Em Currencies 0610


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A presentation I did to support a sales drive of EM debt and Asian currency structured products

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Em Currencies 0610

  1. 1. Why we like Emerging Market currencies Marshall Gittler Chief Strategist, International Deutsche Bank (Suisse) SA 22 June, 2010 Tel: +41(0)22 739 0463 e-mail: marshall.gittler@db.com
  2. 2. Why we like Emerging Market (EM) currencies on all time horizons Short-term: China has started to allow its currency to appreciate. That should allow other Asian countries to let their currencies rise as well without losing relative competitiveness. It may also spur speculation about upward pressure on EM currencies in general. Medium-term: We expect EM countries to raise rates & let their currencies appreciate to restrain inflation. One reason inflation is rising in EM countries is because of FX intervention. Raising interest rates is one way to deal with inflationary pressures. Rising interest rates should cause currencies to appreciate. Allowing FX appreciation should also dampen inflationary pressures as well as alleviating problems arising from intervention. Long-term: Currencies tend to appreciate as countries grow richer. Rising wealth in the developing world is likely to be one of the major global trends over the next decade.Global Investment Solutions Page 2
  3. 3. Why we like EM currenciesCNY appreciation, halted last year, has resumed CNY was on an appreciating trend until the global financial crisis hit in mid-2008 and the CNY has room to appreciate government called a halt. Had they let it 8.00 USD/CNY: actual* vs previous trend continue on the same path, it would currently be around 26% stronger vis-à-vis the USD. 7.50 The government announced that it would "further reform the exchange rate regime and 7.00 enhance the exchange rate flexibility" by resuming the previously announced daily 6.50 trading bands (±0.5%) around the daily fixing = 26% rate announced by the Chinese government. USD/CNY appreciation 6.00 The currency appreciated by 0.45% on June May 07~Jul 08 trend 21st, the first day of trading after the news. The market was forecasting the currency 5.50 would rise 2.3% over the next 12 months, vs *until Friday, June 18th 1.8% on the previous trading day. 5.00 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Source: Bloomberg Finance LP, DB Private Wealth ManagementGlobal Investment Solutions Page 3
  4. 4. Why we like EM currenciesUS-China trade tension pushed China to revalue Tensions between the US and China have been increasing as the US US trade deficit with China starting to widen again Congress looks for an issue that everyone can agree on, while China US trade with China 12m moving sum $bn becomes more assertive in the world $bn 400 0 political arena. 350 Against this hostile background, Treasury -50 Secretary Geithner delayed the annual 300 Treasury report on currencies, which 250 -100 would probably have branded China a Balance (R) “currency manipulator” and forced the US 200 Imports from China (L) -150 Exports to China (L) to take retaliatory measures. He probably 150 did this to give China time to allow the -200 CNY to appreciate without seeming to 100 give in to foreign pressure. (Apparently, it -250 50 worked.) 0 -300 00 01 02 03 04 05 06 07 08 09 10 Source: Bloomberg Finance LP, DB Private Wealth ManagementGlobal Investment Solutions Page 4
  5. 5. Why we like EM currenciesG20 meeting was the last straw Pressure was building on China not only from the US, but also from other CNY has been stable to lower since 2009 countries, including some other EM 1 Jan 2008 Recent movement of the Renminbi countries. Brazil and India have publicly = 100 against various currencies criticized China’s FX policy. 150 USD That put China in a bind ahead of the EUR 140 June 26/27 G20 meeting, where China JPY should be playing a leading role among 130 BRL the developing nations. It was looking as MXN INR if the CNY would be a major topic of 120 discussion this weekend. 110 By allowing the CNY to appreciate again, China has defused this issue for now. 100 The move does not satisfy those who were looking for a large one-off 90 revaluation, and there are still questions 80 about how rapidly the government will 2008 2009 2010 allow the currency to appreciate. Source: Bloomberg Finance LP, DB Private Wealth ManagementGlobal Investment Solutions Page 5
