The Recession, The Ox And Obama

www.td.com/economics

TD Economics Global Markets February 10, 2009

THE RECESSION, THE OX AND OBAMA With the arrival of the hard month of February, it seems that the weather patterns serve as a worthy barometer of economic and (and some) financial market trends. Though not ‘new’ news, the G7 economies have fallen off a cliff, as the economic data continues to disappoint in a big way. The unravelling in the global economy has been so virulent that it has even caused the IMF to significantly lower their expectations for global growth for 2009 to just 0.5%. Advanced economies are predicted to fall by 2% in 2009, while emerging markets that are used to growth well in excess of 5% are poised to grow only 3% this year. It seems that as we usher in the Chinese New Year, which is the Year of the Ox, the global recession is likely to be just as stubborn as its namesake.

CONTRIBUTION TO U.S. GDP GROWTH, Q4-2008 Per cent -3.8

Real GDP

Personal Cons.

-2.5

-0.9

Residential Inv.

Net Trade

0.1

Non-Farm Inventories

1.3

-5

-4

-3

-2

-1

0

1

2

Source: Bureau of Economic Analysis

Fed Tries to Take the Edge Off

With the fed funds rate having been lowered to a range of 0.00% – 0.25% in December 2008, there was clearly little room for manoeuvring at the January 28 FOMC decision. Aside from maintaining the statement that “economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time”, there were a couple important subtleties in the statement. This was the first

time that the Fed admitted downside risk to the inflation outlook. Certainly, the information on prices revealed in the fourth quarter GDP report suggests that price pressures are nowhere to be found. And aside from the technicalities that the Fed delivered on ongoing balance sheet policies, there was a lot of interest on what the FOMC had to say about a possible foray into the Treasury market. The statement noted that “the Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.” The key difference in this sentence compared to December is the use of the phrase prepared to buy (in January) compared to evaluating the potential benefits (in December). The change in wording shows that the Fed is getting closer and is simply waiting for the right time. Facilitating liquidity in the market and easing tight credit

CONTENTS Lead Article: The Recession, the Ox and Obama . . . 1 U.S. Fixed Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Canadian Fixed Income . . . . . . . . . . . . . . . . . . . . . . . . . 5 U.S. Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Canadian Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Japanese Yen . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Euro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 U.K. Pound . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Australian Dollar/New Zealand Dollar . . . . . . . . . . . . 11 Swiss Franc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Summary Foreign Exchange Table . . . . . . . . . . . . . . 13

Global Markets

1

February 10, 2009

www.td.com/economics is still the name of the game. And the commitment to do so was reaffirmed in early February with the announcement that it will extend the shelf life of five emergency loan programs to October 30, 2009 as “substantial strains” remain in the credit markets. Similar extensions on swap lines between the Fed and other central banks were also extended. Those substantial strains in the credit market were detailed in the recent Senior Loan Officer Survey, which was conducted between December 31, 2008 and January 13, 2009. The key theme in the survey was that conditions got slightly better on the credit extension front, but took a turn for the worst on the credit demand front.

SENIOR OFFICER LOAN SURVEY - CREDIT CONDITIONS FOR LARGE/MED-SIZED FIRMS 100

%

7.3 7.1

Unemployment Rate (right)

6.9 50

6.7 6.5

0 6.3 -50

6.1 5.9

-100 5.7 -150

5.5 Jul.07

Jan.08

Jul.08

Jan.09

Source: Statistics Canada

Global Markets

40

40

20

20

0

0

-20

-20

-40

-40

-60

-60 -80 03

04

05

06

07

08

09

to use the remaining funds from last year’s TARP funds. As we go to print, the substance of the plan revolves around the ability to make selective capital injections, to have the authority to dismantle troubled institutions, to have more consumer lending and foreclosure support, and extending guarantees on bank debt. It is still, however, uncertain whether the “bad bank” idea will get traction or whether it will be usurped by the idea of “ring fencing” to guarantee those bad assets within the originating institution. Needless to say, the growing demand for stimulus clearly raises the need for additional debt issuance. And in some sectors of the yield curve, there had already been evidence of significant issuance. This week alone, the Treasury plans to auction $32 billion in three year bonds, in addition to $21 billion of 10-yr notes and $14 billion of 30-yr bonds. And this is just a sampling, and keeps the issue of bond supply concerns in focus, especially in light of the view put forth by the CBO that the U.S. federal budget deficit could be 8.3% of GDP this year. U.S. financial markets will likely remain under pressure against such a dire economic backdrop. Near term, with the fed funds rate unlikely to budge from the 0.00%— 0.25% range, and the Fed’s admission that it is willing to purchase longer dated Treasuries outrights suggests a period where yields will be low and the curve will be flat, despite the substantial bond issuance. And as global investors slowly regain their bearings, the safe haven bid is starting to come off the U.S. dollar. Moreover, with bleak economic fundamentals, investors are unlikely to find the dollar an attractive bet for quite

M/M Net Job Change (left)

Jan.07

60

Source: Federal Reserve Board

Thousands of Jobs

Jul.06

80

% of banks reporting inc. demand for loans

02

CANADIAN LABOUR MARKET

Jan.06

100

60

-80

Recent economic data has been a call to action for the government to get the second stimulus package rolling. In January, the U.S. economy lost 598K jobs, which was the large single monthly decline since Dec 1974. Nevertheless, the unemployment rate is 7.6% and poised to rise further. With data like this, and President Obama now formally in power, the focus is on how quickly the government can get a stimulus package through the Congress. But the size of the stimulus bill remains an issue of contention between the Democrats and the Republicans, as it continues to swell. Current estimates are in the neighborhood of $800billion, with the recent addition of an $18.5 billion tax credit for homebuyers. Moreover, the Treasury will soon unveil how it expects

