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					                                                                                                             Global FX Strategy
                                                                                                             November 23, 2010




Global FX Strategy 2011
                                                                                                               John NormandAC
                                                                                                               (44-20) 7325-5222
                                                                                                               john.normand@jpmorgan.com

                                                                                                               Paul Meggyesi
                                                                                                               (44-20) 7859-6714
                                                                                                               paul.meggyesi@jpmorgan.com

                                                                                                               Ken Landon
                                                                                                               (1-212) 834-2391
                                                                                                               kenneth.landon@jpmorgan.com

                                                                                                               Tohru Sasaki
                                                                                                               (81-3) 6736-7717
                                                                                                               tohru.sasaki@jpmorgan.com

                                                                                                               Junya Tanase
                                                                                                               (81-3) 6736-7718
                                                                                                                junya.tanase@jpmorgan.com

                                                                                                               Arindam Sandilya
                                                                                                               (1-212) 834-2304
                                                                                                               arindam.x.sandilya@jpmorgan.com

                                                                                                               Niall O’Connor
                                                                                                               (1-212) 834-5108
                                                                                                               niall.oconnor@jpmorgan.com

                                                                                                               Thomas Anthonj
                                                                                                               (44-20) 7742-7850
                                                                                                               thomas.e.anthonj@jpmorgan.com




www.morganmarkets.com/GlobalFXStrategy                                                                             J.P. Morgan Securities Ltd.
The certifying analyst is indicated by an AC. See page 102 for analyst certification and important legal and regulatory disclosures.
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.



• Global FX Outlook 2011: Unfinished business (John Normand)                                                          4
  Despite recurring systemic shocks, the dollar is ending 2010 down 3% trade-weighted and lower versus 75% of
  global currencies. 2011 should deliver further but narrower weakness as three area of unfinished business play out:
  fiscal payback, central bank activism and global rebalancing. Expect a 4-5% baseline USD decline trade-weighted.
• Five global macro themes and top trades (Paul Meggyesi, John Normand, Matthias Bouquet) 14
  Fiscal payback has barely begun (EUR/CHF seagull; USD/NOK, GBP/NOK & GBP/CHF put spreads); central
  bank rates are misaligned versus risks; (EUR/SEK & USD/CAD at-expiry digitals); global rebalancing remains
  inevitable, ad hoc and uncoordinated (JPY/KRW, EUR/INR seagulls; AUD vs BRL vol swap); commodity
  currencies should post a late-cycle rotation (AUD/CAD put spread with window knock-out); and valuation gaps
  should narrow by year-end (USD/CAD at-expiry digital put).
• Post-mortem on 2011 forecasts and trade recommendations (John Normand)                                               16
  Forecasts were too bullish on the euro and bearish on sterling, but close on the rest of the majors. Success rates on
  trade recommendations were 68% on options relative value, 59% on directional options trades, 54% on cash and
  47% on technicals. Returns were lower than in 2009 but still positive, in line with industry trends for currency
  managers and global macro funds.
• FX volatility: Low, not lower (Arindam Sandilya, Matthias Bouquet)                                               18
  VXY should decline 1 to 1.5 vols towards 11% in 2011 based on the outlook for systemic surprises next year and
  the current leverage stock. That level would mark the lower end of the vol range, however, given low spillover from
  a subdued rate vol market into FX and contradictory predictions of a high vol month next year from a predictive
  model. Sell front-end FVAs to fade the aggressive vol rally priced into vol curves. Fade the richness of USD/JPY
  and EUR/JPY vols at the back-end of vol curves against commodity FX/ JPY cross vols. Own 5Y-10Y EUR and
  CHF vols as hedge a disorderly dollar decline.
• Long-term technical strategy: Faint-hearted need not apply (Niall O’Connor, Thomas Anthonj) 26
  The medium-term set-up for the dollar is negative but the path to new lows will be a choppy one. EUR/USD is a
  broad range trade with a positive bias, while down-cycles in euro crosses remain intact. JPY will be mixed: new
  lows in USD/JPY with possible bullish breakout on the crosses. Sell EUR/CHF, EUR/TRY and EUR/INR. Keep
  these pairs on the watch-list: AUD/USD, AUD/JPY and AUD/NZD.
• Yen: Turning bearish broadly, but USD/JPY to decline on USD weakness (Tohru Sasaki, Junya
  Tanase)                                                                                                           40
  After a year as the world’s strongest currency, the yen’s performance is set to shift. USD/JPY can still make a new
  all-time low (78), but the yen should begin to weaken on the yen crosses. Significant yen-selling intervention looks
  unlikely next year. Longer-dated volatility should decline.
• Euro: Caught between the two grand experiments (John Normand)                                                       48
  Europe and the US will continue to run their monetary/fiscal experiments in 2011. Europe’s test is whether it can
  manage another year of peripheral stress with an unproven, temporary liquidity facility (EFSF). The US’s is
  whether it can delay fiscal tightening and pursue inflation targeting without triggering a run on the world’s reserve
  currency. Neither trial will run smoothly, which is why the euro’s path will be the most erratic amongst the major
  currencies. EUR/USD should ultimately end the year higher, however.
• Sterling: The half-empty glass (Paul Meggyesi)                                                                  54
  Conflicting forces confined sterling to a wide range in 2010. Valuation and hefty fixed income flows have
  supported GBP, but the dominant force through next year should be the deterioration in the UK's fiscal-monetary
  mix as public sector consolidation bites. Inflation is more supportive for volatility than sterling’s value.
• Swiss franc: The bullish new normal (Paul Meggyesi)                                                          60
  The backdrop of structurally weak growth and low interest rates in developed economies remains bullish for a
  major current account surplus currency such as CHF. The SNB's attempt to prevent CHF appreciation through a
  super-low interest rate policy is as lacking in credibility as was its now-discredited intervention policy.

2
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


• Swedish and Norwegian kronas: More similarities than differences (Paul Meggyesi)                                 66
  NOK enjoys a stronger structural position than SEK (unparalleled fiscal strength) but has suffered by comparison
  with Sweden's strong cyclical recovery. Both currencies should appreciate 3-4% versus EUR through 2011 but SEK
  is the favored pick in H1.
• Commodity currencies: AUD, NZD and CAD are as good as gold (Ken Landon)                                        70
  With the Fed committing to raising inflation, commodity currencies should rally again in 2011. AUD is the
  immediate front-runner, but CAD can outperform the rest of the bloc later this year if the US economy confounds
  the skeptics.
• Long-term valuation: AUD & NZD are fair, CAD has become cheap (Justin Kariya)                                    74
  Despite their high spot levels, AUD and NZD trade close to fair value, based on the underlying terms of trade. CAD
  has become cheap, while JPY remains overvalued. NOK is still the cheapest G-10 currency.
• Model-driven strategies in 2011 (John Normand)                                                                       78
  Even in a year beset by tail risks materializing, model-driven FX strategies all delivered positive returns. In 2011
  returns on carry should be average but price momentum could be above average. Money market rates look
  sufficiently mispriced to sustain rate trends and therefore profitable signals on the forward carry model.
• Global FX Carry Trade Monitor (Sunil Kavuri)                                                                   80
  Despite anecdotal evidence of widespread dollar bearishness, a range of position measures across CTAs, currency
  managers and hedge funds suggests that dollar shorts are roughly half their all-time highs.
• J.P.Morgan FX forecasts versus forwards and consensus                                             82
  Baseline targets by end-2011 include USD/JPY 78, EUR/USD 1.48, GBP/USD 1.70, AUD/USD 1.04, USD/CAD
  0.96, NZD/USD 0.80, EUR/GBP 0.89 and EUR/CHF 1.27.
• FX forecast risk bias, alternative scenarios and trigger events                                                                                      83
  Risks around the baseline are not symmetric for all currencies. We highlight biases, targets under alternative
  scenarios and trigger events for a change in view.
• Data tables
  Recent real effective exchange rate trends ........................................................................................86
  FX performance in 2010: spot versus carry-adjusted returns ............................................................87
  Peripheral bond redemptions in 2011.................................................................................................88
  Global government bond and bank redemptions, 2011 – 2012..........................................................89
  Sovereign credit ratings and actions...................................................................................................90
  Central bank announcement dates in 2011.........................................................................................91
  Event risks in 2011.............................................................................................................................92
• Other J.P. Morgan forecasts
        Rates, Credit, Equities & Commodities ...................................................................................93
        Global growth and inflation forecasts .....................................................................................94
        Global central bank forecasts...................................................................................................95
        Real GDP growth.....................................................................................................................96
        Consumer prices ......................................................................................................................98
        Basic economic statistics: international comparisons ..............................................................99
        Economic outlook in summary ..............................................................................................100
  Prior Research Notes available on www.morganmarkets.com/GlobalFXStrategy ..........................101

                           The source for all tables and charts is J.P. Morgan estimates unless otherwise stated.



                                                                                                                                                        3
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


                                                               Chart 1: Negative rate differentials have coincided with the dollar’s
Global FX Outlook 2011:                                        major bear markets in the late 1980s, mid-1990s and 2000s
                                                               Short-term interest rate spread between the US and rest of the world versus
Unfinished business                                            percentage of currencies against which the dollar appreciated during the year.

                                                                                     % of currencies against which USD appreciated, lhs
•    After a powerful first half rally, the dollar is ending     100%                                                                       6%
     2010 down 3% trade-weighted and lower versus 75%                                spread between US and rest of world, rhs
                                                                                                                                            4%
                                                                  80%
     of global currencies. 2011 should deliver further but
     narrower weakness.                                                                                                                     2%
                                                                  60%
•    Three areas of unfinished business shape the outlook:                                                                                  0%
     (1) fiscal payback has barely begun; (2) central bank        40%
                                                                                                                                            -2%
     rates are misaligned versus risks; and (3) global
     rebalancing remains inevitable, ad hoc and                   20%                                                                       -4%
     uncoordinated.
                                                                   0%                                                                       -6%
•    As these themes evolve, the dollar can fall another 4-             71 74 77 80 83 86 89 92 95 98 01 04 07 10
     5% baseline USD decline trade-weighted, bringing
     the currency near the all-time lows of 2008. Record
     lows are possible on USD/JPY (78), EUR/CHF (1.27)         Three areas of unfinished business…
     and USD/CHF (0.86), and near record lows on               After a powerful first half rally, the dollar reversed course
     USD/CAD (0.96). Other end-2011 targets are 1.48 for       mid-year to end 2010 down 3% trade-weighted and lower
     EUR/USD, 1.04 for AUD/USD and 0.88 for                    versus 75% of global currencies (chart 1). Dollar
     EUR/GBP.                                                  depreciation in a year punctuated by systemic shocks –
•    Despite widespread dollar bearishness amongst             European sovereign funding, China’s feared hard landing,
     investors, neither short USD positions nor leverage       the US’s summer slowdown – highlights the basic principle
     are extreme. Thus consensus is not an obstacle to the     underlying the bearish view outlined last year: debtor-
     current trend.                                            country currencies fall during a global expansion,
                                                               particularly when their central banks commit to low rates
•    Long-term technicals suggest the dollar will follow an    (see Global FX Strategy 2010: New year, new lows,
     erratic path to new lows. Yen crosses appear on the       November 24, 2010). Admittedly this scenario played out
     verge of a breakout higher.                               much more erratically than we expected, and we were far
•    Whether the dollar turns in 2011 depends on Fed           too bullish on EUR/USD. But the framework did deliver the
     policy more than European sovereign stress.               right view on the commodity currencies; the yen and the
                                                               Swiss franc (see 2010 post-mortem on page 16). At the risk
•    FX volatility won’t collapse with rate vol during a       of blithely extrapolating a recent trend, the dollar’s current
     deflationary environment, since too many country-         decline has further to run. The more interesting questions
     specific stresses persist. 11% is the likely floor on     are whether that move will be continuous or erratic; whether
     VXY, with spike risks throughout the year. Owning         it should be as broad or narrower; and how to hedge a range
     long-dated EUR/USD or USD/CHF vol is the best tail        of tail risk scenarios.
     risk hedge.
                                                               Three area of unfinished business from 2010 should
•    Amongst model-driven strategies, price momentum           shape trends next year.
     will likely struggle again while forward carry
     outperforms. Carry returns should be average.             1. Fiscal payback has barely begun. G-10 government
                                                               deficits remain at unsustainable levels in most countries,
•    Risks: The US proves less deflated; US fumbles fiscal     even if they have fallen for the past two years (chart 2).
     tightening; a Spanish funding crisis; another             Major fiscal consolidations since 1970 typically have been
     Homeland Investment Act; and a major economy              five-year processes, which implies that rollover risk remains
     slows materially due to central bank tightening.          substantial in several countries, driving recurring shocks in
•    Top 5 macro themes and trades: (1) Fiscal payback;        Europe and probably requiring sustained asset purchases in
     (2) rate misalignment; (3) inevitable global              the US, Japan and UK. Previous fiscal consolidations have
     rebalancing; (4) commodity currency rotation; and         delivered consistent trends in rates and currencies during
     (5) valuation gaps.                                       the first three years of budget retrenchment, so provide a
                                                               benchmark for tracking whether this process is already
                                                               discounted. The euro has already fallen more than is typical

4
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


during fiscal consolidation, whereas the dollar’s decline has   Chart 2: Primary deficits have declined but are far from sustainable
barely begun.                                                   in the US, UK, Japan and peripheral Europe
                                                                Actual primary deficits for 2009 and OECD estimate for 2010 and 2011.
2. Central bank rates are misaligned versus risks. 2011
                                                                  10%
will not mark a gap year for central banks – most of them
                                                                                                  2009                2010                 2011f
should be moving policy rates considerably relative to             5%
current money market pricing. The Fed has embarked on an
easing cycle of unknown duration and magnitude, and the            0%
Bank of England may follow. Several central banks – RBA,           -5%
Bank of Canada, Riksbank, Norges Bank & Swiss National
Bank – delayed tightening in 2010 due to risks from the US,      -10%
Europe and China. Now that the US is stabilising, China re-
                                                                 -15%
accelerating and Europe managing its sovereign funding




                                                                                                                                  Greece




                                                                                                                                                                                                                       Japan
                                                                                   Germany
                                                                                             France
                                                                                                      Italy




                                                                                                                                                       Australia




                                                                                                                                                                                                     Norway
                                                                                                                                                                                       Switzerland
                                                                                                                       Portugal
                                                                             US




                                                                                                              Spain




                                                                                                                                           UK


                                                                                                                                                                     Canada
                                                                                                                                                                               NZ




                                                                                                                                                                                                              Sweden


                                                                                                                                                                                                                               Ireland
crisis, 2011 carries fewer constraints on rate normalisation,
especially in countries subject to house-price inflation
(Scandinavia, Switzerland). Money markets are not priced
for this outcome (chart 3), and the resulting spread
movements should be dollar-bearish.                             Source: J.P. Morgan, OECD

3. Global rebalancing remains inevitable, ad hoc and            Chart 3: Money markets do not price in the unfinished business of
                                                                higher rates in strong economies
uncoordinated. Global rebalancing, the polite term for a        Current policy rates in G-10 and major emerging markets vs. J.P. Morgan forecasts
lower US trade deficit through a weaker dollar, is a            and current market pricing for end-2011.
recurring theme in currency markets. It first surfaced in the
                                                                 14%
mid-1980s when the US current account deficit reached a                                          current policy rate
then all-time high of 2.5% of GDP, prompting the Plaza           12%
Accord. It reappeared in a September 2003 G-7                                                    JPM forecast by end-2011
                                                                 10%
communiqué calling for flexibility in exchange rates, when         8%
                                                                                                 market pricing by end-2011
the deficit hit a new high of 4.5% of GDP. The April 2006
                                                                   6%
summit formally introduced the term global imbalances and
mentioned China specifically, while the October 2010 G-20          4%
summit floated the idea of current account guidelines. Three       2%
concepts should be clear from the G-7 – and now G-20’s –           0%
paper trail: the G-10 want flexible (and lower) exchange
                                                                                                                                           Riksbank


                                                                                                                                                                   Banxico
                                                                                                 BoJ




                                                                                                                                                      Norges


                                                                                                                                                                             Bacen



                                                                                                                                                                                                        RBI
                                                                                  ECB
                                                                                        BoE


                                                                                                        SNB
                                                                                                                RBA
                                                                                                                         RBNZ
                                                                                                                                  BoC




                                                                                                                                                                                     PBoC
                                                                                                                                                                                              BoK


                                                                                                                                                                                                                NBP
                                                                                                                                                                                                                        SARB
                                                                                                                                                                                                                               CBoT
                                                                         Fed




rates, because their economies generally are weak; this
flexibility requires a change in intervention policy in
emerging markets; and this process will require years to
unfold given emerging markets’ priorities. This ad hoc but      Chart 4: Global rebalancing is always a US initiative
inevitable process has as many implications for volatility as   US current account deficit as percentage of GDP versus major multilateral
for spot movements.                                             agreements to promote rebalancing
                                                                  2%
…unfolding alongside a weak balance of                                                                                      G-20 consider current account targets
payments
                                                                  0%
These three themes are unfolding against a still-weak US                                                                                                                      Apr 2006: G-7
balance of payments position. There is a tendency to             -2%                                                                                                          focus on China's
downplay the US balance of payments story since the                          Plaza Accord                                                                                     surplus
                                                                             coincides with record
current account deficit has fallen from a record 6% of GDP       -4%
                                                                             US deficit/Japan-
in late 2006 to 3% this year. But while the US’s funding                     Germany surpluses                                     Sept 2003: G-7 call for
requirement has fallen, the quality of capital flows remains     -6%
                                                                                                                                   more FX flexibility
poor. Official investors now fund roughly 80% of the US
current account deficit, which is a precarious dependence        -8%
when the US is actively discouraging intervention (i.e.                 70            75                80               85                  90                        95               00                    05               10
official financing), yet offering no yield advantage to re-
attract private investors.



                                                                                                                                                                                                                                         5
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


Long-term investors have a mixed view on the US.                 Chart 5: Foreign official buying of US securities as percentage of US
Corporates clearly see better value in other markets as          current account deficit
                                                                 %, four quarter rolling sum
evidenced by the record pace of foreign direct investment
outflows from the US. The US has experienced a net                140%
outflow of foreign direct investment for most of the past         120%
twenty years, the exceptions being during the dot-com era
(1998-2000) and the Homeland Investment Act window                100%
(2005). The corporate profits recovery has now driven US            80%
corporate’s overseas investment to record levels of $170bn
                                                                    60%
annually (chart 6), a figure which combined with a
widening current account deficit has worsened the US’s              40%
basic balance (chart 8). Equity investors seem more
                                                                    20%
positive. Net foreign buying of US equities has risen to
$10bn per month since equities bottomed in March 2009.               0%
This figure contrasts with no net inflows during the 2003-07                  92   94        96        98        00    02        04   06         08    10
bull market, but is little better than the flows which other
regions attract. Europe, for example, attracts €8bn per
month of net equity flows (chart 7). Emerging Asia pulls in      Chart 6: Foreign direct investment: Record corporate profits growth
$6bn, but for a regional already in surplus, this flow           is motivating record net FDI flows from the US
compounds appreciation pressures from the current account.       S&P500 corporate profits growth year-on-year versus US net FDI flows. FDI shown
                                                                 as four quarter rolling sum.
1: Fiscal payback has barely begun                                 200                                                                                -40%
                                                                                        net FDI flows, $bn, 4 quarter sum, lhs
Fiscal policy was the defining issue for global markets in         150
                                                                                        Corporate profits growth, % oya, rhs
                                                                                                                                                      -30%
the first half of 2010. It receded in Q3 as Europe delivered –     100                                                                                -20%
and the UK promised – unprecedented fiscal tightening,              50                                                                                -10%
then returned in Q4 to drive the European periphery. While
                                                                         0                                                                            0%
European fiscal stress had much less impact on global
                                                                    -50                                                                               10%
currency markets in Q4 than earlier in 2010, it is premature
to write off the issue in currency markets. Primary deficits,     -100                                                                                20%
while down from their highs of 2009 (chart 2), remain             -150                                                                                30%
precariously high, which is why rollover risk continues to        -200                                                                                40%
generate volatility in peripheral Europe. The US does not                    90    93             96        99        02         05    08
face the same refinancing risk since the Fed now purchases
almost all net Treasury issuance. But this policy mix is still
material to currencies since monetisation drives real yields     Chart 7: Cross border buying of US equities is low relative to the
lower and motivates the shift into non-USD currencies. The       US’s funding requirement
same dynamic threatens sterling next year.                       Net foreign purchases of US, Euro area and EM Asian equities, 3-month moving
                                                                 average, billions of USD for US, EUR for Euro area and USD for Asia
To measure the market impact of fiscal tightening and to
                                                                   45
benchmark where this process stands, table 1 presents
                                                                                             Euro area                 EM Asia                  US
stylised facts around the major OECD fiscal consolidations         35
since the 1970s. Major fiscal consolidations are defined as        25
endeavours to move the primary position (deficit net of
interest payments) from a deficit of 3% of GDP to balance,         15
whether through spending cuts, tax hikes or both.                   5
Admittedly 3% is an arbitrary trough for signalling excess
                                                                    -5
deficits, but it is chosen for its resemblance to the
Maastricht criteria.                                              -15

                                                                  -25
                                                                             06         07                  08              09             10




6
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.

Table 1: Characteristics of major OECB fiscal tightening since 1970
        A           B            C                D            E               F              G                   H                  I                 J              K               L             M               N              O
               Year when                     Year when                       Govt            Govt                                                                                Cumulative                    Cumulative     Cumulative
                               Low in                    # of years to                                    Govt revenue/GDP Govt revenue/GDP Avg real GDP          Cumulative                    Cumulative
                 primary                       primary                  expenditure/GDP expenditure/GDP                                                                           change in                     change in     change in
   Country                     primary                     return to                                     when consolidation* when consolidation* growth during     change in                     change in
                  deficit                     balance                        when            when                                                                                  nominal                     policy rates      10-yr
                               balance                     balance                                              began              ended         consolidation      REER*                       equities***
                troughed                      achieved                   consolidation*  consolidation*                                                                             FX**                         (bp)***       yields***
US                      1975         -3.8%          1978              3              35%             32%                30%                31%             3.8%           -8%            -8%            7%              425            100

Ireland                1975          -7.6%         1987            12              49%              48%                38%                 44%            3.6%            0.4%         -50%           403%             -75             -760

Germany                1975          -4.6%         1984             9              49%              45%                43%                 44%            1.9%            -7%          -17%             46%            150             -118

Austria                1976          -3.0%         1990            14              47%              52%                43%                 49%            2.8%            17%           -1%           462%             160               25

Japan                  1978          -5.1%         1985             7              32%              33%                26%                 31%            3.7%            -10%          -3%           118%             150               40

Portugal               1978          -5.2%         1983             5              33%              37%                25%                 33%            2.9%            -41%         -48%             NA             700              155

Sweden                 1980          -5.5%         1986             6              63%              61%                57%                 60%            1.9%            -7%          -36%           590%            -250             -160

Belgium                1981          -8.8%         1987             6              62%              56%                46%                 48%            1.3%            -14%         -19%           188%            -800             -551

Spain                  1982          -6.3%         1997            15              39%              42%                33%                 38%            3.9%            -6%          -37%          1309%           -1365             -992

Denmark                1982          -8.0%         1984             2              60%              56%                49%                 52%            3.3%            -2%          1.6%             41%           -300              NA

US                     1983          -3.1%         1995            12              37%              37%                31%                 34%            3.4%            -19%         -19%           273%            -225             -612

Canada                 1983          -6.4%         1989             6              48%              46%                40%                 41%            3.9%             1%            7%             56%            240             -216

Italy                  1985          -4.6%         1992             7              50%              55%                37%                 45%            2.4%            -8%          -25%             4%            -300               60

Greece                 1989          -5.7%         1994             5              41%              45%                28%                 37%            1.3%            11%          -40%             89%            150             -450

Canada                 1992          -3.8%         1995             3              53%              49%                44%                 43%            2.7%            -4%           -7%             41%           -160              -75

Norway                 1992          -4.7%         1995             3              56%              51%                54%                 54%            4.5%            -2%           -3%             63%           -425             -270

UK                     1993          -5.5%         1997             4              45%              41%                37%                 38%            3.1%            17%           16%             50%            190               10

France                 1993          -3.7%         1998             5              55%              53%                49%                 50%            1.7%            -4%            2%             73%           -325              190

Sweden                 1993       -10.3%           1997             4              71%              61%                59%                 59%            2.0%            16%            9%           118%            -250             -130

Finland                1993          -8.7%         1997             4              65%              57%                56%                 55%            3.2%             1%           11%           108%            -150             -150

Hungary                1994          -6.8%         1996             2              63%              50%                50%                 46%            1.5%             2%          -33%           181%            -200              NA

Germany                1995          -6.7%         1997             2              55%              48%                45%                 45%            1.6%            -8%          -20%             88%            -75              -92

Netherlands            1995          -4.8%         1996             1              56%              49%                47%                 48%            3.2%            -2%            1%             36%            -70              -35

Average                              -5.8%                          6              51%              48%                42%                 45%            2.8%            -3%          -14%           197%            -122             -192

* change in real effective exchange rate from end of year when primary balance troughed to end of year when primary balance achieved
** For US, calculated as change in USD nominal exchange rate index from end of year when primary balance troughed to end of year when primary balance achieved. For Germany, calculated as change in DEM vs. USD. For other European
countries, calculated as change in local currency vs. DEM. For all other countries, calculated as change in local currency vs. USD.
*** change in equity index, policy rate or 10-yr bond yield from end of year when primary balance troughed to end of year when primary balance achieved




                                                                                                                                                                                                                                          7
Global FX Strategy
Global FX Outlook 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


There have been almost 25 examples of such fiscal                     Chart 8: The basic imbalances: US’s position worsening after three
consolidations over the past four decades in the OECD,                years of improvement
                                                                      Basic balances as percentage of GDP in US, Euro area, Japan and China. Basic
involving every major economy but Australia, New Zealand              balance is the sum of current account, net FDI flows and net equity portfolio flows
and Switzerland. Several patterns emerge:
                                                                        15%
• Primary deficits averaged 5.8% of GDP at their troughs                                       US                             Euro area
  (column C) and required six years to return to balance                10%
  (column E), implying improvement of only 1% of GDP per                                       Japan                          China
  annum. The US and UK deficits are falling at this average pace                                                                                      6%
  (chart 9), but peripheral Europe’s by two or three times that          5%
                                                                                                                                                      3%
  rate.
                                                                         0%
• Countries relied equally on revenue increases and                                                                                                 -0.8%
  expenditure cuts. 78% of consolidations (18 of 23 cases)               -5%                                                                        -4%
  involved raising revenue as a percentage of GDP (columns H
  and I), while 74% (17 of 23 cases) involved expenditure cuts
  (Columns F and G). 52% of cases involved both revenue                -10%
  increases and expenditure cuts. In 2010 peripheral Europe                    91        94         97        00         03           06       09
  relied on both; in 2011, so will the UK. The US fiscal debate is
  striking for the lack of consensus around expenditure cuts,
  particularly when the primary deficit is so large.
• Contrary to popular perception, real GDP growth remained            in Europe following the ERM crisis. But the G-10 have also
  stable during previous OECD fiscal consolidations (2.8% on          never constituted such a small share of global GDP: 63%
  average, column J) and equities markets doubled in value            currently, down from 80% in 1990.
  (column M). Some of this resilience could be due to lower
  interest rates, and some to the rise in private sector confidence   Second, refinancing risk will remain considerable for at
  and spending from lower structural deficits. US and UK growth       least the next two years since primary deficits are still very
  is only somewhat lower than the historical norm during fiscal       high, even in those countries where fiscal consolidation is
  tightening (chart 10).                                              progressing at two or three times the normal speed. For
                                                                      Europe, this rollover risk implies that the periphery will
• Central banks cut rates during fiscal tightening by an
  average of 120bp (column N), in turn driving bond yields            present recurring shocks to the euro until or unless the
  down by almost 200bp (column O). US policy rates and bond           periphery secures EFSF financing to remove countries from
  yields fell faster than the historical norm, but bond yields have   the bond market for the next two years, by which time
  another 25-50bp to fall in order to match the usual pattern         primary positions should have returned to balance. For the
  (charts 11 and 12).                                                 US, the risk of a destabilizing Treasury sell-off increases
                                                                      unless the Fed extends its asset purchases. Rollover risk is
• Given the decline in rates, it is unsurprising that exchange
  rates fell in nominal terms by almost 15% on average                less material for the yen given that domestic investors
  during the first four years of fiscal tightening (column L).        dominate the JGB market.
  Real exchange rates fell by much less – only 3% cumulative on       Third, the lack of much consolidation in the US and UK
  average (column K) – since many countries experienced higher
                                                                      may oblige central banks to maintain (US) or restart (UK)
  inflation after exchange rate collapses. The euro already has
  fallen by more than average for this stage of fiscal tightening,    QE programs in order to avoid destabilizing moves in the
  even though only 20% of region needs to consolidate                 bond market. While positive for growth and risky markets,
  dramatically. The dollar, however, is simply tracking the           this fiscal/monetary mix risks a destabilizing move in
  average path (charts 13 and 14). Sterling fell much more than       inflation expectations which triggers the forever-anticipated
  average prior to fiscal tightening (2008), and has been             run on the dollar or on sterling.
  following the typical trajectory since.
                                                                      2: Central bank rates are misaligned versus risks
If patterns repeat, they carry three implications for
currencies next year. First, the fear that fiscal                     Fiscal positions are a legacy of the Great Recession, and
consolidation will derail growth ignores the role of interest         they can influence central bank policy next year beyond
rates. If central banks offset fiscal consolidation with looser       what is currently discounted. In the US, monetary policy
monetary policy as it the norm, expansions will persist,              provides all stimulus because fiscal policy cannot. If the
even if they are less robust that what might occur without            Fed measures success by whether it fosters maximum
fiscal drag. It is true that the world has never experienced          employment and price stability, there are decent risks that it
such simultaneous G-10 fiscal consolidation bar the 1975              will need to extend asset purchases beyond June 2011
tightenings in the US and Germany, or the 1993 tightenings            because the unemployment rate will not have dropped nor


8
Global FX Strategy
Global FX Outlook 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


Chart 9: Primary balances during major OECD fiscal consolidations                                                                                Chart 12: 10-yr bond yields during fiscal consolidations
x-axis shows years before and after fiscal consolidation, where year zero is the                                                                 x-axis shows years before and after fiscal consolidation, where year zero is the
year when the primary deficit reached its low.                                                                                                   year when the primary deficit reached its low. Bond yield shown as change
                                                                                                                                                 compared to year zero.
                              0%
                                                                                                                                                                                                          150




                                                                                                                                                                   change in 10-yr rates, basis points
                          -2%                                                                                                                                                                                                                           OECD average since 1970
                                                                                                                                                                                                          100
  primary balance




                          -4%                                                                                                                                                                              50                                           US (current cycle)
                                                                                                                        average since 1970
                          -6%                                                                                                                                                                                  0
                                                                                                                        US (current cycle)                                                                 -50
                          -8%
                                                                                                                                                                                                          -100
                    -10%                                                                                                UK (current cycle)
                                                                                                                                                                                                          -150
                    -12%                                                                                                                                                                                  -200
                                                    -2                 -1              0           1           2        3           4        5                                                                      -2        -1               0       1           2         3    4       5
                                                                             years around trough in primary deficit                                                                                                                 years around trough in primary deficit




Chart 10: Real GDP growth during fiscal consolidations                                                                                           Chart 13: Nominal FX rates during fiscal consolidations
x-axis shows years before and after fiscal consolidation, where year zero is the                                                                 x-axis shows years before and after fiscal consolidation, where year zero is the
year when the primary deficit reached its low.                                                                                                   year when the primary deficit reached its low. Exchange rates indexed to 100 in
                                                                                                                                                 year zero when primary deficit troughs. Fall in index indicates currency
                                                                                                                                                 depreciation.
                                                    4%
                                                                                                                                                                                  110
                                                    2%                                                                                                                                                                                             nominal FX index, average since 1970
                        real GDP growth




                                                                                                                                                                                  105                                                              USD trade-weighted (current cycle)
                                                                                                                                                   nominal FX, index




                                                    0%
                                                                                                                                                                                                                                                   EUR trade-weighted (current cycle)
                                              -2%                                                                                                                                 100
                                                                                                               OECD average since 1970
                                              -4%                                                              US (current cycle)
                                                                                                                                                                                                 95
                                                                                                               UK (current cycle)
                                              -6%
                                                             -2             -1             0           1           2        3       4        5                                                   90
                                                                                  years around trough in primary deficit                                                                                   -2            -1            0           1           2         3        4
                                                                                                                                                                                                                                   years around trough in primary deficit


Chart 11: Policy rates during fiscal consolidations                                                                                              Chart 14: Real effective FX rates during fiscal consolidations
x-axis shows years before and after fiscal consolidation, where year zero is the                                                                 x-axis shows years before and after fiscal consolidation, where year zero is the
year when the primary deficit reached its low. Policy rates shown as change                                                                      year when the primary deficit reached its low. Exchange rates indexed to 100 in
compared to year zero.                                                                                                                           year zero.
                                                     500                                                                                                                                                 122
               policy rate, change from trough in




                                                                                                       OECD average since 1970                                                                                                                         REER, average since 1970
                  primary deficit, basis points




                                                     400                                                                                                                                                 118
                                                     300                                                                                                                                                 114                                           USD (current cycle)
                                                                                                       US (current cycle)
                                                                                                                                                                                                                                                       EUR (current cycle)
                                                                                                                                                            REER, index




                                                     200                                                                                                                                                 110
                                                                                                                                                                                                                                                       GBP (current cycle)
                                                     100                                                                                                                                                 106

                                                         -                                                                                                                                               102

                                                    -100                                                                                                                                                 98

                                                    -200                                                                                                                                                 94
                                                                  -2             -1            0           1       2        3           4    5                                                           90
                                                                                      years around trough in primary deficit                                                                                   -2         -1               0       1            2        3        4
                                                                                                                                                                                                                               years around trough in primary deficit




                                                                                                                                                                                                                                                                                              9
Global FX Strategy
Global FX Outlook 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


core inflation risen much by then. In the UK, the Bank of        Chart 15. Every 25bp widening in spreads between US and rest of
England may offset the demand slowdown and possible              the world is worth about 1.5% move in the trade-weighted dollar
                                                                 USD trade-weighted index regressed on weighted average interest rate spread of
inflation undershoot from fiscal tightening in 2011. Neither     US vs. main trading partners (x1) and VIX equity market implied volatility (x2).
additional Fed QE nor a restart of Bank of England QE are        Sample 2006-2010.
discounted, judging from the firmness of 10-yr rates over         Y - (0.2377 X2)
the past two months.                                              92
                                                                  90        Y = 4.3003 X1 + 0.2377 X2 + 82.5948
Many other central banks, which should have normalised            88        R² = 83.82%
rates over the past year, have trod slowly due to a               86        standard error = 1.5436
succession of systemic risks from European sovereign              84
stress, the feared China hard landing and the US’s abrupt         82
summer slowdown. Though these risks are fading, is it             80
surprising how little further rate normalisation is currently     78
                                                                  76
discounted. As highlighted earlier in chart 3, the market
                                                                  74
discounts trivial amounts of rate hikes over the next year:       72
another 45bp from the RBA, Bank of Canada and Riksbank,           70
and only 10bp from the Norges Bank and SNB. Only the
                                                                    -2.5        -2.0     -1.5      -1.0   -0.5     0.0    0.5          1.0       1.5
RBNZ looks fairly priced, with 100bp of tightening                                               US - ROW weighted spread
discounted.
                                                                 Chart 16: USD deviations from fair value respond to policy extremes
Money markets look too complacent. Outside of the US,            versus the rest of the world
UK, Japan and core Europe, most central banks have               USD deviations from fair value (positive indicates overvaluation) versus spread
considerable unfinished business normalising rates which         between Fed funds rate and policy rates in the rest of the G-10 (weighted average).
are still too low relative to the risks of inflation or asset      20%                                                                             8%
bubbles cited by those central banks over the past year. This
                                                                   15%                                                                             6%
process will extend rate differentials which have been a key
drier of dollar weakness. More formally, every 25 basis            10%                                                                             4%
points of spread widening between the rest of the world and         5%                                                                             2%
the US is worth about a 1.5 % decline in the trade-weighted         0%                                                                             0%
dollar (chart 15). That doesn’t imply much broad weakness
                                                                    -5%                                                                            -2%
if global rates are only expect to rise 50bp (GDP weighted)
next year by our estimates. The risk is of an undershoot          -10%                  deviation from fair value, lhs                             -4%
given the dollar’s tendency weaken more than models               -15%                  US rate spread to rest of world (lagged one year), rhs     -6%
would predict when US rates are much lower than the rest          -20%                                                                             -8%
of the world (late 1980s, mid-2000s, just as it strengthens                80      84       88        92       96        00    04       08
more than predicted when US rates are much higher than in
other countries (mid-1980s, late 1990s, as in chart 16.
                                                                 easing through whatever policies – local currency
3: Global rebalancing is inevitable, ad hoc and                  appreciation, intervention, rate cuts, capital controls,
uncoordinated                                                    transaction taxes – fit their domestic circumstances (see
Intentional or not, monetary policy clearly aids the US’s        Consequences of a unilateral Plaza Accord, FXMW,
long-standing global rebalancing agenda, since few               October 8, 2010).
investors would hold the currency of a debtor country which      The dollar’s decline so far has been limited and moderate-
pays zero cash rates while pursuing inflation targeting. (The    volatility for two reasons: reserve accumulation and the
exception is during deleveraging.) The surprise isn’t the        revival of European sovereign stress. Since Chairman
dollar’s direction; it is that the move hasn’t been sharper      Bernanke floated the idea of QE II in late August, reserve
and higher-volatility.                                           accumulation by G-10 and EM central banks has reached
The US will probably succeed in advancing global                 record levels of some $140bn per month. But roughly 80%
rebalancing since Fed policy will guarantee onerous levels       of that flow has been directed into non-USD currencies
of capital inflows for at least a year, and probably well into   judging from the gap between reserve accumulation and
the next Fed tightening cycle in late 2012 or 2013. The          foreign purchases of US securities listed in the monthly TIC
process should remain disorderly because it will be ad-hoc,      and weekly Fed custody reports (chart 17). This process
with countries left to manage the consequences of Fed            would only accelerate with QE, since apparent reserve
                                                                 diversification – the difference between reserve


10
Global FX Strategy
Global FX Outlook 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


accumulation and official purchases of US securities – has            Chart 17: Reserve accumulation running at record pace, but so is
been well correlated with US real yields (chart 18) which             reserve diversification
                                                                      Monthly reserve accumulation in G-10 and emerging markets versus foreign official
the Fed is attempting to drive lower through lower nominal            purchases of US securities. USD bn, 3-month moving average.
rates, higher inflation expectations or both.
                                                                        200
                                                                                      gap between reserve accumlation and
The directional implications are well understood and                                  official purchases of US securities
                                                                        150
generally accepted: a lower dollar as fewer reserves are re-                          suggests reserve diversification
invested into the US, and euro participation in any USD                 100
decline (despite the periphery’s liabilities) due to                        50
diversification. The volatility implications are more
                                                                            0
nuanced. Volatility should fall in currencies which remain
managed (mostly in emerging markets) but rise in those                   -50                     foreign official purchases of US securities
countries which are not (mostly in the G-10). The market is            -100                      global reserve accumulation
not priced for this sort of outcome given that vol premia
                                                                       -150
tend to be higher in managed currencies (USD/BRL) than in
                                                                                 00   01    02        03   04    05    06      07    08    09   10   11
unmanaged ones (AUD/USD, USD/CHF), as show in chart
19. EUR/USD vol would normally be bid higher in this
environment, but the euro’s risk premium is already                   Chart 18: Apparent reserve diversification versus US real yields
elevated due to Ireland.                                              Apparent reserve diversification is the difference between monthly reserve
                                                                      accumulation and official purchases of US securities from chart 17. Real yields
Market implications                                                   based on 10-yr TIPS.

Fiscal payback, rate normalisation and global rebalancing               300                                                                           -0.3%
                                                                                                 apparent reserve diversification, $bn, lhs
imply the following trends:                                             225                                                                           0.3%
                                                                                                 US real 10-yr yields (inverted), rhs
• A 4-5% baseline decline in the trade-weighted dollar from             150                                                                           0.8%
  rates moves alone, and risks of up to an 8% decline given the
                                                                            75                                                                        1.3%
  dollar’s tendency to undershoot in a low interest rate
  environment.                                                               0
                                                                                                                                                      1.8%
• An eventual leadership rotation, from JPY and AUD                      -75
                                                                                                                                                      2.3%
  outperformance in 2010 to CAD and CHF as rate cycles
                                                                       -150
  advance in other markets. GBP seems the currency which was                                                                                          2.8%
  unduly stable in 2010 and now due to weaken within Europe,           -225
  even though it is clearly cheap (see respective currency research              03    04        05        06     07      08        09    10    11
  notes on pages 40-70and fair value update on 16).
• FX volatility won’t collapse with rate vol during a deflationary
  environment, since too many country-specific stresses persist.      Chart 19: Ad-hoc global rebalancing implies lower vol in managed
  11% in the likely floor on VXY, with spike risks throughout the     EM currencies and higher vol in unmanaged G-10 ones
  year. Owning long-dated EUR/USD or USD/CHF vol is the               Vol premium (spread between 1-yr implied and realised vol) across currency pairs.
  best tail risk hedge (see FX Derivatives on page 18)                Premia expressed as z-scores.
                                                                        3
• Long-term technicals agree with the macro view that the
  dollar’s path to new lows will be a choppy one. The yen is
  most interesting for its divergence – new lows on USD/JPY but         2
  bullish breakout on the yen crosses – while the euro looks set to
  resume its decline versus Asia (see Long-term technicals on
  page 26).                                                             1

These views seems only partially shared by investors. The               -
consensus sees USD strength in 2011, with December
targets of 1.35 on EUR/USD, 1.60 on GBP/USD, 89 on
USD/JPY, 0.93 on AUD/USD, 1.02 on USD/CAD. Only                        -1
                                                                                 EURGBP




                                                                                  USDJPY
                                                                                 EURNOK

                                                                                 USDNOK
                                                                                 USDSEK




                                                                                 USDRUB
                                                                                 USDCNY
                                                                                 USDTRY
                                                                                  EURSEK




                                                                                  EURJPY
                                                                                 EURCHF
                                                                                 USDCHF




                                                                                 EURHUF
                                                                                 USDZAR


                                                                                 AUDUSD




                                                                                  USDPLN
                                                                                 EURAUD
                                                                                 USDCAD
                                                                                 USDHUF
                                                                                 EURCAD




                                                                                 USDMXN
                                                                                 NZDUSD
                                                                                  EURPLN
                                                                                 EURUSD


                                                                                  USDINR
                                                                                 EURNZD

                                                                                 AUDCAD
                                                                                 USDKRW




                                                                                  USDBRL




certain segments of the investor community (CTAs) are
heavily short of dollars, while currency managers and




                                                                                                                                                          11
Global FX Strategy
Global FX Outlook 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


global macro hedge funds appear to hold only average                   Chart 20: Since US corporates are most exposed to Europe, profits
shorts with average leverage (see Global FX Carry Trade                repatriation would be most negative for EUR and GBP
                                                                       Value of US foreign direct investment by country in $bn. Based on purchase prices
Monitor on page 78).
                                                                           Euro area
What can go wrong?                                                               UK
Since the market’s positioning is already skewed towards USD                 Switz.
weakness, the risk scenarios become much more relevant.                       Japan
Currency-specific risks around the central forecasts are outlined on
                                                                             Mexico
page 83 FX forecasts, risk scenarios and trigger events. Five
                                                                              Brazil
global risks are the following:
                                                                              China
• America proves not so deflated. A surge in employment or                    Korea
  rise inflation could lead the Fed to curb asset purchases,
                                                                             Russia
  prompting a significant sell-off in the bond market. The dollar
  would rally across the board, but this correction should prove as            India
  temporary as Treasury-inspired USD rallies in early 2004 and
                                                                                       0   100     200     300     400     500     600     700     800
  2009. Funding rates, which drive carry trades and hedging
  incentives, matter more for currencies than bond yields, and
  cash rates will remain zero until well into 2012.
                                                                          in foreign currencies, we assume roughly 40% is in euros, since
• The US fumbles fiscal tightening. We discussed this issue at            Euro area accounts for 40% of US foreign direct investment
  length ahead of US mid-term elections, and the risk scenario            (chart 20). This is based on a simplifying assumption that if US
  still holds (see Swapping Fed for fiscal uncertainty, FXMW,             companies make half their overseas investment in Euro area,
  October 29, 2010). Delaying fiscal tightening could require an          they derive half their non-US revenues from Europe. Sterling is
  extension of QE to prevent a destabilizing sell-off in the              next, since UK accounts for 25% of US FDI. So HIA version
  Treasury market. The risk is a surge in inflation expectations          2.0 should be most negative for EUR and GBP, but the impact
  which sparks the always-anticipated run on the dollar. The              should be moderate given the share of overseas profits already
  resulting rise in volatility could force deleveraging in cyclical       held in USD.
  assets such as commodity currencies and strength in other
  reserve currencies (JPY, CHF). The euro’s path is unclear: it        • A major economy slows due to central bank tightening and a
  could surge as the alternative reserve currency or collapse given      strong currency. China’s slowdown is the perennial fear, but
  its equity sensitivity. Our bias is for EUR/USD strength.              Australia is also a candidate given the impact of higher rates
                                                                         and a strong currency on monetary conditions this year.
• A Spanish funding crisis. Europe’s rather quick response to
  Ireland validates our base case: that the EFSF minimizes the
  risk of sovereign contagion and renders the euro vulnerable to
  pullbacks in 2011 rather than trend weakness. Core Europe
  hasn’t balked at funding Ireland because each country’s
  nominal contribution would be small. The same holds if
  Portugal taps the facility. Europe could prove less cohesive if a
  major borrower such as Spain required funding. To be sure,
  there are significant fundamental differences between Spain and
  the rest of the periphery, and the ownership structure of Spanish
  debt (domestics dominate) works against a self-fulfilling
  buyers’ strike. But the risk scenario remains in place as long as
  growth is weak.
• US approves another Homeland Investment Act. The
  original HIA, which Congress passed in 2005 to give tax relief
  to US corporates which repatriated overseas earnings, generated
  an estimated $10bn in repatriation flows and contributed to
  dollar strength that year. The new Congress could consider
  similar legislation in 2011, passage of which would be material
  given the estimated $1trillion in retained earnings which US
  corporates hold abroad. The amount repatriated would be far
  less, since US corporates run operating surplus and have no
  need to repatriate foreign earnings to fund capex or hiring.
  Also, much of these earnings are probably already in dollars,
  since many cash-rich companies tend to price in dollars. From
  our previous surveys of corporate clients, we estimate that 50%
  to 75% of unrepatriated earnings are held in USD. Of that held

12
Global FX Strategy
Global FX Outlook 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.




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                                                                      13
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
John Normand (44-20) 7325-5222
Matthias Bouquet (44-20) 7777-5276
J.P. Morgan Securities Ltd.


Five global macro themes and top trades
Our short-term trade recommendations are outlined and       ⎯ Buy a 12m at-expiry digital EUR put/SEK call
marked to market each Friday in FX Markets Weekly. On         struck at 8.80 for 18.5% of payout.
average we have held cash trades for three weeks and        ⎯ Also USD/CAD (see theme 5).
option trades for three months (see Table 1 in Post-        ⎯ Also GBP/NOK (see theme 1).
mortem: 2011 forecasts and trade recommendations on
page 16). This section focuses instead on five global
macro issues which we expect to define 2011, so             3. Global rebalancing is inevitable, ad hoc and
accordingly the tenor is longer (6-12months) than the       uncoordinated
positions typically recommend in FX Markets Weekly.         Countries will have to consent to global rebalancing – the
1. Fiscal payback has barely begun                          polite term for a lower US trade deficit through a weaker
                                                            dollar – because Fed policy will drive problematic capital
As detailed in the Outlook (pages 4-13), G-10 fiscal        flows over the next year, at least. Selling USD/Asia has
deficits remain high enough to preserve rollover risk for   been the obvious trade for a year. Selling EUR/Asia has
at least the next year, in turn requiring extraordinary     been too, but assumes EUR/USD decouples from the
policy responses in Europe, the US and the UK.              dollar trend for a second consecutive year (unlikely, in
Sovereign stress is best expressed by owning the            our view). An alternative would be selling the yen within
currencies of strong balance sheet countries versus weak    EM Asia. High surplus countries with cheap currencies
ones, which is why European stress is better done           (Korea) face a greater, inevitable adjustment than
through EUR/CHF (also a favourite trade from the 2010       moderate surplus countries with expensive currencies
Outlook) than EUR/USD. US fiscal stress can be hedged       (Japan). Selling JPY/KRW also hedges the risk that a
through USD/CHF or USD/NOK, while the return of UK          global expansion in 2011 comes with an initial bond
QE is a GBP/CHF or GBP/NOK trade.                           market sell-off which lifts USD/JPY. Also buy 12-mo
⎯ Go long a bearish EUR/CHF seagull. Buy a 12-mo            AUD/USD vol versus USD/BRL vol. As discussed in the
  1.30/1.20 EUR put/CHF call spread, sell a 1.4250          Outlook, vol is biased higher in G-10 currencies which
  EUR call/CHF put. Net cost of 0.37%.                      will overshoot due to EM central bank intervention (even
                                                            if their activity declines over time), whereas many
⎯ Buy a 12-mo 5.90/5.50 USD put/NOK call spread
                                                            managed currencies already carry a high risk premium.
  in 1x1.5 notional for 1.36%.
⎯ Buy a 12-mo 9.25-8.75 GBP put/NOK call spread             ⎯ Buy a 12m bearish JPY/KRW seagull, comprising
  with a 2m window knock-out at 9.25. Cost 0.79%              long a 13.00/12.00 JPY put/KRW call spread and
  compared to1.39% for the vanilla put spread.                short a 16.25 JPY call/KRW put. Cost 0.52%.
⎯ Buy a 12-mo 1.53-1.47 GBP put/CHF call spread             ⎯ Buy a 12m bearish EUR/INR seagull. Buy a
  for 1.42%.                                                  64.10/59.00 EUR put/INR call, sell a 70.75 EUR
                                                              call/INR put. Costs 1.51%. (Forward deltas of the
                                                              individual legs are 50/25/25).
2. Central bank rates are misaligned versus risks
                                                            ⎯ Buy a 12-mo AUD vol swap (Expiry 24 Nov 11,
Next year won’t deliver aggressive moves in rates, but it     WMR fixings, Do Not Fix on WMR Hols, No Mean
should deliver bigger moves that what money markets           Adjustment) versus sell 12-mo BRL vol swap
currently discount. The US bond market hasn’t not yet         (Expiry 23 Nov 11, WMR Fixings, Do Not Fix on
digested the scale of Fed asset purchases, and most non-      USD or BRL hols, No Mean Adjustment) equal
US curves price in only 10-50bp of hikes over the next        USD vega on both legs for 0.65 vol pts.
year (see chart 3 on page 5). This pricing seems quite
benign since so many central banks refrained from much
tightening in 2010 given risks from China, the US and       4. Commodity currency rotation
Europe. If China and the US are reaccelerating and          For a year when inflation risks were supposed to support
Europe better equipped to deal with sovereign funding       the commodity and commodity currency complex,
now through the EFSF, relative rate shifts would be as      divergences have been notable. AUD rallied 10% versus
much a driver of USD pairs in 2011 as in 2010. Own          USD, NZD was up 7%, CAD 3.6% but BRL only 1%.
currencies where money markets are priced most              Clearly domestic circumstances drive relative
dovishly.                                                   performance, which means 2011 should only repeat
                                                            2010’s if the rate story remains as unambiguously


14
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
John Normand (44-20) 7325-5222
Matthias Bouquet (44-20) 7777-5276
J.P. Morgan Securities Ltd.

positive for AUD. It won’t be. There are decent risks of a
late-cycle rotation within the commodity bloc, whereby
AUD’s outperformance fades as the RBA ends its
tightening cycle, while CAD begins to deliver if the US
economy gathers momentum and the Bank of Canada
delivers at least 100bp of tightening.
⎯ Buy a 12m 0.97-0.92 AUD put/CAD call spread
  with a 2-month window knock-out at 0.96. Costs
  1.14bp versus 1.80% for the vanilla.

