795008

Global FX Strategy
February 24, 2012
FX Markets Weekly
Outlook: Exit Greece, enter Iran A month of range trading on the dollar index obscures ballistic moves in oil currencies and the yen, and consequently a collapse in correlations across pairs. As the Greek drama slips into a month-long intermission, Iran steps forward with next weeks parliamentary elections. Associated tail risks range from the familiar (rise in oil price, somewhat weaker growth, modest deleveraging) to the unprecedented (armed conflict amongst Israel, Syria and Iran). Putting odds on these outcomes involves more guestimation than the EMU breakup which used to consume markets, but at current levels of the oil price and commodity currencies, some rotation in trades is justified. Take part profits on longs in oil currencies. Macro Trade Recommendations Continue to monetise the reduction in euro tail risk through short USD positions against EUR and NOK, but start to hedge the cyclical risk from an overheating in oil prices by cutting other long NOK exposure. Close NOK/SEK long and switch short GBP/NOK to long EUR/GBP. Also add long EUR/NZD as a defensive overlay. Take profits on the 1.2050 EUR/CHF put that was sold in November vols can go now lower while the SNB will soon need to demonstrate its intervention credentials. EUR/CHF is about to get interesting. FX Derivatives LTROs and relief from Greek event risks will keep the risk premium compression trade alive for a few more weeks, and EM carry will remain in vogue. At-expiry digital calls in select EM (INR, BRL and their yen-crosses) remain favored risk-on plays over the next few weeks. EUR-correlations are still a sale. [EUR/USD or EUR/JPY higher vs. EUR/INR, EUR/CAD, or EUR/BRL lower] dual currency structures combine levered short correlation exposure with a bullish view on risk. Vol curve butterflies in select high-beta currencies can be advantageously used for tail risk hedging. Technical Strategy The long-term up-trend of the JPY has been severely damaged across the board, which implies that a longer phase of JPY weakness is in the cards. Commodity currencies are delivering widespread, intermediate sell-signals, calling for a broader setback in the still intact, long-term up-trends. In this context, buy EUR/NZD. Model-driven strategies and manager performance Carry strategies are stalling. Rate momentum recommends selling USD vs all currencies but GBP and SEK. Research Notes Short NZD/CAD and NZD/NOK (Kevin Hebner) Focus on current accounts why Swiss franc is not following the yen weaker (Paul Meggyesi) China: FX reserve to resume uptrend (Haibin Zhu)
www.morganmarkets.com/GlobalFXStrategy
John NormandAC
(44-20) 7325-5222 john.normand@jpmorgan.com
Paul Meggyesi
(44-20) 7859-6714 paul.meggyesi@jpmorgan.com
Kevin Hebner
(1-212) 834-4254 kevin.j.hebner@jpmorgan.com
Arindam Sandilya
(1-212) 834-2304 arindam.x.sandilya@jpmorgan.com
Thomas Anthonj
(44-20) 7742-7850 thomas.e.anthonj@jpmorgan.com
Contents
Outlook Macro Trade Recommendations Global FX carry trade monitor FX Derivatives Technical Strategy Models and manager performance Research Notes Market movers Event risk calendar Central bank meetings in 2012 J.P. Morgan Forecasts Global central bank forecasts FX vs forwards & consensus Rates, credit, equities & commodities Global growth and inflation forecasts Sovereign credit ratings and actions Gov't and bank bond redemptions Research Notes on morganmarkets.com Global FX Strategy contact page 45 46 47 48 49 50 52 56 2 8 14 16 20 22 24 40 42 44
J.P. Morgan Securities Ltd.
The certifying analyst is indicated by an AC. See page 54 for analyst certification and important legal and regulatory disclosures.
Global FX Strategy FX Markets Weekly February 24, 2012 John Normand (44-20) 7325-5222 john.normand@jpmorgan.com J.P. Morgan Securities Ltd.
Outlook: Exit Greece, enter Iran

A month of range trading on the dollar index obscures ballistic moves in oil currencies and the yen, and consequently a collapse in correlations across pairs. As the Greek drama slips into a month-long intermission, Iran steps in with next weeks parliamentary elections. Associated tail risks range from the familiar (rise in oil price, somewhat weaker growth, modest deleveraging) to the unprecedented (armed conflict amongst Israel, Syria and Iran). Putting odds on these outcomes involves more guesstimation than the EMU breakup which used to consume markets, but at current levels of the oil price and commodity currencies, some rotation is justified. Trades: In the macro portfolio, take part profits on longs in oil currencies (NOK vs GBP and SEK) but stay long vs USD. Also stay long EUR/USD and add a defensive hedge through long EUR/NZD. Take profits on short EUR/CHF put. In the technical portfolio, buy EUR/NZD too. In the derivatives portfolio, stay long straddles in GBP/USD and EUR/CAD; hold risk reversals in EUR/USD and EUR/JPY; stay long G-10 commodity FX vol vs Latam. Next week: Iranian elections, Greek aid votes, 2nd LTRO, EU summit, PMIs
Chart 1: Average correlations across USD pairs have fallen from historic highs as European sovereign risk recedes
Average3-mo implied and realised correlation across all USD pairs
80 75 70 65 60 55 50 45 40 35 30 25 2004
Source: J.P. Morgan
average 3-mo implied correlation across USD pairs, % average 3-mo realised correlation across USD pairs, %
2006
2008
2010
2012
Currency moves versus the dollar since January 1, 2012 along with trade-weighted USD index (JPMQUSD on Bloomberg) 14%
12% 10% 8% 6% 4% 2% 0% -2% -4%
HUF PLN RUB COP MXN BRL INR CLP NZD TRY NOK ZAR CZK MYR AUD CHF SEK THB SGD EUR PHP TWD KRW CAD ILS GBP PEN CNY IDR ISK ARS USD TWI JPY
Chart 2: Currency performance YTD: oil exporters near the top
-6%
Source: J.P. Morgan
The dollar is range trading for a third consecutive week, but stability in the trade-weighted index masks a range of significant shifts this month. Currencies like JPY and GBP have collapsed; the pure oil currencies of NOK and RUB are outperforming globally; and the euro has marked a three-month high. Correlations amongst currencies have fallen from a near-decade high in early January (chart 1), highlighting how country-specific FX markets are becoming now that the Greek drama has moved from centre stage into a month-long intermission. (Expect a flare-up around April elections, particularly if fringe beyond the current Pasok-New Democracy majority gain ground.) In Greeces place steps Iran and the associated tail risks ranging from the familiar (rise in oil price, somewhat weaker growth, modest deleveraging) to the unprecedented (armed conflict amongst Israel, Syria and Iran).
Putting odds on these outcomes involves more guesstimation than the EMU breakup which used to consume markets, but at current levels of the oil price and commodity currencies, some rotation is justified. Take part profits on longs in oil currencies (NOK) but stay short dollars and add to hedges (long EUR/NZD).
For once, less Europe

It is almost always premature to declare that Europe has stabilized, just as it is almost always incorrect to say that nothing has changed in Europe. The base case belongs between these extremes, which is why the view and the forecasts are unchanged even after this weeks agreement on Greece, after this months surge in the euro, and ahead of next weeks second LTRO. We still think the sovereign crisis is more manageable in 2012 than in 2011 given the combination of two LTROs and early-stage structural
reform in Italy and Spain; that the currency will remain in the 1.30s this year and positively correlated with global growth/equities; but that it will weaken episodically on any threat of disorderly Greek debt restructuring. The Eurogroups decision to extend a 130bn financing package conditional on a PSI is the first step towards a managed, orderly default. The next step should come later this year through a further restructuring of official debt (the lending rate has already been cut twice in a year). A sovereign default isnt in itself contagious to currencies; all depends on which debt is restructured and how that work-out is managed, as discussed in previous publications (see What a Greek default would mean for the euro, FXMW, June 24, 2011). Of course the orderly path Greece appears to be on now isnt assured if the next government fails to implement the Troikas programme, but that is an event risk for April or May. So too is the question of Chinas slowdown, since data to be released in March largely cover a February period still distorted by Chinese New Year, thus complicating a judgment on the economys underlying momentum. The US question of how much of the $500bn programmed fiscal tightening Congress will allow to be implemented in January 2013 is an even more distant event risk (Q3 or Q4), though still a huge one.
Chart 3: The supply premium: probably only a few dollars, since demand is rising too
J.P. Morgan global manufacturing PMI versus year-on-year changes in Brent oil price
250 200 150 100 50 0 -50 -100 2000 Brent, change year-on-year JPMorgan global manufacturing PMI (level) 2002 2004 2006 2008 2010 2012
60 55 50 45 40 35 30
Source: J.P. Morgan
Chart 4: Oil volatility has only just begun to rise, and has not yet pulled FX and equity vol higher
Implied volatility in oil (NYMEX OIV index), equities (VIX) and currencies (J.P. Morgan VXY Global of 3-mo implied vol across 22 currencies) 17 16 15 14 13 12 11 10 9 Jun 10
Source: J.P. Morgan
unfortunately, more Iran

Iran, Syria and Israel are the more immediate focus. Although Israels preoccupation with Irans nuclear ambitions and its concerns about Syrias regional sponsorship are longstanding, their chess match has rarely been so tense following a succession of extraordinary events over the past year. Amongst them: the fall of an authoritarian but nonetheless allied through a peace treaty, at least regime in Egypt; the gradual implosion of another authoritarian and inimical regime in Syria; Israeli diplomatic rows with NATO member Turkey; Iranian actions against Israeli diplomats in third countries; the EUs oil embargo against Iran; Iranian parliamentary elections on March 2; and the unfortunate timing of a US Presidential election (Iraq Wars I and II occurred mid-cycle in the Bush Senior and Bush Junior terms). Connecting the dots leads most to conclude that direct conflict is unavoidable and imminent, since Israel considers Irans nuclear program to be so advanced that only a pre-emptive strike by year-end would contain Tehrans threat. Note, however, that Irans imminent threat has been alleged often over the past several years, and that the drop-dead date for a pre-emptive strike has been pushed back repeatedly, which makes it difficult to determine whether this time is truly different. Still, given the escalation in rhetoric, three scenarios seem possible this
VIX (equity implied vol) VXY Global (FX implied vol) OIV (WTI implied vol)
70 60 50 40 30 20 10
Dec 10
Jun 11
D ec 11
Jun 12
year: (1) pre-emptive, unilateral Israeli strike on Iranian nuclear installations; (2) pre-emptive Israeli strike backed implicitly or explicitly by the US and/or Europe; or (3) no strike in favor of a negotiated settlement, perhaps hastened by sanctions. What odds on each outcome? Armchair forecasting around this issue is probably more widespread and imprecise than around the European sovereign crisis, and our guide is based on no more than deduction. The first and second scenarios probably warrant less than 50% odds. We suspect most observers consider option 1 reasonably likely given the consensus that a pre-emptive strike would be an air operation and that Israels air capabilities exceed Irans. The risks, however, are that Israels actions invite
3
CAD trade-weighted
retaliation, whether directly from Iran, indirectly from sympathetic Syria or broadly through disrupted traffic in the Persian Gulf. All the more reason to round up allies through option 2, though this path too is rough. The US Administration has been uncharacteristically disengaged from foreign interventions over the past three years, having borne the enormous cost (estimated $1trillion) of Iraq. Unsurprising then that France and Britain led last years strikes against Libya, and perhaps worrisome that half of that bilateral coalition may not remain in office following French Presidential elections in April/May. If stalemate seems most likely, at least for the next few months, market direction depends on whether prices rise due to a supply premium, in turn crimping demand, pushing down cyclical assets and pushing up the dollar. Surprisingly relative to the noise levels around Israel, Syria and Iran, there is little evidence of a supply premium exceeding a few dollars per barrel, according to J.P. Morgan Commodity Research (see Commodity Mementos, Fenton, February 23). More likely, this months rally reflects an unusual confluence of rising demand (chart 3), Chinas strategic stockbuilding post Lunar Year, refinery closures and a Northern cold snap. That fundamental backdrop explains why implied volatility on oil prices (Nymex OIV index) has risen only from 30.5% to 33.5% this month and remains below its 2012 starting level of 40%, and why equity and currency volatility continues to drift lower (chart 4). Neither have USD/ILS or USD/SAR implied volatilities rallied, counter to their tendency to spike during Middle East tensions. There will be an inflection point at which high prices deliver negative feedback to the global economy and to markets, and we suspect that level is closer to $130140/bbl on Brent. Growth tends to be more sensitive to change rather than the level of the oil price, and every 25% rise in crude prices tends to reduce global growth by 0.5% if sustained for a year. Brent at $130 would mark a 20% rise in prices and therefore begin to prompt some downgrade in growth forecasts, a shift in expectations typically associated with a decline in cyclical assets and a rise in countercyclical ones such as the dollar. This deleveraging ironically, could extend to the oil currencies too, whether the pure ones where the country also runs a current account surplus (NOK, RUB), or the pseudo ones where the country runs a deficit (CAD). Hence the decisions to take partprofits on NOK longs this week: oil prices are passing through the sweet spot where they are unambiguous positives for oil currencies (see Trade Recommendations on page 8).
Charts 5 and 6: commodity currency performance around three major oil shocks
x-axis shows months since beginning of the three shocks of October 1973, January 1979 and August 1990. y-axis shows the trade-weighted currency performance indexed to 100 when the shock occurred, where higher values indicate stronger currencies
112 108 104 100 96 92 88 1 2 3 4 5 6 7 8 9 months since start of shock 10 11 12
1973 1979 1990
105 103 NOK trade-weighted 101 99 97 95 93 91 89 1 2 3 4 5 6 7 8 9 10 11 12 months since start of shock

Source: J.P. Morgan
1973
1979
1990
Commodity FX hedges stress, not a shock

Avoid the temptation to hedge a possible supply shock through longs in oil currencies rather than oil futures, since spikes in volatility can overturn these markets through indiscriminate deleveraging. Historically, commodity currency performance during supply shocks has been inconsistent, at least judging from their paths during the three major supply disruptions of the past forty years: 1973 (Yom Kippur War), 1979 (Iranian Revolution) and 1990 (Iraqi invasion of Kuwait). Charts 5 and 6 track performance for benchmark commodity currencies indexed to 100 in the month of a supply shock. Commodity currencies in emerging markets are excluded since they were either untradeable or too heavily managed during those years to make historical analysis relevant. Even AUD was managed to some degree during the post-Bretton Woods years. Of the major commodity currencies, CAD performed the best in the year following supply shocks,
having rallied after two of the three (1973 and 1979). The US recession which followed the 1990 shock weakened CAD then, however. AUD and NZD sometimes bounced in the initial months of an oil shock but depreciated over the year as global growth slowed. NOK only outperformed after the 1990 shock.
Proxies for fund positions in equities and the euro beta of HFR long/short equity hedge fund index with S&P 500, and beta of currency manager returns with tradeweighted euro. High, positive beta indicates overweight equities and long in euros. Low, negative beta indicates underweight stocks and the euros. Betas calculated on daily data over rolling 21-day window.
Chart 7: Funds have covered their short in euros and their underweight in stocks
Trades: take part profits on oil currencies

In the macro portfolio the most significant change is that we begin scaling out of longs in oil currencies as prices approach the threshold where they could crimp growth. Close short GBP/NOK (gain of 3.8%) and long NOK/SEK (0.6%) but stay short USD/NOK and long EUR/USD. Although some indicators suggest that investors have covered euro shorts (chart 7), European currencies can still tick higher short-term before equities respond to the oil price. Hedge a potential move higher in volatility by owning EUR/NZD (new trade) and in view of the valuation and cyclical challenges facing kiwi (see Research Note on page 24). Also continue hedging event risks through the derivatives portfolio, which holds straddles on GBP/USD (2-yr) and EUR/CAD (1-yr) outright; risk reversals in EUR/USD (6-mo) and EUR/JPY (6-mo); and long vol positions in G-10 commodity currencies versus Latam (AUD/USD vs USD/BRL, EUR/CAD vs EUR/MXN and NZD/USD vs USD/CLP. In the technical portfolio, stay short EUR/Asia. Technicals also support buying EUR/NZD (new trade).
1.2 0.8 0.4 -0.0 -0.4 -0.8 -1.2 Feb 10

Source: J.P. Morgan
beta between HFR equity fund returns & S&P500 beta between currency manager returns & EUR trade-wtd Aug 10 Feb 11 Aug 11 Feb 12
Greek government is scheduled to vote on wage and pension cuts agreed with the Troika. EU leaders hold their quarterly summit on Thursday and Friday and should only bless the Greek program and discuss the fiscal pact plus growth agenda rather than announce any new initiatives. Irans parliamentary elections are Friday. The ECB will hold its second LTRO on Wednesday, at which we expect 350 - 400bn of demand comprising the following: 250-300bn in excess liquidity to cover bank redemptions not funded through the December 2011 LTRO and modest allocations to carry trades; and 120bn of cannibalisation of existing tenders such as existing repos for one week, one month and three months (see todays Global Fixed Income Strategy by Wadhwa and Bassi). High figures between 400bn and 750bn would probably suggest demand for carry trades and therefore weaken the dollar even versus the euro through the usual channel of less credit stress. A figure beyond 750bn would probably signal severe funding stress amongst banks perhaps due to fear of deposit flight, so be negative for risky markets and positive for the dollar. A figure below 200bn would probably signal limited bank appetite for sovereign bonds, so also lift the dollar. Only three central banks meet next: Israel on Monday, Hungary on Tuesday and Philippines on Thursday. All should stay on hold. Peripheral supply is heavy next week. Italy issues 12bn of bills on Monday and 6bn of bonds on Tuesday, followed by Spains auction of 4bn of bonds on Thursday.
Next week: Iranian elections, Greek aid votes, 2nd LTRO, EU summit, PMIs
Next week is packed with policy events and data releases. The US reports the Dallas Fed survey on Monday; durable goods, Conference Board consumer confidence and the Richmond Fed survey on Tuesday; Q4 GDP (second reading) and Chicago Fed survey on Wednesday; and the ISM manufacturing survey on Thursday. In Europe, watch Italian business confidence on Monday for indications that a decline in BTP rates might reverse a five-month slide in corporate sentiment. Germany reports retail sales on Wednesday and the larger economies report final manufacturing PMIs on Thursday. In non-Japan Asia, Chinas PMI Thursday is the most significant, since it is barely scratching above 50 (last reading 50.5). Next is Q4 GDP from India on Wednesday along with Australia private sector credit and retail sales the same day. Policy events begin Monday with a leadership vote in the Australian Labour Party and an EU foreign ministers meeting to discuss sanctions on Syria. Several European parliaments vote on the Greek financing package approved by the Eurogroup this week. The Bundestag vote is set tentatively for February 27 and the Dutch Parliaments for February 28th or 29th. On Tuesday the
Main recommendations: Macro, Technical and Derivatives portfolios I. Macro portfolio (page 8 for details) New/closed trades Take profits on short GBP/NOK (3.8%) opened January 27 at 9.17; and on long NOK/SEK (0.6%) from 1.1710 opened November 22, 2011 in 2012 Outlook. Stopped out of short USD/SEK on February 16 at gain of 0.25%. Position opened January 27 at 6.79. Take profits (1.25%) on short 6-mo 1.2050 EUR/CHF put opened November 22, 2011 in 2012 Outlook. Buy EUR/NZD at 0.6239. Existing trades In cash, stay long EUR/USD from 1.3120 opened February 3. In options, hold 6-mo 76-72.50 USD/JPY ratio put spread in 1x2 notional. II. Technical portfolio (page 20 for details) Stay short EUR/KRW, EUR/INR, EUR/USD, USD/JPY, NZD/CAD and PLN/HUF; and long USD/CZK, EUR/CZK, NOK/SEK, EUR/SEK and USD/ZAR. Buy EUR/NZD. III. Derivatives portfolio (page 14 for details) Hold straddles on GBP/USD (2-yr) and EUR/CAD (1-yr) outright, and NZD/USD vs USD/CLP vol swaps (3-mo). Hold risk reversals in EUR/USD (6-mo) and EUR/JPY (6-mo); sell calls on USD/TRY (6-mo). Stay long G-10 commodity currency vol vs. short LatAm vol: AUD/USD vs USD/BRL, EUR/CAD vs EUR/MXN and NZD/USD vs USD/CLP. Hold EUR/CAD vs. CAD/JPY 1Y1Y forward vols spreads
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Global FX Strategy FX Markets Weekly February 24, 2012 Paul Meggyesi (44-20) 7859-6714 paul.meggyesi@jpmorgan.com J.P. Morgan Securities Ltd.
Macro Trade Recommendations

As one risk factor recedes disorderly Greek default and euro break-up so another takes its place (fear of a supply-driven, anti-risk surge in oil prices). The Iran situation needs to be closely monitored but as yet the rise in the oil price is not sufficient, nor the risk of a pre-emptive Israeli strike on Iran so significant, to justify abandoning the pro-risk bias to the portfolio (short USD vs EUR and NOK). Still, it makes sense to partially hedge the risk that oil boils over and spoils the cyclical party by selling the most overvalued and over owned commodity currency NZD, in this case against EUR, as the shake-out of overly bearish euro positioning is not yet complete. Take profits on short GBP/NOK (and long NOK/SEK) following a two-sigma move over the past week. Roll short GBP (a redundant and never entirely convincing safe-haven) into long EUR/GBP. Take profits on a short EUR/CHF put the trade has realised 60% of its potential. This close to the floor, vols can only rise as the SNBs mettle is tested. New trades: Buy EUR/NZD and EUR/GBP in cash. Closed trades: Take profits on short GBP/NOK and long NOK/SEK. The take-profit level on short USD/SEK was triggered on Feb 16. Take profits on a short 6-month 1.2050 EUR put/CHF call. Existing trades: Stay long EUR/USD and short USD/NOK in cash but tighten stops. In options hold a USD/JPY 1x2 put spread.
FX trade recommendations
Trade recommendations in this section are mostly spot, for easier incorporation into the monthly Global Markets Outlook & Strategy (GMOS), which outlines J.P. Morgans flagship model portfolio across bonds, credit, equities, fx and commodities. Some directional option trades are included here as alternatives to cash position, and as a complement to relative value trades discussed in FX Derivatives section of this publication (p. 16). Current recommendations are marked to market at Friday afternoon London time. A complete inventory of closed trades is presented at the end of this section along with performance statistics such as success rates and average returns per trades.
supposedly high-beta G10 currencies, and in the process put the markets hopes for regime change (risk up and the euro down) firmly back in the box. Yet again this time has not proved to be different the euro remains a pro-cyclical currency. The response to next weeks second 3-year LTRO should be no different. But as one very dark cloud clears, another appears on the horizon in the form of sharply higher oil prices. In the vast majority of cases, higher oil prices go hand-in hand with stronger risk markets and declining volatility, for the simple reason that demand swings tend to dominate supply considerations in the oil market (charts 1 and 2). In this framework a rising oil price is a sign of economic vitality, not a threat to it. The difficulty at present is in attempting to disentangle the extent to which supply fears rather than stronger demand trends are lifting oil, as speculation mounts about a potential Israeli response to Irans nuclear ambitions.
Chart 1: Oil has been positively correlated with risk markets
Daily data, 5Y period
30% 20% y = 0.3286x - 0.0046 R = 0.3111
The portfolio has reaped the benefits from the stabilisation in the euro crisis in recent weeks and attendant rally in European currencies and sell-off in the dollar. Greece has secured its second bail-out, and while implementation risks doubtless abound (national parliaments need to ratify the deal in coming weeks, following which there are Greek elections likely in April) the worst-case scenario of a destructive Greek default and potential EMU break-up has been averted, or at least substantially postponed. Despite the warnings of many in the market, the expansion in the ECBs balance sheet, which has been instrumental in soothing euro zone markets, has not undermined the currency. Quite the opposite in fact the euro has outperformed all of the
8
S&P500, 1month change
10% 0% -10% -20% -30% -40%
-20%
0%
20%
40%
Brent oil, 1month change

