FX & IR Asia Strategy Weekly - jrj.com.cnpg.jrj.com.cn/acc/Res/CN_RES/INVEST/2014/5/9/439e... · 5/9/2014 · that a possible downside surprise to US CPI (15 May) could be on the

FX & IR Strategy

Asia Strategy Weekly

9 May 2014 Non Independent Research – Marketing Communication

www.GlobalMarkets.bnpparibas.com Please refer to important information at the end of the report.

What’s crucial next week • A heavy US activity data (retail sales, IP, housing starts, CPI etc.) calendar next week. Our economists are flagging

that a possible downside surprise to US CPI (15 May) could be on the cards. In Asia, the spotlight will be on India’s election results with exit polls on 12 May and official results out on 16 May. China monthly activity (IP, FAI, retail sales, 13 May) and credit data (10-15 May) will likely show subdued momentum. Elsewhere, India IP, CPI and WPI, and Malaysia Q1 GDP, current account data are also important. Indonesia and Malaysia have scheduled government bond auction next week.

2

Asia FX – more about risk, less about the Fed • The USD is struggling, despite strong US data. We have changed our FX forecasts significantly – we now see scope

for Asian currencies to strengthen in the next 1-3 months, and have pushed back USD strength by about 6 months. • The path is no longer of a smooth USD uptrend. We think Asian currencies rally in the near-term, but will sell-off

sharply at some point in H2. The risk is not of a hawkish Fed, but of a negative risk-event. Volatility and risk premia are at unusually low levels across asset classes, and unlikely to remain this low on a 3-6m view.

3

How is EM real money positioned? • Dynamic portfolio replication helps shed light on what benchmarked EM investor community is doing.

• Funds underperformed the EM rally in Q1 due to defensive positioning. But they seem to have covered their shorts in April, and are now at a “neutral” level of risk allocation. This implies that the short-squeeze rally in EM is over. However, there is still scope for fund managers to increase their beta – they are not aggressively overweight yet.

• Relative to benchmark weights, investors are underweight CEE countries and overweight Brazil and Malaysia. A large underweight position in Thailand was squared in April.

5

Closing 1Y1Y MYR receiver • We entered 1Y1Y MYR receiver in September 2013. Our economists were not expecting a hike and we liked the

carry in forwards. But BNM all but signalled a rate hike in its MPC statement.

• We are closing the received recommendation at a loss of 16bps (with the trade having rolled 15bps)

Asia FX less about US rates, more about risk appetite

1.21

1.23

1.25

1.27

1.29

1.31

1.33

0.3

0.4

0.5

0.6

0.7

0.8

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1.0

Jan-12 Sep-12 May-13 Jan-14

1y1y USD IRS

USDSGD Curncy

%

1.21

1.23

1.25

1.27

1.29

1.31

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0


Asia risk regime index*

USD/SGD (RHS)

Z-score

Source: BNP Paribas * composite index of Asia FX NDF-onshore spreads, FX vol, equity vol, and credit spreads

Mirza Baig: +65 6210 3262

[email protected]

Jasmine Poh: +65 6210 3418 [email protected]

Rohit Garg: +65 6210 3390

[email protected]

Wong Yii Hui: +65 6210 3314 [email protected]

This publication is classified as non-objective research

9 May 2014 Asia Strategy Weekly 1 www.GlobalMarkets.bnpparibas.com

Strategy Views Interest Rates FX

CNY

Bullish. Liquidity should remain flush for now until growth stabilizes. Our receivers in 5y repo is very close now to our target of 4%. We switch from receivers to 1x5 flatteners in CNY repo ND IRS at 34bps, targeting 12bps.

Bullish/range. PBoC has begun to check the pace of depreciation of RMB. We think there is limited scope for further weakness, and expect a range of 6.20-6.25 for USD/CNH spot in the next 3 months. We thus think the USD/CNY fixings will be stable around 6.16, and are sellers of front-dated NDFs.

HKD

Front end and belly HKD rates to underperform USD rates. Increasing financial integration with the Mainland and deteriorating BoP position of Hong Kong means that HKD-USD rates spread will widen. We recommend paying 5y HKD-USD IRS spread around par and expect this spread to widen to 40 bps in 1 year.

Neutral. Range trading will continues to dominate in spot and TT.

INR

Flatter 1s5s and 2s5s. RBI will continue to remain hawkish to control inflation and inflation expectations which should continue to flatten the curve.

Neutral. Exit polls will be released on 12 May and official results will be released on 16 May. The results may be a catalyst for a break of the 60-62 trading range. A decent NDA showing will prompt relief rally. But we think RBI’s need to accumulate FX reserves, and an almost immediate focus on India’s fiscal issues suggests the honeymoon will be very short.

IDR Bullish. The recent sell-off provides an opportunity to buy, in our view. We expect domestic investors to support the 10Y around 8.2%, which would be good entry levels.

Neutral. We think there is not much scope for IDR to appreciate since ownership levels are already high, and BI needs to accumulate reserves. Talks of dividend payments from May till Aug weigh on IDR. Broadly, we are expecting a range-bound market between 11500 and 11800.

KRW

Bullish front end. Our economists expect BOK to be on hold till year-end. However, risks remain on the downside. We recommend receiving 1Y1Y KRW NDIRS – with BOK willing to accept KRW appreciation, there is potential for rate hike expectations to be pushed out.

Bullish. The won continues to strengthen, backed by a sizeable current account surplus (around 6% of GDP), and strong portfolio inflows. BoK seems to be only slowing the trend down.

MYR

Neutral. BNM has started to signal a rate hike. We think there is scope for KLIBOR fixings to rise as the market prices in a rate hike in 3m (next meeting is in July). We have closed our recommendation to receive the 1y1y NDIRS.

Neutral. Fundamentally we remain bearish on MYR, and expect it to struggle on domestic capital flight. . However, in the near-term, we expect the currency to do very well as offshore risk-sentiment improves and a hunt for carry continues.

