sh a spl n U on t a Spr e i n n A y b o t o h P 15 December 2022 04 08 10 11 15 Economic Outlook Energy crisis: how Inflation: reach- Monetry policy: A Fiscal policy: 2023 much longer? ing the peak timid pivot in late another exception 2023 year 17 18 19 20 20 Corporates: trifecta Balance of risks A “perma-risk” out- Capital Markets Too early to re-risk of risks will bite in remains tilted to the look: volatile times Outlook 2023 downside are here to stay Allianz Research Economic Outlook 23-24: Keep calm and carry on Please scan this QR code to listen to our companion playlist to boost your very own energy level

Allianz Research Executive Summary Ludovic Subran, Chief Economist Since our last quarterly economic update in September, the deteriorating [email protected] energy crisis and a challenging policy mix have confirmed our forecast of Ana Boata, slowing growth, sticky inflation and rising interest rates. For next year, we have Head of Economic Research identified eight songs and themes to keep your ear to the ground during the [email protected] great energy quarantine: Andreas Jobst, Head of Macroeconomic and Capital #1. Slow Down. In 2023, we continue to forecast a mild recession in Europe on Markets Research [email protected] the back of the energy crisis, and in the US due to the abrupt normalization of monetary and financial conditions. This triaging recession will test resilience. Eric Barthalon, Stronger balance sheets, demand backlog, and fiscal support will help limit Head of Capital Markets Research the damage. In the emerging world, growth is expected to remain stable in [email protected] 2023. In 2024, we anticipate a recovery in the US while the eurozone could be Jordi Basco Carrera, stuck in a muddle-through scenario because of the energy stop-and-go. Lead Investment Strategist [email protected] #2. Cold Heart. The energy gap will continue to pose concerns in Europe. After Maxime Darmet, record gas storage and energy efficiency gains helped avoid a blackout Senior Economist for France and US scenario in 2022, prospects for next winter (2023-2024) are limited as [email protected] substitution to Russian gas imports will not suffice. Uncertain gas supply will Pablo Espinosa-Uriel, create negative confidence effects and put the region’s fiscal capabilities Investment Strategist to the test to cushion the impact of high electricity prices on firms and [email protected] households. It will also compel policymakers to find ways to enhance energy Françoise Huang, efficiency and stabilize gas consumption beyond near term savings, together. Senior Economist for APAC and Trade The alternative is a repeat of 2012 and a risk of fragmentation in Europe. [email protected] Ano Kuhanathan, #3. Bad Blood. (Geo)politics made a bursting comeback at the forefront Head of Corporate Research of concerns. From a split Congress and a noticeable return to good ‘ole [email protected] protectionism through the Inflation Reduction Act (IRA) in the US, to Europe’s Roberta Fortes, red herring policies to the negative competitiveness shock stemming from Economist for Latin America the energy crisis (sovereignty, re-industrialization), to China’s balancing act to [email protected] exit zero-Covid, and the many important elections upcoming , investors and Maxime Lemerle, corporates will have to play coping strategies and buffers. Lead Advisor Insolvency Research [email protected] #4. Dragon Attack. The shift in China’s containment measures will alleviate Maddalena Martini, pressures on a slowing global trade, and accelerate the decline of producer Economist for Italy & Greece prices. The domestic post-Covid rebound could start to be felt in the second [email protected] half of 2023, and into 2024 as we expect sanitary restrictions to be eased Manfred Stamer, in spring 2023. A faster easing would benefit the global economy while any Senior Economist for Emerging Europe setback could weigh on global trade and delay the easing of inflationary and the Middle East [email protected] pressures. Katharina Utermöhl, Senior Economist for Europe [email protected] 2

15 December 2022 #5. Never Give Up. Emerging markets will face very different challenges and headwinds in the coming months. Political risk has been rising in Latin America, Eastern European countries are being hit harder than most by the energy crisis, and commodity importers throughout the world will have to cope with a strong dollar, high energy and food prices. Credible policy moves will make the difference. Debt sustainability concerns are increasing for some countries in a context of increasing rates and capital flight to safety. #6. Castle on the Hill. Central bankers are determined to fight inflation and make sure that it does not become entrenched. While the current hiking path is about to moderate, central banks’ independence will be tested either way: if erring on the side of keeping their monetary stance more restrictive for longer despite a looming recession, or if throwing in the towel to early and risking stagflation for good. Against the background of moderate quantitative tightening and decreasing system-wide liquidity, there is a risk of squeeze from a policy mistake. #7. Bad Habits. Since 2020, the war against the virus, and now against Russia have one super weapon: fiscal spending. It will remain at the center stage over the next couple of years, from relief measures to the cost of living crisis, to green industrial policies to help with silent wars (climate change, ageing), to fighting the urge to a massive tax policy U-turn. More targeting for aid, and fewer distortions are welcome to avoid that financial markets become very selective. #8. Easy on Me. In 2022, capital markets experienced an unmitigated disaster with an unprecedented price correction in both equities and fixed income. Going forward, earnings forecasts still seem too benign, and even a milder recession is not fully priced in. Fixed income is back but mind the risk. Also, as central banks drain excess system-wide liquidity and trading volumes even in historically liquid markets decline, financial accidents needs to be watched out for. 3

Allianz Research sh a spl n U on on s n oh J e s i n e D y b o t o h P Global Outlook Since our last quarterly economic update, the (after growth of +2.5% in 2022), followed by a rebound deteriorating energy crisis and tough policy choices to below-potential growth of +1.5% in 2024 (Figure 1). have confirmed our forecast of slowing growth, higher Europe will muddle through the ongoing energy crisis, inflation and rising interest rates. While inflationary while the US recovery is constrained by a cautious policy pressures remain stronger than expected, real activity mix. Among emerging markets, growth is expected to has been more resilient than expected in both the remain stable in 2023 at +3.3% – mainly supported by the US and the Europe due to a combination of stronger cautious reopening of China, while most other emerging consumption and scaled-up fiscal support. countries are likely to slow down due to both external and domestic headwinds. A rebound to +4.3% is expected Global growth: Still headed towards a recession in 2024, supported by the policy pivot as well as the After a tumultuous year, we anticipate lackluster growth recovery of Chinese demand. in 2023, followed by differing recovery paths across countries in 2024 (Table 1). Global growth is likely to slow to +1.4% in 2023 (-0.1pp downside revision) and to recover modestly to +2.8% in 2024, with significant divergence across countries. Advanced economies will register a shallow recession of -0.1% in 2023 4

15 December 2022 United States: Despite rapid monetary tightening and continued to weaken rapidly since the summer: home elevated inflation, the economy has proven resilient sales and mortgage demand have dipped amid tighter so far. This is mainly thanks to strong exports amid a financing conditions while residential investment is still large backlog of previously unfilled orders in the falling. We expect GDP growth to fall by -0.3% in 2023, manufacturing sector while consumption is holding up. with the recession starting in Q1 2023. Growth is likely to Households have reduced their savings and the labor pick up by a modest +1.6% in 2024, held back by fiscal market has remained strong, bolstering consumer consolidation and still elevated real interest rates. spending (Figure 2). However, the housing market has Table 1: GDP growth (%) Growth (yearly %) 2020 2021 2022f 2023f 2024f Global (PPP exchange rates) -3.0 6.1 3.1 1.9 3.1 Global (market exchange rates) -3.3 6.0 2.9 1.4 2.8 USA -2.8 6.0 1.9 -0.3 1.6 Latin America -7.1 6.7 3.3 1.2 2.2 Brazil -4.2 5.0 2.8 1.1 2.1 UK -11.0 7.5 4.4 -0.9 0.7 Eurozone -6.3 5.3 3.3 -0.4 1.0 Germany -4.1 2.6 1.8 -0.7 0.6 France -7.9 6.8 2.5 -0.4 0.9 Italy -9.1 6.7 3.8 -0.3 0.8 Spain -11.3 5.5 4.6 0.2 1.2 Russia -2.7 4.7 -2.8 -2.9 1.6 Turkey 1.9 11.4 5.1 1.9 3.8 Central and Eastern Europe -3.3 5.3 0.3 0.2 2.5 Poland -2.0 6.8 5.5 0.7 2.3 Asia-Pacific -1.0 6.1 3.2 3.6 4.5 China 2.2 8.1 2.8 4.0 5.2 Japan -4.7 1.7 1.4 0.8 1.1 India -6.6 8.3 6.7 6.0 6.2 Middle East -4.2 3.9 5.6 3.4 2.6 Saudi Arabia -4.1 3.2 10.2 4.9 3.1 Africa -1.7 5.8 3.2 3.1 3.5 South Africa -6.3 4.9 1.8 1.5 1.4 Source: Allianz Research 5

