Td Securities

7/31/2019 Td Securities

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LONDON TORONTO NEW YORK SINGAPORE

Global MarketsAugust 17, 2011Rates & ForeignExchange Research

STICKS AND STONES MAY BREAK MY BONES,

BUT WORDS DONT DRIVE ECONOMIES

CONTENTSLead Article: Sticks And Stones MayBreak My Bones, But Words Dont DriveEconomies 1U S Fixed Income 4Canadian Fixed Income 6U K Fixed Income 9

Australian Fixed Income 10New Zealand Fixed Income 11U S Dollar 12Canadian Dollar 13Euro 14Japanese Yen 15U K Pound 16Australian Dollar 17New Zealand Dollar 18Swiss Franc 19Summary Fixed Income Table 20

Summary Foreign Exchange Table 21

HIGHLIGHTS

Thebiggestmistakewecanmakeright now is overreacting to fearsin markets, because overreactionhas real consequences for thereal economy The second big-gest mistake we can make rightnow is to ignore the marketsreactions when adjusting macroassumptions, because those re-actions have real consequenceson the real economy

Major forecast revisions includedelaying the first hike by theFederal Reserve to 2013Q3 Thefed funds target rate is forecastto reach 75 basis points by theend of 2013 The next hike by theBank of Canada was also delayedto 2012H2 and the overnight ratewill reach 2 00% by the end of theyear A further 100 basis points of hikes are forecast to occur over the second half of 2013 The Bankof England is also expected toconduct an additional 50bn inasset purchases starting in early2012

Where is the catalyst coming from to change our current global momentum?When interest rates are inept, monetary policy is left to act through balancesheets so equities matter. When nancial conditions are changing so rapidly,forecasters models based only on macro variables tend to lag changes in theeconomy even more than usual, and misconceptions like lower oil prices areimmediately good for growth return to the forefront.

The biggest risk to the global recovery is the inability of the US to sustain a suf -cient pace of growth and the lack of effective policy tools to make much of a differ -ence. A lack of suf cient growth momentum is apparent, while systemic risks that

create the viciouscycles that drovethe subprime andEM currency crisesare not, but wouldquickly emerge wereEuropean leaders tolose their resolveto the Eurozone.So the most likelydownside risk does

not appear to be -nancial oblivion 2.0,

but for those withmemories that dontgo past 2007, reces -sions didnt alwayshave to mean nancial collapse, just a lack of growth for at least six months.

If G7 central banks have qualms with providing easing and markets havequalms with anyone using scal policy, then the one eventual solution would bethat growth and in ation prospects must fall suf ciently until EM central banksfeel the need to ease. This is coming via weaker EM exchange rates already,

and lowering capital controls, reserve requirements, and even interest rates couldfollow if needed.

Fear of a Slack Planet

European political wrangling and sovereign debt stresses have dominated theheadlines. But these fears do not explain the market collapse over the last month.US debt concerns do. In fact, since the start of 2010, the relationship betweenthe level of Eurozone CDS spreads and the level S&P500 is positive higher credit risks in Europe = higher stocks. This is correlation, not causation. Andon a weekly basis, increases in peripheral spreads are correlated with decreasesin equities as you would expect. The public arguments and intransigence of

SO FAR, EUROZONE IS THE ONE PLACE THATHASN'T BEEN PUSHING GLOBAL GROWTH

LOWER*

65

70

75

80

85

90

95

100

105

110

11.Jul10.Jul09.Jul08.Jul07.Jul06.Jul

*TD Securities survey-based estimates for June/July; **Detrended for the 0.6% m/m constant expansion in EM; Source: Bloomberg

IP (Index)

EM**

US

Japan

Eurozone

The start of QE2 heredid generate growth,ust not in the US


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Global Markets August 17, 2011Rates & FX Research

2

European leaders may make for a horrible spectacle, butit has not been a primary driver of the underlying trend inrisk. It is US growth that matters much more. More jobs

= higher stocks.Wary of the unintended consequence that asset purchases

have had on commodity price in ation, the Federal Reservehas used wordsspeci cally a conditional commitmentto hold its policy interest rate unchanged until at least thesecond half of 2013to do what it can. But ultimately,words do not drive economies. In an environment wheregrowth momentum has continued to fall, not rise, and mostof the rest of the world continues to underperform the US,US exports will have a hard time nding buyers. And theFed is not the only constrained central bank. The Bank of Canada will need to respect the policy elastic that binds thetwo economies together and hope that core in ation sub -sides in tandem with the deterioration in economic growth.Elsewhere, the Bank of England will have to revert to asset

purchases to stimulate the economy. Japan continues tooperate in a ZIRP environment Zero Interest Rate Policy

while the Swiss National Bank seems on the verge of becoming the latest NIRP central bank as the market pricesin negative interest rates rather than just zero.

Coming into the shocks of July and August, global mo -mentum was weaker than we have seen since the 2008-2009recessionary period. Relative to the period that spawnedQE2, Japanese production is off more, US growth is slower,and EM deceleration is faster. In fact, the only major eco -nomic area in a better position now than prior to QE2 lastyear is the Eurozone. US production growth has failed tokeep pace with the Eurozone over the last year, and with US

production growth at-lined, it is likely that the Eurozone

economy will contract in Q3 and a 50/50 chance this is fol -lowed with a further contraction in Q4.

The reconstruction-led recovery in Japan continues, but just as in German factory orders, there is a clear divide between domestic strength and the poor performance of foreign-sourced demand. Reconstruction will naturally fuela Q3 rebound, but the lagged effects of the sharp apprecia -tion of the yen will weigh on Japanese exports through theend of the year and potentially drag the economy back into

contraction in Q4. Even sharper appreciation of CHF raisesnot just the risk of contraction in Switzerland but de ation,as the central bank explores radical steps to manage theserisks.

You can lead a horse to liquidity, but EMs need adrink

Recent volatility has spread contagion to emergingmarkets via capital ight. The sharp reversal of previousstrong in ows has induced a marked correction of nearlyall EM crosses in August, the Chinese yuan being the most

notable outlier. Although moves may have been magni ed by the notoriously thin summer liquidity, we can not ignorethe fact that the external environment is mutating rapidly.The simultaneous slowdown of the US and Eurozone willnot be offset by the resilience of EM growth for too long,as suggested by early indicators. In fact, manufacturingactivity surveys sustain the view that the recent soft patchin EM industrial production is going to extend for longer than initially thought. While the lagged effect of Japanesesupply-chain disruptions may have run its course, severalemerging economies are now constrained by structural

bottlenecks. With close-to-zero slack capacity in EMs and

S&P 500 - THE US IS STILL THE BIG CHEESE

900

1100

1300

1500

8/114/1112/108/105/101/10

Source: Bloomberg

Index

US easing: +28%US debt

fears: -20%

Irelandfears

Portugalfears

Greecefears

Greecefearsagain Italy/

Spainfears

HIGHER SPANISH YIELDS ARE RISK ON, RIGHT?

1,000

1,100

1,200

1,300

1,400

8/116/114/112/1112/1011/109/107/105/103/101/10

2

3

4

5

6

Source: Bloomberg

Index

Spanish 5y yield (rhs)

S&P 500 (lhs)

Yield (%)


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developed market (DM) growth forecasts falling, EMs areunlikely to escape the slowdown. Chinese growth remainsmore of a question mark and while a hard-landing remains

unlikely, in our opinion, growth is cooling there as well,which poses additional downside risks.

A second implication of global stress has been the abruptfall of yields. The Feds commitment to hold rates close tozero until 2013 de nitely had an impact on the front-endof EM curves, which trailed interest rates moves in theUS. However, rates have fallen across the whole maturityspectrum, with longer-term IRS yields, where liquidity istypically lower, plunging. Traders are now hoarding dol -lars in the money markets through cross-currency swaps,for example, pushing implied yields lower and promptingseveral EM central banks to implement measures to sup -

port liquidity.

