Currency

OUTLOOK

Macro Currency Strategy July 2011

GBP: between a rock and a hard place
For now, it is the changing dynamics of the EUR and USD that are impacting GBP rather than a specific GBP story itself. For GBP to trade independently, we need to see a dramatic change in the UK economy, either for the better, or for the worse. Until then, GBP will remain trapped between a rock and a hard place. EUR and CHF: Where core EUR might have been Imagine the EUR had been split into two currencies in 2009: EUR-core (EUC) and EUR-periphery (EUP). These currencies would be performing very differently, with a current EUC-USD around 1.80 and EUP-USD of perhaps 1.10. Relative competitive positions within the Eurozone would be very different. Will a new tax holiday boost the USD? There has been discussion of another Homeland Investment Act that would involve a tax break that could see US multinationals repatriate funds from overseas. This could boost the US economy and the USD, at least temporarily.

Disclosures and Disclaimer This report must be read with the disclosures and analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

Macro Currency Strategy July 2011

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Summary
GBP – between a rock and a hard place (pg 3)
For now, it is the changing dynamics of the EUR and USD that are impacting GBP rather than a specific GBP story itself. When Eurozone sovereign risk is dominating market focus, GBP outperforms the EUR but underperforms the USD. Alternatively, when the market is in the mood to punish the USD, GBP outperforms the USD but underperforms the EUR. For GBP to trade independently, we need to see a dramatic change in the UK economy, either for the better, or for the worse. Until then, GBP will remain trapped between a rock and a hard place.

EUR and CHF: Where core EUR might have been

(pg 9)

Since the onset of the sovereign debt problems, EUR and CHF have behaved very differently, which has interesting implications for the Eurozone. Imagine the EUR had been split into two currencies in 2009, EUR-core (EUC) and EUR-periphery (EUP). These currencies would be performing very differently, with a current EUC-USD around 1.80 and EUP-USD of perhaps 1.10. Relative competitive positions within the Eurozone would be very different with the EUC area much less competitive.

Will a new tax holiday boost the USD?

(pg 15)

The US economy is slowing, QE is finished and the debt ceiling issue is lingering. In recent months there has been discussion of another Homeland Investment Act that would involve a tax break that could see US multinationals repatriate funds from overseas to promote investment and job creation. This could boost the US economy and the USD, at least temporarily.

NOK has beauty, but not everyone sees it

(pg 22)

On all metrics that we consider the NOK is more defensive than the CHF. However, the market has been buying the CHF in a frenzy of defensive activity whilst ignoring the NOK. We believe this is a mispricing. Those fleeing from the EUR and the fear of any possible systemic problems would be ill advised to rush into the CHF. It does not offer safety from a break-up scenario or any systemic problems owing to its giant-sized banking sector. In this scenario the NOK would be less exposed than the CHF.

Dollar Bloc

(pg 28)

Canada – CAD easily absorbs shifting BoC policy expectations –We continue to see the overall backdrop for the CAD as supportive, given still-healthy growth in emerging market economies and the associated support that provides to commodity prices, as well as Canada’s superior fiscal condition and modestly better growth trajectory, relative to most other G10 countries. However, we are also hesitant to view those factors as ones that are likely to drive the CAD measurably higher.

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Macro Currency Strategy July 2011

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Australia – AUD still at elevated levels – The set-back in RBA rate hike expectations coupled with the recent weakness in global indicators should take its toll on the AUD. The AUD remains above 1.05 for now, but at such elevated levels we feel that the currency should retrace in the coming months. New Zealand – Recovery in swing – The NZD has performed well over the past few months, with the currency reaching fresh all-time highs on the back of rising rate expectations and positive domestic developments. However, with the summer months bringing a number of events that could see further ‘risk off’ developments we expect a mild retracement.

Key events Date 19 July 20 July 27 July 28 July 2 August 4 August 4 August 9 August 10 August 10 August
Source: HSBC

Event BoC key policy interest rate announcement BoE publishes minutes of July 6-7 meeting Federal Reserve issues Beige Book RBNZ rate announcement RBA rate announcement BoE rate announcement ECB rate announcement FOMC rate announcement Norges Bank rate announcement BoE publishes quarterly inflation report

Central Bank policy rate forecasts Last USD EUR JPY GBP 0-0.25 1.50 0-0.10 0.50 August 11(f) 0-0.25 1.50 0-0.10 0.50 November 11 (f) 0-0.25 1.75 0-0.10 0.50

Source: HSBC forecasts for Fed funds, Refi rate, Overnight Call rate and Base rate

Consensus forecasts for key currencies vs USD 3 months EUR JPY GBP CAD AUD NZD
Source: Consensus Economics Foreign Exchange Forecasts June 2011

12 months 1.405 87.85 1.664 0.986 0.988 0.752

1.429 83.14 1.628 0.968 1.043 0.774

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Macro Currency Strategy July 2011

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GBP – between a rock and a hard place
GBP – stuck in the middle
GBP is caught in the crossfire between negative developments surrounding the EUR and USD. When Eurozone sovereign risk is dominating market focus, GBP underperforms the USD but outperforms the EUR. In this context, GBP-USD is dragged lower because it is caught in the EUR’s orbit as the UK has strong financial and trade links to the Eurozone. Alternatively, when the market is in the mood to punish the USD and Eurozone sovereign risk is less in focus, GBP underperforms the EUR but outperforms the USD by a small margin. In this situation, EUR-GBP goes up as the ECB is still seen trying to normalise monetary policy before the BoE. We believe the market has given GBP a slight advantage versus the USD because the UK is ahead of the curve in trying to deal with its fiscal problem and for a period believed the BoE could raise rates before the Fed. To us, it is the changing dynamics of EUR and USD that are impacting GBP rather than a specific GBP story. For GBP to trade independently, we need to see a dramatic change in the UK economy either for the better or for the worse. Although we maintain a relatively pessimistic view on the UK economy, it will also be the misfortunes of other currencies that will keep GBP trapped in the ‘ugly contest’.

1. GBP against a broad range of currencies has remained weak since late 2008
BoE GBP trade-weighted (B road index) 110 105 100 95 90 85 80 75 70 Jun-06 Oct-06 Feb-07 Jun-07 Oct-07 Feb-08 Jun-08 Oct-08 Mar-09 Jul-09 Nov-09 Mar-10 Jul-10 Nov-10 Apr-11
Source: HSBC, Bloomberg

110 105 100 95 90 85 80 75 70

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Macro Currency Strategy July 2011

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Arise Sir Sterling!...Not...
A persistent feature since the peak of the global financial crisis is GBP’s inability to rally (chart 1). When measuring GBP’s performance against a broad basket of currencies, it remains nearly as weak as it did back in 2008. We have long been cautious on GBP, believing that the looming fiscal tightening would keep UK growth sluggish and in turn keep the currency subdued. The issue for GBP, however, is that its directional pull for some time has been dictated more by developments in other currencies, in particular the EUR and USD. This is shown in our GBP diffusion index below.

The index is scaled between 0 and 100 such that a reading of zero implies that the GBP is falling against all fourteen currencies, and a reading of 100 implies that GBP is rising against all of the currencies. In order to extract information from this index, we take a 20-day moving average.
GBP a sideshow to other currencies

GBP’s diffusion illusion
One way to show whether the market is overly focused on GBP is to look at a diffusion index. This measures the breadth of its movements against a host of currencies (chart 2). Our GBP diffusion index analyses the direction of the daily GBP movements against 14 currencies and measures the proportion that are rising or falling against GBP. Each currency is given an equal weight, as we are looking at the breadth of the rise or fall in GBP rather than the magnitude.

The diffusion index has tended to move in a 35-65 range since the beginning of 2009. When periods of significant GBP strength have occurred against a range of currencies, it has usually been very brief and the index has been associated with a reading near 65. Likewise, when there have been periods of extreme GBP weakness, the index has briefly been below 35. The index is currently at the “rise-fall” 50 level, which means GBP has been basically rising and falling equally against a broad range of currencies. In other words, GBP has been treated as a sideshow to other currencies, as the market has been fixated with EUR and USD risks. The last time that the market was really focused on GBP, albeit in a negative way, was around the UK election last year. GBP has not had primacy for

2. GBP has been more of a sideshow but the lesson learned over the past couple of years is the market’s focus can change quickly
7 5. 0

G B P D iffu s ion In de x 20 dm a
GB P c au g h t in th e m idd le o f E u roz o n e s o ve reig n risk a n d U S de b t p rob le m s . I t h a s b e e n m ore ab o u t U S D an d EU R t h a n G BP in re ce n t m o nt h s

75 . 0

6 5. 0

65 . 0

5 5. 0

55 . 0

4 5. 0

45 . 0

3 5. 0 Hu n g p a r lia m en t co n ce r n s f o r G B P

35 . 0

2 5. 0 J a n-0 9

25 . 0 M a y-0 9 S e p -09 J an -1 0 M a y-1 0 S e p -1 0 J an -1 1 M ay -11

Source: HSBC, Bloomberg

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0 -40.7 0. This has been a constant theme since April last year.1 The interest rate market priced in BoE rate hikes early this year but has more recently priced them out.0 -40.9 0. The UK economy is slowly but surely disappointing.0 Source: HSBC.8 0.0 0.1 1.0 -50. But it steadily became apparent to the market that as real wages remain negatively coupled with the disinflation impact from fiscal tightening.0 -30.0 -20. Initially it was quick to price in BoE rates hikes as headline inflationary pressures were rising. but these trends are not as pronounced as those for the US.0 10. Bloomberg 5 .9 0.0 70.0 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 -35. in either direction. but of course the risk with a weak UK economy is that the market starts to punish GBP.7 0.Macro Currency Strategy July 2011 abc 3. US and UK activity surprise indices trending down US activity surprise 20. some may consider rising rate expectations to be associated with a stronger 5. we would need to see a significant change in the outlook for the economy.0 -30. Bloomberg some time.0 -15.0 10.8 0. For a specific GBP event to happen now.0 1. while inflation continues to beat expectations.0 4.5 Jan-11 0. the market has notably changed its view on UK interest rates (chart 5).0 50. Flip flopping on UK interest rates Despite the weak growth and high inflation story that has been prevalent for some time.0 -20.0 -20.0 -10.0 0. Bloomberg Source: HSBC.5 Jan-11 Feb-11 Mar-11 Apr-11 May -11 Source: HSBC. The interest rate futures see the BoE keeping interest rates unchanged this year 1.0 -50.0 0.0 -30.0 Jan-10 UK activity surprise 20.0 -25. US and UK inflation surprises trending up -10.0 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 40.0 -10.0 US inflation surprise (LHS) UK inflation surprise (RHS) 80. However. The market is no longer expecting BoE rate increases this year GBP forward sw ap Jan 2012 (expected BoE policy rate in J an 2012) 1. rates were not going to rise.6 0. In this low inflation environment. the long-term trends in our UK activity and inflation surprise indices are not as dramatic as those for the US (charts 3 and 4). ICAP.6 0.0 60.

4 1. Also. Portuguese and Irish sovereign debt. and an additional USD 170bn of Spanish and Italian sovereign debt (table 7). After all. which could drag GBP down.8 1. GBP should have fallen back again.0 Jun -10 Source: HSBC. The first mechanism by which problems in the Eurozone could be negative for GBP is through the exposure of UK banks to ‘problem’ Eurozone sovereign bonds. Bloomberg 1. GBP is not immune to Eurozone concerns Let’s not forget that GBP is vulnerable to developments in the Eurozone. UK banks hold about USD 170bn of Greek. if the relationship still held.52 0 . In fact. especially in the pre-crisis environment. as GBP-USD should have traded lower as UK rate expectations fell away. We have long argued that in the post-crisis world other factors can swamp interest rate differentials. then GBP-USD should be closer to 1. So one might expect GBP to be dragged up against the USD.0 1.57 0 . the UK is set to adopt aggressive fiscal tightening while the US looks set to increase its debt ceiling yet again.62 0 .47 0 . The relationship between interest rate differentials and GBP-USD has been breaking down over the past couple of months.6 1.55. and as these expectations waned. GBP is not immune when we consider the UK economy’s financial and trade links with the Eurozone. any fallout from Greece that triggers contagion in the periphery will have a substantive knock-on impact on the UK financial system. Nevertheless.42 Aug-10 O ct-10 Dec-10 Feb-11 A pr-11 Jun-11 GBP.2 1. with a US Presidential election next year. We have shown previously how relative interest rate differentials were a powerful indicator for GBP-USD.2 Short Sterling spread Dec 2011 (UK-US) (LH S) GBP-USD (RHS) 1.Macro Currency Strategy July 2011 abc 6. but on the other foot sits the EUR.72 1 . 6 . the appetite to deal with the deficit in any meaningful way is lacking. According to BIS figures. Our explanation for this change comes down to the relative fiscal forces at play. Interest rate differentials suggest GBP-USD should be lower 1 . We recognise that one needs to be careful drawing too many conclusions from the BIS data. But we have also suggested that in the post-crisis environment relative interest rates do not provide as good a guide for GBP-USD (chart 6). The breakdown in this relationship illustrates how USD-negative dynamics dominated more than the negative headwinds for GBP.67 0 .

