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The Inflection PointQuarterly
April 2018
2
OverviewInflection Point
• 2017 was an ideal economic environment of surprisingly good growth, low inflation, low interest
rates, and strong corporate profits
• This mix created a spectacular phase for investment returns across risky fixed income like emerging
market debt, equities, and some alternative strategies
• But the forces supporting this environment are now beginning to wane:
• Global growth remains good, but with less momentum, and it is now set against higher expectations;
• Low inflation continues, but cyclical inflation pressures are building; and
• The policy mix is becoming a bit less growth-friendly
• We are at an “inflection point” in investment markets
• The key risk that markets perceive is no longer stagnation and deflation. It is now the risk of higher inflation and
faster than expected interest-rate hikes
• This means that the risk properties of global bonds have changed
• We favour selected risk asset classes (global equities, emerging markets, US dollar) over safety
asset classes (global bonds)
3
Source: HSBC Global Asset Management, March 2018
• Last year and into early this year, despite the great economic conditions, the market has remained
anxious about the outlook. We have been climbing a “wall of worry”
Market anatomy2017: a bull market built on anxiety
4
• Yet over the last five years investors have enjoyed strong asset class returns
• Positive, mid-single digit returns from fixed income. Double-digit returns from risky assets
• 2017 performance was fantastic, and much better than expected
• So far in 2018, increased market expectations of faster US interest-rate rises and uncertainties
around a trade war have weighed on global equities and US treasuries
Market anatomyAsset returns over last 5 years and 2017
Source: HSBC Global Asset Management, Bloomberg, Datastream, data as of end February 2018.
Returns shown in USD terms from 31/12/2012-31/12/2017 annualised. (H) denotes currency-hedged returns.
-10
-5
0
5
10
15
20
25
30
35
40
US Treasuries Global Bonds (H) Global ILBs (H) Global IG Credit (H) Global HY Credit(H)
USD EM Debt Local EM Debt US Equities Global Equities EM Equities Commodities Gold
Last 5 years (annualised) 2017 2018 YTD
%, USD Total Returns
5
Source: HSBC Global Asset Management, Global Investment Strategy, March 2018
Synchronised growth
• We track global and countries’ economic growth using a “big data” approach called Nowcasting
• Global growth has been surprisingly good, and we now measure the strongest pace of economic
expansion since the early 2010s. But this pace still remains modest by historic standards
• What is impressive is how widespread growth is. Growth is happening at the same time across global
economies. And the drivers of growth have become more diversified (e.g. investment spending)
• It is a “Balanced Expansion”
Nowcasting the global economy
Nowcast “big data” measure of growth - underlying economic activity strong across DMs and EMs
-4
-2
0
2
4
6
8
World US Eurozone Japan UK EM ex China China India Brazil
Latest Nowcast 1 year ago 18 months ago%
6
0.0
0.5
1.0
1.5
2.0
2.5
3.0
2010 2011 2012 2013 2014 2015 2016 2017 2018
Germany HICP ex energy and unprocessed food (6m MA)
NY Fed UIG: Full data set measure
yoy %
• Low inflation was “a mystery” to central
bankers in 2017
• There has been a persistent undershoot of
inflation targets since the financial crisis
• But cyclical inflation pressures are building
gradually – and the US is at the forefront of
this global trend
Source: HSBC Global Asset Management, Global Investment Strategy, March 2018
…but cyclical inflationary pressures are building
Cyclical InflationGradual and global pressure
There is an inflation undershoot across most DMs…
US inflation: core goods and core services
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17
Core services (6m annualised) Core goods (6m annualised, RHS)%
Target
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
US Eurozone Japan UK Switzerland Sweden NewZealand
Australia Norway
Current 10yr averageyoy
Core goods (6m annualised)
7
• Cyclical inflation is rising but changes in inflation trends tend to be slow and gradual. What’s
more, a little bit of over-heating today will not be enough to offset the below-target inflation rates
we have seen since the financial crisis
• Inflation expectations (the key long-term driver of inflation) remain stable. We are still in a world of
“price stability”
– The structural forces that have delivered low medium-term inflation remain intact (i.e. technological
change, globalisation, deregulation, independent central banks) – for now
