FX Strategies

www.morganmarkets.com/GlobalFXStrategy

Global FX Strategy10 August 2012

FX Markets WeeklyHedging the US fiscal cliff through FX

Global FX Strategy

John Normand AC

(44-20) 7134-1816

[email protected]

J.P. Morgan Securities plc

Paul Meggyesi

(44-20) 7134-2714

[email protected]


Arindam Sandilya

(1-212) 834-2304

[email protected]

JPMorgan Chase Bank NA

Thomas Anthonj

(44-20) 7742-7850

[email protected]


Justin Kariya

(1-212) 834-9618

[email protected]

JPMorgan Chase Bank NA

See page 46 for analyst certification and important disclosures.

OutlookThe view and most trades are unchanged from last week: the mid-summer rush into FX carry isn’t worth buying into when macro data show little evidence of lift and when so many currencies are priced for perfection from policymakers. As an extension of this week’s J.P. Morgan Research update on the US fiscal cliff, today’s FXMW focuses on three issues: how election scenarios (status quo, Republican sweep, different but still-divided government) influence the odds of a US downturn; how currencies should respond to the cyclical versus sovereign credit implications of US fiscal disarray; and how to hedge most efficiently at current levels of volatility and skew. It is still somewhat early to hedge this risk given the imminence of Fed QE3, but currencies most sensitive to the US downturn are rich enough to justify some pre-positioning.

Macro Trade RecommendationsThe continued compression in volatility and elevated valuation of cyclical currencies offer good entry levels to scale into option-based defensive trades for a global economy which remains on the floor thanks to unfinished business in the US (fiscal cliff), Europe (funding the periphery) and China (generating a rebound). Buy USD call spreads versus AUD (1.03-1.00) and CAD (1.01-1.03) to hedge the US fiscal cliff. Concentrate euro shorts on crosses where valuations are least challenging: EUR/USD (1.22-1.19 put spread) and EUR/JPY (cash). Hold a basket of relative value trades in cash and options: short GBP/NOK, short AUD/NZD and long NOK/SEK.

FX DerivativesData vacuum in August is likely to keep a lid on vols and promote carry trades. Add to option-based carry via 6M ATMF/ ATMS spreads in EUR/INR. Open vega-neutral long vol swap vs. short FVA packages at the front-end of the NZD/USD vol curve as a positive carry defensive position. Along similar lines, sell 9M3M USD/CLP FVAs against a beta-weighted amount of 9M3M USD/MXN FVAs.

Technical StrategyThe yen’s broad up-trend has lost momentum but appears to be incomplete in Elliott terms as the final 5th wave is missing. The broad recovery of CE3 currencies since the beginning of June seems to be complete so that the long-term downtrends are expected to be resumed shortly. Stay long EUR/CZK and USD/ZAR & short EUR/USD, GBP/USD, GBP/JPY, NZD/CAD, EUR/KRW, EUR/MXN, NZD/NOK and PLN/HUF.

Research notesIntra-EMU currency valuations: Estimates for a breakup scenario (Justin Kariya)

Introducing Daily FX Strategy Analytics (John Normand and Arindam Sandilya)

ContentsOutlook 2

Macro Trade Recommendations 8

FX Derivatives 14

Technical Strategy 17

Global FX carry trade monitor 19

Research Notes 21

Market movers 33

Event risk calendar 35

Central bank meetings in 2012 37

J.P. Morgan Forecasts

Global central bank forecasts 38

FX vs forwards & consensus 39

Rates, credit, equities & commodities 40

Global growth and inflation forecasts 41

Sovereign credit ratings and actions 43

Gov't and bank bond redemptions 44

Research Notes on morganmarkets.com 45

Global FX Strategy contact page 48

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John Normand(44-20) [email protected]

Outlook: Hedging the US fiscal cliff through FX

The view and most trades are unchanged from last week: the mid-summer rush into FX carry isn’t worth buying into when macro data show little evidence of lift and when so many currencies are priced for perfection from policymakers.

As an extension of this week’s J.P. Morgan Research update on the US fiscal cliff, today’s FXMW focuses on three issues: how election scenarios (status quo, Republican sweep, different but still-divided government) influence the odds of a US downturn; how currencies should respond to the cyclical versus sovereign credit implications of US fiscal disarray; and how to hedge most efficiently at current levels of volatility and skew. It is still somewhat early to hedge this risk given the imminence of Fed QE3, but currencies most sensitive to the US downturn are rich enough to justify some pre-positioning

Trades: In the macro portfolio, add an AUD/USD put spread and a USD/CAD call spread to hedge the cliff. Stay short EUR/USD (1.22-1.19 put spread), EUR/JPY, GBP/NOK and AUD/NZD. In the technical portfolio, stay short EUR/USD, GBP/JPY, EUR/MXN, EUR/KRW. In derivatives, hold option-based carry in EUR/INR, USD/ARS and USD/CNY (6-mo).

Next week: top-tier data in US and Europe, little from China or periphery

Two weeks into August, currencies are moving somewhat more erratically than other asset classes. While global equities, credit spreads and Treasury yields have trended almost uninterrupted this month (+2%, +25bp and -8bp, respectively), the trade-weighted dollar is down only fractionally due to strength in commodity currencies and EM Asia offsetting stability in Europe (chart 1). We argued last week that this summer rush into FX carry wasn’t worth buying into when macro data show little evidence of lift and when so many currencies are priced for perfection from policymakers (see Stealth rallies and the fear of missing out, FXMW, August 3). That remains the view after a week when the majority of Chinese data surprised to the downside (IP, retail sales, trade, loan growth) and when European bond markets began to reflect shortcomings of the ECB's bond-buying proposal.

With the view and trades unchanged, this edition of FXMWextends this week’s J.P. Morgan Research update on the US fiscal cliff,1 since focus on this issue will only sharpen after Presidential nominating conventions in late August/early early September. We examine three issues: how election scenarios (status quo, Republican sweep, different but still-divided government) influence the odds of a US downturn; how currencies should respond to the cyclical versus sovereign credit implications of US fiscal disarray; and how to hedge most efficiently at current levels of volatility and skew. It is still somewhat early to hedge this risk given the imminence of Fed QE3, but currencies most sensitive to the US downturn are rich enough to justify some pre-positioning

Chart 1: 2012 currency performance by region versus USDCurrency performance indexed to Jan 1, 2012 = 100. Rise (fall) in index indicates that currencies appreciate vs USD. Commodity FX bloc includes AUD, NZD, CAD, MXN, BRL, PEN, COP, CLP and RUB. European bloc includes EUR, GBP, CHF, NOK and SEK. EM Asia includes CNY, TWD, KRW, PHP, THB, IDR, MYR and INR.

Source: J.P. Morgan

Fiscal cliff notes

The US fiscal cliff – the 3.5% of GDP fiscal tightening which begins January 1, 2013 unless Congress extends the Bush tax cuts and payroll tax holiday, cancels automatic spending cuts (sequestration) and raises the debt ceiling through next year – is well recognized as the second biggest threat to the global economy in coming months, just behind another European funding crisis and ahead of China's failure to accelerate. It is also understood that like Europe’s funding crisis, America's downturn is entirely avoidable in principle given government discretion over fiscal policy but

1 See the report US Fiscal Cliff: Election outcomes affect policy outcomes published on August 7 (Lee, Feroli, Ramaswamy, Normand and Tusa) and the related conference call recording US fiscal cliff podcast posted on www.morganmarkets.com.

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somewhat inevitable in practice given a dysfunctional political system.

The game-changer which would ensure an uninterrupted expansion is as obvious as it is unlikely before late December: a grand bargain to extend all tax cuts through 2013 in order to allow time for constructing a more balanced, comprehensive fiscal strategy for the next decade. That outcome has almost zero odds of occurring pre-election since Democrats do not want to extend tax cuts to upper income groups, and since Republicans do not want to discuss fiscal policy divorced of entitlement reform.

This sort of philosophical divide, which is more paralyzing in a country with a President and bicameral legislature than in a parliamentary system, renders the election outcome pivotal to whether and when the US economy experiences a contraction – let’s avoid labeling it a recession since it could last only a quarter or two – due to massive fiscal tightening when growth is only running at 1.5% to 2%. Consider these scenarios.

The status quo would see Obama retain the White House, Republicans keep the House and Democrats keep the Senate. That outcome might foster compromise during Congress’s lame duck session in November and December since it will be clear that all sides can hope for no better partners next year (the new Congress will be seated January 3, 2013). Extension of most tax cuts would still be required to avoid a sharp slowdown, but resolution by year-end or a retroactive bill by late January or early February would skirt the most adverse scenario. This is JPM’s base case, resulting in a US slowdown to about 1.5% in Q1.

The Republican sweep envisions Romney securing the Presidency, Republicans retaining the House and also capturing the Senate (Democrats have 23 seats and Republicans 10 seats being contested). Even if work on tax cut extension did not begin until seats changed in January, the certainty from knowing that Republicans would preserve lower tax tables would lift sentiment enough to avoid a meaningful growth slump.

The different but still-divided government scenarios see Obama retaining the White House but Republicans controlling the House and Senate. Alternatively, Romney could take the White House while Congress remains split between Republicans (House) and Democrats (Senate). Obama with a Republican Congress generates the highest odds that the US goes over the cliff since Republicans will have no incentive to negotiate during the lame-duck session; their hand will be stronger come January. Romney with a divided

Congress could deliver an outcome similar to a Republic sweep, since the new President can claim a mandate. And if the Senate is divided 50/50 along party lines, the Romney's Vice President will cast the deciding vote.

From these scenarios is appears that (1) nothing will be accomplished before November 6 elections; (2) a grand bargain during the lame-duck session would only materialize under the status quo (Obama wins White House and Congress remains split); (3) even a grand bargain implies no clarity on tax policy until very late in December or early January; and (4) a different divided government (Democratic White House, Republicans in House and Senate) yields high odds of a US economic contraction. Add to the mix that pre-election polls render the outcome essentially random, and the next few months seem like an American version of this spring’s Greek election coin flip (minus the farcical elements which Communists, Far Leftists and neo-Nazis can lend a campaign).

Chart 2: Compared to government shutdown drama in 1995/96 and 2011 when US growth expectations were rising, the fiscal cliff approaches when consensus forecasts are fallingConsensus on year-ahead US growth from monthly Blue Chip survey

Source: J.P. Morgan

Currencies and the cliff

What impact should this mini-crisis have on currencies into year-end? Probably not much for the trade-weighted dollar (J.P. Morgan index JPMQUSD). The impact instead will be pair-specific, so USD-positive versus cyclical currencies (CAD, MXN, EM Asia) and USD-negative versus major reserve currencies (JPY, possibly EUR and GBP). So even if the broad dollar shows little trend through this mini-crisis, bilateral moves could be sharp as the campaign unfolds.

The fiscal cliff impacts currencies through two channels: weaker USD growth and rising sovereign credit risk. The first impact will probably dominate the second. It is well-know that commodity currencies and high-yield FX are

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positively correlated with US growth, so any event which results in falling US growth expectations will probably support the dollar versus those currencies. As shown in table 1, which calculates the beta between US growth expectations and various currencies, the most vulnerable markets are CAD, TWD, ZAR, COP and MXN. The yen is the only currency which moves inversely with US growth –it appreciates when the US slows due to deleveraging and the unwind of yen-funded carry trades. The euro has been relatively insensitive to shifts in US growth expectations over the past few years, probably because the region's sovereign crisis has dominates all other global macro factors in driving the euro's trend. Thus the best hedge for the US fiscal cliff is to sell CAD and own JPY.

The wildcard in this outlook will be how sovereign credit risk impacts demand for dollars during a period which normally sponsors fairly classic deleveraging across currency markets. The dysfunction in Washington which has created this fiscal cliff scenario is reminiscent of last year's debt ceiling debate, as well as the government shutdown of late 1995 and early 1996 as the Clinton Administration deadlocked against a Republican Congress. Most of these episodes pushed the dollar weaker versus major reserve currencies such as the yen, deutschemark and euro than what cyclical conditions would have predicted as the time. In the 1995, USD/DEM fell 7% and USD/JPY fell 4% in the month ahead of the shutdown, even though interest rates had not moved much against the dollar. In Q1 2011, the dollar fell versus almost every currency as the debt ceiling crisis began to unfold, even though the spike in volatility due to the Arab Spring normally would have driven dollar strength versus cyclical currencies and high-yielders.

To be fair, the fiscal cliff differs from government shutdown in two respects: US growth expectations were rising in late 1995 and early 2011 whereas they are falling now (chart 2); and government shutdowns have minimal systemic impact than comprehensive fiscal tightening. Thus is seems odd to buy inherently cyclical currencies to hedge the cliff even if those countries have stronger fiscal or growth. At current levels and against this backdrop, better to hedge by buying the dollar versus cyclical currencies, by selling the it versus an anti-cyclical one (JPY), or by selling it versus another major reserve currency (EUR, GBP) if one is confident Europe will deliver on banking union and sizable ECB bond purchases this fall. (We’re not that bold yet.)

Fed/ECB easing work against cliff hedges

Most currencies, however, are priced as if the next several months will not be very dramatic. If the fiscal cliff should

Table 1: Currency sensitivity to changes in US growth expectationsBeta and R-squared from regressing change in currency versus USD on changes in year-ahead Blue Chip consensus forecasts for US real GDP growth. Positive (negative) beta indicates that currency appreciates (depreciates) versus USD when consensus expectations on US growth rise (fall).

Source: J.P. Morgan

sponsor some deleveraging, then pre-emptive hedging would be reflected in long USD positions versus commodity currencies and high-yielders, and in an increasing bid for USD calls in those same pairs. The opposite trend has been developing this summer, probably because the twin balance sheet expansions of the Fed and ECB have spawned a global carry trade as strong now in FX as it has been for most of the year in corporate credit. Investors have moved from record long USD earlier this year to close to flat, and the FX option skew (bid for USD calls versus puts) has normalised (chart 3). Vols have cheapened globally, but more in commodity currencies like AUD/USD and USD/CAD than others (chart 4). And while USD calls against cyclical currencies have not cheapened to

Beta R-Sq Beta R-Sq

CAD 0.13 55.4% 0.07 39.8% 47.6%

TWD 0.18 71.7% 0.09 19.6% 45.6%

ZAR 0.05 46.3% 0.04 44.3% 45.3%

COP 0.08 65.4% 0.03 20.5% 43.0%

MXN 0.06 52.3% 0.05 31.1% 41.7%

TRY 0.08 64.1% 0.03 16.8% 40.4%

HUF 0.05 52.7% 0.03 18.8% 35.8%

CLP 0.07 47.1% 0.03 22.8% 34.9%

GBP 0.15 32.4% 0.05 34.0% 33.2%

IDR 0.11 19.4% 0.07 46.6% 33.0%

KRW 0.08 28.6% 0.05 36.5% 32.6%

PLN 0.04 44.1% 0.02 12.4% 28.3%

JPY -0.08 35.3% -0.05 17.4% 26.3%

SGD 0.09 32.4% 0.07 14.1% 23.3%

RUB 0.05 32.7% 0.03 13.1% 22.9%

NZD 0.03 11.8% 0.04 32.9% 22.3%

BRL 0.02 6.1% 0.04 37.8% 22.0%

ILS 0.10 35.6% 0.03 7.4% 21.5%

AUD 0.04 10.3% 0.04 32.1% 21.2%

INR 0.04 15.5% 0.06 25.2% 20.3%

MYR 0.07 23.1% 0.06 13.0% 18.0%

SEK 0.06 10.2% 0.04 20.4% 15.3%

NOK 0.03 3.4% 0.04 22.6% 13.0%

PHP 0.10 13.6% 0.02 1.3% 7.5%

EUR 0.04 4.7% 0.03 10.0% 7.3%

THB 0.05 3.8% 0.05 9.2% 6.5%

CHF 0.02 7.2% 0.02 5.3% 6.2%

Ccy/USD Avg R-SqPast year Past 5 yrs

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extremes (chart 5), vols are low enough and spot rates extreme enough (1.05 on AUD/USD, sub-parity on USD/CAD) to justify an initial hedge in both pairs (see Macro Trade Recommendations on page 8 for further details). Fed QE could present better entry levels, but commodity currencies are already trading rich enough to suggest that current levels aren’t far from the peak in these markets. Favour options to manage the P-n-L volatility around key QE dates (Bernanke’s August 31 Jackson Hole presentation, September 13 FOMC decision), and USD call spreads given the limited move in commodity currencies when global liquidity remains so abundant.

Next week: top-tier data in US and Europe, little from China or periphery

Activity data in most regions is top-tier next week. TheUS reports retail sales on Tuesday, Empire survey and industrial production on Wednesday, Philly Fed on Thursday and Michigan consumer confidence on Friday. The Euro area reports Q2 flash GDP and the German Zewon Tuesday, and the June balance of payments (useful for a read on capital flight) on Friday. The major UK releases are the labour market report and MPC minutes on Wednesday and retail sales on Thursday. In non-Japan Asia, the keyreports are Chinese foreign direct investment (during the week), Indian inflation on Tuesday and New Zealand PMI on Thursday.

Only one central bank meets next week: Turkey on Thursday, but the bank is unlikely to adjust the rate corridor.

There are no bond auctions in the periphery next week.Italy and Spain have cancelled their mid-August bond auctions in line with previous years. The next conventional bond auction in Italy is on August 30 and in Spain on September 6. Spain will come to market next on August 21 with 12-mo and 18-mo t-bills, and Italy on August 13 with 12-mo t-bills. Greece will auction €3bn of t-bills on Tuesday to honor redemptions this month since the next troika disbursement awaits completion of EU/IMF’s September mission.

Chart 3: Expectations of Fed and ECB easing are resulting in much less defensive positioning ahead of the fiscal cliffAggregate IMM positions in USD versus average 6-mo risk reversal across USD-based pairs. For IMM positions, positive (negative) value indicates USD longs (shorts). For risk reversals, positive (negative) value indicates bid for USD calls over USD puts.

Source: J.P. Morgan

Chart 4: Commodity currencies vols are amongst the cheapest globally6-mo at-the-money vols (expressed as 1-yr z-score) versus ratio of 6-mo at-the-money implied to realised vols

Source: J.P. Morgan

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Chart 5:…but most USD calls are not yet cheap6-mo risk reversal ranked by two criteria: (1) ratio of risk reversal to at-the-money vols and (2) difference between risk reversal and realised skew.

Source: J.P. Morgan

Main recommendations: Macro, Technical and Derivatives portfolios

I. Macro portfolio (page 8 for details)

New/closed trades

In options, buy a 2-mo USD/CAD call spread (1.01-1.03) for 38bp and a 2-mo AUD/USD put spread (1.03-1.00) for 65bp.

Existing trades

In cash, stay short EUR/JPY from 96.75 and short GBP/NOK from 9.35. Both positions opened August 3.

In options, hold 2-mo 1.22-1.19 EUR/USD ratio put spread opened July 6.

Hold a 2-mo 1.285-1.265 AUD/NZD put fly (1:2:1 notionals). Position opened August 3.

Hold 2-mo NOK/SEK 1.15/1.18 call spread opened July 20.

Hold a 12-mo 1.1900-1.1100 EUR/CHF put spread, sell a 1.2550 EUR/CHF call in 1x1x1 notional. Opened May 11.

II. Technical portfolio (page 17 for details)

Stay long EUR/CZK, USD/ZAR and shortEUR/USD, GBP/USD, GBP/JPY, EUR/MXN, NZD/CAD, NZD/NOK, EUR/KRW and PLN/HUF.

III. Derivatives portfolio (page 14 for details)

Keep defensive positions with positive slide in AUD/USD and EUR/USD through short 6M6M FVAs against long 1Y6M FVAs, in 1x2 vega notionals, 2Y2Y AUD/USD FVAs. Keep GBP/CAD vs. GBP/JPY correlation short. AddUSD/MXN vs. USD/CLP 9M3M FVA spreads and long 1M vol swap vs. short 1M1M FVA in NZD/USD.

Add option based carry (ATMF/ATMS spread) in EUR/INR, hold in USD/ARS (1-yr) and USD/CNY (6-mo), hold 3M DNTs in select crosses (NZD/SEK, GBP/CAD).

Stay long G-10 commodity currency vol vs. short LatAm vol: NZD-CAD -CLP 3-mo vol fly.

