The Context12th August 2019

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The Context

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Inside this week’s edition…

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Mattel Pulls Priced Trade – Rare But Not a First in The HY Market - by Stephen Carter, p3-4In an 8-K filing with the SEC on Thursday Mattel Inc announced it hadterminated the $250m 6.00% 8yNC3 senior notes deal that priced the previousweek and was scheduled to settle on August 8th.

EUR/SEK Bias Higher Ahead of CPI Risk- by Rachel Bex, p5-6A buy-dips preference is now becoming popular in EUR/SEK, with an eventualbreak above 10.8525 to spur another topside attempt.

Asia Credit Insight: July US$ Issuance Highest Since Jan '18- by Sylvia Xu, p7-9APAC US$ supply for July closed out at a strong US$51.084bn and an increase of31.9% from June’s volume. July’s issuance moreover marked the highestmonthly total since US$52.585bn was sold in January 2018.

Light Touch Russian Sanctions, But it Could Still Get Worse- by Christopher Shiells, p10-12On Friday 2 Aug US President Trump signed an executive order specifyingsanctions that should be imposed on Russia for violating the Chemical andBiological Weapons Control and Warfare Elimination Act of 1991. Under the ActTrump was allowed to choose at least three of six sanctions, and he seems tohave chosen the weaker options and diluted these further with waivers.

China Insight: RMB Depreciation is Needed as Long as Trade Talks Drag on- by Tim Cheung and Riki Zhang, p13-14Despite calmness in the front-end of the forward curve, we still expect theRMB will depreciate further and finally reach 7.5 level against USD over therest of the year as long as Beijing continues adopting a better-late-than-early strategy in dealing with the US on the trade matters.

Know The Flows: Money Market Funds pull in over $100 billion in early August - by Cameron Brandt, p15Mutual fund investors opted for liquidity during the first week of August asthey digested an unpleasant cocktail of weak German data, fears of acurrency war between the US and China, hardening positions on Brexit anddisappointment with the Fed’s 25 basis points cut in US interest rates at theend of July.

US 2/30s Spread – Channel Breakdown Signals Flattening- by Marnie Owen, p17Enter a flattener on a retest of the channel lower bounds near 67.0 for atest of the 43.8 area. Place the stop just above 75.2.

USD Index – MACD Divergence Warns of Potential Top- by Andrew Dowdell, p18

Pronounced slowdown in momentum warns of potential topping, with riskseen back to 95.843/98.740 initially.

Gold Cash – Bulls Not Finished Yet- by Andrew Dowdell, p19June’s multi-year wedge breakout paves the way for a much stronger recovery, with scope seen to 1587.02 then 1696.20. Only below 1439.21 dampens momentum.

Mattel Pulls Priced Trade – Rare But Not a First in TheHY Market

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By Stephen Carter, Head of Content, Americas

In an 8-K filing with the SEC on Thursday Mattel Inc announced it had terminated the $250m6.00% 8yNC3 sr notes deal that priced the previous week and was scheduled to settle on August8th.

In the filing Mattel said: "On August 6, 2019, Mattel, Inc. was made aware of an anonymouswhistleblower letter. To provide the Company with an opportunity to investigate the matters setforth in the letter, the offering of the Company's 6.00% Senior Notes due 2027 that wasscheduled to close on August 8, 2019 has been terminated. The Company intends to refinance its4.350% Senior Notes due October 2020 prior to maturity."

These notes had been holding up well in the secondary market even during a very volatile week,trading at or a little above its par new issue price. Nothing more has been disclosed on what is inthe whistleblower’s letter, and it remains to be seen if it will have a major impact on Mattel andits bond deal, or if Mattel, out of an abundance of caution, is simply playing it safe and making fulldisclosure to investors, especially given the recent secondary market volatility.

While unusual, the cancelation of a new issue after pricing, but before settlement, has happenednumerous times in the history of the high yield market. Over the last 25 years IGM counts at leasteleven such occurrences with the last one happening about 3 years ago when Gogo canceled itsdeal.