Source: J.P Morgan
Chart 2: and negatively correlated with FX volatility, indicating that demand factors have dominated supply considerations in the oil market. Fears of an escalation in Israel/Iran tensions could yet prompt a spike in oil price that harms risk, but we do not appear to be at that point (this could change with another 5-10% rise in oil)
VXY G7 FX volatility, 1month change
15 10 5 0 -5 -10 -40%
Source: J.P Morgan
y = 30.835x 2 - 4.9889x - 0.2121 R = 0.2956
been successful navigated. There will be other hurdles for the euro to overcome, for sure, but for now the market has the wrong tail-risk trade. Short-covering is expected to continue and lead to further euro appreciation, not only against the dollar but most likely against high-beta currencies as well, as these by contrast are heavily overowned. This positioning imbalance favours euro outperformance whatever the risk environment, which is why we favour buying EUR/NZD this week as a partial hedge to a potential overheating in oil prices (5-10% from here) which derails risk markets. As the research note on page 24 sets out, NZD is vulnerable on many fronts economic, valuation and technical. The ECBs second 3-year LTRO next week will gain a lot of focus but this is probably of greater significance now for asset markets than for the currency. That EUR/USD is nearly 3% higher than before the first LTRO supports our judgment that the alleviation of credit risk through the LTRO is more important for the currency than the potential effect of sizeable liquidity creation on inflation expectations. ECB balance sheet expansion has not, and in our opinion will not, drive a wedge between the performance of risk markets and the euro. Stay long EUR/USD. Bought Jan 27 at 1.3120. Marked at 2.1%. Raise stop to 1.3160. Stay short USD/NOK sold Feb 13 at 5.7210. Marked at 2.3%. Tighten stop to 5.71 Stopped out of short USD/SEK on Feb 16 with a profit of 0.3% Buy EUR/NZD at 1.6050 with a stop at 1.5650. Switch short GBP/NOK into long EUR/GBP. Take profits on long NOK/SEK NOK has benefited in quite some fashion from the run-up in the oil price in recent weeks. It is possible, though, to have too much of a good thing and we are taking part profits on our NOK exposure given the risk that another 5-10% gain in oil prices would start to adversely impact risk markets, and prompt the rush for the exit in NOK that is typical when investors turn defensive. The decline in GBP/NOK over the past week has been a two-sigma event, which is a statistically significant threshold for a period of mean-reversion (in the last five years, two-thirds of such moves have been partially reversed in the following week). We remain bearish on GBP, however, and switch instead to long position in EUR/GBP while the cross is fairly valued on a highfrequency basis, sterling is nonetheless vulnerable from a reversal of the safe-haven inflows from the latter part of last year. With credit safety in less demand, there is little to commend GBP to investors (little yield, little growth
9
-20%
0%
20%
40%
Brent oil, 1month change
So far we are comforted by the progressive rather than abrupt run-up in the oil price and by the relatively contained level of oil volatility ((low 30s% compared to 60% last autumn). In addition, the pattern of recent years suggests that it takes a monthly gain in the oil price in excess of 20% before this starts to positively impact FX volatility and to undermine risk. At 12% the rise in Brent over the past month is still some way short of the danger-zone. For now then we do not regard the run-up in oil as a reason to exit our pro-risk, short dollar and long European currency positions. But the risk of an eventually destabilising surge in the oil price, contingent upon an Israeli strike, cannot be dismissed out of hand. To hedge this risk, we are selling what we regard as the most vulnerable of the high-beta currencies. NZD is the most overvalued and over-owned of the commodity currencies and should underperform if risk markets turn sour. But rather than selling NZD/USD our preference is to buy EUR/NZD as we do not believe that the normalisation in excessively bearish euro positions is yet complete. We are also taking profits on two-thirds of NOK longs (roll short GBP/NOK into long EUR/GBP, close long NOKSEK but hold short USD/NOK) as oil currencies are inherently cyclical and would not escape a surge in oil prices which destabilised risk markets.
Trades
Stay long EUR/USD and short USD/NOK albeit with tighter stops Take profit level was triggered on USD/SEK. Buy EUR/NZD in cash Whether or not one believes the second Greek bail-out is credible, in that it establishes a sustainable path for sovereign debt, is besides the point for the currency. What matters is that the key event risk for the euro has
and a central bank that keeps on delivering more QE, even if at a slower pace than previously). Close short GBP/NOK for a net profit of 3.8%. (Sold Jan 27 at 9.17). Close long NOK/SEK for a profit of 0.5%. (Entered Nov 22 at 1.1710). Buy EUR/GBP at 0.8480 with a stop at 0.8310. Take profits on a short a 6-mo EUR/CHF put Since the SNB established its policy floor for EUR/CHF last year, we have recommended monetising the central banks policy objectives by selling downside strikes in EUR/CHF. The trade has worked well, as implied volatility has collapsed (from near 11% when we initiated this trade in late November to under 4% now), to the point where it is now attractive, and in fact prudent, to take profits. It is hard to see implied vols falling much further at the absolute 1.20 floor, which spot is inexorably edging towards, either the SNB has to intervene, and both spot and vols spike, or it doesnt, the floor is overwhelmed with a wave of stop-loss selling, and EUR/CHF reverts to the 20%+ vol pair it was before the floor was announced. Either way, risk-reward justifies taking profits on the short vol, short delta position we have realised just under 60% of potential profit. As for what happens now, our view was always that the floor was reasonably safe in Q1/Q2 but that things would get more interesting in the second half of the year. It would seem that the interesting phase is starting sooner than we anticipated. The SNB has successfully persuaded the speculative community to avoid selling CHF through the threat of unlimited FX intervention. Unfortunately that threat does nothing to eliminate the substantial commercial buying of CHF which results from Switzerlands laughably big current account surplus (19% of GDP in Q3). In short, unless the speculative community sells CHF, and there is little sign of this anymore, the SNB will have no choice but to start intervening to absorb the underlying demand for CHF. In short, the SNBs appetite for unlimited FX intervention is about to be tested. Sold a 6-mo 1.2050 EUR put/CHF call on Nov 22 for 2.05%. Closed at 0.80%. Hold USD/JPY 1x2 put spread In hindsight we have under-appreciated the almost perfect storm of negative yen forces over the past month or two the elimination of Japans surplus, the relatively aggressive easing from the BoJ and its quasi-commitment to an inflation target, and the acceleration in US growth. That being said, the yen is now clearly oversold on
10
interest-rate grounds (we continue to doubt whether USD/JPY can sustain a rally without a trend rise in US bond yields). In addition, the yen should still receive some relief in coming weeks from end-of-fiscal year repatriation. Hold a 6-mo 76-72.50 USD put/JPY call spread in 1x2 notional. Cost 0.15%, worth 0.20%.
Table 1.Current FX spot recommendations and P&L

Long NOK EUR SEK NOK NOK EUR EUR Short SEK USD USD GBP USD NZD GBP Entry date 22/11/11 03/02/12 27/01/12 27/01/12 13/02/12 24/02/12 24/02/12
Active trades are marked to market on Friday afternoon London time.
Entry level Current level 1.1710 1.3120 6.7900 9.1700 5.7210 1.6050 0.8480 1.1770 1.3394 6.7700 8.8350 5.5920 1.6050 0.8480
Stop loss 1.1400 1.3160 6.7700 9.3500 5.7100 1.5650 0.8310
P&L since entry 0.5% 2.1% 0.3% 3.8% 2.3% 0.0% 0.0%
Comments take profits stop changed stop hit on 16 Feb take profits stop changed new trade new trade
Table 2. Current FX derivatives (directional/non-RV) recommendations and P&L

Active trades are marked to market on Friday afternoon London time.
Description Long 6-mo 76-72.50 USD put/JPY call spread in 1x 2 notional Sell 6-mo 1.2050 EUR put/CHF call * P&L in % of asset Entry date 22/11/11 22/11/11 Expiry date 22/05/12 22/05/12 Days to expiry 137 137 Entry level 0.15% 2.05% Current level 0.20% 0.80% P&L since entry* 0.05% 1.25% Comments 2012 outlook 2012 outlook
11
I. Performance statistics 2008 2012

2012 I. Trade Recommendations portfolio Cash # of trades Success rate Average return per trade (% , unweighted) Average holding period (days) Derivatives (non-digital) # of trades Success rate Average return per trade (% , unweighted) Average holding period (days) Derivatives (digital) # of trades Success rate Average return per trade (% , unweighted) Average holding period (days) II. FX Derivatives portfolio (relative value) Vol r.v # of trades Success rate Average return per trade (unweighted)* Average holding period (days) Vol plus directional r.v # of trades Success rate Average return per trade (bp, unweighted) Average holding period (days) Digital # of trades Success rate Average return per trade (% , unweighted) Average holding period (days) III. Technical Strategy portfolio # of trades Success rate Average return per trade (% , unweighted) Average holding period (days) 2011 2010 2009 2008 2008-2012 avg
7 86% 0.9% 36 5 60% -0.2% 65 1 100% 34.3% 73
42 60% 0.0% 24 27 74% 0.9% 71 10 50% -0.9% 87
89 53% 0.0% 23 27 62% 0.3% 54
61 64% 1.0% 20 21 62% 0.5% 59
85 59% 2.0% 31 3 0.0% -0.6% 66 5 20% -3.6% 54
284 59% 0.8% 25 83 64% 0.5% 62 41 39% -2.9% 64
4 21 25% 38% -6.7% -4.7% 60 55
2 33% -0.2 62 3 67% 48 72 NA NA NA NA 2 0% -1.3% 71
37 62% 0.1 44 16 75% 12 27 33 58% 0.1% 54
45 69% 0.7 99 4 50% -8 50 52 46% 0.0% 36
32 63% 0.1 73 46 57% 0.1% 10
13 77% 0.3 53 3 33% 8% 33 87 43% 0.2% 9
129 66% 0.3 71 23 70% 13.3 37 3 33% 8% 33 220 48% 0.1% 23
*P&L in vol points
Chart 1: 2008-2012 performance summary: Average returns per trade

Cash Derivs (non-digital)
RV (non-digital)
2008-12 avg 2012 2011 2010 2009 2008 0% 1% 2% 3%
2008-12 avg 2012 2011 2010 2009 2008 -1% -1% 0% 1% 1% 2%
2008-12 avg 2012 2011 2010 2009 2008 -1.00 0.00

RV (non-digital)
Technical
2008-12 avg 2012 2011 2010 2009 2008 1.00 -2.0% -1.0% 0.0% 1.0%
Chart 2: 2008-2012 Performance summary: Success rate by type of trade

Cash Technical
2008-12 avg 2012 2011 2010 2009 2008 0% 50% 100%
Derivs (non-digital)
2008-12 avg 2012 2011 2010 2009 2008 0% 100%
2008-12 avg 2012 2011 2010 2009 2008 0% 50% 100%
2008-12 avg 2012 2011 2010 2009 2008 0% 50% 100%
12
II. Closed trades 2012 Cash portfolio

Long JPY JPY EUR EUR NOK NOK SEK Short USD EUR SEK USD SEK GBP USD Entry date 31/10/11 06/01/12 20/01/12 13/01/12 22/11/11 27/01/12 27/01/12 Entry level 78.20 98.80 8.760 0.8310 1.171 9.1700 6.790 Exit date 06/01/12 20/01/12 26/01/12 03/02/12 24/02/12 24/02/12 16/02/12 Exit level 77.10 99.50 8.836 0.83 1.177 8.84 6.770 P&L 1.4% -0.7% 0.9% 0.1% 0.5% 3.8% 0.3%
Derivatives (directional)
Entry date Entry level Non-Digital Options Buy 4-mo 100-97 EUR call/JPY put spread, RKI 93.00 on the lower strike Buy a 6-mo 117-112 GBP put/JPY call spread, sell 127 GBP call/JPY put Buy 4-mo 0.75-0.70 NZD put/CAD call spread and sell a 0.83 NZD call/CAD put, RKI 0.85 Buy a bullish 4-mo USD/SEK fly (buy 1x 7.00 call sell 2x 7.50 call and buy 1x 8.00 call) Buy 4-mo 100-95 EUR put/JPY call spread 22/11/11 22/11/11 22/11/11 22/11/11 22/11/11 0.83% -0.19% 0.88% 1.04% 1.13% 20/01/12 20/01/12 27/01/12 27/01/12 03/02/12 1.14% 0.41% -0.75% 0.71% 1.30% 0.31% 0.60% -1.63% -0.33% 0.17% Exit date Exit level P&L (bps)
FX Derivatives portfolio (vol relative value plus directional)

Trade Buy 2M GBP put/AUD call 1.48 One-touch vs. sell 2M GBP call/AUD put 1.59 OneTouch, equal GBP notionals Entry date Entry level Exit date Exit level P&L Units
02/12/11
06/01/12
35
28
% GBP
Buy 2M 35D USD call/NOK put v s. sell 2M 35D USD call/BRL put, equal USD notionals
16/12/11
-76
13/01/12
59.0
135.0
bp USD
Buy 6M 1500 Gold call/ EUR put one touch vs. Sell 2M 1500 Gold call/ EUR put one touch in 1: 1.42 ratio of EUR notionals
09/09/11
42
10/02/12
23
-19
% EUR
FX Derivatives portfolio (vol relative value)

Trade Entry date Entry level Exit date Exit level P&L*
Buy USD/JPY 3M 25D risk-reversals (long USD puts vs. short USD calls, vega-neutral), deltahedged
Buy NZD/USD 3M D/N straddles v s. Sell USD/MXN 3M D/N straddles, 100:90 v ega ratio (both legs deltahedged)
05/12/11
0.8
20/01/12
-0.8
-1.6
11/11/11
27/01/12
2.2
1.2
Technical portfolio
Trade Entry Date Entry level Exit date Exit level P &L
Short GBP v s USD Long USD v s SEK
02/11/11 20/12/11
1.574 6.7856
01/02/12 08/02/12
1.580 6.6430
-0.5% -2.09%
13
Global FX Strategy FX Markets Weekly February 24, 2012 Anna Hibino (81-3) 6736-7729 anna.hibino@jpmorgan.com JPMorgan Chase Bank NA
Global FX carry trade monitor

Chart 1: Japanese retail -- market capitalisation of 100 largest FXdenominated ITs
trn; market capitalization of 100 largest investment trusts; ranked in the order of total asset as of March 2011
30 70 80 25 90 20 100 110 15
Market cap of top 100 ITs, JPY trn, lhs JPY trade-wtd index, inverted, rhs
Chart 2: Japanese retail -- aggregate retail margin shorts in JPY

trn, Japanese retail measured by positions in USD, NZD, EUR, GBP and AUD on Tokyo Financial Exchange; positive indicates shorts in JPY
10 8 6 4 2 0 100 110 120 Apr-09 Apr-10 Apr-11
Aggregate margin shorts in JPY, JPYtrn, lhs JPY trade-wtd, inverted rhs
70 80 90
120 130
-2 -4 Apr-08
10 Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Source: J.P. Morgan, Bloomberg
Source: J.P. Morgan, TFE;
Japanese retail exposure to the top 100 foreign currency ITs
Japanese aggregate margin JPY shorts of 3.2trn declined
as of March 2011 increased from 23.2trn to 23.3trn between February 10th and 17th, which continued to increase this week to 23.5trn. JPY weakness since the beginning of the month may have contributed to an increase in market cap in JPY-terms considering that the tradeweighted JPY fell 3% in the past two weeks.
to 2.2trn two weeks ago, which marks the lowest level since early April of 2011. This week, JPY shorts reached an intraweek high of 2.6trn on Monday and Tuesday, which fell back to 2.2trn as of yesterday.
Chart 3: Japanese retail -- margin position in JPY vs USD, EUR, AUD

mln local currency. positive indicates long in local currency/short in JPY
60 50 40 30 20 10 0 -10 -20 -30 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
USD EUR AUD
Chart 4: CTAs -- aggregate IMM position in USD

$ bn as the sum of net speculative positions on the IMM in AUD, NZD, CAD, EUR, GBP, JPY, CHF and MXN.
$35 $25 $15 $5 -$5 -$15 -$25 -$35 -$45 02 03 04 05 06 07 08 09 10 11 12
Aggregate IMM position in USD, $ bn, lhs USD trade-wtd index, rhs
110 105 100 95 90 85 80 75
Source: J.P. Morgan, TFE
Source: J.P. Morgan, CME
USD longs of $23.1bn declined to $18.3bn between February
Aggregate USD longs rebounded from $7.4b to $13.5bn
10th and 17th, which rebounded to $19.4bn by yesterday. AUD longs declined from A$14.3bn to A$10.3bn in the last two weeks. EUR shorts of -2.0bn as of February 10th increased to -4.7bn, the largest since early April of 2011.
between February 7th and 14th. JPY longs were almost halved from $8.9bn to $4.6bn, while EUR shorts increased from -$23.2bn to -$24.4bn. GBP shorts increased from -$3.3bn to -$4.0bn.
14
Global FX Strategy FX Markets Weekly February 24, 2012 Anna Hibino (81-3) 6736-7729 anna.hibino@jpmorgan.com JPMorgan Chase Bank NA
Chart 5: Market capitalisation of US-listed currency ETFs

Weekly data, $bn. Positive value indicates longs in foreign currency and shorts in USD
Chart 6: Currency managers and global macro hedge funds -- Beta with trade weighted USD
HFR used for global macro hedge funds. Barclay BTOP Index used for currency managers.
3.0 2.0
Global macro hedge funds Currency managers
5 4 3 2 1
Market cap of US-listed FX ETFs, $bn, lhs
75 80 85 90 95
USD trade-wtd index, inverted, rhs
1.0 0.0 -1.0 -2.0 -3.0 -4.0 06 07 08 09 10 11 12
0 06 07
100 11 12
08
09
10
Market cap of US-listed FX ETFs increased from $1.5bn to
Currency mangers returns beta with declined from 0.1 as of
$1.7bn between February 10th and 17th, which further edged up to $1.8bn as of yesterday. The current level is 40% above the 2011 low of $1.3bn, while 3% below the year-to-date high of $1.9bn.
February 10th to -0.1 last Friday, which has since turned flat as of yesterday. Prior to this, betas for currency managers were last in negative territory in early September of 2011. Global macro funds beta declined gradually from 0.2 to 0.1 during the same period.
Chart 7: Currency managers and global macro hedge funds -- Beta with G-10 carry strategies
Positive beta implies a long in carry, a short in dollars. HFR used for global macro hedge funds. Barclay BTOP Index used for currency managers.
3.0
Currency managers
Chart 8: Currency managers and global macro hedge funds -- Beta with emerging markets carry strategies
Positive beta implies a long in carry, a short in dollars. HFR used for global macro hedge funds. Barclay BTOP Index used for currency managers.
2.0
Currency managers Global macro hedge funds
2.0 1.0
Global macro hedge funds
1.5 1.0 0.5
0.0 -1.0 -2.0 06 07 08 09 10 11 12

