GLOBAL ECONOMICS UNIT

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1 NOVEMBER/DECEMBER 2007 C O N T E N T S Forecast Summary... 2 Currencies Strategy... 3 East Asia The Subcontinent...6 The Americas..7 Europe/Africa The dollar should drop further against the euro over the next few weeks but we still expect a USD rally in Credit market stresses will probably continue into next year, oil prices should stay high, and weaker household spending is likely to pull US Q4 GDP growth down sharply - to the 0-2% range. Momentum also looks set to remain heavily against the USD near term and Gulf countries de-pegging from the dollar soon now looks more likely than not. But although the threat of a US recession has climbed we would still rate the risk of a US recession soon as less than a 50% probability and expect US GDP growth to eventually recover in We see the USD rallying next year against European currencies but expect more USD weakness against Asian currencies apart from the JPY. The Fed will probably cut rates another 25bps in mid-december but fixed income markets look too aggressive in their current expectations of how much lower US rates will fall. The Fed is generally less pessimistic on the economic outlook than the markets, which rate the chance of a December rate cut as a near-100% certainty, and see Fed Funds rate falling to 3.75% by mid-2008 (from 4.5% now). Nevertheless, in the end, the Fed will act to help keep the economy out of recession and core inflation should stay low enough for the Fed to cut several more times if needed. We expect the yen to weaken again in 2008 as the global equities bull-market resumes and risk appetite improves. But over the next few weeks the yen is likely to strengthen further - uncertainty over the issues that have pulled equities weaker since early November (on the credit crunch, oil prices, the severity of the US consumer pullback) is unlikely to clear up soon. In the end, though, we expect that the current worst case scenarios dominating market sentiment will not happen. Carry trades should work again in 2008 for a while. Near term on the mature high yield side we would target the AUD, on the exotics side we would target the TRY, IDR, INR, PHP, BRL and the ZAR. The appreciation of the Chinese renminbi should accelerate in our new target is 8% pa after 2007 s likely 6% gain. This Currencies report appears every 2 month and is distributed by . Also published by is Economics for Investment - Weekly. The hard copy Economics for Investment is printed and distributed every two months. Please ask your Relationship Manager if you would like to receive them. All of the Economics for Investment publications can now be accessed on You should always remember that the value of investments will fluctuate and you may get back less than you invested. Unless specified, the source of all information is from American Express Bank Ltd. This information has been prepared based on the opinions of the AEB Global Economics Unit. Such opinions are supported by statistical data and fundamental research. This material is for your information only and is not an offer to buy or sell securities, currencies or other investments. This information is not intended to be used as the primary basis for investment decisions, nor should it be construed as advice designed to meet the particular needs of an individual investor. This is a one time evaluation based on current market conditions and is subject to change. No part of this document may be reproduced in any manner without the written permission of American Express Bank Ltd. GLOBAL ECONOMICS UNIT John Calverley Kevin Grice Sarah Hewin Distribution: aeb.economics@aexp.com American Express Bank Ltd. (the Bank ) (No. FC1863, BR301). Incorporated with limited liability in the State of Connecticut, USA with its head office in New York, USA. The Bank is authorised and regulated by The Financial Services Authority, 25 The North Colonnade, Canary Wharf, London E14 5HS. This material may not be distributed or made available in the United States to U.S. citizens or residents or in any jurisdiction restricted by local law or regulations.