  6. 6. Why we like EM currenciesDomestic pressures another incentive for China to revalue Inflation continues to rise, led by food Real estate prices are rising again % yoy 25 % yoy China inflation 14 China house prices vs money supply % yoy 27 20 12 25 House prices (L) 10 M2 Money supply (R) 15 CPI - general 23 CPI - food 8 21 10 6 19 5 4 17 2 0 0 15 -5 -2 13 2005 2006 2007 2008 2009 2010 2006 2007 2008 2009 2010Source: Bloomberg Finance LP, DB Private Wealth Management Domestic pressures also are forcing China to revalue. The main problem is that inflation is heating up again, led by food. This is a lagging indicator of last year’s expansive monetary policy. Food prices are not that responsive to monetary policy, but housing prices may be. Global Investment Solutions Page 6
  7. 7. Why we like EM currenciesFX reserve accumulation fuelling money supply growth One of the reason why monetary Money supply grows along with FX reserves growth in China is so high is that the 45 $bn % yoy 40 China FX reserve accumulation vs government intervenes heavily in money supply 40 35 the FX market to prevent the CNY 35 12m increase in China from appreciating. It creates and FX reserves (L) 30 30 sells CNY and buys dollars. M1 (R) 25 25 If officials want to slow the pace of 20 20 monetary growth to cool the 15 15 economy, they will have to slow the 10 pace of reserve accumulation. 5 10 0 5 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Bloomberg Finance LP, DB Private Wealth ManagementGlobal Investment Solutions Page 7
  8. 8. Why we like EM currenciesThe “Impossible trinity:” Countries can’t control everything at once The problem for China (and other EM The impossible trinity countries) is called the “Impossible Trinity:” a country cannot control its Fixed exchange rate exchange rate and maintain an independent monetary policy while still being integrated into the world financial system through free capital flows. It can only control two and must let the market control the third. Only 2 are possible at one time Free capital Independent flows monetary policyGlobal Investment Solutions Page 8
  9. 9. Why we like EM currenciesRising intervention fuels money supply growth, inflation Rising money supply growth fuels inflation Asian countries reducing intervention 24 8 % yoy Asia: money supply vs inflation % yoy Change in FX reserves in AxJ 60% Asia ex-Japan countries weighted by PPP 22 7 50% 20 Nominal broad money 6 40% supply growth (L) 30% 18 Inflation (R) 5 20% 16 4 10% 0% 14 3 Six months previous -10% Latest month 12 2 -20% a s an a d na a e K 10 1 ne si re n di r H po iw hi la ay In Ko pi ai C 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 S Ta al ilip Th S. M PhSource: Bloomberg Finance LP, DB Private Wealth Management Many EM countries have chosen to control their exchange rates, but by doing so they lost control of their monetary policy as they sold their currency and thereby increased the money supply. This trend has been especially strong in Asia, where rising monetary growth has fuelled inflationary pressures and given rise to fears of a financial bubble. This may be one reason why several Asian countries have slowed their pace of reserve accumulation recently despite the rising dollar. Money supply growth is slowing as a result. Global Investment Solutions Page 9
  10. 10. Why we like EM currenciesIndia, Malaysia start tightening cycles as inflation rises; FX appreciating 38 % India policy rate, inflation & FX 9 % Malaysia policy rate, inflation & FX 3.116 40 3.214 7 42 3.312 5 3.4 4410 3 3.5 46 8 3.6 1 6 48 3.7 4 50 -1 3.8 2 52 -3 3.9 2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2009 2010 RBI Reverse repo yield (L) India CPI (L) USD/INR (R, inverted) Malaysia overnight policy rate (L) Malaysia CPI (L) USD/MYR (R, inverted)Source: Bloomberg Finance LP, DB Private Wealth Management India and Malaysia have already started down this path. They have let their currencies appreciate since the beginning of 2009, while the central banks of both countries recently started a tightening cycle. Global Investment Solutions Page 10
  11. 11. Why we like EM currenciesIndia, Malaysia, now Singapore; others to follow? The Monetary Authority of Singapore (MAS) surprised the market on 14 April by a Singapore NEER already outside its band combined "recentering of the policy band at Estimated Singapore NEER the prevailing level of the SGD NEER" 104 with upper and lower bands (nominal effective exchange rate) and a shift 103 in the policy band’s slope to "modest and gradual appreciation". This was the first time 102 MAS has adjusted both simultaneously and thus was an aggressive tightening, in our 101 view. 100 MAS explained that Singapore’s recovery “has been stronger than expected, and more 99 entrenched.” It said it expects the economy to 98 continue to improve and inflation to continue Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 to rise for the rest of the year. Source: Bloomberg Finance LP, Goldman Sachs, DB Private Wealth Management We expect that other Asian countries are thinking the same way but have been waiting for China to move first before they too allow further FX appreciation.Global Investment Solutions Page 11
