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8/9/2019 TD BANK JUL 14 Global Markets
1/18
LONDON TORONTO NEW YORK SINGAPORE
Global MarketsJuly 14, 2010
Rates & Foreign
Exchange Research
MANAGING LOW GROWTH AND RETURN
EXPECTATIONS IN A MORE VOLATILE WORLD
CONTENTS
Lead Article: Managing Low Growth and
Return Expectations in a More Volatile
World 1
US Fixed Income 5
Canadian Fixed Income 6
UK Fixed Income 7
Australian Fixed Income 8New Zealand Fixed Income 9
US Dollar 10
Canadian Dollar 11
Euro 12
Japanese Yen 13
UK Pound 14
Australian Dollar 15
New Zealand Dollar 16
Swiss Franc 17
Summary Foreign Exchange Table 18
Downside growth risks opening-up
The global economy is at a sensitive point in the cycle as it transitions
from policy driven expansion to sustained private demand. Global purchasing
managers surveys peaked in May, and the growth tailwind from the inventory
rebuild is blowing with less force. We are at that point in the recovery where
data surprises are no longer all to the upside, and signicant variation in growth
forecasts is distributed about the globe adding to forecast uncertainty.
Since the last edition ofGlobal Markets, surprises have been to the downside
and the G20 has signed-up to short-term, growth depressing, scal austerity.
Market based measures of ination expectations have fallen in response, and USten year yields have declined about 50 basis points to about 3.00% pulling-down
interest rates everywhere.
Yet, getting traction from lower interest rates is difcult with the worlds
banking system still in a state of disrepair and incomplete recovery, as monetary
policy is partially
disconnected from
both households and
small and medium
sized business. Faith
and confidence in
sustained economicrecovery is weak,
and an unwelcome
uncertainty has re-
turned to risk asset
markets, uncertainty
that will be slow to
dissipate.
We have made
much of the distinc-
tion between risk and
uncertainty, where the latter prevents investors from making well calibratedinvestment decisions. So, even as interest rates declined, risk asset markets have
struggled to hold onto their start-of-the-year levels. This uncertainty has been
reected in much higher volatility.
European mismanagement of the Greek scal challenge transformed a con-
tainable problem into an incipient banking system crisis. A negative conuence
of uncertainty owed to gut risk assets and raise fear of economic downside jus
at the time when the global industrial production recovery was peaking.
Guarding against downside risk means more quantitative easing
With bank credit barely available, debt market issuance unimpressive, and
risk assets trading in a volatile range, concern about the durability of the globa
HIGHLIGHTS
Growthissettlinginatasub-par
rate and downside risks domi-
nate
Quantitativeeasing is possible
but doubts about its effective-
ness make it unlikely now
Interestrateswilllikelybekept
lower for longer to facilitate
structural adjustment
Growthandreturnexpectations
should be kept low and reason-
able
Andwithmanydownsideeco-nomicandnancialriskslurking
beneath the surface
Financialvolatilityislikelytobe
high and range bound making
strategic investment decisions
difculttoembrace
Thepublication also includes
quarterly interest rate and ex-
change rate forecasts for the
US, Canada, UK, Australia, and
New Zealand, and also offers ad-
ditional exchange rate forecastsfor the Japanese yen, the euro,
the UK pound, and the Swiss
franc
MAJORGLOBALEQUITYMARKETS:STRUGGLING
TO HOLD START OF YEAR LEVELS
70
75
80
85
90
95
100
105
110
Jan.09 Feb.09 Mar.09 Apr.09 May.09
S&P 500
TSX
DAX
Nikkei
Source: Bloomberg
Index (Jan 6 2009 = 100)
8/9/2019 TD BANK JUL 14 Global Markets
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Global MarketsJuly 14, 2010
Rates & FX Research
2
recovery has put pressure on central banks to once again en-
join with quantitative easing, QE, potentially adding another
measure of cash to what is already abundant global liquidity.
The bar to delivering more QE at the Fed, the ECB andthe BoE is fairly high, both analytically and politically.
QE is not a near-term risk in the absence of another nega -
tive shock, as there are signicant reservations about how
effective a renewed round of QE would be either to keep
faith in the recovery alive, or to effectively boost demand
in response to any downside shock.
Casting doubt on the effectiveness of more
quantitative easing
Why doubt QEs effectiveness? First, commercial banks
in the most effected countries the US and the UK haveessentially hoarded the cash pushed into their balance sheets
by the Fed and the BoE, and higher reserve holdings have
deed our understanding of how the supply of money cre-
ates deposits and loans. Large reserves have not stimulated
renewed and strong loan growth. The desire to hold more
cash is shared by the nancial and non-nancial sectors
alike after the 2008 crisis temporarily disabled the banking
system, and holdings of cash seem in excess of precaution-
ary needs.
QE should depress benchmark government rates, mak-
ing spreads to risky assets more attractive, and by loweringinterest rates, entice precautionary savings to shift towards
current spending. But instead, we continue to see excessive
hoarding of cash that will not aid economic activity until it
is put fully to use.
The desire by commercial banks to hold big reserves at
the central bank seemed understandable when tightening
bank capital requirements and regulatory demands for more
liquidity were at their height after the 2008 crisis, but this
seems less pressing today as credit standards have broadly
ceased to tighten.
Nonetheless, global regulators seem set on much higher
capital requirements, lower leverage ratios, and high li-
quidity requirements all of which constrain top line credi
creation at a time when the economy needs access to credit
in order to grow. Structural headwinds remain intense, and
central banks and regulators appear not to have managed
well the conict between achieving structural stability and
facilitating strong near-term growth.
Secondly, QE also works through non-bank nancia
players, especially institutional investors. QE was expected
to induce a change in investor behaviour. Risk-free assets
VOLATILITY AND RISK SPREADS STILL
RELATIVELY HIGH
0
20
40
60
80
100
120
1/00 9/05 6/06 4/07 12/07 9/08 6/09 3/10
0
200
400
600
800
1000
1200
1400
1600
1800
2000
VIX (lhs)
MOVE Index* (lhs)
Corp-Spreads* (lhs)
CMBS Spread (rhs)
*MOVE Index (an index of US Treasury Volatility), indexed to VIX index in 2005; **Corp-
Spreads (BBB corp spreads over UST'S), indexed to VIX index in 2007; Source Bloomberg
AAA CMBS -Treasury SpreadIndex (March 16 2007 = 16.8)
COMPRESSION IN YIELDS HAS COME FROM
LOWER INFLATION EXPECTATIONS
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Jul.09 Sep.09 Oct.09 Dec.09 Jan.10 Mar.10 May.10 Jun.10
10-Yr Real
10-Yr Break-Even
10-Yr Nominal
%
Source: Bloomberg
LOWER GROWTH AND INFLATION
EXPECTATIONS A COMMON FORCE FOR LOWER
RATES
2.0
2.5
3.0
3.5
4.0
Jan.09 Apr.09 Aug.09 Nov.09 Mar.10 Jun.10
Canada
U.S.
Germany
Source: Bloomberg
%
8/9/2019 TD BANK JUL 14 Global Markets
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Global MarketsJuly 14, 2010
Rates & FX Research
3
essentially government bonds -- taken onto the central
banks balance sheet are paid for by creating reserves leav-
ing investors with cash.
The spring of 2009 was the ideal time to execute quantita-
tive easing and push cash into institutional investors, as the
preconditions to success were highly favourable. Long-run
measures of equity value, and other risk assets, such as price-
earnings ratios and price-to-book, showed unambiguous
value signalling that the risk of loss was likely to be low.
Given that the returns to cash are deeply negative in realterms, this creates a push out of cash into risky assets in the
search for returns that are closer to investment hurdle rates
some distance from current cash rates, which in turn helps
shape an environment of rising condence through capital
gains and recovery of lost wealth. This push is powerful
when value is good, ination is expected to be positive, and
risk of loss is low. It is not so powerful when value is not so
good, and where expectations of deation create a positive
real return to cash should price changes turn south. The risk
of loss from exposure to risk assets is now comparatively
large, undermining the likelihood QE will be as effective.
