China Merchants Securities 2015 Overseas Macroeconomic Outlook

Annual Report
Macro Report
December 1, 2014 Monday
Gradual global recovery process to face
China Merchants Securities (HK) Co. Ltd

Hong Kong Equity Research
Lynn SONG
+852 3189 6122
lynnsong@cmschina.com.hk
increasing risks and challenges in 2015

2015 Overseas Macroeconomic Outlook
On a whole, we expect the big developed economies to see growth edge up in
2015, but downside risks have risen. We expect the recovery will likely remain
modest and uneven as economies continue to struggle to restore growth
dynamism following the crisis years. Challenges remain significant and we
remain cautious on the overseas macro environment moving into 2015.
Dr. Cliff Zhao, CFA

+852 3189 6126
wenlizhao@cmschina.com.hk
Dr. David Xie
+86 755 83295524
xieyx@cmschina.com.cn
US: moderate recovery to accelerate, striving for escape velocity
Main focus in the US will remain on monetary policy normalization; we

expect a hike of 25 bps in mid-2015, and we expect multiple hikes in 2015,
forecasting rate at 1.0% in 2015.
At this point, the recovery may not be at escape velocity, or strong

enough to be self-sustained despite external headwinds, meaning the US
recovery may still be subject to external shocks.
Improving labor and housing markets, still accommodative policy, and

lessened fiscal drag should bolster economic growth moving into 2015.
We view the US most positively of developed economies, forecasting

2015 GDP growth at 2.9% YoY and for the dollar to strengthen further.
Eurozone: recovery to remain lukewarm, rising downside risks
Downside risks prevail in the region, as deflationary pressures and

unemployment continue to weigh on consumption and activity.
Eurozone countries performances are likely to vary moving forward.

We view Germany, Spain and other countries which pursued structural
reforms more favorably, while France and Italy may continue to struggle.
Key forecasts
U.S.
%
GDP
CPI
Unemployment
Current Account /GDP
Fiscal balance /GDP
Policy rate
Dollar index
%
GDP
CPI
Unemployment
Fiscal balance /GDP
Policy rate
EUR/USD
Japan
GDP
Japan: stimulus & trade to buoy 2015 growth, long term risks big
Japans core story remains the same, short term growth fueled by
aggressive stimulus, while long term issues loom on the horizon.
Rate of stimulus to slow after Oct. 31st BoJ stimulus, but BoJ and
government will remain ready to support the economy further if needed.
15E
2.3
2.9
1.7
5.8
-2.4
-2.9
0.25
88.5
1.8
5.6
-2.3
-2.6
1.00
93.0
14E
15E
0.9
0.9
0.5
11.5
2.3
-2.5
0.05
1.25
0.8
11.3
2.5
-2.3
0.05
1.15
14E
15E
0.8
1.1
2.8
3.6
0.1
-8.0
0.1
118.0
1.5
3.4
0.9
-7.8
0.1
121.0
Eurozone
The ECB has exhausted its conventional monetary tools to little effect,
may introduce full-fledged QE; we identify March/July as a possible QE timing.
The Eurozone is set to return to positive YoY growth in 2014, as the
region continues its slow recovery from the debt crisis and austerity. Overall
for the region we expect growth to remain steady at 0.9% YoY in 2015. It is
likely we will see the Euro dip further in 2015.
14E
%
CPI
Unemployment
Fiscal balance /GDP
Policy rate
USD/JPY
Source: BloombergCMS(HK)
Impact of the stimulus, a more favorable trade outlook, a delayed sales

tax, and the base effect may accelerate growth from 2Q15 onward, and we
expect growth to edge up slightly to 1.1% YoY in 2015.
Long term risks tied to government debt and lack of structural reform
remain significant, we remain bearish on Japan for the medium to long term.
To access our research reports on the Bloomberg terminal, type CMHK <GO>
2014 12 1 ()
2015
+852 3189 6122

lynnsong@cmschina.com.hk
2015
, CFA
+852 3189 6126
2015
2015
wenlizhao@cmschina.com.hk
+86 755 83295524

xieyx@cmschina.com.cn
201525
20151.0%
2015
2015GDP
2.9%
14E
15E
GDP
2.3
2.9
CPI
1.7
5.8
1.8
5.6
-2.4
-2.3
/GDP
/GDP
-2.9
-2.6
0.25
1.00
88.5
93.0
14E
15E
%
GDP
0.9
0.9
CPI
0.5
11.5
0.8
11.3
2.3
2.5
201537
2014GDP2015
0.9%2015
/GDP
/GDP
-2.5
-2.3
0.05
0.05
1.25
1.15
14E
15E
2015
%
GDP
0.8
1.1
CPI
2.8
3.6
1.5
3.4
/GDP
0.1
0.9
1031
/GDP
-8.0
-7.8
2015
20151.1%
0.1
0.1
118.0
121.0
: CMHK <GO>
Table of Contents
1. US to continue moderate recovery: is the economy at escape velocity
yet?
1.1 Policy may gradually tighten in 2015, but overall still accommodative;
we expect rate hike in mid-2015
1.2 Dollar likely to maintain upward climb in 2015 and lead to more capital
inflow
1.3 Consumption should continue to drive growth on labor market

improvement, but rate hike may create headwinds
11
1.4 Investment growth may continue to edge up on improving housing

market and replacement of capital stock
14
1.5 Net exports may drag growth slightly amid stronger dollar and weak
external outlook
16
1.6 Key risks in 2015 remain tied to monetary policy and external
environment
17
2. Eurozone recovery to remain lukewarm, with rising downside risks
20
2.1 Policy direction in the EU to remain highly accommodative
22
2.2 Euro may weaken further, with potential capital outflow from the region
in 2015
25
2.3 Limited upside potential for recovery of Eurozone domestic demand

amid continued job market weakness
26
2.4 Investment remains significantly below long term potential, may stay
downbeat in 2015
28
2.5 External demand situation should benefit from weaker Euro, but impact
may be modest as trade partners economies moderate
29
2.6 Risk outlook is balanced to the downside: deflation, reform fatigue, and
geopolitical risks remain significant
30
3. Japans 2015 growth may rise on aggressive stimulus and external trade
balance improvement, but long term concerns remain serious
32
3.1 Japan policy stance likely to push for continued aggressive easing, but
space for further support may be limited
33
3.2 Consumption will remain subdued unless real wage growth rises
substantively
33
3.3 External trade balance may be more positive for growth in 2015 on
energy developments
36
3.4 Further downside pressure on Yen will persist, but pace of depreciation
may slow or stabilize in 2015
37
3.5 Key risks remain centered on huge government debt and lack of
structural reform
38
4. Conclusion
42
3
US Macroeconomic Forecast Table
2008
2009
2010
2011
2012
2013
2014F
2015F
GDP
-0.3
-2.8
2.5
1.6
2.3
2.2
2.3
2.9
CPI
3.9
-0.4
1.6
3.2
2.1
1.5
1.7
1.8
Unemployment
5.8
9.3
9.6
8.9
8.1
7.4
5.8
5.6
Current Account / GDP
-4.7
-2.6
-3.0
-3.0
-2.9
-2.4
-2.4
-2.3
Fiscal balance / GDP
-4.6
-10.2
-8.5
-8.1
-6.6
-0.3
-2.9
-2.6
Policy rate
0.25
0.25
0.25
0.25
0.25
0.25
0.25
1.00
DXY
81.3
77.9
79.0
80.1
79.8
80.0
88.5
93.0
Eurozone Macroeconomic Forecast Table
2008
2009
2010
2011
2012
2013
2014F
2015F
GDP (% YoY)
0.4
-4.4
2.0
1.6
-0.7
-0.5
0.9
0.9
CPI inflation (% YoY)
3.3
0.3
1.6
2.7
2.5
1.5
0.5
0.8
Unemployment
7.6
9.6
10.1
10.2
11.4
12.3
11.5
11.3
-1.6
-0.2
0.0
0.1
1.4
1.5
2.3
2.5
-2.1
-6.4
-6.2
-4.2
-3.7
-2.8
-2.5
-2.3
Policy rate
2.5
1.0
1.0
1.0
0.8
0.25
0.05
0.05
EUR/USD
1.40
1.43
1.34
1.30
1.32
1.35
1.25
1.15
2008
2009
2010
2011
2012
2013
2014F
2015F
GDP (% YoY)
-1.0
-5.5
4.7
-0.6
2.0
1.7
0.8
1.1
1.4
-1.3
-0.7
-0.3
0.0
0.0
2.8
1.5
Unemployment
4.0
5.0
5.0
4.5
4.2
4.0
3.6
3.4
3.3
2.9
3.7
2.0
1.0
0.9
0.1
0.9
-1.9
-8.8
-8.3
-8.9
-9.9
-9.7
-8.0
-7.8
Policy rate
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
USD/JPY
90.6
93.0
81.1
76.9
86.8
105.3
118.0
121.0
Japan Macroeconomic Forecast Table
Sources: Bloomberg, CMS (HK)
1. US to continue moderate recovery: is the economy at escape velocity

