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Morgan Stanley - Starting 2013 Risk Averse

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					                                                                       MORGAN STANLEY RESEARCH


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




         January 3, 2013

         Currencies
                                                                       Trade Recommendations
Global
         FX Pulse                                                      Closed Trades                            Entry          Stop      Target
                                                                       Sell EUR/USD                            1.3200       1.3290      1.2700

         Starting 2013 Risk Averse                                     Buy USD/JPY
                                                                       Sell AUD/USD
                                                                                                                85.00         83.00       94.00
                                                                                                            Enter at 1.0530 or Jan 4 WMR Fix
                                                                       Active Options Trades               Entry Date Expiry Date        Strike
         Spillover from the US. While Asian data have thus far         Long USD call/MXN put               01-Nov-12     05-Feb-13        13.50
                                                                       Short USD call/MXN put              01-Nov-12     05-Feb-13        14.00
         remained strong, the weaker European economic
                                                                       See page 12 for more details. Changes in stops/targets in bold italics.
         performance and the US consumer losing momentum
         have increased the risk that Asian data begin to surprise
         on the downside. The US budget deal fell short of
                                                                       MS Major Currency Forecasts
         generating the initially targeted US$1.4 trillion revenue                            1Q13             2Q13             3Q13             4Q13
         increase, but the agreed upon fiscal tightening will still    EUR/USD                   1.34             1.30            1.25            1.20
                                                                       USD/JPY                     84               87              89              90
         dampen US growth by around 0.75%. Budget tightening
                                                                       GBP/USD                   1.61             1.60            1.58            1.54
         when fiscal multipliers are high is already negative for
                                                                       USD/CHF                   0.90             0.92            0.96            1.00
         growth; fiscal uncertainty concerning future taxes and        USD/CAD                   0.96             0.97            0.98            1.00
         government expenditures presents an additional threat to      AUD/USD                   1.04             1.02            0.99            0.96
         the economy. Recent declines in US consumer confidence        NZD/USD                   0.84             0.83            0.82            0.80
         provided a strong warning to polarized US politicians on      EUR/JPY                    113              113            111              108
         the eventual economic costs of postponing fiscal              EUR/GBP                   0.83             0.81            0.79            0.78
         decisions.                                                    EUR/CHF                   1.20             1.20            1.20            1.20
                                                                       EUR/SEK                   9.00             8.90            8.80            8.70
         Buying USD. Our heavily risk-exposed currency portfolio       EUR/NOK                   7.40             7.20            7.10            7.05
         benefited from market risk appetite during the second half    Note: Forecasts for end-of-period. G10 forecasts updated November 20, 2012.

         of 2012, but with US fiscal uncertainty staying with us for   FX Market Overview                                                         P2
         longer than originally thought, we believe that bullish       The Course Towards JPY Weakness                                            P8
         markets could undergo a significant correction.
                                                                       Strategic FX Portfolio Trade
         Accordingly, we start the year by buying USD.                  Recommendations                                                          P12
         Autonomous JPY-weakening policies. Meanwhile, JPY             G10 & EM Currency Summary                                                 P14
         has started to lose its safe-haven status as the incoming     Global Event Risk Calendar                                                P16
         Japanese government lays out its JPY-weakening                FX Volatility/Carry Grids, Tactical Indicators                            P18
         policies. While the JPY decline experienced over the less     MS FX Positioning Tracker                                                 P21
         liquid holiday period leaves USDJPY vulnerable from a
                                                                       FX and Macro Forecasts                                                    P23
         technical perspective, we believe that a setback towards
         the 85 level offers another opportunity to establish JPY
         short positions. In this week’s FX Pulse, we explain why
         Japan requires JPY weakness. In our view, this is not
         because of the impact a weaker JPY would have on
         competitiveness, but rather, the boost it would offer to
         monetary velocity and credit. Of course, better export
         performance would help Japan, but this is merely a by-
         product of Japanese anti-deflation policies.




                                                                       For important disclosures, refer to the
                                                                       Disclosures Section, located at the end of
                                                                       this report.
                                                                       MORGAN STANLEY RESEARCH

                                                                       January 3, 2013
                                                                       FX Pulse




FX Market Overview
    Morgan Stanley & Co.              Hans Redeker                     aiming to support the economy by bringing forward
    International plc                 +44 20 7425-230
                                                                       investment and consumption spending and creating positive
                                      Dara Blume
                                                                       income and inflation expectations. Michael Woodford’s
                                      +44 20 7425-5749
                                                                       Jackson Hole speech in late August laid out the intellectual
                                      James Lord
                                                                       framework for this policy approach.
                                      +44 20 7677-3254
                                                                       Market participants familiar with the work of Hegel 1 should not
                                                                       be surprised to see Milton Friedman’s monetarism followed by
                                                                       Neo-Keynesianism. As it does so often in life, the antithesis
      While we maintain our view that 2013 be a good year for risk
                                                                       reacts to the thesis. While in the early 1980s a wave of de-
       assets overall, we believe that risk appetite could see a
       setback in the near term                                        regulation set in, putting asset-price movement back into the
                                                                       hands of markets, we are now witnessing a move in the other
      Core European banks considering repaying LTRO funds             direction. Central bankers are using non-standard policy tools
       early could spark another round of balance-sheet tightening
                                                                       to push real yields for risk-free assets decisively into the red.
       within EMU’s peripheral banking sector
                                                                       Exhibit 1
      The US fiscal cliff has been postponed, but polarity between
       the Democrats and the Republicans suggest the upcoming
                                                                       Real Yields Have Declined and Will Stay Low
       debate over the increase of the US debt ceiling will be tough
       to resolve

      Economic uncertainty will prevail, eventually creating spill-
       over effects into Europe and Asia

      Risk markets have moved too far too fast, leaving markets
       exposed to negative headlines

      Leaving short-term corrections aside we like MXN and RUB,
       but we foresee a more difficult trading environment for the
       ZAR and the CZK


                                                                       Source: Reuters EcoWin, Morgan Stanley Research

                                                                       In the early 1980s, real rates rose sharply as central bankers
The 2013 Risk Outlook Is Positive
                                                                       adopted inflation targeting regimes. Now, as central banks
For most of the second half of 2012, Morgan Stanley’s FX               move away from this framework and real rates move into
strategy team argued for a ‘risk on’ stance. Central bank              negative territory, investors will have to take on riskier, higher-
liquidity, the introduction of the ECB’s OMT, rebounding               yielding positions in order to maintain the real value of their
economic data and signs that Japan was beginning a                     portfolios. Yielding assets will see their valuations increase,
meaningful policy shift (see page 8) all contributed to a pickup       which will also have a currency impact. Initially, currencies
in investor risk appetite.                                             with high asset correlations will benefit at the expense of safe-
                                                                       haven currencies. In the long term, investors may focus more
Generally, the shift from riskless into higher yielding assets is
                                                                       on equity and less on fixed income markets in order to
likely to continue during 2013. Central banks are unlikely to
                                                                       maximize returns. This could well create new correlations. In
change course, so unlimited liquidity provision should
                                                                       particular, the US has the largest equity market globally, and
continue. The newly appointed BoE governor Carney has
                                                                       therefore, could benefit from the shift from fixed income into
suggested suspending the BoE’s two-percent inflation target,
                                                                       equity markets.
and implementing a nominal GDP target instead. Similar
interpretations of monetary policies have found support within
the Fed and the BoJ recently. Neo-Keynesianism, state
intervention and regulation have returned, with central banks          1 According to Hegel, "dialectic" is the method by which human history unfolds; that is to say,
                                                                       history progresses as a dialectical process.


.                                                                                                                                                                  2
                                                                     MORGAN STANLEY RESEARCH

                                                                     January 3, 2013
                                                                     FX Pulse




These shifts will be powerful. The high-tech and equity crash        real rates into negative territory and promoting risky assets, it
in 2000 ended a golden era for equity markets. Market                is best to follow the path of least resistance. Liquid assets are
capitalization relative to GDP has declined in most Western          likely to lose their function as traditional safe stores of value
economies over the past decade. Pension funds and other              as the Western World heads towards a prolonged period of
real money accounts have reduced their equity holdings and           negative real rates, which should drive risky asset valuation
reallocated funds into fixed income instruments. As a result,        higher in the medium term.
real money accounts now run historically low equity and high
                                                                     Hence, our risk-positive outlook for 2013 remains solidly
bond allocations. While asset allocation shifts are slow, they
                                                                     underpinned. However, there will be ups and downs on the
can be very powerful.
                                                                     road to higher risk appetite, and we see a strong likelihood
Over the past decade as real money investors focused on              that markets enter a corrective period early this year. We cite
reallocating into fixed income markets, rate and yield               three factors which could lead markets to correct lower. First,
differentials drove currency markets. During the late-1990s          European banks may repay LTRO funds early. Second, the
equity boom, the relative performance of equity markets and          uncertainty about taxes and income stemming from the US
FDI-related flows drove FX markets. Central banks’ use of            fiscal cliff could weigh on the US economy early this year.
non-standard policy tools to create negative real returns for        Third, global rebalancing has not gone far enough. While
risk free (fixed income) asset classes could lead markets to         Asian consumption has risen, accounting for an increasingly
refocus on equity markets, re-establishing relationships             large share of local GDP, Asian consumption is not yet large
witnessed during the late 1990s. Equity markets may drive FX         enough to compensate for a sudden slowdown in US
once again in the future.                                            demand.

Exhibit 2
                                                                     The ECB Is in Focus
Will Equities Rule FX Markets Once Again?
                                                                     Next week all eyes will be back on the ECB. The December
                                                                     statement said risks to inflation were balanced, suggesting
                                                                     interest rates will remain unchanged. However, ECB
                                                                     members representing peripheral countries voted for lower
                                                                     rates in December, suggesting this topic could return to the
                                                                     agenda.
                                                                     Many argued that the decline of EMU’s economic activity
                                                                     provides a strong reason to cut interest rates. However, it is
                                                                     not entirely the weaker performance of EMU economy which
                                                                     necessitates further easing of monetary conditions. Technical
                                                                     details require close ECB examination as well.
Source: Bloomberg, Morgan Stanley Research                           EMU banks, particularly in the core, face declining market
                                                                     funding costs 2 . Hence, the incentive to keep LTRO funding is
Central Banks Move Away from Inflation Targeting                     declining. Some banks have already made official
The Fed adopted an unlimited easing approach in September            announcements that they are considering repaying LTRO
2012, while the BoE will soon be run by Mr. Carney, who              funds in early 2013. The problem is when core banks repay
promotes a nominal GDP targeting approach. In Japan, the             LTRO funds, this will stigmatize the other banks, which face
BoJ’s current governor Shirakawa will likely be replaced by a        higher funding costs and run weaker balance sheets.
more progressive central banker in March. As a result, there         Once stronger banks start repaying their LTRO funds, weaker
is a strong likelihood that monetary policy continues to             banks who keep LTRO funding may find the market becomes
support risky assets and related currencies. While the ECB
has officially maintained its inflation target, President Draghi’s
                                                                     2 According to data from Fitch, US based money market funds increased their exposure to
suggestion to do ‘whatever it takes’ to save the euro has            EMU banks by 6% in November. However, core European banks were the main recipients of
                                                                     these funding inflows. German banks benefited from a 26% increase in US money market
softened, if not effectively replaced, the ECB’s inflation-          inflows. Nonetheless, the allocation of US funds into European banks is still 60% below the
targeting regime with a policy aimed at ensuring the survival        peak reached in May 2011 when these funds allocated 30.6% of their overall holdings to
                                                                     European banks. Nowadays 13.7% of gross exposure is held in European banks.
of the common currency. With central banks globally pushing


