Global Economic Research

January 2012

Foreign Exchange Outlook

Deepening growth and debt distress in Europe, heightened central bank intervention worldwide, sovereign credit rating downgrade activity in advanced economies, asset price adjustments in emerging markets and a strong preference for liquidity-rich currencies are driving capital flows in foreign exchange markets. The USD remains global investors preferred world reserve currency. Flight to liquidity (not credit quality) continues to benefit the USD. Favourable commodity price dynamics, robust sovereign debt profiles and stable monetary policy conditions inject a positive momentum into CAD and AUD. The EUR, which has been weakening since early September, should continue to lose value against the USD throughout 2012. The European Central Bank remains committed to supplying unlimited liquidity support to European banks. We expect 2012 to prove a solid year for the GBP. The CHF appreciation potential against the EUR remains constrained by decisive official intervention. The JPY, which offers a diversification option for global currency portfolios, will be subject to technical resistance over the coming months. The CNY has resumed its gradual appreciation trend as China maintains policies to reinforce global financial stabilization. Leadership succession in North Korea prompted a negative, yet temporary, market reaction across Asia.

Index
Market Tone & Fundamental Focus ......................................................................................... 3 US/Canada.................................................................................................................................. 5 Europe ........................................................................................................................................ 6 Asia/Oceania .............................................................................................................................. 8 Global Currency Forecast....................................................................................................... 10

Foreign Exchange Outlook is available on: www.scotiabank.com and Bloomberg at SCOE

Global Economic Research

January 2012

Foreign Exchange Outlook

Global Foreign Exchange Outlook

December 22, 2011
Euro Yen Sterling Canadian Dollar Australian Dollar Mexican Peso
EURUSD Consensus* USDJPY Consensus* GBPUSD Consensus* USDCAD Consensus* AUDUSD Consensus* USDMXN Consensus*

Actual Q3a 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Q2 13
1.30 78.1 1.57 1.02 1.01 13.80 1.34 77 1.56 1.05 0.97 13.90 1.30 1.32 78 77 1.55 1.56 1.04 1.02 1.00 1.00 13.53 13.72 1.29 1.31 78 77 1.56 1.53 1.02 1.03 1.02 0.97 13.45 13.51 1.28 1.32 80 77 1.59 1.55 1.01 1.02 1.04 0.98 13.15 13.21 1.27 1.32 80 78 1.62 1.56 0.99 1.02 1.06 0.99 13.03 12.91 1.25 1.33 82 78 1.63 1.58 0.98 1.01 1.08 1.00 13.02 12.61 1.25 1.32 83 79 1.65 1.58 0.98 1.01 1.09 0.99 13.10 12.67 1.26 1.32 83 80 1.66 1.59 0.97 1.01 1.09 0.98 13.18 12.72

Spot Price vs. 100 Day Moving Average vs. 200 Day Moving Average - (5yr Trend)

EURUSD
EUR/ USD

USDJPY
100 Day 200 Day

1.62 1.52 1.42 1.32 1.22 1.12

123 116 109 102 95 88 81 74

USD/ JPY 100 Day 200 Day

D ec -0 M 6 ay -0 7 O ct -0 M 7 ar -0 Au 8 g08 Ja n09 Ju n0 N 9 ov -0 Ap 9 r10 Se p1 Fe 0 b11 Ju l-1 D 1 ec -1 1

GBPUSD
2.11 1.96 1.81 1.66 1.51 1.36
GBP/ USD 100 Day 200 Day

D ec -0 6 Ju n07 D ec -0 7 Ju n08 D ec -0 8 Ju n09 D ec -0 9 Ju n10 D ec -1 0 Ju n11 D ec -1 1

AUDUSD
1.12 1.04 0.97 0.89 0.82
AUD/ USD

0.74 0.67 0.59

100 Day 200 Day

D ec -0 7 Ju n08 D ec -0 8 Ju n09

(*) Source: Consensus Economics Inc. December 2011

D ec -0 6 Ju n07 D ec -0 7 Ju n08 D ec -0 8 Ju n09 D ec -0 9 Ju n10 D ec -1 0 Ju n11 D ec -1 1

D ec -0 9 Ju n10 D ec -1 0 Ju n11 D ec -1 1

D ec -0 6 Ju n07

D ec -0 6 Ju n07 D ec -0 7 Ju n08 D ec -0 8 Ju n09 D ec -0 9 Ju n10 D ec -1 0 Ju n11 D ec -1 1

D ec -0 6 Ju n07 D ec -0 7 Ju n08 D ec -0 8 Ju n09 D ec -0 9 Ju n10 D ec -1 0 Ju n11 D ec -1 1

USDCAD
USD/ CAD

1.30 1.22 1.14 1.06 0.98 0.90

100 Day 200 Day

USDMXN
15.2
USD/ M XN

14.1 13.0 11.9 10.8 9.7

100 Day 200 Day

Global Economic Research

January 2012

Foreign Exchange Outlook

MARKET TONE & FUNDAMENTAL FOCUS
Pablo F.G. Brard +1 416 862-3876 Camilla Sutton +1 416 866-5470