0.0 -0.5 -1.0 06 07 08 09 10 11 12
Currency managers returns beta declined from 0.2 to 0.1
Currency managers returns beta with EM carry inched up
between February 10th and 17th, which has since turned negative to -0.1 as of yesterday. Meanwhile, global macro funds beta declined more gradually from -0.2 to -0.1 during the past two weeks.
from flat to -0.1 two weeks ago, which has since turned flat again this week. Global macro funds beta increased from flat to 0.1 in the past two weeks.
15
Global FX Strategy FX Markets Weekly February 24, 2012 Arindam Sandilya (1-212) 834-2304 Matthias Bouquet (44-20) 7777-5276 JPMorgan Chase Bank NA, J.P. Morgan Securities Ltd.
FX Derivatives
LTROs and relief from Greek event risks will keep the risk premium compression trade alive for a few more weeks. EM carry will remain in vogue. At-expiry digital calls in select EM (INR, BRL and their yen-crosses) remain favored risk-on plays. EUR-correlations are still a sale. [EUR/USD or EUR/JPY vs. EUR/INR, EUR/CAD, or EUR/BRL] dual currency structures combine levered short correlation exposure with a bullish view on risk. Vol curve butterflies in select high-beta currencies can be advantageously used for tail risk hedging.
Carry currency pairs ranked in ascending order of the spot move need to trigger a 3M 5:1 levered (i.e. 20% price) at-expiry digital payout, as a fraction of the room left to revert to pre-September11 crash levels. Option direction (call or put) set in the direction of high-beta/EM currency appreciation. No transaction costs.
room left to geared at- Spot-Strike retracement Current Septemberexpiry Distance (E) room needed to revert to prespot (A) crash spot crash levels (C) digital [ abs (D/A-1) ] trigger digital levels (B) [ abs (B/A -1) ] strike (D) payout [E/C]
49.2325 1.7126 46.83 0.6139 1.7615 3.7490 45.53 6.2402 65.55 289.16 12.8513 7.6736 1.3315 106.78 29.62 4.1757 1.5702 1129 0.9973 2.7067 6.6391 10.2171 14.08 2.3453 29.59 1.2563 125.92 1.1809 80.4069 2.2802 480.7500 17.1109 4.9916 0.8337 5.6223 44.0300 1.5380 52.16 0.5468 1.5745 3.3630 51.07 7.0326 62.12 262.02 11.5534 6.6690 1.4683 117.83 27.51 3.9280 1.6571 1050 0.9435 2.9133 6.1409 9.5372 13.10 2.2650 28.63 1.2007 132.60 1.1433 84.8786 2.2115 456.7500 16.4487 4.8168 0.8749 5.3397 10.6% 10.2% 11.4% 10.9% 10.6% 10.3% 12.2% 12.7% 5.2% 9.4% 10.1% 13.1% 10.3% 10.4% 7.1% 5.9% 5.5% 7.0% 5.4% 7.6% 7.5% 6.7% 7.0% 3.4% 3.2% 4.4% 5.3% 3.2% 5.6% 3.0% 5.0% 3.9% 3.5% 4.9% 5.0% 48.1510 1.6627 48.41 0.5936 1.7039 3.6250 47.42 6.5450 64.22 278.40 12.3133 7.2437 1.3930 112.18 28.58 4.0394 1.6192 1084 0.9649 2.8413 6.3130 9.7720 13.40 2.2874 28.87 1.2128 131.18 1.1511 84.1314 2.2222 460.3900 16.5335 4.8371 0.8717 5.3578 2.2% 2.9% 3.4% 3.3% 3.3% 3.3% 4.2% 4.9% 2.0% 3.7% 4.2% 5.6% 4.6% 5.1% 3.5% 3.3% 3.1% 3.9% 3.2% 5.0% 4.9% 4.4% 4.8% 2.5% 2.4% 3.5% 4.2% 2.5% 4.6% 2.5% 4.2% 3.4% 3.1% 4.6% 4.7% 21% 29% 30% 30% 31% 32% 34% 38% 39% 40% 41% 43% 45% 49% 49% 55% 56% 56% 60% 65% 65% 65% 69% 72% 75% 78% 79% 79% 83% 84% 85% 87% 88% 92% 94%
Table 1. EM pairs especially their yen-crosses offer good value as appreciation plays via at-expiry digital options
Best pre-
Retracement
3M 5:1
Fraction of
Pair
USD/INR USD/BRL BRL/JPY JPY/INR USD/TRY USD/ILS TRY/JPY MXN/JPY EUR/INR EUR/HUF USD/MXN USD/ZAR EUR/USD EUR/JPY USD/RUB EUR/PLN GBP/USD USD/KRW USD/CAD RUB/JPY USD/SEK EUR/ZAR JPY/KRW EUR/TRY USD/TWD USD/SGD GBP/JPY NOK/SEK CAD/JPY EUR/BRL USD/CLP EUR/MXN EUR/ILS NZD/USD USD/NOK
Vols have remained soft since we published two weeks back, as risk premium for a European tail event continues to get priced out of asset markets. With the second lot of LTROs scheduled next week and an event risk in Greece pushed back to at least the April elections, our base case is that spread compression continues for a few weeks more, supporting carry trades and keeping a cap on vols. It is undeniable though that FX vols are technically oversold; while they are fighting a losing battle against a deluge of central bank liquidity at the moment, recent developments in the Middle East are a timely reminder that enough catalysts remain on the horizon to catalyze a reversal higher at some point. Decay efficient long vol positions will therefore remain valuable additions to portfolios this year; we present proof-of-concept results for volatility curve butterflies that have delivered asymmetric returns as defensive positions. At-expiry digital calls in select EM (INR, BRL and their yen-crosses) remain favored risk-on plays over the next few weeks. In our last publication, we flagged EM/JPY crosses as attractive appreciation plays via at-expiry digital options (FXMW, Feb 10), and the unexpected lift to USD/JPY from the BoJ liquidity injection since then has worked in favor of those trades. Our preference for atexpiry digitals over single strike vanillas/one-touches was based on the inherent low vol nature of spot rallies in asset currencies, and the fact that some of them had already retraced a large fraction of their post-September deleveraging which placed a soft cap on how much further their rally could run. The choice of yen-crosses as the best value risk-on underlyings to buy digitals in was predicated on a framework that married prevailing option pricing with the headroom left for spot to mean-revert to last years precrash levels an updated version of the same is shown in Table 1. We capture the potential risk-reward of buying digitals at current prices as follows: if a certain currency has, say, 10% room left to rally in order to revert to preSeptember 2011 crash highs and a 3M at-expiry digital
16
Source: J.P. Morgan
option needs to be struck, say, 5% OTMS (in the pro-risk direction) in order to generate a 5:1 payout, the ratio between the spot-strike distance (5%) and the potential retracement room for spot (10%) becomes the performance yardstick of interest. Smaller this ratio, easier it is to violate the strike and therefore more attractive the digital as a riskon buy. Table 1 suggests that select USD/EMs (INR, BRL) and EM/JPY crosses (BRL/JPY, INR/JPY) remain favored buys in the pro-risk digital option universe. BRL/JPY spot for instance needs to rally barely ~3.5% in order to break above the 5:1 digital strike; this represents less than only 1/3rd of the retracement headroom towards its 2011 highs, a much smaller fraction than is the case for crosses at the bottom of the table that require a near re-test of their
previous highs in order to trigger an identical levered payout. We already have some of this exposure on in our model portfolio in the form of a 2Y 43/50 TRY/JPY call spread. In relative value space, EUR-correlations are still a sale in our view, and buying [EUR/USD or EUR/JPY vs. EUR/INR, EUR/CAD, or EUR/BRL] dual currency structures offer a levered way of fading high EURcorrelations with a constructive view on risk. The lift to risk markets from LTROs has had a significant impact on European tail risk perceptions this year. Another EUR 400 500bn uptake of the second lot of repos next week would keep alive the re-pricing of the EUR, with an attendant softening in EUR vols and EUR-based correlations. We have held a bearish view on EUR-correlations for a while now; average pair-wise implied corrs in EUR-crosses have softened from last years peak, but are still high in a historical context and rich to recent realized corrs (chart 2). Prior publications have investigated the directionality of EUR-correlations vis--vis EUR spot (FXMW, March 4, 2011), and found an inverse relationship between them that has only gotten stronger as the debt crisis has rolled on, and that correlations look rich at even adjusted for levels of the trade-weighted EUR. It follows that EUR-correlations should subside further if the spot moves of the past few weeks have legs, and JPMorgans FX Correlation Analyser suggests that EUR corr. shorts are best installed in EUR/USD or EUR/JPY against EUR/high-beta currencies such as AUD, NZD, NOK and SEK where realizeds are clocking 20-30 points under implieds. For directional investors, constructive views on carry currencies can be combined with a bearish take on EUR-correlations through dual currency structures. In keeping with the general message from the correlation screens, chart 3 ranks a number of EUR vs. [USD or JPY, commodity FX or EM] dual digitals (3M tenor, ATMS strikes on both legs) in order of the discount they offer to the cheaper of the two individual digitals; the most attractively geared trades have a generous sprinkling of INR, CAD and BRL. Vol curve butterflies as tail risk hedges in FX In equity markets, VIX futures and options are liquid instruments that allow investors to assume clean long exposure to implied volatility for stress hedging purposes. They are free from contamination with realized volatility that usually clocks 4-5 vol pts. under implieds and acts as a drag on long vol positions. However the steep vol term structure means that there is still an appreciable, albeit smaller, cost of carry in such trades in the form of slide down the vol curve. Our equity derivatives strategists note that the VIX term structure has been upward sloping 80% of the time over the past 20 years, and accordingly designed a framework that offers net long vol exposure via VIX futures
Chart 1. EUR-based implied correlations have begun to decline post-LTROs, but are still rich historically and vs. realized corrs
(%) 50 45 40 35 30 25 20 15 10 5 0 -5
Avg. pairwise 3M EUR-based implied correlations Avg. pairwise 3M EUR-based realized correlations
Feb-08
Source: J.P. Morgan
Feb-09
Feb-10
Feb-11
Feb-12
Chart 2. Dual digitals are a levered way of combining a short EURcorrelation view with a constructive view on risk
3M ATMS [EUR/USD or EUR/JPY higher, EUR/high-beta FX lower] dual digitals, ranked in order of their discount to the cheaper of the two individual digitals. No transaction costs
EUR/USD,EUR/INR EUR/USD,EUR/CAD EUR/JPY,EUR/INR EUR/USD,EUR/BRL EUR/USD,EUR/TRY EUR/USD,EUR/RUB EUR/JPY,EUR/CAD EUR/JPY,EUR/BRL EUR/JPY,EUR/AUD EUR/USD,EUR/KRW EUR/JPY,EUR/KRW EUR/USD,EUR/AUD EUR/USD,EUR/MXN EUR/JPY,EUR/NZD EUR/JPY,EUR/MXN EUR/USD,EUR/NZD EUR/JPY,EUR/TRY EUR/JPY,EUR/RUB EUR/JPY,EUR/NOK EUR/USD,EUR/ZAR 0% 10% 20% 30% 40% 50% 60% 70% 80%
Source: J.P. Morgan
with low negative carry using a careful combination of a short front-end leg with a long in the back-end (Cross-Asset Hedging with VIX: Tools for Trading VIX Options and Futures, 12 Jan 2012). In this section, we present an analysis of a similar strategy in FX, using forward starting variance swaps as analogs of VIX futures; 1Yx6M forward starting variance swaps (6M variance starting in 1Y time) constitute the long vol leg in the exercise, and are partially funded by selling half the vega notional of 6Mx6M forward starting variance swaps. The net package consists of vega longs in 6M and 18M buckets against weighted shorts in 12M, and is reminiscent of duration weighted butterflies on yield curves hence the curve fly nomenclature. Such structures benefit in vol spikes due to their overall long vega exposure, while the negative slide on the short leg
17
Chart 3. EUR/USD and AUD/USD vol curves are upward sloping upto 1Y, with an inflexion point at 1Y beyond which they are inverted
14 AUD/USD 13 EUR/USD
Table 2. Backtesting a vol curve butterfly strategy across the G10/EM universe yields interesting results for nine G10 pairs
12
The table ranks the best performing pairs for a vol curve butterfly strategy across the G10/EM universe, simulated by selling 1X vega notional of 6M6M forward starting variance against buying 2X vega of 1Y6M forward starting variance. Column (D) shows the average 6-month P/L from entering the curve fly position on any given day since Jan 2003 (in vol pts). Column (B) reports the proportion of time the pair is among the 10 top-performing currencies, and (C) the frequency with which it ranks among the bottom 20. The 9 highlighted pairs are selected for their return statistics and liquidity.
( A ) Pair ( B ) ( C ) ( D) ( E ) IR 2.39 2.77 2.04 3.01 2.54 2.77 2.88 2.96 2.90 2.50 2.31 1.30 2.36 2.80 1.78 2.69 1.99 2.40 2.31 1.58 0.71 1.35 0.64 0.51 1.14 0.92 1.09 1.09 0.41 1.64 0.34 0.45 0.12 0.02 -0.10 -0.18 -0.44 -0.64 -0.90 % in top 10 % in bottom 20 Avg P/L (vol pts) 44.9% 52.3% 39.3% 30.4% 43.0% 37.4% 22.8% 28.0% 42.1% 20.3% 30.8% 22.7% 28.0% 33.6% 13.4% 28.0% 31.8% 25.2% 16.8% 7.6% 29.0% 5.6% 25.2% 26.2% 2.8% 19.6% 11.2% 15.9% 30.4% 16.8% 15.0% 4.7% 6.5% 12.1% 2.4% 1.9% 13.6% 11.1% 7.5% 11.2% 15.9% 18.7% 19.0% 15.9% 16.8% 20.3% 10.3% 12.1% 20.3% 17.8% 53.0% 24.3% 20.6% 29.3% 20.6% 34.6% 32.7% 24.3% 40.5% 42.1% 30.8% 43.9% 51.4% 42.1% 48.6% 43.9% 47.7% 51.9% 50.5% 53.3% 62.6% 57.0% 60.7% 83.5% 72.0% 72.8% 80.2% 78.5% 2.27 2.21 2.13 2.09 2.06 2.02 1.98 1.78 1.75 1.74 1.69 1.68 1.60 1.58 1.56 1.54 1.38 1.27 1.26 1.16 1.01 1.01 0.83 0.75 0.72 0.71 0.70 0.64 0.62 0.53 0.42 0.27 0.12 0.02 -0.06 -0.09 -0.45 -0.58 -0.89
11
1 2 3
10 1M 2M Source: J.P. Morgan 3M 6M 9M 1Y 2Y 3Y 4Y 5Y
pays a part of the theta bill in quieter times Given the synthetic vega exposures of curve flies in the three maturity buckets, it is reasonable to expect vol curves exhibiting a kink or a hump at the short tenor (1Y in this study) to be the ideal vehicles for this class of trades. Chart 3 shows that this is indeed the case for AUDUSD and EURUSD at present. As a matter of fact, a blanket backtest of curve flies across G10 and EM pairs shows that these two currencies are among the nine that have consistently yielded the best returns from the strategy since 2003 (table 2). Chart 4 depicts historically simulated returns from the strategy for the nine selected pairs from table 2, taking 1Jul-2007 to be the start date. Each long/short forward starting variance swap spread is assumed to be held for 6months and rolled into fresh positions thereafter. The empirical results suggest that the strategy exhibited favorable long vol properties during the asset market meltdowns of August 2008, May 2010 and August/September 2011, and also benefited from the steepening of vol curves in other risk-on periods. We are aware that transaction costs inhibit the scope for operationalizing variance butterflies as a systematic trading heuristic. As such, this is only a proof-of-concept exercise at this stage. Migrating away from var swaps to vanilla straddles and/or strangles is a natural next step towards a more practical implementation, although that will come with the unavoidable inconvenience of delta-rebalancing on behalf of investors. Further research is also required to isolate optimal indicators for selecting underlyings that comprise a parsimonious curve fly portfolio the net static vol slide of the three legs along the vol curve is one that springs to mind. We will address these issues in a forthcoming publication.
4 5 6 7
NZD/USD NZD/CHF AUD/USD EUR/AUD AUD/CHF EUR/USD GBP/AUD USD/NOK USD/SEK GBP/NZD AUD/NOK USD/KRW AUD/SEK USD/CHF GBP/CHF EUR/NZD EUR/CHF NZD/CAD AUD/CAD EUR/CAD NZD/JPY GBP/USD CAD/JPY AUD/JPY EUR/GBP USD/JPY USD/CAD EUR/SEK GBP/JPY AUD/NZD EUR/JPY EUR/NOK CHF/JPY USD/MXN USD/SGD NOK/SEK USD/ZAR USD/TRY USD/BRL
Source: J.P. Morgan
Chart 4. Cumulative return series for top performing vol curve flies
Cumulative P/L (vol pts.) 50 45 40 35 30 25 20 15 10 5 0 Jul-07 Jan-08 Aug-08 Mar-09 Oct-09 May-10 Dec-10 Jul-11 Feb-12
Source: J.P. Morgan
All return series begin in July 2007 and are rolled into fresh trades every 6-months. P/Ls are in vol pts, excluding transaction costs.
NZDUSD AUDUSD EURAUD EURUSD GBPAUD EURCHF USDNOK USDSEK USDCHF
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Implied volatilities
Current Implied Vols Avg. Implied Vols Z-Score Implied Vols 1M 3M 1Y 1M 3M 1Y 1M 3M 1Y
A UDJP Y A UDUSD CA DJP Y CHFJP Y EURA UD EURCA D EURCHF EURGB P EURJP Y EURNOK EURNZD EURSEK EURUSD GB P JP Y GB P USD NZDUSD USDCA D USDCHF USDJP Y USDNOK USDSEK USDA RS USDB RL USDCLP USDM XN EURCZK EURHUF EURP LN EURRUB USDRUB USDTRY USDZA R USDIDR USDINR USDKRW USDP HP USDSGD USDTWD 1 .9 1 1 .1 1 1 0.9 1 2.0 8.8 8.0 3.4 7.5 1 .5 1 6.5 8.9 6.3 1 0.3 9.8 7.2 1 .5 1 7.6 1 0.5 8.6 1 .0 1 1 .4 1 5.5 1 2.0 1 2.4 1 2.2 8.3 1 .9 1 9.5 8.7 1 0.8 1 .4 1 1 5.6 8.2 9.5 9.4 6.9 7.8 4.6 1 3.0 1 2.0 1 .9 1 1 .9 1 9.9 8.8 4.3 7.7 1 2.2 6.7 1 0.1 6.7 1 0.7 1 0.5 7.6 1 2.3 8.3 1 0.8 9.2 1 .9 1 1 2.2 8.5 1 3.0 1 2.8 1 2.4 8.3 1 2.0 1 0.2 9.4 1 .5 1 1 2.0 1 6.2 1 0.0 1 0.0 1 .0 1 7.2 8.1 5.4 1 5.7 1 3.8 1 4.1 1 3.3 1 .7 1 1 0.2 6.9 8.4 1 4.2 7.4 1 .8 1 7.4 1 .9 1 1 2.2 9.1 1 4.0 9.8 1 2.1 1 .2 1 1 3.3 1 3.9 1 8.0 1 5.8 1 4.1 1 3.6 8.5 1 2.3 1 .1 1 1 .9 1 1 3.8 1 4.2 1 7.7 1 3.1 1 .2 1 1 3.4 8.4 8.5 6.8 1 6.2 1 3.7 1 4.6 1 2.8 1 .5 1 1 .3 1 1 0.0 9.4 1 4.3 8.2 1 .7 1 8.1 1 2.7 1 3.4 1 0.3 1 4.1 1 0.5 1 2.6 1 0.4 1 4.4 1 4.7 5.6 1 4.0 1 2.7 1 2.8 7.2 1 .3 1 1 0.8 1 0.2 1 .1 1 1 2.6 1 6.2 8.4 9.1 1 3.0 7.9 7.5 6.1 1 6.9 1 4.3 1 5.2 1 3.2 1 2.1 1 .8 1 1 0.0 1 0.0 1 5.0 8.4 1 2.5 8.3 1 3.1 1 4.1 1 0.9 1 4.7 1 0.9 1 2.7 1 .1 1 1 4.8 1 5.1 8.3 1 4.7 1 3.1 1 3.4 7.4 1 .8 1 1 .2 1 1 0.9 1 .8 1 1 3.2 1 6.6 9.9 9.7 1 3.6 8.5 7.7 6.6 1 8.6 1 5.2 1 6.7 1 4.2 1 3.1 1 2.5 1 0.3 1 .0 1 1 6.5 8.7 1 .8 1 8.6 1 3.7 1 5.9 1 2.0 1 5.7 1 .7 1 1 2.9 1 2.8 1 5.5 1 5.7 1 6.9 1 6.4 1 4.2 1 5.1 7.6 1 2.7 1 .9 1 1 2.4 1 3.3 1 4.5 1 7.3 1 2.8 1 0.5 1 4.4 9.6 8.1 7.4 -1 .1 -1 .0 -1 .2 -0.3 -1 .6 -2.2 -2.0 -1 .8 -1 .1 -1 .3 -2.1 -1 .4 -1 .3 -1 .3 -1 .8 -1 .1 -1 .5 -0.8 -1 .1 -1 .6 -1 .4 0.0 -0.5 -0.1 -0.2 0.7 0.2 -0.6 -0.8 -0.1 -0.5 -0.2 -0.1 0.2 -1 .0 -0.7 0.2 -1 .3 -1 .2 -1 .1 -1 .3 -0.5 -1 .6 -2.4 -2.1 -2.6 -1 .3 -1 .5 -1 .8 -1 .4 -1 .5 -1 .5 -2.1 -1 .2 -1 .5 -0.9 -1 .4 -1 .6 -1 .5 0.0 -0.5 -0.1 -0.3 0.7 0.1 -0.6 -0.8 -0.1 -0.6 -0.1 0.0 0.2 -0.9 -1 .0 0.3 -1 .1 -1 .2 -1 .1 -1 .4 -0.6 -1 .6 -2.5 -1 .4 -3.6 -1 .6 -1 .3 -1 .0 -1 .1 -1 .6 -2.0 -2.5 -1 .3 -1 .3 -0.5 -1 .8 -1 .6 -1 .2 0.3 -0.3 -0.1 -1 .5 0.7 -0.3 -0.7 -0.3 0.2 -0.2 0.1 0.1 0.5 -0.5 -1 .2 0.3 -0.5
Biggest 3M Implied Volatility Movers

Weekly Changes
USDJPY CADJPY USDCLP USDIDR EURNOK EURCZK USDBRL USDTWD EURSEK USDZAR USDRUB AUDUSD EURAUD EURRUB CHFJPY EURUSD USDCHF USDNOK USDSEK -2.0
Monthly Changes
USDPHP USDSGD USDJPY USDINR USDTWD EURNOK CADJPY USDKRW USDIDR USDCLP USDBRL EURUSD EURRUB USDNOK USDSEK EURGBP GBPUSD EURCHF EURHUF
Vol
Vol
Vol
Vol
-1.5
-1.0
-0.5
0.0
-3
-2
-1
Source: J.P. Morgan
Front-End Vol Rankings

In order of Normalized Volatility Risk Premium*
EURCHF EURRUB USDKRW USDBRL USDCLP CADJPY EURSEK USDIDR EURAUD EURGBP USDTRY EURJPY GBPUSD USDJPY EURCZK NZDUSD USDNOK USDSGD USDZAR
Vols RICH
Vols CHEAP
-0.5
0.0
0.5
1.0
1.5
Source: J.P. Morgan
Current trade recommendations and P&L