6 1. The UK’s response to a fall in GBP was not to increase the volume of goods exported.3 2.6 5. the core EUR would be trading at 1.9 13.0 27.2 6. we show that without the peripheral economies in the EUR.5 7 .Macro Currency Strategy July 2011 abc 7.80 or above. Perhaps that is because the UK has not been as successful as Germany in making and shipping goods to the buoyant emerging market economies.8 21.6 9.3 10. with over 6% bound for Ireland alone.0 4. The fall in the EUR has seen Germany attack the overseas markets with a volume expansion.1 1. this lowers the unemployment rate and stimulates the domestic economy.5 1.9 1.3 53. However. In the next section.9 8.9 2.0 7. and with UK exports highly exposed to developments in the Eurozone. BIS Greece 57 34 1 3 14 7 146 Ireland 30 118 10 14 135 51 462 Portugal 27 36 85 3 24 5 202 Spain 141 182 18 107 47 709 Italy 393 163 31 18 66 37 867 Meanwhile.3 19.5 8.4 5. The main point we are making is that Germany has been able to capitalise on the weakness of the EUR.5 4. UK exports exposed to the Eurozone Exports by destination 2010 US Germany Netherlands France Ireland Belgium-Luxembourg Spain Italy China Sweden Switzerland Hong Kong UAE Japan Canada Value (GBPbn) 38.2 4. but to take a value adjustment that boosted profitability. 8.3 4.6 5.8 7.7 3. The hopes for an export-led recovery based on the large fall in GBP in the latter half of 2008 has not panned out. we do not expect a strong pick-up anytime soon. With the sovereign debt problems in Europe testing investors’ nerves.8 6. BIS consolidated foreign claims of reporting banks (USDbn) Claims vis-à-vis France Germany Spain Switzerland UK USA Total Source: HSBC.1 % total 14.7 1.6 47. the UK recovery has been lacklustre.6 BRICs Eurozone EU-27 Source: ONS 17.1 16.4 141. the second-round impact on the economy is small compared with a volume expansion that creates jobs.1 3. Instead.5 125. table 8 shows that a very high proportion of UK exports are shipped to the Eurozone. this does not seem like a good time to be a trading partner relying on Eurozone growth.

Conclusion GBP is currently stuck between a rock and a hard place.55 and 1. This would not be a good development for GBP. GBP could easily trade at 1. GBP underperforms the EUR. In this situation the UK is the example of how not to do things. GBP is less driven by a UK-specific story. One is that the UK economy powers ahead and the fiscal situation gets resolved – this would see the UK as the role model of how to handle the crisis. but is instead dominated by the changing dynamics of the EUR and USD.45. Before GBP trades more independently.65. which are negative developments surrounding the EUR and USD. fair value is between 1. In contrast. 8 . but marginally outperforms the USD. Here GBP-USD could easily trade at 1. The opposite scenario is the one that seems to be playing out at present: a fiscal tightening turns into a slowdown. we could soon see the market paying closer attention to UK fundamentals than elsewhere. which the market has now also come to accept. In this environment. Should UK growth deteriorate further. When markets are focused on Eurozone sovereign risk. GBP underperforms the USD.75 or above against the USD. when the market’s focus shifts to the US. but outperforms the EUR. which is a clear risk. In the absence of either of these scenarios playing out.Macro Currency Strategy July 2011 abc What could see GBP escape the trap? There are two scenarios that could see GBP move out of its current trapped state. and there is little reason GBP-USD should break out on either sides of this range. Under this scenario. we believe that there needs to be a major change in the outlook for UK economy – either for the better or for the worse. We have a fairly pessimistic view on the UK economy.

7% (chart 2). but it is flat in Switzerland. having spent much of the previous 10 years in a 1. market attention is turning towards the Swiss National Bank.65 range (chart 3).0 0.0 4.0 4.45-1.Macro Currency Strategy July 2011 abc EUR and CHF: where core EUR might have been Will the SNB follow the ECB? With the ECB having raised interest rates for a second time to 1.0 0. suggests that historical relationships in monetary policy are no longer valid.5 0.0 3.5 2. Core inflation in the Eurozone is lower.5% year on year.0 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Source: Bloomberg.0 1. This shows the sixmonth rolling correlation of daily changes in EUR-USD and USD-CHF. Whilst Swiss CPI is currently 0.5 1. the EUR has lost about 20% against the CHF.0 2.5 3. HSBC 9 . Former SNB Vice President Niklaus Blattner has said that “price stability is threatened by the expansion of the money supply” and that “a rate increase would be in order also because of signs of overheating on the property market”.0 % EUR and CHF Policy Rates % 5. at 1. however.5 3.5% at the July 7th meeting. Since the emergence of the sovereign credit problems in the Eurozone in 2010.5 4. Currency performance is the key The main driving force behind this inflation divergence is the performance of the currency.5 2.5 0.5 4.0 1. When the EUR and 1. it is natural that some expect the SNB to follow suit at some point.5 1.0 2.0 3. ECB and SNB policies have historically moved together 5. With ECB rates rising again. Relative inflation experience. Eurozone inflation is currently 2. Swiss interest rate policy has mirrored that seen the Eurozone for most of the past ten years.6% year on year. The new exchange rate environment can be seen even more clearly in chart 4. As can be seen in chart 1.

The correlation did fall to some extent during the financial crisis. HSBC 10 .80 1.the last safe haven”. which makes it more susceptible to swings in ‘risk on-risk off’ sentiment and therefore more volatile.0 4.0 3. but it was fully re-established during the early part of the recovery in 2009.50 1. Chart 5 shows implied 3month EUR-CHF compared with the average of other Euro crosses (NOK.0 -1. Swiss and Eurozone inflation has diverged % y-o-y 5. it has moved above 10% and is well above the average as other volatilities have declined.20 1.0 3.00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Source: Bloomberg.30 1.70 1.20 1. Until the crisis and again in 2009.0 2.50 1. EUR-CHF stability broke down in 2010 1.60 1. PLN. 3.60 1.0 4.00 Jan-00 EUR-CHF 1. this correlation is very high.80 Sovereign credit problems 1.70 1. As we argued in “Swiss Franc .10 1.0 -2. before falling sharply once the sovereign credit issues emerged.Macro Currency Strategy July 2011 abc 2.0 0. and CZK). SEK.10 1.30 1.0 Mar-99 Source: Bloomberg. central bank intervention in USD-JPY has made CHF the only viable safe haven currency.0 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09 Mar-11 CHF move together.0 -1.0 -2. as it was for most of the 1999-2009 period.40 1.0 1. HUF.0 2. EURCHF volatility was below 5%. Currency Weekly 4th April 2011. Since 2010.0 0.40 1. A further demonstration of the changed relationship between EUR and CHF can be seen in implied options volatility.0 1. HSBC Swiss and Eurozone Inflation YoY Swiss Eurozone % y-o-y 5.

Macro Currency Strategy July 2011 abc 4. If the exchange rate is strengthening then. HSBC Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 11 . and vice versa.6m rolling correlation 100% 90% 80% 70% 60% 50% 40% 30% Jun-11 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Source: Bloomberg. economy by combining the effect of interest rate and exchange rate movements. The correlation between EUR and CHF movements has fallen sharply 100% 90% 80% 70% 60% 50% 40% 30% Jun-99 EUR-USD and USD-CHF . An MCI can be used to gauge whether (relative to some benchmark period) monetary conditions are boosting or restraining the 5. other things being equal. HSBC For Swiss monetary policy. the implications of this new CHF behaviour can best be analysed by using monetary conditions indices. there was relatively little change in the MCI between 2002 and 2009. As can be seen. but since then conditions have tightened by the equivalent of about 450bp in interest rates. EUR-CHF implied volatility is now above the European average % 25 EUR-CHF vol versus EUR-other Europe vol Average EUR-Europe vol EUR-CHF vol % 25 20 15 10 5 0 20 15 10 5 0 Jan-99 Source: Bloomberg. Chart 6 shows an MCI for Switzerland using April 2002 as a benchmark and giving an 80% rate to changes in real interest rates and a 20% weight to changes in the effective exchange rate. monetary conditions will be tightening. Monetary Conditions Index A monetary conditions index (MCI) aims to measure the effect of both real interest rate changes and exchange rate moves on the economy. This strongly suggests that the SNB should be in no hurry to increase interest rates.

Macro Currency Strategy July 2011 abc 6.5 0. What would be the value of EUP-USD? There are several possible ways of estimating this. If the EUR is a weighted average of EUC and 7. it would not be unreasonable to suggest that EUC-CHF would have remained fairly stable. Imagine that the EUR had been split into two currencies in 2009.13.5 -1.0% 0.MCI (Apr 2002= 0) 6.5 -2.5 93 88 83 78 Dec-94 -0. HSBC 12 . Swiss monetary conditions have tightened sharply because of currency appreciation 6.5 2.0% 4.0% 5.0% Apr-02 Switzerland .0% 4.0% 1. Given the close association between the behaviour of the Swiss economy and the German economy (chart 7).0% 3. This would mean EUP-USD of about parity.0% 0. call them EUR-core (EUC) and EUR-periphery (EUP) where EUC members were those that had no significant public sector funding problems.5 1.0% 2. HSBC Where core EUR might have been The behaviour of the EUR and CHF over the past 18 months and the tightening of monetary conditions in Switzerland have interesting implications for the Eurozone. The first column assumes that the current EUR is just a simple average of the values of the hypothetical EUC and EUP.0% -1.0% -2.83(about 28% higher than EUR).0% -2.5 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Source: Bloomberg. Assuming EUC-CHF had remained at 2009 EURCHF levels (1.0% -1.0% 2. Swiss and German economies tend to move together 113 108 103 98 German IFO and Swiss KOF Indices IFO (LHS) KOF (RHS) 3.0% 3. The two simplest are shown in table 8. This would also mean EUC-JPY of 144 and EUCGBP of 1.0% 5.0% Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Source: Bloomberg.0% 1.50) this would imply a current EUC-USD of 1.

Chart 9 shows the BIS real effective exchange rates for Greece. With a split EUR or a situation where the peripheral Eurozone deflated internally.53 0. rebased 95'=100) 120 115 110 105 100 95 90 85 80 Jul-02 Jan-04 Jul-05 Jan-07 Jul-08 Jan-10 Source: Bloomberg. Alternative estimates for hypothetical EUP exchange rates Cross Rate EUP-USD EUP-GBP EUP-JPY EUP-CHF EUP-AUD EUP-CAD Source: HSBC Using 50/50 weights 1. the impact would be mostly felt on real incomes and the EUP central bank may also have been reluctant to tighten. Germany’s REER would have been higher and the Greek REER would have been significantly lower.65.82 0.0 0. German and Greek real effective exchange rates would look very different Greece REER 120 115 110 105 100 95 90 85 80 Jan-00 Jul-96 Jan-98 Jul-99 Jan-01 Swiss REER Germany REER (BIS. Inflation in the EUC area would probably be very subdued and the EUC central bank may not have felt the need to raise rates. EUC area holder of EUP bonds would.Macro Currency Strategy July 2011 abc 8.4 0. Relative competitive positions in the Eurozone would have been very different. Inflation in the EUP area would probably be higher but.65 0.00 0.62 79.96 Using GDP weights (65% EUC. 35% EUP) 0. Although the financial cost of the sovereign debt problems may be high for the core countries. Greece’s REER has moved steadily higher. of course.60 0. but Germany’s has fallen implying a stronger competitive position. HSBC 13 .40 51. rather like the UK. What would this mean for economic performance? With a much weaker currency EUP area exports would probably have been performing better and fiscal consolidation may have been slightly easier if there was the prospect of stronger activity. 9. have suffered a big currency loss (assuming they were not hedged) in the same way EUR holders of gilts did in 2007/08. Switzerland and Germany.62 EUP then. they have gained a competitiveness boost from having a currency much less strong than it otherwise could have been. With higher domestic inflation. based on approximate GDP weights this would mean EUP-USD of about 0.93 0.

The relationship between the EUR and the CHF does. however. Assuming a core euro would have remained relatively stable against the CHF. Would two EURs have been better than one? This is impossible to say given the counter-factual nature of the argument. and the central bank would perhaps not have decided to tighten policy. suggest how things might have been different for the Eurozone. then monetary conditions in the core Eurozone would also be significantly tighter. There seems little doubt that a euro-periphery currency would by now be significantly weaker than the EUR. 14 . The sharp change in behaviour of EUR-CHF since the beginning of the Eurozone sovereign debt problems raises the question of how a split euro would have performed over the past eighteen months.Macro Currency Strategy July 2011 abc Conclusion The SNB seems very unlikely to follow the ECB in raising rates because monetary conditions in Switzerland have already been tightened significantly by the strength of the CHF.

Hence. Those already-difficult efforts are severely complicated by the more immediate negotiations on raising the debt-ceiling limit. due both to the time it diverts from other matters. and we cannot completely discount the possibility that proposals such as the Brady bill will be given more serious consideration.Macro Currency Strategy July 2011 abc Will a new tax holiday boost the USD? A new tax holiday on US corporate earnings held abroad? With the US economy weak. Nonetheless. Nonetheless. some review of its detail and the potential FX implications is useful. it appears that more items and proposals are being put on the table. in an effort to address the country’s economic troubles. Hence. Not surprisingly. 1. Bloomberg 15 . USD gains during the 2005 HIA program have peaked interest in new proposals DXY Index 125 115 105 Dollar Index (DXY) DXY Index 125 115 105 2005 USD rally 95 85 75 65 2000 95 85 75 65 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: HSBC. US Representative Kevin Brady (R.. Texas) introduced legislation that would allow companies to repatriate foreign earnings at a 5.25% tax rate instead of the current 35% rate. the legislation has strong support in the business community. the FX market has understandably focused in on the possibility of a corporate tax holiday and the associated repatriation as a potential support for the USD. politicians are under increasing pressure to take additional measures to stimulate job growth. This type of legislation and the associated flows had a profound impact on the USD in 2005 as can be seen by the circled area in chart 1. some members of Congress are once again advocating a tax holiday that would allow US corporations to repatriate overseas earnings at a reduced tax rate. and some previous political opponents to the proposal have recently appeared to soften their position. as senior congressional leaders and the White House progress in their negotiations on the debt ceiling and the broader debt and deficit problem. as well as the associated fiscal constraints.

