Bond letter (2014.12.01 en ww)

Monthly Bond Letter
December 2014
Pictet Asset Management

MONTHLY BOND LETTER | DECEMBER 2014 | 01/12/2014 | 2
CONTENTS
Overview 3
Inflation-linked bonds 5
Credit risk 7
Emerging debt 11
USA 13
Eurozone 15
UK 17
Switzerland 19
Japan 21

OVERVIEW
Recent developments
Slowing economies in China,
Japan, Europe, Brazil and
Russia, coupled with
mounting geopolitical
tensions, unsettling markets
Investors, though reassured
about the health of the US
economy in Q3, are concerned
that adverse influences from
elsewhere will spill over into
America. These anxieties,
compounded by the
widespread deceleration in
inflation and the prospect of
monetary policies staying
accommodating, have
underpinned bonds. Yields on
long bonds drifted down
again, sinking to new lows in
Europe, and the yield curve
flattened out even further.
US GDP expanded by 3.9% in
Q3 2014, and US economic
fundamentals remain sound.
Inflation was steady at a low
1.7%. This mild rate remains a
cause of some disquiet for the
US Federal Reserve which, in
spite of the uneasy state of
financial markets, wound up
its programme of monthly
asset purchases.
Eurozone economy still
struggling, with Commission
forecasts making grimmer
reading than in the spring
According to the European
Commission, the eurozone is
going to take longer to
extricate itself from the
economic quagmire. In order
to give it a push in the right
direction, the Commission has
devised a far-reaching
investment package to kick-start
3 | MONTHLY BOND LETTER | DECEMBER 2014
growth and jobs. It is
now forecasting GDP growth
of 0.8% for this year, followed
by 1.1% in 2015. Individual
eurozone economies are still
experiencing somewhat mixed
fortunes, but the Big Three
(Germany, France and Italy)
do seem to be limping along.
As for inflation, the
Commission is projecting
annual rates averaging 0.5%
for 2014 and 0.8% in 2015.
ECB stirring into action and
aiming to expand its balance
sheet to its 2012 dimensions
As expected, the ECB made no
change to interest rates in
November. Its main
refinancing rate remains
pegged at 0.05%, its marginal
rate at 0.30% and its deposit
rate at -0.20%. During his
press conference, ECB
President Mario Draghi was at
pains to stress the Governing
Council was unanimous in
being prepared to press ahead
further if required. He also
clarified the ECB’s target for
the balance sheet: it is aiming
to expand it by EUR1,000bn.
To achieve that, the ECB will
probably have to push
through fresh accommodating
monetary-policy measures.
Buying up sovereign bonds
remains one such possibility.
The impact of the consumer
sales tax hike still being felt in
Japan, pushing the economy
back into recession
The consensus had been
looking for growth of 2.2% in
Japan in Q2 of its 2014/15
fiscal year whereas its
economy actually contracted
at an annualised rate of 1.6%.
This dismal showing
prompted Prime Minister
Shinzō Abe to postpone the
second hike in the consumer
sales tax and to call a snap
election halfway through his
term of office.
Credit-risk market rebounded in
reaction to ECB statements
Boosted by announcements
made by the ECB, European
corporates were lifted by a
combination of the decline in
benchmark government bond
rates and a narrowing of
credit spreads. They notched
up gains for November.
Ratings-wise, investors tended
to favour superior-grade
corporates, but high-yield
bonds fared strongly as well,
as investors scoured the
markets for yield.
RETURNS – NOVEMBER 2014 10-YEAR GOV'T. BOND YIELDS
% MTD Bonds in $ Bonds in euro
0.6
0.3
0.5
-0.6
0.1
-0.4
2.7
1.3
0.5 0.6
1.0
2.8
3
3
2
2
1
1
0
-1
-1
Govt Inflation
linked
IG HY EMD$ EMD LC Equities
Source: Bloomberg, Barclays, Citigroup, JP Morgan, perf in local currencies
% USA Germany UK Switzerland Japan
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, 10 Yr Govt yields

160
140
120
100
80
60
40
20
Oil WTI (l.s.) Commodities CRB Index (r.s.)
MONTHLY BOND LETTER | DECEMBER 2014 | 4
FORECASTS
Forecasts
The Fed turns QE liquidity
taps off, but soothed market
concerns about the first hike
in the Fed funds rate
Minutes of the last Federal
Open Market Committee
(FOMC) meeting revealed Fed
concerns about the lacklustre
state of economies in China,
Japan and Europe, aggravated
by geopolitical tensions. They
also noted though the solid
anchoring of the US recovery
which continues rebuilding its
strength. FOMC members also
debated the relevant wording
to describe the direction of the
Fed’s monetary policy,
eventually opting to persevere
with the guidance that its
benchmark rates would stay
close to zero for some
“considerable” time. The Fed is
still worried about hiking
rates too early and made it
quite plain the initial hike
would remain contingent on
positive trends being set by
economic data.
Fears about a triple-dip
recession and deflation set to
continue haunting Europe
No growth and even a relapse
yet again into recession could
well reignite concerns over the
state of public finances.
Governments are still battling
with the dilemma of finding it
extremely hard to push
through requisite reforms.
Against this troubled
backdrop, the ECB aims to
pump the size of its balance
sheet back up to 2012
dimensions.
Bank of England also steering
a circumspect course
Although the UK economy is
faring comparatively better
than those of its European
neighbours, GDP growth is
still expected to slacken in
tempo in the run-up to the
year-end, with inflation
possibly slowing to 1%. The
Bank of England (BoE) should,
therefore, retain the status
quo, biding its time for further
evidence that spare capacity is
being mopped up.
Reforms in Japan have still
not seen the light of day, and
an early election may well
muddy the waters
PM Shinzō Abe, keen to take
advantage of personal
popularity ratings that have
not been dented too much,
decided to dissolve the Lower
House of Japan’s Diet to
bolster his political clout to
allow him free rein to push
through his dynamic and
reforming economic policy
agenda as well as to distance
himself somewhat from the
pacifism that has been the
hallmark of Japan’s politics
since World War II. Japan will
go to the polls in an early
general election on 14
December to re-elect 480
members of the Diet. Shinzō
Abe declared that, if the
ruling coalition failed to retain
its majority after the election,
this would mean the Japanese
electorate had rejected the
reflationary reformist policy
package, commonly referred
to as ‘Abenomics’, and that he
would step down.
Against this backdrop of
economic uncertainty
worldwide, subdued inflation
and accommodating monetary
policy, leading bond markets
are likely to hold fairly steady
over the next few weeks.
Upside may be limited, but
European corporates will be
supported by an activist ECB
European corporate bond
markets should continue to be
assisted by investors’ quest for
yield, but the choice of
borrowers will be crucial,
influenced by how companies’
fundamentals are developing
or possible M&A activity. The
state of limbo on the
regulatory front offers a good
reason to err on the side of
caution as regards financials
considering current pricing
levels. The default rate should
stay low, lending support to
high-yield corporates.
GDP COMMODITIES
15
10
5
0
-5
-10
USA EU UK SZ Japan China
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, GDP YoY
600
500
400
300
200
100
0
0
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Commodities