Hold gamma RV risk: EUR/KRW vs. USD/KRW

Risk-reversals: Hold USD/JPY 6M25D risk-reversal longs (long USD puts/short USD calls)

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Just launched: Euro Area Crisis page on www.morganmarkets.com

Breaking news and reference reports on Europe's sovereign debt crisis from J.P. Morgan’s Economics, Rates,

FX, Equity, Credit and Global Asset Allocation Research

https://mm.jpmorgan.com/MorganMarkets?page=EUROAREACRISIS

8


Paul Meggyesi(44-20) [email protected]

FX trade recommendations

Trade recommendations in this section are mostly spot, for easier incorporation into the monthly Global Markets Outlook & Strategy (GMOS), which outlines J.P. Morgan’s flagship model portfolio across bonds, credit, equities, fx and commodities. Some directional option trades are included here as alternatives to cash position, and as a complement to relative value trades discussed in FX Derivatives section of this publication (p. 14).

Current recommendations are marked to market at Friday afternoon London time. A complete inventory of closed trades is presented at the end of this section along with performance statistics such as success rates and average returns per trades.

Macro Trade Recommendations

A cool summer (at least for this London-based writer) should be followed by a warmer autumn as European and US policymakers have unfinished business and the global economy remains on the floor. The continued compression in the volatility risk premia and the elevated valuation of cyclical currencies offer good entry levels to scale into option-based defensive trades.

Buy USD call spreads versus AUD and CAD as hedges against the inevitable fiscal paralysis in the US and likelihood that euro stress resurfaces in September as Spain ponders its bail-out options, Greece struggles to keep the Troika on-side and the ECB needs to flesh out the details of its sovereign backstop.

The dollar stands to benefit not only from adverse global economic conditions and fiscal policy stress, but also more positive market technicals. Average USD valuation and risk reversals are now below their 1Y average, and speculative longs, even though still above average, are 75% below their peak level.

The average risk premium in the euro fell to a two-month low following the ECB meeting last week - we continue to expect this risk premium to re-widen in the autumn. Concentrate euro shorts on crosses where valuations are least challenging, i.e. EUR/USD and EUR/JPY, rather than the Scandinavian crosses where there has been no compression in the euro risk premia.

Two of the macro mean-reversion trades performed well this week (NOK up versus GBP and SEK); the other rather less well (AUD/NZD rallied on divergent labour data). Hold all three trades.

Closed trades: None

New trades: Buy a 2-mo 1.03-1.00 AUD/USD put spread and a 2-mo 1.01-1.03 USD/CAD call spread.

Existing trades: Stay short EUR/JPY (cash) and EUR/USD (2-mo 1x1.5 ratio put spread, strikes 1.22-1.19). Stay short GBP/NOK (cash) and long NOK/SEK (2-mo 1.15-1.18 call spread). Hold a 2-mo AUD/NZD put fly (1.2850x1.2650 x1.2450) and a 1Y EUR/CHF seagull (long a 1.19-1.11 put spread, short a 1.2550 call).

Chart 1: Dollar technicals have turned positive. Valuation and risk reversals are below their 1Y average. Spec longs, while still above average, have declined 75% from their peak. 1Y Z-score for each variable. USD value is defined as the average pair wise

misalignment of USD versus daily valuation models. USD risk reversal is the average USD vs G10 risk reversal.

Source: J.P. Morgan

In our judgment risk/reward considerations now favour scaling into option-based defensive trades in addition to the basket of euro shorts that we added to following the ECB-inspired bounce in the euro last week. The continued compression in risk-premia (JPM’s VXY index of FX volatility hit a new post-Lehman’s low earlier this week) and elevated cyclical valuations fail to properly account for a global business cycle that is languishing at its post-crisis nadir and the fiscal policy risks which still threaten in the Euro area and the US. The market in our opinion places too much confidence in the ability of the monetary authorities to deliver cyclical lift and in the ability and sometimes even willingness of politicians to avoid fiscal and credit accidents.

On the macro-side, while the slight improvement in the US data does negate some of the tail-risk that had been building in the economy, this should not obscure what is still a feeble

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absolute pace of growth (1.5-1.75%). Nor should it obscure the continued deterioration in growth outside of the US. Chinese data this week offered no evidence of the lift that investors have been anticipating for much of the year, while on a broader basis the pace of contraction in global industrial production intensified in June from -0.7% 3m/3m ar in May to around -1.0% in June (the US and the Euro area will report their IP figures next week). As for Europe, the relative calm that has descended in recent weeks is unlikely to outlive the European political and financing holiday of the next few weeks. To cap it all, we are approaching the business end of the US election campaign, which is bound to refocus investors' attention on the dangers of a political class unable to lift its collective gaze from its navel towards the rapidly approaching fiscal cliff.

The question is whether these risks are adequately reflected in market pricing, be it spot market valuations or option-metrics. The absolute level of the VXY (only three-quarters of its May peak) is certainly hard to reconcile with the continued paucity of economic growth and the profusion of unresolved fiscal policy issues. Similar reservations can be applied to spot market valuations, especially in the case of extremely expensive commodity currencies, notably AUD. The dollar offers a useful summary of the market's cyclical complacency - as chart 1 highlights, the dollar is now cheaper on a high-frequency valuation basis than its one-year average, as is the USD risk-reversal. Speculative longs in the dollar are still above average but are 75% smaller than their peak. The conclusion – market techncials are increasingly favourable for building defensive dollar longs.

Trades

Buy a 2-mo 1.03-1.00 AUD/USD put spreadAUD is the preferred vehicle for a defensive trade: 1) AUD is the most expensive of the commodity currencies on our high-frequency models, 0.75 sigma above fair-value; 2) speculative longs in AUD are still 40% of their 2012 peak compared to only 18% for CAD. AUD thus offers greater deleveraging bang-for-one’s buck; and 3) AUD offers leverage to the continuous drip-feed of negative China data, which may soon start to overwhelm optimism towards policymakers’ ability to engineer lift. Buy a 2-mo 1.03-1.00 AUD/USD put spread for

65bp. Spot ref 1.0520.

Buy a 2-mo 1.01-1.03 USD/CAD call spreadThere isn’t the same speculative length in CAD as AUD. Nonetheless, short CAD should offer an effective hedge to the US fiscal cliff, especially now that the heat has gone out of Canada’s economic data. Employment growth has turned negative (-5.1K on average in the past 3 months versus +20.4K in the past 6 months), while Q2 GDP is tracking at 1.5% saar compared to 1.9% in Q1.

Buy a 2-mo 1.01-1.03 USD/CAD call spread for47.5bp. Spot ref 0.9930.

Bearish EUR - Stay short EUR/JPY in cash and short EUR/USD via a 2-mo EUR/USD ratio put spread

Our recommendation to increase EUR shorts in the wake of the ECB-inspired rally was an outlier from the consensus, which instead regarded the ECB’s announcement of potential bond buys as the precursor to a more extensive euro rally. It would be premature to proclaim the trade a success; nonetheless, the euro has clearly lost momentum

Chart 2: The euro risk premium is the smallest in two months. But political holidays and a dearth of peripheral supply offer only a temporary respite – the premium is likely to re-widen in September. Average % deviation of euro-cross rates from their high-frequency fair-value, as defined by pair wise, 1Y regressions of EUR FX vs short-term rate differentials, sovereign credit premia and equity volatility

Source: J.P. Morgan

Chart 3: The euro risk-premium is most pronounced against the strongest credits and economies (NOK and SEK) and least pronounced against currencies with weak growth and compliant central banks (GBP and USD). EUR/CHF is the only pair where the euro is too strong, courtesy of SNB support. Z-score deviation of euro-cross rates from their high-frequency fair-value, as defined by pair wise, 1Y regressions of EUR FX vs short-term rate differentials, sovereign credit premia and equity volatility.

Source: J.P. Morgan

-5

-4

-3

-2

-1

0

1

2

3

4

5

Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12

Euro rich

Euro cheap

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

10



and we expect it to continue to struggle, not only from the realisation that September offers a potential return to both political and bond market stress, but also from the enervating reality of the region’s recession and attendant likelihood of additional monetary easing. Sold EUR/JPY Aug 3 at 96.75. Marked at 0.6%.

Hold a 2-mo EUR/USD 1.22-1.19 ratio put spread in 1x1.5 notional. Bought for 0.35% on July 6.Marked at 0.46%

Stay short GBP/NOK in cash NOK was the best performing major currency over the past week. One always needs to be watchful of positions in NOK and the currency’s vulnerability to deleveraging. Since, however, NOK outperformance is only a very recent phenomenon we doubt whether investors have yet had the chance to accumulate excessive longs. Domestic data, meanwhile, remains generally supportive for NOK. In particular the acceleration in credit growth to a three-year high underscores the extent to which monetary policy is now too loose for the domestic economy and the constraints which this places on the willingness of the Norges Bank to cut interest rates to restrain currency appreciation. Next week's data focus will fall on the UK, where CPI, unemployment, retail sales and the MPC minutes are all due. The data will likely not change the impression of an economy that is at best stagnating and of a central bank with more need and certainly greater inclination to ease than virtually all others. Sold GBP/NOK Aug 3 at 9.35. Worth 0.8%.

Hold a AUD/NZD 2-mo put fly AUD/NZD was trading notably rich to interest rate differentials when we recommended the trade last week. Unfortunately, part of the valuation gap was closed by a relative downgrade in NZD interest rates, following surprising poor Q2 employment data in NZ and satisfactory labour data in Australia. The NZ data, however, is likely to under-estimate growth as much as the strong Q1 GDP numbers over-estimated it. As such we are not yet willing to give up on this macro mean-reversion trade. There is no data of any note in either Australia or NZ next week. Hold a 2-mo AUD/NZD put fly (1.2850x

1.2650x1.2450 in 1x2x1 notional). Bought Aug 3 for 0.29%, worth 0.19%.

Hold a 2-mo NOK/SEK call spread The pendulum of market sentiment, not to mention interest rates, has tilted somewhat back in NOK’s favour over the part week. We expect this process to continue, especially as some of the recent strength in Swedish growth numbers is very hard to reconcile with the very weak global economic and trade backdrop.

2-mo NOK/SEK 1.15-1.18 call spread. Bought on July 20 for 0.57%. Marked at 0.19%.

Hold a bearish 1-yr EUR/CHF seagull The SNB’s July reserve data indicated intervention of CHF 41bn, just over CHF 10bn more than the increase in sight depos. The inference from this is that around one-quarter of the intervention was de-facto sterilised. What the data also highlights is the SNB’s growing FX risk –FX and gold reserves are now 80% of GDP. The SNB’s balance sheet provisions would cover only a 12-13% write-down on these assets through FX appreciation.

Hold a 1Y 1.1900-1.1100 EUR/CHF put spread part financed by selling a 1Y 1.2550 EUR/CHF call. Net cost of 0.13% on May 11. Worth 0.18%.

Chart 4: SNB intervention in the past 3 months stands at CHF 160bn or 29% of GDP. 25% of the intervention in July, and 20% of the intervention since May, was de facto sterilized, as suggested by the difference between the increase in FX reserves and the increase in CHF liquidity (measured by sight deposits at the SNB).

Source: SNB; J.P. Morgan

Chart 5: The SNB’s balance sheet provisions are sufficient to offset a 12-13% writedown on its foreign assets. That coverage would decline to only 9% if the SNB added reserves at the current rate until year-end.

Source: SNB; J.P. Morgan

0

10

20

30

40

50

60

70

May June July

Change in net FX reserves (ex FX swaps and reval)

Change in sight depos

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

2006 2007 2008 2009 2010 2011 2012

11



Table 1.Current FX spot recommendations and P&L

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

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

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

Long Short Entry date Entry level Current level Stop lossP&L since

entryComments

JPY EUR 03/08/12 96.75 96.170 99.00 0.6% Hold

NOK GBP 03/08/12 9.350 9.280 9.600 0.8% Hold

DescriptionEntry

date

Expiry

date

Days to

expiry

Entry

level

Current

level

P&L since

entry*Comments

Buy 12-mo 1.190-1.110 EUR/CHF put spread, sell 1.255 call, 1x1x 1 notl 11/05/12 13/05/13 276 0.13% 0.18% 0.05% Hold

Buy 2-mo 1.22-1.19 EUR/USD ratio put spread 1:1.5 06/07/12 06/09/12 27 0.35% 0.40% 0.05% Hold

Buy 2-mo 1.15-1.18 NOK/SEK call spread 20/07/12 20/09/12 41 0.57% 0.24% -0.34% Hold

Buy 2-mo 1.285-1.265-1.245 AUD/NZD put fly 1:2:1 notionals 03/08/12 05/10/12 56 0.29% 0.22% -0.08% Hold

Buy 2-mo 1.03-1.00 AUD/USD put spread 10/08/12 12/10/12 63 0.65% 0.65% 0.00% New trade

Buy 2-mo 1.01-1.03 USD/CAD call spread 10/08/12 12/10/12 63 0.38% 0.38% 0.00% New trade

* P&L in % of asset

12



I. Performance statistics 2008 – 2012 Chart 1: 2008-2012 performance summary: Average returns per trade

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

2012 2011 2010 2009 2008

2008-2012

avg

I. Macro Trade Recommendations portfolio

Cash

# of trades 21 42 89 61 85 298

Success rate 62% 60% 53% 64% 59% 59%

Average return per trade (%, unweighted) 0.1% 0.0% 0.0% 1.0% 2.0% 0.8%

Average holding period (calendar days) 27 25 23 20 31 25

Derivatives (non-digital)

# of trades 18 27 27 21 3 96

Success rate 72% 74% 62% 62% 0.0% 65%

Average return per trade (%, unweighted) 0.3% 0.9% 0.3% 0.5% -0.6% 0.5%


Derivatives (digital)

# of trades 4 10 4 21 5 44

Success rate 75% 50% 25% 38% 20% 41%

Average return per trade (%, unweighted) 9.5% -0.9% -6.7% -4.7% -3.6% -2.6%


II. FX Derivatives portfolio (relative value)

Vol r.v

# of trades 23 37 45 32 13 150

Success rate 57% 62% 69% 63% 77% 65%

Average return per trade (unweighted)* 0.2 0.1 0.7 0.1 0.3 0.3


Vol plus directional r.v

# of trades 9 16 4 - - 29

Success rate 78% 75% 50% - - 72%

Average return per trade (bp, unweighted) 46 12 -8 - - 19.8

Average holding period (calendar days) 56 27 50 - - 39

Digital

# of trades NA - - - 3 3

Success rate NA - - - 33% 33%

Average return per trade (%, unweighted) NA - - - 8% 8%

Average holding period (calendar days) NA - - - 33 33

III. Technical Strategy portfolio

# of trades 15 33 52 46 87 233

Success rate 33% 58% 46% 57% 43% 48%

Average return per trade (%, unweighted) 0.3% 0.1% 0.0% 0.1% 0.2% 0.1%


*P&L in vol points

0.8%

2.0%

1.0%

0.0%

0.0%

0.1%

0% 1% 2%

2008-12 avg

2008

2009

2010

2011

2012

Cash

0.5%

-0.6%

0.5%

0.3%

0.9%

0.3%

-1% 0% 1%

2008-12 avg

2008

2009

2010

2011

2012

Derivs (non-digital)

0.1%

0.2%

0.1%

0.0%

0.1%

0.3%

-0.5% 0.0% 0.5%

2008-12 avg

2008

2009

2010

2011

2012

Technical

0.3

0.3

0.1

0.7

0.1

0.2

0.0 0.2 0.4 0.6 0.8

2008-12 avg

2008

2009

2010

2011

2012

RV (non-digital)

(vol pts)

59%

59%

64%

53%

60%

62%

0% 50% 100%

2008-12 avg

2008

2009

2010

2011

2012

Cash

65%

0%

62%

62%

74%

72%

0% 50% 100%

2008-12 avg

2008

2009

2010

2011

2012

Derivs (non-digital)

65%

77%

63%

69%

62%

57%

0% 50% 100%

2008-12 avg

2008

2009

2010

2011

2012

RV (non-digital)

48%

43%

57%

46%

58%

33%

0% 50% 100%

2008-12 avg

2008

2009

2010

2011

2012

Technical

13



II. Closed trades 2012

Cash portfolio

Derivatives (directional)

Derivatives (digital)

FX Derivatives portfolio

(vol relative value plus directional)

FX Derivatives portfolio (vol relative value)

Technical portfolio

Long Short Entry date Entry level Exit date Exit level P&L

NOK SEK 22/11/11 1.171 24/02/12 1.177 0.5%

NOK GBP 27/01/12 9.170 24/02/12 8.835 3.8%

SEK USD 27/01/12 6.790 16/02/12 6.770 0.3%

EUR USD 03/02/12 1.312 03/03/12 1.322 0.8%

NOK USD 13/02/12 5.721 09/03/12 5.668 0.9%

EUR GBP 24/02/12 0.848 14/03/12 0.831 -2.0%

EUR NZD 24/02/12 1.605 30/03/12 1.627 1.4%

JPY CAD 23/03/12 82.50 13/04/12 81.10 1.7%

JPY AUD 11/05/12 80.50 25/05/12 77.85 3.4%

JPY CAD 01/06/12 75.40 07/06/12 78.00 -3.3%

USD AUD 01/06/12 0.970 07/06/12 0.998 -2.8%

JPY GBP 01/06/12 120.4 07/06/12 124.2 -3.1%

USD GBP 20/04/12 1.612 15/06/12 1.570 2.7%

NOK GBP 15/06/12 9.309 06/07/12 9.466 -1.7%

USD CAD 01/06/12 1.038 19/07/12 1.010 -2.7%

JPY EUR 06/07/12 98.89 20/07/12 95.82 3.2%

USD SEK 06/07/12 6.990 27/07/12 6.850 -2.0%

Non-Digital Options Entry date Entry level Exit date Exit level P&L (%)

Buy a bullish 4-mo USD/SEK fly (buy 1x 7.00 call sell

2x 7.50 call and buy 1x 8.00 call)22/11/11 1.04% 27/01/12 0.71% -0.33%

Buy 4-mo 100-95 EUR put/JPY call spread 22/11/11 1.13% 03/02/12 1.30% 0.17%

Sell 6-mo 1.2050 EUR put/CHF call 22/11/11 2.05% 24/02/12 0.80% 1.25%

Sell 2-mo 1.20 NOK/SEK call RKI 1.22 09/03/12 0.74% 30/03/12 0.07% 0.67%

Sell 2-mo 1.08 AUD/USD call RKI 1.10 09/03/12 0.77% 31/03/12 0.16% 0.61%

Sell 2-mo EUR/CAD 1.2850 put, buy 1.3500 call 23/03/12 0.40% 05/04/12 -0.21% -0.61%

Buy 2-mo 1.00 AUD/USD put 23/03/12 0.93% 27/04/12 0.15% -0.78%

Sell 2-mo 0.84 NZD/USD call RKI 0.85 09/03/12 0.76% 11/05/12 0.00% 0.76%

Long 6-mo 76-72.50 USD put/JPY call spread in 1x2

notional22/11/11 0.15% 25/05/12 0.00% -0.15%

Sell 2-mo 0.98 USD/CAD call RKI 0.96 20/04/12 0.56% 25/05/12 0.01% 0.55%

Sell 2-mo 0.8150 NZD/USD call RKI 0.8310 04/05/12 0.51% 25/05/12 0.04% 0.47%

Sell 2-mo 8.95 EUR/SEK call RKI 9.05 27/04/12 0.70% 29/06/12 0.00% 0.70%

Sell 2-mo 7.65 EUR/NOK call RKI 7.75 27/04/12 0.61% 29/06/12 0.00% 0.61%

Buy 2-mo 1.25-1.20 EUR/USD put spread 11/05/12 0.48% 13/07/12 2.44% 1.96%

Buy 2-mo 79-77.5 USD/JPY ratio put spread 1:2 06/07/12 0.15% 20/07/12 0.38% 0.23%

Digital Options Entry date Entry level Exit date Exit level P&L (%)

