Morgan stanley - JPY Correction Impact by riteshbhansali

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									                                                                         MORGAN STANLEY RESEARCH


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




         April 25, 2013                                                 Trade Recommendations
         Currencies                                                      Active Trades                          Entry           Stop       Target
                                                                         Long PLN/HUF                           72.00          71.00        75.00
Global                                                                   Long EUR/GBP                            Close at WMR on 26-Apr-13
         FX Pulse                                                        Limit Orders
                                                                         Sell EUR/NZD
                                                                                                                Entry
                                                                                                               1.5420
                                                                                                                                Stop
                                                                                                                              1.5620
                                                                                                                                           Target
                                                                                                                                           1.4820
                                                                         Sell GBP/USD                          1.5550         1.5750       1.4830
         JPY Correction Impact                                           Sell SGD/INR
                                                                         Buy RUB Basket
                                                                                                                 Enter at WMR on 26-Apr-13
                                                                                                                35.08          34.75        36.35
                                                                         Closed Options Trades             Entry Date    Expiry Date        Strike
         Focus on fundamentals. Expectations that portfolio              Long USD call/JPY put             28-Feb-13       02-Sep-13        96.00
         reallocations will provide continued support to global asset    Short USD call/JPY put            28-Feb-13       02-Sep-13       100.00
                                                                         Active Options Trades             Entry Date    Expiry Date        Strike
         markets are being scaled back in line with the less             Long USD call basket               07-Mar-13      07-Jun-13      4% OTM
         ambitious investment intentions revealed by Japanese            Long AUD call/USD put              11-Apr-13     13-May-13        1.0800
         portfolio managers over the past week. This is likely to        Long USD call/MXN put              25-Apr-13       25-Jul-13       12.22
                                                                         Long USD call/MXN put              25-Apr-13       25-Jul-13       12.80
         cause a pause in the recent liquidity-driven currency           See page 25 for more details. Changes in stops/targets in bold italics.
         market trends, especially where currencies have been
         driven away from fundamentals. Such currencies are now         MS Major Currency Forecasts
         likely to be vulnerable to negative data shocks, especially                           2Q13             3Q13            4Q13               1Q14
         given the increased market focus on fundamentals and           EUR/USD                  1.34             1.30             1.26             1.24
         growth dynamics. We put the EUR is this category of            USD/JPY                  100               103              105             106
         vulnerable currencies.                                         GBP/USD                  1.48             1.45             1.43             1.42
                                                                        USD/CHF                  0.93             0.95             0.97             0.97
         JPY correction. The more cautious approach to portfolio        USD/CAD                  1.01             0.99             1.03             1.05
         reallocation by Japanese investors leaves the JPY              AUD/USD                  1.05             1.02             1.01             0.95
         weakening trend vulnerable to a correction. While we           NZD/USD                  0.86             0.89             0.88             0.87
         expect any corrective setbacks in USD/JPY to remain            EUR/JPY                  134               134              132             131
         limited in relation to the recent steep trend, we anticipate   EUR/GBP                  0.91             0.90             0.88             0.87
         broader currency market implications to a JPY rebound.         EUR/CHF                  1.25             1.24             1.22             1.20
                                                                        EUR/SEK                  8.45             8.50             8.45             8.40
         EUR vulnerable. Negative data shocks and increased             EUR/NOK                  7.75             7.70             7.60             7.50
                                                                        Note: Forecasts for end-of-period. G10 forecasts updated March 18, 2013.
         expectations of further ECB easing measures are leaving
         the EUR vulnerable, in our view. Indeed, the EUR appears       FX Market Overview                                                           P2
         to have decoupled from the stabilisation in peripheral EMU     The Case Against EUR Mounts                                                  P8
         bond markets, and we believe there is an increased             USD: Shifting Capital Flows Key to a
         possibility that the EUR returns to its broader downtrend       Long-Term USD-Bullish View                                                 P11
         earlier than previously assumed. We maintain our               NZD: Defying the Great Monetary Easing                                      P15
         medium-term 1.26 forecast for EUR/USD.
                                                                        MXN: Positioning for Tactical Correction                                    P18
         USD optimism. We remain USD bullish on a multi-year            Positioning for China Rebalancing: Short
         basis, based on the relatively more robust economic             SGD/INR                                                                    P22
         outlook in the US, reflected in healthier household and        Strategic FX Portfolio Trade
         corporate balance sheets and more constructive cyclical         Recommendations                                                            P25
         dynamics. The changing composition of inflows to the US        G10 & EM Currency Summary                                                   P28
         is also supportive, confirming the USD as a pro-cyclical
                                                                        Global Event Risk Calendar                                                  P30
         currency rather than a counter-cyclical safe haven/funding
                                                                        FX Volatility/Carry Grids, Tactical Indicators                              P32
         currency.
                                                                        MS FX Positioning Tracker                                                   P35
         We recommend short EUR/NZD positions, with the                 FX and Macro Forecasts                                                      P36
         NZD expected to remain supported despite global easing         FX Bull and Bear Projections                                                P37
         and overall weakness in commodities, while favouring
         bearish SGD/INR strategies to benefit from market
         concerns over slowing global growth.                            For important disclosures, refer to the
                                                                         Disclosures Section, located at the end of
                                                                         this report.
                                                                    MORGAN STANLEY RESEARCH

                                                                    April 25, 2013
                                                                    FX Pulse




FX Overview
Ian Stannard, Meena Bassily                                         of increased global liquidity and a potential reallocation by
                                                                    Japanese portfolio managers could now look exposed, in our
                                                                    view, especially where currency valuations have been pushed
    Expectations of liquidity driven asset market support being
     scaled back, putting focus on fundamentals
                                                                    significantly away from underlying fundamentals.

    Currencies that have been driven away from fundamentals        Indeed, the initial indications regarding potential portfolio
     by liquidity expectations now vulnerable                       reallocation from many of the Japanese real money fund
                                                                    managers is far more cautious than anticipated by the market,
    JPY correction possible as Japanese investors take a
                                                                    with suggestions that any increases in foreign asset holding
     cautious approach to portfolio reallocation
                                                                    will be more moderate and gradual than the market had
    EUR vulnerable as fundamentals weaken and ECB rate cut         originally been anticipating. There also appears to be a
     expectations increase                                          cautious approach to any scaling back of hedging ratios at
    GBP rebound following stronger than expected UK GDP data       this stage, which will also likely come as a disappointment to
     unsustainable in our view                                      a bearish positioned JPY market.

    CHF – safe haven of funding currency?                          The volatility in Japanese markets has also moderated,
                                                                    implying that further fine-tuning of the implementation of BoJ
    EM currencies will be challenged by the soft-patch in global
                                                                    policy at this stage could be kept to a minimum and we would
     growth, and signs of weakness in China in particular
                                                                    expect little in the way of additional or new measures at the
    As such we think THB may start to come under pressure,         April 26 meeting.
     and open a recommendation to go short SGD/INR

    Elsewhere, we think currencies with high commodity             A JPY Correction
     sensitivity and heavy positioning are most vulnerable…
                                                                    This suggests that there could be some initial position
    …We take off our long MXN/JPY trade and wait for an            adjustment given the extent of long positioning in USDJPY
     attractive level to go short the RUB versus the basket         and EURJPY. The lack of new news and stalling upward
                                                                    momentum could see some profit taking, inducing a correction
                                                                    of the recent steep trends. However, we note that the
                                                                    Japanese fund managers have indicated that they would be
Broadening Divergence                                               willing to take advantage of corrections to carry out any
                                                                    reallocation, suggesting that pullbacks in USDJPY and
The divergence between liquidity driven asset markets and
                                                                    EURJPY are likely to remain limited.
underlying fundamentals has not only increased, but also
broadened, in our view. This has not only been the result of        Exhibit 1
asset markets extending gains, but fundamentals                     USDJPY and EURJPY
deteriorating as well, as highlighted by the weakness in
leading indicators of many of the major G10 economies,
consistent with the development of a soft patch, as projected
by Morgan Stanley economists. Hence, with the reduced
prospect of the reallocation of global liquidity, many of the
recent currency market trends could be vulnerable to a
correction. In this regard JPY developments will be important
for broader currency market activity.

The JPY weakening trend now looks set to pause, and we
would not rule out a near-term correction of the recent sharp
decline. However, any such correction is likely to remain
limited, with a BoJ put in place on USDJPY and many of the
JPY crosses. But there is likely to be a broader impact on          Source: Reuters Ecowin, Morgan Stanley
many of the liquidity driven currency market trends of recent
weeks/months. Currencies which have rallied on the prospect

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We would also recommend monitoring domestic asset                  EUR Exposed
markets and the Nikkei in particular. A setback in asset
                                                                   We believe that the EUR also falls into this category, which
(equity) prices could be one factor that prompts additional
                                                                   suggests that it will likely face increased challenges as the
action from the BoJ to ensure that the transmission of
                                                                   prospect of JPY liquidity, in the form of portfolio reallocations,
monetary policy is maintained. The levels of correlation
                                                                   is tempered and the economic fundamentals, especially at the
between the Nikkei and the JPY have been approaching
                                                                   core of Europe, take a renewed turn for the worse, in line with
historical highs once again, suggesting that a supported
                                                                   the global soft patch. Indeed, the vulnerabilities of the EUR
equity market will also limit the downside potential in
                                                                   have been highlighted this past week, with the EUR failing to
USDJPY.
                                                                   gain from the rebound in equity markets and the continued
However, rating agencies have been raising concerns                tightening of sovereign bond spreads. This now leaves the
regarding Japan’s fiscal position once again. This could add       EUR vulnerable to the negative growth indicators from core
to the current more cautious approach towards the JPY, but         European and Germany in particular, where both the
foreign investor participation in the Japanese bond market         manufacturing and services PMI are now below the
remains low, with foreign investor inflows to Japan more focus     boom/bust threshold. The German Ifo has also surprised
on the equity market. This suggests that there is unlikely to be   negatively. As a result ECB rate cut expectations have
much in the way of direct flow impact on JPY from a rating         increased. Our European economics team believes it is
downgrade of Japan. However, it could increase the incentive       possible that the ECB eases over the next couple of meetings
for Japanese investors to move out of their domestic bond          (see Economics and Strategy: Deciphering Draghi, April 22,
markets as risk/reward dynamics continue to shift over time.       2013). The market consensus has also switched to expecting
                                                                   a 25bps rate cut at the May 2 meeting. This appear to be a
There could be a broad near-term impact resulting from any
                                                                   function of the fact that ECB members have put increased
correction in the JPY weakening trend, with currencies that
                                                                   emphasis on the latest data, where negative surprises have
had been supported by liquidity driven asset markets starting
                                                                   been the trend over the past week.
to become exposed to deteriorating fundamentals. We have
recently been highlighting the divergence between asset            Spanish PM Rajoy also commented that EU growth this year
prices and fundamentals by using the example of the                could be worse than originally anticipated and claimed that all
divergence in performance between the liquidity driven equity      EU countries are reviewing their growth projections. While
markets and the more fundamentally driven commodity prices         equity markets are gaining on the prospect of a further policy
and how this is impacting the AUD.                                 response to the weak data, the EUR is no longer benefiting
                                                                   (see Hans’ article page 8).
Exhibit 2
EURUSD Diverging from Equity Markets (DAX)                         Exhibit 3
                                                                   EURUSD and German Ifo




Source: Reuters Ecowin, Morgan Stanley

                                                                   Source: Reuters Ecowin, Morgan Stanley




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Change in Strategy                                                 Exhibit 4
                                                                   GBP and EMU Spreads During BoE QE
This is a change in the behaviour of the EUR, and we have
adapted our trading strategy accordingly to incorporate this
new dynamic. Indeed, we note that the EUR’s correlation to
equity market performance, which had been running at
relative high levels through the end of last year and the
beginning of this year, has now loosened significantly, with
even outright divergence developing in the past week.
Meanwhile, even the narrowing of yield spreads at the
periphery of EMU is failing to provide EUR support. However,
we find that the relative performance of equity markets is still
providing a reasonably good guide, but this indicator is
currently pointing lower for EURUSD.


                                                                   Source: Reuters Ecowin, Morgan Stanley

Selling EURUSD Rebounds                                            The market is likely to scale back expectations of further BoE
We had previously been running near-term positive EUR              QE, which had been building on the possibility of a contraction
positions to take advantage of the potential reallocation flows    in growth (see UK Economics: Good preliminary 1Q GDP; No
and the general risk supportive environment as the EUR             QE (but, again, close call, April 25, 2013). This will likely
shrugged off the underlying negative fundamentals. However,        provide some initial GBP support, but given that this is likely
with question marks over the extent and pace of potential          to be driven more by position adjustment than investment
portfolio inflows, the EUR now appears to be exposed to the        inflows, we would continue to call into question the
fundamentals, just as these are weakening again. Hence,            sustainability of GBP gains.
while we would not rule further near-term EUR rebounds on          Indeed, while the scaling back of QE expectations is likely to
portfolio shifts in the coming weeks, rather than attempting to    see GBP recovering in the near term, the debate regarding
participate we would look to use any such recoveries to return     further easing measures could still return if the positive Q1
to longer term strategic bearish positioning. We reiterate our     momentum is not maintained. Certainly the most recent
longer term bearish EURUSD forecast of 1.26.                       readings from leading indicators are providing a far more
                                                                   mixed picture, with the manufacturing PMI still declining,
GBP Positive Surprise                                              although stabilisation in the services survey is evident.
We remain bearish towards GBP over the medium term                 Moreover, we would also point out the weakness in some of
despite the positive surprise from the UK Q1 GDP data.             the major international indicators, especially those in the UK’s
Although the 0.3% q/q growth means that the UK has avoided         major export markets. Chancellor Osborne has also warned
a triple-dip recession, many of the more forward looking           that the road ahead will not be smooth. The government’s
indicators are still giving less encouraging signals regarding     announcement of the extension to the FLS was in line with
the UK economy. Hence, we maintain our cautious GBP                market expectations, and with its impact still being debated,
stance and would view a near-term GBPUSD rebound as                we would not expect this to provide much in the way of further
providing a medium term selling opportunity.                       comfort to GBP at this stage.




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Exhibit 5                                                          Exhibit 6
GBP and UK Retail Sales                                            CHFJPY and S&P 500




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


GBP Gains Unsustainable…                                           CHF – A Safe Haven or Funding Currency?
We have been sceptical regarding the UK’s ability to attract       The CHF is back under pressure, with EURCHF rebounding
portfolio flows in the current environment. Indeed, GBP has        strongly. This is consistent with the signs of continued
traditionally been a pro-cyclical currency with a strong           stabilsiation in peripheral EMU and the discussion regarding
relationship to the performance of asset markets. Hence, it is     further ECB action to address the impaired monetary policy
interesting to note that GBP currently has the lowest              transmission mechanism in Europe. Indeed, we believe
correlation to the performance of equity markets among the         investors will be increasingly questioning the CHF’s status – is
G10 currencies, consistent with the lack of participation in the   it a safe haven or a funding currency? There are signs that
recent liquidity driven asset market recovery. The recent UK       the CHF’s role as a safe haven is no longer being used. Such
sovereign rating downgrades by Fitch also undermine the            a change in status away from a safe haven to a funding
attractiveness of GBP as an investment destination,                currency will generate a significant market reaction. The CHF
especially for longer term real money mangers looking for          is already the weakest G10 currency over the past few days.
higher rated assets.
                                                                   Moreover, the Swiss leading indicators have also started to
                                                                   weaken in line with the softness in core EMU, and Friday’s
…Providing GBPUSD Selling Opportunity
                                                                   release of the Swiss KoF will also be important. Hence, it is
A lack of portfolio inflows into the UK is likely to deprive GBP   interesting that the negative data from Europe is generating a
of one important source of support, and those looking for          bearish CHF response, again consistent with the view that
support from other sources could be equally disappointed.          safe haven flows are not developing. USDCHF is now testing
The role of GBP as a safe haven has also diminished. Indeed,       the upper end of the major descending channel, currently at
with peripheral EMU markets stabilizing (spreads are record        0.9505, while moving averages are giving bullish USDCHF
narrow levels in some cases), inflows from this source are         signals. A move above the 0.9505 level will open the way for
also expected to remain at muted levels, especially given the      gains towards 0.9660 and 0.9700 initially. We also note that
renewed focus on the UK’s rating and the lack of yield.            CHFJPY has reached the upper end of its 20-year trading
Although a renewed overseas investor inflow into the gilt          range.
market was seen in February, we would view this is as likely
to have been temporary. We believe that the GBPUSD                 USD Driven by Growth
rebound from the 1.4830 mid-March low is likely to run out of
                                                                   The focus is back on growth, and as a result the US GDP
steam in the 1.5550 area, where we would reconsider bearish
                                                                   data for Q1 will be important for the medium term outlook of
strategies. We also maintain our 1.43 year-end forecast.
                                                                   the USD. Indeed, the US growth data (due April 26) is
                                                                   expected to continue to show a relatively robust picture
                                                                   compared to the rest of the G10. Although the more forward


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looking data from the US has been more mixed recently, this        Exhibit 7
has helped to dampen the tapering debated, maintaining the         CNY Curve Flattening and Declining PMIs
favourable asset market conditions. Hence, with relatively
better growth dynamics and continued supportive policy, we          200                                                         59
expect the USD’s relative attractiveness as an investment                                                                       57
destination to be maintained. Indeed, during the portfolio          150
reallocation debate the US was at the forefront with US asset                                                                   55
markets, being the outperformers among the major develop            100                                                         53
markets since the beginning of the year. We remain USD
bullish over the medium term.                                         50                                                        51

                                                                                                                                49
Scaling Back on Growth Sensitive EM Currencies                         0
                                                                                                                                47
A pause/near-term correction is something we are also
increasingly wary of across the EM currency universe. Indeed,        -50                                                         45
with the global economy still struggling through a ‘soft-patch,’       Apr-09     Apr-10    Apr-11              Apr-12      Apr-13
as evidenced by weak PMI readings across both EM and DM                      CNY NDIRS 1s5s                     China PMI (RHS)
earlier in the week, we recommend cautious trading in EM           Source: Morgan Stanley Research, Bloomberg
currencies. As such we have scaled back some of our key
                                                                   As such, we like to use SGD to fund long INR positions, as we
bullish calls such as THB and MXN, as we explain in more
                                                                   see an increasingly compelling case to add long exposure to
detail below.
                                                                   INR. Indeed we expect INR to be one of the key beneficiaries
We see China’s part in the ‘soft-patch’ as particularly            of lower commodity prices, as prices of India’s largest imports
concerning. Even with the weak data flow in China of late,         – oil and gold – decline. This adds to improvements we have
markets appear to be pricing relatively tight domestic liquidity   already started to see in India’s macro indicators, and we
conditions. The spike in 7d SHIBOR this week is largely            remain encouraged by scope for further structural economic
seasonal and likely to normalise after month-end, but the          reform. We think this trade also provides a good platform to
PBoC has been draining liquidity lately via OMOs. Most             play for the rebalancing dynamics we envisage in China (see
notably, the IRS curve has been flattening in recent weeks         Positioning for China Rebalancing: Short SGD/INR article,
(see Exhibit 7), signaling a moderation in growth and inflation    page 22).
ahead. 1y1y is also relatively steady – and CNY fixings versus
                                                                   Elsewhere in Asia, we see THB as particularly vulnerable.
the USD have been setting lower, to 6.23. This leads us to
                                                                   The Thai baht has been one of the best performing EM
believe that we might see more policy-engineered macro
                                                                   currencies so far this year. Inflows into the country’s bond
moderation, which does not bode well for the commodity
                                                                   market have been accelerating, while retail flows from Japan
complex or the global growth impulse.
                                                                   into THB-denominated assets have grown by more than any
This dynamic suggests taking short positions on those              other EM currency since the beginning of the year. To the
currencies that are particularly exposed to slowing growth in      extent that JPY weakness has been responsible for any of the
China. We think TWD and SGD stand out. Indeed, SGD is              pick-up in retail flows into THB since the beginning of the
likely to come under pressure given its hefty exposures to         year, the temporary stabilisation of the JPY that our G10 FX
China and weak growth-related data, and also as the NEER           strategy colleagues expect raises the risk that this inflow
trades to the top of MAS’s trading band. In addition, we think     could slow. With THB valuations arguably stretched, the rising
SGD makes for a good funding currency in AXJ given its             risk of measures from the BoT to curb THB strength and the
negative carry and good liquidity.                                 prospect of stabilisation in USD/JPY, we think the risk/reward
                                                                   is now tilted towards tactical long USD/THB positions. We
                                                                   look for a move to 29.50, and see risks tilted toward a break
                                                                   higher from here.

