Unicredit Macromarkets 2020-21

November 2019
The UniCredit
Macro & Markets
2020-21 Outlook
Macro Research 21 November 2019

Strategy Research
Credit Research
■
“ Late-cycle blues
”
Macro: Global growth is set to weaken further to 2.7% in 2020, as the US economy is likely to enter a downturn,
protectionist tensions are unlikely to fade materially and the resilience of the domestic drivers of eurozone growth
starts to wane. The Fed will probably cut rates by 100bp, while the ECB is expected to stand pat and focus on its
policy review. Economic growth in the CEE region will likely slow as a result of external headwinds.
■ FI: Government bonds should remain supported throughout 2020. We expect 10Y US yields to fall to 1.50%, with the
curve bull-steepening. Room for lower Bund yields is more limited as the bar for further ECB rate cuts is high and the
Bund curve is quite flat. The 10Y yield will likely hit -0.50% at end-2020.
■ FX: Narrower growth and rate differentials between the US and the eurozone offer EUR-USD some upside potential.
We expect the GBP to recover but this will likely be slowed by BoE easing and the risk of a Brexit-related “cliff edge”
in December 2020.
■ Equities: We anticipate strong corrections of up to 20% in global equities in 1H20, with some relief by year-end. 2020
will be dominated by low earnings growth in Europe and slowing earnings growth in the US. We think present
consensus estimates are too high.
■ Credit: The late-stage credit cycle warrants defensive positioning in European IG and HY credit, with a preference for
non-cyclical sectors. Technical factors such as the CSPP should support credit, though this will likely be balanced by
a deterioration in credit fundamentals and the gap to valuations will widen further.
■ CEEMEA: EM hard-currency credit is set to post a good, mostly carry-related performance in 2020 of more than 5%.
Our preference remains BBB and BB rated credit.
Link to webcast Link to presentation
Editors: Marco Valli, Head of Macro Research, Chief European Economist (UniCredit Bank, Milan)
Elia Lattuga, Deputy Head of Strategy Research (UniCredit Bank, London)
Chiara Silvestre, Economist (UniCredit Bank, Milan)
November 2019 Macro & Strategy Research
Macro & Markets Outlook
Contents
3 Executive Summary
4 Global Macro Outlook: Late-cycle blues

9 Scenario Analysis
US car tariffs and their impact on the German economy
Impact on the eurozone economy if the US avoids a recession
Impact of a China hard landing on world and eurozone growth
13 US: A mild recession in 2H20, slightly delayed
18 Eurozone: Domestic resilience set to fade

23 Germany
25 France
27 Italy
30 Spain
32 Austria
33 CEE: Outlook shaped by external risks
38 United Kingdom: Persistent Brexit uncertainties, sluggish growth

40 Sweden & Norway: Tightening cycle likely to have run its course
41 Switzerland: Growth slowing but SNB steady
42 China: Trade uncertainty to weigh on growth
43 Oil: Brent prices to remain weak
44 Cross Asset Strategy: Prefer fixed income as a US recession nears
47 FI Strategy
UST yields to decline on Fed’s action and growth slowdown
Bunds: no respite from negative yields
Portfolio recommendation: overweigh duration in USTs, be more cautious with Bunds
Risk symmetry skewed towards higher Bund yields whereas it is more balanced for USTs
56 FX Strategy: The absence of major FX trends is likely to continue
61 Equity Strategy: Downside risks to prevail, particularly in 1H20
65 Credit Strategy
Investment grade: cashing in carry in a prolonged late cycle
High yield: marked spread widening expected amid economic slowdown
70 CEEMEA Strategy: Solid performance amid hunt for yield
72 Table 1: Annual macroeconomics forecasts

73 Table 2: Quarterly GDP and CPI forecasts
73 Table 3: Oil forecasts
74 Table 4: Comparison of annual GDP and CPI forecasts
75 Table 5: FI forecasts
76 Table 6: FX forecasts
77 Table 7: Risky assets forecasts
Editorial deadline: 20 November 2019, 18:00 CET
UniCredit Research page 2 See last pages for disclaimer.

Executive Summary
Erik F. Nielsen ■ We expect the global economic slowdown to continue for another year as the weakness in
Group Chief Economist
Global Head of CIB Research manufacturing spreads to services and consumers, broadly following the normal pattern for
(UniCredit Bank, London) this late stage of the business cycle. We forecast a trough in global growth in the second
+44 207 826-1765
erik.nielsen@unicredit.eu
half of 2020, followed by a gradual recovery in 2021 – although back towards a lower
trend-growth rate than in the past, primarily because of the rolling back of globalization.
■ We think the US will experience a mild recession in 2H20 while European growth will
bottom out during the same period at low but positive growth rates, with the weakness
concentrated in some countries, including Germany, Italy and Russia. By the end of 2021, we
expect US GDP growth to be back towards 2%, eurozone growth towards 1.5% and the CEE
region at close to double that (all annualized rates). If we are broadly right on this predicted
path, we will see both US and eurozone annual growth at close to 1% in 2020 and 2021,
and about double that in CEE, but with substantial changes over this two-year period.
■ The risks to the outlook seem higher than usual, and they are all man-made. The single
biggest source of uncertainty is trade policy and its impact on sentiment and, hence, on
investment, with important long-term consequences for global value chains and trend
growth. We have assumed a standstill, roughly speaking, in the present trade war, which
has already done substantial damage to growth. We acknowledge the two-way nature of
the risk, although the downside risk seems more prevalent. There is a risk of escalation if
US President Donald Trump starts to look for external scapegoats to blame for the slowing
US economy, as well as the possibility of some roll-back as a way of "declaring victory" in
his highly publicized trade policy.
■ Brexit poses another material risk, primarily to the UK itself but also to the rest of Europe.
The actual timing of Brexit remains unknown (with even a non-negligible probability of it
never happening), but more importantly, Brexit will be followed by a transition period of
great uncertainty about what trade agreements the UK will have with continental Europe,
the US and China – if any.
■ Monetary policy across most of the world is set to ease as the downturn proceeds. We
expect the Fed to cut rates by a total of 100bp, but both the call and the effect are
uncertain, not least since most other major central banks are likely to ease policy –
although not the ECB, which seems to have entered a period of virtual paralysis. This
could have an impact on exchange rates. We expect EUR-USD to move higher, to 1.16 by
the end of 2020.
■ There is also uncertainty with respect to fiscal policy, with much debate about possible
easing in both the US and Europe, but we are not convinced. In the US, the split Congress
is likely to prevent any meaningful policy changes, at least until after the elections, and in
Europe the overwhelming view among the fiscal authorities in those countries with fiscal
room remains one of no urgency.
■ Given this outlook, and present valuations, we recommend a shift towards safer assets.
We expect weak equity markets, with corrections of up to 20%. UST yields seem likely to
fall throughout 2020, ending the year at around 1.0% for the 2Y and 1.5% for the 10Y. An
unchanged ECB stance will likely keep the 2Y German yield around present levels, while
the 10Y Bund yield should move to about -0.5% by the end of 2020. We expect BTPs to be
caught again between search for carry and domestic politics. We see the 10Y BTP/Bund
spread ending the year at 150bp.

Global Macro Outlook

Late-cycle blues
Dan Bucsa ■ Global real GDP growth is set to weaken further from 3.0% in 2019 to 2.7% in 2020 as the
Chief CEE Economist
(UniCredit Bank, London) US economy enters a downturn and protectionist tensions are unlikely to fade. The Fed will
+44 207 826-7954 probably cut rates by 100bp next year, while we expect the ECB to stand pat and focus on
dan.bucsa@unicredit.eu
its policy review. The CEE region will likely slow as a result of external headwinds. Global
Dr. Andreas Rees growth will likely recover modestly to 3.2% in 2021.
Chief German Economist
(UniCredit Bank, Frankfurt) ■ The risks to the global outlook remain tilted to the downside. Most importantly, trade
+49 69 2717-2074
andreas.rees@unicredit.de
tensions could escalate, leading to lower global trade, sentiment, and investment, and a
tightening of broad financial conditions. The risk of a hard Brexit at the end of 2020
Daniel Vernazza, PhD remains, as does the risk of a hard landing in China.
Chief International Economist
(UniCredit Bank, London)
+44 207 826-7805
daniel.vernazza@unicredit.eu
1. Baseline forecasts
Our global GDP We expect global GDP growth to slow from 3.0% in 2019 to 2.7% in 2020 before recovering to
and trade forecasts
a still-modest 3.2% in 2021 (Chart 1). Global trade is likely to remain sluggish: we forecast
meager rises of 0.6% in 2020 and 0.9% in 2021 (2019: -0.4%) compared to a long-term
average annual increase of around 4%. Signs of increasing momentum in global trade are not
likely to emerge before 2021.
Regional and country forecasts We expect the US economy to enter a mild recession in the second half of 2020, driven by
declining corporate profitability and ongoing trade tensions. The weaker global backdrop is
likely to cause the eurozone to slow a little further next year. The Fed will probably cut rates
by 100bp in 2020, while we expect the ECB to stand pat and focus on reviewing its policy. In
emerging markets (EM), the expected cyclical downturn in global trade, commodity prices and
capital flows will likely keep economic growth below potential by tightening financial
conditions. China is expected to slow modestly as the fiscal and monetary stimulus cushions,
but does not arrest, the structural and cyclical slowdown. Several large emerging markets that
experienced contractions in output this year, including Argentina, Brazil, Mexico, South Africa
and Turkey, will probably recover only modestly next year due to persistent structural issues.
The CEE region is set to slow next year as a result of external headwinds.
CHART 1: GLOBAL GROWTH SET TO SLOW FURTHER IN 2020 CHART 2: US SHORT- AND LONG-RUN REAL RATES
Global real GDP growth, % yoy US real 5Y5Y bond yield (%) US real 2Y1Y bond yield (%)
6.0 1.6
Forecasts
5.0
1.2
2001-2018 average
4.0
0.8
3.0
0.4
2.0
0
1.0
0.0 -0.4
-1.0 -0.8
01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19
Source: Bloomberg, IMF, UniCredit Research

2. Key judgements
We have made four key judgments that are critical for our outlook: ongoing trade tensions, the
US entering a mild recession in 2H20, and a limited monetary and fiscal policy response.
Key judgement 1: We expect trade tensions to continue in the medium term, although without escalating further.
trade tensions and
heightened macro uncertainty While the US and China are reportedly close to signing a “Phase one” agreement, it appears
are here to stay tentative and partial. It involves the US delaying or cancelling planned tariff increases (and
possibly some rollback of tariffs in stages), in return for China agreeing to purchase
significantly higher amounts of US agricultural produce. Importantly, however, such an
agreement would not deal with any of the underlying issues in the dispute. Notably, the US
has become markedly skeptical towards the benefits of globalization, if not outright
protectionist, and the issue extends well-beyond US President Donald Trump. Furthermore,
China’s forced technology transfer and subsidies to state-owned enterprises are issues that
both seem insurmountable over the forecast period. Therefore, these trade tensions are likely
to persist. Our base case assumes no escalation but also no large-scale (or significant)
rollback of previous tariffs. The threat of escalation will remain. We do not expect the US to
impose tariffs on cars, which would mostly impact the EU, but the threat will likely remain.
Brexit-related uncertainties are likely to persist over the forecast period, whether the
Conservative Party wins a majority (as seems likely) or not. Geopolitical risks are likely to
remain elevated. Poor economic performance could reinforce political risks in EM, with Latin
America prominent.
Key judgement 2: The US economy is set to slow below potential in the coming quarters and enter a mild
US enters a mild recession
technical recession in 2H20. Our recession probability model signals a high likelihood of a
recession within the next 12 months. Typical late-cycle effects are visible in declining
corporate profit margins, and debt vulnerabilities have increased among US firms. The Fed
has said it will not cut rates again until growth has weakened materially, by which time it may
well be too late.
Key judgement 3: Global monetary policy has been loosened, most notably in the US. This easing has been in
only moderate impulses
from monetary policy response to weaker global growth and significant downside risks. To the extent that the fall in
short-term rates reflects a reduction in the equilibrium rate of interest due to heightened
uncertainty, the stimulus embodied in lower rates is likely to be limited. Indeed, the US 2Y1Y
forward real yield – a useful indicator of the real policy rate at the monetary policy horizon –
has fallen almost in lockstep with the 5Y5Y forward real yield – a gauge of the equilibrium real
rate that is neither stimulative nor restrictive (Chart 2). Indices of broad financial conditions
are only modestly looser compared to where they were a year ago; that is, before the Fed
initiated its shift away from a tightening bias. In most advanced economies, particularly in
Japan and the eurozone, there is much less monetary policy space than there has been
during previous easing cycles. In China, the required deposit reserve ratio (for major banks)
has already been cut from 17% in spring 2018 to 13% and the PBoC has scope for significant
further loosening, although the authorities are wary of inflating a credit bubble.
Key judgement 4: Only moderate impetus can be expected from global fiscal policy. In the US, a split Congress
limited help from fiscal policy
is unlikely to deliver any significant stimulus, especially in light of the pending presidential
election in 2020. In the eurozone, policymakers are either not willing or not in a position to
accelerate spending. In a majority of member states, elevated public indebtedness has put
tight constraints on fiscal policy. In Germany, there are both political and legal arguments for
limiting fiscal expansion, despite significant surpluses in the public budget. Only in China, is a
moderate growth initiative already in the pipeline. Apart from a cut in the VAT rate in spring
2019, credit volumes have been increasing again (Chart 3). But this is likely to do no more
than cushion the structural slowdown in China and the high indebtedness of Chinese
companies makes a significant increase in leverage unlikely. Large budget deficits in many
EM may not allow for increased government spending (Chart 4).

CHART 3: CHINESE CREDIT IMPULSE GETTING STRONGER CHART 4: LARGE EM HAVE LITTLE FISCAL SPACE LEFT
China credit impulse (% of GDP, advanced 9M) 3.0

HR RS
Global manufacturing PMI (rs) RU
30 58 2.0
UA BG
BR
Primary balance (% of GDP)

MX
1.0
CZ
20 56 HU
PL
0.0
AG IN ID SK
TR CL
10 54 -1.0
SA
RO
-2.0
0 52
-3.0
CN
-10 50 -4.0
-5.0
-20 48 -8.0 -6.0 -4.0 -2.0 0.0 2.0 4.0
Sep-09 Sep-11 Sep-13 Sep-15 Sep-17 Sep-19 Budget balance (% of GDP)
Source: Bloomberg, Eurostat, IMF, national statistical offices, NBS, UniCredit Research
3. Current economic conditions

Slowest global growth The global economy has slowed throughout 2019 and, at 2.9% annualized in 3Q19, is now
since 2009
expanding at its weakest pace since 2009. The slowdown likely originated from global trade
tensions (notably US-China trade talks and Brexit negotiations) and associated heightened
macro uncertainty, as well as the impact of the past tightening of financial conditions
(particularly in the US), and domestic weakness in some major emerging markets (Argentina,
Brazil, Mexico, South Africa and Turkey).
Subdued business confidence Business confidence has fallen globally amid heightened trade-policy uncertainty and
geopolitical tensions. This is especially true for the export-dependent manufacturing industry.
The global manufacturing PMI declined further until summer 2019, when some stabilization
set in (Chart 5). In contrast, consumer confidence has so far been relatively resilient, as labor
markets remain solid.
Weak manufacturing, The fall in business confidence has led to investment being either deferred or cancelled.
trade, and investment
Capital goods orders – an indicator of business investment – has been in decline in the US
and the eurozone (Chart 6). Investment goods have the highest imported content, and this
has exacerbated the weakness in global trade, which entered a technical recession in 2Q19.
For many advanced economies, the more export-oriented manufacturing sector has been in
recession for some time.
CHART 5: GLOBAL PMIS SHOW SIGNS OF STABILIZING CHART 6: CAPITAL GOODS ORDERS HAVE TURNED DOWN
Services Manufacturing Manufacturing new export orders Capital goods orders in US and EA OECD business confidence (rs)
Global PMI, differences from averages since 2000 in number of standard deviations % yoy, 3M MA Index
1.2 20 102
101
0.8 10
100
0.4 0 99
98
0.0 -10
97
-0.4 -20 96
95
-0.8 -30
94
-1.2 -40 93
Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Sep-01 Sep-04 Sep-07 Sep-10 Sep-13 Sep-16 Sep-19
Source: IHS Markit, BEA, BLS, ECB, European Commission, OECD, UniCredit Research

Resilient services In contrast, private consumption and services activity has been relatively resilient and has
and consumption
typically been the main – or in some cases only – driver of GDP growth. Unemployment is
historically low, tight labor markets have pushed up wage growth and price pressure remains
low, which has driven real household income growth. This largely explains the relative
resilience of consumer confidence, but the savings rate has gradually increased in the
eurozone, the US, and the UK, perhaps reflecting increased precautionary saving in response
to heightened uncertainty.
Spillover into domestic There are some early signs that the weakness in manufacturing, trade and investment is
services and labor markets
spilling over into domestic services and labor markets. It is true that the global services PMI
has remained slightly above the 50 level that marks no-change recently, and above the global
manufacturing PMI. However, relative to its historical average, the services PMI is now
weaker than the manufacturing PMI (Chart 5). Furthermore, labor markets are cooling off.
This is probably clearest in Germany, the UK and the US. Job openings – a leading indicator
of employment – have been falling in all three regions (Chart 7).
Leading indicators The negative spillover effects from the export-dependent manufacturing sector into the
are subdued
services sector are likely to continue. This is the message from recent leading indicators,
which paint a picture of subdued activity in global trade in the short-term. The OECD and the
Bundesbank leading indicators have continued to decline, albeit less markedly than at the
start of 2019 (Chart 8). Our proprietary leading indicator, which reflects short-term fluctuations
in global trade (on a 3M-3M basis) trod water in October. The latest signal is consistent with
global trade rising by a meager 1% on an annualized basis at the end of 2019.
Emerging markets A combination of poor global trade, lower commodity prices and volatile capital flows has
affected emerging markets (EM) in 2019. Several large EM countries were in recession at the
same time, including Argentina, Brazil, Mexico, South Africa and Turkey, although most of
them have now exited recession or are expected to do so soon. China’s economy continued
to slow due to structural forces and trade tensions with the US. Southeast Asia excluding
China, the EM outperformer in 2H19, benefitted from the Chinese credit impulse but lower
Chinese growth will likely eventually weigh on this region’s growth rates.
CHART 7: JOB OPENINGS HAVE EASED IN SOME COUNTRIES CHART 8: LEADING INDICATORS STILL SOMEWHAT DECLINING
US Germany UK Indices
103
Bundesbank OECD
Job openings to employment ratio (six-month change in ratio, in pp.)
0.8 102
0.6
101
100
0.4
99
0.2
98
0.0 97
-0.2 96
-0.4 95
94
-0.6
93
-0.8
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17 Jan-19
Source: BLS, Bundesbank, Eurostat, OECD, ONS, UniCredit Research

4. The risks
1. Escalating trade tensions The most important risk to our global growth forecasts is an escalation of trade tensions. The
US and China have already threatened further tariff hikes if no “Phase one” agreement is
reached. In this scenario, business confidence, especially among exporters worldwide, could
take a hit and rein in global investment spending even further. Export-dependent countries
such as Germany would probably fall into deep recessionary territory, thereby putting
downward pressure on the eurozone economy as a whole. Supply chains between the US
and China and, to some extent, globally could also be distorted. The EU seems to be
comparatively shielded from such adverse effects. Nearly two-thirds of the EU’s global value
chains are within the EU. Besides effects on global trade, turbulence on FX and bond markets
could amplify the negative impact on the global economy. Given that China imports much less
from the US than the US imports from China, other retaliatory tools may be considered by
Chinese policymakers. In August 2019, the US officially labeled China a currency
manipulator. China responded by temporarily depreciating the CNY against the USD. Another
possibility is that China may decide to continue selling some of its holdings of US treasuries,
which currently amount to around USD 1,100bn, which could result in a sharp rise in medium
to longer-term interest rates. Finally, China might introduce curbs on rare-earth exports that
are key for the tech sector.
US President Donald Trump could raise US auto tariffs. His decision is still pending and the
administration could always trigger a new investigation under the 1962 Trade Expansion Act.
The impact of such tariff hikes would fall disproportionately on the EU and, in particular,
Germany (see Scenario Analysis section on US car tariffs and their impact on the German
economy).
The probability of a no-deal Brexit before the end of 2020 is approximately zero now that Prime
Minister Boris Johnson has agreed a revised Brexit deal with the EU and is campaigning for his
deal ahead of the 12 December general election. However, if Mr. Johnson’s Conservative Party
wins a majority of seats, as we expect, then the risk of a no-deal Brexit at the end of 2020, when
the standstill transition period would end, is very real indeed.
2. Hard landing in China China is trying to rebalance its economy away from exports and overinvestment and towards
consumption. History shows this transition is unlikely to be smooth. Moreover, China’s
corporate sector has amassed huge corporate debt, and now that the economy is slowing
amid trade tensions with the US and slower global growth, the Chinese authorities are
stimulating credit again. Such large increases in credit-to-GDP typically do not end well, often
culminating in a financial crisis or several years of much weaker growth. There is also a risk
that the policy stimulus does not work (see Scenario Analysis on the Impact of a China hard
landing on world and eurozone growth).
3. US avoids a recession In our baseline forecast, we expect the US economy to slow further and enter a mild
recession in 2020. A positive risk scenario is that, instead, the US expands broadly in line with
its potential over the forecast period. This could materialize if pre-emptive Fed easing is more
stimulative than we expect, the US consumer remains resilient against our expectations, and
there is more spare capacity in the labor market than most estimates suggest (see Scenario
Analysis on Impact on the eurozone economy if the US avoids a recession).

Scenario Analysis
US car tariffs and their impact on the German economy
Dr. Andreas Rees US President Donald Trump’s decision on raising US auto tariffs is still pending. 1 The US has
(UniCredit Bank, Frankfurt) already reached trade agreements with several major auto-exporting countries such as
+49 69 2717-2074 Mexico, Canada, Japan and South Korea.2 Hence, the risk of higher tariffs largely affects the
EU, and Germany in particular.
Dr. Thomas Strobel
Economist Back in March 2018, Mr. Trump threatened to raise auto tariffs on cars from 2.5% to 25%, in
(UniCredit Bank, Munich)
line with the 25% tariff on light trucks (pickups). The EU currently charges 10% tariffs on both
+49 89 378-13013
thomas.strobel@unicredit.de cars and light trucks from the US . In our scenario analysis, we assume a US tariff increase to
25% on cars and car parts and examine its effects on the German economy.
Germany’s car exports to the The US export share of the German auto industry is significant, amounting to 13% (EU: 51%;
US are significant… China: 10%). This represents roughly 1½% of German exports in goods and services and
0.7% of GDP. Compared to other countries, German carmakers rank fourth in terms of gross
exports to the US (USD 28bn) after Canada (USD 54bn), Mexico (USD 52bn) and Japan
…however, in terms of global (USD 49bn). However, the rise of global value chains makes Germany’s actual exposure
value chains, Germany’s
exposure becomes smaller smaller. About a third of the value of German gross auto exports to the US can be attributed
to other countries, in particular the EU-15 (USD 5bn) and the newer EU member states in
CEE (USD 1bn).3 The tariff shock would therefore not only have a direct negative impact on
Germany but also an indirect effect on other EU countries.
US tariff shock depends on

The quantification of a US tariff shock on domestic activity not only depends on Germany’s
various factors, such as export (value-added) export exposure. Assumptions on German carmakers’ pricing behavior and
exposure, pricing behavior… how US consumers are likely to respond also have to be made. Since there is a wide range of
possibilities, substantial uncertainty exists. For instance, carmakers could try to pass on
higher tariffs to US consumers or they may leave auto prices unchanged by accepting
reduced profit margins from their US business. The latter could possibly be offset by stronger
demand for cars in other countries, i.e. the decision could also depend on the outlook outside
the US. If prices of German cars increase, US consumers may still continue to buy them due
to quality, branding, etc. Alternatively, given high price elasticity of imports, US consumer
demand could increase for domestically produced or Asian cars.
US TARIFF HIKE STILL A RISK IN 2020 ONE THIRD OF GERMAN AUTO EXPORTS PRODUCED ABROAD
In % Auto exports to the US, in USD bn (2017)

30 60
US tariffs EU tariffs
25 50
Foreign Value Domestic value
20 40
15 30
10 20
5 10
0 0
Cars Light trucks CAN MEX JPN DEU KOR UK ITA
Source: WTO, IMF, UniCredit Research
1
According to some legal experts, by missing the deadline in mid-November, Mr. Trump has forfeited his authority to impose higher car tariffs on basis of the Trade
Expansion Act of 1962. However, the US administration may still find other legal means to demand higher auto tariffs.
2
In its agreement with Japan, customs duties on autos are subject to further negotiation.
3
Huidrom, R. et al., Trade Tensions, Global Value Chains, and Spillovers, Insights for Europe, IMF Working Paper, June 2019

…and import elasticities Estimates of the import elasticity in the economic literature confirm this wide margin of
uncertainty. They range from 0 to 0.15, i.e. from a completely inelastic demand to a decline of
0.15% in demand in response to a tariff hike of 1pp. In a recent analysis, the IMF assumed
the midpoint of this range for the import elasticity (0.08) and a US tariff of 25% imposed on
cars and car parts. Using value-added exports, the impact is estimated to be 0.15% of
German GDP.4 The IMF estimate takes into account not only the direct impact of lower
demand on the German auto industry, but also the effects on domestic suppliers in other
sectors. Examples are the chemical industry, machinery and metals. When gross exports are
applied, the estimated GDP loss is roughly 0.2%. With a substantially higher import elasticity
of 0.15, the estimated negative GDP effect would double (0.3-0.4%).
Besides this first-round impact due to lower export activity, second-round effects are possible.
Second-round effects include
the impact on R&D and
The negative economic impact could multiply by triggering additional negative responses of
business sentiment companies and consumers. In the event of a tariff shock, we consider the following two
transmission channels to be particularly important. Lower research and development
expenditure (R&D) by the German auto industry and a hit to overall German business
sentiment caused by rising uncertainty.
The car industry spends far more money on R&D than any other sector. In 2017, the figure
was about EUR 25bn, or more than a third of total R&D (0.8% of GDP). A US tariff shock
could lead to cuts in R&D expenditure and, hence, in investment activity. The decision to cut
R&D may also depend on the general outlook for the auto industry. The more pessimistic
business expectations are, the more likely such a scenario is.
Another major transmission channel for second-round effects is overall business confidence.
Uncertainty about the impact of a tariff hike on the German economy could lead to a broad-
based and at least temporary decline in business sentiment. Companies in other sectors that
are not actually related to the car industry may decide to play it safe and forgo further capex
spending and hiring. As a result, negative multiplier effects would kick in and put an additional
strain on economic activity.
Uncertainty about the second-round effects is also high. We estimate that another negative
Overall, US tariffs are likely
to shave-off 0.3-0.5%
GDP effect of 0.1-0.3% may materialize. Taken together, the GDP loss resulting from the US
of German GDP hiking tariffs to 25% could amount to 0.3-0.5% in the first year after implementation.
Afterwards, the negative effect will likely start to fizzle out.
HIGH R&D EXPENDITURE OF GERMAN CAR SECTOR FIRST SIGNS OF BOTTOMING OUT IN CAR SECTOR
30
In EUR bn (2017) Ifo survey (balances), 3-month moving average
60.0
25 40.0
20.0
20
0.0
15
-20.0
10
-40.0
5
-60.0
Business expectations Inventory assessment
0 -80.0
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Auto Services Machinery Pharma Chemical ICT
Source: OECD, Ifo, UniCredit Research
4
Huidrom, R. et al., Trade Tensions, Global Value Chains, and Spillovers, Insights for Europe, IMF Working Paper, June 2019

Impact on the eurozone economy if the US avoids a recession

Marco Valli In our baseline forecast, we expect the US economy to slow further and enter a mild recession
Head of Macro Research
Chief European Economist in 2020 (see United States macro section), which is an out-of-consensus call. We provide an
(UniCredit Bank, Milan) indication of how sensitive our eurozone GDP growth forecasts are to this key judgement and,
+39 02 8862-0537
hence, what one might reasonably expect if the US manages to avoid a recession.
marco.valli@unicredit.eu
Daniel Vernazza, PhD Specifically, in this positive risk scenario, we assume that the US economy expands broadly
Chief International Economist in line with potential in 2020 (1.8%) and slightly below it in 2021 (1.5%). Compared to our
(UniCredit Bank, London) baseline scenario, this would imply a positive growth shock amounting to a cumulative 1.3pp
+44 207 826-7805
daniel.vernazza@unicredit.eu over the next two years.
We identify three main reasons why such a scenario could materialize: 1. The Fed has moved
How the US could
avoid a recession preemptively. Its U-turn on monetary policy one year ago has lowered the 10Y UST yield by
around 130bp. Lower mortgage rates have seen the US housing market pick up. And the
transmission to the real economy is still ongoing. In the late 1990s, a similar level of monetary
easing was enough to delay the onset of a recession by a few years; 2. While the US labor
market is running hot by most estimates of the US equilibrium unemployment rate, wage
growth is not exactly running away, which might suggest that the equilibrium unemployment
rate is lower than previously thought. This would reduce the need for a correction in the labor
market. 3. Consumption has been resilient, and while it is rare for an economy to run on a
single growth engine for a sustained period, it is possible that US consumers look through
heightened macro uncertainty and continue spending while investment stays weak. In
particular, the fiscal stimulus could fade later than we expect.
Transmission channels The transmission of firmer US growth to the eurozone would materialize mainly via three
channels: trade, financial conditions and oil prices.
The US is the eurozone’s The trade effects are both direct and indirect. The former are related to effects only channeled
largest trading partner
through bilateral trade linkages between the US and the eurozone. As a reference, the US is
the eurozone’s largest trading partner, accounting for more than 14% of total (extra-euro-
area) merchandise exports. This compares with 12.1% for the UK and 7.4% for China.
Indirect trade effects amplify the transmission of the US shock through the response of
exports and imports in third markets.
Broad financial conditions The impact through financial conditions and market sentiment is the most difficult to predict,
would likely improve
because to a large extent it depends on how the major central banks (starting with the Fed)
react to the stronger growth outlook. Other conditions being equal, resilient growth in the US
would lower the cost of capital, reduce volatility and compress credit spreads. However, the
response of financial markets might become more blurred when a (countercyclical) monetary
policy stance is taken into account. In our simulation, we assume that the net impact on
financial conditions is positive, thus contributing to strengthening the impulse from trade.
Oil prices unlikely to move The response of oil prices is likely to be more contained than in the past. This is due to the
materially higher
more competitive structure of the oil market after the shale revolution in the US, and it seems
likely that OPEC+ could see a weakening of incentives to cap supply if and when oil demand
starts to recover. This would mitigate the upward pressure on oil prices in this positive
scenario – good news for the eurozone, which is a net energy importer.
Eurozone growth could be 0.6- Overall, we estimate that a positive shock to US GDP of 1pp could lift eurozone GDP growth
0.7pp higher
by about 0.5pp. Therefore, in our simulation, eurozone growth could be boosted by a
cumulative 0.6-0.7pp (and core inflation by 0.1-0.2pp). In terms of timing, positive US shocks
tend to be transmitted more slowly to the euro area (and the rest of the world) than
downturns. This implies that some of the boost to eurozone growth would probably materialize
outside our two-year forecasting horizon.

