CURRENCY STRATEGISTS Camilla Sutton, CFA, CMT (416) 866-5470 Sacha Tihanyi (416) 862-3154

Daily Foreign Exchange Update
• • • •
Massive upside surprise to UK GDP sends GBP soaring. German IFO hits three year high, helping EUR ahead of stress tests. Core Canadian inflation remains close to BoC view, neutral impact for CAD today. Stress tests to be released at 12:00 EST.


FX Market Update - Economic data has been particularly supportive for European currencies today, with the German IFO hitting its highest level in three years, while the UK’s second quarter GDP mightily outperformed expectations by growing at its fastest pace in four years. This has left GBP as the best performing currency today by far, while EUR and NZD are also doing well. The USD is generally weaker against most majors, followed by CHF and JPY. European equities could be doing better perhaps, however the looming release of the stress tests seem to be keeping some uncertainty in the market. Nevertheless, US equity futures are sitting in positive territory while commodities remain supported. The yields on US Treasuries are also ticking higher, helped by the after effects of yesterday’s large equity gains. S.T. Stressful Tests - The release of the European stress tests (at 12:00pm EST) is the most important macro event today, as all have been eagerly (and some not so eagerly) anticipating what these results will have to say about the state of European banks, particularly those with strong directional views on EUR. Expectations are set that the stress tests will show a number of failures with a focus of interest on the state of banks in Spain, France and Germany, though the smaller European countries will certainly be watched as well. There is a fine line to be walked by the results; not enough “fails” and critics will say that the tests were not stringent enough, stimulating a sense mistrust and opacity. Should too many banks fail, the market will worry about recapitalization and whether Europe has the financial resources to cover all needs and still provide a buffer for sovereigns. Both of these scenarios would not be positive for EURUSD as it dredges up memories of only months ago when the yields on many Eurozone sovereign bonds looked to be on a one-way ticket to the moon. The best case scenario would be for stress tests that appear stringent enough to identify a number of weak banks (but not too many), allowing for a modest capital boosting exercise. Disappointment with the results may rapidly lead to the market reversing its position on EUR’s questionable short term rebound. S.T. Americas USDCAD (1.0406) • CAD is underperforming today, down 0.2% against the USD as weakness in oil heading into the North American day has hurt the loonie. Canada’s June CPI came in at 1% y/y on the headline and 1.7% y/y on the core measure against 1% and 1.9% expected respectively. Thus Q2 core inflation averaged 1.8% y/y in the second quarter of 2010, compared with the Q2 base case projection of 1.9% from the Bank of Canada, as stated in yesterday’s MPR. This difference is negligible and shouldn’t have any kind of implication for policy. Nevertheless, the miss on the 1.9% expected (total CPI) led CAD to weaken after the data was released. The BoC has marked down its headline inflation estimates over the coming quarters by a reasonable amount, however projections for core inflation (their measure of the underlying trend) has not changed much and is basically showing a flat profile with convergence to the Bank’s 2% target by Q4 of next year. • The stress tests will be important for CAD today. Should the market and EUR react negatively to the news, we will likely see the USD broadly strengthen, which could have positive implications for relative CAD outperformance (rock solid banking system, attractive sovereign position). The deciding factor is how commodity markets take any negative (or positive) news as crude oil’s reaction to any sharp directional risk move will drive CAD, despite the correlation between CAD and oil weakening recently to 0.65 on a rolling 1-month basis. We expect today’s USDCAD range to hold between 1.0333 and 1.0491. S.T.



Europe EURUSD (1.2913) • EURUSD is up 0.2% to leave EUR outperforming today as the currency has been bolstered by better economic data over the past two sessions. Support in EURUSD is now seen at 1.2750 as we have had that level generally hold over the past two sessions upon pushes lower in the pair, while 1.30 is still the key upside level given EURUSD has failed to close above that point on multiple attempts within the past 1.5 weeks. The stress tests will be the most important event for EUR today. Key for confidence in the currency will be transparency and a sense of thorough rigorous tests. Should the market fail to receive a sense that this was achieved through the stress testing procedure, then confidence in EUR will be undermined and the downside risks we believe are inherent in EUR will be realized. To sum it up; an ugly but believable result will end up being much more beneficial for EUR in the medium term than a positive but highly opaque result. • While yesterday it was the manufacturing and service sector PMIs which were positive, today’s German IFO for the month of July jumped to 106.2 (highest since July 2007) against an expected 101.5. This is certainly good news for the Eurozone “core” and provides hope that German momentum will help ensure that general European growth traction is not faltering. • ECB President Trichet has written an opinion piece in today’s FT (see suggested readings), calling for industrialized economies to end fiscal stimulus and restore fiscal sustainability. Mr. Trichet raises a good point about the non-linearities in the economic impact of fiscal restraint on economic growth. Essentially what Mr. Trichet has said is that while fiscal stimulus may have an estimable positive impact on growth at lower levels of debt, or a negative one if it is fiscal restraint we are speaking of, at higher levels of debt the effect is no longer as clear cut or predictable. Debt burdens that reach worrying levels hurt prospects for future growth as confidence wanes and the expectation for higher taxes hinders consumption. We have only to look at the Eurozone periphery for an example of what happens to borrowing costs when the market says enough with debt levels. Interestingly, this puts Mr. Trichet in opposition to what seems to be the tact in the US right now. It would be a strange switch of positions to see the Eurozone as the paragon of fiscal probity but that is exactly what will happen if the US does not address its fiscal outlook over the next 6 to 8 months. Should the US not come to a positive fiscal resolution, then we would be much more in favour of EURUSD trading in line with current levels over that time period. S.T.