PHP Neutral. PHP govies are trading rich relative to UST (recent history) and we remain neutral.

Bullish. The peso has been a key laggard in the Asian FX space and has room to play catch in the near-term. Fitch upgrade of Philippines to BBB from BBB- saw the USDPHP trade below 44.00. Also similar to the SGD, the peso is underpinned by large current account surpluses.

SGD

Bullish. 3y point is relatively cheap on the swap curve. Our current trades include 1y1y vs 2y1y flattener. More importantly, the front-end is no longer following the US, but rather trading lower, in line with more bullish sentiment towards SGD. A likely continuation of this theme means SG rates could continue to outperform US rates.

Neutral. There is scope SGD to appreciate against the USD in the next 1-3months. USD to remain soft as stronger data has not translated into higher US yields while SGD is underpinned by large current account surprises. We are looking at weakness in SGD NEER to establish a long position. In the medium-term, we believe USDSGD will be driven higher to 1.28 by year-end.

TWD Bullish Front end and Steeper curve. Front-end rates likely to remain low while belly and long-end will be dominated by global moves.

Bullish near-term. USD/TWD is balanced between a strong current account surplus, foreign equity inflows on one hand, and domestic capital outflows and CBC intervention on the other. We see the 30.7-29.80 range holding for the year, but at current levels, prefer to be short USD.

THB

Bullish Thai GB and steeper yield curve in front-end. BoT is firmly on hold, while the market is sitting massively received in Thai rates. We think the front-end of the yield curve (1Y3Y) is set to steepen. In bonds, local accounts are capping the curve given flush liquidity. We think global real money accounts will now extend duration and as such likely to receive 10y THB IRS or 2s10s IRS flatteners.

Bullish. While political deadlock persist, there are signs that the opposition may accept the legitimacy of a future election, which is a positive development. Street protests have also ebbed. Meanwhile the current account surplus has improved sharply to the equivalent of 8% of GDP (annualized). This will continue to underpin the Thai baht, which think can extend its gains on any sign of further normalization in the political situation.



What’s Crucial Next WeekGlobal

• US: Apr Retail sales (13 May), Apr PPI (14 May), May Empire manufacturing, Apr CPI, Industrial production, May

Philadelphia Fed business outlook (15 May), Apr Housing starts, May Univ. of Michigan Confidence (16 May). Our US economists expect the run of broadly positive activity releases to continue next week -- retail sales growth to remain steady, housing starts to rebound as poor weather effects waned and consumer confidence to pick up on improving labour market. April CPI report will be important to watch for cues of the next Fed move. Our economists expect the April CPI report to indicate that the FOMC’s inflation projections are generally on track for 2014. Any large downside surprises (not our base case) to medical care services prices, however, as there were last April and May, would substantially lower the odds of the Fed meeting its 1.5% central tendency forecast for Q4/Q4 2014 core PCE inflation.

• Eurozone: Q1 advance GDP (15 May). Our economists expect GDP to post a healthy 0.5% QoQ growth from 0.2% in Q2, confirming the Eurozone recovery.

• BOE inflation report (14 May). Our economists expect the report to only show minor tweaks to the MPC’s forecasts and

the inflation projection for this year may even be nudged down a little. The focus will be on how the commitment views the pace of house price inflation.

• Fed speakers in focus: Fed chair Janet Yellen speaks to US Chamber of Commerce (16 May), Fed Lockhart speaks on

economy (13 May), Fed Bullard speaks on monetary policy (16 May).

Asia • China: Apr New yuan loans, TSF, money supply (10-15 May); Apr Industrial Production, Retail sales, FAI (13 May).

Our China economists expect April activity data to show that growth remains at similarly subdued levels to March. FAI growth may slip further led by the noticeable decline in property investment growth, while infrastructure growth gained momentum from government support. Retail sales are expected to pick up to 12.4% YoY in April from 12.2% prior given the decent household income growth in Q1. April’s total social financing to ease to CNY1.5tn from more than CNY 2tn in March, but much of the fall will be seasonal. Unless the data is significantly weaker than expected, rates should remain supported around current levels. If TSF is much higher than expected, this could prompt larger-sized repo operations by PBoC.

• India: Election exit polls (late evening, 12 May) and Official election results (16 May); Mar Industrial production, Apr CPI (12 May); Apr Exports, Imports (12-15 May); Apr WPI (14 May). The exit polls on 12 May will be the first indication of results. With 90% of the seats been polled by now, these should be indicative of the broad trend. The general consensus is that the NDA (Modi’s party) will take between 230-250 seats (272 needed for majority) of 543 seats. A coalition government led by Modi appears to be the most likely outcome. A break of the 60-62 USDINR trading range could occur, if there was a clear majority mandate for the new government, which we do not expect. On the data front, our economists expect IP to contract 1.5% YoY, paving way for yet another quarter of sub-5% GDP growth. Meanwhile, expect Apr CPI to rebound to 8.7% YoY from 8.3% in March led by food inflation.

• Indonesia: 9m, 1Y, 10Y, 15Y, 20Y government bond auction (12 May). The target of the auction is IDR 8tn. Onshore and global investors are better buyers on dips here, and we expect moderate demand at IDR 10-20tn. After this auction, the DMO will have raised 56% of the gross financing requirement for the full year.

• Malaysia: 20Y MGS auction (exact date to be announced); Mar Industrial production, Manufacturing sales (12 May);

Q1 GDP and Current account balance (16 May). We are expecting the 20Y MGS (04/33) auction next week (exact date is yet to be announced). Offer size should be small and should meet demand from onshore insurance and pension funds. On the data front, expect Q1 GDP to rise to 5.4% YoY from 5.1% in Q4 largely thanks to the favourable statistical base.

• Singapore: Mar Retail sales (15 May); Apr NODX (16 May); Q1 final GDP (17 May).

