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Global Markets November 15, 2011 Rates & Foreign Exchange Research

BREAKING UP IS HARD TO DO

CONTENTSLead Article: Breaking Up is Hard to Do . . . . . . . . . . . . . . . . . . . . . . . . . . 1U .S . Fixed Income . . . . . . . . . . . . . . . . . 5Canadian Fixed Income . . . . . . . . . . . . 6U .K . Fixed Income . . . . . . . . . . . . . . 7Australian Fixed Income . . . . . . . . . . . 8New Zealand Fixed Income . . . . . . . . . 9U .S . Dollar . . . . . . . . . . . . . . . . . . . . . . 10Canadian Dollar . . . . . . . . . . . . . . . . . 11Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . 12Japanese Yen . . . . . . . . . . . . . . . . . . . 13U .K . Pound . . . . . . . . . . . . . . . . . . . . . 14Australian Dollar . . . . . . . . . . . . . . . . . 15New Zealand Dollar . . . . . . . . . . . . . . 16Swiss Franc . . . . . . . . . . . . . . . . . . . . . 17Summary Fixed Income Table . . . . . . 18Summary Foreign Exchange Table . . 19

HIGHLIGHTS

• Our mantra for the Eurozone has remained very simple - that which is not sustainable will not be sustained, everything else is detail .

• There are only three solutions for the Eurozone - ECB buying, fiscal union, or breaking up .

• Our guiding Eurozone principle is that breaking up is hard to do .

• The Reserve Bank of Australia expected to cut its policy rate by 25 basis points in 2012Q1 . There are no other major revisions to the forecasts .

Our strategic mantra for the Eurozone has remained simple – that which is not sustainable will not be sustained and everything else is detail. Tactically, the details make the trade, or honestly these days, make much of Europe untradeable. But the problem is that Europe is not being driven by data but by events, which makes forecasting problematic.

There is still an interesting schism in markets. Growth sentiment continues to underpin positive equity trends, while Eurozone fears drive the volatility. While in fixed income markets, it is Eurozone fears that dominate the trends with global data just the sideshow. The correlation between equities or fixed income is vulnerable to a quick correction depending on which asset class dominates and which one eventually wins this tug-of-war, and all other markets continue to be held hostage in the limbo in between.

One year ago, we laid out our roadmap for how the Eurozone would evolve, and it has stuck to the script. Small peripherals would continue to struggle as Germany outperformed, but Eurozone Leaders would continue to rely on duct tape to get through the issues until a large enough member came under pressure that threatened German growth and stability. Only then would the hard political choices be made. Well, Italy is large, so are we there yet?

The big picture is that we do not have a sustainable so-lution in place yet in Europe. We will ignore any proposal that does not at least halve EUR/USD basis swap and FRA-Eonia spreads from current levels, as nothing is sustainable until pressure on banks is relieved, and the risks of a major financial col-lapse remains high, beyond the small ones of MF Global or Dexia seen so far. The markets will continue to push Eurozone leaders in the direction of “fiscal union or bust.” And, while pundits over the course of the year have raised valid legal, logistical, and politi-cal difficulties in getting to this end game, the bottom line for us remains that no other solution but fiscal union and de facto issuance of Eurobonds is sustainable. Even this development does not mean all immediate problems would be solved, but it would bring a measure of stability as a happy ending came into view.

The July agreements opened the door to debt write-downs, but did not go far enough, so the market pushed for more, Greece fell behind, and we are now looking at a bigger cut for Greece. The October agreements opened the door to a fiscal union, as they announced a 20-30% insurance scheme, but did not go far enough. The market is now pushing for more, and they will get it.

The reason is that after our sustainability mantra, our next guiding principle has been that breaking up is hard to do. It is not impossible, but it is costly for all involved to contemplate even a partial exit from the Eurozone. For that reason,

EUROPEAN FUNDING FEARS HAVE SHOWN NO RELIEF

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11/119/117/115/113/111/1111/109/107/1010

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*3m Euribor-OIS; Source: Bloomberg

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iTraxx Financials Senior* (rhs)

European bank spread for unsecured lending* (lhs)

Spread (bps)

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Global Markets November 15, 2011Rates & FX Research

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we have continued to be cyclical bears but structural bulls on the Eurozone. We still believe the political will to get to fiscal union will be found if the alternative is a breaking-up of the Euro, but costly political mistakes can be made in tense circumstances where policy interventions are ad hoc and improvised.

The problem with digging much deeper than mantras and principles is that a definitive roadmap is fraught with mas-sive uncertainty. We lay out the facts and likely directions for the program countries, and soon-to-be program country of Italy in our opinion, in the box in the box on page 4. The unthinkables that should now be the guideposts for this crisis and in investors’ base case plans include some combination of the following possibilities:• By the end of 2011, European leaders will have laid

the groundwork for a fiscal union, though iterations, evolutions, and implementation will take us well into 2012, the Eurozone recession will be confirmed, the ECB (either alone or in tandem with others) will have provided liquidity relief for banks (but nailing down what is harder as cutting the fee on EUR/USD basis swaps is the most obvious but has a high political hurdle in the Fed) and Greece will likely have announced an involuntary haircut of 50% of market-held debt, meaning CDS will likely be triggered.

• By the end of the first quarter of 2012, Greece will likely have carried out that debt swap, Italian rollover needs will be getting filled via some form of official financing, and at least one rating agency will have downgraded France’s AAA rating.

• By mid-2012, if the US has eschewed peer pressure and avoided recession as we expect, then the ECB will have at least tripled the size of the covered bond buying program in order to ease pressure from bank recapitalizations, and will have cut the refi rate a further 25bps, with a 50/50

chance of a further 50bps cut. And, if the US succumbs to global pressures and slips into recession, the ECB will have begun quantitative easing, an unsterilized purchase of Eurozone government bonds in proportion to their capital shares of the ECB (rather than a credit easing focus on strained governments) in order to inject further stimulus into the economy.

• By end-2012, Greece may well have defaulted again once they have achieved a primary surplus, and the Italian rating downgrades should reach a bottom, but this bottom will be at least some shade of BBB, and we see a one-in-three chance that the bottom is a downgrade to junk status by at least one agency, depending on how quickly Eurozone leaders move towards a functional fiscal union.The moral of this story is that even if a European solu-

tion were decided by the beginning of 2012, and the worst of the market pressure ends in the first quarter of 2012, the residual momentum of the crisis likely still takes us into the end of next year. One of the biggest drivers for a change right now is that with Italy now in need of official shelter from excessive financing rates, the pressure on the EFSF as a stabilizing force has intensified. The spread of French 5y and 10y debt to Germany is now the same spread as that of EFSF debt to Germany – the whole is no longer greater than the sum of its parts in the market’s opinion. So those reserve managers that saw the EFSF as a great way to pick up yield over their German and French bonds will increas-ingly rethink this. We have reached the end of what liquidity and financial alchemy can create out of thin air – the EFSF needs new hard cash, which effectively means a further push down the road of fiscal union.

The Eurozone is in a full-blown recession with a post-modern twist. The twist is that German labour remains highly competitive globally, so as long as US and Chinese

THE CHANGING OF THE GUARD IN RESERVE ASSETS

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*US, Japan, Germany, France; **Sweden, Norway, Australia, New Zealand, UK; Source: Bloomberg

Spread (bps)

Traditional AAAs*

New Guard AAAs**

Spread (bps)

WHO IS SAVING WHOM - FRENCH DEBT NOW TRADES ATTHE SAME YIELD AS EFSF BONDS

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*Average of July and December 2016 bonds; Source: Bloomberg

Spread to Germany (bps)

EFSF* (rhs)

Italy (lhs)

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France (rhs)


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growth remain as resilient as we expect, the German contrac-tion can be mild. And this post-modern world gets odder when we realize that as of July, the average debt rating of EMs in the EMEA region is now higher than that of the GI-IPS. But none of this will moderate the regional recession to any great degree. As recent IMF research has reaffirmed, the direct spill-over effects of German growth are low, as France and Italy have tighter regional interconnections. So, the fact that Italian growth over the next two quarters looks likely to be the weakest in over thirty years should cause forecasters pause, and the fact that credit troubles usu-ally take two quarters to show up fully should further bias forecasts lower. A few growth forecast downgrades are in prospect for next year.

