FOREIGN EXCHANGE RESEARCH

2 September 2010

FX WEEKLY BRIEF Widening peripheral bond spreads: Is this time different?

Although peripheral euro area sovereign yield spreads have widened to levels last reached at the peak of the fiscal crisis earlier this year, the EUR has not weakened significantly. In our view, the banking stress tests are the main reason why this time is different. A not-too-different world 9 The BISs triennial survey of FX markets allows a comparison of the pre- and post-crisis world. FX markets seem unchanged, but there are early signs of some new trends.

Editorial

FX Short-term and Technical Strategy Views 3 Open Trade Recommendations 4

Closed Trade Recommendations and OPERA 12 Forecasts EM FX Views on a Page Weekly performance of currencies versus the USD
AUD NOK SEK NZD PLN BRL ZAR CHF KRW TRY EUR CAD JPY INR MXN RUB CNY -0.3% GBP -0.8% 2.7% 2.5% 2.2% 1.8% 1.7% 1.6% 1.2% 1.2% 1.1% 0.9% 0.8% 0.6% 0.3% 0.3% 0.1% 0.0%

13 15

Figure 1: Currency performance against the EUR in the two episodes of peripheral spread widening
SEK

NOK AUD z JPY

Note: Based on Thursday 4pm London rates. Source: Bloomberg

NZD -2% 0% 2% April 12-May 10

Source: Barclays Capital

BarCap forecasts
4% 6% 8% 10%
3m forecast Returns against forwards

August 5 - August 26

USD Index EUR/USD USD/JPY GBP/USD USD/CAD AUD /USD NZD /USD EUR index EUR/GBP EUR/CHF EUR/SEK EUR/NOK Major EM USD/CNY USD/INR USD/KRW USD/RUB USD/ZAR USD/BRL USD/MXN

84.24 1.25 87.00 1.58 1.06 0.88 0.70 102.54 0.79 1.40 9.30 7.90 6.71 47.0 1125 30.3 7.55 1.80 12.85

2.1% -2.5% 3.4% 3.0% 0.7% -2.1% -1.5% -1.9% -5.3% 8.0% -0.3% -0.4% -1.1% -0.6% -5.0% -1.9% 2.5% 1.5% -2.3%

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 16

Source: Barclays Capital

Barclays Capital | FX Weekly Brief

EDITORIAL

Beware of changing tides

It started off as a ripple, with singular economic data releases surprising to the upside of the consensus, but now has market participants wondering whether it portends a change in the tide in so far as market sentiment and risk aversion are concerned. That market moves have been large could be explained by either the fact that investor positions had become overly bearish or that key economic releases have come at a time when liquidity conditions have worsened with this past week having been sandwiched between a UK bank holiday and the US Labor Day weekend. On the former, our measures of positioning suggest that although FX investors have been less bullish about risky assets, they are by no means overwhelmingly bearish. Indeed, the larger positions may have been in other asset markets, such as US fixed income. As these are squared up, the ensuing move in US interest rates could well support the USD and temper any rally in risky assets. In the very near term, the recovery in market sentiment could be held up by the crucial US non-farm payroll report and ISM non-manufacturing surveys. Consensus expectations do not appear overly pessimistic, looking for a gain to private payrolls, with only two out of 51 economists polled by Bloomberg actually calling for a decline. However, the weakness in other measures of employment point to potential downside risks. Although much has been said and written about the strong ISM manufacturing numbers, it is the services sector, not manufacturing, that is the primary employer and the bigger contributor to US GDP (in terms of Gross Value Added). Our expectation for the ISM non-manufacturing trails consensus forecasts, as well. As a result, gains for risky currencies may be muted. One of the bigger stories to have developed recently has been the widening of European government bond spreads in the euro area periphery close to levels last reached during the euro area sovereign debt crisis. While the EURs recovery appears to have hit a road bump, falling sharply against safe haven currencies, all is not exactly the same. Despite its recent weakness and the increase in spreads, EUR/USD is more than 7% higher than its trough in June. In Widening peripheral bond spreads: Is this time different?, we examine why the EURs response to increased worries about peripheral Europe has not matched its experience during the sovereign debt crisis. The sovereign debt crisis and the grand-daddy of them all the global financial crisis circa 2008 showed how important liquidity can be during periods of market turmoil. The relative simplicity of the FX market, its large size and the variety of participants made it especially attractive to non-traditional FX investors in search of macro hedges for their asset portfolios. The BISs Triennial Central Bank Survey of foreign exchange activity provides a good opportunity to view how FX markets have changed in the pre- and post-global financial crisis world. We discuss the survey results in A not-too-different world.

