Panel: Strategies for managing interest rate and currency risk

Evariste LefeuvreHead of Global Macro

Natixis

Jim LeahyChief Financial Officer

Marathon Asset Management

Frederic GarnierManaging Director, Emerging Markets

Tishman Speyer

Brian ConlyManaging Director, Real Estate

Chatham Financial Corp.

The bumpy road to recovery

Evariste LefeuvreHead of Global Macro

Natixis

Macro / Market themes for 2010 1. The real side: recovery is fragile (weak wages and

deleveraging), no genuine decoupling.2. The money side: early exit strategies. Impact of (excessive)

quantitative easing. The death of Fiat Money ? Inflation is threatening ?

3. Soaring public deficits and Debt: impacting the yield curve ? What about private deleveraging ? FX aspect of fiscal inconsistency (foreign debt)

4. FX market as an asset class: correlation breaks and the role of the dollar: safe haven or new carry trades vehicle ?

5. Conclusion: living in a world with excess liquidity.

Last exit to 2010 (our view)No early exit for monetary policies

0

2

4

6

8

06 07 08 09 10 11

0

2

4

6

8 USD

EUR

GBP

J PY

CAD

AUD

Sources : NATIXIS

Does everyone agree? (market’s view)Money Market 2-year ahead Monetary policy

expectations

-2

-1

0

1

2

3

4

07 08 09

-2

-1

0

1

2

3

4

Euro zone

US

Sources : NATIXIS

Quantitative easing and fiat money risk: genuine ?

Why should CB exit so early as growth is lacklusterAsset providing liquidity => Liability excess reserves hoarding !

FED 's Liability

0

50

100

150

200

04 05 06 07 08 09

0

20

40

60

80

Cash in public's hands / Reserves with the Central Bank (%)

Reserve balances with Federal Reserve Banks (% of Assets) - RHS

Sources : Datastream, NATIXIS, FED

Is inflation always and everywhere a monetary phenomenon ?

Credit growth collapsing (lower credit multiplier), excess capacities worldwide (unemployment) and flat commodity prices curves: no danger !

WTI

40

60

80

100

120

140

05 06 07 08 09 10 11 12

40

60

80

100

120

140

Sources : NATIXIS

Private Sector Credit Growth (%, yoy)

-10

-5

0

5

10

15

02 03 04 05 06 07 08 09

-10

-5

0

5

10

15 US UK Euro zone J apan

Sources : Datastream, FoF, BCE, BOE, NATIXIS

Public debt is always bad for long term interest rates ?

It all depends on the behavior of private agents (private deleveraging can harm growth for a (very) long time) and offset the supply effect of public debt

Japan: Debt (% GDP)

60

80

100

120

140

160

180

200

220

240

90 92 94 96 98 00 02 04 06 08

60

80

100

120

140

160

180

200

220

240 P ublic debt

P rivate debt (households + firms)

Sources : Datastream, FOF, NATIXIS

Public Debts as a share of GDP

30

40

50

60

70

80

90

02 03 04 05 06 07 08 09 10

30

40

50

60

70

80

90 US Euro Zone UK

Sources : Datastream , prévisions NATIXIS

The behavior of the (sovereign) yield curve

A short end of long end effect ? There is a macro carry trade going on: cheap repo at the central bank and steep curve !

Yield curves slopes (10-y vs 2-y)

-50

0

50

100

150

200

250

300

07 08 09

-50

0

50

100

150

200

250

300 Germany

US

Sources : NATIXIS

Correlations breaks

Gold message is weird : higher risk aversion ? Long term inflation risk… Dollar bears ?

Inflation risk premium : a message from gold ?

2,8

3,0

3,2

3,4

3,6

3,8

j-09 a-09 j-09

800

850

900

950

1000

10-y Bund yield

Gold (USD/Ounce) - RHS

Sources : NATIXIS

Do we have a story here ?

The USD: a safe haven trade?DXY and capital flows towards emerging

markets

-2

-1,5

-1

-0,5

0

0,5

1

-20 -10 0 10 20 30

DXY (chg. Over 1 year)

Em

erg

. Mkt

s fl

ow

s (t

rilli

on

s U

SD

)

The USD: a new funding currency?

Ex ante Sharpe ratios: the higher the more attractive the carry trade

BRLUSD -1,5872%AUDUSD -1,4598%NZDUSD -0,9125%ZARUSD -0,4091%

GBPUSD -0,1686%EURUSD -0,0408%JPYUSD 0,0015%CADUSD 0,0187%CHFUSD 0,1706%

(Fwd_3m-Spot)/Vol Impl. 3m

Why is the yen soaring ?

FX as an asset class

Tracking correlations and… regime switches

DJ Eurstoxx 50 et EUR/USD

1,1

1,2

1,3

1,4

1,5

1,6

1,7

1500 2000 2500 3000 3500 4000 4500 5000

DJ Eurostoxx 50

EU

R/U

SD

FX regime switch

Correlation breakdowns: mean reversion or regime switch ?I guess USD/JPY takes the early signal lead…

Macro crosse trades early signs ?

