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For important disclosures, refer to theDisclosures Section, located at the end ofthis report.

M O R G A N S T A N L E Y R E S E A R C H

Global Currency Research TeamFor research analysts, please see contact list at the back of this mat

Global

July 10, 2014

Currencies

FX Pulse

Volatility Wake-Up Call

Risk aversion favors JPY. Our risk-averse FX trading

strategy has started to bear fruit, with JPY crosses coming

under selling pressure. The first half of this year saw risk

rallying and bond yields coming down, but now, as strong

US data sees investors bringing forward expectations ofFed rate hikes, the equity market seems to face increasing

headwinds. When liquidity is ample, valuation tends to

drive the performance of higher-yielding assets, but when

liquidity conditions tighten then asset valuations require

the support of earnings. This support is more difficult to

achieve when corporate profits are running at record highs

relative to output. Other risks are also developing. With the

exception of China, Asian data have disappointed, and in

Europe, the economic surprise indicator has rapidly come

off its spring highs. European bank shares have

underperformed, not boding well for the EUR.

Our trades.Japans investors are volatility and yield

driven. The VIX has rebounded from the lowest level seen

since early 2007, suggesting FX volatility is likely to follow

swiftly should market uncertainty increase from here.

When volatility increases and DM yield curves flatten, then

Japans investors are likely to reduce their outflows,

pushing the JPY higher. Last year, US-based investors

piled into European stocks, mainly buying financials.

Financials have underperformed, suggesting foreign

investors are likely to reduce exposure, adding to EUR

weakness. We add to our EUR bearish portfolio, buying

JPY and the AUD.

In This Weeks Edition

We compare CHF and NOK and conclude that both

currencies offer some similarities. Valuation is rich,

especially in the case of the NOK, and we see NOK losing

its safe-haven credentials. We expect the NOK to come

under prolonged selling pressure, with falling energy

output revealing a substantial competitive gap.

In addition, we explain why EUR/AUD should trade lower

and why the current sterling correction may offer another

sterling buying opportunity.

Trade RecommendationsActive Trades Entry Stop Targe

Short EUR/GBP 0.8130 0.7930 0.780

Long USD/SEK 6.6200 6.7520 7.100

Long USD and JPY v

EUR CHF and SEK 100.00 98.00 106.0

Short EUR/USD 1.3620 1.3660 1.310

Long USD/NOK 6.1800 6.1300 6.700

Long USD/CHF 0.8947 0.8850 0.945

Limit Orders Entry Stop Targe

Sell EUR/AUD 1.4750 1.5030 1.310

Sell EUR/JPY 137.70 139.30 132.5

See page 15 for more details. Changes in stops/targets in bold italics.

MS Major Currency Forecasts

3Q14 4Q14 1Q15 2Q15

EUR/USD 1.33 1.31 1.27 1.24

USD/JPY 102 105 108 113

GBP/USD 1.75 1.73 1.69 1.66

USD/CHF 0.91 0.94 1.00 1.03

USD/CAD 1.16 1.18 1.19 1.20

AUD/USD 0.98 1.00 0.96 0.92

NZD/USD 0.84 0.85 0.82 0.79

EUR/JPY 136 138 137 140

EUR/GBP 0.76 0.76 0.75 0.75

EUR/CHF 1.21 1.23 1.27 1.28

EUR/SEK 9.25 9.20 9.15 9.10EUR/NOK 8.15 8.20 8.30 8.25Note: Forecasts for end-of-period. G10 forecasts updated June 8, 2014

FX Market Overview P2

NOK: The Eroded Safe Haven P6

Sell EUR/AUD P10

Sterling Sustainability P12

Technical Chart of the WeekGBP/USD P14

Strategic FX Portfolio Trade Recommendations P15

G10 & EM Currency Summary P18

Global Event Risk Calendar P20

Tactical Indicators P22

MS FX Positioning Tracker P23

Macro Forecasts P24

FX Forecasts P26

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FX Market Overview

Evan Brown, Calvin Tse, Meena Bassily

Asset market volatility in Europe is unlikely to stay contained

to equities and peripheral bonds. The lower Sharpe ratio of

holding European assets should slow inflows to Europe or

cause outflows. EUR is a sell in our view.

In an environment of rising asset volatility sourced in Europe,

we add short EUR/JPY to our strategic portfolio.

Whats more, the details of the TLTROs are encouraging for

a larger take-up, which should boost EUR liquidity and keep

EONIA low, but add further pressure to EUR.

The FOMC minutes provided little clarity on policy and

suggested significant uncertainty on how the Fed will

normalize interest rates. Given the importance of the USfront end to FX, such uncertainty may only add to FX vol.

Expectations of higher global interest rates going forward

could pressure Norwegian banks funding, with negative

repercussions for NOK.

EM currencies have been undermined by more traditional

risk-off dynamics, with stocks selling-off and peripheral

spreads widening.

We think valuations and technicals on EM currencies are

less attractive, leaving the asset class more vulnerable to

further risk-off dynamics.

IDR has benefitted from the preliminary election results, and

we see further upside risks for the currency, while we think

the relief rally in RUB may meet further challenges.

Its Becoming Less Quiet

FX volatility may be low but increased activity in equity and

bond markets is beginning to spread to currencies. The

epicenter of concern is Europe, where equities and peripheral

bonds have come off since the ECB introduced easing

measures in early June. European equities have

underperformed other global benchmarks in recent weeks,

with bank stocks in particular down 9%. Meanwhile,

peripheral bonds have weakened; the Spain-Germany 10y

spread has widened by 40 bps from the June lows. Some of

the weakness can be attributed to delay of a coupon payment

by the parent company of Portuguese bank. Though this

specific instance is likely to be ring-fenced for now, we

highlight the potential that this is not an isolated issue ahead

of the AQR, but instead that bank balance sheets and liquidity

issues may increasingly come to the fore. Indeed, given

crowded positioning and now tight spreads in the European

peripheral bond space, further liquidation may be in store as

contagion premium gets priced in.

And we also cant ignore the broader deterioration inEuropean economic data, and its co-movement with

European bank performance (Exhibit 1). We have long noted

the relationship between European bank equity performance

relative to the broader index versus EUR/USD (Exhibit 2).

Weaker European bank shares may be providing a leading

indicator of for EUR weakness.

Exhibit 1

European Bank Performance and Euro Eco Surprise

480

500

520

540

560

580

600

620

640

-120

-100

-80

-60

-40

-20

0

20

40

60

80

100

Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14

Banks relative performance - rhs

Euro Area Economic Surprise Index

Source: Bloomberg, Morgan Stanley Research

Exhibit 2

Watch Bank Shares as a Guide for Trading EUR


Finally, some of the price action also reflects a scaling back of

expectations for a QE launch in Europe anytime soon. About

half of the respondents to our cross-asset survey in late May

believed the ECB would launch QE sometime this year

(Survey Results: What If the ECB Did QE?.May 30, 2014). If

we assume some investors were positioned this way, they

may well have unwound such trades in light of recent ECB

commentary. ECB President Draghi has suggested that while

large-scale asset purchases are in the central banks toolkit,
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the Bank would like to wait and see the impact of its recently

announced measures before taking more action. With the

TLTRO not taking effect until September and ongoing legal

questions with the OMT program, we maintain the view that

there is only a 20% probability of such action. And with

French inflation missing to the downside and little sign of

pickup in broader Europe, the market may become

increasingly concerned that Draghi has not and will not do

enough to rescue Europe from deflation.

Given the large run-up in European asset valuations

over recent years, some correction was likely. And of

course, plenty of this support came from foreigners.

With the approximately EUR 1 trillion of gross flows

going to Europe over the last two years, much of which

was unhedged, we now see room for outflows, or at thevery least a slowdown in inflows (seeEUR: What Does

the Flow Say?,May 15, 2014). This should allow EUR

to trade more in line with underlying fundamentals, such

as interest rate differentials. In an environment of asset

market volatility, our favorite way to express a short

EUR position is against JPY.

TLTRO to the Rescue?

Though outright QE isnt likely to emerge out of the eurozone

in the near future, the details of the TLTROs recently

announced suggest that this policy tool may have QE-like

implications. After the last ECB meeting, the big debate

regarding the TLTRO benchmarks was whether the ECB

would set a negative lending benchmark for banks, which had

previously exhibited negative net lending over the prior year.

