EFTA00610276.pdf

Deutsche Bank Markets Research r4 Global Foreign Exchange FX Spot 9 January 2014 FX Blueprint Thin end of the wedge Theme #1: Holler for dollars: Buy USD vs. NZD, CHF, SGD, buy EUR/USD risk 'Research Team reversal London Theme #2: Play it again, san: Buy USD/JPY Bilel Hafeez Theme #3: Home Counties trump Mounties: Buy GBP/CAD James Malcolm Theme #4: Swiss -Out: Sell CHF/NOK Henrik Gullberg George Sarevelos Theme #5: Dingo unchained: Buy AUD/NZD Siddhanh Kapoor Theme #6: SEK to score with thaw: Sell EUR/SEK, buy EUR/NOK put Oliver Harvey Theme #7: Trend not bitter end: Follow trend in JPY and CAD Nicholas Weng Theme #8: Balti not faulty, China still finer: Buy USD/INR put, buy USD/SGD, sell USD/CNH, sell JPY/KRW New York Theme #9: Pole dances, TRY trips: Sell EURIPLN, sell USD/ILS, sell EUR/HUF, Alan Ruskin sell EUR/RUB, buy USD/TRY Daniel Brehon Theme #10: Pesos no prickly pair. Buy MXN vs. USD, CLP, RUB, buy CLP/COP Dreusio GiacomoIli Guilherme Marone Theme #11: Vol to roll: Buy EUR/USD FVAs, USD/JPY vol swaps and risk reversals, AUD/USD puts Singapore Sameer Goel Ma'like Sadie!eye Perry Kojodjojo Sydney Adam Boyton Tokyo Teisuke Tanaka Head of FX Strategy Bilel Hafeez Deutsche Bank AG/London DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013. EFTA00610276 9 January 2014 FX Blueprint: Thin and of the wedge Overview Sticking to regime change; dollar uptrend A neat way of playing the lead-lag between different 2013 marked a fundamental regime change from the segments of the market to the normalization in crisis-prone 2008-2012 period. The dollar's correlation developed markets is to buy the Norwegian krone and to equities flipped, the euro-area avoided a crisis and sell the Swiss franc. The former saw a large unwind of the Fed announced a rolling back, rather than an post-crisis safe-haven inflows last year, while safe- expansion, of QE. If there was a locus of crisis it was in haven flows to Switzerland have yet to be unwound. emerging markets, which felt the shock of Fed taper. We should start to see this happen in 2014. Elsewhere This could hint that the 1990s dynamic of first half in Europe, the Swedish krona should do well as the dollar weakness and developed market crises and Swedish economy finally catches up to German and US second half dollar strength and emerging market crises economic strength. could be repeating itself. Asia-Pac winners and losers We therefore remain committed dollar bulls. If last year In the Asia-Pacific region, one of the largest cross was all about the US long-end being re-priced on taper, moves in 2013 was AUD/NZD, but we expect a major 2014 will mark the re-pricing of the US short-end. reversal this year. Aside from attractive valuations, the December's Fed decision therefore represents only the rates markets will likely price a more hawkish RBA thin end of the wedge for US interest rate compared to an already aggressively priced RBNZ. normalization and its effect on markets. This should We'd look for the Korean won to outperform the allow the USD to strengthen against the core European Japanese yen on an improving current account, a pick- hold-outs to dollar strength, the euro, Swiss franc and up in global growth and a robust domestic financial pound. The equity flow picture should finally move in system. The Singaporean dollar will struggle as favour of the US as slow-moving capital adjusts to the valuations are stretched, household debt is elevated new DM regime. Our favourite expression of dollar and the currency is closely tied to the overall dollar strength would be to buy it against the three most trend. Finally, we'd still buy CNH as the current over-valued currencies in the world, the New Zealand account, inflation and likely capital inflows are Dollar, Swiss franc and Singaporean dollar. supportive, though we remain wary of the carry unwind dynamics seen in the currency. Yen trend still down While we are looking for a reversal in core European Fragile EM; strong EM currency trends, on the yen we remain firmly in the The Indian rupee is the only 