A Balancing Act

2010 Mid-Year Outlook

CONTENTS

EQUITIESPage 1

FIXED INCOMEPage 4

COMMODITIESPage 5

FOREIGNEXCHANGEPage 6

SOVEREIGNDEBT CONCERNSPage 7

01

EQUITIES

2010 was always going to be a more challenging year for theequity investor. But few would have anticipated the wild see-saw action that markets have experienced these past fivemonths. For sure, the handover of the economy’s driving force,

from public stimulus to private consumption and investment,was well expected to be a delicate affair. And after championing global

growth throughout 2009, it was inevitable that China would have to rein in the easymoney to avoid running into asset bubble trouble. Yet few would have expected that budgetaryproblems of a small Mediterranean nation would escalate into a continental crisis that couldthreaten to snuff out global recovery. Little wonder then that financial markets have beenhighly volatile, with frayed nerves ill-affording military tensions in the Korean peninsula,a massive oil spill in the Gulf of Mexico, and tightening financial regulation around the world.

Double trouble?Talk of double-dip recession remains on the lips of bears, but we think global investors may be a tadoveranxious. The recent sell-off of global stocks can largely be put down to worries over two factors:liquidity and leverage. In the short term, markets seem concerned that Europe’s sovereign debt woesmay deteriorate into a liquidity crunch of post-Lehman proportions that first cripples the region’sbanks before spreading out to the rest of the world. Over the longer term, heavily leveragedgovernment balance sheets, especially in Europe, have given rise to anxieties about economic growthand corporate profits as public debt is unwound.

We believe fears about liquidity and funding shortfalls at Europe’s banks and governments areoverdone. While banks are lending to each other at higher interest rates, perceiving greater counterpartyrisks, the actual risk premiums demanded are not worryingly high by historic measures. They arecertainly nowhere near the peaks seen at the height of the sub-prime crisis. This is especially truein Europe, where the European Central Bank (ECB) appears committed to pump in as much liquidityas is needed to prevent a shortage. Fears of a run on Europe’s banking system thus seem excessive.As for sovereign debt, joint efforts by the European Union, International Monetary Fund and the ECBhave greatly reduced the risk of an imminent sovereign insolvency, allowing the region’s troublednations a better chance of restructuring their finances in an orderly fashion.

But medium-term worries about an overleveraged global economy, especially in the developed world,are probably valid. Since the sub-prime crisis, households and banks have been de-leveraging theirportfolios. But this has been accompanied with a corresponding rise in public debt as governmentsdeployed massive amounts of fiscal stimulus to prop up economic activity. Fiscal deficits are startingto reach unsustainable levels that necessitate spending cuts that are likely to be a drag on economicgrowth, especially in the industrialised nations, for many years to come. The problem, ironically,appears to be exacerbated by the provision of short-term liquidity support in the Euro zone, whereaid is proffered on condition of even bigger cuts to government spending. All this has spawned fearsof a global double dip but we believe this is an overly bearish prognosis. We expect global recoveryto be sustained, albeit uneven across economies and possibly at a more modest pace overall.

Double dip earnings?

Nonetheless, markets have sold off since mid-April, with equity valuations coming down sharply.Investors fear a return to recessionary conditions will cause corporate revenues and earnings to fallsharply, missing current forecasts. But Citi analysts, on examining major double dips in variousmarkets in the past 30 years, believe that markets may be too focused on the top line. They pointout that like in previous downturns, cost structures have been radically streamlined over the pastyear of recovery. Company profits, then, are likely to be more resilient than expected, even if theeconomy tanks again. Indeed, current valuations imply a brutal double dip in which the economycontracts even more than in 2008/09, down 1% in nominal GDP terms in both 2011 and 2012. Yeteven in such a severe scenario, corporate earnings would fall just 10% in 2011 and 2% in 2012 – muchless than the 56% plunge in 2008/09.

What all this means is that global equity valuations are starting to look attractive – even if onebelieves that a double dip global recession is on the way. Still, it could take some time for marketsto be convinced that a double dip is unlikely and that corporate earnings are likely to be more resilientif it does happen. In the meantime, volatility is likely to persist, calling for nimble toes – and fingers– while an uneven recovery warrants judicious market selection and stock picking.

With this backdrop, emerging markets remain preferred over developed ones, as strong economicfundamentals are likely to keep capital flowing into these more vibrant markets. Among the developedmarkets, the US is looking the most attractive, buoyed by robust economic momentum.

