The Answer is China?
CitiFX | Corporate FX
Market commentary | November 2015
Stephen Leach
+1 212-723-9332 Information contained in this document may not be reproduced
or disseminated without the prior written consent of Citi
Contents
1
The global economy
Exchange rate developments
Problem countries?
2
The global economy
A ‘broad brush’ view of the global
economy in 2016:
Sluggish GDP growth, with risks
seemingly to the downside
Soft commodity prices
Low inflation
Low interest rates
Increasingly ineffective monetary
policies
Governments unwilling to commit
to fiscal expansion
Not an environment that would
suggest large exchange rate
swings……
…..though the bias is still
toward a stronger U.S. dollar
3
Slow growth = a combination of structural & cyclical factors
Structural =
advanced
economies?
Cyclical = China = emerging markets?
(or is this really structural?)
The global economy
4
Weak recovery Weak investment
Weak
productivity
growth
Weak growth
in wages
Weak
consumption
growth
Advanced economies: A slow growth equilibrium…………
……….seemingly immune to monetary policy changes
The global economy
Negative impact on: FX
rates, balance of payments,
GDP growth, budget
balance, credit/debt
servicing & confidence
5
China Commodity
demand
Commodity
producers
Rest of the
world
Slowdown +
economic
rebalancing
The United States is not strong enough to compensate
The global economy
6
Commodity price forecasts
Dec ‘15 Mar ’16 Jun ‘16 Sep ‘16 Dec ‘16
Brent crude oil ($/barrel) 44 44 50 55 60
Copper ($/MT) 5,550 5,600 5,800 6,100 6,200
Iron ore ($/MT) 50 45 40 38 40
Corn ($/bu) 370 395 405 415 400
Soybeans ($/bu) 890 915 925 900 925
Source: Citi Global Economic Outlook & Strategy, October 2015
The global economy
7
0%
1%
2%
3%
4%
5%
6%
7%
S'11 F'11 S'12 F'12 S'13 F'13 S'14 F'14 S'15 F'15
Advanced economies Emerging markets
THE IMF’S 2016 GDP GROWTH FORECASTS
Per cent
Source: IMF World Economic Outlook database
The global economy
Not just the IMF…..
…..all forecasters
have been
systematically too
optimistic on growth
in emerging markets
8
GDP growth
2015 2016 Revised*
Developed economies 1.9% 2.0% Down
United States 2.4% 2.5% Down
Euro-zone 1.5% 1.6% Down
Japan 0.5% 1.0% Down
U.K. 2.4% 2.5% Down
Emerging markets 3.6% 4.0% Down
Brazil -3.1% -1.8% Down
China 6.9% 6.3% Down
India 7.5% 7.8% ???
Mexico 2.3% 2.8% Down
Russia -3.7% 0.5% Down
Turkey 2.8% 2.0% Down
Source: Citi Global Economic Outlook & Strategy, October 2015; *2016 forecast relative to October 2014
The global economy
9
Inflation
2015 2016 Revised*
Developed economies 0.3% 1.4% Down
United States 0.3% 1.6% Down
Euro-zone 0.1% 1.0% Down
Japan 0.8% 0.5% Down
U.K. 0.1% 1.0% Down
Emerging markets 4.9% 4.4% Unchanged
Brazil 8.9% 7.5% Up
China 1.5% 1.9% Down
India 5.0% 4.8% Down
Mexico 2.8% 3.7% Up
Russia 15.3% 7.7% Up
Turkey 7.7% 7.3% Up
The global economy
Source: Citi Global Economic Outlook & Strategy, October 2015; *2016 forecast relative to October 2014
Contents
10
The global economy
Exchange rate developments
Problem countries?
11
More modest FX moves ahead?
Large depreciation/devaluations have already occurred
Prospective monetary policy changes are small & largely
discounted
The shock effects from the plunge in commodity prices
are in the past; most countries are now in the adjustment
phase
A number of currencies have overshot (Dornbusch
overshooting?)