Turkeys CBRT, for instance, lowered the borrowingdeposit rates on USD and EUR by 1pp to 4.5% and 5.5%,

respectively, after unexpectedly cutting the repo rate by50bp to 5.75% and increasing the o/n borrowing rate from1.5% to 5.0% just one week prior in order to render carry

trades less volatile and hence more attractive to investors.In a similar attempt, Bank Indonesia announced they willuse dollars to buy rupiah-denominated government bonds,to manage their cash balance and maintain currency stabil -ity. Such measures allow central banks to partly unwindthe quantitative tightening they delivered over the last year or so. We would expect this course of action to precedean interruption of monetary tightening rst, and orthodoxmonetary easing after. Yet, before EM policymakers reverten masse to looser policy rates, we would have to see thegrowth outlooks worsen substantially more than we cur -

rently envisage and the in ation outlooks taking a visibly benign drift. But shocks continue to be transmitted throughglobal markets, both in G10 and EM, with lags that willstretch into year-end.

Richard Kelly Head of European Rates & FX Research

+44 20 7786 8448

Cristian MaggioSenior Emerging Market Strategist

+44 20 7786 8436


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U S FIXED INCOME

Earlier this year we adopted a more bullish view on theeconomy centred on favourable underlying fundamentals in

jobs, lending, and income growth to name a few. Coupledwith an in ation forecast that at the time appeared aggres -sive and now looks too conservative, we argued that a high

probability event was for tighter Fed policy in Q1 2012. Thatnow seems a world away. We may have underestimated thefragility of the recovery, but we certainly did not anticipatethe numerous headwinds that have since emerged.

Investors (and economists) now need to navigate aworld in which the pace of growth may struggle to movemuch beyond potential, about 2%. That is the messagefrom the GDP revisions which were uniformly atrocious,and one that re ected an economy uncomfortably close tostall speed. This pace leaves the economy more vulnerableto periodic setbacks at a time when periodic shocks havehappened with alarming regularity. Private sector surplusesmust be unleashed and the current account must improveif the economy is to absorb scal austerity. These are basicaccounting identities. However, private sector activity hasnot demonstrated a capacity or willingness to absorb a scalausterity that has already set in. Con dence in the economyhas faltered; governments on both sides of the Atlantic haveddled. These growth risks are now being re-priced through

risk assets. Odds that the Fed will make progress in achiev -ing its dual mandate over coming quarters are now sharplydiminished. Monetary policy has had to adjust under theseconditions, and it has.

In this environment and with few tools at their disposal,the Fed has to be creative. The commitment to keep ratesunchanged until at least 2013 is the latest example of this, and another rst for a central bank now accustomedto unconventional measures. Few if anybody of us have arm grasp on when the Fed will begin to raise rates. All wenow know is that it is not likely to happen until 2013, and

probably not before Q3 2013.

U S 3-MONTH T-BILL RATES & 10-YEARGOVERNMENT BOND YIELDS

0

1

2

3

4

5

6

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

1

2

3

4

5

6

Actual data to Q2 2011; Forecast by TDBG as at August 2011Source: Federal Reserve Board/Haver Analytics

%

10-yr Gov't Bond Yield

3-mo T-Bill yield

%

Forecast

Spot Rate 2011 201217/08/2011 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

Fed Funds Target Rate (%) 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.75 1.00

3-mth T-Bill Rate (%) 0.02 0.09 0.00 0.05 0.07 0.10 0.10 0.10 0.10 0.10 0.15 0.80 1.10

2-yr Govt. Bond Yield (%) 0.19 0.82 0.46 0.20 0.25 0.25 0.25 0.25 0.60 0.80 0.95 1.15 1.55




10-yr-2-yr Govt. Spread (%) 2.05 2.65 2.70 2.05 2.15 2.25 2.30 2.40 2.15 1.95 1.85 1.85 1.70

f: Forecast by TD Bank Group as at August 17, 2011; All forecasts are for end of period. Source: Bloomberg, TDBG

2013U S FIXED INCOME OUTLOOK

Bernanke launched this commitment against three dissents, a clear af rmation that this is his Fed, his legacy, andhe will do whatever is necessary to avoid a Japan outcome.Recall Bernanke is the author of it cant happen here. Heintends to make good on that pledge. That means his effortsto focus the market away from more QE today does not preclude more innovative methods to ease conditions down theroad if conditions deteriorate further. Nothing can be ruledout down the road, everything has to be on the table untilits not. That includes more QE. If risk assets continue to falland in ation expectations turn decisively the Fed would bemotivated to action. We are not there yet. We also suspectconditions will not deteriorate suf ciently to get us there.

However, we are in a period in which Fed policy is tiltedsquarely toward efforts to promote an uneven recovery ina high risk environment.

Active trading strategies now focus on the curve andmust shift to longer maturities. The 10yr and 30yr sector

become the new 2 and 5 yr trading maturities. Short-termrates may be tied to policy, but longer term rates can stilltrade on the in ation premium, and growth both of which


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drive the expectations for short-term rates beyond 2013.Falling growth expectations and the drop in commodity

prices gives breakevens room to fall as investors need lessin ation protection. If long term in ation expectations fallfrom 2.61% (around their average since last October) and

back toward 2.0% (as in late 2010) expectations for shortrates in the 2-10 year bucket would also likely drift lower.That could keep 10 yr yields pegged at 2.0%, or lower.

The 30yr bond is the outlier here. It is the least tetheredto Fed policy, the part of the curve the Fed is least concernedwith, and the maturity that will most capturing underlyingsentiment on growth and in ation. The 10/30 spread has

Eric Green, Chief U.S. Strategist 212-827-7156

risen to 146bp from 103bp in early April. We suspect thatspread is likely to move through the record high of 164bp

posted on the eve of QE2. The extent to which the commit -ment to low rates for longer is seen as hard or conditionalwill depend on the evolution of the data, and the evolutionof in ation expectations tied to that data. Stronger data willerode con dence in that commitment, as will higher in a -tion, and the extent to which the data move the Feds waywill govern their resolve to purchase long-term assets as

part of the reinvestment program. Much is in play. However,for now we have to think of 10s and 30s trading in 50bpranges round 2.25% and 3.50% respectively.


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CANADIAN FIXED INCOME

It has been an exceptionally tumultuous month for theglobal economy and the world looks far different todaythan it did when Global Markets was last published in themiddle of July. In Europe, the announcement of a second

bailout for Greece failed to stem the fear of contagion intothe economies and banking systems of Italy and Spain. Thismarked a very worrying turn in the European debt saga, asthese two members of the periphery have the unfortunatedistinction of being both too large to bail out or let fail. Thespectre of sovereign risk also jumped across the Atlanticand was accentuated by an equally dysfunctional displayof political brinksmanship in the United States surroundingthe 11th hour increase in the debt ceiling. But in the eyesof S&P, the political showdown continued after the clock struck midnight and in an unprecedented announcement,the long-term sovereign debt rating of the US was cut fromAAA to AA+.

The dramatic resurgence of sovereign risk was matched by equally discouraging news that the pace of the wider economic recovery had slowed signi cantly. Benchmark revisions to US real GDP revealed a much deeper hole fromwhich the worlds largest economy is struggling to climbout of. Growth over the rst half of the year was also gut -ted to the point where a double dip recession has returnedto the popular vernacular. Furthermore, forward-lookingmeasures of economic activity hold little promise that thesoft patch that ensnared the rst six months of 2011 will dis -sipate any time soon. This expectation has been reinforced

by the con dence-sapping sell-off in risky asset markets,as investors struggle to identify which continent and asset

class to shun rst.With scal policy in the US lacking both willingness and

ability to combat these headwinds, it fell once again to theFederal Reserve to provide support to the wider economyand nancial markets. Wary of the unintended consequencesthat additional asset purchases have on commodity pricein ation, the Fed took a page out of the Bank of Canadas

playbook in announcing a conditional commitment to main -tain the current level of the fed funds rate until at least themiddle of 2013. Relative to what the market had priced infor the Fed, this commitment is not altogether extreme, butit will nevertheless have a signi cant impact on yields in

both the US and Canada.