INFLATION-LINKED BONDS
The ECB continuing with its softly-softly approach
Eurozone: economic outlook degraded again, and
a more contingent monetary policy on the cards
On 4 November, the European Commission
published its Autumn 2014 economic
projections. The title of the accompanying press
release – “Slow recovery with very low inflation” –
tells the whole story about the sluggishness of
the economy and is in stark contrast to the more
upbeat strap-line of “Growth becoming broader-based”
for its Spring 2014 forecasts. Its projections
for economic growth and inflation were
unmistakably downgraded: GDP from +1.2% to
+0.8% for 2014 and from +1.7% to +1.1% for 2015;
inflation from 0.8% to 0.5% for 2014 and from
1.2% to 0.8% for 2015.
At its monetary-policy session on 6 November,
the ECB Governing Council, although deciding
not to take any further initiatives, did sketch out
more clearly its likely future interventions. The
somewhat controversial target for increasing the
size of its balance sheet by EUR1,000bn was
confirmed, and featured in black and white in
the official press release, with the key
clarification that it was “signed by the whole
Governing Council unanimously”. Moreover,
Mario Draghi reiterated the ECB’s readiness to
strengthen its accommodating monetary policies
subject to a couple of contingencies:
• if long-term inflationary expectations were to
worsen;
• if measures already in place were not enough
to enable the target for balance-sheet
expansion to be met.
Moreover, in a keynote speech at the Frankfurt
European Banking Congress on 21 November,
Mario Draghi sounded a note of urgency being
added to the battle to reverse the softening of
inflationary expectations: “We will do what we
must to raise inflation and inflation expectations as
fast as possible, as our price stability mandate
requires of us. If, on its current trajectory, our policy
is not effective enough to achieve this, or further risks
to the inflation outlook materialise, we would step up
the pressure and broaden even more the channels
through which we intervene, by altering accordingly
the size, pace and composition of our purchases”.
ECB: corporate bonds issued by
non-financial borrowers likely to be added
to the shopping-list as from December
The next ECB Governing Council meeting will
undertake its quarterly review of the central
bank’s own economic forecasts. On the basis of
the Commission’s recent downgrades, it can be
taken for granted the ECB’s projections will
follow suit. Its most recent forecast for inflation
in 2016 was for a rate of 1.4%. It will be hard for
the ECB to lower that. If it did, it would merely
fuel market expectations about the deflationary
threat. The only way to cushion the blow and
counterbalance the negative macroeconomic
dynamics would be to announce a series of fresh
accommodating initiatives.
Recent comments from Mario Draghi, combined
with the ongoing heated debate about the
legitimacy and legality of any quantitative-easing
programme encompassing sovereign
debt, demonstrate clearly that the ECB is likely
to activate an extra purchasing drive from
December, this time for corporate bonds issued
by non-financial borrowers. After the credit
channel, then the exchange-rate channel, the ECB
is now turning its focus to the portfolio-allocation
channel. Will this be enough to do the
trick though?
Assuming the ECB confines its buying to
securities already deemed acceptable as
collateral security for repo transactions, the scale
of the underlying market would work out at
around EUR500bn. To counter any serious price
distortions, the ECB would only be able to buy
10%-30% of that over the next couple of years,
i.e. around EUR50-150bn worth. That would
indeed be yet one more step in the right
direction, but not a big enough one for the ECB
to hit its target for balance-sheet expansion.
Expectations for inflation do not, therefore, look
likely to get that much-hoped-for hardening
impetus, and the market will continue to look for
the necessary addition of sovereign bonds to the
ECB’s buy-list.

USA EU UK SZ Japan
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, CPI
% 5 Year Real yield 10 Year Real yield 30 Year Real yield
05 06 07 08 09 10 11 12 13
Source: Bloomberg, US Treasury
% USA 10yr EU 10yr UK 10yr Japan 10yr
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, Real Yields
% USA 10 BEI EU 10 BEI UK 10 BEI Japan 5 BEI
INFLATION-LINKED BONDS
PERFORMANCES 2014 (LOCAL CURRENCIES) INFLATION
11.8
5.5 6.1
Inflation Linked Government
17.2
4.6
13.7
10.7
4.6
12.7
3.6
6.4
8.6
20.0
18.0
16.0
14.0
12.0
% YTD
10.0
8.0
6.0
4.0
2.0
0.0
US EMU UK Japan Canada Australia
Source: Bloomberg, Citigroup, Barclays, Citigroup
7
6
5
4
3
2
1
0
-1
-2
-3
UK - TREASURY YIELD COMPONENT USA - REAL RATES
BP Real Yield Nominal Yield Breakeven inflation
6
5
4
3
2
1
0
-1
-2
04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, UK
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
USA - 10-YEAR TREASURY YIELD COMPONENT 10-YEAR REAL YIELDS
% Real yield Nominal yield Breakeven
6.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, US Treasury 10 year
1.0
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
FRANCE - 10-YEAR YIELD COMPONENT 10-YEAR BREAKEVEN INFLATION POINTS
% Real yield 10yr Nominal Yield 10yr Breakeven inflation 10yr
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
09.11 01.12 05.12 09.12 01.13 05.13 09.13 01.14 05.14 09.14
Source: Bloomberg, 10-yr French OAT
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, Break-even Inflation Rates

CREDIT RISK
Yield spreads being squeezed again
Returns in the positive zone
Boosted by announcements made by the ECB,
European investment-grade corporate bonds
posted gains in November as they were lifted
by a combination of declining benchmark
government bond rates and narrowing credit
spreads. Ratings-wise, investors tended to
favour superior-grade corporates, with BBB-category
bonds failing to outperform A-rated
issues as is usually the case when the market is
in an up-phase. As for sectors, sliding
commodity prices hurt the energy and mining
& metals sectors whereas the best returns were
delivered by the automotive, telecom and
consumer sectors. Hybrid debt instruments
also, generally speaking, produced the best
performances. At the other end of the
spectrum, bonds from Brazilian borrowers,
shaken by Petrobras’ troubles, really
struggled.
Financials underperformed by a fraction, but
that can be blamed mainly on spreads
widening on Lower Tier 2 debt, especially
issued by French and Austrian banks. Insurers
outperformed courtesy of, on the one hand,
some good results being reported and, on the
other, by several offers made to swap out of
old subordinated debt. Bucking this positive
trend, Dutch insurers’ returns were in the red
as a result, partly, of decisions to revalue their
mortgage portfolios.
Strengthening of banks deemed to be
systemically important
The recent G20 summit confirmed
governments’ determination to strengthen as
much as possible the world-leading banks
considered as being ‘too big to fail’. The frame
of reference put forward by the Financial
Stability Board was accepted and should be
finalised by end-2015. As far as their likely
direct impact on credit markets, these new
regulations would involve a larger supply
coming onstream of Lower Tier 2 debt or
senior debt issued by holding companies and
included for the purposes of any bail-in
arrangements.
Primary market
The euro-denominated corporates market
retains its particular appeal for issuers from
outside the eurozone on account of the
ongoing brisk demand and advantageous
swap conditions. US borrowers, in particular,
made their presence felt, the likes of AT&T,
Verizon, Apple, IBM, Praxair or 3M. This trend
helped to bolster an already sizeable universe
of euro-denominated bonds. The most
favoured maturity dates ranged around 7 and
15 years, with borrowers generally having
ratings of A to AA.
Looking at financials, both UK and US banks
were active in issuing senior debt. The market
attitude towards subordinated paper was
more reticent though as, on three separate
occasions, the size of issues had to be pruned
or bonds offered with a premium that had to
be made more enticing. In the insurance
sector, activity centred on new Lower Tier 2
debt from CNP, Axa and Generali. The latter
two insurers were in fact swapping new issues
for old subordinated debt that no longer
complied with Solvency 2 requirements.
Outlook
The investment-grade corporates segment will
continue being underscored by the ongoing
non-conventional monetary-policy setting. In
this environment, although bonds from better-quality
issuers are still offering a premium
spread relative to sovereign debt, investors
should cast a very discriminating eye over
what to pick, looking closely at what is
happening to economic and business
fundamentals and/or any M&A activity. The
uncertainties clouding the regulatory front
offer a cogent argument for erring on the side
of caution as regards financials considering
current pricing levels.