                                                                                                                                                             3
                                                                             MORGAN STANLEY RESEARCH

                                                                             January 3, 2013
                                                                             FX Pulse




reluctant to undertake business with these institutions. The rift            Two Factors Working Against the EUR
in the EMU banking sector between stronger and weaker
                                                                             From a currency-market point of view, there are two
banks could increase, with the fault line often running
                                                                             considerations for the EUR, and neither bodes well for the
between core and peripheral countries. Exhibit 3 shows the
                                                                             near-term outlook. First, a discussion on rate cuts would hurt
contribution of Spain to EMU M3 growth, which has not yet
                                                                             the EUR via money-market rate differentials. As markets price
seen any sign of a rebound. In general, peripheral bank
                                                                             in an ECB rate cut, the EUR will come under temporary
balance sheets have remained under consolidation pressure,
                                                                             selling pressure, we think. Second, should the ECB delay
explaining why credit supply within EMU’s periphery has
                                                                             reducing interest rates, some EMU banks may repay some of
remained slow.
                                                                             their LTRO funds. Resulting peer pressure could lead to an
Exhibit 3                                                                    avalanche of LTRO repayments conducted even by banks
Contribution of Spanish M3 Growth to Total EMU                               with relatively weak balance sheets. Money market tensions
M3 Growth vs EUR/USD                                                         could increase, pushing investors out of risky assets. This
                                                                             second scenario would have negative global risk appetite
 10                                  Spanish-German M3 Contribution   1.60
                                     EURUSD (RHS)
                                                                             implications, pushing the USD higher. However, we no longer
                                                                      1.55   view the JPY as a currency that would benefit from risk-
  5
                                                                      1.50   aversion, as Japanese policymakers have begun taking
  0
                                                                      1.45   autonomous measures to weaken the JPY, as explained in
  -5                                                                  1.40   ‘The Course Towards JPY Weakness’, page 8.
                                                                      1.35
-10                                                                          Meanwhile, Greece’s Kathimerini newspaper reported that in
                                                                      1.30   2012, the amount of non-performing loans grew by 50% since
-15
                                                                      1.25   December 2011, when the amount of non-performing loans
-20                                                                   1.20   stood at 16%. Last month, this had grown to 24%. According
   2008           2009          2010         2011        2012                to the numbers, non-performing loans make up a
Source: Bloomberg, Morgan Stanley Research
                                                                             considerable EUR55bln, thus exceeding the total funds set
Bank business is about trust and reputation. Balance sheets                  aside for the recapitalization of the local credit system, which
are important not only with respect to funding costs, but also               is EUR50bln. The Greek banking sector will require additional
for what they say about the bank’s creditworthiness. What                    funding to stay afloat, in our view.
banks try to avoid at all costs is stigmatization. Using long-
                                                                             Non-performing loans are likely to grow in other peripheral
term ECB funds is fine, as long as all banks use these funds.
                                                                             countries with weak economic and asset performance, such
However, once stronger banks withdraw from LTRO funds,
                                                                             as Spain, Portugal and Cyprus. The decline in the Spanish
other banks will not want to be seen as remaining dependent
                                                                             housing market accelerated at the end of 2012. Over the
on central-bank funding.
                                                                             course of 2012, Spanish house prices declined by 16%,
Should banks begin to pay back LTRO funding, the ECB                         leaving the market wondering what the consequences would
would see the monetary transmission mechanism weakened                       be for bank balance sheets. Against this background,
once again. Weaker banks repaying LTRO funding could                         peripheral bond investors may reconsider current exposure
force them to shrink their balance sheets, leading the EMU                   levels. While the OMT should limit an eventual increase of
banking industry to seize up again – a development the ECB                   Spanish bond yields and a flattening of yield curves, we
is unlikely to tolerate. Cutting the ECB’s repo rate and                     believe that a moderate setback in peripheral markets could
cheapening LTRO funding would provide an incentive for                       be enough to push the EUR several big figures lower.
banks to keep their LTRO funding in place, even for stronger
banks. The discussion concerning an ECB rate cut will soon                   From Cliff to Cliff
come back on agenda, we think. For detailed analysis of the
                                                                             Meanwhile, US politicians have hammered out a last-minute
ECB rate outlook, please see ECB Watch: Not Christmas Yet,
                                                                             deal to avoid going over the fiscal cliff. However, uncertainty
December 6, 2012.
                                                                             will persist for the coming months as negotiations enter a
                                                                             more difficult stage. The agreement reached in the early
                                                                             morning hours of New Year’s Day has opened the way for
                                                                             higher taxation of income above USD450k and an increase in


                                                                                                                                           4
                                                                   MORGAN STANLEY RESEARCH

                                                                   January 3, 2013
                                                                   FX Pulse




the capital gains tax to 20% from 15%, and it has also             Exhibit 5
indicated some expenditure cuts. However, the main thing the       Slowing Korean Exports Suggest Equity Market
agreement did was buy another two months for ongoing               Caution
negotiations.

By February, Capitol Hill will have to decide on the debt
ceiling. Republicans have already declared that they will use
the debt-ceiling negotiations as a bargaining tool to get more
expenditure cuts implemented. On the other hand, the
Democrats, led by the President, want to use higher revenues
to help consolidate the US budget deficit.

In light of the fiscal cliff related uncertainties, US consumer
confidence suffered in November and December. Now
uncertainties will persist, not boding well for the consumer and
                                                                   Source: Reuters EcoWin, Morgan Stanley Research
investment climate going forward. In the second half of last
year, we argued that rebounding US house prices, rising US
                                                                   Correcting? Why Now?
income and overall improving economic prospects would lead
to stronger US domestic demand conditions. Since final US          Over the next couple of weeks, positive headlines will be rare,
demand is still more than 60% of global demand, it was no          we think. The US is preparing for another round of intense
surprise to see Asian exports pick up, leading to an overall       budget negotiations in February, while European banks are
improvement of the outlook in Asia.                                considering repaying LTRO funds should these funds remain
                                                                   expensive relative to market rates. Moreover, should US
However, with US demand likely to weaken in an environment
                                                                   demand weaken due to fiscal uncertainties, spillover effects
of fiscal uncertainty, it may not be too long before Asian
                                                                   on the US’s main trading partners could have negative
indicators dip again. Exhibit 4 illustrates the relationship
                                                                   economic consequences.
between US consumer confidence and China’s exports. The
global economy has not yet rebalanced sufficiently to be           Exhibit 6
unaffected by a significant increase in US policy related          Bullish EUR Positioning Leave Markets Vulnerable
uncertainty, suggesting the otherwise bullish asset trend will     to Bearish Headlined Risks
enter a downward correction.

Exhibit 4
US Consumer Confidence vs Chinese Exports




                                                                                                                                Sour
                                                                   ce: Reuters EcoWin, Morgan Stanley Research

                                                                   Identifying positioning relative to anticipated headlines is an
Source: Reuters EcoWin, Morgan Stanley Research                    important tactical trading tool. Exhibit 6 compares the
                                                                   performance of EUR/USD with EUR positioning according to
                                                                   our MS Positioning Tracker. EUR positioning has reached
                                                                   high levels which amplify downward EUR correction risk.
                                                                   Moreover, US M1 has declined over recent months while
                                                                   Asian currency reserves have gone sideways. Hence, USD


                                                                                                                                 5
                                                                      MORGAN STANLEY RESEARCH

                                                                      January 3, 2013
                                                                      FX Pulse




liquidity has become tighter, which is not yet adequately             EM Currencies Likely to Strengthen in 2013
priced into asset and currency markets, as expressed in
                                                                      Our overall view on the EM currency asset class has not
Exhibit 7.
                                                                      changed over the holiday period. We continue to believe that
Exhibit 7                                                             the coming months will offer a generally supportive
USD Liquidity Has Tightened                                           environment for most EM currencies. It is possible that we do
                                                                      see some correction in various USD/EM crosses, particularly
                                                                      if fears rise significantly over the next round of difficult
                                                                      negotiations regarding the US budget.

                                                                      However, valuations on EM currencies are not at stretched
                                                                      levels. Meanwhile, inflows to EM-dedicated funds remain
                                                                      persistent and are likely to increase as the year progresses.
                                                                      Finally, likely further liquidity provision by G3 central banks
                                                                      will continue to provide a tailwind and a floor for markets.

                                                                      Exhibit 9
                                                                      EM NEER and REER Not Looking Stretched
                                                            Source:     120                                                                                          106
Reuters EcoWin, Morgan Stanley Research
                                                                                                                                                                     104
Finally, the volatility adjusted put/call ratio for the S&P 500         115
                                                                                                                                                                     102
has reached low levels. Unlike the nominal put/call ratio,
                                                                                                                                                                     100
which moved higher over the holiday period, the volatility-             110

adjusted put/call ratio has fallen to a low level. Given current                                                                                                     98


low option premiums, investors have not used the option                 105
                                                                                                                                                                     96

market sufficiently to reduce risk. Exhibit 8 illustrates the                                             EM Currency Strength                                       94
                                                                        100
relationship between growth in the equity market and the                                                                                                             92

volatility-adjusted put-call ratio, suggesting that equity market        95                                                                                          90
gains have gone too far and supporting our view that a                    Jan-03   Jan-04   Jan-05   Jan-06   Jan-07   Jan-08    Jan-09   Jan-10   Jan-11   Jan-12

correction will unfold soon.                                                                                  EM REER               EM NEER
                                                                                                                                                                           Sourc
                                                                      e: Reuters EcoWin, Morgan Stanley Research
Exhibit 8
Volatility-Adjusted Put Call Ratio Falls to Low                       As noted earlier, near-term risk wobbles associated with
Levels                                                                concerns over the fiscal cliff may provide better entry points
                                                                      for EM currency longs. That said, we believe that a selective
                                                                      approach to EM currencies is warranted and the days of
                                                                      across-the-board gains for EM currencies are probably behind
                                                                      us. Indeed, in an era of low growth and high uncertainty, we
                                                                      expect investors to show a higher degree of differentiation
                                                                      between markets than has historically been the case.

                                                                      We prefer to focus on those high beta currencies that would
                                                                      typically benefit during periods of positive sentiment toward
                                                                      EM, but are also benefiting from strong domestic reform
                                                                      stories and decent fundamentals. As traditional growth
                                                                      models for many EM countries are no longer suitable for
                                                            Source:   driving economic activity (See Emerging Issues: Can the
Reuters EcoWin, Morgan Stanley Research                               Broken EM Growth Model Be Fixed? September 24th), those
                                                                      governments that take a reformist stance and seek alternative
                                                                      sources of growth will likely see asset markets in their country
                                                                      outperforming, and their currencies appreciating.


                                                                                                                                                                             6
                                                                       MORGAN STANLEY RESEARCH

                                                                       January 3, 2013
                                                                       FX Pulse




Exhibit 10                                                             Of course, prospects for reform are important, but there are
EM PMIs Picking Up                                                     other things to consider as well. The RUB remains supported
                                                                       by continued strength in oil prices, relatively good growth
 60
                                                                       and tightening monetary policy (Morgan Stanley expects one
                                                                       more hike in the currency cycle). With the Central Bank of
 55
                                                                       Russia continuing to back away from the market, we do not
                                                                       see intervention as a serious headwind from current levels
 50
                                                                       (the CBR should start intervening soon if the RUB basket
                                                                       remains at current levels or strengthens, but only in small
 45                                                                    quantities) – and the country’s balance of payments surpluses
                                                                       should be reflected more and more in currency strength.
 40
                                                                       Exhibit 11
                                                                       RUB Intervention Is a Minor Headwind
 35
  Jan-06      Jan-07   Jan-08     Jan-09    Jan-10   Jan-11   Jan-12   39                                                                          CBR Action
             AXJ                CEEMEA               LatAm                                                                                      Sells $250m daily
                                                                       38
Source: Reuters EcoWin, Morgan Stanley Research
                                                                       37                                                                       Sells $135m daily

So far this year, price action has been consistent with our            36                                                                       Sells $70m daily

view. EM currencies have registered robust performance so                                                                                       No intervention
                                                                       35
                                                                                                                                                zone
far, despite the lackluster showing from EUR/USD in the
                                                                       34                                                                       Buys $70m daily
aftermath of the fiscal cliff deal.
                                                                       33                                                                       Buys $135m daily

Our two long-standing favored currencies, the RUB and the
                                                                       32
                                                                                                                                                Buys $250m daily
MXN, have been strong outperformers in the limited trading
                                                                       31
we have seen so far this year, as was the IDR. Although we              Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13
removed our long RUB/JPY position from the portfolio as we                                                       RUB Basket
                                                                       Source: Reuters EcoWin, Morgan Stanley Research
approached the end of 2012 (RUB/JPY was our top-
performing trade in the portfolio for 2012), the RUB remains           Another of our strongest calls for the coming year is long
one of our top picks for the year ahead, as does the MXN.              EUR/CZK. At current levels, we think this remains an
Both Mexico and Russia have benefited from positive reform             attractive opportunity. The Manufacturing PMI for December
momentum.                                                              fell further into contractionary territory, dropping to 46.0 from
                                                                       48.2 in November, which reinforces the expectation that the
The South African rand, which we do not believe will be
                                                                       Czech National Bank may decide to try and weaken the
supported by a strong impetus for reform from the South
                                                                       currency in an effort to provide some stimulus to the
African government, has started the year on the wrong foot,
                                                                       economy. We continue to expect EUR/CZK to re-test the
falling by more than most other currencies and reversing
                                                                       highs around 26, and quite likely break above there later in
some of the gains made in the final few weeks of 2012. In
                                                                       the year.
what is likely to be another year of sub-par global growth, this
distinction between those countries that are making strong
reform efforts to boost economic activity, and those that are
not, is likely to continue – and we formulate our currency
strategy accordingly.




