Line in The Sand: Good and Bad Inflation

LONDON TORONTO NEW YORK SINGAPORE
Global Markets
March 16, 2011
Rates & Foreign
Exchange Research
HIGHLIGHTS THE LINE IN THE SAND: DISTINGUISHING BETWEEN

• The rise in the price of oil trig- GOOD AND BAD INFLATION
gered by geopolitical develop- The global economy is approaching the end of the first quarter of 2011 with
ments poses yet another head-
significant momentum. With activity measures showing rates of growth not seen
wind to both the recovery in
for almost five years, forecasters have responded by revising their expectations
financial markets and the global
for economic output higher. Against this backdrop, the likelihood of deflation
economy.
has become increasingly remote and instead the balance of risk to the forecast
• Each economy will need to cus- has shifted towards higher inflation. But the magnitude of the forecast revisions
tomize their response to higher
to both growth and inflation also reflects a fine balance that is ultimately influ-
energy prices which raises the
enced by more than economics. The concurrent rise in geopolitical tensions in
risk for a policy error in an al-
ready complicated environment. the Middle East and North Africa (MENA) and in the price of oil has increased
the pressure on poli-
• The publication also includes
cymakers who must
quarterly interest rate and ex-
primarily limit its INFLATION'S STABLE SPINE
change rate forecasts for the
U.S., Canada, U.K., Australia, and
impact on infla- Y/Y % Chg. Lehman
50
New Zealand, and also offers ad- tion but also guard Arab Oil
Iran/Iraq Hurricane
Katrina
Brothers
Fails
War
ditional exchange rate forecasts against the risk it 40 Embargo
Iraq
for the Japanese yen, the euro, poses to economic 30 Palestinian Invasion
Unrest
and the Swiss franc. growth. The tragic 20
Gulf War
earthquake in Japan 10
has helped to dimin- 0
ish the magnitude
-10
of the shock—al- Core CPI
though the larger -20
CPI - Energy
fall in crude oc- -30
1970 1975 1980 1985 1990 1995 2000 2005 2010
curred several days
earlier—but events Source: TD Economics, Bureau of Labor Statistics
CONTENTS
in MENA continue
Lead Article: The Line in the Sand:
Distinguishing Between Good and Bad to cast a long shad-
Inflation . . . . . . . . . . . . . . . . . . . . . . . . . 1 ow over energy markets. By contrast, rising inflation caused by the steady ab-
U.S. Fixed Income . . . . . . . . . . . . . . . . . 4 sorption of the resources that had lain idle during the recession is a much better
Canadian Fixed Income . . . . . . . . . . . . 5 problem for central banks to have. So once again, the financial system is now
U.K. Fixed Income . . . . . . . . . . . . . . . . . 6 more exposed to a policy surprise or error than it is to a financial surprise, and
Australian Fixed Income . . . . . . . . . . . . 7 the scale of the macro-driven volatility could be significant if realized.
New Zealand Fixed Income . . . . . . . . . 8
From Each According to His Ability to Fight Inflation, To Each According
U.S. Dollar . . . . . . . . . . . . . . . . . . . . . . . 9
to His Willingness to Fight Inflation
Canadian Dollar . . . . . . . . . . . . . . . . . . 10
Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Just as all politics is local, so too is the impact of the jump in the price of
Japanese Yen . . . . . . . . . . . . . . . . . . . 12 crude oil, and ultimately the response of policymakers. The challenge is most
U.K. Pound . . . . . . . . . . . . . . . . . . . . . . 13 pressing for emerging market economies, where oil is just the latest in a long
Australian Dollar . . . . . . . . . . . . . . . . . 14 string of inflationary shocks that speak to a level of monetary accommodation
New Zealand Dollar . . . . . . . . . . . . . . . 15 utterly at odds with conditions in the wider economy. A reluctance to accept a
Swiss Franc . . . . . . . . . . . . . . . . . . . . . 16 stronger currency—instead a combination of intervention and capital controls
Summary Fixed Income Table . . . . . . 17 remain the preferred options—in the face of accelerating foreign demand only
Summary Foreign Exchange Table . . 18 adds to the risk of higher inflation. The tentative steps taken by Brazil, Chile,
2
March 16, 2011
Global Markets Rates & FX Research
China, Columbia, Hungary, India, Indonesia, Korea, Peru,

OIL PRICE VS . FED FUNDS RATE
Thailand and Vietnam, reflect a growing recognition of this
risk but the lack of conviction in an aggressive campaign of 140
$/Barrel* Percent
20
stimulus withdrawal is palpable. 18
120 Fed Funds Effective
For developed market economies, the analysis is more Rate (rhs) Nominal Oil 16
Price (lhs)
nuanced. The impact of higher energy and food prices will 100 14
restrain growth, as the abundance of economic slack makes it 80
12
less likely that there will be significant pass-through to other 10

60
prices, costs, and wages. The market appears to share this 8
view. Real long term interest rates in the United States have 40 6
declined. However, with nominal interest rates declining 20

4
2
proportionately less, the market’s forecast of future inflation
0 0
edged up a little, but remains within the range prevailing 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
since 2000 and is consistent with the 2.0% rate that most *West Texas Intermediate Cushing
developed market central banks have contracted to deliver. Source: TD Economics, Wall Street Journal, Federal Reserve
For central banks in developed market economies, lower

for longer is still a reasonable risk to take. So long as higher the outcome.
oil prices are not accompanied by significant monetary In central banking terms, the shock to the price of oil
tightening, the oil price spike is unlikely to cause a reces- could reduce the rate of potential GDP growth, raising the
sion. While the earthquake in Japan will exact a heavy toll risk that the available disinflationary slack could be absorbed
domestically, the global recovery remains entrenched. On more quickly than expected. But the lesson of the 1970s
the margin it could stand to benefit from the pullback in is clear: you do not accommodate a negative supply shock
energy prices. It should therefore come as little surprise to and policymakers everywhere are aware of this. As a con-
find that financial markets will continue to seek risk despite sequence, successful inflation management is a function of
the swing in concern towards inflation and the downside how good of a forecaster you are. In this case, it depends
hit to growth. The upside to risky asset markets remains on how accurately you forecast growth relative to the
substantial, especially as developed market equities are economy’s potential, and thus the rate of capacity depletion.
expected to receive an earnings tailwind from the stronger A negative supply shock would tend to give you growth
growth, and the push from low cash rates remains strong. lower than expectations and inflation higher than expecta-
tions. In the United States, growth has surprised on the
The Tipping Point: From Curtailing Inflationary
Excess to Demand Destruction upside, but inflation has not. So it is not clear. Even if po-
tential growth is a bit lower, the effective time that slack will
So in a manner of degree, the financial markets have seen prevail is roughly the same span of time over which demand
the oil price shock as “helpful” in braking overall growth and supply growth is judged to fall, leaving the overall US
momentum. Initial risk asset volatility reflected large inves- monetary policy challenge unchanged. Despite remaining
tor repositioning to take advantage of the rise in the price at an emergency setting when the emergency has long since
of oil by selling assets and countries that must pay more for passed, the Federal Reserve has indicated it sees no reason
oil, and buying oil-producing assets and countries whose to change its overall policy orientation at this point. We
revenues and profits will be boosted. But there is obviously have made only minor changes to our Fed forecast mostly
a deeper resonance that will become apparent should the in response to better growth momentum.
recent move higher in energy prices be sustained.
In Europe the situation is less clear. The European Cen-
There are ambiguities on the net impact of higher oil tral Bank has decided that heady growth in the union’s core
prices over a longer time horizon, and it is well understood countries—mostly Germany—and an earlier than expected
that the rise in the price of oil potentially renders some of move up in core inflation means that the expected slack
the capital stock unproductive. The macroeconomic man- is smaller than they first thought, so they are moving to
agement issue could equally be one of supply rather than shore-up inflation expectations consistent with their infla-
demand management, and the implications on monetary tion mandate. This makes it more difficult for the peripheral
policy and risky asset markets are different depending on
3
March 16, 2011
European countries that must manage a fiscal retrenchment substitute for inflation management. We continue to hold
to cope, but this is beyond the mandate of the ECB. Liquid- our long-standing view that the Bank will take its overnight
ity issues for the euro-areas distressed banking systems will interest rate higher in the second half of 2011.
be met through abundant financing at the current fixed-rate.
Even with the fiscal challenges, and despite the Euro area’s Surprise + Vulnerability = Volatility
many flaws, the recent sovereign debt crisis has given the Set against a prolonged convalescence, the global
euro area the fright it needed to achieve some sort of fiscal economy has stumbled from prospective crisis to prospec-
order and resolution to its sovereign solvency woes. tive crisis, reminding us all that recoveries never move in
Fiscal policy in the US, by contrast, is in a state of com- straight lines. As each passing impediment fades but does
plete incoherency, with no popular acknowledgement of the not completely disappear, both the resistance of the private
problems, and no political incentive to take corrective action sector and the resolve of policymakers is tested. The rise in
today. Consequently, the US dollar is feeling the heat. Our the price of oil has raised the stakes in macro management
forecasts have been revised to reflect this. by introducing potential for policy error into an already
In Canada, the absence of inflationary pressure contin- complicated mix. At this point we continue to think that risk
ues to afford the Bank of Canada the luxury of remaining assets can do well in a world of still robust growth, which
accommodative while assessing the various crosscurrents higher oil prices will merely temper for a while.
impacting the economy and the outlook for inflation. Pru- Volatility is the product of surprise and vulnerability. The
dence, however, must not engender apathy; action will be market’s limited generation of equity volatility in the face of
required in the months ahead. In our assessment, the Bank the oil price surprise suggests that the overall system is not
has underestimated the strength of the US economy and the very vulnerable financially. Granted, the financial system
support it will provide to Canadian exports. With a domestic remains significantly less levered than it was in 2007-2008.
economy that has only begun to decelerate, the modest re- But the reduction in private sector financial leverage has
balancing in the overall economy towards stronger net trade been offset by significantly more leverage at the sovereign
will leave the Bank facing a rapidly diminishing overhang level; the vulnerabilities have been merely redistributed.
of spare capacity. While the strength of the Canadian dol- Indeed, macro vulnerability has substituted for financial
lar is an important ally in restraining inflation, it is not a vulnerability. And this can be just as destabilizing.
Andrew Spence,
Global Head, Rates and FX Research
416-308-4600
David Tulk,
Chief Canada Macro Strategist
416-983-0445
4
March 16, 2011
U.S. FIXED INCOME

