HSBC - Currency Outlook December

Currency
OUTLOOK
Opportunities NOK
Macro Currency Strategy December 2010
With the market so focused on the sovereign risk surrounding the EUR, we look to the NOK. Sovereign risk in Norway is practically obsolete as the government runs a substantial surplus on the back of a sound oil economy; however, the NOK has performed poorly this year. We believe the NOK should increasingly be trading on its strong fundamental merit and favour the currency going into 2011. The SDR Honey the IMF shrunk the yen The IMF recently announced new weights for the SDR valuation basket, which will come into effect on 1 Jan 2011. The largest impact of the new weighting scheme is likely to be negative for the JPY, both from a flow and a sentiment point of view. HKD peg mythbusters The HKD faces little risk from the rise of the RMB. The flexibility of current arrangements is underappreciated. A basket peg would offer no identifiable advantages over the current system.
Disclosures and Disclaimer This report must be read with the disclosures and analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it
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Summary
EUR 2011 retraces, reflects, recovers (pg 3)
In 2011, the idea that the EUR is here to stay dominates our view and quite frankly break-up fears are wildly exaggerated; but this does not mean the EUR will not retrace. Instead of seeing EUR-USD trade close to 1.35 through next year, we now see EUR-USD trading around 1.25 in the first quarter of next year as a point of reflection; after which USD weakness will start to reappear and the EUR will recover.
Opportunities NOK
(pg 4)
With the market so focused on the sovereign risk surrounding the EUR, we look to the NOK. Sovereign risk in Norway is practically obsolete as the government runs a substantial surplus on the back of a sound oil economy; however, the NOK has performed poorly this year. We disagree with the markets treatment of the NOK as a risk on risk off currency and believe it should increasingly be trading on its strong fundamental merit. We have favoured the NOK for some time and still do.
The SDR Honey the IMF shrunk the yen
(pg 9)
The IMF recently announced new weights for the SDR valuation basket, which will come into effect on 1 Jan 2011. The largest impact of the new weighting scheme is likely to be negative for the JPY, both from a flow and a sentiment point of view.
HKD peg mythbusters
(pg 14)
The HKD faces little risk from the rise of the RMB. The flexibility of current arrangements is underappreciated. A basket peg would offer no identifiable advantages over the current system.
HUF...better, but not safe
(pg 19)
An exacerbation of the sovereign debt crisis in Europe would inflict significant collateral damage on Hungary but not to the extent of the FX crisis in 2008-2009. Even so, the HUF remains at risk as both private and public debts are at unsustainable levels. We maintain our bearish HUF view until year-end.
Dollar Bloc
(pg 24)
CAD remains firm, but recent data highlights risks Recently, the CAD has appeared more sensitive to developments on the risk front, rather than more traditional growth fundamentals. However, we think that the softening in the fundamental backdrop poses at least some risk to the CAD. Australia On hold for now As expected, the RBA kept rates on hold at 4.75% in their December meeting. We continue to anticipate that rates will rise multiple times next year, but we have pushed back the timing a little and now expect the next rate rise to be in Q2 2011.
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New Zealand Cause for Pause Recent data suggests that the recovery remains sluggish. With weaker growth and a pause in the tightening cycle by the RBNZ, we feel the NZD could be vulnerable to a move lower going into the New Year.
At a glance all regions
(pg 29)
Key events Date 14 December 15 December 15 December 16 December 21 December 21 December 22 December 27 December 1 January 4 January
Source: HSBC
Event FOMC meeting on interest rates Riksbank rate decision Norges Bank rate decision ECB governing council meeting no rate decision BoJ monetary policy meeting RBA minutes BoE to publish minutes of Dec 8-9 MPC meeting BoJ to publish minutes of Nov 15-16 MPM Estonia joins the Euro from Jan 1 2011 Federal Reserve publishes minutes of Dec 14 meeting
Central Bank policy rate forecasts Last USD EUR JPY GBP 0-0.25 1.00 0-0.10 0.50 December 10(f) 0-0.25 1.00 0.00 0.50 February 11(f) 0-0.25 1.00 0.00 0.50
Source: HSBC forecasts for Fed funds, Refi rate, Overnight Call rate and Base rate
Consensus forecasts for key currencies vs USD 3 months EUR JPY GBP CAD AUD NZD
Source: Consensus Economics Foreign Exchange Forecasts November 2010
12 months 1.347 88.19 1.609 1.022 0.935 0.724
1.374 83.39 1.596 1.015 0.966 0.742
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EUR 2011 retraces, reflects, recovers
EUR downgraded
In 2011, the idea that the EUR is here to stay dominates our view and quite frankly break-up fears are wildly exaggerated; but this does not mean the EUR will not retrace. Instead of seeing EUR-USD trade close to 1.35 through next year, we now see EUR-USD trading around 1.25 in the first quarter of next year as a point of reflection; after which USD weakness will start to reappear and the EUR will recover. We resisted the idea that the EUR would crumble in 2010 and held on to our forecast of 1.35 for the last nine months. In 2011, we envisage greater headwinds for the EUR as sovereign fears continue to linger. However, with no obvious fundamental anchor to guide us where the exchange rate should head, we place more emphasis on fair value PPP. We note that, without the conventional tool kit at the markets disposal, the consensus lurches with every wild swing in the exchange rate. Hence 1.25 for EUR-USD epitomises the EURs sovereign problems but also takes into account the lacklustre US growth picture.
We expect retracement to fair value, to a point of rest and reflection of 1.25 before the EUR recovers as USD problems resurface. On the one extreme we have the possibility of EUR break up being mooted. The other extreme view is the USD could face a meltdown. In the middle of these extremities lies 1.25 for EUR-USD, a point of still water where we can reflect on the extremes. Thus the EUR retraces, reflects and then recovers. We provide our new set of FX forecasts for 2011 below. To be honest, if it were not for these sovereign problems in the euro, we would be talking about the possibility of a cataclysmic fall in the USD in 2011. In essence, we have settled for a middle of the road 1.25 as a starting point in Q1 2011 rather than falling to either extreme.
1. New FX forecasts downgrading the EUR Q1 2011 EUR-USD GBP-USD EUR-GBP EUR-CHF EUR-NOK
Source: HSBC
Q2 2011 1.30 1.54 0.85 1.30 7.50
Q3 2011 1.35 1.59 0.85 1.34 7.40
Q4 2011 1.40 1.61 0.87 1.36 7.40
1.25 1.54 0.81 1.28 7.60
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Opportunities NOK
NOK-ed down but will get up again
With the market so focused on the sovereign risk surrounding the EUR, we look to the NOK. Sovereign risk in Norway is practically obsolete as the government runs a substantial surplus on the back of a sound oil economy. This is reflected by the Norways CDS being the lowest across a broad spectrum of countries. However, the market has shunned the NOK this year, seeing it underperform many currencies. Gold has significantly outperformed the NOK, even though the currency should be considered the best paper currency in the world. The excellent fundamental story for the NOK has not changed and it argues for persistent currency strength. That said, the NOKs short-term direction has been dominated by the shifts between risk on and risk off. We disagree with the markets treatment of the NOK as a risk on risk off currency and believe it should increasingly be trading on its strong fundamental merit. We have favoured the NOK for some time and still do.
NOK the best currency...isnt it?

We have always suggested that the NOK is not for the short term. It is a currency that can face the headwinds of the massive structural changes that are both present and forthcoming. Taking this view into consideration, we have ranked how G10 currencies stack up against one another according to several macro metrics (table 1). Note some currencies have the same rank for a variable. This is a very broad-brushed approach but it draws out the fundamental rationale to like the NOK in a clear way, especially when considering relative sovereign risk. From this perspective, the NOK comes out on top and has done so repeatedly over time. With the NOK looking so good, the currency should be an outperformer. But this has not been the case.
The market has shunned the NOK...
Considering all the expected good news for the NOK, and being one of the soundest currencies when considering sovereign risk, the NOK has traded poorly this year. Furthermore, it did not benefit like other commodity-oriented currencies
1. The NOK still comes out in first place NOK GDP CPI Short rate Budget balance Current account CDS Ranking 7 5 3 1 1 1 1 SEK 2 4 5 3 3 2 2 AUD 1 2 1 5 8 6 3 CAD 5 6 4 4 6 4 4 NZD 3 1 2 6 10 8 5 CHF 6 9 8 2 2 5 6 USD 4 8 9 8 9 3 7 GBP 7 3 7 9 7 9 8 EUR 9 6 6 7 5 10 9 JPY 10 10 10 9 4 7 10
Source: HSBC Note we use an average CDS for the Eurozone. * We forecast headline GDP rather than the mainland economy
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2. The NOK has not performed well this year...
3. ...and has not since the Feds QE2 came alive
15 10 5 0 -5 -10
Currency Performance vs USD (Jan 1 to Nov 29 10')
15 10 5 0 -5 -10
EUR NOK GBP

Source: HSBC, Bloomberg
10 9 8 7 6 5 4 3 2 1 0
Currency Performance vs USD (Aug 1 to Nov 29 10')
10 9 8 7 6 5 4 3 2 1 0
SEK CHF NZD CAD AUD JPY
NOK GBP EUR CAD JPY CHF SEK NZD AUD

when the market factored in the risk of extra QE by the Fed (charts 2 and 3). To us, it makes little sense that the NOK should lag behind the other commodity currencies or underperform other G10 currencies that are hampered by sovereign risk (i.e. EUR).
Gold has outperformed the NOK
NOK...just a EUR at heart?
While many major economies face very large fiscal challenges and the market questions the paper value of these currencies (USD, JPY, GBP, and EUR), gold has outperformed. This makes sense. However, gold, for example, has outperformed the EUR and the NOK at pretty much the same pace (chart 5). This suggests that the market is ignoring the NOKs much stronger fundamental background and treats the currency practically as a EUR proxy.
Based on our macro metrics in table 1, we believe the NOK should be the strongest paper currency in the world. However, when looking at the NOK versus gold, we see yet again how the market has shunned the currency (chart 4).
4. Gold has outperformed the NOK
Gold-NOK (NOK per oz.) 9000 8000 7000 6000 5000 4000 3000 2000 Jan-00 Oct-00 Aug-01 Jun-02 Mar-03 Jan-04 Nov-04 Aug-05 Jun-06 Apr-07 Jan-08 Nov-08 Sep-09 Jun-10
9000 8000 Gold outperforming the NOK 7000 6000 5000 4000 3000 2000
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5. Gold outperforming the EUR and the NOK at the same pace
Gold-NOK (NOK per oz.) 400 350 300 250 200 150 100 Jan-00
Gold-EUR (EUR per oz., rebased 100 = 2000) 400 350 300 250 200 150 100
Dec-00
Nov-01
Oct-02
Sep-03
Aug-04
Jul-05
Jun-06
May-07
Apr-08
Mar-09
Feb-10
In our view, this is irrational and the market should be differentiating the strong position of the NOK versus the weak position of the EUR. Importantly though, the similar performance of the NOK and performance of the EUR suggests the former is being driven by other factors.
shown which currencies and other financial market instruments are dominated by this factor (chart 6). Over the last 80 days the AUD is the most sensitive currency to risk on periods and the JPY is the most sensitive currency to risk off periods. This should not be surprising and fits with the general thinking that the AUD is a high beta currency and the JPY is not.
NOK its all about risk on risk off