ButifQEsinthecardsdoitswiftlyanddoalot
While it may be less effective than before, the asymmet-
ric risk of deation argues that QE might best be used sooner
rather than later and more rather than less in the hope that
it changes perceptions of the balance of risks and is trans-
mitted through the nancial and real economy through the
expectations channel. Quantifying how to proceed is hard
to calibrate precisely when the transmission mechanism is so
vague, so any action has to be decisive and impressive. No
central bank seems willing to take on this commitment now
If a period of deation settles-in, real interest rates ris
deterministically increasing the incentive to hold cash overisky assets, sapping an economys growth momentum. Thi
fear could potentially rise as the pace of economic growth
decelerates in the second half of 2010 and deation risk
slip into uncertain macro forecasts.
We believe QE will nd it harder to leverage the push
from cash today, and it is not clear that pushing asset price
excessively higher to compensate for a poorly performing
banking system justies the risks of a renewed asset price
bubble. Moreover, neither private nor public actors hav
the ability to absorb another negative shock.
Making liquidity abundant in the face of crisis wa
what QE was designed to do, and it did so to great effec
in secondary debt markets, which at the end of 2008 had
ceased to function. Corporate debt spreads were much wide
than the spread consistent with a reasonable probability o
default, even in an environment of considerable economi
and nancial distress, so the big issue was eliminating the
illiquidity premium.
The bank lending market and secondary debt market
are not substitutes: they are complements, so abundan
bank liquidity was a necessary condition to achieve relief in
secondary debt markets. The Feds acquisition of mortgag
backed securities introduced massive amounts of neede
liquidity into the system and kick-started the mortgag
market and brought mortgage spreads down.
Interest rate relief translated into household and corpo
rate cash-ow relief as mortgages and loans were re-priced
facilitating debt reduction or renewed expenditures. Thi
was very helpful in stabilizing the level of prices and output
However, the circumstances that allowed unconventiona
monetary policy to get solid traction in the spring of 2009
are now absent. Equity markets are close to long-run faivalue, suggesting that risk of loss is higher than it was in
March 2009 as the 12% Q2 decline in the S&P made clear
The push from cash is now much weaker.
With the initial conditions for QE less conducive, it i
not clear that a renewed round of QE can really help, so
we will just have to wait for the banking system to become
sufciently capitalized before we should expect a highe
rate of economic expansion and a sustained take up of spare
capacity.
CENTRAL BANK BALANCE SHEETS: TRYING
HARD NOT TO EXPAND
0.0
0.5
1.0
1.5
2.0
2.5
3.0
08 09 10
Federal Reserve
ECB
BoE
Source: Flow of Funds, Bloomberg, ECB
Index (Jan. 2008 = 1)
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Global MarketsJuly 14, 2010
Rates & FX Research
4
A slow growth world is a low return world
Recoveries from nancial crisis are half-speed recover-
ies precisely because the demand for credit is slow, and the
nancial systems ability to supply credit is constrained. So,
we should expect recovery to be slow, disinationary slack
to remain, and interest rates to remain low. The post-war
policy power to reduce economic pain in the face of eco-
nomic distress is all but tapped-out, and expectations that
central banks and QE can provide a quick x are too high.
There are a few key risk events to clear over the summer
months, not least of which is the European bank stress test.
To earn some market credibility, some banks will be found
to be insolvent, and so the next hurdle will be how to resolve
identied insolvency: recapitalization or liquidation. Either
way, there will be some renewed nancial burden for already
over-burdened states. And, with scal drag just around the
corner, more unemployment could mean more bank losses
and more insolvency.
The round of credit rating agency downgrades is likely
not over, and the Euro remains sensitive to more bad scal
news. Moreover, the ECB continues to deny the Eurozones
liquidity needs, and the drag from peripheral Europe which
needs a private sector offset to harsh scal contraction has
barely got going. Meanwhile, signicant outperformance
by the German economy relative to peripheral Europe willraise the hurdle for intervention to stave off disinationary
or even deationary risks for parts of the Eurozone. There
are more negative surprises ahead.
And what about our hopes that Asia can sustain globa
demand to backstop structural drag from the developed
world? Dont bet on it. Asias development plan has devoted
capital to meeting the import needs of the developed worldand while developing Asia acknowledges that it needs to
absorb more of its own output, it cannot redirect productiv
capacity to home markets overnight. Any attempt to do so
would inevitably lead to slower global growth as resource
were redirected. Enterprises can disappear overnight, bu
it takes time for their replacements to emerge.
Correspondingly, investor return expectations likely
remain too high in a low ination world when real interes
rates need to remain abnormally low to achieve recovery
The returns to risk will also likely be low, and given tha
the systems capacity to absorb shocks is small at a vulnerable time, volatility should remain higher than we have
been used to.
When volatility is trading to the bottom end of recen
higher ranges, it remains time to buy insurance rather than
take on more exposure to squeeze-out a bit more return
Risk asset markets are likely to remain highly tactical in th
months ahead and navigating a period of slow economic
growth for those conditioned to high growth is going to b
a challenge.
Andrew Spence
Global Head, Rates and FX Research
416-308-460
EM EXPORTS STILL LAG DEVELOPED WORLD
DEMAND
-40
-30
-20
-10
0
10
20
30
40
5/105/095/085/075/065/05
-15
-10
-5
0
5
10
15
EM Exports* (rhs)
US ISM Import Data (lhs)
*Taiwan and South Korea; Source: Bloomberg
3-month 3m% chan e
JP MORGAN'S GLOBAL PMI
LIKELY PEAKED IN APRIL
30
35
40
45
50
55
60
1/08 5/08 9/08 1/09 5/09 9/09 1/10 5/10
Source: JP Morgan
Index
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Global MarketsJuly 14, 2010
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5
US FIXED INCOME
Growth in the US is peaking and while we believe the
recovery remains in place, the pace of that recovery has be-
come less certain and policy efforts designed to encourage
more borrowing and more spending are at risk of failing.
Risk taking requires clarity and that remains elusive. The
key question is whether the deceleration in the real economy
will produce further downward pressure on core ination,
and how much of a slowdown is in the ofng. Thus far the
economic data has been pointing to little more than a mod-
eration in growth. However, broader support for growth is
fading. The inventory repletion cycle is leveling off, net
exports have transitioned to a net drag on growth, and scal
austerity in some form is fast approaching.
The overall mix of moderating economic activity anddisination continues to look positive for bonds and poor
for risk assets more broadly. Treasury yields have rallied as
real rates and ination expectations have fallen, and market
positioning remains favorable. Net short positions have been
squeezed, but bond portfolio managers have still not made
the adjustment from short to neutral. Real yields (deated
using core CPI or 10 ination swap) are not unsustainably
low and are actually above the 7yr rolling average. Further
real yield compression could therefore magnify the downside
in nominal yields as ination drifts lower. At the same time
net corporate borrowing remains in a steady downtrend,treasury issuance has rolled off its high, and core ination
poised to decelerate further over coming months.
It is little surprise that real rate expectations continue to
recede in this environment. In April, the market was pricing
in almost two rate hikes by Feb 2011. The market has since
pushed out those two rate hikes to December 2011, as the
prevailing view of lower for longer has gained more trac-
tion. Given the entire cross currents in this recovery, we also
expect the Fed will remain more rather than less cautious.