Impact of a China hard landing on world and eurozone growth

Edoardo Campanella Our baseline scenario assumes a smooth deceleration in the growth of the Chinese economy
Economist
(UniCredit Bank, Milan) (see China macro section) throughout the forecasting horizon, down to 5.7% in 2021 from
+39 02 8862-0522 current 6.2%. However, a number of factors pose a risk that the loss of momentum could be
edoardo.campanella@unicredit.eu
harsher and China might face a hard landing.
We assume a large shock to The most prominent risk is an escalation in the US-China trade war. An alternative trigger,
China’s domestic demand
which we explore here, is a severe slowdown in domestic demand. We assume that
traditional monetary and fiscal stimulus proves ineffective in supporting the domestic drivers
of growth at a time when marginal returns of policy action are declining and financial stability
concerns might prevent Beijing from adopting alternative measures. The resulting shock to
domestic demand leads to a meaningful slowdown in China’s GDP growth, from 6.2% in 2019
to 3% in 2021. This implies a GDP loss of about 3pp compared to our baseline and the shock
propagates to the rest of the world through both trade and financial channels.
Transmission channels The main transmission channels are trade (both directly and indirectly through third countries)
and financial markets. Trade links are fairly strong. China is the third most important
destination for euro area exports outside of the eurozone (accounting for around 7% of the
total), after the US and the UK. Only about 70% of these exports are consumed domestically
in China (the remaining 30% are used as intermediate goods within global value chains that
are centered around the Chinese economy). Thus a drop in China’s domestic demand would
not be fully passed on through eurozone exports.
China’s direct financial ties with the eurozone are relatively limited, partly due to remaining
restrictions on cross-border financial transactions, investment and banking activities in China.
However, the shock is likely to meaningfully impact sentiment in financial markets, leading to
a tightening of financial conditions.
Impact on global To quantify the impact of such a scenario on eurozone and world GDP growth, we use
and eurozone GDP growth
elasticities estimated by the OECD.5 When both trade and financial links are considered, a
1pp slowdown in Chinese GDP growth driven by domestic demand is likely to reduce
eurozone GDP growth by -0.25pp and world GDP growth by -0.4pp. In 2021, eurozone GDP
would be roughly 1% lower than that outlined in our baseline scenario, while world GDP would
be 1.5% lower.
CHINA’S HIGH LEVERAGE POSES RISKS ASSESSING THE GROWTH SPILLOVERS
Credit to NFCs (% GDP) Deviation from baseline GDP level (trade + financial links, %)
250 0.0
Asset price bubble Housing bubble
200
Asian crisis
Subprime crisis
-0.6
150
100
-1.2
50
China Thailand Japan United States Spain

0
-1.8
EMU World
Source: Bank for International Settlements, UniCredit Research
5
See OECD, “Interim Economic Outlook”, September 2015.

US
A mild recession in 2H20, slightly delayed
Daniel Vernazza, PhD ■ We expect US real GDP growth of 2.3% in 2019, 1.1% in 2020 and 0.9% in 2021.
(UniCredit Bank, London) The economy will likely enter a mild technical recession in 2H20.
+44 207 826-7805
daniel.vernazza@unicredit.eu ■ The Fed is likely to resume rate cuts in 1Q20, cutting 25bp per quarter until end-2020, as
economic activity comes in weaker than the central bank expects.
A slowdown is already in train The US economy is slowing. Real GDP expanded 1.9% annualized in 3Q19, down from a
quarterly average of 2.6% in 1H19, 2.5% in 2018 and 2.8% in 2017. Payroll gains have
eased: the monthly change in private payrolls averaged 152,000 year-to-date, down from
215,000 in 2018. Following a series of weaker data recently, the Atlanta Fed’s latest estimate
of 4Q19 GDP growth has fallen to just 0.4% annualized; however, we expect a more modest
growth deceleration to 1.6% annualized.
Running on a single The composition of GDP growth reveals that growth is now entirely dependent on personal
growth engine
consumption and, to a lesser extent, public consumption (Chart 1). Fixed investment growth
has been negative for the last two consecutive quarters. A widely used proxy for business
investment intentions, non-defense capital goods orders excluding aircraft, has been falling in
real terms for 9 out of the last 11 months on a 3M/3M basis6. US trade tensions and
associated heightened macro uncertainty is weighing on business confidence, leading firms to
defer or cancel investment decisions. The more export-oriented manufacturing sector entered
a technical recession in 2Q19 and 3M/3M growth remained negative in October (Chart 2).
History suggests that consumption and services, on the one hand, and investment, exports
and manufacturing, on the other, will not be able to decouple for a sustained period.
The fiscal stimulus will fade The Trump administration’s fiscal stimulus has been responsible for pushing real GDP growth
above its long-run potential (around 1.8%) in 2018 and 2019. The Hutchins Center Fiscal
Impact Measure estimates the total impact of the fiscal stimulus – both the direct effects of
federal and local government spending and the indirect effects of government taxes and
transfers on private consumption – and calculates that it contributed a substantial 0.6pp to
average quarterly annualized GDP growth in the first three quarters of 2019. In contrast, it
expects the fiscal impact to be negligible in 1Q20 and then negative from 2Q20 through 3Q21.
Importantly then, the fiscal stimulus is expected to turn into a net drag on growth next year.
CHART 1: RUNNING ON A SINGLE GROWTH ENGINE CHART 2: MANUFACTURING ACTIVITY IS WEAK
Net exports Fixed investment US Manufacturing output (Fed measure) ISM manufacturing output - rs
Government consumption Personal consumption
GDP % 3M/3M Diffusion index
4 70
Average contributions to qoq annualized real GDP growth, pp.
3.5
65
3.0 2
2.5 60
2.0 0
55
1.5
1.0
-2 50
0.5 45
-4
0.0
40
-0.5
-6
-1.0 35
2016 2017 2018 2019*
* 1Q19-3Q19 average -8 30
Source: BEA, Federal Reserve, ISM, UniCredit Research
6
To deflate nominal capital goods orders, we use the US PPI for final demand of private capital equipment.

The labor market is Consumption has also been resilient because of solid personal real income growth (reflecting
showing signs of turning
still-strong payroll gains, decent wage growth and a muted PCE deflator) and relatively high
consumer confidence (in part driven by a wealth effect from high stock prices). While monthly
payroll gains have eased, so far they have still been sufficient to prevent the unemployment
rate from rising. A robust consumer is also evident in the pick-up in the housing market since
the turn of the year, initiated by Fed monetary-policy easing that has lowered mortgage rates.
Still, there are early signs that the labor market is turning. Job openings – historically a
reliable and leading indicator of employment – have been on a declining trend since the turn
of the year and signal a more pronounced slowdown in hiring ahead (Chart 3). Average hourly
earnings growth has been subdued for the past two months, which means personal
consumption growth will likely ease in 4Q19.
CHART 3: FALL IN JOB OPENINGS POINTS TO LOWER JOB GAINS CHART 4: UNIT LABOR COSTS HAVE INCREASED
Non-farm payrolls Job openings - rs US Unit Labor Costs, non-farm business sector (advanced 3 quarters)
US Core PCE - rs
thous., change yoy % yoy % yoy
thous.,change yoy 6.0 3.0
4,000 2,000
2,000 1,000 4.0 2.5
0 0 2.0 2.0
-2,000 -1,000 0.0 1.5
-4,000 -2,000
-2.0 1.0
-6,000 -3,000
-4.0 0.5
-8,000 -4,000
Jan-01 Jan-04 Jan-07 Jan-10 Jan-13 Jan-16 Jan-19 -6.0 0.0
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20
Source: BLS, UniCredit Research
Late cycle, falling margins The current US expansion, at 125 months and counting, became the longest economic
and lower expected earnings
expansion on record on 1 July 2019, beating the previous record set from March 1991 to
March 2001 when the dotcom bubble burst. While recoveries do not die of old age, and the
current expansion has been one of the slowest, we are seeing typical late-cycle effects
playing out. The unemployment rate, at 3.6%, is 1pp below the CBO’s estimate of the
equilibrium rate. It has pushed up unit labor cost growth, to 3.1% yoy in 3Q19 (Chart 4).
Firms, however, have felt unable to pass on these cost rises to consumers, and both headline
and core PCE inflation remain muted. Consequently, profit margins of non-financial
corporations continue to fall: after peaking at 22.9% in late 2014, margins fell to 17.8% in
2Q19 (Chart 5). Margins typically fall ahead of a recession.7 Analysts expect corporate
earnings to decline over the next 12 months, particularly for smaller firms that make up the
Russell 2000 index (Chart 6). As well as the weaker macro outlook, some of the decline in
expected earnings reflects negative base effects from US corporate tax cuts. Declining
profitability will weigh on investment and hiring.
High corporate debt Meanwhile, US corporates have increased their vulnerability to adverse shocks. Corporate debt
increases vulnerabilities
has risen sharply over the last few years and, at 75% of GDP, it is now higher than its previous
4Q08 peak (Chart 7). The debt-service ratio (the ratio of interest payments plus amortizations to
income) of private non-financial companies has also risen sharply due to the rise in debt, past
Fed tightening and weak corporate profits. The good news for corporates is that the Fed has
moved preemptively by cutting interest rates. But this is set against declining profitability.
7
Empirically, it is the change in margins rather than the level that has predictive power for the onset of a recession. Margins have trended higher since the early 1990s,
likely reflecting secular forces including globalization and firm concentration.

Valuations of US equities The accumulation of corporate debt has predominantly not been used to finance productive
are stretched
investment, but rather to finance payouts to shareholders, in the form of dividends and share
8
buybacks. It has boosted share prices, with the S&P 500 making new highs. Valuations of
US equities are already stretched based on current 12M forward earnings estimates. And, in
our view, consensus earnings estimates are far too high (see the Equity Strategy section).
High equity valuations are also predicated on expectations of further monetary policy easing
by the Fed, and if Fed rhetoric were to disappoint those expectations, it could act as an initial
trigger for a sell-off. A sharp fall in equity prices would tighten financial conditions and weigh
on personal consumption and corporate profitability.
CHART 5: PROFIT MARGINS OF NFCS CONTINUE TO FALL CHART 6: LOWER EARNINGS ESTIMATES FOR SMALL FIRMS
US net operating surplus of NFCs, % of net value added S&P 500 Russell 2000
26 Earnings per Share 12M forward estimate, Index 1 Jan 2019=100
105
24
22
100
20
18
16 95
14
12
1947 1956 1965 1974 1983 1992 2001 2010 2019 90
Jan-19 Mar-19 May-19 Jul-19 Sep-19 Nov-19
Source: BEA, Bloomberg, UniCredit Research
Ongoing US trade tensions Adverse shocks are also likely to stem from persistent trade tensions. While the US and
China are reportedly close to signing a “Phase one” trade deal, it is tentative and does not
solve the underlying issues. The reported deal would involve China pledging to buy additional
imports of US agricultural goods and, in return, the US would delay or cancel the planned
implementation of additional tariffs. It does not deal with China’s forced transfer of technology,
nor China’s subsidies to state-owned enterprises. In our view, trade tensions will persist. China
is not going to fundamentally change its approach to state-owned enterprises and treatment of
property rights because the US demands it. A comprehensive trade deal is unlikely given that it
would have to cover tricky issues like “fair playing field” rules, including human rights.
Recession-probability Our US recession-probability model indicates a high 48% probability of a recession within
models are flashing red
12 months, and 70% within two years. The model uses the unemployment rate gap (the
difference between the actual unemployment rate and its estimated equilibrium rate),
residential investment as a share of GDP, and compensation per hour as predictors of a
recession. Financial markets also appear to attach a high probability to trouble ahead, as
evident by the inverted yield curve (the spread between the 10Y and 3M US Treasury yield)
from June to September this year. The slope of the yield curve has now turned positive, in
part thanks to Fed rate cuts and, to a lesser extent, increases in the 10Y yield following
reports that the US and China are close to signing a “Phase one” trade deal. As already
mentioned, we do not think the latter will prove sustainable. The yield curve is still very flat
and the damage could already have been done – indeed, the 3M/10Y spread tends to turn
positive before an NBER-dated recession starts.
8
See the IMF Global Financial Stability Report (October 2019), Chapter 2: “Global Corporate Vulnerabilities”.

CHART 7: US CORPORATE DEBT HAS RISEN SHARPLY CHART 8: RECESSION PROBABILITY MODEL
NBER recession within 1Y within 2Y within 3Y

US credit to PNFCs, % of GDP US debt service ratio of PNFCs (%, rs)
Probability of a US recession within 1, 2 or 3 years (%)
75.0 48.0 100
72.5 46.0
75
70.0 44.0
67.5 42.0 50
65.0 40.0
25
62.5 38.0
0
60.0 36.0 74 77 80 83 86 89 92 95 98 01 04 07 10 13 16 19
Mar-99 Mar-04 Mar-09 Mar-14 Mar-19
Source: BIS, UniCredit Research
A mild recession in 2H20 Reflecting the above, we expect US real GDP growth of 2.3% in 2019, 1.1% in 2020 and
0.9% in 2021. The annual averages conceal a more pronounced slowdown in quarterly
growth rates, ending in a mild technical recession – two consecutive quarters of negative
growth – in 2H20. This is delayed by one quarter compared to our previous forecast since
personal consumption has proved more resilient than we had expected.
Inflationary pressure Inflationary pressure is muted, with headline PCE inflation at 1.3% yoy and core PCE inflation
to ease with demand
– the Fed’s preferred measure – at 1.7% yoy in September. In October, core CPI inflation
eased 0.1pp to 2.3% yoy. Historically, core CPI inflation has averaged around 0.3pp above
core PCE inflation. The recent rise in core inflation from mid-2019 reflects the impact of tariffs
on core goods inflation. Headline CPI inflation is set to rise around the turn of the year, to
2.3% yoy, due to a positive base effect from gasoline prices, and then fall precipitously to
1.2% yoy by end-2020, with lower energy prices and lower core inflation combining. Core CPI
inflation has likely peaked as aggregate demand softens, wage pressure eases, and the past
appreciation of the US dollar weighs on imported goods prices.
US politics and fiscal policy US President Donald Trump is currently facing an impeachment enquiry into whether or not
he sought help from the Ukrainian president to increase his chances of re-election at the
upcoming 3 November 2020 presidential election. The US constitution states that a president
shall be removed from office if convicted. But while the Democrat-controlled House of
Representatives will almost surely vote to impeach Mr. Trump, the chances of two-thirds of
the Republican-controlled Senate voting to convict him are approximately zero, meaning Mr.
Trump would not be removed from office. As for the 2020 presidential election, at the time of
writing it is too early and too close to call. What we know is that President Trump’s job
approval ratings have held up, but whether this will continue to be the case once the economy
turns down is doubtful. The Trump administration is unlikely to stand still once they see the
economy slowing materially – reportedly, they are already looking at tax cuts. But, unlike in
2017, the Republicans do not control the House and even if they were able to target
something the Democrats could support, say tax cuts for low earners and infrastructure
spending, it’s likely to be too little, too late. It seems unlikely that trade tensions would ease
materially if the Democratic presidential candidate were to win.

The Fed says it has At its 29-30 October meeting, the FOMC cut the target range for the fed funds rate to 1.50-
stopped cutting rates
1.75%, the third consecutive 25bp cut this year, but signaled that it is likely done with rate
cuts, unless there is a “material” change to the outlook. Fed Chairman Jerome Powell said,
“We believe monetary policy is in a good place. We see the current stance of policy as likely
to remain appropriate, as long as incoming information about the economy remains broadly
consistent with our outlook.” Chairman Powell also noted that trade developments “have
moved in a positive direction”, citing progress towards a “Phase one” trade deal between the
US and China and a reduced probability of a no-deal Brexit. Several FOMC members have
likened the latest rate cutting cycle to the “insurance cycles” of the late 1990s, which didn’t
end in a recession (Chart 9). In our view, however, while Fed easing has helped to delay the
onset of a (mild) recession slightly, it will not prevent it. And now that the Fed has said only a
material change to the outlook would see them cut rates again, they will only act once it
becomes clear a material slowdown is happening, by which time it will be too late.
We expect the Fed to cut We expect the Fed to pause in December and then to resume rate cuts of 25bp per quarter in
four times in 2020
2020, taking the target range to 0.50-0.75% by end-2020 (Chart 10). This reflects our forecast
for materially lower GDP growth than the Fed currently expects and for trade tensions to
persist in the medium term, which forces the Fed’s hand. In our forecast, the Fed does not
use all its policy space on rates: it will be caught between the academic evidence that it’s best
to move early and aggressively, on the one hand, and the desire to keep some powder dry
given the proximity to the ZLB on the other. We expect the Fed to be on hold in 2021 as
economic growth recovers.
Policy framework review The Fed is currently in the middle of a comprehensive review of its monetary policy framework
and tools, which Fed Chairman Jerome Powell said will likely run to the middle of next year after
commencing in February 2019. Our view is that the Fed will opt to shift towards average inflation
targeting. Some key FOMC participants seem to be in favor, and more widely there is a concern
about inflation expectations becoming de-anchored after several years of below-target inflation.
Average inflation-targeting would also have the benefit of helping to move the equilibrium
nominal interest rate higher, assuming the new average target is credible, and at times when
growth and inflation are weak. Also, average inflation targeting has the appeal of being fairly
easy for the public to understand – as opposed to its close relation “price-level targeting”.
CHART 9: PAST FED EASING CYCLES CHART 10: FED FUNDS TARGET
FOMC members' median projection (September 2019)

UniCredit forecast
Duration NBER Fed funds futures (18 November 2019)
2.50
Start End (months) Rate Recession
Start End Change (pp) 2.25
6/89 9/92 40 9.75 3.00 6.75 YES 2.00

7/95 1/96 7 6.00 5.25 0.75 NO 1.75
09/98 11/98 3 5.50 4.75 0.75 NO
1.50
1/01 6/03 30 6.50 1.00 5.50 YES
1.25
9/07 12/09 28 5.25 0.25 5.00 YES
1.00
Note: Rate cut cycles are defined here as any period where the Fed cut 0.75
interest rates at least three times without hiking rates. Highlighted rows are
“insurance cycles” that did not coincide with a recession. 0.50
Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec-
19 19 19 19 20 20 20 20 21 21 21 21
Source: Bloomberg, Federal Reserve, UniCredit Research

Eurozone
Domestic resilience set to fade
Marco Valli ■ GDP growth is likely to slow further, to 0.8%, in 2020, as global trade remains in the
Chief European Economist doldrums and spillover of external weakness on domestic demand intensifies. We expect a
(UniCredit Bank, Milan) moderate recovery to 1.0% in 2021.
+39 02 8862-0537
marco.valli@unicredit.eu ■ Monetary policy is likely to remain unchanged, but the risk of further easing will probably
increase in 2H20. The ECB’s policy review will be a key event for financial markets.
The eurozone economy is likely to end the year on a weak note, probably expanding by 0.1-
0.2% qoq in 4Q19. This would leave average growth for the whole of 2019 at 1.2%, the
slowest pace of expansion since the recession caused by the sovereign-debt crisis. Prospects
are not favorable, and we forecast that growth will lose further traction in 2020, to 0.8%.
Resilience of the domestic In our baseline scenario, we assume that weakness in global trade will intensify in 2H20 as
drivers of growth will be tested
downward pressure on the US economy builds. This challenging external environment is
expected to increasingly test the resilience of the domestic drivers of eurozone growth. Fiscal
policy is likely to remain only mildly expansionary, while the ECB’s September package
should preserve ample monetary accommodation, but is unlikely to provide sizeable
incremental stimulus. The projected mildly upward trajectory in the trade-weighted euro
exchange rate will add to the struggle of eurozone exporters.
Sequential GDP growth is likely to be firmer in 1H20 (at an annualized pace of 1%) and
weaker in 2H20, when the eurozone economy is likely to approach stagnation. We forecast a
moderate recovery in 2021, with growth likely to accelerate to an annual average of 1.0%.
Spillover of external weakness After 2019 featured a wide gap between the performance of the manufacturing and services
will be key
sectors, the key theme for 2020 will be if, and to what extent, external weakness will spill over
more clearly to domestic drivers of eurozone growth. The main transmission channel will be
fixed investment and its impact on consumers via the labor market.
Investment has been So far, investment in the euro area has remained resilient despite a worsening of firms’
resilient so far
profitability, which has reflected slower output growth and rising unit labor costs. With firms
recording a weakening in their internal generation of funds, external sources of funding have
played a greater role in the financing of investment, as firms have taken advantage of very
loose financial conditions that are a result of ECB policies. This pattern has been mirrored in
the evolution of the financing gap of the non-financial corporate sector, which measures the
excess of firms’ internal funds over their capital expenditure. Since economic activity started
to lose momentum in 2018, the (positive) financing gap has been shrinking rapidly.
CHART 1: EUROZONE GDP FORECASTS CHART 2: INVESTMENT HAS BEEN OUTPACING PROFITS
1.2 3.5
Eurozone* NFCs (four-quarter-cumulated sums, value)
15 6.0
GDP qoq (%) GDP yoy (%, rs) Forecast
1.0 3.0
10 4.0
0.8 2.5
2.0 5 2.0
0.6
1.5
0.4 0 0.0
1.0
0.2
0.5 -5 -2.0
0.0
0.0
-10 -4.0
-0.2 -0.5
-0.4 -1.0 -15 -6.0
Net lending (+)/net borrowing (-), % of GVA - rs
Gross operating surplus (yoy %)
-0.6 -1.5 Gross fixed capital formation (yoy %) * Excludes Ireland
1Q10 1Q12 1Q14 1Q16 1Q18 1Q20 4Q21 -20 -8.0
4Q00 3Q04 2Q08 1Q12 4Q15 2Q19
Source: Eurostat, UniCredit Research

ECB monetary policy ECB monetary policy will probably remain very accommodative and thus continue to play an
provides an important buffer
important role as a shock absorber by keeping credit spreads and banks’ lending standards
supportive. However, this is unlikely to allow for a lasting decoupling of investment from
profitability. In our baseline scenario, demand from abroad fails to pick up and company
profits remain weak, thereby increasing the likelihood that investment growth will lose traction.
Capex – especially transport investment, which has performed strongly in this recovery – will
probably shoulder most of the adjustment, while the construction sector should be more
resilient even if, in line with our forecast, no major infrastructure plans are launched in any of
the big eurozone countries. Spending on intellectual property, which appears to be on a
structurally upward trend, might act as a cushion but is unlikely to prevent a slowdown in
overall investment activity. This is likely to spill over more clearly into the labor market.
Consumers have already The good news is that consumers have already started to build up a precautionary buffer.
started to adjust
Household spending has been subdued for a number of quarters, running at an annualized
pace of about 1%, almost half the growth rate of real disposable income. This has led to a
rebound in the savings rate, indicating that households have already started to adjust to a
more uncertain environment and to prospects of slower job creation. A further increase in
precautionary savings in 2020 is possible, but this would come within a context of strong
balance sheets, which increase households’ resilience to shocks. Unless the labor market and
consumer sentiment take a turn for the worse, the downside potential for household spending
– and, probably, for the whole economy – should remain reasonably contained.
Growth forecasts by country Our forecasts by country reflect a pattern in which a weak global economy damages
comparatively more those countries with a large manufacturing base and high propensity to
export goods. Therefore, we expect that Germany (0.3% in working-day-adjusted terms) will
continue to underperform the rest of the euro area in 2020, with the domestic fiscal impulse
unlikely to be large enough to reverse this trend. France (1.0%) and Spain (1.4%) will
probably confirm growth rates that are above the eurozone average. Italy (0.2%) will keep
lagging behind its main peers.
Risks to the outlook Risks to our growth outlook for the euro area are tilted to the downside. The main adverse
scenario involves an escalation of the trade war, especially if this were to also involve higher
US tariffs on European cars (which would severely hit Germany and almost certainly trigger
retaliation). The main upside risk involves a scenario where US growth remains resilient. The
Scenario Analysis section provides more details.
Core inflation to peak soon With GDP growth set to remain below potential for most of the next two years, the window for
a reacceleration in underlying price pressure will probably close before long. We expect core
inflation to peak within the next few quarters at 1.2-1.3%, after which some stabilization and
slight easing appear likely, as the widening of the output gap feeds into price formation.
CHART 3: CAPEX GROWTH DRIVEN BY TRANSPORT SECTOR CHART 4: HOUSEHOLDS’ PRECAUTIONARY SAVINGS RISE
Capex (% of GDP) Savings rate (%)

6.0 2.2 14.5 2.0
Machinery/equipment Consumer confidence (standardized, rs)
1.5
Means of transport (rs) 14.0
1.0
5.5 2.0
13.5 0.5
0.0
13.0
5.0 1.8 -0.5
12.5
-1.0
12.0 -1.5
4.5 1.6
-2.0
11.5
-2.5
4.0 1.4 11.0 -3.0
1Q95 2Q01 3Q07 4Q13 2Q19 1Q99 2Q04 3Q09 4Q14 3Q19
Source: Eurostat, UniCredit Research

Headline inflation Given our expectation that oil prices will decline from current levels, and with leading
to hover around 1%
indicators pointing to weakness in food inflation at least over the next six months or so, we
forecast that average headline inflation for 2020 will settle at 1%. Its trajectory is likely to be
humped: higher at the beginning of the year and lower afterwards. We predict a tentative
reacceleration in 2021 to an average rate of 1.1%, as increases in non-core components
more than offset slight easing in core inflation. Overall, inflation is going to remain far away
from the ECB’s definition of price stability for the foreseeable future.
We expect the ECB We expect ECB policy to remain unchanged throughout our two-year forecasting horizon. The
to stand pat…
central bank’s “chained guidance”, which links the end of QE to the timing of the first interest-
rate increase, would automatically bring about more asset purchases if and when the timing of
rate normalization is delayed. This mechanism would allow the ECB to cope with reasonably
limited shocks to its baseline scenario without coming under much pressure to loosen
monetary policy further. Given also fierce opposition from part of the Governing Council (GC)
to the September package, the bar for further easing is likely to be very high in the first six
months or so of ECB President Christine Lagarde’s term.
…with the risk of further easing However, in 2H20, the balance of risks is likely to tilt towards further accommodation as the
set to increase in 2H20
US slowdown intensifies, the Fed continues to cut rates and eurozone growth comes close to
a standstill. In such an environment, any clear deterioration in inflation expectations from
already-low levels would inevitably increase pressure on the ECB. If the GC is indeed forced
to do more, a rate cut (possibly with some adjustment to tiering parameters) would probably
be its first choice, especially if financial conditions were to tighten due to appreciation of the
euro. However, with policy rates already deeply negative, any such move would be
implemented mainly, if not exclusively, for signaling purposes.
All eyes on the ECB’s In 2020, the ECB is likely to carry out a review of its monetary-policy strategy. This might be a
policy review
key event for financial markets. We expect such a discussion to address two main topics:
1. the definition of price stability (which is currently “below, but close to 2% over the medium
term”) and, probably, 2. the tools the ECB can deploy to achieve its price goal.
The exact timing and length of the review are uncertain. However, the ECB should proceed
fairly quickly. We estimate that, under the current QE framework, the ECB would be able to
carry out net asset purchases for about a year – and maybe slightly longer if the flexibility
afforded by current rules is fully exploited. Therefore, especially if the ECB plans to shed some
light on its policy tools, the review would need to start within the first months of 2020 and be
wrapped up well before the end of the year due to approaching QE limits and the risk that a
material shock might force the GC to use some of its residual fire power earlier than expected.
CHART 5: PERSISTENT WEAKNESS IN INFLATION CHART 6: MARKETS DO NOT EXPECT INFLATION TO RECOVER
5Y5Y inflation swap (%)

3.5 3.0
Headline HICP (yoy %) Forecast
3.0 2.8
Core HICP (yoy %)
2.6
2.5
2.4
2.0
2.2
1.5
2.0
1.0
1.8
0.5
1.6
0.0
1.4
-0.5 1.2
-1.0 1.0
Sep-14 Jul-16 May-18 Mar-20 Dec-21 Apr-04 Jun-07 Aug-10 Oct-13 Dec-16 Nov-19
Source: Bloomberg, Eurostat, UniCredit Research

Price stability: It seems reasonable that the policy review will want to dispel ambiguity
surrounding the ECB’s inflation goal. If so, discussion around a new definition of price stability
might focus on two lines of thinking that would have very different implications for markets.
Possible tweaks to the The first option, which we regard as more likely, could consist of adopting a symmetric
definition of price stability
inflation goal at or just below 2%, while the second option could be a 1.5-2.5% inflation range.
Implications of the former would be neutral to somewhat dovish: the ECB would either confirm
or slightly increase its current price objective. However, implications of the latter would be
hawkish because markets would likely regard the low end of the range as the new target in an
environment of persistently low price pressure. Hence, the main message would be that the
ECB has decided to throw in the towel. In our view, this would be troublesome, especially at a
time when the Fed’s policy review is likely to strengthen, not weaken, the US central bank’s
commitment to achieving 2% inflation.
If the ECB does switch to a target range where the lower bound is clearly below 2%, inflation
expectations are likely to be affected. Moreover, as markets might start pricing in (premature)
policy normalization, we see a real risk of unwarranted currency appreciation and wider credit
spreads, and this would weigh further on inflation expectations.
Alternatives the ECB might discuss could include switching away from using HICP as the
reference price index. In particular, if the ECB were to target an inflation gauge that, in the
past, recorded consistently higher inflation rates than HICP inflation, this would make it easier
for the ECB to achieve 2% inflation. However, this would be a lowering of the inflation target in
all but name, and markets would react accordingly.
Searching for more clarity Tools: In order for it to be credible, any discussion of an inflation goal would need to be
on limits and instruments
accompanied by more clarity with regard to the instruments the ECB can deploy to meet its
price mandate. Given the peculiar institutional framework of the euro area and the constraints
that it imposes on non-conventional monetary tools, the ECB’s review would have to help
outline the policy scope for Ms. Lagarde if more stimulus is needed down the road. Therefore,
we think that such a review would need to assess how the ECB could disentangle itself from
its self-imposed limits, if they turn out to be inconsistent with the fulfillment of the central
bank’s price objective, but also identify additional assets the ECB could potentially add to its
balance sheet.
As for self-imposed rules, we think that the review will disclose which of the two main limits for
asset purchases (concentration limits and capital keys) could be amended if needed. We think
the ECB could gain flexibility by raising concentration limits on government bonds from their
current 33%, while the capital-key framework is probably more binding.
It is more difficult to assess how transparent the ECB will want to be with regard to assets that
could be potentially purchased. The arsenal is largely a function of what is regarded as
politically acceptable, and if fundamentals change, the line that separates acceptable from
unacceptable tools will move, as it happened in the past. In the current context, we think that
the ECB should not rule out getting involved in (senior) bank bonds and maybe even equities.
However, any such opening to broaden the scope of QE would likely say nothing about when
the GC would deem it appropriate to start buying these assets. We think the bar will be very
high for bank bonds and extremely high for equities. Instead, we expect there to be a clear
rejection of the idea that one day the ECB could engage in “helicopter money”.
The policy review might also touch on tools to mitigate the impact of negative rates on the
financial sector, specific aspects of ECB communication (such as whether to disclose GC
members’ views and votes) and whether the ECB wants to increase its presence in the
market for green bonds – Ms. Lagarde seems very supportive of the latter idea.