Allianz Research Figure 1: Europe and US: recession probabilities (%) Unites States Europe 100 100 80 80 60 60 40 40 20 20 0 1980 1988 1996 2004 2012 2020 0 NBER Recession Technical Recession 2006 2010 2014 2018 2022 Recession Probability Germany UK France Italy Spain Sources: Refinitiv Datastream, Allianz Research Eurozone: While gas rationing is likely to be avoided a higher dependence on gas and larger manufacturing on the assumption that demand for natural gas can sectors (Germany). Spain (and to a lesser extent France) be reduced by at least -10% relative to last year, should be more resilient compared with Eurozone peers. persistently high energy prices will push the Eurozone The energy crisis will depress growth for another few years, into a recession at the turn of the year. We still expect with material downside risks for winter 2023-24 amid a still a bottom-out in H1 2023, followed by a shallow negative output gap in 2024. We expect GDP growth to recovery below potential growth. Scaled-up public fall -0.4% in 2023 before picking up by +1.0% in 2024, which sector support over the past months only partially would make the recovery as weak as after the Eurozone compensates for households’ declining purchasing debt crisis in 2012. All in all, we see a risk that the energy power and lower corporate profitability. We anticipate crisis will put Europe on a lower growth trajectory going only a modest pick-up in 2024-25 for countries with forward. Figure 2: Europe and US: household savings and consumer credit Household saving rate, % Consumer credit, y/y% 30 15 25 US 10 Eurozone 20 UK 5 15 0 10 -5 5 -10 0 -15 US Eurozone UK 2014 2016 2018 2020 2022 2004 2007 2010 2013 2016 2019 2022 Sources: Refinitiv Datastream, Allianz Research China: The coming months are still likely to be difficult. accelerated efforts to move towards an exit from zero- There is a high probability of negative q/q growth in Covid policies, including: (i) doubling down on efforts Q4 2022, with overall growth for 2022 likely at +2.8% and incentives to inoculate the vulnerable population; (down from our forecast of +2.9% previously). We also (ii) easing quarantine conditions for some Covid-19 cases expect soft growth in Q1 2023. As a result, we have cut and contact cases (e.g. at home instead of at quarantine our 2023 GDP growth forecast to +4.0% from +4.5% facilities) and (iii) reducing the frequency and scope of but revised up our 2024 growth forecast from +4.7% testing requirements. As a result, our expectations for a to +5.2%. Against the latest socio-economic backdrop, full reopening from zero-Covid rules is moved forward by Chinese authorities have made concessions and 6

15 December 2022 a few months to spring 2023. This means that, after the vulnerable to increased social risk as a result. Major difficult ongoing winter months where the number of cases EMs in Latin America benefit from the commodity price surged as a result of relaxed restrictions, the post-Covid boom, and a strong job market and resilient domestic rebound could start to be felt a little earlier in the second consumption further helped to boost economic growth half of next year, and into 2024. Real estate will remain in most of 2022. That said, political uncertainties a structural drag on growth but monetary conditions have created headwinds. In Emerging Asia excluding will continue to be accommodative, notably through China, growth is expected to take a step down in 2023 selective liquidity. The domestic recovery becoming more (+5.4% after +5.8% in 2022) before recovering mildly in sustainable should allow the start of a gradual tightening 2024 (to +6.2%). After a year of post-Covid recovery, of monetary policy in H2 2024. Southeast Asian economies are caught up by the negative impact of higher inflation and tightening Emerging markets (EMs) and developing economies (DEs) monetary policies (even though less so than in other will continue to be impacted by strong global headwinds regions), while the export-oriented Asian Tigers are and many are facing additional domestic challenges, all also weighed down by slowing global demand. In the of which vary across regions or if a country is a commodity meantime, the Gulf Cooperation Council economies importer or exporter. Global headwinds include still appear to be the sole winners from the current crises in tightening global liquidity, a strong USD, elevated food the EMDEs world, even though they are also large net and energy prices and the ongoing slowdown of Chinese food importers. They will continue to experience robust demand. Net importers of energy and food will remain growth and improving public and external finances in particularly vulnerable to the adverse effects of the high 2023, while inflation will remain in check in the region, prices for these goods on inflation, public and external thanks to monetary tightening and targeted fiscal finances. Central and Eastern European countries will measures mitigating food-price increases. Last but not be the most affected as they face an energy-supply least, we will be watching the EM election calendar crisis on top of the energy-price crisis over the winter as closely as policy mistakes in the run-up to the elections Russia and Ukraine were their main pre-war suppliers. cannot be ruled out: Nigeria (February), Thailand Many DEs in Africa and Asia as well as non-commodity (May), Türkiye (June), Argentina (October), Poland exporters in the Middle East will also continue to suffer (November) and Bangladesh (December). from the food- and energy-price surge and are especially 7

Allianz Research Energy crisis: how much longer? The evolving policy response to the current energy 150 EUR/MWh in 2024. Risks to the upside could come and food crisis will shape the outlook for next year. from (i) a softer recession, (ii) further supply cuts from The continued uncertainty about gas supply and high producers or (iii) insufficient gas savings in Europe. Risks electricity and food prices will weigh on consumer to the downside could come from a (i) harder recession sentiment and business prospects, resulting in a and (ii) a faster energy transition (through greater stop-and-go growth momentum due to increasingly efficiency or increased electricity availability). entrenched negative confidence effects. Europe is the epicenter of the energy crisis and hence, in the short- A sustained energy-demand reduction will be key in run, the negative impact will be most pronounced, what shapes up to become a more persistent energy- while risks remain clearly tilted to the downside. supply crisis. In our baseline scenario, we assume Europe More specifically, the depth of the cost-of-living crisis will be entering winter 2023/24 with storage at 65-70% in Europe will depend on how low temperatures fall of capacity at best (assuming +20-25pps replenishing this winter, how well EU solidarity holds up and how of stored gas from end-March 2023 to the start of efficiently corporates can wean themselves off Russian November). However, as Europe entered Q3 2022 with gas or switch to less energy-intensive inputs. French storage levels above 80%, we are also penciling in nuclear plants are also coming back on the grid later sustained energy savings. The greater availability of than initially planned, which complicates the current French nuclear power will provide quite a significant “energy balancing act”. buffer. As a downside scenario, we see 40% of storage at the start of winter 2023, which should double the energy We expect energy prices will remain high over the gap and push Europe into its second year of recession next two years. We assume that Russian gas flows to (Figure 3). Going forward, key challenges relate to the Europe via the Nord Stream pipeline will remain at zero design of national energy markets and the compatibility until spring, with a low probability of some resumed of different energy infrastructures (e.g. delivering gas exports in fall 2023 (potentially triggered by peace talks from Spain, where imports outstrip consumption) to other between Ukraine and Russia). Additional limited supply parts of Europe. Scaling up investment in renewable through the Yamal gas pipeline (via Poland) would energy infrastructure and viable alternatives to pipeline be seen as a positive signal by markets. With OPEC+ gas, such as LNG terminals in ports, is also essential, but being conservative and LNG volumes limited, supply will take time. In the meantime, effectively mitigating should remain constrained both for oil and natural gas. the impact of the energy crisis will require a coordinated Furthermore, despite some easing in demand due to the fiscal policy response, (1) repurposing the more than global recession penciled in for 2023 and gas-demand EUR200bn of Next Generation EU funds still remaining destruction, we believe markets will remain tight and and/or (2) setting up a new crisis fund at the European prices high for the next couple of years. We expect oil Commission, using SURE as a blueprint (backed by prices to average 95 USD/bbl in 2023 and 90 USD/bbl government guarantees). in 2024, while TTF natural gas prices would average 170 EUR/MWh in 2023 before consolidating slightly to Figure 3: European gas storage scenarios 100% 75% 50% 25% Upside Baseline Downside 0% Dec-22 Mar-23 Jun-23 Sep-23 Dec-23 Mar-24 Sources: ENTSO-G, Allianz Research 8

