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Global FX Strategy

10 August 2012

FX Markets Weekly
Hedging the US fiscal cliff through FX
Outlook The view and most trades are unchanged from last week: the mid-summer rush into FX carry isnt worth buying into when macro data show little evidence of lift and when so many currencies are priced for perfection from policymakers. As an extension of this weeks J.P. Morgan Research update on the US fiscal cliff, todays FXMW focuses on three issues: how election scenarios (status quo, Republican sweep, different but still-divided government) influence the odds of a US downturn; how currencies should respond to the cyclical versus sovereign credit implications of US fiscal disarray; and how to hedge most efficiently at current levels of volatility and skew. It is still somewhat early to hedge this risk given the imminence of Fed QE3, but currencies most sensitive to the US downturn are rich enough to justify some pre-positioning. Macro Trade Recommendations The continued compression in volatility and elevated valuation of cyclical currencies offer good entry levels to scale into option-based defensive trades for a global economy which remains on the floor thanks to unfinished business in the US (fiscal cliff), Europe (funding the periphery) and China (generating a rebound). Buy USD call spreads versus AUD (1.03-1.00) and CAD (1.01-1.03) to hedge the US fiscal cliff. Concentrate euro shorts on crosses where valuations are least challenging: EUR/USD (1.22-1.19 put spread) and EUR/JPY (cash). Hold a basket of relative value trades in cash and options: short GBP/NOK, short AUD/NZD and long NOK/SEK. FX Derivatives Data vacuum in August is likely to keep a lid on vols and promote carry trades. Add to option-based carry via 6M ATMF/ ATMS spreads in EUR/INR. Open vega-neutral long vol swap vs. short FVA packages at the front-end of the NZD/USD vol curve as a positive carry defensive position. Along similar lines, sell 9M3M USD/CLP FVAs against a beta-weighted amount of 9M3M USD/MXN FVAs. Technical Strategy The yens broad up-trend has lost momentum but appears to be incomplete in Elliott terms as the final 5th wave is missing. The broad recovery of CE3 currencies since the beginning of June seems to be complete so that the longterm downtrends are expected to be resumed shortly. Stay long EUR/CZK and USD/ZAR & short EUR/USD, GBP/USD, GBP/JPY, NZD/CAD, EUR/KRW, EUR/MXN, NZD/NOK and PLN/HUF. Research notes Intra-EMU currency valuations: Estimates for a breakup scenario (Justin Kariya)
Introducing Daily FX Strategy Analytics (John Normand and Arindam Sandilya)

Global FX Strategy John Normand


AC

(44-20) 7134-1816 john.normand@jpmorgan.com J.P. Morgan Securities plc

Paul Meggyesi
(44-20) 7134-2714 paul.meggyesi@jpmorgan.com J.P. Morgan Securities plc

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

Thomas Anthonj
(44-20) 7742-7850 thomas.e.anthonj@jpmorgan.com J.P. Morgan Securities plc

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

Contents
Outlook Macro Trade Recommendations FX Derivatives Technical Strategy Global FX carry trade monitor Research Notes Market movers Event risk calendar Central bank meetings in 2012 J.P. Morgan Forecasts Global central bank forecasts FX vs forwards & consensus Rates, credit, equities & commodities Global growth and inflation forecasts Sovereign credit ratings and actions Gov't and bank bond redemptions Research Notes on morganmarkets.com Global FX Strategy contact page 38 39 40 41 43 44 45 48 2 8 14 17 19 21 33 35 37

See page 46 for analyst certification and important disclosures.


www.morganmarkets.com/GlobalFXStrategy

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

Outlook: Hedging the US fiscal cliff through FX


The view and most trades are unchanged from last week: the mid-summer rush into FX carry isnt worth buying into when macro data show little evidence of lift and when so many currencies are priced for perfection from policymakers. As an extension of this weeks J.P. Morgan Research update on the US fiscal cliff, todays FXMW focuses on three issues: how election scenarios (status quo, Republican sweep, different but still-divided government) influence the odds of a US downturn; how currencies should respond to the cyclical versus sovereign credit implications of US fiscal disarray; and how to hedge most efficiently at current levels of volatility and skew. It is still somewhat early to hedge this risk given the imminence of Fed QE3, but currencies most sensitive to the US downturn are rich enough to justify some pre-positioning Trades: In the macro portfolio, add an AUD/USD put spread and a USD/CAD call spread to hedge the cliff. Stay short EUR/USD (1.22-1.19 put spread), EUR/JPY, GBP/NOK and AUD/NZD. In the technical portfolio, stay short EUR/USD, GBP/JPY, EUR/MXN, EUR/KRW. In derivatives, hold optionbased carry in EUR/INR, USD/ARS and USD/CNY (6-mo). Next week: top-tier data in US and Europe, little from China or periphery Two weeks into August, currencies are moving somewhat more erratically than other asset classes. While global equities, credit spreads and Treasury yields have trended almost uninterrupted this month (+2%, +25bp and -8bp, respectively), the trade-weighted dollar is down only fractionally due to strength in commodity currencies and EM Asia offsetting stability in Europe (chart 1). We argued last week that this summer rush into FX carry wasnt worth buying into when macro data show little evidence of lift and when so many currencies are priced for perfection from policymakers (see Stealth rallies and the fear of missing out, FXMW, August 3). That remains the view after a week when the majority of Chinese data surprised to the downside (IP, retail sales, trade, loan growth) and when European bond markets began to reflect shortcomings of the ECB's bond-buying proposal.
2

With the view and trades unchanged, this edition of FXMW extends this weeks J.P. Morgan Research update on the US fiscal cliff,1 since focus on this issue will only sharpen after Presidential nominating conventions in late August/early early September. We examine three issues: how election scenarios (status quo, Republican sweep, different but stilldivided government) influence the odds of a US downturn; how currencies should respond to the cyclical versus sovereign credit implications of US fiscal disarray; and how to hedge most efficiently at current levels of volatility and skew. It is still somewhat early to hedge this risk given the imminence of Fed QE3, but currencies most sensitive to the US downturn are rich enough to justify some prepositioning
Chart 1: 2012 currency performance by region versus USD
Currency performance indexed to Jan 1, 2012 = 100. Rise (fall) in index indicates that currencies appreciate vs USD. Commodity FX bloc includes AUD, NZD, CAD, MXN, BRL, PEN, COP, CLP and RUB. European bloc includes EUR, GBP, CHF, NOK and SEK. EM Asia includes CNY, TWD, KRW, PHP, THB, IDR, MYR and INR.

108 106 104 102 100 98 96 Jan-12


Source: J.P. Morgan

Europe EM Asia Commodity FX

Mar-12

May-12

Jul-12

Sep-12

Fiscal cliff notes


The US fiscal cliff the 3.5% of GDP fiscal tightening which begins January 1, 2013 unless Congress extends the Bush tax cuts and payroll tax holiday, cancels automatic spending cuts (sequestration) and raises the debt ceiling through next year is well recognized as the second biggest threat to the global economy in coming months, just behind another European funding crisis and ahead of China's failure to accelerate. It is also understood that like Europes funding crisis, America's downturn is entirely avoidable in principle given government discretion over fiscal policy but

See the report US Fiscal Cliff: Election outcomes affect policy outcomes published on August 7 (Lee, Feroli, Ramaswamy, Normand and Tusa) and the related conference call recording US fiscal cliff podcast posted on www.morganmarkets.com.

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

somewhat inevitable in practice given a dysfunctional political system. The game-changer which would ensure an uninterrupted expansion is as obvious as it is unlikely before late December: a grand bargain to extend all tax cuts through 2013 in order to allow time for constructing a more balanced, comprehensive fiscal strategy for the next decade. That outcome has almost zero odds of occurring preelection since Democrats do not want to extend tax cuts to upper income groups, and since Republicans do not want to discuss fiscal policy divorced of entitlement reform. This sort of philosophical divide, which is more paralyzing in a country with a President and bicameral legislature than in a parliamentary system, renders the election outcome pivotal to whether and when the US economy experiences a contraction lets avoid labeling it a recession since it could last only a quarter or two due to massive fiscal tightening when growth is only running at 1.5% to 2%. Consider these scenarios. The status quo would see Obama retain the White House, Republicans keep the House and Democrats keep the Senate. That outcome might foster compromise during Congresss lame duck session in November and December since it will be clear that all sides can hope for no better partners next year (the new Congress will be seated January 3, 2013). Extension of most tax cuts would still be required to avoid a sharp slowdown, but resolution by year-end or a retroactive bill by late January or early February would skirt the most adverse scenario. This is JPMs base case, resulting in a US slowdown to about 1.5% in Q1. The Republican sweep envisions Romney securing the Presidency, Republicans retaining the House and also capturing the Senate (Democrats have 23 seats and Republicans 10 seats being contested). Even if work on tax cut extension did not begin until seats changed in January, the certainty from knowing that Republicans would preserve lower tax tables would lift sentiment enough to avoid a meaningful growth slump. The different but still-divided government scenarios see Obama retaining the White House but Republicans controlling the House and Senate. Alternatively, Romney could take the White House while Congress remains split between Republicans (House) and Democrats (Senate). Obama with a Republican Congress generates the highest odds that the US goes over the cliff since Republicans will have no incentive to negotiate during the lame-duck session; their hand will be stronger come January. Romney with a divided

Congress could deliver an outcome similar to a Republic sweep, since the new President can claim a mandate. And if the Senate is divided 50/50 along party lines, the Romney's Vice President will cast the deciding vote. From these scenarios is appears that (1) nothing will be accomplished before November 6 elections; (2) a grand bargain during the lame-duck session would only materialize under the status quo (Obama wins White House and Congress remains split); (3) even a grand bargain implies no clarity on tax policy until very late in December or early January; and (4) a different divided government (Democratic White House, Republicans in House and Senate) yields high odds of a US economic contraction. Add to the mix that pre-election polls render the outcome essentially random, and the next few months seem like an American version of this springs Greek election coin flip (minus the farcical elements which Communists, Far Leftists and neo-Nazis can lend a campaign).
Chart 2: Compared to government shutdown drama in 1995/96 and 2011 when US growth expectations were rising, the fiscal cliff approaches when consensus forecasts are falling
Consensus on year-ahead US growth from monthly Blue Chip survey

4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1996
Source: J.P. Morgan

2011 debt ceiling debate

1995/96 US gov't shutdown US fiscal cliff run-up

2000

2004

2008

2012

Currencies and the cliff


What impact should this mini-crisis have on currencies into year-end? Probably not much for the trade-weighted dollar (J.P. Morgan index JPMQUSD). The impact instead will be pair-specific, so USD-positive versus cyclical currencies (CAD, MXN, EM Asia) and USD-negative versus major reserve currencies (JPY, possibly EUR and GBP). So even if the broad dollar shows little trend through this mini-crisis, bilateral moves could be sharp as the campaign unfolds. The fiscal cliff impacts currencies through two channels: weaker USD growth and rising sovereign credit risk. The first impact will probably dominate the second. It is wellknow that commodity currencies and high-yield FX are
3

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

positively correlated with US growth, so any event which results in falling US growth expectations will probably support the dollar versus those currencies. As shown in table 1, which calculates the beta between US growth expectations and various currencies, the most vulnerable markets are CAD, TWD, ZAR, COP and MXN. The yen is the only currency which moves inversely with US growth it appreciates when the US slows due to deleveraging and the unwind of yen-funded carry trades. The euro has been relatively insensitive to shifts in US growth expectations over the past few years, probably because the region's sovereign crisis has dominates all other global macro factors in driving the euro's trend. Thus the best hedge for the US fiscal cliff is to sell CAD and own JPY. The wildcard in this outlook will be how sovereign credit risk impacts demand for dollars during a period which normally sponsors fairly classic deleveraging across currency markets. The dysfunction in Washington which has created this fiscal cliff scenario is reminiscent of last year's debt ceiling debate, as well as the government shutdown of late 1995 and early 1996 as the Clinton Administration deadlocked against a Republican Congress. Most of these episodes pushed the dollar weaker versus major reserve currencies such as the yen, deutschemark and euro than what cyclical conditions would have predicted as the time. In the 1995, USD/DEM fell 7% and USD/JPY fell 4% in the month ahead of the shutdown, even though interest rates had not moved much against the dollar. In Q1 2011, the dollar fell versus almost every currency as the debt ceiling crisis began to unfold, even though the spike in volatility due to the Arab Spring normally would have driven dollar strength versus cyclical currencies and highyielders. To be fair, the fiscal cliff differs from government shutdown in two respects: US growth expectations were rising in late 1995 and early 2011 whereas they are falling now (chart 2); and government shutdowns have minimal systemic impact than comprehensive fiscal tightening. Thus is seems odd to buy inherently cyclical currencies to hedge the cliff even if those countries have stronger fiscal or growth. At current levels and against this backdrop, better to hedge by buying the dollar versus cyclical currencies, by selling the it versus an anti-cyclical one (JPY), or by selling it versus another major reserve currency (EUR, GBP) if one is confident Europe will deliver on banking union and sizable ECB bond purchases this fall. (Were not that bold yet.)

Table 1: Currency sensitivity to changes in US growth expectations


Beta and R-squared from regressing change in currency versus USD on changes in year-ahead Blue Chip consensus forecasts for US real GDP growth. Positive (negative) beta indicates that currency appreciates (depreciates) versus USD when consensus expectations on US growth rise (fall). Past year Past 5 yrs Ccy/USD Avg R-Sq Beta R-Sq Beta R-Sq

CAD TWD ZAR COP MXN TRY HUF CLP GBP IDR KRW PLN JPY SGD RUB NZD BRL ILS AUD INR MYR SEK NOK PHP EUR THB CHF
Source: J.P. Morgan

0.13 0.18 0.05 0.08 0.06 0.08 0.05 0.07 0.15 0.11 0.08 0.04 -0.08 0.09 0.05 0.03 0.02 0.10 0.04 0.04 0.07 0.06 0.03 0.10 0.04 0.05 0.02

55.4% 71.7% 46.3% 65.4% 52.3% 64.1% 52.7% 47.1% 32.4% 19.4% 28.6% 44.1% 35.3% 32.4% 32.7% 11.8% 6.1% 35.6% 10.3% 15.5% 23.1% 10.2% 3.4% 13.6% 4.7% 3.8% 7.2%

0.07 0.09 0.04 0.03 0.05 0.03 0.03 0.03 0.05 0.07 0.05 0.02 -0.05 0.07 0.03 0.04 0.04 0.03 0.04 0.06 0.06 0.04 0.04 0.02 0.03 0.05 0.02

39.8% 19.6% 44.3% 20.5% 31.1% 16.8% 18.8% 22.8% 34.0% 46.6% 36.5% 12.4% 17.4% 14.1% 13.1% 32.9% 37.8% 7.4% 32.1% 25.2% 13.0% 20.4% 22.6% 1.3% 10.0% 9.2% 5.3%

47.6% 45.6% 45.3% 43.0% 41.7% 40.4% 35.8% 34.9% 33.2% 33.0% 32.6% 28.3% 26.3% 23.3% 22.9% 22.3% 22.0% 21.5% 21.2% 20.3% 18.0% 15.3% 13.0% 7.5% 7.3% 6.5% 6.2%

Fed/ECB easing work against cliff hedges


Most currencies, however, are priced as if the next several months will not be very dramatic. If the fiscal cliff should
4

sponsor some deleveraging, then pre-emptive hedging would be reflected in long USD positions versus commodity currencies and high-yielders, and in an increasing bid for USD calls in those same pairs. The opposite trend has been developing this summer, probably because the twin balance sheet expansions of the Fed and ECB have spawned a global carry trade as strong now in FX as it has been for most of the year in corporate credit. Investors have moved from record long USD earlier this year to close to flat, and the FX option skew (bid for USD calls versus puts) has normalised (chart 3). Vols have cheapened globally, but more in commodity currencies like AUD/USD and USD/CAD than others (chart 4). And while USD calls against cyclical currencies have not cheapened to

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

extremes (chart 5), vols are low enough and spot rates extreme enough (1.05 on AUD/USD, sub-parity on USD/CAD) to justify an initial hedge in both pairs (see Macro Trade Recommendations on page 8 for further details). Fed QE could present better entry levels, but commodity currencies are already trading rich enough to suggest that current levels arent far from the peak in these markets. Favour options to manage the P-n-L volatility around key QE dates (Bernankes August 31 Jackson Hole presentation, September 13 FOMC decision), and USD call spreads given the limited move in commodity currencies when global liquidity remains so abundant.

Chart 3: Expectations of Fed and ECB easing are resulting in much less defensive positioning ahead of the fiscal cliff
Aggregate IMM positions in USD versus average 6-mo risk reversal across USDbased pairs. For IMM positions, positive (negative) value indicates USD longs (shorts). For risk reversals, positive (negative) value indicates bid for USD calls over USD puts.

50 40 30 20 10 0 -10 -20 -30 -40 -50 2010


Source: J.P. Morgan

aggregate IMM positions, $ bn USD 6-mo skew across major pairs (%)

2.5 2.0 1.5 1.0 0.5 0.0 -0.5

Next week: top-tier data in US and Europe, little from China or periphery
Activity data in most regions is top-tier next week. The US reports retail sales on Tuesday, Empire survey and industrial production on Wednesday, Philly Fed on Thursday and Michigan consumer confidence on Friday. The Euro area reports Q2 flash GDP and the German Zew on Tuesday, and the June balance of payments (useful for a read on capital flight) on Friday. The major UK releases are the labour market report and MPC minutes on Wednesday and retail sales on Thursday. In non-Japan Asia, the key reports are Chinese foreign direct investment (during the week), Indian inflation on Tuesday and New Zealand PMI on Thursday. Only one central bank meets next week: Turkey on Thursday, but the bank is unlikely to adjust the rate corridor. There are no bond auctions in the periphery next week. Italy and Spain have cancelled their mid-August bond auctions in line with previous years. The next conventional bond auction in Italy is on August 30 and in Spain on September 6. Spain will come to market next on August 21 with 12-mo and 18-mo t-bills, and Italy on August 13 with 12-mo t-bills. Greece will auction 3bn of t-bills on Tuesday to honor redemptions this month since the next troika disbursement awaits completion of EU/IMFs September mission.

