From: Daniel Sabba

From: Daniel Sabba To: [email protected] Cc: Paul Morris , Vahe Ste anian , Stewart Oldfield Subject: Update in USDCNH Date: Mon, 03 Nov 2014 17:17:38 +0000 Inline-Images: unnamed; unnamed(1); unnamed(2); unnamed(3); unnamed(4); unnamed(5); unnamed(6); unnamed(7); unnamed(8); unnamed(9) Classification: Public Jeffrey, Rich and I spoke last week on USDCNH, and I wanted to send a recent piece from our research team on this topic. For full disclosure, I personally don't share our research team's recommendation, as USDCNH vol still extremely low and it represents a very cheap out-of-consensus expression of CNH out-performance vs. USD, so don't see the value of crossing bid offer on the transaction. Having said that, our research team advocates closing their USDCNH put spreads as they view "the next phase of FX depreciation will be driven more by China's own worsening fundamentals, namely: 1) slower growth and disinflation, (2) a pick-up in outflows, (3) de-leveraging that increases short-term risks and (4) valuations approaching expensive extremes" You could unwind you $75mm USDCNH put struck at 6.16 expiring on 12-Aug-2015 for $270k bid (Spot ref 6.1310 - the mid would be $315k - pricing as of noon 11/03/2014) You paid $273k for it. More details on the research piece below. Best regards, Daniel -- Forwarded by Daniel Sabbaidbidbcom on 11/03/2014 11:49AM — Classification: Public China growth is facing increasing headwinds, with DB Economics downgrading our 2015 growth forecast to 7.0% this week. In this context, we believe RMB weakness will return to haunt the market in 2015. This weakness will be different from the early 2014 squeeze, which appeared to be engineered by policy-makers to target speculative capital. The next phase of RMB depreciation will be driven more by China's own worsening fundamentals, namely: (1) slower growth and disinflation, (2) a pick-up in outflows, (3) de- leveraging that increases short-term risks and (4) valuations approaching expensive extremes. In our view, the resistance from policy-makers to FX weakness will be minimal since it will reflect underlying fundamentals, and authorities should be comfortable with a more market-driven RMB. Moreover, retaining the current policy bias for appreciation would only pull in more 'hot' money flows, which increase systematic risks in China. With this in mind, we are reducing the long CNH exposure in our portfolio by closing out our USD/CNH put spread. The slowdown in Chinese growth and RMB weakness is also likely impact other Asian currencies. We examine four channels of spillover: (I) exports, (2) FDI, (3) financial linkages, and (4) FX policy, and find the KRW, MYR and TWD to be most likely to be affected. Link: http://pull.dh-gmresearch.com/cgi-bin/pull/DocPuIV2643-DFF1/41968444/DB AsiaFXStrat 2014-10- 23 0900b8c01311c00869.pdf EFTA01204629 Figure 3: The Chinese authorities have been loosening monetary policy, particularly in the past few months Oates Measures announced 8-Apr-14 COB was granted about 100 billion yuan in loans to shantytown rebuilding projects 18-Apr-14 The State Council announces a 50bps RRR cut for county-Ise; ruml commercial arc cooperative banks The PBOC announced an increase in lending to micro and small-sized enterprises (MSEs). arranging 50 billion yuan re-lending quota 21-Mar-14 specially for loans to MSEs. 6-May-14 The PBoC lent RMB100bn to some of srna banks and rural creCt unons va its re-lending tac2rty. 21-May-14 China allows local governments to independently issue bonds. 