146317645 JP Morgan Global Research June 2013

7/27/2019 146317645 JP Morgan Global Research June 2013

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Global Asset Allocation05 June 2013

Global Markets Outlook and Strategy

Global Asset Allocation

Jan LoeysAC

(1-212) 834-5874

[email protected]

JPMorgan Chase Bank NA

Bruce KasmanAC

(1-212) 834-5515

[email protected]

JPMorgan Chase Bank NA

John NormandAC

(44-20) 7134-1816

[email protected]

J.P. Morgan Securities plc

Nikolaos PanigirtzoglouAC

(44-20) 7134-7815

[email protected]


Seamus Mac GorainAC

(44-20) 7134-7761

[email protected]


Matthew LehmannAC

(44-20) 7134-7813

[email protected]


Leo EvansAC

(44-20) 7742-2537

[email protected]


See page 42 for analyst certification and important disclosures.

The EconomyWorld growth forecast stays at 2.3% for 2013, but we have trimmed EMby 0.2%. Global monetary policy remains easy with no overall rate hikesand G4 QE continuing at an unchanged pace through 2014. But Septembernow has almost an even chance with December for start of Fed tapering.

Asset allocationMarkets are in correction mode after Fed talk of an earlier end to QE. Wesee little change in the easy-money regime, and thus keep earning riskpremia. But we now do this largely in equities, as risk premia in fixedincome are too sensitive to a risk scenario of a change in the easy-money

regime and a move away from the search for yield. UW EM asset classesvs DM on a reduced search for yield and downgrades to EM growth.

Cross asset volatilityImplied volatilities spiked across most asset classes. We see opportunitiesin selling volatilities on certain assets, i.e. US HY CDS, Turkish equitiesand Gold in a protected manner. We continue to believe that Nikkeivolatility has higher potential to rise relative to USDJPY volatility.

Fixed incomeWe stay flat duration in DM, but cover our long duration in EM and moveslightly short. We stay long the Euro periphery through Italy.

CreditWe greatly reduce credit overweights, as we believe the search for yieldwill not come back with the same force. Sell EM credit vs US in HG.

EquitiesBuy Euro area against EM as the Euro economy shows signs of bottomingwhile EM growth keeps being cut. Stay OW Japan as we remain believersin long-term reflation in Japan. We cover OW in defensives given itssensitivity to the search for yield.

CurrenciesKeep a short-term focus, given high vol, and sell currencies vulnerable tofurther delevering: IDR and AUD into USD. Buy CHF vs USD and EUR.

CommoditiesStay overall underweight given no yield and falling EM growthexpectations. We are OW energy vs. base and precious metals as webelieve the downside from here is more limited in oil markets. Preciousmetals should continue to suffer given the disinflationary trend and marketfocus on the eventual end of QE.

Contents

Global Economic Outlook Summary 2Economic Outlook 3Central Bank Policy Rate Watch 5Market Forecasts 6Global Market Strategy 7

FX StrategyJ.P. Morgan FX Forecasts vs. Forwards

& Consensus 2Fixed Income Strategy 2Credit Strategy 2Equity Strategy 2Commodity Strategy 3Volatility Strategy 3ETF-only portfolio 4

See page 43 for analyst certification and important disclosures, including non-US analyst disclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm mayhave a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making theirinvestment decision. In the United States, this information is available only to persons who have received the proper option risk disclosure documentsPlease contact your J.P. Morgan representative or visithttp://www.optionsclearing.com/publications/risks/riskstoc.pdf.
http://www.optionsclearing.com/publications/risks/riskstoc.pdfhttp://www.optionsclearing.com/publications/risks/riskstoc.pdfhttp://www.optionsclearing.com/publications/risks/riskstoc.pdfhttp://www.optionsclearing.com/publications/risks/riskstoc.pdfhttp://www.optionsclearing.com/publications/risks/riskstoc.pdf


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05 June 2013

Bruce Kasman (1-212) 834-5515David Hensley (1-212) 834-5516Joseph Lupton (1-212) 834-5735

Global Economic Outlook Summary

Note: For some emerging economies, 2012-2014 quarterly forecasts are not available and/or seasonally adjusted GDP data are estimated by J.P. Morgan.Bold denotes changes from last edition ofGlobal Markets Outlook and Strategy, with arrows showing the direction of changes. Underline indicates beginningof J.P. Morgan forecasts.Source: J.P. Morgan

2012 2013 2014 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 4Q12 2Q13 4Q13 2Q14

The Americas

United States . 1.9 2.4 . 2.4 2.0 . . 2.3 . . . . .ana a . . . . . . . . . . . . . .

Latin America . 2.9 3.7 3.5 2.0 3.8 4.0 3.2 3.7 . . . 4.7 .Argentina . . . . . . . . . . . . . .

Brazil . 2.5 3.5 2.6 2.2 3.0 3.6 3.2 3.8 . . 6.6 6.0 .Chile . 5.2 . 7.9 2.1 . . . 4.2 . . . . .Colombia . . . . . . . . . . . . . .

Ecuador . . . 4.0 . . . . . . . . . .Mex ico . . 3.9 2.7 1.8 . . . . . . . . .Peru . . . . 6.3 . . . . . . . . .Venezuela . 0.0 . 4.2 -7.1 1.0 2.5 2.5 . . . 30.0 35.8 .

Asia/Pacific

Japan . 1.7 . 1.0 3.5 . . . . - . - . . . .Australia . 2.2 2.8 2.3 2.2 . 1.3 1.8 2.4 . . 2.4 2.3 .New Zealand . . . . . . - . . . . . . . .

Asia ex Japan 6.3 6.3 6.6 7.5 4.9 6.3 6.5 6.6 6.7 6.5 3.4 3.5 3.8 4.0China . 7.6 7.7 . . 7.4 7.8 7.8 7.8 . . . 3.1 .Hong Kong 1.5 3.3 . 5.7 0.8 3.0 . . . . . . . .India . . . 5.5 5.1 . . . . . . . . .Indonesia . 5.6 5.4 6.7 5.4 5.0 5.2 . . . . 6.1 6.9 .Korea . . 3.6 . . 2.4 . 4.0 . . . 1.2 1.8 .Malaysia . 5.1 5.3 7.0 0.7 4.3 4.8 5.0 5.5 . . 1.6 1.7 .Philippines 6.8 7.2 5.8 8.0 8.9 5.3 6.1 6.1 5.7 . . 2.7 3.1 .Singapore . 2.7 3.7 . 1.8 7.0 5.3 . . . . 1.0 1.5 .Taiw an . 2.5 . 7.1 -2.7 2.8 4.2 4.8 . . . 0.8 1.3 .Thailand 6.5 4.1 . 11.7 -8.4 8.0 1.5 3.5 . . . 2.2 1.0 .

Africa/Middle East

Israel 3.2 3.1 3.3 2.6 2.8 2.8 3.6 3.6 3.2 3.6 1.6 1.9 2.2 1.9South Africa . 2.3 . . 0.9 . 3.1 3.3 3.3 . . . 5.6 .EuropeEuro area - . -0.7 . - . -0.8 - . . . . . . 1.4 1.2 .

Germany . 0.2 . -2.7 0.3 . . . . . . 1.6 1.7 .France . -0.5 . -0.8 -0.7 - . . . . . . 0.9 0.8 .Italy - . -1.8 . - . -2.1 - . . . . . . 1.3 1.3 .Spain - . . . - . -2.1 - . - . . . . . . . .

United Kingdom . . . - . 1.3 . . . . . . 2.7 2.6 .Emerging Europe . . 3.2 0.8 1.0 2.7 3.8 . 3.0 . . 5.5 . .Bulgaria . . .

Czech Republic -1.2 -0.9 1.8 -1.4 -4.3 2.0 1.5 1.9 1.9 1.9 2.8 1.7 1.9 1.5Hungary - . 0.5 1.5 -1.6 2.8 1.0 1.5 1.5 . . . 2.1 2.1 .Poland 1.9 1.0 2.5 0.0 0.4 1.6 2.3 2.5 2.5 2.5 2.9 0.6 1.3 1.8Romania . 2.6 . . . . .Russia . . 3.4 1.4 1.6 3.3 4.5 . . . . 7.0 5.6 .Turkey . . . . . . .

Global 2.4 2.3 3.0 1.7 2.2 2.7 2.9 3.1 3.3 2.7 2.5 2.3 2.3 2.6Dev eloped markets . 1.0 . -0.4 1.4 1.3 1.5 . 2.2 . . 1.3 1.3 .Emerging markets . 4.7 5.2 5.5 3.6 5.1 5.4 5.2 5.4 . . . 4.1 .

% over a year agoConsumer prices

% over previous period, saarReal GDPReal GDP

% over a year ago


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Economic Outlook

May activity readings expected to show base for liftbeing built.

US growth not likely to be threatened by rate

normalization ...

but vulnerabilities are present for EM countries

with high inflation.

Euro shows tentative sign of a move toward exiting

recession in 2H13; further improvements needed.

The road less traveled

If we are right, this year will be different from last year andglobal growth will rise to a trend-like pace in the second

half. This years buoyancy in equity and credit markets

which reflects the interaction of easy money with reduced

macroeconomic uncertaintyprovides a key support for

this view. But activity indicators remain lackluster, and

judging by the path of industrial activity and our global

GDP nowcaster, we are still tracking last years pathwitha strong start followed by an early spring downshift.

We believe that we are at the fork in the road where the

global economy will turn onto the path less traveled in

recent years. Rather than watch the spring downshift

magnify and produce a growth scare, we think activityindicators will move into midyear in a way that forms the

base for a forecasted second-half lift. Three components ofthis view can be tracked through upcoming data releases.

The global consumer lifts. In each of the past two years,

global retail sales volume growth dipped into midyear,

reinforcing downward momentum in industry and

business sentiment. By contrast, global spending gains

have been accelerating this year, posting an annualized

3% gain in the three months through April. We expect

spending growth to lift further in the coming months,

even as the US consumer rebuilds savings depressed by

the imposition of tax hikes. A decline in global inflation isboosting purchasing power, and developed market

consumer confidence rose in May to its highest level in

over two years. Global auto sales readings for May are

supporting this view, suggesting sales are on track for a

solid current quarter gain.

Steady US labor markets. Government and business

spending are the weak components of final demand.

Fiscal drags are concentrated in the US and Western

Europe while soft business spending is broad-based.

