- Global economic growth may stabilize in 2020 but is not likely to pick up materially
- Bond returns will depend on data and policies as central banks play smaller role
- We have a favorable outlook on corporate and municipal bonds and on mortgage-backed securities
At the outset of 2020, global economic growth is showing more signs of stabilizing. While historical patterns suggest a sizeable recovery after stabilization this year, we expect only a muted bounce in growth. Monetary easings by major central banks have started to filter through the global economy, while trade tensions continue to take a toll on investments and business confidence. But the spillover from faltering manufacturing to services sectors, so far, have been minimal. Labor markets remain firm and are anchoring the global expansion. As global manufacturing activity gradually stabilizes at low levels, recession probabilities have been diminishing.
We expect the U.S. economy to grow at a moderate pace of around 1.75% to 2.00% in 2020. China’s growth has structurally slowed, and policy makers there have been selectively stimulating their economy. Uncertainties around trade and other policy shifts remain fairly high. In this environment, businesses are likely to remain cautious. Economies that are fueled by high consumer spending and supported by relatively young demographics and healthy balance sheets are likely to perform better.
Volatility could tip the Fed into further easing
The Federal Reserve lowered its main policy rate three times in 2019. Together with liquidity operations in U.S. money markets, the Fed’s moves at the front end of the Treasury yield curve are almost equivalent to four rate cuts. Federal Open Market Committee (FOMC) members have signaled the Fed will be on hold until the U.S. economic trajectory changes materially. Other central banks around the world have also addressed market worries by easing monetary conditions. The European Central Bank (ECB) lowered one of its policy rates to a record low and re-initiated its asset purchase program indefinitely.
While the risk of a recession is declining, the low level of growth makes the global economy vulnerable to shocks originating from trade tensions or other political and/or financial market developments. We see a significant chance of an unexpected event increasing volatility in financial markets as 2020 progresses. Relatively high levels of volatility in financial markets or policies could prompt the Fed to cut rates during the course of 2020.
Risk assets depend on policies and data
In 2020, global rates are likely to be determined by the interplay between rising international activity and financial market volatility. While the macro rebound story that risk assets are trying to price in will push sovereign bond rates higher, an occasional recurrence of market volatility that partly reflects less-buoyant global growth will naturally push rates lower.
From the beginning of 2019 until September, the returns on risk assets were led by the rally in global rates. In the final quarter of the year — amid emerging signs of stabilization and positive trade policy news — sovereign bond yields rose, and spreads narrowed. And as central banks take a back seat, data flow and policies will likely dominate the direction and magnitude of bond returns in the early part of 2020.
Data flow and policies will likely dominate the direction and magnitude of bond returns in the early part of 2020.
Stabilizing global growth and lower rates will provide a constructive environment for risk assets. Fixed-income assets that are highly sensitive to positive “risk-on” sentiment will have room to further rally. Therefore, we continue to have a favorable outlook on corporate bonds, municipal bonds, and mortgage-backed securities. We do not expect U.S. assets to materially underperform international securities. The dollar will likely remain strong against other global currencies.
U.S. elections likely to cause headwinds
Policy uncertainties will continue to weigh on the outlook. Unabated trade tensions, impeachment proceedings, and the 2020 U.S. presidential election (featuring progressive proposals) are likely to be the main headwinds for risk assets. While trade negotiations between the United States and China continue, we do not expect any major policy breakthrough.
Politics could also move markets. Many of the Democratic candidates running for president have proposed progressive ideas. Any major policy shift based on these proposals can have material implications for the U.S. economy and financial markets. Adding to the uncertainty is the outcome of the impeachment inquiry.