                                                                                                                                                                    7
                                                                     MORGAN STANLEY RESEARCH

                                                                     January 3, 2013
                                                                     FX Pulse




The Course Towards JPY Weakness
Hans Redeker and Dara Blume                                          consumers continued to anticipate falling prices. Japan has to
                                                                     create positive inflation expectations to boost economic
    JPY weakness is required to increase inflation expectations     activity and the incoming Abe government seems to
                                                                     understand this. Though the JPY is not overstretched from
    Traditional JPY correlations are breaking as Japan
                                                                     the perspective of the real exchange rate, it needs to weaken
     implements a policy of autonomous JPY weakness
                                                                     nonetheless, not to increase competitiveness but rather to
    Japanese banks have accumulated substantial claims              help raise inflation expectations.
     against the Japanese sovereign
                                                                     Exhibit 1
    Rising government bond yields may undermine bank balance        JPY Not Overvalued from a Competitiveness
     sheets…                                                         Perspective
    …But the government needs to increase stimulus to boost           120                                                                                                                                        150
                                                                                            Nominal JPY TWI
     the economy, creating a sovereign credit risk that could          110                  Real JPY TWI (RHS)                                                                                                    140
     increase yields                                                   100
                                                                                                                                                                                                                  130
                                                                        90
    Hence, the BoJ should seek to target low and stable bond                                                                                                                                                     120
                                                                        80
     yields, monetizing debt if necessary                               70                                                                                                                                        110
                                                                        60
    Falling private sector savings mean that without BoJ action,                                                                                                                                                 100
                                                                        50
     capital would need to be imported to fund government                                                                                                                                                         90
                                                                        40
     deficits, which requires a lower yen or higher bond yields                                                                                                                                                   80
                                                                        30
    Without BoJ action, Japan could sink into deeper deflation         20                                                                                                                                        70
                                                                             1975
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     with the sovereign facing severe credit risks

    The incoming coalition government under Abe seems               Source: Haver Analytics, Morgan Stanley Research
     prepared to implement necessary autonomous policy
     changes                                                         There are two ways to create inflation expectations. First,
    The JPY is likely to lose its safe haven status, become a       increase government spending and fund it via the printing
     funding currency, and may trade in future like the USD did in   press. Second, weaken the JPY. However, Japan will have to
     the past                                                        increase inflation expectations without allowing nominal bond
                                                                     yields to rise too much. Consequently, the country will move
                                                                     from positive real yields towards negative real yields, which
The Need for JPY Weakness                                            will undermine the JPY in the long term.

We believe the JPY will weaken, despite the fact that the            In this analysis, we explain why we believe Japan will head
current level of Japan’s real effective FX rate does not signal      towards a period of JPY weakness and relatively stable bond
an extreme overvaluation. While the nominal FX rate reached          yields instead of one of repatriation of Japanese-held foreign
a historical high in 2012, when adjusted for inflation               assets, rising bond yields and JPY strength. The first scenario
differentials, the exchange rate has remained moderate               requires the Japanese authorities take a ‘hands-on approach’,
(Exhibit 1). One might conclude from a superficial analysis          and we believe the incoming government will opt of that.
that the JPY is trading near ‘fair value’ as the fall in             Inaction would mean deeper deflation and introduce
competitiveness stemming from nominal JPY appreciation               sovereign credit risks.
was counterbalanced by Japan’s deflating domestic prices.
However, it is necessary to take into consideration the long-
term destructive impact of deflation on the path of money
circulation.

Over time, deflation has destroyed Japan’s money multiplier.
The moderate easing approach taken by the BoJ over the
past two decades has failed to revive economic activity as

                                                                                                                                                                                                                   8
                                                                 MORGAN STANLEY RESEARCH

                                                                 January 3, 2013
                                                                 FX Pulse




JPY Markets Break Relationships                                  low, although higher debt and deficit levels would have
                                                                 suggested otherwise. Another long-standing relationship has
Non-standard central bank policy measures have become
                                                                 been broken.
standard, suggesting currency markets are in the process of
breaking out of long-term relationships. Most obvious is the
                                                                 Local Banks Require Stable JGBs
break in the previously long-standing correlation in Japan
where the JPY strengthened as interest rate differentials fell   Japan has to revive its economy without allowing bond yields
(Exhibit 2). Moreover, JGB yields have stayed depressed          to rise. Japan’s banking sector has used an increasing share
despite JPY weakness, and the drift lower in US and              of its balance sheet to fund the government, as is typical in
European equity markets over the past couple of weeks has        deflationary economies. As a result, banks’ claims against
not prevented the JPY from falling further (Exhibit 3).          Japan’s sovereign occupy 25% of Japanese bank balance
                                                                 sheets (Exhibit 4) and represent one of Japan’s greatest
Exhibit 2
                                                                 vulnerabilities. Rising asset volatility could force banks to
USDJPY versus 2 year Sovereign Yield Differential
                                                                 consolidate their balance sheets, leading them to reduce
                                                                 exposure to the sovereign. Private credit supply would shrink,
                                                                 counteracting the initial expansionary impact of the new
                                                                 government’s lend-and-spend policy.

                                                                 Exhibit 4
                                                                 Japan’s Banks Highly Exposed to Government Debt

                                                                                                      Banking System Linkages
                                                                                                  Domestic depository institutions'
                                                                                        Balance claims on general government2
                                                                                         Sheet Percent of depository
                                                                                               1
                                                                                        Ranking institutions'           Percent of
                                                                                                 consolidated assets    2012 GDP
Source: Reuters EcoWin, Morgan Stanley Research
                                                                 Japan                       1                                25            83
Exhibit 3
                                                                 Italy                       2                                14            38
Stable JGB Yields – Despite JPY Weakness                         Spain                       3                                10            35
                                                                 Belgium                     4                                 8            24
                                                                 Canada                      5                                 7            15
                                                                 Germany                     6                                 7            23
                                                                 Portugal                    7                                 7            24
                                                                 Greece                      8                                 6            13
                                                                 United States               9                                 6             8
                                                                 United Kingdom             16                                 2             8
                                                                 Australia                  17                                 1             2
                                                                 Source: IMF, Morgan Stanley Research
                                                                 1) Ranking out of 17 G10 countries; 1 = highest bank exposure to government debt relative
                                                                 to balance sheet size; 17 = lowest bank exposure to government debt relative to balance
                                                                 sheet size.
                                                                 2) Includes all claims of depository institutions (excluding the central bank) on general
                                                                 government. UK figures are for claims on the public sector. Data are for fourth quarter 2011
                                                                 or latest available.

                                                                 Hence, Japan’s expansionary fiscal approach will only
Source: Reuters EconWin, Morgan Stanley Research                 succeed if bank balance sheets can remain stable despite a
                                                                 rise in the already high level of government debt. Italy, Spain
JPY weakness is due to autonomous factors overriding the         and other EMU peripheral countries showed what can happen
usual market forces. The incoming LDP-led coalition              when sovereign debt loses its safe asset status. The stronger
government commands a super majority in the Diet and             the link between the sovereign and the banking sector, the
seems ready to implement controversial policies. Japan has       bigger the negative impact on credit availability under this
introduced another public sector spending program funded via     scenario. In EMU, the ECB had to introduce the OMT to break
issuing more government debt, despite its current debt-GDP       the link.
level of 230%. However, JGB yields have remained atypically


                                                                                                                                                            9
                                                                                          MORGAN STANLEY RESEARCH

                                                                                          January 3, 2013
                                                                                          FX Pulse




Japanese banks have used the balance sheet to purchase                                    but domestic investors, including banks, operating in their
government debt, leaving less room for loans to the private                               domestic currency base, could consider sovereign debt as a
sector. Now, with exposure to government debt high, banks                                 riskless asset class. In EMU, the ECB did not serve as a
face a substantial balance sheet risk should JGBs depreciate.                             lender of last resort, with the consequence that certain
A yield increase due to a fall in the Japanese government’s                               portions of the sovereign bond market have lost their safe
credit status would put banks under balance sheet                                         asset status. Bank balance sheets became vulnerable to the
consolidation pressure. Hence, Japan cannot afford sovereign                              fall in sovereign debt prices, leading to sharp decline in bank
bond market volatility without risking a situation similar to that                        lending to the private sector 1 .
in Italy, Spain and the other peripheral countries.
                                                                                          Japan can view EMU as a case study of what can happen to
Exhibit 5                                                                                 bank lending and economic activity when local bond yields
Japan: Bank Credit Supplied to the Private Sector                                         rise within an environment of weak economic performance.
versus JGB Holdings of Commercial Banks                                                   Sovereign bonds once seen as a safe asset class lost this
  26.0%                                                                           42.5%
                                                                                          status, banks’ balance sheets became vulnerable and
  25.0%                                                                           42.0%   declining bank lending pushed economies into severe
  24.0%                                                                           41.5%   recessions. The high exposure of Japan’s banks to the
  23.0%
                                                                                  41.0%   domestic sovereign suggests that Japan has to avoid rising
  22.0%
                                                                                  40.5%   bond yields and their associated risk to the economy.
  21.0%
                                                                                  40.0%
  20.0%
                                                                                  39.5%   Indeed, Japan’s incoming government has to provide the
  19.0%
  18.0%                                                                           39.0%   economy with additional growth stimulus without allowing
  17.0%                                                                           38.5%   bond yields to rise, as this would undermine bank lending
  16.0%                                                                           38.0%   activities given the high exposure of bank balance sheets to
       2003    2004   2005   2006   2007    2008   2009   2010    2011   2012
                                                                                          sovereign debt. The BoJ can help here by absorbing all the
                Government Debt Share of Japanese Bank Balance Sheets
                Credit to the Private Sector Share of Bank Balance Sheets (RHS)           additional bond supply stemming from increasing JGB
Source: Haver Analytics, Morgan Stanley Research
                                                                                          issuance, which otherwise would drive bond yields higher.
                                                                                          Japan’s reduced capacity to generate its own savings will not
New BoJ Duties?                                                                           make the BOJ’s task of controlling bond yields any easier.
The central bank may have to use its balance sheet to keep                                The BOJ’s balance sheet may have to grow exponentially to
yields stable, despite more aggressive government-spending                                keep JGB yields stable.
program. The BoJ could view the EMU as a case study on                                    Japan cannot allow rising sovereign credit risks to drive its
what happens when the safety of the sovereign asset class is                              sovereign bond yields higher. Consequently, the credit risk
called into question. The larger the claims banks have against                            should be transferred from the JGB into the FX market, as it
the sovereign, the more crucial the sovereign credit outlook                              was in the US and the UK. In order to transfer the credit risk
for the creation of private sector credit by banks.                                       away from its sovereign bond markets, the BoJ will have to
When we established our bearish EUR outlook in June 2011,                                 provide an implicit guarantee for JGBs in one form or another.
we argued that peripheral bond prices would fall as sovereign
credit risks rose, and the ECB would be unable to help by                                 The JPY Becoming the ‘New USD’?
directly or indirectly backstopping EMU sovereign debt due to                             Suggesting closer ‘cooperation’ between the BoJ and the MoF
its legal restraints. In the US or the UK, the central bank acts                          or reducing the BoJ independence by changing BoJ law
as the lender of last resort. This implicit bail-out guarantee                            would be a way to communicate to markets that the BoJ
provided by national central banks allowed sovereign credit                               stands ready to print money if required to fund bond
risk to move from the bond market into the currency market.
Investors buying Treasury bonds or Gilts were always
guaranteed to get the notional value paid back. However, the
                                                                                          1
                                                                                            When carry trades were popular from 2003 until June 2008, Japanese real money accounts
                                                                                          moved the bulk of foreign bond investments into the US Treasury market, but when it came
larger the mountain of outstanding government debt, the                                   to the currency allocation the EUR was a favourite. Investors looking to optimize their
                                                                                          risk/return ratio bought US Treasuries but moved currency allocations aggressively into EUR.
greater the task facing the central bank, and the bigger the                              Treasury exposure had the advantage of the ‘implicit’ Fed guarantee that the bond would be
                                                                                          fully repaid in its notional value, which was not the case in Europe, where the ECB did not
implicit currency risk. Indeed, foreign investors had to accept                           backstop sovereign bonds. On the other hand, the EUR benefited from the ECB not acting
a higher currency risk when buying US or UK sovereign debt,                               as lender of last resort, while the Fed’s lender of last resort status transferred sovereign
                                                                                          credit risk into currency risk.



