To 2017 and beyond Investment Outlook - HSBC...Source HSBC Global Asset Management and Barclays Live , as of 30 October 2015. US HY leverage ratio Bank of America Merrill Lynch, as

1For Professional Clients and Institutional Investors only

To 2017 and beyond

Investment Outlook

Xavier Baraton,

Global CIO, Fixed Income

1st December 2016

Global Fixed Income

Year end review & 2017 outlook


Macroeconomic outlook

For Professional Clients and Institutional Investors only3

Performance of financial markets until 21 November 2016 A record year….until mid October

US HY (High Yield) – BofA ML High Yield ; EM Local Debt – JPM GBI-EM GD ; EM Corporate – JPM CEMBI ; EM HC (Hard Currency) – JPM EMBIG, Asian HY Corp – JACI Non Investment Grade

Euro Gov – BofA ML Euro Government, Euro HY - BofA ML Euro High Yield, US IG Corp – BofA ML US Corporate, 10yr UST – Bloomberg UST 10yr Generic, Asian Corp – JACI Corporate

The information above is provided by and represents the opinions of HSBC Global Asset Management and is subject to change without notice.

Source: HSBC Global Asset Management, Bloomberg, BofA ML as of 21 November 2016. Past performance is no guarantee of future results. The views expressed were held at the time of

preparation and are subject to change without notice.

-15%

-10%

-5%

0%

5%

10%

15%

20%2016 MoM 2016 YtD


What has changedFiscal stimulus coinciding with some form of monetary policy exhaustion

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

2011 2012 2013 2014 2015 2016 2017

%

US Euro Area UK

Japan G7

Fiscal stimulus / monetary policy exhaustion

Source: HSBC Global Asset Management, Global Investment Strategy, “What Else Can Central Banks Do?”, Geneva Report on the World Economy 18, “Reality check for the global economy”, PIIE

March 2016 * Fiscal stimulus calculated as the inverse of the change in the cyclically-adjusted primary balance, expressed as a percentage of potential GDP.


What has changed Central banks are more prudent on rates but buy corporate bonds

• ECB / BoE / BoJ are still easing

• Negative rate policies may become

counterproductive – banks business models

• ECB / BoE now buyer of last resort of risky

assets in volatile time

• Mutation of the volatility spike regime into a

more mid-cycle low volatility regime

Source: European Central Bank, as at November 2016.

Bonds and stocks volatility indices

Index

level

0

20

40

60

80

100

120

10

15

20

25

30

35

40

4-Jan-13 4-Jan-14 4-Jan-15 4-Jan-16

VIX Index (LHS) MOVE Index (RHS)


-2

-1

0

1

2

3

4

5

01-2015 07-2015 01-2016 07-2016

%

US EA JP UK

What has changedGlobal activity regains momentum inducing reflationary pressures

-1

0

1

2

3

4

2013 2014 2015 2016 2017

yoy, %

US CPI Euro Area CPIUK CPI Japan CPIChina CPI

Oxford Economics

forecasts

Core CPI

• Fiscal boost can potentially increase inflation above growth when the economy runs close to full

capacity

Source: HSBC Global Asset Management, Global Investment Strategy, data as at October 2016.

Nowcasts


• Depressed term premium with policy

response dominated by central banks

• Vulnerability sentiment and technicals

generate frequent volatility spikes

• An unusually long cycle in developed

markets

• Dollar dependency only fades slowly

while countries adjust structurally

Fixed Income medium term Central ScenarioAn inflection in our medium term scenario

Source: HSBC Global Asset Management, Global Investment Strategy, as at November 2016. The information above is provided by and represents the opinions of HSBC Global Asset Management

and is subject to change without notice.

• A new macro/monetary policy mix making

rates more vulnerable (to the upside)

• Macroeconomic reflationary pressures but

better tamed market volatility

• Better expected returns for high yield over

coming years. Investment grade resilient

but impacted by rising rates

• Better expected returns for emerging

market debt assets

2016 / 2017:

An inflection or transition phase

Medium/long term market context:

A fragile equilibrium

Rates

Volatility

regime

Credit

EMD

Will most likely mean revert


• The market assumed the Fed will stay behind the curve

• Even very long term expectations have been revised downwards. Whilst inflation start to bounce

back

The Fed policy remains a key determinant to US rates

US TIIPS Inflation Break-EvenFOMC Median Fed Fund Projection

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Sep-15 Dec-15 Mar-16 Jun-16 Sept-16

Dec-16 Dec-17 Dec-18 Longer-run

Source: HSBC Global Asset management, Bloomberg, as at November 2016. The information above is provided by and represents the opinions of HSBC Global Asset Management and is subject to

change without notice.

