Global Economic Research Index Market Tone & Fundamental Focus 3 US/Canada 5 Europe 6 Asia/Oceania 8 Developing Asia 10 Developing Americas 11 Global Currency Forecast 13 Foreign Exchange Outlook is available on: www.scotiabank.com and Bloomberg at SCOE Foreign Exchange Outlook December 20, 2012 Diverging central bank policy, uneven progress towards sovereign debt sustainability, political change, progress in Europe, growth in Asia, investors’ global search for yield and a low volatility market environment are the themes that are likely to drive the currency landscape in 2013. The North American outlook is complicated by uncertain fiscal drag, which has proven to be a significant business and market disturbance; however, for FX markets, aggressive Fed policy combined with building growth momentum and favourable risk appetite supports the outlook for the CAD. In Europe, diminished tail risk and shifting market confidence helped to support EUR in the final few months of the year; however, bouts of uncertainty will likely continue to weigh on the currency in 2013; GBP’s outlook is more positive, but it is the Scandies whose outlook shines, as they benefit from relative central bank policy and sentiment. In Asia, the outlook for JPY has deteriorated materially as political uncertainty and rising concerns that the BoJ is in the midst of losing its independence weigh on what was already a difficult currency outlook. CNY continues to appreciate; however, with a narrowed current account surplus and slower pace of FX reserve accumulation we expect only moderate strength in 2013. Happy Holidays! Best wishes for the holiday season from all of us. The next issue of Foreign Exchange Outlook will be on Thursday, January 31, 2013. Global Economic Research 2 Foreign Exchange Outlook December 20, 2012 A ctual Q2a 12 Q3a 12 Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 1.32 1.27 1.29 1.33 1.30 1.29 1.28 1.27 1.26 1.29 1.28 1.27 1.26 1.26 1.26 84.4 80 78 84 85 87 89 90 90 82 82 82 83 83 84 1.63 1.57 1.62 1.63 1.62 1.63 1.64 1.64 1.65 1.60 1.59 1.59 1.58 1.58 1.58 0.99 1.02 0.98 0.97 0.97 0.97 0.96 0.96 0.95 0.99 0.99 0.99 0.99 0.99 0.99 1.05 1.02 1.04 1.05 1.05 1.06 1.07 1.08 1.08 1.04 1.02 1.02 1.01 1.00 0.99 12.78 13.36 12.86 12.78 12.93 12.84 12.95 13.17 13.22 12.79 12.78 12.72 12.65 12.58 12.62 ( * ) Source: Consensus Economics Inc. December 2012 AUDUSD USDMXN AUDUSD USDMXN EURUSD USDJPY GBPUSD USDCAD USDJPY Spot Price vs. 100 Day Moving Average vs. 200 Day Moving Average - (5yr Trend) Consensus* Mexican Peso Consensus* GBPUSD Consensus* Consensus* USDCAD Consensus* Canadian Dollar Australian Dollar Global Foreign Exchange Outlook Euro Yen Sterling December 20, 2012 EURUSD Consensus* 74 81 88 95 102 109 116 123 USD/ JP Y 100 Day 200 Day 1.12 1.22 1.32 1.42 1.52 1.62 EUR/USD 100 Day 200 Day 1.36 1.51 1.66 1.81 1.96 2.11 GBP / USD 100 Day 200 Day 0.90 0.98 1.06 1.14 1.22 1.30 USD/ CAD 100 Day 200 Day 0.59 0.67 0.74 0.82 0.89 0.97 1.04 1.12 AUD/ USD 100 Da y 200 Da y 9.7 10.8 11.9 13.0 14.1 15.2 USD/ MXN 100 Day 200 Day Global Economic Research 3 Foreign Exchange Outlook December 20, 2012 Diverging central bank policy, uneven progress towards sovereign debt sustainability, political change, progress in Europe, growth in Asia, investors’ global search for yield and a low volatility market environment are the themes that are likely to drive the currency landscape in 2013. We expect diverging central bank policies to be a key FX market focus in 2013. The US, Japan, Europe and the UK are all leaning heavily on loose and aggressive monetary policy to stimulate growth and offset tightening fiscal con- ditions. These policies are typically currency negative, with Fed and BoJ policy the most aggressive from a cur- rency perspective. However, many of the other central banks (particularly in the advanced economies) are facing the reality of the risks that high household debt and ele- vated housing prices pose to financial stability in a low interest rate environment (Canada, Sweden, Switzerland, Norway, etc.). Accordingly, even in an environment of sub -trend economic performance and substantial external headwinds, these central banks are completing easing cycles and warning of the risks of higher interest rates. For currencies, these diverging central bank trends are impossible to ignore. For North America, the US focus will be multifaceted, re- volving around i) USD negative Fed policy, ii) fiscal drag combined with the lack of a credible long-term fiscal plan and iii) the improving but still modest growth outlook. Can- ada’s domestic fundamentals are uneven, and vulnerable to what is a historically wide Brent–Western Canadian select oil spread, but the central bank has maintained a hawkish bias since the fall as household debt poses a risk to financial stability and global investors as well as FX reserve managers continue to view Canadian assets as attractive, helping to drive positive Canadian dollar (CAD) flows. On the back of these trends, we expect the CAD to appreciate modestly in 2013. The outlook for the Mexican peso (MXN) is improving, particularly as the economy recovers and the central bank maintains more hawkish policy than the Fed. In the freely floating Latin American