                                                                                                                                                                                 10
                                                                          MORGAN STANLEY RESEARCH

                                                                          January 3, 2013
                                                                          FX Pulse




redemptions. (A change in the law would likely be easy now                Japan would have to change from a capital exporter to a
as the incoming coalition government controls a two-thirds                capital importer and within a market-oriented system, this
majority in the Lower House.) However, transferring Japan’s               would require rising yields for JPY-denominated funds to
credit risk into FX risk will weaken the JPY in the long term.            attract that capital. Rising bond yields would be detrimental
Going forward, the performance of the JPY should become                   for local banks, re-enforcing deflationary trends and pushing
more closely linked to the amount of debt accumulated by                  real yields higher. Sovereign credit risks would balloon.
Japan’s sovereign. The higher the debt, the bigger the
                                                                          The alternative is clear. Provide a combination of monetary
potential obligation of the BoJ to print JPY. In this sense, the
                                                                          and fiscal support for the economy, create positive inflation
JPY may trade like the USD did in the past. Following the
                                                                          expectations via a weakening JPY, increase government
bursting of the high tech bubble, the USD headed towards
                                                                          spending funded (implicitly) by the central bank, and have the
higher public sector deficits. With the private sector unable to
                                                                          central bank ‘control’ the JGB market, keeping bond yields
fund these deficits, the USD had to weaken in order to
                                                                          low and stable. The incoming Abe government seems to be
decrease the price of USD-denominated assets from a foreign
                                                                          ready to implement this alternative policy strategy.
investor’s perspective. Japan too, will lose its ability to fund its
public sector deficits domestically as its current account                Markets will have to accept a break of multiple correlations
moves towards deficit. Should Japan move towards running a                that in the past provided good guidance for judging the
twin deficit, as the US currently does, the JPY would come                performance of the JPY. Japan seems ready to undergo an
under additional selling pressure.                                        autonomous policy shift, which will have long-lasting
                                                                          implications on FX markets. Understanding the necessity for
Exhibit 6
                                                                          this autonomous policy change will make it easier to trade the
Japan’s Current Account Surplus Shrinking
                                                                          JPY. As previous correlations lose relevance, new
  6                                                                       correlations will emerge. The JPY may trade less as a safe-
       % of GDP
  4                                                                       haven currency, and could also see the relevance of nominal
                                                                          rate differentials and the impact of the slope of foreign yield
  2
                                                                          curves decline further. On the other hand, the JPY’s
  0
                                                                          sensitivity to Japan’s debt and deficit outlook may increase.
  -2                                                                      The higher local deficit and debt levels rise, the weaker the
  -4
                                                                          JPY may become and vice versa. The need to keep bond
                                                                          yields stable suggests the level of debt will determine the size
  -6                                                              Japan
                                                                          of the necessary BoJ monetization, which will come at the
                                                                  US
  -8                                                                      expense of an ever-increasing central bank balance sheet. In
    2005     2006      2007      2008      2009    2010   2011   2012
                                                                          the future, the JPY may look more like the USD did in the
Source: Haver Analytics, Morgan Stanley Research                          past. Japan’s politics and markets are in transition. This is not
Japan is in transition, as its political class understands that           because Japan wants to change, but rather because it has to
the country cannot stay within its current deflationary                   change. Understanding Japan’s needs will make it easier to
equilibrium for much longer without endangering its long-term             trade the JPY successfully.
stability. Of course, deflation was a convenient outcome for
Japan’s aging population. However, Japan’s demographics
and insufficient productivity gains will transform Japan’s net
saving surplus into a deficit. In the absence of any action,




                                                                                                                                        11
                                                                                MORGAN STANLEY RESEARCH

                                                                                January 3, 2013
                                                                                FX Pulse




Strategic FX Portfolio Trade Recommendations
Evan Brown, Marc Englander

                            Limit Order: 1.3200, Stop: 1.3290 Target: 1.2700                             European Banks against EUR/USD
                            We think USD will start the year with a firmer tone, as risk          95                          Eurozone Bank and Financial
                                                                                                                              Services Index (LHS)
                            appetite dwindles in the absence of comprehensive fiscal              90                          EURUSD (RHS)
                                                                                                                                                                                   1.34


                            reform. Despite the initial positive market reaction to the fiscal    85
                                                                                                                                                                                   1.32


                            cliff deal, uncertainty on future spending cuts and the prospect                                                                                       1.30

 Limit Order:               of another debt-ceiling showdown should boost safe haven              80                                                                               1.28

Sell EUR/USD                assets in coming months. In Europe, LTRO paybacks could               75
                                                                                                                                                                                   1.26

                            expose weaker EMU banks, leading to credit downgrades and                                                                                              1.24
                                                                                                  70
                            potential ECB easing in coming months (see the FX Market                                                                                               1.22

                            Overview, p.2 for further discussion)                                 65                                                                               1.20
                                                                                                   Jan-12     Mar-12    May-12      Jul-12         Sep-12     Nov-12      Jan-13

                                                                                                    Breaking Long-Term Relationships:
                            Limit Order: 85.00, Stop: 83.00 , Target: 94.00
                                                                                                   USDJPY vs 2yr Sov Yield Differentials
                            USD/JPY has risen by over 10 percentage points since we
                            first recommended going long, and we think the trade has
                            further to run. New PM Abe continues to emphasize the need
                            for a more aggressive BoJ to reverse deflation and JPY
Limit Order:                strength. Broad-based support in the Lower House will likely
Buy USD/JPY                 enable him to appoint dovish candidates to Governor and
                            Deputy Governor positions this spring. And a potential
                            change in the BoJ law to allow unsterilized foreign bond
                            purchases would drive USD/JPY significantly higher.

                            Limit Order: 1.0530, Stop: 1.0600, Target: 0.9700                          AUD/USD Tracking Korean Exports
                            Should US fiscal uncertainty weigh on growth as we expect,            50000              Korean Exports
                                                                                                                                                                                   1.1
                            risk appetite will deteriorate and high-beta currencies like AUD      45000
                                                                                                                     (LHS)
                                                                                                                     AUDUSD (RHS)
                                                                                                                                                                                   1.05

                            should sell off. A more cautious US business and consumer                                                                                              1
                                                                                                  40000                                                                            0.95
                            environment will hurt Asian exporters and reduce demand for                                                                                            0.9
 Limit Order:               Australia’s commodities. Indeed, Korea’s softer than                  35000                                                                            0.85
Sell AUD/USD                expected export data could be a prelude to things to come.            30000
                                                                                                                                                                                   0.8
                                                                                                                                                                                   0.75
                            Finally, Australia’s real yield advantage has eroded, reducing        25000                                                                            0.7
                            AUD’s attractiveness as an investment currency. We will enter                                                                                          0.65

                            at 1.0530 or the Jan 4 WMR Fix.                                       20000
                                                                                                      Jan-08     Nov-08     Sep-09        Jul-10    May-11     Mar-12     Jan-13
                                                                                                                                                                                0.6



                            Spot: 13.03, Long: Strike: 13.5, Cost: 1.02%                          USD/MXN and Call Spread BE (Strike at 13.5 and 14)
                                          Short: Strike 14.0, Cost: -0.29%
      Long:                 MXN’s high correlation to the S&P500 and high-beta skew to            14.5



     USD Call/              the upside make it an ideal candidate for OTM put spreads.            14.1


     MXN Put                Such strategies can help protect against a deeper sell-off due        13.7

                            to continued US fiscal uncertainties, as we approach the debt
      Short:                                                                                      13.3
                            ceiling debates in February. The price of this structure was a
     USD Call/              net 0.73% of notional, which gives it a reward/risk of about
                                                                                                  12.9


     MXN Put                4.5.                                                                  12.5
                                                                                                       Jan-   Feb-   Mar-   Apr-   May-     Jun-    Jul-    Aug-   Sep-   Oct-
                                                                                                        12     12     12     12     12       12     12       12     12     12




Source for all charts: Ecowin, Bloomberg, Haver, Morgan Stanley Research




                                                                                                                                                                                         12
                                                                                                                                          MORGAN STANLEY RESEARCH

                                                                                                                                          January 3, 2013
                                                                                                                                          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
Limit Orders
Sell EUR/USD                                                 $10.0mn                                                                1.3200                    1.3103        1.3290       1.2700
Buy USD/JPY                                                  $10.0mn                                                                   85.00                   86.87            83.00      94.00
Sell AUD/USD                                                 $10.0mn                                                                1.0530                    1.0522        1.0600       0.9700 Enter at 1.0530 or Jan 4 WMR Fix
Cash                                                        $100.0mn            100.0%
Portfolio Mark to Market                                    $100.0mn
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 Data Performance 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
 135

 130

 125

 120
 115

 110
 105
                                                                                                                                 MS FX Strategic Portf olio
 100                                                                                                                             Barclay Currency Fund Index
  95

  90
   Jan-05     Jul-05    Jan-06   Jul-06   Jan-07   Jul-07    Jan-08   Jul-08    Jan-09   Jul-09    Jan-10    Jul-10     Jan-11      Jul-11     Jan-12     Jul-12



Simulated Managed Account Monthly Gross Performance - %
       Year              Jan               Feb                Mar               Apr               May                 Jun                 Jul                  Aug              Sep          Oct           Nov           Dec       Year return
       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        8.64%
       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       2.03%
       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        3.52%
       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        8.96%
       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        2.80%
       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        -3.97%
       2012              0.34              0.46              -0.42              0.52              1.78            -0.43                  0.39                  0.56             0.43        0.53           0.96          0.47        5.72%
       2013              0.00                                                                                                                                                                                                        0.00%


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 Profit        $135.4k
Long USD call/MXN put                       $10.0mn          01-Nov-12          05-Feb-13             13.5000                13.0297              10.01%                1.02%           12.7576         12.70%           0.11%         -$91.0k
Short USD call/MXN put                      $10.0mn          01-Nov-12          05-Feb-13             14.0000                13.0297              10.01%                0.29%           12.7576         13.78%           0.07%          $21.8k
Source: Morgan Stanley Research; see notes above.




                                                                                                                                                                                                                                           13
                                                                                                             MORGAN STANLEY RESEARCH

                                                                                                              January 3, 2013
                                                                                                              FX Pulse




G10 Currency Summary
Calvin Tse and Dara Blume
                USD                                 Political Bickering                                Bullish     Watch: FOMC Minutes, Payrolls, Factory Orders, Claims, Trade

                  0.4%                              Though the fiscal cliff was narrowly avoided, we believe an even larger obstacle in the form of the debt ceiling lies in the months
                                                    ahead. Republicans and Democrats appear to be far apart on key issues, suggesting that an imminent resolution is not likely.
               This should lower global growth prospects, increase the probability of a US sovereign downgrade, and weigh on risk appetite. In
                                                    such an environment, USD is likely to see a comeback. Should payrolls underwhelm expectations, we like selling EURUSD.
                EUR                                 Uncertainty to Weigh on EUR                        Bearish     Watch: Flash CPI, Retail Sales, Unemployment Rate, ECB, German IP

                  1.3%                              The year-end risk rally has resulted in the short-term market being long the common currency. Negative internal
                                                    developments, such as rising Greek non-performing loans, coupled with uncertainty over the US debt ceiling, should lead to
               position squaring, bringing EURUSD back below 1.30, in our view. In the week ahead, the ECB will also come into focus,
                                                    especially as markets may begin to price in a rate cut. Negative rates would catalyze EUR weakness.
                 JPY                                Autonomous Weakening                               Bearish     Watch: Monetary Base, Leading Index, Current Account, Eco Watchers

                  9.3%                              The theme of autonomous JPY weakening continues post elections. With the LDP coalition taking a two-thirds majority in the
                                                    lower house, Abe will be able to more easily push through his aggressive anti-deflation reforms. As this occurs, we expect to
               see an unwinding of currency hedges on foreign investments, further outflow from Japanese money markets, and JPY selling
                                                    from Toshin accounts. JPY weakness should lead to further weakness – we remain bearish.
                GBP                                 Upward Trend Likely to Reverse                     Bearish     Watch: PMI Services, Mortgage Approvals, Trade Balance, BoE, IP

                  0.1%                              GBP should see pressure both from the current risk environment and from underlying fundamentals. Indeed, while PMI
                                                    manufacturing was stronger-than-expected over the last week, data on the whole has been soft recently. Our economists
               continue to expect another round of QE from the BoE in February, and after the UK’s Autumn Statement, the fiscal picture in
                                                    the UK is likely to come increasingly under scrutiny, weighing on GBP.

                 CHF                                Floor to Remain                                    Neutral     Watch: FX Reserves, Unemployment, CPI

                -1.7%                               The SNB is likely to maintain its current exchange rate policy for the time being. Indeed, the SNB revised its 2013 inflation
                                                    forecast down into negative territory, justifying the 1.20 EURCHF floor. We will watch to see if next week’s CPI print shows a
               further intensification of deflation, as seen last month. We also note that the SNB has not had to ramp up its FX reserves to
                                                    protect the floor over recent months; next week’s SNB FX reserves will be important for gauging if that is still the case.

                CAD                                 Fiscal Cliff Main Risk                             Bearish     Watch: Employment Report, Ivey PMI, Housing Starts, Trade

                  1.9%                              The postponement of meaningful decisions on the fiscal cliff to February means uncertainty will weigh on CAD via several
                                                    channels. First, increased uncertainty could lead to lower risk appetite, pressuring commodity currencies. Second, with a
               lack of clarity about government spending and taxes, US consumers may be cautious. The US is Canada’s biggest trading
                                                    partner, and a drop in consumption there would have negative consequences for the Canadian economy and the CAD.
                AUD                                 Uncertainty Could Pressure AUD                     Bearish     Watch: Trade, Retail Sales, Building Approvals

                  1.8%                              With market risk appetite likely to decline over coming weeks, we look for AUD to see pressure. Uncertainty in the US could start
                                                    to impact Asia, as illustrated by the recent softness in Korean exports. Given Australia’s exposure to Asia, this would make AUD
               particularly vulnerable. Indeed, we will watch the upcoming Australian trade release for signs that the uncertainty in the US is
                                                    already starting to weigh on the Australian economy.
                 NZD                                Relative Outperformer                              Bearish     Watch: Building Permits, Trade, Commodity Prices

                  0.2%                              NZD is particularly vulnerable to the slowdown in risk appetite we predict given its large external liabilities. Softening
                                                    economic data releases will also weigh on the currency. However, we continue to expect NZD will outperform its Antipodean
               peer AUD. Indeed, while AUD is vulnerable due to its exposure to industrial commodities, NZD is more exposed to
                                                    agricultural commodities, which should remain supported.

