The Context17th June 2019

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The Context

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Inside this week’s edition…

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The Yen Week – Bias is Neutral- by Tony Nyman and Ed Blake, p3-4Thursday is BOJ day in Japan, considered one of the smaller monetary policymeetings as there are no new forecasts on GDP and inflation. Kuroda and coare widely expected to keep its 'QQE with yield curve control' policyunchanged. However, a number of firms are unsurprisingly indicating thatthe strength of the Yen could be a focus.

Euro Volume Jumps as Investors Grab for Duration- by Kajal Mawdia, p5-6Despite a 4-day week after Whit Monday, Euro-denominated primaryissuance surged to EUR54.46bn, to produce the second highest volumeweek YTD. Sovereigns led supply, capitalising on the plunge in EGB yields asthe 5yr/5yr EUR inflation swap rate hit a record low.

Long-Term FX Forecast: 1.10-1.15 EUR/USD Despite Fed Pricing- by Tony Nyman, p7-9The Euro is doing okay. It's the second best performer so far in Q2 vs theUSD (albeit miles behind the Yen, i.e. +0.7% vs +2.2%), while in June its gainsare being outpaced by just the likes of the CAD and NOK.

USD/ZAR Pullback to be Treated With Caution Amid Weak SAFundamentals - by Natalie Rivett, p10-12The Rand was a notable EM underperformer in the first week of June, withSouth Africa's shocking Q1 GDP release setting USD/ZAR on a path throughthe 15 handle, to nine month highs. A partial Rand recovery has since ensued,but this is predominantly thanks to a broadly softer Dollar post-NFPs and weare not fully convinced of this change in direction.

China Insight: Impact of Baoshang Takeover on The Onshore Debt Market- by Tim Cheung and Riki Zhang, p13Baoshang’s case unlikely marks the start of a series of takeovers. However,we should be wary of the credit risk of small Chinese banks from now onand we expect to see more divergence among China banks in terms offunding costs.

Know the Flows: Central Bank Support Boosts Equity Fund Flows in Mid-June - by Cameron Brandt, p14With the US Federal Reserve voicing support for the goal of sustaining thecurrent recovery, the Bank of Japan continuing to run its ultra-accommodative monetary program and the People’s Bank of China (PBOC)committed to ‘targeted stimulus’, equity investors made a return during thesecond week of June.

Gold/Oil Ratio – Watch For a Return to 25.13- by Ed Blake, p16Watch for a return to the 2018 peak at 25.13, with scope for an extension to27.81. Place a protective stop under former resistance at 18.94.

Euro$ Z9-Z0 Spread – Risks -0.420/-0.450 While -0.220 Caps- by Ed Blake, p17

Sell into any near-term spread narrowing as we await a resumption of thelong-term downtrend targeting -0.420 then projections at -0.450/-0.505.Stop and reverse on a clearance of -0.220.

NZD/USD – Bearish Momentum Fading – by Andrew Dowdell, p18Look to buy for a target of 0.7060. Below .6348 threatens a moresubstantial decline back to the 2015 low at .6130.

The Yen Week – Bias is Neutral

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By Tony Nyman, Head of G10 FX, with technical analysis from Ed Blake

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continued page 4

The Yen Week – cont’d

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Expected Usd/Jpy trading range is 107.75/109.25

It looks a tale of two central bank meetings this week.

Thursday is BOJ day in JAPAN. Considered one of the smaller monetary policy meetings as thereare no new forecasts on GDP and inflation. Kuroda and co are widely expected to keep its 'QQEwith yield curve control' policy unchanged. However, a number of firms are unsurprisinglyindicating that the strength of the Yen could be a focus. Not only has Usd/Jpy made a sustainedbreak below 110, but the Q2 surge in Jpy/Krw from near 10 to 11+ recently will not have goneunnoticed.

We could therefore get a more dovish BOJ this week, particularly if Kuroda sees Powell and cohead that way beforehand. See bottom middle of the Dashboard, BOJ rate cut probability for2019 remains above 50%. The question markets are mulling though is just how much easingfirepower is at the BOJ's disposal?