Intensifying sovereign credit rating downgrade activity in developed economies, uneven shifts in commodity prices, deepening growth and debt distress in Europe, volatile asset-price adjustments in emerging-market high-yield economies, heightened central bank intervention in treasury bond (and currency) markets and renewed stress in interbank funding markets - all while volatility measures have fallen to their August lows - are the major issues affecting capital flows as global currency markets enter a new year. The US dollar (USD) remains global investors preferred world reserve currency. Flight to liquidity (not credit quality) continues to benefit the USD. Even gold prices have been in retrenchment mode as an alternative safe-haven asset. The USD, measured by the trade-weighted DXY index, has increased 8% since early September. Looking ahead, our forecast implies further weakening of the single European currency (EUR) to 1.25 against the USD by the end of 2012. The US economy is not free of fundamental challenges, as evidenced by still high unemployment, a large Federal budget deficit, fiscal and trade policy uncertainties ahead of the November 2012 presidential election and the sluggish recovery of the labourintensive real-estate sector. However, in relative terms, the situation in Europe is worsening and the risk of asset price overvaluation is increasing in developed and developing Asian market instruments, injecting a liquidity premium into the US currency. The EUR, which has been weakening since early September, should continue to lose value against the USD throughout 2012. The European Central Bank (ECB) remains committed to supplying unlimited liquidity support to European banks, while market participants eagerly await policy news related to the implementation of the socalled fiscal compact intended to limit (if not punish) national deficit positions. The IMF has received 150 billion in new European funds to strengthen the multilateral financial war chest. Contributions from the US, the UK and China remain uncertain. Multiple credit rating agency developments occurred in mid December: Fitch downgraded the outlook on the foreign-currency sovereign credit rating of France, Italy and Spain stressing ongoing delays in engineering a seamless solution to the regions sovereign debt crisis. At the same time, Moodys downgraded Belgiums rating by two notches, while S&P placed the sovereign ratings of 15 members of the euro zone on CreditWatch negative. ECB President Draghi stressed that individual countries need to focus on deepening structural reforms to restore global confidence in the regions growth prospects. He noted that further rate cuts will not restore investor confidence in the euro areas fiscal and debt sustainability.

Commodity-linked currencies remain in vogue. Both the Canadian (CAD) and the Australian (AUD) dollar continue to be well supported by favourable commodity-price dynamics, strong sovereign positions and stable monetary policy conditions. On December 6th the Reserve Bank of Australia cut the target cash rate by 25 bps to 4.25% for the second consecutive month, whereas the Bank of Canada has left its reference rate unchanged at 1% since September 2010. Recent official statements/rhetoric in both countries have hinted that no change in the current policy stance is anticipated (despite continuing price pressures in Canada associated with rising food and energy costs). The CAD has also received a boost from persistently strong crude oil prices and recent economic data in the US providing evidence of a modest recovery. We expect the CAD to close 2012 at a rate of 1.02 per USD. The Mexican peso (MXN) had a difficult 2011, but the outlook for 2012 is brighter for similar reasons to the CAD. The British pound (GBP) sits at a crossroads, with weak fundamentals offset by positive flows on the back of its Triple-A status and inter-European diversification play. We expect 2012 to prove a solid year for GBP. The Swiss francs (CHF) appreciation potential against the EUR remains constrained by decisive and well-communicated intervention by the monetary authorities. Meanwhile the Swedish krona (SEK) is poised to strengthen against the EUR during the first half of the year. The Japanese yen (JPY) remains the best-performing currency of the majors, having gained 6.9% versus the USD and 7.4% versus the EUR over the past 12 months. We expect, nevertheless, that the JPY will be subject to technical resistance over the coming months and will weaken modestly throughout the year to reach 82 per USD by next December. Despite its weakened fiscal and debt position, Japan still offers a viable diversification option for global currency portfolios. Elsewhere in the region, the Chinese yuan (CNY) has resumed its gradual appreciation trend at a time when the countrys authorities are introducing changes to existing legislation to allow for higher international investor exposure to local stocks. Geopolitical events in South East Asia instilled a temporary bearish sentiment into regional currencies and equity securities. Leadership succession in North Korea prompted a negative market reaction across the region, with the South Korean won (KRW) being the primary casualty of intensifying geopolitical risk in the Korean peninsula. Regional political events have exacerbated a negative sentiment that was already in place in connection with European developments. Nevertheless, on the basis of favourable interest and growth spreads, we continue to anticipate a bullish tone for the KRW versus the USD in 2012.

