FX Market Headlines

Global growth outlook still faces risks

USD reached the highest net long position since January 2012

Spain grabs more attention in eurozone

UK not excluding further QE

The Long Path Back To Fiscal Sustainability for UK

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FX Forecasts

Global growth outlook still faces risks - This month Citi global team again edged up global growth forecasts, and now expect global GDP to rise by 2.5% this year (up from 2.4% last month), while Citi forecasts for 2013 and 2014 remain at 3.0% and 3.5% respectively. PPP-weighted Citi expect global GDP to rise by 3.1% in 2012 (from 3.0% last month), by 3.5% in 2013 and 3.9% in 2014 (2013 and 2014 forecasts unchanged from last month). However, Citi economists also note the near term economic outlook remains for below trend global growth and there are many headwinds to recovery: First, Citi believe that the EMU sovereign debt crisis is not over, and financial market strains probably will increase again. Indeed, in recent days risk appetite has retreated and the latest PMIs in Europe point to a deeper recession. Second, the recent rise in oil prices will probably hit growth, because oil consumers (whose real incomes fall) will adjust faster and further than oil producers. The two prior occasions when oil prices hit $125-$130/barrel, in mid- 08 and mid- 11, were both followed by marked downturns in the CESIs and consensus growth forecasts. Third, China’s Citi Economic Surprise Index has turned negative and activity clearly is weakening as last year’s policy tightening slows housing activity and credit growth. Further monetary loosening is likely, via continued RRR cuts, and growth probably will rebound later this year, but the extent of the near-term slowdown remains unclear for now. The latest PMI reading for early March highlights the downside risks if the authorities are slow to ease policies. Fourth, there remain major uncertainties about US fiscal policy for 2013 and beyond. At present, broad tax hikes and spending cuts that could stall recovery are on tap for 2013 but forestalling action is unlikely before late this year or next. Fifth, as in 2010 and 2011, the recent rallies in risk assets may peter out – hitting confidence – if central stop adding further stimulus. Private debts remain high in the US and Europe, creating an ongoing bias to high savings that could reassert itself. Given these headwinds, the main central banks probably will continue to maintain a loose policy stance, and will be ready to loosen further if downside risks escalate again.

USD has seen a $5.1bn rise in net long positioning up to Tuesday, reaching a net long position of $18.3bn. This is the longest net position seen in USD since the week ending 24 January and sits somewhat at odds with Fed Chairman Bernanke’s recent more dovish take on labour market developments last week that represented a significant shift in the Fed’s view and as a pre-cursor to expectations for further accommodation. Citi FX Technical team points out that the USD Index has held the 76.4% retracement against the Feb 29th low (i.e. of the rally from 78.09 to 80.73) and a continued hold of 78.71 be needed to set the Index for a decent rally ahead and especially if it breaks above 80.73 (high from March 15th). However, given the narrow range bound sentiment in most units right now, any sustained gains above this level would are difficult to see right now.

The key points in the UK Budget matched the advance leaks: a roughly neutral package that leaves intact the existing fiscal tightening of 5-6% of GDP (in terms of the cyclically adjusted primary balance) over the next 5 years. The high deficit and OBR scrutiny should ensure that Budgets are a zero-sum fiscal game — with every tax cut for some group balanced by offsetting pain elsewhere. This is on top of the tightening of about 3½% of GDP that already occurred in the 2010/11 and 2011/12 fiscal years. The OBR's near term fiscal forecasts (£126bn in 2011/12, £120bn in 2012/13 excluding the transfer of the Royal Mail pension fund) are disappointing, but realistic in Citi view. Beyond 2012/13, Citi expect that real and nominal GDP will undershoot the OBR’s forecasts, hence leading to repeated revenue undershoots and deficit overshoots. The general government debt/GDP ratio is likely to rise to about 100% in coming years, having been around 40% a few years ago. Citi regard the UK as a relatively weak AAA. Citi assume that S&P will put the UK on negative outlook at some stage (as Moody’s and Fitch already have done). Citi do not expect that a negative outlook — or indeed a ratings downgrade — would seriously derail gilts, given the sluggish economy and falling inflation, plus the government’s strong commitment to fiscal consolidation.