The FOMC Wednesday, of course, is being viewed as the real main event. We note there isa 17% probability of a Fed cut this month, 83% July and 99% 2019. There are plenty of marketparticipants who expect Powell and co to lay the groundwork for a move possibly as early asJuly.

As ever, related markets are a potential driver:• Oil - Despite raised US-Iran tensions, stays around the middle of the rough Usd 60-65/brl

range• US 10-year yield - Centring around 2.10% pre FOMC. A move on 2.00% or 2.15% after?• S&P 500 - Also, mid-range of current 2800-3000. Futs in light positive territory at +0.2%

despite Trump's warning of an epic Wall Street crash if he's not re-elected in 2020.

RISK - The market is not completely positioned one way. Recall GS said earlier in June they donot see a 2019 Fed rate cut and for the June FOMC expect Powell and co to try not to fuelmarket expectations of an imminent rate cut and fall short of a clear easing bias, while stressingthat it would respond to a large adverse shock (such as China on trade), presenting a near-termupside Usd potential.

• Fell from 112.40 (24 April top) to reach 107.82 (5 June low, near 61.8% retracement of104.87/112.40 rally), before ranging under 108.80 (11 June high)

• Studies are improving, however, while the 108.80/109.02 zone (11 June high/13 May low)caps corrective gains, watch for a return to 107.77

• Below signals a downside extension to 106.65 (76.4% retracement of 104.87/112.40 rally)

• Only over 109.02 offers short-term relief to 109.93 (30 May lower high)

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Euro Volume Jumps as Investors Grab for Duration

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By Kajal Mawdia, Credit Analyst

• Despite a 4-day week after Whit Monday, Euro-denominated primary issuance surged toEUR54.46bn, to produce the second highest volume week YTD. Sovereigns led supply,capitalising on the plunge in EGB yields as the 5yr/5yr EUR inflation swap rate hit a record low

• Sovereigns accounted for 76.8% of the SSA weekly haul as demand totalled over EUR86.8bn.Among the western European region, Kingdom of Spain and Republic of Italy's syndicated10yr and 20yr trades delivered the highest cover ratios with investors attracted by the higheryields available here than elsewhere in Europe

• Covered saw the biggest increase in activity, going from an almost zero issue week theprevious week to EUR8.75bn (via 12 tranches)

• Corps saw a number issuers hit the long end while Vattenfall's debut 7yr Greentrade achieved the highest covered, supported by the borrower's rare appearance in seniorformat. The deal priced broadly flat to fair value

• FIG volume hit a 10-week high. The biggest sized trades came from Natwest Markets,CaixaBank and Banco Santander that printed EUR1.25bn apiece

• Best performing deal of the week goes to Vattenfall's aforementioned EUR500m 0.5% Jun2026 Green bond which having landed at m/s +55bps on Thurs was trading around 6bpstighter in secondary on Friday afternoon

• Volume by maturity - Demand for duration meant the 10yr+ maturity bucket proved mostpopular as borrowers tried to lock in long term funding at low rates/tight spreads

• iTraxx Main and Crossover trended wider from Weds having posted fresh multi-week tightson Tuesday

• EPFR data for the week ending 12th June 2019 showed inflows into Euro-denominated IGbond funds for a seventh consecutive week, albeit at a slower pace of an equivalent$1,575.36m versus the prior week's $2,461.18m. In contrast, Euro-denominated HY funds(Western Europe) saw a sixth straight week of outflows

continued page 6

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Sector No. Deals Total

Volume

(Eur/bln)

Total Vol

(prev

week)

Total Vol %

Change

FIG 15 10.1 3.75 169%

Corp 17 11.05 9.9 12%

SSA 13 22.45 6.5 245%

Covered 12 8.75 0.5 1650%

High

Yield

5 2.11 0.65 225%

Total 62 54.46 21.3 156%

Vol by

maturity1 < 4yrs 4 < 7yrs 7 < 10yrs 10+yrs

7.645 10.54 13.575 22.7

Euro Volume – cont’d

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Long-Term FX Forecast: 1.10-1.15 EUR/USD Despite Fed Pricing

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By Tony Nyman, Head of G10 FX

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continued page 8

Long-term FX Forecast - cont’d

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The EURO is doing okay.