-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

07-2006 07-2009 07-2012 07-2015

US 5-year US 30-year


Vulnerability of the US curve. A path to a new rangeThis also reflects the end of austerity and central bank pause

US government yields (%)



Government 10-year real yields (%)

0

1

2

3

4

5

6

06-2007 06-2009 06-2011 06-2013 06-2015

10-year generic yield 2-year generic yield

30-year generic yield

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

06-2009

US 10-year real yield German 10-year real yield


Currencies: high degree of stability recentlyWith the major exception of the Brexit-induced sharp fall in GBP

US Dollar Index• With the major exception being the

Brexit-induced sharp fall in GBP

• Increased expectations for a December

rate hike by the Fed have led to a

strengthening in the Dollar Index

• The ‘convenient’ 1.05-1.15 range may

temporarily be broken to the downside

• Political developments (trade barriers)

remain the main tail risk



75

80

85

90

95

100

105

04-2014 10-2014 04-2015 10-2015 04-2016 10-2016

DXY Index


Credit overview


Corporate profits vs wage growth

as % of nominal GDP

2.5

3.0

3.5

4.0

4.5

5.0

5.5

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

%

HY Leverage Ratio HY Ex-Energy Leverage Ratio

2.5

3.0

4.5

5.0

5.5

HY Leverage Ratio HY Ex-Energy Leverage Ratio

3.5

4.0

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

US HY: several indicators are picturing a cycle coming to an end

US HY leverage ratio

Source HSBC Global Asset Management and Barclays Live , as of 30 October 2015. US HY leverage ratio Bank of America Merrill Lynch, as of 5 October 2015.

25

30

45

50

55

35

40

1960 1970 1980 1990 2000 2010

42

43

46

44

45

47

48

51

49

50

52

Corporate profits (LHS)

Wage and salary (RHS)

Corporate profits, average

Wage and salary, average


US IG: Corporate America goes shareholder-friendlyAnother sign of end of cycle

Earnings payout ratio

1Q16

Interest coverage ratio

Source: JP Morgan, Morgan Stanley, as at March 2016.


However, with a slow Fed, financial conditions remain accommodatingCreating a unique environment for credit with a slow default wave most likely

US financial conditions have tightened recently

Goldman Sachs Financial Conditions Index

Source: Bloomberg, Goldman Sachs, as of November 2016.

98

99

100

101

102

103

104

105

06-2007 06-2008 06-2009 06-2010 06-2011 06-2012 06-2013 06-2014 06-2015 06-2016


More challenging refinancing for CCCs though

• Appetite for HY has been more measured with the increase in defaults and outflows

• No maturity walls though, limiting acceleration risks, except for CCCs

Source HSBC Global Asset Management and Bank of America Merrill Lynch, as at June 2016.

Developed markets high yield issuance volumes

(US$ Bn)US HY maturity profile – distribution for each rating

category (%)

CCCBBB

1987 1991 1995 1999 2003 2007 2011 2015

250,000

200,000

150,000

100,000

50,000

0

2016 2018 2020 2022 2024 2026

CCCBBB

25

20

10

5

0

15


The HY price adjustment has already happenedTechnicals have been partly cleaned up

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

US HY peak-to-trough 1986-2016

0

200

400

600

800

1000

1200

198

9

199

1

199

3

199

5

199

7

199

9

200

1

200

3

200

5

200

7

200

9

201

1

201

3

201

5

High Yield Index – H0A0

-12.6%

Source HSBC Global Asset Management and Bank of America Merrill Lynch, as of June 2016.


Credit scenario: a ‘cold’ and manageable crisis already started in the US More measured in Euro, offering value

Inter rating spread differential in US High YieldGrowing default rate in the US

In Europe companies are far less advanced in

the cycle

Default rates should remain modest (between

2 and 3%)

Valuations have not fully adjusted

Growing vulnerability of the US HY segment

But macroeconomic environment will remain

benign

Default rates likely to remain above average

for a few years (~5%)

Source HSBC Global Asset Management and Bank of America Merrill Lynch, as of September 2016.

0

5

10

15

20

25

30

1999 2001 2003 2005 2007 2009 2011 2013 2015

BofA-ML US HY EU HY EM HY

0

500

1,000

1,500

2,000

2,500

0

100

200

300

400

500

600

1990 1993 1996 1999 2002 2005 2008 2011 2014

US BBs vs BBBs US Bs vs BBs US CCCs vs Bs

LTM Issuer Default Rate, %

(RHS)


Emerging Market Debt


Different drivers of EM performance so far this year

Oil driven Flow driven Risk driven

Source: Bloomberg, HSBC Global Asset Management. as of Nov 07 2016 . Past performance is no guarantee of future results. The views expressed were held at the time of preparation and are

subject to change without notice.