which estimates total repatriation associated with the program at USD700bn. the Brady bill (H. as well as the broader range of USD500bn to USD1trln. We look at this below. insurance. also known as the American Jobs Creation Act (AJCA). we will focus on figures provided by the bi-partisan congressional JCT. For purposes of comparison.5 14. This moved the USD substantially in 2005 and the fear is it will have the same impact. Importantly. Weak labour market pressures Washington to act 11 10 9 8 7 6 5 % US Unemployment Rate % 11 10 9 8 7 6 5 4 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 4 Jul-11 Source: HSBC. the bulk of which occurred in 2005.6 105. real estate All others Total Source: Redmiles (IRS). Bloomberg Sizeable amounts of USD repatriation are estimated As noted. 2005 HIA Repatriation by Industry Industry Manufacturing .7 14. an economist at the Internal Revenue Service (IRS).Macro Currency Strategy July 2011 abc 2.3 29. ranging from USD500bn up to USD1trln.R. the JCT estimate. 2008 USD bn 289. Both the current level of foreign earnings and the upward trend in the series suggest a notably higher amount of accumulated earnings abroad relative to 2004.4 68. 3.8 361. estimates that total repatriation from HIA was USD362bn. compared with 21% in the 2000-2009 period. and 14% in the 1990-1999 period.6 13. USD repatriation would likely be larger today than under the 2004-2005 HIA program Higher estimates of repatriation for the current proposal relative to the original HIA stem from several factors. titled the “Freedom to Invest Act of 2011”) calls for a onetime 85% relief in the tax burden on repatriated foreign earnings of US corporations.Computer/Electronic . A 2008 report authored by Melissa Redmiles.Pharmaceutical Wholesale and retail trade Information Finance. The Bureau of Economic Analysis reports that the foreign operations of US corporations generate 24% of profits from overseas operations. are greater than the total repatriation which stemmed from 2004 Homeland Investment Act (HIA).8 16 . 1834. There are varying estimates on the amount of repatriation potentially stemming from the program.

assessing the matter from an accounting perspective. in some cases. Overseas earnings most likely to be held in local currencies There is also the potential that some portion of the accumulated earnings being held abroad may already be in USD. the total daily volume of spot and outright forward transactions combined was USD840bn at that time.9 10 5 0 Netherlands Source: Redmiles (IRS). Ireland and Luxembourg are specifically cited).9%. And anecdotally. accounting for 40. there may well now be some tendency for corporations to accumulate earnings overseas in anticipation of another tax holiday.1 7. those figures provide some reasonable basis for estimating the sources of repatriation going forward.2% (chart 4). some may conclude the spot impact of repatriation coming into the FX market now could well be similar to that in 2005. following the 2004-2005 HIA experience. Among those. And while we are primarily referencing the JCT estimate of potential repatriation. as a percent of total repatriation % 30 25 20 15 9. the economy is roughly 23% larger today than at the end of 2004 (using nominal GDP measures).6 7. Eurozone countries dominate the list (the Netherlands.965trn. we think 17 . Hence. In order to assess the potential impact of those flows on the FX market.3 times greater than in 2004. According to the 2004 BIS Triennial Central Bank Survey.Macro Currency Strategy July 2011 abc 4. leaving it roughly near the change in overall FX volumes that has occurred over the same time.0 6. The working assumption on the potential repatriation in the new proposal of USD700bn is 1.2 10 5 0 Switzerland Bermuda Ireland Canada Luxembourg UK Beyond that.1 % 30 25 20 15 9.1% and the UK at 6. some 2. changes in local tax structures may have resulted in some changes today relative to 2004.7% of the total USD362bn in flows. This is difficult to estimate and the data is not readily available. The geographic distribution of 2005 repatriation is instructive The Redmiles IRS report also breaks down geographically the primary sources of the funds repatriated under the HIA program. accounting for roughly three-quarters of the total flows. However. While shifting dynamics in the global economy and.7 7. with correspondingly larger corporate earnings. Other key sources were Switzerland at 9. percent of total 26. Canada at 7.93 times greater than the USD362 of actual repatriation in 2005 cited in the Redmiles IRS report. The same survey in 2010 showed the total daily volume of spot and outright forwards was USD1. 2005 HIA Repatriation by country. we should consider them in the context of the change in total FX volumes between 2004 and the present. 2008 2005 HIA Repatriation by Country. the wider range of estimates (USD500bn to USD1trn) leave some level of uncertainty in this process.

forecasts for total USD purchases relative to the size of the FX market were fairly small. and extrapolating that out into current estimates. Viewed in that manner. but they are in the minority. the USD performed well during 2005. Moreover. and the estimated impact on the USD was also thought to be limited. On the surface. which would be undesirable. Not only are those sums a fraction of the ~USD 2trn in daily volumes in the FX market (spot and forward outright transactions). Hence. disclosure. But as it happened. those figures appear to be fairly small compared with total volumes in the FX market. holding USD would create income statement volatility at the local level. There were several factors supporting the USD in 2005. their books are not in USD). There are some corporations which have global USD functional subsidiaries. where the yields locally will likely be higher than those of USD paper. including:  USD 285bn in EUR-USD  USD 70bn in USD-CHF  USD 50bn in USD-CAD  USD 43bn in GBP-USD 18 . The 2005 USD rally had several sources Recall during the 2005 HIA experience. generates some reasonably sized USD purchases/foreign currency sales. corrective forces within Estimating potential future repatriation Using the 2004-05 HIA example. 2008 50 0 Sw itzerland Bermuda Ireland Canada Luxembourg UK that most foreign subsidiaries of US corporations are local currency functional (that is. generating a strong counter-trend in the midst of its broader 2002-2008 decline. accompanied by a more aggressive Fed tightening trajectory. and estimates for the newly proposed tax holiday USD bn 200 150 100 2005 HIA Potential Repatriation From New Tax Holiday USD bn 200 150 100 50 0 Netherlands Source: Redmiles (IRS). etc.Macro Currency Strategy July 2011 abc 5. with the USD having fallen sharply and fairly consistently in the 2002-2004 period.). some may want to make a modest downward adjustment to these figures to account for some portion being held in USD – notwithstanding that we think the bulk of the funds are held in foreign currencies. In addition. it suggests that a majority of these holdings are in local currency and not in USD. 2005 HIA Repatriation by country. risk reporting. further diluting their impact on exchange rates. Hedging these USD balances via FX derivative contracts introduces hedging costs. US multinationals are more likely to hold the local currency. along with the additional administrative demands of managing a hedging program (rolling hedges. a key development being stronger-than-expected US growth. but the potential repatriation flows would be spread out over a period of time.

Another similarity is that the expected USD repatriation from a new tax holiday on foreign earnings would be small relative to total FX market volumes. Cyclical forces were big factors in the USD’s 2005 rally % 6. The differences now are most glaring in terms of US and global growth. The Dollar Index is currently trading near three-year lows. In essence. but the USD still performed well. but seemingly more differences.0 5. 2005 vs. And because of factors such as the severe debt overhang and clogged credit channels. Clearly. And within that broader dynamic. is a further complicating condition. That was the case in 2005.0 1. additional HIA-related inflows also contributed to the USD’s gains. Repatriated funds as economic stimulus But importantly as well. with potentially even greater benefits as the repatriated funds would go directly to corporations and theoretically trickle down to the rest of the economy.. pre-crisis. rather than remain concentrated as excess liquidity in the banking and financial system.e. One important similarity is that the USD is trading at relatively weak levels. albeit near the bottom of the three-year range. that is the primary rationale supporting the proposal. but more differences There are some similarities. there is also the concept that capital inflows stemming from the proposed tax holiday could act as stimulus for the broader economy. as was the case from 2002 to 2004.0 Jan-04 Fed Funds Target Rate (LHS) USD Index.0 2. some analysts are even likening it to another round of Fed quantitative easing. and as well as in the role that risk appetite has on the FX market.0 3. DXY (RHS) DXY Index 96 94 92 90 88 86 84 82 80 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 Source: HSBC. the ongoing shifts in risk appetite have and can continue to overwhelm traditional fundamentals as drivers for currencies. which remains a key feature in financial markets. Bloomberg the broader downtrend also worked to the currency’s advantage. the prospect of a US-growth-led boost to the USD seems very low at this stage. The importance of risk appetite and the “risk on-risk off” (RORO) dynamic.0 4. economic growth rates in the US and other developed economies are well below those which prevailed six years ago. rather than having essentially moved straight down for the past three years. today: some similarities. Indeed. this would theoretically be 19 . Those are issues for economists to debate.0 0. Along those same lines.Macro Currency Strategy July 2011 abc 6. But if it were to actually develop in that manner and support US growth. in the FX market and the global economy today relative to six years ago. i.

But the limited size of the flows in relation to the FX market. Balancing those factors against one another. Congressional passage appears unlikely for now Of course.Macro Currency Strategy July 2011 abc 7. Congress under pressure to improve the economy % 100 90 80 70 60 50 40 30 20 10 0 Oct-09 Jul-09 Jan-10 Jan-09 Apr-09 Apr-10 % 100 90 80 70 60 50 40 30 20 10 0 Apr-11 Jul-11 Congressional Job Disapproval Congressional Job Approval Oct-10 Jul-10 Source: HSBC. are factors that suggest to us that a repatriation-related boost to the USD will be difficult indeed. the USD. better US economic growth is positive for risk appetite in a manner that tends to work against. and that issue is precluding debate and consideration of most other items. as markets may anticipate the flows and/or as they actually occur. key to all of this is getting the current bill moved into law. In addition. we are sceptical that a new tax holiday on foreign earnings would provide sustained support for the USD. with the JCT estimating the cost of the current legislation at USD78bn over 10 years. if the effects were similar to those of Fed QE. Finally. Moreover. Democrats in Congress tend to oppose the bill because they feel it will primarily support large corporations and their shareholders. and that appears to face some serious headwinds. and the exceedingly poor fiscal backdrop in the US. both Democrats and Republicans will have a seriously difficult time supporting the legislation during a period when fiscal considerations and constraints are so severe. But there are several good reasons to be sceptical of such rationale. Similarly. in a RORO world. the notion that a new tax holiday will support growth now is far from assured. Gallup USD supportive. First. It is also the case that the immediate and overwhelming focus in Washington is on the debtceiling negotiations. the weak cyclical position of the US and associated accommodative Fed policy stance. rather than for. because the original HIA program was generally not deemed as having generated broad economic benefit (it primarily was seen as helping individual corporations and their shareholders). any discussion of changes in the broader tax regime taking place in the context of the debtceiling negotiations are focused more on 20 Jan-11 . In general terms. They cite the lack of trickle down effects from the 2004-2005 HIA program as evidence of such. with few obvious benefits for the middle class and/or broader economy. the added liquidity and boost to risk appetite have proven to be USD-bearish in recent years. That does not preclude the potential for some temporary gains in the currency.

and appears unlikely to progress into law. which would entail both individual and corporate tax policies. There are a few factors that maintain some scope for this bill to move forward. The Brady bill. that was also the case during the 2004-2005 HIA episode. and its prospects for passing at a later date also appear limited. current conditions in the US and global economy. The FX market has understandably taken interest in these proceedings. and in so doing they will continue to garner the attention of the FX market. Moreover. They will attempt to garner more support for the legislation in the coming months and make a stronger push for it in the autumn. making it more difficult for the USD to benefit from repatriation flows in the same way it did in 2005. and pressure on Congress to address ongoing economic weakness. and the USD appreciated notably during the period. is not consistent with those efforts (it essentially creates another tax loophole). given the potential for the USD to benefit from repatriation flows. are different now.Macro Currency Strategy July 2011 abc comprehensive tax reform. efforts to promote the tax holiday will continue on Capitol Hill. it seems very unlikely that this bill will become law in the immediate future. But. as well as the notion that “all things are on the table” in the current debtceiling negotiations. However. as well as the drivers in the FX market. including the dire state of the economy/labor market and the ensuing need for politicians to be seen as addressing it. with many items being considered in the current debtceiling negotiations. While the overall amount of expected repatriation stemming from the proposal is small relative to total flows in the FX market. a one-time tax holiday. which also creates impediments to its passage. 21 . the current legislation faces fairly stiff resistance in Congress at this stage. and the increasing importance of fiscal consolidation to both parties. Bill sponsors understand these hurdles and currently remain focused on the more immediate debt ceiling issue. Conclusion – Not a slam dunk for the USD Efforts to implement a tax holiday for US corporations to repatriate foreign earnings have picked up some momentum recently as Congress feels pressured to respond to ongoing weakness in the economy. based on current priorities in Washington. Still.