2010 Mid-Year Outlook:A Balancing Act

USReduced liquidity and a risk appetite retreat sparked byEurope’s debt problems have renewed headwinds for the US’economic recovery. Citi analysts have pushed back theirexpectations for the Federal Reserve’s first policy rate hike to2Q11. They also believe that active exit strategies may remainon hold until officials are confident that retrenching riskappetite will not undermine economic activity. Still, there aresigns that the economy has strengthened on business andconsumer spending, with surging profits triggering hiring andequipment spending. Barring further deterioration in financialconditions, the labour market should continue to support therecovery process.

Markets are likely to be volatile for the rest of the year, givenuncertainties in the global macroeconomic backdrop. But lowinterest rates, rebounding corporate profits and a recoveryin household income and consumption could lend support tosee the S&P 500 spike above 1,200 before easing off. Citi’send-2010 forecast for the S&P 500 and Dow Jones IndustrialAverage currently stand at 1,175 and 11,150 respectively.

EuropeThe European Stabilisation Mechanism and European CentralBank (ECB) asset purchases are helping to contain the spill-over of the sovereign debt crisis. But additional austeritymeasures by the more fiscally strained countries are expectedto increase the GDP growth differentials among the Euro areamembers in 2010. For the time being, the ECB is likely to keeplending banks unlimited funds via open market operationswith full allotment to avert any potential liquidity shortagesin the region’s fragile banking system. This suggests thatshort-term money rates are likely to stay significantly belowthe policy rate in the remainder of 2010. With low growth andlow inflation, the ECB is expected to leave policy ratesunchanged until 2Q11 or 3Q11.

European equities offer good value relative to cash and bonds,as valuations remain compelling. At the end of May 2010,European equities were trading at price-to-book levels belowthe long-term average, at prices less than 10x estimatedearnings in 2011. Our analysts anticipate earnings growth toexceed 20% in 2010 and 2011 on the back of global economicrecovery and positive operational leverage. Risks, however,remain elevated as equities climb a wall of worry, and wewould continue to watch fiscal risks and policy exit strategiesclosely. Citi’s end-2010 targets for the Dow Jones Stoxx 600and FTSE 100 are currently 280 and 6,000 respectively.

JapanJapan’s economy is likely to maintain above-trend growth(around 1% annualized) in the quarters to come. Driving thisis a combination of a continued uptrend in exports, a pickup inbusiness and housing investment, and a modest improvementin labour conditions. Real GDP is forecast to slow to an averageannualized gain of 2.6% in 2H10, bringing full-year growth to3.5%. Nonetheless, the Bank of Japan (BoJ) is anticipated tokeep policy rates on hold at 0.10% through 2011 as uncertaintiessurrounding the global economy persist.

Citi analysts expect Japanese equities to keep trending higherin the rest of the year, estimating the end-2010 fair value forTOPIX at 1,050. That implies a 19% appreciation from the

02 2010 Mid-Year Outlook:A Balancing Act

Equities

market’s close at the end of May. A sustained global recovery,strong corporate earnings and a turnaround in domestic demandare expected to support Japanese stocks.

Asia-Pacific ex-JapanFiscal austerity and potential strains in banking systems maybe a drag for Euro zone growth, but these are unlikely to havea significant impact on Asia at this juncture. Yet if Europe –and thus the global economy – suffer a sharper-than-expectedslowdown, more trade-dependent economies like Singapore,Taiwan, Hong Kong, Malaysia, Korea and Thailand are going tobe more vulnerable than the domestic demand-driveneconomies of India, Indonesia, China and the Philippines.

Nevertheless, over the medium term, Asia is likely to be seenas a relative “safe haven” given its strong fundamentals.Furthermore, the bias of global policymakers towards keepingmonetary policy looser for longer inevitably provides avenuesfor liquidity to shift increasingly into the region. Valuations,for their part, are getting more attractive and expectations,more realistic. The price-to-book ratio for the MSCI AC Asiaex-Japan index has declined from a peak of 2.9x (October 2007)to the historic average of 1.8x at the end of May 2010. Onbalance, Citi analysts expect the North Asian markets of HongKong, Korea and Taiwan to offer better opportunities, with apreference for the telecoms, banking, technology, and energysectors. That said, Asian stocks may be weighed down in thenear term by China’s aggressive moves to slow propertyinvestment and a stronger US dollar.