yet?
The US economy has shown encouraging signs of recovery in 2014, and we currently view the
US most favorably among the major developed economies. In particular, unemployment
recovered notably faster than initially expected, and despite some remaining pockets of
weakness, was a driver for the recovery.
Although a weak 1Q14 from extreme weather conditions is likely to drag growth for the year as
a whole, growth gained traction starting in 2Q14, and we expect the current trajectory of
accelerating growth to carry forward into 2015.
Chart 1: US GDP bounced back strongly after weak 1Q14, set to accelerate further
in 2015
12
Forecast ->
1Q: 2.5% YoY
2Q: 3.0% YoY
3Q: 3.0% YoY
4Q: 3.2% YoY
10
8
6
4
2
0
-2
-4
-6
-8
US GDP growth (% YoY)
15
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
-10
US GDP growth (% QoQ SAAR)
The key catalysts for growth remain in a virtuous cycle of continued labor market recovery
stimulating consumption, the housing market, and hopefully economic investment, as well as
from capital flow entering the US economy. These factors should outweigh what should be
slightly less accommodative monetary and fiscal policies in 2015. A downside risk to keep in
mind would be the possibility of contagion, if economic activity slows in the other major global
economies, it may also create a headwind on US growth. At this point, the recovery may not
be at escape velocity, or strong enough to be self-sustained despite external
headwinds, meaning the US recovery may still be subject to external shocks.
In the US, we identify the following as some of the key issues to watch for in 2015:
1. When will the Fed start to raise interest rates? What frequency and scale will the rate hikes
have? What will the impact be on the real economy and the markets?
2. Can the improvement of the labor market continue into 2015 and drive consumption?
3. Will a potential moderation of other major global economies drag US growth?
4. With a newly elected Republican-controlled Congress, will policy gridlock be exacerbated or
eased? Impact will likely be seen more in 2016 fiscal budget.
5. Will another polar vortex causing extremely cold weather drag 1Q15 growth again?
We continue to view the US most favorably among the major developed economies. Overall, we
forecast 2015 GDP growth to rise to 2.9% YoY.
1.1 Policy may gradually tighten in 2015, but overall still accommodative; we expect rate
hike in mid-2015
The US is entering a phase of policy normalization following an extended period of very
accommodative policy; this is a sugarcoated way of indicating upcoming policy tightening. The
most important event for the US in 2015 is the timing of the first interest rate hike.
In accordance with the amendment of the Federal Reserve Act of 1977, the Fed has two core
goals, known colloquially as their Dual Mandate: the two goals are to achieve maximum
employment, and stable prices. With the labor market steadily recovering, highlighted by
unemployment falling to 5.8% in October, and with inflation forecasted to edge up further toward
the 2% target in 1H15, we expect a series of rate hikes to likely begin in mid-2015.
Chart 2: Job market has entered a stage of recovery, with
unemployment falling to 5.8%
600
12
400
10
Chart 3: Inflation below target but may escalate to exceed

2% in 1H15
6
5
4
200
8
-200
-400
-1
-600
-800
-2
14
13
12
11
10
09
08
07
06
05
04
03
02
PCE Inflation (% YoY)

Fed target inflation rate (%)
Non-farm payrolls (000s), LHS

Unemployment rate (%), RHS
01
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
-3
00
-1,000
In our view, there is likely to be a series of rate hikes (2-3) in succession to boost the Fed
Funds Target Rate to 1.0% by the end of 2015, but there will likely be a time gap between
each, with the gap between the first and second likely to be the longest to allow for the Fed to
observe the impact of the hike. It is also possible later rate hikes may be by a larger scale if the
economy strengthens enough. We expect as economic conditions allow, the Fed will eventually
try to steer rates to 3-4%, as evidenced by their long-term projections, but it is likely to take
several years to reach that range.
The impact of a series of rate hikes will be significant, as the first true move of
tightening (QE taper is merely a smaller stimulus rather than an actual tightening) in the
recent era of extraordinarily accommodative monetary policy. We view that monetary
policy normalization is likely to cause significant ripples in the financial markets and
some modest headwinds on the real economy, but given a well-planned and careful
communications strategy by the Fed, cautious incremental moves to allow for the
markets to process moves in a gradual and calm manner, and continued improvement in
economic fundamentals, these spillover effects should not be destabilizing.
Chart 4: Interest rate hikes set to begin after long period

of near zero rates
7
Chart 5: Federal reserve balance sheet ballooned after

QE programs
5,000
F
O
R
E
C
A
S
T
6
5
4
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
14
13
12
11
09
15
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
16
Fed Balance Sheet (USD bn)

MBS (USD bn)
Fed Funds Target Rate (%)
10
Treasury notes (USD bn)
Over the last several years, QE programs caused the Fed balance sheets to more than
double in size. It is possible that the Fed will also cease reinvestment of asset purchases
in late 2015, which will passively reduce its balance sheet. As the goal of policy
normalization is to increase long term interest rates, ceasing reinvestments may be a
method of pushing long term interest rates higher.
With that said, we expect the Fed will not be in a hurry to cease reinvestment, remaining
cautious amid a weak external environment.
In the meantime, the Fed has already started using less scrutinized tools such as the
overnight reverse repos (ON RPP) and the term deposit facility (TDF) to control liquidity
and impact short term market rates.
The Feds announced USD 300 bn reverse repo program to be conducted in December
2014, which will also test the impact of draining liquidity on the market and economy. The
goals of the policy were to test the effects of widening spread between the ON RPP rate and the
interest on excess reserves rate on money markets and the effectiveness of an ON RRP facility
in providing a floor for money market rates during policy normalization. ON RPPs are a form of
temporary open market operations (QE, for example was a permanent OMO) which involves
the Fed Trading Desk selling a security under an agreement to repurchase that security in the
future, and can be used to temporarily affect the size of the Federal Reserve System's
portfolio and influence day-to-day trading in the federal funds market.
The term deposit facility (TDF) is another tool used to manage the aggregate quantity of
reserve balances held by depository institutions. By increasing the term deposit facility, the
Fed removes bank reserves from the system, and drains liquidity; the 7 day TDF is usually
several basis points above the interest rate on excess reserves. The Fed has already been
quietly testing out the newest rounds of TDFs since 2013.
Thus far, these tools seem to have a limited impact on short term money rates, as the scale is
still smaller and designed for technical purposes. Moving forward, it is likely these tools may
be expanded to influence short term money rates.
It should be noted that monetary policy conditions will still remain quite accommodative relative
to historical levels, and the Fed is likely to be cautious with monetary policy normalization, as it
is very much possible that tightening policy too rapidly would take the wind out of the recovery.
Furthermore, we would like to emphasize that the Fed will tighten monetary policy only due to
strength in the economy; should the data suddenly show significant deterioration, there is room
for the Fed to reverse direction on policy at their discretion.
Moving on to fiscal policy, the US growth has been dragged by fiscal policy in the past several
years following the 2013 sequester. As 2015 is the second year of the two-year budget deal
brokered for FY 2014-2015, the fiscal drag should be similar to 2014. Overall, we view that
both public and private investment growth to date still remains below the long term trend.
Chart 6: FY 2015 budget expenditure breakdown
General
Government
3%
Other
Spending
7%
Chart 7: Interest rate payments are expected to balloon in

coming years, rate hikes to increase interest burden
900.0
Interest
5%
800.0
700.0
Transportati
on
5%
Protection
4%
Pensions
19%
616
474
392
400.0
Health Care
20%
Defense
13%
300.0
721
812
551
600.0
500.0
Welfare
8%
669
772
318
223
252
200.0
100.0
Education
16%
0.0
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Net Interest Estimate (USD bn)
Sources: US OMB, CMS (HK)
Sources: US OMB, CMS (HK)
There is also hope for the new Congress to be able to reach more bipartisan agreements and
pass more fiscal policy measures than the current Congress, which has been noted as one of
the least productive Congresses in US history. If the incoming Congress is able to come to a
longer term fiscal agreement (likely involving entitlement reform), there is a potential for an
upside risk of a streamlined or relaxed budget which would lead to increased fiscal spending in
the short term. With that said, we currently do not expect policy gridlock to disappear; the
Republican policymakers will likely be emboldened by the results of the midterm elections, but
with the president maintaining veto powers, significant policy changes are unlikely in 2015.
1.2 Dollar likely to maintain upward climb in 2015 and lead to more capital inflow
Monetary policy divergence widening occurred earlier than expected, as the BoJ stimulus
policies at the end of October as well as the ECB rate cuts and ABS purchases came months
before people had expected. This has led to a faster than expected rise of the dollar in 2014 in
the later months of the year.
We expect the appreciation momentum of the dollar to continue in 2015, as we expect the
monetary policy normalization process, as well as the continued improvement of economic
fundamentals will help boost the dollar via capital inflow. In our view, the pace of appreciation
may be slower in 1H15 before accelerating in 2H15, or approximately around when the series of
US rate hikes is likely to begin.
Chart 8: Dollar index has traditionally moved closely with interest rates
120
9
8
110
7
100
6
5
90
4
80
70
1
60
Benchmark interest (%), LHS
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
99
98
97
96
95
94
93
92
91
90
Dollar Index, RHS
Rate hikes will also influence capital flow across the world, particularly those which relied on an
interest rate differential between the US to attract capital flow. This effect may be magnified as
the worlds major central banks experience divergence in their monetary policy, with the US
beginning normalization while the ECB and BOJ ease policy further; the US benchmark rate of
0.25% is already higher than that of the Eurozone (0.15%) and Japan (0.1%), while just a shade
below the UKs (0.5%). If a series of rate hikes are made in relatively quick succession, this will
put the US benchmark rates significantly above most of its developed economy peers, meaning
developed market focused funds will find the US relatively attractive, and emerging economies
may also become significantly less attractive.
In the charts below, we can see that the capital flow into the US from mutual funds and ETFs
has a strong positive correlation with the strength of the dollar, and conversely, emerging market
capital flow data showed some negative correlation with the strength of the dollar.
Chart 9: Strength of dollar has highly correlated with

capital inflow
Chart 10: Emerging markets may face capital outflow with

rising USD, historical data showed negative correlation
1.5
120
120
1.0
110
110
0.5
100
100
0.0
90
(0.5)
90
0
80
Sources: EPFR, Bloomberg, CMS (HK)
14
13
12
11
10
09
08
07
06
05
04
03
02
01
US Capital Flow (% MoM), LHS
14
13
12
11
10
09
08
07
06
60
60
05
-6
(2.0)
04
70
03
70
-4
(1.5)
(1.0)
02
-2
01
80
Emerging Asia Capital Flow (% MoM), LHS