2 Economics for Investment Currencies Spot per US$ 21/11/07 CURRENCY FORECAST SUMMARY 3 month forecast per US$ % Change* 3 month interest rate, % Implied return, 3 months, %** Large devaluation risk, %*** 12 month forecast per US$ % Change* EAST ASIA Japanese Yen/US$ Japanese Yen/Euro Australian Dollar Chinese Renminbi Hong Kong Dollar Indonesia Rupiah Korean Won Korean Won/JPY New Zealand Dollar Australian Dollar/NZD Philippine Peso Singapore Dollar Taiwan Dollar Thai Baht THE SUBCONTINENT Indian Rupee THE AMERICAS Canadian Dollar Argentine Peso Brazilian Real Mexican Peso EUROPE/MIDDLE EAST/AFRICA Euro UK Pound/US$ UK Pound/Euro Swiss Franc/US$ Swiss Franc/Euro Hungarian Forint Hungarian Forint/Euro Polish Zloty Polish Zloty/Euro Russian Rouble Turkish Lira Turkish Lira/Euro South African Rand South African Rand/Euro * -ve = depreciation, +ve = appreciation, ** return on USD investment in currency over 3 months, *** defined as a 10% or more devaluation against the US$ over three months. American Express Bank Ltd. 2 EFI Currencies Nov 2007

3 FROM GFM A TECHNICAL ANALYSIS VIEW JAPANESE YEN We expect the yen to depreciate again in 2008 but, right now, look for the USD to remain under pressure. The Y106/105 zone should be a staging post bottom fish there if reached? 125 USD/JPY The gyrations in the Japanese yen this year have been linked to the funding of other trades and general perceptions of liquidity constraints which to many traders links the yen to global equity markets (the correlation has been good, see chart). The widespread use of the yen for funding carry trades has been called into question again and again over the last few years, with the death of the carry trade written more than a few times by many pundits. Of note is that the CFTC futures data is finally turning around and is showing net long positions by non-commercials. Therefore, is this finally the end of the carry trade? Source: DATASTREAM/G3H8 YEN: MOVES IN LINE WITH GLOBAL EQUITIES Global equities - MSCI index (rhs) USD/JPY We would say, probably not (hedged answer, or what!!). On the domestic front, the JPY is expected to mark time in a wide range. The Bank of Japan is not in a hurry to raise rates even though economic growth data is finally picking up again, because inflation readings are not actually alarming enough to force the BoJ s hand. The proverbial Japanese housewife is probably still a long term factor in this market, while hedge funds and traditional currency funds will be loathe to get long of the yen below Y110. True, the USD side of the story has been under pressure for some time now. With the Fed seen as keen to keep the housing slump from spreading, the risk has to be on them cutting interest rates even further. But Fed Chairman Bernanke and his colleagues in recent weeks do seem to be trying to reduce market expectations of aggressive further rate cuts, and this may offer the USD some support at some stage. Trading strategy? The current bout of yen strength does seem to have room to run on further. Technically, a breakdown through Y109 would leave Y105.60/105 to aim for, with Y offering strong support below this level. After the USD tumble? We still favor long term USD buying ahead of Y104.40, which, given forward points of around 675 or so, would put the 2yr. fwd closer to Y98. Bargain basement levels? As long as spot doesn t break much below Y105, then the technical USD basing view will remain intact for Y112 to be regained, then to Y118. Still leaning to Y120/122 again, but this may be a Q2/Q target area rather than any sooner Sourc e: DATASTREAM/G3H9 260 AEB Global Financial Markets Analysis from: Gerry Celaya, Redtower Research American Express Bank Ltd. 3 EFI Currencies Nov 2007

4 EAST ASIA CURRENCIES JAPANESE YEN Spot Month Forecast Source: 07 Datastream We expect renewed yen weakness in 2008 as the global equities upswing likely resumes, risk appetite improves and carry trades become popular again for a time, even though JPY volatility will probably stay higher than before the credit crunch. Japanese retail investors are also likely to short the yen again and should retain a strong appetite for foreign bonds. Exports will probably slow but Japan s economic upswing should continue as the current housing slump fades and household spending holds up despite weak wage gains. Nevertheless, GDP growth now looks set to stay weak, keeping inflation virtually non-existent, and rates very low. The next BOJ hike will probably be delayed to Q Large devaluation risk*: 10% AUSTRALIAN DOLLAR Spot Month Forecast 0.94 The AUD has rallied as expected, and the rally should continue as carry trades resume. Australia s