There have been a variety of reasons why deals have been canceled, including customerscancelling contracts with the issuer, not getting regulatory approval, revised financial outlook,stockholder rejecting the takeover (this happened twice), covenant violation, hurricanes, ratingsdowngrade, snags in an acquisition agreement, and a lawsuit disclosure.

Sometimes these were small technical problems causing only a slight delay and only minorchanges to pricing, but other times the problems were more serious causing a major delay andsubstantial changes to pricing. And in some cases the deal never returned to the market as otherfinancing was done, the reason for the deal went away, or in one case the issuer went bankrupt afew months later.

Here is our list of high yield deals that have been canceled after pricing but before settlementover the last 25 years:

On 05/26/16 Gogo Intermediate Holdings canceled its $525m 12% 6yNC3 sr sec notes deal afterAmerican Airlines canceled their contract with Gogo. Gogo subsequently priced a revised deal afew weeks later.

On 06/03/11 Equiniti Bondco plc canceled its GBP440m sr sec fixed/floater two-part deal(GBP250m 6.75% 5.5yNC2 and GBP190m L+550bp 5.5yNC1 FRN) because by the settlement dateit had not yet received regulatory authorization from the UK FCA for the technical change ofcontrol of the internal transfer of a subsidiary. The next day Equiniti priced a revised deal with anescrow arrangement that mitigated the FCA authorization process risk for investors.

On 08/16/12 The ServiceMaster canceled its $1bn 6.125% 8yNC3 sr notes deal after it "slightly"lowered its revenue outlook and "marginally" lowered its EBITDA outlook. A revised deal pricedthe same day.

0n 12/19/07 Legends Gaming canceled its $220m two-part deal ($160m 12% 4.75yNC3 sr secnotes and $60m 17% 5yNC3 sr sub PIK notes). This deal did not return to the market. Legendssubsequently filed for Chapter 11 bankruptcy protection three months later.

On 05/08/07 OSI Restaurants canceled its $550m 9.625% 8yNC4 sr notes after the specialmeeting of stockholders was postponed to allow more time to roundup the necessary votes toapprove the LBO. A month later shareholders approved a sweetened takeover offer and the bonddeal was repriced.

On 12/19/06 CSC Holdings (Cablevision Systems canceled its $1bn 8.375% 10yNCL sr notes dealafter technical covenant violations under CSC Holdings' existing bank credit agreement andcertain possible technical violations under other debt instruments were ascertained during thecourse of preparing for the financing of its special dividend. As a result CVC decided not proceedwith the special dividend or the sr note offering. The deal did not return to market and CSC neverpaid a special dividend.

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Mattel Pulls Priced Trade – cont’d

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On 09/30/05 Pregis canceled its two-part notes deal (EUR100m 3ME+475bp 7.5yNC1 sr sec 2ndlien FRN and $150m 11.875% 8yNC4 sr sub notes) due to worries of potential supply disruptionscaused by hurricanes in the US Gulf Coast region. The deal was repriced a week later.

On 07/15/02 Dave & Busters canceled its $155m 12.25% 7yNC4 sr sec note deal after theshareholders did not approve the LBO. Rather than following the original plan of placing the dealin escrow while awaiting the completion of the acquisition, the deal was canceled before itsettled. Shareholder approval of the takeover was never received and the whole LBO transactionwas terminated 3 months later.

On 07/23/02 Illinois Power canceled its USD325m 1st mortgage bond two-part deal (USD100m10.625% 5yNCL and $225mm 10.625% 10yNCL) after S&P downgraded its debt ratings. This dealwas investment grade rated at the time of pricing (Baa2/BBB-).

On 07/02/99 Quest Diagnostics canceled its $300m 9.875% 10yNC5 sr sub notes deal. Theproceeds were to be used to fund Quest’s acquisition of SmithklineBeecham"s clinical laboratoryoperations. However, on 07/02/99 Quest announced that this acquisition would not closebecause Quest and Smithkline had not been able to come to terms on a definitive data accessagreement, which was one of the ancillary contracts related to the acquisition. The bond dealnever returned to the market. The acquisition was completed in August 1999, financed with anupsized bank bank loan.