It's the second best performer so far in Q2 vs the USD (albeit miles behind the YEN, i.e. +0.7% vs+2.2%), while in June its gains are being outpaced by just the likes of the CAD and NOK.

Clearly, the YEN wins best when it's a negative risk backdrop, but we're slightly surprised that theEUR has not made more gains on its relative safe haven status given its C/A surplus etc.

With the market probability pricing in Fed rate cuts, i.e. near 100% in 2019, 80%-plus in July, yielddifferentials should at least be more supportive given the ECB was less dovish than manyinvestors expected in June. See bottom middle of the EUR Dashboard, though ECB 2019 rate cutprobability stands at 55%, we are surprised that EUR/USD hasn't been trying higher towards1.1500 in this backdrop.

Of course, there's still time but given we maintain relatively neutral-to-bullish USD forecastsgenerally we are happy by the lack of current topside momentum and still see a rough 1.1000-1.1500 range ahead (even through the 3 and 6 months period!?).

Still, worth pointing out the views of other leading firms:

• NORDEA – Interesting stuff from the Scandi bank who say a long EUR/USD position is thesecond best G10 trade in the three months leading up to the first Fed cut (first EUR/NZD).EUR/USD has picked up during the 60 trading days preceding the first rate cut from the Fed infive out of the last six rate cutting cycles on average by roughly 3%. Nordea cite as reason theECB is the “easing turtle", which is why the rate spread is temporarily supportive. NoteEUR/USD often moves lower again 6-12 months into the cutting cycle, probably as the ECBtends to follow the Fed with a time lag.

• CS – As some ECBers are said to be concerned that inflation expectations are becoming'deanchored', a differing view from the Swiss giant who cites the consistent demise of the EU5yr/5yr inflation swap, on multi-year lows at 1.19%, which makes it hard to have confidence ina sustained EUR rally. In fact, current EUR/USD strength could in fact be linked to technicalshort covering in EUR/CHF and EUR/JPY, left exposed by the recent "risk on" recovery in global

equities. CS remain sellers of EUR/USD on moves towards 1.1400 and won't change that viewuntil levels above Mar highs around 1.1450 are breached or the EUR 5y5y inflation swaps turnsupwards materially.

Throw in the fact that the Brexit mess and weight shows few signs of improving, the Italians arestill playing fiscal wars with the EU, Trump is now targeting Germany trade wise and growthdifferentials are hardly moving in the Eur's direction and we'll happily stay where we are, at 1.10 –1.15.

continued page 9

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Long-term FX Forecast - cont’d

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• Bearish momentum off the 2018 peak (1.2555) has slowed considerably, as evidenced by theRSI indicator which has been unable to reach oversold levels

• In addition, bears have been unable to break convincingly through the 200-Week MA, whichitself has flattened out

• Potential is seen for a period of congestion before a more meaningful attempt to rally

• Dips below the 1.1107 current run low are expected to prove short-lived, with fresh buyersanticipated around the 1.1000 handle

• On rallies, prior reaction highs at 1.1448 & 1.1570 present formidable barriers

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USD/ZAR Pullback to be Treated With Caution Amid Weak SA Fundamentals

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By Natalie Rivett, Senior EM Analyst & Ed Blake, Chief FI Technical Analyst

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continued page 11

USD/ZAR - cont’d

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The Rand was a notable EM underperformer in the first week of June, with South Africa's shockingQ1 GDP release setting USD/ZAR on a path through the 15 handle, to nine month highs. A partialRand recovery has since ensued, but this is predominantly thanks to a broadly softer Dollar post-NFPs and we are not fully convinced of this change in direction.

