Since early December, global market sentiment has been quite upbeat, as developments seen as risks including a tit-for-tat tariff escalation, an acute, unplanned and hard Brexit and (premature) monetary tightening and credit stress receded. These reinforced our view that global recession was unlikely, though growth remains relatively sluggish. All these trends and continued monetary support from major central banks (G3+ China), helped support risk assets, including oil prices. While the beginning of the year has been met with dangerous escalation in the Middle East, markets largely shrugged off these developments (in part due to the lack of persistent physical shocks) and valuations (equity and credit spreads have only become more stretched), though non-US assets have lagged. Can these trends continue? And if so, will this performance spread to other markets? This piece summarizes a base scenario for 2020 and briefly summarizes some things that could go wrong (weakening growth) and go right (leading to a more sustained and sustainable upswing)
Baseline outlook for 2020 currently is a modest growth, slow grind scenario with limited real investment and consumption driven growth. It involved moderate global growth at a very similar pace to 2019 as risks of global recession remain in abeyance, but economic activity fails to expand meaningfully. EU and Asian trading nations experience a moderate expansion, while the U.S. slightly downshifts. Existing tariffs cap and uncertainty cap investment growth. Past monetary stimulus triggers modest credit cycle in commodity rich EM. Fiscal stance is only modestly supportive. Over the course of the year, the lack of meaningful growth upswing contributes to select risk-off of growth linked assets, but central bank support argues against persistent drawdowns.
On a country basis, a few major emerging markets like Russia and Brazil continue to exit their post-2014 near-recessions, but other peers like South Africa and Mexico continue to stagnate, as SOE contingent liabilities are a drag on growth, credit and other fiscal capacity. GCC oil producers expand a bit, but non-oil growth suffers from restrained on-and off-balance sheet spending and attempts to balance the oil market restrict output.
What can go wrong?
- Renewed weakness of global economic activity either due to lack of stimulus or failure to move into sustainable moderate upswing or series of discrete economic events. A confidence hit due to extreme weather or health event could have some impact on consumption, services and travel, while persistent trade uncertainty might continue to delay investments. In some EM, tight fiscal policy too limits the pump priming impact.
- Credit market pressure (if Fed repo pledge or other CB support fails) or pricing in hikes/monetary adjustment. As the latter requires a pick up in inflation this seems unlikely aside from some select emerging and frontier markets.
- Resumption of tit-for-tat tariff pressure either between the US and China (less likely) or more likely U.S. EU rhetorical conflict. The Trump administration has set out its fault-lines with the EU. While actual implementation of meaningful tariffs is still a risk scenario, the U.S. willingness to use auto tariffs as a counter for each perceived EU violation may hit markets. EU officials could start in retaliation to think about reductions/additional costs on US energy especially LNG (their long-term energy security does argue against this).
- Oil price spike due to a major supply outage (Iraq or Saudi Arabia). A major and protracted outage from such a major producer might be needed to undermine recent fundamentals. With OPEC+ holding production offline, and US (and other non-OPEC producers like Brazil increasing output at a slower pace, a meaningful -and protracted outage would likely be required to offset sluggish.
What can go right and boost growth momentum into a more meaningful upswing?
- Significant fiscal shift including investment in infrastructure would be critical to overall investment, which has underperformed consumption– EU green new deal for example. Though if occurs the impact will be more likely to impact 2021+ performance, as indeed will planned UK fiscal stimulus.
- Shift in private sector credit cycle as lower rates passed on. So far, only a few countries have experienced credit growth (to private sector) in line with nominal GDP, and almost none have such growth in excess of growth rates. Following last years rate cuts, government financing benefited most from lower rates, with interest rates to consumers and business being stickier. This reflects existing vulnerabilities and underperforming assets in select banking systems (Brazil, India and of course China), but also issues on assessing credit quality. An EM credit cycle that shifts more meaningfully as banks pass on more of the past rate cuts to consumers and business (Brazil, India, South Africa, Russia, GCC) would be positive for growth. This requires in many cases financial reforms and in some cases continued policies to address underperforming assets.
- Reduction in tariffs especially between the U.S. and more clarity on future direction of trade rules.