Foreign Exchange Applied Framework of Analysis

Transcription

1 This material is not investment research or a research recommendation for regulatory purposes. Please find further important information at the end of this document. Foreign Exchange Applied Framework of Analysis Investment Strategy and Research Private Banking and Wealth Management August 2014

2 Why FX? Motivation for Focus on Currency Allocation Cash Holdings Are High by Historical Standards Hard Currency Deposit Interest Rates Are Low and Negative in Real Terms Mistrust of any Single Traditional Hard Currency Is High Few Clear Alternatives to Hard Base Currencies Capital and Purchasing Power Preservation Are Critical Mandates August

3 Some Basic Ideas: PPP and Productivity Real Exchange Rates (RER) vs. Real Relative GDP per Capita Sources: Credit Suisse estimates, Penn World Table August

4 What Drives Markets? Our Framework Directional Views Based on Fundamental, Technical and Quant Factors Technical analysis uses proven methods of momentum and pattern recognition to identify entry and exit points from trends. T e c h n i c a l s Value analysis is based on economically sound and statistically robust models of the equilibrium price, around which a market should mean revert over the longer term. Quant Directional views derived from value, cycle and technicals are overlaid with a quantitative model, focusing on relative total returns. A simple directional view that accords with a strong expected total return receives a higher conviction rating. Cycle analysis seeks logical fundamental relationships between economic data, policy variables and market trends. It is most heavily weighted for the tactical (three to six month) time horizon. c In the absence of any other signals, a very strong quant rating can also determine the directional view. August

5 Our Process at a Glance Analytical framework Views and forecasts Portfolio implementation e c h n T i c a l s Spot Drivers Target Currency pair Outlook Last 30 days 25/06/14 Value Cycle Tech 3M 12M EUR/USD RUB PLNAUD MXN FX USD base USD USD/JPY GBP/USD USD EUR/CHF c USD/CHF AUD/USD USD/CAD SGD CNH AUD CAD MXN FX EUR base USD EUR EUR PLN RUB GBP NOK Our approach to currency analysis and forecasting is a balance between long-term value estimates, medium term cyclical regularities and technical analysis Based on these key factors of currency determination, we derive clear directional views and targets Qualitative exchange rate opinions are translated into specific portfolio allocations Our currency allocation process is aimed at preserving wealth through diversification as well as generating income from currency views August

6 Analytical Framework What Drives Currencies? We Combine Value, Cycle and Technical Components to Derive Directional Views Value The Credit Suisse Fair Value (CSFV) model constitutes an anchor for our framework It is a theoretically sound and statistically robust econometric model for measuring whether a currency is expensive or cheap CSFV provides long-run exchange rate valuations driven by macroeconomic relationships across currencies, such as relative prices, productivity, yield and external balances The value model is most heavily weighted for the long term Cycle We also analyze the behavior of exchange rates through the global economic cycle Different currencies display differing sensitivity to the global economic cycle, reflecting the structure of their domestic economies We identify which currencies tend to be strongest and weakest in differing economic circumstances Cyclical analysis is most heavily weighted for the medium term e c h n T i c a l s Technicals Technical analysis focuses on the behavior of the price itself It defines exchange rate trends, tracks momentum and identifies price patterns which may indicate shifts in the balance of currency supply and demand Technical analysis is most heavily weighted for short-term strategy and forecasting c August

7 Currency Driver 1: Value Our Fair Value Model Determines whether a Currency Is Over- or Undervalued Purchasing power parity (PPP) Deviation in % from Fair Value 40 Expensive/Overvalued Real central bank rate differential Econometric model Long-term equilibrium rate differential 10 0 Relative productivity Net foreign assets and liabilities JPY Cheap/Undervalued SEK NOK CHF CAD GBP USD EUR AUD NZD Purchasing power parity (PPP): this concept estimates an exchange rate that would offset differences between home and foreign goods price levels, equalizing basic competitiveness Real central bank rate differential: difference between the current inflation adjusted central bank policy rates an indicator of relative central bank tightness. Relatively tight monetary policy is a key attractor of short-term capital inflow. Long-term equilibrium rate differential: similar to above, but based on the estimated long-term convergence level of interest rates that would be consistent with inflation being around its policy target and the economy working at full capacity Relative productivity differential: the difference between inflation adjusted GDP per capita. High home productivity is consistent with high real returns to investment and can also offset some rises in non-traded goods prices, reducing overvaluation relative to PPP. Net foreign assets and liabilities differential: difference between a country s external assets and liabilities, adjusted for changes in valuation and exchange rates. High net foreign assets reflect cumulative surpluses, consistent with effective competitiveness. High liabilities are penalized as they represent vulnerability to shocks. August

