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Emerging issues

IQ Investment Quarterly October 2015

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Contents

Executive summary

Treasury supply and demand dynamics: Implications of the shifts ahead

Asia ex-Japan’s external fundamentals are in better shape than in the 1990s

Emerging market Asia will benefit overall from the current long-term commodity cycle

Macroeconomic charts

Financial market charts

Market data

Macro and Investment Strategy team

Important information

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Executive Summary

Overview

While the outlook for global growth has brightened in

the developed world, a shadow has been cast over

the outlook for the emerging world. In terms of

valuations, emerging markets are generally a lot

cheaper, and although many economies have

problems, we do not think these are on the same

scale as during the Asian financial crisis or the period

of emerging market hyperinflation in the 1980s, for

example. However, there are risks and investors will

likely need to be patient for value to be realized. In

particular, it may take time for investors to regain

confidence, with more aggressive policy action

potentially needed in the meantime. What’s more, not

all emerging markets are created equal or will be as

successful in stabilizing their situations, suggesting

careful discrimination by investors is critical. Overall,

this argues for a careful and selective approach, as

well as emphasizing the need now more than ever

for investors to diversify their investments by both

region and asset class.

The outlook for China – the largest emerging market

economy by far, with 15% of global domestic product

(GDP) at market exchange rates in 2015 (compared

to 3% for Brazil, 2.7% for India and 2% for Russia) –

is critical. We think China has plenty of policy options

still available to stabilize its economy, and although

growth is slowing, it is not as weak as some recent

financial press headlines suggest. Property prices

and credit growth are recovering and service sector

growth is accelerating; however, heavy industry and

fixed asset investment, especially related to the

property sector, remains weak.

Nevertheless, investor uncertainty over the outlook

for global, and in particular, emerging market growth

has led to poor performance in risk assets in recent

months. The MSCI All Country World Index is down

over 10% year to date (-12% so far in Q3) in US

dollar terms, after having been up year to date at the

end of Q2. Both developed and emerging markets

have suffered, but it is emerging market assets that

have borne the brunt of the sell-off, with the MSCI

Emerging Market Index down almost 19% year to

date in US dollar terms and 10% in local currency

terms. Credit spreads have also widened for US,

European and emerging market high yield and

investment grade debt in recent months. The

decision by the US Federal Reserve (Fed) not to

raise rates in September temporarily halted the

dollar’s rise but did little to boost risk appetite as it did

little to remove concern about the outlook for

emerging market growth (all figures are as at

September 29, 2015).

Core government bond yields have stabilized after

Q2’s “bund tantrum,” but, interestingly, have not

fallen much despite the increase in volatility in risk

assets that would normally have been expected to

support so-called “safe-haven” assets.

Overall, we think some of the fears about the outlook

for global growth are overdone, and, in particular,

comparisons to the Asian financial crisis of 1998 are

wide off the mark. In this quarterly, we examine three

related issues in detail: the outlook for US Treasury

markets and their supply and demand dynamics; a

comparison of the current macroeconomic state of

Asia ex-Japan to its situation in the run-up to the

Asian financial crisis in the late 1990s; and the

medium- to long-term outlook for commodities and

the implications for regions including Asia.

US Treasury supply and demand

dynamics

Since the Global Financial Crisis, the United States

Treasury (UST) market has significantly benefited

from strong structural demand globally. However, we

anticipate this support declining going forward, and,

importantly, at the same time we should see US

policy rates rise for the first time in almost a decade.

The Fed is unlikely to halt the reinvestment of US

Treasuries on its balance sheet before the end of

2016. But once its balance sheet begins to shrink,

the decline will likely persist into the medium term. At

the same time, China’s recent steps to increase two-

way volatility in the Chinese yuan market has led to a

rapid decline in foreign exchange reserves, although

they remain at very comfortable levels. This shift will

see China become a net UST seller between 2015-

2017, before beginning a more gentle reserve

accumulation path from 2018 onwards. Saudi Arabia

has seen the drop in oil prices move its budget from

a comfortable surplus to a net deficit. If half this

deficit is funded by the sale of USTs, this will not

result in a significant decrease in holdings, but will

remove a previously firm net accumulator.

Another negative factor on the demand side for US

Treasuries is the less favourable demographic trend

in the US that will mean the Federal Trust Funds

(e.g., US Social Security funds) will gradually lessen

their purchase levels going forward, although they

are not forecast to become net sellers for at least

another nine years. However, a positive demand

factor is the Basel III Accord, which is likely to see

increased demand from US commercial banks for

the remainder of the decade. However, this alone will

not be able to halt the marginal upward pressure

rates are likely to experience from an overall net

reduction in demand.

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Asia ex-Japan, compared to the 1990s

Asian financial crisis

Concerns about China’s economic slowdown, foreign

exchange policy uncertainty and the equity market

correction, as well as worries over the impact of a

Fed rate lift-off and further weakness in global

commodity prices, jolted Asian financial markets over

the last quarter. Recent economic data showed

continued weakness in the region and Asia faces

persistent headwinds in the form of sluggish global

trade, excess capacity, weak productivity of capital,

high leverage and demographic challenges.

In particular, China’s transition to slower-trend

growth will affect the rest of the region via trade and

financial linkages and could mean continued weaker

commodity prices and disinflationary pressures.

However, amid policy buffers we do not forecast a

sharp slowdown in China. Moreover, comparing Asia

today versus during the Asian financial crisis,

external fundamentals are in much better shape.

Most Asian countries have a flexible foreign

exchange policy and Asia is now collectively better

prepared, with improved financial backstops.

Although Fed policy tightening will present a

challenging transition for Asia, we believe the

adjustment since the “Taper Tantrum” has now

placed the region in a better position to withstand the

cycle of rising US interest rates and manage

external/market volatility. The US interest rate

trajectory, the Chinese and global growth outlooks

and Asian/emerging market currency volatility remain

key near-term risks to Asian financial markets, with

volatility also likely to remain high. However, we

remain constructive on Asian equities and credits in

the medium to long term, given the region’s overall

solid macro and corporate fundamentals, positive

reform agenda and long-term growth prospects, as

well as the potential structural support from a

growing local investor base.

The medium- to long-term outlook for

commodities and implications for

regions

Commodity prices follow a regular long-term trend

cycle, mainly due to the lag in the supply and

demand response to price signals. Over the past 100

years, this cycle has shown a regular pattern,

expanding for about 10 years and consolidating for

about 20 years. However, overall, relative to US

inflation, commodity prices have followed a

downward trend since the mid-19th century.

Net commodity-exporting countries with poor

productivity gains tend to catch up more slowly with

advanced economies on a GDP per capita basis

versus countries that are net commodity importers

and have experienced stronger productivity gains,

such as China and India.

In the current part of the long-term commodity cycle,

lower commodity prices provide an opportunity for

positive equity performance within Asia ex-Japan as

they help push profit margins higher. Bonds also

benefit through lower inflation, although higher credit

risk for issuers exposed to commodities reduces the

overall positive impact.

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Executive Summary

5

Treasury supply and demand dynamics Implications of the shifts ahead David Semmens, Senior Macro and Investment Strategist

Summary

Since the Global Financial Crisis, the United

States Treasury (UST) market has significantly

benefited from strong structural demand globally.

We anticipate this support declining going

forward, and, importantly, at the same time we

should see US rates rise for the first time in

almost a decade

Since 2007, the US Federal Reserve (Fed) has

purchased USD1.7 trillion of Treasuries,

outstripping even the USD1.5 trillion that we

estimate to be the increase in the level of China’s

Treasury holdings

The Fed is unlikely to halt the reinvestment of US

Treasuries on its balance sheet before the end of

2016. But once its balance sheet begins to shrink,

the decline will likely persist into the medium term

At the same time, China’s recent steps to

increase two-way volatility in the Chinese yuan

market has led to a rapid decline in foreign

exchange reserves, although they remain at very

comfortable levels. This shift is likely to see China

become a net UST seller between 2015-2017,

before beginning a more gentle reserve

accumulation path from 2018 onwards

Saudi Arabia has seen the drop in oil prices move

its budget from a comfortable surplus to a net

deficit. We anticipate that half this deficit will be

funded by the sale of USTs, which will not result

in a significant proportional decrease in holdings,

but will remove a previously firm net accumulator

The less favourable demographic outlook for the

US will mean that the Federal Trust Funds (FTFs)

(e.g., US Social Security funds) will gradually

lessen their purchase levels going forward,

although they are not forecast to become net

sellers for at least another nine years

The Basel III Accord is likely to see increased

demand from US commercial banks for the

remainder of the decade. However, this alone will

not be able to halt the marginal upward pressure

rates are likely to experience

What are the key structural drivers of

USTs?

Much has been made of a forthcoming rate hike from

the Fed, and whether it will happen this year.

Regardless of when this move occurs, the US

economic recovery indicates that rates will eventually

rise from emergency levels. The UST market is

closely linked to the Fed Funds Target Rate (FFTR),

with the short end of the curve driven by the FFTR

itself and the longer end influenced by the anticipated

terminal rate. In this article, we examine some of the

supply and demand dynamics likely to affect the UST

market over the next few years.

An aging population will drive persistent fiscal deficits

with UST issuance expected at USD7.8 trillion in the

coming decade (Figure 1), a similar amount to the

total outstanding public debt in 2005. With

investments of USD6.1 trillion, representing 46% of

publicly available USTs, foreign investors hold

significant amounts of US government debt. Although

foreign demand has been supportive for Treasuries,

this dynamic will alter in the coming years. China and

Saudi Arabia deserve particular attention, although

for different reasons.

Critical drivers will arise from within the US itself.

Firstly, we expect the Fed will halt the reinvestment

of USTs on its balance sheet at the end of 2016 at

the earliest. To begin with, the Fed will want the

market to focus on the forthcoming rate-hiking cycle.

Also, going forward, the various FTFs, whose assets

are earmarked for specific expenditures such as

Social Security Trust Funds (SSTF) and Medicare,

will face increasing demand on these assets as the

population ages. This process will lower – and

ultimately eliminate – their investment rates and see

a large purchaser of US government securities

become a seller. Importantly, growing demand will

come from commercial banks as regulatory

requirements increase the need for high-quality liquid

assets.