100

% % of banks tightening loan standards

80

A New Captain at the Helm

150

%

2

February 10, 2009

www.td.com/economics some time. As such, we think the greenback will face a rather bearish environment in the coming quarters.

carefully economic and financial developments in judging to what extent further monetary stimulus will be required.” With rates already at historical lows, there is little further room to ease. As such, we forecast the Bank of Canada to deliver just one more 50bps rate cut on March 3, lowering the overnight rate to 0.50%. It is unlikely that rates will be cut further, given the numerous technical problems it will create in money markets and some financial instruments linked to the overnight rate. Aside from the monetary stimulus already in the pipeline, the recent federal budget released on January 27 delivered a healthy dose of fiscal stimulus. Increased spending and tax cuts on a number of fronts led the Finance Department to project the budget deficit to widen to $33.7 billion in FY 2009-2010. The deficit for FY2010-2011 is expected to be $30 billion. Running budget deficits is surely anathema to Canadians, but the severity of the global recessionary headwinds argues for countercyclical spending. Monetary policy easing will push rates at the short end of the Canadian bond market lower. Looser fiscal policy means robust issuance in Canada which will likely meet with sufficient demand, allowing yields across the curve to follow suit. Continued softness in commodity prices as spare capacity continues to build will remain a key drag on the Canadian dollar in the near term, though the prospect of U.S. dollar weakness as 2009 unfolds and a slow rebound in commodity prices could allow the loonie to appreciate modestly.

Spilling Red Ink in Canada

Recessionary headwinds from the U.S. have now gripped Canada. This has not only been apparent in the economic data, but also the increasingly dour rhetoric that has come out of both the Bank of Canada and the Federal government. And while fourth quarter GDP data will not be released until early March, there is already a lot of pessimism built in to the forecast. In February, the Canadian economy posted a record loss of 129K jobs, and the unemployment rate is now 7.2%. And other data also points to ongoing deterioration almost across the board. On the domestic side, weak housing starts, auto sales and consumer spending have kept consumption under pressure. On the external side, the deep recession in the U.S. bodes poorly for Canada’s manufacturing sector. The Bank of Canada continues to ease rates. At its most recent meeting on January 20, it cut another 50bps from the overnight rate leaving it at 1.00%.The statement that the Bank of Canada released was quite dovish. The communiqué cited that global economic conditions have deteriorated since December as a result of the intensifying financial crisis. Moreover, global confidence continues to erode as a result of deep uncertainty about the global economy. Against this backdrop the Bank left the door open for further rate cuts by saying that it “will continue to monitor

Charmaine Buskas, Senior Economics Strategist 416-982-3297

Global Markets

3

February 10, 2009

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U.S. FIXED INCOME The past month saw the U.S. Treasury bond market sell off fairly substantially, with the U.S. 2-year yield higher by 22 basis points and the U.S. 10-year yield higher by 54 basis points to 3.07%. In turn, the slope of the yield curve between the 2-year and 10-year sectors has steepened by a fairly substantial 32 basis points. Contributing to this market move has been a renewed sense of concern about the ongoing supply of government bonds, combined with a tentative improvement in market confidence despite an ongoing flurry of dismal economic figures. Now that the U.S. target for the fed funds rate has hit rock-bottom at 0.00-0.25%, there is little wiggle room left for the Federal Reserve with regard to traditional monetary policy. Similarly, there is little debate in the market on this subject – the fed funds rate cannot go any lower, and the Fed has committed to keeping it low for “some time”. Focus has shifted to a handful of other subjects, including inflation expectations, bond supply, and unorthodox Fed measures. Although TD does not expect true deflation (defined as deflation with both breadth and persistence) to hit the U.S., it is clear that inflation is falling rapidly. Markets have arguably allocated too much attention to the printing of money at the Fed: this is unlikely to spur inflation in the current environment, and it can be rapidly unwound if conditions were to change. In turn, bond yields, especially at the long end, can afford to fall. Bond supply is clearly a pressing issue in the U.S., and presents the greatest upside risk to long-dated bond yields. However, the substantial bond issuance of the past six months has been met by ample demand. And although public sector issuance is sharply up, overall issuance is no higher than normal due to a private sector drought, especially since savings rates (and thus investible funds) are

rising. Furthermore, the U.S. Federal Reserve has readily mused about possibly buying long-dated Treasuries directly to pull down borrowing rates. This is a time of extreme uncertainty both in the bond market and the world. TD believes that the balance of risks tilt toward notably lower government bond yields in the U.S., especially at the longer-end of the curve. This means that the yield curve should flatten, too. Eventually, bond yields will have to rise as the recession is exited, but this is a discussion that remains premature given evident problems everywhere. Eric Lascelles, Chief Economics and Rates Strategist 416-982-8979 U.S. 3-MONTH T-BILL RATES & 10-YEAR GOVERNMENT BOND YIELDS %

6

%

6

Forecast

10-yr Gov't Bond Yield 5

5

4

4

3

3

2

2

1

1

3-mo. T-Bill yield 0

0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Actual data to: Q4 2008; Forecast by TD Economics as at Feb 2009; Source: Bank of Canada/Haver Analytics

U.S. FIXED INCOME OUTLOOK Spot Rate Fed Funds Target Rate (%)

2008

2009

2010

2/9/2009

Q1

Q2

Q3

Q4

Q1F

Q2F

Q3F

Q4F

Q1F

Q2F

Q3F

Q4F

0.00

2.25

2.00

2.00

0.00

0.00

0.00

0.00

0.00

0.00

0.50

1.00

1.50

3-mth T-Bill Rate (%)