2 September 2010

Barclays Capital | FX Weekly Brief

FX SHORT-TERM VIEWS AND TECHNICAL STRATEGY

Week-ahead views, confidence levels and OPERA allocation
Currency EUR JPY GBP CHF CAD AUD NZD SEK NOK Bias Bullish Bearish Bearish Neutral Bearish Bullish Bullish Bullish Neutral Weekly view We expect few surprises from the US employment report, which may, given the recent data flow, feel like good news. After payrolls tomorrow, the data schedule is relatively light in the US. JPY should be more influenced by US Treasury auctions and the risk of intervention by Japanese authorities. More data are to be released in the UK than in other major economies this week. The BoE is unlikely to do anything market-moving, but we think the risks to the data are to the downside The CHF has been the star currency of the summer, which has led it to become firmly overvalued. It may be too soon for its rise against the EUR to reverse, but it is likely to slow. Weakness in US and Canadian economic data could lead to a potential softening of the BoCs stance. US payrolls data could be a modest positive for risk. We expect the RBA to remain on hold next week and think it could continue to talk down the prospects for further rate hikes this year. Local labour market data also hold downside risks. A return from summer holidays could lead to higher trading volumes and investors putting on risk. The Swedish economy remains buoyant and any rally in risky assets is likely to lead to SEK outperformance. EUR/NOK has been going sideways recently. We see little reason for this to change in the very near term. Allocation 0.36% -0.36% -0.36% 0.00% -0.36% 0.36% 0.36% 0.36% 0.00%

Note: We use these views as inputs to our OPERA portfolio. High confidence views are signified by an asterisk. All views expressed relative to the USD. Source: Barclays Capital

Technical strategy
The secular trend for USD/CHF is down. While that move has paused during the past two years, an unfolding bearish Pennant formation suggests it is far from over. Recent CHF strength on the crosses is driving USD/CHF closer to the edge of the pattern. Although current price action is benign and we expect further range trading in the months ahead, it is worth noting that 0.9915 may be an important tipping point. A close below 0.9915 would complete the formation, signal that the secular downtrend has resumed, turn our long-term outlook bearish (targeting 0.9500 on a near-term horizon) and suggest a growing risk for a return to trendline support at 0.8560 in the coming years. This is a heads up to that long-term risk.

Source: CQG

2 September 2010

Barclays Capital | FX Weekly Brief

Open trades, as of 2 September 2010

Original Spot reference % of notional Current spot reference Mark to market Net profit since inception Profit change (since 26/8)

Trade/date/macro views

Expiry

Initial rationale: In the short run, we think that EUR/GBP is likely to continue to range trade but that the second half of the year should see general GBP strength once the UK election is over and the MPC comes closer to tightening policy. Long 7m EUR/GBP 1x2 put spread (0.88 and 0.83 strikes), 18/03/10 0.8955 0.95% 18/10/10 0.8325 +2.55% +0.48pp

Initial rationale: Both carry and value look attractive, but returns will likely depend heavily on the various risk scenarios vis--vis higher US interest rates, China tightening, and sovereign fiscal issues. As a result, we recommend being long a less regime-dependent strategy VECTOR (for details and a description of current allocation, please see VECTOR: Value Enhanced Carry Trading of Exchange Rates, 15 October 2009 and VECTOR Monthly Rebalancing Update, 15 July 2010). Long VECTOR strategy, 18/03/10 219.8156 216.5243 -1.50% -0.43pp

Initial rationale: The spread between EUR/AUD and EUR/GBP implied vols is near historical lows, and our analysis suggests the spread tends to widen under various risk scenarios, including a repricing of the risk premium associated with China. Long 0.55 vega of 1y 12.1% EUR/AUD vol swap, short 0.45 vega of 1y 11.35% EUR/GBP vol swap, 17/03/10 EUR/AUD vol: 11.7% EUR/GBP vol: 10.9% 17/3/11 EUR/AUD vol: 12.74% EUR/GBP vol: 11.02% +1.64% -0.18pp

Initial rationale: Implied volatility curves are significantly upward sloping, suggesting that the market believes volatility has already bottomed, although we are just a few months into the recovery. We think this steepness is unlikely to persist. Although the trade did not reflect our initial rationale once the first leg expired, we decided to keep it because it is consistent with our bullish EUR/JPY view. Long 3m 132.50 EUR/JPY straddle, short 2y EUR/JPY strangle (strikes: 155.50 and 109.25), 25/9/09 132.90 0% 24/12/09 (expired) 27/09/11 107.93 -5.56% +0.33pp

Initial rationale: The volatility spread between USD/CAD and EUR/USD is at historically low levels, and this represents a true mispricing based on the risk scenarios considered. Furthermore, the themes considered in FX Quarterly support a rise in USD/CAD volatility and a fall in EUR/USD volatility, thereby implying a widening of the spread. Long 6m USD/CAD volswap at 13.80%, short 6m EUR/USD volswap at 13.75%, 25/06/10 USD/CAD vol: 12.90% EUR/USD vol: 14.35% 27/12/10 USD/CAD vol: 12.11% EUR/USD vol: 12.46% +1.30% +0.36pp

Initial rationale: A relative ranking of currency performance based on Barclays Capitals views for various asset classes and alternative risk scenarios suggests that the SEK will do well, while the JPY will not. Long 3m SEK/JPY call spread (12.4 and 13 strikes), 25/06/10 11.51 1.01% 27/9/10 11.59 -0.88% -0.04pp

Initial rationale: As fiscal adjustments become the major issue among the G4 economies, the GBP is in relatively better shape than the G3, with a budget proposal that has laid out an aggressive plan for fiscal consolidation and a weaker exchange rate to assist in the adjustment process. Long 6m worst of GBP call, EUR, USD and JPY put 2% OTM (strikes: 0.8080,1.5203,136.29), 25/06/10 EUR/GBP: 0.8242 GBP/USD: 1.4905 GBP/JPY: 133.62 0.75% 23/12/10 EUR/GBP: 0.8326 GBP/USD: 1.5397 GBP/JPY: 129.69 -0.32% -0.25pp