CANADIAN 3-MONTH T-BILL RATES & 10-YEARGOVERNMENT BOND YIELDS

0

1

2

3

4

5

6

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

1

2

3

4

5

6

Actual data to Q2 2011; Forecast by TDBG as at August 2011Source: Bank of Canada/Haver Analytics

%


3-mo T-Bill yield

%

Forecast

Spot Rate 2011 201217/08/11 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

Overnight Target Rate (%) 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.50 2.00 2.00 2.00 2.50 3.00

3-mth T-Bill Rate (%) 0.87 0.96 0.90 1.10 1.10 1.10 1.15 1.60 2.10 2.10 2.15 2.65 3.102-yr Govt. Bond Yield (%) 0.99 1.83 1.59 1.10 1.20 1.25 1.90 2.15 2.40 2.55 2.80 2.95 3.20




10-yr-2-yr Govt. Spread (%) 1.43 1.52 1.52 1.55 1.55 1.70 1.30 1.10 1.00 0.85 0.75 0.80 0.75

Canada-U S Spreads3-mth T-Bill Rate (%) 0.85 0.87 0.90 1.05 1.03 1.00 1.05 1.50 2.00 2.00 2.00 1.85 2.00



10-yr Govt. Bond Yield (%) 0.18 -0.12 -0.05 0.40 0.35 0.45 0.65 0.60 0.65 0.65 0.75 0.75 0.70

30-yr Govt. Bond Yield (%) -0.57 -0.75 -0.83 -0.60 -0.75 -0.55 -0.45 -0.40 -0.40 -0.35 -0.20 -0.20 -0.20


CANADIAN FIXED INCOME OUTLOOK2013


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Extending Lower for Longer and Respecting thePolicy Elastic

The combination of a weaker international growthoutlook and the Feds conditional commitment will keepthe Bank of Canada on hold for longer than many privatesector forecastersand likely the Bank itselfwould haveexpected last month. Recall that in the communiqu ac -companying the July Fixed Announcement Date (FAD), theBank dropped the quali er eventually from their forward-looking language that some of the policy accommodationcurrently in place would need to be removed. In response,the market began to price in rate hikes in to late 2011 andmany economists pulled their expectations for hikes forwardto as early as the September FAD. In defending our call for the next hike to arrive in January 2012, we noted that for the Bank to feel comfortable hiking in 2011 the interna -tional headwinds and the downside risks they engenderedwould need to abate. Instead, the downside risks related togovernment debt levels and slowing economic momentummaterialized and migrated into the base case outlook.

In contemplating the range of actions the Bank could takewe expect that the theme of lower for longer will prevailand have pushed back the timing of the rst rate hike by six

months to July 2012. The overnight rate is then forecast to belifted by 25 basis points at the next three FADs to nish theyear at 2.00%. At this point, we expect the Bank to move tothe sidelines and reassess conditions in the wider economy

before resuming the withdrawal of stimulus in tandem withthe Fed in the second half of 2013. The overnight rate isexpected to reach 3.00% by the end of the year.

Our outlook for the Bank of Canada is conditioned primarily on a revised forecast for the Canadian economy but also respects the limit to how far the overnight rate candeviate from the fed funds target rate set by the FederalReserve. Our revised outlook for the Fed takes them at their word that they will wait until 2013Q3 before withdrawingstimulus. The hikes expected by the Bank in the second half of 2012 will therefore take the policy rate spread to 175 basis

points, which is more than one standard deviation above thehistorical average. In our view, the Bank will be hesitantto push this spread wider given the impact it will have oncausing the Canadian dollar to appreciate at a time where theoutlook for economic growth is increasingly reliant on netexports. From a more fundamental perspective, a wideninginterest rate differential is inconsistent with two economiesthat share an economic cycle.

Looking exclusively at Canadas domestic economy,one could make the case that the cyclical relationships nolonger hold and that the current level of the overnight rateis too low. After all, the interest rate sensitive sectors of theCanadian economyresidential investment and consumer spendinghave responded as desired and business invest -ment, which had previously lagged the recovery, has begunto make up for lost time. However, there is only so far thatdomestic factors can carry economic growth. UltimatelyCanada is a small open economy that will be weighed down

by what is forecast to be a very subdued level of foreigndemand. When the international weakness is paired withfatigued households and a smaller footprint for governmentspending, the output gap is now forecast to widen in the com -

OIS SWAPS: PROBABILITY OF A JANUARY 2012HIKE

-200

-150

-100

-50

0

50

100

150

07/01 07/07 07/13 07/19 07/25 07/29 08/04 08/10 08/16

BoC July Meeting

Source: Bloomberg, TD Securities

0 10203040

-2.75

-2.25

-1.75

-1.25

-0.75

-0.25

0.25

0.75

1.25

1.75

2.25

2.75

3.25

3.75

1992 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

OVERNIGHT RATE MINUS FED FUNDS TARGET

RATE

Source: Haver Analytics, TD Securities

P e r c e n t

Frequency

+1 Std Dev.

-1 Std. Dev

Forecast


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David Tulk, Chief Canada Macro Strategist 416-983-0445

ing quarters before gradually closing thereafter. We estimatethat the output gap will close by the middle of 2013, whichis 12 months later than what the Bank had forecast in their July Monetary Policy Report (MPR). A slower trajectory for economic growth and a slower pace of capacity absorptionis forecast to allow core in ation to retreat from its recentascent towards the 2.0% target in the coming quarters.

Slower Stimulus Withdrawal to Weigh on the Curve

The objective of the Federal Reserve in adopting a condi -tional commitment is to anchor as much of the front end as

possible to ensure that the slope of the curve remains steep.Pairing this in uence with a more leisurely pace of stimuluswithdrawal by the Bank of Canada will also keep yields inCanada quite subdued ahead of the return of rate hikes inthe second half of 2012. At that point we expect the curveto atten, which will be reinforced when the Fed begins towithdraw stimulus a year later. In the long end, we expectthat continued foreign interest in Canadian securities willhelp keep yields subdued, especially relative to the US wherethe road to scal consolidation is muddied by the politicsaround the 2012 Presidential election.

Risks around the Outlook Still Skewed to the

DownsideThe announcement of the conditional commitment by

the Fed was likely met with some consternation within theBank of Canada. After all, the Canadian economy faces fewof the structural headwinds as its southern neighbour and isstruggling to manage the ensuing rise in household leverage.Barring a dislocation in short-term funding markets caused

by an international crisis, this structural head start will likelykeep the Bank from considering a cut in the overnight rate.And even if Bank feels constrained in pushing its policyrate ahead of the Fed, there is a deeper recognition that the

wider global recovery is likely to be far more subdued thaninitially forecast. In this vein, the theme of lower for longer remains the preferred policy action. Finally, in the event thateconomic growth can scale the wall of worry and overcome

both the scal drag and related uncertainty, the Bank will be quick to act. However, our view is that this is the lower probability risk at the present time.

0

3

6

9

0

3

6

9%

LOWER FOR LONGER CONSISTENT WITH GROWTHBACKDROP

Overnight RateForecast

%

-8

-6

-4

-2

0

2

4

6

8

-8

-6

-4

-2

0

2

4

6

8

GDP (Q/Q Ann)Forecast

1

2

3

1

2

3

Core CPIForecast

-4

-2

0

2

4

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013-4

-2

0

2

4

Output GapForecast

Source: Statistics Canada, Bank of Canada, Haver Analytics, TD EconomicsShaded for when Q/Q GDP growth is greater than 2%.


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U K FIXED INCOMESimply pushing out rate hikes further into the future is

no longer likely going to be enough. Renewed asset pur -chases will likely be needed in order to provide additionalstimulus into the UK economy. We downgraded our UK Outlook in July , but this was clearly not enough given thefurther deceleration in global data and the rapid deteriora -tion in markets since then. In ation is still rising towards5% later this year, and that makes easing right now opticallyunpalatable. But in ation risks will fade with each passingmonth while global growth risks will rise. The net result isthat easing risks will continue to rise in the months ahead.

Ultimately, we expect the complex calculus of balancingthe exceptionally high level of in ation with increasingly

poor economic growth will lead the BoE to announce pur -chases of 50bn in gilts in the rst quarter of 2012, likely inFebruary in tandem with the In ation Report. This couldcome as early as November if the hard data suggest a morerapid contraction in growth. But we dont expect foreign de -mand to have decelerated fast enough to outweigh the fearsover in ation by that point. Additionally, up to this point,the service sector in the UK appears to have maintainedan even keel even as the manufacturing sector contracts.This is tempering the drag on UK demand to start Q3, butis unlikely to persist. So early in 2012, following two weak quarters of growth, likely even weaker growth in the Eu -rozone, and with UK in ation nally falling towards 2%,further stimulus will likely be seen as warranted.