Emerging Europe Capital Flow (% MoM), LHS
Latin America Capital Flow (% MoM), LHS
DXY, RHS
DXY, RHS
Sources: EPFR, Bloomberg, CMS (HK)
Capital flow has already been returning to the US despite rates remaining at record lows,
particularly after the sheen on the emerging markets wore off over the past several years amid a
slowdown in China and political instability in the ASEAN region. This is a trend that is likely to
continue in our view: with Europe still mired in a weak and unsteady recovery, Japan attempting
to ward off stagflation with aggressive but short-sighted stimulus, and Chinas growth trajectory
slowing, the US is a relative bright spot in the major global economies. Expected
appreciation of the dollar will also add to the attractiveness of US assets.
Examining historical data over the past 25 years, we can see that the relationship between
interest rates and capital flow is not linear, but does show a loose correlation. As capital flow
data is far too volatile on a monthly basis, we chose a 6 month moving average to present this
data. During this recent era of low rates, net capital flow has correlated more closely with the
implementation of QE, as seen in the chart below.
10
Chart 11: Higher relative interest rates may lead to greater capital inflow, but
historical data is inconclusive
9
150
100
7
6
50
5
4
3
2
(50)
1
(100)
Benchmark Interest Rate (%), LHS
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
99
98
97
96
95
94
93
92
91
90
Net Capital Inflow 6M MA (USD bn),RHS
Regardless, between improving economic fundamentals and a series of impending rate hikes, it
is likely that capital flow will continue to return to the US, which should continue to benefit the
US financial markets and to a lesser extent the real economy.
1.3 Consumption should continue to drive growth on labor market improvement, but rate
hike may create headwinds
Overall, consumption has been relatively solid in 2014, slightly accelerating on a year on year
basis from 2013, but remaining below 2012 levels. We view that consumption should continue
to grow in 2015 for two main reasons. Firstly, continued improvement of the job market should
continue to support US consumption, and secondly, a stronger dollar will also make imported
goods cheaper for consumers. These factors should offset a likely drag coming from a rate hike
in 2015.
The US labor market improved at a faster than expected pace in 2014, with the headline
unemployment rate dipping below 6%, and nonfarm payroll data surging to recovery highs. 2014
was mostly a recovery at the level of quantity rather than quality. While there are still some
weaknesses in underlying labor market data, overall the trend is positive, and should continue
into 2015. We expect a slower recovery of the headline numbers, but a gradual improvement of
underlying data to show a gradual improvement of job quality as well as job quantity.
11
Chart 12: Nonfarm payrolls rebounded strongly while

unemployment dipped to lowest since July 2008
Chart 13: Underemployment remains a consideration, as

gap between U6 and headline shows quality of jobs
remained lackluster
600
12
400
10
20
18
16
200
14
12
-200
-400
10
8
6
-600
-800
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
-1,000
Gap between U6 and headline (ppt)

U6 Unemployment rate (%)
Unemployment rate (%)
Non-farm payrolls (000s), LHS

Unemployment rate (%), RHS
Improvements in the labor market and also improvement in households balance sheets will lead
to more supportive conditions for consumption.
Chart 14: Household debt burden declining and rise of disposable income growth
may boost consumption
14
14
12
13
10
8
12
6
11
10
0
9
-2
-4
Household debt service ratio (%), LHS
15
13
11
09
07
05
03
01
99
97
95
93
91
89
87
85
83
81
Disposable income growth (% YoY), RHS
The USD has been on an upward trend as monetary policy divergence continues in most of the
worlds major central banks. A stronger dollar will decrease the cost of imported products,
encouraging additional consumption.
With this said, the likely impending series of rate hikes will also take some of the wind out of the
consumption recovery. Big ticket discretionary spending which is traditionally installment based
(such as cars, high end electronic appliances, etc.) is the most likely to be significantly
impacted, as a rate hike will also likely spillover to make installment based purchases costlier.
12
Our analysis of past periods of rate hikes has indicated that the effect on retail sales is likely to
come with a slight lag of roughly 2-4 months, meaning that the US retail sector and companies
relying on sales to US consumers may begin to face headwinds in 4Q15 or so if the rate hike
process starts around the middle of the year.
Chart 15: Retail sales growth has been negatively correlated with benchmark
interest rate historically
15
9
8
10
6
5
-5
3
2
-10
-15
Benchmark Interest Rate (%), LHS
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
99
98
97
96
95
Retail Sales (% YoY, Lag 2M), RHS
Households may be influenced to save more if real interest rates rise, which will further
compound the headwind effect on consumption. As seen in the chart below, historically since
1980, household savings rates have been very closely correlated with real interest rates. The
recent few years may be the only clear exception where savings rates showed major volatility
despite declining real interest rates, which is likely explained by a more conservative outlook
following the financial crisis.
13
Chart 16: Household savings rates traditionally has strong positive correlation with
real interest rates
12
14
10
12
10
2
0
-2
Household savings (% of disposable income), LHS
14
12
10
08
06
04
02
00
98
96
94
92
90
88
86
-6
84
82
-4
80
Real interest rate (%), RHS
With that being said, the first several upcoming rate hikes impact on savings rates should be
relatively minute, mostly because the rate hike is unlikely to outweigh the rising CPI inflation,
and real interest rates should be incremental. Furthermore, it should also be noted that US
consumer culture has historically not been very savings focused, relative to many Asian
economies in particular; US average household savings as a % of total disposable income has
not topped 13% in nearly 40 years (1975). This trend may shift in the future, but is unlikely to be
seen immediately.
In summation, overall a series of rate hikes is likely to create some drag on retail sales, and
possible contagion is also a downside risk to the consumption outlook. Given the current
upward recovery momentum of the US economy, we still believe there is room for continued
improvement overall in the US consumption growth in 2015, but after a series of rate hikes and
as lagged effects begin to emerge in data, we expect consumption growth may moderate in
2016.
1.4 Investment growth may continue to edge up on improving housing market and
replacement of capital stock
Overall investment has recovered since the financial crisis. While there is some concern that a
rate hike will drag investment (as higher interest rates encourage saving and reduce the risk
adjusted rate of return), overall an improvement of economic fundamentals should offset this
effect, and as long as the US economy avoids contagion from the external environment,
conditions should still remain relatively accommodative for investment in 2015.
As mentioned in the earlier section on policy, public investment should be relatively stable in
2015 as the government enters the second year of a budget agreement.
14
Chart 17: Historically investment has positively correlated with interest rate
movements
Benchmark Interest (%),LHS
14
13
12
11
10
09
08
-25
07
06
-20
05
04
-15
03
02
-10
01
00
-5
99
98
97
96
95
10
94
93
15
92
91
20
90
Private investment (%YoY),RHS
In previous periods of rate movements, we have seen that private investment growth has
historically positively correlated with the benchmark rate, indicating that economic fundamentals
are a better predictor of investment than the benchmark interest rate, as rates are typically hiked
in times where fundamentals are strong and vice versa. A downside risk would be a situation
where the US economy is dragged by contagion and headwinds from monetary policy
normalization further hurt sentiment, which may lead to the opposite effect of a drop of
investment.
Chart 18: Home sales on recovering trend, but still below
pre-bubble levels
7500
1,600
Chart 19: Improving confidence has led to an increase of

housing starts in 2014, may pick up further in 2015
80
2,500
7000
1,400
6500
1,200
70
2,000
60
6000
1,000
5500
800
5000
50
1,500
40
1,000
30
4500
4000
10
0
New home sales (000s), LHS
Housing Starts (000s), LHS
Existing home sales (000s), RHS
NAHB Builder Confidence Index, RHS
14
13
12
11
10
09
08
07
06
05
04
03
02
00
14
13
12
11
10
09
08
07
06
05
04
03
3000
02
200
01
3500
00
400
20
500
01
600
On residential investment, recent improvement in the housing market has increased the
likelihood of further upward momentum of residential investment. As seen from the charts
above, recent housing market data including the National Association of Home Builders (NAHB)
15
confidence index and housing starts and sales data, the recovery of the housing market is on an
upward trajectory and this has translated into a higher number of housing starts in 2014, though
the pace of improvement remains gradual. With that said, we expect that a series of rate hikes
and the subsequent impact on mortgages will act as a headwind on the housing market, and
limit residential investment growth to modest levels.
Non-residential investment should continue on an upward trend, and may gain some steam in
2015. One major reason is that as companies have put off replenishing capital stock over the
past several years, and a combination of necessity and improved confidence should lead to
additional investment.
Overall, investment growth should continue to edge up and contribute to growth, but the
pace is likely to be modest.
1.5 Net exports may drag growth slightly amid stronger dollar and weak external outlook
Trade is a less significant driver of growth compared to consumption and investment in the US,
as the US persistently runs a current account deficit as a net importing country. We view several
key points to note regarding trade.
While global activity is likely to improve overall in 2015, there are likely some continued
headwinds for global trade for the US. Outside of continental North America, the other
major export destinations for the US such as the EU, China, ASEAN, and Japan are not
likely to see a significant bump in domestic demand in 2015, meaning in turn it is unlikely
that demand for US exports will rise significantly.
The USD may appreciate further in 2015, which would also impact the competitiveness of
US exports, acting as a further drag on exports. We expect net exports as a whole to
slightly drag GDP growth in 2015.
In contrast, the recent shale gas development has vastly decreased US energy imports,
and in terms of trade structure may decrease the import burden of the US economy.
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Chart 20: US trade deficit widened in 2014, still

significant
Chart 21: US export breakdown by region (2014 ytd)

40%
-10,000
30%
-20,000
20%
-30,000
10%
-40,000
0%
-50,000
-10%
-60,000
-20%
-70,000
-30%
-80,000
-40%
Canada
15%
Others
47%
Mexico
12%
Trade Balance (USD mn), LHS

Export YoY Growth, RHS
Import YoY Growth, RHS
European
Union
13%
Japan
3%
China
ASEAN 6%
4%
16
1.6 Key risks in 2015 remain tied to monetary policy and external environment
There are also some notable downside risks, mostly from potential contagion impacting trade
and financial markets. The Fed and the IMF warn that risks have not been adequately priced in
by the financial markets, and there is a risk of some correction if sentiment sours, similar to how
the Eurozone sentiment abruptly turned in 2H14.
We view that risks associated with monetary policy may escalate in 2015. US QE tapering, one
of the biggest perceived risks of the year, was carried out without much difficulty, concluding
asset purchases in October on schedule. However, while QE tapering was tightening in the
sense of reducing the pace of easing, in absolute terms the Fed was still injecting money into
the financial system as asset purchases continued.
2015 will mark the first real tightening with the first benchmark interest rate hike since 2006,
and ending an era of near zero interest rates. We view a rate hike will have a larger impact on
financial markets than on the real economy of the US.
Historically, we have observed brief periods of stock market downturns after a rate hike, but the
improvement of economic fundamentals usually outweighed the impact of a rate hike and the
historical correlation is actually positive rather than negative. Given the current unique situation
of divergent monetary policy direction from the major central banks, the downside risk may be
bigger than it was in the past. With that said, we believe the improving economic fundamentals
of the US will limit the downside risk.
Chart 22: S&P 500 historical performance vs benchmark rate