Initial rationale: A high inflation environment is likely to be associated with strong commodity prices CAD upside. Low inflation and global growth concerns may lead to an increase in risk aversion and another flight to quality USD upside. And a mixed picture could result in US monetary policy remaining very loose while the BoC tightens. USD/CAD is likely to move outside the 1.00-1.10 range it has been in since October 2009. Long 4m USD/CAD put at 1.00 and KO for the first 2m at 0.99, and Long 4m USD/CAD call spread 1.10 and 1.1250, with the second leg KI at 1.15, 25/6/10 1.0450 0.90% 28/10/10 1.0530 -0.37% -0.06pp

Note: Closed recommendations are at the end of this publication. Source: Barclays Capital

2 September 2010

Barclays Capital | FX Weekly Brief

FOCUS: EUR AND SOVEREIGN RISK

Widening peripheral bond spreads: Is this time different?

Aroop Chatterjee +1 212 412 5622 aroop.chatterjee@barcap.com Paul Robinson +44 (0) 20 7773 0903 paul.robinson3@barcap.com Raghav Subbarao +44 (0) 20 7773 4144 raghav.subbarao@barcap.com

Although peripheral euro area sovereign spreads have widened to levels last reached at the peak of the fiscal crisis earlier this year, the EUR has not weakened significantly. We believe that the banking stress tests are the main reason why this time is different. It has been dj vu all over again for global asset markets European government bond spreads in the euro area (EA) periphery have widened close to levels last reached during the euro area sovereign debt crisis circa three months ago, while the EURs recovery appears to have hit a road bump, falling sharply against the likes of the JPY, CHF and USD over the recent past. However, all is not exactly the same: the recent widening in peripheral bond spreads differs in some ways, and despite its recent weakness and the increase in spreads, EUR/USD is more than 7% higher than its trough in June. What explains the dampened response of the EUR to the increased worries about peripheral Europe, and how are things likely to develop? In our view, there were several important reasons why the EUR weakened so significantly in the earlier period. First, monetary policy expectations changed. Part of the reason was that fiscal policy was expected to be tighter, especially, but not only, in the peripheral economies. The natural corollary is somewhat looser monetary policy than would otherwise be the case. As the exchange rate is more closely linked with monetary policy, this would typically lead to a weaker real exchange rate. But part was also because the relationship between the ECB and the euro area governments had also appeared to change most notably when the ECB announced that it would start purchasing government bonds. The risk premium on the EUR also increased significantly. Again, there were several aspects to this, in particular: The EA appeared more vulnerable to weaknesses in global growth. Prior to the crisis, the EA had increasingly become a two-state economy. Some economies, notably Germanys, ran large current account surpluses and had relied to a large extent on

Figure 1: The recent rise and fall of EUR/USD coincided with changes in the real yield differential
0.8 0.6 0.4 0.2 1.4 0 -0.2 -0.4 -0.6 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Real yield differential (LHS) EUR/USD (RHS) 1.3 1.2 1.1 pp 1.7 1.6 1.5

Figure 2: Currency performance versus the EUR

SEK CHF NOK GBP AUD CAD JPY USD NZD -2 0 2 4 6 8 10

April 12 - May 10
Source: Barclays Capital

August 5 - August 26

Note: The real interest rate differential is that implied by 10y swap rates. Source: Barclays Capital

2 September 2010

Barclays Capital | FX Weekly Brief

exports to drive growth, while others, for example Spain, had had booming domestic demand driven by credit and a large current account deficit. Following the crisis, it appeared likely that the German part of the EA would carry on saving but the Spanish part would increase its savings rate significantly. The result would be that a large part of demand for EA goods and services would need to come from outside the EA, and therefore a global slowdown would lead to a weak EUR at the same time as underperformance of global risky assets. This correlation would be expected to lead to an increased risk premium. The way the EA would work in the future had become less clear, to the point where many were wondering whether it would continue to exist. What was clear was that some important issues needed to be addressed and that the uncertainties that this brought about increased market nervousness about holding the EUR. The health of the EA banking system came into focus. There was widespread uncertainty about how exposed the banks were to EA sovereign debt, but the prospect of a vicious circle between the public finances and banks became a concern. So what has changed so that increased spreads have less effect on the EUR? An important factor has been the softening economic picture in the US, which has led to an increase in the perceived likelihood of future monetary easing from the Fed. As Figure 1 shows, the recent path of EUR/USD has moved with relative interest rates in the two economies. The weaker outlook for the US economy has been a key driver of the recent increase in global risk aversion. The increase in sovereign risk spreads has reflected the weakness of risky assets across markets falling equity prices, widening corporate credit spreads, rising implied volatilities etc. Previously, the sovereign issues had driven the risk aversion. Consistent with that, as Figure 2 shows, the EURs decline has been concentrated against the safe-haven currencies; the broad decline seen during the previous episode has not been repeated. There has been some negative news on the peripheral economies. S&P downgraded Ireland's sovereign credit rating one notch (to AA from AA-, outlook negative) on concerns about the rising cost of supporting the country's banks, and there was a weakerthanexpected Q2 GDP print in Greece (alongside the media reports of increasing internal tension Figure 3: Benchmark equity index correlations with the DAX Figure 4: Dispersion of sovereign yields and changes in sovereign yields
350 300 160 140 120 100 80 60 40 20 Dec-09 Mar-10 Jun-10 0 Sep-10