                                                                   Outside of Asia, we see the currencies that are most
                                                                   vulnerable as those that have seen a heavy build up in
                                                                   positioning over the past few months, and/or, those that have


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a particularly high level of sensitivity to commodities. MXN     Correction article, page 18). In Russia, we think momentum
and RUB fall into this camp. First in Mexico, we think long-     could benefit the currency in the very near term, but we
side positioning in Mexican local markets is heavy, and          ultimately see an increasingly bearish story on RUB – related
progress on structural reform is well priced-in. This suggests   to both the decline in commodity prices and the direction of
the rally in the currency is vulnerable to any more corrective   monetary policy. Therefore, we wait for an attractive level to
price action across global risk markets related to any further   go short the RUB against the basket (see Trade
deterioration in global growth conditions. As such we pare       Recommendations section).
back our long MXN/JPY recommendation in anticipation of a
near-term consolidation (see MXN: Positioning for Tactical




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The Case Against EUR Mounts
Hans Redeker and Dara Blume                                          hedged, especially when the yield curve is steep, making
                                                                     prices for hedge structures attractive. This suggests that
                                                                     tighter spreads did not drive EUR higher on their own – rather
    We have long maintained a view that EUR would begin a
     structural decline in 2H13 – but there are growing risks that
                                                                     the correlation between tighter spreads and stronger equity
     this shift occurs sooner rather than later.                     markets gave extra support to EUR. When bond spreads
                                                                     narrowed, equity markets rallied and vice versa. We based
    Peripheral bond market spreads have decoupled from              our call for EUR support over the summer months on the
     EUR/USD, and no longer trade in line with risk appetite.
                                                                     assumption that this relationship continued, with tighter
    European equity markets have underperformed other               spreads leading to an equity market rally, and a temporary
     regions, even with the current global liquidity backdrop,       EUR rebound.
     suggesting that EMU faces cyclical headwinds.
                                                                     Exhibit 1
    Weakening global growth also poses an obstacle to               EURUSD Has Decoupled from Yields…
     EUR/USD…
                                                                      10 yr spread over Bund, bp, Inverted Scale
    …as well as to the German economy.                               100                                                       1.50
                                                                                   Spain      Italy     EURUSD (RHS)
    German economic weakness is particularly worrisome for           200                                                       1.45
     EUR, as it reduces opposition to rate cuts in the ECB…
                                                                      300                                                       1.40
    …and increases the chance that Germany undertakes
     private structural reforms that widen the intra-EMU              400                                                       1.35
     competiveness gap.
                                                                      500                                                       1.30
    All in all, risks to EUR are mounting.
                                                                      600                                                       1.25

                                                                      700                                                       1.20
Until now, we have been calling for EUR to trade higher over            Jun-11            Dec-11            Jun-12   Dec-12
the next quarter. However, recent market developments have           Source: Bloomberg, Morgan Stanley Research
made us more cautious on EUR, and we now see substantial
                                                                     However, EMU financial data have provided mixed signals
downside risks to the common currency. While peripheral bond
                                                                     over recent weeks. Before the introduction of the OMT, which
spreads have continued to narrow, they have failed to support
                                                                     effectively positioned the ECB as a ‘lender of last resort’, EMU
EUR. Furthermore, the underperformance of the euro area
                                                                     sovereign credit spreads were tightly linked with the
equity market suggests that EMU faces cyclical headwinds,
                                                                     performance of local equity markets. Furthermore, tighter
even in an environment of a global growth soft patch, which on
                                                                     bond spreads generally translated into stronger business
its own should weigh on EUR. Indeed, softening in global
                                                                     sentiment within the euro area, also supporting EUR/USD.
growth has impacted German trade and forward-looking
indicators, suggesting that German resistance to rate cuts could     This is no longer the case. Over the past few weeks EMU
fade (see Deciphering Draghi, April 22, 2013). A slowdown in         equity markets have not only declined in absolute terms, but
German growth, particularly in the export sector, could lead to      also grossly underperformed the US equity markets.
competitive reforms in the private sector, which while at first      Business sentiment has also failed to receive support, with
glance are EUR-positive, could increase the divergence               PMIs declining even as spreads tighten. Finally, while
between the core and the periphery within EMU, which is EUR-         peripheral sovereign funding costs have come down, this has
negative in the long run. As all these factors come to the           not translated into better funding costs for the private sector,
forefront, we see significant risks to EUR upside.                   and bank lending remains weak. As each of these measures
                                                                     has declined individually, the effect has spiralled as well, with
Bond Markets Have Failed to Support EUR/USD                          weak bank lending accelerating the decline in equity markets
                                                                     and business sentiment, and vice versa. As a result, bond
Over recent weeks, we have seen a break in the EUR/USD
                                                                     spreads have further decoupled from EUR/USD (see Exhibit
trading pattern. Until recently, EUR/USD traded in step with
                                                                     1), with the declines in peripheral yields not matched by gains
peripheral bond spreads, as can be seen in Exhibit 1.
                                                                     in EUR. This suggests that tighter sovereign spreads, on their
However, while bond spreads have come in, EUR has failed
                                                                     own, are no longer sufficient to lead EUR/USD higher.
to make gains. Of course, bond inflows are typically currency-

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Exhibit 2                                                                 Tracker, April 8, 2013), bankers will focus even more now on
…as Tighter Spreads Have Not Helped EMU                                   improving the quality of balance sheets, and will reduce
Shares…                                                                   balance sheets, including loans.

 10 yr spread over Bund, bp, Inverted Scale                               Second, in the past, wider bond spreads raised concerns
 100
                Spain                                               2.2   about the availability of safe assets for banks, calling bank
                Italy
 200            Relative EU-US Equity Market (RHS)                        asset quality into question, and leading to balance sheet
                                                                    2.1
                                                                          contraction. However, as bond spreads have narrowed, this
 300                                                                2
                                                                          has not led to a reversal in bank balance sheet contraction, as
 400                                                                1.9   banks have other low-quality assets on their balance sheets.
                                                                    1.8   In an environment of deleveraging, and in the absence of a
 500
                                                                    1.7   comprehensive banking union, poor asset quality is likely to
 600                                                                1.6
                                                                          keep banks from expanding their loan books. Subsequently,
                                                                          the link between private and public sector funding costs
 700                                                                1.5
                                                                          breaks down. This breakdown has increased the divergence
   Jun-11            Dec-11           Jun-12       Dec-12
                                                                          between equity and bond markets, and has also led economic
Source: Bloomberg, Morgan Stanley Research
                                                                          sentiment indicators to disappoint. The slowdown in
Exhibit 3                                                                 economic data has also fed through to even more
…or Supported Business Confidence                                         underperformance in the equity markets.
                                               BP, Inverted Scale
 60                                                                 50    Declining Equity Markets Lead to Declining EUR

                                                                    150   The underperforming equity market has widespread currency
 55                                                                       implications, as it could be a sign of the cyclical position of the
                                                                    250   EMU economy. A decline in share prices can be caused by
 50                                                                       weakening earning expectations or softening liquidity
                                                                    350   conditions. On the latter, it’s true that excess liquidity in the
 45                                                                       Eurosystem has fallen to €370 billion from over €600 billion at
             EMU PMI                                                450   the start of the year. However, our interest rate strategists
             Italian Spreads (RHS)                                        have highlighted that EONIA should not be impacted so long
 40          Spanish Spreads (RHS)                                  550
                                                                          as excess liquidity remains above €150 billion (see ECB
  Jan-10          Oct-10         Jul-11        Apr-12   Jan-13            Tender Tracker, April 19, 2013). Moreover, global liquidity
Source: Bloomberg, Morgan Stanley Research                                conditions remain ample, with the BoJ promising to double its
EMU policy adjustments have contributed in driving a wedge                monetary base within two years. Hence, it is unlikely that
in the performance of peripheral bond and equity markets.                 liquidity conditions have caused the underperformance in
The ECB’s OMT has reduced tail risks for bond investors,                  European equity markets. Instead, the weak equity market
while the Cyprus deposit bail-in has increased non-sovereign              performance might signal a deterioration in the cyclical
bond capital market risks within an environment of the                    position of EMU’s economy.
weakening growth.
                                                                          Weaker Global Growth, Weaker EUR
However, it is not only the divergence between peripheral
bond markets and equity markets that explains the lack of                 Equity market underperformance comes at a time of
support for EUR. The decline in sovereign funding costs has               disappointing global growth across the board. In the US,
failed to filter through into falling private sector funding costs        fiscal uncertainty and effective spending cuts have called the
in peripheral countries. The link between sovereign bond                  US recovery into doubt, causing our surprise indicator to fall
prices, bank balance sheets and bank credit seems to have                 abruptly from its February highs. Meanwhile, sluggish Asian
weakened. There are two reasons to mention for this. First,               export data have become the norm, and despite strong capital
the deposit bail-in used in Cyprus provided a stark warning for           inflows and credit creation in China, economic indications
depositors in weaker banks. While data do not yet show                    have continued to come in weak. Generally, EUR trades in
substantial deposit shifts (see European Loans and Deposits               line with global growth, as can be seen in Exhibit 4.



                                                                                                                                           9
                                                                      MORGAN STANLEY RESEARCH

                                                                      April 25, 2013
                                                                      FX Pulse




Exhibit 4                                                             German Performance Leads EUR
Weakening PMI Does Not Bode Well for EUR
                                                                      The consequences from weaker German growth also pose a
                                                                      risk to EUR. Some suggest that underperformance in
  4         G10 Weighted PMI - 3 M Change          EURUSD 1.5
                                                                      Germany could be good for the eurozone, as it reduces
  3                                                          1.45     resistance against additional expansionary measures. If the
  2                                                                   strongest EMU economy rolls over, this should lower core
                                                             1.4      EMU inflation risks, allowing the ECB to cut rates more
  1
                                                             1.35     aggressively. Hence, weaker German data often translate into
  0                                                                   an immediate bearish EUR reaction.
                                                             1.3
 -1                                                                   There are other reasons to believe that poor German export
 -2                                                          1.25     performance could weigh on German growth. Germany has a
 -3                                                          1.2      long and successful tradition of increasing competitiveness
                                                                      via private sector reform which decreases unit labour costs,
  Jan-09 Oct-09 Jul-10 Apr-11 Jan-12 Oct-12
                                                                      thereby pushing the real effective exchange rate down.
Source: Bloomberg, Morgan Stanley Research
                                                                      Reforms are often used particularly in response to lagging
Indeed, global growth has become weak enough to weigh on              foreign demand. Should Germany undergo such reforms
German export performance, with export orders shrinking for           again, the internal devaluation that would result could
the first time since 2009. Germany is one of the countries            increase the competitiveness gap in the eurozone once again.
most exposed to global trade within EMU, with 58% of its
                                                                      Outside the spectrum of managing the nominal exchange
exports sent outside the currency zone. Interestingly, we
                                                                      rate, there is little that EMU policy-makers can do to avoid the
calculate Germany’s fair value EUR/USD exchange rate at
                                                                      German private sector from supporting its exporters by
1.53, thus far above the current market price. It seems that
                                                                      undertaking structural reforms to boost competitiveness. The
global growth has slowed to a degree where even the
                                                                      economy is privately organized and when corporate
competitive Germany is failing to generate net income abroad.
                                                                      management decides to give productivity-enhancing
This is concerning, as with domestic credit growth soft and
                                                                      measures another go, the government – especially in an
government spending limited due to austerity, EMU needs to
                                                                      election year – will not stand against this approach.
grow externally. Weak global data suggest that EMU will find
                                                                      Therefore, the path of least resistance for EUR is lower.
it very difficult to generate income from abroad, given current
EUR levels, and indeed, even Germany is struggling to do so.
Hence, EUR should trade lower.
                                                                      Conclusion
                                                                      The case against EUR is slowly mounting. While we have
Exhibit 5
                                                                      long maintained a view that EUR would begin its decline in
EMU Exports: Outside and Inside the Eurozone
                                                                      2H13, the risks are rising that this begins sooner rather than
                        Exports Share of Exports   Share of Exports
                                                                      later. Peripheral bond markets no longer trade like a risky
                     (% of GDP)          to EMU     Outside of EMU
Belgium                   89.8%           61.0%              39.0%    asset class, but rather, with the support of the OMT, have
Netherlands               78.2%           62.6%              37.4%    regained their fixed income characteristics. We expected
Ireland                   54.7%           40.4%              59.6%    continued bond market inflows to keep EUR strong over the
Austria                   41.1%           55.3%              44.7%    summer months, but the breaking link between peripheral
Germany                   38.6%           42.0%              58.0%
Portugal                  24.9%           64.2%              35.8%
                                                                      bonds and the equity market, combined with the weak global
Italy                     23.5%           43.3%              56.7%    economic picture and its impact on the German economy,
France                    21.1%           49.1%              50.9%    have weakened EUR. The chance of a summer EUR rally
Spain                     20.3%           54.3%              45.7%    has become slimmer and would require EMU equity markets
Greece                    10.7%           35.2%              64.8%
Source: Haver Analytics, Morgan Stanley Research
                                                                      to catch up to US markets, as well as a rebound in global
                                                                      growth signals. Weak global and EMU leading indicators
                                                                      suggest to us that EUR/USD could fall back to 1.2650 over
                                                                      the next month or so.




                                                                                                                                   10
                                                                       MORGAN STANLEY RESEARCH

                                                                       April 25, 2011
                                                                       FX Pulse




USD: Shifting Capital Flows Key to a Long-Term USD-Bullish View
Gabriel de Kock                                                        increasingly clear that currency depreciation is key to
                                                                       economic revival in the euro area, Japan and the UK. And
                                                                       the G10 commodity currencies face longer-term challenges
    Our multi-year USD-bullish stance is partly made in the USA,
     reflecting a more advanced post-crisis recovery in household
                                                                       from supply-driven downward pressure on commodity prices
     and bank balance sheets, healthy corporate financials, a          after the peak of the super-cycle and a sharp decline (and
     constructive cyclical dynamic and opportunities created by        possible reversal) in EM FX reserve accumulation.
     the shale oil & gas revolution.
                                                                       Our analysis of medium-term economic fundamentals implies
    Our USD optimism, in part, also reflects weak economic            that the US has become a more attractive investment
     fundamentals elsewhere. It is increasingly clear that             destination than its largest G10 peers and will attract
     currency depreciation is key to economic revival in the euro      substantial capital inflows over time. But, it’s not just the
     area, Japan and the UK.                                           volume of capital inflows and outflows that matters; it also is
    Our USD call implies that the USD is a pro-cyclical               whether capital flows are currency-hedged, which depends in
     investment currency rather than a countercyclical safe            part of the equity-fixed income short-term-long-term mix of
     haven/funding currency.                                           capital flows. On this front, a significant USD-supportive shift
                                                                       is underway. As a result, we expect the pro-cyclical USD
    Shifts in the pattern of global capital flows are key to a new
     procyclical USD dynamic. Historically the US has been an
                                                                       price action of the past decade – appreciation when economic
     importer of fixed-income capital, in part reflecting the USD’s    activity accelerates and depreciation during economic
     role as a reserve currency, and an exporter of equity capital.    slowdowns -- to give way to the procyclical swings of the pre-
                                                                       2002-period.
    Fixed-income inflows into the US are declining and do not
     buoy the USD because relatively low short rates around the
                                                                       Let’s Get Pro-Cyclical
     world incentivize foreign investors to FX-hedge their
     positions in US fixed income.                                     A call for USD appreciation amid a gradually improving global
    Equity capital outflows were pro-cyclical and largely not FX-     growth environment has to confront the counter-cyclical USD
     hedged, weakening the USD when growth accelerates, but            price action ingrained in investors’ minds by the post-2001
     improved US investment opportunities are reversing the            experience. And, as Exhibit 1 shows, there is no strong
     historical pattern.                                               evidence as yet that the USD is reverting to the counter-
                                                                       cyclical dynamic seen in 1995-2001: Broadly speaking, the
    Short-term capital flows, which dominated FX price action
     after the global financial crisis, boosting the USD in risk-off
                                                                       USD gains coincided with a significant slowdown in global
     environments and undercutting it in periods of market             industrial production.
     optimism, have fallen off sharply.                                Exhibit 1
                                                                       USD Still Looks Counter-Cyclical: World IP and USD
                                                                       Index (Yr/Yr % Chg), 1991-Mar 11
Structurally USD Bullish                                                 15                                                                      -20
We anticipate substantial USD appreciation against the G10                                                                                       -15
                                                                         10
currencies as the US leads the G10 economic recovery over a                                                                                      -10
two- to three-year forecast horizon. USD gains within the G10              5                                                                     -5
more than fully offset moderate longer-term depreciation                                                                                         0
                                                                           0
against the currencies of faster-growing EM economies.                                                                                           5

Our USD-bullish stance is partly “made in the USA,” reflecting            -5                                                                     10

a more advanced post-crisis recovery in household and bank                                                                                       15
                                                                        -10              Global IP (Left)
balance sheets, healthy corporate financials, a constructive                                                                                     20
                                                                                         Narrow Nominal $ (Right, Inverted)
cyclical dynamic, and opportunities created by the shale oil &          -15                                                                      25
gas revolution. But, it also reflects cyclical and structural                  91   93    95   97    99     01     03   05   07   09   11   13
economic challenges elsewhere in the G10. It is becoming               Source: Haver and Morgan Stanley Research




                                                                                                                                                 11
                                                                   MORGAN STANLEY RESEARCH

                                                                   April 25, 2013
                                                                   FX Pulse