And on 11/18/96 Blue Chip Casino canceled its US86m 13.75% 7yNC4 sr note issue due to alawsuit disclosure. They tried again in March of 1997 to raise the financing for the construction ofa riverboat casino complex in Michigan City, Indiana with an $80m 7yNC4 sr sec note deal, butthis deal was postponed on 03/19/97. And then finally on 09/15/97 they priced a $45m 5y sr subdisc note deal (9.50% at 72.725 to yield 18%) and a $40m bank loan.

Also of note was a deal that was canceled in the investment grade market a couple of years ago.

On 02/18/17 The Kingdom of Bahrain canceled its $750m two-part deal ($450m 5.875% due01/26/21 (3y) and $300m 7.00% due 01/26/26 (7y)) after S&P downgraded Bahrain to BB fromBBB- the day after the deal priced. The downgrade was part of S&P's action on many sovereignsworldwide based on a global change in the agency's oil price assumption for 2016 (down 20%)and 2017-2019 (down by almost 30%).

The very complicated wrinkle with this cancellation was that both issues were fully fungible tapsof outstanding deals making an already difficult operational task of winding down the canceledtrades in the new issue even more difficult. Usually, when an already-priced trade is canceled, allbuy and sell orders are wiped clean. However, because the Bahrain deal was a tap, andimmediately fungible, leads and the issuer said they would cancel all the buy orders, but sellorders that had occurred between pricing and cancellation would stand. This basically left anyonewho had sold the bond quickly after pricing with a massive short - having to deliver bonds theythought they had bought but that no longer existed.

Ultimately the deal was repriced the following week at a smaller $600m size and 25bp back of theoriginal tap yield.

The Mattel price terms were as follows:

08/01/19 $250m Mattel Inc 144A/Reg S sr unsec guaranteed notes due 8/15/2027 (8y). NC3,then at 104.500, 103.000, 101.500, 100. Equity claw: 3yrs 40% at 106.00 until 8/15/22. Existingratings B1/BB-. Via BAML/Citi/WFS/Miz/MUFG/RBC/HSBC joint books. Co-mgrs: GS, MS, Key.6.00% at 100. +417bp vs 2.25% 8/15/27. No reg rights. IPT 6.25% area. Px talk 6.00%-6.25%.Settle 8/8 (T+5). 144A CUSIP: 577081BC5. Did investor call is 08/01 at 11am. Books closed at1:30pm 08/01. UOP: along with cash on hand, to redeem and retire all of the 4.35% sr notes due2020 and pay related prepayment premiums and transaction fees and expenses. Biz: IP-driven,high-performing toy company. HQ: El Segundo, CA

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EUR/SEK Bias Higher Ahead of CPI RiskBy Rachel Bex, Senior FX Analyst

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EUR/SEK surged to near three month highs of 10.8373 on August 7th as currency war risksintensified after PBoC allowed its yuan to fall below 7 vs the Usd.

Threatening tweets from Trump regarding lower interest rates and the growing risk ofefforts from within the White House to cap the Usd followed, while an aggressive RBNZ ratecut of 50bps saw players start to price in the possibility of dynamic policy easing across theglobe as Central Banks attempt to shore up their economies amid the global growthslowdown/trade war risks.

In turn, specs have been quickly pricing out the possibility of a Riksbank rate hike by the endof this year.

Indeed, while Governor Ingves told markets at the last CB decision that a hike at the turn ofthe year was still being penciled in, recent developments suggest such a move is nowunlikely, with players instead busy pricing IN the chances of a Riksbank cut by end-2019.

In a very timely manner, focus now swings firmly to Swedish inflation figures due on the14th. Consensus looks for the main CPIF rate to drop further to just 1.4% y/y from 1.7% inJune – well below the Riksbank's 2% target.

Such a read should see expectations for any more Riksbank hikes in this this cycle drop tovirtually zero, and encourage another bout of Sek selling.

Staying with the inflation theme, Prospera releases its Inflation Expectations Survey onThursday.

