QUARTERLY FIXED INCOME AND CURRENCY REVIEW AND OUTLOOK

Transcription

1 FOR WHOLESALE CLIENTS ONLY. NOT TO BE DISTRIBUTED TO RETAIL CLIENTS. NOT TO BE REPRODUCED WITHOUT PRIOR WRITTEN APPROVAL. PLEASE REFER TO ALL RISK DISCLOSURES AT THE BACK OF THIS DOCUMENT. QUARTERLY FIXED INCOME AND CURRENCY REVIEW AND OUTLOOK JANUARY 2018

2 SUMMARY UK GOVERNMENT BONDS // 5 Andrew Wickham, Head of Global Rates and Deputy Head of Fixed Income (London) Gilt yields buck global rise Bank of England delivers first rate hike in a decade Brexit uncertainty keeps gilt yields near historic lows Gloomy growth and lower inflation in 2018 EUROPEAN GOVERNMENT BONDS // 6 Gareth Colesmith, Senior Portfolio Manager, European Fixed Income ECB normalising policy Core Europe yields modestly rose in Q4 Yields continue to trade within a range Political risk events have relatively muted effects US GOVERNMENT BONDS // 7 Isobel Lee, Head of Global Fixed Income Bonds Tax cuts boost growth sentiment and rate forecasts but fiscal deficit a concern New Federal Reserve chair Jerome Powell will take his position in February Tax cuts provide a boost to growth prospects We raise our forecast for the federal funds rate, expecting four interest rate hikes over the year GLOBAL INVESTMENT GRADE CREDIT // 8 Peter Bentley, Head of UK and Global Credit Navigating tight valuations Global growth and accommodative monetary policy supportive Tightest global credit spreads since financial crisis Valuations make for a trickier environment in 2018 US INVESTMENT GRADE CREDIT // 10 Jesse Fogarty, Senior Portfolio Manager Post-crisis tights Economic growth, strong earnings and low inflation supportive M&A appetite highlights idiosyncratic risks Caution warranted as valuations tighten

3 EMERGING MARKET DEBT // 11 Colm McDonagh, Head of Emerging Market Fixed Income Conditions remain supportive 2017 concluded with record levels of inflows into the asset class Improving fundamentals Strong investor demand SECURED LOANS // 13 Ranbir Singh Lakhpuri, Portfolio Manager, Secured Finance Issuer-friendly environment drives record volumes Technical backdrop remains strong amid high issuance volumes Pockets of weakness emerge in secondary prices Strong demand for asset class likely to remain HIGH YIELD // 14 Uli Gerhard, Senior Portfolio Manager, High Yield Low default rates and limited supply expected to support market High yield hit by a sharp sell-off in November, but markets quickly recovered Positive economic data should support earnings and keep default rates low Limited supply looks set to maintain technical support for the asset class ASSET-BACKED SECURITIES // 15 Shaheer Guirguis, Head of Secured Finance Asset-backed securities continue to offer strategic value Market driven by technical factors Technical backdrop remains highly supportive, with demand outstripping supply Asset-backed securities offer strategic value given fundamental credit quality and security CURRENCIES // 16 Paul Lambert, Head of Currency USD weakens despite US economic strength US dollar falls despite positive US economic data and rate hike Some growth-sensitive currencies supported by positive data Growth data and rate expectations likely to drive future markets

