Kathleen Stephansenppt Jan 1010

The 2010 Euro Outlook January, 2010

Kathleen StephansenChief Economist

ALADDIN CAPITAL LLC6 Landmark Square, Stamford, CT 06901 / Phone: (203) 487-6700 / Fax:

(203) 487-6764

1

Euro/USD: where to?

ALADDIN CAPITAL LLC6 Landmark Square, Stamford, CT 06901 / Phone: (203) 487-6700 / Fax: (203) 487-6764

2

Euro Reference Exchange Rate: US Dollar

EOP, USD/EUR

09080706Source: European Central Bank /Haver Analytics

1.6

1.5

1.4

1.3

1.2

1.1

1.6

1.5

1.4

1.3

1.2

1.1

3

• The crisis underscored the non-sustainability of global imbalances.

• Any adjustment should lead to an intensification of capital flows directed to emerging economies and to reserve diversification.

• We believe the dollar is on a longer-term downward trend and the euro should benefit partially from this adjustment.

• Near-term, the tension between positive and negative factors will keep the Euro-USD in a relatively tight range. We project it to end the year close to 1.50.

• Historical perspective: The Euro has been a success. The challenge ahead is to restore growth without the benefit of the demand impulse from the peripheral countries.

The Euro Outlook


Much hinges on the CNY/USD. The end of the 2005 peg has benefited the euro and is the manifestation of a currency

redistribution away from the dollar.


4

Foreign Exchange Rate: European Monetary UnionUS$/Euro

Foreign Exchange Rate: People's Republic of ChinaYuan/US$

090807060504Sources: Federal Reserve Board /Haver Analytics

1.6

1.5

1.4

1.3

1.2

1.1

8.4

8.0

7.6

7.2

6.8

USD-CNY (RHS)

EUR-USD (LHS)

China’s contribution to global growth has risen steadily this past decade


5

Chinese and US contribution to global growth in ppt (PPP weights)

Sources: IMF/Haver Analytics

-1

-0.5

0

0.5

1

1.5

2

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

e20

10e

US Contribution China Contribution

… Reflecting the strength in exports but also in infrastructure build


6

Sector contribution to real GDP growth

Sources: China National Bureau of Statistics/Haver Analytics

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Consumption Fixed Investment Net exports

7

Structural changes


Structural changes bring tensions in currencies that reflects shifts in financing and capital flows.

The near-term adjustments to credit restraint, de-leveraging and restructuring of debt, private demand in the G-2 (US & UK) could be a restraining factor to the positive multiplier effects of recovering trade flows, a negative for the euro.

The longer-run de-emphasis of the US consumer implies a narrowing of the US current account deficit, a factor that should slow the pace of USD decline.

The burden shifts to China to redirect its drivers of growth away from exports to domestic demand. This process has started already but will gain traction in years to come. This reduces the demand for dollars and benefits the EM space and currency diversification away from the dollar, a positive for currencies such as the euro.

US: Consumer-led growth is set to change


8

Sector contribution to real GDP growth

Sources: BEA/Haver Analytics

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

6.00

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Consumption Fixed Investment Net Exports

Marked decline in the share of industrial countries’ consumption to global consumption


Shares of Regional Consumption to World Consumption

Sources: Bureau of Economic Analysis/Haver Analytics

9

4%

5%

6%

7%

8%

9%

10%

11%

12%

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 0872%

74%

76%

78%

80%

82%

84%NJA LATAM Industrials (rhs)

Sources: DataStream International; IMF; OECD

China’s current account surplus should decline, implying less aggressive purchases of US Treasuries, and a slowdown in

demand for dollars


10

China: BOP: Current Account Balance as a Percentage of GDP

%

08070605040302010099Source: State Administration of Foreign Exchange/Haver Analytics

12

10

8

6

4

2

0

12

10

8

6

4

2

0

The expansion of Chinese domestic demand benefits NJA-ex China. NJA export share to China tripled over the period 1998-

2009, jumping to 15.4% in 2009 from 4.8% in 1998


11

Note: 2009 statistics cover the first 10 months of the yearSources: Datastream

15,000

215,000

415,000

615,000

815,000

1,015,000

1,215,000

1,415,000

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 20093.0

5.0

7.0

9.0

11.0

13.0

15.0

NJA Exports to ROW ($mln, LHS) NJA Exports to China ($Mln, LHS)

Share of Exports to China (%, RHS)

A shift in trade flows should lead to FX reserve diversification. To date, upward pressures on Asian currencies against the USD

implies intervention, thereby limiting the decline of the USD.