85

90

95

100

105

110

115

08 09

600

800

1000

1200

1400

1600

USD/J P Y

SP 500 - RHS

Sources : Bloomberg

Correlation breakdown as an early signal ?

-1,0

-0,5

0,0

0,5

1,0

08 09

-1,0

-0,5

0,0

0,5

1,0

Rolling correlation (1-month)

Average

Sources : Natixis

A new conundrum ? Everything's up !

USUAL SUSPECT: GLOBAL LIQUIDITY ! Who’s to blame ? FX Pegs…

An indicator of bubbles intensity

0

0,01

0,02

0,03

0,04

0,05

0,06

0,07

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

-5

0

5

10

15

20

25

30

Over-reaction of markets: absolute change of 36-th months rolling volatility (S&P 500)

Global liquidity (%, yoy) - RHS

Sources : Datastream, NATIXIS

Tracking the cycle to forecast risk aversionVIX & PMI : forecasts

35

40

45

50

55

60

98 99 00 01 02 03 04 05 06 07 08 09 10 11

10

15

20

25

30

35

40

45

Global P MI Manufacturing

VIX - inv. Scale - RHS

Sources : Bloomberg

VIX and Global liquidity explains many things !

An example: Modeling the EUR/USD

0

10

20

30

40

50

60

70

80

90

100

7.6

8.0

8.4

8.8

9.2

9.6

10.0

10.4

10.8

11.2

11.6

2004 2005 2006 2007 2008 2009 2010

VIXLIQ_M

1.1

1.2

1.3

1.4

1.5

1.6

1.7

2006 2007 2008 2009 2010

EURBORNESUP_EURBORNEINF_EURPREV_EURFWD_EUR

To concludeThe cycle has changed: structural impact of the crisis on the functioning of economies: deleveraging, public debt…Don’t be afraid of inflation: at least in the short run.There is no hurry to exit Huge amounts of liquidity due to stockpiling of FX reserves, to a much lesser extent to Quantitative EasingVolatility tracks the cycle and the W is looming

FX to be treated as an asset class (all but YEN)Rates to remain low at the short endLong end more and more capped by Bank’s carry, maturity transformation strategies…

Hot Topics – Open Discussion• How best to execute a hedging strategy in the current difficult credit markets. • Liquidity management strategies for FX hedge portfolios.• Managing counterparty credit risk in a post-Lehman world.• FX Hedging in currency pairs where the FX forward curve is stacked against you (e.g. BRL, MXN, INR).• Hedging the interest rate risk associated with the acquisition of debt securities such as whole loans, CMBS paper, CDO/CLOs, etc.• Hedging interest rate risk in a challenging steep yield curve environment.

TablesExchange rates forecasts

Today 3 months 6 months 12 months

Main currencies

EUR/USD 1,4562 1,44 1,39 1,45Fwrd 1,46 1,46 1,46

USD/JPY 89,59 89 89 95Fwrd 89 89 89

EUR/JPY 130,46 128 124 138Fwrd 130 130 130

GBP/USD 1,5894 1,59 1,50 1,52Fwrd 1,59 1,59 1,59

EUR/GBP 0,9162 0,90 0,93 0,95

Fwrd 0,92 0,92 0,92

EUR/CHF 1,5200 1,52 1,50 1,53Fwrd 1,51 1,51 1,50

USD/CHF 1,0438 1,06 1,08 1,06Fwrd 1,03 1,03 1,03

Commodity currencies

AUD/USD 0,8698 0,90 0,85 0,88Fwrd 0,86 0,85 0,84

NZD/USD 0,7159 0,73 0,70 0,73Fwrd 0,71 0,71 0,70

USD/CAD 1,0821 1,06 1,05 1,02Fwrd 1,08 1,08 1,08

USD/ZAR 7,6581 7,50 7,60 7,40Fwrd 7,79 0,00 0,00

USD/NOK 5,8009 5,85 6,04 5,66Fwrd 5,82 5,84 5,89

Maturity 30/09/09 3m 6m 12m

2-year NATIXIS 0,95 1,13 1,08 1,39Forward 1,25 1,51 2,05TILT* 1,31 0,77 1,38

5-year NATIXIS 2,31 2,32 2,17 2,40Forward 2,54 2,74 3,13

TILT 2,63 2,14 2,7010-year NATIXIS 3,31 3,34 3,21 3,50

Forward 3,42 3,52 3,71

TILT 3,73 3,40 3,7830-year NATIXIS 4,05 4,09 3,97 4,18

TILT 4,59 4,58 4,60

United States

30/09/09 3m 6m 12m

1,27 1,29 1,27 1,49

1,53 1,83 2,371,36 1,23 1,38

2,40 2,47 2,43 2,592,57 2,74 3,05

2,37 2,27 2,533,22 3,35 3,30 3,38

3,38 3,48 3,67

3,30 3,20 3,473,95 4,06 4,00 4,05

4,09 4,09 4,11

Germany