In recent months, we have published substantive analysis on the risk on risk off paradigm (see Currency Quant Special, Risk on risk off: the full story, 10 November 2010). We have also
6. The extent to which assets are driven by Risk on Risk off
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7. The NOK has increasingly been dominated by the risk on risk off factor
0.6 0.5 0.4 0.3 0.2 0.1 0 -0.1 -0.2 -0.3 Jan-05 May-05 Nov-05
NOK's sensitivity to 'Risk on - Risk off (260-day rolling correlation)'
0.6 0.5 0.4 0.3 0.2 0.1 0 -0.1 -0.2 -0.3
Jul-06
Feb-07
Jul-07 Dec-07 Apr-08 Sep-08 Feb-09 Jun-09
Oct-09 Mar-10 Aug-10
We believe that instead of the NOK being driven by its strong fundamentals, the currency is dominated by the risk on risk off factor. The NOK performs well when it is risk on and by default, it does not perform well when it is risk off. What is striking, however, is how much the NOKs direction is dominated by the risk on risk off factor. This is masking the positive fundamental story for the NOK. That said, the relatively positive fundamental story for the NOK should be more in the price.
In the pre-crisis era, the NOK, like many other currencies, was not driven by risk on risk off. However, we can see how the NOK has steadily become more sensitive to risk on risk off over recent years (chart 7). This change in nature of the NOK is similar to the other commodity currencies. Nevertheless, when considering the outperformance of the other commodity currencies in recent months, we believe the NOK is lagging by too much. It should have benefitted more in the risk on bounce than was the case.
8. Norway has a low weight in government bond indices for a reason...Norway has very low debt levels
B lo o m b e rg E F F A S G o v t . b o n d w e i g h t s ( % ) 40 35 30 25 20 15 10 5 0 JP Y US D EUR G BP CAD AUD PL N CHF SEK Z AR NO K NZD 40 35 30 25 20 15 10 5 0
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Meanwhile, if the market moves to a risk off mode, then the NOK should be holding up better than the other commodity currencies and also those currencies that are bogged down with poor fundamentals. The NOK should be performing well in both environments. The markets treatment of the NOK as only a risk on currency is simply wrong to us.
Sovereign risk in Norway is practically obsolete as the government runs a substantial surplus on the back of a sound oil economy. Therefore it should not be a surprise that Norways weighting in global government bond indices is very low (chart 8). However, clearly this is a good thing, especially when the market is concerned about poor fiscal outlooks in many countries. This combined with the NOKs current underperformance suggests that there is clear room for it to strengthen (chart 8). The rationale to favour the likes of the EUR, USD, GBP and JPY (the so-called HIICs Heavily Indebted Industrial Countries) over the NOK is beyond us.
Conclusion Should be as strong as Fort NOKs

The NOK is currently a risk on currency, however we believe that it should also perform very well when market sentiment is deteriorating. In other words, the NOK is a currency for good times and bad. Fundamentals for the NOK remain strong and as a result we believe that it should be less dominated by the risk on risk off factor than it currently is.
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The SDR Honey the IMF shrunk the yen
New SDR weights JPY negative

The IMF recently announced a re-weighting of the SDR Special Drawing Rights. The largest impact of the new weighting scheme is likely to be negative for the JPY, both from a flow and a sentiment point of view. SDRs are subject to a great deal of confusion in the market, and much of the confusion relates to the fact that SDRs are made up of fixed currency amounts rather than fixed weights. That is, 1 SDR is equal to a basket of specified fixed amounts of four other currency pairs (table 1). This means that the actual weights in the SDR are constantly changing because of exchange rate fluctuations and this should be borne in mind when looking at the consequences of an official re-weighting. It is inherently rather complex and we go through it step by step below. In the appendix we give a potted history of the SDR for those who are unfamiliar with them.
This means quite simply that a holding of 1 SDR is precisely a holding of 63.2 USD cents, 41 euro cents, 18.4 yen and 9.03 pence. Importantly, it is not a genuine currency in itself; rather, it is a prescribed holding of specified amounts of four currencies. This composition has not changed since Jan 2006 and will remain until 1 Jan 2011 when a new SDR composition will come into being. However, as a result of exchange rate moves, the relative values of the fixed currency amounts in the SDR have changed since 2006. This means that the effective weights have also changed. While the target rates in 2005 are shown in table 2, current weights are different. As of Friday 19 November, somebody holding SDRs would have weights which are approximately as shown in table 3.
Weighting changes
The last time the composition of the SDR was changed was in Jan 2006. At the end of 2005, the fixed currency amounts for one SDR were defined as shown in table 1.
1. The current composition of the SDR Currency USD EUR JPY GBP
Source: IMF
Amount 0.632 0.41 18.4 0.0903
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2. 2005 Target Weights Currency USD EUR JPY GBP

Source: IMF
2005 Weighting 44% 34% 11% 11%
Where have these effective weights come from?
The SDR is made up of fixed amounts of USD, EUR, JPY and GBP. We can use current exchange rates to calculate a USD-value for all of these currency amounts (or the value in any other currency for that matter). Once we have done this, we can calculate the percentage of the SDRs current value that comes from each constituent currency. As exchange rates have moved since Jan 2006, the effective weights of each currency in the SDR have also shifted. The IMF has now announced new SDR weights which will be effective as of 1 Jan 2011. They are as shown in table 4. However, as before, the SDR will still be composed of fixed currency amounts. Despite knowing these weights, the precise composition of the new SDR will not be known until the end of the year. Once this new composition comes into force, anyone who holds a portfolio in SDRs will then need to rebalance their holdings. As a result, some market participants expect the redefinition of the SDR to result in potentially significant flows.
The confusing aspect here is that while the official USD weight in the existing SDR is 44% (table 2), the actual USD weight today is in reality is 40.6% (table 3) because of moves in EUR-USD since 2005. When trying to gauge what transactions will need to occur in Jan 2011, we need to compare the actual weights now (table 3) with the new weights (table 4). Note that we do not use the 2005 weights (table 2) for this comparison. As an example, from table 3 we can see that the actual USD weight is now 40.6 % and the new USD weight from table 4 is 41.9%. So somebody holding SDRs would have to buy USDs to match the new basket even though compared to 2005 the official USD weight has dropped!
Additional complication
The situation is even more complicated than this since the new weights (table 4) are converted into fixed currency amounts using average FX rates over the three months running up to 1 Jan 2011. What this means in practice is that the SDR weights from 1 Jan 2011 will differ from the stated weights albeit probably not by much.
3. Effective weighting scheme in today's SDR Currency USD EUR JPY GBP
Source: HSBC
Effective Weighting Today 40.5% 36.0% 14.2% 9.3%
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4. The SDR weighting scheme announced by the IMF for January 2011 Currency USD EUR JPY GBP
Source: IMF
Nov-2010 Weighting 41.9% 37.4% 9.4% 11.3%
The SDR change - negative for the JPY

In Table 5 we show the move from the current effective weights (table 3) to the stated target weights (table 4). The results in this table show a relatively small rebalancing for USD, EUR and GBP. As the effective weights at year-end for both the current and the new SDR composition are unknown yet, it is hard to say with confidence whether we will see significant flows in these currencies on the back of this. However, we can say with confidence that the JPY weighting in the SDR will be significantly reduced. The effective weight of JPY in an existing SDR basket is around 14% and this will drop to around 9.3%. As things stand, this will be offset by additional holdings in USD, EUR and GBP. The exact distribution across these currencies is not fully clear yet as it depends on the FX moves between now and 1 Jan 2011.
Impact on the market

Market impact can come in two forms. First, what transactions will need to occur as a result of the re-balancing? Second, what do the new weights signify about the importance of each of the currencies? It is hard to estimate the size of real holdings in SDRs and the extent to which re-balancing transactions will need to take place. SDRs are "allocated" to nations by the IMF, but the extent to which SDRs are held as actual reserves or are just the unit of account for potential obligations is not entirely clear. According to the IMF1, the total cumulative "allocations" amount to around USD318 billion. If this number is taken at face value it would mean on 1 Jan 2011 approx $15 billion of JPY would need to be sold against USD, EUR and GBP in order to re-balance. In practice, it is likely to be considerably less as "allocations" are not held in reserve and managed as reserves in the normal way. The situation with respect to private holdings is also difficult to estimate, but is unlikely to be very large in comparison to the size of the FX market.
5. The expected shift in basket weights Currency Effective Weighting Today (Table 3) USD EUR JPY GBP
Source: HSBC, IMF
2010 Weighting (Table 4) 41.9% 37.4% 9.4% 11.3%
Change in weight (Table 4 minus Table 3) +1.4% +1.4% -4.8% +2.0%
40.5% 36.0% 14.2% 9.3%
http://www.imf.org/external/np/exr/facts/sdr.htm
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The change in the official weights could perhaps be more significant from the point of view of market sentiment. The reduced official USD weight could be construed as a reflection of declining USD dominance, and thus seen as negative versus the rising official weight of the EUR. What is certainly clear is that the JPY weight is reduced, both in official terms and in actual terms. As such, we expect this forthcoming change to the SDR composition to have the greatest impact on JPY.
Addition of EM currencies to the SDR basket

As a result of the stratospheric rise of Emerging Markets since the last time the IMF changed the SDR, there had been widespread speculation that the SDR basket might be widened to contain some EM currencies. In particular, the Chinese yuan would appear to be a natural choice for inclusion in the SDR basket. Indeed, there had been calls from some Beijing officials for this to happen so the choice to not include the CNY in the SDR basket has surprised some market participants. The Wall Street Journal reports2 that whilst the IMF did consider including the yuan in the SDR basket, they ultimately rejected it because they considered it to fail the selection criterion of being a freely usable currency this despite the recent attempts to open up the CNY market through the offshore CNH market. So it appears that whilst capital controls and currency restrictions are prevalent in the EM world this will preclude them from being included in the SDR.
Will the SDR become a new reserve currency? No.

It is commonly asked if SDRs can be used as a reserve currency, instead of the USD. The simple answer to this is that the SDR is not a genuine currency it is really just a unit of account. When one chooses to hold reserves in SDRs all it really means is that you hold your reserves in USD, EUR, JPY and GBP in the SDR-prescribed ratios. It might indeed be sensible to hold reserves in a mix of currencies as plenty of reserve mangers do but there is nothing intrinsically different about an SDR. It is just one particular choice of basket.
Appendix
A brief history of the SDR
The SDR was created by the IMF in 1969 with the purpose of supplementing the official reserves of member countries. Under the Bretton Woods fixed exchange rate system its value was originally equal to 0.888671 grams of gold. This value was chosen since it was the value of one
6. Total SDR allocations Date 1970-72 1979-81 28 August 2009 9 September 2009 Total
Source: IMF
Amount allocated (SDR bn) 9.3 12.1 161.2 21.5 204 bn (equivalent to about USD 318bn)
http://online.wsj.com/article/BT-CO-20101117714605.html
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USD at the time. As a new international reserve asset, many thought the SDR would become increasingly important in supporting world trade and financial development. However, when the Bretton Woods system collapsed in 1973 the SDR became far less important. Its value was redefined in terms of a basket of sixteen currencies, which was reduced to five in 1981. Today, the SDR is defined in terms of four currencies dollars, euros, sterling and yen. Each currency within the SDR is given a specific weight, which is reviewed every five years based on the relative importance of that currency in world trade and financial markets. The weights announced by the IMF in the 2005 and 2010 reviews are given in tables 2 and 4. Since SDRs were created the IMF have allocated an amount equivalent to around $318 billion (table 6). By far the biggest allocation came in response to the global financial crisis on the 28th August 2009. The IMF believed this would smooth the need for adjustment and add to the scope of expansionary policies in liquidity constrained countries.
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HKD peg mythbusters

Myths of the HKD-USD peg
The HKD peg has once again come under scrutiny. In this piece we review some of the most common misconceptions about the peg, and address whether the HKD is at imminent risk of being displaced by the RMB. We conclude that while Hong Kongs linked exchange rate system may not deliver Hong Kong the optimal economic outcomes at all times, the benefits and flexibility offered by the current regime continue to be underappreciated. Moreover, recent years have highlighted that other currency regimes do not themselves guarantee optimal performance. differential between the two economies has been wide such as in such as the late 1980s and notably through the mid 2000s and even some periods when growth has moved in opposite directions such as in the US recession of the early 1990s and then during the Asian financial crisis in 1997-98. At present both economies are experiencing a post-crisis recovery and Hong Kongs growth has yet to notably outstrip that seen in the US.
Myth 2: HK prices are unusually buoyant this cycle

The discussion on growth notwithstanding, there are clear differences on inflation and property prices between the two economies. On asset prices particularly, there is little question that those in Hong Kong have risen strongly over the past 18 months. However, the latest increase in prices is very much in line with what we have seen at a similar stage of previous cycles. Chart 2 shows the performances of Hong Kongs property and equity markets over the past two decades. While property prices are close to the highs of 13 years ago, and seem almost certain to reach that milestone soon, the equity market is still well below pre-crisis levels. Even so, on a relative basis the increases have been less extreme than often presumed. Chart 3 indexes both equity and property prices to 100 at the start of each cycle. So far, property prices have gained 43% this cycle, compared with 109% between 2003 and 2008, 57% between 1995
Myth 1: The HK and US economies are unusually divergent this cycle

