HSBC_Currency Outlook December

8/3/2019 HSBC_Currency Outlook December

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Macro

Currency Strategy

December 2010

EUR 2011 retraces, reflects, recovers

In 2011, the idea that the EUR is here to stay dominates our view and quite frankly break-up fe

wildly exaggerated; but this does not mean the EUR will not retrace. Instead of seeing EUR-U

close to 1.35 through next year, we now see EUR-USD trading around 1.25 in the first quarter

year as a point of reflection; after which USD weakness will start to reappear and the EUR wil

Opportunities NOK

With the market so focused on the sovereign risk surrounding the EUR, we look to the NOK. S

risk in Norway is practically obsolete as the government runs a substantial surplus on the back

oil economy; however, the NOK has performed poorly this year. We disagree with the market

of the NOK as a risk on risk off currency and believe it should increasingly be trading on it

fundamental merit. We have favoured the NOK for some time and still do.

The SDR Honey the IMF shrunk the yen

The IMF recently announced new weights for the SDR valuation basket, which will come into

Jan 2011. The largest impact of the new weighting scheme is likely to be negative for the JPY,

a flow and a sentiment point of view.

HKD peg mythbusters

The HKD faces little risk from the rise of the RMB. The flexibility of current arrangements is

underappreciated. A basket peg would offer no identifiable advantages over the current system

HUF...better, but not safe

Summary


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December 2010

New Zealand Cause for Pause Recent data suggests that the recovery remains sluggish. W

growth and a pause in the tightening cycle by the RBNZ, we feel the NZD could be vulnerable

lower going into the New Year.

At a glance all regions

Key events

Date Event

14 December FOMC meeting on interest rates15 December Riksbank rate decision15 December Norges Bank rate decision16 December ECB governing council meeting no rate decision21 December BoJ monetary policy meeting21 December RBA minutes22 December BoE to publish minutes of Dec 8-9 MPC meeting27 December BoJ to publish minutes of Nov 15-16 MPM1 January Estonia joins the Euro from Jan 1 20114 January Federal Reserve publishes minutes of Dec 14 meeting

Source: HSBC

C t l B k li t f t


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Currency Strategy

December 2010

EUR downgraded

In 2011, the idea that the EUR is here to stay

dominates our view and quite frankly break-up

fears are wildly exaggerated; but this does not

mean the EUR will not retrace. Instead of seeing

EUR-USD trade close to 1.35 through next year,

we now see EUR-USD trading around 1.25 in the

first quarter of next year as a point ofreflection;

after which USD weakness will start to reappear

and the EUR will recover.

We resisted the idea that the EUR would crumble

in 2010 and held on to our forecast of 1.35 for the

last nine months. In 2011, we envisage greater

headwinds for the EUR as sovereign fears

continue to linger. However, with no obvious

fundamental anchor to guide us where the

exchange rate should head, we place moreemphasis on fair value PPP.

We note that, without the conventional tool kit at

the markets disposal, the consensus lurches with

every wild swing in the exchange rate. Hence 1.25

We expect retracement to fair value, to

rest and reflection of 1.25 before the EU

as USD problems resurface. On the one e

have the possibility of EUR break up beiThe other extreme view is the USD could

meltdown. In the middle of these extrem

1.25 for EUR-USD, a point of still water

can reflect on the extremes. Thus the EU

reflects and then recovers. We provide o

of FX forecasts for 2011 below.

To be honest, if it were not for these so

problems in the euro, we would be talk

the possibility of a cataclysmic fall in th

2011. In essence, we have settled for a

the road 1.25 as a starting point in Q1 2

than falling to either extreme.

EUR 2011 retraces, reflects, rec


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Currency Strategy

December 2010

NOK-ed down but will get up again

With the market so focused on the sovereign risk

surrounding the EUR, we look to the NOK.

Sovereign risk in Norway is practically obsoleteas the government runs a substantial surplus on

the back of a sound oil economy. This is reflected

by the Norways CDS being the lowest across a

broad spectrum of countries.

However, the market has shunned the NOK this

year, seeing it underperform many currencies.

Gold has significantly outperformed the NOK,

even though the currency should be considered

the best paper currency in the world.

The excellent fundamental story for the NOK has

not changed and it argues for persistent currency

strength. That said, the NOKs short-term

direction has been dominated by the shifts

between risk on and risk off.

We disagree with the markets treatment of the

NOK as a risk on risk off currency and believe

it should increasingly be trading on its strong

NOK the best currency...isn

We have always suggested that the NO

the short term. It is a currency that can

headwinds of the massive structural chaare both present and forthcoming. Taki

view into consideration, we have ranke

currencies stack up against one another

to several macro metrics (table 1). Note

currencies have the same rank for a var

This is a very broad-brushed approach

draws out the fundamental rationale to

NOK in a clear way, especially when c

relative sovereign risk. From this persp

NOK comes out on top and has done so

repeatedly over time. With the NOK lo

good, the currency should be an outper

this has not been the case.

The market has shunned the NOK...

Considering all the expected good new

NOK, and being one of the soundest cu

when considering sovereign risk, the N

t d d l thi F th it

Opportunities NOK


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December 2010

when the market factored in the risk of extra QE

by the Fed (charts 2 and 3). To us, it makes little

sense that the NOK should lag behind the other

commodity currencies or underperform other G10

currencies that are hampered by sovereign risk

(i.e. EUR).

Gold has outperformed the NOK

Based on our macro metrics in table 1, we believe

the NOK should be the strongest paper currency

in the world. However, when looking at the NOK

versus gold, we see yet again how the market has

shunned the currency (chart 4).

NOK...just a EUR at heart?

While many major economies face very

challenges and the market questions the p

of these currencies (USD, JPY, GBP, and

gold has outperformed. This makes sense

However, gold, for example, has outpe

EUR and the NOK at pretty much the s

(chart 5). This suggests that the market

the NOKs much stronger fundamental

background and treats the currency pra

a EUR proxy.

2. The NOK has not performed well this year... 3. ...and has not since the Feds QE2 came alive

-10

-5

0

5

10

15

SEK CH F NZD CAD AUD JPY

-10

-5

0

5

10

15Currency Performance vs USD %%

(Jan 1 to Nov 29 10')

EUR NOK GBP

0

1234

567

89

10

NOK GBP EUR CAD JPY CHF SEK N

Currency Performance vs USD%

(Aug 1 to Nov 29 10')

Source: HSBC, Bloomberg Source: HSBC, Bloomberg

4. Gold has outperformed the NOK


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Macro

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December 2010

In our view, this is irrational and the market

should be differentiating the strong position of the

NOK versus the weak position of the EUR.

Importantly though, the similar performance ofthe NOK and performance of the EUR suggests

the former is being driven by other factors.

NOK its all about risk on risk off

In recent months, we have published substantive

analysis on the risk on risk off paradigm (see

Currency Quant Special, Risk on risk off: thefull story, 10 November 2010). We have also

shown which currencies and other finan

market instruments are dominated by th

(chart 6).

Over the last 80 days the AUD is the m

sensitive currency to risk on periods a

is the most sensitive currency to risk o

This should not be surprising and fits w

general thinking that the AUD is a high

currency and the JPY is not.

5. Gold outperforming the EUR and the NOK at the same pace

100

150

200

250

300

350

400

Jan-00 Dec-00 Nov-01 Oct-02 Sep-03 Aug-04 Jul-05 Jun-06 May-07 Apr-08 Mar-09 Feb

Gold-NOK (NOK per oz.) Gold-EUR (EUR per oz., rebased 100 = 2000)

Source: HSBC, Bloomberg

6. The extent to which assets are driven by Risk on Risk off


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December 2010

We believe that instead of the NOK being driven

by its strong fundamentals, the currency is

dominated by the risk on risk off factor. The

NOK performs well when it is risk on and by

default, it does not perform well when it is risk

off. What is striking, however, is how much the

NOKs direction is dominated by the risk on

risk off factor. This is masking the positive

fundamental story for the NOK. That said, the

relatively positive fundamental story for the NOK

should be more in the price.

In the pre-crisis era, the NOK, like many

currencies, was not driven by risk on r

However, we can see how the NOK has

become more sensitive to risk on risk

recent years (chart 7). This change in nat

NOK is similar to the other commodity c

Nevertheless, when considering the

outperformance of the other commodit

currencies in recent months, we believe

is lagging by too much. It should have more in the risk on bounce than was t

8. Norway has a low weight in government bond indices for a reason...Norway has very low debt levels

B l oo m b e rg E F F A S G o v t . bo n d w e ig h t s (% )

7. The NOK has increasingly been dominated by the risk on risk off factor

-0.3

-0.2

-0.1

0

0.1

0.2

0.30.4

0.5

0.6

Jan-05 May-05 Nov-05 Jul-06 Feb-07 Jul-07 D ec-07 Apr-08 Sep-08 Feb-09 Jun-09 Oct-09 Mar-10

NOK's sensitivity to 'Risk on - Risk off (260-day rolling correlation)'



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December 2010

Meanwhile, if the market moves to a risk off

mode, then the NOK should be holding up better

than the other commodity currencies and also

those currencies that are bogged down with poor

fundamentals. The NOK should be performingwell in both environments. The markets

treatment of the NOK as only a risk on currency

is simply wrong to us.