• Philippines: Mar Overseas workers remittances (15 May).

• Hong Kong: Q1 GDP (16 May).

Jasmine Poh +65 6210 3418



Asia FX – more about risk, less about the Fed US data is surpassing expectations, but the USD is still struggling. The

relationship of Asia FX with US rates is breaking down, but strengthening vs. measures of risk appetite. There is scope for Asian currencies to appreciate in the next 1-3 months.

But volatility and risk premia are at unusually low levels. Risk perception is unlikely to stay this low for long. A build-up of carry trades at these levels will set the market up for a significant squeeze later. The risk is not of a hawkish Fed, but of a negative risk event. We would be buying vol here.

Our FX forecasts for Q2 were bullish on the US dollar: we thought that once US data punches through the weather gloom, the USD would benefit. But even though the data are surpassing expectations, the USD is still struggling. A longstanding relationship between front-end US rates and USD/Asia that we have followed closely has broken down (chart 1 below). The decoupling suggests Asian currencies are no longer about Fed policy – which the market feels is comfortably on hold for at least one year.

Instead, correlations are picking up against indicators of risk appetite, specifically global equity vol and EM bond spreads. In addition, cross-sectional returns in EM currencies tell us that spot returns are being driven by the level of carry – the best performing EM currencies YTD are those with higher yields (BRL, IDR, INR, TRY), the laggards are mainly low yielders.

So it’s not about US rates anymore – at least not until the Fed signals a change. Recovery without tightening is great for risk appetite, and the market is piling in. Our analysis suggests real money bond investors have turned neutral in terms of risk allocation, but have the capacity to increase their beta if they are confident that volatility will remain low. This scaling up of risk in a benign risk environment should be the driver for further strength in Asian currencies.

The problem is that the lower the USD goes now, the harder it will bounce later. It is the nature of carry trades to flounder after they flourish. Broader measures of financial volatility and risk premia are already at very low levels. Sure, they could go lower still, but at some point the engine will run out of juice, and volatility will spike. We can’t predict what the catalyst would be, but we think the continuation of low volatility in every asset class is unsustainable on a 3-6m view.

Chart 1: US rates no longer driving USD/SGD Chart 2: Changes to our Asia FX forecasts*

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1y1y USD IRS

USDSGD Curncy

%

Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 151.24 1.26 1.28 1.30 1.35 1.35 1.401.30 1.28 1.30 1.32 1.35 1.35 1.403.25 3.35 3.40 3.40 3.42 3.45 3.503.32 3.35 3.40 3.40 3.42 3.45 3.50

11800 12000 12000 12000 12250 12500 1280011800 12000 12250 12300 12400 12500 1280032.00 32.40 33.00 33.00 33.00 33.30 33.5032.50 33.00 33.50 34.00 34.50 35.00 35.5043.80 44.40 44.80 45.00 45.00 45.50 46.0044.80 45.20 45.50 45.50 45.50 46.00 46.5030.00 29.80 29.80 29.70 29.70 29.60 29.5030.50 30.30 30.00 30.00 29.70 29.70 29.501020 1010 1000 1000 980 980 9501120 1080 1050 1050 1020 1000 100060.00 62.00 64.00 65.00 65.00 65.50 65.5060.00 62.00 64.00 65.00 65.00 65.50 66.0021,100 21,300 21,300 21,300 21,300 21,600 21,600 21,100 21,300 21,300 21,300 21,300 21,600 21,600

TWD

KRW

INR

VND

SGD

MYR

IDR

THB

PHP

Source: Bloomberg, BNP Paribas Source: BNP Paribas * bold are new



Changes in FX forecasts

We are adjusting our Q2 Asia FX forecasts to reflect the following views:

• There is scope for Asian currencies to appreciate in the next 1-3 months.

• We are agnostic about the distribution of returns over this period, but we think there is not much scope for INR and IDR to appreciate since ownership levels are already high, and their central banks would need to accumulate reserves.

• The results for India’s general elections are due next week and may be a catalyst for a break of the 60-62 trading range, if there was a clear majority mandate for the new government, which we do not expect.

Overall, the appreciation trend should be gradual as local central banks will intervene to smooth the market, or re-build FX reserves. The risk to our Q2 forecasts is for a move lower than we currently expect.

We maintain a trajectory of USD strength in H2 and next year for most pairs. Specifically:

• We remain bearish on INR and IDR relative to consensus; partly because we think volatility will pick up at some stage and put pressure on deficit currencies. Our economists are also less enthusiastic about how much political developments would change ground realities.

• We still expect medium-term appreciation in KRW and TWD. These currencies have scope to rise from a long-term valuations perspective, and are underpinned by strong external surpluses.

• In contrast, we have the USD appreciating vs SGD, THB, PHP and especially, MYR. We continue to think that build-up of leverage in the last few years makes these currencies vulnerable to a rise in US rates. But we have pushed the trajectory back by 3-6 months, and revised THB more significantly due to a more buoyant recovery in external balance.

So what do we do here?

On a 1-2month view, we see scope for catch-up in MYR, THB & PHP and would be short USD vs. these currencies. We also like the KRW/TWD cross higher. We think the RMB has already bottomed, or is very close to a bottom, and would trade USD/CNH in a 6.20-6.25 range. We would leave IDR and INR alone for but generally expect 11500-11800 and 60-62 range respectively.

On a 3-6m view, we don’t think this benign risk environment can persist when risk premia are already at very low levels. We are forecasting a stronger USD in H2, not because of US rates outlook, but because of a probable global risk-aversion event. SGD vol curve is among the flattest in the region, and the level of vols is close to historic lows. We recommend buying 6m6m FVA, currently offered at 5.1%

Mirza Baig [email protected]

Jasmine Poh [email protected]

Chart 3: MYR, PHP are the key laggards this year Chart 4: SGD vols are near historic lows

90

92

94

96

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106

Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14

MYR PHPIDR INRSGD KRW

USD/CCY 1 Jan 2014 = 100

0

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8

10

12

14

16

Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

6m6m USDSGD FVA

6m USDSGD realized vol

volatility (%)

Source: Bloomberg, BNP Paribas Source: Bloomberg , BNP Paribas

This section is classified as non-objective research


How is EM real money positioned? Dynamic portfolio replication helps shed light on what benchmarked EM investor

community is doing.