The BoE has none of their existing gilt holdings maturinguntil July 2013, so there is no ability to proxy an OperationTwist as in the US to roll short-term holdings further out thecurve. Mervyn King also made clear in his press confer -ence on August 10th that he is not a fan of the conditionalcommitment to hold rates at their current level for a de ned

period of time as is being used by the Fed now and was used before by the Bank of Canada. In buying gilts, the BoE has

preferred avoiding bonds maturing in the coming few yearsin order to avoid having to worry about the rollover issue,has avoided holding over 50% of any particular issue, and

prefers to buy benchmarks to maximize the impact on themarket.

This leaves the BoEs holdings fairly light in the 2015sto 2017s, 2019s to 2020s, 2025s, and anything 2034 andout. With most of the buying likely having to occur beyondthe 5y sector, 2s10s is likely the best bet for signi cantattening as bond buying will be coupled with diminishedin ation fears. And while 10s30s could steepen slightly onthis buying in the coming quarters, this is the area with thegreatest potential for attening once we move into 2012.The underlying message is that it is unlikely that we haveseen the bottom in yields yet, as dramatically low as they are.

There are four clear risks to the BoE re-embarking onasset purchases. The high level of in ation could start to

push UK wage demands higher, in which case the MPCwould have no choice but to hike. The global environmentmay prove less gloomy than some indicators are suggesting,in which case the MPC may be able to wait out the weak -ness. The Fed could embark on QE3 or further easing, inwhich case global momentum would improve and offset theBoEs major downside risk. And gridlock could keep theMPC from acting, as disagreements on the principal risksand likely forecasts may leave a split decision short of theneeded ve votes. We expect to see at least two votes for asset purchases by November and potentially even three.

Richard Kelly Head of European Rates & FX Research

+44 20 7786 8448

U K FIXED INCOME OUTLOOKSpot Rate 2011 2012 201317/08/11 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

Bank Rate Target (%) 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75 1.00 1.25 1.50 1.75

3-mth T-Bill Rate (%) 0.51 0.65 0.65 0.70 0.70 0.70 0.70 0.70 0.95 1.20 1.45 1.70 1.95

2-yr Gilt Yield (%) 0.59 1.36 0.83 0.70 0.60 0.50 0.70 1.00 1.50 1.80 2.10 2.30 2.50

5-yr Gilt Yield (%) 1.26 2.44 2.07 1.45 1.35 1.20 1.60 2.20 2.60 2.90 3.15 3.30 3.40

10-yr Gilt Yield (%) 2.45 3.69 3.38 2.65 2.55 2.30 2.40 2.60 3.00 3.30 3.50 3.70 3.90

30-yr Gilt Yield (%) 3.88 4.36 4.29 3.95 3.90 3.80 3.90 4.10 4.20 4.30 4.30 4.30 4.30

10-yr-2-yr Gilt Spread (%) 1.86 2.33 2.55 1.95 1.95 1.80 1.70 1.60 1.50 1.50 1.40 1.40 1.40

f: Forecast by TD Bank Group as of August 17, 2011; All forecasts are for end of period. Source: Bloomberg, TDBG
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10/21


10

AUSTRALIAN FIXED INCOME

The Australian xed income market is increasingly pre -dicting that Australias growth prospects have deterioratedrapidly due to patchy domestic data and escalating sovereigndebt issues in the United States and Europe. But in reality,the Asian region remains strong and provides a powerful

buffer between the struggling G7 economies and Australia,hence we continue to push back against market pricing of a drastic easing of monetary policy in the coming months.

Amongst the outsized risk off nancial market reactionto the US credit rating downgrade, the OIS strip priced asmuch as 170bp of cash rate cuts by year end, reversing theentire 2009/10 tightening cycle. Even at the time of writ -ing, 100bp of cash rate cuts are still priced by year end.This is far too pessimistic and completely disregards theRBAs above-target 3%/yr underlying in ation forecaststhrough to end-2013. Since the July Global Markets, 3yr yields have rallied 50bp to 3.77% while 10yrs have rallied35bp to 4.50% (the cash rate is 4.75%), steepening the yieldcurve by 15bp to 70bp, defying widespread expectationsfor a atter curve.

Given clear downside risks to global growth and delayedstart or resumption of G7 central bank tightening cycles,we have similarly scaled back our RBA tightening cycleover the next 18 months. Our prior +25bp tightening to5% by year end has been pushed into March 2012, followed

by a prolonged pause, with the risks skewed towards thattightening not being required at all. Looking ahead into2013, a global growth upswing could lure the consumer

back into spending the last few years of income gains,and we expect the RBA to counter with two more +25bpadjustments to 5.5%.

We see no case for lowering the cash rate outside of areturn to dysfunctional credit markets. This current growthcycle is not about the consumer and housing sectors, but

towards an outsized $A100b investment boom and as -

Spot Rate 2011 2012 201317/08/11 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

Cash Target Rate (%) 4.75 4.75 4.75 4.75 4.75 5.00 5.00 5.00 5.00 5.00 5.25 5.50 5.50

3-mth Bank Bill Rate (%) 4.89 4.89 5.00 4.90 4.95 5.10 5.10 5.10 5.10 5.10 5.35 5.60 5.60




10-yr-3-yr Govt. Spread (%) 0.72 0.45 0.47 0.60 0.45 0.20 0.10 0.00 0.00 0.00 0.00 0.10 0.20

AUSTRALIA FIXED INCOME OUTLOOK


AUSTRALIAN 3-MONTH T-BILL RATES & 10-YEAGOVERNMENT BOND YIELDS

0

1

2

3

4

5

6

7

8

9

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

1

2

3

4

5

6

7

8

9

Actual data to Q2 2011; Forecast by TDBG as at August 2011Source: Reserve Bank of Australia/Haver Analytics

%


3-mo T-Bill yield

%

Forecast

sociated rise in exports. However, this is proving to be adif cult sell, hence consumer and business sentiment havematerially weakened.

Our yield curve forecasts were particularly challengingto construct this month. The entire yield curve has beentrading below the cash rate for weeks, and while we expectnormalization next year, patience is required until then. Weforecast a very mild sell-off at the longer end compared withthe 2-3yr part of the curve, attening the curve once more,and given our core view of a glacial rise in US bond yields,our prior theme of narrowing spreads to U.S. 10 year yieldscan no longer be our base case.

Annette Beacher, Head of Asia-Paci c Research+65 6500 8047


11/21


11

NEW ZEALAND FIXED INCOME

New Zealand xed income markets have not escapedthe global nancial market rout of recent weeks, with 10yr yields falling another 50bps to 4.50%, practically on top of Australia. Short end yields also fell, but less so, meaningcurve attening continues with the 2-10yr spread narrowingfrom around +170bp to +150bp.

Stronger than expected March quarter GDP (+0.8% vsRBNZ +0.3%) and June quarter CPI (+1% vs +0.7%) drovethe RBNZ proclamation in late July that its 50bp emer -gency post-earthquake March cash rate cut was no longer needed. The data reports backed up strong snapbacks in

business and consumer con dence (August consumer con -dence rose again from 109.4 to 113.3). So while consensushas lost faith in the RBNZs resolve, our base case remainsfor +50bp next month as the Bank can justify the move viaa full set of upgraded growth and in ation forecasts.

When we changed our call to +50bp in September, wenever assumed this was the start of an aggressive monetary

policy tightening cycle as there are two separate decisions to be made by the RBNZ: (1) reverse the post-earthquake cutfrom 2.5% to a still very accommodative 3.0%; well aheadof (2) implementing a gentle tightening cycle next year.

After the cash rate reversal to 3% (base case September,

risk case two gentle +25bp steps by year end) we expecta pause through to mid-2012, followed by +75bp of hikesin H2 2012 as the Christchurch post-earthquake rebuilding

process bumps up employment, wages and in ation. Whilethese forecasts appear aggressive compared with our other central bank projections, activity continued at a solid pacedespite the February earthquake, in ationary expectationsare rising rapidly and the post-earthquake South Islandrebuilding required is all-but immune to the events in thenorthern hemisphere.

