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THEMES FOR 2011 Camilla Sutton, CFA, CMT

(416) 866-5470
Sacha Tihanyi
(416) 862-3154
Monday, November 1, 2010

As we approach year‐end, it seemed timely to review some of the key themes that should prove important currency drivers in 
2011. We expect USD weakness to the overriding theme; accordingly our forecast look for most major currencies to appreciate 
against the USD. On the non‐USD crosses, we expect AUD and EUR to outperform; CAD to prove a mid performer and JPY and 
GBP to underperform. 
Currency wars  
This is not a simple theme and one that is complicated by closed 
door  discussions.  It  is  hard  to  decipher  who  fired  the  first  shot, 
but  the  combination  of  China’s  currency  policy  and  the  US’ 
monetary policy have left other nations struggling with the direc‐
tion  of  their  own  currencies  (mainly  under  the  weight  of  un‐
wanted  currency  appreciation).  Many  of  the  periphery  nations 
are  left  with  domestic  economies  that  justify  tighter  monetary 
policy,  but  wrestling  with  the  currency  impact  of  such  a  path 
combined  with  already  strong  currencies  on  the  back  of  yield 
seeking  flows.  The  tactics  used  by  these  periphery  nations  are 
defensive  more  than  offensive  and  include  capital  controls  and 
intervention in order to slow the pace of currency appreciation. 
We  expect  this  to  remain  a  dominant,  potentially  the  dominant 
theme in 2011.   
Asian block of currencies will be pressured 
The heavy lifting of USD weakness has been undertaken mainly by the non‐Asian currency block (with a few notable exceptions). 
Chart 1 summarizes the IMF’s view on the under or over valuation of each region of currencies. According to all three of their 
methods,  the Asian  block  is  significantly  undervalued,  while  the  advanced  economies  are  essentially  inline  to  overvalued  and 
LatAm is somewhat mixed. We expect the Asian block of currencies will come under increased appreciatory pressure in 2011, 
which will see a notable shift in global FX patterns. 
Sentiment  is  a  key  driver  of  currencies  and  swings  in  this  can 
have  real  implications  for  valuations.  As  chart  2  highlights,  the 
market  is  currently  short  USD  against  every  primary  currency. 
Our base case is that the case for USD bears builds further, pres‐
suring  the  currency  lower.  However,  swings  in  sentiment  will 
likely  also  create  some  brief  periods  of  retracement;  but  these 
should prove temporary. 
Relative growth patterns 
As the advanced economies struggle with below trend growth, it 
is likely that those that are better positioned on the growth front 
will outperform on the currency front as well. This should benefit 
AUD  and  CAD,  weigh  on  the  UK  and  the  US.  The  European 
growth pattern is somewhat divergent, with relatively strong growth expected from Germany, but weaker growth from many of 
the other EU members. Accordingly, the growth outlook for the EU as a whole should be a fairly neutral driver of EUR. 
Monetary policy 
Relative interest rates always play an important role in currency markets, but with the widely diverging path that lie ahead, their 
importance  will  be  noteworthy  in  2011.  The  currency’s  of  country’s  whose  central  banks  are  easing  policy  and  using  non‐
GLOBAL FX STRATEGY Monday, November 01, 2010

conventional tools to meet mandates should lag. This includes the USD and GBP. The central banks that are unlikely to turn to asset 
buying programs, like the ECB, will likely see currency appreciation. Whereas countries who otherwise would be pursuing tighter 
policy should also strengthen but to varying degrees. This includes AUD, CAD and much of the emerging nations. 
Fiscal policy 
Fiscal  policy  will  take  on  new  importance  in  2011,  as  the  market  is  provided  with  evidence  as  to  whose  austerity  measures  are 
achieving the fine balance of reigning in deficits while still supporting growth. A difficult task indeed. The market’s view is likely to be 
supportive of Europe (and EUR) as it does the heavy lifting up front;  as well as AUD and CAD as their associated fiscal balances are 
more moderate.  However, the UK’s strict response could well face criticism, while the US’ lack of a credible plan will certainly weigh 
on its currency. 
Sovereign risk 
Sovereign risk was an important theme in 2010; it has the potential to play a major role in 2011, but our base case is that it plays a 
more limited part than it did this year. There is the real potential for one of the weaker EU members’ sovereign position to bubble 
into a significant problem. However, the combination of the market’s new found experience with the EU treaties, exposures and 
processes as well as progress on the crisis resolution mechanism, should leave the market reaction as more muted. 
Risk Aversion  
Risk  aversion  can  spike  any  time,  often  will  little  warning,  which  is  why  it  generates  such  a  violent  market  response.  We  expect 
bouts of USD supportive risk aversion to be a recurring theme in 2011. However, these should prove temporary. Their impact will be 
to slow the downward trend in the USD, but not reverse it. 
In summary, our forecast look for most major currencies to appreciate against the USD. On the non‐USD crosses, we would expect 
AUD and EUR to outperform; CAD to prove a mid performer and JPY and GBP to underperform leading into December 2011. 

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