In contrast to popular perception, the divergence between the economic performance of the Hong Kong and US economies at present is not unusual by historical standards (chart 1). There have been a number of periods when the GDP growth
1. US and Hong Kong GDP has not diverged all that much
20 15 10 5 0 -5 -10
% y /y
Mar-82
Mar-91 US GDP
Mar-00 HK GDP
Mar-09
Source: CEIC, HSBC
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2. Asset prices have risen sharply since early 2009
3. but this is not alarming compared to previous cycles
35000 30000 25000 20000 15000 10000 5000 Jan-93 Jan-97 Jan-01 Jan-05 Jan-09
180 160 140 120 100 80 60
400 300 200 100 0 Jan-93 Jan-97 Hang Seng Jan-01 Jan-05 Jan-09
Hang Seng
Source: CEIC, HSBC
Property Price Index ('99=100, rhs)
Property Price Index
Source: CEIC, HSBC. Both series indexed to 100 at start of new cycle indicated by vertical bars. Cycles begin at previous troughs of Hang Seng index.
and 1997, and 41% from 1993 to 1995. Some further gains, therefore, would not be out of line with history. The recent strong steps taken to ensure the property cycle remains orderly (see HK Economic Spotlight of 19 November), also suggest that a more cyclical approach to macro-prudential policy can play a useful countervailing role. More to the point, however, consumer price inflation remains quite low by historical standards. The latest CPI reading of 2.6% yoy is below Hong Kongs average CPI of 3.1% over the last 20 years, and well below the peaks of 12.5% (1991), 10.4% (1995) and 6.3% (2008) seen in previous cycles (chart 4). Our economists foresee a further pickup in inflation to 3.5-4% over the next two years as asset price gains feed through (see Pressures on, 22 November). That said, the inflation peak this cycle is still expected to be well below historical norms. It is also worth pointing out that Hong Kong is not the only economy facing strong rises in asset prices. Since the beginning of 2010, every equity market in the region is higher. The Hang Sengs gain of 6%, however, is eclipsed by the gains recorded in Indonesia (45%), Thailand (35%) and the Philippines (33%) amongst others. Furthermore, Korea, China, India and Singapore have all introduced measures in recent years to
contain strong property prices, suggesting that there is little unique about the gains in property prices being seen in Hong Kong. Before we move on, it is worth reviewing some economics associated with a currency peg. If monetary conditions in Hong Kong need to tighten, and neither the currency nor interest rates are in a position to contribute, then Hong Kongs price level needs to adjust. This occurs through higher inflation for a period. Once the price level has adjusted sufficiently, however, the rate of inflation should return to a lower, more stable, level. In other words, there is no reason to expect loose monetary policy to result in a destabilizing, permanent increase in the rate of inflation.
4. HK CPI well below previous peaks and LT average
15 10 5 0 -5 -10 Jan-83 Jan-88 CPI

Source: HSBC, CEIC
Jan-93
Jan-98
Jan-03 LT av erage
Jan-08
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Myth 3: The rise in HKMA reserves means flows into HK asset markets have been unprecedentedly large
At present there seems to be particular confusion between gross and net flows into the HKD, and how these flows interact with the HKMAs intervention activities. In an environment where there are flows into Hong Kong asset markets, the HKMA only needs to intervene when these assetrelated inflows are not offset by other outflows. Typically, when the HKMA intervenes to buy USD-HKD (the flow channel of intervention) the resulting liquidity increase generates a decline in HK interest rates, such that some market participants will buy USD-HKD to benefit from the positive carry. Chart 5 highlights the 2004 intervention episode as having had such an impact. This second interest rate channel of intervention is generally the more powerful of the two. With US interest rates at such low levels, HKMA intervention adds liquidity, but this does not generate any meaningful decline in HK interest rates. The interest channel, as a consequence, is muted. So reserves are not necessarily increasing because gross inflows are much larger than normal (though they may be), but because the arbitrage/carry flows are not occurring this time. In sum, flows into Hong Kong asset markets may or may not have been unprecedented. We actually just dont know.
5. Monetary base grew significantly in 2009
2 % 1 0 -1 -2 -3 Jan-00 Jan-03 Jan-06 Jan-09 HKDbn
1200 1000 800 600 400 200
HK/US 1m diff (LHS)

Source: CEIC, Bloomberg, HSBC
Monetary base
Its well known that a currency board can only be run against fully-deliverable currencies. At present, therefore, the universe of potential candidates for inclusion in the basket would be EUR, JPY, GBP, CAD, SGD, AUD, NZD, CHF, NOK and SEK. The inclusion of smaller currencies that are not used for global invoicing, have little impact on the global economy, and have only modest direct trade relationships with Hong Kong would make little sense. That leaves the EUR and JPY as actionable candidates. Australia and Switzerland comprise only 1% of total trade with Hong Kong, and the UK is only 1.6%. Running a currency basket against the EUR and JPY, however, would do little to increase Hong Kongs interest rates at present, as both are running interest rates close to zero (chart 6).
6. Interest rates at historic lows across developed markets
7 6 5 4 3 2 1 0 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Myth 4: A HKD peg to a basket of currencies would be a superior currency arrangement at present
Running a currency board against one currency has the advantage of being clearer and more transparent than one against a (announced or unannounced) basket. Despite this, lets consider whether running a currency board against some sort of basket would be a superior arrangement for Hong Kong in current circumstances.
ECB Refi Rate BoE Base Rate

Source: HSBC, CEIC, Bloomberg
BoJ Discount Rate Fed Target Rate
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Myth 5: The RMB is likely to displace the HKD as a transaction currency in Hong Kong
Current market speculation seems to have solidified, particularly on issues related to the RMB. The argument seems to be that the RMB will be increasingly used as a transaction currency in HK, causing a flight of deposit transfers from the HKD into the RMB, as investors seek to move from a depreciating currency (the HKD, by virtue of the peg) into an appreciating one. To avoid such an outcome, so the argument goes, the HKMA needs to revalue the HKD. The stock of RMB deposits in HK has certainly risen in recent times (chart 7). Deposits have more than doubled this year, from RMB63bn to RMB150bn in September. But would revaluing the HKD slow any deposit shift? Unquestionably, a broad expectation of revaluation could temporarily stem any deposit shift into RMB. Once a HKD revaluation were to occur, however, Hong Kong would be left with a stronger currency. Presumably from that point investors might, if the markets currency framework is correct, again fear that the RMB would appreciate more than the HKD in the future. Why not take advantage of stronger levels of the HKD to shift into RMB deposits at better
7. RMB deposits have risen sharply in recent months
160 140 120 100 80 60 40 20 0 Feb-04 Feb-05 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 RMB depositis in HK
Source: CEIC, HSBC
levels? Given this, a revaluation of the HKD could hardly be expected to solve the problem of currency substitution; if in fact there is one. So if a revaluation wouldnt solve a problem of excessive currency substitution, lets consider how likely such an outcome is in the first place. For currency substitution to occur there needs to be a shift from HKD deposits into RMB deposits. A shift out of deposits held in other foreign currencies would have little impact on the HKD. Consider the backdrop. Hong Kong residents have typically kept around 45% of their bank deposits in foreign currency (chart 8). This proportion has been remarkably stable since 2000, with a range of only 43% to 50%. It seems more likely that, initially at least, the shift into RMB will be at the expense of other foreign currency deposits, rather than savers HKD deposits. In the past two years, USD deposits have fallen modestly, but with both RMB and HKD deposits rising. Consider also that the RMB is not easily usable in Hong Kong. Some retail outlets do allow the use of RMB, but almost none display dual prices, nor return change in RMB. In addition, the RMB is certainly not convertible globally. This, to us, suggests that the public are unlikely to shift towards using RMB as a day-to-day currency
8. RMB deposits are still a small proportion of total
60%
RMB bn
50% 40% 30% 20% 10% 0% Jan-00 Jan-02 HKD

Source: CEIC, HSBC
Jan-04 USD
Jan-06
Jan-08
Jan-10 Other
RMB
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instead of HKD anytime soon, even if they shift to holding more RMB as a store of wealth. Beyond these points, even if some shift from HKD into RMB deposits were to occur, consider also the equilibrating nature of the peg. At present there is excess demand for the HKD, which, due to HKMA intervention to keep USD-HKD within the 7.75/7.85 band, has resulted in injections of HKD liquidity and very low Hong Kong interest rates. If savers sell the HKD, however, USDHKD should start to shift away from the lower end of the convertibility zone, where it is at present, to the upper end. Towards the upper end of the band the HKMA will begin to intervene to buy the HKD. This will reduce HKD liquidity and Hong Kong interest rates will begin to rise. Were the outflow from HKD to persist, interest rates would ultimately increase enough to induce savers to reconsider selling HKD in the first place. In other words, not only would the peg rebalance pressures for HKD depreciation, but it would do so via higher Hong Kong interest rates precisely the monetary response that popular argument requires at present.
Conclusion... Perfection in imperfection

Hong Kong has run a currency board to the USD since 1983. It is clearly a currency and monetary policy arrangement which suits Hong Kong. Much of the periodic pressure on the HKD peg likely reflects, at least partly, a generic distrust of fixed exchange rates, rather than giving due consideration of Hong Kongs particular circumstances. Certainly neither clean nor managed floats have always delivered the best of economic outcomes for all countries in recent years. Having a fully convertible currency within a transparent exchange rate mechanism has allowed Hong Kong to establish itself as the pre-eminent North Asian financial centre, and a key regional trade, finance and FDI entrepot.
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Eurozone sovereign risk is on the radar of the financial markets. This risk is not a neutral parameter for CEE given the trade and financial links. Within the region, Hungary remains clearly the most vulnerable country as the levels of public and private debt stay persistently high. Moreover, the sensitivity of the private debt to the exchange rate movements still constitutes an aggravating risk factor. Nevertheless, a repeat of the 2008-09 episode is unlikely even if Eurozone sovereign risk deteriorates further. Although there could be knock-on impacts, Hungary is better armed thanks to a current account surplus, light positioning and an alert central bank. debt, which had been the main transmission channel of the crisis, remains at elevated levels. In terms of a percentage of GDP, we estimate that the private debt represents 115% this year (chart 1), slightly below the all-time high of 2009 and the highest of the region after Latvia. Largely denominated in foreign currencies and notably in CHF, it is a permanent threat to financial stability. Households have reduced strongly their demand for credit; signs of revival have emerged since mid-2009. As a result, the exposure of households to exchange rate movements has not diminished. The mortgage debt denominated in foreign currencies still represents about 65% of total loans (chart 2). The Hungarian central bank (NBH) has estimated recently that the debt burden of FX loans reached 9% of households disposable income in Q2, close to the peak reached in 09 Q1 (chart 3), because of the CHF-HUF upward movement. As the cross
Murat Toprak
FX Strategist - EMEA +44 20 799 5415

