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Morgan Stanley -Liquidity Limits Risk Pause by riteshbhansali

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Liquidity Limits Risk Pause

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									                                                                         MORGAN STANLEY RESEARCH


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




         February 28, 2013                                              Trade Recommendations
         Currencies                                                      Closed Trades
                                                                         Long USD/JPY                          Stopped at 92.10 on 25-Feb-13
                                                                         Long EUR/AUD                          Stopped at 1.2700 on 25-Feb-13
Global
         FX Pulse                                                        Long EUR/JPY                          Stopped at 120.70 on 25-Feb-13
                                                                         Long "FX Policy" Basket               Stopped at 98.50 on 25-Feb-13

         Liquidity Limits Risk Pause                                     Long EUR/USD
                                                                         Active Trades
                                                                                                              Took Profit at 1.315 on 27-Feb-13
                                                                                                                  Entry           Stop      Target
                                                                         Long AxJ/JPY                            103.90         100.00      110.00
         EUR overshoot brought to a halt. The uncertain political        Short AUD/NZD                           1.2338         1.2700      1.1000
                                                                         Active Options Trades               Entry Date Expiry Date          Strike
         environment post the Italian election has brought our EUR
                                                                         Long USD call/JPY put               28-Feb-13     02-Sep-13         96.00
         overshoot scenario to an end. We now suggest that further       Short USD call/JPY put              28-Feb-13     02-Sep-13        100.00
         EUR/USD upside potential in the coming months is likely         See page 15 for more details. Changes in stops/targets in bold italics.

         to be more limited, while the near-term risks have shifted
         to the downside. As a result, we closed our long EUR/USD       MS Major Currency Forecasts
         position from 1.3090 as recommended in last week’s FX                                  1Q13            2Q13             3Q13              4Q13
         Pulse at 1.3150 (see FX Strategy Special Note: Closing          EUR/USD                  1.32             1.36             1.32            1.26
         EUR Longs, February 26, 2013).                                  USD/JPY                    95               97               99            100
         JPY still the liquidity provider. While the inconclusive        GBP/USD                  1.60             1.62             1.60            1.57
         Italian elections have dented risk appetite, likely having a    USD/CHF                  0.91             0.88             0.91            0.95
                                                                         USD/CAD                  0.98             0.97             0.98            1.00
         broader impact on global currency markets, the liquidity
                                                                         AUD/USD                  1.07             1.10             1.08            1.05
         side of the equation remains intact. Hence, corrections to
                                                                         NZD/USD                  0.86             0.88             0.86            0.84
         recent trends could prove to be short-lived. Indeed, the
                                                                         EUR/JPY                  125              132              131             126
         prospect of further monetary policy action from Japan has       EUR/GBP                  0.83             0.84             0.83            0.80
         been given another boost by the official nomination of          EUR/CHF                  1.20             1.20             1.20            1.20
         Kuroda as the next BoJ governor. Hence, we believe that         EUR/SEK                  8.80             9.00             8.80            8.70
         the pullback in USD/JPY will remain limited, providing a        EUR/NOK                  7.40             7.50             7.30            7.05
         renewed buying opportunity.                                    Note: Forecasts for end-of-period. G10 forecasts updated January 10, 2013.


         GBP the medium-term underperformer. We believe the             FX Market Overview                                                          P2
         moving of the monetary policy goalposts in the UK will         The Case for Prolonged Sterling Weakness                                    P7
         leave GBP vulnerable. Indeed, inflation expectations are       CAD: It’s Not That Bad                                                     P13
         already on the rise, driving UK rate and yield differentials   Strategic FX Portfolio Trade
         on some measures deeper into negative territory. This is        Recommendations                                                           P15
         reducing the attractiveness of GBP from an investment          G10 & EM Currency Summary                                                  P18
         perspective, as well as eroding its safe-haven credentials.
                                                                        Global Event Risk Calendar                                                 P20
         We keep our focus on GBP/USD, where the risk of a more
                                                                        FX Volatility/Carry Grids, Tactical Indicators                             P22
         significant move lower is now building, in our view.
                                                                        MS FX Positioning Tracker                                                  P25
         CAD remains attractive. Following the recent sharp             FX and Macro Forecasts                                                     P26
         decline in the CAD, as a result of an adjustment to the
                                                                        FX Bull and Bear Projections                                               P28
         changing tone of the BoC and the softer patch of
         economic data, we believe that the currency is likely to
         maintain its relative attractiveness within the G10. Indeed,
         the BoC is unlikely to ease policy, in our view, suggesting
         that the CAD is unlikely to be subjected to the same
         pressure as GBP and JPY. In addition, on a terms-of-trade
         basis the case can be made that the CAD is undervalued
         compared to the overvaluation of its commodity currency
         peer, the AUD.                                                  For important disclosures, refer to the
                                                                         Disclosures Section, located at the end of
                                                                         this report.
                                                                           MORGAN STANLEY RESEARCH

                                                                           February 28, 2013
                                                                           FX Pulse




FX Overview
    Morgan Stanley & Co.                        Hans Redeker               Exhibit 2
    International plc                           +44 20 7425-2430
                                                                           Seat Distribution in the Senate
    Morgan Stanley & Co. LLC                    Vitali Meschoulam
                                                +1 212 761 1889




      The outcome of the Italian Election has brought our EUR
       overshoot scenario to an end.
      While events in Italy have been felt globally and there may still
       be aftershocks to come, we expect risk supportive liquidity
       conditions to prevail.
      Sharply downward-correcting JPY crosses offer medium-term
       buying opportunities as Japan’s JPY weakening ‘Abenomics’
       will stay firmly in place.
      EM currencies have not been immune from the election in Italy,
       but we maintain our constructive stance on EMFX, and view
       any setbacks as a buying opportunity.


                                                                           Source: Morgan Stanley Research, Italian Ministry of the Interior
Italian Vote Disappointment
                                                                           The political direction Italy takes will steer EMU capital
Our call for a EUR overshoot no longer holds due to the                    markets in general, with the BTP staying at the epicenter of
Italian election results, which could leave Italy in a political           events. Italy is one of the stronger peripheral countries. Its
vacuum created by the fragmentation in the Italian Parliament.             private sector commands a strong asset base and its
Over recent months, Italy enjoyed strong inflows into its                  balanced current account suggests Italy is not dependent on
capital markets, driving sovereign bond yields lower. The                  capital imports. In this light, the probability that the country
election result has sent Italy back into the muddy waters of               undertakes successful reform measures is reasonably high.
political instability, leaving room for speculation, rumours and           Nonetheless, its population voted against austerity and
disappointment. No question, volatility will benefit.                      restructuring, leaving the rest of Europe puzzled.
Exhibit 1
Seat Distribution in the Italian Parliament                                Italian Markets Matter
                                                                           Italy has the third-biggest sovereign bond market globally and
                                                                           with 35% of BTPs held outside of Italy, the outlook for Italy’s
                                                                           sovereign bonds will be important for international portfolio
                                                                           stability. Monday afternoon’s price action was a stark
                                                                           reminder of this, as unwinding of EURJPY longs led market
                                                                           volatility higher following the surprising election results.
                                                                           Investors liquidated assets to cover EMU related losses, even
                                                                           in parts of their portfolios that might not be directly impacted
                                                                           by the events in Italy. For example, the EM currency ‘darlings’
                                                                           such as the MXN, RUB and previously strongly-performing
                                                                           AXJ currencies were hit sharply. Indeed, Italy is too big to
                                                                           ignore and should the political situation deteriorate
                                                                           significantly, this could have ramifications beyond the EMU.
                                                                           However, the message provided by the Italian electorate is
                                                                           also a cry for economic growth, especially by the younger
Source: Morgan Stanley Research, Italian Ministry of the Interior
                                                                           generation. The ECB may have to listen. EMU’s periphery,

.                                                                                                                                              2
                                                                         MORGAN STANLEY RESEARCH

                                                                         February 28, 2013
                                                                         FX Pulse




and especially Italy, faces an overvalued exchange rate which            Exhibit 5
we highlighted in FX Pulse: Heading Towards EUR Over-                    Holders of Italian Government Debt
Valuation. Weak economic prospects feed populism, but with                                                                                 % of
                                                                                                                                          Total
                                                                                                                                                                         % of
                                                                                                                                                                         Total
fiscal options barely existing, a nominal devaluation of the             Marketable Debt Holder (bn)                  Amount (Jul-11)    (Jul-11)   Amount (Nov-12)    (Nov-12)
                                                                         ECB - SMP (Non-Italian NCB) *                                                € 86               5.1%
exchange rate could be the catalyst for the growth peripheral            ECB - SMP (Central Bank of Italy) *                                          € 24               1.4%
                                                                         Domestic Holdings                            € 815               50%        € 994               59%
EMU desperately needs. We calculated the fair EURUSD rate                - Central Bank of Italy **                      € 70              4.3%          € 72              4.3%
                                                                         - Italy Monetary Financial Institutions **     € 262             16.2%         € 375             22.1%
for Italy at 1.19. A move below this level could raise export            - Italy Other Financial **                     € 298             18.4%         € 344             20.3%
                                                                         - Italian Resident *                           € 184             11.4%         € 203             12.0%
revenues, boosting income and employment and thus                        Foreign Holdings                             € 805               50%        € 592               35%
                                                                           -- European Non-Italian Banks ***            € 110              6.8%          € 71              4.2%
showing the light at the end of the tunnel.                                -- US Banks ***                                 €6              0.4%            €8              0.5%
                                                                           -- Japanese Banks ***                         € 15              0.9%          € 15              0.9%
                                                                           -- Italian fund managed abroad *              € 50              3.1%          € 50              2.9%
There is another reason why the FX rate may become                         -- Others                                    € 624             38.5%         € 449             26.4%
                                                                              of which (at least):
increasingly important. In peripheral EMU, the monetary                       --- European Non-Italian Insurance &
                                                                         Mutual Fund *
transition channel seems to still be blocked as revealed in the
                                                                                                                                 € 230     14.2%               € 220     13.0%
                                                                              -- Remaining Others (Largely RM Asset

release of January monetary data. While private sector
                                                                         Managers)                                               € 394     24.3%               € 229     13.5%
                                                                         Total                                        € 1,620                       € 1,697

funding costs in the periphery have declined over recent                 Source: Morgan Stanley Research
                                                                         *Morgan Stanley Estimate; **Banca d’Italia data, ***BIS data and Morgan Stanley Estimate
months, they are still well above those faced in core countries,         Exhibit 6
as shown in Exhibit 4. No wonder private credit demand has               EURJPY versus BTP-Bund Yield Spread
remained exceptionally weak. When domestic monetary
transition does not work, then the exchange rate may come
into play.

Exhibit 3
Spread Between Italian and German Corporate Loan
Rates at New High
  6.50
         %
  6.00
  5.50
  5.00
  4.50
  4.00
              Spain
  3.50                                                                   Source: Morgan Stanley Research, Reuters EcoWin
              Italy
  3.00
              Germany
  2.50        France                                                     Political Options and Market Implications
  2.00
  1.50                                                                   Italy still has options for forming a government. Nonetheless,
      2007        2008         2009        2010     2011   2012   2013
                                                                         it will be difficult for a minority government led by the centre
Source: Morgan Stanley Research, Haver Analytics                         left’s Bersani to rely on the goodwill of the Senate, or for a
Exhibit 4                                                                grand coalition which includes the centre left and centre right
EMU: Private Sector Loan Decline                                         parties, to receive similar international recognition as the
                                                                         outgoing technocrat government under Mario Monti. Hence,
                                                                         we believe it will remain difficult for the BTP market to gain the
                                                                         same traction as it did when markets thought Italy was more
                                                                         politically stable.

                                                                         Japanese investors looking for non-JPY investments abroad
                                                                         liked BTPs in the past, given high yields and a strong
                                                                         sovereign rating. Spain never made Japan’s EMU bond
                                                                         shopping list due to its weak sovereign rating. Hence, BTP
                                                                         swings could have an important impact on the performance of
                                                                         EURJPY.
Source: Morgan Stanley Research, Haver, Analytics




                                                                                                                                                                            3
                                                                     MORGAN STANLEY RESEARCH

                                                                     February 28, 2013
                                                                     FX Pulse




The outlook for BTPs depends on a number of factors,                 share prices which would boost Lifers’ balance sheets, could
including economic growth and ECB policy. In summer 2012,            convince the Japanese investors community to take more risk
the ECB’s introduction of the OMT reduced tail risks, implicitly     in the upcoming fiscal year, particularly by sending funds
lowering volatility, which helped stabilize the Italian debt         abroad. The current trend in markets of JPY strength and
market last summer. The activation of the OMT, which would           equity weakness could lead Lifers to take a less aggressive
allow the ECB to intervene in peripheral bond markets,               reallocation strategy, which is counter productive for Japan’s
requires the respective country to comply with austerity and         hopes to increase monetary velocity. Hence, Japan’s
restructuring. The problem is that the Five Star Movement and        authorities could consider taking measures to move markets
the parties supporting Berlusconi ran their election campaigns       back into the desired direction of a weaker JPY and improved
on an anti-EMU and anti-austerity platform. These parties            asset markets. USDJPY dropping below 90.00 would increase
now control the majority in the Senate. Markets may soon             the chance that Japan takes action, turning markets around.
question if Italy would be able to agree to the conditionality
that would be necessary for OMT access, with the Senate              Trading USDs
controlled by anti-EMU, anti-austerity parties.
                                                                     Over the course of the past week, the USD has appreciated
Italian politics are likely to dominate EUR trading over the next    against all G-10 currencies, except the JPY. The front end of
few weeks. Should Italy be able to form a grand-coalition            the US money market curve has steepened, lending support
government, commanding a majority in the Senate, the EUR             to the DXY. Indeed, the US economy has strengthened
should rally. In this case, markets would re-price falling tail      further, and looks ready to move from Twilight into Daylight,
risks into the BTP market as Italy would be able to agree on         supported by rising asset prices and debt service costs falling
conditionality in order to access the OMT, if required.              to the lowest level witnessed in more than two decades.
However, a coalition government, composed of centre left and
                                                                     More Liquidity for Leveraged Economies
centre right parties, might be built on few common interests,
and hence have little ability to pass legislation. The centre left   However, G-10 economies, including the US have remained
forming a minority government or Italy heading towards new           highly leveraged. Of course, there has been a transfer of
elections could be even worse for the EUR. A minority                leverage from the private to the public sector. With
government might not have the political support to apply for         government funding costs generally lower than private sector
the OMT if required, while new elections would leave Italy in a      funding costs, the sensitivity of the economy to rising yields
political vacuum, for which markets may require a higher risk        might be somewhat reduced, but overall economies require
premium to hold EUR denominated assets.                              cheap rates to remain buoyant. Hence, expectations that the
                                                                     Fed could terminate QE early are grossly misleading, in our
JPY Corrects Sharply Higher                                          opinion.

