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Fixed Income Summary and View
December 2008
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Summary
2 contrarian forces one inflationary and the other deflationary
have been in playsince last year
Strong demand from emerging economies leading commodities higher
and fuellinginflation worldwide
Housing led credit crisis in the US starting to exert a
deflationary force
The first force was dominant till early July 2008 leading
commodity prices to freshpeaks and inflation to multi year highs.
Since then, however, the second force hasconclusively taken
hold
As a result commodity prices have fallen 50% from the top,
growth and inflationnumbers are toppling worldwide, and central
bankers have shifted focus toachieving financial stability and
protecting growth
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Inflation Is Falling Across The Globe
Commodity prices peaked in July 2008and are down by more than
50% since
then
The intensity of the fall indicates thestrength of the ongoing
de-leveraging
process
In line with the above, inflation is fallingat a sharp pace in
almost all majoreconomies across the world
Recent data has sparked serious threatof deflation in the US
Source: Bloomberg
Source: Bloomberg
PRODUCER PRICE INDEX
4.5
5
5.5
6
6.5
7
7.5
8
8.5
9
9.5
10
10.5
3 1 - J a n - 0
8
2 9 - F e b - 0
8
3 1 - M a r - 0 8
3 0 - A p r - 0 8
3 1 - M a y - 0
8
3 0 - J u n - 0
8
3 1 - J u l - 0 8
3 1 - A u g - 0
8
3 0 - S e p - 0
8
3 1 - O c t - 0 8
US EUROZONE UK CHINA
COMMODITY PRICES
200
250
300
350
400
450
500
J a n - 0
8
F e b - 0
8
M a r - 0 8
A p r - 0 8
M a y - 0
8
J u n - 0
8
J u l - 0 8
A u g - 0
8
S e p - 0
8
O c t - 0 8
N o v - 0
850
60
70
80
90
100
110
120
130
140
150
GENERIC COMMODITY INDEX CRUDE PRICE
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As Growth Collapses
Major economies like the US, UK, EuroZone, Japan, Hong Kong and
Singapore
are witnessing a significant slowdown ingrowth
Lead indicators are pointing towards
further contraction around the world(including in China)
Source: Bloomberg
Source: Bloomberg
GDP
8
8.5
9
9.5
10
10.5
11
11.5
12
12.5
13
M a r - 0 7
J u n - 0
7
S e p - 0
7
D e c - 0
7
M a r - 0 8
J u n - 0
8
S e p - 0
8-0.5
0
0.5
1
1.52
2.5
3
3.5
4
4.5
5
CHINA US EUROZONE
PURCHASING MANAGERS' INDICES
34
36
38
40
42
44
46
48
5052
54
56
58
60
62
64
3 1 - J a n - 0
7
2 8 - F e b - 0
7
3 1 - M a r - 0 7
3 0 - A p r - 0 7
3 1 - M a y - 0
7
3 0 - J u n - 0
7
3 1 - J u l - 0 7
3 1 - A u g - 0
7
3 0 - S e p - 0
7
3 1 - O c t - 0 7
3 0 - N o v - 0
7
3 1 - D e c - 0
7
3 1 - J a n - 0
8
2 9 - F e b - 0
8
3 1 - M a r - 0 8
3 0 - A p r - 0 8
3 1 - M a y - 0
8
3 0 - J u n - 0
8
3 1 - J u l - 0 8
3 1 - A u g - 0
8
3 0 - S e p - 0
8
3 1 - O c t - 0 8
3 0 - N o v - 0
8
US EUROZONE UK CHINA
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Policy Response Has Been Unprecedented
The US Fed has been proactive incutting rates given that the US
has been
the epicenter of the current crisis
Inflation targeting Central Bankers ofEurope have also shifted
stance. UK has
cut drastically recognizing the catchingup required
Most Asian central bankers, mostnotably the Peoples Bank of
China, havestarted cutting aggressively as well
Source: Bloomberg
POLICY RATES
1
1.5
2
2.5
3
3.5
4
4.5
5
5.5
6
6.5
7
7.5
8
3 1 - J a n - 0
7
2 8 - F e b - 0
7
3 0 - M a r - 0 7
3 0 - A p r - 0 7
3 1 - M a y - 0
7
2 9 - J u n - 0
7
3 1 - J u l - 0 7
3 1 - A u g - 0
7
2 8 - S e p - 0
7
3 1 - O c t - 0 7
3 0 - N o v - 0
7
3 1 - D e c - 0
7
3 1 - J a n - 0
8
2 9 - F e b - 0
8
3 1 - M a r - 0 8
3 0 - A p r - 0 8
3 0 - M a y - 0
8
3 0 - J u n - 0
8
3 1 - J u l - 0 8
2 9 - A u g - 0
8