15 December 2022 Global trade continues to slow as industrial activity to contract by -1.3% in value terms (-0.2pp from our previ- recedes despite easing supply-side constraints (Figure ous forecast). A mild recovery should be possible in 2024, 4). Oversupply in the manufacturing sector has worsened with global trade in goods and services growing by +3.6% since Q3 2022, notably in Europe. New orders and back- in volume terms (i.e. roughly 1pp below the pre-pandemic logs of work are at their lowest level since the pandemic long-term average) and a neutral price effect resul- in 2020. Hence, the manufacturing sector is expected to ting from opposing sectoral trends. Beyond the cyclical remain in recession in 2023 due to lower demand, mainly developments, trade and industrial policies will remain for consumer-driven industries, and a more pronounced topical over the coming years. While our past research 1 destocking process from corporates in sectors where has shown that reshoring was more talk than walk and oversupply is highest. The largest cliff is expected in cycli- that critical dependencies on China are too numerous to 2 cal sectors such as construction, consumer goods (electro- be disentangled , policymakers across the world seem nics, household equipment etc.) and retail. Supply chains focused on taking action to secure supply chains (e.g. EU continue to normalize, supported by slowing demand Chips Act, US Inflation Reduction Act). Not all trade par- and China’s progressive reopening. The Global Supply ticipants will be hindered by such protectionist measures Chain Pressure Index reached its lowest level since early (e.g. Southeast Asia benefiting from US-China tensions), 2020 and freight rates are three times lower compared to but global trade may be heading towards lower growth the beginning of this year (though still twice higher than rates in the coming years compared to the pre-pandemic pre-pandemic levels). A normalization in supply chains long-term average. would lower inflation by more than -1pp in advanced eco- nomies by mid-2023. A manufacturing recession along with the continued slow recovery of services trade and a 1 See Global Trade Report: Battling out of supply-chain disruptions correction in price pressures mean that we expect global 2 See Globalization 2.0: Can the US and EU really “friendshore” away trade in goods and services to grow by only +0.7% in volu- from China? me terms in 2023 (-0.5pp from our previous forecast) and Figure 4: State of global trade Demand is slowing down fast… …with new orders and backlogs of work at their lowest level since the worst of the pandemic 60 30% 2021: supply shortfall, strong 30 15% k) r H1 2021 H1 2021 o 0 0% w f o Mar-22 gs Jan-22 -30 -15% o kl -60 -30% Bac Mar-22 + 2007 2011 2015 2019 2023 s Sep-22 der r Oct-22 Demand (new orders & backlogs of works) - Stocks o Jun-22 Jun-22 Aug-22 ew (manufacturing PMI indices, y/y), lhs N Global trade of goods (volume, y/y), rhs d ( Aug-22 an Sep-22 Nov-22 H1 2020 em D Oct-22 Nov-22 H1 2020 2022: headingto 2020: excessive supply, low demand oversupply Production shortfall (New orders - Output) US Eurozone Sources: Markit, Allianz Research 9

Allianz Research Inflation: reaching the peak Inflation will remain uncomfortably high over the near (from 10.4% in 2022) and remain elevated at 5.9% in 2024. term, averaging 6.4% at the global level in 2023 before Structural factors (including demographics) will keep receding to 3.9% in 2024 (Table 2). It should continue to labor markets tight despite the anticipated recession, remain strong over the coming quarters (despite strong and policy support will prevent larger adjustments disinflationary base effects in 2023), with core inflation in domestic demand and hence stronger disinflation, remaining rather sticky next year. For instance, in the notably for services. On the goods side, imported Eurozone, energy prices should still explain about a deflation from China starting to be more visible in the third of total inflation compared to almost 50% in 2022 coming months. This should shave off at least -0.5pp of (Figure 5). Besides the lower contribution from supply inflation in the US, Eurozone and the UK, and support chains and a negative contribution from demand and a downward adjustment in inflation expectations. In monetary policy, a stronger euro should reduce inflation the US, according to the NFIB survey, the share of small by around -1pp in 2023-24. In advanced economies, corporates that want to increase prices in the coming we expect inflation to reach 4.7% in 2023 (down from months fell to 34% from a peak of 52% in March. In the 7.4% in 2022). Continued wage pressures coupled with Eurozone, the same share decreased from close to 60% in persistently high energy and food prices will keep April to 44% recently. inflation at 2.4% until late 2024, especially in Europe. Inflation in emerging markets will decline to only 8.5% Table 2: Inflation (%) Inflation (yearly %) 2020 2021 2022f 2023f 2024f Global 2.6 4.3 8.6 6.4 3.9 USA 1.3 4.7 8.1 4.1 2.3 Latin America 11.8 13.9 16.2 14.2 10.3 Brazil 3.2 8.3 9.6 4.8 3.6 UK 0.9 2.6 9.0 7.5 3.5 Eurozone 0.3 2.6 8.5 6.1 2.6 Germany 0.5 3.1 8.8 6.8 2.4 France 0.5 1.6 5.8 5.4 2.3 Italy -0.1 1.9 8.0 5.8 2.2 Spain -0.3 3.1 8.6 4.8 3.5 Russia 3.4 6.7 14.0 12.0 7.9 Turkey 12.3 19.6 72.6 36.1 20.6 Central and Eastern Europe 4.5 8.1 14.8 11.8 5.6 Poland 3.4 5.1 14.5 11.8 5.5 Asia-Pacific 2.2 1.7 3.7 3.2 2.7 China 2.5 0.9 2.0 2.2 2.4 Japan -0.0 -0.2 2.3 1.9 1.5 India 6.6 5.1 7.0 5.8 4.7 Middle East 9.9 15.8 25.0 21.6 12.9 Saudi Arabia 3.5 3.1 2.5 2.6 2.1 Africa 10.0 12.4 17.5 14.1 8.8 South Africa 3.3 4.6 7.0 5.1 4.7 Sources: Refinitiv Datastream, Allianz Research 10

15 December 2022 Figure 5: Eurozone and US: decomposition of headline CPI inflation US Eurozone Services Goods Food Energy 100 Services Goods Food Energy 100 9 29 24 40 35 75 75 49 50 50 73 25 39 25 34 28 22 0 17 0 2021 2022e 2023f 2021 2022e 2023f Sources: Refinitiv, Allianz Research Monetary policy: A timid pivot in late 2023 Central banks remain determined to fight inflation, rental-prices growth will soon soften. Upstream ser- but we expect the hiking cycle to slow in the coming vices price pressures are already easing and the upco- months (Figure 6). Given sticky core inflation, we expect ming recession should contribute to further downside rates in advanced economies to stay at high levels for pressures. We expect the Fed’s balance sheet run-off longer and a less ambitious pivot in 2023 despite the to remain on autopilot over the forecasting horizon, recession. However, during early 2023, the restrictive with a roughly USD90bn monthly decline in assets monetary stance risks becoming increasingly politicized per month, as targeted by the FOMC. Through 2024, as central bankers are expected to continue prioritizing though, we expect the Fed to keep running down its fighting inflation over supporting growth. This will be the mortgage-backed securities holdings but to steady its ultimate litmus test for their independence. It will also Treasuries holdings. Banks’ reserve balances at the constrain the pace at which they unwind quantitative Fed should settle at around 9% of GDP by the end of easing. The proactive run-off of the US Federal Reser- 2024, a level consistent with sufficiently ample liquid ve’s balance sheet continues to strengthen the restrictive assets. The Fed is not likely to wind down its balance stance but is unlikely to accelerate to prevent further sheet faster for fear of spooking financial market upside pressure on long-term rates and potentially turbulence. fueling further volatility spikes in the Treasury market. In the Eurozone, the potential of rising fragmentation risk • Eurozone: As opposed to the US Fed, persistently high due to rising peripheral sovereign spreads will limit the inflation for most of next year will delay the ECB’s scope for rapid quantitative tightening. potential interest rate cuts to 2024. We expect the ECB to slow the pace of rate hikes after the December • The US: We expect the US Federal Reserve to hike meeting (+50bps) to reach a terminal rate of 2.75% interest rates to 5% by March 2023. A moderate pivot for the effective policy rate (deposit rate) until May (-75bps) is expected in November-December 2023 2023. Slowing growth and rising unemployment will against a backdrop of rapidly falling inflation and mitigate wage-price pressures as supply-demand a weak economy. Nevertheless, monetary policy imbalances gradually subside. One year after the US will remain tight outright, with real rates expected Fed, the ECB is likely to kick off the reduction of its to remain largely positive through 2024. Inflation is balance sheet in Q1 2023, mostly driven by additio- clearly cooling down in the goods sector – a sign of nal (early) repayments of TLTROs. Unwinding QE will softening demand for goods, a stronger USD and the focus on the “old” asset purchase program APP while easing of supply-chain disruptions. Elevated core ser- PEPP will remain untouched. In particular, we expect vices inflation still looks concerning, but we believe a passive run-off based on scheduled redemptions via that by Q2 2023 it will start to come down convin- a progressively declining cap on reinvestments. As a cingly. Home prices have started to come down on result, government debt holdings should only decline a sequential month-on-month basis, and we believe by up to 5% next year. 11