The Week Ahead

USD:

 Apr 2, Fed releases March 28th remarks of President Bullard to a monetary policy conference in Beijing.  Apr 2, Fed President Pianalto to speak to the Economic Roundtable of the Ohio Valley.  Apr 3, Fed President Williams to participate in a San Francisco University Symposium simulation of an FOMC meeting.  Apr 4, Fed President Williams speaks to San Francisco Planning and Urban Research business breakfast.  Apr 5, Fed President Bullard to speak to the 13th Annual InvestMidwest Venture Capital Forum.  Apr 2, March ISM Manufacturing Activity Index: Citi. 52.5, Feb. 52.4, Jan. 54.1, Dec. 53.1, Nov. 52.2, Oct. 51.8 - Citi expects the ISM manufacturing index was unchanged at a modest level in March. This index has hovered in the same general range, consistent with modest growth in manufacturing, since last summer. Not much has changed fundamentally, except Citi worry that orders for capital equipment may be fading. Note: The March Chicago purchasing managers’ reading was sky high once again. But this regional survey has consistently outperformed other regional and national surveys. As a result, Citi do not find Chicago to be a useful barometer of activity elsewhere.  Apr 4, March ISM Nonmanufacturing Activity Index: Citi. 56.0, Feb. 57.3, Jan. 56.8, Dec. 53.0, Nov. 52.6 - The nonmanufacturing index jumped at the start of the year, led by business activity, orders, and employment. This rise struck Citi as odd, because the pickup was not matched by gains in overall activity. Real GDP is likely to be in the 2% range for the quarter. Citi suspects that this index was boosted by the extremely mild weather. The March report will be an important test of this hypothesis. Seasonal factors expect a pronounced pickup in activity that will be difficult to match from current elevated levels.  Apr 6, March Employment Situation (Thousands Unless Indicated): Total Employment – Citi.185, Feb. 227, Jan. 284, Dec. 223; Unemployment Rate (Percent) – Citi. 8.3, Feb. 8.3, Jan. 8.3, Dec. 8.5 - Citi looks for a pullback in payroll gains in March from the outsized increases of the previous three months. Citi estimates that payroll gains were padded by about 100,000 in total over that span because of a combination of spring-like weather and seasonal factors anticipating at least some winter disruptions. The hardest part of the March forecast was gauging how much to throttle back the gains, especially considering that March weather was mild as well. Note 1: When Citi pulled out the sectors most influenced by weather, we found that there has been underlying improvement in other sectors. The gradual strengthening has been consistent with better results in business and employment surveys. Note 2: The decline in government jobs seems to be tapering off. Note 3: The labor force jumped by more than 700,000 in the past two months. Citi wouldn’t be surprised by a pullback this month.

EUR:

 Apr 2, Euro area Manufacturing PMI, Mar Final Forecast: 47.4 Prior: 49.0: Citi expects a downward revision of the flash estimate of 47.7 for March because Citi does not expect that the performance of countries that did not report a flash estimate was that much better relative to Germany (where the manufacturing PMI was down by 2.1 points MM) and France (drop of 2.6 points).  Apr 2, Euro area Unemployment Rate, Feb Forecast: 10.8% Prior: 10.7% - The unemployment rate has increased by 0.1 points in each of the past seven months to the highest reading since summer 1997, before the introduction of the euro. During this period, the seasonally adjusted number of unemployed people has increased by 1.1 million. While benign weather conditions might limit the rise in February, Citi expects a further increase as the recession in many euro area countries feeds through to the labor market.  Apr 3, Euro area Industrial Producer Prices, Feb Forecast: 0.4% MM, 3.4% YY Prior: 0.7% MM, 3.7% YY - Higher energy prices are likely the driving factor for the monthly increase in producer prices. However, benign base effects, caused by even stronger commodity price gains last year, probably will contribute to a further decline in the YY rate to the lowest reading since June 2010.  Apr 4, Euro area Services PMI, Mar Final Forecast: 48.7 Prior: 49.4; Composite PMI, Mar Final Forecast: 48.5 Prior: 49.3 - While Citi expects a confirmation of the flash estimate of the service sector PMI, with a monthly decline of 0.7 points, Citi expects a downward revision of the composite PMI amid the expected lower reading for the sentiment in the manufacturing sector.  Apr 4, Euro area Retail Sales, Feb Forecast: -0.3% MM Prior: +0.3% MM - Retail sales increased in January for the first time since August. While the retail PMI improved in February, other sentiment indices remained gloomy and we expect another fall in retail sales in February, probably contributing to another quarter of falling private consumption in 1Q.  Apr 5, ECB Board Meeting: ECB — On Hold in April - At the meeting on Wednesday 4th April, Citi expects that the ECB Governing Council will leave the refi rate at 1.0% and the non-standard measures unchanged. Citi believes the Council is likely to repeat that there are some early signs of a stabilization of the economy and that inflation will remain elevated for a while given higher energy prices and indirect tax increases. However, the ECB is likely to expect inflation to moderate in line with its target over the medium-term, leaving the Governing Council some room to cut rates in 2H 2012 in Citi’s view. Regarding the non-standard measures, ECB President Mario Draghi is likely to repeat that the two 3Y LTROs have been a success, but that it would require more time to assess the full impact of the measures. Looking forward, Citi believes the President will keep the door open for additional measures (which Citi expects the ECB will use in 2H), but will stress that there is currently no need for such measures and that the ECB has all instruments in place to act if inflationary pressure emerge. The German-led debate regarding the early exit strategy from the very accommodative monetary stance reflects increasing domestic price pressures in the euro area’s largest

economy, which will probably lead to an end of the period in which German inflation has been below the euro area average in Citi’s view. .

CHF:

 Apr 2, PMI, Mar Forecast: 48.0 Prior: 49.0: The PMI has improved for two months in a row but, with the EMU PMI weakening a bit, Citi doubt the Swiss PMI will continue to strengthen. Such a figure would leave the PMI below 50 for the sixth consecutive month, implying continued sluggishness in the economy.  Apr 5, Consumer Prices, Mar Forecast: 0.0% MM, -1.2% YY Prior: -0.4% MM, -0.8% YY: Inflation is likely to remain in firmly negative territory, with the weakness in the YY rate this month exacerbated by base effects from the unusually strong price reading of March 2011 (when prices rose 0.6% MM, the biggest March rise for over 20 years. Inflation is likely to remain negative for the next 2-3 years if the CHF stays around current levels.

GBP:

 2 Apr, Manufacturing PMI (Mar) Forecast: 50.5 Prior: 51.2 - Manufacturing PMI slipped back in Feb. after gains in the prior three months, and Citi expects another slight dip this month. Such a figure would suggest that manufacturing output is just expanding, but only barely.  4 Apr, Services PMI (Mar) Forecast: 54.2 Prior: 53.8 - The services PMI fell quite sharply in February, by more than 2 points, and Citi expects little change either way in the March data. The long run average for this series is about 55, and hence a reading below that would indicate sub trend output growth.  5 Apr, of England Board meeting – No change this week but Citi continuse to expect that QE will be expanded further, especially given the continued strains in the euro area.  5 Apr, Industrial Production (Feb) Forecast: -0.1% MoM, -3.1% YoY Prior: -0.4% MoM, -3.8% YoY; Manufacturing Output (Feb) Forecast: -0.2% MoM, -0.2% YoY Prior: 0.1% MoM, 0.3% YoY - Industrial production in January was hit by continued weakness in oil and gas output, plus weather-related weakness in utilities output. For the February data, Citi expects that manufacturing output fell back a bit, roughly offsetting a rebound in utilities output from the low January figure. Such a figure would leave industrial production in January-February about 0.4% below the Q4 average.