3 0 - S e p - 0
8
3 1 - O c t - 0 8
2 8 - N o v - 0
8
US EUROZONE UK CHINA
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A Similar Theme is Underway In India
Wholesale Price Index (WPI) inflationhas fallen drastically over
the past few
weeks in line with global trends
We expect it to fall to below 3% levels byMarch 2009
GDP growth is decidedly slowing despitesupport hitherto from the
services sector Source: Bloomberg &
HSBC AMIN research
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
J a n - 0
2
M a y - 0
2
S e p - 0
2
J a n - 0
3
M a y - 0
3
S e p - 0
3
J a n - 0
4
M a y - 0
4
S e p - 0
4
J a n - 0
5
M a y - 0
5
S e p - 0
5
J a n - 0
6
M a y - 0
6
S e p - 0
6
J a n - 0
7
M a y - 0
7
S e p - 0
7
J a n - 0
8
M a y - 0
8
S e p - 0
8
J a n - 0
9
ProjectedInflation
Source: Bloomberg
GDP
7
7.5
8
8.5
9
9.5
10
10.5
11
3 0 - J u n - 0
5
3 0 - S e p - 0
5
3 1 - D e c - 0
5
3 1 - M a r - 0 6
3 0 - J u n - 0
6
3 0 - S e p - 0
6
3 1 - D e c - 0
6
3 1 - M a r - 0 7
3 0 - J u n - 0
7
3 0 - S e p - 0
7
3 1 - D e c - 0
7
3 1 - M a r - 0 8
3 0 - J u n - 0
8
3 0 - S e p - 0
8
GDP
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With Further Weakness Ahead
Relative freeze in domestic creditmarkets has happened starting
October
2008
Monthly growth indicators like trade dataand purchasing managers
index point to
sharply lower prints in incremental GDPnumbers
Source: Bloomberg
Source: Bloomberg
TRADE
68
1012141618202224
26283032343638404244464850
3 1 - M a r - 0 7
3 0 - A p r - 0 7
3 1 - M a y - 0
7
3 0 - J u n - 0
7
3 1 - J u l - 0 7
3 1 - A u g - 0
7
3 0 - S e p - 0
7
3 1 - O c t - 0 7
3 0 - N o v - 0
7
3 1 - D e c - 0
7
3 1 - J a n - 0
8
2 9 - F e b - 0
8
3 1 - M a r - 0 8
3 0 - A p r - 0 8
3 1 - M a y - 0
8
3 0 - J u n - 0
8
3 1 - J u l - 0 8
3 1 - A u g - 0
8
3 0 - S e p - 0
8
3 1 - O c t - 0 8
EXPORTS IMPORTS
PURCHASING MANAGERS' INDEX
44
46
48
50
52
54
56
58
60
3 1 - M a y - 0
8
3 0 - J u n - 0
8
3 1 - J u l - 0 8
3 1 - A u g - 0
8
3 0 - S e p - 0
8
3 1 - O c t - 0 8
PURCHASING MANAGERS' INDEX
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Policy Has Been Proactive
Policy makers have been quite proactive sofar with monetary as
well as otheradministrative tools
However, while bank lending rates havebeen cut in response, flow
of credit is still toresume fully
We expect more rate cuts ahead given theneed to anchor overnight
rates at much lowerlevels in order for banks to feel
thesteepness
The 1 yr swap rate is already pricing inovernight rates of below
5%
Government security yields have fallen butstill look lucrative
as rate cuts shouldcontinue
Source: Bloomberg
RATES
5
6
7
8
9
10
11
3 1 - J a n - 0
7
2
8 - F e b - 0
7
3 0 - M a r - 0 7
3
0 - A p r - 0 7
3 1 - M a y - 0
7
2
9 - J u n - 0
7
3 1 - J u l - 0 7
3 1 - A u g - 0
7
2 8 - S e p - 0
7
3 1 - O c t - 0 7
3
0 - N o v - 0
7
3
1 - D e c - 0
7
3 1 - J a n - 0
8
2
9 - F e b - 0
8
3 1 - M a r - 0 8
3
0 - A p r - 0 8
3 0 - M a y - 0
8
3
0 - J u n - 0
8
3 1 - J u l - 0 8
2 9 - A u g - 0
8
3 0 - S e p - 0
8
3 1 - O c t - 0 8
2
8 - N o v - 0
8
REPO RATE 1 YEAR OIS 10 YEAR GOVERNMENT SECURITY
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Excess Supply Is No Longer A Worry
Government will breach its fiscal target for the year, in line
with our long held view
However, given rising delinquencies on loan books and trader
appetites already whipped bya sharp rally so far, the additional
supply will be comfortably absorbed
RBI is already committed to providing liquidity for incremental
borrowing throughsimultaneous buy-back of market stabilization
bonds
The opening up of spread between government securities and the
swap curve partly reflectsexpectation of additional supply.
