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Morgan stanley -Fed Separation; USD Correction

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Fed Separation; USD Correction

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									                                                                         MORGAN STANLEY RESEARCH


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




         July 18, 2013

         Currencies

Global
         FX Pulse                                                       Trade Recommendations
         Fed Separation; USD                                             Closed Trades
                                                                         Short EUR/JPY                          Stopped at 131.30 on 17-Jul-13

         Correction                                                      Short GBP/USD
                                                                         Long USD/UAH 6M NDF
                                                                                                                  Close at WMR on 19-Jul-13
                                                                                                                  Close at WMR on 19-Jul-13
                                                                         Active Trades                           Entry          Stop          Target
         Focus on relative rate expectations. Most G10 central           Long EUR/CHF                           1.2310        1.2310          1.3000
                                                                         Short USD/JPY                          100.00        101.00           95.00
         banks now have some form of forward rate guidance in
                                                                         Short GBP/NZD                          1.9175        1.9500          1.8600
         place, suggesting that the currency market focus on rate        Limit Orders                            Entry          Stop          Target
         expectations will intensify. As a result, we expect             Buy AUD/USD                            0.9125        0.9025          0.9600
                                                                         See page 18 for more details. Changes in stops/targets in bold italics.
         currencies to re-establish historical relationships with
         changes in relative rate expectations. Indeed, our analysis
         finds that these relationships continue to hold (even           MS Major Currency Forecasts
         tighten in some cases) in forward guidance regimes.                                   3Q13             4Q13            1Q14               2Q14
                                                                         EUR/USD                 1.29             1.26             1.24             1.22
         Policy differentiation. Fed Chairman Bernanke’s                 USD/JPY                 103               107              110             114
         differentiation between QE tapering and interest rate           GBP/USD                 1.45             1.41             1.40             1.38
                                                                         USD/CHF                 0.98             1.02             1.06             1.09
         policy has reduced US tightening expectations and
                                                                         USD/CAD                 1.06             1.08             1.10             1.12
         increased uncertainty regarding the timing of tapering,         AUD/USD                 0.91             0.88             0.86             0.84
         leaving the USD vulnerable to a further corrective setback      NZD/USD                 0.78             0.76             0.75             0.74
         in the near term. We look to tactical AUDUSD long               EUR/JPY                 133               135              136             139
         strategies to position for a USD setback, given the relative    EUR/GBP                 0.89             0.89             0.89             0.88
                                                                         EUR/CHF                 1.27             1.29             1.31             1.33
         hawkishness of the RBA.
                                                                         EUR/SEK                 8.70             8.70             8.50             8.35
                                                                         EUR/NOK                 7.70             7.60             7.50             7.40
         GBP most vulnerable to guidance. The MPC minutes                Note: Forecasts for end-of-period. G10 forecasts updated June 6, 2013

         suggest that the BoE is set to introduce a more formal          FX Market Overview                                                          P2
         forward guidance framework, most likely in August. Given
                                                                         Currency Impact of Guidance                                                 P7
         that GBP has historically been the G10 currency most
                                                                         Russia: Crossing the RUBicon                                               P11
         sensitive to changes in rate expectations, we expect
                                                                         Strategic FX Portfolio Trade Recommendations                               P18
         renewed weakness over the medium term. We view near-
                                                                         G10 & EM Currency Summary                                                  P21
         term GBPUSD rebounds as providing renewed selling
         opportunities. Even EURGBP has the potential to push            Global Event Risk Calendar                                                 P23
         higher, given that ECB guidance is likely to remain more        FX Volatility/Carry Grids, Tactical Indicators                             P25
         informal as a result of political and constitutional            MS FX Positioning Tracker                                                  P28
         constraints.                                                    Macro Forecasts                                                            P29
                                                                         FX Bull and Bear Projections & Forecasts                                   P30
         Fed relief for EM currencies. We think the Fed’s
         renewed dovishness is likely to provide some relief for EM
         currencies, given the heavy short positioning, although the
         negative medium-term outlook for the asset class remains
         in place. We are more constructive on RUB given higher
         oil prices, while mindful of policy responses in INR and
         TRY.                                                            For important disclosures, refer to the
                                                                         Disclosures Section, located at the end of
                                                                         this report.
                                                                     MORGAN STANLEY RESEARCH

                                                                     July 18, 2013
                                                                     FX Pulse




FX Overview
Gabriel de Kock, Ian Stannard, Meena Bassily                         UK away from a consumer spending-, real estate- and
                                                                     finance-driven economy towards export- and investment-led
     Expected monetary policy divergence is dominating the G10      growth. Similarly, a weaker EUR could play a key role in
      FX price action again.                                         allowing monetary stimulus to bypass dysfunctional financial
                                                                     transmission in the EMU periphery, particularly if the German
     Fed Chairman Bernanke has deflated market tightening
                                                                     Constitutional Court curtails the effectiveness of the ECB’s
      expectations and raised the risks surrounding the timing and
                                                                     OMT backstop, as we expect (See Currency Impact of
      pace of QE tapering…
                                                                     Guidance, p.7).
     …paving the way for a deeper USD correction until the
                                                                     Exhibit 1
      markets see compelling evidence of a 3Q growth pickup.
                                                                     FX Recoupling with Yield Spreads
     Post-election reform momentum in Japan and consolidating               %
      US yields may soon reignite the USD/JPY rally.                  -0.8                                                                  84

     Markets may have misread the MPC’s shift from QE to                                                                                   82
                                                                        -1
      forward guidance as having a hawkish tilt, setting the stage
                                                                                                                                            80
      for a GBP selloff in August.                                    -1.2
                                                                                                                                            78
     Constraints on the ECB’s ability to adopt aggressive forward
                                                                      -1.4
      guidance suggest EUR will outperform GBP.                                                                                             76
                                                                      -1.6                          US-G10 ex-US Avg. 2Yr Swap Rates
     Lingering downside risks on growth, particularly in China,                                                                            74
                                                                                                    DXY (Right Axis)
      pose medium-term downside for G10 commodity currencies.
                                                                      -1.8                                                      72
     The AUD sell-off has matched commodity prices, allowing a         Mar-11 Jul-11 Nov-11 Mar-12 Jul-12 Nov-12 Mar-13 Jul-13

      hawkish RBA tilt. We position for a tactical AUD/USD rally.    Source: Bloomberg and Morgan Stanley Research


     EM currencies can make further gains on the back of the        Tapering ≠ Tightening, and More
      dovish Fed and given still heavily short EM positioning…
                                                                     Chairman Bernanke’s dovish tilt from the sanguine tone of his
     …however the recovery is choppy as currencies are driven       June 19 post-FOMC press conference has, we believe, set
      by positioning adjustments on the one hand and a negative      the stage for a deeper, longer-lasting USD correction. Over
      medium-term outlook for the asset class on the other.          last week’s NBER Q&A and today’s Humphrey Hawkins
     High oil prices keep us more constructive RUB in the near-     testimony, the chairman appears to have achieved two key
      term, while we are mindful of policy responses in INR and      Fed communications objectives, First, markets now appear to
      TRY, but look for attractive levels to establish USD longs.    separate QE tapering starting later this year, from policy
                                                                     tightening which, by FOMC forecasts will be delayed well
                                                                     into 2015. Indeed, the latest fed funds futures pricing
It’s the Monetary Policy, Stupid                                     appears consistent with the FOMC’s expectations (Exhibit 2).
                                                                     Exhibit 2
It should come as no surprise that shifting monetary policy
                                                                     Fed Funds Futures Price May 15 Rate Hike
expectations dominated the G10 FX price action in this week
packed with monetary policy risk events (BoE, RBA and                 120    bp                                                        bp   120
Riksbank minutes, Bernanke’s Humphrey-Hawkins testimony
                                                                      100                                                                   100
and the first BoC policy decision under Governor Poloz’s
leadership). But the FX-rates recoupling has been underway             80
                                                                                       5/1/13            6/19/13
                                                                                                                                            80
for some time, gaining momentum with the Fed’s attempts to                             7/9/13            7/17/13
                                                                       60                                                                   60
clarify its exit strategy (Exhibit 1).
                                                                       40                                                                   40
The ECB and BoE’s shift toward forward guidance also has
intensified the market’s focus on prospective monetary policy          20                                                                   20

divergence. We have argued before that forward guidance to               0                                                        0
lower expected real interest rates and weaken the currency                Jul-13 Nov-13 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15
should play a key role in the BoE’s attempts to rebalance the        Source: Bloomberg, Morgan Stanley



.                                                                                                                                                2
                                                                              MORGAN STANLEY RESEARCH

                                                                              July 18, 2013
                                                                              FX Pulse




Second, he raised market uncertainty about the timing and                     The greenback’s fate after the July FOMC meeting very much
pace of tapering – probably not enough to dislodge the                        should depend on the incoming data. Morgan Stanley’s US
consensus view that tapering will start in September, but                     Economics team believes that third-quarter US economic
keeping alive the risk that weak data will delay tapering and                 growth could reach 3%, as the drag from sequestration wanes
slow its pace.                                                                and the second-quarter inventory drawdown triggers
                                                                              restocking. Should this outlook play out in the data, the next
Against the backdrop of very disappointing 2Q growth and
                                                                              leg of the long-term USD rally could start as early as August.
markets comfortable with QE tapering starting well before
year-end, Bernanke hammered home the message that Fed                         Cautious on Tactical JPY Shorts
policy, including the timing and pace of tapering, remains data
                                                                              We are increasingly cautious regarding our tactical long JPY
dependent with “no preset timetable.” Repeating the FOMC
                                                                              position ahead of this weekend’s Japanese Upper House
statement language that downside risks have diminished, he
                                                                              elections. Arguing that the JPY has become the safe-haven
emphasized that the recovery remains weak and vulnerable to
                                                                              currency of choice, we positioned for a near-term USDJPY
a long list of downside risks, including disappointing global
                                                                              pullback anticipating that a further rise in US yields would
growth and lingering fiscal drag. And he left no doubt that
                                                                              undermine risk sentiment broadly (see FX Pulse: The JPY
policy tightening is far away and will be gradual, reiterating
                                                                              Risk, July 3, 2013.
that the jobs picture remains “far from satisfactory” –
disappointing labor market performance and too-low inflation                  We believe that the window for such a setback is now starting
could delay tightening until well after the 6.5% unemployment                 to close. Opinion polls for the Japanese upper house election
rate trigger is reached.                                                      suggest that PM Abe’s ruling coalition will win a commanding
                                                                              majority on Sunday (Exhibit 3). Large majorities in both houses
The shift in language on inflation since mid-June is more
                                                                              of the Diet should put PM Abe in a position to forge ahead on
dramatic. He repeated his earlier assessment that much of
                                                                              “Third Arrow” structural reforms that would boost Japan’s
the sharp slowdown in core inflation reflects transitory shocks
                                                                              growth potential, buoying equities and investor sentiment and
and that inflation expectations remain broadly stable. But,
                                                                              underpinning both retail and institutional capital outflows.
Chairman Bernanke unambiguously raised the rhetorical
volume on the risks associated with too-low inflation, noting                 Exhibit 3

that falling inflation raises the cost of capital, slowing capex              Election Polls Signal a Commanding LDP-NKP
and potentially posing a risk of outright deflation.                          Upper House Victory
                                                                               50    %                                                      %   50
A Deeper USD Correction
                                                                                                       Asahi Shimbun (July
Where does the latest installment in Fed communication leave                   40                      13th-July 14th)                          40
the USD? As noted earlier, we still expect tapering to start in                                        Kyodo News (July 13th-
September, possibly with some signals after the July FOMC                      30                      14th)                                    30
meeting 1 . But we see no data releases or events on the                                               Nihon Keizai Shimbun
                                                                                                       (July 17th)
calendar that could reignite a USD-supportive updraft in US                    20                                                               20
yields before the July FOMC meeting (Jul 30-31).
                                                                               10                                                               10
Indeed, while the chairman’s Humphrey-Hawkins testimony
sounded notably dovish compared to his June 19 post-FOMC                        0                                                               0
press conference, the fed funds futures pricing is strikingly                         LDP      DPJ      JRP      NKP   YP     JCP   PLP   U/O
similar, while 10-year Treasury yield closed 14 basis points                  Note: U/O = undecided or uncertain
higher than on June 19. In short, it appears likely that                      Source: Reuters Ecowin, Morgan Stanley

markets will follow through with more dovish pricing that
would weigh down yields and the USD, reversing the price
action seen in the two weeks following the June FOMC.




1
 Signaling tapering in July FOMC statement will pose its own communications
challenges as it will follow very weak 2Q GDP release.


                                                                                                                                                    3
                                                                     MORGAN STANLEY RESEARCH

                                                                     July 18, 2013
                                                                     FX Pulse




Renewed momentum on structural reform could be the trigger           AUD Move Reassures the RBA
for the next stage in the USDJPY rally. Thus, we will watch the
                                                                     The RBA minutes released on Tuesday morning probably
JPY reaction carefully over the coming days, with the potential
                                                                     produced the most significant hawkish surprise of the past
to switch back to our structural bullish stance on USDJPY. We
see a move above the 101.55 area as the first sign that the          Exhibit 4

major uptrend is resuming. See J-Insight: The Third Arrow:           AUD Sell-Off with Commodity Price Drop
What's Next?, July 9, 2013.                                           1.1                                                         1.1

(Mis)Reading the MPC Minutes                                          1.0                                                         1.0

Market participants appeared to read the 9:0 vote against             0.9                                                         0.9
further QE (the first unanimous vote since October 2012) in           0.8                                                         0.8
the minutes of the July 4 meeting as a bearish shift on the
                                                                      0.7                                                         0.7
part of the MPC. However, the underlying details of the
minutes suggest that what has changed is the MPC’s                    0.6                                                         0.6
preferred tools rather than its policy stance. The MPC has for                         AUDUSD
                                                                      0.5                                                         0.5
some time harboured mixed views on the efficacy of gilts                               Commodity Price-Based Fair Value
purchases, and appears to be aligning with the widening               0.4                                                         0.4
academic consensus viewing forward guidance as the most                     87       91       95        99        03   07   11
                                                                     Source: RBA, Haver and Morgan Stanley Research
powerful policy tool when policy rates are at the zero bound
(See Currency Impact of Guidance, p.7).                              week. While the markets expected an easing bias, pricing a
The BoE is considering other methods of unconventional               60% chance of a 25-basis-point rate cut at the August RBA
easing, including forward guidance, and will produce a report        policy meeting, the minutes concluded that “Given the
on these alternative measures alongside the August inflation         exchange rate adjustment that was occurring, and with the
report. Our interest rate strategists have suggested that the        substantial degree of monetary stimulus already in place,
MPC will adopt forward guidance at that time, aiming to cap or       members (of the Policy Board) assessed the current stance of
further lower front-end yields (see MPC Minutes: Reinforces          policy to be appropriate for the time being.”
Likelihood of August Forward Rate Guidance, July 17, 2013).          Exhibit 4, which shows our commodity price-based AUD
The resulting shift in interest-rate differentials should weigh on   valuation model, explains the RBA’s response to the AUD
GBP which, historically, has been among the most interest-           depreciation since mid-April. It shows that before this sell-off
sensitive currencies in the G10, consistent with one of our          global investor demand for Australian government bonds kept
most bearish outlooks within the G10.                                the AUD more than 10% overvalued relative to Australia’s
                                                                     terms of trade. With the AUD failing to cushion the
Less Scope for the ECB
                                                                     contractionary impact of falling commodity prices the RBA had
The ECB issued forward guidance for the first time on July 4,        to consider easing policy to absorb the commodity price
stating that “The Governing Council expects the key ECB              shock. But now the RBA can afford to wait and see and
interest rates to remain at present or lower levels for an           further easing may be off the agenda unless the very real risk
extended period of time.” Its guidance was vague by                  of another downshift in the Chinese growth outlook triggers
contemporary norms and we believe this was no accident. In           another commodity price drop. With AUD short positioning
our view it reflects a combination of divergent views on the         among the most extreme in the G10 and EM currency space,
Governing Council, perceived legal constraints on ECB policy         we prefer to position for a deeper USD pullback by buying
and concern about a backlash at the upcoming German                  AUD/USD at 0.9125 (see Strategic FX Portfolio and MS
election and in German Constitutional Court’s ruling on the          Positioning Tracker on pages 18 and 28).
constitutionality of the OMT. Reflecting these concerns, we
expect that the ECB’s forward guidance will remain limited in        Seamless Transition in Ottawa
scope at least until the early fall, particularly compared to the    In contrast with the RBA surprise the BoC policy decision on
Bank of England’s. Thus while we expect the ECB’s forward            Tuesday marked as smooth a central bank leadership
guidance to weigh on the EUR in time, we see significant             transition as one could imagine. Some market participants
upside for EUR/GBP on a three-month time frame (see G4:              fretted that the BoC’s new Governor, Steve Poloz, may
What's left in the Toolbox?, July 11, 2013).