4 We expect the Bank of England to hike once more in 2018, taking the base rate to 0.75% ANDREW WICKHAM

5 UK GOVERNMENT BONDS GILT YIELDS BUCK GLOBAL RISE Andrew Wickham Head of Global Rates and Deputy Head of Fixed Income (London) Bank of England (BoE) delivers first rate hike in a decade Brexit uncertainty keeps gilt yields near historic lows Gloomy growth and lower inflation in 2018 In early November, the BoE hiked its policy rate by 25bp to 0.5% and signalled the start of a gradual increase in rates. BoE Governor Mark Carney stated two additional rate increases would be consistent with achieving the BoE s mandate over the forecastable horizon. Minutes from the Monetary Policy Committee meeting in December echoed this and stated further modest increases in interest rates are likely to be needed. Nominal inflation continued to rise in the UK during the period, with the consumer price index reaching 3.1% in November, the highest in nearly six years. Carney is now also required to write a letter to Chancellor Philip Hammond explaining how the central bank intends to bring inflation back to its 2% target. Other economic data releases were generally positive, with Q3 GDP beating expectations and rising to 0.4% while the average reading of the IHS Markit purchasing managers index (PMI) for manufacturing activity was 57.0 over Q4, the best since Q However, the Office for Budget Responsibility downgraded its estimate of productivity growth by 0.6% on average for the four years to With regard to Brexit, the UK and European Union reached an agreement on the first part of the Brexit process that will allow talks about a future trade pact to begin. Brexit uncertainty and the challenge the government faces still remain, however, including the question on the border between Ireland and Northern Ireland, which kept gilt yields near historical lows: 10-year and 30-year yields fell by 13bp and 11bp respectively over the fourth quarter. Looking ahead, Chancellor Hammond unveiled a subdued growth forecast of 1.4% for the UK economy in Meanwhile, the impact of sterling s devaluation is gradually fading and the BoE forecast that inflation will fall in coming months. As for monetary policy, the BoE has a tightening bias but is in no rush to raise rates, especially given that Brexit uncertainty remains, though it is somewhat reduced for now. We expect the BoE to hike once more in 2018, taking the base rate to 0.75%. The pricing of the gilt market reflects this, with gilt yields lagging the rising pace in the US and Europe. The UK s projected gilt issuance also recently increased by 59bn over the next five years. Figure 1: UK 10-year government bond yield Yield (%) Jan 17 Feb 17 Mar 17 Apr 17 May 17 Jun 17 Jul 17 Aug 17 Sep 17 Oct 17 Nov 17 Dec 17 UK 10-year government bond yield 1 Source: Bloomberg, as at 31 December

6 EUROPEAN GOVERNMENT BONDS ECB NORMALISING POLICY Gareth Colesmith Senior Portfolio Manager, European Fixed Income Core Europe yields modestly rose in Q4 Yields continue to trade within a range Political risk events have relatively muted effects Economic data continued to improve over the quarter. For example, eurozone unemployment hit its lowest level since January 2009, dropping to 8.8%, and the IHS Markit manufacturing PMI reached a 17-year high above 60. The European Central Bank (ECB) announced it would reduce its monthly asset purchases from 60bn to 30bn per month for nine months from January There was no commitment to setting an end date to the programme, despite calls from ECB Governing Council members such as Bundesbank President Jens Weidmann. Jozef Makúch, governor of the National Bank of Slovakia, also stated policy discussions are becoming tilted towards the evolution of policy rates. Political headlines continued to be a key theme. In Spain, the region of Catalonia held its controversial independence referendum. Amid a 40% voter turnout, 90% voted in favour of succession. In response, the central Spanish government suspended the region s autonomy and issued arrest warrants for Catalan leader Carles Puigdemont (who fled to Belgium) and four other politicians. Regional elections were held at the end of the quarter, and three pro-independence parties narrowly retained a surprise majority amid a record voter turnout of 82%. However, the path to forming a government remained difficult. Spanish sovereign spreads generally narrowed by between 5bp and 12bp across the curve. Markets also nervously eyed political developments in Italy, where a new electoral law known as Rosatellum was approved and a general election was confirmed for March Italian spreads also narrowed by 5bp to 12bp. In Germany, coalition talks between the Christian Democratic Union (CDU) and Christian Social Union (CSU), Free Democratic Party and Green Party collapsed largely due to disagreements over immigration policy. Subsequently, the CDU and CSU entered discussions with the Social Democratic Party about resuming the grand coalition. Looking ahead, given the strength of economic data in Europe and the reduction of technical support from the ECB, government bond yields will likely face upwards pressure. This may be exacerbated should the ECB officially call an end to its asset purchases this year. The possibility of a rate hike by year-end could add a further negative impulse. A short duration position could therefore be desirable. In peripheral Europe, markets will focus on the upcoming Italian election where the populist Five Star movement will likely be the largest party and may (if it is willing) have the chance to govern as part of a coalition. Concerns regarding Catalonia will remain in the background but are less likely to be a major focus for markets. Figure 2: European real GDP and economic confidence Index level % Dec 04 Dec 06 Dec 08 Dec 10 Dec 12 Dec 14 Dec ECB bank lending survey, demand for loans for fixed investment (LHS) Investment (from GDP) % year-on-year (RHS) 2 Source: Bloomberg, as at 30 September