We have modestly pushed back the beginning of the
tightening regime to Q2 2011 and expect year end 2011
fed funds to come in around 1.00%, an expectation that
US 3-MONTH T-BILL RATES & 10-YEAR
GOVERNMENT BOND YIELDS
0
1
2
3
4
5
6
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
0
1
2
3
4
5
6
Actual data to: Q2 2010; Forecast by TDBFG as at July 2010;Source: Federal Reserve Board/Haver Analytics
%
10-yr Gov't Bond Yield
3-mo T-Bill yield
%
Forecast
US FIXED INCOME OUTLOOK
Spot Rate 2009 2010 2011
12/07/10 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
Fed Funds Target Rate (%) 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.50 0.75 1.00
3-mth T-Bill Rate (%) 0.14 0.18 0.18 0.11 0.05 0.16 0.18 0.25 0.35 0.35 0.70 1.05 1.25
2-yr Govt. Bond Yield (%) 0.64 0.80 1.11 0.95 1.14 1.02 0.61 0.70 0.80 1.05 1.30 1.50 1.70
5-yr Govt. Bond Yield (%) 1.83 1.66 2.55 2.34 2.68 2.54 1.78 1.85 1.90 2.20 2.25 2.35 2.55
10-yr Govt. Bond Yield (%) 3.04 2.66 3.53 3.31 3.84 3.83 2.93 3.05 3.00 3.40 3.60 3.70 3.80
30-yr Govt. Bond Yield (%) 4.04 3.53 4.33 4.05 4.64 4.71 3.89 4.00 3.90 4.35 4.40 4.40 4.50
10-yr-2-yr Govt. Spread (%) 2.40 1.86 2.42 2.36 2.70 2.81 2.32 2.35 2.20 2.35 2.30 2.20 2.10
f: Forecast by TD Bank Financial Group as at July 12, 2010; All forecasts are for end of period. Source: Bloomberg, TDBFG
remains slightly more aggressive than is currently priced in
the market. This expectation is premised by what we expec
will be an upward sloping growth and ination prole a
that time, one that will warrant a move off the zero bound
Quantitative easing is another, though admittedly, contrary
consideration. While we recognize the growing case for such
actions, there is simply not sufcient evidence thus far to
endorse such a move in our forecast prole. Moreover, the
hurdles at the FOMC given its current composition sugges
a pretty high threshold in 2010.
The 10 year treasury yield is expected to hold around
3% at the end of Q3, driven by ongoing uncertainty, falling
ination, and in an August month which is normally the mos
bullish for rates in the calendar year. In Q4 it moves lower inyield owing to these considerations and on technical factors
but closes out the quarter at 3.0 %. Thereafter, rates move
higher and the curve bear attens. The year end 2011 targe
of 3.8% is achieved as the deation scare and term premium
are unwound and higher real rate expectations gain traction
Eric Green, Chief U.S. Strategist, 212-827-7156
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Global MarketsJuly 14, 2010
Rates & FX Research
6
CANADIAN FIXED INCOME
Canadian bonds have rallied by 20-30bps across the
yield curve since the last Global Markets in mid-June, par-
roting a similar shift elsewhere in the world. Primarily, this
has reected a souring of attitudes towards global growth
prospects and the ination outlook, speculation that some
central banks might re-engage quantitative easing, and gen-
eral risk-aversion. Despite the rally, Canadas 10-year yield
is still more than 60bps above its early 2009 low, indicating
that current concerns are an order of magnitude less severe
than during the worst of the credit crunch.
In fact, notwithstanding the substantial rally in Cana-
dian bonds, it is fair to argue that Canada continues to waft
blissfully above the fray, barely affected by the weighty
reality of global events below. In contrast to much of theworld, Canadian credit is owing, jobs are being created at
a blistering pace, and the housing market is booming. Ac-
cordingly, Canadian monetary policy has diverged from the
global trend, with the Bank of Canada initiating its tighten-
ing sequence by adding 25bps to the overnight rate on June
1st. At present, the market anticipates another rate increase
in late July, but has serious reservations about aggressively
pricing in further hikes. In turn, the short end of the Canadian
curve has an unsustainably low yield.
TD believes that the Bank of Canada has more scope for
rate increases than the market imagines. Domestic condi-tions argue for an overnight rate discernibly higher than it
is right now, closer to 1.00% according to various simple
monetary policy rules, and destined to rise further as the re-
covery progresses. What (rightly) keeps the Bank of Canada
from immediately seeking out this destiny are several global
risks that skew to the downside. It is this precarious balance
that ultimately denes the Bank of Canadas actions.
While TD remains comfortably on the high side of the
market consensus for the Bank of Canada, we have none-
theless scaled back our hiking expectations to reect the
aforementioned global risks and slowing second half growth
removing one hike from late 2010, and another from late
2011. Nonetheless, the prospect of a Bank of Canada over-
night rate at 2.50% at the end of 2011 still argues forcefully
for higher yields, and while the near term will continue to be
coloured by ckle shifts in risk appetite, the medium term
and beyond should reveal a period of rising yields in Canada
and a attening curve. Given our newly downgraded U.S
forecast, we expect Canadian bonds to underperform the
U.S. across the curve into year-end 2010.
CANADIAN 3-MONTH T-BILL RATES & 10-YEAR
GOVERNMENT BOND YIELDS
0
1
2
3
4
5
6
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
0
1
2
3
4
5
6
Actual data to: Q2 2010; Forecast by TDBFG as at July 2010;
Source: Bank of Canada/Haver Analytics
%
10-yr Gov't Bond Yield
3-mo T-Bill yield
%
Forecast
CANADIAN FIXED INCOME OUTLOOK
Spot Rate 2009 2010 2011
12/07/10 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
Overnight Target Rate (%) 0.50 0.50 0.25 0.25 0.25 0.25 0.25 1.00 1.25 1.75 2.00 2.25 2.50
3-mth T-Bill Rate (%) 0.51 0.35 0.25 0.23 0.19 0.29 0.51 1.10 1.35 1.85 2.10 2.35 2.55
2-yr Govt. Bond Yield (%) 1.67 1.08 1.21 1.27 1.48 1.74 1.39 1.95 2.05 2.30 2.60 2.80 3.00
5-yr Govt. Bond Yield (%) 2.50 1.75 2.47 2.58 2.77 2.90 2.33 2.65 2.75 2.95 3.25 3.40 3.50
10-yr Govt. Bond Yield (%) 3.20 2.78 3.36 3.31 3.61 3.57 3.08 3.35 3.40 3.60 3.80 3.90 3.95
30-yr Govt. Bond Yield (%) 3.74 3.56 3.86 3.84 4.08 4.12 3.65 3.85 3.90 4.00 4.15 4.20 4.25
10-yr-2-yr Govt. Spread (%) 1.53 1.70 2.15 2.04 2.13 1.83 1.69 1.40 1.35 1.30 1.20 1.10 0.95
Canada-US Spreads
3-mth T-Bill Rate (%) 0.37 0.17 0.07 0.12 0.14 0.13 0.33 0.85 1.00 1.50 1.40 1.30 1.30
2-yr Govt. Bond Yield (%) 1.03 0.28 0.10 0.32 0.34 0.72 0.78 1.25 1.25 1.25 1.30 1.30 1.30
5-yr Govt. Bond Yield (%) 0.67 0.09 -0.08 0.24 0.09 0.36 0.55 0.80 0.85 0.75 1.00 1.05 0.95
10-yr Govt. Bond Yield (%) 0.16 0.12 -0.17 0.00 -0.23 -0.26 0.15 0.30 0.40 0.20 0.20 0.20 0.15
30-yr Govt. Bond Yield (%) -0.30 0.03 -0.47 -0.21 -0.56 -0.59 -0.24 -0.15 0.00 -0.35 -0.25 -0.20 -0.25
f: Forecast by TD Bank Financial Group as at July 12, 2010; All forecasts are for end of period. Source: Bloomberg, TDBFG
Eric Lascelles, Chief Canada Macro Strategist
416-982-8979
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Global MarketsJuly 14, 2010
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7
UK FIXED INCOME
A dash of European stability and a pinch of a credible
budget can make a big difference. While European yields
have been marching higher as the ECB normalizes liquidity,
gilt yields are slightly lower than one month ago and 8-13
basis points lower on 2s and 10s since the release of the UK
budget. The June 22nd budget forecasts net debt to GDP
peaking at 70% of GDP by the 2013/14 scal year one year
earlier and four percentage points lower than the previous
budget. The risk of a rating downgrade will continue to
lurk over the market, but the message appears to be that if
the government can implement the budget as is, even if the
economy is slightly weaker than expected, then the U.K.
should be able to retain its AAA rating.