Murat.toprak@hsbcib.com
Structural vulnerabilities persist

Private debt still constitutes a systemic risk
The financial crisis has hardly changed the overall debt picture in Hungary. The high level of private
1. Private external debt (% of GDP)
% of GDP 140 120 100 80 60 40 20 0 Russia
Private external debt
% of GDP 140 120 100 80 60 40 20 0 Kazakhstan
Turkey
Israel
Czech Republic
Romania
Lithuania
South Africa
Hungary
Bulgaria
Ukraine
Estonia
Poland
Source: HSBC, World Bank, IMF
Latvia
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2. Loans denominated in foreign currencies (% of total)
3. Debt burden in % of disposable income
70 60 50 40 30 20 10
70 60 50 40 30 20 10 0
% 16 14 12 10 8 6 4 2 0
HUF loans
FX loans
% 16 14 12 10 8 6 4 2 0
0 Jan-04
Source: HSBC, NBH
Jan-06
Jan-08
Jan-10
04 Q1 05 Q1 06 Q1 07 Q1 08 Q1 09 Q1 10 Q1
Source: HSBC, NBH
reached an all-time high in Q3, the debt burden has probably reached a new peak recently. The situation remains very fragile and an exacerbation of the sovereign crisis in Europe would push CHF-HUF to critical levels. This risk is all the more important due to the concerns over the fiscal policy of the government.
The fiscal policy raises question over the debt sustainability
than in the other countries of the region. So its easy to understand why the fiscal consolidation in Hungary is crucial for FX stability. On that front there are reasons for concern. The government has indeed opted for an unorthodox fiscal policy, combining reduction in personal income taxes and implementation of temporary levies in the banking, telecommunication, energy and retail sectors. The success of this policy in supporting economic activity and achieving fiscal deficit targets is uncertain. But the most controversial measure is the reform of the pension system. The government has
Besides having the highest private external debt in the region, Hungary also has the misfortune to suffer from the highest public debt in CEE. The debt to GDP ratio is at 80% (chart 4), very close to the Eurozone average, but significantly higher
4. Government debt (% of GDP)
% of GDP 90 80 70 60 50 40 30 20 10 0 Estonia
Source: HSBC, EU
Government debt
% of GDP 90 80 70 60 50 40 30 20 10 0
Bulgaria
Romania
Lit huania
Czech Rep
Latvia
Poland
Hungary
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5. EUR-HUF through the crisis
EUR-HUF 320 310 300 290 280 270 260 250 240 230 220 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 September 08 - Lehman files for bankruptcy May 10 - Greek fiscal cris is intensifies 320 310 300 290 280 270 260 250 240 230 220
decided to withhold social security transfers to the private pension system and invited members of the private pension funds to adopt the state pension system. The assumption that 90% of the three million pensioners will adopt the state system appears particularly high. The deficit of the pension system is expected to reach HUF900bn in 2011 and the government hopes to finance HUF540bn thanks to the return of pensioners to the state-run system. If the governments assumption proves too optimistic, the revenue shortfall would be substantial, putting the 2011 fiscal deficit target of 2.9% of GDP at risk. In the longer-term, the success of fiscal consolidation is not guaranteed as the fiscal measures are mainly concentrated on the revenue side, while structural reforms aimed at reducing the structural deficit are missing. The structural deficit, which measures the underlying trend of the fiscal policy, is likely to widen strongly in 2011. The NBH estimates that it may reach 4.5% of GDP after 2.5% in 2010. But the main concern is the effect of the reform system in coming years as the public sector will have to carry the burden of pensioners going forward. Therefore, the fiscal deficit might increase to 5-6% of GDP when the effects of the temporary taxes/transfers will disappear by 2012-13. Moodys has recently
downgraded Hungary by two-notches on fiscal concerns. Both Moodys and S&P now rate Hungary at the cusp of junk rating with a negative outlook.
but several factors mitigate the risks

Although debt levels stay very high and fiscal woes remain, a repeat of the 2008-09 crisis appears unlikely (chart 5). Without minimising the potential knock-on effects of a Eurozone sovereign crisis on Hungary, there are three factors mitigating the risks weighing on the HUF.
The current account balance is in surplus
Hungary is less vulnerable than in 2008 as the current account balance is now in surplus. When the financial crisis erupted the current account deficit was equivalent to 7.2% of GDP. Currently, the balance shows a surplus of 0.9% of GDP thanks to a strong recovery in exports (charts 6 and 7). This situation implies that Hungary now has a net external financing capacity, while it had very wide external financing needs in 2008. The slight improvement in economic activity has recently led to an increase in imports but the domestic demand remains too sluggish to generate any significant deterioration in the near-term.
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6. Current account balance is in surplus
7. thanks to a recovery in exports
2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0 -7.0 -8.0 -9.0 Q1 1995
1-year accumulated, EUR bn
2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0 -7.0 -8.0 -9.0 Q1 2009
% yoy 50 40 30 20 10 0 -10 -20 -30 Jan-00
Exports
% yoy 50 40 30 20 10 0 -10 -20 -30
Q3 1998
Q1 2002
Q3 2005
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Source: HSBC, Thomson Reuters Datastream
Admittedly, the loosening of fiscal policy may lead to an increase in external financing needs but this is a medium-term issue.
Positioning is light
The central bank is on alert
The capital flow dynamics have improved since the start of 2010. The financial account of the balance of payments shows that portfolio flows have recovered after a very strong outflow in 2008-09 (chart 8). High-frequency data also indicate an increase in appetite of foreigners for Hungarian assets. Non-resident holdings of Hungarian bonds have recently reached their highest levels since Q1 2009 (chart 9). Nevertheless, the positioning is light in Hungarian markets from a historical perspective but also relative to other markets of the region.
The central bank is another parameter to take into account. Interest rates are at low levels, offering the NBH room to manoeuvre if the currency depreciates sharply. In a severe action, the central bank had raised the key rate by 300bp in October 2008. This large hike was not successful in stabilising the currency during this turbulent period. However, this time around the central bank could limit the fall of the HUF more efficiently. The NBH is indeed aware of the current market circumstances and is ready to act in a pre-emptive manner. A better macro and financial outlook in Hungary would also increase the effects of monetary policy action.
8. Capital flows (1-year accumulated, EUR bn)
9. Non-resident holdings of Hungarian bonds (HUF bn)
EUR bn Portfolio flows FDI EUR bn 8.0 8.0 6.0 6.0 4.0 4.0 2.0 2.0 0.0 0.0 -2.0 -2.0 -4.0 -4.0 -6.0 -6.0 -8.0 -8.0 -10.0 -10.0 Q1 1996 Q1 1999 Q1 2002 Q1 2005 Q1 2008
HUF bn 3600 3400 3200 3000 2800 2600
HUF bn 3600 3400 3200 3000 2800 2600 2400 2200 2000
2400 2200 2000 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

Source: HSBC, AKK
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The central bank has already showed its commitment to counter the risks stemming from the governments policy. The MPC raised interest rates by 25bp in November and signalled that further rate hikes might be needed. The deterioration of the countrys risk profile could indeed cause sustained currency weakness, which in turn increases the inflation risk (chart 10). Another rate hike of 25bp is very likely at the beginning of 2011. It is also worth noting that the NBH has currently substantial foreign currency reserves as its disposal. Admittedly, the Hungarian central bank does not have a tradition of intervention. However, we believe that if the NBH did not intervene in 2008 to stop the rapid depreciation of its currency, it was partly because of the low level of its reserves at that time. In the past two years, the FX reserves have almost doubled to reach EUR 33.5bn (chart 11). While the interest rates were the only tools during the 2008-09 crisis, the NBH may now use both rates and FX reserves to counter an excessive HUF weakness.
The government fiscal policy for 2011 and the pension reforms add risk to an already fragile situation. Along with the Irish situation, we keep our HUF-bearish view. However, even if the Eurozone situation worsens, we do not expect an FX crisis like in 2008-2009. Despite having some strong negatives, unlike in 2008 there are now some counterbalancing positives. As in May-June this year, the 290-295 area should be the top for EUR-HUF. Should sovereign risk conditions in the Eurozone improve, then EURHUF could come down to the low 270s but at this level we believe it would represent a buying opportunity for EUR-HUF. The outlook for CHFHUF is more uncertain as it would also depend on the market appetite for Swiss franc if the global risk appetite deteriorates further. But given the financial stability risk, the NBH should follow it very closely.
Conclusion
An exacerbation of the sovereign debt crisis would inevitably inflict significant collateral damages on Hungary. The HUF is all the more at risk as both private and public debts are at unsustainable levels.
10. Inflation persistently above target
11. FX reserves at high level
8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0
% government's forecasts
8.0 7.0 6.0 5.0 4.0 3.0 2.0
EUR bn 40 35 30 25 20 15 10 5 0 Jan-00
FX reserves
EUR bn 40 35 30 25 20 15 10 5 0
NBH's target
1.0 0.0 Jan-12 Jan-14
0.0 Jan-08
Jan-10
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Source: HSBC, Thomson Reuters Datastream , Hungarian government
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Dollar Bloc
CAD remains firm, but recent data highlights risks
The CAD has traded at the strong end of its range against the USD through much of the past two months, generally consistent with the expansion of risk appetite over that period, but less so with the fundamental backdrop in Canada, which has softened by some measures relative to conditions from just a few months ago. On balance, the CAD has appeared more sensitive to developments on the risk front, rather than more traditional growth fundamentals. However, we think that the softening in the fundamental backdrop (chart 1) is worth highlighting and poses at least some risk to the CAD, particularly when it is trading at stronger levels. Moreover, even with the expansion in risk, USD-CAD has failed to make sustained declines below the parity threshold. fell 1.3% and imports were up 1.6%. The deterioration in net exports was evident in the monthly trade and quarterly current account figures as well. On the trade account, the September deficit widened out to C$2.5bn from a C$1.5bn deficit in August. And the monthly trade balance has now been in deficit in six out of the prior seven months. Mirroring the deterioration in the trade accounts is the quarterly current account data, where the balance widened to a deficit of C$17.5bn in Q3, the largest quarterly deficit on record and following the C$12.9bn deficit in Q2. After running a healthy current account surplus for much of the decade, Canadas external position has deteriorated measurably since the inception of the global financial and economic crisis (chart 2). That trend has persisted in current quarters and it is likely that the full year current account deficit for 2010 will exceed the record C$43.5bn deficit in 2009. To the extent that Canadas external surplus had been a pillar of support for the CAD for many years, that is clearly no longer the case.
Downside surprises
On the real sector front, Canadian Q3 GDP rose 1.0% annualized, weaker than the 1.5% gain expected and down from 2.3% in Q2. The biggest drag came from the trade account, where exports
1. Economic growth has softened from the pace registered earlier this year
6. 0 4. 0 2. 0 0. 0 -2. 0 -4. 0 -6. 0 -8. 0 2005 Q 1 2006 Q 1 2007 Q 1 2008 Q 1 2009 Q 1 2010 Q1 % C anadian G DP, SAAR % 6. 0 4. 0 2. 0 0. 0 -2.0 -4.0 -6.0 -8.0
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And on the contrary, the external balance should now be viewed more accurately as a restraint on the currency, other things being equal.
Even strong data is weak
Seemingly better news on the economy came from the November labor market data, which showed unemployment dropping to a new cycle low of 7.6% from 7.9% in October. However, that decline was due to a big decline in the labor force as the participation rate fell to 66.9% from 67.2%. Given that labor market participation is typically expected to increase during an economic recovery, this is not a positive development (future developments will, however, be more important if this turns out to be a trend rather than a one-off). In addition, the 15.2K rise in net employment was made up entirely of part-time jobs as full-time positions fell 11.5K. Contrary to the first half of the year, where employment rose 300K, less than 40K new jobs have been created in the second half of 2010, a concerning development.
Rates on hold
weaker than projected just 1 months ago, aligning it with the weaker reading on Q3 GDP but still giving the statement a more dovish spin. And like the GDP data, the BoC specifically noted that net exports have been weaker than expected, due in part to persistent strength in the CAD (as well as weak productivity). While it is not unusual for the BoC to reference the CAD in this manner, it does highlight the BoCs sensitivity to CAD developmentsnot necessarily in the level of the currency per se, but in terms of the pass through and impact on monetary conditions it can have on a small, open economy such as Canadas. The BoC also used the same wording for their forward guidance on policy as they did in October, saying any further reduction in monetary policy stimulus would need to be carefully considered. That outlook, along with the weaker economic performance reinforces the notion that the BoC is in no hurry to resume the tightening program they halted in October. And those sentiments may also limit the upside for the CAD, particularly as it leaves the CAD at a yield disadvantage relative to other commodity-linked currencies.
Against that backdrop, it was no surprise that the Bank of Canada left the overnight target rate unchanged at 1.0% at the December 7 announcement. In the statement, the BoC noted that economic activity in H2 2010 is slightly
2. Current account deterioration diminished a pillar of support for the CAD

CAD bn 15 10 5 0 -5 -10 -15 -20 2003
Canadian Current Account Balance
CAD bn 15 10 5 0 -5 -10 -15 -20
2004
2005
2006
2007
2008
2009
2010
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Conclusion CAD at risk to the risk trade