                 SEK                                Tied to a Weak Eurozone                            Bearish     Watch: PMI Services, Riksbank Minutes, CPIF, IP, Average House Prices

                -1.3%                               We remain bearish on SEK, especially on a relative value basis against its Scandinavian peer, NOK. Indeed, Sweden is
                                                    highly exposed to a weak eurozone, which we expect to remain in recession this year. As such, both growth and rate
               differentials should play against SEK. Should economic data continue to deteriorate, we do not rule out another Riksbank
                                                    cut, though it is against their own forecasts. In the week ahead, CPIF and IP will be the main data points to watch.
                NOK                                 Auspicious Position                                Bullish     Watch: Unemployment Rate, Industrial Production, Retail Sales, CPI

                -1.7%                               We expect NOK to remain supported by Norway’s relatively high rates, large dual surplus position, and pristine sovereign
                                                    bond rating. Furthermore, the Norges Bank remains one of the most hawkish developed market central banks and still sees
               hikes further out. As such, we remain constructive and foresee continued strength against both EUR and SEK. The next
                                                    week is big on the data front, with the unemployment rate, industrial production, retail sales, and CPI all released.




Charts are 3M performance against USD, as normally quoted                                                                                                                               14
                                                                                                                    MORGAN STANLEY RESEARCH

                                                                                                                     January 3, 2013
                                                                                                                     FX Pulse




EM Currency Summary
EM Strategy Team
                                -1.9%
                                                                       External demand improvements, stronger demand from domestic firms and capital inflows have helped to
CNY     Neutral
                                drive further appreciation in CNY.
                                 6.4%
                                                                       Prospects for policy adjustment – as with the recent passage of FDI in retail and the increase in the cap on
INR     Bullish
                                foreign investor limits in local bonds – are likely to bolster capital inflows and benefit the currency.
                                 0.4%
                                                                       The currency is likely to be dragged down by funding vulnerabilities and the low prospect of the central bank
IDR     Bearish
                                tightening policy rates.
                                -1.7%
                                                                       CNY appreciation and institutional flows into local bonds provide underlying support for KRW. Macro-
KRW Neutral
                                prudential measures may seek to limit FX exposures.
                                 0.5%
MYR Bearish
                                MYR has lagged the decline in USD/AXJ and is supported by steady macro-fundamentals.
                                 0.5%
                                                                       THB is supported by positive macro-dynamic conditions, even though THB is overvalued and susceptible to
THB     Neutral
                                weaker external demand conditions.
                                -0.3%
                                                                       Stabilization in global economic activity is likely to bolster TWD, but Taiwan’s uneven export recovery and low
TWD Neutral
                                carry leave it less compelling than regional peers.
                                 5.1%                                  The domestic economy remains weak and, with policy rates near zero, the CNB continues to cite the
CZK     Bearish
                                   exchange rate as the most effective tool at its disposal to stimulate its export-reliant economy. We
                                                                       recommended long EUR/CZK in FX 2013 Outlook: The Year of JPY Weakness, November 20, 2012.
                                 2.9%
                                                                       The weakness seen over the holiday period was not justified by any fundamental developments and therefore
HUF     Bullish
                                we recommend short-term tactical short positions.
                                 2.8%                                  ILS has seen a significant rally over the past six weeks. Political risks have largely died down for now, while
ILS     Neutral
                                the current though, given have shown signs of improvement. We doubt that ILS will outperform broader EM
                                                                     currencies
                                                                                  account data
                                                                                               its lower beta.
                                 4.4%
                                                                       As widely expected, the NBP has continued to cut rates, and we think the policy rate can go as low as 3.25%.
PLN     Neutral
                                This should weigh on the currency, while any correction in EUR/USD should also be an important driver.
                                 2.4%                                  RUB remains backed by the most convincing fundamental story in CEEMEA, in our view. We also look for
RUB     Bullish
                                  more rate hikes, and an increase in portfolio inflows ahead of Euroclearability in the OFZ market. To this end,
                                                                       we stay long RUB/JPY in our FX portfolio.
                                -0.3%                                  We now expect the CBT to ease policy further by cutting the policy rate and the lower end of the overnight
TRY     Bearish
                                  interest rate corridor by as early as December. We think that this easing and a clear bias from the central
                                                                       bank for a weaker exchange rate will put TRY under pressure.
                                 1.0%                                  The external position in South Africa remains weak, and given the deteriorated domestic business and
ZAR     Bearish
                                  investment climate, we remain concerned about the deficit’s financing. We hold a bearish view, and think that
                                                                       USD/ZAR will reach 9.25 in 1H13.
                                 2.7%                                  As we had expected, the BCB continued to defend BRL from further weakening in a policy shift that evidenced
BRL     Neutral
                                  inflation concerns. Indeed, we expect the BCB to continue intervening on both sides of the currency, keeping
                                                                       USD/BRL moving sideways.
                                 2.4%
                                                                       We see room for CLP to strengthen further on the back of higher copper prices and especially after fiscal cliff
CLP     Bullish
                                concerns have dissipated. However, intervention fears could reappear if USD/CLP gets below 470.
                                 1.6%                                  After the recent appreciation, we believe that the central bank and the government will intervene stronger to
COP     Neutral
                                   contain further gains in the currency. If economic data continue to disappoint, policy-makers are likely to
                                                                       increase strong-side intervention in an effort to boost manufacturing.
                                 2.6%                                  We expect MXN to continue strengthening towards 12.60, after the US reached a deal on the fiscal debate.
MXN Bullish
                                  We believe that strong fundamentals and ambitious reforms in the incoming government’s agenda will lend
                                                                       support to the currency going forward.
                                 0.7%                                  PEN has strengthened in the past two months, driven by a less dire international environment and higher
PEN     Neutral
                                    copper prices. We expect the central bank to keep preventing any meaningful appreciation from current
                                                                       levels.


Charts show 3M performance against USD, as normally quoted                                                                                                                               15
                                                                               MORGAN STANLEY RESEARCH

                                                                               January 3, 2013
                                                                               FX Pulse




Global Event Risk Calendar
Dara Blume
Date   (GMT)               Ccy   Time    (GMT)   Event                                           Ref. Period     MS forecast     Market    Previous
       04-Jan        Fri
                           CNY   01:45           HSBC Services PMI                                         Dec                                  52.1
                           SEK   07:30           PMI Services                                              Dec                      47.2        46.4
                           EUR   08:58           PMI Services                                              Dec                      47.8        47.8
                           GBP   09:28           PMI Services                                              Dec                      50.2        50.2
                           GBP   09:30           Mortgage Approvals                                        Nov                    54.0K       53.0K
                           EUR   10:00           Flash CPI                                                 Dec                   2.1%Y       2.2%Y
                           CAD   13:30           Employment Report                                         Dec                      0.0K      59.3K
                           CAD   13:30           Industrial Product Price                                  Nov                  -0.2%M      -0.1%M
                           USD   13:30           Nonfarm Payrolls                                          Dec         185K        150K        146K
                           USD   15:00           Factory Orders                                            Nov      -0.2%M       0.4%M       0.8%M
                           USD   15:00           ISM Non-Manufacturing                                     Dec                      54.0        54.7
       06-Jan              JPY   23:50           Monetary Base                                             Dec
       07-Jan   Mon
                           CHF   08:00           SNB FX Reserves                                           Dec                               427.4B
                           EUR   10:00           PPI                                                       Nov                               2.6%Y
                           CAD   15:00           Ivey PMI                                                  Dec                                  47.5
                           RON    NA *           BNRO Rates Decision                                                  5.25%                   5.25%
       08-Jan   Tue
                           AUD   00:30           Trade Balance                                            Nov                                -2088M
                           CHF   06:45           Unemployment Rate                                        Dec                                 3.10%
                           SEK   08:30           Riksbank Minutes                                Mtg of Dec 18
                           NOK   09:00           Industrial Production                                    Nov                                -0.3%M
                           EUR   10:00           Consumer Confidence (Final)                              Dec                                   -26.6
                           EUR   10:00           Retail Sales                                             Nov                                -1.2%M
                           EUR   10:00           Unemployment Rate                                        Nov                                11.70%
                           USD   20:00           Consumer Credit                                          Nov                  $12.750B    $14.158B
                           NZD   21:45           Building Permits                                         Nov                                -1.5%M
       09-Jan   Wed
                           AUD   00:30           Retail Sales                                              Nov                               0.0%M
                           THB   07:30           BoT Rates Decision                                                   2.75%                   2.75%
                           SEK   08:30           Budget Balance                                            Dec                                  8.2B
                           NOK   09:00           Retail sales                                              Nov                              -1.4%M
                           GBP   09:30           Visible Trade Balance                                     Nov                                 -9.5B
                           CAD   13:15           Housing Starts                                            Dec                               196.1K
                           NZD   21:45           Trade Balance                                             Nov                                -718M
                 *         RUB    NA *           CBR Rates Decision                                                   5.50%      5.50%        5.50%
                           PLN    NA *           NBP Rates Decision                                                   4.00%      4.00%        4.25%
       10-Jan   Thu
                           AUD   00:30           Building Approvals                                        Nov                              -7.6%M
                           SEK   08:30           CPIF                                                      Dec                               0.8%Y
                           SEK   08:30           Industrial Production                                     Nov                               0.5%M
                           NOK   09:00           CPI Underlying                                            Dec                               1.3%Y
                           NOK   09:00           PPI                                                       Dec                               0.0%Y
                           GBP   12:00           BoE Rates Decision                                                   0.50%      0.50%       0.50%
                           EUR   12:45           ECB Rates Decision                                                   0.50%      0.75%       0.75%
                           CAD   13:30           Building Permits                                          Nov                               15%M
                           EUR   13:30           Draghi Press Conference
                           USD   13:30           Initial Jobless Claims                            Wk of Jan 5
                           USD   15:00           Wholesale Inventories                                    Nov                    0.3%M       0.6%M
                           PEN   23:00           BCRP Rates Decision                                                  4.25%       4.25%       4.25%
                           JPY   23:50           Current Account                                           Nov                              ¥376.9B
                           JPY   23:50           Bank Lending Ex-Trusts                                    Dec                               1.3%Y
                 *         CNY    NA *           Foreign Exchange Reserves                                 Dec                             $3285.1B
                 *         CNY    NA *           New Yuan Loans                                            Dec                   565.0B      522.9B
                 *         CNY    NA *           Trade Balance                                             Dec                  $20.60B     $19.63B
                           IDR    NA             BI Rates Decision                                                    5.75%                   5.75%
       11-Jan   Fri
                           KRW   01:00           BoK Rates Decision                                                   2.75%      2.75%       2.75%
                           CNY   01:30           CPI                                                       Dec                   2.3%Y       2.0%Y
                           CHF   08:15           CPI                                                       Dec                              -0.4%Y
                           SEK   08:30           Average House Prices                                      Nov                              1.957M
                           GBP   09:30           Industrial Production                                     Nov                              -0.8%M
                           CAD   13:30           Trade Balance                                             Nov                               -0.17B



                                                                                                                                                 16
                                                                                                  MORGAN STANLEY RESEARCH

                                                                                                  January 3, 2013
                                                                                                  FX Pulse