Figure 1: J.P. Morgan Global GDP nowcast and equity prices%q/q, saar %q/q

Source: J. P. Morgan, MSCI

We expect these drags to fade but not until later this

year. In the meantime business sentiment needs to

remain stable. The behavior of US corporates is ofparticular importance, and we look for supporting news

on Friday with May employment expected to rise at a

solid pace (180,000).

Global manufacturing gets leaner. Last years dip in

consumer spending and business sector pullback turned a

spring downshift in industry into a swoon where global

output contracted sharply. Our forecast anticipates

continued sluggish manufacturing output growth.

However, this growth will reflect a pace of inventory

accumulation lagging behind final sales, laying the

groundwork for a stronger second half. This weeks

global May PMI delivered a message consistent with thisview as the output reading edged up while theorders/inventory ratio moved more notably higher.

Dont taper your enthusiasm

The marked shift in the distribution of macroeconomic risks

is central to our forecast that global growth will return to

trend before year-end. Although the economy has been

stuck in a prolonged rut, the threats posed by a Europe

sovereign debt crisis, a drop off the US fiscal cliff, and EM

overheating have all fallen by the wayside. A reflationary

regime shift in monetary policy has also materially

improved the risk distribution on Japanese growth. These

changes were expected to be felt first through risingbusiness sentiment and the more effective transmission of

easy money to global financial markets. Only gradually

were they anticipated to combine with fading drags

notably from fiscal tightening in the US and Europetofuel a return to trend-like global growth.

The grinding lift in growth seen in the data to date aligns with

our forecast, but the interaction of reduced tail risks and easy

money has gained considerably more traction in global

financial markets than had been expected. In addition, global

-12

-6

0

6

1218

1

2

3

4

56

04 06 08 10 12 14

Global GDP nowcast

Equity price

(local FX)

Trend growth


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05 June 2013


inflation has fallen sharply, a development that has opened

the door for additional easing by EM central banks. Firming

growth expectations have, however, raised concerns relatedto the Federal Reserve, which Chairman Bernanke reinforced

recently by acknowledging that QE tapering could begin in

the next few meetings. We believe that tapering is most

likely to begin in December and will take place gradually

over the course of a few meetings. However, the window for

considering action will open in September, when the Fed can

assess 3Q labor market conditions. If employment gains are

averaging close to 200,000 at this juncture, the Fed will

probably act. This is not our call as we expect some softening

through the summer months before seeing a return to stronger

payroll gains.

The Feds new policy framework significantly reduces theodds of a US financial market disruption (see US: will the

Fed tapering lead to a repeat of the 1999 sell-off? GDW,

May 17, 2013). Notably, the decision to taper asset

purchases is being telegraphed as the beginning of the end

of easing that comes in response to an improved economic

picture. It is not designed to signal an earlier start to

tightening, for which the Fed has laid out thresholds to

guide expectations. As it communicates its views on the

exit, the Fed can credibly argue that the decision to taper

does not alter its views on when economic thresholds will

be met.

While we believe the Fed can effectively signal its policyintent to maintain low interest rates, the response of

financial markets to tapering will also depend on global

developments. If tapering were accompanied by a broader

turn in global policy its potential to generate turbulence

would be magnified. However, outside of Brazil and

Indonesia, no other large central bank is forecast to tighten

policy this year. Indeed, there is more easing in the pipeline.

In part, this reflects the relative outperformance of the US

economyit is the only major economy to grow close to

trend over the past year. In addition, inflation has fallen

sharply and now stands below central bank targets across

most of the globe.

A more interesting question relates to the potential relative

swings in global capital flows alongside shifting growth

expectations. A long period of extremely accommodative

US monetary policy has generated sizable capital inflows

and asset price appreciation in commodity-producing

nations and those EM countries that were relatively

unscathed by the financial crisis. While these economies are

not threatened by domestic policy tightening, they now face

the prospect of Fed tapering as economic performance

continues to disappoint.

Figure 2: New orders/finished goods inventory manufacturing PMIRatio

Source: J. P. Morgan, Markit

Flash PMIs hint at widening gap

The overall message from the May manufacturing PMIs is

that downward momentum in manufacturing may be fading.The output reading is stable at a level consistent with 2.5%

growth in global IP. Meanwhile, a significant rise in the

orders reading and fall in inventories reversed worrisome

movements last month. If reports elsewhere send a

consistent message, it would support our view that growth

is primed to pick up next quarter. However, the PMIs also

point to further EM underperformance. Chinas May Markit

manufacturing PMI disappointed, falling below the 50-

threshold for the first time since November last year. In the

details, the new orders component has now fallen

considerably over two months. Since the last GMOS, we

have revised down our China GDP forecast for the current

quarter and the year, and the May PMI supports the view

that growth is poised to remain below 8%.

By contrast, the flash PMIs delivered upside surprises in

both the US and the Euro area. The Euro area all-industry

output PMI rose 0.8pt in May, double the increase in April.

In particular, the periphery continues to gain ground and

narrow the gap with Germany. Our forecast that the Euro

area economy will exit recession this year is based on three

factors, including diminished fiscal headwinds, easier

financial conditions, and a stronger export backdrop. The

publication of the stability and growth programs shows that

fiscal targets have been watered down in light of weaker-than-expected growth outcomes. While governments are

maintaining previous commitments to structural tightening,

they are being permitted to run wider cyclical deficits as the

automatic stabilizers ramp up. With that said, the peak rate

of structural adjustment is past and this years moderation

looks to be a little greater than expected, easing from 1.7%-

pts of GDP in 2012 to 0.9%-pt this year.

0.90

0.95

1.00

1.05

1.10

1.15

1.20

2011 2012 2013 2014

Emerging

Developed


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05 June 2013

David Hensley (1-212) 834-5516Michael Mulhall (1-212) 834-9123

Central Bank Policy Rate Watch

Official Current Forecast

rate rate (%pa) 05-07 avg Trough1

Jul 11 next change Jun 13 Sep 13 Dec 13 Mar 14 Jun 14

Global 2.13 -224 30 -61 2.13 2.14 2.14 2.17 2.20

excluding US 2.79 -153 31 -69 2.78 2.80 2.79 2.84 2.88

Developed 0.41 -308 0 -40 0.41 0.41 0.40 0.39 0.39

Emerging 5.35 -168 47 -91 5.35 5.39 5.39 5.51 5.60

Latin America 6.30 -447 42 -273 6.30 6.86 6.89 6.95 6.95

EMEA EM 4.41 -205 46 9 4.28 3.98 3.96 4.04 4.04

EM Asia 5.35 -45 87 -67 5.39 5.36 5.36 5.51 5.66

The Americas 1.48 -384 32 -55 1.48 1.60 1.61 1.62 1.62

United States Fed funds 0.125 -438 0 0 16 Dec 08 (-87.5bp) 19 Jun 13 On hold 0.125 0.125 0.125 0.125 0.125

Canada O/N rate 1.00 -273 75 0 8 Sep 10 (+25bp) 17 Jul 13 3Q 14 (+25bp) 1.00 1.00 1.00 1.00 1.00Brazil SELIC O/N 8.00 -725 75 -450 29 May 13 (+50bp) 10 Jul 13 10 Jul 13 (+50bp) 8.00 9.00 9.00 9.00 9.00

Mexico Repo rate 4.00 -387 0 -45 8 Mar 13 (-50bp) 7 Jun 13 On hold 4.00 4.00 4.00 4.00 4.00

Chile Disc rate 5.00 31 450 -25 12 Jan 12 (-25bp) 13 Jun 13 On hold 5.00 5.00 5.00 5.00 5.00

Colombia Repo rate 3.25 -406 25 -125 22 Mar 13 (-50bp) 28 Jun 13 Nov 13 (+25bp) 3.25 3.25 3.75 4.50 4.50

Peru Reference 4.25 19 300 0 12 May 11 (+25bp) 13 Jun 13 On hold 4.25 4.25 4.25 4.25 4.25

Uruguay Reference 9.25 200 300 125 28 Dec 12 (+25bp) 27 Jun 13 3Q 14 (-25bp) 9.25 9.25 9.25 9.25 9.25

Europe/Africa 1.35 -251 0 -60 1.32 1.26 1.25 1.27 1.27

Euro area Refi rate 0.50 -248 0 -100 2 May 13 (-25bp) 6 Jun 13 On hold 0.50 0.50 0.50 0.50 0.50

United Kingdom Bank rate 0.50 -444 0 0 5 Mar 09 (-50bp) 6 Jun 13 On hold 0.50 0.50 0.50 0.50 0.50

Czech Republic 2-wk repo 0.05 -235 0 -70 1 Nov 12 (-20bp) 27 Jun 13 On hold 0.05 0.05 0.05 0.05 0.05

Hungary 2-wk dep 4.50 -263 0 -150 28 May 13 (-25bp) 25 Jun 13 25 Jun 13 (-25bp) 4.25 3.50 3.25 3.25 3.25

Israel Base rate 1.25 -300 75 -200 27 May 13 (-25bp) 24 Jun 13 On hold 1.25 1.25 1.25 1.25 1.25

Poland 7-day interv 2.75 -177 0 -175 5 Jun 13 (-25bp) 3 Jul 13 3 Jul 13 (-25bp) 2.75 2.50 2.50 2.50 2.50

Romania Base rate 5.25 -294 0 -100 29 Mar 12 (-25bp) 1 Jul 13 1 Jul 13 (-25bp) 5.25 4.50 4.25 4.00 4.00

Russia Repo rate 5.50 N/A N/A N/A 13 Sep 12 (+25bp) Jun 13 Jun 13 (-25bp) 5.25 4.75 4.75 4.75 4.75

South Africa Repo rate 5.00 -329 0 -50 19 Jul 12 (-50bp) 18 Jul 13 4Q 14 (+50bp) 5.00 5.00 5.00 5.00 5.00

Turkey 1-wk repo 4.57 N/A N/A N/A N/A 18 Jun 13 N/A 4.50 4.50 4.50 5.00 5.00

Asia/Pacific 3.59 -8 69 -54 3.60 3.59 3.57 3.64 3.74

Australia Cash rate 2.75 -319 0 -200 7 May 13 (-25bp) 2 Jul 13 Nov 13 (-25bp) 2.75 2.75 2.50 2.25 2.25

New Zealand Cash rate 2.50 -488 0 0 10 Mar 11 (-50bp) 13 Jun 13 Sep 13 (+25bp) 2.50 2.75 2.75 3.00 3.00

Japan O/N call rate 0.05 -17 0 -2 5 Oct 10 (-5bp) 11 Jun 13 On hold 0.05 0.05 0.05 0.05 0.05