2011

2012

Chart 4: Commodity currencies vols are amongst the cheapest globally


6-mo at-the-money vols (expressed as 1-yr z-score) versus ratio of 6-mo at-themoney implied to realised vols
0.8 0.7 0.6 0.5 6M ATM /Realised-1 0.4 0.3 USD/TWD USD/TRY USD/CLP EUR/USD USD/KRW USD/COP USD/THB USD/IDR USD/PHP USD/INR USD/ILS vol rich

USD/MYR

USD/CHF USD/SGD 0.2 USD/JPY USD/MXN AUD/USD GBP/USD 0.1 USD/ZAR USD/CAD USD/PLN 0.0 vol USD/RUB USD/HUF -0.1 cheap USD/CNY -1.8 -1.6 -1.4 -1.2 -1.0 -0.8 -0.6 -0.4 -0.2 1yr z-score of 6M ATM

0.0

0.2

Source: J.P. Morgan

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

Chart 5:but most USD calls are not yet cheap


6-mo risk reversal ranked by two criteria: (1) ratio of risk reversal to at-the-money vols and (2) difference between risk reversal and realised skew.
0.5 0.0 -0.5 6M 25D RR - 6M Realised Skew -1.0 -1.5 -2.0 -2.5 TRY/USD -3.0 -3.5 -4.0 -4.5 CHF/USD TWD/USD THB/USD NOK/USD ILS/USD GBP/USD SGD/USD PHP/USD NZD/USD MYR/USD AUD/USD SEK/USD CLP/USD INR/USD CAD/USD EUR/USD RUB/USD IDR/USD KRW/USD BRL/USD 1.6 2.0 2.4 USD calls cheap USD/JPY

Main recommendations: Macro, Technical and Derivatives portfolios I. Macro portfolio (page 8 for details) New/closed trades In options, buy a 2-mo USD/CAD call spread (1.01-1.03) for 38bp and a 2-mo AUD/USD put spread (1.03-1.00) for 65bp. Existing trades In cash, stay short EUR/JPY from 96.75 and short GBP/NOK from 9.35. Both positions opened August 3. In options, hold 2-mo 1.22-1.19 EUR/USD ratio put spread opened July 6. Hold a 2-mo 1.285-1.265 AUD/NZD put fly (1:2:1 notionals). Position opened August 3. Hold 2-mo NOK/SEK 1.15/1.18 call spread opened July 20. Hold a 12-mo 1.1900-1.1100 EUR/CHF put spread, sell a 1.2550 EUR/CHF call in 1x1x1 notional. Opened May 11. II. Technical portfolio (page 17 for details) Stay long EUR/CZK, USD/ZAR and short EUR/USD, GBP/USD, GBP/JPY, EUR/MXN, NZD/CAD, NZD/NOK, EUR/KRW and PLN/HUF. III. Derivatives portfolio (page 14 for details) Keep defensive positions with positive slide in AUD/USD and EUR/USD through short 6M6M FVAs against long 1Y6M FVAs, in 1x2 vega notionals, 2Y2Y AUD/USD FVAs. Keep GBP/CAD vs. GBP/JPY correlation short. Add USD/MXN vs. USD/CLP 9M3M FVA spreads and long 1M vol swap vs. short 1M1M FVA in NZD/USD. Add option based carry (ATMF/ATMS spread) in EUR/INR, hold in USD/ARS (1-yr) and USD/CNY (6-mo), hold 3M DNTs in select crosses (NZD/SEK, GBP/CAD). Stay long G-10 commodity currency vol vs. short LatAm vol: NZD-CAD -CLP 3-mo vol fly. Hold gamma RV risk: EUR/KRW vs. USD/KRW Risk-reversals: Hold USD/JPY 6M25D riskreversal longs (long USD puts/short USD calls)

USD calls ZAR/USD -5.0 rich -5.5 -2.4 -2.0 -1.6 -1.2 -0.8 -0.4 0.0
Source: J.P. Morgan

MXN/USD 0.4 0.8 1.2

2yr z-score of 6M 25D RR / ATM

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

Just launched: Euro Area Crisis page on www.morganmarkets.com


Breaking news and reference reports on Europe's sovereign debt crisis from J.P. Morgans Economics, Rates, FX, Equity, Credit and Global Asset Allocation Research

Paul Meggyesi (44-20) 7134-2714 paul.meggyesi@jpmorgan.com

Global FX Strategy 10 August 2012

Macro Trade Recommendations


A cool summer (at least for this London-based writer) should be followed by a warmer autumn as European and US policymakers have unfinished business and the global economy remains on the floor. The continued compression in the volatility risk premia and the elevated valuation of cyclical currencies offer good entry levels to scale into option-based defensive trades. Buy USD call spreads versus AUD and CAD as hedges against the inevitable fiscal paralysis in the US and likelihood that euro stress resurfaces in September as Spain ponders its bail-out options, Greece struggles to keep the Troika on-side and the ECB needs to flesh out the details of its sovereign backstop. The dollar stands to benefit not only from adverse global economic conditions and fiscal policy stress, but also more positive market technicals. Average USD valuation and risk reversals are now below their 1Y average, and speculative longs, even though still above average, are 75% below their peak level. The average risk premium in the euro fell to a twomonth low following the ECB meeting last week - we continue to expect this risk premium to re-widen in the autumn. Concentrate euro shorts on crosses where valuations are least challenging, i.e. EUR/USD and EUR/JPY, rather than the Scandinavian crosses where there has been no compression in the euro risk premia. Two of the macro mean-reversion trades performed well this week (NOK up versus GBP and SEK); the other rather less well (AUD/NZD rallied on divergent labour data). Hold all three trades. Closed trades: None New trades: Buy a 2-mo 1.03-1.00 AUD/USD put spread and a 2-mo 1.01-1.03 USD/CAD call spread. Existing trades: Stay short EUR/JPY (cash) and EUR/USD (2-mo 1x1.5 ratio put spread, strikes 1.221.19). Stay short GBP/NOK (cash) and long NOK/SEK (2-mo 1.15-1.18 call spread). Hold a 2-mo AUD/NZD put fly (1.2850x1.2650 x1.2450) and a 1Y EUR/CHF seagull (long a 1.19-1.11 put spread, short a 1.2550 call).

FX trade recommendations
Trade recommendations in this section are mostly spot, for easier incorporation into the monthly Global Markets Outlook & Strategy (GMOS), which outlines J.P. Morgans flagship model portfolio across bonds, credit, equities, fx and commodities. Some directional option trades are included here as alternatives to cash position, and as a complement to relative value trades discussed in FX Derivatives section of this publication (p. 14). Current recommendations are marked to market at Friday afternoon London time. A complete inventory of closed trades is presented at the end of this section along with performance statistics such as success rates and average returns per trades.
Chart 1: Dollar technicals have turned positive. Valuation and risk reversals are below their 1Y average. Spec longs, while still above average, have declined 75% from their peak.
1Y Z-score for each variable. USD value is defined as the average pair wise misalignment of USD versus daily valuation models. USD risk reversal is the average USD vs G10 risk reversal.
3 2 1 0 -1 -2 -3 -4 Jan-10
Source: J.P. Morgan

USD IMM Jul-10

USD risk reversal Jan-11 Jul-11

USD Value Jan-12 Jul-12

In our judgment risk/reward considerations now favour scaling into option-based defensive trades in addition to the basket of euro shorts that we added to following the ECBinspired bounce in the euro last week. The continued compression in risk-premia (JPMs VXY index of FX volatility hit a new post-Lehmans low earlier this week) and elevated cyclical valuations fail to properly account for a global business cycle that is languishing at its post-crisis nadir and the fiscal policy risks which still threaten in the Euro area and the US. The market in our opinion places too much confidence in the ability of the monetary authorities to deliver cyclical lift and in the ability and sometimes even willingness of politicians to avoid fiscal and credit accidents. On the macro-side, while the slight improvement in the US data does negate some of the tail-risk that had been building in the economy, this should not obscure what is still a feeble

Paul Meggyesi (44-20) 7134-2714 paul.meggyesi@jpmorgan.com

Global FX Strategy 10 August 2012

absolute pace of growth (1.5-1.75%). Nor should it obscure the continued deterioration in growth outside of the US. Chinese data this week offered no evidence of the lift that investors have been anticipating for much of the year, while on a broader basis the pace of contraction in global industrial production intensified in June from -0.7% 3m/3m ar in May to around -1.0% in June (the US and the Euro area will report their IP figures next week). As for Europe, the relative calm that has descended in recent weeks is unlikely to outlive the European political and financing holiday of the next few weeks. To cap it all, we are approaching the business end of the US election campaign, which is bound to refocus investors' attention on the dangers of a political class unable to lift its collective gaze from its navel towards the rapidly approaching fiscal cliff. The question is whether these risks are adequately reflected in market pricing, be it spot market valuations or optionmetrics. The absolute level of the VXY (only three-quarters of its May peak) is certainly hard to reconcile with the continued paucity of economic growth and the profusion of unresolved fiscal policy issues. Similar reservations can be applied to spot market valuations, especially in the case of extremely expensive commodity currencies, notably AUD. The dollar offers a useful summary of the market's cyclical complacency - as chart 1 highlights, the dollar is now cheaper on a high-frequency valuation basis than its oneyear average, as is the USD risk-reversal. Speculative longs in the dollar are still above average but are 75% smaller than their peak. The conclusion market techncials are increasingly favourable for building defensive dollar longs.

Buy a 2-mo 1.01-1.03 USD/CAD call spread for 47.5bp. Spot ref 0.9930. Bearish EUR - Stay short EUR/JPY in cash and short EUR/USD via a 2-mo EUR/USD ratio put spread Our recommendation to increase EUR shorts in the wake of the ECB-inspired rally was an outlier from the consensus, which instead regarded the ECBs announcement of potential bond buys as the precursor to a more extensive euro rally. It would be premature to proclaim the trade a success; nonetheless, the euro has clearly lost momentum
Chart 2: The euro risk premium is the smallest in two months. But political holidays and a dearth of peripheral supply offer only a temporary respite the premium is likely to re-widen in September.
Average % deviation of euro-cross rates from their high-frequency fair-value, as defined by pair wise, 1Y regressions of EUR FX vs short-term rate differentials, sovereign credit premia and equity volatility 5

4 3 2 1 0 -1 -2 -3 -4 -5

Euro rich

Euro cheap

Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12


Source: J.P. Morgan

Trades
Buy a 2-mo 1.03-1.00 AUD/USD put spread AUD is the preferred vehicle for a defensive trade: 1) AUD is the most expensive of the commodity currencies on our high-frequency models, 0.75 sigma above fairvalue; 2) speculative longs in AUD are still 40% of their 2012 peak compared to only 18% for CAD. AUD thus offers greater deleveraging bang-for-ones buck; and 3) AUD offers leverage to the continuous drip-feed of negative China data, which may soon start to overwhelm optimism towards policymakers ability to engineer lift. Buy a 2-mo 1.03-1.00 AUD/USD put spread for 65bp. Spot ref 1.0520. Buy a 2-mo 1.01-1.03 USD/CAD call spread There isnt the same speculative length in CAD as AUD. Nonetheless, short CAD should offer an effective hedge to the US fiscal cliff, especially now that the heat has gone out of Canadas economic data. Employment growth has turned negative (-5.1K on average in the past 3 months versus +20.4K in the past 6 months), while Q2 GDP is tracking at 1.5% saar compared to 1.9% in Q1.

Chart 3: The euro risk-premium is most pronounced against the strongest credits and economies (NOK and SEK) and least pronounced against currencies with weak growth and compliant central banks (GBP and USD). EUR/CHF is the only pair where the euro is too strong, courtesy of SNB support.
Z-score deviation of euro-cross rates from their high-frequency fair-value, as defined by pair wise, 1Y regressions of EUR FX vs short-term rate differentials, sovereign credit premia and equity volatility. 1.0

0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 -3.5

Source: J.P. Morgan 9

Paul Meggyesi (44-20) 7134-2714 paul.meggyesi@jpmorgan.com

Global FX Strategy 10 August 2012

and we expect it to continue to struggle, not only from the realisation that September offers a potential return to both political and bond market stress, but also from the enervating reality of the regions recession and attendant likelihood of additional monetary easing. Sold EUR/JPY Aug 3 at 96.75. Marked at 0.6%. Hold a 2-mo EUR/USD 1.22-1.19 ratio put spread in 1x1.5 notional. Bought for 0.35% on July 6. Marked at 0.46% Stay short GBP/NOK in cash NOK was the best performing major currency over the past week. One always needs to be watchful of positions in NOK and the currencys vulnerability to deleveraging. Since, however, NOK outperformance is only a very recent phenomenon we doubt whether investors have yet had the chance to accumulate excessive longs. Domestic data, meanwhile, remains generally supportive for NOK. In particular the acceleration in credit growth to a threeyear high underscores the extent to which monetary policy is now too loose for the domestic economy and the constraints which this places on the willingness of the Norges Bank to cut interest rates to restrain currency appreciation. Next week's data focus will fall on the UK, where CPI, unemployment, retail sales and the MPC minutes are all due. The data will likely not change the impression of an economy that is at best stagnating and of a central bank with more need and certainly greater inclination to ease than virtually all others. Sold GBP/NOK Aug 3 at 9.35. Worth 0.8%. Hold a AUD/NZD 2-mo put fly AUD/NZD was trading notably rich to interest rate differentials when we recommended the trade last week. Unfortunately, part of the valuation gap was closed by a relative downgrade in NZD interest rates, following surprising poor Q2 employment data in NZ and satisfactory labour data in Australia. The NZ data, however, is likely to under-estimate growth as much as the strong Q1 GDP numbers over-estimated it. As such we are not yet willing to give up on this macro meanreversion trade. There is no data of any note in either Australia or NZ next week. Hold a 2-mo AUD/NZD put fly (1.2850x 1.2650x1.2450 in 1x2x1 notional). Bought Aug 3 for 0.29%, worth 0.19%. Hold a 2-mo NOK/SEK call spread The pendulum of market sentiment, not to mention interest rates, has tilted somewhat back in NOKs favour over the part week. We expect this process to continue, especially as some of the recent strength in Swedish growth numbers is very hard to reconcile with the very weak global economic and trade backdrop.
10

2-mo NOK/SEK 1.15-1.18 call spread. Bought on July 20 for 0.57%. Marked at 0.19%. Hold a bearish 1-yr EUR/CHF seagull The SNBs July reserve data indicated intervention of CHF 41bn, just over CHF 10bn more than the increase in sight depos. The inference from this is that around onequarter of the intervention was de-facto sterilised. What the data also highlights is the SNBs growing FX risk FX and gold reserves are now 80% of GDP. The SNBs balance sheet provisions would cover only a 12-13% write-down on these assets through FX appreciation. Hold a 1Y 1.1900-1.1100 EUR/CHF put spread part financed by selling a 1Y 1.2550 EUR/CHF call. Net cost of 0.13% on May 11. Worth 0.18%.
Chart 4: SNB intervention in the past 3 months stands at CHF 160bn or 29% of GDP. 25% of the intervention in July, and 20% of the intervention since May, was de facto sterilized, as suggested by the difference between the increase in FX reserves and the increase in CHF liquidity (measured by sight deposits at the SNB).
Change in net FX reserves (ex FX swaps and reva l) 70 60 50 40 30 20 10 0 May
Source: SNB; J.P. Morgan

Change in sight depos

June

July

Chart 5: The SNBs balance sheet provisions are sufficient to offset a 12-13% writedown on its foreign assets. That coverage would decline to only 9% if the SNB added reserves at the current rate until year-end.
90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2006 2007 2008 2009 2010 2011 2012

Source: SNB; J.P. Morgan

Paul Meggyesi (44-20) 7134-2714 paul.meggyesi@jpmorgan.com

Global FX Strategy 10 August 2012

Table 1.Current FX spot recommendations and P&L


Active trades are marked to market on Friday afternoon London time.

Long JPY NOK

Short EUR GBP

Entry date 03/08/12 03/08/12

Entry level 96.75 9.350

Current level 96.170 9.280

Stop loss 99.00 9.600

P&L since entry 0.6% 0.8%

Comments Hold Hold

Table 2. Current FX derivatives (directional/non-RV) recommendations and P&L


Active trades are marked to market on Friday afternoon London time.
Description Buy 12-mo 1.190-1.110 EUR/CHF put spread, sell 1.255 call, 1x1x 1 notl Buy 2-mo 1.22-1.19 EUR/USD ratio put spread 1:1.5 Buy 2-mo 1.15-1.18 NOK/SEK call spread Buy 2-mo 1.285-1.265-1.245 AUD/NZD put fly 1:2:1 notionals Buy 2-mo 1.03-1.00 AUD/USD put spread Buy 2-mo 1.01-1.03 USD/CAD call spread * P&L in % of asset Entry date 11/05/12 06/07/12 20/07/12 03/08/12 10/08/12 10/08/12 Expiry date 13/05/13 06/09/12 20/09/12 05/10/12 12/10/12 12/10/12 Days to expiry 276 27 41 56 63 63 Entry level 0.13% 0.35% 0.57% 0.29% 0.65% 0.38% Current level 0.18% 0.40% 0.24% 0.22% 0.65% 0.38% P&L since entry* 0.05% 0.05% -0.34% -0.08% 0.00% 0.00% Comments Hold Hold Hold Hold New trade New trade

11

Paul Meggyesi (44-20) 7134-2714 paul.meggyesi@jpmorgan.com

Global FX Strategy 10 August 2012

I. Performance statistics 2008 2012


2012 I. Macro Trade Recommendations portfolio Cash # of trades Success rate Average return per trade (%, unweighted) Average holding period (calendar days) Derivatives (non-digital) # of trades Success rate Average return per trade (%, unweighted) Average holding period (calendar days) Derivatives (digital) # of trades Success rate Average return per trade (%, unweighted) Average holding period (calendar days) II. FX Derivatives portfolio (relative value) Vol r.v # of trades Success rate Average return per trade (unweighted)* Average holding period (calendar days) Vol plus directional r.v # of trades Success rate Average return per trade (bp, unweighted) Average holding period (calendar days) Digital # of trades Success rate Average return per trade (%, unweighted) Average holding period (calendar days) III. Technical Strategy portfolio # of trades Success rate Average return per trade (%, unweighted) Average holding period (calendar days) *P&L in vol points 2011 2010 2009 2008-2012 avg 2008

Chart 1: 2008-2012 performance summary: Average returns per trade


Cash Derivs (non-digital) 2012 2011 2010 1.0% 2.0% 0.8% 0% 1% 2% 2009 2008 2008-12 avg -1% 0% 0.3% 0.9% 0.3% 0.5% 0.6% 0.5% 1% RV (non-digital) 2012 2011 2010 2009 2008 2008-12 avg (vol pts) 0.1 0.3 0.3 0.0 0.2 0.4 0.6 0.8 0.1 0.7 0.2 Technical 2012 2011 2010 2009 2008 2008-12 avg -0.5% 0.0% 0.3% 0.1% 0.0% 0.1% 0.2% 0.1% 0.5%

21 62% 0.1% 27 18 72% 0.3% 56

42 60% 0.0% 25 27 74% 0.9% 71

89 53% 0.0% 23 27 62% 0.3% 54 4 25% -6.7% 60

61 64% 1.0% 20 21 62% 0.5% 59 21 38% -4.7% 55

85 59% 2.0% 31 3 0.0% -0.6% 66 5 20% -3.6% 54

298 59% 0.8% 25 96 65% 0.5% 61 44 41% -2.6% 62

2012 2011 2010 2009 2008 2008-12 avg

0.1% 0.0% 0.0%

4 10 75% 50% 9.5% -0.9% 44 87

Chart 2: 2008-2012 Performance summary: Success rate by type of trade


Cash 2012 2011 62% 60% 53% 64% 59% 59% 0% 50% 100% Derivs (non-digital) 2012 2011 2010 2009 2008 2008-12 avg 0% 0% 65% 50% 100% 72% 74% 62% 62% RV (non-digital) 2012 2011 2010 2009 2008 2008-12 avg 0% 57% 62% 69% 63% 77% 65% 50% 100% 2012 2011 2010 2009 2008 2008-12 avg 0% Technical 33% 58% 46% 57% 43% 48% 50% 100%

23 57% 0.2 83 9 78% 46 56 NA NA NA NA 15 33% 0.3% 115

37 62% 0.1 44 16 75% 12 27 33 58% 0.1% 54

45 69% 0.7 99 4 50% -8 50 52 46% 0.0% 36

32 63% 0.1 73 46 57% 0.1% 10

13 77% 0.3 53 3 33% 8% 33 87 43% 0.2% 9

150 65% 0.3 73 29 72% 19.8 39 3 33% 8% 33 233 48% 0.1% 28

2010 2009 2008 2008-12 avg

12

Paul Meggyesi (44-20) 7134-2714 paul.meggyesi@jpmorgan.com

Global FX Strategy 10 August 2012

II. Closed trades 2012 Cash portfolio


Long NOK NOK SEK EUR NOK EUR EUR JPY JPY JPY USD JPY USD NOK USD JPY USD Short SEK GBP USD USD USD GBP NZD CAD AUD CAD AUD GBP GBP GBP CAD EUR SEK Entry date 22/11/11 27/01/12 27/01/12 03/02/12 13/02/12 24/02/12 24/02/12 23/03/12 11/05/12 01/06/12 01/06/12 01/06/12 20/04/12 15/06/12 01/06/12 06/07/12 06/07/12 Entry level 1.171 9.170 6.790 1.312 5.721 0.848 1.605 82.50 80.50 75.40 0.970 120.4 1.612 9.309 1.038 98.89 6.990 Exit date 24/02/12 24/02/12 16/02/12 03/03/12 09/03/12 14/03/12 30/03/12 13/04/12 25/05/12 07/06/12 07/06/12 07/06/12 15/06/12 06/07/12 19/07/12 20/07/12 27/07/12 Exit level 1.177 8.835 6.770 1.322 5.668 0.831 1.627 81.10 77.85 78.00 0.998 124.2 1.570 9.466 1.010 95.82 6.850 P&L 0.5% 3.8% 0.3% 0.8% 0.9% -2.0% 1.4% 1.7% 3.4% -3.3% -2.8% -3.1% 2.7% -1.7% -2.7% 3.2% -2.0%

FX Derivatives portfolio (vol relative value plus directional)


