Figure 1: Global Growth Slows in 2019

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Sources: State Street Global Advisors Economics, Oxford Economics, International Monetary Fund (IMF). The above forecast is an estimate based on certain assumptions and analysis made by the State Street Global Advisors Economics Team. There is no guarantee that the estimates will be achieved.

Figure 2: Chinese Economic Growth to Stabilize

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Source: IMF, State Street Global Advisors Economics. The above forecasts are estimates based on certain assumptions and analysis. There is no guarantee that the estimates will be achieved.

Figure 3: US Equity % of World Index Near 16-Year High

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— MSCI USA Market Cap as % of MSCI ACWI Market Cap

Source: FactSet, MSCI, State Street Global Advisors. Past performance is not a guarantee of future results.

Global Capital Markets OutlookBy Jerry Holly, Senior Portfolio Manager, Investment Solutions GroupPages 9–10:• Although economic growth downgrades were omnipresent

during the first quarter, the related dovish shift from central banks and easing trade tensions allowed for plentiful gains across global stock markets.

• US equities continue to look like a stable investment, but their relative outperformance has led them to make up a significant proportion of the global equity market — possibly constraining future relative returns.

• Concerns abound about the state of credit markets, including the size and composition of debt burdens around the world, but shorter-term we continue to see a constructive environment for certain asset classes like high yield bonds.

Emerging Markets OutlookBy Simona Mocuta, Senior Economist, Global Macro and ResearchPage 7–8:• While 2018 started out as a promising year, it ultimately

proved to be a difficult one for emerging markets as twin headwinds of Fed tightening and a deepening US-China trade dispute took a toll. Instead of an expected uptick, performance actually moderated by 0.1% to 4.6%.

• Risks stemming from the two challenges above appear to be fading; the Fed’s caution should alleviate pressure from EM currencies, while trade talks appear on a more positive footing.

• Growth as a whole likely slips incrementally on average this year; it will likely stabilize in the second half and rebound modestly in 2020.

Global Economic Outlook By Simona Mocuta, Senior Economist, Global Macro and ResearchPages 2–6:• Global economic growth appears likely to slow from 3.6% in

2018 to 3.4% in 2019, revisiting the lows of 2016. The latest downgrade to the outlook is primarily a function of dimmed expectations for the advanced economies, while prospects for the developing economies are not materially changed from several months ago.

• Energy prices retain an outsized influence on global inflation dynamics. Inflation in the advanced economies reaccelerated in 2017–18 alongside oil prices, but is expected to ease by 0.4 percentage point to 1.6% in 2019.

• Weaker data has led to a reassessment of the near-term outlook for monetary policy, by both markets and policymakers. The Federal Reserve shifted from projecting three rate hikes in 2019 to being on hold until 2020. Depending on how Brexit evolves, the Bank of England may be able to raise rates in 2019, but the ECB and Bank of Japan are unlikely to make a move this year.

ForecastsSecond Quarter 2019

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Global Economic OutlookBy Simona Mocuta, Senior Economist, Global Macro and Policy Research

Global Growth Slows But the Expansion ContinuesGlobal growth accelerated by half a percentage point to a six-year high of 3.8% in 2017, but gradually lost momentum over the course of 2018. Whereas 2017 was a year of “synchronized global growth”, 2018 brought into focus the “great divergence” between a US economy speeding up on the back of fiscal stimulus and a steadily-slowing rest of the world. The result was a two-tenth deceleration in global growth. A further slowdown is likely in 2019 as we are poised to revisit the 2016 lows. Amid this more sobering backdrop, it is important to recognize a few things. Firstly, a slowdown is not a recession. Secondly, while the US participates in the deceleration, it retains its relative outperformance vis-à-vis most other developed economies, particularly the eurozone. Thirdly, the latest downgrade to the outlook is primarily a function of dimmed expectations for the advanced economies, while prospects for the developing economies are not materially changed from several months ago. Finally, while growth slows on average in 2019, performance will likely improve over the course of the year so that we end the year on a stronger footing, which likely extends into a mild improvement in activity in 2020.

Energy prices have had and retain an outsized influence on global inflation dynamics. Inflation in the advanced economies reaccelerated in 2017–18 alongside oil prices, but is expected to ease by 0.4 percentage point to 1.6% in 2019, before picking up gently in 2020. Meanwhile, the gradual elimination of economic slack has helped revive core inflation measures in most economies. However, a generalized “inflation deficit” persists — a puzzling trend that has dogged central banks around the world, preventing many from taking any action toward normalizing policy.

Indeed, weaker data has led to a drastic reassessment of the near-term outlook for monetary policy, both by the markets and by policymakers themselves. Nowhere was the shift more dramatic than in the case of the Federal Reserve (Fed); last September it was still projecting three rate hikes in 2019, but has now declared itself on hold until 2020. We still view this as a (unusually long) pause rather than the end of the tightening cycle altogether, but there are clear two-way risks to the outlook. The Bank of Canada has been second behind the Fed in its normalization progress and we still expect it to push through another hike this year. Depending

on how Brexit evolves, the Bank of England may be able to do the same. By contrast, the European Central Bank (ECB) and the Bank of Japan (BoJ) have not been able to move at all thus far, nor will they do so this year. Meanwhile, the Reserve Bank of Australia (RBA) probably remains on hold as a modest fiscal stimulus injection minimizes the need for monetary policy intervention.