8 Currency Driver 2: Cycle Analysis of Currency Performance during Phases of the Global Cycle (1/2) Overheating Peak Slowdown Contraction Recovery AUDGBP CAD EUR CHFSGD USD USD EUR CAD SGD JPY GBP AUD USD JPY CHF EUR JPY GBP CADSGD SGD CAD AUD JPY EUR CHF CHF USD AUD GBP Trough Note: The bar charts show the average performance of selected major exchange rates in each individual phase of the global economic cycle through the analyzed period, All FX rates vs. USD, except USD which is a trade weighted index. August

9 Currency Driver 2: Cycle Analysis of Currency Performance during Phases of the Global Cycle (2/2) Sources: Bloomberg, Credit Suisse August

10 Currency Driver 2: Cycle Analysis of Currency Strategies during Phases of the Global Cycle (1/2) Overheating Peak Slowdown Contraction Recovery Carry Exploits bias in forward rates Buy high yielding currencies Sell low yielding currencies AUDGBP CAD EUR CHFSGD Momentum Captures medium term FX trends Buy upward trending currencies Sell downward trending currencies USD Carry Exploits bias in forward rates Value Mean reversion Credit Suisse Fair Value Model USD Buy high yielding currencies Sell low yielding currencies Buy undervalued currencies Sell overvalued currencies EUR CAD SGD JPY GBP AUD USD JPY Growth Economic indicators Emerging Markets Real appreciation of EM FX Buy strong economy currencies Sell weak economy currencies Buy emerging market currencies Sell developed market currencies AUD CHF EUR JPY GBP CADSGD Terms of Trade (ToT) Relative price comparison between imports and exports Buy improving ToT currencies Sell deteriorating ToT currencies GBP SGD CAD AUD JPY EUR CHF Trough CHF USD Growth Economic indicators Emerging Markets Real appreciation of EM FX Buy strong economy currencies Sell weak economy currencies Buy emerging market currencies Sell developed market currencies Note: The bar charts show the average performance of selected major exchange rates in each individual phase of the global economic cycle through the analyzed period, All FX rates vs. USD, except USD which is a trade weighted index. August

11 Currency Driver 2: Cycle Analysis of Currency Strategies during Phases of the Global Cycle (2/2) Debtor Creditor August

12 Currency Driver 3: Technicals Analysis of Technical Momentum, Trend and Price Patterns Trend A new long-term uptrend is starting as price is moving above both moving averages (MAs) The short-term MA is broken several times, but prices remain above the long-term MA these corrections are buying opportunities A long-term downward correction starts as the price is breaking below both MAs 1 2 Medium-term trend (11-week moving average) Long-term trend (40-week moving average) Momentum Year 1 Year 2 Year 3 The long-term momentum ends its decline and starts to advance: a long-term cycle bottom has been established The medium-term momentum indicator has several troughs while the long-term momentum advances all these dips are buying signals The long-term momentum indicator peaks risk of a long-term top Long-term momentum Medium-term momentum Year 1 Year 2 Year 3 August

13 Views and Forecasts Currency Drivers with Resulting Views and Forecasts Spot Drivers Target Currency pair Outlook Last 30 days Value Cycle Tech 3M 12M EUR/USD USD/JPY GBP/USD EUR/CHF USD/CHF AUD/USD USD/CAD FX rate 2 Signals on FX drivers 3 Directional currency views 4 Price development in the last 30 days and latest spot rate for listed currency pairs, quoted as per market convention: price of one unit of the first currency measured in units of the second currency Directional signals on our key factors of currency determination: cycle, value and technicals Overall tactical (three to six months) directional currency views, resulting from weighted combinations of the input factors FX forecasts Exchange rate forecasts for three and twelve months August

14 EUR/USD Trades on Firm Side of Fair Valuation Fair Value (FV) EUR/USD EUR/USD Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 Jan 12 Jan Stdev -1 Stdev Fair value EUR/USD Sources: Bloomberg, Credit Suisse/IDC August

