FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY NOT FOR RETAIL USE OR DISTRIBUTION IN BRIEF

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1 FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY NOT FOR RETAIL USE OR DISTRIBUTION Reflation takes root Emerging market debt strategy Q AUTHORS IN BRIEF Reflation remains the dominant theme, with global growth synchronised and emerging market (EM) fundamental data continuing to improve. Emerging markets are well positioned to adjust to gradual and well-telegraphed US Federal Reserve (Fed) policy normalisation, having already undergone considerable adjustment since We have increased the probability of a China stabilisation scenario, acknowledging what have been stronger-than-targeted supply-side reforms. However, lingering structural issues still need to be addressed. Sovereign and corporate technicals are expected to be supportive through the second quarter owing to heavy repayments in April and ongoing strong investor demand. Politics, protectionism and policy mistakes represent the three key risks for the rest of the year. Following strong first-quarter performance, tighter valuations and limited market risk premium, we have shifted our focus from beta to carry favouring local currency debt, idiosyncratic stories, shorter-dated bonds with a bias towards Latin America and highyielding names. Reflation in evidence as EM assets deliver strong first-quarter performance across the board EXHIBIT 1: PERFORMANCE SUMMARY FOR Q Pierre-Yves Bareau Head of Emerging Market Debt, J.P. Morgan Asset Management EM Equities EM Local USD S&P (US Equities) EM Local EUR EM Sov USD HY EM Corp USD HY EM Sov USD EM Sov USD IG EM Local Rates EM Local FX EM Corp USD US HY EM Corp USD IG US HG UST Intermediate Commodities 11.45% 6.50% 5.53% 5.03% 4.09% 3.87% 3.87% 3.66% 3.23% 3.17% 2.97% EM debt sectors 2.59% 2.39% Non-EM debt sectors 1.25% 0.54% -2.33% -4% -2% 0% 2% 4% 6% 8% 10% 12% 14% Derek Traynor, CFA Client Portfolio Manager, Emerging Market Debt, J.P. Morgan Asset Management Source: Bloomberg, J.P. Morgan Asset Management. Indices do not include fees or operating expenses and are not available for actual investment. Past performance is not an indication of future performance; EM= Emerging Markets, DM= Developed Markets; IG: Investment Grade; HY: High Yield; UST: US Treasury, EM Hard Currency Sovereign- JP Morgan EMBI Global Diversified, EM Local- JP Morgan GBI EM Global Diversified, FX- Foreign Exchange, US High Yield- JP Morgan Domestic High Yield, US HG- JP Morgan JULIR ex-em. Commodities- Bloomberg Commodities Total Return, EM Equities- MSCI- EM.

2 REFLATION REMAINS THE DOMINANT THEME We entered the year optimistic about the global economy s growth prospects and the potential for cyclical assets to outperform in what we dubbed the start of the reflation era in our Q EMD Outlook - Entering the Reflation Era. With the second quarter now upon us, it seems this stance has largely been vindicated. Cyclical and pro-growth assets including EM local currency debt and the high-yield segments of EM credit have led the way, registering strong single-digit returns. Performance has been driven by more than sentiment alone. EM fundamental data has exhibited positive momentum and provided the solid base from which assets could perform: growth is recovering, inflation decelerating, current accounts strengthening and fiscal deficits narrowing. By our estimates, EM real GDP growth increased to 4.4% in the fourth quarter 2016 (Exhibit 2), driven by recovery in Brazil and Russia and stabilisation in China. Hard economic data prints including industrial production, retail sales and export volumes all show strong readings, while aggregate EM purchasing managers indices (PMI) continue to trend upwards in expansionary territory (Exhibit 3). EM real GDP growth rose to 4.4% in Q (Q/Q SAAR %) EXHIBIT 2: EM DM GROWTH ALPHA VS. EM & DM REAL GDP GROWTH Q11 4Q12 4Q13 EM-DM "alpha" EM DM 4Q14 4Q15 4Q Aggregate EM PMIs continue to pursue their upward trajectory EXHIBIT 3: MARKIT MANUFACTURING PMI FOR EMERGING VS. DEVELOPED MARKETS Mar 14 Sep 14 Mar 15 Sep 15 Mar 16 Sep 16 Source: J.P. Morgan, Markit; data as of 31 March Although political and policy uncertainties persist, global growth is positively synchronised and we expect reflation to remain the dominant theme this quarter. While US growth stuttered over the fourth quarter of 2016, activity surveys have since surged and point to a stronger recovery for the US economy beyond the first quarter. Against this stronger growth backdrop, we now expect EM developed market (DM) growth alpha to stabilise, with a growth differential of 2.5%. While we await concrete policy proposals from the Trump administration, we expect fiscal policy to inject substantial growth impetus into the US economy over the medium term. Assuming all else is equal with respect to protectionism and trade policy, EM economies stand to benefit from the inevitable increase in US import demand. Trump s proposed USD 1 trillion infrastructure programme has obvious supportive implications for EM commodities exporters, principally those in Latin America and EMEA. EM DM Source: J.P. Morgan Asset Management; data as of 31 March SAAR - Seasonally-adjusted annualised return. 2 EMERGING MARKET DEBT OUTLOOK

