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Joseph Little, Chief Global Strategist

Non-contractual document. This publication is intended for Professional Clients as defined by

MIFID only and should not be distributed to or relied upon by Non professional clients. The

information contained in this publication is not intended as investment advice or

recommendation.

For illustrative purpose only, this document is a global view of the recent evolution of the

economic conditions. This is a marketing support which does not constitute neither an

investment advice or a recommendation to buy or sell investment.

This commentary is not the result of investment research and is not subject to legal requirements

designed to promote the independence of investment research and is not subject to any

prohibition on dealing ahead of its dissemination.

Inflection Point

March 2018

2 Non-contractual document

OverviewInflection Point

2017 was a “Goldilocks” economic environment of surprisingly-good growth, low inflation, low interest rates, policy

accommodation, and strong corporate profits

– This created a spectacular phase for investment returns

We argue that the forces that have driven 2017’s Goldilocks economics are beginning to wane

– Growth trends continue to be strong and synchronized – it is a “balanced expansion”

– …But cyclical inflation pressures are building gradually and globally…

– …Even if longer-term, structural inflation remains well-behaved…

– …The policy mix now becomes less favourable than what we have recently experienced

We are at an “inflection point” in investment markets

– The principal shock to the system has shifted away from secular stagnation and deflation toward the risk of higher inflation and

much faster-than-expected interest rate hikes

– This means that the risk properties of global bonds have changed

Price is the principal determinant of asset class attractiveness

– Selective exposure to risk assets offers the best way to back the “balanced expansion” (late cycle equities like Europe & Japan;

Emerging Market asset classes)

– The outlook for fixed income asset classes is more tricky. Conventional notions of safety have changed

Source: HSBC Global Asset Management, Global Investment Strategy, March 2018. The commentary and analysis presented in this document reflect the opinion of HSBC Global Asset Management

on the markets, according to the information available to date. They do not constitute any kind of commitment from HSBC Global Asset Management.


Fed policy guidance remains for 3 rate hikes in 2018 – in line

with market expectations. The risk is that they are forced to

deliver more by faster-than-expected inflation

The ECB struck a more hawkish tone at its January meeting,

confirming the possibility that QE could end in September. But

we don’t expect the first interest rate hike until 2019

BoE Governor Carney has signalled that rates may need to go

up faster than assumed at the November inflation report. Brexit

uncertainty and cyclical risks limit a rapid policy normalisation

At the BoJ, Governor Kuroda has been nominated for a second

five year term and has signaled that the central bank will start

thinking about how to exit its stimulus program in 2019

Summary

• Globally, growth trends look like a “balanced expansion” across

sectors and regions, with negligible recession risk

• Our Nowcast points to continued synchronised global expansion

with global growth now at +5.0% in Q1, up from +4.3% in the

previous quarter. EMs are providing new momentum to global

growth

• The market has begun to recognise cyclical inflation pressures.

Across the major economies, key inflation metrics have bottomed

and are rising gradually (even in Europe and Japan)

• The key macro question is whether the shift in inflation narrative is

justified by the fundamentals? Cyclical inflation is on the rise, 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 “strong

demand recovery”. Is this an inflection point?

• Bonds have been bad hedges for multi asset investors during the

recent episode. We now measure a term premium of +50bps in

10-year USTs. But ROW bonds still carry a significant negative

bond premium. We stay UW. Inflation hedges (TIPS) make

sense. The dollar is the only true safe haven

• Risks are asymmetric in global credits. The economic

environment remains supportive, but the good news is already

priced in. We maintain our UW

• The recent sell-off increases the case for global equity

exposures, given strong fundamentals. We prefer “late cycle”

equities (Japan, Europe) and EM (equities and EMD local FX)

LO

W T

O H

IGH

IM

PA

CT

LOWER TO HIGHER PROBABILITY

Macro Outlook Central Banks

Key Views Key Risks

Political uncertainty

Policy error

Productivity boom

Cyber attack

Renewed secular

stagnation

Market mis-behaviour

Inflation shock


on the markets, according to the information available to date. They do not constitute any kind of commitment from HSBC Global Asset Management. Any forecast, projection or target where

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.