Conclusion Should be as strong as

Fort NOKs

The NOK is currently a risk on currency,however we believe that it should also perform

very well when market sentiment is deteriorating.

In other words, the NOK is a currency for good

times and bad. Fundamentals for the NOK remain

strong and as a result we believe that it should be

less dominated by the risk on risk off factor

than it currently is.

Sovereign risk in Norway is practically

as the government runs a substantial su

the back of a sound oil economy. There

should not be a surprise that Norways

in global government bond indices is ve(chart 8).

However, clearly this is a good thing, e

when the market is concerned about po

outlooks in many countries. This comb

the NOKs current underperformance s

that there is clear room for it to strength

8). The rationale to favour the likes of t

USD, GBP and JPY (the so-called HIIC

Heavily Indebted Industrial Countries)

NOK is beyond us.


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Macro

Currency Strategy

December 2010

New SDR weights JPY negative

The IMF recently announced a re-weighting of the

SDR Special Drawing Rights. The largest

impact of the new weighting scheme is likely tobe negative for the JPY, both from a flow and a

sentiment point of view. SDRs are subject to a

great deal of confusion in the market, and much of

the confusion relates to the fact that SDRs are

made up of fixed currency amounts rather than

fixed weights. That is, 1 SDR is equal to a basket

of specified fixed amounts of four other currencypairs (table 1). This means that the actual weights

in the SDR are constantly changing because of

exchange rate fluctuations and this should be

borne in mind when looking at the consequences

of an official re-weighting. It is inherently rather

complex and we go through it step by step below.

In the appendix we give a potted history of theSDR for those who are unfamiliar with them.

Weighting changes

The last time the composition of the SDR was

changed was in Jan 2006 At the end of 2005 the

This means quite simply that a holding o

precisely a holding of 63.2 USD cents, 4

cents, 18.4 yen and 9.03 pence. Importan

a genuine currency in itself; rather, it is a

holding of specified amounts of four curr

This composition has not changed since

and will remain until 1 Jan 2011 when a

composition will come into being.

However, as a result of exchange rate mo

relative values of the fixed currency amo

SDR have changed since 2006. This mea

effective weights have also changed. Wh

target rates in 2005 are shown in table 2,

weights are different. As of Friday 19 No

somebody holding SDRs would have we

are approximately as shown in table 3.

The SDR Honey the IMF shrunk th


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Macro

Currency Strategy

December 2010

Where have these effective weights come

from?

The SDR is made up of fixed amounts of USD,

EUR, JPY and GBP. We can use current

exchange rates to calculate a USD-value for all of

these currency amounts (or the value in any other

currency for that matter). Once we have done this,

we can calculate the percentage of the SDRs

current value that comes from each constituent

currency. As exchange rates have moved since

Jan 2006, the effective weights of each currency

in the SDR have also shifted.

The IMF has now announced new SDR weights

which will be effective as of 1 Jan 2011. They are

as shown in table 4.

However, as before, the SDR will still be

composed of fixed currency amounts. Despite

knowing these weights, the precise composition ofthe new SDR will not be known until the end of

the year.

Once this new composition comes into force,

anyone who holds a portfolio in SDRs will then

The confusing aspect here is that while

USD weight in the existing SDR is 44%

the actual USD weight today is in realit

(table 3) because of moves in EUR-US

2005. When trying to gauge what trans

need to occur in Jan 2011, we need to c

actual weights now (table 3) with the n

(table 4). Note that we do not use the 2

weights (table 2) for this comparison.

As an example, from table 3 we can see

actual USD weight is now 40.6 % and

USD weight from table 4 is 41.9%. So

holding SDRs would have to buy USD

the new basket even though compared

official USD weight has dropped!

Additional complication

The situation is even more complicated

since the new weights (table 4) are confixed currency amounts using average

over the three months running up to

2011. What this means in practice is th

weights from 1 Jan 2011 will differ fro

stated weights albeit probably not by

2. 2005 Target Weights

Currency 2005 Weighting

USD 44%EUR 34%JPY 11%

GBP 11%Source: IMF


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Macro

Currency Strategy

December 2010

The SDR change - negative for the

JPY

In Table 5 we show the move from the current

effective weights (table 3) to the stated target

weights (table 4). The results in this table show arelatively small rebalancing for USD, EUR and

GBP. As the effective weights at year-end for

both the current and the new SDR composition

are unknown yet, it is hard to say with confidence

whether we will see significant flows in these

currencies on the back of this.

However, we can say with confidence that the

JPY weighting in the SDR will be significantly

reduced. The effective weight of JPY in an

existing SDR basket is around 14% and this will

drop to around 9.3%. As things stand, this will be

offset by additional holdings in USD, EUR and

GBP. The exact distribution across these

currencies is not fully clear yet as it depends on

the FX moves between now and 1 Jan 2011.

Impact on the market

Market impact can come in two forms.

transactions will need to occur as a resu

re-balancing? Second, what do the new

signify about the importance of each ofcurrencies?

It is hard to estimate the size of real hol

SDRs and the extent to which re-balanc

transactions will need to take place. SD

"allocated" to nations by the IMF, but t

to which SDRs are held as actual reserv

just the unit of account for potential obnot entirely clear.

According to the IMF1, the total cumul

"allocations" amount to around USD31

this number is taken at face value it wo

on 1 Jan 2011 approx $15 billion of JPY

need to be sold against USD, EUR and

order to re-balance. In practice, it is lik

considerably less as "allocations" are no

reserve and managed as reserves in the

way. The situation with respect to priva

holdings is also difficult to estimate, bu

4. The SDR weighting scheme announced by the IMF for January 2011

Currency Nov-2010 Weighting

USD 41.9%EUR 37.4%JPY 9.4%

GBP 11.3%Source: IMF
http://www.imf.org/external/np/exr/facts/sdr.htmhttp://www.imf.org/external/np/exr/facts/sdr.htmhttp://www.imf.org/external/np/exr/facts/sdr.htm


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December 2010

The change in the official weights could perhaps

be more significant from the point of view of

market sentiment. The reduced official USD

weight could be construed as a reflection of

declining USD dominance, and thus seen asnegative versus the rising official weight of the

EUR. What is certainly clear is that the JPY

weight is reduced, both in official terms and in

actual terms. As such, we expect this forthcoming

change to the SDR composition to have the

greatest impact on JPY.

Will the SDR become a new reserve

currency? No.

It is commonly asked if SDRs can be used as a

reserve currency, instead of the USD. The simple

answer to this is that the SDR is not a genuine

currency it is really just a unit of account. When

one chooses to hold reserves in SDRs all it reallymeans is that you hold your reserves in USD, EUR,

JPY and GBP in the SDR-prescribed ratios. It might

indeed be sensible to hold reserves in a mix of

currencies as plenty of reserve mangers do but

there is nothing intrinsically different about an SDR.

It is just one particular choice of basket.

Addition of EM currencies to t

basket

As a result of the stratospheric rise of E

Markets since the last time the IMF cha

SDR, there had been widespread specu

the SDR basket might be widened to co

EM currencies. In particular, the Chine

would appear to be a natural choice for

in the SDR basket. Indeed, there had be

from some Beijing officials for this to h

the choice to not include the CNY in th

basket has surprised some market parti

The Wall Street Journal reports2 that w

IMF did consider including the yuan in

basket, they ultimately rejected it becau

considered it to fail the selection criteri

a freely usable currency this despite t

attempts to open up the CNY market th

offshore CNH market. So it appears tha

capital controls and currency restriction

prevalent in the EM world this will pre

from being included in the SDR.

Appendix

A brief history of the SDR

The SDR was created by the IMF in 19

purpose of supplementing the official r

member countries. Under the Bretton W

fixed exchange rate system its value wa

originally equal to 0.888671 grams of g
http://online.wsj.com/article/BT-CO-20101117-714605.htmlhttp://online.wsj.com/article/BT-CO-20101117-714605.htmlhttp://online.wsj.com/article/BT-CO-20101117-714605.html


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December 2010

USD at the time. As a new international reserve

asset, many thought the SDR would become

increasingly important in supporting world trade

and financial development.

