The Context14th October 2019

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The Context

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Inside this week’s edition…

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Pressure on South Africa to Restructure Eskom & Keep Debt in Check Ahead of Moody's Review - by Natalie Rivett and Ed Blake, p3-5Eskom is the biggest threat to the economy, which means restructuring isessential. The ANC has said it is working on a plan for Eskom and this is expectedto be unveiled, along with a new Chief Executive Officer (Eskom has been withoutone since July), ahead of the 30th October mid-term budget statement.

The CAD Week - Bias is Neutral- by Mark Mitchell, p6-7The stellar Canadian jobs report last Friday sent Usd/Cad spiralling down to1.3171 at one stage, its lowest level for a month. The data has pushed interestrate cut expectations before year end significantly lower.

Euro Corp Snapshot: Weekly Supply Jumps- by David Corbell, p8Despite ongoing economic concerns and a volatile backdrop, the Europeancorporate market saw supply accelerate sharply last week where issuers printeda total of EUR14.067bn. That is over six times the EUR2.15bn that printed theprior week.

China Insight: The US May Consider Limiting Investments in China- by Tim Cheung and Riki Zhang, p9-10On USD/CNH, we now think 7.20 will be re-seen by the end of Oct due to thefailure of the US-China negotiations in mid-Oct to yield meaningful progresstowards an end of confrontation. Any further news increasing the speculationover a potential limitation on US investors' portfolio flows into China in themedium term could make 7.40 reachable by the end of this year.

Know The Flows: Trade Issues, Earnings, And Political Risk Reclaim Center Stage From Central Bankers in Early October - by Cameron Brandt, p11After a quarter when both the US Federal Reserve and European Central Bankreversed course on the normalization of their monetary policies, the focus duringthe first week October shifted from central bankers to the Sino-Chinese tradewar, the latest corporate earnings season and impending elections in Spain,Canada and Argentina.

UK/EU 10yr Spread – Resistance at 111 is Key to Direction- by Ed Blake, p13

Buy on a break over 111 for a resumption of broader widening targeting 121/128.Reverse stance on a downside break of clustered support at 101.

EUR/GBP – Remains Locked Within Broad Sideways Range- by Andrew Dowdell, p14

Above .9020 followed by .9149 suggests a bullish resolution. Below .8723/.8681 and the 200-Week MA risks back to .8472, possibly .8314/05.

Gold – Bulls Looking to Resume For 1557.11 And Beyond- by Ed Blake, p15

Buy into near-term dips as we await an uptrend resumption to 1557.11 then1590.41/1620.13. Place a protective stop under the recent 1459.14 low.

Pressure on South Africa to Restructure Eskom & Keep Debt in Check Ahead of Moody's Review

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By Natalie Rivett, Senior EM Analyst and Ed Blake, Chief FI Technical Analyst

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South Africa – cont’d

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Eskom is the biggest threat to the economy, which means restructuring is essential

Earlier this month, the ANC's top decision-making body approved a range of economic policyinterventions to achieve a higher rate of economic growth and economic inclusion, upon reaching abroad consensus about the challenges South Africa faces. It was agreed the country needs toincrease spending on infrastructure, produce more renewable energy and fix ailing state companies.With regards to the latter, Eskom is, of course, front and centre to South Africa's problems; not onlyis it failing operationally, but it is also a heavy fiscal burden on the government.

ZAR128bn (USD8.4bn) in bailouts has been assigned to Eskom over three years, to maintain itssolvency, but so far there has been no comprehensive turnaround plan for the state utility thatsupplies more than 90% of South Africa's power

To fix ongoing losses at Eskom, financial support from the government must be combined withrestructuring measures. However, this is no easy task as the utility has a long list of troubles. It is notgenerating enough revenue to cover its costs despite tariff increases, has ageing and inefficientpower plants and has been plagued by mismanagement over the years, leaving it with a bloatedworkforce for which trade unions are strongly opposed to shrinkage.