'fragile five' currency we bearish camp and look for a trend extension from last like to be long. Current account improvement, portfolio year. What adds to our confidence is that major yen inflows after last year's reduction and beneficial policy turns tend to see the yen move by 43% on average,and action adds up to a bullish case. By contrast, the we're nowhere near such a move yet. On fundamentals, Turkish lira and South African rand should continue to the BoJ is also conspicuous amongst the major central struggle as their current account dynamics are poor. banks in ramping up QE, the basic balance of While both Indonesian rupiah and the Brazilian real also payments is heavily negative and foreigners have yet to suffer from rickety current accounts and domestic unwind their safe-haven inflows to Japan that were dynamics, better valuations and high carry may prevent accumulated in the crisis years. excessive weakness. Not all EM is bad. We like the Polish zloty, Israeli shekel and Mexican peso. The first on growth, the second on commodities and third on Rest of G10 We underestimated UK growth in 2013, but for 2014 expected FDI and cyclical pick-up. we intend not to miss the changes in the UK economy. The starkest one will likely be the pick-up in inflation, Last year's Blueprint's Trades which will only add to expectations of a more hawkish Our trades from the last Blueprint were mixed. Our best Bank of England. The pipeline for FDI into the UK also trade was going long MXN/BRL (+7.1%) while our looks good. The main weakness for the pound remains worst was being short TRYIZAR (-3.6%). Overall, 6 of the current account deficit, so as a FX trade we like to the themes made money while 4 lost money. Overall, buy the pound against another current account deficit our 10 themes made a 0.47% average retum. currency, the Canadian dollar. Helping the bearish CAD case is that expectations of a hawkish Bank of Canada Bi!al Hafeez, London appear overdone given the disconnect between the US and Canadian economy, the likely reversal of the surge of bond inflows seen since 2008 and a turn lower in commodity prices. Page 2 Deutsche Bank AG/London EFTA00610277 9 January 2014 FX Blueprint: Thin end of the wedge Theme #1: Holler for dollars ▪ We expect the Fed and a recovery in US equity 'Curve Flattening Very Bullish USD inflows to be the two main pillars of support for the dollar in 2014. Buy USD vs. NZD, CHF and SGD on ChingelnDAYerounicifferentmoves in 2yr-10/rUSyleidcufve cycle and extreme valuation. 20ra 19804orisy e The Euro-area current account remains supportive 2096 'Etetbtlorr II for the euro, but tight liquidity is fully priced, the 15% 10% risk of negative rates is material, portfolio inflows 6% are peaking and we are reaching the 20% FX over- 0% valuation bound. Buy 12m EUR/USD 1.4011.31 risk reversals for zero cost. -10% 'Growth' •15% Don't Rely on Fed Dovishness -2096 Last year was all about pricing out QE, even though -25% tapering is just beginning. The overwhelming message Beer Twist But Beer ai TNSt Flatten linen Flatten Steepen Steepen Steepen is that the market front-runs major events, and that the timing of re-pricings is very unpredictable. Just as 2013 Sourer Ocuadre Sank iMf was about QE unwinds and higher long-end yields, we think this year will be about the re-pricing of "low for long" and higher short-end yields. 'UST Selling Last Year Offset By Cash and Hedging First, US short-end expectations are exceptionally C..sourative US short-term ponfoho flows Immlo & ST benign. The market is not pricing the first rate hike until 2000 loans, Do USD) Q3 2015, just in line with FONT projections, and by 1800 which time a simple linear extrapolation of the US 1600 unemployment rate takes us well below 6%. Second, 1400 the US yield curve is close to all-time steepness 1200 extremes. On the one hand, this means that the risks 1000 are skewed towards flattening, historically one of the 800 most supportive yield curve environments (chart 1). On 600 the other hand, the forwards are extremely high, 400 suggesting that even if these are realized, the US dollar 200 will climb up the carry ladder and drop-out of the bottom-3 yield ranking by year-end. 94 96 98 00 02 04 06 08 10 12 Foreigners to Come Late to the Party SOU/014 Ditatitho Hunk abentre RAMC* LP, ONIStehat The second building block to our bullish USD view is our positive outlook on growth and by extension US Equity Valuations Not Extreme, Inflows Should Recover equity inflows. 