Morgan Stanley - Differentiating Risks

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					                                                                           MORGAN STANLEY RESEARCH

                                                                           Global Currency Research Team
                                                                           For research analysts, please see contact list at the back of this material.

         October 25, 2012

                                                                           Trade Recommendations
         FX Pulse                                                          Closed Trades
                                                                           Long EUR/USD                                Took Profit on Oct-23

         Differentiating Risks                                             Long EUR/GBP
                                                                           Active Trades
                                                                                                                  Exit at Oct 26 WMR or 0.8020
                                                                                                                    Entry           Stop     Target
                                                                           Short GBP/MXN                            20.50          21.50       18.00
         We have scaled back some of our risk exposure, taking             Long USD/JPY                             78.00          78.50       85.00
         profits on EUR/USD and EUR/GBP long positions. Weak               Short AUD/NZD                           1.2580        1.2800      1.1000
                                                                           Long RUB/JPY                            2.5550        2.4900      3.1500
         EMU data, signs of complacency among European                     Limit Orders                             Entry           Stop     Target
         politicians and lingering US fiscal-cliff concerns stand in       Buy CHF/JPY                              82.00          80.60       92.00
         sharp contrast to signs of better US consumer demand,             Buy EUR/USD                             1.2775        1.2700      1.3400
                                                                           Active Options Trades               Entry Date Expiry Date         Strike
         stronger Asian trade and returning capital flows to Asia.
                                                                           Long GBP put/USD call               02-Aug-12      02-Nov-12      1.5112
         Repeated HKMA intervention, rising local currency reserves
                                                                           See page 15 for more details. Changes in stops/targets in bold italics.
         and onshore USD/CNY reaching the lower end of its band
         indicate investors have moved back into Asia, providing a
         positive backdrop for local currencies and risk appetite.
                                                                           MS Major Currency Forecasts
                                                                                                  4Q12            1Q13             2Q13              3Q13
         Conflicting signals require us to differentiate our risk          EUR/USD                   1.34            1.30             1.25            1.20
                                                                           USD/JPY                     84              85               87              89
         investments. Signs that EMU politicians are becoming
                                                                           GBP/USD                   1.61            1.59             1.54            1.52
         complacent have increased the tail risk that the OMT will
                                                                           USD/CHF                   0.90            0.85             0.88            0.96
         not be activated to intervene in Spanish bond markets by          USD/CAD                   0.93            0.95             1.00            1.01
         the end of the year. We think it is likely that Cyprus, Greece,   AUD/USD                   1.05            0.99             0.92            0.90
         and Slovenia all ask for financial assistance in the first week   NZD/USD                   0.86            0.82             0.76            0.75
         of November. Should Spain not request aid at the same             EUR/JPY                   113              111             109             107
         time, the EUR may come under significant selling pressure.        EUR/GBP                   0.83            0.82             0.81            0.79
         For now, we believe this tail risk is too high to justify the     EUR/CHF                   1.20            1.10             1.10            1.15
         reward, explaining our more cautious EUR approach. The            EUR/SEK                   8.80            8.60             8.50            8.40
                                                                           EUR/NOK                   7.50            7.30             7.20            7.10
         strong UK Q3 GDP report convinced us to close our                 Note: Forecasts for end-of-period. G10 forecasts updated September 13, 2012.
         EUR/GBP long position.
                                                                           FX Market Overview                                                         P2
         JPY trends lower. Our bearish JPY call based on the               G10: Current Account Adjustment and the
         assumption of a more aggressively anti-deflation BoJ               Exchange Rate                                                             P7
         seems to be working out. The latest weekly security-flow          EMFX Vol Exceptionally Cheap as Potential
         data showed continued JPY weakening outflows. The                  Tail Risks Approach                                                      P12
         weakening JPY should provide a further boost to global            Strategic FX Portfolio Trade
         liquidity as we expect funds leaving the JPY to seek higher        Recommendations                                                          P15
         returns elsewhere.                                                G10 & EM Currency Summary                                                 P18
                                                                           Global Event Risk Calendar                                                P20
         Current Account Balances and FX. We look at the impact            FX Volatility/Carry Grids, Tactical Indicators                            P22
         current account shifts have on currencies. While EM
                                                                           MS FX Positioning Tracker                                                 P25
         currencies tend to move in line with current account swings,
                                                                           FX and Macro Forecasts                                                    P26
         DM FX markets’ reaction to current account swings is more
         complex due to the dominance of financial transactions. As        Appendix                                                                  P28
         EM markets lack depth and liquidity, official exchange rate
         policies and commercial transactions reflected in the current
         account still dominate the direction of FX. In DM, the impact
                                                                           For important disclosures, refer to the
         of current account shifts on FX is largely via their effect on    Disclosures Section, located at the end of
         relative yield and capital return expectations.                   this report.
                                                                     MORGAN STANLEY RESEARCH

                                                                     October 25, 2012
                                                                     FX Pulse

FX Overview
    Morgan Stanley & Co.              Ian Stannard                   Indeed, central bank policy, especially the potentially
    International plc                 +44 (0)20 7677 2985
                                                                     unlimited provisions of liquidity from the ECB and the Fed, are
    Morgan Stanley & Co.              Meena Bassily                  the driving force behind this change in market behaviour. But
    International plc                 +44 20 7677-0031               now that the initial optimism appears to be waning the
                                                                     sustainability of the risk recovery could be called into
      Narrowing growth and interest rate differentials have made    question. Given the renewed sensitivity of currencies to asset
       currencies more sensitive to asset market performance.        market performance, the impact of any renewed equity market
                                                                     volatility on the near-term trading behaviour of FX markets
      But the current liquidity driven nature of asset markets is
                                                                     should not be underestimated, in our view.
       being challenged by economic data disappointments.

      EUR also facing fresh challenges as the prospect of Spain     Asset Markets Driving FX
       delaying a request for aid has dented optimism…
                                                                     Indeed, risk appetite has certainly been hit sharply over the
      …we have closed our EUR long positions, but look to use       course of the past week. Non-financial sector earnings
       setbacks to re-establish bullish strategies.                  disappointed, while economic indicators were mixed and the
      We also find GBP vulnerable to the underperformance of UK     markets perception of EMU developments moved from
       asset markets.                                                resolution towards complacency once again. There has been
                                                                     good reason for investors to reduce some risk exposure in the
      The CAD and NOK are two currencies that have maintained
                                                                     past week and to become more cautious. In this context, we
       their sensitivity to interest rate expectations…
                                                                     have found work by our Equity Strategy Team (see European
      …with the CAD being vulnerable to the recent mixed            Equity Strategy: Weekly Update ) interesting in helping us
       messages from the BoC.                                        interpret the current developments of risk sentiment. The
      The NOK remains supported by structural, cyclical and flow    changing dynamics between asset markets and economic
       dynamics, in our view.                                        developments are becoming increasingly important for FX
                                                                     markets, in our opinion.
        We maintain our selective EM buying strategy.
                                                                     Exhibit 1
                                                                     One-year Forward Price Earning Ratio (Europe)
Changing FX Behaviour                                                       MSCI Europe - N12M PE
                                                                                                                                       ECB announces OMT (06/09)

We have examined the impact of globally low interest rates
and the narrowing of rate and yield spreads on currency
                                                                                                                                              Draghi bumblebee
                                                                                                                                               speech (26/07)
markets in recent weeks and concluded that, generally                10.5                                              End of
speaking, FX markets have reduced their sensitivity to
changes in rate differentials. We also note that growth              10.0

differentials globally are narrowing, particularly between the        9.5
US and the rest of the world. These structural changes are
                                                                                                                                                            EU Summit
having a significant impact on FX markets, in our view.               9.0                                                       ECB announces
                                                                                                                                  LTRO (8/12)

The clearest change in behaviour we have noted is a general           8.5

increase in currency market sensitivity to relative asset market      8.0
performance. This has certainly been the case for many of the          Sep-10    Dec-10    Mar-11   Jun-11    Sep-11   Dec-11        Mar-12       Jun-12         Sep-12

traditionally high-beta currencies, with the EUR being a good        Source: Morgan Stanley Equity Strategy

example. The German equity market has become a good
leading indicator for the EUR, with EURUSD following the             Exhibit 1 shows the evolution of the one-year forward price-
recovery in European asset markets since the announcement            earning ratio, which is reaching the upper end of the trading
of the ECB’s OMT programme.                                          range seen in recent years. While equity markets might be
                                                                     generally in a trend towards higher valuations as central

.                                                                                                                                                                         2
                                                                                                                   MORGAN STANLEY RESEARCH

                                                                                                                   October 25, 2012
                                                                                                                   FX Pulse

banks substitute inflation for nominal growth targets, the                                                         months was initially European centric (later broadened by the
relative high valuation reached now makes it more difficult to                                                     Fed’s QE3) it should not come as a surprise that the EUR is
extend the risk rally further, especially without improving                                                        among the first currencies to feel the effects of a setback in
economic fundamental conditions.                                                                                   the risk recovery.

                                                                                                                   Moreover, while disappointing leading growth indicators
PMIs Leading
                                                                                                                   globally may start to challenge the broader risk recovery, the
Exhibit 2 compares corporate earnings relative to the                                                              EUR is also currently facing some more European-specific
evolution of the PMI. Our Equity Strategy Team has found                                                           concerns, namely the increasing market perception that Spain
that generally positive earning surprises are achieved when                                                        may delay its request for aid from the EU, resulting in a
the PMI moves above the 51/52 area. The latest EMU flash                                                           setback for European asset markets, and the EUR. This has
PMI shows the index not only way below the 51/52 threshold                                                         also generated an impact on the broader risk recovery in
required for positive earning surprises, but that the latest                                                       currency markets with many of the high-beta currencies
European PMIs have continued to decline, not boding well for                                                       suffering their most significant setback for over a month.
the Q4 earning outlook. We would suggest that the global risk
recovery will become increasingly focused on the                                                                   EURUSD Long Closed…
performance of PMIs, as investors will await signs of
                                                                                                                   As a result of the more European-specific nature of some of
economic improvement before following the liquidity driven
                                                                                                                   the challenges to the risk recovery currently developing, we
asset market optimism further.
                                                                                                                   have closed and taken profit on our long EURUSD position
Exhibit 2                                                                                                          established in September.
EPS and Global PMI
                                                                                                                   The developments of the past week provide a powerful
                                            40                                                   60                example of how quickly market sentiment can shift, especially
                                            30                                                                     when markets are being driven by a liquidity-led asset market
 MSCI Europe - Trailing EPS Growth, yoy %

                                                                                                                   recovery, where economic and financial fundamentals are
                                                                                                                   lagging. Hence, any suggestions that the policy response,
                                            10                                                   50
                                                                                                                   either monetary or fiscal, is faltering could see the risk
                                                                                                      Global PMI

                                                                                                                   recovery suffer a setback.
                                                                                                                   Exhibit 3
                                            -20                                                  40
                                                                                                                   EURUSD and Risk Adjusted Yields
                                                       Trailing EPS Growth
                                                                                                                      1.50                                                     1.50
                                                       Global PMI (RHS)

                                            -50                                                  30                                                                            1.45
                                                  06    07          08       09   10   11   12                        1.00
Source: Morgan Stanley Equity Strategy
                                                                                                                                                    Risk Adjusted Yield Diff
The EUR Example                                                                                                                                                                1.35
Indeed, following the softness in the most recent leading                                                                                                                      1.30
indicators (especially in Europe) the risk rally appears to have                                                     -0.50
come to a halt, for the time being at least. FX markets which                                                                                                                  1.25
have been trading at higher levels of correlation to asset                                                           -1.00                                                     1.20
markets are now also likely to reflect this pause with a                                                                 Jan-11     May-11 Sep-11 Jan-12   May-12 Sep-12
setback. This is likely to be particularly evident in the case of
the EUR, among the G10 currencies. We note that the EUR                                                            Source: Morgan Stanley

has seen one of the most significant increases of sensitivity to
                                                                                                                   In the specific case of the EUR, any news that challenges the
equity market performance over the past few months and
                                                                                                                   initial success that the ECB’s announcement regarding the
hence the recent increase of equity market volatility is
                                                                                                                   OMT has had on reducing market risk premium in the
expected to have an impact on the EUR. Moreover, given that
                                                                                                                   peripheral of Europe will have a negative impact on the EUR,
the global central bank policy response over the past few

                                                                   MORGAN STANLEY RESEARCH

                                                                   October 25, 2012
                                                                   FX Pulse

in our view. Thus, we continue to monitor risk-adjusted yields     Exhibit 4
in Europe closely to gauge the markets assessment of the           UK and US Equities (MSCI)
balance of risk/return. Currently, our EURUSD risk adjusted
yield indicator remains in a positive position, suggesting that
despite the current market correction the overall assessment
of the balance of risk/reward has not deteriorated as yet to a
level that would have a sustained negative impact on the

…but still Medium-Term EURUSD Bullish
While the current market assessment of European
developments may have switched from one of potential
resolution back to policy complacency, we believe that this
could also prove to be temporary. Markets are currently
factoring the prospect of a potential delay in Spain stepping
                                                                   Source: Reuters Ecowin, Morgan Stanley
forward and asking for EU aid. However, we continue to
believe that Spain will eventually accept assistance               We have identified the UK Chancellor’s Autumn statement as
(potentially in early November as part of a group of countries     an event risk, as the extent of the UK government’s fiscal
including Greece, Cyrus and Slovenia), restoring the more          overshoot will likely be revealed, while the OBR will still likely
favourable risk assessment in the Eurozone. We await a             have to revise lower growth forecasts for next year, despite
deeper setback of EURUSD into the 1.2775 area to re-               the Q3 upward surprise to GDP. We believe that these events
examine the potential for medium-term bullish strategies.          will start to dislodge the safe haven flows that have been a
                                                                   major factor in driving GBP to overvalued levels in recent
Relative Equity Markets and GBPUSD                                 months. The reversal of safe haven flows is likely to leave
As well as the EUR, we also note that GBP’s beta to equity         GBP vulnerable over the medium term, in our opinion.
markets has increased significantly over the course of the         Exhibit 5
past few months. However, in the case of GBP, it is not just       UK Exports and GBP TWI
the general performance of global equity markets that is
having an impact on GBP, but also the relative performance.
This relationship is particularly important for GBPUSD against
the relative performance of UK-US equity market
performance. Here we note that the UK equity market has
started to underperform quite significantly over the course of
the past couple of months, providing a negative backdrop for
GBP from a market perspective (see Exhibit 4).

These negative signals from the relative equity market
performance coincide with the negative structural issues that
are developing in the UK economy. While GBP may enjoy
some near-term support from the stronger-than-expected UK
Q3 GDP data, which showed the UK economy emerging from
                                                                   Source: Reuters Ecowin, Morgan Stanley
three quarters of negative growth, the negative signals from
leading indicators still provide a less than encouraging picture
for the medium term.

                                                                   MORGAN STANLEY RESEARCH

                                                                   October 25, 2012
                                                                   FX Pulse

Policy Focus on GBP?                                               Exhibit 6
                                                                   US-Canada Relative Rate Expectations and
While BoE governor King called into question the
effectiveness of QE in a speech over the past week, he also
indicated that the BoE stood ready to do more if required.
However, we find these comments of interest, especially in
the context of the recent change in tone we have detected in
BoE comments regarding GBP. Recently, we sense that BoE
members have started to become more focused on GBP. It
can be argued that the safe haven flows from Europe have
pushed GBP higher, reducing the effectiveness of QE, having
a direct negative impact on the UK economy via a reduction in
competitiveness. A disappointing export performance is often
cited by UK policy makers as the reason for the UK’s growth
undershoot. Hence, a weaker GBP would potentially improve
the effectiveness of the BoE’s QE policy, in our view.