2500
9
8
2000
7
6
1500
5
4
1000
3
2
500
1
0
Benchmark Interest (%),LHS
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
99
98
97
96
95
94
93
92
91
90
S&P 500,RHS
US treasuries historically closely tracked the benchmark rate, but in the latest era of near zero
interest rates, the government bond yield has begun to move with QE instead. As a series of
rate hikes begins, we expect bond yields (particularly the 2 year bond yield) may move closely
with the rate, but any escalation of risk may push yields down as safe haven flows are likely to
flow to the US first and foremost. .
17
Chart 23: Treasury yields have correlated strongly with the benchmark rate
historically, with 2 year yield most sensitive
10
9
8
7
6
5
4
3
2
1
Benchmark Interest (%)
Treasury Yields-2yr (%)
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
99
98
97
96
95
94
93
92
91
90
Another concern for the US is if a slowdown of other economies will have a spillover effect on
US growth. While from the perspective of economic fundamentals the US looks to gain
momentum in 2015, it is possible a general downturn of sentiment globally may also create
headwinds on growth. At the moment, the Fed does not view possible contagion as a major
threat; FOMC minutes acknowledged a weaker external outlook, but viewed external situation
impact on domestic economy to be quite limited.
A special point to note in the US case may be potential downside risks stemming from the
recent decline in crude oil prices. Historically, a downward dip of crude oil prices would be a
welcomed trend for an energy importing country such as the US, but now presents some risks.
One factor which has been big in the recent US resurgence has been the shale gas industry,
and more affordability of crude oil may impact the shale gas industrys competitiveness; if
shales price competitiveness is diminished, it could reduce the viability of the industry and lower
investment which previously contributed to the US recovery.
Separately, according to meteorologists, initial signs of another polar vortex in 2015 leading to a
colder winter have emerged. 1Q14 growth was heavily dragged by the polar vortex, as an
unusually harsh winter led to less consumption and construction activity. If this factor emerges
again in 2015, 1Q15 growth may once again start off sluggish.
1.7 Conclusion
Though economic fundamentals look to be strengthening, downside risks to the scenario both
tied to domestic policy normalization and external headwinds remain a consideration. At this
juncture, we cannot confidently say the US has fully reached escape velocity yet, but a
moderate recovery is in progress, and we expect it to continue in the next several years.
We reiterate that of the developed economies, we view the US most favorably, as recovering
labor and housing markets as well as still accommodative (if turning toward tightening)
monetary and fiscal policy should combine to buoy growth further. Our 2015 GDP growth
forecast is 2.9% YoY.
18
Chart 24: US Macroeconomic Forecast Table
2008
2009
2010
2011
2012
2013
2014F
2015F
GDP
-0.3
-2.8
2.5
1.6
2.3
2.2
2.3
2.9
CPI
3.9
-0.4
1.6
3.2
2.1
1.5
1.7
1.8
Unemployment
5.8
9.3
9.6
8.9
8.1
7.4
5.8
5.6
-4.7
-2.6
-3.0
-3.0
-2.9
-2.4
-2.4
-2.3
-4.6
-10.2
-8.5
-8.1
-6.6
-0.3
-2.9
-2.6
Policy rate
0.25
0.25
0.25
0.25
0.25
0.25
0.25
1.00
DXY
81.3
77.9
79.0
80.1
79.8
80.0
88.5
93.0
19
2. Eurozone recovery to remain lukewarm, with rising downside risks

The Eurozone economy disappointed the markets lofty expectations in 2014, but is still set to
finish the year with weakly positive YoY growth, particularly after a weak 2Q14 was revised
upward and a 3Q14 GDP slightly exceeded market forecasts.
Chart 25: Eurozone GDP growth returned to positive YoY growth in 2014, ytd
performance in line with our forecast
6
Forecast ->
1Q: 0.7% YoY
2Q: 0.9% YoY
3Q: 1.0% YoY
4Q: 1.2% YoY
4
2
0
-2
-4
Eurozone GDP (% QoQ)
15
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
-6
Eurozone GDP (% YoY)
As we saw during the year, the market consensus forecasts were repeatedly revised downward
until roughly in line with our start of the year forecast. The main reason was both domestic and
external demand failed to live up to lofty expectations. Within the Eurozone itself, the
emergence of deflation as a significant threat has dragged consumption via inflation
expectations. Externally, initial projections were overly optimistic, as US growth was dragged by
a weaker than expected 1Q14, and as Japans recovery momentum faded following the
consumption tax hike.
A weak and uneven recovery should still continue in the Eurozone, mostly reflecting a gradual
recovery in Spain and the periphery countries and continuing relative outperformance of
Germany. Several countries have also shown signs of improvement from the austerity process
which heavily drained growth in 2012, and as structural reforms have improved the
competitiveness of various European economies.
20
Chart 26: Germany moderated in 2014, but remains the

key driver of Eurozone growth
Chart 27: Spain showed signs of recovery with hopes of

maintaining growth into 2015
0
0
-2
-2
-4
-4
-6
Germany GDP (% YoY)
Spain GDP (% QoQ)
14
13
12
11
10
09
08
07
06
05
04
03
02
01
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
Germany GDP (% QoQ)
00
-6
-8
Spain GDP (% YoY)
As seen from the charts below, France and Italy have both grown at low levels in 2014. We
emphasize that despite a rebound of Frances GDP in 3Q, this was driven by an accumulation of
inventories, while consumption and investment remained negative. The continued struggles in
France and Italy, as well as a potential relapse of select periphery countries present potential
downside risks.
Chart 28: France GDP surprisingly rebounded in 3Q14,
but underlying data showed continual weakness
5
Chart 29: Italy GDP has failed to reach positive levels

since 1H11, may remain near zero moving forward
6
3
2
0
-1
-2
-2
-4
-3
-4
-6
France GDP (% QoQ)
Italy GDP (% QoQ)
France GDP (% YoY)
14
13
12
11
10
09
08
07
06
05
04
03
02
01
-8
00
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
-5
Italy GDP (% YoY)
Low bank lending has been a symptom of lackluster economic activity across European
countries. In the region as a whole, borrowing demand is improving slowly but remains
lackluster despite very favorable conditions set up by the ECBs rate cuts and TLTRO program,
and banks continue to struggle to find qualified borrowers to lend to.
21
The Eurozone 3Q14 bank lending survey published at the end of October illustrated this trend
clearly; the indicator measuring credit standards for loans eased -2% (marking negative net
tightening, i.e. eased credit conditions) across the Eurozone, but the improvement for loan
demand has consistently undershot expectations. By country, the survey showed that borrowing
demand is slowly recovering in Germany, France, and Spain, but deteriorating further in Italy.
Chart 30: Weak lending continues to drag the economy, but signs of lending
demand gradually recovering
20
15
10
5
0
Eurozone M3 growth (% YoY)
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
-5
Eurozone loan growth (% YoY)
Eurozone CPI inflation (% YoY)
Moving forward in 2015, we believe the key points to watch for in the Eurozone include:
1. Divergent performances of various Eurozone countries is likely to continue, as countries
such as Germany and Spain may show improvement while France and Italys outlooks
remain bleak.
2. Will the deflation threat remain a major threat or will deflationary pressures decline in 2015?
3. Growing possibility of full-fledged QE in 2015, what will be the impact and timing of a
potential full-fledged QE?
4. Will there be a fiscal policy push to match aggressive ECB support? If so, risks for
exacerbating the debt crisis may resurface down the line.
5. Risks in the region have also risen, with downside risks prevalent. Will risks topple the
Eurozone back into recession?
Overall, we expect growth to remain steady in the Eurozone for a GDP growth of 0.9%
YoY in 2015, lower than current market expectations.
2.1 Policy direction in the EU to remain highly accommodative

Deflation emerged as a more considerable risk in 2014, as inflation dipped to just above 0 in the
Eurozone, with several countries already falling into deflation. Despite initially dismissing
deflation as a legitimate concern, the ECB ended up easing policy by more than expected at the
start of the year. While it still remains to be seen if the latest round of stimulus measures will
boost the economy as its effects gradually emerge, policymakers have become significantly
more downbeat, downgrading present and future growth forecasts.
22
The ECB has led the charge in the most recent series of policy actions to fend off deflation and
boost growth, cutting rates twice in 2014, restarting a new TLTRO program, and starting asset
purchases of covered bonds and ABS in a preparatory step for full-fledged QE.
Chart 31: ECB cut rates twice in 2014, including a cut to
push deposit rates to negative levels
Chart 32: TLTRO program started in September
900.0
800.0
700.0
600.0
500.0
400.0
300.0
200.0
100.0
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
-1
0.0
10/14
09/14
08/14
07/14
06/14
05/14
04/14
03/14
02/14
01/14
12/13
11/13
10/13
09/13
08/13
07/13
06/13
05/13
04/13
03/13
02/13
ECB Main Refinancing Rate (%)

ECB deposit facility (%)
ECB marginal lending rate (%)
Eurozone core inflation (% YoY)
LTRO outstanding (EUR bn)