Allianz Research • China: Monetary policy will remain selectively • Emerging markets: Most central banks will need accommodative over the coming year to support to keep raising interest rates in light of persistently the economy, contain any systemic risk from the real higher energy and food prices and strong down- estate sector and facilitate continued fiscal policy ward FX pressures. However, only a few have easing. We expect just two more policy rate cuts reached positive real interest rates so far (e.g. Bra- in 2023 (before a stabilization in 2024), meaning zil, Mexico, Saudi Arabia, Vietnam). Nonetheless, that this round of monetary easing will have been some central banks, mainly in Central and Eastern more dragged out and less intense than in the past Europe (CEE), are likely to be the first to cut rates (-40bps over two years vs. -50bps in less than three again in mid-2023 to support the economy in the quarters in late-2019/early-2020). Chinese policy- wake of the sharp global growth slowdown, follo- makers are wary of structural vulnerabilities (overall wed by other regions in Q4 2023. The largest ones indebtedness, risk of overcapacity) and potential will be in Latin America (between 200 to 300bps in inflationary pressures coming from the post-Covid Brazil, Colombia and Chile) and smaller ones (50 reopening. The monetary stance is likely to switch to 100bps) in the Middle East and very few Afri- to neutral and restrictive in H2 2024, when the can and Asian countries. Overall, we expect key post-Covid domestic recovery becomes sustainable. interest rates to remain above 2021 levels by the end of 2024. Figure 6: Eurozone and US: current and past policy rate-hiking cycles (%) United States Eurozone 8 3 6 2 4 2 1 0 0 1M 6M 11M 16M 21M 26M 31M 36M 1M 6M 11M 16M 21M 26M 31M 73-74 79-80 80 99-00 05-08 2011 94-95 99-00 04-06 15-18 22 22-24 (f) 2022 22-24 (f) Sources: Refinitiv Datastream, Allianz Research 12

15 December 2022 Net capital outflows from EMs and attended FX pressures Sovereign debt distress has markedly risen during will continue next year (Figure 7). The widening interest- 2022, in particular in developing economies but also rate differentials relative to the US and the Eurozone in some EMs. The main reasons are the strengthened leave the door open to further capital outflows from EMs USD making repayments of USD-denominated debt 1 to appealing advanced economies.³ This situation will more expensive (as outlined above), higher interest exacerbate in case countries pursue a different monetary rates (increased risk premia) complicating the rolling- policy (e.g. Türkiye) and could lead to liquidity problems, over of maturing debt, widening budget deficits due although concentrated in smaller EMs. Moreover, to increased subsidies and transfers to mitigate the conditions remain largely favorable for the USD, especially impact of higher energy and food prices on people in the short term, since the US Fed is expected to maintain and companies, as well as the resumption of debt- a hawkish stance for a while longer while most other service payments for DEs that participated in the central banks are bound to face more pressure to become G20 debt relief initiative (DSSI) that ended in 2021. In dovish as domestic demand slows and/or risks to financial our updated public-debt-sustainability risk analysis, stability increase. In addition, the winter weather in Europe we identify several African countries (Egypt, Ghana, and the ongoing Russia-Ukraine conflict also point to the Kenya, Malawi, and Tunisia) as well as Costa Rica, risk of further energy price spikes and risk-off mode - which El Salvador, Jordan, Laos, and Pakistan as highly accentuates the safe haven role of the US dollar. Hence, susceptible to debt distress (Table 3).⁴2Note that the the USD will remain relatively strong for some time yet. risk of sovereign default also remains very high in This certainly puts pressure on countries that have a high Argentina and has continued to increase in Turkey, external debt denominated in USD as they have to buy although the latter should avoid defaulting, thanks the greenback to repay their USD debt with cheaper local to sizeable swap arrangements between the Turkish currencies. Moreover, a stronger US dollar also increases central bank and its counterparts in a number of import costs, meaning that major central banks might limit countries (for example China, Qatar, South Korea, and a potential future monetary-easing cycle to contain price UAE). pressures. 4 Out of the 25 countries in Table 3, Zambia, Sri Lanka, Lebanon and Ukraine are already in default or quasi-default. On the other hand, 3These outflows are not only a problem for emerging markets, but they some countries such as South Africa, Brazil, India and Romania also bring reputation costs to the US Federal Reserve, and leave the door appear in the table due to a few very badly scoring indicators but are open to other countries seeking to expand their financial influence by unlikely to default in the next two years, for example thanks to a low providing cheaper credit (e.g. China or GCC). See our full report: Financial share of FX debt and/or moderate interest payments falling due. globalization: moving towards a polarized system? Figure 7: Eurozone and US: current and past policy rate hiking cycles (%) 250 EM - Asia Ex-China LatAm 4 CEE MEA China US FCI (Chicago Fed) - rhs 3 125 2 t h g bn i D 1 > T -- S U 0 0 < oose L -1 -125 -2 2003 2007 2011 2015 2019 2023 Sources: IIF; Refinitiv Datastream; Allianz Research. Monthly flows aggregated by quarter. Flows are aggregated as soon as they are reported, but different countries report the data with different lags. 13

Allianz Research Table 3: Public debt sustainability risk score (25 most vulnerable EMDEs, out of 102 markets scored, as of December 2022) Debt Shock Foreign Effective Public Debt (due to Exchange- Interest Rate Interest Country Sustainability Covid-19 denominat Maturing Fiscal Interest (interest pay- Rate - Rank (from high risk Risk Score Total Public Debt and war in ed Public Public Balance Payments ments in % of Growth to low risk) (0 = high risk; (% of GDP) Ukraine; Debt Debt (% of GDP) (% of fiscal public debt at Differential 100 = low risk) increase in (% of total (% of GDP) revenues) the end of (%) public debt- public previous year) to-GDP ratio) debt) max(2022;2023) 2019 -> 2022 2022 2023-2024 2022-2023 2023 2023 2023 1 Zambia 0.0 115 15 73 8.9 -7.9 35 8.5 4.8 2 Sri Lanka 6.7 131 48 36 9.3 -9.9 79 9.1 6.7 3 Malawi 6.8 71 22 54 8.6 -7.7 36 9.8 14.9 4 Ghana 10.8 85 22 55 3.7 -8.2 50 9.9 17.7 5 El Salvador 11.9 89 14 64 4.0 -6.6 19 6.7 2.2 6 Ukraine 13.4 90 38 70 4.8 -17.0 11 8.7 13.7 7 Egypt 13.8 95 11 26 13.9 -7.4 43 11.2 10.8 8 Kenya 14.4 70 12 57 4.5 -6.1 25 7.3 5.0 9 Laos 19.5 109 45 86 0.3 -5.0 22 3.4 10.8 10 Costa Rica 20.4 67 10 42 9.4 -4.1 35 8.5 2.0 11 Jordan 20.8 94 15 45 10.3 -6.4 16 4.8 -0.9 12 Tunisia 20.8 85 16 67 4.9 -9.0 11 3.8 4.4 13 South Africa 22.3 73 14 33 2.9 -7.8 19 7.9 5.3 14 Bahrain 23.6 120 17 63 11.0 1.3 21 4.0 0.6 15 Bangladesh 24.0 29 29 75 1.1 -5.9 27 7.9 2.7 16 Uganda 28.2 53 15 70 2.3 -4.8 20 6.7 -1.7 17 Brazil 30.9 93 4 6 7.6 -7.5 22 8.1 -0.6 18 Pakistan 30.9 78 0 34 3.3 -5.0 40 8.1 3.9 19 Lebanon 32.3 175 2 38 52.8 -3.2 33 3.6 2.1 20 Turkey 34.4 44 9 55 2.5 -5.2 11 12.1 1.8 21 India 34.7 94 14 6 2.3 -9.4 29 7.5 -2.7 22 Moldova 36.3 45 11 59 2.2 -6.0 6 5.4 3.4 23 Dominican Republic 37.7 61 7 77 6.5 -2.7 22 6.0 -2.8 24 Romania 38.2 55 18 51 4.2 -6.3 6 4.1 0.3 25 Argentina 38.7 81 -10 68 4.9 -4.6 6 4.6 2.5 Source: Allianz Research. Note: For the calculation of the PDSRS, each of the indicators was rescaled from 0 to 100, with 0 denoting the highest risk and 100 the lowest (not visible in the columns 4-11, which show the actual values). Then the PDSRS was calculated as the average of the indicators, thus also ranging between 0 and 100. 14