Trade Buy 2M GBP put/AUD call 1.48 One-touch vs. sell 2M GBP call/AUD put 1.59 OneTouch, equal GBP notionals Buy 2M 35D USD call/NOK put vs. sell 2M 35D USD call/BRL put, equal USD notionals Buy 6M 1500 Gold call/ EUR put one touch vs. Sell 2M 1500 Gold call/ EUR put one touch in 1: 1.42 EUR notionals Buy EUR/CAD 2M 4% OTMS EUR calls vs. Sell EUR/MXN 2M 4% OTMS EUR Sell USD/TRY 6M 10D USD call/TRY put delta-hedged Buy 2Y 43/50 TRY call/JPY put spread Buy 2M 35D EUR call/AUD put vs. Sell 2M 35D EUR call/MXN put, equal EUR notionals Buy 3M 470/500 DNTs in USD/CLP Buy 2M 35D USD/CAD call vs. Sell 2M 35D USD/RUB call Entry date Entry level 02/12/11 7 Exit date 06/01/12 Exit level 35 P&L 28 Units % GBP

16/12/11

-76

13/01/12

59

135

bp USD

09/09/11 20/01/12 06/01/12 27/01/12 27/04/12 04/05/12 21/06/12

42 -38 80 275 -23 18 -73

10/02/12 23/03/12 05/04/12 05/04/12 04/05/12 16/05/12 10/08/12

23 0.0 77 382 44 0 -1

-19 37.8 3 107 67 -18 72

% EUR bp EUR bp USD bp TRY bp EUR % USD bp USD

Derivatives (directional)
Non-Digital Options Entry date Entry level Exit date 1.04% 1.13% 2.05% 0.74% 0.77% 0.40% 0.93% 0.76% 0.15% 0.56% 0.51% 0.70% 0.61% 0.48% 0.15% 27/01/12 03/02/12 24/02/12 30/03/12 31/03/12 05/04/12 27/04/12 11/05/12 25/05/12 25/05/12 25/05/12 29/06/12 29/06/12 13/07/12 20/07/12 Exit level 0.71% 1.30% 0.80% 0.07% 0.16% -0.21% 0.15% 0.00% 0.00% 0.01% 0.04% 0.00% 0.00% 2.44% 0.38% P&L (%) -0.33% 0.17% 1.25% 0.67% 0.61% -0.61% -0.78% 0.76% -0.15% 0.55% 0.47% 0.70% 0.61% 1.96% 0.23% Buy a bullish 4-mo USD/SEK fly (buy 1x 7.00 call sell 22/11/11 2x 7.50 call and buy 1x 8.00 call) Buy 4-mo 100-95 EUR put/JPY call spread Sell 6-mo 1.2050 EUR put/CHF call Sell 2-mo 1.20 NOK/SEK call RKI 1.22 Sell 2-mo 1.08 AUD/USD call RKI 1.10 Sell 2-mo EUR/CAD 1.2850 put, buy 1.3500 call Buy 2-mo 1.00 AUD/USD put Sell 2-mo 0.84 NZD/USD call RKI 0.85 Long 6-mo 76-72.50 USD putJPY call spread in 1x2 / notional Sell 2-mo 0.98 USD/CAD call RKI 0.96 Sell 2-mo 0.8150 NZD/USD call RKI 0.8310 Sell 2-mo 8.95 EUR/SEK call RKI 9.05 Sell 2-mo 7.65 EUR/NOK call RKI 7.75 Buy 2-mo 1.25-1.20 EUR/USD putspread Buy 2-mo 79-77.5 USD/JPY ratio putspread 1:2 22/11/11 22/11/11 09/03/12 09/03/12 23/03/12 23/03/12 09/03/12 22/11/11 20/04/12 04/05/12 27/04/12 27/04/12 11/05/12 06/07/12

FX Derivatives portfolio (vol relative value)


Trade Entry date Entry level Exit date Exit level P&L*

Buy EUR/CAD 1Y D/N straddles, delt -hedged a Buy 1Y GBP/USD vs. GBP/JPY correl swap Buy USD/MXN 2M1M FVAs vs. Sell 2M3M FVAs, equal USD vega notionals Buy 6M AUD/USD vs. AUD/EUR correl swap Sell 6M USD/JPY vol swaps, sell USD/MXN vol swaps, buy MXN/JPY vol swaps, 70:100:130 vega ratio Buy USD/PLN vs. Sell EUR/PLN 2M vol swaps, 100:150 Buy EUR/RUB 1M1M FVAs vs. Sell 1M vol swaps, equal vega notionals Buy AUD/USD vs. Sell AUD/CAD 3M straddles, delta-hedged, 100:130 vega Buy EUR/CAD vs. Sell CAD/JPY 1Y1Y FVA, 150:50 vega Buy NZD/USD vs. Sell USD/MXN 3M vol swaps, equal USD vega notionals Buy USD/JPY 6M straddles vs. Sell 2M straddles, vega-neutr al (delta-hedged) Sell USD/RUB 6M vol swap

04/11/11 05/04/12 05/04/12 13/01/12 08/05/12

12 58.0 -0.6 59.0 -1.1

01/06/12 01/06/12 08/06/12 13/06/12 13/06/12

9.8 68.4 0.8 50.6 -0.9

-2.6 10.4 1.3 -8.4 -0.2

18/04/12

1.6

19/06/12

1.5

0.1

25/05/12

0.8

25/06/12

-2.4

-3.2

05/04/12 03/02/12 05/04/12 27/04/12 06/06/12

1.2 8.9 1.0 1.3 17.3

29/06/12 29/06/12 06/07/12 06/07/12 13/07/12

2.1 8.2 -2.7 0.4 13.1

1.0 -0.7 -3.6 -0.9 4.1

Technical portfolio
Trade Entry Date Entry level Exit date Exit level P &L

Derivatives (digital)
Digital Options Buy 3-mo EUR/NOK 7.59-8.05 double-no-touch Buy 2-mo 1.045 USD/CAD At expiry digital call Buy 2-mo 1.55 GBP/USD At expiry digital put Buy 3-mo 7.3820 - 7.6835 EUR/NOK range binary Entry date Entry level Exit date Exit level P&L (%) 22/11/11 11/05/12 11/05/12 29/06/12 22.0% 16.25% 13.0% 20.00% 03/02/12 25/05/12 29/06/12 06/08/12 56.3% 26.54% 26.3% 0.00% 34.3% 10.29% 13.3% -20.00%

Short GBP vs USD Long USD vs SEK Short EUR vs USD Short USD vs JPY Long NOK vs SEK Long EUR vs NZD Long EUR vs SEK Short NZD vs JPY Long CAD vs JPY Short GBP vs USD Short EUR vs INR Short GBP vs CHF Long USD vs CZK Short NZD vs USD Long USD vs SEK

02/11/11 20/12/11 25/10/11 22/11/11 10/02/12 24/02/12 23/01/12 23/03/12 20/04/12 21/03/12 23/11/10 23/05/12 10/08/11 24/07/12 05/04/12

1.574 6.786 1.337 78.16 1.179 1.609 8.785 67.31 81.63 1.588 70.20 1.500 17.26 0.790 6.696

01/02/12 08/02/12 24/02/12 24/02/12 14/03/12 05/04/12 05/04/12 12/04/12 08/05/12 30/05/12 21/06/12 19/07/12 26/07/12 27/07/12 06/08/12

1.580 6.643 1.347 81.15 1.179 1.609 8.801 66.89 79.72 1.550 71.51 1.535 20.69 0.809 6.700

-0.5% -2.1% -1.0% -3.9% 0.0% 0.0% 0.1% 0.3% -2.3% 1.2% -1.9% -2.4% 20.0% -2.5% 0.1%

13

Arindam Sandilya (1-212) 834-2304 arindam.x.sandilya@jpmorgan.com Matthias Bouquet (44-20) 7134-1819 matthias.bouquet@jpmorgan.com

Global FX Strategy 10 August 2012

FX Derivatives
Data vacuum in August is likely to keep a lid on vols and promote carry-type trades. Add to option-based carry via 6M ATMF/ ATMS spreads in EUR/INR. Open vega-neutral long vol swap vs. short FVA packages at the front-end of the NZD/USD vol curve as a positive carry defensive position. Along similar lines, sell 9M3M USD/CLP FVAs against a betaweighted amount of 9M3M USD/MXN FVAs. Lower vols, steeper vol curves and flatter risk-reversals all materialized as expected in a week devoid of much in terms of economic news. The only calendar item of note for risk markets, the Chinese activity data dump for July, was a mixed bag broadly a little weaker than consensus that reinforced expectations of further policy stimulus in the autumn and contained the fallout on risk markets. The state of stasis can well continue until Jackson Hole at the end of the month when Fed policy/ QE-III will come into renewed focus. Lackluster price action till then should keep a lid on vol and fuel demand for carry/decay-earning strategies. This hardly implies throwing caution to the wind we advocate range trades (DNTs) in very select crosses with low risksensitivities (NZD/SEK, GBP/CAD, USD/JPY) and ATMF/ATMS option spreads in high carry/vol underlyings such as USD/CNY and EUR/INR. As has been the case since the beginning of the year, we also remain on the lookout for carry-efficient vol protection where available, and advocate vol curve flatteners in NZD/USD. We add to option-based carry through ATMF/ATMS spreads in EUR/INR. Asian currencies provide a rich seam of option-based carry trades to mine. Last week, we opened USD/CNY 6M ATMF/ATMS put spreads; another one that stands out is EUR/INR (chart 1). Over-extended declines in EUR-crosses over the past two months is a concern for investors looking to earn carry via short EUR/EM, but EUR/INR is less afflicted than most owning to the persistent cheapness of INR. Our Asian strategists have scaled back their tactical bullishness on the rupee from last month, noting that the retracement in the currency from all time lows following an upturn in political sentiment in June has stalled recently, since policy paralysis persists and longterm investment inflows remain unconvincing. We expect the stand-off between bearish fundamentals and still net short INR positioning to be supportive of a long carry stance, especially when aided by the ballast of a short EUR leg in EUR/INR. It helps that max payout/cost ratios of EUR/INR ATMF/ATMS spreads are near the upper end of their historical range (chart 2), so this is as good a time as
14

Chart 1. EUR/INR is a favored candidate within the option-based (ATMF/ATMS) carry trade universe.
Max payout/cost ratio of 6M ATMF/ ATMS spreads (on mids) 2.4 2.3 2.2 2.1 2.0
EUR/INR USD/CNY AUD/SGD USD/CHF EUR/USD EUR/RUB EUR/TRY USD/INR AUD/CHF JPY/INR AUD/CAD EUR/AUD EUR/CAD EUR/GBP RUB/JPY AUD/NZD EUR/NOK USD/JPY NZD/CHF EUR/SEK CHF/JPY NZD/CAD CAD/CHF SEK/CAD CAD/BRL EUR/NZD EUR/ILS GBP/AUD TRY/JPY EUR/K EUR/HUF BRL/JPY GBP/CAD
Mar-10 Oct-10 May-11 Dec-11 Aug-12

1.9

Source: J.P.Morgan

Chart 2. with maximum payout/cost ratios near 3-yr highs


Max payout/cost ratio of 6M EUR/INR ATMF / ATMS put spread (on mids) 2.7 2.6 2.5 2.4 2.3 2.2 2.1 2.0 1.9 1.8 Aug-09

Source: J.P.Morgan

any to be earning carry in the cross. Positive carry protection in the form of vega-neutral vol curve flatteners is available in NZD/USD. 1M NZD/USD implied vols have dipped to alarmingly low levels that are not only 2.5 vols below trailing 1M realized vols, but also nearly at par with the lowest realized vol print since the EU crisis erupted (chart 3). August being the data/news vacuum month that it is slated to be, it is hard to find catalysts for sharp gamma outperformance in all likelihood, realized vols will mean-revert lower from current levels amid uninspiring price action in spot but the asymmetry in chart 3 makes it unlikely that an outright long gamma position will turn out to be a total lemon even absent European shocks. A better position is to combine a long 1M vol swap position with a short 1M1M FVA to create a net positive carry package that is reasonably insulated from broad vol downdrafts. The 1M1M FVA trades at a 1.2 vol premium over spot 1M implieds (on mids) due to the steepness of the vol curve (chart 4), and that static slide accrues to the FVA

Arindam Sandilya (1-212) 834-2304 arindam.x.sandilya@jpmorgan.com Matthias Bouquet (44-20) 7134-1819 matthias.bouquet@jpmorgan.com

Global FX Strategy 10 August 2012

seller if the vol curve remains unchanged over the following month. There are a couple of ways of viewing such vol swap/FVA packages. First, in the spirit of earning carry in a quiet month, they can be conceived of as positive vol carry constructs with low beta to the macro risk backdrop at inception the long gamma leg hedges out the directional vol exposure of the FVA short, without sacrificing any (and in fact, adding to) ex-ante vol carry. Second, equal vega weightings on the two legs effectively reduce the trade to a vega-neutral long 1M/short 2M calendar spread; vol traders will recognize this is a classic curve flattening play, albeit with flat-vega products as opposed to vanillas. Assuming unchanged implied and realized vols over the next month, one stands to earn ~ 3 vols based on current pricing; shave off 1.0-1.5 vols to account for realizeds mean-reverting lower, and it still leaves an acceptable ~1.5-2.0 vol of P/L on the table. In relative value, we recommend selling USD/CLP FVAs hedged with a weighted amount USD/MXN FVAs to earn risk premium along the back-end of vol curves in a risk-controlled fashion. Chart 5 shows that a spread of 3M in 9M USD/CLP forward vols over a beta-weighted amount of 3M in 9M USD/MXN forward vols is trading near 2-yr highs, and offers ~2.5 vols of static slide into spot 3M implied vols (on mids). Carry aside, hold-to-maturity returns from selling the weighted FVA spread are biased asymmetrically positive, since spot implied vol spreads have printed below current entry levels more than 90% of the time over the past few years; with the two cash exchange rates delivering tepid realized vols consistent with relative implieds another 2 pts. or so lower from here, that statistic is unlikely to be challenged. And while not obvious at first glance, a short CLP/long MXN vol package is an anti-risk trade in disguise, having displayed a reliable pattern of declining meaningfully during episodes of stress (chart 5). We open a 100 (CLP):80 vega weighted FVA spread in our portfolio.

Chart 3. Front-end NZD/USD vols have dipped to alarmingly low levels, below trailing realized vols and nearly at par with the lowest realized vol print in the post EU-crisis era..
26 24 22 20 18 16 14 12 10 8 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 NZD/USD 1M realized vol NZD/USD current 1M implied vol

Source: J.P.Morgan

Chart 4. while 1M1M forward vols trade at a decent premium over spot 1M implied vols owing to the steepness of the vol curve
NZD/USD 1M1M forward vol - 1M implied vol (vol pts.) 3.0

2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 Aug-10
Source: J.P.Morgan

Feb-11

Aug-11

Feb-12

Aug-12

Chart 5. Selling expensive USD/CLP forward vols hedged with a beta-weighted amount of USD/MXN forward vols offers meaty static slide into spot implied vols and performs handsomely during stress
vol pts. 6

5 4 3 2 1 0 -1 -2 -3 -4 Aug-10
Source: J.P.Morgan

USD/CLP - 0.8*USD/MXN 3M in 9M BS fwd vol spread USD/CLP - 0.8*USD/MXN 3M implied vol spread

2.5 vol pts.

Vol spikes

Feb-11

Aug-11

Feb-12

Aug-12

15

Arindam Sandilya (1-212) 834-2304 arindam.x.sandilya@jpmorgan.com Matthias Bouquet (44-20) 7134-1819 matthias.bouquet@jpmorgan.com

Global FX Strategy 10 August 2012

Implied volatilities
Current Implied Vols Avg. Implied Vols Z-Score Implied Vols 1M 3M 1Y 1M 3M 1Y 1M 3M 1Y
A UDJPY A UDUSD CADJPY CHFJPY EURAUD EURCAD EURCHF EURGBP EURJPY EURNOK EURNZD EURSEK EURUSD GB PJPY GB P USD NZDUSD USDCAD USDCHF USDJP Y USDNOK USDSEK USDA RS USDB RL USDCLP USDM XN EURCZK EURHUF EURPLN EURRUB USDRUB USDTRY USDZA R USDIDR USDINR USDKRW USDP HP USDSGD USDTWD 10.4 8.8 9.1 10.9 7.7 7.4 2.2 6.5 10.8 7.3 8.2 7.7 9.1 9.1 7.0 9.3 6.4 9.3 6.7 9.6 9.8 17.0 10.3 10.5 12.8 7.2 10.5 8.7 9.8 1 .2 1 9.9 15.5 6.4 1 0.1 7.0 5.8 5.0 3.5 1 2.1 1 0.0 1 0.4 1 2.2 8.6 8.1 4.0 7.2 1 2.2 7.5 9.3 8.0 9.8 1 0.5 7.8 1 0.5 7.0 1 0.1 7.8 1 0.8 1 .0 1 20.0 1 .3 1 1 .2 1 1 3.2 7.7 1 .2 1 9.5 1 0.2 1 .7 1 9.6 1 6.4 8.6 1 0.7 8.5 6.5 5.9 4.0 1 5.0 1 2.2 1 2.7 1 4.3 1 0.2 9.5 6.5 8.7 1 4.1 7.7 1 .0 1 8.3 1 .3 1 1 2.7 9.3 1 2.7 8.3 1 .7 1 1 0.0 1 2.7 1 2.8 23.0 1 3.3 1 2.8 1 3.7 7.9 1 .7 1 1 0.3 1 .3 1 1 2.8 1 .9 1 1 7.0 1 2.2 1 .4 1 1 .1 1 8.0 6.9 5.1 1 4.6 1 2.9 1 3.2 1 2.5 1 0.6 1 0.3 8.8 8.7 1 3.5 7.7 1 .1 1 7.7 1 2.2 1 2.1 9.2 1 3.3 9.6 1 2.5 9.7 1 3.8 1 4.1 7.8 1 3.7 1 2.5 1 3.0 7.3 1 .3 1 1 0.3 1 0.3 1 .4 1 1 2.2 1 6.4 8.4 9.4 1 .5 1 7.3 7.4 5.8 15.5 13.6 13.9 12.9 1 .3 1 10.9 9.2 9.3 14.2 8.0 1 .8 1 8.0 12.6 12.9 9.9 14.0 10.0 12.7 10.4 14.3 14.6 10.2 14.4 13.0 13.6 7.5 1 .7 1 10.9 10.9 12.0 12.9 16.8 9.8 10.0 12.6 7.9 7.8 6.4 1 7.4 1 4.8 1 5.6 1 4.0 1 2.6 1 .8 1 1 0.1 1 0.5 1 5.9 8.5 1 3.0 8.5 1 3.4 1 4.7 1 .2 1 1 5.2 1 0.9 1 3.2 1 2.2 1 5.2 1 5.4 1 7.5 1 6.1 1 4.0 1 4.7 7.8 1 2.6 1 .7 1 1 2.4 1 3.4 1 4.3 1 7.5 1 2.8 1 .0 1 1 4.1 9.1 8.3 7.4 -1 .6 -1 .7 -2.1 -0.6 -1 .9 -1 .9 -1 .5 -1 .9 -1 .4 -0.3 -1 .7 0.0 -1 .6 -1 .7 -1 .7 -1 .6 -1 .6 -1 .2 -2.1 -1 .8 -1 .7 1 .3 -0.8 -0.6 -0.1 -0.1 -0.3 -0.8 -0.2 -0.1 -1 .5 -0.2 -0.6 0.3 -1 .5 -1 .2 -1 .2 -1 .7 -1 .5 -1 .8 -2.2 -0.4 -2.1 -2.0 -1 .5 -1 .9 -1 .2 -0.4 -1 .7 0.0 -1 .6 -1 .5 -1 .6 -1 .7 -1 .8 -1 .2 -2.1 -1 .8 -1 .6 1 .5 -0.9 -0.7 -0.1 0.1 -0.3 -0.8 -0.4 -0.1 -1 .6 -0.1 -0.4 0.4 -1 .6 -1 .2 -1 .2 -1 .8 -1 .5 -1 .9 -2.4 0.1 -2.4 -2.0 -1 .4 -1 .6 -1 .4 -0.8 -1 .9 -0.2 -1 .8 -1 .5 -1 .7 -1 .9 -1 .9 -1 .0 -2.2 -1 .8 -1 .7 1.5 -1 .2 -0.6 -0.4 0.1 -0.6 -1 .1 -0.7 -0.3 -1 .7 -0.2 -0.3 0.3 -1 .7 -1 .1 -1 .2 -1 .8

Biggest 3M Implied Volatility Movers


Weekly Changes
EURPLN USDARS EURHUF EURNOK EURCZK EURSEK USDJPY EURGBP USDZAR USDPHP USDKRW EURRUB AUDUSD AUDJPY USDINR NZDUSD USDCHF EURUSD USDSEK USDNOK