US: On The Down Slope Of The Mini CycleThe US economy had a good year in 2018, with GDP expanding by a solid 2.9%. Passage of the TCJA (Tax Cuts and Jobs Act) in December 2017 had a clear and positive effect on business confidence. The combination of corporate tax cuts, the immediate expensing of capital expenditures and a broad deregulation effort pushed capex intentions sharply higher during the first half of 2018. That these sweeteners were extended against the backdrop of solid demand and elevated levels of capacity utilization also helped. Meanwhile, the taxation of overseas profits provided an additional financing source as repatriation inflows exceeded half a trillion dollars during the first three quarters (versus $150 billion in 2017 as a whole). Unsurprisingly, then, private nonresidential fixed investment grew 7.0% year-over-year (y/y) in 2018, the most since 2012. Business equipment investment grew 7.5%, while investment in intellectual property jumped 7.7%, the most since 2000. Unfortunately, not every sector did so well. Residential investment continued to suffer from a combination of high input costs, labor shortages, and softer demand resulting from higher mortgage rates. It shrank incrementally throughout the year for the first annual contraction (-0.2%) since 2012.

Our belief is that there is more life in this capex cycle. However, the outlook has undeniably darkened, with evidence of momentum loss now several months old. There are a number of reasons behind this. The first has to do with uncertainties regarding US trade policy. It took much longer than initially expected to renegotiate the old NAFTA, and the US-China trade conflict escalated beyond what most observers anticipated in the early stages. Admittedly, since the G20 meeting in Argentina, we have avoided further tariff escalation. But this remains a very contentious negotiation, if only because it is a very difficult one. We continue to believe that a deal will be reached so that no additional tariffs are imposed, but there is no doubt that even the tariffs already in place are impacting spending decisions and causing supply chain disruptions. The longer this situation drags on, the more significant the impact is likely to be. Secondly, the combination of rising interest rates and lower oil prices has not been friendly to the housing and energy sectors. It is worth noting that nonresidential structures investment grew 3.4% q/q during the first half but contracted 1.0% during the second. Finally, external demand has clearly eroded. This is itself partly due to trade uncertainties,

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but numerous other factors — such as Brexit, China’s prior de-leveraging campaign, the decline in oil prices, and idiosyncratic factors such as Germany’s new emission standards — also played key roles.

Consumer spending has responded modestly to fiscal stimulus per se, likely because the bulk of the cuts benefits higher income individuals who have small marginal propensities to spend. However, household spending has been well supported by the very strong labor market, which has provided not only employment opportunities, but also a sense of employment security that has driven consumer sentiment higher. Meanwhile, the lifting of the discretionary spending caps led to higher actual expenditures on defense and non-defense. Having dipped slightly in 2017, government consumption increased 1.3% in 2018, while government investment jumped 2.7%, the most since 2009.

As the positive effects of the fiscal stimulus wear off and the current headwinds of softer global growth hit home, GDP growth likely moderates to 2.3% in 2019 and then further still in 2020. However, this leaves the US still as the growth leader among the large developed markets — matched only by Australia, but still well ahead of the eurozone and Japan. In fact, the expected profile of global growth in 2019 is one of a synchronized slowdown rather than a true “global convergence. How about a recession? While the risks of a recession cannot be dismissed — particularly in an expansion that by mid-2019 would become the longest ever in US history — it is not our baseline scenario.

US InflationInflation has been quite volatile over the past two years, and while most measures of core inflation are now close enough to the 2.0% target, it remains too soon to declare victory. Nevertheless, noticeable progress has been made over the last year and we do not see the latest retreat in headline inflation as portending serious weakness in the core measures. Indeed, whereas the slowdown in inflation during the first half of 2017 affected both headline and core inflation metrics almost simultaneously (reflecting introduction of unlimited wireless telephone plans, an unusual abundance of used cars coming off lease, and seasonal declines in apparel prices), the most recent pullback seems to be much more the direct result of a decline in oil prices during October–December (halfway retraced since then). Thus, whereas headline CPI (consumer price index) inflation touched a 29-month low of 1.5% y/y in February, the core CPI inflation rate has remains above 2.0% y/y and core PCE (personal consumption expenditure) inflation remains close to 2.0% (1.8% as of January). Meanwhile, wage inflation has strengthened over the past year: the employment cost index hit a post-recession high of 2.9% y/y in the fourth quarter, while average hourly earnings touched a post-recession high of 3.4% y/y in February. Although it took much longer than

anticipated, it appears that the tight labor market is finally generating some wage inflation…the Phillips curve (which graphs the relationship between unemployment and wages) may yet be resurrected.

Fed’s Dovish ShiftThe Fed’s dramatic dovish pivot in March appears somewhat incongruous with this backdrop. The new “dot plot” implies no hikes at all in 2019, and only one more in 2020. Back in December, the Committee anticipated two hikes this year…in September it anticipated three! How should we read this change? There is no doubt that, following nine rate hikes, the Fed can afford to pause since, unlike most key central banks, it’s already a long way along the normalization path. The real question is whether it has actually come to the end of that road. We do not believe so. But, especially in light of the violent market reaction to the December hike (the Federal Open Market Committee (FOMC) may not publicly admit it, but they most likely wish they hadn’t hiked then), the Fed is rightly very worried about inverting the yield curve. The Fed is therefore in full risk management mode, operating under a “do no (further) harm” mentality. The thinking has clearly changed from “we will move unless we are forced to stop” to “we will move only if we have to and can do so.” This means the Fed has to answer two questions: (1) will they have to? (2) will they be able to do so?

On the first question, we think the answer is yes. The Committee seems to agree, since a majority of members do expect another hike in 2020. While it will take a while for this to materialize, we do anticipate global (and domestic) growth to reaccelerate from the second quarter onward. Meanwhile, inflationary pressures seem likely to continue to build, starting with wages. While we’ve long argued that the Fed needs to lower its NAIRU (non-accelerating inflation rate of unemployment) closer to 4.0% — which they have been timidly doing — even under their new, weaker forecasts, the labor market continues to operate in an extremely tight environment.