The more pressing driver on the short end of the curvecontinues to be the strong three-way risks for the Bank of
England. While ination is easing towards the 2% target
by year-end, it also continues to surprise consensus to the
upside. Ination expectations remain elevated, survey evi-
dence suggests there is not as much slack in the economy
as the fall in GDP purports, and the BoE has at least one
dissenter looking for rates to move higher.
But demand data continues to disappoint on the down-
side, GDP in the second half of the year is unlikely to breach
a 2% annualized pace, and one-off factors of currency
depreciation and tax increases, as well as scal tightening,continue to be cited by doves as reasons to look through the
current pressures. We see the BoE beginning to raise rates
in the rst quarter of 2011, and even see a good tail risk this
comes a quarter earlier, but OIS markets have yet to fully
price in even one rate hike over the next 12 months. As the
move from the BoE is priced in by the market in the second
half of the year, we see the currency and short-end yields
being supported from their lows.
Nevertheless, the normalization in rates will be quite
gradual. Real 2-year yields will struggle to turn positive as
nominal yields just touch 2.50% by end-2011. As 10-year
yields move towards 4.25% by end-2011, this will still leave
the 2s10s spread at a historically steep 175 basis points
GBP strength against the EUR will have to do most of the
work in reining in ination as U.K. yields are held back by
a sluggish domestic recovery and the gravitational pull of
U.S. yields only slowly traipsing off the oor.
Richard Kelly, Senior Strategis
+44 20 7786 8448
UK 3-MONTH T-BILL RATES & 10-YEAR
GOVERNMENT BOND YIELDS
0
1
2
3
4
5
6
Mar.03 Mar.05 Mar.07 Mar.09 Mar.11
Actual data to: Q2 2010; Forecast by TDBFG as at July 2010;
Source: Bank of Canada/Haver Analytics
%
10-yr Gov't Bond Yield
3-mo T-Bill yield
%
Forecast
UK FIXED INCOME OUTLOOK
Spot Rate 2009 2010 2011
13/07/2010 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
Bank Rate Target (%) 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75 1.00 1.25 1.50
3-mth T-Bill Rate (%) 0.49 0.67 0.55 0.41 0.46 0.57 0.54 0.65 0.70 1.05 1.30 1.45 1.70
2-yr Gilt Yield (%) 0.78 1.19 1.33 0.88 1.32 1.16 0.75 1.10 1.25 1.95 2.10 2.35 2.50
5-yr Gilt Yield (%) 2.06 2.36 2.88 2.64 2.81 2.71 2.07 2.20 2.25 2.65 2.90 3.25 3.50
10-yr Gilt Yield (%) 3.38 3.17 3.69 3.59 4.02 3.94 3.36 3.50 3.55 3.80 3.90 4.15 4.25
30-yr Gilt Yield (%) 4.19 4.17 4.40 4.09 4.42 4.53 4.17 4.10 4.15 4.20 4.35 4.45 4.50
10-yr-2-yr Gilt Spread (%) 2.60 1.97 2.36 2.71 2.70 2.78 2.61 2.40 2.30 1.85 1.80 1.80 1.75
f: Forecast by TD Bank Financial Group as at July 14, 2010; All forecasts are for end of period. Source: Bloomberg, TDBFG
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AUSTRALIAN FIXED INCOME
The RBA left the cash rate unchanged at 4.5% for both
the June and July RBA Board meetings, citing that prevail-
ing average lending rates are appropriate for now. Thosedecisions were widely expected. However, with ongoing
risk aversion and concerns that a sluggish Europe and US
will spillover into Asian growth prospects, there has been
a near-indenite shelving of expectations for higher cash
rates in Australia. Responding to global matters more
than domestic, bonds yields continued to plummet in the
last month: 3-year yields down 18bp to 4.58% and 10-year
yields down 23bp to 5.18%. In other words, 3-year yields
are practically at to cash (sometimes yields are sub-cash
in the more risk-off trading days) and there is next to no
term premium priced.Nevertheless, safe-haven appetite for Australian AAA-
rated/high-yield bonds is ongoing, with auctions attracting
a bid/cover ratio of over 3 in recent weeks. There are hits
and misses, such as a recent ination-linked bond attract-
ing a bid/cover of nearly 6, but a new mid-curve maturity
(Jun 16) attracted a thin bid/cover of 1.9. We suspect the
4.75% coupon of the 16s is relatively unattractive compared
with its mid-curve neighbours of 6.25% for the Apr 15s and
6.00% for the Feb 17s.
The RBAs most recent communiqu in early July stated
that growth in Asia was very strong, ination appearslikely to be at or above the 3% upper tolerance level, and
the terms of trade are approaching their peak of two years
ago. We believe restrictive monetary policy is appropri-
ate for Australia given strong economic ties to the fastest
growing region in the world; the economy is already fully
employed; and ination is already at the top of the RBAs
2-3% target band. However, acknowledging ongoing uncer-
tainty about global growth prospects, we reluctantly pushed
out 50bp of tightening, so that the cash rate is forecast to
be 5% by year end and 6% by end-2011.
The OIS market in the last month has oscillated between
AUSTRALIA FIXED INCOME OUTLOOK
Spot Rate 2009 2010 2011
14/07/2010 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
Cash Target Rate (%) 4.50 3.25 3.00 3.00 3.75 4.00 4.50 4.75 5.00 5.25 5.75 6.00 6.00
3-mth Bank Bill Rate (%) 4.87 3.78 3.20 3.20 4.00 4.45 4.40 5.25 5.50 5.75 6.20 6.20 6.20
3-yr Govt. Bond Yield (%) 4.58 3.02 4.17 4.72 4.66 5.28 4.42 4.80 5.05 5.50 5.80 6.00 6.00
5-yr Govt. Bond Yield (%) 4.80 3.25 4.86 5.10 5.16 5.52 4.67 5.10 5.28 5.55 5.90 6.00 6.00
10-yr Govt. Bond Yield (%) 5.18 4.26 5.62 5.38 5.64 5.78 5.10 5.20 5.30 5.75 6.00 6.00 6.00
10-yr-3-yr Govt. Spread (%) 0.60 1.24 1.45 0.66 0.98 0.51 0.68 0.40 0.25 0.25 0.20 0.00 0.00
Forecast by TDBFG as at July 14, 2010; All forecasts are for end of period. Source: Bloomberg, TDBFG
AUSTRALIAN 3-MONTH T-BILL RATES & 10-YEAR
GOVERNMENT BOND YIELDS
0
1
2
3
4
5
6
7
8
9
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
0
1
2
3
4
5
6
7
8
9
Actual data to: Q2 2010; Forecast by TDBFG as at July 2010;
Source: Reserve Bank of Australia/Haver Analytics
%
10-yr Gov't Bond Yield
3-mo T-Bill yield
%
Forecast
pricing 20% chance of a 25bp cut in the cash rate to 20%
chance of a 25bp hike in the cash rate by year end literally
swaying with the risk on/risk off breeze. This is unhelpful
and best ignored for now.
We have dramatically shaved down our bond yield
forecasts, primarily due to our US colleagues forecasting
later and lesser tightening by the US Federal Reserve and
subsequent slashing of bond yield forecasts. We still expec
the Australian curve to underperform the US yield curve due
to higher ination and interest rate expectations.
The 3-10 year curve is currently +60bp, and we expec
attening to continue to around +25bp heading into year
end. Into 2011 we have the unusual forecast of a zero
yield curve, with the short end beholden to higher domes-tic interest rates, but the long-end beholden to lower bond
yields globally due to excess capacity and weak inationary
pressures.