                                                                                                                                    4
                                                                  MORGAN STANLEY RESEARCH

                                                                  July 18, 2013
                                                                  FX Pulse




advocate a shift away from the BoC’s soft tightening bias         Policy Spillover to EM Currencies
(“Over time, …a gradual normalization of policy interest rates
                                                                  Shifting monetary policy expectations from G10 central banks
can also be expected…”) in response to lingering corporate
                                                                  have also heavily influenced the price action across EM
caution. But, the policy announcement and the Bank’s
                                                                  currencies. Of course it was Bernanke’s more dovish
Monetary Policy Report showed no notable changes in
                                                                  statement that was the most important driver for the EM
substance or forecasts.
                                                                  universe, and as this sets the stage for a more firmly
We believe that the USD/CAD eventually will rally                 grounded USD correction, we would expect EM currencies to
significantly, largely because a still overheated housing         make further gains, amidst still heavily short EM positioning.
market and high household debt will limit the BoC’s ability to
                                                                  However, we believe price action is likely to remain choppy,
match Fed policy tightening. But our expectation for a deeper
                                                                  as markets will be driven by Fed-related positioning
USD correction suggests waiting for better levels to establish
                                                                  adjustments on the one hand (which will be increasingly data
long USD/CAD positions.
                                                                  dependant), and what we believe remains a negative
Divergent NOK & SEK Guidance                                      medium-term outlook for the asset class on the other. The risk
                                                                  is that data from the US continue to print soft, prompting
The Riksbank struck a more hawkish tone in its minutes,
                                                                  further market reassessment on the timing of QE tapering
released earlier this week. The central bank shifted from
                                                                  which, next to strong technicals, would provide a firmer base
viewing risks skewed towards a cut towards believing that a
                                                                  for a summer rally across EM currencies before more
cut and a hike are evenly balanced. Two key factors drove
                                                                  fundamental weakness kicks in.
this shift. First, the central bank remains concerned with high
levels of household debt and the threat that lower rates could    Exhibit 5

pose to financial stability. Second, the committee expects a      How Far Have EM Currencies Retraced?
2H recovery to support the Swedish economy, putting upward           4
pressure on inflation and employment.                                                                    % deviation of currencies from May
                                                                     2
                                                                                                                     8th levels
The more balanced view of the Riksbank contrasts with other          0
central banks that are sounding increasingly more open to           -2
further easing, such as the ECB, BoE, and even the Norges           -4
Bank. As discussed above, the ECB and BoE have taken                -6
steps toward forward guidance, while the Norges Bank, which
                                                                    -8
already publishes its repo rate forecasts, revised its expected
                                                                   -10
policy rate path downwards at its last meeting. This provides
                                                                   -12
some downside risks to NOKSEK – we note in particular that
the cross seems to be breaking below the 30-year trend.            -14    MXN
                                                                         MYR
                                                                          HUF

                                                                          ZAR

                                                                           INR
                                                                          TRY
                                                                            ILS
                                                                         RUB



                                                                          CZK




                                                                          THB
                                                                          PHP
                                                                          PLN




                                                                           IDR




                                                                         SGD




                                                                          PEN
                                                                          BRL

                                                                          CLP
                                                                         COP
                                                                         KRW



                                                                         TWD




However, we are cautious that SEK strength from the more
hawkish tone could be somewhat limited, for two reasons.                               Range                                     Current
First, a large appreciation in SEK to the levels seen in 1Q of    Note: Performance for CEE currencies is vs EUR, all other EM is vs USD
                                                                  Source: Reuters Ecowin, Morgan Stanley
this year could see pushback from the Riksbank. Second,
there are growing risks to the 2H recovery story which is         In addition to being a choppy recovery for EM currencies, we
central to the Riksbank’s forecasts. Our economists have          also believe it will be an uneven one, whereby currencies with
revised down their estimate of 2Q US GDP growth, political        comparatively worse fundamentals and larger external
uncertainty in EMU is on the rise, and data out of Asia has       imbalances will lag behind. The above exhibit shows how
been soft. As such, it is possible the Riksbank may need to       uneven the recovery has been as currencies such as BRL,
reverse some of its hawkishness in the future, weighing on        INR, ZAR and TRY remain closer to the weak point of the last
SEK. Therefore, while we see room for some further tactical       couple months. Whereas currencies with better contained
declines in NOKSEK, we expect the upward trend to continue        current account deficits or surpluses have performed better,
in the long run.                                                  such as ILS, HUF and CZK.

                                                                  We are also mindful of the distorting impact on currency
                                                                  performance caused by the persistent rise in oil prices, as well


                                                                                                                                              5
                                                                 MORGAN STANLEY RESEARCH

                                                                 July 18, 2013
                                                                 FX Pulse




as the more pronounced role of policy makers within EM. One      near term, we remain concerned by the fundamental
of the key beneficiaries to high oil prices has been the         challenges that the country faces which may undermine the
Russian ruble which has traded well compared to its historical   currency over time.
beta in past corrections. We think strong oil combined with
                                                                 Meanwhile in Turkey, the CBT announcement at the
continued USD selling by the CBR will continue to support the
                                                                 beginning of the week, stating that a widening of the corridor
RUB in the near term, with the RUB basket recovering back
                                                                 would be discussed at the MPC meeting on July 23, has
toward the middle of the corridor. (See Russia Economics &
                                                                 reduced bearish speculation on the currency. However, we
Strategy: Crossing the RUBicon, page 11).
                                                                 argue that the stakes are now higher ahead of the meeting, as
On the policy front, recent developments in India and Turkey     the TRY is priced for a meaningful widening of the corridor –
are of note. In India several measures were announced this       and absent this we would expect depreciation pressure to
week, whereby the RBI has effectively increased interest         return on TRY. Indeed, similar to INR we believe the
rates so to support the currency, which marks a reversal to      fundamental backdrop argues for eventual currency
their previous monetary policy stance, (see: India Economics:    weakness, and therefore look for attractive levels to establish
RBI Announces Quantitative Tightening, Increasing Downside       USD long positions for the medium term.
Risks to Growth, June 16th ,2013). These measures, along
with several others, have helped drive USD/INR below 60.
While these measures will help stabilize the currency in the




                                                                                                                              6
                                                                      MORGAN STANLEY RESEARCH

                                                                      July 18, 2013
                                                                      FX Pulse




Currency Impact of Guidance
Ian Stannard                                                          flexible data depended approach to tapering of QE was
                                                                      outlined, while the conditionality for rate hikes was increased,
    Following the introduction of forward guidance by the BoE        effectively leaving the market with an overall dovish
     and ECB, most G10 central banks now employ some sort of          interpretation and pushing back market expectations for rate
     guidance policy.                                                 hikes, with the first full hike currently not priced in until May
                                                                      2015.
    Recent research has found that guidance has an influence
     on market interest rate expectations…                            Throughout most of the G10, inflation has remained subdued,
    …and here we investigate whether there is an impact on           with disinflationary pressures evident in some places which, in
     currency market behaviour.                                       our view, provides the incentive and scope for central banks
                                                                      to implement policy guidance. Even in cases where there is
    Our analysis finds that the relationship between market
                                                                      evidence of an economic recovery developing, the muted
     interest rate expectations and currencies continues to hold in
                                                                      inflation outlook is currently allowing policy makers to employ
     a forward guidance regime.
                                                                      forward guidance with the aim of preventing rate expectations
    We believe that GBP is likely to experience the most             from rising too quickly and risk undermining the recovery
     significant impact from forward guidance…                        process. The UK is one country in the G10 where inflation
    …as GBP is historically one of the most sensitive currencies     could be an issue in the near term, but with the BoE’s
     to relative changes in interest rate expectations.               flexibility around the inflation target being confirmed by
                                                                      Chancellor Osborne earlier in the year, there appears little to
    We view near-term GBPUSD rebounds as selling
                                                                      prevent the BoE pushing ahead with more formal dovish
     opportunities…
                                                                      guidance. Hence, given the extensive use of policy guidance
    …with potential for EURGBP to push higher given likely           within the G10, we have examined the impact on currency
     political/constitutional constraints on ECB guidance.            markets to ascertain whether there is likely to be a significant
                                                                      change in currency market behaviour as a result.
                                                                      Exhibit 1
                                                                      US-Average Non US G10 2-Year Yield Differential…
Guidance – Policy Tool of Choice
Following the decision at this month’s ECB and BoE policy
meetings to introduce forms of forward guidance into their
statements (BoE also introduced a statement after its
unchanged policy decision), most G10 central banks now
operate with some form of forward interest rate guidance.
These vary from providing projections of interest rates to time
contingent and threshold based guidance in the case of the
Fed. These measures have been implemented in many cases
to provide further monetary accommodation where interest
rates have reached or are approaching the lower bound. But,
in some cases we also suspect that central banks have
introduced these measures in attempts to counter any                  Source: Reuters Ecowin, Morgan Stanley
unwelcome tightening of international financial conditions
resulting from the US moving towards a reduction in asset             Guidance USD Bullish
purchases. Even the Fed is attempting to decouple its own
interest rate policy from the prospects of tapering asset             With forward guidance currently appearing to be the policy
purchases, again with the use of forward guidance. Indeed,            tool of choice, we now expect currency market to place an
Fed chairman Bernanke appears to be been relatively                   increased emphasis on relative changes in interest rate
successful in providing that distinction between the two              expectations and yield//rate differentials. We note that the
policies with his testimony this past week, where a more              USD rally since the 2011 lows, and especially over the course


                                                                                                                                      7
                                                                          MORGAN STANLEY RESEARCH

                                                                          July 18, 2013
                                                                          FX Pulse




of the past year, has been supported by the relative                      A good example of is the CAD, where following the global
development of US versus average non-US G10 yields (see                   financial crises of 2008, the BoC introduced forward rate
Exhibits 1&2).                                                            guidance in April 2009, with the BoC communicating that it
Exhibit 2                                                                 would keep rates at the 0.25% level until the end of Q2 2010,
…Re-establishing Relationship with USD Since the                          conditional on the inflation outlook. However, following the
Beginning of the Year                                                     implementation of this guidance USDCAD continued to
                                                                          decline. In fact, USDCAD extended the major downtrend to
                                                                          the lowest levels since 2007. This continued appreciation of
                                                                          the CAD developed even in an environment of the BoC
                                                                          guidance being viewed as successful in lowering rate
                                                                          expectations and yields at the time. However, it must be
                                                                          remembered that the Fed was also implementing aggressive
                                                                          monetary easing measures including QE and providing
                                                                          forward guidance of its own during this period. Indeed, the
                                                                          Fed had introduced loose forward guidance in December
                                                                          2008 and then followed this with its assertion that it would
                                                                          maintain low rates for an “extended period” in March 2009. In
                                                                          fact, the decline in USDCAD is consistent with the
                                                                          developments in relative interest rate expectations and the 2-
Source: Reuters Ecowin, Morgan Stanley                                    year yield spread between the US and Canada at that time
                                                                          (see Exhibit 3).
Impact of Guidance                                                        Exhibit 3
Most of the recent research carried out on forward guidance 1             Relative US-Canada Rate Expectations and
suggests that the there is, to varying degrees, an impact on              USDCAD
interest rates, with the introduction of forward guidance, or the
change in guidance, appearing to influence market interest
rate expectations. This impact is also found to persist beyond
the initial reaction. Several research studies also find that
there is an increase in the predictability of interest rates
following the introduction of forward guidance, not just for
short term rates, but also for medium term yields. Most
studies found that there was a more significant impact on
short term rates, while the effect on longer term rates
appeared not to be as strong.

While there is evidence that central bank forward guidance
has an influence on interest rates, the impact on currencies is
more difficult to gauge given the many other factors which                Source: Reuters Ecowin, Morgan Stanley
also drive currencies. Indeed, it is relative policy that is
important for currency pairs, and more specifically the change            Returning to Traditional Relationships
in relative policy. But even this still needs to be viewed within
                                                                          Over the past few years we have generally found that there
the context of the global policy and investment environment,
                                                                          has been a decline in the correlation between currencies and
making it difficult to identify the exact impact of policy
                                                                          yields and interest rate expectations, especially where other
guidance on currencies.
                                                                          policy tools such as QE have been used. This was certainly
                                                                          the case with EURUSD, where the relative size of the ECB
                                                                          and Fed balance sheet proved to be a good guide for the
1
                                                                          currency pair over the past few years since the introduction of
  Methods of Policy Accommodation at the Interest-Rate Lower Bound, by    QE and other balance sheet expanding measures. But, this
Michael Woodford, September 16th, 2012, discusses much of the available
research on the subject.
                                                                          correlation between balance sheets and currency has also

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now broken down, and we would expect a return to the more          2014. We believe this is an example of where the change in
traditional relationships. The correlation between currencies      relative rate expectations needs to be taken into account.
and rates/yields is currently close to historically low levels     While the Riksbank has maintained its previous dovish
generally within the G10, but we would expect this traditional     stance, many other G10 central banks have increased their
correlation to reassert itself as central bank guidance puts the   dovishness, in many cases via forward guidance. This is
market focus back on relative rate expectations.                   highlighted by the 5% decline in NOKSEK over the past
                                                                   month.
Indeed, there have been some very recent examples of how
forward guidance has impacted currency markets, one being          Exhibit 5

the NOK reaction to the change in the Norges Bank’s                US-Average Non US G10 Relative Rate Expectations
guidance. Over the past year there had been a significant          (12m-1m rates) and USD
divergence between NOK and Norwegian rate expectations,
with the NOK moving sharply higher despite rate expectations
moving lower. However, this gap is now closing rapidly with a
sharp fall in the NOK. This decline in the NOK coincides with
more dovish guidance from the Norges Bank at its June 20
meeting, where the repo rate path projections were lowered.
The Norges Bank projections now do not see a rate hike until
the end of 2014, previously this was signaled for Q3 2014.
Exhibit 4
Norwegian Rate Expectations and NOK TWI


                                                                   Source: Reuters Ecowin, Morgan Stanley


                                                                   Relationships Hold – Even Under Guidance
                                                                   Given these recent observations regarding the impact of
                                                                   forward guidance (relative changes in forward guidance) on
                                                                   currencies, we have carried out some analysis where we have
                                                                   found that traditional relationships between currencies and
                                                                   rate expectations and yield spreads continue to hold, even in
                                                                   a forward guidance regime. We specifically study the cases of
                                                                   CAD, NZD, SEK and NOK, where our analysis suggests that
Source: Reuters Ecowin, Morgan Stanley                             there is even a slight tightening of the relationship between
                                                                   currencies and rates/yields in a forward guidance regime,
However, one currency which does not appear to have
                                                                   although in most cases this is not statistically significant. We
reacted fully to the change of interest rate expectations is the
                                                                   have found the largest positive changes in the cases of the
SEK, where despite declining rate expectations the SEK has
                                                                   CAD and NZD, while the improvement in the relationship was
remained relatively well supported. However, this could be a
                                                                   not as evident regarding the SEK and NOK. In no cases did
function of the fact that the Riksbank has not reinforced
                                                                   we detect a deterioration in the relationship under forward
bearish guidance recently, leaving its previous repo rate
                                                                   guidance.
projection in place, while elsewhere central banks have been
re-emphasizing and reinforcing dovish guidance. Indeed, we         Hence, with the initial signs suggesting that forward guidance
would also suggest that the latest Riksbank minutes provided       has an impact on market interest rates expectations, and that
a more balanced assessment of policy, rather than                  a decoupling of non-US G10 yield and US yields is taking
reasserting the previous dovish tone. It is interesting to note    place, we maintain our medium term USD bullish strategy,
that the SEK has been one of the best performing G10               despite the likelihood of some near-term volatility being
currencies over the past month despite continuing to signaling     generated by the Fed’s own forward guidance this past week,
that rates will be held at a low level until the second half of    which has pushed US rate hike expectations out to May 2015.