Date   (GMT)              Ccy       Time   (GMT)    Event                                                              Ref. Period        MS forecast    Market   Previous
                          USD      13:30            Trade Balance                                                                 Nov        -$40.2B    -$40.5B    -$42.2B
                          USD      19:00            Monthly Budget Statement                                                      Dec                   -$20.0B
                          JPY       NA              Eco Watchers Survey (Outlook)                                                 Dec                                 41.9
        13-Jan            NZD      21:45            Retail Card Spending                                                          Dec                              0.5%M
        14-Jan   Mon
                          AUD      00:30            Home Loans                                                                     Nov                             0.1%M
                          EUR      10:00            Industrial Production                                                          Nov                            -1.4%M
                          CAD      15:30            BoC Senior Loan Officer Survey                                                  4Q                               -15.8
                          NZD      21:45            Food Prices                                                                    Dec                            -0.8%M
                          JPY      23:50            M2                                                                             Dec                             2.1%Y
                          CNY       NA              Actual FDI                                                                     Dec                            -5.4%Y
        15-Jan   Tue
                          NOK      09:00            Trade Balance                                                                  Dec                               31.9B
                          GBP      09:30            PPI                                                                            Dec                              2.2%Y
                          GBP      09:30            ONS House Price                                                                Nov                              1.5%Y
                          GBP      09:30            CPI                                                                            Dec                              2.7%Y
                          EUR      10:00            Trade Balance                                                                  Nov                                7.9B
                          USD      13:30            Empire Manufacturing Survey                                                    Jan                                 -8.1
                          USD      13:30            Advance Retail Sales                                                           Dec                              0.3%M
                          USD      13:30            PPI                                                                            Dec                              1.5%Y
                          USD      15:00            Business Inventories                                                           Nov                              0.4%M
                          JPY      23:50            Domestic CGPI                                                                  Dec                             -0.9%Y
        16-Jan   Wed
                          JPY      05:00            Consumer Confidence                                                            Dec                                39.4
                          CHF      08:15            Retail Sales                                                                   Nov                             2.7%Y
                          NOK      09:00            Existing Homes                                                                  4Q                             0.6%Q
                          EUR      10:00            CPI                                                                            Dec
                          USD      13:30            CPI                                                                            Dec                              1.8%Y
                          USD      14:00            Net Long-term TIC Flows                                                        Nov                               $1.3B
                          USD      14:15            Industrial Production                                                          Dec                              1.1%M
                          USD      14:15            Capacity Utilization                                                           Dec                             78.40%
                          USD      15:00            NAHB Housing Market Index                                                      Jan                                  47
                          BRL       NA              COPOM Rates Decision                                                                       7.25%                7.25%
        17-Jan   Thu
                          AUD      00:30            Employment Report                                                              Dec                              13.9K
                          CHF      08:15            PPI                                                                            Dec                             1.2%Y
                          EUR      10:00            Construction Output                                                            Nov                            -1.6%M
                          CAD      13:30            International Securities Transactions                                          Nov                             13.26B
                          USD      13:30            Building Permits                                                               Dec                               900K
                          USD      13:30            Initial Jobless Claims                                                 Wk of Jan 12
                          USD      15:00            Philadelphia Fed Manufacturing Survey                                           Jan                                8.1
                          CLP      21:00            BCC Rates Decision                                                                         5.00%                5.00%
                          NZD      21:45            CPI                                                                             4Q                              0.8%Y
        18-Jan    Fri
                          AUD       00:30              Export price index                                                           4Q                            -6.4%Q
                          CNY       02:00              GDP                                                                          4Q                             2.2%Q
                          CNY       02:00              Industrial Production                                                       Dec                            10.1%Y
                          CNY       02:00              Retail Sales                                                                Dec                            14.9%Y
                          GBP       09:30              Retail Sales                                                                Dec                             0.1%M
                          CAD       13:30              Manufacturing Sales                                                         Nov                            -1.4%M
                          USD       14:55              U. of Michigan Confidence                                                   Jan                                72.9
                          MXN       15:00              Banxico Rates Decision                                                                  4.50%                4.50%
     Upcoming Policy Events
        20-Jan            EUR        NA                German Regional Elections in Lower Saxony
        21-Jan            EUR       16:00              Eurogroup Meeting
        22-Jan             JPY      05:00              BoJ Rates Decision                                                                      0.10%     0.10%      0.10%
        23-Jan            CAD       14:00              BoC Rates Decision                                                                      1.00%     1.00%      1.00%
        23-Jan             INT       NA                World Economic Forum
        30-Jan            USD       19:15              FOMC Rates Decision                                                                     0.25%     0.25%      0.25%
        30-Jan            NZD       20:00              RBNZ Rates Decision                                                                     2.50%     2.50%      2.50%
        05-Feb            AUD       03:30              RBA Rates Decision                                                                      2.75%     2.75%      3.00%
        07-Feb            EUR        NA                Euro Summit
        13-Feb            SEK       08:30              Riksbank Rates Decision                                                                 1.00%     1.00%      1.00%
        15-Feb             INT       NA                G20 FinMins and CB Governors Mtg
        24-Feb            EUR        NA                Italian Elections (Tentative)
        01-Mar            USD        NA                Spending Sequester Takes Effect
        14-Mar            CHF       08:30              SNB Rates Decision                                                                      0.00%     0.00%      0.00%
        14-Mar            NOK       09:00              Norges Bank Rates Decision                                                              1.50%     1.50%      1.50%
        20-Mar             JPY       NA                Two Deputy BoJ Governors' Terms End
        27-Mar            USD        NA                Continuing Resolution Funding Federal Government Expires
        08-Apr             JPY       NA                BoJ's Shirakawa's Term Ends
        19-Apr             INT       NA                IMF and World Bank Spring Mtg
       15-Sep             EUR        NA                German President Elections (Tentative)
* Denotes timing approximate or not confirmed / All times and dates are GMT / Source: Morgan Stanley Research, Bloomberg




                                                                                                                                                                              17
                                                                      MORGAN STANLEY RESEARCH

                                                                      January 3, 2013
                                                                      FX Pulse




Cross-Currency Carry and Vol Opportunities
  Morgan Stanley & Co. LLC        Ronald Leven                        Implied Volatility: ARS was an outlier at down about 500bps
                                  +1 212 761-3413                     since the December 20th publication (note the heat map only
  Morgan Stanley & Co.            Corentin Rordorf                    shows the change for the past week) but generally speaking
  International plc               +44 20 7677-0518                    vols have firmed over year-end, especially for G10 currencies.

                                                                      With vols firmer, there are no new currencies in the blue zone
FX Forward Implied Carry: Modest moves with only a few                and quite a few have gone into the red zone vs where vols are
exceptions – as usual, ARS was one, declining roughly                 realizing: CHF, NOK, SEK, EUR and ZAR. One outlier was
200bps, and PHP also saw a relatively big 150bps decline.             CNY which became cheap vs realized.
Otherwise rate moves since we published on December 20th              NOKSEK dropped into the blue zone vs realized, making it
were generally modest, without much directional bias (note            cheap on both metrics. Otherwise, the trend was for higher
that the heat map only shows the change for the past week).           implieds vs realized; JPY, HKD, IDR, MXN, MXNJPY,
HUF saw the biggest gain since our last publication but was           EURRUB and PLN all went into the red zone.
up a modest 50bps.
                                                                      With vols generally firm, vol curves were biased to flatten, so
Given the generally stable rate environment, it should not be         no new curves became extreme.
surprising that there were no new extremes generated in
outright rate levels and only one currency – TRY – became             Where is the value in volatility? Finding value in the vol
extreme on a vol-adjusted basis.                                      markets remains a challenge as we enter the new year.
                                                                      Indeed, the heat map has the unfortunate combination that –
Skew was also fairly stable over year-end, with a bias for            with the one exception of CNY – no vols that are cheap on an
moderation. Indeed, both the skew for AUDCHF puts and for             outright basis are also cheap vs where vols are realizing.
EURMXN calls are getting historically close to zero.                  Moreover, while we continue to believe that vols are basing,
Where is the value in carry? 2013 is going to be a                    we think that 2013 is not likely to see substantially higher vols
challenging year to find attractive carry opportunities. Indeed,      and, consistent with this, our recent attempts to go long vol
as we start the year the main theme is many traditionally high        when currencies have dropped into the blue zone on both
carry currencies – especially, AUD, NZD, IDR, BRL, TRY,               metrics have failed to generate any profit. The biggest
ZAR, etc. – are offering near record low levels of outright           mispricing is that vol curves are implying a dramatic upturn in
carry. The main offset is that implied volatility is also near all-   volatility this year – most curves are near record levels of
time lows for most currencies so in many cases carry remains          steepness. For the year ahead, while we will continue to look
attractive on a vol-adjusted basis. Indeed, with vol skew also        for opportunities to get long shorter-maturity volatility, against
tending toward moderation, static carry – i.e., buying the            this we will look for ways to get short the back end of the vol
ATMF call and selling the same maturity ATMS call –                   curve.
continues to offer attractive potential return for some
currencies. In some cases – RUB, TRY and, especially, INR –
the opportunity to earn attractive static carry (our threshold is
normally a 2-to-1 or better potential pay out) aligns with our
constructive view on the currency. We are holding static carry
trades on these currencies and will look to roll them and/or
add longer maturity trades. In some other cases – especially
AUD – the static carry is attractive but we are bearish on the
currency. But we will look to put trades on if spot moves to
levels that are more closely aligned to our forecast.



                                                                      Carry and volatility heat map is on the following page.



                                                                                                                                     18
                                                                                                                MORGAN STANLEY RESEARCH

                                                                                                                January 3, 2013
                                                                                                                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     5.6    0.0      1%       1.1     47%       1.23     97%      1.11     99%     0.8     14%     59%     USDCAD   0.8    0.0    69%       0.14      99%        1.17       1.95
            USDCHF     7.4    -0.3     2%       1.3     89%       1.14     88%      1.07    100%     0.6      8%     79%     USDCHF   -0.6   -0.2   30%       -0.09      6%       -1.10       1.09
            USDJPY     8.9    -0.1    13%       1.4     89%       1.10     45%      1.31     96%     1.1     12%     98%     USDJPY   -0.3   -0.1   79%       -0.03     65%       -1.32       1.91
            USDNOK     8.7    -0.4     1%       1.3     97%       1.14     88%      1.06    100%     0.5      5%     27%     USDNOK   1.3    0.0    16%       0.16      78%        1.01       3.69
  G10




            USDSEK     9.5    -0.4     2%       1.2     93%       1.11     83%      1.06    100%     0.7      7%     32%     USDSEK   0.8    0.0    41%       0.09      49%        0.86       2.31
            GBPUSD     6.2    0.0      4%       1.3     87%       1.19     90%      1.23     98%     -0.5    -8%     87%     GBPUSD   -0.1   0.1    72%       -0.02     54%       -1.15       2.26
  USD




            NZDUSD     9.1    0.1      3%       1.1     80%       1.14     84%      1.05    100%     -1.6    -18%    58%     NZDUSD   -2.3   0.0    84%       -0.26     15%       -1.02       1.20
            AUDUSD     7.3    -0.4     1%       1.2     91%       1.25     98%      1.04    100%     -1.8    -24%    32%     AUDUSD   -2.7   0.0    87%       -0.36     15%       -0.96       2.17
            EURUSD     7.7    -0.3     2%       1.3     87%       1.14     86%      1.06    100%     -0.6    -7%     65%     EURUSD   0.3    -0.1   85%       0.04      90%        1.14       2.37
  ,




            EURAUD     7.2    -0.4     2%       1.1     46%       1.18     91%      1.00     95%     0.7     10%     40%     EURAUD   3.1    -0.1   28%       0.43      87%        0.98       2.31
            EURCAD     7.0    -0.1     2%       1.0     20%       1.14     86%      1.07     98%     -0.2    -3%     45%     EURCAD   1.1    -0.1   87%       0.16      95%        1.16       2.32
            EURCHF     3.1    0.1      3%       1.6     76%       1.58     89%      1.76     95%     1.0     31%     99%     EURCHF   -0.3   -0.1   81%       -0.11     34%       -1.06       2.38
            EURGBP     5.7    -0.1     2%       1.2     70%       1.20     94%      1.23     95%     -0.3    -6%     27%     EURGBP   0.5    0.0    68%       0.08      82%        1.14       2.33
  G10




            EURJPY    11.4    0.4     14%       1.2     76%       1.05     36%      1.27     88%     -0.2    -2%     99%     EURJPY   0.0    0.0    96%       0.00      96%        0.05       2.26
            EURNOK     5.3    0.2      2%       1.2     74%       1.13     90%      1.12     94%     0.2      4%      3%     EURNOK   1.7    -0.1   54%       0.32      96%        1.04       2.32
  EUR




            EURNZD     8.3    -0.4     5%       1.0     32%       1.16     84%      1.00     96%     0.7      8%     34%     EURNZD   2.7    -0.1   56%       0.33      85%        1.03
            EURSEK     6.5    -0.2    17%       1.1     42%       1.09     83%      1.15     99%     0.3      4%      3%     EURSEK   1.1    -0.1   65%       0.18      75%        0.94       2.16
  ,




            GBPAUD     6.4    -0.3     2%       1.1     63%       1.24     96%      1.08     99%     0.9     13%     63%     GBPAUD   2.6    -0.1   25%       0.41      91%        0.95       2.18




                                                                                                                                                                                                        Volatility and Carry Global Heatmap
            GBPCAD     6.0    0.2      4%       1.0     29%       1.15     84%      1.08     96%     -0.3    -4%     55%     GBPCAD   0.7    0.0    77%       0.11      83%        1.17
            GBPCHF     5.7    -0.1     3%       1.2     69%       1.26     91%      1.34     97%     0.2      3%     100% GBPCHF      -0.8   -0.1   42%       -0.14     15%       -1.11       2.06
            GBPJPY    10.4    0.0      8%       1.2     82%       1.04     33%      1.30     85%     0.2      2%     100% GBPJPY      -0.4   0.0    95%       -0.04     66%       -1.27
  G10




            CHFJPY    11.1    0.4     23%       1.2     74%       1.04     43%      1.09     40%     0.3      2%     99%     CHFJPY   0.4    -0.1   88%       0.03      94%        0.96      -20.48
            AUDCAD     5.6    -0.3     1%       1.0     32%       1.27     98%      1.07     99%     -0.9    -16%    12%     AUDCAD   -1.9   0.0    100%      -0.34     53%       -0.87       2.03
  Crosses