12

09080706Sources: BOK, BoT, RBI /Haver

1500

1400

1300

1200

1100

1000

900

52

48

44

40

36

32

28

Korea Won-USD (LHS)Thai Baht-USD (RHS)India Rupee-USD (RHS)

13

• Global FX diversification away from the USD;

• Global liquidity;

• Return to risk appetite;

• The timing of the ECB monetary policy exit.

Near-term positive Euro factors


EM countries, whose currencies are under upward pressure, incur FX reserves accumulation that is set to continue


Intl Liquidity: EM Foreign Exchange (NSA, EOP, Tril.US$)

Sources: Bloomberg Financial Markets/Haver Analytics/

14

0.000

0.500

1.000

1.500

2.000

2.500

3.000

3.500

4.000

… which is linked to the rise in global liquidity and risk appetite


Quantitative Liquidity Measures (percent of G3 GDP)

Sources: IMF/ Eurostat/Haver Analytics

15

-2

0

2

4

6

8

10

12

2000Q1 2001Q1 2002Q1 2003Q1 2004Q1 2005Q1 2006Q1 2007Q1 2008Q1 2009Q1

Base Money Plus Reserves Reserves Base Money

Synchronized growth brings a return to risk appetite


VIX and PMIs

Source: WSJ; Markit/Haver Analytics

16

30.00

35.00

40.00

45.00

50.00

55.00

60.00

Jan-06 May-06Sep-06Jan-07 May-07Sep-07Jan-08 May-08Sep-08 Jan-09 May-09Sep-091.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

10.00Global PMI (LHS) VIX (Inv. Scale- RHS)

… A positive for the Euro


Source: WSJ; Markit/Haver Analytics

17

1.1800

1.2300

1.2800

1.3300

1.3800

1.4300

1.4800

1.5300

1.5800

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

10.00

US$/EUR VIX (Inv. Scale RHS)

Foreign appetite for US assets has slowed


18

movv12m<LT001GN>movv12m<LT001KN>movv12m<LT001MN>movv12m<LT001PN>

0908070605040302010099Sources: TREASURY, TREASURY, TREASURY, TREAS /Haver

100000

80000

60000

40000

20000

0

-20000

100000

80000

60000

40000

20000

0

-20000

TotalNet Foreign Purchase of US TreasurysNet foreign Purchase of US StocksNet Foreign Purchase of US Fedral Agencies

Net foreign purchases of US assets, 12-month moving average, $ Mil.

European appetite for US assets has slowed the most


19

Net European (including the UK) purchases of US assets, 12-month moving average, $ Mil.

Europe: Net Fgn Transactions of Long-Term Securities

12-month MovingAverage Mil.$

09080706050403020100Source: Department of Treasury /Haver Analytics

45000

37500

30000

22500

15000

7500

45000

37500

30000

22500

15000

7500

Will the ECB exit QE ahead of the Fed? We believe so, and it should lead to a gradual widening pressure on Europe-US yield

spreads


20

BOE

090807Sources: BoE, BoJ, FRB, ECB /Haver

6

5

4

3

2

1

0

6

5

4

3

2

1

0

EuroUSJapanUK

21

• Euro area growth differentials with the US;

• Euro area needs rebalancing of growth;

• Perceived Sovereign Risk fears.

Near-term negative Euro Factors


Growth differentials between the US and the Euro area favor the USD, replacing the risk aversion/USD relationship


22

-4

-3

-2

-1

0

1

2

3

4

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

US Real Gross Domestic Product (SAAR, Bil.Chn.2005$) % Change - Annual Rate

Sources: Bureau of Economic Analysis/Statistical Office of the European Communities/Haver Analytics

Euro area Real Gross Domestic Product (Mil.Chn.00.Euros) % Change Y/Y

Note: Aladdin projections in Red

Collapse in growth in smaller countries


23

1110090807060504030201Sources: Statistical Office of the European Communities /Haver Analytics

6

4

2

0

-2

-4

-6

6

4

2

0

-2

-4

-6

SpainPortugalEuro Area

1110090807060504030201Sources: Statistical Office of the European Communities /Haver Analytics