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Indeed, the spread between US 2-year yields and average               Of the two central banks, we expect the BoE to implement a
G10 2-year yields (excluding US) has traditionally been a             more explicit guidance policy framework, while the ECB’s
good guide for the USD. Although this relationship loosened           forward guidance will likely have to remain less formalized
over the past three years, the USD now appears to be re-              given political and constitutional constraints. However, in both
establishing its correlation with this yield spread, providing the    cases we would expect a significant currency market impact,
USD with support. If the non-US central banks are successful          but with GBP leading the way to the downside.
in decoupling from US rates/yields with their use of forward
                                                                      Historically, we have found that GBP is particularly sensitive
guidance, we would view this as consistent with a general
                                                                      to changes in the front end of the UK curve, especially out to
outperformance of the USD.
                                                                      the two year sector. Hence, the introduction of a forward
                                                                      guidance framework aiming to flatten the front end of the
GBP Most Vulnerable
                                                                      curve (or prevent steepening) is likely to put GBP under
As forward guidance policies put the focus back on rate               further pressure. In fact, we would suggest that the
expectations, we expect the traditional relationships between         introduction of an effective forward guidance strategy could
currencies and relative changes to rate expectations to tighten       have a more negative impact on GBP than the previous
once again. Where guidance has not yet been fully                     rounds of QE.
implemented is likely to be where currencies are most                 Exhibit 7
vulnerable to a significant adjustment lower. This puts the           UK-US Relative Rate Expectations and GBPUSD
focus on GBP. Moreover, given our findings regarding the
continuation of the relationship between rate expectations and
currencies, we also believe currencies which are historically
highly sensitive to changes in relative rate expectations will be
vulnerable in an environment where forward guidance is used
to lower rate expectations. Again we find that GBP stands out.
Exhibit 6
Shifts in UK Rate Expectations
 1.60
            May Inflation Report

 1.40       July MPC

            Current Pricing

 1.20

 1.00
                                                                      Source: Reuters Ecowin, Morgan Stanley
 0.80

 0.60
                                                                      Bearish GBPUSD

 0.40                                                                 While we maintain our medium term GBPUSD bearish view,
                                                                      the Fed’s separation of its QE tapering and interest rate policy
 0.20
                                                                      is likely to provide near-term scope for a further corrective
 0.00                                                                 USD setback. However, we would view any further near-term
        3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16
                                                                      GBPUSD gains as providing a renewed selling opportunity.
Source: Bank of England, Bloomberg, Morgan Stanley
                                                                      The likelihood of the BoE introducing a formal rate guidance
The BoE and the ECB are the latest of the G10 central banks           framework in August, together with an anticipated pickup in
to join the guidance club, with references in their most recent       US data after the current soft patch, suggests that relative
monthly statements. Moreover, the BoE minutes from the July           rate expectations will once again point to a lower GBPUSD.
meeting also highlight that the MPC is considering                    We maintain our year-end forecast of 1.41 for GBPUSD, with
alternative/additional policy tools in more detail, with some         a further decline towards 1.34 anticipated for 2015. The
form of more formal forward rate guidance framework                   current EURGBP setback is also likely to be temporary, in our
appearing to be the favoured approach, which could be                 view, with likely constraints on ECB policy guidance resulting
introduced as early as the August inflation meeting/inflation         in a push higher into the 0.8800/0.8900 area by the end of the
report.                                                               year.


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Russia: Crossing the RUBicon
Morgan Stanley & Co. International plc   James Lord          +44 207 677 3254    Not so high beta. The RUB traded well compared to its
OOO Morgan Stanley Bank                  Jacob Nell          (7 495) 287 2134    historical beta during the recent EM correction. Many of the
Morgan Stanley & Co. International plc   Alina Slyusarchuk   (44 20) 7677 6869   factors that caused this better performance are likely to
                                                                                 remain in place, which should prompt some continued
  We are short term constructive on the RUB, as the broader
   market stabilizes, oil prices remain strong and the CBR                       strength in the currency in the near term.
   continues to sell USD. However, we see a weaker RUB by                        We see some reasons for being constructive on the RUB
   year-end, thanks particularly to USD strength and CBR
                                                                                 in the short term. Oil prices remain strong and the Central
   easing. Fundamentally, with declining support from the
                                                                                 Bank of Russia (CBR) continues to sell USD. The broader
   balance of payments, we no longer expect real RUB
                                                                                 market should continue to trade well in the short term too on
   appreciation.
                                                                                 the back of recent dovish commentary from the US Fed and a
  The Russian ruble has performed in line with the broader                      normalisation of liquidity conditions in China, particularly amid
   market during the recent EM currency correction, which is                     the backdrop of still-heavy long USD/EM positioning. (See
   atypical of its status as a high-beta currency.
                                                                                 Global EM Investor: Some Kind of Normal, July 15.) Further
  Short term constructive. We think strong oil prices, less                     near-term relief for broader EM assets should help RUB trade
   risk from fixed income outflows related to Fed tapering, the                  well in the short term too and we see potential for the RUB
   CBR’s sizeable USD selling, and prior underperformance                        basket to move to around the middle of the corridor (35.25)
   explain why the RUB performed in line with peers, rather                      over the coming weeks, at which point risk/reward of being
   than underperforming during the May-June correction.                          long RUB would no longer look attractive.
     Thus, the RUB may stay strong in the short term, particularly               But expect a weaker RUB before year-end. However, we
     against a backdrop of greater stability for the broader market.
                                                                                 see a number of risks on the horizon. EM currencies in
     Continued dovish Fed comments plus a normalisation of
                                                                                 general could come under pressure again given the ongoing
     financial conditions in China should contribute to EMFX
     strength and the RUB basket trading to the middle of the
                                                                                 growth slowdown in the China (though Russia could be
     corridor (around 35.25, or a USD/RUB rate of 31 assuming                    somewhat insulated from this). Furthermore, renewed USD
     stable EUR/USD) over the summer.                                            strength, CBR easing, MinFin USD purchases all mean that
                                                                                 any gains will probably be limited to around the middle of the
  However, a number of risks could undermine RUB in 4Q.
                                                                                 intervention corridor, and the RUB could weaken again into
   The significant easing of policy we expect from the CBR. The
                                                                                 year-end. We target USD/RUB 33 by year-end.
   start of Ministry of Finance USD purchases in August may
   also contribute, although this could be mitigated by additional               Crossing the RUBicon. More fundamentally, declining
   CBR selling of USD, as well as the relatively small size of the               support for the RUB from the Russian balance of payments –
   purchases.                                                                    as the declining current account surplus is now balanced by
  Crossing the RUBicon. More fundamentally, declining                           private sector capital outflows – means we have switched
   support for the RUB from the Russian balance of payments                      from expecting real RUB appreciation to a more neutral
   means we have switched from expecting real RUB                                position on the currency. This implies, going forward, that the
   appreciation to a more neutral position on the currency. This                 RUB is likely to weaken in nominal terms and the corridor is
   implies, going forward, that the RUB is likely to weaken and                  likely to keep shifting higher to offset the impact of Russian
   the corridor to keep shifting higher to balance higher Russian                inflation being higher than US and eurozone inflation, and
   inflation.
                                                                                 keep the RUB broadly flat in real terms.
  Finally, broader market strength could lose steam.
                                                                                 Why Has the RUB Traded So Well?
   Fundamentals in EM are weak, with China’s growth
   slowdown weighing on the asset class. Eventual Fed                            The Russian ruble has performed in line with the broader
   tapering could lead to more concerns over fixed income flows                  market during the recent EM currency correction. Our index of
   to EM. It is unlikely that the RUB will be fully immune from                  23 EM currencies depreciated by 6.0% versus the USD during
   this process. We target USD/RUB 33 by year-end.
                                                                                 the EM currency correction that started on May 8, compared
                                                                                 with 6.4% for the RUB.



                                                                                                                                               11
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                                                                                                                                               FX Pulse




Exhibit 1                                                                                                                                      happens at a time of global growth concerns and commodity
RUB Typically Underperforms, But Not This Time                                                                                                 price weakness. The strength of oil causes a headache for the
    2
                                                                                                                                               rest of EM, which on the whole comprises net energy
                                                                                                                                               importers, but it is a boon for Russia and explains some of the
    0
                                                                                                                                               resilience of the currency.
    -2

    -4                                                                                                                                         In fact, as Exhibit 2 shows, a significant divergence has
    -6
                                                                                                                                               opened up between the RUB and our proxy indicator for
    -8
                                                                                                                                               Russia’s terms of trade, which of course is dominated by oil.
                                                                                                                                               On the basis of this alone, the RUB should’ve actually
   -10
                                                                                                                                               strengthened. But of course, it hasn’t, and naturally this is
   -12
                                                                                                                                               because there have been other flows offsetting the benefit of
   -14
                                                                                                                                               a higher oil price.
   -16
                                                                                                                                               Second, Russia is less vulnerable to a reversal of fixed
                                                                                       MXN




                                                                                                                                       EM Av
                                                                                                         MYR



                                                                                                                           BRL
                                 HUF
               IDR




                                       SGD


                                                   RON


                                                               PEN


                                                                           PLN




                                                                                                                     INR


                                                                                                                                 ZAR
         CNY



                           CZK



                                             COP




                                                                     RUB


                                                                                 THB


                                                                                             PHP
                                                                                                   CLP


                                                                                                               TRY
                     TWD




                                                         KRW




                                                                                                                                               income flows than most EM economies. Much of the recent
                       Chg vs USD Since May 9                              Average Chg During Prior Corrections                                strength in the USD has been driven by rising US Treasury
Source: Bloomberg, Morgan Stanley                                                                                                              yields and the associated market assessment on the size of
Exhibit 2
                                                                                                                                               future asset purchases from the US Fed.
Oil Up, RUB Down                                                                                                                               This caused disruption in EM fixed income markets because
                                                                                                                                               of the extent to which QE from the Fed has contributed to
   125                                                                                                                                 27
                                                                                                                                               significant fixed income flows in high-yielding EM economies.
   120
                                                                                                                                       28      An end to QE naturally raises concerns about the durability of
   115
                                                                                                                                       29      these flows.
   110
                                                                                                                                       30
                                                                                                                                               As Exhibit 3 highlights, Russia has received a lower level of
   105
                                                                                                                                               fixed income inflows since the global recovery began in 2Q09
   100                                                                                                                                 31      compared to the average EM economy. Recently exposure
    95
                                                                                                                                       32      has been rising, which is consistent with our own metrics (See
    90                                                                                                                                         Market Technical Watch: Underweight Risks and Increasing
                                                                                                                                       33
    85                                                                                                                                         Cash, July 2), but overall the difficulty of gaining access to
    80                                                                                                                                 34      Russian fixed income securities in recent years has meant
     Jan-11                            Oct-11                              Jul-12                         Apr-13                               that overall exposure is low. As such, it stands to reason that
            Index of Russia's Commodity Exposure                                                     USD/RUB (RHS, inv)                        the currency has less to lose from a potential reversal or
Source: Bloomberg, Morgan Stanley                                                                                                              slowdown in fixed income flows compared to other markets.
                                                                                                                                               Exhibit 3
During the last four EM currency corrections (which we define
                                                                                                                                               Fixed Income Inflows Have Risen, but Still Relatively Low
here as a larger than 5% depreciation in our index versus the
                                                                                                                                                 3.0
USD), the RUB has depreciated by over 10%, compared to a                                                                                                      Debt security portfolio inflows, 4Q rolling sum, %GDP
market average of 7.3%. In other words, the RUB typically has                                                                                    2.5

a high beta to the market during corrections, but on this                                                                                        2.0
occasion the beta has been roughly 1.                                                                                                            1.5

The performance of other EM currencies has been                                                                                                  1.0

inconsistent with history too, such as the EUR-linked CEE                                                                                        0.5
currencies which have deviated from script the most. The                                                                                         0.0
price action of the latter though is easily explained by the                                                                                    -0.5
atypical strength of the EUR during the EM sell off.
                                                                                                                                                -1.0
The resilience of the RUB requires a little more explanation,                                                                                   -1.5
but we can see four principal reasons.                                                                                                                 4Q05     4Q06     4Q07     4Q08     4Q09     4Q10      4Q11    4Q12

First, oil prices have actually headed higher over the past                                                                                                         RUB                                 EM Avg
                                                                                                                                               Source: Morgan Stanley, Haver
few months. Typically, when EM currencies weaken it

                                                                                                                                                                                                                       12
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Third, the RUB had already spent February-April                                       which prompted us to remove our bearish RUB trade on June
underperforming the broader EM currency asset class.                                  24. (See Global EM Investor: Are We There Yet)
This meant that the May correction was starting from an
                                                                                      Exhibit 5
already weak base. The main reason for the RUB
underperformance at this point was the weakness in oil prices,                        RUB Interventions Picked Up in June
with Urals crude dropping 18% from peak to trough during                                25,000                                                                                 35

Feb-Apr.                                                                                20,000                                                                                 34

Exhibit 4                                                                                                                                                                      33
                                                                                        15,000
Significant RUB Underperformance in Feb-Apr                                                                                                                                    32
                                                                                        10,000
  108
                                                                                                                                                                               31
                                    Significant underperformance during
                                                                                         5,000
                                    Q1 set the stage for a relatively more                                                                                                     30
  106
                                    resilient performance in Q2
                                                                                             0
                                                                                                                                                                               29
  104
                                                                                        -5,000                                                                                 28
  102
                                                                                       -10,000                                                                                 27
                                                                                             Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13
  100
                                                                                                                 CBR Purchases of FX (USDmn)                USD/RUB
   98                                                                                 Source: Haver, Bloomberg

   96
                                                                                      The following chart reflects our understanding of the current
   94                                                                                 intervention mechanism.
    Sep-11       Jan-12       May-12           Sep-12               Jan-13   May-13
                                           RUB vs EM                                  Exhibit 6
Source: Bloomberg, Morgan Stanley
                                                                                      MS Understanding of CBR Intervention Policy
                                                                                         Width           Range                  Rule
Exhibit 4 above highlights that the decline of the RUB was in
                                                                                                                             CBR moves corridor 0.05 up for $450m
proportion to the oil price decline that we saw, based on                                                        31.75       "non-target" purchases
recent correlations.                                                                     1.00       31.75 – 32.75            CBR buys $350m daily
Fourth, central bank support for the RUB has been                                        1.00       32.75 – 33.75            CBR buys $250m daily
meaningful. Plenty of EM central banks have emerged to                                   1.00       33.75 – 34.75            CBR buys $170m daily (observed)
support their currencies in recent weeks, deploying a                                    1.00       34.75 – 35.75            no interventions (observed)
combination of interest rates and selling currency reserves.                             1.00       35.75 – 36.75            CBR sells $70m daily (observed)
This is familiar territory for the CBR, which regularly                                  1.00       36.75 – 37.75            CBR sells $200m daily (observed)
                                                                                         1.00       37.75 – 38.75            CBR sells $300m daily
intervenes on both sides of the market in a mechanistic
                                                                                                                             CBR moves corridor 0.05 down for $450m
fashion to smooth out volatility.                                                                   38.75                    "non-target" sales
                                                                                      Source: CBR, Morgan Stanley Research. Intervention is against the basket which is 55%
Recently, the RUB has been trading well inside the CBR’s                              USD and 45% EUR. Note that the CBR announces the edges of the 7 RUB wide corridor and
                                                                                      the level of cumulative “non-target” intervention required to move the corridor by 5 kopecks,
USD selling zone, which means that the central bank has sold                          but the intra-corridor intervention bands are not published. We have estimated them by
a reasonable amount of USD in support of the RUB. Data for                            looking at the level of CBR intervention, which is published daily, for those bands marked
                                                                                      “observed” and by extrapolation for the other bands.
June show that the CBR sold just over USD2.7bn and
EUR245mn into the market as the RUB basket traded in the                              The new CBR governor Nabiullina has affirmed her
upper half of the corridor. This marks the largest monthly                            commitment to the floating RUB, with the CBR intervening to
intervention since the worst days of the Eurozone crisis during                       smooth volatility, not to target a particular exchange rate. We
4Q of 2011.                                                                           expect the CBR to continue with its current regime, which
Admittedly, the size of intervention is small compared to the                         implies rising intervention as the RUB approaches the edge of
2008/09 period when the RUB basket corridor was narrower,                             the corridor.
and the quantities of intervention were larger. However, it is                        Short-term Support for the RUB
still true that the RUB would almost certainly be weaker if it
weren’t for the fact that the CBR was selling a large quantity                        Many of the above factors that caused RUB to trade well
of USD. Indeed, it is the prospect of central bank support                            during the May-June correction remain in place, and they


