RBC Capital Markets LLC Global Head of FX Strategy Three ...

December 16, 2016

Currency Report Card December 2016

Three-month forecast returns

Most bullish Most bearish

NZD GBP

BRL KRW

AUD SEK

Source: RBC Capital Markets

12-month forecast returns

Most bullish Most bearish

NZD CHF

JPY EUR

BRL SGD


Forecast revisions this month: USD revised higher against almost all G10 currencies, including:

EUR/USD: Profile revised lower. Q1 2017 now 1.02 (previously 1.08); Q4 now 0.96 (1.05)

USD/JPY: Profile revised higher. Q1 2017 now 120 (95); Q4 now 110 (97)

USD/CAD: Profile revised higher. Q1 2017 now 1.35 (1.34); Q4 now 1.38 (1.33)

AUD/USD: Short-term profile revised lower. Q1 2017 now 0.74 (0.79); long-term unchanged

All forecasts extended to 2018 and MXN and BRL forecasts reintroduced.

JPY and NZD outperformance; SGD, EUR and CHF underperformance


Global FX Strategy RBC Europe Limited Chief Currency Strategist Adam Cole Royal Bank of Canada – Hong Kong Branch Head of Asia FX Strategy Sue Trinh RBC Capital Markets LLC Global Head of FX Strategy Elsa Lignos Associate Daria Parkhomenko RBC Dominion Securities Inc. Chief Technical Analyst George Davis All values in USD unless otherwise noted. Priced as of prior trading day’s market close, ET (unless otherwise stated).

-15

-10

-5

0

5

10

15

TR

Y

NZ

D

JPY

BR

L

AU

D

MX

N

SE

K

NO

K

CA

D

IDR

INR

PLN

CN

Y

KR

W

GB

P

HU

F

SG

D

EU

R

CH

F

Max

Min

End period

12 month forecast currency returns vs USD, quarterly, % including carry

For Required Conflicts Disclosures, please see page 24.For Required Conflicts Disclosures, please see page 24.Disseminated: December 16, 2016 17:50ET; Produced: December 16, 2016 17:50ET

December 16, 2016 2

Table of contents Majors

US Dollar .............................................................................................................................. 3

Euro ..................................................................................................................................... 4

Japanese Yen ....................................................................................................................... 5

Sterling ................................................................................................................................ 6

Swiss Franc .......................................................................................................................... 7

Scandis

Swedish Krona ..................................................................................................................... 8

Norwegian Krone ................................................................................................................ 9

Commodity Currencies

Canadian Dollar ................................................................................................................. 10

Australian Dollar ................................................................................................................ 11

New Zealand Dollar ........................................................................................................... 12

Asia

Chinese Yuan ..................................................................................................................... 13

Indian Rupee ..................................................................................................................... 14

South Korean Won ............................................................................................................ 15

Singaporean Dollar ............................................................................................................ 16

Indonesian Rupiah ............................................................................................................. 17

EMEA

Turkish Lira ........................................................................................................................ 18

Czech Koruna ..................................................................................................................... 19

Latin America

Mexican Peso .................................................................................................................... 20 Brazilian Real ..................................................................................................................... 21

Forecasts ........................................................................................................................... 22

Currency Report Card - December 2016

December 16, 2016 3

US Dollar Elsa Lignos

1-3 Month Outlook – Waiting for inauguration

We had said in the event of a Trump win we would expect a wave of risk aversion but also USD strength. The risk aversion lasted barely four hours; the real story has been USD strength, with trade-weighted USD up 6% since Election Day. The primary driver has been Fed expectations. Heading into the election, markets were priced for just 1.5 hikes by the end of 2017. That is now up to 2.5 hikes and could rise further. The size of the rally in USD may seem outsized for just one extra hike next year but the build-up in expectations has fuelled the whole forward curve higher. US 2yr swaps have moved from just above 1% to 1.50%. Recall this time last year how bullish the consensus was on USD – markets were looking for 2-4 hikes this year (and the Fed’s dot plot median pointed to 4); as that failed to materialise, markets didn’t just push back the expected hikes, they began to lose faith that they would ever be delivered at all. The forward curve flattened substantially and parallel shifts became the norm. With many long USD positions squeezed out in the run-up and immediate aftermath of the election, there was even more room to rally. But we think USD strength can keep going. Many point to the danger of history repeating itself (a bullish USD consensus at the start of the year which is crushed by the Fed failing to deliver). We think four factors will offer USD more support this time around: (1) a tax cut on overseas earnings now looks very likely and though many argue overseas earnings are already held in USD and should therefore have no impact, similar arguments were made ahead of HIA in 2005 and they turned out to be wrong; (2) inflationary pressures are stronger so the risk of the Fed failing to deliver is lower; (3) the likelihood of more protectionism is underpriced in our view and that would hurt the US’s major trading partners more than USD; (4) the potential for a shift to a destination-based cash flow corporate tax introduces another source of upside USD risk. For more on these themes please see Total FX, 2 Dec 2016.

6-12 Month Outlook – More clarity on tax reform

The fundamentals of the US economy appear strong enough to sustain modest rate hikes, so it is hard not to look for USD strength to be maintained as rates rise. The potential changes to the tax code discussed above seem more likely to materialise over a 6-12 month horizon than sooner (lobbyists are already gearing up to fight any radical changes that hurt their interest groups), and that would be another source of support for USD in H2.

Indicators

Current (Previous)* Official cash rate 0.75% (0.50%) Trend interest rates (10yr average) 1.9% Bias in interest rate market Higher Core PCE Inflation %Y/Y Oct (Sep) 1.7% (1.7%) Inflation target Price stability Budget balance % GDP FY15 (FY14) -2.6% (-2.8%) Budget balance target % GDP - GDP Growth % q/q SAAR Q3 (Q2) 3.2% (1.3%) Trend GDP %y/y 2.5% Purchasing Power Parity Value - Spot - PPP Valuation - Current account balance % GDP Q2 (Q1) -2.7% (-2.6%) Trend current account balance % GDP -3.7% Moody's Foreign Currency Rating Aaa Outlook Stable * Current is latest month, quarter or year

Source: RBC Capital Markets; Bloomberg

1. After a year of parallel shifts….

2. …the US forward curve has steepened spectacularly


Forecasts

Source: RBC Capital Markets estimates

Q1f Q2f Q3f Q4f Q1f Q2f Q3f Q4f

EUR/USD 1.02 1.00 0.98 0.96 0.98 1.00 1.02 1.04

USD/JPY 120 118 115 110 105 107 108 109

USD/CAD 1.35 1.38 1.38 1.38 1.37 1.36 1.35 1.33

2017 2018

-10

0

10

20

30

40

50

60

Jan 16 Apr 16 Jul 16 Oct 16

to end-2016

through 2017

Fed tightening priced into forward curve, bp

-10

0

10

20

30

40

50

60

70

Jan 16 Apr 16 Jul 16 Oct 16

to end-2016

through 2017

Fed tightening priced into forward curve, bp


https://www.rbcinsight.com/CM/Share/ResearchViewer/?SSS_C173B97508DEB669093A8D6AFD9B7364

December 16, 2016 4

Euro Elsa Lignos 1-3 Month Outlook – Weak EUR/USD on strong USD

Since the December FOMC meeting, EUR/USD has broken to new lows but that is a USD move rather than EUR-related. The Italian referendum came and went with little fuss. The probability of any of the upcoming elections resulting in an anti-EU government may be low, but we do not expect political uncertainty to be resolved in 2017 either. Italian elections (by May 2018) will maintain the overhang of political uncertainty. There are typically two ways in which support for a populist party falls: one is electing it to power and the other is a more positive economic/social outlook which makes voters less likely to opt for the anti-establishment. Greece has experienced the former and Spain to some degree has witnessed the latter. But weak growth prospects in much of the Euro area make it hard to envisage a fall in populism on improving voter sentiment (our European economists discuss their 2017 outlook here, in particular how political uncertainty, weak investment, and slow wage growth will weigh on Euro area growth in H2). That leaves the persistent threat of an anti-EU government hanging around through 2017. If that risk were realised, we would expect EUR/USD to trade much lower than many anticipate. To try to quantify the magnitude of the impact, we return to our synthetic EUR framework (for the original methodology, please see here). This shows independent EUR direction by measuring a periphery risk premium (the difference between our synthetic EUR/USD measure and real EUR/USD, Figure 1). The risk premium has risen in 2016 (dragged higher by the UK referendum) but it remains low compared to the crisis peak in August 2012. We think that 2012 peak would be a good starting point for how high the risk premium could rise in the event of a EUR referendum being held in a Eurosceptic country. Applying that to current spot would mean EUR/USD trading to 0.70. If that sounds extreme, it is only because the current strength of USD makes the starting point that much lower.

6-12 Month Outlook – Monitoring political risks

The political drivers described above remain tail risks rather than a base case for now. For our base case forecast we are focused on the lack of inflationary pressure in the Euro area. Until inflation picks up, the ECB will be stuck at or below the zero bound. Our end-2017 target for EUR/USD has been cut to 0.96 on USD strength.

Indicators

Current (Previous)* Official cash rate 0.00% (0.05%) Trend interest rates 10y average 1.9% Bias in interest rate market Lower HICP core Inflation %Y/Y Oct (Sep) 0.8% (0.8%) Inflation target Close to but less than 2.0% Budget balance % GDP FY15 (FY14) -2.1% (-2.6%) Budget balance target % GDP 3% of GDP-Unless special circumstances GDP Growth %Y/Y Q3 (Q2) 1.6% (1.6%) Trend GDP %y/y 1.1% Purchasing Power Parity Value Oct 1.2649 Spot end-Nov 1.0588 PPP Valuation EUR/USD is undervalued Current account % GDP Q2 (Q1) 3.3% (3.1%) Trend current account balance % GDP 0.3% Moody's Foreign Currency Rating Aaa (Germany) Outlook Stable * Current is latest month, quarter or year

Source: RBC Capital Markets; national polling agencies

1. EUR/USD has been falling but that is all USD strength

2. EUR has been getting stronger on most crosses recently


Forecasts



EUR/USD 1.02 1.00 0.98 0.96 0.98 1.00 1.02 1.04

EUR/JPY 122 118 113 106 103 107 110 113

EUR/CAD 1.38 1.38 1.35 1.32 1.34 1.36 1.38 1.38

20182017

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

05 06 07 08 09 10 11 12 13 14 15 16

EUR/USD

"Synthetic" EUR/USD

Out of sample

-20

-10

0

10

20

30

40

50

05 06 07 08 09 10 11 12 13 14 15 16

RBC estimate of EUR's risk premium, USc


https://www.rbcinsight.com/CM/Share/ResearchViewer/?SSS_6D850CF8195B0CE8CFC5A7792D9E7A0D

https://www.rbcinsight.com/CM/Share/ResearchViewer/?SSS_11D0C672B980AA4FFDFEB5E764C0D10D

December 16, 2016 5

Japanese Yen Adam Cole

1 – 3 Month Outlook – Further USD/JPY upside

JPY has underperformed almost every other currency since the US election – even MXN is up slightly against JPY. The proximate cause is clear. JPY is more leveraged to interest rate differentials than any other G10 currency and the main transmission mechanism from the US election to FX markets has been a significant repricing of US rate prospects. With detail starting to emerge on post-election capital flows, however, it is becoming clear that JPY weakness is not (so far at least) being driven by the capital outflows from Japan. As global yields have jumped, Japanese investors have been net sellers of foreign bonds. The MoF’s data show cumulative net selling of JPY0.8trn in the four full weeks since the election, compared to average weekly buying of JPY0.5trn year-to-date. Most likely, this reflects profit taking on unhedged foreign bond holdings. In most markets, FX gains over the last month are large enough to more than offset capital losses on underlying bond holdings. Whatever the reason, the fact that capital has been flowing into Japan since the US election suggests the JPY selling pressure is coming from elsewhere. Most likely, the FX flow reflects transactions that have no underlying capital flow associated with them – broadly speaking, speculative positioning. The timing of market moves since the US election supports this (Figures 1 and 2, see Total FX, 9 December 2016). All of the measures of positioning we monitor show a rapid rebuild of JPY-shorts in recent weeks, but none are yet at extreme levels. As such positioning should not be an obstacle to USD/JPY upside – perhaps to the low 120s – if US rate expectations continue to rise toward the three 2017 hikes the Fed’s median forecast shows. In the absence of stronger capital outflows, risk becomes more symmetric around those levels.