15 December 2022 Fiscal policy: 2023 another exception year; prepare for fiscal consolidation in 2024 Most countries have taken bold steps to cushion the energy prices on real disposable incomes and soften impact of the energy crisis on firms and households. the blow on demand. However, it can also slow down In Europe, most of the current fiscal measures have the reduction in inflation rates overall. We estimate been extended into 2023 for a total of more than 3% that current measures directly reduce inflation rates by of GDP on average in Europe (close to 5% of GDP or lowering energy prices most in the UK (-3.7pps in 2023), more than EUR600bn since September 2021) (Figure 8). followed by more than -2pps in Germany, France, Italy Unsurprisingly, the fiscal response is somewhat higher and Spain. By doing so, however, they “free” 1.7% of in countries with a larger energy-intensive industry and/ GDP of domestic demand on average as the decline or greater gas dependence. In most countries, the total of household disposable incomes in 2023 will be more measures (e.g. price caps, energy tax cuts, liquidity and than halved from -4.3pps to -1.7pps on average (more equity injections, state-guaranteed loans and furlough than EUR1,300 per household). However, coordination schemes) amount to around half of the Covid-19 at the European level is likely to continue to disappoint, packages. With the energy crisis – and in turn the notably as regards the electricity market, which will inflation hit to the private sector – not yet past the peak, raise the potential fiscal cost. we expect EU governments to increase spending further. However, the big fiscal leaps are behind us as the In the US, fiscal policy has decisively shifted towards room for maneuver is much more constrained amid a restrictive stance since the second half of 2021 rising interest rates. Governments need to find a (Figure 9). Because of the lagged effects of fiscal way to enhance energy efficiency and stabilize gas policy, it is expected to weaken the economy in end consumption beyond near-term savings (which currently 2022-early 2023, supporting our call of an upcoming stands at only 10%). Indeed, without demand reduction fall in inflation and a recession. However, we expect (through market prices or fiscal policy), countries could the Democrat-led White House and the Republican-led fall into a vicious cycle of higher prices leading to more House to agree on a modest fiscal easing – to the tune fiscal slippage. Conversely, limited fiscal space and of 0.2% of GDP – around the middle of next year to ineffective energy policy could further slow economic support a flagging economy. In 2024, we expect fiscal growth and raise the odds of a longer and deeper policy to turn restrictive again (to the tune of 1% of recession at a time when rising interest-rate burdens GDP) despite the Presidential election, amid mounting challenge debt sustainability. In particular, diminishing fiscal imbalances. Public deficits should be close to 7% fiscal space could require difficult policy trade-offs as of GDP in 2023 for the general government, pushed governments also tackle important structural challenges up by a rapidly growing interest payment bill (which outside the current energy crisis, such as the green we expect to top USD1,000bn by 2024) amid elevated transition of their economies and the launch of bold borrowing costs. pension reforms, such as in France and Spain. Available fiscal support will reduce the impact of higher 15

Allianz Research Figure 8: Europe - Fiscal support measures to fight the energy crisis (%) 10 9 8 Liquidity support to energy utilities 1/ 7 Current fiscal measures t 6 Pre-conflict measures or EU median p p 5 u S l 4 3.8% a sc i 3 F 2 3.2% of t n 1 ou m 0 A y a e e * . k d ly a a n x. a n a a d a y s a d c h i i i a i ia i i ry a m i u lt UK n a t n u v i n k h n i u n a r ni n an EZ* EU et ar t t r gal a a a I a L t u pa a c o a an eec N m l ede t va la g gi ve rw yp t l m M r r ro ua La us r S m o n gar F G h w ze u l C re er en Fin C t S A o lo C P Bello No Es I G D Li P Ro S H Bu S Sources: Refinitiv Datastream, Allianz Research Figure 9: Fiscal and monetary impulse in advanced and emerging economies (pp) TR Looser -10 -8 2022 EZ e t -6 US UK Ra -4 y c ) 2023 i l t o en -2 JPN e Pc 0 v i per t 2 CHN ec In f ( f E US CHN 4 l BRA JPN BRA Rea 6 EZ UK Tighter 8 TR -5 -4 -3 -2 -1 0 1 2 3 4 5 Tighter Fiscal Impulse Looser Sources: Refinitiv Datastream, Allianz Research 16

15 December 2022 Corporates: The trifecta of risks (financing, wages & recession) will bite in 2023 The confluence of slower growth, higher inflation and fully the estimated extra energy bill of over EUR150bn higher interest rates has increased corporate risks, mainly for French, German, Italian, Spanish and British in the construction, transportation, telecom, machinery corporates. The Q3 earnings season indicated the & equipment, retail, household equipment, electronics, first cracks, notably in consumer and energy-intensive automotive and textiles sectors. The energy crisis means sectors. However, corporates are rapidly adjusting on a massive profitability shock for European firms, which the downside their expectations for 2023. With rising governments can only partially offset. The fiscal packages uncertainty, business confidence is also decreasing. In that have been put on the table for corporates are enough addition, the layoff cycle has kicked off, given the rise to avoid a strong wave of insolvencies due to profitability in labor costs, especially in sectors that experienced a losses in most impacted sectors (metals, paper, machinery strong boom during the pandemic, such as technology and equipment, wood, mining) but they will not offset (Table 4). Table 4: Estimated extra energy bill for corporates in 2023 (EUR Bn / % GDP) Extra electricity cost Extra gas Total (% GDP) cost France 14 3 0.7% Germany 27 9 1.0% Italy 29 8 2.0% Spain 19 6 1.9% UK 31 9 1.4% Total 120 36 1.2% High cash balances and pricing power provided France are most at risk. However, strong bank-lending a significant buffer against the monetary policy growth has compensated for more expensive and normalization in 2022, but the worst is still to come. As less liquid corporate bond markets (+22% y/y in new cash holdings of firms were high and strong demand loans YTD), which should help mitigate the refinancing combined with significant pricing power, corporates pressure in 2024, when corporate issuers face a wall of showed resilience in 2022 both in terms of revenues and redemptions (Figure 10, following page). In addition, profitability. However, the interest rate shock and the more than 50% of corporate loans increased their higher wage bill in response to unprecedented inflation maturity to above five years, with less than 20% below could amount to a profitability shock similar to that seen one year. Many corporates also managed to secure during the Covid-19 lockdown. We forecast that the fixed-term loans for longer-term borrowing. Looking at upcoming rises in key rates in the US, UK and Eurozone wages, the bill is slightly higher for Europe’s industrial should increase average interest rates for corporates by sectors compared to the US. Hence, an increase in an additional 200bps by mid-2023, which in turn will cut wages of 4-5% in 2023 could wipe out between -0.5pp margins by -1.5pp in the US, -2.2pps in the UK and more to -1pp of margins on average. than -3pps in the Eurozone countries. Italy, Spain and 17

Allianz Research Figure 10: EUR & US Outstanding corporate debt maturity profile (in USD & EUR Bn) 90 US IG US HY 80 EUR IG EUR HY 70 60 50 40 30 20 10 0 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Sources: Refinitiv Eikon, Allianz Research. Note: Excludes debt maturing after 2031 and perpetuals The balance of risk remains tilted to the downside In our downside scenario, more disruptive energy-supply In our upside scenario, there would be a substantial constraints, for instance as a result of a cold winter, would resumption of gas supply to Western Europe, which require rationing, implying harsher shocks to industrial would prevent a recession, and central banks would production, labor markets and broader confidence, reach their terminal rates by moving more steadily pushing 2023 GDP growth deeply into negative territory while keeping a tight monetary stance as the better and increasing the probability of Europe entering a outlook favors more persistent domestic inflationary second year of recession in 2024. In particular, the pressures. Our estimates suggest that Russia can currently benign situation in the labor market, suggesting a survive without gas exports to Europe for more than a rebalancing via a reduction in vacancies rather than higher year as it sells more to new markets (e.g. India, China, unemployment (especially in the US), might take more time Türkiye). While a full end of the war seems unlikely in to adjust but could deteriorate quickly as economic growth H1 2023, we do see some signs that a ceasefire could slows further. Even without further energy shocks, there materialize in the foreseeable future. A ceasefire would is also a risk that inflation could rebound if fiscal support indeed release some of the market pressure as well as through price caps is lifted prematurely as policy space supply constraints. A swift reversal of China’s zero-Covid becomes increasingly constrained by rising interest rates. strategy could also lead to earlier positive re-opening Higher-for-longer inflation would push central banks to effects that could revitalize slowing global trade and hike more throughout 2023, increasing the risks of a policy accelerate the decline of producer prices, which had mistake (including further reducing market liquidity, which reached record levels only a few months ago. could precipitate a financial crisis). 18