                                                                   Exhibit 2
Proponents of a pro-cyclical dollar turn often point to the
breakdown in the tight relationship between the USD and            But the USD Has Decoupled From Equities: USD Index
                                                                   and S&P500, 2009-April 24, 2013
equity prices at the start of 2012. Since then, the broad
                                                                    100                                                                            600
S&P500 rally has coincided with gradual, if irregular, USD
appreciation. However, this breakdown is not a foolproof                                                 USD Narrow TWI (Left)
                                                                      95
                                                                                                                                                   800
signal. The longer time series of three-month correlations                                               S&P 500 (Right, Inverted)
between daily percent changes in the narrow trade-weighted            90
                                                                                                                                                   1000
USD and the S&P500 index remains negative (Exhibit 3).                85
The correlations also change sign frequently and do not, with                                                                                      1200
the exception of the period since 2009, consistently signal           80
pro- or counter-cyclical USD valuation changes. We have to                                                                                         1400
                                                                      75
base the case for a pro-cyclical USD on fundamental grounds.
                                                                      70                                                                           1600
It’s Not Only Size That Matters                                        Jan-09     Oct-09      Jul-10      Apr-11    Jan-12        Oct-12
                                                                   Source: Bloomberg and Morgan Stanley Research
Long-term capital inflows have over-funded the US current
                                                                   Exhibit 3
account deficit over the past 20 years, with the exception of
the 4Q08-3Q09 when the global financial crisis played havoc        Correlations Not the Last Word: 3-Mth Moving Correlation
with cross-border capital flows. Indeed, net long-term inflows     of Narrow USD Index with S&P500, 1995- Apr 13
over-funded the current account deficit for well over half of        0.6                                                                               0.6
this time period. Despite this evident stability in the US
                                                                     0.4                                                                               0.4
international funding position, the USD trended higher from
early 1995 until February 2002, rising near 40% cumulatively         0.2                                                                               0.2

against the G10 currencies on a trade-weighted basis and             0.0                                                                               0
subsequently falling about 38% by August 2011.
                                                                    -0.2                                                                               -0.2
FX analysts often hold as an article of faith that a currency
                                                                    -0.4                                                                               -0.4
eventually will if rise long-term capital inflows over-fund its
international borrowing needs. But, the USD experience              -0.6                                                                               -0.6
underlines that the magnitude of capital flows is not enough to     -0.8                                                                               -0.8
determine currency direction, it also is crucially important               95     97     99    01        03    05    07       09        11    13
whether the flows are FX-hedged or not. Long-term capital
                                                                   Source: Bloomberg and Morgan Stanley Research
inflows that over-fund the current account deficit, as has been
                                                                   Exhibit 4
the case in the US since the beginning of 2010, will have little
impact on the currency if the flows are FX-hedged and would        US Current Account Deficit and Long-Term Capital
be supportive if not hedged.                                       Inflows (USD Bn, 4-Quarter Sum), 1991-Mar 13E
                                                                    1400               Long-Term Portfolio Inflows                                 1400
Whether capital flows are FX-hedged depends in part on the
composition of capital flows and in part on market conditions.      1200               Net Long-Term Inflows                                       1200
Equity investors and retail investors tend to hedge much less       1000               Current Account Deficit                                     1000
actively than their counterparts in the fixed-income universe.
                                                                      800                                                                          800
Fixed-income investors typically run active FX overlay
programs, basing their hedging decisions on Libor spreads             600                                                                          600
and relative yield curve slopes.                                      400                                                                          400
A USD-Positive Shift in the Composition of Capital Flows              200                                                                          200
We have argued before that trends in the composition of US               0                                                                         0
capital inflows and outflows, not just their levels, have played     -200                                                                          -200
a key role in USD performance over time (see USD Outlook:                    91   93    95    97    99    01   03   05       07    09    11   13
Growth is Not Enough, February 17, 2011). And we see
                                                                   Source: Haver and Morgan Stanley Research estimates (E)



                                                                                                                                                           12
                                                                    MORGAN STANLEY RESEARCH

                                                                    April 25, 2013
                                                                    FX Pulse




                                                                    Exhibit 5
mounting evidence of a USD-supportive shift in the make-up
of international capital flows from and into of US (see Setting     USD-Supportive Shift in US Long-Term Capital Flows (4-
the Stage for USD Strength, Part I and Part II).                    Quarter Sums, $Bn), 1970-2010
                                                                     1000             Fixed Income Net Inflow                                         1000
The US has consistently been a net recipient of fixed-income
inflows since the early 1990s, in part reflecting the USD’s role                      Equities & FDI Net Inflow
                                                                       800                                                                            800
as a reserve currency. In contrast, the US with the exception                         Adjusted for HIA
of the 1997-2002-period, and briefly in 2006, has been a net           600                                                                            600
investor of equity capital (equity portfolio investments and           400                                                                            400
foreign direct investment) abroad (Exhibit 6).
                                                                       200                                                                            200
Robust US growth and strong productivity performance in the
late 1990s and early “naughts” drove strong US equity market              0                                                                           0
performance culminating in the dotcom bubble. During this
                                                                      -200                                                                            -200
period the US markets attracted large equity capital inflows
that, since cross-border equity capital flows largely are             -400                                                                            -400
unhedged, in turn fueled a powerful USD rally. Weak US                         91 93 95        97 99 01 03             05 07 09 11               13
growth also was associated with USD strength as capital             Note: The academic consensus is that HIA flows into the US primarily came from “trapped
                                                                    cash” held overseas in USD, and consequently had little impact on the USD.
sought a safe haven in the US markets amid slowing global           Source: Haver and Morgan Stanley Research.
economic activity. In short, the USD performed well in weak-        Exhibit 6
and strong-growth environments, and poorly otherwise when           Attractive to FX-hedge Long-Term Fixed Income
capital inflows slowed. This pattern has become known as            Investments in the US
the “dollar smile.”
                                                                      3                                                                                   3
Starting in 2002, US portfolio managers have aggressively             2                                                                                   2
diversified into foreign (notably EM) equity markets to
capitalize on a significant improvement in EM macroeconomic           1                                                                                   1

fundamentals. At the same time, US companies poured                   0                                                                                   0
money into direct investments abroad, largely to take
                                                                     -1                                                                                   -1
advantage of opportunities created by China’s accession to
the WTO in 2001. FX reserve managers facing steep                    -2                                                                                   -2
increases in EM FX reserves and foreign money managers               -3
                                                                                         US-G10 Trade Weighted 10S-2S Slope Spread
                                                                                                                                                          -3
searching for yield invested heavily in US fixed income                                  US-G10 Trade-Weighted 3m Libor Spread
(including agencies and MBS).                                        -4                                                                                   -4
                                                                          91    93    95    97     99     01     03     05    07     09     11     13
With US investors and corporates increasing their offshore          Note: Starting in January 2007 the EMU average bond yields are for AAA-rated sovereigns.
                                                                    Source: Haver and Morgan Stanley Research.
equity exposure as strong economic growth boosted EM
equity market performance and profits, the USD depreciated          government bond yield spreads will remain tight as central
steadily (if unevenly) amid strong global growth from 2002-08,      banks seek to support economic activity and practice financial
a trend that continued after interruptions by the global            repression to tacitly support government budgets (Exhibit 6).
financial crisis and the first phase of the EMU debt crisis.        Investors increasingly are tilting away from US government
                                                                    bonds to corporate securities in response to stronger
A fundamental shift in the USD dynamic and the composition
                                                                    corporate balance sheets and deteriorating fiscal
of US international capital flows appears to have taken hold in
                                                                    fundamentals.
2011. The pace of fixed-income inflows into the US dropped
off sharply, in part reflecting yield compression across the        We also believe a rotation into US equities from the G10-ex-
G10 and in part the sharp slowdown in the pace of EM                US is underway. This shift is the response to stronger US
reserve accumulation. At the same time net equity capital           cyclical fundamentals reflecting significantly more advanced
outflows slowed notably.                                            post-crisis household and financial-sector balance sheet
                                                                    repair and strong nonfinancial corporate financial positions in
The shift in the pattern of US international capital flows likely
                                                                    the wake of aggressive crisis-related cost-cutting. The shale
will persist, and even accelerate, in coming years. Core G10
                                                                    oil and gas revolution also promises attractive investment

                                                                                                                                                          13
                                                                    MORGAN STANLEY RESEARCH

                                                                    April 25, 2013
                                                                    FX Pulse




                                                                    Exhibit 7
opportunities in the US energy sector and in energy-intensive
sectors that will benefit from cheap oil and gas.                   US Short-term Capital Inflows (USD Bn, 12 Month Sum)
                                                                    and Yr/Yr Change in the Broad USD TWI, 1991-Jun 11
In contrast, the fallout from aggressive fiscal austerity and the
                                                                      400                                                                     15
sovereign debt crisis caps corporate earnings prospects in
Europe. And, rapidly growing mining capacity signals the end          300
                                                                                                                                              10
of the commodity super-cycle presaging a significant
                                                                      200
slowdown in capital flows to G10 and EM commodity-                                                                                            5
producing economies.                                                  100

Improved cost competitiveness should slow the pace of off-               0                                                                    0
shoring of US manufacturing capacity and the related FDI             -100
                                                                                                                                              -5
outflows. Thus, while we see sustained US capital outflows
                                                                     -200
driven by the trend diversification into structurally faster-
                                                                                   Short-Term Capital Inflows (Left Axis)                     -10
growing EM economies, we expect the US to be a net                   -300
                                                                                   Broad Trade-Weighted USD (Right Axis)
recipient of equity capital flows in coming years.                   -400                                                                     -15
Cost Fundamentals Favor FX Hedging                                           91   93   95    97    99   01      03   05   07   09   11   13
                                                                    Source: Haver and Morgan Stanley Research
Narrow yield differentials already have undermined the
relative attractiveness of US fixed income assets, as shown         term safe-haven inflows drove the USD surge during the
by the rapid flattening of the US Treasury yield curve relative     global financial crisis, and their reversal the USD retracement
to a trade-weighted average of government bond curves               in 2009-11. But, the volume and volatility of short-term capital
elsewhere in the G10 (Exhibit 6). In addition, cost                 flows have diminished significantly. And, improvement in the
fundamentals favor currency-hedging existing and new                global risk climate (and reduced systemic vulnerability
positions in the US fixed-income market. The US 3-month             associated with gradual advances on private- and public
Libor rate is low relative to short-term interest rates elsewhere   sector balance sheet consolidation) suggests that short-term
in the G10 implying that short-term FX hedging via forwards is      flows will be a lesser FX driver in coming years, much like the
essentially free. And we do not foresee a significant shift in      experience over the 1991-2006 period. If this hypothesis
this pattern before the FOMC starts tightening policy in 2015.      turns out to be correct, net equity capital inflows should
                                                                    emerge as the predominant USD driver, fueling a multi-year
Hot Money Flows                                                     rally against the G10 currencies.
A final USD-positive capital flows development can be seen in
net short-term capital flows. As illustrated in Exhibit 7, short-




                                                                                                                                              14
                                                                       MORGAN STANLEY RESEARCH

                                                                       April 25, 2013
                                                                       FX Pulse




NZD: Defying the Great Monetary Easing
Sung Woen Kang, Economist (44 20) 7425 8995                            The Economy Is Looking Better
Evan Brown, CFA (212) 761-2786
                                                                       GDP growth exceeded consensus expectations at 1.5%Q in
                                                                       4Q12, as all industries posted positive quarterly growth with
    Despite sluggish growth and inflation, the RBNZ is unlikely to    the exception of manufacturing. Merchandise exports held up
     cut rates, in our view. Concerns about a potential run-up in      in February, rising 8.0%Y, as dairy products saw continued
     housing prices and excessive credit growth will likely keep       demand. In addition, new dwelling consents reached their
     the RBNZ on hold until an eventual hike in 1Q14.
                                                                       highest level since May 2008 and monthly net long-term
    NZD trades at a premium because of its stable ratings,            migration continued to increase. Inflation declined marginally,
     relatively high real yields and low probability of FX             to 0.86%Y (0.4%Q) in 1Q13, below the 1-3% target range for
     intervention.                                                     the fourth consecutive quarter, but the RBNZ expects inflation
    We favour NZD longs despite concerns over weakness in the         to pick back up to target; hence, we believe that it is unlikely
     commodity complex.                                                to change its stance. Growth is higher, inflation lower and real
                                                                       rates are still relatively expansionary.

                                                                       Furthermore, the factors listed as contributing to a dampened
The RBNZ left the OCR unchanged at 2.50% at its April 24               growth outlook exaggerate the need for further easing in the
meeting, and Governor Wheeler reiterated that rates will likely        short term, in our view.
remain on hold at 2.50% through year-end. We believe that                      According to the RBNZ, the Household Labour Force
the RBNZ will continue to defy the Great Monetary Easing                        Survey overstates the degree of labour market weakness
theme despite an uneven domestic recovery and the global                        due to the methodology and quality of its surveys.
economy lingering in twilight.
                                                                               Fiscal consolidation to the tune of 3.2% of GDP over the
There is no doubt that New Zealand’s recovery has been                          next four years is a significant force, but will mainly be
uneven, for four reasons: i) A struggling labour market; ii)                    concentrated in 2014 and 2015, and could even be
Fiscal consolidation; iii) A strong NZD weighing on both                        delayed if needed, given modest public debt.
exports and inflation; and (iv) A drought that damaged growth.
                                                                               A quick look at the divergence in economic growth
In addition to the dampened domestic outlook, recent global                     between New Zealand and its main currency partners
economic data have been tracking below expectations in                          puts the strong NZD into perspective and even suggests
some important parts of the global economy. China’s 1Q GDP                      scope for further strength (see Exhibit 1).
deceleration and weak US manufacturing and employment
prints, among others, affirmed the soft patch our Global                       Worsening drought conditions are likely to ease, as the
Economics team forecast for 1H13. Commodity prices have                         winter season (June-August) typically brings more rain in
also seen some sharp declines, meaning weaker terms of                          the northern and central parts of the island.
trade and lower global headline inflation in the near term.            Exhibit 1
                                                                       Economic Growth Divergence
GME3 in Full Swing
                                                                                                              GDP QoQ% saar
                                                                           6%
The third phase of the Great Monetary Easing cycle is well
                                                                           5%
under way, as the aggressive change in Japanese monetary
                                                                           4%
policy raises the stakes for central banks globally (see The
                                                                           3%
Global Macro Analyst: The Higher the Stakes, the Higher the
Risks, April 10, 2013). Coupled with a benign inflation outlook,           2%

central banks are likely to react to strong currencies and tight           1%

financial conditions by keeping monetary policy easy.                      0%
                                                                                                                                               United States
                                                                        -1%                                                                    Australia
While the RBNZ has delayed tightening, we do not expect it to           -2%
                                                                                                                                               New Zealand

cut rates. Three conditions are likely to discourage the RBNZ                   2011.Q1   2011.Q2   2011.Q3   2011.Q4   2012.Q1   2012.Q2   2012.Q3   2012.Q4

from easing more aggressively: i) The economy is looking               Source: BEA, ABS, Statistics NZ, Morgan Stanley Research
better; ii) The RBNZ want to avoid a housing bubble if
possible; iii) There are risks to easing at this point in the cycle.


                                                                                                                                                         15
                                                                         MORGAN STANLEY RESEARCH

                                                                         April 25, 2013
                                                                         FX Pulse




RBNZ Wants to Avoid Housing Bubble                                       Exhibit 3
                                                                         NZD and EM Currency Appreciation Post BoJ
Given the importance of New Zealand’s housing cycle as a
                                                                         Regime Change
driver of both real activity and financial cycles, housing prices
have come under increasing scrutiny of late. On the back of                                                        Total returns since April 3 close (%)
historically accommodative monetary policy, lower mortgage                 7.0

rates and easier credit, house prices continue to stretch                  6.0

higher (see Exhibit 2), reinforced by supply-side constraints              5.0
predominantly in Canterbury and Auckland. These pressures
                                                                           4.0
have been flagged as potentially problematic from both an
                                                                           3.0
inflationary and financial stability perspective by the RBNZ.
                                                                           2.0
Less than a month after the March MPS extended forward
rate guidance through 2013, Deputy Governor Spencer                        1.0


signalled a readiness to raise the OCR profile if rising house             0.0




                                                                                              C ZK*




                                                                                                                                                                PLN *

                                                                                                                                                                        HU F*




                                                                                                                                                                                                    KR W **

                                                                                                                                                                                                              TW D **
                                                                                                                                                                                BR L
                                                                                       CN Y




                                                                                                                                                          MYR
                                                                                                      C OP




                                                                                                                         C LP

                                                                                                                                TH B

                                                                                                                                       TRY




                                                                                                                                                                                       R UB
                                                                                 INR




                                                                                                             PEN

                                                                                                                   IDR




                                                                                                                                             M XN

                                                                                                                                                    NZD




                                                                                                                                                                                              ZAR
prices and credit growth were to trigger excessive
consumption and inflationary pressures.
Exhibit 2                                                                Source: Bloomberg, Haver Analytics; As of April 10; *Versus EUR; **Versus JPY; Note:
                                                                         Green = growth speeding up, red = growth slowing down; amber = growth at the trough.
RBNZ Watching House Prices
                                                                         A policy dilemma… The RBNZ therefore must balance an
                           Real house price index index
 1600                                                             25%
                                                                         uneven recovery and under-target inflation with the building
 1500
                                                                  20%    risks of increasing housing prices and credit growth.
 1400
                                                                  15%    Currently, the bank is forecasting a return to the 2.0%Y
 1300
                                                                  10%
                                                                         inflation target by mid-2015. A cut in the OCR may help to
 1200
                                                                         return inflation to target sooner, as well as provide support
 1100                                                             5%
                                                                         against the various downward pressures on the economy, but
 1000
                                                                  0%
                                                                         such a move would likely trigger unwanted financial stability
  900

  800
                                                                  -5%    issues, given the backdrop of high private debt levels and
  700
                                                  YoY%- rhs
                                                                  -10%   elevated house prices. In addition, lags in the effects of such
  600                                                             -15%
                                                                         a policy decision may also risk medium-term inflationary
    2003.Q1      2005.Q1       2007.Q1      2009.Q1     2011.Q1          pressures.
Source: RBNZ, Statistics NZ, Morgan Stanley Research
                                                                         …calls for a policy mix: The RBNZ is well aware of the
                                                                         importance of preemptively tackling a potential housing
Easing at This Point in the Cycle Carries Risks
                                                                         bubble. While it would like to avoid such a scenario, it is
Financial markets have been dominated by yield-seeking                   unlikely to rush to hike the OCR at this stage. Given the
liquidity, amid extraordinary global monetary easing, most               current economic backdrop, we believe that the RBNZ will
recently from Japan. As markets figure out which carry trades            retain easy monetary conditions by keeping rates on hold and
would benefit, high-yielding economies have attracted capital            deal with the upside risk of house prices via cautious
inflows and currency appreciation. New Zealand, owner of one             implementation of macro-prudential policies.
of the highest interest rates in the DM world, indeed
                                                                         Currently, non-tradable inflation remains elevated, reflecting
appreciated in the aftermath of the BoJ policy changes (see
                                                                         gradual tightening in domestic capacity, while NZD strength is
Exhibit 3). More interestingly, the colours of the bars indicate
                                                                         helping to balance out the upward pressure via the effect on
whether economic growth has picked up (green shading) or is
slowing (red shading). By this metric, New Zealand compares              tradable inflation (see Exhibit 4). Weakening in the currency
with the likes of Mexico and Turkey; like these economies, New           would diminish this offsetting force:
Zealand has passed the trough for economic growth, hence                 We therefore see the RBNZ keeping the OCR on hold at 2.50%
cutting rates to fight currency appreciation entails a greater risk      through 2013, with the first move being a hike of 25bp in 1Q14,
at this juncture. In fact, history tells us that RBNZ responses to       on the back of a global re-acceleration and tightening of global
limit NZD TWI appreciation by cutting the interest rate ends up          liquidity in the latter half of 2013. Thereafter, we forecast the
self-defeating – lower short-term rates boost economic growth,           OCR stepping up to reach 3.25% by the end of 2014.
long-term interest rates and ultimately NZD.

