MARKETS OUTLOOK

Bumpy Roads Ahead

3Q 2011

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Highlights
2 Global Overview
Global markets have taken a turn for the worse as the 2Q draws to a close (as of June 10, the MSCI World equity index is down nearly 8% from its May 2nd peak) and we think investor uncertainty remains high going into the 3Q.

AUSTRALIA: Flood waters recede to prospects of recovery

Massive floods carried over from late 2010 into early 2011 battering the northeastern region of Australia. Making matters worse was the landing of Cyclone Yasi, a category 5 system, on northern Queensland in early February.

USD Suffering from Bi-polar Disorder

We think the USD is most likely to stay on the soft-side against other major currencies, but we also expect periodic bouts of USD strength on safe haven buying as risk sentiment seems to us most likely to remain under pressure.

NEW ZEALAND: Post-quake economic aftershocks point towards a modest recovery

New Zealands economy also suffered its fair share of natural disaster related setbacks. Just months after a magnitude 7.1 earthquake rocked the Canterbury region in September, a magnitude 6.3 quake struck Christchurch resulting in widespread social and financial costs (estimated to be around $12-$13B).

Europe continues to live dangerously

The Greek parliament has narrowly approved additional deficit reduction measures necessary to secure the next instalment of the EU/IMFs original EUR 110 bio bailout package, likely preventing an imminent Greek default this summer.

Potential 3Q Event Risks to Monitor

Recent history has certainly taught us to expect the unexpected, so any number of unforeseen events may conspire to upset financial markets in the months ahead. However, where we can identify significant event risks, we outline below how we expect them to play out in the 3Q.

Pot holes in the road to fiscal harmony in UK

We move into the third quarter with a cloud hanging over the UK economy. After a disappointing expansion in the first quarter, signs are pointing to further weakness in the second as elevated commodity prices hit consumer confidence.

JAPAN: A long and winding road to recovery

The tragic 2011 Tohoku earthquake certainly took its toll on Japan Q1 GDP which contracted at an annualized rate of -3.5%. Negative Jan-Mar real growth was a given as domestic production and consumption eroded almost instantaneously.

Brian Dolan Chief Currency Strategist Kathleen Brooks UK Research Director Dan Hwang Sr. Technical Strategist Eric Viloria, CMT Sr. Technical Strategist Chris Tevere, CMT Sr. Technical Strategist

Foreign exchange and other leveraged trading involves significant risk of loss and is not suitable for all investors.