0.29

1.37

1.81

0.75

0.09

0.20

0.20

0.30

0.30

0.50

1.00

1.50

2.25

2-yr Govt. Bond Yield (%)

1.03

1.58

2.62

1.96

0.76

0.80

0.75

1.00

1.10

1.50

1.75

1.95

2.15

5-yr Govt. Bond Yield (%)

2.00

2.44

3.33

2.98

1.55

1.50

1.45

1.70

1.80

2.10

2.35

2.45

2.60

10-yr Govt. Bond Yield (%)

3.03

3.41

3.97

3.82

2.21

2.30

2.25

2.50

2.55

2.75

2.95

3.05

3.15

30-yr Govt. Bond Yield (%)

3.75

4.29

4.52

4.31

2.68

3.00

2.90

3.10

3.10

3.30

3.55

3.65

3.80

10-yr-2-yr Govt. Spread (%)

2.00

1.83

1.35

1.86

1.45

1.50

1.50

1.50

1.45

1.25

1.20

1.10

1.00

f: Forecast by TD Economics as at Feb 2009; All forecasts are for end of period. Source: Bloomberg, TD Economics

Global Markets

4

February 10, 2009

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CANADIAN FIXED INCOME primarily upon one’s forecast for U.S. yields, plus a handful of Canada-specific considerations. Given the TD forecast for significantly lower U.S. yields, it is probable that Canadian government yields will also decline in the coming weeks and months so as to better align with a rockbottom overnight rate, a return to deflation fears, and – very tentatively – a burgeoning appetite for Canadian bonds from Asian investors. The yield curve could flatten again in the near term. Relative to the U.S., Canadian bonds should underperform in the near future given the likelihood of a big U.S. rally. But as conditions normalize later in 2009 and beyond, Canadian bonds could begin to outperform again. Eric Lascelles, Chief Economics and Rates Strategist 416-982-8979

Despite another 50 basis point rate cut by the Bank of Canada in January, Canadian bonds followed the U.S. directional lead and sold off modestly over the past month. The Canadian 2-year bond yield rose by a cautious 4 basis points, while the 10-year yield rose by a modest 16 basis points. In turn, the Canadian yield curve steepened slightly, and managed to notably outperform the U.S. In the 10year sector, the Canadian outperformance was by almost 40 basis points – a substantial sum. The general motivation for higher bond yields in Canada has been growing inflation concerns, bond supply fears, and a traditional inclination to track U.S. market moves. However, these worries have each been less profound in Canada than in the U.S. For instance, whereas the U.S. Federal Reserve has printed money to stimulate the economy, this same step has not been taken in Canada, and as such represents a side-stepping of an important inflation concern. On a similar note, while Canadian bond issuance is very clearly at a record high, it still pales in comparison to the U.S. program. TD forecasts that the Bank of Canada will cut the overnight rate by a further 50 basis points in March to a 0.50% level. Although further easing to 0.00% territory as in the U.S. cannot be completely discounted, it is not clear that Canada should want to take such a drastic step (with potentially burdensome complications) given that the root of the problem lies outside of Canada’s borders. The market has a broadly similar view of the situation. Presently, the outlook for Canadian bond yields depends

CANADIAN 3-MONTH T-BILL RATES & 10-YEAR GOVERNMENT BOND YIELDS %

6

%

6

Forecast

10-yr Gov't Bond Yield 5

5

4

4

3

3

2

2

3-mo. T-Bill yield 1

1

0

0 2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Actual data to: Q4 2008; Forecast by TD Economics as at Feb 2009; Source: Federal Reserve Board/Haver Analytics

CANADIAN FIXED INCOME OUTLOOK Spot Rate Overnight Target Rate (%)

2008

2009

2010

2/9/2009

Q1

Q2

Q3

Q4

Q1F

Q2F

Q3F

Q4F

Q1F

Q2F

Q3F

Q4F

1.00

3.50

3.00

3.00

1.50

0.50

0.50

0.50

0.50

0.50

1.00

1.50

2.00

3-mth T-Bill Rate (%)

0.76

1.97

2.52

1.79

0.80

0.70

0.70

0.80

0.90

1.00

1.50

1.80

2.60

2-yr Govt. Bond Yield (%)

1.16

2.62

3.25

2.78

1.10

1.10

1.05

1.20

1.25

1.65

1.90

2.10

2.30

5-yr Govt. Bond Yield (%)

1.96

2.91

3.46

3.16

1.69

1.70

1.65

1.85

1.90

2.20

2.45

2.55

2.70

10-yr Govt. Bond Yield (%)

3.07

3.44

3.73

3.76

2.68

2.65

2.60

2.60

2.65

2.85

3.00

3.10

3.15

30-yr Govt. Bond Yield (%)

3.80

3.94

4.08

4.23

3.46

3.35

3.15

3.15

3.10

3.25

3.45

3.55

3.60

10-yr-2-yr Govt. Spread (%)

1.91

0.82

0.48

0.98

1.58

1.55

1.55

1.40

1.40

1.20

1.10

1.00

0.85

Canada-U.S. Spreads 3-mth T-Bill Rate (%)

0.47

0.60

0.71

1.04

0.71

0.50

0.50

0.50

0.60

0.50

0.50

0.30

0.35

2-yr Govt. Bond Yield (%)

0.13

1.04

0.63

0.82

0.34

0.30

0.30

0.20

0.15

0.15

0.15

0.15

0.15

5-yr Govt. Bond Yield (%)