Funds underperformed the EM rally in Q1 due to defensive positioning. But they seem to have covered their shorts in April, and are now at a “neutral” level of risk allocation. This implies that the short-squeeze rally in EM is over. However, there is still scope for fund managers to increase their beta – they are not aggressively overweight yet.

Relative to benchmark weights, investors are underweight CEE countries and overweight Brazil and Malaysia. A large underweight position in Thailand was squared in April.

Dynamic portfolio replication techniques have helped break the mystique of hedge funds’ investment strategies. When a fund reports high frequency returns, and it is known that it would invest in X combinations of Y assets, then it becomes possible to estimate the underlying portfolio composition using dynamic optimization techniques. We used similar principles1 to work out what the benchmarked EM investor community is doing with their country allocations. Our data set is 38 EM fixed income funds that report daily portfolio returns. Their combined AUM is about USD80bn. The methodology is described at the end of this note, together with the assumptions that need to be made to derive the conclusions below. Key take-aways: 1. The average investor went neutral in April from underweight in Q1, and did quite well. Before we get to portfolio replication, a simple comparison of fund returns against the benchmark index tells us something about risk allocation. Specifically, if benchmarked funds are underperforming the index in a rally, or outperforming in a sell-off, they are likely to be positioned defensively (low duration, more cash, underweight high yield country). Chart 1 below tracks the weighted average performance of our sample funds (monthly returns weighted by AUM) against JP Morgan’s GBI EM Global Diversified index (unhedged). We chose this index because many of the funds in our sample are explicitly benchmarked against it; the index captures both FX and bond performance; and it is one of the most widely followed benchmarks.

1 See page 4 for methodology and caveats/assumptions

Chart 1: In April funds did not underperform the rally Chart 2: The majority of funds outperformed in April

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Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14

bps funds' perf. Vs. index

GBIEM-GD index (RHS)

no taper, caughtmarket short

again, caught short in Feb

Index level

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bps% of funds outperforming indexFunds' perf vs. index (RHS)

Source: BNP Paribas, Bloomberg Source: BNP Paribas, Bloomberg



The story the chart tells is as follows: (i) Funds managed to outperform the index during the initial tapering sell-off (May-Aug

2013) by being positioned defensively. (ii) They suffered heavily in September when Bernanke balked at tapering and EM rallied.

They underperformed again in October, but by a smaller margin, probably because they became less defensive.

(iii) This year, Feb and March showed similar underperformance – EM rallied, but performance suffered, again reflecting an overall defensive positioning.

The key point relevant today, is that EM rallied in April and the vast majority of funds did not underperform the benchmark. This means their defensive positioning has largely been covered and they are back to at least a neutral level of risk allocation, perhaps even a slight overweight. This is not to say that the market is ripe to sell-off: funds are not aggressively overweight yet. There is scope for them to increase their overall beta, especially if they become confident that investor redemptions are over. Our analysis confirms this conclusion from another angle: The “cash” component that we backed out from portfolio weights fell by 0.3% of AUM in April relative to the three month window. 70% of the funds in our sample reduced their cash allocation in April. However, the level of cash exposure at 6% still seems high relative to the 2-3% buffer investors kept during periods of strong EM bull market. It is hard to say what is the new normal for cash levels – but we will explore that in a follow-up note. 2. April saw a large rotation out of CEE, into Asia The methodology section below describes our portfolio replication in more detail. But to put it simply, we are constructing EM model portfolios that best track the reported performance of each fund. We replicated each fund’s performance over a 1-month window (all of April) and over a 3-month window (Feb-April). The shift in country weights between those windows is our estimate of how the underlying portfolio was rebalanced in the latest month. (Also note the simplifying assumptions listed below). We find that there was a significant reduction of exposures in Poland, Russia and Hungary in April, and a corresponding increase in South Africa, Indonesia and Thailand. The shift was probably driven by two factors: a desire to reduce short positions against high yielders (Brazil allocation also increased modestly), and the escalation of Ukraine/Russia tensions. We are surprised at the scale of adjustment in Thailand – perhaps Thailand benefited more because investors were also unwinding a long-standing underweight position (see next point).

Chart 3: Portfolio weights April vs. Feb-April… Chart 4: … reveals April rotation out of CEE into Asia

0%

2%

4%

6%

8%

10%

12%

14%

THB

PHP

IDR

MYR

MXN

PEN

BRL

CO

P

TRY

HU

F

RU

B

PLN

ZAR

RO

N

NG

N

cash

April window

3m window

portfolio weight

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-1%

0%

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5%

cash

PLN

HU

F

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B

MXN TR

Y

PHP

RO

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N

CO

P

BRL

PEN

MYR ZA

R

IDR

THB

change in portfolio weight April vs. Feb-April window




3. Investors are underweight TRY, HUF, RUB and MXN, overweight MYR and BRL A high portfolio allocation for some countries would be warranted simply because they command a high weight in the benchmark index. So a good measure of positioning is how portfolio exposure compares against index weight (see chart 5 next page). The upshot is that investors are underweight Russia, Hungary, Turkey, and surprisingly, Mexico. They are overweight in Brazil, Malaysia, and to a lesser extent, South Africa. Thailand appeared to be a large underweight on a 3-month window, but its weight increased sharply in the 1-month window, which now puts it almost on par with its index weight (the market saw strong inflows in March-April – see chart 6). A more doubtful result is the large underweight exposure we found for Mexico. The country is a darling among EM investors and very likely to have an overweight exposure (March saw some bond outflows, but after massive inflows in prior months – see chart 6). We suspect the Mexico result reflects some of the weaknesses in our analysis (see next page). Specifically, the absence of sovereign USD bonds, corporate bonds, duration granularity, and presence of multi-colinearity in our data set could be distorting results.