10 local governments to sell bonds on their own cretin 22-May-14 The Pea.: lent 300 billion yuan to the Ch na Development Bank 'or re-lending to reconstruction projects of shanty towns 30-May-14 Targetted RRR cut for financial institutions with loans. to SME and agricultural sectors 6-..k4n-14 The Peat lent 100 billion yuan to scree small- and medium-sized banks to allow them to re-lend the cash to agricultural projects 9-Ari-14 PBoC announces it moil cut the RRR by 50bp for many small banks, effective 18 June 12-Jun-14 The Peat announced a string of credit measure to heap exporters 30-Jun-14 CBRCs tweak loan-to-deposit ratios to support growth 7-Jul-14 The Peoples Bank of Chra started a 100 brIlon yuan (518 blicn) quota for Wending 'or agriculture and small businesses. 20-Jul-14 I PBOC oats COB a RMBltm credit line for Shantytown developments 31-Jul-14 Pea: cuts its 14-day repo opera:on today by 10bp to 3.7%. PBoC announces that it 411 ricrease its rediscount tacky quota by RMB12bn for some of its branches to support the financing of 8-Aug-14 the agricultural sector and small and micro enterprises 27-Aug-14 Peat sets aside another 20bn yuan for a reencling program 18-Sep-14 Local press reported PBOC monied out Standing Lending Facility (SLF) operation. prcvding 500 billion liquidity to five major banks. 18-Sep-14 Peat cuts its 14-day repo opera: on tccay by 2Cbo to 3 5%. The PBOC and the CBRC jointly announced measures to loosen mortgage policy and encourage banks to support shantytown 30-Sep-14 projects and better-quality developers. 14-Oct-14 PBoC cuts its 14-day repo opera: on tccay by 1Cbp to 3 4% 17-Oct-14 PBoC announced it moil inject RMB200bn into Joint-Stock banks Figure 4: RMB policy normally moves in sync with monetary policy 12 10% 8% 6% 4% 2% 0% 25% 20 15% 10 5% -2% 1 1 I I i I I • I 4% I i I m.e.6 Emma, 0% ..4046 JaM08mm J4010 4M-I2 J00-I4 -Deposit rates (%. INS) CNY-f:0111(%Y0Y.LHS1 RRRI%.RH51 Solna Oath. Batt a Snits, Fist • IP Figure 6: RMB could again shift towards being more market-driven. particularly since fundamentals no longer support a strong RMB 6.50 6.45 6.40 625 620 625 6.20 6.15 6.10 6.05 6.00 80.0 Jan-12 Jul-12 Jan-13 Jul-13 Jan- 4 Jul-14 —CNY Spot I.rSD Index Irebased to 2 Jan 2012 =100. RHSI Figure 5: Ongoing RMB strengthening could add to the disinflationary environment China is facing 12.0% 10.0% 80% 60% 40% 2.0% 0.0% -2.0% 2007 2008 2009 2010 2011 10% -2% -4% 2012 2013 2014 20 5 —04YarpecetionvsUSD IPEloClecnosl —Chins CPI IRHSI &feat olglehe s* a Mangey FkenzaP Figure 7: From a valuation perspective, the RMB is looking expensive -10% -20% -30% -2 std dev -40% Jan-00 Jan-03 Jan-06 Jan-09 Jan-12 FREER: Deviation from LT average: CNY Savor Daase• Bant CRC Ellatarg Anne LP Swam Oates Bak, a tent,* Fame LP EFTA01204630 Figure 8: China tends to experience capital outflows I Figure 9: Recent weakening in growth and RMB has resulted in flows into China becoming more balanced 20.0% 60 16.0% 16.0% 20 14.0% 120% 20 10.0% to 6.0 4.0% 2.0% -100 0.0 120 maws Mat07 lae09 maw. 11 Mar.13 fl op. Currency & Deco (RHSI —Materiel peed* 1%YoY. 3MMA) Spa a Dawes Batt a akestarg livatea LP Figure 10: Corporates are actively rebuilding their USD balance sheets.... 700 Sbn 603 500 400 C: Jut12 Jeee13 Jul.13 Jar-I4 Jul-14 F)( depo in ChM —USCUCNY spot IRHSI Swear Causes &A cac abaseenti a sea LP 6.40 6.35 6.3D 6.25 6.20 6.15 6.10 6.05 Figure 12: Increasingly. 7.5% growth target is not achievable in the absence of stimuli 14.0% % YoY % YoY, 13.0% 3MMA 12.0% 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% .1arbtombetigaretiGDPeicta2 •Lan-hip TigaA13 II,, (96 YoY. 3MMA) 120 100 80 60 40 20 O Sbn 40 .40. .60 60 Jan-10 Jan-11 Jan-I2 Jan-13 Jan-14 rade bar a FDI —Jet Fl FX purchases &en Ofleche Bata raC abonhas F LP 'unexplained* (base Figure 11: And actively hedging more of their FX risks 80 70 60 50 40 30 20 10 0 -10 20 ao Jaral 1 Jace12 Jan-13 —Net USDICNY hods by corporates 'IAS) ibis MI Mina sum Sara Ogresrio s .raC atarday Fs= 6.10 6.15 8.20 6.25 8.30 6.35 6.40 6.45 6.50 Jan-14 USD/CNY Sped I Figure 13: More credit required for every incremental bit of GDP grout 20% 18.0 CNY tm 16.0 12% 8.0 6.0 • I I I I 8.0 6.0 10% 4.O 1 I II I I 4.O 8% 2.0 16.0 14.0 18% • 14.0 • 12.0 16% 12.0 14 10.0 10.0 0.0 M . I . Z . Z . I . M . 