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1、17 November 2017 EM FX: What is driving EM FX? Page 2 Deutsche Bank AG/London What factors are driving global market dynamics? To assess what is driving broader market moves we use a Principal Component Analysis (PCA)1 on return indices corresponding to 11 key market variables: S&P, Eurostoxx, 10y U
2、ST, EM equities, EM FX, USD TWI, crude oil, gold, European financials, US IG corporate bonds and CNH-CNY basis (capturing China-related stress). We focus on the past 6 months. We find that over the past 6 months, oil prices have been the main variable capturing global market dynamics the first PCA f
3、actor is highly correlated to crude, and explained 55% of global market dynamics (charts 1 and 2). This is partly because it captures important factors around global growth and the broad dollar. The other key variable capturing market dynamics is US 10Y yields, which explains 20% of the variance (th
4、e second PCA factor is most correlated with US 10Y yields; chart 3). The importance of US rates is unsurprising, given that it captures Fed policy dynamics and US tax reform expectations; US rates are also a key driver of the broad dollar and of global risk sentiment. Lastly, EM equities which likel
5、y reflect broader risk sentiment explain 10% of market dynamics (the third PCA factor is most correlated with the MSCI EM equities index; chart 4). Together, crude prices, US rates and EM equities capture the bulk of the global market dynamics. 1: PCA suggests that oil prices, US rates and EM equiti
6、es explain a majority of market dynamics over the past 6m 2: First PCA factor (first principal component) is highly correlated with crude Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, Bloomberg Finance LP 1 Principal Component Analysis (PCA) is an analytical tool that helps iden
7、tify independent uncorrelated factors that explain moves in a time series. Our analysis is based on the methodology reported in the DB House View (February 9 2016). 17 November 2017 EM FX: What is driving EM FX? Deutsche Bank AG/London Page 3 3: Second PCA factor (second principal component) is high
8、ly correlated with US rates 4: Third PCA factor (third principal component) is most correlated with EM equities Source: Deutsche Bank, Bloomberg Finance LP Source: Deutsche Bank, Bloomberg Finance LP Is EM FX fairly valued on PCA metrics, and are there any currencies that are significantly misaligne
9、d? We build a short-term valuation metric derived from the Principal Component Analysis; specifically, we estimate the fair value of EM FX implied by the first 3 PCA factors using a linear regression. Using a broad EM FX index vs. USD, we find that EM FX is currently cheap vs. the level implied by t
10、he principal components (chart 5). Therefore, according to the external drivers of market dynamics we consider, EM FX is cheap. This is largely driven by the fact that EM FX has remained weak despite falling US yields since late October. 5: Our short-term PCA metric suggests that EM FX is cheap 67 .
11、0067 .5068 .0068 .5069 .0069 .5070 .0070 .5071 .0071 .5072 .00Ma y /20 17 J u n /2 017 J u l /201 7 Au g/2 017 Se p /201 7 Oct/ 2017E M FX Im p l ie d b y fi rs t 3 P C A facto rsSource: Deutsche Bank; Bloomberg Finance LP; Note: EM FX index is FEMCS on Bloomberg Further, we aim to explore which cur
12、rencies are significantly misaligned on this PCA metric. To assess this, we repeat the same procedure as above, but for individual currencies (rather than the EM FX index) that is, we estimate the fair value for different currencies implied by the first 3 PCA factors using a linear regression. We fi
13、nd two currency pairs that are significantly misaligned USDRUB and USDBRL. RUB is 4.5% cheap vs. its PCA fair value (chart 6), while BRL is 3.5% cheap (chart 7). Hence, this analysis suggests both currencies have room to appreciate in the near term. These results are broadly in line with our recent
14、recommendations to go long both currencies (see EM 17 November 2017 EM FX: What is driving EM FX? Page 4 Deutsche Bank AG/London Monthly). 6: RUB is significantly undervalued on short-term PCA valuation metrics 7: BRL is also undervalued 56.0056.5057.0057.5058.0058.5059.0059.5060.0060.5061 .00Ma y /
15、201 7 J u n /201 7 J u l/20 17 Au g/20 17 Se p /201 7 Oct/2017U SDRU B Implie d b y f irs t 3 P CA f act o rs3.053.103.153.203.2 53.303.353.4 0Ma y /201 7 J u n /201 7 J u l/20 17 Au g/20 17 Se p /201 7 Oct/2017U SDB RL Implie d b y f irs t 3 P CA f act o rsSource: Deutsche Bank; Bloomberg Finance L
16、P Source: Deutsche Bank; Bloomberg Finance LP What is driving EM FX as an asset class? While the PCA analysis sheds light on the drivers of overall market dynamics, it does not inform us specifically about the drivers of EM FX. We use an augmented beta analysis which estimates the contribution of the various market drivers to EM FX moves to further investigate what drives EM FX.2 As chart 8 shows, broad USD and US rates are currently the main driver