Friday, July 23, 2010 GBPUSD (1.5431) • GBP is leading the majors, up 1% against the USD as the UK’s advanced Q2 GDP number shocked markets by coming in at 1.1% q/q against expectations of a 0.6% q/q gain. This sent cable back through 1.54 and towards last week’s highs. This has ensured that the six week uptrend in the pair remains in place today as support had been tested over the past two sessions (support now holds at 1.5175 today). Particularly encouraging in the growth data is that manufacturing output increased by 1.6% in the quarter, the most since 1999 (services increased by 0.9%). Combined with the upside surprises to inflation and a dissent on the Bank of England’s policy committee, this data may well help push additional GBP strength on more hawkish BoE expectations. S.T. Asia / Oceania USDJPY (87.19) • USDJPY is trading towards the middle of its weekly range as JPY is the worst performing major today, down 0.3% against the USD. Rate spreads still hold the most sway over USDJPY from a 1-month rolling correlation basis. Though having declined over the month of July, we still see a rather strong 0.62 correlation between USDJPY and 2-year rate spreads between US and Japanese government bonds. There is virtually nil correlation between USDJPY and global equities, however this is not to say that the yen, despite its propensity to strengthen regardless of all other factors, is not still tied to the risk trade. The rolling 1-month correlation between global equities and AUDJPY remains extremely (and consistently) elevated at the current 0.89, proof that the risk trade is still in vogue. S.T.

Key Pricing & Levels
USDCAD EURUSD GBPUSD USDCHF USDJPY AUDUSD USDMXN DXY (USD index) CRB Commodity Gold WT Crude (Nymex) Nat Gas (Nymex) BoC Noon Rate 30 Day Hist Vol 12.7 11.8 10.7 10.0 8.1 16.2 11.0 8.1 Spot 1.0406 1.2913 1.5431 1.0452 87.19 0.8941 12.73 82.37 266.86 1,197.50 78.85 4.62 1.0376 1 Day Change 0.0035 0.0021 0.0172 0.0023 0.24 0.0008 - 0.04 - 0.26 5.33 2.55 -0.45 -0.02 1 Week 100 Day 200 Day Pivot 1st Pivot 1st Change MA MA Support Resistance -0.0176 1.0301 1.0416 1.0333 1.0491 -0.0017 1.2880 1.3634 1.2778 1.3007 0.0129 1.4997 1.5565 1.5237 1.5537 -0.0058 1.0912 1.0638 1.0393 1.0514 0.62 91.15 90.67 86.61 87.51 0.0252 0.8868 0.8966 0.8796 0.9029 - 0.20 12.61 12.77 12.68 12.84 - 0.11 83.58 80.49 81.94 83.08 2.65 265.57 270.63 N/A N/A 4.50 1,181.46 1,146.97 1,185.21 1,205.88 2.82 78.42 77.66 76.81 80.25 0.10 4.36 4.74 4.52 4.73 CAD (close from Bloomberg not BoC): 1.0371 7/23/2010

Pricing Source: Bloomberg

Today's Releases & Speakers Period Cons 10:00 AM MX Trade Balance JUN P 100.0M 10:00 AM MX Unemployment Rate JUN 5.1% 12:00 PM EC European Banking Supervisors Release Stress-Test Results

Last Significance 178.9M Medium 5.1% Medium High

Commodities Oil ($78.80) • Crude oil is trading lower today, but surged through topside resistance at its 100-day moving average yesterday, a very bullish signal for oil. It also pushed to its highest level since early May, and will now target the 80 level much more firmly. S.T.

Suggested Reading Stimulate no more – it is now time for all to tighten, Jean-Claude Trichet, FT (July 22, 2010)

Hungary PM rejects new IMF deal and austerity, Chris Bryant, FT (July 22, 2010) Smaller Banks See Loan-Book Rebound, Marshall Eckblad, WSJ (July 23, 2010) Bank stress test success hinges on data, not failure count, BB (July 23, 2010)


Our July Monthly FX Strategy Call is now available, please dial in at your convenience. Dial: 416-695-5800 Passcode: 77386016# This month's 20-minute call is hosted by Sacha Tihanyi and discusses: 1) Economic and FX forecast update - less tightening for the Fed and BoC 2) USD decline - factors driving the downturn The presentation can be found at: Conference call commands Press 1 – Skip backward 5 seconds Press 3 – Skip forward 5 Press 4 – Skip backward 5 minutes Press 6 – Skip forward 5 minutes Press 5 – Pause the playback If you have any questions, please contact: Camilla Sutton at (416)866-5470, or Sacha Tihanyi at (416)862-3154,

Friday, July 23, 2010

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