A buy-dips preference is now becoming popular in EUR/SEK, with an eventual break above10.8525 to spur another topside attempt.

Technical studies are bullish while above 10.6386, and note:

• Potential is seen for a period of congestion following the retreat from Wed's 10.8373high, just shy of the May 10.8525 peak

• Dips should attract fresh bids in the 10.6616/10.6386 area

• Further weakness below 10.5867/10.5782 threatens wider topping

• An eventual return higher & break above 10.8525 remains favoured, opening 76.4% ofthe 2009-2012 fall at 10.9370

EUR/SEK – cont’d

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Asia Credit Insight: July US$ Issuance Highest Since Jan '18

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By Sylvia Xu APAC Credit Analyst

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❖ APAC US$ supply for July closed out at a strong US$51.084bn and an increase of 31.9% from June’s volume.❖ July’s issuance moreover marked the highest monthly total since US$52.585bn was sold in January 2018.

Three Japanese financial names in the shape of Sumitomo Mitsui Financial Group, Mizuho FinancialGroup and Mitsubishi UFJ Financial Group contributed a combined US$13.75bn to July’s total, whichin turn underpinned the busiest week of the year for regional issuance when US$28.95bn priced inthe second week of July.

Westpac Banking Corp's US$2.25bn subordinated T2 dual-tranche transaction marked a milestone inthe APAC primary US$ market as the first US$ bond from an Australian lender following theannouncement from the Australian Prudential Regulation Authority (APRA) requiring Australianbanks to raise 3% regulatory capital (risk weighted assets) by January 1, 2024.

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Asia Credit Insight – cont’d

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Market Type Reg S only issuance retained top spot atUS$23.255bn or 45.5% of the monthly total, albeit with anotable drop from June's 73.9%. Meanwhile, SEC-Registeredand 144A/Reg S issuance both made a larger contribution tothe overall total in July, as once again the US$13.75bn sold bythe three Japanese financials and Westpac Banking Corp'sUS$2.25bn subordinated T2 dual-tranche transaction were allin SEC-Registered format. continued page 9

Source: Informa Global Markets (IGM)

Sector breakdown Financials rose to the top spot withUS$22.25bn or 43.6% of the monthly total, up from24.6% in June. This replaced the top contributing sector(SSA/SOE/LGFV) which declined to US$9.95bn in July fora market share of 19.5%, down sharply from 44.1% ofthe total in June. The sharp increase in financial supplywas predominantly thanks to the three Japanese issuershighlighted prior.

Jurisdiction Japanese issuers made a notablecontribution to July’s increase in volumes, pricing acombined US$16.75bn which represents 32.8% ofthe monthly total. That said, China retained itsnumber one position as the highest volume issuerof US$ offshore bonds with US$21.805bn whichequates to 42.7% of the total monthly volume.

Asia Credit Insight – cont’d

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Rating investment grade issuance rose slightly inJuly with the US$37.35bn raised making up 73.1%of the monthly total, up from 60.4% in June. Thispercentage increase largely came at the expense ofunrated issuance which declined to US$3.65bn or7.1% of the monthly total, down from US$6.013bnor 15.5% in June.

Elsewhere, the contribution from high-yieldborrowers saw a smaller decline in July inpercentage terms with the US$10.084bn pricedmaking up 19.7% of the total, down from 24.1% theprevious month.

Maturity One clear trend in July was a rise in issuance inthe 8-10 year and >10 years maturity buckets whichcontributed 26.2% and 7.7% of July's volumerespectively, as regional issuers looked to capitalize onthe opportunity to lock-in lower rates and extend theirmaturity profile.

It was the very short-end of the curve which retained topspot in terms of the overall contribution to the totalhowever, with the US$19.355bn raised in the 0-3.5-yearmaturity bucket representing 37.9% of July's total.