Figure 1: US federal debt outstanding (USD trn)

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Sources: Bloomberg, HSBC Global Asset Management, September 2015

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Supply: Structural issues remain

unaddressed despite smaller deficits

Firstly, turning our attention to the supply of USTs,

we will discuss the outlook for total issuance in the

coming years. The U.S. Department of the Treasury

issues the national debt of the US government. The

primary purpose of this debt, at present, is to allow

the government to finance its deficit, which has been

running since 2002 and has seen the federal debt

held by the public rise from 31% of GDP in 2001 to

74% at the end of 2014. Critically, while the economy

has been improving, and therefore significantly

boosting government receipts, the rise in government

expenditure has been greater still. Interestingly, the

rise in government expenditure between 2015 and

2025 will, according to the Congressional Budget

Office (CBO), be driven primarily by the aging of the

US population, boosting mandatory spending such

as healthcare (+84% to USD1,900 billion) and Social

Security (+76% to USD1,550 billion). At the same

time, revenues are only expected to rise 54% to

USD5,000 billion, leading to a deficit of USD1,008

billion by 2025, up from USD426 billion in 2015 – an

increase of 137%. This means a further

approximately USD7,830 trillion worth of US

Treasuries will be issued in the coming decade,

which represents a similar amount to the total

outstanding public debt in 2008.

Demand: Facing testing times ahead

Focusing on demand in the Treasury market, we

shall address the position of five interesting and very

different participants in the market: namely the Fed,

China, Saudi Arabia, the FTFs and commercial

banks. It is important to note that the proportions

outstanding discussed in this article include those

held by the FTFs even though those securities held

by the FTFs are not available to the public and are

also excluded from net debt calculations by

institutions such as the International Monetary Fund

(IMF). However, the forthcoming decline in

purchases by the FTFs as shown in Figure 1 will see

a proportional decline in holdings, meaning an

increase in overall net excess supply, and therefore

should be included for consideration.

Federal Reserve: The reinvestment of Treasuries

will end, just not yet

The largest purchaser of US government debt since

2007 has been the Fed, which purchased USD1.7

trillion of Treasuries within its quantitative easing

program, outstripping even the USD1.5 trillion that

we estimate to be the true increase in the level of

China’s Treasury holdings in the same period. This

introduction of a new number – one buyer of

Treasuries brought yields to record low levels despite

the rapid rise in issuance previously discussed.

Therefore, the date at which the Fed decides to halt

reinvestment of its balance sheet holdings, which has

held USD2.5 trillion worth of UST since November

2014 when quantitative easing ended, will have a

significant impact on investors. For example,

assuming reinvestment were to end on December

31, 2015, this would see an additional USD216 billion

worth of Treasuries available for purchase during

2016, which represents 9% of the Fed’s UST

holdings or 1.1% of all USTs, including those held by

the FTFs (Figure 2), followed by 1.0% in 2017 and

1.8% in 2018. If reinvestment were to end at the end

of 2017, an estimated 1.8% of all UST holdings

would first impact the market in 2018. The continued

extension of reinvestment by the Fed could see

these holdings mature and require rolling over. We

expect the Fed will wish to maintain market focus

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Treasury supply and demand dynamics

Figure 2: Impact on marginal UST demand given various

end points of Fed balance sheet reinvestment

End of Fed reinvestment YE2015 YE2016 YE2017

Year Ending

Delta in

demand (USD

bn)

Delta in total

outstanding

USTs

Delta in

demand (USD

bn)

Delta in total

outstanding

USTs

Delta in

demand (USD

bn)

Delta in total

outstanding

USTs

2005 26 0.3% 26 0.3% 26 0.3%

2006 35 0.4% 35 0.4% 35 0.4%

2007 -24 -0.3% -24 -0.3% -24 -0.3%

2008 -279 -2.6% -279 -2.6% -279 -2.6%

2009 301 2.5% 301 2.5% 301 2.5%

2010 234 1.7% 234 1.7% 234 1.7%

2011 661 4.4% 661 4.4% 661 4.4%

2012 -15 -0.1% -15 -0.1% -15 -0.1%

2013 548 3.2% 548 3.2% 548 3.2%

2014 256 1.4% 256 1.4% 256 1.4%

2015 0 0.0% 0 0.0% 0 0.0%

2016 -216 -1.1% 0 0.0% 0 0.0%

2017 -194 -1.0% -194 -1.0% 0 0.0%

2018 -372 -1.8% -372 -1.8% -372 -1.8%

2019 -329 -1.5% -329 -1.5% -329 -1.5%

2020 -220 -1.0% -220 -1.0% -220 -1.0%

Sources: US Federal Reserve, Bloomberg, HSBC Global Asset Management, September 2015 Actual results may differ materially from projected results.

7

Treasury supply and demand dynamics

on forthcoming monetary policy changes in the Fed

policy rate rather than any balance sheet mechanics,

and therefore we assume reinvestment will continue

through to the end of 2016 at the earliest.

This could also allow the Fed to reduce market

uncertainty. If there is any risk to this view, it is that of

further reinvestment potentially to the end of 2017.

Either way, demand from the Fed will be neutral, not

offering the significant support seen in five of the

prior six years. From 2017 onwards, it is expected to

become a net subtracter of demand, peaking at

-1.8% of outstanding assets in 2018.

China: Declining foreign exchange

reserves will see a former major buyer

turn into a seller While we do not have an exact breakdown of the

maturities of USTs held by the various central banks

and within foreign countries, the most recent annual

US Treasury International Capital (TIC) report shows

that central banks typically hold treasuries with a

slightly shorter weighted average maturity of 3.6

years, compared to the maturity of foreign holdings

as a whole, which stands at 4.0 years. Importantly,

the average maturity of foreign holdings is almost

two years shorter than that of USTs as a universe

(Figure 3).

There are some doubts within the Treasury market

as to the real size of China’s UST holdings, officially

reported at USD1.2 trillion (or around 20% of total

foreign holdings). However, Bloomberg’s estimate of

China’s foreign exchange holdings is currently at

USD3.6 trillion. Given that we expect the reported

proportion of US dollars within China’s foreign

exchange reserves will be close to the reported

global average of around 65% as stated by the IMF,

this would indicate that China’s UST holdings could

be USD1.1 trillion higher than the TIC data shows.

While China’s reserve accumulation has been well

documented, it is anticipated that, going forward,

China will ultimately need to lessen the pace of

reserve accumulation and therefore purchase fewer

USTs, to allow greater two-way movement in the

exchange rate, with the ultimate aim of facilitating the

renminbi’s inclusion in the Special Drawing Rights.

We therefore anticipate that the recent decline in

China’s reserves will persist for the coming two years

as the government emphasizes the quality rather

than the quantity of growth, and as financial and

foreign exchange market liberalization continues. We

do not believe that China will make a snap change in

its foreign exchange policy; we rather assume a

gradual adaptation, with the eventual goal of a fully

convertible floating renminbi in the distant future. We

anticipate an initial two-year period during which

exchange reserves are allowed to decline by 10% for

the remainder of 2015 and through 2016 and then

decline 6.5% through 2017 to help lessen yuan

volatility before gradual reserve accumulation begins

once more. We expect this new phase of

accumulation to be conducted at a more modest rate

of 5% per annum, to maintain a strong import

coverage ratio, but without being as excessive – and

ultimately distortive for the Chinese and global

economy – as the previous accumulation period. The

biggest jolt will likely be felt in 2015 and 2016 (Figure

4) as markets adjust to the notion of China selling

rather than buying USTs in the short term.

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Figure 4: Marginal demand based on forecasts of

China’s foreign exchange reserves

Sources: Bloomberg, HSBC Global Asset Management, as of September 2015. Actual results may differ materially from projected results.

Figure 3: Key UST holders maturity profile

Sources: TIC report, US Department of the Treasury, Bloomberg, HSBC Global Asset Management, as of September 2015

Maturity

(years)

Foreign

holdings of

US debt

Foreign

official

holdings of

US debt

Federal

Reserve

balance

sheet

UST

issued

<1 17% 17% 4% 20%

1-2 19% 21% 8% 14%

2-3 17% 19% 12% 11%

3-4 10% 10% 14% 9%

4-5 8% 8% 11% 8%

5-6 7% 7% 8% 7%

6-7 7% 6% 7% 5%

7-8 3% 3% 5% 4%

8-9 3% 3% 2% 3%

9-10 4% 3% 1% 2%

10-15 2% 1% 4% 4%

15-20 0% 0% 0% 2%

20-25 1% 0% 9% 4%

25-30 3% 2% 12% 7%

Average

Maturity (yrs) 4.0 3.6 8.9 5.9

Marginal

change year-

end

China UST holdings

(USD bn)

China demand as % of

outstanding USTs

2005 136 1.7%

2006 161 1.9%

2007 300 3.3%

2008 272 2.6%

2009 295 2.4%

2010 291 2.1%

2011 217 1.4%

2012 85 0.5%

2013 331 1.9%

2014 14 0.1%

2015 -243 -1.3%

2016 -217 -1.1%

2017 -129 -0.7%

2018 97 0.5%

2019 102 0.5%

2020 107 0.5%

8

Saudi Arabia: Fiscal deficits from lower

oil prices will likely see UST holdings dip

The recent decline in oil prices has seen a sharp

drop in the rate of foreign exchange reserve

accumulation in the Middle East, particularly in Saudi

Arabia. Saudi Arabia’s reserves peaked in August

2014 at USD746 billion before tumbling to USD672

billion 10 months later, driven by the 55% decline in

oil prices to around USD40 per barrel during the

same period. Low oil prices present a significant

quandary, given that the IMF estimates that Saudi

Arabia’s fiscal breakeven level has risen to USD103

per barrel, up from USD37.6 in 2008, due to the rise

in government expenditure as a proportion of GDP

from 29% to 50% over the same period. Using the

IMF’s forecasts for expected government net

borrowing, Saudi Arabia can be expected to run a

government deficit of USD92 billion in 2015, followed

by USD57 billion the following year. While Saudi

Arabia is currently a net lender, these deficits are

likely to be financed in part by the issuance of

government debt, but also, more importantly, by

Saudi Arabia switching from being a net buyer of

USTs to being a net seller. We assume that half of

this deficit will be financed by the net selling of USTs,

although our alternative scenario allows for the

complete financing of this deficit with USTs, as

shown in Figure 5.

Importantly, while the US TIC report does not break

out the level of holdings specific to Saudi Arabia,

similarly to China, we assume that Saudi Arabia

holds around two-thirds of its foreign exchange

reserves in US dollars. It also has one of the largest

five foreign exchange reserve levels in the world.

Therefore, while the budget deficit will not cause a

significant drag on UST demand, the impact will be

on the change in net demand, which turned negative

in 2014 compared to prior average net demand of

1.0%. This indicates a further drag for the underlying

demand in the Treasury market.

Federal Trust Funds: Shifting from buyer

to seller will increase the free float

In the US, the structural path ahead is a fairly gradual

economic path driven by demographics. Between

2015 and 2025, the population in the 20-64 age

bracket – typically working but not eligible for benefits

– will rise by 6.3 million out of a total population

increase of 26.0 million, meaning their proportion in

the overall population will drop from 60% to 57% over

the period. Conversely, the proportion of the

population aged 65 and over will rise from 15% in

2015 to 19% in 2025 – an increase of 38%,

representing an additional 18.1 million people.