Given the current correction in asset markets and the recent       Source: Reuters Ecowin, Morgan Stanley
upward surprise to UK data we are proposing to close our
                                                                   The NOK’s sensitivity to asset markets is also declining, while
EURGBP long position at this stage. However, once again we
                                                                   interest rate dynamics have remained a major driving factor
believe that any further EURGBP setback is likely to be
                                                                   for the currency. This reinforces our view that the NOK will
temporary and will present a renewed opportunity to enter
                                                                   remain relatively well supported over the medium term,
more medium-term bullish strategies at more attractive levels.
                                                                   offering some protection from any asset market volatility.
                                                                   Moreover, given the more mixed signals from the BoC, the
Still Interest Rate Sensitive
                                                                   Norges bank is now left as clearly the most hawkish of the
While we have identified asset markets as a major driver for       G10 central banks.
FX markets in the current environment, there are a couple of
notable exceptions to this observation. As well as currencies      NOK and SEK - Structural, Cyclical and Flow
where valuations have been distorted by safe-haven flows           Divergence
(most notable GBP and SEK), we also find that the CAD and
                                                                   The stance of the Norges banks now contrasts sharply with
NOK have maintained relatively high betas to interest rates,
                                                                   that of the Riksbank, which has taken a significant turn to the
with sensitivity to asset markets currently declining. The CAD
                                                                   dovish side. The Riksbank has cut its growth and inflation
has highlighted its continued sensitivity to interest rates with
                                                                   forecasts significantly, while also lowering its repo rate
the reaction to the mixed signals from the BoC over the past
                                                                   projection. This coincides with the renewed weakness of
week. While the statement accompanying the BoC monetary
                                                                   leading economic indicators in Sweden, while the fact that
policy meeting still maintained a relatively hawkish tone, the
                                                                   international factors are now being cited for the dovish stance
market interpreted the comments from BoC Governor Carney
                                                                   also puts the focus on the SEK, we believe.
very differently, coming to a far more dovish conclusion,
leading to increased CAD volatility over the past week. But        We expect underperformance of the SEK as a result. There
once again we believe that USDCAD rebound will be                  has been a change in the historical performance of the SEK,
temporary and the dovish comments from the BoC will not be         which would normally be expected to perform in a more risk
reflected in a change of policy dynamics at this stage,            positive environment. Indeed, the use of the SEK as a safe
suggesting that the CAD will remain supported by the Fed’s         haven to developments in Europe is likely to prove a negative
implicit growth targeting policy response.                         factor over the medium term, especially once Spain accepts
                                                                   EU assistance, as we anticipate, allowing risk premiums in
                                                                   peripheral EMU to be reduced further, leading to an
                                                                   unwinding of safe haven flows.

                                                                   Hence, we remain positive on the NOKSEK, which we believe
                                                                   is supported by cyclical and structural factors as well as flows.

                                                                  MORGAN STANLEY RESEARCH

                                                                  October 25, 2012
                                                                  FX Pulse

Exhibit 7                                                         Exhibit 8
Swedish Rate Expectations and EURSEK                              CNY Appreciation is Supportive of EMFX Strength


                                                                   7.7                                                                       105




                                                                   6.2                                                                       85
                                                                    Jan-05    Jan-06   Jan-07   Jan-08   Jan-09   Jan-10   Jan-11   Jan-12

                                                                                   USD/CNY (LHS)                            USD/EM (RHS)
Source: Reuters Ecowin, Morgan Stanley                            Source: Morgan Stanley Research, Bloomberg

EMFX - Focus on Asia Positives Not European
Negatives                                                         We believe such flows will be maintained owing to the
                                                                  structural reallocation of portfolios towards EM. We have
Further tentative signs of stabilization in Asia’s macro          worked extensively on this topic, and estimate potential
fundamentals and global trade should be supportive of our         inflows of around US$2 trillion over the next 3-5 years (see
constructive but selective stance on cyclical EM currencies.      EM Profile: Small Fish in a Big Pond, May 2, 2012). In
This week, we saw China HSBC PMI tick higher to 49.1,             addition, market indicators remain favorable, with both our EM
Taiwan industrial production beat expectations at 6.5%Y for       funding stress index and EMFX volatility index touching on the
September, and exports from Thailand beat expectations at         lowest levels since January 2008.
0.2%Y for September. This builds on top of a positive stream
of data seen in preceding weeks. This, combined with              However, there are multiple risks on the horizon with residing
ongoing CNY appreciation, should keep EM currencies well          uncertainty over the timing of Spain’s eventual petition for aid
bid, despite the creeping risks seen in Europe over the past      and attention increasingly turning to the US election and the
week (see Exhibit 8).                                             potential impact on fiscal cliff discussions into year-end. In
                                                                  light of these risks, we continue to believe that the correct
The technical backdrop for EM currencies also remains             strategy is to be selective when buying EM currencies and we
supportive, and we think keeps risk/reward on long EM             prefer those that are supported by solid fundamentals.
positions as attractive. Last week, EPFR reported an inflow of
$1.4b into EM dedicated funds. This is the sixth consecutive      Our favorite currency is RUB, to which we see a strong
week with inflows above $1bn, and the first time in the series’   domestic story. Russian local government bonds (OFZs) are
history that EM has received inflows above $1bn for this          nearing the final stage of Euroclear entry, which we estimate
length of time.                                                   will result in an inflow of $20-30b over the next 1-2 years (see
                                                                  EM Strategy Comment: Russia Local Markets – Bullish as
                                                                  Euroclear Approaches, Oct 24). This adds to other reasons to
                                                                  be bullish on RUB, including a solid external balance,
                                                                  outperforming growth and a hawkish central bank – which we
                                                                  think will hike rates twice more over the coming six months.
                                                                  We enter long RUB/JPY in our FX Portfolio.

                                                                      MORGAN STANLEY RESEARCH

                                                                      October 25, 2012
                                                                      FX Pulse

G10: Current Account Adjustment and the Exchange Rate
Gabriel de Kock                                                       expect the external balance improvement to regain
                                                                      momentum in 2013. Morgan Stanley’s US Economics team
    Fiscal tightening in the G10 and ongoing efforts to shift EM     believes that most of the “fiscal cliff” will be postponed during
     economies from an export-driven to a domestic demand-led         the post-election lame-duck session in Congress, but that the
     growth model should accelerate global rebalancing in 2013.       elimination of the temporary payroll tax cut and the roll-off of
                                                                      American Recovery and Reinvestment Act spending could
    Market participants often differ in their assessment of the
                                                                      yield up to 1.5 percentage points of GDP in budgetary savings
     currency implications of global rebalancing – the narrowing of
     G10 current account deficits and EM surpluses.                   in 2013. And it is easy to imagines scenarios where the
                                                                      political stalemate in Washington results in more aggressive
    We show that the “Bretton Woods Model” in which current          and disorderly fiscal consolidation through sequestration of
     account surpluses (or falling deficits) drive currency
                                                                      budgetary outlays.
     appreciation does not apply to the G10, with free cross-
     border capital mobility and freely floating exchange rates.      Exhibit 1
                                                                      US & China Current Account Balances (% GDP),
    For many EM countries that intervene heavily in the FX
     markets to support a Bretton Woods II export-led growth
     model, current account surpluses still spell FX appreciation      7             US Deficit (Left)                                                12
     and vice versa.
                                                                                     China Surplus (Right)
                                                                       6                                                                              10
    In the G10, the currency implications of rebalancing largely
     depend on the shocks driving rebalancing. Consumer                5                                                                              8
     deleveraging and fiscal consolidation should be associated
     with currency depreciation.                                       4                                                                              6

    But rebalancing reflecting production increases, particularly     3                                                                              4
     of tradeable goods like oil, should appreciate the currency or
                                                                       2                                                                              2
     leave it unchanged.

    While G10 current account deficits typically are associated       1                                                                              0
     with prior FX appreciation, they also can be sources of FX            95       97     99     01      03      05    07        09        11
     vulnerability to shocks in global risk sentiment and financial   Source: Haver and Morgan Stanley Research
     intermediation if financed with short-term capital inflows.
                                                                      Exhibit 2
                                                                      Government Savings to Drive the Next Phase of US
                                                                      Current Account Adjustment, 1995—2Q 12
US and Global Rebalancing Set to Accelerate
                                                                           7             Sectoral Net Savings (% GDP)
Global rebalancing was a hot-button issue when the US
current account deficit surged to 6.4% of GDP in 2006. Since
then, however, rebalancing has proceeded apace in the US
and its most important EM trading partners. The US current               -1
account deficit has fallen by half, relative to GDP since 2006,
as consumers ramped up their savings to repair crisis-                   -5
damaged balance sheets and businesses hoarded cash in
response to disappointing market opportunities. China’s                  -9               Households
surplus has dropped even faster, reflecting a combination of                              Government
growth outperformance and gradually increasing reliance on             -13
domestically-driven expansion (Exhibit 1).                                     95    97      99      01      03    05        07        09        11
                                                                      Source: Haver and Morgan Stanley Research
The US current account improvement stalled after 2008, when
a steeply rising government deficit absorbed increases in             At the same time, we see limited downside to US household
household and corporate savings (Exhibit 2). (Recall that the         and corporate savings. The weak fall earnings season has
current account balance represents national savings.) But we          underscored that corporations face challenges on the profit

                                                                     MORGAN STANLEY RESEARCH

                                                                     October 25, 2012
                                                                     FX Pulse

front, but they also are most unlikely to expand capex               This “conventional” view harkens back to the Bretton Woods
aggressively in the midst of a slow-motion global recovery.          era when countries had fixed, but adjustable exchange rates
Household balance sheets remain in dismal shape, despite a
modest recovery in house prices and equities trading near
                                                                     Exhibit 3
four-year highs, suggesting the risk of a steep drop in the
                                                                     Wealth Collapse Puts a Floor Under Household
household savings rate is low (Exhibit 3).
                                                                     Savings (% Disposable Income), 1952-3Q 12E
The outlook for a further narrowing of the US external deficit is     6.5             Net Wealth/Disposable Income (Left)            0
far from unique. Indeed, fiscal consolidation, household                              Savings Rate (Right, Inverted)
balance sheet repair and cautious corporates signal                   6.0                                                            2
significant national savings gains core DM economies
including the UK, the euro area and Japan. Similarly, while           5.5
the transition to domestic demand-driven growth has been a                                                                           6
bumpy one in most EM countries, they continue to make                 5.0
progress. In short, we appear to be in the midst of a multi-
year, or structural, rebalancing of the global economy, which,        4.5                                                            10
in our view, will weaken G10 FX against EM currencies.
                                                                      4.0                                                            12
However, the US experience most likely will differ from that of             52 57 62 67 72 77 82 87 92 97 02 07 12
its G10 counterparts in one key respect. New technologies            Source: Haver and Morgan Stanley Research
that allow the cheap exploitation of shale oil and gas will,
according to some news reports (AP: US may soon become               Exhibit 4

world's top oil producer), turn the US into the world’s largest      US Net Oil (Energy) Imports and Current Account
petroleum producer by the end of this decade. More to the            Deficit (% GDP), 1995-2Q12
point, these technologies most likely will guarantee the US’s         7             Current Account
energy independence, which would cut the current account                            Net Oil Imports
deficit by nearly 2% of GDP (Exhibit 4). We’ll argue below
that this production shock will bolster the USD, in sharp             5
contrast to the contraction of domestic demand relative to            4
national income driven by fiscal consolidation and household
The Bretton Woods (II) Model
In discussions with market participants we sometimes run into
a view about the relationship between the current account and         0
the exchange rate that we believe simply does not apply to                95     97       99      01      03     05   07   09   11
the G10 world of huge international capital flows and freely         Source: Haver and Morgan Stanley Research

floating exchange rates.                                             and importantly, international capital mobility was limited. In
At the risk of erecting a straw man for easy demolition, we’ll       this environment, excessive domestic spending (or an
characterize this “conventional” view as follows: Large              overvalued exchange rate) leads to a trade deficit and hence
current account deficits signal future currency depreciation         a current account deficit. But since the government and
because the country in question has to borrow to finance it’s        central bank are committed to maintaining a fixed exchange
current account deficit and the bigger the deficit relative to the   rate, the central bank finances the deficit until it no longer is
size of the economy the bigger the haircut that foreign              willing or able to lose international reserves. At that point it
suppliers of capital demand to buy the deficit country’s             can devalue the currency, thus eventually correcting the
liabilities. Similarly, large surpluses imply a significant supply   deficit. Or it can set its currency afloat, forcing its citizens to
of foreign currency on the market and, hence, appreciation of        find financing abroad, which results in currency depreciation.
the exporter’s currency.                                             The “Bretton Woods model” also fits very well in the Bretton
                                                                     Woods II world in which EM central banks foster domestic
                                                                     industrialization by intervening in the FX market to keep their

                                                                                MORGAN STANLEY RESEARCH

                                                                                October 25, 2012
                                                                                FX Pulse

currencies undervalued, thereby providing a subsidy to                          became increasingly excited about the prospects of US high-
exporters at the expense of importers and consumers and                         tech and internet companies, allocating greater portfolio
running persistent current account surpluses. Reserve                           shares to American tech stocks.
managers, in turn, invest the intervention proceeds in the
                                                                                Exhibit 5
capital markets of DM importers, recycling the funds to
                                                                                China: Current Account Balance (% of GDP) and
finance the DM (primarily US) current account deficits.
                                                                                Real Trade-Weighted CNY, 1995-2Q12
In the Bretton Woods II world, persistent current account
                                                                                 125               Real Trade-Weighted CNY (Left)                           11
surpluses and (typically) unsterilized FX intervention
                                                                                 120               Current Account (Right)
eventually fuel inflationary pressure in the EM exporters.                                                                                                  9
These inflationary pressures, if unchecked, drive up domestic
                                                                                 110                                                                        7
prices and wages, effecting a real currency appreciation. Or,
as often has been the case, the EM central banks allow their                                                                                                5
currencies to appreciate, slowing domestic credit growth and
                                                                                  95                                                                        3
easing price pressures. Needless to say, political pressure
from DM authorities seeking to ease competitive pressure on                                                                                                 1
domestic producers has played a key role in the decision to                       85
allow EM FX appreciation.                                                         80                                                                        -1
                                                                                        95        97    99    01     03          05    07   09    11
Exhibit 5 uses the example of China to illustrate the                           Source: Haver, and Morgan Stanley Research
relationship between the current account balance and the real
trade-weighted exchange rate of an EM exporter in the                           Exhibit 6

Bretton Woods II system. However, the pattern is more                           US: Real Trade-Weighted USD & Current Account
generally true for EM countries, as our regression results in                   Balance (% GDP) 1989-3Q12
Exhibit 7 below confirm, since policymakers typically manage                     130                                                                            -7
their exchange rates to favor export industries or at least to                   125                                                                            -6
protect them from large and often reversible currency-driven                                                                                                    -5
competitiveness shocks. 1                                                                                                                                       -4
The G10 FX-Current Account Relationship                                                                                                                         -3
Now fast-forward to the G10 world of the first decade of the                     105
21st century. Central banks in the G10 hardly ever intervene
                                                                                 100                                                                            0
in the FX market, global capital markets are deep and capital
                                                                                  95                    USD (Left)                                              1
is highly mobile internationally. Crucially, investors can adjust                                       Current Account (Right, Inverted Scale)
cross-border portfolios instantaneously in response to new                        90                                                                            2
information, while trade flows and current accounts still                              89    91    93   95   97    99       01    03   05   07   09   11   13

respond to price signals with a lag associated with shifts in                   Source: Haver and Morgan Stanley Research

production. In this environment portfolio shifts and currency                   But, recall that the net exports of US financial assets over any
movements are in the drivers’ seat, with currency appreciation                  given period is limited by the US current account deficit. In
followed by a widening in the current account deficit and vice                  other words foreign investors had to “convince” US asset-
versa.                                                                          holders to sell USD assets in exchange for FX-denominated
A concrete example -- the US tech stock bubble and the rapid                    assets. And how did they “convince” them? With a greater
USD rise from late 1995 to early 2002 – is useful to illustrate                 demand for USD than the supply at the initial exchange rate,
the typical G10 FX-current account relationship illustrated with                they bid up the USD and tech stocks until enough holders of
US data in Exhibit 6. In the latter half of the 1990s, US firms                 USD assets were willing to make the exchange and, of
exploiting information technology generated very rapid                          course, some foreign buyers have been priced out of the
productivity growth and earnings gains. Investors worldwide                     market. The resulting rise in the USD made imports more
                                                                                attractive to US buyers and US exporters less competitive.
                                                                                As a result, the US trade deficit (and current account deficit)
  We used an EM sample including Brazil, Mexico, Chile, Poland, Turkey, South
Africa, China, Taiwan, Korea and Singapore to confirm this broader pattern,

                                                                                    MORGAN STANLEY RESEARCH

                                                                                    October 25, 2012
                                                                                    FX Pulse

surged, increasing the net supply of dollars (and USD-                              depreciation triggered by the decline in US yields would start
denominated assets) to satisfy foreign investors’ demand.                           to clear the market for US-produced goods and services.