The ANC has said it is working on a plan for Eskom and this is expected to be unveiled, along with anew Chief Executive Officer (Eskom has been without one since July), ahead of the 30th Octobermid-term budget statement (MTBS). The MTBS will need to clarify to both investors and ratingagencies how Eskom's bailouts and other costs associated with its reform can be funded at a timewhen economic growth and tax revenue is falling short of target.

'Ramaphoria' has dissipated amid slow pace of reforms

It did not take long for 'Ramaphoria' to start to wane and by the middle of last year, it looked tohave completely dissipated, less than 6-months after it was ignited on hope that PresidentRamaphosa could reform the struggling economy, restructure state owned companies and crack-down on corruption. It quickly became clear that Ramaphosa's ability to push through unpopularpolicies would be constrained by his fragile hold on the deeply fractured ANC and staunchopposition from labour unions, and this has largely contributed to the slow pace of both Eskom

and wider economic reform that has frustrated investors and businesses alike.

The Rand has ultimately slumped circa 23% vs. the Dollar since Ramaphosa's inauguration lastFebruary (refer to the dashboard), to be the third worst performing EM currency, whilst businessconfidence has sunk to the lowest levels since 1985 (according to the Chamber of Commerce andIndustry).

Against this backdrop, it is perhaps unsurprising that appetite for South African equities has beentrailing behind that of all Emerging Markets for over a year now. As the EPFR data in the dashboardshows, net cumulative flows for South African equity funds in percentage terms – tracked sinceRamaphosa's inauguration – have deteriorated to -1.95% in the latest recorded week and thiscompares to -0.6% for EM equity funds. It is a different story for bonds, with net inflows to SouthAfrican bond funds outpacing that of EMs, which may be thanks to the fact that SAGBs have beenoffering among the highest real yields in the EM space.

Another dim view from Fitch this year, but what aboutMoody’s?

Fitch has already taken another dim view this year of South Africa's deteriorating economic andfiscal performance, resulting in a downgrade of its outlook from stable to negative in August.However, it is Moody's that remains the key focus for investors given that it is the only one of thebig three agencies to retain South Africa at investment grade. A removal of this final IG rating wouldsee the country fall out of key gauges such as Citi's World Government Bond Index, promptingautomatic selling of local debt instruments.

Moody’s signalled ahead of its 1st November assessment that it will not downgrade the sovereignrating to junk this year because of the stable outlook currently in place. Historically, Moody's hasfirst revised the outlook of countries with a stable outlook to negative before a junk downgrade.However, it could still have reason to revise the outlook to negative on any failure to produce acredible turnaround plan for Eskom, which would ultimately put further pressure on the fiscalshortfall over the medium-term.

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South Africa – cont’d

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Back in February, the Treasury forecast a fiscal gap of 4.5%/GDP for the year beginning 1st April andif realised this would be the widest since the 6.3% reported in the 2010 fiscal year, while estimatesfor gross debt were revised higher from last October’s projections for every year through 2027,with the figure expected to stabilise at 60.2%/GDP in 2023-24 (see the dashboard).

It is difficult to see how this debt/deficit trajectory will not worsen further. The government has littleroom to manoeuvre on the fiscal front and cannot rely on raising taxes as this could place evengreater strain on the economy by further undermining consumption spending and consumerconfidence. Finance Minister Mboweni has already acknowledged that the outlook for economicgrowth has worsened significantly since the February budget and is likely to remain below 2% for atleast the next two years.

Upside risks to USD/ZAR heading into the MTBS andMoody's rating review

With two sub-IG credit ratings, the market already considers South Africa as junk, with its 5-yearCDS trading consistently above that of Brazil (which is rated two steps lower, into junk by Moody's)since last October. As the mid-term budget statement and Moody's rating review looms, thepremium to Brazil has widened afresh over the past month, with South Africa's 5-year CDS havingclimbed to the highest level since June, reflecting investor uncertainty as to how much more leewaythe sovereign can realistically be given (see dashboard).

At the beginning of the year, we felt with strong conviction Moody's would eventually be forcedto downgrade South Africa to junk, though given what we mentioned in the previous section itwould now seem the bar is high for such a move. So, should Moody's continue to give SouthAfrica the benefit of the doubt on 1st November – especially if it keeps its outlook at stable - thenUSD/ZAR will see some relief downside. Studies have already been deteriorating amid the widerpick-up in risk sentiment of late, turning the focus to 14.505/14.319 next.