6 – 12 Month Outlook – USD/JPY drifting lower

Longer-term, the BoJ’s tacit admission that it can’t hit its 2% inflation target for three years or more could be taken as either positive or negative for JPY. The failure to lift nominal GDP through either prices or volumes should bring the unsustainability of Japan’s budget imbalance back into focus and for many this is JPY-bearish, not bullish. But the public sector deficit is the counterpart to a large private sector surplus and so long as excess private sector savings fund public sector borrowing, Japan’s imbalances are a purely domestic issue. We revised our USD/JPY forecasts up in the light of the US election results, but still expect USD/JPY to trend lower.

Indicators

Current (Previous)* Official cash rate -0.1% (-0.1%) Trend interest rates 10y average 0.15% Bias in interest rate market Lower CPI Inflation %Y/Y Oct (Sep) -0.4% (-0.5%) Inflation target 2.0% Budget balance % GDP FY15 (FY14) -6.7% (-7.7%) Budget balance target % GDP n/a GDP Growth %Y/Y Q3 (Q2) 1.0% (0.9%) Trend GDP %Y/Y 1.0% Purchasing Power Parity Value Oct 89.10 Spot end-Nov 114.46 PPP Valuation USD/JPY is overvalued Current a/c balance % GDP Q3 (Q2) 3.7% (3.5%) Trend current account balance % GDP 2.7% Moody's Foreign Currency Rating A1 Outlook Stable * Current is latest month, quarter or year


1. Post-election rally all in London/NY time…

2. …which is not normal


Forecasts



USD/JPY 120 118 115 110 105 107 108 109

EUR/JPY 122 118 113 106 103 107 110 113

CAD/JPY 89 86 83 80 77 79 80 82

20182017

99.7

99.8

99.9

100

100.1

100.2

100.3

100.4

100.5

100.6

100.7

00:00 03:00 06:00 09:00 12:00 15:00 18:00 21:00

LDN

ope

n

NY

ope

n

TK

O o

pen

LDN

clo

se

TK

O c

lose

NY

clo

se

GMT

USD/JPY 00:00 GMT = 100, all sessions since Nov 10

99.96

99.98

100.00

100.02

100.04

100.06

100.08

100.10

100.12

100.14

100.16

00:00 03:00 06:00 09:00 12:00 15:00 18:00 21:00

LDN

ope

n

NY

ope

n

TK

O o

pen

LDN

clo

se

TK

O c

lose

NY

clo

se

GMT

USD/JPY 00:00 GMT = 100, October 2016


https://www.rbcinsight.com/CM/Share/ResearchViewer/?SSS_DD72CBBC5241B65A9C8FBEDEA28B06A9

December 16, 2016 6

Sterling Adam Cole 1-3 Month Outlook – Another leg down

GBP outperformance has been a consistent theme in the month since the US election, with EUR/GBP back to the mid-0.80s – levels not seen since September. Various explanations have been put forward, including that the UK may receive favourable treatment from an increasingly protectionist US, undoing some of the potential damage to trade from UK EU exit. We think it unlikely that the market is taking a strong view on this at this early stage, with other, more transitory, factors driving GBP higher. Domestically, growth expectations have been consistently revised up as economic data have surprised to the upside (Figure 1), confounding the pessimism that followed the referendum in June. As a result, markets are now (wrongly, in our view) priced for higher policy rates in 2017. The strong outperformance of financial equities (Figure 2) has also helped GBP and we also note GBP’s historical tendency to outperform during periods of general USD strength such as the last month.

In the early part of 2017, these transitory positives are likely to give way to another wave of pessimism and we maintain our long-standing target for GBP/USD of 1.15 in H1. Economic data are unlikely to maintain the strength seen in Q3 as we begin to see data genuinely reflective of post-referendum corporate sentiment. Early indications for Q4 already look much softer. Politics is also set to deteriorate further once Article 50 is triggered and rising expectations of a relatively “soft” exit are likely to go into reverse.

6-12 Month Outlook – GBP/USD bottoms at 1.15

Longer term, we also see much scope for disappointment on the positive impact of GBP’s fall on economic activity, which is likely to be limited to higher exporter margins (see Total FX, 29 July 2016), with little follow-through in volumes and hence employment and investment. Our 1.15 GBP/USD target is based on an orderly adjustment process, not a funding/balance of payments crisis scenario. In such a scenario, we would expect to see GBP through parity against both USD and EUR. In this context, the ONS’s recent revisions to external trade data have lowered the hurdle for a more disorderly adjustment. Q3 current account data are likely to show the deficit running at a new record high of around 7.5% of GDP. Gilt yields and spreads show no signs of real funding stress yet, however.

Indicators

Current (Previous)* Official cash rate 0.25% (0.25%) Trend interest rates 10y average 3.3% Bias in interest rate market Stable CPI Inflation %Y/Y Oct (Sep) 0.9% (1.0%) Inflation target (HICP) 2.0% Budget balance % GDP FY15 (FY14) -4.3% (-5.7%) Budget balance target % GDP Budget surplus as soon as possible GDP Growth %Y/Y Q3 (Q2) 2.3% (2.0%) Trend GDP %Y/Y 1.5% Purchasing Power Parity Value Oct 1.5116 Spot end-Nov 1.2506 PPP Valuation GBP/USD is undervalued Current a/c balance % GDP Q2 (Q1) -5.3% (-5.1%) Trend current account balance % GDP -3.3% Moody's Foreign Currency Rating Aa1 Outlook Stable * Current is latest month, quarter or year

Source: RBC Capital Markets, Bloomberg

1. UK growth expectations rising

2. GBP outperformance follows financial stocks


Forecasts



GBP/USD 1.15 1.15 1.16 1.16 1.18 1.20 1.23 1.25

EUR/GBP 0.89 0.87 0.85 0.83 0.83 0.83 0.83 0.83

GBP/JPY 138 136 133 127 124 129 133 137

GBP/CAD 1.55 1.59 1.60 1.60 1.62 1.64 1.66 1.67

20182017

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.00

2.25

2.50

-100

-80

-60

-40

-20

0

20

40

60

80

100

Jan 16 Mar 16 May 16 Jul 16 Sep 16 Nov 16

UK ESI, LHS

Consesus 2017 UK GDP forecast, RHS

0.65

0.70

0.75

0.80

0.85

0.90

1.75

2.00

2.25

2.50

Jan-15 Jul-15 Jan-16 Jul-16

MSCI industrials/finacials, LHS

EUR/GBP, RHS


https://www.rbcinsight.com/CM/Share/ResearchViewer/?SSS_D1C33176B6F0A752F4EF96289A0A68C6

December 16, 2016 7

Swiss Franc Elsa Lignos 1-3 Month Outlook – Attention shifts from EUR/CHF

EUR/CHF is approaching levels which will test the SNB’s patience again (spot 1.0720). It briefly dipped below 1.07 on the morning after the Italian referendum (low 1.0693) though buying interest at 1.07 has generally held it above that level. SNB Chair Jordan has reiterated that there are no limits on expanding the SNB’s balance sheet though if that were genuinely true, the SNB would have never abandoned its 1.20 floor. In fact his claim is more nuanced – the SNB is willing to intervene to expand its balance sheet as long as the benefits outweigh the costs. That means the SNB may remain active around 1.07 but if we see independent EUR weakness, the SNB would be more likely to let EUR/CHF hit parity than stomach an exponential expansion in its balance sheet. It appeared to signal as much by inserting a new phrase into its December statement that it will be active in FX markets (the standard line) “while taking the overall currency situation into consideration” (a new addition). That hints at the SNB’s focus shifting away from EUR/CHF to CHF more generally and would mean more downside for EUR/CHF if for example USD/CHF keeps marching higher. We have revised our end-Q2 EUR/CHF forecast marginally lower (now 1.06).

6-12 Month Outlook – The US corporate tax risk

A tax break on overseas earnings is looking increasingly likely in the US. The experience of the Homeland Investment Act suggests USD/CHF could be one of the biggest beneficiaries (see Total FX, 8 July 2011). The question now is more one of timing. The new administration and congress are intent on major tax reform, but the radical shift envisioned by the GOP’s House leadership (a destination-based cash flow corporate tax) is likely to run into a lot of opposition from importers and their lobbyists. If Congress attempts to do all tax reform in one go, it will delay any changes to tax on overseas earnings and will delay the positive impact on USD/CHF to the back end of our forecast profile. Besides US tax risks, our long-term forecast is still driven by the (lack of) inflationary outlook. Extrapolating the SNB’s December forecasts, it would now take until Q2/Q3 2020 to reach its 2% target. The 1.3% conditional inflation forecast for Q3 2019 also assumes rates stay at -0.75% throughout the forecast period. That weak inflation outlook should keep Swiss rates negative even as the rest of the world turns positive. Our end-2017 EUR/CHF forecast is 1.08.

Indicators

Current (Previous)* Official cash rate -0.25 to -1.25% (0.25 to -0.75%) Trend interest rates 10y average 1.70% Bias in interest rate market Neutral CPI Inflation %Y/Y Nov (Oct) -0.3% (-0.2%) Inflation target less than 2.0% Budget balance % GDP FY15 (FY14) -0.24% (-0.2%) Budget balance target % GDP Balanced over the business cycle GDP Growth %Y/Y Q3 (Q2) 1.3% (2.0%) Trend GDP %Y/Y 1.80% EUR Purchasing Power Parity Value Oct 1.2310 EUR/CHF spot end-Nov 1.0772 EUR/CHF PPP Valuation EUR/CHF is undervalued Current a/c balance % GDP Q2 (Q1) 10.0% (10.9%) Trend current account balance % GDP 8.0% Moody's Foreign Currency Rating Aaa Outlook Stable * Current is latest month, quarter or year

Source: RBC Capital Markets; Bloomberg, SNB

1. Another downward revision to SNB inflation forecasts

2. USD/CHF was big beneficiary from HIA flows in 20015

Source: RBC Capital Markets; Bloomberg, IRS, BIS

Forecasts



USD/CHF 1.05 1.06 1.09 1.13 1.12 1.11 1.09 1.08

EUR/CHF 1.07 1.06 1.07 1.08 1.10 1.11 1.11 1.12

CHF/JPY 114 111 105 98 94 96 99 101

CAD/CHF 0.78 0.77 0.79 0.82 0.82 0.82 0.81 0.81

2017 2018

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

Q1-09 Q1-10 Q1-11 Q1-12 Q1-13 Q1-14 Q1-15 Q1-16 Q1-17 Q1-18 Q1-19

Actual SNB Sept 2016SNB Jun 2013 SNB Jun 2012SNB Jun 2014 SNB Jun 2011SNB Dec 2016 2% target