Monthly Changes
EURSEK EURNOK USDZAR EURCHF EURHUF EURPLN USDTRY EURNZD GBPUSD EURAUD USDARS USDINR EURJPY GBPJPY CHFJPY USDIDR CADJPY AUDJPY USDCLP USDBRL

Vol

Vol

Vol

Vol

-1.5

-1.0

-0.5

0.0

0.5

-3

-2

-1

Source: J.P. Morgan

Front-End Vol Rankings


In order of Normalized Volatility Risk Premium*
USDIDR USDTWD USDPHP EURCZK USDCLP USDJPY USDBRL USDTRY USDKRW USDINR EURAUD GBPJPY USDMXN USDZAR EURGBP CHFJPY GBPUSD EURJPY NZDUSD EURSEK -0.2 0.0 0.2 0.4 0.6

Vols RICH

Vols CHEAP

0.8

1.0

Source: J.P. Morgan

Current trade recommendations and P&L


Analyst Description Entry date 02-Mar-12 05-Apr-12 27-Apr-12 04-May -12 Entry 6.8 -18 -2.2 15.3 13.4 -1.1 12.0 -73 2.7 -0.1 14.2 0.3 20.0 105 37 20.0 29.0 167 -1.0 -2.5 Current mid 3.2 -1 -2.8 15.7 13.9 -2.5 21.7 -1 1.4 0.2 13.3 -0.1 38.6 99 33 15.3 30.3 152 -1.4 -3.3 P/L -3.6 17 0.6 0.5 0.6 1.4 -9.7 72 -1.3 0.3 -0.9 -0.4 -18.6 -6 -4 -4.8 1.3 -15 -0.4 -0.8 P/L units Remarks

Sandily a/Bouquet Buy USD/ARS 1Y ATMF/ATMS USD put spread Sandily a/Bouquet Sandily a/Bouquet Buy 6M 4% OTMS BRL call/JPY put vs. Sell 6M 4% OTMS USD call/JPY put, equal JPY notionals Sell 6M USD/JPY vol sw aps and USD/KRW v ol sw aps, buy 6M KRW/JPY v ol sw aps, 100:100:160 vega ratio

% USD Best max pay out/cost ratio optionalized carry trade bp JPY Cross-y en high strikes underpriced relative to USD/JPY high strikes

v ol pts Prox y for USD/JPY v s. USD/KRW correlation short v ol pts Positiv e v ol slide, long v ega position courtesy steep v ol curv e v ol pts Positiv e v ol slide, long v ega position courtesy steep v ol curv e v ol pts Prox y for USD/JPY v s. USD/MXN correlation short corr pts Implied correlations rich to realized bp USD Take profit v ol pts Market-neutral v ol butterfly w ith attractiv e implied-realized technicals

Sandily a/Bouquet Buy AUD/USD 1Y6M FVA / sell 6M6M FVA, 2:1 vega ratio Sell 6M USD/JPY vol sw aps, sell USD/MXN vol sw aps, buy MXN/JPY v ol sw aps, 70:100:130 vega ratio

Sandily a/Bouquet Buy EUR/USD 1Y6M FVA / sell 6M6M FVA, 2:1 vega ratio 04-May -12 Sandily a/Bouquet 08-May -12 04-Jun-12 21-Jun-12 21-Jun-12 25-Jun-12 13-Jul-12 13-Jul-12 16-Jul-12 03-Aug-12 03-Aug-12 03-Aug-12 10-Aug-12 10-Aug-12 10-Aug-12

Sandily a/Bouquet Sell GBP/JPY v s. GBP/CAD 3M correlation swap Sandily a/Bouquet Buy 2M 35D USD/CAD call vs. Sell 2M 35D USD/RUB call Sandily a/Bouquet Buy 3M NZD/USD vol sw ap, buy USD/CAD 3M v ol swap, sell USD/CLP 3M vol sw ap (50:100:-100 vega ratio)

Sandily a/Bouquet Buy 3M EUR/KRW v ol sw ap v s. sell USD/KRW v ol sw ap Sandily a/Bouquet Buy AUD/USD 2Y2Y FVAs (AUD vega) Sandily a/Bouquet Buy USD/JPY 6M 25D risk-reversal (long USD puts vs. sell USD calls, v ega-neutral)

v ol pts Gamma RV implied spread cheap and below realized v ol pts Long v ol, positiv e carry trade with attractiv e entry lev els v ol pts USD/JPY skew s ov er-bid for USD calls relative to realized spotv ol correlations

Sandily a/Bouquet Sell GBP/JPY v s. GBP/CAD 3M correlation swap Sandily a/Bouquet Buy USD/CNY ATMF/ATMS put spread Sandily a/Bouquet Buy NZD/SEK 3M 5.35/5.75 DNT Sandily a/Bouquet Buy GBP/CAD 3M 1.51/1.60 DNT
NEW NEW NEW

corr pts Implied corrs rich, likely to decline if v ols mean-rev ert higher bp USD Positiv e carry spread to position for steepening of vol curve bp USD Best v alue option-based carry trade % NZD Low beta to broad risk, high barrier width/YTD spot hi/lo range % GBP Low beta to broad risk, high barrier width/YTD spot hi/lo range bp EUR Good v alue option-based carry trade v ol pts Positiv e carry , v ega neutral protection v ol pts Positiv e carry , dislocated forw ard v ol spread that performs

Sandily a/Bouquet Sell 1M / buy 6M 2.01 USD/BRL calendar puts (equal notls) 03-Aug-12

Sandily a/Bouquet Buy EUR/INR ATMF/ATMS put spread Sandily a/Bouquet Buy NZD/USD 1M vol sw ap v s. Sell 1M1M FVA Sandily a/Bouquet Buy USD/MXN v s. Sell USD/CLP 9M3M FVA spreads

16

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

Global FX Strategy 10 August 2012

Technical Strategy
EUR The broad flight out of the EUR intensifies particularly against G10 currencies GBP In the footpath of the EUR but with better perspectives to recover against commodity FX JPY The broader up-trend has slowed but seems to be incomplete overall CE3 currencies The latest recoveries couldnt brighten the picture on bigger scale yet Stay long EUR/CZK and USD/ZAR & short EUR/USD, GBP/USD, GBP/JPY, NZD/CAD, EUR/KRW, EUR/MXN, NZD/NOK and PLN/HUF. The fear of a EUR breakup manifests in strong EUR losses across the board The once more intensifying sovereign debt crisis in southern Europe and the rising fear of a EUR breakup finally led to a widespread flight out of the EUR, which has also lost massively against Commodity FX during the risk recovery of the last few weeks. EUR/USD also received temporary support from the latter, but given the classical zigzag consolidation pattern, which failed to clear the keyT-zone at 1.2556/1.2621 (int. 38.2 %/pivot) so far, the broader bear trend appears to be totally intact and former lows at 1.1876 and at 1.641 remain in focus. Given the H & S topping pattern in the weekly chart, an extension to 1.1339 (Fib.-projection), to 1.1212 (61.8 %) and to the H & S projection at 1.1100 wouldnt surprise at all.
Chart 1: EUR/USD Daily Chart: Below 1.2556/1.2621 the EUR bears remain in full control and 1.1876 as well as 1.1641 in focus

on supporting commodity currencies. This led to breaks below historic lows at 1.1717 in EUR/AUD and below 1.5188 in EUR/NZD, which has postponed the expected recovery for a while. We nevertheless like the idea of a broader recovery in EUR/Commodity FX and keep on watching key-pivotal resistance at 1.1777 in EUR/AUD and 1.2263 (minor 38.2 %) in EUR/CAD as breaks above could be the initial spark for such a recovery. The downtrends in EUR/NOK and EUR/SEK are also looking highly stretched and being close to former lows and displaying 5wave patterns in the weekly chart raises the rebound risk significantly. That said we watch minor 38.2 %retracements at 8.2706 in EUR/SEK and at 7.3452/94 (38.2 %/pivot) in EUR/NOK carefully as decisive breaks above could potentially trigger recoveries to 7.9801 (38.2 %) in EUR/NOK and to 9.3420 in EUR/SEK. The decoupling from the EUR crisis seems to fail as GBP gets dragged under with it Being too close to the continent the British Pounds attempts to decouple from the EUR crisis appear to be increasingly desperate while the UK is running deeper into recession and chart set-ups, particularly in GBP/USD and in GBP/JPY, are still showing a great sell-off risk. Particularly the former looks vulnerable as it fails to trade away from monthly triangle support at 1.5450, which if taken out, would leave little doubt that previous lows at 1.4228 and at 1.3504 will be retested. GBP/JPY is also remaining in negative territory as long as 124.53/66 (200 DMA/int. 76.4 %) caps the upside. Below, an extension to 112.59 (Fib.-projection) cant be excluded yet
Chart 2: GBP/USD Daily chart: Below 1.5726/78/85, acceleration down and a break below triangle support at 1.5484 is still looming

The expected recovery in EUR/Commodity FX failed to manifest so far as hopes for fresh liquidity injections from the Fed and the ECB are still driving risk markets and keep

But while the hopes for stabilization have been shattered in GBP/SEK via the latest break below 10.542/10.492 (weekly trend/int. 76.4 %) we remain slightly optimistic that GBP/commodity FX might still succeed in doing so.

17

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

Global FX Strategy 10 August 2012

The latter is still showing a favorable setup for a broader recovery as long as GBP/CAD defends key-support at 1.5249/23 (pivot/int. 76.4 %) and as long as GBP/AUD doesnt display a weekly close below 1.4759 (left shoulder). The broader JPY up-trend has lost momentum but appears to be still intact and incomplete The broader up-trend of the JPY proves to be quite resilient as not even USD/JPY managed to escape the still intact down-rotation yet. As long as key-support at 77.675/595 (last low/int. 76.4 %) is defended though, the start window for a stronger recovery remains open. For the latter to materialize, it however takes a break above 79.143 (keypivot). The bigger down-cycle in EUR/JPY is also missing a 5th wave decline to 91.89/90.18 (Fib.-projections) and possibly to 88.98 (low of 2000) as long as key-pivotal resistance at 98.33 is not taken out.
Chart 3: EUR/JPY Daily Chart: Below 98.33, the downtrend is at least missing one more extension towards 91.89 & 90.18

The same applies for GBP/JPY where breaks below 121.60 and below 120.46 (76.4 % on 2 scales) would resume the broader downtrend for a projected extensions to 115.14 and to 112.59. The intermediate recovery in CE3 currencies looks complete & the downtrend ready to be resumed Having produced classical zigzag consolidation patterns in EUR/CE3 and USD/CE3 since early June, these markets have stabilized right above key-supports at 276.64/274.40 (int. 76.4 %/weekly trend) in EUR/HUF, at 4.0103 (int. 76.4 %) in EUR/PLN and at 222.65 (int. 76.4 %) in USD/HUF, which suggests that the broader up-trend is ready to be resumed. That said, we are now looking for
Chart 4: USD/CZK Weekly Chart: The up-trend appears to be perfectly intact for a test of 21.82 and a potential extension to 23.43

confirming breaks above 4.1477/4.1554 (daily trend/minor 38.2 %) in EUR/PLN, above 284.15/285.23 (int. 38.2 %/daily trend) in EUR/HUF or above 3.3627 (minor 76.4 %) in USD/HUF to signal the resumption of the long-term up-trends. If so, the 2011/2012 highs should be re-tested.
Technical trades
P&L based on postion size

Trade details Long Short HUF EUR CAD KRW USD USD USD USD NOK MXN JPY PLN CZK NZD EUR ZAR SEK GBP EUR NZD EUR GBP

Entry date 11/11/11 11/11/11 22/11/11 22/11/11 22/11/11 05/04/12 21/03/12 03/08/12 07/08/12 18/06/12 20/07/12

Entry level 70.3070 25.2100 0.7921 1548 8.1250 6.6962 1.5989 1.2285 4.8323 17.4200 123.11

Current level 68.1031 25.2000 0.8063 1387 8.1420 6.6995 1.5598 1.2260 4.7990 16.1310 122.15

Stop loss 71.5000 24.1500 0.8501 1505 7.6000 6.7000 1.5800 1.2650 4.9750 17.1550 126.00

P&L since entry % 3.12% -0.01% -2.07% 5.19% 0.32% 0.05% 1.57% 0.08% 0.34% 3.70% 0.39%

Comments

Deeper correction still intact, added at 69.50 on 12th of January Medium term basing pattern suggests further upside. Outlook 2012 trade, added on 9 January at 0.8082 Outlook 2012 trade Outlook 2012 trade Stopped August 8 MT downtrend incomplete; taken half profit at 1.5500 on 30th of May MT downtrend remains incomplete Reversal from long term range highs expected Breakdown from key topping pattern Consoldiation seen as complete, downtrend about to resume

18

Anna Hibino (61-2) 9003-7932 anna.hibino@jpmorgan.com

Global FX Strategy 10 August 2012

Global FX carry trade monitor


Chart 1: Japanese retail -- market capitalisation of 100 largest FXdenominated ITs
trn; market capitalization of 100 largest investment trusts; ranked in the order of total asset as of March 2011
30 70 80 25 90 20 100 110 15 Market cap of top 100 ITs, JPY trn, lhs JPY trade-wtd index, inverted, rhs 10 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 120 130

Chart 2: Foreign institutional investors net positioning in BM&F USD futures


$bn; net positions in USD futures on BM&F for foreign institutional investors
20 15 10 5 2.1 0 -5 -10 -15 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 1.9 1.7 1.5 Foreign institutional investor net USD position, $bn, lhs USD/BRL, rhs 2.7 2.5 2.3

Source: J.P. Morgan, Bloomberg

Source: J.P. Morgan, TFE;

Japanese retail exposure to the top 100 foreign currency ITs as of March 2011 increased from 20.6trn to 20.8trn on Monday, but has since edged down to 20.7trn as of yesterday. The current market cap is just 3% above the yearto-date low of 20.1trn.

Foreign institutional investors net longs in USD of $2.0bn declined to $1.0bn as of Wednesday, reaching the low since early June but standing 83% below the recent high of $11.9bn marked in late September 2011. During the same period, USD/BRL declined by just over 1%.

Chart 3: Japanese retail market capitalisation of BRL-overlay funds


trn; market capitalization of top BRL-overlay investment trusts

Chart 4: CTAs -- aggregate IMM position in USD


$ bn as the sum of net speculative positions on the IMM in AUD, NZD, CAD, EUR, GBP, JPY, CHF and MXN.

54 52 50 48 46 44 42 40 38 36 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 BRL/JPY, lhs Market cap of top BRL overlay funds, JPY trn, rhs

4.300 3.800 3.300 2.800 2.300 1.800

$55 $45 $35 $25 $15 $5 -$5 -$15 -$25 -$35 -$45 02 03 04

Aggregate IMM position in USD, $ bn, lhs USD trade-wtd index, rhs

110 105 100 95 90 85 80 75

05

06

07

08

09

10

11

12

Source: J.P. Morgan, TFE

Source: J.P. Morgan, CME

Market cap of Japanese BRL-overlay was unchanged at 2.9trn this week. BRL/JPY changed little (less than 1%) during the same period. The current market cap level is 19% below the year-to-date high of 3.6trn marked in February of this year.

Aggregate USD longs declined for the second consecutive week from $18.5bn to $11.2bn between July 24th and 31st. EUR shorts also declined for the second consecutive week from $23.9bn to $21.5bn. JPY long increased from $4.0bn to $5.1bn, while AUD longs increased from $2.8bn to $3.9bn.

19

Anna Hibino (61-2) 9003-7932 anna.hibino@jpmorgan.com

Global FX Strategy 10 August 2012

Chart 5: Market capitalisation of US-listed currency ETFs


Weekly data, $bn. Positive value indicates longs in foreign currency and shorts in USD
5 4 3 2 1
Market cap of US-listed FX ETFs, $bn, lhs

Chart 6: Currency managers and global macro hedge funds -- Beta with trade weighted USD
HFR used for global macro hedge funds. Barclay BTOP Index used for currency managers.
3.0 2.0
80 85 90 95

75

Global macro hedge funds Currency managers

1.0 0.0 -1.0 -2.0 -3.0 -4.0 06 07 08 09 10 11 12

0 06 07

USD trade-wtd index, inverted, rhs

100 11 12

08

09

10

Source: J.P. Morgan, Bloomberg

Source: J.P. Morgan, Bloomberg

Market cap of US-listed FX ETFs edged up from the year-todate low of $0.9bn to $1.0bn last Friday, which have since been unchanged throughout the week. The current level is 78% below the 2011 high of $4.5bn.

Currency mangers returns beta with the trade weighted dollar edged down from 0.2 to 0.1 this week, reaching the lowest level of positive beta since late May of this year. Meanwhile, global macro funds' beta was unchanged at 0.1 throughout the week.

Chart 7: Currency managers and global macro hedge funds -- Beta with G-10 carry strategies
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.
3.0 Currency managers 2.0 1.0 Global macro hedge funds

Chart 8: Currency managers and global macro hedge funds -- Beta with emerging markets carry strategies
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.
2.0 1.5 1.0 0.5 Currency managers Global macro hedge funds

0.0 -1.0 -2.0 06 07 08 09 10 11 12

0.0 -0.5 -1.0 06 07 08 09 10 11 12

Source: J.P. Morgan, Bloomberg

Source: J.P. Morgan, Bloomberg

Returns beta with G10 carry for currency managers continued to increase for the fourth consecutive week from 0.2 to 0.3. Global macro funds beta have been moving higher since reaching the year-to-date high in negative beta of -0.8 in late June. This week, their beta moved marginally from 0.1 to flat.

Returns beta with EM carry for currency managers moved from -0.1 to 0.1 last Friday, which has since been unchanged on the week. Global macro funds beta also declined from 0.1 to flat last Friday and has remained unchanged since.

20

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

Global FX Strategy 10 August 2012

Research Note

Intra-EMU currency valuations: Estimates for a breakup scenario


We employ the J.P. Morgan long-term fair value model to estimate intra-euro exchange rate misalignments. Figure 1 shows the real broad effective exchange rate (REER) misalignments for intra-euro theoretical currencies. Germany (-19%), Belgium (-13%), and Austria (13%) are the most undervalued (i.e. should appreciate); and Portugal (+17%), Ireland (+16%), and Greece (+13%) are the most overvalued (i.e. should depreciate). The figure 1 results are generally consistent with other commonly used metrics to assess intra-euro imbalances such as the current account, changes to the current account, and the ECB Harmonized Competitiveness Indicators. But there are some differences. Belgium is the most notable outlier. Flow measures such as the current account do not signal significant exchange rate appreciation. But the fair value model suggests a large undervaluation, which is consistent with Belgiums net international investment surplus that trails behind only Germany and the Netherlands. Signals are also mixed for Finland and France. But the misalignment/imbalances for Finland and France are generally small using different metrics, suggesting only a modest exchange rate adjustment in these countries. Note that the long-term fair value model is not designed to capture the immediate currency impact of an EMU exit such as capital flight related to redenomination risks or the resulting economic dislocations for creditor and debtor countries alike. Rather the model misalignments are one approach for assessing the medium-term exchange rate adjustment if a country were to exit EMU.
Figure 1: Real exchange rate misalignments compared to 1999 levels
Positive values suggest overvaluation (i.e. currency should depreciate)
20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -19% -13% -13% -12% -6% -2% 3% 5% 13% 16% 17%

Austria

France

Finland

Netherlands

Belgium

Greece

Spain

Germany

Source: J.P. Morgan

What are the theoretical fair values of intra-euro currencies?


Since the start of the Euro crisis, the probability of a country leaving the Euro has ebbed and flowed. While EMU break-up is not our central view, investors are understandably interested in the fair value of hypothetical intra-euro currencies given this risk. One common approach to this question is looking at each countrys current account balance and divergences between countries. This is one metric for gauging the degree of exchange rate adjustment required to reduce external imbalances (figure 2). But this metric alone has varying degrees of success in predicting long-term exchange rate adjustments, and current account deficits/surpluses can persist for years or decades. As an alternative approach, we employ the J.P. Morgan long-term fair value model to assess intra-euro exchange rate misalignments2. We estimate the real fair value misalignments of hypothetical intra-euro currencies based on a broader set of variables which typically drive currencies over a longer-term horizon. Our results serve as a robustness check to commonly held views about currency misalignments in the Euro area, but also highlight some differences.
2

See Enhancements to J.P. Morgans Long-term Fair Value Model, September 29, 2011 for details on the JP Morgan longterm fair value model.
21

Portugal

Ireland

Italy

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

Global FX Strategy 10 August 2012

Figure 1 shows the real broad effective exchange rate (REER) misalignments for intra-euro theoretical currencies. Germany (-19%), Belgium (-13%), and Austria (-13%) are the most undervalued (i.e. should appreciate); and Portugal (+17%), Ireland (+16%), and Greece (+13%) are the most overvalued (i.e. should depreciate). The results are generally consistent with the current account balances in figure 2 and other metrics presented in this note. But there are notable differences for countries like Belgium, France, and Finland.