3 EMERGING MARKETS ARE WELL POSITIONED TO ADJUST TO THE REFLATIONARY BACKDROP As expected, the Fed followed December s rate hike with a further increase of 25 basis points (bps) in March. However, the move was widely interpreted as dovish, with no sign of a pick-up in the pace of tightening and no change in the growth and inflation outlook. We expect the overall path of rate normalisation to remain gradual and well-telegraphed. Assuming the Fed does not fall behind the curve as it did in 1994, EM economies are well placed to absorb higher US rates. Fed tightening comes in the context of stronger domestic US and EM growth conditions, and with EM economies in a substantially better fundamental position vs s taper tantrum episode. At the corporate level, the fundamental picture is encouraging, with stabilising leverage and better earnings. At the sovereign level, current accounts across emerging markets have adjusted considerably since their 2013 deficit lows, registering consecutive annual improvements in the subsequent years. Fiscal balances have also shown marked signs of improvement, with some good positive momentum for economies such as Brazil, Russia and Colombia. Unlike in 1994, EM economies are considerably less reliant on external funding today and are no longer suffering from the inability to borrow in local currency (the original sin problem). LOOKING FOR OPPORTUNITIES IN DURATION? LOOK NO FURTHER THAN EMERGING MARKETS While global reflation is generally seen as a positive for credit and more cyclical assets, this benign view is not generally extended to its impact on duration. By definition, reflation usually implies not only stronger growth but also a return to trend inflation, and ultimately to higher rates a combination typically not so supportive of duration. We have already seen the impact of reflation on rates in the US and Germany, where bond yields repriced upwards on the back of signs of resurgent growth, inflation and Trump s policy proposals. However, in emerging markets there have been recent examples of economies that have experienced domestic crises of one form or another, but are now well advanced in their adjustment and at a fundamentally different stage of the monetary policy cycle. Brazil and Russia are two such examples. In these cases, a proactive policy response including higher interest rates and tighter fiscal policy served as the precursor to significant economic adjustment that paved the way for the respective central banks to embark on a credible easing cycle. With inflation sharply decelerating, the easing cycle at a relatively early stage and real policy rates close to historical highs (Exhibit 4), duration should remain supported here in the quarters to come. What about the currency risk? Easier monetary policy does not necessarily require you to hedge out the FX risk. In addition to the attractive real rates on offer, the extent of the adjustment that these economies have undergone has been considerable. Growth now shows signs of bottoming and external balances are stronger, while commodity prices have stabilised. Add to this the beneficial growth effects of global reflation, and the investment case for long exposures to these currencies becomes compelling. Global reflation need not be a challenge for all duration. Some EM policy rates now stand at historical highs EXHIBIT 4: SELECTED REAL EM & DM POLICY RATES Brazil Russia Colombia Germany US -4.0 Feb 13 Aug 13 Feb 14 Aug 14 Feb 15 Aug 15 Feb 16 Aug 16 Feb 17 Source: J.P. Morgan Asset Management, data as of 31 March CHINA: STABILISATION SCENARIO INCREASES ON THE BACK OF REFORM EFFORTS We have increased the probability of stabilisation in our China growth scenario for the next 12 months to 70% from 65% last quarter (Exhibit 5). We take a favourable view of the authorities progress on supply-side reforms s accelerated steel and coal capacity cuts exceeded targets and the authorities are expected to extend overcapacity shutdowns to other sectors this year (Exhibit 6). These capacity cuts are already starting to bear fruit, with tangible cyclical gains bringing renewed optimism. They have driven a producer price index (PPI) inflation recovery as iron ore and steel are important component inputs for many sectors, while coal is often used for power generation, steel production and cement manufacturing amongst others. J.P. MORGAN ASSET MANAGEMENT 3

