FX Market Headlines

EUR rallies as bailout agreed Greece finally secures second bailout JPY weakens on inflation target BoE minutes indicate that more QE could be on the way EURCHF closes in on 1.20 floor

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The FX market was dominated by a rally for the euro and a decline for the Japanese yen last week. The common currency strengthened as Greece finally secured the second bailout. Markets have been bidding up Euro ahead of this week's send long term LTRO from the ECB. Meanwhile, the Japanese yen's fall accelerated on BoJ QE expectations as well as strength in crude oil. Markets were rather subdued elsewhere though, as the US dollar was range bound against sterling and commodity currencies. Technically, the sustainability of Euro's rally is not confirmed yet but yen's reversal looks real.

EU finance ministers eventually approved the second Greek bailout package. The deal requires Greece to bring its debt down to 120.5% of GDP by 2020 from over 164% currently. The agreed reduction was similar to what was requested by the IMF. Moreover, according to Jean-Claude Juncker, the prime minister of Luxembourg, private sector bondholders were expected to incur losses of 53.5% of nominal face value of their Greek bond holdings, up from the previously expected 50.0% nominal write-down. The interest that Greece needs to pay for the first bailout package was lowered to 1.5% over market rates from 2-3% above market rates previously agreed. Moreover, the ECB and the 17 central banks in the Eurozone also agreed to forego profits on their Greek debt holdings. These measures aim to 'further improve the sustainability of Greece's public debt'.

Following the approval, Greece launched the private sector bond swap offer on Friday and the program targets to write-down as much as EUR 100b of its debt. The Greek Finance Ministry noted that at least 90% of the aggregate face amount of all bonds is needed to participate in the PSI. If the participation is between 75% and 90%, Greece might activate the collective-action clauses and that might in turn trigger CDS. Greece will determine whether the take-up rate from investors is enough for the debt deal to proceed by March 9 while actual swap will take place on March 12. IIF managing director Dallara said he's "quite optimistic" of a high take up among bondholders. But all eyes will be on market responses in the next two weeks.

Also supporting the single currency last week was anticipation and speculation ahead of this week's second LTRO from ECB. In the first operation in December, over 500 banks tapped EUR 489b in three year cheap loans from ECB. There have been expectations that this time banks might request as much as EUR 1T, but consensus expectations are around EUR 500b level. The impact to the market is a bit tricky. Some economists say that if the take up is smaller than expected, the impact would be short term bullish and medium term bearish in Euro. On the other hand, if the take up is larger than expected, the impact would be short term bearish and medium term bullish in Euro.

Yen's selloff was another major theme last week. Yen weakness started earlier this month after BoJ announced a clear 1% inflation goal. The target is seen as paving the way to more aggressive quantitative easing from the bank. So far, the BoJ lagged behind Fed and ECB in expanding their balance sheets since 2008 finance crisis. Thus, in spite of BoJ's various efforts including intervention, it failed to halt yen's up trend. However, the situation could now be different as there is a clear inflation target. The BoJ indeed has

more scope to expand quantitative easing than any other major central banks. There is speculation that the BoJ's QE program could top as much as JPY 100T in 2012.

Elsewhere, BOE minutes for the February meeting revealed that 2 (Adam Posen and David Miles) out of 9 members opted for more expansion in asset purchases than decided. The 2 dissenters to the current monetary policy saw a risk of a prolonged period of depressed demand which would cause inflation to fall materially below target in the medium-term. Also, they expected that further easing would alleviate the risks of increasing unemployment. The news raised speculations that the central may increase the amount of asset buying in May

The RBA released minutes for the February meeting, explaining reasons for its decision to leave the policy rate unchanged at 4.25%, instead of a reduction of -25 bps as expected by the market. The central bank appeared comfortable with the domestic economic developments though these might also be affected by the sovereign debt crisis in the Eurozone. It appears that the central bank will stand on the sideline in the coming months. The market nervously watches EURCHF as it nears the post-peg low of 1.2023. USDCHF is also heavy, hitting a low of 0.8930. The case for SNB intervention is getting much louder.