Hong Kong Disc. wndw 0.50 -548 0 0 17 Dec 08 (-100bp) 20 Jun 13 On hold 0.50 0.50 0.50 0.50 0.50

China 1-yr working 6.00 -14 69 -56 7 Jul 12 (-31bp) - 1Q 14 (+25bp) 6.00 6.00 6.00 6.25 6.50

Korea Base rate 2.50 -165 50 -75 9 May 13 (-25bp) 13 Jun 13 4Q 14 (+25bp) 2.50 2.50 2.50 2.50 2.50

Indonesia BI rate 5.75 -412 0 -100 9 Feb 12 (-25bp) 13 Jun 13 13 Jun 13 (+25bp) 6.00 6.00 6.00 6.00 6.00

India Repo rate 7.25 38 250 -75 3 May 13 (-25bp) 17 Jun 13 3Q 13 (-25bp) 7.25 7.00 7.00 7.00 7.00

Malaysia O/N rate 3.00 -24 100 0 5 May 11 (+25bp) 11 Jul 13 On hold 3.00 3.00 3.00 3.00 3.00

Philippines Rev repo 3.50 -356 0 -100 25 Oct 12 (-25bp) 13 Jun 13 On hold 3.50 3.50 3.50 3.50 3.50

Thailand 1-day repo 2.50 -133 125 -75 29 May 13 (-25bp) 10 Jul 13 On hold 2.50 2.50 2.50 2.50 2.50

Taiwan Official disc. 1.875 -71 63 0 30 Jun 11 (+12.5bp) 2Q 13 1Q 14 (+12.5bp) 1.875 1.875 1.875 2.00 2.125

Refers to trough end-quarter rate from 2009-present Effective rate adjusted on daily basis Source: J.P. Morgan

Bold denotes move since last GMOS and forecast changes. Aggregates are GDP-weighted averages.

Change since (bp)Next meetingLast change

Forecast (%pa)


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05 June 2013

Leo Evans(44-20) [email protected]

Market Forecasts

Source: J. P. Morgan

Interest rates Current Jun-13 Sep-13 Dec-13 Mar-14 YTD Return*

United States Fed funds rate 0.125 0.125 0.125 0.125 0.125

10-year yields 2.09 2.00 2.25 2.40 2.50 -1.2%

Euro area Refi rate 0.50 0.50 0.50 0.50 0.50

10-year yields 1.51 1.45 1.60 1.75 1.90 -0.8%

United Kingdom Repo rate 0.50 0.50 0.50 0.50 0.50

10-year yields 2.01 2.05 2.15 2.30 2.50 -1.1%

Japan Overnight call rate 0.05 0.05 0.05 0.05 0.05

10-year yields 0.86 0.50 0.50 0.60 0.70 0.6%

GBI-EM hedged in $ Yield - Global Diversified 5.77 5.62 -0.3%

Credit Markets Current Index YTD Return*

US high grade (bp over UST) 160 JPMorgan JULI Porfolio Spread to Treasury -0.5%

Euro high grade (bp over Euro gov) 138 iBoxx Euro Corporate Index 1.5%

USD high yield (bp vs. UST) 497 JPMorgan Global High Yield Index STW 3.9%Euro high yield (bp over Euro gov) 633 iBoxx Euro HY Index 3.6%

EMBIG (bp vs. UST) 321 EMBI Global -3.8%

EM Corporates (bp vs. UST) 347 JPM EM Corporates (CEMBI) -1.0%

Quarterly Averages

Commodities Current 13Q2 13Q3 13Q4 14Q1 GSCI Index YTD Return*

Brent ($/bbl) 103 104 113 117 117 Energy -2.8%

Gold ($/oz) 1403 1450 1600 1700 1700 Precious Metals -16.9%

Copper ($/metric ton) 7423 7300 7700 7900 7600 Industrial Metals -7.7%

Corn ($/Bu) 5.42 6.50 6.00 5.75 Agriculture -3.8%

3m YTD Return*

Foreign Exchange Current Jun-13 Sep-13 Dec-13 Mar-14 Cash CCY vs. USDEUR/USD 1.31 1.30 1.30 1.30 1.32 EUR -0.8%

USD/JPY 99.2 100 102 105 106 JPY -13.6%

GBP/USD 1.54 1.51 1.49 1.49 1.52 GBP -5.7%

AUD/USD 0.95 0.99 0.99 1.00 1.01 AUD -5.7%

USD/BRL 2.13 2.05 2.02 2.05 2.05 BRL -2.4%

USD/CNY 6.1 6.19 6.17 6.15 6.15 CNY 2.1%

USD/KRW 1116 1090 1070 1040 1030 KRW -3.8%

USD/TRY 1.9 1.8 1.82 1.85 1.85 TRY -2.9%

YTD Return US Europe Japan EMEquities Current (local ccy) Sector Performance * YTD YTD YTD YTD ($)

S&P 1631 15.4% Energy 12.3% 5.9% 2.5% -9.8%

Nasdaq 3406 13.8% Materials 7.9% -1.5% 24.8% -18.0%

Topix 1125 32.1% Industrials 15.2% 12.2% 25.2% -3.9%

FTSE 100 6559 13.2% Discretionary 18.9% 13.3% 41.4% -1.2%

MSCI Eurozone* 161 8.8% Staples 16.7% 14.2% 36.9% 1.0%

MSCI Europe* 1251 11.7% Healthcare 21.0% 20.1% 26.7% 4.5%

MSCI EM $* 1004 -3.7% Financials 20.6% 14.8% 35.0% -0.8%

Brazil Bovespa 52871 -13.1% Information Tech. 10.4% 11.0% 26.3% 4.0%

Hang Seng 22069 -1.4% Telecommunications 9.7% 10.4% 46.0% -5.1%

Shanghai SE 2271 -2.1% Utilities 8.7% 6.6% 47.4% -2.4%

*Levels/returns as of Jun 04, 2013 Overall 15.4% 11.7% 32.1% -3.7%

Local currency except MSCI EM $


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05 June 2013

Jan Loeys(1-212) [email protected]

Global Market Strategy

Markets are in correction mode after Fed talk of anearlier end to QE.

We are not fully following this correction in risk

assets as we see no change in the fundamentals of low

macro vol and cant time how long the correction

will last.

However, credit is showing bad convexity tomonetary policy changes given how much of its

earlier gains have been tied to the search for yield.

We are thus staying net long equities and reduce our

OW credit to a small position, underweighting EM

in credit.

Market volatility and cross asset correlations rose overthe past two weeks as speculation around an early end toFed QE led to a broader correction across world bond andequity markets. Search-for-yield and carry assets got hurtmost. This scenario was not part of our strategy and ourmodel portfolio thus gave back all the gains it had madeearlier in the month, for a flat performance on the month.

From here, we see three options for us and investors:follow the correction; ignore it; or learn and adapt. Ourchoice is the third, to learn and adapt, by staying with our

core strategy of earning risk premia given our ongoing viewof a low macro volatility environment, but to reduceholdings of assets most vulnerable to the end of the easy-money regime.

At the core of our strategy this year is a view that macroeconomic and policy volatility will be subdued and that

this environment dictates earning risk premia that areattractive against history or delivered volatility. Thismeans foremost being long equities, outright and versusother asset classes, and earning high-yielding credit premiaon a view of low volatility in fixed income. We avoid tryingto earn FX and term risk premia (except EM) as we do notconsider the risk premia attractive enough.

Our low macro volatility view is based on the observationthat economic data are coming in so close to expectationsthat neither we nor the consensus has seen fit to make morethan minuscule changes to global growth projections forthis year or next (Figure 1). In addition, we are seeing fewchanges or surprises coming from monetary or fiscal policyin Europe and the US, with only Japan offering somefireworks.

Figure 1: The 2013 and 2014 consensus global growth forecasts%

Source: J.P. Morgan

It is in this market where investors had gotten used to lowmacro and market volatility that increasing talk by Fedofficials on when to start slowing down their pace of large-scale asset purchases suddenly led to higher US Treasuryyields in May. The first 1/4% rise in 10-year UST yields inthe first half of the month did little damage outside bondland. But the second halfs rise, to 2.1% today, unleashed

broad position squaring and selling of higher-yielding bondmarkets and currencies, as well as widely held equity trades(Japan and bond-like stocks). The poster-child trade of thesearch-for-yield world, the 100-year Mexico bond, fell over10% over the second half of May.

A first option for investors is to follow this correction onan implied view that position squaring is far from over, thatUS growth will accelerate and will induce an early end toeasy money, and that one can sell assets now and will bediligent enough to buy them back later at a lower price. Wehave doubts about the validity of these assumptions.

On the Fed, our best guess that the FOMC will announce aslowing (tapering) of its $85bn monthly buying programfrom September or December over a 6-9 month period, withthe first outright rate hike coming only in the second half of2015. Volatility in the payroll gains, rising to 200K gains a

month, could move us to September as the likely start oftapering.

There is the possibility that Fed talk about an earlier end toQE was not simply loose talk, but instead intended to

prevent new asset price bubbles (or frothiness) emerging incredit markets. The correction in markets might thus not beunwelcome to the Fed. At the same time, the % rise in thelong mortgage rate last month back to the level of mid 2011should have highlighted the cost of further jawboning of the

2.3

2.6

2.9

3.2

3.5

Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13

2014

2013


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8



05 June 2013


risk markets, and thus limit it, absent news that theeconomy is accelerating.

On a more global basis, our best guess is that the G4 centralbanks will collectively continue to add another $2 trillion inassets to their balance sheets by the end of next year, on topof the $10 trillion they hold already. This pace of asset

purchases is very much in line with what they have doneover the past 4 years. Bringing all our monetary policy rateforecasts together for the 45 countries we cover, we seeonly a few basis points increase between now and the end of2014. In our forecasts, thus, there is as yet no end to theeasy money regime.

Figure 2: Monetary policy, 2007-14Grey area is J.P. Morgan forecast.

Source: FRB, ECB, BoE, BoJ, other national, J.P. Morgan

No change in the easy money regime could dictate thatone should ignore the recent disturbance in markets andsimply stay long equities and credit, outright or versus cashand safer bonds, taking short-term volatility on the chin onthe assumption the correction is not tradable. Thevehemence of the recent market turbulence and the outrightexpensiveness of assets that benefited most from the globalsearch for yield do suggest to us, however, that we shouldlearn from this correction and accept that the market willcontinue to wonder about when the easy money flow willend and what damage its end will do to markets.