We’d love to believe that there are a lot of people still waiting to re-enter the labor force, and we are delighted that the labor force participation has indeed ticked higher, but the demographics are such that one needs to keep expectations in check. And if wage inflation continues to rise, pricing power should strengthen, and this should eventually translate into higher CPI inflation. This is precisely why central banks argue that if they wait to see “the whites of the eyes of inflation”, they’ve waited too long. Still, given evidence of a global slowdown, given the curve inversion issue, and given the Fed Funds rate is already at the low range of the perceived neutral level, the Fed is willing to let the market see the whites of the eyes of inflation for itself, rather than convince the market that inflation is indeed near. Seen from this perspective, the odd one-year gap built into the new dot plot starts to make some sense. Of course, this does not resolve the puzzling fact that the FOMC does not expect the Fed Funds to even reach the neutral level by

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the end of 2021. Does this mean that the current expansion just keeps going? Or does it mean that, in reality, the Fed believes the neutral rate to be lower than where they tell us it is? Both scenarios are possible, but in truth we don’t think the Committee itself has definitive answers.

An additional dovish surprise in March was the announcement that the pace of the balance sheet runoff will be reduced starting in May and that the runoff will end altogether in September. Since the Fed intends to ultimately return to a pre-crisis situation of only holding Treasuries on its balance sheet, agency debt and mortgage-backed securities will be allowed to continue to run off and the Fed will start buying Treasuries again in October.

Eurozone: From Elation To Despair?In 2017, the eurozone was the undisputed biggest positive surprise of the world economy as growth accelerated to an impressive 2.5%, the best since 2007 and well above potential. Fast forward a year and the story has completely reversed. Some deceleration was expected — bursts of above-potential growth, especially when of such magnitude, rarely last. But the slowdown has been much more severe than most observers had braced for. Growth slowed from a quarterly pace of 0.7% in 2017 to 0.4% q/q during the first half of 2018 and then to 0.2% in the second half. Full-year GDP growth — which in mid-2018 was seen reaching 2.2% — came in at 1.8%. And 2019 may be worse as growth likely cools further to 1.3%.

Both the weak and the strong are hurting in the current eurozone downturn. Germany will grow 1.1% at most this year, which seems good only in relation to Italy’s near-stagnation. By the end of 2018, it had become hard to distinguish between the performance of Italy and Germany: Italy entered a technical recession, while Germany barely avoided one. There is more pain to come, if one judges by the March PMI for Germany: at 44.1 points, the index is now the lowest since 2012 — readings below 50 are indicative of contraction.

Despite the current shared woes, however, there has been a marked divergence between the three big eurozone economies over the longer course of the post-GFC recovery. Germany has boomed, with the unemployment rate falling steadily since mid-2014 to just 5.0% currently (the lowest in the near-30 year history of the series). France has generally lagged, with the (mainland) unemployment rate not beginning to fall until the second half of 2015, and still at an elevated 8.8%. And, Italy has really struggled, with the labor market improvement not beginning until 2015 and proceeding at a very modest pace. It’s taken four years to reduce the unemployment rate by 2.5 percentage points and it’s still above 10%!

A saving grace in the otherwise downbeat eurozone picture is that much of the current weakness reflects negative changes in external demand as well as idiosyncratic factors

such as Germany’s new emissions standards. We had long argued that Brexit is a problem not just for the UK, but for continental Europe as well. On assumptions that some of these challenges are overcome in coming months, there is reason to anticipate a recovery during the second half, at which point y/y comparisons will have also become far more favorable. Meanwhile, the steady if unimpressive labor market healing of the past several years should continue to anchor domestic demand by stabilizing labor income.

As has been the case everywhere, headline consumer price (CPI) inflation has closely reflected the evolution of oil prices over the last several years. In early 2017, it accelerated sharply to 2.0% year-over-year (y/y), while core CPI inflation (which excludes food and energy) continued to drift sideways around 1.0%. Since then, the headline has continued to oscillate with oil prices (which is why it moderated to 1.5% y/y in early 2019), while core hasn’t moved much. Indeed, it was still just 1.0% y/y as of February. Progress on inflation is likely to be slow. The core measure is unlikely to move materially above 1.0% for some time yet given the backdrop of softer growth. Meanwhile, the headline dips to 1.5% in 2019, largely on account of oil prices.

After an abortive attempt to raise policy interest rates early in the recovery, the ECB eased progressively, with the deposit rate falling to zero in 2012, -20 basis points in 2014, -30 basis points in 2015, and to -40 basis points in March 2016. It also introduced a genuine QE program in January 2015, and subsequently made a slew of adjustments and enhancements to it. Then, in early 2017, growth picked up and the threat of a broad-based deflation receded, prompting the Bank to change direction. In April, it began by “tapering” the quantity of assets purchased from €80 billion to €60 billion a month. By January 2018, it tapered to €30 billion a month, and by October to €15 billion. The program ended in December (reinvestments will continue), shifting monetary policy focus away from QE and back to traditional interest rate policies.

However, the ECB’s hopes of initiating genuine policy normalization have been thwarted again. In response to the region’s sharp slowdown, the Bank altered its forward guidance to indicate the expectation that rates will “remain at their present levels at least through the end of 2019.” Previously, this had been “through the summer of 2019.” Additionally, the Governing Council announced a new set of quarterly targeted longer-term refinancing operations (TLTRO-III) scheduled to run from September 2019 to March 2021, each with a two-year maturity. The Governing Council also expects to continue fully reinvesting principal proceeds from asset purchases “for an extended period past the date when it starts raising the key ECB interest rate.” Until eurozone inflation reaches escape velocity, the ECB may have a tough time escaping its current ultra-low rate policies.