Today’s saving grace for Europe has been the resilience of the US economy. As the same IMF research above also reaffirms, the spill-overs from the European economy to the rest of the global economy have been minimal in the past forty years. US growth shocks feed through substantially into other regions, Japanese shocks pass through to a lesser extent, and the Eurozone, even less. The caveat is that these spill-overs are greater the more the shock is financial rather than real economy related, so once again, forecasters must pause for thought. There is little domestically driving the US into recession, but uncertain European politics and the new age global financial linkages leave the transmission mechanisms of global contagion highly uncertain.

The Eurozone crisis remains positive for fixed income markets and our assumption on German and UK rates is that we have yet to see the bottom and will not see it until the first quarter of next year. Rates are obviously abnormally low and subject to much bigger jump risks to rise than fall, but until there is a sustainable solution for the Eurozone, crises and the need for liquidity and capital preservation will keep safe haven yields lower here, just as they will continue to bias spreads of other Eurozone countries higher until a sustainable plan is in place.

Equity markets have shown just the opposite. The Au-gust collapse came on worries of a home-grown US debt debacle, with all the likely spill-overs to global growth that

such an outcome would deliver. The Eurozone headlines drove volatility up and stock prices down, but it was not until fears of a US recession subsided in October, and the expectations of a new Eurozone, allowed equities to es-tablish a relief rally. With consensus growth expectations for the US now stabilized around the “moderate but not recessionary” camp, equities have also stabilized to benefit from the continued strong push from cash. Until the status quo on US growth changes, equities and risk sentiment are unlikely to show much directionality. Until the status quo on Eurozone sustainability is resolved, the bias for European rates will be for new lows, and for global rates to retain their current lows.

So is a muddling solution to the current Eurozone woes possible? Yes, if leaders find another way to provide ad-ditional limited and targeted liquidity, then they could find a way to placate markets through the current frictions. But again, that would not be sustainable. Only the unlimited provision of liquidity for all Eurozone members – whether from ECB buying or fiscal union – will provide a positive end to this crisis. Any other result from any summit in Europe will leave the market and us yearning for the smell of more calm in the morning after.

AVERAGE CREDIT RATING BY REGION

Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11

GIIPSEMEA EM Basket *

AAA

AA

AA

BBB

BB

July 2011

*Czech Republic, Hungary, Poland, Romania, Russia, S. Africa, Slovakia, Turkey; **Moody's, S&P, Fitch; Source: Bloomberg

Average rating**

Richard Kelly Head of European Rates & FX Research

+44 20 7786 8448

http://www.imf.org/external/pubs/ft/wp/2011/wp11218.pdf

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changes in the economy in order to free up potential. Portuguese debt could ultimately be unsustainable and need a writedown, but as long as the IMF program remains on-track, this is nothing we will know for 2-4 years. For all countries, the troika replaces market access so the market loses all relevance for analyzing risks.

• Italy: The most recent casualty in the market looks like itisontrackforofficialtroikafunding,aswell,inouropinion. The immediate issue here is that while Italy has yet to cancel any BTP auctions, they are prefunded sodonotactuallyneedmarketfinancinguntilthefirstquarter of next year. We have previously run down how Italian debt is sustainable even if the interest rate dynamics are not, and what theshapeofofficialfinanc-ing to roll Italy through the next 12 months will look like. Italy’s vulnerability is its large debt stock, which leaves it vulnerable to illiquidity as it must roll its debt in the market. But long maturities mean it is less vulnerable to interest rate shocks – as we have right now – than the likes of the US or Japan. And the fact that their primary balance is zero, so government revenues are enough to meet expenditures on everything but interest payments, means their debt dynamics will not start an IMF program on an explosive trajectory that requires massively front-loaded adjustment. Italy needs time out ofthemarkettorestoreconfidence.ThetrajectoryforItaly’s credit rating depends on the speed with which leadersmovetowardsafiscalunionandthefinancialresources they put behind it. Too little, too late, and at least one rating agency will have downgraded Ital-ian debt to junk status by the end of 2012, which will further exacerbate and entrench the higher equilibrium in Italian debt as this would make it ineligible for many indices and buyers.

• Greece: Greek debt-to-GDP just shy of 200% is un-sustainable – full stop. The current plan to write off 50% of market-held debt, about €100bn, is still just a third of Greece’s total debt. We assume that this write-down will not be voluntary, so it will trigger CDS and the uncertainties with unwinding positions there. We also do not believe that a 50% haircut on market-held debt is enough. So even if everything goes according to plan, Greece will likely have another haircut late in 2012 – when the dynamics will turn from one of the core unwillingtofinanceGreecetooneofGreecenolongerneeding the foreign aid that is providing the leverage right now. But if Greek leaders in the new government cansignanaffirmationtotheIMFthattheyarestickingto the plan, they will receive the delayed tranche of aid this month needed to tide them over into mid-December. Weexpectmid-Decemberiswhenwewillconfirmtheswap will not be voluntary but will go through, to be completed in January. While it is possible they decide to write off more than 50% given it will not be volun-tary, we think this is doubtful, as Eurozone leaders are hesitant to cut Greece’s debt/GDP ratio below that of a country like Italy for fear it creates the impression that Italy would also need a haircut.

• Ireland and Portugal: These smaller peripheral economies continue to be in IMF programs, with the Irish program ahead of schedule while Portugal re-mains broadly on track. Their respective debt paths are sustainable depending on future events. Irish debt is sustainable as long as there is no further shock in the banking sector that sees the government assume futher private liabilities. Portuguese debt is sustain-able, but only if they can at least double their average GDP growth rate to something well north of 2%. This is why the IMF program is focusing on large structural

The Program and Soon-to-Be Program Countries

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U .S . FIXED INCOMEThe Fed is ready to launch a QE3 if conditions warrant a

further expansion of the balance sheet and we suspect risks in Europe and in Washington may be pushing us closer to that moment. However, through year-end the threshold for more QE is higher than most believe. Bernanke is not concerned about the political optics of further balance sheet expan-sion in an election cycle. He has already demonstrated his preparedness to guide policy through dissents and political rancor. There are other reasons.

First, Bernanke wants to hold Washington accountable. The Chairman has stated with increasing intensity that effec-tive policy options have dwindled and that national economic policy must become more conducive to growth, and more rational. On this front hangs two immediate priorities: first, extend the temporary payroll tax deductions enacted last year, extend unemployment benefits, and hopefully extend the payroll relief to businesses to incent hiring as outlined by the Obama Jobs bill. The second priority is to achieve some rational deficit cutting agenda through the super com-mittee. Sadly, on this front the farce continues and as of this writing there is little evidence either of these discussions are proceeding as Bernanke had hoped.

Second, the economic data continues to be more resilient. The sharp rollover in growth momentum has now eased, economic surprises continue to generate positive momen-tum, and with Q3 GDP in at 2.5% and H2 growth likely to average just over 2% the fear of recession that gripped the markets over the summer has now eased considerably. Gross Domestic Income (GDI, the conceptual equivalent of GDP) is also showing more strength than the GDP figures. Since QE is best viewed as a tool to reverse disinflation rather than promote growth, positive upward momentum in core and headline inflation both suggest the urgency to jump into QE is simply not there.