An unrelated argument to take the correction seriously isthat the continued G4 QE flow will at some point over thenext year come primarily from the Bank of Japan. So far,we are seeing little, if any, of this liquidity seeping intoworld markets. The end of Fed QE may thus easily trumpthe impact of maxi-QE by the BoJ.

In Fed hiking cycles over the past half century, 10-yearUST yields on average bottomed and went into end-of-easy-

money mode some 6 months before the first rate hike. In thecurrent cycle, where rate cuts have been complemented withforward rate guidance and large-scale asset purchases, theend of the easy money period is harder to define. It is surelywell before the first rate hike. Given the introduction of rateguidance and large-scale asset purchases, it is more clearlylinked to FOMC utterances on its rate and QE intentions.

Finally, the end of the current easy money regime is set tohave a bigger impact than previous ones as the current onewill have lasted much longer and was much more extreme.We have learned from past regime changes that the longerthey last, the more the market will have gotten used to them,and could even be said to become leveraged and addicted to

the old regime. In addition, after major regime changes, wefind that the leverage to the old one was each time muchlarger and in different places than most of us had assumed.A regime change is like shaking a tree and having no ideawho or what will fall out.

The implication to us is thus that we should stay in a lowmacro vol strategy of earning attractive risk premia, butscale down in the areas that one can suspect are mostleveraged to the easy money regime. To judge this, we usea combination of who gained the most in price and volume,what risk premia became most expensive, and which assetswere most directly linked to easy money.

To address these questions, Figure 3 shows how much themajor asset classes have grown since the end of 2008, whileFigure 4 shows how many standard deviations (z-scores)different risk premia have moved from their historic means.The first shows that EM corporate external debt has grown

by a factor of 3 since the financial crisis, followed by a 2.3times expansion of the US HG market. Global equities,commodity futures and options, US HY and local EM

bonds have grown comparatively much less since 2008. DMgovernment bond markets sit in between, having doubled insize, but a significant part of this growth is sitting on central

bank balance sheets. Private-sector holdings of DM

government bonds have grown much less. For reference, weinclude the total return over this period in our DM and EMFX carry strategies, as we do not have good enough data onoutstandings in the carry market. The total return on carryhas been quite low compared with other risk assets, whichsuggests that this market has not benefited that much fromthe easy money regime.

10

15

20

25

30

1.2

2.2

3.2

4.2

5.2

07 08 09 10 11 12 13 14

%p.a. % of GDP

Global p olicy rate

G-4 central bankbalance sheet


9/44

9



05 June 2013


Figure 3: Growth in asset classes 12/2008 05/2013Ratio of index outstandings, or total return indices in case of FX carry or futures and

options open interest in the case of commodities.

Source: Bloomberg, J.P. Morgan

The risk premia comparison in Figure 4 shows that USequity risk premia, against both cash and USTs, remain veryhigh by their own history. But most other risk premia have

become quite depressed against history.

Figure 4: Z-scores of risk premia

Notes: Govt bond carry is the 10YR minus 3M slope. Govt bond carry-to-riskis the slope divided by exponentially weighted 6M daily return volatility.USHG and HY is the spread to USTs using Barclays corporate indices adjustedfor expected loss given default. For HG the expected default loss is 12bp ayear and for HY bit is 228bp a year. HG and HY carry-to-risk is this spreaddivided by 12M spread return volatility. For EM corporates and externaldebt, carry is the spread to USTs adjusted for expected loss given default,which is 8bp and 21bp respectively. For the carry-to-risk, it is this spreaddivided by 6-month daily volatility of spread returns. FX carry is a basketcomprising four currency pairs offering the highest carry-to-risk, calculatedas 1-mo interest rate differential divided by the annualized daily volatilityof spot (for G10) or 1M forwards/NDFs (for EM currencies) over the past 20trading days. EM currencies are all vs. The USD, G10 currencies can be vs.the USD or vs. one another. Commodity roll is calculated across the 24commodities that comprise the GSCI index. It is an equally weighted basketof commodities with downward sloping forward curves minus an equallyweighted basket of commodities with upward sloping forward curves. Theroll is the return that would be realized from buying/selling the contract

one year ahead and holding it until it becomes the front contract, assumingthe shape of each curve does not change over the period. The S&P500 ERP isthe equity risk premium. The S&P500 ERP vs. bonds is the differencebetween the equity discount rate of the S&P500 and the 10YR real bond

yield (10y nominal UST yield minus 10y Philly Fed inflation expectations).The S&P500 ERP vs. cash is the difference between the equity discount rateof the S&P500 and the real cash rate (3M T-bill yield minus 10y Philly Fedinflation expectations).

A third, related metric of what asset classes and strategieshave gained the most from easy money is more a heuristicone. It is our observation that QE and ZIRP led to a massivesearch for yield by investors, which tells us that the assetswith the highest yield have likely become the mostdependent and thus vulnerable to a change in the easymoney regime.

The conclusion from these analysis and assumptions are

that equities are the preferred risk asset class as it hasgrown much less than the credit markets since the crisis, itsrisk premia are still very high by historic standards, and,outside the defensive sector, have not depended as much onthe global search for yield. Credit as an asset class hasgrown the most since the crisis and remains most tied upwith the search for yield. Under our maintained hypothesisof low macro volatility and still another year of easy money,credit spreads should again come in. But their highersensitivity to us being wrong on this means we should haveonly a small overweight on long-duration credit product.

FX carry has not grown much, but the remaining carry in

this market, given tight interest rate spreads, does not makethis market that attractive to us now. Term premia, whichcan be earned by being long duration, are similarly too lowand too sensitive to a change in monetary policy.Commodity carry (roll) is low but this market has notgrown much and only gold was truly linked to the easymoney regime as it was thought a good hedge againstinflation. With global inflation steadily coming down overthe past year, much of the run up in gold holdings and priceappreciation have now been undone. But other commoditiesare linked to the Chinese growth story, and momentum onour forecasts remains negative there.

Within asset classes, our strategy remains based on relativevalue (mostly mean reversion), relative growth betweencountries, and relative positions.

The sum total of these considerations is that we stay longand add to our overweight equity positions, and greatlyreduce our overweight in longer-duration, higher yield

bonds markets.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

-1.5 -1 -0.5 0 0.5 1 1.5 2 2.5

Japan govt bond carry Jan-88

G10 FX Carry Jan-98

EM external debt Dec-99

US HY spread Jan-87

Global FX carry Jan-98

Commodity roll Jan-90

Euro govt bond carry Jan-88

EM corporates Dec-01

EM FX Carry Jan-98

US HG spread Jan-73

US govt bond carry Jan-88

UK govt bond carry Jan-88

S&P500 ERP vs . Cash Q3 59

S&P500 ERP vs . Bonds Q1 57

Standard deviationsfrom historical average

Series start


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10



05 June 2013


Long-only GMOSportfolio

Our long-only model portfolio remains long equities and

credit against bonds, cash and commodities. Last month, weswitched half of our overweight equities into credit, out offear that global growth would be weakening. Withhindsight, that was a mistake. Our global growth projectionsslipped a tiny bit, all from EM, but this effect was totallydominated by position squaring on the fear of an early endto Fed QE.

We have been signaling in recent months the risk to search-for-yield assets, but have failed to act on it in timeourselves. We think the warning for this market from the

past months correction will likely keep investors wary ofaccumulating too much in the latter stage of the easy money

regime. Hence, we reduce significantly our credit vs safebonds overweight to a small amount, and move 2% of it toequities. Stocks should be able to handle further speculationof an earlier end to fed QE much better than credit as areversal in monetary policy will likely come from growthupgrades rather than from inflation.

We are now 10% overweight equities, against fixed income(4%), cash (4%) and commodities (2%). Within fixedincome, our credit overweight has been brought down toonly 2%.

Our portfolio has an unchanged estimated volatility of

6.4%, using 6 months of daily returns. This remains some1% higher than that of the benchmark, largely as a result ofthe overweight in stocks. Our tracking error is slightlyhigher to 1.5% versus the benchmark as market volatilityhas increased.

Table 1: Global Long-only portfolio%

Source: J.P. Morgan

Within equities, we stay OW Japan, as we remain believersin medium-term reflation in Japan. The dramatic sell-off inJapan is telling us that its previous run-up was largelydriven by fast money rather than long-term investors. Wethink that real money is the more likely investor who will

drive up Japanese equities in the future. In previousportfolios, we were underweight the Euro area. We reverse

this, and go OW as recent data are hinting at a coming endto recession and global investors are UW the region. Wemove UW EM against the Euro area, given negativemomentum in EM equities and economic growth. Our longsin US remain in home builders, and Value. In EM, we stayOW Mexico and Malaysia.

Within bonds, we lost from our long duration in local EMand move to a small short, concentrating on Brazil withinlocal EM. We stay long Italy. In credit, we cover our OWsin higher-yielding sectors, and go UW EM external debtagainst DM credit in USD. In commodities, we stayoverweight energy over base metals as the former is lesssensitive to growth surprises and could become price

stabilized through OPEC intervention. We include preciousmetals in the broad metals UW.

Below, we show in table and bar format how we allocatewithin equities, credit and commodities. In fixed income,we need to take individual bonds instead of ETFs, which, inour view, do not yet have sufficient liquidity and granularityto manage a bond portfolio relative to benchmark.

We initiated last year a balanced long-only model portfolioto present our recommended unlevered allocations acrossglobal equities, bonds, credit, commodities, currencies, andcash, and targets asset allocators. The portfolio is

investable as it consists of individual ETFs (for equitiesand credit), futures (commodities), forwards (FX), and

bonds. Given demand by some clients for an ETF-onlyportfolio, we also reintroduce on simpler version of thislong-only portfolio that consists only of ETFs.

As benchmark, we choose weights that are largely driven byglobal outstandings but adjusted for how we understandmost asset allocators operate. This gives us higher weightsfor credit and lower ones for cash than is implied by marketoutstandings. The benchmark thus consists of 45% equities,30% public sector bonds, 15% credit, 5% each forcommodities and USD cash. Fixed income assets are all

hedged into USD, while equities are unhedged.

Our asset allocation exercise takes place on two levels. Infollowing pages, we allocate long only within bonds, credit,equities and commodities in single asset class long-only

portfolios. Below, we then allocate across these activeallocations from a top down point of view.

