Kathleen Stephansen Jan 1010

The 2010 Euro Outlook January, 2010

Kathleen Stephansen

Chief Economist

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

(203) 487-6764

1

Euro/USD: where to?

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

2

Euro Reference Exchange Rate: US Dollar

EOP, USD/EUR

09080706

Source: European Central Bank /Haver Analytics

1.6

1.5

1.4

1.3

1.2

1.1

1.6

1.5

1.4

1.3

1.2

1.1

3

• We believe the Euro-USD will be in a relatively tight range over the next 12

months, ending the year close to 1.50.

• Volatility is likely to dominate currency markets and the EUR-USD in

particular, given the tension between positive and negative factors.

• The crisis has set in motion a more rapid adjustment in global imbalances.

We believe that the dollar is in a longer-term downward trend, adjusting to

capital flows being directed to emerging economies and leading to reserve

diversification that accompanies this adjustment.

• Historical perspective: The Euro has been a success. The challenge ahead

is to restore growth without the benefit of the demand impulse from the

peripheral countries.

The Euro Outlook


The end of the 2005 CNY/USD peg coincided with a sharp

appreciation of the Euro/USD and is the manifestation of a

currency redistribution away from the dollar.


4

Foreign Exchange Rate: European Monetary UnionUS$/Euro

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

090807060504

Sources: Federal Reserve Board /Haver Analytics

1.6

1.5

1.4

1.3

1.2

1.1

8.4

8.0

7.6

7.2

6.8

USD-CNY (RHS)

EUR-USD (LHS)

5

• Global rebalancing

• Global FX diversification away from the USD;

• Global liquidity;

• Return to risk appetite;

• The timing of the ECB monetary policy exit.

Positive Euro factors


6

Structural changes


In adjusting to credit restraint, de-leveraging and restructuring of debt, private

demand in the G-2 (US & UK) could be a restraining factor to the positive multiplier

effects of recovering trade flows.

Specifically, we believe in the de-emphasis of the US consumer.

The burden then shifts to China to redirect its drivers of growth away from exports

to domestic demand. This process has started already but will gain traction in

years to come. We note that the other two major surplus/saver countries, Germany

and Japan, show even smaller inclination than China in relying on consumption to

drive growth.

This is a multi-year process demanding infrastructure build, followed by

diversification towards services and consumption industries.

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


Shares of Regional Consumption to World Consumption

Sources: Bureau of Economic Analysis/Haver Analytics

7

4%

5%

6%

7%

8%

9%

10%

11%

12%

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

72%

74%

76%

78%

80%

82%

84%

NJA LATAM Industrials (rhs)

Sources: DataStream International; IMF; OECD

US: Consumer-led growth is set to change


8

Sector contribution to real GDP growth

Sources: BEA/Haver Analytics

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

6.00

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Consumption Fixed Investment Net Exports

It is a dynamic we saw with China, whose contributions to global

growth has risen steadily this past decade


9

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

Sources: IMF/Haver Analytics

-1

-0.5

0

0.5

1

1.5

2

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

e

2010

e

US Contribution China Contribution

China: The massive infrastructure build was first related to the

2008 Olympics, then to the development of the domestic

economy


10

Sector contribution to real GDP growth

Sources: China National Bureau of Statistics/Haver Analytics

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Consumption Fixed Investment Net exports

China’s current account surplus should decline, implying less

aggressive purchases of US Treasuries, and a slowdown in

demand for dollars


11

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

%

08070605040302010099

Source: State Administration of Foreign Exchange/Haver Analytics

12

10

8

6

4

2

0

12

10

8

6

4

2

0

As Chinese demand continues to rise, it increasingly benefits

NJA. NJA export share to China tripled over the period 1998-

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


12

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

15,000

215,000

415,000

615,000

815,000

1,015,000

1,215,000

1,415,000

1994 1995 19961997 19981999 20002001 20022003 20042005 20062007 2008 2009

3.0

5.0

7.0

9.0

11.0

13.0

15.0

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

Share of Exports to China (%, RHS)

Upward pressures on Asian currencies against the USD implies

intervention, thereby limiting the decline of the USD. A shift in

trade flows would lead to FX reserve diversification


13

09080706Sources: BOK, BoT, RBI /Haver

1500

1400

1300

1200

1100

1000

900

52

48

44

40

36

32

28

Korea Won-USD (LHS)

Thai Baht-USD (RHS)

India Rupee-USD (RHS)

EM countries, whose currencies are under upward pressure,

incur FX reserves accumulation that is set to continue


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

Sources: Bloomberg Financial Markets/Haver Analytics/

14

0.000

0.500

1.000

1.500

2.000

2.500

3.000

3.500

4.000

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

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


Quantitative Liquidity Measures (percent of G3 GDP)

Sources: Bloomberg Financial Markets/ Eurostat/Haver Analytics/Merrill Lynch.