A 1% increase in productivity is associated with 0.58% currency appreciation. A 1 percentage point increase to gross government debt/GDP is associated with 0.21% currency depreciation. A 1 percentage point increase to net investment income/trade is associated with 0.20% currency appreciation. Using these relationships, one can estimate how intra-euro model estimates would have changed since 1999. The year countries adopted the euro is a logical benchmark, but one should note that this base year assumes all countries real broad effective exchange rates were close to fair value in 1999. Table 1 (next page) shows the estimated change to fair value and the contribution of each variable.

Fair value model estimation procedure for theoretical currencies:


Predicting where a new currency would trade is complex and reflects highly unpredictable under and overshooting dynamics. However, the misalignments in the real broad effective exchange rates provide some information about the direction and magnitude of the nominal exchange rate adjustment required for a currency to revert to its
Figure 2: Intra-EMU current account balances (%GDP)
Chart shows the level of current account balances (%GDP) 10 8 6 4 2 0 -2 -4 -6 -8 -10

Finland

Netherlands

Belgium

Germany

Source: Bloomberg

equilibrium value. The JP Morgan fair value model estimates this adjustment based on structural drivers including terms of trade, productivity, debt levels, and net investment income, which are typical long-term drivers for exchange rates. As discussed in Enhancements to JP Morgans Long-term Fair Value Model (Sept 2011), the model employs four explanatory variables that economic theory suggests should affect a wide range of currencies over different time periods. We estimate coefficients for these variables using a global set of 19 currencies and then apply the following relationships to 11 Euro area countries: A 1% increase in terms of trade is associated with 0.34% currency appreciation.
22

Portugal

Greece

Austria

France

Ireland

Spain

Italy

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

Global FX Strategy 10 August 2012

Table 1: Contribution of variables to fair value model estimates


(a)The row Change to FV shows the change to the fair value estimate since 1999. (b) The row Change to REER shows the change to real broad effective exchange rate indices since 1999 (c) The final row Misalignments is the difference between (b) and (a)

Austria Belgium Finland Terms of trade Productiv ity Debt/GDP NII/trade (a) Change to Fair Value (b) Change to REER (c) Misalignment
Source: J.P. Morgan.

France -3.4% 5.8% -5.9% 0.6% -2.9% -9.2% -6.4%

Germany -1.5% 9.7% -4.3% 0.7% 4.5% -14.4% -18.9%

Greece 1.4% 7.1% -13.9% -1.9% -7.3% 5.3% 12.6%

Ireland -6.2% 11.4% -11.9% -2.9% -9.6% 6.6% 16.2%

Italy -5.1% 0.0% -1.4% 0.3% -6.2% -2.8% 3.4%

Netherlands Portugal 0.4% 8.2% -0.3% 0.5% 8.8% -3.3% -12.1% -2.3% 2.4% -12.8% -1.3% -14.0% 3.4% 17.4%

Spain -3.8% 6.5% -1.4% -0.4% 0.9% 6.1% 5.2%

-3.1% 11.2% -1.6% 0.3% 6.9% -5.6% -12.5%

0.3% 8.6% 3.8% 0.0% 12.6% -0.1% -12.7%

-22.4% 12.6% -0.3% 1.0% -9.2% -11.1% -2.0%

The largest deterioration in the fundamental fair value was not surprisingly in peripheral countries. Portugals fair value estimate would have declined the most (-14%) followed by Ireland (-9.6%) and Finland (-9.2%). Belgium (+12.6%), Netherlands (+8.8%), and Austria (+6.9%) had the largest rise to fair value. Note that Belgium is the only country that received a positive contribution from the debt/GDP variable. To calculate the misalignment from fair value, we take the change to the fair value estimate and the change to actual REER since 1999, and then take the difference between the actual REER and the fair value estimate.3 The misalignments are presented in table 1. Positive values suggest the new currency should be weaker. Estimating the theoretical fair value of hypothetical currencies will likely have a wide margin of error. For example, the model coefficients were estimated using data from existing currencies that may or may not share similar characteristics to new country-level euro currencies. As a confidence check, we compare the misalignments in figure 1 to other commonly used metrics for euro area countries.

account (%GDP) data and figure 3 looks at the change to the current account since 1999. The change shows the improvement/deterioration in each countrys external position since the EMU formed. We use two sample periods in figure 3 because many countries have reduced imbalances between 2010 and 2012. But this improvement is partly due to weaker domestic demand (e.g. Ireland) and therefore the more balanced current account will underestimate the extent of necessary FX adjustment. We focus more on the shorter 1999 2010 sample. Results are generally consistent with the REER misalignments in table 1. Countries like Germany, Austria, and Netherlands would likely have stronger currencies than the current EUR, while peripheral countries (Greece, Italy, Portugal, and Spain) would require a weaker currency to reduce imbalances. However, current account metrics in figure 3 do not suggest a large exchange rate adjustment in Ireland. The deterioration in the Irish current account between 1999 -2009 by about 5-6% is likely a better gauge
Figure 3: Change to current account (% GDP)
Chart shows the change to the current account balance (%GDP) for two sample periods

Current account
Euro area countries' external position is one metric for assessing the exchange rate adjustment in an EMU exit scenario.4 Figure 2 on the previous page shows level current

8 6 4 2 0 -2

1999Q1 - 2010Q2 1999Q1 - Present

Austria

Netherlands

France

Spain

Belgium

Ireland

Finland

Germany

Portugal

See also research on Euro area current account imbalances in Flows & Liquidity: Current account progress and risks July 20, 2012.

Source: Bloomberg 23

Greece

Italy

The fair value model coefficients were estimated using the JP Morgan real broad effective exchange rates (CPI and PPI deflator). This series does not include intra-euro countries so we use the BIS real broad effective exchange rate indices (based on CPI) as an alternative.

-4 -6 -8 -10

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

Global FX Strategy 10 August 2012

of the required FX adjustment and consistent with the fair value model overvaluation. Also, the current account data provide different signals than the fair value model for Belgium, Finland and France. The model suggests a new Belgium currency should appreciate significantly despite a current account balance close to zero. France has a marginal current account deficit, but also a small REER undervaluation. Finlands current account lines up with the fair value misalignment, but the deterioration in the current account suggests a weaker currency.

Figure 4: ECB Harmonized Competiveness Indicators (based on unit labor costs)


Values above (below) 100 suggest deterioration (improvement) in cost competitiveness since 1999

140 130 120 110 100 90 80


Austria

Current index level (2012Q1)

Peak level

Competiveness indicators
One final metric for assessing Euro area misalignments are the ECBs Harmonized Competiveness Indicators (HCI) based on unit labor costs (ULC).5 This series can be used as a proxy for competitiveness and ULC differentials in the euro area, which the IMF notes are important aspects of the Euro area's growing current account divergences. Figure 4 shows the current level of the HCIs and the peak level of the series in 2008-09. The base year for the indices is 1999 when the value was 100. So current values above 100 suggest a deterioration in cost competiveness (e.g. Ireland) and values below are an improvement (e.g. Germany). Apart from Ireland, the loss of competitiveness in the periphery was relatively modest (see peak level bars), but the divergence from Germany and Austria is large. The HCIs confirm Germany and Austria's substantial undervaluation in the fair value model. In addition, Germanys large divergence from pre-EMU levels (around 80) suggests that Germanys competitiveness is a bigger problem for euro stability than peripheral countries competitiveness (which is close to pre-EMU levels around 100). A vital aspect of the euro survival will be some internal adjustment, which reduces the justification for external adjustment via currency redenomination. REER misalignments can be reduced by some internal deflation in the periphery. For example, Irelands competitiveness (as proxied by the HCI) deteriorated significantly more than any other country between 1999 and 2008, and then returned close to pre-EMU levels at 100. However, the

France

70
Germany

Netherlands

Spain

Finland

Greece

Portugal

Belgium

Source: ECB

divergence between Germany and peripheral countries remains large. The chart suggests a more effective way to restore equilibrium exchange rates is for Germany to run relatively higher inflation.

Conclusions
This note presented REER misalignments and examined other metrics for comparison. Table 2 (next page) summarizes all of these results. The highlighted cells suggest the new theoretical currency will depreciate based on the metrics in the first column and white cells suggest the opposite. From table 2, one can infer the following about likely exchange rate adjustment in an EMU breakup scenario: Most likely to strengthen: Germany and Austria Likely to strengthen: Netherlands Likely to weaken: Spain, Ireland Most likely to weaken: Greece, Italy, Portugal Signals less clear: Belgium, Finland, France

The ECBs HCI indices provide measures of euro area countries' cost competitiveness. The series are equivalent to effective exchange rates but are deflated using unit labor costs for the total economy, calculated as the ratio of the compensation per employee and labour productivity (with labour productivity measured as GDP at constant prices divided by the total number of persons employed).
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The REER undervaluation for Belgium, Finland, and France is not supported by the other metrics we examined in this paper. But the misalignment/imbalances for Finland and France are generally small suggesting only a modest exchange rate adjustment in these countries. Belgium is the most notable outlier. Flow measures such as the current account do not signal significant exchange rate appreciation. But the fair value model suggests a large

Ireland

Italy

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

Global FX Strategy 10 August 2012

Table 2: Summary results of various metrics


The highlighted cells suggest currency depreciation

Metrics 1. REER misalignments 2. CA (%GDP) 3. Change to CA (1999Q1 - 2010Q2) 4. HCI


Source: J.P. Morgan.

Austria Belgium Finland -12.5% 1.95 4.56 93.3 -12.7% -0.77 -4.75 101.6 -2.0% -0.66 -4.01 101.8

France -6.4% -2.26 -3.95 101.8

Germany -18.9% 5.72 6.91 81.5

Greece 12.6% -8.78 -7.74 104.1

Ireland 16.2% 0.08 -2.49 107.9

Italy 3.4% -2.78 -4.37 104.8

Netherlands Portugal -12.1% 9.22 2.35 103.1 17.4% -5.42 -3.96 103.8

Spain 5.2% -3.27 -3.58 99.2

undervaluation, which is consistent with Belgiums net international investment surplus that trails only Germany and the Netherlands.

Caveats
The long-term fair value model is not designed to capture the immediate currency impact of an EMU exit such as capital flight related to redenomination risks or the resulting economic dislocations for creditor and debtor countries alike (see Answers to 10 common questions on EMU breakup, Normand and Sandilya, December 9, 2011). Rather the model misalignments are one approach for assessing the medium-term direction and magnitude of adjustment if a country were to exit the EMU.

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Global FX Strategy 10 August 2012

Research Note

Introducing Daily FX Strategy Analytics: available on iPad & www.morganmarkets.com


J.P. Morgans Daily FX Strategy Analytics are a set of eight reports covering rule-based trading models, valuation measures and industry positioning proxies developed by the Global FX Strategy team over the past several years. Many of these frameworks will be familiar to clients who have followed the Investment Strategies series of quantitative research notes or who subscribe to FX Markets Weekly. Chartpacks now present all such tools in a high-frequency, user-friendly format to assist in tactical trading and hedging. This product note details the methodology for each model or indicator and highlights the daily reports features. Two chartpacks comprise eight standalone reports (more to be added in future), most of which are singleslide: (1) global FX carry buys high-yielding currencies versus low-yielding ones for G-10, emerging markets and global baskets; (2) interest rate momentum buys currencies in whose favour interest rate expectations have moved over the past month; (3) carry plus rate momentum buys high-yielding currencies only if rate expectations in that country are also rising, so combines models (1) and (2); (4) spot momentum plus rate momentum buys currencies exhibiting both price and interest rate momentum, so combines standard price momentum and model (2); (5) spot mean reversion sells (buys) currencies that have appreciated (depreciated) significantly in the recent past; (6) fund manager performance tracks return composites for institutional investors active in currency trading, such as global macro hedge funds, currency managers and emerging markets funds; (7) positioning proxies and style indicators employ regressions to measure the degree to which managers are exposed to major funding currencies (USD, EUR) or investment styles (carry, momentum). (8) daily fair value regressions link spot rates econometrically to cyclical drivers to identify currencies most vulnerable to a short-term correction due to significant under- or overvaluation. All reports can be accessed daily by approximately 9AM London time through iPad or on www.morganmarkets.com/GlobalFXStrategy.

Eight daily reports for tactical trading and hedging


J.P. Morgans Daily FX Strategy Analytics are a set of eight reports covering rule-based trading models, valuation measures and industry positioning proxies developed by the Global FX Strategy team over the past several years. Many of these frameworks will be familiar to clients who have followed the Investment Strategies series of quantitative research notes or who subscribe to FX Markets Weekly. Chartpacks now present all such tools in a high-frequency, user-friendly format to assist in tactical trading and hedging. This product note details the methodology for each model or indicator and highlights the daily reports features. Two chartpacks comprise eight standalone reports (more to be added in future), most of which are single-slide: (1) global FX carry buys high-yielding currencies versus low-yielding ones for G-10, emerging markets and global baskets; (2) interest rate momentum buys currencies in whose favour interest rate expectations have moved over the past month; (3) carry plus rate momentum buys high-yielding currencies only if rate expectations in that country are also rising, so combines models (1) and (2); (4) spot momentum plus rate momentum buys currencies exhibiting price and interest rate momentum, so combines standard price momentum and model (2); (5) spot mean reversion sells (buys) currencies that have appreciated (depreciated) significantly in the recent past; (6) fund manager performance tracks return composites for institutional investors active in currency trading, such as global macro hedge funds, currency managers and emerging markets funds;

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Global FX Strategy 10 August 2012

(7) positioning proxies and style indicators employ regressions to measure the degree to which managers may be exposed to major funding currencies (USD, EUR) or investment styles (carry, momentum); and (8) daily fair value regressions link spot rates econometrically to cyclical drivers to identify currencies most vulnerable to a short-term correction due to significant under- or overvaluation. All reports can be accessed daily by approximately 9AM London time through two channels: on iPad for those users who have added the module Latest FX Research to their device (see blue box for product note detailing iPad set-up with the J.P. Morgan Research application); or on the Global FX Strategy website via URL www.morganmarkets.com/GlobalFXStrategy under the section Daily Quantitative Research Reports. The first seven reports are bundled as a single PDF called Daily FX Alpha Chartpack, given their brevity and the modular nature of some models serving as an overlay to others. The eighth report called Daily FX Fair Value Regressions is issued separately given its length (one slide each on dozens of USD pairs, EUR crosses and intraregional crosses). Previous J.P. Morgan reports cited in this publication and available on www.morganmarkets.com/GlobalFXStrategy: Alternatives to standard carry and momentum in FX, Normand, Aug 8, 2008 Rotating between G-10 and emerging markets carry, Normand, Jul 9, 2007 JPMorgans FX Barometer, Normand, September 22, 2004 Rebalancing VXY and Introducing VXY Global, Normand and Sandilya, March 25, 2011 Introducing the JP Morgan VXY and EM-VXY, Normand and Sandilya, December 11, 2006 Following Global FX Strategy on iPad and iTunes, Normand and Meggyesi, April 4, 2012

Explanatory notes for daily reports


Of the eight reports described in this product note, the first four have been discussed extensively in the research notes listed above in the blue box. Three others on manager performance, position proxies and short-term fair value will probably be familiar to regular readers of the flagship publications FX Markets Weekly where they are often referenced as inputs to J.P. Morgans currency outlook and trade recommendations. The mean-reversion model is newer work which is simple enough conceptually to explain in this note rather than as a standalone paper. The chartpacks now present all such models and indicators daily in a more user-friendly format to assist in tactical trading and hedging. Most reports are single-slide. 1. Global FX carry The global FX carry report outlines the pair selection process and tracks daily performance for a long-only FX carry strategy in G-10, emerging markets and globally. As opposed to the standard carry methodology which chooses pairs based on absolute yield differentials, this approach constructs baskets of the four currency pairs offering the highest risk-adjusted yield, or carry-to-risk ratio. It is analogous to an ex-ante Sharpe ratio on currency pairs, an approach found in previous J.P. Morgan research to outperform the conventional strategy of choosing pairs based on rate differentials alone. This metric was first proposed in the 2004 paper J.P. Morgans FX Barometer (see blue box), so returns since that date are out-of-sample. Carry-to-risk is calculated as the 1-mo interest rate differential divided by the annualised daily volatility of spot for G-10 and 1-mo forwards/NDFs for emerging markets currencies over the past 20 trading days. (1-mo forwards are used for the volatility calculation on emerging market currencies since central bank management of spot rates understates some currencies underlying risk.) Rate differentials are based on implied yields calculated from 1mo FX forwards, spot and 1-mo US swap rates. The G-10 universe comprises 15 eligible pairs: AUD, CAD, CHF, EUR, GBP, JPY, NOK, NZD and SEK versus USD; CHF, GBP, NOK and SEK versus EUR; and EUR and USD versus JPY. The emerging markets universe comprises 22 pairs, all versus USD: ARS, BRL, CLP, COP, MXN, PEN, CNY, IDR, INR, KRW, MYR, PHP, SGD, THB, TWD, CZK, HUF, ILS, PLN, RUB, TRY and ZAR. Currencies in the G-10 and EM universes are ranked by carry-to-risk as shown in table 1 of the report, and the four pairs in each set with the highest CTR are purchased for the G-10 and EM strategies. The global carry basket also comprises four currencies two each from the G-10 and EM universes. This restriction is imposed to control for liquidity differences between G-10 and EM currencies,
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Global FX Strategy 10 August 2012

since an unconstrained basket would almost always favour EM pairs for their higher yield. Baskets are rebalanced monthly on the last business day. Turnover is infrequent since the rank order of currencies' yield is stable, so transaction costs are trivial. Table 1 of the report lists the carry, volatility and carry-torisk ranking for all eligible pairs (exhibit 1). Table 2 list the baskets current holdings and performance statistics over the past week, month, three months, year and year-to-date. Chart 1 plots returns for each strategy indexed to January 1998 = 100. Annualised annual returns over the past 5, 10 and 15 years for all models are provided on the sixth report comparing rule-based strategies to active managers.
Exhibit 1: Global FX carry report

yielder, since funding currencies can rally too if their yield deficit diminishes. The model involves three parameters: (1) the reference interest rate used to capture monetary policy expectations over the near term (we use 1-month swap rates 3 months forward); (2) the lookback period over which the change in spread is measured (we use past month, or 21 trading days); and (3) the rebalancing frequency indicating how often the change in spreads is calculated and trades executed (we use daily). The 2008 paper provides extensive discussion of the models performance sensitivity to choice of inputs. Table 1 on the daily report outlines the trade selection process for the dollar (top half) and for the euro (bottom half) versus all major currencies. For each bloc, the top line indicates the current signal for USD (or EUR) versus the reference currency; the change in spreads in basis points over the past month that has generated the signal; and returns from trading the signals over the past week, three months, one year and year-to-date (exhibit 2) Table 2 provides another perspective on signals and returns. For the USD pairs and the EUR crosses, the table lists current positions extracted from table 1 and the returns from trading all signals in the bloc over the past week, month, three months year and year-to-date. As a consistency check, note that the returns in table 2 for the USD bloc match the average returns across pairs for the dollar in table 1. The same cross-check applies to EUR pairs. Chart 2 plots the basket returns since 2008. Since this models parameters were determined in the 2008 paper (see blue box), returns since then are out-of-sample.
Exhibit 2: Interest rate momentum report

Source: J.P. Morgan

2. Interest rate momentum The interest rate momentum strategy derives signals for currencies from changes in short-term interest rate expectations between two countries. The intuition is that currencies respond as much to changes in rate expectations (the rate momentum concept) as they do to current rate differentials (the standard carry concept). For example, rising rates relative to the rest of the world usually signal a countrys cyclical strength which draws capital inflows and sponsors currency appreciation, even for a low-yielding currency. Previous J.P. Morgan reports in 2004 and 2008 (see blue box) referred to this concept as Forward Carry since changes in rate expectations could be likened to investors forward-looking view of carry. In these new chartpacks we simplify the terms and rename this approach interest rate momentum to avoid more cumbersome expressions once we combine models 1 and 2 in the next sections. Applying interest rate momentum to FX trading follows the rule of buying the currency in whose favour rates have moved over some defined period, and selling the currency when that rate momentum reverses. The guideline applies regardless of whether the focus currency is a high or a low28

Source: J.P. Morgan

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

3. Carry plus rate momentum Given that any asset market could be driven by several factors which can reinforce or offset one another, signals should sometimes be combined into a composite indicator. Carry plus rate momentum thus combines the concepts of standard carry (model 1) and interest-rate momentum (model 2) in an attempt to better time entry into and exit from high-yield currencies. The traditional filter for carry trades employs so-called risk appetite measures, which are composites and often overfitted jumbles of volatility, credit spreads and sometimes commodity prices. J.P. Morgan's alternative, outlined in 2008 (blue box) focuses on more ordinary cyclical shifts which undermine carry trades too. That is, if currencies show an empirical tendency to rise and fall with changes in spreads between countries the conclusion from the previous interest rate momentum model then the riskiest carry trades would be high-yield currencies where cyclical conditions were deteriorating and rates falling. The safest trades would be high-yield currencies in which the economy were accelerating and rates rising. The strategy captures this dynamic by using interest rate momentum as an overlay to carry through three steps: (1) each month, rank currencies by their carry-to-risk ratio as described in the global FX carry report; (2) for each currency, also measure the change in rate expectations over the past month as described in the interest rate momentum report; and (3) hold only higher-yielding currencies which also exhibit interest-rate momentum. The daily report maps the process. Table 1 presents daily calculations for carry-torisk and interest-rate momentum (exhibit 3). To minimise transaction costs, however, the model only rebalances once per month, when the standard carry basket rebalances. Table 2 shows those monthly positions and returns. Chart 1 compares the performance of the overlay strategy to the performance of its components of G-10 carry (model 1) and rate momentum (model 2).