Mirza Baig [email protected]

Jennifer Kusuma [email protected]

Chart 5: Portfolio weights April vs. benchmark index weight reveals the overweight/underweight countries Chart 6: EM bond flows as reported by the main OW/UW

countries

-6%

-5%

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0%

1%

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3%

MXN

RU

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HU

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RO

N

PHP

CO

P

ZAR

PEN

MYR BR

L

weight in April portfolio vs. GBI EM-GD index weight

THB IDR MYR TRY HUF ZAR PLN MXN BRL

Apr 1532 1337 - 802 384 246 - - -

Mar 378 1647 - -1348 246 713 - -1271 ‐

Feb -210 1331 636 -1071 -546 771 -601 5726 3282

Jan -44 306 -124 -599 -1897 -2024 -2231 503 3697

Dec -631 100 435 -1408 790 -205 350 6594 239

Nov -415 776 -1103 -1650 -1389 -1452 -498 2673 -416

Oct -2183 2118 2194 801 1363 469 -2244 -1842 100

Sept 630 868 4954 490 498 2016 863 4451 8382

Aug 2280 -157 -1058 1018 -668 -475 -1323 -1155 7969

July -3021 216 -4069 -2530 111 560 105 2142 6173

June 608 -1885 -3534 -354 420 -1540 -1631 -2044 4825

May -1680 463 1085 -244 718 -327 17 168 -2331

Apr -1465 1833 3941 3453 1103 2224 568 979 -1936




Methodology: • We picked a sample of 38 EM dedicated bond funds that report daily performance. These

funds are listed with their last reported AUM and NAV in Appendix 1. We used 5-day changes in NAV to smooth the data (see assumption 1 below).

• For asset returns, we are using Bloomberg local sovereign bond total return indices (in

USD). The data captures both currency and bond returns. Again, we use 5-day changes in total returns. The model portfolio returns are dependent on the weighted performance of these bond indices, plus a cash component earning 3m USD LIBOR.

• Portfolio replication is done using non-linear optimization (Generalized Reduced Gradient

Algorithm). The objective is to minimize tracking error of the model portfolio against changes in reported NAV. Country weights are constrained within 150% and 50% of current weight in the GBI EM-GD index. For example, since Brazil’s weight in the index is 10%, the maximum allocation limit is set at 15% and minimum at 5%.

• The exercise is done over 1-month window (capturing all of April), and over a 3-month

window (February through April). The shift in country weights between those windows is the estimate for how the underlying portfolio was rebalanced in the latest month.

• Portfolio weights (including cash) are recorded, and averaged across the sample funds

weighted by AUM.

Caveats & assumptions: 1. We used changes in NAV as a proxy for total returns. In reality, NAV understates total

returns because NAV is reported after management fees and any coupons/dividend pay-outs.

2. We assumed all funds invest predominantly in local currency government bonds. In reality, most funds – benchmarked or otherwise – invest some portion in corporate bonds to enhance yield.

3. Similar to 2 above, we have only included countries that are in the GBI-EM global

diversified index in the analysis. In practice, many investors buy “off-index” countries for yield-enhancement, portfolio diversification or capital appreciation.

4. We are assuming duration exposure for an investor in a market matches the duration of the

country sub-index perfectly. In other words, we are treating each country’s bond market as a single asset. In reality, fund managers can leverage returns by varying stance on duration, owning off-the-run vs. on-the-run bonds, and switching between hard currency and local currency bonds.

5. The 1m and 3m windows used for minimizing tracking error assumes that any allocation

changes are made discretely at the beginning of those periods. In reality, fund managers might have made allocation changes unevenly over that window or even churned a position within that window (i.e. bought and sold) which locked in a p&l swing.

6. Co-linearity – there is a high degree of correlation between EM assets, particularly for those

in the same region. Thus the cross-correlation of returns can pollute coefficients. 7. In calculating overweight/underweight allocation relative to benchmark, we are assuming all

the funds are benchmarked to the GBI EM global diversified index.



Appendix: List of funds in sample Serial

number Name Asset Under Management (USD mn)

Net Asset Value (USD per unit)

1 PIMCO EMERGING LOCAL BOND-IS 10,860 9.5 2 OPPENHEIMER INTL BOND FD-A 9,200 6.2 3 STONE HARBOR-EMK LC DB-IUSDA 8,620 142.2 4 PICTET-EMERG LOCAL CCY-P-USD 7,280 182.7 5 PIMCO-EMRG LCL BD-USDINS-ACC 5,680 13.8 6 JB LOCAL EMERGING BOND FND-C 5,540 336.4 7 JB LOCAL EMERGING BOND FND-B 5,540 308.0 8 ASHMORE-EM LOC CUR BD-IUSDD 2,910 103.0 9 JPMORGAN F-EM MAR LO C D-A€A 2,910 13.3

