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G10 currencies

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See table for current exchange rates and CIO forecasts
• We believe the risks to the EURUSD currency pair are now more balanced, as tail risks on the European side have been considerably reduced.
• The GBP trended higher despite stimulus measures by the Bank of England. The main reason is the need for diversification out of the EUR and USD and decisive UK policy making. We maintain an overweight after the strong rebound of economic data in 3Q 2012 which we expect to persist into 2013.
• The CAD remains supported by better growth dynamics. However in the short term, around the US elections and fiscal cliff debate, a setback cannot be ruled out. We also remain underweight in the AUD.
• The SNB has shown that it can defend the CHF floor. With EUR tail risk reduced the CHF likely recovers together with the EUR against most other currencies. Thus we close the CHF underweight.
• We expect stronger policy intervention in Japan to weaken the JPY over the coming months.

Recommendations
Tactical (6 months)
• We continue to have a preference for the GBP and keep the short in the JPY.

Strategic (1 to 2 years)
• We recommend that investors diversify from large USD and EUR exposures into minor currencies. Structural financing issues weigh on all the major currencies.
• The best diversifiers based on long-term macroeconomic fundamentals are the CAD and the SEK. The AUD, NOK and CHF should only be added at better entry levels. The GBP also remains attractive.

Positive scenario
FX targets: EURUSD >1.35 / EURJPY 115
• The announcement of unlimited QE in the US, as well as a stronger-than-expected acceleration of global growth or further European integration would be EURUSD positive. EURUSD should trade above 1.35 in this case. Yen weakness should come as the Bank of Japan intervenes to weakens its currency.

Negative scenario
FX targets: EURUSD <1.25 / EURJPY 90
• The European growth outlook deteriorates further with continued recession in 2013. The euro could rapidly fall below 1.25. A European debt-default cascade (possibly triggered by a disorderly Greece euro exit) is a tail risk for the single currency. Risk aversion would lead to an extended USD and JPY rally.
Note: Scenarios refer to global economic scenarios (see slide 7)

What we're watching Why it matters
Chinese growth
We expect China to land softly and then recover. Should China disappoint with a hard landing, then risk-unwinding would support USD and JPY vs. risk-taker currencies. In the base case, a Chinese recovery should support the AUD in the medium term, but a dip below parity is likely in the short term.

European sovereign crisis, ECB policy
The main focus lies on the Spanish application for ESM/ECB support, which would be EUR positive; a rate cut (not expected) would hurt the EUR. Key date: Nov 8, ECB meeting

US growth and Fed policy response
What will the Fed do once Operation Twist ends at year end? How will the presidential elections change political power in Washington? Key dates: Nov 6, US presidential elections; Dec 12, FOMC meeting

UBS CIO FX forecasts

[Table Header] 24-10-12 3M 6M 12M PPP
EURUSD 1.294 1.30 1.32 1.34 1.30
USDJPY 79.75 80 82 86 79
USDCAD 0.991 0.94 0.94 0.92 0.98
AUDUSD 1.0322 0.97 1.00 1.05 0.74
GBPUSD 1.6018 1.65 1.68 1.70 1.69
NZDUSD 0.8138 0.78 0.80 0.83 0.60
USDCHF 0.9346 0.93 0.92 0.92 1.03
EURCHF 1.2097 1.21 1.21 1.23 1.33
GBPCHF 1.4974 1.54 1.54 1.56 1.73
EURJPY 103.27 104 108 115 102
EURGBP 0.8079 0.79 0.79 0.79 0.77
EURSEK 8.6577 8.20 8.00 8.00 8.86
EURNOK 7.4373 7.30 7.20 7.20 8.53

Source: Thomson Reuters, UBS, as of 15 October 2012
Note: Past performance is not an indication of future returns.

UBS
For further information please contact CIO asset class specialist Thomas Flury, thomas.flury@ubs.com
Please see important disclaimer and disclosures at the end of the document.
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