The largest holder of federal debt in the US is

essentially the US government itself. The FTFs are

earmarked for specific expenditure such as SSTF

and Medicare. The next decade will see a critical

change with the increasing requirement of mandatory

spending forcing the FTF to become an increasingly

marginal buyer USTs before finally turning into a

seller, although the exact timing of this remains

under debate.

For instance, purchases of total new issuance by the

FTF are forecast to drop from 45% in 2005 to 11% in

2020. The CBO forecasts that the FTF will actually

sell Treasuries in 2024, although the SSTF’s own

trustees forecast this occurring in the mid-2030s.

While they do not differ as much for the coming five

years, we will use the more cautious CBO forecasts.

Based on these, over the next five years we would

expect the FTF to annually purchase between half

and two-thirds as much as the annual USD195 billion

seen over the last decade, with the structural shift

from buyer to seller occurring in 2024. The coming

five years will see marginal demand of between 0.6

and 1.0 percentage points coming from the FTF, but

this is a drastic reduction from the 5% or greater net

demand that was standard prior to 2005, and the 3%

net demand of the last decade. This will have a

dramatic impact on overall net demand, as well as on

the free-float of treasuries available for purchase.

As previously outlined, without legislative change

surrounding entitlement spending, which appears

unlikely given the politically unpopular nature of any

alterations, the US will see mandatory spending

consistently rise going forward as detailed previously.

This will ultimately drive UST supply higher. A key

risk would be a slowdown in the economic recovery

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Treasury supply and demand dynamics

Figure 5: Scenarios assuming Saudi Arabia’s

anticipated budget deficits are funded by selling USTs

100% 50%

Year end

Delta in

demand

(USD bn)

Delta in

total

outstanding

USTs

Delta in

demand

(USD bn)

Delta in total

outstanding

USTs

2005 70 0.9% 70 0.9%

2006 92 1.1% 92 1.1%

2007 63 0.7% 63 0.7%

2008 164 1.6% 164 1.6%

2009 -18 -0.1% -18 -0.1%

2010 27 0.2% 27 0.2%

2011 80 0.5% 80 0.5%

2012 108 0.7% 108 0.7%

2013 65 0.4% 65 0.4%

2014 -3 0.0% -3 0.0%

2015 -92 -0.5% -46 -0.3%

2016 -57 -0.3% -29 -0.1%

2017 -41 -0.2% -21 -0.1%

2018 -42 -0.2% -21 -0.1%

2019 -39 -0.2% -20 -0.1%

2020 -40 -0.2% -20 -0.1%

Sources: IMF, Bloomberg, HSBC Global Asset Management, as of September 2015 Actual results may differ materially from projected results.

9

Treasury supply and demand dynamics

that would see revenues fall and expenditures rise

even further, driving down UST purchases sooner

while additionally boosting their supply.

Regulatory demand: Loan growth will be

good for UST demand

The agreement in 2010 of the Basel III Accord led to

a dramatic increase in regulatory capital

requirements, albeit phased in between 2013-2019.

Figure 8 models the resulting need for US

commercial banks to increase their UST and similar

holdings, which currently stand at USD645 billion, in

line with the amount of asset growth that can be

FOR USE ONLY

Figure 6: Expected evolution of US demographics

Source: CBO, as of September 2015. Actual results may differ materially from projected results.

expected given a nominal growth rate of US GDP at

4.5% between the second half of 2015 and 2020.

Since US commercial banks’ asset growth has been

around 1.5 times that of nominal GDP, we assume a

growth rate of 7% in assets annually over the same

time period. Finally, since the financial crisis and the

announcement of the introduction of Basel III,

holdings of high-quality liquid assets have been at

around 4% of total assets, although we estimate this

will rise to 6% by the end of 2020, in line with greater

capital requirements. Although unlikely, even if the

ratio of assets held were to remain at 4%, this would

see an increase of around USD40-50 billion going

forward (i.e., 0.3% additional marginal demand).

What is more likely is that additional demand is tilted

to the upside, with the ratio of assets held doubling to

8% by 2020, which would generate additional

marginal demand of USD103 billion (0.8% of

outstanding USTs) in 2015, rising rapidly to USD260

billion (1.6% of outstanding USTs) in 2020 (Figure 8).

While the risks are tipped to the upside, our

assumption of a 6% UST/asset ratio (Figure 9) would

lead to an additional marginal demand of USD74

billion in 2016 (0.6% of outstanding Treasuries held

by the public), accelerating steadily to reach USD153

billion in 2020 (0.9% of outstanding Treasuries held

by the public).

Figure 7: Forecast change in UST demand from

Federal Trust Funds

Year-end

Federal Trust Fund demand

(USD bn)

FTF demand

as % of

outstanding

USTs

2005 254 3.2%

2006 309 3.6%

2007 293 3.2%

2008 267 2.5%

2009 148 1.2%

2010 179 1.3%

2011 126 0.8%

2012 134 0.8%

2013 -33 -0.2%

2014 278 1.6%

2015 1 0.0%

2016 219 1.1%

2017 169 0.9%

2018 189 0.9%

2019 141 0.7%

2020 113 0.5%

Sources: CBO, Bloomberg, HSBC Global Asset Management, as of September 2015. Actual results may differ materially from projected results.

Figure 8: Expected annual marginal demand given

various terminal UST/asset ratio assumptions

Year End 4% 5% 6% 7% 8%

2015 45 59 74 88 103

2016 39 71 103 136 168

2017 41 77 114 151 188

2018 43 84 126 168 210

2019 45 92 139 186 233

2020 47 100 153 207 260

Figure 9: Expected annual marginal demand

assuming a 6% holding of high-quality liquid assets

Sources: Bloomberg, HSBC Global Asset Management, as of September 2015. Actual results may differ materially from projected results.

Marginal change in…

Commercial bank

marginal demand (USD

bn)

Commercial bank

marginal demand

as % of

outstanding USTs

2011 -87 -0.6%

2012 83 0.5%

2013 -46 -0.3%

2014 160 0.9%

2015 74 0.4%

2016 103 0.5%

2017 114 0.6%

2018 126 0.6%

2019 139 0.7%

2020 153 0.7%

Sources: Bloomberg, HSBC Global Asset Management, as of September 2015. Actual results may differ materially from projected results.

10

Treasury supply and demand dynamics

Conclusion

With net excess marginal Treasury supply jumping in

2015, we expect supply will step higher in 2016,

before drifting lower in the later part of the decade

(Figures 10 & 11). This is important, as the change in

marginal supply will come at a time when the Federal

Open Market Committee is likely to be embarking on

its first rate-hiking cycle in decade. However, the net

excess supply that we foresee in the coming years is

significantly lower than that seen between 2008 and

2010. Interestingly, 2015 was a year of exceptionally

low issuance, since the debt ceiling limit was reached

in March 2015 and had still not been raised as of

September 2015; it is estimated by the Treasury that

emergency measures can continue until the end of

October 2015. However, this situation is not

sustainable and we anticipate that normal issuance

will occur going forward.

The gradual downward drift in FTF demand from

1.1% of total outstanding UST issuance in 2016 to

0.5% in 2020 – compared to the 3% average seen

over the last decade – will be the key structural shift.

FOR USE ONLY

In the near to medium term, we anticipate the market

will also be impacted by the decline in Chinese

demand, which will cause a sharp swing from a peak

of 3.3% of outstanding issuance in 2007 to -1.2% in

2015/2016 and -0.7% in 2017, before resuming

additions of 0.5% from 2018 onwards. Similarly,

while we anticipate that the decline in Saudi Arabia’s

holdings will be minimal compared to the amount

outstanding, it is the shift from being a steady net

purchaser to a marginal net seller that is noteworthy.

However, the decline in the Fed’s holdings will be the

main evident drag, peaking in 2018 at -1.8% of

outstanding issuance. The marginal declines, at -

0.1%, also reflect the Fed’s switch from buyer to

seller, dropping from a prior average of 1%.

Overall, while regulatory changes from US banks

could see this source of marginal demand double to

more than US153 billion from USD74 billion, this

alone will be unable to halt the increase in net excess

marginal supply, which we expect should add to

upward pressure on US Treasury rates in the coming

years.

Figure 10: Combined anticipated marginal excessive UST supply (USD bn)

Figures in USD bn Delta in supply Delta in demand

Year-end Total federal debt issued

(A)

Debt owned

by the public

Fed balance

sheet (B)

China UST

holdings (C )

Saudi Arabia

UST holdings

(D)

Federal Trust

Funds (E ) US banks (F)

Excess marginal

supply

(A-(B+C+D+E+F)

2005 560 306 26 136 70 254 NA 74

2006 495 186 35 161 92 309 NA -101

2007 529 235 -24 300 63 293 NA -103

2008 1,500 1,233 -279 272 164 267 NA 1076

2009 1,590 1,442 301 295 -18 148 NA 864

2010 1,758 1,579 234 291 27 179 NA 1027

2011 1,184 1,058 661 217 80 126 -87 186

2012 1,268 1,134 -15 85 108 134 83 873

2013 740 773 548 331 65 -33 -46 -125

2014 703 425 256 14 -3 278 160 -2

2015 397 396 0 -243 -46 1 74 612

2016 865 646 0 -217 -29 219 103 788

2017 686 517 -194 -129 -21 169 114 747

2018 714 525 -372 97 -21 189 126 695

2019 805 664 -329 102 -20 141 139 772

2020 863 749 -220 107 -20 113 153 728

Sources: Bloomberg, IMF, CBO, HSBC Global Asset Management, as of September 2015. Actual results may differ materially from projected results.

11

Treasury supply and demand dynamics

FOR USE ONLY

Figure 10: Combined anticipated marginal excessive UST supply

(as a proportion of total outstanding UST issuance)

Sources: Bloomberg, IMF, CBO, HSBC Global Asset Management, as of September 2015.

Actual results may differ materially from projected results.