Markets Outlook 3Q 2011

FOREX.com 3Q 2011 Markets Outlook

Global Overview
Global markets have taken a turn for the worse as the 2Q draws to a close and we think investor uncertainty remains high going into the 3Q. Economic data in the major economies (US, Europe, UK and Japan) all showed signs of deterioration over the last couple of months, undercutting prospects for the global recovery as a whole. Key emerging markets, which had been the primary source of global growth in the first half of the year are showing signs of the effects of higher interest rates and other policy measures, like Chinas increases to its Required Reserve Ratio to curb bank lending. To us, this suggests emerging economy growth, especially out of Asia, may be unable to pick up the slack from any further weakness seen in the major economies, and this biases our view for global growth to the downside in the months ahead. Stubbornly high unemployment in the major developed economies remains the primary obstacle to more robust growth... Stubbornly high unemployment in the major developed economies remains the primary obstacle to more robust growth there. But economic policy makers appear obsessed with deficit reduction and are unable or unwilling to develop initiatives to increase employment in a more rapid or meaningful way. This leaves organic job growth to fill the void, and recent weakness in May US employment data, for example, doesnt leave us feeling especially optimistic on the jobs front. Indeed, looming government job cuts, especially in the UK and US state and local governments, may offset a significant portion of private sector job creation, potentially leading to further disappointing employment news in coming months. Overall, we think job creation numbers will be the critical data points in the months ahead, and we will update our outlook on global demand accordingly. Additionally, we think most major economies are likely to see a continuation of deleveraging (saving more/spending less) on both the government and household levels, which we think will generate further headwinds to consumption growth. Barring any unexpected stimulus initiatives in the major economies, ongoing deleveraging reinforces our view that growth in the major economies will remain on the anemic-side, and this seems most likely to us to keep investors risk sentiment biased to the downside. The glass is not entirely half-empty, however, as global growth remains positive overall. While we think GDP growth in the major economies is likely to remain weaker than was expected at the start of the year, risks of a double-dip recession are minimal in our view. Although a slide back into technical recession seems most likely to be avoided, sluggish growth against a backdrop of austerity measures and high unemployment may mean it increasingly feels like a recession. As well, there is a case to be made that some of the weakness in recent economic data series may only be temporary. Commodity price increases early in the year likely weighed on personal consumption, so the recent declines in major commodities holds out the prospect that consumption growth may recover sooner than we expect. Finally, the downside adjustment in financial markets in the 2Q may represent the bulk of markets adjusting to (or pricing-in) weaker growth expectations in the 2H of 2011, potentially meaning that further declines will be minimal. That prospect also suggests potentially sharp rebounds in risk sentiment if economic data should begin surprising to the upside. Overall, we think key markets direction and risk sentiment will remain heavily data dependent given the high level of uncertainty and diversity of opinion. For currencies, we think an overall environment of heightened risk aversion (risk off) will tend to support safe haven currencies, such as the JPY and the CHF in particular, and to undermine commodity currencies like AUD, CAD, and NZD. Our view also suggests that the JPY-crosses (carry trades) are biased to the downside. The USD seems most likely to us to remain on the Foreign exchange and other leveraged trading involves significant risk of loss and is not suitable for all investors.

...most major economies are likely to see a continuation of deleveraging(saving more/ spending less)...

Markets Outlook 3Q 2011

weak-side against most other major currencies, but we dont think it will weaken significantly further from 2Q levels, due to occasional safe-haven demand for US Treasuries. Should any of the key Event Risks we outline below come to pass, then we think the USD could see a more dramatic strengthening, with the exception of the US debt default scenario. The EUR outlook will hinge greatly on the outcome of the Greek debt crisis, but we would also highlight the potential for greater EUR weakness if incoming Eurozone data point to a greater slowdown in the 2H, potentially leading markets to reduce ECB rate hike expectations. GBP should also stay weak against most other major currencies as the economy struggles with austerity. ...we dont foresee significant trends developing in the 3Q given the uncertainty of the outlook... Overall and perhaps most importantly, we dont foresee significant trends developing in the 3Q given the uncertainty of the outlook and the potential for monetary policy makers to stay on the sidelines as a result, meaning few changes to interest rates of major currencies. We think a range-bound environment is most likely to prevail and would favor a shorter-term approach to trading in the major currencies. Of course, all bets are off if any of the Event Risks we highlight at the end of this outlook should transpire.

This may see the USD bounce around in relatively narrow ranges against other major currencies.

USD Suffering from Bi-polar Disorder

We think the USD is most likely to stay on the soft-side against other major currencies, but we also expect periodic bouts of USD strength on safe haven buying as risk sentiment seems to us most likely to remain under pressure. This may see the USD bounce around in relatively narrow ranges against other major currencies. Our expectation for overall USD weakness is based on our view that the Fed will maintain its accommodative policies for the rest of the year after winding up its asset purchase program (QE2) at the end of June. Recent weakness in US data has reinvigorated market speculation over whether the Fed may pursue a third round of asset purchases (QE3). We dont think this is likely as Fed officials have indicated a consensus to move toward exiting current extraordinary measures. Fed speakers have also repeatedly indicated that the bar for additional QE would be set very high, meaning a more severe US downturn would be needed rather than just moderating growth. Lastly, the Fed based prior rounds of QE on its dual mandate of seeking maximum employment and stable inflation of around 2%. The employment case still holds, but the risks of deflation appear to have evaporated, leaving the Fed with a weaker justification for additional asset purchases. However, if the US outlook continues to weaken, speculation on QE3 will likely increase and we think this would also weigh on the USD.

