citigold 2019 mid-year outlook - citibank india...in october, yen strength and escalation in trade...

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2019 MID-YEAR OUTLOOK

EMBRACING UNCERTAINTY IN A SLOWER GROWTH ENVIRONMENT


EMBRACING UNCERTAINTY IN A SLOWER GROWTH ENVIRONMENT | II

All forecasts are expressions of opinion, are not a guarantee of future results, are subject to change without notice and may not meet our expectations due to a variety of economic, market and other factors. Likewise, past performance is no guarantee of future results.

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E C O N O M Y1 Divergence in Global Growth

Protect the Downside

2

5

8

12

15

18

E Q U I T I E S2 Exploiting Late Cycle Opportunities

B O N D S3C O M M O D I T I E S4 Pockets of Opportunities

C U R R E N C I E S5 Uncertainty Could See Safe Haven Currencies in Vogue

P O L I T I C S6 Risks Remain Elevated

CITI’S TOP THEMES

C O N T E N T S


EMBRACING UNCERTAINTY IN A SLOWER GROWTH ENVIRONMENT | 1


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EMBRACING UNCERTAINTY IN A SLOWER GROWTH ENVIRONMENT

After a strong rebound that saw Global equities gaining 16.7% in the first 4 months of 2019, we are now entering seasonally weaker summer months. This weakness is further amplified by US-China trade risks dominating global market concerns. Citi analysts see markets as unprepared for the heightened risk of a prolonged economic struggle that could extend beyond the two economies and as a result, a period of de-risking within equities should be expected.

At the same time, earnings are slowing, not reversing. Citi analysts expect global Earnings-Per-Share (EPS) growth of 4% in 2019, slightly below consensus estimate of 5%. Valuations are also reasonable as the MSCI AC World benchmark trades on a trailing Price-to-Earnings of 17x, in-line with the long-run average.

Importantly, financial conditions are accommodative as monetary policy is expected to be on hold in most developed markets. If the current weakening in financial conditions and negative trade impact spreads to overall domestic economic weakness, the US Federal Reserve (Fed) could follow financial markets with interest rate cuts. However, the Fed is likely to be reactive to trade news rather than leading in Citi’s view.

Volatility is anticipated to remain elevated, and Citi analysts believe that a highly diversified multi-asset class portfolio approach remains essential in today’s environment.

*All returns in USD as of 31 May 2019.

Nevertheless, Citi analysts still expect global growth of 2.9% in 2019 paired with steady inflation of 2.5% for 2019. Global growth projections have stabilized at about the long-term average of 3%. However, this projection masks divergence between countries (slowing developed markets and recovering emerging markets). US growth is expected to moderate to 2.7% in 2019 due to fading fiscal stimulus and somewhat slower investment counterbalancing robust consumption. Meanwhile, trade tensions with US, China’s slowdown and Brexit weigh on European growth, offset to a greater extent stable consumption, with Citi analysts forecasting European GDP growth of 1.2% in 2019. In Emerging Markets, Citi anticipates GDP growth of 6.4% in 2019 on the back of China’s ongoing recovery as well as policymakers being much more ready to support the economy to offset the consequences of trade tensions.




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Source: Citi Research. As of 22 May 2019.

Global DM EM Dashed lines show 2000-2017 average growth.

GDP Growth forecasts

%YY

Forecasts6.0

5.0

4.0

3.0

2.0

1.0

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023


DIVERGENCE IN GLOBAL GROWTH

E C O N O M Y1Key Takeaways• Citi analysts expect

global growth of 2.9% in 2019 and 2020. Inflation may remain steady at 2.5% in 2019 and 2020.

• Developed Markets (DMs) target 1.8% growth in 2019 and 1.6% in 2020, while Emerging Markets (EMs) are anticipated to grow 4.4% in 2019 and 4.6% in 2020, reflecting the divergence between the 2 regions.

• Financial conditions, uncertainty shocks, and the US-China trade tensions are global factors that could negatively affect consumption, investment, trade, and GDP.

Global growth projections have stabilized at about the long-term average of 3%. However, this projection masks divergence between countries (slowing Developed Markets and recovering Emerging Markets).