Buy 3-mo EUR/NOK 7.59-8.05

double-no-touch22/11/11 22.0% 03/02/12 56.3% 34.3%

Buy 2-mo 1.045 USD/CAD At expiry

digital call11/05/12 16.25% 25/05/12 26.54% 10.29%

Buy 2-mo 1.55 GBP/USD At expiry

digital put11/05/12 13.0% 29/06/12 26.3% 13.3%

Buy 3-mo 7.3820 - 7.6835 EUR/NOK

range binary29/06/12 20.00% 06/08/12 0.00% -20.00%

Trade Entry date Entry level Exit date Exit level P&L Units

Buy 2M GBP put/AUD call 1.48 One-touch

vs. sell 2M GBP call/AUD put 1.59 One-

Touch, equal GBP notionals

02/12/11 7 06/01/12 35 28 % GBP

Buy 2M 35D USD call/NOK put vs. sell

2M 35D USD call/BRL put, equal USD

notionals

16/12/11 -76 13/01/12 59 135 bp USD

Buy 6M 1500 Gold call/ EUR put one

touch vs. Sell 2M 1500 Gold call/ EUR put

one touch in 1: 1.42 EUR notionals

09/09/11 42 10/02/12 23 -19 % EUR

Buy EUR/CAD 2M 4% OTMS EUR calls

vs. Sell EUR/MXN 2M 4% OTMS EUR 20/01/12 -38 23/03/12 0.0 37.8 bp EUR

Sell USD/TRY 6M 10D USD call/TRY put

delta-hedged06/01/12 80 05/04/12 77 3 bp USD

Buy 2Y 43/50 TRY call/JPY put spread 27/01/12 275 05/04/12 382 107 bp TRY

Buy 2M 35D EUR call/AUD put vs. Sell

2M 35D EUR call/MXN put, equal EUR

notionals

27/04/12 -23 04/05/12 44 67 bp EUR

Buy 3M 470/500 DNTs in USD/CLP 04/05/12 18 16/05/12 0 -18 % USD

Buy 2M 35D USD/CAD call vs. Sell 2M

35D USD/RUB call21/06/12 -73 10/08/12 -1 72 bp USD

Trade Entry date Entry level Exit date Exit level P&L*

Buy EUR/CAD 1Y D/N straddles, delta-hedged 04/11/11 12 01/06/12 9.8 -2.6

Buy 1Y GBP/USD vs. GBP/JPY correl swap 05/04/12 58.0 01/06/12 68.4 10.4

Buy USD/MXN 2M1M FVAs vs. Sell 2M3M

FVAs, equal USD vega notionals 05/04/12 -0.6 08/06/12 0.8 1.3

Buy 6M AUD/USD vs. AUD/EUR correl swap 13/01/12 59.0 13/06/12 50.6 -8.4

Sell 6M USD/JPY vol swaps, sell USD/MXN vol

swaps, buy MXN/JPY vol swaps, 70:100:130

vega ratio

08/05/12 -1.1 13/06/12 -0.9 -0.2

Buy USD/PLN vs. Sell EUR/PLN 2M vol swaps,

100:15018/04/12 1.6 19/06/12 1.5 0.1

Buy EUR/RUB 1M1M FVAs vs. Sell 1M vol

swaps, equal vega notionals 25/05/12 0.8 25/06/12 -2.4 -3.2

Buy AUD/USD vs. Sell AUD/CAD 3M straddles,

delta-hedged, 100:130 vega05/04/12 1.2 29/06/12 2.1 1.0

Buy EUR/CAD vs. Sell CAD/JPY 1Y1Y FVA,

150:50 vega03/02/12 8.9 29/06/12 8.2 -0.7

Buy NZD/USD vs. Sell USD/MXN 3M vol

swaps, equal USD vega notionals 05/04/12 1.0 06/07/12 -2.7 -3.6

Buy USD/JPY 6M straddles vs. Sell 2M

straddles, vega-neutral (delta-hedged)27/04/12 1.3 06/07/12 0.4 -0.9

Sell USD/RUB 6M vol swap 06/06/12 17.3 13/07/12 13.1 4.1

Trade Entry Date Entry level Exit date Exit level P&L

Short GBP vs USD 02/11/11 1.574 01/02/12 1.580 -0.5%

Long USD vs SEK 20/12/11 6.786 08/02/12 6.643 -2.1%

Short EUR vs USD 25/10/11 1.337 24/02/12 1.347 -1.0%

Short USD vs JPY 22/11/11 78.16 24/02/12 81.15 -3.9%

Long NOK vs SEK 10/02/12 1.179 14/03/12 1.179 0.0%

Long EUR vs NZD 24/02/12 1.609 05/04/12 1.609 0.0%

Long EUR vs SEK 23/01/12 8.785 05/04/12 8.801 0.1%

Short NZD vs JPY 23/03/12 67.31 12/04/12 66.89 0.3%

Long CAD vs JPY 20/04/12 81.63 08/05/12 79.72 -2.3%

Short GBP vs USD 21/03/12 1.588 30/05/12 1.550 1.2%

Short EUR vs INR 23/11/10 70.20 21/06/12 71.51 -1.9%

Short GBP vs CHF 23/05/12 1.500 19/07/12 1.535 -2.4%

Long USD vs CZK 10/08/11 17.26 26/07/12 20.69 20.0%

Short NZD vs USD 24/07/12 0.790 27/07/12 0.809 -2.5%

Long USD vs SEK 05/04/12 6.696 06/08/12 6.700 0.1%

14


Arindam Sandilya(1-212) [email protected]

Matthias Bouquet(44-20) [email protected]

FX Derivatives

Data vacuum in August is likely to keep a lid on vols and promote carry-type trades. Add to option-based carry via 6M ATMF/ ATMS spreads in EUR/INR.

Open vega-neutral long vol swap vs. short FVA packages at the front-end of the NZD/USD vol curve as a positive carry defensive position. Along similar lines, sell 9M3M USD/CLP FVAs against a beta-weighted amount of 9M3M USD/MXN FVAs.

Lower vols, steeper vol curves and flatter risk-reversals all materialized as expected in a week devoid of much in terms of economic news. The only calendar item of note for risk markets, the Chinese activity data dump for July, was a mixed bag – broadly a little weaker than consensus that re-inforced expectations of further policy stimulus in the autumn and contained the fallout on risk markets. The state of stasis can well continue until Jackson Hole at the end of the month when Fed policy/ QE-III will come into renewed focus. Lackluster price action till then should keep a lid on vol and fuel demand for carry/decay-earning strategies. This hardly implies throwing caution to the wind – we advocate range trades (DNTs) in very select crosses with low risk-sensitivities (NZD/SEK, GBP/CAD, USD/JPY) and ATMF/ATMS option spreads in high carry/vol underlyings such as USD/CNY and EUR/INR. As has been the case since the beginning of the year, we also remain on the lookout for carry-efficient vol protection where available, and advocate vol curve flatteners in NZD/USD.

We add to option-based carry through ATMF/ATMS spreads in EUR/INR. Asian currencies provide a rich seam of option-based carry trades to mine. Last week, we openedUSD/CNY 6M ATMF/ATMS put spreads; another one that stands out is EUR/INR (chart 1). Over-extended declines in EUR-crosses over the past two months is a concern for investors looking to earn carry via short EUR/EM, but EUR/INR is less afflicted than most owning to the persistent cheapness of INR. Our Asian strategists have scaled back their tactical bullishness on the rupee from last month, noting that the retracement in the currency from all time lows following an upturn in political sentiment in June has stalled recently, since policy paralysis persists and long-term investment inflows remain unconvincing. We expect the stand-off between bearish fundamentals and still net short INR positioning to be supportive of a long carry stance, especially when aided by the ballast of a short EUR leg in EUR/INR. It helps that max payout/cost ratios of EUR/INR ATMF/ATMS spreads are near the upper end of their historical range (chart 2), so this is as good a time as

Chart 1. EUR/INR is a favored candidate within the option-based (ATMF/ATMS) carry trade universe….

Source: J.P.Morgan

Chart 2. …with maximum payout/cost ratios near 3-yr highs

Source: J.P.Morgan

any to be earning carry in the cross.

Positive carry protection in the form of vega-neutral vol curve flatteners is available in NZD/USD. 1M NZD/USD implied vols have dipped to alarmingly low levels that are not only 2.5 vols below trailing 1M realized vols, but also nearly at par with the lowest realized vol print since the EU crisis erupted (chart 3). August being the data/news vacuum month that it is slated to be, it is hard to find catalysts for sharp gamma outperformance – in all likelihood, realized vols will mean-revert lower from current levels amid uninspiring price action in spot – but the asymmetry in chart 3 makes it unlikely that an outright long gamma position will turn out to be a total lemon even absent European shocks. A better position is to combine a long 1M vol swap position with a short 1M1M FVA to create a net positive carry package that is reasonably insulated from broad voldowndrafts. The 1M1M FVA trades at a 1.2 vol premium over spot 1M implieds (on mids) due to the steepness of the vol curve (chart 4), and that static slide accrues to the FVA

1.9

2.0

2.1

2.2

2.3

2.4

EU

R/I

NR

US

D/C

NY

AU

D/S

GD

US

D/C

HF

EU

R/U

SDE

UR

/RU

BE

UR

/TR

YU

SD

/IN

RA

UD

/CH

FJP

Y/I

NR

AU

D/C

ADE

UR

/AU

DE

UR

/CAD

EU

R/G

BP

RU

B/J

PY

AU

D/N

ZDE

UR

/NO

KU

SD

/JP

YN

ZD

/CH

FE

UR

/SE

KC

HF

/JP

YN

ZD

/CAD

CA

D/C

HF

SE

K/C

AD

CA

D/B

RL

EU

R/N

ZDE

UR

/ILS

GB

P/A

UD

TR

Y/J

PY

EU

R/K

…E

UR

/HU

FB

RL/

JPY

GB

P/C

AD

Max payout/cost ratio of 6M ATMF/ ATMS spreads (on mids)

1.8

1.9

2.0

2.1

2.2

2.3

2.4

2.5

2.6

2.7

Aug-09 Mar-10 Oct-10 May-11 Dec-11 Aug-12

Max payout/cost ratio of 6M EUR/INR ATMF / ATMS put spread (on mids)

15




seller if the vol curve remains unchanged over the following month. There are a couple of ways of viewing such vol swap/FVA packages. First, in the spirit of earning carry in a quiet month, they can be conceived of as positive vol carry constructs with low beta to the macro risk backdrop at inception – the long gamma leg hedges out the directional vol exposure of the FVA short, without sacrificing any (and in fact, adding to) ex-ante vol carry. Second, equal vega weightings on the two legs effectively reduce the trade to a vega-neutral long 1M/short 2M calendar spread; vol traders will recognize this is a classic curve flattening play, albeit with flat-vega products as opposed to vanillas. Assumingunchanged implied and realized vols over the next month, one stands to earn ~ 3 vols based on current pricing; shave off 1.0-1.5 vols to account for realizeds mean-reverting lower, and it still leaves an acceptable ~1.5-2.0 vol of P/L on the table.

In relative value, we recommend selling USD/CLP FVAs hedged with a weighted amount USD/MXN FVAs to earn risk premium along the back-end of vol curves in a risk-controlled fashion. Chart 5 shows that a spread of 3M in 9M USD/CLP forward vols over a beta-weighted amount of 3M in 9M USD/MXN forward vols is trading near 2-yr highs, and offers ~2.5 vols of static slide into spot 3M implied vols (on mids). Carry aside, hold-to-maturity returns from selling the weighted FVA spread are biased asymmetrically positive, since spot implied vol spreads have printed below current entry levels more than 90% of the time over the past few years; with the two cash exchange rates delivering tepid realized vols consistent with relative implieds another 2 pts. or so lower from here, that statistic is unlikely to be challenged. And while not obvious at first glance, a short CLP/long MXN vol package is an anti-risk trade in disguise, having displayed a reliable pattern of declining meaningfully during episodes of stress (chart 5). We open a 100 (CLP):80 vega weighted FVA spread in our portfolio.

Chart 3. Front-end NZD/USD vols have dipped to alarmingly low levels, below trailing realized vols and nearly at par with the lowest realized vol print in the post EU-crisis era…..

Source: J.P.Morgan

Chart 4. …while 1M1M forward vols trade at a decent premium over spot 1M implied vols owing to the steepness of the vol curve

Source: J.P.Morgan

Chart 5. Selling expensive USD/CLP forward vols hedged with a beta-weighted amount of USD/MXN forward vols offers meaty static slide into spot implied vols and performs handsomely during stress

Source: J.P.Morgan

8

10

12

14

16

18

20

22

24

26

Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12 Aug-12

NZD/USD 1M realized volNZD/USD current 1M implied vol

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0NZD/USD 1M1M forward vol - 1M implied vol (vol pts.)

Aug-10 Feb-11 Aug-11 Feb-12 Aug-12

-4

-3

-2

-1

0

1

2

3

4

5

6vol pts.

Aug-10 Feb-11 Aug-11 Feb-12 Aug-12

USD/CLP - 0.8*USD/MXN 3M in 9M BS fwd vol spreadUSD/CLP - 0.8*USD/MXN 3M implied vol spread

2.5 vol pts.

Vol spikes

16




Implied volatilities Biggest 3M Implied Volatility MoversWeekly Changes Monthly Changes

Source: J.P. Morgan

Front-End Vol RankingsIn order of Normalized Volatility Risk Premium*

Source: J.P. Morgan

Current trade recommendations and P&L

1M 3M 1Y 1M 3M 1Y 1M 3M 1YAUDJPY 10.4 12.1 15.0 14.6 15.5 17.4 -1.6 -1.5 -1.5

AUDUSD 8.8 10.0 12.2 12.9 13.6 14.8 -1.7 -1.8 -1.9

CADJPY 9.1 10.4 12.7 13.2 13.9 15.6 -2.1 -2.2 -2.4

CHFJPY 10.9 12.2 14.3 12.5 12.9 14.0 -0.6 -0.4 0.1

EURAUD 7.7 8.6 10.2 10.6 11.3 12.6 -1.9 -2.1 -2.4

EURCAD 7.4 8.1 9.5 10.3 10.9 11.8 -1.9 -2.0 -2.0

EURCHF 2.2 4.0 6.5 8.8 9.2 10.1 -1.5 -1.5 -1.4

EURGBP 6.5 7.2 8.7 8.7 9.3 10.5 -1.9 -1.9 -1.6

EURJPY 10.8 12.2 14.1 13.5 14.2 15.9 -1.4 -1.2 -1.4

EURNOK 7.3 7.5 7.7 7.7 8.0 8.5 -0.3 -0.4 -0.8

EURNZD 8.2 9.3 11.0 11.1 11.8 13.0 -1.7 -1.7 -1.9

EURSEK 7.7 8.0 8.3 7.7 8.0 8.5 0.0 0.0 -0.2

EURUSD 9.1 9.8 11.3 12.2 12.6 13.4 -1.6 -1.6 -1.8

GBPJPY 9.1 10.5 12.7 12.1 12.9 14.7 -1.7 -1.5 -1.5

GBPUSD 7.0 7.8 9.3 9.2 9.9 11.2 -1.7 -1.6 -1.7

NZDUSD 9.3 10.5 12.7 13.3 14.0 15.2 -1.6 -1.7 -1.9

USDCAD 6.4 7.0 8.3 9.6 10.0 10.9 -1.6 -1.8 -1.9

USDCHF 9.3 10.1 11.7 12.5 12.7 13.2 -1.2 -1.2 -1.0

USDJPY 6.7 7.8 10.0 9.7 10.4 12.2 -2.1 -2.1 -2.2

USDNOK 9.6 10.8 12.7 13.8 14.3 15.2 -1.8 -1.8 -1.8

USDSEK 9.8 11.0 12.8 14.1 14.6 15.4 -1.7 -1.6 -1.7

USDARS 17.0 20.0 23.0 7.8 10.2 17.5 1.3 1.5 1.5

USDBRL 10.3 11.3 13.3 13.7 14.4 16.1 -0.8 -0.9 -1.2

USDCLP 10.5 11.2 12.8 12.5 13.0 14.0 -0.6 -0.7 -0.6

USDMXN 12.8 13.2 13.7 13.0 13.6 14.7 -0.1 -0.1 -0.4

EURCZK 7.2 7.7 7.9 7.3 7.5 7.8 -0.1 0.1 0.1

EURHUF 10.5 11.2 11.7 11.3 11.7 12.6 -0.3 -0.3 -0.6

EURPLN 8.7 9.5 10.3 10.3 10.9 11.7 -0.8 -0.8 -1.1

EURRUB 9.8 10.2 11.3 10.3 10.9 12.4 -0.2 -0.4 -0.7

USDRUB 11.2 11.7 12.8 11.4 12.0 13.4 -0.1 -0.1 -0.3

USDTRY 9.9 9.6 11.9 12.2 12.9 14.3 -1.5 -1.6 -1.7

USDZAR 15.5 16.4 17.0 16.4 16.8 17.5 -0.2 -0.1 -0.2

USDIDR 6.4 8.6 12.2 8.4 9.8 12.8 -0.6 -0.4 -0.3

USDINR 10.1 10.7 11.4 9.4 10.0 11.0 0.3 0.4 0.3

USDKRW 7.0 8.5 11.1 11.5 12.6 14.1 -1.5 -1.6 -1.7

USDPHP 5.8 6.5 8.0 7.3 7.9 9.1 -1.2 -1.2 -1.1

USDSGD 5.0 5.9 6.9 7.4 7.8 8.3 -1.2 -1.2 -1.2

USDTWD 3.5 4.0 5.1 5.8 6.4 7.4 -1.7 -1.8 -1.8

Z-Score Implied VolsAvg. Implied VolsCurrent Implied Vols

-1.5 -1.0 -0.5 0.0 0.5

USDNOKUSDSEKEURUSDUSDCHFNZDUSDUSDINRAUDJPYAUDUSDEURRUBUSDKRWUSDPHPUSDZAREURGBPUSDJPYEURSEKEURCZKEURNOKEURHUFUSDARSEURPLN

Vol

Vol

-3 -2 -1 0 1 2

USDBRLUSDCLPAUDJPYCADJPYUSDIDRCHFJPYGBPJPYEURJPYUSDINR

USDARSEURAUDGBPUSDEURNZDUSDTRYEURPLNEURHUFEURCHFUSDZAREURNOKEURSEK

Vol

Vol

-0.2 0.0 0.2 0.4 0.6 0.8 1.0

EURSEKNZDUSDEURJPY

GBPUSDCHFJPY

EURGBPUSDZARUSDMXNGBPJPYEURAUDUSDINR

USDKRWUSDTRYUSDBRLUSDJPYUSDCLPEURCZKUSDPHPUSDTWD

USDIDR

Vols RICH

Vols CHEAP

Analyst Description Entry date EntryCurrent

midP/L

P/L

unitsRemarks

Sandily a/Bouquet Buy USD/ARS 1Y ATMF/ATMS USD put spread 02-Mar-12 6.8 3.2 -3.6 % USD Best max pay out/cost ratio optionalized carry trade

Sandily a/Bouquet Buy 6M 4% OTMS BRL call/JPY put vs. Sell 6M 4%

OTMS USD call/JPY put, equal JPY notionals 05-Apr-12 -18 -1 17 bp JPY

Cross-y en high strikes underpriced relative to USD/JPY high

strikes

Sandily a/Bouquet Sell 6M USD/JPY vol swaps and USD/KRW v ol sw aps,

buy 6M KRW/JPY v ol swaps, 100:100:160 vega ratio27-Apr-12 -2.2 -2.8 0.6 v ol pts Prox y for USD/JPY vs. USD/KRW correlation short

Sandily a/Bouquet Buy AUD/USD 1Y6M FVA / sell 6M6M FVA, 2:1 vega ratio 04-May -12 15.3 15.7 0.5 v ol pts Positiv e v ol slide, long vega position courtesy steep v ol curv e

Sandily a/Bouquet Buy EUR/USD 1Y6M FVA / sell 6M6M FVA, 2:1 vega ratio 04-May -12 13.4 13.9 0.6 v ol pts Positiv e v ol slide, long vega position courtesy steep v ol curv e

Sandily a/Bouquet Sell 6M USD/JPY vol swaps, sell USD/MXN vol swaps,

buy MXN/JPY vol swaps, 70:100:130 vega ratio 08-May -12 -1.1 -2.5 1.4 v ol pts Prox y for USD/JPY vs. USD/MXN correlation short

Sandily a/Bouquet Sell GBP/JPY vs. GBP/CAD 3M correlation swap 04-Jun-12 12.0 21.7 -9.7 corr pts Implied correlations rich to realized

Sandily a/Bouquet Buy 2M 35D USD/CAD call vs. Sell 2M 35D USD/RUB call 21-Jun-12 -73 -1 72 bp USD Take profit

Sandily a/Bouquet Buy 3M NZD/USD vol sw ap, buy USD/CAD 3M vol

swap, sell USD/CLP 3M vol sw ap (50:100:-100 vega ratio)21-Jun-12 2.7 1.4 -1.3 v ol pts

Market-neutral vol butterfly w ith attractive implied-realized

technicals

Sandily a/Bouquet Buy 3M EUR/KRW v ol sw ap v s. sell USD/KRW v ol sw ap 25-Jun-12 -0.1 0.2 0.3 v ol pts Gamma RV – implied spread cheap and below realized

Sandily a/Bouquet Buy AUD/USD 2Y2Y FVAs (AUD vega) 13-Jul-12 14.2 13.3 -0.9 v ol pts Long v ol, positive carry trade with attractive entry lev els

Sandily a/Bouquet Buy USD/JPY 6M 25D risk-reversal (long USD puts vs. sell

USD calls, vega-neutral)13-Jul-12 0.3 -0.1 -0.4 v ol pts

USD/JPY skews ov er-bid for USD calls relative to realized spot-

v ol correlations

Sandily a/Bouquet Sell GBP/JPY vs. GBP/CAD 3M correlation swap 16-Jul-12 20.0 38.6 -18.6 corr pts Implied corrs rich, likely to decline if vols mean-revert higher

Sandily a/Bouquet Sell 1M / buy 6M 2.01 USD/BRL calendar puts (equal notls) 03-Aug-12 105 99 -6 bp USD Positiv e carry spread to position for steepening of vol curve

Sandily a/Bouquet Buy USD/CNY ATMF/ATMS put spread 03-Aug-12 37 33 -4 bp USD Best v alue option-based carry trade

Sandily a/Bouquet Buy NZD/SEK 3M 5.35/5.75 DNT 03-Aug-12 20.0 15.3 -4.8 % NZD Low beta to broad risk, high barrier width/YTD spot hi/lo range

Sandily a/Bouquet Buy GBP/CAD 3M 1.51/1.60 DNT 03-Aug-12 29.0 30.3 1.3 % GBP Low beta to broad risk, high barrier width/YTD spot hi/lo range

NEW Sandily a/Bouquet Buy EUR/INR ATMF/ATMS put spread 10-Aug-12 167 152 -15 bp EUR Good v alue option-based carry trade

NEW Sandily a/Bouquet Buy NZD/USD 1M vol sw ap v s. Sell 1M1M FVA 10-Aug-12 -1.0 -1.4 -0.4 v ol pts Positiv e carry , v ega neutral protection

NEW Sandily a/Bouquet Buy USD/MXN vs. Sell USD/CLP 9M3M FVA spreads 10-Aug-12 -2.5 -3.3 -0.8 v ol pts Positiv e carry , dislocated forward v ol spread that performs

17


Thomas Anthonj(44-20) [email protected]

Technical Strategy

EUR – The broad flight out of the EUR intensifies particularly against G10 currencies

GBP – In the footpath of the EUR but with better perspectives to recover against commodity FX

JPY – The broader up-trend has slowed but seems to be incomplete overall

CE3 currencies – The latest recoveries couldn’t brighten the picture on bigger scale yet

Stay long EUR/CZK and USD/ZAR & short EUR/USD, GBP/USD, GBP/JPY, NZD/CAD, EUR/KRW, EUR/MXN, NZD/NOK and PLN/HUF.