USD strength seems most likely to us to stem from periodic bouts of risk aversion...

USD strength seems most likely to us to stem from periodic bouts of risk aversion, which tend to be relatively short-run phenomena, meaning a sustained trend toward USD strength is unlikely to develop in our view. Of course, the nature of events behind any increase in risk aversion determines the length of the time risk is off, and here we see a potential Greek default/restructuring as the most likely candidate to trigger another financial crisis, potentially leading to a more sustained period of USD strength. We think the end of QE2 could also provide the USD with a boost to start the 3Q, but we dont expect US yields to rise dramatically, likely limiting the dollars gains in the process. A positive resolution to the US debt limit dispute could also provide the greenback with some temporary gains, but the risks are clearly that the political showdown drags on and markets express extreme disillusionment with US political gridlock, which we think would be negative for the USD. Better than expected US data is another source of potential USD-strength, but we also think it would tend to be short-lived, as a better US outlook is a positive for the global recovery and risk sentiment.

Europe continues to live dangerously

As this outlook goes to press, the Greek parliament has narrowly approved additional deficit reduction measures necessary to secure the next instalment of the EU/IMFs original EUR 110 Foreign exchange and other leveraged trading involves significant risk of loss and is not suitable for all investors.

Markets Outlook 3Q 2011

... we think markets will continue to fear a potential Greek default down the road.

bio bailout package, likely preventing an imminent Greek default this summer. While solving the short-term funding needs of Greece, the plans so far do nothing to resolve the larger issue of Greek solvency in the years ahead. The measures buy Greece some time to bring down deficits, but also likely consign it to additional years of recession. Greece does not have a stellar track record in meeting deficit reduction targets and negative or stagnant growth will make the goal that much more difficult to achieve. As a result, we think markets will continue to fear a potential Greek default down the road. The drama will likely be reprised later in the fall when the EU/IMF review Greeces progress in meeting its deficit targets, with future aid hanging in the balance. The next act of the Greek tragedy will be for EU/IMF leaders to construct a second bailout package to secure financing of the Greek state through 2012. Estimates of the second bailout have ranged from EUR 80 bio to more than one hundred billion euros, but the entire process carries the potential that additional bailouts will be required for Ireland and Portugal as well. Overall, we think peripheral debt concerns will continue to hang over the EUR, potentially limiting its upside. In Figure 1 below, its clear to us that Eurozone debt problems will be with us for many years to come. Figure 1: IMF projections of Euro-area government debt to GDP (%). Problems in the periphery wont go away any time soon.
180 160 140 120 100 80 60 40 20 0 2011 2012 2013 2014 2015 2016 Germany Greece Ireland Italy Portugal Spain

(Note: For informational purposes only; not offered for trading by FOREX.com.) Source: IMF

EU leaders and Eurozone banks are also in discussions on how to manage Greek banks debt. A French proposal would have Eurozone banks roll over maturing Greek debt into longer-term bonds with certain inducements and collateral mechanisms. However, credit rating agencies, which have given mixed signals on how they would view a debt rollover, have recently signalled such rollovers would constitute a default event. If so, Greek bank debt would be ineligible as collateral for ECB funding, likely rendering the Greek banking system insolvent and potentially triggering a wave of credit contagion that could quickly become another global financial crisis. We think this issue will also act as a headwind to potential EUR upside. In the first week of July, the ECB is poised to raise its benchmark refi rate another 0.25% to 1.5%, in our opinion, according to ECB officials recent comments. Right now the market expects another 2 hikes (one in July and one by year end). But if growth follows the US and UK Foreign exchange and other leveraged trading involves significant risk of loss and is not suitable for all investors.