Daily FX 2005 HIA Inflow/ 2005 H2

turnover inflow turnover FX change

USDbn USDbn (x100) vs USD

CHF 253 35.8 14.13 -2.4

GBP 513 22.3 4.34 -3.8

EUR 1555 161.3 10.37 -2.1

JPY 755 5 0.66 -5.8

CAD 210 25.5 12.15 5.4

AUD 302 3.5 1.14 -3.9


https://www.rbcinsight.com/CM/Share/ResearchViewer/?SSS_C1F130EAD68E9D70B7F505AE813CED26

December 16, 2016 8

Swedish Krona Adam Cole 1-3 Month Outlook – Still a funding currency

After rallying to a peak of around 10 in the wake of the late-October Riksbank meeting, EUR/SEK has reversed most of those gains and SEK has stabilised more broadly. With the exception of the bout of SEK weakness in November, however, EUR/SEK is still at the high since the financial crisis and only GBP has performed worse than SEK in 2016. EUR/SEK’s rally to the highs in November reflected a surprisingly dovish Riksbank statement, but the theme of SEK underperformance was already well entrenched and we expect it to re-emerge, carrying EUR/SEK back to 10 in early 2017. At the last policy meeting, the Riksbank left open the question of whether its QE programme would be extended beyond the end of the year, though it will have to address that question at the upcoming meeting (December 21) as the current programme expires shortly after that. Given its consistently dovish stance it seems likely they will elect to extend purchases into 2017. This is a relatively minor factor in driving SEK weakness, however. Our negative stance is driven more by markets’ current focus on outright yield and SEK’s status as the most efficient funding currency in G10 carry trades (see Total FX, 2 September 2016). The post-election rise in US yields has so far done little more than lift global yields off the lows (see Figure 2 on page 12) and carry seems set to remain a theme in FX returns into early 2017, weighing on SEK again. As has been the case for much of 2016, the domestic news flow has been more positive, but has mattered less than in the past. Underlying inflation is back on a rising trend (1.6% y/y in November) and activity data still point to above trend growth. But until either the Riksbank removes SEK’s funding currency status, or carry disappears as a major driver, our bias will be for SEK weakness.

6-12 Month Outlook – Eventual recovery

Unless we get a major shock to risk appetite, it is hard to see either of these conditions being satisfied in the short term. Eventually, carry will stop working as a global FX theme (either due to higher yields on conventional assets or higher vol) and/or the Riksbank will finally start to raise rates. We expect that to happen by the back end of our forecast horizon, so we eventually look for SEK to rebound from deeply undervalued levels.

Indicators

Current (Previous)* Official cash rate -0.50% (-0.50%) Trend interest rates 10y average 3.0% Bias in interest rate market Flat CPIF Inflation %Y/Y Oct (Sep) 1.4% (1.2%) Inflation target (UND1X) 2.0% Budget balance % GDP FY15 (FY14) -1.07% (-1.71%) Budget balance target % GDP Cyclical average surplus of 1% GDP Growth %Y/Y Q3 (Q2) 2.8% (3.6%) Trend GDP %Y/Y 2.0% EUR Purchasing Power Parity Value Oct 8.7002 Spot end-Nov 9.7731 PPP Valuation EUR/SEK is overvalued Current a/c balance % GDP Q2 (Q1) 4.5% (4.6%) Trend current account balance % GDP 6.0% Moody's Foreign Currency Rating Aaa Outlook Stable * Current is latest month, quarter or year


1. NOK/SEK no longer following rate spreads

2. On any measure, SEK is historically cheap


Forecasts



USD/SEK 9.80 9.70 9.59 9.48 8.98 8.70 8.53 8.37

EUR/SEK 10.00 9.70 9.40 9.10 8.80 8.70 8.70 8.70

NOK/SEK 1.12 1.10 1.08 1.06 1.04 1.04 1.04 1.04

CAD/SEK 7.26 7.03 6.95 6.87 6.55 6.40 6.32 6.29

20182017

0.95

0.97

0.99

1.01

1.03

1.05

1.07

1.09

1.11

90

100

110

120

130

140

150

160

170

180

190

200

210

220

Jul-15 Jan-16 Jul-16

NO-SE 2yr swap, LHS

NOK/SEK, RHS

70

80

90

100

110

120

130

85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

CPI-based REER

RULC-based REER

NEER

Sweden TWI, post-float average=100


https://www.rbcinsight.com/CM/Share/ResearchViewer/?SSS_BB8E30BBA7EA50E406CAB96C7FC69643

December 16, 2016 9

Norwegian Krone Elsa Lignos 1 – 3 Month Outlook – Macroprudential rules

NOK is a middle of the pack performer over the last month. Though it was boosted by the OPEC deal on 30 November, it unwound most of those gains on 14 December as EUR/NOK squeezed higher on an announcement of new macroprudential rules. The rules limit borrowing to five times income and impose stricter amortization but they were softer than expected on loan to value restrictions (banks have leeway of 10% while the banking regulator had argued there should be few or no exceptions). The rules are tighter for Oslo, with even tighter restrictions for second homes. Experience from other countries suggests the new rules may cool house price inflation but are unlikely to prevent it as long as rates remain low.

In its latest rate decision (15 December), Norges Bank kept rates at 0.5% as widely expected, but it also kept its marginal easing bias, with a slightly higher probability of a rate cut than hike in 2017. Markets also reflect that bias; FRAs are still priced for a small risk of cuts (Figure 1). Part of the central bank’s concern stems from inflation which has been softening in recent months though core inflation is still well above 2% (Figure 2). Rates are likely to remain on hold in the months ahead, but we think firmer oil prices coupled with higher rates in the rest of the world mean Norges Bank’s next move is still much more likely to be a hike than a cut. That should push EUR/NOK lower (our end Q1 target is unchanged at 8.90).

6–12 Month Outlook – Positive fiscal impulse

The minority government struggled to pass its 2017 budget but after weeks of talks, the Liberal Party and Christian Democrats agreed to back the ruling coalition of the Conservatives and the Progress Party. Fiscal policy for next year is set to remain expansionary and the last minute compromise added an extra NOK6bn of spending. The government will also increase the withdrawal from the sovereign wealth fund giving one more year of a positive fiscal impulse. Oil & gas capex is expected to fall again next year, though in part that is because less money is being set aside for scrapping offshore infrastructure because of stronger projections for future oil & gas demand. Our end-2017 EUR/NOK forecast is unchanged at 8.60. Further out NOK should be boosted by a faster-than-anticipated pace of Norges Bank normalization.

Indicators

Current (Previous)* Official cash rate 0.5% (0.5%) Trend interest rates 10y average 3.6% Bias in interest rate market Neutral CPI (ex energy and taxes) %Y/Y Nov (Oct) 2.6% (2.9%) Inflation target % 2.5% Budget balance % GDP FY15 (FY14) 6.9% (9.1%) Budget balance target % GDP Structural, non-oil deficit < 4% GDP Mainland Growth %q/q Q3 (Q2) 0.2% (0.4%) Trend GDP %q/q 0.6% EUR Purchasing Power Parity Value Oct 8.6685 Spot end-Nov 9.0264 PPP Valuation EUR/NOK is overvalued Current a/c balance % GDP Q3 (Q2) 4.9% (6.4%) Trend current account balance % GDP 12.0% Moody's Foreign Currency Rating Aaa Outlook Stable * Current is latest month, quarter or year


1. Still a small bias for cuts in the forward curve

2. Core inflation has slipped in recent months


Forecasts



USD/NOK 8.73 8.80 8.88 8.96 8.67 8.40 8.24 8.08

EUR/NOK 8.90 8.80 8.70 8.60 8.50 8.40 8.40 8.40

NOK/SEK 1.12 1.10 1.08 1.06 1.04 1.04 1.04 1.04

CAD/NOK 6.46 6.38 6.43 6.49 6.33 6.18 6.10 6.07

20182017

-0.75

-0.50

-0.25

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.00

2.25

13 14 15 16

3m NIBOR

4th generic FRA

Difference

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Jan-06 Jan-09 Jan-12 Jan-15

Core CPI (ex energy & tax changes) %y/y


December 16, 2016 10

Canadian Dollar George Davis 1 – 3 Month Outlook – Uncertainty dominates

USD/CAD traded to a nine-month high of 1.3589 in November as the market digested the ramifications of Trump’s victory in the US Presidential election. Resulting uncertainty is expected to linger through the first quarter of 2017 as well, as Trump’s protectionist platform has set the stage for the US to exit the Trans-Pacific Partnership trade deal. Although nothing has been specified yet, this also raises concerns that the new US administration may seek to renegotiate the NAFTA agreement and present even more challenges to Canada’s already-weak export performance as the lack of clarity hinders investment on the part of exporters. Of note, non-energy exports – a key pillar in the Bank of Canada’s growth rotation thesis – were down -0.8%y/y in October on a volume basis as Canada continues to lose ground to key competitors such as Mexico. While we expect real export growth of 2.6% in 2017, net exports overall are forecast to have a fairly neutral impact on GDP growth, with weak US industrial production serving as a risk (Figure 1). Expectations surrounding US tax reform will also feature prominently, as the potential repatriation of overseas profits by US corporations will exert a bullish influence on the USD. USD/CAD will not be immune to this development and when the uncertainty around exports and policies from the new US administration are added to the mix, we see the scope for USD/CAD to trade to 1.35 in Q1 2017.

6 – 12 Month Outlook – Pros and cons

While we expect oil prices to improve and average USD56/bbl in 2017, other risks are expected to temper the benefit to CAD. Recent macroprudential measures undertaken to slow house price appreciation are forecast to lead to a slowdown in the housing sector that will weigh on GDP growth relative to previous years. This, in turn, may lead to a more cautious response from the Canadian consumer – who is expected to shoulder the burden of growth in 2017 but is weighed down by record high levels of household debt. Interest rates will also be a driving force in 2017 in the form of widening US-CA rate differentials as the BoC remains on hold due to the large amount of slack in the Canadian economy while the Fed is expected to hike twice as more stimulative fiscal policy maintains higher inflation expectations in the US. We look for USD/CAD to trade to 1.38 by mid-2017 in response to these developments.

Indicators

Current (Previous)* Official cash rate 0.50% (0.75%) Trend interest rates 10y average 1.38% Bias in interest rate market Neutral Core CPI Inflation %Y/Y October (September) 1.7% (1.8%) CPI Inflation target range %Y/Y 1-3% Budget balance % GDP FY15 (FY14) 0.1% (-0.3%) Budget balance target % GDP Balanced over the business cycle GDP Growth %Q/Q saar Q3 (Q2) 3.5% (-1.3%) Trend GDP %Q/Q 1.57% Purchasing Power Parity Value Oct 1.2422 Spot end-Nov 1.3437 PPP Valuation USD/CAD is overvalued Current account balance % GDP Q3 (Q2) -3.5% (-3.4%) Trend current account balance % GDP -2.06% Moody’s Foreign Currency Rating Aaa Outlook Stable * Current is latest month, quarter or year

Source: Haver Analytics, RBC Capital Markets

1. Weak US IP levels do not bode well for CA exports

2. Widening US-CA rate spreads to weigh on CAD

Source: Bloomberg, RBC Capital Markets

Forecasts



USD/CAD 1.35 1.38 1.38 1.38 1.37 1.36 1.35 1.33

EUR/CAD 1.38 1.38 1.35 1.32 1.34 1.36 1.38 1.38

CAD/JPY 88.9 85.5 83.3 79.7 76.6 78.7 80.0 82.0

20182017

-30

-25

-20

-15

-10

-5

0

5

10

15

20

Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan 16

CA Non-Energy Goods Exports

US Industrial Production

% Y/Y growthCorr = 0.86

0

0.1

0.2

0.3

0.4

0.5

0.6

1.25

1.3

1.35

1.4

1.45

1.5

Dec-15 Mar-16 Jun-16 Sep-16 Dec-16

USD/CAD (LHS)

2yr US-CA Yield Spread (RHS)



Australian Dollar Elsa Lignos 1 – 3 Month Outlook – Still benefiting from carry

Though AUD/USD is down 5% since the US election, AUD is middle of the pack against the rest of the world. There is still a notable gap between where rate differentials ‘predict’ AUD/USD should be and where spot is actually trading (Figure 1).