However, when the Bretton Woods system

collapsed in 1973 the SDR became far less

important. Its value was redefined in terms of a

basket of sixteen currencies, which was reduced

to five in 1981. Today, the SDR is defined in

terms of four currencies dollars, euros, sterling

and yen. Each currency within the SDR is given a

specific weight, which is reviewed every five

years based on the relative importance of that

currency in world trade and financial markets.

The weights announced by the IMF in the 2005

and 2010 reviews are given in tables 2 and 4.

Since SDRs were created the IMF have allocated

an amount equivalent to around $318 billion(table 6). By far the biggest allocation came in

response to the global financial crisis on the 28th

August 2009. The IMF believed this would

smooth the need for adjustment and add to the

scope of expansionary policies in liquidity

constrained countries.


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December 2010

Myths of the HKD-USD peg

The HKD peg has once again come under

scrutiny. In this piece we review some of the most

common misconceptions about the peg, andaddress whether the HKD is at imminent risk of

being displaced by the RMB. We conclude that

while Hong Kongs linked exchange rate system

may not deliver Hong Kong the optimal economic

outcomes at all times, the benefits and flexibility

offered by the current regime continue to be

underappreciated. Moreover, recent years havehighlighted that other currency regimes do not

themselves guarantee optimal performance.

Myth 1:

The HK and US economies are

unusually divergent this cycle

In contrast to popular perception, the divergencebetween the economic performance of the Hong

Kong and US economies at present is not unusual

by historical standards (chart 1). There have been

a number of periods when the GDP growth

differential between the two economies

wide such as in such as the late 1980s

notably through the mid 2000s and ev

periods when growth has moved in opp

directions such as in the US recession

early 1990s and then during the Asian f

crisis in 1997-98. At present both econ

experiencing a post-crisis recovery and

Kongs growth has yet to notably outstr

seen in the US.

Myth 2:HK prices are unusually buoy

cycle

The discussion on growth notwithstand

are clear differences on inflation and pr

prices between the two economies. On

prices particularly, there is little questio

those in Hong Kong have risen strongly

past 18 months. However, the latest inc

prices is very much in line with what w

seen at a similar stage of previous cycle

HKD peg mythbusters


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Macro

Currency Strategy

December 2010

and 1997, and 41% from 1993 to 1995. Some

further gains, therefore, would not be out of line

with history. The recent strong steps taken to

ensure the property cycle remains orderly (seeHK

Economic Spotlightof 19 November), also suggest

that a more cyclical approach to macro-prudentialpolicy can play a useful countervailing role.

More to the point, however, consumer price

inflation remains quite low by historical

standards. The latest CPI reading of 2.6% yoy is

below Hong Kongs average CPI of 3.1% over the

last 20 years, and well below the peaks of 12.5%

(1991), 10.4% (1995) and 6.3% (2008) seen in

previous cycles (chart 4). Our economists foresee

a further pickup in inflation to 3.5-4% over the

next two years as asset price gains feed through

(see Pressures on 22 November) That said the

contain strong property prices, suggesti

there is little unique about the gains in

prices being seen in Hong Kong.

Before we move on, it is worth reviewi

economics associated with a currency p

monetary conditions in Hong Kong nee

tighten, and neither the currency nor in

are in a position to contribute, then Hon

price level needs to adjust. This occurs

higher inflation for a period. Once the p

has adjusted sufficiently, however, the

inflation should return to a lower, more

level. In other words, there is no reason

loose monetary policy to result in a des

permanent increase in the rate of inflati

2. Asset prices have risen sharply since early 2009 3. but this is not alarming compared to previou

5000

10000

15000

20000

25000

30000

35000

Jan-93 Jan-97 Jan-01 Jan-05 Jan-09

60

80

100

120

140

160

180

Hang Seng Property Pr ice Index ( '99=100, rhs)

0

100

200

300

400

Jan-93 Jan-97 Jan-01 Jan-05

Hang Seng Property P

Source: CEIC, HSBC Source: CEIC, HSBC. Both series indexed to 100 at start of new cycl

vertical bars. Cycles begin at previous troughs of Hang Seng index.
http://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=UUJKumn3Ge&n=284575.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=UUJKumn3Ge&n=284575.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=UUJKumn3Ge&n=284575.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=UUJKumn3Ge&n=284575.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&key=UUJKumn3Ge&n=284575.PDF


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Myth 3:

The rise in HKMA reserves means

flows into HK asset markets have

been unprecedentedly large

At present there seems to be particular confusion

between gross and net flows into the HKD, and

how these flows interact with the HKMAs

intervention activities. In an environment where

there are flows into Hong Kong asset markets, the

HKMA only needs to intervene when these asset-

related inflows are not offset by other outflows.

Typically, when the HKMA intervenes to buyUSD-HKD (the flow channel of intervention) the

resulting liquidity increase generates a decline in

HK interest rates, such that some market

participants will buy USD-HKD to benefit from the

positive carry. Chart 5 highlights the 2004

intervention episode as having had such an impact.

This second interest rate channel of interventionis generally the more powerful of the two.

With US interest rates at such low levels, HKMA

intervention adds liquidity, but this does not

generate any meaningful decline in HK interest

rates. The interest channel, as a consequence, is

muted. So reserves are not necessarily increasing

because gross inflows are much larger thannormal (though they may be), but because the

arbitrage/carry flows are not occurring this time.

In sum, flows into Hong Kong asset markets may or

may not have been unprecedented. We actually just

Its well known that a currency board can

run against fully-deliverable currencies. A

therefore, the universe of potential candid

inclusion in the basket would be EUR, JP

CAD, SGD, AUD, NZD, CHF, NOK an

inclusion of smaller currencies that are no

global invoicing, have little impact on theeconomy, and have only modest direct tra

relationships with Hong Kong would ma

sense. That leaves the EUR and JPY as a

candidates. Australia and Switzerland com

1% of total trade with Hong Kong, and th

only 1.6%. Running a currency basket ag

EUR and JPY, however, would do little tHong Kongs interest rates at present, as

running interest rates close to zero (chart

6. Interest rates at historic lows across develope

7

5. Monetary base grew significantly in 2009

-3

-2

-1

0

1

2


HK/US 1m diff (LHS) Mone

% HK

Source: CEIC, Bloomberg, HSBC


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December 2010

Myth 5:

The RMB is likely to displace the HKD

as a transaction currency in Hong

Kong

Current market speculation seems to have

solidified, particularly on issues related to the

RMB. The argument seems to be that the RMB

will be increasingly used as a transaction currency

in HK, causing a flight of deposit transfers from

the HKD into the RMB, as investors seek to move

from a depreciating currency (the HKD, by virtue

of the peg) into an appreciating one. To avoid

such an outcome, so the argument goes, the

HKMA needs to revalue the HKD.

The stock of RMB deposits in HK has certainly

risen in recent times (chart 7). Deposits have more

than doubled this year, from RMB63bn to

RMB150bn in September. But would revaluingthe HKD slow any deposit shift?

Unquestionably, a broad expectation of

revaluation could temporarily stem any deposit

shift into RMB. Once a HKD revaluation were to

occur, however, Hong Kong would be left with a

stronger currency. Presumably from that point

investors might, if the markets currency

framework is correct, again fear that the RMB

would appreciate more than the HKD in the

future. Why not take advantage of stronger levels

of the HKD to shift into RMB deposits at better

levels? Given this, a revaluation of the

could hardly be expected to solve the p

currency substitution; if in fact there is

So if a revaluation wouldnt solve a pro

excessive currency substitution, lets co

how likely such an outcome is in the fir

For currency substitution to occur there

be a shift from HKD deposits into RMB

A shift out of deposits held in other for

currencies would have little impact on t

Consider the backdrop.

Hong Kong residents have typically ke

45% of their bank deposits in foreign c

(chart 8). This proportion has been rem

stable since 2000, with a range of only

50%. It seems more likely that, initially

the shift into RMB will be at the expen

foreign currency deposits, rather than sHKD deposits. In the past two years, U

deposits have fallen modestly, but with

and HKD deposits rising.

Consider also that the RMB is not easil

Hong Kong. Some retail outlets do allo

of RMB, but almost none display dual p

return change in RMB. In addition, the

certainly not convertible globally. This

suggests that the public are unlikely to

towards using RMB as a day-to-day cu


19/46

Macro

Currency Strategy

December 2010

instead of HKD anytime soon, even if they shift to

holding more RMB as a store of wealth.

Beyond these points, even if some shift from

HKD into RMB deposits were to occur, consider

also the equilibrating nature of the peg. At present

there is excess demand for the HKD, which, due

to HKMA intervention to keep USD-HKD within

the 7.75/7.85 band, has resulted in injections of

HKD liquidity and very low Hong Kong interest

rates. If savers sell the HKD, however, USD-

HKD should start to shift away from the lower

end of the convertibility zone, where it is at

present, to the upper end. Towards the upper end

of the band the HKMA will begin to intervene to

buy the HKD. This will reduce HKD liquidity and

Hong Kong interest rates will begin to rise. Were

the outflow from HKD to persist, interest rates

would ultimately increase enough to induce savers

to reconsider selling HKD in the first place. In

other words, not only would the peg rebalance

pressures for HKD depreciation, but it would do

so via higher Hong Kong interest rates precisely

the monetary response that popular argument

requires at present.

