David_Woo

USD: Vicious Circle David Woo Head of Global FX Strategy, Barclays Capital

America is running both expansionary monetary and loose fiscal policies 15 Real Fed Funds rate

Budget balance as a share of GDP

percent

10

5

0

-5

2

Mar-07

Mar-05

Mar-03

Mar-01

Mar-99

Mar-97

Mar-95

Mar-93

Mar-91

Mar-89

Mar-87

Mar-85

Mar-83

Mar-81

Mar-79

Mar-77

Mar-75

Mar-73

-10

Periods of such policy stance were always characterized by a weak USD periods of negative real Fed Funds rate and budget balance<-3% of GDP real t rade-weight ed USD index against major currencies 140 130 120 110 100 90 80

3

Mar-07

Mar-05

Mar-03

Mar-01

Mar-99

Mar-97

Mar-95

Mar-93

Mar-91

Mar-89

Mar-87

Mar-85

Mar-83

Mar-81

Mar-79

Mar-77

Mar-75

Mar-73

70

Eurozone exporters may be suffering from the strengthening euroâ&#x20AC;Ś.

US export to eurozone (USD, 6m/ 6m, SA, AR)

40

eurozone export to US (EUR, 6m/ 6m, SA, AR) 30

percent

20 10 0 -10 -20

4

Jan-08

Jan-07

Jan-06

Jan-05

Jan-04

Jan-03

Jan-02

Jan-01

Jan-00

Jan-99

Jan-98

Jan-97

Jan-96

Jan-95

-30

…but euro’s rise against the USD has been supported by evolving relative fundamentals 1.6

real eur/ usd

2.5

real int diff

1.6

real eur/ usd

3

fiscal diff

2

1.5

1.5

2

1.5 1.4 1 1.3 1.2

0.5

1.3

0

1.2

-0.5

1.1

1.4 1

0

1.1

-1

-1

5

Q1-08

Q1-07

Q1-06

Q1-05

-3 Q1-04

0.8 Q1-03

Q1-08

Q2-07

Q3-06

Q4-05

Q1-05

Q2-04

Q3-03

Q4-02

Q1-02

Q2-01

Q3-00

Q4-99

-2.5 Q1-99

0.8

Q1-02

-2

-2

0.9

Q1-01

0.9

1

Q1-00

-1.5

Q1-99

1

EUR/USD uptrend and oil uptrend are becoming mutually reinforcing EUR/ USD (left axis)

1.62

Brent crude 6-month futures (right axis)

120 110

40

1.57 100

1.47

90

1.42 80

1.37 1.32

70

20 USD per barrel

1.52

52 week rolling correlation between EUR/ USD and Brent futures

60

per cent

1.67

0

-20 -40

1.27

6

28/ 12/ 2007

28/ 12/ 2006

28/ 12/ 2005

28/ 12/ 2004

28/ 12/ 2003

28/ 12/ 2002

28/ 12/ 2001

28/ 12/ 2000

28/ 12/ 1999

2/ 4/ 08

2/ 1/ 08

2/ 10/ 07

2/ 7/ 07

2/ 4/ 07

2/ 1/ 07

2/ 10/ 06

2/ 7/ 06

2/ 4/ 06

50 2/ 1/ 06

1.17

-60 28/ 12/ 1998

60

1.22

USDâ&#x20AC;&#x2122;s vicious circle

7

This is the first time in twenty years that Eurozone inflation is rising while the Fed is cutting rates 5

Fed rate cut cycle

eurozone inflation (y/ y)

4.5 4 3.5 3 2.5 2 1.5 1 0.5

8

Jan-08

Jan-07

Jan-06

Jan-05

Jan-04

Jan-03

Jan-02

Jan-01

Jan-00

Jan-99

Jan-98

Jan-97

Jan-96

Jan-95

Jan-94

Jan-93

Jan-92

0

Increase in oil prices has prevented an improvement of US trade deficit, despite US slowdown and USD weakness Breakdown of US trade balance

10 0

-20 -30 -40 -50 -60

Industrial supplies, excl petroleum goods

Consumer goods

Auto and parts

Food, feeds, and beverages

Other goods Jan-08

Jan-07

Jan-06

Jan-05

Jan-04

Jan-03

Jan-02

Jan-01

Jan-00

Jan-99

Jan-98

Jan-97

Jan-96

Jan-95

Jan-94

Jan-93

Jan-90

Jan-92

petroleum goods

-70

9

Capital goods

Jan-91

bln of USD

-10

Preconditions for a sustainable USD recovery • Sharp slowdown in China: such an event would dampen global marginal demand for oil, and, by triggering a correction of oil prices, break the vicious circle.

• Big correction of the US equity market: there are no signs of any decoupling of ROW from US financial markets. Synchronized equity sell-off would be followed by synchronized global economic slowdown • Visible negative knock-on effect of USD decline on US asset prices: If further USD decline were to reduce appetite for US assets and drive down US asset prices, then US policy makers may be forced to change their ways 10

But if China is slowing at all, it is slowing very gradually 100

sales of vehicles (y/ y)

80

China's crude oil imports (y/ y)

80

sales of vehicles (y/ y, 3-m MA)

3-m MA

60

60 40 percent

percent

40

20

20 0

0

-20 -20

-40

11

Jan-07

Jan-06

Jan-05

Jan-04

Jan-03

Jan-02

Jan-01

-60 Jan-00

Jan-08

Jan-07

Jan-06

Jan-05

Jan-04

Jan-03

Jan-02

Jan-01

Jan-00

Jan-99

Jan-98

-40

Meanwhile, global oil inventory remains tight 360

US crude inventory

240

US gasoline stock

350 2008

230

340 330

2007

2006

2005

220

320 210

310 300

200

290 2008

2007

2006

2005

190

280 180

270 1

12

7

13

19

25 31 week

37

43

49

1

5

9 13 17 21 25 29 33 37 41 45 49 week

Bond vigilantes are suppressed by inelastic demand from reserve managers 80

140

160

Spread between 1 year IRS 9 year forward and 1 year IRS 4 year forward

140

Foreign official sector accumulation of USD assets (4Q-MA, left axis) 120

Foreign official sector accumulation of USD assets/ Current account (4Q-MA, right axis)

120 100

60 50

60 40

80

percent

80

bln of USD

basis points

100

70

40 60

30

20 40

20

0

13

Q3-07

Q4-06

Q1-06

Q2-05

Q3-04

Q4-03

Q1-03

0 Q2-02

0 Q3-01

10

Q4-00

20

Q1-00

01/ 05/ 2008

01/ 01/ 2008

01/ 09/ 2007

01/ 05/ 2007

01/ 01/ 2007

01/ 09/ 2006

01/ 05/ 2006

01/ 01/ 2006

01/ 09/ 2005

01/ 05/ 2005

01/ 01/ 2005

01/ 09/ 2004

01/ 05/ 2004

01/ 01/ 2004

-20

Positioning and sentiment indicate scope for further USD rally in the short-term is limited

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