-0.04

0.47

0.13

0.18

0.14

0.20

0.20

0.15

0.10

0.10

0.10

0.10

0.10

10-yr Govt. Bond Yield (%)

0.04

0.03

-0.24

-0.06

0.47

0.35

0.35

0.10

0.10

0.10

0.05

0.05

0.00

30-yr Govt. Bond Yield (%)

0.05

-0.35

-0.44

-0.08

0.78

0.35

0.25

0.05

0.00

-0.05

-0.10

-0.10

-0.20

f: Forecast by TD Economics as at Feb 2009; All forecasts are for end of period. Source: Bloomberg, TD Economics

Global Markets

5

February 10, 2009

www.td.com/economics

U.S. DOLLAR The currency markets remain thin and choppy overall and investors currently have little real conviction about where the major currencies are heading, it would appear. The market appears to be split still between investors who expect the various economic and financial sector bail-out packages to support a quicker US economic recovery and underpin the USD and those, like ourselves at TD, who remain concerned that the overall cost (low interest rates and heavy borrowing) of these plans will ultimately weigh on the currency. The uncertainty in the markets that has prevailed over the past few weeks has tended to support the USD overall though we tend to think that short-term USD demand related to risk aversion is diminishing and that the USD is at risk of easing to levels which are fundamentally more justifiable in the next few months. The USD is overvalued by some 7.5-8.5% relative to its equilibrium fundamental fair value estimate (as of the end of Q4 2008), according to our models. While the USD may be finding support from improving (real) interest rate differentials and terms of trade gains as commodity prices fall, some of these positive fundamental variables are set to fade in the coming months. Meanwhile, the US’ deteriorating fiscal position is a significant negative variable that we think will ultimately catch up with the USD in the months ahead. A large increase in US public debt and equivocal foreign enthusiasm for further increases in existing, and already large, portfolios of US government bonds suggest to us that the currency is vulnerable to a move lower if investors get even just a little choosier about where to invest. Although Treasury Secretary Geithner reiterated the “strong dollar” mantra of the previous incumbents, the USD’s recent appreciation is perhaps not necessarily welcome as it will curb exports and add to growth concerns.

U.S. DOLLAR USD per EUR

JPY per USD

132

1.24 1.28

124

1.32 1.36

116

1.40 1.44

108

1.48 1.52

100

USD per EUR

1.56

JPY per USD

1.60

92

1.64 1.68

84

Jan-07

Jun-07

Nov-07

Apr-08

Sep-08

Feb-09

Source: Federal Reserve Bank of New York/Haver Analytics

TRADE-WEIGHTED U.S. DOLLAR 132

Index: 1997 = 100

128 124 120 116 112 108 104 100 96 92 00

01

02

03

04

05

06

07

08

*Nominal broad exchange rate. Last plotted: Feb 2009 Source: Federal Reserve/Haver Analytics

U.S. DOLLAR FUNDAMENTALS

Shaun Osborne, Chief Currency Strategist 416-983-2629

Interest Rate Spreads

–

Business Cycle

–

Inflation Differential

–

Fiscal Balances

–

Current Account

–

Politics

N

Legend: - is negative, + is positive, N is neutral for currency

U.S. DOLLAR OUTLOOK Spot Price Trade-wtd. USD

2008

2009

2010

2/9/2009

Q1

Q2

Q3

Q4

Q1F

Q2F

Q3F

Q4F

Q1F

Q2F

Q3F

Q4F

110.8

95.6

95.8

101.4

107.4

108.6

107.4

106.1

103.8

102.9

102.5

102.6

103.1

JPY per USD

91.6

104

106

106

91

95

100

102

102

104

108

110

110

USD per EUR

1.306

1.562

1.576

1.409

1.397

1.400

1.450

1.500

1.550

1.550

1.550

1.500

1.450

USD per GBP

1.495

1.987

1.993

1.781

1.463

1.556

1.611

1.705

1.761

1.782

1.782

1.744

1.706

f: Forecast by TD Economics as at February 9, 2009; All forecasts are for end of period; Source: Federal Reserve of New York, TD Economics

Global Markets

6

February 10, 2009

www.td.com/economics

CANADIAN DOLLAR If it wasn’t clear before it certainly is now – the Canadian economy tumbled into recession in the fourth quarter of 2008. Since the last issue of Global Markets one month ago, nearly every single Canadian data release has come in at or below expectations. Most notable was last week’s employment report, which showed that 129K jobs were lost in January, the biggest monthly drop in both absolute and percentage terms since the data series began in the mid-1970s. Nonetheless, the Canadian dollar has held up as well as can be expected, given the clear deterioration in the economic data. Not even last week’s doozy of an employment report could push USD/CAD meaningfully higher, as it only barely hit a new high for the week; the run up in USD/CAD in the immediate aftermath of the jobs report was reversed before noon, which suggests to us that the Canadian dollar is not ready to sell off all that much. While Canadian fundamentals have deteriorated compared to where they were a year ago (particularly the expected move from a twin-surplus to a twin-deficit situation in 2009), relative to the US the Canadian outlook is absolutely glowing. The Canadian government budget deficit will be only a drop in the bucket compared to the US deficit, the Bank of Canada is unlikely to match the Fed’s zero interest rate policy, and the risk of deflation in Canada is much smaller than in the US. Therefore we expect to see USD/CAD move lower through 2009 as the US dollar loses favour with investors.