The inverse relationship between the real trade-weighted                            Exhibit 7
exchange rate and the currency illustrated for the US in                            Regression Results on G10 and EM Current
Exhibit 8 is broadly true for the G10 currencies other than the                     Account-FX Relationships, 1989-2Q12
CHF and NOK. 2                                                                      Current Account Chg on Exchange Rate Chg
Finally, Exhibit 7 reports regression results to confirm that EM                                              Beta              T-stat   R-squared
current account surpluses typically lead to real currency
                                                                                    G10                       -0.02             2.11       0.07
appreciation, while in the G10 surpluses usually reflect the
impact of prior depreciation. The beta of 12-month real                             EM                        0.01              0.14       0.005
exchange rate changes on the current account balance at the
                                                                                    Exchange Rate Change on Current Account
beginning of the period is positive and statistically significant
for the 10 EM countries in our sample, confirming the Bretton                                                 Beta              T-stat   R-squared
Woods II relationship. In the G10, this beta is statistically                       G10                       0.05              1.27       0.04
insignificant, showing that the current account has no                              EM                        0.43              4.30       0.16
predictive power for the real exchange rate. Similarly, the
                                                                                    Source: Haver and Morgan Stanley Research
statistically significant negative beta of four-quarter G10
current account changes on the contemporaneous four-                                However, the depreciation needed to eliminate the excess
quarter real exchange rate changes support our view that in                         supply of US goods and services most likely would be
the G10 the real exchange rate is in the driver’s seat. In EM,                      significantly larger than the initial decline triggered by a
by contrast, real exchange rate changes do not drive shifts in                      smaller bond supply. Additional depreciation could occur via
the current account. With these relationships in hand we turn                       a nominal USD drop as the fiscal tightening dampens US
to the impact of rebalancing on the USD.                                            economic activity, driving down real interest rates and equity
                                                                                    prices and lifting capital outflows. Or it could reflect
Rebalancing and the USD
                                                                                    expansionary monetary policies aimed at supporting growth.
A narrowing of the US current account deficit largely driven by                     Falling US inflation relative to the US’s trading partners also
US fiscal tightening should weaken the USD on a real trade-                         would contribute to real depreciation. In EM exporters a
weighted basis. Indeed, this statements holds generally for                         mirror-image adjustment would take place over time as rising
any rise in US savings relative to investment, whether driven                       consumption largely falls on domestically produced goods and
by a shift in private savings behavior or government policy. 3                      services, resulting in excess demand that drives up the real
A fiscal tightening reduces US domestic demand and                                  trade-weighted exchange rate.
immediately decreases the supply of US government bonds                             A broad-based increase in US output, has the same general
sold to fund the federal budget, putting downward pressure on                       USD impact as a rise in private or government savings that
yields and undercutting the USD. 4 At the same time, since                          lowers domestic demand relative to GDP. But an increase in
US domestic demand largely is directed at US-produced                               the production of a tradeable good like oil that can be sold on
goods and services (imports make up less than 18% of GDP),                          world markets in large quantities is different. The income and
the fiscal tightening results in an excess supply of US goods                       wealth generated by its production (and by the increase in the
and services. Over time the real trade-weighted USD                                 value of exploitable land) raises demand for other US-
                                                                                    produced goods resulting in excess demand that eventually
                                                                                    drives a real currency appreciation. In fact, in our view, such
2                                                                                   a production increase could, in extremis, give the US a bout of
    Data available on request.
                                                                                    Dutch disease.
  Readers will recall a theoretical counterexample from their undergraduate
economics classes. If capital is not very mobile internationally, falling US        Current Account Funding and FX Vulnerability
interest rates may not lift capital inflows (lower outflows) enough to offset the
trade balance improvement brought about by falling import demand and the            Current account deficits are typically seen as a source of
USD would rise. This case not only is a curiosity in the post-globalization
environment, but also eventually would be overturned by falling US inflation or
                                                                                    currency vulnerability and surpluses as a source of resilience.
easier monetary policy.
                                                                                    But experience during the global financial crisis again
  An increase in private savings has the same effect by increasing the demand
for financial assets.
                                                                                    underscored that it is not just the size of current account

                                                                   MORGAN STANLEY RESEARCH

                                                                   October 25, 2012
                                                                   FX Pulse

imbalances that matter, but also how such imbalances are
funded and the resulting composition of external assets and

A surplus country that largely accumulates foreign real assets
through foreign direct investments will see little currency-
boosting repatriation flows in the event of a rise in risk
aversion, while countries that recycle surpluses in the form of
portfolio investments and bank loans, like Japan, can
experience unwanted repatriation flows and currency
appreciation in times of crisis. By the same token, countries
that rely on portfolio flows and short-term borrowing
experience bouts of acute currency weakness during times of
market stress (see Reversing Safe-Haven Flows: Sterling
Leads the Bearish Ranking, August 9, 2012).

Similarly, the global financial crisis taught us that many EM
economies running current account surpluses built up FX
reserve stocks while private citizens continued to borrow
abroad, often through syndicate loans that left them
vulnerable to a global bank deleveraging. In these cases, a
history of current account surpluses often left investors with a
false sense of security.

                                                                          MORGAN STANLEY RESEARCH

                                                                          October 25, 2012
                                                                          FX Pulse

EMFX Vol Exceptionally Cheap as Potential Tail Risks Approach
 Morgan Stanley & Co. LLC                      Juha Seppala               Exhibit 1
                                               +1 212 761-1949
                                                                          EMFX Vol, MS EM Funding Stress Index, and the VIX
                                                                           35                                                                   120

    In early October, EMFX vol fell below 9% for the first time in        30                                                                   100
     five years. There are at least two possible explanations for
     this recent downward trend.                                           25                                                                   80

    The first potential explanation is the global liquidity provided      20                                                                   60
     by DM central banks. Our second explanation is the reduced            15                                                                   40
     inflation volatility in emerging-market countries.
                                                                           10                                                                   20
    On the other hand, according to our EMFX vol fair value
     model, EMFX vol was exceptionally cheap in July 2011 and               5                                                                   0
     April 2012 – and it is again currently. In the previous two             Oct- Apr- Oct- Apr- Oct- Apr- Oct- Apr- Oct- Apr- Oct- Apr- Oct-
                                                                              06   07  07    08   08   09  09    10  10    11   11   12  12
     episodes, EMFX vol spiked up within the next 1-4 weeks.
                                                                                      EMFX Vol           EMFSI (RHS)     VIX (RHS)
     Could that happen again?
                                                                          Source: Morgan Stanley Research, Bloomberg
    There are clearly several potential tail-risk events in the near
                                                                          This can also be seen in Exhibit 1, where we show how well
     term: (i) the presidential election and fiscal-cliff issues in the
     US, (ii) a potential reemergence EMU breakup concerns in             both EMFSI and the VIX equity volatility index have predicted
     Europe, and (iii) the leadership transition in China.                EMFX vol in the past, especially around the 2008-2009
                                                                          financial crisis. This is especially true when EMFSI is above
    Deep out-of-the-money USD call / EM put spreads offer an
                                                                          the critical level of 20. It fell below that level on August 14,
     attractive vehicle to hedge against tail risks. We make three
                                                                          and this was the first time since November 2011. We earlier
     such recommendations against: (i) the risks in the US (3m
                                                                          highlighted this development in FX Pulse: Volatility,
     USD call / MXN put spread with strikes at 13.5 and 14),
     (ii) risks in Europe (3m USD call / HUF put spread with              Correlation, and Risky Assets: The PCA+ Update (August 16).
     strikes at 230 and 240), and (iii) risks in Asia (3m USD call /      We also highlighted in this article that the VIX fell below 14,
     KRW put spread with strikes at 1150 and 1175).                       that is, to the lowest level in five years. Since then the VIX has
                                                                          increased above the level of 18.

Low for Long?                                                             We do not have a definite answer on why FX vol is so low at the
                                                                          moment. However, there are at least two possible explanations.
October 16, 2012, was an important date, although it passed               First, the global liquidity provided by DM central banks is
without much notice. On that date, our EM Funding Stress                  probably an important element. The global liquidity provision has
Index fell below the level of 14 for the first time since January         sent flows towards EM countries as lower DM rates have made
2008. And even in January 2008, MS EMFSI was below the                    EM markets more attractive, especially EM local markets.
level of 14 for only one day. The previous time EMFSI was
below 14 for several days in a row was in August 2007.                    These flows have had a dampening effect on volatility, both
                                                                          because they reduced the downside on the long EMFX
Similarly, EMFX vol (calculated as an average of 3m implied               positions and because EM central banks have responded to
vol of 13 EM currencies) fell below 9% in early October for the           currency appreciation by weak-side intervention measures –
first time since October 2007, that is, for the first time in five        thus reducing the upside on the long EMFX positions.
years. This obviously raises several important questions. Why
are the vols so low? What will happen in the near future?                 The second explanation is the reduced inflation volatility in
Does this suggest any obvious trade opportunities?                        emerging-market countries. This has allowed EM central
                                                                          banks to move to the direction of Central Bank of Brazil, which
The observation highlighted in the first paragraph about                  in its latest statement mentioned the desire to keep rates “low
EMFSI is an important one, as we have previously shown that               for long.”
EMFSI has been a powerful tool in predicting future evolution
of EM asset prices (see EM Profile: Monitoring Funding
Markets – EM Funding Stress Index, December 7, 2011).

                                                                                MORGAN STANLEY RESEARCH

                                                                                October 25, 2012
                                                                                FX Pulse

Exhibit 2                                                                       Exhibit 3
EM Inflation Realized Volatility vs. EMFX Implied Volatility                    EMFX Vol Fair Value Model
 40                                                                        30     Currency         Current 3m vol Fair 3m vol                    Rich/Cheap
 35                                                                        25        BRL                   8.19                12.06           47% Cheap          ▲
                                                                                     CLP                   9.14                9.64            5% Cheap           ▲
 30                                                                        20
                                                                                     COP                   8.46                9.76            15% Cheap          ▲
 25                                                                        15        HUF                   8.04                9.30            16% Cheap          ▲
 20                                                                        10         IDR                  7.41                9.65            30% Cheap          ▲
                                                                                      ILS                  7.86                6.60             16% Rich          ▼
 15                                                                        5
   Feb- Aug- Feb- Aug- Feb- Aug- Feb- Aug- Feb- Aug- Feb- Aug- Feb- Aug-
                                                                                      INR                  11.17               12.40           11% Cheap          ▲
    06 06 07 07 08 08 09 09 10 10 11 11 12 12                                        KRW                   6.86                11.02           61% Cheap          ▲
       EM Inflation Vol       EMFX Vol (RHS)
                                                                                     MXN                   10.68               9.89             7% Rich           ▼
Source: Morgan Stanley Research, Bloomberg
                                                                                     PHP                   6.00                7.09            18% Cheap          ▲
“Low for long” policy clearly has reduced bond volatility, and                       PLN                   7.75                8.72            13% Cheap          ▲
as we wrote earlier, in the context of low G10 FX volatility,
                                                                                     RUB                   10.31               9.94             4% Rich           ▼
central bank efforts to cap long-term rates suppress both the
                                                                                     SGD                   5.04                6.24            24% Cheap          ▲
bond volatility and the volatility in other markets (see FX
Pulse: G10: The Valley of the Vols, July 12, 2012).                                  TRY                   7.83                11.75           50% Cheap          ▲
                                                                                     ZAR                   16.91               17.61           4% Cheap           ▲
Exhibit 2 displays GDP-weighted realized EM inflation                           Source: Morgan Stanley Research, Bloomberg
volatility, calculated using a 2y rolling window of monthly
                                                                                Exhibit 4
headline inflation, against EMFX implied volatility. Correlation
                                                                                EMFX Vol Model Relative Cheapness (-) or Richness (+)
is 0.42. While in the past, especially around the 2008-2009
financial crisis, inflation volatility has lagged EMFX volatility,                20%
now it seems that the reverse is true. Recent spikes in EMFX                      10%
volatility have been related to DM scares (the US debt ceiling
debate, possible EMU breakup) and not to concerns about
EM inflation.                                                                    -10%

Yes, EMFX Vol Is Low, But Is It Cheap?
According to our EMFX vol fair value model, yes Virginia,
EMFX vol is very cheap (see EM Profile: How to Value EMFX                              Jan- Apr-    Jul-    Oct-   Jan- Apr-   Jul-   Oct-   Jan- Apr-   Jul-   Oct-
Implied Vol?, June 28, 2010). Exhibit 3 shows the most recent                           10   10      10      10     11   11     11    11      12   12     12     12
model fair value assessments. EMFX vol, particularly in AXJ,                                EMFX     AXJ

is very cheap. The next obvious question is if the model is any                 Source: Morgan Stanley Research

good.                                                                           We previously highlighted July 2011 and April 2012
To answer this question, Exhibit 4 display time series of how                   undervaluations in real time in EM Quantitative Strategy
rich (+) or cheap (-) the model considered EMFX vol in                          Update: Go with the (EM) Flow (July 28, 2011) and FX Pulse:
general and AXJ vol in particular to be. According to the                       Take Advantage of Low EM Currency Volatility (April 26,
model, vol was exceptionally cheap in July 2011, April 2012,                    2012). We conclude that, at least as an extreme value
and currently (in the sense of AXJ FX vol being more than                       indicator, the aggregated model has some value.
30% undervalued and EMFX vol being more than 15%
undervalued). In the previous two episodes, EMFX vol spiked                     Could EMFX Vol Spike Up Again?
up within the next 1-4 weeks. May and October 2010 spikes                       One way to interpret the record low vols is that they are signs
were also preceded by extreme EMFX vol cheapness.                               of Complacency, not a sign that the Crisis has passed, in the
                                                                                sense of the CRIC cycle (see Japan Economics: Politics and