The Fed is inclined to stay on message and remain odd QE based real funds rate up almost 300bps from its current
man out until more certainty that labor demand is sufficient level will take a combination of rate hikes (100bps in 2012)
for them to “consider the recovery truly self-sustaining.” and a reduction in the balance sheet. Natural run-off (almost
In the March statement, optimism appears to be building. $500B from June 2011-Dec 2012) will accomplish 75bp
The key elements such as the commitment to QE2 and to 100bp of tightening. Given these assumptions, and the
“exceptionally low for extended period” remained intact as ability to lock up excess reserves through a variety of tested
expected, and will do so for the foreseeable future. However, facilities, policy will remain more than sufficiently accom-
the tone of the statement is a clear indication that things are modative to help guard against a relapse in the recovery.
moving their way as the committee takes more baby steps The Fed has a great deal of flexibility in managing down
toward taking us closer to an exit strategy. their balance sheet. How they use that flexibility will depend
Risks do evolve, often in an unpredictable fashion. The on the ability of the market to absorb the run-off, or sales,
Japan disaster will affect global growth momentum through in the context of its objective of price stability and employ-
interrupted trade linkages, idle domestic production, and ment. This debate is in its infancy. However, it will mature
through a negative wealth effect to name a few. Commodity over coming quarters as the Fed brings a timeline for trim-
markets are down sharply since the earthquake contributing ming their loose accommodative policies into sharper focus.
to the disinflationary impulse from this event and breakevens Our outlook for rates is broadly unchanged from the prior
in the US hit their lowest level in three weeks. On the other two publications. Our Q1 end forecasts were changed in light
side of this, however, the rebuilding efforts in Japan and what of the sharp rally in rates. However, we suspect that rally
is sure to be a more aggressive turn in the monetization of a will not endure in a post disinflation strong growth environ-
disastrous debt predicament will likely fuel a more inflation- ment. Neither are they likely to lurch higher. They will drift
ary bias later this year. The extent of this move will depend higher over the course of the year and with the end of QE2
on how extensive the damage and dislocations from this well anticipated one must be careful to assume an immedi-
earthquake prove to be. For now, the Fed has every incen- ate sell-off should occur. We do believe that the cards are
tive to stay on message. Economic momentum and inflation heavily stacked against lower rates, and our 3.95% year-end
are moving their way and events in Japan are not likely to forecast may ultimately prove to be modestly conservative.
materially change their fundamental outlook, or ours. Perhaps the greatest risk to that view resides with energy
Despite the geopolitical and natural disaster crosscur- markets. An oil supply shock within a period of immense
rents swirling through financial markets, we have elected economic slack should push yields lower. That has been the
to pull forward our tightening in 2012 from Q3 to Q2 and pattern in the past. It has been the pattern during the most
have raised our year-end forecast from 1.00% to 1.25%. recent period as well.
With QE2 completed in June and the reinvestment of MBS
run-off likely to expire sometime in September, passive
policy tightening will commence in the final quarters of Eric Green, Chief U.S. Strategist
212-827-7156
2011. Real fed funds are not exceptionally low relative to the
pivot points of prior tightening regimes, but when factoring
for QE, it clearly is. If a realistic policy prescription for the
end of 2012 is a real rate closer to –0.25%, then taking the
U .S . FIXED INCOME OUTLOOK

Spot Rate 2010 2011 2012
3/16/2011 Q1 Q2 Q3 Q4 Q1F Q2F Q3F Q4F Q1F Q2F Q3F Q4F
Fed Funds Target Rate (%) 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.50 1.00 1.25
3-mth T-Bill Rate (%) 0.09 0.16 0.18 0.16 0.12 0.10 0.15 0.20 0.20 0.30 0.55 0.80 1.35
2-yr Govt. Bond Yield (%) 0.58 1.02 0.61 0.42 0.59 0.60 0.75 0.80 0.90 1.15 1.30 1.70 1.95
10-yr-2-yr Govt. Spread (%) 2.68 2.81 2.32 2.09 2.70 2.80 3.00 3.10 3.05 2.90 2.80 2.50 2.30
f: Forecast by TD Bank Group as at Mar. 16, 2011; All forecasts are for end of period. Source: Bloomberg, TDBG
5
March 16, 2011
CANADIAN FIXED INCOME