CANADIAN DOLLAR USD per CAD

CAD per USD

1.12

0.893

1.08

0.926

1.04

0.962

1.00

1.000

0.96

1.041

0.92

1.087

0.88

1.136

0.84

1.190

0.80

1.250

0.76

1.316

Jan-07

Jun-07

Nov-07

Apr-08

Sep-08

Feb-09

Source: Federal Reserve Bank of New York/Haver Analytics

TRADE-WEIGHTED CANADIAN DOLLAR 125

Index: 2000 = 100

120 115 110 105 100 95 90 85 00

01

02

03

04

05

06

07

08

*Real broad effective exchange rate. Last plotted: January 2009 Source: Haver Analytics/JP Morgan

Jacqui Douglas, Currency Strategist 416-982-7784

CANADIAN DOLLAR FUNDAMENTALS Interest Rate Spreads

+

Business Cycle

N

Inflation Differential

+

Fiscal Balances

N

Current Account

N

Politics

N

Legend: - is negative, + is positive, N is neutral for currency

CANADIAN DOLLAR OUTLOOK Spot Price

2008

2009

2010

2/9/2009

Q1

Q2

Q3

Q4

Q1F

Q2F

Q3F

Q4F

Q1F

Q2F

Q3F

Q4F

CAD per USD

1.217

1.008

1.021

1.064

1.219

1.250

1.220

1.205

1.149

1.149

1.136

1.136

1.124

USD per CAD

0.821

0.992

0.979

0.940

0.820

0.800

0.820

0.830

0.870

0.870

0.880

0.880

0.890

JPY per CAD

75

103

104

100

75

76

82

85

89

90

95

97

98

CAD per EUR

1.590

1.575

1.609

1.500

1.703

1.750

1.768

1.807

1.782

1.782

1.761

1.705

1.629

CAD per GBP

1.82

2.003

2.035

1.895

1.784

1.944

1.965

2.054

2.025

2.048

2.025

1.982

1.917

f: Forecast by TD Economics as at February 9, 2009; All forecasts are for end of period; Source: Federal Reserve of New York, TD Economics

Global Markets

7

February 10, 2009

www.td.com/economics

JAPANESE YEN With the bulk of the global deleveraging process likely complete and incremental improvements in the global credit markets lessening demand for the typical “refuge” currencies, we expect the JPY to trade much more defensively overall in the coming year. Indeed, if there is a currency that will underperform a weak USD this year, our forecasts indicate that it will be the JPY. The fundamental news from Japan continues to deteriorate sharply; exporters have been hit hard by the global slump in demand and exporters are reporting unusual operating losses and large reductions in output in response to the new global reality. Japan has reported five consecutive monthly trade deficits (and looks to be heading for a sixth) – its worst trade performance since the early 1980s – consumer confidence levels are plunging as job losses mount and business investment is being slashed as demand falls and local bankruptcies rise. Japanese industrial production fell more than 16% in the December year and machine tool orders data for January are down 84.4% over the past 12 months. The economy has fallen harder and faster than the other major economies and it seems to us that the JPY is looking somewhat overvalued. Japan’s overall trade performance is typically a longer term driver of the JPY’s direction against the USD, with weak trade conditions generally pushing the JPY lower and strong growth in trade generally lifting the currency. The recent slide in Japan’s trade balance has yet to be reflected fully in the JPY exchange rate, we think. Meanwhile, the obvious struggles facing the domestic economy are liable to leave policy makers even more sensitive to currency “volatility” (or JPY appreciation) even if the global landscape is much less conducive to unilateral intervention currently; verbal intervention remains an option that the Japanese monetary authorities will not be afraid to use to counter JPY gains.

JAPANESE YEN 84

JPY per USD

88

JPY per EUR

JPY per USD

92

JPY per EUR

96 100 104

110 115 120 125 130 135 140 145 150 155

108 112 116 120

160 165 170

124 128 Jan-07

Jun-07

Nov-07

Apr-08

Sep-08

Feb-09

Source: Federal Reserve Bank of New York/Haver Analytics

TRADE-WEIGHTED YEN Index: 2000 = 100 100

90

80

70

60 00

01

02

03

04

05

06

07

08

*Real broad effective exchange rate. Last plotted: January 2009 Source: Haver Analytics/JP Morgan

YEN FUNDAMENTALS

Shaun Osborne, Chief Currency Strategist 416-983-2629

Interest Rate Spreads

–

Business Cycle

–

Inflation Differential

–

Fiscal Balances

–

Current Account

+

Politics

N

Legend: - is negative, + is positive, N is neutral for currency

JAPANESE YEN OUTLOOK Spot Price

2008

2009

2010

2/9/2009

Q1

Q2

Q3F

Q4F

Q1F

Q2F

Q3F

Q4F

Q1F

Q2F

Q3F

JPY per USD

92

104

106

106

91

95

100

102

102

104

108

110

Q4F 110

JPY per EUR

120

162

167

150

127

133

145

153

158

161

167

165

160

JPY per GBP

137

206

212

189

133

148

161

174

180

185

192

192

188

JPY per CAD

75

103

104

100

75

76

82

85

89

90

95

97

98

f: Forecast by TD Economics as at February 9, 2009; All forecasts are for end of period; Source: Federal Reserve of New York, TD Economics

Global Markets

8

February 10, 2009

www.td.com/economics

EURO We remain of the opinion that the EUR is more likely to rally than decline significantly and are comfortable with our above consensus call for EUR/USD to head back above the $1.50 level later this year. Volatility remains high in the currency markets at present but we think the EUR is close to an important base versus the USD and that it is unlikely to decline much below the low $1.20s from here. Euro zone fundamental news remains – for the most part – very soft, reflecting the weakened state of the global economy and the EUR is certainly unlikely to get a free-ride higher against the USD in the next few months. Risks clearly remain; the European Central Bank (ECB) left interest rates unchanged at its February policy meeting (as it had indicated was likely) but left the door open for further rate reductions in March. However, intra-euro zone sovereign credit differentiation risks have eased a little in the past few weeks, despite rating agency actions on a number of the “weaker” credits; sovereign credit default swaps have eased modestly over the second half of January and spreads between Italian government bonds and German bunds has narrowed to its lowest level since late November. The immediate concern about cracks showing up in the euro project may have passed but the strains on the smaller economies resulting from the need to boost domestic growth and respect euro zone fiscal standards may not sit well with investors. While our more positive EUR view reflects the expectation of a “win by default” to some degree as the USD declines, the EUR remains the only real alternative to investors who are looking to diversify risk away from the US. Portfolio and foreign direct investment inflows into the euro zone remained strong late last year the trend in these inflows (or outflows) have provided consistent guidance on the EUR’s underlying trend in the past.