                                                                                                                                                                                                                        16
                                                                                        MORGAN STANLEY RESEARCH

                                                                                        April 25, 2013
                                                                                        FX Pulse




Exhibit 4                                                                               New Zealand’s contained inflation makes NZD particularly
Tradable versus Non-Tradable Inflation                                                  attractive. One measure of real yields across countries is the
 7%                                          Inflation Y%
                                                                                        nominal interest rate minus the YoY CPI forecast (see Exhibit
 6%
                                                                                        5). For those looking for real-yield returns, NZD is the
                                                                                        outperformer in G10 by a healthy margin. And while the soft
 5%
                                                                                        patch in global growth may put further pressure on commodity
 4%
                                                                                        prices, demand for agricultural products, New Zealand’s main
 3%
                                                                                        export, is generally more resilient to economic weakness
 2%

 1%                                                                                     We originally recommended going long NZDJPY, but ongoing
 0%                                                                                     Japanese foreign bond sales have made us more cautious on
 -1%                                                           Tradables
                                                                                        JPY weakness. Instead, we like funding long NZD positions
 -2%
                                                               Nontradables             in EUR, as our short-term optimism in the common currency
                                                               Target Range
                                                                                        is fading (see The Case Against EUR Mounts on page 8).
 -3%
   2003.Q1         2005.Q1         2007.Q1           2009.Q1    2011.Q1       2013.Q1   The main risk to this trade is if the ECB launches an asset-
Source: Statistics NZ, Morgan Stanley Research                                          supportive program, such as funding for lending for Small and
                                                                                        Medium Enterprises. This type of policy could attract risk-
Risks to our call include: a global economy struggling to
                                                                                        absorbing capital to EUR, as was the case with the LTRO and
navigate its way into the ‘daylight’, continued undershooting of
                                                                                        OMT. Please see our Strategic FX Portfolio on page 25 for
inflationary pressures, or persistently negative domestic
                                                                                        details.
economic conditions, such as a worsening drought. In such
scenarios, the RBNZ is likely to leave rates anchored at                                Exhibit 5
2.50% and push back rate hikes further into 2014, in our view.                          Nominal Rate – MS/Consensus CPI %Y Forecast
On the other hand, an early rate hike cannot be ruled out,
                                                                                          2.5                                                                             2.5
although we do not think that the RBNZ will do so at this
juncture. Housing pressure spillovers to other regions outside                            2.0                                                                             2.0
                                                                                                          1-Yr Deposit         10-Yr Govt
Christchurch and Auckland, and a reversal in the trend for                                1.5                                                                             1.5
household deleveraging, would give the RBNZ reason to                                     1.0                                                                             1.0
consider carefully such action, in our view.                                              0.5                                                                             0.5

                                                                                          0.0                                                                             0.0
Portfolio Flows to Boost NZD
                                                                                         -0.5                                                                             -0.5
Last week, the IMF stated that NZD is overvalued by about
                                                                                         -1.0                                                                             -1.0
10%. We have argued that traditional valuation models based
                                                                                         -1.5                                                                             -1.5
on terms of trade and other metrics are less relevant in the
current environment of abundant global liquidity. A hunt for                             -2.0                                                                             -2.0
                                                                                                                         CHF


                                                                                                                                   CAD




                                                                                                                                                  AUD




                                                                                                                                                                    NZD
                                                                                                           EUR*


                                                                                                                  USD




                                                                                                                                                        NOK
                                                                                                    GBP




                                                                                                                                                              SEK
                                                                                                                                            JPY




yield, stable rating and policy-makers’ hesitancy to intervene
in FX markets will make a currency trade at a premium. This                             Source: Bloomberg, Morgan Stanley Research; NZ and Norway inflation forecasts are
                                                                                        Bloomberg consensus.
has and will continue to support NZD, in our view. We
forecast NZD/USD to approach 0.90 this year.




                                                                                                                                                                            17
                                                                                    MORGAN STANLEY RESEARCH

                                                                                    April 25, 2013
                                                                                    FX Pulse




MXN: Positioning for Tactical Correction
Robert Habib, Rashique Rahman, Juha Seppala                                         Exhibit 2
                                                                                    MXN versus USD/EM Forecast Path
     We remain bullish on MXN over the medium term – but                           104
      expect near-term consolidation.
                                                                                    102
     Progress on structural reforms is well priced-in and long-side
      positioning in Mexico local markets is heavy; these factors                   100
      suggest that the rally in MXN is likely to stall in the coming
                                                                                      98
      weeks, particularly if global growth conditions deteriorate.

     Pare back longs in anticipation of near-term consolidation;                     96

      there is likely considerable resistance as we near 12 on
                                                                                      94
      USD/MXN, and we see a 12.1 to 12.5 range.
                                                                                      92
                                                                                         Mar-13       Jun-13        Sep-13       Dec-13    Mar-14   Jun-14
                                                                                                                 MXN                      EM
MXN has well-outperformed high-beta EM peers since 3Q12.
                                                                                    Source: Morgan Stanley Research, Bloomberg
We have, since August 2012, recommended long MXN,
funded in JPY. In large part, this outperformance on MXN has
been due to expectations over structural reforms, following                         How much more upside is there for MXN?
the formation of the ‘Pacto de Mexico’ – a collection of
legislative measures agreed upon by the Congressional                               We see steady USD/MXN downside over the coming
parties.                                                                            quarters, to 11.60 by end-2014 – suggesting there is further
                                                                                    scope tor the peso to outperform EM peers.
As our LatAm economics team eloquently put it in “Mexico’s
Moment Faces the Cycle”, Week Ahead in Latin America,                               However, we believe that downside momentum in USD/MXN
(January 18, 2013), the much-needed structural reforms on all                       is overextended and due for a period of consolidation.
social and fiscal fronts were engineered by President Pena                          The reasons are as follows –
Nieto’s government and have received strong support from
the Congress – thus far we have seen education and labor                            1.     We believe there are high expectations of successful
reform and are close to passage of telecoms-sector reform.                                 passage of structural reforms already in the price;

                                                                                    2.     Short-term market momentum indicators suggest
                                                                                           USD/MXN is oversold; long-side positioning in Mexico
Exhibit 1
                                                                                           local markets is also high; and
USD/MXN vs. USD/High-Beta EM Currencies*
                                                                                    3.     A dovish Banxico may serve to limit further near-term
  14.5                                                                        104          appreciation of the peso.

  14.0                                                                        101   Deterioration in global growth conditions would only serve to
                                                                                    reinforce the influence of these factors.
  13.5                                                                        98
                                                                                    We look for a near-term tactical correction in MXN before re-
  13.0                                                                        96
                                                                                    entering longs, and take profit on our recommendation to buy
                                                                                    MXN/JPY (see Global EM Investor: Still Waiting for Spring,
  12.5                                                                        93    April 22, 2013).

  12.0                                                                        90    How to Price in Political Reforms?
     Jan-12   Mar-12   May-12   Jul-12   Sep-12    Nov-12   Jan-13   Mar-13
                        MXN                       EMFX High-Beta                    The most recent passing of the telecoms bill through both the
* Geometric average of CLP, MXN, CZK, HUF, PLN, RUB, ZAR, IDR, IRN, MYR and SGD.    Senate and Congress was an important step towards
Source: Morgan Stanley Research, Bloomberg
                                                                                    improving the country’s competitiveness in the sector.
                                                                                    However, the House will need to vote once more on an


                                                                                                                                                      18
                                                                      MORGAN STANLEY RESEARCH

                                                                      April 25, 2013
                                                                      FX Pulse




amended version that just passed the Senate, and the bill is          (April 24, 2013) we find that EM dedicated investor exposure
expected to be signed into law in mid-March after it has been         to Mexico local bonds has increased by 0.62% – the most in a
ratified by 17 state legislatures.                                    month, to 2.3% overweight versus their benchmark.
                                                                      Positioning in Mexico is now at levels close to overtaking
Although it is difficult to measure precisely, we expect the          Brazil as the most overweight local market, despite its lower
currency market to have priced in the passing of the Telecom          carry and market size.
bill, and the foreign inflows it will lead in the sector, since the
                                                                      Our short-term market momentum indicator (SAMI) also
biggest two hurdles in getting the legislation passed are now
                                                                      shows that USD/MXN momentum is quite stretched currently,
behind us (the passing by the Chamber of Deputies on March
                                                                      whereas broader USD/EM is in neutral ground between
22 and by the Senate on April 19 despite their modifications).
                                                                      overbought and oversold.
The market’s support for these reforms was further increased          These findings lead us to believe that the market has more
when Banxico itself gave its note of confidence to the                than priced in the pace of structural reform as well as
government’s reform program by cutting rates on March 8,              anticipation of Japanese institutional investors’ reallocation to
causing the currency to rally 1% on the day.                          Mexican debt.
However, this week’s delay in the presentation of the                 Exhibit 3
Financial Reform Bill was the first time the political opposition     Investors Are Heavily Positioned in MXN
(PAN and PRD) chose to deliberately distance themselves
                                                                         2000                                                              14.50
from the ‘Pacto de Mexico’ in protest to inconsistencies with
the PRI’s campaign financing (specifically, that social                  1000
                                                                                                                                           14.00
programs should not be used to advance political goals).                     0
While we do not believe that these issues will impact further                                                                              13.50
                                                                         -1000
negotiations, undeniably there are political risks to further                                                                              13.00
                                                                         -2000
reforms going forward, especially as regional elections are
scheduled for July 7, and the opposition might try to bargain            -3000                                                             12.50

for key offices.                                                         -4000
                                                                                                                                           12.00
                                                                         -5000
What’s more, the next two reforms on the energy and fiscal
                                                                                                                                           11.50
side are expected no earlier than 2H13.                                  -6000

                                                                         -7000                                                             11.00
Anecdotally, we believe that there is scope for disappointment
                                                                             Jan-12 Mar-12 May-12 Jul-12     Sep-12 Nov-12 Jan-13 Mar-13
if the energy bill does not include constitutional change to limit
the Pemex oil monopoly.                                                                IMM positioning (USD MM Long)             USDMXN
                                                                      Source: Morgan Stanley Research, CFTC/IMM
Nonetheless, we remain encouraged by the reforms the Pena
Nieto government has already pushed forward on the fiscal,            As we first mentioned in Interest Rate and FX Strategy – J-
energy and telecom front (see “Brazil and Mexico: Seizing the         Insight: What Will Japan’s Investors Do Now? (April 17,
Moment”, Week Ahead in Latin America, March 15, 2013),                2013), Japanese life insurance companies are likely the main
and thus continue to forecast USD/MXN reaching 11.60 in               domestic institutional investor to increase their holdings of
4Q14 (see FXTract, April 2, 2013).                                    foreign bonds by 2-3%, equivalent to US$60-100 billion over
                                                                      the next one to two years – part of which is likely to be
Heavy Positioning                                                     invested in EM local markets, with a preference for Brazil and
                                                                      Mexico.
Long-side positioning in Mexico local markets is heavy and
downside momentum for USD/MXN is stretched. These                     Indeed, the sheer size of the Mexican local market (US$168
factors alone warrant caution in long-side MXN and local bond         billion), in addition to favorable tradability/liquidity, relatively
positioning.                                                          high yields to global peers and its inclusion in the WGBI,
                                                                      makes Mexico a likely candidate to receive Japanese flows.
Foreign ownership of MBonos has increased to 57% of the
                                                                      And, as we expected, we have already seen evidence of flows
total, while positioning in FX futures – as measured by IMM
                                                                      from Japan picking up significantly, with Toshin data
data – is now at all-time high (see Exhibit 2).
                                                                      suggesting that the allocation to MXN-denominated assets
Local bond positioning on the part of EM dedicated investors          has increased by 117% since June 2012 (after adjusting for
also confirm this finding, and in our Market Technical Watch          exchange rate changes).


                                                                                                                                             19
                                                                                            MORGAN STANLEY RESEARCH

                                                                                            April 25, 2013
                                                                                            FX Pulse




Exhibit 4                                                                                   the S&P500 on down days, and illustrates MXN’s current
Japan Exposure to MXN – Toshin                                                              vulnerability to a bout of risk aversion.
 450                                                                                  60%   Exhibit 5
 400                                                                                        MXN Rolling 3m Correlation to the S&P500 on Down
                                                                                      50%
 350
                                                                                            Days*
 300                                                                                  40%    0.80

 250                                                                                         0.70
                                                                                      30%
                                                                                             0.60
 200
                                                                                             0.50
 150                                                                                  20%
                                                                                             0.40
 100
                                                                                      10%    0.30
  50
                                                                                             0.20
   0                                                                                  0%
       J-03   J-04   J-05   J-06   J-07   J-08   J-09     J-10   J-11   J-12   J-13          0.10
       Toshin MXN denominated assets (JPYbn*)           Foreign Ownership of Mbonos (%)      0.00
*MXN-denominated Toshin assets are measured using a constant January 2003 MXN/JPY.               Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13
Source: Morgan Stanley Research, Bloomberg, Banxico, Toshin                                 *We calculate rolling 3-month correlation using daily data, but using only those days when
                                                                                            the S&P500 sold off.
                                                                                            Source: Morgan Stanley Research, Bloomberg
A Dovish Banxico
                                                                                            What’s more, recent data seem to confirm the beginning of a
Banxico’s last statement warned of the relative tightening                                  slowdown in the US. Though our global economics team sees
caused by MXN’s recent strength, followed by Mexico’s                                       global recovery in 2H13 after this latest ‘soft patch’, the latest
exchange commission scrapping the daily auction mechanism                                   news on employment and retail sales point towards the US
on April 8, aimed at limiting bouts of peso weakness. In the                                economy losing some of its 1Q13 momentum. Our US
aftermath, the market priced in the risk of further potential                               economics team forecasts growth to lower to 1.0% for this
actions to stem currency strength, despite assurances by                                    incoming quarter before rising again to 2.6% (see The Global
authorities about their commitment to a free-floating exchange                              Macro Analyst, April 24, 2013).
rate.

Our Mexico economist, Luis Arcentales, does not believe that                                Pare Back Longs in Anticipation of Consolidation
Banxico is likely to cut rates at Friday’s monetary policy                                  We anticipate MXN to correct near these levels, on the back
meeting on exchange rate strength alone, despite the local                                  of heavy positioning and incoming risks, before continuing to
rates market pricing in some easing. Yet, absent a rate cut,                                rally to our projected forecast of 11.60 for end-2014. We
we expect the central bank to discuss once more the capital                                 expect it to approach 12.50 near-term (a 3% move higher),
inflows that could lead to ‘unnecessary’ tightening.                                        but prefer to express our view via option structures.
While this is unlikely to cause material MXN weakening by
itself, it is likely to limit large MXN gains in the short term,                            Buy USD Call/MXN 1x2 Put Spreads
particularly as we near 12.0 on USD/MXN.                                                    We recommend positioning for a potential sell-off via an
                                                                                            ATMF three-month option structure instead of outright selling
Vulnerable to the US/Global ‘Soft Patch’                                                    MXN, especially since the correction might also be limited.
Heavy positioning is likely only to accentuate MXN’s reaction to                            We prefer to express our view via a three-month 1x2 MXN put
any signs of a US/Global slowdown.                                                          spread, with the second strike at 12.80, and costing 58bp of
                                                                                            notional. This structure has unlimited losses to make the
MXN has historically had a high beta to the global markets, and                             option structure cheaper, hence the main risk is for the peso
in particular, a tendency to sell off more on negative news than                            to sell off more aggressively than we anticipate. In the case of
rally on good news. Indeed, our FX Tail-Risk Hedges filter                                  a sell-off, the trade would generate positive profit until
suggests that MXN is still the best currency to use to hedge a                              USD/MXN hits 13.35.
downturn in US equities. Exhibit 3 shows MXN’s correlation to



                                                                                                                                                                                    20
                                                                                   MORGAN STANLEY RESEARCH

                                                                                   April 25, 2013
                                                                                   FX Pulse




Exhibit 6
Payoff Structure of a 3m 1x2 MXN Put Spread, K =
12.80
 5.0%
 4.0%
 3.0%
 2.0%
 1.0%
 0.0%
 -1.0%
 -2.0%
 -3.0%
       11.7       11.95   12.2   12.45        12.7   12.95   13.2   13.45   13.7
         Payoff


Source: Morgan Stanley Research, Bloomberg.