The fear of a EUR breakup manifests in strong EUR losses across the board

The once more intensifying sovereign debt crisis in southern Europe and the rising fear of a EUR breakup finally led to a widespread flight out of the EUR, which has also lost massively against Commodity FX during the risk recovery of the last few weeks. EUR/USD also received temporary support from the latter, but given the classical zigzag consolidation pattern, which failed to clear the key-T-zone at 1.2556/1.2621 (int. 38.2 %/pivot) so far, the broader bear trend appears to be totally intact and former lows at 1.1876 and at 1.641 remain in focus. Given the H & S topping pattern in the weekly chart, an extension to 1.1339 (Fib.-projection), to 1.1212 (61.8 %) and to the H & S projection at 1.1100 wouldn’t surprise at all.

Chart 1: EUR/USD – Daily Chart: Below 1.2556/1.2621 the EUR bears remain in full control and 1.1876 as well as 1.1641 in focus

The expected recovery in EUR/Commodity FX failed to manifest so far as hopes for fresh liquidity injections from the Fed and the ECB are still driving risk markets and keep

on supporting commodity currencies. This led to breaks below historic lows at 1.1717 in EUR/AUD and below 1.5188 in EUR/NZD, which has postponed the expected recovery for a while. We nevertheless like the idea of a broader recovery in EUR/Commodity FX and keep on watching key-pivotal resistance at 1.1777 in EUR/AUD and 1.2263 (minor 38.2 %) in EUR/CAD as breaks above could be the initial spark for such a recovery. The downtrends in EUR/NOK and EUR/SEK are also looking highly stretched and being close to former lows and displaying 5-wave patterns in the weekly chart raises the rebound risk significantly. That said we watch minor 38.2 %retracements at 8.2706 in EUR/SEK and at 7.3452/94 (38.2 %/pivot) in EUR/NOK carefully as decisive breaks above could potentially trigger recoveries to 7.9801 (38.2 %) in EUR/NOK and to 9.3420 in EUR/SEK.

The decoupling from the EUR crisis seems to fail as GBP gets dragged under with it

Being too close to the continent the British Pound’s attempts to decouple from the EUR crisis appear to be increasingly desperate while the UK is running deeper into recession and chart set-ups, particularly in GBP/USD and in GBP/JPY, are still showing a great sell-off risk. Particularly the former looks vulnerable as it fails to trade away from monthly triangle support at 1.5450, which if taken out, would leave little doubt that previous lows at 1.4228 and at 1.3504 will be retested. GBP/JPY is also remaining in negative territory as long as 124.53/66 (200 DMA/int. 76.4 %) caps the upside. Below, an extension to 112.59 (Fib.-projection) can’t be excluded yet

Chart 2: GBP/USD – Daily chart: Below 1.5726/78/85, acceleration down and a break below triangle support at 1.5484 is still looming

But while the hopes for stabilization have been shattered in GBP/SEK via the latest break below 10.542/10.492 (weekly trend/int. 76.4 %) we remain slightly optimistic that GBP/commodity FX might still succeed in doing so.

18


Thomas Anthonj(44-20) [email protected]

The latter is still showing a favorable setup for a broader recovery as long as GBP/CAD defends key-support at 1.5249/23 (pivot/int. 76.4 %) and as long as GBP/AUDdoesn’t display a weekly close below 1.4759 (left shoulder).

The broader JPY up-trend has lost momentum but appears to be still intact and incomplete

The broader up-trend of the JPY proves to be quite resilient as not even USD/JPY managed to escape the still intact down-rotation yet. As long as key-support at 77.675/595 (last low/int. 76.4 %) is defended though, the start window for a stronger recovery remains open. For the latter to materialize, it however takes a break above 79.143 (key-pivot). The bigger down-cycle in EUR/JPY is also missing a 5th wave decline to 91.89/90.18 (Fib.-projections) and possibly to 88.98 (low of 2000) as long as key-pivotal resistance at 98.33 is not taken out.

Chart 3: EUR/JPY– Daily Chart: Below 98.33, the downtrend is at least missing one more extension towards 91.89 & 90.18

The same applies for GBP/JPY where breaks below 121.60 and below 120.46 (76.4 % on 2 scales) would resume the broader downtrend for a projected extensions to 115.14 and to 112.59.

The intermediate recovery in CE3 currencies looks complete & the downtrend ready to be resumed

Having produced classical zigzag consolidation patterns in EUR/CE3 and USD/CE3 since early June, these markets have stabilized right above key-supports at 276.64/274.40 (int. 76.4 %/weekly trend) in EUR/HUF, at 4.0103 (int. 76.4 %) in EUR/PLN and at 222.65 (int. 76.4 %) in USD/HUF, which suggests that the broader up-trend is ready to be resumed. That said, we are now looking for

Chart 4: USD/CZK– Weekly Chart: The up-trend appears to be perfectly intact for a test of 21.82 and a potential extension to 23.43

confirming breaks above 4.1477/4.1554 (daily trend/minor 38.2 %) in EUR/PLN, above 284.15/285.23 (int. 38.2 %/daily trend) in EUR/HUF or above 3.3627 (minor 76.4 %) in USD/HUF to signal the resumption of the long-term up-trends. If so, the 2011/2012 highs should be re-tested.

Technical trades

P&L based on postion size

Trade details P&L Comments

Long Short Entry Entry Current Stop since entry

date level level loss %

HUF PLN 11/11/11 70.3070 68.1031 71.5000 3.12% Deeper correction still intact, added at 69.50 on 12th of January

EUR CZK 11/11/11 25.2100 25.2000 24.1500 -0.01% Medium term basing pattern suggests further upside.

CAD NZD 22/11/11 0.7921 0.8063 0.8501 -2.07% Outlook 2012 trade, added on 9 January at 0.8082

KRW EUR 22/11/11 1548 1387 1505 5.19% Outlook 2012 trade

USD ZAR 22/11/11 8.1250 8.1420 7.6000 0.32% Outlook 2012 trade

USD SEK 05/04/12 6.6962 6.6995 6.7000 0.05% Stopped August 8

USD GBP 21/03/12 1.5989 1.5598 1.5800 1.57% MT downtrend incomplete; taken half profit at 1.5500 on 30th of May

USD EUR 03/08/12 1.2285 1.2260 1.2650 0.08% MT downtrend remains incomplete

NOK NZD 07/08/12 4.8323 4.7990 4.9750 0.34% Reversal from long term range highs expected

MXN EUR 18/06/12 17.4200 16.1310 17.1550 3.70% Breakdown from key topping pattern

JPY GBP 20/07/12 123.11 122.15 126.00 0.39% Consoldiation seen as complete, downtrend about to resume

19


Anna Hibino(61-2) [email protected]

Global FX carry trade monitorChart 1: Japanese retail -- market capitalisation of 100 largest FX-denominated ITs

Chart 2: Foreign institutional investors – net positioning in BM&F USD futures

¥trn; market capitalization of 100 largest investment trusts; ranked in the

order of total asset as of March 2011

$bn; net positions in USD futures on BM&F for foreign institutional

investors

Source: J.P. Morgan, Bloomberg Source: J.P. Morgan, TFE;

Japanese retail exposure to the top 100 foreign currency ITs as of March 2011 increased from ¥20.6trn to ¥20.8trn on Monday, but has since edged down to ¥20.7trn as of yesterday. The current market cap is just 3% above the year-to-date low of ¥20.1trn.

Foreign institutional investors’ net longs in USD of $2.0bn declined to $1.0bn as of Wednesday, reaching the low since early June but standing 83% below the recent high of $11.9bn marked in late September 2011. During the same period, USD/BRL declined by just over 1%.

Chart 3: Japanese retail – market capitalisation of BRL-overlay funds

Chart 4: CTAs -- aggregate IMM position in USD

¥trn; market capitalization of top BRL-overlay investment trusts $ bn as the sum of net speculative positions on the IMM in AUD, NZD,

CAD, EUR, GBP, JPY, CHF and MXN.

Source: J.P. Morgan, TFE Source: J.P. Morgan, CME

Market cap of Japanese BRL-overlay was unchanged at ¥2.9trn this week. BRL/JPY changed little (less than 1%) during the same period. The current market cap level is 19% below the year-to-date high of ¥3.6trn marked in February of this year.

Aggregate USD longs declined for the second consecutive week from $18.5bn to $11.2bn between July 24th and 31st. EUR shorts also declined for the second consecutive week from $23.9bn to $21.5bn. JPY long increased from $4.0bn to $5.1bn, while AUD longs increased from $2.8bn to $3.9bn.

70

80

90

100

110

120

13010

15

20

25

30

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Market cap of top 100 ITs, JPY trn, lhs

JPY trade-wtd index, inverted, rhs

1.5

1.7

1.9

2.1

2.3

2.5

2.7

-15

-10

-5

0

5

10

15

20

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Foreign institutional investor net USD position, $bn, lhsUSD/BRL, rhs

1.800

2.300

2.800

3.300

3.800

4.300

36

38

40

42

44

46

48

50

52

54

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12

BRL/JPY, lhs

Market cap of top BRL overlay funds, JPY trn, rhs75

80

85

90

95

100

105

110

-$45

-$35

-$25

-$15

-$5

$5

$15

$25

$35

$45

$55

02 03 04 05 06 07 08 09 10 11 12

Aggregate IMM position in USD, $ bn, lhs

USD trade-wtd index, rhs

20



Chart 5: Market capitalisation of US-listed currency ETFs Chart 6: Currency managers and global macro hedge funds -- Beta with trade weighted USD

Weekly data, $bn. Positive value indicates longs in foreign currency and

shorts in USD

HFR used for global macro hedge funds. Barclay BTOP Index used for

currency managers.

Source: J.P. Morgan, Bloomberg Source: J.P. Morgan, Bloomberg

Market cap of US-listed FX ETFs edged up from the year-to-date low of $0.9bn to $1.0bn last Friday, which have since been unchanged throughout the week. The current level is 78% below the 2011 high of $4.5bn.

Currency mangers’ returns beta with the trade weighted dollar edged down from 0.2 to 0.1 this week, reaching the lowest level of positive beta since late May of this year. Meanwhile, global macro funds' beta was unchanged at 0.1 throughout the week.

Chart 7: Currency managers and global macro hedge funds -- Beta with G-10 carry strategies

Chart 8: Currency managers and global macro hedge funds -- Beta with emerging markets carry strategies

Positive beta implies a long in carry, a short in dollars. HFR used for global macro hedge funds. Barclay BTOP Index used for currency

managers.

Positive beta implies a long in carry, a short in dollars. HFR used for global macro hedge funds. Barclay BTOP Index used for currency

managers.

Source: J.P. Morgan, Bloomberg Source: J.P. Morgan, Bloomberg

Returns beta with G10 carry for currency managers continued to increase for the fourth consecutive week from 0.2 to 0.3. Global macro funds’ beta have been moving higher since reaching the year-to-date high in negative beta of -0.8 in late June. This week, their beta moved marginally from 0.1 to flat.

Returns beta with EM carry for currency managers moved from -0.1 to 0.1 last Friday, which has since been unchanged on the week. Global macro funds’ beta also declined from -0.1 to flat last Friday and has remained unchanged since.

75

80

85

90

95

1000

1

2

3

4

5

06 07 08 09 10 11 12

Market cap of US-listed FX ETFs, $bn, lhs

USD trade-wtd index, inverted, rhs

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

06 07 08 09 10 11 12

Global macro hedge funds

Currency managers

-2.0

-1.0

0.0

1.0

2.0

3.0

06 07 08 09 10 11 12

Currency managers


-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

06 07 08 09 10 11 12

Currency managers


21


Justin Kariya(1-212) [email protected]

Research Note

Intra-EMU currency valuations: Estimates for a breakup scenario

We employ the J.P. Morgan long-term fair value model to estimate intra-euro exchange rate misalignments. Figure 1 shows the real broad effective exchange rate (REER) misalignments for intra-euro theoretical currencies.

Germany (-19%), Belgium (-13%), and Austria (-13%) are the most undervalued (i.e. should appreciate); and Portugal (+17%), Ireland (+16%), and Greece (+13%) are the most overvalued (i.e. should depreciate).

The figure 1 results are generally consistent with other commonly used metrics to assess intra-euro imbalances such as the current account, changes to the current account, and the ECB Harmonized Competitiveness Indicators. But there are somedifferences.

Belgium is the most notable outlier. Flow measures such as the current account do not signal significant exchange rate appreciation. But the fair value model suggests a large undervaluation, which is consistent with Belgium’s net international investment surplus that trails behind only Germany and the Netherlands.

Signals are also mixed for Finland and France. But the misalignment/imbalances for Finland and France are generally small using different metrics, suggesting only a modest exchange rate adjustment in these countries.

Note that the long-term fair value model is not designed to capture the immediate currency impact of an EMU exit such as capital flight related to redenomination risks or the resulting economic dislocations for creditor and debtor countries alike. Rather the model misalignments are one approach for assessing the medium-term exchange rate adjustment if a country were to exit EMU.

Figure 1: Real exchange rate misalignments compared to 1999 levels

Positive values suggest overvaluation (i.e. currency should depreciate)

Source: J.P. Morgan

What are the theoretical fair values of intra-euro currencies?

Since the start of the Euro crisis, the probability of a country leaving the Euro has ebbed and flowed. While EMU break-up is not our central view, investors are understandably interested in the fair value of hypothetical intra-euro currencies given this risk. One common approach to this question is looking at each country’s current account balance and divergences between countries. This is onemetric for gauging the degree of exchange rate adjustment required to reduce external imbalances (figure 2). But this metric alone has varying degrees of success in predictinglong-term exchange rate adjustments, and current account deficits/surpluses can persist for years or decades.

As an alternative approach, we employ the J.P. Morgan long-term fair value model to assess intra-euro exchange rate misalignments2. We estimate the real fair value misalignments of hypothetical intra-euro currencies based on a broader set of variables which typically drive currencies over a longer-term horizon. Our results serve as a robustness check to commonly held views about currency misalignments in the Euro area, but also highlight some differences.

2 See Enhancement’s to J.P. Morgan’s Long-term Fair Value Model, September 29, 2011 for details on the JP Morgan long-term fair value model.

-19%

-13% -13% -12%

-6%

-2%

3%5%

13%16% 17%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

Ger

man

y

Bel

gium

Aus

tria

Net

herla

nds

Fra

nce

Fin

land

Italy

Spa

in

Gre

ece

Irela

nd

Por

tuga

l

22



Figure 1 shows the real broad effective exchange rate(REER) misalignments for intra-euro theoretical currencies. Germany (-19%), Belgium (-13%), and Austria (-13%) are the most undervalued (i.e. should appreciate); and Portugal (+17%), Ireland (+16%), and Greece (+13%) are the most overvalued (i.e. should depreciate). The results are generally consistent with the current account balances in figure 2 and other metrics presented in this note. But there are notable differences for countries like Belgium, France, and Finland.

Fair value model estimation procedure for theoretical currencies:

Predicting where a new currency would trade is complex and reflects highly unpredictable under and overshooting dynamics. However, the misalignments in the real broad effective exchange rates provide some information about the direction and magnitude of the nominal exchange rate adjustment required for a currency to revert to its

Figure 2: Intra-EMU current account balances (%GDP)

Chart shows the level of current account balances (%GDP)

Source: Bloomberg

equilibrium value. The JP Morgan fair value model estimates this adjustment based on structural drivers including terms of trade, productivity, debt levels, and net investment income, which are typical long-term drivers for exchange rates.

As discussed in Enhancements to JP Morgan’s Long-term Fair Value Model (Sept 2011), the model employs four explanatory variables that economic theory suggests should affect a wide range of currencies over different time periods. We estimate coefficients for these variables using a global set of 19 currencies and then apply the following relationships to 11 Euro area countries:

• A 1% increase in terms of trade is associated with 0.34% currency appreciation.

• A 1% increase in productivity is associated with 0.58% currency appreciation.

• A 1 percentage point increase to gross government debt/GDP is associated with 0.21% currency depreciation.

• A 1 percentage point increase to net investment income/trade is associated with 0.20% currency appreciation.

Using these relationships, one can estimate how intra-euro model estimates would have changed since 1999. The year countries adopted the euro is a logical benchmark, but one should note that this base year assumes all countries real broad effective exchange rates were close to fair value in 1999. Table 1 (next page) shows the estimated change to fair value and the contribution of each variable.

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The largest deterioration in the fundamental fair value was not surprisingly in peripheral countries. Portugal’s fair value estimate would have declined the most (-14%) followed by Ireland (-9.6%) and Finland (-9.2%). Belgium (+12.6%), Netherlands (+8.8%), and Austria (+6.9%) had the largest rise to fair value. Note that Belgium is the only country that received a positive contribution from the debt/GDP variable.

To calculate the misalignment from fair value, we take the change to the fair value estimate and the change to actual REER since 1999, and then take the difference between the actual REER and the fair value estimate.3 The misalignments are presented in table 1. Positive values suggest the new currency should be weaker.

Estimating the theoretical fair value of hypothetical currencies will likely have a wide margin of error. For example, the model coefficients were estimated using data from existing currencies that may or may not share similar characteristics to new country-level euro currencies. As a confidence check, we compare the misalignments in figure 1 to other commonly used metrics for euro area countries.

Current account

Euro area countries' external position is one metric for assessing the exchange rate adjustment in an EMU exit scenario.4 Figure 2 on the previous page shows level current

3 The fair value model coefficients were estimated using the JP

Morgan real broad effective exchange rates (CPI and PPI deflator).

This series does not include intra-euro countries so we use the BIS

real broad effective exchange rate indices (based on CPI) as an

alternative.