7 US GOVERNMENT BONDS TAX CUTS BOOST GROWTH SENTIMENT AND RATE FORECASTS BUT FISCAL DEFICIT A CONCERN Isobel Lee Head of Global Fixed Income Bonds New Federal Reserve (Fed) chair Jerome Powell will take his position in February Tax cuts provide a boost to growth prospects We raise our forecast for the federal funds rate, expecting four interest rate hikes over the year The US yield curve flattened over the quarter, as yields of shorter-maturity bonds rose but 30-year yields fell. The Fed raised interest rates by 25bp as expected in December, taking its target range to 1.25%-1.50%. Minutes from the Federal Open Market Committee meeting stated that a couple of members expressed concern about whether inflation would return to 2 percent on a sustained basis in the medium term. On the other side of the argument, the minutes also noted that a couple of participants expressed concern that the persistence of highly accommodative financial conditions could, over time, pose risks to financial stability. The economy continues to perform well, nonfarm payrolls data for November showed a gain of 228,000 and the unemployment rate remained at 4.1%, an 18-year low. At the end of 2017 the Senate approved the final version of President Trump s tax bill, the most significant reform to the US tax system for decades. This reduces the corporate tax rate from 35% to 21% and simplifies individual taxes, lowering tax rates for most income brackets. A number of major US companies reacted to the news by announcing special employee bonuses. This has caused a number of forecasters to increase their expectations for growth in both 2018 and The stronger domestic outlook, combined with a broad-based global upswing, should underpin a continued normalisation of US interest rates through the year. Financial conditions have actually eased in the US due to significant equity market gains, with the Goldman Sachs Financial Conditions Index now showing the easiest conditions since As a result, and assuming that financial conditions don t unexpectedly tighten as a result of equity market weakness or a larger-than-expected rise in longermaturity bond yields, we now expect the Fed to raise rates four times in 2018, most likely once per quarter. Jerome Powell will take over as Fed chair in February and is likely to reiterate the message of gradual normalisation in interest rates and a reduction in the Fed s balance sheet. The more robust economic outlook means that the unemployment rate is likely to continue to decline and to fall below 4%. This would support a higher terminal rate for the federal funds rate and raises the risk that the economy will require a faster policy response. One further result of the tax reform is the effect on the fiscal deficit, which is now expected to rise to 3% to 3.5% of GDP in 2018 and 4% to 4.5% of GDP in This should weigh on longer maturities over time and temper any further yield-curve flattening. Figure 3: US yield curve flattened over the quarter Yield % US treasuries tenor (years) 30 September December Source: Bloomberg, as at 31 December