This was answered in the latest press release, where we

learned that there would be two benchmarks for banks. For

those which had been shrinking lending books, they will be

allowed to borrow from the TLTROs, just so long as they

shrink less. This is encouraging for a larger take-upexactly

what Draghi wants. EUR1trn was mentioned as a total cap,

which suggests that for the six TLTROs in 2015/2016, we

could see an additional EUR600bn being taken after theEUR400bn this year. This should not only keep EONIA low

with more excess liquidity flooding the system, but given

already tight spreads, should eurozone banks use this

additional cash to purchase domestic sovereign bonds or

replace funding facilities, such moves would likely crowd

foreign investors out of these markets. In a sense, the

TLTROs have the potential to act as a quasi-QE via the

banks, which in our view, is medium-term bearish for the

EUR.

Fed Uncertainty May Add Volatility

The FOMC minutes from the June meeting added little clarity

to the policy discussion, and rather confirmed the uncertainty

and even disagreement among FOMC members on the

outlook for inflation, employment and slack in the US

economy. With bond markets positioned defensively going in,

yields and the broad USD fell. For more insight on how the

recent improvement in inflation and labor markets is affecting

the FOMCs thinking, we will keep a close eye on Fed Chair

Yellens Humphrey-Hawkins testimony next Tuesday (July

15).

What the minutes did offer was an extensive discussion of the

Feds exit strategy, but without any conclusions. If anything,the discussion suggested a striking amount of uncertainty on

how one of the worlds most important financial institutions is

going to normalize policy. There was extensive discussion of

which levers will be used and how such as fed funds,

reverse repos and the interest rate on excess reserves. But

participants highlighted the complexities and potential

unintended consequences of employing particular strategies

(seeTreasury Market Commentary,July 9, 2014). Given the

importance of the front end of the US yield curve to FX,

persistent uncertainty on the Feds controls and mechanisms

is a significant risk. This only reinforces our conviction in

tactical USD/JPY weakness.

Watch the Flows

As we move through a summer of unprecedentedly low FX

volatility, it has been increasingly important to monitor where

the carry flows are going. To gauge this, one of our favored

proxies has been taking a look at Japanese investment

activity; not only do the Japanese have large cash balances to

invest, but due a prolonged period of ultra-low yields in Japan,

these investors are consistently looking for returns abroad.

Moreover, the MoF provides relatively timely and detailed

monthly data on portfolio outflows.

Earlier this week, the latest data through May were released.

The one clear favorite among the Japanese has been AUD.Indeed, as seen in Exhibit 3, Japanese investors have now

bought AUD for eight straight months. This buying has been

concentrated primarily in the bond space, both sovereign and

other.

Elsewhere, after pretty heavy selling of EUR-denominated

securities year-to-date, the Japanese were very large buyers

of EUR securities (Exhibit 3). However, the details were not

very encouraging. Almost all of the European inflow was

driven by a surge in buying of French sovereign bonds,

funded by further sales of German bonds. Given recent
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action by the ECB, less attractive valuations, and potential

contagion fears stemming from Portugal, we do not believe

that further strong inflows into the eurozone are likely.

Exhibit 3

Recent Japanese Buying of EUR Probably a One-off

Source: MoF, Morgan Stanley Research

Another Way to Play Carry

Another trade we like in the ongoing carry environment is long

AUD against NOK. We believe that NOK has been supported

by quasi-safe-haven flows, which we would expect to slow.

High levels of Norwegian household debt have been funded

by Norwegian banks, which in turn rely on a high proportion of

wholesale funding. Much of this comes from overseas and is

short term, creating high risks to Norwegian banks if globalinterest rates rise, pressuring net interest margins. As we

expect US yields rise in the second half of the year,

Norwegian banks could come under pressure, creating risks

for NOK and driving a foreign deposit outflow.

Traditional Risk-Off Hits EM Currencies

In the wake of the FOMC minutes UST yields are slightly

lower across the curve; however, EM currencies have

performed poorly versus the USD while yields in higher-beta

emerging markets have ticked higher. Of course, peripheral

spread widening and a sell-off in both DM and EM equities

helps explain the weakness in EM currencies, but the price

action also suggests declining UST yields (and a dovish Fed)

on their own may not be enough to keep EM volatility

suppressed on a sustained basis.

Indeed, we have recently argued that valuations are less

compelling across the EMFX complex and technicals more

neutral relative to periods earlier in the year. All of this means

a number of risk factors have the capacity to undermine EM

currencies, with the delay of a coupon payment by the parent

company of Portuguese bank Espirito Santo being the latest

such catalyst.

Exhibit 4

UST Yields vs EMFX

0.1

0.2

0.3

0.4

0.5

0.6

0.7

93

95

97

99

101

103

105

Jan-13 Jul-13 Jan-14 Jul-14

USD/EM US 2y (RHS)


We still think that a favourable external funding environment

can limit the scope and severity of any near-term spike in EM

volatility; however, weaker valuations in general keep us more

selective on the asset class. This is especially the case in light

of a still mild recovery in EM exports with Chinese export data

for June disappointing ours and market expectations and

continuing the trend seen in other Asia economies that have

reported trade data for the month of June.

The above discussion on weakness in European assets mayalso undermine our broadly constructive outlook on the Polish

zloty and other CEEMEA currencies. As has been the case

over prior periods of euro-centric risk-off, the PLN and HUF

have usually acted as proxies and underperformed. In a

scenario of these risks receding, we think attractive levels to

sell EUR/PLN may be realized, backed by our still positive

overall assessment of the Polish economy.

IDR Maintains Strength

Elections have passed in Indonesia, with unofficial election

results via quick count showing a close victory for Jokowi with

52-53% of the votes in his favour (official results are slated tobe announced on July 20). In addition, there have been

unconfirmed local reports of a potential alliance switch by the

second largest party, Golkar (which controls 16% of

parliamentary seats). If confirmed, this would increase

Jokowis coalition to 53% of seats (see below chart for

coalition split between Jokowi and Prabowo). We had written

about the possibility of this scenario in our pre-election note

as a positive risk for IDR (seeIndonesia Economics and

Strategy: The Election Square-Off,June 26, 2014). That said,

given Indonesias consensus-driven policy-making process,
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we believe that even under a majority government, structural

reforms will be gradual (seeIndonesia Economics:

Presidential Elections: When the Dust Settles,July 9, 2014).

Bank Indonesia (BI) also kept rates on hold at 7.5% this week

as widely expected by the market. Overall, the market has

reacted positively to this development, having sustained the

pre-election rally and with 1m IDR NDF down to 11670 on the

week.

Exhibit 5

Potential Indonesia Coalition Mix with Golkar PartySwitch

0

50

100

150

200

250

300

350

Jokowi Prabowo

SeatsDemokrat

GolkarPPP

PKS

PAN

Gerindra

Hanura

Nasdem

PKB

PDI-P

Source: Morgan Stanley Research, Local news sources

Elsewhere, the RUB staged a strong recovery over 2Q14,

which is also reflected in an expansion in the reported current

account surplus for 2Q14, leaving the 4Q rolling sum at

US$51.5 billion. The annualised expansion was largely driven

by an increase in energy exports and contraction in imports,

which may be explained by the depreciation of the RUB

earlier in the year. While we think the recent recovery in RUB

is fair given the Central Bank of Russias maintenance of tight

monetary policy and a reduction in sanction-related risks, we

think the recovery is reaching a mature phase and likely to

slow. This is particularly the case as oil prices have corrected

lower and the RUB basket is closer to the lower bounds of the

corridor than the top. As such, while the current account

surplus improvement is a welcome development, we seereduced value in chasing RUB strength from current levels,

though we would argue tight monetary policy can leave

RUB in a better position relative to currencies such as TRY

and ZAR.
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NOK: The Eroded Safe HavenHans Redeker, Sheena Shah

The CHF and NOK have many similarities, but contrary to

common belief, the NOKs function as a safe-haven currency

is not well developed.

Private-sector balance sheets have deteriorated in

Switzerland and Norway, where local asset valuations look

stretched.

Debt-laden private sector balance sheets are a source of

deflation, as Sweden has shown.

Norways energy investment is slowing down as oil

production declines

and we are now seeing spill-over effects in the non-energy

sector.

Weakening energy exports expose the Norwegian economy

to foreign competitiveness.

We suggest buying AUD/NOK and USD/NOK

The Swiss Franc of the North

Not so long ago, the NOK was often referred to as the SwissFranc of the North due to the currencys safe-haven qualities.

Like Switzerland, Norway has large foreign assets due to its

pension fund holdings. However, both countries have seen

vulnerabilities increase over recent years. The NOK may

remain the Swiss Franc of the North, as both currencies are

expected to weaken significantly over the next few yearsbut

while this expression once stood for currency strength and

stability, we believe it may come to signify currency weakness

in the future.