As the first quarter of 2011 draws to a close, risk aver- concession to bring the 2 year yield closer to market pricing
sion is once again in the ascendency, causing yields across in Q1 but have pushed the yield higher over the balance of
the Canadian curve to retreat dramatically. The first wave 2011. In Q2 this forecast is driven by the expectation of
accompanied the rise of geopolitical tensions the Middle hawkish rhetoric by the Bank as they lay the groundwork
East and North Africa (MENA), where the concurrent in- for a July hike, while actual hikes combined with limited
crease in the price of oil threatened to undermine what was issuance will contribute to higher yields over the balance
becoming a durable recovery in global growth. In recent of the year. Yields on 5s are also expected to increase over
days, the aftermath of the tragic earthquake and tsunami in 2011, due to both Bank hikes and seasonal weakness in the
Japan has arrested the rise in the price of oil but has done mortgage market.
little to prevent a second wave of risk aversion from fuel- The outlook for 10 year yields remains largely un-
ling additional demand for the safety of government bonds. changed, and when combined with the revisions to 2s
Without these two developments, yields across the curve contributes to a flatter curve over 2011. After steepening to
were unfolding largely as expected. And given that events 160 bps in Q2, the curve will flatten to 145 bps by the end
in MENA and Japan are not expected to have a tremendous of the year and to 95 bps by the end of 2012.
impact on Canada, we are reluctant to chase what could The clear risk to this forecast is if events in the geopoliti-
prove to be transitory factors driving yields lower. As such, cal arena contribute to additional risk aversion and cause a
most of the revisions to our forecast in March are cosmetic further flight to quality. Although yields across the curve
in nature. However, we do acknowledge a downside risk are utterly inconsistent with conditions in the Canadian
to yields should the turmoil in the global economist persist. economy, we have a tremendous amount of respect for the
The cornerstone of the forecast is our longstanding call degree of fear providing a bid. There is a difference between
that the Bank of Canada remains on the sidelines until July what markets should do and what they will do. And in the
before proceeding with four 25 basis point hikes to end the extreme event that the recovery in the global economy is
year with an overnight rate of 2.00%. The market has also threatened, the Bank of Canada will also elect to remain on
pivoted around a July start date until recently where events hold for longer than we currently expect and the curve will
in Japan have pushed the expected start date for hikes fur- steepen as a result.
ther into the second half of the year. This move is likely an
overreaction, and instead we would point to the recovery David Tulk, Chief Canada Macro Strategist
in Canadian exports and US employment as evidence that 416-983-0445
the Bank will be compelled to resume withdrawing stimulus Ian Pollick, Portfolio & Rates Strategist
in July. 416-983-7184
In the short end of the curve, we have made a modest
CANADIAN FIXED INCOME OUTLOOK

Spot Rate 2010 2011 2012
Overnight Target Rate (%) 1.00 0.25 0.50 1.00 1.00 1.00 1.00 1.50 2.00 2.25 2.50 2.75 3.00
3-mth T-Bill Rate (%) 0.94 0.29 0.51 0.88 1.04 1.00 1.05 1.50 2.00 2.25 2.50 2.80 3.05
10-yr-2-yr Govt. Spread (%) 1.55 1.83 1.69 1.38 1.53 1.55 1.60 1.55 1.45 1.45 1.25 0.90 0.95
Canada-U .S . Spreads
3-mth T-Bill Rate (%) 0.85 0.13 0.33 0.72 0.80 0.85 0.90 1.35 1.80 1.95 2.15 2.20 1.85
10-yr Govt. Bond Yield (%) -0.12 -0.26 0.15 0.25 -0.05 0.00 0.00 0.10 0.10 0.15 0.25 0.20 0.15
30-yr Govt. Bond Yield (%) -0.74 -0.59 -0.24 -0.32 -0.70 -0.80 -0.95 -0.80 -0.70 -0.55 -0.55 -0.50 -0.50
6
March 16, 2011
U.K. FIXED INCOME

We are in a holding pattern for UK fixed income as we will indeed fall back to the 2% target in January next year
await the first rate hike from the Bank of England. Fears will reassure the market that 4% inflation is not a permanent
that high oil prices would weigh on growth helped to push feature, and allow the long end to support flattening, as well.
yields lower since the end of February, and this was further Over the next month, the new budget is likely to show that
reinforced by the damage in Japan, with 5s significantly better growth has lowered borrowing requirements and help
underperforming. We do not see either of these events as yields fall slightly further, but tightening is coming and the
shocks with permanent effects, and as a result, while we curve will ultimately flatten aggressively on the back of that.
have adjusted our forecasts for yields lower for end-Q1, our
remaining forecasts remain virtually unchanged. Richard Kelly
The MPC was in a four-way split as of February so the Head of European Rates & FX Research
prospects are certainly not clear cut. While one member +44 20 7786 8448
voted to increase asset purchases and add more stimulus to
the economy, two voted for a 25 basis point hike, one voted
for a 50 basis point hike, and the remaining five voted to
keep rates unchanged for now. One of the biggest deciding
UK 3-MONTH T-BILL RATES & 10-YEAR
factors among those voting to keep rates unchanged was GOVERNMENT BOND YIELDS
simply not wanting to give the impression that the BoE was 6
% %
6
racing for the exit. This would also give the MPC a chance Forecast
to ensure data was indeed looking better, which it is in our 5 5
opinion. But the shock would now would be getting to Au-

4 4
gust without a rate hike, and we expect it will come in May. 10-yr Gov't Bond Yield
BoE Governor Mervyn King in March described UK 3 3
real rates as “unsustainably low.” This does provide an out

2 2
for the MPC on delivering rate hikes. Real rates can rise 3-mo . T-Bill yield
through an increase in Bank rate, as we expect to start in 1 1
May, or through a fall in inflation expectations, as Mervyn
0 0
King may hope. 10-year breakevens are 9bps lower than 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
they were at the time of our last Global Markets, but nominal Actual data to Q4 2010; Forecast by TDBG as at March 2011
10-year yields have fallen 32bps so lower real yields is not Source: Bank of England/Bloomberg
what the MPC wants.

The one confounding factor in gilts has been the inability
of the curve to flatten. At the front end, the market seems
to only be half-heartedly pricing in hikes. Once the first is
delivered in May, the market should get the message. Also,
as we move into the end of the year, the forecast that inflation
U .K . FIXED INCOME OUTLOOK

Spot Rate 2010 2011 2012
Bank Rate Target (%) 0.50 0.50 0.50 0.50 0.50 0.50 0.75 1.00 1.25 1.50 2.00 2.50 3.00
3-mth T-Bill Rate (%) 0.62 0.57 0.54 0.57 0.57 0.65 1.00 1.20 1.45 1.70 2.20 2.70 3.20
2-yr Gilt Yield (%) 1.23 1.16 0.75 0.65 1.10 1.25 1.85 2.10 2.35 2.45 2.70 3.10 3.50
5-yr Gilt Yield (%) 2.29 2.71 2.07 1.61 2.20 2.35 3.05 3.25 3.50 3.65 3.80 4.00 4.25
10-yr Gilt Yield (%) 3.53 3.94 3.36 2.95 3.40 3.50 3.90 4.10 4.30 4.30 4.45 4.70 4.80
30-yr Gilt Yield (%) 4.28 4.53 4.17 3.90 4.19 4.30 4.70 4.80 4.90 4.95 4.95 4.85 4.70
10-yr-2-yr Gilt Spread (%) 2.30 2.78 2.61 2.30 2.30 2.25 2.05 2.00 1.95 1.85 1.75 1.60 1.30
f: Forecast by TD Bank Group as at Mar. 16, 2011; All forecasts are for end of period. Source: Bloomberg, TD Bank Group
7
March 16, 2011
AUSTRALIAN FIXED INCOME

Although data continue to be consistent with trend probability ahead of our March TD-MI Monthly Inflation
growth and full employment, and the RBA is not likely to Gauge, released at the end of this month. If the Inflation
raise rates any time soon, ACGB 10-year yields have ral- Gauge continues to be tame, we will modestly adjust our
lied 30bp in the past month, to 5.4%. The bond market has RBA tightening profile from +100bp by year end to +75bp
benefited from rising geopolitical risks in the Middle East by year end. Either way, the OIS market is well short of
and now Japan’s disaster. pricing in this scenario (currently it is predicting a Cash
Domestic demand-supply dynamics are also supportive Rate of 4.71% by year-end!), but strategies to capitalize on
for bonds. In contrast to the forthcoming surge in G20 this mispricing (pay OIS 12 month or curve flattening) can
government bond issuance, Australian bond supply is likely wait for another month or two.
to fall well short of demand. Adding to future demand
prospects, the Australian Prudential Regulation Authority
(APRA) recently proposed a very narrow range of assets that Annette Beacher, Head of Asia-Pacific Research
banks can hold to satisfy Basel III minimum liquid asset re- +65 6500 8047
quirements; just cash, ACGBs and semi-government bonds.
While favourable for sovereign bonds, supra-national paper AUSTRALIAN 3-MONTH T-BILL RATES & 10-YEAR
(AAA-rated AUD denominated ‘kangaroo’ bonds) is left at GOVERNMENT BOND YIELDS
a relative disadvantage. To fill the gap, the RBA is propos- 9
% %
9
ing a ‘committed liquidity facility’ which will accept supras 8 Forecast 8
3-mo . T-Bill yield
and other securities in fulfillment of Basel requirements, 7 7
but at a cost to banks. This has seen the kangaroo market 6 6
underperform since the APRA announcement. 5 5
The timing of the proposed introduction of Basel liquid-
4 4
ity requirements is also somewhat problematic, coming into
3 10-yr Gov't Bond Yield 3
effect on 1 January 2015. By then, supply of Commonwealth
2 2
bonds will be limited as the budget is forecast to be into
surplus two years prior. 1 1
Outsized demand for ACGBs has been reflected in recent 0 0