Meanwhile, the strongest currency in town over the past week         Exhibit 7
was the JPY. However, positioning, and not a change in the           Gross Debt of Selected G-10 Economies
fundamentals, pushed JPY crosses sharply lower. Italy’s                                                        Debt (% of GDP)
uncertainties will remain a source of market volatility,                                                                          Non-financial
eventually leading to another round of JPY cross selling.                                  Total         Household     Government corporations
                                                                     Australia             214%            113%           24%         77%
Nonetheless, we believe a stronger JPY creates JPY selling           France                304%             63%           86%        155%
opportunities, as conditions for JPY weakness have become            Germany               242%             62%           81%        100%
even move convincing with ADB’s Kuroda official nomination           Greece                302%             66%          165%         70%
to succeed current BOJ governor Shirakawa. Kuroda stands             Ireland               506%            120%          106%        279%
                                                                     Italy                 292%             51%          120%        120%
ready to take bold monetary action (see FX Pulse: Japan's            Japan                 466%             79%          230%        157%
Election: A New Era for JPY?, December 6, 2012).                     Portugal              422%             92%          108%        222%
                                                                     Spain                 343%             88%           69%        186%
                                                                     UK                    304%            100%           82%        122%
Strong JPY and Weak Equities Disliked by Tokyo
                                                                     US                    303%             89%          103%        111%
                                                                     Source: Morgan Stanley Research, Haver,
Moreover, ahead of the end of Japan’s fiscal year end, JPY
strength and equity weakness does not work in favor of
Japanese authorities. A weak JPY combined with strong local


                                                                                                                                             4
                                                                  MORGAN STANLEY RESEARCH

                                                                  February 28, 2013
                                                                  FX Pulse




Exhibit 8                                                         EMFX: Flows and Cross-Currents
US: Financial Obligation Ratios Have Fallen
                                                                  Despite favourable valuations, currencies across EM continue
                                                                  to be caught in the crosswinds of broader global trends and
                                                                  shifting international imbalances. As we have argued, though
                                                                  EMFX remains attractive in absolute terms, headwinds such
                                                                  as a declining general current account balance, increased
                                                                  domestic resistance toward appreciation amidst a revived
                                                                  currency war debate, and specific idiosyncratic drivers all
                                                                  make for a more convoluted picture for the asset class in the
                                                                  current atmosphere.

                                                                  In addition, global market risks including the US sequester,
                                                                  changes at the BoJ and European elections are likely to
                                                                  continue to suppress EMFX (and indeed other risky asset)
Source: Reuters EcoWin                                            performance in coming weeks; until greater clarity can be
Exhibit 9                                                         gleaned by markets. But given our generally constructive view
US: Asset Prices Are Rising                                       on the asset class, we look to use any residual EMFX
                                                                  weakness to reinforce our country-specific views. Our base
                                                                  case is that the above risks result in broadly market-friendly
                                                                  outcomes after a period of volatility, allowing EM assets to
                                                                  recover some of their recent losses.

                                                                  Accordingly, however, not all currencies are attractive.
                                                                  Perhaps most strikingly in the near term, faced with strong
                                                                  inflows resulting from ongoing liquidity provision by DM
                                                                  central banks, policy makers in EM are likely to continue to
                                                                  resist appreciation in a variety of forms. Efforts to promote
                                                                  currency weakness to protect countries’ competiveness are
                                                                  found in a mix of interest rate cuts, FX purchases and macro-
Source: Reuters EcoWin                                            prudential measures, with varied impacts on each country’s
                                                                  goals.
Over the course of the past year, liquidity and not corporate
earnings have driven risk. Asset valuations are on the rise,      Within the CEEMEA region, the monetary policy responses
with central banks keeping funding costs low in order to avoid    have been diverse. The Czech National Bank has been one
endangering the economic recovery of highly leveraged             institution that many in the market expected would enter into
economies. Liquidity should remain asset price supportive for     the realm of currency intervention as a means to stimulate the
now, suggesting the recent correction is building the             economy, particularly with interest rates pushing up against
foundation for the next rally to develop. The Italian election    the zero bound and the economy expected to remain weak.
result has ended our call for a ‘EUR overshoot’, but it has not   However, the CNB recently backed away from outright
altered our view that asset prices will stay supported in the     intervention, arguing that the currency weakness seen already
medium term.                                                      was stimulus enough for the economy.

Translated into FX action, this view suggests the JPY will        Elsewhere in CEEMEA, only Turkey explicitly mentions the
come under renewed selling pressure and the USD will give         currency as a key variable it aims to control. The CBT aims to
up some of its recent gains against currencies other than the     prevent an aggressive rise in the real effective exchange rate
JPY. The combination of ample central bank liquidity and          in order to help to rebalance the economy, and will likely act
economies moving from Twilight towards Daylight suggests          to weaken the currency if its REER index heads much higher.
the risk rally will eventually lead to rising commodity prices,   Allowed by declining inflation, central banks in Peru and
with commodity currencies moving up again. We see                 Colombia are likely to keep FX purchases together with
AUDUSD near 0.98 offering good risk-reward to target 1.06.        macro-prudential adjustments, such as buybacks or less


                                                                                                                              5
                                                                                                                                                                                                                                                                          MORGAN STANLEY RESEARCH

                                                                                                                                                                                                                                                                          February 28, 2013
                                                                                                                                                                                                                                                                          FX Pulse




issuance of external debt. PEN is likely to continue reacting to                                                                                                                                                                                                          appear to justify a monetary stimulus. Beyond Banxico’s
these measures, while we believe that intervention tools in                                                                                                                                                                                                               move, we believe that there are many reasons for sustaining
Colombia will be insufficient to absorb large inflows into the                                                                                                                                                                                                            our positive view on MXN going forward. An ambitious reform
country. Chile and Mexico stand at the other extreme of the                                                                                                                                                                                                               agenda in Mexico should improve the country’s medium-term
spectrum in what seems as more orthodox approach to                                                                                                                                                                                                                       outlook, and the news flow on these reforms should lend
exchange rate policy. Yet, verbal intervention in Chile and                                                                                                                                                                                                               support to the currency. In particular, the energy reform is
potential rate cuts signaled by Banxico could continue to limit                                                                                                                                                                                                           expected to open the oil sector to private investors, which
further rallies in CLP and MXN. In contrast, climbing inflation                                                                                                                                                                                                           could drive substantial inflows into Mexico.
expectations in Brazil pushed policy makers to take a pause
                                                                                                                                                                                                                                                                          In Brazil, the BCB is likely to leave rates unchanged, but
in the currency war and change their bias towards a stronger
                                                                                                                                                                                                                                                                          markets will be looking at any signaling of future hikes. In the
real, which led to a brief period of BRL strength, which is now
                                                                                                                                                                                                                                                                          past, the COPOM has mentioned that interest rates would be
unlikely to continue.
                                                                                                                                                                                                                                                                          kept low for long, but more recently, the tone from policy
Indeed, all attention next week will be focused on Central                                                                                                                                                                                                                makers has opened the door to hikes, due to accelerating
Bank meetings in Mexico and Brazil. Mexico is expected to                                                                                                                                                                                                                 inflation expectations. The signaling of hikes for the first time
cut interest rates given recent dovish messages from Central                                                                                                                                                                                                              since 2010, could be interpreted as an effort to fight inflation
Bank’s members. Yet, our economist believes Banxico will                                                                                                                                                                                                                  via monetary policy and not via the exchange rate.
remain on hold throughout 2013 as economic data do not
Exhibit 10                                                                                                                                                                                                                                                                 Exhibit 11
Strong Flows into EMFX-related Funds                                                                                                                                                                                                                                       EM Current Account Balance (%, GDP)
 3,500
                                                                                                                                                                                                                                                                              800                                                                         4.0%
                                                                                                                                                                                                                                                                                          4Q Sum, USDbn
 2,500                                                                                                                                                                                                                                                                                                                                                    3.5%
                                                                                                                                                                                                                                                                              600
 1,500                                                                                                                                                                                                                                                                                                                                                    3.0%
                                                                                                                                                                                                                                                                              400
   500                                                                                                                                                                                                                                                                                                                                                    2.5%
                                                                                                                                                                                                                                                                              200
  -500                                                                                                                                                                                                                                                                                                                                                    2.0%
                                                                                                                                                                                                                                                                                0
 -1,500                                                                                                                                                                                                                                                                                                                                                   1.5%
                                                                                                                                                                                                                                                                              -200
 -2,500                                                                                                                                                                                                                                                                                                                                                   1.0%

                                                                                                                                                                                                                                                                              -400                                                                        0.5%
 -3,500
          5-Jan-11

                     9-Feb-11




                                                                                                      12-Oct-11
                                16-Mar-11



                                                        25-May-11

                                                                    29-Jun-11




                                                                                                                  16-Nov-11

                                                                                                                              21-Dec-11

                                                                                                                                          25-Jan-12

                                                                                                                                                      29-Feb-12



                                                                                                                                                                             9-May-12

                                                                                                                                                                                        13-Jun-12

                                                                                                                                                                                                    18-Jul-12




                                                                                                                                                                                                                                        31-Oct-12

                                                                                                                                                                                                                                                    5-Dec-12

                                                                                                                                                                                                                                                               9-Jan-13
                                                                                           7-Sep-11




                                                                                                                                                                                                                            26-Sep-12
                                            20-Apr-11




                                                                                3-Aug-11




                                                                                                                                                                  4-Apr-12




                                                                                                                                                                                                                22-Aug-12




                                                                                                                                                                                                                                                                              -600                                                                        0.0%
                                                                                                                                                                                                                                                                                     02     03    04        05   06   07   08   09     10    11     12

                                                                                                                                                                                                                                                                                          Trade Balance                         Service Balance
                                                                      Hard CCY                                    Local CCY                                       Blend CCY                                                                                                               Income Balance                        Other
                                                                                                                                                                                                                                                                                          Current Account                       Current Account (% GDP, RHS)

Source: Morgan Stanley, EPFR                                                                                                                                                                                                                                               Source: Morgan Stanley Research, Bloomberg consensus




                                                                                                                                                                                                                                                                                                                                                                 6
                                                                       MORGAN STANLEY RESEARCH

                                                                       February 28, 2013
                                                                       FX Pulse




The Case for Prolonged Sterling Weakness
Hans Redeker, Ian Stannard                                              course on government austerity. Hence, there will be only
                                                                        minor budget adjustments, leaving the BoE with the heavy
    Sterling has further downside potential, most likely to develop    lifting to get the economy going again. A weak GBP is likely to
     against the USD.                                                   play a key role within these monetary-inspired reflation policies.
    The BoE appears to be using sterling as a policy tool to           In the long term, declining real UK yields are the result of
     reflate the economy…
                                                                        falling productivity levels. The return on the real side of the
    …with near zero interest rates and the impact of QE waning,        economy should equal, in risk adjusted terms, the financial
     sterling is the next instrument to use.                            sector real yield. Since, the BoE controls money market
                                                                        rates, it can control - within an environment of positive
    The weak export performance, and rising trade and current
     account deficits, suggest sterling is overvalued.
                                                                        inflation - the level of real money market rates. When the
                                                                        BoE implicitly moved the timeline for reaching its 2% inflation
    Revenues via net export-boosting sterling weakness should          target from two to three years in the latest Inflation report,
     be used to promote investment relative to consumption.             this sent a message to investors that the central bank was
    When the British economy benefited from the 36% sterling           willing to tolerate higher inflation for longer, and that real
     depreciation from 2008/2009 authorities emphasized                 money market rates will stay depressed for some time.
     maintaining living standards instead of supporting the supply      Consequently, real rates and yields have moved deeply into
     side of the economy.                                               the red, reducing the attractiveness of sterling.
    Currency weakness buys time, but is not a panacea.                 Exhibit 1
                                                                        Sterling’s Inflation Link Breaks

Downgrade Offers Little Surprise Potential
The old phrase ‘sell the rumour, buy the fact’ has worked
once again for Sterling. Moody’s cut the UK’s AAA rating by
one notch last Friday, with a stable outlook, leaving Germany
and Canada as the only remaining G-7 countries with AAA
credit ratings. Nonetheless, the UK’s downgrade was priced
into credit markets, and the downgrade actually supported
GBP as it led investors to take profits on sterling short
positions. Despite the muted sterling reaction to the
downgrade, we make the case that sterling has further
downside potential. The post downgrade GBP rebound offers               Source: Reuters Ecowin, Morgan Stanley Research

a selling opportunity against the USD. The re-emergence of              Exhibit 2
volatility in EMU bond markets following the Italian elections          Relative UK–US yield Curve Has Shifted to the
should keep EURGBP range-bound for the time being.                      Downside

Real Rate Expectations Fall
While sterling has stabilized with the help of renewed EMU
turbulence, we believe more weakness is in store. Inflation-
adjusted government bonds no longer offer real yield, a sign
that public authorities’ funding position has remained strong,
despite the sovereign downgrade. This argument is often
used by those who advocate increased government
spending on infrastructure, which could enhance the UK’s
medium-term growth prospects, supporting sterling.
However, Chancellor Osborne has indicated he will stay the
                                                                        Source: Reuters Ecowin, Morgan Stanley Research


                                                                                                                                        7
                                                                    MORGAN STANLEY RESEARCH

                                                                    February 28, 2013
                                                                    FX Pulse




BoE’s Warnings                                                       account deficit has reached 3.5% of GDP, mainly driven by a
                                                                     marked deterioration of the UK’s trade position. Unit wage
Warning signals suggesting sterling should weaken have
                                                                     costs have outpaced those in EMU and the US, as shown in
been in place for some time, but up until the end of last year,
                                                                     Exhibit 6. At the same time, employment has increased,
sterling remained supported. Indeed, sterling traded at a
                                                                     suggesting labour is serving as a substitute for capital,
substantial safe-haven premium as investors leaving EMU
                                                                     typical for an economy with insufficient savings, or other
searched for alternative investments within Europe.
                                                                     barriers, to generate capital.
GBP only came under selling pressure after the BoE started
                                                                     UK bank balance sheets are still weighed down by
moving its inflation goal posts, reducing real money market
                                                                     underperforming assets accumulated during the pre-crisis
return expectations. Hence, the BoE signaling real money
                                                                     boom, making it difficult for corporates to gain access to
market returns will be negative for some time has pushed
                                                                     credit. Banks’ reluctance to add to their portfolio of
sterling out of the safe-haven currency club.
                                                                     outstanding loans leaves corporates with little choice other
In hindsight, it was remarkable how markets interpreted the          than to decrease the stock of capital relative to their labor
BoE’s debate over the effectiveness of QE. Indeed, the BoE           pool. This drives down both productivity and corporate
questioning the effectiveness of QE was not a sign that the          profitability, reducing the attractiveness of investment further.
bank was considering withdrawing accommodation, but
                                                                     Japan offers a good illustration of the relationship between
rather, that it was looking for alternative instruments to revive
                                                                     credit availability, productivity and profitability. Once the
the economy.
                                                                     availability of credit dries out, corporate profitability enters a
The interest rate tool was exploited by moving market rates          long-term declining trend with falling productivity rates
virtually to zero and the QE instrument was unable to flatten        providing the catalyst. A country in need of capital imports,
the nominal yield expectation curve sufficiently to provide a        as expressed by the UK current account deficit, will see its
powerful signal to revive the economy. One of the few                currency decline when local return expectations fall in
remaining instruments left in the monetary toolbox was               response to falling productivity. The reason why Japan’s
currency weakness. Lowering real rate expectations by                currency stayed strong despite falling productivity and
moving the goal posts of inflation targeting has caused              profitability trends is that its large domestic saving base was
sterling to decline. The BoE’s policy shift reminded market          more than sufficient to meet its capital requirements. In the
participants that sterling weakness was in the interest of the       UK, this is not the case.
BoE.
                                                                     Exhibit 4
Exhibit 3                                                            Current Account Deficit Has Reached Multi-Decade
The Safe Haven Sterling Premium Is Gone                              High

                                                             1.68
  1.1                                                        1.66
                                                             1.64
  0.9
                                                             1.62

  0.7                                                        1.6
                                                             1.58
  0.5                                                        1.56
                                                             1.54
  0.3
                                                             1.52
  0.1                                                        1.5
   Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12

                            UK-US 1Y1Y      GBPUSD (RHS)

Source: Reuters Ecowin, Morgan Stanley Research                         Source: Reuters Ecowin, Morgan Stanley Research


What Does the Current Account Tell Us?
However, the BoE’s signal of lower real rates is in line with
our long-term analysis of the British economy. Its current


                                                                                                                                      8
                                                                    MORGAN STANLEY RESEARCH

                                                                    February 28, 2013
                                                                    FX Pulse




Exhibit 5                                                            Warnings From Investment to Consumption Ratio
Financial Account Has Weakened
                                                                     Simultaneously, British public authorities moved into
                                                                     austerity, but instead of focusing austerity on reducing
                                                                     consumption and promoting investment, the opposite
                                                                     happened. British fiscal policy predominantly prioritized
                                                                     short-term living standards over longer-term investment.