The Swiss Case in a Nutshell

Norway and Switzerland have faced safe-haven inflows overrecent years, but with relatively small local bond and equity

markets, and a lack of other alternatives, safe-haven flows

either went directly into real estate or alternatively boosted

local banks deposit holdings. In Switzerland, banks retreated

from risky businesses such as holding foreign currency

denominated assets, boosting instead conservative domestic

lending activities, usually asset backed. House prices

appreciated in nominal and real terms, reaching rich valuation

levels. As Swiss banks shrank their balance sheets, foreign

asset holdings declined, leading to repatriation-related CHF

demand. Banks reducing their foreign asset holdings could

not contribute to the recycling of the 12% current-account

surplus into long-term foreign asset holdings. Consequently,

the CHF rallied, pushing the real effective exchange rate up

sharply. Bank lending to the booming domestic real estate

sector not only prevented the CHF from trading near fair

value, it also boosted private wealth, promoting domestic

demand via this wealth effect. Household debt rose against

an ever-rising source of real estate collateral. Now

Switzerland is left with an ambitiously valued CHF exchange

rate, high private-sector debt levels, lofty Swiss bankmortgage exposure, and a falling inflation rate.

Exhibit 1

Swiss Banks Run Conservative Balance Sheets,Focusing on Mortgage Lending and Cash Holdings

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

00 01 02 03 04 05 06 07 08 09 10 11 12 13

Mortgage loans Liquid+MMI Banks Customers Other

Source: SNB, Morgan Stanley

The unit-cost-adjusted exchange rate in Switzerland has

appreciated by 50% since 1995, which has been, next to

Australia (95%) and Canada (48%), one of the highest

increases within the G-10. While in Canada and Australia,

rising commodity prices boosting local terms of trade justified

some of the rise of the real effective exchange rates, the

Swiss REER rise found its support from unhealthy safe-haven-motivated portfolio and deposit inflows. The lack of

long-term direct investment inflow is a long-term bearish

factor for the CHF, in our view.

Masking Funding Risks in Norway

Norway has had a similar experience. In the absence of a

large liquid sovereign bond market or equity market, safe-

haven-related inflows went into bank deposits (Exhibit 3).

Despite foreign accounts boosting their deposit holdings with

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Norwegian banks, the financial sector has remained highly

dependent on wholesale funding (see Exhibit 4). The reason

for this wholesale funding dependence relates to Norways

Exhibit 2

Swiss and Norwegian House Prices Have Rallied

Source: Macrobond, Morgan Stanley Research

Exhibit 3

Norways Save-Haven Flows Went into BankDeposits


Exhibit 4

Norwegian Banks Wholesale Funding (% of Assets)

0

10

20

30

40

50

60

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

Source: Norges Bank, Morgan Stanley Reaearch

Exhibit 5

Norwegian Loan to Deposit Ratio Boosted byForeign Deposits

40

50

60

70

80

90

100

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2008

2009

2010

2011

2012

2013

Banks incl. covered-bond-issuing entities

Parent banks

Source: Norway Finanstilsynet, Morgan Stanley Research

pension fund, which absorbs national saving surpluses,

recycling these surpluses into foreign asset holdings.

Norways households save via real estate investments and

trust funds rather than placing deposits with banks.

This wholesale funding dependency is the Achilles heel of

Norway, preventing the NOK from acting as the ultimate safe-

haven currency. When stress becomes elevated, local banks

will have to pay a liquidity and credit-risk premium, forcing

banks to adjust their loan exposures accordingly. In 2008,

tighter global liquidity conditions pushed credit growth from15% to 4%. The NOK came under significant selling pressure

from autumn 2008 onwards. Whats more, much of

Norwegian wholesale funding comes from overseasroughly

60% according to the Norwegian FSA. Though a lot of

Norwegian banks swap their FX funding into NOK, mitigating

the FX risk somewhat, this doesnt avoid risk altogether, as

the Norges Bank has highlighted. These FX swaps rely on a

foreign counterparty to provide NOK funding to domestic

banks via swapsif concerns arise about NOK, this funding

becomes more expensive, adding further concerns about

NOK and making it even more expensive for banks to fund

swaps.

With Simultaneous Housing Risks

A housing boom at the same time that foreign central banks

increased monetary accommodation, reducing funding costs,

made mortgage deals increasingly lucrative. This creates

risks for Norwegian banks, which make most of their

operating revenue via net interest income. Rising US rates

could drive global rates higher, boosting Norwegian banks

funding costs, and reducing the effectiveness of low policy

rates. When global funding costs rise, the Norges Bank may

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have to take an even more dovish tone to avoid a tightening

of domestic financial conditions. NOK selling pressure would

rise from two sides in this case. First, lower interest-rate

differentials will weaken the relative attractiveness of the

NOK, and secondly, foreign accounts holding NOK

denominated deposits may consider moving these holdings.

Norways real estate sector has reached overvalued levels on

several fronts, and household debt is even higher than in

Sweden. The low level of liquid asset holdings relative to

liabilities limits Norways capacity to work as a shock

absorber. High private-sector debt in combination with

overvalued asset prices has the potential to unleash

deflationary forces. We have highlighted these deflationary

characteristics when setting out the framework for our bearishSEK call (SEK: Disinflationary Decline,May 29, 2014). With

rising debt levels, the efficiency of debt tends to decline. While

at the starting point of leveraging up, credit generates fast

income and output growth, the growth rate of income and

output tends to decline with increasing debt levels. Moving

funds from liquid into non-liquid asset classes and increasing

the cost of asset liquidation has the potential to reduce the

flexibility of households and corporates. In Sweden, the

combination of high private-sector debt and the dominance of

non-liquid asset holdings among households broke the

transmission mechanism between growth and inflation.

Symptomatic was the decline of Swedens service sector

performance. Despite Norways current inflation rate running

near the Norges Banks target, the structure of its private

sector balance sheets suggests there are risks that Norway

goes down the Swedish path.

Exhibit 6

Norwegian House Prices Have Risen SharplySince 1985

-100

0

100

200

300

400

500

1985

1987

1989

1990

1992

1993

1995

1997

1998

2000

2001

2003

2004

2006

2008

2009

2011

2012

2014

House prices

House prices/consumer prices

House prices/wage income per wage-earner-hour worked

Source: Norway Finanstilsynet, Morgan Stanley Research

Exhibit 7

Norways Real Estate Sector Is Expensive


Exhibit 8

Non-Energy Sector Terms of Trade Have Been Poor

85

95

105

115

125

135

145

155

165

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

ToT

ToT (non-oil)

Source: Haver Analytics, Morgan Stanley Research

Energy Running Out of Steam

Norges Bank highlighted declining oil-sector investment and

the risk that the weakening energy sector would develop

growth-reducing spillover effects. Declining oil-sector

investment is in line with falling oil and gas output. Oil

production peaked in the year 2001, reaching 3.3mln bpd. As

oil fields have become mature, oil production has declined by

more than 60% from its peak. While declining revenues willweaken Norways current-account surplus, there should be no

direct bearish impact for the NOK from this side, given the

buffer function of the petroleum fund.
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Exhibit 9

Energy Production Decline Could UndermineOil & Gas Extraction Investment


However, declines in energy sector performance will weaken

domestic activities via slowing oil-sector investment. More

importantly, declining energy-sector support will unmask the

non-core energy sectors loss of competitiveness. Since the

start of Norways oil boom, itsmanufacturing sector has faced

a loss of relevance. Now, as the energy sector shrinks,

Norway will have to regain its internal and external

competitive positions. Productivity needs boosting via

structural reform, but initially structural reform will hold back

domestic demand. A weakening NOK will have to work as abuffer.

How to Trade the View

Given that our framework suggests the Fed will prepare

markets for higher rates, pushing risk assets into a higher

volatility regime, USD/NOK longs are the preferred currency

pair. However, should the strong USD view not develop or be

postponed by a dovish Fed for longer, we should consider

alternative asset currencies. What we need to look for is the

anti-NOK. We need a currency representing an area where

banks have reduced their wholesale funding reliance, where

house prices are not trading near historical highs, where

households have not accelerated their leverage position, and

where commodity exports appear secure (with little risk of

resources running short). The AUD ticks all these boxes. Ofcourse, one risk is that non-resource competitiveness in

Australia is as bad as the non-energy competitiveness of

Norway. Two-thirds of Australian exports go to Asia, and an

autonomous Asian slowdown will certainly work against the

AUD. However, the points of vulnerability are very different

when comparing NOK and AUD. With China showing

tentative signs of stabilization, AUD/NOK is a good long to

play for now, we believe.