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
primary market tenders achieving bid-to-cover ratios of 4-5 Actual data to Q4 2010; Forecast by TDBG as at March 2011
(the 2010 average was 3.8). To us, that signals that yields in Source: Reserve Bank of Australia/Haver Analytics
secondary markets across the curve are too low and therefore
Aussie bonds are expensive again. 2 year yields are 4.76%
and 3 year yields are 4.91%, the latter well below our mid-
year target of 5.30%.
We expect the RBA to remain on hold at 4.75% for
some time as evidence gathers that outside of the flood-
impacted spike of fresh produce prices, inflation remains
subdued. Hence our May RBA tightening call has a 50/50
AUSTRALIA FIXED INCOME OUTLOOK

Spot Rate 2010 2011 2012
Cash Target Rate (%) 4.75 4.00 4.50 4.50 4.75 4.75 5.00 5.25 5.75 5.75 6.00 6.00 6.00
3-mth Bank Bill Rate (%) 4.93 4.43 4.91 4.89 4.98 5.00 5.25 5.50 5.75 6.00 6.00 6.00 6.00
10-yr-3-yr Govt. Spread (%) 0.49 0.51 0.68 0.21 0.27 0.55 0.40 0.30 0.05 0.05 0.00 0.00 0.00
8
March 16, 2011
NEW ZEALAND FIXED INCOME

There have certainly been some significant events im- forecast of 4%. The cleanest trading strategy from these
pacting New Zealand’s fixed income market over the past projections is to pay 12 month OIS, as the Bank plans to
month. Most significant was the Christchurch earthquake reduce extreme monetary stimulus as soon as rebuilding
on 22 February. After the quake, the curve steepened 11bp, commences. We still prefer long AUDNZD for all the rea-
with the 3-10 year spread widening from 173bp before the sons we’ve listed in prior publications, but now the yield
tragic event to 184bp afterwards. Swap market pricing of differential is even more skewed towards the AUD.
end-2011 OCR expectations fell 35bp from 3.35% (i.e. 35bp
over cash) to 3.00%. Roland Randall, Senior Strategist
Over the weeks that followed the earthquake and led up +65 6500 8047
to the RBNZ’s OCR decision and Monetary Policy Statement
on 10 March, the market not surprisingly steepened further.
10 year yields rose another 4bp to 5.63% while 3-year yields NEW ZEALAND 3-MONTH T-BILL RATES & 10-
pared 19bp to 5.56%. This caused the 3/10 spread to widen YEAR GOVERNMENT BOND YIELDS
a further 23bp to 207bp. Swaps fully priced a 25bp cut, in 10
% %
10
the event, RBNZ cut 50bp to 2.5%. 9 3-mo . T-Bill yield
Forecast 9
The next day (11 March), it was Japan’s turn to suffer 8 8
an enormous earthquake. While the 9.0 magnitude shake, 7 7
subsequent tsunami and potential nuclear contamination 6 6
are together a much bigger event on most metrics than the 5 5
New Zealand earthquake (6.3 magnitude), the impact in NZ 4 10-yr Gov't Bond Yield 4
fixed income markets has so far been much less. The curve 3 3
has remained steep and there has been a rally of about 17bp 2 2
across the curve. Swaps are not expecting any adjustment 1 1
to the OCR for at least six months and a full 25bp hike is 0 0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
priced in only12 months from now.
Actual data to Q4 2010; Forecast by TDBG as at March 2011
The economy is expected to limp along. There’s a mate- Source: Reserve Bank of New Zealand/Haver Analytics
rial risk of negative GDP prints for 4Q 2010 and 1Q 2011.
We have revised 2011 GDP from 2½% to 1½% on very poor
data so far and a weak domestic demand outlook.
Given that annual GDP had already fallen over both 2008
and 2009, the output gap is wide and inflationary pressures
completely absent. Furthermore, beginning reconstruction
may be delayed many months as it cannot start until the
ongoing aftershocks stop.
We think all this is sufficient for RBNZ to leave the OCR
at 2.5% until early next year, before delivering 100bp of
tightening to 3.5% by end-2012, a reduction from our prior
NEW ZEALAND FIXED INCOME OUTLOOK

Spot Rate 2010 2011 2012
Cash Target Rate (%) 2.50 2.50 2.75 3.00 3.00 2.50 2.50 2.50 2.50 2.75 3.00 3.25 3.50
3-mth T-Bill Rate (%) 2.57 3.90 2.70 3.00 3.25 2.70 2.70 2.70 2.70 2.95 3.20 3.45 3.70
10-yr-3-yr Govt. Spread (%) 2.14 1.43 1.17 1.20 1.88 2.10 2.00 1.90 1.75 1.65 1.20 0.95 0.95
9
March 16, 2011
U.S. DOLLAR
The USD has had a rough start to the year, having been
U .S . DOLLAR
one of the worst performing currencies so far. In fact, the USD per EUR JPY per USD
DXY index has come close in recent days to re-testing the 1.16
1.20 USD per EUR 134
lows that it saw in early November 2010, around the an- 1.24
JPY per USD
nouncement of QE2. While US government bond yields 1.28 126
1.32
had been rising into February, they’ve since turned around 1.36
118
and even before the most recent market turmoil were nearly 1.40 110
back to the levels where they began 2011. At the same time, 1.44
1.48 102
yields had been rising in other parts of the world, so rate 1.52
94
differentials have generally been working against the USD. 1.56
1.60
As we’ve pared back some of the euro weakness that we 1.64
86
were forecasting, we’ve also pared back some of the USD 1.68 78
strength. As we discuss in the section on the euro, it seems Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
that euro zone leaders did a better job of kicking the can Source: Federal Reserve Bank of New York/Haver Analytics
down the road than we had suspected. Markets seem to be

more or less satisfied with what they’ve accomplished, so
the EUR has helped up better than we had thought it would. TRADE-WEIGHTED U .S . DOLLAR
However, we still expect the USD to gain some ground
Index: 2000 = 100
this year on a trade-weighted basis, as markets begin to pay 110
a little more attention to its superior growth prospects. We 105

still see US GDP growth essentially doubling the growth 100
rate in the UK, the euro zone, and Japan this year, which 95
should help to keep the USD well-supported. Recently
90
markets have begun to abandon the binary risk on/risk off
behaviour that characterized the last three years or so, mean- 85
ing that better US economic data should lead to a stronger 80
USD more often, returning to a more normal relationship. 75
It will likely be a rather long time though before the USD 70