Conclusion...

Perfection in imperfection

Hong Kong has run a currency board to

since 1983. It is clearly a currency and

policy arrangement which suits Hong K

Much of the periodic pressure on the

likely reflects, at least partly, a generic

fixed exchange rates, rather than giving

consideration of Hong Kongs particula

circumstances. Certainly neither clean n

managed floats have always delivered t

economic outcomes for all countries in

years. Having a fully convertible curren

a transparent exchange rate mechanism

allowed Hong Kong to establish itself a

pre-eminent North Asian financial cent

key regional trade, finance and FDI ent


20/46

Macro

Currency Strategy

December 2010

HUF...better, but not safe

Eurozone sovereign risk is on the radar of the

financial markets. This risk is not a neutral

parameter for CEE given the trade and financiallinks. Within the region, Hungary remains clearly

the most vulnerable country as the levels of public

and private debt stay persistently high. Moreover,

the sensitivity of the private debt to the exchange

rate movements still constitutes an aggravating

risk factor. Nevertheless, a repeat of the 2008-09

episode is unlikely even if Eurozone sovereignrisk deteriorates further. Although there could be

knock-on impacts, Hungary is better armed thanks

to a current account surplus, light positioning and

an alert central bank.

Structural vulnerabilities persist

Private debt still constitutes a systemic risk

The financial crisis has hardly changed the overall

debt picture in Hungary. The high level of private

debt, which had been the main transmis

channel of the crisis, remains at elevate

terms of a percentage of GDP, we estim

the private debt represents 115% this y

1), slightly below the all-time high of 2

the highest of the region after Latvia.

Largely denominated in foreign curren

notably in CHF, it is a permanent threa

financial stability. Households have red

strongly their demand for credit; signs

have emerged since mid-2009. As a resexposure of households to exchange ra

movements has not diminished. The mo

debt denominated in foreign currencies

represents about 65% of total loans (ch

Hungarian central bank (NBH) has esti

recently that the debt burden of FX loan

9% of households disposable income ito the peak reached in 09 Q1 (chart 3),

the CHF-HUF upward movement. As t

HUF...better, but not sa

1. Private external debt (% of GDP)


21/46

Macro

Currency Strategy

December 2010

reached an all-time high in Q3, the debt burden

has probably reached a new peak recently. The

situation remains very fragile and an exacerbation

of the sovereign crisis in Europe would push

CHF-HUF to critical levels. This risk is all the

more important due to the concerns over the fiscalpolicy of the government.

The fiscal policy raises question over the debt

sustainability

Besides having the highest private external debt in

the region, Hungary also has the misfortune to

suffer from the highest public debt in CEE. The

debt to GDP ratio is at 80% (chart 4), very close

to the Eurozone average, but significantly higher

than in the other countries of the region

easy to understand why the fiscal conso

Hungary is crucial for FX stability.

On that front there are reasons for conc

government has indeed opted for an un

fiscal policy, combining reduction in p

income taxes and implementation of te

levies in the banking, telecommunicatio

and retail sectors.

The success of this policy in supporting

activity and achieving fiscal deficit targe

uncertain. But the most controversial mereform of the pension system. The gover

2. Loans denominated in foreign currencies (% of total) 3. Debt burden in % of disposable income

0

10

20

30

40

50

60

70


0

10

20

30

40

50

60

70% %

0

2

4

6

810

12

14

16

04 Q1 05 Q1 06 Q1 07 Q1 08 Q1 09 Q1

HUF loans FX loans%

Source: HSBC, NBH Source: HSBC, NBH

4. Government debt (% of GDP)


22/46

Macro

Currency Strategy

December 2010

decided to withhold social security transfers to the

private pension system and invited members of the

private pension funds to adopt the state pension

system. The assumption that 90% of the threemillion pensioners will adopt the state system

appears particularly high. The deficit of the pension

system is expected to reach HUF900bn in 2011 and

the government hopes to finance HUF540bn thanks

to the return of pensioners to the state-run system. If

the governments assumption proves too optimistic,

the revenue shortfall would be substantial, puttingthe 2011 fiscal deficit target of 2.9% of GDP at risk.

In the longer-term, the success of fiscal

consolidation is not guaranteed as the fiscal

measures are mainly concentrated on the revenue

downgraded Hungary by two-notches o

concerns. Both Moodys and S&P now

Hungary at the cusp of junk rating wi

negative outlook.

but several factors mitigate

risks

Although debt levels stay very high and

woes remain, a repeat of the 2008-09 c

appears unlikely (chart 5). Without min

the potential knock-on effects of a Euro

sovereign crisis on Hungary, there are t

factors mitigating the risks weighing on

The current account balance is in su

Hungary is less vulnerable than in 2008

5. EUR-HUF through the crisis

220

230

240

250

260

270

280

290

300

310

320

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

EUR-HUF

September 08 - Lehman

files for bankruptcy

May 10 - Greek fiscalcrisis intensifies


M


23/46

Macro

Currency Strategy

December 2010

Admittedly, the loosening of fiscal policy may

lead to an increase in external financing needs but

this is a medium-term issue.

Positioning is light

The capital flow dynamics have improved since

the start of 2010. The financial account of the

balance of payments shows that portfolio flows

have recovered after a very strong outflow in

2008-09 (chart 8). High-frequency data also

indicate an increase in appetite of foreigners for

Hungarian assets. Non-resident holdings of

Hungarian bonds have recently reached their

highest levels since Q1 2009 (chart 9).Nevertheless, the positioning is light in Hungarian

markets from a historical perspective but also

relative to other markets of the region.

The central bank is on alert

The central bank is another parameter t

account. Interest rates are at low levels

the NBH room to manoeuvre if the curr

depreciates sharply. In a severe action,

bank had raised the key rate by 300bp i2008. This large hike was not successfu

stabilising the currency during this turb

period. However, this time around the c

bank could limit the fall of the HUF mo

efficiently. The NBH is indeed aware o

current market circumstances and is rea

in a pre-emptive manner. A better macrfinancial outlook in Hungary would als

the effects of monetary policy action.

6. Current account balance is in surplus 7. thanks to a recovery in exports

-9.0-8.0-7.0-6.0-5.0-4.0-3.0-2.0

-1.00.01.02.0

Q1 1995 Q3 1998 Q1 2002 Q3 2005 Q1 2009

-9.0-8.0-7.0-6.0-5.0-4.0-3.0-2.0

-1.00.01.02.0

1-year accumulated, EUR bn

-30

-20

-10

0

1020

30

40

50

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08

Exports% yoy

Source: HSBC, Thomson Reuters Datastream Source: HSBC, Thomson Reuters Datastream

Macro


24/46

Macro

Currency Strategy

December 2010

The central bank has already showed its

commitment to counter the risks stemming from

the governments policy. The MPC raised interest

rates by 25bp in November and signalled that

further rate hikes might be needed. Thedeterioration of the countrys risk profile could

indeed cause sustained currency weakness, which

in turn increases the inflation risk (chart 10).

Another rate hike of 25bp is very likely at the

beginning of 2011.

It is also worth noting that the NBH has currently

substantial foreign currency reserves as its

disposal. Admittedly, the Hungarian central bank

does not have a tradition of intervention.

However, we believe that if the NBH did not

intervene in 2008 to stop the rapid depreciation of

its currency, it was partly because of the low level

of its reserves at that time. In the past two years,

the FX reserves have almost doubled to reach

EUR 33.5bn (chart 11). While the interest rates

were the only tools during the 2008-09 crisis, the

NBH may now use both rates and FX reserves to

counter an excessive HUF weakness.

Conclusion

An exacerbation of the sovereign debt crisis would

inevitably inflict significant collateral damages on

Hungary. The HUF is all the more at risk as both

private and public debts are at unsustainable levels.

The government fiscal policy for 2011 an

pension reforms add risk to an already fr

situation. Along with the Irish situation, w

our HUF-bearish view. However, even if

Eurozone situation worsens, we do not eFX crisis like in 2008-2009. Despite hav

strong negatives, unlike in 2008 there are

counterbalancing positives.

As in May-June this year, the 290-295

be the top for EUR-HUF. Should sover

conditions in the Eurozone improve, th

HUF could come down to the low 270s

level we believe it would represent a bu

opportunity for EUR-HUF. The outlook

HUF is more uncertain as it would also

the market appetite for Swiss franc if th

risk appetite deteriorates further. But gi

financial stability risk, the NBH should

very closely.