The GDP release laid bare the true extent of the South African economy's flagging health at thebeginning of the year. The far deeper than expected contraction of 3.2% q/q - the biggest slump in adecade - was yet a further reminder of the challenges President Ramaphosa faces boosting theeconomy and guiding it back to sustainable and balanced growth.

South Africa's economic outlook remains weak & debt burden at risk of worsening

The better than expected April manufacturing production and retail sales data that have sincefollowed (former at a little over four-year high of 2.8% m/m and near three-year high of 4.6% y/y)offers some tentative hope the economy will avoid falling into a second technical recession in ayear. However, the economic outlook remains rather bleak as near-record high unemployment,electricity and fuel price hikes, below-inflation wage growth and higher taxes erode households’spending power, and this is placing pressure on the SARB to loosen monetary policy. Traders arenow betting on a ca. 25bp rate cut as soon as the July meeting (as per 3x6 month FRA spread to 3-month JIBAR, see the previous dashboard).

At the same time the spotlight has once again been thrown on the tussle within the ANC to get theSARB to play a more active role in stimulating growth, that could potentially further complicateRamaphosa's plans to turn the economy around. Some within the governing party, includingsecretary general Magashule, want to see the SARB's role expanded alongside approval to explorequantitative easing or central-bank asset purchases. This, as further financial support for Eskom,beyond the USD4.9bn (ZAR69bn) three-year bailout outlined in February, looks unavoidable. Thestate utility has more than USD30bn of debt and over half of this is state guaranteed.

Hence, South Africa's debt burden is at risk of worsening more than projected in the face ofadditional support to public enterprises and economic weakness, at least in the near-term, andparticularly with high unemployment making revenue collection targets even more difficult for thegovernment. The Treasury's worst-case scenario is for gross debt to deteriorate to 60.2%/GDP in thefiscal year ending February 2024 (see the dashboard), but according to Moody's will top 70% should

the government fail to contain spending and funding risks from Eskom.

Moody's – the only one of the big three rating agencies to retain South Africa's sovereign debt atinvestment grade - has indicated that its patience may be wearing thin, recently commenting thatthe government's policy objective to boost economic activity while consolidating its fiscal positionwould prove even more difficult in the low-growth environment.

Upside risks to USD/ZAR persist, despite recent correction

So, although USD/ZAR has reversed some of the ca. 2.5% advance for the week ended 7th June, wewill not be getting carried away with the move. We maintain that weak fundamentals will continueto undermine the Rand and leave the currency particularly vulnerable to any external shocks. Withnet long Rand positioning at a nine-month peak (CFTC data, see dashboard) and cumulative netinflows to South African bonds at ytd highs (EPFR data, see dashboard), it seems that many investorsstill risk being caught on the wrong foot.

From a technical perspective, the outlook for USD/ZAR is still constructive; with the pullbackexpected to stall ahead of the 14.400 handle, keeping the door open for a return to the 7th Juneapex of 15.173 and possible break higher. Only below 14.400 would threaten this bullish outlook.

continued page 12

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USD/ZAR - cont’d

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• Extended the 4-1/2 month recovery from 13.236 (2019 low - 31 January) through a 41-monthfalling trendline to reach 7th June 15.173 spike high, before correcting

• Studies remain reasonably constructive and while dips hold over 14.403/14.426 (14 June lowand a 4-1/2 month rising trendline), watch for a return to test 15.173

• A clearance would then expose 15.384 (equality projection of 13.236/14.748 rally from13.872), beyond which targets 15.696 (2018 peak - 5 September)

• Only a return below 14.403 would suggest a broader bullish failure and threaten a returntowards 14.130 (16 May low)

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China Insight: Impact of Baoshang Takeover on The Onshore Debt Market

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By Tim Cheung, Head of China, Riki Zhang EM AnalystOn 24 May, PBOC and CBIRC jointly announced to take over Baoshang Bank for one year due toserious credit risk. As far as we are aware, Baoshang Bank already showed multiple red flags oncredit risk in 2017, with 28.8% y/y asset growth, around 30% of assets in receivableinvestments, 46% of loans in unsecured lending, and a decline of total CAR to 9.3% in the sameyear (vs the minimum requirement of 10.5% in the same year). We are surprised that theregulators did not step in until it was confirmed that 6 out of Baoshang's top 10 debtors hadalready defaulted on their debt obligations.