Markets Outlook 3Q 2011

lower, then a second hike later this year will become less likely. This would be a negative signal for the euro in our opinion, as the single currency loses its yield support at the same time as it gets battered by peripheral debt fears. A chief driver of a stronger euro this year has been a weak dollar. But thats not all investors need to be aware of. A chief driver of a stronger euro this year has been a weak dollar. If the Federal Reserve remains on hold or if the debt ceiling in the US is not lifted in the next few months then we could see another leg lower in the dollar, sending the euro above 1.5000. So while our central scenario is for further headwinds in the currency bloc, we are not writing off the euro. Generally we think it will be a summer of range trading between 1.3800 and 1.4800. We move into the third quarter with a cloud hanging over the UK economy.

Pot holes in the road to fiscal harmony in UK

We move into the third quarter with a cloud hanging over the UK economy. After a disappointing expansion in the first quarter, signs are pointing to further weakness in the second as elevated commodity prices hit consumer confidence. The International Monetary Fund (IMF) predicts that the UK economy will expand at a pretty lacklustre 1.5 per cent this year, before picking up to 2.5 per cent in 2012. Since growth has been pretty much flat since September the expectation is that the third and fourth quarters of the year will do the heavy lifting on the growth front. However, a weak housing market, a private sector still embarking on repairing its balance sheet and continued headwinds from the governments fiscal consolidation measures could thwart growth going forward and the risks are increasing that growth may need to be revised down even further for this year. Whether the dip in growth is a malaise or something more serious is going to be critical for the government in the coming months. In its March budget it forecast growth of 1.7 per cent this year, which is already above the forecast of the IMF. However, growth needs to be strong for the government to achieve its fiscal targets. But things arent looking good. Government spending grew at 1.1 per cent in Q1, higher than the 0.6 per cent in Q4 2010. If the government wants to achieve its ambitious target of closing the UKs deficit by 2014-15 then it will have to close its purse strings, which will weigh on the economy. But the choices open to the government at this juncture are not that attractive. Go ahead with cuts and see growth figures fall, or continue spending and make a mockery of the coalition Governments fiscal plans. Credit rating agency Moodys highlighted the difficult position the Chancellor finds himself in when it said that slower growth combined with weaker-than-expected fiscal consolidation could threaten the UKs triple-A sovereign credit rating. Expectations of rate hikes have been eroded since the start of the year, (as seen in figure 2). If growth remains weak, they could fall even further. We think a downgrade for the UK would cause Gilt yields to shoot higher. This would be devastating for the government as it would make the task of bringing the countrys finances under control more difficult as debt servicing costs would rise. While we dont think a downgrade is imminent for the UK - and Moodys also said this wasnt its central scenario - if hopes of a third quarter recovery get crushed then fears about the UKs credit rating will come home to roost.

...the risks are increasing that growth may need to be revised down even further for this year.

Figure 2: 3-month GBP rates (SONIA GBP swap rate)

0.68 0.66 0.64 0.62 0.6 0.58 0.56 0.54 0.52 0.5

Lower short-term UK rates suggest BOE rate hikes are less likely. (Note: For informational purposes only; not offered for trading by FOREX.com.) Source: Bloomberg

...if hopes of a third quarter recovery get crushed then fears about the UKs credit rating will come home to roost.

Foreign exchange and other leveraged trading involves significant risk of loss and is not suitable for all investors.

Markets Outlook 3Q 2011

We continue to agree with the market that a rate hike in the next three months seems unlikely. Weak growth at the same time as fiscal consolidation measures start to bite suggests the Bank of England needs to keep rates on hold. The market is currently looking for a rate hike by February 2012, which would be close to three years without any policy action from the BOE. We expect the Bank to continue to look through high inflation figures even though energy costs are expected to remain elevated as some providers get ready to increase their prices by nearly 20 per cent over the next few months. Overall, we think that the pound will trade with a weak bias, but that its fortunes will be dependent on the US and Europe. It may remain fairly well supported against the dollar if the Fed continues to signal no change to rates for some time yet. Likewise, while we think it is more vulnerable to weakness against the euro, it all depends on how the EU authorities resolve the next stage of the Greek financial crisis.