                                                                                                             21
                                                                   MORGAN STANLEY RESEARCH

                                                                   April 25, 2013
                                                                   FX Pulse




Positioning for China Rebalancing: Short SGD/INR
Kritika Kashyap, James Lord
                                                                   industry are manufactured in Asia. 40% of Taiwan’s electronic
    China and global growth slowdown fears are at the forefront
                                                                   exports and 21% of Singapore’s exports are directed to
     of market attention once again. We believe it is worth
     exploring high-carry trades that benefit from this trend.     China, making these countries among the most exposed to
                                                                   China’s rebalancing, in our view.
    A manufacturing slowdown in China places a number of AXJ
     currencies at risk, such as TWD and SGD. The associated       Commodity prices have already declined sharply this year on
     move lower in commodity prices would benefit INR.             concerns that global growth has hit another soft patch. Oil and
                                                                   gold prices are down nearly 15%, the CRB metals index is
    We recommend going short SGD/INR as a good carry trade
                                                                   down 8.5% and vegetable oil prices (crude palm oil) are down
     that takes advantage of low commodity prices, while also
     positioning for China’s rebalancing.                          nearly 7% since mid-February. Further declines in these
                                                                   commodities cannot be ruled out, driven by a further
                                                                   slowdown in global and China’s growth, and would have
China Slowdown Fears Re-emerge                                     significant knock-on effects in our markets (see FX Pulse:
                                                                   Global Commodity Boom Revisited, Part 1: FX, April 18,
At a time when data from the US and Europe have turned             2013).
softer, disappointment in growth indicators from China has
raised renewed questions about the global growth recovery,         Positioning for Falling Commodity Prices and
and commodity prices have fallen as a result.                      Slower China Growth
Given the risk of these trends continuing, we believe it is        We recommend a short SGD/INR position via 3m forwards.
worth exploring some high-carry trading strategies that would      This trade is high positive annualised carry, at around 5.5%.
benefit. We recommend short SGD/INR as a good carry trade
within AxJ that takes advantage of softer commodity prices         We target spot SGD/INR at 42.2, with a stop at 44.8. The
while also positioning for softer growth in China.                 entry is the current 3m forward rate of 44.26. Risk/reward for
                                                                   this trade is around 4.3:1, when measured in terms of total
China’s slower growth is arguably an inevitable consequence        return.
of its economic transition to a new growth model – one that
relies on domestic consumption rather than the export-             The trade complements our recommendation to buy INR/IDR,
dependent growth it has seen over the past decade. Our             given prospects for ongoing balance of payments
China economics team believes that this economic                   deterioration in Indonesia to weigh on the rupiah.
restructuring is necessary for more sustainable growth in          Exhibit 1
China as export demand from DM is likely to remain low going       Momentum in the Middle of Range
forward – and it is interesting to note that policy-induced CNY
appreciation has gathered pace despite the clear growth             100                                                                     46
                                                                                SGD Overbought
slowdown, suggesting that a stronger CNY is viewed as part           90
of these broader reform efforts.                                     80
                                                                                                                                            45
                                                                     70
Impact on Commodities, Manufacturing                                 60
                                                                     50                                                                     44
China’s economic transition is likely to weigh on currencies
                                                                     40
that were supported by the previous investment-for-export
                                                                     30
growth model. This is a key reason for our team’s medium-                                                                                   43
                                                                     20
term bearish views on AUD, given the prospect of lower
                                                                     10                                         SGD Oversold
demand for commodities from China.
                                                                      0                                                                     42
Asian currencies which have been so far been supported by             Jun-12        Aug-12      Oct-12      Dec-12       Feb-13   Apr-13
exports of mid-value chain machinery and electronics                                FX Momentum (LHS)                             SGD/INR
products to China’s heavy industry could also suffer. Most of      Source: Bloomberg, Morgan Stanley Research
the electronics and machinery-related product for China’s


                                                                                                                                            22
                                                                                   MORGAN STANLEY RESEARCH

                                                                                   April 25, 2013
                                                                                   FX Pulse




SGD makes for a good funding currency in AxJ due to its                            As Exhibit 2 highlights, lower interest rates as proxied by the
negative carry, weak growth prospects and good liquidity. In                       implied yield on INR FX forwards tend to be associated with a
addition, the S$NEER Index is currently near the top of the                        stronger currency.
MAS’s trading band and hence risks are skewed to the
                                                                                   Exhibit 3
downside for SGD.
                                                                                   Declining Commodity Prices Should Improve
We maintain our long-term bullish call on INR, which also                          India’s Trade Balance
provides the highest positive carry in the region.
                                                                                      4%                                         Trade Balance as % of GDP
INR to benefit from lower commodity prices: INR has been
                                                                                      2%
under sharp depreciation pressure since mid-2011 due to its
high twin deficits, which had given rise to a poor macro of                           0%

structurally low growth and high inflation.                                          -2%

As prices of India’s largest imports – oil and gold – decline,                       -4%

we think this reduces India’s macro vulnerability through an                         -6%
improving trade balance and lower imported inflation. Our                            -8%
economists believe that for every 10% reduction in crude oil                        -10%
                                                                                                           Oil                               Gold
                                                                                                           Coal                              Fertilizer
prices, India’s current account deficit will narrow by 0.6% of
                                                                                    -12%                   Others                            Food products
GDP, while the fiscal subsidy burden declines by 0.14% of
                                                                                                           Total
GDP or around US$2.9 billion.                                                       -14%
                                                                                               F2000

                                                                                                       F2001

                                                                                                                 F2002

                                                                                                                         F2003

                                                                                                                                   F2004

                                                                                                                                           F2005

                                                                                                                                                   F2006

                                                                                                                                                           F2007

                                                                                                                                                                   F2008

                                                                                                                                                                           F2009

                                                                                                                                                                                   F2010

                                                                                                                                                                                           F2011

                                                                                                                                                                                                   F2012

                                                                                                                                                                                                           F2013
We have already seen an improvement in India’s macro
indicators this year after the government put on track its plan                    Source: Ministry of Commerce, CEIC, Morgan Stanley Research
to consolidate the fiscal deficit starting last September.
As we saw inflation trending lower, the RBI also shifted its
policy emphasis towards encouraging growth, cutting its                            We think that as government reforms continue, and if
benchmark rates by 25bp twice this year. We think that a                           commodity prices stay near current levels, the combination of
further drop in commodity prices will give the RBI more room                       lower inflation, a narrower current account deficit, and higher
for monetary easing; this should not only improve India’s                          GDP growth should elicit more foreign capital inflows that will
overall macro environment, but also boost Indian equity                            prove positive for INR.
markets that see the major chunk of foreign investor flows
(see India Cross-Asset Strategy: The Commodity Sell-Off:                           There are risks: political volatility and headline risk remain in
Implications on India, April 23, 2013).                                            place as we near the general elections in 2014 and the
                                                                                   current account, though narrowing, remains large and the
Exhibit 2
                                                                                   currency sensitive to prospects for its ongoing financing.
SGD/INR vs 3m INR Carry                                                            These risks are well accounted for in the recent
  46                                                                               underperformance of INR, in our view.
                                                                             8.5
                                                                                   SGD has high exposure to China manufacturing:
  45                                                                               Singapore is the most export-oriented economy in AxJ. Its
                                                                             7.5
                                                                                   highest export market share – 21% of total exports – is to
                                                                                   China (including Hong Kong), and so a slowdown in
                                                                             6.5
  44                                                                               China/global growth poses significant risks for SGD.
                                                                             5.5   Furthermore, Singapore’s exports are mainly in the form of
  43                                                                               electronics and machinery components, which are also under
                                                                             4.5   threat of losing competitiveness due to JPY weakness. This is
                                                                                   reflected in Singapore’s export data, which show that
  42                                                                         3.5
                                                                                   electronics exports have underperformed other sectors.
   Apr-12     Jun-12     Aug-12     Oct-12   Dec-12   Feb-13    Apr-13

            SGD/INR         Implied 3m Carry From FX Forwards (ann, % RHS)
                                                                                   While the rest of AxJ has shown signs of economic recovery
Source: Bloomberg, Morgan Stanley Research
                                                                                   starting in 4Q12, Singapore’s economy has been reeling in a
                                                                                   stagflationary environment.


                                                                                                                                                                                                           23
                                                                            MORGAN STANLEY RESEARCH

                                                                            April 25, 2013
                                                                            FX Pulse




Broad indicators of economic growth in Singapore have                       Risks to the trade: A renewed global risk-aversion would
consistently lagged expectations.                                           lead to sharp foreign outflows from EM markets – in which
                                                                            case INR may underperform the region as it is highly
These external fundamental trends are already taking their toll
                                                                            dependent on foreign capital inflows to fund its current
on the economy, and make us more bearish on the currency,
                                                                            account deficit and as foreign holdings of Indian equities have
particularly given that Singapore’s 2013 budget did not add
                                                                            already increased quite a lot this year.
any fiscal stimulus, and the MAS maintained the policy status
quo through an appreciating currency.                                       Another risk could be if Singapore’s government implements
                                                                            structural reforms to improve industrial productivity and lower
As Exhibit 4 shows, the restrictive policy and subdued growth
                                                                            the supply-side restrictions in the asset and labour markets.
has led to a sharp flattening of the IRS curve over the past
                                                                            However, even in this case, the appreciation in SGD is
couple of months. With SGD now trading at the top of the
                                                                            capped by the MAS’s trading band.
trading band, fundamental trends in the economy have tilted
the risk/reward in favour of a move towards the middle of the               Exhibit 5
trading band at least.                                                      S$NEER Is Trading at the Top of the Band
Exhibit 4                                                                    125

Weak Growth, Flat IRS Curve                                                                       S$NEER Model

                                                                             120                  Top
   90                                                                1.32                         Center
                                                                                                  Bottom
                                                                             115
   80                                                                1.3
                                                 SGD weakness,
                                                 Steeper IRS
   70                                            curve               1.28    110



   60                                                                1.26    105


   50                                                                1.24
                                                                             100

   40                                                                1.22
                                                                              95
                                                                                Jan-02


                                                                                         Jan-03


                                                                                                   Jan-04


                                                                                                            Jan-05


                                                                                                                     Jan-06


                                                                                                                              Jan-07


                                                                                                                                       Jan-08


                                                                                                                                                Jan-09


                                                                                                                                                         Jan-10


                                                                                                                                                                  Jan-11


                                                                                                                                                                           Jan-12


                                                                                                                                                                                    Jan-13
   30                                                                1.2
    Jan-12      Apr-12      Jul-12      Sep-12    Dec-12    Mar-13
                                                                            Source: Bloomberg, Morgan Stanley Research
                      SGD IRS 1s5s (bp)            USD/SGD
Source: Bloomberg, Morgan Stanley Research




                                                                                                                                                                                        24
                                                                     MORGAN STANLEY RESEARCH

                                                                     April 25, 2013
                                                                     FX Pulse




Strategic FX Portfolio Trade Recommendations
Evan Brown, Marc Englander

                 Limit Order: 1.5420, Stop: 1.5620, Target: 1.4820                                 NZD Benefiting from Real Yield
                 We wish to express our bullish NZD view against EUR as the            2.5                                                                                             2.5


                 common currency transitions into a funding currency. We               2.0

                                                                                       1.5
                                                                                                        1-Yr Deposit            10-Yr Govt
                                                                                                                                                                                       2.0

                                                                                                                                                                                       1.5
                 believe NZD trades at a premium because of its stable                 1.0                                                                                             1.0

Limit Order:     ratings, relatively high real yields and low probability of FX        0.5                                                                                             0.5

    Sell         intervention. Despite sluggish growth and inflation, the RBNZ         0.0                                                                                             0.0


 EUR/NZD         is unlikely to cut rates, due to concerns about increasing           -0.5

                                                                                      -1.0
                                                                                                                                                                                       -0.5

                                                                                                                                                                                       -1.0
                 housing prices and excessive credit growth. We favor NZD             -1.5                                                                                             -1.5

                 longs despite concerns over weakness in the commodity                -2.0                                                                                             -2.0




                                                                                                                                    C D




                                                                                                                                                    A D




                                                                                                                                                                            ND
                                                                                                                  U D




                                                                                                                                                           N K



                                                                                                                                                                    S K
                                                                                                                          C F
                                                                                                 G P




                                                                                                                                             Y
                                                                                                          U *
                                                                                                         E R
                 complex, as food prices are likely to remain sticky.




                                                                                                                           H
                                                                                                  B




                                                                                                                                                            O
                                                                                                                                           JP
                                                                                                                                     A




                                                                                                                                                     U
                                                                                                                   S




                                                                                                                                                                             Z
                                                                                                                                                                     E
                 Entered: .8500, Close at: 26 April WMR                                    Real Yield Differentials Drive GBPUSD
                 Limit Order: 1.5550 Stop: 1.5750, Target: 1.4830
                 Despite the surprisingly positive UK GDP print, we remain
  Close:         bearish GBP over the medium-term. But we now prefer to
   Long          short GBP against USD rather than EUR. We expect EUR to
                 come under pressure as it trades more in line with softening
 EUR/GBP
                 economic fundamentals rather than liquidity-driven assets.
Limit Order:     Meanwhile, we favor USD as the composition of flows to the
    Sell         US changes over time. Specifically, flows should shift from
 GBP/USD         FX-hedged bond inflows to unhedged equity and FDI, given
                 the US’s comparatively bright growth and investment outlook.
 12 Apr 2013     Entered: 72.0, Stop: 71.0, Target: 75.0                              Foreign Inflows into CEEMEA Local Debt
                                                                                      2,500                                     2012 Monthly Avg (USD m)
                 Even though the NMB cut rates by 25bps this week, we                 2,000                                     Jan-Feb13 Avg (USD m)
                 believe more rate cuts are likely to come. In addition, we are
                                                                                      1,500
  Entered:       bearish HUF as a decline in FX denominated debt should
                 free policy-makers to allow for more HUF weakness. In our
                                                                                      1,000
   Long
  PLN/HUF        view, PLN should remain supported because Poland’s                    500



                 relatively large bond market and attractive yields could                    0



                 potentially attract inflows from Japan.                               -500
                                                                                                        PLN                     ZAR               TRY                     HUF


 7 Mar 2013      Hold USD Call Basket                                                                  USD Appreciating through ‘14

                 Despite the recent ‘soft patch’ surfacing in US economic data,       92
                                                                                                                        DXY Projection
                                                                                      90
                 we remain bullish USD in the long-term. As the US moves              88
 Long USD        from twilight into daylight, domestic growth should outperform       86

Call Against     the rest of the world in 2H 2013. We believe investors will look
                                                                                      84
                                                                                      82

 Basket of       for FDI and equity investment opportunities in the US,               80
                                                                                      78
 Short EUR       supporting the greenback. In addition, Japanese real money           76

                 investors who expect further JPY weakness will likely let
                                                                                      74
 GBP, JPY                                                                             72

                 currency hedges roll off, providing further support for USD.         70
                                                                                       Jan-08 Nov-08 Sep-09 Jul-10 May-11 Mar-12 Jan-13 Nov-13 Sep-14



                 Entry: 26 Apr WMR (NDF), Stop: 44.76 (NDF),
                                                                                                 SGD Weakness with a Steeper IRS
                 Target: 42.20 (NDF)
                                                                                           90                                                                                   1.32



                 We recommend gaining exposure to short SGD/INR as                         80
                                                                                                                                                 SGD weakness,
                                                                                                                                                                                1.3

                                                                                                                                                 Steeper IRS
                 global and China growth fears continue and the risk that oil              70                                                    curve                          1.28

Limit Order:     prices continue to fall. Singapore’s fundamentals are                     60                                                                                   1.26

    Sell         deteriorating and are vulnerable to a downturn in China.                  50                                                                                   1.24

  SGD/INR        Meanwhile, India's macro vulnerabilities are receding and                 40                                                                                   1.22
                 stand to improve as commodity prices fall.
                                                                                           30                                                                                   1.2
                                                                                            Jan-12       Apr-12         Jul-12        Sep-12      Dec-12         Mar-13

                                                                                                                SGD IRS 1s5s (bp)                  USD/SGD




                                                                                                                                                                                       25
                                                                               MORGAN STANLEY RESEARCH

                                                                               April 25, 2013
                                                                               FX Pulse




                           Limit Order: 35.08, Stop: 34.75, Target: 36.35                                  RUB Basket Correcting Lower
                                                                                                 36.25
                                                                                                 36.05
                           We remain concerned over the medium term outlook for                  35.85


 Limit Order:              RUB, and falling oil prices pose clear risks for the currency.        35.65
                                                                                                 35.45
                                                                                                                                   RUB Basket

                           The currency benefits from having high carry, which means             35.25
     Buy                   that picking entry points are important. Given current upside         35.05

 RUB Basket                momentum in commodity prices we believe it is best to wait
                                                                                                 34.85
                                                                                                 34.65

                           for an improved level.                                                34.45
                                                                                                 34.25
                                                                                                    Jan-01 Jan-18 Feb-04 Feb-21 Mar-10 Mar-27 Apr-13 Apr-30


                           USDMXN Spot: 12.13, Strike 1: 12.22, Strike 2: 12.80                 Payoff Structure of a 3m 1x2 MXN Put
                           Premium: 58bps                                                       Spread, K = 12.80
                                                                                                  5.0%
                           We remain bullish on MXN over the medium term – but                    4.0%
                           expect near-term consolidation. Progress on structural                 3.0%
 Long USD                  reforms is well priced-in and long-side positioning in Mexico          2.0%

Call/MXN 1x2               local markets is heavy; these factors suggest that the rally in        1.0%


 Put Spread                MXN is likely to stall in the coming weeks, particularly if            0.0%
                                                                                                 -1.0%
                           global growth conditions deteriorate. We prefer to express            -2.0%
                           our view via a three-month 1x2 MXN put spread, costing                -3.0%

                           58bp of notional.                                                             11.7
                                                                                                          Payoff
                                                                                                                   11.95   12.2   12.45   12.7   12.95   13.2   13.45   13.7




28 Feb 2013                                                                                     Toshin Foreign-Denominated Assets Well
                           Close USD/JPY Call Spread                                                        Below 2007 Peak

   Long                    We continue to favor bullish USDJPY strategies as Japanese
USD/JPY Call               investors begin to participate in the move. We expect
   at 96                   (1) Japanese real money institutions to unwind currency
                           hedges on foreign investments, (2) fresh outflows from
   Short
                           Japanese money markets, and (3) Toshin accounts to sell
USD/JPY Call               further JPY.
   at 100

 11 Apr 2013               Spot: 1.0560, Strike: 1.08, Premium: 10.87 bps                       Strong Chinese Imports AUD-Supportive


                           We use historically low AUDUSD vol to enter a 1-month call
                           with a 1.08 strike. We favour short term AUD strength as
     Buy:                  (1) abundant global liquidity continues to support relatively
   AUD/USD                 high-beta/high-yielding currencies, and (2) recent RBA
     Call                  commentary has signalled comfort with AUD strength,
                           reducing the probability of a rate cut. The maximum loss is the
                           10.87 bps premium paid for the option.

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




                                                                                                                                                                               26
                                                                                                                             MORGAN STANLEY RESEARCH

                                                                                                                             April 25, 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
Active Trades
Long PLN/HUF                                             $10.0mn            10.1%             12-Apr-13                 72.00                72.5200                71.00       75.00          $69.7k              -$3.9k            $65.8k
Long EUR/GBP                                             $10.0mn            10.1%             24-Apr-13                   0.85               Close at WMR on 26-Apr-13                        -$85.0k              -$0.1k            -$85.1k
Limit Orders
Sell EUR/NZD                                             $10.0mn                                                       1.5420                 1.5276             1.5620       1.4820
Sell GBP/USD                                             $10.0mn                                                       1.5550                 1.5444             1.5750       1.4830
Sell SGD/INR                                             $10.0mn           All levels 3M NDF. Enter at close on 26-Apr-13                                           44.76       42.20
Buy RUB Basket                                           $10.0mn                                                        35.08                  35.34                34.75       36.35
Cash                                                     $79.2mn         79.8%
Portfolio Mark to Market                                 $99.2mn
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. Reported returns do not take into
account transaction fees and other costs; past performance is no guarantee of future results. (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
 135                                                                                                                                                                          PLN

 130

 125
                                                                                                                                                                              EUR
 120
 115

 110                                                                                                                                                                          HUF

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

  90
                                                                                                                                                                                    -10       -5           0                5       10
   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             -0.77           0.19           0.05                                                                                                                                                       -0.75%



Options Trades
Trade Recommendation                      Notional      Entry Date     Expiry Date          Strike           Entry Spot         Entry Vol         Entry Cost           Current Spot       Current Vol      Current Cost             P&L
Closed Trades                                                                                                                                                                                 Total 2013 P&L                          -$80.7k
Long USD call/JPY put                      $10.0mn       28-Feb-13        02-Sep-13          96.0000               92.3400           12.00%               1.80%              99.3700          11.80%                 4.74%           $293.1k
Short USD call/JPY put                     $10.0mn       28-Feb-13        02-Sep-13         100.0000               92.3400           12.60%               0.93%              99.3700          12.13%                 2.56%          -$163.0k
Active Trades
Long USD Basket (v JPY,                                                                                            GBPUSD: 1.5049
EUR, GBP)                                  $10.0mn        07-Mar-13      07-Jun-13           4% OTM                 USDJPY: 94.67                         0.45%                                                      0.15%            -$30.0k
Long AUD Call/USD Put                      $10.0mn        11-Apr-13      13-May-13             1.0800               1.0560      6.88%                     0.11%               1.0311           8.28%                 0.00%            -$10.9k
Long USD call/MXN put                       $5.0mn        25-Apr-13       25-Jul-13             12.22                12.13      9.60%                     1.94%                                                                       -$96.9k
Short USD call/MXN put                     $10.0mn        25-Apr-13       25-Jul-13           12.8000              12.1340     11.30%                     0.68%                                                                        $67.9k

Source: Morgan Stanley Research; see notes above.