15 EUR/USD: Yields Spread Marginally in Euro s Favor EUR/USD Two-Year Government Bond Differential and Two-Year Swap Spread Plus two standard deviations Average= -0.14% EUR/USD 2Y government bond differential 2Y swap spread EUR minus USD Minus two standard deviations 0.80 Jan 99 Jan 01 Jan 03 Jan 05 Jan 07 Jan 09 Jan 11 Jan 13 EUR/USD Spot Sources: Bloomberg, Credit Suisse/IDC August

16 EUR/USD: Upward Trend and Momentum Topping EUR/USD Spot vs. Momentum and Trend Indicators EUR/USD medium-term trend long-term trend Jul 12 Nov 12 Mar 13 Jul 13 Nov 13 Mar 14 medium-term momentum long-term momentum Sources: Bloomberg, Credit Suisse/IDC August

17 USD/JPY Is Richly Valued Fair Value (FV) USD/JPY USD/JPY Jan 88 Jan 92 Jan 96 Jan 00 Jan 04 Jan 08 Jan Stdev -1 Stdev Fair value USD/JPY Sources: Bloomberg, Credit Suisse/IDC August

18 US vs. Japan Rate Spreads Are Historically Narrow USD/JPY Two-Year Government Bond Differential and Two-Year Swap Spread Plus two standard deviations Average= 2.49% USD/JPY 2Y government bond differential Minus two standard deviations 2Y swap spread USD minus JPY Jan 90 Jan 94 Jan 98 Jan 02 Jan 06 Jan 10 Jan 14 USD/JPY Spot Sources: Bloomberg, Credit Suisse/IDC August

19 USD/JPY Trend and Momentum Have Neutralized USD/JPY Spot vs. Momentum and Trend Indicators USD/JPY medium-term trend long-term trend Jul 12 Nov 12 Mar 13 Jul 13 Nov 13 Mar 14 medium-term momentum long-term momentum Sources: Bloomberg, Credit Suisse/IDC August

20 GBP/USD Now Very Expensive Fair Value (FV) GBP/USD GBP/USD Jan 88 Jan 92 Jan 96 Jan 00 Jan 04 Jan 08 Jan Stdev -1 Stdev Fair value GBP/USD Sources: Bloomberg, Credit Suisse/IDC August

21 UK vs. US Rate Spreads Are Rising, but Still Low USD/GBP Two-Year Government Bond Differential and Two-Year Swap Spread Plus two standard deviations Average= 0.78% Minus two standard deviations GBP/USD 2Y government bond differential 2Y swap spread GBP minus USD Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 Jan 12 Jan 14 GBP/USD Spot Sources: Bloomberg, Credit Suisse/IDC August

22 GBP/USD Rising on Trend, but May Be Overextended GBP/USD Spot vs. Momentum and Trend Indicators GBP/USD medium-term trend long-term trend Jul 12 Nov 12 Mar 13 Jul 13 Nov 13 Mar 14 medium-term momentum long-term momentum Sources: Bloomberg, Credit Suisse/IDC August

23 EUR/CHF Credibly Floored by Swiss National Bank Fair Value (FV) EUR/CHF EUR/CHF Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 Jan 12 Jan Stdev -1 Stdev Fair value EUR/CHF Sources: Bloomberg, Credit Suisse/IDC August

24 SNB s Floor Is Solid at 1.20, but Rate Spreads Are Narrow EUR/CHF Two-Year Government Bond Differential and Two-Year Swap Spread Plus two standard deviations Average= 1.07% Minus two standard deviations -0.5 EUR/CHF 2Y government bond differential 2Y swap spread EUR minus CHF Jan 99 Jan 01 Jan 03 Jan 05 Jan 07 Jan 09 Jan 11 Jan 13 EUR/CHF Spot Sources: Bloomberg, Credit Suisse/IDC August

25 EUR/CHF: Trend and Momentum Are Neutral EUR/CHF Spot vs. Momentum and Trend Indicators EUR/CHF medium-term trend long-term trend Jul 12 Nov 12 Mar 13 Jul 13 Nov 13 Mar 14 medium-term momentum long-term momentum Sources: Bloomberg, Credit Suisse/IDC August

26 The Swiss Franc Is Expensive Compared to US Dollar Fair Value (FV) USD/CHF USD/CHF Jan 88 Jan 92 Jan 96 Jan 00 Jan 04 Jan 08 Jan Stdev -1 Stdev Fair value USD/CHF Sources: Bloomberg, Credit Suisse/IDC August