USD/JPY since March 2011

JAPAN: A long and winding road to recovery

The tragic 2011 Tohoku earthquake certainly took its toll on Japan Q1 GDP which contracted at an annualized rate of -3.5%. Negative Jan-Mar real growth was a given as domestic production and consumption eroded almost instantaneously. Rising out of its ashes, however, are encouraging signs that an economic recovery may be taking form. Hampered by supply disruptions and power outages, industrial production swooned by more than -15% in March but managed to post a modest recovery as output increased +1.0% in April. Admittedly, April production printed worse than consensus estimates of around +2.8% but the sharp rise of +8.0% (expected +2.7%) for May Manufacturers expectations (data released by the Ministry of Economy, Trade and Industry) suggests Japans economy may be carving out a bottom. Preliminary May industrial production, which rose 5.7% MoM (expected +5.5%), also suggests a recovery is underway. As unfortunate and ironic as it may be, the natural disasters in New Zealand and Australia may be a boon to Japans recovery. As both economies continue to recover, Japanese exports may reap the benefits of heightened AU & NZ reconstruction demand for equipment and machinery. The case can be made that the current environment is ripe for Japans economic recovery to set sail. While supply chain disruptions are likely to remain a growth impediment for the foreseeable future, progress is inevitable and Japanese companies are likely to maximize output levels accordingly. Furthermore, Japanese companies have sufficient cash - capital expenditures have been relatively depressed in prior years and should allow firms to boost investments as both sentiment and production conditions improve. Although encouraging signs for post-disaster recovery are beginning to surface, the road to recovery will be a long and winding one. Although encouraging signs for post-disaster recovery are beginning to surface, the road to recovery will be a long and winding one. Downside risks to a sustained Japanese economic recovery are both abundant and significant continued supply chain disruptions, potential yen strength, higher oil prices, a flare up in EZ periphery debt issues, a sluggish U.S. economic recovery, more aggressive EM policy tightening (mainly China), a lingering Fukushima nuclear crisis, delays in the passage of a comprehensive reconstruction plan, and fiscal tightening on a domestic level. The most pressing hurdle, however, is the timely passage of a comprehensive reconstruction plan. The government plans to submit a draft to parliament by July 15 with hopes of implementation by the end of July. According to the IMF, reconstruction costs may range between 2 - 4 percent of GDP over several years. The Japanese government acted swiftly Foreign exchange and other leveraged trading involves significant risk of loss and is not suitable for all investors.

Source: FOREX.com

...the natural disasters in New Zealand and Australia may be a boon to Japans recovery.

Markets Outlook 3Q 2011

in passing an initial supplementary budget of around 0.8% of GDP but has faced political headwinds with the passage of a second supplementary budget. The preliminary draft of the second supplementary budget proposed raising the consumption tax in stages from 5% to 10% by 2015. Estimated revenues would amount to around 2.5% of GDP or about 12.5 trillion a year which still may not suffice if total costs end nearer to the higher end of the IMFs estimated range. Further complicating the situation is the detriment that a twofold increase would have on private capital expenditures higher consumption taxes would likely see Japanese firms rein in spending resulting in a sluggish pace of recovery. The Japanese government is facing a daunting task as it must implement fiscal policy reform while simultaneously incentivizing private spending, all in the face of mounting public pressure and opposition from a myriad of entities. Making the situation even more arduous is the current global backdrop which is loaded with external risk factors. The combination of significant internal and external risks casts a shadow of uncertainty atop Japans post-quake recovery prospects. However, we think that the impending passage of a secondary budget plan may see reconstruction efforts assist Japans economy in posting a modest Q3 recovery but expect a more substantial rebound to materialize in 2012.