1 . Iffi 1-2.0 6% -2.0 0.0 4% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 • Bank Loans • Bonds & Equity •Smes5 Son Orathaatt a Snobs, Sists San Ortshthank a amen bra IP • Offbalance sheet financing • Others when the domestic economy slows EFTA01204631 Figure 14: China's overall debt level is rising dramatically, particularly corporate debt, which stands at 150% of GDP Figure 15: China's corporate debt has been rising faster than that of the US over the past few years 250% 160% Scott Wren. oat CSC IlbambsySvme•LP 100% MCcrporate debt MLOCal Gest with LGFV Jana 19409 Jan-10 Jan-11 Jan-I2 .190-13 1 1 1 11 meential pow • Household bans Son Couffiese Sink CSC Scombn Feat, 120% 150% 100% SO% 60% 50% 20% 0% 40% 0% 2000 2009 2010 2011 2012 2013 MCC.00(010 debt as a %d GDP US Menne 1 140% 200% I Figure 18: Rising risk of loss-making enterprises and possible default if credit growth slows further 20% 18% • 16% 14% 1. 1 . 1 . 12% 10% :3% 6% 4% 2% 0% . Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan 12 Jan-13 BNo of Loss Making Enterprise % of total Large •Medium ANew Yuan loans growth (RHSI aria Cfroutas efla* CRC akeithegrovers 35% 30% 25% 20% 15% 10% 5% 0% I Figure 16: SOEs' RoA has not picked up, despite rising debt level 6.0% 11 9.0% 8.0% 5.0% 7.0% 4.0% 6.0% 3.0% 5.0% 4.0% 2.0% 3.0% 1.0% 2.0% 1.0% 0.0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 0.0% Figure 19: Industrial profitability is at risk of declining as IP slows YoY% 3MMA 18 13 3 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Iridustnal men Industrial Enterprise profitability YoY% 3MMA 100% :30% 60% 40% 20% Sacra Onesta hot CSC Beanbag Fetal°. LP 0% -20% -40% Figure 17: In fact, net profit margin has been low despite easy funding compared with private enterprises in China *China SOEs: Return onassets Sower Llamas Bart CSC Sbadwg rests LP % annusbed Mar-03 Mar-05 Mar-07 Mar-09 No' margin SOE lex. France's) Sewn Saari Sank CSC aorta, arra Mari 1 Mar-13 Private (a Financials) EFTA01204632 'Figure 22: Asia exports to China have slowed notably 40% 30% 20% 10% 0% -10% -20% Juh-11 Dec-II Dec-I2 JunI3 Dec-I3 Jun-14 —9C —MY —SI —TA —TH —PH ammwilluerS&AMCMalippaes0 Figure 24: Taiwan and Korea are the most exposed to China % of Boats 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% TA 5K MY PH ID TH SI ROM°. •Asia XCH •EU NNI. America 'China S America MILATAM NEU NAsia Figure 23: Taiwan, Malaysia and Korea are the most exposed to China's slowdown, given that the majority of heir products are electronics % el Everts 100% S0% III W% W% 60% W% 40% 30% 20% W% 0% ID TA MY 5K PH SI TH •0thers *Trans Cu •Chem • Primary ProcCOMachinary•Bectrcesc I SommArmewMAinkUMMmOmpawy0 Figure 25: Chinese investment into Asia is the largest relative to other regions 120 lusobn 100 80 60 40 20 O aid ll 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 SouncAuftes8s4UKAlamby -PkwooLl. SmftmArmsdealonkUKAbankryfornm0 This communication may contain confidential and/or privileged information. If you are not the intended recipient (or have received this communication in error) please notify the sender immediately and destroy this communication. Any unauthorized copying, disclosure or distribution of the material in this communication is strictly forbidden. Deutsche Bank does not render legal or tax advice, and the information contained in this communication should not be regarded as such. EFTA01204633