Exhibit 10

Household Debt (% of Disposable Income)

Source: Haver Analytics, Morgan Stanley Research

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Sell EUR/AUDGeoffrey Kendrick

Weve written a lot about bullish AUD and bearish EUR views.

We now think its time to combine them from a trading

perspective.

On AUD, our view is mostly premised on strong inflows into

government bonds, as well as a structural increase in export

volumes.

On EUR, we think that ECB action has created the necessary

conditions for a grind lower, hence changing the funding

currency of choice.

We look for EUR/AUD to break below its recent range soon

and head towards our year end forecast of 1.3100.

We sell EUR/AUD at 1.4750, stop at 1.5030, targeting 1.3100.

The FX market reaction to last weeks US jobs data suggests

the following is the dominant interpretation (for now):

1. The employment data are strong. A stronger,

consumer-driven US economy will bring forward the

upside EM risk of more demand for exports. Hence

AxJ FX has traded well. This situation should persist

as long as US growth does not switch from the

demand side towards the supply side and as long asthe Fed doesnt decide to start tightening monetary

conditions via moving rate expectations up.

2. Wage growth remains benign, so the Fed can remain

dovish despite the recent uptick in core inflation.

Hence currencies of countries exposed to global

funding concerns remain bid.

In G10, the trade that best reflects this environment is short

EUR/AUD.

AUD

On AUD/USD, we recently changed our forecasts, nowexpecting the pair to reach parity by the end of 2014 (see

AUD: Parity Predicted,June 9).

The main driver of our bullish stance is our expectation that

global demand for high-yielding AAA paper will result in

further strong inflows to Australia. And with gross issuance

around AUD 5.5 billion a month, theres plenty of fresh debt

for global investors to buy.

Indeed, we see this as being achievable despite further

declines (now mostly priced in due to lags between spot and

achieved prices) in the terms of trade. The exogenous factor

which makes this possible is a once-in-a-generation increase

in export volumes.

This point is shown simply in Exhibit 1, where we can see that

since the start of 2005 non-residents have bought a total of

AUD218bn of ACGBs out of a total of AUD236bn net

issuance. Whatever the federal government prints,

non-residents want to buy.

Exhibit 1

Bond Issuance and Non-resident Buying

-10

-5

0

5

10

15

20

25

Mar-05 Mar-07 Mar-09 Mar-11 Mar-13

Net non-resident purchases = AUD218bn

Net bond issuance = AUD236bn

AUDbn qtrly

Source: ABS, AOFM, Morgan Stanley Research

In terms of where the buyers are located, MoF data released

this week showed Japanese investors bought a further

AUD3.3bn of AUD assets in May. This is the strongest month

of buying since May 2012.

In all, Japanese investors have now re-purchased AUD14.3bn

in the eight months to May, having sold AUD34.2bn in the 11

months to September 2013. JPY based accounts are volatility

driven. As long as volatility stays low, Japanese accounts will

continue looking for yield; Australias AAA status pays well.

Two-thirds of Australias exports go into Asia. Hence, the

strength of the Asia economy will remain important when

judging the AUD outlook. The recent data stabilizationwitnessed in China will help the AUD trade. Declining mining

investment has been compensated by a pick up in demand

related to local housing activity. A decline in employment

growth in mining has been compensated by rising

construction employment. Australias housing sector balance

sheets are less stretched compared to other countries where

the housing market boom looks mature, including Norway,

Sweden or Canada. Bullish AUD traders need to watch global

asset volatility, Asian growth health and Australian housing.
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Exhibit 2

Japanese Buying of AUD Assets

-6

-4

-2

0

2

4

6

8

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Equities Other Bonds Sovereign Bonds

AUDbn, monthly

Source: Japan MoF, Morgan Stanley Research

EUR

On EUR, we think recent announcements by the ECB will

prove important in finally creating the necessary conditions for

EUR to weaken. Specifically, we think the details of the

TLTROs announced last week are encouraging.

The big debate after the June ECB regarding the TLTRO

benchmarks was whether the ECB would set a negative

lending benchmark for banks that had previously exhibited

negative net lending over the prior year. This was answered in

a press release last Thursday, which showed that banks thathave exhibited positive net lending up to 30 April 2014 would

be able to borrow TLTRO funds as long as they continue to

lend more.

However, there is a different benchmark for banks that have

been shrinking lending booksthey can borrow from the

TLTROs, so long as they shrink lending less. This is

encouraging for a larger take-up, exactly what Draghi wants.

Indeed EUR1trn was mentioned as a total cap, which

suggests that for the six TLTROs in 2015/2016, we could see

an additional EUR600bn being taken after the EUR400bn this

year.

This should keep EONIA low with more excess liquidityflooding the system, and also potentially crowd foreign

investors out of EU bonds.

In terms of flows, we have also highlighted Japanese selling

of EUR assets (seeEUR: What Does the Flow Say?May 15).

Data released this week shows that total selling is now

EUR24bn in calendar year 2014 to date (to May).

Exhibit 3

Japanese Selling EUR Assets

-25000

-20000-15000

-10000

-5000

0

5000

10000

15000

20000

Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

Japan Net EUR flows (JPY100mn)

Japan Net AUD flows (JPY 100mn)

Japan selling

Japan buying

Source: Japan MoF, Morgan Stanley Research

Within EUR flows, Japanese investors have sold EUR32bn of

bunds this year, partly offset by EUR7bn of net buying of

French paper (in May).

Exhibit 4

Japanese Switching within EUR Assets

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00 Bn EUR,Monthly

Germany France Italy Netherlands

Source: Japan MoF, Morgan Stanley Research.

With portfolio flows increasingly going towards Australia andaway from the eurozone, we like positioning short EURAUD

for a medium term trade. The main risks to our view are a

sharp slowdown in Chinese growth or a potential sudden

spike in global asset volatility.
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Sterling SustainabilityIan Stannard

GBP has remained an outperformer among the G10.

However, short-term indicators and positioning suggest that

recent gains have left GBP in an overextended position

but medium-term positioning remains far more moderate,

implying that setbacks will remain limited, in our view.

Indeed, we believe that the UKs relative growth composition

provides a medium-term positive GBP picture, supported by

FDI flows.

While some further upside potential for GBP/USD is

anticipated, we focus on the crosses, especially EUR/GBP,

for sustained GBP gains.

We also highlight bullish GBP/NOK and GBP/SEK views,

given divergent monetary policy.

GBP: Stretched in the Short Term

GBP has maintained its outperforming position over the

month of June, with gains only topped by NZD within the G10.

We maintain our bullish view, especially as the composition of

UK growth continues to provide a supportive picture, likelyattracting medium-to-longer-term investment inflows. The

increased hawkishness of the BoE, signalled by Carneys

Mansion House speech and followed by the comments from

several MPC members, has also provided GBP with a boost

over the course of the past few weeks.

Market expectations for the first UK rate hike have shifted

significantly over the past month, with even the November

meeting starting to come into focus (first rate hike priced for

January 2015 by the Sonia market). This puts the BoE in the

position of likely being the first of the G4 central banks to hike

interest rates. This has provided GBP with significant support,

and while the case can be made that a rate hike is now

heavily priced in and that short-term speculative positioning

(according to CFTC data) is approaching extreme levels, we

believe that GBP setbacks are likely to remain limited.

but Supported in the Medium Term

Indeed, our MS FX Positioning Tracker, which looks at a

broader set of inputs, suggests that positioning is far more

moderate, implying that while short-term investors have likely

participated in the GBP move higher, this has not been the

case for longer-term investors. Moreover, looking at the

relative GBP-USD developments suggests that positioning for

GBP/USD is almost flat. Traditionally, GBP/USD has

correlated well with our relativeFX Positioning Tracker(see

Exhibit 1), but divergence has developed recentlyagain

consistent with the view that the most recent gains have beendriven more by short-term rather than long-term flows. Hence,

we believe that any near-term corrective setback for GBP as a

result of stretched short-term positioning is likely to remain

limited and could attract renewed longer-term inflows.