FX developments
12
-50%
-40%
-30%
-20%
-10%
0%
ZM
W
UA
H
Bre
nt
BY
R
Iron
ore
BR
L
KZ
T
RU
B
CO
P
MZ
N
GE
L
AO
A
MD
L
AZ
N
UG
X
TJ
S
Co
pp
er
TR
Y
MY
R
DZ
D
TZ
S
MM
K
NO
K
ZA
R
AU
D
TM
T
MX
N
PY
G
KG
S
UY
U
MG
A
NG
N
CL
P
THE WORST PERFORMERS: Last Twelve Months
Per cent change vs. U.S. dollar
October 31, 2014 – October 30, 2015; Source: Reuters, Bloomberg, Citi, various central bank websites
FX developments
13
0%
5%
10%
15%
20%
25%
30%
SC
R
CR
C
THE BEST PERFORMERS: Last Twelve Months
Per cent change vs. U.S. dollar
Put simply, the U.S.
dollar has
appreciated against
virtually everything
October 31, 2014 – October 23, 2015; Source: Reuters, Bloomberg, Citi, various central bank websites
FX developments
14
Russia/Ukraine Commodity
currencies
Most major
currencies
Most Asian
currencies
What’s on the list?
What’s missing from the list?
FX developments
15
Relative monetary policy
Russia/Ukraine
Commodity prices
Slowdown in China
EM growth slowdown
No longer an issue
Still critical for major currencies in 2016
The dominant issue for 2016?
FX developments
16
Real exchange rate
The conventional adjustment pattern
during a crisis
Financial markets overshoot
because the real economy takes
much longer to adjust
The real exchange rate can start
to rebound even before the
trough of the business cycle has
been reached
Economic growth
FX developments
17
Real exchange rate
Economic growth
FX developments
Qualifications for emerging markets/commodity producers?
Illiquid & poorly developed financial markets means that
the exchange rate overshoot can be even larger
The exchange rate changes feed through into debt service
problems (‘original sin’) & credit problems
Governments tend not to have the same ability to run
counter-cyclical monetary & fiscal policies
Resource sectors take even longer to adjust than other
sectors of the economy
18
FX developments
Depreciation Inflation Policy response
Higher interest
rates
FX auction
mechanisms
Financial market
liberalization
Across a broad
range of emerging
markets
19
Overshot
equilibrium
level?
Resisting/insufficient
adjustment
Brazil
Colombia
Mexico
Indonesia
Malaysia
South Africa
Turkey
Angola
Argentina
Bolivia
Nigeria
Egypt
Pakistan
Sri Lanka
Trinidad
Venezuela
Vietnam
FX developments
Contents
20
Problem countries?
--- China
--- Brazil
--- Argentina
--- Mexico
--- Russia
--- Turkey
21
Source: Thomson Reuters, Citi
| Jul | Aug | Sep | Oct | Nov |5.9
6.0
6.1
6.2
6.3
6.4
6.5
6.6Yuan per U.S. dollar
CHINESE RENMNBI: Onshore CNY
Limit of 2% band
Limit of 2% band
Not as
inconsequential
as it appears
China
22
What did China do on August 11?
Adopted a market-determined fixing rate
Devalued the fixing rate by 1.8%
Why?
To move to a more flexible market-determined FX rate
Result?
Strong downward pressure on the renminbi
Massive PBOC intervention to limit depreciation & maintain
market stability
Imposition of draconian reserve requirement on FX
derivatives
China
23
| 2011 | 2012 | 2013 | 2014 | 2015 |
0
40
80
120
-40
-80
-120
-160
Billions of U.S. dollars
CHINA: Financial sector FX purchases or sales
A proxy for central
bank intervention…..
…..but includes
intervention in the
offshore CNH market
Reserve requirement
on onshore FX
derivatives
prompted trading
shift to offshore
CNH market
Source: Bloomberg, Citi
China
24
Outlook?
Chinese authorities to allow at worst a gradual
depreciation…..