% outstanding Delta in supply Delta in demand

Year-end

Total federal

debt Issued

(A)

Debt Owned by

the Public Fed (B) China (C)

Saudi Arabia

(D)

Federal Trust

Funds (E)

US Banks

(F)

Total

Amount of

Treasuries

Outstanding

(USD bn)

Excess Marginal

Supply

(A-(B+C+D+E+F)

2005 7.0% 3.8% 0.3% 1.7% 0.9% 3.2% 8,028 0.9%

2006 5.8% 2.2% 0.4% 1.9% 1.1% 3.6% 8,523 -1.2%

2007 5.8% 2.6% -0.3% 3.3% 0.7% 3.2% 9,052 -1.1%

2008 14.2% 11.7% -2.6% 2.6% 1.6% 2.5% 10,552 10.2%

2009 13.1% 11.9% 2.5% 2.4% -0.1% 1.2% 12,142 7.1%

2010 12.6% 11.4% 1.7% 2.1% 0.2% 1.3% 13,900 7.4%

2011 7.9% 7.0% 4.4% 1.4% 0.5% 0.8% -0.6% 15,084 1.2%

2012 7.8% 6.9% -0.1% 0.5% 0.7% 0.8% 0.5% 16,352 5.3%

2013 4.3% 4.5% 3.2% 1.9% 0.4% -0.2% -0.3% 17,092 -0.7%

2014 3.9% 2.4% 1.4% 0.1% 0.0% 1.6% 0.9% 17,794 0.0%

2015 2.2% 2.2% 0.0% -1.3% -0.3% 0.0% 0.4% 18,191 3.4%

2016 4.5% 3.4% 0.0% -1.1% -0.1% 1.1% 0.5% 19,056 4.1%

2017 3.5% 2.6% -1.0% -0.7% -0.1% 0.9% 0.6% 19,742 3.8%

2018 3.5% 2.6% -1.8% 0.5% -0.1% 0.9% 0.6% 20,456 3.4%

2019 3.8% 3.1% -1.5% 0.5% -0.1% 0.7% 0.7% 21,261 3.6%

2020 3.9% 3.4% -1.0% 0.5% -0.1% 0.5% 0.7% 22,124 3.3%

12

Asia ex-Japan’s external fundamentals are in better shape than in the 1990s Renee Chen, Senior Macro and Investment Strategist

Summary

Concerns about China’s economic slowdown,

foreign exchange policy uncertainty and a

correction in A-shares, as well as worries over the

impact of a US Federal Reserve (Fed) lift-off and

further weakness in global commodity prices,

jolted Asian financial markets in July and August

Recent economic data has shown continued

weakness in the region, with uncertainties

remaining over the growth outlook. Asia faces

headwinds such as sluggish global trade, excess

capacity, weak productivity of capital, high

leverage and demographic challenges

Fed policy tightening will present a challenging

transition for Asia. However, the adjustment since

the “Taper Tantrum” has now placed the region in

a better position to withstand the cycle of rising

US interest rates and manage external/market

volatility

China’s transition to slower-trend growth will affect

the rest of the region via trade and financial

linkages and could mean weaker commodity

prices and disinflationary pressures. However,

amid policy buffers we do not forecast a sharp

slowdown in China

Comparing Asia today to during the Asian

financial crisis shows that external fundamentals

are in much better shape: most Asian countries

have a flexible foreign exchange policy, Asia is

now collectively better prepared (with improved

financial backstops) and many countries still have

the policy space and flexibility to implement

countercyclical measures

The trajectory of US interest rates, the outlook for

Chinese and global growth and Asian/emerging

market currency volatility remain key near-term

risks to Asian financial markets. Market volatility is

also likely to remain high in the near term

However, we remain constructive on Asian

equities and credit in the medium to long term,

given the region’s overall solid macro/corporate

fundamentals, positive reform and long-term

growth prospects, as well as the potential

structural support from a growing local investor

base

Heightened financial market volatility

Concerns about China’s economic slowdown, foreign

exchange policy uncertainty and a correction in A-

shares, as well as worries over the impact of the

coming Fed interest rate rise and further weakness in

global commodity prices, jolted Asian financial

markets in July and August in a global risk-off

environment. In particular, China’s surprise move to

a more market-based yuan-fixing mechanism on

August 11 and a one-off yuan devaluation had ripple

effects across the region and injected significant

volatility into Asian financial markets, affecting

equities, currencies and bonds. The MSCI AC Asia

ex Japan Index posted a negative total return in Q3.

Asian markets did receive some respite from the

Fed’s decision to hold off from raising interest rates

at its September 16-17 meeting, although the Fed’s

stance reflecting concerns over global growth also hit

risk appetite. Chinese policymakers continue to

remain supportive. The People’s Bank of China

(PBoC) cut policy rates by 25bps and the reserve

requirement ratio by 50bps on August 25, in order to

help stabilize both growth and financial markets.

Emerging Asian currencies weakened across the

board against the US dollar, euro and yen and on a

trade-weighted basis in July and August, particularly

following the yuan devaluation. This signalled more

general risk aversion toward emerging market assets

and, in some cases, concerns about domestic policy

credibility (China and Indonesia), political stability

(Malaysia) and/or reform prospects (India).

Nevertheless, most currencies pared some of their

losses in September on the back of a retreat in the

US dollar heading into the Fed policy meeting and

the subsequent decision not to hike rates.

Asian local-currency sovereign bond markets were

likewise hit in August, particularly Singapore,

Indonesia and Malaysia. Lower commodity and oil

prices also hurt Indonesian and Malaysian rates,

while Malaysia faced increased political risk. On the

other hand, government bond yields in China and

Korea fell and in India held relatively stable. Bond

yields in most countries (excluding Indonesia)

retreated in September as the foreign exchange sell-

off and risk aversion (toward emerging markets)

eased.

In the US dollar credit space, Asian spreads widened

against a range-bound trading of US Treasuries (10-

year Treasury yields ended the month roughly flat) in

August. High-beta Indonesian credits were bottom

FOR USE ONLY

13

Asia ex-Japan’s external fundamentals are in better shape than in the 1990s performers. Sovereign credit default swaps jumped in

countries such as Indonesia, Malaysia and Thailand.

However, the impact was modest relative to other

asset classes. The Fed rate decision and modestly

dovish comments provided some lift to the credit

market. The JACI Composite Index had a negative

total return of -0.5% in Q3 but still posted a positive

1.6% return year to date (September 30).

Macro challenges ahead for Asia…

Recent economic data from the region overall has

shown continued weakness, particularly in foreign

trade and industrial activity. Weak manufacturing

PMIs reflect contracting trade flows, sluggish

domestic demand, inventory adjustments and low

capacity utilization rates (Figure 3).

Trade contraction and sluggish domestic

demand

Sluggish Asian trade reflects both cyclical weakness

in global demand and a structural downshift in the

trade intensity of global growth. Falling prices, largely

driven by lower commodity prices, and currency

movements also weighed on trade growth in US

dollar terms. The structural decline in the elasticity of

trade to GDP (or economic growth being less import-

intensive), notably in the US and China, suggests

Asia is unlikely to get the same cyclical boost from

the global/US growth recovery as in the past.

The rebalancing of China’s economy towards

consumption and the services sector means less

import demand for commodities and capital goods,

affecting countries such as Indonesia, Malaysia and

Taiwan. The decline in commodity prices has also

reduced demand from commodity-producing

emerging market countries for Asian exports.

Meanwhile, China is increasing its production

capacity domestically and moving up the value chain,

thus increasingly competing with the regional higher-

value-added producers, such as Taiwan and Korea,

in the global market. China is also exporting goods in

which it has excess capacity, such as steel, posing

challenges to countries producing these goods.

Stronger currencies on a real effective exchange rate

(REER) basis over the past few years have been a

headwind for many countries’ exports and a policy

concern for some central banks in the region.

Despite lower energy prices boosting real incomes,

domestic demand has been lacklustre in most

countries. Policymakers in the region have also

eased monetary policy, increased fiscal stimulus,

accelerated infrastructure investment and relaxed

macro-prudential measures (e.g., China, Korea,

Indonesia and Taiwan have relaxed property-sector

measures), but so far these have had little impact

and more measures could be announced.

Cyclical and structural downshifts in growth

Asia’s generally slower economic growth rates

following the 2008-2009 Global Financial Crisis

(GFC) reflect not only cyclical headwinds but also a

structural downshift in growth rates. This is

compounded by the large overhang of private sector

leverage as the region’s response to a sharp

slowdown in external demand during the GFC was a

sharp increase in debt-fuelled domestic investment

and production capacity (Figure 2).

This caused excessive investment and misallocation

of capital and credit in many countries, keeping

unprofitable projects and inefficient companies afloat,

creating excess capacity and resulting in PPI

deflation. The trend in the productivity of capital,

measured by the Incremental Capital Output Ratio

(ICOR), which measures the additional capital

required to increase one unit of output, has

deteriorated in many countries. Lower ICOR has

contributed to slowing total factor productivity growth

(Figure 3).

Furthermore, there is an unfavourable demographic

shift in northeast Asian economies, Singapore and

Thailand, in the form of aging populations and

declining fertility rates. The UN forecasts that the size

of the working-age population will shrink over the

next five years in China, Hong Kong, Korea, Taiwan

and Thailand. Whether Asia can continue growing

strongly will crucially depend on reforms to clear

structural bottlenecks and boost productivity growth.

FOR USE ONLY

Figure 1: Manufacturing PMIs indicated weakness in

industrial activity (excluding India)

Sources: Bloomberg, HSBC Global Asset Management, as of

September 7, 2015

14

Asia ex-Japan’s external fundamentals are in better shape than in the 1990s

… compounded by Fed policy tightening

and a slowdown in Chinese growth

Going forward, Asian economies and financial

markets also face the key twin headwinds of Fed

policy tightening and China’s growth slowdown.

However, while these headwinds could increase

uncertainty over the region’s growth outlook and

volatility in financial markets, we believe the risks are

manageable and unlikely to lead to a significant

slowdown in Asia’s economic growth.

Fed policy tightening

Fed policy tightening will present a challenging

hurdle for Asia and could affect the region via

financial linkages, such as risks of capital outflows,

higher costs of capital (reflecting higher risk

premiums), a tightening of financial conditions,

increased financial market volatility and a correction

of asset prices.

Consequently, there could be a spill-over impact on

the real economy via downward currency effects

alongside upward pressure on (real) interest rates

and tighter liquidity conditions. Also, significant

currency volatility could constrain the ability to ease

policy in the face of tighter financial market

conditions. Vulnerability to this trend will be more

significant for countries with current account deficits,

a high reliance on foreign capital or sizable foreign

debt, and/or high domestic leverage.

However, the current situation differs from the 2013

“Taper Tantrum.” Taper talk was a surprise but a rate

hike will not be. Asian central banks and financial

institutions have been proactive in keeping leverage

in check. Post-GFC, Asian policymakers introduced

pre-emptive macro-prudential measures to address

the build-up of financial imbalances from rapid credit

growth, high private sector leverage, asset price

inflation (property prices in particular) and volatile

capital flows. Efforts have also been directed towards

strengthening macroeconomic fundamentals, with a

greater focus on current account and fiscal balances.

The region's current account balance in aggregate

today is in a much better position than prior to the

2013 “Taper Tantrum.”