The economy is in a “balanced expansion”


Source: HSBC Global Asset Management, Global Investment Strategy, March 2018

Synchronised GrowthNowcasting the global economy

• We track over 1,200 macro-economic indicators in our “big data” Nowcasting model for global growth

• We now measure the strongest pace of global growth since the early 2010s

• The pace of growth is still modest by historic standards, but the breadth of global growth is

impressive. There is growth-synchronisation across global economies. And drivers of growth are

diversified

• It is a “Balanced Expansion”

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%


Synchronised GrowthPMI Manufacturing heatmap*

*:Red indicates above 50, blue indicates below 50. Source: Bloomberg, HSBC Global Asset Management, as at January 2018

Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18

World 52.0 52.0 52.7 52.7 52.9 52.9 52.7 52.6 52.6 52.7 53.2 53.2 53.5 54.0 54.5 54.4

DM 52.6 52.9 53.8 54.1 54.1 53.9 54.1 54.1 53.8 53.9 54.2 54.6 55.2 55.8 56.2 56.3

United States 53.4 54.1 54.3 55.0 54.2 53.3 52.8 52.7 52.0 53.3 52.8 53.1 54.6 53.9 55.1 55.5

Canada 51.1 51.5 51.8 53.5 54.7 55.5 55.9 55.1 54.7 55.5 54.6 55.0 54.3 54.4 54.7 55.9

United Kingdom 53.9 53.1 55.8 55.4 54.6 54.3 57.2 56.5 54.2 55.4 56.8 56.1 56.3 58.1 56.2 55.3

Eurozone 53.5 53.7 54.9 55.2 55.4 56.2 56.7 57.0 57.4 56.6 57.4 58.1 58.5 60.1 60.6 59.6

Germany 55.0 54.3 55.6 56.4 56.8 58.3 58.2 59.5 59.6 58.1 59.3 60.6 60.6 62.5 63.3 61.1

France 51.8 51.7 53.5 53.6 52.2 53.3 55.1 53.8 54.8 54.9 55.8 56.1 56.1 57.7 58.8 58.4

Italy 50.9 52.2 53.2 53.0 55.0 55.7 56.2 55.1 55.2 55.1 56.3 56.3 57.8 58.3 57.4 59.0

Spain 53.3 54.5 55.3 55.6 54.8 53.9 54.5 55.4 54.7 54.0 52.4 54.3 55.8 56.1 55.8 55.2

Ireland 52.1 53.7 55.7 55.5 53.8 53.6 55.0 55.9 56.0 54.6 56.1 55.4 54.4 58.1 59.1 57.6

Japan 51.4 51.3 52.4 52.7 53.3 52.4 52.7 53.1 52.4 52.1 52.2 52.9 52.8 53.6 54.0 54.8

EM 51.1 50.8 51.1 50.8 51.3 51.6 51.0 50.6 50.8 51.0 51.7 51.4 51.2 51.6 52.2 51.9

China 51.2 50.9 51.9 51.0 51.7 51.2 50.3 49.6 50.4 51.1 51.6 51.0 51.0 50.8 51.5 51.5

Indonesia 48.7 49.7 49.0 50.4 49.3 50.5 51.2 50.6 49.5 48.6 50.7 50.4 50.1 50.4 49.3 49.9

South Korea 48.0 48.0 49.4 49.0 49.2 48.4 49.4 49.2 50.1 49.1 49.9 50.6 50.2 51.2 49.9 50.7

Taiwan 52.7 54.7 56.2 55.6 54.5 56.2 54.4 53.1 53.3 53.6 54.3 54.2 53.6 56.3 56.6 56.9

India 54.4 52.3 49.6 50.4 50.7 52.5 52.5 51.6 50.9 47.9 51.2 51.2 50.3 52.6 54.7 52.4

Brazil 46.3 46.2 45.2 44.0 46.9 49.6 50.1 52.0 50.5 50.0 50.9 50.9 51.2 53.5 52.4 51.2

Mexico 51.8 51.1 50.2 50.8 50.6 51.5 50.7 51.2 52.3 51.2 52.2 52.8 49.2 52.4 51.7 52.6

Russia 52.4 53.6 53.7 54.7 52.5 52.4 50.8 52.4 50.3 52.7 51.6 51.9 51.1 51.5 52.0 52.1

Turkey 49.8 48.8 47.7 48.7 49.7 52.3 51.7 53.5 54.7 53.6 55.3 53.5 52.8 52.9 54.9 55.7

Poland 50.2 51.9 54.3 54.8 54.2 53.5 54.1 52.7 53.1 52.3 52.5 53.7 53.4 54.2 55.0 54.6


Synchronised GrowthZero risk of recession

• The Nowcast is our favourite way to understand the global growth cycle

• The risk of recession is basically zero

• Many economists have argued that after a historically long economic expansion, we are “due a

recession”…

• …But business cycles do not run on clocks, and the usual catalysts for a recession are not in place