Portugal Italy Spain France Greece 0% 20% 07 Jun 10

Source: Bloomberg

250 200 150 100 50 0 Sep-09

Dispersion in euro area soveregeign bond yields (bp, left)

40%

60% 02 Sep 10

80%

100%

Dispersion in the daily changes of euro area sovereign bond yields (bp, right)
Source: Bloomberg, Barclays Capital

2 September 2010

Barclays Capital | FX Weekly Brief

in Greece on the fiscal austerity measures). But compared with the May episode, these events were relatively minor. This is reflected in the relatively higher (more positive) correlation between various European country benchmark equity indices and the German DAX equity index compared with the low levels during the April-May episode (Figure 3). Consistent with the above factors, the speed of the deterioration in the prospects for the peripheral economies has been much more muted. Figure 4 shows the evolution of EA government bond yields over the past year. The rise in spreads in May happened very quickly, and though the spreads have risen back to similar levels at the peak, the move this time has been much more orderly and come as much less of a surprise. And though the correlation between increased sovereign risk and increased demand for USDs is still intact in the currency forwards and money market as shown by the highly negative correlation between the dispersion of sovereign bond yields and the EUR/USD 1y basis swap (Figure 5) the widening of the EUR/USD basis swap has been much more modest this time around. One way to illustrate the reduced importance of the sovereign issues on the EUR during the current episode is to use our Financial Fair Value (FFV) model. Whereas EUR crosses were extremely undervalued with respect to our short-term fair value model for exchange rates in May, the current level of undervaluation is much smaller (Figure 6). Some of the undervaluation was clearly due to sovereign risk (which is not included in the FFV model): a framework similar to the FFV model incorporating sovereign risk shows that much of the undervaluation was clearly driven by a risk premium associated with the euro area. However, Figure 5 also shows that even after accounting for the sovereign risk effect, the undervaluation of EUR crosses has been much smaller this time around. The results from the FFV analysis suggest that sovereign risk has less of a negative effect on the EUR. In our view, an important reason why has been the calming effect of the bank stress tests. The fears of financial contagion emerging as a result of the increase in sovereign risk appear to have reduced. During the previous flare-up in fiscal risks, counterparty risk and the demand for dollars were key ingredients in transforming the flareup into a crisis. However, despite the increase in sovereign spreads, Libor-OIS spreads have been declining steadily since July, while demand for dollars at the ECB's auctions has been conspicuously tiny the most recent auction had only one bank bidding for $60mn for dollar funding, while the first USD auction, held on May 12, attracted seven bidders for Figure 5: Basis swaps are negatively correlated with sovereign yield spreads
100% 80% 60% 40% 20% 0% -20% -40% -60% -80% -100% -120% Feb-10 -15 -20 -25 -30 -35 -40 -45 -50 -55 Apr-10 Jun-10 Aug-10

Figure 6: Deviations from fair value based on the financial fair value model
2 1 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 EUR/USD FFV May FFV with sovereign risk May
Source: Barclays Capital

EUR/CHF

EUR/GBP

EUR/NOK

EUR/SEK

Correlation between the sovereign bond yield dispersion and EUR/USD 1y basis swap (left) EURUSD 1y basis swap (bp, right)
Source: Bloomberg, Barclays Capital

FFV Aug FFV with sovereign risk Aug

2 September 2010

Barclays Capital | FX Weekly Brief

$9.2bn of funding. This is clearly a reflection of the stabilizing influence of the facilities put in place by the ECB, EU and the IMF some of which provide various EA sovereigns the ability to lend directly to their banks. We think there remains some EUR downside. Pessimism about the US economy appears overdone, and we think that the strength of the EA data in Q2 is highly unlikely to persist. However, while sovereign concerns are not likely to go away, risk appetite may return to the markets, which should buoy the EUR, and we think that it is unlikely that the sovereign concerns are going to escalate significantly. Add to that, we expect the US mid-term elections, which loom ever larger, to lead to increased concern about the US fiscal position. This is likely to become an increasingly important USD negative over the next few quarters. EUR/USD risks remain to the downside in the short run, but we may see a period of range trading while each currencys weak points battle it out.

2 September 2010

Barclays Capital | FX Weekly Brief

FOCUS: BIS REPORT

A not-too-different world
David Forrester +65 6308 3406 david.forrester@barcap.com

The BISs Triennial survey of foreign exchange activity 1 provides a good opportunity to view FX markets in a pre- and post-global financial crisis world. While FX markets do not look all that different, there are early signs of important long-term trends in FX markets.

FX investment is still healthy

The BIS survey points to FX turnover growing by 20% over the 2007-10 period. While this is significantly less than the 50-70% growth witnessed over the 2001-04 and 2004-07 periods, we do not think that this drop-off in growth signals a decline in investor interest in FX or investors confidence. Unlike the period following the dot.com bubble bust in 2000, FX turnover is still growing rather strongly, especially FX spot trading (Figure 1).
The slower rate of growth in FX turnover was driven by weak growth in FX swaps turnover

Most of the drop-off in turnover growth could also be considered more structural than cyclical. The lions share of the decline in FX turnover growth was driven by a large decline in the growth in FX swap transactions. We think this is due to tighter controls on credit lines during and after the financial crisis, especially to corporates, which fits well with the (small) decline in FX turnover going through non-financial customers. The slower growth in FX swap transactions also possibly reflects a decline in the demand for investor hedging of foreign asset holdings via swaps.