Subsequently, we expect the entire yield curve to slowly

drift upward over the forecast horizon, expecting 10yr yieldsto return to 5.35% by end 2012. While New Zealands

economic growth is not expected to match Australias in2012, we expect 10 yr yields to again trade at a discount toAustralia (Australia AAA, NZ AA+ with negative outlook)as well as rising global interest in Australian bonds beingnot quite matched by appetite for New Zealand bonds. The

proportion of offshore ownership of Australian bonds is 73%(as at March 2011) while the share for New Zealand bondshas steadily fallen to 60% as at July 2011.

Spot Rate 2011 2012 201317/08/11 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

Official Cash Rate (%) 2.50 2.50 2.50 3.00 3.00 3.00 3.25 3.50 3.75 4.00 4.00 4.25 4.50

3-mth Bank Bill Rate (%) 2.94 2.63 2.65 3.30 3.30 3.30 3.55 3.80 4.05 4.30 4.30 4.55 4.80




10-yr-2-yr Govt. Spread (%) 1.51 2.21 1.78 1.10 1.00 1.00 1.00 0.95 0.85 0.75 0.85 0.70 0.70


NEW ZEALAND FIXED INCOME OUTLOOK

NEW ZEALAND 3-MONTH T-BILL RATES & 10- YEAR GOVERNMENT BOND YIELDS

0

1

2

3

4

5

6

7

8

9

10

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

1

2

3

4

5

6

7

8

9

10

Actual data to Q2 2011; Forecast by TDBG as at August 2011Source: Reserve Bank of New Zealand/Haver Analytics

%


3-mo T-Bill yield

%

Forecast



12/21


12

Considering a downgraded sovereign credit rating, aweaker US economic outlook and Fed tightening prospects

pushed back to the middle of 2013, there is little positive tosay about the USD. As ever in the FX business though, thestory is not just one-sided and despite gloomy fundamental

prospects in the US, the outlook for the USD is perhaps notsigni cantly worse now than a few weeks back.

With the US economy slowing to stall speed, an unfa -vourable outcome to the pending de cit reduction talks inthe US could prompt automatic spending cuts which wouldfurther impinge on the domestic outlook. But scope for anymonetary policy offset to counter the potential scal drag isvery limited, meaning that growth will have to largely takecare of itself. The bumpy growth environment means thatrisk assets are liable to remain subject to bouts of investor aversion in the months ahead, which may support the USD.

The broad decline in the USD since late 2008 whenthe Fed started its quantitative easing experiment has beenconcentrated disproportionately in the smaller, mainlycommodity-related, currencies, such as the AUD and NZD,followed by the CHF. Increasingly, however, the weak USD is causing friction in some jurisdictions (Japan andSwitzerland) while alternative, exible exchange rateslook unappealing because of their own domestic problems(EUR and GBP). Investors might not like the USD butthere is a dearth of viable and liquid alternatives to take its

place at the moment especially in periods of heightenedmarket anxiety.

Indeed, the late July slump in global stock markets il -lustrated that the USDs liquidity premium still counts as asource of support in times of market stress. From July 21 st through the market rebound on August 9 th, only the JPY andthe CHF bettered the USD in terms of overall performance.The US outlook is not that appealing at the moment but we

dont like many alternatives to the USD that much either.

U S DOLLAR

U S DOLLAR

1.161.201.241.281.321.361.401.441.481.521.561.601.641.68 76

84

92

100

108

116

124

132

140

Feb-07 Sep-07 Apr-08 Nov-08 Jun-09 Jan-10 Aug-10 Mar-11

USD per EUR

JPY per USD

JPY per USD

Source: Federal Reserve Bank of New York/Haver Analytics

USD per EUR

TRADE-WEIGHTED U S DOLLAR

70

75

80

85

90

95

100

105

110

03 04 05 06 07 08 09 10 11

Index: 2000 = 100

*Nominal broad effective exchange rateSource: Haver Analytics/JP Morgan

U S DOLLAR OUTLOOKSpot Price 2011 2012 2013

17/08/11 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

Trade-wtd. USD 95.4 96.5 94.7 94.3 95.0 94.1 93.3 92.5 92.0 92.9 92.6 92.8 92.4

JPY per USD 76.5 83 81 76 76 78 78 83 85 88 88 90 90

USD per EUR 1.448 1.416 1.450 1.440 1.400 1.400 1.400 1.450 1.450 1.420 1.420 1.380 1.380

USD per GBP 1.649 1.603 1.605 1.636 1.556 1.591 1.591 1.667 1.706 1.711 1.711 1.725 1.725

f: Forecast by TD Bank Group as at August 17, 2011; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBG

Interest Rate Spreads Business Cycle N

Inflation Differential Fiscal Balances

Current Account N Politics N

Legend: - is negative, + is positive, N is neutral for currency

U S DOLLAR FUNDAMENTALS

Shaun Osborne, Chief FX Strategist 416-983-2629


13/21


13

CANADIAN DOLLAR

The CAD has been one of the worst performing major currencies in the quarter so far, losing nearly 2% versus theUSD at writing, with only the AUD losing more groundover the period. All of the losses have come in the pasttwo weeks or so, coinciding with the increasing uncertaintyregarding Europes sovereign credit crisis, worries about theUS economic outlook and the slide in global stocks.

The CAD retains a strong and positive correlationwith US equity market performances (a situation that has

persisted for most of the time since 2009). For this reasonalone, we nd it impossible to accept the idea of the CADas a safe haven. The CAD has certainly bene tted fromdiversi cation ows from central banks and sovereignwealth funds looking to spread their risks but this does notconfer safe haven status on the currency. In times of equitymarket weakness especially, the CAD will tend to under-

perform its peers. That is not a safe haven.Typical currency safe havens usually provide the reas -

surance of solid external accounts, high domestic savings(which reduces the need to seek nancing from abroad) or (like the USD) provide investors with deep, liquid capitalmarkets to park cash in times of uncertainty. These are notcharacteristics readily associated with the CAD.

With global growth struggling and the US economyteetering around a rate of expansion that is barely up to potential, we suspect that the outlook for risk assets may berather bumpy in the months ahead. Given the CADs posi -tive linkage with equity market performance at the moment,this should be a negative for the CAD.

The uncertain global outlook and slow growth prospectsin the US are feeding into materially weaker levels of activ -ity in Canada. We have pushed back our Bank of Canadatightening call even further into 2012 now (to Q3 from Q1).In this environment, we expect the CAD to under-perform

and look for USD/CAD to move up to the 1.02/1.04 arealate this year before recovering in 2012.

CANADIAN DOLLAR

0.76

0.80

0.84

0.88

0.92

0.96

1.00

1.04

1.08

1.12


USD per CAD CAD per USD


1.316

1.250

1.190

1.136

1.041

1.087

0.893

1.000

0.962

0.926

TRADE-WEIGHTED CANADIAN DOLLAR

80

90

100

110

120

130

140

150

160

03 04 05 06 07 08 09 10 11

Index: 2000 = 100


CANADIAN DOLLAR OUTLOOKSpot Price 2011 2012 2013


CAD per USD 0.980 0.971 0.963 1.010 1.042 1.000 0.971 0.952 0.952 0.962 0.962 0.971 0.971

USD per CAD 1.021 1.030 1.038 0.990 0.960 1.000 1.030 1.050 1.050 1.040 1.040 1.030 1.030

JPY per CAD 78 86 84 75 73 78 80 87 89 92 92 93 93

CAD per EUR 1.418 1.374 1.397 1.455 1.458 1.400 1.359 1.381 1.381 1.365 1.365 1.340 1.340

CAD per GBP 1.62 1.556 1.547 1.653 1.620 1.591 1.545 1.587 1.625 1.645 1.645 1.675 1.675


Interest Rate Spreads + Business Cycle +

Inflation Differential + Fiscal Balances +

Current Account N Politics N


CANADIAN DOLLAR FUNDAMENTALS



14/21


14

EURO

At writing, EUR/USD is all but unchanged over thequarter so far. The single currency remains beset with itsown challenges represented by the simmering sovereignscal/banking crisis on the one hand and slowing growthmomentum on the other. As a consequence, it has been un-able to make any signi cant progress against the USD over the course of the past few weeks.