AUDUSD ended the week slightly heavy around 1.0690 though leveraged, real money and bank names add to positions - possible leadership issues adding to AUD heaviness but the only real impact of a change in PM would likely be the mining tax - Rudd seen more mining friendly

G20 finance ministers and central bankers met in Mexico over the weekend. The main topic of the weekend - discussion on how to increase the IMF’s resources and the possibility of increasing the size of the IMF or combining the EFSF and ESM

The ECB’s LTRO tender follows on February 29, global manufacturing PMI data (March 1), and GDP reports for Switzerland (March 1) and Canada (March 2) come thereafter. The German parliament also votes on the Greek bailout package (February 27).

The EU Summit on March 1-2 (Thursday-Friday) - this is the forum where the issue of combining the EFSF and ESM will be discussed in more detail and potentially decided.

In Australia we have the all-important shoot out between current PM Gillard and ex-foreign minister Rudd on Monday (10.00AM Sydney time) for the leadership of the Labor Party and the PM's job - implications for the mining industry of particular relevance to AUD

FX Forecasts

The Week Ahead

USD:

 Feb. 28, Fed Board Governor Duke to testify to Senate Banking Committee on the “State of the Housing Market.”  Feb. 28, Cleveland Fed President Pianalto to speak to the Medini County Economic Development Corporation annual meeting.  Feb. 29, Dallas Fed President Fisher to speak to the Bolsa Mexicana on the “U.S. Economic Overview.”  Feb. 29, Fed Chairman Bernanke to deliver the FOMC’s semiannual report to the House Financial Services Committee.  Feb. 29, Philadelphia Fed President Plosser to speak th the Forecasters Club in New York.  Mar. 1, Cleveland Fed President to speak to the City Club of Cleveland Business Leaders.  Mar. 1, Fed Chairman Bernanke to deliver semi-annual Humphry Hawkins testimony to Senate Banking Committee.  Mar. 1, Fed Board Governor Raskin to speak on the economic outlook in Connecticut.  Mar. 1, Atlanta Fed President Lockhart to speak to the Atlanta Fed’s Banking Industry Outlook Conference.  Mar. 1, San Francisco Fed President Williams to speak at the CFA’s Economic Forecast Dinner in Hawaii.  Mar. 2, St. Louis Fed President Bullard to speak to the BMO Bank of Montreal Lecture in Economics in Vancouver B.C.  Feb. 28, January Durable Goods Orders (Percent Change): New Orders Total – Citi. -2.5 %, Dec. 3.0 %, Nov. 4.2 %, Oct. 0.1 %; Excl. Transportation – Citi. 0.0, Dec. 2.2, Nov. 0.3, Oct. 1.6 - Durable goods orders likely fell sharply in January on a major retreat in aircraft orders following several large increases. Away from the tumultuous transportation sector orders were likely unchanged as core capital goods orders were impacted by the same pattern of weakness in the first month of the quarter that we observed for the past few years. Note 1: Motor-vehicle orders likely rose sharply as seen in the IP data already released for the month. Note 2: A major wild card in January is the trajectory of aluminum orders, which have risen in the face of plummeting prices. Implicit quantity indexes based on dollar orders and spot metal prices imply unrealistic increases.  Feb. 28, February Consumer Confidence: Citi. 66.0, Jan. 61.1, Dec. 64.8, Nov. 55.2, Oct. 40.9 - Consumer confidence likely jumped in February as the large December decline reversed. Sustained reductions in jobless claims, and higher equity prices probably more than offset the impact of rising gasoline prices to drive confidence to the highest level of the recovery.  Feb. 29, Q4’11 (P) GDP Growth (Percent Change at Annual Rate Unless Noted): Citi. 2.5 %, Q4’11 (A) 2.8 %, Q3’11 1.8 %, Q2’11 1.3 %, Q1’11 0.4 % - Citi analysts think fourth quarter real GDP will be