4 See also research on Euro area current account imbalances in Flows & Liquidity: Current account progress and risks July 20, 2012.

account (%GDP) data and figure 3 looks at the change to the current account since 1999. The change shows the improvement/deterioration in each country’s external position since the EMU formed. We use two sample periods in figure 3 because many countries have reduced imbalances between 2010 and 2012. But this improvement is partly due to weaker domestic demand (e.g. Ireland) and therefore the more balanced current account will under-estimate the extent of necessary FX adjustment. We focus more on the shorter 1999 – 2010 sample.

Results are generally consistent with the REER misalignments in table 1. Countries like Germany, Austria, and Netherlands would likely have stronger currencies than the current EUR, while peripheral countries (Greece, Italy, Portugal, and Spain) would require a weaker currency to reduce imbalances. However, current account metrics in figure 3 do not suggest a large exchange rate adjustment in Ireland. The deterioration in the Irish current account between 1999 -2009 by about 5-6% is likely a better gauge

Figure 3: Change to current account (% GDP)

Chart shows the change to the current account balance (%GDP) for two sample

periods

Source: Bloomberg

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1999Q1 - Present

Table 1: Contribution of variables to fair value model estimates(a)The row ‘Change to FV’ shows the change to the fair value estimate since 1999. (b) The row ‘Change to REER’ shows the change to real broad effective exchange rate indices since 1999(c) The final row ‘Misalignments’ is the difference between (b) and (a)

Source: J.P. Morgan.

Austria Belgium Finland France Germany Greece Ireland Italy Netherlands Portugal Spain

Terms of trade -3.1% 0.3% -22.4% -3.4% -1.5% 1.4% -6.2% -5.1% 0.4% -2.3% -3.8%

Productiv ity 11.2% 8.6% 12.6% 5.8% 9.7% 7.1% 11.4% 0.0% 8.2% 2.4% 6.5%

Debt/GDP -1.6% 3.8% -0.3% -5.9% -4.3% -13.9% -11.9% -1.4% -0.3% -12.8% -1.4%

NII/trade 0.3% 0.0% 1.0% 0.6% 0.7% -1.9% -2.9% 0.3% 0.5% -1.3% -0.4%

(a) Change to Fair Value 6.9% 12.6% -9.2% -2.9% 4.5% -7.3% -9.6% -6.2% 8.8% -14.0% 0.9%

(b) Change to REER -5.6% -0.1% -11.1% -9.2% -14.4% 5.3% 6.6% -2.8% -3.3% 3.4% 6.1%

(c) Misalignment -12.5% -12.7% -2.0% -6.4% -18.9% 12.6% 16.2% 3.4% -12.1% 17.4% 5.2%

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of the required FX adjustment and consistent with the fair value model overvaluation.

Also, the current account data provide different signals than the fair value model for Belgium, Finland and France. The model suggests a new Belgium currency should appreciate significantly despite a current account balance close to zero. France has a marginal current account deficit, but also a small REER undervaluation. Finland’s current account lines up with the fair value misalignment, but the deterioration in the current account suggests a weaker currency.

Competiveness indicators

One final metric for assessing Euro area misalignments are the ECB’s Harmonized Competiveness Indicators (HCI) based on unit labor costs (ULC).5 This series can be used as a proxy for competitiveness and ULC differentials in the euro area, which the IMF notes are important aspects of the Euro area's growing current account divergences.

Figure 4 shows the current level of the HCI’s and the peak level of the series in 2008-09. The base year for the indices is 1999 when the value was 100. So current values above 100 suggest a deterioration in cost competiveness (e.g. Ireland) and values below are an improvement (e.g. Germany). Apart from Ireland, the loss of competitiveness in the periphery was relatively modest (see peak level bars), but the divergence from Germany and Austria is large. The HCI’s confirm Germany and Austria's substantial undervaluation in the fair value model. In addition, Germany’s large divergence from pre-EMU levels (around 80) suggests that Germany’s competitiveness is a bigger problem for euro stability than peripheral countries’ competitiveness (which is close to pre-EMU levels around 100).

A vital aspect of the euro survival will be some internal adjustment, which reduces the justification for external adjustment via currency redenomination. REER misalignments can be reduced by some internal deflation in the periphery. For example, Ireland’s competitiveness (as proxied by the HCI) deteriorated significantly more than any other country between 1999 and 2008, and then returned close to pre-EMU levels at 100. However, the

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The ECB’s HCI indices provide measures of euro area countries' cost competitiveness. The series are equivalent to effective exchange rates but are deflated using unit labor costs for the total economy, calculated as the ratio of the compensation per employee and labour productivity (with labour productivity measured as GDP at constant prices divided by the total number of persons employed).

Figure 4: ECB Harmonized Competiveness Indicators (based on unit labor costs)

Values above (below) 100 suggest deterioration (improvement) in cost

competitiveness since 1999

Source: ECB

divergence between Germany and peripheral countries remains large. The chart suggests a more effective way to restore equilibrium exchange rates is for Germany to run relatively higher inflation.

Conclusions

This note presented REER misalignments and examined other metrics for comparison. Table 2 (next page) summarizes all of these results. The highlighted cells suggest the new theoretical currency will depreciate based on the metrics in the first column and white cells suggest the opposite.

From table 2, one can infer the following about likely exchange rate adjustment in an EMU breakup scenario:

Most likely to strengthen: Germany and Austria

Likely to strengthen: Netherlands

Likely to weaken: Spain, Ireland

Most likely to weaken: Greece, Italy, Portugal

Signals less clear: Belgium, Finland, France

The REER undervaluation for Belgium, Finland, and France is not supported by the other metrics we examined in this paper. But the misalignment/imbalances for Finland and France are generally small suggesting only a modest exchange rate adjustment in these countries. Belgium is themost notable outlier. Flow measures such as the current account do not signal significant exchange rateappreciation. But the fair value model suggests a large

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undervaluation, which is consistent with Belgium’s net international investment surplus that trails only Germany and the Netherlands.

Caveats

The long-term fair value model is not designed to capture the immediate currency impact of an EMU exit such as capital flight related to redenomination risks or the resulting economic dislocations for creditor and debtor countries alike (see Answers to 10 common questions on EMU breakup, Normand and Sandilya, December 9, 2011).Rather the model misalignments are one approach for assessing the medium-term direction and magnitude of adjustment if a country were to exit the EMU.

Table 2: Summary results of various metricsThe highlighted cells suggest currency depreciation

Source: J.P. Morgan.

Metrics Austria Belgium Finland France Germany Greece Ireland Italy Netherlands Portugal Spain

1. REER misalignments -12.5% -12.7% -2.0% -6.4% -18.9% 12.6% 16.2% 3.4% -12.1% 17.4% 5.2%

2. CA (%GDP) 1.95 -0.77 -0.66 -2.26 5.72 -8.78 0.08 -2.78 9.22 -5.42 -3.27

3. Change to CA (1999Q1

- 2010Q2)4.56 -4.75 -4.01 -3.95 6.91 -7.74 -2.49 -4.37 2.35 -3.96 -3.58

4. HCI 93.3 101.6 101.8 101.8 81.5 104.1 107.9 104.8 103.1 103.8 99.2

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Research Note

Introducing Daily FX Strategy Analytics: available on iPad & www.morganmarkets.com

J.P. Morgan’s Daily FX Strategy Analytics are a set of eight reports covering rule-based trading models, valuation measures and industry positioning proxies developed by the Global FX Strategy team over the past several years.

Many of these frameworks will be familiar to clients who have followed the Investment Strategies series of quantitative research notes or who subscribe to FX Markets Weekly. Chartpacks now present all such tools in a high-frequency, user-friendly format to assist in tactical trading and hedging. This product note details the methodology for each model or indicator and highlights the daily reports’ features.

Two chartpacks comprise eight standalone reports(more to be added in future), most of which are single-slide:

(1) global FX carry buys high-yielding currencies versus low-yielding ones for G-10, emerging markets and global baskets;

(2) interest rate momentum buys currencies in whose favour interest rate expectations have moved over the past month;

(3) carry plus rate momentum buys high-yieldingcurrencies only if rate expectations in that country are also rising, so combines models (1) and (2);

(4) spot momentum plus rate momentum buys currencies exhibiting both price and interest rate momentum, so combines standard price momentum and model (2);

(5) spot mean reversion sells (buys) currencies thathave appreciated (depreciated) significantly in the recent past;

(6) fund manager performance tracks return composites for institutional investors active in currency trading, such as global macro hedge funds, currency managers and emerging markets funds;

(7) positioning proxies and style indicators employ regressions to measure the degree to which managers are exposed to major funding currencies (USD, EUR) or investment styles (carry, momentum).

(8) daily fair value regressions link spot rates econometrically to cyclical drivers to identify currencies most vulnerable to a short-term correction due to significant under- or overvaluation.

All reports can be accessed daily by approximately9AM London time through iPad or on www.morganmarkets.com/GlobalFXStrategy.

Eight daily reports for tactical trading and hedging

J.P. Morgan’s Daily FX Strategy Analytics are a set of eight reports covering rule-based trading models, valuation measures and industry positioning proxies developed by the Global FX Strategy team over the past several years. Many of these frameworks will be familiar to clients who have followed the Investment Strategies series of quantitative research notes or who subscribe to FX Markets Weekly. Chartpacks now present all such tools in a high-frequency, user-friendly format to assist in tactical trading and hedging. This product note details the methodology for each model or indicator and highlights the daily reports’ features.

Two chartpacks comprise eight standalone reports (more to be added in future), most of which are single-slide:

(1) global FX carry buys high-yielding currencies versus low-yielding ones for G-10, emerging markets and global baskets;

(2) interest rate momentum buys currencies in whose favour interest rate expectations have moved over the past month;

(3) carry plus rate momentum buys high-yieldingcurrencies only if rate expectations in that country are also rising, so combines models (1) and (2);

(4) spot momentum plus rate momentum buys currencies exhibiting price and interest rate momentum, so combines standard price momentum and model (2);

(5) spot mean reversion sells (buys) currencies that have appreciated (depreciated) significantly in the recent past;

(6) fund manager performance tracks return composites for institutional investors active in currency trading, such as global macro hedge funds, currency managers and emerging markets funds;

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(7) positioning proxies and style indicators employ regressions to measure the degree to which managers may be exposed to major funding currencies (USD, EUR) or investment styles (carry, momentum); and

(8) daily fair value regressions link spot rates econometrically to cyclical drivers to identify currencies most vulnerable to a short-term correction due to significant under- or overvaluation.

All reports can be accessed daily by approximately 9AM London time through two channels:

on iPad for those users who have added the module Latest FX Research to their device (see blue box for product note detailing iPad set-up with the J.P. Morgan Research application); or

on the Global FX Strategy website via URLwww.morganmarkets.com/GlobalFXStrategy under the section Daily Quantitative Research Reports.

The first seven reports are bundled as a single PDF called Daily FX Alpha Chartpack, given their brevity and the modular nature of some models serving as an overlay to others. The eighth report called Daily FX Fair Value Regressions is issued separately given its length (one slide each on dozens of USD pairs, EUR crosses and intra-regional crosses).

Explanatory notes for daily reports

Of the eight reports described in this product note, the first four have been discussed extensively in the research notes listed above in the blue box. Three others on manager performance, position proxies and short-term fair value will probably be familiar to regular readers of the flagship publications FX Markets Weekly where they are often referenced as inputs to J.P. Morgan’s currency outlook and trade recommendations. The mean-reversion model is newer work which is simple enough conceptually to explainin this note rather than as a standalone paper. The chartpacks now present all such models and indicators daily in a more user-friendly format to assist in tactical trading and hedging. Most reports are single-slide.

1. Global FX carry

The global FX carry report outlines the pair selection process and tracks daily performance for a long-only FX carry strategy in G-10, emerging markets and globally. As opposed to the standard carry methodology which chooses pairs based on absolute yield differentials, this approach constructs baskets of the four currency pairs offering the highest risk-adjusted yield, or carry-to-risk ratio. It is analogous to an ex-ante Sharpe ratio on currency pairs, an approach found in previous J.P. Morgan research to outperform the conventional strategy of choosing pairs based on rate differentials alone. This metric was first proposed in the 2004 paper J.P. Morgan’s FX Barometer(see blue box), so returns since that date are out-of-sample.

Carry-to-risk is calculated as the 1-mo interest rate differential divided by the annualised daily volatility of spot for G-10 and 1-mo forwards/NDFs for emerging markets currencies over the past 20 trading days. (1-mo forwards are used for the volatility calculation on emerging market currencies since central bank management of spot rates understates some currencies’ underlying risk.) Rate differentials are based on implied yields calculated from 1-mo FX forwards, spot and 1-mo US swap rates.

The G-10 universe comprises 15 eligible pairs: AUD, CAD, CHF, EUR, GBP, JPY, NOK, NZD and SEK versus USD; CHF, GBP, NOK and SEK versus EUR; and EUR and USD versus JPY. The emerging markets universe comprises 22 pairs, all versus USD: ARS, BRL, CLP, COP, MXN, PEN, CNY, IDR, INR, KRW, MYR, PHP, SGD, THB, TWD, CZK, HUF, ILS, PLN, RUB, TRY and ZAR.

Currencies in the G-10 and EM universes are ranked by carry-to-risk as shown in table 1 of the report, and the four pairs in each set with the highest CTR are purchased for the G-10 and EM strategies. The global carry basket also comprises four currencies – two each from the G-10 and EM universes. This restriction is imposed to control for liquidity differences between G-10 and EM currencies,

Previous J.P. Morgan reports cited in this publication and available on www.morganmarkets.com/GlobalFXStrategy:

Alternatives to standard carry and momentum in FX, Normand, Aug 8, 2008

Rotating between G-10 and emerging markets carry, Normand, Jul 9, 2007

JPMorgan’s FX Barometer, Normand, September 22, 2004

Rebalancing VXY and Introducing VXY Global, Normand and Sandilya, March 25, 2011

Introducing the JP Morgan VXY and EM-VXY, Normand and Sandilya, December 11, 2006

Following Global FX Strategy on iPad and iTunes, Normand and Meggyesi, April 4, 2012

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since an unconstrained basket would almost always favour EM pairs for their higher yield. Baskets are rebalanced monthly on the last business day. Turnover is infrequent since the rank order of currencies' yield is stable, so transaction costs are trivial.

Table 1 of the report lists the carry, volatility and carry-to-risk ranking for all eligible pairs (exhibit 1). Table 2 list the baskets’ current holdings and performance statistics over the past week, month, three months, year and year-to-date. Chart 1 plots returns for each strategy indexed to January 1998 = 100. Annualised annual returns over the past 5, 10 and 15 years for all models are provided on the sixth report comparing rule-based strategies to active managers.

Exhibit 1: Global FX carry report

Source: J.P. Morgan

2. Interest rate momentum

The interest rate momentum strategy derives signals for currencies from changes in short-term interest rate expectations between two countries. The intuition is that currencies respond as much to changes in rate expectations (the rate momentum concept) as they do to current rate differentials (the standard carry concept). For example, rising rates relative to the rest of the world usually signal a country’s cyclical strength which draws capital inflows and sponsors currency appreciation, even for a low-yielding currency. Previous J.P. Morgan reports in 2004 and 2008 (see blue box) referred to this concept as Forward Carry since changes in rate expectations could be likened to investors’ forward-looking view of carry. In these new chartpacks we simplify the terms and rename this approach interest rate momentum to avoid more cumbersome expressions once we combine models 1 and 2 in the next sections.

Applying interest rate momentum to FX trading follows the rule of buying the currency in whose favour rates have moved over some defined period, and selling the currency when that rate momentum reverses. The guideline applies regardless of whether the focus currency is a high or a low-

yielder, since funding currencies can rally too if their yield deficit diminishes. The model involves three parameters: (1) the reference interest rate used to capture monetary policy expectations over the near term (we use 1-month swap rates 3 months forward); (2) the lookback period over which the change in spread is measured (we use past month, or 21 trading days); and (3) the rebalancing frequency indicating how often the change in spreads is calculated and trades executed (we use daily). The 2008 paper provides extensive discussion of the model’s performance sensitivity to choice of inputs.

Table 1 on the daily report outlines the trade selection process for the dollar (top half) and for the euro (bottom half) versus all major currencies. For each bloc, the top line indicates the current signal for USD (or EUR) versus the reference currency; the change in spreads in basis points over the past month that has generated the signal; and returns from trading the signals over the past week, three months, one year and year-to-date (exhibit 2)

Table 2 provides another perspective on signals and returns. For the USD pairs and the EUR crosses, the table lists current positions extracted from table 1 and the returns from trading all signals in the bloc over the past week, month, three months year and year-to-date. As a consistency check, note that the returns in table 2 for the USD bloc match the average returns across pairs for the dollar in table 1. The same cross-check applies to EUR pairs. Chart 2 plots the basket returns since 2008. Since this model’s parameters were determined in the 2008 paper (see blue box), returns since then are out-of-sample.

Exhibit 2: Interest rate momentum report

Source: J.P. Morgan

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3. Carry plus rate momentum

Given that any asset market could be driven by several factors which can reinforce or offset one another, signals should sometimes be combined into a composite indicator. Carry plus rate momentum thus combines the concepts of standard carry (model 1) and interest-rate momentum (model 2) in an attempt to better time entry into and exit from high-yield currencies.

The traditional filter for carry trades employs so-called risk appetite measures, which are composites – and often overfitted jumbles – of volatility, credit spreads and sometimes commodity prices. J.P. Morgan's alternative, outlined in 2008 (blue box) focuses on more ordinary cyclical shifts which undermine carry trades too. That is, if currencies show an empirical tendency to rise and fall with changes in spreads between countries – the conclusion from the previous interest rate momentum model – then the riskiest carry trades would be high-yield currencies where cyclical conditions were deteriorating and rates falling. The safest trades would be high-yield currencies in which the economy were accelerating and rates rising.

The strategy captures this dynamic by using interest rate momentum as an overlay to carry through three steps: (1) each month, rank currencies by their carry-to-risk ratio as described in the global FX carry report; (2) for each currency, also measure the change in rate expectations over the past month as described in the interest rate momentum report; and (3) hold only higher-yielding currencies which also exhibit interest-rate momentum. The daily report maps the process. Table 1 presents daily calculations for carry-to-risk and interest-rate momentum (exhibit 3). To minimise transaction costs, however, the model only rebalances once per month, when the standard carry basket rebalances. Table 2 shows those monthly positions and returns. Chart 1 compares the performance of the overlay strategy to the performance of its components of G-10 carry (model 1) and rate momentum (model 2).

Exhibit 3: Carry plus rate momentum report

Source: J.P. Morgan

4. Spot momentum plus rate momentum

Just as rate momentum can overlay carry, it can also filter pairs for a traditional spot momentum model. Typical momentum frameworks involve only two parameters: the momentum measure and the rebalancing frequency. Momentum can be defined as simple momentum, which calculates equally-weighted performance over a lookback period, or an exponentially-weighted moving average, which places more emphasis on recent observations. The rebalancing frequency can be of any length – intraday, daily, weekly, monthly. For simplicity, and to fit the approach of most investment managers, this model focuses on daily horizons rather than on intra-day ones more common to algorithmic accounts.

Previous J.P. Morgan research in 2008 (see box) determined that simple spot momentum performed as well as exponentially-weighted moving averages, and that medium-term momentum (1-year lookback) performed better than shorter-term models. As a refinement of the standard spot momentum strategy which buys currencies that have outperformed recently, we add an overlay based on the interest rate momentum model. So rather than hold all currencies exhibiting positive price momentum over the medium term, this model holds only those currencies that have appreciated over the past year (they exhibit positive spot momentum) and have also witnessed increases in rate expectations over the past month (they exhibit interest rate momentum too). The intuition is that a medium-term price trend is more likely to persist if short-term cyclical momentum is also moving in the currency’s favour.

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Exhibit 4: Spot momentum plus rate momentum report

Source: J.P. Morgan

Table 1 of the daily report outlines the pair selection process (exhibit 4). Column 1 lists all eligible pairs, column 2 calculates the change in spot over the past year and column 3 shows the signal based on price momentum alone. Columns 4 and 5 then calculate the change in rate spreads over the past month and the corresponding rate momentum signal. These figures are identical to spread movements reported in table 1 of the interest rate momentum report, since that model’s trading rule is the overlay in this framework. Column 6 determines which pairs should then be held because they exhibit a medium-term price trend and short-term rate momentum. Currencies which meet both criteria are selected for inclusion in the basket shown in table 2 (last line). Basket returns are plotted in chart 1 and compared to standalone strategies of spot momentum and rate momentum.

