Invesco: Central Banks and Geopolitics to Shape the Course of the Global Economy in 2020

For the US, we expect an environment of modest growth of approximately 2% in 2020, which exceeds consensus expectations. Our view is that growth bottoms early in the year at approximately 1%, and then accelerates as the year progresses. We expect inflation to remain relatively benign, at about 2.2%.

The growth slowdown of 2019 was driven by the lagged results of Fed tightening in 2018 and the ongoing uncertainty of the US-China trade conflict. The Fed has since unwound most of the tightening, and financial conditions have eased meaningfully. The yield curve has normalized, and the dollar has weakened modestly. We believe the Fed will deliver as many interest rate cuts as necessary to support the economic expansion.

We expect the US-China trade wars to continue in the short term, although there is an increasing likelihood of incremental improvements as we get closer to the presidential election in November 2020. That election could increase economic policy uncertainty in the early part of 2020, but it should decline toward the end of the year. Cycles tend to end with policy mistakes, and the risks have risen. However, it is our base case that the policy mix will continue to get modestly better.

The bottom line is that the big US macro narrative has not changed. It is still an environment of relatively weak growth and benign inflation. The good news is that slow growth, benign inflation, and an easy Fed could be conducive to the economic cycle going on for far longer than most people suspect. Nonetheless, in that environment, the primary rule of policymaking is to do no harm. We believe the Fed and central banks globally will deliver more accommodation if necessary to support the economic expansion. And so we do not expect a recession in 2020. The classic signs of recession — Fed tightening, tighter financial and credit conditions — are not present at this time.

Canada Outlook

We expect Canadian gross domestic product (GDP) growth to exceed expectations at approximately 2% for 2020 versus consensus expectations of 1.6%. Canada has already shown signs of a stabilization and pickup in economic growth thanks to a number of factors, including improvements in the housing market and higher wage growth, and we expect this will continue. After a policy-induced slowdown in 2017/2018, real GDP growth bottomed at 1.4% in the first quarter of 2019 and improved to 1.6% in the second quarter, and we expect it to converge with the US at 2% by the latter part of 2020. We expect inflation to pick up slightly to approximately 2.2% by the latter part of 2020.

We believe the Bank of Canada (BOC) could be one of the few central banks to raise rates in 2020 (most likely the second half of 2020). However, we do not believe this will create headwinds for the Canadian economy. The Canadian economy and stock market tend to do best in an environment of quickening global growth, rising commodity prices, and an appreciating Canadian dollar, which would be consistent with interest rate hikes. We expect the BOC to stay on hold for the rest of the year and resume raising interest rates perhaps in the second half of 2020.

Eurozone Outlook

We expect economic growth of about 1% or less in 2020. The economy has been negatively impacted by a lack of fiscal stimulus as well as the US-China trade war, and those factors are likely to be present in the coming year.

The eurozone has been having great difficulty in generating an adequate policy response. We expect the weakness in the manufacturing sector to bleed over into the services sector at a greater extent. We are starting to see initial cracks in the labor market in Germany with working hours being reduced, which is likely to carry over through 2020. The overall story is weak.

And yet the bigger issue is that the eurozone is not working as it was intended to — being a monetary union but not a fiscal one is creating enormous challenges. One challenge continues to be a significant capital imbalance between periphery and core eurozone countries.

Geopolitical risks should continue to be an issue for the eurozone. In Italy, we worry about higher political fragmentation. The reality is that so far the only hard number in the Italian budget law is the deficit. While the new Italian coalition is much more willing to interact in a constructive way with the European Union (EU), there is a significant chance in 2020 that the majority coalition collapses, especially in the back half of year. GDP growth expectations for Italy fall in a range of 0% to 0.4%.

We expect the European Central Bank (ECB) to remain accommodative in 2020, continuing QE purchases and possibly even cutting rates again. If governments, especially Germany, appear unwilling to provide fiscal stimulus, we could see the ECB explore more experimental monetary tools — particularly ones that could mimic fiscal stimulus. However, we’re mindful that dissent against monetary easing plans by outgoing ECB President Mario Draghi may make this task more difficult for new ECB President Christine Lagarde, as she is seen as a consensus builder. Therefore, further monetary easing may not be possible in the absence of a deeper downturn or outright recession.

UK Outlook

We expect the UK economy will grow at less than 1% in 2020. The economic policy uncertainty created by Brexit has depressed business investment and business confidence.