ChinaChina is facing pressures not only from tightening domesticpolicies but also from a slower global economic recovery. Whiledomestic economic growth remains robust, downside riskscould develop in the second half of the year, overridingoverheating risks. Such uncertainties surrounding policy andeconomic trends are likely to weigh on Chinese stocks, anduntil they diminish, the market may remain bumpy.

In the near term, equities may find support in: 1) A slowingpace of liquidity tightening; 2) Government help with bankrecapitalizations; 3) Abating IPO activity; and 4) State-ownedagencies going long on shares. Dramatic policy easing, suchas policy rate cuts, though does not appear on the radar ofChinese policymakers. Yet at this juncture, these seem to beinsufficient catalysts for the market to break out of a downwardtrend. Weighing down on the market are concerns about: 1)Further tightening in the property sector; 2) A more restrictiveenergy policy; 3) A slowdown in export growth on the back ofeuro weakness; and 4) A further squeeze on corporate earningsdue to a rising gap between producer and consumer prices. Allin, Citi analysts tip the Shanghai A-share index to fall to the2200-2500 range in the second half of this year.

IndiaThe domestic recovery is increasinglybroad-based as reflected inmacro (loan growth, non-oilimports) and micro (autosales, cement dispatches,diesel consumption) data.Citi analysts are thusmaintaining an FY11 GDP

Equity valuations are attractive, with positive earningsmomentum. Russia stands out within CEEMEA as the marketwith the most attractive earnings yield, in both absolute andhistorical terms. Earnings forecasts have risen a lot, loweringprice-to-earnings and increasing earnings yield (earnings dividedby price). At around 15%, earnings yield is almost three timeshigher than bond yields. This is higher than that of emergingmarket peers and nearly two standard deviations above theeight-year average. This would suggest that equity valuationsare cheap relative to bonds, and are even more compellingonce the sharp fall in rouble interest rates is considered.

Latin AmericaThe positive case for Latin America centres on 1) strongearnings momentum, 2) rising GDP growth forecasts (notablyin Brazil and Mexico), and 3) underperformance of the region’sequity market relative to emerging market peers. In addition,the region does not appear to be overly vulnerable to anyworsening of the EU fiscal crisis, aside from the region’s above-average market volatility. Posing greater risk would probablybe a sharp slowdown in China's growth, which would hurtcommodity prices and thus commodity-exposed equity markets,such as Brazil and Peru.

Growth momentum is largely expected to continue, thoughunevenly across the region. Countries like Brazil and Peru areexpected to tighten rates further given robust GDP growth,while Chile is expected to only start hiking slowly in the comingmonths. However, risks from external factors are biased towarddelays, and to shorter tightening cycles in some countries.

BrazilCiti economists have raised their 2010 GDP growth forecastsfor Brazil to 7.6%. Retail sales, industrial production and thelabour market all point to an economy that is growing at fullthrottle. CPI inflation is now expected to end 2010 at 5.8%,close to the upper limit of the government’s target band of6.5%. This suggests a need for larger monetary policyadjustment – the Selic rate is expected to reach 13.25% byJanuary 2011, with 450 bps of total hikes (including 75 bpsof tightening already executed). Recent market volatility,though, may prompt the central bank to be more gradual inits policy tightening.

Brazil stocks receive good support from good earningsmomentum and GDP growth. They have also underperformedthus far in 2010. While valuations may look stretched comparedto historical trends, they have fallen sharply this year and arenow in line with other emerging markets. A recent rise ininterest rates should eventually be a long-term positive forequity markets. Citi analysts remain positive on Brazil andexpect the Bovespa to end 2010 at 80,000.

Equities

032010 Mid-Year Outlook:A Balancing Act

growth estimate of 8.4%, led by industry and services at9.1% and agriculture at 4%. However, with inflation muchhigher than the desired policy level of 5%, the ReserveBank of India (RBI) may hike interest rates by an additional75 bps in 2010.