Annette Beacher, Senior Strategist
+65 6500 8047
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NEW ZEALAND FIXED INCOME
New Zealand bond yields in the last month have dramati-
cally underperformed their Australian cousins, primarily due
to the RBNZ only just embarking on the normalization of
the cash rate. The cash rate was at last lifted by 25bp to
2.75% last month and the RBNZ is widely tipped to fol -
low up with +25bp to 3% later this month. While all cash
rate increases have been priced out of the Australian curve,
the New Zealand curve has priced additional tightening at
each opportunity for quite some time. Subsequently, while
3-year and 10-year yields have rallied in the past month on
overall safe-haven trading, yields have only fallen by 9bp
and 10bps respectively, and spot yields are well above the
prevailing cash rate.
While we were wrong expecting the RBNZ to be more pro-active in restoring the stance of monetary policy to
more neutral levels like the RBA, it is now unfortunate that
the RBNZ are embarking on a tightening course just as the
economy appears to have stalled. Recent activity data have
stagnated such as retail sales, home sales and house prices.
The OIS market has priced most of our near-term cash
rate view, with a cash rate of 3.5% by year end (TD 4%),
but stalls thereafter. We remain of the view that cash rates
are highly unlikely to sit at a still-accommodative 4% by the
end of next year and expect further tightening by the RBNZ
next year back to more neutral levels.As with Australia, we have lowered our New Zealand
bond yield forecasts due to much reduced US yield forecasts.
We still expect the New Zealand yield curve to underperform
the US curve (due to higher ination and interest rates as
well as reecting risk of holding AA+ paper) with spreads to
the US expected to continue rising from the current +230bp
to +285bp by year end. We also expect underperformance
against AAA-rated Australia, with the current spread of
+25bp expected to trade closer to +55bp by year-end.
The 3-10 year curve is currently +114bp, and we expec
attening to continue to around +65bp heading into year
end. Into 2011 we have a similar situation to Australiapublishing the unusual forecast of a zero yield curve by
the second half of next year, with the short end beholden to
higher domestic interest rates, but the long-end beholden to
lower bond yields globally due to excess capacity and weak
inationary pressures.
NEW ZEALAND FIXED INCOME OUTLOOK
Spot Rate 2009 2010 2011
14/07/2010 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
Cash Target Rate (%) 2.75 3.00 2.50 2.50 2.50 2.50 2.75 3.25 4.00 5.00 6.00 6.50 6.50
3-mth T-Bill Rate (%) 2.87 3.00 2.78 2.80 2.90 3.90 2.70 3.50 4.50 5.50 6.30 6.60 6.60
3-yr Govt. Bond Yield (%) 4.29 3.88 3.59 4.04 5.00 4.54 4.15 4.80 5.20 5.95 6.20 6.55 6.55
5-yr Govt. Bond Yield (%) 4.75 4.50 4.57 4.80 5.49 5.18 4.63 5.20 5.75 6.20 6.50 6.55 6.55
10-yr Govt. Bond Yield (%) 5.43 5.23 5.97 5.63 5.81 5.98 5.32 5.70 5.85 6.30 6.55 6.55 6.55
10-yr-2-yr Govt. Spread (%) 1.14 1.35 2.38 1.59 0.81 1.43 1.17 0.90 0.65 0.35 0.35 0.00 0.00
Forecast by TDBFG as at July 14, 2010; All forecasts are for end of period. Source: Bloomberg, TDBFG
NEW ZEALAND 3-MONTH T-BILL RATES & 10-
YEAR GOVERNMENT BOND YIELDS
0
1
2
3
4
5
6
7
8
9
10
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
0
1
2
3
4
5
6
7
8
9
10
Actual data to: Q2 2010; Forecast by TDBFG as at July 2010;
Source: Reserve Bank of New Zealand/Haver Analytics
%
10-yr Gov't Bond Yield
3-mo T-Bill yield
%
Forecast
Annette Beacher, Senior Strategis
+65 6500 804
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The USD has stabilized over the course of the past
month or so but the underlying trend remains favourable
and we continue to look for broader USD gains through the
remainder of the year even as US fundamental challenges
remain apparent.
The US economic recovery has stumbled, with labour
market gains remaining weak and the housing sector still
soft. At the same time, inationary pressures remain very
benign. These factors will keep the Fed on hold for longer
than we had previously expected. With US interest rates
remaining depressed while yields have risen elsewhere,
interest rate differentials have become less USD supportive
than they were in May and June. Fortunately for the USD,
the market appears to have become somewhat less sensitiveto interest rate spreads since April.
However, the economic outlook is not entirely incon-
sistent with our expectations and the US economy is still
expected to produce decent growth in 2011 (at a time when
the rest of the developed world is likely to be experienc-
ing a sub-par expansion still). Growth of just under 3%
should compare favourably with weak expansions in other
developed jurisdictions around the world and underpin an
extension of the recent USD recovery.
While central banks appear to be continuing to diversify
exposure away from the USD (albeit perhaps at a muchslower pace than in 2009), the USD and USD-denominated
assets generally retain a premium over the alternatives in
times of uncertainty or nancial market anxiety. The USD
remains the primary global reserve currency and will con-
tinue to attract signicant support from global investors
during phases of market uncertainty.
The stabilization in the USD over the past month may
delay slightly our expectations for a fairly rapid rise in the
currency against the likes of the EUR and GBP in the second
half of this year. But we still anticipate the USD appreciating
from a trend point of view as the secular USD bear trend ofthe past eight years unwinds.
US DOLLAR
US DOLLAR
1.16
1.20
1.24
1.28
1.32
1.36
1.40
1.44
1.48
1.52
1.56
1.60
1.64
1.68 84
92
100
108
116
124
132
140
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
USD per EUR
JPY per USD
JPY per USD
Source: Federal Reserve Bank of New York/Haver Analytics
USD per EUR
TRADE-WEIGHTED US DOLLAR
70
75
80
85
90
95
100
105
110
03 04 05 06 07 08 09 10
Index: 2000 = 100
*Nominal broad effective exchange rate
Source: Haver Analytics/JP Morgan
US DOLLAR OUTLOOK
Spot Price 2009 2010 2011
7/13/2010 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
Trade-wtd. USD 103.7 111.2 105.4 102.7 102.4 102.7 105.1 107.8 107.3 107.9 108.7 107.9 108.2
JPY per USD 88.7 99 96 90 93 93 88 90 91 95 100 102 105
USD per EUR 1.272 1.325 1.403 1.464 1.432 1.351 1.224 1.130 1.080 1.050 1.030 1.020 1.000
USD per GBP 1.518 1.432 1.646 1.598 1.616 1.518 1.495 1.345 1.317 1.280 1.288 1.275 1.282
f: Forecast by TDBFG as at July 13, 2010; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBFG
US DOLLAR FUNDAMENTALS
Interest Rate Spreads Business Cycle +
Inflation Differential Fiscal Balances
Current Account N Politics N
Legend: - is negative, + is positive, N is neutral for currencyShaun Osborne, Chief FX Strategist
416-983-2629
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CANADIAN DOLLAR
While CAD may have largely kept pace with the USD
over the last month, trading mostly in a tight 94-98 US
cent range, CAD joins the USD at the bottom of the overall
performance league against the other major currencies since
the last issue of Global Markets. And this is despite Canada
experiencing some of the strongest job growth and GDP
growth of any major country over the rst half of the year.
With growing fears of a double-dip recession in the US,
CAD seems to be getting punished because of the Canadian
economys tight links with the US. And we cant really argue
with that logic, since a stalling out of the US economy would
be a big hit not only to the Canadian economic recovery,
but to the global recovery as well.
At the moment, risk sentiment is still the biggest driverfor currency markets, and we think that the current calm
may be too good to last. There are still too many unan-
swered questions about the sustainability of the recovery,
and how the global economy is going to fare in the face of
scal contraction. Additionally, Canada in the process of
transitioning from a period of sharp recovery with well
above-trend GDP and employment growth, to a period of
slower, more sustainable growth. This will likely lead to a
lot more downside surprises to the economic data than what
weve seen recently, as markets take some time to adjust to
the new reality.Even with the Bank of Canada raising interest rates, it
looks like the bigger risk for CAD in the next couple of
months is another move lower as some shock causes another
ight toward the safety of the USD. We still expect to see
CAD slip to around 90 cents US before rebounding, once
the US economic recovery nally becomes more apparent.