Global Economic Research

January 2012

Foreign Exchange Outlook

CANADA
Camilla Sutton +1 416 866-5470 Eric Theoret +1 416 863-7030

The Canadian dollar (CAD) has seen relatively minor movement through mid-December, falling slightly vs the USD but gaining on the crosses against the majority of its peer currencies. Though CAD movement is influenced by swings in commodity prices, the currency has been showing signs of greater stability on a relative basis when compared to its commodity peers. The relative outperformance can generally be attributed to ongoing improvement in the economic outlook for the US, as well as expectations for a soft landing in China, as growth in the worlds second largest economy begins to slow from currently elevated levels. As such, the focus for CAD remains on the outlook for global growth and sustained commodity demand. Given Scotia Economics forecast for oil to average US$95 in 2012, we expect a trend of steady appreciation vs the USD into year-end 2012. Although uncertainty continues to hang over the outlook for EUR, volatility measures remain subdued, suggesting that the path for CAD remains closer to that seen in 2010, with less depreciation than the post-Lehman fall from 2008. Meanwhile, sentiment indicators continue to suggest a stronger CAD, with a steady accumulation of investors long positions as shorts pare back their bets. In the current environment, an accelerant of support for CAD has been, and is expected to remain, the sustained inflow of international investment into Canada from portfolio diversification amid an intensification of sovereign risk. The preference for Canadian exposure relative to other developed economies is the result of moderate government debt metrics that are expected to improve into the end of the decade. A solid fiscal framework is underpinned by the Bank of Canadas strong commitment to its inflation target, with room for action on the part of policymakers to act in either direction. While Canadian economic indicators are beginning to show signs of slowing, the outlook for growth is stable and should provide for CAD strength. Given the factors outlined above we expect CAD to appreciate to 1.02 by Q4 2012.

Currency Trends
FX Rate AUDCAD CADJPY EURCAD USDCAD 12 m 1.021 81.28 1.336 0.998 Going Back 6m 1.033 83.62 1.397 0.963 3m 1.015 73.37 1.406 1.050 Spot 22-Dec 1.036 76.40 1.334 1.023 3m 1.040 76.47 1.316 1.020 Outlook 6m 1.050 79.21 1.293 1.010 12 m 1.058 83.67 1.225 0.980 FX Rate AUDCAD CADJPY EURCAD USDCAD

AUDCAD
1.07 1.05 1.03 1.01 1.00 0.98 0.96 De c-10 89.0 86.0 83.0 80.0 77.0 74.0 71.0 Dec-10

CADJPY

Fe b-11 Apr-11

Jun-11 Aug-11

Oct-11

De c-11

Fe b-11 Apr-11

Jun-11 Aug-11

Oct-11

De c-11

EURCAD
1.45 1.42 1.39 1.36 1.33 1.30 1.27 De c-10 1.06 1.04 1.02 1.00 0.98 0.96 0.94 Dec-10

USDCAD

Fe b-11 Apr-11

Jun-11 Aug-11

Oct-11

De c-11

Fe b-11

Apr-11

Jun-11

Aug-11

Oct-11

De c-11

Global Economic Research

January 2012

Foreign Exchange Outlook

CANADA AND UNITED STATES
Fundamental Commentary Adrienne Warren +1 416 866-4315 Gorica Djeric +1 416 866-4214

UNITED STATES - US economic indictors continued on their positive run the final months may make for the strongest quarter since mid-2010. Aside from acting as an offsetting force to escalating concerns over the European debt crisis, data reveal that the real economy excluding the deleveraging sectors (construction, finance, real estate, government) is showing gradual improvement. The labour market is a clear example. Since bottoming in February 2010, non-deleveraging sectors jointly rehired over 3 million Americans, averaging a stepped-up monthly gain of 150,000 since September. In contrast, the deleveraging sectors shed more than 600,000 posts, with the government accounting for 80% of the losses. While consumer sentiment spiked to a six-month high in November, and underlying inflation is easing, household finances remain buffeted by strong headwinds, including high unemployment, tepid wage growth, a fragile housing market, ongoing deleveraging and political gridlock in both Brussels and Washington, including the ongoing debate over the nearing expiry of US jobless benefits and payroll tax deductions. As the economy rebalances away from an over-reliance on the domestic consumer, business investment and exports are expected to add the most to growth. Robust corporate profits have been a bright spot of the recovery. Aside from a record liquidity cushion, businesses are also focusing on boosting productivity and efficiencies through automation and export diversification providing a stronger contribution to the overall economy. Over the past two decades, US exports to emerging markets grew by nearly 350%. China has become the third biggest export destination, with a compound growth rate of just under 20% since its accession to the World Trade Organization in 2001, well above the 7% growth registered by the rest of the world.

CANADA - The latest economic indicators are consistent with positive, yet moderate growth. Real GDP is on track to increase around an annualized 1-2% rate in the final quarter of 2011, with relatively solid domestic demand tempered by weak export conditions. The economy faces a number of significant headwinds, including a sluggish US recovery and intensifying sovereign debt concerns in Europe which will likely keep growth in the slow lane through at least mid-2012. Exports are being constrained by weak global demand, as well as by ongoing competitive challenges associated with the persistently strong Canadian dollar and persistently weak labour productivity growth. While Canadian exporters continue to enjoy strong sales growth in faster-growing emerging markets, the slower-growing markets of the United States and Europe still account for over 80% of international shipments. Fiscal stimulus is winding down, with public sector spending expected to act as a modest drag on growth in 2012-13. Consumer sentiment has deteriorated alongside a more moderate pace of job creation and weak income gains. Nonetheless, retailers continue to report modest sales growth, aided by deep incentives. Home sales and construction remain quite buoyant, with buyers taking advantage of historically low interest rates. Business investment also remains a bright spot. While sentiment surveys suggest businesses have become more concerned over the economic outlook, they nonetheless continue to signal strong capital investment intentions, supported by competitive pressures, healthy corporate balance sheets, favourable credit conditions and tax incentives. Prices of key commodities, while easing back from their early-year highs, remain at profitable levels and continue to attract sizeable long-term investments in the mining and oil & gas sectors.