Bernanke is doing what he can to plug some current into household and business confidence to achieve buy-in to this recovery. Meanwhile, politicians in Washington appear eager to achieve quite the opposite effect. European leaders don’t seem to be far behind. The Fed is left picking up the pieces

Spot Rate 2011 201215/11/2011 Q1 Q2 Q3 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 1.003-mth T-Bill Rate (%) 0.01 0.09 0.02 0.05 0.05 0.10 0.10 0.10 0.10 0.10 0.15 0.80 1.102-yr Govt. Bond Yield (%) 0.23 0.82 0.25 0.20 0.25 0.30 0.30 0.35 0.50 0.80 0.95 1.15 1.555-yr Govt. Bond Yield (%) 0.88 2.27 0.95 0.90 0.90 1.00 1.25 1.40 1.55 1.65 1.70 1.95 2.1010-yr Govt. Bond Yield (%) 2.01 3.47 1.75 1.90 1.90 2.00 2.40 2.65 2.75 2.75 2.80 3.00 3.2530-yr Govt. Bond Yield (%) 3.05 4.51 2.91 3.05 3.00 3.25 3.75 3.90 4.00 4.05 4.10 4.20 4.30

10-yr-2-yr Govt. Spread (%) 1.78 2.65 1.50 1.70 1.60 1.70 2.10 2.30 2.25 1.95 1.85 1.85 1.70

f: Forecast by TD Bank Group as at November 15, 2011; All forecasts are for end of period. Source: Bloomberg, TDBG

U .S . FIXED INCOME OUTLOOK2013

and Bernanke knows the risks are high. One such risk is easing the rigor of the central bank’s inflation mandate. Over the long term that imperative is being expressed through chatter on nominal GDP targeting which is nothing more than a thinly guised easing of price stability.

The policy today is to achieve a yield curve that is low and flat. If his hand is forced, more QE becomes likely but the effects of that policy has proven to achieve just the opposite, a higher and steeper curve. Bernanke may target MBS, but what about the level of rates? In effect it pushes policy away from deploying a rate based strategy in “low for longer” and Twist, and back toward the balance sheet/ portfolio rebalancing strategies of QE. The more the Fed meddles in the economy and blows up its balance sheet, the more uncertain is the near term outcome, and the more uncertain is the ultimately fall-out from a policy that has little precedent in this country.

As risks go, none are larger than Europe. However, a fis-cal mistake in Washington also cannot be ignored. Failure to extend existing payroll deductions, as well as unemployment benefits would represent a hit to GDP in 2012 of 0.5% to 0.8%. For fiscal policy to be growth neutral, both measures must be passed. Otherwise, it would suggest GDP in 2012 could be closer to 1.8% than our current expectation of 2.6%.

It is in this environment of unknowns that we publish the latest rate forecasts. We suspect that the outcome in rates space is likely to be more binary over the next two months with rates testing or possibly moving through the high or low of its recent range depending on how events unfold. The problem is that nothing sufficiently concrete has changed since the October round. For now we stick to our ranges, and operate with the view that the recent low in yield has been set. Operation Twist, “low for longer,” and growth risks will keep rates low while a reflationary Fed “mindset” keeps that trade two-sided. However, neither inflation nor growth is likely to be significant drivers for Treasuries over the next several weeks. Volatility, uncertainty, and liquidity could be.

Eric Green, Chief U.S. Strategist212-827-7156


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CANADIAN FIXED INCOMESince the last Global Markets publication, the waves of

turmoil emanating from Europe have once again pulled Ca-nadian government yields towards the bottom of their recent trading ranges and rekindled expectations that the Bank of Canada will lower its policy interest rate. The outlook is still exceptionally murky and even though the risk that the crisis expands further cannot be easily dismissed, the worst case outcome does not have a sufficiently high probability to be incorporated into the base case forecast. Instead, we continue to expect that the Bank of Canada will remain comfortably on the sidelines in holding the overnight rate unchanged at 1.00% until early 2013. We expect as well that the prevailing range for Canadian yields will also remain intact through year-end with investor sentiment and the tone of headlines determining the exact location at a given moment in time.

From the perspective of the Bank of Canada, the Eu-ropean sovereign risk crisis has a direct impact on Canada through financial market channels and an indirect impact through international trade linkages that will weigh on the outlook for growth and inflation. In the unlikely event that the domestic funding market becomes impaired in response to developments in Europe, the Bank would be prepared to provide liquidity through its short-term lending facilities and could contemplate a cut in the overnight rate to bolster confidence.

In managing the wider macroeconomic implications of the debt crisis, the Bank’s overnight rate already stands at an exceptionally accommodative level and its revised economic forecasts outlined in the October Monetary Policy Report

sends a clear message that ‘lower for longer’ remains the preferred strategy. Moreover, fiscal policy could be relied upon to provide an additional dose of stimulus if required. This view stands in contrast to the market that continues to hold out hope for at least one 25 basis point cut by the middle of next year. Even though we believe this expectation will not be met, we are sympathetic of the market’s pricing purely from a risk management perspective.

The forecast for the rest of the yield curve remains largely unchanged and roughly targets the midpoint of the range that has been in place since early August. We see 2s finishing the year around 95 basis points with a bias towards the top of the 80-110 basis point range. For 5s, we have nudged down our Q4 expectation just slightly and have identified a range of 125 to 160 basis points. Finally, we have made small tweaks to both 10s and 30s to stand near the top of their ranges of 200-240 and 265-300 basis points respectively.

Looking further into 2012, yields at the front end are expected to remain reasonably well anchored while the ex-pectation that sentiment gradually improves will help push longer-dated yields higher. But with growth in the Canadian economy expected to average just 1.9% in 2012, the pre-vailing level of yields is quite low by historical standards and subject to downside risk in the event that the outlook fails to improve.

Spot Rate 2011 201215/11/2011 Q1 Q2 Q3 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 1.00 1.00 1.25 1.75 2.00 2.503-mth T-Bill Rate (%) 0.88 0.96 0.90 0.82 0.90 0.90 0.90 0.95 1.00 1.30 1.80 2.10 2.602-yr Govt. Bond Yield (%) 0.89 1.83 1.59 0.89 0.95 1.00 1.00 1.10 1.40 1.90 2.30 2.70 3.105-yr Govt. Bond Yield (%) 1.36 2.77 2.33 1.40 1.40 1.55 1.85 2.05 2.20 2.40 2.70 3.10 3.4010-yr Govt. Bond Yield (%) 2.09 3.35 3.11 2.16 2.25 2.40 2.80 3.05 3.30 3.50 3.60 3.70 3.9030-yr Govt. Bond Yield (%) 2.72 3.76 3.55 2.77 3.00 3.25 3.45 3.55 3.75 3.83 3.85 4.00 4.10

10-yr-2-yr Govt. Spread (%) 1.20 1.52 1.52 1.27 1.30 1.40 1.80 1.95 1.90 1.60 1.30 1.00 0.80

Canada-U .S . Spreads 3-mth T-Bill Rate (%) 0.87 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 1.00 1.50 1.25 1.50 2-yr Govt. Bond Yield (%) 0.66 0.87 0.88 0.77 0.85 0.80 0.80 0.85 0.90 1.20 1.65 1.30 1.50 5-yr Govt. Bond Yield (%) 0.48 1.01 1.34 0.69 0.70 0.70 0.70 0.75 0.90 1.10 1.35 1.55 1.5510-yr Govt. Bond Yield (%) 0.08 0.50 1.38 0.50 0.50 0.55 0.60 0.65 0.65 0.75 1.00 1.15 1.3030-yr Govt. Bond Yield (%) -0.33 -0.12 1.36 0.26 0.35 0.40 0.40 0.40 0.55 0.75 0.80 0.70 0.65


2013CANADIAN FIXED INCOME OUTLOOK

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


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U .K . FIXED INCOMEThe QE era came earlier than expected as the MPC sur-

prised markets with an aggressive announcement of £75bn in gilt purchases spanning the four months from October to February. This will then take the MPC to their Quarterly Inflation Report in February as the next key date to evaluate the program. Given the developments in the UK and Euro-pean economy and the aggressive easing from the BoE, we expect them to extend these purchases with a further £50bn over three months announced in February.

This comes in spite of inflation now having breached the 5% threshold as the rally in oil prices in the spring passed through into utility price hikes in August and September. The Minutes from the October MPC meeting suggested that the decision to re-introduce QE was driven more by a lack of faith in Eurozone leaders to contain the debt crisis, rather than any shockingly bad data out of the UK. Although the UK data has been soft enough on its own to justify further stimulus, with the PMIs continuing to sink and jobless claims rising again. We’ll get further detail on the BoE’s thinking in this week’s Quarterly Inflation Report.