                                                                   MORGAN STANLEY RESEARCH

                                                                   October 25, 2012
                                                                   FX Pulse

Policy in 2009: Caught in the CRIC Cycle, January 7, 2009).        Exhibit 5
There clearly are several potential risks in the horizon.          USD/MXN and Call Spread BE (Strikes at 13.5 and 14)
The most obvious is the US presidential election on                 14.5
November 6 and the approaching fiscal cliff negotiations. The
August 2011 debt-ceiling debate provides some                       14.1
foreshadowing of what the near future could hold. MSCI EM
equity index fell 28% in two months, USD/EM lost                    13.7
approximately 10% of its value, and the EMBI credit spread
widened from 300bp to 489bp, again in two months.                   13.3

In EM FX Strategy Update: EM FX in 2011 – A
Contemporaneous Approach (January 13, 2011), we found               12.9
MXN to be the EM currency which is most correlated with the
S&P 500, that is, with US political and economic risks. In          12.5
                                                                       Jan-12 Feb-12Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12
addition, positioning in MXN seems to be quite crowded, at
                                                                   Source: Morgan Stanley Research, Bloomberg
least relative to historical levels.
                                                                   Exhibit 6
Hence, 3m out-of-the-money USD call / MXN put spread with
strikes at 13.5 and 14 could be attractive tail-risk hedges for    USD/HUF and Call Spread BE (Strikes at 230 and 240)
the US election and fiscal cliff. We found the cost to be 0.65%     250
and the maximum upside (net of costs) to be 2.92%,                  245
suggesting a maximum-reward / maximum-loss ratio of 4.5.
The breakeven exchange rate is at 13.59, while the spot is
12.97. Exhibit 5 shows how the breakeven compares to                235
historical spot levels. Given the call spread’s tail-risk hedge     230
nature, it is certainly possible that USD/MXN will not reach the
breakeven level. In that case, the maximum cost is the upfront
fee of the option structure, 0.65% of the notional.                 220

Another potential source for big tail risk events is EMU
breakup. In EM Profile: Hedging Against a European Selloff          210
                                                                      Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12
(January 24, 2012), one of the worst currency performers
                                                                   Source: Morgan Stanley Research, Bloomberg
around Europe-related risk events was HUF. Exhibit 6
displays USD/HUF cross-rates this year, together with the          Exhibit 7
breakeven rate of 232 for 3m USD call / HUF put spread with        USD/KRW and Call Spread BE (Strikes at 1150 and 1175)
strikes at 230 and 240 (cost = 0.88%, maximum upside =
3.29%, reward/risk = 3.7). Similar to the MXN structure, the
maximum cost is 0.88% of the notional.
Finally, the Chinese leadership transition remains a big
question mark. Given that Korea has the most undervalued
FX vol, according to our model, and it is highly exposed to
potential Chinese problems, it would be a natural tail-risk         1140
hedge. Exhibit 7 displays USD/KRW exchange rate and the
breakeven rate of 1152 for 3m USD call / KRW put spread             1120
with strikes at 1150 and 1175 (cost = 0.2%, maximum upside
= 1.93%, reward/risk = 9.6). Again, the risk is that the upfront
cost of 0.2% won’t be received back.                                      Jan-12 Feb-12Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12
                                                                   Source: Morgan Stanley Research, Bloomberg

                                                                           MORGAN STANLEY RESEARCH

                                                                           October 25, 2012
                                                                           FX Pulse

Strategic FX Portfolio Trade Recommendations
Evan Brown, Marc Englander

  23 Oct 2012           Entered: 2.5550, Stop: 2.4900, Target: 3.1500                           Oil Exports Support Russia’s economy

                        We remain bullish RUB as it is one of the few currencies in           150

                        the world benefitting from a hawkish central bank. Moreover,          100
     Enter:             the currency’s sensitivity to oil prices means it will be one of        0

     Long               the main beneficiaries of stabilizing global growth. We stay           -50

    RUB/JPY             bearish JPY as pressure mounts on the BoJ to take more                -150
                        aggressive action to weaken the currency.                                Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
                                                                                                        Goods                         Services                    Income
                                                                                                        Transf ers                    C/A                         Financial Account

  15 Oct 2012           Entry: 1.2580, Stop Tightened: 1.2800, Target: 1.1000                 AUD/NZD Tracking AUS-NZ Swap Spread
                        Despite some stabilization in the Asian growth outlook, our           0.7                                                                              1.31

                        commodity strategists remain bearish iron ore prices.                 0.6

     Enter:             Meanwhile, they are generally bullish food prices going into                                                                                           1.28
     Short              next year, suggesting an AUD/NZD short position. Moreover,            0.3

    AUD/NZD             new RBNZ Governor Wheeler did not shift to a more dovish              0.2                    AUS 3yr vs NZ 3yr Swap                                    1.25

                        stance this week, while we expect the RBA to continue easing
                                                                                              0.1                                                                              1.24

                        in the near term.                                                      Jun-12             Jul-12           Aug-12          Sep-12        Oct-12

                        Entered: 1.2850, Take Profit at: 1.2980
  27 Sep 2012                                                                                                        Peripheral 10y Yields
                        Limit Order: 1.2775, Stop: 1.2700, Target: 1.3400
                        We closed our long EUR/USD trade, booking a profit of                 7.5
     Close:             $100k, and now wait for a dip to re-establish the trade. We              7
      Long              decided to take profit earlier this week as Spain is taking its       6.5
    EUR/USD             time to apply for EMU financial assistance, raising tail-risks.          6

                        Despite the OMT in place, the market may not tolerate Prime           5.5
  Limit Order:
 Buy EUR/USD            Minister Rajoy’s complacency. Nevertheless, we would re-                 5

                        enter our position at lower levels as Spain may apply for funds       4.5
                                                                                                     1/1                    4/1                    7/1                  10/1
                        by early November. We maintain our year-end target of 1.34.
                                                                                                 JPY Supported by Easily Reversible
  24 Sep 2012           Entered: 78.00, Raise Stop to: 78.50, Target: 85.00                                   Flows
                        We think central bank policy will stay in focus ahead of the          200
                                                                                                                      MMI Inflows
                                                                                                                      Short Term Private Sector External Debt
                        October 30 BoJ outlook review. Political pressure is                                          JPY TWI (RHS)
     Hold:                                                                                    160
                        increasing on the BoJ to act and pull Japan out of deflation.                                                                                            160
     Long                                                                                     140                                                                                150

    USD/JPY             This may mean aggressive JPY-weakening policies in coming             120                                                                                140
                        months. Meanwhile, Japanese banks have been buying an                 100

                        increasing share of JGBs. As a result, rising JGB yields could         80
                        destabilize bank balance sheets, further pressuring JPY. We            60                                                                                100
                                                                                                 2003      2004      2005   2006    2007    2008   2009   2010   2011     2012
                        raise our stop to protect profits.
Source for all charts: Bloomberg, Haver, EcoWin

                                                                        MORGAN STANLEY RESEARCH

                                                                        October 25, 2012
                                                                        FX Pulse

Strategic FX Portfolio Trade Recommendations
  10 Aug 2012           Entered: 0.7850, Close at 0.8020 stop or Fri WMR                        GBP Stands to Correct Recent Highs

                        With signs of complacency in Europe and signs of a modest
    EUR/GBP             rebound in the UK economy, we look to take off our EURGBP
                        longs for now.

  09 Aug 2012           Entered: 20.50, Stop: 21.50, Target: 18.00                                                                 Mexico PMIs
                                                                                                              Manufacturing and Non-Manufacturing PMIs
                                                                                                                     (Seasonally adjusted, diffusion indices, 3mma)
                        We remain constructive on MXN due to Mexico’s positive             58

     Hold:              growth story, as well as the Mexican policy-makers’ tendency       56


     Short              to intervene less in currency markets than their peers in          52

    GBP/MXN             LatAm. We like to fund this trade with GBP, as we forecast         50


                        general sluggishness in the UK economy and a reversal of           46

                        safe haven flows in the near term.                                 44             Non-manufacturing

                                                                                                Jan-   Jul-   Jan-   Jul-   Jan-   Jul-   Jan-   Jul-   Jan-   Jul-   Jan-   Jul-   Jan-   Jul-   Jan-   Jul-
                                                                                                 05     05     06     06     07     07     08     08     09     09     10     10     11     11     12     12

                                                                                                                     Swiss External Assets:
                        Limit Order: 82.00, Stop: 80.60, Target: 92.00                                               High Proportion of FDI
                        This long-term trade reflects differences in the structure of
                        flows in Switzerland and Japan. Over the next few quarters,
  Limit Order:
     Long               we expect the EURCHF peg to break, and CHF to re-join JPY
    CHF/JPY             as a traditional safe haven. As discussed in our piece JPY:
                        Trading Potential Intervention, Japanese outflows are mostly
                        short-term and hedged, whereas Swiss external assets are
                        more structural in nature. Bottom line: official attempts to
                        weaken JPY will likely be more successful than in CHF.
  02 Aug 2012           Spot: 1.5552, Strike: 1.5112, Cost: 0.60%                                                    UK PMI Manufacturing

                        We stay bearish on the UK economy over the medium term,            60
                        as the country endures ongoing public and private                  55
                        deleveraging. Meanwhile, safe haven flows could reverse out        50

                        of the UK over time, especially if the country is downgraded
                        (see GBP Events Risks Loom, October 11, 2012).                     35

                                                                                            Mar-06 Dec-06 Sep-07 Jun-08 Mar-09 Dec-09 Sep-10 Jun-11 Mar-12

Source for all charts: Bloomberg, Haver, EcoWin

                                                                                                                                                     MORGAN STANLEY RESEARCH

                                                                                                                                                     October 25, 2012
                                                                                                                                                     FX Pulse

Strategic FX Portfolio
                                                                                    Nominal                                                                                                                                                Carry         Portfolio
Trade Recommendation                                Notional                        Weight                  Entry Date                 Entry Level              Current                Stop             Target           Spot P&L          P&L          Contribution
Closed Trades
Long EUR/USD                                                       $10.0mn                                      27-Sep-12                     1.2850            Took profit on 23-Oct at 1.2980                             $101.2k         -$1.5k           $99.6k
Long EUR/GBP                                                       $10.0mn                                      10-Aug-12                     0.7850                             Will take profit at 0.8020 stop or Oct 26 WMR
Active Trades
Short GBP/MXN                                                      $10.0mn                     9.4%             09-Aug-12                       20.50                    20.84               21.50           18.00         -$163.1k        $85.2k            -$78.0k
Long USD/JPY                                                       $10.0mn                     9.8%             24-Sep-12                       78.00                  80.15                 78.50           85.00          $273.1k         $2.0k           $275.1k
Short AUD/NZD                                                      $10.0mn                     9.5%                16-Oct-12                  1.2580                   1.2611           1.2800              1.1000           -$23.7k        -$0.8k           -$24.4k
Long RUB/JPY                                                       $10.0mn                     9.6%                23-Oct-12                  2.5550                   2.5697           2.4900              3.1500            $58.9k        $3.6k            $62.4k
Limit Orders
Buy CHF/JPY                                                        $10.0mn                                                                      82.00                    86.23               80.60           92.00
Buy EUR/USD                                                        $10.0mn                                                                    1.2775                   1.3016           1.2700              1.3400
Cash                                                               $54.1mn               51.7%
Portfolio Mark to Market                                         $104.4mn
Source: Morgan Stanley Research
*Stops for all trades are based on spot
Notes: (1) Stops are based on the WMR fixing. (2) The portfolio represents hypothetical, not actual, investments. For more details regarding calculations, please see “Reading FX Tactical Trade
Performance” at the back of FX Pulse. Our FX Performance Data Package contains complete performance statistics. (3) Reported returns are unleveraged. (4) In the case that trade allocations are
increased, entry levels are a weighted average. * Global Risk Demand Index – US Pat. No. 7,617,143. We updated our methodology for our portfolio recently (FX Pulse: Watching Europe, October
13, 2011).
Performance on Recommended Discretionary Currency Portfolio and Market Benchmark
 Simple return, index

 130                                                                                                                                                                             MXN
 115                                                                                                                                                                             RUB

 110                                                                                                                                                                             AUD
                                                                                                                                          MS FX Strategic Portf olio             JPY
 100                                                                                                                                      Barclay Currency Fund Index
  95                                                                                                                                                                             GBP

  90                                                                                                                                                                                   -20            -10            0                10    20
   Apr-04     Oct-04    Apr-05    Oct-05   Apr-06    Oct-06   Apr-07   Oct-07   Apr-08    Oct-08   Apr-09     Oct-09   Apr-10    Oct-10     Apr-11     Oct-11   Apr-12                                      Now          Last Pulse        USD

Simulated Managed Account Monthly Gross Performance - %
       Year                Jan                 Feb                 Mar                   Apr                May                 Jun                  Jul                 Aug                 Sep              Oct                 Nov            Dec      Year return
       2004                                                                                                 2.03            -0.73                    1.42                -1.07               -0.90            0.23               0.80            0.44       1.57%
       2005                0.28                0.11                0.68              -0.63                  2.08                1.39                 -0.20               1.84                1.62             0.15               0.85            0.17       8.35%
       2006               -1.11                1.70                4.36              -0.37                  1.24            -0.44                    0.52                -1.47               -0.85            -0.84              -0.58       -0.01          2.16%
       2007               -0.75               -0.77                -1.08             0.94                   0.36            -2.02                    1.07                2.75                1.26             0.45               1.16            0.18       3.56%
       2008                1.07                2.25                2.72              -1.41              -0.53                   1.28                 -0.17               -0.24               -0.86            3.12               0.62            0.87       8.72%
       2009                0.74               -0.97                -0.15             -1.09                  0.50            -0.87                    0.30                0.22                2.00             0.77               1.27            0.55       3.27%
       2010               -0.01               -0.27                1.71              1.13                   1.39            -0.86                    -2.36               0.95                0.67             -0.30              0.13            0.66       2.83%
       2011               -1.20                0.29                -1.71             0.51               -1.11               -0.33                    0.84                -1.02               0.50             -1.03              -0.18           0.44       -4.00%
       2012                0.32                0.47                -0.43             0.49                   1.76            -0.43                    0.20                0.56                0.42             0.67                                          4.03%

Options Trades
Trade Recommendation                          Notional           Entry Date         Expiry Date               Strike             Entry Spot             Entry Vol           Entry Cost             Current Spot          Current Vol  Current Cost   P&L
Active Trades                                                                                                                                                                                                                         Total P&L: $204.5k
Long GBP put/USD call                               $10.0mn        02-Aug-12             02-Nov-12                 1.5112               1.5552                  8.21%            0.60%                      1.6121              7.97%        0.00%    -$60.2k
Source: Morgan Stanley Research; see notes above.