5. Spot mean reversion

Mean-reversion models can be constructed in several ways ranging from the fundamental econometric (report 8 to be discussed later) to the technical. This fifth report focuses on technical models which are simple to construct by backtesting the profitability of a counter-trend strategy following extraordinary spot moves in either direction. The intuition is that market moves which are outsized in a statistical sense represent an overreaction to positive or negative news, or an irrational optimism or pessimism. Thus when investors have more complete

information on events, markets retrace. This phenomenon is so well documented in the behavioural finance literature –and exploited through the Investment Strategies series –than it merits little more discussion in this note. The issue is whether a trading rule can identify over and undershoots and profitably trade their mean reversion.

In this model, extraordinary moves are defined as spot gains or losses of 1-sigma, 2-sigmas or 3-sigmas over the prior five trading days based on London closing spot rates. The trading rule is to position in the opposite direction to profit from potential mean reversion. The position is held over the next five trading days and performance statistics such as spot return and success rate (ratio of profitable trades to total trades) are calculated. Trading signals generated within that five-day holding period are ignored for the purpose of return statistics calculations; fresh signals contribute to performance statistics only if they are generated after the five-day holding period elapses.

The daily report highlights those pairs which have posted 1, 2 or 3-sigma moves over the past five days (exhibit 5). It also provides performance statistics for the contrarian trading rule over three sample periods of the past year, five years and ten years. Based on success rates and profitability, the grid characterises a signal’s conviction on a high-to-low scale:

High: 70%+ success rate and 1% average profit.

Relatively high: 60%+ success rate and 0.5% average profit.

Medium: 51%+ success rate and 0.25% average profit.

Relatively low: 50%+ success rate and 0% average profit & below medium.

Low: all others.

Unlike the previous four models, daily signals from the mean reversion model are not amenable to aggregation into a basket of trades as a consistent investment strategy. This is due to the nature of technical mean-reversion models. If mean reversion occurs most predictably after two or three-sigma moves but these are by definition rare events, then the model will rarely hold positions. When the models does position, it may hold exposure for only a few days. Compare the approach to carry, which is almost always invested in some number of high-yielders, or rate momentum, which is always long or short some pairs, and it becomes clearer that this mean-reversion signal is intended for intra-week traders targeting modest, infrequent retracements.

Exhibit 5: Spot mean reversion report

Source: J.P. Morgan

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6. Fund manager performance

Fund manager performance is tracked on the alpha chartpack’s first slide under a summary of signals and performance from the model-driven strategies. Since models are an attempt to replicate common investment styles, manager returns are one benchmark for assessing their value.

There is no single-best manager composite for institutional investors who actively trade currency, hence this slide's provision of several groupings covering currency funds (those which trade only or primarily currencies) and hedge funds (global macro and emerging markets). For currencies, we use the HFR Currency Index, Barclay Currency Trader Index, Barclay BTOP and Parker-Blacktree; for global macro funds, the HFR Macro Index; and for emerging markets, the HFR Emerging Markets Total and Composite indices (exhibit 6).

Note that half of manager composites report their returns monthly (usually two to three weeks after month end) and half report daily (with a one to five-day lag). Since the J.P. Morgan models are updated every weekday based on the previous day’s closing market levels, there is an inevitable reporting mismatch versus industry composites. Since we are generally only interested in return trends over some medium-term horizon such as the past quarter or year, this gap is not so meaningful.

Exhibit 6: Fund manager performance

Source: J.P. Morgan

7. Positioning proxies and style indicators

Manager returns can be used to infer positioning in major funding currencies and dominant investment styles. For example, if a group of investors is known to focus on currencies (e.g. currency overlay funds) and currency investors almost always hold either long or short exposure to the dollar, then a positive (negative) beta between currency manager returns and the trade-weighted dollar suggests that managers are long (short) the dollar. The level

of that beta relative to its long-term trend can suggest whether manager are extremely long or short the currency.

This approach holds several shortcomings, which we readily admit. First, the approach is most conclusive for currency managers rather than global macro funds or emerging markets fund managers, since the later two groupings invest in multiple asset classes. Second, the approach is more valid for determining exposure to currencies which managers almost certainly hold exposure to – like USD, EUR or JPY – by virtue of those currencies being dominant funding currencies. Calculating the same beta for manager returns with respect to AUD, for example, would be misleading since the manager could be exposed to a range of high-yield or commodity or Asian currencies which correlate well with AUD.

With these caveats in mind, the report charts three positioning proxies (top row) and three style indicators (bottom row). Charts 1 to 3 plot the rolling 30-day beta from regressing daily fund manager returns on the trade-weighted dollar and trade-weighted euro (exhibit 7). For currency managers, charts 1 and 2 plot the average beta for two daily manager series (Barclay BTOP and Parker-Blacktree) and for global macro funds, chart 3 plots the beta for the daily HFR Macro index. Note that the reporting delay on various monthly manager series renders these data too stale to use as a high-frequency position proxy. Charts 4 to 6 regress manager returns on three styles – global carry, spot momentum and interest rate momentum for USD and EUR pairs – to test for evidence that currency managers are following these approaches. For example, a high, positive beta with respect to carry suggests that managers are quite long of high-yield currencies. A high, positive beta with respect to the spot momentum strategy suggests that managers are invested in trend-following strategies.

Exhibit 7: Positioning proxies and style indicators

Source: J.P. Morgan

32



8. Daily FX fair value regressions

Daily fair value regressions are an alternative for determining a currency’s vulnerability to mean reversion because the spot rate has significantly over or undershot the change in underlying fundamentals. This approach differs from a technical overshooting model in that a regression linking spot to several cyclical variables determines whether a currency is rich or cheap, as opposed to a technical framework which bases that decision on the currency’s level or the magnitude of a recent move. The intuition is that value is context-dependent, so AUD/USD at 1.10 seems expensive in level terms but would not seem unusual if the Chinese economy were expanding at 10% per annum, driving commodity prices and Australian rates higher.

The approach is thus as follows. Each slide in the chartpack presents daily regression results for a currency pair over four sample periods of the past 3 months, 6 months, 1 year and 2 years. Models regress the log-level of the spot exchange rate on the level of cyclical variables such as short-term interest rate spreads (1-mo rates 12-mos forward to capture expected rate changes); commodity prices (oil or CRB index); equity volatility (VIX) and sovereign spreads (simple average of 5-yr spreads between Italy, Spain, Portugal and Ireland versus Germany). Conceptually, these regressions should be tailored more specifically to each market, but in the interest of simplicity, we choose roughly equivalent specifications across pairs. Data availability also drives the choice of variables, since some quite sensible inputs – like a country-specific basket of commodity prices – are not published on a daily basis.

The top row of graphs show the regression line and scatter plot over the four sample periods, and the bottom row plots the residual (difference between actual and predicted spot rate) as a percentage of spot. The regression equation is listed at the bottom of each slide, and the regression coefficients and R2 above the scatter plots (exhibit 8).

For scatter plots, the x-axis displays values for a single variable (rate spreads in exhibit 8) while the y-axis shows the spot rate adjusted for the remaining variables. Thus in a multivariate regression of the form Y = a1 + b1x1 + b2x2 + b3x3, the scatter plot y-axis shows (Y – a1 – b2x2 – b3x3) versus the x1 variable. This is the standard way of presenting a scatter plot in two dimensions for a multivariate regression. For the residual plots, a positive (negative) value indicates that the base currency is strong(weak) for the given level of fundamentals. Although we have not tested for a degree of misalignment associated systematically with mean reversion, we have observed in practice that roughly 3%-5% mispricings in either direction have tended to flag reversals within two to three months.

Exhibit 8: Daily fair value regressions for EUR/USD

Source: J.P. Morgan

Since the models employ log levels on the y-axis, coefficients are interpreted as follows (using EUR/USD as an example): as inputs into the regression, x1 (rate differentials) is expressed in percentage points, as is x2

(S&P500 implied volatility or the VIX) and x3 (average 5-yr peripheral spreads to Germany). So based on a regression run over the past year, EUR/USD rallies 1.7% for every 10bp widening in the spread between Euro and US 1-mo rates 12-mo forward, and sells off 1.1% for every 100bp widening of peripheral spreads.

In addition to providing regressions on dozens of pairs, the packet summarises results across currencies on the first two slides (exhibit 9). Traditionally, we have used this grid to screen for currencies that appear to be the most mispriced, and hence most vulnerable to a near-term reversal.

Exhibit 9: Summary of fair value mispricings across currencies

Source: J.P. Morgan

33




Market movers(all times BST; +9hrs for Sydney, +8hrs for Tokyo, -5hrs for New York)

Date Country Data/Event

JPM Consensus

Aug 13 (Mon) Japan 00:50 GDP (%q/q, saar) 2Q 2.0 2.3 (1Q) 4.7

Euro area 10:00 Italy sells bills

New Zealand 23:45 Retail sales ex inflation (%q/q) 2Q 0.6 0.3 (1Q) -0.6

Aug 14 (Tue) UK 00:01 RICS house price survey (%bal, sa) Jul na -24 (Jun) -22

Japan 00:50 All sector activity index (%m/m, sa) Jun -0.5 -0.3 (May) 0.7

Australia 02:30 NAB business confidence (%bal, sa) Jul -3.0 na (Jun) -3

India 07:30 WPI (%oya) Jul na 7.2 (Jun) 7.25

Switzerland 08:15 Producer and import prices (%m/m) Jul na na (Jun) -0.3

Sweden 08:30 IP (%m/m, sa) Jun na -1.0 (May) 3.5

08:30 CPI (%oya) Jul na 0.8 (Jun) 1.0

08:30 CPI core (%oya) Jul na 0.8 (Jun) 0.9

UK 09:30 CPI (%oya) Jul na 2.3 (Jun) 2.4


Euro area 06:30 France GDP flash (%q/q, sa) 2Q na -0.2 (1Q) 0.0

07:00 Germany GDP flash (%q/q, sa) 2Q na 0.1 (1Q) 0.5

10:00 IP (%m/m, sa) Jun na -0.7 (May) 0.9

10:00 ZEW business survey (index) Aug na na (Sep) -22.3

10:00 Germany ZEW business survey (index) Aug na -19 (Jul) -19.6

10:00 GDP flash (%q/q, sa) 2Q na -0.2 (1Q) 0.0

10:00 Greece to sell 3.125bn 3-month bills

US 12:30 NFIB small business survey (index, sa) Jul na na (May) 91.4

13:30 PPI (%m/m, sa) Jul na 0.2 (Jun) 0.1

13:30 Retail sales (%m/m, sa) Jul na 0.3 (Jun) -0.5

15:00 Business inventories (%m/m, sa) Jun na 0.3 (May) 0.3

Aug 15 (Wed) Australia 01:30 Westpac consumer confidence (%m/m, sa) Aug 1.0 na (Jul) 3.7

02:30 Wage cost index (%q/q, sa) 2Q 0.9 na (1Q) 0.9

Norway 09:00 Trade balance (NOK, bn) Jul na na (Jun) 29.5

UK 09:30 BoE MPC minutes

09:30 Claimant count (000's ch, m/m, sa) Jul na 4.9 (Jun) 4.9

09:30 Average weekly earnings (3M, %oya, sa) Jun na 1.8 (May) 1.5

09:30 Unemployment rate (%, sa) Jun na 8.1 (May) 8.1

Forecast Previous

34




Market movers(all times BST; +9hrs for Sydney, +8hrs for Tokyo, -5hrs for New York)

Date Country Data/Event

JPM Consensus

Aug 15 (Wed) New Zealand 09:30 Fonterra Milk Powder Auction Results Due

US 13:30 Empire state mfg. survey (DI, sa) Aug na 7.0 (Jul) 7.39

13:30 CPI (%m/m, sa) Jul na 0.2 (Jun) 0.0

13:30 CPI core (%m/m, sa) Jul na 0.2 (Jun) 0.2

14:00 TIC long-term net flows ($ bn) Jun na na (May) 55.044

14:15 IP (%m/m, sa) Jul na 0.5 (Jun) 0.43

14:15 Capacity utilization (%bal, sa) Jul na 79.2 (Jun) 78.9

15:00 NAHB housing market index (sa) Aug na 34 (Jun) 35

Aug 16 (Thu) US 01:00 Fed's Kocherlakota speaks

Australia 06:45 RBA's Debelle Speaks on Panel at Conference in Sydney

UK 09:30 Retail sales (%m/m, sa) Jul na -0.2 (Jun) 0.3

09:30 Retail sales ex auto fuel (%m/m, sa) Jul na 0.0 (Jun) 0.1

Euro area 10:00 CPI (%oya) Jul na 2.4 (Jun) 2.4

Turkey 12:00 CBRT rate announcement Aug 5.75 5.75 (Jul) 5.75

Canada 13:30 Manufacturing sales (%m/m, sa) Jun na 0.3 (May) -0.39

US 13:30 Initial jobless claims (000ch) 11-Aug na 365 04-Aug 361

13:30 Housing starts (000s, saar) Jul na 753 (Jun) 760

13:30 Building permits (000s, saar) Jul na 765 (Jun) 760

15:00 Philadelphia Fed index (DI, sa) Aug na -4.0 (Jul) -12.9

Chile 23:00 BCCh rate announcement Aug 5.00 5.00 (Jul) 5.00

New Zealand 23:45 Producer prices inputs (%q/q) 2Q na na (1Q) 0.3

23:45 Producer prices outputs (%q/q) 2Q na -0.2 (1Q) -0.1

Aug 17 (Fri) US 01:00 Fed's Kocherlakota speaks

Sweden 07:00 AMV unemployment rate (%) Jul na 4.5 (Jun) 4.4

Euro area 07:00 Germany PPI (%oya) Jul na 1.2 (Jun) 1.6

09:00 Current account (EUR bn, sa) Jun na na (May) 10.90

10:00 Trade balance (EUR bn, sa) Jun na 9.8 (Apr) 6.3

Canada 13:30 CPI (%oya) Jul na 1.6 (Jun) 1.5


US 14:55 U. Michigan consumer confidence prelim (index) Aug na 72.0 (Jul) 72.3

15:00 Leading indicators (%m/m, sa) Jul na 0.2 (Jun) -0.3

Forecast Previous

35



Event risk calendarMonth Date Country Event

August 2012 14 Kenya Presidential election

27 US Republican Party Convention

29 Brazil COPOM rate announcement

31 Switzerland SNB balance sheet items

31 US Bernanke Jackson Hole speech

September 2012 Hong Kong Legislative Council elections

3 Euro area Eurogroup meeting

3 US Democratic Party Convention

2-9 APEC APEC 2012 Leaders Week in Vladivostok

6 Euro area ECB rate announcement

11 Euro area European Commission to detail proposal for single bank supervisor

12 Euro area German Constitutional Court ruling on ESM/Fiscal Pact expected

12 Euro area Netherlands parliamentary elections

12 US FOMC rate announcement

13 New Zealand RBNZ Monetary Policy Statement

13-14 G20 Meeting of Finance Ministers and Central Bank Governors


October 2012 China Chinese leadership transition

China 18th Congress of the Chinese Communist Party


7 Venezuela Presidential election

8-9 Euro area Eurogroup/Ecofin meeting


12-14 IMF/World Bank IMF/World Bank annual meeting in Tokyo

18-19 Euro area EU leaders summit

24 Canada BoC Monetary Policy Report

23-24 US FOMC rate announcement (incl. press conference)

25 Sweden Riksbank Monetary Policy Report

36



Event risk calendarMonth Date Country Event

October 2012 28 Ukraine Parliamentary elections

31 Norway Norges Bank Monetary Policy Report

31 Euro area Euro area Bank Lending Survey


November 2012 6 US Presidential and Congressional elections


9 Australia RBA Statement on Monetary Policy

9-10 G20 Meeting of Finance Ministers and Central Bank Governors

12 Euro area Eurogroup meeting

14 UK BoE Quarterly Inflation Report


30 Romania Parliamentary elections


December 2012 Switzerland Presidential appointment

South Africa ANC elective conference


6 New Zealand RBNZ Monetary Policy Statement

11 US FOMC rate announcement

13-14 Euro area EU leaders summit

19 South Korea Presidential election


January 2013 1 Ireland Ireland assumes EU Presidency

2 US US budget sequesttration begins (automatic spending cuts)

3 US Newly-elected US House and Senate take office

20 US US Presidential Inauguration Day

37



Central bank announcement dates in 2012/132012 2013

AUG SEP OCT NOV DEC JAN FEB MAR APR MAY JUN JUL

Australia 7 4 2 6 4 5 5 2 7 4 2

Brazil 29 10 28

Canada 5 23 4 23 6 17 29 17

Chile 16 13 18 13 13

Colombia 31 28 26 23 14

Czech Republic 2 27 1 19

Euro area 2 6 4 8 6 10 7 7 4 2 6 4

Hungary 28 25 30 27 18

India 17 30

Indonesia 9 13 11 8 11

Israel 27 24 29 26

Japan 9 19 5,30 20 20

Korea 9 13 11 8 13

Malaysia 6 8

Mexico 7 26 30

New Zealand 13 25 6 31 14 24 13

Norway 29 31 19

Philippines 13 25 13

Poland 5 3 7 5

South Africa 20 22

Sweden 6 25 18

Switzerland 13 13

Thailand 5 17 28

Turkey 16 18 18 20 18

United Kingdom 2 6 4 8 6 10 7 7 4 9 6 4

United States 1 13 24 12 30 20 1 19 31

38

Global Economic Research10 August 2012

David Hensley(1-212) [email protected]

Global central bank forecasts

1 Refers to peak rate between 2007-08 and trough rate from 2009-present

Bold denotes move since last GDW and forecast changes. Underline denotes policy meeting during upcoming week. Aggregates are GDP-weighted averages.

