currencies 0211

Deutsche Bank

Private Wealth Management

FX Outlook

Marshall Gittler

Chief Strategist, EMEA

Place des Bergues 3

CH-1211 Geneve 1

Switzerland

[email protected]

+41 (0) 22 739 0463

February, 2011

mailto:[email protected]

Marshall Gittler, Chief Strategist EMEA

FX Outlook, Feb. 2011

Deutsche Bank


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Currency Outlook: Our forecasts vs mkt, GM

2

We are somewhat more bullish on USD/bearish on EUR short-term

Mostly in line with market on majors GM is more bullish JPY, less bullish EUR

long-term

Source: Bloomberg Finance L.P.



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USD is within the normal range of valuation vs majors

Source: Bloomberg Finance LP, DB Global Investment Solutions

Currency outlook: USD PPP USD PPP valuation is not excessive either way

— USD is somewhat undervalued vis-a-vis EUR and JPY and fairly valued vis-a-vis GBP. The undervaluation is

not at the level that would usually trigger a counter move.



Deutsche Bank


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USD cycle is largely on track


Currency outlook: USD Cycle



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Market is already discounting a successful conclusion to Eurozone talks

Source: Bloomberg Finance LP

Currency outlook: EUR/USD We look for some EUR weakness in the near term

— The market is already discounting a successful conclusion to the Eurozone debt problem, as shown by the fact

that the EUR/USD basis swap curve is nearly back to where it was before the debt crisis began. Hence we

cannot expect much further positive impetus from that corner.

— On the contrary, the risks are that some hiccups occur in the process. The Irish elections for example or a failed

auction could knock confidence.

— Meanwhile, the improvement in the basis – and in the Eurozone CDS – may have stalled. This could presage

further EUR weakness.



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Stocks are also discounting a successful conclusion


Currency outlook: EUR/USD We look for some EUR weakness in the coming three months

— We can see the same in the

equity market, where the largest

gainers in Europe this year have

been the peripheral countries.



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Market assumption that Fed lags behind ECB could be tested


USD could get a boost from change in Fed expectations

6m to 1st

rate hike 11m to 1st

rate hike

13m to 1st

rate hike

15m so

far…

— The market is assuming that the ECB is likely to raise rates sooner than the Fed (an assumption that we would

agree with).

— Nonetheless, we would think it more likely that market brings forward its assumptions for the likely time of Fed

rate hikes than for ECB rate hikes. This is particularly the case if our forecast for a 7.8% US unemployment

rate at the end of this year is realized.

Currency outlook: EUR/USD



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On the other hand…Stronger US growth isn’t always good for USD


— People often think of a currency

rate as the “stock price” of a

country and assume that a

country with relatively stronger

growth will have a relatively

stronger currency.

— However the history of EUR/USD

shows that generally, when US

growth has exceeded that of

Eurozone growth, the euro has

tended to strengthen against the

dollar. This may be because a

strong US economy tends to suck

in imports and hence the current

account deficit widens.

Currency outlook: EUR/USD



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Market looking for UK rate hikes, but weak growth may delay them


Much depends on tightening expectations

— Inflation in the UK is rising, as are inflationary expectations. As a result, the market is now fully pricing in a rate

hike by June.

— However, we believe that the market is getting ahead of itself. On the contrary, we have moved back our

forecast for the first rate hike to August, due to weak growth and dovish comments by BoE Gov. King.

— We believe there could be some disappointment in the market and GBP could come under pressure again as a

result.

Currency outlook: GBP



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UK budget deficit may also be a drag on the currency


— While the government has pledged to reduce the budget deficit, so far it has continued to creep higher as a %

of GDP. This means the government will have to cut spending further, which would put pressure on the BoE to

refrain from hiking rates even longer.

Currency outlook: GBP



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Rate differential isn’t enough to look for a much weaker JPY now


We look for a modestly weaker JPY

— The rate differential between JPY and USD is current not enough to expect a major move out of JPY assets

and into USD assets.