                                                                                                                                                                                                                                          27
                                                                                                     MORGAN STANLEY RESEARCH

                                                                                                     April 25, 2013
                                                                                                     FX Pulse




G10 Currency Summary
Calvin Tse, Dara Blume

             USD                            Soft Patch                                        Neutral      Watch: GDP, Home Sales, Confidence, ADP, ISM, Claims, Payrolls

               3.7%                         US economic data continue to disappoint, raising suspicion that the current “soft patch” may end up being a “rough patch” in the
                                            US growth trajectory. Furthermore, Chinese growth has also slowed as the government pushes forward in the rebalancing of its
     economy. As such, global growth is expected to remain weak, which may prompt a short-term correction in risky assets and thus
                                            support USD. GDP, ISM, and payrolls will be especially important to keep an eye on this week.
             EUR                            Watching the ECB                                  Bearish      Watch: M3, Consumer Confidence, Flash CPI, Unemployment Rate, ECB

              -3.1%                         With economic data surprising to the downside, we believe there is a high probability the ECB cuts rates at its upcoming

  
                                            meeting. Even more important than the actual rate decision will be Draghi’s subsequent speech, especially if it opens the
                                            door for further, more aggressive measures going forward. A dovish central bank, weaker global growth, and political
                                            uncertainty are likely to weigh on the EUR, in our view. We have flipped stances and now look to employ bearish strategies.
              JPY                           Domestic Flows to Drive JPY                       Bearish    Watch: CPI, BOJ, PMI, Jobless Rate, IP, Retail Trade, Monetary Base

               9.5%                         In the near term, we may see a technical pullback in USDJPY towards the bottom end of the ascending trend channel. That
                                            said, we like to buy USDJPY on such dips. Joint policy from both the central bank and government to overcome deflation will
     result in further outflows from Japan over a multi-year time frame, weighing on the currency. While no new actions are
                                            expected, the upcoming BoJ meeting will be important as it coincides with the semi annual outlook on prices.
             GBP                            Sell on Rallies                                   Bearish      Watch: Consumer Confidence, Mortgage Approvals, PMI

              -3.6%                         Following the better-than-expected UK GDP number, we maintain our bearish GBP view and look to sell into rallies. While
                                            the stronger GDP number reduces the chances of further QE, it does not change the fiscal challenges the UK faces or the
     low real yields offered in the country. Furthermore, while the broad-based improvement in services is encouraging, we are
                                            concerned the strong reading could lead to complacency from policy-makers, slowing further gains in the UK economy.

             CHF                            Floor to Stay                                     Neutral      Watch: KoF Swiss Leading Indicator, PMI

               0.7%                         CHF is becoming increasingly attractive as a funding currency given its negative real yields and the stability provided by the
                                            EURCHF floor. Indeed, CHF was the worst-performing G10 currency over the past week. With the central bank likely to
     maintain its accommodative monetary policy and exchange rate floor, the conditions that suggest CHF could be used as a
                                            funding currency remain. CHF is particularly attractive against USD, as the latter has been increasing its beta to risk.

             CAD                            Near-Term Upside                                  Bullish      Watch: GDP, Industrial Product Prices, Trade

               2.1%                         We maintain our medium-term bullish CAD view. Canada’s liquid AAA bond market is attractive as other G10 countries face
                                            downgrades. Furthermore, the BoC’s Carney reiterated that hikes will be appropriate at some point – while we believe that
      the central bank will remain on hold for the rest of the year, this tightening bias stands in stark contrast with other dovish G10
                                            central banks, and should support CAD. We are slightly more cautious in the near term given falling commodity prices.
             AUD                            Liquidity Over Adversity for Now                  Bullish      Watch: PMI, Building Approvals, Terms of Trade, PPI

              -1.4%                         We maintain our medium term AUD bullish view, as we think high real yields, a strong AAA rating, and a large liquid bond
                                            market should support the currency. Indeed, S&P reaffirmed the country’s AAA rating just this week. However, over the
     longer term the currency could be challenged by weakening fundamentals, including the end of the commodity supercycle.
                                            We will watch to see if Australian terms of trade continue to decline, suggesting falling consumer purchasing power.
             NZD                            G10 Outperformer                                  Bullish      Watch: Building permits, M3, Commodity Prices

               0.5%                         NZD has outperformed in the G10 space, and we expect this trend to continue. High real yields and a more hawkish central
                                            bank should boost the currency, particularly in an environment of abundant central bank liquidity and globally low rates.
     While commodity prices have been underperforming, agricultural prices have not been hit as hard as industrials. New
                                            Zealand is more exposed to soft commodities, so should benefit from this divergence.

             SEK                            Stuck in the Middle                               Neutral      Watch: Econ Tend. Survey, Trade, Riksbank Minutes, Retail Sales, PMI

               1.3%                         SEK is currently stuck between two forces. On the one hand, a weakening German economic outlook bodes poorly for
                                            Swedish growth, given its large export exposure into the core of Europe. On the other hand, its AAA rating, relatively high
     yield, and current account surplus makes SEK an attractive investment for many real money investors. As such, we expect
                                            relatively range-bound trading. The Economic Tendency survey, retail sales, and PMI are all big risk events this week.
            NOK                             Still an Alternative Safe Haven                   Neutral      Watch: Unemployment Rate, Retail Sales, PMI

               5.5%                         NOK is likely to underperform other risky currencies in the current environment of strong risk appetite. Furthermore, soft oil
                                            prices should also hurt the Norwegian economy, given crude’s large dominance in its export basket. Nonetheless, the
     currency’s fiscal and trade surpluses mean that it will likely retain its alternative safe haven status, and should risk appetite
                                            fade, it will remain relatively well supported. On the week, the labor data, retail sales, and PMI will be important to watch.



                                                                                                                                                                            28
                                                                                                                  MORGAN STANLEY RESEARCH

                                                                                                                   April 25, 2013
                                                                                                                   FX Pulse




EM Currency Summary
EM Strategy Team
                            -0.4%
                                                                      External demand improvements, stronger demand from domestic firms for RMB and capital inflows provide
CNY    Neutral
                                 context for modest appreciation pressures going forward.
                              1.5%
                                                                      Ongoing efforts at structural reform are a medium-term supportive factor for INR, as is the high carry. However,
INR    Bullish
                                 in the near term, a less dovish RBI and political jitters might keep the currency at weaker levels.
                            -1.2%
       Bearis                                                         Given the challenging macro backdrop of current account deficit, along with high growth and rising inflation we
IDR    h                         are biased towards further IDR depreciation in the long term.
                                                                      KRW remains under pressure due to JPY weakness and geopolitical tensions. However, this move is heading
                              6.8%
                                                                      towards oversold territory and should reverse as tensions in the region abate. Medium term KRW should remain
KRW    Neutral
                                neutral as improved data would encourage foreign inflows, but the government is likely to implement macro-
                                                                      prudential measures to limit the pace of FX appreciation.
                              0.9%                                    MYR should be supported in the medium term by the strong macro mix, including a still-healthy current account
MYR    Bullish
                                surplus, and increased foreign demand for local bonds – although we might see some near term weakness due
                                                                      to the upcoming elections in May.
                            -2.4%                                     THB has been among the biggest beneficiaries of the reflationary flows from Japan into EM bonds, and also
THB    Bullish
                                 continues to be supported by its positive macro-dynamic environment. We think these foreign inflows will keep
                                                                      appreciation pressure on THB even though valuations seem stretched.

                              3.5%                                    Positive macro environment of high growth, stable inflation and a steady current account surplus keep us bullish
PHP    Bullish
                                 on the currency. Also, the recent upgrade to investment grade by Fitch and a disciplined fiscal balance makes
                                                                      the high yielding Peso bonds attractive for foreign investment.

                              2.8%                                    EUR/CZK has found a top to its upward trend at the 26.00 level and we think it would take a significant
CZK    Neutral
                                deterioration in the domestic/external economy and/or a more aggressive tone from the CNB (who have kept to
                                                                      a weak CZK bias) to see a break above this level in the near term. As such we are neutral.
                              2.3%                                    Our strategy of buying EUR/HUF on the dip has worked, and we maintain a bearish view on the currency as we
       Bearis
HUF    h                         expect the National Bank of Hungary to persist with additional rate cuts, and as there remains a high risk for
                                                                      other unorthodox measures to be taken to stimulate the economy.
                            -2.8%                                     The BoI intervention earlier in the month has slowed down the fall in USD/ILS; however, we think the ILS should
ILS    Bullish
                                 ultimately strengthen over the medium term given a supportive fundamental story in Israel. As such, we
                                                                      recommend buying ILS on any dips.
                              2.6%                                    The most recent data in Poland has been relatively weak; however our economists continue to believe that rates
PLN    Bullish
                                should remain on hold for now. We think rates on-hold, in addition to prospect for more inflows related to increased
                                                                      global liquidity, is likely to keep PLN supported.
                              4.2%                                    In the latest MPC meeting we have seen a shift in policy bias that opens the door for future rate cuts, in our
       Bearis
RUB    h                        economist’s view. This changing policy, along with a risk that the Central Bank of Russia’s mandate will place
                                                                      greater emphasis on growth has increased the downside-risks to our RUB forecasts.
                              1.9%
       Bearis                                                         We expect TRY to come under pressure as we believe the market will anticipate further measures by the CBT to
TRY    h                         depreciate the currency.

                              2.4%                                    We think USD/ZAR can head higher over coming months and recently revised our USD/ZAR peak to 9.40.
       Bearis
ZAR    h                        Indeed fundamentals remain weak, and positioning in the local market remains heavy, which leaves the currency
                                                                      vulnerable to another period of weakness.
                            -2.7%
                                                                      We see USD/BRL staying between 1.95 and 2.0, due to BCB’s intervention on both the weak- and the strong-
BRL    Neutral
                                 side of the currency, and on the back of high inflation and low growth concerns.
                            -0.6%                                     The market has tested the central bank’s resolve to stem currency strength as copper rallied aggressively after
CLP    Neutral
                                the positive Chinese inflation data. We expect however the currency to revert back to levels very close to 470 on
                                                                      the back of verbal intervention from policy-makers, and do not expect them to resort to USD buying.
                              2.8%                                    COP continues to weaken on the back of verbal intervention from policy-makers, attempting to continue to
COP    Neutral
                                 weaken it to 1,950. We believe they will be unsuccessful in the long-run however, and COP will see appreciating
                                                                      pressures this month given the repatriation of flows and strong FDI.
                            -3.8%                                     BoJ stimulus has pushed MXN to rally further close to two-year highs, despite the Banxico showing signs of
MXN    Bullish
                                increasing discomfort towards the currency’s strength. Nevertheless, we do not believe they are likely to
                                                                      intervene to stem further strength at current levels, and see further upside for USD/MXN and JPY/MXN.
                              1.1%                                    USD/PEN has rallied on the back of BoJ stimulus, and the Central Bank of Peru has reacted by buying USD
PEN    Neutral                      even more aggressively, thus further draining dollar liquidity. We expect them to attempt to defend the currency
                                                                      more forcefully near 2.57 levels.




                                                                                                                                                                                       29
                                                                                   MORGAN STANLEY RESEARCH

                                                                                   April 25, 2013
                                                                                   FX Pulse




Global Event Risk Calendar
Marc Englander

Date   (BST)           Ccy            Time   Event                                                    Ref. Period   MS forecast   Market    Previous
       25-Apr   Thur
                         JPY    NA           BoJ Rate Decision                                            26-Apr         0.10%     0.10%      0.10%
       26-Apr   Fri
                        CHF     8:30         KOF Swiss Leading Indicator                                     Apr                     0.98       0.99
                        COP      NA          BANREP Rate Decision                                         26-Apr        3.00%      3.25%      3.25%
                        EUR     9:00         Eurozone M3                                                     Mar        2.8%Y      3.0%Y      3.1%Y
                        EUR    11:00         ECB Announces 3-Year LTRO Repayment
                        JPY     0:15         Markit/JMMA PMI Manufacturing                                   Apr                                50.4
                        JPY     0:30         CPI                                                             Mar                             -0.7%Y
                        JPY    7:30          BoJ's Kuroda spks
                        MXN    15:00         Banxico Rate Decision                                          Apr          4.00%     4.00%     4.00%
                        SEK     8:15         Consumer Confidence                                            Apr                       3.9        2.8
                        SEK    8:30          Trade Balance                                                  Mar                                7.1B
                        SEK    8:30          Household Lending                                              Mar                   4.6%Y      4.5%Y
                        USD    13:30         GDP                                                           1Q A         2.9%Q     3.0%Q      0.4%Q
                        USD    14:55         U. of Michigan Confidence                                     Apr F           73.9      73.5       72.3
       27-Apr   Sat
                        CNY    2:30          Industrial Production                                           Mar                            17.2%Y
                        CNY     NA           Leading Index                                                   Mar                             100.23
       29-Apr   Mon
                        EUR    10:00         Eurozone Economic Confidence                                     Apr                    89.5        90
                        NZD    23:45         Building Permits                                                Mar                              1.9%Y
                        SEK     8:30         Riksbank Monetary Policy Minutes                       Mtg of Apr-16
                        SEK     8:30         Retail Sales                                                    Mar                             1.0%M
                        USD    13:30         PCE Core                                                        Mar                  0.1%M      0.1%M
                        USD    15:00         Pending Home Sales                                              Mar                  0.9%M     -0.4%M
                        USD    15:30         Dallas Fed Manufacturing Activity                                Apr                               7.4
       30-Apr Tues
                        AUD     2:30         Private Sector Credit                                           Mar                  0.3%M      0.2%M
                        CAD    13:30         GDP                                                             Feb                             1.0%Y
                        CHF     6:30         SNB's 1st Quarter Results
                        EUR    10:00         Eurozone CPI                                                    Apr                   1.6%Y      1.7%Y
                        EUR    10:00         Eurozone unemployment rate                                      Mar                  12.10%     12.00%
                        GBP     9:30         Mortgage Approvals                                              Mar                               51.7K
                        GBP     9:30         M4                                                              Mar                              0.5%Y
                        JPY     0:30         Overall H'hold Spending                                         Mar                              0.8%Y
                        JPY     0:50         Industrial Production                                           Mar                              0.6%M
                        NOK     9:00         Retail Sales                                                    Mar                              0.5%M
                        NOK    11:15         Norges Bank Governor Address Parliament
                        NZD     4:00         M3                                                              Mar                             6.6%Y
                        USD    14:00         S&P/CaseShiller Home Price Index                                Feb                             146.14
                        USD    14:45         Chicago PMI                                                     Apr                       53      52.4
                        USD    15:00         Consumer Confidence                                             Apr          59.0       60.0      59.7
       1-May    Wed
                        AUD     0:30         AiG Performance Manufacturing Index                             Apr                                44.4
                        CAD    22:50         BoC's Carney spks (Alberta)
                        CNY     2:00         Manufacturing PMI                                               Apr                     50.9       50.9
                        GBP     9:30         Manufacturing PMI                                               Apr                     48.8       48.3
                        NOK    8:00          PMI                                                             Apr                                50.1
                        USD    13:15         ADP Employment Change                                           Apr                               158K
                        USD    15:00         Construction Spending                                           Mar         0.2%Y     0.5%Y      1.2%Y
                        USD    15:00         ISM Manufacturing                                               Apr           50.3      51.0       51.3
                        USD    19:00         FOMC Rate Decision                                            1-May         0.25%     0.25%      0.25%
                        USD    22:00         Vehicle Sales                                                   Apr        15.20M    15.30M     15.22M
       2-May    Thur
                        AUD     2:30         Building Approvals                                              Mar                  1.5%M       3.1%M
                        AUD     2:30         Export Price Index                                               1Q                  4.1%Q      -2.4%Q
                        CAD    13:30         Int'l Merchandise Trade                                         Mar                              -1.02B
                        CHF     8:30         PMI Manufacturing                                               Apr                                 48.3
                        CZK    12:00         CNB Rate Decision                                             2-May         0.05%     0.05%      0.05%
                        EUR     9:00         Eurozone PMI Manufacturing                                      Apr                     46.5        46.5
                        EUR    12:45         ECB Rate Decision                                             2-May         0.50%     0.50%      0.75%
                        EUR    13:30         ECB's Draghi holds Press Conference
                        GBP     9:30         PMI Construction                                                Apr                                47.2
                        RON      NA          BNR Rate Decision                                            2-May          5.25%     5.25%      5.25%
                        SEK     7:30         PMI                                                             Apr                                52.1
                        USD    13:30         Trade Balance                                                  Mar        -$41.8B    -$42.3B   -$43.0B
                        USD    13:30         Nonfarm Productivity                                          1Q P                    1.7%Q    -1.9%Q
                        USD    13:30         Initial Jobless Claims                                 Wk of Apr-26                               339K



                                                                                                                                                 30
                                                                                                  MORGAN STANLEY RESEARCH

                                                                                                  April 25, 2013
                                                                                                  FX Pulse