Exhibit 1

GBP/USD and MS FX Posit ion ing Tracker

1.45

1.50

1.55

1.60

1.65

1.70

-18

-13

-8

-3

2

7

12

2010 2011 2012 2013 2014

GBP-USD positioning GBP/USD (rhs)

Source: Morgan Stanley Research, Bloomberg

Indeed, it is interesting that the UK equity market has

underperformed the other major markets globally despite the

strong growth pictureanother sign, in our view, that foreign

investors have yet to participate in the more positive growth

outlook. We believe that one of the most encouraging signsfor the medium-term GBP outlook is the strong pick-up in UK

business investment within the 1Q GDP data. This contrasts

with many other G10 countries, where the pace of recovery

has been slow and business investment has been a missing

component from the growth picture. In this regard, the UK

stands out, which is likely to bode well for medium-to-longer-

term inflows to the UK, suggesting that GBP gains could

prove durable over the medium term.
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Exhibit 2

UK FDI and Portfolio Inflows and GBP/USD


Sustainable Gains

The macro-prudential measures announced by the FPC over

the past month also add to the potential sustainability of the

UK recovery, we believe. The steps announced are unlikely to

have any immediate impact on the housing market and in fact

should provide room for the recovery to extend further, while

aiming to help to prevent overheating developing in the future.

Indeed, while mortgage approvals data for the UK,

traditionally a leading indicator for house prices, have slowed

since the beginning of the year, house price indices havecontinued to put in a robust performance, suggesting that the

slowing of mortgage approvals is likely a function of the new

regulations surrounding the mortgage application process

rather than a slowing of underlying demand. As a result, we

expect GBP to remain supported over the medium term.

on the Crosses

We expect GBP gains to be most sustained against

currencies where central bank policy is continuing to develop

dovish dynamics. Hence, we have recently highlighted long

GBP/SEK and GBP/NOK positions alongside our bearish

EUR/GBP strategies. The ECB is set to maintain its easingposition, while the Scandinavian central banks have taken a

renewed dovish stance over the past month (with the

Riksbank surprising with a 50bp rate cut), responding to the

international environment and the dovishness of the ECB

more specifically. This implies that currency strength has

become an issue for both the Riksbank and Norges Bank.

Political and business pressure is also building on the ECB to

take action regarding the currency, with concerns being

expressed that the strength of EUR is having a negative

impact on European exports.

Exhibit 3

UK-Norway Relative Interest Rate Expectations andGBP/NOK


By way of contrast, the BoE has been far less vocal regarding

GBP of late, even given that on a trade-weighted basis GBP

is now at the highest levels since 2008. This is likely a

function of the more balanced growth picture that has

developed in the UK, with business investment gaining some

momentum and even exports putting in a reasonably good

performance. This is a significant change compared to recent

years, when both the UK Chancellor and the BoE have

emphasized the role of GBP in the rebalancing of the

economy. We would take this as a sign that the divergence in

monetary policy also appears to be extending to central

banks attitude towards currency strength. Hence, we believe

that GBP is likely to remain relatively well supported on many

of the crosses. We maintain our EUR/GBP year-end forecast

of 0.7600, even extending towards 0.7400 in 2015.

We also maintain our view that GBPUSD is set to target the

1.7500 area over the coming quarter (seeTechnical Chart of

the WeekGBPUSD). However, these gains may not proveas sustainable, as we would expect a generally stronger USD

to take the steam out of GBP/USD going into the end of the

year, with GBP/USD even coming under pressure next year.

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Technical Chart of the WeekGBP/USD Sheena Shah10-year GBPUSD Chart

1.30

1.40

1.50

1.60

1.70

1.80

1.90

2.00

2.10

2.20

04 05 06 07 08 09 10 11 12 13 14

2004 05 06 07 08 09 10 11 12 13 14

RSI

1

2

3

1.9338

1.3503

1.7043A

B

GBPUSD is currentlyprogressing within a 4

thwave

correction. This 4th

wave is A-B-Cwave structured with theCwave in progress. This Cwave is not yet complete,suggesting 1.73. Momentumindicators have reachedextreme levels, but have notyet rolled over. According tothis interpretation, short-termcorrective activity should belimited to 1.6950, after which

the next impulse should start.

2-year GBPUSD Chart

1.451.50

1.55

1.60

1.65

1.70

1.75

Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14

15Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14

RSI

(1)

(2)

5=(3)

(4)1

2

3

4

1

2 1.6257

1

2

3

4

1.4814

3

GBPUSD is currently in anupward-trending C-wave,which began from a low of1.4814 in July 2013. Trendchannel support intervenes at1.69. A daily close price belowchannel support and theimplicit break of the 1.6950Elliott support provide amedium-term bearish signal.In this case we would assumethat the bigger 4

thwave

correction starting in 2009 iscomplete.

90-day GBPUSD Chart

1.64

1.65

1.66

1.67

1.68

1.69

1.70

1.71

1.72

1.73

1 55 109 163 217 271 325 379 433 487 541 595 649 703 757 811 865 919 973 1027

150000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000

10 Mar 14 26 Mar 14 11 Apr 14 29 Apr 14 16 May 14 03 Jun 14 19 Jun 14 07 Jul 14

RSI

i

ii

i

ii

iii

iv

iii

iv

3

1.7063

1.6923

1.7180

However, short-term charts,the absence of negativedivergence and a slowstochastic still pushing highersuggest that GBPUSD has notyet traded its long-termcorrective top. Nonetheless,the next impulse higher,ideally starting from above1.6950, should finish thebroader 4

thwave starting

from 1.3503. Long-terminvestors should prepare for along-term bear market settingin soon.

For a description of the Elliott Wave Theory see:Trading TechnicalsThe Elliott Wave Method,January 10, 2014.Source: Bloomberg, Morgan Stanley Research
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Strategic FX Portfolio Trade RecommendationsEvan Brown

Enter: 137.70, Target: 132.50, Stop: 139.30 Weak EZ Banks to Lead EUR Lower?

Limit Order:Short

EUR/JPY

Volatility is rising in major asset markets, and FX vol is beginning toreact. The epicenter of concern is Europe, where European bankequities and peripheral bonds have come under pressure. Given howmuch foreigners have invested in Europe over the past two years, wethink higher vol is likely to reduce flows into Europe and perhaps lead tooutflows. Meanwhile, we hold our long-standing view of a tacticalcorrection higher in JPY, as a pick-up in vol and BoJ on the sidelinesshould lead to JPY strength. The key risk to this trade is if recentwobbles in risk are only short-lived.

Enter: 1.4750, Target: 1.3100, Stop: 1.5030 Japanese Steady Buyers of AUD Assets

Limit Order:Short

EUR/AUD

We remain bearish on EUR, as highlighted above, but think AUD canremain supported on steady demand for highly rated assets with decentyield. With US 10-year yields remaining under pressure, at least in thenear term, Australias rate advantage is clear. Of course, the key risk tothis trade is an improving US economy and higher US rates, whichwould damage AUDs relative attractiveness.

7-July-14 Enter: 6.1800, Target: 6.7000, Stop: 6.1300 Norges Bank Signals Dovish Rate Path

Enter:Long

USD/NOK

We stay short NOK, where valuation is rich and safe-havencharacteristics are questionable. Falling energy output should highlight

Norways lack of competitiveness in manufacturing. Recognizing theneed for FX weakness, Norges Bank recently came out on the dovishside, pushing out rate hikes by six more months. In contrast, the USDreal effective exchange rate is at historical lows, suggesting room fornormalization. The key risk to this trade is US nominal yields stayingsuppressed due to a dovish Fed.

4-July-14 Enter: 0.8947, Target: 0.9450, Stop: 0.8850 Switzerland Second-Farthest fromInflation Target in G10

Enter:Long

USD/CHF

We add to our long USD exposure against the low-yielding CHF. Withdeflationary risks still high in Switzerland, we expect the SNB tomaintain its currency policy for the foreseeable future. Indeed, inflationthis week surprised to the downside, raising the probability that markets

price in the possibility of more aggressive SNB action. As global bondyields rise and volatility picks up, we expect capital to flow out ofSwitzerland.

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Source for all charts: Bloomberg, Haver Analytics, Macrobond, Reuters EcoWin, Morgan Stanley Research

17-Jun-14 Enter: 6.6200, Target: 7.1000, Stop: 6.7520 Riksbank Forecasts Are Too Optimistic

Hold:Long

USD/SEK

Despite a positive surprise, Swedish CPI remains low, while USinflation has been rising steadily. The Riksbank last week surprised onthe dovish side, cutting rates by 50bpvery much in line with ourcautious view on the Swedish economy and SEK. We look for thisinflation divergence to play out further and hold onto this position.

28-May-14 Enter: 0.8130, Target: 0.7800, Stop: 0.7930 UK Foreign Bank Asset Reduction

Hold:Short

EUR/GBP

GBP has had a good run, which makes this weeks tactical correction oflittle surprise. But we would continue buying GBP dips against EUR.The UKs relative growth composition is quite balanced, providing an

attractive destination for both financial and FDI inflows. The potential forfurther UK bank repatriation may also support sterling. In contrast, poorEuropean economic data and ensuing asset weakness are likely to stallor even reverse the ample flows weve witnessed over recent years.Divergent monetary policy only strengthens the case for this trade.

