While there are several factors that raise the risk of recession in 2019, it’s not the most likely scenario. Instead, a slowdown in growth—led by the United States and China—tops the probability list.

In the U.S.: Economic growth will likely drop back toward 2%—a lower but more sustainable rate—as the supports put in place during the financial crisis continue to be removed.

In Europe: Growth won’t be spectacular here either—although Europe is in an earlier stage of the business cycle than the U.S., which should help keep the momentum going in the short term.

In emerging markets: Despite a slowdown China’s growth is expected to remain near 6%, spurred by government intervention. The biggest risk here is the one we’ve all been talking about for months: U.S.-China trade tensions.

What else could tip us into recession? The Federal Reserve might raise interest rates more than expected if inflation shows greater signs of life.

Inflation will continue to languish

For years we’ve said that the new norms of globalization and technological disruption will hold inflation down in the United States, Europe, Japan, and elsewhere. In 2018 we accurately predicted that inflation would rise slightly due to normal business cycles, but in 2019 we don’t anticipate further jumps in core inflation, even despite lower unemployment rates and higher wages.

So where does that leave us? In the U.S., we expect core inflation to remain near 2% and even weaken by the end of 2019. An escalation in either tariffs or oil prices would probably affect U.S. core inflation only temporarily. In Europe and Japan, price pressures are likely to increase gradually as their labor markets also tighten—although inflation should still be well below 2%. Higher wages are likely, yes, but higher inflation is not.

Interest rate increases will come to a screeching halt

The recent bout of financial market volatility and policy uncertainty will likely throw a damper on the Fed’s plans to get back to normal interest rates in 2019. But by midyear, we expect that these effects will have dissipated and the Fed will enact their final hike of the cycle—bringing the policy rate range to 2.50%–2.75%—in the face of stagnant inflation and decelerating growth.

Other developed-market central banks, though, haven’t even begun to lift interest rates from post-crisis lows. We expect the first rate increase from the European Central Bank in September 2019, followed by very gradual hikes thereafter. Japan is late to the party and we don’t foresee any rate increases there in 2019.

Most emerging-market countries don’t control their own destinies and will be forced to tighten along with the Fed, but China has the means to buck that trend.

Investing will continue to help you reach your goals

In 2018, markets dealt with quite a few bursts of volatility, to say the least. And we don’t expect much to change in 2019. In fact, it’s possible that 2019’s volatility could outdo 2018’s.

But do we expect to enter a sustained bear market in the near future? Not without a recession. That said, our outlook remains guarded and we expect pretty modest returns over the next several years, given the economic factors above.

But all hope is not lost. Longer-term, our 10-year outlook for investment returns is beginning to improve slightly when we factor in higher short-term interest rates across major developed markets. This is the first (modest) upgrade in our global market outlook in more than 10 years.

Our global bond return outlook is now 2.2%–4.2% compared with last year’s outlook of 1.5%–3.5%—although it does still lag behind the historical average of 4.7%.

Returns in global stock markets are likely to be about 5%–7% for U.S.-dollar-based investors. This remains significantly lower than the experience of previous decades and of recent years when they’ve risen 12.6% annually since the market bottom. We do, however, expect the prospects for higher returns to increase thanks to slightly more attractive stock valuations.

As was the case last year, the risk of a “correction” (10% loss) for stocks is considerably higher than for high-quality bond portfolios.

For more insights into the global markets in 2019 and beyond, see our economic and market outlook.

Note:

All investing is subject to risk, including the possible loss of the money you invest.