Exhibit 3: Carry plus rate momentum report

Source: J.P. Morgan

4. Spot momentum plus rate momentum Just as rate momentum can overlay carry, it can also filter pairs for a traditional spot momentum model. Typical momentum frameworks involve only two parameters: the momentum measure and the rebalancing frequency. Momentum can be defined as simple momentum, which calculates equally-weighted performance over a lookback period, or an exponentially-weighted moving average, which places more emphasis on recent observations. The rebalancing frequency can be of any length intraday, daily, weekly, monthly. For simplicity, and to fit the approach of most investment managers, this model focuses on daily horizons rather than on intra-day ones more common to algorithmic accounts. Previous J.P. Morgan research in 2008 (see box) determined that simple spot momentum performed as well as exponentially-weighted moving averages, and that mediumterm momentum (1-year lookback) performed better than shorter-term models. As a refinement of the standard spot momentum strategy which buys currencies that have outperformed recently, we add an overlay based on the interest rate momentum model. So rather than hold all currencies exhibiting positive price momentum over the medium term, this model holds only those currencies that have appreciated over the past year (they exhibit positive spot momentum) and have also witnessed increases in rate expectations over the past month (they exhibit interest rate momentum too). The intuition is that a medium-term price trend is more likely to persist if short-term cyclical momentum is also moving in the currencys favour.

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Global FX Strategy 10 August 2012

Exhibit 4: Spot momentum plus rate momentum report

In this model, extraordinary moves are defined as spot gains or losses of 1-sigma, 2-sigmas or 3-sigmas over the prior five trading days based on London closing spot rates. The trading rule is to position in the opposite direction to profit from potential mean reversion. The position is held over the next five trading days and performance statistics such as spot return and success rate (ratio of profitable trades to total trades) are calculated. Trading signals generated within that five-day holding period are ignored for the purpose of return statistics calculations; fresh signals contribute to performance statistics only if they are generated after the five-day holding period elapses. The daily report highlights those pairs which have posted 1, 2 or 3-sigma moves over the past five days (exhibit 5). It also provides performance statistics for the contrarian trading rule over three sample periods of the past year, five years and ten years. Based on success rates and profitability, the grid characterises a signals conviction on a high-to-low scale: High: 70%+ success rate and 1% average profit. Relatively high: 60%+ success rate and 0.5% average profit. Medium: 51%+ success rate and 0.25% average profit. Relatively low: 50%+ success rate and 0% average profit & below medium. Low: all others. Unlike the previous four models, daily signals from the mean reversion model are not amenable to aggregation into a basket of trades as a consistent investment strategy. This is due to the nature of technical mean-reversion models. If mean reversion occurs most predictably after two or threesigma moves but these are by definition rare events, then the model will rarely hold positions. When the models does position, it may hold exposure for only a few days. Compare the approach to carry, which is almost always invested in some number of high-yielders, or rate momentum, which is always long or short some pairs, and it becomes clearer that this mean-reversion signal is intended for intra-week traders targeting modest, infrequent retracements.
Exhibit 5: Spot mean reversion report

Source: J.P. Morgan

Table 1 of the daily report outlines the pair selection process (exhibit 4). Column 1 lists all eligible pairs, column 2 calculates the change in spot over the past year and column 3 shows the signal based on price momentum alone. Columns 4 and 5 then calculate the change in rate spreads over the past month and the corresponding rate momentum signal. These figures are identical to spread movements reported in table 1 of the interest rate momentum report, since that models trading rule is the overlay in this framework. Column 6 determines which pairs should then be held because they exhibit a medium-term price trend and short-term rate momentum. Currencies which meet both criteria are selected for inclusion in the basket shown in table 2 (last line). Basket returns are plotted in chart 1 and compared to standalone strategies of spot momentum and rate momentum. 5. Spot mean reversion Mean-reversion models can be constructed in several ways ranging from the fundamental econometric (report 8 to be discussed later) to the technical. This fifth report focuses on technical models which are simple to construct by backtesting the profitability of a counter-trend strategy following extraordinary spot moves in either direction. The intuition is that market moves which are outsized in a statistical sense represent an overreaction to positive or negative news, or an irrational optimism or pessimism. Thus when investors have more complete information on events, markets retrace. This phenomenon is so well documented in the behavioural finance literature and exploited through the Investment Strategies series than it merits little more discussion in this note. The issue is whether a trading rule can identify over and undershoots and profitably trade their mean reversion.

Source: J.P. Morgan

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Global FX Strategy 10 August 2012

6. Fund manager performance Fund manager performance is tracked on the alpha chartpacks first slide under a summary of signals and performance from the model-driven strategies. Since models are an attempt to replicate common investment styles, manager returns are one benchmark for assessing their value. There is no single-best manager composite for institutional investors who actively trade currency, hence this slide's provision of several groupings covering currency funds (those which trade only or primarily currencies) and hedge funds (global macro and emerging markets). For currencies, we use the HFR Currency Index, Barclay Currency Trader Index, Barclay BTOP and Parker-Blacktree; for global macro funds, the HFR Macro Index; and for emerging markets, the HFR Emerging Markets Total and Composite indices (exhibit 6). Note that half of manager composites report their returns monthly (usually two to three weeks after month end) and half report daily (with a one to five-day lag). Since the J.P. Morgan models are updated every weekday based on the previous days closing market levels, there is an inevitable reporting mismatch versus industry composites. Since we are generally only interested in return trends over some medium-term horizon such as the past quarter or year, this gap is not so meaningful.
Exhibit 6: Fund manager performance

of that beta relative to its long-term trend can suggest whether manager are extremely long or short the currency. This approach holds several shortcomings, which we readily admit. First, the approach is most conclusive for currency managers rather than global macro funds or emerging markets fund managers, since the later two groupings invest in multiple asset classes. Second, the approach is more valid for determining exposure to currencies which managers almost certainly hold exposure to like USD, EUR or JPY by virtue of those currencies being dominant funding currencies. Calculating the same beta for manager returns with respect to AUD, for example, would be misleading since the manager could be exposed to a range of high-yield or commodity or Asian currencies which correlate well with AUD. With these caveats in mind, the report charts three positioning proxies (top row) and three style indicators (bottom row). Charts 1 to 3 plot the rolling 30-day beta from regressing daily fund manager returns on the tradeweighted dollar and trade-weighted euro (exhibit 7). For currency managers, charts 1 and 2 plot the average beta for two daily manager series (Barclay BTOP and ParkerBlacktree) and for global macro funds, chart 3 plots the beta for the daily HFR Macro index. Note that the reporting delay on various monthly manager series renders these data too stale to use as a high-frequency position proxy. Charts 4 to 6 regress manager returns on three styles global carry, spot momentum and interest rate momentum for USD and EUR pairs to test for evidence that currency managers are following these approaches. For example, a high, positive beta with respect to carry suggests that managers are quite long of high-yield currencies. A high, positive beta with respect to the spot momentum strategy suggests that managers are invested in trend-following strategies.
Exhibit 7: Positioning proxies and style indicators

Source: J.P. Morgan

7. Positioning proxies and style indicators Manager returns can be used to infer positioning in major funding currencies and dominant investment styles. For example, if a group of investors is known to focus on currencies (e.g. currency overlay funds) and currency investors almost always hold either long or short exposure to the dollar, then a positive (negative) beta between currency manager returns and the trade-weighted dollar suggests that managers are long (short) the dollar. The level

Source: J.P. Morgan

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Global FX Strategy 10 August 2012

8. Daily FX fair value regressions Daily fair value regressions are an alternative for determining a currencys vulnerability to mean reversion because the spot rate has significantly over or undershot the change in underlying fundamentals. This approach differs from a technical overshooting model in that a regression linking spot to several cyclical variables determines whether a currency is rich or cheap, as opposed to a technical framework which bases that decision on the currencys level or the magnitude of a recent move. The intuition is that value is context-dependent, so AUD/USD at 1.10 seems expensive in level terms but would not seem unusual if the Chinese economy were expanding at 10% per annum, driving commodity prices and Australian rates higher. The approach is thus as follows. Each slide in the chartpack presents daily regression results for a currency pair over four sample periods of the past 3 months, 6 months, 1 year and 2 years. Models regress the log-level of the spot exchange rate on the level of cyclical variables such as short-term interest rate spreads (1-mo rates 12-mos forward to capture expected rate changes); commodity prices (oil or CRB index); equity volatility (VIX) and sovereign spreads (simple average of 5-yr spreads between Italy, Spain, Portugal and Ireland versus Germany). Conceptually, these regressions should be tailored more specifically to each market, but in the interest of simplicity, we choose roughly equivalent specifications across pairs. Data availability also drives the choice of variables, since some quite sensible inputs like a country-specific basket of commodity prices are not published on a daily basis. The top row of graphs show the regression line and scatter plot over the four sample periods, and the bottom row plots the residual (difference between actual and predicted spot rate) as a percentage of spot. The regression equation is listed at the bottom of each slide, and the regression coefficients and R2 above the scatter plots (exhibit 8). For scatter plots, the x-axis displays values for a single variable (rate spreads in exhibit 8) while the y-axis shows the spot rate adjusted for the remaining variables. Thus in a multivariate regression of the form Y = a1 + b1x1 + b2x2 + b3x3, the scatter plot y-axis shows (Y a1 b2x2 b3x3) versus the x1 variable. This is the standard way of presenting a scatter plot in two dimensions for a multivariate regression. For the residual plots, a positive (negative) value indicates that the base currency is strong (weak) for the given level of fundamentals. Although we have not tested for a degree of misalignment associated systematically with mean reversion, we have observed in practice that roughly 3%-5% mispricings in either direction have tended to flag reversals within two to three months.
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Exhibit 8: Daily fair value regressions for EUR/USD

Source: J.P. Morgan

Since the models employ log levels on the y-axis, coefficients are interpreted as follows (using EUR/USD as an example): as inputs into the regression, x1 (rate differentials) is expressed in percentage points, as is x2 (S&P500 implied volatility or the VIX) and x3 (average 5-yr peripheral spreads to Germany). So based on a regression run over the past year, EUR/USD rallies 1.7% for every 10bp widening in the spread between Euro and US 1-mo rates 12-mo forward, and sells off 1.1% for every 100bp widening of peripheral spreads. In addition to providing regressions on dozens of pairs, the packet summarises results across currencies on the first two slides (exhibit 9). Traditionally, we have used this grid to screen for currencies that appear to be the most mispriced, and hence most vulnerable to a near-term reversal.
Exhibit 9: Summary of fair value mispricings across currencies

Source: J.P. Morgan

Justin Kariya (1-212) 834-9618 justin.p.kariya@jpmorgan.com Anna Hibino (61-2) 9003-7932 anna.hibino@jpmorgan.com

Global FX Strategy 10 August 2012

Market movers
(all times BST; +9hrs for Sydney, +8hrs for Tokyo, -5hrs for New York)
Date Aug 13 (Mon) Country Japan Euro area New Zealand Aug 14 (Tue) UK Japan Australia India Switzerland Sweden 00:50 10:00 23:45 00:01 00:50 02:30 07:30 08:15 08:30 08:30 08:30 UK Euro area 09:30 09:30 06:30 07:00 10:00 10:00 10:00 10:00 10:00 US 12:30 13:30 13:30 15:00 Aug 15 (Wed) Australia Norway UK 01:30 02:30 09:00 09:30 09:30 09:30 09:30 Data/Event JPM GDP (%q/q, saar) Italy sells bills Retail sales ex inflation (%q/q) RICS house price survey (%bal, sa) All sector activity index (%m/m, sa) NAB business confidence (%bal, sa) WPI (%oya) Producer and import prices (%m/m) IP (%m/m, sa) CPI (%oya) CPI core (%oya) CPI (%oya) CPI core (%oya) France GDP flash (%q/q, sa) Germany GDP flash (%q/q, sa) IP (%m/m, sa) ZEW business survey (index) Germany ZEW business survey (index) GDP flash (%q/q, sa) Greece to sell 3.125bn 3-month bills NFIB small business survey (index, sa) PPI (%m/m, sa) Retail sales (%m/m, sa) Business inventories (%m/m, sa) Westpac consumer confidence (%m/m, sa) Wage cost index (%q/q, sa) Trade balance (NOK, bn) BoE MPC minutes Claimant count (000's ch, m/m, sa) Average weekly earnings (3M, %oya, sa) Unemployment rate (%, sa) Jul Jun Jun na na na 4.9 1.8 8.1 (Jun) (May) (May) 4.9 1.5 8.1 Jul Jul Jul Jun Aug 2Q Jul na na na na 1.0 0.9 na na 0.2 0.3 0.3 na na na (May) (Jun) (Jun) (May) (Jul) (1Q) (Jun) 91.4 0.1 -0.5 0.3 3.7 0.9 29.5 2Q Jul Jun Jul Jul Jul Jun Jul Jul Jul Jul 2Q 2Q Jun Aug Aug 2Q 0.6 na -0.5 -3.0 na na na na na na na na na na na na na 0.3 -24 -0.3 na 7.2 na -1.0 0.8 0.8 2.3 2.0 -0.2 0.1 -0.7 na -19 -0.2 (1Q) (Jun) (May) (Jun) (Jun) (Jun) (May) (Jun) (Jun) (Jun) (Jun) (1Q) (1Q) (May) (Sep) (Jul) (1Q) -0.6 -22 0.7 -3 7.25 -0.3 3.5 1.0 0.9 2.4 2.1 0.0 0.5 0.9 -22.3 -19.6 0.0 2Q 2.0 Forecast Consensus 2.3 (1Q) 4.7 Previous

33

Justin Kariya (1-212) 834-9618 justin.p.kariya@jpmorgan.com Anna Hibino (61-2) 9003-7932 anna.hibino@jpmorgan.com

Global FX Strategy 10 August 2012

Market movers
(all times BST; +9hrs for Sydney, +8hrs for Tokyo, -5hrs for New York)
Date Aug 15 (Wed) Country New Zealand US 09:30 13:30 13:30 13:30 14:00 14:15 14:15 15:00 Aug 16 (Thu) US Australia UK Euro area Turkey Canada US 01:00 06:45 09:30 09:30 10:00 12:00 13:30 13:30 13:30 13:30 15:00 Chile New Zealand Aug 17 (Fri) US Sweden Euro area 23:00 23:45 23:45 01:00 07:00 07:00 09:00 10:00 Canada US 13:30 13:30 14:55 15:00 Data/Event JPM Fonterra Milk Powder Auction Results Due Empire state mfg. survey (DI, sa) CPI (%m/m, sa) CPI core (%m/m, sa) TIC long-term net flows ($ bn) IP (%m/m, sa) Capacity utilization (%bal, sa) NAHB housing market index (sa) Fed's Kocherlakota speaks RBA's Debelle Speaks on Panel at Conference in Sydney Retail sales (%m/m, sa) Retail sales ex auto fuel (%m/m, sa) CPI (%oya) CBRT rate announcement Manufacturing sales (%m/m, sa) Initial jobless claims (000ch) Housing starts (000s, saar) Building permits (000s, saar) Philadelphia Fed index (DI, sa) BCCh rate announcement Producer prices inputs (%q/q) Producer prices outputs (%q/q) Fed's Kocherlakota speaks AMV unemployment rate (%) Germany PPI (%oya) Current account (EUR bn, sa) Trade balance (EUR bn, sa) CPI (%oya) CPI core (%oya) U. Michigan consumer confidence prelim (index) Leading indicators (%m/m, sa) Jul Jul Jun Jun Jul Jul Aug Jul na na na na na na na na 4.5 1.2 na 9.8 1.6 2.0 72.0 0.2 (Jun) (Jun) (May) (Apr) (Jun) (Jun) (Jul) (Jun) 4.4 1.6 10.90 6.3 1.5 2.0 72.3 -0.3 Jul Jul Jul Aug Jun 11-Aug Jul Jul Aug Aug 2Q 2Q na na na 5.75 na na na na na 5.00 na na -0.2 0.0 2.4 5.75 0.3 365 753 765 -4.0 5.00 na -0.2 (Jun) (Jun) (Jun) (Jul) (May) 04-Aug (Jun) (Jun) (Jul) (Jul) (1Q) (1Q) 0.3 0.1 2.4 5.75 -0.39 361 760 760 -12.9 5.00 0.3 -0.1 Aug Jul Jul Jun Jul Jul Aug na na na na na na na 7.0 0.2 0.2 na 0.5 79.2 34 (Jul) (Jun) (Jun) (May) (Jun) (Jun) (Jun) 7.39 0.0 0.2 55.044 0.43 78.9 35 Forecast Consensus Previous

34

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

Global FX Strategy 10 August 2012

Event risk calendar


Month August 2012 Date 14 27 29 31 31 September 2012 3 3 2-9 6 11 12 12 12 13 13-14 28 October 2012 4 7 8-9 10 12-14 18-19 24 23-24 25 Country Kenya US Brazil Switzerland US Hong Kong Euro area US APEC Euro area Euro area Euro area Euro area US New Zealand G20 Switzerland China China Euro area Venezuela Euro area Brazil IMF/World Bank Euro area Canada US Sweden Event Presidential election Republican Party Convention COPOM rate announcement SNB balance sheet items Bernanke Jackson Hole speech Legislative Council elections Eurogroup meeting Democratic Party Convention APEC 2012 Leaders Week in Vladivostok ECB rate announcement European Commission to detail proposal for single bank supervisor German Constitutional Court ruling on ESM/Fiscal Pact expected Netherlands parliamentary elections FOMC rate announcement RBNZ Monetary Policy Statement Meeting of Finance Ministers and Central Bank Governors SNB balance sheet items Chinese leadership transition 18th Congress of the Chinese Communist Party ECB rate announcement Presidential election Eurogroup/Ecofin meeting COPOM rate announcement IMF/World Bank annual meeting in Tokyo EU leaders summit BoC Monetary Policy Report FOMC rate announcement (incl. press conference) Riksbank Monetary Policy Report

35

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

Global FX Strategy 10 August 2012

Event risk calendar


Month October 2012 Date 28 31 31 31 November 2012 6 8 9 9-10 12 14 28 30 30 December 2012 6 6 11 13-14 19 28 January 2013 1 2 3 20 Country Ukraine Norway Euro area Switzerland US Euro area Australia G20 Euro area UK Brazil Romania Switzerland Switzerland South Africa Euro area New Zealand US Euro area South Korea Switzerland Ireland US US US Event Parliamentary elections Norges Bank Monetary Policy Report Euro area Bank Lending Survey SNB balance sheet items Presidential and Congressional elections ECB rate announcement RBA Statement on Monetary Policy Meeting of Finance Ministers and Central Bank Governors Eurogroup meeting BoE Quarterly Inflation Report COPOM rate announcement Parliamentary elections SNB balance sheet items Presidential appointment ANC elective conference ECB rate announcement RBNZ Monetary Policy Statement FOMC rate announcement EU leaders summit Presidential election SNB balance sheet items Ireland assumes EU Presidency US budget sequesttration begins (automatic spending cuts) Newly-elected US House and Senate take office US Presidential Inauguration Day

