1

Global Economic Prospects

October 2014

Christopher J Probyn

Chief Economist

2

Global

• We expected 2014 to be “a year of improvement”

• But that has not happened:

–The US had a bad first quarter

–Japan had a bad second quarter

–The Eurozone lost momentum prematurely

• Now it seems that 2014 will be “more of the same”

• Real improvement will have to wait until 2015…

• … With geopolitical events skewing the risks to the downside

3

'70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14-1

0

1

2

3

4

5

6

7

Pe

rce

nt

Sources: IMF, SSgA Economics Team

World GDP Growth

World GDP, % chg y/ySSgA Economics Team Forecast

Average Historical Growth Rate (3.6%)

Global Global

4

Global Developing Economies

'10 '11 '12 '13 '14 '153

3.5

4

4.5

5

5.5

6

6.5

7

7.5

8

Pe

rce

nt

Forecast

Sources: Oxford Economics & SSgA Economics

Developing Economies GDP Growth with Forecast

Developing Economies GDP (ppp weights), % chg y/y

5

Global Advanced Economies

'10 '11 '12 '13 '14 '151.2

1.4

1.6

1.8

2

2.2

2.4

2.6

2.8

3

3.2

Pe

rce

nt

Sources: Oxford Economics & SSgA Economics

Advanced Economies GDP Growth with Forecast

Advanced Economy GDP (ppp weights), % chg y/y

6

US

• Fiscal drag was so much smaller in 2014 than 2013 that growth

was expected to accelerate quite markedly

• Unfortunately, all the “kick” from the reduction of fiscal drag was

offset by the first-quarter contraction

• So, this year will look a lot like last year

• But there are grounds for optimism about next year

7

Global US

'07 '08 '09 '10 '11 '12 '13 '14 '15-3

-2

-1

0

1

2

3

4

Pe

rce

nt

Forecast

Sources: Oxford Economics, SSgA Economics Team

US GDP Growth with Forecast

US Real GDP, % chg y/y

8

US

• Fiscal drag will be reduced further

–This should add about 0.5 percentage point to GDP growth in 2015

• Private-sector fundamentals appear solid

–Consumer fundamentals are generally strong

–Housing has picked up

–Capital spending has revived

– International trade is recovering

• Recent data have been strong

–Employment and unemployment insurance claims

–Manufacturing and non-manufacturing ISM

–Consumer confidence

–Light vehicle sales

9

US

'06 '07 '08 '09 '10 '11 '12 '13 '148

9

10

11

12

13

14

15

16

17

18

Mill

ion

s

Sources: Dept of Commerce & NBER

US Vehicles Sales

US Light Vehicle Sales, number of units at annual rateRecession Periods - United States

10

US

• Recent data suggest that the pick-up in the second quarter is

continuing into the third

• Indeed, we expect growth to average around 3.0% over the next

six quarters

• This also seems to be in line with Fed thinking, and explains the

ongoing reduction of monetary accommodation

• Tapering will end in October

• And policy rates will begin rising around mid-2015

• The exact timing and pace of tightening will be data dependent

11

US

• We do not see any real danger in this approach:

–There is no sign of wage inflation

–There is some slack left in the labor market

(Latest research suggests “true” unemployment is around 7.0% not 6.1%)

–The unemployment rate fell to around 4.0% in both 2000 and 2007 without

much impact on inflation

• Hence, the Fed should continue to focus on growth and not

worry about inflation

12

US

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '141

1.5

2

2.5

3

3.5

4

4.5

Pe

rce

nt

Source: BLS

US ECI, Wages and Salaries

US Employment Cost Index, Wages and Salaries, % y/y

13

Japan

• In 2013, the government embarked on aggressive policy

stimulus to speed up growth and end deflation:

–Fiscal package

–BoJ adoption of a formal 2.0% inflation target

–Large quantitative easing program

–Proposed structural reforms

• Financial markets adjusted rapidly, with the yen depreciating

and the Nikkei soaring, and growth and inflation accelerated

• A casual glance suggested that Abenomics was working, but…

–The pick-up of inflation reflected the effects of the lower exchange rate,

which are temporary rather than permanent

–The pick-up of growth reflected the effects of a fiscal stimulus package,

which faded as the year went on

14

Japan

• In 2014, the economy has not done so well:

–The consumption tax (VAT) hike that was enacted on April 1 this year sent

the economy into a tailspin

–And it is having difficulty regaining traction

• While the economy should ultimately prove resilient, and growth

will resume it is unlikely to exceed 0.8% in 2014

• Moreover, with another VAT hike scheduled for October next

year, we expect growth to accelerate to just above 1.0% in 2015

15

Japan

08 09 10 11 12 13-5

-4

-3

-2

-1

0

1

2

3

Pe

rce

nt

AbenomicsBegins

Source: Japan's Cabinet Office

Japan's Real GDP Growth

Japan's Real GDP, sa, quarter over quarter

16

Japan

'08 '09 '10 '11 '12 '13 '14-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Pe

rce

nt

©FactSet Research Systems

Japanese Inflation

Japan CPI, % chg y/yJapan CPI, excluding food and energy, % chg y/yJapan CPI, excluding fresh food (core), % chg y/y

Official Target

17

Japan

• Will Abenomics work?

• There are two goals:

–Speed up growth

–End deflation

• Success on speeding up the underlying growth rate of the

economy depends on structural reforms… and the commitment

to these remains unclear

• Inflation has accelerated

– But only because of one-off effects

– However, the unemployment rate is at a level where this acceleration

could be sustained… if wages pick-up

18

Eurozone

• In the Eurozone, the recovery is distinctly lackluster

• Indeed, growth stalled in the second quarter, and is only likely to

reach about 0.8% this year and 1.3% next year

• There is continued divergence between members preventing

robust growth for the region as a whole

• The labor market is chronically weak

• Inflation is too low and trending even lower

• The ECB is easing, but private sector credit is still contracting

19

Eurozone

'07 '08 '09 '10 '11 '12 '13 '14 '15-5

-4

-3

-2

-1

0

1

2

3

4

Pe

rce

nt

Forecast

Sources: Oxford Economics, SSgA Economics Team

Eurozone GDP Growth with Forecast

Eurozone Real GDP, % chg y/y

20

Eurozone

'07 '08 '09 '10 '11 '12 '13 '14 '157

8

9

10

11

12

13

14

Pe

rce

nt

Forecast

Sources: Oxford Economics, SSgA Economics Team

Eurozone Unemployment with Forecast

Eurozone Unemployment Rate

21

'06 '07 '08 '09 '10 '11 '12 '13 '14-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Pe

rce

nt

Source: FactSet Research Systems

Eurozone CPI and Core CPI

CPI ex. energy, food, alcohol and tobacco, % chg y/y CPI, % chg y/y ECB Target Rate (2.0%)

Eurozone

22

Eurozone

'06 '07 '08 '09 '10 '11 '12 '13 '14-4

-2

0

2

4

6

8

10

12

14P

erc

en

t

Source: ECB

Eurozone Credit Growth

Eurozone Credit to Private Sector, % chg y/y

23

Eurozone

• In addition, the region has serious structural flaws

• Competitiveness and economic performance are diverging and

the problem seems set to persist

–Nominal exchange rates are locked

– Internal devaluations are not working

–Fiscal transfers to compensate for competitive differences are not part of

the current structure

24

Eurozone

'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '1495

100

105

110

115

120

125

130

135

140

Re

-in

de

xe

d: Q

1 1

99

9 =

10

0

Source: Eurostat

GDP Price Deflators: Eurozone Core

Italy GDP Price DeflatorGermany GDP Price Deflator

France GDP Price Deflator

25

Eurozone

'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '1470

80

90

100

110

120

130

Ind

ex, Ja

n. 1

99

9 =

10

0

Sources: Bundesbank, INSEE, ISTAT

Industrial Production: Eurozone Core

German Industrial ProductionFrench Industrial Production

Italian Industrial Production

26

Eurozone

• The policy prescriptions employed so far have focused on the

adjustment of the uncompetitive countries through fiscal restraint

and structural reform

• But, it is important that both competitive and uncompetitive

countries adjust:

–While it would be difficult to persuade Germany to boost inflation to

become less competitive, there is a strong argument for boosting its

domestic demand

–This would be an alternative way to lower the country’s trade surplus with

other Eurozone members and thereby reduce the potential for unstable

capital flows

27

'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14100

150

200

250

300

350

Eu

ro B

illio

ns (

ch

ain

ed

20

00

)

Source: Eurostat

German Exports vs Household Spending

German Real Exports of Goods & ServicesGerman Real Household Consumption Expenditures

Eurozone

28

Eurozone

'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '1420

40

60

80

100

120

140

EU

R B

illio

ns

Source: German Bundesbank

German Trade With Other Eurozone Members

German Merchandise Trade Balance with Other Eurozone Members

29

Financial Markets

• US and Eurozone markets are decoupling because:

– Geopolitical tensions—especially Ukraine—are seen as a greater threat to

Europe than the US

– The Eurozone recovery has stalled, while the US recovery has regained

momentum

– US inflation is 2.0% and stable, while Eurozone inflation is 0.3% and

trending lower

– The ECB has cut interest rates, introduced T-LTROs and is poised to

engage in QE, while the Fed is tapering asset purchases

• This has caused:

– Eurozone equities to weaken relative to the US

– Bunds to rally relative to Treasuries

–EUR/USD to weaken

30

2012 2013 201490

100

110

120

130

140

150

160

Ind

ex: Ja

n 3

, 2

00

8 =

10

0

©FactSet Research Systems

Equities: US, Eurozone

Eurozone MSCI EMU - Price IndexUS S&P 500 - Price Index

Financial Markets

31

Financial Markets

2012 2013 20140.80

1.20

1.60

2.00

2.40

2.80

3.20

Pe

rce

nt

@Factset Research Systems

US and German Bond Yields

10 Year Treasury Note, Yield - United States10 Year Govt. Benchmark Note, Yield - Germany (Left)

32

Category—Title

2012 2013 20141.20

1.25

1.30

1.35

1.40

EU

R/U

SD

Source: Eurostat

Euro-Dollar Exchange Rate

The Euro/Dollar Exchange Rate

Financial Markets

33

Financial Markets

• In 2015:

– US equities are projected to yield a 9.0% total return on earnings growth and

dividend yield. No multiple expansion

– Eurozone equities are projected to yield a 4.0% total return largely on

dividend yield, with little price appreciation

– US bond yields are projected to rise, with the yield on the 10-yr Treasury

hitting 3.30% by the end of the year

– Eurozone bond yields are also projected to rise but by less, with the yield on

the 10-yr Bund hitting 1.25% by the end of the year

– EUR/USD is projected to weaken to 1.18 by the end of the year

Source: SSgA Solutions Group

Thank You

35

Disclosures

The views expressed in this material are the views of Chris Probyn through the period ended October 14, 2014 and are

subject to change based on market and other conditions. All information has been obtained from sources believed to be

reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability

or completeness of, nor liability for, decisions based on such information.

This document contains certain statements that may be deemed to be forward-looking statements. All statements, other

than historical facts, contained within this article that address activities, events or developments that SSgA expects,

believes or anticipates will or may occur in the future are forward-looking statements. These statements are based on

certain assumptions and analyses made by SSgA in light of its experience and perception of historical trends, current

conditions, expected future developments and other factors it believes are appropriate in the circumstances, many of

which are detailed herein. Such statements are subject to a number of assumptions, risks, uncertainties, many of which

are beyond SSgA’s control. Readers are cautioned that any such statements are not guarantees of any future

performance and that actual results or developments may differ materially from those projected in the forward-looking

statements.

The information contained herein does not constitute investment advice and it should not be relied on as such. It should

not be considered a solicitation to buy or an offer to sell a security. It does not take into account the specific

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Investing involves risk including the risk of loss of principal.

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