GDP Growth forecasts

Note: Dashed lines show 2000-2017 average growth.Source: Citi Research. As of 22 May 2019.




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Asia is expected to grow 5.7% in 2019 and business cycle expansion is likely to last beyond this year. However, renewed US-China trade risks poses downside risks. Government policy effectiveness in China is key to offset the consequences of trade tensions and Citi anticipates 2019 GDP growth of 6.4% in China.

DIVERGENCE IN GLOBAL GROWTH / 1

Expectations are that US growth would be restrained at 2.7% in 2019, with a still robust consumption slightly counterbalancing a fading fiscal stimulus and somewhat slower investment.

Trade tensions with US, China’s slowdown and Brexit weigh on growth, offsetting to a greater extent stable consumption, with Citi analysts forecasting 1.2% GDP growth in 2019.

GDP growth is expected to remain weak at 0.7% in 2019 and the looming Value Added Tax (VAT) hike (if not delayed again), has scope to further weaken growth at a time when the trade outlook remains uncertain.

The recovery in Emerging Markets depends on a range of effective policies amidst challenging political climates in Latin America (Argentina and Brazil), although on balance these economies are less exposed to the US-China trade dispute. Mexico, on the other hand, remains vulnerable to trade tensions with the US. In EMEA, recovery in Turkey and more solid growth in Russia are also important underpinnings of the EM growth recovery.

JAPAN

US

EUROPE

Asia / China

EMERGING MARKETS (EMs)




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1 / DIVERGENCE IN GLOBAL GROWTH

Risks to the global growth outlook include:

Citi analysts expect inflation of 1.5% in Developed Markets and 4.0% in Emerging Markets in 2019

Upside risks to global inflation include:

Tightening labour markets.

Escalation of trade tariffs.

Higher commodity/energy prices.

• China and/or US slowdown.

• Rising protectionism and trade tensions.

• Heightened political risks. (See “6. Politics – Risks Remain Elevated”)




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Equities are often seasonally weaker in May – August

MSCI Asia Ex-Japan Index returns by month (2010-18)

Hit Rate (% of negative years, Right)Asia Ex-Japan Avg Returns

2.0

3.0

1.0

0.0

-1.0

-2.0

-3.0

100

75

50

25

0

JA

N

FEB

MA

R

AP

R

MA

Y

JU

N

JU

L

AU

G

SE

P

OC

T

NO

V

DE

C

Source: Citi Private Bank. As of 20 May 2019.

Avg Monthly Returns (%) Years w/ Negative Mth (%)

Summer Risks

EXPLOITING LATE CYCLE OPPORTUNITIES

E Q U I T I E S2Key Takeaways• Given a strong 1Q19

rally, seasonally weaker summer months and re-emergence of trade tensions, Citi analysts believe a period of de-risking within equities should be expected.

• As a result, Citi analysts have tactically reduced their global equity allocation to underweight. Within equities, Citi still prefers Emerging Markets (EM), particularly Asia, in the long term.

• Cyclical stocks have rebounded in 1Q19 as recession fears have subsided. However, economies are growing at a slower pace and trade risks appear elevated. Amongst the defensives, Citi analysts are overweight the more growth-oriented Health Care and Communication Services sectors.

Financial markets weakened over the course of May as investors came to see a lower probability of a quick resolution of trade disputes. In light of trade fears revival, Citi analysts have scaled back on risk allocations by tactically reducing global equities to underweight.

Equities are often seasonally weaker in May – August


Earnings Slowing, not Reversing Citi analysts expect global EPS growth of 4% in 2019, slightly below consensus estimate of 5%. Markets will start looking towards global EPS prospects in 2020, where consensus currently forecasts 11% growth. This could be vulnerable if the global economy continues to slow. However, EPS downgrades are not fatal - since 1989, consensus initial forecasts have been too high in 21 years. But in 15 of those years, global equities have still made gains despite earnings downgrades.

Reasonable Valuations; US Looks Expensive while EM Offers Value

The MSCI AC World benchmark now trades on a trailing Price-to-Earnings of 17x, in-line with the long-run average. Within regions, US looks most expensive, while EM offers best value.