Furthermore, currency mismatch risk looks

manageable at the sovereign level. In fact, much of

Asian corporate US dollar debt is in sectors with

natural hedges, such as US dollar revenues and

overseas business, and in many countries the rise in

external debt has come with an increase in foreign

assets held by residents. High domestic savings and

liquid domestic capital markets are also helping to

finance the debt. Furthermore, against a backdrop of

divergent business cycles, shifts in foreign exchange

rates could be a constructive force that could

promote rebalancing over time, if the pace of

adjustment is moderate and gradual. In fact, currency

depreciation in some countries is a deliberate policy

choice and should on balance be supportive of Asian

growth via export competitiveness.

Additionally, due to the data-dependent nature of the

Fed’s monetary policy, we believe US rate increases

would occur alongside an improving US economy,

which would be positive for Asian and global growth.

Overall, we expect orderly Fed tightening to have

little disruptive impact on Asian economies or

financial markets, but there will likely be increased

volatility in the near term.

Chinese growth slowdown

While we expect fiscal and monetary policy support

to help stabilize the Chinese economy, to roughly

meet the official target of “about 7%” for this year,

downside risks to the growth outlook remain.

Moreover, short-term stimulus measures will not help

FOR USE ONLY

Figure 2: Rapid build-up in Asian private sector debt

Sources: BIS, CEIC, HSBC Global Asset Management, September 2015

Figure 3: Slower total factor productivity growth post-

GFC

Sources: Conference Board Total Economy Database, HSBC Global Asset Management, September 2015

15

Asia ex-Japan’s external fundamentals are in better shape than in the 1990s address structural headwinds. We think the

government needs to push forward with structural

reforms and accept lower growth in the short term to

secure longer-term, sustainable, balanced and stable

growth. However, financial market volatility complicates

policymaking and risks weakening reform momentum

in the near term. We expect Chinese policymakers to

lower their growth target in the upcoming 13th Five-

Year Plan of National Development (2016-2020) to

about 6.5%.

China’s growth slowdown could also impact the region

via cross-border banking linkages or via foreign direct

investment. Hong Kong, Korea and Taiwan are

relatively more exposed to China in this respect.

Meanwhile, uncertainty over China’s foreign exchange

policy and the potential spill-over effects could pose

challenges for other countries in the region in

managing their exchange rates. Asian markets are

sensitive to yuan moves through trade, tourism and

financial linkages. Countries that compete more directly

with China on global markets (e.g., Taiwan, Korea, the

Philippines and Thailand) or rely on exports for

Chinese domestic demand (ASEAN) would be the

most affected. Tourists from China also account for a

relatively large share of total arrivals in Hong Kong,

Korea, Taiwan and Thailand. Countries with relatively

weaker external positions or companies with significant

US dollar debt exposure would also be vulnerable from

a competitive depreciation of regional currencies.

China’s growth slowdown, foreign exchange policy

uncertainty and the structural change in its trade could

therefore adversely impact almost all countries across

the region, given that China is their largest or second-

largest export market. Within Asia, India and the

Philippines are relatively more insulated, especially

India given its small exposure to China’s final demand

(Figure 4).

On the yuan front, we believe capital outflow pressures

could gradually slow. The government has tightened its

scrutiny of cross-border capital flows, using tools such

as the new derivative rule to discourage speculative

and arbitrage flows on yuan depreciation. There are

some fundamental supports for the yuan (e.g., solid

external balances) and the PBoC will maintain

control in the near term. Sharp or substantial yuan

depreciation looks unlikely amid economic/political

concerns. In the medium term, we believe the foreign

exchange reform objective remains intact, given the

importance of a market-driven, flexible foreign

exchange policy to address economic imbalances,

help the economy better cope with external shocks

and maintain monetary policy autonomy as China

opens up its capital account.

Asia is robust on macro risk metrics;

long-term growth prospects are solid

Recent financial market turbulence, coupled with

generally disappointing macro data coming out of the

region, have raised concerns about the risk of

another Asian financial crisis in the making.

Moreover, there are some similarities between the

current macro trends in the region and the pre-1997-

1998 Asian financial crisis (AFC) environment. These

include: (1) a period of low (real) interest rates, aided

by easy monetary policy in the US; (2) misallocation

of resources and capital into unproductive areas; (3)

the rapid build-up of corporate and household debt;

(4) a stronger US dollar and (5) falling commodity

prices. Nevertheless, there are also major

differences between the two periods.

External fundamentals are in much better shape

Most countries in the region are now running current

account surpluses, have large foreign exchange

reserves and lower external debt-to-GDP ratios

(Figures 5, 6, 7). In the run-up to the AFC, many

countries undertook unsustainable short-term foreign

exchange borrowing to finance large current account

deficits. In contrast, a large part of the debt build-up

in this period has been in domestic rather than

external debt, and Asia is now less reliant on short-

term external funding.

FOR USE ONLY

Figure 4: Direct export exposure by destinations

(share of total exports)

Sources: CEIC, HSBC Global Asset Management, September 2015

Figure 5: Most countries now run current account

surpluses versus deficits in AFC

Sources: CEIC, HSBC Global Asset Management, September 2015

16

Asia ex-Japan’s external fundamentals are in better shape than in the 1990s

Most Asian countries now have flexible foreign

exchange policies

Asian foreign exchange regimes prior to the AFC

were pegged to the US dollar or heavily managed,

encouraging significant foreign exchange borrowing.

As the US dollar began to appreciate with the Fed

starting its tightening cycle in 1994, many Asian

currencies appreciated sharply on an effective

exchange-rate basis, just as current account deficits

widened, resulting in significantly overvalued

exchange rates in the run-up to the AFC. Massive

capital outflows and insufficient foreign exchange

reserves to defend the currencies eventually led to a

collapse of Asian currency pegs and a substantial

depreciation of many Asian currencies.

With the notable exception of Hong Kong, foreign

exchange policies today are much more flexible,

even in the case of China since it ended the yuan’s

peg to the US dollar in 2005, gradually widened the

daily trading band and adjusted the daily fixing

FOR USE ONLY

Figure 6: External debt-to-GDP ratio is lower now than

in AFC in most countries

Sources: CEIC, HSBC Global Asset Management, September 2015

Figure 7: Foreign exchange reserve buffers versus

short-term external debt are more sufficient now than

during the AFC in most countries

Sources: CEIC, HSBC Global Asset Management, September 2015

mechanism. Although the REER has appreciated in

many currencies over the past few years, in most

countries we do not observe overvaluations,

especially against current-account positions. Based

on our long-term expected returns model, some

currencies look attractively valued or even

undervalued, particularly following the recent

depreciation.

Asia is now collectively better prepared with

improved financial backstops

Asian policymakers are much better prepared and

coordinated to pre-emptively address risks to

regional economic and financial stability, especially in

the areas of cross-border surveillance and crisis

management. In addition to the traditional

International Monetary Fund credit lines, Asia has

central bank bilateral swap lines and regional

financial safety nets (e.g. the USD240 billion Chiang

Mai Initiative for Multilateralization) to provide short-

term liquidity at times of liquidity crisis.

ASEAN+3 (China, Japan and Korea) policymakers

have worked to develop stronger bond markets

regionally through the Asia Bond Markets Initiative.

Moreover, Asia’s financial institutions and central

banks are better equipped and capitalized to deal

with the challenges ahead. Sources of financing are

also more diversified following efforts to develop and

deepen the domestic capital markets, with many

having established liquid bond markets.

Many countries still have the policy space and

flexibility to implement countercyclical measures

The 1997-1998 AFC was made worse by policy

interest rate hikes to defend overvalued currency

pegs and to keep high inflation in check. The sharp

rise in (real) interest rates led to a rise in non-

performing loans, a banking system crisis with a

significant tightening of financial conditions and,

eventually, an economic recession.

Today, despite the turbulence in financial markets,

there are no signs of unusual stress in short-term

funding markets or of a credit crunch in any major

Asian economy. We expect central banks in the

region to maintain an accommodative monetary

policy. In some cases they could even ease further

(e.g., China, India and Thailand).

CPI inflation is still running below central bank

targets in most countries and this is likely to continue,

while PPI deflation is observed across the region

(excluding Indonesia).

Asian governments today are far less dependent on

foreign exchange borrowing and the development of

a liquid domestic bond market provides another

source of financing. Therefore, there is space for

most countries to expand fiscal policy, given the

highly manageable levels of public debt, although the

fiscal space varies across the region.

17

Fed policy tightening is likely to be more gradual

this time around

The Fed surprised the markets by beginning to

tighten monetary policy aggressively in 1994. This

time around, a Fed lift-off should not be too much of

a surprise and the pace of increases in (real) interest

rates is likely to be more gradual than in the 1990s

with the magnitude of rate hikes smaller.

Investment implications

Equities

The US interest rate trajectory, Chinese and global

economic outlook, global equity market and currency

volatility remain key near-term risks to Asian equities,

while weak commodity prices could affect related

sectors.

However, the backdrop of a gradual Fed tightening

cycle should be supportive of equities, as long as US

growth also improves. Also, overall supportive macro

policies and the lagged growth impulse from lower

energy costs should help underpin a moderate

recovery in domestic demand and earnings

prospects. We believe policymakers in most

countries in the region remain committed to structural

reforms, which could prompt re-rating potential, while

China’s accelerated capital market liberalization and

further financial integration in the region could be

medium-term market catalysts.

Valuations metrics are also attractive. The MSCI

Asia ex-Japan Index has fallen by more than 20%

from the recent highs in late April (as of September

18) versus a 25% and 21% correction in the 1994

and 2004 tightening cycle, respectively. For this

index, the current trailing price-to-book ratio (P/B) of

1.3x is very close to the 2008-2009 lows (GFC) and

troughs seen in the SARS episode and 2001 global

recession. The P/B is especially low when set

against the potential for return on equity pickup in the

medium term on reforms. We think current valuations

have priced in a lot of fear factors and Asia ex-Japan

equities offer attractive risk-adjusted rewards based

on our long-term expected returns model.

Local currency bonds

Higher US interest rates and currency risks will likely

remain headwinds to Asian local-currency bonds in

the near term, while overall risk sentiment toward

emerging markets is another key driver. The Fed’s

delayed lift-off and slightly dovish tone reflects

concerns about global growth, which could weigh on

risk sentiment and be negative for Asian currencies.

Investors are also likely to continue watching

developments in China. The near-term inflation

outlook remains benign, with weakness in commodity

prices, while uncertainty over the growth outlook

Asia ex-Japan’s external fundamentals are in better shape than in the 1990s

FOR USE ONLY

remains high for a large part of the region, leaving

room for some countries to ease monetary policy

further. Higher US/developed market bond yields

could affect the countries that depend more on

external funding or where foreign holdings of local

debt are relatively high (e.g., Indonesia and

Malaysia). Markets with still accommodative

monetary policy or room for further easing, less

sensitivity to currency weakness, positive reform

prospects and more attractive valuations could do

relatively well. Domestic political risks (e.g., in

Malaysia) could also affect local-currency bonds

while supply is another technical factor to consider.