A not too different world, but change is coming

The USD is still the number one currency in terms of market share. It held an 84.9% share in average daily FX turnover in April 2010, down from 85.6% in April 2007. Note that the BISs shares in turnover sum to 200% rather than 100% as two currencies are involved in each transaction. The G3 currencies (USD, EUR and JPY) also remain strongly favoured with the EUR and JPY experiencing large increases in their shares of FX turnover to 39% and 19%, Figure 1: Change in FX trading volumes (3 years to April %)*
80 70 60 50 40 30 20 10 0 -10 -20 -30 2001 2004 2007 2010 -3 TRY KRW JPY CAD SEK USD NOK GBP Other
9

Figure 2: Change in share of FX turnover 2007-10 pp

3 2 1 0 -1 -2

Spot transactions Foreign exchange swaps Options and other products

BRL SGD

AUD

NZD HKD

INR HUF

EUR

Note: * Currency swaps are an exchange of a stream interest rate payments in different currencies, while foreign exchange swaps are an agreement to exchange of two currencies (principal only) at a time in the future. Source: BIS

Source: BIS

Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity (www.bis.org). The surveys are conducted in April every three years with the latest two surveys being conducted in April 2007 and 2010.

2 September 2010

CHF

Outright forwards Currency swaps

Barclays Capital | FX Weekly Brief

respectively, this more than offsetting the decline in the USDs share (Figure 2). The G3s overall market share grew to 143% from 140%.
Large currencies such as the USD, GBP and CHF have not only lost ground to the EUR and JPY, but also smaller commodity and EM currencies

But there has been some drift toward G10 peripheral currencies, especially the AUD and CAD as well as EM currencies such as the TRY and KRW and BRL. (Turkey and Brazil have also seen a rise in their shares of global FX turnover within their borders.) These gains, along with the gains in the EUR and JPYs shares in turnover, were at the expense of the other currencies category, but also the GBP, USD, SEK, NOK and CHF. We think that there are a few interesting observations to be made here. 1. We believe that the modest shift toward the smaller G10 currencies as well as EM currencies is beginning to reflect the shift in the main drivers of global growth EM countries and the commodity producers that are helping to fuel their growth. This is a trend that we expect to continue into the future. The prominence of carry trades has also contributed to the rising market shares of TRY, BRL and AUD. The significantly higher interest rates in Turkey, Brazil and Australia that attract these carry trades are also likely to continue as long as EM growth outpaces growth in the G4 by a large margin.

Higher levels of FX turnover are coinciding with higher levels of liquidity, which is making currencies such as the AUD and CAD even more attractive for inclusion in central bank reserves

2. The growing share in turnover of the AUD and CAD is reflected in their improving levels of liquidity, according to our measures of liquidity. While the USD/JPY and EUR/USD remain by far the most liquid currencies (consistent with the G3s growing market share), the liquidity of the CHF and GBP have fallen to below or level with the liquidity in of the AUD and CAD (Figure 3). 3. We wrote in Are peripheral currencies reserve worthy?, FX Special, 8 July, 2010, that it is worthwhile for reserve managers to consider diversifying their baskets with the AUD and the CAD. The AUD and CAD represent good stores of value given their credibleinflation-targeting central banks, low levels of public debt relative to the G4 and their ability to act as hedges against commodity-based inflation. The AUDs and CADs lower levels of liquidity relative to larger G10 currencies may hold reserve managers back, but BIS survey data along with our own liquidity indicators suggest that this may be becoming less of an issue, especially relative to the GBP and CHF. The AUD overtook the CHF to become the fifth most-traded currency in the world in 2010. 4. The IMF COFER data suggest that the USD maintains a dominant share (61.5%) in central banks FX reserves and that this is down only modestly since 2007 (from 65.3%)

Figure 3: FX spot liquidity

1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 07/01/08 04/08/08 AUD
Source: Barclays Capital

Figure 4: Currency shares in central bank FX reserves

70 60 50 40 30 20 10

02/03/09 CAD

28/09/09 GBP

26/04/10 CHF

0 USD GBP JPY CHF EUR Others % share Q1 2007

Source: IMF COFER data

% share Q1 2010

2 September 2010

10

Barclays Capital | FX Weekly Brief

- Figure 4. The USD has made room in FX reserves for the EUR and other currencies. We believe that other currencies consist mainly of peripheral G10 currencies such as the AUD and CAD. The COFER data suggest that there is still a lot of diversifying away from USDs to be done by central banks.

The bottom line

Large currencies such as the CHF, GBP and USD are losing market share not only to the EUR and JPY, but also to smaller currencies such as the AUD, CAD, KRW, TRY and BRL. We expect this trend to continue and to be a long-term positive for these smaller currencies. The gains in FX liquidity these smaller currencies are experiencing make them more attractive for inclusion in central banks reserves. We think that this will be particularly important for the AUD and CAD. Along with improving liquidity, the AUD and CAD also act as good stores of value, which further increases their attractiveness for being included in central bank reserves.