LTRO repaid (EUR bn)
In terms of monetary policy, ECB president Mario Draghi has stated repeatedly the ECBs
willingness to act to prevent deflation, and has backed up his words with action. While we
expect this willingness to continue, the ECBs remaining tools are very much limited, with the
benchmark interest rate down near the zero bound. We have also observed that some of the
measures taken so far are not overly strong; the ECB has stated it would like to return balance
sheets to around 2012 levels; as of the start of November 2014, ECB balance sheets were
roughly EUR 940 bn smaller than the average level of 2012.
Chart 33: ECB targets returning monetary base to 2012
levels, indicating over EUR 900 bn expansion to come
Chart 34: ABS market remains too small for ECB

purchases to provide a significant impact
3,500
1400
100%
ECB Target
90%
3,000
1200
2,500
1000
70%
2,000
800
60%
1,500
600
40%
400
30%
80%
50%
1,000
20%
200
500
10%
14
13
12
11
10
09
08
07
06
ECB Eligible Asset Backed Securities (EUR bn), LHS

ABS used as collateral (EUR bn), LHS
% of ABS available for purchase, RHS
ECB Total Assets (EUR bn)
0%
04
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
05
23
As deflationary pressures may persist with weak commodity prices dragging down headline
inflation, and weak consumption keeping core inflation low, the general market expectation is for
the ECB to eventually to start a full-fledged QE program of government asset purchases in
2015, overriding German opposition. The odds for such an action have increased significantly
over the past year, as the Eurozone remains near deflation and growth remains weak. With that
said, we do not necessarily believe QE will solve all of the Eurozones ills, particularly given
Japans renewed struggles despite aggressive QE. We view that the impact of keeping the
possibility of QE as a potential policy support may actually be more useful than
implementing QE itself.
With that said, we can speculate on the possible timing for QE announcements. we identify
March 2015 as a possible month for such a program to be forced through, as the first
monetary policy meeting is likely to be spent debating the impact of earlier policy measures.
Due to the ECBs rotating vote system, if the vote is not passed in March, July would be
the first time Germany does not have a vote in 2015. If the discussions on the topic are
contentious, July may be more likely, as Germanys Bundesbank President Jens Weidmann (the
most vocal dissenter against QE) does not have a vote.
The ECBs voting system is made on a rotating basis, with the central bank presidents from the
largest five countries (Germany, France, Italy, Spain, and Netherlands) in one group (1 omitted
each month), and the other Eurozone countries central bank presidents in another rotating
group (3 omitted each month).
Chart 35: ECB voting rights rotation will leave Germany without a vote in July
2015
Group 1 country without a vote Group 2 countries without a vote
Jan
Spain
Belgium, Ireland, Greece
Feb
France
Ireland, Greece, Cyprus
Mar
Italy
Greece, Cyprus, Lithuania
Apr
Netherlands
Cyprus, Lithuania, Latvia
May
Germany
Lithuania, Latvia, Luxembourg
Jun
Spain
Latvia, Luxembourg, Malta
Jul
France
Luxembourg, Malta, Austria
Aug
Italy
Malta, Austria, Portugal
Sep
Netherlands
Austria, Portugal, Slovenia
Oct
Germany
Portugal, Slovenia, Slovakia
Nov
Spain
Slovenia, Slovakia, Finland
Dec
France
Slovakia, Finland, Belgium
Even in the case of QE being successfully initiated, the impact on the real economy may not be
overly significant. As any potential QE program would have to be split by the size of the country
(namely the contribution to the ECB), the lions share of the purchases would be in Germany
and France, which already have relatively low yields. While asset prices may climb following
QE, this may not necessarily translate to real economic growth, as seen by the Eurozones
performance in 1H14.
24
With that said, monetary policy will likely remain as accommodative as possible in 2015 and
should remain a support to growth. We currently expect Draghi to ultimately win the power
struggle and embark on QE, and it is possible that smaller incremental measures such as
further LTROs to boost lending may also be taken.
The Eurozone fiscal policy outlook is complex, as fiscal policy remains fragmented in lieu of a
fiscal union. Currently, the ECB, IMF, and various bodies are calling for increased fiscal policy
support from countries with the capacity to do so, with Germany as the most obvious and most
significant choice. We view that the fiscal drag may continue to grow smaller as the fiscal
consolidation processes ease.
Chart 36: Debt to GDP ratio remains at elevated levels, still rising overall in region
200.0
180.0
160.0
140.0
120.0
100.0
80.0
60.0
40.0
20.0
0.0
Eurozone
Germany
France
2011 Debt to GDP (%)

Italy
Spain
Portugal
Ireland
Greece

1H14 Debt to GDP (%)
With that said, the governments with room to elevate spending are also those who were more
fiscally responsible and less likely to engage any in stimulus spending. Given government debt
levels remain very escalated and given the debt crisis is still fresh in the minds of policymakers,
it is unlikely we will see a significant fiscal push in 2015.
On the policy side, Eurozone policy should remain supportive for growth. We expect
significant support from monetary policy to continue with odds of QE increasing, and for
the fiscal drag to be diminished further in 2015.
2.2 Euro may weaken further, with potential capital outflow from the region in 2015
In terms of the Euro, after persisting at high levels at the start of the year, the Euro declined
starting in 2Q14 as economic data persistently underperformed expectations and sentiment
experienced a downturn after early optimism.
25
Chart 37: Euro fell against the USD and GBP starting in
2Q as sentiment soured
Chart 38: Euro down significantly against most major

currencies in the year to date (as of Nov 27)
1.70
1.60
0.8
EURKRW
(4.90)
EURGBP
EURCAD
EURCHF
(1.99)
EURDKK
(0.27)
0.7
1.20
(5.14)
(3.98)
0.75
1.30
EURAUD
(5.93)
0.85
1.40
EURCNY
(7.90)
0.9
1.50
EURUSD
(9.25)
0.95
EURJPY
1.12
0.65
EURSEK
4.39
0.6
31.15
14
13
12
11
10
09
08
07
06
05
1.10
-20.00
EURUSD, LHS
-10.00
0.00
10.00
20.00
30.00
EURRUB
40.00
EURGBP, RHS
% change (ytd)
We expect a continued depreciation of the Euro in 2015, primarily reflecting several key
reasons:
Disparity of economic fundamentals may widen in 2015 as the US recovery may

accelerate at a faster pace than the Eurozones.
Existing ECB measures such as the ABS/covered bond purchase program, the TLTRO
program will continue to expand the ECB balance sheet, and there is also an increasing
possibility for additional easing such as QE in the Eurozone.
The US is very likely to hike rates in 2015, further widening the monetary policy divergence
and strengthening the dollar vs the euro. It is quite likely there will be a series of rate hikes.
The depreciation of the Euro and very cheap borrowing costs may also lead to some carry
trade from Europe, though Japan may remain a more favorable environment to conduct
carry trade.
With that said, we do not expect the pace to be as rapid as in 2014, as many of these factors
should have already been priced in. Our expectation is for the EURUSD to dip further to 1.15 in
2015.
2.3 Limited upside potential for recovery of Eurozone domestic demand amid continued
job market weakness
In the long term, revitalizing domestic demand is essential if the Eurozone is to fully recover its
growth. Consumption in the Eurozone has taken a battering due to a combination of austerity, a
weak job market and labor reforms, as well as a heavy downturn of sentiment. Most recently,
deflationary concerns have become another factor dragging consumption. We expect inflation
to remain at low levels in 2015, which may trigger continued pressure on the ECB to
push out QE.
26
Chart 39: Eurozone retail sales growth showed

consumption picture remained downbeat
Eurozone retail sales growth (% YoY)
14
13
12
11
10
09
08
07
06
05
04
03
02
14
00
-1
13
-6
12
11
-4
10
09
-2
08
07
06
05
04
03
02
01
01
Chart 40: Eurozone hovering near deflation in 2014,

pressure may ease slightly in 2015
Eurozone Inflation (% YoY), LHS
Eurozone retail sales growth (% MoM)
Eurozone Core Inflation (% YoY), LHS
On a YoY basis, we saw that Eurozone retail sales had indeed picked up in 2014, illustrating
that the turning point had been crossed and a weak recovery is in progress. Consumer
sentiment skyrocketed in 1H14, returning to near pre-crisis levels as strength in the financial
markets as well as real economy buoyed sentiment. With that said, the level of improvement for
actual consumption was less than what many had hoped for previously; sentiment had run too
far ahead of actual performance, and moderated sharply in the middle of the year.
Chart 41: Eurozone consumer sentiment surged before falling sharply mid-year
5
140
120
-5
100
-10
80
-15
60
-20
-25
40
-30
Eurozone business sentiment (LHS)
14
13
12
11
10
09
08
07
06
05
04
03
-40
02
01
-35
00
20
Eurozone consumer sentiment (RHS)
27
The limiting factor in the Eurozone consumption picture is the weak job market constraining
consumers disposable income. While most countries in the Eurozone have showed gradual
improvement in the jobs data, the pace has been slower than hoped for and has constrained
consumer spending. In addition to Germany which has maintained the most favorable
employment situation since the global financial crisis, a key exception may be Spain, which
has seen unemployment rate drop at a relatively fast pace in 2013-2014 and is beginning
to see some positive signs in domestic consumption.
Chart 42: Eurozone employment situation slowly
recovering but still weak, France is an exception
Chart 43: Weak real wage growth outside of Germany

continues to limit spending power
30
25
20
15
10
0
-2
14
13
12
11
10
09
08
07
06
05
04
03
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
Eurozone unemployment (%)

France unemployment (%)
Spain unemployment (%)
02
-4
Germany wage growth (% YoY)

France wage growth (% YoY)
Italy wage growth (% YoY)
Spain wage growth (% YoY)
Germany unemployment (%)

