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Goldman Sachs Research
Global Markets Daily: EM FX: China slowdown risk not fully priced
Published 06:05 AM Tue Mar 18 2014
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Chinese growth has slowed significantly; sequential IP growth in Jan-Feb was
near 0%.
A clear shift back towards CNY TWI appreciation may not occur until activity
recovers.
But, in our view, positioning for a weaker CNY is not the best way to trade
slower China growth.
Instead, commodity producing EM FX and China’s NJA trading partners look
more exposed.
We find that the BRL, KRW and MYR have not fully priced the slowdown in
China growth...
…whereas the CLP and COP reflect it perhaps a bit too much.
We recommend tactical long positions in the German DAX.
1. CNY into band widening and a China growth slowdown
Broad risk sentiment recovered yesterday and overnight, as markets absorbed
the latest outcomes in Crimea and tensions between Russia and the EU/US.
That said, EM assets opened in the European trading session on the soft side
. Yesterday, our equities trading strategists recommended establishing long
positions in the German Dax (here). We view the near-term weakness in
equities as a tactical opportunity to obtain exposure in German equities in
a year where equity returns are likely to be positive but more volatile
compared with last year. The Turkish MPC today is unlikely to lead to a
shift in the CBRT’s monetary policy stance.
At the second trading session following the announcement of the CNY band
widening, the fixing remains within the recent tight ranges but the CNH
continues to edge higher towards the upper end of the band. The wider
trading band around the CNY may lead to additional volatility around the fix
in the onshore market and in the offshore CNH market. But, in itself, it is
less clear what this means for the direction of the CNY – which will still
be governed by the PBoC fix. After the last widening of the band in 2012,
the CNY did not resume its clear appreciation trend for a few months.
One key factor here will be the near-term trajectory of Chinese activity
data. It is likely that the tighter financial conditions in China at the end
of last year and early in 2014 caused activity to slow (see “The renewed
tightening in EM financial conditions”, EM Macro Daily, January 16, 2014),
along with the weaker-than-expected external demand and heightened anti-
corruption initiatives. But the degree of slowing in the January-February IP
data was greater than most market expectations. Our China Economics team
estimates that sequential IP growth through the period was close to 0%, one
of the lowest prints since the global financial crisis. The softer recent
data also help to explain the ongoing easing in financial conditions,
through a much lower 7-day repo rate and measures to encourage currency
weakness in recent weeks. A clear shift back towards CNY appreciation may
not occur until activity recovers from these weak levels.
Our forecasts call for sequential growth to pick up from these low levels,
which may well be the low point in growth in H1. But while sequential growth
may pick up and support China-linked assets, in the medium term it is
unlikely to be smooth sailing for Chinese financial instruments (rates,
currency or corporate equities and credit) because the Chinese authorities
are more likely to be comfortable with taking reform steps and restraining
credit when growth is more robust.
2. Commodity producers and NJA FX are more exposed to China growth risk
Historically, the CNY has not been the best way to trade growth views in
China. Broader FX policy considerations typically overwhelm growth concerns.
Even more market-determined instruments, such as the CNY NDF forwards or
the CNH, typically trade in line with views on the degree of appreciation
that the Chinese authorities will pursue.
Instead, as we discussed in our latest EM Weekly ('China Risks Weigh on EM
Assets'), weaker China growth is better reflected in the exchange rates of a
) commodity producing countries and b) China’s NJA trading counterparties.
As we argued, the China growth view is increasingly becoming a fresh axis of
differentiation in the performance of different EM currencies. And this
comes at a time when current account related concerns appear to be largely
priced and heavily reflected in current FX levels.
We use the sensitivities to our China growth risk factor to rank EM
currencies. Among commodity producing EM nations Chile is the most exposed
to China growth risk. This is a reasonable finding given the high
sensitivity of Chile’s copper export volumes and value to China import
growth. Brazil and South Africa follow in terms of ranking. In contrast Peru
and Indonesia are much less exposed.
Among NJA currencies, Korea, Malaysia and Taiwan are among the most
sensitive countries. Again, Indonesia and Philippines are much less exposed
to China growth risk.
3. BRL, MYR and KRW do not yet fully reflect China slowdown risks
The sharp depreciation in the CLP in response to lower copper prices
highlights that China growth risks are to some extent already reflected in
EM FX performance. So the key question relative to those ex-ante assessments
is where high sensitivity to China growth risk is not well reflected in
prices. And, vice versa, where this risk is already largely priced (and
perhaps too aggressively priced).