% Aaa Aa A Baa BB B
04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Barclays, EUR yields
MTD QTD YTD
7.2 7.6 8.1 7.5
0.8 1.1 1.0 1.3
0.4 0.6 0.6 1.0 0.8
0.5
3.2
AAA AA A BBB BB B
Source: Bloomberg, Barclays, Corporate Bonds in euro
% IG Corporates Ex Financials Financials Industrials Utilities
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, Barclays, EUR yield spreads
7.8
MTD QTD YTD
8.2 8.1
8.8
1.0 1.1 1.1 1.0 0.9
CREDIT RISK
RETURNS ON BONDS IN EURO CREDIT SPREADS (EURO)
7.8
MTD QTD YTD
5.9
11.8
0.6 1.0 1.0 1.0 1.3 0.9 1.5 1.5
9.0
14.0
12.0
10.0
8.0
%
6.0
4.0
2.0
0.0
IG HY EMU Gvt Germany Gvt
Source: Bloomberg, Barclays, Citigroup, Bonds in euro
35
30
25
20
15
10
5
0
YIELD COMPONENT (EURO) RETURNS ON BONDS IN EURO
% German Govt swap IG HY
25.0
20.0
15.0
10.0
5.0
0.0
04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Barclays, Eur yields
1.2
13.4
2.0
16.0
14.0
12.0
10.0
8.0
%
6.0
4.0
2.0
0.0
INVESTMENT GRADE SPREADS BY MATURITY (EURO) INVESTMENT GRADE SPREADS BY SECTOR (EURO)
% 1-3 yr 3-5 yr 5-7 yr 7-10 yr 10+ yr
2.0
1.5
1.0
0.5
0.0
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, Barclays, EUR yield spreads
1.5
1.0
0.5
INVESTMENT GRADE RETURNS BY MATURITY (EURO) INVESTMENT GRADE RETURNS BY SECTOR (EURO)
MTD QTD YTD
% Source: Bloomberg, Barclays, Corporate Bonds in Euro
5.4
2.3 2.1 3.0
0.1 0.2 0.6 1.2 1.7
0.2 0.5 1.1
9.9
14.2
20.2
25.0
20.0
15.0
10.0
5.0
0.0
1-3 year 3-5 year 5-7 year 7-10 year 10+ year
0.6 0.6 0.6 0.5 0.5
7.3
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Global Non-Financial Industrial Utilities Financial
%
Source: Bloomberg, Barclays Corporates Bonds in Euro

CREDIT RISK
European high-yield corporates initiating a rebound
Favourable environment for credit
The European high-yield market advanced this
month, achieving a positive return with limited
volatility. In doing so, its pattern of performance
proved different from the US high-yield segment
which had a flat-to-negative performance in
November. Macroeconomic conditions
continued to be weak, and headline
macroeconomic risks persist in Europe. Towards
the end of the month, Mario Draghi again
insisted on the need to stimulate inflation to
appropriate levels “without delay”. As a result,
German business confidence edged up, and risky
assets reacted very positively as investors
repriced possible implementation of some sort of
QE before the year is out. The People’s Bank of
China unexpectedly cut its reference rate, and
investors still need to assess the exact meaning
and consequences of such a decision. The oil
price continued its slide in November, breaking
the level of USD80/barrel early in the month.
Lower oil prices are positive for consumers, but
negative for the energy sector.
Corporate news
Idiosyncratic risks dominated the headlines once
again in November beyond the usual activity
due to the reporting season. Abengoa fell into
troubled waters due to communication issues
regarding its corporate structure and the level of
guarantees. Thanks to proactive communication,
bonds from Abengoa partly recovered. The
Portuguese business unit from OI attracted
several bids, including Altice and a group of
private-equity investors made of Apax Partners
and Bain Capital. Liberty Global continued to
increase its holdings in Ziggo, buying an
additional 10% of the capital. Ziggo shares will
be delisted as a result. Fiat received official
approval to merge with Chrysler, and Isolux, the
Spanish construction company, is planning an
IPO for next year. Regarding financials, RBS
whose subordinated debt is rated high-yield
announced that the capital base it reported to the
ECB had been overstated. Adjusted figures
shows the UK lender is still passing the test, but
by a very slim margin.
Technicals
Credit-rating agencies proved active in
November. Crown was upgraded to BB by S&P.
Wepa was upgraded to B1 by Moody’s. On a less
positive note, Obrascon was downgraded to B1
by Moody’s. Piaggio’s S&P rating was pruned by
one notch to B+. On the primary market, Jaguar
Motors Land Rover issued a 2019 USD bond.
Ontex issued a 2021 bond, and Ziggo came with
a 2019 bond paying a 7.125% coupon. Rhiag and
Belden tapped existing bonds whereas Obrascon
called its 2015 bonds with a premium. After
several weeks of outflows, investors moved
again into the asset class in November.
Outlook
The sell-off experienced in September and
October is now behind us. The correction over
the last two months led to an increase in overall
yield and a widening of spread dispersion. The
overall spread-to-worst still stands above its
December 2013 level. Spread dispersion offers
bottom-up opportunities, primarily in the lower-rated
space. Idiosyncratic risks remain key for
the high-yield segment though. In Europe,
ongoing weak growth and inflation are set to
persist, considering the European Commission
revised its growth expectations downwards for
2015 and 2016. Hence, Mario Draghi’s actions
and communications will be closely scrutinised.
A broad-based QE will boost technicals in favour
of high-yield corporate bonds, benefiting first the
BB segment that is already supported by steady
demand from institutional investors and
investment-grade funds. On the corporate front,
the earnings reporting season proved that
fundamentals remain steady. Corporates remain
conservative with cash on their balance sheets.
Default rates are set to remain low. All in all,
fundamentals remain decent in Europe, liquidity
is poor, but the liquidity premium encapsulated
in bond spreads has accordingly been restored.
Technicals slightly improved on the back of the
lower slate of primary issuance, inflows picking
up and volatility moving down from its recent
high.