MONETARY POLICY COMMENTARY

Derek Holt +1 416 863-7707

Karen Cordes Woods +1 416 862-3080

UNITED STATES - We continue to expect the Federal Reserve to keep the fed funds rate on hold at 0.25% until at least the third quarter of 2013. However, the current FOMC voting structure will shift at the first FOMC meeting next of 2012 (on January 25th), ushering in a more dovish composition to replace this years more hawkish tilt. As a result, the bar will be lowered regarding further unconventional monetary policy easing. This could come in the form of another round of quantitative easing should the US economy continue to muddle along in its current state or take a turn for the worse amid further uncertainty regarding a longterm resolution in Europe. Or, perhaps more plausible at least at the outset, we will likely witness a shift in the wording of the FOMC statement either via a conditional commitment by the Fed or further clarity regarding the current language in order to enhance guidance on the Feds reaction function.

CANADA - While we agree with the Bank of Canadas view that Canadian household debt-to-GDP is reaching stressed levels, we are more cautious on the future outlook given the sudden slowing in household debt growth. Indeed, the industry-wide consumer loan book which includes all fixed and variable rate installment loans, credit card balances and drawn lines of credit has slowed to a crawl, and stopped growing after accounting for inflation. The industrywide mortgage loan book has slowed to among the weakest growth paces in decades. This provides a cautionary note against further policy tightening that could risk tipping the ship right over from a soft landing to a potentially harder one. It also supports our forecast that the Bank of Canada will remain on the sidelines until the second quarter of 2013, barring a liquidity crisis stemming from the current European debt situation.

Global Economic Research

January 2012

Foreign Exchange Outlook

EUROPE
Currency Outlook Camilla Sutton +1 416 866-5470 Eric Theoret +1 416 863-7030

EURO ZONE - EUR is entering the last week of December essentially flat to where it began the year, suggesting that EUR has actually been quite resilient in the midst of the crisis. This resiliency has most recently been on the back of flows (both official sector and bank recapitalization). However these appear to be slowing, opening the door to fundamentally driven EUR downside. The ongoing crisis, loose monetary policy, negative sentiment and a technical downtrend should all weigh on EUR in 2012. Temporarily EUR might move towards its 2010 low of 1.1877, however this is unlikely to be sustainable. We hold a Q112 EURUSD target of 1.29 and a Q412 target of 1.25 UNITED KINGDOM - Relatively weak fundamentals that include low growth, strict austerity and loose monetary policy leave the backdrop for GBP as notably soft. Sentiment is also bearish, with the CFTC reporting a net short GBP position of $3.8bn as of December 13th. However, on a relative basis, GBP is likely to be rewarded for its Triple-A status, its well defined path ahead and its low beta properties. Accordingly, we hold a Q112 forecast for GBPUSD of 1.56 and a yearend target of 1.63. SWITZERLAND - The EURCHF floor is widely seen as credible, unleashing the potential for unlimited FX intervention by Swiss authorities. Leading into the December Swiss National Bank meeting the market speculated that the floor might be pushed to 1.25, however authorities failed to so do. With a credible floor in place and ongoing pressure on EUR, it is unlikely that we see significant price action in CHF during January. We hold a Q112 EURCHF target of 1.24. SWEDEN - The Swedish krona is closing 2011 essentially where it began, having spent most of the year trading within a range. Strong EURSEK support lies at 8.86, but we do not expect this level to hold as ongoing EUR weakness weighs heavily on the cross.
Currency Trends
FX Rate EURUSD GBPUSD EURCHF EURSEK 12 m 1.34 1.56 1.25 8.99 Going Back 6m 1.45 1.61 1.22 9.18 3m 1.34 1.56 1.22 9.20 Spot 22-Dec 1.30 1.57 1.22 8.99 3m 1.29 1.56 1.24 9.10 Outlook 6m 1.28 1.59 1.24 9.00 12 m 1.25 1.63 1.24 8.80 FX Rate EURUSD GBPUSD EURCHF EURSEK

EURUSD
1.68 1.46 1.64 1.41 1.60 1.36 1.56

GBPUSD

1.31

1.26 De c-10

Fe b-11 Apr-11

Jun-11 Aug-11

Oct-11

De c-11

1.52 De c-10

Fe b-11

Apr-11

Jun-11

Aug-11

Oct-11

De c-11

EURCHF
9.40 1.38 9.25 1.30 1.23 1.15 1.08 1.00 De c-10 9.10 8.95 8.80 8.65 De c-10