Jacqui Douglas, FX Strategist
416-982-7784
CANADIAN DOLLAR
0.76
0.80
0.84
0.88
0.92
0.96
1.00
1.04
1.08
1.12
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
USD per CAD CAD per USD
Source: Federal Reserve Bank of New York/Haver Analytics
1.316
1.250
1.190
1.136
1.041
1.087
0.893
1.000
0.962
0.926
TRADE-WEIGHTED CANADIAN DOLLAR
80
90
100
110
120
130
140
150
160
03 04 05 06 07 08 09 10
Index: 2000 = 100
*Nominal broad effective exchange rate
Source: Haver Analytics/JP Morgan
CANADIAN DOLLAR OUTLOOK
Spot Price 2009 2010 2011
13/07/10 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
CAD per USD 1.031 1.260 1.162 1.069 1.052 1.015 1.064 1.124 1.053 1.031 1.020 1.010 1.000
USD per CAD 0.970 0.794 0.860 0.935 0.951 0.985 0.940 0.890 0.950 0.970 0.980 0.990 1.000
JPY per CAD 86 79 83 84 88 92 83 80 86 92 98 101 105
CAD per EUR 1.312 1.670 1.631 1.566 1.507 1.371 1.302 1.270 1.137 1.082 1.051 1.030 1.000
CAD per GBP 1.57 1.804 1.913 1.709 1.700 1.541 1.590 1.512 1.386 1.320 1.314 1.288 1.282
f: Forecast by TDBFG as at July 13, 2010; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBFG
CANADIAN DOLLAR FUNDAMENTALS
Interest Rate Spreads + Business Cycle +
Inflation Differential + Fiscal Balances +
Current Account N Politics N
Legend: - is negative, + is positive, N is neutral for currency
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EURO
Although the EUR has recovered a little poise over the
past month, the single currency remains the worst perform-
ing major currency over the course of the year so far, hav-
ing lost 12% against the USD and nearly 14% against the
CAD. We think there is more EUR pain to come over the
balance of the year.
The EURs current rebound versus the USD merely
reects an adjustment in market positioning, we feel. After
an extremely rapid fall earlier this year and a sharp build
up in short EUR positions among speculators and investors,
a pause in the underlying trend down is hardly a surprise.
We remain concerned by the scal challenges facing the
euro zone as governments attempt to stabilize borrowing
and the European Central Bank (ECB) expands its balancesheet. We are unconvinced at least in the near-term by
the argument advanced by ECB President Trichet that budget
consolidation will boost condence and growth. Rather,
growth may slow in the second half of the year and the
outlook for the euro zone remains rather weak (expansion
of around 1% perhaps at best for 2011).
While sovereign bond spreads have stabilized and the
Greek government successfully returned to the capital
markets for short-term funding, the scal crisis facing
Europe remains unresolved. Sovereign credit spreads
remain elevated. Ten-year Greek government bond yieldsare trading some 780bps over German bunds. The level
of Greek sovereign spreads (and sovereign credit default
swaps) continues to suggest that the market is anticipating
a Greek government debt restructuring at some point in the
next few years.
Meanwhile, commercial bank stress tests which are due
to be conducted in late July may inuence short-term EUR
sentiment. If the tests are viewed as a stringent examina-
tion of capital adequacy and the majority of banks pass, the
EUR may continue to rally towards USD1.30. A weak test
of banks ability to deal with potential losses may convincethe markets that the EU leadership is avoiding, rather than
confronting, crisis and will undermine the EUR, however.
EURO
1.18
1.22
1.26
1.30
1.34
1.38
1.42
1.46
1.50
1.54
1.58
1.62
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
105
110
115
120
125
130
135
140
145
150
155
160
165
170
175
USD per EUR
JPY per EUR
USD per EUR JPY per EUR
Source: Federal Reserve Bank of New York/Haver Analytics
TRADE-WEIGHTED EURO
110
115
120
125
130
135
140
145
150
03 04 05 06 07 08 09 10
Index: 2000 = 100
*Nominal broad effective exchange rate
Source: Haver Analytics/JP Morgan
EURO FUNDAMENTALS
Interest Rate Spreads N Business Cycle N
Inflation Differential N Fiscal Balances
Current Account + Politics
Legend: - is negative, + is positive, N is neutral for currency
EURO OUTLOOK
Spot Price 2009 2010 2011
13/07/10 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
USD per EUR 1.272 1.325 1.403 1.464 1.432 1.351 1.224 1.130 1.080 1.050 1.030 1.020 1.000
JPY per EUR 113 131 135 131 133 126 108 102 98 100 103 104 105
GBP per EUR 0.838 0.926 0.852 0.916 0.886 0.890 0.819 0.840 0.820 0.820 0.800 0.800 0.780
CAD per EUR 1.312 1.670 1.631 1.566 1.507 1.371 1.302 1.270 1.137 1.082 1.051 1.030 1.000
f: Forecast by TDBFG as at July 13, 2010; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBFG
Shaun Osborne, Chief FX Strategist, 416-983-2629
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JAPANESE YEN
Despite a number of problems confronting Japan on a
number of fronts, the JPY has been the best performing ma-
jor currency so far this year. Low yields, more deation, a
stumbling recovery in the export sector, political uncertainty
and very signicant long-term scal and demographic chal-
lenges have not prevented the JPY from racking up a 5.5%
gain versus the USD this year.
The JPY retains a signicant safe-haven premium in
times of nancial market volatility, due to Japans status as
a current account surplus-generating economy. With major
national equity markets mostly losing ground so far this
year, the JPY has found strong support in times of extreme
market volatility.
Although leverage has been leaking out of the nancialsystem this year, the JPYs status as a low yielding fund-
ing currency for carry trades in commodities, equities and
currencies has also prompted some short-covering driven
gains in times of market uncertainty.
We expect the JPY to retain a relatively rm undertone
in the near-term (and accept that the JPY may continue to
outperform if nancial market uncertainty persists). How-
ever, with export growth faltering and domestic deation-
ary pressures continuing to strengthen, we suspect that the
Japanese monetary authorities would be intolerant of the
JPY rising signicantly beyond the high reached againstthe USD in May (just under JPY85).
In the longer-run, we expect Japans large scal imbal-
ance, ageing population and depleting domestic savings to
spell trouble for the JPY. PM Kans DPJ lost signicant
ground in the recent Upper House elections and will need
support from the smaller parties to pass legislation. The
chances of pushing through meaningful scal reforms in
the near future appear fairly slim.
Shaun Osborne, Chief FX Strategist
416-983-2629
JAPANESE YEN
84
88
92
96
100
104
108
112
116
120
124
128
105
110
115
120
125
130
135
140
145
150
155
160
165
170
175
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
JPY per USD
JPY per EUR
JPY per USD JPY per EUR
Source: Federal Reserve Bank of New York/Haver Analytics
TRADE-WEIGHTED YEN
75
80
85
90
95
100
105
110
115
120
03 04 05 06 07 08 09 10
Index: 2000 = 100
*Nominal broad effective exchange rate
Source: Haver Analytics/JP Morgan
JAPANESE YEN OUTLOOK
Spot Price 2009 2010 2011
13/07/10 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
JPY per USD 89 99 96 90 93 93 88 90 91 95 100 102 105
JPY per EUR 113 131 135 131 133 126 108 102 98 100 103 104 105
JPY per GBP 135 142 159 143 150 142 132 121 120 122 129 130 135
JPY per CAD 86 79 83 84 88 92 83 80 86 92 98 101 105
f: Forecast by TDBFG as at July 13, 2010; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBFG
YEN FUNDAMENTALS
Interest Rate Spreads Business Cycle N
Inflation Differential Fiscal Balances
Current Account + Politics
Legend: - is negative, + is positive, N is neutral for currency
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UK POUND
Sterling has stabilized in the aftermath of the UK gen-
eral election and last months tough budget. The coalition
Conservative/Liberal governments intention of delivering
approximately GBP40 bn in decit reductions per year
through 2015 appears to have reassured the ratings agen-
cies, for the moment, while not spooking investors unduly.