Since the last GMOS, our model long-only portfolio lost0.66%, some 12bp more than the benchmark. Ouroverweight equities made money, but this was offset by theoverweight in credit against government debt. Since

Allocations Annualised volatility

Assets BM Active Portfolio Active BM Active Portfolio

Equities 45% 55% 10% 11.3% 11.6%

Bonds 30% 24% -6% 2.0% 2.1%

Credit 15% 17% 2% 1.6% 2.5%

Commodities 5% 3% -2% 9.6% 9.7%

FX overlay 0% 0% 0.0% 0.0%

Cash 5% 1% -4% 0.0% 0.0%

Total 100% 100% 0% 5.14% 6.36%


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11



05 June 2013


inception of this long-only portfolio in August, the long-only GMOSportfolio has outperformed the benchmark by

3%; YTD (Dec-May) we have an outperformance of thebenchmark by 0.3%.

Long-only Equities portfolio Regional allocation

Source: J.P. Morgan

Long-only Equities portfolio Sectoral allocation

Source: J.P. Morgan

Long-only Credit portfolio

Source: J.P. Morgan

Long-only Bond portfolio

Source: J.P. Morgan

-15% -10% -5% 0% 5%

MSCI EM

MSCI Mexico

MSCI Malaysia

MSCI Japan

Eurostoxx50

-15% -10% -5% 0% 5% 10%

S&P500

DJ US Home builders

S&P500 Financials

-8% -6% -4% -2% 0% 2% 4% 6%

EM $ Corporates

EM $ Sovereigns

US High-Yield

US Municipals

Europe High-Yield

US High-Yield Loans

Europe High-Grade Colltrlzd

Sterling High-Grade

Europe High-Grade

US High-Grade

-5% 0% 5% 10%

EMU Core

Other DM

EM

Japan

MBS

US

Index-Linked

EMU Periphery


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12



05 June 2013


Long-only Commodities portfolio

Source: J.P. Morgan

Long-short GMOS tactical exposures

The long-short GMOSmodel portfolio continues the tacticaloverlay exposures we have published here since 1995. Theyextend across bonds, currencies, credit, equities andcommodities and are calibrated to a target Var, or trackingerror, of 100bp of the overall size of an underlying global

portfolio.

Given the turbulence in markets, we reduce tactical risk to60bp. Relative to last month, we stay significantlyoverweight equities to government bonds, and add 2% from

credit. In commodities, we stay long natural gas and keepthe long Brent through a bullish time spread position whichhas less downside. We take profit on our RV long in Brentvs WTI. We move our energy OW versus both base and

precious metals now. In fixed income, we stay long 5-yearItaly, and take a loss on long Brazil outright. In credit, wecover the long spread duration position and focus more onrelative momentum and value. This means long DM vs EMin US HG. We move long US HY loans vs bonds and staylong EU vs US HY. We keep the barbell out of euro senior

bank bonds into covered and subordinated. In equities, westay long Japan, US home builders, and Value, andoverweight Mexico and Malaysia against EM.

Overall risk allocationBp Var on y-axis, directional risk contributions to the portfolio in light grey

bars

Source: J.P. Morgan

Cross Asset Positions

Source: J.P. Morgan

Hedges

Source: J.P. Morgan

-10% -5% 0% 5% 10% 15%

Base metals

Precious metals

Livestock

Agriculture

Energy

Deviation from benchmark allocation

-10

0

10

20

30

40

50

60

70

80

0 5 10 15 2

MSCI World vs. GBI

0 5 10 1

CDX.IG 3s5s flattener

Long Equity Volatility


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13



05 June 2013


Equity Strategy

Source: J.P. Morgan

Fixed Income Strategy

Source: J.P. Morgan

FX Strategy

Source: J.P. Morgan

Credit Strategy

Source: J.P. Morgan

0 5 10 15

OW Mexico vs MSCIEM

Sector Position andMomentum: OW

OW BKX vs S&P500

OW Malaysia vsMSCI EM

OW MSCI EMU vsMSCI EM$

OW US HomeBuilders vs S&P500

OW US value stocks

OW Topix vs Korea

OW Topix vs Taiwan

0 5 10 15

Euro Money marketflattener

Long US vs UK realyields

Long 5Y Italy

0 5 1

CHF vs USD

CHF vs. EUR

USD vs AUD

USD vs IDR

0 5 10

Euro Covered vsSenior bank bonds

OW DM v s EM spreadto USTs

Asia HY vs IG

Euro subordinated vssenior bank bonds

Long Euro vs US HYin CDS

Long US HY loans vs

Bonds Spread toUSTs

US HG Financials vsnon-financials

(spreads)


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14



05 June 2013


Commodity Strategy

Source: J.P. Morgan

GMOS long-short performance

Investors who held the recommended positions in thelong-short portfolio would have earned no return sincethe last GMOS. The main gains came from being longequities vs bonds, banks and value in the US, and

Malaysia in EM, oil and palladium and bearish positionsin JGBs. But we offset this through losses in Brazil localbonds, defensives stocks, and JPY shorts. Since Dec 31,2012, the portfolio is up 102bp.

Performance (cumulative return, basis points)

since last GMOS (1 May YTD

Total 0 102Equities -1 -14Bonds -4 12Credit 0 46Currency -3 12Commodity 4 19Cross-asset 5 20Hedges -1 7

J.P. Morgan model portfolio performanceQuarterly performance*, bp, not annualized

* The GMOS performance reported is calculated as of closing on the date of the GMOS

publication. Any necessary adjustment for market movements today will be made in the

following GMOS, reflected in the YTD GMOS performance section. Source: J.P. Morgan.

0 5 10 15 20

Long Brent timespread

Long energy vs. base

metals

Long Corn vs Wheat

Long Lead vs basemetals

Long Natural Gas

Long Palladium vsbase metals

Long Palladium vsprecious metals

Long commodity carry

-100

-50

0

50

100

150

200

250

300

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13


15/44

15

Global FX Strategy


05 June 2013

John Normand(44-20) [email protected]

FX Strategy

Mays global bond market sell-off now ranks as thethird worst of the post-Lehman era measured in yield

terms, but the most disruptive judged by the rise in

equity/rate/FX volatility and contagion to emerging

markets.

Disorderly rates markets like these have been much

more problematic for alpha generation thanenvironments characterized by rising Treasury rates or

even tighter Fed policy. Historically fund managers

have been able to generate decent returns when rates

normalise but not when rate vol surges.

Treasury volatility should peak soon barring a majorupside surprise on payrolls. JGB stability is somewhat

harder to forecast since that market remains in the

early stages of price discovery under a new BoJ regime.

More-frequent purchase operations should help

(eventually).

Strategy: Position selectively for deleveraging throughlongs in USD (vs AUD and IDR) and CHF (vs EUR and

USD), but keep positions light ahead of payrolls.

Although Mays global bond market rout is only the thirdworst of the post-Lehman era measured in yield terms,1 it is

probably the most disruptive judged by the rise in

equity/rate/FX volatility and contagion to emergingmarkets. Over the past month the dollar is up 3% trade-weighted compared to its usual decline of about 2% duringTreasury sell-offs; the currency is higher across all pairs

but CNY and HUF; and consequently correlations havemean-reverted from almost decade lows (Figure 1). Wehave discussed previously the unusual cyclical andtechnical nature of these FX moves. The US continues todecouple from several hangover economies still trying torebalance themselves (China, Australia, parts of EMEA),which in turn leaves vulnerable huge positionconcentrations in several high-yield markets (Australia,

New Zealand, parts of EM) as US rates start to normalize.Structural factors like US energy independence or

equity/FDI flows have little to

1

US 10-yr yields have risen 45bp since May 1, compared to sell-

offs of 140bp in spring 2009 (March to June 2009) following theFeds first QE announcement, and 130bp from October 2010 toFebruary 2011.

Figure 1: FX correlations have mean-reverted to levels more typicalof systemic events like a major US Treasury sell-off3-mo realized correlations on baskets of G-10 and emerging markets currencies

Source: J.P. Morgan

Figure 2: Brutal moves a two-sigma sell-off in Treasuries and inEM local currency debtRolling 1-month yield changes in 10-yr Treasuries and EM local currencies debt(measured by yield on J.P. Morgan GBI-EM index)

Source: J.P. Morgan

do with this years dollar trend, and probably nothing to dowith this months moves (see The beginning of the end ofeasy money implications for the dollar, FX volatility and

correlation, May 24, 2013).

The core view has not changed this years broad USDrally is overdone and should narrow over the summer assome growth gaps narrow, particularly versus Europe. But

given how disorderly markets have become in May, weexamine how much more sensitive alpha generation is tovol spikes versus simply rising bond yields or Fedtightening. The results are only somewhat surprising: risingrate volatility and spikes in rate vol are the most

problematic environments, rising interest rates the least andrising equity vol and Fed rate hikes in between. Hedgefurther disorder in global markets by selling AUD and IDRvs USD and by adding CHF longs vs EUR and USD, butavoid too many defensive trades: rates and rate vol havealready repriced considerably for this Fed environment.

10

20

30

40

50

60

70

80

2009 2010 2011 2012 2013

USD pairs (G-10) 3-mo realised correlation, %USD pairs (EM) 3-mo realised correlation, %

-60

-50-40

-30

-20

-10

0

10

20

30

40

50

May 12 Nov 12 May 13

US 10yr, rolling 1mo change (bp)GBI-EM yield, rolling 1mo change (bp)


16/44

16

Global FX Strategy


05 June 2013


Worst in four years based on vols

This months UST sell-off has been the most vicious of

the past four years, once contagion to emerging marketsand moves in volatility are considered. US 10-yr yieldrises of some 50bp occur fairly regularly, but contagion toEM local markets on this scale is a rarer event (Figure 2).This months vol moves are unusual, too, highlighting howmuch more disorderly the rate sell-off has become. For thefirst time in four years a US rate move is pushing equity andEM FX volatility higher (Table 1), and while US rate vol hasalways risen during Treasury sell-offs, the magnitude of thismonths rally (+28bp in 3Mx10YR swaption vol) is thesecond strongest of the past six episodes.

Rising Japanese rate vol for unrelated reasons the BoJs

contradictory promises to buy overwhelming amounts ofJGBs to push yields lower and to achieve 2% inflation intwo years isnt helping either. JGBs are almost asvolatile as Treasuries now for the first time in decade(Figure 3), a development which undermines high-yieldcurrencies since Japanese investors are unlikely to step-uptheir foreign asset purchases when their domestic marketsare becoming higher-yielding as well as unruly. The MoFsweekly portfolio report indeed confirms that Japan has nointerest in the rest of the world given the performance of itsdomestic markets. (Theyve sold almost 2trn in foreign

bonds in the past two weeks.)