Source: HSBC Global Asset Management, Global Investment Strategy, March 2018
Still a “price stability” regimeStructural inflation remains low
Medium-term inflation expectations
1.5
2.0
2.5
3.0
3.5
4.0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
5Y5Y Inflation swap forward University of Michigan 5-10 years
FRBNY 3 year%
Actual US inflation versus target
95
100
105
110
115
120
125
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
US Target Inflation (2%) Actual Core CPI Actual PCEIndex
8
Source: HSBC Global Asset Management, Global Investment Strategy, March 2018
• The interest-rate cycle remains “slow and low” compared with history
• But the synchronised growth and the emergence of cyclical inflation mean that the interest-rate
cycle should now accelerate
• Interest rates will rise this year and central banks will reduce the size of their balance sheets
Policy MixCyclical inflation means that policy is becoming more of a headwind
US rate tightening cycles Central Bank Balance Sheets
We are here
-200
-100
0
100
200
300
400
Dec-17 Mar-18 Jun-18 Sep-18 Dec-18
ECB FED BoJ G3 totalUSDbn, change from
previous quarter
June 2018 onwards: estimates
0
1
2
3
4
5
6
0 6 12 18 24 30
Cum
ula
tive in
cre
ase in
Fe
d F
unds R
ate
(%
)
Months
1976-1980 1983-1984
1986-1989 1994-1995
1999-2000 2004-2006
2015-current month
9
Asian trade had a decent start to 2018
Note: CN = China; HK = Hong Kong; IN = India; ID = Indonesia; JP = Japan; KR = Korea; MY = Malaysia; PH = Philippines; SG = Singapore; TW = Taiwan; TH = Thailand.:
Source: CEIC, Bloomberg, HSBC Global Asset Management, data as of February 2018.
Asian trade had a decent start to 2018, supported by robust global demand
growth and capex cycle…
… while rising US protectionism and US-China trade tensions is a key risk … though some leading indicators suggest that trade growth may be
peaking…
-20
-10
0
10
20
30
40
2011 2012 2013 2014 2015 2016 2017 2018
% yoy; 3mma
Asia ex. China & Japan exports China capital goods imports
US core durable goods orders German capital goods orders
0
20
40
60
80
100
120
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
% bal/diffusion index
Morgan global trade leading index (LHS)
Nomura Asia export leading index (one-month lead) (RHS)
-4
-2
0
2
4
6
8
10
12
14
ID IN PH CN KR TH TW MY SG HK
% GDPGoods trade relations with the US (2016-17 average)
Goods exports to the US % GDP Goods trade balance against the US % GDP
• Asian trade had a decent start to the year, continuing to benefit from a global “balanced expansion” and solid demand from China.
• Some leading indicators suggest trade momentum may be peaking, and the boost from the consumer electronics cycle is beginning to fade.
• But the global capital expenditure cycle, including China’s demand for industrial upgrading, should remain positive for Asia’s trade in the near term.
• One key risk to watch is rising US protectionism. US trade policies targeting China could generate a chain reaction affecting China’s suppliers, including in Asia (particularly Korea, Taiwan and Japan).
10
Inflation remains contained in most countries
Note: * Food (ex. meals away from home); ** Food ex. food servicing services; *** Food & non-alcoholic beverages.
Source: CEIC, Bloomberg, HSBC Global Asset Management, data as of February 2018. Any forecast, projection, or target contained in this presentation is for information purpose only and is not guaranteed in any
way. HSBC accepts no liability for any failure to meet such forecasts, projections or targets. For illustrative purpose only.
Inflation is expected to rise moderately in 2018 but to remain well contained,
falling within central bank target ranges in most countries
PPI inflation has eased on base effectsCore CPI inflation has been stable in most countries, despite some
volatility in Jan-Feb 2018 from the Lunar New year holiday distortions
0
1
2
3
4
5
6
7
AU CN HK IN ID KR MY PH SG TW TH
% yoyActual inflation & inflation consensus/forecasts vs. central
bank (CB) targets
2017 (Q4) 2018 (Jan-Feb) 2018 (consensus) CB upper target CB lower target
4% medium-term target
-2
0
2
4
6
8
10
12
2012 2013 2014 2015 2016 2017 2018
% yoy
CN ID IN KR PH SG TH TW MY
-15
-10
-5
0
5
10
15
20
2014 2015 2016 2017 2018
% yoyPPI
CN IN ID KR MY SG TW TH
• Inflation remains under control across Asia, with core inflation largely stable. Currency appreciation, and output gaps that are still negative, help keep a lid on inflation in many countries.
• Overall, we do not expect inflation to be a major factor in monetary policy this year, except in the Philippines and India. We expect EM Asian central banks to be on hold or, at most, to normalise policy very gradually.