Domestic data have been mixed – Q3 GDP unexpectedly dropped into negative territory and the lower starting point for growth will require downward revisions to the RBA’s forecasts at its next update in February. The housing market is starting to moderate, net exports were a drag (-0.2ppts) and domestic demand was particularly weak in Q3, contracting 0.5%q/q. Our economists look for the sub-trend pact of activity to continue in 2017. The household savings rate is at its lowest since 2008 and productivity growth is soft.

Despite this, we look for AUD to remain a relative outperformer in G10 against most but not against USD. The disconnect can be explained by looking at the outright level of yields rather than rate dynamics. With a cash rate at 1.50%, AUD remains the second highest yielder in G10. We have discussed the return of carry as a driver in G10 FX several times before (see Total FX, 2 September 2016). Though US yields have risen spectacularly since the election, global yields are not following fast enough to banish carry as an FX driver (see Figure 2 on the next page). We look for AUD/USD to drift lower though EUR/AUD and GBP/AUD should also be lower reflecting AUD outperformance on those crosses.

6 – 12 Month Outlook – Need for fiscal consolidation

Longer term, the balance of risks remains to the downside, but ongoing demand for yield should limit this to fluctuations within the recent range. The need for fiscal consolidation over the longer term is consistent with our AU rates strategists’ view that the RBA will need to do more of the work in supporting growth (we look for another rate cut in 2017 taking the cash rate down to a historical low of 1.25%). In real trade-weighted terms, AUD is still some 10% above its long-term average and the impact of previous weakness on economic activity has been limited. Our end-2017 forecast is 0.72.

Indicators

Current (Previous)* Official cash rate 1.5% (1.5%) Trend interest rates 10y average 4.4% Bias in interest rate market Downward CPI Inflation %Y/Y Q3 (Q2) 1.3% (1.0%) CPI Inflation target range %Y/Y 2.0-3.0% Budget balance % GDP FY15E/14 -2.7%/-3.2% Budget balance target % GDP Balanced over the business cycle GDP Growth %Y/Y Q3 (Q2) 1.8% (3.1%) Trend GDP %Y/Y 2.8% Purchasing Power Parity Value Q3 0.7299 Spot end-Nov 0.7385 PPP Valuation AUD/USD is fairly-valued Current account balance % GDP Q2 (Q1) -2.7% (-3.8) Trend current account balance % GDP -4.4% Moody’s Foreign Currency Rating Aaa Outlook Stable * Current is latest month, quarter or year


1. Still a large gap between AUD/USD and rate differentials

2. Domestic data surprises cycling around zero


Forecasts



AUD/USD 0.74 0.74 0.73 0.72 0.72 0.72 0.73 0.73

EUR/AUD 1.38 1.35 1.34 1.33 1.36 1.39 1.40 1.42

AUD/NZD 1.04 1.03 1.00 0.97 0.97 0.97 0.97 0.97

AUD/CAD 1.00 1.02 1.01 0.99 0.99 0.98 0.99 0.97

20182017

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

0.60

0.65

0.70

0.75

0.80

0.85

0.90

Oct-14 Apr-15 Oct-15 Apr-16 Oct-16

AUD/USD, LHS

AU-US 2yr swap spread, RHS

-100

-80

-60

-40

-20

0

20

40

60

80

100

Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16

AU ESI

AU ESI 12 wk mov avg

RBC economic surprise indicator - Australia


https://www.rbcinsight.com/CM/Share/ResearchViewer/?SSS_BB8E30BBA7EA50E406CAB96C7FC69643


New Zealand Dollar Adam Cole 1-3 Month Outlook – Still propped up by yield

NZD is the best-performing G10 currency in 2016 and, with the exception of CAD and USD, has maintained that status in Q4 to date. On the face of it, NZD’s consistent outperformance is puzzling. Forward rate differentials have moved consistently in the wrong direction for most of the year (Figure 1) and the 2yr spread to the US hit a new low as US rates rose in the wake of the election. Our reading of this has been, and continues to be, that the role of rates in driving FX returns has changed this year as outright yield has taken over from rate dynamics as the main driver for the highest and lowest yielding currencies. In other words, carry has come back as significant driver of G10 FX returns. To the extent that the demand for FX carry reflects the low level of yields on conventional assets (Figure 2), one might expect NZD’s outperformance to reverse as global yields rise. Two factors, however, suggest caution on turning bearish too soon. Firstly, the rise in yields so far still leaves (front end in particular) rates at extremely depressed levels historically (Figure 2). Secondly, upward revisions to central bank rate expectations are so far wholly limited to the US. Our economists’ expectations for policy rates in all other G10 countries are either flat or lower through the whole of 2017. So, while there will clearly be setbacks in the performance of carry trades in G10, until there really is a paradigm shift in global bond markets that goes beyond the US, we think carry is a theme which markets will keep coming back to as a support for NZD. Against this background, changes in domestic monetary policy matter less, unless they imply NZD losing its high-yield status. Our economists expect only one more RBNZ cut in Q2 2017 and NZD will remain the highest-yielding G10 currency. We expect further gains on most crosses in 2017 H1.

6-12 Month Outlook – Strength will eventually bite

In real terms, NZ’s trade balance is showing some improvement driven by services. But exports of non-commodity goods continue to decline. NZD is well above its long-term average real effective exchange rate but with trade accounting for a decreasing share of FX turnover, a currency can spend much longer in ‘overvalued’ territory – in some cases as long as several decades (see Total FX here). We still expect to see NZD/USD grind lower as NZ/US policy diverges more meaningfully in late 2017 and 2018, but that is a longer-term story. Our end 2017 forecast is 0.74, revised lower on the back of a stronger USD.

Indicators

Current (Previous)* Official cash rate 1.75% (2.0%) Trend interest rates 10yr average 5.40% Bias in interest rate market Flat CPI Inflation %Y/Y Q3 (Q2) 0.4% (0.4%) Inflation target 1.0-3.0% Budget balance % GDP FY15E/FY14 -0.1%/-0.5% Budget balance target % GDP Balanced over business cycle GDP Growth %Y/Y Q2 (Q1) 3.6% (3.0%) Trend GDP %Y/Y 3.1% Purchasing Power Parity Value Q3 0.6594 NZD/USD end-Nov 0.7083 Valuation NZD/USD is overvalued Current account balance % GDP Q2 (Q1) -2.9% (-3.1%) Trend current account balance % GDP -4.2% Moody's Foreign Currency Rating Aaa Outlook Stable * Current is latest month, quarter or year

Source: RBC Capital markets, Bloomberg

1. NZD defies gravity…

2. …as carry takes over from rate dynamics


Forecasts



NZD/USD 0.71 0.72 0.73 0.74 0.74 0.74 0.75 0.75

EUR/NZD 1.44 1.39 1.34 1.30 1.32 1.35 1.36 1.39

AUD/NZD 1.04 1.03 1.00 0.97 0.97 0.97 0.97 0.97

NZD/CAD 0.96 0.99 1.01 1.02 1.01 1.01 1.01 1.00

20182017

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0.55

0.60

0.65

0.70

0.75

0.80

Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 Oct-16

NZD/USD, LHS

2yr swap differential, RHS

0

1

2

3

4

5

6

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

Unweighted average G10 2yr swap, %

FX carry basket yield, %


https://www.rbcinsight.com/CM/Share/ResearchViewer/?SSS_810EB8E5229B5A03D41A33C9435860EB


Chinese Yuan Sue Trinh 1-3 Month Outlook – Depreciation to slow

The government has signaled that recent depreciation in RMB has gone too far, too fast for now. Cross-border capital controls to limit outflows come ahead of USD/RMB breaking above the psychologically important 7.00 level. Some reported examples include the increased scrutiny over outward investment projects and the lowering of the limit required for preapproval of outward transactions from USD50mn to USD5mn. Increased capital controls coincide with tighter monetary conditions. We estimate that average PBC liquidity in December so far is the tightest since May 2016. We expect tight conditions to persist until the end of Lunar New Year (27 January – 2 February 2017) which should keep a floor under RMB depreciation. The pay-back of tight conditions will come later.

Meantime, President–elect Trump has pledged to label China a currency manipulator and slap 45% tariffs on imported Chinese goods on his first day in office (20 January 2017). The US is currently legally constrained from taking either of these actions, but rules could be rewritten. Notwithstanding the fact very little is known about what trade measures Trump will implement, historical precedent suggests China will retaliate if it were to face large US import tariffs. This would escalate what has been a long running US-China trade war.

6 – 12 Month Outlook – Few options left

Of particular concern is the continued trend deterioration in key labour market indicators and other indicators pointing toward stalling in the economic rebalancing toward the services sector. There is also a limit to how much China can rely on State support. Despite calls for widening the fiscal deficit toward 5%, an augmented fiscal deficit measure that includes (estimated) local government and off-budget activity is already ~8% of GDP. This means the potential for meaningful fiscal stimulus in China is much lower than appreciated, particularly if the liquidity driven resurgence in the property sector fades, weighing on revenues from land sales. Our concerns about a widening political risk premium and the negative implications for structural reform are crystalising with President Xi being pronounced as the "core" of the Communist Party leadership, which is designed to convey his unquestioned authority. We remain comfortable targeting USD/CNY at 7.5 in 2017.

Indicators

Current (Previous)*

Official cash rate 1.5% - 4.35 % (1.75%-

4.60%) Trend interest rates (10yr average) 2.85%-6.07% Bias in interest rate market Lower CPI Inflation %Y/Y last (prev) 2.3% (2.1%) Inflation target 3.0% Budget balance % GDP last (prev) -3.5% (-1.80%) Budget balance trend % GDP -1.21 GDP Growth % y/y last (prev) 6.7% (6.7%) Trend GDP %y/y 9.9 RBC-POLAR misalignment 11% Spot end-November 6.8894 FX Valuation Overvalued Current account balance % GDP last (prev)

2.4% (2.4%)

Trend current account balance % GDP 4.1 Moody's Foreign Currency Rating Aa3 Outlook Negative

* Current is latest month, quarter or year

Source: RBC Capital Markets, PBC, Bloomberg

1. Tighter monetary conditions

2. China has been intervening to support RMB

Source: RBC Capital Markets, PBC, Bloomberg

Forecasts



USD/CNY 7.00 7.20 7.40 7.50 7.60 7.70 7.70 7.75

EUR/CNY 7.14 7.20 7.25 7.20 7.45 7.70 7.85 8.06

CNY/JPY 17.1 16.4 15.5 14.7 13.8 13.9 14.0 14.1

CAD/CNY 5.19 5.22 5.36 5.43 5.55 5.66 5.70 5.83

20182017

-600

-400

-200

0

200

400

600

800

07 08 09 10 11 12 13 14 15 16

RRR liquidity 3m rolling average

PBC liquidity measures (incl OMOs), USDbn,3m rolling average

6.00

6.20

6.40

6.60

6.80

7.002500

2700

2900

3100

3300

3500

3700

3900

4100

Sep 09 Sep 10 Sep 11 Sep 12 Sep 13 Sep 14 Sep 15 Sep 16

China FX reserves, USDbn, LHS

USD/CNY, reverse order, RHS



Indian Rupee Sue Trinh 1-3 Month Outlook – Door ajar for RBI to cut again in Q1

INR was one of AXJ’s outperformers since the end of October (-1% versus USD).