While balance sheet restructuring is underway, some protection is planned for Baoshang'sdepositors and creditors:

1. All retail depositors will be fully protected under the deposit insurance scheme;

2. Depositors and creditors with less than CNY50mn outstanding will be protected under thedeposit insurance scheme;

3. Up to 80% of the unprotected depositors' exposures and at least 70% of the unprotectedcreditors' principle will be protected, as per Caxin.

Nothing is certain yet for the outstanding BAOSHA bond issues due to lack of informationreleased by the regulators so far. However, the third point listed above opens the possibility ofa 20% and 30% haircut for the CNY6.5bn BAOSHA 4.8% Dec 2025 Tier 2 CNY-denominatedonshore bond issue, which somehow is still trading at around 99% of the par value.

After the Baoshang takeover was announced, we have seen a few changes in the onshorenegotiable certificate of deposit (NCD) market dynamics:

1. Sharp decline in the issuance scale of onshore NCDs (chart 1);

2. Notable fall in the success rate of issuance, led by AA+ rated as well as AA rated and belowissuers (chart 2);

3. Rise in the NCD issuance yields of city commercial banks and rural commercial banks to thelevels higher than those registered before Baoshang was taken over (chart 3).

Baoshang’s case unlikely marks the start of a series of takeovers. However, we should bewary of the credit risk of small Chinese banks from now on and we expect to see moredivergence among China banks in terms of funding costs.

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Know The Flows: Central Bank Support Boosts Equity Fund Flows in Mid-June

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By Cameron Brandt, Director, Research

With the US Federal Reserve voicing support for the goal of sustaining the current recovery, theBank of Japan continuing to run its ultra-accommodative monetary program and the People’sBank of China (PBOC) committed to ‘targeted stimulus’, equity investors made a return during thesecond week of June. EPFR-tracked US, Japan and China Equity Funds all took in fresh money,enabling Equity Funds overall to post inflows for only the second time since mid-March.

The European Central Bank (ECB) is also promising more support for a flagging regional recovery,and Europe Bond Funds extending their longest inflow streak since 1H15. But political noise,ranging from the ruling Conservative Party’s leadership contest in the UK -- and its implications forBrexit -- to Italy’s threats to launch a parallel currency, drowned out the ECB’s signal for equityinvestors: Europe Equity Funds posted outflows for the 18th week running.

Overall, the week ending June 12 saw a net $3.2 billion flow into EPFR-tracked Equity Funds whileBond Funds absorbed another $16.7 billion and Money Market Funds $23.6 billion. Since thebeginning of May investors have steered over $135 billion into Money Market Funds which,collectively, are on pace to exceed the full-year totals for 2017 and 2018 by the end of the month.

At the asset class and single country fund level, Total Return, Municipal and Mortgage BackedBond Funds extended their current inflow streaks while flows into High Yield and InflationProtected Bond Funds climbed to eight and 20-week highs respectively. Redemptions fromAustralia Equity Funds hit levels last seen in 2Q16 while Israel Equity Funds recorded their biggestweekly inflow since 2Q15 and China Bond Funds since late 1Q13.

Sector Funds also benefited from the dovish tone of central bank commentary during the secondweek of June, with eight of the 11 major groups tracked by EPFR recording net inflows thatranged from $5 million for Infrastructure Sector Funds to $1.07 billion for Commodities SectorFunds.