— Historically, USD/JPY has tended to decline (i.e., the yen has strengthened) when the 2yr swap spread is

below 250 bps. Currently it is only 83 bps.

Currency outlook: JPY



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But the picture should change in 2H



— We expect though that eventually the market will start to discount a rise in rates in other countries and go back

to funding carry trades via JPY instead of USD.




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Weaker Japanese economy may cause upward pressure on USD/JPY



— We think this is especially so since Japan’s economic indicators are starting to surprise less on the upside,

while US indicators are surprising more on the upside. That too should lead to JPY weakness over time.




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Falling C/A surplus may also put pressure on the currency



— The other potential concern for the yen is the current account surplus. As China tightens policy and activity

there slows, Japan’s exports may struggle.

— Japan is the one major exporting country whose exports have not yet recovered back to the level before the

crash. This may be because of JPY strength. We think further JPY strength would be damaging for the

economy and therefore the government is likely to take steps to prevent it if it starts happening.


% yoy % yoy



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SNB intervention kept CHF from strengthening vs EUR


We look for a modestly weaker CHF

— The impact of the SNB’s intervention can be seen clearly in these graphs. USD/CHF followed the risk aversion

index fairly closely, but EUR/CHF has diverged from it considerably – particularly when the market was risk

averse and therefore one would expect buying CHF against EUR such as in late 2009.

— We expect that over the next year, as concerns about the global economy and the Eurozone’s problems

continue to fade, risk aversion will recede and EUR/CHF can move up somewhat.

— The risk in the short term however is that the hopes for the Eurozone to solve its problems are already in the

market and there could be some disappointment if there are any bumps in the process.

Currency outlook: CHF

Risk averse/ CHF

strengthening Risk averse CHF

strengthening

Risk seeking

CHF weakening Risk seeking

CHF weakening

% %



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CHF already overvalued vs USD


We look for a modestly weaker CHF

— We think it will be difficult for CHF to gain further on USD as it is already 25% overvalued (taking an average of

PPP valuation based on CPI and PPI).

— EUR/CHF is fairly valued on that basis, but only after massive intervention in the FX market by the Swiss

National Bank.

Currency outlook: CHF

25% undervalued

25% overvalued



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Commodity currencies are moving more with rates than commodities


— Two major factors support the commodity currencies: commodities, of course, but also interest rates.

— The currencies seem to be tracking rate expectations more closely nowadays than commodity prices.

— The fact that AUD and NZD rate differentials are starting to turn down while CAD differentials remain stable

makes us expect that CAD is likely to be the best performer among the three commodity currencies.

Currency outlook: Commodity currencies



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We expect CAD to outperform AUD


— AUD tends to follow economic activity in China. We expect the Chinese economy to slow as the government

fights inflation. That may weigh on AUD.

— On the other hand, the improving employment picture in Canada should allow the Bank of Canada to keep on

its modest tightening trend.

Currency outlook: Commodity currencies



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EM countries are adjusting via inflation, not FX revaluation


Currency outlook: EM

— EM countries are resisting FX appreciation and instead are intervening in the market to keep their currencies

from rising vs USD.

— The increase in the money supply arising from the intervention is one reason why inflation in these countries is

rising so much. This is causing further adjustment nonetheless, because even if the nominal rate stays stable, it

is effectively an appreciation of the currency with the higher inflation rate.



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We expect carry to continue to perform


Currency outlook: DB Currency Indices

— Looking at the three DB currency indices,

carry has done fairly well since bottoming

out in late August (+7.1%) but momentum

has not really done anything since mid-

2009, and valuation is down 7.3% from its

peak in June.

— As a result, the overall index was fairly

steady last year (+0.7%) and is up only

slightly (+0.3%) this year.

— We feel the outlook for carry is good. Risk

aversion is on the wane and with inflation

rising in EM countries, we expect they are

likely to raise their interest rates further.

— Valuation however does not seem

compelling to us right now as several of

the major currencies are relatively near

fair value against each other.



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