gets anywhere near the highs from a decade ago, as it still 03 04 05 06 07 08 09 10 11
has a brutal fiscal situation to deal with. We don’t expect any *Nominal broad effective exchange rate
Source: Haver Analytics/JP Morgan
real progress to be made on that front until after the 2012
Presidential election, so the USD will likely continue more
of this broad range-trading for some time to come.
U .S . DOLLAR FUNDAMENTALS
Interest Rate Spreads – Business Cycle +
Jacqui Douglas, Senior FX & Macro Strategist
Inflation Differential – Fiscal Balances –
416-982-7784
Current Account N Politics N
Legend: - is negative, + is positive, N is neutral for currency
U .S . DOLLAR OUTLOOK
Spot Price 2010 2011 2012
Trade-wtd. USD 97.2 101.9 105.1 100.1 99.2 97.9 98.7 99.2 100.0 99.9 100.0 100.9 101.5
JPY per USD 80.7 93 88 84 81 85 90 92 95 98 98 100 100
USD per EUR 1.394 1.351 1.224 1.363 1.338 1.380 1.350 1.300 1.250 1.250 1.230 1.210 1.200
USD per GBP 1.607 1.518 1.495 1.571 1.561 1.624 1.667 1.646 1.623 1.667 1.685 1.658 1.644
f: Forecast by TD Bank Group as at Mar. 16, 2011; All forecasts are for end of period; Source: Federal Reserve, Bloomberg, TDBG
10
March 16, 2011
CANADIAN DOLLAR
Since the last issue of Global Markets, we have revised
CANADIAN DOLLAR
our profile for the Canadian dollar, building in more strength USD per CAD CAD per USD
1.12
through the remainder of 2011. We had always thought that 0.893
CAD had good fundamentals, but that some sort of crisis 1.08 0.926
in the euro zone would weigh on the currency temporarily. 1.04 0.962
Since the crisis that we were expecting seems to have been 1.00 1.000
pushed off into the future, it looks like CAD fundamentals 0.96 1.041
will prevail, and USD/CAD should continue to trade below 0.92 1.087
1.0 for the bulk of the next year. 0.88 1.136
However, we do still see the risk of periodic bursts higher 0.84 1.190
in USD/CAD, as the recent market turmoil around develop- 0.80 1.250
ments in Japan has shown. The latest weekly Commitment 0.76 1.316
of Traders report data showed that CAD net longs are still at Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
extreme levels, raising the risk of a short squeeze for USD/ Source: Federal Reserve Bank of New York/Haver Analytics
CAD and possibly exacerbating any move higher. The more

the market moves toward a one-way bet (weaker USD), the
higher the risk that we see a correction. TRADE-WEIGHTED CANADIAN DOLLAR
But outside these bouts of risk aversion, we do think that Index: 2000 = 100
CAD will do quite well for the next year or so. The Bank of 160
Canada is likely to begin another series of rate hikes in the 150
middle of this year, and while it won’t be the only central 140
bank raising rates in the next few months, it will be just about 130
the only one raising rates because the output gap is closing, 120
not because headline inflation is looking toasty. We expect
110
CAD to remain well-supported while the Bank is raising
rates, but if the currency gains too much ground, it does risk 100
pushing the Bank back onto the sidelines. We think that this 90
relationship will help to put a floor under USD/CAD, and 80

keep CAD from getting too far ahead of itself. 03 04 05 06 07 08 09 10 11
*Nominal broad effective exchange rate
416-982-7784
CANADIAN DOLLAR FUNDAMENTALS
Interest Rate Spreads + Business Cycle +
Inflation Differential + Fiscal Balances +
CANADIAN DOLLAR OUTLOOK

Spot Price 2010 2011 2012
CAD per USD 0.982 1.015 1.064 1.029 0.998 0.971 0.971 0.962 0.962 0.971 0.980 1.020 1.064
USD per CAD 1.018 0.985 0.940 0.972 1.002 1.030 1.030 1.040 1.040 1.030 1.020 0.980 0.940
JPY per CAD 82 92 83 81 81 88 93 96 99 101 100 98 94
CAD per EUR 1.369 1.371 1.302 1.403 1.336 1.340 1.311 1.250 1.202 1.214 1.206 1.235 1.277
CAD per GBP 1.58 1.541 1.590 1.617 1.558 1.576 1.618 1.582 1.561 1.618 1.652 1.691 1.749
11
March 16, 2011
EURO
The EUR has performed much better than we had fore-
EURO
cast so far in 2011, forcing us to abandon our call for the USD per EUR JPY per EUR
EUR/USD to reach parity in the next year, and pushing 1.62 175
170
the big drop in the EUR further into the forecast horizon. 1.58
165
1.54
European officials appear to have done enough to satisfy 160
1.50 155
the markets for now, although we think that there are still 1.46
150
some serious flaws with their plan. Greece still looks to be 1.42
145
140
insolvent to us, but that issue may not rear its head until 1.38 135
130
closer to 2013, when Greece will be forced to start borrow- 1.34
125
ing in the markets again. 1.30 120
1.26 USD per EUR 115
ECB President Trichet’s most recent press conference 110
1.22 JPY per EUR
also helped to support the EUR, as he used the “serious 1.18
105
100
vigilance” (with respect to inflation) wording that typically Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
signals a rate hike in the next meeting or two. German-US Source: Federal Reserve Bank of New York/Haver Analytics
2-year rate spreads pushed through 100bps this month for the
first time since the very beginning of 2009 as markets pulled
forward rate hike timing for the ECB. Despite the pull-back TRADE-WEIGHTED EURO
in energy prices from their peaks earlier this month, with
Index: 2000 = 100
Brent crude oil prices still well north of $100/bbl, the ECB 150
looks almost certain to hike rates in April or May. 145
Through the remainder of 2011 and 2012 we still see 140

EUR/USD falling, just not quite a steeply as we did before. 135
There are still a lot of things that could go wrong in the euro
130
zone, from the final details of the euro area deal at the end of
March to the stress tests later this spring to Ireland imposing 125
haircuts on its senior bank debt at some point. And the list 120
goes on. However, having the ECB deliver a couple of rate 115
hikes this year (while the Fed is on hold) should limit the 110
extent of the EUR’s losses, with EUR/USD falling to 1.25 03 04 05 06 07 08 09 10 11
by the end of 2011. *Nominal broad effective exchange rate


416-982-7784
EURO FUNDAMENTALS
Interest Rate Spreads N Business Cycle N
Inflation Differential N Fiscal Balances –
Current Account + Politics –
EURO OUTLOOK
Spot Price 2010 2011 2012
USD per EUR 1.394 1.351 1.224 1.363 1.338 1.380 1.350 1.300 1.250 1.250 1.230 1.210 1.200
JPY per EUR 112 126 108 114 109 117 122 120 119 123 121 121 120
GBP per EUR 0.867 0.890 0.819 0.868 0.857 0.850 0.810 0.790 0.770 0.750 0.730 0.730 0.730
CAD per EUR 1.369 1.371 1.302 1.403 1.336 1.340 1.311 1.250 1.202 1.214 1.206 1.235 1.277
12
March 16, 2011
JAPANESE YEN
The JPY has been relatively steady to start 2011, with
JAPANESE YEN
USD/JPY trading in an 80.50 to 84 range so far this year.
JPY per USD JPY per EUR
However, what happens going forward has become much 80 100
JPY per USD 106
more difficult to predict after the recent natural disaster in 84
112
88 JPY per EUR
Japan, with the full scope of the disaster still unclear. 92 118
Markets are focusing at the moment on the upside risks 96 124
130
to the yen, with USD/JPY having fallen from a high of 83.30 100
136
104
last week to around 80.50 at time of writing, approaching the 142
108
early November low of 80.22. After the Kobe earthquake in 112
148
154
1995, USD/JPY fell from around 100 to a low of just below 116 160
80 (its all-time low) on repatriation flows and insurance 120 166
124 172
payments from foreign insurance companies. However, with
USD/JPY already so close to its all-time low of 79.75, we Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
doubt that officials will allow much more of a move lower Source: Federal Reserve Bank of New York/Haver Analytics
in USD/JPY in the wake of the most recent earthquake

without putting up a fight. We think that currency interven-
tion becomes a much bigger risk around current levels of
TRADE-WEIGHTED YEN
USD/JPY, as the last thing the Japanese economy needs as
Index: 2000 = 100
it attempts to recover is a stronger currency. 120
On the other hand, we’ve seen Japanese government 115
bonds (JGBs) underperform the last few days, as markets 110
seem to be wondering how the already highly-indebted 105