Macro


25/46

Macro

Currency Strategy

December 2010

CAD remains firm, but recentdata highlights risks

The CAD has traded at the strong end of its range

against the USD through much of the past two

months, generally consistent with the expansion

of risk appetite over that period, but less so withthe fundamental backdrop in Canada, which has

softened by some measures relative to conditions

from just a few months ago. On balance, the CAD

has appeared more sensitive to developments on

the risk front, rather than more traditional

growth fundamentals. However, we think that the

softening in the fundamental backdrop (chart 1) isworth highlighting and poses at least some risk to

the CAD, particularly when it is trading at

stronger levels. Moreover, even with the

expansion in risk, USD-CAD has failed to make

sustained declines below the parity threshold.

Downside surprises

On the real sector front, Canadian Q3 GDP rose

1.0% annualized, weaker than the 1.5% gain

expected and down from 2.3% in Q2. The biggest

drag came from the trade account, where exports

fell 1.3% and imports were up 1.6%. Th

deterioration in net exports was evident

monthly trade and quarterly current acc

figures as well. On the trade account, th

September deficit widened out to C$2.5

C$1.5bn deficit in August. And the mo

balance has now been in deficit in six o

prior seven months.

Mirroring the deterioration in the trade

the quarterly current account data, whe

balance widened to a deficit of C$17.5b

the largest quarterly deficit on record an

following the C$12.9bn deficit in Q2. Arunning a healthy current account surpl

much of the decade, Canadas external

has deteriorated measurably since the in

the global financial and economic crisis

That trend has persisted in current quar

is likely that the full year current accou

for 2010 will exceed the record C$43.5in 2009. To the extent that Canadas ex

surplus had been a pillar of support for

for many years, that is clearly no longe

Dollar Bloc

Macro


26/46

Currency Strategy

December 2010

And on the contrary, the external balance should

now be viewed more accurately as a restraint on

the currency, other things being equal.

Even strong data is weak

Seemingly better news on the economy came from

the November labor market data, which showed

unemployment dropping to a new cycle low of

7.6% from 7.9% in October. However, that decline

was due to a big decline in the labor force as the

participation rate fell to 66.9% from 67.2%. Given

that labor market participation is typically expected

to increase during an economic recovery, this is not

a positive development (future developments will,

however, be more important if this turns out to be a

trend rather than a one-off). In addition, the 15.2K

rise in net employment was made up entirely of

part-time jobs as full-time positions fell 11.5K.

Contrary to the first half of the year, where

employment rose 300K, less than 40K new jobs

have been created in the second half of 2010, a

concerning development.

Rates on hold

Against that backdrop, it was no surprise that the

Bank of Canada left the overnight target rate

unchanged at 1.0% at the December 7announcement. In the statement, the BoC noted

that economic activity in H2 2010 is slightly

weaker than projected just 1 months a

aligning it with the weaker reading on Q

but still giving the statement a more do

And like the GDP data, the BoC specif

that net exports have been weaker thandue in part to persistent strength in the

well as weak productivity). While it is

for the BoC to reference the CAD in th

it does highlight the BoCs sensitivity t

developmentsnot necessarily in the l

currency per se, but in terms of the pass

and impact on monetary conditions it ca small, open economy such as Canada

The BoC also used the same wording for

forward guidance on policy as they did in

saying any further reduction in monetar

stimulus would need to be carefully cons

That outlook, along with the weaker eco

performance reinforces the notion that th

no hurry to resume the tightening progra

halted in October. And those sentiments

limit the upside for the CAD, particularly

leaves the CAD at a yield disadvantage r

other commodity-linked currencies.

2 Current account deterioration diminished a pillar of support for the CAD

Macro


27/46

Currency Strategy

December 2010

Conclusion CAD at risk to the risk

trade

Despite the recent intensification of stresses in the

Eurozone sovereign debt market (another risk

noted by the BoC), the overall level of riskappetite in the market has been at a relatively high

level. As we noted at the outset, this is consistent

with the general firmness of the CAD. And if

there is a risk to our expectation for a steady,

rather than appreciating bias in the CAD, it could

come from a further, sustained expansion of risk

appetite. That said, the latest gains in crude oilprices to $90, and the move in equities back to

their cycle highs has not pushed USD-CAD

sustainably below parity. That does not preclude

the chance that a further expansion in the risk

trade will do just that. But that is the risk scenario;

our central view remains that the CAD, while

likely to remain well supported, is unlikely toregister further sustained gains against the USD.

Macro


28/46

Currency Strategy

December 2010

Australia On hold for now

As expected, the cash rate was left unchanged at

4.75% at the RBAs latest meeting on the 7th

December. So mortgagors can breathe easy after

last month's effective 40bp tightening. The post-announcement statement also contained few hints

of further moves, but given the next move is not

in the near term - in our view, Q2 2011 - it is

unsurprising that the RBA is not signaling it yet.

They did, however, repeat the same mantra about

the high level of commodity prices and the effect

on investment and incomes, which will be the key

reason for raising rates further.

RBA staying steady

There is no indication from the statement about

any concern that the GDP numbers were weaker

(in real terms) than generally expected (or about

weak retail sales). Indeed, the statement points to

strong national income growth, a pick up in

mining investment and continued household

cautiousness, as expected.

The statement reminds us that employment

growth has been very strong over the past year

and wages have picked up. It is this combination

that is currently driving growth in household

incomes and will support more consumer

spending at some point: albeit at the moment

household saving remains elevated.

No surprises

The main message we would draw out

statement is from what is not said: info

from omission, if you please. That is, th

mention of any concern about the weakGDP numbers in Q3 or recent weaknes

sales. Indeed, the statement suggests th

narrative is playing out as expected.

Overall, as we have said before, the bre

document necessarily means that it can

much territory. And given that we have

great deal of briefing from the RBA rec

official statement of monetary policy, a

testimony to a parliamentary committee

number of speeches by RBA officials -

surprise that there are no surprises.

Expect further rate hikes in 2011

A hold by the RBA in their December mwas as expected. We continue to anticip

rates will rise multiple times next year,

have pushed back the timing a little. W

expect the next rate rise to be in Q2 20

Macro

C St t


29/46

Currency Strategy

December 2010

New Zealand Cause for Pause

The RBNZ kept rates on hold at 3.00% in their

latest meeting on the 9th December. This was

largely as expected, both by HSBC and by the

market. The associated monetary policy statementindicates that demand has been weaker than they

had previously expected.

The statement signalled that households continue to

be cautious in their spending behaviour, corporate

investment intentions are below average and that

near-term growth has softened. Governor Bollard

signalled that interest rates will need to stay low

until the recovery becomes more robust. However,

in the medium term, the expectations for further rate

hikes remain as growth will be supported by rising

exports and rebuilding following the earthquake in

Canterbury in September.

It seems that further tightening is likely to be put

on hold in the near term, and in fact we do not

expect another rate hike until Q2 2011. Recent

data suggests that the recovery remains sluggish,

with domestic demand remaining weaker than

anticipated. Building permits fell by 2.0%, against

expectations for a 1.4% rise, while manufacturing

and construction activity has also showed signs of

slowing. The weaker outlook for growth in the

near-term and pause in the tightening cycle is

likely to weigh on the NZD.

Risk off dominates

While fundamentals are important, mov

NZD are largely the result of the shifts

risk on and risk off. Over the past m

NZD has been the worst performing ma

currency, largely as a result of the Euro

crisis leading to a contraction in risk ap

expect these problems in the Eurozone

to persist going into next year and for

be the dominant theme in the coming m

While we expect the NZD to trade arou

levels until year end, we feel retracemecontinue in the New Year.

Macro

Currency Strategy


30/46

Currency Strategy

December 2010

CLP/USD CLP: Peso to remain firm in 2011

400

450

500550

600

650

700

750

800

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1

400

450

500550

600

650

700

750

800 We see growth remaining strong next year, with o

recently upping their 2011 GDP growth forecast to5.5% previously. We expect interest rates to contito 4.25% by April next year, and then to remain onshould help the CLP remain firm, especially as amcurrencies, rate differentials with the US tend to bsensitivity in Chile. As a traditional funding currenctightening periods CLP tends to see an unwinding

crosses. Copper prices should hold up through strdemand, and this should remain a supportive factthat said, should USD-CLP dip lower towards the 450 level, we would expect central bank interventinitiated, likely in the form of daily USD purchasesamount, as per early 2008. We therefore expect Uend 2011 at 450.