Despite the recent intensification of stresses in the Eurozone sovereign debt market (another risk noted by the BoC), the overall level of risk appetite in the market has been at a relatively high level. As we noted at the outset, this is consistent with the general firmness of the CAD. And if there is a risk to our expectation for a steady, rather than appreciating bias in the CAD, it could come from a further, sustained expansion of risk appetite. That said, the latest gains in crude oil prices to $90, and the move in equities back to their cycle highs has not pushed USD-CAD sustainably below parity. That does not preclude the chance that a further expansion in the risk trade will do just that. But that is the risk scenario; our central view remains that the CAD, while likely to remain well supported, is unlikely to register further sustained gains against the USD.
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Australia On hold for now

As expected, the cash rate was left unchanged at 4.75% at the RBAs latest meeting on the 7th December. So mortgagors can breathe easy after last month's effective 40bp tightening. The postannouncement statement also contained few hints of further moves, but given the next move is not in the near term - in our view, Q2 2011 - it is unsurprising that the RBA is not signaling it yet. They did, however, repeat the same mantra about the high level of commodity prices and the effect on investment and incomes, which will be the key reason for raising rates further.
RBA staying steady
No surprises
The main message we would draw out from the statement is from what is not said: information from omission, if you please. That is, there is no mention of any concern about the weaker real GDP numbers in Q3 or recent weakness in retail sales. Indeed, the statement suggests that the narrative is playing out as expected. Overall, as we have said before, the brevity of this document necessarily means that it cannot cover much territory. And given that we have received a great deal of briefing from the RBA recently - the official statement of monetary policy, a three hour testimony to a parliamentary committee and a number of speeches by RBA officials - it is no surprise that there are no surprises.
Expect further rate hikes in 2011
There is no indication from the statement about any concern that the GDP numbers were weaker (in real terms) than generally expected (or about weak retail sales). Indeed, the statement points to strong national income growth, a pick up in mining investment and continued household cautiousness, as expected. The statement reminds us that employment growth has been very strong over the past year and wages have picked up. It is this combination that is currently driving growth in household incomes and will support more consumer spending at some point: albeit at the moment household saving remains elevated. The Reserve Bank has clearly been watching the sovereign debt developments in Europe carefully, though it also points out that Asia is moving in the other direction, with strong growth and rising price pressures. Finally, the RBA once again flaunts its forwardlooking credentials, suggesting that it views the current setting of monetary policy as appropriate for the economic outlook.
A hold by the RBA in their December meeting was as expected. We continue to anticipate that rates will rise multiple times next year, but we have pushed back the timing a little. We now expect the next rate rise to be in Q2 2011.
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New Zealand Cause for Pause

The RBNZ kept rates on hold at 3.00% in their latest meeting on the 9th December. This was largely as expected, both by HSBC and by the market. The associated monetary policy statement indicates that demand has been weaker than they had previously expected. The statement signalled that households continue to be cautious in their spending behaviour, corporate investment intentions are below average and that near-term growth has softened. Governor Bollard signalled that interest rates will need to stay low until the recovery becomes more robust. However, in the medium term, the expectations for further rate hikes remain as growth will be supported by rising exports and rebuilding following the earthquake in Canterbury in September. It seems that further tightening is likely to be put on hold in the near term, and in fact we do not expect another rate hike until Q2 2011. Recent data suggests that the recovery remains sluggish, with domestic demand remaining weaker than anticipated. Building permits fell by 2.0%, against expectations for a 1.4% rise, while manufacturing and construction activity has also showed signs of slowing. The weaker outlook for growth in the near-term and pause in the tightening cycle is likely to weigh on the NZD.
Risk off dominates
While fundamentals are important, moves in the NZD are largely the result of the shifts between risk on and risk off. Over the past month, the NZD has been the worst performing major currency, largely as a result of the Eurozone debt crisis leading to a contraction in risk appetite. We expect these problems in the Eurozone periphery to persist going into next year and for risk off to be the dominant theme in the coming months. While we expect the NZD to trade around current levels until year end, we feel retracement will continue in the New Year.
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Latin America at a glance

CLP/USD
800 750 700 650 600 550 500 450 400 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06
800 750 700 650 600 550 500 450 400
CLP: Peso to remain firm in 2011 We see growth remaining strong next year, with our economists recently upping their 2011 GDP growth forecast to 6.0% from 5.5% previously. We expect interest rates to continue to climb, to 4.25% by April next year, and then to remain on hold. This should help the CLP remain firm, especially as among Latam currencies, rate differentials with the US tend to be the most sensitivity in Chile. As a traditional funding currency, during tightening periods CLP tends to see an unwinding of short CLP crosses. Copper prices should hold up through strong Chinese demand, and this should remain a supportive factor in 2011. All that said, should USD-CLP dip lower towards the psychological 450 level, we would expect central bank intervention to be initiated, likely in the form of daily USD purchases of a set amount, as per early 2008. We therefore expect USD-CLP to end 2011 at 450.
Source: Thomson Reuters Datastream
BRL/USD
4.00 3.50 3.00 2.50 2.00 1.50 Jan-04 Jan-07 Jan-09 Jan-11 Jan-03 Jan-05 Jan-06 Jan-02 Jan-08 Jan-10
4.00 3.50 3.00 2.50 2.00 1.50
BRL: Policy ambiguity and intervention to hold the USD firm With inflation pressures creeping higher, rate hikes are now being fully priced in beginning in January. Rising rate expectations are keeping the BRL well supported, but we expect the USD to remain relatively firm into year-end. There has been some discussion among market commentators that higher inflation could raise policymakers tolerance for currency appreciation. However, we would tend to disagree with this line of thinking, and believe that USD-BRL below 1.70 produces an increasing chance of authorities raising intervention rhetoric. This is particularly true, as there is high seasonal component to inflation in the year-end period. Additional currency measures that the government could use include the use of the sovereign wealth fund to buy USDs, as well as further tax increases, or new regulatory measures to curb portfolio inflows.
COP/USD
3000 2800 2600 2400 2200 2000 1800 1600 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11
3000 2800 2600 2400 2200 2000 1800 1600
COP: Local USD supply shortages still dominating Front end forward points remain in negative territory due to the ongoing shortage of USD supply onshore. The daily USD20m central bank dollar purchases coupled with the governments decision to delay the monetization of some USD3.0bn have dried dollar supply onshore. However, local bank cash positions have begun to improve lately, and should this trend continue the negative technical position of the market that has haunted the COP, may begin to normalise. We remain constructive on the COP in the medium-term given the abundant FDI inflows and the recovery in the production of oil, coal, gas, and gold. We thus like to sell USD on spikes based on the belief that early next year the government will be forced to bring funds into the country from overseas. Modest intervention will persist through March (USD20m per day), but this unsterilized activity will need to be contained should inflation pressures build.
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Europe at a glance
CHF/EUR
1.70 1.66 1.62 1.58 1.54 1.50 1.46 1.42 1.38 1.34 1.30 1.26 Jan-06 Jan-08 Jan-10 Jan-02 Jan-04 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
1.80 1.70 1.60 1.50 1.40 1.30 1.20 1.10 1.00 0.90
euro-swiss (LHS)
dollar-swiss (RHS)
Switzerland: CHF staying strong The CHF has remained strong in the face of renewed peripheral stresses in the Eurozone, despite the ECB increasing its purchases of the regions bonds and the EU/IMF pledging support for Ireland. Additional support for the CHF has come from some robust economic data. The latest PMI reached 61.8, which was a four month high. Q3 GDP also printed a reasonably strong 0.7%. Some moderation in growth is expected going forward. Some SNB board members suggest accommodative policy cannot be maintained forever. This hawkish lean puts the focus on the SNB meeting on the 16 December. We still expect the SNB to keep rates steady until Q3 2011. Although the SNB has not intervened for a while, one cannot completely rule out the idea of it doing intervention to weaken the CHF again, especially if Eurozone problems intensify.
NOK/EUR
Norway: Opportunities NOK
10.50 10.00 9.50 9.00 8.50 8.00 7.50 7.00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11
10.50 10.00 9.50 9.00 8.50 8.00 7.50 7.00

See Opportunities NOK on page 4.
SEK/EUR
12.00 11.60 11.20 10.80 10.40 10.00 9.60 9.20 8.80 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-02 Jan-11
12.00 11.60 11.20 10.80 10.40 10.00 9.60 9.20 8.80
Sweden: SEK from strength to strength The Swedish economy has generally been better than expected in recent months. This has given the Riksbank the conviction to raise interest rates and suggest more tightening is to come. The Riksbank members have indicated that the strength of the SEK could lead to a lower than expected inflation profile over time. However, if growth remains as solid as it was in Q3, then the Riksbank may need to reconsider and tighten at a faster pace. The outlook for the SEK is relatively strong. It is not as strong a story as the NOK but it is in a better place than the EUR and a number of other currencies. The next main focus is the Riksbank rate decision on 15 December and the accompanying minutes on 3rd Jan 2011. We expect the policy rate to be increased to 2.00% by end 2011.
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Europe/Africa at a glance
EUR/HUF
310 300 290 280 270 260 250 240 230 220 Jan-07 Jan-04 Jan-05 Jan-06 Jan-08 Jan-09 Jan-02 Jan-03 Jan-10 Jan-11
310 300 290 280 270 260 250 240 230 220
Hungary: the HUF stays vulnerable The persistently high level of debt and the uncertainties surrounding the governments unorthodox fiscal policy leave the HUF vulnerable. The tensions between the government and the central bank (NBH) are not HUF-supportive. The governments decision to change the NBH law to reduce the role of the governor and redefine the mandate raises questions about the independence of monetary policy. In an attempt to defend itself and its inflation target, the NBK caught the market by surprise with a rate hike of 25bp in Nov. The open discord is unlikely to ease in the near-term, undermining the attractiveness of local assets. We are keeping our HUFbearish bias into year-end, especially since the countrys rating is under threat. We do not see the currency pair spiralling out of control like in 2008-09. A current account surplus, a light positioning and an active NBH offer some protection.
EUR/PLN
5.00 4.60 4.20 3.80 3.40 3.00 Jan-04 Jan-06 Jan-08 Jan-10 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-02
5.00 4.60 4.20 3.80 3.40 3.00
Poland: The PLN has the potential to recover The zloty took a hit at the end of November as the euro sovereign crisis worsened. The important positioning and relative large liquidity offered by the Polish market explain the currency underperformance. However, there is no reason for a weak PLN from a fundamental standpoint. Admittedly, the central banks communication remains confusing but the key point is that the economy is growing at a strong pace (+4.2% y-o-y in Q3) and a key rate at 3.50% adapted for the crisis is no longer justified. We continue to believe that the central bank will raise rates in coming months. Strong growth led by domestic demand, sound financial system, positive carry dynamics and rather supportive balance of payments form the cornerstone of our PLN-bullish view.
TRY/USD
1.90 1.80 1.70 1.60 1.50 1.40 1.30 1.20 1.10 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-02
1.90 1.80 1.70 1.60 1.50 1.40 1.30 1.20 1.10
Turkey: lightening of positioning USD-TRY surged from below 1.40 to above 1.50 in November. Although the movement has been primarily driven by the USD strength as EUR-TRY remained steady, the heavy positioning on the Turkish market has led to significant underperformance of the lira. The lightening of positioning in the equity market is rather positive news but we remain on the defensive in the month ahead as some position clearing is still likely. From a macro fundamental standpoint, conflicting signals persist. The improvement of the fiscal situation fuels expectations for a rating upgrade with ultimately the investment grade status. However, the external imbalances widened with a rapid expansion of imports. The current account deficit is an issue for FX stability, particularly with a central bank having no intention to raise rates. CBRT is risking to remain behind the curve, while the rate cycle is turning in CEE.
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Asia at a glance
CNY/USD
8.40 8.20 8.00 7.80 7.60 7.40 7.20 7.00 6.80 6.60 Jan-05 Jan-06 Jan-08 Jan-09 Jan-10 Jan-11 Jul-06 Jan-07 Jul-10 Jul-05 Jul-07 Jul-08 Jul-09 8.40 8.20 8.00 7.80 7.60 7.40 7.20 7.00 6.80 6.60
CNY Continued pressure on RMB RMB continues to face elevated levels of appreciation pressure. For example, even with the G20 out of the way, international political pressure has not eased. Markets are still awaiting the US Treasurys semi-annual report on currencies, originally due mid-October. Moreover, a state visit by President Hu to Washington in January is still forthcoming. Meanwhile, inflation has risen more than expected, leading the authorities to announce unexpected tightening moves, as well as a likely shift of the official stance away from accommodation. The trade surplus continues to rebound sharply, though this is likely due to seasonal effects. This could mean more appreciation pressure over the medium-term. In the near-term, we continue to emphasize the increased importance of broader global currency movements and the broad strength or weakness of the USD in determining moves in USD-RMB.
HKD/USD
HKD USD peg myth busters
7.86 7.84 7.82 7.80 7.78 7.76 7.74 7.72 7.70 97 99 01 03 05 07 09 11
7.86 7.84 7.82 7.80 7.78 7.76 7.74 7.72 7.70