  12. 12. Why we like EM currenciesAs short rates rise, FX should appreciate as well We have seen how several Asian central banks have begun to tighten policy to deal AxJ-USD 3m spreads is generally widening with the inflationary threat. As a result, their 11 Spread of AxJ 3m rates vs USD 3m short-term interest rates have been rising. 10 % 9 In the US however there is currently little fear 8 of higher inflation and the Fed has stated that 7 India short rates are likely to remain low “for an 6 Indonesia 5 Korea extended period of time.” 4 Malaysia 3 Philippines The spread between short-term Asian 2 Singapore interest rates and USD rates is rising as a 1 Taiwan 0 result. This widening interest rate differential -1 Thailand is likely to support Asian currencies going -2 forward – and other EM currencies as well. -3 -4 -5 2007 2008 2009 2010 Source: Bloomberg Finance LP, DB Private Wealth ManagementGlobal Investment Solutions Page 12
  13. 13. Why we like EM currenciesHow did other Asian currencies react when CNY was floated in 2005? Most Asian currencies underperformed the CNY in the days after the USD peg was Other currencies outpaced CNY after 2005 unpegging dropped in 2005. Movement of Asian currencies vs USD 120 22 July 2005 However, after a few months, the = 100 currencies generally appreciated more than 115 CNY KRW IDR the CNY (except for INR). INR SGD THB The Chinese Yuan did not move during the 110 2008 crisis (as seen on pgs. 3 and 5). 105 100 95 90 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Source: Bloomberg Finance LP, DB Private Wealth ManagementGlobal Investment Solutions Page 13
  14. 14. Why we like EM currenciesOther EM countries also feeling inflationary pressure Inflation is turning up in Latin Inflation turning up in Latam, Asia; slowing in EMEA America. The high level of inflation 12 in Eastern Europe and the Middle % CPI inflation rates weighted by GDP at PPP East (EMEA) has been coming 10 down recently, but it remains 8 relatively high. 6 Rising interest rates (which should help EM currencies to appreciate) 4 and rising currencies are two of the 2 ways that we expect EM central banks to deal with the inflationary 0 G3 (inc UK) East Asia (ex Japan) danger. Latam EMEA -2 2004 2005 2006 2007 2008 2009 2010 Source: Bloomberg Finance LP, DB Private Wealth ManagementGlobal Investment Solutions Page 14
  15. 15. Why we like EM currenciesCapital controls are not likely to be a long-term solution Some countries have tried capital Capital controls didn’t work for THB or BRL controls as another way of dealing with the “impossible trinity,” that is, 115 4m before date of keeping hold of FX and monetary imposition = 100 policy by restraining capital flows. Week when controls BRL 110 were imposed Previous attempts at controlling FX (19 Dec 06 for THB) rates through capital controls have generally proved ineffective. Brazil 105 tried something similar back in THB (9/06 2008, but it had only a temporary to 4/07 effect. Thailand also tried to 100 restrict inflows in 2006, but this too caused only a short-term plateau in the upward trend. 95 Dec-07 Feb-08 Apr-08 Jun-08 We see this as a way of slowing the trend, but not defeating it. Source: Bloomberg Finance LP, DB Private Wealth Management Global Investment Solutions Page 15
  16. 16. Why we like EM currenciesEM currencies likely to appreciate as EM countries get wealthier As countries become more Richer countries tend to have richer currencies developed, their export sectors become more efficient & more Currency valuation vs GDP 20% competitive and labor costs start to Brazil Hungary rise. Other sectors have to raise their 10% Turkey Czech wages too in order to keep pace. As a Currency over/undervaluation based on Economists Big Mac index 0% result, wages – and price levels – Colombia Chile tend to rise1. -10% Argentina If wages and price levels rise -20% Poland Mexico simultaneously, it means that the -30% Indonesia South Africa Russia purchasing power of the currency -40% rises relative to that of other countries. Thailand Malaysia Philippines -50% We expect rising prosperity in EM to China be one of the major economic themes -60% 0 5,000 10,000 15,000 20,000 25,000 of the next decade. Rising FX rates GDP/capita (based on PPP) should accompany this trend. 1This is known as the “Balassa-Samuelson effect” Source: Bloomberg Finance LP, IMF, DB Private Wealth ManagementGlobal Investment Solutions Page 16