Analyst Description Entry date 19-Aug-11 04-Nov -11 Entry 1.5 12.4 Current mid -1.6 9.8 P/L -3.1 -2.6 P/L units v ol pts. v ol pts. Remarks Was originally a 3M/2Y calendar spread, 3M leg has been unw ound, continue to hold long 2Y as low bleed protection Attractiv e entry location w ith v ols hav ing fully retraced their Aug/Sep rally , flat v ol curv e minimizes negativ e v ol slide EUR/USD risk-rev ersals hav e narrow ed massiv ely in sov ereign refunding calendar USD/TRY v ols ex pensiv e, v ol curv e ex tremely steep, selling Sandily a/Bouquet Sell USD/TRY 6M 10D USD call/TRY put delta-hedged Buy EUR/JPY v s. Sell EUR/GBP risk-rev ersals (60K v ega/leg v s 100K v ega/leg), 3M 25D, delta-hedged 06-Jan-12 80 98 -18 bp USD longer-dated v anillas a transaction cost efficient w ay of getting short forw ard v olatility Sandily a/Bouquet 13-Jan-12 13-Jan-12 20-Jan-12 20-Jan-12 27-Jan-12 27-Jan-12 1.1 59.0 4.7 -38 -0.4 275 8.9 5.6 0.3 53.4 5.6 -10 0.2 394 7.8 4.9 -0.8 -5.6 0.9 28 0.6 119 -1.1 -0.7 v ol pts. corr pts EUR/JPY risk-rev ersals better v alue than EUR/USD as defensiv e holds, EUR/GBP skew s ex pensiv e Asy mmetric protection against a v ol spike; historically low implieds coupled w ith higher realizeds EUR/MXN high strikes price in a much stronger EUR rally relativ e to EUR/CAD than has historically been deliv ered
Sandily a/Bouquet Buy GBP/USD 2Y D/N straddle Sandily a/Bouquet Buy EUR/CAD 1Y D/N straddles, delta-hedged Buy EUR/USD 6M 25D risk-rev ersals, v ega-neutral, deltahedged
Sandily a/Bouquet
06-Jan-12
3.1
2.8
-0.3
v ol pts. December and should re-price ahead of a heav y peripheral
Sandily a/Bouquet Buy 6M AUD/USD v s. AUD/EUR correlation sw ap Sandily a/Bouquet Buy AUD/USD v s. Sell USD/BRL 6M straddles Sandily a/Bouquet Sandily a/Bouquet Buy EUR/CAD 2M 4% OTMS EUR calls v s. Sell EUR/MXN 2M 4% OTMS EUR calls, equal EUR notionals Buy NZD/USD 3M v s. Sell USD/CLP 3M v ol sw ap spread, equal USD-v ega on each leg
v ol pts. USD/BRL v ols are rich v s. AUD/USD v ols bp EUR
v ol pts. USD/CLP gamma rich v s. NZD/USD gamma bp TRY High ex -ante carry /premium and potential for FX appreciation v ol pts. Carry efficient long VXY prox y , w ith some relativ e v alue edge v ol pts. RV in v ega ex pressed in fw d space due to fav orable curv es
Sandily a/Bouquet Buy 2Y 43/50 TRY call/JPY put spread
Sandily a/Bouquet Buy EUR/CAD v s. Sell CAD/JPY 1Y1Y FVA, 150:50 v ega 03-Feb-12 ti Sandily a/Bouquet Buy USD/CAD v s. Sell USD/BRL 1Y1Y FVA, 220:110 v ega 08-Feb-12 ti
19
Global FX Strategy FX Markets Weekly February 24, 2012 Thomas Anthonj (44-207) 742-7850 thomas.e.anthonj@jpmorgan.com J.P. Morgan Securities Ltd.
Technical Strategy
EUR Looking better across the board, but not on safe ground yet against the USD GBP Back to normal or can the safe haven status be recovered? JPY Shapes of a major setback crystallizing Commodity FX Facing stronger headwinds and an increased setback risk Stay long EUR/NZD (new trade), EUR/SEK, NOK/SEK, USD/CZK, EUR/CZK, USD/ZAR and short EUR/USD, EUR/INR, NZD/CAD, EUR/KRW, USD/JPY, and PLN/HUF
above 79.703/761 (daily trend/int. 76.4 %) in the USD Index would deliver additional hints that the intermediate USD downtrend has reached an exhaustion point. The strong recovery of EUR/GBP hasnt reached safe ground yet. In line with the newest aid package for Greece, GBP lost its safe haven status against the EUR, which resulted in a break above the first resistance barrier at 0.8455/75 (int. 38.2 % on 2 scales) in EUR/GBP. In terms of wave counts though (corrective double zigzag still possible) and also taking other charting tools like Ichimoku-clouds and trend lines into account, we cant confirm a game change yet. For the latter to be indicated and in order to eliminate the risk of just performing an intermediate recovery in a still intact downtrend, this market would have to break above 0.8528/75/81 (pivot/daily,-weekly trend) and display two consecutive higher daily closes (10pm CET) of the red lagging line above the cloud (currently at 0.8602)
Chart 2: EUR/GBP Daily Chart A break above 0.8475/0.8528 is required to reverse the still prevailing downtrend
The EUR recovery, apart from EUR/JPY, is not on safe ground yet. The broad recovery of the EUR across the board since the beginning of this year looks good on first sight, but apart from EUR/JPY, stronger evidence that this could constitute a sustainable up-trend is still missing. EUR/USD is the best example as it would take a decisive break above 1.3414/24/34 (int. 38.2 %/broadening triangle/minor 50 %) to at least delay the imminent threat of accelerating down south for a test of 1.2600/1.2588 (76.4 %/pivot).
Chart 1: EUR/USD Daily Chart Below 1.3414/34, the long-term downtrend remains intact and 1.2600/1.2588 in focus
Above the latter though, there would be room for a broader recovery to 1.3731-82/1.3864 (200 day MA/50 %/76.4 % on lower scale) and possibly to 1.3971 (weekly trend). On the downside it would now take a break below pivotal support at 1.3294 to indicate that a top is in place, which would have to be confirmed though via a break below daily trend line support (at 1.3061 today). An equivalent break
20
Below, the risk of at least testing the 2010 low at 0.8067 remains high and would receive fresh support via a break below 0.8424/09 (minor 38.2 %/pivot). For the latter to be confirmed though, it requires breaks below 0.8331 and 0.8289 (minor 76.4 %/daily trend). In terms of Cable, the upside looks to be rather capped though as long as a strong resistance between 1.5857 (daily trend) and 1.5906/29/47 (200 day MA/last top/int. 76.4 %) has not been broken decisively on daily close (10pm CET). Below, this market remains at risk of at least missing a deeper setback to 1.5459/1.5397 (daily trend/int. 76.4%), which would be indicated on a break below 1.5649/45 (double-low).
Global FX Strategy FX Markets Weekly February 24, 2012 Thomas Anthonj (44-207) 742-7850 thomas.e.anthonj@jpmorgan.com J.P. Morgan Securities Ltd.
Signs for a trend reversal of the long-term JPY bull-trend are mounting The impulsive structures of the rally from the 97.03 low shown in the daily chart of EUR/JPY and the recent break above pivotal resistance at 80.23/25 in USD/JPY are bearing testimony of an ongoing game change on big scale.
Chart 3: EUR/JPY Monthly Chart The possibility of having only performed a countertrend decline is clearly showing in this chart
The up-trends in Commodity FX are looking increasingly vulnerable While the up-trends of AUD/USD and NZD/USD seem to have reached their intermediate exhaustion points already, it is EUR/Commodity FX, which is now giving hints that we might have seen the lows for the time-being. The break above key-Fib.-resistance at 1.3373 (int. 38.2 %) in EUR/CAD, the reversal of EUR/NZD right at a projected 5th wave target around 1.5600 as well as the breaks above 1.2422/82 (last tops) in EUR/AUD provides strong proof for this view. That said and as we see the biggest recovery
Chart 4: EUR/NZD Weekly Chart The potential completion of a broader 5-wave cycle down inherits big recovery potential
As the shown wave counts above clarify, this reversal could be for good and long lasting in case the downward sloping line at 114.93 would also be taken out. A break above 111.62 (Oct. high) in EUR/JPY would in every which case provide further evidence that a long-term trend reversal has taken place, whereas setbacks at current will most likely be well-supported at 105.09 (int. 38.2 %), which would provide a fresh buying opportunity. Additional proof for a broader JPY weakness could be delivered via a break above 127.80 to 1.2843/49 (daily trend channel/weekly.-monthly trend in GBP/JPY
Technical trades
P&L based on postion size
potential in EUR/NZD to 1.7616 (weekly trend) and possibly to 1.8135 (Nov. 11 high), we established a strategic long position in the latter at 1.6030 with a stop at 1.5640 and intend to add up on a break above 1.6207/92 (pivot/minor 38.2 %)
Trade details Long USD USD HUF EUR INR JPY CAD KRW USD EUR NOK EUR Short EUR CZK PLN CZK EUR USD NZD EUR ZAR SEK SEK NZD Entry date 25/10/11 10/08/11 11/11/11 11/11/11 23/11/10 22/11/11 22/11/11 22/11/11 22/11/11 23/01/12 10/02/12 24/02/12 Entry level 1.3369 17.2550 70.3070 25.2100 64.900 78.160 0.7921 1548 8.1250 8.7845 1.1550 1.6030 Current level 1.3407 18.6500 69.3291 25.0070 65.685 80.620 0.8356 1510 7.6116 8.8209 1.1786 1.6034 Stop loss 1.3470 18.2500 73.3500 24.1500 70.850 81.150 0.8426 1670 6.8000 8.6650 1.1450 1.5650
P&L since entry % -0.47% 8.14% 1.37% -0.78% -1.31% -3.17% -5.53% 1.23% -6.21% 0.41% 0.63% 0.01%
Comments
Long-term downtrend intact, added at 1.2800 on 10th of January Long-term bottoming formation confirmed, added on 9 September Deeper correction still intact, added at 69.50 on 12th of January Medium term basing pattern suggests further upside. Outlook 2011 trade, added on 25 April and 27 September Outlook 2012 trade; added Feb 17 Outlook 2012 trade, added on 9th of January at 0.8082 Outlook 2012 trade Outlook 2012 trade Countertrend decline seen as complete Broader down-consolidation seen as complete Broad down-cycle seen as complete. Bigger recovery expected
21
Global FX Strategy FX Markets Weekly February 24, 2012 Sunil Kavuri (44-20) 7777-1729 sunil.d.kavuri@jpmorgan.com J.P. Morgan Securities Ltd.
Model-driven strategies & manager performance

Alpha strategies: Price Momentum Overlay (buy Alpha strategies: Carry Carry strategies posted modest declines across the board: currencies with momentum in spot FX and in rate G10 carry (-0.2%); forward carry overlay (-0.2%), EM spreads) Price momentum overlay was the worst performer on the carry (-0.2%). The G-10 basket cut its short EUR positions week (-0.5%) but still up 1.5% YTD. It is not always fully and added a long NZD vs. USD. EM carry remains the invested: It will only take a position when signals from rate strongest performing strategy YTD up 7.3%. G-10 with expectations and movement in spot FX confirm one forward carry overlay also fell (-0.2%) and is down YTD another. The strategy added long USD vs. GBP, SEK to its (-0.1%). The strategy only buys high yield currencies if rate present portfolio of short USD vs. CHF, JPY, NZD and expectations are also moving in that currencys favor. The AUD. strategy removed its short EUR positions and holds short USD vs. AUD and NZD and short EUR vs. NOK and Macro hedge fund and currency manager SEK.EM carry also rebalanced its positions (occurs performance monthly) with the only change replacing long USD vs. Currency managers gave back some gains for the year but are TWF with long USD vs. CNY. up in 2012 (Parker Blacktree Index +1.7% Barclay BTOP +0.5%). That said, currency managers continue to Alpha strategies: Forward Carry (trade FX on rate underperform the majority of our model-driven strategies in spread movements) 2012, but their returns are also less volatile. The forward carry strategy is limited to and fully invested in the nine USD pairs. Signals from this strategy are driven Macro hedge funds also were down on the week and by the change in rate spreads between currency pairs. pared the strong gains accumulated in 2012. Our only Forward carry delivered a modest decline on the week daily composite (HFR global hedge funds) is now up (-0.1%) and now up +2.6% YTD. The strategy is now short 0.1% in 2012. The monthly composites performed USD vs. all currencies apart from GBP, SEK. The best strongly in January - The HFR EM Index climbed 4.4% performing currency pairs in 2012 are NOK (+1.0%), SEK in January, its strongest performance since May 2009 (+0.7%), CHF (+0.7%) and NZD (+0.7%). JPY(-0.1%) is (+9.6%) and the HFR global macro hedge fund index rose the only currency to post negative returns in 2012. 1.1%. The HFRI Fund Weighted Composite index (+2.6%) posted the second highest monthly performance since December 2010. Equity Hedge strategies (+3.8%) performed the best led by Fundamental, Growth, Value and Energy/Basic Materials sub-strategies.
Table 1: Current signals and recent performance

Returns Strategy G-10 carry Emerging markets carry Forward Carry (9 USD pairs) Short USD vs. all currencies apart from GBP, SEK G-10 carry with Forward Carry overlay Price Momentum overlay (9 USD pairs) Short USD vs. AUD, NZD Long USD vs. GBP,SEK and short USD vs. CHF, JPY, AUD, NZD -0.1% -0.2% -0.6% 0.6% 0.2% -0.1% 2.3% 1.1% -2.9% 5.4% 3.9% -23.2% 2.6% -0.1% 1.5% Positions Short USD vs. AUD, NZD Short USD vs. ARS, INR, TRY, BRL and long USD vs. CNY 1W -0.2% -0.2% 1M 0.7% 4.0% 3M 3.7% 5.5% 12M 3.4% -1.3% YTD 2.8% 7.3%
Source: J.P. Morgan. Note: Bid-offer spreads were taken into account when implementing daily strategy models, YTD returns are non-annualized.
22
Chart 1: Performance of FX alpha strategies

350 300 250 200 150 100 50 0 01 03 05 07 09 11
G-10 Carry EM Carry
Chart 2: Performance of FX alpha strategies (USD pairs)

180 170 160 150 140 130 120 110 100 90 80 00
Forward Carry Forward Carry Overlay Price Momentum Overlay
02
04
06
08
10
12
Source: J.P. Morgan
Source: J.P. Morgan
Table 2: Long-term performance of FX alpha strategies, currency managers and global macro funds
FX alpha strategies Currency manager performance Barclay Currency Barclay Group Traders BTOP FX** Index* Hedge fund performance HFR emerging market hedge funds*
Emerging Forward carry G-10 carry Markets carry (rates (unlevered) (IncomeEM) momentum) 2012 YTD YTD return Std dev IR 2011 Avg annual return Std dev IR 2007-2011 (5 years) Avg annual return Std dev IR 2002-2011 (10 years) Avg annual return Std dev IR 2.1% 11.0% 0.2 5.1% 8.5% 0.6 3.4% 11.1% 0.3 11.0% 11.2% 1.0 6.3% 7.8% 0.8 3.3% 6.7% 0.5 0.7% 10.2% 0.1 -9.8% 12.6% -0.8 1.9% 6.9% 0.3
G-10 carry with Forward Carry overlay
Price momentum Overlay
Parker Blacktree CMI**
HFR currency index*
HFR global HFR global macro hedge macro hedge funds** funds*
2.8% 0.3% 9.8
7.3% 0.4% 16.7
2.6% 0.3% 8.4
-0.1% 0.3% -0.3 5.0% 9.5% 0.5
1.5% 0.3% 5.4 -27.3% 14.8% -1.8
1.7% 0.2% 9.7 -6.2% 3.5% -1.8
0.5% 0.2% 2.4 -4.4% 4.9% -0.9
NA NA NA 3.0% 3.3% 0.9
0.4% 0.4% 1.0 -1.6% 4.3% -0.4
0.1% 0.2% 0.6 -4.9% 0.9% -5.4
1.1% 1.1% 1.0 -4.0% 4.9% -0.8
4.4% 4.4% 1.0 -13.8% 12.0% -1.1
-2.4% 10.5% -0.2 2.7% 8.5% 0.3
-2.8% 10.5% -0.3 -2.2% 10.8% -0.2
1.5% 3.2% 0.5 NA NA NA
0.4% 4.1% 0.1 NA NA NA
0.2% 2.3% 0.1 3.5% 4.8% 0.7
-0.3% 5.0% -0.1 NA NA NA
-0.5% 1.0% -0.5 NA NA NA
5.3% 5.7% 0.9 10.1% 5.7% 1.8
-3.1% 14.4% -0.2 17.2% 12.5% 1.4
* monthly return composites ** daily return composites 2012 YTD returns and std dev are non-annualized Strategy descriptions
G-10 and emerging markets carry strategies select four currencies with highest ratio of carry (1-mo rate differential) to volatility (annualized spot vol over past 30 days). Forward Carry buys the currency in whose favor rate expectations have moved over the past month. Expectations are based on 1mo rates 3mos forward. Forward Carry Overlay only buys high yield currencies if rate expectations are also moving in that currencys favor, so combines standard carry and Forward Carry concepts. Forward Momentum Overlay only buys currencies which have appreciated in spot terms over the past year and are experiencing rising rate expectations relative to another currency over the past month. Thus it combines the standard price momentum framework with Forward Carry. All strategies are described in Alternatives to Standard Carry and Momentum in FX (Normand and Ghia, August 8, 2008) posted on www.morganmarkets.com/GlobalFXStrategy.
23
Global FX Strategy FX Markets Weekly February 24, 2012 Kevin Hebner (1-212) 834-2391 kevin.j.hebner@jpmorgan.com JPMorgan Chase Bank NA
Research Note
Short NZD/CAD and NZD/NOK

Three domestic risks loom over the NZ macro outlook. First, JP Morgan estimates there is a 50% probability that seismic activity will delay reconstruction, which the RBNZ projects to be the chief domestic growth driver over the next three years. Further, there is a deep underlying imperative for both government and household deleveraging. Together, these risks suggest a high likelihood that the NZ economy will underperform relative to trend, expectations and its peers (e.g., Australia and Canada). The challenging domestic macro backdrop constitutes a major headwind for the NZD. This is demonstrated by the strong empirical relationship between the NZD and domestic leading indicators, 3-mo and 10-yr bond yields, retail sales and credit card expenditures, and housing-related data. JP Morgans constructive global outlook poses the key risk to our bearish view on the high beta NZD. Although NZD/USD possesses a strong positive correlation with several proxies for the global cycle (e.g., MSCI world, commodity indices, PMIs and IP), most suggest the NZD has already overshot and it appears due for a correction. All three of our models suggest the NZD/USD is expensive (by 8 to 20%) and vulnerable to the downside. By contrast, the USD/CAD appears fairly valued, indicating short NZD/CAD may be a good cross to consider. This view is reinforced by IMM data, which attests to the NZD being significantly overbought relative to the CAD. From a technical perspective, the setup on the crosses offers a compelling backdrop to sell NZD. Technicals support shorting the NZD against the CAD, NOK and AUD. Bearish NZD views are well expressed through atexpiry digital NZD put/CAD call.
1. Domestic risks to NZs growth outlook lie overwhelmingly to the downside

Reconstruction delays This section examines the three domestic downside risks facing the NZ economy: reconstruction delays, as well as household and government deleveraging. Regarding the former, the RBNZ has repeatedly emphasized that the key domestic risk is that continuing aftershocks cause the commencement of rebuilding to be postponed beyond 2H12. This is why, following the Canterbury regions devastating earthquakes in September 2010 and February 2011, we have framed NZs growth outlook around the timing and extent of reconstruction of dwellings and infrastructure in the region. The RBNZs working assumption is that around NZD20 billion of damaged property needs to be rebuilt. This represents about 10% of GDP a very large shock indeed. According to the Earthquake Commission (EQC; the governments earthquake fund), 100,000 homes in Canterbury were damaged by the earthquake, with the governments main target being that 80% are repaired by 2014. The NZ Treasury optimistically forecasts that this reconstruction boom will herald a multi-year period of 3%plus GDP growth kicking off in 2H12. However, the resumption of significant aftershocks has thrown that reconstruction timeline into serious question. Since the first major Canterbury earthquake in September 2010, the region has experienced over 10,000 aftershocks of differing severity. In a January 27 speech, RBNZ Governor Bollard emphasized that significant aftershocks are still occurring there have been more than 400 greater than Richter magnitude 4, including more than 40 greater than Richter magnitude 5 since September 2010 and this has been a shock to everyones hopes for recovery and rebuilding. Although seismic activity is the main reason to expect widespread delay in reconstruction, other factors are also important. For example, insurance claims have involved some unique and unusual aspects (e.g., building code changes, land remediation), which mean that assessing the value of claims is complex and takes time. Further, severe land damage has presented major technical problems for rebuild. Finally, various regulatory (e.g., building standards) and legal issues are still being resolved. The significant tremors in late-December 2011 highlighted the risks to the reconstruction timeline, since rebuilding cannot proceed until the recent history of shocks decays to an acceptable tolerance level.
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Given the overwhelming size of the reconstruction boost, assumptions regarding its timing are crucial to understanding the likely growth dynamic through 2015. While we believe there is a 50% probability that rebuilding occurs in 2H of this year as currently projected by the government, we place a 35% likelihood on a minor delay (to 2Q of 2013) and a 15% chance on a major delay (to 4Q of 2013). Chart 1 shows how sensitive our growth forecasts for 2012 and 2013 are to different assumptions regarding the reconstruction timeline. Clearly, the downside risks are considerable and it would be imprudent for currency investors to ignore them. Government deleveraging NZ, like almost all G10 countries, has developed a fiscal austerity plan that will dampen growth over coming years. However, NZs central and local governments now also face significant costs as a result of the devastating earthquakes. The largest of these additional charges comes from the NZD11.7 billion EQC insurance cost (which does not yet include expenditures due to the December 2011 aftershocks). Total claims are highly likely to exhaust the EQCs available assets (that is, the National Disaster Fund), with the government bearing the cost of any subsequent claims. The government will also need to replenish that well, in case there is another disaster. Further, the government also faces significant expenses related to the purchase of residential properties in the red zone (the most damaged areas), support for AMI (the Christchurch-based insurer the government bailed out in 2010), and costs associated with damage to infrastructure. Earthquake-related public expenditure estimated at NZD13.6 billion contributed to a marked deterioration in the governments operating deficit over the 2010/2011 year, and further earthquake-related expenditure will be required over the coming years. The resulting pressure on the governments debt position was highlighted by Standard and Poors when they downgraded NZs long-term sovereign rating to AA last September. In response to the costs associated with the earthquakes, the governments budget has incorporated an increased focus on fiscal consolidation with a reduction in new discretionary spending over the coming four years. As a consequence, fiscal austerity will constitute a major headwind for the NZ economy well into 2015.
Chart 1: GDP growth forecasts under delayed Christchurch reconstruction

%4q/4q
3.0 2012 2.5 2013
2.0
1.5
1.0 2H12 start (base case)

Source: JP Morgan Economics
2Q13 start
4Q13 start
Household deleveraging Although this is the most difficult of the three domestic risk factors to forecast in terms of timing, it is likely the most important given its potential impact on future growth. To illustrate, the household savings rate in NZ has been dismally low for over 20 years (in fact, it has been negative for 15 of the last 16). This has engendered a steadily rising ratio of private sector credit to GDP (now at 140%) and a vertiginous multiple of household debt to disposable income (currently over 150%). These remarkable holes in the consumer balance sheet make the economy doubly vulnerable to disappointing domestic growth or even moderately higher interest rates. Redressing these imbalances has been a key area of focus for both the NZ Treasury and the RBNZ. Further, the problem is accentuated by two related afflictions: NZs seemingly permanent current account deficit (it has averaged over 5% of GDP during the last two decades), and its significantly negative net foreign asset position (roughly 100% of GDP; better than Hungary and Portugal, but worse than Spain and Greece). Many countries with similar ratios have run into considerable financial stress during the last three years and are required to pay significantly higher real interest rates than countries with less stretched ratios. A large adjustment to the savings rate is required to repair household balance sheet. When this rebalancing occurs, it will cap consumption growth unless the labour market gains a very substantial lift, for example, from rebuilding activity. It is hardly surprising then that the RBNZ has repeatedly emphasized its view that NZs biggest domestic risk is the inevitable acceleration in household deleveraging. Given that Statistics NZ only provides annual data on the savings rate, we get little direct visibility on how the household deleveraging process is advancing. However,
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retail and credit card spending, as well as housing market credit and sales data, provide a more high frequency guide to how this is playing out. The high probability of reconstruction delays, as well as the deep underlying imperative for deleveraging by both the household sector and the government, suggest domestic demand is likely to remain subdued for some time. To understand what this means for the NZD, the following section examines the relationship between the currency and five categories of domestic indicators that should be negatively affected by the three domestic risks discussed above.
Chart 2: NZ PMI vs. NZD/USD

5-yr correlation: 0.63
60 55 50 0.70 45 40 35 07
Source: Bloomberg
0.90
0.80
0.60 NZ PMI, lhs NZD/USD, rhs 08 09 10 11 12
2: NZ faces a challenging domestic outlook, with risks clearly balanced to the downside. This backdrop constitutes a serious headwind for the NZD.
The first section of this note argued that three domestic risks loom over the NZ macro outlook, together suggesting a high likelihood that NZs economy will underperform. This section extends that argument by demonstrating that this backdrop is likely to be significantly negative for the NZD. This is done by examining the NZDs relationship to five different types of domestic variables: leading indicators; interest rates; retail and credit card spending; home prices and housing credit; and the current account. Charts 2 and 3 show the two best leading indicators for NZs domestic economy, the NZ PMI and the NZ Confidence (business activity) index, which possess 5-year correlations to the NZD/USD of 0.63 and 0.58, respectively. Our assessment of the macro outlook suggests these indicators are apt to remain sluggish, which would likely be negative for the currency. Finally, note that both of these leading indicators suggest the NZD/USD is currently overvalued by about 5%. In terms of market-based indicators, few are better at explaining FX dynamics than the 10-yr and 3-mo yields, both of which are likely to remain well behaved given our tepid outlook for NZ growth. Charts 4 and 5 show the 3-mo change in the NZD/USD vs. the 3-mo standardized change in the two yields, which exhibit correlations of 0.64 and 0.58, respectively. Note that the 10-yr yield chart suggests the NZD/USD is currently about 10% overvalued, while the 3-mo yield chart indicates the NZD is roughly fairly valued against the USD.
0.50
Chart 3: NZ Confidence (business activity) vs. NZD/USD

50 40 30 20 10 0 -10 -20 -30 06
Source: Bloomberg
NZ confidence - business activity, lhs NZD/USD, rhs
0.90
0.80
0.70
0.60
0.50 07 08 09 10 11
Chart 4: 10-yr yield (standardized) vs. NZD/USD (3-mo chg)

3.0 2.0 1.0 0.0 0% -1.0 -2.0 -3.0 -4.0 06 07 08 09 10 11
Source: Bloomberg and JP Morgan
NZ 10Y yield (standardized), lhs NZD/USD (3m chg), rhs
30% 20% 10%
-10% -20% -30%
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Chart 5: 3-mo yield (standardized) vs. NZD/USD (3-mo chg)

3.0 2.0 1.0 0.0 0% -1.0 -2.0 -3.0 -4.0 06 07 08 09 10 11
Chart 6: NZ retail spending and credit card spending (standardized) vs. NZD/USD (3-mo chg)
30% 20% 10%
NZ 3M yield (standardized), lhs NZD/USD (3m chg), rhs
5-yr correlation: 0.53 (retail) and 0.57 (credit card)

3.5 2.5 1.5 0.5 -0.5 -1.5
NZ retail spending (standardized), lhs NZ credit card spending (standardized), lhs NZD/USD (3m chg), rhs
30% 20% 10% 0% -10% -20% -30%
-10% -20% -30%
-2.5 06 07 08 09 10 11
Next, we examine retail sales and credit card expenditures. Unfortunately, the monthly retail sales data was discontinued in Sept 2010, so we have spliced it together with the credit card spending series. Chart 6 shows the strong relationship between the 3-mo change (standardized, 3mma) in these two variables and the 3-mo change in the NZD/USD. Observe that the combined spending series indicates the NZD/USD is currently about 10% overvalued. We expect retail spending growth to be sluggish for two reasons: consumer deleveraging and the challenging labour market (especially if the pace of reconstruction disappoints). On that note, chart 7 shows the strong relationship between NZs unemployment rate and the AUD/NZD, a relationship which suggests the AUD/NZD is slightly undervalued. This is particularly relevant given that we expect only a very slow decline in unemployment through 2012 and 2013. Fourthly, home prices, housing credit and dwelling sales all correlate solidly with the currency. Regarding home prices, chart 8 shows that the 3-mo change (standardized, 3mma) has a correlation of 0.48 with the 3-mo change in the NZD/USD. Further, the 3-mo change in housing credit (again, standardized, 3mma) has a correlation of 0.43, while dwelling sales have a correlation of 0.29. The housing sector faces numerous challenges over the next two years, constituting a serious headwind for the NZD. Finally, we turn to the quarterly current account data. NZ has suffered from a sizeable CA deficit for over 30 consecutive years, a deficit that has averaged over 5% of GDP during the last two decades. The 3-mo change in the CA (expressed as a % of GDP and standardized) exhibits a correlation of 0.49 with the 3-mo change in the NZD/USD. This suggests that any improvement in NZs historically terrible CA position would probably result in a stronger NZD/USD. However, this is unlikely to improve in a significant and sustainable manner for some time yet. To a large extent the same argument applies to NZs net
Chart 7: NZ unemployment vs. AUD/NZD

7.0 6.0 5.0 4.0 3.0 02 03 04 05 06 07 08 09 10 11 12
Source: Bloomberg
NZ unemployment (sa), lhs AUD/NZD, rhs
1.40
1.30
1.20
1.10
1.00
Chart 8: Home prices (standardized) vs. NZD/USD (3-mo chg)

2.0 house price level (standardized), lhs NZD/USD (3m chg), rhs 30% 20% 10% 0.0 0% -10% -1.0 -20% -2.0 08 09 10 11
Sources: Bloomberg and JP Morgan
1.0
-30%
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investment income position, which appears equally dismal and possesses a (similarly defined) correlation of 0.25 with the NZD/USD. To conclude this section, the five categories of domestic variables examined above demonstrate that the domestic macro backdrop we envision is highly likely to be negative for the NZD/USD. However, the next section examines the key risk to this bearish view. That is, J.P. Morgan expects a constructive global outlook though 2012, with growth actually accelerating into 2H. This type of backdrop often provides a nice tailwind for the high beta NZD.
Chart 9: MSCI world equity index vs. NZD/USD.