2013 stood out for large dollar cash accumulation, on the back of UST liquidation and an —Relative P/E ratio, US vs world•, 12m lead Ohs adjustment of USD hedge ratios (chart 2). The year has 1.2 Net equity inflows Ohs, % gross flowsl f 120% also stood out for record outflows from US equities as Americans have invested large amounts offshore and 1.t 70% foreigners have refused to engage in the S&P 500 rally. 1.0 But looking at relative valuations, outflows have overshot what is a relatively benign valuation picture 0.9 20% for US stocks. Using the average P/E ratio of Hong Kong and UK stocks as a global proxy, we find that 0.8 -30% valuations are close to the medium-term average (chart 0.7 3). The odds therefore seem skewed towards higher -80% equity inflows into the US, which combined with a 0.6 flatter US curve should see an improvement in portfolio flows that was lagging this year. 0.5 I 130% 96 97 98 99 00 01 03 04 05 06 07 08 10 11 12 13 14 Swear thvescne Bonk lleamingMime t0 'we pan*oddby the ME end*op Sang I Deutsche Bank AG/London Page 3 EFTA00610278 9 January 2014 FX Blueprint: Thin end of the wedge Hard to See EUR Story Get Any Better IEUR/USD Still Tracking Rate Differentials The EUR was the star performer in 2013, despite a strong dollar elsewhere. The Euro-area's large current 1.0 EUR/USD Ohs) 0.1 account surplus has helped, which has pushed the mplied 2yr E R/USD yields (rhs) 1.38 basic balance into positive territory and in the past has 0 been associated with broad-based EUR-appreciation. It 1.36 is for this reason that we expect the EUR to continue to 1.30 -0.1 hold up relatively well against many G10 FX. Looking at 1.32 drivers more relevant to EUR/USD however, the positive factors that have driven strength versus the 1.3 -0.2 dollar have peaked. 1.28 1.26 -0.3 First, interest rate differentials should turn lower over 1.24 2014. Looking across different tenors as well as bond -0.4 versus implied forward yields, we find that the euro is 1.22 most sensitive to short-dated forward-implied yields. 1.2 -0.5 Last year short-end European yields moved higher not Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 only on the back of ECB LTRO liquidity withdrawal, but Sono Damen, &trot Consenws economy, tr ancectormegotions as the cross-currency basis also moved back to flat for the first time since 2008 (chart 1). For this year, the risks are skewed the other way. There is less than IPortfolio Inflows Into Euro-Area Peaked 200bn EUR of excess liquidity left, EONIA is back to the refi rate and cross-currency basis is flat, so there is no 400 Euro - World Business Surveys (Ihs) -20 room left for higher short-end European yields. In Net Portfolio flow, inveretd outho 300 -15 contrast, the ECB retains a strong easing bias and -10 negative rates or additional liquidity injections remain a 200 strong possibility. 100 -5 0 0 On the flow side, the best is behind us as well. Portfolio 5 inflows into the Euro-area have been dominated by -100 10 equity, but cumulative purchases are now back to -200 trend and on a relative valuation basis Euro-area 15 equities are at a 10-year high. On the outflows side, 300 20 European offshore investment remains very pro-cyclical, -400 25 so an improving cycle should lead to a pick-up in Euro- -500 30 area outflows (chart 2). Add to that the peak in the 08 08 10 11 12 13 current account surplus on the back of recovering &am basset* (WA Scoarteg fa no, 0' domestic demand and the risk of additional ECB easing, and we like buying a 1.42p/1.34c EUR/USD risk reversal for zero cost. INZD, SGD, CHF Most Expensive FX in the World (a) Other Dollar Crosses to Short 30 PPP valuation adjustedforproductivity Looking outside of EUR/USD, NZD, SGD, and CHF are I 20 -. and terms of trade (BEER) our top shorts. The Swiss franc is a higher beta version of EUR/USD, with valuations more stretched and 10 greater potential for capital outflows. NZD and SGD are JIllrrr the most over-valued currencies in the world, having lagged all other FX in the USD appreciation that has -10 - materialized so far. We therefore like buying USD vs. NZD, CHF and SGD. This basket has a steady —80% -20 correlation with both the narrow and broad USD trade- -30 weighted indices over the last ten years. 