2 September 2010

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Barclays Capital | FX Weekly Brief

FX CLOSED TRADE RECOMMENDATIONS & OPERA

Closed portfolio trades 2010
Original Cost as % of notional 1.06% 0.80% Mark to market at time of closing Profit as % of notional -1.06% +1.83%

Trade/Date Long 8m 1.70 GBP call/USD put, short 8m 1.90 GBP call/USD put, 19/5/2009 Long worst of 4m ATM spot AUD, CAD and NOK calls/CHF put, 9/12/2009 Short EUR/SEK, target: 9.65, stop-loss: 10:30, 9/12/2009 Long 6m 1x1.5 USD/JPY call spread (89 and 95 strikes), 9/12/09 Short AUD/CAD, target: 0.91, stop-loss: 0.98, 9/12/2009 Long 3m 1.2630 AUD/NZD put, 4/3/10 Long USD vs basket of JPY and AUD (50:50), stop-loss: -1.5%, target: +3.0%, 18/03/10 Long 1m 1.27 EUR/USD put and short 1.23 EUR/USD put with a RKI at 1.19, 10/05/10 Long AUD, NZD, NOK versus USD, EUR and JPY basket, 25/6/10

Spot reference 1.5480 AUD/CHF: 0.9287 CAD/CHF: 0.9659 CHF/NOK: 5.6388 10.4907 87.79 0.9629 1.3110 USD/JPY: 90.01 AUD/USD: 0.9212 1.2925 AUD/USD: 0.8646 NZD/EUR: 0.5740 NOK/JPY: 13.7667

Expiry 19/1/10 9/4/10

Current spot 1.6128 AUD/CHF: 0.9717 CAD/CHF: 1.0427 CHF/NOK: 5.5016 9.7244 94.55 0.9190 1.2490 USD/JPY: 90.10 AUD/USD: 0.8240 1.2192 AUD/USD: 0.9009 NZD/EUR: 0.5560 NOK/JPY: 13.8188

1.54% 0.47% 0.72% -

9/6/10 4/6/10 10/06/10 -

+7.23% +2.06% +3.60% +1.23% +5.00% +3.10% 0.90%

Source: Barclays Capital

BarCap OPERA Recommended portfolio allocation (left) and cumulative returns (right)
0.50%
Weights 1%

0.45% 0.40% 0.35% 0.30% 0.25%

0%

0.20% 0.15% 0.10% 0.05%

-1% JPY CAD NZD AUD NOK USD GBP EUR CHF SEK

0.00% 1-Jun-09

29-Sep-09

27-Jan-10

27-May-10

Note: BarCap OPERA (Optimised Exchange Rate Allocation) represents an optimal portfolio allocation for the week ahead that best takes advantage of our short-term views and the associated confidence levels. Cumulative excess returns since 3 October 2008, when OPERA was launched. See Behind the scenes of the BarCap OPERA for details. Source: Barclays Capital

2 September 2010

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Barclays Capital | FX Weekly Brief

FORECAST TABLES
Forecasts Spot EUR/USD USD/JPY GBP/USD USD/CHF USD/CAD AUD/USD NZD/USD EUR/JPY EUR/GBP EUR/CHF EUR/SEK EUR/NOK
Source: Barclays Capital

Forecast vs Outright Forward 6 Month 1.30 89 1.67 1.09 1.08 0.84 0.69 116 0.78 1.42 9.25 7.85 1 Year 1.30 92 1.67 1.12 1.10 0.82 0.67 120 0.78 1.45 9.20 7.80 1 Month -1.0% -1.5% 2.0% 5.9% -0.2% -0.6% 0.8% -2.4% -2.9% 4.9% 2.0% 1.2% 3 Month -2.5% 3.4% 3.0% 10.8% 0.7% -2.1% -1.5% 0.8% -5.3% 8.0% -0.3% -0.4% 6 Month 1.4% 5.9% 8.5% 8.2% 2.4% -5.6% -2.1% 7.4% -6.6% 9.7% -1.0% -1.5% 1 Year 1.5% 9.8% 8.7% 10.8% 3.9% -5.8% -3.4% 11.4% -6.6% 12.4% -2.0% -3.0%

1 Month 1.27 83 1.57 1.07 1.05 0.90 0.72 105 0.81 1.36 9.50 8.00

3 Month 1.25 87 1.58 1.12 1.06 0.88 0.70 109 0.79 1.40 9.30 7.90

1.28 84 1.54 1.01 1.05 0.91 0.72 108 0.83 1.30 9.31 7.89

Long-term FX forecasts (Majors)

18m EUR JPY GBP CHF CAD AUD NZD EUR/JPY EUR/GBP EUR/CHF EUR/SEK EUR/NOK
Source: Barclays Capital

2 yrs 1.28 94 1.67 1.15 1.11 0.80 0.65 121 0.77 1.47 8.96 7.87

3 yrs 1.28 96 1.67 1.16 1.12 0.79 0.64 122 0.76 1.48 8.83 7.91

4 yrs 1.27 97 1.67 1.18 1.13 0.78 0.63 123 0.76 1.49 8.71 7.94

5 yrs 1.26 98 1.67 1.19 1.14 0.78 0.63 123 0.75 1.51 8.59 7.98

1.29 94 1.67 1.14 1.11 0.81 0.66 121 0.77 1.47 9.02 7.85

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Barclays Capital | FX Weekly Brief