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UK: Trying To Cope With Brexit ChaosThe British economy proved more resilient than anticipated following the result of the referendum on EU membership in June 2016. Indeed, despite the surprise, GDP rose 1.8% in 2016 largely because of an improvement in consumer spending. And just as that faded, exports picked up on the lagged effects of sterling’s devaluation to keep growth buoyant in 2017. However, momentum waned in the early part of 2018, only to re-accelerate in the second and third quarters on a combination of the World Cup, Royal Wedding, and unusually warm weather. Nevertheless, sluggish real wage gains and fragile home prices (particularly in London) have hindered consumption, while the chaos currently surrounding Brexit — especially the persistent possibility of a no-deal outcome — has weighed on business sentiment and investment. Hence, the economy advanced just 1.4% in 2018, the twin lowest since 2012.

Assuming the cliff-edge is avoided, and the UK enters into a transitional period — effectively retaining membership — growth does not slow any further. However, considerable damage to investment has already been done: fixed investment was flat last year, the worst performance since the Global Financial Crisis. Repeated delays and attempts to push back the deadline do not, in our view, make reaching an ultimate agreement any easier since the Brexit the UK seems to want amounts to an unsolvable puzzle (the equivalent of the “impossible trinity” in economics). The UK cannot retain full free access to the European market without also accepting the free movement of people (even though the EU may offer some concessions), and it cannot drive its own trade agreements without somehow imposing a border between Ireland and Northern Ireland. Therefore, while the current delays have the benefit of at least avoiding a “no deal” outcome for the time being, there is the downside of prolonged uncertainty. Still, we remain optimistic that, given the tremendous negative impact on both UK and eurozone economies, all efforts will be made to avoid such an outcome. Unfortunately, even if that is the case, the sharp growth slowdown in the eurozone, combined with lower global growth, means a deal will come at a time when its economic benefits (in terms of reviving business investment and consumer spending) may be greatly tempered. Therefore, we now expect growth to remain anemic at 1.4% this year, before picking up to 1.8% in 2020. There are considerable two-way risks to these projections, however, and we will of course revisit these numbers accordingly. Despite such sluggish growth over the next two years, the labor market likely remains tight, with the unemployment rate continuing to hover around a multi-decade low of 4.0%.

Inflation accelerated sharply in 2017 on a combination of rising oil prices and the depreciation of sterling following the referendum result. Indeed, headline consumer price inflation jumped 2.0 percentage points to 2.7%, by far the highest in the G7. Oil prices rose about 80% between the

beginning of 2016 and the end of 2017, contributing to an acceleration of inflation around the G7. But, the UK was simultaneously buffeted by a precipitous drop in sterling, which plunged from around $1.50 to $1.20 between June and September 2016. Fortunately, such an exchange rate movement had only a temporary effect on inflation and that is now beginning to fade. Lower oil prices have also contributed to a disinflationary push in recent months. The combination of more favorable base effects, stronger sterling, and weak growth should help push inflation from 2.5% in 2018 to 1.9% in 2019 and 2020. But a no-deal Brexit might send sterling tumbling, and wage inflation has picked up of late, with average weekly earnings recently hitting 3.5% y/y, the highest since the Global Financial Crisis.

The Bank of England cut the Bank Rate to help bolster the economy in the aftermath of the referendum, but has since changed course. Moreover, unless there is a no-deal Brexit we expect the BOE to continue tightening gradually. Shortly after the referendum shock, the Bank cut its policy rate 25 basis points to just 0.25%. It maintained that rate for 15 months, before hiking 25 basis points in November 2017. It followed with another hike in August 2018, leaving the rate at 0.75%, the highest since 2009. Assuming an agreement is reached that ushers in a transition period, the BOE seems likely to hike once in 2019, and at least once more in 2020.

Japan: Steady, But SlowThe Japanese economy surprised to the upside in 2017, when real GDP growth reached an impressive 1.9% y/y, but struggled last year amid a string of natural disasters — including an unusual combination of drought and floods. Still, despite outright contractions in the first and third quarter, a larger-than-anticipated rebound in the fourth quarter helped the economy grow 0.8% in 2018. The problem this year is that exports are increasingly challenged by slower overseas demand — both in specific markets such as semiconductors and autos, but also more broadly due to second-hand effects of the US-China trade dispute. In turn, the softer export outlook threatens to undermine capex spending, exacerbating downside risks. We are indeed carefully watching business surveys for signs about the potential severity of this effect. Against this more downbeat backdrop, private consumption remains well supported by a strong labor market and steady — if not stellar — wage gains. We even see the potential for some front-loading of consumption ahead of the Value Added Tax (VAT) increase scheduled for October. The combination of weaker external demand and resilient domestic demand results in uninspiring GDP growth of 0.7% in 2019. Typically, a VAT hike tends to depress demand in subsequent quarters, but this is less likely to be the case this time around due to the offsetting fiscal measures the government is planning. Additionally, increased spending surrounding the 2020 Olympics should also provide support, limiting the downside.

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While headline GDP growth continues to lag most other developed economies, there are some signs that “Abenomics” (Prime Minister Abe’s macro-economic policy package containing the so-called three arrows of monetary stimulus, fiscal stimulus and structural reform) is having some positive impact on economic performance. One striking development has been the notable uptick in female labor force participation. Among the working age population, Japanese female labor force participation now exceeds that of the United States. We credit government policies on improving the affordability of childcare for this impressive achievement that is especially critical given Japan’s otherwise troubling demographics.