The policy agenda The European policy agenda for 2020 will be busy, with the completion of Banking Union,
reforming the European Stability Mechanism (ESM), addressing trade policy and setting a
new multi-year EU budget.
Banking Union The discussion surrounding the completion of the Banking Union with a common deposit-
guarantee scheme will continue to be highly complex with regard to striking the right balance
between risk reduction and risk sharing. The difficulty of solving the regulatory issue of how to
treat sovereign bonds on banks’ balance sheets leads us to think that a breakthrough with
regard to deposit insurance is not imminent.
Reform of ESM Reform of the ESM is based on four pillars: a common backstop to the Single Resolution
Fund, conditions for eligibility for precautionary credit lines, commitment to introducing single-
limb CACs into euro area government bonds issued starting from 1 January 2022, and the
ESM’s role in future financial-assistance programs. The new ESM treaty will come into force
when it has been ratified by all 19 ESM member states. At this stage, it is unclear whether the
whole proposed package will survive the approval process, but it is highly like that the ESM’s
role and prominence will increase going forward.
Trade policy Trade policy will also be in the limelight, with the new European Commission set to engage
shortly after Brexit in discussions with the UK on a free-trade agreement and having to deal
with the implications of the World trade Organization (WTO) ruling on a case involving Airbus
and Boeing. The WTO found that Boeing received billions of dollars of illegal subsidies in a
case dating back to 2005. Trade arbitrators are expected to allow the EU to impose its own
retaliatory tariffs on US imports. This would follow a US decision to impose punitive tariffs on
USD 7.5bn of imports from Europe on the back of the first leg of the WTO ruling, which dealt
with illegal subsidies received by Airbus.
New EU budget Last but not least, we expect the new EU budget for 2021-27 to reallocate funds from EU-
CEE to southern Europe due to the latter’s worse economic performance, higher youth
unemployment and bigger number of immigrants from outside Europe. Greece, Portugal and
Italy will likely receive the largest increase in euro terms. In contrast, CEE countries could see
their annual allotment decline by 0.2-1.0% of GDP per year, with Hungary and Poland the
most affected.

Germany
Dr. Andreas Rees ■ We expect GDP growth of 0.7% for 2020 and 0.8% for 2021, after presumably 0.6% for
(UniCredit Bank, Frankfurt) this year. Note that the 2020 figure is artificially inflated by a higher number of working
+49 69 2717-2074 days. Adjusted for this calendar effect, GDP growth is only 0.3%. The 2019 and 2021 data
are not distorted by such an effect.
Dr. Thomas Strobel
Economist
■ In line with our global outlook, the export activities of German companies are likely to lose
(UniCredit Bank, Munich) further momentum in 2020 before a recovery sets in in 2021. In our baseline scenario, we
+49 89 378-13013 assume there will be neither any US tariff hikes on European cars nor any escalation in
thomas.strobel@unicredit.de
US-China trade tensions. Hence, the forecast risks for German exports and the overall
German economy point to the downside (see the scenario analysis section for more details).
■ In 2020, downward pressure on exports and on capacity utilization in the manufacturing

sector is likely to dampen the capex spending of industrial companies. In 3Q19, capacity
utilization already decreased slightly below its long-term average of roughly 83.5% after
hitting its second-highest level in more than 25 years. As a result, more negative spillover
effects from the manufacturing industry into the services sector, which has been
comparatively robust so far, are likely. This in turn will further dampen total capex
spending, which services companies account for more than half of.
■ As a result, the labor market is likely to cool further, in line with the significant decline in
job vacancies. With an increase of 340,000 yoy, job creation has already been
significantly less brisk than it was at the turn of the year 2017/2018 (+660,000 yoy). As a
dampening factor, companies will probably shy away from layoffs and hold on to more
workers than necessary in the slowdown (labor hoarding). This would be a response to
the difficulty of getting qualified personnel in the past few years and the recurring costs of
hiring staff when growth picks up again in the medium-term. Reductions in hours worked
on a voluntary basis (overtime) or in the use of short-term benefits is therefore more likely.
Given the labor hoarding, wage increases should only decline somewhat to roughly 2%-
2.5% across sectors in 2020 and 2021 (2019: +3%). This, in turn, should help dampen the
impact of the negative labor market on private consumer expenditures.
■ The construction industry will probably remain a pillar of growth. Although there are signs
of overheating in some bigger cities, the demand for housing will continue to be strong. In
addition to the fundamental reasons for this strength, such as the process of catching up
after underinvestment in recent years and rising population, persistently low interest rates
are likely to contribute, as well.
CAPACITY UTILIZATION DECLINING JOB CREATION TO SLOW FURTHER
Capacity utilization in manufacturing sector, in % 1000 200

90.0
Employment, in 1,000 yoy Vacancies, in 1,000 yoy (rs)
88.0 800 150
86.0
600 100
84.0
400 50
82.0
80.0 200 0
Long-term average
78.0 0 -50
76.0
-200 -100
74.0
72.0 -400 -150
70.0 -600 -200

1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Source: Ifo, Labor Agency, UniCredit Research

Outlook for fiscal policy

Fiscal policy set to be We expect a moderately expansionary fiscal policy stance in 2020 and 2021. According to the
moderately expansionary
in 2020 and 2021 latest projection of the Stability Council, a joint body of the central government and the federal
states, the surpluses in the structural budget are likely to only gradually decline each year, to
0.5% of GDP in 2020 and then to 0.25% in 2021. Hence, the comparatively strong fiscal
impulse this year (around 0.6%), will probably not be sustained. Additional spending to tackle
climate change amounts to EUR 54bn from 2020 to 2023. However, this package will only
have a negligible net effect on growth, as the fiscal burden for companies and private
households will increase in turn. As in previous years, we expect public investment to grow at
a disproportionately high rate compared to GDP growth. However, these increases will still
remain far less pronounced than government savings due to declines in interest rates.
According to the Bundesbank, the public sector saved about EUR 370bn in interest
expenditures from 2008 to 2018 (public investment: EUR +26bn).
Germany’s debt brake limits Both legal and political factors prevent the government from pursuing a strongly expansionary
fiscal growth impulse… stance. From a legal perspective, the debt brake enshrined in the constitution places tight
constraints on fiscal policy. Only a structural deficit of 0.35% of GDP is allowed. According to
the latest budget plans, an additional amount of about EUR 11-12bn per year from 2020 to
2023 could therefore (theoretically) be spent by the central government. This would equal a
non-negligible, but still limited, growth impulse of 0.3% of GDP per year compared to the
baseline scenario. Note that the federal states are even obliged to run a balanced structural
budget from next year onwards. In our view, the cooling of the labor market could limit the
degree of fiscal flexibility further, as the decline in income tax revenue may be stronger than
anticipated. Political reasons also speak against a fiscal boost. The CDU/CSU tries to attract
…and cooling of labor market
may limit fiscal flexibility conservative voters by reining in public spending. Hence, an abrogation of the debt brake is
further unlikely, since it would require a two-thirds majority in the Bundestag and the Bundesrat.
Debt brake allows for higher The debt brake only allows significantly higher discretionary public spending in the case of
public spending only under
certain circumstances
deep recessions and natural disasters. Since the precise quantifications of economic pain
thresholds are not prescribed by law, the government has substantial room to maneuver. In
our view, the course of fiscal policy is only likely to change in the event of a decline of about
1% in GDP and/or a strong rise in the unemployment rate by roughly 1pp.
In such a risk scenario, the government may increase public spending and frontload the planned
cut of the solidarity surcharge from 2021 to 2020. In August, finance minister Olaf Scholz
suggested making additional expenditures of EUR 50bn in the event of an “emergency” (roughly
1.5% of GDP).
FISCAL POLICY ONLY SLIGHTLY EXPANSIONARY PUBLIC INVESTMENT RISING BUT BIG BANG UNLIKELY
Structural budget balance of government, in % of GDP Public gross fixed capital formation, in % of GDP; *1H19
1.5 3.5
Projection of Stability Council
1.0 3
0.5
2.5
2
0.0
1.5
-0.5
1
-1.0
0.5
-1.5
0
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2019*
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
-2.0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
Source: Federal Statistical Office, Stability Council, IMF, UniCredit Research

France
Tullia Bucco ■ We expect GDP growth to ease from 1.3% in 2019 to 1.0% in 2020, before regaining some
Economist
(UniCredit Bank, Milan) momentum in 2021 and settle at 1.2%. France’s comparatively smaller exposure to
+39 02 8862-0532 countries that suffered the most globally, strong export specialization in aeronautics for
tullia.bucco@unicredit.eu
which demand, particularly from China, has remained robust, and sizeable fiscal stimulus
in favor of households will continue to be supportive factors. After a stable growth
performance at 1.2% annualized in the first three quarters of 2019, GDP will likely grow at
a 1.0% annualized pace through 1H20, before slowing further in 2H20 amid weakening
external demand.
■ Our forecast for a moderation in GDP growth in 2020 is mainly explained by a deceleration
in gross fixed investment (to 1.8% from a solid 3.4% in 2019), particularly of non-financial
corporations – their investment rate hit a record high in 2019 at 24%. The unwinding of the
one-off boost to profit margins stemming from the transformation of the tax credit for
competitiveness and employment into a permanent cut in employers’ social contributions,
is likely to lead to a softer pace of investment over our forecast horizon.
■ The deceleration in household residential investment will probably gather pace, reflecting,
among other factors, the refocusing of some support fiscal measures on areas of tight
supply. Nonetheless, the slowdown is likely to remain gradual given that financing
conditions and households’ capacity to buy are expected to remain favorable, on average.
Government investment is set to weaken in line with the local electoral cycle (municipal
elections are scheduled for March 2020).
■ As investment growth is set slow, the role of consumption as a key growth engine is likely
to strengthen. We forecast a moderate acceleration in private consumption (from 1.2% to
1.4% in 2020), as the sizeable fiscal stimulus targeting households (worth 0.7% of GDP in
2020) is likely to start filtering through to spending more decisively and to largely offset the
negative impact of a slowdown in employment. This baseline scenario rests on the
assumption that social discontent partly recedes from current levels.
■ The government’s fiscal stance is planned to be mildly expansionary in 2020 (worth 0.1%
of GDP), also reflecting the “exceptional circumstances” that led the Elysée to announce
additional fiscal measures in favor of low-to-middle-income households. We see upside
risks to the 2.2% deficit target included in the Budget Law due to limited details on
expenditure reduction plans and a likely slippage in GDP growth below government
forecast, which is more optimistic than ours.
A ONE-OFF FACTOR BOOSTED CORPORATE INVESTMENT ENCOURAGING IMPROVEMENT IN CONSUMER CONFIDENCE
Non-financial corporations (yoy %, smoothed)

130 6
15 15
120 4
10 10
110
5 5 2
100
0 0
0
90
-5 -5
-2
Gross operating surplus 80
-10 -10 Consumer confidence
Gross fixed capital 70 Household spending on goods (yoy %, rs) -4

-15 -15
formation
Household consumption (yoy %, rs)
-20 -20 60 -6
4Q00 3Q04 2Q08 1Q12 4Q15 2Q19 Mar-99 Aug-02 Jan-06 Jun-09 Nov-12 Apr-16 Sep-19
Source: INSEE, UniCredit Research

Reform momentum faces hurdles

Social discontent is, Halfway through his five-year mandate, French President Emmanuel Macron is facing a new
once again, on the rise
wave of social discontent after the yellow-vest protests that raged in the country until last
spring. This new wave of discontent was mainly triggered by the announcement of savings
targeting healthcare spending as part of the 2020 social security budget law, and the main
guidelines of a pension reform that aims to improve the system’s fairness by eliminating the
privileges enjoyed by a few categories of public workers (e.g. firefighters, policemen).
Macron’s reformist drive This flare-up of social unrest marks a setback for Mr. Macron, who in the past few weeks has
is being put to a test
lost some of the popularity he had recovered since April at the cost of sizeable fiscal
concessions to yellow-vest protesters and a deviation from the ambitious fiscal targets he had
previously pledged. According to polls, the French population fears a deterioration of the
quality of institutions that make up the country, such as national health insurance, pension
insurance and education. Meanwhile, new defections within the parliamentary majority have
occurred, with some members questioning the seriousness of the ruling party’s commitment
to renewing politics and bringing about social change. Nonetheless, Mr. Macron can still count
on a solid majority and a very weakened opposition, which has shown on several occasions
that it is unable to capitalize on the government’s moments of difficulty.
The pension reform, which is expected to be adopted by parliament before next summer, is a
major test of the government’s ability to pursue reforms in the second half of Mr. Macron’s
term. In the past, other governments have had to abandon a reform of public-sector special
regimes in the face of street protests. However, Mr. Macron’s proposal to exempt workers
affiliated to these regimes from the reform to assuage the protests seems inconsistent with
the aim of improving equality among workers. The provision of preferential treatment to
public-sector workers has lost social and political legitimacy – the need to attract workers to
the civil service has vanished over time – and would deny the very logic of the reform, i.e.
improving the fairness of the system.
“Act II” of Macron’s After mainly focusing on economic reforms in the first part of his term, Mr. Macron is now
presidential term expected to address reforms aimed at improving the functioning of parliament and reforming
the state, including a reduction in the number of MPs, the introduction of more proportionality
in parliamentary elections, and the possibility for local communities to set themselves apart
from national rules. However, these reforms face many hurdles. It is very unlikely that the
Senate, which is controlled by the center-right, would approve any of these measures limiting
its influence. Meanwhile, local authorities will hardly accept increased responsibility if this
were not accompanied by greater autonomy in the management of financial resources. This is
all the more likely as the Elysée’s recent decision to fully abolish the housing tax for all
households by 2023 will increasingly weigh on local finances.
Economic reform proposals to be discussed next year aim at providing a further boost to the
supply-side with the partial abolition of the production tax (which weighs on firms’
competitiveness), and at introducing new forms of “flexicurity” for individuals via the
establishment of a guaranteed basic income conditional on seeking work, which should merge
existing welfare entitlements. The main factor that can hinder the adoption of these reforms is
the limited resources the government can count on unless a major spending review (which is
currently not in the agenda) is carried out.
Addressing the divide between In the face of the deep social discontent expressed by the population, we think that one of the
large urban areas and town government’s top priorities to maintain reform momentum is to foster measures aimed at
and villages remains key
overcoming the territorial divide between “peripheral” territories and big cities on which
discontent built in the first place. This requires, as a minimum, strengthening existing policies
or adopting new ones in the field of housing, urban development and infrastructure with the
aim of ensuring public services are as uniform as possible across the entire country.

Italy
Dr. Loredana Maria Federico ■ We expect Italy to face another year of weak growth in 2020, with real GDP expanding by
Chief Italian Economist
(UniCredit Bank, Milan) 0.2%, a similar rate as in 2019, and recovering to 0.5% in 2021. Next year, exporters are likely
+39 02 8862-0534 to (again) face flattish global demand (and weaker imports from the eurozone), and the
loredanamaria.federico@
unicredit.eu
currency is not projected to act as a mitigating factor as it did in 2019. Capex is expected to
weaken further, while a recovery will continue to characterize other investment aggregates,
especially construction. We are penciling in an easing of financial conditions thanks to the
ECB’s package and lower government-bond yields, and this should prevent fixed investment
from becoming a drag on GDP. Private consumption is expected to drive growth, albeit at a
subdued pace, due to slowing job creation and increasing uncertainty as a result. Italy’s GDP
outlook is expected to improve in 2021, when a strengthening of world trade growth should
provide a fresh impulse to exports and capex.
■ Given subdued growth, we forecast that CPI inflation will remain below 1.0% in 2020-21. Still,
we expect core inflation to broadly stabilize around its current level (0.6-0.7%), as the expected
development of the output gap does not suggest a material deceleration.
■ Two main downside risks to our baseline scenario could lead to a recession in Italy. On trade,
while Germany is likely to be affected the most if the US imposes car tariffs on Europe, Italy
will not be immune: 1. Car exports to the US make up 27% of Italy’s total exports of cars,
although this accounts for only 0.8% of total Italian exports. 2. The share of car parts Italy
exports to Germany is significant (22%), on top of Germany’s position as Italy’s first trading
partner. On the domestic front, while we do not expect early elections, there is a non-negligible
risk that the governing parties will not be able to muddle through on the bumpy road ahead.
Uncertainty about the outcome of a new election could lead to a repricing of funding costs for
the government and banks, and this would be transmitted to the real economy.9
■ The fiscal outlook is expected to benefit from the low-yield environment. Risks to the 2020
budget deficit target are low. Should fiscal slippage emerge next spring, we see room for
public-spending cuts, or the government might be in the position to recalibrate the imple-
mentation of its policy measures aimed to reduce the tax wedge, stimulate investment and
promote family policy and social inclusion. In 2021, while we assume that the government will
search for measures to replace currently targeted VAT revenue (worth 1% of GDP), we don’t
expect the budget deficit/GDP to improve compared to 2020, as growth recovery is likely to be
slow. We forecast that public debt/GDP will increase modestly in 2020-21, as the interest rate-
growth differential will remain positive, although declining, leaving Italy in a disadvantageous
position compared to its main eurozone peers. Such an outcome also suggests that any extra
savings in terms of interest expenditure should be used to lift growth properly.
WEAK, BUT NOT FALLING ACTIVITY AFTER ALL THE CHANCE TO CATCH UP SHOULD NOT BE MISSED
Italy's real GDP & composite PMI indicators (MA(3)) Public debt: interest rate-growth differential (pp)
4
5
Italy's real GDP, yoy (%) Italy (rs)
62 2010-14
France (rs) Germany (rs)
4
2 58 2015-19
3
54 Eurozone avg. (2015-19)
2
0 50
1
46
-2 42 0
38 -1
-4 34 -2
Oct-09 Oct-11 Oct-13 Oct-15 Oct-17 Oct-19 Germany France Italy Spain Portugal
Source: Markit, Istat, Eurostat, UniCredit Research
9
See our Economics Thinking – Assessing the impact of Italy’s sovereign stress on the real economy, March 2019.

Politics (once again) could be a game changer

Our baseline scenario does Political uncertainty is expected to remain a key theme in our outlook. The scenario we see as
not include snap election
most likely involves Italy avoiding an early election over the forecast horizon. The window for
calling an early election will close at the end of 1H21, as Italy’s constitution does not allow
parliament to be dissolved in the six-month period before the mandate of the current President
of the Republic ends (the so-called blank semester). Our baseline scenario also takes into
account that, should the current government headed by Prime Minister Giuseppe Conte
collapse, political parties (probably with the exception of the League and the right-wing Brothers
of Italy) will likely attempt to form another government during the current legislative term.
Therefore, a government crisis might generate some market instability, but we would expect this
to be temporary if early elections are avoided. Still, we predict that the road ahead will be
bumpy, and the probability of early elections is not negligible.
The following are The current government, based on an alliance between the Five Star Movement (M5S) and the
the main reasons:
Democratic Party (PD), along with support from former Prime Minister Matteo Renzi’s new
liberal movement, Italy Alive, and the left-wing Free and Equal party, has presented Italy’s 2020
draft budgetary plan. As is usually the case when tough decisions have to be taken, the share of
the vote projected to go to the two main parties of the coalition (M5S and PD) is now lower than
The high political cost of it was in August 2019. One could argue that a further decline in their projected vote shares, as
approving the 2020 budget plan
suggested by opinion polls, might exacerbate instability within the ruling coalition, and MPs
might find it more convenient to bring down the government to stop the draining of electoral
support for their respective parties. However, we think it would be much more advantageous for
MPs to assume that the government agenda might eventually pay off, and this might help
rebuild consensus over the next two years. This is also because, in the case of the M5S, for
example, the difference between its vote share in the March 2018 election (about 32%) and its
average vote share in polls in 3Q19 (19%) shows that the political disposition of the more
unstable portion of its electorate has already shifted.
In the same vein, the formation of a new government has accelerated a reduction in
The strong benefit of government-bond yields, with the 10Y BTP-Bund spread hitting a low of 130bp in October 2019.
the low-yield environment Low yields, also due to the benefits from a new round of quantitative easing by the ECB,
present a nearly unique window of opportunity in terms of public resources to be saved, one
that could prove costly if squandered by the governing parties.
We assume that it will not be easy for the political parties within the ruling coalition to find rapid
agreement on how to replace the current electoral law, and, eventually, on how to promote a
return towards a more proportional system – a goal that is part of the government’s program.
We think that this will create a disincentive to call elections in the short term. The current
The outcome of the next electoral system, the Rosatellum, is characterized by a mix of majoritarian and proportional
election suggested by the polls representation, according to which about 40% of seats are assigned on a single-district, first-
past-the-post basis. Based on current opinion polls – and as long as the candidates of the
center-right parties are supported by a pre-election coalition – a scenario could materialize in
which the center-right coalition wins most of the first-past-the-post districts in addition to gaining
proportional representation of roughly 50%.10 The M5S and the center-left parties could end up
with significantly reduced influence in the next parliament, as opposed to having more than
about 55% of the seats in the current legislature.
Still, the political outlook However, the governing parties do not form a cohesive coalition, and the government’s program
is highly uncertain and…
is too vague to mitigate possible causes of conflict that have been emerging and are likely to
continue to emerge in the coming months. Therefore, a political accident could occur: one that
…we see destabilizing factors
could lead to a government collapse, the lack of an alternative majority, and a snap election. We
threating the longevity have identified at least four destabilizing factors that could support a risk scenario, with a non-
of parliament negligible probability of an early election taking place over the forecast horizon.
10
Winning 40% of the vote in the proportional system and 60% of the first-past-the-post districts could be enough to achieve a nearly absolute majority in parliament.

1. The outcome of regional Italy will hold several important regional elections next year, starting in Emilia Romagna and
elections, starting at the end of
January Calabria (26 January) and continuing with Campania, Liguria, Marche, Puglia, Toscana and
Veneto. All of these regions, except for Liguria and Veneto, are currently governed by center-left
parties. Therefore, defeats in some of them – with Emilia Romagna (a stronghold of the PD) first
in line – could put the governing parties under severe stress.
2. A possible referendum to The beginning of 2020 is also expected to provide clarity as to whether it will be possible to
change the electoral law
promote the referendum requested by the center-right to abolish the proportional part of the
Rosatellum, and thereby changing it into a purely majoritarian system. Should such a
referendum be scheduled (most likely for next spring), this could accelerate attempts by
governing parties to change the electoral law and reduce the scope of such a referendum.
Given the still-divergent positions within the ruling coalition with regard to how to change the
electoral system, such acceleration could fuel instability and will require party leaders to exhibit
a degree of political savvy in order to navigate such thorny issues. A scenario in which the
referendum on the Rosatellum is held, only the center-right parties campaign for change and
the referendum passes, would present further opportunities for opposition parties to consolidate
their positions and thereby destabilize parliament.
3. The constitutional In the first half of 2020, the next steps to definitively approve constitutional reform aimed at
amendment to reduce
the number of MPs reducing the number of MPs will also be taken.11 If such a constitutional amendment is passed,
it will lead to a 37% reduction in the number of seats in Italy’s parliament, significantly reducing
the ability of leaders of political parties to guarantee a role for party members in parliament in
the next legislature. Therefore, a scenario in which an early election hinders the completion of
the approval process cannot be ruled out. In January, it should become clear whether the
requirements to have a confirmative referendum have been met. If this is not the case, the last
steps needed to approve the reform will probably be taken in February and March. Otherwise,
they will probably be postponed to late spring. Both periods could be marked by a sharp
increase in political uncertainty.
4. The appointment of a new When 2021 arrives political parties will shift their focus to the election of the President of the
President of the Republic
Republic, which is scheduled for the beginning of 2022. The chance to nominate a candidate for
the presidency could be seen by political leaders as a very prominent achievement. Therefore,
the prospect of such an appointment could increase pressure on the opposition parties to fuel
such political instability that Italy is compelled to hold a snap election before July 2021.
A risk scenario with Should the risk scenario materialize, with Italy holding an election over the forecast horizon,
a non-negligible probability
current opinion polls suggest that the League, the Brothers of Italy and Forza Italia will probably
gain an absolute majority in the next parliament, with the final outcome conditional on the
electoral system in place. The key points of such a coalition’s economic agenda are expected to
be focused on a swift and significant tax reduction and on boosting public investment. Its fiscal
stance and, above all, approach to the European Commission in terms of compliance with EU
budget rules (constructive vs. confrontation) are likely to remain much less clear. Still, given that
the outcome of the European Parliament election in May 2019 affirmed the supremacy of
Europe’s mainstream parties, we see little incentive for a potential center-right/right government
in Italy to pursue anti-EU rhetoric. Such parties are more likely to espouse the position that they
will try to change the eurozone and Europe from within. This is expected to leave investor
concerns mainly centered on fiscal sustainability in the medium term.
11
While the process of approval for this constitutional reform has already been concluded in parliament, a confirmative referendum can be requested so that the
constitutional amendment can be definitively approved. In addition, the reform envisages a two-month period in which the government will have to act to adapt
current features and organizations of parliament to the lower number of MPs.

Spain
Edoardo Campanella ■ We expect the Spanish economy to grow by 1.4% in 2020 and by 1.5% in 2021, down from
Economist
(UniCredit Bank, Milan) 1.9% this year. Recent national account revisions point to weaker growth momentum than
+39 02 8862-0522 previously assumed, particularly as a result of less-vibrant domestic demand. Over the last
three quarters, households have significantly increased their savings rate, from around 5%
to above 7% – an increase that might reflect both precautionary motives in the face of a
more-challenging global environment and a genuine rebound after the lows recorded
during the recovery. However, the slowdown in domestic demand has also come from
investment. Weakness in the manufacturing sector since mid-2018 has had an adverse
impact on growth in equipment investment.
■ Going forward, we expect the savings rate to stabilize around current levels throughout the
forecast horizon, but there might be room for a further increase especially in case of a
deterioration in consumer confidence stemming from both a less-bright labor market and a
more-challenging global environment. Investment is likely to decelerate amid trade
tensions and weak global growth, albeit high levels of capacity utilization and favorable
financial conditions remain very supportive. Construction investment is likely to lose
momentum as the economic cycle matures. On the external-demand front, we estimate
that net exports will modestly contribute to GDP growth. Indicators for foreign orders from
Spain’s main export regions – including the euro area, which is Spain’s main export market
– point to a continuation of this slackness in the near future.
■ The labor market is losing some shine as a result of a cyclical slowdown. The latest data
on Social Security registrations point to a slowdown in employment, which started during
the summer. This employment slowdown, which has been relatively broad-based across
sectors, has been somewhat more pronounced in construction and industry. While the
pace of job creation is likely to decline, we still expect the unemployment rate to drop
below 13% by 2021.
■ The political stalemate in Spain has been weighing on public finances. The 2018 budget
was rolled over into 2019. We now expect something similar to happen also in 2020, with
the budget deficit set to reach 2.2% of GDP next year (this is based on a scenario in which
legislation remains unchanged, taking into account a less-benign macro outlook). This
projection includes the wage increase for public employees stipulated for 2018-20 and an
annual pension revaluation that is in line with inflation. Overall, the fiscal stance of Spain is
expected to remain broadly neutral throughout our forecasting horizon.
HOUSEHOLDS BOOST SAVINGS LABOR MARKET BECOMES LESS BRIGHT
6.0 16 Affiliates to social security by sector (yoy; %)

20
Construction Industry Services Total
3.0 12 10
0
0.0 8
-10
-3.0 4
Real disposable income (in % yoy) -20
Real household consumption (in % yoy)
Savings rate (as % of disposbale income, RS)
-6.0 0 -30
4Q00 1Q02 2Q03 3Q04 4Q05 1Q07 2Q08 3Q09 4Q10 1Q12 2Q13 3Q14 4Q15 1Q17 2Q18 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17 Jan-19
Source: Eurostat, INE, UniCredit Research

The political stalemate is set to continue

Different coalition scenarios At the time of writing, after an inconclusive election – with Ciudadanos almost being wiped out
and the far-right Vox doubling its support – the PSOE and Podemos have been working on a
coalition government that will assign top ministerial posts to both parties. Since together the
two parties are 21 MPs short of having an absolute majority in Spain’s 350-seat parliament,
they will have to rely on external support or abstention on the part of other parties. Without
important political concessions, particularly with regard to Catalonia’s independence, such a
government will struggle to take off. If it were to find its feet, it could be short-lived. Hence, a
grand coalition between the People's Party (PP) and PSOE, which would enjoy more
comfortable parliamentary arithmetic, might eventually emerge in order to guarantee some
governability and to stem the advance of the far right.
Loss of reform momentum A weak government in a highly fragmented parliament at a time when economic growth is
decelerating is likely to slow the implementation of important structural measures necessary
to consolidate the banking system, to further overhaul Spanish labor law and to address
factors that might impair productivity in the medium and long term. This might create growth
challenges for the country going forward. Given a wide scoreboard of indicators that capture
different dimensions of Total Factor Productivity, which is the main driver of growth in the long
run, Spain hardly ranks close to best-in-class and is actually closer to an economy like Italy.
The Catalan stumbling block Moreover, Spain’s future government might lack the necessary resolve and cohesiveness to
tackle rising secessionist tensions in Catalonia. Social unrest recently resurfaced in the region
when, last October, Spain's Supreme Court sentenced nine Catalan separatist leaders to
between nine and 13 years in prison for sedition. Catalan independence might represent the
main stumbling block for the stability of any coalition government, as the main parties have
radically different views on the issue. PP and Vox do not want to get into negotiations with
Barcelona to reform the legal status of the region, whereas Podemos wants to hold another
independence referendum in Catalonia. PSOE, instead, supports constitutional reform that
shifts the current system of autonomous rule towards a federalist system – this is likely to be
the only acceptable compromise for both Madrid and Barcelona to stabilize the situation.
System of autonomies vs. Under both a system of autonomies and a federalist system, regions have parliaments with
federalist solution
legislative powers and possess competencies in key social policy areas such as health,
education, culture and so on. However, in a state of autonomous rule, the central government
can heavily interfere in the domestic affairs of the autonomous region. For example, it has the
power to impose its policies across regions and control all tax revenues, redistributing them
locally with a high degree of discretion.
PARLIAMENT BECOMES EVEN MORE FRAGMENTED CATALANS QUESTION THE STATUS QUO
%
Podemos PSOE Others Ciudadanos PP Vox respondents Do you believe Catalonia should be...
40
April election 30
Status quo
Absolute majority 20
November election 10
0
An independent state An autonomous A state in a federal A region of Spain
0 175 350 community Spain
Number of seats in lower house *Poll conducted by the Generalitat de Catalunia
Source: Ministry of Interior, CEO Catalunia, UniCredit Research