5. Valuation gaps to narrow
Valuation signals continue to work on average across
currencies, assuming a sufficiently long investment
horizon (see Long-term valuation on page 74). The most
misaligned currencies are JPY (20% too strong), NOK
(20% too cheap) and CAD (10% too cheap). We are
short JPY and long NOK and CAD elsewhere amongst
the five global themes, but highlight an alternative
USD/CAD trade here given the possibility of a sharp
move if the Bank of Canada or oil prices surprise to the
upside this year. (NOK is less oil-sensitive given the
Petroleum Fund’s activity.)
⎯ Buy a 12m at-expiry-digital USD put/CAD call,
  strike 0.94. Costs 21% of payout.




                                                             15
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
Sunil Kavuri (44-20) 7777-1729
J.P. Morgan Securities Ltd.



Post-mortem on 2010 forecasts and trade recommendations
Year-ahead forecasts                                          Table 1: Forecast errors in 2010: J.P. Morgan versus consensus
                                                              Forecast error is the percentage difference between the realised rate and the
When we wrote the last year-ahead outlook in November         forecast 12 months earlier. A positive (negative) error indicates that the base
2009, we expected the Fed environment to drive the            currency appreciated more (less) than JPM or the consensus expected.
dollar to new lows in 2010 versus the yen, Swiss franc                                                                                                        Forecast
                                                                         Spot on Nov 24, 2009              Forecast for Q4    Spot on Nov 23,    Forecast      error:
and the euro, and for commodity currencies to appreciate      Currency      (2010 Outlook     Forecast for     2010:         2010 (2011 Outlook error: JPM   Consensus

5% (CAD) to 10% (AUD). We were also bullish on                             publication date) Q4 2010: JPM Consensus           publication date)
                                                              USD/JPY            89                89            96                 83             -7%         -13%
EUR/GBP, expecting fiscal tightening to weaken                EUR/USD            1.50             1.50          1.45               1.37            -9%          -5%
sterling, and bearish on EUR/CHF, expecting the SNB to        EUR/GBP            0.90             0.90          0.88               0.86            -4%          -1%

abandon currency intervention as the economy                  EUR/CHF            1.51             1.46          1.53               1.36            -7%         -11%
                                                              EUR/SEK           10.34             9.60          9.64               9.38            -2%          -3%
accelerated. At the time most of these views were non-        EUR/NOK            8.42             7.50          7.92               8.17            9%           3%
consensus. Most analysts expected USD/JPY to rally on         USD/CAD            1.06             1.01          1.06               1.01            0%           -5%

Japanese fiscal crisis and/or higher US rates during a        AUD/USD            0.92             1.00          0.90               0.99            -1%         10%
                                                              NZD/USD            0.73             0.74          0.67               0.77            4%          15%
recovery. Analysts were mixed on the euro – half thought
sovereign credit would weaken the currency while half
                                                              Source: J.P. Morgan forecasts based on Global FX Strategy 2010 published on November
considered the risk exaggerated. Most analysts were           24, 2009. Consensus forecasts based on published consensus in November 2009
positive on sterling because it was cheap or because the
UK could better manage its excessive deficit than             Trade recommendations
Europe, while most thought the SNB would never                Trade recommendations are detailed each Friday in FX
abandon its defense of the franc given its greater focus on   Markets Weekly and are classified as macro directional
competitiveness and deflation.                                trades (cash and options); derivatives relative value
In the event, we made a couple of very bad initial calls      and technical trades.
but forecast the majority of currencies better than the       I. Macro trade recommendations
consensus. Table 1 compares 12-month ahead forecasts
made by J.P. Morgan and the consensus in November             For cash trades, this year’s performance was worse than
2009, with the realized spot rate a year later. The           in 2008 and 2009 but still positive, so similar to the
difference is the forecast error, where a positive            performance trend amongst currency managers and
(negative) value indicates that the base currency             global macro funds (see Model-driven strategies on page
appreciated more (less) than forecast. This exercise          78). We recommended 82 cash positions with a 54%
oversimplifies forecasting and sets a very high bar, since    success rate and an average return of 10bp, compared to
we, like investors and corporates, revise forecasts over      success rates of 60%-65% and average returns of 1%-2%
the course of the year rather than stick with a year-ahead    in 2008 and 2009. Directional options trades (non-
target or trade when new information arises. We only          digitals) performed much better. Of the 27
benchmark the original year-ahead forecast for brevity        recommendations, 59% generated positive returns
here.                                                         averaging 30bp each. We reduced the number of digital
                                                              recommendations from 21 in 2009 to six in 2010 but still
We forecast the correct direction for seven of nine pairs,    achieved a poor success rate of 17%. Average holding
missing on EUR/USD and so on EUR/GBP too. The                 periods were comparable in 2010 to 2009: 23 days for
consensus correctly forecast the direction of only four       cash trades and 54 days for options trades.
pairs (EUR/USD, EUR/GBP, EUR/SEK and
EUR/NOK), misjudging the commodity currency rally,            II. Relative value derivatives recommendations
USD/JPY’s decline and EUR/CHF’s decline.                      Relative value options positions had their best year in
Our most accurate calls were on USD/CAD (no forecast          three. We recommended 41 trades this year compared to
error) and AUD/USD (-1% error, or too bullish on              32 in 2009 and 13 in 2008. These trades generated a
AUD). Our worst were on EUR/USD (-9%, or too bullish          success rate of 68% this year versus 63% in 2009, and
on the euro) and EUR/NOK (9%, or too bearish on               average returns of 70bp compared to 10bp last year.
EUR/NOK). J.P. Morgan’s forecast errors were lower            Average holding periods were longer in 2010 to 2009:
than the consensus’s for seven of nine pairs.                 104 days versus 73 days in 2009.




16
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
Sunil Kavuri (44-20) 7777-1729
J.P. Morgan Securities Ltd.


III. Technical trade recommendations                                                                         Chart 1: 2008-2010 performance summary: success rate by type
                                                                                                             of trade
2010 was not a good year for our technical
                                                                                                                                                                   54%
recommendations. We recommended 43 trades with a                                                                        Cash                                           64%              2010
success rate of 47% and an average return of zero. This                                                                                                              59%                2009
performance compares to 2009 when we issued 46                                                                                                                       59%
                                                                                                                  Non-digital                                         62%               2008
recommendations with a success rate of 57% and an                                                                                 0%
average return of 10bp. Holding periods tended to be                                                                                        17%
                                                                                                                       Digital                         38%
longer this year at 35 days, compared to 10 days in 2009.                                                                                     20%
.                                                                                                                                                                          68%
                                                                                                              RV (non-digital)                                           63%
Table 2. Performance statistics 2008 – 2010                                                                                                                                      77%
                                                                                           2008-2010                                                         47%
                                                2010 YTD        2009         2008         weighted avg              Technical                                       57%
I. Trade Recommendations portfolio
                                                                                                                                                           43%
Cash
                                                                                                                                 0%         20%      40%           60%          80%       100%
# of trades                                                82          61           85              228
Success rate                                          54%          64%          59%                59%
Average return per trade (%, unweighted)              0.1%        1.0%         2.0%               1.0%
Average holding period (days)                              23          20           31               25
                                                                                                             Chart 2: 2008-2010 performance summary: average returns per
                                                                                                             trade
Derivatives (non-digital)
# of trades                                            27              21            3               51                                                                    0.1%
Success rate                                          59%          62%         0.0%                57%             Cash                                                        1.0%
Average return per trade (%, unweighted)              0.3%        0.5%         -0.6%              0.3%                                                                             2.0%
Average holding period (days)                          54              59           66              57
                                                                                                                                                                               0.3%
Derivatives (digital)                                                                                         Non-digital                                                       0.5%    2010
# of trades                                                 6          21            5               32                                                          -0.6%                  2009
Success rate                                          17%          38%          20%                31%
Average return per trade (%, unweighted)             -4.7%        -4.7%        -3.6%              -4.5%
                                                                                                                                              -4.7%                                     2008
                                                                                                                  Digital                     -4.7%
Average holding period (days)                              64          55           54               57
                                                                                                                                                   -3.6%
II. FX Derivatives portfolio (relative value)
Vol r.v
                                                                                                                                                                           0.0%
                                                                                                               Technical                                                   0.1%
# of trades                                                41          32           13               86
                                                                                                                                                                            0.2%
Success rate                                          68%          63%          77%                67%
Average return per trade (unweighted)*                 0.7             0.1          0.3             0.4
Average holding period (days)                          104             73           53               85
                                                                                                                        -10%          -8%    -6%     -4%      -2%         0%       2%      4%

Vol plus directional r.v
# of trades                                                 3      NA           NA                       3
Success rate                                          67%          NA           NA                 67%
Average return per trade (unweighted)*                     21      NA           NA                   21
Average holding period (days)                              50      NA           NA                   50

Digital
# of trades                                                 -      NA                3                   3
Success rate                                                -      NA           33%                33%
Average return per trade (%, unweighted)                    -      NA               8%              8%
Average holding period (days)                               -      NA               33               33

III. Technical Strategy portfolio
# of trades                                                43          46           87              176
Success rate                                          47%          57%          43%                47%
Average return per trade (%, unweighted)              0.0%        0.1%         0.2%               0.1%
Average holding period (days)                              35          10            9               16
*P&L in vol points for 2010




                                                                                                                                                                                          17
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Arindam Sandilya (1-212) 834-2304
Matthias Bouquet (44-20) 7777-5276
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


                                                                 Chart 1. The vol outcome in 2010 was surprisingly benign despite
FX Derivatives: Low, not                                         one of the larger intra-year peak-to-trough swings in the dollar

lower                                                             24%          Rolling 1-y r Min/max
                                                                                                         Rolling 1-y r       vol pts.
                                                                                                                                  17
                                                                                                        VXY mov es
                                                                               DXY range                                          13
•    The volatility outcome was surprisingly tame in a            21%
     year that delivered a number of systemic shocks.                                                                             9
                                                                  18%
•    The outlook for surprises on growth and monetary                                                                             5
                                                                  15%
     policy fronts for next year is fairly benign, and the                                                                        1
     investor leverage picture is marginally heavier vis-à-       12%
     vis last year, with dollar shorts representing the                                                                           -3
     most substantial position overhang.                           9%                                                             -7

•    Our model linking currency volatility to leverage             6%                                                             -11
     and surprise factors projects VXY to leak 1.0-1.5               Dec-99     Feb-02       Apr-04    Jul-06       Sep-08   Nov -10
     vols lower towards the high 10s/low 11s in 2011.
                                                                 ahead piece (Global FX Strategy 2010, Nov 24, 2009),
•    We consider that the lower end of the vol range
                                                                 highlighting the basic principle underlying the rather tame
     given the lack of sovereign leverage in the frame-
                                                                 rangebound view of vols that we began the year with –
     work, low spillover from a subdued rate vol market
                                                                 namely that shocks translate into meaningful increases in
     into FX and contradictory readings from a financial
                                                                 volatility only in the presence of excessive leverage, and
     variable based predictive model that sees high odds
                                                                 that deleveraging as a dynamic had exhausted far too much
     of a May’10 style high vol month next year.
                                                                 of its steam over 2007-09 to be able to provide a sustained
•    Lack of strong directional momentum in vols should          lift to FX vols this time around. The wild card in that view
     reduce the efficacy of systematic short gamma               was the growing substitution of private sector gearing with
     strategies. Vol carry should be a more reliable             sovereign leverage in G4 that was difficult to accommodate
     source of returns – sell front-end FVAs to fade the         as a vol driver within a clean econometric construct. Fortu-
     aggressive rally in vols priced into vol curves.            nately for us (and the market), unwinding the large stock of
                                                                 outstanding assets on central bank balance sheets was a
•    Trades: Fade the richness of USD/JPY and                    moot issue this year with the summer slowdown forcing the
     EUR/JPY vols at the back-end of vol curves against          Fed into a second round of LSAPs. As we head into 2011
     commodity FX/ JPY cross vols. Marry this vega rich          however, these concerns are likely to resurface, probably
     cheap to a view on de-correlation between them via          with greater intensity if JPM Economics’ forecast of a
     geared dual currency options. Own 5Y-10Y EUR                renewed upswing in global growth next year comes to
     and CHF vols to hedge a disorderly dollar decline.          fruition and the exit strategies rear their head again.

Surprisingly tame                                                Updating the shock – leverage framework

As far as years go, 2010 was not one lacking in macro            To arrive at a baseline view for volatility next year, our first
surprises. Peripheral Europe delivered a debt crisis of epic     port of call is a theoretical construct presented in our last
proportions that re-opened the book on bond investing in         year-ahead publication that conceptualized volatility as the
weaker sovereigns and ignited a heated debate about the          product of the supply of macroeconomic surprises and the
sustainability of the Euro. US policy expectations shifted       vulnerability of markets to those surprises, i.e. leverage.
radically from mulling exit strategies at the beginning of the   Surprises can be thought of as market-relevant exogenous
year to a second round of QE by November, driving one of         events/news, either in the form of unexpected developments
the larger intra-year peak-to-trough swings (19%) in the         in macro-economic variables such as growth or inflation, or
dollar in recent memory (chart 1) and setting off a currency     unanticipated policy actions by the government. Charts 2
wars debate in political and financial circles. In between,      and 3 depict the tight linkage between growth and monetary
sporadic headlines around a Chinese hard landing did their       policy surprises to the business cycle, using US as a proxy
bit to spark multiple mini flights-to-quality in high-beta FX.   for the rest of the world. Of the two, the latter has the more
However, barring contagion from Greece and co. in May,           contentious definition, measuring as it does the temporal
the vol outcome of systemic shocks this year has been            dispersion of US short rates. With 2-year yields close to
surprisingly benign. VXY has softened ~ 1 vol from early         their nominal zero bound, it is worth questioning if their
January levels at the time of going to print and is more or      volatility (or lack thereof) represents the true uncertainty
less unchanged from the time we published our last year-         surrounding the impact of unprecedented Fed actions over

18
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Arindam Sandilya (1-212) 834-2304
Matthias Bouquet (44-20) 7777-5276
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


the past two years. Chart 3 incorporates 10Y rates as an          Chart 2. Growth surprises in the US are likely to remain muted in
alternative to 2s as an arguably more sensitive gauge of          2011 given our forecast of only a modest drop in unemployment…..
                                                                  Growth surprises defined as the rolling 12M standard deviation of monthly changes
policy shock in the current climate since it captures term        in the 1-year ahead consensus US growth expectations. Shaded areas represent
premium over and above short rates that are likely to remain      NBER recessions. Exit from the most recent recession assumed to be Jun’09.
anchored near zero for a while. Definitional issues not-                   %           Growth                      YoY change in US          %
withstanding, the outlook for surprises for next year is fairly     0.6                                                                           4
                                                                                      Surprise                      Unemployment
benign, judging by their empirical employment link. JPM             0.5                                                                           3
Econ. forecasts pencil in only a mild improvement in labor
markets by end-2011 – unemployment rate is slated to drop           0.4                                                                           2
from 9.6% currently to 9.4% by Q4’11 – even as economic             0.3                                                                           1
activity receives a substantial lift from loose policy, with
real GDP growing 2.5% in the US and 3% globally. If we              0.2                                                                           0
are correct on our predictions, both growth and monetary            0.1                                                                           -1
policy shocks will be modest next year, as indicated in the                                                                   F'cast
forecasts on charts 2 and 3. The two are of course not              0.0                                                                           -2
mutually exclusive, and are more likely than ever to overlap             Dec-90       Feb-95        May-99         Jul-03       Oct-07     Dec-11
in the current milieu of policy being retooled with the
                                                                  Source: J.P. Morgan, Blue Chip Indicators
express purpose of boosting activity, even at the risk of
future inflation.                                                 Chart 3. ….as are monetary policy surprises
                                                                  Monetary policy surprises defined as the rolling 12M standard deviation of monthly
The severity of the fallout from that risk is a function of       changes in either 2Y or 10Y US swap rates. Shaded areas represent NBER
system leverage, to which the public sector has contributed       recessions. Exit from the most recent recession assumed to be Jun’09
handsomely in recent times even as the private sector has                 bp                                                                     %
                                                                    60            Monetary Policy Surprise (2s)     YoY change in US
withdrawn. Of the latter, corporates and households are                                                                                              4
                                                                                  Monetary Policy Surprise (10s)      Unemployment
fairly tame from a gearing standpoint. The trend of falling                                                                                          3
                                                                    50
corporate financing gaps and rising cash reserves has
                                                                                                                                                     3
continued unabated, and we expect credit market debt of the         40                                                                               2
nonfinancial corporate business sector to be about flat next
                                                                                                                                                     1
year. Personal savings rates have dipped only marginally            30
                                                                                                                                                     0
from last year’s highs, but re-leveraging is still some way
                                                                                                                                                     -1
off given still depressed levels of spending on credit-             20
                                                                                                                                                     -1
sensitive goods and cautious attitudes of both borrowers and                                                                     F'cast
                                                                    10                                                                               -2
lenders toward new credit obligations three years after the
credit crisis began. Investor leverage as defined by outright        Dec-90          Mar-95         May-99         Aug-03        Oct-07     Dec-11

positions in high-yield currencies held by global macro
                                                                  Chart 4. Currency managers and global macro hedge funds have
hedge funds, dedicated currency managers, CTAs or                 increased their holdings of high-beta/EM FX in the lead up to QE II,
Japanese retail has picked up substantially in H2 in the run-     while CTAs hold close to record dollar shorts
up to QE II (chart 4), after being forced to de-lever in May      Average of rolling 30-day betas from regressing daily returns for i) a composite of
after Greece went global. Not surprisingly, much of the           25 dedicated currency funds compiled by JPMorgan and ii) HFR global macro
move was funded in dollars rather than via traditional low        hedge funds on returns from JPMorgan’s IncomeFX and IncomeEM carry baskets.
yielders such as yen or Swiss francs, and CTA dollar shorts                                                                  IMM USD        $ bn
                                                                    1.5             Av g. currency manager /                                   30
at $30bn represents one of the largest spec holdings of its                                                                  positions
                                                                                    global macro HF beta
                                                                                                                                                 20
kind in IMM history. With the yen grinding higher for most
                                                                    1.0
of the year, Japanese retail was shy to display its pre-crisis                                                                                   10
penchant for yen-funded carry trades, and cut overall                                                                                            0
positions in half from a mid-year high of $6bn. Net-net, we         0.5
                                                                                                                                                 -10
head into 2011 with a marginally heavier investor leverage
picture vis-à-vis last year, with dollar shorts representing                                                                                     -20
                                                                    0.0
the most substantial position overhang.                                                                                                          -30

Our econometric model, which incorporates these shock              -0.5                                                                          -40
and leverage variables, points to a year of soft FX volatility           Jan-06       Dec-06         Dec-07        Dec-08      Dec-09     Nov -10
ahead. Chart 5 lays out the forecast details: VXY is              Source: J.P. Morgan, Bloomberg
currently trading at the upper-end of its forecast band,
and should leak 1.0-1.5 vols lower towards the high

                                                                                                                                                      19
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Arindam Sandilya (1-212) 834-2304
Matthias Bouquet (44-20) 7777-5276
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


10s/low 11s over the course of 2011. Clearly, subdued              Chart 5. VXY is set to soften 1.0-1.5 vols given the investor leverage
growth and policy surprises in our framework act as drags          stock and the supply of surprises
                                                                   Growth surprises as defined in Chart 2; Monetary policy surprises as defined in
on vol that are not adequately offset by the leverage stock in     Chart 3; Investor leverage taken to be the average beta of CSFB Tremont hedge
on investor books. The net outcome sounds plausible: the           fund index on JPMorgan’s IncomeFX and IncomeEM carry baskets
central forecast of 10.8 is a hair’s breadth away from a long      Forecasts
run average for the VXY, and a gradual decline towards              Umeploy - YoY           Grow th      Monetary       Inv estor
                                                                                                                                    VXY
those levels keeps intact the mean-reversion process kick-            ment Unemp. Surprise Policy Surprise Lev erage
started by the first round of QE in March’09. Additionally,                 9.4        -0.3      0.12              30            1.02       10.8
with large output gaps keeping central banks in deflation
fighting mode – or at least loath to preemptively tighten              25                                                                           F'cast
                                                                                         VXY Actual
policy given the global backdrop – and therefore in no
hurry to turn off the liquidity tap, short tail rate vols in G3                          VXY Model = 3.34 + 0.11*Monetary Policy Surprise +
                                                                       20                6.76*Grow th Surprise + 3.29*Inv estor Lev erage
should continue on their downward spiral of the past 18-
                                                                                         +/- 1 Std. Error Bands
months, most appreciably in the US where near zero front-
end yields have already undergone a lognormal shuffle, the             15                                                   Adj R 2 = 42%
effect of normal basis point volatility being forced to fall
and yield changes becoming lognormally distributed as
                                                                       10
rates get closer to zero, lest the probability of the underlying
rate crossing the barrier becomes substantial (see Fixed
Income Markets Weekly, Aug 6) . To the extent that FX                  5
markets look to rate markets for direction, this suggests a             Jul-96        Feb-99         Sep-01    Apr-04      Nov -06       Jun-09      Dec-11
concomitant fall in FX vol.
                                                                   Chart 6. Spillover from the rates vol market into the FX vol market
Lower vol – really?                                                has tailed off sharply of late
                                                                   Spillover index based on variance decomposition of 10-week ahead forecast errors
There are mitigating arguments, however. First, the                of a 2 period VAR between 3M2Y US swaption vol and VXY over rolling 100-week
leverage variable in our model severely understates                windows. Methodology adapted from Measuring Financial Asset Return and
financial system gearing, given that it captures only investor     Volatility Spillovers, With Application to Global Equity Markets, Diebold, F. and
leverage and ignores the fiscal leverage buildup altogether–       Yilmaz, K. Weekly data since 1992.
largely because public sector leverage measures are too low            50%
                                                                                                                            Credit crisis erupts
frequency compared to other inputs, and too slow moving to
                                                                                     High       Asia/LTCM
be a significant explanatory variable in a G7 context. If this         40%                                                                        Lehman
                                                                                  Spillov er
was a serious omission in the past, it takes on egregious
proportions while mulling FX vol prospects for 2011in the              30%
post QEII world where the likelihood of a disorderly exit
from unconventional policies has increased manifold. This              20%                                     Tech crash
necessitates an upward adjustment to model forecasts, and
leaves us inclined to considering high 10s as a floor for
                                                                       10%
VXY instead of the central tendency.
Second, it is not clear to us that there is clear transmission          0%
channel for exporting low rate volatility to the currency                   Apr-94          Aug-97        Dec-00        Mar-04          Jul-07       Nov -10
market. Even the extreme scenario of deflation in 2011 –
arguably the most bearish environment for rate vols based          Source: J.P. Morgan, Bloomberg
on the Japanese experience – would be unprecedented if it          country-specific stresses persist. Chart 6 lends some support
followed the textbook definition of a synchronized fall in         to our skepticism. It adapts a recently developed technique1
prices and very weak output in the G-3, and would likely           to gauge spillover effects across asset markets to 3M2Y US
create credit stresses in most major economies: weaker             swaption vols and VXY through a normalized spillover
corporate earnings in the US, sovereign funding constraints        index that is floored at zero and capped at 1, and plots this
in peripheral Europe or a negative terms of trade shift for        metric over rolling 100-week windows. While linkages
the commodity exporters. Japan’s experience may be the             between rates and FX spiked significantly around market/
proper template for thinking about the trajectory for rate
vol, but it seems less instructive for FX when a number of
                                                                   1
                                                                    Measuring Financial Asset Return and Volatility Spillovers, With
                                                                   Application to Global Equity Markets, Diebold, F. and Yilmaz, K



20
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Arindam Sandilya (1-212) 834-2304
Matthias Bouquet (44-20) 7777-5276
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


economic downturns in 1998, 2002 and 2007-08, they have                Chart 7. Financial market variable based predictive models suggest
been sharply on the wane since the end of the recession,               high probability of a May’10 style blow-up month next year
                                                                       Probit model specifying the cumulative probability of a ‘high volatility’ month for the
which essentially means that currency vol is now more or               VXY at some point over the next 1-year as a function of the current VXY level, US
less its own animal, ebbing and flowing in response to                 10Y rates, gold price level and YoY % change in gold prices. Methodology adapted
idiosyncratic factors. Prime among them next year is going             from Financial Market Perceptions of Recession Risk, King, T.B., Levin, A.T., and
to be the financing situation in peripheral Europe. The                Perli, R. Shaded areas represent high volatility months. Monthly data since Jan‘93.
combination of a large enough backstop for funding Ireland,            100%
Portugal and Spain through 2012 and yet a potentially
tortuous path to activating it has effectively served to make           80%
our EUR/USD forecast bimodal – 1.25 with a financing
crisis in spring of next year and 1.45 without (FX Markets              60%
Weekly, Nov 5). This is hardly the sanguine state of affairs
that puts G7 volatility to bed.                                         40%

Third, our attempt to corroborate the subdued vol forecast
                                                                        20%
above with market based predictive models yields
conflicting results. Drawing heavily on the considerable
                                                                         0%
body of academic literature on forecasting recessions using
financial market variables such as the yield curve, we model                 Jan-93       Aug-96        Mar-00        Oct-03        May-07        Nov-10
the cumulative probability of observing a high volatility              Chart 8. Short gamma strategies did not deliver the stellar returns of
month a la May’10 over the next year (as opposed to the                yesteryears in 2010, and much of the returns were front loaded
                                                                       Short gamma returns calculated as the P/L from selling a basket of 3M delta
marginal probability of being in a high vol month exactly 1-           hedged ATM straddles, with the basket composition mimicking that of
year ahead) conditional on a vector of currently observable            J.P. Morgan’s VXY G7 index. Options are re-struck at the start of the month, and
explanatory variables. A systematic examination of                     assume no transaction costs.
univariate and multivariate recession-style models across a              vol pts.                                                                    vol pts.
                                                                         2                                                                                  8
broad spectrum of input variables2 indicates that current
vols levels, US 10Y rates, and levels and changes in gold                1
prices embed crucial information about the one-year ahead                                                                                                  6
probability of a vol spike. The inputs are not wildly                    0
unrealistic: abnormally low vol levels that precede jumps in
volatility reflect overly complacent markets ripe for mean-             -1                                                                                 4
reversion; long-end rates and gold prices capture some form
of risk premium – possibly inflation – that eventually                  -2
                                                                                                                                   Cum.P/L
materialize in the form of disorderly currency moves. Chart                                                                                                2
                                                                        -3
7 plots the vol spike probability from a probit model                                  Weekly P/L
incorporating those four variables, and suggests extremely              -4                                                                                 0
high odds of a large monthly spike in vols in 2011.                       Jan-10      Feb-10       Apr-10    Jun-10       Jul-10     Sep-10      Oct-10
So what do we make of these apparently contradictory
observations? At the very least, they dent the notion of a             deliver the stellar returns of yesteryears, but will probably
rates led collapse in currency vol. Our bias is to believe that        perform as well as 2010 (chart 8), which is not saying much
next year will turn out to be similar to 2010, with mean               given monthly returns of around 0.5 vols pre bid/offer,
vol levels akin to or maybe a tad softer than this year’s,             much of it front-loaded before the European infection.
but with a significant probability of at least one outsized            Large intermittent drawdowns are a part of life in the short
jump event of the kind spawned by Greece in Q2’10.                     gamma lane, and expect next year to be no different given
                                                                       the odds of at least one major vol episode.
Which trade?
                                                                       The possibility of a spike however does not automatically
Lack of a clear directional trend in vols makes strategic risk         preclude vol selling in all forms. One approach to vol
taking an onerous proposition. Short gamma is unlikley to              investing is to back out option market expectations of
                                                                       volatility as priced into the vol term structure via forward
                                                                       vols, not unlike extracting the trajectory of policy rates from
2
  Methodology adapted from Financial Market Perceptions of Recession
Risk, King, T.B., Levin, A.T. and Perli, R., Finance and Economics
Discussion Series, Divisions of Research & Statistics and Monetary
Affairs, Federal Reserve Board, Washington, D.C.

                                                                                                                                                           21
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Arindam Sandilya (1-212) 834-2304
Matthias Bouquet (44-20) 7777-5276
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


Chart 9 . Vol curves price in a sustained rally in front-end vols over              Chart 10. High ex-ante static slide from forward to spot vols is a
the course of next year that is unlikely to be realized in our view                 harbinger of positive ex-post P/Ls from FVAs
Black-Scholes forward volatilities for a basket of USD-majors that mimic the        Performance of 3M3M forward volatility trades in the direction of positive static
composition of the VXY                                                              slide along the vol curve i.e. short FVAs along an upward sloping curve and long
                                                                                    along an inverted curve, contingent on various thresholds of the ex-ante slide. No
  Vol (%)
  14.0                                                                              transaction costs.
                                                                                     Slide Threshold          0.00         0.50       1.00        1.50         2.00
  13.5                                                                               Av g. P/L (ann.)         1.52         3.28       5.08        7.75         10.05
                                                                                     Stdev P/L (ann.)         4.43         5.14       6.27        8.01         8.60
  13.0                                                                               Information Ratio        0.34         0.64       0.81        0.97         1.17
                                                                                     Success Ratio            57%          60%        60%         61%          65%
  12.5                                                           Current
                                                                 3-mo Forw ard        1.2                                                                                                                             66%
                                                                 6-mo Forw ard                                                                 IR
  12.0
                                                                 1-y r Forw ard       1.0                                                                                                                             64%
  11.5
         0          2           4           6           8          10          12     0.8                                                                                                                             62%
                                                                        Tenor (M)
                                                                                      0.6                                                                                                                             60%
yield curves. It is possible to be cautious about the prospects                                                                                                                                Success
for volatility in general, but disagree with the pricing of                           0.4                                                                                                          Ratio              58%
forward vols that requires an unsustainably strong vol rally                                                                                                              Current
to materialize. Such is the case with front-end G7 vols at                            0.2                                                                                                                             56%
present. Chart 9 illustrates the point by plotting the term
                                                                                                    0.00                                            0.50               1.00               1.50                 2.00
structure of the VXY at various points forward in time as
                                                                                                                          At-inception static slide threshold for forw ard v ol trading (v ol pts.)
inferred from current curve shapes of the individual basket
constituents. While a 1 vol jump in 3-month implieds over                           Chart 11. Back-end vols in commodity FX/JPY crosses are cheap,
the next quarter is a distinct possibility, we have grave                           while USD/JPY and EUR/JPY vols are expensive
doubts about a 2 vol increase over the course of the full                           X-axis is a measure of the historical rich/cheap of implied vols, while Y-axis is a
year. History is kind to our skepticism: chart 10 details the                       measure of forward gamma performance defined as the ratio of breakeven vol/
                                                                                    recent realized vol of forwards. Breakeven vol is the value of realized vol R that
returns from trading positive vol carry contingent on
                                                                                    satisfies: (t/T) * R2 + (1-t/T)*IT-t |t 2 - IT |0 2 = 0, IT-t |t = Implied Vol of tenor T-t at time t;
various ex-ante levels of static slide, and shows that current                      IT |0 = Implied Vol of tenor T at time t = 0. The breakeven vol denotes the minimum
levels are consistent with a information ratio of ~ 0.9 and                         amount of realized vol decaying 2Y forwards need to deliver in order to keep a
60% probability of positive P/L from fading the option                              daily delta-hedged ATM straddle in the black, assuming complete monetization of
                                                                                    the vol slide along the vol surface (both along the term structure and the skew).
market bullishness on vol. Obviously forward vol levels and                         USD/JPY implied vols are rich on a z-score basis, and forwards are delivering
slide will vary over the course of the year, and we will                            insufficient realized vol relative to breakeven vols.
doubtless find better locations for installing FVA shorts
                                                                                                                                  1.5
than at present. However if vol levels do not shift radically                                                                                                                    EURJPY        USDJPY
                                                                                                                                                                                                              Value
                                                                                        6M Breakeven Vol of 2Y DN Straddles/ 6M




as we expect, positive carry vol trades of this ilk stand to                                                                                                           GBPUSD
                                                                                                                                                                                    CHFJPY                    SELLS
                                                                                                                                                                      GBPJPY
perform well.                                                                                                                     1.4
                                                                                              Realized Vol of 2Y Forward




                                                                                                                                                                                             EURGBP
Familiar themes continue to present themselves at the back-                                                                       1.3                      AUDNZD
                                                                                                                                                             EURSEK
end of vol curves. The most compelling of these is the                                                                                     NOKSEK          USDCAD
divide between USD/JPY and select cross-yen vols that fall                                                                                                    NZDUSD
                                                                                                                                                                                                 EURUSD
                                                                                                                                  1.2
on opposite ends of the rich/cheap spectrum in G10 (chart                                                                                AUDCAD
                                                                                                                                                             EURNZD
                                                                                                                                                                     AUDUSD
                                                                                                                                                                                      EURAUD
                                                                                                                                                       NZDJPY
11). USD/JPY and EUR/JPY have been for the last few                                                                                                                    AUDJPY
                                                                                                                                                                                    USDSEK
                                                                                                                                                                                              GBPCHF
months, and still remain, the vega sell of choice in G10,                                                                         1.1
                                                                                                                                               Value                            USDNOK

trading rich to almost every commonly tracked vol metric;                                                                                      BUYS             EURNOK
                                                                                                                                                                                              USDCHF
                                                                                                                                                       CADJPY
the 1 vol + uptick in implieds over the past two months                                                                           1.0
creates interesting entry levels into fresh shorts. A large                                                                             -0.2        0.0      0.2     0.4       0.6      0.8             1.0       1.2
fraction of the vol bid can be explained by the relentless                                                                                                 5-Year Z-Score of 2Y Implied Vol
buying of OTM topside strikes 2Y and out in tenor from the
leveraged community to position for an eventual weakening
of the yen, possibly on account of US-style fiscal concerns.
Bulk of these positions are strategic/long-term in nature,


22
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Arindam Sandilya (1-212) 834-2304
Matthias Bouquet (44-20) 7777-5276
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


and are unlikely to be liquidated despite the substantial           Chart 12 .Commodity FX/JPY cross-yen vols are at attractive
mark-to-market pain they have taken over the past 18-               historical locations to own vs. USD/JPY vols
                                                                                                                     AUDJPY/ USDJPY 1Y Implied Vol Ratio
months, and vega shedding by PRDC books is unlikely to                2.4                                            NZDJPY/ USDJPY 1Y Implied Vol Ratio
come into play unless spot (and forwards) begin to exhibit                                                           CADJPY/ USDJPY 1Y Implied Vol Ratio
                                                                      2.2
signs of a definitive turn higher – not our base case for next
year. As a result, a good part of the back-end vol richness           2.0
may prove persistent, but the combination of richness vis-à-          1.8
vis realized vols and sharp slide along a steep vol curve
                                                                      1.6
makes them attractive sells on rallies. We prefer to express
such trades through short 1Y1Y FVAs that are currently                1.4
trading at historically attractive levels, and exploit curve          1.2
steepness by offering in excess of 2 vols of slide.
                                                                      1.0
Cross-yen vols – particularly AUD/JPY, NZD/JPY and                     Nov-07       May-08         Nov-08      May-09          Nov-09        May-10          Nov-10
CAD/JPY – have cheapened significantly relative to
USD/ JPY over the past three months. Most of this is on             Chart 13. EUR and CHF back-end vols have been stellar holds since
account of the grind lower in USD/ JPY since April that has         inflation risks first reared their head in the aftermath of QE I
led to yen-crosses under-performing dollar pairs in the             Rolling 6-month return on premium on EUR/USD and USD/CHF 5Y D/N straddles
direction of currency strength, thereby reducing the                  70%                                                                           EUR/USD
incentive to own the more expensive JPY-cross vol over the            60%
                                                                                                                                                    USD/CHF
USD vol on at least one side of the spot distribution.                50%
Continued compression of cross yen vs. USDJPY vol                     40%
spreads requires persistent USD-weakness and grinding
                                                                      30%
yen-strength. Both of these are consensus views at present,
                                                                      20%
and owning cross-yen vols against USD/JPY vols is an
interesting way of positioning for the market being caught            10%
complacent around its view from historically attractive                0%
locations (chart 12).                                                -10%

While not at optimal entry levels currently, positive vol            -20%
                                                                        Apr-09            Jun-09         Sep-09             Dec-09         Feb-10        May-10
carry and lack of back-end vol supply dovetail nicely to
suggest value in owning long-dated (5Y – 10Y) EUR/USD
                                                                    Chart 14. Combining vol rich/cheap with a view on de-correlation
and USD/CHF vols. EUR and CHF are the two currencies                within the yen-bloc yields highly geared payoffs
that are most responsive to a dollar crisis scenario (Hedging       6M [USD/JPY↓ K =2% ITMS, CCY/JPY↑ K = ATMS] dual at expiry digital options, ranked in
the always inevitable dollar crisis, Oct 16, 2009), long-           order of the discount to the cheaper of the two individual digitals.
dated vols in both slide positively along inverted vol curves,        80%
and benefit disproportionately from a decoupling of the
                                                                      70%
dollar and US rates fostered by currency debasement led
inflation concerns. Such decorrelation between FX and rates           60%
is positive for long-dated vols as it increases the volatility of     50%
forwards; further out in tenor the forward, higher the                40%
impact. Trades of this ilk first garnered investor interest in        30%
early ’09 after QE I was announced, and have delivered
                                                                      20%
stellar returns since then (chart 13) even in the midst of an
extended period of vol normalization from crisis peaks.               10%
                                                                       0%
Finally, the relative cheapness of high-beta/JPY cross vols
                                                                                                                      KRW
                                                                              INR




                                                                                                               CAD



                                                                                                                             AUD




                                                                                                                                                 NZD
                                                                                                                                           CHF
                                                                                    TRY




                                                                                                                                                       SEK

                                                                                                                                                               NOK
                                                                                           BRL

                                                                                                   MXN

                                                                                                         ZAR




                                                                                                                                     EUR




relative to USD/JPY can be married to a view on de-
correlation between them through multi-currency option
structures that yield attractive gearing vis-à-vis individual       currency next year powers most high beta FX and their yen-
vanilla options, even with strikes set in the money (chart 14).     crosses higher. The additional cushion of in-the-money
The directional divergences that such structures demand is          strikes increases the odds of positive payoff from these
in line with our macro-view of a grind lower in USD/JPY             options without sacrificing much by way of leverage.
towards 75 in coming months, even as the broad USD sell
off and the reversion of yen back to the status of a funding

                                                                                                                                                                     23
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Arindam Sandilya (1-212) 834-2304
Matthias Bouquet (44-20) 7777-5276
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.



Post-mortem: 2010 FX
Derivatives Trade
Recommendations
Trade performance in 2010 resulted in a higher overall hit       Table 1. Performance statistics 2008 – 2010
                                                                                                                                                            2008-10
rate than in 2009 (table 1), even as the number of trade                                                               2010      2009        2008
                                                                                                                                                          w eighted av g
recommendations increased. Barring the blow-up in May            Vanilla Options
this year, liquidity conditions were decent enough for us to     # of trades                                              26     27          13                22
enter into a number of relative value positions. We end the      Success rate                                          58%       63%         77%              64%
year with a hit rate of 68%, with vol products – FVAs and        Av erage return per trade (bp, unw eighted)              -4     10          60                14
vol swaps – contributing the lion’s share. The increased         Vol Products*
number of FVA recommendations this year in keeping with          # of trades                                              18      3           ---              11
our rangebound vol view stood us in good stead, returning        Success rate                                          83%       67%         ---              81%
83% profitable trades with an average P/L of 1.7 vols/trade.     Av erage return per trade (v ol pts, unw eighted)        1.7    -0.6        ---              1.38
                                                                 Digital
Four trading themes worked well for us in 2010. First,           # of trades                                              ---    ---          3                 3
positive carry vol trades epitomized by the short FVAs           Success rate                                             ---    ---         33%              33%
referred to above netted attractive returns in Q1. Also          Av erage return per trade (%, unw eighted)               ---    ---         8%                0.1
included in this list are short vol swap vs. long FVA trades     Total
that offer positive/flat carry on both legs and are quasi-       # of trades                                              44     30          16                30
hedged against a vol event. Second, proxy long correlation       Success rate                                          68%       63%         69%              67%
positions to hedge against a peripheral Europe led systemic      *Vol products include volatility swaps and Forward Volatility Agreements (FVAs)
meltodwn as expressed through vol spreads (for transaction       Chart 1: 2008-2009 Performance summary: Success rate by type of
cost reasons) turned out well. Examples are long AUD vol         trade (average P/L)
vs. short EUR vol and long MXN/JPY vol against short                                                               Vanilla Options
EUR/JPY vol. Third, the bearish USD/JPY theme worked              2010
consistently all year in all forms, be they short 6M
strangles, 3M3M FVAs or relative value spreads against            2009
long AUD vol. Finally, proxy long USD-correlation trades
involving buying USD-based vols against selling cross-vols        2008
generated high hit ratios in Q4.
                                                                           -10        0          10           20            30          40            50             60
Vanilla trades closed this year returned -4 bp per trade, with                                                       bp
large drags from legacy’08 and ’09 positions that were
closed out in early Jan. Without those close-outs, average
                                                                  2010
unweighted P/Ls and hit rates would jump to 13 bp and
64% respectively. The largest loss among this year’s trades                                                                          Vol Products
                                                                  2009
was recorded by a short GBP/AUD straddle recommend-
ation (-3.9 vol pts.) that was ill-timed just before the flash
crash in May. In contrast, we traded risk-reversals better,              -1.0         -0.5            0.0        0.5             1.0                1.5              2.0
                                                                                                            Vol points
with short EUR/SEK, USD/BRL and USD/CAD skew
positions all posting decent returns.
Pure vol products that isolate the vol view and obviate the
need for delta hedging and dealing with strike drift issues
recorded far better performance than their vanilla
counterparts. Improved liquidity was one reason why we
were able to recommend more flat vega products this year
compared to 2008 and 2009, and will hopefully continue to
be the case next year as well.




24
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Arindam Sandilya (1-212) 834-2304
Matthias Bouquet (44-20) 7777-5276
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.




                                                      This page left intentionally blank




                                                                                           25
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.



Long-term Technical Strategy: Faint-hearted need not apply
•    The medium term setup for the USD is negative but       Faint-hearted need not apply
     the path to new lows is likely to be a choppy one.      The technical outlook for the USD in 2011 is bearish but
•    EUR/USD - The extremity of the two most                 like the price action seen in 2010, the path to new lows
     outstanding scenarios leads inevitably to               won’t be without its share of twists and turns. From a broad
     consolidation scenarios which look to be more           perspective, the backdrop is negative as trends are stretched,
     realistic, but would suggest a broad range trade        but still intact and show little evidence of a significant shift
     with a positive bias throughout 2011.                   at this point. Moreover, the long term consolidation patterns
                                                             for EUR/USD and the Dollar Index imply an eventual
•    Down-cycles in EUR crosses are generally still intact   bearish USD resolution in line with our preferred view for
     and incomplete but face stronger rebounds after the     next year. Importantly, the advances in commodity
     next cycle lows. Key-resistance barriers have           currencies maintain a bullish setup and are incomplete from
     therefore to be monitored carefully for signs of        an Elliott wave perspective as new highs are expected
     trend exhaustion.                                       against the USD and EUR next year. Also, the downtrend
•    GBP will remain the currency of surprises, but this     for USD/JPY is mature, but we still sense another round of
     time the setup for a very positive one is given. This   weakness is likely to develop to eclipse the 79.92 secular
     option has to be drawn shortly though to avoid a        low from 1995.
     less surprising failure.                                Chart 1: Dollar Index - Weekly Chart – The decline from the June
                                                             peak has nearly matched the drop from the 2009 high as key support
•    Commodity currencies remain in position for             levels are once again holding.
     additional strength against the USD led by AUD and
     NZD; CAD should continue to lag despite the view
     for a breakdown to the medium term range.
•    JPY should be mixed for 2011; new lows for
     USD/JPY should lead to a broad consolidation
     phase; while JPY crosses maintain the overall range
     bias, we see a growing risk of a bullish breakout and
     renewed trending bias.
•    Scandies remain in good shape for the next 3-6
     months but are expected to run into a major setback
     thereafter.
•    The CEEMEA region is expected to expand its gains
     against EUR and USD but could face mounting
     head winds by the end of Q1 and into Q2.
•    Asia EM should maintain the overall
     outperformance bias against the USD highlighted by      From a technical perspective, there are many similarities to
     the strength in KRW and INR; a bullish shift            the current framework relative to early-2010. In turn, some
     against EUR is expected and is a key theme for          caution is warranted to an initial overly bearish USD view.
     2011.                                                   At that time, the Dollar Index entered the new year having
                                                             undergone a persistent drop resulting in a nearly 17%
•    Latam FX outperformance should continue into            decline from the 2009 peak compared to the 15% drop from
     2011 but is expected to narrow; MXN and CLP             this year’s June high (chart 1).
     should stand out.
                                                             Much like early-2010, a bullish reversal has developed from
•    Trades: Sell EUR/CHF, EUR/TRY and EUR/INR.              several critical support levels given the overhang of USD
                                                             short positions and the prospect of QEII. These key support
•    Keep these pairs on the watch list: AUD/USD,
                                                             levels include the 75.60 trendline from the 2008 low for the
     AUD/JPY and AUD/NZD.
                                                             DXY, as well as the 1.4375/1.45 zone for EUR/USD
                                                             (76.4% retracement from November peak and the 2008
                                                             downtrendline). The current retracements have led to

26
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


bullish USD reversal patterns on the monthly charts. Also,            Note that while we sense EUR/USD will eventually release
AUD/USD has struggled to sustain above the key 1.00                   higher, the prospects for continued weakness on the EUR
resistance and pivot zone. In line with this theme, our               crosses suggests the upward trajectory will at times be a
medium term momentum studies are reaching oversold                    struggle. In this regard, current trends in the likes of the
levels consistent with previous cycle lows for the USD                EUR/commodity FX crosses should extend into next year.
(chart 2). As such, we sense the price action for the USD             Also, EUR/CHF and EUR/GBP remain vulnerable to
into year-end and during the early-part of 2011 will be               further weakness with short EUR/CHF one of our top trade
vulnerable to additional corrective work, if not a two-sided          ideas for next year.
bias.
                                                                      We expect the path to new USD lows to be led by the
Importantly, our medium term momentum metrics also                    commodity currencies as well as EM. In this regard, we see
point to a retracement phase particularly as these studies            room for new cycle highs in AUD/USD, as well as
have hit levels consistent with a bullish reversal in the USD.        NZD/USD amid a still-bullish backdrop for commodities
Moreover, our preferred short term trend strength indicators          particularly for base and precious metals. USD/CAD is
(ADX/VHF) are at levels that suggest a new short term                 likely to maintain the grinding decline below the important
trend is developing and given the bullish monthly reversal            .9930 April low. Moreover, the backdrop for risk remains
patterns since November, we sense this will result in a               positive with new highs expected for equity markets. As
higher USD over the short term timeframe.                             such, we see potential for AUD/USD to test the 1.05/1.07
                                                                      zone, while NZD/USD targets the .85/.87 area and
Chart 2: DXY - Weekly Chart – Medium term momentum studies are
as oversold as previous cycle lows raising the risk of a corrective   USD/CAD pushes closer to the .97/.96 zone.
phase.                                                                Despite the recent reversal from important support at the
                                                                      1995 low at 79.92, USD/JPY stays vulnerable to new lows
                                                                      and a closer test of medium term targets in the 77/75 zone.
                                                                      We note that the decline will likely turn into a grind lower
                                                                      given maturity of the downtrend and the medium term
                                                                      oversold setup. Also, we see an increasing risk that the JPY
                                                                      crosses will transition out of the current range bias into a
                                                                      trending environment. While still unconfirmed, we are
                                                                      closely monitoring key resistance levels for a clear signal
                                                                      that an upside breakout is underway. Given the potential for
                                                                      JPY to strength early next year with new cycle lows for
                                                                      USD/JPY, we sense the bullish cross JPY theme may be a
                                                                      Q2 development.
                                                                      We maintain a bullish view for EM and sense the
                                                                      outperformance will be a major theme into next year while
                                                                      noting the bullish path is likely to narrow. For Latams,
                                                                      MXN and CLP should lead the way against USD and EUR.
However, unlike the past two bullish USD shifts, we sense             Also, the positive backdrop for Asia EM remains intact with
this retracement will be short-lived before resuming the              new highs expected for KRW and INR against both the
overall USD bear trend. This is consistent with where the             USD and EUR.
USD is within the medium term consolidation pattern for
the Dollar Index, as well as EUR/USD. Also, the deep                  Also, the technical setup for TRY has improved suggesting
oversold setup for EUR/USD registered by our monthly                  a broader outperformance bias is likely to develop against
momentum models imply that retracements should                        EUR and the USD next year. In turn, we see potential for
eventually lead to an upside extension. Moreover,                     EUR/TRY to renew the medium term trending bias with a
commodity currencies should continue to outperform with               break below critical support at the 1.90 range lows for 2010.
new highs expected against the USD as the trends remain               Given structures in EUR/USD emphasize two
incomplete. Under this backdrop, we see a deeper extension            extreme, but completely adverse scenarios – the
of the USD bear trend developing beyond a short term                  unexpected truth looks to be in between
corrective phase leading to a test of the 1.50 area in
EUR/USD and the 71/70 zone for the DXY. This should                   Looking back at the price action of the last 2 ½ years there
then lead to a more sustained USD recovery during the                 are immediately two scenarios sticking out which could not
second half of 2011.                                                  be any more contrary in their implications. The most
                                                                      obvious is a textbook A-B-C consolidation pattern (black)