1600 1400 1200 1000 800 600 400 08
Source: Bloomberg
0.90 0.80 0.70 0.60 0.50 0.40 10 11 12
MSCI world equity index, lhs NZD/USD, rhs 09
3: J.P. Morgans constructive global outlook poses the key risk to our bearish view on the high beta NZD
We forecast a modest global economic expansion that is projected to accelerate into the second half of this year. The two key drivers of this constructive outlook are: extraordinarily loose monetary policy from all G4 central banks, with the PBoC expected to deliver 200 bps of RRR cuts during 2012; and diminished tail risks in Europe, largely due to the ECBs hugely successful LTRO. This is a marked improvement from our outlook of just two months ago, and suggests an environment with reasonable risk appetite, albeit one that remains challenged by the familiar G4 malaise of the last few years. The currencies of most small open economies are highly geared to the global cycle and the NZD is certainly no exception. Chart 9 shows that the MSCI world equity index and the NZD/USD are highly correlated, although the NZD has been stronger over the last year than its historical relationship would suggest. This is particularly important given that the MSCI index is one of our two favourite proxies (along with the global PMI) for the global cycle. As a commodity currency it is not too surprising to observe that the NZD is highly correlated such series as the ANZ world commodity price index (5-year correlation of 0.78), as well as the CRB (0.81), Brent oil (0.77) and Milk futures (0.73). The CRB and Brent are among the most important drivers of several commodity currencies (e.g., the CAD). However, the importance of milk futures is rather unique to NZ, where dairy products now account for over 25% of exports. Chart 10 suggests the NZD/USD is roughly fairly valued, while the terms of trade relationship in chart 11 indicates the pair is significantly overvalued. JP Morgans short-term economic view is to a significant extent driven by recent dynamics in global and regional PMIs, many of which are key drivers of the NZD and other commodity currencies. To illustrate, over the last 5-years the NZD/USD has exhibited a very high correlation with the IFO (0.80), ISM services (0.71), ISM manufacturing (0.67),
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Chart 10: ANZ world commodity price index vs. NZD/USD.

320 300 280 260 240 220 200 180 160 140 06
Source: Bloomberg
ANZ world commodity price index, lhs NZD/USD, rhs
0.90
0.80
0.70
0.60
0.50 07 08 09 10 11
Chart 11: New Zealand Terms of Trade.

5-year correlation: 0.53
135 130 125 120 115 110 105 100 95 03 04 05 06 07 Source: Bloomberg and JP Morgan 08 09 10 11 12 0.60 0.55 0.75 0.70 0.65
ToT, lhs NZD/USD, rhs
0.85 0.80
global manufacturing PMI (0.69), global services PMI (0.66) and China PMI (0.44). The IFO is our favourite European leading indicator and generally provides an excellent read on the global cycle. Chart 12 indicates the NZD has recently traded more firmly, by about 5%, than its historical relationship with the IFO would justify. Commodity currencies can also be viewed as being driven by the global production cycle, with various IP series representing the best quality hard data high frequency indicators. For example, the NZD has an impressive 5-year correlation of 0.81 with global IP. Regional measures are also effective, with US IP yoy exhibiting a correlation of 0.72, followed by Europe at 0.69 and China at 0.63. Chart 13 includes JP Morgans forecasts for global 2012 IP, and suggests the NZDs recent strength already incorporates expectations of modest IP growth in the year ahead. The discussion above illustrated the strong relationship between the level of the NZD/USD and four types of macro variables (equity indices, commodity prices, PMIs and IP). We now extend this analysis by presenting evidence regarding the relationship between the 3-mo change in the NZD and the 3-mo change in the same four types of topdown factors. Chart 14 shows that the 3-mo changes in the NZD/USD and MSCI world equity index have been highly correlated (0.78) over the last five years. This chart suggests that the recent strength in the NZD is justified by the appreciation observed in the MSCI index and is one of the key reasons why our trade recommendations focus on shorting the NZD against various mid- or high-beta crosses (e.g., CAD, AUD, NOK), rather than against the low-beta USD. Although not shown here, the 3-mo change in the NZD is also highly correlated with the 3-mo change in a host of commodity prices: the CRB (0.70), Brent oil (0.64) the ANZ world commodity price index (0.59), and Milk futures (0.43). Turning next to PMIs, the empirical evidence suggests that JP Morgans obsession with these indices is definitely warranted. Over the last 5-years the 3-mo change in the NZD/USD has a very high correlation with the standardized 3-mo change in the key PMIs. To illustrate, the NZD has exhibited an impressive correlation with the global manufacturing PMI (0.74), global services PMI (0.45) ISM manufacturing (0.68), ISM services (0.45), IFO (0.65), and China PMI (0.56). Chart 15 suggests the NZD has exhibited more strength recently than is justified by its strong historical relationship with JP Morgans global PMI. Finally, as discussed above, commodity currencies are also driven by the global production cycle. The evidence is quite convincing, with the 3-mo change in the NZD being highly correlated with the standardized 3-mo change in global IP (0.65), US IP (0.48) and Chinese IP (0.36).
Chart 12: IFO Business Climate vs. NZD/USD.

120 115 110 105 0.70 100 95 90 85 08
Source: Bloomberg
IFO, lhs NZD/USD, rhs
0.90
0.80
0.60
0.50 09 10 11 12
Chart 13: Global IP (level) vs. NZD/USD.

120 115 110 105 100 95 90 06 07 08 09 10 11 12
Global IP (level), lhs Global IP forecast, lhs NZD/USD, rhs
0.90 0.80 0.70 0.60 0.50 0.40
Chart 14: MSCI world (3-mo chg) vs. NZD/USD (3-mo chg).
5-yr correlation 0.78
300 200 100 0 -100 -200 -300 -400 -500 06
Source: Bloomberg
MSCI, lhs NZD/USD, rhs
25% 15% 5% -5% -15% -25%
07
08
09
10
11
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While the above analysis demonstrates convincingly that the NZD should be expected to benefit from the constructive global backdrop, it tells us less about the implications for the NZD relative to other currencies. Consequently, table 1 shows the expected performance of select currencies in the event that growth turns in a surprisingly strong performance, proxied here by a 10% increase in JP Morgans global PMI. Table 2 is similar, but employs the MSCI world equity index as its proxy for global growth. In both tables the lowest expected return currencies are the usual suspects (JPY, USD, and CNY). Amongst high beta currencies, the BRL and AUD are the clear standouts, with the NZD possessing the second highest expected return among the G10. For example, the regressions show that when the global PMI rises by 10%, on average the NZD appreciates by 5.1%, somewhat below the AUDs 5.7%, but well ahead of the CADs 3.2%. Using the MSCI world equity index the corresponding results are 4.6% for the NZD, compared with 5.6% for the AUD and 3.4% for the CAD. The two tables below indicate that, if the current risk-on environment remains in place for a while longer, the USD should continue to underperform. This suggests it may be preferable to express a negative NZD via select crosses, for example against the AUD, CAD or NOK.
Chart 15: Global mfg. PMI headline (standardized) vs. NZD/USD (3-mo chg).
5-yr correlation 0.74
4 3 2 1 0 -1 -2 -3 -4 -5 06 07 08 09 10 11
Global mfg. PMI headline (standardized), lhs NZD/USD (3m chg), rhs
30% 20% 10% 0% -10% -20% -30%
To illustrate this argument, chart 16 shows that there exists a strong relationship between the global services PMI and the NZD/CAD. However, the NZD/CAD appears to have overshot by about 5% and seems due for a notable correction. Chart 17 illustrates the solid correlation between Chinese IP and the AUD/NZD. In this case the AUD/NZD seems to have undershot the recent increase in Chinese IP by about 5%, again suggesting significant downside for the NZD against another one of its key crosses.
Global PMI coefficient is based on a regression of the 3-mo % change in various currencies and the 3-mo % change in the global manufacturing PMI index, using the last 10-years of monthly data.
Table 1: Expected currency performance if Global PMI rises by 10%
Low beta
JPY -2.3% EUR 1.9% NOK 3.9%
JPMQUSD -1.7% RUB 2.3% KRW 4.0%
CNY -0.2% CAD 3.2% IDR 4.3%
CHF 0.7% MXN 3.3% TRY 4.7%
SGD 1.0% GBP 3.5% NZD 5.1%
MYR 1.0% SEK 3.7% ZAR 5.6%
TWD 1.0% HUF 3.7% AUD 5.7%
INR 1.6% PLN 3.8% BRL 6.0%
Mid beta
High beta
Sources: JP Morgan and Bloomberg
Table 2: Expected currency performance if MSCI world equity index rises by 10%
MSCI world equity index coefficient is based on a regression of the 3-mo % change in various currencies and the 3-mo % change in the global manufacturing PMI index, using the last 10-years of monthly data.
Low beta
JPMQUSD -2.2% EUR 2.6% SEK 4.2%
JPY -1.3% IDR 3.1% NZD 4.6%
CNY -0.1% NOK 3.3% ZAR 4.9%
MYR 1.3% GBP 3.4% HUF 4.9%
SGD 1.4% CAD 3.4% TRY 5.5%
TWD 1.5% RUB 3.6% AUD 5.6%
CHF 1.5% MXN 3.9% PLN 5.6%
INR 2.4% KRW 4.1% BRL 6.9%
Mid beta
High beta
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4: All three of our models are bearish NZD/USD

We have three models for the NZD/USD that are regularly updated in our Key Currency Views monthly. Currently all three models suggest NZD/USD is expensive and overdue for a correction. Chart 18 illustrates our short-term model which employs three explanatory variables: a 2-yr yield spread (vol adjusted), the CRB food index and milk futures. It is estimated using daily data and indicates the NZD/USD should trade at 0.75, about 9% cheaper than the current spot rate. Our medium-term model also employs three variables: the global PMI, China PMI, and the ANZ world commodity price index. It is estimated using monthly data and, as shown in Chart 19, indicates NZD/USD at 0.76, 8% below recent levels. The NZD is a high-beta currency, and has been supported by upturns in the global and China PMIs. However, NZs commodity prices, proxied here by the ANZ index, have declined by almost 10% since mid-2011. This has resulted in a lower terms of trade and advocates a lower value for the NZD in our medium-term model. We also have developed short- and medium-term models for the AUD and CAD. The AUD/USD models produce similar results to those for the kiwi, signaling a 7-10% overvaluation in the currency. However, the USD/CAD is close to fairly valued according to our short-term model and is only marginally expensive (4%) using our medium-term model. Finally, JP Morgans long-term fair value model covers 19 currencies and employs four explanatory variables: terms of trade, productivity growth, net investment income, and government debt. Although the model is not very useful as a guide for short- or medium-term trade decisions, it is very effective in illustrating the NZDs deteriorating fundamentals and its vulnerability on most crosses. Relative to 3-yr forwards, the NZD/USD is almost 20% overvalued. Further, Chart 20 shows that NZD is the 2nd most expensive G10 currency (after the JPY), while the CAD is the 2nd cheapest (following the SEK).
Chart 16: Global services PMI vs. NZD/CAD.

Correlation 0.61
60 55 50 45 40 35 30 07 08 09 10 11 12
Global mfg PMI headline, lhs NZD/CAD, rhs 0.80
0.70
0.60
Chart 17: China IP vs. AUD/NZD.

Correlation 0.76
9000 8000 7000 6000 5000 4000 3000 2000 06
Source: Bloomberg
China IP (level), lhs AUD/NZD, rhs
1.40
1.30
1.20
1.10 07 08 09 10 11
Chart 18: Short-term model for NZD/USD
Daily model variables include 2-yr yield spread (vol adjusted), CRB food index, and milk futures prices
5: IMM positioning suggests the NZD is overbought, especially vs. the CAD
Over the last three months the NZD has outperformed the AUD and CAD by 3% and 7%, respectively, in spite of a challenging domestic outlook. In fact, the NZD has outperformed the CAD by an inexplicable 12% over the last year. Our three models suggest this rally is stretched and IMM spec positions present a similar story. Recent CFTC data shows how speculators are positioned in the market, with the IMM series covering 9 major currencies (See
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Kariya Feb. 17 2012 IMM Update: Specs trim JPY net longs). Based on the most recent data, NZD net long positions are almost two sigmas above the 1-yr and 3-yr average. The buildup in spec NZD net longs is not that surprising given the recent upturn in the global PMI and the MSCI world equity index. Further, there is good reason to be skeptical of a major near-term correction if global activity data continues to improve. However, relative to the CAD (a higher beta peer), the kiwi also appears significantly overbought (chart 21). The 3-year z-score suggests NZD/CAD positioning is stretched, indicating the CAD may start playing catch-up regardless of the constructive near-term risk environment.
Chart 19: Medium-term model for NZD/USD

0.90
Monthly model variables include the global manufacturing PMI, China manufacturing PMI, and ANZ world commodity price index.
Model Estimate Actual
0.80
0.70
0.60
0.50 05 06 07 08 09 10 11 12
6: The technical picture supports shorting the NZD against the CAD, NOK and AUD
The strong outperformance for NZD since the start of the year has led to a test of several critical levels while raising the risk that a reversal is close. Importantly, the extension into important levels lines up with the current momentum extremes implying the outperformance trends will likely struggle to continue. While NZD/USD has paused against the key .8400/.8500 resistance zone, the setup on the crosses offers a more compelling backdrop to sell NZD particularly given the persistent risk-on trend. NZD/CAD highlights this developing view. We sense a reversal is due with the cross approaching critical .8375/.8425 zone and 2011 highs. While the price action has shifted into a range below this important resistance zone, the setup implies a potential topping pattern. In turn, follow-through weakness below the key .8260 support area would confirm the onset of a deeper retracement allowing a pullback initially into the .8125/.8060 zone, if not lower.
Chart 22: NZD/CAD The failure against the key .8375/.8425 resistance zone amid an overbought setup highlights the potential for a downside retracement.
Chart 20: Deviations from long-term real trade-weighted fair value (%)
A positive value indicates over valuation
Source: JP Morgan
Chart 21: IMM spec positions suggest NZD/CAD is overbought
Graph shows NZD/CAD spot rate since mid 2009 vs. NZD/CAD IMM net long positions. NZD/CAD spec position takes a 3 year z-score. Values over +1 suggest the cross is overbought and values below -1 suggest the cross is oversold.
Source: Bloomberg
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Another cross that offers an intriguing setup is NZD/NOK. The failure to sustain the break above the critical 4.75/4.80 resistance/target zone suggests the trend from the Nov 11 low is mature and due a corrective phase a setup confirmed by the momentum setup seen at the recent highs. This is consistent with the violation of the important 4.75/4.72 support zone which has reasserted the short term bearish setup given the head and shoulders topping pattern. In turn, a closer test of initial downside targets near 4.61/4.59 seems likely with a growing risk the cross can test deeper targets near 4.53/4.50. We also note that AUD/NZD is attempting to base against important support amid an oversold and bullishly diverging momentum backdrop a mirror image to the setup seen at the December peak. The 1.28/1.27 support zone represents the key breakout area from October, as well as important Fib retracement levels. Sustaining above the 1.2930/65 initial resistance levels would be the first clear sign the cross is forming at least a short term low while positioning for a retest, if not break of the December high.
Chart 23: NZD/NOK The breakdown below the important 4.75/4.72 support area suggests at least a short term top in place and onset of a deeper corrective phase.
Chart 24: NZD/CAD vols have collapsed over the past few months, resulting in historically cheap at-expiry digital option prices
14 13 12 7.5% 11 7.0% 10 9 Jan-10 Spot-strike distance of 6M 5:1 geared at-expiry digital NZD puts/CAD calls Jun-10 Nov-10 Apr-11 Sep-11 6.5% 6.0% Feb-12 NZD/CAD 6M ATM vol 9.0% 8.5% 8.0%
7. Bearish NZD views are well expressed through at-expiry digital NZD put/CAD call
Bearish NZD views are well expressed through NZD/CAD options since base vol levels there have collapsed over the past few months (chart 24), even undershooting a broad index of currency volatilities (JPMorgans VXY Global index). As a result, at-expiry digital NZD puts/CAD calls are currently priced at historically attractive levels chart 24 shows that rarely has it been possible in recent times to strike 6M NZD puts this close (~ 5.5%) to prevailing spot and yet generate a 5:1 gearing on such structures. Given a long-run history of NZD/CAD spot behavior, a decline of this magnitude is distinctly achievable; chart 25 illustrates that 5% - 6% downdrafts have been par for the course in past spot corrections, not to mention that such levered payout thresholds compare very favorably with the 7%-8% current spot overvaluation discussed earlier. We propose the following structure: off spot ref. 0.8320, buy a 6M 0.7850 at-expiry digital NZD put/CAD call for 21.75% CAD indicatively (maximum payout/cost ratio = 4.6:1)
Source: JP Morgan
Chart 25: The magnitude of spot decline required to trigger a 5:1 digital payout at current prices is distinctly achievable in the light of historical spot behavior
Rolling 6-month returns of NZD/CAD spot 30% 20% 10% 0% -10% -20% Feb-02
Source: JP Morgan
Magnitude of spot decline required to trigger 5:1 6M atexpiry digital NZD put/CAD call
Feb-04
Feb-06
Feb-08
Feb-10
Feb-12
33
Global FX Strategy FX Markets Weekly February 24, 2012 Paul Meggyesi (44-20) 8769-1906 Paul.meggyesi@jpmorgan.com JPMorgan Securities Ltd.
Research Note
Focus on current accounts why CHF is not following the yen weaker
Despite the singular focus on the yen, Japan is not the only country where current account dynamics have shifted to an extent that is potentially material for the exchange rate. NZ and the UK have suffered a bigger deterioration in their external balances than Japan in recent years, while on the other side Norway and Switzerland have enjoyed the most significant improvements (in what were already sizeable surpluses). If current account imbalances both the level and the pace of change - really are becoming more prominent drivers of currencies, a weaker yen is not the most compelling strategy implication. On the positive side, NOK and CHF are stand-out buys, while in the opposing category of deficit countries whose balances have deteriorated, GBP arguably is the worst offender. There are also interesting relative dynamics within the commodity bloc, where the significant improvement in Australias external deficit in recent years is juxtaposed by the trend deterioration in Canadas deficit. As far as the Swiss franc is concerned, the unassailable strength in Switzerlands eternal balance underpins our still structurally bullish view of the currency and illustrates the difficulties the SNB will face in maintaining the floor in EUR/CHF over any extended period of time. The yen and the franc are typically lumped together as safe-haven, anti-risk currencies because they are both surplus and creditor countries, but in recent years Switzerlands current account has improved out of all recognition to Japans. As a result, the balance of payments hurdle for franc weakness is an awful lot higher than it is for JPY weakness, which is why in a pro-risk environment the yen has started to weaken whereas the franc is still beating most-comers. Recent yen depreciation is not a precursor to CHF depreciation, irrespective of the risk environment. If anything, CHF/JPY can continue to appreciate.
Current accounts have resurfaced in the markets consciousness as drivers of exchange rates following the much-hyped elimination of Japans trade surplus and the attendant decline in the yen. But Japan is not the only
Exhibit 1: Switzerland and Norway not only have the largest current account surpluses in G10, they have seen the strongest improvement in recent years
20 NOK 15
Current account, % GDP
CHF
10 5 0 JPY
SEK
EUR GBP CAD USD 0 2 4 6 8 AUD
-5 NZD -10 -2
Current account, 2Y change, % GDP