Source: J.P. Morgan

Official Current Forecast

rate rate (%pa) 05-07 avg Trough1Jul 11 next change Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13

Global 2.32 -206 48 -39 2.25 2.17 2.17 2.18 2.25 2.28

excluding US 3.04 -128 56 -45 2.95 2.85 2.85 2.85 2.94 2.99

Developed 0.52 -297 0 -30 0.52 0.42 0.43 0.43 0.44 0.44

Emerging 5.71 -137 82 -56 5.52 5.46 5.45 5.46 5.64 5.73

Latin America 6.53 -424 20 -250 6.21 6.21 6.21 6.21 6.63 7.06

EMEA EM 5.28 -117 134 94 5.09 4.97 4.83 4.88 4.89 4.92

EM Asia 5.58 -29 107 -40 5.42 5.37 5.41 5.41 5.55 5.55

The Americas 1.52 -380 36 -52 1.45 1.45 1.48 1.48 1.58 1.67

United States Fed funds 0.125 -438 0 0 16 Dec 08 (-87.5bp) 13 Sep 12 On hold 0.125 0.125 0.125 0.125 0.125 0.125

Canada O/N rate 1.00 -273 75 0 8 Sep 10 (+25bp) 5 Sep 12 1Q 13 (+25bp) 1.00 1.00 1.25 1.25 1.50 1.50

Brazil SELIC O/N 8.00 -725 0 -450 11 Jul 12 (-50bp) 29 Aug 12 29 Aug 12 (-50bp) 7.50 7.50 7.50 7.50 8.25 9.00

Mexico Repo rate 4.50 -337 0 0 17 Jul 09 (-25bp) 7 Sep 12 On hold 4.50 4.50 4.50 4.50 4.50 4.50

Chile Disc rate 5.00 31 450 -25 12 Jan 12 (-25bp) 16 Aug 12 On hold 5.00 5.00 5.00 5.00 5.00 5.00

Colombia Repo rate 5.00 -231 200 50 27 Jul 12 (-25bp) 28 Sep 12 28 Sep 12 (-25bp) 4.50 4.50 4.50 4.50 4.50 4.50

Peru Reference 4.25 19 300 0 12 May 11 (+25bp) 9 Aug 12 On hold 4.25 4.25 4.25 4.25 4.25 4.25

Europe/Africa 1.71 -215 16 -25 1.67 1.48 1.45 1.46 1.46 1.46

Euro area Refi rate 0.75 -223 0 -75 5 Jul 12 (-25bp) 6 Sep 12 Oct 12 (-25bp) 0.75 0.50 0.50 0.50 0.50 0.50

United Kingdom Bank rate 0.50 -444 0 0 5 Mar 09 (-50bp) 6 Sep 12 On hold 0.50 0.50 0.50 0.50 0.50 0.50

Czech Republic 2-wk repo 0.50 -190 0 -25 28 Jun 12 (-25bp) 27 Sep 12 27 Sep 12 (-25bp) 0.25 0.25 0.25 0.25 0.25 0.50

Hungary 2-wk dep 7.00 -13 175 100 20 Dec 11 (+50bp) 28 Aug 12 30 Oct 12 (-25bp) 7.00 6.50 6.00 6.00 6.00 6.00

Israel Base rate 2.25 -200 175 -100 25 Jun 12 (-25bp) 27 Aug 12 27 Aug 12 (-25bp) 2.00 2.00 2.00 2.00 2.25 2.50

Poland 7-day interv 4.75 23 125 25 9 May 12 (+25bp) 5 Sep 12 Nov 12 (-25bp) 4.75 4.50 4.25 4.25 4.25 4.25

Romania Base rate 5.25 -294 0 -100 29 Mar 12 (-25bp) 27 Sep 12 On hold 5.25 5.25 5.25 5.25 5.25 5.25

Russia Repo rate 5.25 N/A N/A N/A 14 Sep 11 (-25bp) Aug 12 On hold 5.25 5.25 5.25 5.25 5.25 5.25

South Africa Repo rate 5.00 -329 0 -50 19 Jul 12 (-50bp) 20 Sep 12 20 Sep 12 (-50bp) 4.50 4.50 4.50 4.50 4.50 4.50

Turkey Effctve rate 7.85 -809 210 160 N/A² 16 Aug 12 N/A² 7.20 6.75 6.25 6.50 6.50 6.50

Asia/Pacific 3.78 8 87 -36 3.68 3.63 3.63 3.64 3.73 3.73

Australia Cash rate 3.50 -244 50 -125 5 Jun 12 (-25bp) 7 Aug 12 Dec 12 (-25bp) 3.50 3.25 3.00 3.00 3.00 3.00

New Zealand Cash rate 2.50 -488 0 0 10 Mar 11 (-50bp) 13 Sep 12 1Q 13 (+25bp) 2.50 2.50 2.75 3.00 3.00 3.25

Japan O/N call rate 0.05 -17 0 0 5 Oct 10 (-5bp) 9 Aug 12 On hold 0.05 0.05 0.05 0.05 0.05 0.05

Hong Kong Disc. wndw 0.50 -548 0 0 17 Dec 08 (-100bp) 14 Sep 12 On hold 0.50 0.50 0.50 0.50 0.50 0.50

China 1-yr working 6.00 -14 69 -56 7 Jul 12 (-31bp) - 3Q 12 (-25bp) 5.75 5.75 5.75 5.75 6.00 6.00

Korea Base rate 3.00 -115 100 -25 12 Jul 12 (-25bp) 9 Aug 12 4Q 12 (-25bp) 3.00 2.75 2.75 2.75 2.75 2.75

Indonesia BI rate 5.75 -412 0 -100 9 Feb 12 (-25bp) 9 Aug 12 4Q 12 (-25bp) 5.75 5.50 5.50 5.50 5.50 5.50

India Repo rate 8.00 113 325 0 17 Apr 12 (-50bp) 17 Sep 12 1Q 13 (+25bp) 8.00 8.00 8.25 8.25 8.25 8.25

Malaysia O/N rate 3.00 -24 100 0 5 May 11 (+25bp) 6 Sep 12 On hold 3.00 3.00 3.00 3.00 3.00 3.00

Philippines Rev repo 3.75 -331 0 -75 26 Jul 12 (-25bp) 13 Sep 12 13 Sep 12 (-25bp) 3.50 3.50 3.50 3.50 3.50 3.50

Thailand 1-day repo 3.00 -83 175 -25 25 Jan 12 (-25bp) 5 Sep 12 4Q 12 (-25bp) 3.00 2.75 2.75 2.75 2.75 2.75

Taiwan Official disc. 1.875 -71 62.5 0 30 Jun 11 (+12.5bp) 3Q 12 3Q 12 (-12.5bp) 1.750 1.625 1.625 1.625 1.625 1.625

Change since (bp)Last change Next mtg

Forecast (%pa)

39




J.P. Morgan FX forecasts vs. forwards & consensusExchange rates vs. U.S dollar

Current

Majors Aug 10 Sep 12 Dec 12 Mar 13 Jun 13 forward rate Consensus** Past 1mo YTD Past 12mos

EUR 1.23 1.22 1.24 1.25 1.25 1.0% 1.6% 0.1% -5.5% -14.0%

JPY 78.2 78 78 80 80 0.1% 1.9% 1.9% -1.7% -1.8%

GBP 1.56 1.56 1.58 1.58 1.58 1.3% 1.9% 0.6% 0.3% -4.0%

AUD 1.05 1.01 1.02 1.02 1.04 -1.9% 0.0% 2.7% 3.2% 1.7%

CAD 0.99 1.02 1.02 0.99 0.98 -2.2% -1.0% 2.5% 2.7% -1.1%

NZD 0.81 0.77 0.77 0.77 0.78 -4.2% -2.5% 1.8% 4.4% -2.5%

JPM USD index 82.2 82.8 83.0 82.8 82.7 -1.2% -0.3% 5.3%

DXY 82.9 83.3 82.2 81.8 81.7 -0.9% 3.3% 10.9%

Europe, Middle East & Africa

CHF 0.98 0.98 0.93 0.92 0.92 5.4% 6.1% 0.1% -4.3% -22.3%

ILS 4.00 4.00 3.98 3.95 3.90 0.9% -3.3% -0.7% -4.7% -11.5%

SEK 6.69 7.01 6.85 6.76 6.72 -1.9% 2.8% 4.6% 3.0% -3.0%

NOK 5.94 6.11 5.93 5.84 5.80 0.7% 2.5% 2.9% 0.6% -6.9%

CZK 20.54 21.72 20.81 20.48 20.56 -1.3% -0.3% 0.9% -3.9% -17.1%

PLN 3.34 3.44 3.43 3.40 3.36 -1.1% 0.4% 2.4% 3.2% -12.8%

HUF 227 238 234 228 224 -1.1% 1.6% 3.9% 7.0% -15.3%

RUB 31.95 32.98 32.27 31.91 31.91 1.5% 0.0% 2.3% 0.6% -7.7%

TRY 1.79 1.82 1.80 1.75 1.75 1.6% 0.0% 1.2% 5.7% -0.4%

ZAR 8.11 8.40 8.30 8.20 8.10 -0.4% -3.6% 1.7% -0.3% -11.2%

Americas ARS 4.60 4.90 5.00 5.20 5.35 2.7% -1.0% -1.3% -6.5% -9.6%

BRL 2.02 2.00 1.98 1.95 1.95 4.2% 1.0% 0.9% -7.6% -19.5%

CLP 477 490 500 500 500 -2.7% -1.4% 3.1% 8.8% -1.3%

COP 1792 1825 1825 1850 1850 0.0% -1.4% -0.4% 8.2% -0.1%

MXN 13.31 13.20 12.50 12.20 12.00 6.5% 5.6% 1.2% 6.0% -6.6%

PEN 2.62 2.68 2.68 2.68 2.70 -1.4% -1.9% 0.7% 3.1% 4.9%

VEF 4.29 4.30 4.30 6.50 6.50 -0.1% 0.0% 0.0% 0.0% 0.0%

LACI 104.8 103.8 105.5 106.4 106.6 0.9% 0.4% -9.8%

Asia CNY 6.36 6.33 6.30 6.30 6.25 1.2% 0.0% 0.1% -1.0% 0.5%

HKD 7.76 7.80 7.80 7.80 7.80 -0.6% -0.3% 0.0% 0.1% 0.4%

IDR 9485 9700 9800 10000 9800 -1.8% -4.0% -0.5% -4.4% -9.9%

INR 55.3 54.0 52.0 55.0 53.0 9.0% 4.7% 0.6% -4.0% -17.9%

KRW 1130 1150 1150 1090 1090 -0.8% -1.7% 0.9% 1.9% -4.3%

MYR 3.12 3.19 3.22 3.15 3.10 -2.5% -3.7% 2.0% 1.6% -3.9%

PHP 41.86 42.50 42.50 42.25 41.50 -1.4% -1.2% 0.0% 4.7% 1.6%

SGD 1.25 1.28 1.30 1.28 1.27 -4.2% -3.8% 1.4% 4.0% -3.0%

TWD 29.96 30.25 30.50 30.25 30.25 -2.1% -2.5% -0.1% 1.1% -3.2%

THB 31.46 32.50 32.50 31.00 31.00 -2.5% -3.8% 0.9% 0.3% -4.9%

ADXY 115.5 116.6 119.7 121.1 121.1 0.4% 0.3% -3.5%

EMCI 95.4 93.8 95.0 95.6 96.62 1.8% 2.2% -7.7%

Exchange rates vs Euro

JPY 96 95 97 100 100 -0.9% 0.3% 1.9% 4.0% 14.2%

GBP 0.786 0.780 0.785 0.790 0.790 0.3% 0.3% 0.5% 6.1% 11.6%

CHF 1.20 1.20 1.15 1.15 1.15 4.3% 4.3% 0.0% 1.3% -9.7%

SEK 8.19 8.55 8.50 8.45 8.40 -2.9% 1.2% 4.5% 8.8% 12.7%

NOK 7.28 7.45 7.35 7.30 7.25 -0.3% 0.8% 2.8% 6.4% 8.3%

CZK 25.16 26.50 25.80 25.60 25.70 -2.3% -1.9% 0.8% 1.7% -3.6%

PLN 4.09 4.20 4.25 4.25 4.20 -2.1% -1.2% 2.4% 9.2% 1.4%

HUF 278 290 290 285 280 -2.1% 0.0% 3.8% 13.3% -1.6%

RON 4.53 4.60 4.65 4.70 4.65 -0.4% -4.5% -0.2% -4.6% -5.2%

TRY 2.19 2.22 2.23 2.19 2.19 0.5% -1.6% 1.1% 11.8% 15.8%

RUB 39.14 40.24 40.01 39.89 39.89 0.5% -1.6% 2.3% 6.6% 7.1%

indicates rev ision resulting in stronger local FX , indicates rev ision resulting in weaker local FX

* Negativ e indicates JPM more bullish on USD than consensus,** Bloomberg FX Consensus Forecasts

Source: J.P.Morgan

JPM forecast gain/loss vs Dec-12* Actual change in local FX vs USD

Actual change in local FX vs EUR

40



J.P. Morgan forecasts: rates, credit, equities & commodities

Source: Bloomberg, Datastream, IBES, Standard & Poor's Services, J.P. Morgan estimates

Interest rates Current Sep-12 Dec-12 Mar-13 Jun-13 YTD Return*

United States Fed funds rate 0.125 0.125 0.125 0.125 0.125

10-year yields 1.53 1.75 2.00 2.00 2.00 3.0%

Euro area Refi rate 1.00 0.75 0.50 0.50 0.50

10-year yields 1.40 1.00 0.90 1.00 1.20 3.6%

United Kingdom Repo rate 0.50 0.50 0.50 0.50 0.50

10-year yields 1.54 1.35 1.50 1.70 1.80 3.8%

Japan Overnight call rate 0.05 0.05 0.05 0.05 0.05

10-year yields 0.75 0.85 0.95 0.95 0.95 2.1%

GBI-EM hedged in $ Yield - Global Diversified 5.76 6.00 5.9%

Credit Markets Current Index YTD Return*

US high grade (bp over UST) 199 JPMorgan JULI Porfolio Spread to Treasury 7.6%

Euro high grade (bp over Euro gov) 254 iBoxx Euro Corporate Index 5.6%

USD high yield (bp vs. UST) 647 JPMorgan Global High Yield Index STW 8.7%

Euro high yield (bp over Euro gov) 953 iBoxx Euro HY Index 11.7%

EMBIG (bp vs. UST) 346 EMBI Global 10.6%

EM Corporates (bp vs. UST) 411 JPM EM Corporates (CEMBI) 9.8%

Quarterly Averages

Commodities Current 12Q3 12Q4 13Q1 13Q2 GSCI Index YTD Return*

Brent ($/bbl) 106 95 100 105 95 Energy -2.5%

Gold ($/oz) 1618 1655 1725 1750 1775 Precious Metals 0.4%

Copper ($/metric ton) 7465 8000 8300 8500 8700 Industrial Metals -2.7%

Corn ($/Bu) 7.90 7.50 7.00 6.80 6.70 Agriculture 26.3%

YTD Return*

Foreign Exchange Current Sep-12 Dec-12 Mar-13 Jun-13 in USD

EUR/USD 1.24 1.22 1.24 1.25 1.25 EUR -4.3%

USD/JPY 78.6 78 78 80 80 JPY 1.5%

GBP/USD 1.57 1.56 1.58 1.58 1.58 GBP 2.0%

USD/BRL 2.01 2.00 1.98 1.95 1.95 BRL -3.5%

USD/CNY 6.38 6.33 6.30 6.30 6.25 CNY -0.5%

USD/KRW 1138 1150 1150 1090 1090 KRW 2.0%

USD/TRY 1.81 1.82 1.80 1.75 1.75 TRY 9.5%

3m cash index

YTD Return

Equities Current (local ccy)

S&P 1377 9.4%

Nasdaq 2945 13.2%

Topix 726 -0.7%

FTSE 100 5627 3.3%

MSCI Eurozone* 131 3.9%

MSCI Europe* 1042 4.8%

MSCI EM $* 916 2.2%

Brazil Bovespa 55072 -0.4%

Hang Seng 19275 7.4%

Shanghai SE 2129 -3.2%

*Levels/returns as of Jul 26, 2012

Local currency except MSCI EM $

US Europe Japan EMSector Allocation * YTD YTD YTD YTD ($)

Energy 1.0% -4.3% -17.2% -5.8%

Materials 4.2% 0.9% -14.9% -5.0%

Industrials 6.2% 7.1% -2.6% 2.7%

Discretionary 12.2% 15.2% 0.4% 0.1%

Staples 10.1% 11.2% 11.5% 8.2%

Healthcare 10.7% 11.9% 7.8% 13.8%

Financials 12.5% 1.9% 14.1% 5.1%

Information Tech. 11.7% 7.7% -12.1% 3.7%

Telecommunications 20.1% -2.5% 3.1% 9.5%

Utilities 6.8% -2.4% -21.1% 4.5%

Overall 9.4% 4.8% -0.7% 2.2%

41

Global Economic Research10 August 2012

David Hensley(1-212) [email protected]

Carlton Strong(1-212) [email protected]

Global growth and inflation forecasts

Source: J.P. Morgan estimates.

Note: For some emerging economies, 2010-2012 quarterly forecasts are not available and/or seasonally adjusted GDP data are estimated by J.P. Morgan.

Bold denotes changes from last edition of Global Data Watch, with arrows showing the direction of changes. Underline indicates beginning of J.P. Morgan forecasts.

2011 2012 2013 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q11 2Q12 4Q12 2Q13

The Americas

United States 1.8 2.2 2.0 2.0 1.5 1.5 2.0 1.5 2.3 2.5 3.3 1.9 1.5 1.3

Canada 2.4 2.1 2.2 1.9 2.0 2.1 2.0 2.2 2.2 2.4 2.7 1.9 2.1 2.2Latin America 4.2 2.9 3.7 3.2 2.1 4.0 3.8 3.8 3.9 3.9 7.2 6.1 6.0 6.6

Argentina 8.9 3.3 2.2 3.6 -4.5 8.0 6.0 0.0 1.5 0.5 9.6 10.0 10.0 11.0

Brazil 2.7 1.7 4.1 0.8 2.4 4.5 4.6 4.3 4.3 4.3 6.7 5.0 4.9 5.0Chile 6.0 5.0 4.5 5.7 3.5 3.8 5.0 4.6 4.7 4.4 4.0 3.2 3.1 3.0

Colombia 5.9 3.5 4.5 1.1 2.2 3.0 3.5 5.0 6.0 6.0 3.9 3.4 2.9 2.9

Ecuador 7.8 4.0 4.0 2.8 3.5 4.0 4.0 4.0 4.0 5.0 5.5 5.1 4.2 4.0Mexico 3.9 3.6 3.5 5.3 2.1 1.7 3.4 4.4 3.7 3.3 3.5 3.8 4.0 3.9

Peru 6.9 6.0 7.0 8.2 5.5 5.5 6.0 8.0 8.0 7.0 4.5 4.1 2.9 3.0

Venezuela 4.2 5.5 0.0 10.9 6.0 3.0 -6.0 -1.0 0.0 3.0 28.5 23.9 23.4 31.7

Asia/Pacific

Japan -0.7 2.6 1.2 4.7 2.0 1.0 0.8 1.0 1.2 1.3 -0.3 0.1 0.1 -0.3Australia 2.1 3.2 2.8 5.3 1.3 1.6 2.4 4.4 3.3 1.8 3.1 1.0 1.5 2.2

New Zealand 1.3 2.5 2.8 4.7 0.4 3.3 3.0 2.3 3.4 3.2 1.8 1.1 2.5 2.7

Asia ex Japan 7.4 6.1 6.7 7.2 5.5 5.9 6.4 6.8 7.0 7.2 4.9 3.9 3.4 3.9China 9.2 7.7 8.5 6.8 6.9 8.0 8.5 8.7 8.7 8.7 4.6 2.9 2.4 3.3

Hong Kong 5.0 1.9 3.6 1.6 3.0 3.5 3.5 3.0 3.5 5.0 5.7 4.2 2.5 2.4

India 6.5 6.0 6.5 5.8 6.3 5.8 5.6 6.2 6.5 6.8 8.4 10.2 9.8 9.3

Indonesia 6.5 5.0 3.7 4.8 4.0 3.0 3.0 3.5 4.5 5.0 4.1 4.5 3.9 3.4Korea 3.6 2.5 3.3 3.5 1.5 2.0 3.5 3.5 3.5 4.0 4.0 2.4 2.2 2.8

Malaysia 5.1 3.0 2.5 5.1 1.0 0.0 1.0 2.0 4.0 4.5 3.2 1.7 1.1 1.1

Philippines 3.8 5.3 3.5 10.2 3.6 1.2 1.2 4.5 4.5 4.5 4.7 2.9 2.3 2.4Singapore 4.9 2.2 3.5 10.0 -0.8 0.8 4.1 4.1 4.1 4.1 5.5 5.2 3.1 2.4

Taiwan 4.0 1.1 3.9 1.3 3.2 1.8 3.8 4.5 4.6 4.8 1.4 1.7 2.1 1.9

Thailand 0.1 3.5 2.3 52.1 4.0 1.0 0.0 2.0 3.0 4.0 4.0 2.5 1.3 1.9

Africa/Middle East

Israel 4.8 2.9 4.4 3.0 3.2 6.1 7.4 4.5 2.8 2.4 2.5 2.3 2.5 2.1

South Africa 3.1 2.5 3.6 2.7 2.4 3.5 4.5 3.7 3.2 3.4 6.1 5.8 5.6 5.7

Europe

Euro area 1.5 -0.5 0.1 0.1 -1.0 -1.0 -0.5 0.5 0.5 1.0 2.9 2.5 2.1 1.6

Germany 3.1 0.9 1.1 2.1 0.5 0.3 0.5 1.5 1.5 1.8 2.6 2.1 1.7 1.4France 1.7 0.1 0.6 0.1 -0.5 -0.3 0.0 0.8 1.0 1.3 2.6 2.3 2.2 1.8

Italy 0.5 -2.2 -1.0 -3.2 -2.5 -2.5 -1.5 -0.8 -0.5 0.0 3.7 3.6 3.4 2.9

Spain 0.7 -1.3 -0.9 -1.3 -1.6 -2.8 -2.0 -0.5 0.5 0.5 2.7 1.9 2.9 2.4

United Kingdom 0.8 -0.6 1.4 -1.3 -2.8 2.0 0.5 1.5 2.0 2.5 4.6 2.8 2.1 1.8

Emerging Europe 4.8 2.7 3.2 3.0 -0.8 2.1 2.9 3.3 3.0 3.2 6.4 4.9 5.5 5.4

Bulgaria 1.7 1.0 2.5 … … … … … … … … … … …Czech Republic 1.7 -1.1 0.9 -3.1 -1.3 0.2 0.9 1.5 -0.6 2.5 2.4 2.7 2.9 2.5

Hungary 1.6 -1.2 1.0 -4.1 -1.3 -0.5 0.5 1.0 1.5 2.0 4.1 5.4 5.3 3.3

Poland 4.3 2.8 2.6 3.2 1.5 1.5 2.0 3.0 3.0 3.5 4.6 3.9 3.4 2.8Romania 2.5 0.8 1.0 -0.5 1.3 -0.4 2.8 1.6 -1.2 1.2 3.4 2.2 4.4 4.0