                                                                                                                                                                              13
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should continue to provide support for the currency in the near                             Finally, our tactical stance on the market remains Neutral,
term.                                                                                       as many of the broader global risks for EM currencies
                                                                                            have become more benign. In EM FX we moved to Neutral
Indeed, we believe that strong oil prices will continue to be
                                                                                            from Reduce (i.e., sell into strength) on July 1 (see Global EM
supportive of the RUB since our commodity analysts continue
                                                                                            Investor: Taking Stock of the Sell-off). Chairman Bernanke
to see near-term strength in crude prices (see US Oil Data
                                                                                            has softened his tone on US monetary policy, prompting some
Show Improving Global Oil Fundamentals, July 8).
                                                                                            USD weakness and more stability in US bond yields.
Russia is heavily dependent on oil, which accounts for two-                                 Furthermore, although the slowdown in China continues,
thirds of exports and half of federal budget revenues (see                                  monetary conditions have eased significantly compared to the
Russia Economics: Responding to Oil's Challenge, November                                   volatility we saw in June, prompting a normalization of the
12, 2012 for more discussion of the impact of oil on Russia).                               China rates market – and this should help to foster some
Some observers have argued that oil is likely to weaken, as                                 near-term stability in EM risk assets.
the prices for some metals, such as aluminium, nickel and iron
                                                                                            This, in the context of strong oil and CBR support, should help
ore, have weakened. But we see two reasons for significant
                                                                                            RUB perform relatively well in the near term.
resistance to a lower oil price. First, the oil market is
reasonably tight, with for instance the IEA recently reducing its                           While we can see reasons for some near-term strength in
estimate of spare capacity, and DM demand may pick up if                                    RUB, there are substantial medium-term risks that mean good
growth picks up in the US and Europe, in line with the MS                                   entry points for long USD positions will likely emerge over the
forecast for an average $108/bbl price in 3Q13. Second,                                     course of 3Q.
unlike other commodities, oil has a cartel in OPEC and a
                                                                                            RUB Risks on the Horizon
cartel leader in Saudi Arabia, which has a track record of
being willing to adjust production in support of their price                                Although current levels mean that short-term risk/reward
objectives, which is currently $100/bbl. Moreover the core Gulf                             favours being long RUB vs the basket, any rebound will
3 producers are currently producing 2 mmpobd above their                                    probably be limited to around the middle of the CBR’s
2009-10 average level, giving them scope to reduce                                          intervention corridor, which currently starts around 35.75, and
production.                                                                                 is around 3.4% stronger than current levels. Indeed, we see a
                                                                                            number of risks that could undermine the RUB into year-end.
Exhibit 7
2 mmbopd Gulf 3 Production Excess over 09-10 Average                                        First, we expect the USD to remain strong on the back of
Level a Headwind to Oil Below $100/bbl                                                      strong US economic growth and the implications this has on
                                                                                            US monetary policy and US Treasury yields. The slowdown in
 16000      mbopd
                                                                                            capital flows to EM that should accompany this process will
 15000
                                                                                            keep pressure on EM currencies. While the RUB has less to
                                                                                            lose than others from this process, as we described earlier, it
 14000                                                                                      is unlikely that the currency would be entirely insulated.

                                                                                            Second, Russia’s balance of payments is no longer
 13000
                                                                                            supportive of a stronger RUB. This is partly because the
 12000                                                                                      current account surplus has fallen, and we forecast it this year
                                                                                            at a more modest 2.3% of GDP. Moreover, the current
 11000                                                                                      account surplus is now fully offset by net private sector capital
                                                                                            outflows, which are broadly equivalent in size. In fact in 1H13,
 10000                                                                                      on preliminary data, the current account surplus was
     Jan-02         Jan-04        Jan-06        Jan-08        Jan-10       Jan-12
                                                                                            USD32bn, while private sector capital outflows were
                             Gulf 3 actual             Gulf 3 average 09/10
                                                                                            USD38bn. Looking ahead, we also see prospects of
Source: JODI, Morgan Stanley Research. Gulf 3 = Saudi Arabia, Kuwait and United Arab
Emirates. Note assumed that Kuwait production in April 2013 flat at the March 2013 level,   continuing structural decline in the current account surplus,
and UAE production flat to April 2013 at the November 2012 level.
                                                                                            with export growth capped by limited potential for expanding
Furthermore, the absence of heavy positioning in the bond                                   key oil and gas exports, and import growth running at 5-6%,
market and the CBR’s USD selling mechanisms will continue                                   supported by strong income growth.
to provide some support for the currency.


                                                                                                                                                         14
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                                                                                         FX Pulse




BoP Seasonality. However, the Russian balance of                                         Exhibit 9
payments has a pronounced seasonal pattern, though history                               BOP Seasonality: Strong in Spring, Weak in 3Q
suggests that this results in similarly seasonal performance in
the RUB only in the first half of the year. The strongest                                            US$ billion, Average 2009-2012

months for the current account are January to May as a result                              10
of lower imports; then from June to August net dividend
                                                                                             5
payments and the travel services deficit keep the current
account weak, before the current account returns to a stable                                 0
surplus in September-December (though at lower levels than
in Jan-May). The financial account follows a different pattern:                             -5
a wide deficit at the start of the year driven by private sector
capital outflows, before strengthening to a spring surplus, and                           -10
then returning to deficit in the second half. On balance, these
                                                                                          -15
patterns imply that RUB gets the most support from the
                                                                                                 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
balance of payments in 1H (particularly March-May) and less
support in 2H, with 3Q particularly weak. Over the last five                                         Current account                  Financial account
years, however, 3Q has generally seen a fairly stable RUB,                                           ow PS Capital outflows           Balance
with the exceptions of the Eurozone crisis in 2011 and Global                            Source: CBR, Morgan Stanley Research

Financial Crisis in 2008.
                                                                                         Third, the CBR has begun to cut rates. In September 2012,
Exhibit 8                                                                                when inflation moved above the 5-6% target, the CBR hiked
Crossing the RUBicon: Declining RUB Support from the                                     rates. With inflation holding above target, the CBR has kept
Balance of Payments                                                                      rates on hold since, despite rate cuts and monetary easing in
                                                                                         many countries and a growth slowdown in Russia. Now, after
    70
             US$ billion                                                                 three months of largely symbolic cuts in longer rates in April-
    50
                                                                                         June, following a sharp deceleration in inflation in June-July
                                                                                         and continued signs of weak growth, the CBR announced a
    30                                                                                   new auction facility at the July rates meeting, which we
                                                                                         believe amounts to a significant easing. The first auction on
    10
                                                                                         July 29 will offer the equivalent of over 20% of the liquidity
   -10
                                                                                         currently provided by the CBR to banks, at much longer
                                                                                         durations (1 year) and at lower rates (up to 175 bps lower),
   -30                                                                                   and tied to short term rates, so positioned to benefit from any
                                                     US$ -130.2 bn
                                                                                         subsequent cuts in policy rates. Further, we expect a further
   -50
      1Q-04 1Q-05 1Q-06 1Q-07 1Q-08 1Q-09 1Q-10 1Q-11 1Q-12 1Q-13                        50 bps of cuts in short-term policy rates this year as inflation
                                                                                         falls back to target levels in 2H13 (see Russia Economics:
            private sector flows             current account                balance
                                                                                         Russian LTRO, July 12, for details).
Source: CBR, Morgan Stanley Research. Balance refers to the sum of the current account
and private sector flows.
                                                                                         Fourth, MinFin will start buying USD. The MinFin plans to
                                                                                         start buying dollars for transfer to the Reserve Fund through
                                                                                         the market, starting in August, which adds to pressure on the
                                                                                         RUB. Still, this additional USD buying may not have a major
                                                                                         impact for two reasons:

                                                                                          Any MinFin USD buying that pushed RUB weaker within
                                                                                           the corridor could be offset by even more CBR intervention.
                                                                                           Generally CBR intervention (currently $200 mn per day) is
                                                                                           significantly larger than potential MinFin USD purchases
                                                                                           (up to $40-50 mn per day, according to Deputy Finance
                                                                                           Minister Moiseev);


                                                                                                                                                          15
                                                                                         MORGAN STANLEY RESEARCH

                                                                                         July 18, 2013
                                                                                         FX Pulse




 The scale of the planned Reserve Fund transfer is smaller                              RUB corridor approximately flat in real terms against the USD
  than in previous years, at 149 bn RUB or under $5 bn by                                to end-2013.
  year-end, and even that is at risk, given the decision to use
                                                                                         Small impact from a further downwards step in
  oil revenues to cover any shortfall in non-oil revenues.
                                                                                         intervention levels. We expect another step to widen the
Exhibit 10                                                                               corridor and reduce the levels of intervention, as part of the
2013 MinFin Reserve Fund Transfer Under $5 bn                                            ongoing planned transition to a freely floating RUB in 2015.
                                                                                         However, we think that the step is not imminent, since we
    40                                                                                   believe the CBR would prefer, as in the past, to widen when
          US$ billion
                                                                                         the RUB is in the non-intervention zone, to avoid triggering
    30
                                                                                         speculative pressure. Moreover, in line with past moves, we
    20                                                                                   expect the change to be modest, perhaps taking another $20-
                                                                                         50 mn off the level of intervention at each level, widening the
    10
                                                                                         non-intervention central zone and further widening the corridor
     0                                                                                   by another RUB.

   -10                                                                                   Multiple lobbies for engineering a weaker RUB. The RUB
                                                                                         is still close to historical highs in real or inflation-adjusted
   -20
                  2011                  2012                  2013F                      terms. Since 2009, the RUB has continued to strengthen
                    CBR interventions: Total CBR purchase of FX                          against the USD in real terms, despite regular periods of
                    CBR interventions: Total CBR sale of FX                              weakness in nominal terms. Even after the significant
                    Reserve Fund transfer
                                                                                         weakening in June, RUBUSD was in real terms just back to
Source: CBR, MinFin, Morgan Stanley Research, 2013 Reserve Fund transfer estimate from
Finance Minister Siluanov                                                                the level of December 2012. In response to this strong
                                                                                         appreciation, we see several powerful lobbies for engineering
Exchange rate policy. A key driver of the RUB is the CBR’s                               a weaker RUB. They include exporters, who have costs in
exchange rate policy. On current settings, or even with a                                RUB and revenues in FX; manufacturers, who face foreign
further modest downward step in intervention levels, a RUB                               competition; the MinFin, which favours a weaker RUB since it
staying in the second intervention band would maintain the                               increases the budget’s RUB income from oil and gas; and
RUB corridor broadly flat in real terms. More radical moves in                           some policymakers, such as Belousov, the President’s
exchange rate policy, dramatically reducing CBR intervention                             economic adviser, who see a weaker RUB as supportive of
or targeting a weaker RUB, are often discussed in Moscow.                                growth. We therefore see a risk of a shift in exchange rate
However, we see any near-term change as unlikely, given                                  policy to one which supports a weaker RUB.
Governor Nabiullina’s endorsement of current exchange rate
                                                                                         Exhibit 11
policy.
                                                                                         In Real Terms, the RUB Is Still Close to Historical Highs
Current settings and RUB would keep the corridor
                                                                                                      2005 = 100
broadly flat in real terms. The CBR gradually moves the                                    135

corridor in response to pressure. For instance, since the start                            125
of June the CBR has moved the corridor down 10 kopecks to
                                                                                           115
reflect cumulative “non-target’ sales of $900 mn. Broadly, the
                                                                                           105
idea is that target sales are related to smoothing the RUB
impact of movements in oil prices, and non-target sales are                                  95
related to smoothing the RUB impact of speculation. In                                       85
practice, 22% of total CBR dollar interventions since 2010
                                                                                             75
have been non-target. On current settings, if this proportion
holds going forward, and the RUB continues to sit in the                                     65
                                                                                              Jan 03       Jan 05       Jan 07         Jan 09     Jan 11       Jan 13
second intervention zone, selling $200 mn per day, then the
CBR would move the corridor roughly every 10 trading days,                                                  REER                NEER            Bi-Currency Basket

or by a further 60 kopecks, or a further 1.6% in total to 32.35-                         Source: CBR, Morgan Stanley Research

39.35 RUBBSKT by year-end. This in turn would keep the


                                                                                                                                                                        16
                                                                  MORGAN STANLEY RESEARCH

                                                                  July 18, 2013
                                                                  FX Pulse




But continuity more likely, we think. Despite this, we see         Continuity at the CBR. Governor Nabiullina has stressed
three reasons for expecting the CBR to keep the current             that she will act in line with the policy of Igantiev’s CBR.
market-driven exchange rate policy broadly unchanged:               The significant easing which she is introducing is, we think,
                                                                    in line with Ignatiev and Ulyukayev’s policy. However, a
 Nabiullina support. Governor Nabiullina has strongly
                                                                    change in the exchange rate policy would be a major
  endorsed the current exchange rate regime, and the
                                                                    departure.
  objective of allowing the rate to be determined by market
  forces (which would be difficult to reconcile with a REER        Crossing the RUBicon. With a declining current account
  target, for instance) while smoothing volatility (which would     surplus and capital outflows which broadly match the
  argue against any radical change in the intervention              current account surplus, there is now little fundamental
  mechanism that might lead to a significant further move in        pressure from the balance of payments for further real
  the RUB).                                                         appreciation of the RUB.




                                                                                                                              17
                                                                    MORGAN STANLEY RESEARCH

                                                                    July 18, 2013
                                                                    FX Pulse




Strategic FX Portfolio Trade Recommendations
Dara Blume

               Limit Order: 0.9125, Stop: 0.9025, Target:                        AUD Bearish Positioning at Extreme Levels
               0.9600
               After the more hawkish-than-expected RBA minutes,                                                    AUD-USD Positioning
               we wish to position for tactical AUD strength as the            10
                                                                                                                    AUDUSD (RHS)
                                                                                                                                                                          1.1

               central bank has scaled back market expectations for
               further rate cuts. Our positioning tracker has also              5
                                                                                                                                                                          1.05

Limit Order:   shown short AUD positions moving out of extreme                  0

    Buy        territory. We like expressing this view against USD,                                                                                                       1


 AUD/USD       given Bernanke’s dovish tone in his latest testimony             -5


               and recent weakness in US data. However, over the               -10
                                                                                                                                                                          0.95


               longer term we remain bearish AUD given its exposure
               to softer-than-expected Chinese economics and global            -15
                                                                                 Jan-11          Jul-11         Jan-12             Jul-12           Jan-13        Jul-13
                                                                                                                                                                        0.9


               commodities.
 3 July 2013   Entered: 100, Stop: 101, Target: 95                            JPY Increasingly Used as a Funding Currency
               Although we remain tactically bullish JPY as it
               transitions into a funding currency role (see The JPY
               Risk, July 3, 2013 ), we tread cautiously ahead of the
               Japanese Upper House elections. The strong opinion
   Hold:       polls lead us to believe that there will be renewed
               momentum on reforms, especially on the structural
   Short       front, weighing on JPY. We monitor JPY’s reaction
  USD/JPY      closely to determine when to switch to our structurally
               bullish USD/JPY stance, but we keep in mind that
               Bernanke’s dovish tone as of late may continue to
               weigh on USD, supporting our current bearish
               USD/JPY position.
               Entered: 1.9175, Lower Stop to: 1.9500,
 4 July 2013                                                                   Rates Expectations Suggest Lower GBP/NZD
               Target: 1.8600
                                                                                                                                                                    2.05
               Even though the BoE minutes showed a 9-0 vote                    -1.40

               against QE, the tone of the central bank did not                 -1.60

                                                                                -1.80
                                                                                                                                                                    2



   Hold:       change, as it is considering alternative easing                  -2.00
                                                                                                                                                                    1.95


               measures and forward guidance, which should bring                -2.20
                                                                                                                                                                    1.9

   Short       GBP under renewed selling pressure. Meanwhile, NZD               -2.40                                                                               1.85

  GBP/NZD      could benefit from some retracement in rates as US
                                                                                -2.60
                                                                                                                                                                    1.8
                                                                                -2.80

               data softens somewhat and Bernanke takes a dovish                -3.00                                                                               1.75
                                                                                    Jun-12           Sep-12         Dec-12            Mar-13             Jun-13
               tone.                                                                                           GBP-NZD 1Y1Y        GBPNZD (RHS)



               Entered: 1.2310,: Stop: 1.2310,
6 June 2013                                                                                   Switzerland Still Mired in Deflation
               Target: 1.3000
                                                                                15                                                                                   -3.0
                                                                                                CHF Narrow TWI (Lagged 18 Mth, Left)
               Though risks in the Euro Area periphery are rising due           10
                                                                                                Core CPI ( Right)                                                    -2.0
               to political concerns, we believe the SNB will stick to its           5

   Hold:       currency floor going forward. Moreover, we expect                     0
                                                                                                                                                                     -1.0


   Long        CHF to become an attractive funding currency, given               -5                                                                                  0.0

  EUR/CHF      the central bank is unlikely to allow rates to rise, even       -10                                                                                   1.0
               as other central banks begin to remove some                     -15                                                               Yr/Yr % Chg
                                                                                                                                                                     2.0
               accommodation.                                                  -20
                                                                                         00     02        04       06         08            10      12       14




                                                                                                                                                                                18
                                                                                     MORGAN STANLEY RESEARCH

                                                                                     July 18, 2013
                                                                                     FX Pulse




18 July 2013           Entered: 8.82, Close at 19 July WMR Fix                                                      FX Reserve Coverage Falling
                       We have exited our long USD/UAH NDF trade. We                             100




                       entered this trade because of the external challenges                         80




 Take Profit           Ukraine faces, which in an environment of a strong                            60




                       USD and concern about capital inflows to EM should                            40


   Long
                       have resulted in more of a devaluation risk priced into                       20


 USD/UAH               the curve in our view. With the USD on the back foot                          0


  6M NDF
                                                                                                     Jan-05     Jan-06       Jan-07    Jan-08       Jan-09   Jan-10     Jan-11    Jan-12   Jan-13


                       following some weaker US data and Fed dovishness,                                            Foreign Reserves/S-T External Debt by Remaining Maturity (%)



                       we no longer believe this is an appropriate trade.