                                                                                                                                 27
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


displayed between the July 08 top at 1.6040 and the 1.1876         context too short to mark a IIIrd wave impulse on the same
low in June 10 is very bullish and implies that the long-          scale, but could have well displayed a wave 1 sub-count
term, pre-2008 bull-trend has been resumed. This would             within the bigger IIIrd wave impulse down. It is at this point
conclusively lead to a retest and most likely break above the      worth mentioning that a 2nd wave recovery on lower scale,
all-time high at 1.6040. A Fibonacci-projection for an             provided we are really dealing with one, would never break
                                                                   the 76.4 % retracement of the preceding decline. That said
Chart 3: EUR/USD - Weekly Chart – Only a range-breakout between
1.4506 and 1.2444/1.2339 will clarify the bigger picture           and in order to stay intact, it is absolutely essential for this
                                                                   bear-scenario, that 1.4375-1.4506 (int. 76.4 %/weekly
                                                                   trend) is not taken out. To be confirmed though and to open
                                                          (X)      significant downside potential to 0.9138/0.8999 (wave
                                                                   III/wave 3 projections) it would take a break below
                                                          C/B      1.2444/1.2329 (int. 76.4 %/left shoulder).
                                            c/A                    But given the extreme implications provided by these two
                                                                   scenarios with price projections around 1.6400 or below
                                                                   parity and considering the thematic dead heat between QE
                                                                   (US) and peripheral risks in southern Europe, the necessary
                                                                   search for an in-between and more realistic scenario had to
                                                                   be launched. Fortunately the USD Index (seen chart 2)
                                                                   provided exactly the missing link in form of a huge
                                                      B            consolidation triangle. Not that this pattern would in the
                                                                   long run prevent any of the extreme scenario’s to unfold,
                                                                   but it suggests that the market is going to spend the next 3-4
                                                                   months to form the completing E-leg up of the triangle
extended 3rd wave impulse cuts in at 1.6410 to name a              towards 83.559/713 (pivot/int. 61.8 %) before launching a
target. For this scenario to be confirmed it requires breaks       more sustainable decline leading to an expected triangle
above 1.4375/1.4506 (int. 76.4 %/weekly trend) and                 breakout in the 2nd half of 2011.
ultimately above 1.5147 (last top).                                The interim and most likely scenario for EUR/USD
The other, extremely negative scenario assumes that                would accordingly consist of an intermediate down-swing
1.6040 has not been the start of a broad consolidation, but        to 1.2795 or 1.2444 (int. 61.8/76.4 %) to complete a B-wave
of a new long-term bear-trend. Conclusively we’d have a            down. Provided the latter is not broken decisively (lower
wave I down to 1.2329 at hand while the recovery to 1.5147         than 1.2329 (left shoulder), this should then be followed by
would have to be classified as wave II up. The following           another major up-swing to 1.4375 or to 1.5147 (int. 76.4
decline to 1.1876 is in this                                       %/pivot) where a B-Wave of a broader flat consolidation or
                                                                   an X-wave of a complex double-zigzag would most likely
Chart 4: USD Index– Weekly Chart –Triangle defense is supporting   top out to be followed by another major decline towards
an intermediate USD recovery before heading lower again
                                                                   1.1212 (int. 61.8 %) in form of wave C or A within a
                                                                   double-zigzag.
                                                                   So taken everything together, EUR/USD seems to be bound
                                                                   to trade a broad range. Lower first to key-support between
                                                (E)                1.2795 or 1.2444/1.2329 and then up to 1.4375 or 1.5147.
                                                                   Only a premature, straight breakout of the outer barriers
                                                                   would favor one of the two first mentioned extreme
                                                                   scenarios
                                                                   Downtrends in EUR crosses are generally still
                                                                   intact and expected to extend; some trends are
                                          (D)                      mature suggesting an increased risk of entering
                                                                   into broader recoveries
                                                                   Given the safe haven status of JPY and CHF it was quite
                                                                   surprising that the risk market rally of the last 3-4 months
                                                                   did not trigger a break above key-resistance barriers
                                                                   between 116.49 and 118.06/15 (int. 38.2 % on 3 scales) in

28
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


EUR/JPY and at 1.3926/56 (last top/int. 38.2 %) in               of forming the right shoulder of an inverted H&S bottoming
EUR/CHF what leads to the general assumption that the            formation is certainly given. For the latter to receive
down-trends are still intact and missing another leg down to     confirmation it would however take a break above
be complete.                                                     1.3926/56 (int. 38.2 %/pivot), what would at the same time
                                                                 confirm a long-term trend reversal up.
EUR/JPY is in this context the most vulnerable to a sudden
and lasting trend reversal as the initial rally from 88.97 in    EUR/Commodity FX is in comparison to EUR/JPY &
2000 up to 169.97 in 2008 is displaying a straight line up       EUR/CHF and in its historical comparison far from trading
and a 5-wave structure (wave I, or A). This implies that the     anywhere close to an extreme. Looking at price movements
following decline has a great chance of forming a higher         as far back as 1970, the dramatic declines seen in the last 2
bottom in form of a IInd wave down of a new, long-term           years appear a lot less extreme as these markets have
up-trend or as a B-wave down within a huge A-B-C up-             roughly only retraced 1/3 of the preceding rallies. What is
consolidation. That said, the downside seems to be very          also apparent though is the fact that within the extensive
limited as the usual target zone for such a setback around       bear-trends seen in the last two years we haven’t seen any
108.09 (76.4 of the initial rally) has already been reached.     countertrend rallies which could in its form or extent be
But as long as key-resistance between 116.49 and 118.06/15       classified as a B.-or 2nd wave rally up. So this risk still
is not taken out, what would confirm the 2nd higher bottom       persists and is pretty high due to the fact that the last major
and open significant upside, the market remains vulnerable       bases on the way up, which is a classical target for a first
to the formation of the right shoulder of a possible inverted    bear-cycle down, have already been reached or are close by.
H&S pattern around 107.85/32 (int. 76.4 %/left shoulder) or
                                                                 Chart 6: EUR/CHF - Weekly Chart –Below 1.3926/56 the market
to a minor new low in between 105.43 and 99.85. Only a           remains vulnerable and is risking a minor new low
break below the latter would open the downside for a re-test
of the 88.97 bottom.
Chart 5: EUR/JPY - Weekly Chart –Below 116.49 to 118.06/15 the
market remains vulnerable and is risking a minor new low




                                                                                                                T-junction




                                            T-junction


                                                                 In EUR/CAD the last major base from October 00 at
                                                                 1.2569 already triggered a dynamic short-covering rally in
                                                                 June, which didn’t hesitate to break above key-Fib.-
                                                                 resistance at 1.4178 (int. 38.2 %). That said it is
EUR/CHF looks different in a way that the broader                questionable whether we are still dealing with a 4th wave
downtrend already led to new all-time lows, which gives a        rebound only and not with a broader up-swing to 1.4979
slightly higher probability that these lows will even be         (int. 50 %) and to 1.5576 or 1.6315 (int. 61.8/76.4 %) at a
exceeded towards projected Fibonacci-targets at                  later stage. To on the other hand revive the broader bear-
1.2523/1.2463 and potentially to 1.2038 at a later stage         trend and to get projected targets at 1.2146 (91 low) and at
(chart 6). But given the structures of the last major decline    1.1690 (Fib.-projection) back in focus it would take a break
from 1.6828 in October 07 the market remains at risk of          below 1.3373 (76.4 % of the last advance from 1.3071). The
having already completed a 5-wave cycle of higher scale at       bear-trends in EUR/AUD and EUR/NZD have on the other
1.2765 so that the ongoing decline might turn out to be a        hand not been dented yet.
countertrend decline only, as long as key-support at
                                                                 The broad, down-rotation in EUR/AUD has not been
1.3072/18 (left shoulder/int. 76.4 %) is not broken
                                                                 dented yet and only a break above the last top at 1.4373
decisively. Only below the latter, projected targets at
                                                                 would be a serious threat to the AUD bulls due to the
1.2523/1.2463 would be reachable whereas above, the risk

                                                                                                                               29
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


currently displayed double-bottom at 1.3648/45 (chart 7).          consolidation pattern, which implied that the market had
That said, a break above 1.4373 would immediately                  already resumed the pre-2009 bull-trend. The latter can still
challenge 1.5016 (a preceding top & double-bottom                  unfold though under the condition that key-support between
projection), which could however be part of a broader 4th          0.8331 and 0.8274 (int. 76.4 % on two different scales) is
wave recovery to 1.5463/77 (pivots) or to 1.6222/1.6463            defended. It would take a break above 0.8651 (pivot)
(int. 38.2 %). A break below 1.3645 would on the other             though to get the EUR bulls back on track whereas a break
hand dissolve the imminent rebound risk but not the highly         below 0.8274 could be the initial spark for a substantial, and
oversold market conditions. This risk will                         in its extent absolutely surprising GBP rally to 0.7744 (50
                                                                   % of the 2000-2008 bull-trend) and potentially to 0.7258/54
Chart 7: EUR/AUD - Weekly Chart –Below 1.4373, the down-rotation
remains intact and 1.2858 in focus                                 (61.8 %/pivot) to name the next obvious targets.
                                                                   Chart 8: EUR/GBP - Weekly Chart –The break below pivotal support
                                                                   at 0.8534 could be an early indicator for a strong GBP rally




                                                 T-junction
                                               T-junction
                                                                                           T-junction




resurface and increase substantially the closer the market
trades towards 1.2852 (50 % of the 1974 to 2008 bull-
trend), so that investors should be alert for signs of trend       With that in mind we looked at other GBP pairs to see
exhaustion. EUR/NZD looks exactly the same in terms of             whether we could find additional evidence for a looming,
displayed structures, but with the old bottoms from 2007,          strong GBP rally. Cable is in this context the next
2005 and 1997 at 1.7035, at 1.6337 and at 1.6098 in fairly         prominent example where the defense of the 76.4 %
close reach now additional gains for NZD after the strong          retracement of the Jan.09-Aug.09 rally at 1.4339 on weekly
performance of the last two years could be a lot harder to
                                                                   Chart 9: GBP/USD - Weekly Chart – Make or break at 1.6379!
achieve, while the risk of running into a broader 4th wave
recovery of bigger scale to a projected target at 2.0423 (int.
38.2 %) is permanently given. It would take a break above
1.8415 (76.4 % of the last down-swing) and ultimately
above the last top at 1.8704 though to confirm the latter,
whereas a break below 1.7035 would at least give room to
challenge 1.6337 and 1.6098.
The setup for a surprisingly strong GBP
outperformance in the first half of 2011 is given                                                                    T-junction
and would certainly materialize once key-barriers
are taken out.
The combination of better than expected fundamental data
                                                                                                                    T-junction
(GDP) and highly oversold market conditions provided the
right ingredients at the end of October for the latest GBP
rally.
This was strong enough to clear key barriers, like pivotal         close keeps the door open for a potential IIIrd wave rally of
support at 0.8534 in EUR/GBP (chart 8). Note this break            bigger scale with a projected price target at 1.9956 (wave I
strongly questions the favored, completed double-zigzag

30
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


x 1.618) what could potentially be reached in the 2nd half of    wave) to new lows. But as already covered like in the other
2012 (Chart 9). But equivalent to a break in EUR/GBP below       pairs, it would take initial breaks above key-barriers to
0.8331/0.8274 it would take a decisive break above the key-      escape the broader down-rotation. Such barriers are at
T-junction at 1.6379 (int. 76.4 %) on weekly close to kick-      1.6542/1.6730 (minor 38.2 %/pivot) in GBP/CAD, at
start a minimum rally to 1.7332 (50 %). The latter would still   1.6512/75 (minor 38.2 %/pivot) in GBP/AUD, at 2.1029
have to be cleared to get a potential C-wave rally within a      (minor 38.2 %) in GBP/NZD and at 9.801/9.824 (weekly
broader up-consolidation out of the way and to finally get the   Ichimoku-lagging/double-top) in GBP/NOK. Only decisive
IIIrd wave rally on bigger scale into the spotlight. Below       breaks above these barriers on daily close (10pm CET)
1.6379 though, the market is at least running the risk of        would deliver the start signal for a broader GBP recovery to
performing an intermediate setback to 1.4717/1.4511 (int.        1.8171 (int. 38.2 %) in GBP/CAD, to 1.7760, 1.8477 and
76.4 %/triangle support) in form of a 2nd wave setback or of     possibly 2.0083 (int. 38.2 % on 3 different scales) in
a D-wave down within a broader A-B-C-D-E triangle-               GBP/AUD, to 2.3593 (int. 38.2 %) in GBP/NZD and to
consolidation whereas only the former would keep the door        10.493 (int. 38.2 % in GBP/NOK.
open to potentially perform a strong rally. A decisive break
                                                                 Chart 10: GBP/JPY - Weekly Chart –Above 126.75/46, strong
(weekly close) below triangle support would on the other         acceleration up is possible on trend line breaks
hand re-open the downside for a potential extension of the
Nov.07-Jan.09 bear-trend with a projected target at 1.2987
(76.4 % of the 1985 – 2007 bull trend).
GBP/JPY and GBP/CHF are also offering the possibility
of a strong GBP rally, although the setup is slightly
different in a way that GBP/JPY, similar to Cable, has
managed to stabilize around a 76.4 % retracement at 129.33
on monthly close, what offers the more bullish prospect of
performing a 3rd wave impulse up to 198.01 (wave 1,
Jan.09-Aug.09 x 1.618). GBP/CHF in contrast failed to put
in a second higher bottom, but as last month's break below
the 2008 low at 1.5127 failed to trigger any follow-up (low
at 1.5093) we are almost left with a double-bottom which
could have marked a 3rd wave low or a 5th wave low on
higher scale. Both counts would enable the market to at
least perform a 4th wave recovery or a 1st wave impulse up
to 1.8118 (last top) or 1.8864 (int. 38.2 % = wave 4 target)     In summary: GBP could be the shooting star of the first
whereas only a break above the latter would constitute a         half of 2011 provided the mentioned resistance barriers are
game change on broader scale. But despite the fact that the      taken out. Particularly against Commodity FX though,
start window for a strong GBP recovery is currently open in      chances of reversing the long-term downtrends remain
these currency pairs, it still requires decisive upside breaks   rather slim. A failure to surpass the mentioned barriers
to escape the long-term down-rotations.                          would on the other hand imply that Cable is forming a huge
Conditional in GBP/JPY would be the defense of                   consolidation triangle and the downtrend against
126.75/46 (double-bottom) and breaks above weekly trend          Commodity FX will most likely be resumed straight away.
line resistances between 137.08/26 to 140.20 (chart 10). As      USD/JPY still at risk, but cross JPY poised for a
for GBP/CHF setbacks should be limited to 1.5300 (76.4 %         bullish shift
of the Oct.-Nov. rally) whereas key-barriers at 1.6008 (top
of Sep. 17th) and ultimately at 1.6485 (weekly trend) have       JPY was the best performing currency over the past year
to be cleared to get 1.8118 and 1.8864 into focus.               against the USD as the decline from the May peak led to a
                                                                 test of critical support in the 80/79 zone. USD/JPY remains
GBP/Commodity FX is surprisingly also supporting the             vulnerable to new lows despite the reversal from this key
idea of a profound GBP rally but given the still negative        support area in early-November. USD/JPY remains
structures of these 10-12 years long bear-trends we would        vulnerable to new lows despite the reversal from the key
most likely “only” be confronted with a 4th wave recovery        80/79 support area in early-November. While the bounce has
of bigger scale, which could be quite extensive though           advanced deeper than expected demonstrating the best price
given the extent of the preceding declines, but limited to       action since Q1, we continue to see risk for new lows and a
internal 38.2 % retracement’s. The latter would                  more sustained break of the important 79.92 low from 1995.
conclusively have to be followed by another decline (5th         This view is consistent with an incomplete Elliott wave

                                                                                                                             31
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


pattern as key resistance levels have been largely left intact.      shift can develop during Q1. Importantly, the key levels
Moreover, the lack of momentum divergences on the weekly             remain well-defined with breaks confirming the onset of a
studies suggests the ultimate low is not in place just yet.          more sustained trending bias. In this regard, the 85/88 levels
                                                                     will be important for AUD/JPY, while the 66 and then
With the 85/86 resistance zone intact, the short term bias for
                                                                     critical 69 area for NZD/JPY will define the next leg up to
new lows will continue to develop. Note this area includes
                                                                     the advance from the January 2009 cycle low.
the 38.2% retracement from the May peak as well as the
September highs and should continue to act as a short term           AUD should continue to lead and NZD to follow,
cap. In turn, we still see risk that targets in the 75/76 area       while CAD has a view of the field in this race
Chart 11: USD/JPY - Monthly Chart – While the decline has held the   AUD was one of the best performing currencies again over
important 79.92 low from 1995, the downside risks remain intact.     the past year with broad-based strength amid the recovery in
                                                                     risk markets and a persistent rally in metals. Despite the
                                                                     extent of the bullish action over the past few months, we
                                                                     continue to see potential for this trend to continue, as the
                                                                     rally from the 2010 low, as well as the advance from the
                                                                     2008 cycle low remain incomplete.
                                                                     Chart 13: AUD/USD - Weekly Chart – The .9400 breakout area will
                                                                     now act as key support and maintain the short term bullish bias for
                                                                     new highs.




can be hit. From there, we would expect USD/JPY to
transition into a broader consolidation phase, as the JPY
outperformance trend should be met with more significant
slowdown in momentum against key targets suggesting a
higher risk of a broader retracement. This would ideally
coincide with a more sustained breakout in the JPY crosses.
While many of these pairs have traded in well-defined
ranges over the past several months, we sense that a bullish
Chart 12: AUD/JPY - Weekly Chart – Broad range intact, but breaks      Similar to the short term USD view though, some further
above 85/88 would confirm the next leg to the medium term rally phase. consolidation seems likely to develop below the November
                                                                     high particularly as prices have struggled to hold above the
                                                                     key 1.00 target area. However, we fail to see evidence of a
                                                                     sustained reversal at this point while implying any
                                                                     corrective phase is viewed as a buying opportunity as new
                                                                     highs during the first half of 2011 are expected. The key
                                                                     bullish development for AUD/USD over the past year was
                                                                     the breakout through the critical .9400 resistance area and
                                                                     medium term range highs. The subsequent rally phase
                                                                     continues to develop with a strong trending bias and seems
                                                                     incomplete from an Elliott perspective. Note that this level
                                                                     will now act as key support along with the .9225 September
                                                                     breakout levels. We see targets in the 1.04/1.05 area with
                                                                     potential to test the 1.07 zone, near the critical breakdown
                                                                     zone from early-1982. From there, the setup would suggest
                                                                     a higher risk of a deeper pullback and recovery phase for
                                                                     the USD. The setup on the crosses affirms the bullish view.

32
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


The persistent trends for AUD/CAD remain intact with little         Scandies are expected to extend their gains
evidence of a reversal. Moreover, we continue to see upside         against EUR and USD into 2011, but risk a broader
potential for AUD/NZD beyond this consolidation phase               setback by end of Q1 or into Q2.
below the key 1.32 resistance zone.
                                                                    The picture shown in EUR/NOK is pretty much in line with
Similar to AUD, we continue to see bullish potential for            what we have discussed in the preceding paragraph on
NZD into next year. The advance above the critical .7635            EUR/AUD and EUR/NZD but with the slight difference
resistance area and October ’09 high against the USD                that EUR/NOK has already enjoyed a well-defined 6months
reasserted the overall bullish bias confirming the medium           long up-consolidation.
term breakout phase. In turn, we see potential for a test and
                                                                    Chart 15: EUR/NOK - Weekly Chart –Below 8.2392/8.2642, the down-
likely break of the .8213 high from March 2008. Note that           rotation remains intact and 7.6249 & 7.5206 in focus
while the .7635/.7400 levels will maintain the short term
bullish bias, the .7100/.7000 zone should now act as a floor
and should hold on deeper pullbacks to maintain the
medium term bullish view for new highs. Deeper targets
rest in the .8500/.8700 zone, which include Elliott
projections from the June low.
Chart 14: USD/CAD - Weekly Chart – The medium term range points
to a bearish resolution below the key .9930 support.


                                                                                                                 T-junction




                                                                    Following this pattern and the displayed double-top right
                                                                    around the projected 4th wave target at 8.2392 (int. 38.2 %)
                                                                    the market looks to be ready to perform its 5th wave
                                                                    decline. The first natural target for such a decline is the 07
                                                                    low at 7.6249 followed by calculated Fib.-targets at 7.5206,
                                                                    7.3187/32,7.3030 and at 7.2509 as well as the Jan.03 low at
                                                                    7.2176. A break above 8.2392 and 8.2642 (pivot) would on
                                                                    the other hand ring the alarm bell, calling for a potential 2nd
                                                                    wave recovery based on the whole decline from 10.1761 to
It was the year of the range for USD/CAD, as the price action
                                                                    7.6773. Such a recovery would have a minimum target of
maintained the well-defined 1.00/.9900 support zone and
                                                                    8.9267 (50 %) to highlight the potential behind. In
1.08/1.09 resistance area. We see prices breaking out of this
                                                                    comparison USD/NOK is a lot less inspiring although it
range in 2011 in line with the overall bearish USD view and
                                                                    could be argued that a slight negative bias is prevailing as
general strength in the commodity currencies. As such, a
                                                                    long as the lagging line of the daily Ichimoku-indicator has
violation of the critical .9930 April low should lead to an
                                                                    not displayed two consecutive daily closes (10pm CET)
extension into the .9800/.9700 zone initially with risk of a test
                                                                    above the cloud (at 6.2395 today). As long as the market
of deeper targets near .9500 which should be a max.
                                                                    trades below, the downside is slightly favored with weekly
Importantly, the price action over the past few months has
                                                                    trend line support at 5.6439 and the 76.4 % retracement of
suggested an increased risk of a downside resolution to the
                                                                    the Apr.08 to Oct.08 rally at 5.5036, in focus next. Only a
broad range given the “lower-highs” since the May peak.
                                                                    decisive break below the latter on weekly close (lower than
Despite this setup, we sense that any breakdown will
                                                                    5.45) would re-challenge the 08 low at 4.9443
maintain a bias for a grind to new lows particularly as the
price action has failed to demonstrate an impulsive, trending       In terms of SEK the situation is trickier as the risk of at
bias. This reflects a higher risk that the decline from the May     least running into a stronger setback is certainly higher.
high is turning into a wedge, or diagonal pattern. Importantly,     According to Dow’s theories and in the absence of major
the 1.07/1.09 resistance zone will continue to act as key           reversal signals though, we still see a better chance of
resistance and maintain the overall view for new lows.              extending the broader SEK bull-trend into 2011 but monitor

                                                                                                                                   33
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


the triggers for a stronger setback very carefully. In that         stronger setback as USD/RUB has already penetrated
context USD/SEK is probably the better indicator as a well-         weekly triangle resistance at 31.327 and the last top at
defined pivotal resistance at 7.0420 (assumed wave 1) is not        31.420. It would take a break above key-pivotal resistance
too far away and should actually cap the upside in order for        at 31.965 (02 high/June 10 high) though to confirm a
the down-rotation to remain fully intact. Below this T-             stronger USD recovery into 33.496 or 34.655 (int. 61.8/76.4
junction the downside stays open for another bear-swing             %) from where the broader down-trend is expected to be
towards the low of 2008 at 5.8208, but bear in mind that the        resumed. A break below triangle support at 29.372 would
lowest weekly closes so far have all been in the area of the        on the other hand resume the downtrend straight away,
76.4 % retracement of the 2008-2009 bull-run what reminds           targeting 26.239 (76.4 %) and the 08 low at 23.061 next.
us of the increased risk of potentially putting in another 2nd      EUR/RUB already had a decent recovery in the last 6
higher bottom around 6.6059 (76.4 % of the last minor up-           months and with the decisive resistance barrier at 44.700
swing).                                                             (int. 76.4 %) almost in close reach now the upside potential
                                                                    looks rather limited. Only a decisive break above 44.700
Chart 16: USD/SEK - Weekly Chart –Below 7.0420, the down-rotation
remains intact and 5.8208 in focus                                  (i.e. a break above previous tops at 45.525/46.426) would
                                                                    indicate a resumption of the long-term up-trend whereas
                                                                    below, the downside remains open for a minimum setback
                                                                    to 33.653/210 (08 & 06 lows).
                                                                    Chart 17: USD/ZAR - Weekly Chart –Below 7.1824, the down-rotation
                                                                    remains intact and 6.4295 and 5.9365 in focus




                                                      T-junction




                                                                                                                   T-junction



The defense of the latter and/or the break above 7.0420
would end this bear-story in favor of a much broader
recovery to at least 7.7472 (76.4 % of the Jun.-Oct. decline).
As for EUR/SEK, the bigger picture is clearly negative and
suggests an extension toward the 8.0480 March 2000 low
following the break of old lows from 2003 and 2007
                                                                    The second most vulnerable currency to a stronger setback
between 8.8487 and 8.9302.
                                                                    in the CEEMEA region seems to be ZAR. The latter has
However, the fact that the market has lost significant              made significant gains in the last 2 years against EUR and
ground in the last two years following the decline from             USD but has shown a loss of momentum in the last several
11.7861 and given the proximity to this support zone                months. Another worrisome factor is the well-defined five-
illustrates that rebound risk is fairly. A break above the last     wave decline from the last major top at 11.8708 (Oct.08) in
double-top at 9.4271/79 could already be the trigger                USD/ZAR which suggests that the market is currently
opening the upside for an internal 4th wave recovery to             performing the 5th wave impulse down. This could extend
9.6427 (int. 38.2 %) and potentially to 9.87787/9.9312 (int.        to 6.4295 (07 low) and maybe even towards 5.6050 (04
38.2 % on higher scales).                                           low), but under the permanent risk of reversing sharply for a
                                                                    minimum recovery to 8.2615 (former top/int. 38.2 %). A
The CEEMEA region is expected to remain well bid
                                                                    break above 7.0857 and 7.1824 (daily double-top/38.2% on
into 2011, but will face a high setback risk by end
                                                                    lower scale) could be the trigger, whereas below, 6.4295
of Q1 and into Q2
                                                                    and 5.9365 (2006 low) remains in focus.
The general theme of a continued outperformance of
                                                                    EUR/ZAR also inherits an increased risk of a bounce as a
CEEMEA currencies persists, but accompanied by a not to
                                                                    potential inverted H&S bottom has formed right above
ignorable risk of a looming countertrend rally. That said,
                                                                    9.0640 (76.4 % of the 2006-2008 bull-run). That said the
RUB technically looks to be the most vulnerable to a
                                                                    market would have to break below the latter to be able to

34
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


extend the downside towards 8.11 (Fib.-projection) and the          Chart 19: EUR/HUF - Weekly Chart – Unless daily channel resistance
low of 2006 at 7.1576. A break above 9.7924 (neckline)              at 280 is taken out, the downside remains wide open
would on the other hand call for a stronger recovery to
10.2657 (minor 38.2 %) and most likely to 10.7748 or                                                          T-junction
11.1302 (38.2 % on higher scales).
TRY in comparison looks a lot stronger and unless a key-
resistance barrier at 2.0435/2.0557 (pivot/int. 38.2 %) in
EUR/TRY is taken out the downtrend remains fully intact.
Chart 18: EUR/TRY - Weekly Chart – Below 2.0435/2.0557, the down-
rotation remains fully intact with 1.8635/1.8067/20 in focus.


                                                                                                              T-junction


                                                  T-junction


                                                                    confirmed decline to 260.95 (March low) and possibly to
                                                                    249.04 (76.4 % of the 2008-09 bull-trend) on a break. This
                                                                    negative scenario would be weakened on a break above
                                                                    daily trend channel resistance at 280.03, but only a break
                                                                    above 284.59/285.80 (int. 76.4 %/weekly trend) would be a
                                                                    game changer and call for a broader countertrend rally to
                                                                    295.67or 303.87 (61.8/76.4 % of the Mar.09-Mar.10
                                                                    decline). USD/HUF displays exactly the same story. It
                                                                    remains in negative territory as long as 208.39/209.08 (int,.
Below the latter, a straight extension and break below              38.2 %/pivot) is not taken out, but needs to break below the
monthly trend line support at 1.8634 can be expected which          last low at 190.66 to confirm a push below 191.57 (76.4 %)
should then challenge 1.8067/20 (Fib.-projections). A               and to free the downside for a decline to massive support
stronger bounce can then be expected before old lows at             between 175.67/173.47 (Oct.09 low/Fib.-projection) and
1.7196 (08 low) and at 1.6636 (07 low) would be in focus.           169.19 (76.4 % of the July 08 – Mar.09 bull-trend). A break
Only a break above 2.0435/2.0557 would temporarily delay            above 209.08 would on the other hand risk a rebound to
such a decline in favor of a stronger bounce to 2.1550 or           223.04 and 230.69 (61.8/76.4 % of the last down-swing) but
2.2165 (61.8/76.4 % of the last down-swing). USD/TRY                only above the latter a game change would be indicated.
has formed a huge broadening topping pattern between
                                                                    CZK is not much different but the failure to trigger any
2003 and 2009 and seems to be on its way to test and most
                                                                    follow-up below key-Fib.-support at 24.494 (76.4 % of the
likely break below the 76.4 % retracement of the last bull-
                                                                    July 08 – Feb.09 bull-trend) in EUR/CZK is somewhat
market impulse at 1.3077. Such a break would finally give
                                                                    worrisome. A rebound to 25.020/089 (pivot/weekly
room to challenge the 2008 low at 1.1480 and triangle
                                                                    breakout line) could in this context still be tolerated but
support at 1.0822. Only a break above pivotal resistance at
                                                                    once the latter has given way, a stronger recovery to
1.4702 would weaken the downtrend in favor of a stronger
                                                                    25.835/955 (76.4 % of the last down-swing/triangle
recovery to 1.5296 or 1.5633 (int. 61.8/76.4 % of the last
                                                                    resistance) would be the least to be expected. It would take
down-swing).
                                                                    a break above 25.955 & 26.617 (Oct.09 top) for a trend
CE3 currencies (HUF, CZK and PLN) look to be set for a              reversal though). Below 25.089, the EUR bears remain in
broad range trade through most of 2011 but maintain a               control and old lows at 23.705 and at 22.894 in focus.
bullish bias medium-term as long as key-barriers are not
                                                                    USD/CZK remains in negative territory below 18.581
taken out.
                                                                    (pivot) and 18.834 (weekly break out line) and provided the
EUR/HUF clarifies this general setup very well, but also            latter is not taken out, it is expected to challenge 16.557
the necessity to break below 268.29 (int. 76.4 %) for a             (76.4 % of the 08-09 rally) next. Only a decisive break
                                                                    below the latter (i.e. a weekly close below 16.20) would



                                                                                                                                    35
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


Chart 20: EUR/CZK - Weekly Chart –Unless 25.089 is taken out, the   the latter would be a game changer in favor of a much
downside remains open for a test of former lows                     broader recovery to 4.5076 and 4.6691 (61.8/76.4 %).
                                                                    USD/PLN looks a little different in a sense that it bounced
                                                                    quite a bit from the last 2.7273 low marked 3 weeks ago,
                                                                    but unless key-resistance at 2.9825/2.9978 (pivot/int. 38.2
                                                                    %) is taken out, a test and break below the 09 low at 2.6998
                                                                    can be expected shortly. Such a break would finally open
                                                                    the downside for an extension to 2.4665 (76.4 % of the 08-
                                                                    09 bull trend). A break above 2.9978 would, like in the
                                                                    other pairs, be an indication that a much stronger recovery
                                                                    to at least 3.2228 or 3.3398 (61.8/76.4 % of the last down-
                                                                    swing is on its way. Only a break above monthly trend line
                      T-junction
                                                                    resistance at 3.4084 would however be a real game-changer,
                                                                    challenging the 76.4 % retracement of the 09-10 bear swing
                                                                    at 3.6282.
                                                                    Asia EM: Bull trends intact despite holding key
                                                                    levels against the USD; a bullish shift against EUR
open the way for a re-test of 14.392 (08 low) though. A             expected
break above 18.834 would on the other hand ring the alarm           Our view for Asia EM FX into 2011 remains bullish.
bell, calling for a minimum recovery to 20.036 or 20.739            Despite the test and so far hold of critical targets over the
(61.8/765.4 % of the last down-swing) if not a test of              past few weeks, the positive technical backdrop should
monthly trend line resistance at 21.333. Above the latter,          allow for additional outperformance deeper into the new
24.432 (38.2 % on higher scale) would be in focus.                  year. Similar to the USD view, the short term risks can
Chart 21: EUR/PLN - Weekly Chart –Below 4.0100/4.0281 the EUR       allow for additional short term consolidation against the
bears remain in control and 3.6053 in focus                         November highs, but corrections should be tempered before
                                                                    the bull trends extend. We note several supporting factors to
                                                                    this view.
                                                                    Chart 22: ADXY - Weekly Chart – A short term consolidation against
                                                                    the 2008 highs should lead to a continuation of the medium term
                                                                    uptrend
                                                  T-junction




                      T-junction




A bit of a favorite within CE3 could be PLN as this market
has already broken the 76.4 % retracement of the Aril-May
up-swing in EUR/PLN at 3.9233 decisively. As such,
chances of breaking below the last bottom at 3.8238 for an
extension towards 3.6053 (76.4 % of the 08-09 bull-trend)
are fairly good. Only a break above massive resistance
between 3.9917/4.0024 (int. 38.2 % on two scales) and               Using the ADXY Index as a guide (chart 22), the persistent
4.0100/4.0281 (pivots) would be an alarming signal calling          rally during the second half of 2010 has led to a test of the
for a minimum rally to 4.1455 (weekly trend) and the                important 116.20/116.35 resistance area and 2008 highs. In
decisive T-junction at 4.1922 (int. 38.2 %). A break above          turn, we sense a short term corrective phase should develop.
                                                                    Still, we view this retracement as an opportunity to

36
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


establish/add to long positions. In a similar manner, we also      allow for a consolidation phase, but the medium term
note that several USD pairs are testing and holding critical       backdrop via trend analysis, long term momentum studies
targets and levels including USD/KRW, USD/INR and                  and Elliott wave analysis continues to argue for new lows
USD/TWD. However, we expect these support levels to                into the first half of next year. Breaks of the 30.00 area
eventually give way in line with the broader trends.               which represents the 2008 low should set the stage for an
                                                                   extension into the 28.00/27.50. Note that the 31.30/31.65
Trend analysis suggests little evidence of a sustained
                                                                   levels will maintain the bias for new lows. For USD/SGD,
reversal at this point despite the extent of the bull trend
                                                                   we see potential for new lows to seek the 1.26/1.24 targets.
from the 2009 cycle low. In that regard, our long term
momentum gauge maintains the buy signal from September             Chart 24: EUR/KRW - Weekly Chart – The corrective phase from the
2009. Moreover, our weekly moving average system retains           June low seems nearly complete amid the overbought setup
a buy signal from July ’09, while our trend strength studies       implying the medium term downtrend is back on track.
continue to improve and show the most bullish setup since
4Q’08. The positive backdrop for risk highlighted by the
setup for Asian equity markets argues for new highs.
Chart 23: USD/KRW - Weekly Chart – The pause above the important
1100 support reflects a corrective bias and suggests new lows.




                                                                   The technical setup for EUR/Asia FX crosses is supportive
                                                                   to the general bullish bias. While the advances from the
                                                                   June lows are still effectively intact, the character of the
                                                                   price action reflects a corrective bias. This setup implies a
                                                                   consolidation phase within the medium term declines from
Looking at the individual currencies, we continue to see a         the 2009 highs. In turn, we sense a return to the underlying
bullish setup for KRW. While the decline has stalled against       downtrend is likely to develop and is a key trading theme
the critical 1100 support zone against the USD (chart 23),         for 2011. This should allow for EUR/KRW to retest and
the overall risks continue to point lower. Breaks here would       then break the important 1400 area (chart 24). Moreover,
suggest the medium term downtrend is back on track                 EUR/INR is likely to establish new lows below the key 55
seeking a closer test of the 1050/1000 targets. We continue        support area.
to view the 1155/1170 area as key resistance which should          Latams: MXN and CLP to lead the way
hold to maintain this view.
                                                                   Our 2010 Outlook highlighted the bullish framework for
USD/INR was one of our favorite views for the 2010                 Latam FX including the view for a deeper decline in
Outlook, but that failed to fully live up to expectations as       EUR/MXN. While the performance against the USD fell
the 44 support area proved to be too strong. While we see          short of our expectations, we still sense the backdrop for
an increased risk that this area can allow additional              additional outperformance is intact for 2011. Like the broad
corrective work into year-end, the medium term setup               USD view, the risks suggest a choppy trajectory particularly
suggests an eventual breakdown. In this regard, targets enter      given the proximity of a number of important support levels
at 42 and then 40, while the 46 and 47 resistance levels will      and targets.
maintain the downside bias.
                                                                   Despite the failure to extend below the important
Despite the magnitude of the declines in USD/TWD and               12.13/12.00 support area, the range bias in USD/MXN that
USD/SGD since June, the overall downside risks remain              has persisted for all of 2010 still argues for a downside
intact. Similar to other USD pairs, the short term setup can       resolution (chart 25). Similar to USD/CAD, the price action

                                                                                                                                  37
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


Chart 25: USD/MXN - Weekly Chart – The setup suggests a growing            important 1.70/1.69 support area failed to elicit the
risk of a downside break to the medium term range following the            acceleration lower and a retest of the 2008 cycle low near
impulsive decline from the August high.                                    1.56 as expected. While the risk of a more protracted
                                                                           corrective phase has increased following this failure, we
                                                                           still sense a test of this key target remains possible, but note
                                                                           the risks of a broader consolidation phase have increased
                                                                           against the USD.
                                                                           Instead, we turn our focus to CLP as we continue to see
                                                                           potential for additional outperformance in 2011 but note
                                                                           that additional range action is likely to develop first. Still,
                                                                           with USD/CLP breaking the critical support area in the
                                                                           483/485 zone, the medium term downtrend is back on track
                                                                           (chart 26). Note that while the 500/506 resistance area
                                                                           holds, the short term downside bias remains intact.
                                                                           However, a reversal above the 525 area is necessary to
                                                                           invalidate the downside potential for a test of deeper targets
                                                                           near 450, if not 430.
                                                                           Trade Recommendations:

since May suggests a growing risk for new lows especially                  •     Sell EUR/CHF at market for a decline to 1.3100 and
given the impulsive decline from the August peak. In turn,                       1.2550, stop at 1.4000
we see potential for prices to extend into support near 11.80                  ⎯ The downside is still favored looking for a trend
with medium term risk for a test of the 11.20/11.08                              extension into 1.2535/1.2465 and potentially to
retracement support of the rally from the 2008 cycle low.                        1.2040 (Fib.-projections) at a later stag.
Despite the sharp reversal from the June low, we sense that                    ⎯ Partial profit-taking is however recommended in the
EUR/MXN is due another leg down and continuation of the                          1.31 handle to take the formation of a potential
downtrend from the 2009 cycle high. The October high                             inverted H&S bottoming formation into account.
failed below the 17.65/85 resistance zone which includes                       ⎯ Stops should be placed above 1.3926/56 (pivot/int.
the key 50% retracement of that decline from the 2009                            38.2 %) as such a break would signal the end of the
cycle high. Moreover, the current decline reflects a trending                    long-term downtrend.
bias. A violation of the 16.38/16.14 support levels should
set the stage for another run at the 15.28 low.                            • Sell EUR/TRY at market for a decline to 1.8100, add
                                                                             up at 2.0250, stop at 2.0650
Chart 26: USD/CLP - Weekly Chart – The medium term decline
remains intact following the violation of the critical 485 support area.       ⎯ The downside remains wide open for an extension to
                                                                                 at least 1.8070 (fib.-projection) with the option to
                                                                                 overshoot towards the September 01 low at 1.7196.
                                                                               ⎯ Only a break above key-resistance at 2.0435/2.0557
                                                                                 (pivot/int. 38.2 %) would seriously dent the
                                                                                 downtrend and would call for a much broader up-
                                                                                 consolidation.
                                                                           •     Sell EUR/INR at market for a decline to 52, add at
                                                                                 64.25, stop at 66.10
                                                                               ⎯ The corrective phase from the May low has nearly
                                                                                 run its course and is finally due for a reversal in line
                                                                                 with the medium term downtrend.
                                                                               ⎯ Note the advance has effectively held key resistance
                                                                                 in the 63 area. Breaks of the 60.20 and 58.50 support
                                                                                 levels should reassert the medium term downside
                                                                                 bias for a retest and then break of the 55.13 low.
We also note that USD/BRL effectively maintained a range
bias for much of the past year as the breakdown below the

38
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Niall O’Connor (212) 834-5108
Thomas Anthonj (44-207) 742-7850
JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.


Trade Watch List:
As we monitor for a short term correction in the USD, we
will be looking for a better setup and location to establish
long positions with the focus on AUD/USD. In line with the
potential AUD outperformance bias, we see a growing risk
that AUD/NZD can break out of the medium term range
above the key 1.32 resistance zone.
Moreover, we see potential for AUD/JPY to extend above
the critical 85/88 resistance area in line with the next leg up
from the 2008 lows and consistent with our view for cross
JPY to re-establish the medium term uptrends.
For EM, we will await better levels to establish short
positions in USD/CLP and USD/MXN and for EUR
crosses including EUR/MXN, EUR/BRL and EUR/KRW.




                                                                  39
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Tohru Sasaki (81-3) 6736-7717
Junya Tanase (81-3) 6736-7718
JPMorgan Chase Bank NA



Research Note
Yen: Turning bearish broadly, but USD/JPY to decline on USD
weakness
                                                               2010 in review: USD/JPY approaches a post-war
•    In the first half of 2010, both USD and JPY became a
                                                               low, with yen the strongest G-10 currency
     strong currency, with USD/JPY trading in a 88-95
     range. In the latter half of the year, broad USD          Year 2010, particularly in the second half, saw USD/JPY
     weakness led to a decline in USD/JPY, pushing the         following a down-trend to reach 80.22, the lowest level
     pair close to its post-war-low in 4Q. Although our call   since April 1995, in line with our expectations from the
     for USD/JPY to decline was correct, the actual path       2010 outlook (JPY: What would push USD/JPY to all-time
     differed from expectations.                               lows?) published in November 2009. However, at the end of
                                                               2009, we had forecasted that USD/JPY would test the low
•    We expect JPY to be a weak currency in 2011, thus         before mid-2010 but was likely to rebound in the second
     replacing the bullish view on JPY we had maintained       half amid growing expectations for Fed hikes in response to
     over the past three consecutive years. With economic      an upturn in the US economy. The actual scenario proved
     upturns gaining momentum worldwide and risk assets        somewhat different from the forecast.
     trading firmly amid the excess liquidity environment,
     we expect JPY to decline against most of major            The USD/JPY movements in 2010 can be divided into two
     currencies.                                               major phases. In the first-half of the year, investors adopted
                                                               a risk-averse stance due to mounting concerns over
•    The magnitude of JPY decline should be larger against
                                                               sovereign credit risk in European peripherals. As a
     high-yield, commodity and EM currencies in
                                                               consequence, both USD and JPY strengthened against the
     particular.
                                                               majors with USD/JPY trading in a 88-95 range. In the
•    However, we expect USD to be even weaker than JPY.        second-half of the year, a broad USD weakness proved to
     Accordingly, we expect USD/JPY to continue its            be no exception for USD/JPY, thus driving the pair lower.
     downtrend led by the USD weakness. Our end-2011           Following is a chronological review of the developments in
     target is 78.                                             USD/JPY through 2010.
•    JPY-selling intervention is unlikely.                     From January to mid-March, risk aversion among investors
                                                               heightened given a series of concerns: (i) the Greek fiscal
•    The Nikkei index has developed stronger correlations
                                                               crisis; (ii) the outlook for the global (the US and China, in
     with JPY-crosses than with USD/JPY. Given our
                                                               particular) economy; and (iii) the implications surrounding
     expectations for JPY to trade lower against EM and
                                                               new US financial regulations. Equity markets sold off
     high-yield currencies in 2011, we believe a USD/JPY
                                                               across the board, while in the FX markets, both USD and
     decline to 78 will not necessarily be negative for the
                                                               JPY strengthened with JPY-crosses broadly declining. With
     Nikkei index.
                                                               JPY appreciating beyond a strong USD, USD/JPY slid from
•    Any appreciation in EM Asian currencies led by CNY        93 to 88 during this period. However, from this point until
     appreciation should be positive for Japan’s economy.      late April, JPY lost ground against most major currencies
                                                               amid a global rebound in stock prices. By early May,
•    Three preconditions for a USD/JPY rebound;
                                                               USD/JPY had rebounded to just under 95 (94.99), which
     1) Heightening expectation on Fed hikes,
                                                               ultimately became the high for 2010.
     2) Deterioration in European fiscal problems,
     3) Acceleration in Japanese foreign investments.          Amid growing concerns over European sovereign risk in
                                                               early May, JPY moved higher against other major
•    Risk scenarios which make JPY the strongest major
                                                               currencies while USD/JPY temporarily slipped below 88. In
     currency again in 2011; 1) Tightening capital control
                                                               the early morning of May 10 Tokyo time, the EU and the
     in EM countries, 2) European fiscal problems.
                                                               IMF agreed on a measure to set up a €750 billion rescue
•    We remain bearish USD/JPY vols, especially at the         fund for the Euro area. Simultaneously, the ECB made the
     back-end. Subdued front-end vols are best exploited       decision to start purchasing bonds and also to expand
     through 1X2 put spreads and butterflies to position for   liquidity injection measures. Although stock prices
     a grind lower in spot. The cheapness of cross-yen vols    rebounded momentarily, they quickly resumed their
     vis-à-vis USD/JPY can be married to a view on de-         downward trend and JPY continued to strengthen.
     correlation between them through smartly geared
     multi-currency option structures.

40
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Tohru Sasaki (81-3) 6736-7717
Junya Tanase (81-3) 6736-7718
JPMorgan Chase Bank NA


With the exemption of a correction phase in August, June         Chart 1: JPY’s performance against the majors in 2011 (as of Nov.15)
onward saw a steadily weakening USD against the other            %
major currencies including JPY. Between June and July,               0
deteriorating sentiment regarding the US economy led to a
decline in US nominal long-term interest rates, which                -5
pushed the USD weakness further. FRB Chairman Ben
Bernanke’s remarks in Jackson Hole on Aug 27 boosted
                                                                   -10
prospects for further Fed easing, which spurred a broad
rally in the risk markets and a decline in US real interest
rates due to expectations of higher domestic inflation. All of     -15
these developments further weighed on the USD .
                                                                   -20
As USD/JPY continued to slide, on September 15, the day
                                                                             AUD   NZD      CHF          CAD     SEK       USD    GBP       NOK   EUR
following the re-election of Naoto Kan as a Prime Minister,
Japan’s MoF conducted a JPY-selling intervention for the
first time since March 2004 (selling ¥2.1 trillion, a scale      Source: Bloomberg, J.P. Morgan
representing the largest single-day JPY-selling intervention
                                                                 Chart 2: JPY’s NEER
on record). In response, USD/JPY abruptly surged 3 yen,
moving from high-82s to high-85s while JPY sharply                 120
declined against non-USD majors as well. USD/JPY traded
firmly as fears of further intervention reigned for some time      115
thereafter, but gradually resumed its downward move. In
                                                                   110
early October, USD/JPY slipped below its pre-intervention
level. Early November saw the pair extending its low to            105
80.22, the lowest reading since April 1995.
                                                                   100
For the year 2010 as a whole, JPY emerged as the strongest
G-10 currency (chart 1). According to our estimate, the              95
yen’s nominal effective exchange rate also appreciated by
                                                                      Jan-10       Mar-10          May -10            Jul-10      Sep-10      Nov -10
more than 10% over the same period (chart 2).