AUD/USD since March 2011

AUSTRALIA: Flood waters recede to prospects of recovery

Massive floods carried over from late 2010 into early 2011 battering the northeastern region of Australia. Making matters worse was the landing of Cyclone Yasi, a category 5 system, on northern Queensland in early February. Alongside extensive social costs, the nation suffered tremendous economic costs as farmland, crops, infrastructure, and coal mines were either left in ruins or heavily damaged. The damage bill from the natural disasters has been estimated to be greater than $7.3B according to Queensland Treasurer Andrew Fraser while lost production from the coal mining industry has been estimated to be around $12B. As a result, Australias economy suffered its largest contraction since Q3 1991 (-1.3%) as GDP declined -1.2% in the first quarter of 2011 largely attributable to the -1.4% GDP drag from coal mine disruptions. While the Australian economy took a step back in Q1, Q2 data supports prospects for Q3 growth. RBA commodity prices rose to fresh highs by +2.3% in May keeping the uptrend for terms of trade intact. Rising terms of trade suggest higher real domestic incomes and when combined with resilient retail sales (April Retail Sales rose +1.1%) paints a healthy domestic consumption picture. Firming external demand, however, will likely be the primary driver to Australias Q3 economic recovery. Modest April coal export volumes April figures improved upon the prior month but still remain well below pre-quake levels suggest flooding induced declines have yet to rebound. This bodes well for Q3 GDP as the removal of flooding related obstructions will likely lead to recovering coal export volumes and subsequent boosts for aggregate growth figures. In terms of the investment outlook, recent capital expenditure data (Q1 capex printed +3.4% vs. expected +2.7%) suggests business spending will remain strong for the foreseeable future. Australian companies forecast investments to total about $150B by June 30, 2012 spurred on by resilient Asian demand for resources. Not to mention GDP boosts from reconstruction efforts which are expected to reach around $5B. Ultimately, Australias Q3 growth outlook seems poised to accelerate driven by strengthening business investments, reconstruction efforts, and rebounding export volumes. Foreign exchange and other leveraged trading involves significant risk of loss and is not suitable for all investors.

Source: FOREX.com

While the Australian economy took a step back in Q1, Q2 data supports prospects for Q3 growth.

Markets Outlook 3Q 2011

NEW ZEALAND: Post-quake economic aftershocks point towards a modest recovery

NZD/USD since March 2011 New Zealands economy also suffered its fair share of natural disaster related setbacks. Just months after a magnitude 7.1 earthquake rocked the Canterbury region in September, a magnitude 6.3 quake struck Christchurch resulting in widespread social and financial costs (estimated to be around $12-$13B). The economic aftershocks were substantial - activity stalled, consumer & business confidence weakened, and expected tourist revenues were revised sharply lower. The RBNZ promptly responded in March with an emergency 50bp cut to the official cash rate down to 2.5% in hopes of buoying an expedient recovery. Recent positive NZ data surprises suggest the central banks response is starting to pay dividends - visitor arrivals rose +8.2% in April and April business confidence recovered much of its March losses with the details of the report showing a rebound in activity expectations to levels just short of pre-quake levels.
Source: FOREX.com

A number of factors suggest the recent pickup in NZ economic activity may extend into the 3Q. To start, New Zealand will be the host of Rugby World Cup (RWC) 2011 which kicks off on Sept. 9th and ends on October 23rd. The greater than 85,000 estimated attendees are expected to boost total GDP by about +0.5%. Further buoying NZ growth prospects are elevated agricultural commodity prices. If Asian demand for NZ commodity exports (mainly milk and dairy products) remains firm, rising rural incomes on the back of higher profit margins may have a spillover effect into equipment and machinery investments. In its June Monetary Policy Statement, the RBNZ projected Canterbury reconstruction to add around +2% to GDP growth over 2012 while acknowledging additional boosts to GDP are likely to extend into later years. The timing of reconstruction, however, remains uncertain due to damaged NZ statistics facilities and will likely see initial GDP benefits deferred out to 2012. Overall, we think New Zealands economy may stage a modest Q3 recovery on the back of firm Asian agricultural commodity demand, RWC driven increases to tourist revenues, and improving confidence from steady near term accommodative RBNZ monetary policy. Both economies of New Zealand and Australia are vulnerable to the same external risk factors that would potentially thwart a sustainable Japanese recovery EZ sovereign debt issues, U.S. growth moderation, a deteriorating U.S. fiscal situation, ongoing MENA unrest, and the potential for a hard landing in emerging markets (mainly China). However, we think the increasing potential of a substantial slowdown for China growth poses the most significant risk to economic recoveries in New Zealand, Australia, and Japan. All three disaster afflicted economies rely heavily on China demand for export volumes and any demand deterioration out of China would result in a similar impact on AU, NZ, and JP export volumes.