On a trade-weighted basis, the GBP is actually little
changed since the start of the year, whilst losing modest
ground against the EUR and gaining against the USD in
nominal terms. This is probably not a bad result for the
UK economy considering the challenges that policy mak-
ers are facing.
On the one hand, many of the indicators that have
been in strong recovery mode since late 2008/early 2009 manufacturing output, consumer sentiment, house prices
are now starting to show signs of attening out and scal
tightening is about to bite. The fact that the GBP remains
relatively competitive will help foster the recovery. The
trade weighted GBP is still some 20% below the level pre-
vailing at the start of 2007.
On the other hand, policy makers may not want to see
that much more weakness in the exchange rate due to the
persistent upward pressure on domestic prices. The rise
in core ination to 3.1% in the June year reects some
temporary factors and most policy makers are inclined tolook through the current strength in prices due to still
weak overall activity. One, Andrew Sentence, is not and
voted for a rate increase at the June policy meeting, however.
We think a tightening in UK monetary policy is unlikely
until at least late this year or early next year and feel that
the GBP is unlikely to pick up signicant ground versus
the EUR while the economic outlook remains dubious. We
expect EUR/GBP to hold around 0.84 in Q3 while the GBP
should lose ground to a stronger USD.
Shaun Osborne, Chief FX Strategist
416-983-2629
BRITISH POUND
0.65
0.69
0.73
0.77
0.81
0.85
0.89
0.93
0.97
1.01 1.30
1.40
1.50
1.60
1.70
1.80
1.90
2.00
2.10
2.20
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
GBP per EUR
USD per GBP
GBP per EUR USD per GBP
Source: Federal Reserve Bank of New York/Haver Analytics
TRADE-WEIGHTED POUND
70
75
80
85
90
95
100
105
110
115
03 04 05 06 07 08 09 10
Index: 2000 = 100
*Nominal broad effective exchange rate
Source: Haver Analytics/JP Morgan
UNITED KINGDOM POUND
Spot Price 2009 2010 2011
13/07/10 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
USD per GBP 1.518 1.432 1.646 1.598 1.616 1.518 1.495 1.345 1.317 1.280 1.288 1.275 1.282
GBP per EUR 0.838 0.926 0.852 0.916 0.886 0.890 0.819 0.840 0.820 0.820 0.800 0.800 0.780
CAD per GBP 1.57 1.80 1.91 1.71 1.70 1.54 1.59 1.51 1.39 1.32 1.31 1.29 1.28
f: Forecast by TDBFG as at July 13, 2010; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBFG
POUND FUNDAMENTALS
Interest Rate Spreads N Business Cycle N
Inflation Differential + Fiscal Balances
Current Account Politics
Legend: - is negative, + is positive, N is neutral for currency
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15
AUSTRALIAN DOLLAR
AUSTRALIAN DOLLAR
0.58
0.66
0.74
0.82
0.90
0.98
1.06
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
50
60
70
80
90
100
110
120
USD per AUD
JPY per AUD
JPY per AUDUSD per AUD
Source: Federal Reserve Bank of New York/Haver Analytics
TRADE-WEIGHTED AUSTRALIAN DOLLAR
70
80
90
100
110
120
130
140
150
03 04 05 06 07 08 09 10
Index: 2000 = 100
*Nominal broad effective exchange rate
Source: Haver Analytics/JP Morgan
AUSTRALIAN DOLLAR OUTLOOK
Spot Price 2009 2010 2011
13/07/10 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
USD per AUD 0.883 0.691 0.806 0.883 0.898 0.917 0.841 0.900 0.880 0.860 0.840 0.820 0.790
JPY per AUD 78.27 68.41 77.70 79.19 83.53 85.65 74.35 81.00 80.08 81.70 84.00 83.64 82.95
AUD per CAD 1.098 1.148 1.067 1.059 1.059 1.074 1.118 0.989 1.080 1.128 1.167 1.207 1.266
NZD per AUD 1.226 1.236 1.249 1.221 1.242 1.292 1.228 1.286 1.294 1.284 1.292 1.323 1.317
f: Forecast by TDBFG as at July 13, 2010; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBFG
AUSTRALIAN DOLLAR FUNDAMENTALS
Interest Rate Spreads + Business Cycle +
Inflation Differential + Fiscal Balances +
Current Account N Politics N
Legend: - is negative, + is positive, N is neutral for currency
Roland Randall, Strategist
+65 6500 8047
Australia looks once again a stand out amongst devel-
oped economies. After signicant volatility due to ongoing
debate over whether risk and commodity currencies are out
of favour, another round of better than expected economic
data as well as a not-dovish RBA Board meeting commu-
niqu all reassured markets that Australias economic per-
formance is not yet being derailed by gathering headwinds
to global growth.
After the RBA and the employment report xed income
markets capitulated, taking out expectations for a cut to the
Cash Rate (that were, mind you, always unrealistic) and the
AUD outperformed its dollar bloc peers. Indeed, the AUD
was languishing around $US0.84 by late June, but after
the RBA and employment combination the AUD swiftlypunched past $US0.87 and has been trading convincingly
above that level since.
The relatively low correlation of Australias economic
fundamentals to those of the US and Europe is a point worth
repeating, and one that should see the AUD outperform the
more closely tied CAD as the US picture weakens further
over 2H 2010.
Further local data surprises at a time when global markets
have come to expect macro indicators to weaken will only
iname expectations for tighter monetary policy and push
the AUD higher, toward our $0.90 end-September quartertarget. Australia is not, of course, completely immune to
the fortunes of the US and Europe but for now is somewhat
insulated by its much stronger trade ties with Asia.
While we are comfortable with our September target,
more immediate trading conditions will be dominated by
thin and whippy summer volumes for which funds have
already positioned themselves. Net longs in AUD non-
commercial futures are close to zero and at their lowest level
since 1Q 2009, providing few clues about which direction
the market is betting the AUD will move from here.
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NEW ZEALAND DOLLAR
Like its trans-Tasman neighbour Australia, the NZD/
USD strengthened by nearly 3% over the past month before
dipping in late June on anti-commodity currency sentiment.
A subsequent revival in risk sentiment pushed commodity
currencies stronger from the beginning of July, likely driven
by a combination of positive sentiment factors including the
resumption of exibility for the Yuan peg. Periods of risk
on do, however, feel tenuous as headwinds to US growth
appear to be strengthening again.
In terms of the immediate outlook, currency markets are
now rmly positioned for the northern hemisphere sum-
mer vacation, which means that no one is overweight risk
currencies. The NZD is no exception. Net positions in non-
commercial NZD futures are never large but have fallen toalmost zero recently, the rst time they have been this low
since 1H 2009. Clearly, traders would rather not bet on the
direction of the NZD for the next month or so. More than
likely the NZD will be directionless for a while.
The fact that the RBNZ is tightening when few others are
while ination outcomes remain moderate appears fully
priced in New Zealand markets. There is a good chance that
the RBNZ will disappoint by delaying monetary tightening
(while the RBA is more likely to surprise by tightening more
and/or sooner than consensus predicts). This explains why
the AUD sits below our near-term forecasts with room toappreciate but the NZD remains above our forecasts and we
expect it to depreciate. Of the two antipodean currencies,
the NZD is more likely to sell off in coming months and we
forecast $0.70 by 30 September. On the other hand, further
appreciation is likely to be capped by the fact that risk will
be off more than it is on if we are right that G7 data will
contain more disappointments than upside surprises over
the next quarter.