00 George Saravelos, London, -50 ou_occ<noomm-zleceoavo>-zei.oiln-a.ler4r4ticca ,..aaD Bilal Hafeez, London, zvmw D..cE,cr.dpeori ev, r2v mo Ea-ni optuE-lozo,c d mgvo.mucen vz Somas OwitstAo Byµ libonits7 Fiume fit Page 4 Deutsche Bank AG/London EFTA00610279 9 January 2014 FX Blueprint: Thin end of the wedge Theme #2: Play it again, san We always suspected 2013 would be special, and in this publication a year ago urged investors not to wait 'What happens in year after big" USD/JPY move? for a dip in USD/JPY to buy. We highlighted the 6 ongoing deterioration in Japan's balance of payments Trend reverses Trend continues and huge pent-up energy in risk-averse short-term s - capital flows post-GFC. We noted how sentiment was shifting but investors seemed overly cautious, and 4 pointed out that trend turns are typically worth 20.25% on a first-year basis - basically what ensued. It didn't matter that we couldn't anticipate the BoJ's radical departure or mixed Fed signals on QE. The associated 2 • swings in risk appetite and positioning created some bumps in the road. But a single-minded focus and conviction ultimately paid off big time. 0 -25%-301-15%-10%-5% 0% 5% 10% 15% 20% 25% 50% 35% Last year's gain now appears to be this year's pain. The yen posted its largest percentage point loss in 34 years Scum.: &vow,. Bent Boor nnFaience UP. • &.c. N/ ass POSt Sot kgego and the Nikkei its biggest rally since 1972. Both go into the New Year on their highs, even as WY JGB yields ILong-term trends in USDJPY are within 5bp of their end-2012 level. Few savor the Date Rate Log chg Months prospect of chasing or fighting such markets. 13/01/1971 358.44 14/03/1973 254.45 -34% 26.0 The trend is yet young 08/12/1975 306.84 19% 32.8 Still, outsized (10%+) moves in USD/JPY have extended 30/10/1978 177.05 -55% 34.7 in the following year twice as often as they retraced: 12 04/11/1982 277.65 45% 48.1 times versus 6 since 1971 (top chart).1 We think this is 25/11/1988 121.10 -83% 72.7 a multi-year-trend, and historically such moved have 17/04/1990 160.20 28% 16.7 cumulatively been worth 43% (log terms) with a 19/04/1995 79.75 -70% 60.1 standard deviation of 20%, typically lasting for just over 11/08/1998 147.66 62% 39.7 three years (see chart 2). Mechanically speaking, that 26/11/1999 101.25 -38% 15.5 would take spot to 116 in December, and well through 31/01/2002 135.15 29% 26.2 most conceptions of 'fair value.' One should not shy 17/01/2005 101.69 -28% 35.6 from forecasting such things, because overshoot is 22/06/2007 124.14 20% 29.2 very much the norm for FX (chart 3). 31/10/2011 75.35 -50% 52.3 Abs avg 43% 37.7 Base money differentials matter, will grow Stdev 20% 16.7 As far as the eye can see policy settings also imply it. 20/12/2014 116.00 43% 38.6 Deputy Govemor Iwata argued in October that past San Ammo. Gant &bombe.Memo UP experience both in the US and Japan show QE works mainly via changes in the money stock. (Hence the importance of the BoJ's commitment to doubling the monetary base; he asserts 'the current level of the IFair value contestable, overshoot is not monetary base is irrelevant.') Time lags in transmission 160 mean its impact - including on the yen (top chart over 150 page) -- will build even as the initial expectations boost 140 from 'shock and awe' ebbs. Consequently, markets 130 need not fear the absence of further easing by the Bank 120 if, as seems likely, the consumption tax hike in Q2 110 passed smoothly. Governor Kuroda has also made clear 100 that Japan's massive money expansion will continue 90 until the 2% core CPI target is not only achieved but REER (2005*100) deemed secure on a sustainable (medium-term) basis. 