revised down in the preliminary report, largely due to lower inventory accumulation than the Commerce Department had assumed. The pattern of inventory changes has been erratic in recent quarters, with a third quarter outright decline followed by a jump to $56 billion that added nearly two percentage points to growth. The December inventory report suggested that the huge contribution was overstated somewhat. Note 1: There wasn’t much revision to growth rates of other key sectors. Consumer spending probably was slightly softer, but investment was stronger. Note 2: Qualitatively, the revised fourth quarter report still should show that domestic demand was downbeat and the overall economic growth trajectory was modest at best.  Feb. 29, February Chicago Purchasing Managers’ Index: Citi. 59.0, Jan. 60.2, Dec. 62.2, Nov. 62.5 - While the Chicago purchasing managers’ index may have edged down in February, the level likely remained in the stratosphere. Chicago area business has been exceptionally strong throughout the recovery, probably reflecting the ongoing rebound in the motor vehicle industry. Note: Because of the emphasis on vehicles, the Chicago PMI has been out of synch with other regional and national surveys. As a result, Citi analysts have not focused on this index because it has been a poor guide to other business surveys.  Mar. 1, January Personal Income and Consumption (Percent Change): Personal Income – Citi. 0.3 %, Dec. 0.5 %, Nov. 0.1 %, Oct. 0.4; Personal Spending – Citi. 0.5, Dec. 0.0, Nov. 0.1, Oct. 0.1; Core PCE (12-Month Percent Change) – Citi. 1.8, Dec. 1.8, Nov. 1.7, Oct. 1.7 - Both personal income and consumer spending gains were solid in January. The rise in payrolls and in average hourly earnings indicates another hefty gain in wage and salary income. Nevertheless, spending probably outpaced income, spurred by a jump in motor vehicle purchases, dampening the savings rate. Note: Although income and spending figures started the year off on good notes, Citi analysts worry that demand growth could be reined in by rising energy costs. The recent jump in gasoline prices, if it continues, threatens to siphon off a portion of consumers’ spending power  Mar. 1, February ISM Manufacturing Activity Index: Citi. 54.0, Jan. 54.1, Dec. 53.1, Nov. 52.2, Oct. 51.8, Sept. 52.5 - Citi analysts look for little change in the February ISM manufacturing index, despite soaring factory output around the turn of the year. Production gains have been widespread, especially among durable goods industries, but this strength has not found its way into the survey results. Citi analysts think the ISM figures have remained consistent with more modest growth because the recent surge has been driven by a rebound in inventory building in the fourth quarter, which is temporary. Note: The sharp increase in manufacturing payrolls has not been reflected in the ISM manufacturing employment gauge either.

EUR:

 Feb 27, Euro area M3, Jan Forecast: 1.8% YY, 1.8% 3-M YY Prior: 1.6% YY, 1.9% 3-M YY - Following the drop in M3 growth in December that might have been somewhat overstated by year-end effects, Citi analysts expect a small rebound in M3 growth, which is partly due to base effects. After the 0.6% MM fall