There’s no evidence to date that asset purchases have fuelled an increase in market inflation expectations, support-ing our view that the BoE can still deliver further stimulus without any damage to the longer-term inflation outlook. In fact, UK 5y BE rates are only about 5-10bps higher now than their lows in September, compared to a 15bps increase in Germany and a 45bps increase for the US. And not only has the UK has been the laggard in changes in shorter-term inflation expectations, but both 10y and 20y expectations have hit new lows in recent weeks.

Going forward, we believe that as long as half measures and partial solutions are put in place by European leaders, we cannot conclusively say that we have seen the bottom in UK yields. Add to that ongoing QE and the likelihood of more given the recession in the Eurozone and risks for the UK and we think that we still have more room to go on the

downside. We expect 5s to trade below 1.00%, 10s to trade below 2.00%, and 30s to trade below 3.00% with the peak risks of stress in the Q4 2011 to Q1 2012 period, given the redemption schedule for Greece and uncertainty around finalizing the 26 October European deal.

Since the last issue of Global Markets we also pushed back the timing of the first BoE rate hike by one quarter to Q1 2013. Downside risks to Eurozone growth have only increased, and recent data in the UK point to a recession, albeit a relatively mild one. So 5% headline inflation right now can be largely ignored while growth expectations needed to fuel real yields are lacking.

Jacqui Douglas, Senior Global Strategist +44(0)20 7786 8439

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

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U .K . FIXED INCOME OUTLOOKSpot Rate 2011 2012 201315/11/2011 Q1 Q2 Q3 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 0.50 0.75 1.00 1.25 1.503-mth T-Bill Rate (%) 0.53 0.63 0.54 0.53 0.55 0.55 0.70 0.70 0.70 0.95 1.20 1.45 1.702-yr Gilt Yield (%) 0.49 1.36 0.83 0.58 0.50 0.45 0.65 1.00 1.40 1.55 1.80 2.10 2.305-yr Gilt Yield (%) 1.06 2.44 2.07 1.37 1.00 0.90 1.25 2.00 2.50 2.70 2.90 3.15 3.2510-yr Gilt Yield (%) 2.16 3.69 3.38 2.43 2.10 1.95 2.05 2.60 2.90 3.05 3.30 3.50 3.7030-yr Gilt Yield (%) 3.16 4.36 4.29 3.55 3.10 2.95 3.50 4.10 4.10 4.20 4.30 4.30 4.30

10-yr-2-yr Gilt Spread (%) 1.67 2.33 2.55 1.85 1.60 1.50 1.40 1.60 1.50 1.50 1.50 1.40 1.40f: Forecast by TD Securities as of November 15, 2011; All forecasts are for end of period. Source: Bloomberg, TD Securities


8

AUSTRALIAN FIXED INCOMEThe Australian Commonwealth Government bond

(ACGB) curve has bull steepened over the past month on renewed global risk aversion and the new reality of the RBA in (temporary) easing mode. Bonds between 3Y and 10Y maturities rallied 25-32bps; which outperformed the equivalent Canadian bonds but underperformed New Zea-land. The 3-10Y curve spread steepened, albeit only a little, from 64bps to 68bps.

The RBA delivered one 25bp cut on 1 November, taking the Cash Rate to 4.5%. It said that “more neutral” monetary policy settings were now appropriate given that growth was expected to be around trend and inflation around the middle of the 2-3% target band throughout the next two years. We think “more neutral” is likely to mean another easing, taking the policy rate to a ‘clearly not restrictive’ 4.25%. Markets, however, continue to imply an expectation that the RBA will be forced to take rates to accommodative settings, pricing in cuts totaling another 125bps or so over the coming year.

ACGB moves have aligned with global bond markets; hence the price action seen in Australia over the past month has clearly been dominated more by shifts in global risk appetites more than by changes to the domestic monetary policy outlook. In the month to mid-October, Australian bonds underperformed USTs and Canadian bonds on bet-ter domestic economic data. A month later, and ACGBs have outperformed during the rally. There was a flight to quality as events in Europe began to spiral downwards; and contrary to prior bouts of risk aversion, Australia has been a beneficiary of these FTQ flows this time.

We see more central banks, pension funds and insurers diversifying into AUD. We expect these real money flows to continue to rise over time. The ACGB yield curve is likely to flatten in 2012, once the weight of money regains appetite for longer maturities and is prepared to again move out the curve. The desire for longer maturities and the

Spot Rate 2011 2012 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

Cash Target Rate (%) 4.50 4.75 4.75 4.75 4.50 4.25 4.25 4.25 4.25 4.25 4.25 4.25 4.25 3-mth Bank Bill Rate (%) 4.64 4.92 4.96 4.77 4.65 4.65 4.65 4.65 4.65 4.45 4.45 4.45 4.45 3-yr Govt. Bond Yield (%) 3.40 5.03 4.68 3.61 3.50 3.90 4.00 4.25 4.55 4.65 4.75 5.00 5.00 5-yr Govt. Bond Yield (%) 3.56 5.23 4.77 3.78 3.65 4.10 4.25 4.50 4.75 4.80 4.90 5.15 5.15 10-yr Govt. Bond Yield (%) 4.08 5.48 5.15 4.21 4.20 4.40 4.50 4.70 4.80 4.90 4.95 5.20 5.20

10-yr-3-yr Govt. Spread (%) 0.68 0.45 0.47 0.60 0.70 0.50 0.50 0.45 0.25 0.25 0.20 0.20 0.20

AUSTRALIA FIXED INCOME OUTLOOK

Forecast by TD Bank Group as at November 15, 2011; All forecasts are for end of period. Source: Bloomberg, TDBG

AUSTRALIAN 3-MONTH T-BILL RATES & 10-YEARGOVERNMENT 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 Q3 2011; Forecast by TDBG as at November 2011 Source: Reserve Bank of Australia/Haver Analytics

%


3-mo . T-Bill yield

%

Forecast

search for yield will be major catalysts once risks to global growth subside and risk appetites return. A curve flattening strategy in 2012 is supported by our view that the RBA’s easing phase is shorter than currently priced, but is not dependent on it. While the world is so uncertain it’s not the time to make flattener bets just yet. Meaningful flattening may not occur until 2H 2012. Convexity remains in demand to profit from volatility; and short-maturities with the lower event risk that they imply remain preferred by investors and speculators alike.

Roland Randall, Senior Strategist+65 6500 8047


9

NEW ZEALAND FIXED INCOMENew Zealand Government bonds (NZGBs) continue to

outperform their Dollar-Bloc peers. 10-year yields at 4.15% are now 3bps lower than the Australian equivalent at 4.18%, from 17bps above a month ago. The NZGB curve has bull flattened in contrast to the bull steepening in its Australian counterpart. Nevertheless, the NZGB curve remains very steep by Dollar-Bloc standards. The 2-10Y curve spread was 180bps at its widest point in the past month (in late October), before narrowing to 143bps today. The short-end is firmly anchored to an accommodative 2.5% cash rate (OCR), while the long-end retains some growth and inflation premium as well as some vestige of the RBNZ’s long-held promise of “future OCR increases”.

The outperformance of NZGBs can be put down to several factors. One, the RBNZ whittled down that tight-ening bias in its latest OCR communiqué. Markets have reduced expectations, with not even one 25bp hike now implied within a year. While the RBNZ remains unique still promising policy tightening, markets no longer completely believe it. Second, the process of pricing out rate hikes and curve flattening has been assisted by a string of soft data prints. Inflation is muddied by tax changes, but at 0.4%Q/Q was well below consensus. Exports also disappointed as did employment growth. Retail sales, the only exception, were temporarily boosted by the rugby World Cup. Third, rebuilding after the earthquake – the key driver expected to boost growth and inflation going forward – is taking longer than expected to get going.

Further out, the domestic rebuilding process should eventually tighten economic capacity and thus keep inflation buoyant, but that’s probably a story for 2H 2012. If global headwinds abate as we expect, then a more traditional tight-ening cycle can commence in the latter months of 2012 for OCR targets of 3.50% by end-2012 and 4.25% by end-2013.