80 — — — Polynomial trend (3) 70 • — Linear trend 60 • 71 74 77 80 83 86 89 92 95 98 01 04 07 10 13 Scurry Oeinschr Bret 8bombeep 'mane LIP xFor the Nikkei the same stets using a 20% threshold are 5 and 10, i.e., only halt as many large moves continue. Deutsche Bank AG/London Page 5 EFTA00610280 9 January 2014 FX Blueprint: Thin end of the wedge External accounts highlight major vulnerability 'Relative base money growth will only point higher Japan's balance of payments still promises a brisk tailwind for yen weakness. The trade account has 30 140 deteriorated further, against most expectations of 20 130 stabilization. This is overwhelmingly an oil and gas story, though lackluster external shipments and 120 10 strengthening domestic demand are supplementary 110 issues. Net FDI outflows a similar-sized drag that is 0 only likely to get bigger even if the current account 100 gradually improves. That reflects a massive cost-of- -10 90 funding advantage spurring catch-up after Japanese -20 corporates have been risk averse and lagged their — ease money Pp 80 competitors in overseas expansion over the last two (%YoY.1N-LtS) -30 70 - USCUPY (RHS) decades. Overall it leaves Japan's 'narrow basic balance' in a pretty neutral state (middle chart). -no 60 00 01 02 03 04 OS 06 07 08 09 10 11 12 13 14 Cross-border portfolio flows have also had little impact Santa Oaercaraant abaft." &Awe CP on the yen thus far. Foreign equity inflows seem to have been largely hedged and new bond outflows were 'Narrow basis balance still under pressure limited to banks' offshore treasury activity. Henceforth, real money inflows to Japanese stocks should pick up, JOY aril, 3mma but will probably be balanced by growing Japanese 3.0 ! outflows into foreign bonds and stocks - the latter encouraged by the new NISA scheme and more 2.0 - aggressive GPIF portfolio adjustment away from JGBS. 1.0 That would leave the financial account's short-term loans balance as largest swing factor again. It captures 0.0 carry trades and foreign asset hedging activity and responds to risk aversion and investor's perception of l iTransfe s -1.0 long-term interest rate differentials. It is several orders i' of magnitude larger than other BoP components and ncome -2.0 II seen in stock terms retains scope for several hundred Goods & services —1 m(6nvina) billion dollars of yen-selling unwinds (lower chart). 3.0 02 04 06 08 10 12 Abenostics abound Same' Dana* awe Seam:Keg "'nano, CP Conventional market tops are characterized by hubris in the mainstream which creates unquestioning acceptance of a 'new status quo.' By contrast, most 'Financial account's 'other investment balance' is key forecasts for Japanese asset prices strike us as intensely conservative as there is tremendous 30 Ise foreign asset 60 — Short-term loans skepticism that the country's long-term prospects have (WY aril, commutative) hedge demand 70 really been changed by the advent of Abenomics.2 20 - USD1PY (RHS, inverted) 80 Inevitably there will be bumps along the way, and 10 90 nobody should expect a free lunch. But until the basic 100 tenets of what remains a uniquely favorable backdrop 0 110 of fundamentals and potential flows are challenged or •10 • 120 overshadowed (geopolitics, anyone?), encourage investors to replay last year's template as this year's and 190 -20 basic game plan. We expect FX-equity correlations to unwinds 140 Carry trade extends. remain extraordinarily high and volatility to stay -30 150 elevated. Our end-2014 and 2015 USD/JPY forecasts of 96 98 00 02 04 06 08 10 12 14 115 and 120 are reiterated with upside risks. &Knee' Deutsche aset 8boftwg 'nine.