FX universe, the Chil- ean (CLP) and Columbian (COP) pesos are not expected to repeat their 8-9% 2012 returns. The outlook for the Pe- ruvian sol (PEN) is strong and could well outperform in the Latam FX space. The Brazilian real (BRL), which proved the worst-performing currency in 2012, is ex- pected to remain biased for weakness but contained with- in the relatively stable range that characterized the se- cond half of 2012. Europe is likely to be an ongoing theme; however, the market will not suffer tunnel vision the way it did during some periods in 2012. The outlook for the monetary union will be plagued by periodic bouts of uncertainty as political discussions threaten both the banking union and the ulti- mate path towards a fiscal union, and this will weigh on the euro (EUR). Helping to offset this is ECB policy, which is unlikely to prove as aggressive or currency negative as Fed policy, and a focus on the material progress Europe has made over the last year. Accordingly, the EUR is ex- pected to slowly trend modestly lower, closing 2013 at lower levels than it traded at in late December. The British pound (GBP) is a less attractive play in 2013 than it was in 2012 particularly as the UK’s rating is increasingly at risk, monetary policy is likely to remain expansionary and the UK’s economic outlook is weighed down by Europe. However, we expect modest appreciation year-over-year as the UK continues to benefit from European diversifica- tion flows, positive sentiment and a credible and estab- lished fiscal plan. The outlook for the other European cur- rencies, particularly the Scandies, is more positive. We have an appreciating trend built in for the SEK and NOK. In Asia, newly elected Japanese Prime Minister Abe had a three-pronged campaign: 1) fiscal stimulus to help lift the economy, which could ultimately push its fiscal bal- ance even further into deficit and threaten the country’s credit rating; 2) implementing a 2% inflation target and maintaining support for aggressive BoJ policy; and finally 3) a hard line in the China/Japan territorial dispute. To- gether these policies are likely to prove JPY negative. Accordingly, we have revisited our 2013 year end USDJPY forecast and raised it from 87 to 90. In China, the stabilization of the economy and progress towards a more freely traded exchange rate is likely to keep the slow trend of appreciation in place. We hold a 2013 6.10 year-end USDCNY target. Political developments in Ko- rea combined with the won’s (KRW) relative undervalua- tion on a real effective exchange rate basis are likely to lead to an appreciating trend in 2013. For the Australian dollar, the outlook is positive, but currency gains are likely to lag the CAD’s. We expect growth in China to increase to 8% in 2013, which would help support the Australian economy, this combined with US Fed policy should sup- port the AUD. However, repeated warnings by the central bank that mining investment has peaked are difficult to ignore. Accordingly, we look for modest AUD appreciation in 2013. The most important risks to our forecasts include: 1) a sudden and unexpected spike in inflation; 2) geopolitically induced higher oil prices; 3) a hard landing in China or 4) a political impasse in either Europe or the US which threatens the global economic recovery. MARKET TONE & FUNDAMENTAL FOCUS Pablo F.G. Bréard +1 416 862-3876 Camilla Sutton +1 416 866-5470 Global Economic Research 4 Foreign Exchange Outlook December 20, 2012 As December draws to a close, CAD is up 3.7% year-to-date, within reach of our December 2011 CAD forecast, which called for 4.0% appreciation in 2012. Looking out to 2013, we expect further CAD appreciation, with the currency closing the year at 1.04 (equating to 0.96 in USDCAD). From our perspective, relative monetary policy is the most important driver. The Bank of Canada (BoC) has maintained a hawkish bias as the risks associated with household debt threaten financial stability; however, the domestic economic backdrop combined with external risks dampen the need for tighter policy in Canada. Regardless of whether BoC policy is viewed as hawkish or neutral juxtaposed against Fed policy it suggests USD weakness and CAD appreciation. On the fiscal front, the International Monetary Fund (IMF) expects Can- ada to generate a deficit of -3.0% of GDP in 2013, an improvement over the estimated 3.8% in 2012, but still a large im- balance. The government’s plan, which is viewed credibly by markets, is to move towards a balanced budget by calen- dar year 2018. This compares favourably with the outlook for the US fiscal deficit, which the IMF estimates at 8.7% of GDP in 2012, declining to 7.3% of GDP in 2013, with no credible fiscal plan to move the US close to a balance budget. Accordingly, current fiscal balances combined with their outlook should favour investment in Canada and hence support CAD. GDP growth is typically a weak driver of FX, accordingly we are not concerned that Canada is expected to lag the US in both 2013 and 2014, as it did in 2012. Traditionally, CAD has been viewed as a petrol currency; however, this is an increasingly complex relationship. There are three key components: 1) oil prices, which are expected to remain sup- portive of the Canadian economic backdrop; 2) the widening of the Brent-WTI spread, which is a weight against the Ca- nadian economy. Canada exports oil prices below WTI levels (at Canadian Western Select), but still imports a significant portion of central and eastern Canada oil demands at Brent prices. Accordingly as the spread widens, Canada is export- ing at far lower prices than it is importing at and creates a net drag to the economy. 