EURSEK

Fe b-11

Apr-11

Jun-11

Aug-11

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Fe b-11 Apr-11

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Global Economic Research

January 2012

Foreign Exchange Outlook

EUROPE
Fundamental Commentary Sarah Howcroft +1 416 863-2859

EURO ZONE - The European Central Bank (ECB) will likely continue to loosen monetary policy in the new year, even as inflation remains above the banks 2% target. We expect the ECB to reduce the main refinancing rate by another 50 basis points (bps), taking the policy rate to 0.50% by early-2012. This action will build on the two quarterpoint cuts and the various liquidity-boosting measures implemented at the November and December meetings. Even bringing the rate to a historic low, however, will not preclude a technical recession in the currency union. Despite a modest improvement in the preliminary December estimates, most euro zone PMIs remain firmly below the neutral threshold between expansion and contraction, while business and consumer confidence also display persistent fragility (though the German IFO survey has shown improvement). Long-term sovereign bond yields have eased somewhat in recent weeks; however, they remain elevated by historical standards for most members, maintaining pressure on governments to accelerate fiscal consolidation and structural reform measures. As evidenced by Belgiums recent downgrade by both Moodys and S&P, the wave of downward rating action continues unabated, with virtually every euro zone member now on negative credit watch by one or more of the major rating agencies. Indeed, each agency has recently vocalized a patent loss of faith in the political process within the union, indicating that a satisfactory solution to the crisis is not attainable at present. SWITZERLAND - The Swiss authorities remain committed to enforcing the minimum exchange rate for the franc (CHF) of 1.20 per euro, and will continue to defend the floor with unlimited foreign currency buying coupled with potential capital controls and/or negative interest rates. In its December monetary policy assessment, the Swiss National Bank (SNB) indicated that even with the floor the strong currency is dampening the economy, and when combined with the intensifying debt and banking crises in the euro zone, will limit GDP growth to around % in 2012. We expect that output will be even weaker in 2012, with the economy registering a mild recession in the first half of the year. The KOF Leading Economic Indicator dropped again in November, posting a 27-month low. Any additional measures employed to further weaken the CHF (i.e., a higher floor and/or capital controls) would be unlikely to boost growth materially in the near term, and may actually prove destabilizing to financial markets. The consumer price index registered a second yearly contraction in November, and inflation is set to remain negative for some time, averaging around -0.2% y/y in 2012 before picking up gradually in the medium term. Even as exports contract over the coming year, Switzerland will maintain a healthy albeit declining current account surplus in the range of 10% of GDP. While the fiscal balance may slip into deficit in 2012 for this first time since 2005, the gross general government debt will remain low by developed-market standards, at close to 50% of GDP.

UNITED KINGDOM - Britains economic performance, as well as the sterling (GBP), will continue to reflect developments in the euro zone and the persistent fragility of the domestic market. Political turmoil may jeopardize investors generally favourable perceptions of the nation, as relations within the governing coalition and between Prime Minister Camerons administration and other EU heads of state are tested by the ongoing crises and the uncertainty over the future of the European project. Nevertheless, unlike many of its European neighbours, the UK retains a stable outlook on its triple-A rating from each of the major credit rating agencies. With certain key indicators (including PMIs, retail sales and exports) illustrating a better than anticipated picture in the fourth quarter, we have edged up our expectation for output growth in 2011 to 0.9%. A somewhat slower rate of expansion of 0.7% in 2012 will nonetheless mark a clear outperformance relative to the largest euro zone nations, reinforcing GBP strength versus the euro through 2012. This trend will continue in 2013. Inflation has moderated from its September peak of 5.2% y/y to 4.8% as of November, and will likely drop rapidly in the coming months given the base effects of tax increases implemented in the past year. The Bank of England (BoE), set to hold the bank rate at 0.50% through the second quarter of 2013, is widely expected to boost its bond purchasing program, and will likely announce additional quantitative easing within the first few months of 2012. SWEDEN - Following a strong economic performance in 2011, the Swedish economy will slow considerably in 2012. Even with an expected softening in the final quarter of 2011, robust GDP growth through September averaging 5.1% will sustain a rate of around 4% for the year overall. Nevertheless, the effects of the euro area crisis have begun to materialize within Swedens borders. In November the Economic Tendency Indicator measuring consumer and business confidence reached its lowest level since September 2009, while the PMI remained in contractionary territory for the fourth straight month. Following the recent expansionary moves of several peer central banks, on December 20th the Riksbank opted to reduce the benchmark repo rate by 25 basis points to 1.75%. The Executive Board judged that intensifying fiscal restraint in the euro zone will constrain exports in 2012, and that domestic consumption and investment will suffer from reduced confidence and labour market fragility. Though currently elevated, the headline inflation rate at 2.8% y/y in November has drifted lower in recent months, and is projected to fall below the banks 2% target in 2012. Underlying inflationary pressures remain subdued, with the core rate at just 1.1% y/y. Of note, the central bank assesses that the highly-capitalized Swedish banking system is well-positioned to weather the financial turbulence emanating from Europe, and that the governments fiscal position is such that stimulative measures may be used to offset any adverse economic shocks in the medium term. 7

Global Economic Research

January 2012

Foreign Exchange Outlook

ASIA/OCEANIA
Currency Outlook Camilla Sutton +1 416 866-5470 Eric Theoret +1 416 863-7030