                                                                     Public investment declined from 3.5% to 1.5% of total public
                                                                     expenditure since 2010 when austerity measures began.
                                                                     Lower investment outlays contributed meaningfully to
                                                                     expenditure cuts. Adding the private sector into the equation,
                                                                     the ratio of investment relative to consumption has declined
                                                                     to a new historical low. Exhibit 8 shows sterling tends to fall
Source: Reuters Ecowin, Morgan Stanley Research                      when the investment / GDP ratio weakens and there is good
Exhibit 6                                                            reason for this relationship. Investments can generate future
British Unit Costs Have Risen Strongly                               returns, increase the capital stock and hence help reduce the
                                                                     current account deficit. The low investment/consumption
                                                                     ratio suggests the current account deficit will remain until it
                                                                     can be balanced out by sterling weakness.

                                                                     Exhibit 8
                                                                     Too Little Investment and Too Much Consumption




                  Source: Reuters Ecowin, Morgan Stanley Research
Exhibit 7
Weak British Exports



                                                                     Source: Bloomberg, Toshin, Morgan Stanley Research


                                                                     Sterling Weakness Buys Time…
                                                                     However, currency weakness is not a panacea for healing a
                                                                     structurally weak economy. Currency weakness may be an
                                                                     important catalyst to kick-start activity, boosting short-term
                                                                     profitability and creating new incentives, but when sterling
                                                                     depreciated by 36% in 2008/09 positive effects petered out
                                                                     during the course of 2010. A one-time currency downside
Source: Reuters Ecowin, Morgan Stanley Research
                                                                     adjustment buys time by creating temporary income, but only
                                                                     the supply side of the economy can generate permanent
                                                                     income. On this front, the British economy has not yet
                                                                     delivered.




                                                                                                                                  9
                                                                  MORGAN STANLEY RESEARCH

                                                                  February 28, 2013
                                                                  FX Pulse




…to Restructure                                                    beginning of the year, establishing itself as the weakest
                                                                   currency among the G10).
The UK needs to boost investment relative to consumption in
order not only to bring its current account deficit lower, but     The JPY weakness has been driven by the change of monetary
also to generate stronger permanent income, we think.              policy and the introduction of an inflation target, in a more
Within a closed economy, a change in the ratio between             determined effort by Japanese officials to pull the Japanese
consumption and investment has to occur via rising interest        economy out of deflation. While the economic circumstances in
rates, which increase the attractiveness of savings relative to    the UK are somewhat different the case can be made that the
consumption. The resulting larger pool of savings can then         change in monetary policy is also behind GBP’s decline. As far
support investment.                                                as GBP is concerned the change (or perceived change) in tone
                                                                   is far more subtle, but we believe the impact on GBP is likely to
The good thing is that the UK is an open economy and
                                                                   be just as significant.
therefore can increase savings by boosting exports via a
lower exchange rate, avoiding a large cut in consumption.          Indeed, while the market had been looking towards potential
The UK has taken this route before. However, income                changes in policy approach under the leadership of new BoE
generation from a pickup in net exports via a weaker               governor Carney when he takes over in July, a more flexible
exchange rate is not permanent unless the currency                 interpretation of the inflation target mandate already appears
depreciation is permanent. Sterling’s 2008/2009 experience         to be under way, with the BoE currently appearing to be
suggests the UK should use the income boost provided by            willing to look through higher inflation for a more prolonged
the exchange rate to refocus its economy away from                 period. Hence, with this moving of the inflation goal posts as
consumption and towards investment. Failure to do so could         discussed above, inflation expectations in the UK have risen
lead sterling weakness to stay with us for some time and risk      significantly.
becoming permanent.
                                                                   Exhibit 10
Exhibit 9                                                          UK CPI and GBPUSD
UK and Japanese Inflation Expectations




                                                                   Source: Reuters Ecowin, Morgan Stanley Research

Source: Reuters Ecowin, Morgan Stanley Research
                                                                   Rising inflation expectations in Japan have been a central
                                                                   part of the change in Japanese policy and our analysis has
GBP Following JPY
                                                                   found that inflation expectations have been a good leading
We have recently made comparisons between GBP and the              indicator for the JPY. Indeed, while Japan was in a
JPY. While this may seem a little stretched, we suggest that       prolonged deflationary environment, Japanese investors
there are some similarities and that there are some lessons        were comfortable with the low yields provided by domestic
that can be drawn from the JPY experience as far as GBP is         assets as these still provided real positive returns. However,
concerned. Indeed, the JPY and GBP have been the                   the rise of inflation expectations risks leaving Japanese
underperformers among the G10 since the beginning of the           investors with negative real returns, implying a greater
year (in fact GBP has fallen more than the JPY since the           incentive to seek higher yields overseas, putting the JPY
                                                                   under pressure.


                                                                                                                                10
                                                                  MORGAN STANLEY RESEARCH

                                                                  February 28, 2013
                                                                  FX Pulse




Flexible Approach                                                  Negative Real Rates Increases Attractiveness of
                                                                   Overseas Investment
It can be argued that a similar situation is now occurring in
the UK, with the BoE signalling a more flexible approach to        This more flexible approach to inflation targeting now being
inflation targeting. Indeed, the BoE’s latest inflation reports    adopted by the BoE has seen a sharp rise in UK inflation
shows that inflation is projected to remain above target way       expectations, which has seen UK real interest rates turning
beyond that the two-year time horizon, which has been the          increasingly negative. In fact UK real rates are now the most
period on which the BoE has focused to bring inflation back        negative within the G10. In recent research we have
to target. BoE Governor King, at the BoE’s press conference,       discussed how we believe that the market is now placing
and subsequently other members of the MPC at the                   more attention on real rates and yields, suggesting that GBP
Treasury Select Committee hearing, have highlighted the            is likely to be the underperformer among the G10. Our
willingness to look through increasingly longer periods of         analysis of GBP real yield spreads, adjusting yields for
higher inflation, playing down the significance of the             inflation expectations, provides a very negative picture for
traditional two-year time horizon.                                 GBP. Indeed, we have found that yield spreads adjusted for
                                                                   inflation expectations are currently providing one of the best
Moreover, the BoE has also suggested that further monetary
                                                                   guides for GBP, especially in the case of GBPUSD (see
easing measures are possible, with a preference for further
                                                                   Exhibit 11). Hence, we expect GBPUSD to remain under
QE appearing to be expressed by some members, even with
                                                                   pressure, with an increasing risk that a move below the 1.50
inflation above target beyond the traditional two-year time
                                                                   level will start to unfold.
horizon. Deputy Governor Tucker suggested that more QE is
possible and could be more effective than the previous round       Exhibit 12
of QE seen last autumn, citing reduced global headwinds.           Net International Investment Position of G10
We would take these comments as implying that the
slowdown in safe haven inflows to the UK could see the
exchange rate transmission channel of QE being more
effective – namely QE developing a more pronounced
weakening of GBP. Overall, we interpret the most recent
comments from BoE members as being consistent with a
weaker GBP.

Exhibit 11
GBPUSD and Yields Spread Adjusted for Inflation
Expectations


                                                                   Source: Reuters Ecowin, Morgan Stanley Research

                                                                   Indeed, as was the case in Japan, UK investors are now
                                                                   faced with the prospect of increasingly negative real returns
                                                                   on their domestic investments, which could increase the
                                                                   incentive to seek higher returns overseas. In Japan the
                                                                   extent of the potential JPY negative portfolio outflows is
                                                                   highlighted by the huge domestic savings in Japan. On first
                                                                   examination the net asset position and level of domestic
                                                                   savings level of the UK look somewhat more moderate and
                                                                   suggests that the GBP negative effect from potential portfolio
Source: Reuters Ecowin, Morgan Stanley Research                    outflows could be more limited.

                                                                   However, while UK domestic savings may be somewhat
                                                                   more moderate, suggesting potential portfolio shifts by
                                                                   domestic investors could well be of lesser magnitude than


                                                                                                                               11
                                                                 MORGAN STANLEY RESEARCH

                                                                 February 28, 2013
                                                                 FX Pulse




potential outflows from Japan, looking at the gross asset and     tools for GBPUSD has been the relative performance of the
liability position in the UK these are far more extensive in      banking sector. However, as can been seen in Exhibit 14,
terms of % of GDP, in fact the largest amongst the G10, with      GBPUSD has fallen sharply since the beginning of the year
an overall negative net international investment position.        despite the outperformance of the UK banking sector,
Hence, we believe that there is potential for significant         highlighting the breakdown in this relationship. This is
portfolio outflows, driven not just by domestic investors, but    coincides with the idea of a move to a more flexible inflation
also foreign investors. We make the point above that with         targeting policy which has developed over the past two
negative real interest rates and yields, GBP’s role as a safe     months.
haven is eroded (the rating downgrade also works against
                                                                  Exhibit 14
GBP), removing an important pillar of support for GBP. But
                                                                  GBPUSD and Relative Performance of UK Banking
the prospect of negative real rates in the UK will be seen as
                                                                  Sector
making GBP unattractive.

Exhibit 13
Gross Financial Asset Position of G10




                                                                  Source: Reuters Ecowin, Morgan Stanley Research


                                                                  Conclusion
Source: Reuters Ecowin, Morgan Stanley Research
                                                                  Sterling has further downside potential, we think. The BoE
This has become evident with GBP’s recent sharp                   pushing real rate expectations further into the red has
divergence from relative equity market performance. While         reduced the attractiveness of sterling markedly. As EMU
the BoE policy stance appears to be helping to maintain the       instability has reduced the attractiveness of the EUR too, we
out performance of the UK equity market this has not              suggest expressing sterling weakness via the USD.
benefited GBP. Traditionally there has been a close
correlation between the outright and relative performance of
equity markets and GBP. Historically, one of our favoured




                                                                                                                              12
                                                                     MORGAN STANLEY RESEARCH

                                                                     February 28, 2013
                                                                     FX Pulse




CAD: It’s Not That Bad
Evan Brown, CFA                                                       to evolve into a prolonged depreciation, the market would have
                                                                      to start pricing in easing from the BoC. We see this is as
    Some market participants think CAD is likely to follow JPY       extremely unlikely, despite weak economic data.
     and GBP to prolonged weakness. We disagree.
                                                                      Exhibit 1
    Despite poor data of late, the BoC is unlikely to ease policy    CAD/USD Back in Line with Rate Spreads
     given supportive financial conditions, housing bubble
                                                                        120                                                                                         1.03
     concerns and resilient US growth.
                                                                        110                                                                                         1.02

    Our valuation measures suggest CAD is under-, not                                                                                                              1.01
                                                                        100
     overvalued.
                                                                                                                                                                    1.00
                                                                         90
    CAD remains an attractive destination for further reserve                                                                                                      0.99

     diversification in our view.                                        80
                                                                                                                                                                    0.98

                                                                         70
                                                                                                                              Canada-US 2-Year                      0.97
                                                                                                                              Rate Spread (lhs)
                                                                         60
                                                                                                                              CADUSD (rhs)                          0.96
CAD Bears Emerge
                                                                         50                                                                                         0.95
                                                                           Jan-   Feb- Mar-   Apr- May- Jun-   Jul-   Aug- Sep- Oct-   Nov- Dec- Jan-   Feb- Mar-
CAD has weakened by over 4% against USD since mid-                          12     12   12     12   12   12    12      12   12   12     12   12   13     13   13

                                                                      Source: Bloomberg, Morgan Stanley Research
January, and for good reason. Canadian economic data
have been consistently poor, with employment, inflation and           In fact, the bulk of that weak data is backward looking.
retail sales printing below expectations. The Bank of                 Worse than expected retail sales, inflation and export
Canada softened its tightening bias, stating that rate hikes          numbers were from December. This was a time when global
were “less imminent.” The market has now priced out all rate          growth had contracted and US fiscal cliff uncertainty weighed
hikes for 2013, consistent with our view that the BoC will            on sentiment. But we must separate these numbers from
remain on hold for the foreseeable future.                            forward-looking indicators, which are actually quite positive.
CAD has traded within a remarkably narrow range in the post-          Indeed, Canada’s survey on investment intentions showed
crisis period, so the speed of its decline in the absence of a        continued growth even as anticipated investment in the
major risk-off period has raised eyebrows. Indeed, some are           resource sector moderated (Exhibit 2). This suggests the
questioning whether CAD is set to follow JPY and GBP in               competitive challenge from the U.S. in energy will not be
falling back to earth, as safe haven interest unwinds. Demand         debilitating, as other sectors pick up the slack. Consistently,
for protection against CAD depreciation, as measured by 25-           Canada’s January Ivey PMI rose well above the crucial 50
delta risk reversal prices, has risen near 5-year highs (see          threshold which separates expansion from contraction.
Options Heat Map, p. 22). And our positioning tracker signals         Consumer confidence also ticked up in January and has
large short positions in CAD (p. 25).                                 maintained its upward trend.
We are less bearish CAD for three reasons: (1) the BoC’s              Exhibit 2
next move is still much more likely to be a hike than a cut, (2)      Canada Investment Intentions Edge Up
CAD is, if anything, undervalued, and (3) Canada remains an
                                                                       400
attractive destination for reserve allocation. As such, we
                                                                       350
anticipate a retracement towards parity and look to fade CAD
                                                                       300
weakness.
                                                                       250
                                                                       200
Why the BoC Won’t Cut
                                                                       150
CAD’s recent depreciation makes sense in light of the evolving         100
BoC outlook; indeed, USD/CAD has re-aligned with US-                    50
Canada 2-year spreads (Exhibit 1). As of now, Canada’s rate               0
expectations are essentially flat this year. For CAD weakness                 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
                                                                      Source: StatCan. Note: Actual from 2003-2011, 2012 preliminary actual and 2013 intentions