Austria
Stefan Bruckbauer ■ At an estimated growth rate of 1.5%, the Austrian economy has lost considerable
Chief Austrian Economist
(Bank Austria) momentum in 2019 compared to the previous year. The unfavorable international
+43 505 05 41951 environment, such as the slowdown in global trade, the weakening German economy and
stefan.bruckbauer@
unicreditgroup.at
economic-policy uncertainties (trade-policy conflicts, Brexit, etc.) have dampened export
dynamics and put pressure on industrial development. Investment has lost momentum in the
Walter Pudschedl course of the year, especially investment in equipment. Private consumption has remained
Economist
the most important driver of growth and, supported by fiscal measures (e.g. a reduction in
(Bank Austria)
+43 505 05 41957 health insurance contributions for low-income earners), will continue to be the main pillar of
walter.pudschedl@ economic growth in 2020 and 2021. Given the ongoing weakness of the global economy, we
unicreditgroup.at
expect the very long investment cycle to come to an end. However, favorable financing
conditions and above-average capacity utilization should prevent a slump. In the difficult
global environment, net exports will hardly be able to contribute to growth in the coming
years, which we expect to be well below potential at 1.0% in 2020 and 1.3% in 2021.
■ Weaker growth will put an end to the improvement in the Austrian labor market. After the
decline in the unemployment rate to 4.6% in 2019, we expect a slight increase to 4.7% in
2020, due to a decline in employment growth to below 1% year-on-year, which is thus not
sufficient to compensate for the increasing supply of labor. For the first time since 2016, the
unemployment rate will likely rise again in 2020, but should stay at 4.7% in 2021 as well.
■ Supported by the low oil price, inflation fell in the second half of the year. For 2019, we
expect an annual average inflation rate of 1.5%, after 2.0% in the previous year. As a result
of lower economic growth, inflationary forces will hardly be felt in 2020 and 2021, and there
is hardly any upward momentum in sight from the external side either. We expect the
inflation rate to stay at 1.5% in 2020 and to rise slightly to 1.8% in 2021.
■ Following the first surplus in the general government budget since 1974 of 0.2% of GDP in
2018, the financial year 2019 should also close with a slight surplus of 0.5% of GDP. Due to
weaker growth and some recent decisions in the Austrian parliament, partly on the eve of
snap elections (e.g. noticeable pension increases), we expect the budget balance to
deteriorate in 2020 and 2021, but still consider a slight surplus to be possible. At the end of
2021, total public debt will presumably amount to only around 65% of GDP.
ECONOMIC GROWTH TO FALL BELOW POTENTIAL THE OIL PRICE WILL CONTINUE TO DAMPEN INFLATION
Contribution to GDP change in %-points Transport Housing, energy Food Other effects Total CPI
3.5 3.0%
Net exports Investment Public consumption
Private consumption Change in inventories GDP yoy (%) Forecast
3.0 2.5%
2.5 2.0%
2.5 2.4
2.0 1.5%
1.5 1.0%
1.5
1.0 1.3 0.5%
1.0
0.5 0.0%
0.0 -0.5%
-0.5 -1.0%
2017 2018 2019E 2020F 2021F Jan-17 Aug-17 Mar-18 Oct-18 May-19 Dec-19 Jul-20 Feb-21 Sep-21
Foreca
Source: Statistik Austria, UniCredit Research

CEE
Outlook shaped by external risks
Dan Bucsa, ■ In EU-CEE12, we expect economic growth to slow to 2.6% in 2020 from 3.6% in 2019,
Chief CEE Economist
(UniCredit Bank, London) affected by weaker global trade and a cyclical downturn in the US. Economic growth could
+44 207 826-7954 recover to 2.8% in 2021 if global trade rebounds (Charts 1 and 2). Growth in the western
Balkans will follow the same trajectory as in EU-CEE. We expect rate cuts in Czechia and on
hold in all other EU-CEE countries and Serbia.
■ Growth in Turkey is likely to pick up gradually to around 2% in 2020 and 3% in 2021,

remaining below potential in both years. The CBRT may cut its policy rate to 10% or lower,
keeping the real interest rate close to zero. In Russia, economic growth could remain below
1.5% in 2019-20 if investment under the national projects fails to start. We expect the CBR
to cut the policy rate to 5.75% or below in 2020 as inflation remains below the 4% target.
■ The main political risks will be a smaller EU fund allotment to central Europe, thwarted
European integration in the western Balkans and US sanctions in Turkey and, to a lesser
extent, in Russia.
Domestic demand will In EU-CEE, 2020 will further highlight the gap between strong domestic demand and weak
remain the biggest growth
driver in EU-CEE exports. A dense election cycle is coming to an end and, as a result, fiscal impulse could
peak in the first half of 2020. Although private consumption has been the strongest and most
stable contributor to economic growth for four years, it has received additional support from
wage and pension increases. Fast income growth will help households weather external
headwinds at the beginning of 2020. Eventually, weaker exports will affect industrial
production and wage bargaining, even after the expected recovery in global trade at the
beginning of 2021.
CHART 1: GROWTH BELOW POTENTIAL IN 2020… CHART 2: … WITH A RECOVERY IN 2021
yoy (%), Private consumption Public consumption Fixed investment yoy (%), Private consumption Public consumption Fixed investment
pp Net exports Inventories, error GDP pp Net exports Inventories, error GDP
Poland Poland
Bulgaria Bulgaria
Hungary Hungary
Serbia Serbia
Croatia Croatia
Romania Romania
Turkey Turkey
Czechia
Czechia
Slovenia
Slovenia
Slovakia
Slovakia
Russia
Russia
-2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0
-2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0
Source: Eurostat, national statistical offices, UniCredit Research
Labor market tension is easing In fact, labor market tension is already easing in EU-CEE. The manufacturing sector is the
most affected due to slowing exports (Chart 3). Current vacancy levels are still close to all-
time highs, with construction standing out, but the combination of slower wage growth in the
private sector and smaller raises in the public sector is expected to weigh on consumption.
12
EU-CEE comprises Bulgaria, Croatia, Czechia, Hungary, Poland, Romania, Slovakia and Slovenia – all CEE countries that are members of the EU.

More open economies first to The more open economies such as Czechia, Hungary, Slovakia and Slovenia will be hit first,
slow due to weaker exports…
with domestic demand expected to slow significantly already in 1H20. The disruption in global
supply chains will affect these countries more than the rest of the region, as their exports have a
higher content of imports. Since EU-CEE producers are price takers, higher production costs
could continue to eat into margins and profits, reducing investment. In the four countries, poor
external demand could delay some FDI projects, especially greenfield ones. In bigger
economies such as Poland and Romania, where domestic demand makes a larger contribution
to GDP, the slowdown may be more pronounced in 2H20. However, their recovery in 2021 is
likely to be more muted as well. Finally, Croatia and Bulgaria could be less affected by the
slowdown in eurozone growth than countries in EU-CEE of similar size due to their weaker
integration into eurozone production chains, especially in car manufacturing.
… which will affect investment… Throughout EU-CEE, capex is expected to decelerate in 2020, recovering in 2H21 when
global trade should be in better shape. Moreover, FDI could be dominated by intercompany
debt. During downturns, eurozone companies transfer cheap loans to their subsidiaries in EU-
CEE without charging the country risk, as banks have to do. EU funds will be the main tool to
offset this cyclical slump in private investment, with the end of the current EU budget in 2020
likely to boost inflows in 2020-21. However, experience from 2012-14 showed that EU-funded
investment at the end of the current EU budget tends to be less efficient and contribute less to
potential growth.
… due to little scope Fiscal policy will have little leeway to boost investment in 2020-21. Czechia and Bulgaria are
for fiscal stimulus in 2020-21… exceptions in terms of existing fiscal space, though not necessarily when it comes to actual
infrastructure spending. Governments increased public outlays too soon, with fiscal impulses
peaking in 2020 (Chart 4). Crowded out by social and wage spending, public investment is
also suffering from misallocation. In the run-up to elections, governments tend to divert funds
from nationally-important infrastructure projects to small projects that become a source for
graft and bribes to local authorities. As a result, the biggest infrastructure investment, namely
the introduction and expansion of 5G networks, is likely to be private as well in 2020-21.
CHART 3: LABOR MARKET SHORTAGES EASING IN EU-CEE CHART 4: FISCAL IMPULSES PEAKED TOO SOON
Companies facing labour shortages, fiscal impulse, % of GDP 2019F 2020F 2021F
balance of answers (yes-no), % Range (2000-19) 4Q19
2.5
80.0
70.0 2.0
60.0 1.5
50.0
1.0
40.0
30.0 0.5
20.0 0.0
10.0
-0.5
0.0
-10.0 -1.0
Constr
Ind
Constr
Ind
Constr
Ind
Constr
Ind
Ind
Constr
Ind
Constr
Constr
Ind
Constr
Ind
-1.5
BG HR CZ HU PL RO SK SI -2.0
HU RS SI HR SK PL TR RO RU CZ BG
Source: national statistical offices, central banks, AMECO, UniCredit Research
… and also consumption Slower wage growth may impact consumption, since the 2017-19 spending spree was
financed mostly through income growth rather than borrowing. Even though monetary
conditions will remain accommodative, we do not expect lending to accelerate in order to
offset weaker consumption. For the same reason, the absence of significant household
leveraging, the risk of real estate bubbles popping in EU-CEE is much lower than it was
during the global financial crisis. The only places where house prices adjusted for wage
growth are higher than they were before the global financial crisis are Prague and Budapest,
which hare both strong investment markets.

Western Balkan slowdown Western Balkan countries could be hit harder by external weakness. Lack of access to the
similar to that in EU-CEE
European common market and to steady sources of FDI could lead to choppy growth rates.
Political uncertainty and the cyclical downturn in Europe will remain a drag on growth. Thus,
public infrastructure spending is likely to dominate investment, while households will benefit
from better income growth as governments reverse some of the recent fiscal tightening.
Low growth in Russia without Better insulated from external risks, Russia is struggling to evade the constraints of its low
a boost to investment spending
potential growth. If investment under the national priorities announced by President Vladimir
Putin in 2018 does not start, GDP growth could remain below 1.5% in 2020-21, leading to
further divergence from Europe and other EM. That said, there is scope for better growth
ahead. Russia’s adjustment to previous commodity price shocks, large reserves and a fiscal
breakeven oil price of around USD 45/bbl would allow the government to raise fiscal spending
even if commodity prices fall further from their current levels.
Gradual recovery Turkey’s exit from recession may be followed by faster growth rates of 2.2% in 2020 and 3.1%
in Turkish growth
in 2021. However, a return to potential growth of more than 4% per year is unlikely in the
absence of structural reforms. This means that unemployment will continue to rise and the
negative output gap will widen further. As Turkey is over-reliant on fiscal spending and bank
lending, growth is likely to fluctuate with global financial conditions and investor appetite for
lending to emerging markets. While companies rolled over all their long-term liabilities in
2019, potential corrections in equity prices in the US (see Cross Asset Strategy section) could
curb credit flows to Turkey. Banks rolled over around 60% of their long-term foreign funding in
2019, a signal that there is not yet appetite for releveraging.
Inflation to peak in 1Q20 Headline inflation is expected to peak in 1Q20 throughout EU-CEE due to a base effect in fuel
and return thereafter to
within target ranges in EU-CEE prices combined with above-target core inflation. The peak will very likely see inflation leave
target ranges temporarily. However, low imported inflation from the eurozone and the global
slowdown we expect could combine to keep inflation inside target ranges in 2020-21 (Chart 5).
There will be differentiation in disinflation, with Czechia likely to have the lowest inflation rate
among EU-CEE countries outside the eurozone. In Poland and Hungary, disinflation could be
more limited due to a significant fiscal impulse and very loose monetary conditions,
respectively. The outlier is Romania, where inflation could miss the target for three
consecutive years (2019-21) if gas and energy prices are re-liberalized.
The NBP, the NBH and the NBR Thus, we expect the NBP, the NBH and the NBR to be on hold throughout 2020-21 (Chart 6),
expected on hold in 2020-21
although monetary conditions in these countries will be significantly different. A very orthodox
approach to monetary policy means that the NBP is likely to pit inflationary risks against lower
growth and external factors, with the result being stable interest rates and a PLN that will
remain slightly undervalued and trading above EUR-PLN 4.30 for the most part.
The NBH’s preference for loose monetary conditions and the active use of FX swaps to provide
HUF liquidity could translate into very low BUBOR rates, combined with gradual HUF
depreciation throughout 2020-21. The latter may be needed to offset the elimination of the
corporate sector’s savings surplus due to central bank lending schemes and poor exports,
especially in 2020. The low cost of carry will keep the HUF as the preferred short in the region.
The NBR will maintain a combination of negative real interest rates and RON real
appreciation that bodes ill for disinflation and exports. Due to strong domestic demand and
likely price increases ahead, inflation expectations will remain loosely anchored. Gradual
RON depreciation to the EUR-RON 4.90-5.00 range by 2021 will be insufficient to offset the
loss of external competitiveness, evident especially when adjusting effective exchange rates
with unit labor costs. Thus, Romania’s exports could remain the weakest in EU-CEE.
Potential rate cuts in Czechia The CNB will start 2020 with a hawkish bias that is likely to wane once inflation starts falling from
if growth and inflation slow
its 1Q20 peak. An outright dovish bias could emerge if exports turn out to be weaker than in the
CNB’s extremely optimistic scenario. In a scenario of lower inflation and lower growth, the
proactive CNB Board is likely to cut interest rates already in 2020. Higher nominal and real
interest rates than in the rest of central Europe could help the CZK outperform its regional peers.

The NBS on hold In Serbia, the central bank may cut interest once more to 2% before the end of 2019 and
keep the policy rate at that level in 2020-21. Serbia is a latecomer to the domestic demand
boom in CEE and, as a result, the output gap remains close to zero and is failing to exert
pressure on consumer prices. Absent large supply shocks, inflation could stay below the 3%
target in 2020-21 and the NBS may have to lower its target in the coming years. At the same
time, the currency remains overvalued and vulnerable to volatile capital flows due to the large
C/A deficit. If FX-index lending slows, the pressure will rise on the RSD.
The CBR is expected to cut In Russia, inflation is unlikely to return to the 4% target in 2020. With growth close to potential,
the key rate to around 5.75%
in 2020… domestic demand will exert muted pressure on prices. As inflation expectations and the FX
pass-through decline, inflation could struggle to return to target sustainably and the CBR may
have to lower its target in the next two years. Meanwhile, more rate cuts are likely, to at least
5.75% by mid-2020. Further easing would be warranted if the central bank again reassesses
its high estimates of equilibrium rates as risk and potential growth assessments decline. The
RUB is close to fair value and could remain close to current valuation levels in 2020-21.
… and the CBRT could keep the In Turkey, the CBRT is returning to its near-zero real-interest-rate policy of yesteryear. After a
real interest rate close to zero short-term spike above 10% in 1Q20, we expect inflation to stabilise in the high single digits in
2020-21, meaning that the policy rate could be cut to (or slightly below) 10%. Risk appetite for
EM assets and financial conditions in core markets will continue to shape TRY volatility. Thus,
we expect the TRY to weaken faster towards the end of each half of next year. However,
inflation may outpace nominal depreciation in both 2020 and 2021, reducing some of the TRY
undervaluation. Due to the credit-driven growth model and reliance on foreign funding, the
TRY will remain the currency in CEE that is most vulnerable to abrupt changes in risk
appetite, especially if stronger domestic demand drives the C/A into a deficit again.
CHART 5: INFLATION CLOSER TO TARGETS BY 2020 CHART 6: POLICY RATES STABLE OR FALLING IN 2020-21
annual inflation (eop, %) 2019E 2020F 2021F Inflation target policy rates, % 2019E 2020F 2021F
12 15.0
10
12.0
8
9.0
6
6.0
4
2 3.0
0
0.0
HR SI BH SK RS CZ BG PL HU RU RO TR
HU PL CZ RS RO RU TR
Source: statistical offices, central banks, UniCredit Research
All EU-CEE countries to lose Political risks will continue to weigh on CEE in 2020-21. For EU-CEE, negotiations for a new
funds in the 2021-27 EU budget
EU budget are unlikely to yield a better outcome for the Visegrád four. While the other
countries will see their nominal allocations increase, there will be declines across the board in
percent of average GDP for 2021-2713. Cuts in the EU fund allotment will be 0.2-0.3% of GDP
per year in Romania, Bulgaria and Slovenia and 1.0-1.1% of GDP in Hungary and Poland.
The impact on GDP growth will depend on how countries time EU fund inflows. Thus, active
spenders from EU funds like Hungary could bear the brunt in 2022-25, while the impact will
be larger in 2027-28 for late spenders such as Czechia and Romania.
13
For details, please see the CEE Quarterly – A moment of reckoning from 27 June 2018, pages 17-23.

Western Balkans need an EU The decision not to grant Albania and Northern Macedonia a roadmap for EU accession will
accession roadmap to avoid
economic and political turmoil impact politics in the western Balkans while also weakening reform momentum. The best
outcome would be a rapid adoption of the seven-stage accession model proposed by the
French administration14 (the suggested deadline is January 2020). These stages are 1. rule
of law, fundamental rights, justice and security; 2. education, research and space, youth,
culture, sports, environment, transport, telecommunications and energy; 3. employment,
social policy, health and consumer protection; competitiveness; 4. economic and financial
affairs; 5. internal market, agriculture and fisheries; 6. foreign affairs; and 7. other matters.
Fulfilling requirements under this scheme would grant gradual access to EU markets and
institutions, while hopefully preventing economic divergence and increased political turmoil.
Risk of limited US sanctions Turkish President Recep Tayyip Erdogan’s determination to install S-400 missiles may lead
on Turkey… to US Congressional sanctions, although US President Donald Trump seems less keen on
punishing the Turkish administration. While sanctions remain a risk, they seem to be less of a
drag on appetite for Turkish assets than they were for most of 2019. Punitive measures may
be confined to certain people and institutions rather than being far reaching and a risk to
market stability.
…and falling risk of US According to the US Congress, Russia could still face sweeping sanctions if there is evidence of
sanctions on Russia
interference in the 2020 elections. The risk might be mitigated by the ever-increasing numbers
and sources of fake social media accounts involved in the US election campaign on all sides.
14
For details, please see The non-paper “Reforming the European Union accession process” from November 2019.

UK
Persistent Brexit uncertainties, sluggish growth
Daniel Vernazza, PhD ■ We expect UK GDP growth of 1.3% in 2019, 0.8% in 2020 and 0.9% in 2021. The subdued
(UniCredit Bank, London) growth outlook reflects a continuation of Brexit uncertainties, weaker global growth and an
+44 207 826-7805 adjustment to a less open UK economy.
daniel.vernazza@unicredit.eu
■ The BoE will likely cut the bank rate by 75bp to zero in 2020 and keep it there in 2021.
Brexit uncertainties UK GDP growth has been particularly volatile due to Brexit developments, but underlying
and weaker global growth
growth has weakened. Quarterly GDP growth averaged only 0.2% in the first three quarters of
2019, down from an average of 0.4% in 2018. Business surveys have been consistently
weak, and the composite PMI remained below 50 in October. Brexit-related uncertainties and,
in part, subdued global growth are likely responsible for the weakness.
The new Brexit deal foresees The UK government and the EU agreed a revised Brexit deal in mid-October. As a result, the
a less open UK economy
probability of a no-deal Brexit happening before end-2020 is now approximately zero, and the
effective sterling index rose accordingly. However, Brexit uncertainties will linger. The UK
government suspended legislation to implement the Brexit deal when MPs rejected its
accelerated timetable; the EU granted the UK a three-month Brexit extension to 31 January 2020;
and MPs triggered an early general election for 12 December. The election will effectively be
a proxy referendum on Brexit. The revised Brexit deal foresees a much looser future
relationship between the UK (excluding Northern Ireland) and the EU. This is based on a
simple free trade agreement (FTA), little or no regulatory alignment and the downgrading of
“level playing field” rules that will make it harder to agree a deep FTA with the EU, resulting in
higher long-run costs compared to former UK Prime Minister Theresa May’s deal.
Base case: Conservatives win Our base case scenario envisions the Conservative party winning a majority of seats in the
a majority, and the UK leaves
the EU with Mr. Johnson’s deal 12 December election for three main reasons: 1. Opinion polls put the Conservative Party in
the lead by a vote-share margin of around 10-15pp over the Labour Party. This is likely a
large enough lead for it to win a majority of seats. 2. The leadership approval rating of Labour
leader Jeremy Corbyn is extremely low – the lowest of any opposition leader since Ipsos Mori
began polling in 1977. 3. The remain vote is more split than the leave vote, even more so now
that the Brexit Party has stood down its candidates in the 317 seats the Conservatives won in
the 2017 general election. If so, the UK will leave the EU by 31 January 2020 with UK Prime
Minister Boris Johnson’s Brexit deal. Still, anything can happen in the remaining three weeks
of the campaign.
THE LABOR MARKET HAS TURNED CONSERVATIVE PARTY IN THE LEAD
Employment Vacancies - rs Con Lab SNP Lib Dem Brexit

thous.,change yoy thous., change yoy If there were a general election tomorrow, which party would you vote for?
1,000 200 50%
Snap general election
150 announced for 12 December
800 45%
600 100 40%

50 35%
400
0 30%
200
-50 25%
0
-100
20%
-200
-150
15%
-400 -200
10%
-600 -250
5%
-800 -300
Jan-01 Jan-04 Jan-07 Jan-10 Jan-13 Jan-16 Jan-19 0%
Aug-19 Sep-19 Oct-19 Nov-19
Source: Office for National Statistics, various opinion polls, UniCredit Research

Brexit uncertainties Under Mr. Johnson’s Brexit deal, the UK would formally leave the EU and enter the standstill
will persist
transition period to end-2020. During this transition period, the UK would be treated as if it
were an EU member state (except the UK will have no voting rights) and, thus, market access
would not change from current arrangements. However, since the future UK-EU relationship
will almost certainly take much longer than 11 months to conclude, ratify and implement, it
raises the risk of a hard Brexit happening on 1 January 2021. The withdrawal agreement
provides the option to extend the standstill transition period once for either one or two years
by mutual consent of the UK government and the European Council, with the decision due to
be taken by 1 July 2020. Mr. Johnson has ruled out an extension, and, for several reasons
(including those involving timing and politics), an extension of the transition period is highly
unlikely. In our view, the most likely outcome is that Mr. Johnson manages to achieve an FTA
by end-2020 (possibly serving as an interim arrangement to pave the way for a final FTA),
which includes transitional arrangements lasting at least 18 months (to give firms time to
adjust to the new set of rules). An FTA will likely do little to help UK-EU trade in services.
…irrespective of the If, however, Mr. Johnson does not win a majority, the next UK government would likely seek
election result
to hold a referendum on a negotiated Brexit deal versus remaining in the EU, subject to a
further extension of Article 50 being agreed with the EU to facilitate a referendum while the
UK is still an EU member. The European Council would likely (albeit reluctantly) extend
Article 50, presumably to end-2020. This would allow sufficient time to hold a referendum. An
extension beyond end-2020 would be very difficult politically because the new EU budget
starts on 1 January 2021. Should the UK vote to remain in the EU while still under the
Article 50 process, then the UK would remain in the EU on current terms.
Fiscal stimulus is on the way Both of the UK’s main political parties (Conservatives and Labour) are promising significant
but not a game changer
government-spending increases financed by additional borrowing. The Conservatives have
announced plans for net public investment to rise by around 1% of GDP over four years, and
Labour would more than double this rise. Using a fiscal multiplier for investment spending of
one (which the Office for Budget Responsibility uses), the Conservatives’ plans would add
around 1pp to GDP growth over four years. Both parties have pledged to run a balanced
current budget (i.e. excluding investment). While fiscal stimulus will boost growth, it is likely to
only cushion weakness generated from persistent Brexit uncertainties, weaker global growth
and the hit to productivity that is sure to result from a less open UK economy.
GDP and CPI forecasts We expect UK real GDP growth of 1.3% in 2019, 0.8% in 2020 and 0.9% in 2021. Headline
CPI inflation should ease to around 1.3% in 2Q20 in large part due to lower regulated utility
prices (which the MPC will look through) and ease a little further to 1.2% by end-2020 due to
the appreciation of sterling and weaker aggregate demand. Inflation is likely to recover with
demand in 2021.
BoE to cut the bank rate We expect the Bank of England’s monetary policy committee (MPC) to cut the bank rate by
to zero in 2020
25bp in 1Q20, 2Q20 and 3Q20 (taking the bank rate to zero) and to leave it there through
2021. At the MPC’s 7 November meeting, two MPC members, Jonathan Haskel and Michael
Saunders, voted for an immediate 25bp rate cut. In the past, the adjustment of interest rates
has often been preceded by a minority of MPC members dissenting at prior meetings, paving
the way for a policy move. The MPC minutes stated that policy could respond to changes in
the outlook in either direction: “If global growth failed to stabilise or if Brexit uncertainties
remained entrenched, monetary policy might need to reinforce the expected recovery in UK
GDP growth and inflation”… “[If, however,] these risks did not materialise and the economy
recovered broadly in line with the MPC’s latest projections, some modest tightening of policy,
at a gradual pace and to a limited extent, might be needed”. By “reinforce”, the BoE means
rate cuts, and although the MPC was careful to avoid getting dragged into election politics, it
is clear that the most likely scenario involves Brexit uncertainties becoming entrenched.

Sweden & Norway

Tightening cycle likely to have run its course
Chiara Silvestre The recovery of the Swedish economy is holding back. After growing by 2.4% in 2018, GDP is
Economist
(UniCredit Bank, Milan) on track to expand by a modest 1.4% in 2019 and growth is forecast to stabilise in 2020. We
chiara.silvestre@unicredit.eu expect a small pickup to 1.7% in 2021. The growth prospects for 2020-21 reflect not only the
steep fall in housing investment, which is accounting for a large part of the easing in domestic
demand, but also the challenging external environment which has started to weigh on capex.
Sweden: GDP growth is After a strong performance into 2019, which has mirrored the well-built competitive position of
slowing
Swedish exporting industries, exports are expected to slow significantly, due to lower growth
prospects for Sweden’s major trading partners. The cooling down of economic activity will
likely cause a deterioration of the labor market, with stagnating employment and rising
unemployment rate leading to weaker wage growth. In this environment, a slowdown of
private consumption appears likely.
The Riksbank is likely The liftoff of the repo rate to zero in December is almost a deal done. After December, the
to pause at least until end-2021
Riksbank forecasts a “prolonged period” of unchanged interest rates. In our view, the
challenging external environment, in combination with slower GDP expansion and inflation
rates averaging 1.5% in both 2020 and 2021 will lead the Riksbank to keep interest rates at
zero throughout the forecasting horizon.
Norway: GDP growth Norway’s cyclical upturn is taking a break. After 2.5% in both 2018 and 2019, the growth rate
set to decelerate
of mainland GDP is forecast to slow to 1.5% in 2020. Our GDP forecasts take into account,
externally, the deterioration in growth prospects of some of Norway’s main trading partners,
as well as our expectations of weakening in Brent prices. The latter is likely to lead to a
decline of strong growth rates of petroleum investment which has underpinned GDP growth
for most of 2019. This negative impulse will probably extend to the mainland economy, which
includes oil-related activities. Just as in Sweden, domestic risks to the outlook mainly stem
from the uncertainties in the housing market and the historically high level of household debt,
which makes households more vulnerable in the event that house prices fall steeply.
Norges Bank expected While lifting interest rates to 1.50% in September, the Norges Bank unveiled its plan to take a
to stand pat through 2021
break from the tightening cycle. In the wake of this announcement, as well as growing global
risks and their potential impact on the outlook for oil prices and the domestic economy, we
expect the Norges Bank to stand pat through the end of 2021.
GDP GROWTH SET TO LOSE STEAM AFTER DECEMBER, TIME TO PAUSE ALSO FOR RIKSBANK
Real GDP (yoy, %) Sweden Norway % Repo rate (Sweden) Depo rate (Norway)
4.5
6.00
4.0 5.25
Forecast Forecast
3.5 4.50
3.0 3.75
2.5 3.00
2.0 2.25
1.50
1.5
0.75
1.0
0.00
0.5
-0.75
0.0
2015 2016 2017 2018 2019 2020 2021 -1.50
1Q04 3Q07 1Q11 3Q14 1Q18 3Q21
Source: Norges Bank, Riksbank, Statistics Norway, Statistics Sweden, UniCredit Research

Switzerland
Growth slowing but SNB steady
Dr. Andreas Rees ■ We expect the Swiss economy to grow 0.6% in 2020 and 0.7% in 2021 (2019: +0.8%).
(UniCredit Bank, Frankfurt) The expectation for a slowdown in 2020 is mainly based on a weaker growth outlook for
+49 69 2717-2074 Europe, which is Switzerland’s most important single trading partner.
■ Risks to our forecast are skewed to the upside, as additional revenue from royalties
Dr. Thomas Strobel associated with major international sporting events may boost GDP growth. This would be
Economist
(UniCredit Bank, Munich) similar to 2018, when additional revenue from royalties (such as World Cup and Olympic
+49 89 378-13013 Winter Games) led to a significant upward revision of growth data in 1H.
thomas.strobel@unicredit.de
■ Exports have already lost considerable momentum in recent quarters. Muted global trade
and the cooling of the European economy will probably continue to dampen foreign
demand for Swiss goods in 2020. One stabilizing factor could be the pharmaceutical
sector, which has been benefiting from demographic changes abroad.
■ We expect overall investment activity to weaken further. Falling capacity utilization in the
manufacturing industry is likely to weigh on the capex spending of companies. In addition,
overcapacities and vacancies will persistently dent investment activity in the construction
sector in 2020 and 2021.
■ Inflation rates are likely to decline further in the next few quarters, since the weaker
economy will continue to dampen domestic price pressure. We expect consumer price
inflation to ease to only 0.1% yoy in 2020 from 0.4% yoy in 2019 (2021: +0.2%).
■ The SNB is likely to remain on hold in 2020 and 2021 with its key policy rate at -0.75%. In
order to soften possible upward pressure on the CHF, the SNB may additionally intervene
in FX markets. It is true that SNB President Thomas Jordan recently sounded (surprisingly)
dovish. He pointed out that the SNB stands ready to cut interest rates further into negative
territory. Furthermore, the SNB obtained moderate leeway to cut its key policy rate if
necessary. By not imposing charges on banks’ sight deposits as large as 25 times the
amount of minimum reserves (up from 20) in September, the effective interest charge on
banks was reduced to about -0.3% from -0.4%. However, we think that further interest rate
cuts by the SNB are only likely in the case of an emergency, i.e. a rapid and strong
deterioration in global (and/or European) economic activity followed by additional interest
rate cuts and an increase in the pace of bond purchases by the ECB.
GROWTH TO SLOW FURTHER ON GLOBAL SLOWDOWN SNB TO REMAIN ON HOLD
Forecast SNB policy rate, in % ECB deposit rate, in %

3.0 4.5
Real GDP (in % qoq) Real GDP (in % yoy, rs) 0.10
2.0 3.0 0.00
-0.10
1.0 1.5
-0.20
-0.30
0.0 0.0
-0.40
-1.0 -1.5 -0.50

-0.60
-2.0 -3.0 -0.70
-0.80
-3.0 -4.5
1Q08 1Q10 1Q12 1Q14 1Q16 1Q18 1Q20 -0.90
Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19
Source: Federal Statistical Office, Bloomberg, UniCredit Research