The government securities curve still provides a lucrative entry
point as it might gear up forthe next leg of rally when fears
around absorption of incremental excess supply aredecidedly
eliminated.
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Credit Spreads May Still Compress Reluctantly
India has had a phenomenal credit cyclewith the stock of credit
having doubled over
last 3 years
A sustained current account deficit duringthis time has meant we
have consistentlyrelied on external funding
The current risk aversion (as reflected inrising emerging market
bond spreads andweakening currencies) has led to severe fall
in external sources of funding
With equity markets being weak and banksless willing to lend,
the process of
channeling domestic savings intoinvestments has been disrupted
as wellSource: Bloomberg
Source: Bloomberg
INDIA'S PHENOMENAL CREDIT CYCLE
5000075000
100000125000150000175000200000225000250000275000300000325000350000375000400000425000450000475000500000
M
a r - 0 1
M
a r - 0 2
M
a r - 0 3
M
a r - 0 4
M
a r - 0 5
M
a r - 0 6
M
a r - 0 7
M
a r - 0 83
4
5
6
7
8
9
10
11
12
13
14
NON FOOD CREDIT (INR CRS) CREDIT TO GDP RATIO (%)
ASIAN CURRENCIES AND EMERGING MARKET BOND SPREADS
102103104105106107108109110111112113114115116117118
J a n - 0 7
F e b - 0 7
M a r - 0 7
A p r - 0 7
M a y - 0 7
J u n - 0 7
J u l - 0 7
A u g - 0 7
S e p - 0 7
O c t - 0 7
N o v - 0 7
D e c - 0 7
J a n - 0 8
F e b - 0 8
M a r - 0 8
A p r - 0 8
M a y - 0 8
J u n - 0 8
J u l - 0 8
A u g - 0 8
S e p - 0 8
O c t - 0 8
N o v - 0 8
100150200250300350400450500550
600650700750800
ASIA DOLLAR INDEX EMERGING MARKETS' BOND SPREADS
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Credit Spreads May Still Compress Reluctantly (cont)
All this means that demand for funds far outstrips supply as of
now. As long as this is thecase, it is unlikely that there will be
any meaningful compression in spreads
Some stability in international risk appetite (and in turn
currency) may lead stabilization incorporate spreads domestically
since it may open window for external funds again
A sustained contraction in spread will, however, only happen
once demand versus supply ofcredit finds a better balance than
currently
Consequently, current strategy favors government securities in
building duration. Atsome point, however, as triggers mentioned
above begin to fructify we will go
overweight corporate bonds
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The last secular bond bull run lasted approximately 3 years
beginning October2000
Average returns of of 17 income funds which were in existence
over this fullperiod were: Year 1 = 16.9%, Year 2 = 16.6% and Year
3 = 7.9% (all returnspost expenses)*
Average returns over the 3 years was 13.8% (post expenses)
There are 2 inferences to be made:
Duration play can potentially be much more powerful than play on
credit risk
One needs to stay invested over the period of a cycle in order
to benefit fullyfrom a fall in interest rates
Income Fund returns during the last cyclical bull run
*Source: MFIE, HSBC AMIN Research
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Disclaimer
This document has been prepared by HSBC Asset Management (India)
Private Limited (HSBC) for informationpurposes only and should not
be construed as an offer or solicitation of an offer for purchase
of any of the funds ofHSBC Mutual Fund. All information contained
in this document (including that sourced from third parties), is
obtainedfrom sources HSBC, the third party believes to be reliable
but which it has not independently verified and HSBC, thethird
party makes no guarantee, representation or warranty and accepts no
responsibility or liability as to the accuracy
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available information and rates of taxation applicable at the time
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Expressions of opinion are those of HSBC only and are subject to
change without notice. It does nothave regard to specific
investment objectives, financial situation and the particular needs
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Risk Factors
Investors may obtain Offer Documents/ Scheme Information
Document/Statement of Additional Information and KeyInformation
Memorandums along with application forms from the office of HSBC
Mutual Fund, 314 D. N. Road, Fort,Mumbai 400 001. Tel: 022-6666
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Risk Factors: All investments in mutual funds and securities are
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Thank You