4 Probability of stabilising growth in China is raised EXHIBIT 5: OUR CHINA SCENARIOS 12-MONTH SCENARIO Q2 PROBABILITY (Q1 PROBABILITY) CHINA GROWTH Rapid deterioration 20% (25%) 3-4% Soft landing 10% 4-5% Stabilisation 70% (65%) ~6-7% Acceleration 0% >7% Source: J.P. Morgan Asset Management. China s 2016 capacity cuts exceeded annual targets EXHIBIT 6: CAPACITY CUTS FOR IRON/STEEL & COAL IN Excess capacity NDRC planned capacity cuts in target Accomplished Iron and steel Coal Source: J.P. Morgan Asset Management, Deutsche Bank, European Union Chamber of Commerce in China, Morgan Stanley, MIIT Chinese Ministry of Industry and Information Technology, National Development and Reform Commission (NDRC); data as of March Chinese manufacturers are more confident in re-pricing their products higher and industrial profits have improved on the back of profit margin expansion, rebounding operating cash flow and inventory restocking. To give a sense of the gains, in December, industrial state-owned enterprises (SOEs) recorded their strongest growth in profit (+6.7% y/y) and revenue (+0.3% y/y) since 2012, while central SOEs saw January profits increase 24.5% y/y and revenues increase 8.7% y/y. The authorities also continue to use fiscal and infrastructure investment levers to stabilise growth, offsetting some of the dampening growth effects from an engineered real estate slowdown. However, more is required in terms of reforms. This growth stability now gives the authorities the scope to shift focus towards concerted corporate (mainly SOE) deleveraging and risk control. The financial system remains too dependent on the rapid response from the People s Bank of China the central bank in dealing with liquidity distress scenarios created by interlinked financial markets. While these risks still need to be resolved, the recent reform efforts have increased the probability of a growth stabilisation scenario. We believe that the conditions remain in place for this growth stability and reform progress to anchor EM growth more broadly in the coming quarters, while China s PMI should stay firm on the back of more resilient new domestic and export orders. EM SOVEREIGN AND CORPORATE TECHNICALS LOOK FAVOURABLE IN THE SECOND QUARTER Both the demand and supply sides of the technical equation look supportive for the second quarter, with some additional positive seasonal dynamics at play. EM sovereign net supply (ex-gulf states) for the full year is expected to be close to flat, with coupon and amortisation repayments heaviest in April (Exhibit 7). Similarly, for EM corporates, we expect full-year net issuance to be significantly lower than previous years, with April also standing out as the key month for repayments. Extending the window beyond this year, the picture on corporate repayments remains constructive: they are expected to remain elevated for the coming four years, with cash flows from amortisations and coupons set to exceed USD 250 billion annually. 4 EMERGING MARKET DEBT OUTLOOK

5 Favourable sovereign supply technicals, with heavy repayments due in April EXHIBIT 7: SOVEREIGN REPAYMENTS DUE IN 2017 USD Billions Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: J.P. Morgan Asset Management; data as of 31 March On the demand side of the equation, investor interest in EM debt has been robust year to date. The proprietary fund flows monitor developed by our Quantitative Research team captures over USD 11 billion of inflows into EM debt and USD 11 billion of inflows into EM equity funds and exchangetraded funds year to date as of March end. (Exhibit 8). Demand has remained strong despite the Fed s ongoing policy normalisation. The Institute of International Finance, for example, noted that in the week to 22 March, its measure of daily non-resident portfolio flows to emerging markets advanced sharply to levels last seen in September Flows have recovered since post-trump sell-off EXHIBIT 8: EM DEBT CROSS-SECTOR FUND FLOWS MONITOR (1-YR CUMULATIVE, USD M) 25,000 20,000 15,000 10,000 5,000 0 Mar 16 May 16 Jul 16 Sep 16 Nov 16 Jan 17 While this might seem remarkable in the context of a Fed tightening cycle, it simply reflects an emerging investor consensus (and our view for the past number of months) that reflation is a net positive for EM assets and EM economies are well placed to deal with gradual and well-telegraphed Fed policy normalisation. Assuming we avoid some of the risks described in the next section, we expect this positive demand dynamic to persist. RISKS: PROTECTIONISM, POLITICS AND POLICY ERRORS The risks we highlighted in our Q EMD Outlook Entering the Reflation Era are still relevant today, but are not necessarily specific to the second quarter. US protectionism is a real concern with most of the risks concentrated in the second half of the year. However, this is a topic that remains subject to a high degree of uncertainty and speculation. Amongst the variants