CE4 and emerging markets forecasts

Emerging Markets FX Forecasts Spot USD/CNY USD/HKD USD/INR USD/IDR USD/KRW USD/MYR USD/PHP USD/SGD USD/THB USD/TWD USD/ARS USD/BRL USD/COP USD/CLP USD/MXN USD/PEN EUR/CZK EUR/HUF EUR/PLN EUR/RON USD/RUB BSK/RUB USD/TRY USD/ZAR USD/ILS USD/EGP USD/UAH 6.81 7.77 46.71 9010 1181 3.13 44.90 1.35 31.14 31.99 3.95 1.74 1807 495 13.03 2.80 24.72 285 3.97 4.27 30.68 34.58 1.51 7.26 3.78 5.70 7.89 1 Month 6.78 7.77 46.0 8950 1150 3.12 45.00 1.35 31.25 31.75 3.94 1.85 1790 500 12.80 2.80 24.67 285 3.95 4.25 30.80 33.57 1.50 7.40 3.75 5.68 7.90 3 Month 6.71 7.77 47.0 8900 1125 3.10 45.00 1.35 31.00 31.40 4.05 1.80 1750 490 12.85 2.74 24.50 285 3.88 4.30 30.30 33.03 1.50 7.55 3.70 5.65 7.90 6 Month 6.63 7.80 47.5 8900 1075 3.08 44.50 1.35 30.75 30.75 4.30 1.75 1700 480 12.90 2.68 25.40 285 3.85 4.30 29.50 32.82 1.50 7.75 3.70 5.65 7.80 1 Year 6.48 7.80 46.5 8800 1025 3.05 44.00 1.34 30.50 30.00 4.60 1.75 1700 480 12.90 2.75 24.29 280 3.80 4.20 29.50 32.82 1.50 7.90 3.70 5.60 7.80 1 Month -0.3% 0.0% -1.9% -0.8% -2.6% -0.3% 0.1% 0.3% 0.3% -0.6% -0.7% 5.7% -0.9% 1.1% -2.1% 0.4% -0.2% -0.2% -0.8% -0.7% 0.2% -0.29% -1.4% 1.5% -0.9% -0.9% 0.0% Forecast vs Outright Forward 3 Month -1.1% 0.1% -0.6% -2.3% -5.0% -1.2% -0.3% 0.3% -0.5% -1.4% 0.7% 1.5% -3.3% -1.1% -2.3% -1.6% -0.9% -0.8% -2.9% -0.4% -1.9% -3.03% -2.4% 2.5% -2.3% -2.5% -0.8% 6 Month -1.9% 0.5% -0.5% -3.4% -9.6% -2.3% -2.2% 0.4% -1.4% -3.0% 4.3% -3.1% -6.3% -3.6% -2.9% -3.8% 2.8% -1.8% -4.2% -1.8% -5.4% -4.76% -3.9% 3.8% -2.5% -4.1% -4.3% 1 Year -3.4% 0.6% -4.2% -6.9% -14.4% -4.0% -4.7% -0.4% -2.4% -4.5% 5.3% -7.0% -7.9% -4.9% -4.8% -1.8% -1.7% -5.3% -6.4% -6.7% -7.3% -6.72% -7.1% 2.9% -2.6% -7.8% -7.4%

Policy rate forecasts (%, end of quarter)

Current FOMC BoJ MPC ECB Riksbank Norges Bank SNB BoC RBA RBNZ 0.00-0.25 0.10 0.50 1.00 0.50 2.00 0-0.75 0.75 4.50 3.00 2010Q3 0.00-0.25 0.10 0.50 1.00 0.75 2.00 0.25 0.75 4.50 3.25 2010Q4 0.00-0.25 0.10 0.50 1.00 1.00 2.25 0.25 1.00 4.75 3.25 2011Q1 0.00-0.25 0.10 1.00 1.00 1.25 2.50 0.25 1.25 5.00 3.50 2011Q2 0.00-0.25 0.10 1.50 1.25 1.50 2.75 0.50 1.50 5.25 3.50

Percent deviation from PPP (+ overvaluation/- undervaluation)

As of 02/09/10 vs. EUR vs. USD EUR 0% 5% USD -5% 0% AUD 19% 23% CAD 5% 10% CHF 17% 22% GBP -11% -6% JPY 14% 19% SEK -15% -10% NOK 3% 8% NZD 16% 21%

Note: Daily updates for this table is available on Barclays Capital Live: https://live.barcap.com/BC/barcaplive?menuCode=MENU_FI_FX_GLB_FXH. Source for all tables: Barclays Capital

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Barclays Capital | FX Weekly Brief

EM FX VIEWS ON A PAGE
Tactical Currency bias Emerging Asia
TWD CNY KRW Bullish Bullish Bullish The Cross-Strait agreement is still one of our favourite structural transformation stories. We expect an increase in two-way variations in the CNY exchange rate, along with moderate appreciation. Although still bullish, we are slightly more cautious on the KRW owing to a smaller financial account surplus that reflects a more tepid interest rate outlook and tighter FX regulations. Structural reforms, putting the country on track to get to investment grade, and robust BoP suggest IDR strength. Thai rate normalization will likely continue to help modest THB appreciation. We remain bullish as the government pursues its multi-year restructuring programme, with the key catalyst being privatizations. Local equities markets and potential large IPOs will likely drive HKD. 0.41 Sell 4m USD/CNY NDF Sell USD/KRW via 1m NDF outright 0.52 Buy 20y IDR bonds, FX unhedged 0.24 0.20 Buy 3m USD/MYR put spreads 0.19 -0.60 0.19 3.65 3.20 3.15 3.05 3.00 2.80 0.53 4.25 4.20