Longest economic expansions in DMs (since 1949)US treasury yield curve slope and recessions

32

64

67

70

71

83

103

0 20 40 60 80 100 120

US 2010-today

UK 1992-2008

US 1991-2008

France 1975-1993

UK 1956-1974

Australia 1962-1982

Australia 1992-today

Length of expansion (no. of consecutive quarters of positive real GDP growth)0

0,1

0,2

0,3

0,4

0,5

0,6

0,7

0,8

0,9

1

-100

-50

0

50

100

150

200

250

300

350

1988 1992 1996 2000 2004 2008 2012 2016

Recession 2-10s 10-30sbps




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 the inflation-

targeting central bankers in 2017

• There has been a persistent undershoot of

inflation targets since the GFC

• But cyclical inflation pressures are building -

gradually. And the US is at the forefront of

this global trend

Cyclical InflationGradual and global pressure

…but cyclical inflationary pressures are building

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%

Current 10yr averageyoy




Tracking InflationInflation heatmap*

*:Red indicates above target, blue indicates below target. Source: Bloomberg, HSBC Global Asset Management, as at February 2018

Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18

United States 1.5 1.6 1.7 2.1 2.5 2.7 2.4 2.2 1.9 1.6 1.7 1.9 2.2 2.0 2.2 2.1 2.1

Canada 1.3 1.5 1.2 1.5 2.1 2.1 1.6 1.6 1.3 1.0 1.2 1.4 1.6 1.4 2.1 1.9 1.7

United Kingdom 1.0 0.9 1.2 1.6 1.8 2.3 2.3 2.7 2.9 2.6 2.6 2.9 3.0 3.0 3.1 3.0 3.0

Euro Zone 0.4 0.5 0.6 1.1 1.8 2.0 1.5 1.9 1.4 1.3 1.3 1.5 1.5 1.4 1.5 1.4 1.3

France 0.4 0.4 0.5 0.6 1.3 1.2 1.2 1.2 0.8 0.7 0.7 0.9 1.0 1.1 1.2 1.2 1.3

Germany 0.7 0.8 0.8 1.7 1.9 2.2 1.6 2.0 1.5 1.6 1.7 1.8 1.8 1.6 1.8 1.7 1.6

Italy 0.1 -0.2 0.1 0.5 1.0 1.6 1.4 1.9 1.4 1.2 1.1 1.2 1.1 1.0 0.9 0.9 0.9

Portugal 0.6 0.9 0.6 0.9 1.3 1.6 1.4 2.0 1.5 0.9 0.9 1.1 1.4 1.4 1.5 1.5 1.0

Spain 0.2 0.7 0.7 1.6 3.0 3.0 2.3 2.6 1.9 1.5 1.5 1.6 1.8 1.6 1.6 1.2 0.5

Sweden 0.9 1.2 1.4 1.7 1.4 1.8 1.3 1.9 1.7 1.7 2.2 2.1 2.1 1.7 1.9 1.7 1.6

Switzerland -0.2 -0.2 -0.3 0.0 0.3 0.6 0.6 0.4 0.5 0.2 0.3 0.5 0.7 0.7 0.8 0.8 0.7

Japan -0.5 0.2 0.5 0.3 0.5 0.2 0.2 0.4 0.4 0.3 0.5 0.6 0.7 0.2 0.5 1.1 1.3

Australia 1.3 1.5 1.5 1.5 2.1 2.1 2.1 1.9 1.9 1.9 1.8 1.8 1.8 1.9 1.9 1.9 -

New Zealand 0.4 1.3 1.3 1.3 2.2 2.2 2.2 1.7 1.7 1.7 1.9 1.9 1.9 1.6 1.6 1.6 -

China 1.9 2.1 2.3 2.1 2.5 0.8 0.9 1.2 1.5 1.5 1.4 1.8 1.6 1.9 1.7 1.8 1.5

South Korea 1.3 1.5 1.5 1.3 2.0 1.9 2.2 1.9 2.0 1.9 2.2 2.6 2.1 1.8 1.3 1.5 1.0

India 4.4 4.2 3.6 3.4 3.2 3.7 3.9 3.0 2.2 1.5 2.4 3.3 3.3 3.6 4.9 5.2 5.1

Brazil 8.5 7.9 7.0 6.3 5.4 4.8 4.6 4.1 3.6 3.0 2.7 2.5 2.5 2.7 2.8 3.0 2.9

Mexico 3.0 3.1 3.3 3.4 4.7 4.9 5.4 5.8 6.2 6.3 6.4 6.7 6.4 6.4 6.6 6.8 5.6

Russia 6.4 6.1 5.8 5.4 5.0 4.6 4.3 4.1 4.1 4.4 3.8 3.3 3.0 2.7 2.5 2.5 2.2

Turkey 7.3 7.2 7.0 8.5 9.2 10.1 11.3 11.9 11.7 10.9 9.8 10.7 11.2 11.9 13.0 11.9 10.3