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Citi analysts believe that consensus EPS growth of around 6% for 2019 is too optimistic and expect 1% instead. Japanese equities are trading at 13x forward Price-to-Earnings (P/E), a 10% discount to a 10-year average. Risk could come from upper house election in July, sales tax hike in October, yen strength and escalation in trade tensions.

Citi analysts believe that an eventual US trade deal, though with more extended negotiations, is more likely than a complete breakdown. Whatever happens, policymakers in China are much more ready to support the economy if negotiations go awry compared with 12 months ago. Furthermore, mildly recovering growth in China is becoming more broad-based, leading Citi analysts to believe that China’s economic improvements only began in March. For longer-term investors, Asian markets are likely to continue to outperform, especially in China, Citi’s favoured region.

The US equity market has reached 55% of world equity index market capitalization, well above the 23% share of world GDP measured in USD. It has reached this strong point through globalization, and trade risks pose a threat to US profits. Citi analysts do not believe a severe escalation of US tariffs and retaliation measures are embedded in current corporate earnings estimates and are tactically underweight US equities.

Consensus estimates suggest European companies could grow their earnings by 8% in 2019 and 10% in 2020. However, there are downside risks to corporate earnings forecasts as US-European trade tensions may escalate later in the year. Nevertheless, European equity valuations are reasonable and assuming eventual trade conflict de-escalation, Citi analysts would seek selective opportunities in sectors like Health Care.

Attractive valuations, 4.9% average dividend yield, and undervalued currency, are offset by uncertainty over Brexit and domestic politics. Citi analysts focus on selective areas in UK such as large-cap high yielders with substantial overseas earnings.

JAPAN

US

EUROPE& UK

EMERGING MARKETS (EMs)




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EXPLOITING LATE CYCLE OPPORTUNITIES / 2

Sectors to watchCyclical stocks have rebounded in 1Q19 as recession fears have subsided. However, economies are growing at a slower pace and trade risks appear elevated. Amongst the defensives, Citi analysts are overweight the more growth-oriented Health Care and Communication Services sectors.

MATERIALSCiti analysts favour Materials based on supply discipline and free cashflow generation. Global materials sector EPS could grow 5% in 2019 and another 7% in 2020. The sector is trading at a 13x 2019E Price-to-Earnings, a 13% discount to the benchmark.

COMMUNICATION SERVICES Citi analysts retain a constructive view on the global Telco landscape given upcoming 5G deployments and the opportunities to improve revenue monetization. The Telco sector also trades at 12x 2019E Price-to-Earnings, a 20% discount to the market. Separately, with above-average growth and fundamentals largely intact, there are still long-term opportunities in the Internet sector. However, valuations look expensive with sector trading at 22x 2019E Price-to-Earnings, roughly at a 40% premium.

HEALTH CARECiti analysts prefer Health Care due driven by 2 trends: Aging Population and EM Consumer growth and expect mid to high single-digit earnings growth, with US and EU large-caps offering 9% and 7% 5-year Earnings-Per-Share Compound Annual Growth Rate from 2019. Health Care firms that make products, drugs, and equipment for a global environment could outperform.




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With central bank policy turning dovish and core non-US rates still near historical lows, Citi analysts believe that the demand for yield may likely persist.

3PROTECT THE DOWNSIDE

B O N D S

Key Takeaways• Amid a revival of trade

fears, Citi’s overweight stance on fixed-income quality may help navigate more volatile mid-year markets and potentially strengthening risk-adjusted returns.

• Citi analysts remain constructive on US Investment Grade (IG) bonds, as yield curves are steeper than Treasury markets and spreads are wider in longer maturities.

• Within Emerging Market Debt (EMD), Citi analysts prefer to be selective and maintain overweights in Asia (USD and local currency debt).

US fixed income markets now price in two 25 bps easing steps by the US Federal Reserve (Fed) this year and further cuts in 2020. Citi analysts also see action by the Fed dependent on trade developments. If the current weakening in financial conditions and negative trade impact spreads to overall domestic economic weakness, the Fed could follow financial markets with interest rate cuts. However, the Fed is likely to be reactive to trade news rather than leading in Citi’s view.

With short-term economic developments broadly in line with European Central Bank’s (ECB) baseline, then very little should be expected in terms of new monetary policy announcements besides maintaining its dovish tone in coming meetings. The ECB is expected to delay the timing of a first rate hike by 18 months to 1Q21.