10-year NZGBs look expensive trading at less than a 200bp discount to USTs and trading at lower yields to AC-

GBs, despite poorer credit quality. New Zealand’s inferior economic and fiscal metrics should demand a greater dis-count to compensate investors for the risk than it does. The -4bp spread between Australia and New Zealand 10yr bond yields is well below our +15-30bp forecast range over the next twelve months. We expect Australian bonds to remain better supported and hence NZGBs to sell off by more when risk appetites return in 2012, hence we recommend a long ACGB/short NZGB strategy.

Spot Rate 2011 2012 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

Official Cash Rate (%) 2.50 2.50 2.50 2.50 2.50 2.50 2.75 3.25 3.50 3.50 3.75 4.00 4.25 3-mth Bank Bill Rate (%) 2.73 2.63 2.65 2.87 2.75 2.80 3.05 3.55 3.80 3.80 4.15 4.30 4.55 2-yr Govt. Bond Yield (%) 2.58 3.45 3.22 2.87 2.70 3.00 3.25 3.75 4.25 4.50 4.75 5.00 5.00 4-yr Govt. Bond Yield (%) 2.93 4.40 4.03 3.33 4.10 4.10 4.15 4.25 4.75 4.90 5.10 5.20 5.25 10-yr Govt. Bond Yield (%) 4.01 5.66 5.00 4.42 4.10 4.65 4.80 4.90 5.00 5.20 5.25 5.45 5.45

10-yr-2-yr Govt. Spread (%) 1.43 2.21 1.78 1.55 1.40 1.65 1.55 1.15 0.75 0.70 0.50 0.45 0.45

Forecast by TD Bank Group as at November 15, 2011; All forecasts are for end of period. Source: Bloomberg, TDBG

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 Q3 2011; Forecast by TDBG as at November 2011Source: Reserve Bank of New Zealand/Haver Analytics

%


3-mo . T-Bill yield

%

Forecast

Roland Randall, Senior Strategist+65 6500 8047


10

The USD’s medium-term performance has been quite mixed. Over the past three months, the USD has gained broadly against its major currency peers and has made even deeper gains versus the main developing market currencies. Over the past month, however, the USD has tended to lose ground broadly. Currency market sentiment remains fluid and highly volatile which has contributed to meagre returns for currency investors this year generally.

Economic growth held up better than expected overall in Q3. Better growth signals have supported risk assets since late September, perhaps accounting for some of the USD’s recent softness. However, forward-looking data suggest that growth momentum in the developed economies is weakening and will turn more obviously weaker around the turn of the year. This may embellish the USD’s safe-haven status again.

Investor concern about the outlook for (global) growth and, by extension, risk assets should be a USD positive. The situation in Europe is also a major concern (also a po-tential USD-positive). But Federal Reserve policy makers continue to lean towards providing additional support for the soft US economy, if needed, which is clearly a potential risk for the USD.

On balance, we think these challenges and uncertainties suggest a bias towards USD gains in the near-to-medium term. The USD may also benefit from the fact that the usual currency “safe haven” universe is shrinking due to aggres-sive FX intervention from the Swiss and Japanese authorities to try and halt or reverse appreciation in their currencies. In times of heightened uncertainty, the USD may command a significant liquidity premium.

Weak US fiscal and external balances will keep USD gains in check. But considering the USD’s generally de-pressed levels against the major currencies, we do not expect it to fall significantly in the medium-to-longer term. Against its major currency peers, the USD still looks very “cheap” from a longer-term or historic perspective.

U .S . DOLLAR

U .S . DOLLAR

1.161.201.241.281.321.361.401.441.481.521.561.601.641.68 74

82

90

98

106

114

122

130

138

Mar-07 Nov-07 Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-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 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

Trade-wtd. USD 99.1 96.5 94.7 100.2 97.6 98.3 96.7 96.0 93.8 93.6 92.8 93.0 92.6 JPY per USD 77.0 83 81 77 76 78 78 83 85 88 88 90 90 USD per EUR 1.355 1.416 1.450 1.339 1.300 1.280 1.300 1.320 1.350 1.400 1.420 1.380 1.380 USD per GBP 1.587 1.603 1.605 1.557 1.477 1.455 1.494 1.517 1.588 1.687 1.711 1.725 1.725

f: Forecast by TD Bank Group as at November 15, 2011; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBG

U .S . DOLLAR FUNDAMENTALSInterest Rate Spreads – Business Cycle N

Inflation Differential – Fiscal Balances –

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

Shaun Osborne, Chief FX Strategist 416-983-2629


11

CANADIAN DOLLARDespite a fairly volatile month, the CAD has essentially

remained range bound (notwithstanding the brief dip through parity) and is near the same level as a month ago. Like most FX majors, the CAD continues to be strongly hitched to market risk sentiment which has been driven by the euro zone debt crisis.

While the Canadian economy has so far been relatively insulated from the crisis in Europe, BoC governor Carney has reiterated that the significant downside risks to Canada from an economic shock across the Atlantic remain acute. So while recent data releases may have painted a rosier picture of Q3 Canadian output in the rear-view mirror, the outlook remains fraught with uncertainty. In view of these murky prospects, the key message on rates from the BoC remains lower for longer.

With the Canadian and US outlooks hinging on the evolution of events in Europe, we expect North American data releases to continue to be shrugged off by the CAD. Instead since indications suggest that the turmoil in Europe will continue for some time, the relationship between risk sentiment and the CAD (the S&P500 being a key indica-tor) should, in all likelihood, continue into the early part of the new year. This should be a setting where the CAD will lose support. With this in mind, we continue to feel that the broader bias for USD/CAD is higher and maintain our forecast that the pair will rise into year end and peak at 1.087 (USD0.92) in Q1 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


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 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

CAD per USD 1.021 0.971 0.963 1.050 1.042 1.087 1.042 1.000 0.952 0.962 0.962 0.971 0.971 USD per CAD 0.979 1.030 1.038 0.952 0.960 0.920 0.960 1.000 1.050 1.040 1.040 1.030 1.030

JPY per CAD 75 86 84 73 73 72 75 83 89 92 92 93 93 CAD per EUR 1.384 1.374 1.397 1.406 1.354 1.391 1.354 1.320 1.286 1.346 1.365 1.340 1.340 CAD per GBP 1.62 1.556 1.547 1.635 1.539 1.581 1.557 1.517 1.513 1.622 1.645 1.675 1.675


CANADIAN DOLLAR FUNDAMENTALSInterest Rate Spreads N Business Cycle +

Inflation Differential + Fiscal Balances +

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

Greg Moore, FX Strategist 416-982-7784


12

EUROThe EUR is proving quite resilient in the face of the

continuing – and spreading – sovereign fiscal tensions in the euro zone. But we expect a combination of weaker growth and lower interest rates together with the continued stresses related to the sustainability of euro zone’s debt problems to pull the EUR lower through the early part of 2012.

Euro zone political leaders have stepped up efforts to address the fiscal crisis and new, technocratic governments have replaced the Papandreou and Berlusconi administra-tions in Greece and Italy respectively. Elections in Spain are expected to deliver a new right of centre government. Yet investors lack confidence that Europe’s bail-out plans provide enough resources to fully resolve the debt crisis.

Indeed, bond market tensions have increased, rather than abated in the past two weeks. In many cases, sovereign borrowing costs have soared to (or beyond) euro lifetime highs and peripheral bond market tensions are now spilling over into large and systemically important economies (Italy, Spain and France). The crisis appears to have entered a new and more dangerous phase.

Ultimately, we expect the threat of greater sovereign bond market turmoil to force the European Central Bank (ECB) to support bond markets more aggressively and become the crisis circuit-breaker. In the final analysis, common euro zone government bond issuance will be needed to resolve the issue of fiscal sustainability. But the ECB’s clear reluctance to step beyond the current, limited intervention in the market (and Germany’s resistance to the idea of more active involvement) suggests that tensions may persist – and rise further – until the politicians and the ECB get the message.