Source: Informa Global Markets (IGM)

Light Touch Russian Sanctions, But it Could Still Get Worse

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By Christopher Shiells, Managing Analyst EM

Latest US sanctions move on Russia the minimum called for

On Friday 2 Aug US President Trump signed an executive order specifying sanctions that shouldbe imposed on Russia for violating the Chemical and Biological Weapons Control and WarfareElimination Act of 1991 (CBW Act). Under the Act Trump was allowed to choose at least three ofsix sanctions, and he seems to have chosen the weaker options and diluted these further withwaivers. The options chosen are:

1. Opposition to multilateral loans from international financial institutions (IMF, WB etc).2. A prohibition on US banks participating in the primary market for non-RUB denom bonds

issued by the Russian sovereign and lending non-Ruble denom funds to the Russian sovereign,after Aug-26.

3. Additional licensing restrictions on the export to Russia of US goods and technology on theCommerce Department-controlled list.

The move was a long time coming: the State Department had said in Sep that sanctions could beimplemented in November, but delays continued amid a reluctance from US President Trump togo down this route, and the administration appeared to act only under pressure from Congress.

Draconian measures avoided

The measures unveiled a week ago were less draconian than the Kremlin and some investors hadanticipated. The first sanction is largely a moot point given there is very little of this multilaterallending to Russia and the licensing restrictions for exports are narrow, limited to items forchemical and biological weapons proliferation.

Of main relief to Russian investors was that the second sanction did not cover Russia's RUB-denominated OFZ bonds. This was always seen as a major fear for Russian investors, along withthe nuclear option of a complete ban on all trading in Russian debt, that could inflict majordamage on Putin's ability to raise capital. According to CB figures, the amount of OFZs held byforeigners is up at 30% of the total amount issued (see graph on dashboard below), recoveringsharply this year from near two-year lows at the end of 2018.

The Russian government issued a total of USD6.3bn in Eurobonds this year (twice the originalplan), and up to 80-90% were bought by foreigners. This covers upcoming external maturitiesuntil September 2023, according to our calculations. Thus the inability of the sovereign to issue

Eurobonds in the near future matters little for the Russian economy and financial markets.

On top of this, Russia has some of the strongest credit metrics across all emerging markets:general government debt remains around 15%/GDP, with the total amount gradually falling overthe last year under USD500bn, external balances are in surplus and international reserves havereached circa USD518bn. If required, Russia could repay all of its external debt tomorrow and stillbe left with approx. USD 70bn of funds (see graph in dashboard below).

RUB best performer this year, but sanction risk suggests this may not last

As news of the sanctions broke, the Rouble and related Russian markets sold off, but amid abackdrop of broader risk-off flows, these markets were outperforming thanks to the abovementioned 'light touch' of the sanctions. Thus, OFZ yields are back where they were pre-announcement, aided by yet another global shift in yields lower on weak global growth concerns,whilst USD/RUB upside has been limited to 66 for now.

The EPFR country flows data (see dashboard below) shows that investors fled Russian exposedfunds after sanctions were put in place from 2014 and that after recovering for ca. 2-years frommid-2016, started to deteriorate again when new sanctions were put in place during 2018.Specifically the threat of sanctions on Russian govt debt saw foreigners shed their holdings ofOFZs, which fell to 24.4% the lowest in 2-years. However, these have picked up again over the lastyear, as noted above.

The latest CBW sanctions have been discussed since autumn 2018, and thus investors have hadplenty of time to sell their exposures, and whilst there has been no significant turnaround ininvestor flows according to the EPFR data since the turn of the year, the RUB has been the bestEM FX performer vs the USD (up 6.93% at time of writing), whilst yields on 10-year OFZ bondshave dropped ca. 130bp, behind only Turkey as the biggest CEEMEA mover.

Thus history suggests that sanctions have a negative impact on Russian markets and flows, butperhaps due to a function of sanctions fatigue and stronger global capital flows, investors are now'numb' to the new sanctions threat, especially as the latest actions suggest little appetite for moreharsh penalties.

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Russian Sanctions – cont’d

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Russian Sanctions – cont’d

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Sanctions overhang

These sanctions do provide a warning to Russian investors who had begun to believe that thesanctions regime had paused, as the executive order came one day after a US Senate panelpassed a measure that would punish companies that help Russia's state-owned Gazprom to builda pipeline from Russia to Germany. These come on top of a number existing sanctions bills thatare yet to be approved.