Further buoying NZ growth prospects are elevated agricultural commodity prices.

While China poses the greatest risk to our outlooks for a broadbased rebound in the economies of Asia-Pacific, the current global environment is unusually fragile and clouded with uncertainty.

While China poses the greatest risk to our outlooks for a broad-based rebound in the economies of Asia-Pacific, the current global environment is unusually fragile and clouded with uncertainty. Accordingly, we acknowledge that any one of the aforementioned risks has the potential to derail growth for not only an individual economy but for the global economy as well (see Potential 3Q Event Risks to Monitor below).

Potential 3Q Event Risks to Monitor

Recent history has certainly taught us to expect the unexpected, so any number of unforeseen events may conspire to upset financial markets in the months ahead. However, where we can

Foreign exchange and other leveraged trading involves significant risk of loss and is not suitable for all investors.

Markets Outlook 3Q 2011

identify significant event risks, we outline below how we expect them to play out in the 3Q. Greece Bailout Risk--The matter of Greek debt remains a topic of significant concern and active debate among EU, IMF, and ECB officials. The next tranche of aid under the 110 billion euro bailout agreed last year will be required in mid-July. The aid must be approved by Euro zone finance ministers in the Eurogroup and the IMFs executive board before it can be released to Greece. The Greek government must show that it is committed and working towards austerity as part of the terms of the original bailout, and because Greece cannot go back to the capital markets next year as initially planned, there are now discussions for a new aid program for the troubled nation. German Finance Minister Schaeuble is calling for the new aid program to involve existing Greek bond holders to swap their bonds for longer dated maturities. Any restructuring, reprofiling or rescheduling will be viewed by the ratings agencies as a credit event or default. Such an event would likely weigh heavily on the euro as Greece bond yields continue to move higher, along with the yields of Portugal and Ireland. ...increased financial stresses on the periphery could put pressure on the common currency should conditions deteriorate. The issue of Greece is also a threat to the creditworthiness of Portugal and Ireland. Moodys said that given how a Greek restructuring may be a model for other rescues, multi-notch downgrades for Portugal and Ireland could result. The bonds of these two nations are currently still investment grade but are on the edge of junk ratings. Further downgrades could see peripheral bond yields sharply higher as a junk rating would cause benchmark tracking funds to offload them. FX markets have shifted focus back and forth between ECB monetary policy and sovereign debt concerns and increased financial stresses on the periphery could put pressure on the common currency should conditions deteriorate. Spanish Fiscal Revolt--Spains GDP is roughly twice that of Greece, Ireland, and Portugal combined. The region of Catalonia, Spains largest region, has an economy the size of Portugal and plans a 2011 deficit twice as wide as its target. As with many of the nations in the Euro zone, Spain is tightening its fiscal belt and implementing austerity measures to meet deficit targets. Many of Zapateros Socialist voters reside in Catalonia and the Prime Minister is now faced with the choice of fiscal discipline or voter support. The general election is in nine months and politically motivated actions are a threat to fiscal stability. Moreover, the Peoples Party (PP) which pledged austerity in regions governed by the party, have alleged that the ruling Socialists have accumulated hidden debt adding to the nations economic uncertainty. Despite the politics, Spain must act to reduce its fiscal deficits or face a potential rating downgrade which would result in higher funding costs and increase negative sentiment. A deteriorating fiscal position in Spain could see the market quickly punish the sovereign in the form of higher yields and would have severe negative implications for the Euro zone and common currency should such a large EZ economy topple. U.S. Debt Ceiling--The U.S. has approached its debt ceiling and is now faced with the seemingly modest task of raising the debt ceiling which it has done 10 times over the past decade and 74 times since 1962. This now appears to be a large challenge as the political parties quarrel over spending cuts and long term debt reduction measures. Treasury Secretary Timothy Geithner and other key officials have been urging Congress to raise the legal borrowing limit to protect the full faith and credit of the United States and avoid catastrophic economic consequences. Ratings agencies have taken note as this past quarter S&P put the U.S. rating on negative outlook. Fitch said if the debt ceiling is not raised by August 2, the US sovereign rating will be placed on rating watch negative. Moodys warned if there is no progress on increasing the statutory debt limit in Foreign exchange and other leveraged trading involves significant risk of loss and is not suitable for all investors.