Euro zone politicians pulled out all the stops to put to -gether a large support package for Greece (its second bailout) at the end of July but then seemed to promptly dispersefor their summer vacations, leaving some of the importantdetails of the broader agreements regarding the expandedcapabilities European Financial Stability Facility to benalized in September.

Investors have been unimpressed by the political procras -tination. Concerns that politicians were not doing enoughquickly enough to tackle the crisis (leaders also continue torule out the issuance of common euro zone bonds as a meansof defusing the crisis) have been re ected in rising pressureon core bond spreads and the euro zone banks, where stockshave been volatile and interbank bank lending has appearedmore constrained. In response, the ECB has reactivated its

bond market support programme and although interventionhas been aggressive, some tensions persist.

Meanwhile, weak demand across the euro zone may cre -ate near recession conditions in the second half of the year.Fiscal consolidation efforts across the region are liable tocompound that trend, which may bolster social unrest. Thechances of further ECB tightening this year have diminishedsigni cantly and we expect monetary policy to remain onhold until early 2012.

The scal challenges facing the euro zone are not insur -mountable but they are certainly signi cant. Until there ismore clarity on prospects (and considering the uncertain

outlook facing the USD also), the EUR is likely to trade ina wide and choppy range in the months ahead.

EURO

1.18

1.22

1.26

1.30

1.34

1.38

1.42

1.46

1.50

1.54

1.58

1.62


USD per EUR

JPY per EUR

USD per EUR JPY per EUR


TRADE-WEIGHTED EURO

110

115

120

125

130

135

140

145

150

03 04 05 06 07 08 09 10 11

Index: 2000 = 100


EURO OUTLOOKSpot Price 2011 2012 2013


USD per EUR 1.448 1.416 1.450 1.440 1.400 1.400 1.400 1.450 1.450 1.420 1.420 1.380 1.380

JPY per EUR 111 118 117 109 106 109 109 120 123 125 125 124 124

GBP per EUR 0.878 0.883 0.903 0.880 0.900 0.880 0.880 0.870 0.850 0.830 0.830 0.800 0.800

CAD per EUR 1.418 1.374 1.397 1.455 1.458 1.400 1.359 1.381 1.381 1.365 1.365 1.340 1.340



Interest Rate Spreads N Business Cycle N

Inflation Differential N Fiscal Balances

Current Account + Politics Legend: - is negative, + is positive, N is neutral for currency

EURO FUNDAMENTALS


15/21


15

JAPANESE YEN

The JPY has performed strongly over the past few weeksthough the gains have re ected the risk averse trends inthe markets as investors seek refuge from the uncertaintiesaround the world rather than Japanese fundamentals.

Still, while the Japanese economy remains weak, it isrecovering, and Japanese stocks, while inevitably lower inthe midst of a global retrenchment in risk assets have heldup better than many other markets around the world so far this year.

GDP recorded its third quarter of negative growth inQ2 although the 1.3% (annualized) decline was better thanmarket forecasts, in keeping with a generally improvingtone of data relative to expectations over the past monthor so. The recovery is being bolstered by reconstructionin the earthquake/tsunami-affected regions and improvingexports. Japanese GDP growth is expected to turn positivein Q3, although of cials are concerned that a stronger JPYwill hinder the recovery. Weaker global prospects may alsoget in the way.

Speculative buying of JPY in response to the uncertain -ties in Europe and the US has been facilitated by declininglong term rates around the world especially in the US

which are compressing interest rate spreads relative toultra-low yields in Japan.

USD/JPYs slide towards the low seen in March justabove JPY76 prompted an aggressive response from theJapanese monetary authorities. The BoJ sold a total of JPY4 tn in direct (unilateral) intervention on August 4th (muchlarger than its other recent forays into the market) and an -nounced additional measures aimed at keeping long-termrates low.

The impact of these measures on the JPY was only transi -tory, however. With US yields poised to remain lower for longer and the global economic soft patch extending into amore serious slowdown that seems likely to keep risk as -sets trading defensively, we think the JPY is liable to stayrelatively strong in the next few months. Further actionfrom the Japanese authorities may be required to preventthe JPY from rising.

JAPANESE YEN

768084889296

100104108112116120124

100106112118124130136142148154160166172


JPY per USD

JPY per EUR

JPY per USD JPY per EUR


TRADE-WEIGHTED YEN

75

80

85

90

95

100

105

110

115

120

125

03 04 05 06 07 08 09 10 11

Index: 2000 = 100


JAPANESE YEN OUTLOOKSpot Price 2011 2012 2013

17/08/11 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4FJPY per USD 76 83 81 76 76 78 78 83 85 88 88 90 90JPY per EUR 111 118 117 109 106 109 109 120 123 125 125 124 124JPY per GBP 126 133 129 124 118 124 124 138 145 151 151 155 155JPY per CAD 78 86 84 75 73 78 80 87 89 92 92 93 93


Interest Rate Spreads Business Cycle N

Inflation Differential Fiscal Balances

Current Account + Politics


YEN FUNDAMENTALS



16/21


16

U K POUND

Sterling has had a good run in the past few weeks, to the point that it is the third best performing major currency inthe current quarter so far behind the safe haven JPY andCHF. While the GBP may gain modestly as investors castaround for triple A-rated sovereign alternatives scope for signi cant GBP gains is limited.

The shocking images of the public rioting recentlyhardly seemed to faze investors but the broader backdropfor the UK economy remains soft. Economic data has dis -appointed broadly and while in ationary pressures remainelevated, policy makers are increasingly pre-occupied withthe downside risks facing the economy. Bank of England(BoE) Governor King has written his seventh consecutiveletter to the UK government explaining why in ation (4.4%)has surpassed the 2% target (temporary factors explain alot of the overshoot) and why policy is liable to remainaccommodative.

Governor Kings latest missive stresses that equitymarket volatility and the latest developments in the eurozone were of particular concern for the central bank dueto the risk of severe stress and dislocation in the nancialmarkets. The minutes of the August policy meeting revealeda distinctly dovish leaning to discussions.

The governors willingness to look through the tem - porary rise in in ation and the focus on external risks toeconomic growth suggests the threshold for renewed mon -etary easing in the UK is not especially high. In fact, giventhe weakening growth outlook, we now think that the BoEwill resume asset purchases either late this year or early thenext (perhaps more likely) in a bid to support the recovery.

In the short-run, GBP gains based on deteriorating pros - pects abroad may be seen but with more QE sailing over thehorizon towards the UK, short-term gains will be limitedand may give way to renewed losses into the end of the year.

We have downgraded our GBP forecast as a consequenceand look for EUR/GBP to remain close to 0.88/90 over thenext few months.

BRITISH POUND

0.65

0.69

0.73

0.77

0.81

0.85

0.89

0.93

0.97

1.01 1.30

1.40

1.50

1.60

1.70

1.80

1.90

2.00

2.10

2.20


GBP per EUR

USD per GBP

GBP per EUR USD per GBP


TRADE-WEIGHTED POUND

70

75

80

85

90

95

100

105

110

115

03 04 05 06 07 08 09 10 11

Index: 2000 = 100


UNITED KINGDOM POUNDSpot Price 2011 2012 2013


USD per GBP 1.649 1.603 1.605 1.636 1.556 1.591 1.591 1.667 1.706 1.711 1.711 1.725 1.725

GBP per EUR 0.878 0.883 0.903 0.880 0.900 0.880 0.880 0.870 0.850 0.830 0.830 0.800 0.800

CAD per GBP 1.62 1.56 1.55 1.65 1.62 1.59 1.54 1.59 1.62 1.65 1.65 1.67 1.67


Interest Rate Spreads - Business Cycle N

Inflation Differential + Fiscal Balances

Current Account Politics Legend: - is negative, + is positive, N is neutral for currency