                                                                                                                                                                       13
                                                                  MORGAN STANLEY RESEARCH

                                                                  February 28, 2013
                                                                  FX Pulse




Housing is another reason why the BoC is reluctant to ease         Exhibit 3
further. Governor Carney and his colleagues have                   Terms of Trade Suggest CAD Is Not Overvalued
repeatedly warned that keeping rates too low for too long
                                                                    1.7                                                                    1.7
could risk stoking a housing price bubble with dangerous
consequences. Canada’s household debt-to-GDP ratio is               1.5                                                                    1.5
elevated at 150% – the BoC’s tightening bias and
macroprudential measures were designed to keep pressure             1.3                                                                    1.3
on consumers and banks to delever. Policy remains
accommodative, as indicated by the BoC’s financial                  1.1                                                                    1.1
conditions index, which is near record-highs.
                                                                    0.9          USDCAD                                                    0.9
Is a housing bubble already bursting? We have seen large
                                                                                 USDCAD Commodity Price-Based Fair Value
misses in housing starts and building permits in recent             0.7                                                                    0.7
months. And housing prices are moderating. But these data                 02   03    04    05     06    07   08   09   10   11   12   13
must be viewed in the context of where they are happening.         Source: Morgan Stanley Research, Haver
The Ontario and Quebec housing markets are softening,
which we see as a healthy development given oversupply             A Favorable Destination
(particularly in multi-family structures). Housing in other
                                                                   We also think central banks will use CAD weakness to
regions, such as commodity-producing Alberta, remain
                                                                   continue diversifying their reserves. Canada’s AAA rating
robust.
                                                                   and relatively sound political/financial system make it a
Finally, the impressive resilience of the US consumer in spite     favorable destination for official sector inflows. Indeed, the
of fiscal uncertainty should assuage doubts about Canada’s         IMF’s recognition of CAD as an official reserve currency
outlook. Positive surprises in US consumer confidence,             reflects increased central bank accumulation of the currency
durable goods and housing all bode well for Canada’s               in recent years. We have previously argued that reserve
exports, 75% of which go to the United States. Along with          managers are opportunistic; they use currency weakness to
Fed policy, which we expect to remain accommodative, the           build positions Reserve Managers Don't Drive, They React,
BoC should be able to resist additional easing.                    April 5, 2012). Thus we would not be surprised to see official
                                                                   sector flows cushion CAD’s decline.
CAD May Be Undervalued
                                                                   Skew Provides an Opportunity
Another concern among investors is that the CAD is
overvalued. Actually, both our short-term and long-term            Increased demand for protection against CAD depreciation
indicators suggest CAD is slightly undervalued at these            provides favorable pricing for expressing the opposite view.
levels. Our high-frequency misalignment model (p. 25),             We take advantage of historically high skew and establish a
which incorporates data across rates, commodities, equity          zero-cost risk reversal, buying a 3M CAD1.0090 USD put
and vol markets, signals that CAD is due for a correction          and selling a CAD1.0630 USD call. USD/CAD would need to
higher.                                                            reach its 2010 highs to lose money, while the trade is in the
                                                                   money if USDCAD retraces toward parity, as we forecast.
Meanwhile, our long-term fair value measure of USD/CAD
based on the BoC’s commodity price index tells the same            Could we see prolonged weakness in CAD? Yes, but we
story. In the absence of a significant decline in energy prices    think it would require a meaningful deterioration in the global
(which we don’t expect), USDCAD's fair value is 0.99. Our          economy. A US growth shock, perhaps related to fiscal
commodity strategists think the risks to energy prices are         contraction and uncertainty, would hit Canada particularly
skewed to the upside, which may support Canada’s terms of          hard given export ties. This week’s surprising Italian election
trade. And while the spread between western Canadian               result is a reminder that tail risks remain in Europe. And
crude and WTI is wider than average, it has rebounded              China continues its fragile transition to a consumer-led
sharply in the last few weeks.                                     economy. But right now we are encouraged by ongoing
                                                                   global monetary easing as well as economic green shoots in
                                                                   the US—we trade CAD accordingly.



                                                                                                                                           14
                                                                       MORGAN STANLEY RESEARCH

                                                                       February 28, 2013
                                                                       FX Pulse




Strategic FX Portfolio Trade Recommendations
Evan Brown, Marc Englander

                 Spot: 92.34, Expiry 02 Sep 2013; Low Strike 96.00,                        Toshin Foreign-Denominated Assets Well
 28 Feb 2013                                                                                           Below 2007 Peak
                 High Strike 100.00, Cost 0.87%
                 Despite the recent retracement in USDJPY, we believe the
                 JPY weakness trend will remain intact. We expect (1)
  Entered:       Japanese investors to unwind currency hedges on foreign
    Long         investments, (2) outflows to continue from Japanese money
USD/JPY Call     markets, and (3) Toshin accounts to sell further JPY. We
                 favor a USDJPY call spread to take advantage of historically
   Spread
                 elevated skew. The maximum loss is the premium of 87 bps
                 and the payout ratio is greater than 4:1.

 15 Feb 2013     Entered: 103.90, Stop: 100.00, Target: 110.00                                       AxJ Basket vs JPY Rebounding
                                                                                           130
                 Despite some commentary from global policymakers                          125
                                                                                                                                                  AXJ Basket/JPY
                 expressing concern over JPY weakness, we believe AxJ will                 120
                                                                                           115
    Hold:        appreciate in the long term. AxJ policymakers should                      110


    Long         rebalance their economies toward domestic sources of                      105


                 demand, following China’s lead. We like selling JPY against
                                                                                           100

   AxJ/JPY                                                                                  95

                 an equal-weighted basket of CNY, KRW, TWD and SGD                          90

                 indexed to 100, in Jan 2005 (see chart).
                                                                                            85
                                                                                            80
                                                                                             Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13


                                                                                                   EURUSD Re-Coupling with Core Yld
 28 Feb 2013     Entered: 1.3090, Close at: 1.3150                                                            Spreads
                                                                                                                                                                        0.05
                                                                                            1.36
                 We hit our long EUR/USD order on Monday after the Italian                                                                                              0
                                                                                            1.35
 Entered and     elections, but closed our long position at 1.3150 later in the                                                                                         -0.05
                 week. Given the uncertain political outcome in Italy, we think the         1.34
   Exited                                                                                                                                                               -0.1
                 risks to EUR may be skewed to the downside. The medium-                    1.33
    Long         term trajectory of EUR/USD will be determined by the ability of            1.32                                                                        -0.15
  EUR/USD        the Italian government (once established) to agree upon and                1.31
                                                                                                                                EURUSD
                                                                                                                                German-US 2yr Sprd (rhs)                -0.2

                 implement the necessary conditionality to access the OMT.                    1.3                                                                       -0.25
                                                                                                03-Jan              18-Jan          02-Feb          17-Feb

 22 Feb 2013     Entered: 1.2338, Stop: 1.27, Target: 1.10                                         NZD Offers Best Real Yields in G10
                                                                                                                                                                        2.12
                 We believe there are many constraints on the RBNZ to weaken
                                                                                           2.15
                                                                                                                      10yr Bond Ylds - MS CPI F'Cast
                 the currency successfully, which we have pointed out previously           1.65
                                                                                                                                                          1.25   1.29
  Entered:       (see Positioning for Policy, Feb 13, 2013). We think NZD will
                                                                                                                                                   1.18
                                                                                           1.15                                            0.95

   Short         continue to outperform AUD given its improving economic                   0.65
                                                                                                                                    0.58

  AUD/NZD        outlook and real yield advantage. Indeed, we think there is more                                    0.24
                                                                                                                             0.34

                                                                                           0.15
                 easing to come (50 bps) from the RBA in 1H 2013 while the                                  -0.03
                 RBNZ stays on hold.                                                       -0.35    -0.18
                                                                                                    GBP     EUR*    CAD      USD    CHF    NOK    SEK     JPY    AUD    NZD


                                                                                                              Long EUR,NZD,MXN vs
 25 Feb 2013     Entered: 100, Stopped Out: 98.50                                                              Short JPY,KRW,PEN
                                                                                           102

                 Our structured basket of long EUR, NZD and MXN versus short               100

    Exit:        JPY, KRW and PEN fell below our stop after the surprising                   98


    Long         Italian election result hit risk appetite. This trade reflected our         96


 “FX Policy”     views on which policymakers will be most and least active in                94


                 attempting to fight currency strength. For a full discussion of our
                                                                                             92
   Basket                                                                                    90
                 reasoning, please see Positioning for Policy (Feb 13, 2013).                88
                                                                                              Jan-12          Apr-12          Jul-12         Oct-12        Jan-13




                                                                                                                                                                                15
                                                                                MORGAN STANLEY RESEARCH

                                                                                February 28, 2013
                                                                                FX Pulse




  25 Feb 2013               Entered: 1.2900, Stopped Out: 1.2700                                    Japanese Portfolio Flows (12m Sum)



      Exit:                 Following the surprising Italian election results, EUR declined
      Long                  sharply and we hit our 1.27 stop. For the time being, we expect
    EUR/AUD                 the political uncertainty in Italy to keep EUR under pressure.



  25 Feb 2013               Entered: 123.30, Stopped Out: 120.70                                         EURJPY Following Portfolio Inflows
                                                                                                    50000                                                                               140
                                                                                                                                            EMU Peripheral Portfolio Inflows
                                                                                                                                            (3mo MA LHS)                                135


                            The Italian election also stopped us out of EUR/JPY, in line            35000                                   EURJPY (RHS)
                                                                                                                                                                                        130




      Exit:                 with broad risk-off move seen in various markets. We still              20000                                                                               125




                            believe that JPY will continue to weaken due to fundamental
                                                                                                                                                                                        120
                                                                                                     5000

     Long                                                                                                                                                                               115


                            and structural changes in the BoJ monetary policy, but look to          -10000                                                                              110

    EUR/JPY
                            re-establish JPY shorts against USD rather than EUR.                    -25000
                                                                                                                                                                                        105


                                                                                                                                                                                        100


                                                                                                    -40000                                                                              95
                                                                                                         Feb-09     Nov-09        Aug-10        May-11      Feb-12       Nov-12




  25 Feb 2013               Entered: 93.20, Stopped out: 92.10                                               Money Market Flows Leaving Japan
                                                                                                                                                                                  -7.5
                                                                                                                                           USDJPY (lhs)
                                                                                                      100
                                                                                                                                           Money Market inflows (1yr              -2.5
                            Increased volatility and risk-off sentiment following the                  95                                  sum, rhs, inverted)

     Exit:                  surprise Italian election results pushed us out of our long                                                                                           2.5
                                                                                                       90
     Long                   USD/JPY position. However, this does not dissuade our                                                                                                 7.5
                            bearish JPY view. We look to re-establish our position at                  85
    USD/JPY
                            better levels.                                                                                                                                        12.5
                                                                                                       80
                                                                                                                                                                                  17.5
                                                                                                       75
                                                                                                        Jan-09    Sep-09     May-10   Jan-11    Sep-11    May-12     Jan-13

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




                                                                                                                                                                                             16
                                                                                                                            MORGAN STANLEY RESEARCH

                                                                                                                             February 28, 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
Closed Trades
Long USD/JPY                                             $10.0mn                               08-Feb-13                  93.20        Stopped at 92.10 on 25-Feb-13                            -$119.4k                $0.8k              -$118.6k
Long EUR/AUD                                             $10.0mn                               14-Feb-13                 1.2900       Stopped at 1.2700 on 25-Feb-13                            -$149.0k             -$10.5k               -$159.4k
Long EUR/JPY                                             $10.0mn                               15-Feb-13                 123.30       Stopped at 120.70 on 25-Feb-13                            -$217.5k               -$0.2k              -$217.7k
Long "FX Policy" Basket                                  $10.0mn                               08-Feb-13                 100.00        Stopped at 98.50 on 25-Feb-13                            -$151.3k                $6.8k              -$144.6k
Long EUR/USD                                             $10.0mn                               25-Feb-13                 1.3090 Took Profit at 1.315 on 27-Feb-13                                $45.8k                -$0.2k                $45.7k
Active Trades
Long AxJ/JPY                                             $10.0mn             10.1%             15-Feb-13                 103.90               103.05         100.00          110.00              -$78.8k                $4.6k               -$74.2k
Short AUD/NZD                                            $10.0mn             10.1%             22-Feb-13                 1.2338               1.2350              1.270        1.100             -$10.4k               -$0.1k               -$10.5k
Cash                                                     $79.2mn          80.0%
Portfolio Mark to Market                                  $98.9mn
Source: Morgan Stanley Research
*Stops for all trades are based on spot
Notes: (1) Stops are based on the WMR fixing. (2) The portfolio represents hypothetical, not actual, investments. For more details regarding calculations, please see “Reading FX Tactical Trade
Performance” at the back of FX Pulse. Our FX Performance Data Package contains complete performance statistics. (3) Reported returns are unleveraged. (4) In the case that trade allocations are
increased, entry levels are a weighted average. * Global Risk Demand Index – US Pat. No. 7,617,143. We updated our methodology for our portfolio in 2011 (FX Pulse: Watching Europe, October
13, 2011).
Performance on Recommended Discretionary Currency Portfolio and Market Benchmark
 Simple return, index
                                                                                                                                                                                 AUD
 135

 130
                                                                                                                                                                                  JPY
 125

 120                                                                                                                                                                        AxJ Basket

 115
                                                                                                                                                                             FX Basket
 110
 105                                                                                                                                                                             NZD
                                                                                                                                     MS FX Strategic Portf olio
 100                                                                                                                                 Barclay Currency Fund Index
                                                                                                                                                                                 EUR
  95

  90                                                                                                                                                                                     -30     -20          -10        0           10     20
   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     Jan-13                               Now           Last Pulse          USD
                                                                                                                                                                                                                                           mn




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             -0.23             -0.82                                                                                                                                                                                             -1.05%


Options Trades
                Trade Recommendation                              Notional            Entry Date              Expiry Date                    Strike          Entry Spot              Entry Vol                      Entry Cost


                Long USD call/JPY put                                  $10.0mn             28-Feb-13             02-Sep-13                    96.0000               92.3400                    12.00%                         1.80%
                Short USD call/JPY put                                 $10.0mn             28-Feb-13             02-Sep-13                   100.0000               92.3400                    12.60%                        -0.93%
Source: Morgan Stanley Research; see notes above.