12

8

4

0

-4

-8

12

8

4

0

-4

-8

IrelandGreeceEuro Area

GDP year-on-year % change

Loss of competitiveness…


24

Business Sector: Unit Labor Cost % Change - Year to Year SA, 1992=100

EA 16: Unit Labor Costs % Change - Year to Year SA, 2000=100

0908070605040302010099Sources: BLS, ECB /Haver

6

4

2

0

-2

-4

6

4

2

0

-2

-4

Euro Area

US

…And deterioration in the Euro area fiscal outlook…


25

Sources: OECD/Haver Analytics

-15

-10

-5

0

5

BE DE IE GR ES FR IT CY LU MT NL AT PT SI SK FI

2008 2009 (est.) 2010 (f)

Euro area General Government Balance-to-GDP

… Have led to sovereign fears, a negative for the Euro


26

Greece: 10-Year Government Bond Yield%

Germany: 10-Year Government Bond Yield%

0908070605040302Sources: Financial Times /Haver Analytics

6.00

5.25

4.50

3.75

3.00

2.25

6.00

5.25

4.50

3.75

3.00

2.25

Germany

Greece

The fiscal situation has deteriorated in the US as well, dampening the negative effect on the Euro/USD


Budget deficits (-)/surpluses (+) by fiscal year (as a percentage of gross domestic product)

Source: Congressional Budget Office

27

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

… With the accumulation of debt at both the Federal


28

Federal Government: Liabilities: Credit Market Instruments

SA, Bil$

09080706050403Source: Federal Reserve Board /Haver Analytics

8000

7000

6000

5000

4000

3000

8000

7000

6000

5000

4000

3000

… And State and Local Government Levels


29

State & Local Govt: Liabilities: Credit Market Instruments

SA, Bil$

09080706050403Source: Federal Reserve Board /Haver Analytics

2400

2200

2000

1800

1600

1400

2400

2200

2000

1800

1600

1400

30

• The success story

Historical Perspective


Euro declines rapidly against the USD, then rebounds strongly


Sources: Bloomberg/Cumberland Advisors

31

USD/EUR

0.8

0.9

1

1.1

1.2

1.3

1.4

1.5

1.6Ja

n-91

Jan-

92

Jan-

93

Jan-

94

Jan-

95

Jan-

96

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

After 2002 the Euro was fully deployed and national currencies were withdrawn from circulation

From 1999-2002 the Euro was trading in electronic markets and the FX market

The European Currency Unit (ECU), a theoretical "basket" currency, is used as a proxy for the Euro when calculating the USD/EUR exchange rate, pre-1999

The Euro’s success measured by its rapid expansion: After ten years, 11 became 16


32

Original Member CountriesAustriaBelgiumFinlandFranceGermanyIrelandItalyLuxembourgNetherlandsPortugalSpain

1999

Later EntriesGreece (2001)Slovenia (2007)Cyprus (2008)Malta (2008)Slovakia (2009)

2001 - 2009

Legally Obliged to Join in FutureEstonia (2011)Lithuania (2011)Latvia (2012)Poland (2013)Czech. Republic (2013)Hungary (2013)Bulgaria (2015)Romania (2015)

2011 - 2015

Sources: The Euro Area, European Central Bank, ww w.ecb.int/euro/intro/html/map.en.html; WhereEastern Europeans Stand on Euro Adoption, Thompson Financial,www.forbes.com/feeds/afx/2009/01/22/afx5951139.html; January 2009 Reuters poll of analysts on euroadoption dates

33

International debt issued in Euros and USD is roughly equal


Sources: BIS Quarterly Review: 'June 2009

Amounts outstanding of international bonds and notes, by type, sector and currency (in billions of US dollars)

0

2000

4000

6000

8000

10000

12000

14000

1993 1995 1997 1999 2001 2003 2005 2007

US

D b

illio

nsEuroUS dollar

Global cash outstanding in Euros Is Greater than in USD

ALADDIN CAPITAL LLC6 Landmark Square, Stamford, CT 06901 / Phone: (203) 487-6700 / Fax: (203) 487-6764 34

Note: Euro area (changing composition) - Net Circulation - number of banknotes/coins in circulation (for banknotes it has to be calculated, and equals created notes less destroyed notes less stocks of the NCB) - Banknotes - All denominations - 1st design - Stock - denominated in Euro. Sources: Federal Reserve Bank of St. Louis, European Central Bank, and Cumberland Advisors

190

290

390

490

590

690

790

890

990

1090

Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

US

Dol

lar

Euro Circulation in USD

USD Circulation

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Kathleen Stephansenppt Jan 1010