China
Trade uncertainty to weigh on growth
Edoardo Campanella We expect China’s structural and cyclical slowdown to continue throughout our forecasting
Economist
(UniCredit Bank, Milan) horizon, with the GDP growth rate falling to 5.9% yoy in 2020 and to 5.7% in 2021 – outside the
+39 02 8862-0522 6.0-6.5% growth range set by Beijing for this year. Signs of sluggish economic performance come
from multiple fronts. China’s exporters are taking the hit from the trade war with the US. Retail
Roberto Mialich sales eased again in 3Q19, dragged down by the slump in auto sales. Investment growth within
FX Strategist the private sector has decelerated sharply and state investment has offset it. The decline in
(UniCredit Bank, Milan)
output PPI inflation has eroded the profitability of industrial corporates, restricting their ability to
+392 88 62-0658
roberto.mialich@unicredit.eu invest. Also, the shifting of bank credit away from the private sector in favor of SOEs as a result of
both President Xi Jinping’s expansion of state power over the Chinese economy and the ongoing
growth deceleration is creating inefficiencies that might impair productivity going forward.
Trade war is the The trade war remains the main source of uncertainty over the next two years. The “Phase one”
main downside risk
trade deal, if finalized, is expected to bring some temporary relief in the months leading up to the
US presidential elections. And the additional pork imports from the US that Beijing is supposed
to commit to should reduce the inflationary pressures caused by the consumer price spikes
recently recorded as a result of the African swine fever. But trade tensions will likely resurface
once the two superpowers start to deal with stumbling blocks, such as technology transfer, SOE
subsidies and more generally “The Made in China 2025” industrial strategy. An intensification of
trade tensions would lead to a deterioration in sentiment, exports and investment.
More limited scope for China has less policy space to stimulate the economy than in the past due to increasing
stimulus measures
financial stability challenges. In the absence of a major economic shock, we do not see an
ambitious stimulus package in 2020 and expect major policy measures to be targeted and
selective. This could take the form of more monetary-policy easing by lowering the required-
reserve ratio for large banks (to 12% or lower by the end of 2019 from 13%) and cutting
benchmark lending rates for smaller banks. On the fiscal front, local governments will likely be
granted more flexibility in issuing special-purpose bonds to fund infrastructure projects.
USD-CNY back towards 6.90 USD-CNY has corrected sharply downwards from the peaks above 7.18 hit in September
in 2020, but 2021 may tell
a different story thanks to progress made in trade talks between Beijing and Washington. There have already
been attempts to drag the pair below 7.00 and we think that it is possible that further declines,
say towards 6.90, could occur in 2020. However, lower Chinese economic growth would make
the PBoC more prudent about allowing a more intense CNY appreciation, especially if, after the
finalization of “Phase one”, trade negotiations are frozen ahead of the US presidential election.
In this case, USD-CNY may well rebound back towards 7.10 in 2021.
THE STATE IS TAKING OVER PRIVATE INVESTMENT SHARPLY DOWN
Flows of loans to NFCs by ownership (%) Investment growth (yoy, %)

60
100
state private
Private State
50
75
40
50 30
20
25
10
0
2010 2011 2012 2013 2014 2015 2016 0
Feb-05 Aug-06 Feb-08 Aug-09 Feb-11 Aug-12 Feb-14 Aug-15 Feb-17 Aug-18
Source: National Bureau of Statistics, UniCredit Research

Oil
Brent prices to remain weak
Edoardo Campanella We expect Brent to average USD 57/bbl in both 2020 and 2021. However, these averages
Economist
(UniCredit Bank, Milan) hide a V-shaped rather than a flat path for oil prices. The price weakness is due to
+39 02 8862-0522 fundamental factors, with supply remaining abundant and global demand slowing, whereas
the directionality reflects our macroeconomic outlook, with the US entering a technical
recession in late 2020 and then recovering some ground the following year.
Supply glut still the main issue Oil producers continue to pump more crude than the market can absorb. OECD commercial
inventories are stuck at around 2,900mn bbl – well above their pre-shale-boom average of
2,600mn bbl. Since US producers seem to have overcome many of the bottlenecks that might
have hindered production, we expect OPEC+ to adopt longer curbs at its December meeting,
extending them well into 2020. This might be enough to bring some short-lived market relief.
In reality, especially considering the scenario of a US recession, deeper cuts would be
required, but too many producers, Russia in particular, are opposing them. This is a risky
strategy, especially because a US-Iran diplomatic rapprochement concerning Teheran’s
nuclear program could bring back around 2mn Iranian barrels a day to the market, more than
offsetting the current OPEC+ cap of 1.2mb/d. Today’s curbs could only work if US producers
postponed investments in the face of low prices in order to remunerate their shareholders.
Demand not too concerning Demand weakness is less concerning than many market participants seem to believe. Growth in
oil demand is expected to show a decline from 2.1mb/d in 2018 to 0.8mb/d in 2019. Such a drop
would be in line with the development in oil demand recorded during other cyclical slowdowns,
such as those seen in 2002 and 2011-12. The current situation is very different from what
happened during the last financial crisis, when demand contracted by a cumulative 1.8mb/d
between 2008 and 2009. Moreover, a partial resolution of the trade tensions between the US
and China with the “Phase one” agreement, might stimulate demand somewhat and offset some
of the weakness caused by the US downturn.
Geopolitical risk The only factor that can really push prices high is sentiment, either because of a much-rosier
in the background
global growth outlook or as result of a geopolitical shock. When it comes to the latter, the
main source of risk is escalating tension in the Middle East between the two main regional
powers, Saudi Arabia and Iran. Skirmishes in the Strait of Hormuz have been going on for
many months. Equally, the drone attacks on some of Riyadh’s key oil infrastructure have
exposed unexpected vulnerabilities. However, given the oil-glut issue, only a major and
lasting geopolitical shock would be able to significantly impact prices.
V-SHAPED PATH FOR BRENT SLOWING DEMAND, BUT NOT COLLAPSING
Brent (USD/bbl) Oil demand growth (mb/d)
Spot Futures UniCredit Forecast

3
80
70
1.5
60
Financial
50 crisis
0
Cyclical slowdown Cyclical slowdown Cyclical slowdown
40
30
Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 -1.5
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source: IEA, Bloomberg, UniCredit Research

Cross Asset Strategy

Prefer fixed income as a US recession nears
Elia Lattuga ■ 2020 asset performance will be a tug of war between monetary stimulus and deteriorating
Cross Asset Strategist
(UniCredit Bank, London) growth prospects, at a time when most assets look rich compared with fundamentals.
+44 207 826-1642
elia.lattuga@unicredit.eu ■ We see a high probability of sharp drawdowns for risky assets as a US recession nears.
The Fed’s action will boost the return of USTs, but will fail to prevent large intra-year
corrections in global equities. Correlations will work their way to EUR assets, where non-
cyclical sectors should be preferred on both equities and credit. The quest for yield and
supportive flows speak for positive returns for credit, both on sovereign and corporates.
A spectacular and Equities and bonds have delivered outstanding performances in the course of 2019, topping
very correlated asset
performance in 2019 the return of the last ten years for several assets. At the time of writing, the MSCI world is up
by over 20% YTD and returns are solid across countries, especially across developed
markets. Meanwhile, fixed income benchmarks returns are in the upper single digit, with some
credit exposure returning over 10%. Moreover, risk adjusted performance was very positive
(e.g. European credit returned over 3x their realized volatility). A similarly sharp equity rally
happened in 2017, when synchronized acceleration in GDP growth across the globe fueled
risky asset performance, while risk free asset returns were flat to slightly negative. 2019 has
not conformed to such script so far. Both risky and risk free assets delivered solid
performances, and the elevated cross asset correlation recalls QE driven rallies rather than
the typical risk-on environment. Indeed, the macroeconomic environment differed too. A
strong labor market, rising input costs and decreasing revenue growth, have been behind
dropping corporate bottom lines. Reported earnings for both the eurozone and US indices
poin to profit recession, and expectations for future earnings growth remain bleak. Meanwhile,
increasing leverage and large payouts to shareholders are amplifying risks to bondholders,
especially on US low rated corporates.
Still, sell-off episodes in risky assets have so far been short-lived in 2019. On the contrary,
equity indices marked new record highs (e.g. the S&P500) and further widened the gap
between macroeconomic (and corporate) fundamentals and assets valuations. The prospect
of a marked GDP growth slowdown, taking the US economy into a recession in, is set to
undermine such momentum. How long can easy monetary policy keep asset prices valuations
at current levels, against deteriorating growth? It is the key question for asset returns in 2020.
US growth is running on one engine alone – consumption. We believe that the petering out of
the fiscal stimulus will expose its fragility, pushing the US into a shallow recession in 2H20.
CHART 1: ASSETS PERFORMANCE AT A GLANCE CHART 2: EPS GROWTH AND VALUATIONS (S&P 500)
EU equities US equities EM equities PE (12M FWD EPS) 12M FWD EPS (rs)
EGB core bonds UST bonds EU Credit IG 20 40%
EU Credit HY EM HC bonds EM LC bonds
40%
18 30%
30%
16 20%
20%
14 10%
10%
0% 12 0%
-10%
10 -10%
-20%
2019 (YTD) 2018 2017 2016 8 -20%
Aug 10 Feb 12 Aug 13 Feb 15 Aug 16 Feb 18 Aug 19
Source: Bloomberg, Refinitiv Datastream, UniCredit Research

A 20% drawdown on global Timing the market reaction to such an event is difficult. However, given the high level of
equities
valuations and the build-up of imbalances (e.g. VIX short positions have risen sharply on
CFTC data), we believe that the probability of a global equities drawdown in the 20% ballpark
ahead of the recession is high. The trigger might come from negative news on the consumer
side, denting growth prospects, or might be related to sentiment potentially accompanying
political developments or policy decisions. In this case, tightening financial conditions would
themselves be a driver of the growth slowdown. A recovery in global growth in 2021 would lay
the foundation of a recovery in appetite for risky-assets following the bearish turn we foresee.
The Fed has already delivered some precautionary cuts to extend the current economic cycle,
and more easing (more than what the market discounts) is likely to come as the slowdown
materializes. While it might be able to offset some of the losses and reduce the magnitude of
the drawdown compared to past recessions, the Fed will unlikely be able to halt cyclical forces
and defy gravity for long. Chart 3 shows that on average the downside of the S&P500 at times
of economic recessions has been just over 30%, since the1950’s, with the last two episodes
(2001 and 2008) showing above average losses.
Prefer long duration Deteriorating risk appetite will be tailwind for the bond market, adding to the support offered
on USD denominated assets
by rate cuts from the Fed. We see 10Y UST yields dropping as low as 1.50% by year-end,
with long duration adding up to over 5% total return over 2020. In the case of prior recession
periods (from the 1950’s onward), USTs have delivered returns of over 10% on average with
peaks at over three times such level, outperforming both cash, credit and equity exposure.
The starting government bond yield level is much lower this time, as yields have been on a
downward trend for over thirty years, but we expect a solid performance, especially in the
current market environment. Credit will benefit somewhat, but as one moves towards lower
rated paper, the sensitivity to the slowdown will increase while the support of the Fed will fade
out. The US credit cycle poses further risks, given the rising leverage, falling profits and rising
default rates. Therefore when it comes to USD denominated assets, we prefer the risk reward
offered by duration over credit exposure.
CHART 3: S&P 500 DRAWDOWNS IN PREVIOUS RECESSIONS* CHART 4: PERFORMANCE THROUGHTOUT THE RECESSION**
Average Last 3 episodes
0 40%
30%
-10
20%
-20
10%
-30
0%
-40
-10%
-50
-20%
-60 -30%
-70 -40%
2007 1973 2001 1969 1981 1990 1957 1953 1960 S&P 500 10Y UST Baa Credit 3M Tbill Comm
*The red line indicates the average for the considered episodes Source: NBER, Bloomberg, Refinitiv Datastream, UniCredit Research
**US economic cycles since 1950
European equities, Correlation will work its way into European assets, also exposing European equities to losses.
less risky than US peers
but still exposed Domestic developments are not supportive of an equity bull story either. We see eurozone
growth deteriorating throughout 2020 as global headwinds continue. Further, while ECB’s
September package will preserve ample monetary accommodation, the bar for sizeable
incremental stimulus is high. Cheaper valuations compared with US equities and a higher
equity premium (consequence of lower yields across Europe) remain supportive factors for
European equities, at least in relative terms, and create the potential for further positive
momentum in a positive risk scenario where global growth recovers. However, all these
variables considered, we recommend a defensive allocation for European equities and prefer
sectors such as Food & Beverage, Health Care, Personal & Household Goods and Utilities.

Credit exposure to be preferred ECB’s flows will continue to support the assets targeted by the asset purchase program (APP).
for EUR denominated assets
However, we believe that Bunds are close to their fair value and long duration in EUR and will
deliver muted returns. Thanks to ECB’s flows and featuring the scarce attribute of a yield pick-
up, government bonds across periphery offer better potential. Similarly, we believe that
corporate credit will attract solid demand thanks to the hunt for yield and its positive technical
picture (CSPP and lower expected supply). Some caution is warranted: exposure to the global
cycle and/or to negative credit rating dynamics needs careful consideration when picking across
ratings and sectors, especially across high yield. We think that European companies remain less
vulnerable to credit concerns compared with their US peers but spread dispersion will continue
across the rating spectrum, with the lowest rated segments more exposed to losses. Hence, we
project solid returns from EUR high yield (over 3%) mainly coming from carry but spreads will
likely widen as well. Just as with equities, we prefer less cyclical sectors.
CHART 5: MIND THE CORRELATION (YOY RETURNS) CHART 6: RELATIVE VALUATIONS IN EU
S&P500 EU HY US HY E/P STOXX Europe 600 Bund yield IG ytw HY ytw

80% 14
60% 12
40%
10
8
20%
6
0%
4
-20%
2
-40%
0
-60%
-2
Nov 10 May 12 Nov 13 May 15 Nov 16 May 18 Nov 19
Source: Bloomberg, Refinitiv Datastream, UniCredit Research
ECB’s flows might trigger ECB’s measures might turn out to be more supportive than in the past for EUR denominated
more portfolio reallocation
on domestic assets assets, particularly credit (sovereign and corporate). Indeed, asset purchases during 2015-17
than during APP 1 fueled large outflows of funds from the eurozone, as the proceeds of bond sales to the ECB (by
residents) were mostly reinvested in foreign assets. Little portfolio reallocation into other EUR
denominated assets (being it credit or equities) happened. Balance of payment data suggests
that in that period, US government bonds along with Gilts and JGBs attracted strong interest by
eurozone investors. Judging from the targeted investments, yield enhancement and liquidity
considerations may have driven such outflows. At that time, USTs offered an attractive pick-up
on Bunds (over 50bp), even after hedging for the currency risk. This situation is no longer the
case. The cost of hedging EUR-USD exposure over a 3M horizon (via FX swaps) is nearly 2.5%
annualized, making UST yielding less than Bunds (e.g. on a 10Y maturity) once FX risk is
covered. In this respect, investing in foreign bonds might be less attractive than during the first
APP. Additionally a larger share of the reinvestments might be reallocated towards EUR
denominated assets. Whether equities will benefit from such flows hinges on the growth outlook.
A growth re-acceleration in 2021 would improve prospects for both equities and high yield and
make them attractive following the cheapening induced by the approaching US recession.
Deteriorating risk appetite but Risk aversion will likely prevail in global markets during the US slowdown. However, a shallow
no sizable fund repatriation
US recession and supportive monetary policy should help avoid a meltdown in risky asset
performance. In this area, we do not envisage sizable and prolonged repatriation of funds in the
US. Consequently we believe that EM bonds – especially hard currency denominated ones –
will continue to attract investors seeking a yield pick-up. As the US credit cycle remains a threat,
we believe that the EMEA region offers the best risk reward. Similarly, while risk aversion will be
tailwind to risk haven currencies, we do not see the US dollar gaining much strength. The extent
of monetary policy synchronization should limit the extent of swings in FX majors. Moreover,
both the growth and rate differential between the US and the eurozone are expected to narrow,
creating the case for a moderately higher EUR-USD over the forecast horizon.

FI Strategy
UST yields to decline on Fed’s action and growth slowdown
Dr. Luca Cazzulani ■ We expect UST yields to fall throughout 2020 due to a downturn in the US and the Fed
Deputy Head of FI Strategy
(UniCredit Bank, Milan) delivering four rate cuts. We see the 2Y UST yield ending the year at 1% and 10Y at
+39 02 8862-0640 1.50% with the 2/10Y spread bull steepening.
luca.cazzulani@unicredit.eu
■ Deteriorating growth and inflation outlook and an accommodative ECB will keep the 2Y
Chiara Cremonesi
FI Strategy German yield trading sideways, while they are likely to trigger a moderate decline in the
(UniCredit Bank, London) 10Y Bund yield to -0.50% by the end of 2020.
+44 207 826-1771
chiara.cremonesi@unicredit.eu ■ BTPs will again be caught between appetite for carry, weakness in fundamentals and
domestic politics. We see the 10Y BTP/Bund spread ending the year at 150bp.
Michael Rottmann
Head of FI Strategy
(UniCredit Bank, Munich)
■ We recommend overweighing duration in USTs next year. In the euro area, negative Bund
+49 89 378-15121 yields require either a very bold duration extension or credit spread exposure.
michael.rottmann1@unicredit.de
■ Risk to our forecast is asymmetrically skewed towards higher yields in Bunds while is more
balanced in USTs.
An amazing year for bonds The end of 2018 and 2019 saw a turnaround in market sentiment that deeply affected the
on both sides of the Atlantic
rates universe. We started the year with most analysts predicting further rate hikes by the Fed
and the ECB normalizing the depo rate to 0%, and we are ending the year with central banks
having turned dovish, with both the Fed and the ECB cutting rates and the ECB resuming QE.
The reason behind the change in the central banks’ stance on both sides of the Atlantic (first
the Fed and then, with a sizeable lag, the ECB) has to do with global trade and global growth
slowing down, subdued inflation and inflation expectations and, most importantly, global
uncertainty rising to unprecedented levels. As a result, 2019 was also the year when bonds
delivered impressive returns, as yields declined sizably across the board: USTs
(all maturities) delivered a 7.3% total return YTD, Bunds 4.3%.
CHART 1: CHART 2:
UCG FORECASTS VS. FORWARDS US CURVE EXPECTATIONS VS PAST EASING CYCLES*
3.50% 3.50% 600

2Y UST yield 10Y UST yield bp
2Y forecasts 10Y forecasts 381
400
2Y forwards 10Y forwards
3.00% 3.00%
213
200 169
122 89
2.50% 2.50% 22 15 33 6
0
-63
2.00% 2.00% -200
-175
Easing cycles with recession
-400
Insurance cut cycles
1.50% 1.50%
Our expectations for this cycle
-600
-575
1.00% 1.00%
-800
Dec-17 Dec-18 Dec-19 Dec-20 Dec-21
fed fund change 10Y-FF change 2-10Y change 2Y-FF change
*The chart shows the change in bp occurred between the beginning and the end of Fed easing cycles. We computed the average during easing cycles
with a recession and insurance cut cycles starting from 1989. Insurance cut cycles are: Jul1995-Feb1996, Aug1998-Dec1998. Easing cycles including a recession are
May1989- October 1992, Dec2000-Jul2003, Sep2007-Jan2009.
Source: Bloomberg, UniCredit Research
More specifically, in the US, 2019 saw a combination of downward revisions to monetary
policy expectations and a compression of the term premium that led to a sharp decline in UST
yields, of around 90bp for the 2Y (from 2.50% to 1.60%) and about the same for the 10Y
(from 2.65% to around 1.75%).

We expect 2020 to be another We expect 2020 to be another year of declining UST yields, with the 2Y ending at 1% and the
year of declining yields
10Y at 1.50%. The 2/10Y UST spread should continue steepening (although quite moderately
compared to previous easing cycles) reaching 50bp area. US growth slowdown, with the
economy experiencing a moderate recession in 3Q and 4Q, subdued inflation and inflation
expectations, a much more dovish Fed’s call compared to what is priced in by markets and global
uncertainty remaining elevated are the main reasons supporting our bullish call for US rates.
The Fed’s monetary policy We expect the Fed to deliver four rate cuts, one each quarter, with the fed funds rate ending
and its impact on UST yields
and the UST curve 2020 at 0.50-0.75%. This is a much more aggressive view than the market, which is currently
discounting only one to two rate cuts by the end of 2020. Hence, our view on UST yields is
much more dovish than the forwards suggest (Chart 1).
So far, the Fed has been delivering an insurance cut cycle cutting the fed funds rate by 75bp
in the last four months. Next year, we expect the Fed to move from an insurance cycle to full-
fledged easing15 due to a continuing slowdown in the economy. We expect a total of 175bp
easing during this cycle.
Compared to the last “proper” easing cycles that included a recession, the total amount of
cuts delivered by the Fed is likely to be much lower this time, which in our view should
translate into a much more moderate steepening of the UST curve compared to previous
easing cycles (Chart 2).
In this respect, we expect the 2Y/fed fund spread to end 2020 at 25bp, less steep than on average
in the previous “proper” easing cycles, when the end point of this spread was on average 50bp.
CHART 3: TERM PREMIUM HAS BEEN FALLING AT CHART 4:

THE START OF THE CURRENT EASING CYCLE UCG FAIR VALUE MODEL FOR 10Y REAL UST YIELDS
7.00% 500 5.00% 5.00%

Fed funds mid (ls) 10Y real UST yield
10Y UST term premium (ACM, bp, rs)
6.00% 400 Model fit without trade (QE, F, Y*)
4.00% 4.00%
Model fit with trade (trade, QE, F, Y*)
5.00% 300
3.00% 3.00%
4.00% 200
2.00% 2.00%
3.00% 100
2.00% 0 1.00% 1.00%
1.00% -100 0.00% 0.00%
0.00% -200
1995 1998 2001 2004 2007 2010 2013 2016 2019 -1.00% -1.00%
1997 2000 2003 2006 2009 2012 2015 2018
Trade: trade uncertainty index

QE: Fed’s holdings of USTs as % of US marketable debt
F: Foreign holdings of USTs as % of US marketable debt
Y*: potential growth by CBO
Moreover, during the past easing cycles, the 10Y UST (nominal) term premium started
increasing as the Fed delivered the rate cuts, signaling that investors expected interest rate
volatility as well as inflation volatility to pick-up in the future. In this cycle, we did not observe this
dynamic; the term premium actually declined once the Fed started cutting rates (Chart 3).
We think that this is related to global political uncertainty and trade-related uncertainty, as well as
subdued inflation expectations; as we expect uncertainty to remain at elevated levels next year,
and inflation expectations to remain subdued, we took into account this factor in our forecasts.
15
We use the following convention: we call insurance cycles the Fed’s easing cycle in which the economy did not go into recession and that are shorter in length, while
we call “proper” easing cycles the ones which included a recession. Starting from 1989, we consider insurance cycles the one in July 1995-February 1996 and the one in
16
August 1998-December 1998. We consider “proper” easing cycle the ones in May 1989- October 1992, December 2000-July 2003 and September 2007-January 2009
https://www.policyuncertainty.com/wui_quarterly.html

Global uncertainty is playing Another way of predicting the performance of the 10Y UST yield next year is by looking at the
a major role in compressing
long-term real UST yields real yield and inflation expectations going forward.
Our quarterly model of the fair value of 10Y UST real yields, which is based on US potential
growth, as well as holdings of USTs by foreign investors and by the Fed, both expressed as a
percentage of US federal marketable debt, shows that 10Y UST real yields should be some
135bp higher than they are now. The fit of our model started diverging from the actual value in
September 2018, around the time that uncertainty linked to trade started increasing.
Once we include an indicator related to trade uncertainty in our model (we use the World
Trade Uncertainty Index compiled by Ahir, Bloom and Furceri and available on Bloomberg16),
the residual practically vanishes. In a nutshell, the indication we get is that trade uncertainty is
currently playing a major role in compressing long-term UST real yields (Chart 4).
We expect 10Y real UST yields In this respect, next year will not be the year when 10Y UST real yields converge to the fair
to edge down further next year
value predicted by our non-augmented model (the one without the trade uncertainty variable):
first, we expect the fair value of our non-augmented model to decline (although moderately)
and second, we expect the level of trade-related uncertainty to remain high.
Potential growth is the variable in our model most likely to trigger a (moderate) decline in fair
value. In its current estimates, the CBO predicts potential growth will decline in the US in the
next two years and this could even become more pronounced next year. The other two
variables will probably be mostly neutral. Foreign flows into USTs will probably be smaller
than this year17 and the Fed’s holdings of USTs will likely increase, although the increase will
probably concentrate on T-bills, which will provide less support than outright buying of USTs.
All in all, this indicates that UST real yields have room to decline further from the current 0.10-
0.15% and to slide towards 0% over the course of next year.
Inflation expectations Inflation expectations in the US are currently subdued, with 10Y US breakeven rates trading
to remain very subdued
in the 1.60-1.65% area. According to our quarterly model based on the output gap and PCE
core inflation (the Fed’s favorite inflation gauge), breakeven inflation rates should be around
35-40bp higher than they are now. That said, with growth slowing and the output gap opening
up again, we see little room for core inflation to rise. This paints a picture of declining inflation
expectations. Declining, oil prices will also add another reason for inflation expectations to
decrease. We expect 10Y breakeven rates to re-test the 1.50% lows during 2020.
Putting together our view for real yields and inflation expectations, we expect to end the year
with 10Y nominal UST yields at 1.50%. Note that 1.50% is a very important support level and
it is very near the historical low. We do not think that this level will be broken to the downside,
but our call still sees 10Y USTs reaching it.
Last but not least, in the first part of the year, we see high probability of a drawdown in the
range of 20% for global equities, in anticipation of the technical recession. This factor should
provide some extra-support to USTs, at least at the start of the year.
16
https://www.policyuncertainty.com/wui_quarterly.html
17
TICs flows show that from January 2019 until September 2019, there have been record flows of foreign investment into USTs, with more than USD 500bn of
inflows. The increase was widespread, with Japan and the eurozone being the main contributors, but Taiwan, Hong Kong, Singapore, Thailand, India, UK, Canada,
Saudi Arabia and Norway also active. We note that this has happened with foreign official investors increasing their exposure to USTs, likely as a consequence of
the increase in central-bank reserves.

A quick glance at 2021 In 2021, we expect the US economy to recover and global trade to enjoy a brighter outlook
in the US
compared to 2020. This means that very gradually we expect long-term real UST yields to
come back towards their long-term equilibrium. With inflation expectations also gradually on
the rise, we have a target of 2.50% for the 10Y UST yield at the end of 2021. We also see the
2Y yield increasing, although much more moderately, as this tenor is not as significantly
impacted directly by global uncertainty, and the growth recovery will likely be moderate. This
means that we expect the 2/10Y UST spread to widen further to 120bp by the end of 2021, a
much more aggressive call than that implied by the forwards.
Bunds: no respite from negative yields

10Y Bund yields have dropped EGBs have had a very good year, supported by slowing growth momentum, accommodative
50bp in 2019, sinking below 0%
ECB monetary policy and political uncertainty (Brexit and trade war). The 10Y Bund yield
moved from 0.20% to -0.70% in August, before rising back towards -0.30%. The low-yield
environment has favored yield hunting, driving cross-country spreads tighter. In this context,
Italy significantly outperformed other EGBs, reflecting an improving domestic political picture.
Core EGBs require a short- Core yields are set to enter 2020 at very low (if not negative) levels, with yield curves
term, trading oriented attitude:
expect episodes of volatility extremely flat. Term premium has been declining in recent years and we estimate it to be
negative. With carry absent or negative, buying core EGBs requires a bias for yields to go
even lower. Furthermore, investors are likely to be quick to take profit as soon as positive
momentum loses steam. Put differently, market is likely to be dominated by investors with a
short-term approach and this is likely to lead to higher volatility.
Key reasons why we expect We see the following key reasons for Bund yields to decline in 2020: deteriorating global
core yields to stay low:
growth and inflation outlook, easy monetary policy (including QE) and deteriorating risk
appetite.
Moderating growth… We expect the growth outlook to deteriorate in the second part of 2020, with the slowdown
originating in the US and affecting the eurozone. This also should support demand for fixed-
income assets because of the expected central bank action.
…weak inflation… At the same time (and related) we project inflation to remain sluggish (core around 1.1/1.2%
in 2020 and in 2021). We also expect oil prices to decline during 2020. Hence, while
breakeven inflation in the eurozone appear to be about 30bp undervalued relative to our fair
value model, a meaningful increase next year is unlikely.
CHART 5: CHART 6:
UCG BUND YIELD FORECASTS IN ONE CHART UCG MODEL FOR GERMAN REAL YIELDS POINTS SOUTH
1.00% 1.00%
2Y Bund yield 10Y Bund yield 4.00% 300
2Y forecasts 10Y forecasts Residual (RS) Actual Fit
2Y forwards 10Y forwards
3.00% 225
0.50% 0.50%
2.00% 150
0.00% 0.00%
1.00% 75
-0.50% -0.50% 0.00% 0
-1.00% -75
-1.00% -1.00%
Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 -2.00% -150
2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

…the ECB policy stance… In a context of subdued inflation and deteriorating growth outlook, the ECB is indeed likely to
maintain an accommodative policy stance and, if anything, may come under pressure to
deliver further easing to match at least in part the bold action we expect by the Fed. The less
controversial measure in this case would be to cut rates further. Lower funding rates would
put downward pressure on yields, especially at the short and medium maturities.
In addition, the ECB will run QE in 2020. We expect purchases of public securities to be EUR
…with QE keeping scarcity
going… 125bn in nominal terms, which roughly matches the entire euro area net issuance. As in the
past, in some jurisdictions QE purchases will exceed net issuance. In particular, for Germany
we calculate that QE purchases will exceed net issuance by roughly EUR 30bn. In this
respect, scarcity will continue to intensify over the course of next year, providing ongoing
support to Bunds – amplifying yield drops and cushioning the rise in the event of a sell-off.
…correlation with In relation to Fed easing, we expect US yields to be falling during 2020. Since the start of the
other markets… EMU, the correlation of 10Y US and Bund yields has ranged from 50% to 90%. This is
another factor that should exert downward pressure on Bund yields.
…and portfolio reallocation. Furthermore, with slowing growth in the US we expect a period of significant correction in
equity markets. When, such episodes occur, investors tend to turn to EGBs. Indeed, equities
and bond returns are negatively correlated, especially during sell-off episodes. For example,
the S&P dropped 20% between October and late December 2018, during the same period,
10Y UST yields dropped by 45bp.
According to our model for German 10Y real yields, if we consider QE next year as well as
some moderation in growth momentum, the fair value is likely to decline towards -1.50%.
CHART 7: SCHATZ TO REMAIN CAPPED BY ECB FUNDING CHART 8: ASSESSING THE BTP BUND SPREAD*
0.00% 0.00% 400 400

135.3 134.8 134.1 134.8 136.2 136.7
ECB depo rate 2Y Bund yield
0.7 1.4 1.8 0.7 0.2 0.2
UCG depo rate fcst. UCG 2Y forecast
-0.20% -0.20%
300 300
10Y IT-GE yield spread
-0.40% -0.40% 10Y IT-SP yield spread
200 200
-0.60% -0.60%
-0.80% -0.80%
100 100
Rate cut
French elections expectations,
& QE pressure trade tension
& Brexit
-1.00% -1.00%
Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 Jan-22 0 0
Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20
*Numbers indicate debt/GDP and growth, including our forecasts. Black line is the average since the start of QE excluding periods of severe political uncertainty.
Dotted lines represent the range in the same period.
Our forecasts for Bund yields: Against the backdrop of our economic scenario, we expect 10Y Bund yields to drop toward
10Y to reach -0.5%
at the end of 2020 -0.50% in late 2020, a period when downward pressure originating from the US will be
particularly intense. A long lasting move below this target would require expectations of lower
ECB rates. As soon as the economic picture improves in early 2021, we expect yields to drift
higher with the 10Y turning positive at the end of the forecasting horizon.
2Y broadly sideways 2Y Bund yields are likely to trade mostly sideways in 2020. With the ECB not delivering
further easing, repo rates stabilizing at or slightly below the deposit rate and ongoing scarcity
as a result of QE, room for directionality is limited.