Source: Thomson Reuters Datastream

BRL/USD BRL: Policy ambiguity and intervention to hold t

1.50

2.00

2.50

3.00

3.50

4.00

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

1.50

2.00

2.50

3.00

3.50

4.00 With inflation pressures creeping higher, rate hike

being fully priced in beginning in January. Rising rexpectations are keeping the BRL well supported,expect the USD to remain relatively firm into year-has been some discussion among market commehigher inflation could raise policymakers tolerancappreciation. However, we would tend to disagreeof thinking, and believe that USD-BRL below 1.70 increasing chance of authorities raising interventioThis is particularly true, as there is high seasonal inflation in the year-end period. Additional currenc

that the government could use include the use of twealth fund to buy USDs, as well as further tax incnew regulatory measures to curb portfolio inflows.


Latin America at a glan

Macro

Currency Strategy


31/46

Currency Strategy

December 2010

CHF/EUR Switzerland: CHF staying strong

1.261.301.34

1.381.421.461.501.541.581.621.661.70

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

0.901.00

1.101.201.301.401.501.601.701.80

euro-swiss (LHS) dollar-swiss (RHS)

The CHF has remained strong in the face of renewperipheral stresses in the Eurozone, despite the Eincreasing its purchases of the regions bonds andpledging support for Ireland.

Additional support for the CHF has come from someconomic data. The latest PMI reached 61.8, whicmonth high. Q3 GDP also printed a reasonably strSome moderation in growth is expected going forw

Some SNB board members suggest accommodatcannot be maintained forever. This hawkish lean pon the SNB meeting on the 16 December. We stillSNB to keep rates steady until Q3 2011. Althoughnot intervened for a while, one cannot completely idea of it doing intervention to weaken the CHF agespecially if Eurozone problems intensify.


NOK/EUR Norway: Opportunities NOK

7.007.50

8.00

8.50

9.00

9.50

10.00

10.50

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

7.007.50

8.00

8.50

9.00

9.50

10.00

10.50

See Opportunities NOK on page 4.


Europe at a glance

Macro

Currency Strategy


32/46

Currency Strategy

December 2010

EUR/HUF Hungary: the HUF stays vulnerable

220

230

240250

260

270

280

290

300

310

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1220

230

240250

260

270

280

290

300

310 The persistently high level of debt and the uncerta

surrounding the governments unorthodox fiscal pthe HUF vulnerable. The tensions between the gothe central bank (NBH) are not HUF-supportive.

The governments decision to change the NBH lawthe role of the governor and redefine the mandatequestions about the independence of monetary poattempt to defend itself and its inflation target, the

the market by surprise with a rate hike of 25bp in open discord is unlikely to ease in the near-term, the attractiveness of local assets. We are keeping bearish bias into year-end, especially since the cois under threat. We do not see the currency pair scontrol like in 2008-09. A current account surplus, positioning and an active NBH offer some protecti


EUR/PLN Poland: The PLN has the potential to recover

3.00

3.40

3.80

4.20

4.60

5.00

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1

3.00

3.40

3.80

4.20

4.60

5.00 The zloty took a hit at the end of November as the

sovereign crisis worsened. The important positionrelative large liquidity offered by the Polish marketcurrency underperformance. However, there is no weak PLN from a fundamental standpoint.

Admittedly, the central banks communication remconfusing but the key point is that the economy is strong pace (+4.2% y-o-y in Q3) and a key rate atadapted for the crisis is no longer justified. We conbelieve that the central bank will raise rates in com

Strong growth led by domestic demand, sound fin

system, positive carry dynamics and rather suppoof payments form the cornerstone of our PLN-bulli


Europe/Africa at a glanc

Macro

Currency Strategy


33/46

y gy

December 2010

CNY/USD CNY Continued pressure on RMB

6.60

6.80

7.00

7.20

7.40

7.60

7.80

8.00

8.20

8.40

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11

6.60

6.80

7.00

7.20

7.40

7.60

7.80

8.00

8.20

8.40

RMB continues to face elevated levels of appreciapressure. For example, even with the G20 out of international political pressure has not eased. Maawaiting the US Treasurys semi-annual report on originally due mid-October. Moreover, a state visiHu to Washington in January is still forthcoming. Minflation has risen more than expected, leading theto announce unexpected tightening moves, as we

shift of the official stance away from accommodatsurplus continues to rebound sharply, though this to seasonal effects. This could mean more apprecpressure over the medium-term. In the near-termto emphasize the increased importance of broadecurrency movements and the broad strength or wethe USD in determining moves in USD-RMB.


HKD/USD HKD USD peg myth busters

7.707.72

7.74

7.76

7.78

7.80

7.82

7.84

7.86

97 99 01 03 05 07 09 11

7.707.72

7.74

7.76

7.78

7.80

7.82

7.84

7.86

See HKD peg mythbusters on page 14.


Asia at a glance

Macro

Currency Strategy


34/46

December 2010

VND/USD VND structural problems still pressuring curre

14000

15000

16000

17000

18000

19000

20000

Jan-01

Jan-02

Jan-03

Jan-04

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

14000

15000

16000

17000

18000

19000

20000 Depreciation pressures on VND are rising, and we

into focus with three recent developments: 1) The state owned enterprise has asked to delay a USDrepayment due on 20 Dec 2) The imposition of a 1export tax from 1st Jan 2011; and 3) the ongoing rbetween the USD-VND official fix and the implied NDF market. We have noted earlier that the AuguUSD peg would not have a meaningful impact on

more structural problems which are driving the VNsuch as the trade deficit and high inflation. Only wtightened substantially enough to start limiting thesthe market likely become more confident in the VNpressure subside. We still expect another shift in toccur, most likely in Q1 2011, and pressure will recurrency to weaken further.


KRW/USD KRW not a core long

800

1000

1200

1400

1600

1800

2000

97 99 01 03 05 07 09 11

800

1000

1200

1400

1600

1800

2000 The recent N. Korean artillery shelling, causing bo

military deaths, and the unfolding response from ocountries represent a more serious episode than thas become accustomed to. We have been upbeaAsian currencies this year, but since May KRW hacore long for us due to the asymmetric nature of thintervention. The BOK has historically aggressiveldownside to USD-KRW, but not the upside, and hhesitant in the past to re-supply to the market the removed through intervention. A genuine further dthe current political situation may well see a shift t

central bank dollar selling. In this case, however, cdollar is likely to prove difficult. As such, the latestdevelopments on the Korean peninsular reinforce asymmetry of risk to the currency.


Asia at a glance continu

Macro

Currency Strategy

D b 2010


35/46

December 2010

For full details of the construction methodology of

the HSBC REERs, please see HSBCs New

Volume-Weighted REERs Currency Outlook

April 2009.

The value of a currency

Since FX prices are always given as the amount of

one currency that can be bought with another, the

inherent value of a currency is not defined. For

example, if EUR-USD goes up, this could be

because the EUR has increased in value, the USD

has decreased in value, or a combination of both.One possible method for getting some insight into

changes in the value of a currency is to look at

movements in the value of a basket of other

currencies against the currency of interest. For

example, if EUR-USD increased over some time

period, one could see how EUR had performed

against a range of other currencies to determinewhether EUR has become generally more valuable

or whether this was simply a USD-based move. An

effective exchange rate is an attempt to do this and to

represent the moves in index form.

How should we weight tbasket?

If we are trying to create an index for th

in value of a currency against a basket o

currencies, we now need to decide on h

weight our basket. One possible solutio

to simply have an equally-weighted bas

rationale for this would be that there is

reason for choosing to put more empha

one exchange rate. However, this could

lead to the situation where a large move

relatively small currency can strongly i

the REERs and NEERs for all other cu

To avoid this, the indices are generally

so that more important currencies get

weighting. This, of course, begs the qu

how importance is defined.

Trade WeightsWeighting the basket by bilateral trade

the most common weighting procedure

creating an effective exchange rate inde

because the indices are often used to m

HSBC Volume-Weighted REER

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December 2010

To do this properly would require us to have

accurate FX volumes for all currency pairs

considered in the index. However, these are not

available. The BIS triennial survey of FX volumes

only gives data for a small number of bilateral

exchange rates. However, the volumes are split by

currency for over 30 currencies. From these

volumes we can estimate financial weightings for

each currency. We believe that this gives another

plausible definition for importance, and one

which may be more relevant for financial

investors than trade weights. We call this

procedure volume weighting and the indices

produced through this procedure we call the

HSBC volume-weighted REERs.

We would argue that if you are a financial market

investor, the effective value of a currency you

would be exposed to is more accurately

represented by the HSBC volume-weighted indexrather than the trade-weighted index.