JAPAN - USDJPY traded within a notably tight range in December (77.13 to 78.17 to December 21st), suggesting the market is unwilling to push it in either direction and decreasing the value of technicals. Positive yen flows are expected to be offset by medium term weak fundamentals; however, after repeated rounds of official FX intervention USDJPY seems temporarily frozen. The CFTC reports that investors hold a net long yen position of US$5.7 billion. We hold a Q412 target of 82. CHINA - After trading in a relatively tight range in November, the yuan took another leg lower in mid-December, bringing its year-to-date appreciation against the USD to 4.2% and confirming it as the strongest primary currency in 2011. We expect a slow measured pace of appreciation to continue for the yuan and hold a Q112 forecast of 6.26. AUSTRALIA - AUD is entering the new year close to parity against the USD but at a record high against EUR. The fundamental backdrop has recently softened, but judging the currency on a relative basis, its outlook is still firm. AUD has a significant yield advantage in developed markets, making it an expensive short. Sentiment remains positive, with the CFTC reporting that investors hold a net long position of US $3.5 billion. In addition, AUDs Triple-A status should see it benefit from positive flows. We hold a Q112 AUDUSD target of 1.02. NEW ZEALAND - NZD has hugged AUDs price pattern fairly closely; however technicals have turned against the currency as it has developed a well defined downward trend. A bright outlook for AUD and positive investor sentiment towards NZD are likely to keep the currency supported. We hold a Q112 target of 0.81.

Currency Trends
FX Rate USDJPY USDCNY AUDUSD NZDUSD 12 m 81.1 6.61 1.02 0.78 Going Back 6m 80.6 6.46 1.07 0.83 3m 77.1 6.38 0.97 0.76 Spot 22-Dec 78.1 6.34 1.01 0.77 3m 78.0 6.26 1.02 0.76 Outlook 6m 80.0 6.19 1.04 0.78 12 m 82.0 6.07 1.08 0.81 FX Rate USDJPY USDCNY AUDUSD NZDUSD

USDJPY
86.8 84.5 6.59 82.3 6.50 80.0 77.8 75.5 De c-10 6.41 6.68

USDCNY

Feb-11 Apr-11 Jun-11 Aug-11 Oct-11

De c-11

6.32 De c-10

Fe b-11 Apr-11 Jun-11 Aug-11 Oct-11

De c-11

AUDUSD
1.11 1.07 1.04 1.00 0.97 0.93 De c-10 0.89 0.85 0.81 0.77 0.73 0.69 De c-10

NZDUSD

Fe b-11 Apr-11 Jun-11 Aug-11 Oct-11

De c-11

Fe b-11 Apr-11

Jun-11 Aug-11

Oct-11

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Global Economic Research

January 2012

Foreign Exchange Outlook

ASIA/OCEANIA
Fundamental Commentary Oscar Snchez +1 416 862-3174

JAPAN - Still elevated global uncertainty will continue to support the Japanese yens (JPY) safe-haven status. The Bank of Japan (BoJ) will persist in its interventions to battle excessive appreciation; with exchange rate strengthening forces countered by uncertainty regarding the countrys industrial recovery. The BoJ is expected to maintain a loose monetary policy stance, backed by sporadic expansions of its domestic bond buying program. Consumer prices registered a positive average yearly gain in the third quarter, the first since late 2008, with supply side pressures already filtering through as a high energy tally and dependence on imported fuel in the context of an economic rebound raise domestic costs. These effects are contravening traditional deflationary forces exacerbated by last years earthquake/tsunami. Given the background of a near-zero benchmark interest rate, extended quantitative easing by the BoJ will continue to be a key support in an environment where large manufacturing firms are suffering from a strong yen. Recent performance highlights the waves of recovery as GDP advanced at a 1.5% quarterly rate (6% y/y) in the third quarter, led by the industrial sector and exports, which surpassed year earlier levels notwithstanding yen strength. Renewed setbacks due to supply shortages from Thailand will detract from activity in the fourth quarter, leading us now to expect a slight GDP contraction in 2011. The Japanese economy will expand at a 3.3% y/y rate in 2012, and converge to medium-term speed (of 1.5%) in 2013. AUSTRALIA - The Australian dollar (AUD) will remain well supported in the medium term. An appreciating trend will resume as firm external and improving fiscal account fundamentals, strong ties to Asia and exposure to highly bid commodities all work in favour of the AUD, with inflation still challenging the Reserve Bank of Australias (RBA) 2-3% target. While the core inflationary measure moderated during the latest quarterly reading, the fall was predicated upon a flat goods prices advance and the strongest pickup in services costs in three years. The results point to persistent local pressures, as implied by favourable conditions within the mining sector where investment spending continues to propel ahead. While labour markets are less strained in non-mining activities, there is no evidence of slack, with the unemployment broadly steady at a little over 5%. The countrys terms of trade have peaked, but they remain elevated, enticing further investment in the resource sector. The downtrend in inflation and an uncertain global outlook, combined with evidence of cooling in the local residential market, opened the door for looser monetary conditions. The RBA left the benchmark cash rate unchanged at its latest monetary policy meeting, after lowering it twice by a total of 50 basis points to 4.25%. RBA authorities judge current conditions to be in favour of an economic expansion broadly in line with trend, given that the countrys main trading partners are also still recording solid growth. Australian GDP is expected to expand at an average 3.2% y/y rate in 2011-13.