8 GLOBAL INVESTMENT GRADE CREDIT NAVIGATING TIGHT VALUATIONS Peter Bentley Head of UK and Global Credit Global growth and accommodative monetary policy supportive Tightest global credit spreads since financial crisis Valuations make for a trickier environment in 2018 Global investment grade credit markets performed over the final quarter of 2017 in much the same fashion they had throughout the year. Amid low risk market volatility, global credit spreads reached their tightest levels since the global financial crisis (see Figure 4). The continuing synchronised global growth upswing and benign inflation backdrop continued to support the market. Gradual efforts to normalise central bank policy left markets unfazed. A key announcement came from the ECB, which said it would taper its monthly purchases from 60bn to 30bn beginning in 2018, but the impact on credit was softened when ECB President Mario Draghi stated the bank will continue buying sizeable quantities of corporate bonds. In the US, the Fed began slowly reducing its balance sheet, and as was widely anticipated, hiked policy rates in December. The credit rally paused briefly in November, partly driven by negative idiosyncratic earnings results from high yield names. These included UK chicken supplier Boparan, brick-and-mortar retailers such as New Look and the Italian construction company Astaldi. Global M&A activity in the US was also a reminder that idiosyncratic risks remain a theme. However, credit spreads went on to steadily tighten into year-end, with the passage of the US tax reform bill in Congress acting as a further global tailwind. Looking ahead, market fundamentals look strong. Default rates will likely be around record lows and the global growth picture will likely be positive for corporate earnings. Furthermore, the potential for rising government bond yields is unlikely to threaten credit markets as long as moves remain orderly and contained. But 2018 will likely be a trickier year for credit investors than With valuations at material tights, the risks of a market correction could be asymmetric, particularly in an environment in which technical support from central banks will reduce at an accelerating rate. Stock and sector selection and the ability to hedge credit risk exposure could be key drivers of returns. Figure 4: Global credit spreads hit post crisis lows Credit spread (bp) Dec 97 Dec 99 Dec 01 Dec 03 Dec 05 Dec 07 Dec 09 Dec 11 Dec 13 Dec 15 Dec 17 Spreads as measured by the ICE BofAML Global Corporate Index Current level 4 Source: Bloomberg, as at 31 December

9 2018 will likely be a trickier year for credit investors than 2017 PETER BENTLEY

10 US INVESTMENT GRADE CREDIT POST-CRISIS TIGHTS Jesse Fogarty Senior Portfolio Manager Economic growth, strong earnings and low inflation supportive M&A appetite highlights idiosyncratic risks Caution warranted as valuations tighten The US dollar (USD) credit market started the final quarter of 2017 on a strong note on the back of continued Goldilocks conditions of encouraging global growth, a continued benign inflation environment and an overall accommodative monetary policy environment. An earnings-blackout period early in the quarter made for a relatively quiet primary market which helped USD credit markets initially outperform their peers on an excess-return basis. However, in November, issuance in the USD credit market stepped up, providing modest technical pressure on credit spreads. This heightened as M&A news flow led to renewed concerns about idiosyncratic risks. In a single week Sprint and T-Mobile ended their merger discussions, Broadcom bid to take over Qualcomm, AT&T faced antitrust scrutiny over its takeover of Time Warner and Disney entered talks to acquire assets from Twentieth Century Fox. Idiosyncratic concerns in high yield markets also contributed to some market weakness. USD credit notably underperformed euro and sterling credit during this period. In the run-up to the end-of-year holiday period, the US market recovered from this blip. As is typically the case, levels of primary market activity were muted over the holiday period. Markets went back to focusing on economic optimism, particularly as the Trump administration successfully passed the Tax Cuts and Jobs Act, which reduces the corporate tax rate from 35% to 21%, effective 1 January The package is estimated to cost $1.5trn over 10 years and is the most significant US tax reform since the Reagan administration. By the end of the period, USD credit markets tightened to the lowest levels since The immediate outlook looks positive. We expect credit to benefit from record-low default rates in 2018, continued improvement in the global growth picture, a tailwind from the change in corporate tax policy and continued improvements in earnings. At present, credit risk overweights in the market, though significant, do not appear to indicate an overstretched market. A small long position in credit risk overall therefore looks warranted. However, investors need to be cautious given historically tight valuations. Stock and sector selection will be key to delivering outperformance. Figure 5: USD investment grade credit spreads Credit spreads (bp) Dec 97 Dec 99 Dec 01 Dec 03 Dec 05 Dec 07 Dec 09 Dec 11 Dec 13 Dec 15 Dec 17 Spreads as measured by the ICE BofAML US Corporate Index Current level 5 Source: Bloomberg, as at 31 December