of protectionism that we have identified, we attach higher probabilities to more benign developments such as US companies being offered incentives through lower corporation taxes and other sweeteners, or some form of non-tariff deal renegotiations. We attach a lower probability to less benign paths that involve greater risk and complexity, such as the imposition of new tariffs or a border adjustment tax (BAT), but we cannot rule them out. We take comfort from the fact that recent speeches and public comments by key US officials have been more conciliatory or have pushed back the timings of key policy decisions that could have implications for emerging markets. Beyond the US, political risks are largely focused on developed markets. While the Dutch elections passed without incident, the populist French candidate Marine Le Pen still has a chance (at the time of writing) of winning France s presidential election. Within emerging markets, Turkey and South Africa stand out as the largest political risks. The failed coup attempt in Turkey last July, and the resultant state of emergency, helped President Erdogan to consolidate power and push aggressively toward a presidential system change. Should Turkey s 16 April referendum return a yes vote, the constitution will be amended to establish a presidential system and grant the president further executive powers. There are concerns that this may push Turkey closer to illiberal democracy by weakening the country s institutions. Source: J.P. Morgan Asset Management Quantitative Research team; data as of 31 March J.P. MORGAN ASSET MANAGEMENT 5

6 In South Africa, both markets and the currency came under pressure late in the quarter after President Zuma sacked well-respected finance minister Pravin Gordhan. While this story was just unfolding at the end of the first quarter, it has the potential to unleash considerable volatility for South African assets and the currency over the coming weeks. The final notable risk remains with the Fed falling behind the curve in the event US growth and inflation evolve at a clip faster than that currently expected. The Fed s 1994 tightening cycle, which resulted in considerable EM underperformance, is often cited as a comparable event. However, such comparisons are tenuous. EM debt markets have matured considerably since the mid-1990s and are far less reliant on foreign currency debt. Furthermore, since 2013, emerging markets have adjusted considerably and are now in a fundamentally stronger position. Nevertheless, a Fed that is behind the curve, and the likely resultant moves in US yields and the dollar, will undoubtedly have serious implications for EM assets. The global reflation narrative remains our base case EXHIBIT 9: EMERGING MARKET DEBT ROADMAP Q OUR INVESTMENT STRATEGY AND ROADMAP Looking at our investment roadmap for the second quarter, not a huge amount has changed since the first quarter (Exhibit 9). The global reflation narrative remains our central scenario despite the turbulent start to Trump s presidency and lingering European political risks. While defeat on the US healthcare bill was undoubtedly a major setback for Trump, we still expect his administration to push ahead with deregulation, tax reform and large-scale infrastructure spending. Hard data in emerging markets over the fourth quarter of 2016 industrial production, retail sales and exports all provide evidence of nascent recovery, while survey data and leading indicators for both developed and emerging markets convey a strong sense of optimism. On the US monetary policy front, we expect the Fed to follow a path of well-telegraphed policy normalisation. Against a backdrop of growth and substantial EM external adjustment, we expect emerging markets to remain well positioned to absorb these higher Fed rates. The strength of demand for EM assets in the wake of March s Fed hike shows that this is Scenario Fade Base Case: Reflation Acceleration Themes Probability 20% 60% 20% Growth Global growth fails to lift off EM-DM alpha stabilises as global growth moves slightly higher DM or China accelerates Moderate reflation supportive for EM assets MACRO Inflation Financial conditions Policy Space Reflation falters Feedback loops (e.g. USD, volatility) push DM central banks to stay dovish Policy mistakes (e.g. protectionism) increase global uncertainty DM mild reflation EM differentiation Gradual tightening with Fed normalisation Differentiated EM policy cycle as Trump prioritises domestic policy in US EM inflation expectations increase Fed forced to move more aggressively US fiscal policy pushes growth faster, sooner Valuations advocate for carry over beta Alpha: Local EMD basket biased to LatAm and HY STRATEGY Commodities Weaker Supported Re-pricing higher Beta Alpha Long Buy duration and IG From credit to duration Rates IG long-end From beta to carry Basket of local EMD Idiosyncratics + short-end carry LatAm vs Asia Long inflation Short, wait for better reentry point Long USD/EM FX Pay rates Commodity producers Alpha: Idiosyncratics with positive event skew Risks: Feedback loops hit global growth + China, protectionism, aggressive reflation and tightening. Source: J.P. Morgan Asset Management; data as of 31 March The opinions and views expressed here are those held by the author at the date of publication which are subject to change and are not to be taken as or construed as investment advice. 6 EMERGING MARKET DEBT OUTLOOK