It is the danger that the budget falls short of what is needed to appease Moody's that presentsthe clear upside risks to USD/ZAR. However, as the following technical analysis suggests, bullsmust first regain 15.056.

• Declines from 15.399 (2 October high) through a 2-1/2 month rising trendline at 14.864 toreach last Friday's 14.707, 3-1/2 week low

• Deteriorating studies suggest initial risk to 14.505 (13 September reaction low, near 61.8%retrace of 13.14/15.500 rally), perhaps 14.319 (29 July high)

• Bulls must regain last Friday's 15.056 high (near 4 October low at 15.026) to stabilize for15.311/15.399

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The CAD Week - Bias is NeutralBy Mark Mitchell, Senior FX Analyst

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Expected Usd/Cad trading range is 1.3170-1.3350

The stellar Canadian jobs report last Friday sent Usd/Cad spiralling down to 1.3171 at onestage, its lowest level for a month. As you can see by the bottom, middle pane of theabove dashboard, the data has pushed interest rate cut expectations before year endsignificantly lower. The news from the jobs report was strong across the board and shouldkeep the BoC very much on the sidelines for now, but in the back of our head, there isalways the nagging doubt that the jobs data are normally a lagging indicator.

However the strong report should help PM Trudeau's chances of re-election. According tomost polls Trudeau's Liberal Party and the opposition Conservative Party are neck andneck, so it comes down to who does best when Canada votes next Monday. A minorityparliament could be the outcome, leaving the Liberals and Greens as potentialkingmakers.

So the election uncertainty may have put off a few Loonie buyers after the strong jobsdata, but before the election this week, Usd/Cad is likely to be pulled around by globalgrowth dynamics.

We see the Loonie remaining supported to start the week, but the positive mood derivedfrom the jobs report may fade heading into the weekend amid the election uncertainty.Bids are seen at 1.3170 and again at 1.3130/40 in Usd/Cad, while offers remain solid upabove 1.3300.

• Threat of topping grows, following successive failures to re-establish a foothold abovethe 200-Day MA (approx 1.3285) and Fri's sharp break lower

• Ranging may persist in the near-term, but a breach of 1.3134/06 would see bears gaintraction for a re-test of Jul's 1.3016 low initially

• Above Fri's 1.3300 is needed to stabilise and re-open Oct/Sep's 1.3348/1.3383 peaks

RISKS - The highlights of the North American data calendar are both released tomorrow inthe form of US retail sales and Canadian CPI.

The CAD Week – cont’d

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Euro Corp Snapshot: Weekly Supply Jumps

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Despite ongoing economic concerns and a volatile backdrop, the European corporate market sawsupply accelerate sharply last week where issuers printed a total of EUR14.067bn. That is over sixtimes the EUR2.15bn that printed the prior week. All of last week's deals printed Monday throughThursday with primary market participants getting a well-earned break on Friday.

With activity picking up in the latest week, volume is now running a hefty 37% ahead of the sameperiod in 2018. Recall, that comes after a hugely busy September which saw IG/split rated issuersraise a record EUR63.25bn via single currency deals.

While there were more issuers competing for the attention of investors this week, the averagebid to cover (where books were communicated) still came in a healthy 2.55 times. And there waslittle to suggest that issuers had to pay up for funding where the average NIC (where calculated)was 6.72bps, down a shade on the week prior. The week's issuers also enjoyed positive tractionduring the execution process where deals were tightened by an average of 19.1bps from IPTs toreoffer.

Pipeline lighter, earnings ahead

With the pipeline having thinned somewhat, it will likely fall to opportunistic issuers to boostsupply in the coming week. The sharp improvement seen in sentiment toward the end of theweek could tempt issuers although how many will be in a position to proceed with a new deal isnot clear with earnings season looming.

Of those issuers in the pipeline, Deutsche Bahn appears likely to strike soon with its 2-part hybridafter wrapping investor calls on Friday.