The outlook for India’s equity market has turned moreconstructive considering that domestic macro headwinds areeasing. Inflation may have peaked and pressures on fiscaldeficit appear to have been reversed. At the same time, micromomentum and corporate rationality are still in place, withfree cash flows rising on the back of reasonable earningsgrowth. Finally, India stocks are no longer expensive, tradingbelow long-term average valuations. The ratio of price to one-year forward earnings is at about 15x, while the price-to-bookratio is at about 2.8x. Rising dependence on global capitalflows may however raise market beta. With a more supportivemacro picture, and a sustainable micro backdrop, Citi analystsbelieve Indian stocks should trade at their long-term averagemarket multiple, or 18,100 on the Sensex, and 5,450 on theNifty, for December 2010.

Central & Eastern Europe, the Middle East andAfrica (CEEMEA)CEEMEA appears to be the weak link of the emerging markets,even though Russia’s and Turkey’s economies are expected tostage strong rebounds this year. Spill-over from Europe’s fiscalproblems is likely to be negative on balance, with the regionvulnerable to any worsening of the EU fiscal crisis. On theground though, developments are looking more positive withindustrial production rising at an average annual rate of nearly10%. Retail sales and confidence surveys have also moved intopositive territory. The region’s key attractions are its valuationsand interest rates. Forward earnings are priced at less than 10x,while rates in Russia and Hungary are likely to fall further.

CEEMEA equities have been gradually getting cheaper. Withcorporate earnings up and share prices down, valuations havecome off and CEEMEA is now trading slightly below the 10-yearaverage valuation multiple and is at a discount to other emergingmarkets. All in, while recognising a recent increase in volatility,Citi analysts expect that over the course of the year, localtailwinds may be powerful enough to lift markets higher.

RussiaWithin CEEMEA, Citi analysts prefer Russia and expect theeconomy to post strong growth of about 6% in 2010, led byhousehold consumption. This is higher than the official forecastof 3.5%, though government officials have publicly stated thatgrowth may exceed 4.5%–5% and 6% is possible under an

optimistic scenario (Deputy Economy Minister Klepach,Reuters, April 2010). Expectations are for consumption

confidence and retail sales to improve, real wagesto increase and unemployment to stabilise. With a

strong balance of payments, further ratecuts cannot be ruled out. But asconsumption recovers, the Central

Bank of Russia may allow rubleappreciation. Oil price fallsstemming from poorer globalgrowth prospects remain themain risk factor for theRussian economy.

Asian credit outlook – Pressure from sovereigns may weighfurther on spreads near term but spreads are attractiveon a longer horizon

Asian credit spreads have widened as Europe’s sovereign debtcrisis progresses, with growing uncertainty about howpolicymakers will respond. But selective oversold names maybe worth a look, given the high carry available.

From an industry perspective, property and land appreciationtaxes are expected to remain a near-term overhang for China’sreal estate sector. This may deter real money from buyingaggressively though we remain neutral on the sector as thefinancial profiles of property developers remain healthy.

Among Indonesian credits, we continue to prefer the powersector, which benefits from a high-degree of stability fromcost pass-through mechanisms and satisfactory financialmetrics. The coal sector also looks interesting, given a verycompelling medium-term picture for the industry.

For the commodity-linked economies of Australia, New Zealandand Canada, tightening risks remain elevated. The Bank ofCanada and the Reserve Bank of New Zealand have alreadystarted to raise rates. At 4.50%, the Reserve Bank of Australiahas paused but a resumption of tightening is expected laterthis year.

Within Asian Emerging Market Sovereigns – With the Fedunlikely to hike rates until early 2011 at the earliest and withthe Euro zone growth outlook highly uncertain, Asian emergingmarket central banks are likely to moderate their hawkishstance on interest rates. The sole exception to this is likelythe Reserve Bank of India, which is grappling with double-digit inflation.

04 2010 Mid-Year Outlook:A Balancing Act

FIXED INCOME

Central Bank Rates & Domestic Currency Sovereign Bonds

Credits – Investment Grade And High Yield USD Denominated Bonds

With the evolution of debt concerns in Europe and the pathof policy response looking increasly uncertain, the markethas been reluctant to take directional bets in the sovereignbond space.

We remain favorably disposed towards better-quality nameswithin the high-yield space, on the basis that recent marketweakness provides opportunities to accumulate names thatexhibit relatively low refinancing risk and a lack of defaulthistory. Nevertheless, liquidity strains due to funding blockagesin the Euro area financial system will be a key concern andcould put refinancing-dependent credits under the gun. Suchconcerns should not be underestimated, particularly when itcomes to playing the high-beta sector. Nonetheless, theremay still be some advantage in getting into certain oversoldnames at the risk of wearing limited downside, given the highcarry available.