Data Frequency

This is something which is rarely consi

when constructing REERs inflation d

generally released at monthly frequency

the usual procedure is to simply create indices by default. However, some cou

release their inflation data only quarterl

usual procedure for these countries is to

pro-rata the change over the period. He

an implicit assumption that the rate of i

changes slowly. We take this assumptio

further and assume that it is valid to sprinflation out equally over every day in t

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December 2010


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December 2010

USD REER index EUR REER index

80

100

120

140

160

Jul-95 Jul-98 Jul-01 Jul-04 Jul-07 Jul-10

80

100

120

140

160

USD Trade-Weighted REER USD Volume-Weighted REER

1996=1001996=100

60

75

90

105

120

Jul-95 Jul-98 Jul-01 Jul-04 Jul-07

E U R Vo lu me -Wei ght ed RE ER E UR Tr ad e-W1996=100

Source: HSBC Source: HSBC

JPY REER index GBP REER index

75

90

105

120

75

90

105

120

JPY Trade-Weighted REER JPY Volume-Weighted REER

1996=1001996=100

95

110

125

140

GBP Tr ade-Wei ghte d R EER GBP Vol ume- W1996=100

HSBC Volume Weighted

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December 2010

CAD REER index CHF REER index

80

90

100

110

120

130

140

150

Jul-95 Jul -98 Jul-01 Jul-04 Jul-07 Jul-10

80

90

100

110

120

130

140

150

CA D T ra de -We ig hte d RE ER CAD Vo lu me -We ig hte d R EER

60

70

80

90

100

110


CHF V olume-We igh ted RE ER C HF Tr ade- We ight

1996=100


AUD REER index NZD REER index

60

80

100

120

140

160

Jul-95 Jul-98 Jul-01 Jul-04 Jul-07 Jul-1060

80

100

120

140

160

AUD Trade-Weighted REER AUD Volume-Weigh ted REER

1996=1001996=100

60

80

100

120

140


N ZD Volume-We ighted RE ER N ZD Trade-W ei

1996=100


SEK REER index NOK REER index

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Euro dollar vs forwards Euro Swiss vs forwards

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

1.60

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

USD/EUR

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

1.60

USD/EURForward Forecast

1.26

1.31

1.36

1.41

1.46

1.51

1.56

1.61

1.66

1.71

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan

CHF/EUR Forward Forecas t

Source: Thomson Reuters Datastream, Reuters, HSBC Source: Thomson Reuters Datastream, Reuters, HSBC

Cable vs forwards Euro sterling vs forwards

1.30

1.40

1.50

1.60

1.70

1.801.90

2.00

2.10

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

USD/GBP

1.30

1.40

1.50

1.60

1.70

1.801.90

2.00

2.10

USD/GBPForward Forecast

0.55

0.60

0.65

0.70

0.75

0.80

0.85

0.90

0.95

1.00

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Ja

GBP/EUR Forward Forecas t

Source: Thomson Reuters Datastream, Reuters, HSBC Source: Thomson Reuters Datastream, Reuters, HSBC

Dollar yen vs forwards Euro yen vs forwards

105

115

125

135

JPY/USD

105

115

125

135

JPY/USDForward Forecas t

125

135

145

155

165

175

JPY/EUR Forward Forecast

HSBC forecasts vs forw

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3 Month Money

End period 2006 2007 2008 2009Q4 Q4 Q4 Q4 Q1 Q2 Q3f Q

North America

US (USD) 5.3 4.7 1.4 0.3 0.3 0.5 0.3 0

Canada (CAD) 4.2 4.5 1.9 0.5 0.4 0.8 1.2 1Latin America

Mexico (MXN) 7.2 7.3 8.2 4.6 4.6 4.5 4.6 4

Brazil (BRL) 12.8 11.2 13.0 8.7 9.1 10.8 10.7 10

Argentina (ARS)* 7.1 10.0 17.1 10.4 9.1 9.1 9.2 9

Chile (CLP)* 5.0 7.1 8.5 1.8 1.2 1.9 4.0 5Western Europe

Eurozone 3.7 4.6 2.9 0.7 0.6 0.7 0.8 1Other Western Europe

UK (GBP) 5.3 5.9 2.8 0.6 0.6 0.7 0.7 0

Sweden (SEK) 3.3 4.7 2.5 0.5 0.5 0.6 1.0 1

Switzerland (CHF) 2.1 2.6 0.6 0.3 0.2 0.1 0.2 0

Norway (NOK) 3.9 5.9 4.0 2.2 2.3 2.8 2.6 2EMEA

Hungary (HUF) 8.1 7.6 10.0 6.2 5.5 5.3 5.4 5

Poland (PLN) 4.2 5.1 5.8 4.2 4.0 3.8 3.7 3

Russia (RUB)* 6.5 6.3 20.6 6.6 4.2 3.4 4.0 7

Turkey (TRY) 17.6 16.0 15.5 7.5 7.6 7.7 7.5 7

Ukraine (UAH) 7.6 6.6 20.0 16.1 8.0 5.6 5.5 9

South Africa (ZAR) 9.2 11.3 11.4 7.1 6.5 6.6 6.6 6Asia/Pacific

Japan (JPY) 0.4 0.6 0.6 0.3 0.2 0.2 0.2 0

Australia (AUD) 6.5 7.3 4.1 4.1 4.4 4.9 4.9 5

New Zealand (NZD) 7.7 8.9 6.0 3.0 2.8 3.3 3.3 3Asia-ex-Japan

China (CNY) 1.8 3.3 1.7 1.7 1.7 1.7 1.7 1Asia ex-Japan & China

Hong Kong (HKD) 3.9 3.5 1.0 0.1 0.1 0.6 0.3 0

India (INR) 7.0 8.3 9.2 5.1 4.6 5.5 6.3 6

2010

Short rates

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8-Dec-10 2009 2010 2011

last Q3 Q4 Q1 Q2 Q3 Q4f Q1f

Latin America vs USD x x x x x x x x x x

Argentina (ARS) 3.97 3.84 3.80 3.88 3.93 3.97 4.10 4.15

Brazil (BRL) 1.68 1.78 1.74 1.78 1.80 1.69 1.74 1.70

Chile (CLP) 477 533 533 533 547 484 480 470

Mexico (MXN) 12.47 13.50 13.10 12.36 12.84 12.60 12.25 12.10Columbia (COP) 1888 1930 2043 1920 1916 1801 1850 1850

Peru (PEN) 2.82 2.88 2.89 2.84 2.83 2.80 2.75 2.75

Venezuala (VEF) 4.29 2.15 2.15 4.30 4.30 4.30 4.30 4.30

Eastern Europe vs EUR

Czech Republic (CZK) 25.08 25.31 26.40 25.41 25.69 24.57 24.80 24.75

Hungary (HUF) 278 270 270 266 285 277 275 270

Russia vs USD (RUB) 31.17 30.09 30.24 29.36 31.20 30.40 30.80 29.70

Romanian (RON) 3.24 4.25 4.30 4.09 4.15 4.25 4.25 4.20

Turkey vs USD (TRY) 1.49 1.48 1.50 1.52 1.59 1.45 1.46 1.48

Simple rate

Poland (PLN) 4.05 4.24 4.11 3.86 4.14 3.98 3.90 3.85

Middle East vs USD x x x x x x x x x

Egypt (EGP) 5.79 5.50 5.48 5.48 5.50 5.71 5.70 5.72

Israel (ILS) 3.64 3.77 3.75 3.80 3.85 3.75 3.57 3.53

Emerging markets forec

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end period 2006 2007 2008 2009 2010

Q4 Q4 Q4 Q3 Q4 Q1 Q2 Q3

Americas x x

x Canada (CAD) 1.16 0.99 1.23 1.07 1.05 1.01 1.06 1.03

x Mexico (MXN) 10.80 10.92 13.69 13.50 13.10 12.36 12.84 12.60

x Brazil (BRL) 2.14 1.77 2.31 1.78 1.74 1.78 1.80 1.69

x Argentina (ARS) 3.06 3.15 3.45 3.84 3.80 3.88 3.93 3.97

Western Europe x x x x x x x x x x

Eurozone (EUR*) 1.32 1.46 1.39 1.46 1.43 1.35 1.22 1.37

Other Western Europe x x x x x x x x x x

x UK (GBP*) 1.96 1.99 1.44 1.60 1.61 1.52 1.50 1.58

x Sweden (SEK) 6.84 6.46 7.91 6.99 7.14 7.20 7.78 6.73

x Norway (NOK) 6.23 5.43 7.00 5.80 5.78 5.94 6.50 5.86

x Switzerland (CHF) 1.22 1.13 1.06 1.04 1.03 1.05 1.08 0.98

Emerging Europe x x x x x x x x x x

x Russia (RUB) 26.4 24.5 29.4 30.1 30.2 29.4 31.2 30.4

x Poland (PLN) 2.90 2.46 2.96 2.90 2.86 2.85 3.38 2.91

x Hungary (HUF) 191 173 191 185 188 196 233 203

x Czech Republic (CZK) 20.9 18.2 19.3 17.3 18.4 18.8 21.0 18.0

Asia/Pacific x

x Japan (JPY) 119 112 91 90 93 93 88 84

x Australia (AUD*) 0.79 0.88 0.70 0.88 0.90 0.92 0.84 0.97

x New Zealand (NZD*) 0.71 0.77 0.58 0.72 0.73 0.71 0.69 0.74

North Asia x x x x x x x x x x

x China (CNY) 7.81 7.31 6.82 6.83 6.83 6.83 6.78 6.69

x Hong Kong (HKD) 7.77 7.80 7.75 7.80 7.80 7.80 7.80 7.80

x Taiwan (TWD) 32.6 32.4 32.9 32.2 32.1 31.8 32.3 31.2

x South Korea (KRW) 930 936 1263 1177 1166 1133 1223 1140South Asia x x x x x x x x x x