3) As US production increases, some have questioned what the impact on Canadian oil will be. Balancing all these issues, we view oil prices as a neu- tral driver of CAD in 2013. Summing up, we expect CAD to strengthen year-over-year. CANADA Camilla Sutton +1 416 866-5470 Eric Theoret +1 416 863-7030 12 m6 m3 m 3 m6 m12 m AUDCAD 1.04 1.04 1.02 1.02 1.03 1.04 AUDCAD CADJPY 75.63 78.11 80.10 87.63 89.69 93.75 CADJPY EURCAD 1.35 1.29 1.27 1.26 1.25 1.22 EURCAD USDCAD 1.03 1.02 0.98 0.97 0.97 0.96 USDCAD Currency Trends Spot 20-Dec OutlookGoing Back FX Rate FX Rate EURCAD USDCAD 1.035 85.41 1.307 0.987 AUDCAD CADJPY 0.99 1.01 1.03 1.05 1.07 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 72.0 75.0 78.0 81.0 84.0 87.0 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 1.21 1.24 1.27 1.30 1.33 1.36 1.39 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 0.96 0.98 1.00 1.02 1.04 1.06 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Global Economic Research 5 Foreign Exchange Outlook December 20, 2012 UNITED STATES - US GDP growth is constrained by the uncertainty surrounding the ‘fiscal cliff’ negotiations in Con- gress. Business confidence is low and consumer confi- dence, which had been gaining momentum, has softened with the University of Michigan Confidence Index moving down to 74.5 in December from 82.7. The outlook for con- sumption has improved on gains in the jobs and housing markets, however, retail sales figures have been patchy (flat in November excluding autos) and households face possible tax increases in the New Year hurting disposable income. The job market has some momentum with non- farm payrolls adding almost 800,000 jobs in the past five months, including another 146,000 in November. The un- employment rate moved down to 7.7%, from a peak of 10%, but this masks the decline in labour force participa- tion as people become discouraged looking for work. The housing market also continues to turn around from de- pressed levels, with housing starts heading towards 900,000 (from a low of 523,000 in 2009), while the Case- Shiller Home Price Index has shown monthly increases since March. Meanwhile, business investment remains de- pressed and contracted by 1.8% annualized in Q3, but should benefit from eventual clarity of the fiscal issues, re- inforced by the Fed’s aggressively accommodative mone- tary policy. Industrial production rebounded in November, rising by 1.1% m/m, offsetting weakness in October due to Hurricane Sandy. However, the ISM Manufacturing Index moved below 50 again, confirming that the outlook for pro- duction continues to be mixed. Even though the US will outperform most other advanced economies next year, the rebound remains weak in comparison to previous post- recession recoveries. This is largely because of the ongo- ing fiscal drag, consumer deleveraging, and weak global demand which limits any major improvements in the net trade balance, all of which restrain potential US economic growth. CANADA - The Canadian economy has lost momentum in recent quarters. The slow pace of the US and global recov- ery, the persistent strength in the Canadian dollar and low- er prices for key domestic resources are weighing on man- ufacturing output and export earnings. Despite a continued large surplus in commodities trade, growing deficits in man- ufactured goods and services have pushed Canada’s cur- rent account shortfall to around $70 billion, or 4% of GDP. Business confidence and investment intentions remain rea- sonably positive, but the volatile and uncertain global eco- nomic and financial environment is tempering capital spending, and scaling back some resource expansion plans. While the pace of job growth so far remains healthy, concern over high household debt burdens has contributed to more moderate consumer spending and household bor- rowing. Home sales have slowed steadily since the spring as high prices and a tightening in mortgage rules have eroded affordability, notwithstanding generationally low borrowing costs. This in turn has begun to moderate the pace of new homebuilding. Federal and provincial public sector restraint also is expected to remain a drag on growth through 2014, though to a smaller degree than in many other advanced nations. Overall, the Canadian economy is expected to post moderate growth of 1.7% in 2013, picking up to 2.3% in 2014 as improving global economic condi- tions support higher commodity prices, stronger exports and corporate earnings, and rising business capital invest- ment. Headline and core inflation rates have moved back toward the lower end of the Bank of Canada’s 1-3% target range, with underlying price trends restrained by modest wage growth, limited retail pricing power and Canadian dollar strength. CANADA AND UNITED STATES Adrienne Warren +1 416 866-4315 