One area where Abenomics has clearly not delivered so far has been on inflation. There were false starts in 2013–14 and again in 2017–18. For instance, inflation accelerated in late 2017–early 2018, with headline consumer price inflation exceeding 1.0% through March and then again from August to October. However, it has since completely relapsed amid lower energy prices. Underlying inflation has also been languishing. Both the headline and national core (which excludes only fresh food products) have hovered around just below the 1.0% mark. The new Bank of Japan (BoJ) core (which excludes fresh food and energy) — has been steady at just below 0.5%. We retain the expectation that, eventually, the very tight labor market (unemployment is at 2.5%, the lowest since the 1990s) will translate into sufficient wage growth to push broad inflation higher. Wage inflation had indeed turned notably higher over the course of 2018, reaching multi-decade highs (though this still only meant 1.5% y/y). However, momentum has recently fizzled out so it remains to be seen whether the 163 job vacancies available

for every 100 applicants mean the labor market is tight enough to ignite wage inflation in a sustainable manner. While we await such evidence, we see headline inflation settling around 0.9% in 2019 before accelerating to 1.2% in 2020 on the impact of the VAT hike.

Because of the lack of progress on inflation, the BoJ’s hands are tied, with no meaningful change to policy anticipated before 2020 at the earliest. In 2016, the ongoing failure to boost inflation prompted the Bank to conduct a comprehensive assessment of its policy actions. And in light of that, it changed the policy framework yet again, introducing “quantitative and qualitative easing with yield curve control,” under which it tried to control the shape of the yield curve by establishing a negative short-term interest rate (of -10 basis points) while simultaneously targeting a zero percent yield on the 10-year Japanese Government Bond. In July 2018, the Bank made some technical adjustments to this framework meant to allow it to maintain ultra-low interest rates for longer. It also formally introduced forward guidance, all in an effort to override the effects of prolonged deflation on inflation expectations. It is a gargantuan task. Investors had been speculating about a possible change (increase) to the Bank’s target on 10-year bond yields (more to boost the profitability of the financial sector than impose restraint), but holding the line seems to be more prudent for the time being. And so, it should not be surprizing that the BoJ is alone among the major central banks in not even discussing an exit, let alone its specifics. On the contrary, a lack of progress on the inflation front might induce the BoJ to undertake additional stimulus measures in late 2019 or early 2020.

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Emerging Markets OutlookBy Simona Mocuta, Senior Economist, Global Macro and Policy Research

Emerging Markets: Regaining Balance?While 2018 started out as a promising year, it ultimately proved to be a difficult one for emerging markets as the twin headwinds of steady Fed tightening and a deepening US-China trade dispute took their toll. Early expectations of a modest uptick in growth were therefore dashed and performance actually moderated by a tenth to 4.6%. Notwithstanding considerable current weakness, however, there are reasons to anticipate some improvement over the course of 2019. Risks stemming from the two challenges above appear to be fading. The Fed has essentially taken itself out of the equation for the time being, which should alleviate pressure from EM currencies and their respective central banks. This in turn should open the door for a slight tilt towards more supportive domestic monetary policies as the year advances. While undeniably complex and contentious, trade negotiations between the US and China have embarked on a more positive trajectory post the G20 summit in Argentina. This shift in tone underscores our key assumption, which is that enough progress will be made towards a deal that there is no further tariff escalation from this point onward. Investors appear to share this more sanguine view as data from the Institute of International Finance show an upsurge in portfolio capital inflows into emerging markets during the first two months of 2019. Nevertheless, considerable damage has already been done by the trade conflict, while sharply weaker growth in Europe and a slowdown in the US exacerbate the challenges. Thus, growth for the region as a whole likely slips incrementally further on average this year; it will likely stabilize in the second half and rebound modestly in 2020.

China: Growth Deceleration Unfolding, But No Further Downgrades After a strong 2017, when Chinese growth accelerated a tenth to 6.8%, momentum waned sharply during the second half of 2018. By the fourth quarter, GDP growth touched 6.4% y/y, the lowest since early-2009. Even before the ratcheting up of the trade dispute with the US, we were expecting growth to moderate amid a multi-year deleveraging effort. With those trade tensions hitting home the policy calculations have changed. Deleveraging

has been put on the backburner for now, with fiscal and monetary policies turning more supportive in order to shield the economy — especially employment and domestic consumption. Recognizing the tougher operating environment, the government has recently lowered its growth target from “around 6.5%” last year to 6.0–6.5% in 2019. This, however, simply brings the government’s projections close to our own expectations. Given our assumptions about the directional evolution of the trade talks, and given the more supportive domestic policy backdrop (focused on tax cuts and fee reductions for individuals and corporations), we see no compelling reason to further reduce our 6.2% growth forecast for 2019. In this respect, China actually stands out amid most other economies where incoming data had forced such downgrades. That said, the medium-term trajectory for China remains one of moderate deceleration in line with a declining potential growth rate.

India: Old Weaknesses Re-emergeThe domestic policy backdrop has turned more supportive in India as well, but how effective it will be in reviving activity remains questionable. Although relatively less impacted by the trade conflict given its reduced dependence on export demand, India’s economy has also lagged recently. The steady increase in oil prices through much of 2018 had brought some of India’s long-standing soft spots (dependence on imported oil, sizable fiscal deficits, etc.) back into focus. The rupee hit record lows against the dollar in early October, before a reversal in oil prices helped it recover. However, high-frequency data remain soft, with some industrial sector metrics on the verge of stagnation. Having raised interest rates twice in late-2018, the Reserve Bank of India has since changed course, pushing through a modest 25 basis point cut in February. Another cut is likely before long. Meanwhile, a modest fiscal stimulus package was announced in the new interim budget in February. But the key events are the upcoming elections running from April 11 to May 2019, which are widely expected to lessen the political clout of Prime Minister Modi’s business-friendly BJP. Geopolitical tensions are also sapping confidence as tensions have recently flared up with Pakistan. We therefore see India’s growth converge towards 7.0% in both 2019 and 2020.