See HKD peg mythbusters on page 14.
IDR/USD
16000 14000 12000 10000 8000 6000 4000 2000 97 99 01 03 05 07 09 11
16000 14000 12000 10000 8000 6000 4000 2000
IDR rate hike required Moody's upgraded Indonesia's sovereign rating from Ba2 to Ba1, one notch below investment grade. Our credit team expects Indonesia to become investment grade next year. Despite such developments bond inflows have been falling in recent weeks, due to the ongoing rise in inflationary forces. BI has again desisted from increasing rates citing more portfolio inflows and the higher cost of sterilization as part of the reasons. It also commented on preparing to mitigate the negative impact of foreign inflows, which to us suggests that the government could introduce further regulatory changes such as increasing the SBI holding period from 1 to 3 months and reducing SBI auctions while increasingly using term deposits to manage liquidity. Given this, in the short term at least, we see no value in selling USD-IDR particularly since further regulatory changes to the bond market are likely.
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Asia at a glance continued

VND/USD
20000 19000 18000 17000 16000 15000 14000 Jan-03 Jan-04 Jan-05 Jan-08 Jan-01 Jan-02 Jan-06 Jan-09 Jan-10 Jan-11 Jan-07
20000 19000 18000 17000 16000 15000 14000
VND structural problems still pressuring currency Depreciation pressures on VND are rising, and were brought into focus with three recent developments: 1) The report that a state owned enterprise has asked to delay a USD60m loan repayment due on 20 Dec 2) The imposition of a 10% gold export tax from 1st Jan 2011; and 3) the ongoing rise in spread between the USD-VND official fix and the implied rates in the NDF market. We have noted earlier that the August shift in the USD peg would not have a meaningful impact on some of the more structural problems which are driving the VND lower such as the trade deficit and high inflation. Only when policy is tightened substantially enough to start limiting these issues will the market likely become more confident in the VND and pressure subside. We still expect another shift in the band to occur, most likely in Q1 2011, and pressure will remain on the currency to weaken further.
KRW/USD
2000 1800 1600 1400 1200 1000 800 97 99 01 03 05 07 09 11
2000 1800 1600 1400 1200 1000 800
KRW not a core long The recent N. Korean artillery shelling, causing both civilian and military deaths, and the unfolding response from other countries represent a more serious episode than the market has become accustomed to. We have been upbeat on EM and Asian currencies this year, but since May KRW has not been a core long for us due to the asymmetric nature of the BOK's intervention. The BOK has historically aggressively limited the downside to USD-KRW, but not the upside, and has seemed hesitant in the past to re-supply to the market the dollars it has removed through intervention. A genuine further deterioration in the current political situation may well see a shift to more active central bank dollar selling. In this case, however, capping the dollar is likely to prove difficult. As such, the latest developments on the Korean peninsular reinforce this unique asymmetry of risk to the currency.
SGD/USD
1.90 1.80 1.70 1.60 1.50 1.40 1.30 1.20 97 99 01 03 05 07 09 11
1.90 1.80 1.70 1.60 1.50 1.40 1.30 1.20
SGD now an EM currency Singapore is becoming increasingly linked to the emerging world. We have shifted the composition of the weights in our S$NEER more towards EM currencies at the expense of the USD. This has two main implications. First, Singapore will begin to manage its policy in line with regional peers rather than the developed word. This is also in conjunction with an ongoing increase in intraregional trade. Second, SGDs correlation with EUR should start declining. SGD has always had a strong correlation with EUR given the large USD weight in the basket and being seen as a proxy for risk sentiment. With growth in developed nations and EM diverging, SGDs performance should start decoupling from EUR. We remain bullish on SGD given the strong economy and FDI flows. With the NEER trading towards the middle of the recently steepened band, we like to be long SGD despite the small negative carry.
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HSBC Volume-Weighted REERs

How should we weight the basket?
If we are trying to create an index for the change in value of a currency against a basket of other currencies, we now need to decide on how to weight our basket. One possible solution would be to simply have an equally-weighted basket. The rationale for this would be that there is no a priori reason for choosing to put more emphasis on any one exchange rate. However, this could clearly lead to the situation where a large move in a relatively small currency can strongly influence the REERs and NEERs for all other currencies. To avoid this, the indices are generally weighted so that more important currencies get higher weighting. This, of course, begs the question of how importance is defined.
For full details of the construction methodology of the HSBC REERs, please see HSBCs New Volume-Weighted REERs Currency Outlook April 2009.
Mark McDonald FX Strategist HSBC Bank plc +44 20 7991 5966 mark.mcdonald@hsbcib.com
The value of a currency

Since FX prices are always given as the amount of one currency that can be bought with another, the inherent value of a currency is not defined. For example, if EUR-USD goes up, this could be because the EUR has increased in value, the USD has decreased in value, or a combination of both. One possible method for getting some insight into changes in the value of a currency is to look at movements in the value of a basket of other currencies against the currency of interest. For example, if EUR-USD increased over some time period, one could see how EUR had performed against a range of other currencies to determine whether EUR has become generally more valuable or whether this was simply a USD-based move. An effective exchange rate is an attempt to do this and to represent the moves in index form. There are two main approaches to building an effective exchange rate: Nominal Effective Exchange Rates (NEERs) and Real Effective Exchange Rates (REERs). NEERs simply track the weighted average returns of a basket of other currencies against the currency being investigated; REERs deflate the returns in an attempt to compensate for the differing rates of inflation in different countries. The reason for doing this is that, particularly over long time frames, inflation can have a large impact on the purchasing power of a currency.
Trade Weights
Weighting the basket by bilateral trade-weights is the most common weighting procedure for creating an effective exchange rate index. This is because the indices are often used to measure the likely impact of exchange rate moves on a countrys international trade performance.
Volume Weights
The daily volume traded in the FX market dwarves the global volume of physical trade. From this it is possible to make a convincing argument that the weighting which would be really important would be to weight the currency basket by financial market flows, rather than bilateral trade.
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To do this properly would require us to have accurate FX volumes for all currency pairs considered in the index. However, these are not available. The BIS triennial survey of FX volumes only gives data for a small number of bilateral exchange rates. However, the volumes are split by currency for over 30 currencies. From these volumes we can estimate financial weightings for each currency. We believe that this gives another plausible definition for importance, and one which may be more relevant for financial investors than trade weights. We call this procedure volume weighting and the indices produced through this procedure we call the HSBC volume-weighted REERs. We would argue that if you are a financial market investor, the effective value of a currency you would be exposed to is more accurately represented by the HSBC volume-weighted index rather than the trade-weighted index.
Data Frequency
This is something which is rarely considered when constructing REERs inflation data is generally released at monthly frequency at best so the usual procedure is to simply create monthly indices by default. However, some countries release their inflation data only quarterly. The usual procedure for these countries is to simply pro-rata the change over the period. Here there is an implicit assumption that the rate of inflation changes slowly. We take this assumption one step further and assume that it is valid to spread the inflation out equally over every day in the month.
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HSBC Volume Weighted REERs

USD REER index
USD Trade-Weighted REER 1996=100 160 USD Volume-Weighted REER 1996=100 160
1996=10 0
EUR REER index

EUR Volume-Weighted REER 120 EUR Trade-Weighted REER
1996 =100
120
140
140
105
105
120
120
90
90
100
100
75
75
80 Jul-95
80 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10
60 Jul-95
Source: HSBC
Source: HSBC
JPY REER index

JPY Trade-Weighted REER 1996=100 120 JPY Volume-Weighted REER 1996=100 120
GBP REER index

1996=100 140 GBP Trade-Weighted REER GBP Volume-Weighted REER 1996=100 140
105
105
125
125
90
90
110
110
75
75
95
95
60 Jul-95 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10
60
80 Jul-95
Source: HSBC
Source: HSBC
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CAD REER index

CAD Trade-Weighted REER 150 140 130 120 110 100 90 80 Jul-95 CAD Volume-Weighted REER 150 140
CHF REER index

CHF Volume-Weighted REER 1996=100 110 CHF Trade-Weighted REER 1996=100 110
100
130 120 110 100
100
90
90
80
80
70
90 80 Jul -98 Jul-01 Jul-04 Jul-07 Jul-10
70
60 Jul-95
Source: HSBC
Source: HSBC
AUD REER index

AUD Trade-Weighted REER 1996=100 160 AUD Volume-Weighted REER 1996=100 160
NZD REER index

NZD Volume-Weighted REER 1996=100 140 NZD Trade-Weighted REER 1996=100 140
140
140
120 120
120
120
100 100
100
100
80
80
80
80
60 Jul-95
60 Jul-95
60 Jul-98 Jul-01 Jul-04 Jul-07 Jul- 10
Source: HSBC
Source: HSBC
SEK REER index

SEK Trade-Weighted REER 1996=100 110 SEK Volume-Weighted REER 1996=100 110
NOK REER index

NOK Trade-Weighted REER 1996=100 130 120 NOK Volume-Weighted REER 1996=100 130 120
100
100
110
90 90
110 100 90
100 90
80
80
80
70 70
80 70 60 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10
70
60 Jul-95 60 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10
60 Jul-95
Source: HSBC
Source: HSBC
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HSBC forecasts vs forwards

Euro dollar vs forwards
USD/EUR 1.60 1.50 1.40 1.30 1.20 1.10 1.00 0.90 0.80 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Euro Swiss vs forwards

Forward Forecast
USD/EUR 1.60 1.50 1.40 1.30 1.20 1.10 1.00 0.90 0.80
CHF/EUR
1.71 1.66 1.61 1.56 1.51 1.46 1.41 1.36 1.31 1.26 Jan-00 Jan-02
Forward
Forecast
CHF/EUR
1.71 1.66 1.61 1.56 1.51 1.46 1.41 1.36 1.31 1.26
Jan-04
Jan-06
Jan-08
Jan-10
Source: Thomson Reuters Datastream, Reuters, HSBC
Cable vs forwards
USD/GBP 2.10 2.00 1.90 1.80 1.70 1.60 1.50 1.40 1.30 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Forward Forecast USD/GBP 2.10 2.00 1.90 1.80 1.70 1.60 1.50 1.40 1.30
Euro sterling vs forwards

GBP/EUR 1.00 0.95 0.90 0.85 0.80 0.75 0.70 0.65 0.60 0.55 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Forward
Forecast
GBP/EUR 1.00 0.95 0.90 0.85 0.80 0.75 0.70 0.65 0.60 0.55
Dollar yen vs forwards

JPY/USD 135 125 115 105 95 85 75 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10
Euro yen vs forwards