                                                                                                                                                                                                                                                 17
                                                                                                             MORGAN STANLEY RESEARCH

                                                                                                             February 28, 2013
                                                                                                             FX Pulse




G10 Currency Summary
Calvin Tse and Dara Blume
                USD                                 Recovery Underway                                 Bullish      Watch: Personal Income, ISM, ADP, Factory Orders, Trade, Payrolls

                  1.7%                              US economic data have recently been robust, with consumer confidence, core durable orders, and housing numbers all
                                                    surprising strongly to the upside. Should this trend continue, markets may begin to consider the possibility that asset purchases
               end sooner than originally envisioned, supporting USD. In that regard, this week’s ISM and payrolls figures should have a large
                                                    influence on how the dollar trades.
                EUR                                 Political Uncertainty                             Neutral      Watch: PMI, Flash CPI, Retail Sales, Q4 GDP, ECB, German IP

                  1.6%                              Our bullish EUR stance to start the year was driven by the prospects of a better economic outlook in the eurozone, additional
                                                    JPY liquidity in the markets, and attractive yields provided by the periphery resulting in large portfolio inflows. However, the
               surprise results of the Italian elections have proven to be a near-term game changer, as political risk is likely to prompt
                                                    investor caution. As such, we now view risk to the EUR to the downside.
                 JPY                                New Easing Regime                                  Bearish     Watch: Jobless Rate, CPI, Leading Index, BoJ, Q4 GDP, Trade

                13.3%                               As expected, Kuroda and Iwata were appointed as the BoJ Governor and Deputy Governor, respectively. We expect these
                                                    nominations to pass both houses of the Diet, leading to more aggressive central bank policy going forward. Additionally,
               heading into the new fiscal year, our research shows that domestic investors are likely to sell roughly JPY 6trn worth of yen.
                                                    As such, both easy policy and large flows should prompt further JPY weakness.
                GBP                                 A Mini JPY?                                       Bearish      Watch: PMI Manufacturing, Mortgage Approvals, PMI Services, BoE

                -5.3%                               The shift in policy from the BoE is reminiscent of what we’ve seen in Japan, though perhaps on a smaller scale. Central
                                                    banks in both countries have signaled they are willing to tolerate a higher level of inflation in order to support growth more
               aggressively, and for both, a weaker exchange rate is a part of this process. While we don’t expect a change in policy at next
                                                    month’s BoE meeting, we do expect the BoE’s more flexible approach to inflation targeting will continue to weigh on GBP.

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

                  0.2%                              We have seen some green shoots in the Swiss economy but do not expect this will change the SNB’s willingness to hold its
                                                    ground. Better than expected results in the KoF leading indicator and GDP both point to economic improvement, and we will
               watch to see if the PMI reflects the same trend. However, with ongoing deflation, we expect the SNB will hold its ground and
                                                    maintain the floor, even if the economy starts to pick up. We will watch CPI and FX reserves next week.

                CAD                                 Room for Near Term-Correction                     Neutral      Watch: GDP, BoC, Ivey PMI, Trade, Housing Starts, Employment Report

                  2.7%                              We believe CAD could correct its recent weakness in the near term, for three reasons. First, the BoC, which meets next
                                                    week, is unlikely to cut rates. Second, our models suggest CAD is under-, not over-valued. Third, CAD is an attractive
               reserve currency, and could see inflows on this front. Next week we will get a wave of domestic data; we expect data from
                                                    2013 to start showing signs of improvement, also supporting the currency.
                AUD                                 Deterioration in EMU Could Offer Support          Neutral      Watch: Current Account, Retail Sales, RBA Meeting, GDP, Trade

                -1.0%                               We remain bearish AUD, particularly against its antipodean peer NZD. However, we recognize AUD could receive some
                                                    near-term support from the fragmentation of the Italian parliament in the wake of elections. Indeed, many had reallocated
               funds from AUD into EUR as economic and political stabilization improved the relative attractiveness of EMU assets. With
                                                    political instability in Italy, some of these flows could reverse, supporting AUD, particularly against EUR.
                 NZD                                Attractive Real Yields                            Neutral      Watch: Commodity prices, global risk environment

                  2.2%                              We expect NZD to outperform within the commodity currency space, as its high real yields and strong economic performance
                                                    lead the currency upwards. The main risk to our strengthening NZD call stems from a deterioration in global risk appetite,
               which could be driven by political instability in EMU or fiscal concerns in the US. However, barring a sharp decline in global
                                                    risk appetite, we think NZD could strengthen against USD, and in particular against AUD.

                 SEK                                Upside for SEK                                    Bullish      Watch: PMI, Q4 GDP, Current Account, Average House Prices, IP

                -3.7%                               We remain constructive on SEK, given the recently strong economic data, and the recent shift of the Riksbank towards a
                                                    more hawkish stance, in contrast to other developed market central banks. Furthermore, with the UK losing its AAA rating by
               Moody’s, and with an uncertain political environment in Italy, Sweden’s relatively high yield, pristine sovereign rating, current
                                                    account surplus, and healthy fiscal situation look appealing. This week, PMI and GDP data will garner the most attention.
                NOK                                 Dovish Norges                                     Neutral      Watch: PMI, Unemployment Rate, Industrial Production

                -0.2%                               We believe NOK is likely to underperform its Scandinavian peer SEK in the near term. Indeed, economic data have been
                                                    relatively lackluster. Furthermore, the Norges Bank has shifted towards a more dovish stance, with Governor Olsen
               suggesting that rate cuts could be on the cards should NOK continue to strengthen. On the week, we will be watching PMI
                                                    closely, especially if there is a continued divergence between Norway and Sweden. We like NOKSEK shorts, targeting 1.12.




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

                                                                                                                       February 28, 2013
                                                                                                                       FX Pulse




EM Currency Summary
EM Strategy Team
                                 0.2%
                                                                         External demand improvements, stronger demand from domestic firms for RMB and capital inflows provide
CNY     Neutral
                                   context for modest appreciation pressures going forward.

                               -0.1%
                                                                         Prospective monetary policy easing over 1Q is likely to be positive for growth expectations and support the
INR     Bullish
                                   currency. Ongoing efforts at structural reform are a medium-term supportive factor, as is the high carry.

                                 0.9%
                                                                         A challenging backdrop still for the balance of payments, which suggests an ongoing bias towards
IDR     Bearish
                                   depreciation.

                                 0.2%
                                                                         JPY weakness a prospective medium-term headwind. Macro-prudential measures likely in prospect in an
KRW Bearish                         effort to limit FX exposures and the pace of appreciation.

                                 2.0%
                                                                         MYR has lagged the decline in USD/AXJ and is supported by steady macro-fundamentals, even in the context
MYR Bearish                        of the upcoming elections.

                               -2.9%
                                                                         THB is supported by positive macro-dynamic conditions, even though THB is overvalued and susceptible to
THB     Neutral
                                    weaker external demand conditions.

                                 1.9%
                                                                         Stabilization in global economic activity is likely to bolster TWD, though the low carry leaves it less compelling
TWD Neutral                        than regional peers.

                               -0.4%
                                                                         While outright intervention is not imminent, the CNB has suggested its weak currency bias is still in place, so
CZK     Bearish
                                    we keep to a medium term bearish view on the currency.

                                 2.8%
                                                                         Growing uncertainty on the replacement of Central Bank governor Simor, whose term ends in March, as well
HUF     Bearish
                                   as a weak macro backdrop keeps us bearish on HUF.

                               -2.8%                                     Israel’s fundamentals are better than most in the region. In addition, we have not seen any signal for
ILS     Neutral
                                    intervention from the central bank. Some risks remain, related to the change in central bank governor. As
                                                                         such, we stay neutral for now, but are turning more constructive.
                               -0.2%
                                                                         We have seen further indication that the NBP take a pause in cutting rates in the March meeting, which along
PLN     Bullish
                                   with improvements in Euro area leading indicators may keep the currency better supported.

                               -1.4%                                     Given the build up in long RUB positioning since the start of the year, the currency came under pressure with the
RUB     Neutral
                                    pick up in external risk related to the Italian elections. We think any more weakness would present good
                                                                         opportunities to start going long the RUB once again.
                                 0.7%
                                                                         We stay bearish on TRY as we think the CBT will continue to follow policies that limit appreciation in the real
TRY     Bearish
                                   effective exchange rate, which has now moved into ‘overvalued’ territory according to the central bank.

                               -0.5%
                                                                         The external position in South Africa remains weak, and given the domestic business and investment climate
ZAR     Bearish
                                   has deteriorated, we remain concerned about the deficit’s financing. We maintain our bearish view.

                               -7.6%                                     USD/BRL has moved sideways between 1.95 and 2.0, given that the BCB has intervened on both the weak-
BRL     Neutral
                                   and the strong-side of the currency, on the back of high inflation and low growth concerns. We believe this will
                                                                         continue as long as inflation expectations remain high and economic activity doesn’t rebound.
                               -1.5%                                     CLP has corrected on the back of intervention fears and lower copper prices, which should continue to stem
CLP     Neutral
                                   appreciation in the coming weeks. We believe that strong fundamentals and a relatively high carry, could drive
                                                                         CLP strength into the medium term.
                               -0.9%
                                                                         COP reacted modestly to the recent bout of intervention measures and thus, tools in Colombia seem to be
COP     Bullish
                                   losing some of its power to absorb incoming inflows. We like short USD/COP positions with target at 1,740.

                               -2.0%                                     We expect MXN to continue strengthening due to strong fundamentals and ambitious reforms in the
MXN Bullish                        government’s agenda. We like long MXN funded by JPY with a target at 7.5, but further prospects of rate cuts
                                                                         by Banxico could weigh on the currency in the short term.
                                 0.1%
                                                                         PEN strengthened in the first weeks of the year, reaching the highest levels seen since 1996. Even after the
PEN     Neutral                     recent correction, we expect the central bank to keep preventing any meaningful appreciation.



Charts show 3M performance against USD, as normally quoted                                                                                                                                    19
                                                                                            MORGAN STANLEY RESEARCH

                                                                                             February 28, 2013
                                                                                             FX Pulse




Global Event Risk Calendar
Marc Englander

Date   (GMT)           Ccy     Time      (GMT)   Event                                                           Ref. Period         MS forecast   Market     Previous
        1-Mar   Fri
                        CAD    13:30             GDP                                                                           4Q                  0.6%Q       0.6%Q
                        CHF     8:30             Manufacturing PMI                                                                                  52.10         52.5
                        CLP    11:30             CBC Minutes
                        CNY     1:30             Manufacturing PMI                                                         Feb                        50.5        50.4
                        EUR     9:00             Eurozone Manufacturing PMI                                                                          47.80       47.80
                        EUR    10:00             Eurozone CPI                                                              Feb                      2.0%Y       2.0%Y
                        EUR    10:00             Eurozone Unemployment Rate                                                Jan                     11.80%      11.70%
                        EUR    11:00             ECB announces 3Y LTRO Repayment
                        GBP     9:30             Manufacturing PMI                                                         Feb                          51        50.8
                        GBP     9:30             Mortgage Approvals                                                        Jan                                   55.8K
                        NOK     8:00             PMI                                                                       Feb                                    50.5
                        NOK     9:00             Unemployment Rate                                                         Feb                                  2.70%
                        RUB     NA   *           CBR Rate Decision                                                       1-Mar            5.50%     5.50%       5.50%
                        SEK     7:30             PMI                                                                       Feb                                    49.2
                        SEK     8:30             Current Account                                                            4Q                                   66.1B
                        SEK     8:30             GDP                                                                        4Q                                 0.5%Q
                        USD     8:30             Core PCE                                                                  Jan                      1.3%Y       1.4%Y
                        USD    13:30             Personal Income                                                           Jan          -2.0%M     -2.4%M      2.6%M
                        USD    14:55             U. of Mich Confidence                                                     Feb                         76.3       76.3
                        USD    15:00             ISM Manufacturing                                                         Feb              52.5       52.1       53.1
                        USD    22:00             Vehicle Sales                                                             Feb           15.00M    15.00M      15.23M
                        USD     NA               Spending Sequester Takes Effect
       2-Mar    Sat
                        USD    3:00              Fed's Bernanke spks
       3-Mar    Sun
                        EUR    9:00              Eurozone Services PMI                                                   Feb F
                        USD    NA                Institute of Int'l Bankers Conference (Washington)
       4-Mar    Mon
                        EUR 10:00                Eurozone PPI                                                                  Jan                            -0.2%M
                        EUR 14:00                Eurogroup mtg (Brussels)
                        GBP 9:30                 PMI Construction                                                          Feb                                    48.7
       5-Mar    Tues
                        AUD 0:30                 Current Account                                                            4Q                                -14900M
                        AUD 0:30                 Retail Sales                                                              Jan                                 -0.2%M
                        AUD 3:30                 RBA Rate Decision                                                       5-Mar            3.00%     3.00%       3.00%
                        CNY 1:45                 HSBC Services PMI                                                         Feb                                      54
                        EUR 8:00                 EcoFin mtg (Brussels)
                        EUR 10:00                Eurozone Retail Sales                                                     Jan                                 -3.4%Y
                        GBP 9:30                 PMI Services                                                              Feb                                    51.5
                        SEK 7:30                 PMI Services                                                              Feb
                        USD 15:00                ISM Non-Manf. Composite                                                   Feb                                    55.2
       6-Mar    Wed
                        AUD     0:30             GDP                                                                        4Q                                  0.5%Q
                        BRL     NA               SELIC Target Rate                                                       6-Mar            7.25%     7.25%       7.25%
                        CAD    15:00             BoC Rate Decision                                                       6-Mar            1.00%     1.00%       1.00%
                        CAD    15:00             Ivey PMI                                                                  Feb                                     58.9
                        EUR    10:00             Eurozone GDP                                                             4Q F                                 -0.6%Q
                        GBP     9:45             BoE's King and Bailey spk (London)
                        JPY     NA               BoJ Rate Decision                                                       7-Mar            0.10%     0.10%      0.10%
                        PLN     NA               NBP Rate Decision                                                                        3.75%     3.75%      3.75%
                        USD    13:15             ADP Employment Change                                                     Feb                       160K        192K
                        USD    15:00             Factory Orders                                                            Jan                                 1.8%M
                        USD    19:00             Fed Beige Book
       7-Mar Thurs
                        AUD    00:30             Trade Balance                                                             Jan                                  -427M
                        CHF     6:45             Unemployment Rate                                                         Feb                                  3.10%
                        CHF     8:00             FX Reserves                                                               Feb                                 427.0B
                        CHF     9:00             SNB's Jordan discusses 2012 annual results
                        CNY     NA               Trade Balance                                                             Feb                                $29.15B
                        EUR    11:00             German Factory Orders                                                     Jan                                 0.8%M
                        EUR    12:45             ECB Rate Decision                                                                        0.75%     0.75%       0.75%
                        EUR    13:30             ECB's Draghi spks
                        GBP    12:00             BoE Rate Decision                                                                        0.50%     0.50%       0.50%
                         IDR    NA               Bank of Indonesia Rate Decision                                         7-Mar            5.75%     5.75%       5.75%
                        JPY     5:00             Leading Index                                                           Jan P                                    93.4
                        JPY    23:50             Trade Balance                                                             Jan                                -567.6B
                        JPY    23:50             GDP                                                                      4Q F                                -0.1%Q
                        JPY     NA               Eco Watchers Survey: Current                                              Feb                                    49.5
                        MYR    10:00             MAS Rate Decision                                                       7-Mar           3.00%      3.00%       3.00%
                        PEN    23:00             BCRP Rate Decision                                                        Mar           4.25%      4.25%       4.25%
                        USD    13:30             Trade Balance                                                             Jan           -43.5B                -38.5B
                        USD    13:30             Nonfarm Productivity                                                     4Q F                     -1.5%Q     -2.0%Q
                        USD    13:30             Initial Jobless Claims                                            Wk of Mar-4                                   344K