US dollar credit

The key driver/risk of Asian US dollar credit will be

fund flows amid concerns over Fed policy tightening

and China. A delayed Fed rate hike and slightly

dovish comments could be short-term positive for

Asian credit. However, beyond some short-term

adjustments, uncertainty over the Fed policy outlook

remains. High yield credit tends to be more sensitive

to shifts in market sentiment, while investment grade

credit remains susceptible to US Treasury volatility.

Fed policy tightening could put pressure on credit

markets. The risk of significant spread-widening

could result from increased redemption pressure

and/or negative credit events (e.g., rating

downgrades or defaults). The credit fundamentals of

some companies could deteriorate due to currency

volatility (those that have large unhedged

USD/foreign exchange exposure or face currency

mismatch risks), weaker top-line growth and

continued commodity-price weakness.

However, generally we do not expect a significant

rise in default rates, particularly given the limited

bond refinancing requirements over the next 6-12

months. Chinese corporates now also have cheaper

onshore funding alternatives. Near-term support for

Asian corporate credit should also come from

relatively solid credit fundamentals (versus other

emerging markets), still good carry in the high yield

space, a combination of tepid global and domestic

growth and low inflation, accommodative monetary

policy in most countries, and largely supportive

demand-supply dynamics. We have also seen

increasing demand from onshore investors for US

dollar credits, especially those names that have

strong connections to the onshore market, in a bid to

diversify their currency risk.

We think the recent market volatility has led to some

market dislocation and that in some spaces a much

more bearish macro/fundamental scenario has been

priced in, although we need to be selective given the

near-term challenging macro environment and

currency risks. In the medium to long term, we

remain constructive on Asian credit.

18

Emerging market Asia may benefit overall from the current long-term commodity cycle Herve Lievore, Senior Macro and Investment Strategist

Summary:

Commodity prices follow a highly cyclical trend,

mainly due to the lag in the supply and demand

response to price signals. Over the past 100

years, this cycle has showed a regular pattern,

expanding for about 10 years and consolidating

for around 20 years. Relative to US inflation,

commodities have followed a downward trend

since the mid-19th century

Net commodity-exporting countries with poor

productivity gains tend to catch up more slowly

with advanced economies on a GDP per capita

basis compared to countries like China and India,

which are net commodity importers and have

experienced stronger productivity gains

Lower commodity prices provide an opportunity

for positive equity performance as they help push

profit margins higher. Bonds also benefit through

lower inflation, although higher credit risk for

issuers exposed to commodities reduces the

overall positive impact

Introduction

The recent sharp correction in commodity prices has

mainly had a negative impact on other asset classes,

as it has heightened concerns about growth in key

markets for commodities, especially China. However,

going forward, this sharp drop also represents an

opportunity as it should strengthen profit margins

across non-commodity sectors and maintain inflation

at low levels. In this regard, given their strong

productivity gains during the last commodity cycle,

China and India and, to a lesser degree, Asia ex-

Japan in general, seem to be best positioned to

benefit from the current phase of the commodity

cycle.

The dynamics of commodity cycles

Over the past 10 to 15 years, commodities have

increasingly been included in diversified portfolios as

a hedge against inflation or as an indirect way to gain

exposure to the rapid development of large emerging

economies. However, from a long-term investment

perspective, understanding the cyclical behaviour of

commodities is crucial to avoid pitfalls.

Commodities are a peculiar asset class in many

ways. The most obvious difference with equities and

bonds, for example, is related to valuation. While

most other assets can (and should) be valued on a

discounted future cash-flow basis, pure commodities

(excluding stocks or bonds of commodity producers)

do not generate any cash flows and their prices are

determined by short-term supply and demand.

Economic theory tells us that the market price

reflects the marginal cost of production. This may

certainly hold true during the upward phase of the

commodity cycle, but not necessarily so during

downward phases, especially at the beginning. This

is because producers have to squeeze their profit

margins and set their price at the average cost of

production, which temporarily becomes the market

price, to preserve their market share.

Commodities are also cyclical by nature, for at least

two reasons. As inputs into the production process,

raw materials are impacted by broad industrial cycles

in leading economies such as China, Europe and the

US. During these cycles, inventories play a crucial

role as a key determinant of supply. In addition to

these relatively short-term cycles, commodities are

also influenced by their own, long-term cycle, which

is fundamentally driven by the supply and demand

response to price signals. Typically, during periods of

low prices, consumers’ purchasing power increases,

pushing commodity prices higher as the utilization

rate of productive capacity increases. Higher profits

provide an incentive for commodity producers to

invest in new production capacity that can become

productive more than 10 years later. By this time,

commodity prices have increased considerably,

weighing on demand by forcing consumers to find

alternatives or to reduce consumption. At the end of

this investment cycle, supply significantly exceeds

demand and, unless producers decide to voluntarily

limit their output, prices collapse. However, evidence

shows that prices don’t usually return to levels that

prevailed before the beginning of the investment

cycle (Figure 1). In the first half of the 1980s, to

prevent a sharp decline in prices, Saudi Arabia

agreed to play the role of “swing producer,” cutting its

production by 77% between August 1981 and August

1985. This policy failed, as new production capacity

was added in non-OPEC countries, particularly in the

Gulf of Mexico and the North Sea. Prices collapsed

when Saudi Arabia decided to resume production.

Interestingly, the Saudis have refused to act as a

swing producer in 2014 and 2015, letting market

forces determine prices.

FOR USE ONLY

19

Emerging market Asia may benefit overall from the current long-term commodity cycle

The consolidation phase of the cycle usually spans

many years as consumers’ purchasing power is

restored and production capacities are restructured,

which is typically a long process. For example,

although the decline in crude oil prices started in the

early 1980s, the restructuring of major US oil

companies continued until the end of the 1990s.

Since the beginning of the 20th century, three

commodity cycles have taken place and a fourth

cycle probably started in 2002. As shown in Figure 1,

the upward phase of the cycle (blue-shaded areas)

tends to last around 10 years. The consolidation

phase is longer, lasting on average 22 years. Given

the relatively small number of observations, definitive

conclusions cannot be drawn. However, there is an

undeniable regularity, with an overall cycle spanning

three decades, one-third of which is characterized by

rapid price increases. From past observations, it

seems that the consolidation phase of the current

cycle started in 2011 and the significant drop since

then is likely to continue for some time, although

temporary rebounds are likely to occur.

Commodity cycles from a historical

perspective

To get a better understanding of economic forces

involved in long-term commodity cycles, we have

built a price index made of 15 commodities, including

agricultural products, energy and industrial metals,

for which prices are available since at least the 19th

century (with the exception of natural gas). Some

series start as far back as 1700 (wheat, rice, sugar,

beef, coal and iron). This price index has obvious

technical limitations. For example, in the 18th century

and first-half of the 19th century, markets were less

internationally integrated than they are today, with

prices tending to reflect local conditions. We

addressed this issue by comparing prices in different

countries to isolate local distortions. Another

limitation comes from the fact that prices have not

always been determined by market forces. The

presence of cartels has often resulted in artificial

price stability, like crude oil before 1973. Bearing

these limitations in mind, some important lessons

can be drawn from the index and its sub-

components.

Figure 2 shows the evolution of agricultural product,

energy and industrial metal prices since the early 18th

century, measured by the 10-year moving average of

yearly fluctuations. The general pattern of the curve

has changed considerably over time. In the period

before the beginning of the Industrial Revolution, in

the second half of the 18th century, price volatility

was limited, generally hovering in a +/-3% range.

This mostly reflects low growth in income per capita

and the absence of a strong industrial base during

this period. The Industrial Revolution increased price

volatility substantially. The range of price fluctuations

widened to +/-7% as industrialization boosted

demand for raw materials and investments in new

production capacities. However, cycles remained

slow, with only two complete cycles between 1780

and 1880. The 20th century saw profound changes

and the strengthening of the cyclical dynamic of

commodities. The range of price fluctuations widened

further to +25%/-10% and the cycle length fell from

about 50 years in the 19th century to 30 years.

FOR USE ONLY

Figure 1: Commodity cycles since 1900

Source: HSBC Global Asset Management, September 2015

Figure 2: Annual commodity price fluctuations

(10-year average)

Source: HSBC Global Asset Management, September 2015

20

Emerging market Asia may benefit overall from the current long-term commodity cycle

Cycles in the 20th century were triggered by shocks:

the two world wars and the end of the link between

the US dollar and gold in August 1971 (the end of the

Bretton Woods system). In contrast, the current cycle

coincided with the rapid development of China in the

context of loose global monetary conditions.

It is also worth noting that agriculture, energy and

industrial metal cycles are synchronous. While the

magnitude of the cycle may diverge from one

category to another, and some differences may exist

in the short term, the overall trend is remarkably

similar. These similarities are not surprising given the

fact that the distinction between categories of

commodities is fading, with grains used as biofuel

for example.

One last notable characteristic of commodity prices

is that they have risen less rapidly than prices of

manufactured goods and services in the long run, at

least since the middle of the 19th century. Figure 3

shows the nominal commodity price series deflated

by the US consumer price index since 1800,

calculated by the Federal Reserve of Minneapolis,

as a proxy for non-commodity goods and services

prices. The curve shows a downward trend,

interrupted only temporarily during investment

cycles. From a long-term investment perspective,

this characteristic is important as it suggests that

commodities are a good hedge only against inflation

driven by commodities. Most of the time,

commodities are a poor hedge against inflation, even

when including precious metals.

This observation was previously made in 1949 by

Hans Singer and Raul Prebisch. Their thesis, which

triggered heated debates, was that commodity prices

decline relative to manufactured goods prices in the

long term. Singer and Prebisch limited their analysis

to tradable goods, as their focus was on the terms of

trade and their implications on the economic

development of commodity producers. This

framework is restrictive in the sense that it only

considers economic development through trade,

and not through the purchasing power of commodity

producers or the real return for investors. Due to

lower productivity gains, prices of services (which are

mostly non-tradable) rise more quickly than those of

manufactured goods and commodities.

Impact of commodity cycles on

countries

Since the commodity cycle peak of 2011, several

emerging economies have experienced episodes

of stagflation, a deterioration of their current account

balance or a sharp depreciation of their exchange

rate. Countries like Brazil, Venezuela and Russia are

the most representative of this trend, sharing one

common denominator: they are all net commodity

exporters.

Figure 4 shows the evolution of the nominal effective

exchange rate of emerging market currencies

between Q2 2014 and Q2 2015 and their commodity-

exporting status. Net commodity importers typically

experienced an appreciation of their currencies,

again on a trade-weighted basis, while net

commodity exporters saw their currencies

depreciate. In the short run, an appreciation of their

currency represents a hurdle for commodity

importers as it reduces their manufactured goods’

price-competitiveness. However, in the longer run,

lower input prices coupled with productivity gains

help mitigate the initial loss of price competitiveness.