Source: J.P. Morgan
country where the current account is on the move and where this should be capable of influencing the exchange rate. Exhibits 1 and 2 plot the current account position for G10 countries (using a rolling 4 quarter average to smooth out quarterly volatility in the data) as well as the change in the current account position over recent years. As should be clear from these charts, the deterioration in Japans current account is certainly not the most extreme of this group of countries both NZ and the UK have seen a bigger deterioration in the past two years. Moreover, even following the weakening in Japans balance, the country still runs a decent overall surplus, in contrast to the NZ and the UK which run moderate deficits. It is understandable perhaps why the yen has weakened as a consequence of the whittling away of Japans current account surplus. Less understandable is why GBP and NZD have been so indifferent to the worsening in their external positions current account fundamentals in these countries are inferior to Japan, not only in terms of the level but also the trajectory of the current account. In view of which, singling out the yen as the currency most vulnerable to a weakening in its external position, as the market has done, seems a little odd. On the other side of the coin, Norway and Switzerland have enjoyed substantial improvements in what were already substantial current account surpluses. The Swiss performance is particularly creditable the surplus has grown by 6% of GDP in the past two years and has now averaged a little more than 15% of GDP over the past year. If that were not enough, the surplus surged to a massive
34
19% of GDP in Q3, not only a record for Switzerland but also a record for any G10 economy, which is quite some
Exhibit 2: Current account balances (four quarter average, percent of domestic GDP)
AUD Latest Change ov er: 1y 2y 3y 4y 5y 1.5 1.0 3.2 3.6 3.1 0.4 -0.2 -3.8 -3.9 -4.8 -1.5 -0.8 -1.2 -2.8 -1.9 -0.8 -1.2 4.4 4.2 4.0 1.5 2.9 -0.6 1.9 -2.3 0.9 -0.1 -1.7 -1.4 0.0 -0.2 6.3 13.1 3.9 1.0 -0.4 -1.1 -1.8 0.2 0.1 0.1 -0.1 1.6 2.2 3.1 -0.2 0.2 0.8 -0.8 -0.2 -2.3 CAD -2.9 JPY 2.1 NZD -4.3 NOK 14.8 SEK 7.7 CHF 15.4 GBP -2.9 USD -3.1 EUR -0.5
Source: J.P. Morgan
achievement in view of the alleged massive overvaluation of the Swiss franc. For those who struggle to reconcile this massive current account surplus with the strength of the franc, it is worth noting that trade in goods accounts for less than 20% of Switzerlands surplus. 60% of the surplus comprises less price sensitive services while investment income from overseas assets makes up another third. The latter is the product of Switzerlands massive net foreign assets, which at 132% of GDP are the largest in the developed. Despite the attention the FX market has given the issue, the adjustment in Japans external balance is by no means the most noteworthy of the major economies, nor the most significant for exchange rate performance. There are deficit countries where the current account has deteriorated by more than in Japan, while there are surplus countries that have seen a significant improvement. If current account imbalances both the level and the pace of change really are becoming more prominent drivers of currencies once more, a weaker yen is not the most compelling strategy implication. On the positive side, NOK and CHF are the stand-out currencies to buy, while in the opposing category of deficit countries whose balances are deteriorating, GBP is arguably the worst offender. There are also interesting relative dynamics within the commodity bloc, where the significant improvement in Australias external deficit in recent years is juxtaposed against a trend deterioration in Canadas deficit (the relative Australian-Canadian current account deficit has improved in Australias favour by 7% of GDP in the past three years). This goes some way to explaining the otherwise elevated level of AUD/CAD, and cautions against positioning for a sharp reversal. As far as the Swiss franc is concerned, the unassailable strength in Switzerlands eternal balance underpins our still structurally bullish view of the currency and illustrates the difficulties the SNB will face in maintaining the floor in EUR/CHF over any extended period of time. There is still a massive imbalance in the underlying commercial
demand/supply for CHF (the SNB peg has not abolished the current account) and over time the SNB will be required to absorb this inflow, either through renewed liquidity injection or renewed FX intervention. Many (including the SNB no doubt) had thought (hoped) that EUR/CHF would bounce once the crisis in the euro zone subsided, based upon the premise that excess demand for the franc was largely safe haven in nature. Such a view underestimates the sheer power of Switzerlands current account dynamics, and we would cite this weeks modest sell-off in EUR/CHF as evidence that the safe-haven dimension to the franc has been substantially overstated while the current account dimension has been underappreciated. Against the backdrop of a stronger euro, the franc is the second strongest G10 currency over the past week, second only to NOK.
Exhibit 3: Switzerlands current account surplus is now six times as large as Japans
Current account balance, rolling 4Q average, % GDP
16 14 12 10 8 6 4 2 0 90Q1 93Q1 96Q1 99Q1 02Q1 05Q1 08Q1 11Q1 Japan Switzerland
Source: J.P. Morgan
As a final aside, it is worth directly comparing the current account trajectory in Switzerland with that of Japan. The purpose of this is to differentiate the franc from the yen, and to show why the recent depreciation in the yen should not be viewed as precursor to a sharp depreciation in the franc. The yen and the franc are typically lumped together as safehaven, anti-risk currencies because they are both surplus and creditor countries, yet in recent years Switzerlands current account has improved out of all recognition to Japans (exhibit 3). Its surplus is now 12% of GDP greater than Japans, or put another way its surplus is six times as large as Japans relative to the size of the economy. What this means is that the capital outflow required to offset Japans current account surplus and to weaken the yen is consequently way smaller than the capital outflow required from Switzerland. In other words, the balance of payments hurdle for franc weakness is an awful lot higher than it is for yen weakness, which is why in a pro-risk environment the yen has started to depreciate weaken whereas the franc is still beating most-comers. CHF/JPY may not be a cross
35
which receives much attention. Nonetheless, current account dynamics firmly favour a continued recovery in CHF versus JPY (exhibit 4).
Exhibit 4: The massive improvement in Switzerlands current account surplus versus Japan bodes well for CHF/JPY
Current account balance, rolling 4Q average, % GDP
110 105 100 95 90 85 80 75 70 65 60 90Q1 93Q1 96Q1 99Q1 02Q1 05Q1 08Q1 11Q1 CHF/JPY Swiss-Japan current a/c, % GDP 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0
Source: J.P. Morgan
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Global FX Strategy FX Markets Weekly February 24, 2012 Haibin Zhu (852) 2800-7039 Grace Ng (852) 2800-7002 Lu Jiang (852) 2800-7053 JPMorgan Chase Bank, N.A., Hong Kong
Research Note
FX reserves, trade balance, and FDI inflows

US$ bn, 3mma
80 60 40 20 0 -20 05 06 07 08 09 10 11 FX reserves Sum of trade balance and FDI inflows
China: FX reserves to resume upward trend

With current account surplus narrowing, temporary fall in FX reserves late last year exaggerated by capital flow Fundamental trade and FDI flows still support rising FX reserves; persistent capital outflows unlikely RRR cuts to complement reserve money growth and ensure stable expansion in broad money supply
Balance payments
US$ bn
Current account Goods Services Income Current transfers Capital and financial account Direct investment Portfolio investment Others Errors and omissions Overall balance
US$ bn 80 60 40 20 0 -20 2007 2008 2009 2010 2011 Merchandise trade balance
Amid lingering uncertainty over the global economy and financial markets, some concerns have also risen regarding Chinas underlying macro picture. One of the recent worries has been the fall in Chinas official FX reserves during the last few months of 2011, even at a time of decent merchandise trade surplus and FDI inflows (first chart). In our view, the fall in Chinas FX reserves late last year, exaggerated by short-term capital outflows, was temporary. While the Chinese economy is going through a rebalancing from export-led to more domestic demand driven growth, which would lead to more balanced external accounts and hence slower FX reserve accumulation, this is a gradual process. For this year, we still expect FX reserves to return to an upward trend. This will in turn support some steady, gradual appreciation of the currency, with the CNY/USD rate likely to appreciate toward 6.1 by end-2012.
2008 412.4 360.7 -11.8 17.7 45.8 46.4 121.7 42.7 -118.0 20.9 479.5
2009 261.1 249.5 -29.4 7.3 33.7 180.9 70.3 38.7 71.9 -43.5 398.4
2010 305.4 254.2 -22.1 30.4 42.9 226.0 124.9 24.0 77.1 -59.7 471.7
1-3Q11 141.2 172.9 -40.0 -14.6 23.0 250.0 121.4 18.3 110.3 -15.9 375.4
4Q11 59.9 70.9 -15.4 0.4 3.9 _ 49.1 _ _ _ 12.4
Merchandise trade balance and banks net FX settlement

Commercial banks' net FX settlement with domestic corporates and households
Latest trend on external flows

One of the key features of Chinas balance of payments accounts in recent years has been the persistent twin surplusesboth the current account and the capital and financial account. The current account reflects the competitiveness of the export sector, while net capital inflow reflects international investors interest in investment opportunities in the Chinese economy, as well as general expectations of CNY appreciation in recent years. Regarding the latest trend in the fundamental external flows, the State Administration of Foreign Exchange (SAFE) last week released some of the key 4Q11 BoP figures (table). The current account continued to show a decent surplus, though the surplus was 41.4% below 4Q10. As such, the 2011 current account surplus fell to 2.8% of GDP, compared to 5.1% of GDP in 2010. Meanwhile, foreign direct investment registered a solid inflow in 4Q11, up 25.6%oya.
In our view, the fact that Chinas FX reserves fell in 4Q11, despite the decent surpluses registered on the trade and FDI fronts, was likely driven by two factors. One was the intense stress in the global financial market on the back of the Euro sovereign debt crisis, which caused the general outflow of short-term capital from emerging economies. The other was concerns about the slowdown in Chinas economy and the possibility of a hard landing. Such factors in turn led to some reassessment of the near-term outlook for CNY. In this regard, while foreign capital flows are difficult to track, there were signs of some notable changes in the Chinese domestic private sectors preferences regarding currency holding by late last year. Data on the net balance of FX settlement and sales by banks on behalf of clients suggest that the onshore private sector (corporates and households) turned into net buyers of foreign exchange
38
Global FX Strategy FX Markets Weekly February 24, 2012 Haibin Zhu (852) 2800-7039 Grace Ng (852) 2800-7002 Lu Jiang (852) 2800-7053 JPMorgan Chase Bank, N.A., Hong Kong
in November and December, despite a steady trade surplus figures (last chart, previous page), a phenomenon rarely observed in recent years. At the same time, onshore foreign currency deposits has spiked in recent months, rising 28.8%oya in January this year (while renminbi deposits rose at a moderate 12.4%oya). Meanwhile, using a methodology similar to a recent SAFE study on cross-border capital flows, we estimate that the fall in FX reserves in 4Q11 could imply short-term capital outflows of around US$65 billion during the quarter. Accordingly, SAFE officials recently commented that they noticed a rise in capital outflows toward end-2011.
Hot money flow estimates by SAFE

US$ bn
Trade balance Net FDI inflow Income from overseas investment Chinese companies overseas listing Sub-total (1) FX reserve net change (2) Hot money (2-1) 2006 177.5 45.4 50.3 39.4 312.6 285.3 -27.3 2007 264.3 49.9 76.2 12.7 403.1 460.9 57.8 2008 298.1 50.5 92.5 4.6 445.7 478.3 32.6 2009 195.7 42.2 99.4 15.7 353.0 382.1 29.1 2010 183.1 46.7 128.9 35.4 394.1 469.6 75.5
Fundamentals point to rising FX reserves

Going into 2012, Chinas FX reserves will likely resume their upward trend, though the pace of expansion may be somewhat slower than in previous years. The fundamental, core factors of external flows, namely merchandise trade and FDI, remain positive. The January trade report showed that the trade surplus surged to US$27.3 billion; we expect the 2012 trade surplus to be US$155 billion. Moreover, solid net direct investment inflows have been registered in recent years (even during the 2008-09 global financial crisis), and this will likely continue this year. But, as seen late last year, potential swings in short-term capital flows remain a key uncertainty. In this regard, it should be noted that our global team believes that Euro area policymakers will be able to contain financial stress this year, and the US economy should register decent, steady growth. Meanwhile, a hard-landing scenario is unlikely in China, with the government taking a proactive fiscal stance and implementing prudent monetary policies to ensure reasonable economic growth. Taking all these factors into consideration, we expect CNY/USD to maintain a gradual appreciation path to reach 3%-4% this year. Given this global and domestic macro backdrop, it is unlikely that China will experience consistent capital outflows in the near term.
In the SAFE calculation, hot money refers to the net change in FX reserves that is not related to stable, regular trade and investment flows. This calculation broadly refers to the more volatile cross-border flows, but does not necessarily mean speculative, illegal, or unexplainable flows.
Merchandise trade balance

US$ bn 50 40 30 20 10 0 -10 2008 2009 2010 2011 nsa sa
J.P. Morgan forecast
2012
Inward and outward direct investment

US$ bn 120 100 80 60 40 20 2006 2007 2008
Inward direct investment
Outward direct investment
2009
2010
2011
Impact on domestic monetary policy

In Chinas monetary regime, the rise in FX reserves has been an important source of reserve money growth (as well as the single most important component of the central banks balance sheet) in recent years. In our baseline scenario, we assume that PBoC purchase of FX reserves will total 1.94 trillion yuan in 2012, which will be about 24% less than 2011. This would in turn suggest the need to reduce the reserve requirement ratio (RRR), in order to raise the money multiplier to prevent a slowdown in M2 money supply growth (see China: fine-tuning the pace of monetary easing, GDW, February 3). We expect three to four 50bp cuts in the RRR this year, leading to 14% M2 growth.
PBoC balance sheet: foreign assets as share of total assets

%share
90 80 70 60 50 40 03 05 07 09 11
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Global FX Strategy FX Markets Weekly February 24, 2012 Sunil Kavuri (44-20) 7777-1729 Justin Kariya (1-212) 834-9618 Anna Hibino (81-3) 6736-7729 J.P. Morgan Securities Ltd, JPMorgan Chase Bank NA
Market movers
(all times GMT; +11hrs for Sydney, +9hrs for Tokyo, -5hrs for New York)
Date Country Data/Event JPM During the week Feb 25/26 Feb 26 (Sun) Feb 27 (Mon) United Kingdom G20 New Zealand Australia Euro area 21:45 23:00 09:00 09:00 09:00 10:00 13:30 17:00 17:30 US Israel Japan Feb 28 (Tue) Japan Thailand Euro area 15:00 15:30 15:30 23:50 05:00 07:00 07:00 10:00 10:00 10:00 13:00 22:00 Switzerland Sweden Hungary US 17:30 08:30 13:00 13:30 14:00 15:00 15:00 15:00 New Zealand S. Korea Japan Feb 29 (Wed) New Zealand United Kingdom US Australia 21:45 23:00 23:15 23:50 00:00 00:01 00:15 00:30 00:30 00:30 Switzerland Sweden Euro area 08:00 10:00 08:30 08:55 08:55 10:15 United Kingdom 14:30 Nationwide house prices sa (%m/m) G20 FinMin and Central Bankers meet in Mexico City Trade balance (NZD mn) Australian leadership vote M3 (%oya) Italian business confidence EU foreign ministers meet to discuss potential sanctions on Syria Italy sells bills ECB's Praet speaks at CDU conference in Berlin German lower house votes on Greek bailout package ECB's Asmussen at Berlin Podium event on tax Pending home sales (%m/m, sa) Dallas Fed survey (index) BoI rate announcement Retail sales (%m/m, sa) Shoko chukin small firm survey (DI) Industrial production (%oya) GfK German consumer confidence Italy to sell bonds and floating rate notes Euro-zone economic confidence (index) Euro-zone consumer confidence final (index) German CPI (%m/m,sa) Greek government votes on austerity measures SNB's Jordan speaks in Zurich PPI (%m/m) NBH rate announcement Durable goods orders (%m/m, sa) S&P/CS HPI (%oya) Consumer confidence (index, sa) Richmond Fed mfg Index Fed's Duke Testifies on Housing to Senate Banking Committee Buliding permits (%m/m, sa) Industrial production (%oya) PMI mfg. (index, sa) IP (%m/m, sa) NBNZ business confidence (index) GfK consumer confidence Fed's Pianalto speaks on economy in Ohio Construction work done (%q/q) Private sector credit (%m/m) Retail sales (%m/m, sa) KOF swiss leading indicator CPI-EU Harmonized (%m/m) GDP (%q/q, sa) German Unemployment change (000s) German Unemployment rate (%,sa) ECB 3-yr LTRO results expected Finland's Parliament votes on second Greek Bailout Treasury Minister Hoban testifies on euro area crisis 4Q Jan Jan Feb Jan 4Q Feb Feb -1.2 0.3 0.7 n.a. n.a. n.a. n.a. n.a. -0.8 0.3 0.3 -0.11 -0.3 n.a. -5 6.7 (3Q) (Dec) (Dec) Jan Jan 3Q Jan Jan 12.5 0.3 -0.1 -0.17 0.3 1.6 -34 6.7 Jan Jan Feb Jan Feb Feb n.a. n.a. n.a. 0.5 n.a. n.a. n.a. -3.9 n.a. 1.5 n.a. -27 Dec (Dec) Jan Dec Dec Jan 2.1 2.8 50.70 3.8 16.9 -29 Jan Feb Jan Dec Feb Feb n.a. 7.00 n.a. n.a. n.a. n.a. n.a. 7.00 -1.0 -3.55 63.0 10 Dec (Jan) (Dec) (Oct) (Jan) (Jan) -0.2 7.00 3.0 -3.67 61.1 12 Feb Feb Feb n.a. n.a. n.a. 94.0 -20.2 0.5 Jan Jan Jan 93.4 -20.2 -0.4 Jan Feb Feb Jan Feb Jan Mar n.a. n.a. 2.50 1.4 n.a. n.a. n.a. 1.0 15.9 2.50 1.0 n.a. -16.1 6.0 (Dec) (Jan) (Jan) Dec Jan Dec Feb -3.5 15.3 2.50 0.3 45.7 -25.8 5.9 Jan Feb n.a. n.a. 1.8 92 Dec Jan 1.6 92.1 Jan 315 167 Dec 338 Feb n.a. Forecast Consensus 0.3 Jan -0.2 Previous
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Global FX Strategy FX Markets Weekly February 24, 2012 Sunil Kavuri (44-20) 7777-1729 Justin Kariya (1-212) 834-9618 Anna Hibino (81-3) 6736-7729 J.P. Morgan Securities Ltd, JPMorgan Chase Bank NA
Market movers
(all times GMT; +11hrs for Sydney, +9hrs for Tokyo, -5hrs for New York)
Date Country Data/Event JPM Feb 29 (Wed) US 13:30 13:30 13:30 13:30 14:30 14:45 15:00 18:00 19:00 Japan Mar 1 (Thu) Australia China Switzerland Sweden Philippines Norway Euro area 08:15 08:55 08:55 09:30 10:00 11:00 United Kingdom US 09:30 13:30 13:30 13:30 13:30 13:30 15:00 15:00 17:30 Canada Japan 13:30 23:30 23:30 23:30 23:30 23:30 23:30 23:50 Mar 2 (Fri) Euro area 07:00 10:00 Iran United Kingdom Canada 09:30 13:30 13:30 05:00 05:00 00:30 00:30 01:00 02:30 06:45 08:30 07:30 08:00 08:00 09:00 GDP second (%q/q, saar) Personal consumption (%q/q, saar) GDP price index (%q/q, saar) PCE core (%q/q, saar) Fed's Fisher speaks on economy in Mexico city Chicago Fed PMI Fed's Bernanke delivers semi-annual Monetary Policy Report Fed's Plosser speaks on economy in New York Fed's Beige Book Construction orders (%oya) Housing starts (%oya) Building approvals (%m/m) Private capital expenditure(%q/q) PMI mfg. (index, sa) HSBC PMI mfg. (index, sa) GDP (%q/q) PMI mfg. (index, sa) Swedbank PMI survey BSP rate announcement Norway PMI (index,sa) Unemployment rate (%, sa) EU leaders summit Spain PMI mfg (index,sa) German PMI mfg (index,sa, final) France PMI mfg (index,sa,final) Spain to sell bonds HICP flash (%oya) Portugal IP (%m/m) PMI mfg. (index, sa) Personal income (%m/m, sa) Personal spending (%m/m, sa) PCE core (%m/m, sa) PCE deflator (%oya) Initial jobless claims (000s) ISM mfg. index (sa) Construction spending (%m/m, sa) Fed's Lockhart speaks on economy and banking in Atlanta Current account (bn CAD, sa) Jobs to applicants ratio (sa) All household spending (%oya) Unemployment rate (%, sa) Tokyo CPI (%oya) Nationwide CPI (%oya) Nationwide core CPI (%oya) Monetary base (%oya) EU leaders summit Retail sales (%m/m, sa) Italian deficit to GDP report (%) Iran Parliamentary elections PMI Construction index GDP (%m/m, sa) GDP (%q/q, saar) Feb Jan 4Q n.a. n.a. n.a. 51.3 0.3 1.8 (Jan) (Dec) (3Q) 51.4 -0.1 3.5 Jan 2011 n.a. n.a. 0.4 n.a. (Dec) 2010 0.1 4.6 4Q Jan Jan Jan Feb Jan Jan Feb n.a. 0.72 -0.8 4.5 -0.2 -0.2 -0.1 n.a. -9.6 0.72 -0.9 4.5 -0.2 -0.1 -0.2 n.a. (3Q) Dec Dec Dec Jan Dec Dec Jan -12.1 0.71 0.5 4.6 -0.3 -0.2 -0.1 15.0 Feb Jan Feb Jan Jan Jan Jan 25-Feb Feb Jan n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 2.6 n.a. 52.0 0.5 0.4 0.2 2.3 n.a. 54.5 1.0 (Jan) Dec (Jan) (Dec) (Dec) (Dec) (Dec) 18-Feb (Jan) (Dec) 2.7 -1.5 52.1 0.5 0 0.2 2.4 351 54.1 1.5 Feb Feb n.a. n.a. 50.1 50.2 Jan Jan 50.1 50.2 Jan Jan Jan 4Q Feb Feb 4Q Feb Feb Mar Feb Feb n.a. -3.5 1.8 7.0 n.a. n.a. n.a. n.a. n.a. 4.00 n.a. n.a. n.a. -3.3 2.0 3.8 50.8 n.a. -0.1 48.5 n.a. 4.00 n.a. n.a. Dec Dec Dec (3Q) Jan Jan 3Q Jan Jan Jan Jan Jan 1.5 -7.3 -1.0 12.3 50.5 48.8 0.2 47.3 51.4 4.25 54.9 2.8 Feb n.a. 61.8 (Jan) 60.2 4Q 4Q 4Q 4Q n.a. n.a. n.a. n.a. Forecast Consensus 2.8 1.9 0.4 1.1 (4Q) (4Q) (4Q) (4Q) 2.8 2.0 0.4 1.1 Previous
41
Global FX Strategy FX Markets Weekly February 24, 2012 Justin Kariya (1-212) 834-9618 justin.p.kariya@jpmorgan.com JPMorgan Chase Bank NA
Event risk calendar

Month February 2012 Date 25-26 27 27 28 29 29 29 29 March 2012 1 1-2 2 3-4 4 6 6 7 8 8 8 12-13 13 15 15-16 18 20 20 21 21 25 30-31 April 2012 3 4 5 11 15 17 18 18 20-22 22 24-25 Country G20 Australia Euro area Euro area Euro area Euro area Euro area US Euro area Euro area Iran Euro area Russia New Zealand US Brazil New Zealand UK Euro area Euro area US Norway G20 Euro area New Zealand Euro area UK Euro area Hong Kong Euro area Euro area New Zealand Euro area UK South Korea North Korea New Zealand Canada Brazil IMF/World Bank Euro area US Event G20 meeting of Finance Ministers and Central Bank Governors Australian leadership vote Bundestag vote on second Greek Bailout Greek parliament votes on austerity measures Finland parliament votes on second Greek Bailout ECB 3-yr tender results Italy redemption (Eur 46.5BN) Fed's Bernanke delivers semi-annual MPR Expected final draft of the Euro Area 'Fiscal Compact' EU leaders summit Parliamentary election Greece PASOK to hold national conference Presidential election Fonterra dairy auction results Republican primaries 'Super Tuesday' COPOM rate announcement RBNZ Monetary Policy Statement BoE rate announcement ECB rate announcement Eurogroup/Ecofin meeting FOMC rate announcement Norges Bank Monetary Policy Report G20 Sherpas meeting Greek PASOK votes on new leader Fonterra dairy auction results Greece redemption (EUR 14bn) UK budget report Ecofin meeting Hong Kong election for Chief Executive Eurogroup/Ecofin meeting Greece possible parliamentary elections Fonterra dairy auction results ECB rate announcement BoE rate announcement Legislature elections 100th anniversary of the birth of Kim Il-sung Fonterra dairy auction results BoC Monetary Policy Report COPOM rate announcement IMF/World Bank spring meeting in Washington French Presidential election (round 1) FOMC rate announcement (incl. press conference)
42
Event risk calendar