Japanese government is going to pay for the clean-up from 100
the earthquake and tsunami. As estimates for the financial 95
toll of the earthquake begin to roll in, markets may finally 90
put a little more attention on Japan’s weak fiscal position, 85
putting downward pressure on the JPY. 80
Overall we’re still happy with our forecast for USD/ 75
JPY, as rate differentials are likely to continue to move in 03 04 05 06 07 08 09 10 11
the USD’s favour, particularly in the second half of the year *Nominal broad effective exchange rate
as markets start to pay more attention to the timing of the
Fed’s first rate hike. We see USD/JPY climbing into the
mid-90s by the end of 2011.
YEN FUNDAMENTALS
Jacqui Douglas, Senior FX & Macro Strategist Interest Rate Spreads – Business Cycle N
416-982-7784
Inflation Differential – Fiscal Balances –
Current Account + Politics –
JAPANESE YEN OUTLOOK

Spot Price 2010 2011 2012
JPY per USD 81 93 88 84 81 85 90 92 95 98 98 100 100
JPY per EUR 112 126 108 114 109 117 122 120 119 123 121 121 120
JPY per GBP 130 142 132 131 127 138 150 151 154 163 165 166 164
JPY per CAD 82 92 83 81 81 88 93 96 99 101 100 98 94
13
March 16, 2011
U.K. POUND
GBP action over the last few weeks has been choppy, as
BRITISH POUND
markets continue to go back and forth over just how soon the GBP per EUR USD per GBP
0.65 2.20
Bank of England is likely to raise rates. The UK recovery
is progressing well, with the survey data pointing to strong 0.69 2.10
growth ahead. The manufacturing PMI has been sitting at 0.73 2.00
a record high for the last two months now, and the services 0.77 1.90
PMI has moved back decisively above 50 after some weaker 0.81 1.80
readings at the end of 2010. We think there’s some good 0.85 1.70
momentum here, and expect to see a nice rebound in Q1 0.89

GBP per EUR
1.60
GDP from the weakness seen in Q4. 0.93 USD per GBP 1.50
The Bank of England’s February Inflation Report sug- 0.97 1.40
gested that the UK is only one upside inflation surprise away 1.01 1.30
from raising rates, as its inflation projections now point to an Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
equal chance of CPI being above target as below target at the Source: Federal Reserve Bank of New York/Haver Analytics
end of the monetary-policy relevant forecast horizon. This

means that a rate hike from the BoE will be coming in May
(with the next Inflation Report) if not sooner. While GBP/
TRADE-WEIGHTED POUND
USD has pulled back in the last few days on risk aversion,
Index: 2000 = 100
we think that it should turn around when uncertainty dies 115
down, rising further into the 1.60s by the middle of the year. 110
The EUR/GBP call is a little more uncertain in our view, 105
given that the ECB is also going to be raising rates sometime 100
over the next meeting or two. However, we think that GBP 95

will be the bigger beneficiary this year from rising rates as 90
GBP is still looking rather undervalued after getting hit quite 85
hard during the 2008-2009 recession. Furthermore, the UK 80
has a concrete plan to bring its government finances under 75
control, while the euro zone is still dealing with credit rating 70
downgrades and questions over solvency. We expect to see 03 04 05 06 07 08 09 10 11
EUR/GBP move lower through the course of 2011 as GBP *Nominal broad effective exchange rate
continues to recoup some of its recession losses.

416-982-7784
POUND FUNDAMENTALS
Interest Rate Spreads N Business Cycle N
Inflation Differential + Fiscal Balances –
Current Account – Politics –
UNITED KINGDOM POUND

Spot Price 2010 2011 2012
USD per GBP 1.607 1.518 1.495 1.571 1.561 1.624 1.667 1.646 1.623 1.667 1.685 1.658 1.644
GBP per EUR 0.867 0.890 0.819 0.868 0.857 0.850 0.810 0.790 0.770 0.750 0.730 0.730 0.730
CAD per GBP 1.58 1.54 1.59 1.62 1.56 1.58 1.62 1.58 1.56 1.62 1.65 1.69 1.75
14
March 16, 2011
AUSTRALIAN DOLLAR
In forecasting AUD movements we need to distinguish
AUSTRALIAN DOLLAR
between risk sentiment and Australian macro fundamentals.
On sentiment, the AUD is traded as a risk proxy and 1.06
USD per AUD JPY per AUD
120
after the Japan disaster had been pushed to the bottom of
110
the $US0.98-1.02 range traded for the last quarter. Every 0.98
time the news gets worse in Japan we are likely to see more 0.90
100
selling. In addition, Japanese are large holders of AUD and 90

will be adding selling pressure by repatriating funds for sen- 0.82
80
timent/safe haven/need reasons. This will go on for months,
0.74
although it may already have been partially priced in. 70
USD per AUD
On macro fundamentals, the AUD outlook hasn’t 0.66 JPY per AUD 60
changed significantly as a result of Japan’s problems, at least
0.58 50
not so far. Australia has exposure to Japan, but less than at Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
the time of the Kobe earthquake in 1995; and that had no
Source: Federal Reserve Bank of New York/Haver Analytics
long term impact on AUD/USD. Australia’s exports to Japan
are mostly resources, which may fall but then will rebound
on reconstruction; and goods imported from Japan (mostly
TRADE-WEIGHTED AUSTRALIAN DOLLAR
vehicles) can be sourced elsewhere or purchases deferred.
Index: 2000 = 100
If nuclear fallout were to shutter Tokyo, a city of 36m 160
people at the heart of Japan’s services sector which accounts 150
for 70% of GDP, then global growth prospects would dim 140
and the AUD would be lower for longer. But it’s too early 130
to forecast such an event. 120

As the US improves, we expect investors to turn to USD 110
at the expense of AUD. Despite a strong economy and likely 100
rising policy rate differentials later this year, the AUD/USD 90
will steadily fall over 2011-2012. We target $US0.96 and 80
0.85 for 2011 and 2012 respectively. 70
As well as the outcome of Japan’s crisis, other ‘known 03 04 05 06 07 08 09 10 11
unknowns’ that could see the AUD fall below its recent *Nominal broad effective exchange rate
trading range include China (a slump in Chinese imports
set alarms ringing but we think it was the Lunar New Year
effect) as well as the outcomes of MENA political and EUR AUSTRALIAN DOLLAR FUNDAMENTALS
solvency crises. Interest Rate Spreads + Business Cycle +
Inflation Differential + Fiscal Balances +
Roland Randall, Senior Strategist
+65 6500 8047
AUSTRALIAN DOLLAR OUTLOOK

Spot Price 2010 2011 2012
USD per AUD 0.992 0.917 0.841 0.967 1.023 0.990 0.980 0.970 0.960 0.920 0.880 0.840 0.800
JPY per AUD 80.03 85.65 74.35 80.78 83.01 84.15 88.20 89.24 91.20 90.16 86.24 84.00 80.00
AUD per CAD 1.026 1.074 1.118 1.005 0.979 1.040 1.051 1.072 1.083 1.120 1.159 1.167 1.175
NZD per AUD 1.352 1.292 1.228 1.317 1.312 1.338 1.380 1.426 1.455 1.438 1.419 1.400 1.379
15
March 16, 2011
NEW ZEALAND DOLLAR