2 % 7. and in our view the NOK looks very undervalued versus the CHF. Closing the door on the JPY meant that the much less liquid CHF would have to bear most of the defensive flows. In an environment of nominal returns the NOK just about pips the CHF. CHF inflation is 0. but not everyone sees it Why CHF and not the NOK? The market’s love affair with the CHF continues.90 7.90 7.75 7. Now we find ourselves asking why this squeeze into CHF has not spilt over to what we would see as an even better defensive play. when the G7 intervened in the JPY.00 7.80 7.65 Jan-11 Source: HSBC.70 7. with EUR-NOK trading in a tight 3% range (chart 1). Bloomberg EUR-NOK EUR-NOK 8.25%. it made sense that the ultra-defensive CHF would do well. we assumed that by limiting the upside on the other defensive currency. the JPY. The Norges Bank started raising rates at the tail end of 2009 and they currently stand at 2. whereas CHF rates are stuck at a mere 0. As the Arab spring and the Eurozone crisis intensified. Even in real terms the NOK comes out on top. It seems strange to us that since the beginning of the year the NOK has been trading as a proxy for the EUR. We would advise switching out of CHF into NOK.Macro Currency Strategy July 2011 abc NOK has beauty.65 Feb-11 Mar-11 Apr-11 May-11 Jun-11 22 .15%.70 7.85 3.00 7. In fact. the NOK and the Eurozone have little in common.80 7.85 7. namely the NOK. whereas 1.75 7.95 7. However.95 7.25%. Since the beginning of the year EUR-NOK has traded in a tight range EUR-NOK 8. further upward pressure would be exerted on the CHF. We look at a host of defensive indicators and try to ascertain why the market has not pushed some of the excess liquidity into the NOK. Inflation and rates a score draw On the rates and inflation front there is barely a cigarette paper between the two economies.4% giving a negative real return of 0.

they are both down around 5% this year. has a market cap of a mere ~EUR 163bn (NOK1. this puts the CHF in an excellent position.0 Jan-90 Source: HSBC. the NOK pips the CHF.0 0.0 Jan-08 Norway Switzerland % 6. CHF and NOK policy rates since 2008 % 6.0 -5. some four times larger.0 5.0 4. Bloomberg NOK has a real positive return of 0.0 2. the OBX. In terms of performance. So. if one were to hold the currency in a real deposit account.Macro Currency Strategy July 2011 abc 2.0 10.0 5. if one wants to move into local equities then the CHF offers more liquidity.0 0. Having said that.0 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Source: HSBC.0 4. Compared to many of their G10 counterparts.0 5. Budgets and Current Account – NOK wins On the budget and current account front there is little contest.0 10.0 0. Norway’s excellent budgetary position outshines the strong Swiss position % GDP 25.0 0. when comparing this with the Norwegian 3.0 2. However. The Swiss budgetary position has improved.0 1. which in a global context is quite the result. Bloomberg Swiss bugetary position Norway budgetary position % GDP 25.0 15. and they are expecting a surplus in 2011.0 -5. this does raise the question: if you are going into the CHF for defensive reasons why buy an asset class that counteracts those defensive qualities? Thus the relative size of the equity markets does not explain the rally in the CHF relative to the NOK.0 3. The Norwegian equity market.0 20.0 1.0 5. Of course.0 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 23 .0 15.27trn) versus the SMI Swiss equity market of ~EUR 675bn (CHF800bn).0 20.65%.0 3.

if we take into account net debt to GDP. CHF is marvellous but NOK is spectacular So there is no doubt that the budgetary position. those looking for protection from any break-up scenario. Looking at gross debt to GDP ratios. Both countries have gross debt to GDP ratios of around 50%. While Switzerland maintains its strong position. debt to GDP. both Switzerland and Norway have fantastic surpluses (chart 6). despite it being one of the most over-valued currencies in the world on an OECD PPP basis. From a budgetary situation Norway and the Eurozone are like chalk and cheese. pension. has an excellent budget surplus. Lastly. and other accounts receivable. 5. The reason that Norway’s net debt to GDP ratio is so much better than its gross level is largely due to the Norwegian Government Pension Fund (discussed later). This is absolutely incredible and shows why the NOK should not be trading in a tight range against the EUR. IMF Source: HSBC. Switzerland and Norway as equals. These financial assets are: monetary gold and SDRs. debt securities. It is even harder to explain why the NOK has been so closely tied in with the EUR (see chart 1). These statistics underlie the defensive stability of the CHF. this is very positive and is half the level of many countries and a quarter of the size of Japan’s (chart 4). are obviously looking for value preservation and are therefore still happy to buy the CHF despite the somewhat tenuous FX valuation metrics. However. Switzerland and Norway appear equals. from this perspective. and current accounts of Switzerland put it in a fantastic position relative to many countries in the world. or any other possible disaster scenario that may befall the EUR. … but Norway’s net debt to GDP ratio is a clear winner % 250 200 150 100 50 0 Japan Gross debt to GDP % 250 200 150 100 50 0 -100 -200 200 100 0 % Net debt to GDP % 200 100 0 -100 -200 Switzerland Japan United Kingdom Source: HSBC. which the IMF calculates as gross debt minus financial assets corresponding to debt instruments1. So. it is hard to explain why the NOK has lagged the CHF. 1 24 Switzerland Euro area United Kingdom Euro area Norway Norway . and standardized guarantee schemes. However. currency and deposits.. helped by oil. In particular. which the IMF defines as ‘all liabilities that require payment or payments of interest and/or principal by the debtor to the creditor at a date or dates in the future’. For this reason some are still happy to buy the CHF..Macro Currency Strategy July 2011 abc 4. when we look at current accounts. Norway is the clear outperformer. it is not difficult to understand why the CHF has been one of the best performing currencies this year. IMF budgetary position. loans. insurance. an embarrassment of riches becomes apparent – Norway. Norway is in a league of its own as its net debt to GDP is a surplus of over 150% (chart 5).

it would seem the memories of that particular issue remain in the Eurozone but not in Switzerland. if one is buying CHF 25 . the spot NOK market according to the BIS is ~USD12bn a day. Ireland. with the market looking for a defensive home it caused the CHF to rise and this has indeed been the case. Spain and Italy combined is USD56bn. According to the BIS data Swiss banks’ exposure to Greece. Portugal. That is. Liquidity argument cuts both ways but it should have also seen the even less liquid NOK rise at even faster pace. and to Greece. we would far prefer to hold the NOK than the CHF. Bloomberg Switzerland C/A Norway C/A % of GDP 20 16 12 8 4 0 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 On an OECD PPP basis the NOK is not that far behind the CHF as both are equally over-valued currencies ~+40%. these metrics also beg the question of why the AUD is as equally overvalued. we would turn the argument on its head. This then continues to raise the question as to why the market shunned the defensive properties of the NOK in favour of the CHF. Swiss exposure to Eurozone One often cited reason why the NOK has not performed as well as the CHF is that the CHF offers greater liquidity. Hence it would take a lot less money flowing into the NOK to push the currency higher. However.Macro Currency Strategy July 2011 abc 6. Meanwhile. Thus. about the same size as French banking exposure to Greece alone. On this basis we would rather own either NOK or CHF rather than the AUD. However. Of the USD56bn about 50% of claims are against banks and the private sector and roughly 20% of claims against sovereigns are secured with guarantees and collateral. for example. However. This argument seemed to work well. in a world of excess liquidity that is looking for a defensive home. CHF Banks versus Petroleum fund’s holding of EUR assets The size of the two biggest Swiss banks relative to GDP is some 300%. the defensive money would have to squeeze into the USD92bn a day CHF spot market. We used this argument to justify why post the JPY intervention the CHF would be squeezed higher. This has not been the case as the NOK has underperformed the CHF over recent months (chart 7). the less the liquidity the greater the move. The Swiss problems with their banking system during the crisis led some to believe that the CHF was losing its safe-haven status. with the metrics shown above. We would argue that. Nevertheless. For a while this seemed true. when the G7 shut the door on the USD300bn a day spot yen market. are a mere USD3bn. Swiss and Norwegian current accounts both show large surpluses % of GDP 20 16 12 8 4 0 Mar-00 Source: HSBC. However.

50 6.70 6. Therefore.10 5. According to the SNB stability report. the ratio of the two biggest banks’ assets to GDP is highest in Switzerland”. they say: “The potential losses under this scenario would be substantial. the Swiss authorities continue to worry about contagion effects.10 5. In fact.90 5.50 6. however. which owns a lot of Eurozone assets? It makes sense to look at the GPF given Norwegian banks are comparatively small compared to Swiss banks. the GPF has approximately USD600bn (NOK3. which is nearly 50% larger than Norway’s economy.70 Feb-11 Mar-11 Apr-11 May-11 Jun-11 for protection against a disaster scenario of a banking crisis or a Eurozone break up. from a pure currency perspective. As background. So. 26 . where the two big banks would also be affected by credit and market losses caused by an overall deterioration of the economic and financial market situation. it seems to make sense to buy and own NOK.70 Jan-11 Source: HSBC. Here one would have a currency that would be immune from both a banking crisis and a euro break-up scenario. This raises the question of why buy the CHF if one is worried about a major problem in the Eurozone and the associated problems this would cause in the banking system. which is more than six times the annual gross domestic product (GDP) of Switzerland. Norway owns a lot of Eurozone assets as well Although there are some concerns about the links of Swiss banks’ exposure to the Eurozone. what about Norway’s Government Pension Fund (GPF). Bloomberg 6.582 billion.90 5. amplified by potential contagion effects from the sovereign debt crisis in the peripheral euro area.30 6. they believe credit and market risk. Furthermore they say “the two big banks” – UBS and Credit Suisse – account for twothirds of total assets. the impact of direct exposures to the peripheral euro area must be considered in a broader sense. at the end of 2010 the total assets of the Swiss banking sector amounted to CHF 3.1trn) assets under management. Although the direct exposure to the periphery is small.70 6.Macro Currency Strategy July 2011 abc 7 The NOK has underperformed the CHF over the past couple of months as Greece becomes a worry again CHF-NOK 6. On this front the CHF does not offer protection at all. one has to ask how the CHF banks could remain immune to systemic contagion. Compared with the other G10 countries. would constitute the most important source of risk for these banks under the adverse scenario. which is roughly four times Swiss GDP.30 6.” It should be noted. that a resurgence of problems in the euro area periphery is exactly one of the potential triggers for the adverse scenario. In fact.

From a currency perspective.3 2. the exposure to Europe via its assets holdings is substantial. The GPF also holds a substantial portion of Eurozone banks bonds and equities. But on all these metrics the NOK is in an even sounder position and should be considered in a league of its own. around 80% of the GPF’s assets are denominated in EUR. Ireland and Portugal government bonds are a little over USD6bn or a mere 1% of its portfolio. Moreover. .6 7. The SNB alluded to the problems for Swiss banks from the Eurozone under a very adverse scenario.Macro Currency Strategy July 2011 abc 8. When we look at a range of measures. Greece. the holdings of Spain. That said. EUR.0 4. But we believe the market is overlooking some key risks for the CHF if significant stress emerges from the Eurozone. Those worried about a European break-up and systemic banking problems that rushed into the CHF should. whose banks are a multiple of GDP.9 1.4 1. for all intents and purposes. albeit smaller. the direct holdings of sovereign government bonds in the peripheral part of Europe are small. We too have advocated the CHF.1 Just like Switzerland.5 0.6 0. we find the CHF is a fantastic currency versus the USD.2 3.3 3.6 3. The same cannot be said for Switzerland.4 3.0 0.6 2. GBP. The difference is that one is a fund where it can absorb losses without a material impact on the economy and the banking system. which would feel the strain from contagion.8 1. 27 . GBP and JPY. The fund’s asset mix is about 60% equities and between 35 and 40% in fixed income. Nearly 30% of the equity holdings are held in Europe whilst nearly 60% of the fixed income investments are European paper.2 3. Conclusion – Switch out of CHF and into NOK The market has fled into the CHF as the key defensive currency of choice. Those that have sought solace in the CHF should take a closer look at the NOK. especially following the coordinated intervention against the JPY in March. So. the GPF is a multiple of GDP.2 4. Switzerland has an outstandingly large banking sector Size of the banking sector (ratio of total assets to annual GDP) Belgium* Canada France* Germany* Italy* Japan Netherlands* Sweden* Switzerland United Kingdom* United States * Banking sector figures as at end of June 2010 Source: SNB Size of the largest banks (ratio of total assets to annual GDP) 2.2 2.0 1.3 2. The reason being that Switzerland’s indirect exposure to the Eurozone is very high. the NOK has traded in a narrow range versus the EUR and should be making substantive headway.1 1.5 6. JPY and USD. For instance. Do we have the same potential problem as Switzerland where the direct exposure is small but the indirect exposure is large? We would argue no. have their holdings in NOK.

as ones that are likely to drive the CAD measurably higher. More dovish BoC In the weeks that followed.2% in June. the Bank of Canada altered the language in its policy statement. given still-healthy growth in emerging market economies and the associated support that provides to commodity prices. BoC Gov.8% in March up to 9. and continues to be. as well as Canada’s superior fiscal condition and modestly better growth trajectory. Challenging backdrop deteriorated in a manner that clearly got the attention of Canada’s policy makers. Carney’s subsequent comments in late-June were notably more dovish. the CAD would have trouble benefitting from such an event. as markets became increasingly aware of the downside risks to growth. In addition. Most obvious in that regard was. partly because some amount of tightening was already priced into the curve. On balance. but more because the currency was already trading at relatively high levels. On May 31. in comments on June 24. relative to most other G10 countries. But more importantly. and the unemployment rate rising from 8. observed that Canada’s economy faced “substantial headwinds” and that “monetary policy may still need to be stimulative in order to close the output gap and in order to get inflation back on target. signaling that “some of the considerable policy stimulus currently in place will eventually be withdrawn. The most dramatic events stemmed from the Eurozone sovereign debt crisis. and that was part of the broader 68bp decline from the April peak 2. and the ripple effects that could have on the global economy. we observed at the time that despite the seeming increase in the scope for a summer rate hike by the BOC.” Even so. Carney. The implied yield on the March 2012 BA future fell 25 bp between May 21 and June 24. front-end Canadian yields had already been falling in the run-up to Carney’s June 24 remarks. with job growth remaining anemic.Macro Currency Strategy July 2011 abc Dollar Bloc CAD easily absorbs shifting BoC policy expectations While there have been further developments and changes in Canada’s economy and the central bank policy outlook. or more recent cyclical developments. the “soft patch” which had developed in the US economy since the spring persisted and threatened to evolve into an outright slowdown. USD-CAD continues to hold in the approximate 5-cent range in which it has trade since the beginning of this year. better readings on indicators such as employment and the PMI were countered by disappointing outcomes in international trade and labor productivity. That helped US-Canada yield spreads narrow roughly 50 bp since April.” So while the signal in the May 31 policy statement was presumably designed to prepare the market for the eventual normalization in policy.23% to the low in late June of 1. the international backdrop Against that backdrop. But we are also hesitant to view those factors. the Canadian data flow was reasonably good. As it happened. USDCAD has correlated reasonably well with 28 .55%. reducing some of the “carry” appeal of the CAD. We continue to see the overall backdrop for the CAD as supportive. the deterioration in the labor market.