13-Jun-14 Enter: 100, Target: 106, Stop: 98 Inflation Diverging in the G10 Space

Hold:Long JPYand USD

against ShortBasket

of EUR, CHF,and SEK

We see a clear divergence in inflationary pressures within the G10space with the EMU, Sweden and Switzerland battling disinflation, whilethe US experiences rising inflation. As such, we short these currenciesin a basket against USD and JPY as central banks keep policy easy forlongeras buttressed by the Riksbanks aggressively dovish rate cutdecision last week and the ECBs dovish tone. While the FOMC did notadjust its policy outlook at its last meeting, the strong US employmentreport last week added to the possibility of the Fed moving to a less

dovish stance in coming months, in our view.

27-June-14 Enter: 1.3620, Target: 1.3100, Stop: 1.3660 EUR Has Decoupled from 1y1y Spread

Hold:Short

EUR/USD

We recommend selling EUR on rallies in the medium term. The ECBdelivered a comprehensive package of dovish measures in June thatwe think will lower real rates over time. It may take the passing of theAQR and an end to European bank repatriation to accelerate thedecline, but ECB President Draghi has capped EUR upside in the nearterm, in our view. A very strong US employment report last week isindicative of a rebounding US economy, and we expect US rates togradually move more in favor of USD in coming months.

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FX Pulse

Strategic FX PortfolioTrade Recommendation Notional

Nominal

Weight Entry Date Entry Level Current Stop Target Spot P&L

Carry

P&L

Portfolio

Contribution

Active Trades

Short EUR/GBP $10.0mn 10.0% 28-May-14 0.8130 0.7937 0.7930 0.7800 $226.2k $4.3k $230.5k

Long USD/SEK $10.0mn 10.0% 17-Jun-14 6.6200 6.7894 6.7520 7.1000 $225.8k - $3.6k $222.1k

Long USD and JPY v

EUR CHF and SEK $10.0mn 13-Jun-14 100.00 100.68 98.00 106.00 $59.2k -$1.0k $58.2k

Short EUR/USD $10.0mn 10.0% 27-Jun-14 1.3620 1.3601 1.3660 1.3100 $8.1k $0.3k $8.4k

Long USD/NOK $10.0mn 10.0% 7-Jul-14 6.1800 6.1716 6.1300 6.7000 - $22.9k -$1.2k -$24.0k

Long USD/CHF $10.0mn 10.0% 4-Jul-14 0.8947 0.8928 0 .8850 0 .9450 -$29.7k $0.1k -$29.6k

Limit Orders

Sell EUR/AUD $10.0mn 10.0% 1.4750 1.4478 1.5030 1.3100

Sell EUR/JPY $10.0mn 10.0% 137.70 137.76 139.30 132.50

Cash $39.2mn 39.3%

Portfolio Mark to Market $99.6mn Source: Morgan Stanley Research;

Notes: (1) Stops are based on the WMR fixing. (2) The portfolio represents hypothetical, not actual, investments. For more details regarding calculations, please see Reading FX Tactical TradePerformance at the back of FX Pulse. Our FX Trade Performance Package (10 Jul 2014)contains complete performance statistics. (3) Reported returns are unleveraged. Reported returns do nottake into account transaction fees and other costs; past performance is no guarantee of future results. (4) In the case that trade allocations are increased, entry levels are a weighted average. *Global Risk Demand IndexUS Pat. No. 7,617,143. We updated our methodology for our portfolio in 2011(FX Pulse: Watching Europe, October 13, 2011).

Performance on Recommended Discretionary Currency Portfolio and Market Benchmark

90

95

100

105

110115

120

125

130

135

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

MS FX Strategic Portfolio Barclay Currency Fund Index

Simple return, index

-30 -20 -10 0 10

CHF

NOK

SEK

EUR

AUD

GBP

Basket

Last Pulse Now

USD mn

Simulated Managed Account Monthly Gross Perform ance - %

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Year r etur n

2006 -1.11 1.70 4.36 -0.37 1.24 -0.44 0.52 -1.47 -0.85 -0.84 -0.58 -0.01 2.03%

2007 -0.75 -0.77 -1.08 0.94 0.36 -2.02 1.07 2.75 1.26 0.45 1.16 0.18 3.52%

2008 1.07 2.25 2.72 -1.41 -0.53 1.28 -0.17 -0.24 -0.86 3.12 0.62 0.87 8.96%

2009 0.74 -0.97 -0.15 -1.09 0.50 -0.87 0.30 0.22 2.00 0.77 1.27 0.55 3.27%

2010 -0.01 -0.27 1.71 1.13 1.39 -0.86 -2.36 0.95 0.67 -0.30 0.13 0.66 2.80%

2011 -1.20 0.29 -1.71 0.51 -1.11 -0.33 0.84 -1.02 0.50 -1.03 -0.18 0.44 -3.97%

2012 0.34 0.46 -0.42 0.52 1.78 -0.43 0.39 0.56 0.43 0.53 0.96 0.47 5.72%

2013 -0.23 -0.66 0.08 0.10 0.26 0.05 -0.71 -0.13 -0.62 0.23 1.17 -0.27 -0.75%

2014 1.08 -0.68 -0.47 -0.02 -0.20 -0.29 0.30 -0.28%

Source: Morgan Stanley Research; see notes above.
https://ny.matrix.ms.com/eqr/article/webapp/bf04c7ee-e1a0-11e3-b4fc-deaab8bfb8dd?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/bf04c7ee-e1a0-11e3-b4fc-deaab8bfb8dd?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/bf04c7ee-e1a0-11e3-b4fc-deaab8bfb8dd?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/8e0f1e59-ee0a-4a27-8345-1b74b0d309f6?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/8e0f1e59-ee0a-4a27-8345-1b74b0d309f6?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/8e0f1e59-ee0a-4a27-8345-1b74b0d309f6?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/8e0f1e59-ee0a-4a27-8345-1b74b0d309f6?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/bf04c7ee-e1a0-11e3-b4fc-deaab8bfb8dd?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/bf04c7ee-e1a0-11e3-b4fc-deaab8bfb8dd?ch=rpinthttps://ny.matrix.ms.com/eqr/article/webapp/f4223a26-083b-11e4-a557-265f51da9937?ch=rpint

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G10 Currency SummarySheena Shah

USD Selective Long USD Strategy Bullish Watch: Retail Sales, Industrial production, FOMCs Yellen speech

1.0%

We remain selectively long USD against the disinflationary currencies (EUR, CHF and SEK) and those at risk of rising bondyields (CAD). We are selective because the Feds current dovish stance could have bearish implications for the USD. The USeconomy has shown broadening signs of improvement and with unit labor costs rising, inflation rates should stay supported.This week, we will be watching the FOMCs Yellens Humphrey Hawkins testimony.

EUR European Bank Performance Watched Bearish Watch: Industrial production, ZEW, trade balance, CPI (F),

-2.1%

With weakness in European banks, we expect EURUSD to come under further pressure, since the performance of thecurrency correlates well with European bank equity performance. Regional production data has also been coming in weak,with Germany showing the largest monthly fall in industrial production since April 2012. With the ECB remaining dovish due tolow inflation, we like to sell EURGBP driven by divergences in central bank policy.

JPY JPY Strength on the Crosses Bullish Watch: Industrial production, BoJ, Retail sales

0.4%

We expect JPY to remain supported, especially on the crosses and expect USDJPY to move down to 98 in the comingmonths.JPY strength could also come from the BoJ reducing its duration of JGB holdings. Our economists expect the BoJ toease in October; however, until then the likelihood is low, keeping JPY supported. Falling risk appetite will also likely supportthe JPY. We see weakening commodity prices and easing equity markets helping our bearish cross JPY trades.

GBP Rate Hikes in the Pipeline Bullish Watch: CPI, Employment Report

2.6%

UK data has eased somewhat over recent weeks, with house prices falling and industrial production disappointing.However, we remain bullish and note that our positioning tracker suggests that long GBP holdings may be less saturatedthan the price action suggests, making room for further upside moves. Next weeks inflation and unemployment data willbe key for currency performancewe will watch wage growth as a key indicator for rate hikes.