CHINA - The renminbi (CNY) will appreciate at a slower pace through the coming year. While gradual CNY appreciation remains a primary policy to promote domestic market development, weakening exports to Europe and a downtrend in inflation have opened the door to more limited currency gains. A milder food price advance, combined with favourable base effects, underpins the recent fall in headline inflation to 4.2% y/y, from a 6.5% mid-year crest. While elevated raw material costs still loom in the background, overall inflation is expected to close the year at 4.7%. On the back of falling price pressures the Peoples Bank of China (PBoC) switched its monetary stance, lowering the required reserve ratio (RRR) for banks by 50 basis points. Further credit easing moves are expected. RRR calibration is a recourse utilized by the PBoC as the main tool to manage liquidity, while interest rate changes are aimed at redirecting expectations of asset overvaluation. Chinas role as the global growth pace-setter will intensify going forward, as advances in domestic demand balance subdued export growth. In the midst of inflation stabilization, steady nominal retail sales growth points to improving consumer conditions. Infrastructure developments such as social housing have compensated for falls in investment elsewhere. We expect the economy to expand at an 8.8% y/y average rate during 2011-13. No material structural change in Chinas currency regime is foreseen, and year-end rates of CNY6.32 per USD for 2011 and 6.07 for 2012 are anticipated. NEW ZEALAND - The New Zealand dollar (NZD) will pare back some of the losses brought about by recent waves of global uncertainty. However, economic underperformance will condition a return to early year heights as the Reserve Bank of New Zealand (RBNZ) adopts a growth supportive stance. Price stabilization will continue through the first months of the New Year. Annual inflation came down at the last quarterly reading, to 4.6% y/y, driven by slower price gains in tradable items on the back of NZD support. While there was no change in non-tradable goods inflation, the annual tally did ease on base effects. Overall, headline inflation remains above the RBNZs 1-3% comfort zone, with monetary authorities still sanguine about rising price pressures. Indicators of consumer spending display weakness as lacklustre income growth and wealth downgrades hurt purchasing power. Business confidence has also worsened, reaching levels observed only in the midst of the Christchurch earthquake that shook the country in the first quarter of 2011. On the external front, export values have slowed, as foreign shipments to Australia fail to compensate for falling sales to Europe and North America. Still, we expect New Zealands GDP to expand at a 3% y/y rate in 2012-13 on the back of persistently solid Asian growth. Positioning in NZD has been less volatile in comparison to the Australian dollar, remaining net-long for most of 2011. We forecast continued NZD appreciation through 2012 with an expected 0.81 per US dollar end-year rate. 9

Global Economic Research

January 2012

Foreign Exchange Outlook

GLOBAL CURRENCY FORECAST (end of period)

2010 2011f 2012f 2013f 2011f Q4 Q1 2012f Q2 Q3 Q4 Q1 2013f Q2 Q3 Q4

MAJOR CURRENCIES
Japan Euro zone UK Switzerland
USDJPY EURUSD EURJPY GBPUSD EURGBP USDCHF EURCHF 81 1.34 109 1.56 0.86 0.93 1.25 78 1.30 101 1.55 0.84 0.95 1.24 82 1.25 103 1.63 0.77 0.99 1.24 84 1.29 108 1.68 0.77 0.97 1.25 78 1.30 101 1.55 0.84 0.95 1.24 78 1.29 101 1.56 0.83 0.96 1.24 80 1.28 102 1.59 0.81 0.97 1.24 80 1.27 102 1.62 0.78 0.98 1.24 82 1.25 103 1.63 0.77 0.99 1.24 83 1.25 104 1.65 0.76 1.00 1.25 83 1.26 105 1.66 0.76 0.99 1.25 84 1.28 108 1.67 0.77 0.98 1.25 84 1.29 108 1.68 0.77 0.97 1.25