Russia: A Difficult Recovery Russia’s economy has emerged from the 2015–2016 recession, but the recovery has been shallow and slow. It has also become harder amid broad emerging markets turbulence, country specific concerns around sanctions and lower oil prices. Following contractions of 2.5% in

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2015 and 0.2% in 2016, growth strengthened to 1.6% in 2017 and a tad better than that last year. But this looks to be as good as it gets for now amid a shift to tightening in monetary policy and a relapse in oil prices that look likely to keep growth well below 2.0% over the next couple of years. Beyond these near-term constrains, medium- to long-term economic performance remains challenged by a stark lack of economic diversification and extremely poor demographics. Aggressive policy action to remedy these issues is needed, but does not seem likely, especially in the near term.

Brazil: Another Chance

Perhaps nowhere have politics been as central to the economic outlook as in Brazil. Although presidential elections are now out of the way, whether the political drama will cool for long enough to allow for meaningful progress with structural reforms remains questionable. Disappointment on the reform agenda had already triggered a sharp depreciation of the real through September, which hastened the end of a disinflationary trend that Brazil, alongside so many EMs, had experienced over the course of 2017. Monetary easing — which amounted to nearly 800 basis points worth of rate cuts over two years — has subsequently run its course. Against this backdrop, growth likely fails to accelerate much in the near term, though we see GDP expanding 1.7% this year compared with 1.1% last year.

State Street Global Advisors 9

Forecasts

There is an investment adage that equity markets have a tendency to ride the elevator on the way down and then take the stairs on the way back up. After all, investors had to wait nearly four years to recover from losses incurred during the tech crash in the early 2000s and it took approximately three years to recoup the wealth that was eviscerated during the global financial crisis.1 And while the market downturn in late 2018 was not quite so severe, the recovery underway so far in 2019 is putting that adage to the test. Stock markets have not quite recovered all of the losses sustained during the fourth quarter of 2018, although a vigorous rally in the first quarter of 2019 brought many markets close to the highs achieved in the summer and fall of 2018.

On the surface, analysts and investors might have been skeptical that such a rally could take shape if they constrained their view to the relentless wave of economic growth downgrades put forth by formidable institutions. The International Monetary Fund (IMF) kicked off the pessimistic pronouncements in January when it downgraded global growth projections and cited the effects of tariff increases in the United States and China, as well as specific weakness in Germany, Italy and Turkey. The Bank of Canada lowered output expectations due to the effects on that economy of lower oil prices. The European Commission, which now sees only 1.3% growth in Europe in 2019, echoed the IMF in citing substantial risks to the global economy. Confronted by near-term Brexit uncertainty, a weaker global backdrop and tighter financial and credit conditions, the Bank of England shifted its 2019 forecast for the United Kingdom down to only 1.2%. The list goes on with the Reserve Bank of Australia, the European Central Bank (ECB) and the Federal Reserve all ratcheting down their expectations for growth during the early months of 2019.

But the dour sentiment associated with near-term growth projections represented only one side of a very important coin, because the concomitant effect of having lowered growth expectations was a global about-face on the part of central banks to shift away from a tilt toward tighter monetary policy. That shift, coupled with skeptical sentiment, less-than-aggressive positioning, and economic data that was sufficiently mixed to ward off immediate recession fears allowed many equity and commodity markets to print double-digit advances. For the most part those market conditions still prevail and set the stage for a continued stock market rally, even if the pace of gains inevitably slows down from the swift ascent of early 2019.

Policy Pivots Float Financial Assets

In the post-GFC era, it has not been a successful strategy to bet against the largesse and support of monetary policymakers around the world. And in early 2019, financial

assets of all kinds found a warm reception on that front as central banks across developed and emerging markets adopted a less hawkish stance. Stocks had already rallied nicely in January by the time Federal Open Market Committee (FOMC) members reinforced that a patient approach would be taken with respect to interest rates. An emphasis on flexibility pertaining to balance sheet normalization — a process that had previously been on “autopilot” — served as icing on the cake. The ECB followed the dovish pivot in March as they extended their forward guidance to keep interest rates stable through the end of the year. It also announced a new set of targeted long-term refinancing operations (TLTROs), which should at least keep financial conditions stable as earlier sets of loans mature. Oddly, the Bank of Japan may have bucked the trend in at least maintaining a more even keel, but with short-term policy rates at -0.1% and a balance sheet equivalent to the nation’s entire GDP — a turn to the dovish side may be somewhat constrained in the world’s third largest economy. Nonetheless, this repeated shift toward accommodative financial conditions bolstered prospects for equities and helped push interest rates lower as well. And even when it seemed as though no further dovish re-pricing was possible, the Federal Reserve’s announcement of its intention to halt balance sheet reductions in September of 2019 helped bonds stage a significant rally to close the quarter. While the market reactions clearly suggest that these policy developments have been priced in to some extent, the follow-through of accommodative financial conditions and the potential for a prolonged lower-volatility environment could very well provide just the foundation that financial assets desire to continue to perform in 2019.

Other political and policy developments also supported general risk-on sentiment. And in large part they took on the form of deferred decisions — both with respect to US/China trade and in Brexit negotiations. Stock markets were lifted in February as consensus came to view an extension of the US/China trade truce as the most likely outcome and the United States came through with an official announcement to delay planned tariff increases on Chinese imports later in the month. As to Brexit, the pound sterling reached a two-year high versus the euro as the market started to come to terms with at least a slight extension to the March 29 deadline as a likely outcome. But the durability of these supports is more questionable. While the tariff delays can be made indefinitely and there is also upside opportunity if a broader deal is reached, there are risks that breakdowns in discussions lead the Trump administration to continue to take action. And with the December US trade deficit hitting its highest level since before the global financial crisis, the administration’s patience could be tested. With Brexit the challenges of additional deferrals are more apparent, as thorny issues relating to European Parliamentary elections and even European Union permission to delay Brexit come to the fore.

