We see 2020 being influenced by three cycles fighting for supremacy. First, the traditional macro cycle, which is typically the dominant market driver. The issue here is whether there is a looming recession in the developed world. Second, the monetary policy cycle, traditionally dependent on the broader macro cycle, but due to changing central bank priorities now increasingly divorced from it. Finally, the political cycle, which, due to its ability to trigger sudden changes in policy priorities, deserves greater attention in the next few years.
Slowdown, yes; recession, no
Our economic analysis shows the macro cycle remains quite flat, but still indicates no recession. Labour market walls are holding, continuing to insulate consumers from most of the weakness in business activity. Meanwhile, central banks have pivoted towards more growth support, which should help release some of the pent-up investment demand and allow a modest pick-up in global growth to 3.4% in 2020 from 3.3% in 2019.
For illustrative purposes only. Source: Macrobond, Bloomberg, PineBridge Investments Calculations as of 10 October 2019
China, US plod along
Throughout 2019, China’s service sector activity indicators showed growth in the domestic economy held up, while the more export-oriented manufacturing sector stalled. Most of the government’s stimulus measures were targeted at the consumer. What complicates the picture is the resumption of China’s structural slowdown – essentially driven by lower productivity gains – that will produce weaker expansion rates in the coming years. An easing in trade tension would clearly be a relief. A rebound in business investment in the US and the eurozone could also limit downside risks for Chinese manufacturers. As long as unemployment remains low, the Chinese consumer will continue to prevent a more serious slowdown.
Meanwhile, the current US business cycle has been the longest on record. Job growth has started to slow, but it won't take much to boost US business sentiment and release pent-up investment demand. A US-China trade truce would help, as would a stronger signal that the Federal Reserve understands this isn't a moment for "fine-tuning". It needs to do "whatever it takes" to prevent a more serious slowdown. We expect further easing steps in 2020 and a more supportive rhetoric to generate a modest rebound in business investment that should keep overall GDP growth just above the 2% potential growth rate.
Policy dominates macro
Economic fundamentals usually determine the policy cycle. However, structurally lower inflation is forcing central banks to renew easing measures irrespective of the underlying macro fundamentals. The European Central Bank’s decision to restart quantitative easing pulled yields down even further, creating the yield curve inversion that some fear is forecasting a recession. We see the policy side is now dominating the macro cycle, and we expect more easing around the world in 2020, no matter what the economic fundamentals show. If bond yields don't rebound, the Federal Reserve will have to cut rates much deeper to regain control of the yield curve.
Risk from political power shifts
The biggest risk in a world dominated by the policy cycle is a sudden change in those very policy priorities, which could come in the form of a surprise election result that forces investors to reassess asset quality and prices. The biggest electoral event in 2020 is likely the US election, but Europe deserves even more attention in the next few years. The UK continues to grapple with Brexit, while anti-EU parties are challenging for power in major European countries. Germany is facing elections in 2021, the outcome of which, following Chancellor Angela Merkel’s decision to retire, are uncertain.
A paradoxical world
Traditional risk analysis is less important in an environment dominated by the policy cycle. Any downside risk that materialises only means more central bank easing. Conversely, any upside risk to growth would diminish the market-friendly policy support and could paradoxically hasten the advance of the next recession through a sharp market sell off. Overall, 2020 is an environment where growth will remain lacklustre, but financial markets can deliver above-trend performance as a result of further policy-induced declines in bond yields.
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Last updated 22 July 2019