94 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 developments in the yield spread over the past year. That said. But in that regard. it could present more immediate risks to Canadian growth. accumulating USD in the process. maintaining a source of support for the CAD. if the current “soft patch” in US growth were to persist or intensify. given the Canadian economy’s sensitivity to that in the US. we would make several observations. Of course.06 1. And that supports the cycle of reserve manager USD diversification. BA futures) (LHS) -0. we would note that the US economic “soft patch” from last summer through the autumn was generally accompanied by an appreciating CAD versus the USD. and that has developed again more recently.9 -1. Although growth in some developed economies has stumbled. First. suggesting that EM-led demand for commodities will persist. many remain at elevated levels. growth in emerging market economies continues to hold up well.02 0. factors that are also favoring the CAD.5 Aug-10 Source: HSBC.3 -1. reserve managers continue to intervene to limit appreciation in their own 29 . Shift in US-Canada yield spreads reduces the CAD’s interest rate cushion US-Canada Yield Spread (March 2012 Eurodollar. this is one factor we think will keep the Bank of Canada sidelined at the July policy announcement. But the CAD’s resilience in the face of US economic weakness in the recent past was notable. Several sources of support currencies. Second.7 -0. if recent history was any guide. keeping some “carry” in place for the CAD. particularly if markets begin to see more pronounced weakness in the Canadian economic data. Bloomberg 0. Beyond the yield-related considerations.1 USD-CAD (RHS) 1.98 -1. And it may also present more direct risks to the CAD. which continues to weigh on the greenback more broadly. even with the spread narrowing. the fact that the Bank of Canada was tightening policy during part of that period did not hurt either. and support currencies such as the CAD. although the larger magnitude of the rise in the spread in the past few months might have been expected to see the exchange rate rise more than it did.5 -0. While commodity prices have pulled back from their recent highs. Indeed. there were several periods over the past year where the volatility in the spread exceeded that in the exchange rate.Macro Currency Strategy July 2011 abc 1. Developments in US growth specifically continue to be important for the CAD. there are other. mostly familiar. Also on the EM theme. Hence. Canadian yields are still roughly a full percentage point higher at that term (3-month rates in March 2012).

could be equally important. That does not preclude the CAD from remaining strong if the favorable conditions cited above persist (or falling if they don’t).Macro Currency Strategy July 2011 abc Conclusion In the more immediate term. but we remain skeptical that the currency can register further gains from here. But amid all of that.9500. monthly GDP and employment in the days and weeks afterwards. our outlook for the CAD remains pretty consistent. such as the type that influence risk appetite. there is already a lot of good news priced into the loonie. we see limited additional upside for the CAD versus the USD. followed by readings on inflation. if not more so. 30 . retail sales. Essentially. primarily because with USD-CAD approaching 0. scheduled key events for the CAD are the aforementioned BoC policy statement on July. And unscheduled events.

Consumer sentiment takes a tumble 2. We continue to expect the next RBA move to be up.Macro Currency Strategy July 2011 abc AUD – still at elevated levels The AUD has remained resilient despite a number of threats that could have harmed the currency. the strength of the AUD also looks overdone as the RBA are likely to keep rates on hold for longer than previously thought. may just be the first of a series of ‘risk off’ events that could cause the currency to retrace. On the domestic front. the AUD looks vulnerable. consumer confidence is now at its lowest level since June 2009 (chart 1). but are pushing back the timing of our call from August to Q4.8% rise – the RBA will probably need more time to let the smoke clear before they respond. Australia activity surprise index trending down Index 130 120 110 100 90 80 Consumer sentiment Index 130 120 110 100 90 80 70 85 80 75 70 65 Jan-10 Apr-10 85 80 75 70 65 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 70 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Source: HSBC. However. as have retail sales. Bloomberg 31 .50% by Q4 2012. We think the chance of an RBA cut is very small. The bottom line is that even with an elevated CPI print on 27th July – we still expect a 0. The fragile global financial situation and weak local confidence will keep them sitting on their hands. with a more elongated tightening cycle of another 50bp to follow through 2012. Paul Bloxham. and the report has not only continued the trend of weaker US activity data in recent months. With the Australian activity surprise index also trending down (chart 2) an August tightening seems far less likely. the shocking US non-farm payrolls print that has already weighed on the AUD. We expect the cash rate to reach 5. Indeed. As the AUD remains exposed to global events as a result of the ongoing ‘risk on – risk off’ phenomenon. Nonetheless. We think this is overdone and partly reflects global investors using the Australian bond market to buy insurance against the possibility of a large negative global financial event triggered by European developments. but suggests an intensification of the economic "soft patch" in a manner that could well lead to additional calls on the Fed to take more action. Our Australian economist. While Australian employment has continued to rise modestly. Tightening cycle to be more elongated maligned carbon tax and also unrest in Greece. believes this weakness is temporary – partly due to the much 1. the Australian consumer and business confidence indices have fallen. the RBA are likely to continue with their ‘wait and see’ approach. Markets have responded to recent developments by pricing in easing by the RBA. Bloomberg Source: HSBC. which was prominent in the media in Australia. To call the US labour market statistics disappointing is an understatement. including the recent downgrade of some Australian banks and fears of a China slowdown.

Prospects for growth in H2 are strong on the back of high meat and dairy prices. The US non-farm payrolls release may prove to be a tipping point as ‘risk off’ makes a strong comeback. be strong.0 1.Macro Currency Strategy July 2011 abc AUD – game changer The set-back in RBA rate-hike expectations. with 85.4 0. We have long thought the quake’s impact would be geographically contained and that H2 2011 would Time will tell if March’s rate cut in response to the quake was a policy error – we think it may have been. The more upbeat tone from the Governor and rising inflation expectations suggests a policy reversal is to come sooner rather than later. The AUD fell aggressively in the aftermath of the report and. We continue to expect the next hike to come in Q4 this year.0 4.0 5. the postmeeting statement was more hawkish than the market expected. but see upside risks to inflation that 3. The more hawkish tone sent NZD-USD as high as 0.0 0. coupled with the recent weakness in global indicators.0 Mar-01 New Zealand CPI % 6. Time to tighten New Zealand – Recovery in full swing The New Zealand economy is finally recovering.7% in 2011 and 4. this report will start to raise questions about whether global weakness could persist. Inflation continues on upward path 4.8 0.9 0. inflation expectations have already risen to the top of the RBNZ’s comfort zone. which are boosting incomes and rural investment.0 1. Over a longer time frame. but the risk is for an earlier move.4 0. While the RBNZ kept the cash rate on hold at 2. The AUD remains above 1.0 2.0 5.0 3. while the RBA had hoped that the downturn in global growth was temporary.8 0.3 RBNZ target band 2. with the Governor shifting his tone from rates on hold for ‘some time’ to rates are on hold ‘for now’.9 0. The economy has been weak since early 2008. We continue to expect inflation to hold above the RBNZ’s target band well into 2012 (chart 3).7 0.5 0. We still expect GDP growth of 1. should also take its toll on the AUD.5 0. and the rebuilding and repair of the quake-damaged Canterbury region.0 3. so our GDP forecasts were already quite high – the highest in the consensus survey – so we have left them unchanged this quarter.3 Jan-01 NZD-USD 0.50% in their latest meeting.0 Mar-03 Mar-05 Mar-07 Mar-09 Mar-11 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Source: Bloomberg.0 4.05 for now.0 0.6 0.7 0.83 (chart 4). somewhat worryingly. so it’s well overdue for a pick-up. the Rugby World Cup. we still expect 175bp by end 2012.000 visitors expected in September and October. Inflation pressures are expected to build and. but at such elevated levels we feel that the currency should retrace in the coming months.3% in 2012. after a long period of economic malaise and some false starts.0 0. HSBC Source: Bloomberg. with 8% of GDP to be spent over coming years. HSBC 32 . NZD-USD hitting highs % 6.6 0.

33 . The recent talk of the potential for more QE by the Fed has also pushed the currency higher. However. The summer months also bring a number of events that could see further ‘risk off’ developments. the fact that the US economy is performing so poorly is likely to weigh on risk and harm the NZD. but with troubles in the Eurozone periphery still lingering and contagion fears spreading to the likes of Italy. focus will be on the US debt-ceiling issue. In particular.Macro Currency Strategy July 2011 abc could see more aggressive rate hikes needed next year. and while QE3 in the US may be a temporary support. ‘Risk off’ to weigh on the Kiwi The NZD has performed well over the last few months. in the medium term we continue to expect the currency to retrace. Therefore. as the dominant driver of the currency continues to be the fluctuations between ‘risk on’ and ‘risk off’. the markets appetite for risk is likely to be curtailed and this will weigh on the NZD in the months to come. with the currency reaching fresh all-time highs on the back of rising rate expectations and positive domestic developments.

Source: Thomson Financial Datastream EUR-SEK 12.80 8.00% on 5 July. it seems the market is overlooking key risks for the CHF if the Eurozone crisis deteriorates. However.  The Riksbank last raised its policy rate to 2.70 1.  Further rate increases should support the SEK but the positive story for the currency is broader than just expected rate increases.40 10.30 1.  The SNB kept rates on hold at 0.40 1.40 Sweden: Sensitive to risk off but fundamentally sound  The SEK has stabilised versus the EUR in recent weeks.00 9.70 1.50 7. in particular whether sovereign risk within the Eurozone intensifies.00 9. the SEK also stands to benefit from being a country with relatively sound fiscal and current account balances.25% in June and made several dovish remarks regarding the Swiss economic outlook.40 Jan-03 Jan-04 Jan-06 Jan-07 Jan-09 Jan-10 Jan-11 Jan-05 Jan-08 Jan-02 12.00 7.60 11.20 8. due to Switzerland’s giant sized banking sector.10 Jan-06 Jan-02 Jan-04 Jan-05 Jan-07 Jan-08 Jan-10 Jan-11 Jan-09 Jan-03 1. Recent economic indicators still point to robust growth in the Swedish economy.50 8.00 8.00 11. Like the NOK.80 10. We expect the key rate to be increased by another 50bps this year.Macro Currency Strategy July 2011 abc Europe at a glance EUR-CHF 1.70 EUR-CHF (LHS) Source: Thomson Financial Datastream USD-CHF (RHS) Switzerland: The market’s love affair with CHF continues  The ongoing Eurozone crisis keeps sending CHF to new record highs against the EUR as the market rushes to the perceived safety of the ultra-defensive currency.00 Jan-03 Jan-04 Jan-06 Jan-07 Jan-09 Jan-10 Jan-11 Jan-05 Jan-08 Jan-02 10.30 1.20 10.50 7. especially if global risk appetite improves. and consider CHF as a fantastic currency versus the G4 currencies. and we do not expect a rate hike until Q1 2012.00 11. Source: Thomson Financial Datastream 34 .50 10.10 0. EUR-NOK Norway: NOK has beauty.80 10. but not everyone sees it 10.00 9.20 1.00 7.50 1.50 8.00 8. implying the need for additional rate hikes by the Riksbank.60 11. but we maintain there is room for the currency to strengthen.90 0. It makes little sense to buy CHF if fleeing from fears of systemic problems or a break up scenario. While we believe the CHF will stay strong for now.50 9.50 1.50 10. this is contingent on labour-market conditions remaining strong and on external conditions. but the policy rate remains low by historical standards.80 8.60 1. Key events released in the coming weeks include Q2 GDP on 29 July and CPI on 11 August.60 9.20 8.60 9.40 10.50 9. our preferred call in a risk-off environment is the NOK. However.00  See pages 22 – 28. Inflationary pressures remain benign.00 9. We expect the CHF to continue to appreciate in the current environment. The CHF ascent is perceived as a key threat to exports and growth.20 10.

long KRW-TWD. and with a reacceleration in the Asian data unlikely to manifest itself until the next cycle of monthly data. SGD's relative low volatility. A glance at simple risk-adjusted spot returns reveals that.5 1. On the funding side. Thus TWD should continue to underperform so long as growth and global conditions in general remain in question. Bloomberg Source: HSBC.0 KRWTWD SGDTWD INRTWD INRIDR KRWIDR SGDTHB KRWTHB SGDIDR INRTHB KRWPHP MYRTWD Sharpe ratio v s USD since 1-May -11 Source: HSBC. However. and China more broadly. Risk-adjusted returns on short USD-Asia have been poor 2. with debt issues in the developed world continuing to fester and overshadow the global environment. and long KRW-THB stand out having generated the best risk-adjusted returns. However. 18 May 2011). growth sensitive equity flows. we believe there will continue to be better opportunities in trading Asian FX via relative value and regional crosses in the coming weeks (see "Asian FX Focus: Bullish Strategies for Choppy Markets".5 2.Macro Currency Strategy July 2011 abc Asia – regional overview Relatively more attractive We continue to believe that Asian currencies offer good value over the medium-term.0 KRW CNH TWD IDR SGD THB PHP INR MYR 0. which concluded last week with a surprisingly stable result. This highlights two particularly well performing currencies – SGD and KRW. several relative value trades within Asia have outperformed any trade that pits Asian currencies against the USD or EUR.5 0.0 1.5 0. long SGD-THB. THB's underperformance has coincided with uncertainty leading up to the parliamentary elections.353 1. for TWD we had earlier identified particular vulnerability to external demand. which we had underestimated. should persist even beyond the next MAS policy meeting in October. as well as two particularly poor performing ones – THB and TWD. Bloomberg 35 . Asia cross trades have offered better risk-adjusted returns 1. In particular.0 0. but also due to greater policy permissiveness for KRW strength. as well as its explicit FX policy of gradual appreciation against a basket comprising many regional peers. though some volatility is likely.the result of more FX policy management against KRW weakness. Thus THB's underperformance may not necessarily last. which we had anticipated. since May. 1. On the positive side. long SGDTWD.0 Sharpe ratio since 1-May -11 Short USDINR Sharpe ratio = 1. KRW's positive performance has been more surprising to us .