            AUDCHF     7.6    -0.4     2%       1.1     61%       1.22     89%      1.13     99%     -0.6    -8%     97%     AUDCHF   -3.3   -0.2   83%       -0.43      7%       -0.99       1.08
            AUDJPY    10.4    0.0      2%       1.3     92%       1.13     64%      1.27     80%     -0.5    -5%     99%     AUDJPY   -2.9   -0.1   96%       -0.28     47%       -1.01       2.09
            AUDNZD     5.6    0.1      6%       1.1     53%       1.12     79%      1.04     95%     -0.3    -5%     22%     AUDNZD   -0.3   0.0    75%       -0.06     70%       -0.57       2.09
            NOKSEK     5.3    -0.1     3%       1.0     30%       1.11     86%      1.12     71%     0.2      4%     37%     NOKSEK   -0.5   0.0    58%       -0.10     52%       -5.31       0.24
  ,




            USDCNY     1.6    -0.3    13%       0.5      0%       1.23     10%      3.06     96%     0.2     13%     67%     USDCNY   0.6    -0.8   73%       0.38      75%        0.66       2.09
            USDHKD     0.7    0.0     33%       6.4     92%       1.38     35%      4.55     29%     -0.8    #####   17%     USDHKD   -0.1   0.0    86%       -0.16     87%       -0.47      10.41
            USDIDR     6.2    -0.2     1%       2.4     97%       1.42     80%      1.43     72%     3.0     48%     74%     USDIDR   2.4    -1.0    6%       0.38      34%        1.68       1.95
            USDINR    10.2    -0.2    40%       1.2     46%       1.02     18%      1.24     76%     0.3      3%      1%     USDINR   6.1    -0.2   59%       0.60      61%        0.93       2.61
AXJ BLOCK




            USDKRW     5.4    -0.4     0%       1.7     96%       1.39    100%      1.48     94%     1.5     27%     36%     USDKRW   2.2    0.1    77%       0.41      100%       0.78       1.80
            USDMYR     5.2    0.2      2%       1.2     58%       1.23     95%      1.30     83%     0.9     17%     33%     USDMYR   1.8    0.1    65%       0.35      95%        0.96       1.97
            USDPHP     5.1    0.1      1%       1.5     84%       1.22     80%      1.36     81%     0.7     14%      2%     USDPHP   -2.5   1.1     0%       -0.48      0%       -0.31       1.68
            USDSGD     3.6    0.2      2%       1.4     86%       1.29     97%      1.64    100%     0.7     18%     55%     USDSGD   0.0    0.0    69%       0.00      71%        3.50       1.68
            USDTHB     7.0    0.0     34%       2.8     92%       1.14     50%      1.25     45%     0.8     11%     13%     USDTHB                                                1.01       2.04
            USDTWD     3.6    0.1      1%       1.4     62%       1.24     85%      1.90     99%     0.4     10%     60%     USDTWD   -2.8   -0.8   40%       -0.77      6%       -0.68       1.55
,




            USDARS    15.0    -3.0    68%      15.8     94%       1.83     42%      1.43     33%     7.0     47%     38%     USDARS   27.1   -2.6   74%       1.81      82%        1.16       2.68
            USDCLP     8.8    0.0      0%       1.5     83%       1.26     99%      1.27     89%     3.0     34%     89%     USDCLP   4.8    -0.5   80%       0.55      96%        0.98       2.08
            USDCOP     7.5    0.0      0%       1.9     94%       1.43    100%      1.19     70%     3.0     40%     91%     USDCOP   3.3    0.0    46%       0.44      83%        1.10       1.96
  LATAM




            USDMXN    10.3    0.1     23%       1.4     81%       1.13     71%      1.14     53%     2.9     28%     34%     USDMXN   3.6    0.4    40%       0.35      76%        1.02       1.97
            USDBRL     9.1    -0.8     3%       1.4     74%       1.13     63%      1.45     99%     2.6     29%     30%     USDBRL   5.1    0.0     6%       0.57      68%        1.04       2.25
            EURBRL    10.3    -0.3     8%       1.2     73%       1.07     37%      1.27     62%     3.6     35%     36%     EURBRL   5.5    -0.1    8%       0.53      46%        1.04       2.26
  BLOCK




            EURMXN     9.4    0.2      3%       1.2     51%       1.12     70%      1.34     94%     1.7     18%     11%     EURMXN   3.9    0.3    54%       0.42      97%        1.03       2.16
            BRLJPY    13.1    -0.6     5%       1.3     78%       1.07     37%      1.42    100%     -2.7    -20%    99%     BRLJPY   -5.1   0.0    96%       -0.39     52%       -1.06       0.65
            MXNJPY    14.0    0.1     12%       1.3     80%       1.09     58%      1.17     75%     -2.5    -18%    95%     MXNJPY   -3.7   0.3    69%       -0.26     22%       -1.05       0.49
  ,




            EURCZK     5.9    0.0      0%       1.5     96%       1.18    100%      1.00     66%     1.6     27%     76%     EURCZK   0.0    0.0    34%       0.01      34%        1.81       1.70
            EURHUF     9.0    0.8     14%       1.1     62%       1.10     75%      1.03     88%     2.8     31%     74%     EURHUF   4.6    0.3    53%       0.51      87%        0.78       1.99
            EURILS     7.0    -0.2     1%       1.2     69%       1.11     84%      1.12    100%     0.6      9%     95%     EURILS   1.6    -0.2   81%       0.23      94%        0.88       2.18
            EURPLN     6.9    0.2     11%       1.2     77%       1.26     99%      1.00     59%     2.3     33%     92%     EURPLN   4.0    0.0    84%       0.58      96%        0.79       2.02
            EURRUB     8.8    0.6     19%       1.4     95%       1.10     32%      1.54     95%     1.5     17%     34%     EURRUB   7.1    0.5    77%       0.80      82%        0.89       2.56
            EURTRY     6.5    -0.3     1%       1.2     71%       1.29     92%      1.42     82%     1.0     15%      7%     EURTRY   5.1    0.2     8%       0.79      82%        1.00       2.52
  EMEA




            EURZAR    11.9    0.0      5%       1.1     41%       1.18     94%      1.16     55%     2.2     18%     24%     EURZAR   5.4    -0.2   24%       0.46      80%        0.98       2.21
            USDHUF    13.5    0.8     12%       1.2     97%       1.10     88%      1.02     91%     3.3     24%     74%     USDHUF   4.3    0.4    25%       0.32      69%        0.75       1.91
            USDILS     7.7    0.0     17%       1.1     59%       1.08     83%      1.06     86%     1.5     20%     74%     USDILS   1.3    -0.1   63%       0.16      78%        0.81       1.88
  BLOCK




            USDPLN    11.7    0.2     11%       1.3     97%       1.25     98%      0.99     61%     2.8     24%     70%     USDPLN   3.7    0.1    76%       0.32      96%        0.76       1.92
            USDRUB     9.5    0.4     19%       1.3     76%       1.14     45%      1.44     91%     1.9     20%     16%     USDRUB   6.3    0.1    69%       0.66      83%        0.93       2.30
            USDTRY     6.0    -0.4     0%       1.3     85%       1.42     99%      1.37     83%     1.6     27%     37%     USDTRY   4.8    0.3     5%       0.80      89%        1.00       2.31
            USDZAR    13.6    0.0      2%       1.2     88%       1.15     96%      1.13     60%     2.7     20%      1%     USDZAR   5.1    -0.1    4%       0.37      55%        0.97       2.07
  ,




                                                                                                                                                                                 1/2/2013


Note: Access is available to the carry metrics on an interactive basis at:https://secure.ms.com/eqr/quotient/webapp/servlet/IRSHomeServlet
Contact your Morgan Stanley sales representative if you do not have access.
Source: Morgan Stanley Research




                                                                                                                                                                                                              19
                                                                                    MORGAN STANLEY RESEARCH

                                                                                    January 3, 2013
                                                                                    FX Pulse




G10 FX Tactical Indicators
Marc Englander

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

    2%                                                                             100
    1%
                                                                                    50
    0%
   -1%                                                                               0
   -2%
   -3%                                                                             -50
   -4%                                                                            -100
   -5%
   -6%                                                                            -150
              SEK NOK CHF GBP EUR CAD NZD AUD DXY JPY                                Jun-12                     Aug-12                  Oct-12                      Dec-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
   10
                                                                                         3

    5
                                                                                         2
                                                                                         1
    0
                                                                                         0
                                                                                      -1
    -5
                                                                                      -2
  -10                                                                                 -3
             SEK   NOK      GBP   NZD AUD      CAD USD      EUR   CHF      JPY
                                  Current      Last Pulse
                                                                                      May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12

Source: Morgan Stanley                                                           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
                                                                                     AUD
    0.2
                                                                                     CAD
   0.15
                                                                                     MXN
    0.1                                                                              GBP

   0.05                                                                              CHF

         0                                                                           NZD

                                                                                     EUR
  -0.05
                                                                                      JPY
   -0.1
     Dec-11        Feb-12    Apr-12   Jun-12   Aug-12   Oct-12    Dec-12                     -15          -10              -5                              5                 10

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




                                                                                                                                                                              20
                                                                                                                         MORGAN STANLEY RESEARCH

                                                                                                                         January 3, 2013
                                                                                                                         FX Pulse




Morgan Stanley FX Positioning Tracker
Calvin Tse and Gabriel de Kock


Overall Score                                                                                  Component Scores
         This     Last
                                Short               Neutral                    Long
                                                                                                                                                   Since Monday (December 24), positioning in the
         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               G10 currencies has changed materially. We
                                                                                                                                                    calculate the largest long positions to be in NZD
  USD      1       2                                                                               9   -3                0      -4      USD       and NOK. The largest short is in JPY.
  EUR      3      -1                                                                               1    4                2       4      EUR
                                                                                                                                                   EUR positioning moved into long territory from
  JPY     -7      -6                                                                           -9      -9       2        -6     -9      JPY       neutral. This was driven by our own clients, and
                                                                                                                                                    by global macro hedge funds, who were both
  GBP      2       3                                                                           -3      10                -2      3      GBP
                                                                                                                                                    large buyers recently.
  CHF      1       0                                                                               0    6                       -2      CHF
                                                                                                                                                   JPY positioning moved into extreme short
  CAD      2       1                                                                           -4       6                        3      CAD       territory. Toshin accounts continue to sell the
                                                                                                                                                    currency, while sentiment has also soured
  AUD      4       4                                                                                1    7                        5      AUD
                                                                                                                                                    further.
  NZD      5       6                                                                               6    3                               NZD
                                                                                                                                                   We will provide a full updated report and refresh
  NOK      5       5                                                                                5                                    NOK       positioning scores for all of our underlying sub-
                                                                                                                                                    indicators next Monday.
  SEK      0      -2                                                                               0                                    SEK
                                                                                                                                                                        For Methodology see Appendix



Morgan Stanley High-Frequency Misalignment Monitor
1Yr                                                     2 January, 2013
                 EUR         JPY           GBP              CHF       AUD                     CAD        NZD             NOK            SEK
                                                                                                                                                   JPY undervaluation, along with NOK and NZD
USD             -0.2%       -3.3%         -0.7%            -0.1%      0.4%                   -0.6%       1.3%            2.5%          -0.2%
                                                                                                                                                    overvaluation, is the key takeaway from our
EUR                         -3.0%         -0.4%             0.2%      0.7%                   -0.4%       1.5%            2.8%          0.1%
                                                                                                                                                    High-Frequency Misalignment Monitor. We
JPY                                       2.6%              3.2%      3.7%                   2.7%        4.6%            5.8%          3.1%         believe the JPY move is justified by the Abe
GBP                                                         0.6%      1.1%                   0.0%        1.9%            3.2%          0.5%         government’s aggressive rhetoric on BoJ policy
CHF                                                                   0.5%                   -0.6%       1.3%            2.6%          -0.1%        and expectations for aggressive easing, if
AUD                                                                                          -1.0%       0.9%            2.1%          -0.6%        overdone near term. After NOK, the NZD, AUD
CAD        > +/- 1 sd                                                                                    1.9%            3.1%          0.4%         and CHF are the most overvalued in the G10.
NZD        > +/- 2 sd                                                                                                    1.2%          -1.5%
                                                                                                                                                   Statistically, NOK overvaluation is the strongest
NOK        > +/- 3 sd                                                                                                                  -2.7%
                                                                                                                                                    signal from our one-year model, which yielded
2Yr                                                                                                                                                 the highest and most reliable trading profits in
                EUR          JPY           GBP               CHF               AUD            CAD         NZD            NOK            SEK         back tests. The model signals NOK shorts vs
USD             0.7%        -5.1%         -0.1%              5.3%             0.6%           0.5%         3.7%           4.6%          3.3%         all of the other G10 currencies except NZD, with
EUR                         -5.8%         -0.8%              4.6%             -0.1%          -0.2%        3.1%           3.9%          2.6%
                                                                                                                                                    2-σ overvaluations against USD, EUR, JPY,
                                                                                                                                                    GBP and CAD. The model continues to signal
JPY                                       5.0%              10.4%             5.7%           5.6%         8.9%           9.7%          8.4%
                                                                                                                                                    JPY longs against USD, AUD, NZD and NOK
GBP                                                          5.4%             0.7%           0.6%         3.9%           4.7%          3.4%         with 2-σ undervaluations.
CHF                                                                           -4.7%          -4.8%       -1.6%           -0.7%         -2.0%
AUD                                                                                          -0.1%        3.1%           4.0%          2.7%        CHF and NOK are the most expensive relative
CAD        > +/- 1 sd                                                                                     3.3%           4.1%          2.8%         to fair values estimated over two-year look-back
NZD        > +/- 2 sd                                                                                                    0.9%          -0.5%        windows, while JPY is the weakest. The models
NOK        > +/- 3 sd                                                                                                                  -1.3%        signal NOK shorts against the G10 excluding
                                                                                                                                                    CHF, with a 3-σ mispricing against JPY and 2-σ
3Yr                                                                                                                                                 overvaluations vs. USD, EUR GBP and CAD. It
                EUR          JPY           GBP               CHF               AUD            CAD         NZD             NOK           SEK         also signals G10 shorts against JPY, with USD,
USD             0.8%        -7.2%         0.6%               3.9%             0.3%           0.1%         2.5%            4.1%         1.8%         CAD, NOK and SEK at the 3-σ level and the
EUR                         -8.0%         -0.1%              3.1%             -0.5%          -0.7%        1.7%            3.4%         1.1%         other JPY crosses with 2-σ misalignments.
JPY                                       7.9%              11.1%             7.5%           7.3%         9.7%           11.4%         9.0%        NOK, CHF and NZD are the most expensive
GBP                                                          3.2%             -0.4%          -0.6%        1.8%            3.5%         1.2%         G10 currencies and JPY the cheapest, in our
CHF                                                                           -3.6%          -3.8%       -1.4%            0.3%         -2.1%        three-year model, which yields the slowest-
AUD                                                                                          -0.2%        2.2%            3.9%         1.5%         changing misalignment estimates.
CAD        > +/- 1 sd                                                                                     2.4%            4.1%         1.7%
NZD        > +/- 2 sd                                                                                                     1.7%         -0.7%       Overall, NOK shorts and JPY longs are the key
NOK        > +/- 3 sd                                                                                                                  -2.3%
                                                                                                                                                    signals from of the MS Misalignment Monitor.
Note: Misalignment measured as the overvaluation of the column currency vs the row currency                                                                             For Methodology see Appendix




