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Credit and Fixed Income

30 January 2010

Philip Barleggs

2CMINST-0336

Growth Strong growth, with variations

The global economy will probably experience strong growth in the first half 2010. Asia is set to shine while the major economies will be held back by muted consumption growth

Inflation Inflation in range

The significant excess capacity around the world should lead core inflation to decline until mid-year. Headline inflation has been rising because of commodity prices but is not expected to overshoot

Policy Removal of policy support

Fiscal policy is becoming less supportive. And monetary policy is being effectively tightened as quantitative easing (QE) ends. We expect policy rates in the G4 to remain unchanged in 2010

Global Economic Outlook

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Growth Outlook – US

Source: Thomson Reuters Datastream

1980 1985 1990 1995 2000 2005 2010

35

40

45

50

55

60

65

-4

-2

0

2

4

6

8

10

USA: ISM manufacturing PMI - lagged 1q (lhs) GDP growth (yoy %) (rhs)

Leading Indicators Point to Strong Growth in the US but questions remain about sustainability

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Growth Outlook – Europe

Sentiment suggests softer recovery in Europe

Source: Thomson Reuters Datastream

98 00 02 04 06 08 1060

70

80

90

100

110

120

-6

-4

-2

0

2

4

6

Eurozone: Economic Sentiment Indicator - lagged 1q (lhs) GDP growth (yoy %) (rhs)

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Inflation Outlook

Large Output Gap should act as a Drag on Core Inflation

Source: Thomson Reuters Datastream

1980 1985 1990 1995 2000 2005 2010

-3

-2

-1

0

1

2

3

4 -6

-4

-2

0

2

4

USA: 1y change in unemployment rate (%, 6m moving average) – lagged 7m (lhs)1y change in core CPI (yoy %, 6m moving average) (rhs)

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Supportive Drivers

Economic Recovery & Stimulus packages

De-leveraging continues, fundamental improve

Comparative position versus Sovereigns improving

Investment inflows

Credit Outlook

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Risk Factors

Sovereign debt crisis deepens

How overweight are investors already?

Credit Outlook

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Yield Level Gradually higher yields Economic growth, large government deficits, and the prospect of rate hikes will probably lead to gradually higher yields

Curve Curve to flatten - eventuallyWe expect curves to remain very steep for several months before flattening when investors start pricing in upcoming rate hikes

Inflation Breakeven inflation attractive in the USA, too high in EuropeFor US bond investors, TIPS are an attractive insurance policy against higher-than-expected inflation. We prefer nominals in the UK and in the Eurozone

Swap Spreads Swap spreads to tightenWe expect swap spreads to tighten, except for US swap spreads as their directionality to yields leave them vulnerable to a correction in bonds

Global Government Bond Strategy

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Yield levels Superior yield on corporates provides comfortable break-even levels

Flat spread curve enables capture of risk premiums at short maturities

Spreads Spread tightening is supported by improving fundamentals

Compression between rating bands has further to go

Overweight Corporate bonds

Economic recovery on track

Valuations attractive

Asset allocation inflows expected

Global Credit Strategy

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Central Banks – Lower for longer

Asset Reflation – Substantial cash reserves put to work

Focus Turns to Fundamental Data – Scaling back of official intervention

Macro Themes for 2010

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Higher Yields

Narrower Credit Spreads

Lower Volatility

Inflation: Is it Cheap?

Investment Themes for 2010