POUND FUNDAMENTALS



17/21


17

AUSTRALIAN DOLLAR

AUSTRALIAN DOLLAR

0.58

0.66

0.74

0.82

0.90

0.98

1.06


50

60

70

80

90

100

110

120

USD per AUD

JPY per AUD

JPY per AUDUSD per AUD

Source: Federal Reserve Bank of New York/Haver Anal tics

TRADE-WEIGHTED AUSTRALIAN DOLLAR

70

80

90

100

110

120

130

140

150

160

03 04 05 06 07 08 09 10 11

Index: 2000 = 100


AUSTRALIAN DOLLAR OUTLOOKSpot Price 2011 2012 2013


USD per AUD 1.056 1.033 1.072 1.050 1.040 1.020 1.000 0.970 0.940 0.910 0.880 0.850 0.850

JPY per AUD 80.78 85.86 86.31 79.80 79.04 79.56 78.00 80.51 79.90 80.08 77.44 76.50 76.50

AUD per CAD 0.966 0.997 0.968 0.943 0.923 0.980 1.030 1.082 1.117 1.143 1.182 1.212 1.212

NZD per AUD 1.261 1.356 1.293 1.235 1.268 1.275 1.250 1.244 1.237 1.247 1.257 1.269 1.308


Interest Rate Spreads + Business Cycle +Inflation Differential + Fiscal Balances +Current Account N Politics N


AUSTRALIAN DOLLAR FUNDAMENTALS

It has been a roller coaster ride for the AUD in the pastmonth: the AUD was a bene ciary of the debacle to liftthe US debt ceiling, but collapsed swiftly due to risk-off sentiment following the US credit rating downgrade. TheAUD slumped from a post- oat high of $US0.108 in lateJuly back to parity on 9 August, and more recently has re -traced half the losses to just under $US1.06. As is alwaysthe case during extreme volatility, only rarely were theseoutsized moves connected to fundamentals or changes inthe outlook for the Australian economy.

We do not expect such trading extremes to continue go -ing forward, assuming the AUD can revert to the $US1.04-1.07 range experienced during most of May-July. We ex -

pect dips towards parity to be snapped up by opportunisticmedium-term commodity/China bulls, while lofty levelscloser to $US1.10 tend to bring out the pro t-takers trim -ming outsized net long positions.

While the AUD is widely quoted as the fth most tradedcurrency, its comparatively small size means that any talk of the AUD becoming a true global reserve currency or asafe-haven currency is somewhat far fetched, despite rock solid AAA-rated fundamentals. Nevertheless, while the

bond market continues to price global sub-par growth andnear-zero growth rates, the AUD has held up extremely

well during the most recent crisis. The collapse of LehmanBros saw the AUD slump from $US0.85 to $US0.60, sowhile bond yields are threatening to revisit those levelsduring the current crisis, in contrast the AUD is clearlyan outperformer.

As our North American colleagues anticipate an evenmore measured return to a neutral Fed Funds rate, andother central banks are expected to pause for longer, our forecasts for AUD have been tweaked a little higher for 2012 and 2013. Our existing forecast of a return to parity

by mid-2012 is now expected to persist for longer, and our

end-2012 forecast has been upgraded from $US0.94 to$US0.97. We do not expect sub-$US0.90 prints until thesecond half of 2013, when the US Federal Reserve startsthe tightening process, eventually boosting the USD.



18/21


18

NEW ZEALAND DOLLAR

The kiwi dollar followed a similar path to the AUD over the last month, reaching a fresh post- oat high of $US0.8843due to the anti-USD sentiment during the lifting of the USdebt ceiling debacle and also swiftly sinking to $US0.80 fol -lowing the nancial market rout in the wake of the US creditrating downgrade. The AUDNZD cross-rate was extremelyvolatile during that time, oscillating around 1.25 on average

but nudging 1.23 at one stage. The NZD remains historicallystrong against the AUD at present as the RBNZ tightening

bias is very clear, even if consensus has pushed back thenext tightening from September to December. At no stagehas the OIS strip priced lower cash rates for New Zealand.

We expect the NZD to remain well supported for sometime as the RBNZ is the most likely central bank to lift itscash rate next. We are of the view that the recent correctionin the NZD gives a window of opportunity for the RBNZto swiftly reverse the March 50bp insurance cut at the OCR Review next month. Should the RBNZ lose its nerve andwait, likely much calmer markets and the return to risk-ontrading means the NZD could swiftly revisit lofty record-high levels, ironically making that expected RBNZ hikequite uncomfortable to deliver.

While we havent materially changed our cash rate fore -casts for the RBNZ going forward (we still expect it to risefrom 2.5% at present to 3.75% by end-2012) our predictionof delayed central bank tightening elsewhere means slightlyhigher NZD forecasts for next year. Our year end $US0.82target remains unchanged, but we have lifted our end-2012target to $US0.78. A couple of months ago we dropped our long AUDNZD recommendation, and this remains the case,targeting 1.27 by year end and 1.24 by end-2012.

TRADE-WEIGHTED NEW ZEALAND DOLLAR

90

100

110

120

130

140

150

160

03 04 05 06 07 08 09 10 11

Index: 2000 = 100


NEW ZEALAND DOLLAR

0.48

0.54

0.60

0.66

0.72

0.78

0.84


40

50

60

70

80

90

100

USD per NZD

JPY per NZD

JPY per NZDUSD per NZD

Source: Federal Reserve Bank of New York/Haver Anal tics

NEW ZEALAND DOLLAR OUTLOOKSpot Price 2011 2012 2013


USD per NZD 0.838 0.762 0.829 0.850 0.820 0.800 0.800 0.780 0.760 0.730 0.700 0.670 0.650

JPY per NZD 64.08 63.30 66.75 64.60 62.32 62.40 62.40 64.74 64.60 64.24 61.60 60.30 58.50

NZD per CAD 1.218 1.353 1.252 1.165 1.171 1.250 1.288 1.346 1.382 1.425 1.486 1.537 1.585

NZD per AUD 1.261 1.356 1.293 1.235 1.268 1.275 1.250 1.244 1.237 1.247 1.257 1.269 1.308


Interest Rate Spreads + Business Cycle N

Inflation Differential + Fiscal Balances N

Current Account Politics NLegend: - is negative, + is positive, N is neutral for currency

NEW ZEALAND DOLLAR FUNDAMENTALS Annette Beacher, Head of Asia-Paci c Research+65 6500 8047


19/21


19

SWISS FRANC

The CHFs 17% year to date gain (nearly 6% in thequarter so far) versus the USD (the strongest performanceof all the major currencies in both cases) has put the cur -rency on collision course with the vital export sector andthe market on collision course with the Swiss monetaryauthorities once again.

Given stresses apparent in Europe and the US, solidexternal accounts and scal policy settings have made theCHF an attractive destination of investors. Euro zone scalconcerns and volatility in global equities drove the EUR/CHF exchange rate almost to parity 33% below the 10-year average for the cross.

The Swiss National Bank (SNB) has intervened directlyin the foreign exchange markets over the past couple of yearsin a bid to temper CHF gains but the action has only servedto temporarily halt the currencys appreciation.

Now, the massive overvaluation, in the SNBs words,of the CHF forced the central bank to take more action tocurb gains. So far, the SNBs response has been limited toaggressive liquidity and monetary techniques rather thandirect intervention in the currency. Speculation of a peg to

SWISS FRANC OUTLOOKSpot Price 2011 2012 2013


CHF per USD 0.785 0.919 0.840 0.799 0.821 0.843 0.843 0.828 0.828 0.859 0.859 0.906 0.906

CHF per EUR 1.137 1.301 1.219 1.150 1.150 1.180 1.180 1.200 1.200 1.220 1.220 1.250 1.250

CHF per CAD 0.801 0.947 0.872 0.791 0.789 0.843 0.868 0.869 0.869 0.894 0.894 0.933 0.933


SWISS FRANC

1.02

1.08

1.14

1.20

1.26

1.32

1.38

1.44

1.50

1.56

1.62

1.68

0.70

0.76

0.82

0.88

0.94

1.00

1.06

1.12

1.18

1.24


CHF per EUR

CHF per USD

CHF per EUR CHF per USD



the EUR has so far proven to be incorrect.Heightened global uncertainty and an outlook that is

fraught with substantial risks suggest that the CHF willremain relatively well supported unless or until the Swiss authorities take more radical action on currency appreciation.