18 July 2013           Entered: 1.550, Close at 19 July WMR Fix                                            UK Offers Lowest Real Yields in G10
                                                                                                  2.5                                                                                      2.5
                       We wish to take profit on our short GBPUSD position,                       2.0                       1-Yr Deposit                                                   2.0
                                                                                                  1.5                                                                                      1.5
                       in light of Bernanke’s dovish testimony, which could                       1.0                       10-Yr Govt                                                     1.0
 Take Profit:          lead to some near-term volatility in USD. However, we                      0.5                                                                                      0.5

   Short               maintain our medium term bearish GBPUSD view,                              0.0
                                                                                                 -0.5
                                                                                                                                                                                           0.0
                                                                                                                                                                                           -0.5
  GBP/USD              given the UK’s exposure to external funding conditions                    -1.0                                                                                      -1.0
                                                                                                 -1.5                                                                                      -1.5
                       and the divergence between monetary policy in the two                     -2.0                                                                                      -2.0
                       countries.




                                                                                                                                                                            SEK


                                                                                                                                                                                     ZD
                                                                                                                                                      JPY
                                                                                                                               SD




                                                                                                                                              C D




                                                                                                                                                             A D

                                                                                                                                                                      N K
                                                                                                                     EU *




                                                                                                                                      C F
                                                                                                              G P


                                                                                                                       R




                                                                                                                                       H
                                                                                                               B




                                                                                                                                               A




                                                                                                                                                              U

                                                                                                                                                                       O




                                                                                                                                                                                    N
                                                                                                                              U
17 July 2013           Entered: 130.0, Stopped out: 131.30                                                EUR/JPY Trading with Peripheral Yields
                       While we remain bearish on the EUR based on political
                       developments and weak data releases this past week,                     135                                                                                         4.00
                                                                                               130
                       we were pushed beyond our stop in light of recent                       125
                                                                                                                                                                                           4.50

                       developments in Japan. As noted above, pre-election                     120
                                                                                                                                                                                           5.00

    Close:             polls have put PM Abe and his reform measures back                      115                                                                                         5.50

    Short              in the spotlight and we believe that the JPY will be                    110                                                                                         6.00

   EUR/JPY             weaker as the reforms gain momentum post-elections.                     105
                                                                                                                                                                                           6.50

                       In fact, the BoJ’s anchoring of real yields in Japan                    100                                                   EURJPY
                                                                                                                                                     Spanish 10yr (rhs, inverted)          7.00
                                                                                                95
                       versus other currencies has seen Japanese investors                      90                                                                                         7.50
                       favor Euro assets especially with the recent rise in Euro                 Jul-12               Oct-12                Jan-13           Apr-13               Jul-13

                       yields.
Source for all charts: Reuters Ecowin, Haver Analytics, Bloomberg, Morgan Stanley Research




                                                                                                                                                                                                    19
                                                                                                                               MORGAN STANLEY RESEARCH

                                                                                                                               July 18, 2013
                                                                                                                               FX Pulse




Strategic FX Portfolio
                                                                          Nominal                                                                                                                                    Carry         Portfolio
Trade Recommendation                        Notional                      Weight             Entry Date              Entry Level         Current              Stop          Target               Spot P&L            P&L          Contribution
Closed Trades
Short EUR/JPY                                               $10.0mn             10.1%              03-Jul-13              130.00        Stopped at 131.30 on 17-Jul-13                                -$98.9k         -$0.1k           -$98.9k
Short GBP/USD                                               $10.0mn             10.1%              21-Jun-13              1.5500           Close at WMR on 19-Jul-13                                 $195.5k          -$2.0k          $193.4k
Long USD/UAH 6M NDF                                         $10.0mn             10.1%              21-Jun-13              8.8200           Close at WMR on 19-Jul-13                               -$143.4k           $0.0k          -$143.4k
Active Trades
Long EUR/CHF                                                $10.0mn             10.1%              06-Jun-13              1.2310             1.2386            1.2310         1.3000                   $48.1k         $1.2k             $49.3k
Short USD/JPY                                               $10.0mn             10.1%              03-Jul-13              100.00             100.59            101.00          95.00                  -$42.8k         -$0.7k           -$43.5k
Short GBP/NZD                                               $10.0mn             10.1%              04-Jul-13              1.9175             1.9266            1.9500         1.8600                  -$48.8k         $9.4k            -$39.4k
Limit Orders
Buy AUD/USD                                                 $10.0mn                                                       0.9125             0.9147            0.9025         0.9600
Cash                                                        $48.9mn        49.3%
Portfolio Mark to Market                                    $99.1mn
Source: Morgan Stanley Research; *Stops for all trades are based on spot , changes to stops/targets in bold/italics

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                                                                                                                                                     USD/UAH 6M
 135                                                                                                                                                                         NDF

 130
                                                                                                                                                                                NZD
 125
 120                                                                                                                                                                               JPY

 115
                                                                                                                                                                                EUR
 110

 105
                                                                                                                                                                                CHF
 100

  95                                                                                                                                                                            GBP
                                                                                                                                          MS FX Strategic Portf olio                                                              USD m n
  90
                                                                                                                                          Barclay Currency Fund Index                    -20            -10      0           10       20
   Jan-05     Jul-05    Jan-06   Jul-06   Jan-07   Jul-07    Jan-08   Jul-08     Jan-09   Jul-09   Jan-10   Jul-10    Jan-11   Jul-11   Jan-12   Jul-12   Jan-13
                                                                                                                                                                             Now               Las t Puls e




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               0.07          -0.38            0.50             -0.50                                                                                                  -1.12%

Source: Morgan Stanley Research; see notes above.




                                                                                                                                                                                                                                            20
                                                                                                              MORGAN STANLEY RESEARCH

                                                                                                              July 18, 2013
                                                                                                              FX Pulse




G10 Currency Summary
Calvin Tse and Dara Blume

                USD                                 Data-Dependent                                     Bullish      Watch: Chicago Fed, Home Sales, PMI, Claims, Durables, U-Mich

                  0.3%                              Given that the Fed has left itself flexibility on how quickly it tapers quantitative easing based on how the incoming data evolve, we
                                                    believe that USD will be extremely reactive to economic numbers going forward. Stronger-than-expected prints are likely to scale
               forward expectations of tapering, increase US rates and support USD, and vice versa. In this regard, over the next week regional
                                                    Fed surveys, home sales, initial jobless claims and durable goods numbers will be important to watch.
                EUR                                 Forward Guidance                                   Bearish      Watch: PMI, M3, German IFO

                  0.1%                              We continue to look for further EUR weakness as the ECB has moved into a new easing regime. With eurozone growth still
                                                    in recession, inflation low, peripheral spreads widening and political risk reemerging, we believe that the ECB will continue to
               look for new easing measures should the economy require them. Therefore, leading indicators of growth, namely PMI and
                                                    the German IFO survey, are likely to be important indicators for the central bank and should thus drive EUR trading.
                 JPY                                Elections Are Key                                  Bearish    Watch: MoF International Securities Data, Leading Index, Trade, CPI

                -0.3%                               The main risk event will be the Japanese elections this weekend. Should the LDP gain a majority in the Upper House on July
                                                    21, this should allow Abe to easily push through growth-enhancing reform. Coupled with aggressive monetary easing, we
               expect this to drive outflows from Japan, weighing on JPY over the medium term. That said, failure to garner a majority,
                                                    though not our base case, is likely to result in extreme volatility in JPY trading.
                GBP                                 Changing Tools, Not Tone                           Bearish      Watch: PSNB, GDP

                -0.8%                               GBP has received some support from stronger-than-expected data and the headline 9-0 vote against QE revealed in the
                                                    latest BoE minutes. However, we maintain our bearish GBP view, as we note that the central bank has not changed its
               dovish tone, but rather is considering alternative mixes of policy measures to ease monetary conditions. Forward guidance is
                                                    the most likely measure to be used, which would weaken GBP, in our view.

                 CHF                                Funding USD                                        Bearish      Watch: M3

                  1.4%                              We maintain our expectation that CHF will transition into a funding currency in the medium term. The SNB is unlikely to
                                                    remove its monetary accommodation and will likely stick to its EURCHF floor, even as rates rise elsewhere. However, CHF
               could retrace somewhat against USD over coming weeks as USD becomes slightly more volatile due to softer data and
                                                    comments from Bernanke.

                CAD                                 Signs of Vulnerability                             Bearish      Watch: CPI, Retail Sales

                  1.3%                              The market took the BoC statement as dovish, though the changes from the last statement were only marginal. As such,
                                                    there is room for some minor tactical retracement in USDCAD. That said, however, the BoC remains firmly on hold,
               particularly given the high levels of household debt, while the FOMC will likely taper its asset purchases over the coming
                                                    months, even if this comes later than initially expected. As such, we expect USDCAD to remain supported.
                AUD                                 Stretched Shorts                                   Bearish      Watch: CPI

               -11.9%                               Our FX Positioning Tracker shows that AUD short positioning is in extreme territory, which has historically been a good
                                                    indicator of a tactical rebound in the currency. Coupled with more hawkish-than-expected RBA minutes, we believe that there
               is scope for a short squeeze in the near term. The CPI release this week will be of heightened importance, given that the
                                                    market remains split over whether or not the RBA cuts rates in August. A high print should support AUD and vice versa.
                 NZD                                Susceptible to Weakness                            Bearish      Watch: Trade Balance, RBNZ

                -7.6%                               Over the medium term, we remain bearish on NZD. Slowing Chinese growth will continue to drag on the Asian region as a
                                                    whole, especially open economies tied to exports. Furthermore, as the US economy recovers and US yields move higher,
               this should disproportionately weigh on NZD, given its large current account deficit and reliance on foreign funding. The main
                                                    risk event for the week will be the RBNZ meeting, where we expect the central bank to remain on hold.

                 SEK                                A More Balanced View                               Neutral      Watch: Economic Tendency Survey, PPI, Unemployment, Trade

                  1.9%                              The Riksbank struck a more balanced tone in the minutes of its latest meeting, saying that the risks of a cut and a hike are
                                                    now roughly even, as opposed to the past, when they were skewed towards a cut. This contrasts with other European central
               banks, such as the ECB, Norges Bank and BoE, and could offer SEK support in the near term. However, we are cautious
                                                    that the central bank would likely push back should SEK strengthen beyond the highs reached in 1Q.
                NOK                                 Cautious against SEK                               Neutral      Watch: Oil Prices, Risk Appetite

                  4.1%                              NOK remains attractive over the long term in an environment of rising interest rates, given its dual surpluses. However,
                                                    though rising oil prices should offer some support to NOK in the near term, we are cautious that it is likely to see pressure as
               Norges Bank revised the repo rate path down at its latest meeting, while other central banks, notably the Riksbank and the
                                                    FOMC, are taking a more hawkish stance.



                                                                                                                                                                                    21
                                                                                                                     MORGAN STANLEY RESEARCH

                                                                                                                     July 18, 2013
                                                                                                                     FX Pulse




EM Currency Summary
EM Strategy Team

                                   -0.6%
                                                                         We expect CNY to stabilize at these levels, given the backdrop of capital outflows from EM as concerns
CNY     Neutral
                                      increase about the growth slowdown in China from the ongoing economic rebalancing.
                                                                         Concerted measures from the RBI and the Finance Ministry indicate that policy-makers prefer USDINR to
                                    10.5%
                                                                         remain close to 60. We do not rule out further measures to be implemented in case INR sees another round
INR     Neutral
                                      of weakness due to global investor sentiment. On the other hand, the fundamental trend for USDINR remains
                                                                         biased to the upside. Hence, we change our near-term stance on the currency to neutral.
                                      2.9%                               Risks from rising inflation due to fuel price hikes as well as the shifts in funds away from the EM markets are
IDR     Bearish                                                          causing foreign outflows from Indonesian local bond and equity markets. Given the high levels of past foreign
                                      speculative flows into the Indonesian bond markets and BI’s declining FX reserves, we remain bearish on IDR.
                                      0.7%                               We hold a neutral stance on KRW. While Korea’s current account surplus support and continued foreign
KRW Neutral                                                              inflows to the local bond market are positive for the currency, we could see some downward pressure on KRW
                                      due to further weakness in JPY that we expect after the Japanese upper house elections.
                                      4.7%                               We think that MYR is among the currencies more vulnerable to the ongoing global risk-aversion as foreign
MYR Bearish                                                              ownership of Malaysian bonds as a percentage of its central bank’s FX reserves is high compared to peers in
                                      the region. We expect further weakening in MYR as local rates markets sell off.
                                      8.6%                               We expect further weakness in THB mainly on account of a continued sell-off in local rates, which are rising
THB     Bearish                                                          along with higher US rates. Japanese reflation-related flows into Thai government bonds have also slowed in
                                      the last few months.
                                                                         While PHP’s fundamentals warrant relative currency outperformance compared to the region, given its
                                   5.6%
                                                                         positive macro of high growth, a steady current account surplus and fiscal discipline, downside risks to the
PHP     Neutral
                                  currency remain from the global investor sentiment and BSP’s bias to prevent a significant relative
                                                                         appreciation in the peso.
                                      0.4%                               CZK has traded like a safe haven through recent bouts of EMFX volatility. Low positioning, low yield and low
CZK     Bearish                                                          external funding requirements help to explain this. However, the CNB has kept to its bias for a weak koruna
                                      and, as the currency outperforms, it is possible we see rhetoric for intervention pick up. We stay bearish.
                                     -2.3%                               HUF did not come under the same selling pressure as other EM currencies during the sell-off in May-June
HUF     Bearish                                                          and so, from a technical perspective, is not as well positioned to take advantage of the current bear market
                                      rally. In addition, we think that a continued dovish policy bias from the NBH will work against the currency.
                                     -0.8%                               ILS remains one of the few currencies within EM which is likely to benefit from an improving fundamental
ILS     Neutral                                                          backdrop over the medium term – which helps to explain recent resilience. However, the BoI has been clear
                                      in its bid to prevent the currency from appreciating, thus we see limited gains and fade any ILS strength.
                                      4.6%                               PLN has outperformed in the recent correction, and beyond the rise in EUR/USD we see several domestic
PLN     Neutral                                                          factors that help explain outperformance. Our economists believe the NBP has reached the end of its cutting
                                      cycle, and several measures may be taken for more expansive fiscal policy. We are neutral on PLN.
                                      2.9%                               We are constructive on RUB in the short term as oil prices remain strong and the CBR continues to sell USD.
RUB     Neutral                                                          However, we see a weaker RUB by year-end thanks particularly to USD strength and CBR easing. In
                                      addition, we see declining support from the balance of payments over the medium term.
                                      8.6%                               The CBT has taken more aggressive action to stabilize the currency, and increased market expectation for a
TRY     Bearish                                                          widening of the interest rate corridor. We think that a meaningful tightening in policy will be necessary to
                                      reduce TRY’s vulnerability during periods of market weakness. We look to buy USD/TRY on dips.
                                      8.2%                               We continue to see a strong case for depreciation in ZAR as gold prices decline and put pressure on the
ZAR     Bearish                                                          country’s weak external position, and the currency remains vulnerable to any potential outflow from the bond
                                      market. However, heavy short positioning and a less dovish SARB may limit the downside in the near term.
                                    12.7%
                                                                         Weakening fundamentals and a worsening political backdrop do not bode well for BRL, despite the large
BRL     Bearish
                                      carry. It should underperform in the short run.
                                      5.8%                               Copper weakness continues to be an important risk for the country’s current account, and the large local
CLP     Neutral                                                          positioning remains an important hurdle for investors to increase exposure. Nonetheless, CLP should gain
                                      from lower volatility, given its attractive carry.
                                      3.7%
                                                                         Continued commodity weakness should weigh on COP, particularly given the country’s already weakened
COP     Bearish
                                      manufacturing sector and BanRep’s insistence on continuing its daily USD purchasing program.
                                      4.5%
                                                                         Positioning has diminished, and the lower volatility environment should allow investors to resume long
MXN Bullish
                                      positions in MXN, as US relative strength and the reforms in Mexico bode well for the currency.
                                      6.9%
                                                                         The lack of liquidity should keep foreign investors from increasing exposure to the Peruvian local market.
PEN     Neutral
                                        The BCP continues to intervene on the weak side via CDs to protect the currency and stem volatility.