Russia 4.3 3.6 3.4 4.6 -1.5 3.0 3.5 4.0 4.0 3.5 6.8 3.7 6.1 6.7

Turkey 8.5 2.8 4.5 … … … … … … … 9.2 9.4 6.5 5.8

Global 3.0 2.5 2.7 3.0 1.7 2.2 2.5 2.8 3.0 3.2 3.8 2.8 2.6 2.5

Developed markets 1.3 1.2 1.3 1.7 0.5 0.7 0.9 1.2 1.5 1.8 2.7 1.8 1.6 1.3

Emerging markets 6.1 4.7 5.3 5.6 3.8 4.9 5.3 5.5 5.6 5.7 5.7 4.6 4.4 4.8

Memo:Global — PPP weighted 3.8 3.0 3.3 3.7 2.2 2.8 2.8 2.8 2.8 2.8 4.2 3.3 3.0 3.1

% over a year ago

Consumer prices

% over previous period, saar

Real GDP

% over a year ago

Real GDP

42



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43



Sovereign credit ratings and actions

Source: Ratings agencies via Bloomberg

Rating View Rating View Rating View Rating Outlook Rating Outlook Rating Outlook

Argentina B (-) B3 B 4-Apr-11 23-Apr-12 29-Jun-05 14-Aug-08 12-Jul-10 12-Jul-10

Australia AAA Aaa AAA 25-Feb-11 17-Sep-07 21-Oct-02 24-May-06 28-Nov-11 28-Nov-11

Austria AA+ (-) Aaa (-) AAA 13-Jan-12 13-Jan-12 26-Jun-77 13-Feb-12 10-Aug-94 15-Feb-08

Belgium AA (-) Aa3 (-) AA (-) 13-Jan-12 13-Jan-12 16-Dec-11 16-Dec-11 27-Jan-12 27-Jan-12

Brazil BBB Baa2 (+) BBB 17-Nov-11 17-Nov-11 20-Jun-11 20-Jun-11 4-Apr-11 4-Apr-11

Canada AAA Aaa AAA 29-Jul-02 18-May-07 3-May -02 24-May-06 12-Aug-04 22-May-07

Chile A+ (+) Aa3 A+ 18-Dec-07 16-Dec-10 16-Jun-10 16-Jun-10 1-Feb-11 1-Feb-11

China AA- Aa3 (+) A+ (-) 16-Dec-10 16-Dec-10 11-Nov-10 11-Nov-10 6-Nov -07 11-Apr-12

Colombia BBB- Baa3 BBB- 16-Mar-11 16-Mar-11 31-May-11 31-May-11 22-Jun-11 22-Jun-11

Cy prus BB (-) Ba3 (-) BB+ (-) 2-Aug-12 2-Aug-12 13-Jun-12 13-Jun-12 25-Jun-12 25-Jun-12

Czech Republic AA- A1 A+ 24-Aug-11 24-Aug-11 12-Nov-02 8-Dec-08 4-Mar-08 13-Dec-11

Denmark AAA Aaa AAA 27-Feb-01 26-Sep-07 23-Aug-99 24-May-06 10-Nov-03 18-Dec-07

Finland AAA (-) Aaa AAA 13-Jan-12 13-Jan-12 4-May -98 24-May-06 5-Aug-98 11-Dec-07

France AA+ (-) Aaa (-) AAA (-) 13-Jan-12 13-Jan-12 25-Feb-92 13-Feb-12 10-Aug-94 16-Dec-11

Germany AAA Aaa (-) AAA 13-Jan-12 13-Jan-12 29-Apr-93 23-Jul-12 10-Aug-94 6-Nov -07

Greece CCC (-) C WR CCC WR 2-May -12 7-Aug-12 2-Mar-12 2-Mar-12 17-May-12 17-May-12

Hong Kong AAA Aa1 (+) AA+ 16-Dec-10 16-Dec-10 10-Nov-10 10-Nov-10 25-Nov-10 25-Nov-10

Hungary BB+ (-) Ba1 (-) BB+ (-) 21-Dec-11 21-Dec-11 24-Nov-11 6-Dec-10 6-Jan-12 6-Jan-12

India BBB- (-) Baa3 BBB- (-) 25-Feb-11 25-Apr-12 22-Jan-04 20-Dec-11 1-Aug-06 18-Jun-12

Indonesia BB+ (+) Baa3 BBB- 8-Apr-11 8-Apr-11 18-Jan-12 18-Jan-12 15-Dec-11 15-Dec-11

Ireland BBB+ (-) Ba1 (-) BBB+ (-) 13-Jan-12 13-Jan-12 12-Jul-11 17-Dec-10 27-Jan-12 27-Jan-12

Israel A+ A1 A 9-Sep-11 9-Sep-11 17-Apr-08 17-Apr-08 11-Feb-08 11-Feb-08

Italy BBB+ (-) Baa2 (-) A- (-) 13-Jan-12 13-Jan-12 13-Jul-12 12-Jul-12 27-Jan-12 27-Jan-12

Japan AA- (-) Aa3 A+ (-) 25-Feb-11 26-Apr-11 24-Aug-11 24-Aug-11 22-May-12 22-May-12

Malaysia A- A3 A- 8-Oct-03 27-Jul-11 16-Dec-04 24-May-06 8-Nov -04 9-Jun-09

Mex ico BBB Baa1 BBB 14-Dec-09 28-Jul-11 6-Jan-05 24-May-06 23-Nov-09 23-Nov-09

Netherlands AAA (-) Aaa (-) AAA 13-Jan-12 13-Jan-12 20-Feb-12 23-Jul-12 10-Aug-94 26-Oct-07

New Zealand AA Aaa AA 29-Sep-11 29-Sep-11 21-Oct-02 13-May-99 29-Sep-11 29-Sep-11

Norway AAA Aaa AAA 9-Jul-75 28-May-09 30-Sep-97 13-May-99 13-Mar-95 18-Dec-07

Peru BBB Baa3 (+) BBB 30-Aug-11 30-Aug-11 16-Dec-09 21-Mar-11 10-Nov-11 10-Nov-11

Philippines BB+ Ba2 (+) BB+ 4-Jul-12 4-Jul-12 15-Jun-11 29-May-12 23-Jun-11 23-Jun-11

Poland A- A2 A- 29-Mar-07 27-Oct-08 12-Nov -02 24-May-06 18-Jan-07 10-Nov-08

Portugal BB (-) Ba3 (-) WD (-) 13-Jan-12 13-Jan-12 13-Feb-12 13-Feb-12 11-May-12 24-Nov-11

Romania BB+ Baa3 (-) BBB- 27-Oct-08 29-Nov -11 6-Oct-06 29-Jun-12 4-Jul-11 4-Jul-11

Russia BBB Baa1 BBB 8-Dec-08 27-Jun-12 16-Jul-08 12-Dec-08 4-Feb-09 16-Jan-12

Singapore AAA Aaa AAA 25-Feb-11 2-May -08 14-Jun-02 14-May-03 14-May-03 7-Mar-08

Slov akia A A2 (-) A+ 13-Jan-12 13-Jan-12 13-Feb-12 13-Feb-12 8-Jul-08 8-Jul-08

Slov enia A (-) Baa2 (-) A- (-) 3-Aug-12 3-Aug-12 2-Aug-12 2-Aug-12 8-Aug-12 8-Aug-12

South Africa BBB+ (-) A3 (-) BBB+ (-) 1-Aug-05 28-Mar-12 16-Jul-09 9-Nov -11 25-Aug-05 13-Jan-12

South Korea A A1 (+) A+ (+) 27-Jul-05 12-Oct-07 14-Apr-10 2-Apr-12 24-Oct-05 7-Nov -11

Spain BBB+ (-) Baa3 (-) BBB (-) 26-Apr-12 26-Apr-12 13-Jun-12 13-Jun-12 7-Jun-12 7-Jun-12

Sweden AAA Aaa AAA 16-Feb-04 22-Jan-07 4-Apr-02 15-Nov -03 8-Mar-04 18-Dec-07

Switzerland AAA Aaa AAA 17-Feb-11 1-Dec-03 29-Jan-82 15-Nov-03 10-Aug-94 11-Jun-07

Taiwan AA- Aa3 A+ 25-Feb-11 11-Jun-10 20-Jul-99 24-May-06 20-Nov-01 26-Jan-11

Thailand BBB+ Baa1 BBB 31-Oct-06 9-Dec-10 26-Nov-03 28-Oct-10 16-Apr-09 19-Apr-10

Turkey BB Ba1 (+) BB+ 19-Feb-10 1-May -12 20-Jun-12 20-Jun-12 3-Dec-09 23-Nov-11

United Kingdom AAA Aaa (-) AAA (-) 17-Feb-11 26-Oct-10 31-Mar-78 13-Feb-12 26-Oct-95 14-Mar-12

United States AA+ (-) Aaa (-) AAA (-) 5-Aug-11 5-Aug-11 2-Aug-11 2-Aug-11 10-Aug-94 28-Nov-11

Venezuela B+ B2 B+ (-) 19-Aug-11 19-Aug-11 7-Sep-04 15-Jan-09 15-Dec-08 4-Apr-12

S&P Moody 's Fitch Recent S&P Action Recent Moody's Action Recent Fitch Action

RATING SCALE S&P MOODY's Fitch RATING SCALE S&P MOODY's Fitch

Upper Investment Grade AAA Aaa AAA Lower Non-Investment Grade B+ B1 B+

AA+ Aa1 AA+ B B2 B

AA Aa2 AA B- B3 B-

AA- Aa3 AA- CCC+ Caa1 CCC+

A+ A1 A+ CCC Caa2 CCC

A A2 A CCC- Caa3 CCC-

A- A3 A- CC Ca CC

Lower Investment Grade BBB+ Baa1 BBB+ C C C

BBB Baa2 BBB Default SD RD

BBB- Baa3 BBB- D D

Non-Investment Grade BB+ Ba1 BB+

BB Ba2 BB

BB- Ba3 BB-

44



Redemptions for €-denominated marketable debt, 2012-2013Euro area

€bn

Note: Marketable debt includes conventional bonds plus inflation linkers, floaters and zero coupon bonds for non-conventional bonds

Source: J.P. Morgan

Bonds T-Bills Banks Bonds T-Bills Banks Bonds T-Bills Banks Bonds T-Bills Banks Bonds T-Bills Banks Bonds T-Bills Banks Bonds T-Bills Banks

Aug-12 0 10 3 12 30 2 8 2 1 0 1 0 0 0 0 1 45 8 20 44 5

Sep-12 2 7 7 11 17 4 0 3 2 0 0 0 0 0 0 44 28 19 13 26 12

Oct-12 20 7 5 20 16 6 0 1 1 0 1 0 0 1 1 35 31 22 40 25 12

Nov-12 0 4 10 13 5 5 0 2 1 0 1 0 0 0 3 0 14 8 13 11 18

Dec-12 0 8 5 30 26 10 2 2 0 1 2 0 0 0 0 29 11 7 33 37 15

Total 2012 22 35 28 86 94 26 10 10 4 1 4 1 0 1 4 109 130 65 119 143 62

Jan-13 14 3 12 0 9 4 0 0 1 0 0 0 0 0 1 61 12 44 14 12 18

Feb-13 0 6 7 21 9 10 6 0 1 0 2 2 0 0 2 0 12 25 27 16 22

Mar-13 0 4 10 0 9 6 0 0 0 0 2 0 0 0 1 31 12 34 0 14 17

Apr-13 15 4 11 29 20 7 0 0 1 0 0 0 6 0 3 52 12 12 50 24 22

May-13 0 2 4 0 7 1 17 0 2 0 1 2 0 0 1 0 13 11 17 10 10

Jun-13 1 6 9 19 0 1 1 0 0 0 1 0 0 0 0 17 0 15 21 7 10

Jul-13 15 4 9 14 0 1 1 0 1 0 0 0 0 0 2 77 0 17 30 4 13

Aug-13 0 2 4 25 0 4 6 0 0 0 0 0 0 0 0 0 0 9 31 2 8

Sep-13 0 0 7 10 11 5 0 0 0 10 0 0 0 0 1 49 0 9 20 11 12

Oct-13 16 0 14 0 0 3 0 0 0 0 1 1 0 0 0 40 0 23 16 1 18

Nov-13 0 0 7 18 0 4 0 0 0 0 0 0 0 0 0 0 0 5 18 0 11

Dec-13 0 0 2 20 0 5 2 0 1 0 0 0 0 0 1 11 0 11 22 0 9

Total 2013 61 30 95 156 64 51 33 0 7 10 6 5 6 0 13 338 61 215 266 101 170

* Germany, France, Netherlands, Belgium

** Spain, Italy , Greece, Portugal, Ireland

IrelandSpain Greece PortugalItaly Core* Periphery**

45



Prior Research Notes available on www.morganmarkets.comIntroducing Daily FX Strategy Analytics: available on iPad & www.morganmarkets,com,Normand, Aug 10, 2012

Intra-EMU currency valuations: Estimates for a breakup scenario,Kariya, Aug 9, 2012

The euro in a world with several Japans,Normand, Aug 2, 2012

Keeping it real: life after peak in Aussie terms of trade, Jarman & Kennedy, Jul 26, 2012

Some notable shifts in Japanese retail investments: From Toshin to Uridashi, and from BRL to other high-yielding EM FXs, Tanase & Hibino, Jul 18, 2012

JPM Euro survey results: Universally bearish, moderately short against all regions & unconvinced of EMU break-up or enlargement, Normand, Jul 17, 2012

India and Indonesia: two odd peas in the EM Asia pod, Ong & Chinoy, Jul 16, 2012

ECB to focus on monetary transmission in second half,Fuzesi & Mackie, Jul 13, 2012

RBA’s job far from complete in this stop-start easing cycleWalters, Jul 13, 2012

Corporate hedging survey: This summer is different, Kariya, Hibino, Jul 6, 2012

Central bank balance sheet chartpack, Meggyesi, Jul 5, 2012

BoJ’s record high-current account deposits and USD/JPYSasaki, June 29, 2012

Japan to hike the consumption tax: implications for the yenSasaki, June 26, 2012

Still too early to become AUD bullishHebner, June 22, 2012

What might a Euro area roadmap look like?Mackie, June 15, 2012

Examining JPY’s valuation: has JPY been overvalued?Tanase & Hibino, June 15, 2012

UK: what has weaker sterling ever done for us?,Monks, May 25, 2012

The key issue is not the survival of the Euro area, but what sort of Euro area survives, Mackie, May 25, 2012

What should we expect after Hollande’s victory?Brun-Aguerre, May 11, 2012

JPY: Now looking for a range in high 70's, Sasaki, Tanase & Hibino, May 4, 2012

Implications of the Dutch government collapse, Panageas, Apr 24, 2012

Is FX liquidity abnormally low? Normand, Apr 4, 2012

Can BoJ achieve its inflation goal? Adachi, Mar 29, 2012

China: determinants of CNY exchange rate,Zhu & Ng, Mar 23, 2012

Corporate hedging survey: Where have all the hedgers gone? Kariya, Mar 23, 2012

Short NZD/CAD and NZD/NOK, Hebner, Feb 23, 2012

Focus on current accounts – why CHF is not following the yen weaker, Meggyesi, Feb 23, 2012

China: FX reserves to resume upward trend, Zhu, Ng & Jiang, Feb 17, 2012

Building Europe’s firewalls: a progress report,Barr & Mai, Feb 3, 2012

Asian FX and Japanese corporate earnings – KRW/JPY is key, Tanase, Feb 1, 2012

Metals Review and Outlook, Jan 2012: Demand needs a Spark, Jansen & Fu, Jan 30, 2012

Portuguese second package unlikely to include PSI,Mai, Jan 27, 2012

Corporate hedging survey: Despite Euro stress, FX management practices mostly unchanged, Kariya, Kavuri, Hibino, Jan 20, 2012

Central bank balance sheet chartpack, Meggyesi, Jan 19, 2012

Commodity Currencies: Risks loom large for Q1 of 2012, especially for the AUD, Hebner, Sandilya, Kariya,Jan 10, 2012

M&A and FX in 2012: Japan/Europe rotation worth monitoring, Normand, Jan 9, 2012

JPY:New FSA regulations on overlay funds could narrow retail path to BRL, Tanase & Hibino, Jan 4, 2012

Answers to 10 common questions on EMU breakup,Normand & Sandilya, Dec 7, 2011

46



Disclosures

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http://www.optionsclearing.com/publications/risks/riskstoc.pdf

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consumption tax (shouhizei) calculated by multiplying the executed price by the commission rate which was individually agreed between JPMorgan Securities Japan Co., Ltd., and the customer in advance. Financial Instruments Firms: JPMorgan Securities Japan Co., Ltd., Kanto Local Finance Bureau (kinsho) No. 82 Participating Association / Japan Securities Dealers Association, The Financial Futures Association of Japan, Type II Financial Instruments Firms Association and Japan Investment Advisers Association. Korea: This report may have been edited or contributed to from time to time by affiliates of J.P. Morgan Securities (Far East) Ltd, Seoul Branch. Singapore: JPMSS and/or its affiliates may have a holding in any of the securities discussed in this report; for securities where the holding is 1% or greater, the specific holding is disclosed in the Important Disclosures section above. India: For private circulation only, not for sale. Pakistan: For private circulation only, not for sale. New Zealand: This material is issued and distributed by JPMSAL in New Zealand only to persons whose principal business is the investment of money or who, in the course of and for the purposes of their business, habitually invest money. JPMSAL does not issue or distribute this material to members of "the public" as determined in accordance with section 3 of the Securities Act 1978. The recipient of this material must not distribute it to any third party or outside New Zealand without the prior written consent of JPMSAL. Canada: The information contained herein is not, and under no circumstances is to be construed as, a prospectus, an advertisement, a public offering, an offer to sell securities described herein, or solicitation of an offer to buy securities described herein, in Canada or any province or territory thereof. Any offer or sale of the securities described herein in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant Canadian securities regulators and only by a dealer properly registered under applicable securities laws or, alternatively, pursuant to an exemption from the dealer registration requirement in the relevant province or territory of Canada in which such offer or sale is made. The information contained herein is under no circumstances to be construed as investment advice in any province or territory of Canada and is not tailored to the needs of the recipient. To the extent that the information contained herein references securities of an issuer incorporated, formed or created under the laws of Canada or a province or territory of Canada, any trades in such securities must be conducted through a dealer registered in Canada. No securities commission or similar regulatory authority in Canada has reviewed or in any way passed judgment upon these materials, the information contained herein or the merits of the securities described herein, and any representation to the contrary is an offence. Dubai: This report has been issued to persons regarded as professional clients as defined under the DFSA rules.

General: Additional information is available upon request. Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively J.P. Morgan) do not warrant its completeness or accuracy except with respect to any disclosures relative to JPMS and/or its affiliates and the analyst's involvement with the issuer that is the subject of the research. All pricing is as of the close of market for the securities discussed, unless otherwise stated. Opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. The recipient of this report must make its own independent decisions regarding any securities or financial instruments mentioned herein. JPMS distributes in the U.S. research published by non-U.S. affiliates and accepts responsibility for its contents. Periodic updates may be provided on companies/industries based on company specific developments or announcements, market conditions or any other publicly available information. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise.

"Other Disclosures" last revised August 10, 2012.

Copyright 2012 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of J.P. Morgan. #$J&098$#*P

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J.P. Morgan Global FX Strategy

London

John Normand MD Head, Global FX Strategy (44-20) 7134-1816 [email protected]

Paul Meggyesi MD FX Strategy (44-20) 7134-2714 [email protected]

Thomas Anthonj ED Technical Strategy (44-20) 7742-7850 [email protected]

Matthias Bouquet VP Derivatives Strategy (44-20) 7134-1819 [email protected]

New York

Ken Landon MD FX Strategy (1-212) 834-2391 [email protected]

Kevin Hebner ED FX Strategy (1-212) 834-4254 [email protected]

Niall O’Connor ED Technical Strategy (1-212) 834-5108 [email protected]

Arindam Sandilya ED Derivatives Strategy (1-212) 834-2304 [email protected]

Justin Kariya Associate FX Strategy (1-212)-834-9618 [email protected]

Tokyo

Tohru Sasaki MD FX Strategy (81-3) 6736-7717 [email protected]

Junya Tanase ED FX Strategy (81-3) 6736-7718 [email protected]

Sydney

Anna Hibino Associate FX Strategy (61-2) 9003-7932 [email protected]

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