CENTRAL BANKS, EUR & GEOPOLITICS Camilla Sutton l Chief Currency Strategist (416) l camilla.sutton@scotiabank.com

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1 DIAL IN: (local to Toronto) PASSCODE: # CONFERENCE CALL COMMANDS Press 1 Skip backward 5 seconds Press 3 Skip forward 5 Press 4 Skip backward 5 minutes Press 6 Skip forward 5 minutes Press 5 Pause the playback CENTRAL BANKS, EUR & GEOPOLITICS Camilla Sutton l Chief Currency Strategist (416) l camilla.sutton@scotiabank.com February 23, 2012

2 SCOTIABANK S FORECAST FX USD is volatile but drifts slowly lower REAL GDP A softened growth profile f 2013f f 2013f USDCAD US CADUSD Canada AUDUSD Mexico EURUSD Euro Zone (0.5) 0.9 GBPUSD UK USDJPY Japan 1.0 (0.4) USDCNY China INFLATION Expected to remain contained INTEREST RATES Remain accomodative US Q411 Q412 Q413 Canada FED BoC COMMODITIES Yearly averages ECB Oil BoE Gold 1,569 1,750 1,650 BoJ RBA

3 SCOTIABANK S FORECAST USDCAD Q412 FORECAST: Scotia: 0.98 Mean & median forecast of 1.00 Suggest USDCAD will need significant catalyst to shift away from parity. EURUSD Q412 FORECAST: Scotia: 1.25 Mean and median of 1.30 Distribution of forecast suggest binary risk of collapse and recovery. 2

4 SCOTIABANK S FORECAST VERSUS CONSENSUS HIGH AND LOW GBPUSD Scotia s forecast more aggressive USDJPY Scotia expects slow grind higher High forecast High forecast Scotia sforecast Scotia s forecast Low forecast Low forecast Q211 Q311 Q411 Q112 Q212 Q312 Q412 Q211 Q311 Q411 Q112 Q212 Q312 Q412 EURCHF Scotia s forecast close to mean AUDUSD Scotia s forecast more aggressive 1.30 High forecast 1.10 High forecast 1.03 Scotia s forecast Scotia s forecast Low forecast Low forecast Q211 Q411 Q212 Q412 Q111 Q411 Q212 Q412 3

5 FX THEMES HIGH BETA, LONG RISK OUTPERFORMS Early 2012 themes: 1. Shifting global growth outlook 2. Central bank fueled risk rally 3. Low volatility & carry trades 4. EUR, EUR, EUR 5. What are we missing oil 6. Sovereign positions 7. Risk aversion waiting for recurring spikes 4

6 GLOBAL GROWTH OUTLOOK HAS CHANGED US 2012 GDP FORECAST 1 STABILIZES & BEGINS TO IMPROVE CHINA S 2012 GDP FORECAST 1 FALLS BUT ONLY SOFT LANDING EURZONE 2012 GDP FORECAST 1 FALLS INTO RECESSION GERMAN 2012 GDP FORECAST 1 FALLS FROM 2% TO 0.2% 1. Forecast is consensus estimate provided by Bloomberg 5

7 WHO WINS ON GROWTH STORY FROM HERE Growth outlook and impact on FX Advanced economies differentials are not that large Positive for some EM (MXN) Positive to neutral for CAD and USD Neutral GBP Negative EUR Short term indicators to watch PMIs 6

8 RELATIVE CENTRAL BANK POLICY Attitude towards QE as well as direction and level of rates matters. Positive for AUD (level & direction), CAD (direction), NZD (level and direction) Negative for USD (QE, level & direction), JPY (QE, level & direction) Mixed for EUR (negative on level, positive on QE) Watch for a shift in tone the Fed a number to a few the BoE, data suggest an end to QE 7

9 PRICING OF RISK, VOLATILITY & CARRY VIX COLLAPSES IS THIS AN ACCURATE PRICING OF RISK? FX VOL COLLAPSES IS THIS AN ACCURATE PRICING OF RISK? G7 currency vol JPM VIX (S&P vol) Pricing of risk shifts dramatically lower Equity and currency volatility measures fall back to summer lows. Suggests market is complacent with near term risk. Suggests market believes that government and or central banks will step in. 8

10 POLICIES FUEL CARRY TRADE THE CARRY TRADE COMES BACK Short USD, EUR & JPY vs Long AUD, NOK & NZD AUD CLIMBS BACK TO ITS HIGHS 100 Dec Jan Feb 98 Carry trade fueled by current central bank policy Low volatility, yield differentials & high liquidity lay foundation for strong carry environment. Fueling of risk trade. Negative for USD, EUR & JPY Positive for high yielding AUD, NOK & NZD and emerging market FX. 9

11 TEMPORARILY BOUTS OF RISK AVERSION Risk aversion impacts markets materially Expect bouts of risk aversion to recur throughout the year. Driven by Europe, Iran, uncertainty Risk aversion tends to be temporary (lasting a few months) and interrupts a trend violently. Negative for risk sensitive CAD, AUD, SEK and MXN. Neutral for lower beta GBP. Positive for USD and JPY. 10