11 EMERGING MARKET DEBT CONDITIONS REMAIN SUPPORTIVE Colm McDonagh Head of Emerging Market Fixed Income 2017 concluded with record levels of inflows into the asset class Improving fundamentals Strong investor demand Emerging market debt (EMD) enjoyed a strong finish to the year, with each of the three sub-sectors of the asset class delivering positive returns for the fourth quarter. Like much of 2017, this quarter was something of a Goldilocks environment for EMD: the global economy has entered a sustained and synchronised cyclical upswing, emerging market sovereign and corporate fundamentals continue to see improvement, global inflationary conditions remain largely benign, and the USD spent much of the year in decline. Against this backdrop developed market central banks remained accommodative, and have only tentatively approached the process of policy normalisation in a manner that is both gradual and well-telegraphed. Meanwhile, key emerging market central banks retained scope to ease policy throughout the year. While scope for further emerging market central bank easing into 2018 is limited, the likelihood of broad-based hiking cycles remains a relatively distant prospect. The combination of emerging market monetary policy easing and USD weakness has been particularly supportive of emerging market local currency debt assets, which outperformed. Demand technicals ended the year in robust fashion, with total flows into emerging market fixed income reaching a recordbreaking high of US$112.8bn (see Figure 6), surpassing the previous record of US$103.1bn set in Longer-term strategic inflows from institutional investors, who largely remain underallocated to EMD, were a significant source of this demand. Inflows from this segment of the investor base reached US$33.8bn also a record high. As emerging market fundamentals continue to improve and the percentage of plans with an allocation to EMD increases, we should see these demand dynamics persist. Records were also set on the supply side of the technicals equation. Gross emerging market sovereign issuance came in at US$174.5bn, while gross emerging market corporate issuance reached US$481bn. Despite such strong gross issuance, the technical backdrop remained very supportive. Net issuance which offsets the gross number with amortisations and buybacks was significantly below these record levels. This, combined with strong investor demand, ensured the supply was easily absorbed. Despite rich valuations, we remain constructive on EMD into 2018 given the ongoing improvement in emerging market macro fundamentals and strong levels of investor demand. Risks to the outlook are predominantly exogenous in nature and include the potential for a higher-than-expected repricing of US treasuries should growth and inflation quicken, and a stronger USD as the Fed hikes and tax reforms entice the repatriation of offshore US corporate cash balances. That being said, some risks are more country-specific. It is a very active political calendar in emerging markets with, for example, elections in Brazil and Mexico being two events that warrant closer monitoring given the potential for destabilising outcomes. Figure 6: Net EMD flows in 2017 (cumulative) Previous record of $103.1bn (2012) Full year inflows: $112.8bn $bn Dec 16 Mar 17 Jun 17 Sep 17 Dec 17 Cumulative net flows into EMD 6 Source: JPMorgan, as at 31 December

12 We expect strong demand, robust liquidity and positive issuance conditions to remain for the loan market RANBIR SINGH LAKHPURI

13 SECURED LOANS ISSUER-FRIENDLY ENVIRONMENT DRIVES RECORD VOLUMES Ranbir Singh Lakhpuri Portfolio Manager, Secured Finance Technical backdrop remains strong amid high issuance volumes Pockets of weakness emerge in secondary prices Strong demand for asset class likely to remain At the start of Q4, the European loan market continued its strong performance with spreads grinding tighter and issuance climbing higher. Opportunistic refinancing and repricing dominated issuance in October after the rush in September, providing 10.6bn out of a total volume of 11.3bn. M&A-related issuance was limited after a busy September. Low default rates and favourable credit conditions continued to support demand and any new money supply was easily absorbed by investors, while secondary prices held firm. The evolution of loan documentation, particularly with regard to the reduction of maintenance covenants, remained topical for investors. There are concerns that the current one-size-fits-all approach to covenants in loan documentation is not actually a good fit for all credits, but we have yet to see how this will play out through the cycle. Issuance levels remained elevated throughout the period with 16.2bn coming through in November alone, the second-busiest month of the year (following 17.6bn issued in March). This tipped 2017 European leveraged loan issuance to 120.4bn, the highest level recorded since 2007 s 165.5bn. Activity during the month was driven by a mix of both borrowers rushing to reprice loans as well as M&A financing. The technical backdrop remained strong and as such this high level of issuance was easily absorbed by investors. However, in the secondary market in November and December, the sheer volume of primary issuance began to take its toll on prices, revealing pockets of weakness with specific loans trading down. Looking ahead in 2018, expected tapering of the ECB s quantitative easing programme may impact demand across corporate credit overall, while potential rate rises may drive demand towards floating rate products. However, we expect strong demand, robust liquidity and positive issuance conditions to remain, presenting a favourable backdrop for the loan market. Figure 7: Loan spreads bp Dec 99 Dec 01 Dec 03 Dec 05 Dec 07 Dec 09 Dec 11 Dec 13 Dec 15 Dec 17 Spread of Credit Suisse Western European Institutional Leveraged Loan Index (5-year discount margin) 7 Source: Bloomberg, as at 31 December