15 December 2022 A “perma-risk” outlook: volatile times are here to stay Russia’s invasion of Ukraine triggered the return of have significant international implications, including geopolitical risk, and we think this is here to stay. We on to what extent the US will continue to underwrite deem the risk of an outright military confrontation European security as well as that of Taiwan. Expect between major powers as low, given that governments China, Russia and other large powers to watch will likely prioritize tackling big challenges on the domestic this space closely. Economic warfare via sanctions front. In Europe, the war in Ukraine and its political and (mainly on tech) should continue in any scenario, with economic implications will continue to dominate the policy Southeast Asia a clear economic winner of intensifying debate. The energy crisis threatens to become a political US-China tensions. China looks set to prioritize crisis should the EU fail to respond in a unified manner in domestic affairs, too – with a focus on generating the next two years, with EU elections scheduled for May sustainable economic growth and social peace – after 2024. Further political and economic divergence could a spike of social discontent over extended Covid-19 aggravate the longstanding trend of falling support for the restrictions in late 2022 served as a warning shot. two largest parliamentary groups (EPP and S&D) in favor In Latin America, the verdict on whether the region of Eurosceptic parties. This in turn could mean even more will continue to turn left is still out (watch Argentina’s political deadlock and less progress on important reform general election in 2023) as tough economic initiatives. Meanwhile US general elections in November headwinds and rising interest rates are reducing fiscal 2024 will show whether Democrats manage to build on room for pricey policy promises. recent resilience - which in turn would likely lead to more protectionist policies. The US election results could also 19

Allianz Research h s a l p s n n U a o k s n i s o a K n n a o y J o b t Capital Markets o h P Too early to re-risk! 2022 was an unmitigated disaster for capital policy rates cushion downside pressures on valuations and markets. The combination of higher interest rates allow for some long duration positioning. However, the despite slowing growth led to an unprecedented price rebounding momentum will be short-lived as fiscal support correction in both equities and fixed income. This left is gradually withdrawn going into 2024, with most asset investors with no place to hide and effectively killed classes slowly converging to (but not reaching) their long- any ex-ante diversification benefit, resulting in unseen term average returns. high interest-rate volatility. In this context, market fractures have started to appear, such as the recent In this uncertain environment, the expected correction turmoil in the UK Gilt market, as funding becomes in illiquid alternative assets has been overlooked. Less expensive and scarce. Despite not representing, as of transparent valuations and limited trading make them at today, an imminent systemic risk, the combined effect risk of being most severely hit in case investors are forced of high volatility and higher funding costs, amplified to sell. Because of this, and as liquidity drains and the by leverage and concentration risk, could set off a so- recession approaches, the likelihood of negative surprises called “liquidity spiral”, with funding needs triggered by in these segments continues to be high. The good news is falling prices increasing demand for safe collateral to that by late 2023, the global economy and markets will cover margin calls and shore up liquidity buffers. start leaving behind three years of extreme market and economic instability to start forming, once again, a much- The current volatile market dynamics are likely to spill needed but still timid structural cyclical positive trend over into the first half of 2023 as investors attempt to (Figure 11, following page). front-run the recovery path. Our economic scenario warrants a defensive tactical short-term positioning and hold-to-maturity investment in quality fixed income in the near term. During the second half of 2023, subsiding inflationary pressures and stabilizing 20

15 December 2022 Figure 11: US equity vs 10y government bond yearly total returns (%) 40 ) 30 % n 1985 r 1986 1995 u 2008 et20 r al t o t 10 ( d n Bo 0 1931 1941 10y 1969 2021 S-10 1999 U 2022 YTD 2009 -20 -60 -40 -20 0 20 40 60 S&P 500 (total return %) Sources: Refinitiv Datastream, Allianz Research Given the complexity of the current market and economic in equity markets this year has been driven by valuation context, we see seven themes shaping our 2023-2024 effects (i.e. reduction in price-earnings multiples) due capital market view: to higher real rates rather than earnings per se. With earnings expectations trending downward next year, Capital MarketsRemain cautious in the short run. Capital markets are there is still material downside risk for equity valuations bound to remain capricious as the timing and severity of at current levels. For instance, our identification method the expected recession (and its implications on policy) for equity-market bubbles suggests that the correction remain uncertain. Continued economic uncertainty will in US equities has not fully played out. With the S&P 500 continue to which could prevent a structural positive trend perceived return currently standing at about 8% it can be reversal until central banks reach peak hawkishness (i.e. inferred that the S&P 500 could fall by up to -10% over Q1 2023). In addition, current valuations suggest that the next 12 months. In general, a typical post-bubble markets still do not fully price in the expected balance correction tends to depress perceived returns to the low sheet erosion of companies (even for those with pricing single digits. High-quality credit and defensive equity will power) as demand falters. For instance, the correction most likely outperform in the short run (Figure 12). Figure 12: Inflation and monetary policy dominate market performance 10 US CPI (y/y%) US Core CPI (y/y%) 8 Fed Funds Rate (%) 10y UST (%) US IG Corp. yield (%) 6 4 2 0 -2 2008 2010 2012 2014 2016 2018 2020 2022 2024 Sources: Refinitiv Datastream, Allianz Research 21

Allianz Research At the mercy of monetary policy. For the past year, weight on assets and sectors less sensitive to interest market performance has been mainly driven by macro- rates. However, after the monetary policy pivot in late induced changes in monetary policy expectations and 2023, micro fundamentals (i.e. corporate balance sheets) not by corporate fundamentals. While a snapback to will regain more relevance and start driving market fundamentals will happen eventually it is unlikely to performance (Figure 13). occur during the course of next year. As a result, it is worth being cautious in the near term, putting more Figure 13: EUR assets vs ECB policy expectations 250 1y ECB policy change (bps) 5 2y ECB policy change (bps) 200 EUR IG Corporate spread (bps) 4 Eurostoxx (reb 100) 150 10y EUR Swap rate (% - rhs) 3 100 2 50 1 0 0 -50 -1 2021 2022 2023 Sources: Refinitiv Datastream, Allianz Research Respect the policy pivot line. The current energy crisis to nine months. EMs are likely to outperform as the initial has amplified increasing cross-country heterogeneity. conditions are far “cheaper” than those of developed Over the next two years with expect even greater markets, allowing for a stronger rebound that should be divergence within and across regions. Consequently, further fueled by a global and broad-based re-risking turn respecting the policy-pivot cue and the degree of (Figure 14). economic resilience of each country will be key to generate positive returns, especially over the next six Figure 14: Global monetary policy expectations (%) 12 US - Fed Funds (%) Eurozone - Deposit rate (%) 10 UK - BoE rate (%) Japan - BoJ rate(%) 8 Chile - Bank of Chile rate (%) India - Bank of India rate (%) 6 4 2 0 -2 2014 2016 2018 2020 2022 2024 Sources: Refinitiv Datastream, Allianz Research. Note: 1y and 2y ahead policy expectations based on OIS rates. 22