Charts show 3M performance against USD, as normally quoted                                                                                                                                 22
                                                                                    MORGAN STANLEY RESEARCH

                                                                                    July 18, 2013
                                                                                    FX Pulse




Global Event Risk Calendar
Dara Blume

Date   (GMT)           Ccy   Time    (GMT)   Event                                                      Ref. Period         MS forecast   Market   Previous
        19-Jul   Fri
                       CAD   13:30           CPI (YoY)                                                            Jun                     1.20%      0.70%
                       GBP   09:30           PSNB ex Interventions                                                Jun                       8.0B       8.8B
                       INT    NA             G20 Finance Ministers and Central Bank Governors Meeting
                       NZD   04:00           Credit Card Spending SA (MoM)                                            Jun                           -0.60%
       22-Jul    Mon
                       CHF   08:00           M3 (YoY)                                                                 Jun                            9.70%
                       USD   15:00           Existing Home Sales                                                      Jun        5.28M    5.24M      5.18M
       23-Jul    Tue
                       CAD   13:30           Retail Sales (MoM)                                                   May                                0.10%
                       EUR   15:00           Consumer Confidence                                                 Jul A                     -16.2      -18.8
                       HUF   13:00           NBH Rates Decision                                                                  4.00%    4.00%      4.25%
                       NZD   23:45           Trade Balance                                                            Jun                              71M
                       TRY   12:00           CBT Rates Decision                                                                  4.50%               4.50%
                       USD   14:00           Richmond Fed Manufacturing Index                                         Jul                                 8
       24-Jul Wed
                       AUD   02:30           CPI (YoY)                                                             2Q                                 2.50%
                       CNY   02:45           HSBC Flash Manufacturing PMI                                          Jul                                  48.2
                       EUR   08:58           PMI Manufacturing                                                   Jul A                       49         48.8
                       JPY   00:50           Trade Balance                                                        Jun                              -¥821.0B
                       NZD   22:00           RBNZ Official Cash Rate                                                             2.50%    2.50%       2.50%
                       USD   15:00           New Home Sales                                                           Jun         481K     484K        476K
       25-Jul    Thu
                       EUR   09:00           M3 (YoY)                                                             Jun                     3.00%      2.90%
                       EUR   09:00           German IFO - Business Climate                                         Jul                     106.5      105.9
                       GBP   09:30           GDP (QoQ)                                                           2Q A                                0.30%
                       PHP   09:00           BSP Rates Decision                                                                           3.50%      3.50%
                       SEK   08:30           Unemployment Rate SA                                                 Jun                                7.90%
                       SEK   08:30           Household Lending (YoY)                                              Jun                                4.70%
                       USD   13:30           Initial Jobless Claims                                       Wk of Jul 19
                       USD   13:30           Durable Goods Orders (MoM)                                           Jun            0.40%    0.90%      3.70%
                       USD   16:00           Kansas City Fed Manufacturing Survey                                  Jul                                   -5
       26-Jul    Fri
                       COP    NA             BanRep Rates Decision                                                               3.25%    3.25%      3.25%
                       JPY   00:30           CPI (YoY)                                                            Jun                               -0.30%
                       SEK   08:30           Trade Balance                                                        Jun                                  5.7B
       28-Jul          CNY    NA             Leading Index                                                        Jun                                  99.6
       29-Jul    Mon
                       GBP   09:30           Mortgage Approvals                                                       Jun                            58.2K
                       ILS   15:30           BoI Rates Decision                                                                  1.25%    1.25%      1.25%
                       JPY   00:50           Retail Trade (MoM)                                                       Jun                            1.50%
                       JPY    NA             BoJ's Kuroda spks (Tokyo)
                       NZD   23:45           Building Permits (MoM)                                               Jun                                1.30%
                       SEK   08:30           Retail Sales s.a. (MoM)                                              Jun                                0.80%
                       USD   15:00           Pending Home Sales (MoM)                                             Jun                                6.70%
                       USD   15:30           Dallas Fed Manufacturing Survey                                       Jul                                  6.5
       30-Jul    Tue
                       AUD   04:05           RBA's Stevens spks (Sydney)
                       CAD   13:30           Industrial Product Price (MoM)                                       Jun                                 0.00%
                       EUR   08:00           Spanish GDP (QoQ)                                                   2Q P                                -0.50%
                       EUR   10:00           Consumer Confidence                                                 Jul F
                       INR   06:30           RBI Rates Decision                                                                  7.25%    7.25%      7.25%
                       JPY   00:30           Overall Hhold Spending (YoY)                                         Jun                               -1.60%
                       JPY   00:30           Jobless Rate                                                         Jun                                4.10%
                       JPY   00:30           Job-To-Applicant Ratio                                               Jun                                   0.9
                       JPY   00:50           Industrial Production (MoM)                                        Jun P                                1.90%
                       SEK   08:30           GDP (QoQ)                                                           2Q P                                0.60%
                       USD   14:00           S&P/CaseShiller Home Price Index                                     May                               152.37
                       USD   15:00           Consumer Confidence                                                   Jul                                 81.4



                                                                                                                                                        23
                                                                                                  MORGAN STANLEY RESEARCH

                                                                                                  July 18, 2013
                                                                                                  FX Pulse




Date    (GMT)              Ccy       Time    (GMT)    Event                                                              Ref. Period          MS forecast   Market   Previous
         31-Jul Wed
                           AUD      02:30             Private Sector Credit (MoM)                                                  Jun                                 0.30%
                           CAD      13:30             GDP (MoM)                                                                    May                                 0.10%
                           CHF      08:00             KOF Swiss Leading Indicator                                                   Jul                                  1.16
                           EUR      10:00             CPI (YoY)                                                                    Jul                                 1.60%
                           EUR      10:00             Unemployment Rate                                                            Jun                                12.10%
                           EUR      14:00             Belgian GDP (QoQ)                                                           2Q P                                 0.00%
                           JPY      00:15             PMI                                                                           Jul                                  52.3
                           NZD      04:00             M3 (YoY)                                                                     Jun                                 6.20%
                           USD      13:15             ADP Employment Change                                                         Jul                                 188K
                           USD      13:30             Employment Cost Index (QoQ)                                                   2Q                                 0.30%
                           USD      13:30             GDP QoQ (Annualized)                                                        2Q A             0.30%               1.80%
                           USD      14:45             Chicago PMI                                                                   Jul                                  51.6
                           USD      19:00             FOMC Rate Decision                                                                           0.25%    0.25%      0.25%
                           USD       NA               U.S. Treasury Department Releases Refunding Statement
         1-Aug    Thu
                           AUD      00:30             PMI                                                                               Jul                              49.6
                           AUD      02:00             HIA New Home Sales (MoM)                                                         Jun                             1.60%
                           AUD      02:30             Import price index (QoQ)                                                          2Q                             0.00%
                           AUD      02:30             Export price index (QoQ)                                                          2Q                             2.80%
                           AUD       NA               Retail Sales Ex Inflation (QoQ)                                                   2Q                             2.20%
                           CNY      02:00             Manufacturing PMI                                                                 Jul                              50.1
                           CNY      02:45             HSBC Manufacturing PMI                                                            Jul                              48.2
                           CZK      12:00             CNB Rates Decision                                                                           0.05%               0.05%
                           EUR      08:58             PMI Manufacturing                                                           Jul F
                           EUR      12:45             ECB Rates Decision                                                                           0.50%               0.50%
                           EUR      13:30             ECB'S Draghi Holds Press Conference After Rate Decision
                           GBP      09:28             PMI Manufacturing                                                                Jul                               52.5
                           GBP      12:00             BoE Rates Decision                                                                           0.50%    0.50%      0.50%
                           NOK      08:00             PMI                                                                           Jul                                  46.7
                           SEK      07:30             PMI                                                                           Jul                                  53.5
                           USD      13:30             Initial Jobless Claims                                               Wk of Jul 26
                           USD      15:00             Construction Spending (MoM)                                                  Jun                                 0.50%
                           USD      15:00             ISM Manufacturing                                                             Jul                                  50.9
                           USD      22:00             Total Vehicle Sales                                                           Jul                               15.89M
         2-Aug    Fri
                           AUD      02:30             PPI (YoY)                                                                     2Q                                 1.60%
                           CHF      08:30             PMI Manufacturing                                                             Jul                                  51.9
                           EUR      10:00             PPI (YoY)                                                                    Jun                                -0.10%
                           GBP      09:30             PMI Construction                                                              Jul                                    51
                           JPY      00:50             Monetary Base End of period                                                   Jul                              ¥173.1T
                           NOK      09:00             Unemployment Rate                                                             Jul                                2.50%
                           USD      13:30             Payrolls                                                                      Jul                                 195K
                           USD      13:30             Unemployment Rate                                                             Jul                                7.60%
                           USD      13:30             PCE Core (YoY)                                                               Jun                                 1.10%
                           USD      15:00             Factory Orders (MoM)                                                         Jun                                 2.10%
                           USD      17:15             Fed's Bullard (voter) spks (Boston)
    Upcoming
       6-Aug               AUD      05:30             RBA Rates Decision                                                                           2.75%    2.75%      2.75%
       8-Aug               JPY       NA               BOJ Rates Decision                                                                           0.05%    0.05%      0.05%
       4-Sep               CAD      15:00             BoC Rates Decision                                                                           1.00%    1.00%      1.00%
       5-Sep               SEK      08:30             Riksbank Rates Decision                                                                      1.00%    1.00%      1.00%
      19-Sep               CHF      08:30             SNB Rates Decision                                                                           0.00%    0.00%      0.00%
      19-Sep               NOK      09:00             Norges Bank Rates Decision                                                                   1.50%    1.50%      1.50%
      22-Sep               EUR       NA               German Presidential Elections (Tentative)

Denotes timing approximate or not confirmed / All times and dates are GMT / Source: Morgan Stanley Research, Bloomberg




                                                                                                                                                                         24
                                                                                                                     MORGAN STANLEY RESEARCH

                                                                                                                     July 18, 2013
                                                                                                                     FX Pulse




Cross-Currency Carry and Vol Heat Map
                7/16/2013                              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
                            Vol      Chg      Perc.    Real     Perc.    Imp Rat   Perc.   Imp Rat   Perc.    RR        Imp    Perc             Carry     Chg     Perc.    Carry      Perc.   Carry Rat
            USDCAD            8.0      -0.3     22%      1.07     42%      1.01      88%     0.99      12%    1.4      -18%    30%     USDCAD    0.9      0.0     1%       0.11      84%        0.97
            USDCHF            10.2     0.2      19%      0.88     15%      0.99      12%     1.11      82%    1.1      -11%    15%     USDCHF   -0.3      0.0    78%       -0.03     67%        1.44
            USDJPY            13.4     0.2      71%      1.01     23%      0.98      22%     1.02      79%    -1.4     11%     51%     USDJPY   -0.2      0.0    90%       -0.01     93%        1.88
            USDNOK            11.9     -0.1     23%      0.85     6%       0.97      23%     1.16      55%    1.0       -9%    66%     USDNOK    1.4      0.1    27%       0.12      44%        0.90
  G10




            USDSEK            12.0     -0.1     22%      0.98     27%      0.92      9%      1.06      81%    1.0       -9%    70%     USDSEK    0.8      0.0    52%       0.07      45%        0.93
            GBPUSD            9.1      0.0      29%      0.92     5%       0.97      23%     1.07      81%    -1.2     -14%    47%     GBPUSD   -0.3      0.0    40%       -0.03     35%        0.72
  USD




            NZDUSD            12.9     -0.2     32%      0.97     31%      1.01      17%     1.06      43%    -2.1     -17%    70%     NZDUSD   -2.7      -0.1   22%       -0.21     25%        1.01
            AUDUSD            12.3     -0.2     31%      1.00     38%      0.95      16%     1.16      99%    -2.3     -20%    62%     AUDUSD   -2.6      0.0    86%       -0.21     76%        0.92
            EURUSD            8.7      -0.1     14%      1.00     16%      0.93      13%     1.17      94%    -1.0     -12%    61%     EURUSD    0.2      0.0    64%       0.02      67%        1.50
  ,




            EURAUD            12.0     0.0      64%      1.12     53%      1.04      36%     1.12      87%    1.2      10%     44%     EURAUD    2.8      0.0    19%       0.23      18%        0.95
            EURCAD            8.6      -0.1     19%      1.37     94%      0.89      7%      1.16      95%    -0.5      -6%    28%     EURCAD    1.1      0.0    76%       0.13      81%        1.04
            EURCHF            5.7      -0.7     43%      1.00     39%      0.94      8%      1.08      83%    1.7      -31%      8%    EURCHF   -0.2      0.0    93%       -0.03     95%        1.38
            EURGBP            7.7      0.1      21%      1.29     82%      0.95      28%     1.42      75%    0.4       5%     64%     EURGBP    0.4      0.0    64%       0.05      67%        1.02
  G10




            EURJPY            12.8     -0.9     20%      1.24     85%      1.02      21%     1.15      69%    -2.5     20%     59%     EURJPY    0.0      0.0    79%       0.00      79%        3.20
            EURNOK            8.8      0.2      63%      0.90     15%      1.06      39%     1.14      38%    0.9      -11%    63%     EURNOK    1.5      0.1    38%       0.18      37%        0.96
  EUR




            EURNZD            12.8     0.0      65%      1.06     57%      0.88      7%      1.01      57%    1.1       9%     39%     EURNZD    2.9      0.1    88%       0.23      58%        1.03
            EURSEK            8.4      -0.2     57%      1.12     58%      0.90      6%      1.14      95%    0.9      -11%    71%     EURSEK    1.0      0.0    50%       0.12      47%        1.02
  ,




            GBPAUD            12.0     -0.1     48%      0.98     28%      0.90      10%     1.06      71%    1.2      -11%    49%     GBPAUD    2.4      0.0    14%       0.20      17%        0.94




                                                                                                                                                                                                          Volatility and Carry Global Heatmap
            GBPCAD            8.3      0.2      25%      1.14     53%      0.88      7%      1.15      90%    -0.5      6%     68%     GBPCAD    0.7      0.0    87%       0.08      79%        1.05
            GBPCHF            8.6      -0.3     24%      1.33     88%      0.92      8%      1.08      78%    0.3       -4%      4%    GBPCHF   -0.6      0.0    80%       -0.07     49%        1.13
            GBPJPY            11.9     -0.9     25%      1.23     84%      0.95      10%     1.22      72%    -2.5     21%     71%     GBPJPY   -0.4      0.0    76%       -0.04     59%        1.23
  G10




            CHFJPY            11.1     -0.6     13%      1.20     82%      1.06      40%     1.14      40%    -2.3     22%     89%     CHFJPY    0.1      0.0    60%       0.01      66%        0.73
            AUDCAD            9.6      0.1      40%      1.00     19%      1.06      54%     1.17      69%    -1.2     13%     49%     AUDCAD   -1.7      0.0    99%       -0.18     89%        0.90
  Crosses




            AUDCHF            12.8     0.0      42%      0.97     38%      0.93      9%      1.17      95%    -1.1      9%     12%     AUDCHF   -2.9      0.0    94%       -0.23     82%        0.98
            AUDJPY            13.9     -0.3     27%      1.00     50%      0.89      8%      1.17      87%    -3.9     29%     80%     AUDJPY   -2.8      0.0    95%       -0.20     71%        0.99
            AUDNZD            7.0      0.4      25%      1.04     32%      1.05      38%     1.13      38%    -0.3      5%     74%     AUDNZD    0.1      0.1    89%       0.01      90%        3.72
            NOKSEK            7.4      -0.2     51%      0.90     8%       0.98      24%     1.06      81%    0.2       -2%    96%     NOKSEK   -0.5      0.0    56%       -0.07     58%        0.84
  ,




            USDCNY            1.8      0.1      26%      1.27     17%      0.89      7%      1.08      61%    0.5      -26%    22%     USDCNY    2.6      -0.2   88%       1.43      97%        0.69
            USDHKD            0.4      0.0      0%       1.58     47%      1.42      37%     2.60      57%    -0.4     88%     51%     USDHKD   -0.1      0.0    87%       -0.25     69%        0.71
            USDIDR            13.0     -0.4     63%      1.60     63%      1.75      90%     6.00      57%    4.8      -36%    62%     USDIDR   23.5      4.0    95%       1.81      100%       0.53
            USDINR            12.3     -0.6     78%      1.15     37%      1.02      10%     1.33      28%    1.9      -15%    72%     USDINR    8.5      1.2    87%       0.69      75%        0.86
AXJ BLOCK




