Risk & Reward：Trouble brews in FX markets as no-deal Brexit looms

Risk & Reward | August 9, 2019 Analyst certifications and other disclosures on last page. This research report has been created by CCB International Securities Ltd. 1 我们的平衡且低波动投资组合的资产配置如图1所示，且自6月以来一直保持不变。 今年以来，我们的平衡投资组合的表现，首次超过了60:40的股票债券投资组合和标准普尔风险平价指数(S&P Risk Parity Index)。低波动性投资组合仍然落后于基准，但我们预计它将很快成为最佳表现者。两周前，我们注意到，所有资产类别的异常强劲表现都不具备可持续性。本周我们注意到两项不寻常的事态发展。首先，黄金表现已连续52周优于全球股市和债市。黄金的优异表现几乎总是预示着避险情绪的加剧。其次，随着人民币兑美元汇率突破7关口，新兴市场货币指数本周突破趋势支撑位。如果这一突破在未来一周得到证实，新兴市场的资本外流将会加剧。需多加谨慎。 Asset allocations of our balanced and low volatility portfolios are shown in Fig 1 and are unchanged since Jun.1 For the first time this year, our balanced portfolio is outperforming its benchmarks, the 60:40 portfolio and the S&P Risk Parity Index. The low volatility portfolio is still lagging but we expect it will soon be the best performer. Two weeks ago we noted that unusual strength seen across all asset classes is invariably unsustainable.2 This week we note two ominous developments. First, gold is now outperforming both global stocks and bonds on a rolling 52-week basis. Gold outperformance almost always foreshadows heightened risk aversion. Second, the EM Currency Index broke trend support this week as the RMB/USD pushed through the 7 threshold. Should this break be confirmed in the coming week, capital outflow from EM will intensify. This is a time for caution. While many currencies have broken support versus the US dollar in the past week, three key currencies have yet to break. First, the broad US dollar Index is still testing the high from way back in 2002. Second, sterling is still holding the low from 2016. Developments in these currencies likely hold the key to developments in all asset classes. Third, the yen is holding key support just above 105. The outlook for the dollar will depend on whether or not we see a currency war. If a pattern of competitive currency devaluation unfolds, global banks will begin to withdraw liquidity from the global system, which would force the US dollar higher against all currencies except the yen. Japanese banks are heavily exposed to leveraged US dollar credit. The combination of a breakdown in the yen and widening spreads would turn these banks into forced sellers. The TOPIX Bank Index is skirting close to its all -time low and will be a key indicator to watch. The pound could be a trigger for disorder in FX markets in Sep. When the UK parliament returns from summer recess on 3 Sep the opposition plans to hold a no-confidence vote to bring down Boris Johnson’s government and avoid a no-deal Brexit on the 31 Oct deadline. The Conservative Party has a working majority of just one vote so it is possible the Johnson government will not survive. If so, the convention is for the UK PM to resign. It is convention, not law. Most expect Johnson will hold on. After a 14-day cooling-off period, the opposition will attempt to form a “government of national unity”. If this attempt fails an election must be called within 25 days. By convention, the incumbent PM picks the election date to be approved by the queen. In this event, Boris Johnson will select a date after the 31 Oct deadline; he will not ask for an extension and exit will be triggered under Article 50. If the no-confidence vote fails or parliament cannot form a government of national unity, hard Brexit is likely and markets will fall into turmoil. Fig 1: Our global asset allocation portfolios Balanced Portfolio Low Volatility Portfolio Asset ETF Ticker 28-Jun-19 2-Aug-19 28-Jun-19 2-Aug-19 U S 1-3 Year Treasury SHY 24.0% 24.0% 76.5% 76.5% U S 7-10 Year Treasury I EF 6.0% 6.0% 0.0% 0.0% U S 20+ Year Treasury TLT 6.0% 6.0% 0.0% 0.0% U S TI Ps TI P 6.0% 6.0% 0.0% 0.0% U S I nv estment Grade Bond LQD 6.0% 6.0% 0.0% 0.0% U S High Yield Bonds HYG 6.0% 6.0% 0.0% 0.0% EM Bond - U S$ EM B 6.0% 6.0% 8.5% 8.5% DM Equity - Long ACWI 25.0% 25.0% 15.0% 15.0% DM Equity - Short SH 0.0% 0.0% 0.0% 0.0% EM Equity - Long EEM 5.0% 5.0% 0.0% 0.0% EM Equity - Short EU M 0.0% 0.0% 0.0% 0.0% Gold GLD 5.0% 5.0% 0.0% 0.0% Gold Stocks GDX 0.0% 0.0% 0.0% 0.0% Oil U SO 0.0% 0.0% 0.0% 0.0% Source: Bloomberg, CCBIS Fig 2: Performance comparison Performance Balanced CCBI Portfolios Benchmarks US Agg Bond Index US$ EM Bond Index MSCI World MSCI EM Gold Balanced Portfolio Low Volatility Portfolio S&P Risk Parity Index (10% vol) 60:40Portfolio Return 2019-ytd 10.0% 7.2% 9.2% 8.4% 7.9% 12.6% 8.4% 6.9% 14.1% 52 week 10.0% 8.2% 7.5% 6.3% 7.9% 11.4% 4.7% -0.4% 9.7% 3yr (ann) 8.7% 6.7% 5.9% 8.9% 2.3% 5.3% 13.1% 11.6% 1.6% 10yr (ann) 8.0% 6.2% 6.7% 8.1% 3.6% 6.9% 9.5% 4.2% 4.0% Risk Max Drawdow (10 yr) -9.2% -7.8% -10.8% -11.8% -4.7% -12.8% -21.9% -37.1% -44.7% Volatility (10 yr) 8.0% 5.9% 5.9% 9.0% 3.2% 7.6% 15.7% 20.6% 15.0% Reward/Risk (10 yr) 1.0 1.3 1.1 0.9 1.1 0.9 0.6 0.2 0.3 Source: Bloomberg, HFRX, LPX Group, CCBIS Fig 3: Rolling 52-week returns Source: Bloomberg, CCBIS Fig 4: FX markets reach a key decision point Source: Bloomberg, CCB