TRADE-WEIGHTED NEW ZEALAND DOLLAR
70
80
90
100
110
120
130
140
150
160
03 04 05 06 07 08 09 10
Index: 2000 = 100
*Nominal broad effective exchange rate
Source: Haver Analytics/JP Morgan
NEW ZEALAND DOLLAR
0.48
0.54
0.60
0.66
0.72
0.78
0.84
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
40
50
60
70
80
90
100
USD per NZD
JPY per NZD
JPY per NZDUSD per NZD
Source: Federal Reserve Bank of New York/Haver Anal tics
NEW ZEALAND DOLLAR OUTLOOK
Spot Price 2009 2010 2011
13/07/10 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
USD per NZD 0.720 0.560 0.646 0.723 0.723 0.710 0.685 0.700 0.680 0.670 0.650 0.620 0.600
JPY per NZD 63.85 55.37 62.22 64.87 67.23 66.31 60.55 63.00 61.88 63.65 65.00 63.24 63.00
NZD per CAD 1.346 1.418 1.333 1.293 1.315 1.387 1.373 1.271 1.397 1.448 1.508 1.597 1.667
NZD per AUD 1.226 1.236 1.249 1.221 1.242 1.292 1.228 1.286 1.294 1.284 1.292 1.323 1.317
f: Forecast by TDBFG as at July 13, 2010; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBFG
NEW ZEALAND DOLLAR FUNDAMENTALS
Interest Rate Spreads + Business Cycle N
Inflation Differential + Fiscal Balances N
Current Account Politics N
Legend: - is negative, + is positive, N is neutral for currency
Roland Randall, Strategist
+65 6500 8047
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SWISS FRANC
The Swiss franc has been the top performing currency
over the last month, as the Swiss National Bank (SNB)
nally threw in the towel on its attempts at intervening in
the foreign exchange market. Specically, the SNB said
that the deationary risk in Switzerland has largely dis-
appeared, and that only in the case of a renewed threat
of deation would it take all the measures necessary to
ensure price stability.
The latest Swiss ination report was admittedly pretty
soft, and well be keeping a close eye on those gures going
forward. But assuming that ination does evolve roughly
in line with what the SNB is expecting, we think that EUR/
CHF will be allowed to drift lower as the EUR continues to
depreciate (according to our forecasts). Were forecastinga series of fresh all-time lows in EUR/CHF going forward,
falling to 1.25 by the end of 2010, and 1.20 at the end of
2011.
Jacqui Douglas, FX Strategist
416-982-7784
SWISS FRANC OUTLOOK
Spot Price 2009 2010 2011
13/07/10 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
CHF per USD 1.054 1.140 1.086 1.036 1.036 1.051 1.077 1.150 1.157 1.171 1.184 1.186 1.200CHF per EUR 1.341 1.510 1.524 1.517 1.484 1.420 1.318 1.300 1.250 1.230 1.220 1.210 1.200
CHF per CAD 1.022 0.904 0.935 0.969 0.985 1.036 1.013 1.024 1.100 1.136 1.161 1.174 1.200
f: Forecast by TDBFG as at July 13, 2010; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBFG
SWISS FRANC
1.30
1.34
1.38
1.42
1.46
1.50
1.54
1.58
1.62
1.66
1.70
0.97
1.00
1.03
1.06
1.09
1.12
1.15
1.18
1.21
1.24
1.27
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
CHF per EUR
CHF per USD
CHF per EUR CHF per USD
Source: Federal Reserve Bank of New York/Haver Analytics
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i i i th i f ti l i i t i d i thi t f l d ff d
SUMMARY FOREIGN EXCHANGE TABLE
Spot Price 2009 2010 2011
13/07/10 Q1 Q2 Q3 Q4 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F
Exchange rate to US dollar
Japanese yen JPY per USD 88.65 99 96 90 93 93 88 90 91 95 100 102 105
Euro USD per EUR 1.272 1.325 1.403 1.464 1.432 1.351 1.224 1.130 1.080 1.050 1.030 1.020 1.000
U.K. pound USD per GBP 1.518 1.432 1.550 1.598 1.616 1.518 1.495 1.345 1.317 1.280 1.288 1.275 1.282
Swiss franc CHF per USD 1.054 1.140 1.086 1.036 1.036 1.051 1.077 1.150 1.157 1.171 1.184 1.186 1.200
Canadian dollar CAD per USD 1.031 1.260 1.162 1.069 1.052 1.015 1.064 1.124 1.053 1.031 1.020 1.010 1.000
Australian dollar USD per AUD 0.883 0.691 0.806 0.883 0.898 0.917 0.841 0.900 0.880 0.860 0.840 0.820 0.790
NZ dollar USD per NZD 0.720 0.560 0.646 0.723 0.723 0.710 0.685 0.700 0.680 0.670 0.650 0.620 0.600
Exchange rate to Euro
U.S. dollar USD per EUR 1.272 1.325 1.403 1.464 1.432 1.351 1.224 1.130 1.080 1.050 1.030 1.020 1.000
Japanese yen JPY per EUR 113 131 135 131 133 126 108 102 98 100 103 104 105
U.K. pound GBP per EUR 0.838 0.926 0.852 0.916 0.886 0.890 0.819 0.840 0.820 0.820 0.800 0.800 0.780
Swiss franc CHF per EUR 1.341 1.510 1.524 1.517 1.484 1.420 1.318 1.300 1.250 1.230 1.220 1.210 1.200
Canadian dollar CAD per EUR 1.312 1.670 1.631 1.566 1.507 1.371 1.302 1.270 1.137 1.082 1.051 1.030 1.000
Australian dollar AUD per EUR 1.441 1.917 1.740 1.658 1.595 1.473 1.456 1.256 1.227 1.221 1.226 1.244 1.266
NZ dollar NZD per EUR 1.766 2.368 2.173 2.024 1.981 1.903 1.787 1.614 1.588 1.567 1.585 1.645 1.667
Exchange rate to Japanese yen
U.S. dollar JPY per USD 88.65 99 96 90 93 93 88 90 91 95 100 102 105
Euro JPY per EUR 112.8 131 135 131 133 126 108 102 98 100 103 104 105
U.K. pound JPY per GBP 135 142 149 143 150 142 132 121 120 122 129 130 135
Swiss franc JPY per CHF 84.1 86.8 88.7 86.6 89.8 88.8 82.1 78.2 78.6 81.1 84.4 86.0 87.5
Canadian dollar JPY per CAD 86.0 78.5 82.9 83.9 88.4 92.0 83.1 80.1 86.5 92.2 98.0 101.0 105.0
Australian dollar JPY per AUD 78.3 68.4 77.7 79.2 83.5 85.6 74.4 81.0 80.1 81.7 84.0 83.6 83.0
NZ dollar JPY per NZD 63.9 55.4 62.2 64.9 67.2 66.3 60.5 63.0 61.9 63.7 65.0 63.2 63.0
Exchange rate to Canadian dollar
U.S. dollar USD per CAD 0.970 0.794 0.860 0.935 0.951 0.985 0.940 0.890 0.950 0.970 0.980 0.990 1.000
Japanese yen JPY per CAD 86 79 83 84 88 92 83 80 86 92 98 101 105
Euro CAD per EUR 1.312 1.670 1.631 1.566 1.507 1.371 1.302 1.270 1.137 1.082 1.051 1.030 1.000
U.K. pound CAD per GBP 1.57 1.80 1.80 1.71 1.70 1.54 1.59 1.51 1.39 1.32 1.31 1.29 1.28
Swiss franc CHF per CAD 1.022 0.904 0.935 0.969 0.985 1.036 1.013 1.024 1.100 1.136 1.161 1.174 1.200
Australian dollar AUD per CAD 1.098 1.148 1.067 1.059 1.059 1.074 1.118 0.989 1.080 1.128 1.167 1.207 1.266
NZ dollar NZD per CAD 1.346 1.418 1.333 1.293 1.315 1.387 1.373 1.271 1.397 1.448 1.508 1.597 1.667
f: Forecast by TDBFG as at July 13, 2010; All forecasts are for end of period
Source: Federal Reserve Bank of New York, Bloomberg, TDBFG