In a decision that was unexpected by consensus, RBI did not cut policy rates in December and left the repo rate at 6.25%. Supplementary liquidity operations – liquidity provisions and open market operations – have helped improve the monetary transmission mechanism, and reduced any urgency to follow up October’s rate cut. The RBI cited upside risks to its 5% by March 2017 inflation projection. Regarding the demonetization, RBI would prefer to see more data as to its (downside) impact on growth and inflation. Further downside surprises to below target (4%) would increase the risks of another rate cut in February.

6 – 12 Month Outlook –Implementation of structural reforms key

Reforms hold the key to INR’s performance over the longer term. There is a strong foundation with great plans in place, but implementation is crucial. Some key reforms to monitor are listed below.

Though the demonetization has been disruptive in the short term, it is likely a case of short-term pain for long-term gain. Effective implementation would ultimately reduce the size of the informal sector, reduce corruption and increase the government’s tax base.

The clean-up of bad debt in the banking sector is a crucial performance indicator for RBI Governor Patel. Fitch rates India at “BBB-” with a “stable” outlook, as does S&P Ratings, while Moody’s rates it at an equivalent “Baa3” but had raised the outlook from “stable” to “positive” last year. India’s debt-to-GDP ratio was 67.4% in 2015 and the government estimates stressed assets in the banking industry total USD120bn and resolution has been slow. Any negative shock would be borne by the government, yet PM Modi has vowed to narrow the fiscal deficit to 3.5% in the year ending March 2017, which would be a 9-month low.

Passing the GST bills has met with some difficulty and some details are yet to be decided before full implementation, likely in FY17/18.

Indicators

Current (Previous)* Official cash rate (Repurchase Rate) 6.25% (6.25%) Trend interest rates (10yr average) 6.75% Bias in interest rate market Flat CPI Inflation %Y/Y last (prev) 3.63% (4.31%) Inflation target 5% in March 2017 Budget balance % GDP last (prev) -3.9% (-3.5%) Budget balance trend % GDP -5.15 GDP Growth % y/y last (prev) 7.3% (7.1%) Trend GDP %y/y 6.4 RBC-POLAR misalignment 3.5% Spot end-November 68.4 FX Valuation Overvalued Current account balance % GDP last (prev)

-0.5% (-0.8%)

Trend current account balance % GDP -1.35% Moody's Foreign Currency Rating Baa3 Outlook Positive


Source: RBC Capital Markets, RBI, Bloomberg

1. Short-term rates have caught up with policy rates

2. Rajan stabilised INR & was instrumental in its recovery


Forecasts



USD/INR 71.0 72.0 72.0 73.0 73.0 73.0 73.0 73.0

EUR/INR 72.4 72.0 70.6 70.1 71.5 73.0 74.5 75.9

INR/JPY 1.69 1.64 1.60 1.51 1.44 1.47 1.48 1.49

CAD/INR 53 52 52 53 53 54 54 55

2017 2018

6.0

7.0

8.0

9.0

10.0

11.0

12.0

13.0

Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16

India 1m CP rate

RBI REPO policy rate

80

85

90

95

100

105

110

05 06 07 08 09 10 11 12 13 14 15 16

Rajan comes into office

INR REER



South Korean Won Sue Trinh 1-3 Month Outlook – KRW resilience temporary

KRW has been a middle-of-the-road performer since the end of October (-2% versus USD) which has been surprising since the domestic political scandal has escalated in the past month. MPs have voted to impeach President Park over a corruption scandal and the Constitutional Court must decide whether to uphold the motion in a process that could take up to 180 days. Prime Minister Hwang has assumed all presidential duties on an interim basis. Even the ordinarily stoic finance ministry turned more cautious in expressing concern about further risks to the economy from such “domestic issues”, which could result in weaker consumption and investment at a time when many global uncertainties persist. Political uncertainty is yet another factor to add to the list of reasons we are cautious on KRW, which includes record household debt, the restructuring of zombie companies, weak exports with an uncertain trade outlook and North Korea’s growing nuclear and missile threat.

The political scandal has hit confidence hard with consumer confidence in November falling to the lowest level since April 2009. Fiscal policy paralysis will mean the onus is on the BoK to keep monetary policy accommodative. The BoK has expressed concerns about the financial stability risks of low interest rates – household debt has hit successive highs and was last at KRW1295.8trn in Q3 2016, but the annual growth has slowed and is running around 11.2%y/y and the BoK may point to this as a mitigating factor. Though it stood pat on rates in December, the BoK warned that the downside risks outweigh the upside risks.

6-12 Month Outlook – Room to move lower

We think many of the longer-term issues for KRW remain in play. Korea’s world beating current account surplus of 7.8% of GDP is oft-cited as a bullish KRW factor. However, the surplus is a reflection of weak corporate investment and consumption growth and a lack of structural and fiscal policies to boost those areas. Domestically, there will be no traction for key structural reforms – e.g., of the labour market – ahead of the presidential election on 20 December 2017. We think there is scope for KRW to correct lower since it is relatively expensive to recent years on a real effective basis. Our target for USD/KRW remains 1310 by Q2 2017 (consensus: 1205).

Indicators

Current (Previous)* Official cash rate 1.25% (1.25%) Trend interest rates (10yr average) 3.45% Bias in interest rate market Flat CPI Inflation %Y/Y last (prev) 1.3% (1.3%) Inflation target 2.0% (2016-2018) Budget balance % GDP last (prev) -0.03% (0.86) Budget balance trend % GDP 1.4 GDP Growth % y/y last (prev) 2.6% (2.7%) Trend GDP %y/y 4.1 RBC-POLAR misalignment 2.1% Spot end-November 1177.8 FX Valuation Fairly valued Current account balance % GDP last (prev)

7.25% (7.9%)

Trend current account balance % GDP

3.0%

Moody's Foreign Currency Rating Aa2 Outlook Stable



1. Growth in household borrowing has slowed

2. KRW in overshoot territory

Source: RBC Capital Markets, BIS, Bloomberg

Forecasts



USD/KRW 1270 1310 1290 1280 1290 1300 1310 1320

EUR/KRW 1295 1310 1264 1229 1264 1300 1336 1373

JPY/KRW 10.6 11.1 11.2 11.6 12.3 12.1 12.1 12.1

CAD/KRW 941 949 935 928 942 956 970 992

20182017

0

200

400

600

800

1000

1200

1400

05 07 08 09 10 12 13 14 15

0

2

4

6

8

10

12

14Household debt, KRWtrn, LHS

Rate of change, %y/y

-35%

-25%

-15%

-5%

5%

15%

25%

Feb 95 Feb 00 Feb 05 Feb 10 Feb 15

BIS Broad REER, deviation from LT average, %



Singaporean Dollar Sue Trinh 1-3 Month Outlook – SGD to underperform

SGD has been one of AXJ’s underperformers since the end of October (-2.4% versus USD). Singapore’s exposure to weak global demand was laid bare in the October trade report showing non-oil domestic exports contracted further by 12%y/y from -5%. This is worrisome because Singapore does not have the buffer of strong domestic demand; private consumption represents just 36.8% of GDP, the lowest in the region. The Q3 Manpower report showed total employment contracted by 2.7k following slower growth in the past two quarters. This was the first decline since Q1 2015. The Fed proved much more hawkish than anticipated in December with officials now expecting three hikes in 2017 (from two previously). This is bad news for SGD on a number of fronts. Firstly, Singapore’s growth and inflation has become desynchronized with the US, yet expected changes in the Fed funds rate are typically passed through to Singapore’s benchmark interest rate, SIBOR. This partly reflects Singapore’s status as a wealth management centre and the importance of attracting capital inflows. Overall, we think the MAS would prefer to keep the pace and magnitude of domestic interest rate increases smaller than that in the US given the overhang of domestic debt in Singapore. Second, SGD may be used as a proxy for MYR and IDR shorts due to liquidity constraints and high negative carry in those currencies. MYR and IDR have some of the weakest external positions in Asia and are exposed to a higher USD and US interest rates.

6 – 12 Month Outlook – Rocky road ahead

Weakness in Chinese demand leaves SGD vulnerable. Singapore’s economy has seen a large structural shift in export orientation where it has become more and more dependent on China. China’s share of Singapore’s exports has risen steadily from 3.8% in 1995 to 14% in June 2016. In contrast, the US’s share of Singapore’s exports has fallen from 21.3% to 6.6%. An expansionary fiscal stance (1% of GDP in the year to June) has helped to fill the gap from weak private demand. Despite expansionary fiscal and accommodative monetary settings, economic growth is not expected to pick up next year. We cannot rule out an intermeeting easing via re-centring the S$NEER lower. The precedent of an inter-meeting easing was set in January 2015 when MAS reduced the slope of the policy band.

Indicators

Current (Previous)* Official S$NEER Target Zero percent appreciation Trend interest rates (10yr average) 1.85% Bias in interest rate market Flat CPI Inflation %Y/Y last (prev) -0.1% (-0.2%) Inflation target Price stability (-1.0-0.0%y/y) Budget balance % GDP last (prev) -1.02% (0.7) Budget balance trend % GDP 0.6 GDP Growth % y/y last (prev) 1.1% (2.0%) Trend GDP %y/y 5.4 RBC-POLAR misalignment -1.7% Spot end-November 1.4255 FX Valuation Fairly valued Current account balance % GDP 21.7% (20.7%) Trend c/a balance % GDP 20.1 Moody's Foreign Currency Rating Aaa Outlook Stable


Source: RBC Capital Markets, Manpower

1. Employment contraction

2. SIBOR – in tandem with US rate expectations


Forecasts



USD/SGD 1.50 1.60 1.58 1.56 1.57 1.58 1.59 1.61

EUR/SGD 1.53 1.60 1.55 1.50 1.54 1.58 1.62 1.67

SGD/JPY 80.0 73.8 72.8 70.5 66.9 67.7 67.9 67.7

CAD/SGD 1.11 1.16 1.14 1.13 1.15 1.16 1.18 1.21

20182017

-20

0

20

40

60

80

06 07 08 09 10 11 12 13 14 15 16

Employment change

0

2

4

6

8

10

99 01 03 05 07 09 11 13 15

Fed funds, %

SIBOR, %



Indonesian Rupiah Sue Trinh 1-3 Month Outlook – Consolidation

IDR was a middle-of-the-road performer since the end of October (-2% versus USD).

After cutting its benchmark policy rate by another 25bps in October to 4.75%, BI opted to sit pat in November despite sluggish growth and weak inflation, suggesting BI was more concerned about capital outflows in the wake of the US election and a looming Fed rate hike. Indonesia is vulnerable to funding reversals given its strong reliance on external financing and foreign ownership of IDR-denominated government bonds.

BI said there is sufficient stimulus in the pipeline to support growth, even though it lowered its growth forecast for 2017 and that the policy rate is “appropriate”. One of the factors that may also be giving BI pause is that lending rates have become less responsive to benchmark cuts. Banks are unwilling to pass on policy rate cuts given the steady increase in non-performing loans from 2.49% to 3.22% since the end of 2015.

With liquidity remaining tight in China in the short term and much global uncertainty in the next 1-3 months, we expect BI to prioritise stability over growth and expect USD/IDR to consolidate around 13500/600 in the short term.