15 December 2022 Large passive sources of market demand are likely remain neutral or even negative, thus structurally departing. After many years co-living with QE, the mitigating the effect of central banks pulling back. Of era of permanent asset demand is coming to an end. course, this will entirely depend on central banks’ approach Central banks’ gradual pull-back from markets through to quantitative tightening, which we still believe will be quantitative tightening (QT) will most likely add some moderate (no direct sales). Apart from the direct effect of short-lived upward pressures on yields . Our calculations the lack of central bank purchases, the overall slowdown suggest the immediate effect of the push back will be in money supply due to tightening financial conditions will around 10-30bps for both long-term sovereign yields continue to have a deteriorating effect on risk appetite in and investment-grade corporate spreads. However, the next six to nine months. However, once the hawkish tilt at current yield levels, market participants will be is reverted in H2 2023, markets should start feeling a timid willing to absorb additional supply as yield hunters will reacceleration of money growth, adding tailwinds for risky increasingly try to lock in higher-income assets. This assets by pushing valuations higher (Figure 15). should especially be the case for investment-grade corporate credit, especially since net issuance will most Figure 15: US assets vs money supply 600 US IG spread change (y/y - bps) 30 US HY spread change (y/y - bps) 400 12m ahead implied Fed Funds change (bps) 25 US M2 money supply (y/y% - rhs) 200 20 0 15 -200 10 -400 5 -600 0 2010 2012 2014 2016 2018 2020 2022 Sources: Refinitiv Datastream, Allianz Research 23

Allianz Research A mild recession is still a recession. The expected mild outpacing upside potential in the short run. Additionally, this recession in most advanced economies next year will expected direct economic challenge to corporates’ top and directly challenge the still positive and relatively high bottom lines paired with still-high financing costs will most earnings expectations across major economies. In fact, likely lead to a minor acceleration of defaults, though these earnings expectations seem too high at the moment, will remain at historically low levels, and some increase in especially since numerous economic indicators point fallen angels (corporates downgraded from investment towards a timid earnings contraction in 2023 (the grade to high yield). However, and moving into 2024, the same holds for corporate margins). Because of this, still resilient aggregate corporate balance sheets will push we believe that equity and high-yield corporates still through and lead to the beginning of a recovery phase, with have some room for correction, with the downside risks micro-fundamentals leading market performance (Figure 16). Figure 16: US earnings growth (y/y%) 60 S&P500 EPS growth (%) 2022 (consensus) 50 2023 (consensus) 2024 (consensus) 40 AZ Research estimate 30 20 10 0 -10 -20 2015 2016 2017 2018 2019 2020 2021 2022 2023 Sources: IBES, Refinitiv Datastream, Allianz Research. Do not expect high-performing years. The fine balance between economic, geopolitical, and market uncertainty leaves too many open fronts to shift towards an aggressive investment strategy as a single bad data point has the power to derail markets. Because of this, and given the fact that this situation may continue for longer than markets and economists are currently anticipating, it seems reasonable to assume that the combination of relatively high risk aversion, deteriorating fundamentals, macroeconomic uncertainty and increasing market liquidity issues will put a lid on market performance moving forward. In this regard, our risky assets decomposition models still show that markets are walking on thin ice, especially because the unstable balance between market sentiment and economic resilience will continue to be challenged down the line until a global economic rebound trend is clearly formed (Figure 17). 24

15 December 2022 Figure 17: EMU profit margins vs economic confidence 50 9 40 8 30 7 20 6 10 5 0 -10 4 -20 3 -30 2 -40 Consumer confidence (y/y) 1 Industrial confidence (y/y) -50 EMU net profit margin (9m lag - % - rhs) 0 2003 2006 2009 2012 2015 2018 2021 Sources: Worldscope, Refinitiv Datastream, Allianz Research Board the ESG train. Even though the current energy crisis outperformance of such assets vis a vis ESG laggards. will most likely lead to a relative outperformance of oil & Embracing the ESG transition within capital markets gas sectors and of energy-rich countries in the short run, is likely to act like a downside hedge since most new the ESG trend will continue to gain relevance in the next money and investment strategies will inevitably be two years. Investors are likely to continue transitioning to scrutinized based on ESG principles. As it is well known, ESG-intensive investment strategies, with most fresh capital “the trend is your friend” (Figure 18). being deployed with such a sustainable bias. This new market rebalancing act is bound to generate a structural Figure 18: Infrastructure investment by type 80% Solar Wind Other Ren. Gas (broad) 60% Fossil fuels Other non-Ren. 40% 20% 0% 2010s Post Covid 2010s Post Covid 2010s Post Covid 2010s Post Covid 2010s Post Covid US Germany France Spain Italy Sources: Refinitiv Datastream; Allianz Research. Notes: “Ren.” is used as abbreviation of renewables in “Other ren.” and “Other non- ren”; the category „gas” includes LNG and regasification plants; the category “other renewables” includes geothermal, biomass and hydroelectric. 25

Allianz Research These themes inform our global strategy. We expect Corporate credit – Optimizing the risk-return profile. fixed income, especially investment-grade corporate The extreme “macro-based” 2022 fixed income credit, to outperform equities in 2023, particularly underperformance has pushed corporate yields structurally towards year-end, but not at any cost. In 2024, higher with most of the move triggered by higher long- equities should slightly outperform fixed income, with term rates. In 2023 policy rate expectations will continue emerging markets outpacing both Europe and the US. to dominate corporate credit performance leaving micro Importantly, and due to the current high yields, high fundamentals out of scope and leading to exacerbated quality fixed income may already prove interesting for short-term volatility with a high probability of short- hold-to-maturity investors that can withstand short- lived spread widenings and price underperformance for term volatility (Table 5). In summary: both investment-grade and high-yield credit. However, corporate spreads are bound to compress due to recovering Sovereign rates – A bit too early to overweight fundamentals, relatively high cash positions, improving duration. We expect the prolonged hiking cycle to forward-looking economic sentiment during the second half fully dominate both ends of the sovereign curve next of next year. We expect spreads to remain close to current year leading to flattened yield curves. As market levels for the remainder of the year, with the possibility expectations are coincident with our economists’ policy of some widening waves in H1 2023 (~180bps for IG). path a long-duration overweight call is not warranted Afterwards we expect a structural compression of spreads, as there is still a high risk of markets readjusting for with both IG and HY credit slowly crawling towards long- higher short-term rates. In the Eurozone, this situation term averages (~160bps in 2023 and ~140bps in 2024). could lead to an increase in fragmentation risk which Within this camel-hump-shaped trajectory, we expect high- could keep sovereign spreads persistently higher in yield credit to underperform especially in H1 2023 and to the short run. Because of that, we expect US Treasury structurally compress in 2024 (~450bps by 2024). yields to move timidly lower over the next two years and especially in 2024 due to a decline in the short- Equities – Caution along the investment horizon. Equity end of the curve leading to a timid bull steepening. markets have come under pressure in 2022 due to mounting Numerically, we target a 3.6% 10y US Treasury yield stagflationary concerns weighing on market sentiment. The for 2023 and 3.5% for 2024. Moving across the Atlantic, market leaders of the past 10 years have quickly become we expect 10y Bunds to follow a similar pattern but the main drag to market performance (around -10 to -20% with a delay as the ECB policy turn will most probably ytd). However, and despite the increased recessionary take slightly longer than the US. In this environment, certainty, markets continue to refrain from crossing the we expect the 10y Bund to remain flat at 1.9% in 2023 bear market line and will probably finish the year with while decreasing 20bps to 1.7% in 2024. a low double-digit negative performance, probably underestimating this cycle’s implications on aggregate Emerging markets fixed income - Yields are high, demand. Because of this, it seems too early to call for an but pressures have not left. Rising yields and strong equity market trough and we believe that it is possible corrections over the last two years make EMs to see another sizeable market correction in the short- increasingly attractive later in the year. However, the run should markets readjust for a more aggressive policy risks coming from a weak macroeconomic outlook path or for a deeper recession. This downside pressure remain. Commodities exporters still have an edge in will continue to be exacerbated by the still-high earnings the short-run, but tailwinds from China’s reopening expectations, which will have to readjust in the next 12 and a potential Fed pivot would favor other Southeast months (especially in the US). Moving into late 2023, equity Asian countries. We expect a volatile first half of markets should regain some traction as the push coming the year for hard currency spreads, that could reach from declining short-term rates and the overall economic maximums close to 400, but that should compress recovery should aid risk appetite (~5% to 8% total return towards year end (below 350bps in 2023) and even both in 2023 and 2024). Regionally, we expect Europe and more in 2024 (below 300bps), owing to still high EMs to still post single-digit positive price returns in 2023 commodity prices and improving macro fundamentals. while the US will most likely remain flat. In 2024, we should Similarly, we think there will be interesting entry points see a reacceleration of equity returns, with broad markets through the year in the local currency environment performing just short of double-digit returns and with EM as EM central banks wait for the Fed to move and showing some growing momentum due to low valuations inflation to cool down. The GBI-EM div. will experience in some Asian markets, although with the important caveat sustained yields decreases (6.5% in 2023 and 6% in of important downside risks coming from China and 2024). geopolitics. 26