As of this writing, the Dec. 12 election looks like a three-way race with different leading parties offering quite different visions for the future of the UK:

Liberal Democrats will likely campaign to remain in the EU. Labour may seek a second Brexit referendum to confirm the results of the first. And the prime minister wants to get Brexit done on the basis of the deal he negotiated in October, essentially rendering the election as a referendum on himself and his version of Brexit.

Johnson’s deal (which would need to be ratified by the UK and EU parliaments) seeks to keep Northern Ireland aligned with the EU, with a customs border in the Irish Sea. The UK mainland would then be able to engage in regulatory divergence from the EU after the transition period (currently slated to expire at the end of 2020). Depending on the election result, this might simply end up moving the no-deal goal post to Dec. 31, 2020, or Jan. 31, 2021, or potentially later.

Japan Outlook

We expect the Japanese economy to stabilize in early 2020 after a fourth-quarter 2019 deceleration caused by the effects of the new consumption tax. We then expect the economy to modestly re-accelerate. Our base case expectation for GDP growth in 2020 is approximately 0.4%.

We believe the increased tax burden should slow consumption demand, although the impact should be much smaller than what we saw with the 2014 consumption tax increase. We believe the Japanese government is likely to initiate accommodative fiscal policy to help counter the headwinds created by the new consumption tax. We also believe the Tokyo Olympic Games will increase tourism and help boost economic growth.

We don’t expect the Bank of Japan (BOJ) to ease policy unless the yen strengthens significantly. However, if the yen does strengthen, we expect the BOJ to consider a variety of policy tools including additional purchases of equity exchange-traded funds (ETFs), if necessary. In addition, four other potential policy easing measures mentioned by Governor Haruhiko Kuroda include:

China Outlook

Chinese economic growth has modestly decelerated, but we believe the fundamentals remain solid as the transition continues to a consumption, services-led economy. We expect GDP growth in 2020 to be approximately 5.8% to 6%, which is around consensus expectations.

China’s property market continues to be buoyant and is likely to see continued robust investment growth, in our view, which should be positive for the Chinese economy. We expect further softening of the renminbi heading into 2020 — but at a measured clip, which should also be supportive of economic growth. Other positive catalysts for the Chinese economy include fiscal stimulus measures that should boost fixed asset investments, and our expectation that there will be a stabilization in the tariff wars.

In terms of the US-China trade war, we believe China will not make a deal to end the conflict if it requires any major concessions beyond narrowing the trade deficit. China appears willing to allow the trade war to continue rather than to agree to demands that it views as detrimental to the Chinese economy and its future strategic position. However, we remain positive on the Chinese economy because we believe China will utilize the fiscal and monetary tools necessary to support its economy despite headwinds created by the ongoing trade war.

Our expectations for the People’s Bank of China (PBOC) in 2020 include relatively modest monetary stimulus. The PBOC could continue loosening monetary policy with potential cuts to the required reserve ratio.

Other emerging market outlooks

India

We expect GDP growth in India to be about 5.5% to 6% for the year. We expect growth to slow earlier in 2020 and then modestly re-accelerate, helped by the planned corporate tax cuts for next spring. We expect economic growth to slightly underperform expectations next year.

The Indian economy has been slowing sharply, with consumption recently taking major hits following weak investment. Auto sales in particular have been disappointing. We expect that weakness to continue into early next year.

However, we believe the economy will benefit from significant fiscal and monetary stimulus over the course of the year. The Reserve Bank of India appears poised to provide further accommodation, and corporate tax cuts should be very stimulative, in our view. However, there are longer-term negative implications given that the true fiscal deficit is high and some of the impending fiscal stimulus could be financed by the Reserve Bank of India (profits, capital, dividends). In addition, financial sector reform and general structural reforms are still lagging.

Asian emerging markets

Growth in Asian emerging markets remains strong, although we expect it to modestly decelerate. We expect economic growth in 2020 to be approximately 6.2%, led by Indonesia and Vietnam, which have been benefiting from trade war supply chain disruptions. Small, open economies such as Hong Kong and Singapore could experience lackluster economic growth.

European emerging markets

We expect more modest economic growth in European emerging markets in 2020 — approximately 2%.

Latin America

Our expectations for GDP growth in 2020 are modest at 2% (versus a consensus about 2.4%).