in new loans transaction in December, Citi analysts expect a smaller decline of around 0.2% MM in January.  Feb 28, Euro area Economic Confidence, Feb Forecast: 93.0 Prior: 93.4; Industrial Confidence, Feb Forecast: -7.5 Prior: -7.2; Consumer Confidence, Feb Final Forecast: -20.2 Prior: -20.7 - After stabilizing in January, which might have been upwardly distorted by unusually mild winter weather in that month, Citi analysts expect economic confidence to deteriorate again in February, when unusually cold winter weather probably had some negative impact on the sentiment reading.  Feb 29, Euro area HICP, Jan Final Forecast: -0.7% MM, 2.7% YY Prior: 0.3% MM, 2.7% YY - Citi analysts expect a confirmation of the flash estimate for January. The split probably will show an increase in the core inflation rate (mainly amid indirect tax increases) from 1.6%YY in December to 1.8% YY in January. But, mainly due to base effects, energy price gains are likely to moderate from 9.7% YY in December to 7.8% YY in January.  Mar 1, Euro area Manufacturing PMI, Feb Final Forecast: 49.0 Prior: 48.7 - Citi analysts expect a confirmation of the flash estimate.  Mar 1 Euro area HICP, Feb Flash Estimate Forecast: 2.7% YY Prior: 2.7% YY - Despite benign base effects, Citi analysts expect inflation to be unchanged in February. Increasing oil prices and unusually cold weather probably prevented a decline in inflation in February.  Mar 1 Euro area Unemployment Rate, Jan Forecast: 10.5% Prior: 10.4% - While unusually mild weather in northern Europe probably distorted January unemployment temporarily on the downside, Citi analysts expect that ongoing job losses in the periphery countries contributed to an increase in the unemployment ratio.  Mar 2, Euro area Industrial Producer Prices, Jan Forecast: 0.3% MM, 3.3% YY Prior: -0.2% MM, 4.3% YY - The ongoing decline in the YY rate reflects benign base effects, which are mainly due to large swings in commodity prices.

CHF:

 Feb 29, KOF Economic Barometer, Feb Forecast: -0.35 Prior: -0.17 - The Kof index has weakened for eight consecutive months, and currently is at the lowest since July 2009. Citi analysts expect another modest decline this month, reflecting the drag from the strong CHF and EMU weakness, leaving the index at a level consistent with recession.  Mar 1, GDP, 4Q Forecast: 0.1% QQ, 1.2% YY Prior: 0.2% QQ, 1.5% YY - Weakness in the KOF and PMI surveys in recent months suggest that the Swiss economy is softening markedly. It is uncertain in our view as to whether GDP already started to fall in 4Q or whether the decline starts in 1Q, but some negative GDP figures are likely. .  Mar 1, PMI, Feb Forecast: 47.2 Prior: 47.4 - The PMI has been below 50 for five months in a row, signaling renewed contraction in the manufacturing sector. Citi analysts expect another weak reading this month, which would suggest that the economy is shrinking in 1Q.

GBP:

 Mar 1, Manufacturing PMI, Feb Forecast: 51.1 Prior: 52.1 - The manufacturing PMI has risen for three months in a row but Citi analysts anticipate a slight pullback this month. The UK’s main export markets in the euro area are weak, and investment in the UK is likely to be weak given the drop in capacity use and uncertain outlook.

AUD:

 29 Feb, Private Sector Credit, Jan: Forecast: 0.3%, Previous: 0.3% - Credit should continue to increase at a steady rate of 0.3% in January. The components are likely to also exhibit similar moves to those seen in recent months. Soft other personal and business credit should be exceeded by moderate gains in owner-occupier and investor credit growth.  29 Feb, Retail Sales, Jan: Forecast: 0.4%, Previous: -0.1% - Following the weaker than expected December result, retail sales should produce a 0.4% gain in January. Consumer sentiment gained in the month and employment was well above expectations. Reports of some mild improvement in Department stores in January and post-Xmas sales being pushed in the New Year back up the positive forecast. Note that positive seasonal adjustment factors for January suggest there is some slight upside risk to the forecast.  I March, Private Capex, Q4: Forecast: -3.5%%, Previous: 12.3% - Fundamentals are positive for the capex outlook, but similar to the construction work done data, Citi analysts expect some payback to the large 12.3% rise in Q3. This would still leave annual growth at close to 30%.