10 7.84 7.84 7. We expect the longer-term gradual appreciation pace of around 4% per annum to persist. Moreover.30 Jul-05 Jul-08 Jan-05 Jan-06 Jan-07 Jan-09 Jan-10 Jan-08 Jan-11 Jul-11 Jul-06 Jul-09 Jul-07 Jul-10 8.76 7. a US heavy equipment manufacturer announced its second CNH bond offering and the biggest foreign CNH issuance yet.76 7.4% reinforce a view that China’s tightening stance will persist. the sovereign debt rating is just one notch away from investment grade – and on positive watch – on Fitch and S&P’s ratings. Source: Thomson Financial Datastream 36 . Source: Thomson Financial Datastream USD-HKD 7. we continue to believe CNH to be the best place to hold long RMB positions.40 8. which the authorities continue to have full control over.72 7. but should generally ensure that cross-border RMB continues to grow steadily. We do not believe this “stretched” valuation will preclude IDR from continuing to see real appreciation over the medium term. and adds further to the fundamentally bullish story we have outlined for IDR since the start of the year. with more acute financial market instability associated with sovereign debt concerns in the developed world. against heightened volatility in FX markets elsewhere.60 6. Meanwhile.10 7.  We continue to see the RMB onshore-offshore spread to be a function of appreciation expectations and risk appetite.82 7.82 7.30 China: CNY appreciation pace steady  The CNY’s pace of gradual appreciation has become more stable and independent. We expect the pace of appreciation to slow in the coming months as inflation demonstrates that it has peaked and begins to trend-decline.20 6. Beyond these issues. with the emergence and growth of a high-yield class of offshore RMB bonds.40 8.74 7.80 7. there is an incentive to reinforce perceptions of stability in China’s currency markets.80 7. most recently with the introduction of an official USD-CNH fix by the Hong Kong Treasury Markets Association.86 7.78 7.70 97 99 01 03 05 07 09 11 7.86 7. with continuing solid growth and inflation peaking at 6. For example.72 7.74 7. Source: Thomson Financial Datastream USD-IDR 16000 14000 12000 10000 8000 6000 4000 2000 97 99 01 03 05 07 09 11 16000 14000 12000 10000 8000 6000 4000 2000 Indonesia: IDR still not overvalued  IDR remains attractive to us. The CNH bond market continues to grow. and as the tightening cycle ceases by end 3Q.20 6.60 6.78 7. the stability of a sizable fundamental external surplus reinforces a sanguine view of IDR valuation.50 7.90 6. despite appearing to be the most overvalued currency on a range of our usual valuation metrics.50 7. This should translate into an ongoing gradual appreciation for the currency. The latest round of economic data. This type of structural flow-shift is difficult to model. Achievement of investment grade would structurally increase foreign demand for the already popular Indonesian bond market. hence the re-narrowing of this spread in recent months.70 Hong Kong: : CNH market continues to steadily grow  The offshore RMB (CNH) market continues to grow.80 7. A PBoC circular regarding cross-border RMB transactions clarifies some rules.Macro Currency Strategy July 2011 abc Asia at a glance USD-CNY 8.90 6. However. The structural shift the economy is undergoing is hard to quantify on most valuation measures.80 7.

Over the medium term. and these flows have been largely into short-term instruments. Although FX policy has shifted to curbing volatility. 37 .80 1.90 1.80 1. Exposure.60 1. As such. with inflation still a concern.40 1. there is less pressure on the MAS to tighten for now. MAS is also more inclined to keep the NEER on the strong side of the band. given inflation is showing signs of peaking. S$NEER’s correlation with EUR seems to be declining. This in our view is in part due to SGD’s characteristic as a safe haven currency in Asia.30 1. if one believes that things are about to turn up and the world looks a better place. Source: Thomson Financial Datastream USD-KRW 2000 1800 1600 1400 1200 1000 800 97 99 01 03 05 07 09 11 2000 1800 1600 1400 1200 1000 800 South Korea: KRW – Asia’s most RORO currency  KRW is the most highly correlated Asian currency with the Risk on-Risk off factor. For October’s MPC meeting.20 Singapore: SGD . making SGD an attractive currency to buy against the basket. THB has been able to shrug off domestic political events. In addition. THB's underperformance coincided with uncertainty leading up to the parliamentary elections and global concerns. the likelihood is that MAS will maintain S$NEER’s “modest and gradual” appreciation. In addition. Previously.60 1. and a slowdown in economic data. This means KRW-USD rallies the most when risk is on and suffers the most when risk is off. sovereign concerns in developed markets. this has not reduced KRW’s high correlation with the Risk on–Risk off factor. However. we think it is still too early to call.40 1. For the time being. KRW would appear to be the best buy in Asia against the USD. Over the past few months.70 1.50 1. however. Source: Thomson Financial Datastream USD-THB 55 50 45 40 35 30 25 20 97 99 01 03 05 07 09 11 Source: Thomson Financial Datastream 55 50 45 40 35 30 25 20 Thailand: THB better placed post-elections  In May and June.Macro Currency Strategy July 2011 abc Asia at a glance continued USD-SGD 1. we remain constructive on THB given that the current account surplus is likely to widen out again and the BoT remains one of the region’s most hawkish central banks. In the absence of inflation accelerating again. While the relative stability seemingly achieved from Peau Thai’s election victory will help to boost shorter term sentiment on THB. April’s MPC statement clearly suggests the hurdle for further tightening is much higher than before. we are wary of some volatility in the currency given this exposure to foreign flows. Foreign holdings of Thai bonds are close to record highs.90 1. are making it difficult for risky assets to rally. with further rate hikes expected through the year.70 1. These more speculative flows are likely to be most highly responsive to changes in risk appetite.NEER-ly uncorrelated value Long SGD against a basket of currencies of its major trade partners (S$NEER) to hedge against global risk is increasingly attractive.20 97 99 01 03 05 07 09 11 1.30 1. Foreign capital flows are now having a much large influence on THB.50 1. has changed. The liquid nature of the equity market and relatively accessible bond market mean KRW and Korea’s status as one of the larger Asian economies sees a lot of shorter term portfolio flows. this should reduce the downside risk for S$NEER. However.

despite external noise 108 106 104 102 100 98 96 94 92 90 Jan-10 Apr-10 Source: HSBC. but we believe short-term strength is likely to be hampered by new FX measures and heavy market positioning. we still believe that the longer-term picture remains constructive. but are struggling to post meaningful fresh gains into new ranges due to the uncertain global environment (see chart below. with data for the latest week from EPFR showing net outflows in both fixed income and equity funds from the Latin America region. up from USD109bn last year. while external conditions will still dictate short-term moves in Latam FX. although there are other uncertainties also keeping investors sidelined. the 12-month rolling FDI figure exceeded that of portfolio flows at the beginning of this year (for the first time since the global financial crisis hit in late 2008). Finally. The good news is that FDI as a share of inflows is increasing. Latam currencies holding ground. Bloomberg Jul-10 Oct-10 Jan-11 Apr-11 HSBC Latam FX Index Jul-11 38 . Lower portfolio inflows puts more pressure on the foreign direct investment (FDI) channels of the region’s capital accounts. we remain sidelined in CLP and PEN. Meanwhile. For Brazil specifically. higher yields and robust balances of payments. but only insofar as US economic data can improve. Meanwhile. Brazilian FX flow data from the central bank showed that the country posted its first monthly net outflow of funds of the year in June. Where we see value We like the COP.Macro Currency Strategy July 2011 abc Latin America – regional overview Treading Water Latam currencies remain relatively strong. based on stronger growth. we do not expect capital controls to be used. In other words. showing HSBC’s tradable Latam FX Index). we still see room for MXN strength. Recent fund flow data for Latam has also been less supportive for Latam currencies. We would expect this situation to persist at least until an acceptable resolution can be found to the US debt-ceiling negotiations and the situation in Europe. The BRL still has room to rally over the medium term. where the FDI picture remains very solid. oil production is expanding and while public sector inflows are being held back as far as possible. where we see limited room for strength thanks to ongoing central bank intervention and China’s efforts to cool its economy (where much of Chile and Peru’s commodity exports are destined). 1. and we expect total FDI for the Latam region to exceed USD136bn this year. including stubbornly high US unemployment and concerns of a hard landing in China where inflation rose again in June (though we would note our economists expect China’s inflation to roll over in 2H).

To counter these inflows authorities are using a mix of tools to limit COP strength.52/USD target based on continued strong FDI and equity flows. Source: Thomson Financial Datastream 39 . which has seen nominal O/N rates hiked by 475bps over the last year. On the positive side. suggesting some vulnerability for the BRL based on current market positioning. up from USD9bn in May.0 3.0 3. We remain constructive on the medium-term outlook for the COP.5 3. compared to the three months they were given following the January announcement. Rising oil.5 1. including daily USD purchases. working against the CLP is ongoing central bank intervention (USD50m per day) and concerns about a hard landing in China (the primary recipient of Chile’s main export. we maintain our year-end BRL1.Macro Currency Strategy July 2011 abc Latin America at a glance USD-COP 3000 2800 2600 2400 2200 2000 1800 1600 Jan-03 Jan-05 Jan-06 Jan-07 Jan-08 Jan-10 Jan-11 Jan-04 Jan-09 Jan-02 3000 2800 2600 2400 2200 2000 1800 1600 Colombia: COP supported by strong capital flows  Private sector flows. However. We expect the USD to firm modestly through 2H’11 and to see USD-CLP ending the year at 480. We would look to use any risk aversion moves towards 1800 to sell USD-COP. With growth and interest rate differentials potentially peaking soon.0 1.5 3. copper prices have recently broken higher. Meanwhile. and the strong correlation seen between copper and the peso has helped the currency to firm in early July. hedging external debt and setting up an oil windfall fund.7bn. the hedging program is almost complete). Also helping the CLP has been the interest rate tightening cycle. Officials indicated they would prefer to see these positions reduced down to below USD10bn again. Source: Thomson Financial Datastream USD-CLP 800 750 700 650 600 550 500 450 400 Jan-06 Jan-07 Jan-11 Jan-02 Jan-03 Jan-04 Jan-05 Jan-08 Jan-09 Jan-10 800 750 700 650 600 550 500 450 400 Chile: CLP still at the mercy of copper prices  There are various factors both helping and hindering the CLP at present. some of these tools may be reaching the limits of their effectiveness (for example.0 2. Banks were given just five days to adjust to the new measures. That said.0 1.0 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 4. and the government has said it has no plans to implement capital controls. plus ongoing intervention planned to total USD12bn through the year and continued efforts by China to slow growth and reduce inflation. coal and gold production will keep these investment flows on a positive track.0 2.5 2. composed primarily of long-term capital flows (FDI) into the oil and mining sector.5 1. withholding both Ecopetrol dividends and external financing flows offshore.0  New measures aimed at reducing local banks’ short USD positions were announced on 8th July. Meanwhile offshore investors’ long BRL position on the local futures exchange stand close to USD20bn. These involve 60% nonremunerated reserve requirements on positions over USD1bn. remain buoyant and supportive of a stronger COP. we remain cautious on the CLP. In late June. especially in the wake of the sovereign’s upgrade to investment grade. copper). local banks held total short USD positions of USD14. a tightening of the previous measures that were announced last January.5 2. Source: Thomson Financial Datastream USD-BRL Brazil: BRL in the cross-hairs again 4.

high inflation and deteriorating balance of payments are not PLN-supportive.65 for end of Q3 as the central bank is firmly dovish and expectations of rate hikes are pushed back. Moreover. Similarly. The Eurozone sovereign crisis represents obviously a downside risk. high interest rates and narrowing current account deficit should drive EUR-RON towards 4. The other central banks. we see the recent upgrade by Fitch to investment grade as supportive for capital inflows. The lack of carry momentum combined with signs of slowing economic activity may maintain without clear direction. we do not expect any changes in policy rates during the summer and only minor increases in Czech Republic. Recent signs of a slowdown in the global economy and the risks attached to the sovereign debt issue are obviously the primary factors behind the cautious approach of EMEA central banks. A central bank on hold. Even. and also on food prices. After having increased its interest rates by 100bp in H1. the Polish central bank has signalled its intention to make a pause. Nevertheless. Hungary. Israel and eventually Turkey before year-end. Meanwhile. particularly during the summer period.00 by year-end. which were not in a tightening mode. If anything. Therefore. has offered some comfort to the central banks. The retreat on commodity and energy prices. Consequently. the Russian central bank has said that further tightening is not needed at this stage. We have also revised our forecast on USD-TRY to 1. The central banks’ neutral stance is not without consequences for FX. a tight fiscal policy. have simply reiterated that the current monetary conditions were consistent for now with the macroeconomic trends and risks. Most of the central banks believe that they will be able to achieve their inflation target in the medium term with current policy rates. we continue to see the risk of a wider and sudden depreciation with USD-TRY surging to the 1. the Bank of Israel seems to have loosened its very aggressive stance. a prudent monetary policy and a fiscal consolidation programme will support the forint. Romania. our constructive view on the HUF and the RON are intact. we have adjusted some of our forecasts. We see EUR-HUF trending to 255. In Romania. 40 .70-75 area. We now no longer see upside potential on the PLN for the rest of the year. This is typically the case in Czech Republic. a recovering economy. The emergence of a large current-account surplus. an increasing number of central banks in the EMEA region have adopted a “neutral bias” regarding the monetary policy.Macro Currency Strategy July 2011 abc EMEA: regional overview Turning more cautious EMEA central banks on a “wait & see” stance We turn more cautious In the past two months. those factors are negative. South Africa and even in Turkey. but the FX interventions of the Ministry of finance may limit the downward pressures on the zloty.