6 – 12 Month Outlook – Widodo premium

IDR has had a good 2016. As of mid-December, IDR is the best performing AXJ currency, thanks to policy credibility, in particular, President Widodo’s improved credibility in the past year. But with signs monetary policy may be running into its limit and the budget under pressure (with new Finance Minister Indrawati revising the 2016 deficit projection from 2.35% to 2.5%), we don’t expect a repeat performance for IDR in 2017. A big downside risk is if the tax amnesty fails to draw as many funds as expected.

Domestic demand, particularly private investment, remains a drag on growth. Meanwhile, a further decline in global trade growth will weigh on Indonesian exports. With investment and exports weaker and a likely slowing in government expenditure, the onus will be on BI to maintain an accommodative monetary policy. We think there is scope for USD/IDR to reclaim 2016 highs.

Indicators

Current (Previous)* Official cash rate (7d Reverse repo rate) 4.75% (5.00%) Trend interest rates (10yr average) - Bias in interest rate market Flat CPI Inflation %Y/Y last (prev) 3.58% (3.31%) Inflation target 4%+/-1.0% Budget balance % GDP last (prev) -1.93% (-2.15%) Budget balance trend % GDP -2% GDP Growth % y/y last (prev) 5.02% (5.18%) Trend GDP %y/y 5.5 RBC-POLAR misalignment -0.9% Spot end-November 13,555 FX Valuation Overvalued Current account balance % GDP last (prev)

-2.1% (-2.1%)

Trend current account balance % GDP -2.1% (-2.2%) Moody's Foreign Currency Rating Baa3 Outlook Stable



1. Banks reluctant to pass through cuts to lending rates

2. Rising bank NPL ratio


Forecasts



USD/IDR 14100 14300 14500 14700 14720 14740 14760 14800

EUR/IDR 14382 14300 14210 14112 14426 14740 15055 15392

JPY/IDR 117.5 121.2 126.1 133.6 140.2 137.8 136.7 135.8

CAD/IDR 10444 10362 10507 10652 10745 10838 10933 11128

2017 2018

13.0

13.5

14.0

14.5

15.0

0

2

4

6

8

10

Dec 14 Jun 15 Dec 15 Jun 16

Bank Indonesia Reference Rate, %, LHS

Indonesia Real GDP, %y/y, LHS

Bank Indonesia 7d reverse repo rate, %, LHS

Indonesia Base Lending Rates 30d ma % RHS

2.00

2.50

3.00

3.50

Dec 14 Jun 15 Dec 15 Jun 16

Indonesia Bank NPL, %, LHS



Turkish Lira Daria Parkhomenko 1-3 Month Outlook – TRY weakness is not going away

USD/TRY rallied ~12% since Nov, reaching a record high of 3.59 (2 Dec) as Erdogan called for lower rates. USD/TRY fell below 3.35 in early Dec, but it is now back at ~3.50. In response to the rally and “to contain the adverse impact of exchange rate developments on expectations and the pricing behavior,” CBT hiked its o/n lending and one-week repo rates by 25bp and 50bp on 24 Nov, but this was not sufficient to stem TRY weakness. We believe it will take a much larger hike to reverse this rally, but given the political backdrop, we believe TRY will need to weaken further from current levels for CBT to defy Erdogan. We are in a minority, looking for CBT to remain on hold on 20 Dec (consensus: 25bp hike in o/n lending rate), accelerating TRY weakness. In its latest press release, CBT highlighted that TRY is an “upside risk” to inflation, while growth is a “downside risk.” Given its “cautious stance”, we expect CBT to first monitor how these factors play out before acting. But by H1 2017, we think CBT may be forced to defy Erdogan and hike again as TRY weakness intensifies driven by four factors: (1) Investor sentiment towards Turkey is not improving. Foreign selling of Turkish gov’t debt has not stopped (whereas after the July coup, net inflows supported TRY). (2) Fitch is set to review Turkey by the end of Feb (the current rating is one notch above non-IG with a negative outlook). A downgrade would raise banks’ external funding costs (Oct 2016: banks’ share of ST external debt = 60% or 62% of FX reserves). (3) Political uncertainty is not likely to abate given Erdogan’s bid for executive presidency (referendum likely in the spring). (4) Erdogan is not fully indifferent to TRY weakness as he did encourage locals to convert FX to TRY in early December. It is also not unreasonable to expect CBT to surprise the markets as it did in Jan 2014 – three of the six MPC members from 2014 are still part of the current MPC and Erdogan had also argued against higher rates ahead of the 2014 meeting.

6-12 Month Outlook – USD/TRY at 3.50 in Q2 2017

Weak fundamentals and CBT’s loyalty to simplification are likely to constrain a significant reversal in USD/TRY in 2017. The rising unemployment rate may weigh on domestic demand, while Turkey’s current account deficit and low FX reserves make it vulnerable to external headwinds. However, a potential turnaround in foreign flows and risk appetite may add support to TRY.

Indicators

Current (Previous)*

Official cash rate 8.0 (7.5)

Trend interest rates (10yr average) 6.46

Bias in interest rate market Easing

CPI Inflation %Y/Y Nov (Oct) 7.00 (7.16)

Inflation target 5.00%

Budget balance % 2015 (2014) -1.2 (-1.3)

Budget balance trend % GDP -2.1

GDP Growth % y/y Q3 (Q2) -1.8 (3.1)

Trend GDP %y/y 3.3 4.16 RBC-POLAR misalignment -6.12%

Spot-end (November) 3.44

FX Valuation Undervalued

Current account % GDP 2015 (2014) -4.5 (-5.9)

Trend current account balance % GDP -5.9

Moody's Foreign Currency Rating Ba1

Outlook Stable * Current is latest month, quarter or year

Source: Bloomberg, Turkish Statistical Institute, RBC Capital Markets

1. Foreign net transactions in Turkey’s govt domestic debt

2. Foreign tourist arrivals are still contracting


Forecasts



USD/TRY 3.50 3.50 3.45 3.43 3.40 3.35 3.30 3.25

EUR/TRY 3.57 3.50 3.38 3.29 3.33 3.35 3.37 3.38

TRY/JPY 34.3 33.7 33.3 32.1 30.9 31.9 32.7 33.5

2017 2018

-600

-400

-200

0

200

400

600

Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16

Weekly transactions (USD mn)4-wk. moving avg.

net outflows

net inflows

-50

-40

-30

-20

-10

0

10

20

30

40

Jan-08 Jan-10 Jan-12 Jan-14 Jan-16

Foreign tourist arrivals y/y


http://www.tcmb.gov.tr/wps/wcm/connect/tcmb+en/tcmb+en/main+menu/announcements/press+releases/2016/ano2016-57

http://www.tcmb.gov.tr/wps/wcm/connect/tcmb+en/tcmb+en/main+menu/announcements/press+releases/2016/ano2016-57

http://www.tcmb.gov.tr/wps/wcm/connect/TCMB+EN/TCMB+EN/Main+Menu/Announcements/Press+Releases/2016/ANO2016-57

http://www.tcmb.gov.tr/wps/wcm/connect/TCMB+EN/TCMB+EN/Main+Menu/Announcements/Press+Releases/2016/ANO2016-57


Czech Koruna Daria Parkhomenko 1-3 Month Outlook – Exit floor in Q3 2017

We are changing our view for CNB’s exit of the EUR/CZK floor from Q2 2017 to Q3 2017 (consensus). We expect CNB to remain cautious to avoid a premature exit. CNB has reiterated in the past five meetings that it is “likely that the commitment will be discontinued in mid-2017” and stressed the importance of a “sustainable fulfilment of the target” to exit the floor. CNB’s current forecast assumes the target of 2.0% y/y will be reached in Q3 2017 (previously Q2 2017). It is true inflation has risen since CNB published its forecast in Nov. CPI y/y was above consensus for the past two months and in Nov it was within CNB’s inflation range (1%-3%) for the first time since Jan 2014. CNB also cited that the Nov figure poses “an inflationary risk" to its forecast. However, one reading is not enough to show a “sustainable fulfilment of the target” and the Nov figure was primarily driven by food prices. The counterargument to this may be that HICP service & core inflation y/y have also risen, but inflation expectations paint a different picture. Financial analysts and Bloomberg consensus expect inflation to reach 2.0% y/y in Nov 2017 and Q3 2017, while non-financials expect 1.3% by Sep 2017. Given the above, it is not yet clear how sustainable the rise in inflation will be going forward. Thus, it will be key to monitor whether or not CNB still considers the risks to be “balanced” before its next Inflation Report on 9 Feb because the Nov inflation figure was released after CNB’s meeting/forecasts in Nov. If CNB determines the risks are inflationary/anti-inflationary, we expect CNB to provide guidance as to when the alternate exit would occur if that risk were to materialize before changing its base-case exit (mid-2017). In terms of sustainability of the floor, CNB has room to build FX reserves. CNB’s FX reserves stand at 37% of GDP and rose by 22pp since it set the floor. In contrast, SNB’s FX reserves stood at 83% of GDP when it pulled the peg and rose by 40pp. CNB’s FX purchases increased in Oct (EUR4.0bn) and Sep (EUR3.5bn), but they were about half of its purchases in Nov 2013 when it set the floor. Even if CNB continues to intervene at a pace of EUR4.0bn/month, FX reserves will only reach 51% GDP and 57% GDP by end of June and Sep, so outright reserve holdings are unlikely to be a constraint on policy.

6-12 Month Outlook – EUR/CZK between 25.5 & 26.0 Although we expect CNB to guide the market towards its exit, the immediate reaction will likely still cause EUR/CZK to break through 25.50 and then settle between 25.5 and 26.0 with CNB ready to intervene to weaken the koruna.

Indicators

Current (Previous)*

Official cash rate 0.05 (0.05)

Trend interest rates (10yr average) 1.22

Bias in interest rate market Neutral

CPI Inflation %Y/Y Nov (Oct) 1.5 (0.8)

Inflation target 1%-3%

Budget balance % 2015 (2014) -0.6 (-1.9)

Budget balance trend % GDP -2.54

GDP Growth % y/y GDP Q3 P (Q2) 1.9 (2.6)

Trend GDP %y/y 2.1 4.16 RBC-POLAR misalignment 0.60%

Spot-end (EUR/CZK, November) 27.05

FX Valuation Neutral

Current account balance % GDP 2015 (2014) 0.89 (0.18)

Trend current account balance % GDP -1.75

Moody's Foreign Currency Rating A1

Outlook Stable * Current is latest month, quarter or year

Source: RBC Capital Markets, Bloomberg, Czech National Bank

1. CNB’s latest forecast revised slightly lower on 10 Nov

2. CNB’s FX purchases (EUR bn)

Source: RBC Capital Markets, Czech National Bank

Forecasts



EUR/CZK 27.0 27.0 25.7 25.7 25.7 25.7 25.7 25.7

USD/CZK 26.5 27.0 26.2 26.8 26.2 25.7 25.2 24.7

PLN/CZK 6.14 6.21 5.98 6.02 6.05 6.08 6.12 6.12

2017 2018

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Jun-18

Actual headline inflation (% y/y)

III-2016

IV-2016

I-2016

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16

FX purchases (in EUR bn)


https://www.cnb.cz/en/monetary_policy/bank_board_minutes/2016/161103_prohlaseni.html

https://www.cnb.cz/miranda2/export/sites/www.cnb.cz/en/monetary_policy/inflation_reports/2016/2016_IV/download/ir_IV_2016.pdf

http://www.cnb.cz/en/public/media_service/comments/2016/16_11_inflace.html

http://www.cnb.cz/miranda2/export/sites/www.cnb.cz/en/financial_markets/inflation_expectations_ft/inflation_expectations_ft_2016/A_inflocek_11_2016.pdf


Mexican Peso 1 – 3 Month Outlook – Uncertainty remains

In the week after the US election, USD/MXN hit an all-time high of 21.3897. It has since recovered somewhat but remains the second worst-performing currency YTD, only behind ARS. This is despite markets pricing in a faster pace of central bank hikes (2yr swaps are up 110 bps since the US election and Banxico followed the Fed’s Dec hike with +50bps). Q1 2017 will be characterized by the uncertainty around Trump’s agenda, as his gov’t starts unveiling details on which campaign pledges will actually be implemented. Currently, we think markets are underpriced for his protectionist agenda. One reform that could find its way through the new US Congress, for example, is the initiative by Sen. Paul Ryan to turn corporate tax into a destination-based cash flow tax, exempting export-generated income from taxation but banning the deduction of imported inputs declared as costs. That would be particularly detrimental for Mexican exporters and doesn’t seem to be on the radar of many market participants. Additionally, even if the potential deterioration of Mexico’s current account due to a contraction of exports and remittances is still unclear, negative prospects could affect capital investment, employment and foreign direct investment in the short term. Though MXN has sold off sharply this year, we see it revisiting 20.75 by the end of Q1 17.