Date   (BST)               Ccy           Time         Event                                                              Ref. Period   MS forecast   Market     Previous
        3-May     Fri
                             AUD    2:30              PPI                                                                        1Q                               1.0%Y
                             CAD    18:05             BoC's Carney spks (Toronto)
                             CNY     2:00             Non-Manufacturing PMI                                                     Apr                                  55.6
                             EUR    10:00             Eurozone PPI                                                              Mar                               0.2%M
                             EUR    11:00             ECB Announces 3-Year LTRO Repayment
                             EUR    14:00             Belgian GDP                                                              1Q P                              -0.1%Q
                             EUR      NA              EU Releases Spring Economic Forecasts
                             GBP     9:30             PMI Services                                                              Apr                     52.1         52.4
                              INR    6:00             RBI Rate Decision                                                       3-May         7.25%     7.25%       7.50%
                             NOK     9:00             Unemployment Rate                                                         Apr                               2.70%
                             USD    13:30             Change in Nonfarm Payrolls                                                Apr          110K       155K         88K
                             USD    13:30             Unemployment Rate                                                         Apr        7.60%      7.60%       7.60%
                             USD    13:30             Average Hourly Earnings                                                   Apr        0.1%M      0.2%M       0.0%M
                             USD    15:00             Factory Orders                                                            Mar                  -1.3%M       3.0%M
                             USD    15:00             ISM Non-Manufacturing Composite                                           Apr                      54.4        54.4
        6-May    Mon
                             AUD    2:30              Retail sales (MoM)                                                       Mar                                 1.30%
                             CAD    13:30             Building Permits (MoM)                                                   Mar                                 1.70%
                             CAD    15:00             Ivey Purchasing Managers Index                                           Apr                                   61.6
                             EUR    9:00              Eurozone PMI Composite                                                  Apr F                                  46.5
                             EUR    10:00             Euro-Zone Retail Sales (MoM)                                             Mar                                -0.30%
                             EUR    14:00             Draghi Speaks at University Ceremony in Rome
                              ILS    NA               BoI Rate Decision
                             RUB     NA               CRB Rate Decision                                                       2-May                               8.25%
                             SEK    7:30              PMI Services                                                              Apr
        7-May   Tues
                             AUD     2:30             Trade Balance                                                             Mar                                -178M
                             AUD     5:30             RBA Rate Decision                                                       7-May         3.00%     3.00%        3.00%
                             CHF     6:45             Unemployment Rate                                                         Apr                                3.10%
                             CHF    6:45              SECO Consumer Confidence                                                  Apr                                    -6
                             CHF    8:00              FX Reserves                                                               Apr                               438.3B
                             CNY     NA               Trade Balance (USD)                                                       Apr                              -$0.88B
                             EUR    11:00             German Factory Orders (MoM)                                               Mar                                2.30%
                             NZD    22:00             RBNZ Financial Stability Report
                             SEK     8:30             Industrial Production (MoM)                                               Mar                                0.50%
                             USD    20:00             Consumer Credit                                                           Mar                             $18.139B
        8-May   Wed
                             CAD    13:15             Housing Starts                                                            Apr                               180.9K
                             CHF     8:15             CPI (YoY)                                                                 Apr                               -0.60%
                             NOK     9:00             Industrial Production (MoM)                                               Mar                               -1.90%
                             NOK    13:00             Norges Bank Rate Decision                                               8-May         1.50%     1.50%        1.50%
                             NZD    23:45             Unemployment Rate                                                          1Q                                6.90%
                             PLN     NA               NBP Rate Decision                                                       8-May         3.25%     3.25%        3.25%
                             SEK     8:30             Budget Balance                                                            Apr                                  5.8B
        9-May Thurs
                             AUD    2:30              Full Time Employment Change                                               Apr                                 -7.4K
                             CNY    2:30              CPI (YoY)                                                                 Apr                                2.10%
                             CNY     NA               New Yuan Loans                                                            Apr                              1060.0B
                             CNY     NA               Money Supply - M2 (YoY)                                                   Apr                               15.70%
                             GBP    9:30              Industrial Production (MoM)                                               Mar                                1.00%
                             GBP    12:00             BoE Rate Decision                                                       9-May         0.50%     0.50%        0.50%
                             GBP    15:00             GDP                                                                       Apr                                0.10%
                              JPY   6:00              Leading Index CI                                                        Mar P                                  97.6
                             KRW    2:00              BoK Rate Decision                                                       9-May         2.75%     2.75%        2.75%
                             MYR    11:00             BNM Rate Decision                                                       9-May                                3.00%
                             PEN    0:00              CRBP Rate Decision                                                        May         4.25%     4.25%        4.25%
                             USD    13:30             Initial Jobless Claims                                                  3-May
                             USD    15:00             Wholesale Sales (MoM)                                                     Mar                               1.70%
       10-May     Fri
                             AUD     2:30             RBA's Statement on Monetary Policy
                             CAD    13:30             Net Change in Employment                                                  Apr                               -54.5K
                             EUR    11:00             ECB Announces 3-Year LTRO Repayment
                             EUR      NA              European Commission Releases Economic Growth Forecasts
                             GBP     9:30             Total Trade Balance                                                       Mar                               -£3642
                              INT     NA              G-8 Mtg (UK)
                             JPY     6:00             Eco Watchers Survey: Outlook                                              Apr                                  57.5
                             JPY     0:50             Trade Balance                                                             Mar                             -¥677.0B
                             JPY     0:50             Bank Lending Ex-Trusts (YoY)                                              Apr                                1.90%
                             NOK     9:00             CPI (YoY)                                                                 Apr                                1.40%
                             USD    13:30             Fed's Bernanke Speaks at Chicago Fed Conference
                             USD    19:00             Monthly Budget Statement                                                  Apr
Extended Calendar
      13-May                 EUR    16:00             Eurogroup meeting (Brussels)
      14-May                 EUR     8:00             EcoFin meeting (Brussels)
      22-May                 EUR      NA              EU Summit
      29-May                 CAD    15:00             BoC Rate Decision                                                     29-May          1.00%     1.00%       1.00%
       7-Jun                  INT     NA              G20 Mtg
      12-Jun                 NZD    22:00             RNBZ Rate Decision                                                     13-Jun         2.50%     2.50%       2.50%
      20-Jun                 CHF     8:00             SNB Rate Decision                                                      20-Jun         0.00%     0.00%       0.00%
        3-Jul                SEK     8:30             Riksbank Rate Decision                                                   3-Jul        1.00%     1.00%       1.00%
      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




                                                                                                                                                                            31
                                                                                                                 MORGAN STANLEY RESEARCH

                                                                                                                 April 25, 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       6.2    -0.2     6%       1.3     83%       1.15     80%      1.12     88%     1.2     19%     75%     USDCAD     0.8    0.0    85%       0.13      95%       0.98        1.89
             USDCHF       8.2    0.2      8%       1.1     38%       1.10     78%      1.17     98%     1.3     16%     99%     USDCHF     -0.4   0.0    61%       -0.05     38%       -1.41       1.08
             USDJPY      12.6    -0.4    66%       1.0     18%       0.96     19%      1.14     48%     0.8      6%     90%     USDJPY     -0.2   0.0    89%       -0.02     88%       -1.63       1.97
             USDNOK       9.2    0.1      8%       1.0     35%       1.11     75%      1.17    100%     1.4     15%     71%     USDNOK     1.4    0.0    17%       0.15      72%       0.92        4.08
  G10




             USDSEK      10.1    0.4     10%       0.9     19%       1.08     70%      1.16    100%     1.4     13%     61%     USDSEK     0.8    0.0    43%       0.08      48%       0.90        2.41
             GBPUSD       7.4    0.0     11%       1.0     14%       1.10     49%      1.17     78%     -1.2    -16%    27%     GBPUSD     -0.2   0.0    57%       -0.03     36%       -0.54       2.36
  USD




             NZDUSD       9.8    -0.4    11%       1.0     32%       1.09     56%      1.15     99%     -1.9    -19%    48%     NZDUSD     -2.4   0.0    53%       -0.25     15%       -1.02       1.25
             AUDUSD       7.9    -0.3     7%       1.1     58%       1.13     72%      1.22    100%     -2.0    -25%    26%     AUDUSD     -2.7   -0.1   87%       -0.34     30%       -0.95       2.26
             EURUSD       8.4    0.0      8%       1.0     17%       1.10     71%      1.19    100%     -1.4    -16%    28%     EURUSD     0.2    0.0    77%       0.03      83%       1.30        2.43
  ,




             EURAUD       8.6    0.0     12%       1.0     31%       1.03     25%      1.21    100%     0.2      2%      3%     EURAUD     3.0    -0.1   25%       0.35      54%       0.98        2.31
             EURCAD       7.9    -0.3     9%       1.1     34%       1.06     52%      1.14     95%     -0.3    -4%     42%     EURCAD     1.1    0.0    81%       0.14      88%       1.05        2.21
             EURCHF       4.9    1.2     35%       1.1     50%       1.06     63%      1.54     81%     1.6     32%     94%     EURCHF     -0.1   0.0    99%       -0.03     98%       -1.60       1.86
             EURGBP       7.3    0.1     12%       0.8      1%       1.04     27%      1.14     68%     -0.2    -2%     34%     EURGBP     0.5    0.0    74%       0.06      77%       0.95        2.11
  G10




             EURJPY      14.8    0.0     56%       0.9      9%       0.97     15%      1.06     25%     -0.9    -6%     94%     EURJPY     0.0    0.0    95%       0.00      94%       0.89        2.34
             EURNOK       6.5    0.5     20%       1.1     56%       0.99     26%      1.14     91%     0.4      5%     16%     EURNOK     1.6    0.0    43%       0.25      71%       0.98        2.32
  EUR




             EURNZD       9.7    0.0     15%       1.0     42%       0.99     17%      1.19    100%     0.2      2%      3%     EURNZD     2.8    0.0    66%       0.29      80%       1.05
             EURSEK       6.7    0.3     20%       0.9     18%       1.00     33%      1.19    100%     0.4      6%     15%     EURSEK     1.0    0.0    57%       0.15      64%       1.00        2.15
  ,




             GBPAUD       7.8    -0.5     9%       0.9     20%       1.09     59%      1.18     98%     0.2      2%      8%     GBPAUD     2.5    -0.1   18%       0.32      52%       0.98        2.22




                                                                                                                                                                                                             Volatility and Carry Global Heatmap
             GBPCAD       7.3    -0.4    13%       0.9     13%       1.03     34%      1.13     89%     -0.4    -5%     39%     GBPCAD     0.6    0.0    78%       0.09      81%       1.12        4.15
             GBPCHF       7.2    0.5      8%       1.0     29%       1.05     37%      1.27     82%     -0.1    -1%     94%     GBPCHF     -0.6   0.0    74%       -0.08     37%       -1.11       2.08
             GBPJPY      13.1    -0.1    39%       0.9     16%       0.97     12%      1.09     30%     -0.8    -6%     92%     GBPJPY     -0.4   0.0    91%       -0.03     72%       -1.09
  G10




             CHFJPY      13.4    0.2     55%       0.9     17%       0.96     15%      1.08     39%     -0.7    -5%     82%     CHFJPY     0.2    0.0    75%       0.01      76%       1.15       -0.27
             AUDCAD       5.9    -0.6     3%       1.0     19%       1.12     76%      1.17     98%     -0.8    -13%    52%     AUDCAD     -1.9   0.0    97%       -0.33     59%       -0.90       2.00
  Crosses




             AUDCHF       8.2    0.1      6%       0.9     31%       1.09     54%      1.26     98%     -0.7    -9%     89%     AUDCHF     -3.1   0.0    84%       -0.38     30%       -0.98
             AUDJPY      13.8    -0.3    27%       1.0     38%       0.98     18%      1.12     34%     -1.3    -9%     95%     AUDJPY     -3.0   0.1    87%       -0.22     68%       -0.96       2.21
             AUDNZD       6.1    -0.1    13%       0.9     14%       1.02     55%      1.15     98%     -0.2    -3%     37%     AUDNZD     -0.2   -0.1   82%       -0.03     82%       -0.05       2.12
             NOKSEK       6.2    0.3     21%       1.0     22%       0.98     23%      1.21     95%     0.2      3%     25%     NOKSEK     -0.6   0.0    57%       -0.09     54%       -5.09       0.23
  ,




             USDCNY       1.5    -0.2    11%       1.4     33%       1.45     38%      2.89     79%     0.0      0%     42%     USDCNY     0.0    -0.4   64%       0.02      64%       7.28        2.34
             USDHKD       0.5    0.0      5%       1.9     58%       1.58     63%      6.06     65%     -0.5    #####   28%     USDHKD     -0.2   0.0    70%       -0.36     46%       -0.73       5.13
             USDIDR       6.8    0.0      8%       1.7     76%       1.43     82%      1.53     80%     2.7     40%     52%     USDIDR     3.4    0.3    28%       0.50      61%       1.42        1.99
             USDINR       8.8    -0.3    18%       1.1     34%       1.13     78%      1.40     98%     0.6      7%      6%     USDINR     6.0    0.2    51%       0.68      73%       1.04        2.68
AXJ BLOCK




             USDKRW       8.4    -0.5    11%       1.2     55%       1.20     80%      1.44     87%     3.0     36%     84%     USDKRW     1.5    0.0    44%       0.18      65%       0.85        1.79
             USDMYR       7.4    0.3     26%       1.5     85%       0.97     5%       1.42     95%     1.8     24%     64%     USDMYR     2.1    0.1    79%       0.28      81%       0.94        1.88
             USDPHP       5.2    0.0      7%       1.4     61%       1.15     54%      1.58     94%     1.2     23%     43%     USDPHP     -0.1   -0.3   17%       -0.03     16%       -1.00       1.64
             USDSGD       4.2    0.5      5%       1.5     86%       1.15     72%      1.67     96%     1.1     26%     88%     USDSGD     0.0    0.0    49%       -0.01     42%       -2.92       1.62
             USDTHB       5.5    0.0     25%       1.3     29%       1.14     19%      1.25     31%     0.8     15%     48%     USDTHB                                                 1.01        2.02
             USDTWD       3.7    0.1      3%       1.1     19%       1.12     38%      1.90     99%     1.0     27%     93%     USDTWD     -1.1   0.1    71%       -0.29     57%       -1.12       1.44
,




             USDARS      15.0    0.0     62%      15.9     94%       1.83     42%      1.71     46%     7.0     47%     32%     USDARS     45.4   3.6    88%       3.03      94%       1.09        2.64
             USDCLP       8.1    0.2      4%       2.4     99%       1.15     81%      1.54    100%     2.3     28%     60%     USDCLP     5.3    -0.1   89%       0.65      96%       0.88        2.08
             USDCOP       7.3    0.0      3%       1.6     63%       1.24     90%      1.43    100%     2.3     31%     63%     USDCOP     3.1    -0.1   47%       0.43      84%       0.98        2.09
  LATAM




             USDMXN       9.5    -0.9    10%       1.3     56%       1.13     73%      1.29     88%     2.2     23%     10%     USDMXN     3.1    -0.1   13%       0.32      63%       1.04        1.95
             USDBRL       9.0    -1.3     8%       1.2     55%       1.19     71%      1.40     88%     2.2     24%     10%     USDBRL     4.6    -0.3    4%       0.51      57%       1.21        2.37
             EURBRL      10.7    -0.6    17%       1.0     35%       1.12     42%      1.33     66%     2.0     19%      1%     EURBRL     4.9    -0.3    5%       0.46      29%       1.22        2.34
  BLOCK




             EURMXN       9.8    -0.7     8%       1.2     43%       1.11     61%      1.33     87%     1.2     12%      5%     EURMXN     3.3    -0.1   30%       0.34      77%       1.06        2.11
             BRLJPY      16.2    -1.2    33%       1.0     27%       1.03     22%      1.22     48%     -1.5    -9%     99%     BRLJPY     -4.6   -0.3   96%       -0.29     88%       -1.22       0.64
             MXNJPY      16.8    -1.0    47%       1.0     25%       0.99     22%      1.14     61%     -2.3    -13%    99%     MXNJPY     -3.2   -0.1   96%       -0.19     85%       -1.07       0.47
  ,




             EURCZK       5.1    0.0      0%       1.2     51%       1.09     86%      1.06     96%     0.9     18%     23%     EURCZK     0.0    0.0    30%       0.01      31%       1.06        1.69
             EURHUF       9.2    0.5     15%       1.2     75%       1.04     60%      1.02     73%     2.3     25%     29%     EURHUF     3.8    -0.4   16%       0.41      52%       0.73        2.09
             EURILS       7.5    0.3      9%       1.0     40%       1.03     48%      1.19     99%     0.6      7%     85%     EURILS     1.4    0.1    73%       0.19      79%       0.93        2.18
             EURPLN       6.6    0.1      3%       1.2     78%       1.14     80%      1.05     94%     1.3     19%     11%     EURPLN     2.8    -0.2   59%       0.43      80%       0.84        2.08
             EURRUB       8.7    0.4     17%       1.3     90%       1.04     9%       1.53     93%     1.6     18%     36%     EURRUB     6.2    0.1    55%       0.71      72%       0.96        2.56
             EURTRY       6.7    0.2      3%       1.0     31%       1.18     60%      1.56     96%     1.1     17%     14%     EURTRY     4.2    -0.2    1%       0.64      63%       1.08        2.43
  EMEA




             EURZAR      12.2    0.0     14%       1.0     23%       1.17     91%      1.22     80%     1.5     12%      2%     EURZAR     5.2    0.0    19%       0.43      60%       0.99        2.24
             USDHUF      13.6    0.5      8%       1.1     75%       1.06     68%      1.01     77%     2.8     21%     47%     USDHUF     3.5    -0.4    5%       0.26      42%       0.69        1.97
             USDILS       7.3    0.2     14%       1.4     87%       1.08     79%      1.14     94%     1.7     23%     85%     USDILS     1.2    0.1    58%       0.16      73%       0.86        1.90
  BLOCK




             USDPLN      11.8    0.2     10%       1.1     70%       1.12     83%      1.05     96%     1.8     15%      9%     USDPLN     2.5    -0.2   21%       0.22      65%       0.80        1.93
             USDRUB       9.4    0.3     17%       1.1     47%       1.05     13%      1.48     96%     2.1     22%     19%     USDRUB     6.0    0.1    53%       0.64      74%       0.94        2.33
             USDTRY       6.1    0.2      2%       1.2     48%       1.29     92%      1.61     97%     1.7     28%     46%     USDTRY     4.0    -0.2    0%       0.65      74%       1.07        2.28
             USDZAR      12.8    0.0      3%       1.1     49%       1.18     96%      1.22     90%     2.1     16%      0%     USDZAR     5.0    0.0     2%       0.39      69%       0.98        2.09
  , COMMOD




             Gold        12.9    0.7      4%       1.1     55%       1.24     63%      1.51     99%     -0.3    -2%      6%     Gold       -0.3   -0.3   51%       -0.02     41%       -0.86
             Silver      22.3    0.3      1%       1.0     45%       1.15     92%      1.14     83%     -1.4    -6%     22%     Silver     -0.6   -0.1   38%       -0.03     30%       0.63
             Platinum    17.5    -0.3     3%       1.1     41%       1.11     12%      1.15      na     1.3      8%      na     Platinum   -0.6   0.4    67%       -0.03     35%       -0.90

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

                                                                                                                                                                                                                    32
                                                                           MORGAN STANLEY RESEARCH

                                                                           April 25, 2013
                                                                           FX Pulse




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



                                                                                                                                                   33
                                                                                MORGAN STANLEY RESEARCH

                                                                                April 25, 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%

   -6%                                                                        -100
             EUR NZD GBP CHF DXY NOK CAD SEK AUD JPY                             Dec-12                               Feb-13                             Apr-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

    5
                                                                                     2

                                                                                     1
    0
                                                                                     0

    -5                                                                            -1

                                                                                  -2
  -10
                                                                                  -3
             USD   GBP       EUR   CAD JPY   NZD AUD       CHF   NOK   SEK
                                   Current    Last Pulse                          Mar-12                 Jul-12                 Nov-12                Mar-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
                                                                                 AUD
    0.2
                                                                                 MXN
   0.15
    0.1                                                                          NZD

   0.05                                                                          CHF

         0                                                                       GBP
  -0.05                                                                          CAD
   -0.1                                                                           JPY
  -0.15
                                                                                 EUR
   -0.2
     May-12         Jul-12     Sep-12   Nov-12   Jan-13    Mar-13   May-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




                                                                                                                                                                   34
                                                                                                                     MORGAN STANLEY RESEARCH

                                                                                                                     April 25, 2013
                                                                                                                     FX Pulse




Morgan Stanley FX Positioning Tracker
Calvin Tse, Gabriel de Kock and Marc Englander

Overall Score                                                                           Component Scores
         This    Last
         Week    Week           Short               Neutral               Long           MS                                   Senti-            Since the last positioning tracker update (April
                       -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               22), positioning in the G10 currencies has
                                                                                                                                                 shifted slightly. We calculate the largest long
  USD      5      5                                                                     10      4              3       7       2      USD
                                                                                                                                                 positions to be in SEK, NZD, and USD. The
  EUR     -4      -5                                                                   -8      4             -6       -6     -3      EUR       largest shorts are in CAD.
  JPY     -4      -4                                                                    -8     -10     2      -3       0      -7      JPY
                                                                                                                                                EUR short positioning moderated intra-week as
  GBP     -5      -5                                                                    -9      -9            -1       1      -4      GBP       Japanese leveraged accounts and global macro
                                                                                                                                                 hedge funds partially covered positions.
  CHF     -2      -1                                                                   -1      0                             -6      CHF