Italy unemployment (%)
Greece unemployment (%)
Furthermore, deflationary threats also acted as a headwind to consumption, as inflation

expectations declined and dragged sales. Various periphery countries are already in a state of
deflation, including Italy, Spain, Portugal, Greece, and Belgium. Moving forward in 2015, both
deflationary pressure and a weak labor market will still persist, meaning the upside
potential for consumption growth is limited. Domestic demand is likely to continue to
constrain growth at relatively lower levels in the short term future.
2.4 Investment remains significantly below long term potential, may stay downbeat in
2015
Gross fixed capital formation was the biggest drag on growth during the European debt crisis
and immediately following, as harsh government austerity severely cut public investment, and
as souring sentiment also dragged private investment.
There are several influencing factors on investment in the Eurozone. The first major factor is
regarding the interest rate environment; the ECB has cut the benchmark rates to historical lows,
with the main refi rate set at 0.05%, marginal lending facility at 0.3%, and deposit rate at -0.2%.
On a positive note, the historically low interest rates encourage investment by reducing the cost
of borrowing. However, to some degree this will also be offset by capital outflow caused by the
interest rate differential, a weaker Euro, and a lackluster macro outlook in the Eurozone. This
impact will likely be magnified in part as the US and the UK are expected to hike interest rates in
2015.
28
Deflation pressure will also drag investment, as companies are more likely to hold on to cash if
they anticipate deflation. With the ECB still struggling to prevent deflation (and as various
periphery countries are already in deflation), this is likely to remain an issue in 2015.
Additionally, the downturn of sentiment will also weigh on investment. While it is impossible to
accurately predict how sentiment will shift in 2015 as surveys are subjective, with the exception
of QE, there are limited upside catalysts for sentiment apparent at this stage, while various
downside risks exist.
A less favorable base effect will further limit the YoY growth figures for gross fixed capital
formation in 2015; 2014s growth looks to be weakly positive on a YoY basis, partly skewed by
2013s negative growth. This effect will phase out in the coming quarters, which may pressure
YoY growth figures.
One potential support for investment growth would be increased fiscal spending; while overall
we expect fiscal consolidation to continue region-wide, governments such as Germany with
relatively healthy balance sheets and a need to upgrade infrastructure may increase investment
slightly in 2015. With that said, just several years removed from the debt crisis, countries are
highly unlikely to be aggressive with fiscal stimulus and risk a relapse.
Overall, we envision a mixed picture for Eurozone investment in 2015, but overall the
pace of recovery should continue to be slow.
2.5 External demand situation should benefit from weaker Euro, but impact may be
modest as trade partners economies moderate
A combination of stronger growth in the US as well as a likely weaker Euro should provide some
level of support for exports in 2015. Analyzing the export breakdown of the Eurozone would
indicate that the US as the largest export destination should provide the bulk of the support for
Eurozone exports in 2015, particularly as the Euro is set to hover at weaker levels against the
dollar in 2015 than 2014.
While there may be a positive boost from the US, any improvement in external demand from the
other trade partners is likely to be limited relatively limited, particularly for countries such as
Japan which are also devaluing their currencies, and for countries such as China which are
experiencing growth moderation.
29
Chart 44: Mixed picture for Eurozone export destinations,

as Euro weakens but geopolitical tensions threaten trade
Chart 45: Historically export growth has negatively

correlated with strength of Euro
50
1.6
US
18%
40
30
1.4
20
10
Switzerland
8%
1.2
Others
53%
-10
-20
China
10%
-30
Russia
Turkey 6%
5%
EUR/USD, LHS
14
13
12
11
10
09
08
07
06
05
04
03
1.0
Export Growth (% YoY), RHS
As an energy importing region in general, the drop in oil prices should reduce import costs. With
crude oil prices dipping sharply and likely to remain at lower levels in 2015, we expect import
costs may decline and improve the Eurozones current account balance slightly. The overall
import breakdown of EU countries showed the imports of petroleum fuels took up approximately
a fifth of total imports.
The geopolitical tensions with Russia, as well as the current turmoil in the Middle East on the
border of Turkey may also be a potential catalyst for trade. In the case of tensions being
resolved in Russia, sanctions may be lifted, providing some relief for European agriculture
exports; current Russian bans on European produce have hurt various farmers across the
region. Turkey may also represent a downside risk; if the conflict with ISIS is exacerbated in
2015, regional stability may be threatened and may impact trade.
2.6 Risk outlook is balanced to the downside: deflation, reform fatigue, and geopolitical
risks remain significant
The key risk in the Eurozone is currently deflation, with the biggest concern being the Eurozone
may fall into Japanization, a prolonged period of low to negative inflation and minimal growth.
On the plus side, the ECB is cognizant of this risk and has acted aggressively to avert it;
aggressive monetary policy may stave off deflation but inflation is likely to remain at
relatively low levels for the foreseeable future. On the negative side, they are running out of
tools to deal with the threat. Demand remains lackluster amid stagnant wages and high
unemployment, dragging price pressures downward, and inflation expectations have also
dipped.
Fiscal policy also presents a risk moving forward, policymakers may soon be forced into a loselose scenario. After the ECBs supportive measures are largely exhausted, Eurozone
constituent countries face a choice of bolstering growth or continuing fiscal consolidation. Either
choice has potential risks; if countries choose to bolster growth with fiscal stimulus, they risk a
relapse into the debt crisis, and if they choose fiscal consolidation they may risk returning to
recession.
30
Reform fatigue and stagnation is another risk. The Eurozone has been through an extended
period of sluggish growth from the global financial crisis, and with many families living
standards declining amid a poor job market, there is a general sense of fatigue and less
patience for further reform bringing short term pain for long term gain. Some countries such as
Italy and France have failed to even fully start this process, and a lack of structural reform
(particularly in the labor market) will drag on their competitiveness. There is some risk that with
impatience, governments may choose to unravel the progress made with shortsighted policies
to boost growth or appeal to the populace. A general sense of reform fatigue would also drag
economic sentiment downward and discourage investment.
As mentioned earlier, geopolitical risks also remain a concern, primarily the situation with Russia
and Ukraine. Tensions remain elevated and there is a downside risk the situation will
deteriorate, leading to further sanctions or possibly even armed conflict. Furthermore,
independence movements in Spain and Italy may provide further downside risk.
In particular, Eastern Europe may be facing additional risk in 2015. Firstly, it faces risks to both
its external trade as well as its energy supply due to the Ukraine conflict. Secondly, a possible
slowdown in Germany will also have a spillover effect on these countries, as Germany is not
only a major trade partner but also heavily invests in Eastern European countries. Thirdly, as
emerging economies, Eastern Europe may be susceptible to a negative impact of capital
outflow caused by a US rate hike.
2.7 Conclusion
In sum, the Eurozone countries are experiencing a degree of divergence, with Germany
and Spain likely to outperform France and Italy in 2015. The recovery should remain
modest, and with few positive catalysts foreseeable, risks remain balanced toward the
downside.
We forecast the region to remain in a state of weak positive growth in the baseline scenario, and
expect 2015 GDP growth to remain relatively stable at 0.9% YoY.
Chart 46: Eurozone Macroeconomic Forecast Table
2008
2009
2010
2011
2012
2013
2014F
2015F
GDP (% YoY)
0.4
-4.4
2.0
1.6
-0.7
-0.5
0.9
0.9
3.3
0.3
1.6
2.7
2.5
1.5
0.5
0.8
Unemployment
7.6
9.6
10.1
10.2
11.4
12.3
11.5
11.3
-1.6
-0.2
0.0
0.1
1.4
1.5
2.3
2.5
-2.1
-6.4
-6.2
-4.2
-3.7
-2.8
-2.5
-2.3
Policy rate
2.5
1.0
1.0
1.0
0.8
0.25
0.05
0.05
EUR/USD
1.40
1.43
1.34
1.30
1.32
1.35
1.25
1.15
31
3. Japans 2015 growth to edge up on aggressive stimulus and current

account balance improvement, but long term concerns remain serious
Japan returned to recession in 2014 as growth in the middle of the year was dragged
significantly by the consumption tax hike in April as well as the beneficial effects from the earlier
stimulus policies phasing out. Furthermore, despite an uptick of inflation created by aggressive
monetary policy, wage growth remained muted, which has further limited consumption appetite.
Chart 47: Japan slipped back into recession after the tax hike in April 2014, but
should see growth edge up in 2015
15
10
5
0
-5
Japan GDP growth (% YoY)
15
14
11
10
09
08
07
06
05
04
03
02
01
00
99
98
97
96
95
-20
13
-15
12
Forecast ->
1Q: -1.0% YoY
2Q: 2.5% YoY
3Q: 1.6% YoY
4Q: 1.2% YoY
-10
Japan GDP growth (% QoQ SAAR)
Japans growth outlook weakened as 2014 progressed and it was clear the first round of
stimulus measures had failed to produce sustainable growth. However, two major measures
were announced in 4Q14 which should bolster 2015 growth and prevent growth from slowing
much further. The first was the aggressive expansion of monetary policy stimulus by the BoJ,
and the second was the announcement the scheduled consumption tax hike from 8% to 10% in
October 2015 would be delayed to 2017.
For 2015, we identify some major points to watch for in Japan:
1) Is Abenomics running out of time to set the Japanese economy on a sustainable long term
growth path?
2) Will the BoJ and government continue to push aggressive stimulus in 2015 or are they
running out of room to ease further?
3) Can policymakers successfully boost real wages on a sustainable basis?
4) Will Japans external trade situation change direction after dragging growth in 2013 and
2014?
5) What impact will the delaying of the scheduled October 2015 tax hike have?
Overall, we expect growth to register at 1.1% YoY in 2015 upon a more favorable policy and
trade outlook, with growth likely peaking in the middle of the year upon the base effect.
32
3.1 Japan policy stance likely to push for continued aggressive easing, but space for
further support may be limited
The first two arrows of Abenomics, aggressive monetary easing and fiscal stimulus, have been
the biggest catalysts for the Japanese economy since Abe entered office at the end of 2012.
Despite some mixed results and serious questions about exacerbating long term issues,
aggressive supportive policy has been useful in boosting financial markets and growth in the
short run. The aggressive stimulus has kept Abe in office for the longest tenure of any Japanese
prime minister since Junichiro Koizumi (April 2001-September 2006).
Regarding monetary policy, the BoJs policy will remain accommodative but is likely to be less
st
aggressive in 2015, after further expanding its stimulus earlier than expected on October 31 .
Currently, the BoJ is set to expand the monetary base by JPY 80 tn per year, as well as
purchasing JPY 80 tn of government bonds, JPY 3 tn of Japanese ETFs, and JPY 90 bn of
Japanese REITs per annum. The most recent voting breakdown showed division within the BoJ
committee, with 5 votes for and 4 votes against the measures, indicating there is some internal
resistance to further stimulus building. Consequently, the possibility for further aggressive policy
expansion has diminished in 2015; but we view that if circumstances dictate it is necessary, the
BoJ will continue to act aggressively.
In terms of fiscal policy, the biggest consideration is the delay of the scheduled consumption tax
hike. At this juncture, after 3Q14 GDP significantly disappointed market forecasts, as public
sentiment turned against the tax hike, and as Abes approval ratings dipped, the Japanese
government chose to delay the unpopular but necessary tax hike until April 2017. This will
improve 2015s growth outlook, but exacerbate long term fiscal problems.
Though the odds of massive fiscal stimulus declined after the delaying of the tax hike, there still
may be further fiscal stimulus packages to provide further support to the economy if necessary.
As the government delayed the sales tax hike, we expect a stimulus package smaller than the
JPY 5.5 tn fiscal stimulus implemented in 2014, with a JPY 2.5-4 tn range possible. It is also
possible that there will be increased public investment on infrastructure as we draw closer to the
2020 Olympics.
Regarding the third Abenomics arrow of structural reform, 2014 confirmed our negative bias.
Despite some measures such as increasing the quota for foreign workers, there was little
progress in achieving meaningful structural reform in other areas. With Abe seemingly mostly
focused on his own re-election and political goals, he appears willing to put off fiscal
consolidation to boost short term growth and his own approval ratings at the expense of long
term fiscal sustainability.
Abes goal to mitigate the government debt situation by increasing tax revenues via revitalizing
the economy will be a difficult challenge, as debt grows faster while growth has yet to pick up
on a sustainable basis.
3.2 Consumption will remain subdued unless real wage growth rises substantively
The main reason consumption remains downbeat is that real household income remained too
weak to drive growth. A gradual relaxation of immigration policy for professionals in December
2013 also increased the supply of cheaper foreign labor, further dragging overall wage levels.
Despite Japanese companies reporting favorable earnings, this has not translated to any
significant increases of wages, and the economy has not entered a virtuous cycle.
33
Chart 48: Virtuous cycle between consumption, wages, and earnings has not yet
emerged
Corporate
profits rise
Additional
sales and
production
Wages are
raised, jobs
are created
Consumers
spend
more
In general, a sense of caution prevents many Japanese companies from raising wages
significantly; as wage cuts are devastating to morale, companies will be conservative to hand
out raises if they are uncertain they can maintain the rate over the long term. Consequently,
consumption has failed to maintain an upward trend.
Chart 49: Real income growth is essential to boost private
demand
Chart 50: Personal consumption remains downbeat