10 INVC EM MT LOC CUR DBT-A-ACC 2,720 178.7 11 BLUEBAY-EM MK LO CU BD-BUSD 2,240 163.9 12 BLUEBAY-EM MK LO CU BD-RUSD 2,240 151.3 13 GOLDMAN SACHS LOC EMG MK-I 1,910 8.5 14 DREYFUS EMG MKT DEBT LOC C-I 1,770 14.1 15 INVESTEC EM MRKT LC DEBT-IA 1,580 27.7 16 PARVEST-BOND WORLD EME-C 1,250 155.7 17 HSBC GIF-GLB EMMK LCL DB-IC 1,060 15.3 18 WISDOMTREE EMRG MKTS DEBT 924 46.2 19 AVI INV-EMGMKT LOC CY-BX-USD 888 8.5 20 BGF-EMK LOC CURR BD-USD D 860 26.2 21 INVESCO-EM LO CURR DT-A DIS 666 9.5 22 LAZARD EMERG MRKTS LCL-IAUSD 503 104.1 23 THREADNEEDLE EMER MKT L-XGA 480 3.0 24 AMUNDI-BOND GLOB EMERG-AEC 382 98.2 25 ABERDEEN GL-EM LC CRCY BD-A2 331 10.7 26 THREADNEEDLE EMRG MKT BOND F 325 0.9 27 NB EMERG MKTS DBT-LOC CUR-I 296 10.3 28 PIONEER-EMMK BD LC-USD-A-ACC 294 84.1 29 BARING EM MKT DEBT L CUR-A£ 131 10.2 30 VOYA EMER LOC CRNCY DEBT-P 95 8.9 31 PBI-GL EMER MARK LOC CURR-Y 70 133.6 32 PBI-GL EMER MARK LOC CURR-JD 70 73.0 33 BTG PACT-EMG MKT BND LX-I 56 10.5 34 FIDELITY-EM LOC CU DB-AA USD 56 9.1 35 ABERDEEN EM MKT DBT L-C 37 8.8 36 PRUDENTIAL EMG MKT DEBT-A 36 8.3 37 SLI-EMERG MKT LCL CUR DBT-DA 24 10.1 38 PIONEER EMG MKT LOCAL CUR-A 13 8.7

Source: Bloomberg

Asia FX & IR Strategy

Current Market LevelsNDF/Offshore Forward Outright Levels NDF Implied Appreciation/Depreciation

CNY CNH INR IDR KRW MYR PHP THB TWDSpot 6.158 6.228 60.00 11545 1023 3.226 43.87 32.51 30.11T/N 6.274 6.185 60.03 11546 1057 3.226 43.87 32.52 30.111m 6.166 6.234 60.30 11590 1024 3.231 43.89 32.60 30.062m 6.173 6.240 60.63 11651 1026 3.237 43.89 32.67 30.033m 6.180 6.246 60.99 11715 1027 3.242 43.93 32.72 30.004m 6.185 6.252 61.38 11785 1029 3.249 43.96 32.77 29.975m 6.189 6.258 61.76 11847 1030 3.256 43.99 32.84 29.956m 6.193 6.263 62.09 11910 1032 3.262 44.01 32.91 29.927m 6.197 6.267 62.45 11978 1033 3.269 44.03 32.97 29.908m 6.201 6.271 62.81 12040 1034 3.275 44.06 33.03 29.879m 6.205 6.276 63.18 12109 1036 3.281 44.09 33.09 29.8510m 6.208 6.280 63.52 12172 1037 3.286 44.13 33.13 29.8311m 6.211 6.284 63.90 12243 1038 3.292 44.17 33.18 29.8112m 6.214 6.289 64.25 12315 1039 3.297 44.21 33.22 29.79Jun IMM 6.168 6.236 60.40 11608 1025 3.233 43.89 32.61 30.05Sept IMM 6.185 6.253 61.47 11800 1029 3.251 43.96 32.80 29.97Dec IMM 6.198 6.268 62.54 11992 1033 3.270 44.04 32.98 29.89Mar IMM 6.208 6.281 63.62 12194 1037 3.287 44.14 33.14 29.82*Note: IMM data is an intrapolation

Curve Carry & RolldownsNDF Curve Rolldown (monthly, as % of notional)* ND IRS/ND OIS* 3M Curve Carry & Rolldown (bp)

CNY CNH INR IDR KRW MYR PHP THB TWD

1X3 -0.02% 0.00% 0.10% 0.17% -0.01% 0.02% 0.06% -0.12% 0.06%1X6 -0.07% -0.02% 0.06% 0.16% -0.03% 0.03% 0.01% -0.05% 0.06% 1y 2.91 -38.44 -10.92 3.11 16.47 2.71 6.38 2.341X9 -0.07% -0.03% 0.12% 0.20% -0.04% 0.02% 0.04% -0.08% 0.07% 2y 4.28 -11.97 -0.47 4.06 8.17 12.70 9.74 3.90

1X12 -0.08% -0.03% 0.08% 0.23% -0.05% 0.00% 0.06% -0.13% 0.08% 3y 4.20 -9.32 -1.07 4.15 7.52 15.68 10.81 4.363X6 -0.05% -0.02% -0.04% -0.01% -0.02% 0.01% -0.05% 0.07% 0.01% 5y 3.71 -5.06 0.85 3.37 6.83 14.38 10.76 4.583X9 -0.05% -0.03% 0.02% 0.03% -0.03% 0.00% -0.02% 0.04% 0.02% 10y 1.84 -3.07 0.43 2.28 5.05 9.29 8.32 3.73

3X12 -0.06% -0.03% -0.02% 0.07% -0.03% -0.02% 0.00% -0.02% 0.02% 1s2s 1.37 26.48 10.45 0.95 -8.30 9.99 3.36 1.566X12 -0.01% -0.01% 0.01% 0.07% -0.02% -0.03% 0.05% -0.09% 0.01% 2s5s -0.57 6.91 1.33 -0.69 -1.34 1.68 1.02 0.68

Jun-Sep -0.04% -0.01% 0.07% 0.14% -0.02% 0.02% 0.03% -0.07% 0.05% 5s10s -1.87 1.99 -0.43 -1.08 -1.78 -5.08 -2.44 -0.85Sep-Dec -0.03% -0.02% -0.02% -0.01% -0.02% 0.00% -0.02% 0.02% 0.01% 2s5s10s 1.30 4.92 1.76 0.39 0.45 6.76 3.46 1.53Dec-Mar 0.00% -0.01% -0.01% 0.01% -0.01% -0.02% 0.02% -0.05% 0.01%