Yield hunting to favor curve With yields constrained in relatively narrow ranges, there is not much room for the curve
flattening, especially at the
extra-long end shape to change. If anything, we have a bias for a moderate bull flattening in the 2/10Y area.
With core yields negative and a generally positive environment for bonds, we expect investors
to roll up along the curve, leading to a flatter 10/30Y. A significant flattening of the German
10/30Y spread from current levels would require 30Y yields to turn negative. While we have
seen this occurring this year, it’s safer to set up this trade with curves where the 10/30Y
spread has room to tighten without the need for negative 30Y yields.
Money market rates: Money market rates are expected to closely track the ECB deposit rate. With excess liquidity
excess liquidity is still king
bound to stay abundant next year, the newly created overnight rate (€STR) should trade
below the ECB deposit rate. The jury is still out as to the effect of tiering – main issue being
an uneven distribution of excess liquidity across jurisdictions and an unknown degree of
market fragmentation – however €STR price dynamics have been constructive so far.
Tensions on MM rates related to tiering (if any) are likely to be relatively limited considering
that there would be no reason to borrow at rates higher than 0%. Significant shocks to €STR
would require a sharp deterioration in risk appetite or in excess liquidity (the latter not on the
table given QE). Finally, tensions on MM rates, especially €STR and Euribor can be
counteracted by the ECB adjusting the parameters. With the ECB not expected to move the
depo in our central scenario, the 3M Euribor should trade sideways. Given the Euribor stands
good chance of remaining in place after the end of 2021, we do not envisage any pressure
towards the end of the forecast horizon.
We expect Bund/swap spreads 2Y Bund-swap spreads have cheapened to less than 30bp this year and are back at their
to remain stable
2014/15 levels. The German short end is a good indicator of risk aversion as swap spreads
widen during episodes of tension. While it would be tempting to use the cheap entry level to
set up hedges against deterioration in risk appetite, carry from this position is highly negative.
Unlike 2Y Bund swap spreads, 10Y Bund-swap spreads are still richer than they were in
2014/15, which reflects the Bunds’ relative scarcity. We see two factors at work in 2020: QE
will keep longer tenors scarce while negative yields should create an incentive for investors to
set up receiving positions. The latter should prevail, driving 10Y Bund swap a bit cheaper.
BTP-Bund: go for the carry BTP credit spreads have tightened significantly this year, reflecting the improving political
but beware of political risk
situation in Italy. The 10Y spread has moved from 250bp at the start of the year to around
155bp and the 2Y spread has tightened 50bp, from 100bp to around 65bp. The 2/10Y yield
spread has tightened accordingly but remains considerably steeper than on the other EGB
curves. In a world of negative yields and high excess liquidity, the still relatively high credit
spread offered by BTPs will be hard to overlook, particularly early in the year when portfolios
and strategies for the year are being set up. QE will provide additional support to BTPs,
buying an estimated two-thirds of net issuance. We therefore expect the BTP-Bund spread to
tighten toward 125bp in early 2020.
Economic fundamentals are likely to be a moderate drag in the medium term: growth is
expected to remain low and below the eurozone average, while debt/GDP is expected to rise
to around 137%. Deteriorating risk appetite related to the slowdown in the US is also likely to
weigh on BTPs later in 2020, pushing the spread back towards 150bp.
Domestic political developments will remain a wildcard throughout the year. While not our
central scenario, a government crisis followed by early elections would lead to significant
spread widening, with the 200/250bp area as a target.

Portfolio recommendation:
overweigh duration in USTs, be more cautious with Bunds
Adding it all up: In this section we calculate expected returns from government bonds in 2020 and 2021 and
duration prescription
provide portfolio recommendations.
Our prescription for USTs in 2020 is clear: overweigh duration as we expect returns to be
positive with price performance and carry working in the same direction. The expected return
from 10Y USTs is in the 5.0% area while 30Y USTs are expected to deliver even higher
returns. Expected returns at both the 2Y and the 10Y, would remain positive even if yields
turn out to be 50bp higher than our forecast.
In 2021 our forecasts require to underweight duration; we expect sharply negative returns
from 10Y USTs, while 2Y USTs should still provide a positive return. Both in 2020 and in
2021, we would also recommend steepening bias in UST portfolios.
Positioning is trickier in the eurozone. Returns from Bunds are likely to be negative at the
short end and slightly positive at the 10Y, although it will not take much to turn them negative
(for example if Bund yields are 50bp above our forecasts, returns would be negative to the
tune of -3%).
Two prescriptions emerge from our forecasts with respect to the euro area: extend duration
beyond the 10Y (a 30bp decline in 30Y yields will work wonders) and/or take credit exposure
(for example buying BTPs).
From the perspective of a EUR based investor, it should be considered that cost of hedging
the USD currency risk via FX forwards runs at around 2.5% for one year. This would erode a
sizable fraction of our expected performance at the 10Y but still leave a positive return, while
would leave expected returns from 2Y USTs at 0%. Taking an un-hedged position in USTs is
not advisable given we expect the EUR-USD to rise to 1.16 by end 2020.
CHART 9: CHART 10:

STAY LONG DURATION IN 2020, ESPECIALLY IN THE US EXPECTED BOND RETURNS: A HISTORICAL PERSPECTIVE*
6% 20%
expected returns 2020 2021 returns* IT GE US
4%
15%
2%
0% 10%
-2%
5%
-4%
-6%
0%
-8%
2Y 10Y 2Y 10Y 10Y
-5%
US Bund IT 2014 2015 2016 2017 2018 2019f 2020e
*returns of Bloomberg-Barclays 7-10Y indices. US in USD Source: Bloomberg, UniCredit Research

Risk symmetry skewed towards higher Bund yields

whereas it is more balanced for USTs
Not only are our rates forecasts well below forwards and consensus forecasts but we predict
limited swings throughout 2020 based on our quarterly forecasts given our subdued growth and
inflation outlook. In contrast, this year’s range for 10Y Bund and UST yields was the widest in
several years. The Bund range has covered 99bp so far, the widest since 2015. In USTs, this
year’s trading range of 133bp is almost three times the average of the past four years. At the
same time, 2020 is rich with unknown knowns, which may lead to stronger directional
momentum than covered by our forecast.
The following risk assessment is not a numeration of various isolated up and downside risks and
we leave aside event risks, such as the US and UK election outcomes and the unlikely case of
strong fiscal stimulus in Germany or a significant move forward in the architecture of the euro
area. While these appealing topics might be highly price-sensitive, they are more appropriate for
a “Ten surprises for 2020”-style publication.
In our view, the risk to our forecast is asymmetrical and skewed towards higher yields in Bunds
but more balanced in USTs.
Risk symmetry in Bunds Discussing the risk symmetry in bond markets, monetary policy aspects come to mind in
tilted to the upside…
Bunds: We see the risk tilted towards higher yields compared to our forecast of 10Y Bunds
being close to -0.5% at YE20.
While no-one knows for sure the exact level of the reversal rate in the euro area, we suspect
that it is not substantially below the current level. Under the assumption that the Bund curve
will not invert at a lower level, this points to the likelihood that the risk is asymmetrical and
tilted to the upside, compared to our forecast for 10Y Bunds. A further argument comes from
the discussion of the ECB monetary policy strategy review. A fully symmetric inflation target of
(or just below) 2% would not be much of a game-changer, in our view, as long as it is not
combined with an average-inflation or price-level targeting approach. With bygones being
bygones and even the current "below, but close to, 2% over the medium term" has not been
achieved over the past years, it is hard to see how a minor change to a symmetric 2% target
is likely to help lift market-based inflation measures higher from the current 1.10%, according
to the EUR zero coupon inflation swap and 1.25% in 5Y5Y forward inflation. A change to an
inflation range of 1.5% to 2.5% would be quite different. Despite market participants possibly
focusing on the lower end of the band, it would most likely reduce speculation about
aggressive monetary accommodation going forward. Even with the macro risk of escalating
trade tensions arising, we find it hard to imagine our -0.5% forecast for 10Y Bunds being
undershot by more than around 30bp.
If there is a significant improvement in global tariff tensions, the door appears open for 10Y
Bunds to return towards the average and midpoint from 2018 at around 0.5%. Tariff reductions
fuel global business sentiment and might encourage speculation that the ECB might reverse at
least the last cut in the deposit rate already in 2021. Further, based on the sequencing of
forward guidance (“… (APP) to end shortly before we start raising the key ECB interest rates”),
this dynamic could also heighten speculation about an end to the current APP program. The
scarcity effect working via a lower term premium would therefore only get smaller and the
expected average risk-free rate would rise modestly.

…but is more balanced In the US, the risk symmetry is more balanced as the reversal rate is nowhere near current
in the US, although current
levels are exceptionally rich levels, even under our subdued baseline scenario. In a worst case scenario where trade
friction escalates and leads to higher tariff rates, key rates may go down all the way to zero
and unconventional tools would again be a reliable option. In our view, prior lows in 10Y USTs
around 1.3% (hit in 2012 and 2016) are not a reasonable floor. Under such circumstances,
the 10Y UST yield could fall into a 0.5-1.0% range, in our view.
In contrast, the 10Y UST yield might return to 2.6%, a level they traded before average tariffs
between China and the US ramped up and measures against Huawei added a technology-
war component to the trade friction.
Compared to our forecast at 1.5%, the risk skew for USTs is much more balanced than our
risk assessment for Bunds.
Additional support in favor of higher yields may arise later in the course of 1H20, when the
outcome of the Fed policy strategy review is announced. We assume the Fed will refrain from
yield-curve control, but introduce an average-inflation approach. Market-based inflation
compensation is likely to move closer to 2% under such a mandate, becoming better
anchored in the future with bygones no longer bygones. In theory, an average-inflation
approach also means that when inflation undershoots, key rates remain lower compared to
the current approach, which might also keep real rates lower. That said, we doubt that, this
will overcompensate the effect from higher break-even inflation rates for longer maturities.

FX Strategy
The absence of major FX trends is likely to continue
Roberto Mialich ■ Ample liquidity conditions and still quite synchronized economic cycles worldwide are more
FX Strategist
(UniCredit Bank, Milan) likely to favor range trading than major trends over the coming quarters. However, more
+392 88 62-0658 Fed easing with the ECB on hold is likely to offer EUR-USD some upside potential.
roberto.mialich@unicredit.eu
■ GBP is set to benefit from a Brexit deal, but the risk of a “cliff-edge” in December 2020 and
BoE easing will likely slow its recovery. Due to lingering risks worldwide, the JPY is likely to
stay firm even if the BoJ moves to steepen the Japanese yield curve. Persisting trade
tensions between US and China will likely limit the downside potential for USD-CNY.
Is volatility dead? The main surprise in FX markets this year has undoubtedly been the very low level of
Then, long live volatility!
volatility, both implied and realized. The anomaly here is that the various sources of risk
worldwide, particularly the trade row between the US and China and Brexit, should have led
to much higher volatility. Nevertheless, FX majors remained confined within tight trading
ranges for most of the year with investors finding difficulty in riding even minor trends.
The volatility puzzle: the role Why has this happened and, more critically, can it continue? We think that an important factor
played by central banks…
behind the modest FX moves has been the provision of ample liquidity by central banks in
their ultra-loose monetary policy accommodation strategies.
…and the risk Chart 1 plots the aggregate of the balance sheets of the G4 central banks (Fed, ECB, BoE
that the phenomenon
may be self-fulfilling… and BoJ) since 2008 against the simple average 3M implied volatility of EUR-USD, USD-JPY
and GBP-USD. Ample available liquidity dragged interest rates into negative territory and a
lower propensity to take currency risks by investors due to global uncertainty reduced the hunt
for protection and thus demand for volatility. This phenomenon tends to become self-fulfilling:
low realized volatility calls for low implied volatility through short gamma strategies and low
volatility hints that currencies will likely stay stuck within tight bands, which does not provide
an incentive for investors to pay extra hedging costs, even if such strategies are cheap.
...in a world economy that In addition, economic cycles remain largely synchronized worldwide, with most regions
is still very synchronized…
experiencing tame inflation pressure and sluggish growth amid expectations of a further
deceleration of both of them. Consequently, monetary policies worldwide tend to be similar,
accommodative and synchronized. This also explains why major trends have failed to
materialize in FX markets this year, while they have been more evident in other asset classes,
like equities and bonds.
CHART 1: CENTRAL BANK LIQUIDITY FLOOD LIKELY PLAYED CHART 2: BENEFITS FROM A US SLOWDOWN?
A KEY ROLE IN REDUCING FX VOLATILITY NOT A ONE-WAY STREET TO THE UPSIDE FOR EUR-USD
40 25 15 1.80
G4 central banks' balance sheet as % of GDP US GDP EMU GDP EUR-USD (rs)
Implied volatility index for G4 FX Majors (rs)
12 1.60
35
20
9 1.40
30
6 1.20
25 15
3 1.00
20
0 0.80
10
15 -3 0.60
10 5 -6 0.40
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

…with more monetary policy Still, major central banks are unlikely to reduce their balance sheets over the course of our 2Y
accommodation ahead
forecast horizon with some becoming even more expansionary, if anything. This is certainly
the case for the Fed and the BoE and most likely for the BoJ, while the ECB has already
announced a new round of QE. Therefore, there appears to be a material risk that FX majors
will remain stuck within tight trading ranges over the coming quarters. Without significant
shocks, breaking the stalemate and restoring major trends may not be easy.
USD: a US slowdown and We envisage a much clearer economic slowdown in the US in 2020. The Fed is therefore
more Fed easing are bad news
likely to be forced to deliver an additional 100bp of easing next year, dragging the upper
bound of the fed funds range rate down to 0.75%, while monetary policy will likely stay on
hold in 2021. This is bolder action than that currently priced in by the US forward curve, which
implies the fed funds effective rate will only drop to 1.50% over a two-year horizon. At the
same time, eurozone GDP growth is likely to remain sluggish, but in the absence of a German
recession and with the ECB expected to remain on hold.
EUR: Still no great upside The scenario we outline would normally suggest a much higher EUR-USD, but we do not
potential ahead…
think that the pair has a huge upside potential. Chart 2 shows that since the launch of the
euro in January 1999, a US slowdown has not necessarily been associated with a strong rise
in EUR-USD, as the move also depends on the economic conditions and prospects of the
eurozone. Still, EUR-USD benefits when growth differentials between US and the eurozone
shrink as we expect in our scenario, but the process might not be very linear. For instance,
Chart 3, which plots EUR-USD against the German Ifo survey and the ISM manufacturing
index (both set equal to 100 in January 2019), shows that for most of the year the worsening
business climate in Germany has dragged EUR-USD lower, even in the face of a slightly
more intense deterioration of business expectations in the US. This was probably because the
manufacturing sector is more relevant for the eurozone than for US growth. Only when the
ISM PMI broke below 50 in September, did EUR-USD receive a (minor) lift, suggesting that a
significant deterioration in the ISM manufacturing index is needed to trigger a USD sell-off.
…but a recovery back We therefore anticipate just a moderate EUR-USD rise back to 1.16 by 4Q20, a level that
to 1.16 by end 2020…
leaves the pair in line with our estimation of its fair value of 1.15 (see the appendix at the end
of this section). The EUR-USD appreciation we expect (5.5% from the current spot rate at
1.10 in 1Y time) would not be dramatic enough to alarm the ECB and would also reduce the
EUR-USD misalignment with the long-term differentials between the eurozone and the US,
which have narrowed this year, in both nominal and real terms (Chart 4). If the Fed remains
steady on rates over the course of 2021, this would likely mean some consolidation, leading
to EUR-USD rising slightly to 1.18 at the most by the end of the year.
CHART 3: WORSENING IN GERMAN BUSINESS CLIMATE HAS CHART 4: EUR-USD STILL OUT OF SYNC WITH NOMINAL AND
PREVAILED OVER US SENTIMENT, DRIVING EUR-USD LOWER REAL YIELD SPREADS BETWEEN THE EUROZONE AND THE US
110 1.16 -1.00 1.20

EU vs. US 2Y bond nominal spread
EU vs. US 2Y bond real spread
1.14 -1.50 1.18
105 EUR-USD (rs)
1.12 -2.00 1.16

100
1.10 -2.50 1.14

95
1.08 -3.00 1.12
90
German IFO (01-Jan-19 = 100) 1.06 -3.50 1.10
US ISM PMI (01-Jan-19 = 100)
EUR-USD (rìs)
85 1.04 -4.00 1.08
Jan-19 Feb-19 Apr-19 Jun-19 Aug-19 Oct-19 Jan-19 Feb-19 Apr-19 May-19 Jun-19 Aug-19 Sep-19 Nov-19

…with one major risk: a more The major risk to our scenario is if the worldwide economic slowdown proves more intense in
intense economic slowdown
outside the US, which would the coming quarters, and notably outside the US, triggering in turn a meltdown in risk appetite.
boost the USDs role as a This would magnify the role of safe-haven currencies, including the USD, and drive a lot of
safe-haven
portfolio flows back into the US from both developed and emerging countries. However, the
ample available liquidity will likely limit the extent of fund repatriation and so it would not spur
a massive sell-off and would not push EUR-USD much below 1.10.
JPY: still firmer, even if BoJ We remain bullish on the JPY, as we still see significant threats to global risk appetite next
action steepens the Japanese
curve considerably year. However, we see at least two factors that might slow the pace of the JPY rise. First, a
deal being reached on the current “Phase one” of the trade row between the US and China
would make safe-haven currencies like the JPY less attractive, but only temporarily, as such a
deal would not represent a definitive solution to the trade dispute. Second, the BoJ is set to
become more accommodative again, trying to steepen the Japanese yield curve by increasing
bond purchases at the medium and shorter maturities. The new easing is potentially JPY
negative (Chart 5), but it would not come as a surprise at this stage, as BoJ Governor Haruiko
Kuroda has already made his policy intentions clear. With global risk factors not being fully
alleviated and in the weaker USD scenario that we imagine, we think that USD-JPY still has
more room to fall than to rise. The pair may briefly exceed 110 in 1Q20, depending on the
timing of the BoJ’s increased bond buying, but we still target 105 in 4Q20 and 103 in 4Q21:
two further steps forward for USD-JPY on the convergence roadmap to its “fair-value”, which
has now slipped below 100 in our estimation.
GBP: room for rebound slowed The sterling outlook continues to be mostly a Brexit story. At the time of this publication, the
by both risk of the Brexit
“cliff edge” and BoE rate cuts Brexit deadline has been delayed to the end of January and a UK general election has been
called for 12 December. The probability of an agreement on the future trade relationship
between UK and EU before the end of the so-called “transition period” in December 2020 is
very low, but the risk of a no-deal/hard Brexit at the end of 2020 (the so called “cliff-edge”)
is still very real. This is because the decision to extend the transition period has to be taken
by 1 July 2020, meaning that Brexit uncertainty will be back again in seven months’ time.
A free trade agreement is not expected to be concluded by then and the main risk is that the
Euroskeptics in the Tory party will not accept an extension to the standstill transition period.
This scenario may limit the effective upside potential for sterling throughout most of 2020,
considering that the BoE will likely also cut the bank rate back to zero, in our view. The GBP-USD
and EUR-GBP levels prior to the 2016 referendum, above 1.40 and just below 0.85,
respectively, remain reference targets over our 2Y horizon (Chart 6), but sterling is not likely
to approach them until late 2021, if at all.
CHART 5: A STEEPER JAPANESE CURVE NOT ENOUGH TO CHART 6: STERLING HEADING BACK TO PRE- BREXIT
PREVENT A WEAKER USD-JPY EXCHANGE RATE REFERENDUM LEVELS
0.20 115 1.65 0.95

GBP-USD EUR-GBP (rs)
10Y vs. 2Y JGB spread USD-JPY (rs)
0.18
0.90
1.55
0.15 113
0.85
0.13
1.45
0.10 110 0.80
0.08 1.35
0.75
0.05 108
1.25
0.03 0.70
Brexit referendum
23 June 2016
0.00 105
1.15 0.65
Jan-19 Feb-19 Apr-19 May-19 Jul-19 Sep-19 Oct-19
2015 2016 2017 2018 2019

CHF: moderately loosening A deal Brexit would make the Swiss franc less attractive as a safe-haven currency in Europe.
its grip against the euro
We expect EUR-CHF to rebound back to 1.15 by 4Q21, which would represent an 8.5%
overvaluation with respect to our calculation of its fair value, now at 1.06. Yet, the SNB has
proved relaxed on the FX front so far this year, as indicated by the size of sight deposits, and
a weaker franc would actually be welcomed at this stage. Moreover, with policy rates still
below the ECB deposit rate (-0.75% vs.-0.50%), the SNB has no great incentive to alter its
stance to offer the franc support, unless external factors impose it, such as more ECB easing.
Although this is not in our scenario.
Commodity currencies: room The AUD, NZD and CAD will probably remain sluggish in 2020 due to a continuation of the
for rebound delayed to 2021
bleak world economic picture, including China slipping below 6.0% growth and lower oil
prices. Progress in trade negotiations between the US and China will probably offer just
temporary relief to these units. Aside from this, by their own standards, both the RBA and the
RBNZ have cut rates heavily this year, down to 0.75% and 1.00%, respectively. There is room
for more easing, but it is small. The BoC has not started an easing cycle yet, but it will likely
kick one off soon, leaving the CAD on a soft tone in 2020. A rebound for these three
commodity currencies may resume in 2021 if the global outlook improves and their central
banks become less expansionary.
Nordics: a slower and The two Nordics remain greatly undervalued, especially the NOK after its drop to record lows
bumpier recovery from lows
against the EUR. Based on our models, EUR-SEK and EUR-NOK should be around 9.10 and
8.90 compared to their current 10.70 and 10.10, respectively, but absorbing this misalignment
is unlikely to be easy. The Riksbank will likely hike this December and stay on hold at zero
thereafter, while the Norges Bank has already ended its tightening cycle. Neither the SEK nor
the NOK can therefore rely on tighter monetary policies at home in 2020 and 2021. They still
have margin to recover in the coming quarters, but less than they had in previous years.
CNY: trade uncertainty to favor USD-CNY has corrected sharply downwards from past peaks above 7.18 hit in September
more walks up and down the
7.00 threshold vs. the USD thanks to progress in trade talks between Beijing and Washington. Early attempts to drag the
pair below 7.00 have already materialized and there is a chance of further declines, even
down to 6.90, in 2020. Still, the lower Chinese economic growth we expect would make the
PBoC more prudent about allowing more intense CNY appreciation. Trade tensions with US
may continue even if the “Phase one” has been finalized. If so, we think that there is a distinct
probability that USD-CNY might trade back above 7.00 throughout most of 2021.
ZAR: still firmer ahead, despite Worsening public finances in South Africa and risks of a new rating downgrade for the country
uncertainty on reforms and
public finances at home remain two clear burdens for the ZAR that may slow the pace of its recovery going forward.
The rescue plan announced for the state power utility has sharply weighed on the country’s
debt ratio, projected in the new budget plan to above 70% of GDP from the previous 56%.
Given the uncertainty that continues to surround the reform plans proposed by President Cyril
Ramaphosa, our previous target of 14.40 for USD-ZAR is probably more likely to be reached
in 2021 rather than 2020, for which 14.60 looks to be the best the ZAR can achieve.
CEE Currencies Our view on CEE currencies is reported in the CEE macro section.

Appendix – FX BEER model updated

Elia Lattuga We have further refreshed our FX fair-value model, BEER by UniCredit, after the update
Deputy Head of
Strategy Research made in June18. The text and the table below sum up major changes to our estimates. Using
Cross Asset Strategist a confidence threshold of +/-5% with respect to fair values:
(UniCredit Bank London)
+44 207 826-1642
elia.lattuga@unicredit.eu ■ EUR-USD remains fairly valued, with its equilibrium level unchanged at 1.15;
Roberto Mialich ■ GBP remains sharply undervalued due to Brexit uncertainty: the fair values for GBP-USD
FX Strategist
and EUR-GBP are now around 1.46 and 0.79, broadly unchanged from June
(UniCredit Bank, Milan)
+392 88 62-0658
roberto.mialich@unicredit.eu ■ USD-JPY has become more overvalued, as its fair level has dipped to 95.7 from 101.2;
likewise the fair value for EUR-CHF is now at 1.06 vs. 1.12 in June.
■ The AUD is still undervalued against the USD, while both the NZD and the CAD are fairly
valued. SEK and NOK show the largest undervaluation in the G10 group.
■ In the CEE3 space, our model detects only a modest undervaluation of the HUF against
the EUR.
FAIR VALUATION OF G10 AND CE3 FX ACCORDING TO BEER BY UNICREDIT
Current BEER by UniCredit Misalignment undervalued* fairly valued* overvalued*

EUR-USD 1.11 1.15 -3.8% EUR-USD
EUR-CHF 1.10 1.06 4.3% EUR-CHF
EUR-GBP 0.86 0.79 9.0% EUR-GBP
EUR-JPY 121 110 9.5% EUR-JPY
EUR-NOK 10.16 9.33 8.9% EUR-NOK
EUR-SEK 10.66 9.09 17.3% EUR-SEK
EUR-AUD 1.61 1.46 9.8% EUR-AUD
EUR-NZD 1.74 1.72 0.8% EUR-NZD
EUR-CAD 1.46 1.46 0.3% EUR-CAD
EUR-PLN 4.27 4.26 0.1% EUR-PLN
EUR-HUF 332 344 -3.6% EUR-HUF
EUR-CZK 25.5 28.2 -9.5% EUR-CZK
USD-CHF 0.99 0.92 8.4% USD-CHF
GBP-USD 1.29 1.461 -11.8% GBP-USD
USD-JPY 109 95.7 13.9% USD-JPY
USD-NOK 9.13 8.09 12.9% USD-NOK
USD-SEK 9.61 7.88 21.9% USD-SEK
AUD-USD 0.69 0.79 -12.4% AUD-USD
NZD-USD 0.64 0.67 -4.6% NZD-USD
USD-CAD 1.32 1.26 4.2% USD-CAD
USD-PLN 3.85 3.70 4.1% USD-PLN
USD-HUF 300 299 0.3% USD-HUF
USD-CZK 23.0 24.4 -5.9% USD-CZK
USTW$ index 91.6 85.8 6.8% USTW$ index
*using a threshold of +/- 5% Source: Bloomberg, UniCredit Research
18
See UniCredit Research FX Perspectives no. 62 - Updating our BEER model: fundamental support for the US dollar is waning. About our methodology, see the original
version of our BEER model in UniCredit Global Themes - Introducing BEER by UniCredit, 3 September 2013.