AMERICAS Canada North

Mexico Argentina Brazil South Chile Colombia Peru Venezuela

USDCAD CADUSD USDMXN CADMXN USDARS USDBRL USDCLP USDCOP USDPEN USDVEF

1.00 1.00 12.3 12.4 3.98 1.66 468 1908 2.81 4.29

1.04 0.96 13.5 13.0 4.50 1.80 515 1940 2.68 4.30

0.98 1.02 13.0 13.3 5.50 1.75 510 1870 2.63 5.15

0.96 1.04 13.3 13.9 6.00 1.85 500 1900 2.58 5.15

1.04 0.96 13.5 13.0 4.50 1.80 515 1940 2.68 4.30

1.02 0.98 13.5 13.2 4.73 1.79 514 1922 2.67 4.50

1.01 0.99 13.2 13.0 4.97 1.77 512 1905 2.65 4.71

0.99 1.01 13.0 13.2 5.23 1.76 511 1887 2.64 4.92

0.98 1.02 13.0 13.3 5.50 1.75 510 1870 2.63 5.15

0.98 1.02 13.1 13.4 5.62 1.77 507 1877 2.62 5.15

0.97 1.03 13.2 13.6 5.74 1.80 505 1885 2.60 5.15

0.97 1.03 13.3 13.7 5.87 1.82 502 1892 2.59 5.15

0.96 1.04 13.3 13.9 6.00 1.85 500 1900 2.58 5.15

ASIA / OCEANIA
Australia China Hong Kong India Indonesia 1/ Malaysia Philippines Singapore South Korea Thailand Taiwan
AUDUSD USDCNY USDHKD USDINR USDIDR USDMYR 1.02 6.61 7.77 44.7 9.00 3.06 0.78 43.8 1.28 1126 30.1 29.3 1.00 6.32 7.75 52.0 9.05 3.12 0.75 43.5 1.28 1140 31.0 30.3 1.08 6.07 7.75 49.7 8.75 3.00 0.81 41.5 1.24 1080 30.0 29.0 1.10 5.84 7.75 48.0 8.35 2.98 0.84 39.7 1.21 1025 29.1 27.9 1.00 6.32 7.75 52.0 9.05 3.12 0.75 43.5 1.28 1140 31.0 30.3 1.02 6.26 7.75 51.4 8.97 3.09 0.76 43.0 1.27 1125 30.7 29.9 1.04 6.19 7.75 50.8 8.90 3.06 0.78 42.5 1.26 1110 30.5 29.6 1.06 6.13 7.75 50.3 8.82 3.03 0.79 42.0 1.25 1095 30.2 29.3 1.08 6.07 7.75 49.7 8.75 3.00 0.81 41.5 1.24 1080 30.0 29.0 1.09 6.01 7.75 49.3 8.65 2.99 0.82 41.0 1.23 1066 29.8 28.7 1.09 5.95 7.75 48.8 8.55 2.99 0.82 40.6 1.22 1052 29.5 28.4 1.10 5.90 7.75 48.4 8.45 2.98 0.83 40.1 1.22 1038 29.3 28.1 1.10 5.84 7.75 48.0 8.35 2.98 0.84 39.7 1.21 1025 29.1 27.9

New Zealand NZDUSD

USDPHP USDSGD USDKRW USDTHB USDTWD

EUROPE / AFRICA
Czech Rep. Iceland Hungary Norway Poland Russia South Africa Sweden Turkey
EURCZK USDISK EURHUF USDNOK EURPLN USDRUB USDZAR EURSEK USDTRY 25.0 115 279 5.82 3.96 30.5 6.63 8.99 1.54 25.3 118 300 5.60 4.40 31.0 8.20 9.20 1.82 24.5 116 290 5.30 4.10 30.5 8.00 8.80 1.74 23.6 114 270 5.00 3.97 30.0 8.10 8.50 1.67 25.3 118 300 5.60 4.40 31.0 8.20 9.20 1.82 25.1 117 297 5.53 4.32 30.9 8.15 9.10 1.80 24.9 117 295 5.45 4.25 30.7 8.10 9.00 1.78 24.7 116 292 5.38 4.17 30.6 8.05 8.90 1.76 24.5 116 290 5.30 4.10 30.5 8.00 8.80 1.74 24.3 115 285 5.30 4.07 30.4 8.02 8.72 1.72 24.0 115 280 0.00 4.03 30.2 8.05 8.65 1.70 23.8 114 275 0.00 4.00 30.1 8.07 8.57 1.69 23.6 114 270 5.00 3.97 30.0 8.10 8.50 1.67

f: forecast; 1/ in thousands

10

Global Economic Research

January 2012

Foreign Exchange Outlook

INTERNATIONAL RESEARCH GROUP

Pablo F.G. Brard, Head pablo.breard@scotiabank.com Daniela Blancas daniela.blancas@scotiabank.com Sarah Howcroft sarah.howcroft@scotiabank.com Estela Ramrez estela.ramirez@scotiabank.com Oscar Snchez oscar.sanchez@scotiabank.com

CANADIAN & U.S. ECONOMIC RESEARCH

Karen Cordes Woods karen.woods@scotiabank.com Gorica Djeric gorica.djeric@scotiabank.com Derek Holt derek.holt@scotiabank.com Adrienne Warren adrienne.warren@scotiabank.com

FOREIGN EXCHANGE STRATEGY

Eduardo Surez eduardo_suarez@scotiacapital.com Camilla Sutton
camilla_sutton@scotiacapital.com

Eric Theoret eric_theoret@scotiacapital.com Sacha Tihanyi sacha_tihanyi@scotiacapital.com

Scotia Economics
Scotia Plaza 40 King Street West, 63rd Floor Toronto, Ontario Canada M5H 1H1 Tel: (416) 866-6253 Fax: (416) 866-2829 Email: scotia.economics@scotiabank.com

This report has been prepared by Scotia Economics as a resource for the clients of Scotiabank and Scotia Capital. Opinions, estimates and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. Neither Scotiabank Group nor its affiliates accepts any liability whatsoever for any loss arising from any use of this report or its contents.