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Allianz Investment Management LLC 2020 Market Outlook

2020 FORECAST SUMMARY:

While we’re not expecting continued outsized asset class returns again in 2020, the Fed has set the table with their “mid-cycle” adjustment to extend the current expansion of the U.S. economy. The 75 basis points of insurance rate cuts that the Fed carried out in 2019 is likely to offset any moderation of growth resulting from fading fiscal stimulus. In this context, we expect real GDP in the U.S. economy to hover somewhere close to two percent. Additionally, with most of the heavy lifting completed by the Fed last year, we expect policy rates to remain on hold for an extended period of time. The bar is set high for the Fed to change policy rates in either direction and we don’t envision a change in policy stance absent a material change to the economic outlook. The economic backdrop should remain supportive and the tight labor market will likely fuel the consumption driven economy and put marginal upward pressure on inflation, which is already starting from a low base. In turn, the 10-year Treasury yield has the potential to move marginally higher, but is likely to remain range-bound for most of the year. Rate cuts from the Fed have pushed the yield curve out of inversion, but it would require a lift in global rates to see the yield curve steepen materially from here. We have witnessed some de-escalation of trade tensions between the U.S. and China, but disruptions to global supply chains is still a key risk going into next year. In addition, the U.S. election in the second half of 2020 has the potential to disrupt the economy should there be a decline in CEO confidence. Overall, heading into 2020 we are cautiously optimistic with the state of the economy as recent Fed easing, positive rhetoric on global trade, and a well-equipped consumer creates a path to extend the current expansion beyond what was previously thought.

1

US GDP GROWTH: U.S. economy continues to grow with real GDP between 1.60% to 2.10%.

Growth has undoubtedly slowed in 2019, but the proverbial effects from global trade tensions were not as pronounced in the U.S. as some of the other developed economies. Much of the strength in the U.S. economy has been delivered from solid consumer spending and heading into 2020 the outcome isn’t likely to be much different. U.S. GDP is poised to end 2019 slightly above 2%, and given the solid economic backdrop, particularly with the health of the labor market, we are expecting 2020 to be fairly similar as the economy extends the expansion we are currently in. The narrative for most of 2019 was focused on trade and the slowing of global growth as traditional supply chains were disrupted and uncertainty weighed on business investment. Now that trade tensions have begun to ease and manufacturing PMIs have turned the corner, a gradual uptick in global growth could support growth domestically. However, downside risks still remain with regards to trade and geopolitics. On balance, we expect growth in the U.S. economy to continue around a trend pace of 2%, but we remain cognizant of the late-cycle risks that pose a threat to the prolonged expansion.

2

FED FUNDS: Fed is unlikely to change policy rates and Fed funds will remain in the range of 1.50% to 1.75%.

Despite differing opinions on the course of monetary policy among Fed officials in 2019, there seems to be a consensus formed by most members to leave policy rates unchanged in 2020. Commentary from Fed officials set the tone as Powell has stated, “Monetary policy is in a good place,” and most other officials agree that the current stance of monetary policy is “appropriate.”  The “mid-cycle adjustment” is complete and now it’s time for the Fed to sit back and assess the landscape as the economy unfolds. Furthermore, market participants are pricing in just shy of one 25 basis point cut in the Fed funds futures market. Given that downside risks slightly outweigh the risks to the upside, it seems appropriate investors are only pricing in a partial cut in the market. Therefore, with the goal of attempting to “sustain the economic expansion” through a series of rate cuts done last year, we don’t expect any changes to the Fed funds rate in the coming year. 

3

INFLATION: (Core PCE) to remain subdued within a range of 1.50% to 2.00%.

Inflation has been a difficult topic, especially for policymakers, as external forces like demographics, low productivity, and higher levels of debt have kept inflationary pressures muted for some time. Next year won’t be any different and we suspect the topic of inflation targeting will be one the Fed will debate very intensely. Against the backdrop of a tightening labor market, an economy growing at trend and robust consumption, we expect inflation to drift back towards the Fed’s 2% target. However, due to the headwinds mentioned above, we don’t expect inflation to move out of our expected range of 1.50% to 2.00%.