economy will likely keep performing well. House prices are rising strongly and the labour market should stay very tight. Wages growth slowed in Q3 (to 1.0% quarter-onquarter) but should pick up soon. The RBA expects that underlying inflation (excluding volatile items) will rise above the 1-3% pa target range by end 2007 and will stay above target to mid Another rate hike looks only a matter of time. Rates rose to 6.75% in early November and the RBA will probably wait until early February - after Q4 inflation data is published - before hiking another 25bps. But the risk is that rates move up in December. Large devaluation risk*: 10% CHINESE RENMINBI Spot Month Forecast China s economy remains very buoyant, with real GDP climbing 11.5% pa in January-September on continued strong investment and exports. Inflation has risen to over 6% pa, and policymakers are worried about overheating. Bank reserve requirements, now at a record 13.5%, will move higher, and more interest rates hikes are likely as well. But the PBOC looks set to pause on rates for a time after 5 rate hikes so far this year. China will not revalue to order but accelerated CNY appreciation against the USD is likely - we expect an 8% gain in 2008 after 2007 s probable 6% pa gain. Faster appreciation will help to rebalance economic growth toward household spending and will ease inflation pressures. Large devaluation risk*: 5% HONG KONG DOLLAR Spot Month Forecast 7.78 *defined as a 10% or more devaluation against the USD in 3 months Strong capital inflows have pushed the HKD to the top of its USDpeg band, triggering central bank intervention, and the HKD will likely stay close to the strong end of the band for a sustained period of time. The HK economy should continue to perform well but the global slowdown points to GDP growth likely slowing a little in our forecast is to around 5% pa, down from Q GDP growth of 6.2% pa. The gain in consumer prices (1.6% pa in September) is likely to be at the top end of the government s forecast range by end-2007 but inflation probably will not become serious enough anytime soon to threaten the HKD peg. Eventually the HKD is likely to re-peg to the CNY but only once the renminbi is fully convertible - a prospect that remains several years away. Large devaluation risk*: 5% American Express Bank Ltd. 4 EFI Currencies Nov 2007

5 EAST ASIA CURRENCIES INDONESIA RUPIAH Spot Month Forecast 8900 The rupiah should appreciate as global risk appetite rises again, Indonesia s economy stays strong and BI rates eventually fall further and lift local debt markets. Q3 GDP growth accelerated to 6.5% pa, the best result since early 1997, as agriculture improved and recent BI cuts continued to stimulate household spending. But higher oil prices will slow economic growth for a while and have lifted inflation to the top of BI s 5-7% pa target range (6.9% in October). BI has left benchmark rates unchanged since July (at 8.25%) and officials have indicated that they will stay on hold in December. But if oil prices fall back next year, as we expect, then rates should fall from Q our target is down to 7.5% by year end. Large devaluation risk*: 10% SOUTH KOREAN WON Spot Month Forecast 910 We expect further gains. Q3 GDP growth accelerated to 5.3% pa, up from Q2 s 5.0% pa, with exports and household spending leading the way. Exports should soften in 2008 but high real income gains (up 5% pa in Q3) and low unemployment should keep consumers spending, and hold economic growth around 5% pa. Inflation has picked up but at 3.0% pa remains inside the % target range. Rates will likely stay on hold at 5% well into 2008 but eventually will probably move higher. The opposition Grand National Party looks set to win the December 18 th presidential election and is expected to implement policies that are more pro-growth and pro-business than those of the Roh Administration it will replace. Large devaluation risk*: 10% NEW ZEALAND DOLLAR Spot Month Forecast 0.79 Over the next three months, the kiwi should move in line with AUD we forecast a modest further rally as global equities pick up again and carry trades move back into favour. But the Kiwi should fall over most of the next 12 months. Higher RBNZ rates are finally hitting the housing market and curbing household spending. October home sales were down 23% pa and Q3 retail sales were up only 0.2% on Q2. But higher food and energy prices will likely soon lift inflation towards the top of the 1-3% pa target range and wages will stay a concern for some time given the very tight labour market. RBNZ rates (now 8.25%) have almost certainly peaked but rates are unlikely fall before Q When rates do fall, so