                                                                                                              MORGAN STANLEY RESEARCH

                                                                                                              October 25, 2012
                                                                                                              FX Pulse

G10 Currency Summary
Calvin Tse and Dara Blume
                USD                                 USD Funding                                        Neutral      Watch: Q3 GDP, Case Shiller, ADP, Claims, PMI, ISM, Payrolls

                -3.7%                               Encouraging growth signs in the globe’s largest economies should support risk sentiment and as such, weigh on USD. Real
                                                    estate prices continue to rise, benefitting American consumers and slowing the pace of deleverage. On the other side of world,
               we are seeing heavy inflows into Asian economies, notably China and Hong Kong, also supporting growth. In the US, there are
                                                    important pieces of data to watch, including Q3 GDP, ADP, ISM, and payrolls. Strong data should further undermine the USD.
                EUR                                 Tightening Spreads                                 Bullish      Watch: Flash CPI, Unemployment, PMI, German Retail Sales

                  5.7%                              Global central bank easing and the resulting “green shoots” in the global economy should support growth in the eurozone.
                                                    Additionally, encouraging headlines from PM Rajoy that he stands ready for OMT activation suggests to us that yields will
               continue to tighten in advance, further propping up the common currency. Lastly, Draghi’s speech defending ECB policies to
                                                    the German Parliament went smoothly, suggesting to us approval of peripheral aid as early as next month.
                 JPY                                Awaiting More Easing                               Bearish      Watch: National CPI, Retail Trade, Jobless Rate, IP, BOJ, PMI

                  1.1%                              Ahead of the October 30 BoJ meeting, speculation concerning further monetary easing is doing the rounds. Indeed, the
                                                    Nikkei reported that the BoJ may increase the APP by JPY10trn at its next meeting. Additionally, Kyodo reported that the
               government will introduce a JPY400bln stimulus package. The weekly MOF security flow data showed a net JPY252bln
                                                    outflow, the second weekly outflow. As such, we think conditions are ripe for further JPY weakness.
                GBP                                 Sell Rebounds                                      Bearish      Watch: Mortgage Approvals, Consumer Confidence, PMI

                  1.6%                              GBP has been supported by its strong GDP reading, which was driven by services, manufacturing, and Olympic ticket sales.
                                                    While this, along with remarks by the BoE’s King earlier in the week, could cause markets to scale back some expectations of
               central bank asset purchases, we remain bearish on the currency. We still expect the government to miss its OBR targets,
                                                    and as the UK’s weak fiscal foothold comes to light in the December Autumn budget statement, we look for GBP to decline.

                 CHF                                Floor to Hold                                      Bullish      Watch: KoF Leading Indicator, Retail Sales, PMI

                -4.7%                               The SNB remains committed to its 1.20 EURCHF floor as it aims to bring inflation towards the 2.0% target. While the Swiss
                                                    economy remains relatively robust despite the slowdown in the Euro Area, a strong exchange rate has kept inflation muted.
               As the economy picks up, this could change should domestic pricing pressure rise. Over the coming week we will watch the
                                                    KoF indicator which has been steadily increasing, and see if it continues to diverge from the declining PMI reading.

                CAD                                 Hawkish, But With Delays                           Neutral      Watch: Industrial Product Price, GDP, Employment

                -1.0%                               The BoC included the ‘withdrawal of stimulus’ phrase in its press statement this week, surprising markets after dovish
                                                    comments by Carney last week. However, Carney tempered this news by saying in a press conference that though hikes
               would likely be needed, they were not as imminent as they had been in the past. Nonetheless, with most other G10 central
                                                    banks in cutting mode, CAD should see support from the central bank’s hawkish bias.
                AUD                                 Tactically Long                                    Neutral      Watch: Building Approvals, Private Sector Credit, Terms of Trade

                -1.4%                               Strong Asian data continues to support AUD. Chinese data has picked up while the HKMA has intervened for the first time since
                                                    Dec. 2009 to stem HKD strength, indicating strong risk appetite. Support for risky assets, particularly in Asia, will support AUD in
               the near term. Furthermore, Australian CPI came in well above expectations, causing markets to price out easing expectations
                                                    somewhat, supporting AUD. However, we remain wary of the currency over the longer term as the commodity supercycle ends.
                 NZD                                A New Governor                                     Neutral      Watch: Building Permits, M3

                  0.7%                              The RBNZ remained on hold as expected at its recent meeting. This was the first meeting for Governor Wheeler, and
                                                    markets had anticipated a somewhat more dovish tone. However, the tone was slightly more hawkish, and the bank did not
               express concern over the recent soft CPI reading as some had expected they would. With a slightly more hawkish central
                                                    bank, supportive risk appetite, and an expanding domestic economy, NZD has room to rally in the near term.

                 SEK                                Switch in Tone                                     Bearish      Watch: Trade, Retail Sales, PMI

                -4.1%                               In line with our expectations, the Riksbank left rates unchanged at 1.25%. That said, the central bank also opened the door
                                                    wide for cuts in December. Indeed, after being on a tightening bias all year, the central bank has now flipped stance, noting
               that "it is now more probable that the repo rate will be cut rather than being raised during the winter". High exposure into a
                                                    rapidly slowing eurozone and low inflation will likely catalyze a cut, furthering weakening SEK.
                NOK                                 Watching Norges                                    Neutral      Watch: Retail Sales, Norges Bank, PMI, Unemployment Rate

                -6.4%                               This will be an important week in Norway, with much economic data to digest. The key highlight will be the Norges Bank rate
                                                    decision. Along with the RBNZ and BoC, the Norges Bank is the only other major central bank with a tightening bias. Should
               they reaffirm this tightening view, we like long NOKSEK positions to play the divergence of growth and rates within

Charts are 3M performance against USD, as normally quoted                                                                                                                              18
                                                                                                            MORGAN STANLEY RESEARCH

                                                                                                            October 25, 2012
                                                                                                            FX Pulse

EM Currency Summary
EM Strategy Team


CNY        Neutral    -2.0%   External demand improvements, stronger demand from domestic firms, and capital inflows have helped
                                                                     drive further appreciation in CNY.

INR        Neutral    -0.1%   Prospects for structural reform likely to benefit the currency in coming months. Cyclically, INR is one of the
                                                                     cheapest in the EM universe from a valuation perspective.

IDR        Bullish    -2.7%   Indonesia’s current account is moving deeper into deficit. That said, IDR's capital account may stabilize
                                                                     under a global reflation (despite heavy foreigner positioning).
                                                                     KRW should benefit in the near term from a reflationary rally. But its macro dynamic of below-trend GDP
KRW        Bearish    1.4%    growth and external surplus is neutral for the KRW in the medium term.
                                                                     We think that MYR should lead to a reflationary rebound because of its open economy. In addition, the
MYR        Bullish    -3.1%   MYR may receive a terms-of-trade boost if we see a commodity rally.

PHP        Bullish    -3.4%   PHP should be supported by a relatively stable BoP and improving credit outlook.

SGD        Bullish    -1.3%   SGD should benefit from a global reflation because of its open economy.

                                                                     THB is supported by the positive macro dynamic conditions, even though the THB is overvalued and
THB        Bullish    -2.1%   susceptible to weaker external demand conditions.
                                                                     TWD will likely be vulnerable due to the weak global cycle and its negative carry. However, we believe that
TWD        Bullish    -2.6%   its cheap valuation should provide a margin of safety.
                                                                     CZK is one of the most attractive shorts. The economy is weak and with policy rates already at 0.25%, the
CZK        Neutral    -2.8%   CNB has indicated it may weaken the currency to stimulate growth.
                                                                     Progress on an IMF deal has been slow, and headline risk on EUR/HUF is high at present, though we
HUF        Bearish    -7.0%   think a deal can be reached in time and therefore maintain our 270 end-year target.
                                                                     The most recent macro releases have shown signs of modest improvement; however, given ongoing
ILS        Bullish    -6.1%   regional security risks and the currency's low beta/carry, we stay neutral.
                                                                     With domestic data continuing to show signs of economic slowdown, the probability of a cut in the
PLN        Neutral    -5.4%   upcoming meeting has risen. However bond inflows remain strong.
                                                                     RON continues to underperform, with external deleveraging and political risks weighing on the currency.
RON        Neutral    0.1%    With less intervention from the NBR, we stay slightly underweight RON.
                                                                     RUB remains very volatile and sensitive to oil prices. However, we still see the fundamental story as
RUB        Bullish    -5.9%   compelling, and with more hikes in the pipeline we stay long RUB/JPY
                                                                     The currency remains highly sensitive to headlines surrounding labour market unrest. In light of this and
ZAR        Bullish    -3.7%   deteriorating fundamentals, we keep to an underweight stance.
                                                                     The Central Bank of Turkey's flexible monetary policy approach has prevented aggressive speculation
TRY        Bearish    6.2%    against the currency. We expect this newfound low beta status to remain in place.
                                                                     NDF-implied yields have come down significantly, suggesting a 20% of devaluation this year. We expect
ARS        Bearish    3.6%    this to be closer to reality, and continue to believe the ARS is likely to depreciate at a faster pace.
                                                                     NBP kept rates on hold for October which should help support the currency over the coming month,
BRL        Neutral    0.3%    particularly given the expansion of the ECB’s bond buying programme.
                                                                     We expect MXN to continue outperforming its peers, given its beta to risk and the country’s strong
MXN        Bullish    -2.7%   fundamentals. We recommend going long funded using JPY.
                                                                     CLP has moved sideways on the back of intervention fears at current levels. We see limited room for
CLP        Bullish    -1.9%   further gains as intervention risks are likely to weigh on the currency.
                                                                     COP continues to be well supported by strong FDI inflows, which has triggered strong intervention from the
COP        Neutral    0.4%    CB and the government. In our view, aggressive intervention is likely to push USDCOP higher.

PEN        Bullish    -1.5%   We believe that strong-side intervention is likely to stall further strengthening.

*3-month history

                                                                                    MORGAN STANLEY RESEARCH

                                                                                    October 25, 2012
                                                                                    FX Pulse

Global Event Risk Calendar
Dara Blume
Date   (GMT)             Ccy   Time     (GMT)   Event                                                  Ref. Period         MS forecast   Market    Previous
       26-Oct Fri
                        CHF    08:00            KOF Leading Indicator                                                Oct                    1.63       1.67
                        COP      NA *           BanRep Rates Decision                                                           4.75%     4.75%      4.75%
                        JPY    00:30            CPI                                                              Sep                     -0.4%Y     -0.4%Y
                        MXN    15:00            Banxico Rates Decision                                                          4.50%     4.50%      4.50%
                        SEK    08:30            Trade Balance                                                    Sep                        6.0B       3.3B
                        USD    13:30            GDP (Prelim)                                                      3Q           1.8%Y      1.9%Y      1.3%Y
                        USD    14:55            U. of Michigan Confidence (Final)                                Oct                        83.0       83.1
       28-Oct           JPY    23:50            Retail Trade                                                     Sep                                1.5%M
       29-Oct   Mon
                        GBP    09:30            Mortgage Approvals                                               Sep                                 47.7K
                        ILS    15:30            BoI Rates Decision                                                                        2.25%     2.25%
                        JPY    23:30            Jobless Rate                                                     Sep                                4.20%
                        SEK    08:30            Retail Sales                                                     Sep                               -0.4%M
                        USD    12:30            PCE Core                                                         Sep                                1.6%Y
                        USD    14:30            Dallas Fed Manufacturing Survey                                  Oct                                   -0.9
       30-Oct   Tue
                        EUR    08:00            Spanish GDP (Prelim)                                                 3Q                             -0.4%Q
                        EUR    10:00            Consumer Confidence (Final)                                          Oct                               -25.6
                        HUF    13:00            MNB Rates Decision                                                              6.25%     6.25%       6.50%
                        INR    05:30            RBI Rates Decision                                                              8.00%     8.00%       8.00%
                        JPY    23:15            PMI                                                                  Oct                                48.0
                        JPY      NA *           BoJ Rates Decision                                                              0.10%     0.10%      0.10%
                        NZD    21:45            Building Permits                                                 Sep                                 1.9%M
                        USD    13:00            S&P/CaseShiller Home Price Index                                 Aug                                 144.61
                        USD    14:00            Consumer Confidence                                              Oct             75.0      72.8         70.3
       31-Oct Wed
                        AUD    21:30            PMI                                                              Oct                                   44.1
                        CAD    12:30            GDP                                                              Aug                                0.2%M
                        EUR    10:00            Flash CPI                                                        Oct                                2.7%Y
                        EUR    10:00            Unemployment Rate                                                Sep                               11.40%
                        EUR    14:00            Belgian GDP (Prelim)                                              3Q                               -0.5%Q
                        NOK    09:00            Retail sales                                                     Sep                               -0.1%M
                        NOK    13:00            Norges Bank Rates Decision                                                      1.50%    1.50%      1.50%
                        USD    12:15            ADP Employment Change                                                Oct                   135K       162K
                        USD    12:30            Employment Cost Index                                                3Q        0.5%Q     0.5%Q      0.5%Q
                        USD    13:45            Chicago PMI                                                          Oct          51.5      51.8       49.7
       01-Nov   Thu
                        AUD    00:30            Export price index                                                3Q                                1.0%Q
                        AUD    00:30            Import price index                                                3Q                                2.4%Q
                        CHF    08:15            Retail Sales                                                     Sep                                5.9%Y
                        CHF    08:30            PMI                                                              Oct                                   43.6
                        CNY    01:00            Manufacturing PMI                                                Oct                       50.3        49.8
                        CNY    01:45            HSBC Manufacturing PMI                                           Oct                                   47.9
                        CZK    12:00            CNB Rates Decision                                                              0.25%               0.25%
                        GBP    09:28            PMI Manufacturing                                                Oct                                   48.4
                        NOK    08:00            PMI                                                              Oct                                   48.9
                    *   RUB      NA *           CBR Rates Decision                                                              5.75%               5.50%
                        SEK    07:30            PMI                                                             Oct                                    44.7
                        USD    12:30            Nonfarm Productivity                                             3Q                      1.3%Q      2.2%Q
                        USD    12:30            Initial Jobless Claims                                  Wk of Oct 27
                        USD    14:00            ISM Manufacturing                                               Oct                         51.5       51.5
                        USD    14:00            Construction Spending                                           Sep            0.7%M     0.7%M     -0.6%M
                        USD    21:00            Total Vehicle Sales                                             Oct            15.00M    15.00M    14.88M
       02-Nov   Fri
                        AUD    00:30            PPI                                                              3Q                                  1.1%Y
                        CAD    12:30            Employment Report                                                Oct                                  52.1K
                        EUR    08:58            PMI Manufacturing                                                Oct                                   45.3
                        GBP    09:30            PMI Construction                                                 Oct                                   49.5

                                                                                                  MORGAN STANLEY RESEARCH

                                                                                                  October 25, 2012
                                                                                                  FX Pulse