As the UK faces political tensions and more Brexit deadlines, Citi analysts see a growing risk that the Bank of England (BoE) may signal that there will be no hike at all this year.

Citi analysts expect the Bank of Canada (BoC) and Reserve Bank of New Zealand (RBNZ) to remain on hold for now, but for the Reserve Bank of Australia (RBA) to cut the cash rate by a total of 50bps this year.

The Bank of Japan (BoJ) may keep status quo for its monetary policy until 2H20. But the probability of the inaction period being extended is increasing amid slow growth in 2020 and heightened US-China trade tensions.

In Asia: India, Indonesia and Philippines are expected to cut rates further.




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PROTECT THE DOWNSIDE / 3

Selective regional markets offer valueIn Citi’s view, long-term US Treasury yields are likely to be constrained by modest economic growth, political uncertainties, below target inflation and low interest rates outside the US. While a flat yield curve limits the opportunity to extend duration in Treasuries, Investment Grade (IG) corporate curves offer better opportunities. Citi analysts find best values in US IG between 5-7 years to maturity.

Within Emerging Market Debt (EMD), Citi analysts prefer to be selective and maintain overweights in Asia (USD and local currency debt), especially in China property and high grade State-Owned-Enterprise (SOE) credit.

In contrast, Citi analysts are now neutral US High Yield (HY) as valuations became expensive. That said, Citi’s neutral view is still based on a strong fundamental outlook for HY issuers.

Intermediate term spreads are attractive across credit qualities


Intermediate term spreads are attractive across credit qualities

AA-rated A-rated BBB-rated

250

200

150

100

50

0


1-3 years 3-5 years 5-7 years 7-10 years 10-20 years 20+ years

Spread (bp)

33

53

89

51

73

115

63

88

141

76

102

161

110

145

213

108

141

200




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INVESTMENT GRADE (IG)

Though yield curves have flattened, US Investment Grade (IG) corporate curves are relatively steeper than US Treasuries (UST). Additionally, IG spread curves have steepened. Over the last 12 months, bond flows have been primarily focused on shorter-dated IG bonds. 1-3yr IG spreads are now near +50bp and slightly above historical tights. In turn, longer duration bond spreads are now much more attractive. Citi analysts find best values in US IG between 5-7 years to maturity.




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HIGH YIELD (HY)

PROTECT THE DOWNSIDE / 3

In contrast, Citi analysts are now neutral on US High Yield (HY) bonds. Refinancing risks are low and default rates have declined to 2.1%, since peaking at 5.1% during the 2015/2016 oil recession. However, valuations have become expensive. The summer months are also typically characterized by higher volatility, where low-quality HY could likely underperform. Nevertheless, the demand for yield is likely to remain longer term and Citi analysts view any pull-backs as an opportunity.

While pockets of political volatility should be monitored, Citi analysts believe EM is positioned to outperform longer term. However, should seasonal volatility in the summer months add to USD strength, then this in turn can put additional pressure on unhedged local positions. As such, Citi analysts retain modest overweights in USD Emerging Market Debt (EMD). In Asia, Citi analysts remain overweight in both USD and local currency debt, and continue to believe that Chinese policymakers could provide supportive financial conditions to cushion the impact of trade tensions and hence remain positive on property and high grade SOE credit.

EMERGING MARKET DEBT (EMD)




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The commodity complex is being hemmed and hawed by opposing forces across the spectrum and within sub-sectors. This has been triggered in part by slower China’s growth prospects and the US escalation of the trade and intellectual property struggle with Beijing, resulting in the erasure of some of the strength commodities experienced over 1Q19. Looking forward into 2H19, Citi analysts still see pockets of opportunities within the commodity space.

POCKETS OF OPPORTUNITIES

C O M M O D I T I E S

Key Takeaways• Oil supply disruption

is likely to support Brent prices even if trade tensions were to escalate. Citi analysts foresee Brent prices hitting a short-term target of US$75/bbl once again, possibly overshooting towards US$78/bbl.