12 OIL PRICES & GEOPOLITICAL RISK RISING Four sides of higher oil prices: 1. Negative for growth sensitive FX (CAD, AUD) OECD estimates that for every $10 increase in oil prices growth falls by 0.2pct points. 2. Negative for risk sensitive FX, if geopolitically induced, (CAD, AUD, SEK) 3. Positive for FX associated with inflation fighting central banks (EUR) OECD estimates that for every $10 increase in oil prices inflation increases by 0.2pct points. 4. Positive for FX of oil exporters (CAD, NOK) 11

13 SOVEREIGN POSITION MATTERS Triple A rated not enough need developed bond market and liquidity. Diversification of $10trn in global FX reserves. Positive for GBP, CAD, AUD, SEK and SGD on rating. Positive for USD and JPY on size of bond market. Negative for EUR, NZD and CHF on lack of bond market, weak rating. 12

14 FLOW AND SENTIMENT CFTC Market is bullish USD, but aggregate position shields changing sentiment. EUR bearish and extreme GBP bearish, but low beta nature has positioning relatively stable CAD increasingly bullish AUD largest net long JPY longs capitulating after BoJ decision 13

15 EURUSD THE GOOD EUR trends lower in 2012, closing at 1.25 but does not collapse as: USD cannot sustainably strengthen with weak fundamental backdrop. High oil prices poses inflation risk and shifts ability of ECB to cut interest rates. ECB not moving towards QE; using LTRO has been positive. Germany has value whether you believe in EMU or not. EUR is a major reserve currency. 14

16 EURUSD THE BAD EUR BECOMES CARRY FUNDING VEHICLE O/N RATES SENTIMENT IS BEARISH EUR BUT VULNERABLE Australia Sweden EURO US EUR trends lower in 2012, closing at 1.25 but does not collapse as: EUR becomes funding vehicle for carry. Sentiment is bearish and vulnerable average EUR short added at Lack of political will to move towards closer fiscal ties; but few other choices. Austerity weighs heavily on growth prospects. Repeated spikes in risk aversion as confusion reigns for Europe. 15

17 EURUSD AND THE UGLY EUR NOWHERE NEAR ITS LOWS Recent changes in Europe (Greek deal not really a win ); medium term negative: ECB swap two tier European bond market EFSF barely an investible vehicle PSI & CAC potential to trigger CDS default No overnight solution this is a long term and difficult road. Economic contagion Bank of Canada estimates that Europe = 0.6 pct pts in Cdn GDP from trade, funding pressures, confidence & credit availability and 1.0 pct pt on world GDP and 0.8 for US. 16

18 USD TRADES IN BLOCKS IS THE BROAD TREND IN THE USD STILL DOWN? Source: Scotia FX Strategy & Bloomberg USD: a more mixed environment USD cannot strengthen sustainably against all the currencies. Expect a shift to a more block based FX movement (Asian block, NAFTA block, EUR.). Positive for growth and fiscally responsible EM & CAD, AUD, GBP. Negative for EUR. 17

19 USDCAD DRIVERS & OUTLOOK USDCAD Drivers I. Broad USD movements II. Global growth outlook III. Europe IV. Domestic fundamentals V. Sovereign positions VI. Interest rate spreads VII. Oil & commodities VIII. Flow & sentiment IX. Risk aversion X. Technicals USDCAD PARITY IS A FAVOURED PLACE Outlook CAD maintains its appreciating trend USDCAD closes 2012 at 0.98 (stronger CAD than the end of 2011) USDCAD closes 2013 at 0.96 (stronger CAD than the end of 2012) 18

20 OUTLOOK RISKS 1) Geopolitical risk Iran. 2) Escalation of European crisis. 3) Further downside pressure on global or US growth. 4) A hard landing in Asia. 5) Black swan cannot forecast. 19

21 SCOTIA S GLOBAL FORECAST AND OUTLOOK FX Outlook f 2013f USDCAD CADUSD EURUSD GBPUSD AUDUSD USDJPY MEDIUM TERM OUTLOOK INTO YEAR END 2012 Bullish CAD: Benefits from risk on and loose global monetary policy, weak USD, relatively strong Canadian economic and sovereign fundamentals; risk is global growth outlook. Bearish EUR: Confusion, uncertainty, no political will for solution, funding side of carry all weigh on EUR; but each leg lower is followed by period of retracement. USD cannot weaken sustainably forever. Neutral JPY: Benefitting JPY are spikes in risk aversion and alternatives to USD; but fundamentals, sentiment and monetary policy no longer support a strong currency. Bullish GBP: Increasingly seen as an alternative to USD and EUR; medium term problems still a weight. Bullish CNY: Authorities allow measured pace of appreciation. Bullish AUD: Supported by ties to Asia, carry trade, interest rates, investor sentiment & USD weakness. 20

22 SCOTIA FX RESEARCH SUMMARY Written Research Provided by FX Strategy Daily FX Update Published at 7:45am (EST) Daily LatAM Update Published at 7:45am (EST) Daily Asian Update Published at 9:30pm (EST) Currency Sentiment CFTC Report Published Fridays Special Reports Active trade strategies; intraday market moving events; monetary policy, etc. Written Research Provided Jointly with Scotia Economics Global Views Weekly update across asset classes FX Monthly Review of global currencies and forecasts Monthly Conference Call Twenty minute update on FX strategy with emphasis on USDCAD outlook and forecast FX Strategy Camilla Sutton, CFA Chief Currency Strategist (416) Eric Theoret Currency Strategist (416) Sacha Tihanyi Asia Senior Currency Strategist Eduardo Suarez LatAM Senior Currency Strategist 21

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