EURO USD per EUR

JPY per EUR

1.62

170

1.58

165 160

1.54

155

1.50

150

1.46

145

1.42

140 135

1.38 1.34 1.30

USD per EUR

130

JPY per EUR

125 120

1.26

115

1.22

110

Jan-07

Jun-07

Nov-07

Apr-08

Sep-08

Feb-09

Source: Federal Reserve Bank of New York/Haver Analytics

TRADE-WEIGHTED EURO 140

Index: 2000 = 100

130

120

110

100

90 00

01

02

03

04

05

06

07

08

*Real broad effective exchange rate. Last plotted: January 2009 Source: Haver Analytics/JP Morgan

EURO FUNDAMENTALS

Shaun Osborne, Chief Currency Strategist 416-983-2629

Interest Rate Spreads

+

Business Cycle

N

Inflation Differential

+

Fiscal Balances

N

Current Account

+

Politics

N

Legend: - is negative, + is positive, N is neutral for currency

EURO OUTLOOK Spot Price USD per EUR

2008

2009

2010

2/9/2009

Q1

Q2

Q3

Q4

Q1F

Q2F

Q3F

Q4F

Q1F

Q2F

Q3F

Q4F

1.306

1.562

1.576

1.409

1.397

1.400

1.450

1.500

1.550

1.550

1.550

1.500

1.450

JPY per EUR

120

162

167

150

127

133

145

153

158

161

167

165

160

GBP per EUR

0.874

0.786

0.791

0.791

0.955

0.900

0.900

0.880

0.880

0.870

0.870

0.860

0.850

CAD per EUR

1.590

1.575

1.609

1.500

1.703

1.750

1.768

1.807

1.782

1.782

1.761

1.705

1.629

f: Forecast by TD Economics as at February 9, 2009; All forecasts are for end of period; Source: Federal Reserve of New York, TD Economics

Global Markets

9

February 10, 2009

www.td.com/economics

U.K. POUND We noted last month that the GBP was showing some signs of trying to stabilize against a range of currencies (including the EUR, CHF and CAD) and we are a little more convinced this month that the worst may be over – at least for the moment – for the GBP. UK economic data remains poor, with industrial production down, consumer confidence plunging and unemployment up. But the housing sector is perhaps showing its first signs of stabilization; Halifax/Bank of Scotland house price data registered the first month over month increase in just under a year in January, with the largest one month gain in prices since 2006 (even though the year on year pace of decline continued to accelerate in the latest three months). There was a modest improvement in mortgage demand in December also. Housing might be stabilizing, albeit at a very low level. Bank of England policy makers have done nothing to discourage the sharp downward adjustment in the value of the GBP in the past few months but, with policy-making eyes starting to look to the horizon for a glimmer of recovery, we can perhaps expect to hear a little more about how low interest rates and the weak pound could provide the platform for a rebound in inflation next year moving forward. There are signs that investors are scenting some bargains. Japanese current account data suggested a huge increase in Japanese demand for UK assets late last year (GBP/JPY reached a record low in January, some 52% below the levels prevailing just prior to the onset of the credit crunch). There are reasons to be fundamentally cautious on the GBP – the cost to the government of shoring up the domestic banking system, for example – but valuation will be the primary driver of a further modest stabilization in the GBP on the crosses in the medium term. This modest out performance could translate into potentially sizeable gains against the USD and JPY – currencies we expect to under perform overall.

BRITISH POUND 0.65

GBP per EUR

USD per GBP

0.69

2.20 2.10

0.73

2.00

0.77

1.90

0.81 1.80 0.85 1.70

0.89

GBP per EUR

0.93

USD per GBP

1.60 1.50

0.97 1.01

1.40

Jan-07

Jun-07

Nov-07

Apr-08

Sep-08

Feb-09

Source: Federal Reserve Bank of New York/Haver Analytics

TRADE-WEIGHTED POUND 106

Index: 2000 = 100

102 98 94 90 86 82 78 74 70 00

01

02

03

04

05

06

07

08

*Real broad effective exchange rate. Last plotted: January 2009 Source: Haver Analytics/JP Morgan

POUND FUNDAMENTALS

Shaun Osborne, Chief Currency Strategist 416-983-2629

Interest Rate Spreads

–

Business Cycle

–

Inflation Differential

+

Fiscal Balances

–

Current Account

–

Politics

N

Legend: - is negative, + is positive, N is neutral for currency

UNITED KINGDOM POUND Spot Price

2008

2009

2010

2/9/2009

Q1

Q2

Q3

Q4

Q1F

Q2F

Q3F

Q4F

Q1F

Q2F

Q3F

Q4F

USD per GBP

1.495

1.987

1.993

1.781

1.463

1.556

1.611

1.705

1.761

1.782

1.782

1.744

1.706

GBP per EUR

0.874

0.786

0.791

0.791

0.955

0.900

0.900

0.880

0.880

0.870

0.870

0.860

0.850

CAD per GBP

1.82

2.00

2.04

1.90

1.78

1.94

1.96

2.05

2.02

2.05

2.02

1.98

1.92

f: Forecast by TD Economics as at February 9, 2009; All forecasts are for end of period; Source: Federal Reserve of New York, TD Economics