27 US vs. Swiss Rate Spreads Remain Narrow USD/CHF Two-Year Government Bond Differential and Two-Year Swap Spread Plus two standard deviations Average= 1.34% Minus two standard deviations USD/CHF 2Y government bond differential 2Y swap spread USD minus CHF Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 Jan 12 Jan 14 USD/CHF Spot Sources: Bloomberg, Credit Suisse/IDC August

28 The Technical Trend Is Neutral for USD/CHF USD/CHF Spot vs. Momentum and Trend Indicators USD/CHF medium-term trend long-term trend Jul 12 Nov 12 Mar 13 Jul 13 Nov 13 Mar 14 medium-term momentum long-term momentum Sources: Bloomberg, Credit Suisse/IDC August

29 AUD/USD Is Trading Expensive compared to Credit Suisse s Fair Value of 0.76 Fair Value (FV) AUD/USD AUD/USD Dec 88 Dec 92 Dec 96 Dec 00 Dec 04 Dec 08 Dec Stdev -1 Stdev Fair value AUD/USD Sources: Bloomberg, Credit Suisse/IDC August

30 AUD/USD: Momentum and Trend Neutral AUD/USD Spot vs. Momentum and Trend Indicators AUD/USD medium-term trend long-term trend Jul 12 Nov 12 Mar 13 Jul 13 Nov 13 Mar 14 medium-term momentum long-term momentum Sources: Bloomberg, Credit Suisse/IDC August

31 AUD/USD: Rate Advantage to Narrow Even More AUD/USD Two-Year Government Bond Differential and Two-Year Swap Spread Plus two standard deviations Average= 1.92% Minus two standard deviations AUD/USD 2Y government bond differential 2Y swap spread AUD minus USD Jan 96 Jan 98 Jan 00 Jan 02 Jan 04 Jan 06 Jan 08 Jan 10 Jan 12 Jan 14 AUD/USD Spot Sources: Bloomberg, Credit Suisse/IDC August

32 Australian Dollar Richly Valued in Simple Commodity Terms RBA Commodity Price Index (Deflated by US CPI) vs. AUD/USD Jan 87 Jan 91 Jan 95 Jan 99 Jan 03 Jan 07 Jan Real RBA Commodity Index in logs AUD/USD (rhs) Sources: Bloomberg, Credit Suisse/IDC August

33 Our Currency Allocation Framework - Dynamic Multi-currency Management Process Targeting Capital and Purchasing Power Preservation 1 Base currency Reference or accounting currency Core diversification Long-run currency allocation. It can be motivated by: Desire to diversify away from a single currency to sustain long-term purchasing power Preference for global liquidity Multi-currency lifestyle 3 Optimal currency portfolio Tactical over- and underweighting of currency universe vs. the core allocation based on our currency views and relative yield attractiveness August

34 Active Management of Currency Exposure Extent of Diversification into FX Is Driven by the View on Base Currency and Risk Appetite Bullish EUR view Overweight EUR Underweight FX 65% 80% EUR 20% 35% FX Neutral EUR view 60% EUR 40% FX Bearish EUR view Underweight EUR Overweight FX 40% 55% EUR 45% 60% FX FX FX EUR base EUR FX FX EUR base EUR EUR FX FX EUR base EUR EUR EUR Note: The illustrated case applies for balanced investors (i.e. risk budget of four to seven percent). August

35 APAC APAC Americas EMEA EMEA Americas Model Currency Portfolios for Balanced Investors Optimal Currency Allocations for Different Base Currencies, Published Monthly USD based model currency portfolio (July 2014) EUR based model currency portfolio (July 2014) Optimal Allocation Optimal Allocation MXN 12% FX 40% RUB PLNAUD 2% 2% 3% USD base USD 60% USD 81% USD 81% MXN 12% CAD 0% RUB 2% PLN 2% EUR 0% GBP 0% CHF 0% SEK 0% NOK 0% TRY 0% ZAR 0% AUD 3% CNH 0% JPY 0% NZD 0% SGD 0% XAU 0% MXN 7% USD 10% CAD 5% PLN 5% AUD 6% FX 40% RUB 5% SGDCNH 4% 2% GBP 5% EUR base NOK 8% EUR 60% EUR 43% EUR 43% NOK 8% GBP 5% RUB 5% PLN 5% CHF 0% SEK 0% TRY 0% ZAR 0% USD 10% MXN 7% CAD 5% AUD 6% SGD 4% CNH 2% JPY 0% NZD 0% XAU 0% How to read the model portfolio charts Base currency (USD, EUR, CHF, GBP, JPY or SGD) 2 Core diversification (benchmark home bias and FX exposure) 3 Tactical allocation to preferred currencies in our chosen universe vs. core exposure (i.e. G10 and selected emerging market currencies plus gold) August