2011 Outlook: Turning bearish on JPY                             Chart 3: Policy rate and S&P500 index
broadly, after three years of bullishness                            %                                   policy rate(global, lhs )
                                                                   10.0                                  policy rate(DM, lhs )                    1800
As excess liquidity supports risk assets, JPY, the                                                                                                1600
                                                                     8.0                                 S&P500(rhs )
major funding currency, to underperform
                                                                                                                                                  1400
J.P. Morgan expects the global economy to track a moderate           6.0                                                                          1200
recovery in 2011. Against this backdrop, the FRB has                                                                                              1000
                                                                     4.0
committed to quantitative easing, comprised of the purchase
                                                                                                                                                  800
of $600 billion in US Treasuries by June next year.                  2.0
                                                                                                                                                  600
Furthermore, the BoJ has decided to set up a fund for asset
purchases including ETFs and J-REITs. Moreover, the ECB              0.0                                                                          400
and the BoE are expected to keep policy rates unchanged at                 1999    2001           2003         2005        2007      2009
very low level through 2011. Therefore, despite the firming
outlook for the global economy in general, our economists        rate target as much as 475 bp, from 6.50% at the beginning
still project that the world’s four major central banks (BoJ,    of 2001 to 1.75% one year later. Subsequent cuts in
FRB, ECB, and BoE) will keep policy rates at very low            November 2002 and again in June 2003 brought the FF rate
levels through 2011, thus implying a support for financial       target down further to 1%. Japan started QE in March 2001,
markets throughout the upcoming year.                            as other countries also began implementing relatively
                                                                 aggressive interest rate cuts. As a result, by September
Such a market climate probably seems familiar for most           2003, policy rates in leading industrial countries had
investors. Faced with the economic downturn that followed        dropped sharply to an average of 1.57% (Chart 3).
the collapse of the IT bubble in 2000 and the September 11,
2001 terrorist attacks on the World Trade Center buildings       As a result of this path of ultra monetary easing by the
in New York, the FRB abruptly lowered the Federal Funds          world’s major central banks, US stock prices bottomed out

                                                                                                                                                        41
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Tohru Sasaki (81-3) 6736-7717
Junya Tanase (81-3) 6736-7718
JPMorgan Chase Bank NA


in October 2002 while the TOPIX and European stock                Chart 4: JPY’s performance against the majors between Oct 02 and
indices marked their lows in March 2003. From that point          Oct 07
                                                                  %
onward, global stocks took off on a five-year rally leading
to their 2007 peaks. During this period, India’s SENSEX               60
index and Brazil’s Bovespa index posted six-fold gains in
scale, while prices for crude oil and gold doubled.                   50

During the five-year rally of the S&P 500 index between               40
October 2002 to October 2007, on the FX front, USD and                30
JPY became the weakest currency while commodity
currencies, such as AUD, CAD and NZD, appreciated by                  20
more than 50% against JPY as investments funded by JPY                10
gathered momentum (chart 4). Additionally, trades aimed to
exploit interest-rate differentials gathered significant               0
momentum after the abrupt fall-off in market volatility in            -10
2005 (chart 5), giving rise to the popular phrase “JPY carry
trade”.                                                                        AUD    CAD   NZD     SEK     EUR   NOK      GBP     CHF    USD

Take another look at chart 3. Policy rates in the leading
industrial countries have fallen to an average of 0.61% at        Chart 5: J.P. Morgan VXY index
                                                                  %
the moment – less than half the corresponding level seen in
September 2003 – while stock prices worldwide have                 25
embarked on a strong rally. Despite these trends, the FRB
and the BoJ are positioned to supply the markets with even         20
more liquidity. It is likely that this liquidity will flood the
markets on a scale even exceeding levels witnessed from            15
2002 to 2007. Such levels of excess liquidity can be
expected to support risk markets and once again weaken
                                                                   10
JPY, a major funding currency. Notably, we believe that
JPY will fall against currencies supported by high interest
rates, of large commodity producer countries, and of                   5
emerging economies.                                                     1999         2001    2003         2005     2007         2009

Downtrend in USD/JPY to sustain in 2011, led by
                                                                  Chart 6: JPY’s performance between Oct 02 and Oct 07
USD weakness                                                      %
We expect USD, another major funding currency, to be                  50                                                  Oct 02-Dec 04
even weaker than a weak JPY in 2011. Thus, we foresee
USD/JPY continuing to fall next year, targeting 78 by year-           40                                                  Jan 05-Oct 07
end. The following justifications support our outlook for             30
relative strength of the JPY against USD.                             20
Reason 1: Fed monetary policy                                         10

Aforementioned trends from 2002 to 2007 should be helpful              0
in understanding the relative performance between USD              -10
and JPY. During this period, USD/JPY fell from late-2002
                                                                   -20
to 2004 but rebounded from 2005 to mid-2007. However, as
Chart 6 illustrates, USD and JPY together lost ground                          NZD    AUD   SEK     EUR    CAD    CHF     GBP    NOK     USD
against other major currencies during both of these periods.
From late-2002 to 2004, USD exhibited overwhelming                Fed’s monetary policies were conceivably the largest factor
weakness followed by JPY, resulting in a decline in               influencing the differentials in USD/JPY performance
USD/JPY. From 2005 to mid-2007, however, JPY emerged              observed during these two periods at a time when both USD
as the weakest currency, losing even more ground than a           and JPY were marked by weakness. Chart 7 clearly shows
weak USD, which consequently facilitated a rebound in             that the FRB’s move to tighten monetary policy with a
USD/JPY.                                                          series of rate hikes starting in June 2004 was the main


42
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Tohru Sasaki (81-3) 6736-7717
Junya Tanase (81-3) 6736-7718
JPMorgan Chase Bank NA


driver of a sustainable rebound in USD/JPY. As we do not           Chart 7: USD/JPY and FF rate target
expect any Fed hikes in 2011, if this call proves to be                                                                              %
correct, it is strongly likely that USD/JPY in 2011 will                  140                           USD/JPY (lhs)                    7
follow a pattern resembling movements observed from late-                 130                           FF target (rhs)                  6
2002 through 2004, rather than that observed from 2005 to                                                                                5
mid-2007.                                                                 120
                                                                                                                                         4
                                                                          110
Reason 2: US-Japan nominal rate differentials                                                                                            3
                                                                          100
The fact that the US – the world’s largest net debtor nation                                                                             2
with the world’s largest current account deficit – and Japan              90                                                             1
– the world largest net creditor nation with the world’s                  80                                                             0
second-largest current account surplus – have adopted                           1999   2001      2003    2005      2007      2009
almost-identical interest rate policies seems fundamentally
abnormal. Therefore, it is reasonable to assume that US            Source: Bloomberg
interest rates should be much higher than that in Japan to
stabilize USD/JPY.                                                 Chart 8: US-Japan 3-month LIBOR spread and USD/JPY
                                                                                                                                    bp
A look into past nominal US-Japan short-term interest-rate           170                                                              1000
against USD/JPY movements reveals that the US-Japan 3-                                                  USD 3M Libor - JPY 3M
                                                                     150               USD/JPY                                       750
month LIBOR spread has never been less than 150bp
whenever USD/JPY had been following a sustained uptrend
(in most periods, the spread has actually been much wider            130                                                             500
than 150bp; Chart 8). Meanwhile, the current US-Japan 3-
month LIBOR spread is less than 10bp. Assuming that                  110                                                             250
Japan maintains its zero interest-rate policy for the time
                                                                      90                                                             0
being, an expansion of this spread requires a full-fledged
                                                                                              150bp
cycle of interest rate hikes from the Fed. In light of our view       70                                                             -250
that we will not see any interest rate hikes from the Fed in
2011, it is unlikely that this precondition for a rise in                 Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-11
USD/JPY will be met next year.
Reason 3: Relatively high real interest rates in                   Chart 9: Real policy rate for G-10 countries (nominal policy rate
Japan                                                              minus core CPI % oya)
                                                                     % (nominal policy rate - core CPI % oy a)
On December 1, 2009, the BoJ in a special meeting decided            4
to adopt a new strategy of open-market operations based on
                                                                     3                                  current (4Q10)
the use of fixed interest rates. This decision set the stage for
a variety of monetary easing measures, eventually leading            2                                  av erage 4Q02-4Q04
up to the comprehensive monetary easing policies                     1
implemented on October 5, 2010. However, all of these
measures have failed to effectively dispel persistently strong       0
deflationary expectations in Japan, thus suspending real             -1
policy rate in Japan at relatively high levels. As a
                                                                     -2
consequence, the current real policy rate in Japan is the
second highest within the G-10 countries, just trailing              -3
behind Australia, the country with the highest G-10 nominal                     AUD JPY NOK NZD CHF EUR CAD SEK USD GBP
policy rate (Chart 9). By contrast, real policy rate in Japan
between 2002 and 2004 was lower in absolute terms than it
is now. Furthermore, JPY’s real policy rate over the period
was significantly lower than comparable rates in countries         G-10 countries, providing further explanation to the USD
of which currencies were outperforming JPY, such as                weakness during these periods.
Australia, New Zealand, and Sweden. Incidentally, US real          MoF’s JPY-selling intervention still unlikely
policy rates during the 2002-2004 period and now are
respectively at the lowest and third-lowest levels within the      Renewed intervention is still unlikely and of limited
                                                                   effectiveness if implemented. Ever since turning bullish on

                                                                                                                                             43
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Tohru Sasaki (81-3) 6736-7717
Junya Tanase (81-3) 6736-7718
JPMorgan Chase Bank NA


JPY in the second half of 2007, we have stood by our view       Chart 10: Nikkei and KRW/JPY
that JPY-selling intervention by Japanese MoF is unlikely.
                                                                                                                        100KRW=JPY
There are two reasons supporting this view. First, as a
                                                                    11500                                                        9
respected member of the G-7, Japan has been siding                                                            Nikkei (lhs)
consistently with other G-7 members in criticizing China’s          11000                                                        8.5
currency policies. Therefore, the perspective of                                                              KRW/JPY(rhs)
                                                                    10500
international coordination makes it politically difficult for                                                                      8
Japan to sell JPY in order to enhance competitiveness of its        10000
currency. Secondly, as a nation with an enormous foreign                                                                           7.5
                                                                     9500
currency reserve, Japan is saddled with huge levels of
currency and interest rate risk and also carries an enormous         9000                                                          7
amount of unrealized losses within its reserve. On
                                                                     8500                                                          6.5
September 15, 2010 Japanese MoF conducted JPY-selling
intervention for the first time since March 2004 against our             Jan-10     Mar-10 May -10   Jul-10     Sep-10   Nov -10
view. Nonetheless, for the two reasons cited above, it
appears unlikely that further interventions will take place.    Source: Bloomberg
Furthermore, the effectiveness should be limited even if the    The bilateral trade balance between Japan and China has
authorities were to intervene again.                            been virtually flat. A strong CNY is expected to have little
Nikkei rallies even with USD/JPY at 78?                         impact on the Japanese economy, largely due to the fact that
                                                                Japanese and Chinese companies are rarely in direct
The effect of USD/JPY on the Japanese economy also              competition with one another. However, as discussed
appears to be changing. Japanese customs data reveals that      above, accelerating CNY appreciation leading way to a
Japanese companies as a whole have become net buyers of         broad appreciation in Asian currencies should be positive
USD/JPY. Due to the fact that Japan has traditionally been a    for the Japanese economy.
nation with a trade surplus, there is no doubt that a weaker
JPY is still beneficial from a corporate profit standpoint.     Three preconditions for a rebound in
However, it is also important to note that the positive         USD/JPY
impact of JPY weakness is more significant against EUR,
AUD and Asian currencies, rather than against USD.              As elaborated earlier, we expect USD/JPY to follow a
Correlations between the Nikkei index and JPY-cross rates       modest downtrend through 2011. However, should any of
have been much stronger than the corresponding correlation      the following risk scenarios take place, there remains a
with USD/JPY – interestingly, the correlation between           possibility for USD/JPY to rebound contrary to our forecast.
KRW/JPY and the Nikkei have been exceptionally strong           Scenario 1: Heightened expectations of Fed hikes
(Chart 10). As noted earlier, we expect JPY-cross rates to
rise broadly next year despite a modest downtrend in            J.P. Morgan projects no rate changes from the Fed
USD/JPY. Should this forecast materialize, it is highly         throughout 2011, while expecting the first future rate hike
likely that the Nikkei index will post gains even as            only from the second quarter of 2012. Nonetheless, should
USD/JPY declines to 78.                                         the Fed act contrary to our expectations and begin lifting
                                                                rates next year, or should the markets begin to factor in such
CNY-led appreciation of Asian FX to be positive                 FRB rate hikes, USD may appreciate and thus fuel a
for Japanese economy                                            rebound in USD/JPY.
Our China economists expect CNY to appreciate gradually         Scenario 2: Markets unsettled by deteriorating
against USD in 2011, with USD/CNY falling to 6.30 by            fiscal conditions in European peripherals
year-end. Given the status quo, it appears that China’s
monetary authorities will be less concerned about economic      Should the fiscal crisis in European peripherals deteriorate
slowdowns domestically or abroad, but rather more               significantly, both USD and JPY should strengthen amid
sensitive of the inflation risk confronting China on the home   declining JPY-cross rates. USD ranked as the third strongest
front (China’s inflation figures in October were higher than    currency during the recent US financial crisis from the
forecasts, prompting us to forecast tighter monetary policy     summer of 2007 to early 2009. Even in such conditions,
by the PBoC). Given these factors, it would not be              USD/JPY still tumbled as much as 20% due to the
surprising if CNY appreciates even faster than our projected    overwhelming strength in JPY. However, JPY’s dominance
pace in the coming quarters.                                    at that time seems to have been a by-product of the “yen
                                                                carry trade” that had been ongoing for several years prior,
                                                                allowing large-scale short JPY positions to build up.

44
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Tohru Sasaki (81-3) 6736-7717
Junya Tanase (81-3) 6736-7718
JPMorgan Chase Bank NA


Although short JPY positions do not appear to have                Chart 11: Relationship between Nikkei index and foreign stock
accumulated significantly this time around, on the other          purchase by Japanese retail investors
hand, large USD short positions could be mounting. Should         JPY bn =monthly net purchase of foreign stocks by retail investors(*)6m M.A
the fiscal crisis in European peripherals exacerbate thus              600           y = 9E-06x 2 - 0.2191x + 1307.5
increasing investors’ risk averseness, it is possible for USD          500                    R 2 = 0.6143
to assume reign as the strongest currency followed by JPY
                                                                       400                                          A verage=12.958
as the second strongest, thus setting the stage for a rebound
                                                                       300
in USD/JPY.
                                                                       200
Scenario 3: Japanese investors and corporates                          100
accelerate foreign investments
                                                                          0
In the event that global economic recovery proceeds at a              -100
pace significantly above our expectations and the Nikkei              -200
rallies by a wide margin, JPY may fall as Japanese
institutional/retail investors increase their investments in                  6000      8000    10000 12000 14000 16000               18000 20000
foreign securities (including the de-hedging of FX-hedged                                              Nikkei
foreign bond investments by Japanese lifers) and Japanese         *"Financial Instruments Firms" + "Investment Trust Management
companies step up their levels of foreign direct investment.      Source: MoF, J.P. Morgan
Should such investment activity intensify, it is highly likely
                                                                  Scenario 2: Markets unsettled by deteriorating
that JPY will weaken further than a weak USD, resulting in
a USD/JPY rebound. Judging from historical data of the            fiscal conditions in European peripherals
correlation between the Nikkei index and Japanese retail          As mentioned earlier, a deterioration of fiscal conditions in
investors’ foreign stock investments, it is evident that retail   Europe could lead to market instability, which would
investors have a tendency to accelerate their foreign stock       consequent in USD strengthening against JPY. However,
investments once the Nikkei rises above 13,000-14,000             JPY is still expected to strengthen against other major
levels (chart 11).                                                currencies. Total Japanese investor holdings in European
                                                                  bonds were recently valued at EUR350 billion (as of the
Risks make JPY the strongest currency                             end of 2009). Although there remains a possibility that
again                                                             current outstanding could already have declined to some
                                                                  extent, if these holdings were further unwound and
Following are a couple of risk scenarios that address the         repatriated to Japan, JPY would be subject to additional
prospect of JPY trending outside our expectations and             upward pressure (particularly against EUR).
climbing against other currencies in addition to USD, thus
sustaining its reign as the strongest major currency from
2010 on into 2011.
Scenario 1: Tightened capital control in emerging
economies
In recent months, emerging nations, alarmed by the
prospect of speculative capital inflow as an outcome of
quantitative easing in the US, have started acting to control
capital inflows. Permeation of such actions gives rise to the
risk of a reversal of foreign capital inflows and the
withdrawal of foreign investment from emerging
economies. Large sums of capital could return to Japan
under such a scenario, causing JPY to rise sharply against
currencies other than USD and EUR (i.e., currencies of
countries that are key sources of capital investment in
emerging economies).




                                                                                                                                                45
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Arindam Sandilya (1-212) 834-2304
arindam.x.sandilya@jpmorgan.com
JPMorgan Chase Bank NA



Still bearish on back-end vol                                     Chart 12. Short vega instruments such as butterflies and 1X2 put
                                                                  spreads have outperformed other vanilla option structures over the
For most of the past year, we have held a bearish view            past two years as vehicles to position for a grind lower in USD/JPY
on USD/JPY volatility, particularly at the back-end of            Statistics for rolling 1-month mark-to-market P/Ls as a fraction of upfront premium
                                                                  for bearish USD/JPY 3M option structures since 1/1/09. The three strikes of the
vols curves 2Y and out, and see little reason to alter that       butterfly are K1 = 50D, K2 = 25D and K3 = strike level chosen to makes the fly
stance in 2011. Front-end USD/JPY implied vols – sub-3M           symmetric. No transaction costs.
in tenor – have averaged around 2 vols lower in 2010 than                                                                                    Success
                                                                   Option Structure            Avg. Stdev.        IR     5-%ile Min
they started the year with, in line with the grinding move                                                                                     Ratio
lower in spot that was atypical in terms of delivering far        50D USD Put                     6%     54%    0.10     -75%      -91%      49%
lower volatility than the carry trade unwind fuelled crashes      25D USD Put                 -12%       58%    -0.20    -84%      -95%      32%
of ‘07/’08. Lower realized vols this time around can be           50D/25D 1X1 Put Spread          18%    54%    0.34     -68%      -87%      60%
partly attributed to the much depleted stock of yen-funded        50D/25D 1X2 Put Spread      107%       92%    1.17     -41%      -196%     84%

carry trades at present given the far more advanced stage of      Butterfly                       30%    52%    0.58     -60%      -83%      70%

the deleveraging cycle today vis-à-vis two years back,              3
obviating the need for another frenzied washout. Part of the
blame also lies at the door of the US rate environment we           2
operated in this year. USD/JPY tracked short-end US yields
almost tick for tick, and with nominal rates approaching a
                                                                    1
theoretical zero threshold, a de-facto soft floor (~75) was
also placed under USD/JPY that reduced spot moves to a
                                                                    0
crawl the closer it got to that level. Additionally, when spot
USD/JPY declines, intervention fears can never be far off,
and so was it this year: first 85 and then the impending 80        -1
                                                                                      1X2 Put Spread
levels brought forth official jawboning/intervention – both
                                                                   -2                 Butterfly
real and imagined – with the effect of keeping yen bulls
from getting overly excited at the prospect of a runaway             Apr-09        Jul-09           Nov -09     Mar-10          Jun-10       Oct-10
USD/JPY sell-off. Finally, issuance has reduced to a trickle
in PRDC structures that used to pay hybrid books out of           Chart 13.…and are also trading at historical lows in upfront premium
                                                                  Upfront premium (bp USD) of USD/JPY 3M 1X2 put spreads and butterflies. The
convexity in the past as the yen strengthened, largely            three strikes of the butterfly are K1 = 50D, K2 = 25D and K3 = strike level chosen
because the appetite for such products from their principal       to makes the fly symmetric. No transaction costs.
consumers – Japanese retail – has more or less disappeared
                                                                   bp USD                                                                  bp USD
after the devastation of 2007/'08. Anecdotal evidence              60                                                                          110
suggests that banks tore up a sizeable fraction of these notes
                                                                                                                           Butterfly
at economically unprofitable levels at the height of the crisis    55              1X2 Put Spread
in attempts to cut risk, when the absence of liquidity in                                                                                        100
option markets made hedging such positions nearly                  50
impossible. Of the legacy positions that still reside on the       45                                                                            90
books, some of the toxic cross-gamma exposure that could
have exacerbated moves at current USD/JPY spot levels has          40
apparently been recycled to leveraged names in the form of                                                                                       80
                                                                   35
dual rates/FX structures, leaving street exposures looking a
lot cleaner.                                                       30                                                                            70
None of these factors are likely to change radically next            Apr-09        Jul-09           Nov -09    Mar-10        Jul-10        Nov -10
year. Our mid-year forecast of 78 reflects a tension between
two funding currencies next year that from current levels         weaker USD/JPY. Chart 12 shows that they have far
ought to amount to little more than a continuation of the         outperformed alternative vanilla option structures such as
past few months, and hence by extension bearish for short-        outright USD puts and 1X1 put spreads since last year when
end vols. In addition to levels, skews have been the prime        spot began its slide from 100, highlighting the contained
casualty of the new lower vol regime, having re-priced            nature of the decline. The case for deploying them is
sharply lower to reflect the much weaker spot-vol                 buttressed by the fact that option premia for structures are
correlation. Subdued vols and low skews argue for                 currently trading close to two-year lows (chart 13).
owning USD put butterflies and 1X2 put spreads as a               Back-end vols continue to look rich, and are a sell on
premium/carry efficient way of playing marginally                 rallies. While front-end implieds have come off in line with

46
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Arindam Sandilya (1-212) 834-2304
arindam.x.sandilya@jpmorgan.com
JPMorgan Chase Bank NA


realized vols, back-end vols have not entirely corrected their   Chart 14. USD/JPY 1Y1Y forward vols are trading close to the upper-
richness, and continue to look stubbornly rich on relative       end of their yearly range, and offer 2 vols+ static slide into spot vols
vega valuations within G10. A large fraction of the vol bid       16.5                                                         1Y1Y BS Forward Vol
can be explained by the relentless buying of OTM topside          16.0
                                                                                                                               1Y Implied Vol
strikes 2Y and out in tenor from the leveraged community
                                                                  15.5
to position for an eventual weakening of the yen, possibly
on account of US-style fiscal concerns. Bulk of these             15.0
positions are likely strategic/long-term in nature, and are       14.5
unlikely to be liquidated despite the substantial mark-to-        14.0
market pain they have taken over the past 18-months, and          13.5
vega shedding by PRDC books is unlikely to come into play         13.0
unless spot (and forwards) begin to exhibit signs of a
                                                                  12.5
definitive turn higher – not our base case for next years. As
                                                                  12.0
a result, a good part of the back-end vol richness may prove
persistent, but the combination of richness vis-à-vis realized      Nov-09      Jan-10     Mar-10      May-10        Jul-10      Sep-10      Nov-10
vols and sharp slide along a steep vol curve makes them
                                                                 Chart 15.Commodity FX/JPY cross-yen vols are at attractive
attractive sells on rallies. We prefer to express such trades    historical locations to own vs. USD/JPY vols
through short 1Y1Y FVAs that are currently trading at                                                    AUDJPY/ USDJPY 1Y Implied Vol Ratio
historically attractive levels, and exploit curve steepness by    2.4                                    NZDJPY/ USDJPY 1Y Implied Vol Ratio
                                                                                                         CADJPY/ USDJPY 1Y Implied Vol Ratio
offering in excess of 2 vols of static slide (chart 14).          2.2
Cross-yen vols – particularly AUD/JPY, NZD/JPY and                2.0
CAD/JPY – have cheapened significantly relative to
USD/ JPY over the past three months, and now fall on              1.8
opposite ends of the rich/cheap divide in back-end vols.          1.6
These vols have cheapened on account of the grind lower in
USD/ JPY since April that has led to yen-crosses under-           1.4
performing dollar pairs in the direction of currency strength,    1.2
thereby reducing the incentive to own the more expensive
JPY-cross vol over the USD vol on at least one side of the        1.0
spot distribution. Continued compression of cross yen vs.          Nov-07      May-08      Nov-08      May-09       Nov-09      May-10       Nov-10
USDJPY vol spreads requires persistent USD-weakness and
                                                                 Chart 16. Combining vol rich/cheap with a view on de-correlation
grinding yen-strength. Both of these are consensus views at      within the yen-bloc yields highly geared payoffs
present, and owning cross-yen vols against USD /JPY vols         6M [USD/JPY? K =2% ITMS, CCY/JPY? K = ATMS] dual at expiry digital
is an interesting way of positioning for the market being        options, ranked in order of the discount to the cheaper of the two
caught complacent around its view from historically              individual digitals.
attractive locations (chart 15).
                                                                  80%
Finally, the relative cheapness of high-beta/JPY cross vols       70%
relative to USD/JPY can be married to a view on de-               60%
correlation between them through multi-currency option
                                                                  50%
structures that yield attractive gearing vis-à-vis individual
vanilla options, even with strikes set in the money (chart        40%
16). The directional divergences that such structures             30%
demand is in line with our macro-view of a grind lower in         20%
USD/JPY towards 75 in coming months, even as the broad            10%
USD sell off and the reversion of yen back to the status of a
                                                                   0%
funding currency next year powers most high beta FX and
                                                                         INR




                                                                                                       CAD



                                                                                                                   AUD



                                                                                                                               CHF

                                                                                                                                     NZD
                                                                                                             KRW
                                                                               TRY

                                                                                     BRL




                                                                                                                                           SEK

                                                                                                                                                 NOK
                                                                                           MXN

                                                                                                 ZAR




                                                                                                                         EUR




their yen-crosses higher. The additional cushion of in-the-
money strikes increases the odds of positive payoff from
these options without sacrificing much by way of leverage.




                                                                                                                                                       47
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.



Research Note
Euro: caught between the two grand experiments
                                                               Chart 1: US vs. Europe: Headline deficits exceed 5% of GDP the US,
•    The euro has always been an experimental                  the European core and the periphery
     currency. Its creators hoped a common currency            % of GDP, primary deficits are net of interest payments
     would deepen political integration, while its
                                                                  0%
     detractors considered monetary union without fiscal
                                                                  -2%
     union to be self-destructive. Greece almost proved
                                                                  -4%
     the euro skeptics right early in 2010, until Europe
                                                                  -6%
     countered with the EFSF.
                                                                  -8%
•    This monetary/fiscal experiment is not over, but           -10%
     neither are policy experiments unilateral. Europe’s        -12%                         2009            2010       2011f
     test is whether it can manage another year of              -14%
     peripheral financing with an unproven, temporary           -16%
     liquidity facility (EFSF). The US’s is whether it can




                                                                                                    France




                                                                                                                                               Greece
                                                                                   Germany




                                                                                                                Italy




                                                                                                                                    Portugal
                                                                          US




                                                                                                                            Spain




                                                                                                                                                        Ireland
     delay fiscal tightening and pursue inflation targeting
     without triggering a run on the world’s reserve
     currency.
                                                               Source : J.P. Morgan, OECD
•    Neither trial will run smoothly, which implies a
                                                               Chart 2: US vs. Europe: Primary deficits still exceed 5% of GDP in
     much more erratic path on EUR/USD than with               the US, France, Spain and Ireland
     other major currencies in 2011. But since Europe is       % of GDP, primary deficit is headline balance less interest payments
     more advanced in curbing deficits, EUR/USD
                                                                  0%
     weakness should be concentrated in Q1. Assuming
     rapid disbursement from the EFSF, the euro should            -2%

     recouple with the dollar trend.                              -4%
                                                                  -6%
•    Euro crosses should weaken, but more narrowly
                                                                  -8%
     than last year. Vols are fairly priced, but owning 2-
     yr EUR/USD is a better hedge than other pairs and          -10%
                                                                                       2009             2010        2011f
     tenors.                                                    -12%
                                                                -14%
•    A simple momentum model on EUR/USD continues
                                                                                                    France




                                                                                                                                               Greece
                                                                                   Germany




                                                                                                                Italy




                                                                                                                                    Portugal
                                                                          US




                                                                                                                            Spain




                                                                                                                                                        Ireland
     to signal short-term turns well.
•    Forecasts: EUR/USD 1.40 in Q1, 1.45 in Q3 and 1.48
     in Q4.
                                                               Source : J.P. Morgan, OECD
•    Risks around forecast: Balanced between European
                                                               sustain rollover risk for at least the next year, generating
     and US funding risks.
                                                               recurring credit stress in Europe and motivating asset
                                                               purchases in the US. Europe’s test is whether it can manage
The euro has always been an experimental currency. Its         financing strains in the periphery with an unproven,
creators considered monetary union the avenue towards          temporary liquidity facility. The US’s is whether it can
political integration, while its skeptics considered unified   delay fiscal tightening and pursue inflation targeting
monetary policy without common fiscal policy to be the         without triggering a run on the world’s reserve currency.
road to self-destruction. Greece almost proved the
euroskeptics right, until Europe launched a €750bn liquidity   Neither trial will run smoothly, which implies a much
pool (EFSF) as a temporary patch to EMU’s fatal flaw.          more erratic path on EUR/USD than with other major
                                                               currencies. Europe’s most difficult period runs through Q1
This monetary/fiscal experiment is not over, but neither are   2011, after which focus should return to the US. Expect
policy experiments unilateral. As discussed in the             EUR/USD to move within a volatile range in late
introduction (Global FX Strategy 2011: Unfinished business     2010/early 2011 before rejoining broader trend of strength
on page 4), G-10 fiscal deficits are so large that they will   against the dollar (Q4 2011 target: 1.48). The euro should
                                                               underperform on the crosses but not as broadly as in 2010.

48
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


Vols are priced fair to marginally rich at present, and         Chart 3: Portugal’s redemptions schedule is more challenging than
owning 2-yr is the most efficient hedge for event risks. A      Ireland’s, with almost €30bn to roll by mid-2011
                                                                Portuguese bond (principal, interest), t-bill and bank redemptions by month, €bn
simple rate momentum model provides decent signals for
short-term turns.                                                9
                                                                                                                                                                               Banks
                                                                 8
Fiscal payback defines EUR/USD’s path                                                                                                                                          Bonds
                                                                 7
Fiscal payback will define EUR/USD’s path over the next          6                                                                                                             T-Bills
year because deficits are still large enough in the periphery    5
and in the US to sustain refinancing risk, in turn requiring     4
extraordinary policy responses from Europe and the US.           3
Although down from record highs in 2009, headline deficits       2
still exceed 5% of GDP throughout Europe and the US              1
(chart 1) and primary deficits exceed 5% of GDP in the US,       0
Ireland, Spain and France (chart 2). For most countries,




                                                                                                                                                                            Nov-11

                                                                                                                                                                                        Dec-11
                                                                         Jan-11




                                                                                                                   May-11

                                                                                                                             Jun-11

                                                                                                                                       Jul-11




                                                                                                                                                                   Oct-11
                                                                                    Feb-11

                                                                                               Mar-11

                                                                                                         Apr-11




                                                                                                                                                 Aug-11

                                                                                                                                                          Sep-11
current deficits still exceed those of any year prior to the
credit crisis, which is why refinancing risks remain
considerable.
Unsurprisingly, the euro tends to weaken around months of
with heavy sovereign redemptions (Greece in spring 2010,        Chart 4: Spanish bank rollovers exceed government’s in H1
                                                                Spanish bond (principal, interest), t-bill and bank redemptions by month, €bn
Spain in June 2010) or policy uncertainty (the region in
November 2010) given the credit risk created by higher           35
rates in the periphery. This issue will recur in 2011 given      30
that sovereign redemptions are very heavy for Portugal                                                                                                                               Banks
                                                                 25
during the first four months of 2011 (chart 3). Spain’s                                                                                                                              Bonds
sovereign redemptions are clustered in May, August and           20
                                                                                                                                                                                     T-Bills
October, but bank refinancing is very heavy in March and         15
April (chart 4). Ireland’s government bond redemptions are
                                                                 10
comparatively light (chart 5), but still difficult to manage
when banking sector liabilities are unknown.                         5
                                                                     0
The US would face the same threat from a disorderly bond
                                                                           Jan-11




                                                                                                                    May-11




                                                                                                                                                                            Nov-11

                                                                                                                                                                                       Dec-11
                                                                                                                              Jun-11

                                                                                                                                        Jul-11




                                                                                                                                                                   Oct-11
                                                                                      Feb-11

                                                                                                Mar-11

                                                                                                          Apr-11




                                                                                                                                                 Aug-11

market were it not for Fed asset purchases, which will                                                                                                    Sep-11
absorb 100% of net Treasury issuance in the first half of
2011. But while Fed purchases limit spike risk in rates, they
lower real yields through lower nominal rates, higher
inflation expectations or both, a dynamic which is dollar-
negative. Thus it is difficult to sidestep currency weakness    Chart 5: Ireland has only €11bn of rollovers in H1 and has prefunded
                                                                Irish bond (principal, interest), t-bill and bank redemptions by month, €bn
during fiscal consolidation: the currency falls either due to
recurring credit stress or lower real yields. The only           6
                                                                                                                                                              Banks
currency-positive scenario involves a loan or fiscal transfer    5                                                                                            Bonds
from stronger to weaker sovereigns. This option prevents a
                                                                                                                                                              T-Bills
liquidity squeeze without cheapening the currency through        4
an increase in money supply, which is why a sovereign
                                                                 3
tapping the EFSF should be seen as euro-positive.
                                                                 2
Modeling the scenarios: 1.25 and 1.45
                                                                 1
Questions around how often the EFSF will be tapped and
how many assets the Fed should purchase will persist             0
throughout 2011. If these issues played out simultaneously,
                                                                                                                   May-11




                                                                                                                                                                            Nov-11

                                                                                                                                                                                       Dec-11
                                                                         Jan-11




                                                                                                                             Jun-11

                                                                                                                                       Jul-11




                                                                                                                                                                   Oct-11
                                                                                    Feb-11

                                                                                               Mar-11

                                                                                                         Apr-11




                                                                                                                                                 Aug-11

                                                                                                                                                          Sep-11




the euro would move little, or simply randomly. More likely
these issues will be unsynchronized and the turns in
EUR/USD policy dependent, an environment which thus
requires scenario analysis around major policy hurdles. The
regression in chart 6 highlights EUR/USD’s sensitivity to

                                                                                                                                                                                                 49
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


peripheral spreads, Euro-US rates and volatility, and the          Chart 6: Every 100bp of spread widening in the peripery is worth 4
coefficients inform two scenarios we first proposed when           cents on EUR/USD, as is every 10 point rise in equity volatility
                                                                   EUR/USD spot regressed on Euro – US rate spreads (x1), average 5-yr peripheral
the peripheral bond markets began to fall in early November        spreads to Germany (x2) and VIX (x3). Sample period is 2005-2010, daily data.
(see Does the periphery still matter for the euro?, FX              Y - (-0.0004 X2 - 0.0040 X3)
Markets Weekly, November 5, 2010).The euro moves about              1.8
                                                                           Y = 0.0012 X1 - 0.0004 X2 - 0.0040 X3 + 1.4844
4 cents for every 100bp change in peripheral spreads, 1 cent
                                                                    1.7 R² = 88.33%
for every 10bp change in Euro- US spreads and 4 cents for                  standard error = 0.0353
every four-point change in equity volatility (chart 6). The         1.6
bearish scenario would involve failed auctions, missed              1.5
fiscal targets, double-dip recession from high rates and a
slow, uncoordinated European response. EUR/USD would                1.4
fall to 1.25 given the resulting 200bp widening in periphery        1.3
spreads, 20bp of Euro-US spread narrowing, and 10 point
                                                                    1.2
rise in equity volatility. The bullish scenario would involve
a rapid request for and approval of EFSF funding, which in          1.1
turn would tighten peripheral spreads some 150bp, widen                  -250 -200 -150 -100 -50      0    50 100               150    200    250
Euro-US spreads another 15bp and lower equity vol by                                        EU - US 1mo 12mos fwd
around three points to 15% on the VIX. That outcome
would strengthen EUR/USD to 1.45.                                  Chart 7: EUR/USD versus rate momentum signals on the euro
                                                                   Signals: 1 indicates a buy for euro because Euro - US rate spreads are widening in
Our view on which scenario will unfold by March 2011 is            euro’s favor. -1 indicates a sell for euro because spreads are narrowing in favor of
unchanged: another sovereign could tap the EFSF; the euro          the US.
will remain volatile within a range until Europe proves that         1                                                                           1.55
it will honor a second funding request; and sovereign access
                                                                                                                                                 1.50
to a liquidity pool with conditionality will lead to euro
strength as credit risk recedes and focus returns to the                                                                                         1.45
dollar’s liabilities. Hence the forecast for an eventual rise in                                                                                 1.40
EUR/USD toward 1.48 by year end – 1.45 baseline, 1.48                0                                                                           1.35
accounting for the dollar undershoot discussed in the global
                                                                                                                                                 1.30
outlook on page 4 – even though the monthly path will                                        signal: 1 = buy, -1 = sell
remain quite erratic.                                                                                                                            1.25
                                                                                             EUR/USD, rhs
                                                                                                                                                 1.20
A simple momentum model for EUR/USD
                                                                    -1                                                                           1.15
As ludicrous as it may sound to discuss quantitative models          Jan-09      May-09      Sep-09       Jan-10      May-10     Sep-10
in the context of an unprecedented policy environment, note
that some simple, standard frameworks continue to flag             tactically-oriented, its signals are reported each week in the
short-term movements in EUR/USD fairly well. For                   Model-driven strategies section of FX Markets Weekly.
several years we have used rate momentum to generate
                                                                   The longer-term issues: who exits first, how much
signals on major currency pairs, since shifts in rate spreads
                                                                   is discounted
capture all manner of macro events such as shifts in growth
momentum or monetary policy (see Alternatives to standard          The longer-term issue for the euro concerns which
carry and momentum, Normand, August 8, 2008). And as               region can reduce its refinancing risk more quickly, and
unprecedented as the European sovereign crisis has been, its       whether a currency has discounted the payback process
macro impact filters into Euro-US rate spreads by                  already. On both issues Europe and the euro look more
depressing European growth and rate expectations relative          advanced. Charts 8 and 9 compare primary positions in the
to the US.                                                         US and Europe since 2007 to the historic norm during
                                                                   major OECD deficit consolidations over the past four
The trading rule to capture this dynamic buys EUR/USD
                                                                   decades, as first outlined in the introduction (see Global FX
when Euro-US rate expectations rise over the past month,
                                                                   Strategy 2011: Unfinished business on page 4).
and sells it when the rate gap narrows (chart 7). Signals
were bearish from January to February, bullish in March,           Major consolidations are defined as movements in the
bearish from April to June and bullish from June through           primary deficit from at least 3% of GDP to balance. On
mid-November. Admittedly this models is purely                     average that process requires five years to achieve. It
contemporaneous and is not a forecasting tool, but for the         typically prompts central bank easing of 120bp, a bond
                                                                   market rally of about 200bp and nominal exchange rate

50
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


declines of 15%. The dark blue lines in charts 8 and 9 trace     Chart 8: Primary balance during major OECD fiscal consolidations
the average path of primary balances during these major          x-axis shows years before and after fiscal consolidation, where year zero marks
                                                                 widest primary deficit.
consolidations, with zero marking the year in which the
deficit troughs and +1 indicating one year after. The path                                 0%

for the US and peripheral Europe is also shown, with 2009                                  -2%
being year zero when primary deficits hit their widest




                                                                  primary balance
levels. Judged by primary deficits the US runs second to last                              -4%                                              average since 1970
in fiscal progress: 8.8% of GDP, compared to 9% for                                        -6%                                              US (current cycle)
Ireland, 8% for Spain and 4% for Portugal and Greece.
                                                                                           -8%                                              Greece (current cycle)
The euro has also fallen more than is typical during
fiscal tightening: is it down 4% since deficits troughed in                          -10%
2009, compared to a flat performance for the dollar (chart                                       -2   -1        0        1         2        3         4          5

10). This move may seem small relative to Europe’s                                                          years around trough in primary deficit
funding risk, but note that since the periphery accounts for
less than 20% of Euro area GDP, the euro’s fall should be
less than the historical norm if only a fraction of the region   Chart 9: Primary balance during major OECD fiscal consolidations
                                                                 x-axis shows years before and after fiscal consolidation
bears the impact of fiscal tightening. The counter argument
is that the euro should fall much more than the norm                                       6%
because debt restructuring is inevitable in one or more                                    3%
sovereigns. Whether it is inevitable veers into a discussion                               0%
                                                                  primary balance



on long-term debt sustainability, which is beyond the scope
of this note. Suffice it to say that the odds of a debt                                    -3%
                                                                                                                                            average since 1970
restructuring before the EFSF expires in 2013 are extremely                                -6%
                                                                                                                                            Portugal (current cycle)
low, since no country would willingly invite this dislocation                              -9%
                                                                                                                                            Spain (current cycle)
when it has recourse to interim financing. And if debt
                                                                                       -12%
restructuring is an issue for 2014, a currency outlook would                                                                                Ireland (current cycle)
have to be conditioned on so many other factors that any                               -15%
scenario analysis would be pure guesswork.                                                       -2    -1           0        1         2        3         4           5
                                                                                                             years around trough in primary deficit
Euro crosses: narrower weakness in 2011
In 2010 sovereign stress delivered a very rate event: euro
weakness on all crosses, whether European, commodity-
linked, Latam or Asia. Table 1, which lists annual spot
returns for benchmark currencies since the euro’s inception      Chart 10: Nominal FX rates during major OECD fiscal consolidations
                                                                 x-axis shows years before and after fiscal consolidation, where year zero marks the
in 1999, highlights how unusual such broad                       widest primary deficit. Exchange rates indexed to 100 in year zero when primary
underperformance is. NOK has never decoupled from the            deficit troughs. Fall in index indicates currency depreciation.
euro’s performance versus the dollar (table 1). NZD, GBP
                                                                                           110
and INR diverged once (8% of observations); AUD and                                                                          nominal FX index, average since 1970
CHF twice (17%); BRL three times (25%); and CAD and                                                                          USD trade-weighted (current cycle)
                                                                                           105
                                                                       nominal FX, index




KRW four years in twelve (33%).The reason is simple:                                                                         EUR trade-weighted (current cycle)
most global currency trends are a dollar phenomenon given
that the US typically leads the global monetary cycle or                                   100

delivers the credit shocks which motivate global capital
flows. The two exceptions to this rule of American                                          95
leadership were the sovereign credit crisis of 2010, and
German Reunification/the ERM crisis.                                                        90
                                                                                                 -2    -1           0        1         2        3          4
From a top-down perspective, the euro’s performance on                                                       years around trough in primary deficit
the crosses reduces to a call on whether the sovereign crisis
will drive trend euro weakness in 2011 as it did in 2010.
Our view is that it won’t, which implies much lower odds of
such a broad decline in the euro crosses. The bottom-up
approach to the euro crosses is more sensible. Given that


                                                                                                                                                                          51
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


their performance has been well correlated with shifts in       Table 1: Decoupling from the dollar trend is rare
rate expectations, the euro crosses which should decline are    Annual changes in spot FX rates vs. USD. Shaded blocks indicate directional
                                                                decoupling between EUR/USD and other pairs
those where rates are biased upwards versus the Euro area
                                                                        EUR     GBP      CHF     SEK    NOK    CAD     AUD    NZD     BRL    MXN      KRW
(CHF, SEK, NOK, CAD, AUD), whereas the crosses which
                                                                1999     -14%     -3%    -14%     -5%    -6%     6%      8%     -2%   -33%      4%     6%
should rise are those were rates are biased lower versus
                                                                2000      -6%     -8%     -1%    -10%    -9%     -4%   -15%   -15%     -8%     -1%    -10%
Europe (GBP, JPY, possibly NZD).
                                                                2001      -6%     -3%     -3%    -10%    -2%     -6%    -9%     -6%   -16%      5%     -4%
Euro volatility: better value in the long dates                 2002      18%    11%      20%    21%    29%      1%    10%     26%    -35%    -12%    11%
                                                                2003      20%    11%      12%    21%     4%      21%   34%     25%     22%     -8%     -1%
Despite the events risks around EUR/USD, volatility is not      2004       8%     7%      9%      8%    10%      8%      4%    10%      9%      1%    15%
an obvious buy at current levels. Across nine euro pairs, vol   2005     -13%    -10%    -13%    -16%   -10%     3%     -6%     -5%    13%      5%     3%
premia are close to their medium run average, whether           2006      11%    14%      8%     16%     8% -0.3%        8%     3%      9%     -2%     9%
measured in absolute or standardized terms (chart 11) for       2007      11%     1%      8%      6%    15%      17%   11%      9%     20%     -1%     -1%
most tenors. There is no urgency to hedge now, since the        2008      -4%    -26%     6%     -17%   -22%   -18%    -20%   -24%    -23%    -20%    -26%
sovereign crisis will run through so many iterations that vol   2009       3%    11%      4%      9%    20%      16%   28%     25%     33%      4%     8%
premia will likely compress as Ireland is addressed, and        2010      -5%     -1%     5%      4%     -4%     3%      9%     7%      1%      6%     3%
before Spain becomes a potential focal point next spring.
For those inclined to pre-position, owning 2-yr EUR/USD         % decouple        0%      17%     8%     0%      33%   17%      8%     25%     67%    33%

vol is compelling because it decays less than the 1-yr, and
slides positively along the vol curve. (The EUR/USD vol         Chart 11: Vol premia across euro pairs is at average levels, so not a
                                                                compelling hedge against event risks
curve is inverted across tenors 1-yr and out, compared to       Vol premia measured as difference between implied (1-yr) and realized (3-mo) volatility in
positively-sloped curves for EUR/JPY and EUR/commodity          absolute terms (%) and standardized terms (z-score). Time series shows the average vol
FX).                                                            premium for seven euro pairs: EUR/USD, EUR/JPY, EUR/GBP, EUR/SEK, EUR/NOK,
                                                                EUR/CHF, EUR/CAD, EUR/NZD and EUR/AUD.
For those able to trade longer-tenor options, the 5-yr and
                                                                  4%                                                                                   3
10-yr offer additional benefit along these dimensions if the
                                                                                 absolute, lhs          z-score, rhs
tail risk is a run on the dollar due to debt monetization. In     2%                                                                                   2
this instance spot and interest rate differentials would                                                                                               1
decouple (lower dollar, high long-end US rates) and lead to       0%
                                                                                                                                                        -
increased volatility of the forward outrights – longer the        -2%
tenor, greater the benefit. Levels permitting, legging into                                                                                           -1
back-end vols either outright, or funded through shorter          -4%
                                                                                                                                                      -2
tenor options in calendar spread structures that exploit the      -6%                                                                                 -3
inversion of the vol curve in longer-dates should remain
strategic trades for 2011.                                        -8%                                                                                 -4
                                                                    Mar-07              Mar-08          Mar-09            Mar-10             Mar-11
Risks: balanced between Euro and US funding
risks
                                                                The ECB should also end non-standard lending measures
The risk of further Fed QE represents the greatest upside       before January – it currently grants full allotment at 1-week
risk to the baseline EUR/USD forecast. This issue is            and 3-mo tenors, with the last 3-mo auction on December
discussed extensively in the global FX outlook on page 4,       23. It could always decide to extend full allotment given the
so is not repeated here.                                        periphery’s reliance on ECB funding (chart 12). But since it
The downside risks stems from the fragile funding situation     views banking (and sovereign) weakness as a fiscal
in Europe. A funding crisis in Spain could result from          responsibility, it is more likely to revert to the pre-crisis
missed fiscal targets or evidence of a double-dip recession     policy of auctioning fixed amounts, in an attempt to shift
(Q4 2010 GDP release is due February 15, 2011). But a           the bank financing burden back to sovereigns. Unless
self-fulfilling funding crisis will take root in Spain less     peripheral banks are capitalized to the point where they can
easily than in Greece, Ireland or Portugal, where non-          borrow sufficiently on the primary market, the risk is that
residents held 70-80% of the bond market. Foreign               declining ECB funding forces bank deleveraging and credit
ownership of the Spanish bond market is 45%, the third          contraction in economies which are already in or near
lowest in the G-10 after the UK (30%) and Japan (6%). A         recession. That prospect would be euro-bearish. Thus even
number of other smaller event risks – additional                in a year when the ECB will be taking no action on rates, its
downgrades, the Italian government falls – are possible but     management of non-standard measures remains material for
should not be trend turners.                                    EUR/USD.


52
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


The possibility of freely-floating emerging market               Chart 12: Percentage of bank assets funded through ECB borrowing
currencies is often seen as euro-negative, and a reason to        20%
sell euro/Asia and euro/Latam. Certainly such a move              18%                                                      Greece
would end reserve diversification, but as discussed in the
                                                                  15%
global FX outlook on page 4, the rest of the world is not
ready for freely floating currencies because they realize that    13%
                                                                                                                           Ireland
Fed policy would deliver a much weaker dollar for at least        10%
the next year. Even if some larger EMs did float, the euro-        8%                                                      Portugal
negative impact from less reserve diversification is only one      5%
capital flow.                                                                                                              Spain
                                                                   3%
                                                                   0%
                                                                     Jan-08   Jul-08   Jan-09   Jul-09   Jan-10   Jul-10   Jan-11




                                                                                                                                      53
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.



Research Note
Sterling: The half empty glass
                                                               Chart 1: Economic healing is less advanced in the UK than in any
•    2010 was a year of choppy consolidation for GBP,          other major economy
     reflecting a balance of conflicting forces – a sluggish   GDP: 100= 2007 Q2
     recovery vs high inflation; fiscal credibility vs the
                                                                106
     economic consequences of consolidation; currency
     undervaluation vs a deteriorating trade position;          104                                                    Australia
     negative real interest rates versus safe-haven             102
     spillover form Euro area stress.                                                                                   Sw itz.
                                                                100
                                                                                                                             US
•    2011 offers little immediate respite from these             98                                                          EUR
     countervailing pressures, but our bias remains for
                                                                 96                                                        UK
     moderate GBP depreciation.
                                                                 94
•    Deleveraging and the pressure this places on both                                      Japan
                                                                 92
     growth and interest rates remains a key component
     of our bearish GBP view. The deleveraging story is          90
     tracking, as evidenced by the decline in GBP’s                   07Q2   07Q4    08Q2    08Q4   09Q2    09Q4    10Q2
     interest rate support to multi-decade lows. We see
     no material recovery in GBP until GBP can shed its        weak UK growth and interest rates, and the bulls, who
     funding currency status.                                  emphasized the more constructive features for the currency
                                                               such as its cheap valuation. Neither camp is likely to land
•    Deleveraging steps up a gear next year as the             the decisive blow in coming months; nonetheless, we
     government starts to deliver its back-loaded fiscal       believe that the broad framework we have laid-out for
     consolidation. The new government may have                sterling over the past year remains valid and that GBP’s
     neutralized the risk of a fiscal crisis and an abrupt     ongoing transition from investment to funding currency will
     depreciation in GBP, but the economic price of this       drag on the trade-weighted exchange rate on average
     fiscal credibility will soon fall due.                    through the course of 2011.
•    High UK inflation complicates the macro policy            There is less extreme negative tail-risk now in GBP, in large
     outlook in the UK and justifies a risk premium in         part because the new coalition government has averted an
     GBP vols, albeit less than the fiscal risk premium        outright fiscal crisis with its ambitious, albeit back-loaded,
     prior to the election.                                    plans for reducing its deficit, in contrast obviously to the
•    Inflation has been to GBP’s short-tem benefit, as it      euro area periphery, which has lurched from one crisis to
     has prevented QEII, and constitutes a key risk to         the next. In addition, inflation has tamed the BoE’s more
     our bearish GBP view should the BoE be forced to          dovish leanings and kept additional quantitative easing at
     tighten policy to combat inflation. That said, we         bay. Nonetheless, the central scenario is still one in which
     would regard a defensive rate hike allied to fiscal       UK growth and interest rates (both nominal and more
     consolidation as a threat to growth and not the basis     particularly real) remain relatively low for relatively longer
     for durable GBP appreciation.                             in the face of disproportionate deleveraging in many key
                                                               areas of the UK economy (households, banks and the
•    GBP is one of the cheapest currencies in G-10 (10%        increasingly the public sector).
     cheap to our fair-value model). A protracted
     undervaluation can be justified both cyclically (the      This relatively downbeat view of UK growth and interest
     low-for-longer outlook for growth and interest            rate prospects has very much tracked developments over the
     rates) and by the lack of a 1992-style export-led         past year (charts 1 and 2) and we would expect that
     rebalancing in the economy.                               relatively weak cyclicals will remain a feature for GBP
                                                               through much of next year. Sterling pre-crisis was very
•    EUR/GBP to peak just below 0.90 in H2.                    much characterized as a relatively high-growth, high yield
                                                               investment currency that tended to trade above its long-run
GBP’s long journey to funding currency status                  fair-value. The opposite side of the coin is now showing:
                                                               GBP as an undervalued funding currency rather than an
2010 has proved an indecisive year for sterling, frustrating   overvalued investment currency.
both the bears, such as ourselves, who have emphasized

54
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


GBP’s undervaluation justified by historically low               Chart 2: If it walks and talks like a funding currency…
interest rates                                                   2Y swap rate differential: UK minus the average of major industrialized economies.

                                                                      6
One of the key areas of disagreement between GBP bulls
and bears relates to the relative significance one should to          5                                   Weighted
attach to the UK’s weak cyclical position on the one hand             4                                   Non-w eighted
and the fact that sterling is heavily undervalued following
                                                                      3
its 30% slump in 2007-2008 on the other. Does the latter
not already compensate for the former, and is sterling not            2
therefore a potential candidate to appreciate as economic             1
healing proceeds, no matter how slowly this occurs?                   0
We shall discuss a little later whether sterling can truly be     -1
regarded as a functionally cheap currency, to the extent that     -2
the undervaluation is either boosting growth or driving an
                                                                        Aug-90                   Aug-94        Aug-98          Aug-02         Aug-06          Aug-10
improvement in the UK’s external accounts. But first we
should calibrate how much of GBP’s apparent
undervaluation can be explained by the UK’s relatively           Chart 3: Deviations in GBP from long-run fair value are cyclical and
weak cyclical backdrop – this can be done by estimating the      can be explained by UK-global interest rate differentials
relationship between GBP’s deviation from fair-value and         The chart plots the residuals of GBP’s TWI from JPM’s estimate of long-run fair
the average short-term interest rate differential between the    value against the average 2Y swap spread between UK and developed economies
UK and other developed economies (using the latter as                                            GBP: Dev iation from long-run fair v alue, lhs, %
                                                                      15                                                                                           4
catch-all proxy for the relative cyclical position of the UK                                     GBP- av erage dev eloped country 2Y sw ap spread, rhs
versus the global norm).                                              10                                                                                           3
The relationship is presented in charts 3 and 4. As should be                   5
                                                                                                                                                                   2
apparent, interest rate differentials do indeed explain the                     0
lion’s share, some 70%, of the deviation of sterling from its                                                                                                      1
                                                                          -5
long-run fair-value. The sensitivity is such that every 1%
                                                                                                                                                                   0
shift in the average interest rate differential pushes GBP        -10
some 5% away from fair-value, meaning that the 40bp               -15                                                                                              -1
deterioration in GBP’s average interest rate differential over
the past year should have depressed GBP by some 2.5%              -20                                                                                              -2
relative to fair-value. As rates currently stand GBP is some                        Aug-90 Aug-93         Aug-96     Aug-99    Aug-02     Aug-05     Aug-08
2.5% richer than this cyclical relationship would suggest.
So yes, GBP’s TWI may be undervalued from a long-term
perspective (by 10%), but it should be even more                 Chart 4: GBP should be even more undervalued versus fair-value
undervalued (12.5%) given the negative spread that exists        (12.5% not 10%) given current interest rate spreads
between short-term UK and foreign interest rates.                The chart plots the residuals of GBP’s TWI from JPM’s estimate of long-run fair
                                                                 value on the horizontal axis against the 2Y swap spread between the UK and an
                                                                 average of developed economies on the vertical axis.

