EFTA01451185.pdf

9 January 2014 FX Blueprint: Thin end of the wedge Hard to See FUR Story Gut Any Better IEURIUSD Still Tracking Rate Differentials The EUR was the star performer in 2013, despite a strong dollar elsewhere. The Euro-area's large current 1.4 .... EUR/USD Ohs) - 0.1 account surplus has helped, which has pushed the -Implied 2yr E R/USD yields (rhs) 1.38 basic balance into positive territory and in the past has been associated with broad-based EUR-appreciation. It 1.36 is for this reason that we expect the EUR to continue to 1.34 hold up relatively well against many GIO FX. Looking at 1.32 drivers more relevant to EUR/USD however, the positive factors that have driven strength versus the 1.3 dollar have peaked. 1.28 1.26 First, interest rate differentials should turn lower over 1.24 2014. Looking across different tenors as well as bond versus implied forward yields, we find that the euro is 1.22 most sensitive to short-dated forward-implied yields. 1.2 I -0.5 Last year short-end European yields moved higher not Jun-12 Sep-12 Dee-12 Mar-13 Jun-13 Sep-13 Dee-13 only on the back of ECB LTRO liquidity withdrawal, but San Gantt** 6* anima ocenenlas Praha, IKOM0011. 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 'Portfolio 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 Busness Surveys Ohs) room left for higher short-end European yields. In —Net Portfolio flow, inyeretd outflow; 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 O On the flow side, the best is behind us as well. Portfolio 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 09 10 11 12 13 current account surplus on the back of recovering San Doursthe /VA &member,' Ansa LP 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. IN2D. SGD, CHF Most Expensive FX in the World (a) Other Dollar Crosses to Short Looking outside of EUR/USD, NZD. SOD, and CHF are 30 1 20 1 PPP valuation adjustedfor productivity and terms of trade (BEER) our top shorts. The Swiss franc is a higher beta version of EUR/USD, with valuations more stretched and greater potential for capital outflows. NZD and SGD are the most over-valued currencies in the world, having lagged all other FX in the USD appreciation that has .110 01 IIIIIIAIr.,,,,,,, firnunimmil 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 1 weighted indices over the last ten years. -d0 George Sal avelos, London, -50 - figal Hafeer. London, PU t:15:82n Oicitt 3gig8W IS TI CLef it2 San dun** an toonbeg #wwe LP Page 4 Deutsche Bank AG/London CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0 107474 CONFIDENTIAL SDNY_GM_00253658 EFTA01451185