Markets Outlook 3Q 2011

We think a failure to lift the debt ceiling would see yields move sharply higher and undermine credibility of U.S. debt by threatening the triple-A credit rating.

coming weeks, it expects to place the U.S. governments rating under review for possible downgrade. We think a failure to lift the debt ceiling would see yields move sharply higher and undermine credibility of U.S. debt by threatening the triple-A credit rating. A default would likely send the dollar sharply lower as Treasuries would lose their safe haven status. While this poses a serious risk, it is not our central view as we believe that the political theater will be put aside in time to raise the debt limit. Hard Landing in China and Other Emerging Markets--As the developed world has been experiencing sluggish growth and deficit problems, China and other emerging economies have outperformed and have been key drivers of global growth. The elevated levels of growth and inflation in these markets have seen monetary policy respond as central banks have raised rates, however this may not be enough to avoid a hard landing. The World Bank warned that emerging economies are operating above capacity and at risk of overheating, most notably in Asia and Latin America and said that fiscal and exchange rate policy may need to play a bigger role to keep inflation in check.

A downturn in Chinas real estate market may see reduced demand for raw materials as well as retail goods which would dampen global growth

Chinas extraordinary growth has been largely attributed to real estate. With better returns than bank deposits, real estate is the preferred investment of the Chinese and is closely tied to construction, infrastructure and consumer spending. A downturn in Chinas real estate market may see reduced demand for raw materials as well as retail goods which would dampen global growth. As emerging economies make up an increasingly larger portion of global output, the performance of their economies is closely linked to risk assets. A hard landing would be a detriment to global growth and see risk come off which would likely benefit the safe havens. Other risk factors in the coming quarter can be seen across the world with Japan continuing to fight a nuclear crisis while the economy attempts to recover from a severe state, the Middle East North Africa region facing ongoing turmoil which may disrupt oil supply and add to overall risk aversion, and the 2011 EU-wide stress tests to be released by the European Banking Authority in the coming months.

Markets Outlook 3Q 2011

10

Expected 3Q 2011 Currency Ranges

EUR/USD GBP/USD USD/JPY USD/CHF AUD/USD NZD/USD USD/CAD EUR/GBP EUR/JPY EUR/CHF 1.3800/1.4800 1.5500/1.6600 78.00/84.00 0.8000/0.8800 1.0200/1.1000 0.7700/0.8600 0.9400/1.0200 0.8500/0.9100 112.00/119.00 1.1600/1.2400 risk to 1.3300 if below 1.3800 risk to 1.5000 if below 1.5500 risk to 88.00 if above 84.00 risk to 0.7500 if below 0.8000 risk to 1.1400 if above 1.1000 risk to 0.7100 if below 0.7700 risk to 0.9000 if below 0.9400 risk to 0.8100 if below 0.8500 risk to 107.00 if below 112.00 risk to 1.1200 if below 1.1600

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Markets Outlook 3Q 2011

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