                                                                                                                                                                     20
                                                                                                 MORGAN STANLEY RESEARCH

                                                                                                  February 28, 2013
                                                                                                  FX Pulse




Date    (GMT)              Ccy      Time    (GMT)    Event                                                               Ref. Period         MS forecast   Market   Previous
         8-Mar    Fri
                            CAD    13:15             Housing Starts                                                                Feb                               160.6K
                            CAD    13:30             Net Change in Employment                                                      Feb                                -21.9K
                            CHF     8:15             CPI                                                                           Feb                               -0.3%Y
                            EUR    11:00             ECB announces 3Y LTRO Repayment
                            EUR    11:00             German Industrial Production                                                  Jan                                0.3%M
                            MXN    15:00             Banxico Rate Decision                                                       8-Mar            4.50%    4.50%       4.50%
                            SEK     8:30             Industrial Production                                                         Jan                                1.3%M
                            USD    13:30             Change in nonfarm payrolls                                                    Feb             125K                 157K
         9-Mar    Sat
                            CNY       NA             New Yuan Loans                                                                Feb                              1070.0B
                            CNY     1:30             CPI                                                                           Feb                               2.0%Y
                            CNY     5:30             Industrial Production                                                         Feb                              10.3%M
                            CNY     5:30             Retail Sales                                                                  Feb                              15.2%Y
       10-Mar    Sun
                            EUR  NA                  Italy Holds Regional Elections
                            NZD 22:45                NZ Card Spending                                                              Feb                                0.4%M
       11-Mar    Mon
                            EUR 8:00                 German Trade Balance                                                              Jan                             12.0B
                             INT NA                  EcoFin meets (Brussels)
                            JPY 0:50                 M3                                                                            Feb                                2.3%Y
                            JPY 0:50                 Machine Orders                                                                Jan                                2.8%M
                            JPY  NA *                Possible Date for Vote on BoJ Nominations
                            NOK 10:00                CPI                                                                           Feb                                1.3%Y
       12-Mar    Tues
                            AUD 1:30                 NAB Business Conditions                                                       Feb                                     -2
                            GBP 10:30                Industrial Production                                                         Jan                                1.1%M
                            GBP 10:30                Trade Balance                                                                 Jan                                -£3201
                            GBP 1:01                 RICS House Price Balance                                                      Feb                                 -4%M
                            JPY 6:00                 Consumer Confidence                                                           Feb                                   43.3
                            JPY 0:50                 Domestic CGPI                                                                 Feb                               -0.2%Y
                            JPY 0:50                 Tertiary Industry Index                                                       Jan                                1.4%M
                            SEK 9:30                 CPI                                                                           Feb                                  1%Y
                            USD 19:00                Monthly Budget Statement                                                      Feb
       13-Mar    Wed
                            AUD 0:30                 Home Loans                                                                        Jan                           -1.5%M
                            EUR 11:00                Italian Bond Auction
                            KRW 1:30                 BoK Rate Decision                                                          14-Mar            2.75%    2.75%      2.75%
                             NZD 21:00               RBNZ Rate Decision                                                         14-Mar            2.50%    2.50%       2.50%
                            USD 13:30                Retail Sales                                                                  Feb                                0.1%M
       14-Mar Thurs
                            AUD     1:00             Consumer Inflation Expectation                                                Mar                                2.2%Q
                            AUD     1:30             Employment Change                                                             Feb                                 10.4K
                            CHF     8:30             SNB Rate Decision                                                          14-Mar            0.00%    0.00%      0.00%
                            CLP    23:00             CBC Rate Decision                                                          14-Mar            5.00%    5.00%      5.00%
                            EUR     NA *             EU Summit
                            JPY     5:30             Industrial Production                                                       Jan F
                            NOK    10:00             Norges Bank Rate Decision                                                  14-Mar            1.50%    1.50%       1.50%
                            NZD    22:30             Business NZ PMI                                                               Feb                                   55.2
                            PHP     9:00             BSP Rate Decision                                                          14-Mar                                 3.50%
                            SEK     9:30             Unemployment Rate                                                             Feb                                  8%M
                            USD    13:30             Current Account                                                                4Q                              -$107.5B
                            USD    13:30             PPI                                                                           Feb                                0.2%M
                            USD    13:30             Initial Jobless Claims                                               Wk of Mar-11
       15-Mar     Fri
                            CAD    14:00             Existing Home Sales                                                          Feb                                 1.3%M
                            CHF     9:15             PPI                                                                           Feb                                0.8%Y
                            EUR    11:00             Euro-Zone CPI                                                               Feb F
                            EUR    12:00             ECB Announces 3-Year LTRO Repayment
                            EUR     NA               Italian Parliament Reconvenes
                            NOK    10:00             Trade Balance                                                                Feb                                  33.5B
                            NZD     1:00             ANZ Consumer Confidence Index                                                Mar                                    121
                            USD    13:30             CPI                                                                          Feb                                 1.6%Y
                            USD    13:30             Empire Manufacturing                                                         Mar                                  10.04
                            USD    14:00             Net Long-term TIC Flows                                                      Jan                                 $64.2B
                            USD    14:15             Industrial Production                                                        Feb                                -0.1%M
                            USD    14:55             U. of Michigan Confidence                                                   Mar P
Upcoming Policy Events
     18-Mar                 JPY       NA             BoJ's Governor Shirakawa steps down
     20-Mar                 USD       NA             FOMC Rate Decision                                                                           0.25%    0.25%      0.25%
     20-Mar                 JPY       NA             Two Deputy BoJ Governors' Terms End
     20-Mar                 USD     19:00            Fed Release Summary of Economic Projections
     17-Apr                 SEK      8:30            Riksbank Rate Decision                                                                       1.00%    1.00%      1.00%
     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




                                                                                                                                                                           21
                                                                                                             MORGAN STANLEY RESEARCH

                                                                                                             February 28, 2013
                                                                                                             FX Pulse




Cross-Currency Carry and Vol Heat Map
                                              Implied Vol Metric                                      RR Metric                                 Carry Metric
                     3M Im   1W      5-Year   Imp vs   5-Year   1Y/3M     5-Yer   5Y/1Y     5-Yer   3M 25d    RR/    Ratio             3M 1W        5-Year   Vol-Adj.   5-Year    1Y/3M     1y Carry/
                     Vol     Chg     Perc.    Real     Perc.    Imp Rat   Perc.   Imp Rat   Perc.    RR       Imp    Perc             Carry Chg      Perc.    Carry      Perc.   Crry Rat   CallSprd
            USDCAD     7.1    0.4     11%       1.5     100%      1.06     51%      1.11     99%     1.5      21%    85%     USDCAD   0.8    0.0    81%       0.12      89%       0.96        1.89
            USDCHF     8.6    0.4      7%       1.3     87%       1.06     61%      1.07    100%     1.1      13%    96%     USDCHF   -0.4   0.0    51%       -0.05     29%       -1.25       1.08
            USDJPY    12.2    0.6     63%       1.3     77%       0.93     15%      1.31     96%     0.6      5%     90%     USDJPY   -0.3   0.0    77%       -0.02     80%       -1.55       1.97
            USDNOK     9.6    0.6      9%       1.2     88%       1.07     61%      1.06    100%     1.4      15%    74%     USDNOK   1.4    0.0    31%       0.15      74%       0.98        4.08
  G10




            USDSEK    10.4    0.7     10%       1.2     94%       1.04     53%      1.06    100%     1.6      16%    78%     USDSEK   0.8    0.0    43%       0.08      47%       0.94        2.41
            GBPUSD     8.8    0.3     24%       1.4     92%       1.06     36%      1.23     98%     -1.2    -13%    49%     GBPUSD   -0.2   0.0    66%       -0.02     58%       -0.46       2.36
  USD




            NZDUSD    10.2    0.6     10%       1.1     78%       1.07     49%      1.05    100%     -2.3    -23%    29%     NZDUSD   -2.4   0.0    75%       -0.23     18%       -1.04       1.25
            AUDUSD     8.4    0.6      7%       1.3     94%       1.13     74%      1.04    100%     -2.5    -29%    10%     AUDUSD   -2.7   0.0    86%       -0.32     39%       -0.92       2.26
            EURUSD     9.0    0.7      9%       1.2     55%       1.03     36%      1.06    100%     -1.5    -17%    23%     EURUSD   0.3    0.0    82%       0.03      86%       1.15        2.43
  ,




            EURAUD     9.2    0.0     15%       1.0     41%       1.03     27%      1.00     95%     0.6      6%      9%     EURAUD   3.0    0.0    28%       0.33      45%       0.94        2.31
            EURCAD     9.1    0.4     18%       1.2     60%       0.97     10%      1.07     98%     0.1      1%     79%     EURCAD   1.1    0.1    86%       0.12      86%       1.00        2.21
            EURCHF     4.6    -1.0    25%       0.8     16%       1.03     57%      1.76     95%     1.7      37%    99%     EURCHF   -0.2   0.0    99%       -0.04     97%       -1.42       1.86
            EURGBP     9.2    0.5     36%       1.1     42%       0.95     8%       1.23     95%     0.4      4%     55%     EURGBP   0.5    0.0    70%       0.05      63%       0.88        2.11
  G10




            EURJPY    15.6    1.4     67%       1.0     41%       0.90     6%       1.27     88%     -1.6    -10%    93%     EURJPY   0.0    0.0    90%       0.00      90%      121.49       2.34
            EURNOK     6.1    0.2     12%       1.2     64%       1.03     45%      1.12     94%     0.2      3%      5%     EURNOK   1.7    0.0    64%       0.28      86%       1.00        2.32
  EUR




            EURNZD    10.5    0.1     20%       1.1     66%       1.00     17%      1.00     96%     0.6      5%      2%     EURNZD   2.7    0.0    58%       0.26      73%       1.06
            EURSEK     6.6    0.0     17%       1.1     58%       1.02     40%      1.15     99%     0.4      5%     12%     EURSEK   1.1    0.1    64%       0.17      72%       1.00        2.15
  ,




            GBPAUD     9.2    0.3     15%       1.3     93%       0.99     17%      1.08     99%     0.6      7%     26%     GBPAUD   2.6    0.0    23%       0.28      38%       0.95        2.22
            GBPCAD     9.1    0.7     24%       1.4     94%       0.94     8%       1.08     96%     -0.3     -3%    71%     GBPCAD   0.7    0.1    78%       0.07      73%       1.10        4.15
            GBPCHF     8.9    0.3     19%       1.3     81%       0.98     15%      1.34     97%     0.3      3%     97%     GBPCHF   -0.6   0.0    70%       -0.07     47%       -1.03       2.08
            GBPJPY    13.1    1.1     39%       1.2     76%       0.93     8%       1.30     85%     -1.5    -11%    84%     GBPJPY   -0.4   0.0    84%       -0.03     70%       -1.13
  G10




            CHFJPY    14.2    1.0     66%       1.1     59%       0.91     7%       1.09     40%     -1.6    -11%    53%     CHFJPY   0.2    0.0    75%       0.01      75%       0.78       -0.27
            AUDCAD     6.4    0.1      6%       1.1     48%       1.07     58%      1.07     99%     -0.9    -13%    46%     AUDCAD   -1.9   0.0    97%       -0.31     73%       -0.88       2.00
  Crosses




            AUDCHF     9.0    -0.4    10%       1.1     54%       1.09     58%      1.13     99%     -0.2     -2%    100% AUDCHF      -3.1   0.0    88%       -0.34     52%       -0.97
            AUDJPY    13.0    2.1     18%       1.3     87%       0.98     18%      1.27     80%     -2.5    -19%    83%     AUDJPY   -2.9   0.0    94%       -0.23     65%       -0.98       2.21
            AUDNZD     6.8    -0.3    18%       1.1     54%       0.99     33%      1.04     95%     -0.3     -5%    28%     AUDNZD   -0.3   0.0    79%       -0.04     78%       -0.08       2.12
            NOKSEK     5.7    0.0      8%       1.1     46%       1.02     41%      1.12     71%     0.2      4%     31%     NOKSEK   -0.6   -0.1   56%       -0.11     47%       -4.71       0.23
  ,




            USDCNY     1.5    0.0      8%       0.5      1%       1.31     20%      3.06     96%     0.2      10%    62%     USDCNY   0.6    -0.3   71%       0.42      73%       1.05        2.34
            USDHKD     0.6    0.0     10%       3.2     78%       1.50     46%      4.55     29%     -0.6    #####   27%     USDHKD   -0.2   0.0    77%       -0.27     63%       -0.86       5.13
            USDIDR     7.0    0.0      9%       1.5     63%       1.29     52%      1.43     72%     2.8      39%    49%     USDIDR   2.2    -0.8    5%       0.32      19%       1.86        1.99
            USDINR     9.7    0.2     31%       1.3     62%       1.05     36%      1.24     76%     1.0      10%     9%     USDINR   7.0    -0.3   73%       0.72      82%       0.91        2.68
AXJ BLOCK




            USDKRW     7.8    0.6      8%       1.4     80%       1.14     71%      1.48     94%     2.5      32%    65%     USDKRW   2.2    0.0    74%       0.28      94%       0.77        1.79
            USDMYR     7.8    -0.1    36%       1.7     94%       1.03     21%      1.30     83%     2.6      33%    96%     USDMYR   2.2    -0.3   86%       0.28      83%       0.89        1.88
            USDPHP     4.7    0.2      0%       1.5     87%       1.17     60%      1.36     81%     1.1      23%    44%     USDPHP   -0.6   -0.1    9%       -0.13      7%       -0.62       1.64
            USDSGD     4.6    -0.2     5%       1.6     93%       1.19     88%      1.64    100%     1.6      35%    99%     USDSGD   0.0    0.0    60%       0.00      59%       -1.28       1.62
            USDTHB     7.0    0.0     31%       1.9     68%       1.14     50%      1.25     45%     0.8      11%    13%     USDTHB                                               1.01        2.02
            USDTWD     4.8    0.0     16%       1.3     48%       0.94     1%       1.90     99%     1.4      29%    97%     USDTWD   -0.9   0.1    80%       -0.19     73%       -1.47       1.44
,




            USDARS    15.0    0.0     65%      14.2     90%       1.83     42%      1.43     33%     7.0      47%    35%     USDARS   45.4   8.7    90%       3.03      96%       0.89        2.64
            USDCLP     7.6    0.0      0%       1.9     99%       1.31    100%      1.27     89%     2.5      33%    84%     USDCLP   5.2    -0.1   89%       0.69      99%       0.89        2.08
            USDCOP     7.3    0.8      3%       1.7     70%       1.21     87%      1.19     70%     2.3      31%    66%     USDCOP   2.9    -0.1   44%       0.41      78%       0.98        2.09
  LATAM