Meanwhile, growth signals in the euro zone are weaken-ing. In the peripheral economies, the forward looking data are extremely soft, which will make the task of closing budget gaps all the harder. We think the euro zone is fac-ing recession early next year (one is already underway in Portugal) which will force the ECB to ease monetary policy further in the months ahead (after surprising the markets with a 25bps cut in November). We expect EUR/USD to weaken to 1.28 in Q1.

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 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

USD per EUR 1.355 1.416 1.450 1.339 1.300 1.280 1.300 1.320 1.350 1.400 1.420 1.380 1.380 JPY per EUR 104 118 117 103 99 100 101 110 115 123 125 124 124 GBP per EUR 0.854 0.883 0.903 0.860 0.880 0.880 0.870 0.870 0.850 0.830 0.830 0.800 0.800 CAD per EUR 1.384 1.374 1.397 1.406 1.354 1.391 1.354 1.320 1.286 1.346 1.365 1.340 1.340


EURO FUNDAMENTALSInterest Rate Spreads N Business Cycle N

Inflation Differential N Fiscal Balances –Current Account + Politics –Legend: - is negative, + is positive, N is neutral for currency

Shaun Osborne, Chief FX Strategist, 416-983-2629


13

JAPANESE YENJapan’s economic recovery took a step forward in Q3,

with GDP growing by the strongest margin in 18 months. The rebound from the severe economic set-back that fol-lowed the March earthquake may be short-lived, however, as global growth signals are weakening again and Japanese efforts to slow or reverse JPY strength have yet to show any significant signs of success.

The Japanese authorities intervened aggressively at the end of October to drive the JPY lower. The initial impact was positive, lifting USD/JPY quickly from JPY75 to above JPY79 in a matter of hours. The cost was likely significant, however, with estimates suggesting that the JPY selling may have been a record for a one-day period.

Since the one-off intervention, the JPY has started to appreciate again. We tend to think that intervention is un-likely to drive the USD significantly higher for a number of reasons. Firstly, there is little sign that Japan has the support of its G7 peers. Secondly, the Bank of Japan (BoJ) typically “sterilizes” FX intervention, which means that the aggregate supply of JPY in the market is left unchanged. This tends to neutralize the impact of the intervention. Finally, economic fundamentals (very low interest rate spreads between Japan and the US, for example, as well as the JPY’s status as a “safe haven”) are liable to keep the JPY better supported overall supported.

In addition, reports indicate that Japanese institutional investors have cut exposure to euro zone sovereign credit aggressively in the past few weeks. Intervention has sim-ply provided these investors with better levels to buy JPY at as they continue to repatriate their investments to safer domestic instruments.

We expect USD/JPY to remain relatively stable in the next few months. More direct (or indirect) support for the USD may be forthcoming if USD/JPY slips back to the JPY75 area. But further intervention will be offset by the JPY-positive factors outlined above. The USD may only really start to stabilize and appreciate against the JPY later in 2012 when longer-term interest rates recover.

JAPANESE YEN

74788286909498

102106110114118122126

100106112118124130136142148154160166172


JPY per USD

JPY per EUR

JPY per USD JPY per EUR


TRADE-WEIGHTED YEN

75

85

95

105

115

125

135

03 04 05 06 07 08 09 10 11

Index: 2000 = 100


JAPANESE YEN OUTLOOKSpot Price 2011 2012 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

JPY per USD 77 83 81 77 76 78 78 83 85 88 88 90 90 JPY per EUR 104 118 117 103 99 100 101 110 115 123 125 124 124 JPY per GBP 122 133 129 120 112 113 117 126 135 148 151 155 155 JPY per CAD 75 86 84 73 73 72 75 83 89 92 92 93 93


YEN FUNDAMENTALSInterest Rate Spreads – Business Cycle N

Inflation Differential – Fiscal Balances –

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



14

U .K . POUNDThe fundamental backdrop to the GBP remains very

challenging. The economy is experiencing a very slow recovery by historical standards and the UK GDP is still some 4.5% below the cycle peak prior to the recession. With inflationary pressures poised to ease in the next few months, the Bank of England (BoE) is liable to ease policy again in the early part of next year, we think.

Forward-looking economic data continue to deteriorate. Manufacturing growth is contracting and expansion in the service sector is slowing, PMI data indicate. In conjunc-tion with a deleveraging consumer and the slower growth trends evident in the major economies around the world, the UK economy is poised to enter a mild recession around the turn of the year.

We think the troublesome inflation picture in the UK will improve sharply in the coming year (partially reflect-ing the base effects of this year’s utility and VAT increases no longer boosting the year-on-year comparisons). In conjunction with the softening growth outlook, the better inflation backdrop will allow a further increase in BoE asset purchases to be announced early next year.

While we think the GBP may fall against a generally firmer USD in the next few months, we do not think the GBP will fall to any significant extent against the EUR. Weak euro zone growth, the euro zone’s sovereign credit tensions and the prospect of more ECB easing will likely leave the EUR/GBP more or less static.

The GBP’s relatively cheap valuation and the prospect of the UK attracting some “safe haven” flows from the uncertainty in Europe may provide some broader offset to soft GBP fundamentals in the next few months also.

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 EURUSD 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 POUND Spot Price 2011 2012 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

USD per GBP 1.587 1.603 1.605 1.557 1.477 1.455 1.494 1.517 1.588 1.687 1.711 1.725 1.725 GBP per EUR 0.854 0.883 0.903 0.860 0.880 0.880 0.870 0.870 0.850 0.830 0.830 0.800 0.800 CAD per GBP 1.62 1.56 1.55 1.63 1.54 1.58 1.56 1.52 1.51 1.62 1.65 1.67 1.67


POUND FUNDAMENTALSInterest Rate Spreads - Business Cycle N

Inflation Differential + Fiscal Balances –Current Account – Politics –Legend: - is negative, + is positive, N is neutral for currency



15

AUSTRALIAN DOLLAR

AUSTRALIAN DOLLAR

0.58

0.66

0.74

0.82

0.90

0.98

1.06

Mar-07 Oct-07 May-08 Dec-08 Jul-09 Feb-10 Sep-10 Apr-11 Nov-1150

60

70

80

90

100

110

120USD per AUD

JPY per AUD

JPY per AUDUSD per AUD


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 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

USD per AUD 1.016 1.033 1.072 0.970 1.030 1.030 1.020 1.020 1.000 1.000 1.000 0.980 0.960 JPY per AUD 78.26 85.86 86.31 74.69 78.28 80.34 79.56 84.66 85.00 88.00 88.00 88.20 86.40 AUD per CAD 0.963 0.997 0.968 0.982 0.932 0.893 0.941 0.980 1.050 1.040 1.040 1.051 1.073 NZD per AUD 1.318 1.356 1.293 1.276 1.256 1.256 1.252 1.252 1.235 1.235 1.235 1.225 1.215


AUSTRALIAN DOLLAR FUNDAMENTALSInterest Rate Spreads + Business Cycle +Inflation Differential + Fiscal Balances +Current Account N Politics NLegend: - is negative, + is positive, N is neutral for currencyRoland Randall, Senior Strategist

+65 6500 8047

The point of maximum pain in the recent USD sell-off was October 27, the day that a deal was struck to rescue Greece. AUD peaked at $1.07 then, having risen from $0.95 at the start of the month. What might have been expected to have been the beginning of a new dawn for risk assets was in fact a sunset. Since October 27 EUR has fallen by around 2.5% and AUD along with it, down 2.8% to $1.02 today. We have seen somewhat of a capitulation in risk-correlated assets including AUD. Greece, Italy, EUR break-up talk, downgrades to global growth, China growth worries, downgrades to Australian growth and a switch into policy easing mode by the RBA. The punches have rolled in and AUD continues to roll with it.

The RBA revised down its growth and inflation forecasts, but still expects growth “close to trend” but now also infla-tion consistent with the 2-3% target. Consequently, the RBA wants interest rates to be around average. They might cut once more (we think they will in 1Q 2012) but that would be it; and thus this is not the start of an easing cycle. With Fed Funds on hold, short-end yield differentials are unlikely to change. Further along the curve we see the yield spread to 10-year USTs narrowing a little as the US curve steepens, but the 200bp yield ‘advantage’ enjoyed by AUD at this tenor may narrow 25bps at most. Yield differentials will continue to be much more stable that broad swings in risk sentiment and thus continue to take a back-seat to ‘risk-on’/’risk-off’ for the foreseeable future.