6
10
8
6
4
0
-2
-2
-4
-6
-4
-8
-10
Real income growth (% YoY)
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
14
13
12
11
10
09
08
07
06
05
04
-6
Personal consumption (% QoQ, SA)
Private demand (% YoY)
Personal consumption (% YoY, SA)
Inflation expectations have been highly volatile over the past two years, mostly moving sharply
when the BoJ implements monetary policy. Historically, this has shown some correlation with
retail sales, as seen in the chart below. Though inflation expectations rebounded following the
BoJs unexpectedly early expansion of stimulus, it will remain challenging to keep inflation
expectations elevated.
34
Chart 51: Inflation expectations traditionally showed some positive correlation with
retail sales, recent inflation expectations rebounded as BoJ pushes stimulus
15
3.5
3.0
10
2.5
2.0
1.5
1.0
0.5
0.0
-5
(0.5)
(1.0)
-10
15
14
13
12
11
10
09
08
07
06
05
04
(1.5)
Core inflation expectations for upcoming 12 months (% YoY), LHS

Retail sales growth (% YoY), RHS
Japanese domestic consumption fluctuated significantly around tax hike in April 2014, surging in
1Q14 before plummeting dramatically in 2Q14. The postponing of the next tax hike originally
scheduled for October 2015 will greatly improve 4Q15 growth and should help bolster 2015
growth as a whole.
We can see from the chart below the impact of the consumption tax on retail sales began to
lessen within one quarter of the release, but the rate of recovery was yet to return to pre-tax
hike levels. The tax hike had the impact of sending the economy back into recession; as 2015
will now avoid this shock following the delaying of the tax hike, overall growth should be higher
than previously expected.
Chart 52: Consumption tax dragged growth sharply in April, growth has not yet
recovered
15
10
5
0
-5
09/14
07/14
05/14
03/14
11/13
09/13
07/13
05/13
03/13
01/13
01/14
tax rate hike in April
-10
Retail sales (% YoY)
35
Consumption growth should be positive in 2015, as consumption may recover slightly on a YoY
basis and contribute to GDP growth due to the base effect from the April 2014 tax hike.
However, unless real wages rise steadily and continuously, the conditions are not in
place for a rapid sustained rise of consumption.
3.3 External trade balance may be more positive for growth in 2015 on energy
developments
The primary driving force for central banks to depreciate their currencies recently has been to lift
inflation rather than boost exports. Consequently, while traditionally a weaker currency has been
a major driver of export growth, but we have not seen this trend so far in the JPYs recent
depreciation phase.
The main consideration for why a weakening yen will not necessarily help boost net exports is
due to Japans economic structure. As Japan as a landmass is not particularly resource rich, it
imports a huge proportion of the raw materials necessary for its manufacturing; with the
depreciation of the JPY, input costs will rise for manufacturers. Rather than absorbing the costs,
we can observe that Japanese exporters have passed on the costs as well; the export price
index has risen concurrently with the import index, meaning the depreciated yen has not
translated into price advantages for most Japanese exporters.
Chart 53: Trade balance remains negative as import
costs outweigh gains in exports
2,000
Chart 54: Import price index has surged with depreciation

of JPY
60
180
40
160
20
140
120
-20
100
-40
80
-60
60
1,500
1,000
500
0
-500
-1,000
-1,500
-2,000
-2,500
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
15
13
11
09
07
05
03
01
99
97
95
93
-3,500
91
-3,000
Trade Balance (JPY bn), LHS

Export Growth (% YoY), RHS
Import Growth (% YoY), RHS
Import Price Index (2010=100)

Export Price Index (2010=100)
Another reason has been the slowdown of export destination countries economies, which has
reduced demand for imports from all countries including Japan. After the US, Japans largest
trade destinations are China and the ASEAN region, both of which showed moderating growth
in 2014.
Furthermore, with the rise of South Koreas electronics industry which has gradually eroded and
then taken over Japans once dominant consumer electronics industry, there are few catalysts
for boosting Japans growth.
However, moving forward, there are some factors which may even out Japans external balance
in 2015. Most significantly, with commodity prices likely to remain at low levels or even weaken
36
further, the price pressure on imports may dip slightly, and counterbalance some of the impact
from the depreciating JPY boosting import prices. This is particularly the case for energy
imports; Japan is now the worlds largest importer of liquefied natural gas, and mineral fuel
imports take up approximately 30% of Japans total imports.
Despite some concerns from the public, there are also expectations for Japan to restart the
nuclear power plants which were shut down after the Tohoku earthquake. As seen from the
chart below, Japanese imports of mineral fuels rose considerably after the earthquake and the
shutdown of the nuclear plants. Restarting Japans nuclear power generation should
significantly decrease import demand for energy, which compounding with weak commodity
prices should reduce Japans import costs and reduce the trade deficit.
Chart 55: Imports of mineral fuels has risen significantly
since the earthquake
Chart 56: Mineral fuel imports compose a significant

portion of total imports
3,500
45
3,000
40
2,500
35
2,000
30
1,500
25
1,000
20
3-11 earthquake
10
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
15
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
500
Mineral fuels imports (% of total imports)
Mineral fuel imports (JPY bn)
On the export side, as our expectations are for China to moderate further, and the ASEAN
region to continue to grow at lackluster levels, demand for Japanese products from these
regions may be weak. With that said, import demand may rise modestly in the US and
possibly some Eurozone countries, and a weaker yen should provide a small tailwind for
exports.
3.4 Further downside pressure on Yen will persist, but pace of depreciation should slow
or stabilize in 2015
The Japanese Yen continued to depreciate sharply in 2014, though the bulk of the depreciation
was following the BoJ further aggressively expanding stimulus. While the BoJ is likely to stand
pat in the earlier months of 2015 while evaluating the impact of its latest actions, a series of Fed
rate hikes likely starting in mid-2015 will serve to widen the monetary policy divergence. We
view the JPY may still have room to depreciate further in 2015, primarily reflecting growing
monetary policy divergence in the US and Japan.
37
Chart 57: Yen movement has been particularly volatile in