Strategic directional view

Current strategy/trades we like

Vol adj 6m returns

Score (1-5)

IDR THB MYR HKD PHP INR

Bullish Bullish Bullish Neutral Bullish Bullish

SGD

Bearish

Sell USD/PHP 3m NDF Robust BoP and strong growth outlook indicate PHP strength despite recent underperformance. The longer term outlook for INR is increasingly clouded on account Buy 1m USD/INR ATMF put of elevated REER and the rising current account deficit. However, the short-term outlook is positive, supported by a weaker dollar and strong equity inflows. SGD is now trading at the top end of the NEER. We like using it as a Sell SGD/MYR spot funding currency for going long other Asians. COP is not misaligned with fundamentals and intervention risks are not as significant as historical valuations suggest, in our view. Strong domestic demand outlook and hawkish monetary policy. Growth peaking already; more a global beta play now. Bad technicals, potential political noise ahead, higher intervention risks. Attractive vol-adjusted carry, low beta to global drivers, lighter positioning and solid fundamentals are supportive of EGP. Benign inflation and recent shekel appreciation may make BoI less tolerant to much more shekel strength, especially if global risk concerns were to pick up. Better than expected Q2 GDP is positive for the currency but fiscal challenges and intervention risks remain. With a difficult political agenda this autumn and asymmetric intervention risks, we prefer to remain on the sidelines for now. With global growth momentum slowing and a less bullish outlook for oil, we see limited upside for further RUB strength in the short run. With no imminent reversal of Fidesz policies vis--vis IMF/EU negotiations, we still remain cautious on the HUF. A robust recovery, light positioning and actively managed FX deposits suggest the TRY will outperform during sell-offs. Recent positive economic data suggest that the recovery is taking hold a positive for the currency. Current aggressive reserve purchases are likely to make way for other measures to weaken the ZAR. New IMF funds are positive for Ukraine assets and will mean an additional powerful support for FX reserves positive for UAH FX intervention remains a big obstacle to appreciation.

0.05

2.60

-0.03

2.30

Latin America COP Bullish CLP MXN BRL Bullish Neutral Bearish

0.37 Short EUR/CLP 9m USD call/BRL put spread 0.24 0.15 0.17

3.20 2.75 2.70 2.05

Emerging EMEA EGP Bullish ILS Neutral

Long EGP via 3m T-bills (USD funded) 2m USD put/ILS RKO call (strike 3.79, RKO 3.69)

0.85 0.26 0.25 0.16 0.35

3.70 3.55 3.35 3.00 2.95 2.80 2.65 2.10 1.85

PLN* RON* RUB HUF* TRY CZK* ZAR UAH KZT

Neutral Neutral Neutral Neutral/ bearish Bullish Neutral Neutral Bullish Neutral

6m 290-310 EUR call/HUF put (tail risk trade/hedge) Long TRY Mar12s/short EUR (0.5), USD (0.5), long TRY/short ZAR

0.11 0.22 -0.26 -0.19

Long UAH via 6m T-bills

Note: *Versus EUR. Changes in tactical bias denoted in bold. The variable score is an index that ranks EM currencies according to the vol-adjusted returns, PPP valuation, carry, systemic risk, basic balance/GDP and reserves accumulated over the past 5y/GDP (5 is the best possible score). For more details on the trade recommendations, please see the EM Dashboard. Source: Barclays Capital

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Barclays Capital | FX Weekly Brief

GLOBAL FOREIGN EXCHANGE RESEARCH

Global
Piero Ghezzi Head of Global Economics, Emerging Markets and FX Research +44 (0)20 3134 2190 piero.ghezzi@barcap.com

G10 FX
Aroop Chatterjee Chief FX Quant Strategist +1 212 412 5622 aroop.chatterjee@barcap.com Yuki Sakasai FX Strategy +81 3 4530 5026 yuki.sakasai@barcap.com Giulia Comotti FX Strategy +44 (0)20 313 42988 giulia.comotti@barcap.com Raghav Subbarao FX Strategy +44 (0)20 7773 4144 raghav.subbarao@barcap.com David Forrester FX Strategy +65 6308 3406 david.forrester@barcap.com Masafumi Yamamoto Chief FX Strategist, Japan +81 3 4530 5038 masafumi.yamamoto@barcap.com Paul Robinson Head of European FX Strategy +44 (0)20 777 30903 paul.robinson@barcap.com Mathieu Zaradzki Chief FX Options Strategist +33 (0) 1 4458 3138 mathieu.zaradzki@barcap.com

Emerging Markets
Michael Gavin Head of EM Strategy +1 212 412 5315 michael.gavin@barcap.com Guillermo Mondino Head of Latin American Research +1 212 526 7791 guillermo.mondino@barcap.com Peter Redward Head of Emerging Asia Research +65 6308 3528 peter.redward@barcap.com Matthew Vogel Head of Emerging EMEA Research +44 (0)20 7773 2833 matthew.vogel@barcap.com

2 September 2010

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Analyst Certification(s) We, Raghav Subbarao, Aroop Chatterjee, Paul Robinson, George Christou, Alanna Gregory and David Forrester, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report. Important Disclosures For current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgibin/all/disclosuresSearch.pl or call 212-526-1072. Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capital may have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/or an affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debt securities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and / or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permitted and subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel to determine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including, but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), the profitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potential interest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing information was obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads are historical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise.

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