JPM_Global_FX_Strategy_2012

 2012 Outlook: Currencies during European recession & global stagnation (John Normand) 4
2012 presents a unique tension between an unprecedented macro environment and very defensive investor
positioning. The next 100 days will be critical in avoiding a sovereign credit event and global recession.
Averting disaster and achieving stagnation should be sufficient to ease the dollar lower next year, but expect
only a 2% trade-weighted decline and another year of above-average volatility (12%-15% on VXY). Global
recession would probably deliver 8% strength in USD, so less than Lehman given existing USD longs.
 Five global macro themes and top trades (Paul Meggyesi, John Normand, Matthias Bouquet) 14
Top five trading themes and recommendations: (1) implementation risks around Europe are huge (EUR/JPY
put spreads , bullish USD/SEK fly); (2) desperate times demand desperate action (short USD/JPY 1x2 put
spreads, short GBP/JPY through seagulls, short 6-mo EUR/CHF puts; (3) no winners in European cage match
(3-mo range binaries in EUR/GBP and EUR/NOK); (4) some safe havens are safer than others (long
NOK/SEK); and (5) valuation re-asserts itself (short NZD/CAD).
 Post-mortem on 2011 forecasts and trade recommendations (John Normand, Sunil Kavuri) 16
Forecast accuracy was better than the consensus for Q1 to Q3, but was poor in Q4 when the dollar turned. On
trade recommendations, returns and success rates on options trades were the highest in four years, whereas
those on cash trades were average.
 FX Volatility: Here to stay (Arindam Sandilya, Matthias Bouquet) 18
European recession and G4 deficit consolidation will keep volatility and the vol-of-vol high again in 2012
(12%-15% on VXY Global). Systematic short gamma strategies should prove ineffective; overlay long vega
hedges through calendar spreads. Risk reversals in high-beta currencies should outperform straddles as
defensive plays. Optionalised carry should provide positive but noisy returns.
 Long-term Technical Strategy: Is resistance futile? (Thomas Anthonj, Niall O’Connor) 30
The USD rally should continue into Q1 following reversal from key supports. Key resistance on DXY is
80.00/81.44. EUR/USD has downside but could stabilize in 1.26/1.28 region. Yen enters another solid year
even with momentum slowing. Commodity currencies still look range-bound. Chart patterns for CEEMEA
currencies are dire, whereas Latam and EM Asia should recover in Q2.
 Feature: ECB debt monetization–correcting a historic anomaly would lift euro (Ken Landon) 46
The ECB’s prohibition against debt monetisation is a historical anomaly. Allowing Fed/Bank of England-like
activity would strengthen the euro by reducing sovereign default risk.
 Yen: USD/JPY to continue its downtrend, with risk of breaking 70 (Tohru Sasaki, Junya
Tanase, Anna Hibino) 50
Even at all-time highs, the yen should benefit from a year of low global rates, sovereign stress and reserve
diversification. The Bank of Japan cannot floor USD/JPY as the SNB did with the Swiss franc.
 Euro: the make-or-breakup year (John Normand) 60
2012 will test what remains of euro resilience. The pivotal issue isn’t Europe’s recession, which is guaranteed
and discounted. The question is whether 2012 delivers a Lehman-like sovereign event. ECB and IMF funding
will be required to prevent this outcome. If combined with structural reform, EUR/USD can remain in a 1.30s
range, even during a European recession.
 Sterling: Still dodging the limelight (Paul Meggyesi) 66
2012 should mark the fourth consecutive year of sterling consolidation, as the UK’s slow-burning economic
malaise cannot compete for attention with the Euro area’s rapidly-evolving fiscal and political drama.
 Swiss franc: Check the dam for cracks (Paul Meggyesi) 70
The fundamental forces which drove record appreciation in 2011 – sizable current account surplus, strong
economy, massive overseas borrowing in CHF – are still intact. The SNB has infinite capacity to peg
EUR/CHF, but the cost in terms of inflation and excess credit growth will become more apparent next year.
Expect the floor to hold at 1.20 before yielding in 2013.
 Swedish and Norwegian kronas: Falling short of safe-haven status (Paul Meggyesi) 76
An assertive SNB and BoJ are sending investors towards other, potential safe havens. NOK and SEK satisfy
only about half the criteria for safe harbors, with NOK preferred due to the Norwegian economy’s lower
correlation to global growth.
 Commodity currencies: Risks loom large for Q1 (Kevin Hebner) 82
Stronger fiscal positions, soaring terms of trade and ongoing reserve diversification are no insulation from
Europe. NZD/USD is the most vulnerable given its internal and external imbalances.
 Long-term valuation: USD fiscal premium is modest (Justin Kariya) 90
Fundamental fair value models suggest that the most expensive currencies are JPY, NZD and BRL while the
cheapest are TRY, MXN and PLN. The dollar is about 5% undervalued.
 Model-driven strategies in 2012 (Sunil Kavuri) 94
Carry and price momentum will struggle again in 2011 if markets remain trendless but volatile. Shorter-term
rate momentum strategies like forward carry have the highest odds of delivering positive returns.
 Global FX carry trade monitor (Anna Hibino) 98
Currency managers and global macro funds hold above-average shorts in G-10 and EM carry. Japanese retail
holds an estimated ¥5.1 trillion ($66bn) in yen shorts, mostly versus USD ($24bn) and AUD (A$32bn).
 J.P. Morgan FX forecasts vs. forwards & consensus 100
Q1 should see USD strength followed by a re-weakening. Baseline targets by Q4 on the benchmarks are DXY
76, JPMQUSD 80, USD/JPY 72, EUR/USD 1.38, GBP/USD 1.58 and AUD/USD 1.04.
 Risk scenarios to accompany 2012 FX forecasts 102
Risks around the baseline are asymmetric for some currencies. This section highlights biases, targets under
alternative scenarios and trigger events for a change in view.
 Data tables
Recent real effective exchange rate trends ............................................................................... 104
FX performance in 2011: spot vs risk-adjusted returns ........................................................... 105
Peripheral bond redemptions in 2012........................................................................................ 106
Global government bond and bank redemptions, 2012-2013 ................................................... 107
Sovereign credit ratings and actions.......................................................................................... 109
Central bank announcement dates in 2012 ................................................................................ 110
Event risks in 2012 .................................................................................................................... 111
 Other J.P. Morgan forecasts
Rates, credit, equities & commodities ................................................................................... 115
Global growth and inflation forecasts ................................................................................... 116
Global central bank forecasts ................................................................................................. 117
Real GDP growth ................................................................................................................... 118
Consumer prices .................................................................................................................... 120
Basic economic statistics: international comparisons ............................................................ 121
Economic outlook in summary .............................................................................................. 122
Research Notes published in 2011 available on www.morganmarkets.com/GlobalFXStrategy ..... 123