EFTA01459596.pdf

12 January 2016 FX Blueprint: Forever Young Europeans abandoning Europe European outflows are being driven by "rear flows On the other side of the Atlantic the recovery remains intact but the euro has not been responsive to better 40 bn BUR. European data. Ongoing ECB dovishness, negative 12rnma yields, and European investors' large underweight in 30 foreign assets all suggest that these outflows are likely Net Europese. to continue, a phenomenon we have previously termed 20 po • *flows Euroglut. Interestingly, the composition of portfolio 10 flows between different investors has undergone a significant transformation over 2015. Non-bank portfolio flows have become the dominant portion of Euro-area capital outflows, suggestive of underlying -10 shifts in European investor preferences rather than changes to bank balance sheets that are also typically hedged (chart 4). 99 01 03 05 07 09 11 13 15 ECB taper not important as Fed rate hikes Scarce GlobsI MotesReS Sbarteg Anne LP Persistent weakness in the oil price and downside surprises to inflation suggest that the risks are skewed toward more ECB easing this year. But could a decision Fed po icy (and short-end) matters more than ECB QE by the ECB to taper its QE purchases later mark the end of the EUR/USD bear run and by extension the 70% - Correlation/beta between different tenors of long-term dollar up-cycle? It is doubtful this would be US- Euro rate differentials and EUFVUSD the case because ECB decisions on QE are more 60% relevant for the long-end of the European curve rather 50% - than near-term rate expectations. The latter in turn exert significantly higher influence on FX (chart 5). So 40% - long as the European short-end remains anchored, it will be the pace and timing of the Fed cycle that will 30% - dominate dollar drivers rather than the pace of ECB 20% - China and risks to dollar outlook 10% - The biggest risk to our dollar view is a significant slowdown in the US economy that stops (rather than 0% decelerates) the Fed hiking cycle and potentially brings 2yr Syr 10yr 30yr easing back on the table. Beyond that, portfolio flows, SOWN Dana* Balt BleentbnRums IF relative central bank cycles, and China's recent willingness to tolerate more dollar strength all suggest the dollar has more scope to appreciate in 2016. The Dollar cycle not unusual or extreme latter is particularly important because past USDCNY stability has prevented the broad trade-weighted dollar 160 USD broad tads-weighted from appreciating as much as the narrow index given 1100v trough or peak n cycle) 1978 up- China's high weighting. Given our ongoing bearishness 150 cycle on RMB (see theme 3) we therefore prefer the broad 140 over the narrow trade-weighted dollar, which also remains cheaper on account of CNY valuations. Indeed, 130 even if the current dollar rally is faster than the late 1990s, it remains well within the bounds of previous 120 dollar cycles. We remain bullish on the dollar while also looking for a move down to 95cents in EUR/USD by the 110 end of the year. 100 George SaravekAy, London, +44(20 754 51947 90 09 11 13 15 17 Saar Dance* ant Pecenterg Inane* IP Page 4 Deutsche Bank AG/London CONFIDENTIAL — PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0120112 CONFIDENTIAL SDNY_GM_00266296 EFTA01459596