too will the NZD. Large devaluation risk*: 20% PHILIPPINE PESO Spot Month Forecast *defined as a 10% or more devaluation against the USD in 3 months There has been some recent modest deterioration in the fiscal position but the economy overall is still performing very well. January-September worker remittances climbed 15% pa, agricultural output improved in Q3, and 2007 GDP growth remains on track to rise close to 7% pa. Exports will likely slow next year but continued economic expansion in the 6-7% range should still be achievable. Inflation remains well below the 4-5% pa 2007 target (2.7% pa in October) and should stay contained. Money supply growth, a recent central bank worry, has also slowed and interest rates were cut 25bps in mid-november (to 5.5%). More cuts are likely in 2008 (probably two more 25bps cuts in Q1 and Q2) but capital inflows should remain strong and further lift the PHP. Large devaluation risk*: 15% American Express Bank Ltd. 5 EFI Currencies Nov 2007

6 EAST ASIA / SUBCONTINENT CURRENCIES SINGAPORE DOLLAR Spot Month Forecast Singapore Q3 GDP growth accelerated to 9.4% pa and the economy is re-balancing with services and construction climbing rapidly, and taking over from manufacturing. Household incomes and employment should keep rising strongly and the boom in residential property prices, up 27% pa in Q3, should continue for a while. Nevertheless, the global economic slowdown should pull 2008 GDP growth down - our forecast is to 6-7% - and the slowdown will be more severe if the US suffers recession. Inflation has accelerated to 2.7% pa and should rise further over the next few months. To help control inflation the MAS has adjusted its FX rate policy to allow slightly faster SGD gains. Large devaluation risk*: 5% TAIWAN DOLLAR Spot Month Forecast 32.0 Taiwan, given its electronics sector dependence, is the most vulnerable Asian economy should the US fall into recession. Assuming the US is just weak, Taiwan s upswing should continue, although GDP growth will likely slow to around 4% pa in Exports and investment have picked up recently, whilst household spending is solid despite employment/income gains that have been weaker than elsewhere in Asia. Q3 GDP growth should come in around 5% pa. Inflation has soared to 5.3% pa and another rate hike (from 3.25%) looks inevitable in December. The central bank will also likely curb any TWD slippage. Elections in January/March 2008 should bring more conciliatory Mainland policies. Large devaluation risk*: 10% THAI BAHT Spot Month Forecast We expect the baht to appreciate. Exports should slow in 2008 but domestic demand weakness is finally ending on the back of lower interest rates and increased public spending. Q3 manufacturing output rose 9% pa, up on Q2 s 6% gain, business sentiment should improve further after the December 23 rd election, and there is a good chance that capital controls will be completely dismantled soon. GDP growth in 2008 should accelerate to % pa, after 2007 s likely 4.3% gain. Core inflation remains low but high oil prices have lifted headline inflation to 2.5%. BoT rates will likely stay on prolonged hold at 3.25% (next meeting in December) but rates should eventually rise next year. Large devaluation risk*: 15% INDIAN RUPEE Spot Month Forecast 39.0 *defined as a 10% or more devaluation against the USD in 3 months The INR will likely weaken over the next few weeks - we expect emerging equities, including India, to stay under pressure whilst there could well be capital outflow stimulated by the changed investment regulations related to Participatory Notes. But the INR rally should resume in India s current economic slowdown should be mild and short lived and capital inflows should hold at a high level next year. Wholesale price inflation, currently down just below 3% pa, is also likely to accelerate again - we forecast back up close to, maybe above, the RBI s 5% inflation cap during the first half of To keep inflation contained, the RBI will probably allow a stronger, although not significantly stronger, rupee. The RBI may also eventually need to hike rates again. Large devaluation risk*: 10% American Express Bank Ltd. 6 EFI Currencies Nov 2007