Global Markets

10

February 10, 2009

www.td.com/economics

AUSTRALIAN DOLLAR We remain a little more pessimistic on the AUD’s outlook than the market consensus for the simple reason that the full effects of the domestic recession have yet to be felt and – despite uncertainties in the market regarding the Reserve Bank of Australia’s policy intentions – risks remain geared towards easier monetary conditions. Short term trends are liable to remain choppy, especially while uncertainty regarding the government’s latest fiscal stimulus plans remains, but the drivers of the AUD fall last year – weak commodity prices and narrowing interest rate differentials – remain in place from our perspective and without a stabilization in the global economy, it remains too soon to expect a stabilization in the AUD. Shaun Osborne, Chief Currency Strategist 416-983-2629

AUSTRALIAN DOLLAR 1.06

USD per AUD

JPY per AUD

120 110

0.98

100

0.90

90 0.82 80 0.74

70

USD per AUD JPY per AUD

0.66

60

0.58

50

Jan-07

Jun-07

Nov-07

Apr-08

Sep-08

Feb-09

Source: Federal Reserve Bank of New York/Haver Analytics

AUSTRALIAN DOLLAR OUTLOOK Spot Price 2/9/2009

2008 Q1

Q2

2009 Q3

Q4

Q1F

Q2F

2010

Q3F

Q4F

Q1F

Q2F

Q3F

Q4F

USD per AUD

0.685

0.944

0.959

0.792

0.703

0.610

0.570

0.580

0.600

0.620

0.640

0.660

0.680

JPY per AUD

62.72

98.08

101.80

84.08

63.94

57.95

57.00

59.16

61.20

64.48

69.12

72.60

74.80

AUD per CAD

1.200

1.051

1.021

1.186

1.167

1.311

1.439

1.431

1.450

1.403

1.375

1.333

1.309

f: Forecast by TD Economics as at February 9, 2009; All forecasts are for end of period; Source: Federal Reserve of New York, TD Economics

NEW ZEALAND DOLLAR We have a below consensus view on the NZD as well. With the economy in the grip of the deepest recession since the 1990s, commodity prices liable to stay soft, S&P putting the country’s foreign currency debt on negative credit watch and the Reserve Bank of New Zealand poised to continue reducing the Official Cash Rate in the coming months, the “Kiwi” remains at risk of pushing below the 50 cent (US) point. Short term gains as the market’s risk appetite improves are possible but are liable to remain modest corrections in the overall trend lower.

NEW ZEALAND DOLLAR 0.84

USD per NZD

JPY per NZD

100

0.78

90

0.72

80

0.66

70

USD per NZD

0.60

60

JPY per NZD 0.54

50

0.48

Shaun Osborne, Chief Currency Strategist 416-983-2629

40

Jan-07

Jun-07

Nov-07

Apr-08

Sep-08

Feb-09

Source: Federal Reserve Bank of New York/Haver Analytics

NEW ZEALAND DOLLAR OUTLOOK Spot Price 2/9/2009

2008 Q1

Q2

2009 Q3

Q4

Q1F

Q2F

Q3F

2010 Q4F

Q1F

Q2F

Q3F

Q4F

USD per NZD

0.685

0.786

0.762

0.670

0.579

0.490

0.450

0.450

0.460

0.480

0.500

0.520

0.540

JPY per NZD

62.72

81.66

80.95

71.07

52.71

46.55

45.00

45.90

46.92

49.92

54.00

57.20

59.40

NZD per CAD

1.200

1.262

1.284

1.403

1.416

1.633

1.822

1.844

1.891

1.813

1.760

1.692

1.648

f: Forecast by TD Economics as at February 9, 2009; All forecasts are for end of period; Source: Federal Reserve of New York, TD Economics

Global Markets

11

February 10, 2009

www.td.com/economics

SWISS FRANC Over the last month the Swiss National Bank (SNB) has become increasingly vocal regarding its concerns about the strength of the Swiss Franc. Most recently, SNB board member Jordan said on February 6th that “a somewhat weaker franc would be welcome for the economy.” But vice-chairman Hildebrand has used stronger language, saying that the SNB “could sell Swiss francs against other currencies without limits.” We expect that the SNB will continue to talk down the currency following any bouts of unwanted appreciation, and the risk of intervention remains on the radar. The Swiss Franc has been the worst-performing major currency on a YTD basis, and we expect to see continued under-performance through 2009 against the Euro as the Franc reflects near-zero interest rates, a large, troubled financial sector, and dwindling exports dragging down the Swiss economy. Jacqui Douglas, Currency Strategist 416-982-7784

SWISS FRANC 1.42

CHF per USD

CHF per EUR

1.46

0.97

CHF per EUR

1.00

CHF per USD

1.03

1.50

1.06 1.09

1.54

1.12 1.58

1.15 1.18

1.62

1.21 1.66

1.24 1.27

1.70 Jan-07

Jun-07

Nov-07

Apr-08

Sep-08

Feb-09

Source: Federal Reserve Bank of New York/Haver Analytics

SWISS FRANC OUTLOOK Spot Price

2008

2009

2010

2/9/2009

Q1

Q2

Q3

Q4

Q1F

Q2F

Q3F

Q4F

Q1F

Q2F

Q3F

Q4F

CHF per USD

1.160

1.034

1.021

1.122

1.069

1.093

1.076

1.060

1.045

1.045

1.045

1.067

1.090

CHF per EUR

1.515

1.616

1.609

1.581

1.493

1.530

1.560

1.590

1.620

1.620

1.620

1.600

1.580

CHF per CAD

0.953

1.026

1.000

1.054

0.877

0.874

0.882

0.880

0.909

0.909

0.920

0.939

0.970

f: Forecast by TD Economics as at February 9, 2009; All forecasts are for end of period; Source: Federal Reserve of New York, TD Economics