  17. 17. Why we like EM currenciesOther reasons for EM currencies to appreciate Growth gap: Growth potential in the G7 countries has been further reduced by the crisis but also by structural factors. The already EM countries forecast to grow faster than DM strong growth lead of the EMs, especially in 14% Annual growth rate Asia, should therefore continue to widen. 12% at PPP Forecast Relative importance of exports is declining. 10% In some countries domestic consumption is 8% becoming increasingly powerful driver of 6% economic growth. This means that the 4% importance of a weak exchange rate for exports 2% is declining. 0% Solid fundamentals (this applies above all to -2% EM Asia and Latin America). 1980 1985 1990 1995 2000 2005 2010 Capital inflows: Privatisations are in the Advanced economies Emerging and developing economies pipeline in several countries (India, Malaysia), as well as the largest share offers ever (Brazil, Source: IMF World Economic Outlook China). Huge infrastructure projects (India, China) should also attract foreign capital.Global Investment Solutions Page 17
  18. 18. Why we like EM currencies Reasons to invest in EM currencies through EM bonds: improved risk profile EM debt burden is falling EM demographics still improving 110 Dependency ratios % Public debt 90 # of children and elderly as a % of working-age population as % of GDP 100 80 90 Advanced economies Forecast Forecast Emerging and developing economies 80 70 70 60 60 50 50 40 40 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 30 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Developed countries Developing countries (ex least developed) EM debt levels are likely to fall as a percent of GDP over the next five years while DM debt levels soar, according to the IMF. Yet the pension burden that DM countries face is still far away. In fact, EM countries could even afford higher debt levels, thanks to their higher growth potential. Productivity increases, positive demographics, liberalization and deregulation give EM better long-term growth potential than in DM. The combination of higher growth, and thus greater sources of revenue for debt servicing, and much lower debt levels should further reduce the historical spreads paid on emerging market debt. Global Investment Solutions Page 18Source: IMF World Economic Outlook Source: United Nations World Population Prospects 2008 Revision, DB PWM
  19. 19. Why we like EM currenciesReasons to invest in EM currencies through EM bonds: higher return potential Yields are generally higher in EM bond markets than in DM bond EM bond yields are generally higher than DM markets. That not only means greater 14 % EM vs DM 10yr bond yields income, but also more room for price 12 appreciation if yields decline and 10 EM countries greater cushion if interest rates move 8 DM countries up. 6 4 Yet some EM countries have a lower 2 risk of being downgraded (or looked at 0 another way, a greater possibility of K G US A l a M ry y o Po u C na a un a R d M sia n do a a a i ut az an si r ic di C e si n pa bi In fric ad U ga Pe being upgraded) than the developed la hi ay ex us In om So Br m Ja an n C al er ol h H countries that offer lower yields. These include Brazil, South Africa, Data as of 22 June 2010 India, Colombia, Mexico and Russia, Source: Bloomberg Finance LP, IMF, DB Private Wealth Management among others.Global Investment Solutions Page 19
  20. 20. Why we like EM currenciesReasons to invest in EM currencies through EM bonds: liquidity, diversification Rapid development, growing size, importance and liquidity of these markets Local Currency bonds have overtaken hard currency bonds in importance. Over the past five years the local market has grown by 18.8% p.a. compared to 8% p.a. for hard currency bonds. In addition to fixed coupon bonds, there is also an increasing supply of inflation linkers. Positive diversification Local bond markets are driven above all by domestic factors, such as the fiscal situation, inflation, external balances, etc., rather than US or ECB monetary policy, which affect many other asset classes globally.Global Investment Solutions Page 20
  21. 21. Why we like EM currencies The new world will be more like the old world India and China are reclaiming their historical role in the world economy Share of World GDP 100% Rest of world 80% 60% Europe & N. America Japan 40% India 20% China 0% 0 500 1000 1500 2000 Year The emergence of the EM countries is more of re-emergence. For most of history, China and India have been the major forces in the global economy. Global Investment Solutions Page 21Source: Angus Maddison, The World Economy
  22. 22. Why we like EM currencies Which ship would you rather be on? The ship used by Chinese Admiral Zheng He in 1405 compared to Columbus’. The Ming Dynastys fleet of giant ships predates the Columbus expedition across the Atlantic by some 85 years. Global Investment Solutions Page 22Photograph of the display in the China Court of the Ibn Battuta Mall in Dubai. Source: Wikipedia