            USDMXN     9.9    1.1     15%       1.3     64%       1.09     56%      1.14     53%     2.8      28%    38%     USDMXN   3.6    0.0    39%       0.36      80%       0.94        1.95
            USDBRL     9.3    0.6      7%       1.4     73%       1.14     62%      1.45     99%     2.5      27%    26%     USDBRL   4.3    -0.3    0%       0.47      41%       1.33        2.37
            EURBRL    10.7    0.7     15%       1.1     52%       1.11     41%      1.27     62%     2.2      20%     0%     EURBRL   4.6    -0.3    1%       0.43      20%       1.32        2.34
  BLOCK




            EURMXN     9.5    0.3      6%       1.2     57%       1.09     53%      1.34     94%     1.4      15%     7%     EURMXN   3.8    0.0    48%       0.40      93%       0.95        2.11
            BRLJPY    15.7    0.8     27%       1.2     67%       0.99     17%      1.42    100%     -2.3    -14%    100% BRLJPY      -4.4   -0.3   100%      -0.28     91%       -1.33       0.64
            MXNJPY    16.1    0.8     41%       1.2     55%       0.95     14%      1.17     75%     -2.5    -16%    99%     MXNJPY   -3.7   0.0    68%       -0.23     55%       -0.98       0.47
  ,




            EURCZK     5.3    0.3      1%       1.3     80%       1.11     93%      1.00     66%     1.2      23%    42%     EURCZK   0.1    0.0    35%       0.01      39%       0.21        1.69
            EURHUF     9.6    0.9     21%       1.1     57%       1.01     41%      1.03     88%     2.1      22%     9%     EURHUF   4.6    -0.3   49%       0.47      75%       0.78        2.09
            EURILS     7.3    0.5      5%       1.3     80%       1.06     66%      1.12    100%     0.6      8%     90%     EURILS   1.5    0.1    78%       0.21      85%       0.92        2.18
            EURPLN     7.4    0.1     12%       1.1     66%       1.11     76%      1.00     59%     1.6      21%    20%     EURPLN   3.6    0.1    73%       0.49      88%       0.88        2.08
            EURRUB     8.5    1.2     15%       1.3     90%       1.14     44%      1.54     95%     1.7      20%    44%     EURRUB   6.2    -0.4   58%       0.73      75%       0.98        2.56
            EURTRY     7.4    0.1      7%       1.2     64%       1.12     40%      1.42     82%     1.6      22%    40%     EURTRY   4.7    0.1     4%       0.64      64%       1.05        2.43
  EMEA




            EURZAR    11.5    0.3      5%       1.0     16%       1.17     91%      1.16     55%     1.8      16%     7%     EURZAR   5.3    0.0    23%       0.46      81%       0.98        2.24
            USDHUF    13.8    1.7     12%       1.2     92%       1.03     56%      1.02     91%     2.6      19%    24%     USDHUF   4.3    -0.4   24%       0.31      65%       0.75        1.97
            USDILS     7.2    0.4      9%       1.3     80%       1.08     79%      1.06     86%     1.3      18%    66%     USDILS   1.3    0.0    61%       0.17      82%       0.87        1.90
  BLOCK




            USDPLN    11.6    0.3      8%       1.1     63%       1.13     88%      0.99     61%     2.1      18%    22%     USDPLN   3.3    0.0    55%       0.29      87%       0.86        1.93
            USDRUB     8.6    1.2     11%       1.3     73%       1.18     64%      1.44     91%     2.2      26%    37%     USDRUB   6.1    -0.3   58%       0.71      84%       0.95        2.33
            USDTRY     6.9    0.7      5%       1.4     92%       1.17     64%      1.37     83%     2.2      31%    74%     USDTRY   4.5    0.1     4%       0.66      75%       1.02        2.28
            USDZAR    12.2    0.3      0%       1.1     60%       1.20     99%      1.13     60%     2.3      19%     0%     USDZAR   5.0    0.0     4%       0.41      82%       0.97        2.09
  ,




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


                                                                                                                                                                                                 22
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                                                                           February 28, 2013
                                                                           FX Pulse




                                                                           Another example is that if the vol curve metrics are indicating the
What’s New This Week?
                                                                           curve is unusually flat or inverted then selling front end vol via
 Vols on JPY-crosses spiked higher, particularly for AUD and              window barriers might be advised.
EUR. EURCHF came off a full vol. Vols in EM were generally
higher, but most are still low relative to their histories.                Some key concepts in the heat map:
 Moves in implied carry were quite idiosyncratic this week. In EM,        Percentiles are calculated as the % of days that the market closed
ARS was the biggest gainer and IDR lost some of its carry                  higher than the current level over the prior five years. So 94% would
advantage. G10 carry was unchanged.                                        indicate that only 6% of the observations over the past five years
                                                                           were above the current level. The percentile extremes are similar to
 EURUSD skew turned more negative and is approaching
                                                                           a z-score but are less sensitive to outliers.
historical lows. Demand for protection against high beta (AUD, NZD,
MXN) downside also rose.                                                   Implied vs realized vol: There is no hard link between implied and
                                                                           realized vol so it is possible – and indeed often – that implied vol
A Users Guide to the Heat Map                                              might be cheap from a historical basis but still be high vs where vol
                                                                           is realizing. We feel that to be truly cheap (or expensive) this metric
The heat map is designed to allow investors to quickly determine
                                                                           should be consistent.
which currency pairs offer relatively high (or low) vol and carry both
compared to other currencies and from a historical perspective. Our        1Y/3M and 5Y/1Y vol: These are the ratios of the indicated
intent in this is to highlight extremes in vol and carry that provide      maturities of implied vol and serve as an indicator of whether the
attractive trading opportunities as well as allow investors who have a     implied vol curve is relatively flat or steep. This serves as an
general interest in buying or selling vol and carry a quick way to         additional indicator if vols are at extremes and can also be helpful in
isolate which currency pairs offer the best relative value at this         determining the value part of the vol curve.
juncture. We do this by indicating extreme highs in red and extreme
                                                                           RR/Imp: This is the ratio of the 3M 25-delta risk reversal skew to 3M
lows in blue. Note that for outright indicators the colors are based on
                                                                           implied vol. We only do percentiles on the ratio because skew is
extreme levels across currencies and show which currency pairs are
                                                                           highly covariant with vol – i.e., skew typically increase as vol rises –
high (red is top 15th percentile and bold is top 10th) and low (blue is
                                                                           so it is important to adjust for the vol level when determining
bottom 15th percentile and bold is bottom 10th) on a relative basis.
                                                                           historical extreme of skew.
For the percentiles the colors instead show whether vol or carry is
extreme from a historical standpoint. A horizontal string of red           Vol-Adj. Carry: Higher carry currencies commonly have relatively
entries indicates a currency pair with high vols on many measures          high implied vol so metrics on this ratio can help determine whether
while a string of blues indicates a currency pair where vol is cheap.      carry is attractive relative to where vol is being priced. A high level
Similarly, a horizontal string of red across the carry metrics indicates   for this metric also would suggest that options offer a viable way to
a currency pair that is offering relatively attractive return on a large   capture carry.
number of indicators (note we do not filter for low return.)
                                                                           1Y/3M Carry Rat: The ratio of 1Y to 3M net carry. To some degree a
Risk reversal extremes can occur independent of the levels of vol          steep curve (red) would be another factor in indicating a good carry
and carry but here too, when currencies are at extremes across             opportunity but the main use of this metric is a quick indication of
currencies and on a historical basis this can indicate an attractive       whether carry is enhanced or compromised by moving to longer
trading opportunity. In addition, the risk-reversals are an important      duration.
component of a second purpose of the heat map, to indicate which
                                                                           1Y Carr /Call Sprd: The numerator is 1Y net carry (i.e. 1Y forward
trade structures take best advantage of the market prices. For
                                                                           vs spot spread) and the denominator is the cost (in % pts.) of a 1Y
instance, if an investor wants to go long EURUSD, they might first
                                                                           call spread going long the ATMF strike and selling the ATMS strike –
reference the first two vol metrics to determine whether vol is cheap
                                                                           i.e., the call spread return is capped at the forward discount. This
or expensive. They might then reference the vol curve metrics and
                                                                           ratio filters for the fact that currencies with high carry frequently have
the carry metrics to determine whether it is attractive to push out
                                                                           high skew for puts – i.e., favoring the lower yield currency. A high
duration to lock in carry and whether vol becomes significantly more
                                                                           value here suggests that call spreads represent a relatively attractive
expensive (or cheaper) at longer maturities. Finally, the risk reversal
                                                                           way to capture carry with limited risk In the current yield environment
skew metrics can be used as an indicator of whether low-delta
                                                                           we believe when this ratio is above 2.0 that it is sensible to consider
options are more or less attractive than at-the-money strikes.
                                                                           call spreads to capture carry.



                                                                                                                                                  23
                                                                                    MORGAN STANLEY RESEARCH

                                                                                     February 28, 2013
                                                                                     FX Pulse




G10 FX Tactical Indicators
Marc Englander
Exhibit 1                                                                        Exhibit 2
Historical Currency Performance                                                  Risk-Adjusted Five-Year Yields
    4%                                                                             100

    2%                                                                              50

    0%                                                                               0

   -2%                                                                             -50

   -4%                                                                            -100

   -6%                                                                            -150
             DXY JPY NZD SEK AUD CHF CAD EUR GBP NOK                                 Sep-12                            Nov-12                      Jan-13
                    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

                                                                                         2
    5
                                                                                         1
    0
                                                                                         0

    -5
                                                                                      -1

                                                                                      -2
  -10
                                                                                      -3
             JPY   USD   CHF      AUD SEK        CAD EUR       GBP   NZD   NOK
                                  Current        Last Pulse                            Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13

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

Exhibit 5                                                                        Exhibit 6
G10 Surprise Index                                                               IMM Positions Summary ($bn)
                   G10 Average          G10 GDP Weighted Average
                                                                                     MXN
    0.2
                                                                                     AUD
   0.15
    0.1                                                                              EUR

   0.05                                                                              NZD

         0                                                                           CAD
  -0.05                                                                              CHF
   -0.1                                                                              GBP
  -0.15
                                                                                      JPY
   -0.2
     Mar-12         May-12     Jul-12        Sep-12   Nov-12    Jan-13                       -12            -7                  -2           3                8

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




                                                                                                                                                                          24
                                                                                                                    MORGAN STANLEY RESEARCH

                                                                                                                    February 28, 2013
                                                                                                                    FX Pulse




Morgan Stanley FX Positioning Tracker
Calvin Tse and Gabriel de Kock
Overall Score                                                                          Component Scores
         This    Last
         Week    Week           Short               Neutral              Long           MS                                   Senti-            Since Monday (February 25), positioning in the
                       -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2     3 4 5 6 7 8   9 10   Flow    IMM   Toshin   TFX     Beta   ment               G10 currencies remains roughly unchanged. We
                                                                                                                                                calculate the largest long positions to be in SEK
  USD      2      2                                                                    10     -1              8      -7      -1      USD
                                                                                                                                                and NZD. The largest shorts are in CAD, GBP,
  EUR      5      5                                                                     9      5              7       2      -1      EUR       and JPY.
  JPY     -4      -5                                                                  -6     -8      5      -9      -5      -3      JPY
                                                                                                                                               JPY shorts were reduced as domestic investors
  GBP     -4      -4                                                                  -10     -5              7      -7      -7      GBP       and global macro hedge funds covered shorts.
                                                                                                                                                Bearish sentiment also moderated.
  CHF     -1      -1                                                                   -1      1                             -2      CHF

  CAD     -5      -5                                                                  -10     -2                             -5      CAD      EUR longs were reduced by Japanese retail and
                                                                                                                                                global macro hedge funds intra-week. However,
  AUD      1      1                                                                    -3     -3              8               1      AUD       this was not enough to move the aggregate
  NZD      7      7                                                                     3     10              7                      NZD       positioning score.

  NOK      2      2                                                                     2                                            NOK      We will provide a full updated report and refresh
  SEK      9      9                                                                     9                                            SEK
                                                                                                                                                positioning scores for all of our underlying sub-
                                                                                                                                                indicators next Monday.
                                                                                                                                                                    For Methodology see Appendix



Morgan Stanley High-Frequency Misalignment Monitor
1Yr                                                      27 February, 2013
                 EUR           JPY               GBP        CHF         AUD             CAD           NZD           NOK             SEK
                                                                                                                                               Our high-frequency misalignment monitor sends
USD             -0.1%         -0.8%             -3.1%      -0.7%       -1.2%           -1.4%         -1.7%          -2.3%          -1.8%
                                                                                                                                                rather mixed signals this week, with significant
EUR                           -0.7%             -3.0%      -0.5%       -1.1%           -1.3%         -1.5%          -2.1%          -1.7%
                                                                                                                                                divergence between the models’ estimates over
JPY                                             -2.3%       0.2%       -0.4%           -0.6%         -0.8%          -1.4%          -1.0%        one-, two- and three-year time windows. GBP
GBP                                                         2.5%       1.9%            1.7%           1.4%          0.9%           1.3%         undervaluation after sterling’s steep decline this
CHF                                                                    -0.5%           -0.8%         -1.0%          -1.6%          -1.1%        year is a standout conclusion, while USD
AUD                                                                                    -0.2%         -0.5%          -1.0%          -0.6%        appears to be entering overvalued territory. We
CAD         > +/- 1 sd                                                                               -0.2%          -0.8%          -0.3%        are bearish GBP on longer-term fundamentals.
NZD         > +/- 2 sd                                                                                              -0.6%          -0.1%
                                                                                                                                               GBP is the richest G10 currency relative to the
NOK         > +/- 3 sd                                                                                                             0.5%
                                                                                                                                                fair values based on our one-year model, which
2Yr                                                                                                                                             yielded the highest and most reliable trading
                 EUR           JPY               GBP          CHF           AUD         CAD          NZD            NOK            SEK          profits in back-tests. USD and EUR are the
USD             -0.5%         -2.7%             -3.3%         0.2%         -0.2%       -2.6%         1.4%           1.2%           2.1%         most expensive; the latter even after the sell-off
EUR                           -2.2%             -2.8%         0.7%         0.3%        -2.1%         1.8%           1.6%           2.6%
                                                                                                                                                after the inconclusive Italian election. The
                                                                                                                                                model signals long GBP positions against USD,
JPY                                             -0.6%         3.0%         2.5%        0.1%          4.1%           3.9%           4.8%
                                                                                                                                                EUR and CAD, with greater-than-2σ
GBP                                                           3.6%         3.1%        0.7%          4.7%           4.5%           5.4%         misalignments.
CHF                                                                        -0.4%       -2.8%         1.1%           0.9%           1.9%
AUD                                                                                    -2.4%         1.5%           1.3%           2.3%        GBP and JPY are the cheapest G10 currencies
CAD         > +/- 1 sd                                                                               3.9%           3.7%           4.7%         relative to fair values estimated over two-year
NZD         > +/- 2 sd                                                                                              -0.2%          0.8%         look-back windows, while SEK and NOK are the
NOK         > +/- 3 sd                                                                                                             1.0%         richest. The two-year model signals (1) GBP
                                                                                                                                                longs against USD, AUD, NOK and SEK and
3Yr                                                                                                                                             (2) CAD longs against USD and SEK, all with
                 EUR           JPY               GBP          CHF           AUD         CAD          NZD            NOK             SEK         2-σ undervaluations.
USD             -0.2%         -4.1%             -4.9%         1.2%         -0.1%       -1.5%         2.0%           0.9%           0.4%
                                                                                                                                               GBP and JPY are the cheapest and NZD and
EUR                           -3.9%             -4.7%         1.4%         0.0%        -1.3%         2.2%           1.1%           0.6%
                                                                                                                                                CHF the most expensive G10 currencies in our
JPY                                             -0.8%         5.2%         3.9%        2.6%          6.1%           5.0%           4.4%         three-year model, which yields the slowest-
GBP                                                           6.0%         4.7%        3.4%          6.9%           5.8%           5.2%         changing misalignment estimates.
CHF                                                                        -1.3%       -2.7%         0.9%           -0.2%          -0.8%
AUD                                                                                    -1.4%         2.2%           1.1%           0.5%        The misalignment monitor does not yield many
CAD         > +/- 1 sd                                                                               3.5%           2.4%           1.9%         strong signals this week, with GBP long
NZD         > +/- 2 sd                                                                                              -1.1%          -1.7%        positions across the G10 the most frequent
NOK         > +/- 3 sd                                                                                                             -0.6%
                                                                                                                                                trading signal.
Note: Misalignment measured as the overvaluation of the column currency vs the row currency                                                                         For Methodology see Appendix