6-12 Month Outlook – MXN on a weakening trend Uncertainty on US policy is not the only thing weighing on MXN. Mexico’s economic fundamentals were already challenging before the election. Leading indicators are deteriorating, oil production is expected to decrease by 9% y/y (by Pemex estimates), gov’t expenditure could fall by more than 1% of GDP and there is potential for further portfolio outflows as rates rise in major economies. We think these factors will offset the spillovers of an uptick in US growth. We expect Banxico will continue to hike to ensure that inflation expectations stay anchored and that MXN adjusts smoothly as it absorbs current account shocks. We look for USD/MXN to trend higher to 20.95 by the end of Q2 2017 and 21.45 at year-end 2017. Oil prices are the one bright spot at the moment and could give the gov’t some space to make up for a contraction in revenues if growth is weaker than the Ministry of Finance predicts. However, with local and federal elections in 2017 and 2018, reaching the fiscal goals (0.4% primary surplus in 2017) will still be a complicated task.

Indicators

Current (Previous)* Official cash rate 5.75 (5.25) Trend interest rates (10yr average) 4.56 Bias in interest rate market Hiking CPI Inflation %Y/Y Nov (Oct) 3.31 (3.06) Inflation target 3.0 (+/-1%) Budget balance % GDP 3Q (2Q) -2.36 (-2.15) Budget balance trend % GDP -3.14 GDP Growth % y/y 3Q (2Q) 2.0 (2.6) Trend GDP %y/y 2.41 Purchasing Power Parity 17 Spot 20.5743 FX Valuation Undervalued Current account balance % GDP Q3 (Q2) -3.21 (-3.15) Trend current account balance % GDP -2.54 Moody's Foreign Currency Rating A3 Outlook Negative



1. MXN was hit hard by US election

2. Activity indicators deteriorate and inflation accelerates


Forecasts



USD/MXN 20.75 20.95 21.15 21.45 21.50 21.20 20.90 20.50

EUR/MXN 21.17 20.95 20.73 20.59 21.07 21.20 21.32 21.32

MXN/JPY 5.78 5.63 5.44 5.13 4.88 5.05 5.17 5.32

CAD/MXN 15.37 15.18 15.33 15.54 15.69 15.59 15.48 15.41

20182017

US Election

80.00

90.00

100.00

110.00

120.00

130.00

Jan 16 Mar 16 May 16 Jul 16 Sep 16 Nov 16

MXN BRL CLP CAD EUR JPY

Index Jan 16=100

US Election

85

90

95

100

105

110

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16

Inflation y/y %

Reference Rate, %

Consumer Confidence index Jan 14=100 (RHS)



Brazilian Real 1 – 3 Month Outlook – Politics driving BRL

Domestic politics and the path of fiscal consolidation will remain the drivers of Brazilian assets in the next couple of months. President Temer has so far been effective in negotiating a real expenditure cap, which was approved without major modifications by Congress. The next step is social security reform, which is likely to cause more problems as it affects household budgets directly. We think that the pension reform will also be approved, but Temer’s political capital will be eroded, making further reforms increasingly difficult. Both external and internal factors have put pressure on Brazilian assets but the deterioration of the CDS and BRL is not yet enough to prevent the continuation of the monetary easing cycle. More important for the Monetary Policy Committee in the short term is the recent pause in the disinflation trend of IPCA components that are more sensitive to economic activity (services). The recent fall in inflation has been explained mainly by the contraction in food prices, which escalated in 2015 and most of 2016, due to supply shocks from extreme weather conditions. It is probable, however, that going forward labour market slack and weaker-than-expected growth will prompt a more widespread disinflation dynamic. The central bank cut 25bps points in its two last meetings (19 Oct and 30 Nov, from 14.25% to 13.75%). The swap curve is pricing another 25 bps cut in January but an increasing number of economists are now expecting cuts of 50 bps, due to the steep deterioration of activity indicators. We see the BCB keeping its pace of cuts at 25 bps in Jan, as services inflation and fiscal reforms will still be a source of uncertainty in Q1 2017. Our end-Q1 target is 3.40.

6-12 Month Outlook – Idiosyncratic risks dominate

Looking ahead, Brazil will not be immune to higher rates in the US and the broad strengthening of USD. However, the bulk of the risks will be idiosyncratic in nature and mainly related to domestic politics. Also, we think Brazil’s terms of trade will benefit from the correction in commodity prices, which are expected to increase in 2017 on the basis of a more balanced oil market, improving economic conditions globally and fiscal expansion in some countries, such as the US. The latter should make up for some of the outflows coming from higher rates in the G10 economies. We see the currency at 3.52 at the end of 2017, slightly outperforming MXN throughout the year.

Indicators

Current (Previous)* Official cash rate 13.75 (14.00) Trend interest rates (10yr average) 11.55 Bias in interest rate market Cutting CPI Inflation %Y/Y Nov (Oct) 6.99 (7.87) Inflation target 4.5% +/-2.0% Budget balance % GDP 3Q (2Q) -9.57 (-10.08) Budget balance trend % GDP -7.53 GDP Growth % y/y 3Q (2Q) -2.9 (-3.6) Trend GDP %y/y -2.8 Purchasing Power Parity 3.35 Spot 3.3857 FX Valuation Undervalued Current account balance % GDP 3Q (2Q) -1.4 (-1.81) Trend current account balance % GDP -3.29 Moody's Foreign Currency Rating Ba2 Outlook Negative



1. Brazilian assets still pricing a favourable risk environment

2. Services inflation has stagnated


Forecasts



USD/BRL 3.40 3.43 3.47 3.52 3.51 3.55 3.55 3.58

EUR/BRL 3.47 3.43 3.40 3.38 3.44 3.55 3.62 3.72

BRL/JPY 35.3 34.4 33.1 31.3 29.9 30.1 30.4 30.4

CAD/BRL 2.52 2.49 2.51 2.55 2.56 2.61 2.63 2.69

20182017

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0

100

200

300

400

500

600

Oct 12 Jun 13 Feb 14 Oct 14 Jun 15 Feb 16 Oct 16

Brazil Govt 5Y CDS (LHS)

BRL (RHS)

2.5

5.5

8.5

11.5

14.5

Jan 11 Nov 11 Sep 12 Jul 13 May 14 Mar 15 Jan 16 Nov 16

IPCA y/y % Services y/y % Food y/y %



Forecasts Spot forecasts



EUR/USD 1.02 1.00 0.98 0.96 0.98 1.00 1.02 1.04

USD/JPY 120 118 115 110 105 107 108 109

GBP/USD 1.15 1.15 1.16 1.16 1.18 1.20 1.23 1.25

USD/CHF 1.05 1.06 1.09 1.13 1.12 1.11 1.09 1.08

USD/SEK 9.80 9.70 9.59 9.48 8.98 8.70 8.53 8.37

USD/NOK 8.73 8.80 8.88 8.96 8.67 8.40 8.24 8.08

USD/CAD 1.35 1.38 1.38 1.38 1.37 1.36 1.35 1.33

AUD/USD 0.74 0.74 0.73 0.72 0.72 0.72 0.73 0.73

NZD/USD 0.71 0.72 0.73 0.74 0.74 0.74 0.75 0.75

USD/CNY 7.00 7.20 7.40 7.50 7.60 7.70 7.70 7.75

USD/CNH 7.03 7.23 7.43 7.53 7.63 7.73 7.73 7.78

USD/HKD 7.75 7.75 7.75 7.75 7.80 7.80 7.80 7.85

USD/INR 71.0 72.0 72.0 73.0 73.0 73.0 73.0 73.0

USD/KRW 1270 1310 1290 1280 1290 1300 1310 1320

USD/SGD 1.50 1.60 1.58 1.56 1.57 1.58 1.59 1.61

USD/MYR 4.50 4.60 4.70 4.70 4.72 4.74 4.76 4.80

USD/IDR 14100 14300 14500 14700 14720 14740 14760 14800

USD/TWD 37.2 37.4 37.6 37.8 37.8 37.8 37.8 37.8

USD/THB 40.0 40.3 40.6 41.0 41.2 41.4 41.7 42.0

USD/PHP 49.4 49.3 49.2 49.0 49.3 49.6 49.8 50.0

USD/TRY 3.50 3.50 3.45 3.43 3.40 3.35 3.30 3.25

USD/PLN 4.31 4.35 4.39 4.45 4.34 4.23 4.12 4.04

USD/HUF 308 312 316 321 313 306 299 293

USD/CZK 26.5 27.0 26.2 26.8 26.2 25.7 25.2 24.7

USD/MXN 20.75 20.95 21.15 21.45 21.50 21.20 20.90 20.50

USD/BRL 3.40 3.43 3.47 3.52 3.51 3.55 3.55 3.58

2017 2018



EUR Crosses



EUR/USD 1.02 1.00 0.98 0.96 0.98 1.00 1.02 1.04

EUR/JPY 122 118 113 106 103 107 110 113

EUR/GBP 0.89 0.87 0.85 0.83 0.83 0.83 0.83 0.83

EUR/CHF 1.07 1.06 1.07 1.08 1.10 1.11 1.11 1.12

EUR/SEK 10.00 9.70 9.40 9.10 8.80 8.70 8.70 8.70

EUR/NOK 8.90 8.80 8.70 8.60 8.50 8.40 8.40 8.40

EUR/CAD 1.38 1.38 1.35 1.32 1.34 1.36 1.38 1.38

EUR/AUD 1.38 1.35 1.34 1.33 1.36 1.39 1.40 1.42

EUR/NZD 1.44 1.39 1.34 1.30 1.32 1.35 1.36 1.39

EUR/CNY 7.14 7.20 7.25 7.20 7.45 7.70 7.85 8.06

EUR/CNH 7.26 7.17 7.23 7.28 7.23 7.48 7.73 7.88

EUR/HKD 7.91 7.75 7.60 7.44 7.64 7.80 7.96 8.16

EUR/INR 72 72 71 70 72 73 74 76

EUR/KRW 1295 1310 1264 1229 1264 1300 1336 1373

EUR/SGD 1.53 1.60 1.55 1.50 1.54 1.58 1.62 1.67

EUR/MYR 4.59 4.60 4.61 4.51 4.63 4.74 4.86 4.99

EUR/IDR 14382 14300 14210 14112 14426 14740 15055 15392

EUR/TWD 38 37 37 36 37 38 39 39

EUR/THB 40.8 40.3 39.8 39.4 40.4 41.4 42.5 43.7

EUR/PHP 50.4 49.3 48.2 47.0 48.3 49.6 50.8 52.0

EUR/TRY 3.57 3.50 3.38 3.29 3.33 3.35 3.37 3.38

EUR/PLN 4.40 4.35 4.30 4.27 4.25 4.23 4.20 4.20

EUR/HUF 314 312 310 308 307 306 305 305

EUR/CZK 27.0 27.0 25.7 25.7 25.7 25.7 25.7 25.7

EUR/MXN 21.2 21.0 20.7 20.6 21.1 21.2 21.3 21.3

EUR/BRL 3.47 3.43 3.40 3.38 3.44 3.55 3.62 3.72

2017 2018



Required disclosures

Conflicts disclosuresThe analyst(s) responsible for preparing this research report received compensation that is based upon various factors,including total revenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or havebeen generated by investment banking activities of the member companies of RBC Capital Markets and its affiliates.