2.28%
5.3
7.4
8.3 8.5
CREDIT RISK
EURO SWAP SPREADS MOODY'S - DEFAULT RATES
BP 2 Yr 5 Yr 10 Yr 30 Yr
45
40
35
30
25
20
15
10
5
0
-5
-10
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, Swap spread EUR
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
FINANCIAL INVESTMENT-GRADE RETURNS (EURO) MOODY'S - RATING DRIFT
7.0 6.7 6.4
8.4
5.3
9.3
8.0
11.7
14
12
10
8
6
4
2
15
10
5
0
-5
-10
-15
-20
-25
-30
STOCK MARKET AND HY SPREAD MOODY’S – DEFAULT RATES
25
20
15
10
5
500
450
400
350
300
250
200
Euro Stoxx 600 HY credit spread
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
HIGH-YIELD SPREAD AND DEFAULT RATE (EURO) HIGH-YIELD RETURNS BY SECTOR (EURO)
1.15%
0.0%
73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13
Source: Moody's
Global All Corp Global Speculative
0.5 0.4 0.4 0.5 0.3 0.8 0.7 1.0
0
%
Source: Bloomberg, BoA Merill Lynch
MTD YTD
-35
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
%
Source: Moody's
Global USA Europe
* Rating drift = (issuer upgrades - issuer downgrades) / rated issuers
0
150
04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Barlcays
0%
06 07 08 09 10 11 12 13 14 15
Source: Moody's
MOODY'S - Speculative Default Rates & baseline scenario
Global US Europe
Realised Forecast
Current Default Rate HY spread
* See methodology details in Moody's Special Comment “Introducing
Moody’s Credit Transition Model” and "A Cyclical Model of Multiple-
Horizon Credit Rating Transitions and Default", August 2007.
Default Rate
Current Rate 2.28%
Pessimistic 7.17%
Central 1.89%
Optimistic 1.05%
HY spread 3.79%
20%
15%
10%
5%
0%
99 01 03 05 07 09 11 13 15
Source: Moody's and Merrill Lynch HY Index
5.7 5.7
0.9 0.9 0.8 1.0 1.0 0.9
9.0
8.0
7.0
6.0
5.0
4.0
%
3.0
2.0
1.0
0.0
Source: Bloomberg, BoA Merill Lynch
MTD YTD

EMERGING-MARKET DEBT
Headwinds continue in the short term, but valuations attractive
Local-currency debt – Recent developments
In November, the market was down 0,4% in USD
terms. Currencies weakened by more than 1,5%,
but this was partly offset by the yield and capital
appreciation in bond prices. A primary driver was
the stronger US dollar whereas a weaker Japanese
yen meant many Asian economies needed to
maintain currency competitiveness. Weaker oil
prices hurt commodity exporters, but
manufacturing exporters benefited from lower
costs. Latin America was the worst-performing
region given its heavy commodity focus, and
growth has remained sluggish. The Brazilian real,
Chilean peso and Colombian peso were all down
by between 2.5% and 4%, but yield and capital
appreciation partially offset this weakness. Mexico
is less commodity-reliant than its neighbours and
benefited from manufactured exports to an
improving US, but Mexico’s central bank
downgraded growth to 2%-2.5% for 2014. Russia
has seen increased tax receipts whilst a small
turnaround in oil prices helped to slow rouble
weakness. Romania cut rates by 25bp, triggering
weakness in the currency. The South African rand
appreciated as the central bank indicated rates
would have to rise eventually. Indonesia hiked
rates by 25bp to 7.75% to contain inflation after the
government raised fuel prices by over 30%. China
unexpectedly cut its lending rate by 40bp, but
ensured that interest paid to savers was protected.
Local-currency debt – Outlook
Yields look attractive for investors while some
currencies remain vulnerable, though for some
countries a weaker currency is part of the solution
to stimulate exports and improve their current-account
balances. There is more differentiation,
with the Philippines and Mexico examples of
strong fundamental stories; correlations have
exhibited some signs of breaking down. The asset
class still needs to recover fully and has not seen a
meaningful return in investor demand. With
expected gradual improvement in developed-market
growth, emerging markets should move
stronger as well, but this will not be in a straight
line as growth remains uneven while potential for
rising US Treasury yields could continue to have an
impact. Notwithstanding short-term challenges, the
asset class remains one the most attractive areas in
the fixed-income segment given the transition to
more normalised global monetary policy.
External debt – Recent developments
External debt was slightly lower, with all the
weakness due to spread widening, whereas the US
Treasury and yield component were contributors.
Investment-grade countries were positive overall
given their closer correlation with US Treasuries,
but below-investment-grade countries were down
by almost 1%, driven by Latin America. High-grade
countries such as Chile, China and Poland all
returned around 20-30bp, largely in line with US
Treasuries. However, Brazil was down by about
25bp given weaker growth expectations and
slashing of the budget-surplus goals. Venezuela
was down by over 10% as current oil price levels
are not seen as sustainable for the government’s
debt-servicing capabilities. A bright spot in Latin
America was the credit-rating upgrade to B+ for the
Dominican Republic. In Eastern Europe, Russia fell
by over 2% and Ukraine declined by 6%. However,
Romania was up by over 1% on the back of the
market-positive Presidential election win for
Johannis who aims to crack down on corruption. In
Asia, attention was on Vietnam which was
upgraded by Fitch to BB- from B+, citing improved
macroeconomic stability. This was exploited as an
opportunity to issue new bonds for the first time in
nearly 10 years. Malaysia was down by about
0.20% given concerns over lower oil prices denting
the trade surplus.
External debt – Outlook
As developed-market monetary stimulus moves
towards normalisation, we expect to see more
significant differentiation between markets, which
is already becoming evident. While gradually
improving global growth will be positive for many
emerging-market countries, higher borrowing costs
could be a negative for some – the same can be said
for lower commodity prices. The potential for US
T-bond yields to be range-bound to steadily
increasing would be supportive and add weight to
the argument that there is value given the spread
level relative to other high-grade-spread asset
classes. However, a rapid and disorderly rise in
yields could create downward pressure in the short
term while, on the whole, prudent fiscal and
economic management will be recognised by
investors over the long term.

