Currencies 0211

Deutsche Bank
Private Wealth Management

FX Outlook

Marshall Gittler
Chief Strategist, EMEA
Place des Bergues 3
CH-1211 Geneve 1
Switzerland
marshall.gittler@db.com
+41 (0) 22 739 0463

February, 2011

Currency Outlook: Our forecasts vs mkt, GM
We are somewhat more bullish on USD/bearish on EUR short-term
GM is more bullish JPY, less bullish EUR
Mostly in line with market on majors long-term

Source: Bloomberg Finance L.P.

Deutsche Bank Marshall Gittler, Chief Strategist EMEA
Private Wealth Management FX Outlook, Feb. 2011 2
005959.01/07/11

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

USD is within the normal range of valuation vs majors

— USD is somewhat undervalued vis-a-vis EUR and JPY and fairly valued vis-a-vis GBP. The undervaluation is
not at the level that would usually trigger a counter move.

Source: Bloomberg Finance LP, DB Global Investment Solutions

005959.01/07/11

Currency outlook: USD Cycle

USD cycle is largely on track


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

Market is already discounting a successful conclusion to Eurozone talks

— The market is already discounting a successful conclusion to the Eurozone debt problem, as shown by the fact
that the EUR/USD basis swap curve is nearly back to where it was before the debt crisis began. Hence we
cannot expect much further positive impetus from that corner.
— On the contrary, the risks are that some hiccups occur in the process. The Irish elections for example or a failed
auction could knock confidence.
— Meanwhile, the improvement in the basis – and in the Eurozone CDS – may have stalled. This could presage
further EUR weakness.
Source: Bloomberg Finance LP
005959.01/07/11

We look for some EUR weakness in the coming three months

Stocks are also discounting a successful conclusion
— We can see the same in the
equity market, where the largest
gainers in Europe this year have
been the peripheral countries.

005959.01/07/11

USD could get a boost from change in Fed expectations

Market assumption that Fed lags behind ECB could be tested

13m to 1st
rate hike

15m so
far…

6m to 1st
rate hike 11m to 1st
rate hike

— The market is assuming that the ECB is likely to raise rates sooner than the Fed (an assumption that we would
agree with).
— Nonetheless, we would think it more likely that market brings forward its assumptions for the likely time of Fed
rate hikes than for ECB rate hikes. This is particularly the case if our forecast for a 7.8% US unemployment
rate at the end of this year is realized.


005959.01/07/11


On the other hand…Stronger US growth isn’t always good for USD
— People often think of a currency
rate as the “stock price” of a
country and assume that a
country with relatively stronger
growth will have a relatively
stronger currency.
— However the history of EUR/USD
shows that generally, when US
growth has exceeded that of
Eurozone growth, the euro has
tended to strengthen against the
dollar. This may be because a
strong US economy tends to suck
in imports and hence the current
account deficit widens.


005959.01/07/11

Currency outlook: GBP
Much depends on tightening expectations

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

— Inflation in the UK is rising, as are inflationary expectations. As a result, the market is now fully pricing in a rate
hike by June.
— However, we believe that the market is getting ahead of itself. On the contrary, we have moved back our
forecast for the first rate hike to August, due to weak growth and dovish comments by BoE Gov. King.
— We believe there could be some disappointment in the market and GBP could come under pressure again as a
result.

005959.01/07/11

Currency outlook: GBP

UK budget deficit may also be a drag on the currency

— While the government has pledged to reduce the budget deficit, so far it has continued to creep higher as a %
of GDP. This means the government will have to cut spending further, which would put pressure on the BoE to
refrain from hiking rates even longer.


005959.01/07/11

Currency outlook: JPY
We look for a modestly weaker JPY

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

— The rate differential between JPY and USD is current not enough to expect a major move out of JPY assets
and into USD assets.
— Historically, USD/JPY has tended to decline (i.e., the yen has strengthened) when the 2yr swap spread is
below 250 bps. Currently it is only 83 bps.