7 a view that resonates with investors. Risks are largely related to protectionism, politics and policy errors, although these are more concentrated in the second half of the year. China growth stabilisation supported by progress in supply-side reforms remains our base case, but mounting excess corporate leverage and other structural issues still need to be addressed. In terms of strategy, EM local currency debt (rates and foreign exchange (FX)) remains our preferred sector, with an overall bias towards Latin America and high yield. Both EM sovereign and corporate spreads have tightened considerably over the past year, and currently sit close to 300bps (as at 31 March). We generally find more value in EM local currency debt, favouring markets that continue to offer attractive real yields, such as Brazil (inflation linked), Russia, Mexico, Indonesia and Colombia. EM FX, on aggregate, remains undervalued according to our valuation models. More specifically within the EM FX complex, we favour fundamentally strong or improving stories, and those which are best placed to benefit from global reflation Indonesian rupiah, Brazilian real and Mexican peso are some examples funded tactically for now through cheap non-us dollar funding currencies. Given the risks posed by protectionism, we are more cautious on open economies and those more dependent on external funding. Overall, we have shifted our focus from market beta to carry this quarter, in the wake of solid first-quarter performance, tighter valuations and the little market premium attached to the risks we have identified. We place an emphasis on short-end names and those idiosyncratic stories that we identify as the most likely to unfold. BUILD STRONGER FIXED INCOME PORTFOLIOS WITH J.P. MORGAN We have built and evolved our fixed income capabilities with just one aim: to build stronger portfolios that solve clients needs. Today we are one of the top fixed income managers in the world. Diverse perspectives, integrated solutions: Access the power of a globally integrated team of investment professionals and our propriety research, encompassing fundamental, quantitative and technical analysis. Benefit from actionable insights designed to help you invest with conviction, from our regular macro and market views to our fixed income portfolio construction tools. Choose from a wide variety of outcome-orientated solutions designed to address all your fixed income needs. J.P. MORGAN ASSET MANAGEMENT 7

8 FOR INSTITUTIONAL/WHOLESALE/PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY NOT FOR RETAIL USE OR DISTRIBUTION NOT FOR RETAIL DISTRIBUTION: This communication has been prepared exclusively for institutional/wholesale/professional clients and qualified investors only as defined by local laws and regulations. The views contained herein are not to be taken as an advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yield may not be a reliable guide to future performance. J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority; in other EU jurisdictions by JPMorgan Asset Management (Europe) S.à r.l.; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited; in India by JPMorgan Asset Management India Private Limited; in Singapore by JPMorgan Asset Management (Singapore) Limited, or JPMorgan Asset Management Real Assets (Singapore) Pte Ltd; in Taiwan by JPMorgan Asset Management (Taiwan) Limited; in Japan by JPMorgan Asset Management (Japan) Limited which is a member of the Investment Trusts Association, Japan, the Japan Investment Advisers Association, Type II Financial Instruments Firms Association and the Japan Securities Dealers Association and is regulated by the Financial Services Agency (registration number Kanto Local Finance Bureau (Financial Instruments Firm) No. 330 ); in Australia to wholesale clients only as defined in section 761A and 761G of the Corporations Act 2001 (Cth) by JPMorgan Asset Management (Australia) Limited (ABN ) (AFSL ); in Brazil by Banco J.P. Morgan S.A.; in Canada by JPMorgan Asset Management (Canada) Inc., and in the United States by JPMorgan Distribution Services Inc. and J.P. Morgan Institutional Investments, Inc., both members of FINRA/SIPC.; and J.P. Morgan Investment Management Inc. Copyright 2016 JPMorgan Chase & Co. All rights reserved b e6-84fc c8a LV JPM /17