Within G10 – We have pushed back expectations for the Fed’sfirst rate hike to early 2011. Also, with macro growth risks onthe rise in the Euro zone, we have pushed out our timeframefor the European Central Bank (ECB) to commence tighteningfrom early-2010 to late-2011. The same applies for the Bankof England and the Bank of Japan.

US and European credit outlook – Pressure from sovereignsand regulatory reform headlines may weigh on spreadsnear term, but we remain constructive

With the onslaught of negative headlines, most recently fromHungary, and continuing widening in spreads of countries likeSpain and Portugal, it is too early to call the dramatic turn incredit markets just yet.

Key issues in the near term include details of the US financialregulatory reform bill that is due to be signed into law in earlyJuly, and the fallout from Europe’s debt contagion, whichseems to be spreading to Eastern Europe.

We suspect the widening in Euro zone periphery spreads cancontinue near term, but the crisis so far has been much smallerin scale than the aftermath of Lehman Brothers’ collapse inlate-2008. As a result, sentiment could change just as rapidlyif the ECB intervenes on a massive scale. However, timing thatshift is all but impossible, and so for investment grade credits,we would prefer to lean against the wind and gradually increaseexposure as markets cheapen.

Commodity prices have come under pressure as investors question the sustainability of theglobal economic recovery. Fiscal tightening in the EU periphery and the UK are expected todampen recovery in those economies. At the same time, recent measures to curb elevatedproperty prices in China have given rise to some uncertainty about China’s growth outlook.This calls for caution in the near-term, given the potentially damaging interaction betweendownward global growth revisions and fragile financial markets. Regardless, the underlyingeconomic backdrop remains one of sustained, albeit uneven, recovery in global growth. Thiscoupled with low interest rates should lend support to commodity prices over the next sixto 12 months.

ENERGY: Elevated risk aversion is expected to weigh on oil prices in the near term, but there aresome early signs that suggest strengthening fundamentals in the crude oil market. Firstly, Chinamay start buying crude for strategic reserves, as it often does when prices are low. Secondly,US$70/bbl is the medium and long-term bottom price for the Organisation of the Petroleum ExportingCountries (OPEC). Even if oil prices do go down from there, it is unlikely to stay below that level forlong. Thirdly, Asian demand remains robust, while finally, US fundamentals should also strengthen.Still, macro risks remain and are likely to cap any price gains. Citi forecasts the West Texas Intermediate(WTI) crude oil price to average US$79.40/bbl in 2010, US$84.30/bbl in 2011 and US$83.50/bbl in2012. Mild weather and robust production are expected to weigh on the US natural gas market. Citianalysts maintain their medium- and long-term forecasts of US$5.00/mmBtu and US$6.25/mmBturespectively to account for the addition of shale gas supply. Shale gas is natural gas produced fromshale formations and typically cost more to produce than gas from conventional wells. Recent studieshowever seem to indicate that breakeven costs for shale gas can be as low as US$3.50/mmBtu, anencouraging development in spite of bearish price movements. Citi forecasts natural gas prices toaverage US$4.50/mmBtu in 2010, US$5.10/mmBtu in 2011 and US$5.40/mmBtu in 2012.

BASE METALS: Base metal prices could fall further in the short term as ongoing fears about growthprospects in the Euro zone and China weigh on the outlook for demand. But Citi analysts remainconstructive over the medium term, based on expectations of continued recovery in global demandand investor flows into the complex. The outlook for copper looks especially favourable, with the marketexpected to tighten up significantly through 2010 as mine supply struggles to keep up with improvingdemand. China still accounts for most of the growth in global demand though OECD consumers shouldalso make a much stronger contribution this year. Citi forecasts copper prices to average US$6,999/mtin 2010, US$7,246/mt in 2011 and US$6,839/mt in 2012.

PRECIOUS METALS: Gold has been regarded as an “alternative currency” for investors and reservemanagers diversifying away from USD and euro in recent months. Investment demand (ETF, futures,bar and coin) is expected to remain the key driver of the yellow metal, as fiscal concerns aboutdeveloped economies are likely to persist. This could see gold prices retest US$1,250/oz over thenext three months. Additionally, China has been increasing its gold reserves, potentially becomingan important longer-term support for gold. Citi analysts forecast prices to average US$1,207.50/ozin 2010, US$1,224.40/oz in 2011 and US$1,117.20/oz in 2012. In the short term, silver is expected tobenefit from being a precious metal and is likely to hold up around US$18.50/oz. Over the mediumterm, silver could potentially outperform gold as market turmoil eases, with investor and consumerdemand resuming, in line with the global economic recovery. Citi forecast silver prices to averageUS$18.30/oz in 2010, US$19.40/oz in 2011 and US$17.60/oz in 2012.