                                                                                                                                   4.0
                                                                   GBP- G10 2Y swap spread, %




                                                                                                 y = 0.1365x + 1.5729
                                                                                                       R 2 = 0.6801                3.0

                                                                                                                                   2.0

                                                                                                                                   1.0

                                                                                                                                   0.0
                                                                                                                     Latest
                                                                                                                                   -1.0
                                                                                           -20   -15          -10             -5          0            5           10

                                                                                                 Dev iation of GBP's TWI from long-run fair-v alue, %




                                                                                                                                                                        55
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


GBP and the global cycle – should GBP be less pro-                  Chart 5: GBP has been quite sensitive to the global business cycle
cyclical than in the past?                                          The chart details the results from bilateral regressions of TWI exchange rates on
                                                                    the global PMI over the past 10 years. The R squared denotes closely of fit of the
Sterling historically has tended to behave as pro-cyclical          relationship; the beta the sensitivity of the currency w.r.t the global PMI.
currency, one that tends to appreciate when the global                            2.0
economy is doing well and vice versa. This can be                                                                  NZD
illustrated in chart 5, which plots the sensitivity between                       1.5
various currencies and the global PMI. The performance in                                            AUD
                                                                                  1.0




                                                                       Beta PMI
GBP over the past year fits easily within this framework,                                                                                      CAD
                                                                                                                         GBP
the broad consolidation in GBP matching the stagnation in                         0.5
the global PMI, as indeed does our forecast for next year,                                NOK                                                SEK
                                                                                           EUR
whereby modest sterling depreciation is expected to occur                         0.0      JPY
alongside a modest slowdown in global growth.
                                                                                  -0.5        USD
A stronger global expansion could yet jeopardize our
                                                                                         0%            10%             20%             30%           40%
negative view on GBP, although in view of the domestic
headwinds that are expected to weigh on UK growth,                                                                  R squared
especially as fiscal tightening bites, it is not clear to us that
GBP will remain as closely tied to the global business cycle
as it was during the pre-crisis boom and subsequent bust.           Chart 6: GBP’s correlation to equities has fallen to zero over the past
After all, the UK economy was hit especially hard during            year – consistent with GBP’s transition to funding currency
the global recession yet has fallen behind in the global            GBP’s correlation to the S&P500 is based on daily changes over a rolling 1Y
                                                                    period. The correlation is shown against GBP’ average 2Y interest rate differential.
recovery, hence the inexorable contraction in UK-global
interest rate differentials since the banking crisis struck in        300                     2Y UK-dev eloped country sw ap differential, %, lhs     0.3
2007. If UK-global rate differentials have ceased to be                                       1Y rolling correlation betw een GBP and S&P500
                                                                      250
directional with the global business cycle, shouldn’t the                                                                                             0.2
exchange rate decouple as well?                                       200

                                                                      150                                                                             0.1
Once again this gets back to our core hypothesis – GBP
transitioning from a high-to low-beta currency. As a result,          100                                                                             0
not only should GBP become less sensitive to the global
                                                                       50
cycle, it should become less sensitivity to the broader                                                                                               -0.1
fluctuations in risk markets. Chart 6 highlights that this              0
broader decoupling from equities is already underway –                -50                                                                             -0.2
sterling’s correlation with the S&P500 has fallen to zero
                                                                         Aug-99                 Aug-02            Aug-05            Aug-08
over the past year.
Fiscal consolidation and the credit squeeze still an
issue for GBP                                                       Chart 7: Growth in UK mortgage lending has fallen to a new all-time
                                                                    low; house prices are starting to decline to reflect this
Deleveraging is an issue for most western economies, but as         Trends in mortgage lending explain 50% of the change in house prices over the
we set out in the 2010 Outlook last November, the UK is             past decade. 1% on credit growth is worth 2% on house prices.
very much at the leading edge of deleveraging in a number                                     Secured bank loans to households, % oy a, lhs
of key areas. Households have barely started the process of                                   Halifax house prices, % oy a, rhs
                                                                     15%                                                                             40%
deleveraging, to the extent that the household/debt ratio hit
a new record high of 110.4% in Q1 and is still 35% above
its decade-ago level despite a 2 point drop in Q2. A recent                                                                                          20%
                                                                     10%
BIS study found that economy-wide debt ratios fall by
nearly as much following a banking crisis as they rose pre-                                                                                          0%
crisis, on which basis the UK has a lot of deleveraging
                                                                       5%
ahead of it.                                                                                                                                         -20%


                                                                       0%                                                                            -40%
                                                                           Jan-99         Jan-01     Jan-03     Jan-05     Jan-07     Jan-09




56
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


The credit cycle has been a central component of the UK           Chart 8: GBP has been highly correlated to UK house prices. GBP is
business cycle. Ongoing weakness in bank lending – an             5% rich following the drop in house prices in recent months
                                                                  GBP TWI vs UK house price inflation over the past 5 years. The R2 of the
outright contraction corporate loans (-3% oya) and the            regression over this period is 88%; that over 10 years is 60%.
lowest ever rate of mortgage lending– questions the
capacity of the private sector to offset consolidation in the                           y = 0.7601x - 0.0489              10%
public sector. And failing a turn in credit expansion, the                                       R 2 = 0.8755              5%
recent decline in house prices is liable to intensify. Credit                                                                    Latest
                                                                                                                           0%




                                                                    GBP TWI, % oya
trends explain 50% of the change in house prices over the
past decade (chart 7), all of which matters for the exchange                                                               -5%
rate because housing and GBP are similarly intertwined -                                                                  -10%
house prices explain nearly 90% of changes in GBP over
                                                                                                                          -15%
the past 5 years (chart 8). After the recent drop in house
prices, GBP is currently 5% too expensive.                                                                                -20%

Fiscal policy has loomed large for GBP over the past year.                                                                -25%
We set out two scenarios for the UK’s sizeable deficit to                            -20%        -15%      -10%       -5%       0%       5%          10%    15%
weaken the currency – either through an abrupt fiscal crisis,                                                 Halifax house prices, % oy a
should the new government fail to convince the markets and
ratings agencies that it had a credible plan for reducing the
deficit, or slow-burning pressure on the currency through         Chart 9: GBP can’t have dodged a fiscal bullet that has yet to be
                                                                  fired
the economic squeeze which fiscal consolidation would             Annual incidence of fiscal consolidation as a percent of cumulative discretionary
entail. The coalition government has played a deft hand so        measures planned for 2010-2015 (GBP 113bn)
far, promising enough future consolidation to ensure against
                                                                    30%
a crisis of confidence, while delivering sufficiently little to
protect the economy.                                                                                                       Spending            Tax
                                                                    25%
But in fiscal policy as in life there is no free lunch and
                                                                    20%
having bought fiscal credibility on the cheap, the economic
bill will soon fall due. On the government’s medium-term            15%
plans set out in the budget, FY 2011-2012 will be the single
most severe year for fiscal retrenchment, following the             10%
current fiscal year which delivers the least tightening (chart
9). The resilience of the economy and GBP to an inevitable              5%
unwinding of government support will soon be tested.
                                                                        0%
GBP and the BoE’s exquisite dilemma                                                         2010-11         2011-12       2012-13         2013-14      2014-15
There is no doubting the UK’s uniquely poor inflation             Source: HM Treasury; J.P. Morgan
performance (chart 10). Even if one allows for the VAT
hike at the start of this year (which has added around 0.5%       Chart 10: The UK is delivering uniquely high inflation
                                                                  Core CPI: Current and current minus 10Y average
to CPI), the UK is the only developed economy where core
CPI is above its 10Y average, and then some.                          4%
                                                                                                     Current      Current minus 10Y av g
Is inflation good or bad for a currency? The long-term                3%
impact is fairly unambiguous, as excess inflation erodes the
purchasing power of the currency and results in nominal               2%
exchange rate depreciation (the basic purchasing power
                                                                      1%
parity framework). In the short-term, however, the answer is
more ambiguous, and depends in large part on the response             0%
function of the central bank – will the central bank choose
to accommodate or fight inflation?                                  -1%

So long as the BoE was willing to accommodate inflation             -2%
in the interests of economic recovery one could argue that
                                                                                            US     AUD      NZD     CHF    NOK      EUR     CAD      SEK   UK
the UK’s unique inflation problem should have biased the



                                                                                                                                                                 57
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


exchange rate lower, not least because this confined the          Chart 11: Are GBP yields attractive? Get real
UK’s real interest rates to the bottom of the developed           Central bank policy rate minus core CPI
world league table (chart 11). This was very much the               4%
situation up until a month or two ago, since when the
balance of opinion on the MPC has turned more cautious on           3%
the outlook for inflation, and hence less eager to ease policy      2%
further to support the real economy. GBP has thus been
                                                                    1%
spared QEII and the subsequent upgrading of UK interest
rate expectations has served to boost the currency.                 0%

J.P.Morgan's central view now is that the conflicting forces        -1%
on monetary policy (growth vs inflation) will perpetuate the
                                                                    -2%
policy status quo over the coming year. There is still greater
risk of additional easing but we do not discount the                -3%
possibility that the Bank hikes at some point next year                      UK      US       CAD     EUR     SEK    CHF     NOK      NZD     AUD
(although the 60% odds which the market attaches to a net
50bp hike seem excessive).
Uncertainty over fiscal policy and the potential for a fiscal     Chart 12: EUR/GBP’s volatility risk premium has declined versus its
crisis was the key factor supporting the risk premium in          pre-election peaks and also relative to other EUR-G10 crosses
                                                                  1Y volatility risk premium. Defined as 1y implied vol/3m realized vol-1. The average
GBP volatility for much of this year, especially in the lead-
                                                                  comprises EUR vs AUD, CAD, CHF, JPY, NOK, NZD and SEK
up to the general election when the long-dated vol premium
in EUR/GBP hit a record high (chart 12). But looking ahead          0.6              EUR/GBP                  Av erage EUR v s G10 crosses
to next year it is the highly uncertain outlook for monetary
policy, as summarized by the current three-way split on the         0.4
BoE’s MPC, which justifies a continued volatility premium
in GBP. This premium is likely to remain higher than the            0.2
historic average, and also higher than in other G-10 EUR
currencies, where idiosyncratic policy risk is less                 0.0
pronounced. That said, the volatility premium it is unlikely
to return to the historic highs of H1 when the election acted       -0.2
as a lightning rod for fears of a UK fiscal crisis.
The risk that the BoE responds to high inflation with a             -0.4
tightening in policy also has to rank as the greatest threat to       Nov -05       Nov -06         Nov -07     Nov -08       Nov -09       Nov -10
our bearish directional view on GBP, at least for the few
months either side of any such tightening. But any knee-jerk
appreciation in GBP from such a defensive tightening in
monetary policy would likely prove short-lived, as doubts         to be a currency-led improvement in either a country’s
would surely surface about the ability of the economy to          external trade performance or its capital flows. This was
cope with a two-pronged tightening in macro-economic              perhaps best seen after 1992, when GBP’s expulsion from
policy, not to mention the risk that higher funding costs         the ERM was associated with a rapid growth in export
would intensify household deleveraging. In short, we find         volumes, an attendant boom in growth, and with a lag,
high inflation allied to a still fragile economy to be an         currency appreciation.
unpromising basis for sustained currency appreciation.            Unfortunately there is little evidence of a similar export-led
1992 this isn’t                                                   economic renaissance this time around, even though GBP’s
                                                                  trade-weighted depreciation in 2007-2008 was nearly
As highlighted earlier, GBP is cheap relative to its long-run     double the magnitude of that in 1992. Three years after
equilibrium value. While this undervaluation can be               GBP’s slide in 1992, export volumes had grown by 30%.
motivated by the UK’s weak cyclical position, it may              Three years on from Northern Rock and export volumes are
nonetheless lead an improvement in the UK’s external              net unchanged (chart 14). Equally discouraging for those
balances to the point where the undervaluation will start to      who believe a cheap currency can help rebalance the
correct itself. In short, if currencies revert to their           economy is the evidence of a renewed deterioration in the
equilibrium levels, a trigger for this mean-revrsion is likely    trade balance over the past year (up 10% ytd to a new all-
                                                                  time high). At over 6% of GDP it is hard to reconcile the

58
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


scale of the merchandise trade deficit with the apparent           Chart 13: GBP’s collapse in 1992 heralded an export boom, not so
cheapness of the currency. The current account is more             this time around
                                                                   UK export volume. Rebased to 100 at the start of GBP’s major depreciation
manageable in scale (just under 2% of GDP) but even here
the trend is no longer improving.                                   150

The capital account picture is more supportive for GBP,             140                           Sep-92
notwithstanding the conflicting influences on capital flows         130                           Jul-07
from valuation (cheap currency vs negative real yields), a
                                                                    120
lackluster UK recovery and exogenous factors such as the
Euro area sovereign crisis and central bank reserve                 110
diversification. One of the most striking features of the           100
capital account over the past year has been the surge of
foreign money into the Gilt market – chart 15. This is one            90
specific illustration of the way in which GBP has benefited           80
from the sovereign crisis in the euro area. It is also likely to            -20       -10         t        10       20            30         40       50
reflect the diversification benefits to GBP from the
continued aggressive accumulation of reserves in EM                                     Months before/after start of GBP depreciation
countries. If 4% of new FX global reserves are invested in
GBP, which is GBP’s current share of total reserves, the           Chart 14: Foreign inflows into Gilts have surged to reached a record
current rate of accumulation of some $600-700bn p.a.               high, helped in part by official inflows, which have supported GBP
would be sufficient to fund 70% of the UK’s current                Foreign purchases of Gilts as reported by the UK DMO. Central bank purchases of
account deficit. That said, it should be noted that not all        GBP are derived from the IMF’s COFER data and adjusted for valuation effects.
central banks regard GBP as a viable reserve currency – the        Actual COFER flows are shown along with an estimated maximum flow, allowing
                                                                   for the fact that COFER data identifies only 2/3 of total FX reserves. £bn, 4Q sum.
SNB, for instance, accumulated more FX reserves than any
other central bank bar China over the past year yet invested         80                     Foreign purchases of Gilts
only 1% of these new reserves into GBP. It bought nearly             70                     Foreign CB purchases of GBP, reported
four times as much CAD as it did GBP.                                60                     Foreign CB purchases GBP, estimated max imum
                                                                     50
The contribution to the UK’s external funding from central
                                                                     40
banks means that the aggregate private sector financing
                                                                     30
hurdle for the UK is not particularly onerous, despite the
disappointing widening in the trade deficit. Moreover,               20
private long-term inflows to the UK have improved,                   10
especially equity flows, which do appear relatively sensitive         0
to currency valuations - a 1% drop in the trade-weighted            -10
exchange rate tends to boost net equity inflows by £5bn. By         -20
contrast, FDI inflows tend to be relatively insensitive either        Q2 1999         Q2 2001     Q2 2003       Q2 2005         Q2 2007     Q2 2009
to currency valuations or the absolute or relative rate of UK
growth. The balance of FDI has certainly improved, but the         Source: UK DMO; IMF COFER; J.P. Morgan
perception that currency undervaluation has led to a surge in
                                                                   Table 1: UK balance of payments summary
foreign takeovers of UK companies appears misplaced –              % of GDP. 2010 is annualized from H1
after all, FDI contributes a small 1% of GDP to net UK                                                  2007             2008             2009        2010
inflows, not exactly a great return from a 30% FX                  Trade balance                       -6.4%         -6.4%             -5.9%          -6.2%
depreciation.                                                      Serv ices                            3.3%             3.8%             3.5%        3.1%
In sum, the UK’s balance of payments position presents few         Income                               1.4%             1.9%             2.2%        1.7%
serious issues for GBP. In our framework, however, this            Transfers                           -1.0%         -1.0%             -1.1%          -1.1%
will limit the magnitude of a future cyclical depreciation in      Current account                     -2.6%         -1.6%             -1.3%          -2.6%
the currency; the improvement in long-term flows is not            Capital account:
sufficient to precipitate a sustained recovery in the              Equity                              -0.8%             6.7%             2.9%        4.0%
exchange rate independent of the UK’s economic and                 FDI                                 -4.4%         -2.6%             -1.1%          1.2%
interest rate cycle.                                               Debt                                 9.8%         15.7%                0.1%        4.8%
                                                                   Current a/c, FDI & equity           -7.8%             2.5%             0.5%        2.6%
                                                                   Source: UK ONS; J.P. Morgan




                                                                                                                                                           59
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.



Research Note
Swiss franc: The bullish new normal
•    The western world’s structural growth malaise             Regime shift underway but not yet complete
     remains bullish for the currencies of current             What a year this has been for the Swiss franc. We argued in
     account surplus countries such as Switzerland as it       our 2010 FX Outlook that franc appreciation was the
     precludes the easy recycling of these surpluses           inevitable consequence of a structural balance of payments
     through private capital outflows.                         mismatch, whereby the new normal of anemic economic
•    Long-term investment outflows from Switzerland            growth in much of the western world and permanently
     have rebounded from their recessionary lows but           lower interest rate differentials between Switzerland and its
     are as yet only sufficient to limit rather than prevent   formerly high-growth, high yield peers would preclude the
     CHF appreciation.                                         outflow of capital which Switzerland needs to recycle its
                                                               large and growing current account surplus (chart 1).
•    The SNB’s attempt to supplement meager capital
                                                               Chart 1: Balance of payments dynamics remain bullish for CHF –
     outflows through FX intervention was not only             yield differentials and hence capital outflow are inadequate relative
     unsustainable in the face of a robust domestic            to the size of Switzerland’s current account surplus
     recovery, but perversely also designed to fail.
                                                                                Sw iss current account. CHF bn, 4Q sum
     Balance sheet risk precludes any repeat of the                  80                                                           -0.5
                                                                                CHF-G10 2Y sw ap spread, rhs
     SNB’s record-breaking intervention.                             70
•    The SNB’s rearguard effort to weaken CHF by                     60
     postponing normalization in monetary policy                                                                                  -1
                                                                     50
     merely delays the inevitable. The robust real estate
                                                                     40
     market is evidence that domestic price stability is
     inconsistent with the current stance of monetary                30
                                                                                                                                  -1.5
     policy. Domestic monetary stability will not be                 20
     sacrificed for FX stability.                                    10
•    Absent intervention, further trend appreciation in          -                                                                -2
     CHF is to be expected, reflecting both structural                Jan-99   Jan-01   Jan-03     Jan-05      Jan-07    Jan-09
     considerations (the balance of payments imbalance)
     and positive cyclical influences (SNB tightening
                                                               The wildcard in this outlook were the lengths to which the
     from mid-2011).
                                                               SNB would go to frustrate currency appreciation by
•    The constraints on the SNB’s ability to control CHF       substituting official for meager private capital outflow.
     through either FX intervention or monetary policy         While we may have underestimated the SNB’s capacity to
     represent a regime shift and justify a new normal         intervene – the SNB probably set a new world record for
     for CHF volatility.                                       intervention of 35% GDP in a little more than a year – we
                                                               were correct to doubt the SNB’s willingness to sacrifice
•    Volatility overshot in 2010 due to position unwinds.      domestic monetary stability for the sake of exchange rate
     The new equilibrium is likely to be close to that of      stability. SNB intervention was never credible because it
     the currencies of other small open European               was never backed by an expansion in the money supply.
     economies with external surpluses, i.e. NOK and           Rather, the SNB fully sterilized the impact of CHF sales on
     SEK.                                                      the domestic monetary base (intervention was essentially
•    Structurally lower yield differentials and higher FX      financed by debt issuance not by money creation – chart 2),
     volatility will preclude a resumption of the swiss        which is why the intervention policy ultimately failed to
     carry trade. Not only that, but deleveraging of the       stem the fundamental tide in CHF. It failed because it was
     previous carry trade is far from complete.                engineered to fail. Moreover, the balance sheet risk that this
                                                               ill-starred adventure has saddled the SNB with means that
•    EUR/CHF to 1.27 by Q3/Q4 as the SNB takes off the         the SNB is to all intents and purposes barred from future
     monetary brakes.                                          intervention. After all, FX reserves now amount to 40% of
                                                               GDP and comprise 75% of the SNB’s balance sheet (chart
                                                               3). The SNB’s balance sheet provision of CHF48bn against


60
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


Chart 2: SNB FX intervention was destined to fail as the central bank                             valuation losses looks far less adequate for a FX portfolio of
refused to print money to fund the intervention                                                   CHF220bn than it did for a portfolio of 50bn in 2008.
  200                          Cumulativ e chage since February 2009, CHF bn
                                                                                                  Having abandoned an intervention policy that was
                                                                                                  inconsistent with the thrust of monetary policy, the SNB has
  150                             SNB FX reserv es
                                                                                                  subsequently adopted a monetary policy that is inconsistent
                                  Sw iss monetary base (cash and bank deposits at
                                                                                                  with the thrust of economic conditions as an alternative way
  100
                                  SNB)                                                            of controlling currency appreciation. This policy has
                                                                                                  enjoyed some success since the SNB slashed its inflation
       50                                                                                         and implicit inertest rate projections at the September
                                                                                                  meeting. But once again the SNB is faced with a
             0                                                                                    fundamental dilemma – will it be willing to sacrifice
                                                                                                  domestic monetary and price stability as it seeks to prevent
   -50                                                                                            currency appreciation through overly loose monetary
                    Feb-09 May -09           Aug-09     Nov -09 Feb-10 May -10 Aug-10
                                                                                                  policy? We doubt that it will be, in much the same way we
                                                                                                  doubted the SNB’s willingness to sacrifice domestic
Source: Swiss National Bank                                                                       stability through unsterilized FX intervention. Near-term
Chart 3: The lasting legacy of SNB intervention - a substantial                                   deflation in Switzerland, courtesy of past franc appreciation,
concentration of FX risk in the central bank’s balance sheet                                      certainly provides the SNB with the fig-leaf to pursue
Composition of SNB assets, % of Swiss GDP                                                         Japanese style-monetary policy for some months yet, but
                                                                                                  there is little real risk of functional deflation in Switzerland.
  50%
                                                                                                  The economy has regained all of the output it lost through
  45%                                        Gold             FX             Other
  40%
                                                                                                  the recession, which puts it closer to Canada or New
                                                                                                  Zealand than to Japan (chart 4); bank lending to households
  35%
  30%
                                                                                                  is strong, both in absolute terms and in an international
                                                                                                  perspective (chart 5), while house price are rising smartly,
  25%
  20%
                                                                                                  partly as a consequence of cheap credit (chart 6).
  15%                                                                                             Chart 5: Swiss credit growth is less impaired than other European
  10%                                                                                             economies relative to pre-crisis norms
      5%                                                                                          Bank lending to households: current vs. average growth 2004-2007
      0%                                                                                             0%
                    Jan-97          Jan-00          Jan-03         Jan-06        Jan-09
                                                                                                     -2%
Source: Swiss National Bank
                                                                                                     -4%
Chart 4: Swiss interest rates are too low given the degree of
economic healing in Switzerland
                                                                                                     -6%
The chart plots a simple measure of a country’s output gap (the net loss in output
from its pre-recession peak) against the level of 2Y swap rates.
                                                                                                     -8%
                     6
                                                                                 Australia         -10%
                     5
                                                                        NZ                         -12%
                     4
  2Y swap rate, %




                                                                                                                GBP          NOK           EUR           SEK         CHF
                                                       Norw ay
                     3
                                             Sw eden
                     2
                                  UK                                 Canada
                                                Euro     US                                       The SNB can continue to prioritize the exchange rate when
                     1                                                                            setting monetary policy for some time yet, but there is little
                                   Japan                                Sw itzerland
                     0                                                                            reason to suppose that these robust domestic conditions can
                                                                                                  be ignored indefinitely, especially given the risk that loose
                         -6%           -4%             -2%         0%           2%           4%
                                                                                                  policy engenders an overheating in the real estate market.
                                        GDP: current v s pre-recession peak, %
                                                                                                  The SNB was forced to abandon its short-lived experiment
                                                                                                  with hard-currency pegging this year when the cost to price
                                                                                                  stability became too great. We expect it similarly to

                                                                                                                                                                           61
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


abandon soft-pegging when the desire to avoid domestic                       which does appear to be borne out by the evidence from
overheating requires it to start to normalize monetary policy                Switzerland over the past decade. However, as table 1
from the middle of 2011. Once this happens the transition in                 details, net equity flows are much more cyclical than FDI
the Swiss franc from an artificially managed, low-yield,
                                                                             Chart 7: FDI and equity outflows from Switzerland have resumed,
low-volatility funding currency towards a structurally                       partly helping to recycle the current account surplus
strong, marginally higher yield and higher volatility freely-                Swiss current account and combined equity and FDI flow, 4Q sum, CHF bn
floating currency will be complete.
                                                                               100                 Current account                FDI & Equity flow
Chart 6: Cheap credit is supporting house price inflation                        80
              Sw iss house prices, % oy a, lhs                                   60
              SNB target rate for 3m Libor, rhs, inv erted                       40
 8%                                                                      0
                                                                                 20
                                                                                  0
 6%                                                                      1      -20
                                                                                -40
 4%                                                                      2      -60
                                                                                -80
 2%                                                                      3     -100
                                                                                   Jan-01         Jan-03          Jan-05          Jan-07        Jan-09
 0%                                                                      4
     Mar-00    Mar-02       Mar-04        Mar-06       Mar-08   Mar-10       Source: Swiss National Bank

                                                                             Chart 8: Switzerland’s basic balance surplus has shrunk from the
Current account recycling – will this get any                                record high in 2009 – less pressure for CHF appreciation
easier?                                                                      Swiss current account Plus net FDI and net equity flow, % GDP. 2010 is
                                                                             annualized from H1
The prospect that the SNB begins the process of
                                                                               14%
normalizing monetary policy much sooner than G3 central
                                                                               12%
banks will further complicate the recycling of the Swiss
current account surplus, as it will further reduce the                         10%
incentive for short-term capital outflows from Switzerland                      8%
(as will the higher level of CHF FX volatility, of course).                     6%
But what of long-term capital flows – are these capable of                      4%
neutralizing the upward pressure on the currency stemming                       2%
from the juxtaposition of a structurally stretched current                      0%
account surplus and structurally challenged short-term                         -2%
interest rates differentials?                                                  -4%
The balance of payments data do reveal an increase in net                             1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
equity and particularly FDI capital outflows in the first half
                                                                             Source: Swiss National Bank
of this year (chart 7). In Q2 in fact the combined outflow of
equity and FDI capital rose to CHF15.4bn, the largest                        Table 1: Relationship between Swiss long-term investment flows and
quarterly outflow since 2006, a sum which is equivalent to                   economic growth
90% of the quarterly current account surplus. If sustained                   Capital flows (measured on a rolling 4Q sum) were regressed on annual GDP
                                                                             growth (Swiss, OECD average and the Swiss-OECD differential). Sample period
this rate of outflow would certainly help to neutralize the                  2002 Q1- 2010 Q2. A negative beta implies that higher economic growth reduces
current account pressure for CHF appreciation (chart 8), but                 capita inflows/increases capital outflows from Switzerland. The beta shows the
the quarterly flow in FDI is notoriously volatile and as such                change in capital flows in CHFbn for a 1% change in GDP growth.
it would be misleading to extrapolate from what is                                                                     Equity         FDI         Total
essentially one quarter’s improvement. At CHF 10bn the                       Sw iss GDP grow th            Beta            -5.2         -3.4          -8.7
standard deviation in the quarterly FDI flow is double that                                                 R2             0.46        0.08           0.31
of net equity flows or the current account surplus.                          OECD GDP grow th              Beta            -6.3         -0.9          -7.3
What has motivated this increase in real investment                                                         R2             0.78        0.01           0.25
outflows? At some basic level one might expect these to be                   Sw iss-OECD grow th           Beta             5.3         -5.8          -0.5
inherently cyclical and responsive to the performance of                                                    R2             0.19        0.10           0.00
both the domestic and international economy, a hypothesis

62
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Global FX Strategy 2011
November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


flow, which is essentially independent of either the             Chart 9: Calibrating the size of the CHF carry trade
domestic or foreign business cycle. (The more random             CHF lending to European countries, CHF bn
nature of FDI flows is perhaps not surprising given the            400
situation-specific nature of M&A activity). Moreover, while
                                                                                Austria          Germany           Other Euro
stronger economic growth in Switzerland and overseas
                                                                   300
should boost real investment outflows from Switzerland, the
                                                                                Hungary          Poland            Other CEE
sensitivity of these flows to growth is sufficiently low that
this is unlikely to derail our forecast of continued franc         200
appreciation. In short, it takes a 1% increase in OECD GDP
growth to boost net equity outflows by just over CHF6bn.
                                                                   100
Even a 2% lift to global growth would thus do little more
than absorb an additional 15-20% of Switzerland’s current
account surplus. So yes, real investment flows can be                0
expected to do more of the heavy lifting in recycling                              1998                     2002                     2007
Switzerland’s external surplus but the scale of such flows is
unlikely to compensate for the continued dearth of hot-          Source: Swiss National Bank - Brown, Peter and Wehrmueller, February 2009
money outflows.
                                                                 Chart 10: Austro-Hungarian appetite for CHF loans has cooled but
The carry trade unwind – not as complete as one                  the outstanding stock of such loans remains large
might suppose                                                    CHF loans to Austria and Hungary (household and non-financial corporations),
                                                                 CHF bn
All of the discussion so far has centered on flow
                                                                   100                Hungary
imbalances. But as important for CHF are stock imbalances,
in particular the scale of the outstanding Swiss carry trade                          Austria
                                                                    80
and the potential for this to be unwound. Prior to the
financial crisis the SNB was content to preside over an
                                                                    60
explosion of foreign borrowing in CHF (indeed, this was
the one of the key channels through which the SNB
                                                                    40
achieved its objective of containing pressure on the
currency to appreciate). The SNB’s focus on the exchange
                                                                    20
rate ensured both the low interest rates and low volatility
that made CHF borrowing so attractive to non-Swiss
                                                                     0
entities. Equally important in fostering the swiss franc carry
trade was the SNB’s implicit guarantee against capital loss          Dec. 02 Dec. 03 Dec. 04 Dec. 05 Dec. 06 Dec. 07 Dec. 08 Dec. 09
through CHF appreciation. At its peak, the SNB estimates
that just one component of the carry trade – foreign bank        Source: Oesterreichische Nationalbank; Magyar Nemzeti Bank; J.P. Morgan

lending to non-bank clients denominated in CHF –                 Two examples should suffice to illustrate this. The
amounted to CHF360bn, comprising CHF238bn from Euro              Hungarian predilection for CHF mortgages is well known
area banks and CHF122bn from non-euro area European              (at its peak 71% of all Hungarian bank lending was
banks (chart 9). To give a sense of scale this amounts to just   denominated in CHF, amounting to CHF24bn). Less well
under 70% of Swiss GDP.                                          known but in fact more substantial is the Austrian
Doubtless there has been a substantial unwind of the more        phenomenon of CHF mortgages. 18% of total bank lending
speculative elements of the CHF carry trade, but despite the     in Austria is denominated in foreign currency, 86% of
regime shift that has increased the relative cost and risk of    which is denominated in CHF. The peak value of these
CHF borrowing, neither foreign households nor corporates         loans was CHF73bn, which alone amounted to 13% of
have made much progress in reducing their sizeable CHF           Swiss GDP. Switzerland’s near neighbors thus embraced
exposure.                                                        CHF mortgages with enthusiasm. Unfortunately, the stock
                                                                 of Austrian and Hungarian loans has declined by an average
                                                                 of only 12% from the peak, a net reduction of CHF 8.4bn
                                                                 on a combined CHF 98bn of loans. If representative of other
                                                                 countries, the experience of Austria and Hungary would
                                                                 imply that CHF loans to non-Swiss, European borrowers
                                                                 still exceeds CHF300bn. There is little risk of these loans
                                                                 being unwound in an aggressive or disruptive manner, in
                                                                 large part because the debt servicing shock from CHF

                                                                                                                                                63
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November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


appreciation is more manageable for the borrower than the         domestic circumstances preclude the kind of exchange rate
ultimate repayment shock. Nonetheless the steady                  management that has depressed CHF volatility in past years,
repayment of these loans as they fall due constitutes yet         it would seem reasonable that CHF volatility should
another source of flow demand for CHF. (Austrian CHF              gravitate towards that of currencies of other developed,
mortgages are typically bullet form, where the entire             open economies within Europe where central banks have
principal is repaid in CHF at the end of the loan. Borrowers      never regarded the currency as a target variable in the way
pay into a savings vehicle to fund the repayment).                the SNB did.
A new normal for CHF volatility                                   Chart 10: The narrowing in CHF interest rate differentials has
                                                                  aggravated the balance of payments imbalance which in turn
Our central thesis for CHF over the past year has been one        warrants a higher equilibrium level for EUR/CHF volatility
of post-crisis regime shift, whereby currency appreciation is
                                                                   15                EUR/CHF 3m implied v o ,lhs                    0
accelerated due to capital account strains and by the SNB
being forced to abandon hard/soft-currency pegging due to          13                2Y CHF-G10 sw ap spread, rhs                   -0.5
domestic policy considerations. This regime shift has              11
                                                                                                                                    -1
implications of course not only for the net direction of the        9
currency but also for the path it takes, in other words its                                                                         -1.5
                                                                    7
volatility. Persistent balance of payment strains, which the                                                                        -2
central bank is prevented from alleviating, should in theory        5
translate to a higher equilibrium level of CHF volatility                                                                           -2.5
                                                                    3
compared to the previous regime in which recycling of the           1                                                               -3
current account proceeded more smoothly and the central
                                                                    -1                                                              -3.5
bank was better able to control the currency through
monetary policy. Evidence for this hypothesis is presented          Nov -00     Nov -02     Nov -04    Nov -06      Nov -08
in chart 10, which plots EUR/CHF implied vols against one
proxy measure of Switzerland’s balance of payments                Chart 11: EUR/CHF volatility – converging on the European average?
strains, the spread between 2Y CHF and G10 interest rates.        Ratio of 3m EUR/CHF implied vol to the average of EUR/GBP, EUR/NOK and
                                                                  EUR/SEK
The initial spike in EUR/CHF vol in 2008 coincided with an
abrupt narrowing in average interest rate differentials.           1.4
While the SNB’s extreme currency intervention through
2009/2010 served to depress volatility temporarily, this has       1.2
subsequently surged again, in line with a further                  1.0
compression of interest rate differentials.
                                                                   0.8
But beyond merely noting that EUR/CHF volatility has
transitioned to a new, higher level, what benchmarks can           0.6
one employ for gauging where the new equilibrium is likely
to lie? One relatively intuitive approach is to compare            0.4
EUR/CHF volatility with the volatility of currencies of            0.2
other developed European economies. Chart 11 plots the
                                                                     Nov -00     Nov -02     Nov -04     Nov -06     Nov -08
ratio of EUR/CHF volatility against the average of
EUR/SEK, EUR/NOK and EUR/GBP volatility. Prior to the
financial crisis, the ratio fluctuated in a relatively small
range around a relatively stable mean of approximately 0.6.
As the banking crisis unraveled the ratio rose to 1 before
declining to only 0.4 as the SNB temporarily succeeded in
fixing the EUR/CHF cross rate in the low 1.40’s. But once
the SNB abandoned its self-imposed peg, EUR/CHF
volatility surged to between 1.1-1.2 times that of the basket.
This likely reflects an overshoot in volatility, driven by the
one-off disruptive unwinding of speculative CHF carry
trades, and the ratio is likely to fall back as the shock-waves
from position deleveraging subside. That said, we doubt
whether EUR/CHF volatility can settle back below the
average of other euro crosses. After all, as global and

64
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Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.




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                                                                       65
Global FX Strategy
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November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.



Research Note
NOK and SEK: More similarities than differences
•    Desynchronization of the Norwegian and Swedish            Chart 1 Public finances are NOK’s strongest fundamental. But SEK
     economies during the recession and early recovery         is also well placed relative to other developed economies
                                                               Public sector net lending, % of GDP
     has caused major stress in the NOK/SEK cross in
     the last few years.                                         20

•    Cyclical momentum favored NOK in 2009 but                   15
     switched to SEK in 2010, resulting in an                                                                                      NOK
                                                                 10
     unprecedented directional decoupling of USD/SEK
     (down) and USD/NOK (up) this year.                           5
                                                                                                                            SEK
•    Growth momentum and the central bank bias                    0
     (Riksbank is less paranoid about the exchange rate           -5                                                              EUR
     and more inclined to tighten) favors further declines                                                                        USD
     in NOK/SEK in H1, but relative cyclical conditions         -10
                                                                                                                             GBP
     should neutralize mid-year as the Norges Bank              -15
     resumes its tightening cycle.
                                                                       1990   1993     1996     1999   2002   2005   2008     2011
•    NOK/SEK should end the year broadly unchanged,
     but with both SEK and NOK 3-4% higher versus              the net debt of either Greece or Ireland. (The OECD puts
     EUR as the Scandinavian interest rate cycle               Norway’s net financial assets at 153% of GDP). Norway’s
     continues to lead the euro area.                          public sector finances are bomb-proof (chart 1).

•    The lack of fiscal stress in Scandinavia, especially in   How then did NOK failed to perform as the fiscal bombs
     Norway, results in a more favorable monetary/fiscal       detonated in the Euro area and many western economies set
     policy mix than in most other western economies.          out plans for relatively aggressive fiscal tightening, which
     Scandinavia’s robust fiscal position stands NOK           in theory should depress growth and interest rate
     and SEK in good stead as attention elsewhere turns        expectations relative to an economy such as NOK where the
     to the unfinished business of fiscal repair.              government has an almost infinite fiscal capacity to support
                                                               the economy. The answer lies partly with positioning –
•    Higher oil prices are a clear positive risk for NOK       NOK essentially was a victim of its own success, as strong
     although the absorption of the current account            fiscal fundamentals meant that positions in the currency
     surplus through the Government Pension Fund               were crowded when the Greek crisis triggered global
     limits the impact on the currency to less pronounced      deleveraging – and partly with the failure of the Norwegian
     wealth effects. The resulting sensitivity of NOK to       economy to build on its resilient performance during the
     oil fluctuations is relatively low.                       global recession in 2008/09.
•    EUR/SEK to drift to 8.95 by autumn 2011;                  The cyclical problem for NOK can be seen in chart 2 –
     EUR/NOK to 7.90. NOK/SEK to base around 1.12.             Norway escaped with only a very mild recession, which
                                                               meant that the Norges Bank was able to start tightening
Leads and lags in Scandinavia                                  policy earlier than any other central bank bar the RBA.
                                                               Since then the recovery has unfolded at a relatively sluggish
One of the more surprising features of 2010 has been the       pace, which coupled with a relatively rapid pace of
failure of NOK to deliver upon its structural promise. Not     disinflation has given the Norges Bank cause to pause since
only did NOK decline in trade-weighted terms (albeit           delivering its third rate hike in May. As a result, 2Y NOK
barely, at -0.4%) but there was a virtually unprecedented      swap rates have fallen by 60bp this year, denying NOK the
directional decoupling between USD/SEK (down) and              cyclical oxygen that it thrived on in 2009.
USD/NOK (up), which resulted in a sharp 8% drop in
NOK/SEK. What went wrong for NOK?                              SEK has the whip hand for now
The structural appeal of NOK is not difficult to discern – a   By contrast, SEK, which was punished for the relatively
double-digit current account surplus and that rare             severe recession that Sweden suffered, depreciating by 11%
phenomenon of a double-digit fiscal surplus plus net public    versus NOK in 2009, has come back to favor. Momentum
sector assets that are larger as a share of the economy than   in the Swedish economy has surged in recent quarters, as

66
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November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


befits a relatively open economy with a strong export base.         Chart 3: SEK is much more sensitive to global business cycle than
Even though the Riksbank has now suspended its own                  NOK
                                                                    Correlation between effective exchange rate and global PMI over past 10 years.
hiking cycle (having matched the Norges Bank’s three rate
increases), cyclical momentum continues to favor SEK over             0.7
NOK for the next one to two quarters. SEK, it should not be           0.6
forgotten, is a highly pro-cyclical currency, both in absolute        0.5
terms and relative to NOK (chart 3).
                                                                      0.4
The monetary pause that refreshes                                     0.3
We are fairly confident in a view that the Norges Bank will           0.2
tighten again next year – we assume 75bp versus only 15bp             0.1
priced into the curve – but we expect this tightening to be           0.0
backdated to H2. The Norges Bank is in no hurry. As such,             -0.1
NOK is a patience trade for us – it should come good again,           -0.2
both versus SEK and EUR, but this appreciation is more
likely to be a mid-to-late year phenomenon. Until then, SEK                   USD JPY EUR CHF NOK                   AUD NZD GBP SEK CAD
is our favored currency pick within Scandinavia. The
Riksbank has recently scaled back its forecasts for interest
rate tightening, but this less hawkish outlook is predicated        Chart 4: NOK might seem much more expensive than SEK
on what is liable to be an excessive caution about the global       Real effective exchange rates. Jan 1970=100
economy. Like the Norges Bank the Riksbank has
                                                                      180
expressed concern at currency strength in a climate of rising
                                                                                                NOK                  SEK
global risks. However, there is far less reason for the               160
Riksbank to let currency appreciation interfere with the
trend in monetary policy given that SEK is not obviously              140
expensive, either from a long-run perspective (chart 4) nor
relative to its long-run equilibrium value (chart 5).                 120

Our central case is also that the Riksbank will delay any             100
further rate increases until H2, but there is a reasonable risk
                                                                       80
that it starts to tighten again in February or April should the
growth numbers continue to impress. As for the scale of                60
tightening, we see a net 100bp next year, double what is
                                                                        Jan-70           Jan-80            Jan-90           Jan-00            Jan-10
priced in. Such a rate of tightening should put the Riksbank
on a par with the RBA and RBNZ, and thus maintain SEK’s
status as a strong candidate for cyclical appreciation.
Chart 2: Cyclical conditions favored NOK during the recession and
early recovery, but economic momentum lies now with Sweden          Chart 5: But NOK is in fact substantially undervalued when taking
GDP: 100= 2007 Q2                                                   into account real fundamentals (public debt, terms of trade etc).
                                                                    Deviation of real effective exchange rate from JPM’s model of long-run fair value
 102
                                                                      10
 101
 100                                                                    5
  99                                          Norw ay                   0
  98                                                                   -5
  97
                                                                      -10
  96                                        Euro
  95                                                                  -15
  94                                                                  -20                         NOK            SEK
                                  Sw eden
  93                                                                  -25
  92
                                                                      -30
       07Q2    07Q4       08Q2      08Q4    09Q2    09Q4   10Q2
                                                                        Feb-97         Feb-00           Feb-03         Feb-06        Feb-09




                                                                                                                                                        67
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November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.


And even as regards the Norges Bank we suspect that its              Chart 7: EUR/SEK is fairly-valued relative to short-run drivers…
concerns over currency strength are misplaced. Yes NOK is            EUR/SEK = 9.30 – 1.15*(2Y EUR-SEK 2Y swap) + 0.018 (VIX). R2 = 0.62. Daily
                                                                     data, three-year sample.
strong in a long-term perspective, but this is more than
justified by the economic impact of Norway’s oil wealth.                12
Indeed, NOK stands out as the cheapest global currency in             11.5              Predicted
our long-run valuation framework (it is 18% undervalued).                               Actual
A narrow focus on the competiveness of Norwegian non-oil                11
exporters obscures the real exchange rate appreciation                10.5
which is justified by the impact of oil on Norway’s terms of
trade, its external surplus and its public sector finances.             10

Chart 6: Headline inflation might be falling in Norway and Sweden      9.5
but house price inflation cannot be overlooked indefinitely
House price indices, 100=Jan 2000                                        9

 240                                          GBP                      8.5
                                                               SEK          Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
 220

 200                                                                 Chart 8: …as is EUR/NOK
                                                                     EUR/NOK = 8.35 – 0.33*(2Y EUR-NOK 2Y swap) – 0.004*(Brent oil) + 0.016 (VIX).
 180
                                                                     R2 = 0.65. Daily data, three-year sample.
 160                                                     NOK
                                                                                            Actual           Predicted
                                                                       10
 140
                                                         CHF
 120                                                                  9.5

 100
                                                                        9
     Feb-00     Feb-02      Feb-04   Feb-06     Feb-08     Feb-10
                                                                      8.5
The current relatively fast rate of disinflation in Norway
certainly allows the Norges Bank scope to defer policy                  8
tightening, but like many central banks it will ultimately
need to choose between maintaining exchange rate stability            7.5
or overall price stability. The sharp recovery in Norwegian             Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
house prices is just one illustration that the stance of
monetary policy is reasonably expansive and cannot be                Table 1: Desychronization: NOK/SEK vs. relative growth and interest
maintained indefinitely without jeopardizing broader                 rate fundamentals
stability (chart 6). Rising house prices are also becoming an
                                                                               GDP grow th, %        Change 2Y sw ap rates
issue for the Riksbank.
                                                                                NOK      SEK         NOK           SEK        NOK/SEK
Calibrating the impact of rates and oil
                                                                       2008      0.6      -0.6       -285          -270         -5.1%
Short-term cyclical models indicate that EUR/SEK and                   2009      -1.2     -5.1        60            -40          9.6%
EUR/NOK are broadly at fair value for the current level of             2010      1.5      4.5         -60           50          -7.8%
interest rates and the global risk premium. Interestingly,
                                                                       2011      2.3      3.1         30            25          -0.5%
EUR/SEK is 2-3 times as sensitive to the interest rate
differential with the euro than NOK - 10bp on the 2Y EUR-
SEK swap spread translates to 1% on EUR/SEK -
suggesting that the main swing variable for the NOK/SEK              impact of higher oil prices is neutralized by matching
cross is the course of Swedish monetary policy. As for oil           overseas investment from the Government pension Fund,
prices, NOK is perhaps surprisingly insensitive to these, at         this relatively weak beta is perhaps not so surprising after
least over the cycle, with a $10 swing in Brent oil                  all.
translating through to less than a 1% move in EUR/NOK. In
view, however, of the way in which the current account




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November 23, 2010

Paul Meggyesi (44-20) 7859-6714
paul.meggyesi@jpmorgan.com
J.P. Morgan Securities Ltd.




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                                                                       69
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November 23, 2010

Ken Landon (1-212) 834-2391
kenneth.landon@jpmorgan.com
JPMorgan Chase Bank NA



Research Note
Commodity currencies: AUD, NZD and CAD are as good as
gold
                                                                Chart 1: Asian central banks are importing inflationary
•    With the Fed committed to higher inflation,                policy from the Fed
     commodities will outperform in 2011, thus boosting         Asian FX Reserves ex-China & Japan vs. ADXY Index
     AUD, NZD, & CAD relative to other G10 FX.
                                                                 1400                                                                 120
•    Strong growth in Asia bodes well for AUD, but any
                                                                 1200                 FX Reserv es                                    115
     growth surprise in the US would benefit CAD.
                                                                 1000                 ADXY Index                                      110
•    Forecast: AUD/USD trending to 1.04 by year-end
     2011. NZD/USD should hit .80 and USD/CAD 0.96.               800                                                                 105

•    Risks: FOMC turns hawkish, BoC remains                       600                                                                 100
     cautious, Australia slows or RBNZ retrenches.                400                                                                 95

The commodity currencies find themselves benefiting from          200                                                                 90
a global liquidity boom. Aggressive debt monetization by             Jan-00     Jan-02     Jan-04     Jan-06        Jan-08   Jan-10
the Federal Reserve has undermined confidence in the USD,
which in turn has caused many central banks to intervene in     Chart 2: Excess liquidity generation in Asia is a positive factor for
FX markets to prevent rapid appreciation of their               AUD/USD
currencies. The result is the creation of excess liquidity in   Asian FX Reserves ex-China & Japan vs AUD/USD
quickly-growing parts of the world, especially in Asia.          1400                                                                 1.05
Signs of excess liquidity are already on view with rising                             FX Reserv es
rates of inflation in countries like China.                      1200                                                                 0.95
                                                                                      AUD/USD
As Chart 1 shows, we have seen this show before. A trend         1000                                                                 0.85
decline in the value of the dollar pushed the ADXY Asian
currency index higher between 2002 and 2008. Notice that          800                                                                 0.75
the weak dollar and appreciating local currencies caused
Asian central banks to accumulate ever-greater amounts of         600                                                                 0.65
FX reserves. The result is excess liquidity that flows
                                                                  400                                                                 0.55
through the financial system, thus enabling Asian countries
to import more commodities, which in turn drive their             200                                                                 0.45
prices higher. With Asia accounting for 65% of Australian
                                                                     Jan-00     Jan-02     Jan-04     Jan-06    Jan-08       Jan-10
exports, AUD usually does particularly well during periods
of generalized USD weakness that encourages excess              However, the concept of demand for money is entirely
liquidity provision and strong growth in Asia, which can be     absent from that type of analysis.
observed in Chart 2.
                                                                The Fed is on record as intending to boost the rate of
The macro environment driving commodity FX                      inflation. Such an aggressive policy pronouncement coupled
At the moment and for the foreseeable future, the Big           with QE2 likely will lead both domestic and foreign
Driver of the commodities currencies is quantitative easing     investors to reduce their USD cash holdings as a precaution
by the Federal Reserve. Although US policymakers are not        against future loss of purchasing power. If the domestic and
targeting a lower USD, their policy actions could easily        international demand for USD money declines, then its
result in a weaker currency. Many economists and Fed            value can fall without active lending of newly created bank
officials point out that currency debasement and inflation do   reserves. This is indeed what was observed during the Fed’s
not necessarily flow from quantitative easing because a         first phase of quantitative easing from March 2009.
necessary ingredient is the lending out of excess bank          Chart 3 shows that AUD/USD, NZD/USD, and CAD/USD
reserves injected by the Fed. If banks do not lend out the      trended higher following the announcement of ‘QE1’ on
money, then the overall money supply will not increase.         18 Mar 2009. However, notice that the CAD lagged behind
                                                                both AUD and NZD, which reflects the close economic ties

70
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Ken Landon (1-212) 834-2391
kenneth.landon@jpmorgan.com
JPMorgan Chase Bank NA


between the US and Canada (the US accounts for                    Chart 3: The USD trended lower against AUD, NZD, CAD ,& Gold
approximately 75% of Canadian exports). In other words,           after the announcement of QE1 in March 2009
                                                                  Currencies & Gold rebased to 100 on day of announcement on 18Mar09
with the US underperforming Asia, the CAD did not receive
the same kind of boost from trade that AUD did during the          150                   AUD/USD
past 18 months.                                                                          NZD/USD
Chart 4 indicates that the same pattern is repeating for QE2,                            CAD/USD
which was essentially announced on 10Aug when the Fed              125
                                                                                         Gold
announced that it would boost purchases of US Treasury
securities with the proceeds of maturing agency debt and
agency mortgage-backed securities. Of course, the                  100
challenge is determining the extent to which QE2 has been
priced in by the markets. Trends in the FX market show that
the USD weakened considerably for the first seven months            75
of QE1, which, if repeated with QE2, would keep the                      -32      0       32      65    97    129     161    194    226       258
pressure on the USD until at least the end of 1Q:2011.                                    Day s from announcement of QE1 on 18Mar09
Of course, it is impossible to project the trend of AUD,
NZD, and CAD by using just the one incidence of                   Chart 4: The USD has also trended lower against AUD, NZD, CAD ,&
quantitative easing implemented by the Fed. However, the          Gold after the effective announcement of QE2 in August 2010
underlying principle makes sense. If the Fed is committed         Currencies & Gold rebased to 100 on day of announcement on 10AUG10
to boosting the rate of inflation in the US, then things priced    120                                 AUD/USD
in dollars should trend higher. Commodities in particular
                                                                                                       NZD/USD
should do well under the Fed’s new marching orders, which
will provide a solid underpinning for AUD, NZD, and                110                                 CAD/USD
CAD.                                                                                                   Gold

Strong growth in Asia will support AUD                             100

As mentioned earlier, the fate of AUD is inextricably tied to
the strength of Asia because of the close trade ties. After the     90
slowdown in the second half of 2010, Asian growth likely
will pick up over the course of 2011. After growing at a
projected 6.2% saar in 2H:2010, Asia ex-Japan is forecasted         80
by JPM to pick up to an average rate of growth of 7.6% in                -50    -40    -30      -20    -10      0   10    20   30   40   50   60
2011. Similarly, China is expected to grow at a projected
8.4% in 2H:2010, but accelerate to an average of 9.3% in
2011. As shown in Chart 5, an expected acceleration of            Chart 5: A pick-up in growth in China will help to support AUD/USD
growth in China bodes well for further upside performance         AUD/USD vs. China Manufacturing New Orders Index
in AUD/USD.                                                        1.0                                                                        70
Meanwhile, after growing at a projected rate of 2.9% in            1.0                                                                        65
2H:2010, Australian growth is forecasted to increase to an
                                                                   0.9                                                                        60
average of 4.2% in 2011. Clearly, the RBA has been leaning
against the wind with rate hikes of 175 bps over the course        0.9                                                                        55
of the last twelve months. However, the current cash target        0.8                                                                        50
at 4.75% remains below what many economists believe to a                                              AUD/USD
                                                                   0.8                                                                        45
“neutral” rate between 5.0% and 5.5%. Australia’s terms of                                            New Orders
trade continues to improve, which has been an important            0.7                                                                        40
factor in the RBA’s decision to tighten policy. There is           0.7                                                                        35
obviously more scope for higher rates in Australia, which          0.6                                                                        30
will further enhance the yield pick-up over both the US and
Europe. We anticipate no change in either Fed or ECB rates            Nov -05         Nov -06         Nov -07       Nov -08    Nov -09




                                                                                                                                               71
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Ken Landon (1-212) 834-2391
kenneth.landon@jpmorgan.com
JPMorgan Chase Bank NA


next year while the RBA is projected to hike rates by          Chart 6: USD/CAD and U.S. payrolls move broadly in line
another 100 bps by the end of 2011. AUD should do well         USD/CAD vs. U.S. payrolls
against both the USD and the EUR. The same can be said          1.3                                                                            -1000
for NZD, which should benefit from additional rate hikes of                      USD/CAD
                                                                1.3                                                                            -800
100 bps by Dec 2011.                                                             Pay rolls (inv erted scale)
                                                                1.2                                                                            -600
Will CAD continue to lag throughout 2011?
                                                                1.2                                                                            -400
AUD/CAD and NZD/CAD have trended higher since mid-
                                                                1.1                                                                            -200
2010, which likely reflects the fact that the US economy has
slowed relative to Asia, thus adding to uncertainty about       1.1                                                                            0
Canadian growth and the course of BoC policy. Of                1.0                                                                            200
particular concern has been stubbornly high unemployment        1.0                                                                            400
in the US. Of course, some of the shifting of economic
strength from the US to Asia reflects the longer-term           0.9                                                                            600
structural trend that has been in place for many years.            Nov -05 Aug-06 May -07 Feb-08 Nov -08 Aug-09 May -10
Asia’s share of global manufacturing is increasing, while
that of the US is in decline. However, the CAD is currently
underperforming other commodities currencies because of        Chart 7: USD/CAD vs. U.S. consumer discretionary equities index
the weakness of the US cyclical rebound, which has been        USD/CAD vs. U.S. consumer discretionary stock sub-index
noted as a key risk in the pronouncements of BoC officials.     1.3                                                                                150
                                                                                    USD/CAD
Over the long-term, Canada will continue to diversify its
                                                                                                                                                   175
trading relationship and become less dependent upon its                             Stocks (inv erted scale)
southern neighbor, but such activity will take many years to    1.2                                                                                200
influence the impact of the US economy on CAD. For the                                                                                             225
coming year, the strength of the US economy relative to                                                                                            250
                                                                1.1
expectations is the key variable that will affect relative                                                                                         275
performance of CAD in the commodities FX complex.                                                                                                  300
                                                                1.0
Chart 6 shows the close tie between the strength of the US                                                                                         325
economy and USD/CAD. In this case, USD/CAD moves                                                                                                   350
broadly in line with trends in US employment, which makes       0.9                                                                                375
sense because of the large share of Canadian exports that
                                                                   Oct-05      Jul-06   Apr-07 Jan-08          Oct-08   Jul-09    Apr-10
head to the country.
Given the importance of US employment and consumption
for Canadian exports, it is also interesting to note that      Chart 8: AUD/CAD moves in line with unemployment trends in
USD/CAD moves in line with cyclically sensitive US             Canada and Australia
consumer discretionary stocks. This is shown in Chart 7.       AUD/CAD vs. Canada-Australia Unemployment Spread

                                                                3.5%                                           CD-AU Sprd                          1.20
Although US underperformance relative to Asia helps to
explain the underperformance of CAD relative to AUD and         3.0%
                                                                                                               AUD/CAD
                                                                                                                                                   1.10
NZD, it also highlights a key risk for future trends in both
AUD/CAD and NZD/CAD. Should US growth in 2011                   2.5%
                                                                                                                                                   1.00
surprise the market relative to current expectations, CAD       2.0%
has plenty of potential to play catch-up with the other                                                                                            0.90
commodities currencies. The decision by US political            1.5%
leaders to extend or not the Bush-era tax cuts could have an                                                                                       0.80
                                                                1.0%
important impact on sentiment, especially among small                                                                                              0.70
                                                                0.5%
businesses that traditionally account for most growth in
employment. Extension of the cuts could be the trigger for      0.0%                                                                               0.60
improved employment in the US, which would benefit                    Jan-90      Jan-94       Jan-98          Jan-02    Jan-06       Jan-10
Canada and the CAD.