8
7
6
5
% EMBI g.d. Spread EMBI g.d. Yield
% Bond markets - GBI-EM g.d. Money Markets - ELMI+
Performance in Local Currencies Exchange gain/loss USD returns
Performance in Local Currencies Exchange gain/loss USD returns
EMERGING-MARKET DEBT
PERFORMANCES (USD) US DOLLAR DEBT - YIELD & SPREAD
0.7
US Treasury EMBI g.d. GBI-EM g.d. ELMI+
1.8
5.6
0.1
1.8
10.0
-0.4
1.1 1.1
-1.5 -2.0
12.5
10.0
7.5
5.0
2.5
0.0
-2.5
-5.0 -3.7
MTD QTD YTD
%
Source: Bloomberg, Index JP Morgan
450
400
350
300
250
200
150
JP MORGAN EMBI GLOBAL DIVERSIFIED LOCAL CURRENCY DEBT - YIELD
25.0
20.0
15.0
10.0
5.0
0.0
-5.0
%
-10.0
8
7
6
5
4
3
2
JP MORGAN GBI-EM GLOBAL DIVERSIFIED PERFORMANCE JP MORGAN GBI-EM G.D.
20.0
10.0
0.0
-10.0
%
-20.0
-30.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
-8.0
JP MORGAN ELMI+ PERFORMANCE JP MORGAN ELMI+
4
100
11.11 03.12 07.12 11.12 03.13 07.13 11.13 03.14 07.14
Source: Bloomberg, JP Morgan Indices
-15.0
MTD YTD
Source Bloomberg: Index JP Morgan
1
11.11 03.12 07.12 11.12 03.13 07.13 11.13 03.14 07.14
Source: Bloomberg, JP Morgan Indices
-40.0
MTD YTD
Source Bloomberg: Index JP Morgan
1.2
3.3
9.4
-1.6 -2.1
-8.2
-0.4
1.1 1.1
-10.0
MTD QTD YTD
%
Source: Bloomberg, Index JP Morgan GBI-EM Global Diversified
8.0
6.0
4.0
2.0
0.0
-2.0
%
-4.0
-6.0
-8.0
-10.0
-12.0
MTD YTD
Source Bloomberg: Index JP Morgan ELMI+
0.2 0.5
3.4
-1.7
-2.5
-7.1
-1.5
-2.0
-3.7
4.0
2.0
0.0
-2.0
-4.0
-6.0
-8.0
MTD QTD YTD
%
Source: Bloomberg, Index JP Morgan ELMI+ Global Diversified

USA
Fed turns QE liquidity taps off, but is reassuring on rate hikes
Recent statistics have pointed towards the US
economy sustaining its growth momentum
After registering 3.9% GDP growth in Q3, the
US economy is still being underpinned by a
sturdy platform of fundamentals. The labour
market continued to pick up in October: the
jobless rate inched down to 5.8%, non-farm
payroll numbers for the private sector showed
a rise in jobs of 209,000, and weekly jobless
benefit claims have remained below the
300,000 threshold over the last ten weeks.
Consumer confidence barometers continued to
move in an upwardly direction, retail sales
rose by 0.3%, the Purchasing Managers’ Index
(PMI) for Manufacturing advanced from 56.6
to 59, and the leading economic indicator
progressed by a further 0.9%. Overall, the
latest data on the housing market were, on
balance, reassuring. The National Association
of Home Builders/Wells Fargo Housing
Market Index, regarded as a forward indicator
for the market, rebounded from 54 to 58, and
property prices continued to climb. Housing
starts did drop by 2.8%, but building permits
were up by 4.8% and sales of existing houses
rose by 1.5%. The US economy looks set to
continue on its forward march, but the
slowdown in evidence in other corners of the
globe, compounded by the fraught geopolitical
landscape, might well have a damaging
knock-on effect which should, on a plus note,
be offset by the slide in oil prices giving
consumer spending a fillip.
Inflation staying below the Fed’s 2%
target rate, with inflationary expectations
softening further
Consumer prices held steady in October, but
tell-tales signs are starting to surface that
pressures on pricing are bubbling up even
though, for now, wage increases are still
moderate. In the month, tumbling petrol prices
offset the hike in medical and health-care
costs. The headline rate of inflation was
unchanged at 1.7% y-o-y, but the core rate
inched up a notch from 1.7% to 1.8%. The
subdued rates of inflation remain a cause for
concern at the Fed.
The Fed’s focus switching
from unemployment to low inflation
In late October, in spite of financial markets
being noticeably unsettled, the Fed pressed
ahead with winding up its programme of
monthly asset purchases. Minutes released for
that FOMC meeting revealed the Fed’s
concerns about the lacklustre state of
economies in China, Japan and Europe,
coupled with all the geopolitical tensions.
They also noted though the solid anchoring of
the US recovery which should continue
rebuilding its strength. Some Fed Board
members voiced their fears about watching
inflation, already pitched below the Fed’s
target, sinking even deeper as oil prices
tumble and the dollar climbs. FOMC members
also debated the relevant wording to describe
the direction of the Fed’s monetary policy,
eventually opting to persevere with the
guidance that its benchmark rates would stay
close to zero for some “considerable” time. The
Fed is still worried about hiking rates too early
and made it quite plain the initial hike would
remain contingent on positive trends being set
by economic data.
Considering the likelihood
of moderate, non-inflationary growth,
the yield curve became even flatter
Mild inflation, economic concerns, geopolitical
worries and the likelihood of the Fed sticking
with its accommodating monetary stance for
much of 2015 should see the US Treasuries
market holding comparatively steady over the
next few weeks.

% 2 year 5 year 10 year 30 year
04 05 06 07 08 09 10 11 12 13 14
% 2-10 year 5-10 year 10-30 year
250
200
150
100
50
New home Sales Existing home Sales
Housing start Bulding Permits
Home price-SPX Shiller 10 Home price-SPX Shiller 20
PMI Mfg PMI Non Mfg NAHB Housing Market
USA
SHORT-TERM RATES (USD) US TREASURY BOND YIELDS
%
2.0
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
Libor 3M Fut. 3M Sep-15 Fut. 3M Sep-16 Fed Funds T-Bill 3M
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, Money Market, USA
6.0
5.0
4.0
3.0
2.0
1.0
0.0
RETURNS FROM GOVERNMENT BONDS BY MATURITY MOVEMENTS IN YIELD SPREADS
4.6 5.1
1.6 2.2
25.0
20.0
15.0
10.0
5.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
INFLATION HOUSING
7
6
5
4
3
2
1
0
-1
-2
-3
CPI CPI Core PCE core deflator PPI
2'500
2'000
1'500
1'000
500
LABOR MARKET PMI AND NAHB
Source: Bloomberg, Us Treasury
0.6 0.1 0.4
0.4 0.7 1.0
1.2 1.8
2.6
0.8
2.4
4.8
8.5
21.5
0.0
Bonds 1-3 year 3-5 year 5-7 year 7-10 year 10+ year
%
MTD QTD YTD
Source: Bloomberg, Citigroup, US Treasury
-0.5
04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, US Treasury
-4
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, USA
0
0
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
600
400
200
0
-200
-400
-600
-800
-1000
12
10
8
6
4
2
0
Unemployment Rate Nonfarm Payrolls Private Nonfarm Payrolls
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
90
80
70
60
50
40
30
20
10
0
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