South Africa 6.1 6.4 6.6 6.7 6.6 6.3 6.1 5.4 5.4 5.1 4.6 4.8 5.1 4.8 4.6 4.7 4.4


• Cyclical inflation is rising. But inflation trends are slow-moving and typically play out gradually.

What’s more, a little bit of over-heating and cyclical inflation today doesn’t offset the serial inflation

undershoot since the GFC

• Inflation expectations (the key long run driver of inflation) remain stable. We are still in a “price

stability” world

– The structural forces that have delivered low medium-term inflation remain intact (i.e. technological

change, globalisation, deregulation, independent central banks) – for now

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




Policy MixCyclical inflation means that policy becomes more of a headwind

• The interest rate cycle remains “slow and low” versus historical experience

• But the synchronised growth and the emergence of cyclical inflation means that the interest rate

trajectory accelerates from here

• Global liquidity conditions remain supportive. But interest rates are - once again - the key policy

variable. Central bank balance sheets are less important than commonly perceived

US rate tightening cycles

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-

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

Source: HSBC Global Asset Management, Global Investment Strategy, March 2018. The commentary and analysis presented in this document reflect the opinion of HSBC Global Asset Management on

the markets, according to the information available to date. They do not constitute any kind of commitment from HSBC Global Asset Management.

The inflection point


An inflection point in the growth-inflation mixThe balance of risks has shifted

“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

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 distributionSource: HSBC Global Asset Management, Global Investment Strategy, March 2018. The commentary and analysis presented in this document reflect the opinion of HSBC Global Asset Management on



• The change in the inflation narrative has forced bond yields higher

• It is an “inflection point”. The risk properties of bonds have changed. The shift in economic risk away

from secular stagnation toward faster-than-expected inflation is an important change of regime

• In the old regime, bonds hedged us against risk aversion. In the new regime, global bonds are bad

hedges

• …How much further can this run? …If bonds are now “risk”, where can investors find “safety”?

Inflection PointThe risk properties of bonds have changed

US treasuries now sell-off on risk-aversion spikes

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18

US 2y Bond Yields US 10y Bond Yields 10Y3M US Forward Rate(%)

Bond yields and expectations of future rates have shifted up

1

1,5

2

2,5

3

3,5

4

5

10

15

20

25

30

35

40

45

2010 2011 2012 2013 2014 2015 2016 2017 2018

VIX Index US 10y Treasury Yield (rhs)Index %




2010 2011 2012 2013 2014 2015 2016 2017 2018

Discounted Inflation

An inflection pointThe market narrative moves to recognise cyclical inflation

• Market perceptions of inflation risk have shifted significantly

– There is a new market narrative around cyclical inflation

– A trend in our “discounted inflation” metric has emerged (long/short portfolio)

– Does this reflect a shift in the quantity of inflation? Or a shift in the price of inflation? …Or both?

Market-implied growth indicator Market-implied inflation indicator

2010 2012 2014 2016 2018

Discounted Growth




Valuation is keyThe risk premium framework

Cash Government Bonds High-Grade Credit Spec-Grade Credit Global Equities Emering Market Equities Alternatives

Cash Rate Term Premium Credit Risk Premium Equity Risk Premium Emerging Markets Risk Premium Alternative Risk Premia

Expected Risk

Sty

lised

Exp

ecte

d R

etu

rns

• We measure “market-implied risk premia” for 300+ asset classes

• This enables us to understand where relative valuation exists in global investment markets

Source: HSBC Global Asset Management, December 2017

Simulated results do not represent actual returns and should not be seen as an indication of future returns


Implied market oddsThe pecking order of asset classes

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

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


Where is “safety” now?The US dollar as an insurance policy

• At the inflection point, bonds are bad hedges for multi asset investors… But where is safety?

• Relative valuation can provide a “margin of safety”

• …And what about the dollar?