• The Philippines are the only country where we see a risk of overheating and material inflation risks, with inflation now close to the upper bound of the central bank’s target.
• Inflation recently cooled off in India, alleviating fears of an earlier than expected tightening of policy rates.
11
China: cautious monetary policy with strengthening financial regulation
Note: Domestic credit tracks the aggregate assets and liabilities of banks, including commercial banks, central banks or both. TSF (adj.) = TSF adjusted for local government debt swap. SLF = standing
lending facility; MLF = medium-term lending facility
Source: CEIC, Bloomberg, HSBC Global Asset Management, data as of March 2018.
Credit support to the real economy remains broadly stable, but credit
impulse from the shadow banking channel is weakening
The PBoC has been managing liquidity via the use of its various tools to
prevent tail-risk events such as a liquidity/credit crunch
The PBoC may raise the OMO/short-term liquidity policy rates further to
keep up with money market rates and when the Fed hikes rates
0
10
20
30
40
50
8
10
12
14
16
18
20
22
24
26
28
2012 2013 2014 2015 2016 2017 2018
% yoyChina: Selected money and credit indicators
Bank loans (LHS) TSF (adj.) (LHS)
Domestic credit (LHS) M2 (LHS)
Banking sector assets (domestic) (LHS) TSF - off-bbank B/S credit (RHS)
• Monetary policy stance will remain neutral this year.
• We believe strong financial regulations will remain in place and shadow banking credit growth will slow further.
• The PBoC may raise its short-term liquidity rates1 again, to bring them closer to money-market interest rates, and to maintain a comfortable China-US rate differential when the Fed hikes US rates.
• However, it should lag the Fed, provided that capital outflow
and inflationary pressures remain benign.
1. OMO (Open Market Operations) short-term liquidity policy rates
0
1000
2000
3000
4000
5000
6000
7000
8000
-1000
-500
0
500
1000
1500
2013 2014 2015 2016 2017 2018
CNY bnCNY bn
SLF o/s (RHS) MLF o/s (RHS)
PSL o/s (RHS) OMO net injection (LHS)
0
1
2
3
4
5
2013 2014 2015 2016 2017 2018
%US Fed funds rate vs. selected China reference rates (for
guiding market rates)
7D reverse repo 14D reverse repo 28D reverse repo
O/N SLF 1Y MLF Fed funds rate
12
Japan continues to post above-trend growth and low inflation
Source: HSBC Global Asset Management, data as of March 2018
Tightest labour market since 1973 but nominal wage growth still is the
lowest on record during an economic expansion
Japan is no longer in deflation but the 2% BoJ inflation target remains a
remote prospect
• Japan’s GDP expanded for an eighth consecutive quarter at the end of 2017, for the first time in 17 years; growth volatility
also declined over the past two years
• Exports and capital expenditure are the key engines of growth. Personal consumption is still subdued, as wage growth
remains lacklustre despite an increasingly tight labour market
• Inflation continues its gradual and uneven pickup, but services and durable goods price increases are still hovering around
0% yoy. The appreciation of the yen and reduced effects from commodity prices are likely to limit inflation pressures
• As inflation remains low, and with the next increase in the sales rate planned for October 2019 (from 8% to 10%), the Bank
of Japan (BoJ) seems unlikely to start normalising its policy in the foreseeable future.
(LHS)
13
2015 2016 2017 2018
Discounted Inflation
• Market perceptions of inflation risk have shifted
• A trend in our market-implied inflation metric has emerged
• The key questions for investors:
• Is this price action justified by fundamentals?
• How big a shift in underlying inflation dynamics is really taking place?
Source: HSBC Global Asset Management, Global Investment Strategy, March 2018
Market-implied growth indicator Market-implied inflation indicator
A trend in market-implied inflation
What is the market discounting?
2015 2016 2017 2018
Discounted Growth
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
2015 2016 2017 2018
Probability of Low Inflation (<1%)
Probability of High Inflation (>3%)
Market-implied “inflation distribution”
14
Source: HSBC Global Asset Management, Global Investment Strategy. Any forecast, projection or target provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management accepts no
liability for any failure to meet such forecast projection or target.