Fundamental Commentary Devin Kinasz +1 416 866-4214 MONETARY POLICY COMMENTARY Derek Holt +1 416 863-7707 UNITED STATES - We expect the Fed to continue with its current pace of asset purchases (US$85/bn per month) for some time yet, although in light of Chairman Bernanke’s statement that the Fed will adjust the monthly pace of pur- chases in response to economic data and economic condi- tions – including fiscal policy developments – it is fairly diffi- cult to have policy certainty with respect to Fed asset pur- chases over a medium-term horizon. Similarly, we expect markets will view the Fed’s interest rate thresholds as con- sistent with its earlier date-based guidance over the coming months; however, there is risk that this could erode and add confusion into markets over time, particularly if the Fed stops publishing the expected date of policy firming of the FOMC participants in its projections. We see risk that the size of the Fed’s monthly purchases could begin to impact market liquidity if the current pace continues into 2014. CANADA - We continue to expect the Bank of Canada (BoC) to remain on hold into 2014 with risks of a longer pause contingent on the trajectory of the economy and global monetary policy conditions. We anticipate that the transition from Governor Carney to a new governor will be smooth, and that markets will continue to expect interest rate policy stability during the leadership change. Recent data have continued to demonstrate that the Bank of Cana- da is wise to raise the “two-sided” risk emanating from im- balances in the household sector – with the emphasis on downside risks. The BoC refers to this as “the biggest do- mestic risk” which is consistent with our long-held view as well. This is one factor contributing to our view that the out- put gap will continue to reflect spare capacity in the Cana- dian economy through Scotiabank’s forecast horizon. Global Economic Research 6 Foreign Exchange Outlook December 20, 2012 EURO ZONE - Progress on the banking union, the future framework of the European Union, Fed policy and short cover- ing have helped to support EUR in the final month of the year. However looking out to 2013, there are significant EUR downside risks that are difficult to ignore; bouts of political uncertainty, economic contraction and negative headlines are likely to weigh heavily on fragile market sentiment driving a small depreciation in EUR in 2013. We hold a Q1 2013 fore- cast of 1.30. UNITED KINGDOM - Sterling is a less attractive play in 2013 than it was in 2012 particularly as the UK’s rating is increas- ingly at risk, monetary policy is likely to remain expansionary and the UK’s economic outlook is weighed down by Europe. However, we expect modest appreciation year-over-year as GBP continues to benefit from European diversification flows, positive sentiment (with the CFTC reporting in mid-December a net long GBP holding of US$2.8 billion) and a credible and established fiscal plan. We hold a Q1 2013 target of 1.62. SWITZERLAND - Plagued by weak growth, deflation and economic ties into the euro zone, the Swiss outlook is chal- lenged. In response, the Swiss National Bank (SNB) remains committed to the EURCHF 1.20 floor, which the market views as credible. The SNB does not foresee the economy exiting deflation until 2014 and even then inflation remains subdued at just 0.4%. Accordingly, we expect the floor to remain in place through 2013. SWEDEN - The outlook for SEK is supported by what we expect is the conclusion of the Riksbank easing cycle, an im- proving growth profile and the outlook for risk sentiment. However, sentiment is fragile and SEK will be vulnerable during periods of EUR weakness. EURSEK traded in a broad range during the last quarter of the year, weakening the im- portance of technical signals. We expect EURSEK to close Q1 2013 at 8.45. EUROPE Camilla Sutton +1 416 866-5470 Currency Outlook Eric Theoret +1 416 863-7030 12 m6 m3 m 3 m6 m12 m EURUSD 1.31 1.27 1.30 1.30 1.29 1.27 EURUSD GBPUSD 1.57 1.57 1.62 1.62 1.63 1.64 GBPUSD EURCHF 1.22 1.20 1.21 1.20 1.21 1.22 EURCHF EURSEK 8.98 8.83 8.46 8.60 8.50 8.30 EURSEK EURUSD GBPUSD EURCHF EURSEK 1.32 1.63 1.21 8.62 Currency Trends FX Rate FX Rate Spot 20-Dec OutlookGoing Back 1.20 1.25 1.30 1.35 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 1.53 1.56 1.58 1.61 1.63 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 GBPUSD 1.20 1.21 1.22 1.23 1.24 1.25 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 8.10 8.25 8.40 8.55 8.70 8.85 9.00 9.15 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Global Economic Research 7 Foreign Exchange Outlook December 20, 2012 EURO ZONE - Real economic weakness, which was ex- pected to materialize earlier in the year as suggested by depressed PMI and sentiment surveys, has taken hold in the euro area in the final months of 2012. After averaging a monthly gain of 0.1% m/m from January through August, industrial production took a sharp turn downward, collapsing 1.9% in September-October. The payback from a resilient third-quarter GDP performance in the largest economies of the euro area (driven largely by one-off calendar effects) will elicit sharp GDP contractions in the final quarter, with nega- tive