Historically such volatility has been much moreproblematic for alpha generation than rising Treasury

yields or Fed rate hikes have been. Table 2 highlightsthese dynamics by comparing the returns of currencymanagers and hedge funds (global macro, emergingmarkets, fixed income and commodity) during variousmarket environments. Section A shows average monthlyreturns over different sample periods depending on dataavailability. Only two composites publish returns since theearly 1990s and can be used to examine patterns acrossmore than one Fed cycle the Barclay Currency TraderIndex for FX funds and the HFR Macro for global macrofunds. Several other indices are available since 2005 for FXfunds (Barclay BTOP, Parker Blacktree and HFRCurrency) and other hedge funds (fixed income sovereign,emerging markets and commodities), so at least can be usedto examine patterns when rates or volatility have risen overthe past eight years.

Section B of the table shows average monthly performancein months when the Fed has hiked the funds rate in 1994,1999 and 2004-06. Section C shows returns in months whenUS 10-yr rates, both nominal and real, have risen by anyamount. Section D shows returns during more extreme rate

Table 1: May 2013 UST sell-off has been more disorderly thanprevious ones judged by moves in equity, rates and FX volatilityChange in volatility for various asset classes: VIX for equities, VXY G10 and VXY

EM for currencies and 3Mx10YR swaption vol for US and Japanese rates

Source: J.P. Morgan

Figure 3: Rare convergence JGBs are now almost as volatile asTreasuries

3Mx10YR swaption vol in the US and Japan

Source: J.P. Morgan

Figure 4: Rising rates are manageable; large moves in rates andhigh rate and equity volatility are notReturns from Table 1 by market environment

Source: J.P. Morgan

18-Mar-09 10-Jun-09 -11% 50bp -2bp -2.5% -2.8%

07-Oct-10 08-Feb-11 -6% 20bp 12bp -2.4% -1.8%

03-Oct-11 27-Oct-11 -20% 7bp 4bp -2.4% -4.1%

24-Jul-12 16-Aug-12 -6% 8bp 7bp -1.0% -0.9%

06-Dec-12 11-Mar-13 -5% 5bp 10bp 1.7% 0.0%

01-May-13 30-May-13 2% 28bp 31bp 1.5% 2.6%

Japan rate vol

(3Mx10YR

swaptions)

G-10 FX vol

(VXY G10)

EM FX vol

(VXY EM)UST sell-off Equity

vol (VIX)

US rate vol

(3Mx10YR

swaptions)

20

40

60

80

100

120

140

160

180

200

220

2001 2004 2007 2010 2013

JA 3Mx10YR swaption vol, bpUS 3Mx10YR swaption vol, bp

-0.6%

-0.4%

-0.2%0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

allmonths

Fedhike

nomr

atesrise

realratesrise

nomr

ates>25bp

realrates>25bp

equityvolrises

equityvol>5pts

ratevolrises

ratevol>15bp

Barclay Currency Traders Index HFR Macro


17/44

17

Global FX Strategy


05 June 2013


moves, defined as increases of more than 25bp per month(one sigma). Sections E and F provide the same

calculations for months when equity and rate vol rise byany amount and by a more extreme 5 points on the VIX or15bp on 3Mx10YR swaption vol.

The results are discouraging for the next several weeksover which Fed and BoJ policy are creating so muchuncertainty; they are more encouraging for the rest of 2013if indeed the inevitable further rise in US rates will becomemore orderly. A few points from the table and Figure 4:

Manager returns during Fed tightening: 1994 was theonly uniformly disastrous experience. Only two managercomposites (Barclay Currency Traders, HFR Macro)

provide sufficiently long data history to examineperformance over more than one Fed tightening cycle.Currency funds, which had generated monthly returnsaveraging 0.5% since 1990, generated lower returns whenthe Fed hiked: -0.6% per month during the 1994 shocktightening, +0.15% per month during the 1999 tighteningand +0.22% per month during the 2004-06 tightening.Global macro funds also lost money in 1994 but maintainedhigh monthly returns during the 1999 and 2004-06 cycles,however (about 0.8%).

Manager returns when rates rise: the greater the sell-off, the worse the returns. In months when Treasuryyields rise, currency funds have generated below-average

returns but still generated alpha (0.3% versus long-termaverage of 0.5%). Global macro fund performance exhibitsa similar pattern, with average monthly returns of 0.76%when yields rise versus 0.99% for the full sample. Asignificant increase in rates, defined as Treasury sell-offsof more than 25bp per month, have been much morechallenging for generating alpha. Returns for currency and

global macro funds have been positive but only about one-fourth as high as the average (Table 1 and Figure 4).

Manager returns when volatility rises: mixed butgenerally the worst of any environment. Manager returnswhen volatility rises are quite variable across fundcategory. They also depend on whether equities or rates aregenerating the vol move. Currency funds, proxied by theBarclay Currency Trader Index since 1990, appear to havesuffered no meaningful reduction in performance whenequity vol rises or when the VIX spikes more than 5 points.But other currency manager indices available since 2005show much worse performance when equity vol increases.All FX fund composites show lower and sometimesnegative returns when rate vol rises. Global macro fundsshow lower-than-average returns when equity or rate vol

rises, and even lower returns when equity and rate vol risesignificantly. No doubt this pattern owes to carry tradeunwinds triggers by interest rate shocks.

Strategy: selectively defensive

These figures make grim reading given levels of realisedvolatility in rate markets and the event risks ahead of US

payrolls. The nearly 30bp increase in US rate vol this monthis well beyond the threshold associated with below-averagefund returns, even though the rise in the VIX has been moremuted (only 1% this month compared to thresholds of 5%usually associated with poor performance). As with USTyields, we expect US rates and rate vol to peak soon since

mortgage-related hedging will probably be less than feared,and since investor positioning is probably short duration bynow. Next Fridays payrolls figure is a huge wild card,however (see todays edition ofGlobal Fixed Income

Markets) . In Japan, we expect that JGB yields and vols arenear a peak too as the BoJ continues to modify its asset

purchase program, now conducting 10 operations per

Table 2: Currency and hedge fund manager returns during various interest rate and volatility environmentsAverage monthly returns for each fund manager composite during various market environments. Sample coverage varies depending on data availability.

Source: J.P. Morgan

B

FX funds

Barclay Currency Traders Index 0.50% 0.26% 0.15% -0.60% 0.15% 0.22% 0.29% 0.13% 0.09% -0.38% 0.62% 0.51% 0.19% 0.17%

Barclay BTOP NA NA 0.09% NA NA 0.01% -0.10% -0.10% 0.06% -0.14% -0.06% -0.09% -0.11% -0.03%

Parker Blacktree NA NA 0.12% NA NA 0.39% 0.03% 0.11% 0.08% 0.14% -0.14% 0.06% -0.06% 0.16%

HFR Currency NA NA 0.03% NA NA -0.08% 0.16% 0.03% 0.33% 0.43% -0.32% -0.46% -0.23% -0.24%

Avg of FX manager composites NA NA 0.10% NA NA 0.14% 0.10% 0.05% 0.14% 0.01% 0.03% 0.01% -0.05% 0.02%

Hedge funds

HFR Macro 0.99% 0.50% 0.41% -0.62% 0.88% 0.81% 0.76% 0.39% 0.24% 0.22% 0.63% -0.20% 0.53% 0.31%

HFR Fixed Income NA NA 0.31% NA NA 0.74% 0.50% 0.06% 1.63% -1.84% -0.36% -3.37% 0.06% -1.51%

HFR Emerging Markets NA 0.76% 0.66% NA NA 1.89% 1.33% 0.27% 3.07% -1.17% -0.82% -4.90% 0.07% -1.96%

HFR Commodity NA NA 0.49% NA NA 2.39% 0.72% 0.50% 0.47% 0.73% 0.52% -0.20% 0.83% 0.45%1 real rates derived from 10-yr US TIPS

All months Months when Fed hikes Months when

nominal US 10-

yr rises

Months when

real1 US 10-yr

rises

Months when

nominal US 10-

yr rises >25bp

Since

1990

Since

2000

Since

20051994 1999

2004-

2006

Months when

real1 US 10-yr

rises >25bp

Months

when equity

vol rises

Months when

equity vol

rises > 5pts

Months

when rate

vol rises

Months when

rate vol rises

> 15bp

A E FC D


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Global FX Strategy

05 June 2013John Normand(44-20) [email protected]

month rather than eight and focused on the 1-5yr sectorwhich has been subject to the most selling pressure by

domestics. Indeed, the BoJ must adjust its program until itpushes yields lower, since without lower yields, Japanesecapital outflows are unlikely to occur, which in turn limitsthe yens downside, the Nikkeis upside and the countrys

broader reflation strategy.

Our strategy therefore remains selective. Higher volis clearly more challenging that just a rising rateenvironment or even a Fed tightening environment, yetrates and vols are probably nearing a near-term peak.Hence we add only a handful of defensive trades ratherthan position for broad deleveraging. On the one hand wesell AUD and IDR vs USD, capturing current accountvulnerabilities in both, bond leverage in the case of AUD

and additional idiosyncratic factors in IDR (cessation ofcoal exports to China?). On the other, we buy CHF vsEUR and USD, as CHF has been used as a key financingcurrency in recent months, pushing CHF to heavilyoversold levels versus short-term valuation metrics. SeeTrade Recommendations in next section.

Trades

Sell AUD vs USDAUD has been a key beneficiary of financial repressionin the West, with foreign bond investors placing 42% ofGDP in AGCB since end-2007. Much of this money

may have come from sticky investors (central banksand SWFs), which limits the risk of outrightrepatriation as yields in the core markets rise.

Nonetheless, the yield back-up, especially if it heraldsthe end of financial repression, begs the question ofhow easily Australia will be able to finance its externaldeficit going forward. Add to this the secular concernswhich continue to dog AUD (less growth and less-investment intensive growth in China; an uncertaintransition from a mining-centric growth model inAustralia) and the near-term outlook for AUD remainsnegative. This weeks back-up in AUD/USD provides

better entry levels for the trade. Next week is importantfor AUD, with not only US payrolls but also China PMIon Sunday and the RBA on Tuesday (a cut is 20%

priced J.P. Morgan expects no change).

Sell AUD/USD at 0.9560 with a stop at 0.9880.