Forward Forecast
JPY/USD 135 125 115 105 95 85 75
JPY/EUR
175 165 155 145 135 125 115 105 95 85 Jan-00
Forward
Forecast
JPY/EUR
175 165 155 145 135 125 115 105 95 85
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
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Short rates
3 Month Money End period North America US (USD) Canada (CAD) Latin America Mexico (MXN) Brazil (BRL) Argentina (ARS)* Chile (CLP)* Western Europe Eurozone Other Western Europe UK (GBP) Sweden (SEK) Switzerland (CHF) Norway (NOK) EMEA Hungary (HUF) Poland (PLN) Russia (RUB)* Turkey (TRY) Ukraine (UAH) South Africa (ZAR) Asia/Pacific Japan (JPY) Australia (AUD) New Zealand (NZD) Asia-ex-Japan China (CNY) Asia ex-Japan & China Hong Kong (HKD) India (INR) Indonesia (IDR) Malaysia (MYR) Philippines (PHP) Singapore (SGD) South Korea (KRW) Taiwan (TWD) Thailand (THB) Notes: * 1-month money. Source HSBC 3.9 7.0 9.5 3.7 4.8 3.4 4.8 1.8 5.3 3.5 8.3 7.8 3.6 3.7 2.5 5.7 2.2 3.7 1.0 9.2 12.0 3.4 6.1 1.4 4.7 1.0 3.6 0.1 5.1 6.6 2.3 3.9 0.7 2.8 0.5 1.4 0.1 4.6 6.6 2.6 3.9 0.7 2.8 0.5 1.4 0.6 5.5 6.6 2.8 3.9 0.6 2.5 0.7 1.4 0.3 6.3 7.0 2.9 4.5 0.4 3.1 0.7 1.7 0.3 6.2 7.6 2.9 5.0 0.7 3.3 0.7 2.2 0.3 6.0 7.1 2.9 5.3 0.8 3.6 0.7 2.3 0.3 6.4 7.3 2.9 5.3 0.8 3.8 0.7 2.3 0.3 6.8 7.3 2.9 5.3 0.9 3.8 0.9 2.3 0.5 7.0 7.3 2.9 5.3 1.0 4.1 1.0 2.3 1.8 3.3 1.7 1.7 1.7 1.7 1.7 1.7 1.7 1.7 1.7 1.7 0.4 6.5 7.7 0.6 7.3 8.9 0.6 4.1 6.0 0.3 4.1 3.0 0.2 4.4 2.8 0.2 4.9 3.3 0.2 4.9 3.3 0.2 5.1 3.5 0.2 5.4 3.5 0.2 5.6 3.6 0.2 5.9 3.9 0.2 6.0 4.1 8.1 4.2 6.5 17.6 7.6 9.2 7.6 5.1 6.3 16.0 6.6 11.3 10.0 5.8 20.6 15.5 20.0 11.4 6.2 4.2 6.6 7.5 16.1 7.1 5.5 4.0 4.2 7.6 8.0 6.5 5.3 3.8 3.4 7.7 5.6 6.6 5.4 3.7 4.0 7.5 5.5 6.6 5.4 3.7 7.0 7.5 9.0 6.6 5.4 4.3 7.5 7.8 8.0 6.6 5.4 4.2 8.0 8.1 7.0 6.6 5.6 4.8 8.0 8.5 7.0 6.6 6.2 4.7 7.8 9.0 9.0 6.6 7.2 12.8 7.1 5.0 3.7 5.3 3.3 2.1 3.9 7.3 11.2 10.0 7.1 4.6 5.9 4.7 2.6 5.9 8.2 13.0 17.1 8.5 2.9 2.8 2.5 0.6 4.0 4.6 8.7 10.4 1.8 0.7 0.6 0.5 0.3 2.2 4.6 9.1 9.1 1.2 0.6 0.6 0.5 0.2 2.3 4.5 10.8 9.1 1.9 0.7 0.7 0.6 0.1 2.8 4.6 10.7 9.2 4.0 0.8 0.7 1.0 0.2 2.6 4.6 10.8 9.5 5.0 1.0 0.7 1.4 0.3 2.7 4.8 11.9 9.6 5.8 1.0 0.7 1.6 0.3 2.8 4.8 12.8 9.7 6.5 1.0 0.7 1.9 0.4 2.9 5.0 12.7 9.7 7.0 1.0 0.7 2.1 0.8 3.2 5.2 12.7 9.6 7.0 1.2 0.9 2.4 0.8 3.4 5.3 4.2 4.7 4.5 1.4 1.9 0.3 0.5 0.3 0.4 0.5 0.8 0.3 1.2 0.3 1.3 0.3 1.9 0.3 2.2 0.3 2.2 0.4 2.5 2006 2007 2008 Q4 Q4 Q4 2009 Q4 Q1 2010 Q2 Q3f Q4f Q1f 2011 Q2f Q3f Q4f
Important note
This table represents three month money rates. These rates may not give a good indication of policy rates.
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Emerging markets forecast table

8-Dec-10 last 2009 Q3 x x 3.84 1.78 533 13.50 1930 2.88 2.15 Q4 x 3.80 1.74 533 13.10 2043 2.89 2.15 2010 Q1 x 3.88 1.78 533 12.36 1920 2.84 4.30 Q2 x 3.93 1.80 547 12.84 1916 2.83 4.30 Q3 x 3.97 1.69 484 12.60 1801 2.80 4.30 Q4f x 4.10 1.74 480 12.25 1850 2.75 4.30 2011 Q1f x 4.15 1.70 470 12.10 1850 2.75 4.30 Q2f x 4.20 1.66 460 12.00 1850 2.75 4.30 Q3f x 4.25 1.64 450 11.80 1950 2.75 4.30 Q4f x 4.30 1.60 450 11.80 2000 2.75 4.30
Latin America vs USD

Argentina (ARS) Brazil (BRL) Chile (CLP) Mexico (MXN) Columbia (COP) Peru (PEN) Venezuala (VEF )
x 3.97 1.68 477 12.47 1888 2.82 4.29
Eastern Europe vs EUR

Czech Republic (CZK) Hungary (HUF) Russia vs USD (RUB) Rom anian (RON) Turkey vs USD (TRY)
Sim ple rate
25.08 278 31.17 3.24 1.49
25.31 270 30.09 4.25 1.48
26.40 270 30.24 4.30 1.50
25.41 266 29.36 4.09 1.52
25.69 285 31.20 4.15 1.59
24.57 277 30.40 4.25 1.45
24.80 275 30.80 4.25 1.46
24.75 270 29.70 4.20 1.48
24.50 270 30.80 4.15 1.50
24.25 265 31.20 4.10 1.47
24.00 265 33.40 4.05 1.45
Poland (PLN)
4.05 x 5.79 x
4.24 x 5.50
4.11 x 5.48
3.86 x 5.48
4.14 x 5.50
3.98 x 5.71
3.90 x 5.70
3.85 x 5.72
3.80 x 5.75
3.75 x 5.77
3.70 x 5.80
Middle East vs USD

Egypt (EGP)
Israel (ILS)
3.64
3.77
3.75
3.80
3.85
3.75
3.57
3.53
3.50
3.46
3.42
Africa vs USD
South Africa (ZAR) Interest rates 6.91 7.58 0.00 7.36 0.00 7.34 6.90 7.67 7.14 6.97 0.00 7.15 0.00 7.10 0.00 7.10 0.00 7.20 0.00 7.20 0.00
Source: HSBC
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Exchange rates vs USD

end period
Americas x x x x Western Europe Other Western Europe x x x x Emerging Europe x x x x Asia/Pacific x x x North Asia x x x x South Asia x x x x x Africa x x Canada (CAD) Mexico (MXN) Brazil (BRL) Argentina (ARS) x Eurozone (EUR*) x UK (GBP*) Sweden (SEK) Norway (NOK) Switzerland (CHF) x Russia (RUB) Poland (PLN) Hungary (HUF) Czech Republic (CZK) x Japan (JPY) Australia (AUD*) New Zealand (NZD*) x China (CNY) Hong Kong (HKD) Taiwan (TWD) South Korea (KRW) x India (INR) Indonesia (IDR) Malaysia (MYR) Philippines (PHP) Singapore (SGD) Thailand (THB) Vietnam (VND) x South Afric a (ZAR) x 1.16 10.80 2.14 3.06 x 1.32 x 1.96 6.84 6.23 1.22 x 26.4 2.90 191 20.9 119 0.79 0.71 x 7.81 7.77 32.6 930 x 44.2 8996 3.53 49.1 1.53 36.0 16050 x 7.05 x 6.83 x 39.4 9393 3.31 41.3 1.44 33.7 16217 x 9.25 x 7.31 7.80 32.4 936 x 48.6 11027 3.46 47.5 1.43 34.9 16900 x 7.58 x 24.5 2.46 173 18.2 112 0.88 0.77 x 6.82 7.75 32.9 1263 x 47.7 9645 3.46 47.6 1.41 33.5 18200 x 7.36 x 1.99 6.46 5.43 1.13 x 29.4 2.96 191 19.3 91 0.70 0.58 x 6.83 7.80 32.2 1177 x 46.4 9425 3.42 46.5 1.41 33.3 18200 x 7.34 x 1.46 x 1.44 7.91 7.00 1.06 x 30.1 2.90 185 17.3 90 0.88 0.72 x 6.83 7.80 32.1 1166 x 44.8 9090 3.26 45.2 1.40 32.3 19050 x 7.67 0.99 10.92 1.77 3.15 x 1.39 x 1.60 6.99 5.80 1.04 x 30.2 2.86 188 18.4 93 0.90 0.73 x 6.83 7.80 31.8 1133 x 46.4 9060 3.24 46.4 1.40 32.4 19000 x 6.97 1.23 13.69 2.31 3.45 x 1.46 x 1.61 7.14 5.78 1.03 x 29.4 2.85 196 18.8 93 0.92 0.71 x 6.78 7.80 32.3 1223 x 44.6 8925 3.09 43.9 1.31 30.4 19475 x 7.15 1.07 13.50 1.78 3.84 x 1.43 x 1.52 7.20 5.94 1.05 x 31.2 3.38 233 21.0 88 0.84 0.69 x 6.69 7.80 31.2 1140 x 43.5 8800 3.00 41.5 1.27 29.0 19800 x 7.10 1.05 13.10 1.74 3.80 x 1.35 x 1.50 7.78 6.50 1.08 x 30.4 2.91 203 18.0 84 0.97 0.74 x 6.67 7.80 29.5 1130 x 43.2 8750 2.97 40.5 1.26 28.0 19800 x 7.10 1.01 12.36 1.78 3.88 x 1.22 x 1.58 6.73 5.86 0.98 x 30.8 2.89 204 18.4 85 0.97 0.76 x 6.63 7.80 28.5 1110 x 42.8 8700 2.94 39.5 1.25 27.0 19800 x 7.20 1.06 12.84 1.80 3.93 x 1.37 x 1.57 6.74 5.85 0.96 x 29.7 3.08 216 19.8 90 0.92 0.73 x 6.60 7.80 28.0 1090 x 42.4 8700 2.91 38.5 1.24 26.0 20000 x 7.20 1.03 12.60 1.69 3.97 x 1.35 x 1.54 7.12 6.08 1.02 x 30.8 2.92 208 18.8 95 0.85 0.72 x 6.57 7.80 27.5 1080 x 42.0 8700 2.88 37.5 1.23 25.0 20000 1.05 12.25 1.74 4.10 x 1.25 x 1.54 6.69 5.77 1.00 x 31.2 2.78 196 18.0 95 0.85 0.72 x 6.54 7.80 27.0 1070 1.10 12.10 1.70 4.15 x 1.30 x 1.59 6.37 5.48 0.99 x 33.4 2.64 189 17.1 95 0.85 0.72 1.10 12.00 1.66 4.20 x 1.35 x 1.61 6.14 5.29 0.97 1.10 11.80 1.64 4.25 x 1.40 1.10 11.80 1.60 4.30 2006 Q4 2007 Q4 2008 Q4 2009 Q3 Q4 2010 Q1 Q2 Q3 Q4f 2011 Q1f Q2f Q3f Q4f
Source: HSBC
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Exchange rates vs EUR & GBP