Month May 2012 1 3 4 6 10 10-11 14 15 15 15 16 21 22-23 25 30 June 2012 5 6 7 10 14 17 18 18-19 19 19-20 20 26 28-29 July 2012 1 1 1 3 4 5 11 17 18 27 31 Date Country China Syria New Zealand Euro area Australia Euro area UK G20 Euro area MENA New Zealand G8 UK Euro area OECD Euro area Brazil India New Zealand Euro area UK Euro area New Zealand Euro area Euro area G20 New Zealand US Norway US Euro area Hong Kong Euro area Mexico New Zealand Sweden Euro area Brazil New Zealand Canada UK US India Event China/US Strategic Dialogue (provisional) Parliamentary election (Postponed from February) Fonterra dairy auction results ECB rate announcement RBA Statement on Monetary Policy French Presidential election (round 2) BoE rate announcement G20 Sherpas meeting Eurogroup/Ecofin meeting Arab League Summit (postponed from March) Fonterra dairy auction results G8 summit in Chicago BoE Quarterly Inflation Report Newly elected French President takes office. OECD Forum EU leaders summit COPOM rate announcement Presidential election (indirect) Fonterra dairy auction results ECB rate announcement BoE rate announcement French legislative election (round 1) RBNZ Monetary Policy Statement French legislative election (round 2) Eurogroup/Ecofin meeting G20 Leaders Summit Fonterra dairy auction results FOMC rate announcement (incl. press conference) Norges Bank Monetary Policy Report Final primary in Republican nomination process EU leaders summit New Hong Kong Chief Executive takes office Cyprus assumes EU Council Presidency Presidential/legislative election Fonterra dairy auction results Riksbank Monetary Policy Report ECB rate announcement COPOM rate announcement Fonterra dairy auction results BoC Monetary Policy Report Olympics begin FOMC rate announcement Presidential election
43
Central bank announcement dates in 2012

2012 FEB Australia Brazil Canada Chile Colombia Czech Republic Euro area Hungary India Indonesia Israel Japan Korea Malaysia Mexico New Zealand Norway Philippines Poland South Africa Sweden Switzerland Thailand Turkey United Kingdom United States 21 9 8 16 15 21 27 8 13 18 5 25 2 29 10 9 27 14 9 14 24 2 9 28 7 MAR 6 7 8 15 23 29 8 27 15 8 26 13 8 9 16 8 14 1 7 29 19 4 19 14 13 21 7 20 25 19 5 31 16 2 9 24 4 24 17 30 23 10, 27 13 27 26 10 31 28 23 10 3 30 25 15 8 8 14 20 14 6 26 4 19 4 31 23 12 12 5 20 26 29 13 5 20 6 13 5 18 6 12 17 18 4 24 28 20 8 18 6 11 31 27 9 9 30 24 19 13 6 7 13 31 29 5,30 11 26 25 31 25 3 25 7 22 30 26 20 8 8 30 6 19 13 5 18 13 20 13 31 APR 3 18 17 17 27 25 3 3 29 29 28 6 26 5 24 27 31 2 2 28 28 27 6 25 4 30 26 23 1 8 27 14 19 6 18 MAY 1 30 JUN 5 5 JUL 3 11 17 AUG 7 29 SEP 4 5 OCT 2 10 23 NOV 6 28 DEC 4 4
44
Global FX Strategy FX Markets Weekly February 24, 2012 David Hensley (1-212) 834-5516 david.hensley@jpmorgan.com JPMorgan Chase Bank NA
Global central bank forecasts

Official rate Global excluding US Developed Emerging Latin America EMEA EM EM Asia The Americas United States Canada Brazil Mexico Chile Colombia Peru Europe/Africa Euro area Refi rate United Kingdom Bank rate Czech Republic 2-wk repo Hungary Israel Poland Romania Russia South Africa Turkey Asia/Pacific Australia New Zealand Japan Hong Kong China Korea Indonesia India Malaysia Philippines Thailand Taiwan Cash rate Cash rate O/N call rate Disc. wndw 1-yr working Base rate BI rate Repo rate O/N rate Rev repo 1-day repo Official disc. 2-wk dep Base rate 7-day interv Base rate Repo rate Repo rate Top of IRC Fed funds O/N rate SELIC O/N Repo rate Disc rate Repo rate Reference Current Change since (bp) Peak
1
rate (%pa) 05-07 avg 2.10 2.89 0.58 6.19 7.44 6.17 5.72 1.31 0.125 1.00 10.50 4.50 5.00 5.00 4.25 1.84 1.00 0.50 0.75 7.00 2.50 4.50 5.50 5.25 5.50 12.00 3.53 4.25 2.50 0.05 0.50 6.56 3.25 5.75 8.50 3.00 4.25 3.00 1.875 -223 -145 -278 -87 -369 -2 -13 -408 -430 -269 -490 -342 38 -224 24 -189 -189 -444 -160 -19 -174 -6 -300 N/A -265 N/A -58 -164 -482 -15 -542 48 -85 -412 164 -22 -282 -75 -62.5
Trough 45 62 5 146 132 221 144 26 0 75 175 0 450 200 300 38 0 0 0 175 200 100 0 N/A 0 N/A 55 125 0 0 0 125 125 0 375 100 25 175 62.5
Last change
Next mtg
Forecast next change
Forecast (%pa) Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 2.02 2.78 0.50 6.14 7.22 6.17 5.71 1.28 1.90 2.62 0.41 5.95 6.83 5.84 5.66 1.22 0.125 1.00 9.25 4.50 4.50 5.50 3.75 1.45 0.50 0.50 0.75 7.50 2.25 4.25 5.25 5.25 5.50 10.50 3.48 4.00 2.50 0.05 0.50 6.56 3.25 5.50 8.25 3.00 4.00 3.00 1.875 1.88 2.59 0.41 5.87 6.83 5.54 5.65 1.22 0.125 1.00 9.25 4.50 4.50 5.50 3.75 1.39 0.50 0.50 0.75 6.50 2.25 3.75 5.25 5.25 5.50 9.50 3.48 4.00 2.75 0.05 0.50 6.56 3.25 5.50 8.25 3.00 4.00 2.75 1.875 1.90 2.61 0.41 5.93 6.83 5.52 5.77 1.22 0.125 1.00 9.25 4.50 4.50 5.50 3.75 1.39 0.50 0.50 0.75 6.00 2.25 3.75 5.25 5.25 5.50 9.50 3.54 4.00 3.00 0.05 0.50 6.81 3.25 5.50 8.25 3.00 4.00 2.50 1.875 1.92 2.64 0.42 5.97 6.83 5.67 5.78 1.24 0.125 1.25 9.50 4.50 4.50 5.50 3.75 1.41 0.50 0.50 0.75 6.00 3.00 3.75 5.50 5.50 5.50 9.50 3.56 4.00 3.25 0.05 0.50 6.81 3.25 5.75 8.25 3.00 4.00 2.50 1.875
-292 -235 -363 -179 -627 -261 -123 -470 -513 -350 -925 -525 -325 -500 -225 -319 -325 -525 -300 -400 -300 -200 -475 N/A -650 N/A -129 -300 -575 -47 -625 -91 -200 -700 -50 -50 -325 -200 -175
16 Dec 08 (-87.5bp) 13 Mar 12 8 Sep 10 (+25bp) 18 Jan 12 (-50bp) 17 Jul 09 (-25bp) 12 Jan 12 (-25bp) 30 Jan 12 (+25bp) 12 May 11 (+25bp) 8 Mar 12 7 Mar 12 16 Mar 12 15 Mar 12 8 Mar 12
On hold On hold 7 Mar 12 (-50bp) On hold 15 Mar 12 (-25bp) Apr 12 (-25bp)
0.125 1.00 10.00 4.50 4.75 5.50 4.25 1.67
24 Feb 12 24 Feb 12 (+25bp)
8 Dec 11 (-25bp) 5 Mar 09 (-50bp) 6 May 10 (-25bp) 20 Dec 11 (+50bp) 23 Jan 12 (-25bp) 8 Jun 11 (+25bp) 2 Feb 12 (-25bp) 14 Sep 11 (-25bp) 18 Nov 10 (-50bp) 4 Jan 12
8 Mar 12 8 Mar 12 29 Mar 12 27 Feb 12 7 Mar 12 29 Mar 12 Mar 12 29 Mar 12 21 Feb 12
8 Mar 12 (-25bp) On hold On hold Mar 12 (-25bp) 2Q 12 (-25bp) 29 Mar 12 (-25bp) 1Q 13 (+25bp) On hold May 12
0.75 0.50 0.75 7.50 2.25 4.50 5.25 5.25 5.50 12.00 3.53
28 Feb 12 27 Mar 12 (+50bp)
6 Dec 11 (-25bp) 10 Mar 11 (-50bp) 5 Oct 10 (-5bp) 6 Jul 11 (+25bp) 10 Jun 11 (+25bp) 9 Feb 12 (-25bp) 25 Oct 11 (+25bp) 5 May 11 (+25bp) 19 Jan 12 (-25bp) 25 Jan 12 (-25bp) 30 Jun 11 (+12.5bp)
6 Mar 12 8 Mar 12 13 Mar 12 8 Mar 12 8 Mar 12 15 Mar 12 9 Mar 12 1 Mar 12 21 Mar 12 Mar 12
May 12 (-25bp) 3Q 12 (+25bp) On hold On hold 4Q 12 (+25bp) On hold 2Q 12 (-25bp) 2Q 12 (-25bp) On hold 1 Mar 12 (-25bp) 3Q 12 (-25bp) 3Q 13 (+12.5bp)
4.25 2.50 0.05 0.50 6.56 3.25 5.75 8.50 3.00 4.00 3.00 1.875
17 Dec 08 (-100bp) 14 Mar 12
1 Refers to peak rate between 2007-08 and trough rate from 2009-present Bold denotes move since last GDW and forecast changes. Underline denotes policy meeting during upcoming week. Aggregates are GDP-weighted averages. Source: J.P. Morgan
45
Global FX Strategy FX Markets Weekly February 24, 2012 John Normand (44-20) 7325-5222 Sunil Kavuri (44-20) 7777-1729 J.P. Morgan Securities Ltd
J.P. Morgan FX forecasts vs. forwards & consensus

Exchange rates vs. U.S dollar Current Majors EUR JPY GBP AUD CAD NZD JPM USD index DXY Feb 24 1.34 80.5 1.58 1.07 1.00 0.84 80.6 78.5 Mar 12 1.30 76 1.55 1.06 1.00 0.80 81.3 79.8 Jun 12 1.34 76 1.57 1.08 0.98 0.82 79.6 78.0 Sep 12 1.36 74 1.58 1.10 0.96 0.84 78.8 76.7 Dec 12 1.38 72 1.60 1.08 0.98 0.82 78.6 75.7 JPM forecast gain/loss vs Dec-12* forward rate 4.8% 9.1% 1.2% 3.8% 2.4% 0.5% Consensus** 7.2% 8.3% 2.3% 6.4% 2.7% 2.1% Actual change in local FX vs USD Past 1mo 2.3% -3.4% 1.0% 1.1% 0.5% 2.5% -0.3% -1.3% YTD 3.5% -4.5% 1.8% 4.9% 2.2% 7.7% -2.3% -2.0% Past 12mos -2.8% 1.7% -2.0% 6.2% -1.7% 12.0% 1.0% 1.9%
Europe, Middle East & Africa CHF ILS SEK NOK CZK PLN HUF RUB TRY ZAR Americas ARS BRL CLP COP MXN PEN VEF LACI Asia CNY HKD IDR INR KRW MYR PHP SGD TWD THB ADXY EMCI Exchange rates vs Euro JPY GBP CHF SEK NOK CZK PLN HUF RON TRY RUB 108 0.848 1.20 8.82 7.48 25.01 4.17 289 4.35 2.36 39.17 99 0.840 1.21 8.90 7.70 24.50 4.15 290 4.37 2.28 38.94 102 0.855 1.21 8.95 7.65 24.50 4.12 290 4.40 2.35 39.17 101 0.860 1.20 8.90 7.60 24.50 4.10 285 4.35 2.31 40.03 99 0.865 1.20 8.80 7.55 24.30 4.10 285 4.35 2.28 40.66 4.1% -3.4% 0.2% 1.6% 1.1% 3.2% 5.6% 5.9% 2.5% 8.7% 1.9% 1.0% -4.6% 4.3% 0.6% 0.2% 2.7% 1.6% 3.2% -0.8% 0.1% -1.8% 0.90 3.77 6.58 5.58 18.65 3.11 215 29.21 1.76 7.60 4.36 1.71 479 1772 13.02 2.68 4.29 112.2 6.30 7.75 9048 48.9 1126 3.01 42.76 1.26 29.58 30.37 117.4 99.7 0.93 3.75 6.85 5.92 18.85 3.19 223 29.96 1.75 7.40 4.50 1.75 530 1950 12.80 2.75 4.30 108.8 6.45 7.86 9400 55.0 1210 3.40 45.50 1.32 30.75 33.00 116.5 96.6 0.90 3.70 6.68 5.71 18.28 3.07 216 29.23 1.75 7.60 4.60 1.77 510 2000 13.20 2.80 4.30 107.3 6.35 7.84 9200 53.0 1150 3.30 44.50 1.30 30.00 32.00 119.6 97.5 0.88 3.65 6.54 5.59 18.01 3.01 210 29.43 1.70 7.70 4.80 1.78 490 1950 12.80 2.75 4.30 108.5 6.30 7.88 9250 52.0 1100 3.10 43.00 1.27 30.50 31.75 121.0 99.1 0.87 3.65 6.38 5.47 17.61 2.97 207 29.46 1.65 7.70 4.90 1.80 480 1900 12.00 2.72 4.30 110.8 6.10 7.80 9480 50.00 1040 3.10 42.30 1.26 29.90 31.00 121.0 101.18 3.2% -0.6% -1.0% 3.7% 9.9% -0.6% 1.9% -0.1% -2.1% 0.7% 0.4% -0.3% -7.0% -2.6% 3.8% -3.4% -1.0% -2.5% -2.1% -2.5% 5.0% 3.8% 6.4% 6.0% 8.1% 10.7% 11.0% 6.8% 13.9% 5.5% 2.9% 1.0% 4.2% -3.8% 9.7% -0.3% -0.1% 11.9% 3.3% 7.9% 7.5% 10.1% 9.0% 10.6% 5.3% 7.3% 1.0% 1.0% -2.2% 3.9% -1.4% 6.5% 0.4% 11.7% 2.6% -0.1% 2.5% 4.8% 3.3% 4.4% 5.0% 5.2% 2.4% 3.8% -0.4% 3.0% 2.9% 2.3% 1.5% 0.4% 0.0% 1.9% 0.1% 0.1% -1.8% 2.4% 0.0% 2.2% 0.9% 0.5% 1.2% 3.3% 0.4% 2.6% 4.4% 1.1% 4.7% 7.1% 5.9% 10.8% 12.8% 10.0% 7.2% 6.4% -1.3% 9.1% 8.5% 9.4% 8.6% 0.6% 0.0% 7.4% 0.0% 0.2% 0.2% 8.4% 2.4% 5.2% 2.5% 3.3% 2.4% 3.9% 2.0% 6.8% 3.1% -3.0% -2.9% 0.7% -4.7% -7.3% -8.0% -0.7% -9.1% -7.3% -7.5% -2.7% 0.0% 7.2% -5.3% 3.9% 0.0% -2.8% 4.5% 0.5% -1.9% -7.1% 0.5% 1.7% 2.5% 1.7% 0.7% 0.9% 1.3% -3.6%
Actual change in local FX vs EUR -5.6% -1.3% 0.2% 0.2% 2.4% 0.9% 2.1% 2.6% -0.2% 0.1% 1.7% -7.7% -1.7% 1.0% 1.1% 3.4% 2.3% 7.1% 9.0% -0.6% 3.6% 6.5% 4.7% 0.9% 6.1% -0.1% 3.6% -2.0% -4.6% -5.3% -2.8% -6.4% 2.1%
indicates rev ision resulting in stronger local FX , indicates rev ision resulting in w eaker local FX * Negativ e indicates JPM more bullish on USD than consensus,** Consensus Economics Publication: Foreign Exchange Consensus Forecasts Feb 2012 Source: J.P.Morgan 46
J.P. Morgan forecasts: rates, credit, equities & commodities

Interest rates
United States Euro area United Kingdom Japan GBI-EM hedged in $ Current Fed funds rate 10-y ear y ields Refi rate 10-y ear y ields Repo rate 10-y ear y ields Ov ernight call rate 10-y ear y ields Yield - Global Div ersified 0.125 1.98 1.00 1.89 0.50 2.08 0.05 0.97 6.26 Current 201 280 636 856 365 403 Index JPMorgan JULI Porfolio Spread to Treasury iBox x Euro Corporate Index JPMorgan Global High Yield Index STW iBox x Euro HY Index EMBI Global JPM EM Corporates (CEMBI) Quarterly Averages Mar-12 0.125 2.25 0.75 2.15 0.50 2.25 0.05 0.90 Jun-12 0.125 2.50 0.50 2.00 0.50 2.10 0.05 0.95 Sep-12 0.125 2.50 0.50 1.95 0.50 2.00 0.05 1.10 Dec-12 0.125 2.50 0.50 1.90 0.50 2.00 0.05 1.15 6.50 0.1% 2.2% YTD Return 2.4% 2.9% 4.5% 9.5% 4.1% 4.8% -1.6% -0.2% -0.4% YTD Return
Credit Markets
US high grade (bp ov er UST) Euro high grade (bp ov er Euro gov ) USD high y ield (bp v s. UST) Euro high y ield (bp ov er Euro gov ) EMBIG (bp v s. UST) EM Corporates (bp v s. UST)
Commodities
Brent ($/bbl) Gold ($/oz) Copper ($/metric ton) Corn ($/Bu)
Current 124 1778 8395 6.38
12Q1 105 1725 8000 6.70
12Q2 110 1825 8500 7.00
12Q3 115 1900 8875 6.80
12Q4 120 1925 9000 6.30
GSCI Index Energy Precious Metals Industrial Metals Agriculture 3m
YTD Return 11.0% 13.8% 10.1% 0.0% YTD Retur in USD 2.9% -4.0% 1.3% 10.2% 0.6% 2.5% 8.8%
Foreign Exchange
EUR/USD USD/JPY GBP/USD USD/BRL USD/CNY USD/KRW USD/TRY
YTD Return
Current 1.34 80.8 1.59 1.71 6.30 1126 1.77
Mar-12 1.30 76 1.55 1.75 6.45 1210 1.75
Jun-12 1.34 76 1.57 1.77 6.35 1150 1.75

US YTD 8.6% 12.4% 10.7% 10.0% 1.2% 3.8% 13.4% 14.4% 0.6% -2.9% 9.1%
Sep-12 1.36 74 1.58 1.78 6.30 1100 1.70
Dec-12 1.38 72 1.60 1.80 6.10 1040 1.65

Europe YTD 5.3% 14.8% 11.6% 16.4% 2.3% 2.1% 15.7% 12.0% -2.1% 1.1% 8.3%
cash EUR JPY GBP BRL CNY KRW TRY
Japan
YTD 11.5% 15.5% 14.8% 22.0% 5.5% 4.8% 27.9% 10.9% 0.0% 10.0% 14.5%
EM
YTD ($) 19.6% 19.1% 20.1% 11.9% 8.1% 12.5% 18.4% 16.2% 5.7% 13.8% 15.8%
Equities
S&P Nasdaq Topix FTSE 100 MSCI Eurozone* MSCI Europe* MSCI EM $* Brazil Bov espa Hang Seng Shanghai SE
Current 1368 2967 834 5936 144 1108 1059 66249 21407 2440
(local ccy) 9.1% 13.6% 14.5% 7.1% 9.7% 8.3% 15.8% 16.7% 15.2% 13.4%
Sector Allocation *
Energy Materials Industrials Discretionary Staples Healthcare Financials Information Tech. Telecommunications Utilities Overall
*Lev els/returns as of Feb 23, 2012 Local currency ex cept MSCI EM $
Source: Bloomberg, Datastream, IBES, Standard & Poor's Services, J.P. Morgan estimates 47
Global FX Strategy FX Markets Weekly February 24, 2012 David Hensley (1-212) 834-5516 Carlton Strong (1-212) 834-5612 JPMorgan Chase Bank NA
Global growth and inflation forecasts

Real GDP
% over a year ago
Real GDP
% over previous period, saar
Consumer prices
% over a year ago
2011 The Americas United States Canada Latin America Argentina Brazil Chile Colombia Ecuador Mexico Peru Venezuela Asia/Pacific Japan Australia New Zealand Asia ex Japan China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Africa/Middle East Israel South Africa Europe Euro area Germany France Italy Norway Sweden United Kingdom Emerging Europe Bulgaria Czech Republic Hungary Poland Romania Russia Turkey Global Developed markets Emerging markets Memo: Global PPP weighted 1.7 2.3 4.3 9.2 2.8 6.3 5.8 8.0 3.9 6.7 4.2 -0.9 1.9 1.7 7.1 9.2 5.0 7.0 6.5 3.6 5.1 3.7 4.9 4.0 1.0 4.8 3.1 1.5 3.1 1.7 0.4 2.7 4.7 0.9 4.7 1.7 1.7 1.7 4.3 2.5 4.3 8.2 2.6 1.3 5.8 3.5
2012 2.3 2.2 3.6 4.5 3.1 4.5 4.5 4.0 3.3 5.0 4.0
2013 2.2 2.5 4.0 4.0 4.5 4.8 5.0 4.0 3.5 7.0 1.0 1.3 3.2 2.9 7.2 9.1 4.2 8.0 5.4 4.0 3.2 4.8 3.7 5.1 3.5 4.4 3.6

3Q11 1.8 3.5 3.1 4.5 -0.2 2.6 7.1 7.1 5.1 6.5 6.7 7.0 3.9 3.2 6.3 8.4 0.4 7.5 5.9 3.3 6.1 3.4 2.0 -0.8 2.1 3.8 1.4 0.2 2.3 1.3 -0.7 3.1 6.6 2.3 3.5 -0.3 1.6 4.1 7.4 3.5

4Q11 2.8 1.7 2.3 6.5 1.5 3.0 3.7 1.0 1.7 3.0 3.5 -2.3 1.8 2.9 5.4 9.2 1.2 5.5 9.9 1.4 4.8 3.5 -2.5 -1.0 -25.0
1Q12 2.0 2.1 2.9 0.0 2.6 5.0 4.2 2.0 2.5 4.0 6.0 1.8 2.8 1.0 7.0 7.2 2.5 7.7 5.0 3.0 5.0 4.3 4.9 3.3 35.0 0.8 2.3 0.0 1.0 0.0 -2.0 0.0 -0.5 1.0 2.0 0.0 -0.3 2.0 -1.2 3.0 2.2 1.2 5.0 3.2
2Q12 2.5 2.6 5.5 5.5 5.7 5.0 4.5 3.5 5.5 5.0 6.0
3Q12 3.0 2.3 3.9 6.5 5.5 6.0 3.5 4.0 0.6 6.5 4.0 1.2 3.5 2.4 7.4 9.5 5.5 7.7 5.0 4.5 2.0 5.7 2.0 5.8 2.0 6.1 2.8 -0.3 1.0 0.0 -1.5 1.0 0.5 2.5 2.5 2.0 1.0 2.5 0.8 3.0 2.7 1.6 5.6 3.7
4Q12 2.0 2.4 3.5 5.0 5.7 6.0 3.0 4.0 1.0 7.6 -3.0 1.2 3.7 1.8 7.7 10.0 6.0 8.0 5.0 5.0 2.5 4.9 1.2 6.5 0.5 7.4 3.2 0.3 1.0 0.0 -1.0 1.0 1.0 1.5 3.7 2.0 1.5 3.0 2.4 4.5 2.6 1.3 5.9 3.7
1Q13 1.5 2.7 4.4 3.0 4.5 4.5 5.5 4.0 5.0 8.0 0.0 1.2 3.3 1.0 7.3 9.1 3.0 8.3 5.5 4.0 4.0 4.5 4.5 4.5 5.0 4.5 3.8 0.5 1.5 0.5 -0.5 2.0 2.0 2.0 3.3 1.5 1.5 3.0 2.5 4.0 2.5 1.3 5.8 3.7
4Q11 3.3 2.8 7.2 9.5 6.7 4.0 3.9 5.5 3.5 4.5 28.5 -0.3 3.8 2.9 5.0 4.6 5.7 9.0 4.1 4.0 3.2 4.7 5.5 1.4 3.5 2.5 6.1 2.9 2.6 2.6 3.7 0.9 2.5 4.6 6.3 2.4 4.1 4.6 3.4 6.8 9.0 3.6 2.8 5.8 4.1
2Q12 1.9 1.7 6.8 10.0 5.1 3.6 3.6 5.3 4.2 4.1 29.1 -0.5 3.2 2.2 3.9 3.0 4.5 8.5 3.6 3.4 1.5 3.9 4.3 1.3 2.8 2.3 6.0 2.0 1.7 2.1 2.9 0.9 1.2 2.5 4.9 2.7 5.3 3.3 3.3 4.4 8.1 2.6 1.7 4.8 3.1
4Q12 1.5 1.7 6.8 11.0 5.1 3.4 3.3 4.7 4.0 2.8 30.3 -0.5 3.3 2.5 3.8 3.1 3.6 7.8 4.0 3.5 1.3 4.0 3.2 1.7 1.4 2.5 6.2 1.8 1.6 1.6 3.2 1.4 1.1 2.0 5.4 2.9 5.4 3.3 4.4 6.3 6.2 2.4 1.4 4.9 3.0
2Q13 1.4 2.0 7.3 11.0 5.3 3.2 3.0 4.7 3.8 2.9 36.5 -0.4 3.0 2.7 4.1 3.9 3.2 7.6 4.0 3.5 1.4 4.0 3.0 1.2 1.4 2.1 5.9 1.6 1.4 1.2 2.8 1.7 1.5 1.8 5.9 2.5 3.5 2.9 4.0 6.8 7.9 2.4 1.3 5.2 3.1
1.2 3.1 2.5 6.5 8.4 3.0 7.3 5.2 3.3 3.9 4.3 2.3 2.9 5.2 2.9 2.7 -0.4 0.7 0.1 -1.8 1.4 1.1 0.6 2.6 1.5 0.5 0.5 2.7 0.8 3.5 2.5 2.2 1.1 4.9 3.1
1.0 2.9 4.4 6.8 7.8 4.0 7.2 4.5 4.0 2.0 4.9 6.6 4.8 15.0 3.2 2.6 -1.5 0.0 -1.0 -2.5 0.0 -0.5 -1.0 1.2 0.8 0.3 2.0 -1.5 1.5 2.0 0.7 5.5 3.0
3.2 3.9 -1.1 -0.7 0.9 -2.9 2.5 1.0 -0.8 4.7 -1.2 1.2 3.5 -0.8 7.0