*Expressed from perspective of buying front-end, selling back-end NDF e.g. short 1X12

Asia Central Bank Rate Decision Priced-in By Markets

Current (%)

Value (%)

Value (%)

Implied Policy

Rate (%)

In the Next

Price-in (bp)

China 6.000 3.000 2.95 12M -5

8.17 7.98 6M -28.09 7.90 12M -10

Indonesia 7.5002.69 2.56 6M 62.79 2.66 12M 163.76 3.38 6M 38

3.82 3.44 12M 44

Philippines 3.500

0.92 1.99 6M 110.99 2.05 12M 17

Thailand 2.000 2.050 2.05 2.05 6M 5

2.49 2.49 May 0

2.49 2.49 Jun -1

Asia FX & IR Strategy: Mirza Baig: +65 6210 3262; Jasmine Poh: x 3418; Rohit Garg: x3390; Wong Yii Hui: x3314

Forward Spread(bp)

-19.0-19.0

No Change

+25bp (Q314)

No Change

BNPP Econs Expecations

(next 6M)

8.190

2.650

3.380

6x9M FRA12x15M FRA

0.808

6x9M FRA

May RBA OIS

June RBA OIS

1D Repo Rate

Taiwan 1.875

6x12M Generic T-Bills

3M Klibor

No Change

Overnight Borrowing Rate

-25 bp(Q3'14)

+25 bp(Q2'14)

No Change

No Change

-38.0

-38.0

106.7106.7

0.0

-38

Australia

Malaysia

Korea

2.500Cash Rate

12x15M FRAOvernight Polcy

Rate

Base Rate

90 CP Discount Rate

India 1m NDOIS

91 CD Rate

6M Generic T-Bills

BI Rate

Repo Rate 8.000

2.500

3.000

1Y1Y Depo

6M Fwd 1M NDOIS1Y Fwd 1M NDOIS

6x9M FRA12x15M FRA

-19

-38

107

-5

Market

-19

-15-15

1Y Bank Lending Rate

Policy Rate Priced In

Spot Spread(bp)

1Y Depo

-15.0-15.0

THBSGD

Policy Rate Change Probability

Note: Carry is with respect to receiving rates and curve flatteners and receiving belly in flies over 3 months

No Change

Name

Current Policy Rate

Name

Spot Benchmark Rate

Name

Forward Benchmark Rate

TWD

Asia FX & IR Curve Dashboard

CNY (Repo)

CNY(Shibor) INR* KRW MYR

‐8.0%

‐7.0%

‐6.0%

‐5.0%

‐4.0%

‐3.0%

‐2.0%

‐1.0%

0.0%

1.0%

2.0%

3.0%

1M 3M 6M 9M 12M

CNY

CNH

INR

IDR

KRW

MYR

PHP

THB

TWD


9 May 2014 Asia Strategy Weekly www.GlobalMarkets.bnpparibas.com

Asia Government Bond Auction Calendar

Date Time (GMT+8) Asia Bonds and Bills Auction 05/12/2014 10:30 SK Korea to Sell KRW2.05 Tln 5-Year Bond05/12/2014 11:00 TH Bank of Thailand to Sell THB28 Bln 91-Day Bills (CB14814B)05/12/2014 11:00 TH Bank of Thailand to Sell THB28 Bln 182-Day Bills (CB14N13A)05/12/2014 11:00 TH Bank of Thailand to Sell THB45 Bln 329-Day Bills (CB15409A)05/12/2014 11:00 CH Agricul Dev Bank of China to Sell CNY5 Bln 3-Year Bonds (1434)05/12/2014 11:00 CH Agricul Dev Bank of China to Sell CNY5 Bln 5-Year Bonds (1435)05/12/2014 13:00 SI MAS to Sell 28-Day Bills (MD14119Z)05/12/2014 13:00 SI MAS to Sell 84-Day Bills (ML14119E)05/12/2014 05/16 IN India to sell INR 50-60Bln 5-9yr Bonds05/12/2014 05/16 IN India to sell INR 80-90Bln 10-14yr Bonds05/12/2014 05/16 IN India to sell INR 20-30Bln 15-19yr Bonds05/12/2014 05/16 IN India to sell INR 20-30Bln 20+yr Bonds05/13/2014 11:30 HK Hong Kong to Sell HKD25.836 Bln 91-Day Bills Q142005/13/2014 11:30 HK Hong Kong to Sell HKD9 Bln 182-Day Bills H144805/13/2014 17:30 IN India to Sell INR 90Bln 91-day bills05/13/2014 17:30 IN India to sell INR 60Bln 364-day bills05/14/2014 11:00 CH China to Sell CNY28 Bln 7-Year Bonds (1406)05/14/2014 11:00 TH Thailand to Sell THB15 Bln Bonds Due 2037 (LBA37DA)05/14/2014 11:30 HK Hong Kong to Sell HKD0.8 Bln 1.1% 8.5-Year Bonds [Reopen]05/14/2014 14:00 SK Korea to Sell KRW1.5 Tln 63-days Financial BillSource: Bloomberg



Asia Central Bank Watch

Interest Rate Current Rate

Date of Last Change

Next Change in Coming Six Months Comments

China 1Y Bank Lending Rate

6.00% -31bp (5/7/12) No Change

The firming in growth has reduced the need for further monetary accommodation. Yet, borrowing costs have clearly risen in recent months and money and credit growth has slowed. The PBOC appears comfortable with the situation. Monetary policy is likely to remain neutral to support growth.

Hong Kong HKMA Base Rate

0.50% -100bp (17/12/08) No Change

The HKMA base rate moves in step with the US Fed funds rate given the currency board. We do not expect the Fed to raise rates for the next couple of years, implying no change in Hong Kong rates.