On the day that the RBNZ cut its policy interest rate by
50bp (more than the market expected) raising Australia’s NEW ZEALAND DOLLAR
cash yield advantage over New Zealand’s to +225bp, the USD per NZD JPY per NZD
0.84 100
AUD/NZD cross rate actually fell. The policy rate was cut in
response to the Christchurch earthquake because an already 0.78 90
weak economy, weakened further by the earthquake, desper-
0.72 80
ately needed help. But FX markets are always a step ahead
and were already betting on when the cut would be reversed 0.66 70
with a hike; and was evidently pleased at the strong action
0.60 60
taken by RBNZ, doing its bit to resurrect economic growth.
USD per NZD
So why do we still forecast AUD/NZD to reach a post- 0.54 JPY per NZD 50
float high of $NZ1.45? First, NZD now has that substantially
bigger (225bp) cash yield disadvantage to AUD. Further, 0.48 40
Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
while markets have priced both RBNZ and RBA to raise
rates by 25bp over the coming year, we think that 25bp Source: Federal Reserve Bank of New York/Haver Analytics
and 100bp respectively is more likely; and that would put

a further 75bp between the two policy interest rates.
Second, we think that the market will soon enough TRADE-WEIGHTED NEW ZEALAND DOLLAR
re-focus on the fact that nearer-term prospects for NZ are 160
Index: 2000 = 100
materially worse than for Australia’s commodity-price- 150

supercharged economy. NZ likely entered a recession at the
140
end of 2010, whereas Australia faces full employment. Wage
130
growth, credit growth, consumer confidence and business
120
confidence are polls apart in these two nations. The difficult
110
reality of New Zealand in 2011 seems to have been passed
100
over for now.
90
While both AUD and NZD are likely to weaken against
80
the USD over 2011, it is lining up to be a year that strongly
favours AUD outperformance relative to NZD. We continue 70
03 04 05 06 07 08 09 10 11
to like our AUD/NZD $NZ1.45 and NZD/USD $US0.66
*Nominal broad effective exchange rate
forecasts for year-end. Further out, 2012 is, hopefully, a Source: Haver Analytics/JP Morgan
wholly positive story for NZD; the economy should begin
to ‘boom’ on the reconstruction effort and interest rates rise.
NEW ZEALAND DOLLAR FUNDAMENTALS
Interest Rate Spreads + Business Cycle N
Roland Randall, Senior Strategist
Inflation Differential + Fiscal Balances N
+65 6500 8047
Current Account – Politics N
NEW ZEALAND DOLLAR OUTLOOK

Spot Price 2010 2011 2012
USD per NZD 0.734 0.710 0.685 0.734 0.780 0.740 0.710 0.680 0.660 0.640 0.620 0.600 0.580
JPY per NZD 59.20 66.31 60.55 61.34 63.29 62.90 63.90 62.56 62.70 62.72 60.76 60.00 58.00
NZD per CAD 1.388 1.387 1.373 1.323 1.284 1.392 1.451 1.529 1.576 1.609 1.645 1.633 1.621
NZD per AUD 1.352 1.292 1.228 1.317 1.312 1.338 1.380 1.426 1.455 1.438 1.419 1.400 1.379
16
March 16, 2011
SWISS FRANC
The Swiss franc has been the top-performing currency
SWISS FRANC
since the last issue of global markets, gaining more than 5%
CHF per EUR CHF per USD
against the USD. This move has been based on risk aversion, 1.20 0.90
with developments in the Middle East and North Africa plus 1.24 0.93
1.28 0.96
the situation in Japan creating strong demand for the safe- 1.32 0.99
haven currency, particularly one that does not belong to a 1.36 1.02
country recovering from once in a lifetime natural disaster. 1.40 1.05

1.44 1.08
USD/CHF has continued to hit fresh cyclical lows in 1.48 1.11
recent days, but EUR/CHF is still a couple of big figures 1.52 1.14
away from the all-time lows reached in December-January. 1.56 1.17

1.60 1.20
CHF per EUR
EUR/CHF has completely ignored the gapping out in 1.64 1.23
CHF per USD
German-Swiss spreads since the middle of February, as the 1.68 1.26
safe-haven demand for CHF has been the dominant driver. Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
But once the tensions fade away, rate spreads may come Source: Federal Reserve Bank of New York/Haver Analytics
back into focus, and tomorrow’s SNB meeting should give
us a better idea of what to expect for Swiss rates. The latest
Reuters poll showed that the median forecast is currently
for the first rate hike to come in September, although a
significant minority (13 of 34 analysts) expect the first rate
rise to come in June.
Our EUR/CHF forecast has been revised along with our
forecast for a stronger EUR/USD profile. We now expect to
see EUR/CHF remain in a 1.30-1.35 range for the bulk of
2011, although the risk remains that we see bursts lower in
EUR/CHF on any increases in market volatility.

416-982-7784
SWISS FRANC OUTLOOK

Spot Price 2010 2011 2012
CHF per USD 0.917 1.051 1.077 0.983 0.934 0.942 1.000 1.031 1.056 1.040 1.057 1.058 1.050
CHF per EUR 1.278 1.420 1.318 1.340 1.251 1.300 1.350 1.340 1.320 1.300 1.300 1.280 1.260
CHF per CAD 0.934 1.036 1.013 0.955 0.936 0.970 1.030 1.072 1.098 1.071 1.078 1.037 0.987
17
March 16, 2011
SUMMARY FIXED INCOME TABLE

Spot Price 2010 2011 2012
United States
Fed Funds Target Rate (%) 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.25 0.50 1.00 1.25
3-mth T-Bill Rate (%) 0.09 0.16 0.18 0.16 0.12 0.10 0.15 0.20 0.20 0.30 0.55 0.80 1.35
10-yr-2-yr Govt. Spread (%) 2.68 2.81 2.32 2.09 2.70 2.80 3.00 3.10 3.05 2.90 2.80 2.50 2.30
Canada
Overnight Target Rate (%) 1.00 0.25 0.50 1.00 1.00 1.00 1.00 1.50 2.00 2.25 2.50 2.75 3.00
3-mth T-Bill Rate (%) 0.94 0.29 0.51 0.88 1.04 1.00 1.05 1.50 2.00 2.25 2.50 2.80 3.05
10-yr-2-yr Govt. Spread (%) 1.55 1.83 1.69 1.38 1.44 1.55 1.60 1.55 1.45 1.45 1.25 0.90 0.95
United Kingdom
Bank Rate Target (%) 0.50 0.50 0.50 0.50 0.50 0.50 0.75 1.00 1.25 1.50 2.00 2.50 3.00
3-mth T-Bill Rate (%) 0.62 0.57 0.54 0.57 0.57 0.65 1.00 1.20 1.45 1.70 2.20 2.70 3.20
2-yr Gilt Yield (%) 1.23 1.16 0.75 0.65 1.10 1.25 1.85 2.10 2.35 2.45 2.70 3.10 3.50
5-yr Gilt Yield (%) 2.29 2.71 2.07 1.61 2.20 2.35 3.05 3.25 3.50 3.65 3.80 4.00 4.25
10-yr Gilt Yield (%) 3.53 3.94 3.36 2.95 3.40 3.50 3.90 4.10 4.30 4.30 4.45 4.70 4.80
30-yr Gilt Yield (%) 4.28 4.53 4.17 3.90 4.19 4.30 4.70 4.80 4.90 4.95 4.95 4.85 4.70
10-yr-2-yr Gilt Spread (%) 2.30 2.78 2.61 2.30 2.30 2.25 2.05 2.00 1.95 1.85 1.75 1.60 1.30
Australia
Cash Target Rate (%) 4.75 4.00 4.50 4.50 4.75 4.75 5.00 5.25 5.75 5.75 6.00 6.00 6.00
3-mth Bank Bill Rate (%) 4.93 4.43 4.91 4.89 4.98 5.00 5.25 5.50 5.75 6.00 6.00 6.00 6.00
10-yr-3-yr Govt. Spread (%) 0.49 0.51 0.68 0.21 0.27 0.55 0.40 0.30 0.05 0.05 0.00 0.00 0.00
New Zealand
Cash Target Rate (%) 2.50 2.50 2.75 3.00 3.00 2.50 2.50 2.50 2.50 2.75 3.00 3.25 3.50
3-mth T-Bill Rate (%) 2.57 3.90 2.70 3.00 3.25 2.70 2.70 2.70 2.70 2.95 3.20 3.45 3.70
10-yr-3-yr Govt. Spread (%) 2.14 1.43 1.17 1.20 1.88 2.10 2.00 1.90 1.75 1.65 1.20 0.95 0.95
18
March 16, 2011
SUMMARY FOREIGN EXCHANGE TABLE