 Date    (GMT)             Ccy       Time (GMT)        Event                                                               Ref. Period         MS forecast   Market   Previous
                         NOK         09:00             Norwegian wealth fund releases 3Q returns
                         NOK         09:00             Unemployment Rate                                                                 Oct                            2.40%
                         NOK         12:00             Norges Bank's Olsen spks (Oslo)
                         RON           NA *            BNRO Rates Decision                                                                          5.25%     5.25%     5.25%
                         USD         12:30             Nonfarm Payrolls                                                              Oct             130K      120K       114K
                         USD         14:00             Factory Orders                                                                Sep                     4.0%M     -5.2%M
        03-Nov           CNY         00:00             Non-manufacturing PMI                                                         Oct                                   53.7
        04-Nov           INT           NA *            G20 Finance Ministers and Central Bankers Meet
        05-Nov    Mon
                         AUD         00:30             Trade Balance                                                                 Sep                               -2027M
                         AUD         00:30             Retail Sales                                                                  Sep                                0.2%M
                         CAD         13:30             Building Permits                                                              Sep                                7.9%M
                         CNY         01:45             HSBC Services PMI                                                             Oct                                   54.3
                         GBP         09:28             PMI Services                                                                  Oct                                   52.2
                         SEK         07:30             PMI Services                                                                  Oct
                         USD         15:00             ISM Non-Manufacturing Composite                                               Oct                                  55.1
        06-Nov     Tue
                         AUD         03:30             RBA Rates Decision                                                                           3.25%    3.00%      3.25%
                         CAD         15:00             Ivey PMI                                                                      Oct                                   60.4
                         EUR         08:58             PMI Services                                                                  Oct                                   46.2
                         EUR         10:00             PPI                                                                           Sep                                2.7%Y
                         GBP         09:30             Industrial Production                                                         Sep                               -0.5%M
                         NZD         20:00             RBNZ Financial Stability Report
                         USD           NA *            US Presidential, House, and Senate Elections
        07-Nov    Wed
                         CHF         08:00             SNB FX Reserves                                                               Oct                               429.3B
                         CHF         08:15             CPI                                                                           Oct                               -0.4%Y
                         EUR         10:00             EU Issues Autumn Economic Forecasts
                         EUR         10:00             Retail Sales                                                                  Sep                                0.1%M
                         EUR         12:10             ECB's Draghi spks (Frankfurt)
                         EUR           NA *            German PM Merkel spks (Brussels)
                         JPY         23:50             Current Account Total                                                         Sep                               ¥454.7B
                         NOK         09:00             Industrial Production                                                         Sep                                0.3%M
                         NZD         21:45             Unemployment Rate                                                              3Q                                 6.80%
                         PLN           NA *            NBP Rates Decision                                                                           4.50%                4.75%
                         SEK         08:30             Riksbank Minutes                                                    Mtg of Oct 25
                         USD         20:00             Consumer Credit                                                              Sep                               $18.123B
        08-Nov     Thu
                         AUD         00:30             Employment Change                                                             Oct                                 14.5K
                         CAD         13:15             Housing Starts                                                                Oct                                225.2K
                         CAD         13:30             Trade Balance                                                                 Sep                                -1.06B
                         CAD         17:00             BoC's Carney spks (Montreal)
                         CHF         06:45             Unemployment Rate                                                             Oct                                 2.80%
                         EUR         07:00             German Trade Balance                                                          Sep                                 16.3B
                         EUR         12:45             ECB Rates Decision                                                                           0.75%    0.75%       0.75%
                         GBP         09:30             Trade Balance                                                                 Sep                               -9844M
                         GBP         12:00             BoE Rates Decision                                                                           0.50%    0.50%       0.50%
                         IDR           NA *            BI Rates Decision                                                                            5.75%    5.75%       5.75%
                         JPY           NA *            Eco Watchers Survey: Current                                                      Oct                               41.2
                         MXN         14:00             CPI                                                                               Oct                           4.77%Y
                         MYR         10:00             BNM Rates Decision                                                                           2.75%                3.00%
                         PEN         23:00             BCRP Rates Decision                                                                          4.25%                4.25%
                         USD         13:30             Trade Balance                                                                Sep                                -$44.2B
                         USD         13:30             Initial Jobless Claims                                                Wk of Nov 3
        09-Nov     Fri
                         AUD         00:30             RBA Statement of Monetary Policy
                         CNY         01:30             CPI                                                                           Oct                                1.9%Y
                         CNY         05:30             Industrial Production                                                         Oct                                9.2%Y
                         CNY         05:30             Retail Sales                                                                  Oct                               14.2%Y
                         EUR         08:00             EcoFin Mtg
                         JPY         05:00             Consumer Confidence                                                               Oct                               40.1
                         KRW         01:00             BoK Rates Decision                                                                           2.75%               2.75%
                         NOK         09:00             CPI                                                                           Oct                                0.5%Y
                         SEK         08:30             Industrial Production                                                         Sep                                0.4%M
                         USD         14:55             U. of Michigan Confidence                                                   Nov P
                         USD         15:00             Wholesale Inventories                                                        Sep                                 0.5%M
      Upcoming   Policy Events
        12-Nov           EUR         16:00             Eurogroup Meeting
        25-Nov           EUR           NA *            Spanish Regional Elections in Catalonia
        04-Dec           CAD         14:00             BoC Rates Decision                                                                           1.00%    1.00%      1.00%
        06-Dec           NZD         20:00             RBNZ Rates Decision                                                                          2.50%               2.50%
        09-Dec           JPY           NA *            General Election (Tentative Date)
        12-Dec           USD         17:30             FOMC Rates Decision                                                                          0.25%    0.25%      0.25%
        13-Dec           CHF         08:30             SNB Rates Decision                                                                           0.00%    0.00%      0.00%
        13-Dec           EUR           NA *            EU Summit
        18-Dec           SEK         08:30             Riksbank Rates Decision                                                                      1.00%               1.25%
* Denotes timing approximate or not confirmed / All times and dates are GMT / Source: Morgan Stanley Research, Bloomberg

                                                                   MORGAN STANLEY RESEARCH

                                                                   October 25, 2012
                                                                   FX Pulse

Cross-Currency Carry and Vol Opportunities
 Morgan Stanley & Co. LLC        Ronald Leven                      6M 15-delta CHF1.145 EUR put for 40bp. The risk is
                                 +1 212 761-3413                   restricted to the premium, which would be lost if the market
 Morgan Stanley & Co.            Corentin Rordorf                  never prices in a significant risk of a EURCHF floor break.
 International plc               +44 20 7677-0518

                                                                   Implied Volatility
FX Forward Implied Carry                                           What moved the most since last week? Moves were
What moved the most since last week? Moves were                    modest in all regions, and while lower across AXJ, elsewhere
modest and mixed with one outlier: ARS was down 130bps.            moves were mixed.
The biggest gain was IDR’s 70bps, reversing last week’s            EURCAD became cheap vs realized, joining NOKSEK as the
market-leading decline.                                            only currencies cheap on both metrics. But the big trend was
NOK carry vs USD became unusually low and JPY carry                in the other direction with many currencies becoming
advantage vs CHF is relatively high. ILS carry vs USD also         expensive vs realized: GBPCHF, AUDJPY, KRW, CLP, COP,
became high but only on a vol-adjusted basis.                      BRL, MXNJPY, HUF, and TRY.

Skew for AUDCHF puts became historically low as did skew           Mixed vols associated with some curve flattening but others
for USDKRW calls. Contrarily skew for USDBRL calls                 getting steep. NOKSEK, IDR, PHP, COP, EURCZK,
became historically extreme.                                       EURPLN, PLN, TRY, and ZAR became extremely steep in
                                                                   the front end.
Where is the value in carry? As a byproduct of the
persistent downtrend in interest rates, increasingly the           Where is the value in volatility? Two weeks ago, we went
extreme is not high rates but rather low rates. For example,       long NOKSEK 6M vol as it dropped into the cheap zone on
the NZD carry advantage vs the USD is getting back down            both metrics. Since then, both 6M implied and short-date
toward historical lows. However, along with the downtrend in       realized vols have moved slightly lower, so we are modestly
cross-currency rate spreads, implied vols have also declined       losing money on this trade. This highlights an ongoing
and on a vol-adjusted basis, NZD carry remains well above          dilemma: while many vols are historically cheap, there is still
the historical average. The implication is that, while outright    little indication that the downtrend is about the reverse.
carry is very unattractive from a historical perspective, it may   That said, we still are looking for opportunities to get tactically
be possible to develop option-related structures that offer        long vol as there are some significant US event risk on the
good return. This is not the case with NZD; despite the low vol    horizon – especially, the US election and the next year’s
level, the carry/call spread ratio is well under 2.0. AUDUSD is    “fiscal cliff” – and the situation with working out Europe’s
in a similar situation to that of NZD, with carry well below       sovereign problems has yet to be solved. As noted above,
average outright but well above average on a vol-adjusted          EURCAD vols are also now cheap on both metrics. Perhaps
basis. Because outright carry is higher, the carry/call ratio is   more important, 1M vol is showing signs of moving higher and
above 2.0. But as we are quite bearish on AUD over the year        at 7.60% is in line with where 3M vol is implied. The
ahead, carry trades are not appropriate at this juncture.          EURCAD curve is steeper than NOKSEK, which argues for
Another trend is diminishing skew for CHF calls; in several        keeping duration shorter. Hence, we recommend buying a
cases – especially vs USD – the skew is now historically low.      3M EURCAD vol swap, which is offered at 8.2%. The
The implication is that the market has largely priced out any      upside is significant as 3M vol has realized as high as 10.80%
prospects for a break of the EURCHF floor. We continue to          this year and 15% over the past three years. Downside should
forecast that the floor will break next year. Moreover, even if    be limited to the historical low 6.2% realized vol that was also
the floor holds, the market is likely to re-price the risk of a    seen earlier this year.
break if, as we forecast, the EUR comes under substantial
selling pressure. We think it is attractive to take advantage of
flat skew to buy a low-delta EUR put. Specifically in this         Carry and volatility heat map is on the following page.
week’s FX Option publication, we recommended buying a

                                                                                                              MORGAN STANLEY RESEARCH

                                                                                                              October 25, 2012
                                                                                                              FX Pulse

                                               Implied Vol Metric                                       RR Metric                                Carry Metric
                      3M Im   1W      5-Year   Imp vs   5-Year   1Y/3M     5-Yer   5Y/1Y     5-Yer   3M 25d    RR/    Ratio             3M 1W        5-Year   Vol-Adj.   5-Year    1Y/3M     1y Carry/
                      Vol     Chg     Perc.    Real     Perc.    Imp Rat   Perc.   Imp Rat   Perc.    RR       Imp    Perc             Carry Chg      Perc.    Carry      Perc.   Crry Rat   CallSprd
             USDCAD     7.0    0.6      4%       1.2     74%       1.14     85%      1.11     99%     1.0      14%    62%     USDCAD   0.8    0.0     71%      0.11       96%      1.10        1.92
             USDCHF     8.2    0.0      0%       1.1     55%       1.16     96%      1.07    100%     1.0      12%    96%     USDCHF   -0.6   0.0     35%      -0.07     12%       -1.21
             USDJPY     7.3    0.4      3%       1.2     72%       1.24     87%      1.31     96%     0.7      9%     100% USDJPY      -0.4   0.0     66%      -0.05     33%       -1.25       1.95
             USDNOK     9.2    -0.2     0%       1.1     64%       1.15     93%      1.06    100%     0.8      8%     41%     USDNOK   1.3    0.0     14%      0.14       71%      1.02        3.98

             USDSEK     9.9    -0.1     0%       1.1     50%       1.12     88%      1.06    100%     1.0      10%    42%     USDSEK   1.0    0.0     43%      0.10       56%      0.85        2.46
             GBPUSD     6.3    0.4      1%       1.2     64%       1.17     87%      1.23     98%     -0.8    -13%    48%     GBPUSD   -0.1   0.0     78%      -0.02     62%       -0.92       2.36

             NZDUSD     9.3    0.2      0%       1.1     70%       1.16     92%      1.05    100%     -1.5    -16%    64%     NZDUSD   -2.3   0.0     86%      -0.25     16%       -0.98       1.08
             AUDUSD     8.6    0.0      0%       1.1     58%       1.19     94%      1.04    100%     -1.7    -20%    50%     AUDUSD   -2.9   0.0     81%      -0.34     28%       -0.93       2.12
             EURUSD     8.5    0.0      0%       1.1     31%       1.13     88%      1.06    100%     -0.9    -10%    56%     EURUSD   0.4    0.0     91%      0.04       95%      0.98        2.38

             EURAUD     7.5    0.0      0%       1.0     30%       1.16     88%      1.00     95%     0.7      9%     40%     EURAUD   3.3    0.0     35%      0.44       95%      0.94        2.32
             EURCAD     7.4    0.2      1%       1.0     14%       1.15     90%      1.07     98%     -0.2     -2%    56%     EURCAD   1.2    0.0     92%      0.16       98%      1.05        2.29
             EURCHF     3.4    -0.2     1%       1.8     83%       1.76     97%      1.76     95%     0.2      6%     98%     EURCHF   -0.2   0.0     97%      -0.07     72%       -1.55       2.71
             EURGBP     6.0    0.1      1%       1.2     64%       1.21     98%      1.23     95%     -0.2     -4%    27%     EURGBP   0.5    0.0     71%      0.08       82%      0.97        2.33

             EURJPY    10.5    0.3      5%       1.1     54%       1.12     68%      1.27     88%     -0.9     -9%    100% EURJPY      0.0    0.0     95%      0.00       95%      11.25       2.45
             EURNOK     5.5    -0.3     1%       0.9     20%       1.11     88%      1.12     94%     0.3      5%      5%     EURNOK   1.7    0.0     63%      0.31       98%      1.01        2.30

             EURNZD     7.9    0.0      0%       1.0     34%       1.15     86%      1.00     96%     0.7      9%     39%     EURNZD   2.8    0.0     60%      0.35      94%       0.98
             EURSEK     7.0    0.3     24%       0.8      5%       1.05     74%      1.15     99%     0.3      4%      3%     EURSEK   1.3    0.0     74%      0.19       80%      0.89        2.16

             GBPAUD     7.1    0.2      1%       1.1     45%       1.19     92%      1.08     99%     1.2      16%    78%     GBPAUD   2.8    0.0     34%      0.40       92%      0.93        2.12
             GBPCAD     6.0    0.3      1%       1.0     31%       1.18     91%      1.08     96%     -0.2     -2%    82%     GBPCAD   0.7    0.0     78%      0.11      83%       1.13
             GBPCHF     6.0    0.0      1%       1.3     90%       1.35     99%      1.34     97%     -0.6    -10%    74%     GBPCHF   -0.7   0.0     54%      -0.12     21%       -1.16       2.28
             GBPJPY     8.6    0.3      1%       1.2     76%       1.17     81%      1.30     85%     -0.4     -4%    100% GBPJPY      -0.5   0.0     80%      -0.06     36%       -1.16

             CHFJPY    10.3    0.1     15%       1.1     62%       1.12     77%      1.09     40%     -0.6     -5%    88%     CHFJPY   0.2    0.0     86%      0.02      88%       1.15
             AUDCAD     6.8    0.3      3%       1.0     32%       1.15     90%      1.07     99%     -0.8    -11%    61%     AUDCAD   -2.2   0.0     97%      -0.32     63%       -0.83       2.03

             AUDCHF     8.2    0.0      0%       1.1     55%       1.17     85%      1.13     99%     -0.8    -10%    89%     AUDCHF   -3.5   0.1     81%      -0.42      8%       -0.97       1.10
             AUDJPY    10.7    0.3      1%       1.3     91%       1.17     83%      1.27     80%     -1.8    -16%    98%     AUDJPY   -3.3   0.0     85%      -0.31     34%       -0.96       2.31
             AUDNZD     5.8    0.1      5%       1.1     41%       1.14     86%      1.04     95%     -0.5     -8%     6%     AUDNZD   -0.6   0.0     66%      -0.10     62%       -0.72       2.10
             NOKSEK     5.5    -0.1     1%       0.9      4%       1.10     87%      1.12     71%     0.2      4%     38%     NOKSEK   -0.3   0.0     68%      -0.06     64%       -7.96       0.19

