Around the Curve

Beyond Pessimism: What Could Go Right

By Jack P. McIntyre, CFA, Portfolio Manager
November, 2019
Six factors that could act as positive catalysts for markets.

Over the last year, 10-year German Bund yields have gradually declined while investor sentiment deteriorated over the course of this period as the U.S.-China trade dispute dragged on, taking global growth down with it. Policymakers failed to adequately address the consequences from these events, and German Bund yields partly reflect the lingering effects of this risk-off overhang.

However, one year later, information risk is starting to dissipate, which we think may improve the odds for a positive fat tail risk event in 2020. We think there are six factors that complement each other to potentially produce a surprise to the upside over the next year.

Source: Bloomberg Finance, L.P. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
  1. U.S.-China Trade  We'll be continuing to monitor whether any tangible progress is made between the two countries. Although relations have started to thaw, the nuance was enough to catch Federal Reserve (Fed) Chair Jerome Powell's attention and time at his October 30 press conference. Policymakers and investors just need China and the U.S. to keep moving the ball forward even if progress is incremental. We would expect the risk-on environment to return if the scheduled December tariffs don't go through.
  2. Fed Policy  While we can't call it quantitative easing, the Fed has resumed balance sheet expansion and has left the door open for future rate cuts. Since Powell has insisted that U.S. monetary policy isn't on a preset course, we'll expect more flexibility from the Fed in how it responds to developments in trade, global and domestic growth, and inflation.
  3. Global Monetary Policy  Central banks around the world are in the midst of a wave of rate cuts to stimulate economic growth and inflation. While developed market central banks might be running out of runway to ease, emerging markets have the room in terms of real rates and a benign inflation backdrop to continue loosening policy.
  4. Fiscal Stimulus  We're increasingly hearing that monetary policy alone won't be enough to cause a rebound in regional and global growth, particularly if enough progress isn't made with respect to the trade dispute. Both the incoming and outgoing European Central Bank presidents have invoked bloc members with twin surpluses to implement fiscal stimulus. Are the odds of Germany delivering a fiscal package increasing? Maybe. Low rates mean that debt servicing costs will be extremely low, but officials will need to think about how either the cost of servicing debt or total debt ratios would look against scenarios of low/contractionary, moderate, or high gross domestic product growth. Regardless, it will be hard for certain countries—like Germany—to justify the extra expenditures.
  5. Global Consumer Optimism  Fed Chair Powell also highlighted the strength of U.S. households in his recent press conference—a trend that is also globally applicable. Wages are rising for the lower socioeconomic echelons while labour markets tighten. Consumers still have reasons to remain optimistic. Consumer confidence will become particularly salient if a trade deal is reached and the slowdown in global growth reaches an inflection point, because these factors collectively may give businesses a reason to resume investment.
  6. Brexit  While the idea of a December snap election may seem like a gamble, Prime Minister Boris Johnson's last-minute negotiations with the European Union and the resulting January 31 "flextension" have significantly reduced the probability of a hard Brexit. For us, a hard Brexit has been one of the more bearish outcomes of this three-year ordeal.

These six areas have the opportunity to create some positive catalysts in 2020, either in stand-alone scenarios or in complement to each other. We'll be watching the 10-year Bund yield closely because any inflection could suggest that the idea for a positive surprise to the upside may be gaining traction with investors. The recent backup in yields could be an early sign of that upside surprise.

Jack P. Mclyntre is a portfolio manager at Brandywine Global. Find out more about Brandywine Global's Fixed Income solutions here: 

Legg Mason Brandywine Global Income Optimiser Fund
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Source: Turner Construction Company, Real Capital Analytics, Q2 2019. Notes: 1) The Turner Building Cost Index includes nonresidential construction and is on annual frequency and is based on a few factors: labor rates and productivity, material prices, and the competitive condition of the marketplace. 2) Land cost data is transaction based for commercial properties.

Members of a “bloc” belong to an association of nations with political or economic interests in common.

Bunds” refers to bonds issued by Germany's federal government. Bunds are available in 10- and 30-year maturities.

Fat tails are statistical distribution phenomena seen whenever there are a lot of events or values that stray widely from the average giving more frequent high and low values; graphically fat tails are seen as a bell curve with a fatter opening.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Quantitative easing (QE) refers to a monetary policy implemented by a central bank in which it increases the excess reserves of the banking system through the direct purchase of debt securities.

Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.

Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

"Brexit" is a shorthand term referring to the UK vote to exit the European Union.

"Flextension" is a shorthand term referring to the flexible extension by the European Union (EU) of the deadline for implementation of Brexit.

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