EMBRACING UNCERTAINTY in a SLOWER GROWTH ENVIRONMENT Citi Priority 2019 MID-YEAR OUTLOOK CONTENTS

2019 MID-YEAR OUTLOOK

EMBRACING UNCERTAINTY IN A SLOWER GROWTH ENVIRONMENT Citi Priority 2019 MID-YEAR OUTLOOK CONTENTS

CITI’S TOP THEMES

1 ECONOMY Divergence in Global Growth 2

2 EQUITIES Exploiting Late Cycle Opportunities 5

3 BONDS Protect the Downside 8

4 COMMODITIES Pockets of Opportunities 12

Uncertainty Could See Safe Haven 5 CURRENCIES Currencies in Vogue 15

6 POLITICS Risks Remain Elevated 18

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. 2019 MID-YEAR OUTLOOK

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.

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.

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.

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ECONOMY 1 DIVERGENCE IN GLOBAL GROWTH

Key Takeaways Global growth projections have stabilized at about the long-term average of 3%. However, this projection masks divergence between countries • Citi analysts expect (slowing Developed Markets and recovering Emerging Markets). global growth of 2.9� in 2019 and 2020. Inflation may remain steady at 2.5� in 2019 and 2020. GDP Growth forecasts • Developed Markets GDP Growth forecasts (DMs) target 1.8� growth in 2019 and %YY 1.6� in 2020, while 6.0 Emerging Markets (EMs) Forecasts are anticipated to grow 4.4� in 2019 and 4.6� 5.0 in 2020, reflecting the

divergence between the 4.0 2 regions. • Financial conditions, 3.0 uncertainty shocks, and the US-China trade tensions are 2.0 global factors that could negatively 1.0 affect consumption, 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 investment, trade, and GDP. Global DM EM Dashed lines show 2000-2017 average growth.

Note: Dashed lines show 2000-2017 average growth. Source:Source: Citi Citi Research. Research. As of 22As May of 222019. May 2019.

EMBRACING UNCERTAINTY IN A SLOWER GROWTH ENVIRONMENT | 2

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 US 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 EUROPE 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 JAPAN time when the trade outlook remains uncertain.

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 Asia / China the consequences of trade tensions and Citi anticipates 2019 GDP growth of 6.4% in China.

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 EMERGING trade tensions with the US. In EMEA, recovery in Turkey MARKETS (EMs) and more solid growth in Russia are also important underpinnings of the EM growth recovery.

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1 / DIVERGENCE IN GLOBAL GROWTH

Risks to the global growth outlook include:

• Rising protectionism and • China and/or trade tensions. US slowdown.

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

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 Higher Escalation of labour commodity/ trade tariffs. markets. energy prices.

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EQUITIES EXPLOITING LATE CYCLE 2 OPPORTUNITIES

Key Takeaways Financial markets weakened over the course of May as investors came to • Given a strong 1Q19 see a lower probability of a quick resolution of trade disputes. In light of rally, seasonally weaker trade fears revival, Citi analysts have scaled back on risk allocations by summer months and tactically reducing global equities to underweight. re-emergence of trade tensions, Citi analysts believe a period of de- Equities are are often often seasonally seasonally weaker weaker in May in May – August – August risking within equities should be expected. MSCI Asia Ex-Japan Index returns by month (2010-18) • As a result, Citi analysts have tactically Avg Monthly Returns (%) Years w/ Negative Mth (%) reduced their global 3.0 100 equity allocation to Summer Risks underweight. Within 2.0 equities, Citi still 75 prefers Emerging 1.0 Markets (EM), 0.0 50 particularly Asia, in the long term. -1.0 • Cyclical stocks have 25 rebounded in 1Q19 as -2.0 recession fears have -3.0 0 subsided. However, JAN FEB MAR AP R MAY JUN JUL AUG SEP OCT NOV DEC economies are growing at a slower pace and trade risks appear Asia Ex-Japan Avg Returns Hit Rate (% of negative years, Right) elevated. Amongst the defensives, Citi Source:Source: Citi Citi Private Private Bank. Bank. As As of of 20 20 May May 2019.2019. analysts are overweight the more growth- Earnings Slowing, not Reversing oriented Health Care Citi analysts expect global EPS growth of 4% in 2019, slightly below and Communication consensus estimate of 5%. Markets will start looking towards global EPS Services sectors. 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.

EMBRACING UNCERTAINTY IN A SLOWER GROWTH ENVIRONMENT | 5

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 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 EUROPE later in the year. Nevertheless, European equity valuations & UK 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.

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 JAPAN 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 EMERGING the economy if negotiations go awry compared with 12 MARKETS (EMs) 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.

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EXPLOITING LATE CYCLE OPPORTUNITIES / 2

Sectors to watch 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.