The impact of exposure/dependence to commodities

on economic development can also be illustrated by

the convergence of a country’s GDP per capita

towards US standards, and by how this convergence

is achieved (i.e., productivity gains versus the

accumulation of capital and labour).

FOR USE ONLY

Sources: Bloomberg, HSBC Global Asset Management, September 2015

Figure 3: Declining trend of real commodity prices

Sources: BIS, WTO, HSBC Global Asset Management, September 2015

Figure 4: Relationship between exchange-rate

fluctuations and commodity-exporting status

21

Emerging market Asia may benefit overall from the current long-term commodity cycle

Figure 5 represents the evolution, between 1981 and

2011, of GDP per capita in the largest emerging

economies and total factor productivity gains in those

countries, relative to US GDP and productivity. The

period covered corresponds to the last complete

commodity cycle, thus neutralizing the impact of

commodity price increases on economic

performance.

The chart shows that net commodity exporters had

mixed results, in terms of catching up with US GDP

per capita, compared to net commodity importers.

More importantly, net commodity exporters saw their

total factor productivity decline relative to US

productivity, while countries like China and India

continued to converge towards US levels. This

suggests that the economic catch-up in net

commodity-exporting countries is slower than in

commodity-importing countries.

This conclusion is consistent with the “natural

resource curse” thesis, which is the seemingly

counterintuitive idea that a country with ample natural

resources tends to develop less rapidly than others

over the long term due to rent-seeking behaviours,

with a distortion in the allocation of capital (i.e., a

suppression of innovation) on the supply side and an

artificially high level of domestic consumption based

on generous but unsustainable fiscal transfers on the

demand side. In this regard, as a majority of

countries in Latin America, Eastern Europe, the

Middle East and Africa are net commodity exporters,

these regions seem to be more exposed to lower

growth than Asia during the consolidation phase of

the commodity cycle.

However, there are numerous counter-examples of

net commodity exporters that have successfully

caught up with more advanced economies, even

during commodity-consolidation periods. The main

lesson that can be learned from these countries, from

FOR USE ONLY

Chile to Norway (even though the latter is not an

emerging market), is that institutions must be put in

place to ensure a counter-cyclical use of natural

resources. In other words, it is essential to save

during periods of price increases in order to be able

to spend during market downturns. Pro-cyclical

policies such as subsidies or other forms of fiscal

redistributions become difficult to maintain when

commodity prices fall sharply. Assets can also be

accumulated in periods of price increases in order to

invest in new industries and to facilitate the

diversification of the economy. Chile offers a good

example of effective counter-cyclical policies with its

structural fiscal balance policy.

Ultimately, the economic outlook of commodity-

exporting countries depends on appropriate policies

as well as sound and transparent institutions

designed to avoid pro-cyclical behaviours. Measures

recently taken in Asia, particularly Indonesia, to

reduce fuel subsidies should, in our opinion, help

maintain the comparative advantage of the region in

terms of future economic development.

Impact of commodity cycles on asset

classes

Commodity cycles mostly affect other asset classes

through profit margins and inflation, both actual and

expected.

Commodities primarily constitute inputs for other

sectors of the economy, so a decline in nominal

prices relative to manufactured goods and services

prices will stimulate profit margins for the latter,

everything else being equal, and in turn support

price-to-earnings ratios and therefore equity prices

(apart from commodity producers, as a decline in raw

material prices is a major drag on their margins).

Sources: Penn World Tables, HSBC Global Asset Management, data between 1981 and 2011

Figure 5: Emerging market commodity exporters

have lower economic performance than

importers

Sources: Bloomberg, Robert Shiller data, HSBC Global Asset Management, September 2015

Figure 6: Long-term relationship of real

commodity prices and US price earnings

22

Emerging market Asia may benefit overall from the current long-term commodity cycle

Figure 6 shows the long-term relationship between

real commodity prices (i.e., prices of commodities

relative to manufactured goods and services) and the

S&P 500 price-to-earnings ratio since 1870. The two

curves are closely correlated, probably for two

reasons. Firstly, real commodity prices can be

interpreted as a proxy for broadly defined profit

margins: the lower the real commodity prices, the

higher the profit margins, everything else being

equal. Secondly, commodity prices are one of the

determinants of inflation, thereby influencing bond

yields and discount rates in discounted cash-flow

valuations. From a historical perspective, periods

of consolidation in commodity prices have been

characterized by rising, above-average price

earnings.

Historically, the consolidation phase of the

commodity cycle has also often been associated

with lower inflation. Since 2011, when commodities

reached their cyclical peak, most major countries

have seen their rate of inflation, both headline and

core, fall below their central bank target. By dragging

inflation expectations lower, as illustrated by US

breakevens in Figure 7, declining commodity prices

are supportive of high-quality bonds. However,

everything else being equal, falling commodity prices

tend to increase credit risk, especially among

commodity producers and commodity-exporting

countries.

Conclusion

The cyclical nature of commodities over the long run

provides valuable insights on the possible direction of

bonds and equities as well as on country risks and

opportunities going forward.

After almost 10 years of sharp price increases,

commodities entered a period of consolidation in

2011, with crude oil lagging, joining the bandwagon

in 2014. From past experience, this period of

consolidation will likely span at least one decade

during which prices may gradually fall to a new

equilibrium, with shorter-term volatility driven by

inventory cycles.

Everything else being equal, lower commodity prices

reinforce our view that equities can potentially offer

better expected returns than high-quality government

bonds. This note also illustrates that, when

considering investing in emerging countries, policies

and institutions matter, and capitalizing on the

potential of emerging markets requires careful

selection. Emerging market Asian countries,

considered as a group, present the distinctive

advantage of being net commodity importers, well

integrated in global trade and capital flows and with

strong industrial and service sectors. China and India

in particular have implemented a wide range of

structural reforms to accelerate the adaptation of

their economies to a changing global environment.

FOR USE ONLY

Figure 7: Inflation expectations are sensitive to

commodity prices

Sources: HSBC Global Asset Management, Bloomberg, as of September 3, 2015

23

1. The most recent activity data points to a continued

slowdown in global economic growth…

2. …while global inflation remains low, pegged down by

falling commodity prices

3. The US economy remains healthy and the labour

market continues to tighten...

4. …but concerns over EM growth and market volatility

have prevented the Fed from raising rates so far

5. The Fed has signalled that the pace of future

interest rate increases will be very gradual

6. The European economy is gradually healing,

supported by loose monetary policy and improving

credit conditions

7. The Chinese economy continued to slow in Q3, with

PMI surveys pointing to a sharp contraction in activity

8. China’s move to a more market-oriented exchange

rate mechanism induced volatility in financial markets in

August

Macroeconomic charts

FOR USE ONLY Sources: Bloomberg, HSBC Global Asset Management. Data as at close of business September 29, 2015.

Past performance is not an indication of future returns.

-200

0

200

400

600

10 11 12 13 14 15

thousands

Change in Non-Farm Payrolls (mom) 6M Moving Average

-4

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Eurozone manufacturing PMI, LHSEurozone M1 growth, RHS (advanced 6M)

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05 06 07 08 09 10 11 12 13 14 15

%

US Fed Funds Target Rate (Upper Bound)

US Treasury 2-year yield

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Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Dec-17

%

Fed 'Dots Chart', Median projection, June 2015

Fed 'Dots Chart', Median projection, September 2015

Bloomberg consensus estimates, 29 September 2015

Market implied estimate on 29 Sep 2015

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Global GDP, qoq annualised (LHS)Global manufacturing PMI (RHS)

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yoy, %

OECD inflation US inflation Eurozone inflation

6.00

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Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15

CNY/USD

USD-CNY spot USD-CNY fixing

24

1. Financial market volatility spiked in August on

concerns about Chinese growth, among other factors

2. And this triggered a sell-off in risk assets, such as

global equities

3. The falls were led by Chinese equities as

policymakers limited their direct intervention in

markets

4. China-related concerns have also contributed to

further commodity price weakness…

5. …which has pushed down market-based measures

of medium-term inflation expectations

6. Developed market government bond yields have

remained range-bound over the quarter

7. The US dollar continued to appreciate in 2015

relative to a basket of currencies on widening relative

interest rate expectations

8. Over the long term, risk assets such as equities still

look attractive relative to perceived “safe-haven”

developed market government bonds in our view

Financial markets charts

FOR USE ONLY Sources: Bloomberg, HSBC Global Asset Management. Data as at close of business September 29, 2015.

Past performance is not an indication of future returns.

1.0

1.5

2.0

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3.0

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07 08 09 10 11 12 13 14 15

%

US Inflation Expectations (5Y5Y forward), LHS

EZ Inflation Expectations (5Y5Y forward), LHS

Fed and ECB Inflation Target

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IndexIndex

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Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15

Rebased Jan 2013 = 100

MSCI AC Wor ld MSCI World (DM) MSCI EM

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Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15

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Index

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German Bund 10Y Yield, RHS Japan JGB 10Y Yield, RHS

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MSCI World Forward Earnings Yie ld minus US TIPS 10-Year Yield

Average

25

FOR USE ONLY

Market data

*Indices expressed as total returns. All others are price returns.

All total return data quoted in US dollar terms. Data sourced from MSCI AC World Total Return Index, MSCI USA Total Return Index, MSCI AC

Europe Total Return Index, MSCI AC Asia Pacific ex Japan Total Return Index, MSCI Japan Total Return Index, MSCI EM Latin America Total

Return Index and MSCI Emerging Markets Total Return Index. Total return includes income from dividends and interest as well as appreciation or

depreciation in the price of an asset over the given period.

Sources: Bloomberg, HSBC Global Asset Management. Data as at close of business 29 September 2015.

Past performance is not an indication of future returns.