CHF Watching Inflation Bearish Watch: PPI, ZEW

2.1%

Inflation slipped down again in Switzerland this week, driven by a decline in foreign prices, which had been moving closerto positive territory over recent months. Should deflationary pressures remain steady or worsen, the SNB could considerlifting its floor. Recent commentary has suggested that the central bank would prefer this option to negative rates, as doongoing concerns about financial stability. This should keep risks weighted towards a weaker CHF.

CAD Its All About Inflation Neutral Watch: Canadian Payrolls, Manufacturing Sales, BoC, CPI

-3.0%

The upcoming week will have a few key releases for Canada, including payrolls, the BoC meeting, and inflation. Thelatest upside surprise in inflation is unlikely to drive a change in BoC policy, but further upside surprises could force thecentral bank to acknowledge a less dovish stance. In the near term, this could offer support to CAD, though over themedium term, poor competitiveness and concerns about export bottlenecks should weaken the currency.

AUD RBA Minutes Watched Neutral Watch: Home loans, RBA minutes, Leading Index, Business Conf.

-0.3%

We expect AUD to be supported by strong inflows into government bonds as well as a structural increase in exportvolumes. However, the domestic data has been mixed, suggesting that there are downside risks for the currency. TheRBA has also been talking about risks due to the strength of the currency. This week we will be watching the RBAminutes for further signs of this view. We like to buy AUD against EUR, driven by the monetary policy divergences.

NZD RBNZ Aggressive Rate Path Neutral Watch: House Prices, CPI, Consumer Confidence

0.6%

With inflation in New Zealand weakening and an aggressive rate hike path from the RBNZ, we have turned bearish againon the NZD. Milk prices have declined 29% since February and previous terms of trade gains have started to ease. Thehousing market has also turned around. All these factors suggest that NZD should trade lower against the USD,especially if US bond yields continue to move higher. The risk is the RBNZ hiking rates, driving NZD higher.

SEK Nearing Attractive Selling Levels Bearish Watch: European data

4.8%

The surprise 50 bp cut from the Riksbank drove SEK weakness. However, as markets now expect an extended on-holdperiod, and inflation surprised on the upside, SEK has retraced a fair share of its post-Riksbank losses. We wouldconsidering buying on any further dips in USDSEK, as we believe that downside risks to Swedish inflation persist, as thelatest print was supported by seasonal factors.

NOK The Next SEK? Bearish Watch: Existing Homes, Trade

4.3%

Risks to NOK are rising on several fronts, in our view. First, banks in Norway are heavily reliant on wholesale funding, much ofwhich is held abroad and is short term. This financing has been used to fund domestic housing assets, meaning a rise inglobal funding costs would pressure banks net interest income. Second, Norways oil investment is likely to declinesignificantly in 2015, with repercussions for the rest of the economy. We like selling NOK against USD and AUD.

Charts show 1M performance against USD, as normally quoted and DXY for USD. Click on any currency for a reference webpage on Matrix.

Click here for interactivecurrency pages:
https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4782https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4788https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4809https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4804https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4813https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4814https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4850https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4855https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4857https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4856https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4788https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4856https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4857https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4855https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4850https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4814https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4813https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4804https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4809https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4788https://matrix.ms.com/f16/common/webapp/common/shared/svc/ping/link?page=67700&subTab=4782

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July 10, 2014

FX Pulse

EM Currency SummaryJessica Liang (AXJ), Meena Bassily (CEEMEA), Felipe Hernandez (LatAm)CNY Neutral

-0.4%

The PBOC introduced unexpected volatility into the CNY fixing this year to discourage speculative positioningin USD/CNY. As we approach quarter-end in the next week, there may be further tightening in onshoreliquidity. We see some likelihood of another round of CNY weakness in 3Q.

INR Neutral1.5%

INR continues to trade well and we expect further gains in the short term, driven by portfolio flows particularly into the equity market. The RBI will likely smooth the trend. Longer-term prospects will hingemore on the success of reform efforts, in our view.

IDR Neutral-2.0%

Post the presidential election on July 9, there have been conflicting reports of both a Jokowi and Prabowo win byquick count. So far the market moves reflect the likelihood of a Jokowi win, with all asset classes rallying. Wewait for confirmation of results on July 20 and also any changes to the current coalition mix.

KRW Bullish-0.4%

Koreas GDP and trade numbers point to economic recovery. At the same time, the BoK has allowedUSD/KRW to break below key levels, which opens the door for more downside, in our view. Korean bondscontinue to see strong inflows from reserve diversification.

MYR Bullish-0.9%

MYR stands to benefit from higher oil prices, global growth recovery and subsiding portfolio outflows. BNMhas turned hawkish at the May meeting, signalling potential rate hikes which will encourage inflows into thebond market.

PHP Bullish-0.8%

The Philippines strong fundamentals and a more hawkish central bank bias support the peso. That said, thecurrency remains susceptible to the broader risk sentiment on EM and Asian currencies.

THB Bearish-0.9%

Continued political uncertainty is likely to remain a drag on GDP growth and exports. Thailand is also exposed tofunding risks, given its weak current account cushion, and FDI flows that supported THB through last year havetaken a hit since November. We remain most bearish on THB in the region.

CZK Neutral-0.4%

EUR/CZK volatility remains suppressed, with the currency trading in an extremely tight range around 27.44. TheCNBs interventionist stance has flushed speculators out of the market, and we expect it to keep EUR/CZK flatuntil there is evidence of a major shift in data in either direction. For now we stay neutral.

HUF Bullish1.5%

More uncertainty surrounding government policy changes with regard to FX mortgages and the impact on thebanks has kept HUF trading with a weakening bias over recent weeks. We still think there is a positivefundamental story at play, and so would recommend selling into sharp spikes higher in EUR/HUF.

ILS Neutral-1.0%

We do not think positioning for ILS weakness on the back of the recent rise in geopolitical risks alone is aprofitable strategy, given Israels reduced reliance on imported energy and Israels strong balance of paymentsdynamics. We think the bigger risk for ILS is BoI intervention, which keeps us neutral on ILS.

PLN Bullish0.4%

Some near-term risks have risen for PLN, given the recent increase in peripheral yield spreads and the NBPslowering of its CPI forecasts, which increase the risk of a policy rate cut. That said, we still think the macrorecovery in Poland is intact, and therefore keep to a strategy of selling EUR/PLN on spikes.

RUB Neutral-0.7%

The current account surplus for 2Q14 was strong and has helped to keep RUB supported over the quarter. Whilemaintenance of tight monetary policy may also help to keep RUB supported, we think the relief rally is in a maturephaseparticularly as oil prices correct lower and RUB no longer benefits from intervention support.

TRY Bearish2.2%

Inflation has remained high and fallen at a slower pace than market expectations, bringing to light the vulnerabilityof TRY in relation to the recent easing measures taken by the CBT and Turkeys structurally high externalfinancing requirements. We stay bearish TRY.

ZAR Bearish0.1%

Continued labor market disruptions have weighed heavily on output and exports, and therefore have weighed oninvestor sentiment towards the rand. We continue to believe that rates are too low to offer the currency adequateprotection to any change in the external environment.

BRL Bearish0.2%

A tight presidential election race and the highest carry in emerging markets amid low core yields and mutedvolatility enhance intervention and keep the currency between 2.20 and 2.25 in the short term. However, we expectBRL to trade above 2.40 after the election, given deteriorating fundamentals and less favorable market conditions.

CLP Neutral0.0%

We expect further rate cuts in response to weak economic growth and this, together with less favorable marketconditions, may push USD/CLP back above 570 in 2H14. A narrowing C/A deficit and more favorable copperprices and sentiment about China should help to limit downside risks.

COP Neutral-1.0%

Inflows from the higher weight in the GBI-EM and those attracted by rate hikes and higher growth should keepCOP well supported and allow it to trade close to 1850 in the near term and outperform. However, interventionand weaker market conditions could push USD/COP to the unofficial target of 1,900-1,950 later in 2014.

MXN Bullish-0.2%

In the short term MXN maintains a high beta to broader risks and upside is limited if market conditions turn lessfavorable. However, we expect the approval of complementary legislation to energy reform and recovering growthto support the currency in 2H14, with USD/MXN likely to outperform.

PEN Neutral-0.3%

Intervention should continue to limit volatility and the speed of currency adjustments in the short term, althoughmore dovish monetary policy could weigh. Decelerating economic growth and eroding external accounts showvaluations need to adjust, and we expect USD/PEN to climb to 2.82 by end-2014, on weaker market conditions.

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Global Event Risk CalendarSheena ShahDate Day Ccy

Time(Ldn)

EventRef.