MATERIALS Citi 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 CARE Citi 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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BONDS 3PROTECT THE DOWNSIDE

Key Takeaways With central bank policy turning dovish and core non-US rates still near • Amid a revival of trade historical lows, Citi analysts believe that the demand for yield may likely fears, Citi’s overweight persist. stance on fixed-income quality may help US fixed income markets now price in two 25 bps easing navigate more volatile steps by the US Federal Reserve (Fed) this year and mid-year markets further cuts in 2020. Citi analysts also see action by the and potentially Fed dependent on trade developments. If the current strengthening risk- weakening in financial conditions and negative trade adjusted returns. impact spreads to overall domestic economic weakness, the Fed could follow financial markets with interest rate • Citi analysts remain cuts. However, the Fed is likely to be reactive to trade news constructive on US rather than leading in Citi’s view. Investment Grade (IG) bonds, as yield curves are steeper than With short-term economic developments broadly in line Treasury markets and with European Central Bank’s (ECB) baseline, then very spreads are wider in little should be expected in terms of new monetary policy longer maturities. announcements besides maintaining its dovish tone in coming meetings. The ECB is expected to delay the timing • Within Emerging of a first rate hike by 18 months to 1Q21. Market Debt (EMD), Citi analysts prefer to be selective and As the UK faces political tensions and more Brexit deadlines, maintain overweights Citi analysts see a growing risk that the Bank of England (BoE) in Asia (USD and local may signal that there will be no hike at all this year. currency debt).

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 value In 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 term spreads spreads are are attractive attractive across creditacross qualitiescredit qualities

Spread (bp) 250

213 200 200

161 150 145 141 141

110 108 100 115 102 89 88 73 76 53 63 50 51

33 0 1-3 years 3-5 years 5-7 years 7-10 years 10-20 years20+ years

AA-rated A-rated BBB-rated

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

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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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PROTECT THE DOWNSIDE / 3

EMERGING MARKET DEBT (EMD)

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.

HIGH YIELD (HY)

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.

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COMMODITIES POCKETS OF OPPORTUNITIES

Key Takeaways The commodity complex is being hemmed and hawed by opposing forces • Oil supply disruption across the spectrum and within sub-sectors. This has been triggered in part is likely to support by slower China’s growth prospects and the US escalation of the trade and Brent prices even if intellectual property struggle with Beijing, resulting in the erasure of some trade tensions were to of the strength commodities experienced over 1Q19. Looking forward into escalate. Citi analysts 2H19, Citi analysts still see pockets of opportunities within the commodity foresee Brent prices space. 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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POCKETS OF OPPORTUNITIES / 4

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, Oil: Prices central banks shifting to a less hawkish tone, and refineries coming back likely to remain from seasonal maintenance. Furthermore, oil demand is less sensitive to supported 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.

OPEC Crude Crude Production Production (million (million barrels/day) barrels/day)

34.0

33.5

32.5

32.0

31.5

31.0

30.5

30.0

29.5

29.0 Jan Feb Mar Apr May JunJul AugSep Oct Nov Dec

2013-17 Range 2013-17 Average 2016 2017 2018 2019

Source: CitiCiti Research. Research. As As of of 8 8May May 2019. 2019.

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4 / POCKETS OF OPPORTUNITIES

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 Precious Metals: project a softer US$, which may allow gold to trade the Gold may higher US$1,300-1,400/oz range. outperform If US-China trade relations deteriorate, gold prices stand to benefit from flight to quality inflows although this may be offset by a weaker EM consumption channel and diminished Asian demand. On the other hand, a clean resolution of the bilateral trade spat may ultimately be positive for both gold and risk assets via a weaker US$.

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 Base Metals: Riding out inclined to conclude a trade deal and gain support before the storm as we head into the 2020 election season. a bullish 2020 political backdrop 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 Bulk Commodities: proved more strongly correlated with China’s fixed asset Beneficiaries of investment than base metals and energy commodities. China’s stimulus Meanwhile, supply disruptions in Brazil may keep iron ore measures prices elevated in the short term.

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CURRENCIES UNCERTAINTY COULD SEE SAFE 5 HAVEN CURRENCIES IN VOGUE

Key Takeaways A potential downgrading of the global growth outlook could • The extension of the see safe haven currencies in vogue. US-China trade dispute together with other unresolved geopolitical USD concerns – Brexit, • Trade tensions have generated risk aversion sentiment a potentially more and adding to USD support, given the greater downside populist European risk to China, EM and the Eurozone from trade conflict parliament and US-EU/ relative to the US. Japan trade tensions • However, Citi analysts believe that the medium to longer risk posing headwinds term bias is for a weaker USD, in line with the historical to the 2H19 outlook. pattern of depreciation (vs. G10) as the long term norm, • This is likely to occurring in bursts of around ten years. Additionally, support safe haven as US fiscal stimulus fades and the US growth outlook currencies such as markedly slows, this may lead to the Fed cutting rates JPY. In contrast, the that could help weaken the USD. commodity currencies are more susceptible to risk aversion though CAD remains most Performance of Dollar Index vs Fed Fund Rate resilient. Performance of Dollar Index vs Fed Fund Rate • In Asia, IDR, MYR, SGD, KRW and THB 77’ 83’ 87’ 94’ 99’ 04’ 15’ remain vulnerable in the short term to an 160 20 escalation in US-China 140 trade tensions and 15 CNY depreciation. 120 10 100 96.511 5 80 2.50 0

1980-1989 1990-1999 2000-20092010-2019

Dollar Index Fed Fund Rate

Source:Source: Citi Research. AsAs ofof 15 15 May May 2019. 2019.