14 HIGH YIELD LOW DEFAULT RATES AND LIMITED SUPPLY EXPECTED TO SUPPORT MARKET Uli Gerhard Senior Portfolio Manager, High Yield High yield hit by a sharp sell-off in November, but markets quickly recovered Positive economic data should support earnings and keep default rates low Limited supply looks set to maintain technical support for the asset class A supportive economic environment and limited supply continued to be positive for the high yield markets. Continued strong performance earlier in the quarter was followed by a sharp sell-off in November, primarily driven by exchange-traded fund flows in the US, but markets broadly recovered. Low government bond yields continued to drive a persistent search for yield by investors, with sustained demand from investment grade investors for lower-rated securities. Defaults continued to run at low levels, supported by the stable macroeconomic backdrop and solid capital markets. Over the fourth quarter there were 12 defaults in the US and none in Europe. We continue to expect growth in the US and Europe to be strong enough to support earnings momentum in 2018, keeping defaults in check. European credit fundamentals remain solid, helped by an improving economy and decent earnings growth. Despite the significant overall tightening in yields and credit spreads, we believe the high yield sector still looks relatively attractive from an income perspective even in a rising-rate environment. The technical picture also remains supportive. Fund flows were negative in 2017 but this has been offset by strong coupon income, and falling supply as a result of rising stars and the refinancing of bonds into loans. In Europe, we expect the ratings upgrades of Telecom Italia and Tesco to shrink the European high yield market by c.10%, further supporting underlying valuations. We do not expect European interest rates to move significantly higher during 2018 and expect this to happen sometime in We anticipate some short-term market weakness, largely due to political concerns over Catalan independence, the Italian elections and Brexit. However, a less favourable supply/demand outlook could present some buying opportunities. Therefore, we continue to look for opportunities, particularly in the US, UK and emerging markets. With idiosyncratic risks growing, we expect bottom-up credit analysis to be even more important in Figure 8: High yield spreads remained tight despite a mid-quarter wobble Credit spreads (bp) Jun 13 Dec 13 Jun 14 Dec 14 Jun 15 Dec 15 Jun 16 Jun 16 Jun 17 Dec 17 US high yield spreads, as measured by the BofA Merrill Lynch US High Yield Master II Index European high yield spreads, as measured by the BofA Merrill Lynch Euro High Yield Index 8 Source: Bloomberg, as at 31 December

15 ASSET-BACKED SECURITIES ASSET-BACKED SECURITIES CONTINUE TO OFFER STRATEGIC VALUE Shaheer Guirguis Head of Secured Finance Market driven by technical factors Technical backdrop remains highly supportive, with demand outstripping supply Asset-backed securities (ABS) offer strategic value given fundamental credit quality and security The year ended on a positive footing for ABS markets. European ABS, unperturbed by the ECB s tapering announcement, continued to rally through October and November, with more subdued performance in December owing to thinning liquidity. The technical backdrop remained highly supportive throughout, owing to a continuation of tight supply conditions and robust investor demand. This positive dynamic helped immunise the asset class against the occasional bouts of volatility experienced by the broader credit market. Indeed, volatility in ABS markets continued to hover at subdued levels according to most measures. Issuance in Europe was largely dominated by the usual offering of prime residential mortgage-backed securities, reset/ refinancing collateralised loan obligations and autos. That being said, November also saw some Irish non-performing loans issuance a market that looks particularly attractive given recovering economic conditions, rising house prices and robust transaction structures as well as the first UK commercial mortgage-backed securities transaction since US structured credit continued to perform well throughout the period, led by higher-beta segments of the market. The market received a boost in December following the passing into law of the US Tax Cuts and Jobs Act, which among other headline-grabbing measures includes a cut in US federal corporation tax from 35% to 21% from the start of A combination of the tax reform legislation and the ongoing improvement in US economic data meant the well-anticipated US rate hike in December had minimal impact on markets. Into 2018, it remains to be seen how strengthening labour market conditions and lower corporation tax rates will influence the Fed s thinking and how investors will react should the Fed pursue a more hawkish path. Looking at more specific sectors, auto ABS performed well in October, setting new post-crisis tights, while student loan ABS and the unsecured consumer market also saw further tightening as investors continued to search for short-dated investment grade exposure with yield pick-up. The market has mostly been driven by technical factors, with demand outstripping supply. However, we continue to believe that ABS markets offer compelling strategic value given the fundamental credit quality and security of the assets. Figure 9: ABS spreads versus Libor Spread (bp) Mar 16 Jun 16 Sep 16 Dec 16 Mar 17 Jun 16 Sep 17 Dec 17 UK RMBS AA GBP FL 5 Yr CMBS Snr Euro FL European EUR Autos Snr FL EURO CLO AAA 5-6yL 9 Source: JP Morgan, as at 12 January