EUROZONE
The ECB stepping up to the plate
The European Commission has downgraded
its economic forecasts
The eurozone economy is still struggling and
the Commission’s Autumn 2014 forecasts
make for grimmer reading than the Spring
2014 set. According to the European
Commission, the eurozone is going to take
longer to extricate itself from the economic
quagmire. In order to give it a push in the
right direction, the Commission has devised a
far-reaching investment package to kick-start
growth and jobs. It is now forecasting GDP
growth of 0.8% for 2014, then 1.1% in 2015.
Back in May, it had been predicting growth of
1.2% for 2014 and 1.7% in 2015. The
Commission’s revised autumn forecasts are
more downbeat than the IMF’s projection for
1.3% in 2015. The downgrade can be blamed
on confidence being knocked by creeping
geopolitical tension and the slowdown in Asia.
Individual eurozone economies are still
experiencing mixed fortunes, with the Big
Three (Germany, France and Italy) seemingly
limping along. As for inflation, the
Commission is projecting annual rates
averaging 0.5% for 2014 and 0.8% in 2015.
Recent data not inspiring optimism and the
spectre of deflation still haunting the eurozone
The eurozone economy remains very sluggish,
but is still just about growing: GDP expanded
by 0.2% in Q3 whereas consensus projections
had been forecasting a mere 0.1% rise. France
sprang a pleasant surprise, recording 0.3%
growth, Greece returned to growth (+0.7%)
and Germany missed slipping back into
recession by the slimmest of margins (+0.1%).
The unemployment rate has remained pitched
up at about 11.5% for several months. The
Manufacturing PMI has just about managed to
keep above the 50-point threshold for the past
four months, but the Services PMI has slipped
back since the summer, retreating from 54.2 to
51.3. Consumer confidence has been waning
since the summer too, and retail sales shrank
by 1.3%. Knock-on effects from the crisis in
Ukraine and the sanctions slapped on Russia
will continue to hamper European economies.
Headline inflation was flat at 0.4% y-o-y in
October, with the underlying rate steady at
0.7%, but that means both bellwether rates are
a long way below the ECB’s 2% official target.
ECB stirring into action and aiming to expand
its balance sheet to its 2012 dimensions
As expected, the ECB made no change to
interest rates in November. Its main
refinancing rate remains pegged at 0.05%, its
marginal rate at 0.30% and its deposit rate at -
0.20%. During his press conference, Mario
Draghi was at pains to stress the Governing
Council was unanimous in being prepared to
press ahead further if required. He also
clarified the ECB’s target for the balance sheet:
it is aiming to expand it by EUR1,000bn. To do
that, the ECB will undoubtedly have to launch
several new measures. Buying up sovereign
bonds remains one such possibility. Last
month, the ECB had made a start on buying
covered bonds and, on 21 November, it
initiated its programme of buying asset-backed
securities in its drive to swell the size
of its balance sheet. We await the outcome of
the second Targeted Longer-Term Refinancing
Operation (TLTRO) in December, which
comes after the outcome of the bank stress
testing and AQR, to see whether the projected
volume of EUR400bn can be reached. Mario
Draghi reiterated in his speech to the
European Parliament his determination to
push through non-conventional monetary
measures, if they prove necessary, to get the
eurozone economy back on the growth track.
10-year sovereign bond yields, which have
sunk to record lows, look set to stay there
Geopolitical risks, an anaemic economy, low
inflation and the latest measures pushed
through by the ECB should continue
underpinning the eurozone bond market,
especially helping peripheral eurozone bonds
that are still offering a premium.

04 05 06 07 08 09 10 11 12 13 14
BP France Netherland Austria Belgium Spain Italy
EU PMI Mfg EU PMI Services EU PMI Composite
140
120
100
80
60
40
20
EU Business Climat Industrial Services
Consumer Construction Economic
EUROZONE
SHORT-TERM RATES (EURO) BUND YIELDS
% Euribor 3M Fut. 3M Sep-15 Fut. 3M Sep-16
1.0
0.8
0.6
0.4
0.2
0.0
-0.2
ECB Repo Eonia Overnight
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, Money, EU
6.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
RETURNS BY MATURITY (EMU GVT) 10-YR GVT SPREADS VS GERMANY
30.0
25.0
20.0
15.0
10.0
5.0
0.0
700
600
500
400
300
200
100
0
EUROZONE - M3 AND LENDING TO PRIVATE SECTOR EUROZONE - PUCHASING MANAGER INDICES
% EU M3 Money Supply EU Lending to private sector
14
12
10
8
6
4
2
0
-2
56
54
52
50
48
46
44
42
EUROZONE - INFLATION EUROZONE - ECONOMIC SURVEYS
Source: Bloomberg, Bund
1.3
0.1 0.3 0.9 1.6
2.8
1.5
0.0
0.2 0.9
2.0
3.7
11.8
1.6
5.3
10.3
15.3
25.0
-5.0
%
MTD QTD YTD
Source: Bloomberg, Citigroup, EMU Gvt Bonds
-100
04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Govt yield spreads
-4
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Eurozone
40
11 12 13 14
Source: Bloomberg, Eurozone PMI index
% EU Inflation EU Core Inflation EU Producer Price
10
8
6
4
2
0
-2
-4
-6
-8
-10
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Eurozone
0
20
10
0
-10
-20
-30
-40
-50
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Eurozone Economic Survey

UK
The BoE has revised its economic forecasts downwards
The UK economy is doing well compared to
the economies of neighbouring countries
After recording 0.7% growth in Q3 2014, the
UK economy has been exhibiting a more
mixed set of signals, suggesting to
commentators that economic growth is likely
to lose a little speed in the final quarter of the
year. The ongoing sluggishness of the
eurozone economy adds further weight to this
supposition. The UK housing market has lost
some of its momentum. The index compiled
by the Royal Institute of Chartered Surveyors,
regarded as a reliable leading indicator for the
housing sector, has been on the slide for
several months, slipping from 30 to 20 in
October, and house prices have also begun to
flag. PMIs have also dipped in recent months.
The jobless flat held firm at 6% in September
and wages growth is pedestrian, edging up
from +0.7% to +1.0%.
Prime Minister Cameron, who will go to the
polls in next May’s general election, has
alluded to risks menacing the UK economy
In an article which appeared in The Guardian
daily newspaper on 17 November, Prime
Minister David Cameron pointed out that, “in
our interconnected world, wider problems in the
global economy pose a real risk to our recovery at
home”. He commented that “the eurozone is
teetering on the brink of a possible third recession”,
along with outlining other problems facing the
global economy and the mounting geopolitical
risks. This array of uncertainties is also
worrying the Bank of England (BoE) which
has adopted a more doveish tone as regards
the likely onset of the next cycle of rate hikes.
As expected in early November, the BoE made
no change to its monetary policy, and shaved
its growth and inflation forecasts
Lacklustre wages growth and the fact the
falling jobless rate is unlikely to filter through
into pressure on pay in the near future owing
to the ongoing slack in the economy explain
why the BoE is preferring to err on the side of
caution, especially as inflation has slipped well
short of its target. The minutes of the last
Monetary Policy Committee (MPC) meeting
revealed that, although two MPC members
were still in favour of an immediate quarter-point
hike in the base rate, the other seven
voiced a broad range of views in their
assessment of the UK economic outlook. The
most circumspect among them are fearful of
the economy running out of steam more than
expected and of inflation staying well below
the official BoE target. Moreover, in its
quarterly report on inflation, the BoE is
projecting that the rate will slide to 1% over
the next six months and not move back up to
its target level before 2017. Inflation in Britain
worked out at 1.3% y-o-y in October, a shade
up on the 1.2% rate reported for September,
but it is still bumping along at five-year lows.
The underlying rate of inflation was, however,
steady at 1.5%.
Sedate inflation, pedestrian wages growth and
worries over the lethargic state of the eurozone
economy, which is weighing on UK exports,
suggest that most of the MPC will continue
advocating making no changes in the coming
months. The MPC will doubtless wait for
further real evidence that slackness in capacity
is being mopped up before taking any action.
Expectations about hikes in the UK base rate
have been unmistakably reined in
Yields on UK gilts fell in November, as they
did on other leading government bond
markets worldwide. Market operators in the
UK are no longer expecting the BoE to lift its
base rate before the end of 2015, so the gilts
market should hold fairly steady over the next
few weeks, buoyed by the mix of economic
uncertainties and low inflation.