005959.01/07/11


But the picture should change in 2H

— We expect though that eventually the market will start to discount a rise in rates in other countries and go back
to funding carry trades via JPY instead of USD.

005959.01/07/11


Weaker Japanese economy may cause upward pressure on USD/JPY

— We think this is especially so since Japan’s economic indicators are starting to surprise less on the upside,
while US indicators are surprising more on the upside. That too should lead to JPY weakness over time.


005959.01/07/11


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

— The other potential concern for the yen is the current account surplus. As China tightens policy and activity
there slows, Japan’s exports may struggle.
— Japan is the one major exporting country whose exports have not yet recovered back to the level before the
crash. This may be because of JPY strength. We think further JPY strength would be damaging for the
economy and therefore the government is likely to take steps to prevent it if it starts happening.


005959.01/07/11

Currency outlook: CHF
We look for a modestly weaker CHF

SNB intervention kept CHF from strengthening vs EUR
Risk averse/ CHF
% strengthening
Risk averse CHF %
strengthening

Risk seeking
CHF weakening Risk seeking
CHF weakening

— The impact of the SNB’s intervention can be seen clearly in these graphs. USD/CHF followed the risk aversion
index fairly closely, but EUR/CHF has diverged from it considerably – particularly when the market was risk
averse and therefore one would expect buying CHF against EUR such as in late 2009.
— We expect that over the next year, as concerns about the global economy and the Eurozone’s problems
continue to fade, risk aversion will recede and EUR/CHF can move up somewhat.
— The risk in the short term however is that the hopes for the Eurozone to solve its problems are already in the
market and there could be some disappointment if there are any bumps in the process.

005959.01/07/11

Currency outlook: CHF
We look for a modestly weaker CHF

CHF already overvalued vs USD

25% overvalued

25% undervalued

— We think it will be difficult for CHF to gain further on USD as it is already 25% overvalued (taking an average of
PPP valuation based on CPI and PPI).
— EUR/CHF is fairly valued on that basis, but only after massive intervention in the FX market by the Swiss
National Bank.

005959.01/07/11

Currency outlook: Commodity currencies

Commodity currencies are moving more with rates than commodities

— Two major factors support the commodity currencies: commodities, of course, but also interest rates.
— The currencies seem to be tracking rate expectations more closely nowadays than commodity prices.
— The fact that AUD and NZD rate differentials are starting to turn down while CAD differentials remain stable
makes us expect that CAD is likely to be the best performer among the three commodity currencies.


005959.01/07/11

Currency outlook: Commodity currencies

We expect CAD to outperform AUD

— AUD tends to follow economic activity in China. We expect the Chinese economy to slow as the government
fights inflation. That may weigh on AUD.
— On the other hand, the improving employment picture in Canada should allow the Bank of Canada to keep on
its modest tightening trend.


005959.01/07/11

Currency outlook: EM

EM countries are adjusting via inflation, not FX revaluation

— EM countries are resisting FX appreciation and instead are intervening in the market to keep their currencies
from rising vs USD.
— The increase in the money supply arising from the intervention is one reason why inflation in these countries is
rising so much. This is causing further adjustment nonetheless, because even if the nominal rate stays stable, it
is effectively an appreciation of the currency with the higher inflation rate.


005959.01/07/11

Currency outlook: DB Currency Indices

We expect carry to continue to perform
— Looking at the three DB currency indices,
carry has done fairly well since bottoming
out in late August (+7.1%) but momentum
has not really done anything since mid-
2009, and valuation is down 7.3% from its
peak in June.
— As a result, the overall index was fairly
steady last year (+0.7%) and is up only
slightly (+0.3%) this year.
— We feel the outlook for carry is good. Risk
aversion is on the wane and with inflation
rising in EM countries, we expect they are
likely to raise their interest rates further.
— Valuation however does not seem
compelling to us right now as several of
the major currencies are relatively near
fair value against each other.


005959.01/07/11

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005959.01/07/11

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