72
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Ken Landon (1-212) 834-2391
kenneth.landon@jpmorgan.com
JPMorgan Chase Bank NA


Chart 8 shows, for example, that AUD/CAD moves broadly            Deleveraging and a weak housing market are not unique to
in line with the spread between the Canadian and Australian       New Zealand, but consecutive declines in housing prices
unemployment rates. That spread is close to historic highs.       that are being weighed down by higher rates and a change
In the last global downturn, Australian unemployment              in taxation could result in sub-par growth. Although RBNZ
increased, but not by nearly as much as that in Canada.           welcomes a rebalancing of household balance sheets, an
Should the US economy surprise to the upside, then Canada         extension of the downtrend could derail the economic
has much to benefit. Its relatively high unemployment rate        recovery or, at a minimum, make the central bank more
could fall sharply. In that event, the Canada-Australia           cautious in tightening policy.
unemployment spread has plenty of room to fall, which
                                                                  Trade rec: long a basket of AUD, NZD, CAD
would serve to turn AUD/CAD lower from its current
elevated levels near 1.0. Furthermore, the BoC has barely         Setting aside the risk scenarios outlined above, our core
started to “normalize” policy while the RBA is well               view is that the USD will remain on a downtrend through
advanced in the process. The market has priced in much of         most of 2011, which in turn will push commodities prices
the good news in Australia while keeping a wary eye on            higher. The terms of trade of the major commodities
Canada. The key question is not whether the cyclical              exporters likely will improve even further. In this
outlook for Australia is better than that for Canada. It likely   environment, AUD, NZD and CAD should outperform not
is. The key question is whether or not a growth surprise in       just the USD, but also other G-10 currencies such as the
the US could change perceptions about Canada and the              EUR and JPY. Given the chance of a surprise to the upside
CAD.                                                              in US growth over the coming year, provided that Bush-era
                                                                  tax cuts are extended, CAD has a good chance to play
What could go wrong?
                                                                  catch-up with other commodities currencies and to
Our bullish view toward the commodities currencies does           outperform over the course of 2011. By the end of 2011, we
face risks on a broad macro level as well as on a country-        forecast AUD/USD, NZD/USD, and USD/CAD at 1.04,
by-country basis. The big risk on the macro level would be        0.80, and 0.96, respectively.
quantitative easing in the US that is much less than is
currently anticipated by the markets. The usual January
rotation of voting members of the FOMC will result in a
Committee that is more hawkish on balance than the one
that voted for QE2. Vocal critics of the Fed’s policy will
also assume leadership positions when the Republicans take
control of key committees in the House of Representatives
in January. If the Fed were to become constrained in
implementing additional quantitative easing, then
commodities prices are vulnerable to a significant
adjustment.
On a national level, high levels of household debt in
Canada could result in extreme caution, thus weighing on
growth and slowing the process by which excess resource
capacity is normalized. Such a result would prevent the
BoC from hiking rates by the 125 bps that we currently
anticipate by the end of 2011.
For Australia, the obvious risk is that China over-tightens
policy, which would hurt commodities exporters. More
country specific, it is important to keep in mind that the
Australian yield curve has flattened considerably since mid-
2009 – more so than other industrialized countries.
Historically, a significant flattening of the yield curve is
following by a slowdown in growth. It doesn’t necessarily
have to pan out that way, especially if Asian growth
remains strong, but this is a risk factor to keep in mind. By
contrast, Canada and New Zealand currently have fairly
steeply-sloped curves, which indicate accommodative
monetary conditions.

                                                                                                                          73
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Justin Kariya (1-212) 834-9618
justin.p.kariya@jpmorgan.com
JPMorgan Chase Bank NA



Long-term valuation: AUD & NZD are fair, CAD has become
cheap
                                                                Chart 1: Misalignments from WFM Q4 fair value estimates vs. USD (%)
•    New fair value estimates suggest that the recent
     strength of commodity currencies is supported by              25
     fundamentals.                                                 20                                  WFM Q4                      Present

•    However, AUD and NZD are vulnerable to some                   15

     correction, while current signals suggest CAD is              10

     undervalued.                                                   5

                                                                    0
•    JPY remains over 10% misaligned relative to all G-
                                                                   -5
     10 crosses; NOK undervaluation has not eased
     despite the recent strength of crude oil prices.             -10

                                                                  -15
•    Two year performance review of fair value model
                                                                  -20
     reveals profitable returns with particularly strong                         NOK         GBP          CAD               CHF                  SEK            EUR          NZD           AUD             JPY
     results for commodity currencies.
                                                                Table 1: G-10 actual and fair-value exchange rates vs. USD, 4Q09-4Q10E
Fed QEII and a weak dollar driving FX                                                       4Q09                       1Q10                           2Q10                   3Q10E                   4Q10E
                                                                                  Actual           FV       Actual               FV             Actual         FV         Actual      FV        Actual       FV
misalignments
                                                                EUR/USD             1.48          1.37        1.38               1.33            1.27          1.24        1.29       1.25       1.39       1.27
Since our last fair value update (World Financial Markets       USD/JPY                90         101             91             100             92            103         86         100        82             99
Q4, September 23), the market has shifted significantly -       GBP/USD             1.63          1.75        1.56               1.74            1.49          1.64        1.55       1.66       1.59       1.65
equities have rallied 7%, commodities are up 9% (CRB spot       USD/CHF             1.02          1.14        1.06               1.08            1.11          1.08        1.03       1.06       0.97       1.06
index), and the dollar has weakened further. The current        USD/CAD             1.06          1.02        1.04               1.01            1.03          1.01        1.04       0.99       1.02       0.94
QEII and weak dollar environment has driven significant         AUD/USD             0.91          0.86        0.90               0.87            0.88          0.88        0.90       0.90       0.98       0.95
misalignments from our Q3 fair value estimates (chart 1)        NZD/USD             0.73          0.68        0.71               0.68            0.70          0.71        0.72       0.71       0.76       0.75

with overvalued currencies (versus USD) deviating further       USD/NOK             5.69          5.12        5.86               5.00            6.24          5.31        6.16       5.38       5.83       5.09
                                                                USD/SEK             7.01          6.68        7.19               6.89            7.59          7.15        7.26       6.96       6.67       6.80
from fair value.
                                                                Notes: E= estimate. Exchange rates are quarterly averages.
Given the movement in FX markets over the past two
months, we estimate new fair value estimates to determine       Chart 2: CRB commodity index vs. NZD/USD and AUD/USD
if the current USD exchange rates are supported by long-run
                                                                 500                                                                                                                                        1
fundamentals. In particular, we focus on commodity                                          CRB index lhs
currencies given that their recent rally leads many to           480                        AUD/USD rhs
                                                                                                                                                                                                            0.95
consider them overvalued.                                        460
                                                                                                                                                                                                            0.9
                                                                 440
Aussie/Kiwi most notable high-β movers                                                                                                                                                                      0.85
                                                                 420
The strength of the AUD/USD and NZD/USD the past two             400                                                                                                                                        0.8
months has been impressive. AUD/USD reached parity, a
                                                                                                                                                                                      Oct-10
                                                                        Jan-10

                                                                                   Feb-10

                                                                                              Mar-10

                                                                                                         Apr-10




                                                                                                                                       Jun-10

                                                                                                                                                   Jul-10

                                                                                                                                                                 Aug-10


                                                                                                                                                                            Sep-10
                                                                                                                       May-10




                                                                                                                                                                                                 Nov-10




level not seen since 1981; and NZD/USD appreciated over
5% since mid-September to 0.77. While a weak dollar
                                                                 500                                                                                                                                        0.8
contributed to this trend, the increase to Australian and New                          CRB index lhs
Zealand export prices are also a likely factor. Given the        480                   NZD/USD rhs
                                                                                                                                                                                                            0.75
close relationship between AUD and NZD with the CRB              460
commodity index (chart 2), we use the index as a proxy for
                                                                 440
estimating changes to 4Q terms of trade (ToT) and fair                                                                                                                                                      0.7
value for Aussie and Kiwi. Table 1 shows that AUD/USD            420

fair value increased to 0.95 from 0.90 (World Financial          400                                                                                                                                        0.65
Markets estimate) and similarly NZD/USD increased to
                                                                                                                                                                                       Oct-10
                                                                        Jan-10

                                                                                   Feb-10

                                                                                              Mar-10

                                                                                                         Apr-10




                                                                                                                                        Jun-10

                                                                                                                                                      Jul-10

                                                                                                                                                                 Aug-10


                                                                                                                                                                             Sep-10
                                                                                                                        May-10




                                                                                                                                                                                                  Nov-10




0.75 from 0.71.


74
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Justin Kariya (1-212) 834-9618
justin.p.kariya@jpmorgan.com
JPMorgan Chase Bank NA


While the 4Q10 AUD and NZD estimates suggest that                Table 3: G-10 actual and fair value real trade-weighted exchange
commodities prices have been a major driver of Aussie and        rates (4Q09=100), 4Q09-4Q10E
Kiwi, both currencies are still slightly overvalued and                                 4Q09            1Q10                  2Q10           3Q10E              4Q10E
                                                                                 Actual        FV   Actual     FV     Actual         FV   Actual    FV      Actual     FV
vulnerable to some correction. As we saw in the week
                                                                 USD              100      103.1    101.0    102.7     102.1      104.0   101.3    103.7     97.2     102.5
following the November 3 FOMC meeting, some upward
dollar movement resulted in sharp declines to AUD/USD            EUR              100      92.4      95.7    89.8          90.9   86.8     90.3    87.3      93.7     87.7

and NZD/USD (both dropped 3% between Nov 5 and Nov               JPY              100      89.9      99.0    89.4          98.0   87.6    104.2    88.8      105.9    88.9

12). During the same period, USD/CAD only increased              GBP              100      112.3     99.4    113.7     100.4      112.3   102.5    112.3 100.1 111.1
1.2%.                                                            CHF              100      93.8      98.6    98.5          98.5   102.6   102.5    101.7 103.9 101.9
                                                                 CAD              100      103.8    101.1    104.2     102.7      105.3    98.9    104.7     99.7     109.7

NOK persistently undervalued; CAD a                              AUD              100      98.0     102.4    99.9      102.3      103.4   102.8    105.0 107.7 110.2

potential dark horse…                                            NZD              100      96.3      97.8    95.8          98.1   101.5    99.2    100.6 100.1 106.0
                                                                 NOK              100      113.8    101.0    118.9     100.9      118.3   100.2    115.6     99.7     121.2
While NZD and AUD have garnered the most attention               SEK              100      107.9    101.1    105.6         99.9   105.7   102.7    107.7 104.7 108.0
from the commodity bloc with their recent strength, CAD          Notes: Exchange rates are quarterly averages except for 4Q10, which is the average through
and NOK have lagged their commodity peers. Both                  Nov 8. E denotes 3Q10 and 4Q10 estimates.
currencies only outperformed JPY among G-10 FX over the
past quarter. As discussed in the previous fair value update,
NOK remains a bargain as the market undervalues                  Table 3: Drivers of changes in fair value real trade-weighted
Norway’s strong fiscal position and the recent rise in crude     exchange rates (% and % contribution), 4Q09-4Q10E
                                                                             Change in RER                             Drivers of fair value changes
oil prices have not been a catalyst for narrowing this
misalignment (NOK is still 13.7% undervalued against                                                                                                  Inv
                                                                              Fair                   Actual Terms of                        Govt    Income Current
USD).                                                                        Value Actual             RER    Trade   Inflation              Debt      Bal  Account
However, persistent undervaluation is less likely to be the      USD             -0.6      -2.9       -0.6          0.6           0.1       -1.2      0.0            0.5
case for the loonie. USD/CAD has 0.90 correlation with           EUR             -5.1      -6.6       -1.4          -2.7          -0.3      -1.2      0.0            0.4
crude prices (chart 3) and therefore the uptrend in oil prices   JPY             -1.2      5.7         1.2          -1.3          -0.3      -1.0      0.0            0.2
above $80 is a bullish signal for CAD. Similar to NZD and        GBP             -1.1      0.1         0.0          0.2           -0.2      -2.3      -0.3           1.5
AUD, we use oil prices as a proxy for estimating 4Q terms        CHF             8.5       3.8         0.8          3.1           -0.1      -0.1      0.2            4.4
of trade for CAD and NOK. The improvement in Canadian            CAD             5.6       -0.3       -0.1          5.5           -0.3      0.2       0.0            0.1
ToT in 4Q lowers USD/CAD fair value to 0.94 from 0.99.           AUD          12.0         7.4         1.5          14.5          -0.2      -0.6      0.1            -3.6
A USD/CAD spot rate of 0.94 was last reached in late 2007        NZD             9.9       0.1         0.0          12.3          0.1       -1.0      0.1            -1.9
when oil prices rallied above $80. Should the American           NOK             6.5       -0.3       -0.1          7.4           -0.1      -1.0      0.1            0.0
economy exceed 3% growth by mid 2011 as our economists           SEK             0.1       4.6         1.0          1.3           -0.4      -0.5      0.0            -1.3
currently forecast, the loonie will be a primary beneficiary     E = estimate.
with 75% of Canadian exports going to the US. We
therefore watch CAD for significant upside in the New
Year.
                                                                 Chart 3: WTI crude oil vs. USD/CAD 1998-2010
Current signals and hedging/investment
opportunities.                                                    140                                                                                                   0.90
                                                                                          WTI crude oil ($) lhs
Table 4 (next page) summarizes current G10 cross-currency         120                                                                                                   1.00
misalignments. JPY remains significantly overvalued, while                                USD/CAD rhs
NOK is over 10% undervalued against almost all crosses            100                                                                                                   1.10
except CAD. As discussed above, CAD offers significant
                                                                    80                                                                                                  1.20
upside and is very cheap relative to AUD, NZD, JPY, EUR,
and CHF. However, deviations from fair value can persist            60                                                                                                  1.30
for extended periods of time – our previous tests suggest
that it takes 18 months on average to eliminate one-half of         40                                                                                                  1.40
any deviation from fair value (see Trading and Hedging              20                                                                                                  1.50
Long-Term FX Fundamentals with J.P. Morgan’s Fair-
Value model April 2009). Thus, we use long-term                        0                                                                                                1.60
misalignments as an input into trade selection along with                  98 99         00 01        02 03 04               05 06        07 08 09            10
short-to-medium trends and risk assessments.

                                                                                                                                                                            75
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Justin Kariya (1-212) 834-9618
justin.p.kariya@jpmorgan.com
JPMorgan Chase Bank NA


For the purpose of back-testing the model’s signals, we use                                          Table 4: G10 exchange rate deviations from 4Q10 fair value (%), 5-12
a simple buy-and-hold trading rule. For a signal to go long                                          Nov 2010
or short FX against a base currency, we compare its                                                                EUR      JPY     GBP       CHF     CAD       AUD     NZD       NOK     SEK
misalignment with its forward premium or discount as                                                 USD            8.6     19.6     -2.0     9.0     -6.2      6.2     4.2       -13.9   1.3
follows: (a) go short foreign currency, buying 1 unit of the                                         EUR                    11.0    -10.6     0.4     -14.8     -2.4    -4.4      -22.5   -7.3
base currency forward if the percentage overvaluation of the                                         JPY                            -21.6     -10.6   -25.8     -13.4   -15.4     -33.5   -18.3
foreign currency exceeds its forward discount (and hence                                             GBP                                      11.1    -4.2      8.2     6.2       -11.9   3.3
the cost of carry) by more than a predetermined critical                                             CHF                                              -15.2     -2.9    -4.9      -22.9   -7.8
threshold value. Reverse the position at the spot rate when                                          CAD                                                        12.3    10.3      -7.7    7.4
the forward contract matures. Similarly, (b) go long FX,                                             AUD                                                                -2.0      -20.0   -4.9
selling $1 forward if the percentage undervaluation of                                               NZD                                                                          -18.0   -2.9
foreign currency exceeds its forward premium by more than                                            NOK                                                                                  15.1
the predetermined threshold and reverse the position at the
                                                                                                     Note: Misalignments measured as average market rates for 5-12 Nov vs. 4Q10 fair values. A
spot rate when the forward contract matures. The objective                                           negative number denotes undervaluation of the column vs. the row currency.
of the back test is to determine whether there are values of
the threshold for which this trading strategy would have
yielded profits in excess of carry.                                                                  High-beta FX (AUD, NZD, CAD, NOK, and SEK) returns
Performance update: JP Morgan fair-                                                                  were extremely strong since 2009. Using the simple buy-
                                                                                                     and-hold trading rule over an 18-month time horizon and
Value model                                                                                          exploiting 10% misalignments resulted in a 15.7% profit.
The fair value model was estimated in September 2008 (see                                            However, less cyclical currencies had mixed results.
A new fair-value model for G10 currencies September 2008)                                            From table 6 (next page), we compare the returns of high-
which now provides two years of estimates to test its                                                beta to core-G4 (GBP, EUR, JPY, and CHF) for USD based
profitability. Table 5 shows the returns for USD-based                                               hedgers/investors. In addition, we examine returns from a
hedgers using the trading rule just described.                                                       theoretical back-test from 2004-08 and our results from
Over the past two years, the model generated positive                                                2009-10. In both periods, the model provides better signals
returns on average for all time horizons and thresholds. The                                         for pro-cyclical currencies. In addition, returns are positive
results are similar to our four year back-test (see Managing                                         on average for each individual high-beta currency.
FX hedge ratios, May 2010), and table 5 highlights the                                               One possible explanation for the models success with pro-
merits of using such a model for long-term forecasting and                                           cyclical FX is that high-beta are more sensitive to changes
hedging. But we note that we have limited data points (8                                             in underlying fundamentals. For example, our current fair
quarters) and cannot draw any statistical conclusions from                                           value estimates reveal significant changes to the commodity
these returns. In addition, it is interesting to note that returns                                   bloc which is driven by their ToT. The rise in commodity
are not equal across currencies.                                                                     prices this past decade (e.g. gold, oil, copper, and coal)


Table 5: USD as base currency – profitability of fair value-based trading rules (% annual, net of carry), 2009Q1 – 2010Q4
                                                                                              Threshold = 0%
     Horizon             Avg.                AUD               CAD                EUR               JPY              NOK               NZD               SEK               CHF               GBP
       2                 6.0%               15.0%             12.2%               2.9%             -8.3%            -6.8%             22.1%              7.4%              5.9%              3.8%
       4                 4.1%               14.4%             13.2%              -2.6%             -5.1%            -8.3%             14.7%              6.9%              2.1%              1.2%
       6                 5.9%               21.2%             11.2%               1.6%             -7.6%            -7.9%             18.7%              7.3%              4.7%              3.5%
                                                                                              Threshold = 5%
     Horizon             Avg.                AUD               CAD                EUR               JPY              NOK               NZD               SEK               CHF               GBP
       2                 5.3%               13.3%             10.3%              -0.8%             -4.4%            -4.0%             19.7%              8.2%              1.4%              3.8%
       4                 4.5%               18.1%             11.9%              -1.3%             -3.8%            -2.6%             14.7%              3.3%             -0.9%              1.2%
       6                 6.3%               21.2%             11.2%               2.6%             -1.4%            -4.8%             18.7%              6.5%             -0.5%              3.5%
                                                                                              Threshold = 10%
     Horizon             Avg.                AUD               CAD                EUR               JPY              NOK               NZD               SEK               CHF               GBP
       2                 5.9%               12.7%              9.1%              -0.8%              3.0%             4.4%             19.7%              3.2%             -0.2%              2.4%
       4                 4.0%               15.8%              8.1%              -1.3%             -1.5%             0.2%             14.7%              0.4%             -1.3%              1.2%
       6                 7.3%               21.2%              7.0%               2.6%             -1.4%              NA              18.7%               NA              -0.5%              3.5%

Note: NA reflects situations when there were no trades for a particular currency and time horizon.




76
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Justin Kariya (1-212) 834-9618
justin.p.kariya@jpmorgan.com
JPMorgan Chase Bank NA


Table 6: USD as base currency – profitability of fair value-based
trading rules (% annual, net of carry), period comparison
Threshold = 0%             2004-2008                 2009-2010
    Horizon         High-β          Core-G4   High-β          Core-G4
       2             2.9%             1.5%    10.0%             1.1%
       4             0.8%            -0.3%     8.2%            -1.1%
       6             0.3%            -0.1%    10.1%             0.6%
Threshold = 5%             2004-2008                 2009-2010
    Horizon         High-β          Core-G4   High-β          Core-G4
       2             3.2%             1.9%     9.5%             0.0%
       4             0.7%             0.2%     9.1%            -1.2%
       6             0.1%             0.5%    10.6%             1.0%
Threshold = 10%            2004-2008                 2009-2010
    Horizon         High-β          Core-G4   High-β          Core-G4
       2             4.9%             2.2%     9.8%             1.1%
       4             1.3%             0.9%     7.9%            -0.7%
       6             1.0%             0.6%    15.7%             1.0%



provided clear signals for commodity FX which were
successfully exploited by the model.
On the other hand, the fair value model does not always
capture underlying trends for our core-G4 currencies, and
misalignments can persist for extended periods of time. For
the 2004-08 period, the model suggested that EUR/USD
was overvalued, but the EUR/USD continued to appreciate
until mid 2008. EUR/USD sharply depreciated in late 2008
as the model correctly signaled, but the upward trend in
EUR/USD persisted for an extended period of time and
rendered a negative return.
Similarly, Japan’s staggering 200% debt/GDP ratio is a
primary driver of the yen’s fair value and the model
currently signals that JPY is over 10% overvalued against
all G10 crosses. Yet the yen appreciated in the second half
of 2010 as the market views JPY as an alternative refuge to
the greenback, which has been on a depreciating trend in
2H10. The yen’s relatively weak long-term fundamentals
have been outweighed by cyclical factors (i.e. global
recession and low rates in the US), which are constructive
for JPY. When the cycle turns, the yen could experience a
sharp correction similar to the EUR. However, it is difficult
to forecast an exact time horizon for a correction and
therefore the fair value is only used as an input in
investment/hedging decisions, in addition to short-term and
medium term trends and risk assessments.




                                                                        77
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


                                                                always preferred overlaying short-term rate momentum –
Model-driven strategies &                                       essentially the forward carry signal – on medium tem price
manager performance                                             momentum. The strategy is called forward momentum
                                                                overlay and buys currencies is two conditions are met: the
                                                                pair has risen over the past year, and rate momentum in that
For a year beset by tail risks which by definition should not   pair has been positive over the past month. This strategy
be forecastable through models, rule-based investment           returned 5.7% this year by avoiding currencies like the euro
strategies performed respectably in 2010. All strategies        where these two signals often conflicted, while focussing on
delivered positive absolute returns (table 1), and risk-        currencies such as JPY, AUD and CHF.
adjusted performance was comparable to industry                 Earlier J.P. Morgan research has explored the issue of
performance amongst currency manages and global macro           forecasting returns from various model-drive strategies,
funds (table 1). The box on the next page describes several     since excess returns tend be regime-dependent (see
model-driven FX strategies which J.P. Morgan has                Currency manager returns, trading styles and Fed cycles,
developed over the past several years and whose signals and     Normand, August 2006 and FX in a world with less
performance are reported each Friday in FX Markets              leverage and more regulation, Normand and Sandilya,
Weekly.                                                         January 2009). Carry performs best when volatility is
In 2010 standard carry strategies delivered returns of 1.2%     declining but policy rates increasing, thereby boosting the
for G-10 currencies and 7.3% on emerging markets (table         rate advantage of high-yielders. Forward carry tends to
1), which is much worse than in 2009 but competitive            perform best when central bank cycles are unsynchronised,
versus the returns for some currency manager benchmarks.        thus causing rate spreads to trend for several months. Price
The G-10 basket suffered from shorts in USD/NOK and             momentum tends to perform best in periods of declining
longs in EUR/CHF, which partially offset gains from long        interest rates, probably because such an environment drives
AUD/USD and NZD/USD this year. This performance is              long-term bear markets for the dollar.
worse than the 8% returns we forecast in the 2010 Outlook       If historical betas hold, then carry should return about 7% in
because the sovereign crisis overturned two typical             2011, assuming volatility stays within a 11%-14% range
European carry trades (long NOK and short CHF).                 (basis VXY). EM carry normally outperforms G-10 carry
A variant on standard carry, forward carry overlay,             simply due to higher yield, but if central bank intervention
returned 3.6% this year by limiting its longs in G-10 high-     limits EM spot gains while driving G-0 overshoots, the
yielders to those currencies where rates were rising. Thus is   return differential between these two may be smaller than
concentrated exposure in currencies such as AUD and NZD         average next year. Forward carry should deliver positive
and avoided other high yielders which often lacked the          returns in 2011 again, since money markets do not price in
gradual upgrade in rate expectations to drive currency          what we would consider reasonable paths for interest rates
appreciation.                                                   over the next year. The resulting upgrade to rates in some
                                                                countries and downgrade in others will sustain the medium-
Indeed, the best performing strategy was forward carry,         term rate trends which render this model profitable. Price
which derives signals from interest rate momentum by            momentum should deliver high-than-average returns for
buying currencies in whose favor interest rate expectations     two reasons: the Fed’s stance could embed a weak dollar
are moving. A currency’s status as a high or low yielder is     trend throughout the year, which make medium-tem
irrelevant. The model has been short USD/JPY for most of        lookback signals more reliable; and macro shocks from
the year as US rates converged on Japan’s; it was only long     Europe are less likely to cause trend reversals along that
AUD and NZD when rate expectations in those countries           path. The performance and signals from each model are
were rising relative to the US; and it has been both long and   reported weekly in the Model-driven strategies section of
short EUR/USD this year depending on how the sovereign          FX Markets Weekly.
crisis and QE swung rate spreads between the US and
Germany.
Simple price momentum performed poorly this year, as we
expected (-5%). The basic model specification bases signals
on the past 12 months’ performance, which is too long a
lookback period for markets a market beset by 2010’s
newer shocks such as sovereign risk and the US mid-year
slowdown. Rather than modify the lookback, we have



78
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd.


Table 1: Performance of model-driven strategies, currency managers and hedge funds, 2000 - 2010
Betas are calculated between monthly returns on strategies/manager composites and the level of volatility/interest rates.

                                                      FX alpha strategies                                                                      Currency manager and hedge fund performance

                                                          Emerging                  G-10 carry with    Forward         Barclay                    Parker         HFR         HFR global      HFR global    HFR emerging
                          G-10 carry     G-10 carry     Markets carry Forward Carry Forward Carry     momentum        Currency Barclay Group     Blacktree     currency     macro hedge     macro hedge    markets hedge
                         (IncomeFX)     (unlevered)     (IncomeEM)    (9 USD pairs)    overlay         overaly     Traders Index* BTOP FX**        CMI**        index*        funds**          funds*         funds*

2010 YTD
YTD return                       7.5%           1.2%              7.3%        18.6%            3.6%         5.7%           3.1%        0.5%            0.9%         2.1%           -2.9%           5.6%            10.6%
Std dev                         18.7%          11.0%             19.2%         7.1%            9.2%         4.5%           2.0%        4.1%            3.3%         5.4%            6.2%          11.0%             9.5%
IR                               0.40           0.11              0.38         2.62            0.39         1.28           1.56         0.13            0.28         0.38           -0.47           0.11             1.11

2009
Avg annual return               57.9%          20.6%             10.2%         7.9%          21.8%         -2.2%           0.9%        5.1%           -1.2%         0.0%           4.3%           20.6%            35.0%
Std dev                           28%            14%                8%         8.6%            13%            7%           1.5%        9.0%            2.8%         2.1%           6.3%           13.6%            10.0%
IR                               2.09           1.51              1.34         0.92           1.64         -0.29           0.61        0.57           -0.41         0.00           0.69            1.51             3.50

2005 - 2009 (5 years)
Avg annual return                4.8%          -0.1%              7.3%         9.4%            2.6%         3.7%           1.1%        6.7%            3.2%         0.7%           7.0%           -0.1%            10.6%
Std dev                           32%            16%               14%         3.6%             15%           6%           1.9%       11.6%            3.0%         3.4%           2.7%           16.0%            30.0%
IR                               0.15          -0.01              0.51         2.61            0.18         0.66           0.58        0.58            1.09         0.20           2.56           -0.01             0.35

2000 - 2009 (10 years)
Avg annual return                9.0%           4.2%             10.2%         6.2%           4.2%         4.9%            3.2%          NA              NA           NA           7.6%            4.2%            10.8%
Std dev                           22%            12%               16%         5.2%          11.5%         4.9%            3.5%          NA              NA           NA           6.1%           12.1%            23.5%
IR                               0.41           0.35              0.63         1.18           0.37         0.99            0.92          NA              NA           NA           1.26            0.35             0.46

* monthly return composites
 ** daily return composites


Source: J.P. Morgan, index providers



Strategy descriptions
G-10 and emerging markets carry strategies select four
currencies with highest ratio of carry (1-mo rate
differential) to volatility (annualized spot volatility over
past 30 days).
Forward Carry buys the currency in whose favor rate
expectations have moved over the past month. Expectations
are based on 1mo rates 3mos forward.
Forward Carry Overlay only buys high yield currencies if
rate expectations are also moving in that currency’s favor,
so combines standard carry and Forward Carry concepts.
Forward Momentum Overlay only buys currencies which
have appreciated in spot terms over the past year and are
experiencing rising rate expectations relative to another
currency over the past month. Thus it combines the standard
price momentum framework with Forward Carry.
All strategies are described in Alternatives to Standard
Carry and Momentum in FX (Normand and Ghia, August 8,
2008).




                                                                                                                                                                                                              79
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Sunil Kavuri (44-20) 7777-1729
sunil.d.kavuri@jpmorgan.com
J.P. Morgan Securities Ltd.



Global FX carry trade monitor
Chart 1: Japanese retail -- market capitalisation of 100 largest FX-                 Chart 2: Japanese retail -- aggregate retail margin shorts in JPY
denominated ITs
¥trn; market capitalization of 100 largest investment trusts excluding funds         ¥trn, Japanese retail measured by positions in USD, NZD, EUR, GBP and AUD
investing in equities; ranked in the order of total asset as of Nov 17th 09          on Tokyo Financial Exchange; positive indicates shorts in JPY
 25                                                                            70      ¥8                             Aggregate margin shorts in JPY, JPYtrn, lhs   70
                                                                                                                      JPY trade-w td, inv erted rhs

                                                                               80      ¥6                                                                           80

 20
                                                                               90      ¥4                                                                           90


                                                                               100     ¥2                                                                           100
 15

                                                                               110     ¥0                                                                           110
               Market cap of top 100 ITs, JPY trn, lhs
               JPY trade-w td index , inv erted rhs                                   -¥2                                                                           120
 10                                                                            120
         06         07           08               09            10                          07                   08                  09                10


Source: J.P. Morgan, Bloomberg                                                       Source: J.P. Morgan, TFE;

• Japanese retail exposure to foreign currency investment trusts,                    • Japanese aggregate margin shorts in yen ended the week at
  after collapsing by ¥3.0trn in last two weeks of October to                          ¥2.9trn, down ¥0.9trn. Aggregate shorts in yen stand under
  ¥14.0trn, has held fairly steady around this level since.                            half their year-to-date peak of ¥6.3trn (31st Aug).
  Exposure is 27% and 58% below the year-to-date high and
  record high respectively.

Chart 3: Japanese retail -- margin position in JPY vs USD, EUR,                      Chart 4: CTAs -- aggregate IMM position in USD
AUD
mln local currency. positive indicates long in local currency/short in JPY           $ bn as the sum of net speculative positions on the IMM in AUD, NZD, CAD,
                                                                                     EUR, GBP, JPY, CHF and MXN.
                                                                                       $30                                                                          110
  50                                                                                                                     Aggregate IMM position in USD, $ bn, lhs
                     USD
  40                                                                                   $20                               USD trade-w td index , rhs                 105
                     EUR
  30
                                                                                       $10                                                                          100
  20                 AUD

  10                                                                                    $0                                                                          95
     0                                                                                -$10                                                                          90
 -10
                                                                                      -$20                                                                          85
 -20
 -30                                                                                  -$30                                                                          80
 -40
                                                                                      -$40                                                                          75
      Jan-08     Jul-08      Jan-09      Jul-09        Jan-10        Jul-10
                                                                                             00   01     02      03      04    05    06    07    08    09    10


Source: J.P. Morgan, TFE                                                             Source: J.P. Morgan, CME

• Japanese margin longs in USD continued to decline, falling                         • Aggregate IMM shorts in USD extended its slide since
  by $0.5bn. This follows the large $8bn drop the previous                             reaching its record on Oct 8th ($35.5bn), to close at $21.2bn.
  week and now stands at $21.8bn. AUD longs rose A$1.8bn to                            Shorts are now 40% lower than the record. The USD was
  A$11.9bn. EUR positions once again turned short to end the                           largely bought against EUR and JPY – longs in each stand at
  week at €2.7bn.                                                                      $1.5bn and $3.4bn respectively.




80
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Global FX Strategy 2011
November 23, 2010

Sunil Kavuri (44-20) 7777-1729
sunil.d.kavuri@jpmorgan.com
J.P. Morgan Securities Ltd.




Chart 5: Market capitalisation of US-listed currency ETFs                             Chart 6: Currency managers and global macro hedge funds -- Beta
                                                                                      with trade weighted USD
Weekly data, $bn. Positive value indicates longs in foreign currency and shorts in    HFR used for global macro hedge funds. Barclay BTOP Index used for currency
USD                                                                                   managers.
  5                                                                          75         3.0
                                                                                                                                   Global macro hedge funds
                                                                                        2.0                                        Currency managers
  4                                                                          80
                                                                                        1.0

  3                                                                          85         0.0
                                                                                       -1.0
  2                                                                          90
                                                                                       -2.0

  1                                                                          95        -3.0
                           Market cap of US-listed FX ETFs, $bn, lhs
                                                                                       -4.0
                           USD trade-w td index , inv erted, rhs
  0                                                                          100               05        06            07        08           09         10
      06           07             08            09           10

Source: J.P. Morgan, Bloomberg                                                        Source: J.P. Morgan, Bloomberg

• US retail exposure to foreign currencies via ETFs rose                              • Currency managers have reduced their exposure to USD
  slightly over the week to reach $2.6bn. The market cap of FX                          shorts, as indicated by beta moving from -0.7 (Nov-12th) to -
  ETFs still stands at approximately half of its 2008 peak but                          0.6. This is less than half its record low of -1.4. Macro funds
  2.5 times larger than its year-to-date low of $1.1bn recorded                         on the other hand increased their USD short exposure as their
  on 1st April.                                                                         returns beta moved from -0.3 to -0.4. Macro funds’ returns
                                                                                        beta hit -0.8 in May this year (record low at -0.9).



Chart 7: Currency managers and global macro hedge funds -- Beta                       Chart 8: Currency managers and global macro hedge funds -- Beta
with G-10 carry strategies                                                            with emerging markets carry strategies
Positive beta implies a long in carry, a short in dollars HFR used for global macro   Positive beta implies a long in carry, a short in dollars HFR used for global macro
hedge funds. Barclay BTOP Index used for currency managers.                           hedge funds. Barclay BTOP Index used for currency managers.

  3.0                                                                                   2.0           Currency managers               Global macro hedge funds
                Currency managers               Global macro hedge funds
  2.0                                                                                   1.5

                                                                                        1.0
  1.0
                                                                                        0.5
  0.0
                                                                                        0.0
  -1.0
                                                                                        -0.5

  -2.0                                                                                  -1.0
           05      06            07        08           09          10                         05        06            07        08           09         10


Source: J.P. Morgan, Bloomberg                                                        Source: J.P. Morgan, Bloomberg

• The exposure of macro and currency managers with G-10                               • Currency managers’ exposure to EM carry reached a new
  carry climbed over the week as their returns beta rose to 0.2.                        high since mid-August, as the beta of their returns rose to
  This is significant as currency managers’ beta has remained                           +0.32. Macro funds increased their exposure to EM carry with
  close to zero since mid-May, whilst the beta for macro funds                          their returns beta rising to +0.3 (vs ytd peak at +0.6, May-
  has also moved similarly since mid-July. Note however beta                            20th).
  is well short of its peak.




                                                                                                                                                                       81
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
Sunil Kavuri (44-20) 7777-1729
J.P. Morgan Securities Ltd.



J.P. Morgan FX forecasts vs. forwards & consensus
Exchange rates vs. U.S dollar
                           Current                                                                            JPM forecast gain/loss vs Dec-11*   Actual change in local FX vs USD
Majors                      Nov 23          Mar 11           Jun 11           Sep 11           Dec 11         forward rate       Consensus**      Past 1mo      YTD     Past 12mos
              EUR              1.35          1.40             1.43      ↓      1.45      ↓      1.48      ↑      9.1%               10.1%          -3.4%       -5.9%       -9.9%
               JPY             83.4           81               80       ↑       79       ↑       78       ↑      6.3%               13.5%          -2.4%       11.6%        6.2%
              GBP              1.59          1.59             1.63      ↓      1.67      ↓      1.70      ↓      7.0%                5.7%          1.5%        -1.6%       -4.0%
              AUD              0.98          1.00      ↑      1.01      ↑      1.03      ↓      1.04      ↓      11.0%              11.7%          -0.5%       8.9%         6.4%
              CAD              1.02          0.99      ↑      0.98      ↑      0.97             0.96      ↓      7.2%                6.6%          0.5%        3.2%         3.6%
              NZD              0.77          0.77      ↑      0.78      ↑      0.79      ↓      0.80      ↓      7.4%               11.0%          2.5%        5.9%         5.5%
JPM USD index                  81.5          79.8             78.8             77.8             76.9                                               0.5%        -2.9%       -0.9%
DXY                            78.5          76.5             75.0             73.9             72.5                                               1.3%        0.8%         4.6%

Europe, Middle East & Africa
              CHF              0.99          0.93      ↓      0.90      ↓      0.88      ↑      0.86      ↓      14.8%              17.4%          -1.2%       4.7%         2.0%
                ILS            3.66          3.75             3.75             3.75             3.75             -2.7%               -2.5%         -0.7%       3.6%         3.3%
              SEK              6.96          6.50      ↓      6.29      ↓      6.17      ↑      6.08      ↓      15.1%              10.0%          -4.9%       2.9%        -0.7%
              NOK              6.08          5.75      ↓      5.59      ↓      5.45      ↓      5.34      ↓      15.1%               7.9%          -4.7%       -4.7%       -7.5%
              CZK             18.30         17.32            17.48      ↓      16.90     ↑      16.22     ↓      12.4%              10.7%          -3.8%       0.9%        -5.0%
               PLN             2.94          2.75             2.66      ↓      2.59      ↓      2.50      ↑      19.4%              11.5%          -3.3%       -2.5%       -6.3%
              HUF               204          196              189       ↓       185      ↑       179      ↓      17.3%              11.2%          -3.5%       -7.5%       -12.5%
              RUB             31.29         29.66      ↑     28.91      ↑      28.69     ↑      28.37     ↑      14.6%               5.6%          -2.8%       -4.0%       -7.9%
               TRY             1.47          1.39             1.38             1.36             1.36             13.7%              11.8%          -3.1%       1.8%         1.7%
              ZAR              7.05          7.00             7.00             7.15             7.30             1.6%                4.1%          -1.6%       4.9%         5.8%

Americas      ARS              3.97          4.15             4.15             4.25             4.25             3.8%                0.9%          -0.4%       -4.4%       -4.3%
              BRL              1.73          1.80             1.82             1.83             1.85             1.5%                -4.3%         -1.4%       0.8%         0.0%
               CLP            480.8          505              500               500              500             -0.7%               -1.1%         1.4%        5.5%         2.7%
              COP              1890          1830             1850             1880             1900             0.6%                -1.3%         -3.3%       8.1%         4.5%
              MXN             12.34         12.50            12.25             12.25            12.25            4.5%                1.8%          -0.4%       5.7%         4.1%
              PEN              2.81          2.84             2.82             2.79             2.78             2.1%                -0.4%         -0.6%       2.7%         2.6%
               VEF             4.29          5.50             5.50             5.50             5.50            -21.9%              -10.5%         0.1%       -49.9%       -49.9%
LACI                         113.16         110.48           110.90           110.37           109.91                                              -0.8%       2.9%         1.6%

Asia          CNY              6.64          6.50             6.40             6.30             6.20             4.0%                1.2%          0.2%        2.8%         2.8%
              HKD              7.76          7.75             7.76             7.76             7.76             -0.4%               0.1%          0.0%        -0.1%       -0.1%
               IDR             8970          8750             8700             8700             8650             7.7%                1.5%          -0.3%       4.8%         5.8%
               INR             45.7          44.0             43.5             43.0             42.5             12.2%               1.9%          -2.5%       1.8%         1.5%
              KRW              1164          1180             1140             1090             1110             2.7%                -6.3%         -3.5%       0.0%        -0.6%
              MYR              3.13          3.07             3.04             3.01             2.97             6.1%                -0.8%         -0.4%       9.6%         8.4%
              PHP            44.185         41.75            41.00             40.25            39.50            11.9%               5.5%          -1.9%       4.5%         6.5%
              SGD              1.31          1.27             1.26             1.24             1.22             6.3%                2.4%          -1.1%       7.1%         5.6%
              TWD             30.54         29.25            28.75             28.25            28.00            5.3%                6.2%          0.9%        4.7%         5.6%
              THB             30.05         30.00            30.00             29.75            29.50            2.2%                -1.5%         -0.3%       11.0%       10.5%
ADXY                          114.5         116.3            117.9             119.9            120.9                                              -0.7%       3.5%         3.2%

Exchange rates vs Euro                                                                                                                            Actual change in local FX vs EUR
               JPY              112          113              114       ↑       115      ↑       115      ↑      -2.6%               3.0%          1.0%        18.5%       17.9%
              GBP              0.85          0.87      ↑      0.89      ↓      0.89      ↑      0.88      ↑      -1.9%               -4.0%         5.0%        4.7%         6.6%
              CHF              1.33          1.30      ↓      1.29      ↓      1.27      ↓      1.27      ↓      5.2%                6.6%          2.2%        11.3%       13.2%
              SEK              9.38          9.10      ↓      9.00      ↓      8.95             9.00             5.5%                -0.1%         -1.5%       9.3%        10.3%
              NOK              8.20          8.05      ↓      8.00      ↓      7.90      ↓      7.90      ↓      5.5%                -2.0%         -1.3%       1.1%         2.7%
              CZK             24.70         24.25            25.00             24.50            24.00            3.0%                0.5%          -0.5%       7.1%         5.4%
               PLN             3.96          3.85             3.80             3.75             3.70             9.4%                1.3%          0.1%        3.6%         4.1%
              HUF               275          275              270               268              265             7.5%                0.9%          -0.1%       -1.8%       -2.8%
              RON              4.31          4.10             4.05             4.00             3.90             15.3%               5.9%          -0.3%       -1.8%       -0.9%
               TRY             1.98          1.95             1.97      ↑      1.97      ↓      2.01      ↑      4.2%                1.5%          0.3%        8.3%        13.2%
              RUB             42.18         41.53      ↑     41.34      ↑      41.60     ↓      41.99            5.0%                -4.1%         0.3%        2.5%         2.1%

↑ indicates revision resulting in stronger local FX , ↓ indicates revision resulting in weaker local FX
* Negative indicates JPM more bullish on USD than consensus,** Consensus Economics Publication: Foreign Exchange Consensus Forecasts November 2010
82
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
Junya Tanase (81-3) 6736-7718
Paul Meggyesi (44-20) 7859-6714
Justin Kariya (1-212) 834-9618
J.P. Morgan Securities Ltd, JPMorgan Chase Bank NA


FX forecast risk bias, scenarios and trigger events
     Currency,                           Ranges/targets for alternative scenarios                            Trigger events
  baseline forecast
   and risk bias
 JPY                        • Bearish: USD/JPY to 75 by mid-2011 if Fed signals willingness to       • US CPI and payrolls reports
                              pursue QE 3
 USD/JPY: Q1 81, Q2                                                                                  • Nikkei rising to above 12000
 80                         • Bullish: Full-fledged acceleration in Japanese investors’ foreign
                              securities investments, including de-hedging FX-hedged foreign
 Bearish bias                 bond investment by Japanese lifers. It brings USD/JPY to 90




 EUR                        • Bearish: Low 1.30s in Q1 if Portugal loses market access and must      • Portuguese t-bill redemptions
                              tap EFSF, followed by lengthier or more contentious approvals            and Spanish bank redemptions
 EUR/USD: Q1 1.40,            process than what Ireland experienced. Ireland or Greece fail to         in Q1. Periphery’s Q4 2010
 Q2 1.45                      comply with deficit reduction targets. 1.25 is possible is Spain         GDP reports due February 15.
                              looses market access and must tap the EFSF.                              Irish elections in Q1 2011.
 Balanced risks
                            • Bullish: Periphery retains market access, or funding through EFSF      • QE risks turn on US CPI and
                              is immediate. Fed continues to drive real yields lower and hints at      payrolls reports, as mentioned
                              extension of QE beyond June 2011.                                        in the yen scenario above.


 GBP                        • Bearish: EUR/GBP to low 0.90s if economy buckles under the             • GDP growth, retail sales,
                              weight of fiscal consolidation and BoE delivers an aggressive QEII.      house prices, BoE Inflation
 EUR/GBP : Q1 0.88,                                                                                    report/ minutes.
 Q2 0.89                    • Bullish: BoE hikes interest rates as inflation expectations rise and
                              threaten to propagate short-term inflation shocks. EUR/GBP to 0.80.    • CPI, survey of inflation
 GBP/USD: 1.59 in             Rapid contagion to Spain that sustains safe-haven demand for Gilts       expectations, wage growth,
 Q1, 1.63 in Q2                                                                                        January VAT hike. Spain CDS

 Balanced risks




 CHF                        • Bearish: SNB refuses to normalize monetary policy as deflation         • Swiss CPI; US Treasury
                              intensifies. Global bond market sell-off, resumption of CHF carry        yields.
 EUR/CHF: Q1 1.30,            trade. EUR/CHF mid 1.40s.
 Q2 1.27                                                                                             • Spanish CDS. Swiss CPI,
                            • Bullish: Sovereign stress spreads to Spain. Earlier tightening from      domestic house prices.
 USD/CHF 0.93 in              the SNB in the face of a turnaround in domestic inflation/much
 Q1, 0.90 in Q2               faster house price appreciation. EUR/CHF to low 1.20s.

 Balanced risks




 SEK                        • Bearish: Renewed round of global deleveraging (global double-dip).     • Equities, global PMI
                              EUR/SEK to mid 10s.
 EUR/SEK: Q1 9.10                                                                                    • Swedish GDP, CPI
 Q2 9.00                    • Bullish: Growth remains robust, inflation bottoms, Riksbank
                              resumes tightening in Q1, rates rise sharply. EUR/SEK to 8.60-
 Balanced risks               8.70.