Equity Strategy
Downside risks to prevail, particularly in 1H20
Christian Stocker, CEFA, ■ We anticipate strong corrections of up to 20% in global equities in 1H20, with some relief
Lead Equity Sector Strategist
(UniCredit Bank, Munich) by year-end 2020. Our 2020 year-end target for the Euro STOXX 50 is 3850, for the DAX
+49 89 378 18603 14000 and for the MSCI Italy 67.
christian.stocker@unicredit.de
■ 2020 will be dominated by low earnings growth in Europe and slowing earnings growth in
the US. We consider consensus estimates to be far too high.
In 2020, equity markets will be caught between very low economic growth in Europe and
deteriorating growth in the US, on the one hand, and ongoing supportive monetary policy of
major central banks on the other hand. At the same time, equity-market valuations have
gradually reached their limit, thus putting a cap on further upside potential. Therefore, our
expectations for the development of equity markets in 2020 are very modest, with estimated
year-end targets for the Euro STOXX 50 of 3850 index points, 1400019 for the DAX and 67 for
the MSCI Italy. The main risk for global equity markets, besides trade issues, is the economic
slowdown we expect to occur in the US, which might even lead to recessionary levels in
2H20. Therefore, we see the high probability of a substantial market correction of around 20%
in the course of 1H20 whose trigger would be the significant economic slowdown in the US
and the realization that the structural theme of this current economic end-cycle will prevent a
noteworthy global cyclical recovery in 2020. The development of equity markets in the second
half of 2020 might be dominated by stabilization efforts, which should be supported by a
more-constructive view on the economic development in 2021 (albeit only moderate initially) and
ongoing accommodative central-bank policy. On balance, this might provide some relief to equity
markets, and may push the index levels up again, to the year-end targets that we forecast.
CHART 1: CHART 2 : EARNINGS ESTIMATES AND CALCULATED

EUROZONE GDP GROWTH AND EARNINGS ESTIMATES EURO STOXX 50 PRICE TARGET 2020
Eurozone GDP, yoy in % 12M fwd. earnings est., 4Q19-4Q20 UCG estimate
Bloomberg GDP consensus estimates, yoy in % Euro STOXX 50 (rs)
UniCredit GDP estimates, yoy in % Euro STOXX 50, UCG estimate (rs)
Euro STOXX 50 12M fwd. earnings est., in % yoy, 4Q19-4Q21 UCG est.(rs) 450 4500
4 40
400 4000
2 20
350 3500
0 0
300 3000
-2 -20
250 2500
-4 -40
200 2000
-6 -60
2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 150 1500
2003 2005 2007 2009 2011 2013 2015 2017 2019
Low-single-digit Euro STOXX Chart 1 shows eurozone GDP growth in percent yoy with UniCredit and Bloomberg estimates
50 earnings growth expected
for 2020/21 as well as growth of Euro STOXX 50 earnings estimates for 2020 that we have
modelled based on our GDP estimates. In this regard, it is important to highlight that our GDP
forecast is below consensus estimates and, therefore, also our earnings-growth estimates
19
Note: The calculated 2020 year-end target of the DAX is about 7% above current levels, while the Euro STOXX 50 and MSCI Italy levels are just 4% above
current levels. This difference does not imply a significantly better scenario for the DAX. The higher expected percentage increase results from the fact that the DAX
is a performance index and, therefore, dividends are included in the DAX performance (we estimate a dividend yield of 3%), while Euro STOXX 50 and MSCI are
pure price indices with dividends paid subtracted from equity prices.

differ strongly from consensus expectations (see Table 1)20. Against this background, we
think that 2020/21 eurozone and US consensus earnings estimates are far too high and,
therefore, might experience strong downward revisions, particularly in 1H20. This, in
combination with high valuation levels going into 2020, and increasing awareness of
significantly slowing US GDP growth during 2020, is reflected in our expectation of a strong
equity-market correction of up to 20% in the first half of 2020. Chart 2 above depicts the flat
course of our Euro STOXX 50 earnings estimates. While some further central bank action is
broadly discounted, we expect more Fed rate cuts than consensus. This should support P/E
valuations over the course of 2020. Our slightly positive year-end target for the Euro STOXX 50
of 3850 points (4.5% above the current level) is based on our assumption that the P/E ratio will
slightly increase from 14 currently to 14.6 due to ongoing accommodative central-bank policy.
TABLE 1: GROWTH OF EARNINGS ESTIMATES CHART 3:

(CONSENSUS AND UNICREDIT) VIX AND NET VIX FUTURE POSITIONS
250000 25
CFTC Cboe VIX futures non-commercial net total, shifted by 3M
S&P 500, 3M change in % (rs)
150000 15
yoy % 2019E 2020E UCG 2020E 2021E

50000 5
S&P 500 1.3 9.3 n.a. 10.6
Euro STOXX 50 1.5 10.5 3.5 8.0
DAX -4.2 13.5 6.0 11.2 -50000 -5
MSCI Italy 4.4 6.2 n.a. 6.9

-150000 -15
-250000 -25
2015 2016 2017 2018 2019 2020
Source: Refinitiv Datastream, Bloomberg, UniCredit Research
Bigger swings in 2020 History tells us that in an environment of sluggish or slowing economic growth rates (which we
expect particularly for the US) and, as a result, decreasing growth of company earnings,
implied volatilities in equity markets increase. Against this background, the current high
degree of investor complacency in the US could be a harbinger of bigger equity market
swings in the next few months. Investors have become ever so comfortable with the current
period of low volatility and are betting it could fall even further in the coming months. This is
reflected in the fact that net-short positions in the CBOE Volatility Index (VIX) futures rose to their
highest level ever, according to the latest Commodity Futures Trading Commission data. Chart 3
shows the correlation between the volatility-short-positioning level (with a lead of 3M) and the
performance of the S&P 500. While an extraordinarily high volatility-short-positioning level is
certainly no timing indicator, it nevertheless indicates the high degree of investor complacency
currently. This makes equity markets particularly vulnerable to sentiment shifts and event risk. In
the past, such high levels of complacency were often followed by a strong decline in the S&P 500
(such as in February 2018 or 4Q18), which will also be reflected in a decline of other developed
equity markets given the role of Wall Street as the world’s leading stock market.
Elevated valuations cap Since the start of 2019, the P/E valuation of the Euro STOXX 50 has increased by almost
positive potential
25% and that of the S&P 500 by 30%. Chart 4 shows the correlation between the eurozone
manufacturing PMI and the P/E ratio of the Euro STOXX 50. Since early 2019, the two time
series have been developing in opposite directions so far, which is uncommon in historical
terms. This year’s increase in the P/E valuation is mainly based on very accommodative US
and ECB central-bank policy. We do not expect central banks to change their policies in the
foreseeable future, which implies that this might continue to support valuations and, therefore,
20
We calculated our earnings-growth estimates based on a regression model comparing past GDP growth and growth of earnings estimates from 2003 until 3Q19.
The model has a solid R2 of 0.87 over this time period.

we expect a slightly higher P/E ratio for the Euro STOXX 50 of 14.6 at the end of 2020. A P/E
valuation above the level of 14.6 (which reflects past highs) is highly unlikely against the
background of a looming slowdown in the US and ongoing subdued economic growth in
Europe. This is also depicted in Chart 5. Apart from individual events, such as the ECB’s
announcement of massive QE early in January 2015 or the US corporate tax reform
announced at the end of 2017, valuations of the Euro STOXX 50 and the S&P 500 are around
their multi-year highs heading into 2020. On balance, we think that the underlying support by
monetary policy will continue, but as long as valuations are not supported by fundamental
improvements in economic data, such valuation levels are basically fragile. Therefore, an
upcoming setback of up to 20% is likely and not unusual in late stages of the economy. Such
a correction would bring the Euro STOXX 50 down to a P/E ratio of 12, which means an index
level of 3100 points (corresponding index levels for the DAX 11000, S&P 500 2500). With
indications of a more-constructive view on the economic development in 2021, most probably
in the course of 2H20, valuations have the potential to recover again.
CHART 4: EUROZONE MANUFACTURING PMI AND P/E RATIO CHART 5: P/E RATIO OF EURO STOXX 50 AND S&P 500
70 18 20
Eurozone manufacturing PMI Euro STOXX 50, P/E ratio based on 12M fwd. earnings estimates
Euro STOXX 50: P/E based on 12M fwd. earnings estimates (rs) S&P 500, P/E ratio based on 12M fwd. earnings estimates
65
16 18
60
16
14
55
14
50 12
12
45
10
40 10
8
35 8
30 6
2003 2005 2007 2009 2011 2013 2015 2017 2019 6
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Source: Refinitiv Datastream, UniCredit Research
What if we are wrong Our economic forecasts and, therefore, our earnings estimates are below-consensus views (see
and consensus is right?
Table 1 above). Should consensus earnings estimates be proven right and economic growth
surprise to the upside globally, the resulting equity-market potential would be accordingly higher.
This would offer additional positive potential of 5-10% above our forecast for the Euro STOXX 50.
For the DAX, with its strong cyclical exposure, the potential would be even higher.
We recommend We think the global growth environment remains too weak to support a lasting outperformance
a defensive allocation
of industrial sectors21 and that the cyclical rally since 3Q19 will be running out of steam going
into 2020. Although we expect some tentative signs of an economic bottoming-out in Europe,
the main European export markets, such as the US and Asia, might be caught in an
environment of slowing growth. Chart 6 shows that earnings estimates in defensive sectors22
continue their strong growth, while earnings estimates in industrial sectors continue to decline.
We do not expect that this behavior of more-favorable earnings development in defensive
sectors compared to industrial sectors will materially change in 2020. Therefore, we recommend
a defensive allocation and prefer sectors such as Food & Beverage, Health Care, Personal &
Household Goods and Utilities. As Chart 7 suggests, industrial sectors might achieve lasting
1
outperformance only upon confirmation of again notable growth of global trade volumes.
21
Industrial sectors (“industrials”): Automobiles & Parts, Basic Resources, Chemicals, Construction & Materials, Industrial Goods & Services
22
Defensive sectors (“defensives”): Food & Beverage, Health Care, Personal & Household Goods, Telecommunications, Utilities

CHART 6: CHART 7: GLOBAL FOREIGN TRADE VOLUME AND RELATIVE

EARNINGS ESTIMATES OF INDUSTRIALS AND DEFENSIVES PERFORMANCE OF INDUSTRIALS/DEFENSIVES
140 80 1,7
Defensives: 12M fwd. earnings estimates (2013=100) Ifo World Economic Survey, foreign trade volume next 6M
MSCI World: relative performance industrials/defensives (rs)
Industrials: 12M fwd. earnings estimates (2013=100)
130
40 1,5
120
0 1,3
110
100 -40 1,1
90
2013 2014 2015 2016 2017 2018 2019 -80 0,9
2007 2009 2011 2013 2015 2017 2019
Source: Refinitiv Datastream, UniCredit Research
EQUITY SECTOR ALLOCATION WESTERN EUROPE
Benchmark Portfolio weight Portfolio Strength of

weight over/underweight – position over/underweight
STOXX Europe 600 Sector (%) (%-points) (%) in % of sector weight
Automobiles & Parts 2.5 -1 1.5 -39
Banks 10.2 0 10.2 0
Basic Resources 2.6 0 2.6 0
Chemicals 4.5 -1 3.5 -22
Construction & Materials 3.3 0 3.3 0
Financial Services 2.3 0 2.3 0
Food & Beverage 6.2 1.5 7.7 24
Health Care 14.5 1 15.5 7
Industrial Goods & Services 11.8 -1 10.8 -8
Insurance 6.4 0.5 6.9 0
Media 2.0 -1 1.0 -49
Oil & Gas 5.2 0 5.2 29
Personal & Household Goods 8.6 1 9.6 12
Real Estate 2.3 -0.5 1.8 -22
Retail 3.0 0 3.0 0
Technology 5.3 0 5.3 -19
Telecommunications 3.3 0 3.3 0
Travel & Leisure 1.5 -0.5 1.0 -32
Utilities 4.4 1 5.4 23
Source: STOXX Ltd., UniCredit Research

Credit Strategy
Investment grade: cashing in carry in a prolonged late cycle
Dr. Stefan Kolek ■ The late-stage credit cycle warrants a defensive positioning in European investment grade
EEMEA Corporate Credit
Strategist (IG): we prefer non-cyclical credit sectors and have only tactical overweights in selected
(UniCredit Bank, Munich) cyclical sectors with still-good credit fundamentals and yield pick-up in 2020.
+49 89 378-12495
stefan.kolek@unicredit.de ■ The benign technical backdrop on the back of the resumption of corporate bond purchases
by the ECB and the expected decline in net issuance should provide support. We expect
the iBoxx Non-Financials and Financials indices’ spreads to amount to 60bp by the end of
the next year. This is close to current levels and should contribute to further widening in the
gap between valuations and credit fundamentals.
Late-stage credit cycle We remain in the late stage of the credit cycle, with the recently implemented QE II by the
likely to be prolonged
by dovish central banks ECB and the expected rate cuts by the Fed likely to further prolong this phase. While our
below-consensus eurozone economic-growth forecast argues in favor of spread widening, i.e.
a realignment of credit spreads with the economic growth dynamics, the relaunch of asset
purchases by the ECB and the related hunt for yield suggest a widening of the gap between
fundamentals and valuations in European credit in the coming months (Chart 1).
Cyclicals’ credit fundamentals The late-stage cycle is feeding through into negative credit-rating dynamics, with cyclical
already feeling the downturn
sectors, e.g. Retail, Media and Capital Goods & Services hit hardest YTD (Chart 2). Given the
expected mild recession in the US, credit metrics of US issuers could experience more
pressure than those of European peers. This is important given that US issuers make up
around 30% of this year’s issuance, driven by appealing cross-currency swaps, which has
reduced funding costs in the European markets. However, iBoxx US IG issuers’ credit-rating
profile is still comparable to that of eurozone peers, and with a large part of IG issuers rated
between A and BBB, we see only limited risk of “fallen angels” over the next twelve months.
European banks are in a better In our view, the picture for the European Banks sector looks better than for Non-Financials
fundamental position than
cyclical non-financials cyclicals. As depicted in Chart 2, upgrades in 2019 in the financial institutions sector by far
exceed downgrades (S&P data), with the positive net change being strongest among
individual credit sectors. Although the weaker growth backdrop will weigh on banks’ asset
quality going forward, the current good capitalization, a decline in non-performing loans and
liquidity provision by the ECB are likely to alleviate the impact of slower growth on Banks
credit relative to their Non-Financial peers. The lower profitability on the back of the low-
interest environment and flat yield curve, while being negative for equity, is neutral for credit.
CHART 1: ITRAXX NON-FINANCIALS VS. ECONOMIC CHART 2: YTD RATING DYNAMICS IN EUROPEAN FINANCIALS
GROWTH EXPECTATIONS AND NON-FINANCIALS
250 -0.85% Upgrades 2019 Downgrades 2019 Net

iTraxx Non-Financials (implied, ls) 12M fwd growth exp. (shifted by 2M) Financial Insts.
Consensus projection UniCredit forecast Insurance
Metal & Mining
Consensus growth exp. (12M fwd.)
iTraxx Non-Financials (in bp)
200 -0.20%
Telcos
Real Estate
Chemicals
150 0.45% Healthcare
Transport
Autos
100 1.10% Technology
Utilities
Oil & Gas
50 1.75% Forest Prods
Cons. Prods
Cap. goods
Media/entert
0 2.40% Retail
Jan-12
Jan-19
Jan-08
Jan-09
Jan-10
Jan-11
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
Jan-20
Jan-21
-10 -5 0 5 10 15
No. of rating actions
Source: Bloomberg, Matkit.com, S&P, UniCredit Research

Technical factors remain The technical backdrop is the key argument why valuations in European credit will not align
key to the widening of the gap
between valuations and with fundamentals in the coming months. First, extraordinary policies by the ECB will keep
fundamentals interest rates at negative yields in a large part of the fixed income universe, leaving investors
looking for yield. Second, although the announced asset purchases by the ECB of EUR 20bn
per month (we estimate these to include up to EUR 4bn of corporate bond purchases per
month) are significantly lower than in 2016-2018, the key difference – the commitment by the
ECB to buy paper for an unlimited time – creates a kind of “anticipatory factor support.”
Moreover, the net asset purchases need to be added to the re-investment of redemptions,
which we estimate to amount to up to EUR 2.5bn per month (Chart 3). Third, this, coupled
with the expected decline in net issuance, should provide Investment Grade Non-Financials
with technical support. We expect net issuance to decline on the back of lower capex and a
lack of (debt-funded) M&A activities, as well as a decline in issuance from US corporates, as
the expected rate cuts by the Fed will reduce the funding advantage in euro relative to USD.
Expected net-supply backdrop Besides the mentioned fundamental arguments in favor of defensive sectors – notably the
further argues for defensive
sectors deteriorating growth picture – the distribution of the expected net supply across the individual
sectors underpins our preference of defensive sectors: using the expected issuance volume
of corporates in our coverage, Chart 4 shows that primarily the defensive sectors, such as
Telecoms, Healthcare, Personal & Household Goods, Food & Beverage as well as Utilities
are seen ending next year with negative net issuance. In the cyclical sectors – Chemicals,
Technology, Automotives & Parts, Basic Resources and Industrial Goods & Services – we
expect positive net supply, which should weigh on the performance in these sectors. We
expect the net supply of senior bank debt to be lower than it was this year and the net supply
of subordinated bank debt to be comparable to this year’s levels.
Investment ramifications: In terms of strategic ramifications, the above-mentioned forces – the late-stage credit cycle and its
we remain defensive in sectors
and prefer Banks to Non- impact on fundamentals and technical factors – should balance out and we expect spreads in both
Financials Subordinated debt Banks and Non-Financials Investment Grade Seniors to end next year close to this year’s levels. In
Non-Financials, we stick with our preference of defensive sectors over cyclicals and have only
tactical overweights in selected cyclical sectors (Basic Resources and Construction & Materials)
which still have good credit fundamentals and offer a yield pick-up. The dovish stance of major
central banks should reduce the risk of volatility going forward, which, coupled with tight spreads in
Senior bonds, should keep the appetite for carry high in the Subordinated universe. In the latter,
we see better value in Banks Subordinated debt, where we expect, on balance, stable credit-risk
premiums, while in Non-Financials Subs, the deteriorating credit metrics and the absence of the
ECB bid should result in moderate (20bp) spread widening. A further supportive factor is the better
credit quality in Banks Subordinated debt with most issuers concentrated in the A- and BBB+
rating brackets, while the NFI Subs rating distribution is skewed towards the BBB- rating bracket.
CHART 3: CHART 4:
CSPP MONTHLY PURCHASES, EXPECTED REDEMPTIONS AND NET BOND SUPPLY FROM IBOXX NON-FINANCIALS ACROSS
IBOXX NON-FINANCIALS NEW-BOND SUPPLY SECTORS (UNICREDIT COVERAGE)
Expected reinvestment Expected net purchasses 3

Reinvestments Primary market purchases
20 2
Secondary market Net issuance (12M MA)
18
16 1
14
0
12 Expected iBoxx NFI net supply
EUR bn
EUR bn
10 -1
8
6 -2
4
-3
2
0 -4
-2
Sep-18
-5
Sep-16
Dec-16
Sep-17
Dec-17
Dec-18
Sep-19
Dec-19
Sep-20
Jun-16
Mar-17
Jun-17
Mar-18
Jun-18
Mar-19
Jun-19
Mar-20
Jun-20
ATO
IGS
OIG
MDI
THE
TAL
PHG
UTI
RET
FOB
TEL
CHE
BAS
CNS
HCA
Source: Markit.com, ECB, UniCredit Research

High yield:
marked spread widening expected amid economic slowdown
Holger Kapitza
Credit & High Yield Strategist
■ European HY credit markets will be caught between a continued slowdown of economic
(UniCredit Bank, Munich) and earnings growth and support factors, such as the hunt for yield, which will benefit HY
+49 89 378 28745 credit from a technical perspective. However, European companies should remain less
holger.kapitza@unicredit.de
vulnerable to credit concerns than their US peers.
■ As the macroeconomic environment will remain the dominant driver for HY credit next year,
which will be in line with continuously weaker credit metrics and rising defaults, we expect the
spreads among HY rating categories to continue to diverge, mainly due to the hunt for safety.
Overall, we see a marked widening of credit spreads in the European HY market next year.
Continued slowdown of the Given the low-yield environment, HY credit markets will remain attractive for credit investors
economy will remain a major
driver for HY markets in 2020 next year. This comes at a time, when economic growth is slowing due to uncertainty on
global trade, earnings growth of US and European companies is weak and credit markets
have entered the end of the credit cycle. Technical support factors, such as the resumption of
the CSPP, which will spur the hunt for yield, will also benefit HY markets from a technical
perspective, although this will be likely balanced by a deterioration in credit fundamentals, in
our view. European HY credit has rallied this year and, amid the flight to rating quality, the
spread dispersion in HY will likely continue in 2020. The spread dispersion is a sign that
investors are concerned about the weakening of economic fundamentals, rising downgrades
and the worsening of credit metrics. In terms of spread dispersion, there is less difference
between Europe and the US, but we see more downside risks in the US. To conclude, we see
considerable credit spread widening pressure in European HY (our spread forecast is 450bp
at FYE 2020, compared to the current level of 350bp), while a likely rise in default rates is
likely to penalize HY bond markets. We recommend investors take a selective and cautious
approach to HY credit and look for bonds that offer decent carry in European HY markets.
CHART 1: CHART 2:
OUR MACRO-CREDIT MODEL FOR EUROPEAN HY NFI EUROPEAN HY MARKETS: SPREAD DIVERGENCE BY RATING
iBoxx NFI HY (ls)

1200 -0.7% European High Yield BB European High Yield B B/BB ratio (rs)
12M fwd growth exp. (rs, inverted, shifted with a 2M lag) 1600 3
Consensus projection (rs)
1000 -0.2% 1400
Consensus growth exp. (12M fwd.)
UniCredit forecast (rs, 12M fwd growth, annualized qoq)

iBoxx NFI HY cum XO (bp)
1200 2.5
800 0.3%
Credit spread (bp)
1000
600 0.8%
800 2
400 1.3% 600

Spread forecast
200 1.8% 400 1.5
200
0 2.3%
Jan-09
Jan-08
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
Jan-19
Jan-20
Jan-21
0 1
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Source: Bloomberg, Markit iBoxx, UniCredit Research
In line with our macro-credit Given our expectation of a continued economic slowdown, we used our macro-credit model to
model, HY credit spreads are
likely to widen materially assess the spread widening pressure on European high-yield bonds. As shown in Chart 1, the
model depicts an inverse correlation of credit spreads with 12M forward consensus growth
expectations, while spreads have the tendency to react to changes earlier. This is why we
shifted growth expectations by two months. In the chart, we also show a projection of
consensus growth extended to 2021 (black dots) and our own growth forecast (dotted line).
Our projection assumes a continued weak economic growth environment in the eurozone of
0.8% (compared to expected average growth of 1.2% for the full-year 2019). This is in contrast

to the projected consensus growth expectations, which show a moderate rebound in growth
expansion to about 1.2% in 2020. Based on our own projection, credit spreads of European HY
would materially widen to around 600bp in 2020 given the economic environment.
Due to technical factors, Notwithstanding some widening pressure for HY due to the sluggish economic backdrop, there
however, our FYE 2020 spread
forecast for HY is 450bp are some technical factors that argue against such a dramatic shift compared to current levels
(the iBoxx HY NFI is 350bp). First, HY credit remains highly sought after given the low-yield
environment, considering the significant amount of negative-yielding bonds in IG markets.
Second, the resumption of the CSPP will strengthen the hunt for yield, which will also benefit HY
markets. Third, after this year’s supply rally (YTD new HY supply is up significantly, by 9.2%
yoy), we expect new issuance likely to ease somewhat in 2020, which will provide support to
secondary markets. The iBoxx HY is trading at 350bp, compared to this year’s peak of 450bp,
while the iTraxx Crossover, which has a different structure, is trading at 235bp (compared to its
YTD high of 370bp). Assuming that spreads move range bound until the end of 2019, settling at
350bp in HY, we set our end-2020 target for HY markets at 450bp.
HY credit For these reasons, we expect the yield change in HY to amount about 100bp. Considering an
and total-return projection
average duration of 4.2Y and current yield-to-worst of 3.5% for HY, this will result in a 12M
total return of 3.1% at end-2020. This is mainly due to the high carry in HY, which provides a
cushion against potential spread widening. However, the attractive return projections for HY
(in particular when compared to IG) have to be weighed against the greater default risk
present in the market (see below).
Due to less-than-bright Against the background of renewed demand for risky assets, European HY markets have
economic backdrop, we
recommend European HY performed strongly this year notwithstanding a weakening of fundamentals as European
investors remain selective, growth decelerates. Amid a flight to rating quality, the rally in HY markets has especially
preferring defensive sectors
benefited BB rated bonds, which significantly tightened this year, thereby outperforming B
rated bonds which narrowed less in relative terms. On the other hand, the lowest rating quality
of CCC rated bonds were in less demand as they widened YTD. Overall, credit spreads in HY
have diverged this year (Chart 2). Moreover, the hunt for safety in HY is also reflected in the
B/BB spread ratio differential of European corporate bonds, which has risen over the course
of the year (Chart 2) and is close to recent peaks. Notwithstanding the richening of BB rated
bonds, we think that BBs will be further supported by the introduction of the new CSPP. From
a tactical perspective, we even see spread-tightening potential for B rated bonds in the near
term as they have lagged behind in the recent spread rally. The near-term effect, however,
should diminish as the credit cycle moves forward and economic growth cools further. Given
the less-than-bright economic backdrop, however, we are sticking to our view that investors in
B rated bonds should remain selective and should show a preference for corporate debt from
less-cyclical sectors.
European and US HY A picture similar to that in Europe is becoming evident in the US HY market. The lowest rating
show similar patterns
but we see more downside risk category in the US HY universe, namely bonds from CCC rated companies, have significantly
factors in the US underperformed this year. US investors have also shifted their attention to higher-rated HY
bonds this year, as B and BB rated bonds have narrowed markedly, while investors have
slightly overweight exposure to B rated bonds in the US, compared to Europe. As a result,
differences in credit spreads among rating categories have also increased in the US. This is
also reflected in the drop in yields of higher-rated HY bonds in the European and US HY
market (Chart 3). However, high-yield credit overall remains a key part of the investment
strategy in Europe and the US as yield remains scarce in global bond markets. Nevertheless,
credit fundamentals are deteriorating, particularly in the US. This has mainly been driven by
an increase in the leverage ratios of US corporates, which could also spill over to European
HY markets as sentiment turns sour. Investors should be aware of this risk as we expect a
(mild) recession to materialize in the US in 2020, and such an economic slowdown could trigger
a substantial volume of downgrades of US corporates to non-investment grade.

CHART 4: EUROPEAN VS. US DEFAULTS: STARTING FROM

CHART 3: LOW LEVELS, EUROPEAN DEFAULTS WILL LIKELY RISE BUT
EUROPEAN VS. US YIELD DEVELOPMENT (YTW) SHOULD OUTPERFORM THOSE OF THE US
European High Yield BB European High Yield B US default rate US baseline forecast
US High Yield BB US High Yield B European default rate Europe baseline forecast
30
14%
12-month trailing default rate

25
12%
20 10%
Yield (%)
15 8%
6%
10
4%
5
2%
0 0%
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
Source: Bloomberg, ICE BofAML, Markit iBoxx, Moody’s, UniCredit Research
Defaults are on the rise, Default rates among European HY bond issuers also suggest a cautious and selective
in particular in the US
approach. So far, HY defaults have remained low by historical standards, comparable with
levels last seen prior to the financial crisis. Moody’s expects European defaults to remain low in
the near-term compared with rising defaults in the US (Chart 4). The agency also expects
European defaults to catch up to the US rate by end of 3Q20 (to 3.7%). In contrast to Moody’s
approach, however, we see a mildly superior performance in European defaults compared to
the US, which, in our view, is warranted by better economic circumstances in Europe next year
and the better shape in which European companies find themselves (Chart 4). A rising default
rate in Europe, is, however, largely not yet priced into HY markets.

CEEMEA Strategy
Solid performance amid hunt for yield
Dr. Stefan Kolek ■ EM hard-currency credit is facing headwinds from the global economic backdrop and the
EEMEA Corporate Credit
Strategist resulting sell off in equities that is expected to occur. However, the hunt for yield, this asset
(UniCredit Bank, Munich) class’s still-solid credit quality and its close correlation with USTs should provide support.
+49 89 378-12495
stefan.kolek@unicredit.de ■ The primary market should remain open for EM issuers, facilitating the refinancing of heavy
redemptions. In emerging Europe, we expect up to USD 50bn in new corporate issues.
We expect to see 5.4-5.8% We expect the yield on the JPM CEMBI index and its emerging European component to tighten
in total return on EM corporate
credit next year by 20-30bp (from currently 4.5% and 5%, respectively) by the end of the next year. This should
translate into total return of around 5.5% next year. This is less than half of the total return
generated YTD (11.9% and 15.1% respectively) and is slightly below the 6.4% average of the
past ten years. This asset class is facing headwinds from the global economic backdrop and the
resulting sell off in equities that is expected to occur. Nevertheless, these factors should be
counteracted by supportive factors: decent carry (which attracts “yield tourists” from crossover
investors amid dovish Fed and ECB policies), credit quality (which remains solid on balance), fair
valuations, high correlation with USTs and relatively low correlation with US HY credit. Our
preference remains oriented towards BBB and BB rated credit and credit from emerging Europe.
EM growth expected EM corporate credit spreads have recently become decoupled from global GDP growth
to accelerate, which would
be EM credit supportive (Chart 1). Easy financing conditions and yield hunting are behind a gap that is now larger than
it was during the ECB’s first round of quantitative easing (QE). While deteriorating global
growth has created headwinds for EM credit, we believe that the performance of the CEMBI
index will not be derailed. Our expectation of a slowdown of the global growth rate to 2.7%
from 3% should support credit-investor-friendly corporate policies and limit the risk that fallen
angels will emerge (the index includes only a minor share of BBB- rated issues on watch
negative). The large share of IG-rated names should attract crossover investors seeking yield.
Inflows into EM have recovered Risk aversion will likely prevail globally during the expected growth slowdown. However, the
and odds are in favor of
them continuing shallowness of the projected US recession and that the Fed is expected to cut rates to a greater
degree than expected should raise the chances that a meltdown in risk appetite and a sizable
repatriation of funds will be avoided. Given the hunt for yield, EM debt portfolios are likely to see
additional inflows. Inflows into EM debt have recovered since 2H18, and while they remain below
2017’s levels, they are still around levels seen in 2014 (during the Fed’s third round of QE). Most
inflows have been into Asian debt (Chart 2), which is largely IG-rated and tends to attract
crossover investors. Emerging European debt continues to be a capital-flow destination, although
inflows have resumed since September, mainly due to a recovery in sentiment towards Turkey.
CHART 1: GLOBAL GDP VS. JPM CEMBI SPREAD INDEX CHART 2: PORTFOLIO INFLOWS INTO EM DEBT
0 8 70.0 Africa & Middle East Emerging Europe
JPM CEMBI spread index (rev. ls) Global GDP Latin America Emerging Asia
6 60.0
200
12M moving average
50.0
4
400
40.0
2
USD bn
30.0
bp
600
0
20.0
800
-2 10.0
1000 0.0
-4
-10.0
1200 -6
Oct-03
Oct-10
Oct-17
May-04
Dec-04
Jul-05
Apr-07
May-11
Dec-11
Jul-12
Sep-13
Apr-14
Nov-14
Jul-19
Mar-03
Feb-06
Sep-06
Nov-07
Aug-09
Jun-08
Jan-09
Mar-10
Feb-13
Jun-15
Jan-16
Aug-16
May-18
Dec-18
Mar-17
-20.0
May-13
May-18
Apr-11
Oct-13
Nov-10
Jul-12
Apr-16
Oct-18
Dec-12
Nov-15
Jul-17
Dec-17
Aug-19
Jan-10
Jun-10
Sep-11
Mar-14
Aug-14
Feb-12
Jan-15
Jun-15
Sep-16
Feb-17
Mar-19
Source: Bloomberg, JPMorgan, IMF, International Institute of Finance, UniCredit Research

We expect USD 40-50bn The expected decent inflows into EM credit should help to absorb new bond supply, which is
in new issues from emerging
European issuers likely to remain strong also next year. USD 434bn of new issues have been placed by EM
corporates YTD, i.e. 23% more than in the same period last year. Next year, EM corporates face
USD 402bn (USD and EUR paper) of redemptions. Bond refinancing, bond calls, prefunding
2021 maturities (which we estimate at USD 350bn) and refinancing loans with bonds are drivers
expected to remain at work in the primary market also next year. At the same time, ample liquidity
coupled with appetite for EM credit risk should keep the primary market open. In emerging
Europe, corporates will redeem USD 33.6bn of bonds in 2020 and USD 30.0bn in 2021 (Chart 3),
which we expect to be refinanced. In addition, Russian corporates face USD 1bn in callable
bonds next year that could also be called and refinanced. All in all, in emerging Europe we expect
USD 40-50bn in new issues in 2020. Besides refinancing, we expect more inaugural paper from
Russian and CEE issuers switching bank loans into bonds (which will contribute to broader
diversification of the market). Moreover, the recent history of increased application of financial
sanctions by the US administration will likely lead EM issuers to diversify their funding sources.
We expect a higher share of euro-denominated issuance, particularly from Russian corporates.
Relative value We view EM corporate credit as fairly valued compared to US BB and BBB rated corporate
debt. As Chart 4 shows, the spread between EM and US BB HY debt is slightly above its two-
yield average and BBB rated EM corporate debt trades close to its two-year average spread
to BBB US corporates, which suggests fair pricing. This is important given the high relevance
of crossover investors, who are interested in particular in IG EM bonds. Given the expected
decline in UST yields, we recommend outright positioning in EM credit. However, we think the
performance will stem primarily from carry, with headwinds from the expected US recession
given the significant correlation between US and EM corporate debt.
Key risk factors include global The key risk to our benign view on EM credit is a deeper-than-expected US recession. In this
growth and US-China relations
context, however, we think within the index emerging European corporates should benefit from their
significant exposure to domestic and eurozone markets. A potential escalation in US-China
tensions could pose another risk, especially if it were to feature financial sanctions against
Chinese banks or corporates. As a result of Chinese corporates’ making up 25% of the JPM
CEMBI index, a deterioration in the fundamental backdrop of Chinese corporates could pose
a risk to EM credit. While we are aware of idiosyncratic risk factors stemming from individual
markets (e.g. Argentina’s debt restructuring), EM credit’s broad diversification limits spillover risk.
Bottom line The bottom line is that we see EM credit as being fairly valued and expect to see only some minor
spread tightening to the end of 2020 amid the hunt for yield, with return being driven by carry.
Headwinds stem from the expected sell-off in equities and a shallow recession in the US, though
emerging European credit should benefit on a relative-value basis. Our preference remains for BBB
and strong BB rated EM credit, which offer decent yield pickup coupled with solid credit metrics.
CHART 3: EM AND EMERGING EUROPEAN USD CHART 4: RELATIVE VALUE –

AND EUR REDEMPTIONS BBB AND BB RATED CORPORATES IN THE US AND EM
CEE Turkey Russia EM (rs) BBB EM vs. US corporate yield difference