             USDCNY     1.7    -0.2    15%       1.4     19%       1.47     37%      3.06     96%     0.2      9%     64%     USDCNY   0.3    0.0     72%      0.20       73%      2.84        2.21
             USDHKD     0.7    0.2     42%       4.5     88%       1.50     50%      4.55     29%     -0.9    #####   12%     USDHKD   -0.1   0.0     93%      -0.12     93%       -0.97       8.48
             USDIDR     7.5    0.0     18%       1.9     88%       1.47     89%      1.43     72%     3.8      50%    78%     USDIDR   5.2    0.7     59%      0.70       82%      1.02        1.89
             USDINR    10.7    0.1     54%       1.0     21%       1.04     25%      1.24     76%     0.7      7%      2%     USDINR   5.8    0.3     58%      0.54       54%      0.95        2.42

             USDKRW     6.7    0.1      5%       1.5     94%       1.33     98%      1.48     94%     1.4      21%    15%     USDKRW   1.9    -0.1    63%      0.28       99%      0.85        1.81
             USDMYR     6.4    -0.2     6%       1.1     38%       1.16     83%      1.30     83%     1.3      20%    51%     USDMYR   1.9    -0.1    72%      0.30       94%      0.89        1.85
             USDPHP     5.3    -0.5     0%       1.1     28%       1.32     98%      1.36     81%     1.2      23%    39%     USDPHP   -0.5   -0.2    6%       -0.09      5%       -0.18       1.68
             USDSGD     4.7    0.0      0%       1.2     57%       1.26    100%      1.64    100%     0.9      18%    58%     USDSGD   0.0    0.0     68%      0.00       69%      22.68       1.68
             USDTHB     7.0    0.0     34%       2.0     76%       1.14     50%      1.25     45%     0.8      11%    17%     USDTHB                                               1.01        2.04
             USDTWD     3.7    -0.1     0%       1.3     46%       1.20     79%      1.90     99%     0.6      16%    75%     USDTWD   -1.3   -0.3    70%      -0.36      53%      -0.89       1.55

             USDARS    17.5    0.0     74%       8.6     85%       2.00     70%      1.43     33%     10.0     57%    64%     USDARS   25.1   -1.3    73%      1.43       61%      1.09        2.98
             USDCLP     9.7    0.5      4%       1.5     90%       1.17     94%      1.27     89%     3.3      34%    91%     USDCLP   5.3    -0.3    91%      0.54       98%      0.88        2.09
             USDCOP     7.8    0.0      0%       1.8     89%       1.39    100%      1.19     70%     3.5      45%    98%     USDCOP   4.7    -0.4    55%      0.60       94%      0.84        2.00

             USDMXN    10.0    -0.3    19%       1.3     60%       1.12     68%      1.14     53%     3.0      30%    57%     USDMXN   3.8    0.0     46%      0.38       81%      1.02        1.97
             USDBRL     7.6    -0.3     0%       1.5     89%       1.49    100%      1.45     99%     3.1      40%    86%     USDBRL   4.9    0.1     2%       0.65       81%      1.01        2.12
             EURBRL     9.3    -0.6     0%       1.1     60%       1.24     84%      1.27     62%     4.1      44%    79%     EURBRL   5.3    0.1     3%       0.57       56%      1.01        2.08

             EURMXN     9.9    -0.5     4%       1.3     78%       1.11     66%      1.34     94%     2.0      20%    17%     EURMXN   4.2    0.0     67%      0.42      100%      1.02        2.03
             BRLJPY    10.5    0.0      0%       1.3     75%       1.32    100%      1.42    100%     -3.0    -29%    74%     BRLJPY   -5.0   0.1     99%      -0.48     21%       -1.02       0.64
             MXNJPY    12.4    0.0      1%       1.3     87%       1.13     83%      1.17     75%     -3.5    -28%    31%     MXNJPY   -4.0   0.0     56%      -0.32     17%       -1.04       0.55

             EURCZK     6.6    0.0     21%       1.1     46%       1.11     97%      1.00     66%     1.6      24%    54%     EURCZK   0.2    0.0     51%      0.04       57%      0.77        1.72
             EURHUF     8.1    0.5      3%       1.1     59%       1.16     87%      1.03     88%     2.3      28%    59%     EURHUF   5.0    0.0     60%      0.61      100%      0.83        2.11
             EURILS     7.5    -0.1     0%       1.0     40%       1.15     93%      1.12    100%     0.4      5%     83%     EURILS   1.8    0.1     92%      0.24       99%      0.89        2.20
             EURPLN     7.9    0.3     15%       1.0     29%       1.20     97%      1.00     59%     2.6      33%    92%     EURPLN   4.5    -0.1    91%      0.57       99%      0.84        2.04
             EURRUB     8.6    0.6     17%       1.2     77%       1.19     60%      1.54     95%     1.2      14%    24%     EURRUB   6.5    0.2     69%      0.75       83%      0.99        2.66
             EURTRY     7.3    0.0      0%       1.1     57%       1.33     97%      1.42     82%     1.5      21%    26%     EURTRY   5.4    0.3     10%      0.75       75%      1.05        2.49

             EURZAR    13.1    -0.2    26%       1.0     15%       1.11     82%      1.16     55%     2.1      16%     6%     EURZAR   5.8    0.1     36%      0.44       71%      0.93        2.16
             USDHUF    13.6    0.5     13%       1.1     90%       1.10     91%      1.02     91%     3.2      23%    70%     USDHUF   4.6    0.0     36%      0.34       77%      0.82        1.93
             USDILS     7.7    -0.1    17%       0.9     27%       1.12     89%      1.06     86%     1.7      22%    84%     USDILS   1.4    0.1     74%      0.18       89%      0.86        1.88

             USDPLN    13.5    0.3     15%       1.0     52%       1.16     98%      0.99     61%     3.5      26%    83%     USDPLN   4.1    -0.1    90%      0.30       96%      0.83        1.92
             USDRUB    10.4    0.6     32%       0.9     17%       1.15     53%      1.44     91%     2.4      23%    30%     USDRUB   6.3    0.1     68%      0.60       82%      0.97        2.25
             USDTRY     7.6    0.0      0%       1.3     90%       1.37    100%      1.37     83%     2.2      29%    50%     USDTRY   4.9    0.0     3%       0.65       72%      1.08        2.21
             USDZAR    16.0    -0.2    33%       1.1     60%       1.09     86%      1.13     60%     3.8      24%    35%     USDZAR   5.4    0.1     12%      0.34       33%      0.93        2.01

Source: Morgan Stanley Research
Note: Access is available to the carry metrics on an interactive basis at:
 Contact your Morgan Stanley sales representative if you do not have access.

                                                                                     MORGAN STANLEY RESEARCH

                                                                                     October 25, 2012
                                                                                     FX Pulse

G10 FX Tactical Indicators
Dara Blume

Exhibit 1                                                                         Exhibit 2
Historical Currency Performance                                                   Risk-Adjusted Five-Year Yields
   2%                                                                              100

   1%                                                                                50
   -2%                                                                              -50

   -3%                                                                             -100
   -4%                                                                                   bp
             EUR CHF      DXY NOK GBP AUD NZD CAD SEK JPY                             May-12                       Jul-12                       Sep-12
                         Monthly             Weekly                                                                USD             EUR              GBP              JPY
Source: Morgan Stanley Research, Bloomberg                                        Source: Morgan Stanley Research

Exhibit 3                                                                         Exhibit 4
Relative Momentum Indicator                                                       MS GRDI – Standardized

    5                                                                                     2

             AUD   EUR   CHF      USD SEK        GBP NZD        NOK   CAD   JPY
                                  Current         Last Pulse
                                                                                       Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12

Source: Morgan Stanley Research                                                   Global Risk Demand Index – US Pat. No. 7,617,143
                                                                                  Source: Morgan Stanley Research

Exhibit 5                                                                         Exhibit 6
G10 Surprise Index                                                                IMM Positions Summary ($bn)
                   G10 Average          G10 GDP Weighted Average
    0.1                                                                               GBP

   0.05                                                                                JPY

         0                                                                            NZD

     Nov-11         Jan-12     Mar-12        May-12    Jul-12     Sep-12                      -10           -5                              5              10              15

                                                                                  Note: Aggregate USD positioning in nominal terms, see following page for details
Source: Morgan Stanley Research                                                   Source: Bloomberg, Morgan Stanley Research

                                                                                                                    MORGAN STANLEY RESEARCH

                                                                                                                    October 25, 2012
                                                                                                                    FX Pulse

Morgan Stanley FX Positioning Tracker
Calvin Tse and Gabriel de Kock

Overall Score                                                                              Component Scores
         This     Last
                                Short               Neutral                Long
                                                                                                                                                 Since Monday (October 22), positioning in
         Week     Week                                                                        MS                               Senti-
                       -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2   3 4 5 6 7 8       9 10       Flow     IMM     Toshin    Beta   ment               the G10 currencies has remained largely
                                                                                                                                                  unchanged. We calculate the largest long
 USD      -5       -5                                                                           -5   -2                 -8     -4      USD       position to be in EUR; the largest short is in
 EUR       5       5                                                                        10        1                  7      1      EUR       USD.

 JPY      -3       -3                                                                           -7   -5        4        -8      0      JPY      GBP positioning inched towards long from
                                                                                                                                                  neutral intra-week. Driving this was our
 GBP       2       1                                                                           -8    6                  6      2      GBP
                                                                                                                                                  proxy for global macro hedge fund
 CHF      -4       -4                                                                       -10      -1                        -1      CHF       positioning, which showed large buying.

 CAD       1       1                                                                            -9    9                         2      CAD      EURUSD positioning remains in long
                                                                                                                                                  territory. Over the week, we calculate that
 AUD      -1       -1                                                                           -3   -3                         3      AUD
                                                                                                                                                  hedge funds added to their positions.
 NZD       1       1                                                                            -2    4                                NZD
                                                                                                                                                 We will provide a full updated report and
 NOK       4       4                                                                            4                                      NOK       refresh positioning scores for all of our
 SEK      -1       -1                                                                           -1                                     SEK       underlying sub-indicators next Monday.
                                                                                                                                                                   For Methodology see Appendix

Morgan Stanley High Frequency Misalignment Monitor
1Yr                                                     24 October, 2012
                 EUR         JPY            GBP            CHF         AUD                CAD         NZD              NOK            SEK
USD             -1.5%       -1.1%           0.8%           1.0%        1.0%               0.2%        1.4%             2.6%           1.2%       NOK, SEK and CHF are the most
EUR                          0.4%           2.3%           2.6%        2.5%               1.8%        3.0%             4.1%           2.8%        significantly overvalued currencies, and EUR
JPY                                         1.9%           2.1%        2.1%               1.4%        2.5%             3.7%           2.3%        the most undervalued, in the latest update of
GBP                                                        0.3%        0.2%              -0.5%        0.6%             1.8%           0.4%        Morgan Stanley’s high-frequency G10 FX
CHF                                                                   -0.1%              -0.8%        0.4%             1.6%           0.2%        Misalignment Monitor reflecting October 24
AUD                                                                                      -0.7%        0.4%             1.6%           0.3%        market prices, unchanged from our October
CAD        > +/- 1 sd                                                                                 1.2%             2.3%           1.0%        19 update.
NZD        > +/- 2 sd                                                                                                  1.2%          -0.2%
                                                                                                                                                 NOK is the most overvalued currency relative
NOK        > +/- 3 sd                                                                                                                -1.4%
                                                                                                                                                  to the fair value calculated from our one-year
                                                                                                                                                  model, which generated the highest and most
2Yr                                                                                                                                               reliable trading profits in back tests. NOK is
                 EUR         JPY            GBP            CHF             AUD            CAD          NZD              NOK           SEK         3 sigma expensive vs EUR and CAD (4.1%
USD             -1.5%       -1.7%           0.9%           2.8%           -0.1%           2.0%        -0.9%             2.3%          2.3%        and 2.3%) – a strong sell signal. The model
EUR                         -0.2%           2.4%           4.3%            1.4%           3.5%         0.6%             3.9%          3.9%        also picks SEK and CHF shorts against EUR,
JPY                                         2.6%           4.5%            1.6%           3.7%         0.9%             4.1%          4.1%        and a NOK short vs GBP, with 2-sigma
GBP                                                        1.9%           -1.0%           1.1%        -1.8%             1.5%          1.4%        misalignments.
CHF                                                                       -2.9%          -0.8%        -3.7%            -0.4%         -0.4%
AUD                                                                                       2.1%        -0.7%             2.5%          2.5%
                                                                                                                                                 CHF is most overvalued relative to fair values
CAD        > +/- 1 sd                                                                                 -2.8%             0.4%          0.4%
                                                                                                                                                  estimated over a two-year look-back window,
NZD        > +/- 2 sd                                                                                                   3.2%          3.2%
                                                                                                                                                  followed by NOK and SEK. These models
NOK        > +/- 3 sd                                                                                                                 0.0%
                                                                                                                                                  signal a NZD/CHF long at the 3-sigma level
                                                                                                                                                  along with EUR/NOK and EUR/SEK longs

3Yr                                                                                                                                              SEK remains the most overvalued G10
                 EUR         JPY            GBP            CHF             AUD            CAD          NZD              NOK          SEK          currency in our three-year model which yields
USD             -3.8%       -2.4%           1.9%           3.4%           -0.3%           2.3%        -1.9%             1.7%         5.6%         the slowest-changing misalignment
EUR                          1.4%           5.7%           7.2%            3.5%           6.0%         1.9%             5.5%         9.4%         estimates.
JPY                                         4.3%           5.8%            2.1%           4.7%         0.5%             4.1%         8.0%
GBP                                                        1.5%           -2.2%           0.4%        -3.8%            -0.2%         3.7%
                                                                                                                                                 Overall, the MS Cross-Misalignment Monitor
                                                                                                                                                  favors short NOK, SEK and CHF positions
CHF                                                                       -3.7%          -1.2%        -5.3%            -1.7%         2.2%
                                                                                                                                                  against EUR, CAD and NZD
AUD                                                                                       2.6%        -1.6%             2.0%         5.9%
CAD        > +/- 1 sd                                                                                 -4.2%            -0.5%         3.3%
NZD        > +/- 2 sd                                                                                                   3.6%         7.5%
NOK        > +/- 3 sd                                                                                                                3.9%                          For Methodology see Appendix

                                                                                                      MORGAN STANLEY RESEARCH

                                                                                                      October 25, 2012
                                                                                                      FX Pulse