                                                                                                                                        83
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
Junya Tanase (81-3) 6736-7718
Paul Meggyesi (44-20) 7859-6714
Justin Kariya (1-212) 834-9618
J.P. Morgan Securities Ltd, JPMorgan Chase Bank NA

        Currency,                        Ranges/targets for alternative scenarios                            Trigger events
     baseline forecast
      and risk bias
 NOK                        • Bearish: Global deleveraging; Norge Bank removes bias to tighten       • Equities, Norwegian CPI
                              as CPI slide intensifies. EUR/NOK to low-mid 9.00s.
 EUR/NOK: Q1 8.05,                                                                                   • Oil price, Norwegian CPI
 Q2 8.00                    • Bullish: Oil price spikes. Domestic disinflation trend ends, Norges
                              Bank proves too cautious on global growth. EUR/NOK to 7.50
 Balanced risks




 AUD                        • Bullish: AUD/USD to 1.05 by end Q1 if RBA surprises with rate          • Australia Q4 2010 CPI due
                              hike on Dec 7, 2010 or Feb 1, 2011, since only 40bp of tightening is     January 25, 2011.
 AUD/USD: Q1 1.00,            priced for the next year.
 Q2 1.01                                                                                             • China PMIs due on 1st of each
                            • Bearish: AUD/USD to 0.95 in Q1 if Chinese growth slows and               month
 Bullish bias                 commodity prices fall 10% from current levels.


 NZD                        • Bullish: NZD/USD to 0.82 by end Q1 if RBNZ raise rates +25bp on        • RBNZ meeting Mar 10, 2011.
                              March 10 and improving global demand driving dairy and meat
 NZD/USD: Q1 0.77             prices higher.                                                         • Fonterra Diary Auctions
 Q2 0.78
                            • Bearish: NZD/USD below 0.75 in Q1 with China tightening
 Balanced risks               monetary policy and RBNZ remaining dovish at their March 10,
                              2011 meeting.


 CAD                        • Bullish: USD/CAD below 0.96 by mid-2011 if BoC begins                  • BoC rate announcement in
                              normalizing rates on March 1, 2011 towards 2.25% year-end; and           March, April, and May 2011.
 USD/CAD: Q1 0.99             +$90 WTI crude prices.
 Q2 0.98                                                                                             • US CPI and payroll reports.
                            • Bearish: USD/CAD to 1.05 in 2011 if US economy slows and BoC
 Bullish bias                 only hikes only 50bp in 2011.




84
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

John Normand (44-20) 7325-5222
Junya Tanase (81-3) 6736-7718
Paul Meggyesi (44-20) 7859-6714
Justin Kariya (1-212) 834-9618
J.P. Morgan Securities Ltd, JPMorgan Chase Bank NA




                                                     This page left intentionally blank




                                                                                          85
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Sunil Kavuri (44-20) 7777-1729
sunil.d.kavuri@jpmorgan.com
J.P. Morgan Securities Ltd.


                                                                                             Table 1: J.P. Morgan real effective exchange rates: recent changes
Recent real effective                                                                        and deviations from long-term average

exchange rate trends
                                                                                                                      Change in REER over past                      Deviation from
                                                                                                             1mo            3mos      12mos         YTD         10-yr avg   40-yr avg.*
                                                                                             Majors
                                                                                                 USD         -2.6%          -6.0%     -2.7%        -2.7%         -11.3%       -11.3%
•         Real effective exchange rate indices are widely utilized                               EUR         3.6%           5.6%      -6.9%        -5.5%          1.4%         5.0%
          as short-hand measures for currency misalignment.                                      JPY         1.0%           5.2%       6.0%         6.1%          9.4%         1.6%
          This approach is overly simplistic, as it assumes that                                 GBP         -1.7%          -1.4%      1.2%        -0.3%         -13.9%        -9.4%
          the equilibrium level of the REER is constant over time                                AUD         2.0%           7.4%       7.1%         7.8%          23.2%        29.7%
          and does not respond to structural changes from                                        CAD         -0.3%          -1.9%     -0.7%        -0.2%          -2.7%       -14.2%
          fundamental variables such as terms of trade,                                          NZD         0.4%           1.1%      -2.0%         0.9%          7.6%         30.6%
          productivity, debt levels and net investment position.                             Europe, Middle East & Africa
          J.P. Morgan’s fundamental fair value model discussed                                   CHF         0.2%           5.7%       4.5%         4.8%          7.7%         20.8%
          on page 16 of this report remains our preferred method                                 SEK         -0.2%          4.2%       3.8%         5.2%          0.5%        -13.4%
          for gauging misalignment. But since REERs are                                          NOK         -1.9%          -0.1%     -0.8%        -0.4%          14.9%        33.2%
          reasonably stable for some currencies and since they                                   PLN         1.4%           5.8%       4.4%         4.1%          5.8%         12.6%
          are more easily tracked than fundamental models, we                                    CZK         1.2%           6.2%       1.7%         2.7%          17.7%        31.3%

          monitor recent trends in table 1 and charts 1-3.                                        ILS        0.1%           0.0%       2.9%         4.2%          12.2%        11.8%
                                                                                                 HUF         4.8%           4.4%      -0.2%         1.9%          4.9%         11.8%
•         For major currencies, USD and GBP REERs are                                            TRY         0.4%           0.7%       6.7%         7.8%          6.7%         7.5%
          roughly 10% below their long-term averages, whereas                                    ZAR         -0.7%          0.7%       9.4%         7.5%          15.5%        18.2%
          the EUR and JPY rates are near their long-term mean.                                   RUB         -3.3%          -5.2%      1.1%         2.3%          21.4%        35.8%

                                                                                              Americas
•         All commodity currencies but CAD trade about 30%                                       BRL         0.5%           5.3%      10.7%        12.3%          52.9%        90.9%
          stronger than their long-term averages. Elevated                                       MXN         2.0%           0.0%       7.0%         3.7%          -3.3%        2.4%
          REERs do not necessarily imply overvaluation,                                          CLP         -0.8%          1.5%       6.4%         2.2%          16.7%        30.9%
          however, since the index does not account for a
                                                                                             Asia
          structural upgrade to a currency’s equilibrium fair                                    CNY         -2.3%          -4.7%      1.7%         0.2%          6.4%         9.8%
          value due to the positive terms of trade shock of the                                  KRW         1.2%           1.4%       2.5%         1.5%         -10.5%       -31.8%
          past decade.                                                                           TWD         0.2%           -2.6%      2.7%         1.6%         -10.4%       -25.8%
                                                                                                 INR         0.8%           -2.5%      7.2%         6.7%          -0.3%       -34.4%
•         Asian REERs, particularly KRW and TWD, are
                                                                                                 IDR         -2.1%          -3.7%      5.0%         4.3%          35.0%        5.1%
          significantly weaker than their long-term average,                                     SGD         -1.3%          -0.5%      5.1%         5.1%          9.6%         5.0%
          reflecting the impact of reserve accumulation.                                         MYR         -2.6%          0.5%      -2.4%        -0.5%          2.5%        -13.6%
                                                                                                 PHP         -0.4%          -1.1%     -5.2%        -5.9%          0.6%         3.4%
Chart 1: Real effective exchange rates of USD, EUR and JPY                                       THB         1.6%           1.6%      10.7%         8.3%          17.3%        1.5%
Index level                                                                                  *Due to data limitations, long-term averages for PLN, ILS, CZK, HUF, RUB are based on
                                                                                             samples of 17 years while CNY is based on a sample size of 20 years.

    140                                                                                      Chart 2: REER deviation from 40-year average
                                 USD                  EUR                   JPY              %
    130
                                                                                               100%
    120
                                                                                                 80%
    110
                                                                                                 60%
    100
                                                                                                 40%
     90
                                                                                                 20%
     80
                                                                                                  0%
     70
                                                                                                 -20%
     60
                                                                                                 -40%
          70     75        80        85        90        95         00        05        10
                                                                                                 -60%
For description of J.P. Morgan real effective exchange rate indices see JPMorgan effective
                                                                                                         JPY
                                                                                                         INR
                                                                                                        TWD
                                                                                                        CAD
                                                                                                        SEK
                                                                                                        USD
                                                                                                        GBP
                                                                                                        THB

                                                                                                        PHP


                                                                                                        TRY
                                                                                                        CNY
                                                                                                        HUF


                                                                                                        CHF
                                                                                                        MXN




                                                                                                         CLP
                                                                                                        CZK
                                                                                                          KR




                                                                                                        NOK
                                                                                                        RUB
                                                                                                        MYR




                                                                                                        SGD
                                                                                                        EUR
                                                                                                         IDR


                                                                                                          ILS
                                                                                                         PLN
                                                                                                        ZAR
                                                                                                        AUD
                                                                                                        NZD



                                                                                                         BRL




rates: revised and modernized, May 30, 2003, Hargreaves and Strong.




86
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Sunil Kavuri (44-20) 7777-1729
sunil.d.kavuri@jpmorgan.com
J.P. Morgan Securities Ltd.


                                                                   Table 1: FX performance attribution: spot versus carry-adjusted
FX performance in 2010: spot                                       returns
                                                                   Carry-adjusted returns based on rolling 1-month FX forwards
versus carry-adjusted returns                                      Performance vs USD
                                                                                      Carry-adjusted return                    Spot return
                                                                              1mo        3mos     12mos       YTD     1mo     3mos    12mos   YTD
•     Currency performance should be measured in carry-            Majors
      adjusted terms rather than as spot returns, to account       EUR        1.8%       6.7%     -5.1%       -2.7%   1.7%    6.7%    -5.1%   -2.7%
      for the interest rate paid or earned on currency             JPY        3.3%       7.1%     12.0%       14.0%   3.4%    7.2%    12.3%   14.2%
      positions. This distinction is also material for corporate   GBP        1.4%       2.1%     -2.4%       -0.8%   1.3%    2.0%    -2.6%   -0.9%
      hedgers to determine whether interest rate differentials     AUD        1.4%       9.4%     13.3%       13.3%   1.1%    8.2%     9.2%   9.7%
      outweighed the spot risk they intended to cover.             CAD        0.8%       1.5%      6.3%       3.6%    0.7%    1.3%     6.1%   3.4%
                                                                   NZD        3.9%       6.2%      8.9%       7.9%    3.7%    5.5%     6.2%   5.7%
•     Table 1 lists currency performance over various
      horizons in carry-adjusted and spot terms. Carry-            EMEA

      adjusted returns are based on rolling 1 month forwards,      CHF        -1.0%      6.1%      4.3%       4.9%    -1.0%   6.2%     4.7%   5.3%
                                                                   ILS        0.8%       4.2%      3.7%       4.6%    0.7%    4.0%     3.4%   4.3%
      so incorporate spot movements and interest rate
                                                                   SEK        0.2%       8.0%      6.2%       7.1%    0.1%    7.9%     6.1%   7.1%
      differentials.
                                                                   NOK        -0.5%      3.9%     -0.6%       0.4%    -0.6%   3.4%    -2.3%   -1.1%
•     In 2010 the best performer in spot terms versus the          CZK        1.6%       7.5%      3.4%       5.3%    1.5%    7.4%     2.9%   4.9%
      dollar was the yen (+14.2%), followed by THB                 PLN        2.1%       8.2%      5.3%       3.5%    1.9%    7.5%     2.6%   1.2%

      (+10.8%) and AUD (+9.7%). The worst performer in             HUF        3.9%       12.7%     1.6%       1.6%    3.6%    11.6%   -3.3%   -2.3%
                                                                   RUB        -0.8%      -1.3%    -1.7%       1.3%    -1.0%   -1.9%   -5.8%   -1.6%
      spot terms was ARS with a 2010 YTD return of -4%,
                                                                   TRY        1.5%       6.8%     11.7%       9.8%    1.0%    5.2%     5.4%   4.7%
      one of the few currencies to decline vs. USD. On a
                                                                   ZAR        1.0%       6.7%     19.2%       11.8%   0.5%    5.1%    12.4%   6.3%
      carry-adjusted basis, however, ARS returned 2.4%. The
      euro was second-to-worst, falling 2.7% in spot terms.        Americas
      In carry-adjusted terms the JPY(+14%) and AUD                ARS        0.8%       1.6%      4.1%       2.4%    0.1%    -0.4%   -3.5%   -4.0%
      (13.3%) were the best performers, followed by ZAR            BRL        0.1%       5.1%     11.2%       9.4%    -0.5%   3.1%     3.7%   3.0%
      (+11.8%) and MYR (11.2%). Versus the euro, the best          CLP        -0.9%      6.5%      7.8%       3.8%    -1.0%   6.4%     8.8%   4.1%

      performers carry-adjusted were JPY, TRY and CHF.             MXN        2.0%       3.5%     11.2%       9.3%    1.8%    2.6%     7.2%   6.1%
                                                                   COP        -0.4%      0.3%      9.5%       11.3%   -2.0%   0.3%     8.5%   10.8%
                                                                   PEN        -0.4%      0.7%      4.1%       3.4%    -0.4%   0.9%     3.9%   3.3%
Chart 1: Carry-adjusted YTD returns versus USD
%                                                                  Asia

    15%                                                            CNY        -0.3%      0.9%      0.5%       0.5%    0.2%    1.3%     2.0%   2.0%
                                                                   HKD        0.0%       0.1%     -0.4%       -0.3%   0.1%    0.1%    -0.1%   0.0%
                                                                   IDR        -0.2%      0.9%     10.9%       8.9%    -0.1%   0.3%     7.0%   5.8%
    10%                                                            INR        1.5%       6.0%      8.9%       8.2%    1.1%    4.5%     5.8%   5.3%
                                                                   KRW        1.4%       5.6%      6.7%       5.0%    1.3%    5.1%     5.5%   4.0%
                                                                   MYR        -0.7%      2.7%     10.7%       11.2%   -0.8%   2.3%     9.5%   9.9%
    5%
                                                                   PHP        2.3%       6.6%     14.0%       10.1%   2.0%    5.8%    10.4%   7.4%
                                                                   SGD        1.3%       4.8%      7.6%       8.0%    1.3%    4.8%     7.5%   8.0%
    0%                                                             TWD        1.5%       3.7%      2.5%       2.2%    1.8%    4.1%     5.6%   4.7%
                                                                   THB        1.3%       7.5%     11.4%       11.2%   1.3%    7.4%    11.0%   10.8%

    -5%                                                            Performance vs Euro
                                                                   JPY        1.6%       1.0%     18.8%       18.6%   1.6%    1.1%    19.1%   18.9%
          HKD



          TWD




           IDR
            ILS




          PHP
          THB
          HUF



          CAD

          CHF


          NZD
          SGD
           INR




          AUD
          KRW
          GBP
          NOK
          CNY
          RUB

          ARS


          CLP


          CZK
          SEK



          BRL
          TRY


          COP

           JPY
          EUR




          PEN
          PLN




          MXN



          MYR
          ZAR




                                                                   GBP        -0.4%      -4.3%     3.5%       2.6%    -0.4%   -4.3%    3.3%   2.5%
                                                                   CHF        -2.7%      -0.2%    10.3%       8.4%    -2.7%   -0.1%   10.6%   8.8%
                                                                   SEK        -1.5%      1.2%     11.3%       9.8%    0.3%    -0.5%   16.9%   11.2%
                                                                   NOK        -2.2%      -2.8%     4.6%       3.1%    -2.3%   -3.3%    2.9%   1.6%
                                                                   CZK        -0.2%      0.7%      8.1%       7.7%    -0.2%   0.7%     7.6%   7.3%
                                                                   PLN        0.3%       1.5%     10.0%       5.8%    0.1%    0.8%     7.2%   3.5%
                                                                   HUF        2.1%       5.6%      6.2%       3.7%    1.8%    4.6%     1.3%   -0.2%
                                                                   TRY        -0.2%      0.3%     17.7%       13.2%   -0.7%   -1.3%   11.4%   8.0%
                                                                   RUB        -2.5%      -7.4%     4.7%       5.2%    -2.7%   -8.0%    0.5%   2.3%




                                                                                                                                                  87
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Sunil Kavuri (44-20) 7777-1729
sunil.d.kavuri@jpmorgan.com
J.P. Morgan Securities Ltd.


                                                                                                                    Chart 2: Spanish government bond, bill and bank redemptions
Peripheral bond redemptions                                                                                         €bn

in 2011                                                                                                              35
                                                                                                                     30
                                                                                                                     25
•       The periphery must redeem €257bn of bonds, €265bn                                                                                                                                                                                Banks
        of t-bills and €162bn of bank debt in 2011. 39%                                                              20                                                                                                                  Bonds
        (€223bn) of their 2011 government redemptions fall in                                                        15                                                                                                                  T-Bills
        August, September and October, while 40% of bank
                                                                                                                     10
        redemptions (€65bn) come due from February to April.
                                                                                                                         5
•       Ireland’s 2011 bond and bill redemptions are small in
                                                                                                                         0
        absolute terms and relative to 2010 GDP (8.6%). Over




                                                                                                                               Jan-11




                                                                                                                                                                                  Jun-11

                                                                                                                                                                                            Jul-11




                                                                                                                                                                                                                       Oct-11

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                                                                                                                                                                                                                                           Dec-11
                                                                                                                                                                        May-11
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                                                                                                                                                    Mar-11

                                                                                                                                                              Apr-11




                                                                                                                                                                                                     Aug-11

                                                                                                                                                                                                              Sep-11
        half (€4.5bn) of Ireland’s government bond
        redemptions fall in November. Over a third (€3.2bn) of
        Ireland’s banks 2011 redemptions occur in September.
•       Spain’s aggregate redemptions are evenly distributed
        through out the year. However, banks see 69% (€57bn)
        of their 2011 redemptions mature in the first half of the                                                   Chart 3: Italian government bond, bill and bank redemptions
        year; while 55% (€69bn) of the government’s                                                                 €bn
        refunding requirements occur in May, August and
                                                                                                                     70
        October. 2011 government redemptions equal 12% of
        2010 GDP.                                                                                                    60
                                                                                                                     50
•       Italy’s bonds and bills redemptions are significant both                                                                                                                                                                         Banks
        in absolute terms (€305bn) and relative to 2010 GDP                                                          40                                                                                                                  Bonds
        (19.6%). Close to 90% of total 2011 redemptions                                                              30                                                                                                                  T-Bills
        (€350bn) will fall on the government, with €192bn of                                                         20
        these obligations in February, March, April and
                                                                                                                     10
        September.
                                                                                                                         0
•       Portugal’s government redemptions are small in
                                                                                                                               Jan-11




                                                                                                                                                                        May-11

                                                                                                                                                                                  Jun-11

                                                                                                                                                                                            Jul-11




                                                                                                                                                                                                                       Oct-11

                                                                                                                                                                                                                                Nov-11

                                                                                                                                                                                                                                           Dec-11
                                                                                                                                          Feb-11

                                                                                                                                                    Mar-11

                                                                                                                                                              Apr-11




                                                                                                                                                                                                     Aug-11

                                                                                                                                                                                                              Sep-11
        absolute terms (€29bn) but represent 18% of 2010
        GDP. Further, 76% of these obligations mature in the
        first half of the year. Bank redemptions are
        concentrated in January and February.

Chart 1: Irish government bond, bill and bank redemptions, €bn
                                                                                                                    Chart 4: Portuguese government bond, bill and bank redemptions
                                                                                                                    €bn
    6
                                                                                    Banks                            9
    5                                                                               Bonds                            8
                                                                                    T-Bills                          7
    4
                                                                                                                     6                                                                                                                   Banks
    3                                                                                                                5                                                                                                                   Bonds
                                                                                                                     4                                                                                                                   T-Bills
    2
                                                                                                                     3
    1                                                                                                                2
                                                                                                                     1
    0
                                                                                                                     0
        Jan-11




                                            May-11

                                                     Jun-11

                                                              Jul-11




                                                                                         Oct-11

                                                                                                  Nov-11

                                                                                                           Dec-11
                          Mar-11
                 Feb-11



                                   Apr-11




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                                                                                                                             Jan-11




                                                                                                                                                                       May-11

                                                                                                                                                                                 Jun-11

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                                                                                                                                                                                                                       Oct-11

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88
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Sunil Kavuri (44-20) 7777-1729
sunil.d.kavuri@jpmorgan.com
J.P. Morgan Securities Ltd.



Global government bond and bank redemptions, 2011-2012
Euro area
€bn
                       Spain                              Italy                       Greece                  Portugal                 Ireland                    Core*                      Periphery**
              Bonds    T-Bills     Banks       Bonds     T-Bills   Banks      Bonds   T-Bills Banks   Bonds    T-Bills Banks   Bonds   T-Bills   Banks   Bonds    T-Bills   Banks   Bonds      T-Bills Banks
    Nov-10       0          10          4          26        14      2          0       0      0        0         3     0        0       0         1       0        57       11        26           27       7
    Dec-10       0          9           4          1         17      4          0       0      1        0         0     0        0       0         1      26        61       10         1           25       9
    Jan-11       5          9           6          0         17      1          0       4      0        0         3     2        0       1         1      69        57       25         6           35      10
    Feb-11       0          6           6          29        17      8          0       0      1        0         3     2        0       1         1       4        43       22        29           26      18
    Mar-11       0          6          15          22        28      4         11       1      1        0         3     1        1       2         0      40        40       27        33           41      21
    Apr-11       2          6          16          1         17      8          0       2      1        5         0     1        1       1         0      58        32       33        10           26      25
    May-11      16          4           5          3         20      2          9       0      2        0         0     1        0       0         1       0        16       21        28           24      10
    Jun-11       0          4          10          1         18      4          0       0      1        7         0     1        0       0         1      25        26       20         9           22      17
     Jul-11      6          4           6          0          8      3          3       0      1        0         2     1        0       0         0      81        14       18         9           14      11
    Aug-11      16          7           1          30         7      1          8       0      0        0         1     0        0       0         0       0        13       15        55           15       3
    Sep-11       0          5           5          39        21      5          1       0      1        0         1     1        0       0         3      51        13       16        40           28      15
    Oct-11      17          8           5          1         22      2          1       0      2        1         1     0        1       0         0      47        11       13        22           31       9
    Nov-11       0          0           3          3          0      7          0       0      2        0         0     0        5       0         1       0         0        9         8            0      13
    Dec-11       0          3           6          1          0      2          6       0      0        0         0     1        0       0         0       2         0       14         7            3      10
 Total 2011     63          63         83       132       173       47         40       8      13       14        15    11       8       5         8      378      265       233       257          265    162
    Jan-12       5          0           5          0          0      4          0       0      2        0         0     4        0       0         1      57        0        47         6            0      17
    Feb-12       1          3          21          37        10      5          0       0      1        0         0     1        0       0         2       0        0        29        39           13      29
    Mar-12       0          0          14          21        14      6         16       0      2        0         0     1        6       0         2      19        0        24        43           14      25
    Apr-12      14          2          15          18        12      2          0       0      0        0         0     0        0       0         3      53        0        18        32           14      20
    May-12       0          0          10          3          0      6         10       0      0        0         0     1        0       0         0       0        0        10        13            0      17
    Jun-12       0          0          22          1          0      3          1       0      1        9         0     2        0       0         2      19        0        18        11            0      30
     Jul-12     19          0           7          17         0      0          2       0      1        0         0     2        0       0         0      81        0        19        39            0      10
    Aug-12       0          0           2          9          0      2         10       0      1        0         0     0        0       0         0       0        0         8        19            0       5
    Sep-12       0          0           7          15         0      3          1       0      2        0         0     0        0       0         0      34        0        17        16            0      12
    Oct-12      23          0           3          19         0      5          1       0      1        1         0     0        1       0         1      52        0        22        46            0      10
    Nov-12       0          0           9          3          0      3          0       0      1        0         0     0        0       0         2       0        0         8         4            0      15
    Dec-12       0          0           4          0          0      9          0       0      0        0         0     0        0       0         0      12        0         7         0            0      14
Total 2012      63          5          121      145          36     48         41       0      11       10        0     13       8       0        13      327       0        227       267          41     206
* Germany, France, Netherlands, Belgium
** Spain, Italy, Greece, Portugal, Ireland


Other countries
Bn of local currency*
                            UK                      US              Japan             Canada          Australia         NZ             Norway            Sweden          Switzerland            Hungary
                     Govt     Banks          Govt     Banks                                                                                                                                  Govt   Banks
        Nov-10        23          5          546        10                3              29               2               1               0                15                 3              270           14
        Dec-10        18          4          502        33               29              42               5               1              147               38                 3              642           83
        Jan-11        16          3          338        24                2              28               5               1               0                16                 3              325           0
        Feb-11        7           6          291        17                2              20               3               1               0                 0                 1              567           58
        Mar-11        39          7          239        12               22              19              0               1                18               77                 0               0            0
        Apr-11        6           7          227        13                2              9                1               1               0                 0                 1              582           0
        May-11        2           9          141        22                0              5                1               1               59                5                 0               0           138
        Jun-11        7           6          115        14               28              31              12               1               15                0                 9              248           14
         Jul-11       9           2           94        16                0              6                0               1               0                 1                 0              185          247
        Aug-11        6           6          147        16                0              6                0               0               0                 5                 0               0            0
        Sep-11        9           7           92        18               19              29               0               0               9                 0                 0              211           0
        Oct-11        0          10           92        15                0              0                1               1               0                 4                 0              436           3
        Nov-11        1          25          120        11               0               0               1               10               0                 4                 0              65            0
        Dec-11        22         14          96         40               29              18              0               0                0                11                 0               2           373
  Total 2011         124         104         1992       217          105                171              26              18              101              122                15              2621         834
        Jan-12        1           5          108        25                0              0                0              0               0                  0                 0               0            0
        Feb-12        1           5          153        27                0              0                1              0               0                  0                 0              229           19
        Mar-12        36         14          102        27               18              10              0               0               0                 5                  0               0            21
        Apr-12        0          11          121        47                0              0               15              1               0                 31                 0               0            0
        May-12        1           9          128        15                0              0                1              0               10                 5                 0               0           124
        Jun-12        32          6           97        62               28              31               1              0               0                  0                 9              526           0
         Jul-12       8           6           95        16                0              0                0              0               0                  1                 0               0            0
        Aug-12        0           4          148        11                0              0                0              0               0                  5                 0               0            0
        Sep-12        9           6           96        17               18              18               0              0               0                  0                 0               0            0
        Oct-12        0           7           95        22                0              0                0              0               0                 67                 0              514           0
        Nov-12        0           5          141        18                0              0                0              0               0                  0                 0              67            0
        Dec-12        6           6           60        12               27              18               0              0               0                  0                 0              22            0
  Total 2012          95         85          1345       299              91              77              18              1               10               115                11              1358         164
* Except for Japan which is expressed in Trillions. Government redemptions cover bonds and bills
                                                                                                                                                                                                                 89
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Sunil Kavuri (44-20) 7777-1729
sunil.d.kavuri@jpmorgan.com
JPMorgan Chase Bank NA



Sovereign credit ratings and actions
                             S&P           Moody's            Fitch                           Recent S&P Action                                     Recent Moody's Action                                          Recent Fitch Action
                      Rating View        Rating View    Rating View                          Action                      Date                         Action                       Date                            Action                   Date

United States          AAA                Aaa            AAA                           Affirmed, O/L stable            10-Jan-08                Affirmed, O/L stable             15-Nov-03                   Affirmed, O/L stable         9-May-08
Canada                 AAA                Aaa            AAA                           Affirmed, O/L stable            18-May-07                Affirmed, O/L stable             24-May-06                   Affirmed, O/L stable        22-May-07
Germany                AAA                Aaa            AAA                           Affirmed, O/L stable            14-Jun-07                Affirmed, O/L stable             24-May-06                   Affirmed, O/L stable         6-Nov-07
France                 AAA                Aaa            AAA                           Affirmed, O/L stable            28-Feb-06                Affirmed, O/L stable             24-May-06                   Affirmed, O/L stable        30-Mar-10
Austria                AAA                Aaa            AAA                           Affirmed, O/L stable            12-Feb-07                Affirmed, O/L stable             24-May-06                   Affirmed, O/L stable        15-Feb-08
Netherlands            AAA                Aaa            AAA                           Affirmed, O/L stable            24-Jan-06                Affirmed, O/L stable             15-Nov-03                   Affirmed, O/L stable         26-Oct-07
Sweden                 AAA                Aaa            AAA                           Affirmed, O/L stable            22-Jan-07                Affirmed, O/L stable             15-Nov-03                   Affirmed, O/L stable        18-Dec-07
Norway                 AAA                Aaa            AAA                           Affirmed, O/L stable            28-May-09                Affirmed, O/L stable             15-Nov-03                   Affirmed, O/L stable        18-Dec-07
Switzerland            AAA                Aaa            AAA                           Affirmed, O/L stable            1-Dec-03                 Affirmed, O/L stable             15-Nov-03                   Affirmed, O/L stable         11-Jun-07
Australia              AAA                Aaa            AAA                           Affirmed, O/L stable            6-Sep-10                 Affirmed, O/L stable             24-May-06                   Affirmed, O/L stable        22-May-08
Singapore              AAA                Aaa            AAA                           Affirmed, O/L stable            1-May-08                Upgrade, O/L stable               14-Jun-02                   Affirmed, O/L stable        18-Aug-10
New Zealand            AA+         (-)    Aaa            AA+          (-)             O/L changed to (-) ↓             22-Nov-10               Upgrade, O/L stable               21-Oct-02                  O/L changed to (-) ↓          15-Jul-09
United Kingdom         AAA                Aaa            AAA                           Affirmed, O/L stable            29-Mar-10               Affirmed, O/L stable              15-Nov-03                   Affirmed, O/L stable         18-Jan-05
Belgium                AA+                Aa1            AA+                           Affirmed, O/L stable            21-May-07              O/L changed to stable ↓            13-Jan-09                   Affirmed, O/L stable        25-May-07
Spain                  AA          (-)    Aa1            AA+                           Downgrade, O/L (-)              29-Apr-10       Downgrade, O/L changed to stable ↑        30-Sep-10                 Downgrade, O/L stable         28-May-10
Japan                  AA          (-)    Aa2            AA-                          O/L changed to (-) ↓             26-Jan-10                upgrade, O/L stable              18-May-09                  Affirmed, O/L stable          3-Sep-09
Ireland                AA-         (-)    Aa2            A+           (-)              Downgrade, O/L (-)              24-Aug-10              Downgrade, O/L stable              19-Jul-10                 Downgrade, O/L (-) ↓           6-Oct-10
Italy                  A+                 Aa2            AA-                           Affirmed, O/L stable            23-Oct-07                Affirmed, O/L stable             19-Oct-06                   Affirmed, O/L stable         6-Dec-07
China                  A+                 Aa3    (+)     A+                           Upgrade, O/L stable              31-Jul-08              Upgrade, O/L positive ↑            11-Nov-10                  Upgrade, O/L stable           6-Nov-07
Czech Republic          A                 A1             A+           (+)              Affirmed, O/L stable            27-Nov-08              O/L changed to stable ↓            8-Dec-08                   O/L changed to (+) ↑          4-Jun-10
Korea                   A                 A1             A+                            Affirmed, O/L stable            12-Jan-10               Upgrade, O/L stable               14-Apr-10                   Affirmed, O/L stable        11-Nov-10
Portugal                A-         (-)    A1             AA-          (-)              Downgrade, O/L (-)              27-Apr-10       Downgrade, O/L changed to stable ↑        13-Jul-10                  Downgrade, O/L (-)           24-Mar-10
Poland                  A-                A2             A-                          O/L changed to stable ↓           27-Oct-08               Affirmed, O/L stable              24-May-06                   Affirmed, O/L stable        10-Nov-08
South Africa          BBB+         (-)    A3            BBB+          (-)             O/L changed to (-) ↓             11-Nov-08         Upgrade, O/L changed to stable ↓        16-Jul-09                  O/L changed to (-) ↓          9-Nov-08
Russia                 BBB               Baa1            BBB          (+)            O/L changed to stable ↑           21-Dec-09              O/L changed to stable ↓            12-Dec-08                  O/L changed to (+) ↑          8-Sep-10
Mexico                 BBB               Baa1            BBB                  Downgrade, O/L changed to stable ↑       14-Dec-09               Affirmed, O/L stable              24-May-06         Downgrade, O/L changed to stable ↑    23-Nov-09
Hungary               BBB-               Baa1    (-)*    BBB          (-)            O/L changed to stable ↑           2-Oct-09                 On review negative               23-Jul-10                  O/L changed to (-) ↓          2-Mar-09
Brazil                BBB-               Baa3    (+)    BBB-          (+)             Upgrade, O/L stable              30-Apr-08                 Upgrade, O/L (+)                22-Sep-09                  O/L changed to (+) ↑          28-Jun-10
India                 BBB-               Baa3           BBB-                         O/L changed to stable ↑           18-Mar-10         Upgrade, O/L changed to stable ↓        22-Jan-04                   Affirmed, O/L stable         9-Feb-09
Iceland               BBB-         (-)   Baa3    (-)     BB+          (-)            O/L changed to stable ↑           23-Apr-10               O/L changed to (-) ↓              6-Apr-10              Downgrade, O/L changed to (-) ↓    5-Jan-10
Greece                 BB+         (-)    Ba1    (-)    BBB-          (-)              Downgrade, O/L (-)              27-Apr-10               Downgrade, O/L (-)                14-Jun-10                   Downgrade, O/L (-)           9-Apr-10
Latvia                 BB                Baa3            BB+          (-)            O/L changed to stable ↑           12-Feb-10              O/L changed to stable ↑            31-Mar-10                 Affirmed, O/L negative         6-Oct-09
Turkey                 BB          (+)    Ba2    (+)     BB+                      Upgrade, O/L changed to (+) ↑        19-Feb-10               O/L changed to (+) ↑              5-Oct-10           Upgrade, O/L changed to stable ↓      3-Dec-09
Ukraine                B+                 B2     (-)      B                           Upgrade, O/L stable              29-Jul-10         Downgrade, O/L changed to (-) ↓         12-May-09                  Upgrade, O/L stable           6-Jul-10
Argentina               B                 B3              B                            Affirmed, O/L stable            13-Sep-10              O/L changed to stable ↓            14-Aug-08                  Upgrade, O/L stable           12-Jul-10


Source: Ratings agencies
Note that ratings refer to foreign currency denominated long term debt for EM countries and domestic currency denominated long term debt for others; * indicates ratings on review/credit
watch/rating watch (+/-)

S&P ratings vs fiscal balance as % of GDP in 2010                                                                                  S&P ratings vs gross government debt as % of GDP in 2010


                                                                              C
                                                                                                                                          C
                                                                             CCC
                                                                                                                                       CCC+
                                                                 AR
                                                                             BB-                                                                                            AR
                            GR                          TU                                                                               BB-
                                                                                                                                                                            TU
                             IC             IN   HU                                                                                                                                                             GR
                                              RU BZ MX                       BBB                                                                                         IN BZ              HU                           IC
                                            SA                                                                                          BBB              RU             MX
                                         PO   PD                                                                                                                        SA
                                                                            SK                                                                                               PD                   PO
                                                IT              CH            A+                                                                                          SK
                 IR                                                                                                                      A+                    CH                                                 IT
                                                                                                                                                                                             IR
                         SP
                           JP                                                AAA                                                                                                 SP                                                        JP
                                           GE CA AU SW SZ
                                                  NZ
                                                                                                                  NO                    AAA                                    US
                      US
                      UK FR                                                                                                                               AU NZ SZNO SW GEUKCA
                                                                                                                                                                             FR

 -14%                        -9%                 -4%                        1%                     6%                                           0%                40%              80%                  120%              160%           200%


Source: J.P.Morgan, OECD, S&P                                                                                                      Source: J.P.Morgan, OECD, S&P
*JPM forecast for 2010 used for EM and OECD forecast used for DM                                                                   *JPM forecast for 2010 used for EM and OECD forecast used for DM




90
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Justin Kariya (1-212) 834-9618
justin.p.kariya@jpmorgan.com
JPMorgan Chase Bank NA



Central bank announcement dates in 2011
                                 2011
                          DEC    JAN    FEB   MAR   APR    MAY   JUN   JUL   AUG   SEP   OCT   NOV   DEC
United States              14     26           15    27           22          9     20          2     13
Euro area                  2      13     3      3    7      5      9    7     4     8     6     3     8
Japan                      21     25    17     15   7,28   20     14
United Kingdom             9      13    10     10    7      5      9    7     4    8      6    10    8
Switzerland                16                  17                 16               15                15
Canada                     7     18             1   12     31          19          7     25          6
Australia                  6             1      1   5      3     7     5      2    6     4      1    6
New Zealand                9     27            10   28            9    28          15    27           8
Norway                     15    26            16          12    22          10    21    19          14
Sweden                     15           15          20                  5
Brazil                     8     19            2    20            8    20    31          19    30
Mexico                           21            4    15     27           8    26          14           2




                                                                                                           91
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Justin Kariya (1-212) 834-9618
justin.p.kariya@jpmorgan.com
JPMorgan Chase Bank NA



Event risks in 2011
Month                      Date    Country          Event
November 2010              30      Portugal         Budget release for October
                           30      Norway           Norges Bank foreign exchange purchases
December 2010              1       New Zealand      Fonterra dairy auction
                           1       United States    Fed's Beige Book
                           2       Euro area        ECB rate announcement
                           2       Ireland          Budget release for November
                           6       Euro area        Eurogroup meeting
                           7       Euro area        Ecofin meeting
                           7       Canada           BoC rate announcement
                           7       Ireland          Irish Parliament votes on 2011-14 budget measures
                           9       New Zealand      RBNZ rate announcement
                           9       United Kingdom   BoE rate announcement
                           16      Switzerland      SNB rate announcement
                           21      Spain            Budget release for November
                           23      Portugal         Budget release for November
January 2011               1       Euro area        Estonia joins the Euro zone from Jan 1st
                           13      United Kingdom   BoE rate announcement
                           13      Euro area        ECB rate announcement
                           17      Euro area        Eurogroup meeting
                           18      Euro area        Ecofin meeting
                           26      US               FOMC rate announcement
February 2011              3       Euro area        ECB rate announcement
                           14      Euro area        Eurogroup meeting
                           15      Euro area        Ecofin meeting
                           15      Euro area        Peripheral Europe flash GDP (Q4 2010)
                           16      UK               BoE Quarterly Inflation Report
March 2011                 1       Canada           BoC rate announcement
                           7       Euro area        ECB rate announcement
                           14      Euro area        Eurogroup meeting
                           15      Euro area        Ecofin meeting
                           15      US               FOMC rate announcement
                           17      Australia        RBA's Quarterly Statement of Monetary Policy
                           20      Euro area        German state election (Saxony-Anhalt)
                           27      Euro area        German state election (Baden-Wurttemberg & Rhineland-Palatinate)
April 2011                 7       Euro area        ECB rate announcement
                           16-17   US               IMF/World Bank spring meetings
                           27      US               FOMC rate announcement
May 2011                   5       Euro area        ECB rate announcement
                           11      UK               BoE Quarterly Inflation Report
                           13      Euro area        Peripheral Europe flash GDP (Q1 2011)
                           16      Euro area        Eurogroup meeting
                           17      Euro area        Ecofin meeting
June 2011                  9       Euro area        ECB rate announcement
                           22      US               FOMC rate announcement
July 2011                  7       Euro area        ECB rate announcement
August 2011                4       Euro area        ECB rate announcement
                           9       US               FOMC rate announcement
                           16      Euro area        Peripheral Europe flash GDP (Q2 2011)
September 2011             8       Euro area        ECB rate announcement
                           20      US               FOMC rate announcement
October 2011               6       Euro area        ECB rate announcement
                           23      Switzerland      Federal elections
November 2011              2       US               FOMC rate announcement
                           3       Euro area        ECB rate announcement
                           14      US               Annual APEC meeting in Honolulu
                           15      Euro area        Peripheral Europe flash GDP (Q3 2010)
December 2011              8       Euro area        ECB rate announcement
                           13      US               FOMC rate announcement


92
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Grace Koo (44-20) 7325-1362
grace.x.koo@jpmorgan.com
J.P. Morgan Securities Ltd.



J.P. Morgan forecasts: rates, credit, equities & commodities
Interest rates                                               Current                       Dec-10       Mar-11        Jun-11       Sep-11                                   YTD Return*
United States                 Fed funds rate                   0.125                       0.125         0.125         0.125          0.125
                              10-year yields                   2.87                         2.25         2.25          2.25            2.25                                    7.4%
Euro area                     Refi rate                        1.00                         1.00         1.00          1.00            1.00
                              10-year yields                   2.71                         2.45         2.50          2.60            2.70                                    7.0%
United Kingdom                Repo rate                        0.50                         0.50         0.50          0.50            0.50
                              10-year yields                   3.39                         3.25         3.35          3.45            3.65                                    6.2%
Japan                         Overnight call rate              0.10                         0.05         0.05          0.05            0.05
                              10-year yields                   1.07                         0.80         0.80          0.90            0.95                                    2.1%
GBI-EM hedged in $            Yield - Global Diversified       6.42                         7.90                                                                               9.0%


Credit Markets                                               Current                     Index                                                                              YTD Return*
US high grade (bp over UST)                                     153                      JPMorgan US Index (JULI) i-spread                                                     9.6%
Euro high grade (bp over Euro gov)                              168                      iBoxx Euro Corporate Index                                                            3.3%
USD high yield (bp vs. UST)                                     617                      JPMorgan Global High Yield Index                                                     13.9%
Euro high yield (bp over Euro gov)                              577                      iBoxx Euro HY Index                                                                  13.0%
EMBIG (bp vs. UST)                                              282                      EMBI Global                                                                          14.0%
EM Corporates (bp vs. UST)                                      318                      JPM EM Corporates (CEMBI)                                                            13.1%

                                                                                                    Quarterly Averages
Commodities                                                  Current                       10Q4          11Q1          11Q2           11Q3      GSCI Index                  YTD Return*
WTI ($/bbl)                                                    81.1                         86.0         88.0          88.0            90.0     Energy                         -7.3%
Gold ($/oz)                                                    1351                         1350         1425          1425            1450     Precious Metals               22.7%
Copper ($/metric ton)                                          8446                         8200         8600          8500            8750     Industrial Metals              4.6%
Corn ($/Bu)                                                    5.49                         5.85         6.00          5.90            5.70     Agriculture                   18.0%


                                                                                                                                                                    3m cash YTD Return
Foreign Exchange                                             Current                       Dec-10       Mar-11        Jun-11       Sep-11                            index    in USD
EUR/USD                                                        1.36                         1.40         1.40          1.43            1.45                          EUR       -4.3%
USD/JPY                                                        83.5                          81           81            80              79                           JPY      11.7%
GBP/USD                                                        1.60                         1.61         1.59          1.63            1.67                          GBP       -0.2%
USD/BRL                                                        1.72                         1.70         1.80          1.82            1.83                          BRL       9.5%
USD/CNY                                                        6.64                         6.60         6.50          6.40            6.30                          CNY       1.6%
USD/KRW                                                        1134                         1150         1180          1140            1090                          KRW       4.2%
USD/TRY                                                        1.45                         1.38         1.39          1.38            1.36                          TRY       9.7%
                                     YTD Return
Equities             Current         (local ccy)           Sector Allocation *             US          YTD       Europe        YTD            Japan      YTD           EM     YTD ($)
S&P                     1195              9.1%             Energy                          OW          11.5%      OW           -1.2%                     3.3%         UW        3.1%
Nasdaq                  2512              11.9%            Materials                       OW          10.6%       N           13.3%           N         -9.6%        UW       17.1%
Topix                   870               -2.4%            Industrials                     OW          17.7%      OW           17.5%           N         3.0%         OW       25.5%
FTSE 100                5733              9.3%             Discretionary                   OW          22.2%      OW           28.8%           N         -7.4%         N       32.2%
MSCI Eurozone*          160               3.9%             Staples                         UW          11.1%      UW           13.8%           UW        1.0%         UW       25.8%
MSCI Europe*            1163              6.9%             Healthcare                       N          0.7%       UW           3.1%            UW        -2.9%        UW       25.9%
MSCI EM $*              1111              14.9%            Financials                      OW          4.1%       OW           -3.0%           OW        -6.0%        OW       16.7%
Brazil Bovespa        70628               3.0%             Information Tech.               OW          6.1%       OW           7.3%            N         -0.1%        OW        5.1%
Hang Seng             23606               11.2%            Telecommunications               N          12.4%       N           11.2%           N         16.3%        UW       14.1%
Shanghai SE             2889              -11.9%           Utilities                       UW          3.9%       UW           -3.4%           UW        -6.3%         N        6.5%
*Levels/returns as of May 13, 2010                         Overall                                     9.1%                    6.9%                      -2.4%                 14.9%
Local currency except MSCI EM $

Source: Bloomberg, Datastream, IBES, Standard & Poor's Services, J.P. Morgan estimates

                                                                                                                                                                                       93
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

David Hensley (1-212) 834-5516
Joseph Lupton (1-212) 834-5735
Michael Mulhall (1-212) 834-9123
JPMorgan Chase Bank NA


Global growth and inflation forecasts
                                 Real GDP                                             Real GDP                                             Consumer prices
                            % o ver a year ago                                 % o ver previo us perio d, saar                             % o ver a year ago
                        2009       2010       2011       2Q10       3Q10       4Q10     1Q11       2Q11          3Q11      4Q11     2Q10    4Q10        2Q11        4Q11
The Americas
United States             -2.6       2.7         2.5      1.7        2.0        2.5        2.0       3.0           3.0      4.0      1.8      1.1   ↑    1.6    ↑    1.2 ↑
Canada                    -2.5       3.0         2.1      2.0        1.5        2.0        2.3       2.0           2.4      2.6      1.4      1.9        2.1         2.1
Latin America             -2.4       5.7         4.1      9.1 ↑      2.4   ↑    3.1 ↑      4.4       6.0           3.4 ↓    4.2      6.6      6.8   ↓    7.0    ↓    7.3
   Argentina              -2.0       8.5         5.5     12.6        0.0        2.0        6.0       8.0           8.0      6.0     10.6     10.5       11.0        12.0
   Brazil                 -0.2       7.5         4.5      5.1        2.3        3.2        5.7       4.7           5.0      5.2      5.1      5.4        5.5         5.3
   Chile                  -1.5       5.5         6.0     19.5 ↑      8.1   ↓    6.0        5.0 ↑     4.0           4.0      4.0      1.2      3.2   ↓    3.6         3.4
   Colombia                0.8       4.5         4.1      3.9        3.7        4.0        4.0       4.1           5.0      5.5      2.1      2.4        2.5         3.5
   Ecuador                 0.4       2.5         3.0      7.7        2.5        3.0        3.0       2.5           2.5      2.0      3.2      3.3   ↓    3.5    ↓    3.8
   Mex ico                -6.5       4.5         3.5     13.5        2.0   ↑    3.1        2.9       9.2          -0.1      2.7      4.0      4.4   ↓    3.8    ↓    3.9 ↓
   Peru                    0.9       8.5 ↑       6.0     12.7        7.0   ↑    4.5 ↑      5.5 ↓     5.2 ↓         6.5 ↓    6.0 ↓    1.2      2.3        2.8         2.6
   Venezuela              -3.3      -1.5 ↑       1.5 ↑    6.7 ↑      0.1   ↓    1.0 ↑      1.0 ↓     1.5 ↑         1.5      1.5     31.9     28.9   ↓   31.6    ↓   34.9 ↓
Asia/Pacific
Japan                     -5.3 ↓    3.5   ↑      1.1 ↑    1.8   ↑   3.9    ↑   -1.5        0.5       1.5          1.8       2.0     -0.9     -0.3        -0.1        -0.5
Australia                  1.2      3.2          3.6      4.9       3.3         2.4        3.4       4.9          3.2       5.2      3.1      3.3         3.8         3.4
New Zealand               -1.7      2.0          2.8      0.7       2.5         2.5        2.6       3.1          4.2       2.8      1.8      4.9         5.6         3.2
Asia ex Japan              5.6      8.9   ↑      7.2      7.2   ↓   5.5    ↓    7.1 ↑      7.5 ↓     7.5          7.7 ↑     7.7      4.5      4.6   ↓     4.3         4.0   ↑
   China                   9.1     10.0          9.0      7.2       8.1         8.7        9.5       9.1          9.3       9.3      2.9      4.0         4.2         3.1
   Hong Kong              -2.8      6.6          4.1      5.7       2.8         3.5        4.2       4.3          4.7       5.0      2.6      2.5         2.2         2.4
   India                   7.4      8.3          8.5      8.5       8.0         8.9        8.0       8.5          8.6       8.9     13.7     10.3         7.5         8.5
   Indonesia               4.5      6.0          5.4      7.5       4.7         7.0        5.3       5.2          5.0       5.0      4.4      5.7   ↓     5.2   ↓     4.8
   Korea                   0.2      6.2          4.0      5.8       3.0         3.8        4.0       4.0          4.5       4.5      2.6      3.4         3.6         3.2
   Malay sia              -1.2      6.8          4.6      7.2       0.0         2.0        4.9       4.9          4.5       4.5      1.6      1.1         1.8   ↑     3.0   ↑
   Philippines             0.9      7.0          4.5      7.7       0.8         1.6        5.7       5.7          5.7       5.7      4.2      2.7         1.9         2.7
   Singapore              -1.3     15.0   ↑      4.2 ↑   27.3   ↑ -18.7    ↑   10.4 ↑      4.1 ↓     9.5 ↑        7.4       7.4      3.1      3.5         1.8         1.6
   Taiw an                -1.9      9.9   ↑      4.1 ↓    1.9   ↓   0.1    ↓    2.3        5.5 ↑     5.0 ↑        5.6 ↑     6.0 ↑    1.1      0.6   ↓     1.2   ↓     2.6   ↑
   Thailand               -2.2      8.5          4.0      0.6       0.0    ↓    2.8        4.9       4.9          4.9       4.9      3.2      2.8   ↑     4.5   ↑     4.0   ↑

Africa/Middle East
Israel                     0.8      3.5          4.5      4.5        3.8 ↑      3.0        4.0       5.0          5.5       5.5      2.8      2.6        3.0         2.8
South Africa              -1.8      2.9          3.1      3.2        3.6 ↑      3.2        3.1       3.1          3.4       2.9      4.5      3.6 ↓      3.8 ↓       4.9 ↓
Europe
Euro area                 -4.0       1.7         1.6      3.9         1.5       1.5        1.0       1.5          1.8       2.0      1.5      1.7         1.1        1.0
  Germany                 -4.7       3.5         2.6      9.5         2.8       2.5        2.0       2.0          2.0       2.0      1.0      1.2         0.6        0.7
  France                  -2.5       1.6         1.6      2.7         1.4       1.5        1.5       1.0          2.0       2.0      1.8      1.3         0.7        1.1
  Italy                   -5.1       1.0         1.3      1.9         0.7       1.0        1.5       1.0          2.0       2.0      1.6      1.7         1.4        1.5
Norw ay                   -1.2       1.5 ↑       2.3 ↑    1.9         3.7 ↑     2.5        2.0       2.0          2.5       2.5      2.6      2.1         1.3        1.3
Sw eden                   -5.1       4.5         3.1      8.0         4.5       3.0        2.3       2.3          2.8       2.8      1.0      1.5         1.6        1.8
Sw itzerland              -1.9       2.9         2.0      3.5         2.5       2.0        1.5       1.5          2.3       2.8      1.0      0.0        -0.3        0.6
United Kingdom            -5.0       1.7         2.3      4.7         3.2       1.5        1.0       2.5          3.0       3.0      3.5      2.8         2.1        2.1
Emerging Europe           -5.3       3.7         4.0      3.8        -1.0       5.4        4.0 ↑     4.3 ↑        4.6 ↑     4.7 ↑    5.7      6.6 ↑       6.8        5.8 ↓
  Bulgaria                -5.0      -0.5         4.0       …           …         …          …         …            …         …        …        …           …          …
  Czech Republic          -4.1       2.5         3.0      3.8         4.4       3.0        2.5       3.0          4.0       4.0      1.2      2.3         2.5        2.6
  Hungary                 -6.7       1.0         2.8      1.6         3.2       2.0        2.0       3.0          3.5       3.5      5.4      4.4         3.4        3.6
  Poland                   1.7       3.5         3.8 ↑    4.1         3.8 ↑     3.5        3.5 ↑     4.0 ↑        4.5 ↑     4.5 ↑    2.3      2.9 ↑       2.8 ↑      2.8 ↓
  Romania                 -7.1      -2.0         1.5       …           …         …          …         …            …         …       4.4      8.0         7.2        4.0
  Russia                  -7.9       3.5         4.5      4.3        -3.6       7.5        5.0       5.0          5.0       5.0      5.9      7.9         8.8        7.6
  Turkey                  -4.7       7.1         4.3       …           …         …          …         …            …         …       9.2      7.9         7.4        6.2
Global                    -2.2      3.7 ↑        3.0      3.9        2.6 ↑      2.7 ↑      2.7       3.4          3.4       3.8      2.5      2.5        2.4         2.2 ↑
  Dev eloped markets      -3.5      2.5 ↑        2.0      2.8        2.2 ↑      1.6        1.5       2.3          2.4       3.0      1.5      1.3        1.3 ↑       1.1 ↑
  Emerging markets         1.3      6.9          5.7      7.0 ↓      3.7 ↑      5.7 ↑      6.1       6.5          6.0       6.2      5.2      5.5 ↓      5.4 ↓       5.1
Memo:
Global — PPP w eighted -0.8         4.6          3.9      4.6 ↓      3.1 ↑      3.6 ↑      3.7       4.3          4.2       4.6      3.2      3.2        3.1         2.9 ↑