In addition to swings in broad risk sentiment and safe-haven flows, AUD is vulnerable to deteriorating economic data from China. We think that this will continue to worsen and raise fears of a ‘hard landing’ there for at least another month; and that could see AUD underperform. But once inflation falls to or below 5% the market will believe in China’s ‘policy put’ and that should ease downward pres-sure on AUD.


16

NEW ZEALAND DOLLARThe NZD was swept up in the risk rally that carried EUR,

AUD and NZD higher through most of October. From the beginning of the month, NZD appreciated more than seven cents from $0.75 to almost $0.83. It peaked on October 27 as European leaders announced they had averted immediate crisis. If the rally to that point was ‘buying the rumour’ and hope of a solution to the European sovereign debt crisis, then from there on it has been a case of ‘selling the fact’ that there remains a long road ahead. NZD has drifted five cents lower since that day. Clearly, the battle between the ‘safe-haven’ USD and the ‘risk-loving’ EUR continues to dominate movements in the EUR-correlated NZD.

The domestic picture for New Zealand remains positive longer term, but recent data have disappointed. Only retail sales beat forecasts, but they’ve been temporarily boosted by the Rugby World Cup. The deteriorating outlook for global growth coupled with domestic data disappointment has pushed out expectations for future RBNZ tightening. Swap market pricing has now completely priced out any expecta-tion of a higher policy interest rate within the next year.

However, we think that 2012 is likely to be better for NZ than markets seem to be anticipating; and so, we sus-pect, does the RBNZ. Uniquely amongst central banks, RBNZ retains a tightening bias. It plans to raise the OCR by mid-year in anticipation of a rapid increase in capacity utilization when the reconstruction of earthquake-damaged Christchurch gets underway. While Christchurch rebuild-ing is delayed for two reasons (ground still not stable and insurance proving difficult to find for work projects) this merely confirms that 2012 is going to be a strong one for construction and domestic activity more broadly.

Despite New Zealand’s softer data, the headwinds facing Australia have been much stronger. China concerns loom larger for the AUD and the RBA shifted into easing mode at the beginning of November. Not surprisingly, NZD has outperformed AUD on the cross rate. AUDNZD has drifted from around $NZ1.29 a month ago to $1.27 now; and we target $1.26 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

0.46

0.52

0.58

0.64

0.70

0.76

0.82

0.88

Mar-07 Oct-07 May-08 Dec-08 Jul-09 Feb-10 Sep-10 Apr-11 Nov-1140

50

60

70

80

90

100

USD per NZDJPY per NZD

JPY per NZDUSD per NZD


NEW ZEALAND DOLLAR OUTLOOKSpot Price 2011 2012 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

USD per NZD 0.771 0.762 0.829 0.760 0.820 0.820 0.815 0.815 0.810 0.810 0.810 0.800 0.790 JPY per NZD 59.37 63.30 66.75 58.52 62.32 63.96 63.57 67.65 68.85 71.28 71.28 72.00 71.10 NZD per CAD 1.270 1.353 1.252 1.253 1.171 1.122 1.178 1.227 1.296 1.284 1.284 1.288 1.304 NZD per AUD 1.318 1.356 1.293 1.276 1.256 1.256 1.252 1.252 1.235 1.235 1.235 1.225 1.215


NEW ZEALAND DOLLAR FUNDAMENTALSInterest Rate Spreads + Business Cycle N

Inflation Differential + Fiscal Balances N

Current Account – Politics NLegend: - is negative, + is positive, N is neutral for currencyRoland Randall, Senior Strategist

+65 6500 8047


17

SWISS FRANCSince the Swiss National Bank stepped into the currency

market to devalue the CHF in early September, the franc has been on a slow grind lower and is now only slightly higher on the year against the EUR and the USD. While the rest of the FX majors have remained highly correlated to market risk sentiment during the volatile markets in recent months, moves in the CHF have been tied more closely with speculation on whether the SNB will take further action to devalue the currency.

Comments from Swiss officials that significant impacts on the real economy from the franc’s strength would not be tolerated have fuelled fears that we could see more measures from the monetary authority. Recent indications that deflationary pressures may be mounting faster than anticipated have only added to these worries. As a testament to the SNB’s resolve, this credible threat has left the floor set against the EUR at 1.20 untested. Moreover, the success of the intervention has essentially removed the franc from the list of safe haven currencies as shown by the CHF’s weak performance against the USD and the JPY since the measure was taken.

With European debt troubles unlikely to subside for some time, markets should remain quite volatile and demand for

SWISS FRANC OUTLOOKSpot Price 2011 2012 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

CHF per USD 0.915 0.919 0.840 0.911 0.938 0.953 0.938 0.924 0.904 0.893 0.880 0.906 0.906 CHF per EUR 1.240 1.301 1.219 1.220 1.220 1.220 1.220 1.220 1.220 1.250 1.250 1.250 1.250 CHF per CAD 0.896 0.947 0.872 0.868 0.901 0.877 0.901 0.924 0.949 0.929 0.915 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

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

CHF per EURCHF per USD

CHF per EUR CHF per USD


safe haven currencies is likely to persist. So despite the SNB’s success so far, it will have to maintain a high profile to deter interest in the CHF as a safe haven destination. With this in mind, the SNB is likely content with their suc-cess at upholding the floor they have set. Nevertheless, the predominant risk appears to be that the SNB will elect to raise the floor if deflationary pressures increase.

Greg Moore, FX Strategist 416-982-7784


18

SUMMARY FIXED INCOME TABLESpot Price 2011 2012 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

United StatesFed 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 1.003-mth T-Bill Rate (%) 0.01 0.09 0.02 0.05 0.05 0.10 0.10 0.10 0.10 0.10 0.15 0.80 1.102-yr Govt. Bond Yield (%) 0.23 0.82 0.25 0.20 0.25 0.30 0.30 0.35 0.50 0.80 0.95 1.15 1.555-yr Govt. Bond Yield (%) 0.88 2.27 0.95 0.90 0.90 1.00 1.25 1.40 1.55 1.65 1.70 1.95 2.1010-yr Govt. Bond Yield (%) 2.01 3.47 1.75 1.90 1.90 2.00 2.40 2.65 2.75 2.75 2.80 3.00 3.2530-yr Govt. Bond Yield (%) 3.05 4.51 2.91 3.05 3.00 3.25 3.75 3.90 4.00 4.05 4.10 4.20 4.3010-yr-2-yr Govt. Spread (%) 1.78 2.65 1.50 1.70 1.60 1.70 2.10 2.30 2.25 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 1.00 1.00 1.25 1.75 2.00 2.503-mth T-Bill Rate (%) 0.88 0.96 0.90 0.82 0.90 0.90 0.90 0.95 1.00 1.30 1.80 2.10 2.602-yr Govt. Bond Yield (%) 0.89 1.83 1.59 0.89 0.95 1.00 1.00 1.10 1.40 1.90 2.30 2.70 3.105-yr Govt. Bond Yield (%) 1.36 2.77 2.33 1.40 1.40 1.55 1.85 2.05 2.20 2.40 2.70 3.10 3.4010-yr Govt. Bond Yield (%) 2.09 3.35 3.11 2.16 2.25 2.40 2.80 3.05 3.30 3.50 3.60 3.70 3.9030-yr Govt. Bond Yield (%) 2.72 3.76 3.55 2.77 3.00 3.25 3.45 3.55 3.75 3.83 3.85 4.00 4.1010-yr-2-yr Govt. Spread (%) 1.20 1.52 1.52 1.27 1.35 1.40 1.80 1.95 1.90 1.60 1.30 1.00 0.80