Central Bank Watch
                                                                                                                 Morgan Stanley Rates Forecasts
                        Next rate       Market         MS
                        decision      expects (bp) expects (bp)           Current             4Q12            1Q13              2Q13              3Q13              4Q13
US                       11 Dec             -1               0              0.15              0.15             0.15              0.15              0.15              0.15
Euro Area                08 Nov             0                0              0.75              0.50             0.50              0.50              0.50              0.50
Japan                    30 Oct             0                0              0.05              0.05             0.05              0.05              0.05              0.05
UK                       08 Nov             -4               0              0.50              0.50             0.50              0.50              0.50              0.50
Canada                   04 Dec             -1               0              1.00              1.00             1.00              1.00              1.00              1.00
Switzerland              13 Dec              -               0              0.00              0.00             0.00              0.25              0.50              0.50
Sweden                   18 Dec            -10              -25             1.25              1.25             1.25              1.25              1.50              1.75
Norway                   31 Oct             -6               0              1.50              1.50             1.75              1.75              2.00              2.00
Australia                06 Nov            -18               0              3.25              3.00             2.75              2.50              2.50              2.50
New Zealand              06 Dec             -4               0              2.50              2.50             2.50              2.75              3.00              3.25
Russia                  1-10 Nov             -              25              5.50              5.75             6.00              6.00              6.00              6.00
Poland                   07 Nov                             -25             4.75              4.50             4.00              3.75              3.75              3.75
Czech Rep                01 Nov                              0              0.25              0.25             0.25              0.25              0.50              0.75
Hungary                  30 Oct                             -25             6.50              6.25             5.75              5.25              5.00              5.00
Romania                  02 Nov              -               0              5.25              5.25             5.25              5.25              5.25              5.25
Turkey                   20 Nov             0                0              5.75              5.75             5.75              5.75              5.75              5.75
Israel                   30 Oct              -               0              2.25              2.00             2.00              2.25              2.75              3.00
South Africa             22 Nov                              0              5.00              5.00             5.00              5.00              5.00              5.00
Nigeria                  20 Nov                              0             12.00              12.00           10.50              9.00              9.00              9.00
China                      N/A               -               0              6.00              6.00             6.00              6.00              6.00              6.00
India                    30 Oct             5                0              8.00              7.75             7.50              7.25              7.00              7.00
Hong Kong              11-12 Dec             -               0              0.50              0.50             0.50              0.50              0.50              0.50
S. Korea                 08 Nov              -               0              2.75              2.75             2.75              2.75              2.75              2.75
Taiwan                   27 Dec              -               0              1.88              1.88             1.88              1.88              1.88              1.88
Indonesia                08 Nov              -               0              5.75              5.75             5.75              5.75              5.75              5.75
Malaysia                 08 Nov              -              -25             3.00              2.75             2.75              2.75              2.75              2.75
Thailand                 28 Nov              -               0              2.75              2.75             2.75              2.75              2.75              2.75
Brazil                   28 Nov             0                0              7.25              7.25             7.25              7.25              7.25              7.25
Mexico                   26 Oct             0                0              4.50              4.50             4.50              4.50              4.50              4.50
Chile                    18 Oct             0                0              5.00              5.00             5.00              5.00              5.00              5.00
Peru                     08 Nov             0                0              4.25              4.25             4.25              4.25              4.25              4.25
Colombia                 26 Oct             0                0              4.75              4.75             4.75              4.75              4.75              4.75
Source: National Central Banks, Morgan Stanley Research forecasts; Note: Japan policy rate is an interval of 0.00-0.10%. Forecasts as of October 3, 2012, except the UK and Australia, which are
as of October 4.
G4 Policy Rate Forecasts                                                                              BRICs Policy Rate Forecasts

  7                       US            Japan             UK             Euro Area                      30                  China            Brazil           Russia             India
  6                                                                                                     25
  4                                                                                                                                                                                 Morgan Stanley
                                                                                                        15                                                                          Forecasts
                                                                             Morgan Stanley             10
  2                                                                          Forecasts

  1                                                                                                       5

  0                                                                                                       0
   2002         2004           2006        2008          2010         2012                                2002          2004         2006         2008         2010          2012
Source: Morgan Stanley Research                                                                       Source: Morgan Stanley Research

                                                                                                MORGAN STANLEY RESEARCH

                                                                                                October 25, 2012
                                                                                                FX Pulse

Morgan Stanley Global Currency Forecasts
 We updated our G10 forecasts on September 13, 2012.
                                      2012                              2013                                     2014                 3Q13 % change to:
                       Current             4Q            1Q           2Q            3Q            4Q           1Q            2Q     Consensus           Forward
EUR/USD                    1.31          1.34          1.30          1.25         1.20          1.15          1.20          1.23               8.9             2.9
USD/JPY                      79            84            85            87           89            90            90            90               1.2             5.7
GBP/USD                    1.62          1.61          1.59          1.54         1.52          1.51          1.54          1.56               1.5             0.8
USD/CHF                    0.92          0.90          0.85          0.88         0.96          1.03          1.03          1.04             -10.4            -3.3
USD/SEK                    6.60          6.57          6.62          6.80         7.00          7.22          7.00          6.91              -4.3            -2.5
USD/NOK                    5.64          5.60          5.62          5.76         5.92          6.09          5.92          5.85              -5.0            -3.9
USD/CAD                    0.98          0.93          0.95          1.00         1.01          1.03          1.02          1.02              -5.1            -7.2
AUD/USD                    1.04          1.05          0.99          0.92         0.90          0.88          0.90          0.90               2.9             4.0
NZD/USD                    0.82          0.86          0.82          0.76         0.75          0.74          0.75          0.75               7.5             7.2
EUR/JPY                     103           113           111           109          107           104          108           111                9.8             8.8
EUR/GBP                    0.81          0.83          0.82          0.81         0.79          0.76          0.78          0.79               6.4             2.2
EUR/CHF                    1.21          1.20          1.10          1.10         1.15          1.18          1.24          1.28              -2.4            -0.5
EUR/SEK                    8.66          8.80          8.60          8.50         8.40          8.30          8.40          8.50               4.8             0.4
EUR/NOK                    7.40          7.50          7.30          7.20         7.10          7.00          7.10          7.20               3.7            -1.0
USD/CNY                    6.25          6.30          6.30          6.30         6.27          6.24             -             -               1.0            -1.0
USD/HKD                    7.75          7.80          7.80          7.80         7.80          7.80             -             -               0.5             0.7
USD/IDR                   9,606         9,800         9,750         9,700        9,650         9,600             -             -               4.3            -2.8
USD/INR                    52.9          56.0          55.0          54.0         53.0          52.0             -             -               7.7            -1.2
USD/KRW                   1,106         1,150         1,133         1,115        1,098         1,080             -             -               5.5             2.7
USD/MYR                    3.04          3.10          3.08          3.05         3.03          3.00             -             -               3.3            -0.1
USD/PHP                   41.19         40.75         40.44         40.13        39.81         39.50             -             -              -0.6            -1.5
USD/SGD                    1.22          1.25          1.24          1.22         1.21          1.19             -             -               3.3             2.4
USD/TWD                   29.20         29.75         29.44         29.13        28.81         28.50             -             -               2.6             2.7
USD/THB                   30.62         31.30         30.88         30.45        30.03         29.60             -             -               4.0             0.2
USD/BRL                    2.03          1.95          1.99          2.03         2.06          2.10             -             -              -0.5            -8.0
USD/MXN                   12.81         12.80         12.70         12.60        12.50         12.40             -             -               2.4            -5.0
USD/ARS                    4.71          4.95          5.00          5.05         7.00          7.00             -             -              -9.3           -17.3
USD/VEF                    4.29          4.30          4.30          4.30         7.50          7.50             -             -             -33.8             0.1
USD/CLP                     472           475           479           483          486           490             -             -              -2.1            -5.5
USD/COP                   1,799         1,800         1,813         1,825        1,838         1,850             -             -               0.4            -4.4
USD/PEN                    2.58          2.59          2.60          2.61         2.62          2.63             -             -               0.8            -1.4
USD/ZAR                    8.65          8.00          8.10          8.25         8.35          8.50             -             -              -2.4           -13.0
USD/TRY                    1.80          1.75          1.75          1.73         1.72          1.70             -             -              -1.1            -7.4
USD/ILS                    3.79          3.95          3.90          3.85         3.80          3.75             -             -               3.9             1.0
USD/RUB                   30.70         29.58         29.25         30.11        31.47         32.13             -             -              -6.0           -10.9
RUB basket                35.03         34.10         33.20         33.50        34.30         34.30             -             -              -1.8            -9.5
EUR/PLN                    4.11          4.00          3.97          3.95         3.93          3.90             -             -              -1.2            -7.1
EUR/CZK                    24.8          25.8          25.6          25.4         25.2          25.0             -             -               5.3             3.0
EUR/HUF                     279           270           270           267          265           260             -             -              -3.6            -7.5
EUR/RON                    4.58          4.70          4.65          4.60         4.55          4.50             -             -               5.6            -1.8
MS Dollar Index            77.0          75.6          77.1          80.0         82.1          84.0          82.4          81.7              -4.0            N/A
MS AXJ Index              111.2         108.5         108.9         110.5        111.6         112.8                                          -3.3            N/A
G10 Forecasts were updated September 13, 2012, except CHF forecasts, which were updated Aug 29, 2012. Forecast changes in bold     Source: Morgan Stanley Research
AXJ Forecasts updated July 5, 2012.
CEEMEA forecasts updated August 2, 2012., except RUB forecasts, which were updated Aug 29, 2012.
MS Index forecasts based on geometric indices

                                                                                   MORGAN STANLEY RESEARCH

                                                                                   October 25, 2012
                                                                                   FX Pulse

   The FX Tactical Trade Recommendations page presents the portfolio of tactical trade ideas of the FX Strategy team and the performance
   of this portfolio over time.
        FX Tactical Trade Portfolio (Note: The portfolios represent hypothetical not actual investments.)
        On 10 June, 2010, we implemented changes to our portfolio to make it more robust and to better reflect our confidence levels and
          relative risk. A detailed explanation of this change can be found in “Portfolio Methodology Update” (10 June 2010).
        In summary, the trades and the weightings are primarily reviewed weekly on Thursdays and published in the Pulse. However, if we
          think there has been a material change to the risk-reward, we will make intraweek changes. We monitor trades daily. We will continue
          to publish the portfolio as a list of trades where our strongest conviction ideas will be given the largest weightings. We will, however,
          also adjust the weights of trades in order to manage our risk exposure.
        A table showing the trade, trade weight, trade entry date, risk allocation and levels for (average) entry, current, stop and target will be
          shown in the Tactical Trade Recommendations section of the FX Pulse.
        If we increase the weighting allocated to a trade, the entry level published in the table will be changed to reflect a proportionally
          weighted rate of the initial entry level and the entry level on the date the weight was increased.
        The expected portfolio volatility (shown in the bottom right of Exhibit 2) is calculated using the covariance method for Value at Risk
          (VaR). The 1 Month option implied volatility for each cross and the 3 month realized correlations of daily spot returns are used to
          construct the covariance matrix for the portfolio.
        Performance Statistics
        We rebalance our portfolio daily at the NY close to keep the weight of each trade consistent with the published weight.
        We will primarily enter and exit trades using the bid or offer rate of the WMR fixing. If we make an intraday change to our portfolio, we
          will cite the closest Bloomberg half hourly fix in our published note and enter/exit at this rate.
        Stops or targets will be triggered if the stated level is met at the WMR fix.
        Returns shown include the cost of carry using the 1W interbank deposit rate if this is quoted liquidly but do not include any other
          expenses, slippage or fees and no interest on cash holdings are included. Reported returns are not levered.
        We have re-estimated our returns from 22 June 2006 to 10 June 2010, when we re-launched the portfolio, to take into account our
          more robust calculation technique.
        We provide a monthly breakdown of our historical portfolio performance back to May 2004 in the Discretionary Tradebook section of
          the Pulse.
   The FX Tactical Indicators table highlights the most recently updated indicators we, as a research team, use as inputs to generate both
   longer and more tactical forecasts.
     •Historical Currency Performance: Price changes in currency over the past week and past month.
     •Risk Adjusted Yields: Nominal five year yields adjusted for five year CDS (weighted average for EUR).
     •Relative Momentum Indicator: Measures the momentum of a currency relative to all other currencies; not indicative of historical
     •MS GRDI*: An index to assess risk sentiment. It looks at ten different asset classes to gauge risk demand. The GRDI index seen in the
     graph is a standardized reading of the index based on the 365-day rolling average.
     •G10 Surprise Index: Measures the performance of actual economic data in G10 countries relative to expectations. G10 Average Index
     is a simple index; G10 GDP weighted average is based on GDP weights.
     •IMM Commitment of Traders Report: The “Aggregate USD Index” is the cumulative aggregate positioning of currencies we track on
     the IMM against the USD. We combine IMM positioning on the AUD, CAD, CHF, EUR, GBP, JPY, and MXN to calculate an aggregate
     USD index to measure overall net positioning.
   FX Positioning Tracker Methodology
       •MS Flow - Our internal flow data track all spot and forward trades transacted by Morgan Stanley FX globally.
       •IMM - We use the US Commodity Futures Trading Commission’s IMM report to track positioning of non-commercial traders.
       •Toshin - The Toshin accounts are Japanese foreign currency investment trusts that seek yield abroad. They typically cater to retail investors and
       offer a higher return by investing in foreign assets on a currency un-hedged basis.
       •TFX - The Tokyo Financial Exchange (TFX) measures Japanese currency trading on margin accounts, and comprises an estimated 10% of the
       retail margin market.
       •Beta - As an alternative proxy for positioning, our Beta-Tracker measures one-month rolling betas of currency managers’ and global macro
       hedge funds’ daily returns on major currency indices.
       •Sentiment - The Daily Sentiment Index gathers opinions on all active US futures, eurozone interest rates, and eurozone equities futures markets.
   Morgan Stanley FX High Frequency Misalignment Monitor Methodology: See the full report

* US Pat. No. 7,617,143.

                                                                                                  MORGAN STANLEY RESEARCH

                                                                                                  October 25, 2012
                                                                                                  FX Pulse

Global FX Strategy Team
Head of Global FX Strategy (London)                      Hans Redeker, Managing Director                          (+44 20) 7425 2430

Head of US FX Strategy (New York)                        Gabriel de Kock, Executive Director                   (+1 212) 761-5154
Senior Currency Strategist (New York)                    Ron Leven, Executive Director                            (+1 212) 761-3413
Currency Strategist (New York)                           Evan Brown, CFA, Associate                                 (+1 212) 761-2786
Currency Strategist (New York)                           Marc Englander, Analyst                                (+1 212) 761-8278

Head of European FX Strategy (London)                    Ian Stannard, Executive Director                         (+44 20) 7677 2985
Currency Strategist (London)                             Dara Blume, Associate                                      (+44 20) 7425-5749

Currency Strategist (Hong Kong)                          Calvin Tse, Associate                                      (+852) 3963-0551

Morgan Stanley entities: London – Morgan Stanley & Co. International plc; New York – Morgan Stanley & Co. LLC; Hong Kong – Morgan Stanley Asia Limited.

                                                                                            MORGAN STANLEY RESEARCH

                                                                                            October 25, 2012
                                                                                            FX Pulse

This material includes trade flow data that have been compiled by the Morgan Stanley Foreign Exchange trading desks from transactions executed
by Morgan Stanley in the over-the-counter foreign exchange markets with its global institutional and high net worth individual customer base. The
data have been aggregated and anonymized in a manner that does not identify the underlying transactions of any particular customer. In compiling,
interpreting, and analyzing the data, Morgan Stanley makes certain assumptions, which may vary over time, relating to the classification of an
account as a client. No representation is made that the aggregated data are reflective of trading patterns or trends in the markets included in this
material for any particular type of customer.

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                                                                                          MORGAN STANLEY RESEARCH

                                                                                          October 25, 2012
                                                                                          FX Pulse

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10-25-12 po

                                                         MORGAN STANLEY RESEARCH

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