end period
Vs euro Americas x x Europe x x x x x x x x Asia/Pacific x x x Vs sterling Americas x x Europe x x x x x Asia/Pacific x x x x x US (USD) Canada (CAD) x UK (GBP) Sweden (SEK) Norway (NOK) Switzerland (CHF) Russia (RUB) Poland (PLN) Hungary (HUF) Czech Republic (CZK) x Japan (JPY) Australia (AUD) New Zealand (NZD) x x US (USD) Canada (CAD) x Eurozone (EUR) Sweden (SEK) Norway (NOK) Switzerland (CHF) x Japan (JPY) Australia (AUD) New Zealand (NZD) 2006 Q4 x x 1.32 1.53 0.67 9.02 8.21 1.61 34.8 3.83 251 27.5 x 157 1.67 1.87 x x 1.96 2.28 x 0.67 13.39 12.19 2.39 x 233 2.48 2.78 2007 Q4 2008 Q4 2009 Q3 Q4 2010 Q1 Q2 Q3 Q4f 2011 Q1f Q2f Q3f Q4f
1.46 1.44 0.73 9.45 7.94 1.66 35.9 3.60 253 26.6 x 163 1.67 1.90 x x 1.99 1.96 x 0.73 12.86 10.81 2.25 x 222 2.27 2.59
1.39 1.72 0.97 10.99 9.73 1.48 40.8 4.12 266 26.8 x 126 1.99 2.38 x x 1.44 1.77 x 0.97 11.37 10.07 1.53 x 130 2.06 2.46
1.46 1.57 0.91 10.22 8.48 1.52 44.0 4.24 270 25.3 x 131 1.66 2.02 x x 1.60 1.72 x 0.91 11.18 9.28 1.66 x 143 1.81 2.21
1.43 1.50 0.89 10.24 8.29 1.48 43.4 4.11 270 26.4 x 134 1.60 1.97 x x 1.61 1.69 x 0.89 11.53 9.33 1.67 x 150 1.80 2.22
1.35 1.37 0.89 9.74 8.03 1.42 39.7 3.86 266 25.4 x 126 1.47 1.91 x x 1.52 1.54 x 0.89 10.92 9.00 1.60 x 142 1.65 2.14
1.22 1.30 0.82 9.53 7.97 1.32 38.2 4.14 285 25.7 x 108 1.45 1.78 x x 1.50 1.59 x 0.82 11.64 9.73 1.61 x 132 1.77 2.18
1.37 1.40 0.87 9.19 7.99 1.33 41.5 3.98 277 24.6 x 114 1.41 1.86 x x 1.58 1.62 x 0.87 10.61 9.23 1.54 x 132 1.63 2.14
1.35 1.42 0.86 9.10 7.90 1.30 41.6 3.90 275 24.8 x 115 1.39 1.78 x x 1.57 1.65 x 0.86 10.61 9.21 1.52 x 134 1.62 2.07
1.25 1.38 0.81 8.90 7.60 1.28 37.1 3.85 270 24.8 x 113 1.36 1.71 x x 1.54 1.69 x 0.81 10.97 9.36 1.58 x 139 1.67 2.11
1.30 1.43 0.85 8.70 7.50 1.30 40.0 3.80 270 24.5 x 124 1.53 1.81 x x 1.54 1.69 x 0.85 10.28 8.86 1.54 x 146 1.81 2.13
1.35 1.49 0.85 8.60 7.40 1.34 42.1 3.75 265 24.3 x 128 1.59 1.88 x x 1.59 1.75 x 0.85 10.16 8.74 1.58 x 151 1.88 2.21
1.40 1.54 0.87 8.60 7.40 1.36 46.8 3.70 265 24.0 x 133 1.65 1.94 x x 1.61 1.77 x 0.87 9.89 8.51 1.56 x 153 1.89 2.24
Source: HSBC
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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: David Bloom, Clyde Wardle, Richard Yetsenga, Robert Lynch, Paul Mackel, Stacy Williams, Perry Kojodjojo, Marjorie Hernandez, Mark McDonald, Daniel Hui and Murat Toprak
Important Disclosures
This document has been prepared and is being distributed by the Research Department of HSBC and is intended solely for the clients of HSBC and is not for publication to other persons, whether through the press or by other means. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other investment products mentioned in it and/or to participate in any trading strategy. Advice in this document is general and should not be construed as personal advice, given it has been prepared without taking account of the objectives, financial situation or needs of any particular investor. Accordingly, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to their objectives, financial situation and needs. If necessary, seek professional investment and tax advice. Certain investment products mentioned in this document may not be eligible for sale in some states or countries, and they may not be suitable for all types of investors. Investors should consult with their HSBC representative regarding the suitability of the investment products mentioned in this document and take into account their specific investment objectives, financial situation or particular needs before making a commitment to purchase investment products. The value of and the income produced by the investment products mentioned in this document may fluctuate, so that an investor may get back less than originally invested. Certain high-volatility investments can be subject to sudden and large falls in value that could equal or exceed the amount invested. Value and income from investment products may be adversely affected by exchange rates, interest rates, or other factors. Past performance of a particular investment product is not indicative of future results. Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues. For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research. * HSBC Legal Entities are listed in the Disclaimer below.
Additional disclosures
1 2 3
This report is dated as at 09 December 2010. All market data included in this report are dated as at close 08 December 2010, unless otherwise indicated in the report. HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner.
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Disclaimer
* Legal entities as at 31 January 2010 Issuer of report 'UAE' HSBC Bank Middle East Limited, Dubai; 'HK' The Hongkong and Shanghai Banking Corporation HSBC Bank plc Limited, Hong Kong; 'TW' HSBC Securities (Taiwan) Corporation Limited; 'CA' HSBC Securities (Canada) 8 Canada Square, London Inc, Toronto; HSBC Bank, Paris branch; HSBC France; 'DE' HSBC Trinkaus & Burkhardt AG, Dusseldorf; E14 5HQ, United Kingdom 000 HSBC Bank (RR), Moscow; 'IN' HSBC Securities and Capital Markets (India) Private Limited, Mumbai; 'JP' HSBC Securities (Japan) Limited, Tokyo; 'EG' HSBC Securities Egypt S.A.E., Cairo; 'CN' HSBC Telephone: +44 20 7991 8888 Investment Bank Asia Limited, Beijing Representative Office; The Hongkong and Shanghai Banking Telex: 888866 Corporation Limited, Singapore branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Fax: +44 20 7992 4880 Securities Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Branch; HSBC Website: www.research.hsbc.com Securities (South Africa) (Pty) Ltd, Johannesburg; 'GR' HSBC Pantelakis Securities S.A., Athens; HSBC Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv, 'US' HSBC Securities (USA) Inc, New York; HSBC Yatirim Menkul Degerler A.S., Istanbul; HSBC Mxico, S.A., Institucin de Banca Mltiple, Grupo Financiero HSBC, HSBC Bank Brasil S.A. - Banco Mltiplo, HSBC Bank Australia Limited, HSBC Bank Argentina S.A., HSBC Saudi Arabia Limited., The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch. 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[286145]
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Main Contributors
David Bloom Global Head of FX Research +44 20 7991 5969 david.bloom@hsbcib.com David is Global Head of FX Research for HSBC. He has been with the Group since 1992. Before taking up his current post, specialising in currencies and market strategies, David was the US economist for the Bank. He also has work experience within equity markets and analysing the UK economy. Paul Mackel Director of Currency Strategy +44 207 991 5968 paul.mackel@hsbcib.com Paul is a senior currency strategist covering the G10 currency markets. He joined HSBC in June 2006 and is based in London, working alongside David Bloom. Prior to joining HSBC, Paul worked in a similar role for other financial institutions.
Stacy Williams Head of FX Quantitative Strategy stacy.williams@hsbcgroup.com +44 20 7991 5967 Stacy is responsible for FX quantitative research, advising the global client base on the development of currency overlay programs and the construction of bespoke hedging strategies. He is also responsible for proprietary model trading systems and developing the banks academic collaborations, principally with the University of Oxford, where he read physics. Mark McDonald FX Quantitative Strategist +44 20 7991 5966 mark.mcdonald@hsbcib.com Mark is a quantitative FX strategist based in London. He joined HSBC in 2005. Before joining the company, he obtained a DPhil from Oxford University, researching in collaboration with the HSBC FX Strategy team. Mark has an MPhys in Physics, also from Oxford University. Richard Yetsenga Global Head of EM FX Strategy richard.yetsenga@hsbc.com.hk +852 2996 6565 Richard is a Hong Kong-based member of HSBCs global emerging markets FX research team covering Asia. Prior to joining HSBC in 2004, he worked in currencies and economics research, including four years with the Australian government.
Daniel Hui FX Strategist, Asia +852 2822 4340 danielpyhui@hsbc.com.hk Daniel is a Hong Kong-based FX strategist covering Asia. Prior to joining HSBC in 2007, he worked as an economist covering Southeast Asia and Greater China. Daniel received his masters degree from Johns Hopkins University, with a concentration in international economics and Asian economic development. Perry Kojodjojo FX Strategist, Asia +852 2996 6568 perrykojodjojo@hsbc.com.hk Perry joined HSBC in 2005 as part of the global FX strategy team. He is based in Hong Kong and covers Asia. Perry received his masters degree in finance from Imperial College London.
Robert Lynch Head of G10 FX Strategy, Americas. +1 212 525 3159 robert.lynch@us.hsbc.com Robert is the Head of G10 currency strategy for HSBC in New York. He has over 10 years of experience as a currency analyst and, in conjunction with the rest of the FX Strategy group, is responsible for helping to formulate the FX Strategy groups views and forecasts for major currencies. Clyde Wardle Emerging Markets Currency Strategist clyde.wardle@us.hsbc.com +1 212 525 3345 Clyde is a New York-based emerging markets currency strategist, focusing mainly on Latin America. He also provides emerging market risk management advice to HSBCs global client base. He has been with the bank for eleven years.
Marjorie Hernandez FX Strategist, Latin America +1 212 525 4109 marjorie.hernandez@us.hsbc.com Marjorie is a New York-based FX strategist covering Latin America. She was formerly part of HSBCs global emerging market research team as an economist focusing on the Andean region. She joined HSBC in 2005.

HSBC - Currency Outlook December

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Currency

Macro Currency Strategy December 2010

Macro Currency Strategy December 2010

The SDR Honey the IMF shrunk the yen

HKD peg mythbusters

HUF...better, but not safe

Macro Currency Strategy December 2010

At a glance all regions

12 months 1.347 88.19 1.609 1.022 0.935 0.724

1.374 83.39 1.596 1.015 0.966 0.742

Macro Currency Strategy December 2010

EUR 2011 retraces, reflects, recovers

Q2 2011 1.30 1.54 0.85 1.30 7.50

Q3 2011 1.35 1.59 0.85 1.34 7.40

Q4 2011 1.40 1.61 0.87 1.36 7.40

1.25 1.54 0.81 1.28 7.60

Macro Currency Strategy December 2010

NOK the best currency...isnt it?

Macro Currency Strategy December 2010

2. The NOK has not performed well this year...

3. ...and has not since the Feds QE2 came alive

Currency Performance vs USD (Jan 1 to Nov 29 10')

EUR NOK GBP

Currency Performance vs USD (Aug 1 to Nov 29 10')

SEK CHF NZD CAD AUD JPY

NOK GBP EUR CAD JPY CHF SEK NZD AUD

NOK...just a EUR at heart?

4. Gold has outperformed the NOK

Macro Currency Strategy December 2010

Source: HSBC, Bloomberg

NOK its all about risk on risk off

Source: HSBC, Bloomberg

Macro Currency Strategy December 2010

NOK's sensitivity to 'Risk on - Risk off (260-day rolling correlation)'

0.6 0.5 0.4 0.3 0.2 0.1 0 -0.1 -0.2 -0.3

Jul-07 Dec-07 Apr-08 Sep-08 Feb-09 Jun-09

Oct-09 Mar-10 Aug-10

Source: HSBC, Bloomberg

Macro Currency Strategy December 2010

Conclusion Should be as strong as Fort NOKs

Macro Currency Strategy December 2010

The SDR Honey the IMF shrunk the yen

New SDR weights JPY negative

Amount 0.632 0.41 18.4 0.0903

Macro Currency Strategy December 2010

2. 2005 Target Weights Currency USD EUR JPY GBP

2005 Weighting 44% 34% 11% 11%

Where have these effective weights come from?

Effective Weighting Today 40.5% 36.0% 14.2% 9.3%

Macro Currency Strategy December 2010

Nov-2010 Weighting 41.9% 37.4% 9.4% 11.3%

The SDR change - negative for the JPY

Impact on the market

2010 Weighting (Table 4) 41.9% 37.4% 9.4% 11.3%

Change in weight (Table 4 minus Table 3) +1.4% +1.4% -4.8% +2.0%

40.5% 36.0% 14.2% 9.3%

Macro Currency Strategy December 2010

Addition of EM currencies to the SDR basket

Will the SDR become a new reserve currency? No.

Macro Currency Strategy December 2010

Macro Currency Strategy December 2010

HKD peg mythbusters