16 CURRENCIES USD WEAKENS DESPITE US ECONOMIC STRENGTH Paul Lambert Head of Currency USD fell in Q4 despite positive US economic data and rate hike Some growth-sensitive currencies supported by positive data Growth data and rate expectations likely to drive future markets The USD began the final quarter of 2017 on a strong note it was the best-performing G10 currency in October, strengthening by 1.6% on a trade-weighted basis. Increasing optimism on tax reform during the month, due to the vital step of a budget resolution being agreed by both Houses of Congress, coupled with strong economic data, provided support for the currency. However, this was followed by a weaker November, when the USD fell by nearly 2% on a trade-weighted basis. This was despite relative interest rates moving in the USD s favour (markets ended November pricing a Fed rate hike in the following month), while the USD also failed to react to further progress on tax reform. Part of the USD weakness can be explained by President Trump s nomination of Jerome Powell for Fed chair early in the month Powell was seen as a continuity candidate and there was some relief that none of the more hawkish candidates were chosen. USD weakness continued in December, despite the Fed delivering the by-then widelyanticipated rate hike, resulting in a 1.5% drop in the currency over Q4 on a trade-weighted basis. In contrast, the euro (EUR) was driven by the eurozone economy s strong fundamentals and rose by 1.6% against the USD during the period, continuing the rally seen in the last few months. The EUR weakened in October after the market interpreted the ECB s quantitative easing tapering announcement as dovish, but reversed its path in November despite political uncertainty in Germany. Elsewhere, some global growth-sensitive currencies performed well in the positive growth environment. In emerging market currencies, the South African rand was the biggest gainer, rallying 9.5% versus the USD over the quarter. The majority of this gain came in December, following the election of Cyril Ramaphosa as the new president of South Africa s ruling African National Congress party. Looking ahead, the global growth outlook remains positive and this is likely to continue to be supportive for growth-sensitive currencies, including emerging market currencies. However, the strength of the US economy is resulting in rising rate expectations and this is periodically supporting the USD and offsetting the positive growth backdrop, which has resulted in choppy markets. We believe the growth dynamic should ultimately dominate, particularly if inflation in the US remains low and the Fed continues to tighten at a cautious pace. Figure 10: Weakening USD through Index level Mar 17 Jun 17 Sep 17 Dec 17 Trade-weighted US dollar index broad 10 Source: Federal Reserve, as at 27 December

17 Adrian Grey CIO ACTIVE MANAGEMENT Head of Fixed Income GLOBAL RATES GLOBAL CREDIT EUROPEAN CREDIT CREDIT ANALYSIS CREDIT EMD INFLATION LINKED MONEY MARKETS US FIXED INCOME RESPONSIBLE INVESTMENT HIGH YIELD CURRENCY IMPLEMENTATION AND OPERATIONS BANK LOANS TRADING PRODUCT SPECIALISTS SECURED FINANCE