7 AMERICAS CURRENCIES CANADIAN DOLLAR Spot Month Forecast The CAD has fallen sharply since early November and we expect the depreciation to continue. The next move in BoC rates now looks like being a cut. Key officials have toughened their rhetoric on the CAD being too strong and on the downside threats to inflation and GDP growth. Recent economic data have been mixed but September manufacturing shipments dropped for the fifth month out of six and the September trade surplus narrowed to a 9-year low. US recession risks have also risen. A BoC cut in December (on the 4 th ) may be too soon but it is a close call and rates are likely to fall (from 4.5%) from early Oil prices should also drop next year and capital inflows should continue. Large devaluation risk*: 10% ARGENTINE PESO Spot Month Forecast 3.15 We have changed our view and now expect peso depreciation. Economic policies under the new president, Cristina Fernandez, will likely stay almost identical to those followed by her husband s administration. Inflation came in at 8.7% pa in October but remains under reported. Nevertheless, public spending is set to stay strong, which will keep GDP growth relatively high and ensure inflation stays a big problem. In the end, Argentina will have to implement more orthodox policies and abandon the cheap ARS strategy to get inflation down. But the country will likely have to be forced into a change by crisis - perhaps triggered by sharply lower commodity prices. Crisis remains unlikely in Large devaluation risk*: 10% BRAZILIAN REAL Spot Month Forecast 1.70 Further sharp gains look unlikely but the real should stay strong. The economy continues to perform well with Q3 GDP growth (published in mid-december) likely to at least match the 5.4% pa gain in April- June. Household spending continues to lead the way, fuelled by good income/employment gains and rapid credit growth. Capacity constraints as well as high food/energy prices have lifted inflation to 4.1% pa, up from 3% in Q1 2007, and 2008 inflation expectations have also moved up. The central bank left rates unchanged in October at 11.25% and rates are likely to stay on hold until inflation expectations start to move down again and GDP growth starts to drop. We expect that rate cuts will resume in Q Large devaluation risk*: 10% MEXICAN PESO Spot Month Forecast defined as a 10% or more devaluation gainst the USD in 3 months The MXN has sold off on the global de-risking but we expect appreciation to resume soon. The economy is picking up with Q3 GDP growth accelerating to 4% pa, after a weak 2.7% pa gain in the first half of 2007, with industrial production, autos output, and exports leading the way. Household spending is also improving, despite consumer confidence remaining low. The central bank surprised the markets and lifted official rates 25bps in October (to 7.5%) - inflation has accelerated to 3.8% pa and is expected to climb to 4.5% next year. Rates should stay on hold this week (Friday). But, provided the US avoids recession in 2008 which, although a close call is what we expect, Mexican rates will likely move up another 25bps in the first half of next year. Large devaluation risk*: 15% American Express Bank Ltd. 7 EFI Currencies Nov 2007

8 EUROPE CURRENCIES per euro EURO Spot Month Forecast 1.46 GDP growth was good in Q3, up 2.8% pa, but is likely to slow in Q4 and in Services sentiment is holding up well but manufacturing is weakening whilst exports, buoyant so far this year, are likely to slow as global growth slackens. Meanwhile, consumers remain cautious. Headline inflation is also well above target and will remain a concern, despite well-behaved core inflation. Nevertheless, euro strength (up 3.5% per USD since the ECB last tightened rates in June), and the ongoing credit squeeze which has lifted market rates, has effectively tightened policy. The euro should rally further in coming weeks, but then depreciate against the USD as current overly negative sentiment on the US eventually improves. Large devaluation risk*: 10% UK POUND Spot Month Forecast 1.97 The economic outlook has worsened, with services and manufacturing sentiment down sharply, retail sales under pressure, and the risks to residential and commercial property rising. The BoE now sees two rate cuts as likely to be necessary in 2008, and may move in December - the key will be how the credit squeeze impacts corporate investment intentions and consumer borrowing, how far global growth slows, and the path of UK inflation expectations. Market expectations of further Fed rate cuts should hold up GBP/USD over the next few weeks. But in 2008 we expect sterling to weaken further against the euro and to eventually fall sharply per USD as the UK s rate premium narrows. Large devaluation risk*: 10% SWISS FRANC Spot Month Forecast 1.14 The CHF should come under renewed pressure against the euro we expect global risk aversion to ease and carry trade activity to resume again in early In addition, the SNB is likely to be more cautious over further interest rate hikes, probably keeping pace with, rather than moving ahead of, the ECB. Policy is still expansionary, retail