Spot Price 2010 2011 2012
Exchange rate to U .S . dollar
Japanese yen JPY per USD 80.67 93 88 84 81 85 90 92 95 98 98 100 100
Euro USD per EUR 1.394 1.351 1.224 1.363 1.338 1.380 1.350 1.300 1.250 1.250 1.230 1.210 1.200
U.K. pound USD per GBP 1.607 1.518 1.495 1.571 1.561 1.624 1.667 1.646 1.623 1.667 1.685 1.658 1.644
Swiss franc CHF per USD 0.917 1.051 1.077 0.983 0.934 0.942 1.000 1.031 1.056 1.040 1.057 1.058 1.050
Canadian dollar CAD per USD 0.982 1.015 1.064 1.029 0.998 0.971 0.971 0.962 0.962 0.971 0.980 1.020 1.064
Australian dollar USD per AUD 0.992 0.917 0.841 0.967 1.023 0.990 0.980 0.970 0.960 0.920 0.880 0.840 0.800
NZ dollar USD per NZD 0.734 0.710 0.685 0.734 0.780 0.740 0.710 0.680 0.660 0.640 0.620 0.600 0.580
Exchange rate to Euro

U.S. dollar USD per EUR 1.394 1.351 1.224 1.363 1.338 1.380 1.350 1.300 1.250 1.250 1.230 1.210 1.200
Japanese yen JPY per EUR 112 126 108 114 109 117 122 120 119 123 121 121 120
U.K. pound GBP per EUR 0.867 0.890 0.819 0.868 0.857 0.850 0.810 0.790 0.770 0.750 0.730 0.730 0.730
Swiss franc CHF per EUR 1.278 1.420 1.318 1.340 1.251 1.300 1.350 1.340 1.320 1.300 1.300 1.280 1.260
Canadian dollar CAD per EUR 1.369 1.371 1.302 1.403 1.336 1.340 1.311 1.250 1.202 1.214 1.206 1.235 1.277
Australian dollar AUD per EUR 1.405 1.473 1.456 1.410 1.308 1.394 1.378 1.340 1.302 1.359 1.398 1.440 1.500
NZ dollar NZD per EUR 1.899 1.903 1.787 1.857 1.715 1.865 1.901 1.912 1.894 1.953 1.984 2.017 2.069
Exchange rate to Japanese yen

U.S. dollar JPY per USD 80.67 93 88 84 81 85 90 92 95 98 98 100 100
Euro JPY per EUR 112.4 126 108 114 109 117 122 120 119 123 121 121 120
U.K. pound JPY per GBP 130 142 132 131 127 138 150 151 154 163 165 166 164
Swiss franc JPY per CHF 88.0 88.8 82.1 85.0 86.8 90.2 90.0 89.3 90.0 94.2 92.7 94.5 95.2
Canadian dollar JPY per CAD 82.1 92.0 83.1 81.2 81.3 87.6 92.7 95.7 98.8 100.9 100.0 98.0 94.0
Australian dollar JPY per AUD 80.0 85.6 74.4 80.8 83.0 84.2 88.2 89.2 91.2 90.2 86.2 84.0 80.0
NZ dollar JPY per NZD 59.2 66.3 60.5 61.3 63.3 62.9 63.9 62.6 62.7 62.7 60.8 60.0 58.0
Exchange rate to Canadian dollar

U.S. dollar USD per CAD 1.018 0.985 0.940 0.972 1.002 1.030 1.030 1.040 1.040 1.030 1.020 0.980 0.940
Japanese yen JPY per CAD 82 92 83 81 81 88 93 96 99 101 100 98 94
Euro CAD per EUR 1.369 1.371 1.302 1.403 1.336 1.340 1.311 1.250 1.202 1.214 1.206 1.235 1.277
U.K. pound CAD per GBP 1.58 1.54 1.59 1.62 1.56 1.58 1.62 1.58 1.56 1.62 1.65 1.69 1.75
Swiss franc CHF per CAD 0.934 1.036 1.013 0.955 0.936 0.970 1.030 1.072 1.098 1.071 1.078 1.037 0.987
Australian dollar AUD per CAD 1.026 1.074 1.118 1.005 0.979 1.040 1.051 1.072 1.083 1.120 1.159 1.167 1.175
NZ dollar NZD per CAD 1.388 1.387 1.373 1.323 1.284 1.392 1.451 1.529 1.576 1.609 1.645 1.633 1.621
f: Forecast by TD Bank Group as at Mar. 16, 2011; All forecasts are for end of period
Source: Federal Reserve Bank of New York, Bloomberg, TDBG
This report is provided by TD Economics for customers of TD Bank Group. It is for information purposes only and may not be appropriate
for other purposes. The report does not provide material information about the business and affairs of TD Bank Group and the members of
TD Economics are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this report
has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. The report contains economic
analysis and views, including about future economic and financial markets performance. These are based on certain assumptions and other
factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank
and its affiliates and related entities that comprise TD Bank Group are not liable for any errors or omissions in the information, analysis or
views contained in this report, or for any loss or damage suffered.

Line in The Sand: Good and Bad Inflation

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Line in The Sand: Good and Bad Inflation

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LONDON TORONTO NEW YORK SINGAPORE

HIGHLIGHTS THE LINE IN THE SAND: DISTINGUISHING BETWEEN

China, Columbia, Hungary, India, Indonesia, Korea, Peru,

less likely that there will be significant pass-through to other 10

declined. However, with nominal interest rates declining 20

For central banks in developed market economies, lower

U.S. FIXED INCOME

U .S . FIXED INCOME OUTLOOK

CANADIAN FIXED INCOME

CANADIAN FIXED INCOME OUTLOOK

U.K. FIXED INCOME

opinion. But the shock would now would be getting to Au-

BoE Governor Mervyn King in March described UK 3 3

real rates as “unsustainably low.” This does provide an out

what the MPC wants.

U .K . FIXED INCOME OUTLOOK

AUSTRALIAN FIXED INCOME

Outsized demand for ACGBs has been reflected in recent 0 0

AUSTRALIA FIXED INCOME OUTLOOK

NEW ZEALAND FIXED INCOME

across the curve. Swaps are not expecting any adjustment 1 1

NEW ZEALAND FIXED INCOME OUTLOOK

down the road than we had suspected. Markets seem to be

a little more attention to its superior growth prospects. We 105

ing that better US economic data should lead to a stronger 80

USD more often, returning to a more normal relationship. 75

It will likely be a rather long time though before the USD 70

1.0 for the bulk of the next year. 0.88 1.136

in USD/CAD, as the recent market turmoil around develop- 0.80 1.250

CAD and possibly exacerbating any move higher. The more

Canada is likely to begin another series of rate hikes in the 150

relationship will help to put a floor under USD/CAD, and 80

CANADIAN DOLLAR OUTLOOK

looks almost certain to hike rates in April or May. 145

Through the remainder of 2011 and 2012 we still see 140

by the end of 2011. *Nominal broad effective exchange rate

Jacqui Douglas, Senior FX & Macro Strategist

in USD/JPY in the wake of the most recent earthquake

On the other hand, we’ve seen Japanese government 115

bonds (JGBs) underperform the last few days, as markets 110

seem to be wondering how the already highly-indebted 105

JAPANESE YEN OUTLOOK

momentum here, and expect to see a nice rebound in Q1 0.89

end of the monetary-policy relevant forecast horizon. This

The EUR/GBP call is a little more uncertain in our view, 105

over the next meeting or two. However, we think that GBP 95

Jacqui Douglas, Senior FX & Macro Strategist

UNITED KINGDOM POUND

selling. In addition, Japanese are large holders of AUD and 90

people at the heart of Japan’s services sector which accounts 150

to forecast such an event. 120

AUSTRALIAN DOLLAR OUTLOOK

NEW ZEALAND DOLLAR

and 100bp respectively is more likely; and that would put

materially worse than for Australia’s commodity-price- 150

NEW ZEALAND DOLLAR OUTLOOK

country recovering from once in a lifetime natural disaster. 1.40 1.05

away from the all-time lows reached in December-January. 1.56 1.17

Jacqui Douglas, Senior FX & Macro Strategist

SWISS FRANC OUTLOOK

SUMMARY FIXED INCOME TABLE

SUMMARY FOREIGN EXCHANGE TABLE