18 IMPORTANT INFORMATION RISK DISCLOSURES Past performance is not indicative of future results. Investment in any strategy involves a risk of loss which may partly be due to exchange rate fluctuations. Portfolio holdings are subject to change, for information only and are not investment recommendations. ASSOCIATED INVESTMENT RISKS Fixed income A credit default swap (CDS) provides a measure of protection against defaults of debt issuers but there is no assurance their use will be effective or will have the desired result. The issuer of a debt security may not pay income or repay capital to the bondholder when due. Derivatives may be used to generate returns as well as to reduce costs and/or the overall risk of the portfolio. Using derivatives can involve a higher level of risk. A small movement in the price of an underlying investment may result in a disproportionately large movement in the price of the derivative investment. Investments in emerging markets can be less liquid and riskier than more developed markets and difficulties in accounting, dealing, settlement and custody may arise. Investments in bonds are affected by interest rates and inflation trends which may affect the value of the portfolio. Where high yield instruments are held, their low credit rating indicates a greater risk of default, which would affect the value of the portfolio. The investment manager may invest in instruments which can be difficult to sell when markets are stressed. Where leverage is used as part of the management of the portfolio through the use of swaps and other derivative instruments, this can increase the overall volatility. While leverage presents opportunities for increasing total returns, it has the effect of potentially increasing losses as well. Any event that adversely affects the value of an investment would be magnified to the extent that leverage is employed by the portfolio. Any losses would therefore be greater than if leverage were not employed.

19 FIND OUT MORE Insight Investment Level 2, 1-7 Bligh Street, Sydney NSW Bruce Murphy Director, Australia and New Zealand bruce.murphy@insightinvestment.com Rob Thompson Head of Adviser Distribution rob.thompson@insightinvestment.com This document is a financial promotion and is not investment advice. This document must not be used for the purpose of an offer or solicitation in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or otherwise not permitted. This document should not be duplicated, amended or forwarded to a third party without consent from Insight Investment. Insight does not provide tax or legal advice to its clients and all investors are strongly urged to seek professional advice regarding any potential strategy or investment. For a full list of applicable risks, and before investing, investors should refer to the Prospectus or other offering documents. Please go to Unless otherwise stated, the source of information and any views and opinions are those of Insight Investment. Telephone calls may be recorded. For clients and prospects of Insight Investment Management (Global) Limited: Issued by Insight Investment Management (Global) Limited. Registered in England and Wales. Registered office 160 Queen Victoria Street, London EC4V 4LA; registered number For clients and prospects of Insight Investment Funds Management Limited: Issued by Insight Investment Funds Management Limited. Registered in England and Wales. Registered office 160 Queen Victoria Street, London EC4V 4LA; registered number For clients and prospects of Insight Investment International Limited: Issued by Insight Investment International Limited. Registered in England and Wales. Registered office 160 Queen Victoria Street, London EC4V 4LA; registered number Insight Investment Management (Global) Limited, Insight Investment Funds Management Limited and Insight Investment International Limited are authorised and regulated by the Financial Conduct Authority in the UK. Insight Investment Management (Global) Limited and Insight Investment International Limited are authorised to operate across Europe in accordance with the provisions of the European passport under Directive 2004/39 on markets in financial instruments. For clients and prospects based in Singapore: This material is for Institutional Investors only. This documentation has not been registered as a prospectus with the Monetary Authority of Singapore. Accordingly, it and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of Shares may not be circulated or distributed, nor may Shares be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor pursuant to Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the SFA ) or (ii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. For clients and prospects based in Australia and New Zealand: This material is for wholesale investors only (as defined under the Corporations Act in Australia or under the Financial Markets Conduct Act in New Zealand) and is not intended for distribution to, nor should it be relied upon by, retail investors. Both Insight Investment Management (Global) Limited and Insight Investment International Limited are exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 in respect of the financial services; and both are authorised and regulated by the Financial Conduct Authority (FCA) under UK laws, which differ from Australian laws. If this document is used or distributed in Australia, it is issued by Insight Investment Australia Pty Ltd (ABN , AFS license number ) located at Level 2, 1-7 Bligh Street, Sydney, NSW Insight Investment. All rights reserved

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