markets were too aggressive in pricing easing. RBI s choice of policy instruments, preference for visible fiscal discipline and inflation concerns have probably prompted markets to defer easing expectations. The improving global growth backdrop and easing of European sovereign risks have also dampened sentiment (Exhibit 18). That said, domestic factors Asia Macro Strategy 8
argue strongly for easing and RBI (in non-japan Asia) is the only central bank with policy rates at highs. The direction of policy moves is clear with uncertainty only in terms of timing and magnitude of easing. We reiterate our 2s5s OIS steepener recommendation Our economist expects RBI to lower the repo rate by 175bp over the next year and also expects another 75bp in CRR cuts. RBI is expected to start easing at the next (Annual) review on 17 April. We also expect a lower liquidity deficit to tighten the basis between the overnight rate and the repo rate (currently 42bp). This coupled with the rate cuts should trigger meaningful steepening in the OIS curve. We reiterate our 2s5s OIS steepener recommendation (Asia rates India: Initiate 2s5s OIS steepeners) as the OIS curve prices in an improving liquidity backdrop, rate cuts amid medium term duration concerns (Exhibit 3). We also retain a long bond (7.99 217) against paid position in 5y OIS recommendation (India: Reiterate long 217 bonds, pay 5y OIS). Bonds will likely remain supported in the near term on manageable net supply. Scheduled issuance for this fiscal is behind us and Rs59bn of bonds mature in April and early May. Bonds have outperformed swaps but we are probably in the late stages of this outperformance (Exhibit 4). Risks to our view comes from expectations of a more measured pace of easing if the government doesn't target fiscal consolidation in the budget tomorrow and/or a surge in global crude prices. Exhibit 17: Markets scale back easing expectations Repo rate, 3m OIS and implied path of 3m rates, current and at previous policy meetings, % 9. Exhibit 18: a similar message from the longer segments Repo rate and market rates, % 9. 8.5 8. 8. 7.5 7. 7. 6. 6.5 Latest Dec meeting 6. Sep meeting 3m OIS Policy rate CS forecast 5.5 Mar-11 Aug-11 Feb-12 Aug-12 Feb-13 Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse 5. 1y Gov 5y IRS Policy rate 5y Gov 4. Mar-9 Mar-1 Mar-11 Mar-12 Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse Asia Macro Strategy 9
Exhibit 19: OIS curve too flat relative to our forecasts Repo rate, % (left), 2s5s OIS spreads, bp (right) Exhibit 2: bond outperformance likely in late stages 5 & 1y bond swap spreads, bp 9. (5) 5 8. Policy rate 2s5s IRS (25) - 7. 25-5 5 6. 75-1 CS 5. forecasts 1 and implied rates 125 4. 15 Mar-1 Sep-1 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13, the BLOOMBERG PROFESSIONAL service -15 5y swaps/gov 1y swaps/gov -2 Mar-9 Mar-1 Mar-11 Mar-12, the BLOOMBERG PROFESSIONAL service Asia Macro Strategy 1
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High volatility investments may experience sudden and large falls in their value causing losses when that investment is realised. Those losses may equal your original investment. Indeed, in the case of some investments the potential losses may exceed the amount of initial investment and, in such circumstances, you may be required to pay more money to support those losses. Income yields from investments may fluctuate and, in consequence, initial capital paid to make the investment may be used as part of that income yield. Some investments may not be readily realisable and it may be difficult to sell or realise those investments, similarly it may prove difficult for you to obtain reliable information about the value, or risks, to which such an investment is exposed. This report may provide the addresses of, or contain hyperlinks to, websites. 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