36

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

Global FX Strategy 10 August 2012

Central bank announcement dates in 2012/13


Australia Brazil Canada Chile Colombia Czech Republic Euro area Hungary India Indonesia Israel Japan Korea Malaysia Mexico New Zealand Norway Philippines Poland South Africa Sweden Switzerland Thailand Turkey United Kingdom United States 2012 AUG 7 29 16 31 2 2 28 9 27 9 9 SEP 4 5 13 28 27 6 25 17 13 24 19 13 6 7 13 13 5 20 6 13 5 18 6 13 OCT 2 10 23 18 26 4 30 30 11 29 5,30 11 26 25 31 25 3 25 17 18 4 24 28 20 8 NOV 6 28 13 23 1 8 27 8 26 20 8 8 30 DEC 4 4 13 14 19 6 18 11 20 13 2013 JAN FEB 5 MAR 5 6 APR 2 17 MAY 7 29 JUN 4 JUL 2 17

23

10

29

7 22

6 19 13 5 18 13 18 6 12

31

14

24

13

16 2 1

10 30

7 20

9 1

6 19

4 31

37

David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com

Global Economic Research 10 August 2012

Global central bank forecasts


Official rate Global excluding US Developed Emerging Latin America EMEA EM EM Asia The Americas United States Canada Brazil Mexico Chile Colombia Peru Europe/Africa Euro area Refi rate United Kingdom Bank rate Czech Republic 2-wk repo Hungary Israel Poland Romania Russia South Africa Turkey Asia/Pacific Australia New Zealand Japan Hong Kong China Korea Indonesia India Malaysia Philippines Thailand Taiwan Cash rate Cash rate O/N call rate Disc. wndw 1-yr working Base rate BI rate Repo rate O/N rate Rev repo 1-day repo Official disc. 2-wk dep Base rate 7-day interv Base rate Repo rate Repo rate Effctve rate Fed funds O/N rate SELIC O/N Repo rate Disc rate Repo rate Reference Current Change since (bp)
1 rate (%pa) 05-07 avg Trough Jul 11

Last change

Next mtg

Forecast next change

Forecast (%pa) Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13 2.25 2.95 0.52 5.52 6.21 5.09 5.42 1.45 2.17 2.85 0.42 5.46 6.21 4.97 5.37 1.45 0.125 1.00 7.50 4.50 5.00 4.50 4.25 1.48 0.50 0.50 0.25 6.50 2.00 4.50 5.25 5.25 4.50 6.75 3.63 3.25 2.50 0.05 0.50 5.75 2.75 5.50 8.00 3.00 3.50 2.75 1.625 2.17 2.85 0.43 5.45 6.21 4.83 5.41 1.48 0.125 1.25 7.50 4.50 5.00 4.50 4.25 1.45 0.50 0.50 0.25 6.00 2.00 4.25 5.25 5.25 4.50 6.25 3.63 3.00 2.75 0.05 0.50 5.75 2.75 5.50 8.25 3.00 3.50 2.75 1.625 2.18 2.85 0.43 5.46 6.21 4.88 5.41 1.48 0.125 1.25 7.50 4.50 5.00 4.50 4.25 1.46 0.50 0.50 0.25 6.00 2.00 4.25 5.25 5.25 4.50 6.50 3.64 3.00 3.00 0.05 0.50 5.75 2.75 5.50 8.25 3.00 3.50 2.75 1.625 2.25 2.94 0.44 5.64 6.63 4.89 5.55 1.58 0.125 1.50 8.25 4.50 5.00 4.50 4.25 1.46 0.50 0.50 0.25 6.00 2.25 4.25 5.25 5.25 4.50 6.50 3.73 3.00 3.00 0.05 0.50 6.00 2.75 5.50 8.25 3.00 3.50 2.75 1.625 2.28 2.99 0.44 5.73 7.06 4.92 5.55 1.67 0.125 1.50 9.00 4.50 5.00 4.50 4.25 1.46 0.50 0.50 0.50 6.00 2.50 4.25 5.25 5.25 4.50 6.50 3.73 3.00 3.25 0.05 0.50 6.00 2.75 5.50 8.25 3.00 3.50 2.75 1.625

2.32 3.04 0.52 5.71 6.53 5.28 5.58 1.52 0.125 1.00 8.00 4.50 5.00 5.00 4.25 1.71 0.75 0.50 0.50 7.00 2.25 4.75 5.25 5.25 5.00 7.85 3.78 3.50 2.50 0.05 0.50 6.00 3.00 5.75 8.00 3.00 3.75 3.00 1.875

-206 -128 -297 -137 -424 -117 -29 -380 -438 -273 -725 -337 31 -231 19 -215 -223 -444 -190 -13 -200 23 -294 N/A -329 -809 8 -244 -488 -17 -548 -14 -115 -412 113 -24 -331 -83 -71

48 56 0 82 20 134 107 36 0 75 0 0 450 200 300 16 0 0 0 175 175 125 0 N/A 0 210 87 50 0 0 0 69 100 0 325 100 0 175 62.5

-39 -45 -30 -56 -250 94 -40 -52 0 0 -450 0 -25 50 0 -25 -75 0 -25 100 -100 25 -100 N/A -50 160 -36 -125 0 0 0 -56 -25 -100 0 0 -75 -25 0 5 Jun 12 (-25bp) 10 Mar 11 (-50bp) 5 Oct 10 (-5bp) 7 Jul 12 (-31bp) 12 Jul 12 (-25bp) 9 Feb 12 (-25bp) 17 Apr 12 (-50bp) 5 May 11 (+25bp) 26 Jul 12 (-25bp) 25 Jan 12 (-25bp) 30 Jun 11 (+12.5bp) 7 Aug 12 13 Sep 12 9 Aug 12 9 Aug 12 9 Aug 12 17 Sep 12 6 Sep 12 13 Sep 12 5 Sep 12 3Q 12 Dec 12 (-25bp) 1Q 13 (+25bp) On hold On hold 3Q 12 (-25bp) 4Q 12 (-25bp) 4Q 12 (-25bp) 1Q 13 (+25bp) On hold 13 Sep 12 (-25bp) 4Q 12 (-25bp) 3Q 12 (-12.5bp) 5 Jul 12 (-25bp) 5 Mar 09 (-50bp) 28 Jun 12 (-25bp) 25 Jun 12 (-25bp) 9 May 12 (+25bp) 29 Mar 12 (-25bp) 14 Sep 11 (-25bp) 19 Jul 12 (-50bp) N/A 6 Sep 12 6 Sep 12 27 Sep 12 27 Aug 12 5 Sep 12 27 Sep 12 Aug 12 20 Sep 12 16 Aug 12 Oct 12 (-25bp) On hold 27 Sep 12 (-25bp) 30 Oct 12 (-25bp) 27 Aug 12 (-25bp) Nov 12 (-25bp) On hold On hold 20 Sep 12 (-50bp) N/A 16 Dec 08 (-87.5bp) 13 Sep 12 8 Sep 10 (+25bp) 11 Jul 12 (-50bp) 17 Jul 09 (-25bp) 12 Jan 12 (-25bp) 27 Jul 12 (-25bp) 12 May 11 (+25bp) 5 Sep 12 29 Aug 12 7 Sep 12 16 Aug 12 28 Sep 12 9 Aug 12 On hold 1Q 13 (+25bp) 29 Aug 12 (-50bp) On hold On hold 28 Sep 12 (-25bp) On hold

0.125 1.00 7.50 4.50 5.00 4.50 4.25 1.67 0.75 0.50 0.25 7.00 2.00 4.75 5.25 5.25 4.50 7.20 3.68 3.50 2.50 0.05 0.50 5.75 3.00 5.75 8.00 3.00 3.50 3.00 1.750

20 Dec 11 (+50bp) 28 Aug 12

17 Dec 08 (-100bp) 14 Sep 12

1 Refers to peak rate between 2007-08 and trough rate from 2009-present Bold denotes move since last GDW and forecast changes. Underline denotes policy meeting during upcoming week. Aggregates are GDP-weighted averages. Source: J.P. Morgan

38

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com Justin Kariya (1-212) 834-9618 justin.p.kariya@jpmorgan.com

Global FX Strategy 10 August 2012

J.P. Morgan FX forecasts vs. forwards & consensus


Exchange rates vs. U.S dollar Current Majors EUR JPY GBP AUD CAD NZD JPM USD index DXY Aug 10 1.23 78.2 1.56 1.05 0.99 0.81 82.2 82.9 Sep 12 1.22 78 1.56 1.01 1.02 0.77 82.8 83.3 Dec 12 1.24 78 1.58 1.02 1.02 0.77 83.0 82.2 Mar 13 1.25 80 1.58 1.02 0.99 0.77 82.8 81.8 Jun 13 1.25 80 1.58 1.04 0.98 0.78 82.7 81.7 JPM forecast gain/loss vs Dec-12* forward rate 1.0% 0.1% 1.3% -1.9% -2.2% -4.2% Consensus** 1.6% 1.9% 1.9% 0.0% -1.0% -2.5% Actual change in local FX vs USD Past 1mo 0.1% 1.9% 0.6% 2.7% 2.5% 1.8% -1.2% -0.9% YTD -5.5% -1.7% 0.3% 3.2% 2.7% 4.4% -0.3% 3.3% Past 12mos -14.0% -1.8% -4.0% 1.7% -1.1% -2.5% 5.3% 10.9%

Europe, Middle East & Africa CHF ILS SEK NOK CZK PLN HUF RUB TRY ZAR Americas ARS BRL CLP COP MXN PEN VEF LACI Asia CNY HKD IDR INR KRW MYR PHP SGD TWD THB ADXY EMCI Exchange rates vs Euro JPY GBP CHF SEK NOK CZK PLN HUF RON TRY RUB 96 0.786 1.20 8.19 7.28 25.16 4.09 278 4.53 2.19 39.14 95 0.780 1.20 8.55 7.45 26.50 4.20 290 4.60 2.22 40.24 97 0.785 1.15 8.50 7.35 25.80 4.25 290 4.65 2.23 40.01 100 0.790 1.15 8.45 7.30 25.60 4.25 285 4.70 2.19 39.89 100 0.790 1.15 8.40 7.25 25.70 4.20 280 4.65 2.19 39.89 -0.9% 0.3% 4.3% -2.9% -0.3% -2.3% -2.1% -2.1% -0.4% 0.5% 0.5% 0.3% 0.3% 4.3% 1.2% 0.8% -1.9% -1.2% 0.0% -4.5% -1.6% -1.6% 0.98 4.00 6.69 5.94 20.54 3.34 227 31.95 1.79 8.11 4.60 2.02 477 1792 13.31 2.62 4.29 104.8 6.36 7.76 9485 55.3 1130 3.12 41.86 1.25 29.96 31.46 115.5 95.4 0.98 4.00 7.01 6.11 21.72 3.44 238 32.98 1.82 8.40 4.90 2.00 490 1825 13.20 2.68 4.30 103.8 6.33 7.80 9700 54.0 1150 3.19 42.50 1.28 30.25 32.50 116.6 93.8 0.93 3.98 6.85 5.93 20.81 3.43 234 32.27 1.80 8.30 5.00 1.98 500 1825 12.50 2.68 4.30 105.5 6.30 7.80 9800 52.0 1150 3.22 42.50 1.30 30.50 32.50 119.7 95.0 0.92 3.95 6.76 5.84 20.48 3.40 228 31.91 1.75 8.20 5.20 1.95 500 1850 12.20 2.68 6.50 106.4 6.30 7.80 10000 55.0 1090 3.15 42.25 1.28 30.25 31.00 121.1 95.6 0.92 3.90 6.72 5.80 20.56 3.36 224 31.91 1.75 8.10 5.35 1.95 500 1850 12.00 2.70 6.50 106.6 6.25 7.80 9800 53.0 1090 3.10 41.50 1.27 30.25 31.00 121.1 96.62 1.2% -0.6% -1.8% 9.0% -0.8% -2.5% -1.4% -4.2% -2.1% -2.5% 0.0% -0.3% -4.0% 4.7% -1.7% -3.7% -1.2% -3.8% -2.5% -3.8% 5.4% 0.9% -1.9% 0.7% -1.3% -1.1% -1.1% 1.5% 1.6% -0.4% 2.7% 4.2% -2.7% 0.0% 6.5% -1.4% -0.1% 6.1% -3.3% 2.8% 2.5% -0.3% 0.4% 1.6% 0.0% 0.0% -3.6% -1.0% 1.0% -1.4% -1.4% 5.6% -1.9% 0.0% 0.1% -0.7% 4.6% 2.9% 0.9% 2.4% 3.9% 2.3% 1.2% 1.7% -1.3% 0.9% 3.1% -0.4% 1.2% 0.7% 0.0% 0.9% 0.1% 0.0% -0.5% 0.6% 0.9% 2.0% 0.0% 1.4% -0.1% 0.9% 0.4% 1.8% -4.3% -4.7% 3.0% 0.6% -3.9% 3.2% 7.0% 0.6% 5.7% -0.3% -6.5% -7.6% 8.8% 8.2% 6.0% 3.1% 0.0% 0.4% -1.0% 0.1% -4.4% -4.0% 1.9% 1.6% 4.7% 4.0% 1.1% 0.3% 0.3% 2.2% -22.3% -11.5% -3.0% -6.9% -17.1% -12.8% -15.3% -7.7% -0.4% -11.2% -9.6% -19.5% -1.3% -0.1% -6.6% 4.9% 0.0% -9.8% 0.5% 0.4% -9.9% -17.9% -4.3% -3.9% 1.6% -3.0% -3.2% -4.9% -3.5% -7.7%

Actual change in local FX vs EUR 1.9% 0.5% 0.0% 4.5% 2.8% 0.8% 2.4% 3.8% -0.2% 1.1% 2.3% 4.0% 6.1% 1.3% 8.8% 6.4% 1.7% 9.2% 13.3% -4.6% 11.8% 6.6% 14.2% 11.6% -9.7% 12.7% 8.3% -3.6% 1.4% -1.6% -5.2% 15.8% 7.1%

indicates rev ision resulting in stronger local FX , indicates rev ision resulting in w eaker local FX * Negativ e indicates JPM more bullish on USD than consensus,** Bloomberg FX Consensus Forecasts Source: J.P.Morgan

39

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

J.P. Morgan forecasts: rates, credit, equities & commodities


Interest rates
United States Euro area United Kingdom Japan GBI-EM hedged in $ Fed funds rate 10-year yields Refi rate 10-year yields Repo rate 10-year yields Overnight call rate 10-year yields Yield - Global Diversified Current 0.125 1.53 1.00 1.40 0.50 1.54 0.05 0.75 5.76 Current 199 254 647 953 346 411 Index JPMorgan JULI Porfolio Spread to Treasury iBoxx Euro Corporate Index JPMorgan Global High Yield Index STW iBoxx Euro HY Index EMBI Global JPM EM Corporates (CEMBI) Quarterly Averages Sep-12 0.125 1.75 0.75 1.00 0.50 1.35 0.05 0.85 Dec-12 0.125 2.00 0.50 0.90 0.50 1.50 0.05 0.95 6.00 Mar-13 0.125 2.00 0.50 1.00 0.50 1.70 0.05 0.95 Jun-13 0.125 2.00 0.50 1.20 0.50 1.80 0.05 0.95 2.1% 5.9% YTD Return* 7.6% 5.6% 8.7% 11.7% 10.6% 9.8% 3.6% 3.8% 3.0% YTD Return*

Credit Markets
US high grade (bp over UST) Euro high grade (bp over Euro gov) USD high yield (bp vs. UST) Euro high yield (bp over Euro gov) EMBIG (bp vs. UST) EM Corporates (bp vs. UST)

Commodities
Brent ($/bbl) Gold ($/oz) Copper ($/metric ton) Corn ($/Bu)

Current 106 1618 7465 7.90

12Q3 95 1655 8000 7.50

12Q4 100 1725 8300 7.00

13Q1 105 1750 8500 6.80

13Q2 95 1775 8700 6.70

GSCI Index Energy Precious Metals Industrial Metals Agriculture

YTD Return* -2.5% 0.4% -2.7% 26.3%

Foreign Exchange
EUR/USD USD/JPY GBP/USD USD/BRL USD/CNY USD/KRW USD/TRY
YTD Return

Current 1.24 78.6 1.57 2.01 6.38 1138 1.81

Sep-12 1.22 78 1.56 2.00 6.33 1150 1.82

Dec-12 1.24 78 1.58 1.98 6.30 1150 1.80


US

Mar-13 1.25 80 1.58 1.95 6.30 1090 1.75

Jun-13 1.25 80 1.58 1.95 6.25 1090 1.75

3m cash YTD Return* index in USD EUR -4.3% JPY GBP BRL CNY KRW TRY 1.5% 2.0% -3.5% -0.5% 2.0% 9.5%

Europe YTD -4.3% 0.9% 7.1% 15.2% 11.2% 11.9% 1.9% 7.7% -2.5% -2.4% 4.8%

Japan
YTD -17.2% -14.9% -2.6% 0.4% 11.5% 7.8% 14.1% -12.1% 3.1% -21.1% -0.7%

EM
YTD ($) -5.8% -5.0% 2.7% 0.1% 8.2% 13.8% 5.1% 3.7% 9.5% 4.5% 2.2%

Equities
S&P Nasdaq Topix FTSE 100 MSCI Eurozone* MSCI Europe* MSCI EM $* Brazil Bovespa Hang Seng Shanghai SE

Current 1377 2945 726 5627 131 1042 916 55072 19275 2129

(local ccy) 9.4% 13.2% -0.7% 3.3% 3.9% 4.8% 2.2% -0.4% 7.4% -3.2%

Sector Allocation *
Energy Materials Industrials Discretionary Staples Healthcare Financials Information Tech. Telecommunications Utilities Overall

YTD 1.0% 4.2% 6.2% 12.2% 10.1% 10.7% 12.5% 11.7% 20.1% 6.8% 9.4%

*Levels/returns as of Jul 26, 2012 Local currency except MSCI EM $

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

40

David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com Carlton Strong (1-212) 834-5612 carlton.m.strong@jpmorgan.com

Global Economic Research 10 August 2012

Global growth and inflation forecasts


Real GDP
% over a year ago

Real GDP
% over previous period, saar

Consumer prices
% over a year ago

2011 The Americas United States Canada Latin America Argentina Brazil Chile Colombia Ecuador Mexico Peru Venezuela Asia/Pacific Japan Australia New Zealand Asia ex Japan China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Africa/Middle East Israel South Africa Europe Euro area Germany France Italy Spain United Kingdom Emerging Europe Bulgaria Czech Republic Hungary Poland Romania Russia Turkey Global Developed markets Emerging markets Memo: Global PPP weighted 1.8 2.4 4.2 8.9 2.7 6.0 5.9 7.8 3.9 6.9 4.2 -0.7 2.1 1.3 7.4 9.2 5.0 6.5 6.5 3.6 5.1 3.8 4.9 4.0 0.1 4.8 3.1 1.5 3.1 1.7 0.5 0.7 0.8 4.8 1.7 1.7 1.6 4.3 2.5 4.3 8.5 3.0 1.3 6.1 3.8

2012 2.2 2.1 2.9 3.3 1.7 5.0 3.5 4.0 3.6 6.0 5.5 2.6 3.2 2.5 6.1 7.7 1.9 6.0 5.0 2.5 3.0 5.3 2.2 1.1 3.5 2.9 2.5 -0.5 0.9 0.1 -2.2 -1.3 -0.6 2.7 1.0 -1.1 -1.2 2.8 0.8 3.6 2.8 2.5 1.2 4.7 3.0

2013 2.0 2.2 3.7 2.2 4.1 4.5 4.5 4.0 3.5 7.0 0.0 1.2 2.8 2.8 6.7 8.5 3.6 6.5 3.7 3.3 2.5 3.5 3.5 3.9 2.3 4.4 3.6 0.1 1.1 0.6 -1.0 -0.9 1.4 3.2 2.5 0.9 1.0 2.6 1.0 3.4 4.5 2.7 1.3 5.3 3.3

