Asia: The pain trade – Deutsche Bank

Research Team at Deutsche Bank, suggests that it feels like flows coming to Asia have settled into a wave pattern over alternating years since the GFC.

Key Quotes

“Year to August aggregate for equity and debt inflows into Asia in the even numbered years over this period have averaged $64bn, against $24bn in the odd numbered years. 2016 fits the pattern (with year to date aggregating just north of $50bn). Interesting though that the inflow momentum this year has been quite so strong even in a typically poor month like August.

Unlike the average since GFC, which puts August as the worst month of the year for equity inflows and the second worst for debt inflows; this year, we are set for August to be the third best month on equity inflows, and at least yield above year to date average flows on debt. Part of this, like we argued in these pages last week, could be an adjustment to the underallocation to Asia in 2015 relative to global QE trends. And part maybe a response to some initial signs of life to the regional data pulse.

The increasingly obvious interdependence of global central bank reaction functions, and the implication therein for both the pace and the terminal point of Fed policy in particular, is likely a big part of the relative appeal of Asia/EM.

Thinking then ahead of the end to summer markets by the turn of the month – and particularly if Jackson Hole and/or NFP fail to shift the dial conclusively on Fed pricing - we suspect the pain trade is likely still for a continuation of the flow trend, and hence stronger Asia/EM FX. We say this both because global QE money has been underallocated to Asia/EM; but also because domestic money is positioned structurally long dollars.

On the other hand, were Fed repricing to drive a near term adjustment higher in USD/Asia, we would see it as a test of whether the markets have been able to migrate from a ‘buy USD dips’ mindset to ‘sell USD rallies’. Asian currencies have been more correlated of late to volatility in CNY and directionality in JPY. Ultimately, we see USD/JPY at 94 by end of this year. And CNY vol to remain relatively well managed. That would still suggest a stronger Asian currency complex by end of the year.

We are cautious about chasing duration exposure at current levels in China, even though we do think the monetary policy stance will loosen somewhat later this year. In Korea, we remain unconvinced about the steepening in curves driven by the news of 50Y KTB issuance.

To us, it seems that it would need a revision of the mandate for the MOSF to trigger substantial enough issuance of super long dated period to cause a meaningful steepening. And finally, in Malaysia, we discuss the implications of MGII inclusion into the GBI-EM index, including possible eventual weight of the sukuks versus conventional government bonds, and what that structurally means for the basis between the two.”