                                                                                                                                                                                              25
                                                                                                     MORGAN STANLEY RESEARCH

                                                                                                      February 28, 2013
                                                                                                      FX Pulse




Central Bank Watch
                         Next rate            Market                MS                                                           Morgan Stanley Rates Forecasts
                         decision           expects (bp)        expects (bp)           Current             1Q13               2Q13               3Q13                4Q13               1Q14
US                         20 Mar                 0                   0                  0.15                 0.15            0.15               0.15                0.15               0.15
Euro Area                  07 Mar                 3                   0                  0.75                 0.75             0.75              0.75                0.75               0.75
Japan                      07 Mar                 0                   0                  0.05                 0.05            0.05               0.05                0.05               0.05
UK                         07 Mar                 -2                  0                  0.50                 0.50             0.50              0.50                0.50               0.50
Canada                     06 Mar                 0                   0                  1.00                 1.00            1.00               1.00                1.00               1.00
Switzerland                14 Mar                 -                   0                  0.00                 0.00             0.00              0.00                0.00               0.00
Sweden                     17 Apr                 -9                  0                  1.00                 1.00            1.00               1.00                1.00               1.25
Norway                     14 Mar                 -1                  0                  1.50                 1.50             1.50              1.75                2.00               2.00
Australia                  05 Mar                 -6                  0                  3.00                 3.00            2.50               2.50                2.50               2.50
New Zealand                14 Mar                 0                   0                  2.50                 2.50             2.50              2.75                3.00               3.25
Russia                   1-15 Mar                 -                   0                  5.50                 5.50            5.75               5.75                5.50               5.25
Poland                     06 Mar                 -                   0                  3.75                 3.75             3.25              3.25                3.25               3.25
Czech Rep                  28 Mar                 -                   0                  0.05                 0.05            0.05               0.05                0.05               0.25
Hungary                    26 Mar                 -                   -                  5.25                 5.25             5.00              5.00                5.00               5.00
Romania                    28 Mar                 -                   0                  5.25                 5.25            5.25               5.25                5.25               5.50
Turkey                     26 Mar                 -                   0                  5.50                 5.50             5.50              5.25                5.25               5.50
Israel                     24 Mar                 -                   0                  1.75                 1.50            1.50               1.50                1.75               2.25
South Africa               20 Mar                 -                   0                  5.00                 5.00             5.00              5.00                5.00               5.00
Nigeria                    19 Mar                 -                 -100                12.00              11.00              11.00             11.00                9.50               9.50
Ghana                         -                   -                   0                 15.00              14.00              13.00             12.00                12.00              12.00
China                        N/A                  -                   0                  6.00                 6.00             6.00              6.00                6.00               6.25
India                      19 Mar                 -                   -                  7.75                 7.75             7.25              7.25                7.25               7.00
Hong Kong                  20 Mar                 -                   -                  0.50                 0.50             0.50              0.50                0.50               0.50
S. Korea                   14 Mar                 -                   0                  2.75                 2.75             2.75              2.75                2.75               3.00
Taiwan                     21 Mar                 -                   0                  1.88                 1.88             1.88              1.88                2.00               2.13
Indonesia                  07 Mar                 -                   0                  5.75                 5.75             5.75              5.75                5.75               5.75
Malaysia                   07 Mar                 -                   0                  3.00                 3.00             3.00              3.00                3.00               3.00
Thailand                   03 Apr                 -                   0                  2.75                 2.75             2.75              2.75                2.75               2.75
Brazil                     06 Mar                 0                   0                  7.25                 7.25             7.25              7.25                7.25               8.25
Mexico                     08 Mar                -12                  0                  4.50                 4.50             4.50              4.50                4.50               4.50
Chile                      14 Mar                 0                   0                  5.00                 5.00             5.00              5.00                5.00               5.00
Peru                       07 Mar                 0                   0                  4.25                 4.25             4.25              4.25                4.25               4.50
Colombia                   22 Mar                 -                   -                  3.75                 3.75             3.75              3.75                3.75               4.00
Source: National Central Banks, Morgan Stanley Research forecasts; Note: Japan policy rate is an interval of 0.00-0.10%. Forecasts as of January 23, 2013
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

  1                                                                                                       5

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

Source: Morgan Stanley Research                                                                        Source: Morgan Stanley Research



                                                                                                                                                                                                26
                                                                                MORGAN STANLEY RESEARCH


                                                                                February 28, 2013
                                                                                FX Pulse




Morgan Stanley Global Currency Forecasts
 We updated our G10 forecasts on January 10, 2013.
                                                  2013                                    2014           4Q13 % change to:
                    Current           1Q          2Q          3Q         4Q        1Q         2Q      3Q Consensus Forward
EUR/USD                  1.31        1.32        1.36      1.32         1.26      1.20        1.15    1.12       0.8          0.6
USD/JPY                    92          95          97         99          100      102         103     104       4.2          7.5
GBP/USD                  1.52        1.60        1.62      1.60         1.57      1.54        1.51    1.45       3.2          5.6
USD/CHF                  0.93        0.91        0.88       0.91         0.95     0.96        1.03    1.11      -5.3         -2.3
USD/SEK                  6.44        6.67        6.62      6.67         6.90      7.17        7.39    7.41       3.2          3.1
USD/NOK                  5.71        5.61        5.51       5.53         5.60     5.83        6.04    6.16      -1.1         -4.0
USD/CAD                  1.03        0.98        0.97      0.98         1.00      1.01        1.03    1.04       0.0         -5.0
AUD/USD                  1.02        1.07        1.10       1.08         1.05     1.00        0.96    0.93       3.8          7.0
NZD/USD                  0.83        0.86        0.88      0.86         0.84      0.80        0.78    0.76       1.2          5.1
EUR/JPY                   121         125         132        131          126      122         118     116       4.5          8.2
EUR/GBP                  0.86        0.83        0.84      0.83         0.80      0.78        0.76    0.77      -1.8         -4.7
EUR/CHF                  1.22        1.20        1.20       1.20         1.20     1.15        1.18    1.24      -4.0         -1.6
EUR/SEK                  8.43        8.80        9.00      8.80         8.70      8.60        8.50    8.30       4.6          3.7
EUR/NOK                  7.48        7.40        7.50       7.30         7.05     7.00        6.95    6.90      -0.1         -3.4
USD/CNY                  6.22        6.30        6.30      6.30         6.30      6.22        6.20    6.18       2.6          0.0
USD/HKD                  7.76        7.80        7.80       7.80         7.80     7.80        7.80    7.80       0.5          0.6
USD/IDR                 9669        9750        9900      10200        10000     9950        9900    9850        4.9          3.5
USD/INR                  54.4        53.3        54.0       55.5         54.5     54.3        54.0    53.5       4.6         -1.9
USD/KRW                 1083        1075        1100       1120         1080     1065        1055    1040        6.7          2.2
USD/MYR                  3.09        3.03        3.05       3.08         3.05     3.03        3.00    2.96       2.3         -1.5
USD/PHP                  40.7        40.7        40.6       40.7         40.6     40.3        39.9    39.7       2.0          0.4
USD/SGD                  1.24        1.21        1.22       1.23         1.21     1.20        1.19    1.18       1.7         -0.5
USD/TWD                  29.6        28.8        29.0       29.1         28.9     28.7        28.6    28.5       1.0         -1.1
USD/THB                  29.8        30.3        30.2       30.3         30.2     30.0        29.9    29.8       2.4          0.8
USD/BRL                  1.98        2.10        2.10      2.10         2.10      2.10        2.08    2.05       5.0          3.2
USD/MXN                  12.8        12.6        12.8       13.4         12.4     12.2        12.0    11.8       7.7          2.4
USD/ARS                  5.04        5.40        5.80      6.20         7.00      7.18        7.35    7.53      12.1         -1.0
USD/VEF                  6.29        7.50        7.50       7.50         7.50     7.50        7.50    7.50      15.4         19.2
USD/CLP                   473         470         480        495          475      470         465     460       5.3          1.8
USD/COP                 1815        1780        1850       1870         1850     1820        1800    1780        5.4          1.3
USD/PEN                  2.59        2.58        2.60      2.62         2.63      2.61        2.59    2.57       3.6          1.5
USD/ZAR                  8.99        8.85        9.00       9.25         9.00     9.00        8.90    8.80       6.3          0.0
USD/TRY                  1.80        1.76        1.78      1.81         1.77      1.76        1.75    1.74       1.7         -1.9
USD/ILS                  3.71        3.85        3.90       3.95         3.90     3.85        3.83    3.83       3.9          5.9
USD/RUB                  30.6        30.8        30.3       30.6         30.4     30.4        30.4    30.4       2.5         -3.2
RUB basket               34.8        35.2        35.2       35.0         34.0     33.1        32.4    32.0       2.9         -2.8
EUR/PLN                  4.15        4.10        4.20      4.30         4.20      4.15        4.15    4.10       4.9          1.5
EUR/CZK                  25.7        26.4        26.4       26.3         26.2     26.1        26.0    25.8       2.3          2.3
EUR/HUF                   296         275         285        290          285      282         280     278       0.0         -4.1
EUR/RON                  4.36        4.60        4.65       4.65         4.60     4.55        4.52    4.50       5.7          3.8
G10 Forecasts were updated January 10, 2013 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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FX Bull/Bear Projections
                         EURUSD                                                               USDJPY                                                                    GBPUSD
 EUR/USD                                                             USD/JPY                                                              EUR/GBP

                      25 Delta Strikes                               120
                                                                                      25 Delta Strikes                                                    25 Delta Strikes
 1.50                 MS Forecast                                    115                                                                  0.95
                                                                     110              MS Forecast                                                         MS Forecast
 1.40                                                                105
                                                                     100                                                                  0.85
 1.30
                                                                      95
 1.20                                                                 90
                                                                      85                                                                  0.75
 1.10                                                                 80
                                                                      75
 1.00                                                                 70                                                                  0.65
    Dec-11          Dec-12           Dec-13           Dec-14           Dec-11           Dec-12             Dec-13         Dec-14             Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15




                         EURCHF                                                              USDCAD                                                                     AUDUSD
 EUR/CHF                                                             USD/CAD                                                              AUD/USD
 1.45                                                                1.25            25 Delta Strikes                                     1.20
                 25 Delta Strikes
 1.40                                                                1.20            MS Forecast                                          1.15
                 MS Forecast                                                                                                              1.10
 1.35                                                                1.15
                                                                                                                                          1.05
 1.30                                                                1.10                                                                 1.00
 1.25                                                                1.05                                                                 0.95
                                                                                                                                          0.90
 1.20                                                                1.00
                                                                                                                                          0.85
 1.15                                                                0.95                                                                                   25 Delta Strikes
                                                                                                                                          0.80
                                                                                                                                                            MS Forecast
 1.10                                                                0.90                                                                 0.75
    Dec-11          Dec-12           Dec-13           Dec-14            Dec-11           Dec-12            Dec-13         Dec-14             Dec-11              Dec-12            Dec-13              Dec-14



                         USDSGD                                                              USDKRW                                                                     USDTHB
 USD/SGD                                                              USD/KRW                                                             USD/THB
                                                                      1240                                                                36
 1.35
                                                                                                                                          35
 1.30                                                                 1190                                                                34      25 Delta Strikes
                                                                                                                                          33      MS Forecast
 1.25                                                                 1140
                                                                                                                                          32
 1.20                                                                 1090                                                                31
                                                                                                                                          30
 1.15                                                                 1040                                                                29
                 25 Delta Strikes                                                                                                         28
 1.10                                                                  990
                 MS Forecast                                                           25 Delta Strikes                                   27
 1.05                                                                                  MS Forecast
                                                                       940                                                                26
    Dec-11           Dec-12           Dec-13           Dec-14            Dec-11            Dec-12             Dec-13                       Dec-11       Dec-12                      Dec-13              Dec-14



                         EURPLN                                                              EURCZK                                                                     USDZAR
 EUR/PLN                                                              EUR/CZK                                                             USD/ZAR
                                                                      28
 4.90                                                                 28                                                                  12.0               25 Delta Strikes
 4.70                                                                 27                                                                  11.0               MS Forecast
 4.50                                                                 27
                                                                      26                                                                  10.0
 4.30                                                                 26
                                                                                                                                            9.0
 4.10                                                                 25
                                                                      25                                                                    8.0
 3.90
                 25 Delta Strikes                                     24           25 Delta Strikes
 3.70                                                                                                                                       7.0
                 MS Forecast                                          24           MS Forecast
 3.50                                                                 23                                                                    6.0
    Dec-11           Dec-12           Dec-13           Dec-14          Dec-11           Dec-12             Dec-13           Dec-14           Dec-11                Dec-12             Dec-13



                         USDBRL                                                              USDMXN                                                                     USDCLP
 USD/BRL                                                              USD//MXN                                                            USD/CLP
 2.70                                                                                                                                     620
                  25 Delta Strikes                                    16.00             25 Delta Strikes                                  600         25 Delta Strikes
 2.50             MS Forecast                                                           MS Forecast                                       580         MS Forecast
                                                                      15.00
                                                                                                                                          560
 2.30
                                                                      14.00                                                               540
                                                                                                                                          520
 2.10                                                                 13.00                                                               500
 1.90                                                                 12.00                                                               480
                                                                                                                                          460
 1.70                                                                 11.00                                                               440
    Dec-11           Dec-12           Dec-13           Dec-14             Dec-11          Dec-12            Dec-13          Dec-14          Dec-11 Jun-12 Dec-12 Jun-13 Dec-13                 Jun-14 Dec-14


Source for all charts: Morgan Stanley Research, Bloomberg; Shaded area is the range of market forecasts. 25 delta strikes are derived from respective implied volatility.




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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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                                                                                                  FX Pulse




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
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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2-28-13 po




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                                                         MORGAN STANLEY RESEARCH




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