carry into the New Year. Nevertheless, there are tenta- tive signs of a turning point; recent survey data saw im- provements in the Ifo and ZEW expectation indexes, as well as the PMIs. We continue to anticipate that a tenuous re- covery will emerge in mid-2013, though on account of the worse expected performance in the fourth quarter of 2012, we have trimmed our GDP expectation for next year to - 0.1% (from 0%). We maintain our 2014 forecast at 1.0%. Tail risks have been reduced by major central bank policy and recent Eurogroup agreements on Greece and the bank- ing union. However, several uncertainties remain, including elections in Italy and Germany, progress on fiscal consoli- dation, bank credit conditions, currency dynamics and com- modity prices. At present we remain of the view that under this scenario, and with inflation expected to remain con- sistent with price stability, the European Central Bank will leave interest rates unchanged through 2014. UNITED KINGDOM – Despite considerable economic data volatility in the fourth quarter, the pound sterling continues to gain. The currency has climbed roughly 2.5% vis-à-vis the US dollar since mid-November, bringing it to a near- term high close to 1.63. Recent support has come from US monetary policy, tentative progress on the euro area bank- ing union, and a slight hawkish lean by the Bank of England in the minutes of the latest Monetary Policy Committee meeting. One factor threatening the sterling’s gradual ap- preciation trajectory is the recent decision by S&P to return the nation’s prized “AAA” sovereign credit rating to negative watch, matching the outlook of the other major rating agen- cies and suggesting a 1-in-3 chance of a downgrade in the next two years. S&P cited concerns about the economic growth outlook and higher than projected borrowing require- ments (as government deficit targets were recently pushed back). On the economic front, developments have been erratic. Likely offsetting a second straight drop in industrial production in October (which carried over into petroleum- dependent manufacturing industries, risking a triple-dip re- cession situation) was a substantial gain in construction output, which jumped 8.3% m/m in October. Though labour market conditions remain solid, growth in retail sales has slowed sharply, averaging 0.8% y/y in October-November, down from 2.4% in the third quarter. Inflation remained un- changed at 2.7% y/y in November. Gas price and utility bill hikes will boost the headline rate in the coming months. SWITZERLAND - In the context of a relatively sound local economic environment, rising imbalances in the mortgage and real estate markets, and remaining external uncertain- ties linked to the euro crisis and US fiscal situation, the Swiss National Bank (SNB) will maintain a neutral bias around its EURCHF 1.20 minimum exchange rate policy through 2013. At the last policy meeting in mid-December, the bank recognized that as the announcements of vast monetary accommodation by major central banks have helped to calm risk sentiment in global financial markets since the summer, pressure on the franc has also eased. Nevertheless, the currency is still considered strong, with persistent demand for safe Swiss assets bringing the yield on ten-year bonds down to 0.33% on December 10 th (a global record low). An impressive 1.4% y/y output gain in the third quarter was driven by a temporary revival in ex- ports, which is expected to be reversed in the final quarter, limiting the overall advance in 2012 to around 0.8%. Despite substantial growth in monetary aggregates in recent months, the bank contends that there is no risk of inflation in the foreseeable future, given continued spare capacity in the economy, an expected increase in unemployment and stable inflationary expectations. The annual pace of defla- tion reaccelerated in November, from -0.2% y/y in October to -0.4%. The SNB remains concerned about the effect of an extended period of low interest rates on the domestic real estate market and banking sector. SWEDEN - With the enduring debt crisis in the euro area weighing more heavily on the Swedish economy, the na- tion’s monetary authorities have employed further policy accommodation, lowering the benchmark repo rate to 1.00% at the central bank meeting on December 18 th . We anticipate that this latest cut marks the bottom of the current easing cycle (a cumulative 100 basis points over the last year), and that the Riksbank will begin to normalize rates by early 2014. The decision was underpinned by the marked loss of economic momentum in the second half of the year – specifically, on the domestic front (external demand has been lacklustre all year). Real GDP growth slowed from 1.3% y/y to 0.7% in the third quarter, and further slowing is implied by declines in industrial production and orders and services production in October. Household and business confidence is deteriorating, as is the outlook for the labour market, and the Riksbank considers consumption and in- vestment to be weak. The bank’s forecast for growth in 2013 was lowered considerably, from 1.8% to 1.2% (the projection for 2012 was left at 0.9%). Furthermore, the threat of inflation has emerged in recent