We run a cross-sectional regression of EM FX returns since the peak of the
China growth factor in mid-December 2012 (vs the USD) and the respective
sensitivity of each EM currency to China growth risk. Our findings indicate
that:
Among commodity producers with high China growth exposure, the BRL reflects
China deceleration risks the least.
In contrast, the CLP and COP reflect relevant risks perhaps slightly
excessively compared with commodity producing peers.
In NJA space, the MYR and KRW have reflected China growth risks less than
one would expect.
The CNH appears to have reflected relevant risks quite heavily but perhaps
that is a statement of the excessively strong starting point.
Although the correlation between the cross-sectional returns for EM
currencies and their betas to China growth risk is high (about 47%), a lot
is left unexplained. For instance, the large underperformance of the RUB vs
its China growth sensitivity is entirely due to idiosyncratic factors (
Ukraine risk escalation), as is the outperformance of IDR (owing to a sharp
narrowing of its current account deficit).
4. Recommended Tactical Trading Views
The following trading ideas from the Global Markets Group reflect shorter-
term views, which may differ from the longer-term ‘structural’ positions
included in our ‘Top Trades’ list further below.
On FX:
Stay long USDKRW (on a spot basis), opened at 1055 on 06 Jan 2014, with a
target of 1100 and a stop on a close below 1030, currently at 1069.
On Rates:
Stay long 10y Japanese break-even inflation (long 10y JGBis versus 10y JGBs)
, opened at 1.16% on 31 Jan 2014, with a target of 1.60% and a stop on a
close below 0.95%, currently at 1.18%.
Stay long LM5 (June-15 Short Sterling) vs short EDM5 (June-15 Eurodollar),
opened at 58bp on 21 Feb 2014, with a target of 20bp and a stop on a close
above 75bp, currently at 49bp.
On Equities:
Go long German equities via the DAX Index, opened at 9171.9 on 18 Mar 2014,
with a target of 10,000 and a stop on a close below 8750, currently at 9154.
5. Recommended Top Trades for 2014
Longer-term structural views are expressed in our Top Trade recommendations.
These are typically managed with a wide stop, and assessed on the basis of
whether the fundamentals continue to support the medium-term investment
theme.
Stay long SP 500 Dec 14 Future and (funded out of) short AUD/USD Dec 14
Future, opened at 1986.8 on 25 Nov 2013, with a target of 2250 and a stop on
a close below 1855, currently at 2059.
Stay long EUR swap (EONIA) 5y rate and short 5y Treasuries, opened at yield
differential of -61 (bps) on 26 Nov 2013, with a target of -130 and a stop
on a close above -35, currently at -83.
Stay long USDCAD (on a spot basis), opened at 1.055 on 27 Nov 2013, with a
target of 1.14 and a stop on a close below 1.01, currently at 1.105.
Close long HSCEI Index and short Copper Dec 14 LME future, opened at 0.0% (
on return basis, corresponding to respective price levels of 11542.1 and
7064.5 in two instruments) on 02 Dec 2013, for a potential loss of -13.5%.
Stay long risk (selling protection) on the 7-year CDX IG Series 21 junior
mezzanine tranche (the 3-7% portion of the loss distribution), opened at 465
(on a running spread basis) on 03 Dec 2013, with a target of 350 (revised
from 395) and a stop on a close above 520 (revised from 585), currently at
413.
Stay long basket in large-cap bank indices in the US, Europe, and Japan,
implemented via equal parts of BKX, SX7E, and TPNBNK indices, opened at 100
on 04 Dec 2013, with a target of 120 and a stop on a close below 90,
currently at 101.5.
Themistoklis Fiotakis - Goldman, Sachs & Co.
+44(20)7552-2901 t*******************[email protected]
Kamakshya Trivedi - Goldman Sachs International
+44(20)7051-4005 k***************[email protected]
Legal and Certification Disclosures
We, Themistoklis Fiotakis and Kamakshya Trivedi, hereby certify that all of
the views expressed in this report accurately reflect our personal views,
which have not been influenced by considerations of the firm's business or
client relationships.
For Reg AC certification, see above. For other important disclosures, go to
www.gs.com/research/hedge.html |
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