Data as at 9th February 2018
The pecking order of asset classesToday’s implied market odds
Asia ex Japan Equity
Asia HY
Asia IG
Asia Local BondsDM Equity
EM Equity
Eurozone Equity H
Frontier Equity GCC Equity
German Bunds
Global ABS
Global Credit
Global HY BB B
Global ILBs
Global REITs
Hedge Funds
Japan Equity H
Japanese JGBs
Sukuk Bonds
US Equity
US IG
US TIPSUS Treasuries
Local EMD
Private Equity
UK Gilts
Commodities
-2
-1
0
1
2
3
4
5
6
7
8
9
10
11
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34
Expected Volatility (%)
Exp
ecte
d R
isk P
rem
ia (
%, N
om
inal, U
SD
)
*Global Fixed Income assets are shown hedged to USD. Local EM debt, Equity and Alternative assets are shown unhedged
Expected Volatility (%)
Exp
ecte
d R
isk P
rem
ia (
%, N
om
inal, U
SD
)
*Global Fixed Income assets are shown hedged to USD. Local EM debt, Equity and Alternative assets are shown unhedged
0.1Sharpe Ratio
0.2Sharpe Ratio
0.3Sharpe Ratio
Current Pecking Order of Asset Classes
15
The balance of risks has shiftedAn inflection point in the growth-inflation mix
“Severe Secular
Stagnation”“Fragile Equilibrium”
“Strong Demand
Recovery”
Description of
Macro
Environment
• Very weak demand growth
• Negative interest rates are
required
• There is a meaningful
threat to corporate
fundamentals and balance
sheets
• There is enough
demand relative to
supply
• Inflation remains low
• The interest rate cycle
will be “slow-and-low”
• Demand is too strong
relative to available supply
• Output gaps go positive &
pressure on real interest
rates rises
• Bond yields move back to
historic norms
Primary Source
Growth recession
Rapid de-leveraging (China)
US-led global reflation
Pre-emptive Fed policy
tightening
Impact on Asset
Pricing
Positive for: DM Government
Bonds, IG Credits
Negative for: EM and
commodity-linked Equity, EM
currencies
Fragile Equilibrium is
maintained
USD overshoots,
May be positive for EM
Equity and EM Local FX
Debt
Negative for: DM
Government Bonds, IG
Credit
Source: HSBC Global Asset Management, Global Investment Strategy, March 2018
Feb 2016 Aug 2017 Nov 2016
Balance of risks firmly in
this direction now
March 2018Market
Perceptions
Of Macro
Environment Not part of the current
return distribution
16
Fed policy guidance remains for 3 rate hikes in 2018 – in line
with market expectations. The risk is having faster inflation than
expected that would force them to hike more than 3 times
The ECB was more hawkish at its January meeting, supporting
the idea that QE could end in September. But we do not expect
the first interest rate hike until 2019
The BoE has suggested that rates may need to rise faster than
was assumed in the November inflation report, but Brexit
uncertainty and cyclical risks limit how fast they can rise
At the BoJ, Governor Kuroda was given a second five-year
term. He has indicated that the BoJ will start thinking about
ending its monetary stimulus program in 2019
Summary
Source: HSBC Global Asset Management, Global Investment Strategy, March 2018
• Globally, we are seeing a “balanced expansion” across sectors
and regions, with negligible recession risk
• Our Nowcast points to continued global growth, which is now at
+5% in Q1, up from +4.3% in the previous quarter. Emerging
markets are providing new momentum to global growth
• Across the major economies, key inflation metrics are rising
gradually (even in Europe and Japan). The market has begun to
recognise these inflation pressures.
• The key question is whether the shift in the market’s perceptions of
inflation is justified by the fundamentals. Cyclical inflation is rising,
but we remain in a structural regime of “price stability”
• The market has begun to accept the narrative of cyclical inflation.
Investor perceptions of macro risk have moved into overheating
and rising interest rates. Is this an inflection point?
• Bonds have recently been bad hedges for multi-asset investors.
We now measure a positive reward for carrying 10-year USTs,
but ‘rest of the world’ bonds still carry a significant negative bond
premium. We remain underweight. Inflation hedges (TIPS) make
sense to us. The dollar is the only true safe haven, in our view
• In global credits, the economic environment remains supportive,
but the good news is already priced in. We remain underweight
• We think strong company fundamentals and the recent sell-off
strengthen the case for global equity and other risk assets. We
prefer “late cycle” equities (Japan, Europe) and emerging
markets (equities and local-currency emerging market bonds)
LO
W T
O
HIG
H IM
PA
CT
LOWER TO HIGHER PROBABILITY
Macro Outlook Central Banks
Key Views Key Risks
Political uncertainty
Policy error
Productivity boom
Cyber attack
Renewed long-term
stagnation
Irrational market
behaviour
Inflation shock
17
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