months, with the headline rate falling below zero in November, to -0.1% y/y, for the first time in three years. The krona has followed a gradual weakening trend since August, though we expect the currency to regain strength in 2013 on the back of the nation’s strong public finances, triple-A credit rating, and comparatively robust growth profile among EU members. EUROPE Fundamental Commentary Sarah Howcroft +1 416 862-3174 Global Economic Research 8 Foreign Exchange Outlook December 20, 2012 JAPAN - The outlook for JPY has deteriorated; the newly elected Prime Minister Abe is expected to increase fiscal stimu- lus at the risk of pressure from rating agencies and global investors, while making aggressive changes at the BoJ, includ- ing the implementation of a 2% inflation target. Finally, the territorial dispute with China poses economic risks. Sentiment has turned rapidly against the yen, with the CFTC reporting a record short yen position of US$14 billion. We hold a Q113 USDJPY target of 85. CHINA - CNY broke away from trading at the upper end of its trading band after onshore authorities finally stepped in to provide liquidity for what had been an unbalanced market since early November. The stabilization in China’s economy has engendered CNY buying pressures on rising expectation for modest appreciation. Policymakers appear content to allow CNY trading to evolve in a more market-determined manner, but still constrained within its daily trading limit. We expect USDCNY to close Q113 at 6.25. AUSTRALIA - The Australian economy is supported by tight monetary policy, limited fiscal tightening and stabilization in the outlook for China. This combined with the FX impact of Fed policy has encouraged bullish investor sentiment. In mid- December the net long AUD position (as reported by the CFTC) stood at a record high of US$10.9 billion. Meanwhile, the low market volatility environment is encouraging the return of carry trades. Accordingly, the outlook for AUD is bright, but dampened by fears over a peak in mining investment. We hold a modest Q113 target of 1.05. NEW ZEALAND - Investor sentiment is increasingly bullish towards NZD, with the net long position at a record high of US$2.1 billion. We are concerned that the market has gotten ahead of itself and the rally is too stretched, accordingly, even though NZD should see modest appreciation in 2013, we expect the first quarter to be disappointing, with NZDUSD closing at 0.81. ASIA/OCEANIA Camilla Sutton +1 416 866-5470 Currency Outlook Sacha Tihanyi + 852-2861-4770 12 m6 m3 m 3 m6 m12 m USDJPY 77.89 79.54 78.24 85.00 87.00 85.00 USDJPY USDCNY 6.35 6.36 6.30 6.25 6.20 6.10 USDCNY AUDUSD 1.01 1.02 1.04 1.05 1.06 1.08 AUDUSD NZDUSD 0.77 0.80 0.83 0.81 0.82 0.83 NZDUSD 84.3 Currency Trends Spo t 20-Dec OutlookGoing Back FX Rate FX Rate 6.23 USDJPY USDCNY AUDUSD NZDUSD 1.05 0.83 75.5 77.5 79.5 81.5 83.5 85.5 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 6.20 6.25 6.30 6.35 6.40 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 0.96 1.00 1.03 1.07 1.10 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 0.74 0.77 0.79 0.82 0.84 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Global Economic Research 9 Foreign Exchange Outlook December 20, 2012 JAPAN - Japan’s weakening economic fundamentals and improved Chinese growth prospects are driving a correc- tion in the Japanese yen’s value, which has been tradition- ally supported by persistent investor risk aversion and mar- kets’ flight-to-liquidity dynamics. We expect Japanese real GDP to grow by 1.7% in 2012, and to record only a modest average gain of 1% in 2013-14 as the tsunami-related re- construction boom vanishes. A change in political leader- ship is taking place. Following general elections held on December 16 th the opposition Liberal Democratic Party (LDP) is returning to office. With its junior partner, the New Komeito party, the LDP will hold a two-thirds majority that will allow it to push through legislation relatively easily. Shinzo Abe, the leader of the LDP and the forthcoming prime minister, has been a very vocal support of further monetary and fiscal stimulus, despite the fact that Japan’s government finances are weak, with the debt-to-GDP ratio likely to surpass 245% in 2013, and that the central bank’s independence may be at risk. Policymakers are seeking to ward off deflation, to encourage a decline in longer-term interest rates, and to provide a boost to private spending. Deflationary pressures are persistent, with consumer prices dropping from year-earlier levels since June 2012 (the headline inflation rate was -0.4% y/y in October). We antici- pate that inflation remains dormant in 2013 before picking up slightly to ½% y/y in 2014. CHINA - China’s economic outlook continues to improve with real GDP, sentiment indicators, industrial production, and retail sales indicating that a revival, albeit modest, is imminent. We expect China’s output growth to reach 8% in 2013 from 7.7% in 2012, and to accelerate to 8⅓% in 2014. Inflation will likely pick up moderately from the No- vember level of 2.0% y/y, reaching 3.3% y/y by the end of 2013. Nevertheless, persistent deflationary pressures fur- ther up the distribution chain (producer prices dropped 