…..provided that a greater sense of two-way risk can be
established
Focus on stability in the run-up to the renminbi’s inclusion
in the SDR
China
25
CHINA: GDP Growth vs. LKQ Index
| '08 | '09 | '10 | '11 | '12 | '13 | '14 | '15 |0%
5%
10%
15%
20%
25%
30%Per cent, year-on-year
LKQ index
GDP
Source: Bloomberg, Citi
Consensus that growth
now around 5-6% rather
than official data
Five-year plan to target
6.5% growth rate
China
26
Brazil
Commodity
prices
Deep
recession
Primary
budget
deficit
Fiscal
austerity
Political
resistance
To austerity
Loss of
investor
confidence
Credit/debt
problems
FX
outflows/
weaker
currency
Political
opposition
to president
27
Source: Thomson Reuters, Citi
BRAZILIAN REAL: 2014-2015
| 2014 | 2015 |2.00
2.25
2.50
2.75
3.00
3.25
3.50
3.75
4.00
4.25Reais per U.S. dollar
Previous record low in October 2002
Undervalued but no
good news
Downgrade to junk?
Impeachment of
president?
Brazil
28
Argentina
Scioli Macri vs.
Supported by CFK
Publicly – favors continuation
of CFK policies, but with more
flexibility & pragmatism
‘Change’ from Kirchnerism
Publicly – favors faster
liberalization of controls –
exchange controls, currency
controls, price controls etc.
29
Source: Bloomberg, Citi
| Jul | Aug | Sep | Oct | Nov |8
9
10
11
12
13
14
15
16Pesos per U.S. dollar
ARGENTINE PESO: 3-month NDFs
Market ‘hoping’ for
Macri?
Reality: current
regime is
unsustainable due to
lack of reserves
Argentina
Argentina
30
Source: Citi, Argentina Macro Flash, October 28
0
5
10
15
20
25
30
Freereserves
China swapline
Dollardeposits
Lebacs
Blockeddebtpayments
International reserves are
reported at about US$26.9
billion
US$13 billion has been
borrowed from China under a
short-term swap facility
‘Blocked’ debt payments –
under the pari passu debt case
– are about US$2.3 billion
‘Free reserves’ may total only
US$1.2 billion.
Mexico
31
USD/Emerging markets USD/Mexican peso
A proxy for emerging
market currencies when
there is no strong reason
to buy pesos
Mexico
32
No strong reason to buy pesos in the current
environment…..
No sign of a significant pick-up in the economy – U.S.
growth not above the required threshold level
Soft oil price outlook undermining Mexico’s balance of
payments & reducing reform-related inflows
…..which undermines support for reforms
Mexico would cut interest rates now were it not for the
external constraint
…..and will follow the Fed regardless of domestic
circumstances
33
Mexico
| 2011 | 2012 | 2013 | 2014 | 2015 |76
79
82
85
88
91
94
97Index, end-2006 = 100
MEXICAN PESO: Real Effective Rate
The peso is undervalued by most metrics – Canada finds it difficult to compete!
Source: Thomson Reuters, Bank for International Settlements, Citi
| '15:1 | '15:2 | '15:3 | '15:4 |14.0
14.5
15.0
15.5
16.0
16.5
17.0
17.5Pesos per U.S. dollar
MEXICAN PESO: 2015
Russia
34
RUB = largely a function of oil prices
Russia has better adjusted to the decline in oil prices than
any other major producer…..
…..albeit at the cost of recession
Interest rates to fall gradually
Sanctions to remain in place
Russia
35
RUSSIAN ROUBLE: 2015
| '15:1 | '15:2 | '15:3 | '15:4 |45
48
51
54
57
60
63
66
69
72
75Rupees per U.S. dollar
Spot
Fitted
Fitted line based on
oil prices
Source: Thomson Reuters, Citi
36
RUSSIA: 'Capital Flight'
| 2012 | 2013 | 2014 | 2015 |
0
15
30
-15
-30
-45
-60
-75
-90
Billions of U.S. dollars
Capital flight Other private sector capital
Source: Central Bank of Russia, Citi,
‘Capital flight’ – in the
Russian context – is
defined as capital
outflows by the non-
financial private
sector
As illustrated, as the
crisis has receded, so
capital flight has
diminished – and
reversed in the 3rd
quarter
Russia
Turkey
37
Turkey’s General Election
A complete turnaround from June
Security concerns trump economic issues
Good news
Relieves political uncertainty
Helpful in addressing military/political conflicts in the
region
Bad news
Pressure for more populist policies?
Less central bank independence?
Limits on presidential power?
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