04 05 06 07 08 09 10 11 12 13 14
% 2-10 year 5-10 year 10-30 year
130
80
30
-20
-70
% Retail Sales (l.s.) Nationwide House Price (l.s.) RICS House Price Bal.(r.s.)
5
0
-5
-10
-15
-20
-25
-30
-35
-40
% PMI Mfg PMI Services PMI Construction Consumer Confidence
UK
SHORT-TERM RATES (GBP) UK TREASURY YIELDS
% Libor 3M Fut. 3M Sep-15 Fut. 3M Sep-16
3.0
2.5
2.0
1.5
1.0
0.5
0.0
BOE Base Rate Swap Sonia 3M
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, Money Market, UK
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
4.7 5.3
25.0
20.0
15.0
10.0
5.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
LABOR MARKET AND EARNINGS HOUSING AND RETAIL SALES
% Unemployment Rate Average Earnings Ex Bonuses Average Earnings
12
10
8
6
4
2
0
-2
30
25
20
15
10
5
0
-5
-10
-15
INFLATION ECONOMIC SURVEYS
Source: Bloomberg, GILT
3.3
0.4
1.2 1.7
2.6
0.9
2.2
3.1
4.2
7.2
12.7
1.6
4.5
7.2
11.1
21.0
0.0
%
MTD QTD YTD
Source: Bloomberg, Citigroup, UK Treasury
-1.0
04 05 06 07 08 09 10 11 12 13 14
-4
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
-120
-20
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
% CPI Core CPI PPI Output
10
8
6
4
2
0
-2
-4
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
-45
70
65
60
55
50
45
40
35
30
25
20
07 08 09 10 11 12 13 14

SWITZERLAND
Franc climbing ahead of the key referendums on 30 November
The Swiss economy still in robust shape
despite GDP growth stalling a little in Q2
Although Switzerland’s economy has lost a
little impetus, it is still doing better than the
eurozone, as can be seen from the upswing in
findings from October economic and business
surveys. The KOF economic barometer ticked
up from 99.1 to 99.8, the Manufacturing PMI
advanced from 50.4 to 55.3 whilst the ZEW-CS
index improved from -30.7 to -7.6. The UBS
Consumption Indicator also recorded a
modest bounce from 1.28 to 1.41, but it is still
heralding a decline in consumer spending over
the coming months. Findings from the
quarterly survey conducted by the State
Secretariat for Economic Affairs (SECO) also
hint at a probable downturn in consumer
spending. Since 2013, the overall consumer
confidence index compiled by SECO has been
cruising along above its long-term average
reading, but, in October this year, it slipped
underneath that line, sliding from -1 to -11.
Sub-indices for confidence about expectations
for the economy, job security and
unemployment fell quite noticeably in
October. Retail sales in real seasonally
adjusted terms slumped by 0.9% in September.
Some barometers for the property sector
appear to be signalling a slight dip in prices,
suggesting that measures adopted by the
Swiss National Bank (SNB) to cool mortgage
lending may well be starting to bear fruit.
Despite that, conditions in the property sector
are still quite taut, as the new record high of
1.29 set by the UBS Swiss Real Estate Market
Bubble index would appear to demonstrate.
Switzerland’s rate of GDP growth looks set to
be fairly moderate over the next few quarters
owing to the stubbornly high Swiss franc,
anaemic eurozone economy and less brisk
domestic demand.
The outcome of popular referendum votes
on 30 November and the ongoing lethargy of
eurozone economies may well make
the SNB’s job that much more awkward
The SNB, whose foreign-currency reserves
now total almost 80% of the country’s GDP,
has not changed its tune. It still regards the
franc as overvalued and intends to continue
fighting to stop the franc climbing above its
ceiling against the euro in order to scotch any
threat of deflation taking hold. The SNB
remains determined to buy foreign currency in
unlimited quantities and push through further
measures, with the prospect of setting negative
interest rates not being ruled out, if it needed
to defend this exchange-rate threshold.
However, the SNB has acknowledged that, if
the Swiss electorate vote in favour of restoring
gold reserves, it would complicate its conduct
of monetary policy. As for the property sector,
the SNB is likely to press ahead with its
counter-cyclical initiatives to keep the market
from overheating. The SNB has trimmed its
GDP growth forecast for 2014 to 1.5% and is
projecting inflation of just 0.1% for 2014, 0.2%
for 2015 and 0.5% in 2016 even with interest
rates being pegged at zero. The SNB’s Thomas
Jordan made it quite plain that deflationary
risks had mounted in Switzerland.
Swiss bond market set to remain
range-bound in next few months
The strong franc, ongoing deflationary risks
and the uncertain global economic outlook are
likely to maintain the pressure on the SNB to
keep interest rates and the ceiling exchange
rate for the franc against the euro unchanged
for a few more months. The outcome of the
key 30 November votes – when the electorate
will, as well as voting on the SNB’s gold
reserves, be asked to rule on the Ecopop
initiative (geared to capping immigration at
0.2%) and an initiative to abolish flat-rate tax
packages – could seriously muddy the waters,
but, even if that were to happen, bond yields
should not flinch much.