– Dollar weakness seems to be connected to the synchronised global growth story; the surprise for investors in

2017 was the economic performance of Europe and Japan

– At this point, there are reasons to be optimistic on the dollar: (i) positive carry, (ii) loose fiscal policy,

(iii) tighter monetary policy

– The dollar has some attractive insurance properties for asset allocators

-300

-250

-200

-150

-100

-50

0

50

100

150

200

1,00

1,10

1,20

1,30

1,40

1,50

1,60

1,70

2005 2007 2009 2011 2013 2015 2017

bpsEUR/USD

EUR/USD, LHSEU-US 2Y rate differential, RHS

90

95

100

105

110

115

120

125

130

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

USD Trade Weighted Exchange RateIndex

Trade weighted dollar Euro-dollar versus rate differential

?




Key portfolio views

• Globally, growth trends look like a “balanced expansion” across sectors and regions, with negligible recession

risk. Macro imbalances are not yet significant

• What has changed since the start of the year is that the market has begun to accept the narrative of cyclical

inflation. In our view, continuing with a pro-risk positioning in multi-asset portfolios makes sense

• The recent sell-off increases the case for global equity exposures, given strong fundamentals. We prefer “late

cycle” equities (Japan, Europe) and EM (equities and local currency debt)

– After the market correction, the global equity premium is 3.3% versus bonds and 3.8% versus cash. This is still a reasonable

ERP given where we find ourselves in the profits cycle

– Many EM debt markets have been impressively resilient in the recent episode – they continue to offer attractive and

idiosyncratic sustainable return

• But the re-pricing of inflation risk forces us to re-assess the risk characteristics of global bonds.

– Bonds are no longer hedging us against spikes in market risk aversion - they are selling-off with equities. This is an “inflection

point”. Global bonds offer low sustainable returns and find themselves in an unfavourable economic environment

– We prefer index-linked bonds to nominals

– The dollar seems to be the safe-haven if the risk scenario of faster inflation materialises

• The outlook for global credits is more tricky. Credit should continue to be a beneficiary of a “balanced

expansion”. But a lot of good news is already priced in – we stay UW in multi-asset portfolios


the markets, according to the information available to date. They do not constitute any kind of commitment from HSBC Global Asset Management. Any forecast, projection or target where 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.

Beyond the inflection point?


• Inflation should be slow-moving and

“persistent” – but there is a risk to the upside

• Wage inflation is accelerating. Investors have

given up on the “Phillips Curve” - perhaps this

is premature?

• Sharply higher oil prices - when cyclical

inflation is already rising – could be a problem

Inflation RiskCan faster inflation materialise?


Breakdown of US employment cost index

0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

4,5

5,0

2002 2004 2006 2008 2010 2012 2014 2016

Management, Professional and related

Sales and Office

Natural resources, construction and maintenance

Production, transportation and material moving

Employment Cost Index

yoy %

Non-linear Phillips Curve in US “city level” data Oil prices and “breakeven inflation” from TIPS

y = -0.374x + 4.078R² = 0.562

y = -0.145x + 2.846R² = 0.577

0

1

2

3

4

0 2 4 6 8 10 12 14

Unemployment rate, %

1-year ahead core CPI, %

1,0

1,4

1,8

2,2

2,6

3,0

-60

-30

0

30

60

90

2010 2012 2014 2016 2018

%, yoyWTI (USD)

Brent (USD)

US 10yr breakeven inflation (RHS)

%

?


• How will inflation-targeting central bankers respond to cyclical inflation?

• Will they tolerate faster inflation after multi-year inflation target undershoots? Or will new central

leaderships adopt a more hawkish profile and seek to “get ahead of the curve”?

• We think the risk of a significant “policy error” is over-played by economists. But a slightly-faster

normalisation of policy could still surprise financial markets

• Parts of the fixed income universe continue to price a very pessimistic economic scenario

Policy riskWill central bankers be more aggressive than we assume?


Fed “dot” plot versus market implied rate hike expectations Euro Area Nowcast model vs. German 10y Bund yield

1,3

1,5

1,7

1,9

2,1

2,3

2,5

2,7

2,9

3,1

2018 2018 2019 2019 2020 2020

% Fed 'Dots Chart', Median projection, Sep 2017

Fed 'Dots Chart', Median projection, Dec 2017

Market implied estimate on 28 Feb 2018

-2,0

-1,0

0,0

1,0

2,0

3,0

4,0

5,0

2010 2011 2012 2013 2014 2015 2016 2017 2018

Euro Area Nowcast 10 year German Bund Yield%


Where is the system vulnerable to faster rates?Are “economic imbalances” a worry?


