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Exhibit 74: Japanese Net Purchases of Foreign Long-Term Debt by Investor Type Additional buying of foreign assets by Japanese investors could put further downward pressure on the yen. 12-Month Rolling Sum, % of GDP 2 Capital Into Japan I iT = Yen Appreciation 0 I I; x Bans Capital Out of ‘| m Pension Trusts = Yen Depreciation 4 Insurers @AIl Other* 2013 2014 2015 2016 Data through November 30, 2016. Note: 03 2016 data used to calculate 04 2016 share of GDP. Source: Investment Strategy Group, Haver Analytics. * All Other defined as central banks, general government, financial instruments firms, investment trust management companies and others. Yen For yen investors, last year was a reminder that markets often take an escalator up but an elevator down. After steadily appreciating almost 20% against the US dollar over the first nine months of 2016, the currency forfeited those gains in just weeks after the surprising US presidential election. Although the net effect was a small 2.8% appreciation last year—breaking a four-year streak of yen weakness—we do not believe further yen strength is likely. There are two reasons for this view. First, the BOJ will likely keep rates negative or close to zero this year by maintaining highly accommodative monetary policy. In turn, Japanese investors will continue to sell low-yielding domestic assets— placing downward pressure on the yen—in order to fund purchases of higher-yielding offshore assets (see Exhibit 74}. Japan’s Government Pension Investment Fund (GPIF)—which manages the world’s largest public pension—is a case in point, as it will need to sell domestic fixed income assets to reach its stated targets for foreign investments. Similarly, Japanese life insurers may increase their exposure to foreign currencies if interest rate differentials between the US and Japan remain wide. Second, Japanese corporations are likely to sell yen to invest in foreign operations with better growth prospects, which will also place downward pressure on the Japanese currency; such announcements are already on the rise."° This is not to suggest that the prospects for the yen are completely one-sided. The higher global rates we expect may make it difficult for the BOJ to maintain such low domestic yields, which would alleviate some of the downward pressure on the currency. Moreover, the many sources of global uncertainty in the year ahead could lead investors back into the yen as a liquid hedge, as we saw in the first half of 2016. Finally, after four years of weakness, the yen has reached undervalued levels. Given this more balanced risk profile, we currently have no tactical position in the yen. British Pound While broader financial markets were unperturbed by the UK’s decision to leave the European Union, the same cannot be said for currencies. Here, the Brexit vote sent the pound tumbling to its lowest level versus the US dollar since the 1985 Plaza Accord."! Although the pound has since recovered some of those losses, its 16.3% decline relative to the US dollar last year still ranks as the worst performance among all developed market currencies. The trajectory of the pound will be largely shaped by the evolution of Brexit negotiations. Even though six months have passed since the vote, there is no greater clarity on how the UK will ultimately exit the European Union and on what terms. Clearly a combative stance could see the pound weaken further as the market discounts lower potential growth in the UK. Alternatively, a more conciliatory negotiating position could lead to upside from today’s depressed levels. Barring a hostile negotiating tack from the UK government, the pound also has several other factors working in its favor. First, foreigners continue to buy pounds to invest in UK-domiciled assets and firms, which is vital to funding the UK’s sizable 5.2% of GDP current account deficit. In fact, one of the largest cross-border acquisitions last year was announced less than one month following the EU referendum.!” Importantly, higher-frequency data shows this merger and acquisition (M&A) momentum is continuing (see Exhibit 75). Second, the Bank of England may need to raise interest rates sooner than markets now expect, as erstwhile sterling depreciation is quickly feeding Outlook | Investment Strategy Group 63 HOUSE_OVERSIGHT_014596