36 USD Model Portfolio Allocation since Inception Model Portfolio Was First Published in December % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Dec 10 Apr 11 Aug 11 Dec 11 Apr 12 Aug 12 Dec 12 Apr 13 Aug 13 Dec 13 Apr 14 USD CAD MXN EUR GBP CHF SEK NOK RUB PLN TRY ZAR JPY AUD NZD SGD CNH XAU Source: Credit Suisse August

37 USD Model Portfolio Performance since Inception Performance According to USD Model Portfolio Published Monthly in Research Monthly Note: FX investment via one month forward contracts. Performance measured in USD terms. Past returns are not indicative of future performance or past dynamic allocations. Sources: Bloomberg, Credit Suisse As of August

38 USD Model Portfolio Risk Parameters Reference Statistics Based on Monthly Return Data from December 2010 to March 2013, According to Monthly Published USD Model Portfolio Risk metrics Core Strategic diversification allocation Optimal portfolio Annualized return -0.9% -0.3% 0.2% Cumulative return -2.2% -0.9% 0.3% Annualized volatility 2.5% 3.3% 3.5% Sharpe ratio (reward to variability ratio) Skewness (asymmetry of return distribution) Excess kurtosis (peakedness and tail heaviness relative to normal distribution) Maximum drawdown (historical peak to trough decline) MAR ratio (reward to max drawdown ratio) Downside volatility (annual volatility of negative returns) Sortino ratio (reward to downside risk ratio) Upside volatility (annual volatility of positive returns) Volatility skewness (upside to downside volatility ratio) Note: Historical statistics are not indicative of future performance % -4.7% -4.7% % 2.5% 2.4% % 1.9% 2.5% Optimal portfolio monthly return distribution vs. normal distribution (with same mean and standard deviation) 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Optimal Portfolio Normal distribution -4.8% -2.9% -1.0% 1.0% 2.9% 4.8% Sources: Bloomberg, Credit Suisse As of August

39 EUR Model Portfolio Allocation since Inception Model Portfolio Was First Published in January % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jan 11 May 11 Sep 11 Jan 12 May 12 Sep 12 Jan 13 May 13 Sep 13 Jan 14 EUR GBP CHF SEK NOK RUB PLN TRY ZAR USD CAD MXN JPY AUD NZD SGD CNH XAU Source: Credit Suisse August

40 EUR Model Portfolio Performance since Inception Performance According to EUR Model Portfolio Published Monthly Note: FX investment via one month forward contracts. Performance measured in EUR terms. Past returns are not indicative of future performance or past dynamic allocations. Sources: Bloomberg, Credit Suisse As of August

41 JPY Model Portfolio Allocation since Inception Model Portfolio Was First Published in January % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jan 11 May 11 Sep 11 Jan 12 May 12 Sep 12 Jan 13 May 13 Sep 13 Jan 14 JPY AUD NZD SGD CNH USD CAD MXN EUR GBP CHF SEK NOK RUB PLN TRY ZAR XAU Source: Credit Suisse August

42 JPY Model Portfolio Performance since Inception Performance According to JPY Model Portfolio Published Monthly Note: FX investment via one month forward contracts. Performance measured in JPY terms. Past returns are not indicative of future performance or past dynamic allocations. Sources: Bloomberg, Credit Suisse As of August

43 Summary FX may be a zero sum game, but value can be extracted via a simple framework for analysis applied in a portfolio context Our framework features a long-run valuation concept around which cyclical factors provide catalysts for mean reversion Technical trend and momentum indicators provide timing and control Blended drivers tend to perform best compared to individual inputs Portfolio context provides diversification and allows clear identification of objective benchmark Optimal portfolios published monthly in real time have preserved capital and added value compared to benchmark allocations August

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