0.3 1.3 0.3 -0.7 1.8 1.7 1.9 3.5 2.5 1.7 1.5 3.0 2.7 3.7 4.5 2.6 1.5 5.6 3.6
2.9 2.2 4.9 3.6
1.6 0.5 4.5 2.5
Source: J.P. Morgan estimates. Note: For some emerging economies, 2010-2012 quarterly forecasts are not available and/or seasonally adjusted GDP data are estimated by J.P. Morgan. Bold denotes changes from last edition of Global Data Watch, with arrows showing the direction of changes. Underline indicates beginning of J.P. Morgan forecasts.
48
Global FX Strategy FX Markets Weekly February 24, 2012 Sunil Kavuri (44-20) 7777-1729 sunil.d.kavuri@jpmorgan.com J.P. Morgan Securities Ltd
Sovereign credit ratings and actions

Rating View United States Canada Germany France Austria Netherlands Sweden Norway Switzerland Australia Singapore United Kingdom Finland Denmark New Zealand Belgium Spain Japan China Italy Czech Republic Korea Poland Ireland South Africa Russia Mexico Portugal Hungary Brazil India Iceland Latvia Turkey Ukraine Argentina Greece AA+ AAA AAA AA AA AAA AAA AAA AAA AAA AAA AAA AAA AAA AA AA A AAAABBB+ AAA ABBB+ BBB+ BBB BBB BB BB+ BBBBBBBBBBB+ BB B+ B CC (-) (-) (+) (+) (-) (-) (+) (-) (-) (-) (-) (-) (-) (-) (-) (-) (-) (-) Rating View Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aaa Aa3 A3 Aa3 Aa3 A3 A1 A1 A2 Ba1 A3 Baa1 Baa1 Ba3 Ba2 Baa2 Baa3 Baa3 Baa3 Ba2 B2 B3 Ca (-) (-) (+) (+) (-) (-) (-) (+) (-) (+) (-) (-) (-) (-) (-) (-) Rating View AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AAA AA+ AA A AAA+ AA+ A+ ABBB+ BBB+ BBB BBB BB+ BB+ BBB BBBBBB+ BBBBB+ B B CCC (-) (+) (-) (-) (+) (-) (-) (-) (-) (-) (-) (-)* (-) Action Affirmed, O/L to negative (-) ? Affirmed, O/L stable Affirmed, O/L changed to stable Downgrade, O/L changed to (-) ? Downgrade, O/L negative (-) Affirmed, O/L changed to (-) ? Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L changed to (-) ? Affirmed, O/L stable Downgrade, O/L changed to stable Affirmed, O/L changed to (-) ? Downgrade, O/L changed to (-) ? Affirmed, O/L changed to (-) ? Upgrade, O/L stable Downgrade, O/L changed to (-) ? O/L stable Affirmed, O/L stable O/L changed to stable ? Affirmed, O/L changed to (-) ? Affirmed, O/L stable O/L changed to stable ? Downgrade, O/L changed to stable ? Downgrade, O/L changed to (-) ? Downgrade, O/L negative (-) Affirmed, O/L changed to positive ? O/L changed to stable ? O/L changed to (-) ? O/L changed to positive ? Affirmed, O/L changed to (+) ? Affirmed, O/L stable Affirmed, O/L stable Downgrade, O/L (-) Date 5-Aug-11 18-May-07 13-Jan-12 13-Jan-12 13-Jan-12 13-Jan-12 22-Jan-07 28-May-09 1-Dec-03 6-Sep-10 1-May-08 29-Mar-10 13-Jan-12 NA 29-Sep-11 13-Jan-12 13-Jan-12 26-Apr-11 16-Dec-10 13-Jan-12 24-Aug-11 12-Jan-10 27-Oct-08 13-Jan-12 25-Jan-11 21-Dec-09 14-Dec-09 13-Jan-12 21-Dec-11 25-Aug-11 18-Mar-10 13-Apr-11 9-Mar-11 20-Sep-11 13-Sep-11 13-Sep-10 27-Jul-11 Action Affirmed, O/L (-) Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L ? (-) Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Upgrade, O/L stable Affirmed, O/L ? (-) Affirmed, O/L stable Affirmed, O/L stable Upgrade, O/L stable Downgrade, O/L negative Downgrade, O/L ? (-) Downgrade, O/L stable Upgrade, O/L positive ? Downgrade, O/L negative (-) O/L changed to stable ? Upgrade, O/L stable Affirmed, O/L stable Downgrade, O/L negative Upgrade, O/L changed to stable ? O/L changed to stable ? Affirmed, O/L stable Downgrade, O/L ? (-) Downgrade, O/L negative Upgrade, O/L (+) Affirmed, O/L stable O/L changed to (-) ? O/L changed to positive ? O/L changed to (+) ? O/L changed to negative O/L changed to stable ? Downgrade, O/L to negative (-) ? Date 2-Aug-11 24-May-06 24-May-06 13-Feb-12 24-May-06 15-Nov-03 15-Nov-03 15-Nov-03 15-Nov-03 24-May-06 14-Jun-02 13-Feb-12 NA NA 21-Oct-02 16-Dec-11 13-Feb-12 24-Aug-11 11-Nov-10 13-Feb-12 8-Dec-08 14-Apr-10 24-May-06 12-Jul-11 16-Jul-09 12-Dec-08 24-May-06 13-Feb-12 11-Nov-11 20-Jun-11 20-Dec-11 6-Apr-10 6-Jun-11 5-Oct-10 15-Dec-11 14-Aug-08 1-Jun-11 Action O/L changed to (-) ? Affirmed, O/L stable Affirmed, O/L stable Creditwatch negative Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable O/L changed to (-) ? Downgrade, O/L changed to (-)? Downgrade, O/L changed to (-) ? Affirmed, O/L changed to (-) ? Upgrade, O/L stable Downgrade, O/L changed to (-)? Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L stable Affirmed, O/L changed to (-)? O/L changed to (-) ? Affirmed, O/L changed to stable Downgrade, O/L changed to stable ? Downgrade, O/L (-) Downgrade, O/L negative Upgrade, O/L stable Affirmed, O/L stable Downgrade, O/L changed to stable Affirmed, O/L stable Upgrade, O/L changed to (+)? Affirmed, O/L changed to stable Upgrade, O/L stable Downgrade, O/L negative
Source: Ratings agencies Note that ratings refer to foreign currency denominated long term debt for EM countries and domestic currency denominated long term debt for others; * indicates ratings on review/credit watch/rating watch (+/-)
S&P ratings vs fiscal balance as % of GDP in 2011

GR
S&P ratings vs gross government debt as % of GDP in 2011

C
GR
C CCC
AR PO IN RU SA PD BE TU IC BZ MX IT
CCC+
AR
BBHU
BBBBB A+ AAA
6%
RU
TU IN MX SA PD SK NZ BZ HU IR
PO IC IT
IR SP JP US NZ
BBB
SK
CH IC
A+ AAA SZ
SW
CH
FR CA AU GE
UK
SP BE FR NO US AU SW IC GE UK CA SZ
-14%
-9%
-4%
1%
0%
40%
80%
120%
160%
200%
Source: J.P.Morgan, OECD, S&P *JPM forecast for 2011 used for EM and OECD forecast used for DM
Source: J.P.Morgan, OECD, S&P *JPM forecast for 2011 used for EM and OECD forecast used for DM
49
Redemptions for -denominated marketable debt, 2012-2013

Euro area
bn
Govt Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Total 2012 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Total 2013 0 21 0 0 23 0 0 0 0 0 0 43 0 0 30 0 0 0 0 18 6 0 0 0 54 UK Banks 6 14 12 9 6 6 4 6 8 5 7 82 9 1 5 2 10 4 4 5 4 7 3 5 59 Govt 157 103 105 133 99 101 152 97 98 147 99 1291 102 153 103 124 149 100 92 126 64 63 121 67 1263 US Banks 36 30 50 23 73 22 14 28 25 22 13 338 21 22 19 25 32 13 7 14 12 15 12 6 199 Japan 0 18 0 0 28 0 0 18 0 0 27 91 0 0 8 0 0 8 0 0 8 0 0 8 34 Canada 0 8 0 0 28 0 0 18 0 0 20 74 0 0 20 0 0 29 0 11 10 0 0 5 75 Australia 1 0 15 1 1 0 1 0 1 10 1 30 0 1 0 1 18 1 0 1 0 1 0 10 34 NZ 0 0 1 0 0 0 0 0 1 0 0 2 0 0 0 11 0 0 0 0 0 0 0 0 13 Cyprus Govt Banks 0 0 0 0 0 0 0 0 0 2 0 3 0 0 0 0 0 2 1 0 0 0 0 0 2 0 0 0 0 0 0 0 1 0 0 0 1 0 0 0 0 0 0 0 0 0 0 0 0 0 Switzerland Govt Banks 0 0 0 0 9 0 0 0 0 0 0 9 0 7 0 0 0 0 0 0 0 0 0 0 7 3 4 2 1 4 5 1 3 0 1 1 23 12 1 1 3 4 5 2 8 5 1 3 1 46 Hungary Govt Banks 229 0 0 0 526 0 0 0 514 67 22 1358 0 831 150 0 0 54 0 25 0 793 72 150 2076 19 21 0 123 0 0 27 0 0 0 0 191 0 3 0 0 0 0 21 0 0 0 0 34 58
Note: Marketable debt includes conventional bonds plus inflation linkers, floaters and zero coupon bonds for non-conventional bonds Source: J.P. Morgan
50
Other countries
Spain Italy Greece Portugal Ireland Core* Periphery** Bonds T-Bills Banks Bonds T-Bills Banks Bonds T-Bills Banks Bonds T-Bills Banks Bonds T-Bills Banks Bonds T-Bills Banks Bonds T-Bills Banks Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Total 2012 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Total 2013 1 0 12 0 0 13 0 0 20 0 0 46 14 0 0 15 0 0 15 0 0 16 0 0 60 3 0 2 0 0 0 0 0 0 0 0 5 0 3 0 1 0 0 0 0 0 0 0 0 4 21 14 15 10 22 7 3 7 4 10 4 117 11 7 9 10 3 8 9 1 6 14 7 2 87 36 27 28 0 0 17 12 10 18 13 30 191 0 21 0 29 0 17 14 25 7 0 18 20 151 10 14 12 0 0 0 0 0 0 0 0 36 0 0 0 0 0 0 0 0 0 0 0 0 0 5 6 2 6 3 0 2 3 5 3 9 44 3 11 6 7 1 1 1 2 4 3 4 3 46 0 14 0 9 0 0 8 0 0 0 2 33 0 6 0 0 17 0 0 6 0 0 0 2 31 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 2 0 0 1 1 1 2 1 1 0 9 1 1 0 1 2 0 1 0 0 0 0 1 7 0 0 0 0 10 0 0 0 0 0 0 10 0 0 0 0 0 0 0 0 10 0 0 0 10 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 0 1 2 2 0 0 0 0 0 8 0 2 0 0 2 0 0 0 0 1 0 0 5 0 6 0 0 0 0 0 0 0 0 0 6 0 0 0 6 0 0 0 0 0 0 0 0 6 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 3 0 2 0 0 0 1 3 0 13 1 2 1 3 1 0 2 0 1 0 0 1 13 0 23 34 0 19 70 0 42 35 0 30 253 61 0 31 52 0 17 77 0 47 40 0 0 325 32 31 23 16 13 8 8 11 0 0 0 142 0 0 0 0 0 0 0 0 0 0 0 0 0 29 24 19 10 18 24 8 19 22 8 7 189 39 24 34 12 11 15 16 7 8 18 4 10 199 37 47 40 9 10 30 20 10 38 13 32 286 14 27 0 50 17 17 29 31 17 16 18 22 258 13 14 14 0 0 0 0 0 0 0 0 41 0 3 0 1 0 0 0 0 0 0 0 0 4 29 25 21 17 30 10 5 12 11 17 13 192 16 22 16 22 9 10 13 3 11 17 11 7 158
* Germany, France, Netherlands, Belgium ** Spain, Italy, Greece, Portugal, Ireland
Note: Maturities in all currencies and jurisdictions and include secured, unsecured and securitised issuance, including MTNs but excluding short-term (maturity of less than one year) and selffunded deals (deals where there is only one bookrunner and it is also the issuer). The data also include any government guaranteed issuance by the banks but no direct issuance by government or government sponsored institutions. Source: J.P. Morgan, Dealogic, Bloomberg
51
Global FX Strategy FX Markets Weekly February 24, 2012 John Normand (44-20) 7325-5222 john.normand@jpmorgan.com J.P. Morgan Securities Ltd
Prior Research Notes available on www.morganmarkets.com

Building Europes firewalls: a progress report, Barr & Mai, Feb 3, 2012 Asian FX and Japanese corporate earnings KRW/JPY is key, Tanase, Feb 1, 2012 Metals Review and Outlook, Jan 2012: Demand needs a Spark, Jansen & Fu, Jan 30, 2012 Portuguese second package unlikely to include PSI, Mai, Jan 27, 2012 Corporate hedging survey: Despite Euro stress, FX management practices mostly unchanged, Kariya, Kavuri, Hibino, Jan 20, 2012 Central bank balance sheet chartpack, Meggyesi, Jan 19, 2012 Commodity Currencies: Risks loom large for Q1 of 2012, especially for the AUD, Hebner, Sandilya, Kariya, Jan 10, 2012 M&A and FX in 2012: Japan/Europe rotation worth monitoring, Normand, Jan 9, 2012 JPY:New FSA regulations on overlay funds could narrow retail path to BRL, Tanase & Hibino, Jan 4, 2012 Answers to 10 common questions on EMU breakup, Normand & Sandilya, Dec 7, 2011 Euro area moves toward a not so grand bargain, Mackie, Barr, Dec 2, 2011 Italy heads toward the IMF, Mai, Barr, Nov 11, 2011 How much can FX intervention lift corporate profits?, Normand, Oct 31, 2011 Asymmetrical correlation between yen and stocks with a bias to stronger yen, Tanase, Hibino, Oct 25, 2011 Corporate hedging survey: EUR/USD will fall to 1.30 by year-end, Kariya, Kavuri, Hibino, Oct 21, 2011 Gold and silver: risk factors dominate, Jansen, Oct 7, 2011 Reserve diversification without the yen has limited value, Normand, Sep 30, 2011 Enhancements to J.P. Morgans Long-term Fair Value Model, Kariya, OConnor, Sep 29, 2011 JPY: Japanese are already pulling out of Brazil, South Africa and Australia, and Korea remains a concern, Sasaki, Tanase & Hibino, Sep 22, 2011 Tail-risk hedging: does volatility trading compensate for FX-risk decoupling?, Bouquet, Sep 20, 2011
52
Slouching towards some kind of fiscal union, Mackie, Sep 13, 2011 Euro area: breaking up is hard to do, Barr & Mackie, Sep 1, 2011 German politics and the euro, Fuzesi, Aug 19, 2011 CHF currency peg reviewing the lessons from 1978, Meggyesi, Aug 16, 2011 Will Japanese retail investors unwind EM investments? Nikkei and BRL/JPY is key, Tanase, Hibino, Aug 9, 2011 USD/JPY reaches target five months early: New target set at 73, Sasaki, Tanase & Hibino, Jul 29, 1011 Does new rule on margin leverage trigger unwinding of JPY shorts?, Tanase, Hibino, Jul 22, 2011 G-3 corporate hedging survey: Weak labor market is by far the greatest risk for growth in 2011, Kariya, Kavuri, Tanase Jun 24, 2011 Long-term valuation: USD is cheap but not a bargain, Kariya, Apr 15, 2011 USD/JPY to peak soon, Tanase & Hibino, Apr 8, 2011 Rebalancing VXY and Introducing VXY Global, Normand & Sandilya, Mar 25, 2011 Earthquake-driven Japanese JPY purchases our best estimate is 10trn, Sasaki, Tanase and Hibino, Mar 23, 2011 G-7 coordinated interventiona much-needed breather, Sasaki, Tanase & Hibino, Mar 18, 2011 The earthquake and its implication on JPY, Sasaki, Tanase & Hibino, Mar 18, 2011 Japanese BRL investments: sharp unwinding is unlikely, but remain wary for FX overlay funds, Tanase, Mar 18, 2011 G-3 corporate hedging survey, Kariya, Mar 18, 2011 Performance of tail-risk hedges year-to-date, Bouquet, Mar 4, 2011 Yield differentials and oil: What they really mean for USD/JPY, Sasaki, Tanase & Hibino, Feb 25, 2011 Japanese fiscal year-end drags on USD/JPY, Tanase & Hibino, Feb 18, 2011 Legacy of weak-yen bubble still weighs on USD/JPY, Sasaki, Tanase & Hibino, Feb 11, 2011 Significant Japanese retail money will be seeking next destinations, Tanase & Hibino, Jan 28, 2011
53
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55
J.P. Morgan Global FX Strategy

London
John Normand Paul Meggyesi Thomas Anthonj Matthias Bouquet Sunil Kavuri MD MD ED VP Associate Head, Global FX Strategy FX Strategy Technical Strategy Derivatives Strategy FX Strategy (44-20) 7325-5222 (44-20) 7859-6714 (44-20) 7742-7850 (44-20) 7777-5276 (44-20) 7777-1729 john.normand@jpmorgan.com paul.meggyesi@jpmorgan.com thomas.e.anthonj@jpmorgan.com matthias.bouquet@jpmorgan.com sunil.d.kavuri@jpmorgan.com
New York
Ken Landon Kevin Hebner Niall OConnor Arindam Sandilya Justin Kariya MD ED ED ED Associate FX Strategy FX Strategy Technical Strategy Derivatives Strategy FX Strategy (1-212) 834-2391 (1-212) 834-4254 (1-212) 834-5108 (1-212) 834-2304 (1-212)-834-9618 kenneth.landon@jpmorgan.com kevin.j.hebner@jpmorgan.com niall.oconnor@jpmorgan.com arindam.x.sandilya@jpmorgan.com justin.p.kariya@jpmorgan.com
Tokyo
Tohru Sasaki Junya Tanase Anna Hibino MD ED Associate FX Strategy FX Strategy FX Strategy (81-3) 6736-7717 (81-3) 6736-7718 (81-3) 6736-7729 tohru.sasaki@jpmorgan.com junya.tanase@jpmorgan.com anna.hibino@jpmorgan.com
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Global FX Strategy

February 24, 2012

J.P. Morgan Securities Ltd.

Outlook: Exit Greece, enter Iran

Chart 2: Currency performance YTD: oil exporters near the top

Source: J.P. Morgan

For once, less Europe

Source: J.P. Morgan

unfortunately, more Iran

105 103 NOK trade-weighted 101 99 97 95 93 91 89 1 2 3 4 5 6 7 8 9 10 11 12 months since start of shock

Commodity FX hedges stress, not a shock

Trades: take part profits on oil currencies

1.2 0.8 0.4 -0.0 -0.4 -0.8 -1.2 Feb 10

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Macro Trade Recommendations

S&P500, 1month change

10% 0% -10% -20% -30% -40%

Brent oil, 1month change

y = 30.835x 2 - 4.9889x - 0.2121 R = 0.2956

Brent oil, 1month change

Table 1.Current FX spot recommendations and P&L

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

Stop loss 1.1400 1.3160 6.7700 9.3500 5.7100 1.5650 0.8310

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

I. Performance statistics 2008 2012

7 86% 0.9% 36 5 60% -0.2% 65 1 100% 34.3% 73

42 60% 0.0% 24 27 74% 0.9% 71 10 50% -0.9% 87

89 53% 0.0% 23 27 62% 0.3% 54

61 64% 1.0% 20 21 62% 0.5% 59

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

284 59% 0.8% 25 83 64% 0.5% 62 41 39% -2.9% 64

4 21 25% 38% -6.7% -4.7% 60 55

2 33% -0.2 62 3 67% 48 72 NA NA NA NA 2 0% -1.3% 71

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

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

32 63% 0.1 73 46 57% 0.1% 10

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

129 66% 0.3 71 23 70% 13.3 37 3 33% 8% 33 220 48% 0.1% 23

*P&L in vol points

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

2008-12 avg 2012 2011 2010 2009 2008 0% 1% 2% 3%

2008-12 avg 2012 2011 2010 2009 2008 -1% -1% 0% 1% 1% 2%

2008-12 avg 2012 2011 2010 2009 2008 -1.00 0.00

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

2008-12 avg 2012 2011 2010 2009 2008 0% 50% 100%

2008-12 avg 2012 2011 2010 2009 2008 0% 100%

2008-12 avg 2012 2011 2010 2009 2008 0% 50% 100%

2008-12 avg 2012 2011 2010 2009 2008 0% 50% 100%

II. Closed trades 2012 Cash portfolio

FX Derivatives portfolio (vol relative value plus directional)

FX Derivatives portfolio (vol relative value)

Short GBP v s USD Long USD v s SEK

Global FX carry trade monitor

Chart 2: Japanese retail -- aggregate retail margin shorts in JPY

Source: J.P. Morgan, Bloomberg

Source: J.P. Morgan, TFE;

Japanese retail exposure to the top 100 foreign currency ITs

Japanese aggregate margin JPY shorts of 3.2trn declined

Chart 3: Japanese retail -- margin position in JPY vs USD, EUR, AUD

Chart 4: CTAs -- aggregate IMM position in USD

110 105 100 95 90 85 80 75

Source: J.P. Morgan, TFE

Source: J.P. Morgan, CME