94
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

David Hensley (1-212) 834-5516
Joseph Lupton (1-212) 834-5735
Carlton Strong (1-212) 834-5612
JPMorgan Chase Bank NA


Global central bank forecasts
                                                    Change from                                              Forecast
                 Official interest rate    Current Aug '07 (bp)       Last change        Next meeting      next change        Dec 10 Mar 11 Jun 11 Sep 11 Dec 11

Global           GDP-weighted average       1.80        -316                                                                    1.80    1.87    1.95    2.01    2.07
  excluding US   GDP-weighted average       2.44        -236                                                                    2.45    2.55    2.65    2.74    2.83
Developed        GDP-weighted average       0.61        -358                                                                    0.62    0.63    0.65    0.68    0.72
Emerging         GDP-weighted average       5.10        -199                                                                    5.12    5.34    5.58    5.74    5.88
  Latin America GDP-weighted average        7.25        -216                                                                    7.27    7.74    8.33    8.39    8.40
  CEEMEA         GDP-weighted average       4.04        -298                                                                    4.05    4.07    4.13    4.32    4.80
  EM Asia        GDP-weighted average       4.75        -151                                                                    4.76    4.97    5.16    5.34    5.38

The Americas     GDP-weighted average       1.28        -453                                                                    1.29    1.38    1.49    1.51    1.55
United States    Federal funds rate         0.125      -512.5      16 Dec 08 (-87.5bp)    14 Dec 10          On hold           0.125   0.125   0.125   0.125   0.125
Canada           Overnight funding rate     1.00        -325        8 Sep 10 (+25bp)       7 Dec 10      1 Mar 11 (+25bp)       1.00    1.25    1.50    1.75    2.25
Brazil           SELIC overnight rate       10.75       -125        21 Jul 10 (+50bp)      8 Dec 10       Mar 11 (+25bp)       10.75   11.50   12.50   12.50   12.50
Mexico           Repo rate                  4.50        -270        17 Jul 09 (-25bp)     26 Nov 10          On hold            4.50    4.50    4.50    4.50    4.50
Chile            Discount rate              3.00        -200       16 Nov 10 (+25bp)      16 Dec 10      16 Dec 10 (+25bp)      3.25    4.00    4.25    4.25    4.25
Colombia         Repo rate                  3.00        -600        30 Apr 10 (-50bp)     17 Dec 10       1Q 11 (+50bp)         3.00    4.00    5.00    5.50    5.50
Peru             Reference rate             3.00        -150        9 Sep 10 (+50bp)       9 Dec 10       May 11 (+25bp)        3.00    3.00    3.50    4.25    4.50

Europe/Africa    GDP-weighted average       1.44        -322                                                                    1.45    1.45    1.46    1.51    1.62
Euro area        Refi rate                  1.00        -300        7 May 09 (-25bp)       2 Dec 10          On hold            1.00    1.00    1.00    1.00    1.00
United Kingdom Repo rate                    0.50        -500         5 Mar 09 (-50bp)      9 Dec 10          On hold            0.50    0.50    0.50    0.50    0.50
Sweden           Repo rate                  1.00        -250        26 Oct 10 (+25bp)     15 Dec 10      15 Dec 10 (+25bp)      1.25    1.25    1.25    1.50    2.00
Norway           Deposit rate               2.00        -250        5 May 10 (+25bp)      15 Dec 10       3Q 11 (+25bp)         2.00    2.00    2.00    2.25    2.75
Switzerland      3-month Swiss Libor        0.25        -225        12 Mar 09 (-25bp)       4Q 10         Jun 11 (+25bp)        0.25    0.25    0.50    0.75    1.00
Czech Republic   2-week repo rate           0.75        -200        6 May 10 (-25bp)      22 Dec 10       2Q 11 (+25bp)         0.75    0.75    1.00    1.25    1.75
Hungary          2-week deposit rate        5.25        -250        26 Apr 10 (-25bp)     29 Nov 10       3Q 11 (+25bp)         5.25    5.25    5.25    5.50    5.75
Israel           Base rate                  2.00        -200        27 Sep 10 (+25bp)     22 Nov 10      22 Nov 10 (+25bp)      2.25    2.50    2.75    3.25    3.50
Poland           7-day intervention rate    3.50        -100        24 Jun 09 (-25bp)     23 Nov 10       2Q 11 (+25bp)         3.50    3.50    3.75    4.00    4.25
Romania          Base rate                  6.25         -75        4 May 10 (-25bp)       5 Jan 11       3Q 11 (+25bp)         6.25    6.25    6.25    6.50    6.75
Russia           1-week deposit rate        2.75         -25        31 May 10 (-50bp)      Nov 10         3Q 11 (+25bp)         2.75    2.75    2.75    3.00    3.50
South Africa     Repo rate                  5.50        -400        18 Nov 10 (-50bp)     20 Jan 11          On hold            5.50    5.50    5.50    5.50    5.50
Turkey           1-week repo rate           7.00        -1050               -             16 Dec 10       4Q 11 (+50bp)         7.00    7.00    7.00    7.00    8.00

Asia/Pacific     GDP-weighted average       3.03        -117                                                                    3.04    3.17    3.30    3.42    3.46
Australia        Cash rate                  4.75        -150        2 Nov 10 (+25bp)       6 Dec 10       Feb 11 (+25bp)        4.75    5.00    5.25    5.50    5.75
New Zealand      Cash rate                  3.00        -500        29 Jul 10 (+25bp)      8 Dec 10      10 Mar 11 (+25bp)      3.00    3.25    3.50    3.75    4.00
Japan            Overnight call rate        0.05         -48         5 Oct 10 (-5bp)      21 Dec 10          On hold            0.05    0.05    0.05    0.05    0.05
Hong Kong        Discount window base       0.50        -625       17 Dec 08 (-100bp)     15 Dec 10          On hold            0.50    0.50    0.50    0.50    0.50
China            1-year working capital     5.56        -101        19 Oct 10 (+25bp)       1Q 11         1Q 11 (+25bp)         5.56    5.81    6.06    6.31    6.31
Korea            Base rate                  2.50        -200       16 Nov 10 (+25bp)       8 Dec 10       1Q 11 (+25bp)         2.50    2.75    3.00    3.00    3.00
Indonesia        BI rate                    6.50        -200        5 Aug 09 (-25bp)       3 Dec 10       2Q 11 (+25bp)         6.50    6.50    6.75    6.75    6.75
India            Repo rate                  6.25        -150        2 Nov 10 (+25bp)      16 Dec 10       Jan 11 (+25bp)        6.25    6.50    6.50    6.75    7.00
Malaysia         Overnight policy rate      2.75         -75         8 Jul 10 (+25bp)     27 Jan 11          On hold            2.75    2.75    2.75    2.75    2.75
Philippines      Reverse repo rate          4.00        -350         9 Jul 09 (-25bp)     30 Dec 10       2Q 11 (+25bp)         4.00    4.00    4.25    4.50    4.50
Thailand         1-day repo rate            1.75        -150        26 Aug 10 (+25bp)      1 Dec 10      1 Dec 10 (+25bp)       2.00    2.25    2.50    2.50    2.50
Taiwan           Official discount rate     1.50        -163       30 Sep 10 (+12.5bp)    23 Dec 10     23 Dec 20 (+12.5bp)    1.625    1.75   1.875    2.00    2.00
Bold denotes move since last GDW and forecast changes. Underline denotes policy meeting during upcoming week.




                                                                                                                                                                  95
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Carlton Strong (1-212) 834-5612
carlton.m.strong@jpmorgan.com
JPMorgan Chase Bank NA



Real GDP growth
     %oya, underlining denotes forecasts
                                           2002    2003    2004    2005    2006    2007    2008    2009    2010    2011
     The Americas                            1.6     2.3     4.0     3.3     3.2     3.2     0.8    -2.6     3.3     2.8
     United States                           1.8     2.5     3.6     3.1     2.7     2.7     0.0    -2.6     2.7     2.5
     Canada                                  2.9     1.9     3.1     3.0     2.8     2.3     0.5    -2.5     3.0     2.1
     Argentina                             -10.9     8.8     9.0     9.2     8.5     8.7     9.9    -2.0     8.5     5.5
     Brazil                                  2.7     1.1     5.7     3.2     4.0     6.1     5.1    -0.2     7.5     4.5
     Chile                                   2.2     3.9     6.0     5.6     4.6     4.6     3.7    -1.5     5.5     6.0
     Colombia                                2.5     3.9     5.3     4.7     6.7     6.9     2.7     0.8     4.5     4.1
     Ecuador                                 3.4     3.3     8.8     5.7     4.8     2.0     7.2     0.4     2.5     3.0
     Mexico                                  0.8     1.4     4.0     3.2     4.9     3.3     1.5    -6.5     4.5     3.5
     Peru                                    5.0     4.0     5.0     6.8     7.7     8.9     9.8     0.9     8.5     6.0
     Venezuela                              -8.9    -7.8    18.3    10.3     9.9     8.2     4.8    -3.3    -1.5     1.5

     Asia/Pacific                           4.4     5.1     6.0     5.8     6.4     7.0      3.5     1.3    6.5     4.7
     Japan                                  0.3     1.5     2.7     1.9     2.0     2.3     -1.2    -5.3    3.5     1.1
     Australia                              4.2     3.0     3.8     2.8     2.8     4.0      2.2     1.2    3.2     3.6
     New Zealand                            4.7     4.4     4.4     2.8     2.7     3.0     -0.2    -1.7    2.0     2.8
     China                                  9.1    10.0    10.1    11.3    12.7    14.2      9.6     9.1   10.0     9.0
     Hong Kong                              1.8     3.0     8.5     7.1     7.0     6.4      2.2    -2.8    6.6     4.1
     India                                  3.8     8.4     8.3     9.5     9.7     9.2      6.7     7.4    8.3     8.5
     Indonesia                              4.5     4.8     5.0     5.7     5.5     6.3      6.1     4.5    6.0     5.4
     Korea                                  7.2     2.8     4.6     4.0     5.2     5.1      2.3     0.2    6.2     4.0
     Malaysia                               5.4     5.8     6.8     5.3     5.8     6.6      4.7    -1.2    6.8     4.6
     Philippines                            4.4     4.9     6.4     5.0     5.3     7.1      3.8     0.9    7.0     4.5
     Singapore                              4.2     4.6     9.2     7.4     8.6     8.5      1.8    -1.3   15.0     4.2
     Taiwan                                 5.3     3.7     6.2     4.7     5.4     6.0      0.7    -1.9   10.1     4.0
     Thailand                               5.3     7.1     6.3     4.6     5.1     4.9      2.5    -2.2    8.5     4.0

     Africa/Middle East                     2.1     2.4     4.7     5.1     5.6     5.4     3.9     -0.8    3.1     3.6
     South Africa                           3.7     2.9     4.6     5.3     5.6     5.5     3.7     -1.8    2.9     3.1

     Euro area                               0.9     0.8    1.9     1.8     3.1     2.7      0.3    -4.0     1.7    1.6
      Germany                                0.0    -0.2    0.7     0.9     3.4     2.6      0.7    -4.7     3.5    2.6
      France                                 1.1     1.1    2.3     1.9     2.4     2.3      0.1    -2.5     1.6    1.6
      Italy                                  0.5     0.0    1.5     0.7     2.0     1.6     -1.3    -5.1     1.0    1.3
     Norway                                  1.4     1.0    4.2     4.5     4.4     6.2      1.6    -1.2     1.6    2.4
     Sweden                                  2.4     2.0    3.5     3.3     4.5     2.7     -0.6    -5.1     4.5    3.1
     Switzerland                             0.4    -0.2    2.5     2.6     3.6     3.6      1.9    -1.9     2.9    2.0
     United Kingdom                          2.1     2.8    3.0     2.2     2.9     2.6     -0.1    -5.0     1.7    2.3
     Bulgaria                                4.5     5.0    6.6     6.2     6.3     6.2      6.0    -5.0    -0.5    4.0
     Czech Rep.                              1.9     3.6    4.5     6.3     6.8     6.1      2.5    -4.1     2.5    3.0
     Hungary                                 4.4     4.3    4.9     3.5     4.0     1.0      0.8    -6.7     1.0    2.8
     Poland                                  1.4     3.9    5.3     3.6     6.2     6.8      5.1     1.7     3.5    4.0
     Romania                                 5.1     5.2    8.4     4.2     7.9     6.0      7.1    -7.1    -2.0    1.5
     Russia                                  4.7     7.3    7.2     6.4     8.2     8.5      5.2    -7.9     3.5    4.5
     Israel                                 -0.4     1.5    5.0     4.9     5.7     5.4      4.2     0.8     3.5    4.5
     Turkey                                  6.2     5.3    9.4     8.4     6.9     4.7      0.7    -4.7     7.1    4.3

     World                                  2.3     2.8     4.1     3.7     4.2     4.3      1.6    -2.2    3.7     3.0
     Developed markets                      1.4     1.8     2.9     2.4     2.8     2.7      0.0    -3.5    2.5     2.0
     G-7                                    1.3     1.8     2.8     2.3     2.6     2.5     -0.2    -3.6    2.7     2.1
     Emerging Economies                     4.7     5.7     7.5     7.1     8.1     8.4      5.5     1.3    6.9     5.7
     Latin America                          0.3     1.6     6.4     4.5     5.4     5.6      4.4    -2.4    5.7     4.1
     Emerging Asia                          7.0     7.6     8.3     8.7     9.7    10.5      6.8     5.6    8.9     7.2
      ex China                              5.0     5.3     6.6     6.3     6.9     6.9      4.0     2.2    7.8     5.5
     Emerging Europe                        4.4     5.8     7.2     6.1     7.2     6.7      3.9    -5.3    3.7     4.0
      ex Russia                             4.1     4.6     7.1     6.0     6.5     5.3      2.9    -3.3    3.9     3.7
     World ex-United States                 2.5     3.0     4.4     4.0     4.8     4.9      2.1    -2.0    4.0     3.2
     Developed Europe                       1.2     1.1     2.2     2.0     3.1     2.8      0.3    -4.1    1.8     1.8
     Euro ex GY, FR, IT                     1.8     1.9     2.8     3.0     3.9     3.7      1.0    -4.0    0.6     0.9

     Using PPP weights:
     World                                  3.1     3.9     5.1     4.8     5.4     5.6      2.7    -0.8    4.6     3.9
     Developed markets                      1.5     1.8     2.9     2.5     2.8     2.7      0.0    -3.4    2.5     2.0
     G-7                                    1.3     1.8     2.9     2.4     2.6     2.5     -0.2    -3.5    2.7     2.1
     Emerging Economies                     5.1     6.4     7.8     7.7     8.6     9.1      6.1     2.5    7.3     6.3
     Latin America                          0.1     1.9     6.5     4.7     5.5     5.8      4.6    -2.2    5.8     4.2
     Emerging Asia                          6.9     8.1     8.5     9.1    10.1    10.9      7.2     6.2    9.0     7.6
      ex China                              4.7     6.0     6.9     6.9     7.4     7.3      4.6     3.3    7.8     6.1
     Emerging Europe                        4.3     5.9     7.1     6.1     7.3     6.9      4.1    -5.4    3.6     4.0
      ex Russia                             4.0     4.6     7.1     5.8     6.5     5.4      3.1    -3.2    3.8     3.7
     World ex-United States                 3.4     4.3     5.5     5.3     6.2     6.4      3.6    -0.2    5.2     4.3
     Developed Europe                       1.2     1.1     2.2     2.0     3.1     2.8      0.3    -4.1    1.8     1.8
     Euro ex GY, FR, IT                     1.8     1.8     2.8     2.9     3.8     3.6      0.9    -3.9    0.7     1.0

96
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Carlton Strong (1-212) 834-5612
carlton.m.strong@jpmorgan.com
JPMorgan Chase Bank NA



Real GDP growth
%q/q, saar, underlining denotes forecasts
                                             2008                           2009                        2010                        2011
                                     1Q     2Q    3Q        4Q      1Q     2Q    3Q      4Q     1Q     2Q    3Q       4Q    1Q     2Q    3Q      4Q

United States                       -0.7     0.6   -4.0    -6.8    -4.9   -0.7    1.6    5.0    3.7    1.7    2.0     2.5   2.0    3.0    3.0    4.0
Japan                                1.3    -2.7   -5.4   -10.4   -15.8    9.9   -1.5    4.2    6.6    1.8    3.9    -1.5   0.5    1.5    1.8    2.0
Canada                              -0.7    -0.1    0.4    -3.1    -7.0   -2.8    0.9    4.9    5.8    2.0    1.5     2.0   2.3    2.0    2.4    2.6
Australia                            4.0     0.9    1.6    -2.9     2.9    2.2    1.3    4.2    2.7    4.9    3.3     2.4   3.4    4.9    3.2    5.2
Euro area                            2.8    -1.7   -2.1    -7.1    -9.6   -0.6    1.7    0.8    1.4    3.9    1.5     1.5   1.0    1.5    1.8    2.0
 Germany                             5.6    -2.7   -1.8    -8.5   -13.1    1.9    2.8    1.3    2.3    9.5    2.8     2.5   2.0    2.0    2.0    2.0
 France                              2.1    -2.6   -1.1    -6.0    -5.7    0.6    0.6    2.5    0.8    2.7    1.4     1.5   1.5    1.0    2.0    2.0
 Italy                               1.8    -2.6   -4.4    -7.9   -11.0   -1.1    1.7   -0.2    1.7    1.9    0.7     1.0   1.5    1.0    2.0    2.0
Norway                              -1.9     3.4   -0.7    -4.5    -2.1   -1.1    1.4    1.8    0.7    1.9    3.7     2.5   2.0    2.0    2.5    2.5
New Zealand                         -1.2    -2.3   -2.6    -4.4    -3.5    0.6    0.9    4.0    2.2    0.7    2.5     2.5   2.6    3.1    4.2    2.8
Sweden                              -3.9    -0.7    0.5   -14.8   -10.6    1.1    1.9    2.3    6.0    8.0    4.5     3.0   2.3    2.3    2.8    2.8
Switzerland                          3.1     2.0   -2.7    -4.5    -3.9   -2.2    3.0    2.9    4.2    3.5    2.5     2.0   1.5    1.5    2.3    2.8
United Kingdom                       2.0    -1.1   -3.5    -8.1    -9.0   -3.1   -1.2    1.4    1.8    4.7    3.2     1.5   1.0    2.5    3.0    3.0

Argentina                            5.1    7.3     5.3    -2.0    -3.4    1.6    1.7    9.6   13.4   12.6     0.0    2.0   6.0    8.0    8.0    6.0
Brazil                               7.5    6.2     5.5   -12.8    -6.1    5.9    8.9    9.8   11.3    5.1     2.3    3.2   5.7    4.7    5.0    5.2
Chile                                7.2    7.6    -5.1    -7.9    -2.8   -0.8    5.1    7.7   -5.2   19.5     8.1    6.0   5.0    4.0    4.0    4.0
Colombia                            -1.4    2.9     0.0    -5.6    -1.2    2.7    4.1    6.5    3.3    3.9     3.7    4.0   4.0    4.1    5.0    5.5
Ecuador                              2.1    9.7     3.1    -1.0    -2.6   -0.8    0.3    1.0    2.1    7.7     2.5    3.0   3.0    2.5    2.5    2.0
Mexico                               4.5    1.1    -2.7    -9.2   -25.1    0.2   10.3   10.1   -2.5   13.5    -3.6    3.1   2.9    9.2   -0.1    2.7
Peru                                11.7    8.3     8.0    -3.1    -3.4   -3.3   10.0   10.5    8.0   12.7     7.0    4.5   5.5    5.2    6.5    6.0
Venezuela                            2.2    9.9     0.2     0.7    -6.6   -6.1   -6.4   -4.4   -3.4    6.7     0.1    1.0   1.0    1.5    1.5    1.5

China                               10.7     8.7    5.8     2.4     7.9   14.4   11.5   12.0   10.5    7.2     8.1    8.7   9.5    9.1    9.3    9.3
Hong Kong                            4.1    -3.9   -3.2    -7.4   -12.2   13.0    1.2   10.0    8.7    5.7     2.8    3.5   4.2    4.3    4.7    5.0
Indonesia                            5.9     6.8    5.2     1.9     5.8    3.8    5.9    8.2    3.0    7.5     4.7    7.0   5.3    5.2    5.0    5.0
India                                6.9     5.9    7.7     1.6     2.2    7.8   12.8    4.8    9.2    8.5     8.0    8.9   8.0    8.5    8.6    8.9
Korea                                4.4     1.7    1.0   -18.8     1.0    9.8   13.4    0.7    8.8    5.8     3.0    3.8   4.0    4.0    4.5    4.5
Malaysia                             7.2     2.3    0.6    -8.8   -12.1    9.9   15.8    8.1    4.8    7.2     0.0    2.0   4.9    4.9    4.5    4.5
Philippines                          0.4     7.1    3.0     1.1    -5.4    5.2    3.4    8.7   11.9    7.7     0.8    1.6   5.7    5.7    5.7    5.7
Singapore                           12.2    -7.7   -2.1   -16.4   -11.0   18.5   11.1   -1.0   45.6   27.3   -18.7   10.4   4.1    9.5    7.4    7.4
Taiwan                               3.6    -2.3   -2.9   -27.2    -4.1   13.5   11.8   18.4   17.3    1.9     0.1    2.3   5.5    5.0    5.6    6.0
Thailand                             4.7     0.3    2.2   -21.5    -7.8   11.9    5.3   17.0   13.9    0.6     0.0    2.8   4.9    4.9    4.9    4.9

Czech Republic                       0.8     3.2    0.8    -3.2   -14.3   -1.8    2.0    2.2    1.5    3.8     4.4    3.0   2.5    3.0    4.0    4.0
Hungary                              3.5    -0.9   -3.8    -7.4   -12.2   -5.1   -3.2    0.0    4.1    1.6     3.2    2.0   2.0    3.0    3.5    3.5
Poland                               6.1     4.1    1.6    -0.4     1.6    2.0    2.8    4.9    2.4    4.1     3.5    3.5   3.0    3.5    4.0    4.0
Romania                              1.5     5.1    6.7    13.1   -15.5   -5.8    0.2   -6.0   -1.2    1.2    -2.8   -1.0   1.0    2.5    3.0    4.0
Russia                               5.1     6.1    4.5    -8.8   -19.8   -3.5    6.4    7.3    3.3    4.3    -3.6    7.5   5.0    5.0    5.0    5.0
South Africa                         1.7     5.0    0.2    -1.8    -7.4   -2.8    0.9    3.2    4.6    3.2     3.6    3.2   3.1    3.1    3.4    2.9
Israel                               5.6     3.6    0.8    -1.6    -2.7    1.2    3.6    4.6    3.9    4.5     3.8    3.0   4.0    5.0    5.5    5.5
Turkey                               7.7    -4.5   -5.6   -21.6   -10.5   14.2   14.7    7.8    6.1   11.7    -3.0   -8.5   6.1   10.4   12.1   14.3

Global                               2.5     0.9   -1.4    -6.7    -6.8    2.2    3.1    4.5    4.4    3.9     2.5    2.7   2.7    3.4    3.4    3.8
Developed market economies           1.0    -0.7   -3.1    -7.2    -8.0    0.5    1.0    3.2    3.2    2.8     2.2    1.6   1.5    2.3    2.4    3.0
Emerging economies                   6.8     5.3    3.4    -5.1    -3.3    6.7    8.7    8.2    7.8    7.0     3.2    5.7   6.0    6.5    6.0    6.2
G-7                                  0.9    -0.9   -3.5    -7.5    -8.4    1.0    0.9    3.6    3.6    2.9     2.3    1.6   1.6    2.3    2.5    3.0
Latin America                        5.5     5.0    1.9    -8.8   -10.9    2.1    7.1    8.4    4.9    9.1     0.8    3.1   4.4    6.0    3.4    4.2
Emerging Asia                        8.1     5.5    4.3    -3.7     3.2   11.8   11.1    9.2   10.7    7.2     5.5    7.1   7.5    7.5    7.7    7.7
                1
Emerging Europe                      4.6     4.9    3.3    -5.0   -14.3   -2.5    4.2    5.0    2.7    3.8    -1.0    5.4   3.9    4.2    4.5    4.6

1. Emerging Europe aggregate excludes Turkey.


Using PPP weights:
Global                               3.6    2.1    0.0     -5.7    -5.2    3.5    4.6    5.6    5.4    4.6    3.0     3.6   3.7    4.3    4.2    4.6
Developed market economies           0.9    -0.6   -3.2    -7.2    -7.8    0.5    1.1    3.3    3.3    2.7    2.2     1.6   1.5    2.3    2.5    3.0
Emerging economies                   7.1    5.7    4.0     -3.8    -1.7    7.5    9.2    8.5    8.2    7.1    4.1     6.2   6.5    6.9    6.5    6.7
G-7                                  0.8    -0.8   -3.6    -7.4    -8.1    0.9    1.0    3.7    3.6    2.8    2.3     1.6   1.7    2.3    2.6    3.1
Latin America                        5.5    5.2    2.1     -8.4   -10.3    2.0    6.9    8.4    5.1    9.2    0.9     3.1   4.4    6.0    3.7    4.3
Emerging Asia                        8.3    6.1    4.9     -2.1    3.8    11.7   11.2    9.4   10.4    7.2    6.1     7.5   7.9    7.8    8.0    8.0
                  1
Emerging Europe                      4.7    5.0    3.4     -5.1   -14.5   -2.6    4.4    5.1    2.7    3.9    -1.2    5.5   4.0    4.3    4.5    4.6




                                                                                                                                                       97
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Carlton Strong (1-212) 834-5612
carlton.m.strong@jpmorgan.com
JPMorgan Chase Bank NA



Consumer prices
underlining denotes forecasts
                                       2008                       2009                       2010                         2011
                                 1Q   2Q    3Q     4Q     1Q     2Q    3Q      4Q     1Q    2Q    3Q      4Q      1Q     2Q    3Q    4Q
%q/q, saar
United States                   4.7   5.2   6.4   -9.2   -2.2   1.9    3.7    2.6    1.5    -0.7   1.5    1.6     1.1    1.0   1.1   1.1

%oy a
United States                   4.2   4.3   5.3    1.6   -0.2   -1.0   -1.6    1.5    2.4    1.8    1.2    1.0    0.9    1.3   1.2    1.1
Japan                           1.0   1.4   2.2    1.0   -0.1   -1.0   -2.2   -2.0   -1.2   -0.9   -0.8   -0.3   -0.6   -0.1   0.0   -0.5
Canada                          1.8   2.4   3.4    1.9    1.2    0.1   -0.9    0.8    1.6    1.4    1.8    1.9    2.0    2.1   2.0    2.1
Australia                       4.2   4.5   5.0    3.7    2.5    1.5    1.3    2.1    2.9    3.1    3.0    3.3    3.5    3.8   3.6    3.4
Euro area                       3.4   3.6   3.8    2.3    1.0    0.2   -0.4    0.4    1.1    1.5    1.7    1.7    1.4    1.1   0.9    1.0
 Germany                        3.1   3.0   3.3    1.7    0.8    0.2   -0.4    0.3    0.8    1.0    1.2    1.2    0.8    0.6   0.6    0.7
 France                         3.3   3.7   3.6    2.0    0.7   -0.2   -0.5    0.4    1.5    1.8    1.8    1.3    0.9    0.7   0.9    1.1
 Italy                          3.3   3.8   4.1    2.9    1.4    0.9    0.1    0.7    1.3    1.6    1.7    1.7    1.8    1.4   1.5    1.5
Norw ay                         3.5   3.2   4.7    3.6    2.4    3.1    1.8    1.4    2.9    2.6    1.9    2.1    1.1    1.3   1.4    1.3
New Zealand                     3.4   4.0   5.1    3.4    3.0    1.9    1.7    2.0    2.0    1.8    1.8    4.9    5.4    5.6   5.2    3.2
Sw eden                         3.2   3.8   4.3    2.4    0.8   -0.4   -1.1   -0.4    1.0    1.0    1.1    1.5    1.4    1.6   1.6    1.8
Sw itzerland                    2.5   2.7   3.0    1.6    0.0   -0.7   -1.0   -0.2    1.1    1.0    0.3    0.0   -0.4   -0.3   0.2    0.6
United Kingdom                  2.4   3.4   4.8    3.9    3.0    2.1    1.5    2.1    3.3    3.5    3.1    2.8    2.6    2.1   1.9    2.1

Argentina                        8.5 9.1 8.9 7.8          6.6 5.5 5.9 7.1             9.0 10.6 10.5 10.5         10.5   11.0   11.5 12.0
Brazil                           4.6 5.6 6.3 6.2          5.8 5.2 4.4 4.2             4.9 5.1 4.6 5.4             5.4    5.5    6.0 5.3
Chile                            8.0 8.9 9.3 8.6          4.8 1.8 -1.9 -3.0          -0.3 1.2 2.2 3.2             3.4    3.6    3.6 3.4
Colombia                         6.1 6.4 7.7 7.8          6.6 4.8 3.2 2.4             2.0 2.1 2.3 2.4             2.4    2.5    3.0 3.5
Ecuador                          5.3 9.1 10.0 9.3         7.9 5.5 3.5 3.9             4.0 3.2 3.6 3.3             3.0    3.5    3.6 3.8
Mex ico                          3.9 4.9 5.5 6.2          6.2 6.0 5.1 4.0             4.8 4.0 4.6 5.1             4.8    4.5    4.3 4.0
Peru                             4.8 5.5 6.1 6.6          5.6 4.0 1.9 0.4             0.7 1.2 2.2 2.3             2.7    2.8    2.3 2.6
Venezuela                       26.2 31.0 34.7 33.4      29.5 28.2 28.7 28.1         27.4 31.9 29.8 28.9         33.1   31.6   33.3 34.9

China                            8.0 7.8 5.3       2.5   -0.6 -1.5 -1.3 0.7           2.2 2.9 3.5 4.0             3.8    4.2   4.2   3.1
Hong Kong                        4.6 5.7 4.6       2.3    1.7 -0.1 -0.9 1.3           1.9 2.6 2.3 2.5             1.6    2.2   2.2   2.4
Indonesia                        6.5 9.0 12.0     11.5    8.6 5.6 2.8 2.6             3.7 4.4 6.2 5.7             5.4    5.2   4.7   4.8
India                            6.3 7.8 9.0      10.2    9.4 8.9 11.8 13.3          15.3 13.7 10.3 10.3          8.3    7.5   8.2   8.5
Korea                            3.8 4.8 5.5       4.5    3.9 2.8 2.0 2.4             2.7 2.6 2.9 3.4             3.2    3.6   3.5   3.2
Malay sia                        2.6 4.9 8.4       5.9    3.7 1.3 -2.3 -0.2           1.3 1.6 1.9 1.1             0.8    1.8   2.9   3.0
Philippines                      5.5 9.7 12.2      9.7    6.9 3.2 0.3 2.9             4.3 4.2 3.8 2.7             2.1    1.9   2.3   2.7
Singapore                        6.6 7.5 6.6       5.4    3.4 0.2 -0.3 -0.8           0.9 3.1 3.4 3.5             2.2    1.8   1.7   1.6
Taiw an                          3.6 4.2 4.5       1.9    0.0 -0.8 -1.3 -1.3          1.3 1.1 0.4 0.6             0.2    1.2   2.1   2.6
Thailand                         5.0 7.5 7.3       2.1   -0.2 -2.8 -2.2 1.9           3.7 3.2 3.3 2.8             2.6    4.5   4.7   4.0
Czech Republic                   7.4 6.8 6.6       4.7    2.1 1.4 0.1 0.4             0.7 1.2 1.9 2.3             2.6    2.5   2.6   2.6
Hungary                          6.9 6.8 6.3       4.3    3.0 3.6 5.0 5.2             6.0 5.4 3.8 4.4             3.8    3.4   3.5   3.6
Poland                           4.1 4.3 4.7       3.8    3.3 3.7 3.5 3.3             3.0 2.3 2.2 2.6             2.8    2.7   2.7   2.9
Romania                          8.0 8.6 8.1       6.8    6.8 6.1 5.0 4.6             4.6 4.4 7.5 8.0             7.5    7.2   3.8   4.0
Russia                          12.9 14.8 14.9    13.8   13.8 12.5 11.4 9.2           7.2 5.9 6.2 7.9             8.4    8.8   8.3   7.6
Israel                           3.6 5.0 5.1       4.6    4.0 3.2 3.2 3.6             3.5 2.8 2.0 2.6             3.1    3.0   2.8   2.8
South Africa                     8.9 10.0 11.0     9.8    8.4 7.7 6.4 6.0             5.7 4.5 3.5 3.6             3.7    3.8   4.6   4.9
Turkey                           8.8 10.3 11.7    10.9    8.4 5.7 5.3 5.7             9.3 9.2 8.4 7.9             6.5    7.4   7.5   6.2

Global                          4.3 4.8 5.3 3.3          1.8     0.9    0.4   1.7    2.5    2.5    2.4    2.4     2.2    2.4   2.3   2.1
Dev eloped market economie      3.2 3.5 4.3 2.0          0.6    -0.2   -0.9   0.7    1.5    1.5    1.3    1.3     1.1    1.2   1.1   1.0
Emerging economies              7.1 8.1 8.0 6.8          5.2     4.1    3.8   4.3    5.2    5.2    5.1    5.5     5.3    5.5   5.6   5.1
G-7                             3.2 3.5 4.2 1.8          0.4    -0.4   -1.1   0.7    1.6    1.4    1.2    1.1     0.9    1.1   1.0   1.0
Latin America                   6.6 7.8 8.6 8.6          7.7     6.9    6.0   5.5    6.2    6.6    6.6    7.0     7.2    7.2   7.5   7.3
Emerging Asia                   6.5 7.2 6.5 4.7          2.4     1.2    1.3   2.9    4.3    4.5    4.4    4.6     4.1    4.3   4.5   4.0
Emerging Europe                 9.7 10.9 11.3 10.2       9.3     8.1    7.4   6.5    6.4    5.7    5.8    6.5     6.5    6.8   6.4   5.9

Using PPP weights:
Global                          5.0 5.6 5.9 4.0          2.5     1.5    1.1   2.4    3.3    3.2    3.1    3.2     3.0    3.1   3.1   2.8
Dev eloped market economie      3.3 3.6 4.3 2.0          0.5    -0.3   -1.0   0.7    1.6    1.5    1.3    1.3     1.1    1.2   1.1   1.0
Emerging economies              7.2 8.1 7.9 6.6          4.9     3.8    3.7   4.4    5.5    5.5    5.2    5.6     5.3    5.4   5.6   5.1
G-7                             3.2 3.5 4.3 1.8          0.4    -0.4   -1.1   0.7    1.6    1.4    1.2    1.1     0.9    1.1   1.1   1.0
Latin America                   6.6 7.7 8.5 8.5          7.6     6.7    5.9   5.4    6.1    6.5    6.5    6.9     7.1    7.1   7.4   7.2
Emerging Asia                   6.7 7.4 6.7 5.0          2.7     1.6    1.9   3.5    5.0    5.1    4.8    5.1     4.4    4.6   4.8   4.3
Emerging Europe                 9.8 11.1 11.4 10.3       9.5     8.4    7.7   6.7    6.4    5.6    5.7    6.6     6.6    6.9   6.5   5.9




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Carlton Strong (1-212) 834-5612
carlton.m.strong@jpmorgan.com
JPMorgan Chase Bank NA



Basic economic statistics: international comparisons
                        Nominal GDP       GDP per      Population     Average CPI    Average real GDP   Unemployment   Budget bal.
                          $ billion       capita, $     million          %oya         growth, %oya         rate, %       % GDP
                           2009            2009          2009           1980-09          1980-09           2009          2009
The Americas
United States                     14119        44871          314.7            3.7         2.7             9.3            -10.0
Canada                             1339        39876           33.6            3.6         2.5             8.3             -3.1

Argentina                          307          7626           39.9          277.2         2.3             10.0           -1.5
Brazil                            1572          8217          189.0          397.6         2.7             8.1            -3.3
Chile                              164          9650           16.8           12.2         4.6             9.6            -4.5
Colombia                           231          5059           45.0           17.3         3.4             13.0           -2.7
Ecuador                             52          3818           13.5           30.3         3.0             9.0            -3.5
Mexico                             876          7988          108.6           31.6         2.3             4.8            -0.5
Peru                               127          4346           28.8          431.0         2.9             10.0           -2.0
Venezuela                          326         11408           28.1           30.6         1.9             7.9            -7.5

Asia
Japan                             5066         39838          127.2            1.2         2.0             5.1            -6.8
Australia                          981         46085           21.3            4.7         3.2             5.6            -2.1
New Zealand                        118         27649            4.3            5.6         2.4             6.1            -2.2
Hong Kong                          211         23282            9.0            5.1         5.1             5.2             0.8
Singapore                          182         38470            4.6            2.1         6.7             3.0            -1.0

China                             4985          3704        1337.4             5.9         10.0            5.0            -3.3
India                             1301          1086        1181.4             8.1         6.3             …              -6.8
Indonesia                          541          2351         227.3            11.0         5.1             8.1            -1.6
Korea                              833         17224          48.2             5.8         6.6             3.7            -1.7
Malaysia                           193          7021          27.0             3.2         6.0             3.9            -7.1
Philippines                        161          1755          90.3             9.8         3.1             7.5            -3.9
Taiwan                             378         16334          23.0             2.8         5.8             5.8            -3.6
Thailand                           266          3921          67.4             4.4         5.5             2.0            -3.9

Europe
Germany                           3337         40612           82.2            2.3         1.7             8.2             -3.3
France                            2657         42628           62.3            3.7         1.9             9.5             -7.5
Italy                             2118         35383           59.9            5.9         1.5             7.8             -5.3
United Kingdom                    2172         35282           61.6            4.6         2.1             7.5            -11.5

Norway                              379        78709            4.8            4.3         2.6             2.7            9.6
Sweden                              406        43893            9.3            4.2         2.0             5.0            -1.0
Switzerland                         493        65106            7.6            2.2         1.8             3.7            -0.1

Bulgaria                            47          6202            7.6             …          1.1             7.6            -3.7
Czech Republic                     190         18352           10.3             …          …               8.1            -5.9
Hungary                            129         12910           10.0           12.4         1.5             9.8            -4.0
Poland                             431         11310           38.1           47.7         2.2             11.0           -7.1
Russia                            1233          8753          141.4             …          …               8.6            -5.9
Romania                            161          7464           21.6             …          …               6.3            -8.3
Turkey                             613          8192           73.9           50.2         4.0             14.0           -5.5

Africa/Middle East
Israel                              196        27273            7.1           47.6         4.3             7.6            -5.2
South Africa                        286         5885           48.2           10.0         2.4             24.2           -6.7




                                                                                                                                  99
Global FX Strategy
Global FX Strategy 2011
November 23, 2010

Carlton Strong (1-212) 834-5612
carlton.m.strong@jpmorgan.com
JPMorgan Chase Bank NA



Economic outlook in summary
                                      Real GDP growth (%oya)      Consumer prices (% oya)     Current acct. bal. (% GDP)
                                  2009       2010       2011   2009     2010        2011    2009       2010         2011
The Americas
United States                     -2.6        2.7        2.5   -0.3        1.6        1.1    -2.7       -3.3        -3.3
Canada                            -2.5        3.0        2.1    0.3        1.7        2.0    -2.8       -2.4        -1.8
Latin America                     -2.4        5.7        4.1    6.5        6.4        7.1    -0.3       -1.2        -1.9
 Argentina                        -2.0        8.5        5.5    6.3        8.2       10.0     3.7        0.0        -1.5
 Brazil                           -0.2        7.5        4.5    4.9        5.0        5.6    -1.6       -2.4        -3.1
 Chile                            -1.5        5.5        6.0    0.4        2.4        3.6     2.6       -1.1        -4.2
 Colombia                          0.8        4.5        4.1    4.2        2.2        2.9    -2.2       -2.0        -2.2
 Ecuador                           0.4        2.5        3.0    5.2        3.5        3.5    -0.6       -0.7        -0.5
 Mexico                           -6.5        4.5        3.5    5.3        4.2        3.9    -0.6       -0.8        -1.3
 Peru                              0.9        8.5        6.0    2.9        1.6        2.6     0.2       -0.7        -2.5
 Venezuela                        -3.3       -1.5        1.5   28.6       29.5       33.0     2.6        7.5         9.5
Asia/Pacific
Japan                             -5.3        3.5        1.1   -1.4       -0.8       -0.3    2.8         3.3        2.3
Australia                          1.2        3.2        3.6    1.8        3.1        3.6   -4.4        -1.8       -2.8
New Zealand                       -1.7        2.0        2.8    2.1        2.6        4.8   -3.0        -3.1       -6.1
Emerging Asia                      5.6        8.9        7.2    2.0        4.3        4.5    5.3         3.7        2.9
 China                             9.1       10.0        9.0   -0.7        3.2        3.8    6.2         4.8        4.1
 Hong Kong                        -2.8        6.6        4.1    0.5        2.3        3.1    8.7         8.7        8.1
 India                             7.4        8.3        8.5   10.9       11.6       10.2   -2.8        -3.3       -3.1
 Indonesia                         4.5        6.0        5.4    4.8        5.0        5.0    3.8         0.6       -0.5
 Korea                             0.2        6.2        4.0    2.8        2.9        3.4    5.1         3.1        1.9
 Malaysia                         -1.2        6.8        4.6    0.6        1.5        2.1   16.5        15.7       14.8
 Philippines                       0.9        7.0        4.5    3.2        3.7        2.3    5.5         4.8        3.5
 Singapore                        -1.3       15.0        4.2    0.6        2.7        1.8   11.5        12.8        9.6
 Taiwan                           -1.9       10.1        4.0   -0.9        0.8        1.4   11.4         7.4        7.1
 Thailand                         -2.2        8.5        4.0   -0.8        3.3        4.0    7.7         3.7        2.4
Africa/Middle East
Israel                             0.8        3.5        4.5    3.3        2.8        3.0     3.9        2.2         1.2
South Africa                      -1.8        2.9        3.1    7.1        4.3        4.4    -4.0       -4.0        -5.0
Europe
Euro area                         -4.0        1.7        1.6    0.3        1.5        1.1   -0.8        -0.6       -0.7
Norway                            -1.2        1.6        2.4    2.2        2.4        1.3   12.8        13.6       13.8
Sweden                            -5.1        4.5        3.1   -0.3        1.2        1.6    7.5         6.9        6.6
Switzerland                       -1.9        2.9        2.0   -0.5        0.6        0.0    8.4         8.8        8.5
United Kingdom                    -5.0        1.7        2.3    2.2        3.2        2.2   -1.3        -1.8       -1.8
Emerging Europe                   -5.3        3.7        4.0    7.7        6.0        6.3    0.5         0.0       -1.0
 Bulgaria                         -5.0       -0.5        4.0    2.8        1.9        2.4   -9.2        -5.5       -7.5
 Czech Republic                   -4.1        2.5        3.0    1.0        1.5        2.4   -1.1        -2.0       -3.0
 Hungary                          -6.7        1.0        2.8    4.2        4.9        3.6    0.2         0.5        0.2
 Poland                            1.7        3.5        3.8    3.5        2.5        2.8   -1.6        -2.5       -3.2
 Romania                          -7.1       -2.0        1.5    5.6        6.3        6.0   -5.1        -5.6       -6.4
 Russia                           -7.9        3.5        4.5   11.7        6.8        8.2    4.0         4.7        3.0
 Turkey                           -4.7        7.1        4.3    6.3        8.7        6.9   -2.3        -5.8       -6.2
Global¹                           -2.2        3.7        3.0    1.2        2.4        2.3      …          …           …
 Developed market economies       -3.5        2.5        2.0    0.0        1.4        1.1    -0.8       -0.9        -1.1
 Emerging market economies         1.3        6.9        5.7    4.3        5.1        5.5     3.0        1.8         1.1
1. JPMorgan sample.




100
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John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd



Prior Research Notes available on www.morganmarkets.com
US-Japan trade war and USD/JPY – implications for          Managing FX hedge ratios: A framework for strategic and
USD/CNY Sasaki, Tanase, Oct 15, 2010                       tactical decisions, Normand, De Kock, Franklin-Lyons &
                                                           Sandilya, May 26, 2010
Precious metals: an immensely supportive backdrop,
Jansen, Oct 8, 2010                                        Reflections on negative interest rates in Switzerland,
                                                           Meggyesi, May 14, 2010
G-3 corporate hedging survey: year-ahead hedge ratios
reach record high, Kim & Normand, Oct 1, 2010              The Nikkei’s impact on Japanese investment in foreign
                                                           securities, Tanase, Apr 30, 2010
Valuation update – NOK & JPY move to further extremes,
Gabriel de Kock, Sep 24, 2010                              Would the ECB ever intervene in EUR/USD?,
                                                           Normand, Apr 30, 2010
“Quasi” unsterilized intervention by MoF/BoJ
Junya Tanase, Sep 24, 2010                                 Picking winners among the G-10 high-beta currencies,
                                                           de Kock, Apr 9, 2010
Market impact of the DPJ leadership election,
Tanase, Kim, Yamawaki, Kuroda, Sept 10, 2010               Corporate hedging recommendation: Hedging against a
                                                           EUR/JPY rally, Sharma, Mar 26, 2010
Fall in USD/JPY can be positive for Japanese firms,
Sasaki, Aug 20, 2010                                       China revaluation wouldn't mean much for G-10,
                                                           Normand, Mar 19, 2010
The weight of Washington - quantifying the impact of
politics on the economy and the dollar,                    Corporate Hedging Survey: More hedging, less hiring,
de Kock, Aug 13, 2010                                      Franklin-Lyons, de Kock, Sharma, Mar 19, 2010
No compelling reason for Japanese lifers to change their   G10 fair value update: EUR and USD fair, Scandies and
FX-hedging strategy in the near future                     Swissie cheap, de Kock, Mar 19, 2010
Tanase & Kim, Aug 6, 2010
                                                           BoJ’s monetary policy has little impact on USD/JPY,
The knowns, unknowns and unknowables about reserve         Sasaki, Tanase, Kim, Mar 12 2010
diversification, de Kock, Jul 9, 2010
                                                           Corporate hedging recommendation: participating in GBP
Euro depreciation widely spread but narrowly felt          downside, Franklin-Lyons, Feb 26, 2010
Hensley & Lupton, Jul 9, 2010
                                                           The real impact of JPY/KRW,
The impact of Japan’s Upper House elections                Tanase and Kim, Feb 26, 2010
Tanase & Kim, Jul 9, 2010
                                                           Exiting EMU: The legal, the likely, and the ludicrous
How far can the yen appreciate from here?                  Normand, Feb 19, 2010
Sasaki, Tanase & Kim, Jul 2, 2010
                                                           Public debt is a minor concern for JPY,
G-10 fair value update: EUR & USD fair, Scandies & GBP     Sasaki, Tanase & Kim, Feb 12, 2010
still cheap, de Kock, Jun 25, 2010
                                                           How do expectations of a CNY revaluation affect JPY?
Corporate Hedging Survey: Corporates expect EUR to         Tanase & Kim, Feb 5, 2010
remain under pressure but not collapse,
                                                           Cross-currency basis likely to normalize further
de Kock, Kim, Sharma & Tanase, Jun 25, 2010
                                                           Franklin-Lyons, Jan 29, 2010
CHF and the SNB’s ballooning balance sheet
                                                           Japanese FX special account now at record-low net worth
Meggyesi, Jun 25, 2010
                                                           Sasaki, Tanase & Kim, Jan 29, 2010
UK: Previewing the emergency budget,
                                                           Examining the link between foreign demand for Japanese
Barr & Monks, Jun 18, 2010
                                                           stocks and USD/JPY, Tanase & Kim, Jan 22, 2010
UK: Previewing the coming fiscal drama,
                                                           G-10 fair value update: NOK and CAD still cheap
Barr, Jun 11, 2010
                                                           De Kock, Jan 8, 2010
How lite is the ECB’s QE-lite?, Meggyesi, Jun 4, 2010
                                                           Corporate Hedging Survey: increasing cross-country
Naoto Kan as Prime Minister does not imply a weaker yen,   divergences in hedging behavior,
Sasaki and Tanase, Jun 4, 2010                             Franklin-Lyons, Sharma & Tanase, Dec 18, 2009

                                                                                                                    101
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John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd


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                                                                                                                                              103
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John Normand (44-20) 7325-5222
john.normand@jpmorgan.com
J.P. Morgan Securities Ltd



J.P. Morgan Global FX Strategy
                                            London
John Normand              MD          Head, Global FX Strategy   (44-20) 7325-5222       john.normand@jpmorgan.com
Paul Meggyesi             MD          FX Strategy                (44-20) 7859-6714      paul.meggyesi@jpmorgan.com
Thomas Anthonj            ED          Technical Strategy         (44-20) 7742-7850    thomas.e.anthonj@jpmorgan.com
Matthias Bouquet          VP          Derivatives Strategy       (44-20) 7777-5276    matthias.bouquet@jpmorgan.com
Sunil Kavuri              Associate   FX Strategy                (44-20) 7777-1729       sunil.d.kavuri@jpmorgan.com


                                           New York
Ken Landon                MD          FX Strategy                 (1-212) 834-2391     kenneth.landon@jpmorgan.com
Kevin Hebner              ED          FX Strategy                 (1-212) 834-4254       kevin.j.hebner@jpmorgan.com
Niall O’Connor            ED          Technical Strategy          (1-212) 834-5108        niall.oconnor@jpmorgan.com
Arindam Sandilya          ED          Derivatives Strategy        (1-212) 834-2304   arindam.x.sandilya@jpmorgan.com
Justin Kariya             Analyst     FX Strategy                 (1-212)-834-9618       justin.p.kariya@jpmorgan.com


                                             Tokyo
Tohru Sasaki              MD          FX Strategy                 (81-3) 6736-7717        tohru.sasaki@jpmorgan.com
Junya Tanase              ED          FX Strategy                 (81-3) 6736-7718        junya.tanase@jpmorgan.com




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