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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

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.

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.

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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 AUD benefitting the local economy. Nevertheless, Canada is not immune to NZD trade tensions which will also pose a hurdle to CAD though probably not CAD 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).

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POLITICS 6RISKS REMAIN ELEVATED

Key Takeaways Some of the main political signposts and geopolitical • Political and policy risks that could move markets in 2019 include: uncertainty affecting trade, sanctions and regulation is generating increased levels of investor concern, with impact on the global economy and financial markets. US • With volatility anticipated to remain elevated, Citi analysts believe that a highly diversified multi-asset class portfolio approach US UK remains essential in • On 7 June, President Trump • Prime Minister May today’s environment. announced the signature of announced she will step down an agreement with Mexico as Conservative Party leader that “indefinitely suspended” on 7 June, paving the way the 5% tariffs scheduled for a contest to decide a new to be implemented by the Prime Minister. US beginning 10 June. The • The UK is scheduled to leave deal came with Mexico’s the EU on 31 October, so commitment to a series of the new PM needs to decide measures aimed at curbing quickly whether to try and migration across the US- leave with or without a deal. Mexico border. However, an anti-EU leader • In Citi’s view, while this may struggle to hang on to removes the immediate a parliamentary majority, trade threat and its potential which makes it difficult to consequences, the risk of the pass any kind of Brexit, US continuing to threaten or any other legislation. Mexico (and other trade Hence, Citi analysts expect partners) with protectionist the PM to call a general measures remains. Citi election to get a mandate analysts also continue to for Brexit and other policies. believe that US-EU trade A second Brexit referendum tensions have not peaked is a possible alternative, but despite the delay in the without control of Parliament implementation of the auto would be risky in terms of tariffs on the EU and Japan the question on the ballot. It (for 6 months in exchange of would not produce a majority a deal to restrict exports to in Parliament for other the US). policies.

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RISKS REMAIN ELEVATED / 6

ITALY NORTH KOREA ITALY • Updated forecasts from the CHINA European Commission in May showed a cut in Italy’s MIDDLE EAST GDP growth projections for 2019 down to 0.1%, with a projected widening in the CHINA Italian fiscal deficit to 3.5% of • On 6 May, the People's Bank • On 10 May, the US GDP, breaching EU’s 3% limit. of China (PBoC) announced announced the imposition of • Euro zone’s third-largest a Reserve Requirement tariffs of an additional 15% economy could be hit with Ratio (RRR) cut for small on $200bn of imports from a fine of 3 billion euros by and medium-size banks. If China. China retaliated by the European Commission necessary, the RRR could be increasing the punitive tariff for accumulating debt and further lowered, and more rate on US$60bn of imports deficits that break EU rule. aggressive easing measures from the US. such as interest rate cuts MIDDLE EAST could also be expected. On the • On April 22, the United States fiscal front, government bond NORTH KOREA announced it would no longer issuance accelerated earlier grant waivers to buyers of this year, and infrastructure • The US and North Korea Iranian crude that are expired spending has started to talks have again hit an in May. Iran has threatened rebound. Citi analysts believe impasse following the Hanoi retaliation over the US the next round of fiscal policy summit in February 2019 as decision to remove sanctions stimulus could focus on Pyongyang is demanding waivers by closing the Strait durable consumption. If the sanctions relief before it of Hormuz, a key waterway various tax cuts were to fail to begins to denuclearize, in the Middle East which boost growth, the authorities while the US insists that carries a fifth of the world’s might revert to the old ways, Pyongyang relinquish its traded oil. All oil exports of namely more infrastructure nuclear weapons before any Iraq, Kuwait, UAE, Qatar and investment. Given that the economic pressure is eased. Bahrain pass through the scope for fiscal and monetary narrow passage, as well as stimulus remains large in some exports from Saudi the near term, Citi analysts Arabia. Any attempt by Iran believe the negative impact to block this would heighten from additional tariffs may be regional geopolitical tension. managed better this time.

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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.

TheThe costscosts ofof poorpoor marketmarket timingtiming areare severesevere

(%) 20

15 17.6

10 11 8.5

5 5.9

0 -2.5 -2.8

-5 Decade 1988 - 1997 Decade 1998 - 2007 Decade 2008 - 2017

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

Source:Source: Citi Private Bank.Bank. As As of of 21 21 May May 2019. 2019.

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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 1.20 Japan 106 105 103 101 UK 1.31 1.34 1.37 1.40 Australia 0.70 0.71 0.72 0.73 China 6.91 6.84 6.75 6.65 Hong Kong 7.84 7.83 7.82 7.81 India 69.4 68.5 68.4 69.2 Indonesia 14425 14275 14269 14409 Malaysia 4.16 4.15 4.11 4.04 Philippines 52.4 52.5 52.6 52.6 Singapore 1.36 1.35 1.35 1.34 South Korea 1197 1186 1174 1162 Taiwan 31.2 31.0 30.8 30.7 Thailand 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 2019 MID-YEAR OUTLOOK

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