AUD:

 2 Apr, Building Approvals, Feb Forecast: 0.5%., Previous: 0.9% - Previous gains in housing finance suggest that private owner-occupier dwelling approvals should pick-up in February. Citi is keeping the expected improvement very mild because of stamp duty changes in NSW that dampened demand for finance in January and are likely also to influence the February building approvals data.  3 Apr, Retail Sales, Feb Forecast: 0.5%., Previous: 0.3% - Citi forecast for retail sales growth in February is an improvement on the pace at the start of the year. However, this reflects the influence of a positive seasonal adjustment factor. In yearly terms, the pace of retail sales has eased and in original terms, reports from large retailers have indicated an ongoing sluggish trend in sales growth.  3 Apr, RBA Cash Rate Decision Forecast: no change, Previous: no change - By itself, Citi does not think the change in the Bank’s description of growth to below trend is enough of a change to signal a rate cut in April. A cut so soon after a neutral March Board statement would suggest the RBA had been materially surprised by developments in recent weeks. That said, a cut can’t be too far off and we expect a cut at the May Board meeting.  4 Apr, Trade Balance, Feb Forecast: $A1.50bn., Previous:-$A 0.67bn - A rebound in Australian iron ore exports from Port Hedland following cyclone activity in January, some recovery in Chinese imports following New Year holiday distortions and a 5.0% fall in Australia imports argue for a sizeable rebound in the trade balance.

CAD:

 Apr 5, LFS Employment (Mar): Net Change in Employment (Mar) - Citi Forecast 5.0K, Median 10.0K, Last -2.8K; Unemployment Rate (Mar) - Citi Forecast 7.5%, Median 7.4%, Last 7.4%: Mediocre Jobs Activity – Employment, as measured by the Labor Force Survey, probably increased by just 5,000 in March, after a modest decline in February and generally disappointing prints in recent months. If correct, the year-to- year rate held at 0.7% the slowest annual pace since March 2010. The unemployment rate likely ticked back up to 7.5% and the participation rate held a cyclical low of 66.5%. On balance, slower growth in the fourth quarter of 2011 after a third quarter bounce, as well as lingering caution among firms, is capping employment growth and contributing to the slowdown in earned income. Income Gauges to Disappoint – Meanwhile wage inflation probably lingered well below pre-crisis norms and the number of hours worked continued to lag jobs growth. These factors are also poised to continue to moderate income growth, which Citi believes, along with massive hits to financial wealth and slower home equity growth, will contribute to less robust consumer spending this year.

JPY:

 April 2, BoJ Quarterly Tankan Survey, Large Mfg. Business Conditions (Mar) Forecast: 1, Previous: -4; Large Nonmfg. Business Conditions (Mar) Forecast: 4, Previous: 4; Small Mfg. Business Conditions (Mar) Forecast: -6, Previous: -8; Small Nonmfg. Business Conditions (Mar) Forecast: -12, Previous: -14; Fiscal 2012 Capital Spending Plans, Large Firms (Mar) Forecast: -1.0, Previous: -0.5; Fiscal 2012 Capital Spending Plans, Small Firms (Mar) Forecast: -20.0, Previous: -7.0 - Citi expects that the business confidence DI for large manufacturing firms will rise to +1 from -4 in the previous December survey. In December, the DI dropped 6 points amid a series of strong headwinds including the heightened Euro-area crisis, a decelerating Chinese economy, appreciation by the yen, and Thailand’s flooding. Since then, the situation in Thailand has been normalizing and yen strength against the US dollar has been partly reversed. Although exports have remained in a sideways range, a dropout of some of these negative factors will likely mean the DI is positive for the first time in two quarters. The headline DI for large nonmanufacturing companies is expected to stay unchanged at +4 in the upcoming survey. Reconstruction demand from last year’s disaster as well as resilient consumer spending has continued to support sentiment among non manufacturers, in Citi’s view. Meanwhile, Citi expects companies to remain cautious about capex. The projected turnaround in manufacturing firm business confidence is unlikely to have any notable positive impact on corporate appetite for business investment, especially for domestic spending. Specifically, Citi expects large firms will revise down FY2011 capex plans to a 0.5% YoY cut from a 1.4% YoY increase assumed in December. Furthermore, they will probably make a cautious start to FY2012 with a planned 1.0% YoY reduction (FY2012 plans are to be revealed for the first time).