> CP 2 For a convincing exposition of this assertion, see Kuroda's recent speech: James Malcolm, London, (+44)20754 50884 https://www.boi.or.iaten/announcements/pressAoen 2013/clata/ko131225 Taisuke Tanaka, Tokyo alacif Page 6 Deutsche Bank AG/London EFTA00610281 9 January 2014 FX Blueprint: Thin end of the wedge Theme #3: - Home Counties trump Mounties • Inflation risks and potential FDI inflows should keep sterling supported this year, but a widening IInflation Could Be Here Sooner Than Market Expects current account deficit and stronger USD will 58.0 , Emplyt PMI, 9m lead constrain gains versus the euro and dollar. We are —GBP AWE reg pay, priv moderately bearish EUR/GBP and GBP/USD, 56.0 forecasting 80p and 1.54 by end-year respectively. 54.0 • As an outright trade we prefer buying GBP versus 52.0 CAD, on which we are more bearish. It remains 50.0 vulnerable to an equally-large current account deficit, QE-flow unwinds and unwinding internal 48.0 imbalances. 46.0 The UK domestic demand cycle has kicked in quicker, 44.0 stronger and more sustainably than anticipated. We 42.0 see inflation and FDI inflows as being the major source of upside risk for GBP next year. 40.0 Jan-01 Mar-03 May-05 Jul-07 Sep-09 Nov-11 San' Sabaf AfarsItpreway. 1W Inflation, not deflation to be theme in 2014 Last year was all about UK growth expectations. This year, the risk is attention turns to prices. First, even IFDI Upside Risk To GBP Next Year though recent inflation prints have surprised to the so downside, pipeline pressure is building. Productivity is 0Budget ler UK Trees end wwwww. hived IndtritMent. MAO GBP not recovering as quickly as the BoE is expecting, so leading to a much faster than expected drop in the unemployment rate. In turn, wage inflation could 11 40 accelerate sharply in 2014 (chart 1). Second, the starting point of inflation is much higher in the UK than 30 the rest of G10. Any turn in the trend will focus minds much more quickly than elsewhere. With the first BoE rate hike still only priced for mid-2015 (a bit earlier than 20 the Fed), there is plenty of potential for near-term yield support as price pressure builds. 10 Outside of monetary policy, FDI is another source of 0 — support. Excluding the Verizone-Vodafone deal, UK 2008 2000 2010 2011 2012 2013 inbound has been muted by pre-crisis standards. Souses Asses &int Doemeerd 'Mang LIP But UK deal-flow is pro-cyclical, tracking the broad trends in equities and global transactions well. IEUR/GBP Holding Up Better on Back of Flow Our equity analysts are positive on both this year. Add to that the UK government's increasing dedication to EUR/GBP (6m lag, Ms/ 130 attracting foreign investment - particularly into the —RICS House Price Balance (rhs, inverted) publicly-owned banks - (chart 2) and FDI stands out as 1 90 a potential additional source of support for GBP in 2014. 0.9 Current Account Deficit Will Constrain Gains vs. EUR 30 0.8 On the flipside, the UK recovery is happening for the "wrong" reasons. Domestic demand, not exports are -20 driving the cycle. The current account deficit is 0.7 deteriorating and stands in contrast to the US and Euro-area. This goes a long way to explain the lag in 0.6 EUR/GBP versus cyclical indicators (chart 3). This is reflected in our conservative EUR/GBP forecasts: we see a slow grind lower to 0.80 by the end of the year, 0.5 12( with GBP/USD revisiting the low 1.50s on the back of a 94 96 98 00 02 04 06 08 10 12 strong USD. Soutar Disney Gant ow-vow guano, LIP Deutsche Bank AG/London Page 7 EFTA00610282  9 January 2014 FX Blueprint: Thin end of the wedge CAD Flow Picture Very Negative We are more bearish CAD. Speculative shorts are building, but on the portfolio flow side, the balance of IUK Inflows Could Improve, Opposite of Canada payments is characterized by a large overhang of fixed 1100 2500 Cumulative bond inflows, income inflow positions as a by-product of Fed QE (chart 4). Canada benefitted from close to 280bn of 1000 local currency, bn "excess" inflows over the 2010.2013, which have 900 2000 -750bn plugged a sharply wider current account deficit similar (UK) in size to the UK. The UK, in contrast, has suffered from 800 1500 1 a lack of inflows in recent years (chart 4). While FDI 700 and underweight fixed income positions have the +280bn 600 (Canada) 1000 potential to "plug" the UK deficit, the risks appear skewed the other way in Canada. 