Global Capital Markets Outlook

By Jerry Holly, Senior Portfolio Manager, Investment Solutions Group

State Street Global Advisors 10

Forecasts

Equities Still UnlovedEquity investments are never without risk, but the promise of an extended period of monetary restraint may prove to be a powerful, if not artificial, pillar upon which price multiples can expand. Add to that an environment where valuations are not demanding, investor sentiment still appears skeptical and fund flows have been moving away from equities, and the setup for stocks could certainly be worse. A jump in multiples has been a defining attribute of the year-to-date market rally, especially as expectations for earnings growth have waned, but major markets are trading at valuations that are largely in line with longer-term historical averages and remain well below the levels that prevailed before the onset of market volatility in early-2018. Looking at sentiment measures, State Street’s Investor Confidence Index has barely edged up from the low it reached in January, and the American Association of Individual Investors (AAII) Survey shows less than 25% of respondents as being bullish. Additionally, fund flows tracked by Bank of America show more than $80 billion in outflows across developed market equities so far this year — with that trend accelerating late in the quarter.2 Some may take that as a negative momentum signal, but there is also room for improved sentiment to lift global stock markets further.

To the extent that equity markets may take their direction from the familiar forces of accommodative policies, one might look for US equities to reclaim their place as a consistent outperformer across the regional leaderboard. On that point, we have our doubts. 2018 was the first year since the global financial crisis in which US equities (as measured by the S&P 500) posted a negative total return. By contrast, MSCI Europe and MSCI Emerging Markets tallied losses in half of the intervening calendar years, while MSCI Pacific registered a loss in three of ten. That pattern of performance led the US market to reach possibly dangerous heights from a relative size standpoint. As can be seen in the chart on page one, the US market reached a lofty position in terms of its own weight across global stock markets in late-2018. The MSCI USA Index currently represents approximately 55% of the total global stock market capitalization. That figure lines up with its prior peak following the bursting of the tech bubble in the early 2000s. While this may only represent one structural indicator, it bears watching especially if calls to break up the US tech sector behemoths gain traction, or further fines afflict those firms with business models that rely on profiting from ostensibly private data.

Rate Reactions May Be Overdone

Even if a reasonably constructive case can be made for equities, bond markets appear to be looking at the world from a different perspective. Declining interest rates, flatter and inverted yield curves, and increased fund flows into fixed income asset classes suggest a more worrisome outlook for the global economy. Benchmark 10-year borrowing rates declined across all G7 countries during the first quarter of 2019. Even in Japan, where the central

bank had been seeking to enforce yield curve control as a policy tool, the yield on the 10-year Japanese government bond fell by more than 10 basis points and slipped into negative territory. A weaker pace of growth, especially in manufacturing sectors, was one culprit that contributed to falling interest rates. Purchasing managers’ indices (PMIs) decelerated the world over, and shifted below 50 (signifying contraction) in some markets, including Europe and Japan. It may then come as less of a surprise that German 10-year bunds followed Japanese government bonds into negative yield territory — the first time those bonds had dipped below the zero barrier since 2016. In the United States, interest rates remained in firmly positive terrain, at least in nominal terms. However, a deceleration in economic data and continued dovish surprises from the Federal Reserve weighed heavily on real yields. By our own estimation, the overall global growth outlook doesn’t seem so maligned as to justify these sharp declines in yields, but if fund flows continue to move into bonds and away from equities then momentum and sentiment effects could reinforce the move lower in yields. Our base case for most bond markets sees interest rates moving modestly higher; there are some exceptions to that, such as in Australia where weaker data and deteriorating business confidence is more likely to pressure yields lower.

Credit assets have become a common bogeyman in terms of potential negative catalysts that may be lurking within global capital markets. Concerns abound that the low interest rate environment has spawned excessive issuance of debt that has been brought to market with lighter covenants and higher debt ratios. And from a more macroeconomic standpoint, the inexorable rise in corporate debt to GDP, particularly in the United States and China, has done little to quell those concerns. We don’t downplay the significance of these trends, but these are long-term issues; in the near term, we see a reasonably constructive environment for asset classes such as high yield bonds. The recent decline in interest rates should make above average debt-to-EBITDA ratios less onerous to service, seasonality effects still favor riskier forms of credit, and to the extent that the recent dip in business capital expenditure intentions reflect a desire to solidify corporate balance sheets that too could help limit the fallout from any future credit events. Shorter-term risks also prevail for credit assets, including relatively lop-sided inflows to the asset class and the possibility of complacency entering into investors search for yield. But with policy cushions including a fresh set of subsidized loans from the European Central Bank and a renewed accommodative stance from the Federal Reserve, investors in credit assets still have some powerful tailwinds at their back.

Unless noted otherwise, all returns are in US dollars as of March 31, 2019.Sources: Bloomberg, FactSet, J.P. Morgan, Barclays, Wall Street Journal, The Economist, MSCI as of March 31, 2019.

1 This, of course, assumes that there was no selling done in the midst of these market downturns.

2 The Flow Show, Bank of America/Merrill Lynch, March 21, 2019.

State Street Global Advisors 11

Forecasts

Base Currency

One-Year Return Forecasts through December 31, 2019 USD (%) EUR (%) GBP (%) JPY (%) AUD (%) CAD (%)

S&P 500 4.8 -1.1 -3.8 -0.6 2.3 -1.2

Russell 2000 4.5 -1.4 -4.1 -0.9 2.0 -1.4

MSCI EAFE 5.1 -0.8 -3.6 -0.3 2.6 -0.9

MSCI EM 9.1 2.9 0.1 3.5 6.5 2.9

Barclays Capital Aggregate Bond Index 2.4 -3.4 -6.0 -2.9 0.0 -3.4

Citigroup World Government Bond Index -0.1 -5.7 -8.3 -5.2 -2.5 -5.8

Goldman Sachs Commodities Index 4.4 -1.5 -4.2 -1.0 1.9 -1.5

Dow Jones US Select REIT Index 3.9 -2.0 -4.7 -1.4 1.5 -2.0

Source: State Street Global Advisors, as of March 31, 2019.The above forecasts are estimates based on certain assumptions and analysis made by State Street Global Advisors. There is no guarantee that the estimates will be achieved.