BULK COMMODITIES: In the short term, there appears to be two main resistances to higher ironore prices. Firstly, Chinese iron ore production is increasing although the grade is declining. Secondly,steel mills facing margin compression are resisting price increases. On balance, prices could potentiallyretreat to around US$130/t in the short to medium term, and perhaps to around US$80/t in thelonger term. The market is moving into an oversupply situation, mainly because of increasingproduction from BHP Billiton, Rio Tinto and Vale. As for coking coal, prices are likely to rise higher.The key difference between the two markets is that there is very little new coking coal supplyscheduled to come on stream and markets are thus expected to remain tight. China and India areexpected to be the main drivers of demand growth. Coking coal prices may rise to US$300/t in themedium term, but these very high prices are unlikely to be sustained. Over the longer term, pricescould retreat to around US$170/t. Citi forecast coking coal prices to average US$213/t in 2010,US$275/t in 2011 and US$200/t in 2012.

AGRICULTURE: Expected good weather and an ample supply of crops justify Citi’s bearish forecastsfor agricultural commodities. Citi analysts remain bearish on corn prices given record US plantingprogress and ample global stockpiles. Our forecasts for new-crop US wheat stocks are expected to bethree times higher than three years ago. This should put downward pressure on prices through theend of the 2010 harvest season. Similarly, soybean prices are expected to ease near term as SouthAmerican exports expand and world supply lines rebuild. Prices could fall further in the next six to 12months, assuming average weather in the US, as inventories build up to relatively burdensome levels.Soybean oil prices, however, may remain in a narrow trading range near term following April’s falls,but could rise medium term as stocks are expected to decline next year.

COMMODITIES

052010 Mid-Year Outlook:A Balancing Act

06 2010 Mid-Year Outlook:A Balancing Act

FOREIGN EXCHANGE

05 2009: A Tale Of Two Halves 072010 Mid-Year Outlook:A Balancing Act

SOVEREIGN DEBT CONCERNS

Portugal

Source: Bloomberg. As of June 09, 2010.

Euro Area Peripheral Sovereign 2-Year Spreads Above German Bonds, Year-to-Date 2010

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Jan-10 Mar-10 May-10

Italy

Spain

Greece

Ireland

08 2010 Mid-Year Outlook:A Balancing Act

Crisis contained but volatility to remain

For the time being, it seems that the fiscal problems facing some Euro governments have been containedby the bold multilateral measures undertaken by the region’s policymakers. However, it is still to be seenhow governments will redress their growing indebtedness over coming years even with the aid of low-costfinancing. As long as such uncertainties exist and the possibility of a Greek debt restructuring remains,European financial markets will likely remain sensitive to developments concerning the ability of governmentsto honour their debt.

Against this backdrop, Asian investors should avoid direct exposure to some of the peripheral Euro sovereignbond issuers. They should also be very selective if investing in European financial sector stocks and bondswhere particular institutions may have significant exposure to sovereign credits. Citi currently favours theoutlook for corporate bonds over equities, believing that non-financial corporate bonds in Europe offerattractive yields for investors following May’s sell-off, and are backed by strong corporate cash flows. Globalequities on the other hand are at risk if sluggish global economic growth translates into earningsdisappointment. In particular, sovereign debt concerns and weaker domestic economic activity are likelyto weigh more on European stocks, though they now offer better dividend yields than equities in othermarkets. In terms of the euro exchange rate, which impacts investment returns for non-Euro investors, Citianalysts forecast the currency to remain subdued against the US dollar, staying around current levels untilthe end of the year without losing significantly more value than it already has, barring escalation of theEuro debt crisis.

The important message for investors is that attractive investment opportunities still exist in the Euro Areadespite the worrying headline news. One strategy that investors may consider in order to take advantageof continuing volatility in Euro Area financial markets would be instalment purchases of Euro assets (non-financial corporate bonds and equities) over the coming months.