• Citi analysts continue to favour gold as a way to reduce overall portfolio volatility or hedge geopolitical and market tail risks, with potential for prices to average US$1,335/oz in 2019.

• Escalated US-China trade tensions have led Citi analysts to prefer bulk commodities over base metals, given that the increased odds of Chinese stimulus measures is expected to benefit demand for steel, iron ore and coking coal.




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OPEC Crude Production (million barrels/day)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec


33.5

34.0

32.5

32.0

31.5

31.0

30.5

30.0

29.5

29.0

2013-17 Range

2017

2016

2019

2013-17 Average

2018

POCKETS OF OPPORTUNITIES / 4

OPEC Crude Production (million barrels/day)


Citi analysts believe that oil can outperform other commodities even if trade tensions were to escalate. This is because supply-side factors can be far more influential than demand changes. The outlook for demand remains robust, with GDP numbers coming in stronger than expected, central banks shifting to a less hawkish tone, and refineries coming back from seasonal maintenance. Furthermore, oil demand is less sensitive to global trade growth than other commodities.

On the other hand, oil supply disruptions are spreading. The situation in the Middle East remains rife with potential military escalation that could impact oil flows, and oil production is currently at risk in Libya, Venezuela, Iran, and Eastern Europe due to geopolitics, US sanctions, and infrastructure issues. OPEC+ is also staying on the sidelines for now, reluctant to add significant volumes to markets so long as overall measures of inventories remain adequate.

Despite the softness in the crude oil market early in May, Citi analysts still foresee Brent prices hitting a short-term target of US$75/bbl once again, possibly overshooting towards US$78/bbl.

Oil: Prices likely to remain

supported




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The stronger-than-expected US dollar move YTD, and particularly since March, has been the primary driver capping gold prices. Looking ahead, Citi analysts still project a softer US$, which may allow gold to trade the higher US$1,300-1,400/oz range.

If US-China trade relations deteriorate, gold prices stand to benefit from flight to quality inflows although this may be offset by a weaker EM consumption channel and diminished Asian demand. On the other hand, a clean resolution of the bilateral trade spat may ultimately be positive for both gold and risk assets via a weaker US$.

Citi analysts have downgraded base metals for 2H19, on the back of elevated US-China trade tensions. However, Citi analysts believe that the ongoing period of trade volatility is unlikely to last given that President Trump may be more inclined to conclude a trade deal and gain support before the 2020 election season.

Citi analysts are most bullish on aluminium in the very near term as tightening supply issues could support prices. Meanwhile, absent a major escalation in the trade dispute from here, Citi analysts are positive on copper, as price has been disproportionately impacted by the trade tensions relative to other cyclically exposed commodities. In zinc, Citi analysts see a short term bounce before a sustained move down to US$2,300/t by year end, while nickel fundamentals look weak and should continue to underperform.

Escalated US-China trade tensions have increased the odds of Chinese stimulus measures. This is expected to benefit demand for steel, iron ore and coking coal, which have proved more strongly correlated with China’s fixed asset investment than base metals and energy commodities. Meanwhile, supply disruptions in Brazil may keep iron ore prices elevated in the short term.

4 / POCKETS OF OPPORTUNITIES

Precious Metals: Gold may

outperform

Base Metals: Riding out the storm as we head into

a bullish 2020 political backdrop

Bulk Commodities: Beneficiaries of

China’s stimulus measures




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Key Takeaways• The extension of the

US-China trade dispute together with other unresolved geopolitical concerns – Brexit, a potentially more populist European parliament and US-EU/ Japan trade tensions risk posing headwinds to the 2H19 outlook.

• This is likely to support safe haven currencies such as JPY. In contrast, the commodity currencies are more susceptible to risk aversion though CAD remains most resilient.

• In Asia, IDR, MYR, SGD, KRW and THB remain vulnerable in the short term to an escalation in US-China trade tensions and CNY depreciation.

A potential downgrading of the global growth outlook could see safe haven currencies in vogue.

UNCERTAINTY COULD SEE SAFE HAVEN CURRENCIES IN VOGUE

C U R R E N C I E S5USD

• Trade tensions have generated risk aversion sentiment and adding to USD support, given the greater downside risk to China, EM and the Eurozone from trade conflict relative to the US.