60 1.30 1. the lira may even suffer a wider and sharper depreciation given its very wide current account deficit (8% of GDP).90 1. the currency depreciation was more limited when the Eurozone sovereign crisis erupted in 2010.00 4.00 Jan-08 Jan-11 Jan-02 Jan-03 Jan-05 Jan-06 Jan-07 Jan-09 Jan-10 Jan-04 5.90 1.80 1.40 1.80 3. and even less so during the re-emergence of the sovereign Greek issue this year  The emergence of a large current account surplus. and with a central bank having adopted a “wait & see” stance.10 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-08 Jan-09 Jan-10 Jan-11 Jan-07 1. We doubt that these measures will be enough to avoid a fall of the lira if this risk scenario materialises. We would rather envisage a weakening of the currency. While the HUF fell sharply in the wake of the Lehman’s bankruptcy.60 4. Therefore.Macro Currency Strategy July 2011 abc EMEA at a glance EUR-PLN 5.00 Poland : Limited room for appreciation  The macroeconomic parameters are not PLN-supportive. Source: Thomson Financial Datastream 41 . the TRY is likely to remain weak. the foreign direct investment flows are very weak pushing coverage of the current account deficit by FDI to historically low levels.20 1.00 4.70 1.  In such a context.50 1. The economy is giving some signs of slowdown. but the FX intervention policy of the Ministry of Finance limits the risk of depreciation.60 4. With such a monetary policy and the persistent macro imbalances. the sensitivity of the Hungarian forint to an external shock has decreased considerably. Source: Thomson Financial Datastream EUR-HUF 320 310 300 290 280 270 260 250 240 230 220 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-02 320 310 300 290 280 270 260 250 240 230 220 Hungary: From fragile to resilient  Since the 2008 global financial crisis.50 1. We retain our constructive view and still see some upside potential left. The CBRT sees the recent signs of a slowdown of economic activity and the easing of inflationary pressures as reasons to keep its monetary policy unchanged.40 1. the expectations are still for an improvement from Q4 this year. In parallel. a prudent monetary policy and a fiscal consolidation programme are HUF-supportive factor.30 1. If anything. We have been bullish on the HUF since the start of year and this is playing out.20 1. Source: Thomson Financial Datastream USD-TRY 1. In the case of a sudden change in capital flows dynamics. inflation is well above the central bank’s target and the current account deficit is widening. On the credit growth and the current account deficit.10 Turkey: Dovish central bank keeps the lira weak  The Turkish central bank reaffirmed its dovish stance.80 3.40 3. with EUR-HUF trending to 255 on a 1-3-month horizon. it considers that the risks have titled to the downside. The CBRT signalled that it would cancel its daily FX purchases and narrow the interest rate corridor in such a scenario. The deficit is mainly financed via portfolio flows with non-resident holdings of Polish bonds at alltime highs.60 1.40 3. the upside potential of the zloty appears very limited.70 1.20 3. we stay neutral on the PLN in the near-term with risks for a weaker currency.80 1.20 3.

NEERs simply track the weighted average returns of a basket of other currencies against the currency being investigated. An effective exchange rate is an attempt to do this and to represent the moves in index form. or a combination of both.com The value of a currency Since FX prices are always given as the amount of one currency that can be bought with another. One possible solution would be to simply have an equally-weighted basket. inflation can have a large impact on the purchasing power of a currency. the indices are generally weighted so that more “important” currencies get higher weighting. REERs deflate the returns in an attempt to compensate for the differing rates of inflation in different countries. How should we weight the basket? If we are trying to create an index for the change in value of a currency against a basket of other currencies.mcdonald@hsbcib. particularly over long time frames. begs the question of how “importance” is defined. To do this properly would require us to have accurate FX volumes for all currency pairs 42 . the inherent value of a currency is not defined. this could clearly lead to the situation where a large move in a relatively small currency can strongly influence the REERs and NEERs for all other currencies. of course. This is because the indices are often used to measure the likely impact of exchange rate moves on a country’s international trade performance. rather than bilateral trade. There are two main approaches to building an effective exchange rate: Nominal Effective Exchange Rates (NEERs) and Real Effective Exchange Rates (REERs). Volume Weights The daily volume traded in the FX market dwarves the global volume of physical trade. please see “HSBC’s New Volume-Weighted REERs” Currency Outlook April 2009. The rationale for this would be that there is no a priori reason for choosing to put more emphasis on any one exchange rate.Macro Currency Strategy July 2011 abc HSBC Volume-Weighted REERs For full details of the construction methodology of the HSBC REERs. For example. Trade Weights Weighting the basket by bilateral trade-weights is the most common weighting procedure for creating an effective exchange rate index. this could be because the EUR has increased in value. From this it is possible to make a convincing argument that the weighting which would be really important would be to weight the currency basket by financial market flows. However. For example. if EUR-USD increased over some time period. one could see how EUR had performed against a range of other currencies to determine whether EUR has become generally more valuable or whether this was simply a USD-based move. One possible method for getting some insight into changes in the value of a currency is to look at movements in the value of a basket of other currencies against the currency of interest. This. the USD has decreased in value. if EUR-USD goes up. we now need to decide on how to weight our basket. Mark McDonald FX Strategist HSBC Bank plc +44 20 7991 5966 mark. The reason for doing this is that. To avoid this.

We believe that this gives another plausible definition for “importance”. the volumes are split by currency for over 30 currencies. We take this assumption one step further and assume that it is valid to spread the inflation out equally over every day in the month. The BIS triennial survey of FX volumes only gives data for a small number of bilateral exchange rates. Data Frequency This is something which is rarely considered when constructing REERs – inflation data is generally released at monthly frequency at best so the usual procedure is to simply create monthly indices by default. 43 . and one which may be more relevant for financial investors than trade weights. However. Here there is an implicit assumption that the rate of inflation changes slowly. However. From these volumes we can estimate financial weightings for each currency.Macro Currency Strategy July 2011 abc considered in the index. some countries release their inflation data only quarterly. the effective value of a currency you would be exposed to is more accurately represented by the HSBC volume-weighted index rather than the trade-weighted index. We call this procedure volume weighting and the indices produced through this procedure we call the HSBC volume-weighted REERs. these are not available. However. The usual procedure for these countries is to simply pro-rata the change over the period. We would argue that if you are a financial market investor.

Macro Currency Strategy July 2011 abc HSBC Volume – Weighted REERs USD REER index USD Trade-Weighted REER 1996=100 160 USD Volume-Weighted REER 1996=100 160 1996=100 120 EUR REER index EUR Volume-Weig hted REER EUR Trade-Weighted REER 1996=100 120 140 140 105 105 120 120 90 90 100 100 75 75 80 Jul-95 80 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 60 Jul-95 60 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 Source: HSBC Source: HSBC JPY REER index JPY Trade-Weighted REER 1996=100 120 JPY Volume-Weighted REER 1996=100 120 GBP REER index 1996=100 140 GBP Trade-Weighted REER GBP Volume-Weighted REER 1996=100 140 105 105 125 125 90 90 110 110 75 75 95 95 60 Jul-95 Jul-98 Jul-01 Jul -04 Jul-07 Jul-10 60 80 Jul-95 80 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 Source: HSBC Source: HSBC 44 .

Macro Currency Strategy July 2011 abc CAD REER index CAD Trade-W eighted REER 1996=100 150 140 130 120 110 100 90 80 Jul-95 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 CAD Volume-Weighted REER 1996=100 150 140 CHF REER index CHF Volume-Weighted REER 1996=100 110 CHF Trade-Weighted REER 1996=100 110 100 130 120 110 100 100 90 90 80 80 70 90 80 70 60 Jul-95 60 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 Source: HSBC Source: HSBC AUD REER index AUD Trade-W eighted REER 1996=100 160 AUD Volume-Weighted REER 1996= 100 160 NZD REER index NZD Volum e-Weighted REER 1996=100 140 NZ D Trade-Weighted R EER 1996=100 140 140 140 120 120 120 120 100 100 100 100 80 80 80 80 60 Jul-95 60 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 60 Jul-95 60 Jul-98 Jul-01 Jul-04 J ul-07 Jul-10 Source: HSBC Source: HSBC SEK REER index SEK Trade-Weighted REER 1996=100 110 SEK Volume-Weighted REER 1996=100 110 NOK REER index NOK Trade-Weighted REER 1996=100 130 NOK Volume-Weighted REER 1996=100 130 100 100 120 120 110 110 90 90 100 100 80 80 90 90 70 70 80 80 60 Jul-95 60 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 70 Jul-95 70 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10 Source: HSBC Source: HSBC 45 .

40 1.Macro Currency Strategy July 2011 abc HSBC forecasts vs forwards Euro dollar vs forwards USD/EUR 1.40 1.10 2.00 0.80 1.20 1.50 1.90 0. Reuters. Reuters.90 1.85 0 .00 0 .10 Jan-06 Jan-08 Jan-10 Jan -12 Source: Thomson Financial Datastream.30 Euro sterling vs forwards GBP/EUR 1. HSBC Cable vs forwards USD/GBP 2.95 0 .50 1.60 0.20 1.10 2.70 0 .60 1.00 1.30 1.65 0 .75 0 .80 0.60 1.70 1.60 1. Reuters.10 1.00 0. HSBC Source: Thomson Financial Datastream.80 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Euro Swiss vs forwards Forecast USD/EUR 1.80 0 .50 1.30 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Forward Forecast USD/GBP 2.70 0.60 1.20 1. HSBC 46 . HSBC Dollar yen vs forwards JPY/USD 135 125 115 105 95 85 75 Jan-00 Jan-02 Jan-0 4 Jan-06 Jan-08 Jan-10 Ja n-1 2 Euro yen vs forwards Forward Forecast JPY/USD 135 125 115 105 95 85 75 JPY/EUR 175 165 155 145 135 125 115 105 95 85 Jan-00 Jan-02 Forward Forecast JPY/EUR 175 165 155 145 135 125 115 105 95 85 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Source: Thomson Financial Datastream.60 1. HSBC Source: Thomson Financial Datastream.30 1.90 0 .50 1.55 Source: Thomson Financial Datastream. Reuters.40 1.80 1.55 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Forward Forecast GBP/EUR 1 .10 Jan-00 Jan-02 Jan-04 Forward Forecast CHF/EUR 1. Reuters.50 1.40 1.95 0.00 0.30 1. Reuters.10 1.85 0.90 0.80 1.40 1.40 1.80 1.90 1.70 1.30 1.60 0 .20 1.50 1.00 1. HSBC Source: Thomson Financial Datastream.70 1.60 1.65 0.70 1.75 0.80 Forward CHF/EUR 1.90 0.

7 2.9 5.4 7.2 0.3 0.6 5.5 6.7 4.3 3.0 7.7 2.4 4.9 2.6 3.6 0.2 10.7 1.7 1.0 6.4 0.9 0.2 12.5 3.0 7.2 2.8 0.2 12.5 1.7 0.7 0.6 4.9 3.0 5.3 8.6 7.8 0.5 0.4 4.3 6.0 6.3 1.3 2.5 6.3 6.0 7.7 2.3 4.3 4.4 0.2 7.6 9.7 1.0 0.0 2.0 2.7 9.2 4.8 0.8 0.1 1.3 1.7 1. These rates may not give a good indication of policy rates.7 5.2 4.1 3.7 2.6 5.0 6.1 0.1 3.5 8.8 12.4 3.1 8.9 0.Macro Currency Strategy July 2011 abc Short rates 3 Month Money End period North America US (USD) Canada (CAD) Latin America Mexico (MXN) Brazil (BRL) Argentina (ARS)* Chile (CLP)* Western Europe Eurozone Other Western Europe UK (GBP) Sweden (SEK) Switzerland (CHF) Norway (NOK) EMEA Hungary (HUF) Poland (PLN) Russia (RUB)* Turkey (TRY) Ukraine (UAH) South Africa (ZAR) Asia/Pacific Japan (JPY) Australia (AUD) New Zealand (NZD) Asia-ex-Japan China (CNY) Asia ex-Japan & China Hong Kong (HKD) India (INR) Indonesia (IDR) Malaysia (MYR) Philippines (PHP) Singapore (SGD) South Korea (KRW) Taiwan (TWD) Thailand (THB) Notes: * 1-month money.7 0.6 5.9 5.3 1.1 5.0 9.2 0.5 7.0 1.5 7.2 3.7 10.2 6.3 5.7 1.3 0.7 0.5 17.9 3.3 2.5 0.5 0.6 2.9 5.4 6.9 5.4 0.6 5.0 9.2 4.0 0.5 0.8 3.6 15.1 6.1 1.0 7.0 4.7 0.7 2.0 7.8 1.2 2.0 4.0 6.9 0.0 12.2 4.1 6.8 0.7 2.1 7.3 1.1 7.5 0.0 2.5 0.4 3.3 3.7 1.4 6.6 7.7 4.5 7.8 4.3 7.9 2.2 4.0 0.0 6.0 0.3 2.3 1.5 0.7 0.9 9.8 7.4 6.7 1.0 0.4 0.6 5.5 9.7 2.9 2.8 20.6 5.2 4.2 0.8 2.9 2006 2007 2008 Q4 Q4 Q4 2009 Q4 Q1 2010 Q2 Q3 Q4 Q1f 2011 Q2f Q3f Q4f Important note This table represents three-month money rates.3 0.3 0.7 9.6 3.4 1.7 0.7 1.8 8.7 0.7 4.1 2.3 0.8 9.6 10.1 1.7 6.8 3.8 7.0 8.3 0.2 13.6 4.2 3.3 1.6 9.5 16.5 20.3 2.2 4.0 3.7 1.3 6.6 4.3 3.8 9.2 2.2 8.0 2.3 2.5 0.2 5.7 3.0 4.7 1.4 4.7 1.3 1.9 5.9 0.3 0.1 4.5 4.6 6.8 3.9 3.4 2.3 16.5 10.9 7.1 9.6 2.3 11.6 7.9 0.3 1.7 0.6 5.2 5.8 11.6 0.3 2.6 8.4 0.7 2.3 6.2 5.7 7.1 5.7 2.1 2.8 0.2 3.7 1.2 2.3 0.2 4.8 0.1 6.2 4.0 9.8 3.1 4.9 2.9 3.3 1.9 4.1 2.8 3.1 1.6 5.8 3.0 3.5 1.8 0.2 4.2 7.3 0.7 7.6 2.8 0.7 1.0 6.3 7.3 4.5 0.5 1.0 6.5 5.3 8.9 5.6 0.0 8.2 0.6 11.8 0.3 7.1 4.7 5.4 5.5 5.5 5.0 11.7 4.3 0.2 0.9 7.9 4.9 8.3 6.6 7.6 7.2 12.6 0.6 5.8 1.8 9.6 4.8 2.6 5.5 0.7 2. Source HSBC 3.7 7.6 8.4 3.8 5.1 5.8 9.8 3.0 3.8 1.2 0.8 8.2 6.6 2.0 0.3 0.6 0.4 7.5 5.9 0.9 0.7 9.4 4.3 0.0 0.0 0.5 1. 47 .3 0.9 0.5 2.2 7.6 4.6 0.5 7.7 1.0 17.3 10.6 6.2 3.6 10.4 1.6 2.3 3.6 6.