The other side to this story of volatile European markets is that perceived “safe haven” assets, such as theUS dollar, gold, US Treasuries, German bunds and even UK Gilts, have all rallied in recent weeks against theeuro. However, this flight to quality may reverse once financial markets understand that the debt crisesin the peripheral Euro Area countries may not derail the global economic recovery. Furthermore, with thefiscal positions of the UK and US governments comparable to the peripheral Euro Area countries, investorsmay demand higher yields on bonds issued by these governments over the coming years (see chart). Theforthcoming mid-term elections in the US may just be the catalyst that focuses the market’s attention onthe fiscal woes of the US government. That may well initiate a broader reassessment of financial risks,starting with a rebound of the euro against the US dollar.

Sovereign Debt Concerns

Robert Watson, CFADirector, Investment AdviceCitigroup - International Consumer Bank

German, UK and US 10-Year Government Bond Yields, Year-to-Date and Q3 and Q4 Forecast Averages

Source: Bloomberg, Citi Investments Research and Analysis. As of June 09, 2010.

2.00

2.50

3.00

3.50

4.00

4.50

%

UK

Germany

US

Citi Forecasts

Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10

2009A 2010F 2011F 2009A 2010F 2011F

3Q10 4Q10 1Q11 2Q11

Current 3Q10 4Q10 2Q111Q11

Exchange Rate Forecasts (vs. USD)

Europe 1.21 1.24 1.27 1.30

Japan 94 95 95 95

UK 1.42 1.46 1.50 1.54

Australia 0.88 0.87 0.87 0.87

China 6.75 6.70 6.67 6.62

Hong Kong 7.76 7.75 7.75 7.75

India 44.0 43.5 42.5 41.5

Indonesia 9150 9175 9200 9150

Malaysia 3.17 3.14 3.14 3.14

Philippines 44.0 43.0 43.3 43.5

Singapore 1.37 1.35 1.34 1.33

South Korea 1080 1090 1040 1040

Taiwan 31.5 31.2 30.8 30.5

Thailand 31.9 31.7 31.9 32.0

Source: Forecasts from Citi Investment Research and Analysis, as of May 19, 2010.

Source: Forecasts from Citi Investment Research and Analysis, as of May 19, 2010.

Economic Growth & Inflation Forecasts

Global -2.0% 3.8% 3.4% 1.4% 2.8% 2.9%

US -2.4% 3.3% 2.9% -0.3% 1.8% 1.3%

Europe -4.0% 1.1% 1.0% 0.3% 1.7% 1.8%

Japan -5.2% 3.2% 2.0% -1.3% -1.1% -0.2%

Latin America -2.4% 5.0% 3.8% 7.4% 8.6% 8.2%

Emerging Europe -5.6% 4.6% 4.0% 8.2% 6.2% 6.2%

Middle East & North Africa 2.3% 4.3% 4.9% 8.9% 6.8% 7.8%

Asia 5.5% 8.5% 7.8% 1.1% 4.2% 4.7%

China 8.7% 10.5% 9.3% -0.7% 3.5% 4.6%

Hong Kong -2.8% 4.7% 5.0% 0.5% 2.0% 2.4%

India 7.2% 8.4% 8.6% 3.7% 7.4% 6.5%

Indonesia 4.5% 5.8% 6.2% 4.8% 4.5% 5.7%

Malaysia -1.7% 7.0% 5.5% 0.6% 2.0% 3.0%

Philippines 0.9% 3.7% 5.1% 3.3% 4.8% 5.2%

Singapore -2.0% 9.0% 5.2% 0.2% 3.2% 2.5%

South Korea 0.2% 5.2% 4.6% 2.8% 3.1% 3.1%

Taiwan -1.9% 5.0% 5.0% -0.9% 1.0% 1.5%

Thailand -2.3% 5.5% 5.0% -0.9% 4.0% 3.8%

GDP Inflation

Interest Rate Forecasts

US 0.25% 0.25% 0.25% 0.25% 0.75%

Europe 1.00% 1.00% 1.00% 1.00% 1.25%

Japan 0.10% 0.10% 0.10% 0.10% 0.10%

Australia 4.50% 4.75% 5.25% 5.50% 5.75%

UK 0.50% 0.50% 0.50% 0.75% 1.00%

Source: Forecasts from Citi Investment Research and Analysis, as of May 19, 2010. Current rates as of May 25, 2010.

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