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By David Corbell, Head of Credit, Europe

China Insight: The US May Consider Limiting Investments in China

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A couple of negative headlines came out on 8 October before the 13th round of US-Chinatrade talks starts.

• The US blacklisted 28 Chinese entities and government agencies over human rightsviolations and repression in Xinjiang;

• White House has started looking to consider limits on the US pension investments inChinese equities;

The first news report suggesting Donald Trump has given the green light for hisadministration to discuss ways to limit US investors' portfolio flows into China came out on27 September. The possible ways, as per the report, include delisting Chinese companiesfrom the US stock exchanges, limiting government pension funds' exposure to the Chinesemarket, and putting caps on the Chinese companies included in stock indexes managed byUS firms. Though the report was already denied by the White House trade advisor PeterNavarro, its re-surfacing suggested Washington could be looking to work it out as a part ofthe US-China decoupling strategy.

Based on EPFR data, US-domiciled mutual funds and closely related investment productshold about USD280bn in Chinese assets, most of which are equities. Based on the FX-adjusted cross-border portfolio flows, Goldman Sachs estimates that US investors boughtabout USD30bn of Chinese equities from mid-2016 through Q1 of this year, but havebegun to pull back on those investments more recently amid prolonged US-China tradedisputes and growing risk of economic slowdown in China (chart 1). The above figures donot include several large Chinese companies that are domiciled outside of China but stillrely on disclosure exemptions as a foreign private issuer. When this is taken into account,the Chinese equities held by US investors could be worth as much as USD785bn.

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

China Insight – cont’d

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As far as the trade talks are concerned, the Chinese Commerce Ministry said very recentlyChina is ready to do a trade deal with the US on selected issues and is prepared to set out atimetable for the harder issues to be worked out next year. This remark reinforces our viewthat the Chinese leaders have a strong bias in favour of a better-late-than-early tactic inpursuing the final solution to the US-China trade conflicts.

Further to our view on USD/CNH FX rate given in the previous issue of this publication, wenow think 7.20 will be re-seen by the end of October (instead of November) due to thefailure of the US-China negotiations in mid-October to yield meaningful progress towards anend of confrontation. Any further news increasing the speculation over a potential limitationon US investors' portfolio flows into China in the medium term could make 7.40 reachable bythe end of this year (chart 2).

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Know The Flows: Trade Issues, Earnings, And Political Risk Reclaim Center Stage From Central Bankers in Early October

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By Cameron Brandt, Director, Research

After a quarter when both the US Federal Reserve and European Central Bank reversed course onthe normalization of their monetary policies, the focus during the first week October shifted fromcentral bankers to the Sino-Chinese trade war, the latest corporate earnings season andimpending elections in Spain, Canada and Argentina.

This shift in focus did not, for the most part, breed investor optimism. On the fixed income sideflows remained heavily biased towards Bond Funds with investment grade mandates during theweek ending October 9. Among Equity Fund groups, both China and US Equity Funds postedoutflows in the run-up to the latest round of trade talks between the two nations, redemptionsfrom Spain Equity and Bond Funds climbed to eight and 13-week high as the country prepares forits fourth general election in as many years and Alternative Funds posted their biggest collectiveoutflow since the first week of August.

Overall, the seven days ending October 9 saw $800 million redeemed from EPFR-trackedBalanced Funds, $322 million from Alternative Funds and $9.7 billion from Equity Funds. Investorssteered a net $10.6 billion into Money Market Funds and $11.1 billion into Bond Funds, and theyretained their appetite for funds with socially responsible (SRI) or environmental, socialgovernance (ESG) goals: year-to-date flows into all funds with SRI or ESG mandates are now justshy of the $80 billion mark.

At the single country and asset class fund level, redemptions from Brazil and Korea Bond Funds hitsix and 35-week highs respectively and China Bond Funds saw their eight-week run of inflowscome to an end while Italy Bond Funds extended their longest inflow streak since 1Q13.Convertible Bond Funds posted their biggest weekly outflow since mid-July and Bank Loans Fundsexperienced net redemptions for the 47th week in a row.