United KingdomBank Rate Target (%) 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.75 1.00 1.25 1.503-mth T-Bill Rate (%) 0.53 0.63 0.54 0.53 0.55 0.55 0.70 0.70 0.70 0.95 1.20 1.45 1.702-yr Gilt Yield (%) 0.49 1.36 0.83 0.58 0.50 0.45 0.65 1.00 1.40 1.55 1.80 2.10 2.305-yr Gilt Yield (%) 1.06 2.44 2.07 1.37 1.00 0.90 1.25 2.00 2.50 2.70 2.90 3.15 3.2510-yr Gilt Yield (%) 2.16 3.69 3.38 2.43 2.10 1.95 2.05 2.60 2.90 3.05 3.30 3.50 3.7030-yr Gilt Yield (%) 3.16 4.36 4.29 3.55 3.10 2.95 3.50 4.10 4.10 4.20 4.30 4.30 4.3010-yr-2-yr Gilt Spread (%) 1.67 2.33 2.55 1.85 1.60 1.50 1.40 1.60 1.50 1.50 1.50 1.40 1.40

AustraliaCash Target Rate (%) 4.50 4.75 4.75 4.75 4.50 4.25 4.25 4.25 4.25 4.25 4.25 4.25 4.253-mth Bank Bill Rate (%) 4.64 4.92 4.96 4.77 4.65 4.65 4.65 4.65 4.65 4.45 4.45 4.45 4.453-yr Govt. Bond Yield (%) 3.40 5.03 4.68 3.61 3.50 3.90 4.00 4.25 4.55 4.65 4.75 5.00 5.005-yr Govt. Bond Yield (%) 3.56 5.23 4.77 3.78 3.65 4.10 4.25 4.50 4.75 4.80 4.90 5.15 5.1510-yr Govt. Bond Yield (%) 4.08 5.48 5.15 4.21 4.20 4.40 4.50 4.70 4.80 4.90 4.95 5.20 5.2010-yr-3-yr Govt. Spread (%) 0.68 0.45 0.47 0.60 0.70 0.50 0.50 0.45 0.25 0.25 0.20 0.20 0.20

New ZealandCash Target Rate (%) 2.50 2.50 2.50 2.50 2.50 2.50 2.75 3.25 3.50 3.50 3.75 4.00 4.253-mth T-Bill Rate (%) 2.73 2.63 2.65 2.87 2.75 2.80 3.05 3.55 3.80 3.80 4.15 4.30 4.552-yr Govt. Bond Yield (%) 2.58 3.45 3.22 2.87 2.70 3.00 3.25 3.75 4.25 4.50 4.75 5.00 5.004-yr Govt. Bond Yield (%) 2.93 4.40 4.03 3.33 4.10 4.10 4.15 4.25 4.75 4.90 5.10 5.20 5.2510-yr Govt. Bond Yield (%) 4.01 5.66 5.00 4.42 4.10 4.65 4.80 4.90 5.00 5.20 5.25 5.45 5.4510-yr-2-yr Govt. Spread (%) 1.43 2.21 1.78 1.55 1.40 1.65 1.55 1.15 0.75 0.70 0.50 0.45 0.45



19

Spot Price 2011 2012 201315/11/2011 Q1 Q2 Q3 Q4F Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F

Exchange rate to U .S . dollar Japanese yen JPY per USD 77.00 83 81 77 76 78 78 83 85 88 88 90 90 Euro USD per EUR 1.355 1.416 1.450 1.339 1.300 1.280 1.300 1.320 1.350 1.400 1.420 1.380 1.380 U.K. pound USD per GBP 1.587 1.603 1.605 1.557 1.477 1.455 1.494 1.517 1.588 1.687 1.711 1.725 1.725 Swiss franc CHF per USD 0.915 0.919 0.840 0.911 0.938 0.953 0.938 0.924 0.904 0.893 0.880 0.906 0.906 Canadian dollar CAD per USD 1.021 0.971 0.963 1.050 1.042 1.087 1.042 1.000 0.952 0.962 0.962 0.971 0.971 Australian dollar USD per AUD 1.016 1.033 1.072 0.970 1.030 1.030 1.020 1.020 1.000 1.000 1.000 0.980 0.960 NZ dollar USD per NZD 0.771 0.762 0.829 0.760 0.820 0.820 0.815 0.815 0.810 0.810 0.810 0.800 0.790

Exchange rate to Euro U.S. dollar USD per EUR 1.355 1.416 1.450 1.339 1.300 1.280 1.300 1.320 1.350 1.400 1.420 1.380 1.380 Japanese yen JPY per EUR 104 118 117 103 99 100 101 110 115 123 125 124 124 U.K. pound GBP per EUR 0.854 0.883 0.903 0.860 0.880 0.880 0.870 0.870 0.850 0.830 0.830 0.800 0.800 Swiss franc CHF per EUR 1.240 1.301 1.219 1.220 1.220 1.220 1.220 1.220 1.220 1.250 1.250 1.250 1.250 Canadian dollar CAD per EUR 1.384 1.374 1.397 1.406 1.354 1.391 1.354 1.320 1.286 1.346 1.365 1.340 1.340 Australian dollar AUD per EUR 1.333 1.371 1.353 1.380 1.262 1.243 1.275 1.294 1.350 1.400 1.420 1.408 1.438 NZ dollar NZD per EUR 1.758 1.859 1.749 1.761 1.585 1.561 1.595 1.620 1.667 1.728 1.753 1.725 1.747

Exchange rate to Japanese yen U.S. dollar JPY per USD 77.00 83 81 77 76 78 78 83 85 88 88 90 90 Euro JPY per EUR 104.4 118 117 103 99 100 101 110 115 123 125 124 124 U.K. pound JPY per GBP 122 133 129 120 112 113 117 126 135 148 151 155 155 Swiss franc JPY per CHF 84.1 90.5 95.8 84.5 81.0 81.8 83.1 89.8 94.1 98.6 100.0 99.4 99.4 Canadian dollar JPY per CAD 75.4 85.6 83.6 73.3 73.0 71.8 74.9 83.0 89.3 91.5 91.5 92.7 92.7 Australian dollar JPY per AUD 78.3 85.9 86.3 74.7 78.3 80.3 79.6 84.7 85.0 88.0 88.0 88.2 86.4 NZ dollar JPY per NZD 59.4 63.3 66.8 58.5 62.3 64.0 63.6 67.6 68.9 71.3 71.3 72.0 71.1

Exchange rate to Canadian dollar U.S. dollar USD per CAD 0.979 1.030 1.038 0.952 0.960 0.920 0.960 1.000 1.050 1.040 1.040 1.030 1.030 Japanese yen JPY per CAD 75 86 84 73 73 72 75 83 89 92 92 93 93 Euro CAD per EUR 1.384 1.374 1.397 1.406 1.354 1.391 1.354 1.320 1.286 1.346 1.365 1.340 1.340 U.K. pound CAD per GBP 1.62 1.56 1.55 1.63 1.54 1.58 1.56 1.52 1.51 1.62 1.65 1.67 1.67 Swiss franc CHF per CAD 0.896 0.947 0.872 0.868 0.901 0.877 0.901 0.924 0.949 0.929 0.915 0.933 0.933 Australian dollar AUD per CAD 0.963 0.997 0.968 0.982 0.932 0.893 0.941 0.980 1.050 1.040 1.040 1.051 1.073 NZ dollar NZD per CAD 1.270 1.353 1.252 1.253 1.171 1.122 1.178 1.227 1.296 1.284 1.284 1.288 1.304

f: Forecast by TD Bank Group as at November 15, 2011; All forecasts are for end of periodSource: Federal Reserve Bank of New York, Bloomberg, TDBG

SUMMARY FOREIGN EXCHANGE TABLE

This report is provided by TD Economics for customers of TD Bank Group. It is for information purposes only and may not be appropriate for 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 report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. The report contains economic analysisandviews,includingaboutfutureeconomicandfinancialmarketsperformance.Thesearebasedoncertainassumptionsandotherfactors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank anditsaffiliatesandrelatedentitiesthatcompriseTDBankGrouparenotliableforanyerrorsoromissionsintheinformation,analysisorviews contained in this report, or for any loss or damage suffered.

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