sales remain robust, and the rise in food and energy prices will lift inflation. But consumer price gains are still well below the SNB s 2% pa threshold for price stability, and economic growth should slow in 2008 as the credit crunch impacts Swiss banks, and on slower growth in the Euro-zone. Nevertheless, the SNB will act to limit any sharp Swiss franc downside vs the euro. Large devaluation risk*: 10% HUNGARIAN FORINT Spot Month Forecast 168 defined as a 10% or more devaluation gainst the USD in 3 months The economy is weak as a result of the ongoing austerity programme, with sluggish agricultural output and slowing construction also holding GDP growth to only 1% pa in Q3. At the same time, accelerating inflation and still-high inflation expectations have raised concerns about stagflation. The NBH is likely to keep rates on hold (at 7.5%) until Q1 2008, but we expect rates to fall by 125bps in 2008 as recent administered price hikes eventually drop out of the consumer price index. Nevertheless, interest rates will stay relatively attractive to elsewhere, growth should recover in 2008, and the twin deficits (fiscal and external) should improve further. Better economic fundamentals and a recovery in carry trade activity should be HUFsupportive. Large devaluation risk*: 20% American Express Bank Ltd. 8 EFI Currencies Nov 2007

9 EUROPE/AFRICA CURRENCIES per euro POLISH ZLOTY Spot Month Forecast 2.47 The zloty s rally against the US dollar and euro should resume at some point over the next three months. The economy is growing rapidly and jobs creation has been strong. Above-target inflation of 3% pa is partly due to likely temporary factors (food, energy), and core inflation should remain comfortably below 2%. But wage growth is in double-digits and the central bank will act to avoid the onset of a wage-price spiral. Official rates look set to rise by 25bps, to 5%, in late November (on the 28 th ), and we expect a further 50bps in hikes in The new government, a coalition of the pro-business Civic Platform and the centrist Peasants Party, is more committed to euro entry and sound fiscal policies. Large devaluation risk*: 15% RUSSIAN ROUBLE Spot Month Forecast per euro 2.30 per euro Capital inflows resumed in October but will stay vulnerable to global credit crunch concerns. Nevertheless, a liquidity shortage in the banking sector should not be too damaging as record-high oil prices continue to support buoyant government finances and strong social spending. The rouble strengthened by 4.7% in real terms in January- October, but should rise more rapidly in 2008 if oil prices stay firm. A price-freeze, implemented to counter rising inflation pressures, is likely to stay in place until after March s Presidential election. But rouble appreciation will remain the main policy tool against inflation - in 2008 appreciation is most likely to be against the euro as the US dollar, we expect, pulls stronger. Large devaluation risk*: 10% TURKISH LIRA Spot Month Forecast 1.16 The lira has stabilised per euro at a strong, and probably overvalued, level. But high local yields, a stable and reforming government, and a likely recovery in economic growth next year should bring further TRY strength in Interest rates, down 125bps since September, look set to fall by a further 200bps to 14% in Nevertheless, lira yields would still compare favourably with other high-yielding exotic currencies. The external deficit is likely to stay wide, some 7.5-8% of GDP, and will leave the TRY vulnerable to periodic bouts of risk aversion. But long-term finance now more than covers the external gap. Iraq invasion risk is another threat, but probably only a minor threat to TRY investors. Large devaluation risk*: 20% SOUTH AFRICAN RAND Spot Month Forecast Source: 07 Datastream defined as a 10% or more devaluation gainst the USD in 3 months The high yield, and the probability that commodity prices will stay well supported, should bring a ZAR bounce-back. Inflation is above the 3-6% pa target band, price pressures are still rising, and another 50bps interest rate hike in December (6 th ) looks likely. But there are signs that the economy is responding to the 350bps rise in rates so far this year, with consumer spending slowing, borrowing down, and business and consumer confidence softer. Slower domestic demand should curb consumer imports, but the external gap, some 7% of GDP, will stay wide on rising infrastructure imports. Politics will also become more prominent in the run-up to ANC leadership elections in December, but in the end should not be too damaging. Large devaluation risk*: 20% American Express Bank Ltd. 9 EFI Currencies Nov 2007