• However, Citi analysts believe that the medium to longer term bias is for a weaker USD, in line with the historical pattern of depreciation (vs. G10) as the long term norm, occurring in bursts of around ten years. Additionally, as US fiscal stimulus fades and the US growth outlook markedly slows, this may lead to the Fed cutting rates that could help weaken the USD.

Performance of Dollar Index vs Fed Fund Rate


Dollar Index Fed Fund Rate

10

5

20

15

0

160

140

120

100

80

1980-1989 1990-1999 2000-2009 2010-2019

77’ 83’ 87’ 94’ 99’ 04’ 15’

96.511

2.50

Performance of Dollar Index vs Fed Fund Rate





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JPY

• JPY has been the typical safe haven currency of choice in times of volatility and a further correction in risky assets, should global geopolitical risks intensify, may exacerbate a strengthening in Yen.

• More medium term, JPY also remains fundamentally cheap given slower BoJ balance sheet expansion and lower yield spreads to the US. Additionally, JPY support comes from central bank reserve asset growth, which led JPY appreciation in late 2013/14 and 2017.

Euro bloc: EUR and GBP – Near term weakness but longer term firmer

GBP

• A more hawkish than expected BoE at the May meeting has left sterling broadly unperturbed. The BoE raised UK GDP expectations across the forecast horizon with inflation forecasts also above target in 2021. This infers that current market expectations for the Bank rate could be too low with less than one hike priced in over the next two years.

• That said, a Brexit deal (or longer extension) is a likely precondition to any hike in 2019 and the political backdrop clearly remains the biggest risk to GBP, particularly if a UK general election looks likely.

EUR

• EUR/USD continues to be broadly range bound. A medium term positive for the single currency remains the fundamental support of the improving euro area broad balance of payments and the US Fed's dovish stance that has led to a significantly less negative spread in front end yields between USD and EUR.

• However, significant euro centric risks remain that can cap EUR upside for now. These include - (1) a potentially more populist European parliament following the May 23rd elections; (2) continuing weakness in euro zone manufacturing led by German auto production; and (3) prospects for a more dovish ECB at the June 6th meeting to support falling inflation expectations.

• But the longer term structural outlook for EUR remains positive, supported by stronger Foreign Direct Investments (FDI) and reserve manager buying versus concerns about the increased net international liability of the US given even further increases in its twin fiscal and current account deficits.




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UNCERTAINTY COULD SEE SAFE HAVEN CURRENCIES IN VOGUE / 5

Commodity Bloc: Vulnerable to risk aversion; CAD most resilient

• Historically, AUD has been one of the more vulnerable during times of heightened risk aversion and the added spectre of a more subdued domestic outlook potentially leading to RBA rate cuts this year, makes AUD even more vulnerable. And while Australia’s terms of trade have performed strongly, escalating US-China trade tensions and resulting CNY depreciation pose a risk given Australia’s strong trade linkages to China.

• The RBNZ also seems to have changed to a more dovish tune at its March meeting and followed up by cutting rates by 25bp to offset “placing upward pressure on the New Zealand dollar”. With NZ rates continuing to price a 50% probability of a further rate cut and highlighting domestic vulnerability, coupled with escalating US-China trade tensions and CNY depreciation, NZD also remains vulnerable given New Zealand’s strong trade linkages to China.

• Of the 3 commodity currencies, CAD remains the most resilient given BoC’s bias to tighten policy as the Canadian economy look likely to pick up in the second half of this year. As a result, the BoC still sees the next move in Canadian rates to the upside with higher oil prices also benefitting the local economy. Nevertheless, Canada is not immune to trade tensions which will also pose a hurdle to CAD though probably not as much as for AUD and NZD.

Asia EM: CNY - More room for RMB depreciation if trade dispute escalates

• Increased uncertainty amidst a lower likelihood of a US-China trade deal near term is likely to see the People's Bank of China (PBoC) revert back to an easing bias which in turn is likely to create more room for RMB depreciation. Citi estimates that a 4.4% depreciation of the RMB (after adjusting for inflation) is needed to offset current tariffs (25% on US$250bn Chinese goods) and more if the US levies tariff on all Chinese goods. For now, the possibility of USDCNY breaking above 7.00 remains low unless the US extends tariffs to all Chinese imports.