India Repo Rate

8.00% +25bp (28/01/14)

+25bp (Q3 2014)

Thanks to falling vegetable prices and base effects, headline and core inflation are now broadly in line with the RBI’s desired disinflationary “glide-path”. The RBI will likely stand pat in April. However, as elevated inflation expectations leave inflation risks still skewed to the upside, it will retain a tightening bias.

Indonesia 1m BI Rate

7.50% +25bp (12/9/13) No Change

With improved monetary policy discipline, narrowing external deficits, a natural downturn in the domestic credit cycle and a benign outlook for inflation, we have withdrawn the 50bp of hikes previously pencilled into our forecasts and now expect BI to remain on hold for the remainder of 2014.

Malaysia Overnight Policy Rate

3.00% +25bp (5/5/11)

-25bp (Q3 2014)

Sluggish nominal GDP growth, strain on corporate-sector debt servicing, weak consumer demand and the tightening of global liquidity should prompt the BNM to cut rates in Q3 2014. BoP concerns limit scope for further easing. The inflation outlook should remain benign barring further subsidised fuel price hikes.

Philippines Overnight Borrowing Rate

3.50% -25bp (25/10/12)

+25bp (Q2 2014)

PHP weakness, strong domestic demand and loose onshore liquidity conditions have tilted the balance of risks for core CPI inflation to the upside, despite low CPI inflation readings currently. In response, BSP is likely to embark on a modest tightening cycle, starting with a 25bp hike in Q2.

Singapore – (13/04/12) No Change

MAS maintained SGD NEER policy settings at its October 2013 meeting. A tight labour market has ensured underlying inflationary pressures persist. As growth risks remain balanced, we do not expect any move for the time being.

South Korea 7 Day Repo Rate

2.50% -25bp (9/5/13)

No Change

The BoK’s assessment of the external and domestic backdrops is slightly more positive than in previous months. A slowdown in China has also been dropped as an explicit policy concern. The BoK’s slightly more optimistic stance suggests rates are likely to remain on hold for some time.

Taiwan Discount Rate on 10 Day Loans

1.875% +12.5bp (30/6/11) No Change

Taiwanese growth is recovering from a weak patch and should rise to an above-trend rate in 2013. However, there is some spare capacity, and inflation will remain contained, as the recent spike in food prices will unwind.

Thailand 1 Day Repo Rate

2.00% -25bp (12/3/14) No Change

After a close vote, the BoT cut its policy rate by 25bp in March. However, with core inflation rising and the tone of dissenting votes seemingly firm, the hurdle for more policy accommodation appears high. Barring further marked deterioration in the growth outlook, the BoT should stand pat for the rest of 2014.

Australia Cash Rate

2.50% -25bp (6/813) No Change

Low inflation and a strong AUD led the RBA to cut the cash rate to a record low in August. With policy guidance dialed back to neutral, our base case now assumes a long period of stable policy rates, with the risk for more easing.

Source: BNP Paribas Economics



BNPP Asia FX & IR Forecast BNP Paribas' End-Quarter Asia-Pacific FX Forecast

Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 Q4 15

USDCNY - - 6.20 - - - 6.10

USDHKD 7.80 7.80 7.80 7.80 7.80 7.80 7.80

USDINR 60.00 62.00 64.00 65.00 65.00 65.50 65.50

USDIDR 11800 12000 12000 12000 12250 12500 12800

USDKRW 1020 1010 1000 1000 980 980 950

USDMYR 3.25 3.35 3.40 3.40 3.42 3.45 3.50

USDPHP 43.80 44.80 45.00 45.00 45.00 45.50 46.00

USDSGD 1.24 1.26 1.28 1.30 1.35 1.35 1.40

USDTWD 30.00 29.80 29.80 29.70 29.70 29.60 29.50

USDTHB 32.00 32.40 33.00 33.00 33.00 33.30 33.50

USDVND 21,100 21,300 21,300 21,300 21,600 21,600 21,600

*Updated as of 8 May 2014

BNP Paribas' End-Quarter Asia-Pacific Interest Rates Forecast

Interest Rates

Year

2014 2015

China Official Interest Rate (%) 3.00 3.25

Hong Kong Official Benchmark Interest Rate (%) 0.50 0.50

India Repo Rate (%) 8.25 7.75

Indonesia Official Benchmark Interest Rate (%) 8.00 7.00

Korea 7D Repo Rate (%) 2.50 3.25

Malaysia Official Benchmark Interest Rate (%) 2.75 2.75

Philippines Official Benchmark Interest Rate (%) 4.00 4.50

Taiwan Discount Rate (%) 2.25 2.38

Thailand Official Benchmark Interest Rate (%) 2.00 2.50

*updated as of Feb 2014



RESEARCH DISCLAIMER: Please see important disclosures in the text of this report. This document has been written by our strategy teams. It does not purport to be an exhaustive analysis, and may be subject to conflicts of interest resulting from their interaction with sales and trading which could affect the objectivity of this report. This document is a marketing communication. They are not independent investment research. They have not been prepared in accordance with legal requirements designed to provide the independence of investment research, and are not subject to any prohibition on dealing ahead of the dissemination of investment research. STEER™ is a trade mark of BNP Paribas The information and opinions contained in this report have been obtained from, or are based on, public sources believed to be reliable, but no representation or warranty, express or implied, is made that such information is accurate, complete or up to date and it should not be relied upon as such. This report does not constitute an offer or solicitation to buy or sell any securities or other investment. Information and opinions contained in the report are published for the assistance of recipients, but are not to be relied upon as authoritative or taken in substitution for the exercise of judgement by any recipient, are subject to change without notice and not intended to provide the sole basis of any evaluation of the instruments discussed herein. Any reference to past performance should not be taken as an indication of future performance. To the fullest extent permitted by law, no BNP Paribas group company accepts any liability whatsoever (including in negligence) for any direct or consequential loss arising from any use of or reliance on material contained in this report. All estimates and opinions included in this report are made as of the date of this report. Unless otherwise indicated in this report there is no intention to update this report. 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