Figure 5: Fed tapering would signal an end to financial repressionand the heavy inflows to high-yield or low credit risk bond marketswhich this has sponsored

Change in foreign ownership of domestic sovereign debt, Q4 2007 to present.Percent of local GDP.

Source: National sources; J.P. Morgan

Figure 6: Currencies are vulnerable where the bond overhang ismost pronounced and the current a/c least forgiving

Source: National sources; J.P. Morgan

Figure 7: The sell-off in EM FX (2% over 1-month) is typical for anon-systemic event. The move has further to run if Fed tapering andhigher bond yields develop into a systemic threat1-month currency returns from the GBI-EM Global Diversified bond index (i.e 1-mototal return in USD -- 1-mo total return in local currency)

Source: J.P. Morgan

0

10

20

30

40

50

60

NZ

D

AU

D

US

D

MY

R

GB

P

EU

R

MX

N

ZA

R

TH

B

PL

N

SE

K

JP

Y

ILS

TR

Y

CA

D

HU

F

BR

L

KR

W

ID

R

RU

B

CH

F

-8

-6

-4

-2

0

2

4

6

8

0 10 20 30 40 50 60

Change in foreign ownership of sovereign debt from 2007, % GDP

Cur

rentaccount,%G

DP

AUDCAD

PLN

TRY ZAR

GBPUSD

NZD

MYR

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13


19/44

19

Global FX Strategy

05 June 2013John Normand(44-20) [email protected]

Buy CHF vs EUR and USDThe FI sell-off puts pressure on the currencies of current

account deficit countries that hitherto enjoyed abundantbond inflows to finance themselves. The natural corollaryto this should be upward pressure on surplus currenciessuch as CHF. The market, by contrast, has beenassuming the exact opposite, that rising yields andstronger stock markets would stimulate capital outflowsfrom Switzerland, which would make recycling ofSwitzerlands overwhelming current account surplussubstantially easier and in turn undermine the franc. Thisweeks deleveraging casts doubt on the latter scenario,and we expect further unwinding of speculative shorts inthe franc. Franc selling has been heavily concentrated onUSD/CHF; nonetheless, a further paring back of riskshould serve to weaken EUR/CHF, which is the most

overvalued G10 cross on out short-term metrics. Thestrong gain in Q1 GDP (+2.5% saar) should preclude theusual run-up in EUR/CHF ahead of the SNBs quarterly

policy meeting on June 20 SNB with Switzerlandoutperforming not only the euro area but also Germanyto a considerable extent, it is hard to see what the SNBs

pretext for raising the EUR/CHF floor could be (or howit could justify this to its international partners)

Sell USD/CHF at 0.9585. Stop at 0.9750.

Sell EUR/CHF at 1.2430 with a stop at 1.2590.

Sell IDR vs USDIDR is vulnerable due to: 1) A weak external position

(current account -2.25% of GDP) will be undermined byChinas plan to fully ban imports of low-grade coal, 93%of which comes from Indonesia (adding 0.5% to thedeficit); 2) Reform of fuel subsidies is unlikely to repairweak domestic confidence in macro-economic policy,even if BI responds with a rate hike; 3) There is aconcentration of bond redemptions, coupon and dividend

payments in June. (See:IDR FX Strategy: Aconcentration of negative risks, Daniel Hui, May 30,2013).

Buy USD/IDR at 9877, stop 9760.

Took profits on long USD vs CAD, CHF and JPY.

We exited this basket of long dollar trades intermittentlyover the past two weeks as USD started to overshoot (vsEurope) and rising rate volatility turned an orderly dollarrally into an exercise into less positive deleveraging.

Long USD/CAD. Bought May 10 at 1.0080, tookprofits May 16 (+1.0%).

Long USD/CHF. Bought May 10 at 0.9550, took

profits May 16 (+0.8%).

Long USD/JPY. Bought April 26 at 98.20. Closed

May 29 for a profit of 2.8%.

Stopped out of short JPY vs KRW and MXN. Hold vs

a high-yield basket in a now worthless basket

We switched funding for these EM trades from USD toJPY on May 10, assuming that a weaker JPY wouldcompensate for any EM wobbles caused by higher USyields. We were wrong on both counts as a funder theyen has rallied sharply on deleveraging flows, whileMXN has suffered from its fundamental popularityamongst overseas investors (as ever in deleveraging,

positioning is everything, fundamentals count for naught).

Long MXN/JPY. Bought May 10 at 8.42, stopped

out May 23 for a loss of 3.8%.

Short JPY/KRW. Sold May 10 at 10.91, stoppedout May 24 for a loss of 2.6%.

Hold a 2-mo worst-of (AUD, BRL, ZAR) call/JPYput. Bought April 12 for 1.59%. Worth 0.0%.

Stay short a 2-mo EUR/NOK strangleInternational positions in NOK are light and central bank

policy is sensitive to NOK in both directions, all ofwhich adds up to a range in EUR/NOK, in our opinion.Unless next weeks PMI and IP data are particularlyweak, we doubt whether EUR/NOK will exceed thehigh-strike.

Sold a 2-mo EUR/NOK 7.37-7.64 strangle onApril 12 for 0.57%. Worth 0.35%.

Hold a bearish 2-mo EUR/SEK risk reversal

EUR/SEK has consolidated in an 8.50-8.75 range for fiveweeks now. While the premise of this trade was wrong(SEK benefitting from cyclical lift), we doubt whetherthe converse will be true - a sharp rally in EUR/SEKfrom here. As such, we hold the trade, even though thecall that we sold is now at-the-money.

Hold a bearish 2-mo EUR/SEK risk-reversal witha downside RKO (8.30 put, RKO 8.05, versus an8.60 call). Bought April 4 for 0.20%. Worth -0.34%.

Hold ratio call spreads in AUD, BRL and NZD vs

USDWe thought carry trades would fade gracefully due to theslow-acting forces of overvaluation and policy pushback,

hence these limited upside structures. The end, when itcame, was rather more spectacular.

Hold a 2-mo AUD/USD call fly (1.07-1.09-1.11 in1x2x1). Bought April 12 for 0.27%. Worth 0.00%.

Hold a 2-mo NZD/USD 0.8750-0.9000 1x2 callspread. Cost 0.39% on April 12; worth 0.00%

Hold a 2-mo USD/BRL 1.95-1.90 1x2 put spread.

Cost 0.33% on April 12. Worth 0.00%.


20/44

20

Global FX Strategy


05 June 2013


Justin Kariya(1-212) 834-9618

[email protected]

J.P. Morgan FX Forecasts vs. Forwards & ConsensusExchange rates vs. U.S dollar

Current

Majors Jun 5 Jun 13 Sep 13 Dec 13 Mar 14 forward rate Consensus** Past 1mo Past 3mo YTD Past 12mosEUR 1.31 1.30 1.30 1.30 1.32 -0.8% 3.2% 0.1% -0.1% -0.8% 5.1%