India (INR) 44.2 39.4 48.6 47.7 46.4 44.8 46.4 44.6

x Indonesia (IDR) 8996 9393 11027 9645 9425 9090 9060 8925

x Malaysia (MYR) 3.53 3.31 3.46 3.46 3.42 3.26 3.24 3.09

x Philippines (PHP) 49.1 41.3 47.5 47.6 46.5 45.2 46.4 43.9

Si (SGD) 1 53 1 44 1 43 1 41 1 41 1 40 1 40 1 31

Exchange rates vs USD

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end period 2006 2007 2008 2009 2010

Q4 Q4 Q4 Q3 Q4 Q1 Q2 Q3Vs euro x x

Americas x x

x US (USD) 1.32 1.46 1.39 1.46 1.43 1.35 1.22 1.37 1

x Canada (CAD) 1.53 1.44 1.72 1.57 1.50 1.37 1.30 1.40 1

Europe x

x UK (GBP) 0.67 0.73 0.97 0.91 0.89 0.89 0.82 0.87 0

x Sweden (SEK) 9.02 9.45 10.99 10.22 10.24 9.74 9.53 9.19 9

x Norway (NOK) 8.21 7.94 9.73 8.48 8.29 8.03 7.97 7.99 7

x Switzerland (CHF) 1.61 1.66 1.48 1.52 1.48 1.42 1.32 1.33 1

x Russia (RUB) 34.8 35.9 40.8 44.0 43.4 39.7 38.2 41.5 4

x Poland (PLN) 3.83 3.60 4.12 4.24 4.11 3.86 4.14 3.98 3

x Hungary (HUF) 251 253 266 270 270 266 285 277

x Czech Republic (CZK) 27.5 26.6 26.8 25.3 26.4 25.4 25.7 24.6 2Asia/Pacific x x x x x x x x x

x Japan (JPY) 157 163 126 131 134 126 108 114

x Australia (AUD) 1.67 1.67 1.99 1.66 1.60 1.47 1.45 1.41 1

x New Zealand (NZD) 1.87 1.90 2.38 2.02 1.97 1.91 1.78 1.86 1

Vs sterling x x x x x x x x x

Americas x x x x x x x x x

x US (USD) 1.96 1.99 1.44 1.60 1.61 1.52 1.50 1.58 1x Canada (CAD) 2.28 1.96 1.77 1.72 1.69 1.54 1.59 1.62 1

Europe x x x x x x x x x

x Eurozone (EUR) 0.67 0.73 0.97 0.91 0.89 0.89 0.82 0.87 0x

x Sweden (SEK) 1339 1286 11 37 1118 1153 10 92 1164 1061 10

Exchange rates vs EUR

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Disclosure appendix

Analyst CertificationThe following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible foopinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expresspersonal view(s) and that no part of their compensation was, is or will be directly or inrecommendation(s) or views contained in this research report: David Bloom, Clyde Wardle, RPaul Mackel, Stacy Williams, Perry Kojodjojo, Marjorie Hernandez, Mark McDonald, Daniel H

Important Disclosures

This document has been prepared and is being distributed by the Research Department of HSBclients of HSBC and is not for publication to other persons, whether through the press or by oth

This document is for information purposes only and it should not be regarded as an offer to seto buy the securities or other investment products mentioned in it and/or to participate in anydocument is general and should not be construed as personal advice, given it has been preparobjectives, financial situation or needs of any particular investor. Accordingly, investors shoconsider the appropriateness of the advice, having regard to their objectives, financial situatioprofessional investment and tax advice.

Certain investment products mentioned in this document may not be eligible for sale in some not be suitable for all types of investors. Investors should consult with their HSBC representathe investment products mentioned in this document and take into account their specific situation or particular needs before making a commitment to purchase investment products.

The value of and the income produced by the investment products mentioned in this docuinvestor may get back less than originally invested. Certain high-volatility investments can bein value that could equal or exceed the amount invested. Value and income from investm

affected by exchange rates, interest rates, or other factors. Past performance of a particular invof future results.

Analysts, economists, and strategists are paid in part by reference to the profitability of HSbanking revenues.

For disclosures in respect of any company mentioned in this report please see the most re

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Disclaimer* Legal entities as at 31 January 2010

'UAE' HSBC Bank Middle East Limited, Dubai; 'HK' The Hongkong and Shanghai Banking Corporation

Limited, Hong Kong; 'TW' HSBC Securities (Taiwan) Corporation Limited; 'CA' HSBC Securities (Canada)

Inc, Toronto; HSBC Bank, Paris branch; HSBC France; 'DE' HSBC Trinkaus & Burkhardt AG, Dusseldorf;

000 HSBC Bank (RR), Moscow; 'IN' HSBC Securities and Capital Markets (India) Private Limited, Mumbai;

'JP' HSBC Securities (Japan) Limited, Tokyo; 'EG' HSBC Securities Egypt S.A.E., Cairo; 'CN' HSBC

Investment Bank Asia Limited, Beijing Representative Office; The Hongkong and Shanghai Banking

Corporation Limited, Singapore branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul

Securities Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Branch; HSBC

Securities (South Africa) (Pty) Ltd, Johannesburg; 'GR' HSBC Pantelakis Securities S.A., Athens; HSBC

Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv, 'US' HSBC Securities (USA) Inc, New York; HSBC

Yatirim Menkul Degerler A.S., Istanbul; HSBC Mxico, S.A., Institucin de Banca Mltiple, Grupo

Financiero HSBC, HSBC Bank Brasil S.A. - Banco Mltiplo, HSBC Bank Australia Limited, HSBC Bank Argentina S.A., HSBC Saudi Arabia Limited., The Hongkong and Shanghai Banking Corporation Limited,

New Zealand Branch.

IssHS

8 C

E14

Tel

Tel

Fax

We

This document is issued and approved in the United Kingdom by HSBC Bank plc for the information of its Clients (asof its affiliates only. If this research is received by a customer of an affiliate of HSBC, its provision to the recipient is between the recipient and such affiliate. In Australia, this publication has been distributed by The Hongkong and (ABN 65 117 925 970, AFSL 301737) for the general information of its wholesale customers (as defined in the Corto retail customers, this research is distributed by HSBC Bank Australia Limited (AFSL No. 232595). These respectthe products or services mentioned in this document are available to persons in Australia or are necessarily suitable foaccordance with local law. No consideration has been given to the particular investment objectives, financial situation The document is distributed in Hong Kong and Japan by The Hongkong and Shanghai Banking Corporation Limited a

office of HSBC Bank USA, National Association. In Korea, this publication is distributed by either The HongkoLimited, Seoul Securities Branch ("HBAP SLS") or The Hongkong and Shanghai Banking Corporation Limited, Seouinformation of professional investors specified in Article 9 of the Financial Investment Services and Capital Markets a prospectus as defined in the FSCMA. It may not be further distributed in whole or in part for any purpose. Both HBby the Financial Services Commission and the Financial Supervisory Service of Korea.Each of the companies listed above (the Participating Companies) is a member of the HSBC Group of Companies,own account as Principal, may have underwritten an issue within the last 36 months or, together with its Directors, offishort position in securities or instruments or in any related instrument mentioned in the document. Brokerage or fCompanies or persons associated with them in respect of any business transacted by them in all or any of the secudocument. This publication is distributed in New Zealand by The Hongkong and Shanghai Banking Corporation LimiteThe information in this document is derived from sources the Participating Companies believe to be reliable but whicThe Participating Companies make no guarantee of its accuracy and completeness and are not responsible for errorsdata, nor shall the Participating Companies be liable for damages arising out of any persons reliance upon this inforpublicly available sources or proprietary data. The opinions in this document constitute the present judgement of the Pato change without notice.This document is neither an offer to sell, purchase or subscribe for any investment nor a solicitation of such an offeresponsibility for the content of this research report prepared by its non-US foreign affiliate. All US persons recintending to effect transactions in any security discussed herein should do so with HSBC Securities (USA) Inc. in theforeign affiliate, the issuer of this report. In Singapore, this publication is distributed by The Hongkong and Sh


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