SSGA Forecasts as of March 31, 2019

Real GDP Growth 2019 (%) 2020 (%)

Global 3.4 3.5

US 2.3 2.0

Australia 2.4 2.7

Canada 1.5 1.8

Eurozone 1.3 1.5

France 1.4 1.6

Germany 1.1 1.6

Italy 0.1 0.4

UK 1.4 1.8

Japan 0.7 0.5

Brazil 1.7 2.7

China 6.2 6.2

India 7.1 7.0

Mexico 1.8 1.9

South Africa 1.3 1.8

South Korea 2.3 2.5

Taiwan 1.5 1.8

Inflation 2019 (%) 2020 (%)

Developed Economies 1.6 1.8

US 1.7 2.0

Australia 1.9 2.2

Canada 2.0 2.1

Eurozone 1.3 1.5

France 1.3 1.4

Germany 1.4 1.7

Italy 0.9 1.0

UK 1.9 1.9

Japan 0.9 1.2

China 2.1 2.2

Central Bank Rates March 31, 2019 (%) March 31, 2020 Forecast (%)

US (upper bound) 2.50 2.75

Australia 1.50 1.50

Canada 1.75 2.00

Euro 0.00 0.00

UK 0.75 1.00

Japan -0.10 -0.10

Brazil 6.50 6.75

China 4.35 4.25

India 6.00 6.00

Mexico 8.25 7.75

South Africa 6.75 7.00

South Korea 1.75 2.00

10-Year Bond Yields March 31, 2019 (%) March 31, 2020 Forecast (%)

US 2.42 2.80

Australia 1.77 1.90

Canada 1.65 2.00

Germany -0.07 0.20

UK 1.00 1.30

Japan -0.09 0.05

Brazil ($) 5.31 5.00

Mexico ($) 4.09 4.10

Exchange Rates March 31, 2019 (%) March 31, 2020 Forecast (%)

Australian Dollar (A$/$) 0.71 0.73

British Pound (£/$) 1.30 1.42

Canadian Dollar ($/C$) 1.34 1.26

Euro (€/$) 1.12 1.19

Japanese Yen ($/¥) 110.68 105.00

Swiss Franc ($/SFr) 1.00 1.08

Chinese Yuan ($/¥ ) 6.72 6.78

State Street Global Advisors 12

Forecasts

Glossary

Basis Point One basis point is equal to one-hundredth of 1 percent, or 0.01%.Capital Expenditure (Capex) refers to investment by a company to acquire or upgrade physical assets, such as a building, IT hardware or a new business.Citigroup World Government Bond Index The WGBI is a widely used benchmark that currently comprises sovereign debt from over 20 countries, denominated in a variety of currencies.Consumer Price Inflation (CPI) A widely used measure of inflation at the consumer level that helps to evaluate changes in cost of living. Deflation A decrease in the general price level of goods and services over a given period. GFC The global financial crisis, or GFC, refers to the period of extreme stress in financial markets and banking systems between mid-2007 and early 2009.Goldman Sachs Commodities Index GSCI is the first major investable commodity index and includes the most liquid commodity futures. Gross Domestic Product (GDP) The monetary value of all the finished goods and services produced within a country’s borders in a specific time period. Economic growth is typically expressed in terms of changes in GDP. Group of Seven (G7) A group consisting of Canada, France, Germany, Italy, Japan, the United Kingdom and the United States. MSCI EAFE Index An equities benchmark that captures large- and mid-cap representation across 22 developed market countries around the world, excluding the US and Canada. MSCI Emerging Markets Index The MSCI Emerging Markets Index captures large and mid-cap representation across 23 emerging markets countries. With 834 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

MSCI World Index The MSCI World Index is a free-float weighted equity index. It includes about 1,600 stocks from developed world markets, and does not include emerging markets. Organisation of Petroleum Exporting Countries (OPEC) 13-member group of oil exporting nations founded to manage global supply and coordinate pricing.Personal Consumption Expenditures (PCE) is the value of the goods and services purchased by US residents.Phillips Curve a graphic representation of the relation between inflation and unemployment which indicates that as the rate of either increases the rate of the other declines.Purchasing Managers’ Index An indicator of the economic health of the manufacturing and services sectors compiled from a survey of purchasing executives.Quantitative Easing (QE) An extraordinary monetary policy measure in which a central bank buys government fixed-income securities to lower interest rates, encourage borrowing and stimulate economic activity.Russell 2000 Index A benchmark that measures the performance of the small-capitalization segment of the US equity universe.S&P 500 Total Return Index The benchmark that reflects returns after reinvestment of dividends of the 500 large cap stocks in the S&P 500 Index.The US Dollar Index Measures the performance of the US Dollar against a basket of major currencies.Value Added Tax (VAT) is a broadly-based consumption tax assessed on the value added to goods and services.Yield Curve A graph or line that plots the yields of bonds with similar credit quality, typically from shortest to longest duration.

13State Street Global Advisors

Forecasts

© 2019 State Street Corporation. All Rights Reserved.ID16189-2491752.1.1.GBL.RTL 0419 Exp. Date: 30/04/2020

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