15 December 2022 Table 5: Capital markets 2023 - 2024 Forecasts year-end figures Last Unit Baseline EMU 2021 2022 2023f 2024f e Government Debt Policy rate (ECB deposit rate) 1.50 % -0.50 2.00 2.75 2.25 Policy Rate (MRO) 2.00 % 0.00 2.50 3.25 2.75 10y yield (Bunds) 1.93 % -0.2 2.10 1.90 1.70 10y EUR swap rate 2.6 % 0.3 2.80 2.20 2.00 Italy 10y sovereign spread 192 bps 136 210 180 160 France 10y sovereign spread 49 bps 37 65 50 40 Spain 10y sovereign spread 104 bps 77 100 85 75 Corporate Debt Investment grade credit spreads 167 bps 98 190 170 140 High-yield credit spreads 501 bps 331 520 540 460 Equity Eurostoxx (total return p.a.) -8 ytd % 23.4 -10 6 7 US 2021 2022f 2023f 2024f Government Debt Policy rate (upper) 4.50 % 0.25 4.50 4.25 3.25 10y yield (Treasuries) 3.50 % 1.5 3.75 3.60 3.50 Corporate Debt Investment grade credit spreads 137 bps 98 160 150 130 High-yield credit spreads 437 bps 310 480 510 440 Equity S&P 500 (total return p.a.) -14.8 ytd % 28.7 -15 2 9 UK 2021 2022f 2023f 2024f Government Debt Policy rate 3.00 % 0.25 3.50 4.00 3.50 10y yield sovereign (Gilt) 3.3 % 1.0 3.20 3.75 3.25 Corporate Debt Investment grade credit spreads 192 bps 115 220 200 160 High-yield credit spreads 651 bps 390 650 680 550 Equity FTSE 100 (total return p.a.) 5.2 ytd % 18.4 4 3 7 Emerging Markets 2021 2022f 2023f 2024f Government Debt Hard currency spread (vs USD) 279 bps 295 320 335 290 Local currency yield 6.8 % 5.72 7.1 6.4 5.9 Equity MSCI EM (total return p.a. in USD) -18.5 ytd % -2.2 -20 7 7 Others 2021 2022f 2023f 2024f Foreign Exchange EURUSD 1.065 $ per € 1.137 1.03 1.06 1.11 Commodities Oil Brent* 83 $ per Bbl 78 97 96 90 Natural Gas Dutch TTF* 132 € per MWh 69 170 173 150 *yearly averages Sources: Refinitiv Datastream; Allianz Research. 27

AALLIANZ RESEARCHllianz Research Our team 28

15 December 2022 Chief Economist Head of Head of Macro & Capital Head of Insurance, Wealth Allianz SE Economic Research Markets Research & Trend Research Allianz Trade Allianz SE Allianz SE Ludovic Subran Ana Boata Andreas Jobst Arne Holzhausen [email protected] [email protected] [email protected] [email protected] Macroeconomic Research Maxime Darmet-Cucchiarini Roberta Fortes Françoise Huang Maddalena Martini Senior Economist for US & France Senior Economist for Ibero-Latam & Africa Senior Economist for Asia Pacific Economist for Italy & Greece [email protected] [email protected] [email protected] [email protected] Manfred Stamer Katharina Utermöhl Senior Economist for Middle East & Senior Economist for Europe Emerging Europe [email protected] Our [email protected] Corporate Research Ano Kuhanathan Aurélien Duthoit Maria Latorre Maxime Lemerle Head of Corporate Research Senior Sector Advisor, B2C Sector Advisor, B2B Lead Advisor, Insolvency Research [email protected] [email protected] [email protected] [email protected] Capital Markets Research Eric Barthalon Jordi Basco-Carrera Pablo Espinosa Uriel Head of Capital Markets Research Lead Investment Strategist Investment Strategist, Emerging [email protected] [email protected] Markets & Alternative Assets [email protected] Insurance, Wealth and Trends Research Michaela Grimm Patricia Pelayo-Romero Kathrin Stoffel Markus Zimmer Senior Economist, Economist, Insurance & ESG Economist, Insurance & Wealth Senior Economist, ESG Demography & Social Protection [email protected] [email protected] [email protected] [email protected] 29

Allianz Research Recent Publications 09/12/2022 | The economics of war, (and its aftermath) 08/12/2022 | Eurozone: Old lessons for a new world 01/12/2022 | House of cards? Perspectives on European housing 30/11/2022 | ESG – from confusion to action 24/11/2022 | Europe: How big will the interest rate shock be in 2023? 23/11/2022 | Black Friday for consumers, bleak Friday for retailers? 18/11/2022 | Financial globalization: moving towards a polarized system? 15/11/2022 | Africa’s journey to net zero: USD7trn just for energy 10/11/2022 | Fixed income is back 09/11/2022 | US midterms: Republicans are back, (fiscal) policy impasses too 04/11/2022 | EU fiscal rules – quo vadis? 03/11/2022 | Picking up contagion in equity and commodity markets 28/10/2022 | Brazilian elections: The calm before the storm? 27/10/2022 | Energy crisis, interest rates shock and untampered recession 21/10/2022 | Market Volatility and Corporate Bonds: Collateral Damage 20/10/2022 | Can the booming battery sector help Europe with its energy crisis? 14/10/2022 | ‘Whatever it takes’ reloaded? 12/10/2022 | Allianz Global Wealth Report 2022: The last hurrah 05/10/2022 | Globalization 2.0: Can the US and EU really “friendshore” away from China? 04/10/2022 | Gilt market meltdown – A first post mortem and key takeaways 30/09/2022 | Eurozone public debt: The interest rates reality check 29/09/2022 | Reverse currency war puts emerging markets at risk 22/09/2022 | US housing market: The first victim of the Fed 20/09/2022 | Shipping: liners swimming in money but supply chains sinking 15/09/2022 | Lights out! Energy crisis, policy mistakes and uncertainty 13/09/2022 | Missing chips cost EUR100bn to the European auto sector 09/09/2022 | Italy’s elections: snapping back? 07/09/2022 | Double trouble? Inflation means less cash and more debt for companies 01/09/2022 | Averting Gasmageddon and securing a just transition 30/08/2022 | Green infrastructure investment: The public sector cannot do it alone 28/07/2022 | How to ease inflation? Non-tariff barriers to trade in the spotlight 26/07/2022 | High yield: have the tourists left? 21/07/2022 | Eurozone: watch credit conditions! 20/07/2022 | Remote Work: Is the honeymoon over? 19/07/2022 | The anatomy of financial bubbles, crashes & where we stand today 13/07/2022 | Back on the (climate ) track Discover all our publications on our websites: Allianz Research and Allianz Trade Economic Research 30

15 December 2022 Director of Publication Ludovic Subran, Chief Economist Allianz SE Phone +49 89 3800 7859 Allianz Group Economic Research https://www.allianz.com/en/economic_research Königinstraße 28 | 80802 Munich | Germany [email protected] @allianz allianz Allianz Trade Economic Research http://www.allianz-trade.com/economic-research 1 Place des Saisons | 92048 Paris-La-Défense Cedex | France [email protected] @allianz-trade allianz-trade About Allianz Research Allianz Research comprises Allianz Group Economic Research and the Economic Research department of Allianz Trade. Forward looking statements The statements contained herein may include prospects, statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such forward-looking statements. Such deviations may arise due to, without limitation, (i) changes of the general economic conditions and competitive situation, particularly in the Allianz Group’s core business and core markets, (ii) per- formance of financial markets (particularly market volatility, liquidity and credit events), (iii) frequency and severity of insured loss events, including from natural catastrophes, and the development of loss expenses, (iv) mortality and morbidity levels and trends, (v) per-sistency levels, (vi) particularly in the banking business, the extent of credit defaults, (vii) interest rate levels, (viii) curren-cy exchange rates including the EUR/USD exchange rate, (ix) changes in laws and regulations, including tax regulations, (x) the impact of acquisitions, including related integration issues, and reorganization measures, and (xi) general compet-itive factors, in each case on a local, regional, national and/or global basis. Many of these factors No duty to update The company assumes no obligation to update any information or forward-looking statement cont- ained herein, save for any information required to be disclosed by law. may be more likely to occur, or more pronounced, as a result of terrorist activities and their consequences. 31