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Central Bank Watch
                          Next rate           Market                    MS                                                        Morgan Stanley Rates Forecasts
                          decision          expects (bp)            expects (bp)      Current                4Q12            1Q13                2Q13                3Q13        4Q13
US                         30 Jan                      -2                     0         0.15                 0.15             0.15               0.15                0.15        0.15
Euro Area                  10 Jan                      -2                     -25       0.75                 0.75             0.50               0.50                0.50        0.50
Japan                      21 Jan                      0                      0         0.05                 0.05             0.05               0.05                0.05        0.05
UK                         10 Jan                      -4                     0         0.50                 0.50             0.50               0.50                0.50        0.50
Canada                     23 Jan                      -1                     0         1.00                 1.00             1.00               1.00                1.00        1.00
Switzerland                14 Mar                      -1                     0         0.00                 0.00             0.00               0.00                0.00        0.00
Sweden                     13 Feb                      -                       -        1.00                 1.00             1.00               1.00                1.00        1.25
Norway                     14 Mar                      -2                     0         1.50                 1.50             1.50               1.50                1.75        1.75
Australia                  04 Feb                      -                       -        3.00                 3.00             2.75               2.50                2.50        2.50
New Zealand                30 Jan                      -4                     0         2.50                 2.50             2.50               2.50                2.75        3.00
Russia                    09-15 Jan                    -                  +25           5.50                 5.50             5.75               5.75                5.75        5.50
Poland                     09 Jan                      -7                     -25       4.25                 4.25             3.75               3.25                3.25        3.25
Czech Rep                  06 Feb                      -3                     0         0.05                 0.05             0.05               0.05                0.05        0.05
Hungary                    28 Jan                      -                      0         5.75                 5.75             5.25               5.00                5.00        5.00
Romania                    05 Feb                      -                      0         5.25                 5.25             5.25               5.25                5.25        5.25
Turkey                        N/A                      0                      0         5.50                 5.50             5.25               5.25                5.25        5.25
Israel                     28 Jan                      -                       -        1.75                 2.00             1.75               1.75                1.75        2.00
South Africa               24 Jan                  -10                        0         5.00                 5.00             5.00               5.00                5.00        5.00
Nigeria                       N/A                      -                      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                      29 Jan                      0                      0         8.00                 8.00             7.75               7.25                7.25        7.25
Hong Kong                  17 Jan                      -                      0         0.50                 0.50             0.50               0.50                0.50        0.50
S. Korea                   13 Feb                      -4                     0         2.75                 2.75             2.75               2.75                2.75        2.75
Taiwan                     21 Mar                      7                      0         1.88                 1.88             1.88               1.88                1.88        2.00
Indonesia                  09 Jan                      -                      0         5.75                 5.75             5.75               5.75                5.75        5.75
Malaysia                   31-Jan                      0                      0         3.00                 3.00             3.00               3.00                3.00        3.00
Thailand                   09 Jan                      0                      0         2.75                 2.75             2.75               2.75                2.75        2.75
Brazil                     16 Jan                      -5                     0         7.25                 7.25             7.25               7.25                7.25        7.25
Mexico                     18 Jan                      0                      0         4.50                 4.50             4.50               4.50                4.50        4.50
Chile                      17 Jan                      -1                     0         5.00                 5.00             5.00               5.00                5.00        5.00
Peru                       10 Jan                      0                      0         4.25                 4.25             4.25               4.25                4.25        4.25
Colombia                  18-25 Jan                    -                       -        4.25                 4.50             4.50               4.50                4.50        4.50
Source: National Central Banks, Morgan Stanley Research forecasts; Note: Japan policy rate is an interval of 0.00-0.10%. Forecasts as of November 19, 2012.
G4 Policy Rate Forecasts                                                                              BRICs Policy Rate Forecasts
 7                   US             Euro Area               Japan        UK                             30               China          Brazil       Russia           India
 6                                                                                                      25
 5                                                                                                      20
 4                                                                                                                                                                     Morgan
                                                                                                        15                                                             Stanley

 3
                                                                    Morgan                              10
 2                                                                  Stanley

                                                                                                         5
 1
 0                                                                                                       0
  2002      2004       2006         2008        2010         2012    2014                                 2002       2004        2006    2008      2010       2012      2014

Source: Morgan Stanley Research                                                                       Source: Morgan Stanley Research




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Morgan Stanley Global Currency Forecasts
 We updated our G10 forecasts on November 20, 2012.
                                                         2013                                 2014                 4Q13 % change to:
                       Current             1Q           2Q              3Q     4Q       1Q         2Q     3Q     Consensus           Forward
EUR/USD                     1.30         1.34          1.30        1.25        1.20    1.15       1.12    1.10             -5.5            -8.1
USD/JPY                       88           84            87          89          90      92         90      90              3.4             2.3
GBP/USD                     1.61         1.61          1.60        1.58        1.54    1.51       1.45    1.45             -3.8            -4.0
USD/CHF                     0.93         0.90          0.92        0.96        1.00    1.00       1.05    1.13              2.0             8.3
USD/SEK                     6.54         6.72          6.85        7.04        7.25    7.48       7.59    7.55              6.9            10.1
USD/NOK                     5.60         5.52          5.54        5.68        5.88    6.09       6.21    6.27              1.1             3.6
USD/CAD                     0.99         0.96          0.97        0.98        1.00    1.01       1.03    1.04              2.0             0.1
AUD/USD                     1.04         1.04          1.02        0.99        0.96    0.93       0.90    0.87             -6.8            -5.6
NZD/USD                     0.82         0.84          0.83        0.82        0.80    0.78       0.76    0.75             -2.4            -0.5
EUR/JPY                     115          113           113          111         108     106        101      99             -0.9            -6.0
EUR/GBP                     0.81         0.83          0.81        0.79        0.78    0.76       0.77    0.76             -1.3            -4.3
EUR/CHF                     1.21         1.20          1.20        1.20        1.20    1.15       1.18    1.24             -2.4            -0.4
EUR/SEK                     8.51         9.00          8.90        8.80        8.70    8.60       8.50    8.30              3.0             1.2
EUR/NOK                     7.28         7.40          7.20        7.10        7.05    7.00       6.95    6.90             -2.5            -4.8
USD/CNY                     6.23         6.30          6.30        6.30        6.30    6.22       6.20    6.18              2.9            -0.3
USD/HKD                     7.75         7.80          7.80        7.80        7.80    7.80       7.80    7.80              0.5             0.7
USD/IDR                    9788         9750          9900       10200       10000    9950       9900    9850               5.0            -1.7
USD/INR                     55.0         53.3          54.0        55.5        54.5    54.3       54.0    53.5              4.8            -6.3
USD/KRW                    1064         1075          1100        1120        1080    1065       1055    1040               3.6            -0.2
USD/MYR                     3.05         3.03          3.05        3.08        3.05    3.03       3.00    2.96              1.7            -1.6
USD/PHP                     40.9         40.7          40.6        40.7        40.6    40.3       39.9    39.7              2.8            -0.2
USD/SGD                     1.23         1.21          1.22        1.23        1.21    1.20       1.19    1.18              1.7            -1.5
USD/TWD                     29.0         28.8          29.0        29.1        28.9    28.7       28.6    28.5              1.0             1.2
USD/THB                     30.5         30.3          30.2        30.3        30.2    30.0       29.9    29.8              1.3            -2.7
USD/BRL                     2.05         2.10          2.10        2.10        2.10    2.10       2.08    2.05              4.0            -2.7
USD/MXN                     12.8         12.6          12.8        13.4        12.4    12.2       12.0    11.8              1.6            -6.4
USD/ARS                     4.93         5.40          5.80        6.20        7.00    7.18       7.35    7.53             22.8            10.1
USD/VEF                     4.29         7.50          7.50        7.50        7.50    7.50       7.50    7.50             15.4            74.6
USD/CLP                     473          470           480         495         475     470        465     460              -2.1            -3.9
USD/COP                    1763         1780          1850        1870        1850    1820       1800    1780               2.9             1.3
USD/PEN                     2.55         2.58          2.60        2.62        2.63    2.61       2.59    2.57              4.4             1.9
USD/ZAR                     8.63         8.85          9.00        9.25        9.00    9.00       8.90    8.80              6.4            -0.5
USD/TRY                     1.79         1.76          1.78        1.81        1.77    1.76       1.75    1.74             -1.1            -5.6
USD/ILS                     3.78         3.85          3.90        3.95        3.90    3.85       3.83    3.83              1.3             2.3
USD/RUB                     30.4         30.5          31.0        31.5        31.2    31.0       30.8    30.6              1.3            -2.8
RUB basket                  34.5         35.2          35.2        35.0        34.0    33.1       32.4    32.0             -1.5            -5.6
EUR/PLN                     4.10         4.10          4.20        4.30        4.20    4.15       4.15    4.10              5.0            -0.7
EUR/CZK                     25.3         26.4          26.4        26.3        26.2    26.1       26.0    25.8              4.0             3.7
EUR/HUF                     290          275           285         290         285     282        280     278               1.8            -5.1
EUR/RON                     4.42         4.60          4.65        4.65        4.60    4.55       4.52    4.50              2.7            -0.4
MS Dollar Index             1.30         1.34          1.30        1.25        1.20    1.15       1.12    1.10             -5.5            -8.1
MS AXJ Index                  88           84            87          89          90      92         90      90              3.4             2.3
G10 Forecasts were updated November 20, 2012 Forecast changes in bold                                            Source: Morgan Stanley Research
AXJ Forecasts updated November 20, 2012.
CEEMEA forecasts updated November 20, 2012
MS Index forecasts based on geometric indices




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Appendix
    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
      performance.
      •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.


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Global FX Strategy Team
Head of Global FX Strategy (London)                      Hans Redeker, Managing Director                          hans.redeker@morganstanley.com          (+44 20) 7425 2430

Head of US FX Strategy (New York)                        Gabriel de Kock, Executive Director                      gabriel.de.kock@morganstanley.com       (+1 212) 761-5154
Senior Currency Strategist (New York)                    Ron Leven, Executive Director                            ronald.leven@morganstanley.com          (+1 212) 761-3413
Currency Strategist (New York)                           Evan Brown, CFA, Associate                               evan.brown@morganstanley.com            (+1 212) 761-2786
Currency Strategist (New York)                           Marc Englander, Analyst                                  marc.englander@morganstanley.com        (+1 212) 761-8278

Head of European FX Strategy (London)                    Ian Stannard, Executive Director                         ian.stannard@morganstanley.com          (+44 20) 7677 2985
Currency Strategist (London)                             Dara Blume, Associate                                    dara.blume@morganstanley.com            (+44 20) 7425-5749

Currency Strategist (Hong Kong)                          Calvin Tse, Associate                                    calvin.tse@morganstanley.com            (+852) 3963-0551

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




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                                                                                          MORGAN STANLEY RESEARCH

                                                                                          January 3, 2013
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                                                         MORGAN STANLEY RESEARCH




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