  CAD     -8      -9                                                                   -8     -10                            -7      CAD      AUD positioning moved to long from neutral as
                                                                                                                                                 Japanese retail were buyers.
  AUD      3      2                                                                    -1      0              8               3      AUD
                                                                                                                                                We will provide a full updated report and refresh
  NZD      5      4                                                                     3     10              4               1      NZD
                                                                                                                                                 positioning scores for all of our underlying sub-
  NOK      3      3                                                                      3                                            NOK       indicators next Monday.
  SEK      9      9                                                                      9                                            SEK                           For Methodology see Appendix




Morgan Stanley High-Frequency Misalignment Monitor
1Yr                                                      24 April, 2013
                 EUR          JPY                GBP         CHF             AUD         CAD           NZD            NOK            SEK
                                                                                                                                                SEK appears to have fallen into undervalued
USD             -0.6%         1.3%              -1.4%       -0.6%            0.2%        0.8%         -1.0%          -1.1%          -3.6%
                                                                                                                                                 territory on our one-year high-frequency
EUR                           1.9%              -0.8%        0.0%            0.8%        1.4%         -0.4%          -0.5%          -3.0%        misalignment metrics. In addition, we remain
JPY                                             -2.7%       -1.9%           -1.2%       -0.5%         -2.4%          -2.5%          -4.9%        bearish GBP, despite its seemingly relative
GBP                                                          0.8%            1.6%        2.2%          0.4%           0.2%          -2.2%        cheapness given the UK’s longer-term
CHF                                                                          0.7%        1.4%         -0.4%          -0.6%          -3.0%        fundamentals.
AUD                                                                                      0.7%         -1.2%          -1.3%          -3.8%
CAD         > +/- 1 sd                                                                                -1.8%          -2.0%          -4.4%       Interestingly, the one-year model yielded the
NZD         > +/- 2 sd                                                                                               -0.1%          -2.6%
                                                                                                                                                 highest and most reliable trading profits in back-
                                                                                                                                                 tests. SEK, NZD and NOK appear to be the
NOK         > +/- 3 sd                                                                                                              -2.4%
                                                                                                                                                 cheapest in the G10 space, followed by GBP.
2Yr                                                                                                                                              The model signals a long SEK against CAD and
                 EUR          JPY                GBP           CHF           AUD         CAD           NZD            NOK            SEK         NOK position with 2-3σ misalignments.
USD             -1.3%         1.7%              -2.1%          1.1%          1.2%       -1.4%          1.4%          -0.6%          -0.8%
                                                                                                                                                Over a two-year look-back window, the matrix
EUR                           3.0%              -0.8%          2.4%          2.5%        0.0%          2.8%           0.7%           0.6%        continues to highlight CAD as very undervalued,
JPY                                             -3.8%         -0.6%         -0.5%       -3.1%         -0.3%          -2.3%          -2.5%        particularly against AUD or JPY. In addition, the
GBP                                                            3.2%          3.3%        0.7%          3.5%           1.5%           1.3%        model signals potential short NZD positions
CHF                                                                          0.1%       -2.4%          0.3%          -1.7%          -1.9%        against CAD.
AUD                                                                                     -2.6%          0.2%          -1.8%          -2.0%
CAD         > +/- 1 sd                                                                                 2.8%           0.7%           0.6%       Through the three-year model, which yields the
                                                                                                                                                 slowest-changing misalignment estimates, CHF
NZD         > +/- 2 sd                                                                                               -2.0%          -2.2%
                                                                                                                                                 and AUD appear to be the most expensive G10
NOK         > +/- 3 sd                                                                                                              -0.2%        currencies. The three-year appears to be
3Yr                                                                                                                                              beginning to align with the one- and two-year
                 EUR          JPY                GBP          CHF           AUD          CAD           NZD            NOK            SEK         monitors, signaling both more JPY overvaluation
                                                                                                                                                 and SEK undervaluation.
USD             -0.1%         0.9%              -3.3%         1.5%          3.1%        -0.8%          0.9%           0.0%          -2.4%
EUR                           1.1%              -3.1%         1.6%          3.2%        -0.7%          1.1%           0.1%          -2.3%       Broadly, the misalignment monitors signal CHF
JPY                                             -4.2%         0.6%          2.2%        -1.7%          0.0%          -0.9%          -3.3%        and AUD shorts, particularly against CAD and
GBP                                                           4.8%          6.4%         2.5%          4.2%           3.3%           0.9%        SEK. Of note, we are increasingly constructive
CHF                                                                         1.6%        -2.3%         -0.6%          -1.5%          -3.9%        on USD and bearish on GBP on longer-term
AUD                                                                                     -3.9%         -2.2%          -3.1%          -5.5%        fundamental grounds.
CAD         > +/- 1 sd                                                                                 1.7%           0.8%          -1.6%                            For Methodology see Appendix
NZD         > +/- 2 sd                                                                                               -0.9%          -3.3%
NOK         > +/- 3 sd                                                                                                              -2.4%
Note: Misalignment measured as the overvaluation of the column currency versus the row currency




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                                                                                                      FX Pulse




Central Bank Watch
                         Next rate             Market               MS                                                           Morgan Stanley Rates Forecasts
                         decision            expects (bp)       expects (bp)           Current             2Q13               3Q13               4Q13                1Q14               2Q14
US                        01 May                   0                  0                  0.15                 0.15             0.15              0.15                0.15               0.15
Euro Area                 02 May                   0                 -25                 0.75                 0.50             0.50              0.50                0.50               0.50
Japan                      26 Apr                  0                  0                  0.05              0.025              0.025             0.025                0.025              0.025
UK                        09 May                   -2                 0                  0.50                 0.50             0.50              0.50                0.50               0.50
Canada                    29 May                   0                  0                  1.00                 1.00             1.00              1.00                1.00               1.00
Switzerland                20 Jun                  -                  0                  0.00                 0.00             0.00              0.00                0.00               0.00
Sweden                       03 Jul               -12                 0                  1.00                 1.00            1.00               1.00                1.00               1.00
Norway                    08 May                   -7                 0                  1.50                 1.50             1.75              1.75                2.00               2.25
Australia                 07 May                  -10                 0                  3.00                 3.00            3.00               3.00                3.00               3.00
New Zealand                13 Jun                  -1                 0                  2.50                 2.50             2.50              2.50                2.75               3.00
Russia                  01-15 May                  -                  0                  5.50                 5.50             5.50              5.25                5.00               4.75
Poland                    08 May                   -                  0                  3.25                 3.25             3.25              3.25                3.25               3.25
Czech Rep                 02 May                   -                  0                  0.05                 0.05             0.05              0.05                0.25               0.50
Hungary                   28 May                   -                 -25                 4.75                 4.50             4.50              4.50                4.50               4.50
Romania                   02 May                   -                  0                  5.25                 5.25             5.25              5.25                5.25               5.25
Turkey                    16 May                   0                  0                  5.00                 5.00             5.00              5.00                5.00               5.50
Israel                    27 May                   -                 -25                 1.75                 1.50             1.50              1.50                2.00               2.50
South Africa              23 May                   -                  0                  5.00                 5.00             5.00              5.00                5.00               5.00
Nigeria                   21 May                   -                  0                 12.00              12.00              12.00             11.00                9.50               9.50
Ghana                     08 May                   -                  0                 15.00              15.00              15.00             15.00                15.00              15.00
China                         N/A                  -                  0                  6.00                 6.00             6.00              6.25                6.25               6.50
India                     03 May                  -25                 0                  7.50                 7.25             7.25              7.25                7.00               7.00
Hong Kong                 01 May                   -                   -                 0.50                 0.50             0.50              0.50                0.50               0.50
S. Korea                  09 May                   -                  0                  2.75                 2.75             2.75              2.75                3.00               3.25
Taiwan                     20 Jun                  -                  0                 1.875              1.875              1.875              2.00                2.125              2.25
Indonesia                 14 May                   -                  0                  5.75                 5.75             5.75              5.75                5.75               5.75
Malaysia                  09 May                   -                  0                  3.00                 3.00             3.00              3.00                3.00               3.00
Thailand                  29 May                   -                  0                  2.75                 2.75             2.75              3.25                3.50               3.50
Brazil                    29 May                   -                  25                 7.50                 7.75             8.25              8.25                8.25               8.25
Mexico                     26 Apr                  0                  0                  4.00                 4.00             4.00              4.00                4.00               4.00
Chile                     16 May                   0                  0                  5.00                 5.00             5.00              5.00                5.50               5.50
Peru                      09 May                   0                  0                  4.25                 4.25             4.25              4.25                4.50               4.75
Colombia                   26 Apr                  0                 -25                 3.25                 2.50             2.50              2.50                3.25               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




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                                                                                                         FX Pulse




FX Bull/Bear Projections
                         EURUSD                                                               USDJPY                                                              GBPUSD
 EUR/USD                                                             USD/JPY                                                              GBP/USD                            25 Delta Strikes
                      25 Delta Strikes                               120
 1.50                 MS Forecast
                                                                                      25 Delta Strikes                                    1.70                               MS Forecast
                                                                     115
                                                                     110              MS Forecast
 1.40                                                                                                                                     1.65
                                                                     105
                                                                     100                                                                  1.60
 1.30
                                                                      95
 1.20                                                                 90                                                                  1.55
                                                                      85
 1.10                                                                 80                                                                  1.50
                                                                      75
 1.00                                                                 70                                                                  1.45
    Dec-11          Dec-12           Dec-13           Dec-14           Dec-11           Dec-12              Dec-13        Dec-14
                                                                                                                                          1.40
                                                                                                                                          1.35
                                                                                                                                             Dec-11           Dec-12            Dec-13          Dec-14

                         EURCHF                                                              USDCAD                                                               AUDUSD
 EUR/CHF              25 Delta Strikes                               USD/CAD                                                              AUD/USD
 1.45                                                                1.25            25 Delta Strikes
                      MS Forecast
                                                                                     MS Forecast                                          1.15
 1.40                                                                1.20
 1.35                                                                1.15                                                                 1.10
 1.30                                                                1.10                                                                 1.05
 1.25                                                                1.05
                                                                                                                                          1.00
 1.20                                                                1.00
 1.15                                                                0.95
                                                                                                                                          0.95
 1.10                                                                0.90                                                                 0.90
    Dec-11          Dec-12           Dec-13           Dec-14            Dec-11           Dec-12             Dec-13         Dec-14                         25 Delta Strikes
                                                                                                                                          0.85
                                                                                                                                                          MS Forecast
                         USDSGD                                                              USDKRW                                                               USDTHB
 USD/SGD                 25 Delta Strikes                             USD/KRW            25 Delta Strikes                                 USD/THB
                                                                      1350               MS Forecast
 1.35                    MS Forecast                                                                                                      34
                                                                      1300
 1.30                                                                 1250                                                                33          25 Delta Strikes
                                                                      1200
 1.25                                                                 1150                                                                32          MS Forecast
                                                                      1100
 1.20                                                                                                                                     31
                                                                      1050
 1.15                                                                 1000                                                                30
                                                                       950
 1.10                                                                  900                                                                29
    Dec-11           Dec-12           Dec-13           Dec-14            Dec-11             Dec-12             Dec-13
                                                                                                                                          28

                         EURPLN                                                              EURCZK                                                               USDZAR
 EUR/PLN                                                              EUR/CZK                                                             USD/ZAR
                                                                      29
 4.70                                                                               25 Delta Strikes                                      13.0
                                                                      28            MS Forecast                                                            25 Delta Strikes
 4.50
                                                                                                                                          12.0
                                                                      27                                                                                   MS Forecast
 4.30                                                                                                                                     11.0
                                                                      26
 4.10                                                                                                                                     10.0
                                                                      25

 3.90            25 Delta Strikes                                     24                                                                    9.0
                 MS Forecast
 3.70                                                                 23                                                                    8.0
    Dec-11           Dec-12           Dec-13           Dec-14          Dec-11           Dec-12              Dec-13          Dec-14
                                                                                                                                            7.0

                         USDBRL                                                              USDMXN                                                               USDCLP
 USD/BRL                                                              USD//MXN                                                            USD/CLP
 2.70                                                                 15.50
                                                                                        25 Delta Strikes
                                                                                                                                          620
                  25 Delta Strikes                                    15.00
 2.50
                                                                      14.50             MS Forecast                                       600            25 Delta Strikes
                  MS Forecast
 2.30                                                                 14.00                                                               580            MS Forecast
                                                                      13.50
 2.10                                                                                                                                     560
                                                                      13.00
 1.90                                                                 12.50                                                               540
                                                                      12.00                                                              520
 1.70
                                                                      11.50                                                              500
 1.50                                                                 11.00
    Dec-11             Dec-12         Dec-13         Dec-14               Dec-11       Dec-12           Dec-13            Dec-14
                                                                                                                                         480
                                                                                                                                         460
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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                                                                                      FX Pulse




Morgan Stanley Global Currency Forecasts
 We updated our forecasts the week of March 18.
                                                    2013                                 2014                           4Q13 % change to:
                        Current             2Q            3Q        4Q        1Q        2Q             3Q      4Q      Consensus          Forward
EUR/USD                     1.31          1.34         1.30         1.26      1.24      1.22       1.20        1.19               0.0           -0.6
USD/JPY                       99           100          103          105       106       107        108         109               3.0            3.9
GBP/USD                     1.54          1.48         1.45         1.43      1.42      1.41       1.40        1.41              -3.3           -6.0
USD/CHF                     0.94          0.93         0.95         0.97      0.97      0.98       1.00        0.98              -0.6            1.2
USD/SEK                     6.59          6.31         6.54         6.71      6.77      6.84       6.92        6.93               0.1           -1.0
USD/NOK                     5.87          5.78         5.92         6.03      6.05      6.07       6.08        6.05               0.9            0.4
USD/CAD                     1.02          1.01         0.99         1.03      1.05      1.07       1.08        1.09              -2.0           -3.6
AUD/USD                     1.03          1.05         1.02         1.01      0.95      0.92       0.87        0.85              -1.0            0.0
NZD/USD                     0.85          0.86         0.89         0.88      0.87      0.85       0.84        0.83               6.0            5.3
EUR/JPY                      130           134          134          132       131       131        130         130               3.4            3.3
EUR/GBP                     0.85          0.91         0.90         0.88      0.87      0.87       0.86        0.84               4.3            5.7
EUR/CHF                     1.23          1.25         1.24         1.22      1.20      1.20       1.20        1.17               0.0            0.6
EUR/SEK                     8.60          8.45         8.50         8.45      8.40      8.35       8.30        8.25               1.8           -1.6
EUR/NOK                     7.66          7.75         7.70         7.60      7.50      7.40       7.30        7.20               4.2           -0.2
USD/CNY                     6.17          6.30         6.30         6.30      6.22      6.20       6.18        6.15               2.4            1.1
USD/HKD                     7.76          7.80         7.80         7.80      7.80      7.80       7.80        7.80               0.5            0.5
USD/IDR                    9718          9760         9850        10000     10100     10200     10200       10200                 1.3           -0.2
USD/INR                     54.2          54.5         52.8         50.0      51.5      50.0       49.0        48.0              -1.3           -5.0
USD/KRW                    1112          1115         1100          1090      1070      1050      1045        1040                0.9           -1.4
USD/MYR                     3.04          3.15         3.10         3.05      3.03      3.00       2.98        2.96               2.3            1.2
USD/PHP                     41.2          40.6         40.4         40.1      39.8      39.5       39.3        39.0              -0.2           -2.0
USD/SGD                     1.24          1.26         1.24         1.22      1.21      1.20       1.20        1.20               0.8            0.2
USD/TWD                     29.7          30.0         29.5         29.2      29.0      28.7       28.6        28.5               0.3           -0.1
USD/THB                     29.1          30.2         29.7         29.5      29.2      29.0       29.0        28.8               1.7            1.2
USD/BRL                     2.01          2.05         2.10         2.10      2.10      2.08       2.05        2.00               6.6            2.2
USD/MXN                     12.1          12.6         12.5         12.4      12.2      12.0       11.8        11.6               2.5            1.6
USD/ARS                     5.17          5.80         6.20         7.00      7.18      7.35       7.53        7.70              10.9            0.9
USD/VEF                     6.29          6.29         6.29         6.29      6.29      6.29       6.29        6.29              -0.2            0.0
USD/CLP                      474           475          470          475       470       465        460         455              -0.8           -3.0
USD/COP                    1837          1800         1820         1850      1820      1800       1780        1750                0.2           -2.2
USD/PEN                     2.63          2.60         2.62         2.63      2.61      2.59       2.57        2.55               2.7           -0.8
USD/ZAR                     9.08          9.25         9.40         9.20      9.10      9.10       8.90        8.80               3.2            1.4
USD/TRY                     1.80          1.83         1.85         1.83      1.80      1.77       1.75        1.75               2.8            1.0
USD/ILS                     3.61          3.80         3.73         3.65      3.65      3.60       3.55        3.55               1.6            2.9
USD/RUB                     31.3          30.5         31.5         30.9      30.2      31.4       32.1        30.9               1.6           -2.0
RUB basket                  35.6          35.2         35.7         34.5      33.5      34.5       35.0        33.5               1.6           -2.3
EUR/PLN                     4.15          4.20         4.20         4.15      4.10      4.00       3.95        3.90               1.7            0.1
EUR/CZK                     25.9          26.0         26.0         25.8      25.7      25.5       25.3        25.0               1.6            0.5
EUR/HUF                      301           310          315          320       320       315        310         305               5.4            3.0
EUR/RON                     4.35          4.35         4.30         4.30      4.25      4.20       4.18        4.15              -1.6           -2.6
MSDI                      81.59         81.41        82.82         84.98     86.19     87.39     88.49       88.95
MS AxJ Index             110.53        109.42       110.53       111.80    112.17    113.30     113.89      114.50
Forecasts were updated March 18, 2013 Forecast changes in bold                                                        Source: Morgan Stanley Research




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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 EM Macro Strategy (New York)                     Rashique Rahman, Managing Director                       rashique.rahman@morganstanley.com       (1 212) 761 6533

Head of US FX Strategy Team                              Gabriel de Kock, Executive Director                      gabriel.de.kock@morganstanley.com       (212) 761 5154
Currency Strategist (New York)                           Evan Brown, CFA, Associate                               evan.brown@morganstanley.com            (212) 761 2786
Currency Strategist (New York)                           Marc Englander, Analyst                                  marc.englander@morganstanley.com        (212) 761 8278

Head of European FX Strategy                             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

LATAM Macro Strategy (New York)                          Robert Habib, Analyst                                    robert.habib@morganstanley.com          (212) 761 1875

CEEMEA Macro Strategy (London)                           James Lord, Vice President                               james.lord@morganstanley.com            (44 20) 7677 3254
CEEMEA Macro Strategy (London)                           Mihail Bozinov, Vice President                           mihail.bozinov@morganstanley.com        (44 20) 7677-1150
CEEMEA Macro Strategy (London)                           Meena Bassily, Associate                                 meena.bassily@morganstanley.com         (44 20) 7677 0031

AXJ Strategy (Hong Kong)                                 Kritika Kashyap, Associate                               kritika.kashyap@morganstanley.com       (852) 2239 7179

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




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                                                                                            MORGAN STANLEY RESEARCH


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

                                                               Disclosure Section
The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley & Co. LLC and/or Morgan Stanley
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Stanley (Proprietary) Limited and/or Morgan Stanley MUFG Securities Co., Ltd. and/or Morgan Stanley Capital Group Japan Co., Ltd. and/or
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