Back to Index Page For further information on EPFR, please click HERE

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UK/EU 10yr Spread – Resistance at 111 is Key to Direction

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Technical Analysis by Ed Blake

• The UK/EU 10yr spread reversed sharply from 121 (2019 high - 19 September) to re-test

strong clustered support at 101, which held

• Improving daily studies and constructive longer-term techs suggest initial tests of resistance

at 111 (2 September former low)

• Above signals a resumption of the broader widening trend re-opening the 2019 peak at 121

(6 May/13 September)

• A failure to regain 111 would leave 101 vulnerable to a re-test, under which signals a 10mth

top and risks 95/90

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STRATEGY SUMMARY

Buy on a break over 111 for a resumption of broader widening targeting 121/128. Reverse stance on a downside break of clustered support at 101

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Resistance Levels

R5 145 17 November 2015 high R4 137 2016 high – 22 April, near 76.4% retrace of 162/61 narrowing at 138 R3 128 23 June 2016 lower high R2 121 2019 peaks – 6 May and 13 September, near 61.8% retrace of 162/61 narrowing at 123 R1 111 2 September 2019 former low

Support Levels

S1 101 24-26 December 2018, 25 March and 9 October 2019 lows S2 95 10 December 2018 higher low, near 50% retrace of 65/121 widening at 93 S3 90 27 August 2018 higher low S4 85 1 May and 19 July 2018 higher lows, near 61.8% retrace of 65/121 widening at 87 S5 82 2 March 2018 higher low

EUR/GBP – Remains Locked Within Broad Sideways Range

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Technical Analysis by Andrew Dowdell

• Trading centrally within a broad sideways multi-year range

• Short-term momentum points lower, but a breach of .8723/.8681 is needed to re-open the March .8472 low

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STRATEGY SUMMARY

Above .9020 followed by .9149 suggests a bullish resolution. Below .8723/.8681 and the 200-Week MA risks back to .8472, possibly .8314/05.

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Resistance Levels

R5 .9520 26 January 2009 high, near the 18 March 2009 high at .9487 R4 .9415 7 October 2016 high R3 .9325 12 August 2019 high R2 .9149 3 September 2019 high R1 .9020 10 October 2019 high

Support Levels

S1 .8723 21 March 2019 high S2 .8681 17 April 2019 high S3 .8635 200-Week MA (approx.) S4 .8472 13 March 2019 low S5 .8305 5 December 2016 low, near the 18 April 2017 low at .8314

Gold – Bulls Looking to Resume For 1557.11 And Beyond

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Technical Analysis by Ed Blake

• Extended the 14-month uptrend to 1557.11 (4 September peak) before easing within a

corrective channel to reach 1459.14 (1 October low)

• Studies (especially longer-term) remain constructive and an uptrend resumption is

favoured to 1557.11

• Above signals new 6½ year highs and opens clustered resistance at 1590.41, perhaps the

1620.13 lower high

• Below 1459.14 risks a deeper short-term pullback to 1400.58 (1 August low, near 50%

retrace of 1266.35/1557.11)

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STRATEGY SUMMARY

Buy into near-term dips as we await an uptrend resumption to 1557.11 then 1590.41/1620.13. Place a protective stop under the recent 1459.14 low

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Resistance Levels

R5 1653.65 13 February 2013 high R4 1620.13 26 February 2013 lower high R3 1590.41 9 April 2013 lower high, near 61.8% retrace of 1921.17/1046.44, 2011-2015 fall at 1587.02 R2 1557.11 4 September 2019, 6½ year high R1 1535.73 24 September 2019 minor lower high

Support Levels

S1 1487.03 8 October 2019 low S2 1459.14 1 October 2019 reaction low, near 19 July 2019 former high at 1453.09 S3 1400.58 1 August 2019 higher low, near 50% retrace of 1266.35/1557.11 rally at 1411.73 S4 1381.90 1 July 2019 higher low, near 61.8% retrace of 1266.35/1557.11 rally at 1377.42 S5 1333.09 17 June 2019 minor higher low, near 76.4% retrace of 1266.35/1557.11 rally at 1334.97

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