15

-2

0

2

4

6

8

10

12

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

Base Money Plus Reserves Reserves Base Money

Synchronized growth brings a return to risk appetite


VIX and PMIs

Source: WSJ; Markit/Haver Analytics

16

30.00

35.00

40.00

45.00

50.00

55.00

60.00

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

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

10.00

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

… A positive for the Euro


Source: WSJ; Markit/Haver Analytics

17

1.1800

1.2300

1.2800

1.3300

1.3800

1.4300

1.4800

1.5300

1.5800

Jan:

2006

May

:2006

Sep:2

006

Jan:

2007

May

:2007

Sep:2

007

Jan:

2008

May

:2008

Sep:2

008

Jan:

2009

May

:2009

Sep:2

009

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

10.00

US$/EUR VIX (Inv. Scale RHS)

Foreign appetite for US assets has slowed


18

movv12m<LT001GN>

movv12m<LT001KN>

movv12m<LT001MN>

movv12m<LT001PN>

0908070605040302010099

Sources: TREASURY, TREASURY, TREASURY, TREAS /Haver

100000

80000

60000

40000

20000

0

-20000

100000

80000

60000

40000

20000

0

-20000

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

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

European appetite for US assets has slowed the most


19

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

Europe: Net Fgn Transactions of Long-Term Securities

12-month MovingAverage Mil.$

09080706050403020100

Source: Department of Treasury /Haver Analytics

45000

37500

30000

22500

15000

7500

45000

37500

30000

22500

15000

7500

The ECB exit strategy has begun, ahead of the Fed, which

should lead to a gradual widening pressure on Europe-US yield

spreads


20

BOE

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

6

5

4

3

2

1

0

6

5

4

3

2

1

0

EuroUSJapanUK

21

• Euro area growth differentials with the US;

• Euro area needs rebalancing of growth;

• Perceived Sovereign Risk fears.

Negative Euro Factors


Growth differentials between the US and the Euro area favor the

USD, replacing the risk aversion/USD relationship


22

-4

-3

-2

-1

0

1

2

3

4

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

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

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

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

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

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

Note: Aladdin projections in Red

Collapse in growth in smaller countries


23

1110090807060504030201

Sources: Statistical Office of the European Communities /Haver Analytics

6

4

2

0

-2

-4

-6

6

4

2

0

-2

-4

-6

Spain

Portugal

Euro Area

1110090807060504030201

Sources: Statistical Office of the European Communities /Haver Analytics

12

8

4

0

-4

-8

12

8

4

0

-4

-8

Ireland

Greece

Euro Area

GDP year-on-year % change

Loss of competitiveness…


24

…And deterioration in the Euro area fiscal outlook…


25

Sources: OECD/Haver Analytics

-15

-10

-5

0

5

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

2008 2009 (est.) 2010 (f)

Euro area General Government Balance-to-GDP

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


26

Greece: 10-Year Government Bond Yield%

Germany: 10-Year Government Bond Yield%

0908070605040302

Sources: Financial Times /Haver Analytics

6.00

5.25

4.50

3.75

3.00

2.25

6.00

5.25

4.50

3.75

3.00

2.25

Germany

Greece

The fiscal situation has deteriorated in the US as well,

dampening the negative effect on the Euro/USD


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

Source: Congressional Budget Office

27

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010(

f)

… With the accumulation of debt at both the Federal


28

Federal Government: Liabilities: Credit Market Instruments

SA, Bil$

09080706050403

Source: Federal Reserve Board /Haver Analytics

8000

7000

6000

5000

4000

3000

8000

7000

6000

5000

4000

3000

… And State and Local Government Levels


29

State & Local Govt: Liabilities: Credit Market Instruments

SA, Bil$

09080706050403

Source: Federal Reserve Board /Haver Analytics

2400

2200

2000

1800

1600

1400

2400

2200

2000

1800

1600

1400

30

• The success story

Historical Perspective


Euro declines rapidly against the USD, then rebounds strongly


Sources: Bloomberg/Cumberland Advisors

31

USD/EUR

0.8

0.9

1

1.1

1.2

1.3

1.4

1.5

1.6Jan-9

1

Jan-9

2

Jan-9

3

Jan-9

4

Jan-9

5

Jan-9

6

Jan-9

7

Jan-9

8

Jan-9

9

Jan-0

0

Jan-0

1

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

After 2002 the Euro was fully

deployed and national currencies

were withdrawn from circulation

From 1999-2002 the Euro was trading

in electronic markets and the FX

market

The European Currency Unit (ECU), a

theoretical "basket" currency, is used

as a proxy for the Euro when

calculating the USD/EUR exchange rate,

pre-1999

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


32

Original Member CountriesAustria

Belgium

Finland

France

Germany

Ireland

Italy

Luxembourg

Netherlands

Portugal

Spain

1999

Later EntriesGreece (2001)

Slovenia (2007)

Cyprus (2008)

Malta (2008)

Slovakia (2009)

2001 - 2009

Legally Obliged to Join in FutureEstonia (2011)

Lithuania (2011)

Latvia (2012)

Poland (2013)

Czech. Republic (2013)

Hungary (2013)

Bulgaria (2015)

Romania (2015)

2011 - 2015

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

33

International debt issued in Euros and USD is roughly equal


Sources: BIS Quarterly Review: 'June 2009

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

0

2000

4000

6000

8000

10000

12000

14000

1993 1995 1997 1999 2001 2003 2005 2007

US

D b

illio

ns

Euro

US dollar

Global cash outstanding in Euros Is Greater than in USD


34

Note: Euro area (changing composition) - Net Circulation - number of banknotes/coins in circulation (for banknotes it has to be calculated,

and equals created notes less destroyed notes less stocks of the NCB) - Banknotes - All denominations - 1st design - Stock - denominated in Euro. Sources: Federal Reserve Bank of St. Louis, European Central Bank, and Cumberland Advisors

190

290

390

490

590

690

790

890

990

1090

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

US

Do

llar

Euro Circulation in USD

USD Circulation

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Kathleen Stephansen Jan 1010

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