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20

SUMMARY FIXED INCOME TABLESpot Price 2011 2012 2013

17/08/2011 Q1 Q2 Q3F Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4FUnited States

Fed Funds Target Rate (%) 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.75 1.00

3-mth T-Bill Rate (%) 0.02 0.09 0.00 0.05 0.07 0.10 0.10 0.10 0.10 0.10 0.15 0.80 1.10





10-yr-2-yr Govt. Spread (%) 2.05 2.65 2.70 2.05 2.15 2.25 2.30 2.40 2.15 1.95 1.85 1.85 1.70

CanadaOvernight Target Rate (%) 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.50 2.00 2.00 2.00 2.50 3.00

3-mth T-Bill Rate (%) 0.87 0.96 0.90 1.10 1.10 1.10 1.15 1.60 2.10 2.10 2.15 2.65 3.10


5-yr Govt. Bond Yield (%) 1.56 2.77 2.33 1.70 1.85 2.00 2.25 2.40 2.75 2.80 3.00 3.35 3.6010-yr Govt. Bond Yield (%) 2.42 3.35 3.11 2.65 2.75 2.95 3.20 3.25 3.40 3.40 3.55 3.75 3.95


10-yr-2-yr Govt. Spread (%) 1.43 1.52 1.52 1.55 1.55 1.70 1.30 1.10 1.00 0.85 0.75 0.80 0.75

United KingdomBank Rate Target (%) 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75 1.00 1.25 1.50 1.75

3-mth T-Bill Rate (%) 0.51 0.65 0.65 0.70 0.70 0.70 0.70 0.70 0.95 1.20 1.45 1.70 1.95

2-yr Gilt Yield (%) 0.59 1.36 0.83 0.70 0.60 0.50 0.70 1.00 1.50 1.80 2.10 2.30 2.50

5-yr Gilt Yield (%) 1.26 2.44 2.07 1.45 1.35 1.20 1.60 2.20 2.60 2.90 3.15 3.30 3.40

10-yr Gilt Yield (%) 2.45 3.69 3.38 2.65 2.55 2.30 2.40 2.60 3.00 3.30 3.50 3.70 3.90

30-yr Gilt Yield (%) 3.88 4.36 4.29 3.95 3.90 3.80 3.90 4.10 4.20 4.30 4.30 4.30 4.30

10-yr-2-yr Gilt Spread (%) 1.86 2.33 2.55 1.95 1.95 1.80 1.70 1.60 1.50 1.50 1.40 1.40 1.40

Australia

Cash Target Rate (%) 4.75 4.75 4.75 4.75 4.75 5.00 5.00 5.00 5.00 5.00 5.25 5.50 5.503-mth Bank Bill Rate (%) 4.89 4.89 5.00 4.90 4.95 5.10 5.10 5.10 5.10 5.10 5.35 5.60 5.60




10-yr-3-yr Govt. Spread (%) 0.72 0.45 0.47 0.60 0.45 0.20 0.10 0.00 0.00 0.00 0.00 0.10 0.20

New ZealandCash Target Rate (%) 2.50 2.50 2.50 3.00 3.00 3.00 3.25 3.50 3.75 4.00 4.00 4.25 4.50

3-mth T-Bill Rate (%) 2.94 2.63 2.65 3.30 3.30 3.30 3.55 3.80 4.05 4.30 4.30 4.55 4.80




10-yr-3-yr Govt. Spread (%) 1.51 2.21 1.78 1.10 1.00 1.00 1.00 0.95 0.85 0.75 0.85 0.70 0.70



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21

SUMMARY FOREIGN EXCHANGE TABLESpot Price 2011 2012 2013


Exchange rate to U S dollar Japanese yen JPY per USD 76.49 83 81 76 76 78 78 83 85 88 88 90 90

Euro USD per EUR 1.448 1.416 1.450 1.440 1.400 1.400 1.400 1.450 1.450 1.420 1.420 1.380 1.380

U.K. pound USD per GBP 1.649 1.603 1.605 1.636 1.556 1.591 1.591 1.667 1.706 1.711 1.711 1.725 1.725

Swiss franc CHF per USD 0.785 0.919 0.840 0.799 0.821 0.843 0.843 0.828 0.828 0.859 0.859 0.906 0.906

Canadian dollar CAD per USD 0.980 0.971 0.963 1.010 1.042 1.000 0.971 0.952 0.952 0.962 0.962 0.971 0.971

Australian dollar USD per AUD 1.056 1.033 1.072 1.050 1.040 1.020 1.000 0.970 0.940 0.910 0.880 0.850 0.850

NZ dollar USD per NZD 0.838 0.762 0.829 0.850 0.820 0.800 0.800 0.780 0.760 0.730 0.700 0.670 0.650

Exchange rate to EuroU.S. dollar USD per EUR 1.448 1.416 1.450 1.440 1.400 1.400 1.400 1.450 1.450 1.420 1.420 1.380 1.380

Japanese yen JPY per EUR 111 118 117 109 106 109 109 120 123 125 125 124 124

U.K. pound GBP per EUR 0.878 0.883 0.903 0.880 0.900 0.880 0.880 0.870 0.850 0.830 0.830 0.800 0.800

Swiss franc CHF per EUR 1.137 1.301 1.219 1.150 1.150 1.180 1.180 1.200 1.200 1.220 1.220 1.250 1.250Canadian dollar CAD per EUR 1.418 1.374 1.397 1.455 1.458 1.400 1.359 1.381 1.381 1.365 1.365 1.340 1.340

Australian dollar AUD per EUR 1.371 1.371 1.353 1.371 1.346 1.373 1.400 1.495 1.543 1.560 1.614 1.624 1.624

NZ dollar NZD per EUR 1.728 1.859 1.749 1.694 1.707 1.750 1.750 1.859 1.908 1.945 2.029 2.060 2.123

Exchange rate to Japanese yenU.S. dollar JPY per USD 76.49 83 81 76 76 78 78 83 85 88 88 90 90

Euro JPY per EUR 110.7 118 117 109 106 109 109 120 123 125 125 124 124

U.K. pound JPY per GBP 126 133 129 124 118 124 124 138 145 151 151 155 155

Swiss franc JPY per CHF 97.4 90.5 95.8 95.2 92.5 92.5 92.5 100.3 102.7 102.4 102.4 99.4 99.4

Canadian dollar JPY per CAD 78.1 85.6 83.6 75.2 73.0 78.0 80.3 87.2 89.3 91.5 91.5 92.7 92.7

Australian dollar JPY per AUD 80.8 85.9 86.3 79.8 79.0 79.6 78.0 80.5 79.9 80.1 77.4 76.5 76.5

NZ dollar JPY per NZD 64.1 63.3 66.8 64.6 62.3 62.4 62.4 64.7 64.6 64.2 61.6 60.3 58.5

Exchange rate to Canadian dollar U.S. dollar USD per CAD 1.021 1.030 1.038 0.990 0.960 1.000 1.030 1.050 1.050 1.040 1.040 1.030 1.030

Japanese yen JPY per CAD 78 86 84 75 73 78 80 87 89 92 92 93 93

Euro CAD per EUR 1.418 1.374 1.397 1.455 1.458 1.400 1.359 1.381 1.381 1.365 1.365 1.340 1.340

U.K. pound CAD per GBP 1.62 1.56 1.55 1.65 1.62 1.59 1.54 1.59 1.62 1.65 1.65 1.67 1.67

Swiss franc CHF per CAD 0.801 0.947 0.872 0.791 0.789 0.843 0.868 0.869 0.869 0.894 0.894 0.933 0.933

Australian dollar AUD per CAD 0.966 0.997 0.968 0.943 0.923 0.980 1.030 1.082 1.117 1.143 1.182 1.212 1.212

NZ dollar NZD per CAD 1.218 1.353 1.252 1.165 1.171 1.250 1.288 1.346 1.382 1.425 1.486 1.537 1.585

f: Forecast by TD Bank Group as at August 17, 2011; All forecasts are for end of period

Source: Federal Reserve Bank of New York, Bloomberg, TDBG

This report is provided by TD Economics for customers of TD Bank Group. It is for information purposes only and may not be appropriatefor other purposes. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this reporthas been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. The report contains economicanalysis and views, including about future economic and nancial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank

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