• EM FX is likely to remain under pressure because (1) the market’s increasing conviction that the US-China dispute may extend beyond the G20 meeting, and (2) as trade tensions extend beyond China to include other US trading partners. This is likely to see pressure on EM FX across the board (Asia, CEEMA and Latam).

AUDNZDCAD




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6RISKS REMAIN ELEVATED

P O L I T I C S

US

US

• On 7 June, President Trump announced the signature of an agreement with Mexico that “indefinitely suspended” the 5% tariffs scheduled to be implemented by the US beginning 10 June. The deal came with Mexico’s commitment to a series of measures aimed at curbing migration across the US-Mexico border.

• In Citi’s view, while this removes the immediate trade threat and its potential consequences, the risk of the US continuing to threaten Mexico (and other trade partners) with protectionist measures remains. Citi analysts also continue to believe that US-EU trade tensions have not peaked despite the delay in the implementation of the auto tariffs on the EU and Japan (for 6 months in exchange of a deal to restrict exports to the US).

UK

• Prime Minister May announced she will step down as Conservative Party leader on 7 June, paving the way for a contest to decide a new Prime Minister.

• The UK is scheduled to leave the EU on 31 October, so the new PM needs to decide quickly whether to try and leave with or without a deal. However, an anti-EU leader may struggle to hang on to a parliamentary majority, which makes it difficult to pass any kind of Brexit, or any other legislation. Hence, Citi analysts expect the PM to call a general election to get a mandate for Brexit and other policies. A second Brexit referendum is a possible alternative, but without control of Parliament would be risky in terms of the question on the ballot. It would not produce a majority in Parliament for other policies.

Key Takeaways• Political and policy

uncertainty affecting trade, sanctions and regulation is generating increased levels of investor concern, with impact on the global economy and financial markets.

• With volatility anticipated to remain elevated, Citi analysts believe that a highly diversified multi-asset class portfolio approach remains essential in today’s environment.

Some of the main political signposts and geopolitical risks that could move markets in 2019 include:




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RISKS REMAIN ELEVATED / 6

UK

ITALY

MIDDLE EAST

CHINA

NORTH KOREAITALY

• Updated forecasts from the European Commission in May showed a cut in Italy’s GDP growth projections for 2019 down to 0.1%, with a projected widening in the Italian fiscal deficit to 3.5% of GDP, breaching EU’s 3% limit.

• Euro zone’s third-largest economy could be hit with a fine of 3 billion euros by the European Commission for accumulating debt and deficits that break EU rule.

MIDDLE EAST

• On April 22, the United States announced it would no longer grant waivers to buyers of Iranian crude that are expired in May. Iran has threatened retaliation over the US decision to remove sanctions waivers by closing the Strait of Hormuz, a key waterway in the Middle East which carries a fifth of the world’s traded oil. All oil exports of Iraq, Kuwait, UAE, Qatar and Bahrain pass through the narrow passage, as well as some exports from Saudi Arabia. Any attempt by Iran to block this would heighten regional geopolitical tension.

NORTH KOREA

• The US and North Korea talks have again hit an impasse following the Hanoi summit in February 2019 as Pyongyang is demanding sanctions relief before it begins to denuclearize, while the US insists that Pyongyang relinquish its nuclear weapons before any economic pressure is eased.

CHINA

• On 6 May, the People's Bank of China (PBoC) announced a Reserve Requirement Ratio (RRR) cut for small and medium-size banks. If necessary, the RRR could be further lowered, and more aggressive easing measures such as interest rate cuts could also be expected. On the fiscal front, government bond issuance accelerated earlier this year, and infrastructure spending has started to rebound. Citi analysts believe the next round of fiscal policy stimulus could focus on durable consumption. If the various tax cuts were to fail to boost growth, the authorities might revert to the old ways, namely more infrastructure investment. Given that the scope for fiscal and monetary stimulus remains large in the near term, Citi analysts believe the negative impact from additional tariffs may be managed better this time.

• On 10 May, the US announced the imposition of tariffs of an additional 15% on $200bn of imports from China. China retaliated by increasing the punitive tariff rate on US$60bn of imports from the US.