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Gold/Oil Ratio – Watch For a Return to 25.13

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Technical Analysis by Ed Blake

• Rallied from 17.08 (2019 low - 23 April) to post new five-month highs over 22.06 (61.8%

retrace of the 25.13/17.08 fall)

• Bullish studies suggest initial scope to 23.26 (26 December 2018 low, near 76.4%

retracement of 25.13/17.08 fall)

• Above opens 24.04 (.618x projection of 13.88/25.13 rally from 17.08) then the 2018 peak

at 25.13 (posted 25 December)

• Any near-term corrective dips should hold well above 18.94 (23 May former high)

____________________________________________

STRATEGY SUMMARY

Watch for a return to the 2018 peak at 25.13, with scope for an extension to 27.81. Place a protective stop under former resistance at 18.94

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Resistance Levels

R5 27.81 2017 peak – 21 June R4 25.73 30 August 2017 lower high, near .764 projection of 13.88/25.13 rally from 17.08 at 25.68 R3 25.13 2018 peak – 25 December R2 24.53 28 December 2018 lower high, near .618 projection of 13.88/25.13 rally from 17.08 at 24.04 R1 23.26 26 December 2018 former low, near 76.4% retrace of 25.13/17.08 fall at 23.23

Support Levels

S1 18.94 23 May 2019 former high S2 18.25 28 May 2019 higher low S3 17.66 21 May 2019 low S4 17.08 2019 low – 23 April S5 15.90 26 October 2018 low

Euro$ Z9-Z0 Spread – Risks -0.420/-0.450 While -0.220 Caps

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Technical Analysis by Ed Blake

• Accelerated the 3-3/4 year downtrend to -0.420 (29/31 May record low), before bouncing

to -0.250 (near an eight-month falling trendline)

• Longer-term studies remain bearishly aligned and while -0.250/-0.220 caps, watch for a

return to -0.420

• Below would expose a series of Fibonacci projections of the -0.060/-0.250 fall from -0.120

at -0.505 and -0.550

• Only above the -0.250/-0.220 zone would avert, suggest a near three-month base and

expose -0.170/-0.120

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STRATEGY SUMMARY

Sell into any near-term spread narrowing as we await a resumption of the long-term downtrend targeting -0.420 then projections at -0.450/-0.505. Stop and reverse on a clearance of -0.220

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Resistance Levels

R5 -0.080 12/13 December 2018 highs R4 -0.120 28 December 2018 and 9/18/22 January 2019 highs, near 61.8% retrace of 0.060/-0.420 R3 -0.170 12 March 2019 high, near 50% retrace of 0.060/-0.420 fall at -0.180 R2 -0.220 17 April and 3 May 2019 lower highs R1 -0.250 10 June 2019 high, near an eight-month falling trendline and 38.2% retrace of 0.060/-0.420

Support Levels

S1 -0.375 4 June 2019 low S2 -0.420 29/31 May 2019 record lows S3 -0.450 Equality projection of -0.060/-0.250 fall from -0.120 S4 -0.505 1.236 projection of -0.060/-0.250 fall from -0.120 S5 -0.550 1.382 projection of -0.060/-0.250 fall from -0.120

NZD/USD – Bearish Momentum Fading

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Technical Analysis by Andrew Dowdell

• Broader decline from .7558 (2017 peak) lacks momentum, with the 200-Week MA now flattening out

• Stochastics have unwound to oversold levels & the market is attempting to hold near multi-year trendline support

____________________________________________

STRATEGY SUMMARY

Look to buy for a target of 0.7060. Below .6348 threatens a more substantial decline back to the 2015 low at .6130.

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Resistance Levels

R5 .7154 21 March 2018 low R4 .7060 6 June 2018 high R3 .6970 4 December 2018 high, near the 21 March 2019 high at .6939 R2 .6783 15 April 2019 high R1 .6682 7 June 2019 high

Support Levels

S1 .6482 23 May 2019 low S2 .6425 8 October 2018 low S3 .6348 20 January 2016 low S4 .6237 23 September 2015 low S5 .6130 24 August 2015 low

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