However, the sanctions that came out of the existing CBW Act were weak, pushed out withoutany context and largely seen as a 'light touch'. They are the minimal sanctions needed to satisfythe CBW's requirements, which may be what US President Trump wanted, in an effort to try andfurther delay any serious sanctions on Russia and reduce the incentive from Congress to push foradditional sanctions. Or the administration may just be withholding full sovereign debt sanctionsand additional technology transfer restrictions for future use where they can count.

As per above, there have been numerous bills proposing sanctions on Russia and specificallysovereign debt put forward by members of Congress for its alleged meddling in US elections of2016. So far these bills have made very little progress in the US Congress, but there is now the riskthat the re-emergence of the Skripal-related sanctions story may give more traction to othermore fearsome sanction bills.

Thus, we would not assume that sanctions against Russia have peaked.

Still scope for Usd/Rub upside, but rangebound for now

This would suggest there is room for USD/RUB to spike again on any sanctions related headlines,although for now if oil prices stabilise, the potential new round of sanctions does not materiallydent economic growth or damage Russia's strong balance sheet. Thus, given the current negativeEM environment and strong bullish positioning in RUB (see CTFC data in dashboard that showsnet longs near record highs), which will limit RUB's ability to quickly bounce back, we seeUSD/RUB contained in the 62.500-66.500 range, with a spike to 69-70 possible on any freshsanctions angst.

• Bias remains broadly higher, with bulls seeking to mark out a fresh base over Jun's 62.499 low,near the 200-Week MA (approx. 63.27).

• Churning may persist in the near-term as momentum builds, but the MACD indicator iscrossing higher, and above 66.223/.231 will firm conviction that a low is in place.

• Short-term dips should attract fresh bids ahead of/near support at 62.499.

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China Insight: RMB Depreciation is Needed as Long as Trade Talks Drag on

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By Tim Cheung, Head of China, Riki Zhang EM Analyst

Asian markets were shocked by Trump's announcement of the imposition of 10% tariff on theremaining USD300bn of Chinese starting, effective 1st September. The announcement cametotally unexpectedly as nobody would think in advance that the face-to-face meeting betweenthe US and Chinese trade negotiators would end up with further widening, instead of narrowing,of the gap between two countries.

What we have seen so far is just the first-order impact of Trump's tariff decision. Given thatChina has already run out of US goods which can be tariffed for the first time, there is goodchance Beijing will respond to Trump with non-tariff retaliation. Non-tariff retaliation couldinclude punishing the "unreliable" US companies selectively. Recall, China said at the end of Mayit would establish a list of so-called unreliable entities of foreign companies and people thatseriously damage the interests of domestic firms. Second-order impact will surface once Beijingdecides how it is going to retaliate, which we think will be known by middle of this month.

After that, investors will shift their attention to whether the next round of trade talks inWashington scheduled for early-September will happen as planned. Recall, China only sent adelegation headed by Vice Minister of Commerce Wang Shouwen, instead of Vice Premier LiuHe, to Washington for trade talks in August 2018 when China had strong disagreement with theUS on many issues. This time round China might be far less interested in making efforts tonarrow down the gap between the US and itself than twelve months ago, so the possibility ofsending a delegation headed by a low-ranked official should not be ruled out. At worst, Chinamay discontinue negotiations straightaway by refusing to send a delegation to Washington. Thethird-order impact will arise if the worst happens.

In the USD/CNH FX market, on August 2nd we saw:

• A sharp rise in the spot rate;

• FX forward points moved to the right substantially;

• Option implied vol curve turned inverted.

Reason for (1) & (2) is very simple - a currency depreciation is needed to compensate for thepotential loss of export competitiveness caused by the new tariffs (chart 1). Chart (3) suggeststhe market was pre-supposing depreciation would happen on an immediate one-off basis.

Eventually, offshore USD/CNH on August 5th surprisingly surged through the 7.00 level.