96 1.56 x 6.33 266 28.52 490 11.15 1.00 6.Macro Currency Strategy July 2011 abc Emerging markets forecast table 14-Jul-11 last 2010 Q1 x x Q2 x Q3 x Q4 x 2011 Q1 x Q2 x Q3f x Q4f x 2012 Q1f x Q2f x Latin America vs USD Argentina (ARS) Brazil (BRL) Chile (CLP) Mexico (MXN) Columbia (COP) Peru (PEN) Venezuala (VEF) x x 4.50 3.78 0.89 1917 2.57 277 30.80 Poland (PLN) Middle East vs USD Egypt (EGP) Israel (ILS) x 5.98 4.38 x 6.00 6.74 4.64 4.44 x x 5.62 3.84 7.80 255 28.90 0.36 25.52 480 11.87 4.80 4.73 4.63 478 11.30 Eastern Europe vs EUR Czech Republic (CZK) Hungary (HUF) Russia vs USD (RUB) 24.72 4.28 1.08 24.80 0.05 25.45 1750 2.67 468 12.89 1872 2.71 3.09 1.20 24.40 23.30 3.00 6.80 x 5.00 255 30.96 3.05 1.00 3.57 x 5.14 6.56 467 11.98 4.50 x 6.71 1769 2.41 266 29.20 260 30.48 24.80 0.30 4.83 4.00 3.50 3.75 x 5.97 0.12 1.29 3.30 3.70 4.43 24.70 260 30.71 4.25 3.55 4.12 1.80 4.48 3.69 1760 2.80 0.36 1920 2.80 23.85 3.34 1.95 1.00 1.30 4.54 475 11.52 3.12 1.56 266 28.93 1.30 1750 2.45 x 6.52 485 11.57 463 11.96 4.95 4.00 3.70 3.35 Africa vs USD South Afric a (ZAR) Interest rates 6.30 3.69 285 31.11 1.20 24.80 Rom anian (RON) Turkey vs USD (TRY) S im ple rate 4.40 x 6.09 278 30.15 1.36 1920 2.00 Source: HSBC 48 .30 1750 2.40 25.10 1.03 4.05 1.90 4.25 1.69 484 12.76 0.00 6.54 3.81 4.97 1.06 1.87 1.85 x 5.03 4.00 6.67 7.65 3.30 4.76 4.41 269 28.14 4.30 1750 2.90 3.34 6.45 3.62 1799 2.10 3.80 546 12.78 525 12.00 6.55 3.25 1.00 6.30 4.30 4.30 4.86 4.59 4.28 1.62 0.90 7.55 3.

4 9425 3.78 x 6.0 80 0.80 31.75 32.52 4.46 173 18.05 x 31.76 x 6.80 28.6 8925 3.0 8300 2.4 2.79 x 6.3 91 0.4 9393 3.93 x 28.45 1.7 8577 3.99 6.5 8400 2.44 x 1.0 8300 2.44 x 1.5 21500 Q2 0.30 1.22 x 1.74 3.3 1.38 233 21.25 7.73 x 6.06 x 1.52 4.8 2.84 x 30.03 x 29.71 177 16.8 93 0.80 28.9 16900 x 7.07 0.77 3.87 x 28.03 0.88 0.34 Source: HSBC 49 .43 1.67 3.40 7.97 0.30 1.4 2.46 7.52 7.50 7.31 30.80 2011 Q1 0.96 x 1.Macro Currency Strategy July 2011 abc Exchange rates vs USD end period Americas x x x x Western Europe Other Western Europe x x x x Emerging Europe x x x x Asia/Pacific x x x North Asia x x x x South Asia x x x x x Africa x x Canada (CAD) Mexico (MXN) Brazil (BRL) Argentina (ARS) x Eurozone (EUR*) x UK (GBP*) Sweden (SEK) Norway (NOK) Switzerland (CHF) x Russia (RUB) Poland (PLN) Hungary (HUF) Czech Republic (CZK) x Japan (JPY) Australia (AUD*) New Zealand (NZD*) x China (CNY) Hong Kong (HKD) Taiwan (TWD) South Korea (KRW) x India (INR) Indonesia (IDR) Malaysia (MYR) Philippines (PHP) Singapore (SGD) Thailand (THB) Vietnam (VND) x South Africa (ZAR) 2007 Q4 0.46 47.80 Q4 0.00 1.78 6.95 0.30 7.35 x 1.4 936 x 39.03 43.25 x 48.78 183 17.40 32.66 6.03 0.94 1.79 Q4f 0.31 7.56 4.27 5.7 9010 3.78 1.3 18200 x 7.83 x 6.87 x 1.5 1.80 27.21 0.30 1.08 x 30.0 1.50 1.0 8300 2.69 7.36 1.14 5.8 81 1.8 1133 x 46.08 1.55 7.52 4.3 1223 x 44.7 81 1.80 30.7 1060 x 42.5 2.7 20500 x 6.40 32.8 2.67 x 1.69 3.59 7.08 43.95 0.88 41.7 80 0.57 6.01 12.77 x 7.21 27.4 2.95 207 18.25 x 1.43 x 1.45 x 1.5 1.15 x 1.85 196 18.95 11.24 29.5 2.34 x 1.89 1.4 9060 3.78 7.2 1.84 187 17.2 21500 x 6.80 x 1.26 30.70 0.34 x 29.4 19475 x 6.6 11027 3.91 203 18.36 1.41 33.4 19000 x 6.62 1.2 2.11 5.97 x 1.31 3.35 7.80 32.6 1.44 33.0 84 0.04 5.58 6.60 6.36 x 6.71 1.76 2009 Q4 1.2 20880 x 6.83 7.79 x 6.83 7.80 27.79 x 6.6 21500 x 6.7 80 0.7 80 0.83 x 9.80 3.97 11.06 12.85 40.90 0.42 x 1.8 1.5 8708 3.84 0.99 12.80 31.92 0.86 188 18.78 3.93 x 1.63 4.97 11.9 1263 x 46.31 5.0 1070 x 42.4 2.58 x 6.23 28.00 11.78 2010 Q1 1.80 32.4 2.26 45.53 0.3 83 1.69 x 6.66 6.06 x 30.71 x 6.91 7.05 13.4 1121 x 44.1 19498 x 6.5 1.03 12.02 43.45 x 1.54 4.81 2.13 x 24.92 1.82 40.28 30.23 30.71 177 16.95 0.96 191 19.0 21500 x 6.46 5.0 1.65 6.00 11.0 88 0.44 Q2f 1.82 7.37 0.71 177 16.7 16217 x 6.4 93 0.4 1.66 6.61 6.61 7.42 46.90 x 30.31 41.80 29.39 x 1.22 28.81 0.3 19050 x 7.3 1.04 5.85 x 30.99 10.73 5.9 1.89 1.80 Q3 1.42 x 1.09 43.97 11.1 1166 x 44.80 28.2 2.31 5.97 x 1.5 1.14 0.37 x 1.91 x 28.24 46.20 5.44 7.12 x 1.17 0.4 1097 x 44.80 32.86 0.4 1050 Q3f 0.90 Q2 1.7 1067 x 43.62 2008 Q4 1.2 112 0.2 3.15 x 1.8 9090 3.35 0.90 0.2 1140 x 44.11 x 1.23 13.72 5.98 x 30.43 34.5 1080 x 42.92 2012 Q1f 1.1 2.91 41.74 x 6.46 x 1.75 183 16.

10 1.45 1.39 1.82 11.06 2.39 x 132 1.95 260 24.07 1.03 266 24.65 1.85 1.4 4.01 8.33 41.51 1.90 255 24.44 1.98 277 24.35 1.52 x 133 1.99 9.5 3.86 9.90 9.18 1.73 1.14 285 25.7 3.47 1.67 x 150 1.6 x 118 1.45 1.7 x 115 1.46 1.74 2.62 x 0.32 38.12 8.38 x x 1.52 1.22 1.8 x 126 1.80 x x 1.84 2.61 x 0.00 1.25 44.90 x x 1.59 x 0.9 3.64 9.85 255 23.91 x x 1.44 x 133 1.4 3.66 x 0.6 x 163 1.94 1.98 266 24.82 x x 1.57 1.3 x 117 1.80 1.10 1.1 x 109 1.50 x 133 1.53 9.30 40.87 10.74 2.02 7.12 266 26.44 1.19 7.37 1.48 43.35 x 130 1.14 1.37 1.66 1.77 2.2 x 114 1.53 7.23 1.49 1.78 1.87 8.63 1.22 40.33 8.61 x 132 1.73 1.82 9.9 3.89 9.58 1.09 1.77 x 0.96 278 25.50 1.65 2.33 1.82 x x 1.7 x 108 1.31 1.35 1.99 1.10 Source: HSBC 50 .43 1.32 44.87 10.33 0.99 1.60 1.10 1.61 1.2 4.60 253 26.25 x 222 2.90 7.41 1.89 8.38 0.0 x 115 1.73 12.47 x 133 1.45 7.90 10.4 3.73 9.44 0.00 1.86 10.46 x 127 1.66 1.97 x x 1.89 10.59 1.14 1.40 0.86 8.44 1.97 1.94 1.56 x 0.89 10.61 1.72 0.20 42.37 10.53 9.40 1.50 0.87 10.87 10.86 x x 1.72 x x 1.61 1.97 11.40 0.69 x 0.66 1.42 39.60 x 142 1.9 3.30 40.01 8.87 1.30 0.86 10.44 0.52 1.50 1.46 1.74 8.89 10.45 1.97 10.80 260 23.4 x 126 1.48 40.54 x 132 1.66 35.55 2.67 1.56 x 0.53 2.95 7.22 1.86 10.86 x x 1.57 x 0.82 x x 1.78 x x 1.29 1.55 x 0.3 4.70 7.99 2.42 1.8 x 115 1.8 4.40 0.27 2.52 1.24 8.44 0.66 x 0.9 3.13 8.81 2.44 1.92 9.34 1.50 1.35 0.15 7.89 11.61 9.25 40.37 0.87 8.70 7.03 1.11 270 26.11 8.80 7.63 2.86 266 25.82 1.54 x 0.60 1.42 1.96 x 0.76 x x 1.10 1.73 2.57 1.80 2.4 x 134 1.7 3.87 8.Macro Currency Strategy July 2011 abc Exchange rates vs EUR & GBP end period Vs euro Americas x x Europe x x x x x x x x Asia/Pacific x x x Vs sterling Americas x x Europe x x x x x Asia/Pacific x x x x x US (USD) Canada (CAD) x UK (GBP) Sweden (SEK) Norway (NOK) Switzerland (CHF) Russia (RUB) Poland (PLN) Hungary (HUF) Czech Republic (CZK) x Japan (JPY) Australia (AUD) New Zealand (NZD) x x US (USD) Canada (CAD) x Eurozone (EUR) Sweden (SEK) Norway (NOK) Switzerland (CHF) x Japan (JPY) Australia (AUD) New Zealand (NZD) 2007 Q4 2008 Q4 2009 Q4 2010 Q1 Q2 Q3 Q4 2011 Q1 Q2 Q3f Q4f 2012 Q1f Q2f 1.87 9.53 x 130 2.60 1.60 1.6 x 114 1.

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com. David was the US economist for the Bank.williams@hsbcgroup. Perry Kojodjojo FX Strategist.com Robert is the Head of G10 currency strategy for HSBC in New York. She was formerly part of HSBC’s global emerging market research team as an economist focusing on the Andean region. She joined HSBC in 2005. is responsible for helping to formulate the FX Strategy group’s views and forecasts for major currencies. Marjorie Hernandez FX Strategist.com David is Global Head of FX Research for HSBC.com Clyde is a New York-based emerging markets currency strategist.hernandez@us. advising the global client base on the development of currency overlay programs and the construction of bespoke hedging strategies. he obtained a DPhil from Oxford University.com. Daniel Hui FX Strategist. Prior to joining HSBC in 2007.mcdonald@hsbcib. Paul Mackel Director of Currency Strategy +44 207 991 5968 paul. He is based in Hong Kong and covers Asia. Before taking up his current post. He is also responsible for proprietary model trading systems and developing the bank’s academic collaborations.hk Daniel is a Hong Kong-based FX strategist covering Asia. Americas +1 212 525 3159 robert.hsbc. researching in collaboration with the HSBC FX Strategy team.mackel@hsbcib. Perry received his master’s degree in finance from Imperial College London. principally with the University of Oxford.hsbc. focusing mainly on Latin America.bloom@hsbcib. Mark has an MPhys in Physics.lynch@us.com Marjorie is a New York-based FX strategist covering Latin America. specialising in currencies and market strategies. He has over 10 years of experience as a currency analyst and. where he read physics. .Main Contributors David Bloom Global Head of FX Research +44 20 7991 5969 david. He also provides emerging market risk management advice to HSBC’s global client base. Clyde Wardle Emerging Markets Currency Strategist +1 212 525 3345 clyde. Asia +852 2822 4340 danielpyhui@hsbc. with a concentration in international economics and Asian economic development.hk Perry joined HSBC in 2005 as part of the global FX strategy team. Asia +852 2996 6568 perrykojodjojo@hsbc. Paul worked in a similar role for other financial institutions. working alongside David Bloom. he worked as an economist covering Southeast Asia and Greater China. Prior to joining HSBC. also from Oxford University.com Paul is a senior currency strategist covering the G10 currency markets. He has been with the Group since 1992. He joined HSBC in 2005. He has been with the bank for eleven years.hsbc. Daniel received his master’s degree from Johns Hopkins University. in conjunction with the rest of the FX Strategy group. Latin America +1 212 525 4109 marjorie. Stacy Williams Head of FX Quantitative Strategy +44 20 7991 5967 stacy. Robert Lynch Head of G10 FX Strategy. He joined HSBC in June 2006 and is based in London.com Mark is a quantitative FX strategist based in London. He also has work experience within equity markets and analysing the UK economy. Mark McDonald FX Quantitative Strategist +44 20 7991 5966 mark. Before joining the company.wardle@us.com Stacy is responsible for FX quantitative research.

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