2.2% y/y in November) alleviate any near-term concerns regarding significant upside pressure on prices. Against this backdrop, we have made a minor revision to our ex- pectations regarding China’s monetary policy path. We now assess that the People’s Bank of China’s benchmark 1 -year lending rate has reached its cyclical bottom at the current level of 6.0%. Monetary tightening will likely com- mence in the first quarter of 2014, taking the policy rate to 6.6% by the end of that year. China’s new leadership, led by Xi Jinping (expected to take over the country’s presiden- cy in March 2013) and Li Keqiang (set to become the premier), continues to highlight the need for a more bal- anced approach to economic development that prioritizes consumption over investment and exports. Such progress would also improve stability and growth in China and the Asian region at large. Nevertheless, we expect any ad- vancement on economic reforms to be gradual in nature. AUSTRALIA - The Australian dollar continues to be sup- ported by relatively strong economic fundamentals, a triple-A sovereign credit rating, still-wide interest rate differ- entials relative to other advanced economies, and portfolio investment inflows. While the peak in resource investment is approaching and monetary easing has taken Australian interest rates to record lows, an imminent, though gradual, revival of the Chinese economy together with strengthening investor sentiment should support the currency through 2013. Inflation will likely continue to climb higher in the near future from the third quarter level of 2.0% y/y, partly reflect- ing the introduction of a carbon tax in July 2012; neverthe- less, we expect the headline rate to remain within the Re- serve Bank of Australia’s (RBA) target range of 2-3% through 2014. Following a benchmark interest rate cut to 3.0% in early December, we assess that the current easing cycle has now reached its bottom, with the RBA likely to begin to normalize monetary conditions in the final quarter of 2013. Australia is one of the fastest-growing economies in the developed world, with the resources sector continu- ing to be the key economic motor. We estimate that real GDP will advance by 3½% in 2012, with growth averaging slightly less than 3% in 2013-14. The output pace slowed slightly to 0.5% q/q (3.1% y/y) in the third quarter of 2012 from 0.6% q/q (3.8% y/y) in the April-June period, reflecting slower household expenditure growth and cutbacks in pub- lic spending. NEW ZEALAND - Initial signs are emerging that New Zea- land’s economic momentum will be picking up in the near term. Improving housing market conditions and recovering consumer confidence point to forthcoming gains in house- hold spending. Domestic demand continues to be the main economic driver, driven by earthquake-related reconstruc- tion investment; meanwhile, subdued external conditions will continue to weigh on the overall economic outlook as the country’s exporters battle with still-weak global demand and an elevated currency. We expect New Zealand’s real GDP to expand by around 1⅔% this year, followed by a modest acceleration to 2⅓% in 2013. The Reserve Bank of New Zealand will likely maintain an accommodative mone- tary stance in the coming quarters, keeping the Cash Rate unchanged at a record low of 2.5% at the next policy meet- ing on January 30 th . Following the December 6 th meeting, monetary authorities noted the improved global outlook, and assessed that the excess capacity in the domestic economy will be eliminated by the end of 2013. An eco- nomic revival will increase inflationary pressures, taking the headline rate to the central bank’s 2% target midpoint in 2013 from the third quarter 2012 level of 0.8% y/y. Despite a large – and widening – current account deficit (averaging 5% of GDP in 2012-13), the New Zealand dollar remains at a historically high level vis-à-vis the US dollar as the coun- try continues to offer more attractive rates of return than most other advanced economies. ASIA/OCEANIA Fundamental Commentary Tuuli McCully + 1 416 863-2859 Global Economic Research 10 Foreign Exchange Outlook December 20, 2012 INDIA - With the RBI holding policy through December and signaling greater ease with inflation, rate cuts remain on tar- get for Q1 2013, a factor that has helped interest in both equities and government fixed income. However, INR remains challenged by a very weak current account position which continues to leave it at the whim of portfolio flows. This makes the positive sentiment that should follow the resumption of an easing cycle fairly beneficial for the rupee. We target 52.25 by the end of next year. KOREA - KRW continues to make new highs as official resistance to won appreciation has only managed to slow the pace of gain. QE-related market forces have been significant drivers of portfolio flows into Korea, as the rolling monthly inflows to equities have reached six month highs while the current account has rebounded to exert further pressure. The new government promises to bring a more tolerant view of KRW appreciation, a feature that helps to underpin our bull- ish outlook. We forecast USDKRW at 1050 by Q4 2013. TAIWAN - TWD continued to see appreciation, though in a very