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6 / RISKS REMAIN ELEVATED

Current global trade tensions remain elevated as focus remains on political headlines rather than on economic fundamentals. Citi analysts believe that diversified high-quality portfolios can provide buffer in times of uncertainty.

Following the sharp equity rally in 1Q19, it makes sense to de-risk portfolios ahead of the seasonally weaker summer months and the ongoing volatility. However, Citi analysts caution against broad-based selling and market timing. In the past two decades, missing just 20 days out of 10 years would have produced negative returns on average for US equities, for what was otherwise the best performing asset class.

The costs of poor market timing are severe


The costs of poor market timing are severe

Annualized return missing the 20 best daysAnnualized S&P Total Return

20

15

10

5

0

-5


Decade 1988 - 1997 Decade 1998 - 2007 Decade 2008 - 2017

(%)

17.6

11

5.9

-2.5

8.5

-2.8




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ECONOMIC GROWTH & INFLATION FORECASTS

GDP Inflation

2018 2019 2020 2018 2019 2020

Global 3.2% 2.9% 2.9% 2.7% 2.5% 2.5%

US 2.9% 2.7% 2.0% 2.0% 1.7% 1.9%

Europe 1.8% 1.2% 1.3% 1.8% 1.3% 1.4%

Japan 0.8% 0.7% 0.1% 1.0% 0.5% 0.6%

Latin America 1.4% 1.6% 2.4% 7.5% 8.3% 6.1%

Emerging Europe 3.1% 1.6% 2.7% 5.9% 6.7% 5.9%

Middle East & North Africa 2.4% 2.7% 3.6% 4.6% 3.6% 4.8%

Asia 5.9% 5.7% 5.6% 2.3% 2.6% 2.6%

China 6.6% 6.4% 6.0% 2.1% 2.6% 2.3%

Hong Kong 3.0% 2.1% 2.1% 2.4% 2.0% 2.3%

India 6.9% 7.0% 7.4% 3.4% 3.8% 4.2%

Indonesia 5.2% 5.0% 4.9% 3.2% 3.3% 3.9%

Malaysia 4.7% 4.7% 4.7% 1.0% 1.4% 2.5%

Philippines 6.2% 6.2% 6.5% 5.2% 2.8% 3.0%

Singapore 3.2% 2.2% 2.5% 0.4% 0.7% 1.2%

South Korea 2.7% 2.4% 2.2% 1.5% 1.0% 1.5%

Taiwan 2.6% 2.1% 1.9% 1.3% 0.8% 1.3%

Thailand 4.1% 3.5% 3.7% 1.1% 1.2% 0.9%

Vietnam 7.1% 6.7% 6.7% 3.5% 3.0% 3.0%

Source: Forecasts from Citi Research. As of 22 May 2019.

EXCHANGE RATE FORECASTS (VS. USD)

3Q19 4Q19 1Q20 2Q20

Europe 1.14 1.15 1.17 1.20Japan 106 105 103 101UK 1.31 1.34 1.37 1.40Australia 0.70 0.71 0.72 0.73China 6.91 6.84 6.75 6.65Hong Kong 7.84 7.83 7.82 7.81India 69.4 68.5 68.4 69.2Indonesia 14425 14275 14269 14409Malaysia 4.16 4.15 4.11 4.04Philippines 52.4 52.5 52.6 52.6Singapore 1.36 1.35 1.35 1.34South Korea 1197 1186 1174 1162Taiwan 31.2 31.0 30.8 30.7Thailand 31.7 31.6 31.6 31.7

Source: Forecasts from Citi Research. As of 22 May 2019.

INTEREST RATE FORECASTS

Current 3Q19 4Q19 1Q20 2Q20

US 2.50% 2.50% 2.50% 2.50% 2.50%

Europe 0.00% 0.00% 0.00% 0.00% 0.00%

Japan -0.10% -0.10% -0.10% -0.10% -0.10%

Australia 1.25% 1.25% 1.00% 1.00% 1.00%

UK 0.75% 1.00% 1.00% 1.00% 1.25%

Source: Forecasts from Citi Research. As of 22 May 2019, current rates as of 14 June 2019.




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NOTES

MIXED FORTUNES

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