Within a few hours after RMB depreciated through the 7.00 level vs the USD, PBOC deliveredtwo statements:

• Online statement: Depreciation of RMB through 7.00 level is attributed to unilateral andprotectionist measures as well as the expectation of additional tariffs on Chinese goods.

• Governor Yi Gang elaborated more in another statement: China won't engage competitivedevaluation. The fluctuation (i.e. RMB depreciated thru 7.00 level) was driven anddetermined by the market. The current RMB FX is at an appropriate level, despite thefluctuation due to recent external uncertainties.

Historically when RMB was under severe depreciation pressure PBOC usually liked to say "thereis no fundamental reason for sustained weakness of RMB" and/or "the recent RMB weakness isnot fundamentally justified". However, PBOC did not say anything like this on 5th of August.

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China Insight – cont’d

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In our view, Chinese leaders do not mind if the RMB depreciates much further, as long as theirstrategy in dealing with the Trump administration can carry on and namely on the below basis:

Bottomline:

• A trade agreement with the US, which may last at least a decade and will likely beirreversible, can be delayed but not avoided.

Adopt a better-late-than-early tactic:

• The later a trade agreement comes, the less unfavourably it will treat China. Thus, Beijinghas tried every possible way to let the trade talks drag on without yielding a solution.

Two possible outcomes if the tactic succeeds:

• China is able to get a less unfavourable deal from the next US president if Trump fails to bere-elected in November 2020; or

• No choice but to reach an agreement with Trump in his second term; which however willunlikely be tougher than anything, if at all, signed at present, because there is no reason forthe US president to be hungry for a big achievement in his second term.

The cost(s) of better-late-than-early tactic:

• Higher tariffs on Chinese exports and some downward pressure on economic growth are thecosts that Beijing has to pay for this tactic. To offset some or all of these costs, Beijing willlet RMB depreciate (chart 2) as long as capital outflows remain under control. With verytight control over capital outflows already in place since early 2016, further RMBdepreciation will unlikely lead to sharp shrinkage in FX reserves as long as PBOC refrainsfrom conducting aggressive FX intervention.

Compared to the RMB depreciation triggered by the change in FX regime in August 2015, thefall in RMB FX through the 7.00 level this time around has not caused much panic in front-endof USD/CNH forward curve. Take 1-month USD/CNH FX swap as an example, upside so far hasbeen capped by 100 pips. That's very low, compared to 2018 year-high 310 (not to mention1000-1200 area seen in 2015/2016). The calmness in the front-end, we think, should beattributed to PBOC liquidity management and forward book management that is keepingliquidity flush (chart 3).

Despite calmness in the front-end of the forward curve, we still expect the RMB willdepreciate further and finally reach 7.5 level against USD over the rest of the year as long asBeijing continues adopting a better-late-than-early strategy in dealing with the US on thetrade matters.

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Know The Flows: Money Market Funds pull in over $100 billion in early August

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By Cameron Brandt, Director, Research

Mutual fund investors opted for liquidity during the first week of August as they digested anunpleasant cocktail of weak German data, fears of a currency war between the US and China,hardening positions on Brexit and disappointment with the Fed’s 25 basis points cut in US interestrates at the end of July. Flows into Money Market Funds jumped to a 32-week high, exceeding the$100 billion mark for only the second time since EPFR started tracking them, while a net $24.9billion flowed out of Equity Funds – their biggest weekly total year-to-date – and another $2.7billion out of Balanced and Alternative Funds combined.

Risk appetite, already in short supply, all but evaporated during the week ending August 7.Redemptions from Emerging Markets Bond, High Yield Bond, Alternatives, and Emerging MarketsEquity Funds hit 11, 12, 32 and 206-week highs respectively while Gold Funds posted their biggestweekly inflow since mid-1Q17 and Municipal Bond Funds on record.

The latest flows breathed fresh life into a rotation from Equity to Bond Funds that started early inthe year and, by early July, appeared to have run its course. Investors fueling this rotationcontinue to pay a significant premium for the perceived safety of cash and fixed income.Collective performance so far this year for all EPFR-tracked Bond Funds is +5.7% and for MoneyMarket Funds +0.24% while Equity Funds are still up nearly 14%.