            USDKRW            8.5      -1.6     13%      0.93     17%      1.00      10%     1.26      72%    2.9      -33%    28%     USDKRW    1.9      0.1    56%       0.22      76%        0.66
            USDMYR            8.0      -1.0     40%      0.96     15%      1.26      87%     1.49      89%    2.2      -28%    22%     USDMYR    2.1      0.0    79%       0.26      74%        0.89
            USDPHP            7.7      0.0      37%      0.98     5%       1.08      41%     1.37      83%    2.2      -29%    25%     USDPHP   -0.4      -1.2   13%       -0.06     14%        -0.84
            USDSGD            6.2      -0.5     25%      0.97     7%       1.05      12%     1.40      79%    1.6      -25%    18%     USDSGD   -0.1      0.0    29%       -0.01     25%        1.12
            USDTHB            5.5      0.0      25%      0.88     8%       1.03      22%     1.56      88%    0.8      -15%    49%     USDTHB    2.0      -0.2   61%       0.36      82%        0.88
            USDTWD            4.5      -0.4     17%      0.93     2%       1.14      22%     1.64      82%    1.0      -23%    17%     USDTWD   -0.8      -0.6   81%       -0.18     74%        0.96
,




            USDARS            17.0     0.0      66%     17.11     92%      1.11      37%     1.57      84%    7.0      -41%    78%     USDARS   47.4      1.0    89%       2.79      91%        1.14
            USDCLP            11.3     -1.3     24%      1.17     23%      1.62      24%     1.71      39%    4.0      -35%    11%     USDCLP    5.9      -0.3   96%       0.52      86%        0.75
  LATAM




            USDCOP            10.8     -1.4     18%      1.37     29%      1.07      53%     1.21      68%    3.5      -33%    24%     USDCOP    3.8      -0.4   61%       0.36      75%        0.97
            USDMXN            12.3     -1.7     36%      1.06     25%      1.05      36%     1.29      83%    4.1      -34%    15%     USDMXN    3.3      0.0    26%       0.27      32%        0.97
            USDBRL            13.6     -1.2     41%      1.07     33%      1.02      30%     1.21      78%    3.8      -28%    75%     USDBRL    7.8      0.2    71%       0.58      75%        1.00
  BLOCK




            EURBRL            13.7     -1.2     57%      0.99     21%      1.02      31%     1.24      42%    3.7      -27%    84%     EURBRL    8.0      0.2    77%       0.59      70%        1.01
            EURMXN            12.8     -1.2     47%      1.09     23%      1.01      20%     1.19      30%    3.4      -26%    54%     EURMXN    3.4      0.0    35%       0.27      40%        0.99
            MXNJPY            17.2     -2.0     46%      1.14     56%      1.04      32%     1.22      47%    -4.5     27%     59%     EURMXN   -3.4      0.0    84%       -0.19     80%        1.02
  ,




            EURCZK            6.2      -0.3     15%      1.09     34%      1.05      42%     1.09      45%    1.1      -18%    77%     EURCZK    0.0      0.0    22%       0.00      22%       11.20
            EURHUF            9.7      -1.0     22%      1.02     33%      1.04      64%     1.32      96%    2.6      -27%    48%     EURHUF    3.9      0.0    18%       0.40      47%        0.87
            EURILS            7.9      -0.2     16%      1.09     46%      1.09      73%     1.03      82%    0.6       -7%    20%     EURILS    1.2      0.1    67%       0.15      70%        0.88
            EURPLN            8.6      -0.9     16%      1.08     46%      0.98      18%     1.11      84%    1.7      -20%    90%     EURPLN    2.5      0.0    35%       0.29      63%        0.96
            EURRUB            9.6      -0.9     27%      0.96     33%      1.08      56%     1.11      98%    1.3      -14%    87%     EURRUB    6.0      0.1    48%       0.62      60%        0.96
            EURTRY            11.8     0.0      61%      1.05     30%      1.01      5%      1.39      34%    3.7      -33%      6%    EURTRY    7.8      0.2    68%       0.66      72%        0.97
            EURZAR            15.4     -0.8     59%      1.01     20%      1.03      20%     1.39      56%    2.9      -19%    64%     EURZAR    5.6      0.0    38%       0.36      32%        1.00
  EMEA




            USDCZK            11.0     -0.3     11%      1.05     46%      1.03      24%     1.10      19%    1.5      -14%    83%     USDCZK   -0.2      0.0    24%       -0.02     22%        2.08
            USDHUF            14.1     -1.2     13%      1.06     64%      1.05      43%     1.18      96%    3.1      -22%    41%     USDHUF    3.7      0.0    11%       0.26      45%        0.84
            USDILS            7.9      -0.4     31%      1.04     35%      1.09      83%     1.02      87%    1.7      -21%    26%     USDILS    1.0      0.1    57%       0.13      63%        0.78
  BLOCK




            USDPLN            13.7     -0.9     14%      1.12     78%      1.03      58%     1.07      67%    2.4      -18%    84%     USDPLN    2.3      0.0    12%       0.17      53%        0.93
            USDRUB            9.6      -0.9     17%      1.07     37%      1.12      81%     1.08      98%    1.8      -19%    97%     USDRUB    5.8      0.1    47%       0.61      70%        0.94
            USDTRY            12.4     0.0      43%      1.37     88%      1.06      17%     1.38      52%    4.2      -36%      4%    USDTRY    7.4      0.1    65%       0.60      68%        0.99
            USDZAR            16.1     -0.8     46%      1.09     50%      1.03      23%     1.37      75%    3.5      -22%    77%     USDZAR    5.4      0.0    32%       0.34      36%        0.99
  ,




            Gold              19.8     -0.9     0.5      0.9      0.03     1.00      0.1      1.3      0.7    -3.8      -0.2     0.0      0.0   -0.5      -1.7    0.7       0.0       0.7        0.7
            Silver            30.6     -1.0     0.2      0.8      0.1      1.0       0.2      1.0      0.2    -4.7      -0.2     0.0      0.0   -1.2      -3.2    0.8       0.0       0.8        0.7
            Platinum          23.4     -0.7     0.5      1.0      0.2      1.0       0.1      1.0       na    -1.4      -0.1     na       0.0   -0.8      -0.8    0.8       0.0       0.5        0.8


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



                                                                                                                                                                                                               25
                                                                           MORGAN STANLEY RESEARCH

                                                                           July 18, 2013
                                                                           FX Pulse




What’s New This Week?                                                       Some key concepts in the heat map:
 In G10, Vol moves were muted. EM vols fell for most crosses,              Percentiles are calculated as the % of days that the market closed
particularly in LatAm and CEEMEA.                                           higher than the current level over the prior five years. So 94% would
                                                                            indicate that only 6% of the observations over the past five years
 Implied carry was generally flat, the main exceptions being that
                                                                            were above the current level. The percentile extremes are similar to
IDR carry rose 4 points and PHP carry fell a point.
                                                                            a z-score but are less sensitive to outliers.
User’s Guide to the Heat Map
                                                                            Implied vs realized vol: There is no hard link between implied and
The heat map is designed to allow investors to quickly determine            realized vol so it is possible – and indeed often – that implied vol
which currency pairs offer relatively high (or low) vol and carry both      might be cheap from a historical basis but still be high vs where vol
compared to other currencies and from a historical perspective. Our         is realizing. We feel that to be truly cheap (or expensive) this metric
intent in this is to highlight extremes in vol and carry that provide       should be consistent.
attractive trading opportunities as well as allow investors who have a
                                                                            1Y/3M and 5Y/1Y vol: These are the ratios of the indicated
general interest in buying or selling vol and carry a quick way to
                                                                            maturities of implied vol and serve as an indicator of whether the
isolate which currency pairs offer the best relative value at this
                                                                            implied vol curve is relatively flat or steep. This serves as an
juncture. We do this by indicating extreme highs in red and extreme
                                                                            additional indicator if vols are at extremes and can also be helpful in
lows in blue. Note that for outright indicators the colors are based on
                                                                            determining the value part of the vol curve.
extreme levels across currencies and show which currency pairs are
high (red is top 15th percentile and bold is top 10th) and low (blue is     RR/Imp: This is the ratio of the 3M 25-delta risk reversal skew to 3M
bottom 15th percentile and bold is bottom 10th) on a relative basis.        implied vol. We only do percentiles on the ratio because skew is
For the percentiles the colors instead show whether vol or carry is         highly covariant with vol – i.e., skew typically increase as vol rises –
extreme from a historical standpoint. A horizontal string of red            so it is important to adjust for the vol level when determining
entries indicates a currency pair with high vols on many measures           historical extreme of skew.
while a string of blues indicates a currency pair where vol is cheap.
                                                                            Vol-Adj. Carry: Higher carry currencies commonly have relatively
Similarly, a horizontal string of red across the carry metrics indicates
                                                                            high implied vol so metrics on this ratio can help determine whether
a currency pair that is offering relatively attractive return on a large
                                                                            carry is attractive relative to where vol is being priced. A high level
number of indicators (note we do not filter for low return.)
                                                                            for this metric also would suggest that options offer a viable way to
Risk reversal extremes can occur independent of the levels of vol           capture carry.
and carry but here too, when currencies are at extremes across
                                                                            1Y/3M Carry Rat: The ratio of 1Y to 3M net carry. To some degree a
currencies and on a historical basis this can indicate an attractive
                                                                            steep curve (red) would be another factor in indicating a good carry
trading opportunity. In addition, the risk-reversals are an important
                                                                            opportunity but the main use of this metric is a quick indication of
component of a second purpose of the heat map, to indicate which
                                                                            whether carry is enhanced or compromised by moving to longer
trade structures take best advantage of the market prices. For
                                                                            duration.
instance, if an investor wants to go long EURUSD, they might first
reference the first two vol metrics to determine whether vol is cheap       1Y Carr /Call Sprd: The numerator is 1Y net carry (i.e. 1Y forward
or expensive. They might then reference the vol curve metrics and           vs spot spread) and the denominator is the cost (in % pts.) of a 1Y
the carry metrics to determine whether it is attractive to push out         call spread going long the ATMF strike and selling the ATMS strike –
duration to lock in carry and whether vol becomes significantly more        i.e., the call spread return is capped at the forward discount. This
expensive (or cheaper) at longer maturities. Finally, the risk reversal     ratio filters for the fact that currencies with high carry frequently have
skew metrics can be used as an indicator of whether low-delta               high skew for puts – i.e., favoring the lower yield currency. A high
options are more or less attractive than at-the-money strikes.              value here suggests that call spreads represent a relatively attractive
Another example is that if the vol curve metrics are indicating the         way to capture carry with limited risk In the current yield environment
curve is unusually flat or inverted then selling front end vol via          we believe when this ratio is above 2.0 that it is sensible to consider
window barriers might be advised.                                           call spreads to capture carry.




                                                                                                                                                   26
                                                                                      MORGAN STANLEY RESEARCH

                                                                                      July 18, 2013
                                                                                      FX Pulse




G10 FX Tactical Indicators
Marc Englander

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

    4%                                                                               130

                                                                                      80
    2%
                                                                                      30
    0%
                                                                                     -20
   -2%                                                                               -70

   -4%                                                                              -120
             DXY NZD AUD EUR CAD CHF SEK GBP JPY NOK                                   Feb-13                          Apr-13                        Jun-13
                    Monthly             Weekly                                                                   USD              EUR             GBP                 JPY

Source: Company Data, Morgan Stanley Research                                      Source: Morgan Stanley Research

Exhibit 3                                                                          Exhibit 4
Relative Momentum Indicator                                                        MS GRDI – Standardized
   10
                                                                                       2.8

    5                                                                                  1.8
                                                                                       0.8
    0
                                                                                      -0.2

    -5                                                                                -1.2
                                                                                      -2.2
  -10
                                                                                      -3.2
             SEK   NOK   CHF      EUR NZD       AUD CAD       GBP   JPY    USD
                                  Current        Last Pulse                             Apr-12                Aug-12              Dec-12               Apr-13


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

                                                                                   Source: Morgan Stanley Research

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

   0.05                                                                                CHF

         0                                                                             CAD
  -0.05                                                                                EUR
   -0.1                                                                                GBP
  -0.15                                                                                 JPY
   -0.2
      Jul-12        Sep-12     Nov-12    Jan-13     Mar-13    May-13      Jul-13              -10                -5                                      5                  10


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




                                                                                                                                                                             27
                                                                                                                   MORGAN STANLEY RESEARCH

                                                                                                                   July 18, 2013
                                                                                                                   FX Pulse




Morgan Stanley FX Positioning Tracker
Calvin Tse, Gabriel de Kock and Evan Brown

Overall Score                                                                         Component Scores
         This    Last
         Week    Week           Short               Neutral             Long           MS                                   Senti-            Since the last positioning tracker update (July
                       -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               15), positioning in the G10 currencies has
                                                                                                                                               shifted slightly. We calculate the largest longs in
  USD      5      6                                                                  10      8             -3       8       3      USD
                                                                                                                                               the majors to be in USD. The largest shorts are
  EUR     -2     -1                                                                  -6      4             -5       2      -4      EUR       in AUD.
  JPY      0     -1                                                                   2     -8      4       5       -2     -4      JPY
                                                                                                                                              AUD short positioning moved back into extreme
  GBP     -5     -5                                                                   -8     -4             -1       -9     -5      GBP       territory. This was driven by Japanese retail
                                                                                                                                               selling.
  CHF     -2     -2                                                                   -4      2                             -4      CHF

  CAD     -1     -1                                                                    7     -6                             -5      CAD      USD long positioning moderated intra-week as
                                                                                                                                               Japanese margin traders were sellers and
  AUD     -7     -6                                                                 -10     -9             -4              -5      AUD       sentiment fell back.
  NZD     -6     -6                                                                   -9     -9              0              -5      NZD
                                                                                                                                              We will provide a full updated report and refresh
  NOK     -8     -8                                                                   -8                                            NOK       positioning scores for all of our underlying sub-
  SEK     -9     -9                                                                   -9                                            SEK
                                                                                                                                               indicators next Monday.
                                                                                                                                                                   For Methodology see Appendix




Morgan Stanley High-Frequency Misalignment Monitor
1Yr                                                       17 July, 2013
                EUR            JPY            GBP             CHF            AUD       CAD           NZD            NOK            SEK
                                                                                                                                              According to our High-Frequency Misalignment
USD             1.1%           2.4%           1.1%            0.2%          -1.9%     -0.6%         -1.4%          -4.3%          -0.4%        Monitor, EUR, USD and JPY remain the most
EUR                            1.3%           0.0%           -0.9%          -3.0%     -1.7%         -2.5%          -5.4%          -1.5%        expensive currencies in the G10. This suggests
JPY                                          -1.3%           -2.2%          -4.3%     -3.0%         -3.8%          -6.8%          -2.8%        G3 currencies could retrace near term against
GBP                                                          -0.9%          -3.0%     -1.7%         -2.5%          -5.4%          -1.5%        some of the smaller G10 currencies. The
CHF                                                                         -2.1%     -0.8%         -1.6%          -4.6%          -0.6%        commodity currencies and NOK appear the
AUD                                                                                    1.3%          0.5%          -2.4%           1.5%        most undervalued.
CAD         > +/- 1 sd                                                                              -0.8%          -3.7%           0.2%       The one-year model, which generates the most
NZD         > +/- 2 sd                                                                                             -2.9%           1.0%        reliable trading signals, suggests long NOK and
NOK         > +/- 3 sd                                                                                                             3.9%        AUD against JPY, EUR and GBP. Indeed,
2Yr                                                                                                                                            given its 3σ misalignment, short GBPNOK
                EUR            JPY            GBP              CHF           AUD       CAD           NZD            NOK            SEK         stands out as particularly attractive.
USD             0.9%           1.5%          -0.6%            -0.6%         -3.0%     -1.4%         -1.8%          -3.1%          -0.4%       Over a two-year look-back window, the matrix
EUR                            0.6%          -1.5%            -1.5%         -3.9%     -2.3%         -2.7%          -4.0%          -1.3%        again highlights NOK and dollar-bloc
JPY                                          -2.1%            -2.1%         -4.5%     -2.9%         -3.3%          -4.6%          -1.9%        undervaluation against the USD. The 2σ
GBP                                                            0.0%         -2.4%     -0.8%         -1.2%          -2.5%           0.1%        misalignments suggest long AUD positions
CHF                                                                         -2.4%     -0.8%         -1.2%          -2.5%           0.2%        against USD and JPY.
AUD                                                                                    1.6%          1.2%          -0.1%           2.5%
                                                                                                                                              The model estimated over a three-year look-
CAD         > +/- 1 sd                                                                              -0.4%          -1.7%           1.0%
                                                                                                                                               back window yields consistent signals. EUR
NZD         > +/- 2 sd                                                                                             -1.3%           1.4%        looks significantly overvalued against the
NOK         > +/- 3 sd                                                                                                             2.7%        commodity currencies.
3Yr
                                                                                                                                              Broadly, the Misalignment Monitor highlights
                EUR             JPY           GBP              CHF           AUD       CAD           NZD            NOK            SEK
                                                                                                                                               tactical shorts of G4 currencies against the
USD             1.3%            0.1%         -1.4%            -0.7%         -2.0%     -3.0%         -5.5%          -3.5%          -2.3%        smaller open economies in Scandinavia and the
EUR                            -1.2%         -2.7%            -2.0%         -3.4%     -4.3%         -6.8%          -4.8%          -3.6%        dollar bloc. We remain structurally USD-bullish,
JPY                                          -1.5%            -0.8%         -2.2%     -3.1%         -5.6%          -3.6%          -2.4%        but favor longer-term short positions in EUR
GBP                                                            0.7%         -0.6%     -1.6%         -4.1%          -2.1%          -0.9%        and JPY.
CHF                                                                         -1.4%     -2.3%         -4.8%          -2.8%          -1.6%
                                                                                                                                                                   For Methodology see Appendix
AUD                                                                                   -0.9%         -3.4%          -1.5%          -0.3%
CAD         > +/- 1 sd                                                                              -2.5%          -0.5%           0.7%
NZD         > +/- 2 sd                                                                                              2.0%           3.2%
NOK         > +/- 3 sd                                                                                                             1.2%
Note: Misalignment measured as the overvaluation of the column currency versus the row currency