4

10-YEAR TREASURY to end 2020 within a range of 1.50% to 2.00%.

Regarding interest rates, 2019 delivered a large downward shift in yields, which was mostly induced by the Fed’s 75 basis points of easing. The yield curve moved out of inversion as a result and rates have been mostly range-bound towards the end of the year. Progress on trade negotiations with China have helped reduce anxiety among investors and yields appear to have formed a bottom in the fourth quarter of 2019. Looking ahead, with a Fed expected to be on the sidelines and global rates continuing to anchor U.S. rates, we are not expecting much change in the overall level of interest rates in 2020. The bottom line is that risks are still weighted towards the downside with the potential for trade-related flare-ups and geopolitics to weigh on rates. While 10-year yields have the potential to drift above 2%, we are expecting the 10-year Treasury yield to end 2020 within a range of 1.50% to 2.00%.

5

EQUITY RETURNS: Equity returns will likely be modest after a strong 2019 and will range between 0.0% to 5.0%.

It was a banner year for U.S. equities in 2019 with major equity indices like the S&P 500® showing the best performance since 2013. Unfortunately, we don’t anticipate 2020 will produce similar results. However, with the tide shifting on global trade and recession fears tamed for the moment, 2020 should bring modest gains for equities. Equity valuations are elevated with an S&P 500 forward 1 Year P/E multiple near 18x. Consumer spending is likely going to be the driver of growth next year and tight labor market conditions coupled with a rising wage environment should give the consumer the means to spend. While rising wages are likely to bolster consumption, elevated wage growth could be a headwind for corporate profits. Earnings are expected to grow modestly next year and against this backdrop we would envision mid-single digit equity returns in 2020. With that said, there are potential uncertainties that pose a risk to our outlook on equities. First, the trade war with China has been de-escalating, but if this narrative were to reverse this would weigh on equity performance. Additionally, with the election looming any signs of an incumbent loss would lead to significant volatility for stocks. Overall, our expectation for equities next year is fairly benign, but with some uncertainties lying ahead with U.S. politics remaining a significant variable.

6

MARKET VOLATILITY: Volatility is expected to pick up in 2H of 2020 as the election cycle heats up.

Market volatility in the equity market was less impressive in 2019 when compared to the equity rout witnessed in December of 2018. Surprisingly, this lack of volatility occurred in the face of rising uncertainty and fears of recession as tariffs with China continued to increase. Fortunately, the Fed instilled a supportive tone into the market and lowered policy rates as a result. This year will likely be different as the Fed will be on the sidelines and market participants will be vulnerable to the ongoing risks, including global geopolitics, trade, and the U.S. election. As such, we suspect equity market volatility will likely remain fairly subdued during the first half of 2020 and begin to pick up in conjunction with the U.S. election cycle.

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KEY RISKS TO FORECAST

Our base case for 2020 calls for moderate economic growth, inflation, and 10-Year U.S. Treasury yields staying relatively range bound, the Fed holding steady on interest rates, and lower equity returns. Our expectation is that this environment keeps the current cycle intact. However, we acknowledge that there are numerous risks that could emerge during the year to derail our forecast. Unforeseen geopolitical shocks or an escalation in the trade situation remain key risks. The U.S. election could produce elevated volatility should a far left presidential nominee gain momentum ahead of November. This scenario could result in an unexpected increase in inflation if Democrats control both the House and presidency. The fading tax stimulus in the U.S. will put further pressure on corporate earnings growth, which could affect equity valuations. While we are not predicting these events to take place in 2020, we are mindful of the risks that lurk in the current environment.

The views expressed above reflect the views of Allianz Investment Management LLC, as of 01/2020. These views may change as market or other conditions change. This report is not intended and should not be used to provide financial advice and does not address or account for an individual's circumstances. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Allianz Investment Management LLC is a registered investment advisor that is a wholly owned subsidiary of Allianz Life Insurance Company of North America. Allianz Life Insurance Company of New York is also a wholly owned subsidiary of Allianz Life Insurance Company of North America.


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