  23. 23. Why we like EM currenciesStrategy recommendations Pure FX Carry trades that involve borrowing in developed-country currencies and investing the funds in EM currencies. FX indices to take advantage of FX appreciation. Bonds We expect higher short-term rates in EM countries. Shorter-maturity bonds should hold up better than the long end during a tightening cycle. Later in the cycle, switch into longer-maturity bonds after rate hikes dampens inflation expectations. Index-linked bonds would benefit from currency appreciation plus growth rates (and hence inflation rates) that are likely to be higher than in the developed countries. Real assets Real assets, such as property, or claims on real assets, such as stocks, can be bought now in currencies that we believe are likely to appreciate in the future.Global Investment Solutions Page 23
  24. 24. Important notesPrivate Wealth Management offers wealth management solutions for wealthy individuals, their families and select institutions worldwide. Deutsche BankPrivate Wealth Management, through Deutsche Bank AG, its affiliated companies and its officers and employees (collectively “Deutsche Bank”) havepublished this document in good faith and on the following basis.This document has been prepared without consideration of the investment needs, objectives or financial circumstances of any investor. Before making aninvestment decision, investors need to consider, with or without the assistance of an investment adviser, whether the investments and strategiesdescribed or provided by Deutsche Bank, are appropriate, in light of their particular investment needs, objectives and financial circumstances.Furthermore, this document is for information/discussion purposes only and does not constitute an offer, recommendation or solicitation to conclude atransaction and should not be treated as giving investment advice.Deutsche Bank does not give tax or legal advice. Investors should seek advice from their own tax experts and lawyers, in considering investments andstrategies suggested by Deutsche Bank. Investments with Deutsche Bank are not guaranteed, unless specified. Unless notified to the contrary in aparticular case, investment instruments are not insured by the Federal Deposit Insurance Corporation ("FDIC") or any other governmental entity, and arenot guaranteed by or obligations of Deutsche Bank AG or its affiliates.Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness orfairness, and it should not be relied upon as such. All opinions and estimates herein, including forecast returns, reflect our judgment on the date of thisreport and are subject to change without notice and involve a number of assumptions which may not prove valid.Investments are subject to investment risk, including market fluctuations, regulatory change, possible delays in repayment and loss of income andprincipal invested. The value of investments can fall as well as rise and you might not get back the amount originally invested at any point in time.This publication contains forward looking statements. Forward looking statements include, but are not limited to assumptions, estimates, projections,opinions, models and hypothetical performance analysis. The forward looking statements expressed constitute the author’s judgement as of the date ofthis material. Forward looking statements involve significant elements of subjective judgements and analyses and changes thereto and/or consideration ofdifferent or additional factors could have a material impact on the results indicated. Therefore, actual results may vary, perhaps materially, from the resultscontained herein. No representation or warranty is made by Deutsche Bank as to the reasonableness or completeness of such forward looking statementsor to any other financial information contained herein.The terms of any investment will be exclusively subject to the detailed provisions, including risk considerations, contained in the Offering Documents.When making an investment decision, you should rely solely on the final documentation relating to the transaction and not the summary contained herein.This document may not be reproduced or circulated without our written authority. The manner of circulation and distribution of this document may berestricted by law or regulation in certain countries, including the United States. This document is not directed to, or intended for distribution to or use by,any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, including the United States, where suchdistribution, publication, availability or use would be contrary to law or regulation or which would subject Deutsche Bank to any registration or licensingrequirement within such jurisdiction not currently met within such jurisdiction. Persons into whose possession this document may come are required toinform themselves of, and to observe, such restrictions.Past performance is no guarantee of future results; nothing contained herein shall constitute any representation or warranty as to future performance.Further information is available upon investors request. Global Investment Solutions Page 24