recent years
Chart 58: Yen depreciated sharply following

st
announcement of stimulus on October 31
140
130
130
120
120
110
110
100
100
90
Oct 31
stimulus
Abe entering
office
90
80
80
USDJPY
12/14
09/14
06/14
03/14
12/13
09/13
06/13
03/13
12/12
09/12
06/12
14
13
12
11
10
09
08
07
06
05
04
03
02
01
00
03/12
12/11
70
70
USDJPY
With the stimulus already expanded in 2014 and some of the major catalysts such as the Fed
rate hike being priced in, we view the pace of JPY depreciation may slow in 2015 and may
return to some bidirectional fluctuation, particularly in the 1H15.
With interest rates at zero, the JPY depreciating further, a government bond market which is
providing negative real returns, its likely that there will be capital outflow from Japan due to a
combination of carry trade factors and some Japanese investors seeking better yields and risk
diversification elsewhere. With that said, the habit of many Japanese investors remains
conservative and domestic focused; actual domestic capital outflow should remain relatively in
check despite unfavorable conditions for investment.
We expect the USDJPY to pass 120 sometime in 2015, and may mostly fluctuate in the
range of 115-125 during the year, if Japans monetary policy remains in the status quo.
Overall, we expect the USDJPY to stabilize around 121 near the end of 2015.
3.5 Key risks remain centered on huge government debt and lack of structural reform
Despite policies improving the short-term outlook, the long-term outlook remains bleak. The
major risks remain the same for Japan in 2015. In the short term, the biggest risks for Japan are
centered on the possibility of public sentiment turning on Abenomics as it seems structural
reforms have been slow to take form, while gains from stimulus appear to be mostly temporary.
As inflation rises without a corresponding rise of wages, and as the weaker yen also boosts
costs of imports and overseas travel, many of the recent gains have actually come at the
expense of households.
Aggressive monetary policy easing has boosted the headline numbers for inflation, but inflation
expectations appear to be mostly tied to stimulus action and policy, as evidenced by a sharp
decline of inflation expectations after the tax hike, and the sharp increases during BoJ stimulus.
38
Chart 59: Inflation expectations recently volatile, shifting significantly with stimulus
4
3
2
1
0
-1
-2
14
13
12
11
10
09
08
07
06
05
-3
Core inflation expectations for upcoming 3 months (% YoY)
One of the biggest concerns is keeping interest rates down amid rising inflation; if government
bond yields rise significantly while growth remains lackluster, the fiscal situation will
deteriorate further and risks to stability will rise. The recent BoJ stimulus may be an added
measure to help keep yields low as the Japanese pension fund rebalances and cuts holdings of
pension funds; the pension funds are expected to cut approximately USD 250 bn of bond
holdings.
The long term concern remains on the governments unsustainable debt situation. The reason
Japan has not yet gone into a crisis despite having significantly higher debt levels than the
Eurozone is that almost all of the bonds are held domestically, where risk-averse investors are
willing to hold the bonds despite low to negative yields. However, given the current pace of bond
issuance, domestic demand is set to be insufficient to purchase all of the new bonds issued by
2020, possibly even earlier as the pension fund redirects investments.
Chart 60: Japan debt to GDP ratio higher than debt crisis countries
250.0
200.0
150.0
100.0
50.0
0.0
Japan
Greece
UK
Eurozone
Germany
US
1H14 Debt to GDP ratio (%)
39
This leads to two potential scenarios, both of which are dangerous: 1) bond purchases will
have to be increasingly reliant on foreign investment, which will make it more subject to
market forces and pressure. 2) the BoJ will print money and purchase government debt,
leading to a potentially permanent monetization of debt. While it is likely Japan can get
away with doing this to a certain extent, there is an extreme downside risk they will rely on this
to handle the debt situation and end up losing the credibility of their currency, such as in postWorld War I Germany. This appears to already be happening; the BoJ now purchases
approximately 70% of all new issued government bonds.
We note that the Japanese government bond situation may already be showing some warning
signs. As seen in the chart below, the real yields on Japanese bonds have fallen to significantly
negative levels after the recent rise of CPI inflation, significantly below historical levels.
Chart 61: Real bond yields have dipped to historically low levels as inflation rises,
which may encourage investors to pull out
10
8
6
4
2
0
Real yield at
historical lows
-2
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
-4
Japan 10-yr government nominal bond yield (%)
Japan 10-yr government real bond yield (%)
3.6 Conclusion
Overall, we expect that aggressive stimulus, a likely more favorable external position, the
delay of the consumption tax hike, as well as the base effect may lead to relatively
favorable numbers for Japanese growth starting in 2Q15 (1Q15 should be weak on a YoY
basis due to the tax hike distortion). In the short run, the odds of a significant drop in growth
are relatively small as the economy continues to be driven by stimulus, but the long term risks
have grown further.
Time may be running out for Abenomics as structural reforms and fiscal consolidation have both
been put off in favor of maintaining short term growth momentum; as seen in mid-2014 following
the tax hike, once this stimulus is slowed or reversed Japans momentum will significantly halter.
Skeptics of Abenomics may increase if the government does not show significant signs of
progress. We remain bearish on Japans outlook over the medium to long term.
40
Chart 62: Japan Macroeconomic Forecast Table
2008
2009
2010
2011
2012
2013
2014F
2015F
GDP (% YoY)
-1.0
-5.5
4.7
-0.6
2.0
1.7
0.8
1.1
1.4
-1.3
-0.7
-0.3
0.0
0.0
2.8
1.5
Unemployment
4.0
5.0
5.0
4.5
4.2
4.0
3.6
3.4
3.3
2.9
3.7
2.0
1.0
0.9
0.1
0.9
-1.9
-8.8
-8.3
-8.9
-9.9
-9.7
-8.0
-7.8
Policy rate
0.1
0.1
0.1
0.1
0.1
0.1
0.1
0.1
USD/JPY
90.6
93.0
81.1
76.9
86.8
105.3
118.0
121.0
41
4. Conclusion: Global economy likely to continue a gradual recovery, but

downside risks remain notable
After a stronger sense of optimism at the start of the year, sentiment has turned more cautious
going into 2015. Globally, divergence between countries growth trajectories and monetary
policy will widen, which may lead to additional shifts in capital flow in 2015.
We continue to view the US most positively of the major developed economies. An improving
labor market and lessened fiscal drag should bolster economic fundamentals moving into 2015.
The main focus in the US will remain on monetary policy normalization; the Fed should err on
the side of caution and hike rates only when economic fundamentals are strong enough to
support it. We expect the first rate hike in mid-2015. With that said, the rate hike may have
significant spillover effects on the rest of the global economy. We expect growth to accelerate
moderately to 2.9% YoY and for the dollar to strengthen further.
The Eurozone is set to return to positive YoY growth in 2014, as the region continues its slow
recovery from the debt crisis and austerity. Downside risks prevail in the region, as
deflationary pressures and unemployment remain troublesome, weighing on
consumption and activity. The ECB has mostly exhausted its conventional monetary policy
tools to little effect, and may be forced to introduce full-fledged QE in 2015; it is likely we will see
the Euro dip further in 2015. Eurozone countries performances are likely to vary moving
forward. In addition to Germany, Spain and other countries which pursued structural reforms
earlier on may see more favorable growth, while France and Italys struggles look likely to
continue. Overall for the region we expect growth to remain steady at 0.9% YoY in 2015.
We view Japans core story remains the same, with short term growth fueled by very aggressive
stimulus, while long term issues are exacerbated and ignored but looming on the horizon. We
st
expect the rate of stimulus to slow after the October 31 expansion of stimulus but for the BoJ
and government to remain ready to support the economy further if needed. The impact of the
stimulus, a more favorable trade outlook, a delayed sales tax, and the weak base effect
should see Japans growth accelerating from 2Q15 onward, and we expect growth to
edge up slightly to 1.1% YoY in 2015. With that said, long term risks remain significant, and
we remain bearish on Japan for the medium to long term.
On a whole, we expect the big developed economies to see growth edge up in 2015, but
downside risks have risen. We expect the recovery will likely remain modest and uneven as
economies continue to struggle to restore growth dynamism following the crisis years.
Challenges remain significant and we remain relatively cautious on the overseas
macroeconomic environment moving into 2015.
42
Investment Ratings
Rating
Definition
OVERWEIGHT
Expected to outperform the market index by > 10% over the next 12 months
NEUTRAL
Expected to outperform or underperform the market index by 10% or less over the next 12 months
UNDERWEIGHT
Expected to underperform the market index by >10% over the next 12 months
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The analysts primarily responsible for the preparation of all or part of the research report contained herein hereby certify that: (i) the views expressed in this research report accurately reflect
the personal views of each such analyst about the subject securities and issuers; and (ii) no part of the analysts compensation was, is, or will be directly or indirectly, related to the specific
recommendations or views expressed in this research report.
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China Merchants Securities 2015 Overseas Macroeconomic Outlook

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China Merchants Securities 2015 Overseas Macroeconomic Outlook

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Annual Report

Gradual global recovery process to face

China Merchants Securities (HK) Co. Ltd

increasing risks and challenges in 2015

Dr. Cliff Zhao, CFA

US: moderate recovery to accelerate, striving for escape velocity

Main focus in the US will remain on monetary policy normalization; we

forecasting rate at 1.0% in 2015.

At this point, the recovery may not be at escape velocity, or strong

Improving labor and housing markets, still accommodative policy, and

We view the US most positively of developed economies, forecasting

Eurozone: recovery to remain lukewarm, rising downside risks

Downside risks prevail in the region, as deflationary pressures and

Eurozone countries performances are likely to vary moving forward.

Impact of the stimulus, a more favorable trade outlook, a delayed sales

+852 3189 6122

+86 755 83295524

December 1, 2014 Monday

1.3 Consumption should continue to drive growth on labor market

1.4 Investment growth may continue to edge up on improving housing

2. Eurozone recovery to remain lukewarm, with rising downside risks

2.1 Policy direction in the EU to remain highly accommodative

2.3 Limited upside potential for recovery of Eurozone domestic demand

December 1, 2014 Monday

US Macroeconomic Forecast Table

Current Account / GDP

Fiscal balance / GDP

Eurozone Macroeconomic Forecast Table

CPI inflation (% YoY)

Current Account / GDP

Fiscal balance / GDP

CPI inflation (% YoY)

Current Account / GDP

Fiscal balance / GDP

Japan Macroeconomic Forecast Table

Sources: Bloomberg, CMS (HK)

December 1, 2014 Monday

1. US to continue moderate recovery: is the economy at escape velocity

US GDP growth (% YoY)

US GDP growth (% QoQ SAAR)

Sources: Bloomberg, CMS (HK)

December 1, 2014 Monday

Chart 3: Inflation below target but may escalate to exceed

PCE Inflation (% YoY)

Non-farm payrolls (000s), LHS

Sources: Bloomberg, CMS (HK)

Sources: Bloomberg, CMS (HK)

December 1, 2014 Monday

Chart 4: Interest rate hikes set to begin after long period

Chart 5: Federal reserve balance sheet ballooned after

Fed Balance Sheet (USD bn)

Fed Funds Target Rate (%)

Sources: Bloomberg, CMS (HK)

Treasury notes (USD bn)

Sources: Bloomberg, CMS (HK)

December 1, 2014 Monday

Chart 6: FY 2015 budget expenditure breakdown

Chart 7: Interest rate payments are expected to balloon in

Sources: US OMB, CMS (HK)

Sources: US OMB, CMS (HK)

December 1, 2014 Monday

Benchmark interest (%), LHS

Dollar Index, RHS

Sources: Bloomberg, CMS (HK)