Conflicts policyRBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request.To access our current policy, clients should refer tohttps://www.rbccm.com/global/file-414164.pdfor send a request to RBC Capital Markets Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, SouthTower, Toronto, Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time.

Dissemination of research and short-term trade ideasRBC Capital Markets endeavors to make all reasonable efforts to provide research simultaneously to all eligible clients, havingregard to local time zones in overseas jurisdictions. RBC Capital Markets' equity research is posted to our proprietary website toensure eligible clients receive coverage initiations and changes in ratings, targets and opinions in a timely manner. Additionaldistribution may be done by the sales personnel via email, fax, or other electronic means, or regular mail. Clients may alsoreceive our research via third party vendors. RBC Capital Markets also provides eligible clients with access to SPARC on theFirms proprietary INSIGHT website, via email and via third-party vendors. SPARC contains market color and commentaryregarding subject companies on which the Firm currently provides equity research coverage. Research Analysts may, fromtime to time, include short-term trade ideas in research reports and / or in SPARC. A short-term trade idea offers a short-termview on how a security may trade, based on market and trading events, and the resulting trading opportunity that may beavailable. A short-term trade idea may differ from the price targets and recommendations in our published research reportsreflecting the research analyst's views of the longer-term (one year) prospects of the subject company, as a result of thediffering time horizons, methodologies and/or other factors. Thus, it is possible that a subject company's common equity that isconsidered a long-term 'Sector Perform' or even an 'Underperform' might present a short-term buying opportunity as a resultof temporary selling pressure in the market; conversely, a subject company's common equity rated a long-term 'Outperform'could be considered susceptible to a short-term downward price correction. Short-term trade ideas are not ratings, nor arethey part of any ratings system, and the firm generally does not intend, nor undertakes any obligation, to maintain or updateshort-term trade ideas. Short-term trade ideas may not be suitable for all investors and have not been tailored to individualinvestor circumstances and objectives, and investors should make their own independent decisions regarding any securities orstrategies discussed herein. Please contact your investment advisor or institutional salesperson for more information regardingRBC Capital Markets' research.For a list of all recommendations on the company that were disseminated during the prior 12-month period, please click onthe following link: https://rbcnew.bluematrix.com/sellside/MAR.actionThe 12 month history of SPARCs can be viewed at https://www.rbcinsight.com/CM/Login.

Analyst certificationAll of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all ofthe subject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directlyor indirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report.

Third-party-disclaimersReferences herein to “LIBOR”, “LIBO Rate”, “L” or other LIBOR abbreviations means the London interbank offered rate as administered by ICE Benchmark Administration (or anyother person that takes over the administration of such rate).

Disclaimer

RBC Capital Markets is the business name used by certain branches and subsidiaries of the Royal Bank of Canada, including RBC Dominion Securities Inc., RBCCapital Markets, LLC, RBC Europe Limited, Royal Bank of Canada, Hong Kong Branch and Royal Bank of Canada, Sydney Branch. The information contained inthis report has been compiled by RBC Capital Markets from sources believed to be reliable, but no representation or warranty, express or implied, is madeby Royal Bank of Canada, RBC Capital Markets, its affiliates or any other person as to its accuracy, completeness or correctness. All opinions and estimatescontained in this report constitute RBC Capital Markets' judgement as of the date of this report, are subject to change without notice and are provided ingood faith but without legal responsibility. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice. Thismaterial is prepared for general circulation to clients and has been prepared without regard to the individual financial circumstances and objectives of personswho receive it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independentinvestment advisor if you are in doubt about the suitability of such investments or services. This report is not an offer to sell or a solicitation of an offerto buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.


https://rbcnew.bluematrix.com/sellside/MAR.action

https://www.rbcinsight.com/CM/Login


RBC Capital Markets research analyst compensation is based in part on the overall profitability of RBC Capital Markets, which includes profits attributableto investment banking revenues. Every province in Canada, state in the U.S., and most countries throughout the world have their own laws regulating thetypes of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, the securitiesdiscussed in this report may not be eligible for sale in some jurisdictions. RBC Capital Markets may be restricted from publishing research reports, from timeto time, due to regulatory restrictions and/ or internal compliance policies. If this is the case, the latest published research reports available to clients maynot reflect recent material changes in the applicable industry and/or applicable subject companies. RBC Capital Markets research reports are current only asof the date set forth on the research reports. This report is not, and under no circumstances should be construed as, a solicitation to act as securities brokeror dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction.To the full extent permitted by law neither RBC Capital Markets nor any of its affiliates, nor any other person, accepts any liability whatsoever for any director consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced orcopied by any means without the prior consent of RBC Capital Markets.

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To U.S. Residents:This publication has been approved by RBC Capital Markets, LLC (member FINRA, NYSE, SIPC), which is a U.S. registered broker-dealer and which acceptsresponsibility for this report and its dissemination in the United States. Any U.S. recipient of this report that is not a registered broker-dealer or a bank actingin a broker or dealer capacity and that wishes further information regarding, or to effect any transaction in, any of the securities discussed in this report,should contact and place orders with RBC Capital Markets, LLC.To Canadian Residents:This publication has been approved by RBC Dominion Securities Inc.(member IIROC). Any Canadian recipient of this report that is not a Designated Institutionin Ontario, an Accredited Investor in British Columbia or Alberta or a Sophisticated Purchaser in Quebec (or similar permitted purchaser in any other province)and that wishes further information regarding, or to effect any transaction in, any of the securities discussed in this report should contact and place orderswith RBC Dominion Securities Inc., which, without in any way limiting the foregoing, accepts responsibility for this report and its dissemination in Canada.To U.K. Residents:This publication has been approved by RBC Europe Limited ('RBCEL') which is authorized by the Prudential Regulation Authority and regulated by the FinancialConduct Authority ('FCA') and the Prudential Regulation Authority, in connection with its distribution in the United Kingdom. This material is not for generaldistribution in the United Kingdom to retail clients, as defined under the rules of the FCA. However, targeted distribution may be made to selected retailclients of RBC and its affiliates. RBCEL accepts responsibility for this report and its dissemination in the United Kingdom.To German Residents:This material is distributed in Germany by RBC Europe Limited, Frankfurt Branch which is regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht(BaFin).To Persons Receiving This Advice in Australia:This material has been distributed in Australia by Royal Bank of Canada - Sydney Branch (ABN 86 076 940 880, AFSL No. 246521). This material has beenprepared for general circulation and does not take into account the objectives, financial situation or needs of any recipient. Accordingly, any recipient should,before acting on this material, consider the appropriateness of this material having regard to their objectives, financial situation and needs. If this materialrelates to the acquisition or possible acquisition of a particular financial product, a recipient in Australia should obtain any relevant disclosure documentprepared in respect of that product and consider that document before making any decision about whether to acquire the product. This research report isnot for retail investors as defined in section 761G of the Corporations Act.To Hong Kong Residents:This publication is distributed in Hong Kong by Royal Bank of Canada, Hong Kong Branch, which is regulated by the Hong Kong Monetary Authority andthe Securities and Futures Commission ('SFC'), RBC Investment Services (Asia) Limited and RBC Investment Management (Asia) Limited, both entities areregulated by the SFC. Financial Services provided to Australia: Financial services may be provided in Australia in accordance with applicable law. Financialservices provided by the Royal Bank of Canada, Hong Kong Branch are provided pursuant to the Royal Bank of Canada's Australian Financial Services Licence('AFSL') (No. 246521.)To Singapore Residents:This publication is distributed in Singapore by the Royal Bank of Canada, Singapore Branch, a registered entity granted offshore bank licence by the MonetaryAuthority of Singapore. This material has been prepared for general circulation and does not take into account the objectives, financial situation, or needs ofany recipient. You are advised to seek independent advice from a financial adviser before purchasing any product. If you do not obtain independent advice,you should consider whether the product is suitable for you. Past performance is not indicative of future performance. If you have any questions related tothis publication, please contact the Royal Bank of Canada, Singapore Branch. Royal Bank of Canada, Singapore Branch accepts responsibility for this reportand its dissemination in Singapore.To Japanese Residents:Unless otherwise exempted by Japanese law, this publication is distributed in Japan by or through RBC Capital Markets (Japan) Ltd. which is a FinancialInstruments Firm registered with the Kanto Local Financial Bureau (Registered number 203) and a member of the Japan Securities Dealers Association ("JSDA").

.® Registered trademark of Royal Bank of Canada. RBC Capital Markets is a trademark of Royal Bank of Canada. Used under license.Copyright © RBC Capital Markets, LLC 2016 - Member SIPC

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Fixed Income & Currency Strategy Research Team

Europe

RBC Europe Limited: Adam Cole Head of G10 FX Strategy +44‐20‐7029‐7078 [email protected] Vatsala Datta UK Rates Strategist +44 20‐7029‐0184 [email protected] Sam Hill, CFA Senior UK Economist +44‐20‐7029‐0092 [email protected] Cathal Kennedy European Economist +44(0)20 7029 0133 [email protected] Peter Schaffrik Global Macro Strategist +44‐20‐7029‐7076 [email protected]

Asia-Pacific

Royal Bank of Canada – Sydney Branch: Su‐Lin Ong Head of Australian and New Zealand FIC Strategy +612‐9033‐3088 su‐[email protected] Michael Turner Fixed Income & Currency Strategist +612‐9033‐3088 [email protected]

Royal Bank of Canada – Hong Kong Branch: Sue Trinh Senior Currency Strategist +852‐2848‐5135 [email protected]

North America

RBC Dominion Securities Inc.: Mark Chandler Head of Canadian FIC Strategy (416) 842‐6388 [email protected] George Davis Chief FIC Technical Analyst (416) 842‐6633 [email protected] Simon Deeley Fixed Income Strategist (416) 842‐6362 [email protected]

RBC Capital Markets, LLC: Michael Cloherty Head of US Rates Strategy (212) 437‐2480 [email protected] Elsa Lignos Senior Currency Strategist (212) 428‐6492 [email protected] Jacob Oubina Senior US Economist (212) 618‐7795 [email protected] Tom Porcelli Chief US Economist (212) 618‐7788 [email protected] Daria Parkhomenko Associate (212) 618‐7857 [email protected]

Commodities Strategy Research Team

North America

RBC Capital Markets, LLC: Helima Croft Global Head of Commodity Strategy (212) 618‐7798 [email protected] Christopher Louney Commodity Strategist (212) 437‐1925 [email protected] Michael Tran Commodity Strategist (212) 266‐4020 [email protected]

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