• The idea of the “balanced expansion” is that growth is sustainable and macro-economic imbalances are not yet

significant. Recession risk remains very low for now

• …But in the scenario of faster interest rate hikes, where are the vulnerabilities?

– “True sovereigns” are able to run economies at higher government debt levels than we thought. But some Euro

zone government debt levels look high

– Canada & Australia private sector debt is a well-known risk

– A number of emerging markets also show high and rising indebtedness (China, Turkey, Mexico, Russia)

Sovereign and Nonfinancial Private Sector Debt-to-GDP Ratios

JPN CAN USA GBR ITA AUS KOR FRA DEU CHN BRA IND ZAF TUR MEX RUS SAU ARG IDN

General 2006 184 70 64 41 103 10 29 64 66 ## 25 66 77 31 45 38 10 26 70 36

Government Latest 239 92 107 89 133 41 38 96 68 44 78 70 52 28 58 16 13 54 28

Households 2006 59 74 96 90 36 105 70 44 65 ## 11 14 10 39 9 12 8 12 4 11

Latest 57 101 79 88 42 123 93 57 53 44 23 10 35 18 16 16 15 6 17

Nonfinancial 2006 100 76 65 79 67 73 83 56 49 ## 105 39 38 33 27 14 32 28 20 14

Corporations Latest 92 102 72 73 71 79 100 72 46 165 44 45 37 67 28 52 50 12 23

Total 2006 343 221 225 210 205 187 183 164 180 ## 142 118 125 104 81 64 49 66 93 61

Latest 388 295 259 250 246 243 232 226 168 254 145 125 124 113 103 84 78 73 68

Advanced Economies Emerging Market Economies


Where is the system vulnerable to faster rates?EM vulnerability heatmap

Sources: AMG Global Investment Strategy, Institute of International Finance, International Monetary Fund WEO Database, Bloomberg, MSCI and various national sources as of Q4 2017

Internal Macro Vulnerabilities External Macro Vulnerabilities

Non-fin. Corp.

Debt (Δ 2008-

2017, % of

GDP)

Hard

Currency

Non-fin

.Corp.Debt (%

of GDP)

Household

Debt (Δ 2008-

2017, % of

GDP)

Government

Debt (% of

GDP)

Primary

Deficit (2017f,

% of GDP)

Inflation

(2018f) minus

central bank

target

Return on

Equity (%)

Real Interest

Rate (%)

Current

Account

Deficit (2017f,

% of GDP)

Net External

Assets (% of

GDP)

Ratio of FX

Reserves to

Monthly

Imports

Net FDI

Inflows (% of

GDP)

Brazil 0.6 15.8 4.2 81.3 -2.5 -0.5 10.5 3.9 -1.4 -33.5 29.3 4.3

China 66.9 7.8 28.8 46.5 -2.8 -0.6 11.7 2.9 1.4 16.0 21.0 1.5

Colombia 13.4 13.1 8.7 45.2 -0.2 0.1 8.6 0.8 -3.8 -48.0 12.1 4.9

Hungary -13.7 34.8 -16.4 81.1 0.1 0.0 14.7 -1.2 4.8 -63.0 3.4 -6.4

India -0.3 8.8 0.3 67.6 -1.5 0.8 14.0 0.7 -1.4 -16.2 10.6 1.9

Indonesia 6.7 10.4 4.9 28.6 -1.1 -0.3 16.9 3.3 -1.7 -35.9 10.1 0.4

Korea 1.0 17.6 20.1 40.5 0.4 -0.1 10.9 0.5 5.6 19.7 9.9 0.8

Malaysia 8.6 18.9 17.6 52.7 -1.0 -0.1 10.0 -0.3 2.4 5.3 6.2 4.6

Mexico 9.4 19.2 3.6 36.0 1.8 0.5 14.5 2.0 -1.7 -44.1 5.0 3.2

Poland 8.2 14.9 5.9 55.6 -0.9 0.1 11.5 -0.6 -1.0 -57.6 5.8 3.1

Russia 10.6 18.3 4.8 16.0 -1.6 0.0 11.3 6.1 2.8 17.3 18.8 2.5

South

Africa2.7 16.2 -8.4 54.2 -0.9 0.9 11.8 2.1 -2.9 7.5 5.9 0.8

Thailand 1.7 11.7 23.2 31.9 -0.7 -1.8 13.5 0.8 10.1 -8.3 11.0 0.4

Turkey 33.3 37.1 5.2 28.8 -1.6 4.5 15.4 -2.4 -4.6 -41.4 4.8 1.4

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