3-Month 1-Year YTD 52-Week 52-Week Fwd

Close Change Change Change High Low P/E

Equity Indices (%) (%) (%) (X)

World

MSCI AC World Index (USD) 374 -11.6 -10.5 -10.3 444 373 14.9

North America

US Dow Jones Industrial Average 16,049 -8.8 -6.0 -10.0 18,351 15,370 14.7

US S&P 500 Index 1,884 -8.4 -4.7 -8.5 2,135 1,821 16.0

US NASDAQ Composite Index 4,517 -8.9 0.3 -4.6 5,232 4,117 19.7

Canada S&P/TSX Composite Index 13,037 -10.0 -13.0 -10.9 15,525 12,705 16.4

Europe

MSCI AC Europe (USD) 395 -12.3 -13.9 -9.3 479 393 14.0

Euro STOXX 50 Index 3,030 -12.7 -4.9 -3.7 3,836 2,790 13.4

UK FTSE 100 Index 5,909 -10.7 -11.1 -10.0 7,123 5,768 15.0

Germany DAX Index* 9,450 -14.7 0.3 -3.6 12,391 8,355 11.8

France CAC-40 Index 4,344 -10.8 -0.3 1.7 5,284 3,789 14.4

Spain IBEX 35 Index 9,394 -13.5 -12.1 -8.6 11,885 9,231 14.3

Asia Pacific

MSCI AC Asia Pacific ex Japan (USD) 386 -18.0 -18.6 -17.4 525 383 11.9

Japan Nikkei-225 Stock Average 16,931 -15.8 3.8 -3.0 20,953 14,529 16.4

Australian Stock Exchange 200 4,918 -9.3 -6.6 -9.1 5,997 4,918 14.8

Hong Kong Hang Seng Index 20,557 -20.8 -11.5 -12.9 28,589 20,368 10.4

Shanghai Stock Exchange Composite Index 3,038 -25.0 28.9 -6.1 5,178 2,280 12.9

Hang Seng China Enterprises Index 9,231 -27.3 -11.6 -23.0 14,963 9,059 7.0

Taiwan TAIEX Index 8,132 -12.0 -9.2 -12.6 10,014 7,203 12.2

Korea KOSPI Index 1,943 -5.7 -4.1 1.4 2,190 1,801 12.1

India SENSEX 30 Index 25,779 -6.8 -3.1 -6.3 30,025 24,834 16.5

Indonesia Jakarta Stock Price Index 4,178 -14.4 -18.7 -20.1 5,524 4,034 13.9

Malaysia Kuala Lumpur Composite Index 1,603 -5.2 -13.2 -9.0 1,868 1,504 15.8

Philippines Stock Exchange PSE Index 6,859 -9.4 -5.6 -5.1 8,137 6,603 18.6

Singapore FTSE Straits Times Index 2,788 -15.0 -15.3 -17.2 3,550 2,740 12.0

Thailand SET Index 1,349 -10.7 -14.9 -9.9 1,620 1,292 14.5

Latam

Argentina Merval Index 9,660 -14.6 -23.3 12.6 12,611 7,276 11.2

Brazil Bovespa Index* 44,132 -16.8 -19.2 -11.7 58,897 42,749 12.5

Chile IPSA Index 3,657 -5.8 -7.3 -5.0 4,148 3,542 15.7

Colombia IGBC Index 9,142 -10.8 -33.4 -21.4 13,725 8,811 23.8

Mexico Index 42,122 -5.8 -6.2 -2.4 46,078 39,257 19.2

EEMEA

Russia MICEX Index 1,631 -0.3 15.8 16.7 1,848 1,310 5.8

South Africa JSE Index 49,384 -5.0 0.0 -0.8 55,355 46,068 16.4

Turkey ISE 100 Index* 74,258 -9.2 -0.5 -13.4 91,806 69,797 9.9

3-Month YTD 1-Year 3-Year 5-Year

Change Change Change Change Change

Equity Indices - Total Return (%) (%) (%) (%) (%)

Global equities -11.2 -8.9 -8.7 19.9 36.0

US equities -8.4 -7.4 -3.3 37.0 77.7

Europe equities -11.9 -7.2 -11.7 13.9 17.4

Asia Pacific ex Japan equities -17.2 -15.4 -16.2 -4.7 -0.5

Japan equities -13.8 -2.5 -6.0 25.9 21.3

Latam equities -26.2 -31.5 -40.9 -45.7 -51.2

Emerging Markets equities -18.4 -17.2 -21.2 -16.7 -17.9

26 FOR USE ONLY

Market Data (continued)

Sources: Bloomberg, HSBC Global Asset Management. Data as at close of business September 29, 2015.

Past performance is not an indication of future returns.

3-Month 1-Year YTD

Close Change Change Change

Bond Indices - Total Return (%) (%) (%)

BarCap GlobalAgg (Hedged in USD) 480.0 1.4 3.2 0.9

JPM EMBI Global 657.0 -2.4 -2.7 -0.8

BarCap US Corporate Index (USD) 2586.5 1.0 1.6 0.0

BarCap Euro Corporate Index (Eur) 226.9 -0.3 -0.4 -2.0

BarCap Global High Yield (USD) 374.3 -3.8 -2.0 -0.6

HSBC Asian Bond Index 377.19 -0.5 2.9 1.2

3 Months 1 Year Year-End

Bonds Close Ago Ago 2014

US Treasury yields (%)

3-Month -0.01 0.00 0.01 0.04

2-Year 0.65 0.63 0.57 0.66

5-Year 1.38 1.62 1.76 1.65

10-Year 2.05 2.32 2.48 2.17

30-Year 2.85 3.10 3.16 2.75

Developed market 10-year bond yields (%)

Japan 0.33 0.45 0.52 0.32

UK 1.76 2.07 2.44 1.76

Germany 0.58 0.79 0.96 0.54

France 0.99 1.24 1.30 0.82

Italy 1.71 2.39 2.40 1.88

Spain 1.89 2.34 2.22 1.60

3 Months 1 Year Year-End 52-Week 52-Week

Currencies (versus USD) Latest Ago Ago 2014 High Low

Developed markets

EUR/USD 1.12 1.12 1.27 1.21 1.29 1.05

GBP/USD 1.52 1.57 1.62 1.56 1.63 1.46

CHF/USD 1.03 1.08 1.05 1.01 1.19 0.98

CAD 1.34 1.24 1.12 1.16 1.35 1.11

JPY 119.74 122.54 109.50 119.78 125.86 105.23

AUD 1.43 1.30 1.15 1.22 1.45 1.12

NZD 1.58 1.46 1.29 1.28 1.60 1.24

Asia

HKD 7.75 7.75 7.77 7.76 7.77 7.75

CNY 6.36 6.21 6.15 6.21 6.45 6.11

INR 65.96 63.85 61.53 63.04 66.89 60.91

MYR 4.46 3.78 3.28 3.50 4.48 3.23

KRW 1,202.05 1,125.19 1,053.88 1,090.98 1,208.72 1,045.58

TWD 33.13 30.97 30.49 31.66 33.33 30.33

Latam

BRL 4.06 3.12 2.45 2.66 4.25 2.36

COP 3,110.82 2,590.40 2,025.99 2,376.51 3,266.52 2,012.53

MXN 17.02 15.69 13.50 14.75 17.34 13.28

EEMEA

RUB 65.93 55.75 39.45 60.74 79.17 39.36

ZAR 13.98 12.24 11.28 11.57 14.16 10.83

TRY 3.04 2.70 2.28 2.34 3.08 2.19

Latest 3-Month 1-Year YTD 52-Week 52-Week

Change Change Change High Low

Commodities (%) (%) (%)

Gold 1,127 -4.4 -7.3 -4.8 1,308 1,072

Brent Oil 48 -22.2 -50.4 -15.9 98 42

WTI Crude Oil 45 -22.5 -52.2 -15.1 95 38

R/J CRB Futures Index 194 -13.4 -31.6 -15.8 283 185

LME Copper 4,970 -14.2 -26.3 -21.1 6,836 4,855

27 FOR USE ONLY

Macro and Investment Strategy team

David Semmens

Senior Macro & Investment Strategist David Semmens is a Senior Macro and

Investment Strategist based in London. His

main areas of expertise are global

macroeconomics, monetary policy, financial

markets and labour economics. He was

previously head of macroeconomic and

country risk research for Euler Hermes in Paris

and the US economist within the research

department at Standard Chartered Bank in

both London and New York. He is a CFA

charterholder, with an Executive MBA from

Judge Business School, Cambridge, and

degrees in economics from the University of

Warwick.

Renee Chen

Senior Macro & Investment Strategist Renee Chen is a Senior Macro and Investment

Strategist at HSBC Global Asset Management.

Prior to this role, she held economist roles at

Macquarie Capital Securities, Nomura and

Citigroup and has over 15 years’ experience in

economic and policy research, focused on

Asia. Renee holds a master’s degree in

international affairs and economic policy

management from Columbia University, New

York and an MBA in finance and investment

from George Washington University,

Washington DC.

Marcus Sonntag

Macro & Investment Strategist Marcus Sonntag is a Macro and Investment

Strategist and provides analysis and research

on the key issues facing the global economy

and asset markets, with a particular focus on

economic forecasting. Marcus joined HSBC

Global Asset Management in 2015 and is

based in the UK. Previously, he worked as an

economist for Deutsche Bundesbank in

Germany, and for Bank of America Merrill

Lynch and Prudential Portfolio Management

Group in London. Marcus holds a PhD in

Economics from Bonn University (Germany)

and the CFA Charter.

Sam Pham

Junior Macro & Investment Strategist Prior to joining the team in London as a Junior

Macro and Investment Strategist, Sam spent

two years rotating within HSBC Securities

Services, focusing on global product, strategy,

project management and sales and business

development. This included six months in New

York as a project manager for the US Sub-

Custody project, an important initiative within

Global Banking and Markets. He holds a first-

class degree in economics from University

College London and an MPhil in finance and

economics from University of Cambridge,

where he specialized in modern portfolio

strategies.

Herve Lievore

Senior Macro & Investment Strategist Hervé Lievore is a Senior Macro and

Investment Strategist based in Hong Kong.

Before joining HSBC, he spent five years at

AXA Investment Managers in London and

Hong Kong as an economist and strategist,

covering Asia and commodities. He was

also involved in the firm’s tactical asset

allocation committees. He started his career

18 years ago at Natixis in Paris, where he

mostly covered Asian markets.

Rabia Bhopal

Macro & Investment Strategist Rabia Bhopal is a Macro and Investment

Strategist and provides analysis and

research on the key issues facing the global

economy and asset markets, with particular

focus on frontier markets. Rabia has been

working in the industry since 2003. Prior to

joining HSBC in 2012, Rabia held

economist roles at Standard & Poor’s,

Lloyds TSB Corporate Markets, Financial

Services Authority and the Economist

Intelligence Unit. She holds a degree in

economics from Brunel University in

London.

Shaan Raithatha

Macro & Investment Strategist Shaan is a Macro and Investment Strategist

and provides analysis and research on key

global macro and investment strategy

issues as well as building econometric

forecasting models. Prior to this role, he

spent 18 months on the HSBC Global Asset

Management Graduate Programme working

as an analyst on both the Global Emerging

Markets Equity and Equity Quantitative

Research teams. Shaan holds a bachelor of

arts degree in economics from the

University of Cambridge and has passed all

three levels of the CFA program.

28

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The material is based on sources believed to be reliable; however, we have not independently verified such

information and make no guarantee, representation or warranty and accept no responsibility or liability as to its

accuracy or completeness. Unless stated otherwise, all data and charts are sourced from Bloomberg, HSBC Global

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