JPY 99.2 100 102 105 106 -5.7% 0.0% 0.1% -4.4% -12.6% -20.6%

GBP 1.54 1.51 1.49 1.49 1.52 -2.9% 0.3% -0.9% 2.6% -5.2% 0.1%

AUD 0.95 0.99 0.99 1.00 1.01 6.3% 2.0% -7.0% -7.1% -8.2% -2.1%

CAD 1.03 1.01 0.99 0.99 0.99 5.0% 3.0% -2.6% -0.5% -4.1% 0.4%

NZD 0.80 0.82 0.83 0.83 0.82 5.8% 2.5% -6.6% -3.9% -4.0% 5.2%

JPM USD index 84.5 85.2 85.1 85.6 85.1 -2.0% -2.0% 1.6% 0.8% 3.6% 0.9%

DX Y 82.6 83.0 83.2 83.5 82.6 1.0% -2.5% 0.3% 0.6% 3.5% -0.3%

Europe, Middle East & Africa

CHF 0.94 0.95 0.95 0.94 0.92 0.2% 5.7% -0.4% 0.0% -2.9% 2.3%

ILS 3.67 3.65 3.70 3.75 3.75 -1.8% -3.5% -2.8% 1.0% 1.8% 6.3%

SEK 6.59 6.54 6.46 6.46 6.33 2.4% 3.2% -0.6% -4.0% -1.3% 9.4%

NOK 5.81 5.77 5.73 5.69 5.57 2.9% 3.2% 0.4% -2.5% -4.3% 5.1%

CZK 19.69 19.88 19.77 19.69 19.32 -0.1% 3.8% -0.3% -1.4% -3.5% 4.5%

PLN 3.28 3.19 3.15 3.12 3.03 6.4% 4.2% -3.2% -3.4% -5.6% 7.2%

HUF 227 223 223 223 220 3.8% 6.0% -0.2% 0.1% -2.9% 6.6%

RUB 32.18 31.72 31.94 31.28 31.03 6.5% -0.2% -3.5% -4.6% -5.1% 2.8%

TRY 1.89 1.80 1.82 1.85 1.85 5.4% -2.7% -5.0% -5.1% -5.8% -2.5%

ZAR 10.00 9.20 9.10 8.80 8.70 17.0% 3.4% -10.0% -8.5% -15.2% -15.7%

Amer icas ARS 5.29 5.60 6.00 6.40 6.85 3.2% -8.4% -1.6% -4.3% -7.1% -15.3%

BRL 2.13 2.05 2.02 2.05 2.05 8.2% -2.4% -5.7% -8.1% -3.7% -5.1%

CLP 503 475 475 475 480 8.5% 1.1% -6.6% -5.1% -4.7% 1.9%

COP 1900 1825 1825 1800 1800 7.5% 2.8% -3.7% -5.1% -7.0% -5.7%

MXN 12.85 12.00 11.90 11.70 11.80 11.8% 2.6% -5.8% -0.7% 0.0% 10.6%

PEN 2.72 2.60 2.60 2.57 2.55 7.2% -0.8% -3.8% -4.3% -6.1% -0.8%

VEF 6.29 6.30 6.30 6.30 8.50 -0.1% 0.0% 0.0% 0.0% -31.7% -31.7%

LACI 101.1 105.4 105.4 105.0 103.9 8.8% -0.5% -5.2% -4.7% -3.4% -0.3%

Asia CNY 6.13 6.19 6.17 6.15 6.15 1.0% -0.8% 0.6% 1.5% 1.7% 3.9%

HKD 7.76 7.80 7.80 7.80 7.80 -0.6% -0.4% 0.0% -0.1% -0.1% 0.0%

IDR 9795 9800 9800 9900 10200 2.8% -1.5% -0.6% -1.0% 0.0% -3.5%

INR 56.7 55.5 55.5 55.5 55.5 6.2% -2.7% -4.5% -3.8% -3.1% -1.9%

KRW 1116 1090 1070 1040 1030 8.7% 5.2% -1.9% -2.6% -4.6% 5.8%

MYR 3.08 3.05 3.02 3.00 2.97 4.1% 0.0% -3.4% 0.8% -0.9% 3.8%

PHP 41.99 40.55 40.25 40.00 39.80 5.7% 2.0% -2.5% -2.9% -2.4% 3.7%

SGD 1.25 1.22 1.20 1.19 1.18 4.9% 4.2% -1.5% -0.4% -2.2% 3.0%

TWD 29.79 29.80 29.50 29.30 29.00 1.1% 0.5% -0.8% -0.5% -2.5% 0.6%

THB 30.54 29.00 28.90 28.90 28.90 7.0% 1.2% -3.0% -2.7% 0.2% 3.4%

ADXY 117.0 116.7 119.7 121.2 121.2 3.3% 0.8% -1.2% -4.7% -1.0% 2.6%

EMCI 92.8 95.5 95.9 96.4 96.5 7.2% 0.8% -3.5% -2.5% -3.1% 1.2%

Exchange rates vs Euro

JPY 130 130 133 137 140 -4.8% -3.1% 0.0% -4.3% -11.9% -24.5%

GBP 0.850 0.860 0.875 0.870 0.870 -2.1% -2.8% -1.0% 2.7% -4.5% -4.8%

CHF 1.23 1.230 1.230 1.220 1.210 1.0% 2.5% -0.5% 0.2% -2.1% -2.6%SEK 8.63 8.50 8.40 8.40 8.35 3.3% 0.0% -0.7% -3.9% -0.5% 4.0%

NOK 7.61 7.50 7.45 7.40 7.35 3.8% 0.0% 0.3% -2.4% -3.5% -0.1%

CZK 25.78 25.85 25.70 25.60 25.50 0.7% 0.6% -0.4% -1.3% -2.7% -0.6%

PLN 4.29 4.15 4.10 4.05 4.00 7.4% 1.0% -3.3% -3.3% -4.9% 1.9%

HUF 298 290 290 290 290 4.7% 2.8% -0.3% 0.3% -2.2% 1.4%

RON 4.46 4.35 4.45 4.50 4.50 1.3% -3.8% -3.6% -2.5% -0.5% 0.0%

TRY 2.48 2.34 2.37 2.41 2.44 6.3% -5.7% -5.2% -4.9% -5.1% -7.2%

RUB 42.13 41.23 41.52 40.66 40.96 7.4% -3.3% -3.7% -4.5% -4.5% -2.4%

BRL 2.79 2.67 2.63 2.67 2.71 9.2% -5.4% -5.8% -8.0% -2.9% -9.7%

MXN 16.83 15.60 15.47 15.21 15.58 12.7% -0.6% -5.9% -0.6% 0.8% 5.2%

indicates rev ision resulting in stronger local FX , indicates revision resulting in weaker local FX. Source: J.P.Morgan

* Positiv e indicates JPM more bullish on local currency than the consensus or forwar d rates. ** Bloomberg FX Consensus Forecasts.

JPM forecast ga in /loss vs Dec -13* Actua l change in local FX vs USD

Actual change in local FX vs EUR


21/44

21



05 June 2013

Seamus Mac Gorain(44-20) [email protected]

As discussed earlier, GMOSfocuses on global tacticalasset allocation. In this section, we focus on medium-term

asset allocation across G10 and EM rates markets. Moreshort-term and detailed recommendations are presented inour sister publications, US Fixed Income Weekly, Global

Fixed Income Markets Weekly, Emerging Markets Outlook

and Strategy, andEM Cross Product Strategy.

Fixed Income Strategy

We are neutral on duration in DM, reasoning thatthe market has now absorbed the change in Fed

communication on tapering, and that bond manager

positions are not supportive of a further rise in

yields.

We look for flatter money market curves across DM

markets, partly reversing the liquidation of carrytrades in recent weeks.

We are modestly bearish on EM local markets, as the

position correction there may have further to run.

US real yields have risen very sharply, with the

combination of rising nominal yields and fallingbreakevens most unusual. We go long US real yields

vs the UK, looking for the 70bp spread to compress.

Bond markets have settled down, after recording their thirdworst return in the past two decades in May. The worst

performers in the correction were US Treasuries, with theFeds tapering talk the main trigger for the backup in yields,US MBS, and EM local bonds, led by Latam, though withconsiderable divergence within EM (Figure 1).

We think that, having absorbed the change in Fedcommunication, bond yields would need further impetus

from the US labor market to move much higher in the nearterm. Our forecast remains for tapering to be announced inDecember, though with almost even odds of a Septembertaper, which now appears to be the market consensus.

That only underlines the importance of Fridays USemployment report. The bond market reaction to surprisesin nonfarm payrolls has been growing in recent years, evenin a lower volatility environment where most othereconomic releases have had a lesser impact, likely reflectingin part the now explicit link between labor market data andthe Feds forward guidance.

One factor arguing against higher yields in our view is thata range of positioning measures suggest than bondmanagers shed duration in May, consistent with the typical

pattern of active investors shedding duration in a sell-offand adding in a rally. Bond positions now look to be aroundthe short end of their range over the past few years.

Bond ETFs have seen heavy outflows this week and last, inthe wake of the sell-off (Figure 2). EM bonds last week sawtheir first weekly outflow since August, focused on hardcurrency rather than local bonds. After $2.5tr of inflows

post-crisis, mutual funds and ETFs have become an

Figure 1: Change in yields since AprilBp

Source: J.P.Morgan, Bloomberg

Figure 2: Weekly flows into bond mutual funds$bn

Source: Bloomberg, J.P.Morgan

increasingly important support for bond markets, and nowhold 14% of the US bond market. Flows into bond fundstend to be strongly related to past returns, and seriallycorrelated even after accounting for past returns. In thatsense, they tend to amplify sustained market moves.Because year-on-year returns on major bond indices are still

positive, we dont expect the recent outflows to become amaterial trend, absent a substantial further sell-off.

0.00 0.20 0.40 0.60 0.80 1.00

EM Asia

Italy

Japan

Spain

Germany

UK

EM Europe

US

Latam

US MBS

-5

-4

-3

-2

-1

0

1

2

3

45

Jan-11 Jul-11 Jan-12 Jul-12 Jan-13


22/44

22



05 June 2013


Figure 3: Change in 10-year US breakevens vs 10-year nominalyieldsMonthly change, bp, past three years. Breakevens on Y-axis, Nominals on

X-axis

Source: J.P. Morgan

We are neutral overall on duration within DM, but do lookfor a reversal of the sharp steepening in money marketcurves across markets, as carry trades predicated on a lowfor long environment have been unwound. We recommendmoney market flatteners in euro (between 1Yx1Y and2Yx1Y rates). EONIA rates two to three years ahead arenow close to 60bp, implying some likelihood of policytightening by then, whereas the current macroeconomicoutlook would justify further ECB easing. We also look for

flatter money market curves in other major markets (e.g.US, UK).

The further narrowing in US inflation breakevens over thepast month, even as nominal yields spiked higher, isstriking. To be sure, US inflation is subdued, but even so, itis very unusual for breakevens to be falling significantly inan environment of significantly rising nominal yields(Figure 3). Ten-year TIPS now offer a yield pickup of closeto 70bp over 10-year index-linked gilts. We look for thisspread to compress, with a medium-term horizon.

EM local bonds underperformed DM by close to 1% in

May, and are now slightly down YTD. Theunderperformance had both common and local drivers. Theformer is essentially a reversal of carry trades as the

possibility of Fed tapering has pushed Treasury yieldshigher. Chief among the latter is the more-aggressive-than-expected tightening cycle in Brazil. The modest outflowsfrom EM bonds so far have been in hard currency ratherthan local currency bonds. We think that the positioncorrection in EM can run a little longer, and so move from along duration position, to a modest short durationposition, focused on Asia (Malaysia, Indonesia), which has

been relatively resilient to the sell-off so far.

Long-short bond portfolio

Curve: 1Yx1Y vs 2Yx1Y EONIA steepener ()

See discussion above.

Cross-market: Long US vs UK in 10yr realyields ()

See discussion above.

Long 5-year Italy ()

We maintain a longstanding overweight in the Euro areaperiphery via 5-year Italy. Much of the demand forperipheral bonds has been driven by the search for yield,in an environment of very low returns on the safest

assets. A rise in US (and by extension, German) yields,purely down to a monetary policy shock, wouldchallenge that dynamic, where a rise in yields associatedwith a better economic outlook would be far moremanageable, and seems the more likely course.

Long only bond portfolio

Our long only bond portfolio complements ourlongstanding portfolio of long-short trades. We take asour starting point a benchmark of $29tr of government andgovernment-like bonds, comprising: (i) conventionalgovernment bonds, as represented by our GBI Global andGBI-EM Global Diversified indices (ii) index-linked bonds,

as measured by our ELSI (euro), GILLI (sterling) andJUSTINE (US) indices and (iii) the J.P.Morgan US MBSindex.

We construct a global bond portfolio using a small numberof liquid securities, which takes this benchmark as its

baseline, but is tilted to reflect the tactical themes discussedabove. Figure 4 shows the main risk exposures of the

portfolio, while Figure 5 shows the eight bonds we suggestusing to attain our recommended exposures, and the weightallocated to each.

The portfolios main exposures, relative to the benchmark,

are an overweight in the EMU periphery, funded broadly byunderweights across lower-yielding DM bond markets, andan overweight in US TIPS within linkers. We move from anoverweight to underweight in EM local bonds, on thegrounds that the position adjustment away from EM couldrun a little longer. Within EM, we focus on Brazil, whichhas underperformed materially on a hawkish central bank,

but where yesterdays decision to lift the 6% tax on foreigninflows into fixed income should be supportive.

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60

-0.6 -0.4 -0.2 0.0 0.2 0.4 0.6

May 2013


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05 June 2013


Figure 4: Portfolio exposuresPer cent of portfolio notional

Source: J.P. Morgan

Figure 5: Recommended portfolio holdings

Source: J.P. Morgan

Figure 6: Performance of benchmark and recommended portfolioPer cent

Source: J.P. Morgan

We stay neutral on US MBS, recognizing that the cor

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146317645 JP Morgan Global Research June 2013