500 400 change relative On the monetary policy side, Canada doesn't appear to trend well placed to benefit from an improving US cycle 300 either. Rate expectations are already running ahead of 200 0 the Fed and BoE by a quarter, and given the BoC's 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 renewed dovishness there is limited potential of these Sown. a* it. rlater Rea&Ye.: Nig happening sooner. Indeed, the correlation between US and Canadian data surprises has dropped off sharply over the last few years, pointing to the divergent trends !GBP/CAD 'Current Account Neutral' Cross in local housing markets and domestic leverage. To boot, Canadian terms of trade have clearly peaked 10 Current account deficits., (my bn (chart 6), with the currency moderately expensive versus non-energy commodity prices and supply glut in North America oil production providing an additional headwind. Big picture, GBP/CAD is a dollar-neutral cross, with correlations with other USD crosses all lying below 50% over 1-3 year time horizons and zero correlation with the broad USD TWI since 1995. The relative performance between UK financials and Canadian stocks does a decent job of explaining big picture turns since the early 1990s. The cross remains more than 20% below its pre-crisis average suggesting plenty of potential for upside as the respective domestic stories play out. 90 91 92 93 95 96 97 98 00 01 02 03 05 06 07 08 10 11 12 Source' °math, eant atiOntteep Aveiro UP George Saravelos, London, Oliver Harvey, London, IUSD/CAD Following Commodity Prices Lower IGBP/CAD a Beta Neutral Cross 95 97 99 01 03 05 07 09 11 13 0.85 45( 2.8 i —GBP/CAD Ohs) 1 —UK fina cials/Toromo stock index (rhs) 0.95 2.6 0.9 40( 1.05 2.4 0.8 1.15 35( 0.7 2.2 1.25 0.6 30( 2 1.35 0.5 1.8 1.45 25( 0.4 1.6 0.3 1.55 20( 1.4 0.2 1.65 — USD/CAD (Ihs, inverted) — BoC Non-energy Commodity Price Index irhs 15( Sewn Amuse-ftBIM Soutar Akan» &Mc &bombers Fran. UP Page 8 Deutsche Bank AG/London EFTA00610283 9 January 2014 FX Blueprint: Thin end of the wedge Theme #4: - Swiss out We can think of three reasons to go short CHF/NOK. INOK one of highest betas to US cycle, CHF lowest 1. The relative cycle is supportive of rate differentials. 35% FX correlations to quarterly US GDP Ekon 1990 Inflation is at a much higher starting point in Norway ARom2000 30% than in Switzerland, leaving the Norges Bank much less room to manoeuvre than the SNB in the event of 25% upside surprises to import prices or stronger European 20% growth. Market pricing in Norway has evolved rapidly from three months ago, with the first hike now 15% expected in Q3 2015 rather than Q1 2014, more or less la% in line with the Norges' own projections. NOK is also much better placed to benefit from a stronger US cycle with one of the strongest correlations to US growth, and CHF one of the weakest. One risk is house prices, which have risen precipitately in Norway over the last 4% five years, a sharp reversal of which could weigh on -10% domestic demand and prompt Norges' dovishness. We AUD sec NOK 1420 GaP CAD EUA 01f JPY think the risks of this are slim, however, (see theme #6), San O.41tithe Sent Scone., name, LP and moderate falls will be welcomed by the central bank as skimming froth from the market. 'Norway flow reversal nearly done, Swiss yet to begin 2. Swiss safe-haven unwind should follow Norway's. not 00,110P4 1yµ9. % GDP Like Switzerland, Norway experienced large-scale safe 5% 9,titualend. not path:. flows haven inflows as a consequence of the financial crisis, 0% helping to pause customary current account surplus recycling. In the latter's case, these inflows have largely reversed, to the tune of NOK 190bn on a 2y/2y 5% basis). This has been one of the primary recent drags on the krone, but appears to have largely run its course, in contrast to Switzerland where it has yet to begin. 3. CHF also more vulnerable to domestic outflows. As well as the foreign inflow, Norway and Switzerland both saw significant repatriation o