CAD:

 Mar. 2, Real GDP (4Q): Citi Forecast 2.0%, Median 1.8%, Last 3.5% - Better-Than-Expected Performance – Real GDP probably expanded by about 2% in the final quarter of 2011, supported by consumer consumption, residential investment and a positive net exports contribution. (Citi analysts had forecasted a 1½% annualized rate of growth for several months.) However, government spending likely fell a second quarter, business investment in machinery and equipment was nominal, and inventories cut roughly 1½% from the headline. Despite the negatives, the fourth quarter performed better than Citi analysts expected, and more in line with the Bank of Canada’s base-case projection. Household income growth likely continued to soften, but to a lesser degree. Also, operating profits were surprisingly strong suggesting that pre-tax corporate profits were stronger-than-expected and that margins remained wide. Mottled Outlook – If our forecasts for the fourth quarter are correct, the Canadian economy expanded by 2.4% y/y in 2011, a tad faster than the 2.3% y/y gait Citi analysts had projected. Meanwhile, stronger- than-expected labor market and spending data out of the United States, pose additional upside to the near-term Canadian outlook. So Citi analysts now anticipate that 2012 will be somewhat stronger (1.9% y/y vs. 1.7% y/y), but not much given enormous downside risks and lingering uncertainties ahead. Risks

aside, the European recession, slower Asian growth, U.S. fiscal consolidation and the persistent strength of the Canadian dollar will dampen Canadian exports over the medium-term. Meanwhile, smaller government, a less robust capex revival and moderating household spending will dampen domestic demand this year and next.

JPY:

 Feb. 28, Retail Sales, Overall (Jan) Forecast: 3.7% YoY; 4.9% SA MoM, Previous: 2.5% YoY; 0.3% SA MoM - Citi analysts estimate that retail sales increased 3.7% YoY and 4.9% MoM in January (+2.5% YoY and +0.3% MoM in December). Based on our projection, January retail sales probably stood 4.4% above the fourth quarter average (+0.8% QoQ in 3Q and -1.3% QoQ in 4Q). Consumer spending is likely to grow in the first quarter as a whole.  Feb. 29, Industrial Production (Jan) Forecast: 1.3% MoM; -1.9% YoY, Previous: 3.8% MoM; -4.3% YoY - Citi analysts expect industrial production to increase 1.3% MoM in January after a 3.8% MoM rise in December. The expected back-to-back gains likely were supported by disappearing adverse impact from parts shortages caused by Thailand’s flooding. Based on our forecast, industrial production in January is estimated to have increased 2.9% from the fourth quarter average, which points to a fairly robust increase in the first quarter as a whole. Citi analysts note, however, that these data may well be overstated due to a highly likely distortion in seasonal adjustments (part of sharp production plunges from October 2008 to early 2009 is regarded as seasonal).  Feb. 29, Housing Starts (Jan) Forecast: -2.7%YoY; 0.811mn units SAAR, Previous: -7.3% YoY; 0.783mn Units SAAR - Citi analysts expect January housing starts to stand at 811k (-2.7% YoY) on a seasonally adjusted annualized basis (783k, -7.3% YoY in December). On a MoM basis, a 3.6% increase is expected (-5.0% MoM in December). Housing starts are expected to rebound in January after a plunge driven by houses built for sales in December. Based on our projection, housing starts likely increased 1.9% in January from the fourth quarter average (-0.5% QoQ in 1Q, -1.0% QoQ in 2Q, +7.2% QoQ in 3Q and -9.8% QoQ in 4Q).  Mar. 2, Nationwide Consumer Prices, Overall (Jan) Forecast: 0.0% YoY, Previous: -0.2% YoY; Excluding Fresh Food (Jan) Forecast: -0.2% YoY, Previous: -0.1% YoY; Excluding Food (but not Alcoholic Beverages) and Energy (Jan) Forecast: -1.1% YoY, Previous: -1.1% YoY - Citi analysts estimate that the nationwide core CPI (excluding fresh food) dropped 0.2% YoY in January, slightly weakening from a 0.1% YoY fall in December amid a smaller boost from petroleum products. Meanwhile, the core CPI excluding special factors is estimated to have declined 0.92% YoY in January, also seeing a slightly larger slide than a 0.89% YoY decline in December. The headline nationwide CPI will likely register no change in January after a 0.2% YoY drop in December while CPI excluding food and energy probably