Asset class outlooks

In addition to our regional outlooks, the Global Market Strategy Office has developed a view of various asset classes heading into 2020. We expect global economic growth to decelerate for much of 2020. Given that we expect continued monetary policy accommodation with little fiscal stimulus, we are more optimistic about capital markets than we are about economic growth. We therefore favor risk assets over non-risk assets. Details of our asset class view are below:

Equities

US. We believe the monetary policy environment will remain supportive of equities in 2020. However, we believe investors will need to be more discerning in this environment. Valuations appear stretched for US equities, in our view, but we recognize that valuations have not often been a good predictor of equity performance in the shorter term. In addition, we believe lower interest rates and low inflation make US equities more attractive. Also, the dollar has weakened recently because of “quantitative easing lite” policies that are expected to be ongoing. That should be positive for US equities. Therefore, we are bullish on US equities, with the caveat that investors should expect more volatility in the coming year.

Canada. We are modestly bullish on Canadian equities. We believe long-term Canadian equity underperformance could be coming to an end as Canadian stocks enjoy some advantages that may be underappreciated by investors. The United States-Mexico-Canada trade agreement (USMCA) appears poised to be ratified, which would benefit Canadian stocks. In addition, the Canadian manufacturing outlook remains positive, suggesting business sentiment is positive, which should bode well for equity returns. Also, Canadian stocks could benefit from a weaker US dollar and the potential for higher commodity prices.

Europe and UK. We are neutral on European (ex UK) equities. Valuations are very attractive (based on an analysis of dividend yield and cyclically adjusted price-earnings ratios), but we have not yet seen signs that the eurozone economy has reached an inflection point. We are bearish on UK equities. We believe it is reasonable to expect earnings declines and slower dividend growth, especially since a large portion of the UK market is exposed to either commodities or banks.

Japan. We are modestly bullish on Japanese equities given that we envision a moderately brighter economic picture for Asia and expect limited downside to US long-term yield in our base case, which will likely result in either more stable or even weaker yen. (It has often been the case that stronger yen worked negatively for Japan equities, including this year.)

Emerging markets. Overall, we are bullish on emerging market equities. Catalysts for emerging markets include a more accommodative Fed. In particular, balance sheet normalization recently ended, which should end the liquidity suck it created for emerging markets. We also expect the search for yield to drive investors to emerging market equities. Asian emerging equities should benefit from fiscal stimulus from China and India. Chinese stocks in particular should benefit from Chinese financial liberalization and the increased weighting of Chinese A share stocks in MSCI indexes. We are bearish on Latin American equities, many of which are too closely tied to the fortunes of commodities prices and some of which we expect to suffer from policy uncertainty. We have a neutral view of emerging Europe equities given decelerating growth in the euro area.

Fixed income

Within fixed income, we believe that higher-yielding investments will outperform given the low rate environment. Therefore, we are bearish to developed government bonds with the exception of UK gilts, whose returns should be driven by declining yields. We prefer investment grade credit to developed sovereign credit, given the former’s higher yields and better total return potential. We are positive on high yield bonds, although we prefer US high yield to eurozone high yield. Even allowing for a widening of spreads and a rise in default rates, we expect returns to be better than that of lower-yielding fixed income asset classes. We are also positive on emerging market debt, also given higher yields and greater total return potential.

Alternatives

Real estate. We are most positive on real estate, given its relatively high yields and potential for outperformance in what we expect to be a relatively low return environment. We favor eurozone and emerging market real estate but favor avoiding UK real estate until Brexit is resolved.

Gold. We are bearish on gold. While we recognize the diversification benefits of gold as well as a lower opportunity cost given lower rates globally, we expect low returns for gold in the coming year given the rally it experienced this year. In addition, gold typically performs best in recessionary or stagflationary environments, neither of which we expect for next year.

Private equity and hedge funds. Private equity looks attractive in this environment given its risk-adjusted return potential, while we are neutral on hedge funds.

Commodities. We are bearish on commodities, as we believe valuations are much higher than historical norms for commodities in real terms. In addition, our historical analysis suggests that industrial commodities have performed poorly when the Fed is cutting rates.

Cash

We have a slight bullish view of cash-like instruments, preferring ultra-short-duration instruments. Our rationale is that such investments can offer a “safe haven” alternative to gold and are currently more attractive than gold given the latter’s stretched valuations. In addition, given the volatility markets are experiencing, having adequate cash on hand enables investors to take advantage of opportunities created by downward volatility.