04 05 06 07 08 09 10 11 12 13 14
% 2-10 year 5-10 year 10-30 year
% CPI Core CPI Producer & Import Price
3
2.5
2
1.5
1
0.5
% PMI Mfg Kof Leading UBS Consumption
SWITZERLAND
SHORT-TERM RATES (CHF) CONFEDERATION BOND YIELDS
%
0.5
0.4
0.3
0.2
0.1
0.0
-0.1
-0.2
-0.3
-0.4
-0.5
Libor 3M Fut. 3M Sep-15 Fut. 3M Sep-16 SNB min/max 3M Libor
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, Money Market, CHF
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
RETURNS FROM GOVERNMENT BONDS BY MATURITY CONFEDERATION - MOVEMENTS IN YIELD SPREADS
14.0
12.0
10.0
8.0
6.0
4.0
2.0
2.5
2.0
1.5
1.0
0.5
0.0
SNB EXCHANGE RESERVES INFLATION
500000
450000
400000
350000
300000
250000
200000
150000
100000
50000
% CHF Trade Weighted Index BNS - Foreign Currency Reserves CHF
160
150
140
130
120
110
100
90
6
4
2
0
-2
-4
-6
HOUSING ECONOMIC SURVEYS
Source: Bloomberg, Confederation
0.6
0.2 0.3
0.7 0.9
1.7
0.8
0.2 0.3
0.7 0.8
2.5
3.7
0.1
1.1
3.5
7.0
12.5
0.0
%
MTD QTD YTD
Source: Bloomberg, Citigroup, Switzerland Gvt Bonds
-0.5
04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Confederation
0
80
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Switzerland
-8
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
500
450
400
350
300
250
200
150
100
50
0
% UBS Real Estate Bubble House Construction Permits
2
1
1
0
-1
-1
-2
-2
-3
Single Family House Price
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
0
130
120
110
100
90
80
70
60
50
40
30
07 08 09 10 11 12 13 14

JAPAN
Sales tax hike impact persisting, tipping Japan back into recession
The consensus had been looking for growth
of 2.2% in Q2 of the 2014/15 fiscal year in Japan
whereas its economy actually contracted
at an annualised rate of 1.6%
Japan had already seen its GDP shrink by 7.3%
in Q1 2014/15 when the economy had been
heavily penalised by the hike in the consumer
sales tax rate from 5% to 8% in early April. The
slump in consumer spending, dented by April’s
hike in the consumer sales tax rate and some
inclement weather, had prompted businesses to
curtail their production and exports had been
faltering despite the lift from a depreciating yen.
The slide in the yen’s value has not resulted in
any upsurge in exports, but has raised the cost of
the import bill and further eaten away at
households’ spending power, already dented by
the hike in the consumer sales tax rate. The
plentiful supplies of liquidity made available to
banks by the Bank of Japan (BoJ), with the end-goal
of encouraging them to lend to business,
have not fed through into a significant increase
in lending. The budgetary reflationary measures,
together with the quantitative easing put in place
by the Bank of Japan (BoJ), have not been able to
bring about a sustainable upswing in the
economy, and reforms pledged by the
government have still not come off the drawing-board.
This turn for the worse has reignited fears
of a repeat of the 1997 scenario when the two-point
hike in the consumer sales tax rate caused
the economic upswing to grind to a standstill.
The BoJ’s announcement in late October that it
would be again boosting its already
unprecedentedly expansionary programme, and
the economy’s relapse into recession pushed the
yen even lower.
Dismal showing by Japan’s economy prompted
Prime Minister Shinzō Abe to postpone second
hike in the consumer sales tax and call a snap
election halfway through his term of office
Japan’s government find itself in an awkward
predicament. In order to bring ballooning debt
(already riding above 230% of GDP) under
tighter control, it had been expecting to be
enjoying the benefits of increased streams of tax
revenue. In contrast, sluggish growth, depressed
by shrinking consumer spending, has painted
the Prime Minister into a corner, forcing him to
postpone the second hike in the consumer sales
tax, due to be raised from 8% to 10%, by 18
months (to April 2017). Moreover, PM Shinzō
Abe, keen to take advantage of personal
popularity ratings that have not been dented too
much, decided to dissolve the Lower House of
Japan’s Diet to buttress his position as Head of
Government to allow him free rein to push
through his dynamic and reforming economic
policy agenda as well as to distance himself
somewhat from the pacifism that has been the
hallmark of Japan’s politics since World War II.
Japan will go to the polls in an early general
election in mid-December to re-elect 480
members of the Diet. Shinzō Abe declared that, if
the ruling coalition failed to secure a majority in
the Lower House after the election, this would
mean the Japanese electorate had rejected the
reflationary reformist policy package, commonly
referred to as ‘Abenomics’, and that he would
step down.
The BoJ is set to expand its monetary base at a
rate of JPY80,000bn a year, with the BoJ
Governor indicating that Japan is today in a
critical phase of its battle to conquer deflation.
Consumer prices have been sliding again over
the last few months. Once the hike in the
consumer sales tax rate is stripped out (effect of
boosting inflation by two percentage points),
inflation works out, using the BoJ’s method of
calculation, at just 1.2%, still some way short of
the 2% target set.
The BoJ’s activist line on monetary policy
likely to continue underpinning the market
for Japanese government bonds (JGBs)
The change in the weighting accorded to bonds
by the Government Pension Investment Fund
(GPIF) from 60% to 40% and the outcome of the
forthcoming early general election might well
create some volatility for JGBs. Nevertheless,
yields on JGBs are likely to continue bumping
along at rock-bottom levels in the coming
months on account of the BoJ’s approach to
monetary policy.

04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, JGB
% 2-10 year 5-10 year 10-30 year
04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, JGB
1 USD in JPY
04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, exchange rates
40
30
20
10
0
-10
-20
-30
-40
% PMI Coincident Index Leading Index Industrial Production YoY
JAPAN
SHORT-TERM RATES (YEN) JAPANESE GOVERNMENT BOND YIELDS
% Libor 3M Fut. 3M Sep-15 Fut. 3M Sep-16
0.5
0.5
0.4
0.4
0.3
0.3
0.2
0.2
0.1
0.1
0.0
BOJ Target BoJ Discount
11.13 01.14 03.14 05.14 07.14 09.14
Source: Bloomberg, Money Market, Japan
3.0
2.5
2.0
1.5
1.0
0.5
0.0
0.7
MTD QTD YTD
0.1 0.3
0.5
0.8
1.9
0.1 0.1 0.2 0.3
1.6
1.2
0.8
2.6
3.6
0.3
3.6
7.4
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
%
Source: Bloomberg, Citigroup, Japan Gvt Bonds
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
INFLATION JAPANESE YEN VERSUS DOLLAR
% CPI CPI Ex-Fresh Food CPI Ex-Food & Energy
5
4
3
2
1
0
-1
-2
-3
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Bloomberg, Japan
130
120
110
100
90
80
70
CONSUMPTION LEADING INDICATOR AND INDUSTRIAL PRODUCTION
60
50
40
30
20
10
0
% Bank Lending Household Spending Consumer Confidence
8
6
4
2
0
-2
-4
-6
-8
-10
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
-50
120
100
80
60
40
20
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Pictet Asset Management
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1211 Genève 73
Switzerland
www.pictet.com
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