At the asset class and single country fund levels, redemptions from Greece, Hong Kong and UKEquity Funds climbed to 11, 15 and 29-week highs respectively. Mortgage Backed and MunicipalBond Funds extended their current inflow streaks, as did Total Return Bond Funds, whileredemptions from Bank Loan Funds climbed to a nine-week high as they added to a run ofoutflows stretching back to mid-4Q18.

Flows to EPFR-tracked Sector Fund groups in early August had a strongly defensive flavor asinvestors weighed the US Federal Reserve’s words and actions at the end of July and the latestescalation of Sino-US trade tensions. Gold Funds recorded their biggest inflow in over two yearsand Consumer Goods Funds took in fresh money for the eighth time in the past 12 weeks whileredemptions from Financial Sector Funds hit a year-to-date high.

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US 2/30s Spread – Channel Breakdown Signals Flattening

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Technical Analysis by Marnie Owen

• Confirmed the break down from a rising 7.5-month channel to signal further flattening

• With the weekly RSI deteriorating and the weekly MACD below the signal line which reinforce the outlook, watch for a test of 43.8 which is near the channel breakdown target at 44.7 as well as a Fibonacci projection at 44.1

• Steepening through 75.2 near the 50 DMA (currently 72.9, not shown) would, instead, refocus the 83.0 area

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STRATEGY SUMMARY

Enter a flattener on a retest of the channel lower bounds near 67.0 for a test of the 43.8 area. Place the stop just above 75.2

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Resistance Levels

R5 111.3 9 February 2018 peak R4 102.0 12 February 2018 narrow/20 February 2017 prior peak R3 92.4 5 March 2018 wide R2 83.0 5 June 2019 range top R1 75.2 31 July 2019 wide

Support Levels

S1 50.1 1.500x 83.0/62.1 from 81.5 near 50.3, 61.8% of the 30.1/83.0 steepener S2 43.8 28 January 2019 trough, near channel breakdown target/1.786x 83.0/62.1 from 81.5 (44.7/1) S3 39.6 2.000x 83.0/62.1 from 81.5 near 40.5 (8 January 2019 trough) S4 30.1 20 December 2018 range bottom S5 23.3 16 July/27 June 2007 narrows

USD Index – MACD Divergence Warns of Potential Top

18

Technical Analysis by Andrew Dowdell

• The rate of ascent is slowing & successive lower peaks in the MACD indicator warn of a potential turn

• Last week’s Shooting Star Candle hints at bullish exhaustion

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STRATEGY SUMMARY

Pronounced slowdown in momentum warns of potential topping, with risk seen back to 95.843/98.740 initially.

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Resistance Levels

R5 100.00 Psychological R4 99.888 11 May 2017 high R3 99.233 2 February 2017 low R2 98.932 1 August 2019 high R1 98.371 23 May 2019 high

Support Levels

S1 96.671 18 July 2019 low S2 95.843 25 June 2019 low, near the 20 March 2019 low at 95.740 S3 95.029 10 January 2019 low S4 94.787 16 October 2018 low S5 93.814 21 September 2018 low

Gold Cash – Bulls Not Finished Yet

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Technical Analysis by Andrew Dowdell

• Broke higher from a multi-year contracting wedge pattern in June

• 200-Week MA is turning higher, having already reverted to support

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STRATEGY SUMMARY

June’s multi-year wedge breakout paves the way for a much stronger recovery, with scope seen to 1587.02 then 1696.20. Only below 1439.21 dampens momentum.

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Resistance Levels

R5 1921.17 6 September 2011 high R4 1796.08 5 October 2012 high R3 1696.20 22 January 2013 high R2 1587.02 61.8% of 1921.17-1046.44 fall R1 1522.75 29 December 2011 low, near the 26 September 2011 low at 1535.07

Support Levels

S1 1439.21 25 June 2019 high S2 1375.34 11 July 2016 high S3 1346.80 20 February 2019 high S4 1266.35 2 May 2019 low S5 1160.39 16 August 2018 low

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