EFTA01459597.pdf

12 January 2016 FX Blueprint: Forever Young Theme #2: Brussels sprouts - sell GBP vs USD & SEK • Stretched valuation, unsustainably large capital inflows and renewed political risks spell the end for IGBP has outperformed almost every other currency since the start of the USD uptrend the sterling uptrend. • Stay short GBP/USD as Fed and Bank of England 135 ma USD broad index, exclucang GBP policy diverges. Short GBP/SEK also makes sense 130 USD/GBP. indexed from a relative value perspective. 125 Sterling has far outshone its peers since the start of the 120 dollar uptrend in April 2011. The pound has fallen just 7% against the greenback versus a 30% move in the 116 broad USD TWI (figure 1), with only the Korean won 110 doing better among floating rate currencies. There are now plenty of reasons to think outperformance is over. 106 100 The pound is expensrve First, sterling is expensive on several metrics. Two year 96 rate spreads suggest cable closer to the low 1.40s. The 90 1 cross has also closely tracked the relative number of -II Jun Jan-I2 Aug-12 Mar-13 04413 May-14 Dmi-14 Ju415 h016 months between a US and UK tightening cycle, which screw cooteriamesfiwarce. OttwIleip Friem LP also imply downside based on current market pricing. Using a medium run valuation framework, the currency The pound already looks expensive to rate spreads is the most expensive among all the majors on a combined PPP, BEER and FEER basis. 29 —2y to nerd ate safeee Record capital inflows may not be sustained 2 year current 2.12 2' Second, it is doubtful whether the huge capital inflows GBP/USD. rhs ZO2 the UK has generated and seen the current account I9 deficit widen to the largest in history can be sustained. 192 As figure 3 shows, these have been very sensitive to I4 1.12 the UK's relative growth rank with other developed economies. Britain has fallen from the top of the pack 09 1-72 back in 2014 to number four today, and will drop to 1.62 number six if the softer growth momentum implied by 0.4 GDP revisions in Q3 December endures. 151 -0.1 1,42 Drilling down into flows, robust net direct investment if was boosted by record M&A inflows last year. This -0.6 L32 may be difficult to repeat given rising US interest rates May-OB Mav40 May-12 May-14 and renewed focus by US authorities on tax inversion deals. Most of the inflows, though, have been portfolio, sayer Deursan• e.+4 Haman Fivnot LP 1 broadly balanced between equity and debt. For the (Debt inflows mean reverting appear to have peaked former, EFPR data suggests that healthy inflows in O2 and Q3 have turned. On the latter, fixed income inflows 7% I —Net capital inflows into the UK. % GDP -1 have been highly sensitive to relative monetary policy 6% —Rank of UK growth versus G10. the stances, with the UK one of the largest beneficiaries of the compression of term premia from ECB QE. But monetary policy divergence may have peaked, with the L. prospects of more ECB easing seemingly off the table 3 for the first half of next year, while the Bank of England 4 has become much more cautious about tightening. 5 Fiscal and monetary tightening may prove a challenge 6 Growth risks appear skewed to the downside too. The UK is set to undergo renewed austerity next year. At 7 1.3% GDP, fiscal tightening is less than previously -8 forecast, yet will still be the largest of major developed 2% If current growth nxamentum continue 9 economies. A sharp increase in fiscal tightening may Oct.87 Deo-91 Feb-96 Apr-00 Jun-04 Aug-08 Oct-12 be the 'hidden' reason growth has slowed this year and SOUK* DIVIIth• sank mrAnityryftnencv tP a further pick-up could put rate hikes on ice indefinitely. Deutsche Bank AG/London Page 5 CONFIDENTIAL — PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0120113 CONFIDENTIAL SDNY_GM_00266297 EFTA01459597