moderate fashion as volatility in USDTWD fell to a multi -year lows in December. The recent stable, strong CNY fixing levels have helped make TWD gains more palatable to the onshore authorities, and while Taiwan’s economy has failed to achieve escape velocity, export indications are im- proving in line with production, justifying a somewhat stronger TWD. We doubt however that TWD can be any kind of outperformer over the next year, and target 28.75 by Q4 2013. HONG KONG - HKD has traded at the strong-side convertibility undertaking of the HKMA for the most sustained period of time since 2009, reflecting strong QE-driven capital inflows; the Hang Seng Index has been the top regional performer since the announcement of QE3. Not only can the HKMA indefinitely maintain the current required interventions to de- fend the strong side of the band, we see no risk that the peg is dropped in the foreseeable future. We target USDHKD at 7.75 through 2013. DEVELOPING ASIA Currency Outlook Sacha Tihanyi + 852-2861-4770 12 m6 m3 m 3 m6 m12 m USDINR 52.89 56.15 54.39 54.13 53.75 53.00 USDINR USDKRW 1162 1151 1123 1069 1063 1050 USDKRW USDTW D 30.34 29.86 29.38 29.01 28.93 28.75 USDTWD USDHKD 7.78 7.76 7.75 7.75 7.75 7.75 USDHKD 1075 USDINR USDKRW USDTWD USDHKD 29.06 7.75 54.85 Currency Trends Spo t 20-Dec OutlookGoin g Back FX Rate FX Rate 48.00 50.00 52.00 54.00 56.00 58.00 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 1065 1095 1125 1155 1185 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 28.70 29.05 29.40 29.75 30.10 30.45 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 7.74 7.75 7.76 7.77 7.78 7.79 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 For Fundamental Commentary on developing Asian economies, please refer to our Foreign Exchange Outlook, December 2012, at www.scotiabank.com. [...]... elevated rates, despite the economic deceleration A fiscal reform package, currently being debated in the Congress, will draw foreign investors’ attention in the coming weeks as taxes; foreign inflows are expected to increase 12 Global Economic Research December 20, 2012 Foreign Exchange Outlook G LOBAL C URRENCY FORECAST 2011 2012f 2013f 2014f (end of period) 2012f Q3a 2013f Q4 Q1 Q2 2014f Q3 Q4 Q1 Q2 Q3... 8.10 Turkey USDTRY 1.89 1.79 1.75 1.73 1.80 1.79 1.78 1.77 1.76 1.75 1.75 1.74 1.74 1.73 f: forecast a: actual 13 Global Economic Research December 20, 2012 Foreign Exchange Outlook International Research Group Canadian & U.S Economic Research Foreign Exchange Strategy Daniela Blancas daniela.blancas@scotiabank.com Derek Holt derek.holt@scotiabank.com Eduardo Suárez eduardo.suarez@scotiabank.com Pablo...Global Economic Research December 20, 2012 Foreign Exchange Outlook DEVELOPING AMERICAS Currency Outlook Eduardo Suárez +1 416 945-4538 BRAZIL - We interpreted the government’s recent unwinding of capital controls, the re-introduction of BRL supportive swaps by the central... Dec-12 USDCO P 525 1945 510 1895 495 1845 480 1795 465 Dec-11 Feb-12 Apr-12 Ju n-12 Aug-12 Oct-12 Dec-12 1745 Dec-11 Feb-12 Apr-12 Ju n-12 Aug-12 11 Global Economic Research December 20, 2012 Foreign Exchange Outlook DEVELOPING AMERICAS Fundamental Commentary Daniela Blancas +1 416 862-3908 BRAZIL - The gradual local economic recovery, the rebound in annual inflation and the central bank’s intervention... headwind heading into 2013, which could lead the USDCLP cross to rise moderately towards 497 by the end of 2013 COLOMBIA - Although the planned cuts to taxes on foreign investment in domestic bonds are expected to be a COP tailwind by boosting foreign interest in domestic fixed income, Congress is simultaneously debating introducing a 5% tax on stock dividends exceeding US$111,222, which were previously... eric.theoret@scotiabank.com Tuuli McCully tuuli.mccully@scotiabank.com Dov Zigler dov.zigler@scotiabank.com Sacha Tihanyi sacha.tihanyi@scotiabank.com Estela Ramírez estela.ramirez@scotiabank.com Foreign Exchange Strategy This report is prepared by The Bank of Nova Scotia (Scotiabank) as a resource for clients of Scotiabank Opinions, estimates and projections contained herein are our own as of the... However, the US fiscal situation, the European sovereign debt crisis and any swings in international risk appetite will affect the currency in the short-term Inflation continues to weigh on the country’s outlook; even though the headline rate decelerated from 4.6% y/y in October to 4.2% in November, driven particularly by discounts offered in the “buen fin”, it remains slightly above the central bank’s... Currency T rends FX Rate Going Back 6 m 2.03 13.71 495 1770 12 m 1.85 13.78 519 1934 USDBRL USDMXN USDCLP USDCOP Spot 20-Dec 2.06 12.78 475 1789 3 m 2.02 12.86 470 1794 3 m 2.11 12.93 493 1810 USDBRL Outlook 6 m 2.12 12.84 494 1820 12 m 2.15 13.17 497 1850 FX Rate USDBRL USDMXN USDCLP USDCOP USDMXN 2.20 14.6 2.12 14.1 2.05 1.97 13.6 1.90 13.1 1.82 12.6 1.75 1.67 Dec-11 Feb-12 Apr-12 Ju n-12 Aug-12 . Global Currency Forecast 13 Foreign Exchange Outlook is available on: www.scotiabank.com and Bloomberg at SCOE Foreign Exchange Outlook December 20,. The next issue of Foreign Exchange Outlook will be on Thursday, January 31, 2013. Global Economic Research 2 Foreign Exchange Outlook December