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Central Bank Watch
                          Next rate           Market                MS                                                            Morgan Stanley Rates Forecasts
                          decision          expects (bp)        expects (bp)           Current              3Q13               4Q13               1Q13              2Q14               3Q14
US                         31 Jul                  1                   0                 0.15                  0.15            0.15               0.15              0.15               0.15
Euro Area                  01 Aug                  2                   0                 0.50                  0.10            0.10               0.10              0.10               0.10
Japan                      08 Aug                  0                   0                 0.05               0.025              0.025             0.025              0.025              0.025
UK                         01 Aug                 -4                   0                 0.50                  0.50            0.50               0.50              0.50               0.50
Canada                     04 Sep                  3                   0                 1.00                  1.00            1.00               1.00              1.00               1.00
Switzerland                19 Sep                  1                   0                 0.00                  0.00            0.00               0.00              0.00               0.25
Sweden                     05 Sep                 -3                   0                 1.00                  1.00            1.00               1.00              1.00               1.25
Norway                     19 Sep                  0                   0                 1.50                  1.50            1.75               2.00              2.25               2.25
Australia                  06 Aug                -14                   0                 2.75                  2.25            2.25               2.25              2.25               2.25
New Zealand                24 Jul                  0                   0                 2.50                  2.50            2.50               2.75              3.00               3.25
Russia                     09 Aug                  -                  -25                5.50                  5.00            4.75               4.75              4.50               4.50
Poland                     04 Sep                 -6                   0                 2.50                  2.50            2.50               2.50              2.75               3.00
Czech Rep                  01 Aug                  0                   0                 0.05                  0.05            0.05               0.25              0.50               0.75
Hungary                    23 Jul                 -5                  -25                4.25                  3.50            3.50               3.50              3.50               3.50
Romania                    05 Aug                  -                  -25                5.00                  4.50            4.25               4.25              4.25               4.25
Turkey                     23 Jul                  -                   0                 4.50                  4.50            4.50               4.50              5.00               5.50
Israel                     29 Jul                 -1                   0                 1.25                  1.00            1.00               1.50              2.00               2.00
South Africa               19 Sep                  0                   0                 5.00                  5.00            5.00               5.00              5.00               5.00
Nigeria                    23 Jul                  -                   0                12.00               12.00              11.00              9.50              9.50               9.50
Ghana                      09 Sep                  -                  100               16.00               17.00              17.00             17.00              17.00              17.00
China                         N/A                  -                   0                 6.00                  6.00            6.00               6.00              6.00               6.00
India                      30 Jul                  -                   0                 7.25                  7.25            7.25               7.00              7.00               7.00
Hong Kong                  31 Jul                  -                   0                 0.50                  0.50            0.50               0.50              0.50               0.50
S. Korea                   08 Aug                  4                   0                 2.50                  2.50            2.50               2.75              3.00               3.25
Taiwan                     18 Sep                 18                   0                1.875               1.875              2.00               2.13              2.25               2.38
Indonesia                  15 Aug                  -                  25                 6.50                  6.75            6.75               6.75              6.75               6.75
Malaysia                   05 Sep                  5                   0                 3.00                  3.00            3.00               3.00              3.00               3.00
Thailand                   21 Aug                  1                   0                 2.50                  2.50            2.50               3.00              3.50               3.50
Brazil                     28 Aug                 51                  25                 8.50                  8.75            8.75               8.75              8.75               8.75
Mexico                     06 Sep                 -3                   0                 4.00                  4.00            4.00               4.00              4.00               4.00
Chile                      13 Aug                -20                   0                 5.00                  5.00            5.00               5.00              5.00               5.00
Peru                       08 Aug                  0                   0                 4.25                  4.25            4.25               4.25              4.25               4.25
Colombia                   26 Jul                 -5                   0                 3.25                  3.00            2.50               2.75              3.50               4.25
Source: National Central Banks, Morgan Stanley Research forecasts; Note: Japan policy rate is an interval of 0.00-0.10%. Forecasts as of July 10, 2013

G4 Policy Rate Forecasts                                                                                BRICs Policy Rate Forecasts
  7                      US            Euro Area             Japan               UK                       30                China           Brazil         Russia           India
  6                                                                                                       25
  5                                                                                                       20
                                                                                                                                                                             Morgan
  4
                                                                                                          15                                                                 Stanley

  3
                                                                            Morgan
                                                                                                          10
  2                                                                         Stanley
                                                                                                           5
  1
                                                                                                           0
  0
                                                                                                            2002       2004         2006      2008       2010       2012      2014
   2002       2004         2006        2008        2010        2012          2014

                                                                                                        Source: Morgan Stanley Research
Source: Morgan Stanley Research



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FX Bull/Bear Projections
                         EURUSD                                                               USDJPY                                                              GBPUSD
 EUR/USD                                                             USD/JPY                                                                GBP/USD                          25 Delta Strikes
                                                                     130                                                                    1.75                             MS Forecast
                     25 Delta Strikes                                                 25 Delta Strikes
 1.50                MS Forecast                                                                                                            1.70
                                                                     120              MS Forecast
                                                                                                                                            1.65
 1.40
                                                                     110                                                                    1.60
 1.30                                                                                                                                       1.55
                                                                     100
                                                                                                                                            1.50
 1.20                                                                  90                                                                   1.45
                                                                                                                                            1.40
 1.10                                                                  80
                                                                                                                                            1.35
 1.00                                                                  70                                                                   1.30
   Dec-11           Dec-12           Dec-13           Dec-14           Dec-11           Dec-12            Dec-13           Dec-14             Dec-11          Dec-12            Dec-13          Dec-14




                         EURCHF                                                              USDCAD                                                               AUDUSD
 EUR/CHF              25 Delta Strikes                               USD/CAD                                                                AUD/USD
 1.45                                                                1.30            25 Delta Strikes                                       1.10
                      MS Forecast
 1.40                                                                1.25            MS Forecast                                            1.05

 1.35                                                                1.20                                                                   1.00
                                                                     1.15                                                                   0.95
 1.30
                                                                     1.10                                                                   0.90
 1.25
                                                                     1.05                                                                   0.85
 1.20                                                                1.00                                                                   0.80
 1.15                                                                                                                                                     25 Delta Strikes
                                                                     0.95                                                                   0.75
                                                                                                                                                          MS Forecast
 1.10                                                                0.90                                                                   0.70
   Dec-11           Dec-12           Dec-13           Dec-14           Dec-11            Dec-12             Dec-13         Dec-14             Dec-11          Dec-12            Dec-13          Dec-14



                         USDSGD                                                              USDKRW                                                               USDTHB
 USD/SGD                                                              USD/KRW            25 Delta Strikes                                   USD/THB
 1.45          25 Delta Strikes                                       1400               MS Forecast
               MS Forecast                                            1350                                                                  37
 1.40                                                                                                                                                  25 Delta Strikes
                                                                      1300
                                                                                                                                            35         MS Forecast
 1.35                                                                 1250
                                                                      1200                                                                  33
 1.30
                                                                      1150
 1.25                                                                 1100                                                                  31
                                                                      1050
 1.20                                                                                                                                       29
                                                                      1000
 1.15                                                                  950                                                                  27
   Dec-11            Dec-12           Dec-13           Dec-14           Dec-11            Dec-12            Dec-13          Dec-14          Dec-11           Dec-12              Dec-13          Dec-14



                         EURPLN                                                              EURCZK                                                               USDZAR
 EUR/PLN                                                              EUR/CZK                                                               USD/ZAR            25 Delta Strikes
                                                                      29                                                                    15.0
 5.10                                                                                                                                                          MS Forecast
                                                                                                                                            14.0
 4.90                                                                 28
                                                                                                                                            13.0
 4.70                                                                 27                                                                    12.0
 4.50                                                                                                                                       11.0
                                                                      26
                                                                                                                                            10.0
 4.30
                                                                      25                                                                     9.0
 4.10
                 25 Delta Strikes                                                        25 Delta Strikes                                    8.0
 3.90                                                                 24
                 MS Forecast                                                             MS Forecast                                         7.0
 3.70                                                                 23                                                                     6.0
   Dec-11            Dec-12           Dec-13           Dec-14         Dec-11            Dec-12              Dec-13          Dec-14            Dec-11          Dec-12              Dec-13         Dec-14



                         USDBRL                                                              USDMXN                                                               USDCLP
 USD/BRL              25 Delta Strikes                                USD//MXN               25 Delta Strikes                           P
                                                                      17.00                                                                 690
 3.30                 MS Forecast                                                            MS Forecast
                                                                                                                                                         25 Delta Strikes
 3.10                                                                 16.00                                                                 640          MS Forecast
 2.90
 2.70                                                                 15.00
                                                                                                                                            590
 2.50                                                                 14.00
 2.30                                                                                                                                       540
 2.10                                                                 13.00
 1.90                                                                                                                                       490
                                                                      12.00
 1.70
 1.50                                                                 11.00                                                                 440
   Dec-11            Dec-12           Dec-13           Dec-14            Dec-11           Dec-12             Dec-13         Dec-14           Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14


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




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Morgan Stanley Global Currency Forecasts
 We updated our G10 forecasts the week of June 6.
 We updated our EM forecasts the week of June 20.
                                                    2013                                    2014                         2015       4Q13 % change to:
                         Current             3Q            4Q            1Q           2Q            3Q          4Q         1Q      Consensus       Forward
EUR/USD                      1.31          1.29         1.26          1.24          1.22         1.20        1.19         1.15               1.6      -1.5
USD/JPY                       100           103          107            110          114          117         120          122              -1.9       2.8
GBP/USD                      1.52          1.45         1.41          1.40          1.38         1.36        1.34         1.33              -2.0      -4.5
USD/CHF                      0.94          0.98         1.02           1.06         1.09         1.12        1.13         1.17               0.5       4.4
USD/SEK                      6.59          6.74         6.90          6.85          6.84         6.92        6.93         7.13              -0.7       1.9
USD/NOK                      6.00          5.97         6.03           6.05         6.07         6.08        6.05         6.17              -1.5      -1.1
USD/CAD                      1.04          1.06         1.08          1.10          1.12         1.14        1.16         1.17               1.9       1.4
AUD/USD                      0.92          0.91         0.88           0.86         0.84         0.82        0.80         0.81               1.1       0.4
NZD/USD                      0.79          0.78         0.76          0.75          0.74         0.72        0.70         0.70               0.0       0.0
EUR/JPY                       131           133          135            136          139          140         143          140               0.3       1.3
EUR/GBP                      0.86          0.89         0.89          0.89          0.88         0.88        0.89         0.86               4.7       3.1
EUR/CHF                      1.24          1.27         1.29           1.31         1.33         1.34        1.35         1.35               1.6       2.8
EUR/SEK                      8.63          8.70         8.70          8.50          8.35         8.30        8.25         8.20               1.8       0.4
EUR/NOK                      7.86          7.70         7.60           7.50         7.40         7.30        7.20         7.10               1.3      -2.6
USD/CNY                      6.14          6.19         6.10          6.09          6.00         5.95        5.90                            1.5      -0.7
USD/HKD                      7.76          7.80         7.80           7.80         7.80         7.80        7.80                            0.3       0.6
USD/IDR                    10060         10200        10400         10600         10800        10900      11000                              1.8      -6.0
USD/INR                      59.7          57.0         59.0           59.0         58.5         58.0        58.0                           -3.0      -7.6
USD/KRW                     1126          1130         1170           1190         1200         1210        1220                            -1.2      -0.3
USD/MYR                      3.19          3.10         3.25           3.28         3.26         3.24        3.20                           -1.6      -3.8
USD/PHP                      43.4          42.5         44.0          45.0          44.0         43.5        43.3                           -0.2      -2.0
USD/SGD                      1.27          1.25         1.29           1.32         1.33         1.34        1.35                           -0.8      -1.3
USD/TWD                      30.0          29.8         30.8          31.3          31.5         32.0        32.2                           -0.7      -0.3
USD/THB                      31.1          30.8         32.0           31.8         31.5         31.3        31.3                            1.2      -1.8
USD/BRL                      2.23          2.10         2.10          2.12          2.15         2.18        2.20                           -3.7      -8.9
USD/MXN                      12.5          12.3         12.5           12.2         12.0         11.8        11.6                           -1.6      -2.9
USD/ARS                      5.44          6.20         7.00          7.18          7.35         7.53        7.70                            3.5      -7.9
USD/VEF                      6.29          6.29         6.29           6.29         6.29         6.29        6.29                           -0.2       0.0
USD/CLP                       499           500          510            505          500          495         490                           -1.0      -2.0
USD/COP                     1881          1890         1900          1880          1860         1820        1800                            -0.8      -1.1
USD/PEN                      2.76          2.70         2.65          2.64          2.63         2.61        2.60                            0.0      -3.5
USD/ZAR                      9.86          9.70        10.50         10.50         10.25        10.25      10.00                            -4.9      -3.8
USD/TRY                      1.92          1.87         1.95          1.95          1.90         1.90        1.87                           -1.6      -5.5
USD/ILS                      3.59          3.73         3.75           3.70         3.65         3.60        3.60                            2.5       3.4
USD/RUB                      32.4          33.0         33.0          32.5          34.0         34.0        33.0                            0.7      -0.8
RUB basket                   36.9          37.3         36.9           36.0         37.4         37.1        35.8                            1.5      -1.6
EUR/PLN                      4.25          4.20         4.40          4.35          4.35         4.30        4.30                           -0.5      -2.1
EUR/CZK                      25.9          26.0         26.0           26.0         25.8         25.8        25.5                            0.0       0.4
EUR/HUF                       294           295          310            310          305          300         295                           -1.0      -1.3
EUR/RON                      4.43          4.45         4.55           4.55         4.50         4.45        4.45                            1.4      -1.2
MSDI                        82.58         84.68        87.03         88.56         90.41        92.13      93.60        95.30
MS AxJ Index              107.65        108.35       106.15        105.06        105.13       105.06      104.92
G10 forecasts were updated June 6, 2013. EM Forecasts were updated June 20. 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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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

Global FX/EM Quantitative Strategist (New York)          Juha Seppala, Vice President                             Juha.Seppala@morganstanley.com          (212) 761 1949
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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This material includes trade flow data that have been compiled by the Morgan Stanley Foreign Exchange trading desks from transactions executed
by Morgan Stanley in the over-the-counter foreign exchange markets with its global institutional and high net worth individual customer base. The
data have been aggregated and anonymized in a manner that does not identify the underlying transactions of any particular customer. In compiling,
interpreting, and analyzing the data, Morgan Stanley makes certain assumptions, which may vary over time, relating to the classification of an
account as a client. No representation is made that the aggregated data are reflective of trading patterns or trends in the markets included in this
material for any particular type of customer.

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