1Q12 2.0 1.9 3.2 3.6 0.8 5.7 1.1 2.8 5.3 8.2 10.9 4.7 5.3 4.7 7.2 6.8 1.6 5.8 4.8 3.5 5.1 10.2 10.0 1.3 52.1 3.0 2.7 0.1 2.1 0.1 -3.2 -1.3 -1.3 3.0 -3.1 -4.1 3.2 -0.5 4.6 3.0 1.7 5.6 3.7

2Q12 1.5 2.0 2.1 -4.5 2.4 3.5 2.2 3.5 2.1 5.5 6.0 2.0 1.3 0.4 5.5 6.9 3.0 6.3 4.0 1.5 1.0 3.6 -0.8 3.2 4.0 3.2 2.4 -1.0 0.5 -0.5 -2.5 -1.6 -2.8 -0.8 -1.3 -1.3 1.5 1.3 -1.5 1.7 0.5 3.8 2.2

3Q12 1.5 2.1 4.0 8.0 4.5 3.8 3.0 4.0 1.7 5.5 3.0 1.0 1.6 3.3 5.9 8.0 3.5 5.8 3.0 2.0 0.0 1.2 0.8 1.8 1.0 6.1 3.5 -1.0 0.3 -0.3 -2.5 -2.8 2.0 2.1 0.2 -0.5 1.5 -0.4 3.0 2.2 0.7 4.9 2.8

4Q12 2.0 2.0 3.8 6.0 4.6 5.0 3.5 4.0 3.4 6.0 -6.0 0.8 2.4 3.0 6.4 8.5 3.5 5.6 3.0 3.5 1.0 1.2 4.1 3.8 0.0 7.4 4.5 -0.5 0.5 0.0 -1.5 -2.0 0.5 2.9 0.9 0.5 2.0 2.8 3.5 2.5 0.9 5.3 2.8

1Q13 1.5 2.2 3.8 0.0 4.3 4.6 5.0 4.0 4.4 8.0 -1.0 1.0 4.4 2.3 6.8 8.7 3.0 6.2 3.5 3.5 2.0 4.5 4.1 4.5 2.0 4.5 3.7 0.5 1.5 0.8 -0.8 -0.5 1.5 3.3 1.5 1.0 3.0 1.6 4.0 2.8 1.2 5.5 2.8

2Q13 2.3 2.2 3.9 1.5 4.3 4.7 6.0 4.0 3.7 8.0 0.0 1.2 3.3 3.4 7.0 8.7 3.5 6.5 4.5 3.5 4.0 4.5 4.1 4.6 3.0 2.8 3.2 0.5 1.5 1.0 -0.5 0.5 2.0 3.0 -0.6 1.5 3.0 -1.2 4.0 3.0 1.5 5.6 2.8

3Q13 2.5 2.4 3.9 0.5 4.3 4.4 6.0 5.0 3.3 7.0 3.0 1.3 1.8 3.2 7.2 8.7 5.0 6.8 5.0 4.0 4.5 4.5 4.1 4.8 4.0 2.4 3.4 1.0 1.8 1.3 0.0 0.5 2.5 3.2 2.5 2.0 3.5 1.2 3.5 3.2 1.8 5.7 2.8

4Q11 3.3 2.7 7.2 9.6 6.7 4.0 3.9 5.5 3.5 4.5 28.5 -0.3 3.1 1.8 4.9 4.6 5.7 8.4 4.1 4.0 3.2 4.7 5.5 1.4 4.0 2.5 6.1 2.9 2.6 2.6 3.7 2.7 4.6 6.4 2.4 4.1 4.6 3.4 6.8 9.2 3.8 2.7 5.7 4.2

2Q12 1.9 1.9 6.1 10.0 5.0 3.2 3.4 5.1 3.8 4.1 23.9 0.1 1.0 1.1 3.9 2.9 4.2 10.2 4.5 2.4 1.7 2.9 5.2 1.7 2.5 2.3 5.8 2.5 2.1 2.3 3.6 1.9 2.8 4.9 2.7 5.4 3.9 2.2 3.7 9.4 2.8 1.8 4.6 3.3

4Q12 1.5 2.1 6.0 10.0 4.9 3.1 2.9 4.2 4.0 2.9 23.4 0.1 1.5 2.5 3.4 2.4 2.5 9.8 3.9 2.2 1.1 2.3 3.1 2.1 1.3 2.5 5.6 2.1 1.7 2.2 3.4 2.9 2.1 5.5 2.9 5.3 3.4 4.4 6.1 6.5 2.6 1.6 4.4 3.0

2Q13 1.3 2.2 6.6 11.0 5.0 3.0 2.9 4.0 3.9 3.0 31.7 -0.3 2.2 2.7 3.9 3.3 2.4 9.3 3.4 2.8 1.1 2.4 2.4 1.9 1.9 2.1 5.7 1.6 1.4 1.8 2.9 2.4 1.8 5.4 2.5 3.3 2.8 4.0 6.7 5.8 2.5 1.3 4.8 3.1

Source: J.P. Morgan estimates. Note: For some emerging economies, 2010-2012 quarterly forecasts are not available and/or seasonally adjusted GDP data are estimated by J.P. Morgan. Bold denotes changes from last edition of Global Data Watch, with arrows showing the direction of changes. Underline indicates beginning of J.P. Morgan forecasts.

41

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

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42

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

Global FX Strategy 10 August 2012

Sovereign credit ratings and actions


S&P Rating Argentina Australia Austria Belgium Brazil Canada Chile China Colombia Cy prus Czech Republic Denmark Finland France Germany Greece Hong Kong Hungary India Indonesia Ireland Israel Italy Japan Malay sia Mex ico Netherlands New Zealand Norway Peru Philippines Poland Portugal Romania Russia Singapore Slov akia Slov enia South Africa South Korea Spain Sw eden Sw itzerland Taiw an Thailand Turkey United Kingdom United States Venezuela B AAA AA+ AA BBB AAA A+ AABBBBB AAAAA AAA AA+ AAA CCC AAA BB+ BBBBB+ BBB+ A+ BBB+ AAABBB AAA AA AAA BBB BB+ ABB BB+ BBB AAA A A BBB+ A BBB+ AAA AAA AABBB+ BB AAA AA+ B+ (-) (-) (-) (-) (-) (-) (-) (-) (+) (-) (-) (-) (-) (-) (-) (-) (+) View (-) (-) (-) Moody 's Rating B3 Aaa Aaa Aa3 Baa2 Aaa Aa3 Aa3 Baa3 Ba3 A1 Aaa Aaa Aaa Aaa C Aa1 Ba1 Baa3 Baa3 Ba1 A1 Baa2 Aa3 A3 Baa1 Aaa Aaa Aaa Baa3 Ba2 A2 Ba3 Baa3 Baa1 Aaa A2 Baa2 A3 A1 Baa3 Aaa Aaa Aa3 Baa1 Ba1 Aaa Aaa B2 (+) (-) (-) (-) (-) (-) (+) (-) (-) (-) (+) (+) (-) (-) (-) (-) (-) WR (+) (-) (+) (-) (-) (-) (+) View B AAA AAA AA BBB AAA A+ A+ BBBBB+ A+ AAA AAA AAA AAA CCC AA+ BB+ BBBBBBBBB+ A AA+ ABBB AAA AA AAA BBB BB+ AWD BBBBBB AAA A+ ABBB+ A+ BBB AAA AAA A+ BBB BB+ AAA AAA B+ (-) (-) (-) (-) (-) (+) (-) (-) (-) (-) (-) (-) (-) (-) WR (-) (-) (-) Fitch Rating View Recent S&P Action Rating 4-Apr-11 25-Feb-11 13-Jan-12 13-Jan-12 17-Nov -11 29-Jul-02 18-Dec-07 16-Dec-10 16-Mar-11 2-Aug-12 24-Aug-11 27-Feb-01 13-Jan-12 13-Jan-12 13-Jan-12 2-May -12 16-Dec-10 21-Dec-11 25-Feb-11 8-Apr-11 13-Jan-12 9-Sep-11 13-Jan-12 25-Feb-11 8-Oct-03 14-Dec-09 13-Jan-12 29-Sep-11 9-Jul-75 30-Aug-11 4-Jul-12 29-Mar-07 13-Jan-12 27-Oct-08 8-Dec-08 25-Feb-11 13-Jan-12 3-Aug-12 1-Aug-05 27-Jul-05 26-Apr-12 16-Feb-04 17-Feb-11 25-Feb-11 31-Oct-06 19-Feb-10 17-Feb-11 5-Aug-11 19-Aug-11 Outlook 23-Apr-12 17-Sep-07 13-Jan-12 13-Jan-12 17-Nov -11 18-May -07 16-Dec-10 16-Dec-10 16-Mar-11 2-Aug-12 24-Aug-11 26-Sep-07 13-Jan-12 13-Jan-12 13-Jan-12 7-Aug-12 16-Dec-10 21-Dec-11 25-Apr-12 8-Apr-11 13-Jan-12 9-Sep-11 13-Jan-12 26-Apr-11 27-Jul-11 28-Jul-11 13-Jan-12 29-Sep-11 28-May -09 30-Aug-11 4-Jul-12 27-Oct-08 13-Jan-12 29-Nov -11 27-Jun-12 2-May -08 13-Jan-12 3-Aug-12 28-Mar-12 12-Oct-07 26-Apr-12 22-Jan-07 1-Dec-03 11-Jun-10 9-Dec-10 1-May -12 26-Oct-10 5-Aug-11 19-Aug-11 Recent Moody's Action Rating 29-Jun-05 21-Oct-02 26-Jun-77 16-Dec-11 20-Jun-11 3-May -02 16-Jun-10 11-Nov -10 31-May -11 13-Jun-12 12-Nov -02 23-Aug-99 4-May -98 25-Feb-92 29-Apr-93 2-Mar-12 10-Nov -10 24-Nov -11 22-Jan-04 18-Jan-12 12-Jul-11 17-Apr-08 13-Jul-12 24-Aug-11 16-Dec-04 6-Jan-05 20-Feb-12 21-Oct-02 30-Sep-97 16-Dec-09 15-Jun-11 12-Nov -02 13-Feb-12 6-Oct-06 16-Jul-08 14-Jun-02 13-Feb-12 2-Aug-12 16-Jul-09 14-Apr-10 13-Jun-12 4-Apr-02 29-Jan-82 20-Jul-99 26-Nov -03 20-Jun-12 31-Mar-78 2-Aug-11 7-Sep-04 Outlook 14-Aug-08 24-May -06 13-Feb-12 16-Dec-11 20-Jun-11 24-May -06 16-Jun-10 11-Nov -10 31-May -11 13-Jun-12 8-Dec-08 24-May -06 24-May -06 13-Feb-12 23-Jul-12 2-Mar-12 10-Nov -10 6-Dec-10 20-Dec-11 18-Jan-12 17-Dec-10 17-Apr-08 12-Jul-12 24-Aug-11 24-May -06 24-May -06 23-Jul-12 13-May -99 13-May -99 21-Mar-11 29-May -12 24-May -06 13-Feb-12 29-Jun-12 12-Dec-08 14-May -03 13-Feb-12 2-Aug-12 9-Nov -11 2-Apr-12 13-Jun-12 15-Nov -03 15-Nov -03 24-May -06 28-Oct-10 20-Jun-12 13-Feb-12 2-Aug-11 15-Jan-09 Recent Fitch Action Rating 12-Jul-10 28-Nov -11 10-Aug-94 27-Jan-12 4-Apr-11 12-Aug-04 1-Feb-11 6-Nov -07 22-Jun-11 25-Jun-12 4-Mar-08 10-Nov -03 5-Aug-98 10-Aug-94 10-Aug-94 17-May -12 25-Nov -10 6-Jan-12 1-Aug-06 15-Dec-11 27-Jan-12 11-Feb-08 27-Jan-12 22-May -12 8-Nov -04 23-Nov -09 10-Aug-94 29-Sep-11 13-Mar-95 10-Nov -11 23-Jun-11 18-Jan-07 11-May -12 4-Jul-11 4-Feb-09 14-May -03 8-Jul-08 8-Aug-12 25-Aug-05 24-Oct-05 7-Jun-12 8-Mar-04 10-Aug-94 20-Nov -01 16-Apr-09 3-Dec-09 26-Oct-95 10-Aug-94 15-Dec-08 Outlook 12-Jul-10 28-Nov -11 15-Feb-08 27-Jan-12 4-Apr-11 22-May -07 1-Feb-11 11-Apr-12 22-Jun-11 25-Jun-12 13-Dec-11 18-Dec-07 11-Dec-07 16-Dec-11 6-Nov -07 17-May -12 25-Nov -10 6-Jan-12 18-Jun-12 15-Dec-11 27-Jan-12 11-Feb-08 27-Jan-12 22-May -12 9-Jun-09 23-Nov -09 26-Oct-07 29-Sep-11 18-Dec-07 10-Nov -11 23-Jun-11 10-Nov -08 24-Nov -11 4-Jul-11 16-Jan-12 7-Mar-08 8-Jul-08 8-Aug-12 13-Jan-12 7-Nov -11 7-Jun-12 18-Dec-07 11-Jun-07 26-Jan-11 19-Apr-10 23-Nov -11 14-Mar-12 28-Nov -11 4-Apr-12

Source: Ratings agencies via Bloomberg


RATING SCALE Upper Investment Grade S&P AAA AA+ AA AAA+ A ALower Investment Grade BBB+ BBB BBBNon-Investment Grade BB+ BB BBMOODY's Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 Fitch AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBDefault RATING SCALE Lower Non-Investment Grade S&P B+ B BCCC+ CCC CCCCC C SD D MOODY's B1 B2 B3 Caa1 Caa2 Caa3 Ca C Fitch B+ B BCCC+ CCC CCCCC C RD D

43

Anna Hibino (61-2) 9003-7932 anna.hibino@jpmorgan.com

Global FX Strategy 10 August 2012

Redemptions for -denominated marketable debt, 2012-2013


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 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Total 2012 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Total 2013 0 2 20 0 0 22 14 0 0 15 0 1 15 0 0 16 0 0 61 10 7 7 4 8 35 3 6 4 4 2 6 4 2 0 0 0 0 30 3 7 5 10 5 28 12 7 10 11 4 9 9 4 7 14 7 2 95 12 11 20 13 30 86 0 21 0 29 0 19 14 25 10 0 18 20 156 30 17 16 5 26 94 9 9 9 20 7 0 0 0 11 0 0 0 64 2 4 6 5 10 26 4 10 6 7 1 1 1 4 5 3 4 5 51 8 0 0 0 2 10 0 6 0 0 17 1 1 6 0 0 0 2 33 2 3 1 2 2 10 0 0 0 0 0 0 0 0 0 0 0 0 0 1 2 1 1 0 4 1 1 0 1 2 0 1 0 0 0 0 1 7 0 0 0 0 1 1 0 0 0 0 0 0 0 0 10 0 0 0 10 1 0 1 1 2 4 0 2 2 0 1 1 0 0 0 1 0 0 6 0 0 0 0 0 1 0 2 0 0 2 0 0 0 0 1 0 0 5 0 0 0 0 0 0 0 0 0 6 0 0 0 0 0 0 0 0 6 0 0 1 0 0 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 3 0 4 1 2 1 3 1 0 2 0 1 0 0 1 13 1 44 35 0 29 109 61 0 31 52 0 17 77 0 49 40 0 11 338 45 28 31 14 11 130 12 12 12 12 13 0 0 0 0 0 0 0 61 8 19 22 8 7 65 44 25 34 12 11 15 17 9 9 23 5 11 215 20 13 40 13 33 119 14 27 0 50 17 21 30 31 20 16 18 22 266 44 26 25 11 37 143 12 16 14 24 10 7 4 2 11 1 0 0 101 5 12 12 18 15 62 18 22 17 22 10 10 13 8 12 18 11 9 170

* Germany, France, Netherlands, Belgium ** Spain, Italy, Greece, Portugal, Ireland

Note: Marketable debt includes conventional bonds plus inflation linkers, floaters and zero coupon bonds for non-conventional bonds Source: J.P. Morgan

44

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

Prior Research Notes available on www.morganmarkets.com


Introducing Daily FX Strategy Analytics: available on iPad & www.morganmarkets,com, Normand, Aug 10, 2012 Intra-EMU currency valuations: Estimates for a breakup scenario, Kariya, Aug 9, 2012 The euro in a world with several Japans, Normand, Aug 2, 2012 Keeping it real: life after peak in Aussie terms of trade, Jarman & Kennedy, Jul 26, 2012 Some notable shifts in Japanese retail investments: From Toshin to Uridashi, and from BRL to other high-yielding EM FXs, Tanase & Hibino, Jul 18, 2012 JPM Euro survey results: Universally bearish, moderately short against all regions & unconvinced of EMU break-up or enlargement, Normand, Jul 17, 2012 India and Indonesia: two odd peas in the EM Asia pod, Ong & Chinoy, Jul 16, 2012 ECB to focus on monetary transmission in second half, Fuzesi & Mackie, Jul 13, 2012 RBAs job far from complete in this stop-start easing cycle Walters, Jul 13, 2012 Corporate hedging survey: This summer is different, Kariya, Hibino, Jul 6, 2012 Central bank balance sheet chartpack, Meggyesi, Jul 5, 2012 BoJs record high-current account deposits and USD/JPY Sasaki, June 29, 2012 Japan to hike the consumption tax: implications for the yen Sasaki, June 26, 2012 Still too early to become AUD bullish Hebner, June 22, 2012 What might a Euro area roadmap look like? Mackie, June 15, 2012 Examining JPYs valuation: has JPY been overvalued? Tanase & Hibino, June 15, 2012 UK: what has weaker sterling ever done for us?, Monks, May 25, 2012 The key issue is not the survival of the Euro area, but what sort of Euro area survives, Mackie, May 25, 2012 What should we expect after Hollandes victory? Brun-Aguerre, May 11, 2012 JPY: Now looking for a range in high 70's, Sasaki, Tanase & Hibino, May 4, 2012 Implications of the Dutch government collapse, Panageas, Apr 24, 2012 Is FX liquidity abnormally low? Normand, Apr 4, 2012 Can BoJ achieve its inflation goal? Adachi, Mar 29, 2012 China: determinants of CNY exchange rate, Zhu & Ng, Mar 23, 2012 Corporate hedging survey: Where have all the hedgers gone? Kariya, Mar 23, 2012 Short NZD/CAD and NZD/NOK, Hebner, Feb 23, 2012 Focus on current accounts why CHF is not following the yen weaker, Meggyesi, Feb 23, 2012 China: FX reserves to resume upward trend, Zhu, Ng & Jiang, Feb 17, 2012 Building Europes firewalls: a progress report, Barr & Mai, Feb 3, 2012 Asian FX and Japanese corporate earnings KRW/JPY is key, Tanase, Feb 1, 2012 Metals Review and Outlook, Jan 2012: Demand needs a Spark, Jansen & Fu, Jan 30, 2012 Portuguese second package unlikely to include PSI, Mai, Jan 27, 2012 Corporate hedging survey: Despite Euro stress, FX management practices mostly unchanged, Kariya, Kavuri, Hibino, Jan 20, 2012 Central bank balance sheet chartpack, Meggyesi, Jan 19, 2012 Commodity Currencies: Risks loom large for Q1 of 2012, especially for the AUD, Hebner, Sandilya, Kariya, Jan 10, 2012 M&A and FX in 2012: Japan/Europe rotation worth monitoring, Normand, Jan 9, 2012 JPY:New FSA regulations on overlay funds could narrow retail path to BRL, Tanase & Hibino, Jan 4, 2012 Answers to 10 common questions on EMU breakup, Normand & Sandilya, Dec 7, 2011

45

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

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46

John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

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John Normand (44-20) 7134-1816 john.normand@jpmorgan.com

Global FX Strategy 10 August 2012

J.P. Morgan Global FX Strategy


London
John Normand Paul Meggyesi Thomas Anthonj Matthias Bouquet MD MD ED VP Head, Global FX Strategy FX Strategy Technical Strategy Derivatives Strategy (44-20) 7134-1816 (44-20) 7134-2714 (44-20) 7742-7850 (44-20) 7134-1819 john.normand@jpmorgan.com paul.meggyesi@jpmorgan.com thomas.e.anthonj@jpmorgan.com matthias.bouquet@jpmorgan.com

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

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

Sydney
Anna Hibino Associate FX Strategy (61-2) 9003-7932 anna.hibino@jpmorgan.com

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