PeriodMS forecast Market Previous

11-Jul FriAUD 02:30 Home Loans (MoM) May -0.5% 0%CAD 13:30 Unemployment Rate Jun 7% 7%EUR 07:00 German CPI (YoY) Jun F 1% 1%GBP 09:30 Construction Output (MoM) May 0.9% 1.2%MXN 15:00 Banxico Rates Decision 3.00% 3% 3%

PEN 00:00 BCRP Rates Decision Jul 4.00% 4% 4%N/A N/A

CNY N/A New Yuan Loans Jun 1100B 955B 871BCNY N/A Aggregate Financing RMB Jun 1425B 1405B

13-Jul SunNZD 23:30 Performance Services Index Jun 54.2

14-Jul Mon

EUR 10:00 Industrial Production (MoM) May 0.8%EUR 18:00 ECB's Draghi spks (Strasbourg)JPY 05:30 Industrial Production (MoM) May F 0.5%

15-Jul TuesAUD 02:30 RBA Minutes JulyCAD 14:00 Existing Home Sales (MoM) Jun 5.9%CLP 23:00 CBCH Rates Decision 4.00% 4% 4%EUR 10:00 German ZEW Survey Expectations Jul 29.8EUR 10:00 Eurozone ZEW Survey Expectations Jul 58.4GBP 09:30 CPI (YoY) Jun 1.5%GBP 09:30 ONS House Price (YoY) May 9.9%GBP 10:00 BOE's Carney, Kohn, Taylor, Bailey spk (London)JPY N/A BoJ Rates Decision 270T 270TNOK 09:00 Existing Homes (QoQ) 2Q 2.14%NZD 23:45 CPI (YoY) 2Q 1.5%

USD 10:00 Feds Yellen Testifies to SenateUSD 13:30 Retail Sales Advance (MoM) Jun 0.4% 0.6% 0.3%USD 13:30 Empire Manufacturing Jul 17.25 19.28

USD 15:00 Business Inventories May 0.6% 0.6%16-Jul Wed

AUD 01:30 Westpac Leading Index (MoM) Jun 0.1%BRL N/A COPOM Rates Decision 11.0% 11% 11%CAD 13:30 Manufacturing Sales (MoM) May -0.1%CAD 15:00 BoC Rates Decision 1.00% 1%CHF 10:00 ZEW Survey Expectations Jul 4.8CNY 03:00 Fixed Assets Ex Rural YTD (YoY) Jun 17.2% 17.2% 17.2%CNY 03:00 Retail Sales (YoY) Jun 12.1% 12.5% 12.5%CNY 03:00 Industrial Production (YoY) Jun 9% 9% 8.8%CNY 03:00 GDP (YoY) 2Q 7.2% 7.4% 7.4%EUR 10:00 Trade Balance May 15794GBP 09:30 Average Weekly Earnings 3M/YoY May 0.7%GBP 09:30 ILO Unemployment Rate 3Mths May 6.6%NOK 09:00 Trade Balance Jun 26.79BUSD 10:00 Feds Yellen Testifies to HouseUSD 14:00 Net Long-term TIC Flows May -24.2BUSD 14:00 Total Net TIC Flows May 136.8B

USD 14:15 Industrial Production (MoM) Jun 0.5% 0.3% 0.6%USD 14:15 Capacity Utilization Jun 79.3% 79.3% 79.1%USD 14:15 Manufacturing Production (MoM) Jun 0.6%USD 15:00 NAHB Housing Market Index Jul 50 49USD 19:00 Fed Releases Beige Book

17-Jul ThursAUD 01:00 Conference Board Leading Index May -0.1CAD 13:30 Int'l Securities Transactions May 10.1BEUR 10:00 Construction Output (MoM) May 0.8%EUR 10:00 CPI (YoY) Jun F 0.5%NZD 02:00 ANZ Consumer Confidence (MoM) Jul 3.4%TRY 12:00 CBT Rates Decision 8.75% 8.25% 8.75%

USD 13:30 Housing Starts Jun 1.02m 1020k 1001kUSD 13:30 Initial Jobless Claims 315k 315kUSD 13:30 Building Permits (MoM) Jun 4.2% -5.1%

Click here for a full, searchable calendar
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17-Jul Thurs

USD 15:00 Philadelphia Fed Business Outlook Jul 15.05 17.8ZAR N/A SARB Rates Decision 5.5% 5.5%

18-Jul FriCAD 13:30 CPI (YoY) Jun 2.3%CNY 02:30 China Property Prices JuneEUR 09:00 Euro-area Current Account May 21.5BUSD 14:55 Univ. of Michigan Confidence Jul P 83.5 82.5USD 15:00 Leading Index Jun 0.4% 0.5% 0.5%

21-Jul MonCHF 08:00 M3 (YoY) Jun 7.57%NZD 04:00 Credit Card Spending (MoM) Jun 3%

22-Jul Tues

AUD 04:00 RBA's Stevens spks (Sydney)CHF 07:00 Trade Balance Jun 2.77BGBP 09:30 PSNB ex Interventions Jun 13.34BGBP 11:00 CBI Business Optimism Jul 33HUF 13:00 NBH Rates Decision 2.2% 2.3%JPY 05:30 All Industry Activity Index (MoM) May -4.3%

JPY 06:00 Leading Index CI May F 105.7USD 13:30 CPI (YoY) Jun 2.1%USD 14:00 House Price Index (MoM) May 0%USD 15:00 Richmond Fed Manufacturing Index Jul 3USD 15:00 Existing Home Sales Jun 4.89m

23-Jul WedAUD 02:30 CPI (YoY) 2Q 2.9%CAD 13:30 Retail Sales (MoM) May 1.1%EUR 15:00 Consumer Confidence Jul A -7.5%GBP 09:30 BoE MinutesNZD 22:00 RBNZ Rates Decision 3.50% 3.25%NZD 23:45 Trade Balance Jun 284.62m

24-Jul ThursCNY 02:45 PMI Manufacturing Jul P 50.7EUR 08:30 German PMI Manufacturing Jul P 52EUR 09:00 PMI Manufacturing Jul P 51.8GBP 09:30 Retail Sales (MoM) Jun -0.5%JPY 00:50 Trade Balance Jun -910.8B

SEK 08:30 Unemployment Rate Jun 8%SEK 08:30 PPI (YoY) Jun 2.8%USD 13:30 Initial Jobless Claims 315k 315kUSD 15:00 New Home Sales Jun 504kUSD 16:00 Kansas City Fed Manufacturing Activity Jul 6

25-Jul FriEUR 07:00 German GfK Consumer Confidence Aug 8.9EUR 09:00 IFO Expectations Jul 104.8EUR 09:00 M3 (YoY) Jun 1%GBP 09:30 GDP (QoQ) 2Q A 0.8%JPY 00:30 CPI (YoY) Jun 3.7%NZD 02:00 ANZ Business Confidence Jul 42.8RUB 10:30 CBR Rates Decision 7.5% 7.5% 7.5%SEK 08:30 Household Lending (YoY) Jun 5.007%SEK 08:30 Retail Sales (MoM) Jun -0.73%SEK 08:30 Trade Balance Jun 0.2USD 13:30 Durable Goods Orders Jun -0.9%

Upcoming Risk Events

30-July USD 19:00 FOMC Rates Decision July 0.1% 0.1%05-Aug AUD 05:30 RBA Rates Decision Aug 2.5% 2.5%07-Aug GBP 12:00 BoE Rates Decision Aug 0.5% 0.5%04-Sep SEK 08:30 Riksbank Rates Decision Sep 0.25%18-Sep NOK 09:00 Norges Bank Rates Decision Sep 1.5%25-Sep CHF 08:30 SNB Rates Decision Sept 0.0% 0.0%N/A Denotes timing approximate or not confirmed / All times and dates are GMT and correct as of the date of publication / For a full list of economic events see the calendar on the Morgan StanleyMatrix Platform/Source: Morgan Stanley Research, Bloomberg
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FX Pulse

G10 FX Tactical IndicatorsSheena Shah

Exhibit 1

Historical Currency Performance

-4%

-3%

-2%

-1%

0%

1%

2%

3%

GBP CAD NZD CHF JPY EUR AUD DXY SEK NOK

Monthly Weekly


Exhibit 2

FXVIX (FX Volatility Index)

5.2

6.2

7.2

8.2

9.2

10.2

11.2

Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14


Exhibit 3

Relative Momentum Indicator

-10

-5

0

5

10

GBP CAD NZD CHF EUR USD AUD JPY SEK NOK

Current Last week


Exhibit 4

MS GRDIStandardized

-4

-3

-2

-1

0

1

2

3

Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Ma

Date post:	03-Jun-2018
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