80 450 180
BB EM vs. US corporate yield difference
400 160
70
140
350
60
120
300
50 100
USD bn
USD bn
bp
250
40 80
200 average yield difference
60
30
150 40
20
100 20
10 50 0
Nov-17
Nov-18
Jul-18
Jul-19
May-18
Sep-18
May-19
Mar-18
Mar-19
Sep-19
Jan-18
Jan-19
0 0
2020 2021 2022 2023
Source: Bloomberg, JPMorgan, Bank of America Merrill Lynch, UniCredit Research

November 2019
OutlookMacro & Markets Outlook
Table 1: Annual macroeconomics forecasts

Government budget balance General government debt Current account balance
GDP (%) CPI inflation (%)* Central Bank Rate (EoP) (% GDP) (% GDP) (% GDP)
2019 2020 2021 2019 2020 2021 2019 2020 2021 2019 2020 2021 2019 2020 2021 2019 2020 2021
World 3.0 2.7 3.2 - - - - - - - - - -
US 2.3 1.1 0.9 1.8 1.7 1.5 1.75 0.75 0.75 -4.7 -5.1 -4.8 106.9 109.0 110.9 -2.4 -2.1 -2.0
Eurozone 1.2 0.8 1.0 1.2 1.0 1.1 -0.50 -0.50 -0.50 -0.8 -1.0 -0.9 88.4 88.9 89.2 3.5 3.3 3.3
Germany 0.6** 0.7** 0.8** 1.4 1.4 1.5 - - - 1.0 -0.3 -0.3 59.7 58.7 57.7 7.7 7.3 7.5
France 1.3 1.0 1.1 1.1 1.1 1.2 - - - -3.1 -2.4 -2.2 99.0 99.7 100.0 -0.4 -0.5 -0.5
Italy 0.2 0.2 0.5 0.6 0.7 0.8 - - - -2.2 -2.3 -2.3 136.2 136.6 136.8 2.8 2.7 2.6
Spain 1.9 1.4 1.5 0.9 0.9 1.1 - - - -2.3 -2.2 -1.9 96.6 96.2 95.7 2.4 2.5 2.2
Austria 1.5 1.0 1.3 1.5 1.5 1.8 - - - 0.5 0.2 0.2 70.4 68.3 66.1 2.3 2.3 2.4
Greece 1.6 1.9 2.1 0.3 0.5 0.8 - - - 1.3 1.0 1.0 174.7 169.4 163.8 -0.9 -1.1 -0.8
Portugal 1.9 1.5 1.5 0.2 0.5 0.7 - - - -0.1 -0.1 0.2 119.4 117.2 114.1 -0.4 -0.5 -0.5
CEE
Poland 4.1 3.2 3.4 2.9 2.9 2.5 1.50 1.50 1.50 -1.2 -1.7 -2.0 46.8 45.9 45.5 -0.3 -1.0 -0.6
Czechia 2.4 1.9 2.0 2.8 2.5 2.1 2.00 1.75 1.50 0.0 -0.7 -1.2 30.8 30.1 30.1 1.0 1.4 1.5
Hungary 4.8 2.7 2.9 3.8 3.2 3.3 0.90 0.90 0.90 -1.8 -1.3 -2.0 67.7 66.2 65.7 -1.2 -0.8 -0.3
Russia 1.1 1.1 1.4 3.3 3.5 4.0 6.25 5.75 5.75 1.1 0.3 0.2 12.4 13.7 14.5 5.0 4.1 4.1
Turkey 0.3 2.2 3.1 11.7 9.6 8.9 12.0 10.0 10.0 -5.5 -5.1 -4.9 30.9 31.8 33.2 0.3 -1.5 -1.9
Other Europe
UK 1.3 0.8 0.9 1.8 1.3 1.5 0.75 0.00 0.00 -2.1 -3.0 -3.5 83.0 83.9 85.0 -4.5 -3.5 -3.0
Sweden 1.4 1.4 1.7 1.7 1.5 1.5 0.00 0.00 0.00 0.5 0.3 0.4 37.0 35.0 34.0 3.0 3.5 3.0
Norway 2.5*** 1.5*** 1.7*** 2.2 2.0 2.2 1.50 1.50 1.50 7.0 7.0 6.0 40.0 40.0 40.0 6.5 7.0 6.0
Switzerland 0.8 0.6 0.7 0.4 0.1 0.2 -0.75 -0.75 -0.75 0.6 0.4 0.5 40.5 39.8 38.9 9.7 9.1 9.3
Others
China 6.2 5.9 5.7 2.3 2.5 2.9 4.35 4.35 4.35 -6.0 -6.2 -6.1 55.0 59.0 65 1.0 0.9 0.7
Japan 0.9 0.2 0.7 0.6 1.0 0.4 -0.10 -0.10 -0.10 -3.0 -2.7 -2.5 238.0 237.0 237.0 3.3 3.3 3.2
*Annual averages, except for CEE countries, for which end-of-period numbers are used.**Non-wda figures. Adjusted for working days: 0.6% (2019), 0.3% (2020) and 0.8% (2021). Source: UniCredit Research
***Mainland economy figures. Overall GDP: 1.5% (2019), 1.2% (2020) and 1.5% (2021).

Table 2: Quarterly GDP and CPI forecasts

REAL GDP (% QOQ, SA)
3Q19 4Q19 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21 4Q21
US (annualized) 1.9 1.6 1.2 0.7 -0.2 -0.1 1.1 1.5 1.5 1.9
Eurozone 0.2 0.2 0.3 0.2 0.1 0.1 0.2 0.3 0.3 0.4
Germany 0.1 0.1 0.2 0.1 0.0 0.0 0.2 0.3 0.4 0.4
France 0.3 0.2 0.3 0.3 0.2 0.1 0.3 0.3 0.3 0.4
Italy 0.1 0.1 0.1 0.1 0.0 0.0 0.1 0.2 0.2 0.2
Spain 0.4 0.4 0.4 0.3 0.3 0.3 0.4 0.4 0.4 0.4
Austria 0.1 0.2 0.3 0.3 0.2 0.2 0.3 0.4 0.4 0.4
CEE
Poland (% yoy) 3.9 3.7 3.7 3.4 3.4 2.4 2.7 2.7 3.7 4.1
Czechia 0.3 0.0 0.6 0.7 0.6 0.6 0.3 0.4 0.6 0.6
Hungary (% yoy) 5.0 4.2 3.4 3.1 2.4 2.0 1.7 2.6 3.3 3.8
Russia 0.8 0.4 0.3 0.2 -0.1 -0.2 0.3 0.5 0.6 0.6
Turkey (% yoy) 1.0 3.7 3.0 2.3 2.1 1.7 2.0 2.6 3.0 4.4
Other Europe
UK 0.3 0.2 0.3 0.2 0.1 0.3 0.1 0.3 0.3 0.3
Sweden 0.4 0.4 0.4 0.4 0.3 0.3 0.4 0.5 0.5 0.6
Norway (mainland) 0.7 0.5 0.3 0.3 0.2 0.2 0.5 0.5 0.6 0.7
Switzerland 0.2 0.2 0.2 0.1 0.1 0.0 0.2 0.2 0.3 0.4
CPI INFLATION (% YOY)
3Q19 4Q19 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21 4Q21
US 1.8 2.0 2.2 1.9 1.5 1.2 1.3 1.4 1.5 1.6
Eurozone 1.0 1.0 1.3 0.9 0.8 0.9 0.9 1.1 1.3 1.2
Germany 1.4 1.3 1.7 1.5 1.2 1.2 1.3 1.5 1.7 1.6
France 1.0 1.0 1.3 1.1 1.0 1.0 1.0 1.2 1.3 1.3
Italy 0.4 0.4 0.6 0.7 0.6 0.7 0.6 0.7 0.8 0.9
Spain (HICP) 0.4 0.7 1.2 0.8 0.7 0.9 1.0 1.1 1.2 1.2
Austria 1.4 1.2 1.4 1.5 1.6 1.6 1.6 1.7 1.9 2.0
CEE
Poland (EoP) 2.6 2.9 3.6 2.5 2.9 2.9 2.4 2.3 2.3 2.5
Czechia 2.7 2.7 2.7 2.5 2.5 2.4 2.1 2.1 2.1 2.1
Hungary 2.8 3.8 3.8 3.4 3.2 3.2 2.9 3.1 3.1 3.3
Russia 4.0 3.3 2.7 2.8 3.3 3.5 3.5 3.5 3.8 4.0
Turkey 9.3 11.7 11.9 11.4 9.3 9.6 10.0 10.5 9.7 8.9
Other Europe
UK 1.8 1.5 1.5 1.3 1.3 1.2 1.3 1.4 1.5 1.6
Sweden 1.4 1.5 1.4 1.5 1.5 1.5 1.5 1.5 1.5 1.5
Norway 1.6 1.7 1.8 2.0 2.1 2.1 2.2 2.2 2.1 2.1
Switzerland 0.3 0.1 0.2 0.1 0.1 0.1 0.0 0.0 0.3 0.3
Source: UniCredit Research
Table 3: Oil forecasts

Current 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21 4Q21
Brent (USD/bbl, average) 62 63 58 53 55 55 58 58 58

Table 4: Comparison of annual GDP and CPI forecasts

GDP (%)
UniCredit IMF European Commission OECD

(Oct-19) (Nov-19) (Nov-19)
2019 2020 2021 2019 2020 2021 2019 2020 2021 2019 2020 2021
World 3.0 2.7 3.2 3.0 3.4 3.6 2.9 3.0 3.1 2.9 2.9 3.0
US 2.3 1.1 0.9 2.4 2.1 1.7 2.3 1.8 1.6 2.3 2.0 2.0
Eurozone 1.2 0.8 1.0 1.2 1.4 1.4 1.1 1.2 1.2 1.2 1.1 1.2
Germany 0.6* 0.7* 0.8* 0.5 1.2 1.4 0.4 1.0 1.0 0.6 0.4 0.9
France 1.3 1.0 1.1 1.2 1.3 1.3 1.3 1.3 1.2 1.3 1.2 1.2
Italy 0.2 0.2 0.5 0.0 0.5 0.8 0.1 0.4 0.7 0.2 0.4 0.5
Spain 1.9 1.4 1.5 2.2 1.8 1.7 1.9 1.5 1.4 2.0 1.6 1.6
Austria 1.5 1.0 1.3 1.6 1.7 1.6 1.5 1.4 1.4 1.5 1.3 1.3
Greece 1.6 1.9 2.1 2.0 2.2 1.7 1.8 2.3 2.0 1.8 2.1 2.0
Portugal 1.9 1.5 1.5 1.9 1.6 1.5 2.0 1.7 1.7 1.9 1.8 1.7
CEE
Poland 4.1 3.2 3.4 4.0 3.1 2.7 4.1 3.3 3.3 4.3 3.8 3.0
Czechia 2.4 1.9 2.0 2.5 2.6 2.6 2.5 2.2 2.1 2.6 2.1 2.3
Hungary 4.8 2.7 2.9 4.6 3.3 2.9 4.6 2.8 2.8 4.8 3.3 3.1
Russia 1.1 1.1 1.4 1.1 1.9 2.0 1.0 1.4 1.5 1.1 1.6 1.4
Turkey 0.3 2.2 3.1 0.2 3.0 3.0 0.3 3.1 3.5 0.3 3.0 3.2
Other Europe
UK 1.3 0.8 0.9 1.2 1.4 1.5 1.3 1.4 1.4 1.2 1.0 1.2
Sweden 1.4 1.4 1.7 0.9 1.5 2.1 1.1 1.0 1.4 1.4 1.2 1.2
Norway 2.5** 1.5** 1.7** 1.9 2.4 1.6 1.6 1.9 1.9 2.5 2.0 1.7
Switzerland 0.8 0.6 0.7 0.8 1.3 1.6 1.0 1.6 1.3 0.8 1.4 1.0
Others
China 6.2 5.9 5.7 6.1 5.8 5.9 6.1 5.8 5.6 6.2 5.7 5.5
Japan 0.9 0.2 0.7 0.9 0.5 0.5 0.9 0.4 0.6 1.0 0.6 0.7
CPI INFLATION (%)***
UniCredit IMF European Commission OECD

(Oct-19) (Nov-19) (Nov-19)
2019 2020 2021 2019 2020 2021 2019 2020 2021 2019 2020 2021
US 1.8 1.7 1.5 1.8 2.3 2.4 1.8 2.1 2.0 1.8 2.2 2.2
Eurozone 1.2 1.0 1.1 1.2 1.4 1.5 1.2 1.2 1.3 1.2 1.1 1.4
Germany 1.4 1.4 1.5 1.5 1.7 1.7 1.3 1.2 1.4 1.3 1.2 1.5
France 1.1 1.1 1.2 1.2 1.3 1.4 1.3 1.3 1.3 1.3 1.2 1.3
Italy 0.6 0.7 0.8 0.7 1.0 1.1 0.6 0.8 1.1 0.6 0.6 1.2
Spain 0.9 0.9 1.1 0.7 1.0 1.4 0.9 1.1 1.4 0.8 1.1 1.3
Austria 1.5 1.5 1.8 1.5 1.9 1.9 1.5 1.6 1.6 1.5 1.6 1.7
Greece 0.3 0.5 0.8 0.6 0.9 1.3 0.5 0.6 0.9 0.4 0.4 0.9
Portugal 0.2 0.5 0.7 0.9 1.2 1.3 0.3 1.1 1.4 0.3 0.5 1.0
CEE
Poland 2.9 2.9 2.5 2.4 3.5 3.4 2.2 2.6 2.5 2.3 2.9 2.8
Czechia 2.8 2.5 2.1 2.6 2.3 2.0 2.6 2.3 2.0 2.8 2.5 2.3
Hungary 3.8 3.2 3.3 3.4 3.4 3.3 3.4 3.1 3.0 3.3 3.4 4.1
Russia 3.3 3.5 4.0 4.7 3.5 3.9 4.5 3.7 4.0 4.9 4.0 4.0
Turkey 11.7 9.6 8.9 15.7 12.6 12.4 15.3 10.3 9.3 15.8 13.2 10.0
Other Europe
UK 1.8 1.3 1.5 1.8 1.9 2.0 1.8 2.0 2.2 1.9 2.0 1.8
Sweden 1.7 1.5 1.5 1.7 1.5 1.6 1.7 1.5 1.6 1.8 1.8 1.8
Norway 2.2 2.0 2.2 2.3 1.9 2.0 2.3 2.0 2.0 2.3 2.0 2.2
Switzerland 0.4 0.1 0.2 0.6 0.6 0.9 0.8 1.3 1.3 0.4 0.4 1.0
Others
China 2.3 2.5 2.9 2.3 2.4 2.8 - - - 2.5 2.2 1.9
Japan 0.6 1.0 0.4 1.0 1.3 0.7 0.5 1.1 0.7 0.6 1.1 1.2
*Non-wda figures. Adjusted for working days: 0.6% (2019), 0.3% (2020) and 0.8% (2021); **Mainland economy figures. Overall GDP: 1.5% (2019), 1.2% (2020) and 1.5% (2021);
***Annual averages, except for CEE countries, for which end-of-period numbers are used.
Source: IMF, European Commission, OECD, UniCredit Research

Table 5: FI forecasts
INTEREST RATE AND YIELD FORECASTS (%)
Current 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21 4Q21

EMU
Refi rate 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
Depo rate -0.50 -0.50 -0.50 -0.50 -0.50 -0.50 -0.50 -0.50 -0.50
3M Euribor -0.41 -0.40 -0.40 -0.40 -0.40 -0.40 -0.40 -0.40 -0.40
2Y Schatz -0.64 -0.60 -0.65 -0.70 -0.70 -0.60 -0.60 -0.50 -0.50
fwd -0.67 -0.67 -0.68 -0.67 -0.66 -0.65 -0.64 -0.62
5Y Obl -0.58 -0.55 -0.60 -0.70 -0.70 -0.60 -0.50 -0.35 -0.20
10Y Bund -0.35 -0.35 -0.40 -0.50 -0.50 -0.35 -0.20 0.00 0.20
fwd -0.31 -0.29 -0.26 -0.24 -0.22 -0.20 -0.18 -0.16
30Y Bund 0.18 0.15 0.05 -0.10 -0.10 0.10 0.25 0.50 0.70
2/10 29 25 25 20 20 25 40 50 70
2/5/10 -18 -15 -15 -20 -20 -25 -20 -20 -10
10/30 52 50 45 40 40 45 45 50 50
2Y EUR swap -0.34 -0.30 -0.35 -0.40 -0.40 -0.30 -0.30 -0.20 -0.20
5Y EUR swap -0.23 -0.20 -0.25 -0.35 -0.35 -0.25 -0.15 0.00 0.15
10Y EUR swap 0.07 0.00 -0.10 -0.25 -0.25 -0.05 0.15 0.35 0.55
US
Fed Fund 1.75 1.50 1.25 1.00 0.75 0.75 0.75 0.75 0.75
3M Libor 1.89 1.40 1.15 0.90 0.75 0.75 0.80 0.85 0.85
2Y UST 1.57 1.40 1.20 1.10 1.00 1.05 1.15 1.20 1.30
fwd 1.58 1.58 1.58 1.59 1.59 1.59 1.59 1.59
5Y UST 1.58 1.50 1.40 1.35 1.30 1.45 1.60 1.80 2.00
10Y UST 1.74 1.70 1.60 1.55 1.50 1.70 1.90 2.20 2.50
fwd 1.78 1.81 1.83 1.85 1.88 1.90 1.92 1.94
30Y UST 2.20 2.20 2.10 2.10 2.05 2.25 2.40 2.70 3.00
2/10 16 30 40 45 50 65 75 100 120
2/5/10 -15 -10 0 5 10 15 15 20 20
10/30 46 50 50 55 55 55 50 50 50
2Y USD swap 1.56 1.50 1.30 1.25 1.15 1.20 1.30 1.35 1.45
10Y USD swap 1.63 1.65 1.55 1.55 1.50 1.70 1.90 2.20 2.50
UK
Key rate 0.75 0.50 0.25 0.00 0.00 0.00 0.00 0.00 0.00
Spreads Current 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21 4Q21
10Y UST-Bund 208 205 200 205 200 205 210 220 230
10Y BTP-Bund 155 125 135 150 150 150 150 150 150
10Y EUR swap-Bund 42 35 30 25 25 30 35 35 35
10Y USD swap-UST -11 -5 -5 0 0 0 0 0 0

Table 6: FX forecasts
EUR Current 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21 4Q21
G10
EUR-USD 1.11 1.13 1.14 1.15 1.16 1.16 1.17 1.18 1.18
EUR-CHF 1.10 1.11 1.12 1.13 1.13 1.13 1.14 1.15 1.15
EUR-GBP 0.86 0.87 0.87 0.86 0.86 0.85 0.85 0.85 0.84
EUR-JPY 120 124 123 122 122 122 122 122 120
EUR-NOK 10.14 10.00 9.95 9.90 9.85 9.80 9.75 9.70 9.65
EUR-SEK 10.69 10.55 10.50 10.45 10.40 10.35 10.30 10.25 10.20
EUR-AUD 1.62 1.66 1.70 1.74 1.78 1.73 1.70 1.66 1.62
EUR-NZD 1.72 1.79 1.84 1.89 1.93 1.87 1.83 1.79 1.74
EUR-CAD 1.47 1.49 1.53 1.55 1.58 1.55 1.54 1.53 1.51
EUR-TWI 96.8 99.1 99.3 99.6 99.9 99.9 100.7 101.0 101.0
CEEMEA & CHINA
EUR-PLN 4.29 4.32 4.30 4.29 4.30 4.29 4.35 4.30 4.30
EUR-HUF 333 332 327 333 335 328 332 336 340
EUR-CZK 25.6 25.5 25.5 25.5 25.4 25.4 25.4 25.3 25.3
EUR-RON 4.78 4.83 4.84 4.82 4.85 4.92 4.93 4.92 4.95
EUR-TRY 6.33 6.45 6.56 6.84 7.17 7.32 7.46 7.61 7.76
EUR-RUB 70.8 74.8 76.3 78.0 79.3 80.9 82.1 83.1 83.1
EUR-ZAR 16.4 16.7 16.8 16.9 16.9 16.9 17.0 17.1 17.0
EUR-CNY 7.78 7.97 7.98 7.99 8.00 8.06 8.19 8.26 8.32
USD Current 1Q20 2Q20 3Q20 4Q20 1Q21 2Q21 3Q21 4Q21
G10
EUR-USD 1.11 1.13 1.14 1.15 1.16 1.16 1.17 1.18 1.18
USD-CHF 0.99 0.98 0.98 0.98 0.97 0.97 0.97 0.97 0.97
GBP-USD 1.29 1.30 1.31 1.33 1.35 1.36 1.37 1.39 1.40
USD-JPY 108 110 108 106 105 105 104 103 102
USD-NOK 9.16 8.85 8.73 8.61 8.49 8.45 8.33 8.22 8.18
USD-SEK 9.66 9.34 9.21 9.09 8.97 8.92 8.80 8.69 8.64
AUD-USD 0.68 0.68 0.67 0.66 0.65 0.67 0.69 0.71 0.73
NZD-USD 0.64 0.63 0.62 0.61 0.60 0.62 0.64 0.66 0.68
USD-CAD 1.33 1.32 1.34 1.35 1.36 1.34 1.32 1.30 1.28
USTW$ 92.4 91.4 91.3 90.8 90.5 89.9 89.0 87.9 87.3
DXY 97.9 96.6 95.8 95.0 94.2 93.9 93.1 92.2 91.8
CEEMEA & CHINA
USD-PLN 3.88 3.82 3.77 3.73 3.71 3.70 3.72 3.64 3.64
USD-HUF 301 294 287 290 289 283 284 285 288
USD-CZK 23.1 22.6 22.4 22.2 21.9 21.90 21.70 21.40 21.40
USD-RON 4.31 4.27 4.25 4.19 4.18 4.24 4.21 4.17 4.19
USD-TRY 5.71 5.71 5.75 5.95 6.18 6.31 6.38 6.45 6.58
USD-RUB 64.0 66.2 66.9 67.8 68.4 69.7 70.2 70.4 70.4
USD-ZAR 14.79 14.75 14.70 14.65 14.60 14.55 14.50 14.45 14.40
USD-CNY 7.03 7.05 7.00 6.95 6.90 6.95 7.00 7.00 7.05
Forecasts are end-of-period Source: Bloomberg, UniCredit Research

Table 7: Risky assets forecasts

EQUITY AND CREDIT FORECASTS
Current Mid-2020 End-2020

Equities
Euro STOXX 50 3680 3400 3850
DAX 13150 12000 14000
MSCI Italy 63 58 67
Credit
iBoxx Non-Financials Senior 55 60 60
iBoxx Financials Sen 54 60 60
iBoxx High Yield NFI 350 400 450
Source: Bloomberg, Markit iBoxx, UniCredit Research

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District, Bucharest, Romania
l) UniCredit Bank AG New York Branch (UniCredit Bank, New York), 150 East 42nd Street, New York, NY 10017. Regulatory authority: “BaFin“ – Bundesanstalt für
Finanzdienstleistungsaufsicht, Marie-Curie-Str. 24-28, 60439 Frankfurt, Germany and New York State Department of Financial Services, One State Street, New York, NY 10004-1511
Further details regarding our regulatory status are available on request.
ANALYST DECLARATION
The analyst’s remuneration has not been, and will not be, geared to the recommendations or views expressed in this report, neither directly nor indirectly.
All of the views expressed accurately reflect the analyst’s views, which have not been influenced by considerations of UniCredit Bank’s business or client relationships.
POTENTIAL CONFLICTS OF INTERESTS
You will find a list of keys for company specific regulatory disclosures on our website https://www.unicreditresearch.eu/index.php?id=disclaimer.
RECOMMENDATIONS, RATINGS AND EVALUATION METHODOLOGY
You will find the history of rating regarding recommendation changes as well as an overview of the breakdown in absolute and relative terms of our investment ratings, and a note on the
evaluation basis for interest-bearing securities on our website https://www.unicreditresearch.eu/index.php?id=disclaimer and https://www.unicreditresearch.eu/index.php?id=legalnotices.
ADDITIONAL REQUIRED DISCLOSURES UNDER THE LAWS AND REGULATIONS OF JURISDICTIONS INDICATED
You will find a list of further additional required disclosures under the laws and regulations of the jurisdictions indicated on our website
https://www.unicreditresearch.eu/index.php?id=disclaimer.
E 19/3
UniCredit Research page 78

UniCredit Research* Macro & Strategy Research
Erik F. Nielsen Dr. Ingo Heimig

Group Chief Economist Head of Research Operations
Global Head of CIB Research & Regulatory Controls
+44 207 826-1765 +49 89 378-13952
erik.nielsen@unicredit.eu ingo.heimig@unicredit.de
Marco Valli
Chief European Economist
+39 02 8862-0537
marco.valli@unicredit.eu
European Economics Research

Dr. Loredana Federico Stefan Bruckbauer
Dr. Andreas Rees Chief Italian Economist Chief Austrian Economist Daniel Vernazza, Ph.D. Tullia Bucco
Chief German Economist +39 02 8862-0534 +43 50505-41951 Chief International Economist Economist
+49 69 2717-2074 loredanamaria.federico@ stefan.bruckbauer@ +44 207 826-7805 +39 02 8862-0532
andreas.rees@unicredit.de unicredit.eu unicreditgroup.at daniel.vernazza@unicredit.eu tullia.bucco@unicredit.eu
Edoardo Campanella Walter Pudschedl Dr. Thomas Strobel

Economist Economist Chiara Silvestre Economist
+39 02 8862-0522 +43 50505-41957 Economist +49 89 378-13013
edoardo.campanella@unicredit.eu walter.pudschedl@unicreditgroup.at chiara.silvestre@unicredit.eu thomas.strobel@unicredit.de
EEMEA Economics Research

Dan Bucşa
Chief CEE Economist
+44 207 826-7954
FI Strategy Research
Michael Rottmann Dr. Luca Cazzulani Francesco Maria Di Bella Chiara Cremonesi Kornelius Purps
Head Deputy Head FI Strategist FI Strategist FI Strategist
+49 89 378-15121 +39 02 8862-0640 +39 02 8862-0850 +44 207 826-1771 +49 89 378-12753
michael.rottmann1@unicredit.de luca.cazzulani@unicredit.eu francescomaria.dibella@unicredit.eu chiara.cremonesi@unicredit.eu kornelius.purps@unicredit.de
Credit Strategy Research

Holger Kapitza Dr. Stefan Kolek
Credit & High Yield Strategy EEMEA Corporate Credits &
+49 89 378-28745 Strategy
holger.kapitza@unicredit.de +49 89 378-12495
stefan.kolek@unicredit.de
Equity Strategy Research FX Strategy Research Cross Asset Strategy Research
Christian Stocker, CEFA Roberto Mialich Elia Lattuga

Lead Equity Sector Strategist FX Strategist Deputy Head of Strategy Research
+49 89 378-18603 +39 02 8862-0658 Cross Asset Strategist
christian.stocker@unicredit.de roberto.mialich@unicredit.eu +44 207 826-1642
elia.lattuga@unicredit.eu
UniCredit Research, Corporate & Investment Banking, UniCredit Bank AG, Am Eisbach 4, D-80538 Munich, globalresearch@unicredit.de
M/S 19/5+DB
Bloomberg: UCCR, Internet: www.unicreditresearch.eu
*UniCredit Research is the joint research department of UniCredit Bank AG (UniCredit Bank, Munich or Frankfurt), UniCredit Bank AG London Branch (UniCredit Bank, London), UniCredit Bank AG Milan Branch
(UniCredit Bank, Milan), UniCredit Bank AG Vienna Branch (UniCredit Bank, Vienna), UniCredit Bank Austria AG (Bank Austria), UniCredit Bulbank, Zagrebačka banka d.d., UniCredit Bank Czech Republic and
Slovakia,ZAO UniCredit Bank Russia (UniCredit Russia), UniCredit Bank Romania.
UniCredit Research page 79

Unicredit Macromarkets 2020-21

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November 2019

Macro Research 21 November 2019

Link to webcast Link to presentation

4 Global Macro Outlook: Late-cycle blues

13 US: A mild recession in 2H20, slightly delayed

18 Eurozone: Domestic resilience set to fade

33 CEE: Outlook shaped by external risks

38 United Kingdom: Persistent Brexit uncertainties, sluggish growth

43 Oil: Brent prices to remain weak

44 Cross Asset Strategy: Prefer fixed income as a US recession nears

56 FX Strategy: The absence of major FX trends is likely to continue

61 Equity Strategy: Downside risks to prevail, particularly in 1H20

70 CEEMEA Strategy: Solid performance amid hunt for yield

72 Table 1: Annual macroeconomics forecasts

Editorial deadline: 20 November 2019, 18:00 CET

UniCredit Research page 2 See last pages for disclaimer.

UniCredit Research page 3 See last pages for disclaimer.

Global Macro Outlook

Source: Bloomberg, IMF, UniCredit Research

UniCredit Research page 4 See last pages for disclaimer.

UniCredit Research page 5 See last pages for disclaimer.

China credit impulse (% of GDP, advanced 9M) 3.0

Primary balance (% of GDP)

3. Current economic conditions

UniCredit Research page 6 See last pages for disclaimer.

Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17 Jan-19

Source: BLS, Bundesbank, Eurostat, OECD, ONS, UniCredit Research

UniCredit Research page 7 See last pages for disclaimer.

UniCredit Research page 8 See last pages for disclaimer.

US tariff shock depends on

In % Auto exports to the US, in USD bn (2017)

Source: WTO, IMF, UniCredit Research

UniCredit Research page 9 See last pages for disclaimer.

Auto Services Machinery Pharma Chemical ICT

Source: OECD, Ifo, UniCredit Research

UniCredit Research page 10 See last pages for disclaimer.

Impact on the eurozone economy if the US avoids a recession

UniCredit Research page 11 See last pages for disclaimer.

Impact of a China hard landing on world and eurozone growth

CHINA’S HIGH LEVERAGE POSES RISKS ASSESSING THE GROWTH SPILLOVERS

China Thailand Japan United States Spain

Source: Bank for International Settlements, UniCredit Research

UniCredit Research page 12 See last pages for disclaimer.

CHART 1: RUNNING ON A SINGLE GROWTH ENGINE CHART 2: MANUFACTURING ACTIVITY IS WEAK

Source: BEA, Federal Reserve, ISM, UniCredit Research

UniCredit Research page 13 See last pages for disclaimer.

2,000 1,000 4.0 2.5

-2,000 -1,000 0.0 1.5

Source: BLS, UniCredit Research

UniCredit Research page 14 See last pages for disclaimer.

Source: BEA, Bloomberg, UniCredit Research

UniCredit Research page 15 See last pages for disclaimer.

NBER recession within 1Y within 2Y within 3Y

Source: BIS, UniCredit Research

UniCredit Research page 16 See last pages for disclaimer.

FOMC members' median projection (September 2019)

6/89 9/92 40 9.75 3.00 6.75 YES 2.00

Source: Bloomberg, Federal Reserve, UniCredit Research

UniCredit Research page 17 See last pages for disclaimer.

Source: Eurostat, UniCredit Research

UniCredit Research page 18 See last pages for disclaimer.

Capex (% of GDP) Savings rate (%)

Source: Eurostat, UniCredit Research