Global Markets

12

February 10, 2009

www.td.com/economics SUMMARY FOREIGN EXCHANGE TABLE Spot Price

2008

2/9/2009

Q1

Q2

2009 Q3

Q4

Q1F

Q2F

2010

Q3F

Q4F

Q1F

Q2F

Q3F

Q4F

Exchange rate to U.S. dollar Japanese yen

JPY per USD

91.6

104

106

106

91

95

100

102

102

104

108

110

110

Euro

USD per EUR

1.306

1.562

1.576

1.409

1.397

1.400

1.450

1.500

1.550

1.550

1.550

1.500

1.450

U.K. pound

USD per GBP

1.495

1.987

1.993

1.781

1.463

1.556

1.611

1.705

1.761

1.782

1.782

1.744

1.706

Swiss franc

CHF per USD

1.160

1.034

1.021

1.122

1.069

1.093

1.076

1.060

1.045

1.045

1.045

1.067

1.090 1.124

Canadian dollar

CAD per USD

1.217

1.008

1.021

1.064

1.219

1.250

1.220

1.205

1.149

1.149

1.136

1.136

Australian dollar

USD per AUD

0.685

0.944

0.959

0.792

0.703

0.610

0.570

0.580

0.600

0.620

0.640

0.660

0.680

NZ dollar

USD per NZD

0.543

0.786

0.762

0.670

0.579

0.490

0.450

0.450

0.460

0.480

0.500

0.520

0.540

1.450

Exchange rate to Euro U.S. dollar

USD per EUR

1.306

1.562

1.576

1.409

1.397

1.400

1.450

1.500

1.550

1.550

1.550

1.500

Japanese yen

JPY per EUR

120

162

167

150

127

133

145

153

158

161

167

165

160

U.K. pound

GBP per EUR

0.874

0.786

0.791

0.791

0.955

0.900

0.900

0.880

0.880

0.870

0.870

0.860

0.850

Swiss franc

CHF per EUR

1.515

1.616

1.609

1.581

1.493

1.530

1.560

1.590

1.620

1.620

1.620

1.600

1.580

Canadian dollar

CAD per EUR

1.590

1.575

1.609

1.500

1.703

1.750

1.768

1.807

1.782

1.782

1.761

1.705

1.629

Australian dollar

AUD per EUR

1.908

1.655

1.644

1.778

1.988

2.295

2.544

2.586

2.583

2.500

2.422

2.273

2.132

NZ dollar

NZD per EUR

2.404

1.988

2.067

2.104

2.412

2.857

3.222

3.333

3.370

3.229

3.100

2.885

2.685

Exchange rate to Japanese yen U.S. dollar

JPY per USD

91.6

104

106

106

91

95

100

102

102

104

108

110

110

Euro

JPY per EUR

119.7

162

167

150

127

133

145

153

158

161

167

165

160

U.K. pound

JPY per GBP

137

206

212

189

133

148

161

174

180

185

192

192

188

Swiss franc

JPY per CHF

79.0

100.4

104.0

94.6

85.2

86.9

92.9

96.2

97.6

99.5

103.3

103.1

100.9

Canadian dollar

JPY per CAD

75.3

103.1

104.0

99.7

74.6

76.0

82.0

84.7

88.7

90.5

95.0

96.8

97.9

Australian dollar

JPY per AUD

62.7

98.1

101.8

84.1

63.9

58.0

57.0

59.2

61.2

64.5

69.1

72.6

74.8

NZ dollar

JPY per NZD

49.8

81.7

80.9

71.1

52.7

46.6

45.0

45.9

46.9

49.9

54.0

57.2

59.4

0.890

Exchange rate to Canadian dollar U.S. dollar

USD per CAD

0.821

0.992

0.979

0.940

0.820

0.800

0.820

0.830

0.870

0.870

0.880

0.880

Japanese yen

JPY per CAD

75

103

104

100

75

76

82

85

89

90

95

97

98

Euro

CAD per EUR

1.590

1.575

1.609

1.500

1.703

1.750

1.768

1.807

1.782

1.782

1.761

1.705

1.629

U.K. pound

CAD per GBP

1.82

2.00

2.04

1.90

1.78

1.94

1.96

2.05

2.02

2.05

2.02

1.98

1.92

Swiss franc

CHF per CAD

0.953

1.026

1.000

1.054

0.877

0.874

0.882

0.880

0.909

0.909

0.920

0.939

0.970

Australian dollar

AUD per CAD

1.200

1.051

1.021

1.186

1.167

1.311

1.439

1.431

1.450

1.403

1.375

1.333

1.309

NZ dollar

NZD per CAD

1.512

1.262

1.284

1.403

1.416

1.633

1.822

1.844

1.891

1.813

1.760

1.692

1.648

f: Forecast by TD Economics as at February 9, 2009; All forecasts are for end of period Source: Federal Reserve of New York, TD Economics

This report is provided by TD Economics for customers of TD Bank Financial 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 Financial Group and the members of TD Economics are not spokespersons for TD Bank Financial 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 Financial 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.

Global Markets

13

February 10, 2009