120

115

110

105

100

95

EMBIG GBI-EM Gdiv Oil (RHS)

Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16

55

50

45

40

35

25

20

30


Stable to improving fundamentals

(4.00)

(3.50)

(3.00)

(2.50)

(2.00)

(1.50)

(1.00)

(0.50)

-

0.50

1.00

1.50

1993 1996 1999 2002 2005 2008 2011 2014

Emerging Market Current Account (% of GDP)

-2

0

2

4

6

8

10

12

2010 2011 2012 2013 2014 2015 2016

EM Growth Tracker

EM ASIA

LATAM

EM EMEA

Source: Bloomberg, HSBC Global Asset Management. as of August 26, 2016. Past performance is no guarantee of future results. USD/ELMI theoretical is composed of HSBC Global Asset

Management calculations based on inflation-adjusted productivity differentials between EM and US productivity indices.

IIF EM Coincident Indicators (%)


Fund flows have been supportive

Annual Cumulative Flows : Hard Currency

(USD bn)

Annual Cumulative Flows – Local Currency

(USD bn)

Source: HSBC Global Asset Management, as of November 2016.

70

50

10

-10

30

Jan Mar May Jul Sep Nov

25

15

-5

-15

5

35

Jan Mar May Jul Sep Nov


Local rates and currencies also reflect relative attractiveness

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

1.20

Ja

n-0

1

Ja

n-0

2

Ja

n-0

3

Ja

n-0

4

Ja

n-0

5

Ja

n-0

6

Ja

n-0

7

Ja

n-0

8

Ja

n-0

9

Ja

n-1

0

Ja

n-1

1

Ja

n-1

2

Ja

n-1

3

Ja

n-1

4

Ja

n-1

5

Ja

n-1

6

USD/ELMI historical USD/ELMI theoretical

Source: Bloomberg, HSBC Global Asset Management. as of Nov, 2016 . Past performance is no guarantee of future results. The views expressed were held at the time of preparation and are subject

to change without notice.

Emerging Market FX valuationEM vs DM historical yields (%)

0

2

4

6

8

10

12

Ja

n-0

3

Ja

n-0

4

Ja

n-0

5

Ja

n-0

6

Ja

n-0

7

Ja

n-0

8

Ja

n-0

9

Ja

n-1

0

Ja

n-1

1

Ja

n-1

2

Ja

n-1

3

Ja

n-1

4

Ja

n-1

5

Ja

n-1

6

G-3 blended rate EM Local yield

Difference


Conclusion


Source: HSBC Global Asset Management, Global Investment Strategy

What has not changedLingering risks

Size of bubbles = impact x probability

0

2

4

6

8

10

0 2 4 6 8 10

Neg

ati

ve

Im

pa

ct

(0

=lo

we

st,

10

= h

igh

es

t)

Probability (0=lowest, 10 = highest)

China hard

landing

Elevated political

uncertainty

Monetary policy

less potent

Reverse globalisation

Faster Fed

tightening


We remain short duration in USD portfolios. Reduce our short in Europe on policy divergence

‒ Anticipation of a 2.5%-3% range for the US 10-year Treasury yield.

‒ German Bund yields to be more resilient and oscillate around 0.5% with ECB remaining prudent

‒ The yield differential could oscillate between 200bp and 250bp between US and EUR 10-year rates, before

edging down again on macro and monetary convergence towards 2018

‒ Trading range for the US curve. Avoid the belly of the curve (3 to 7 year segment)

‒ Carry position on EUR peripheral sovereign with a preference for Italy on relative value

Selective view on credit particularly in the US. Favour BBs and Bs

‒ Diversification into HY risky assets remains justified but is now only fair value.

‒ Fundamental scenario remains more supportive in Europe for both IG and HY

‒ To compare with a cold wave of defaults in the US (4% to 5% default rate vs 2% to 3% in Europe)

‒ Selective issuer and industry selection is paramount as well as focusing on BB-B segments

EMD: neutral and selective position after 2016 strong performance

‒ Despite still positive fundamentals, valuations have become slightly less convincing in absolute terms

‒ Technical may remain sideways until US rates stabilise (at higher levels)

‒ Dispersion will persist around positive long term expected returns.

‒ This commands selective country, currency and corporate selection as well as rotation between assets

‒ As of YE 2015, local rates look more attractive

‒ Overall, like for credit investments, volatility should be better behaved justifying higher investment ratios

Prudence on rates. Constructive yet selective view on EMD and credit

Source: HSBC Global Asset Management, Bloomberg, BofA ML as at November 2016. Past performance is no guarantee of future results. The views expressed were held at the time of preparation

and are subject to change without notice.


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To 2017 and beyond Investment Outlook - HSBC...Source HSBC Global Asset Management and Barclays Live , as of 30 October 2015. US HY leverage ratio Bank of America Merrill Lynch, as