Global growth prospects remain clouded by a number of interconnected risks: a sustained decline in global manufacturing activity due to ongoing global trade tensions, a more pronounced slowdown in Europe and China, the possibility of policy missteps by developed market (DM) and emerging market (EM) central banks, and newer flashpoints in Hong Kong and Saudi Arabia, with ramifications that remain unknown.
While downside risks have risen this year, we believe global growth should prove to be resilient in 2020. We remain encouraged by the ongoing strength of the consumer globally and the enormous amount of monetary stimulus supplied by both DM and EM central banks—the combined weight of these two forces should truncate downside growth risks as we move closer to 2020.
In the U.S., we’re encouraged by a recent rebound in consumer spending and a tentative improvement in manufacturing data. We see nothing in Fed policy nor in the ongoing growth rates of nominal GDP that would suggest any inflation spikes over the near- to mid-term.
For the eurozone, while there are many downside risks and some countries might be at the brink of a technical recession, we feel that the market has become too pessimistic and we look for growth to recover modestly next year.
This macro backdrop, along with reasonably solid credit fundamentals, is likely to continue to provide strong technical support for corporate bonds. The U.S. investment-grade market remains a compelling destination for global investors given its size, liquidity and attractive yield, relative to the UK, Europe and Japan. With inflation declining in many EM countries – which allows central banks to lower rates and support economic activity – we also believe EM real yields look attractive with additional room to compress.
Europe: Growth Sturdy, Risks Rising, All Eyes on Brexit
Looking ahead to 2020, we expect eurozone growth to be around 1%, which reflects recent disappointments in soft data including service PMIs. While there are many downside risks and some countries might be at the brink of a technical recession, we feel that the market has become too pessimistic. In addition, the European Central Bank (ECB) has restarted its asset purchase program, linking its duration explicitly to inflation outcomes.
We expect the German economy to accelerate in 2020 and a growth rebound in Italy on abating political noise. Other large eurozone countries could slow somewhat, but are likely to grow supported by accommodative monetary and fiscal policies across the continent. Risks around this baseline for 2020 are skewed to the downside; for example, if the service sector weakness in soft data becomes more pronounced and starts showing up increasingly in hard data. Other key risks next year include a disorderly Brexit, higher crude prices, and further trade escalation.
Eurozone Growth Remains the Principal Source of Global Growth Worries
Citi Economic Surprise Index, Jan 2019 through Sept 2019
China: No Quick Fix
China’s economy is slowing for both structural and cyclical reasons at a time when the global economy is softening. Although USDCNY has traded above the 7.00 level, we do not consider the bilateral exchange rate to be of great significance as Chinese policymakers have fixed the CNY via a basket of trading partner currencies. On U.S.-China trade tensions, we do not expect to see a quick permanent turnaround in the near term, as neither country appears keen to concede meaningful ground. Looking ahead, escalating tensions and uncertainty will continue to weigh on sentiment, leading to further drags on capital expenditures and consumer confidence.
Asia in general looks well poised to provide fiscal easing to address near-term cyclical shocks from trade tensions and structural headwinds from the global economy. Countries likely to increase policy accommodation include Korea, Singapore, Hong Kong and Taiwan. Yet in EM economies, the case for structural reforms, for removing more barriers to foreign investment, increasing banking system liquidity to support domestic corporates and for infrastructure investment remains critical. Recent data out of Thailand and even the Philippines suggest economic growth continues to decelerate, driven by a slowdown in external demand and with domestic growth highly dependent on fiscal impulse and execution. Inflation (or the lack thereof) supports the base case for more monetary support even as central banks in Asia are increasingly aware that the challenges lie not just in policy rates but in still-weak transmission channels. Price pressures are subdued across Asia, with structural factors such as informal employment and still-strong demographic growth in EM Asia keeping wages low.
Against this backdrop, Asia local currency bonds in selected markets such as China, India and Indonesia could outperform broader EM this coming year. Asian currencies and local bond yields may benefit from the Fed dovish pivot amid subdued inflationary pressures. An emphasis on higher-carry currencies could help maintain a yield buffer/advantage, noting that the yield spread between the JPMorgan Government Bond Index (Emerging Markets Asia) vs. the Citi World Government Bond Index stands at over 250 bps (as at 30 September 2019). In addition, Asian USD bonds, especially issues by Asian Investment-Grade corporates, crossover credits and Asia sovereigns/quasi-sovereign entities can be key considerations for investors looking for a diversifier and yield enhancer.
Australia: Avoiding Stall Speed, for Now
Growth in Australia has slowed in line with other DMs and we now expect growth of 2.0%-2.5% in 2019. Although a reluctant cutter, the Reserve Bank of Australia (RBA) reduced rates three times since June 2019 after almost three years on the sidelines and has maintained an explicit easing bias. The market has brought forward expectations for the next rate cut, perceiving a greater likelihood of one more cut before year end and the possibility of further easing in 2020.
Additionally, we now expect growth of 2.0%-2.5% in 2019 as there are indications that the housing market has bottomed. Although very strong, jobs growth has failed to keep pace with record labor force participation over the past year, resulting in a small rise in the unemployment rate, one of the key indicators the Reserve Bank of Australia (RBA) has explicitly targeted in its rate-setting deliberations. This would point to at least another cut in the near term.
Growth in the Slow Lane
Cautious Optimism Amid Change
Consumers Hold the Key
Looking Beyond the U.S.
Shifting the Global Balance
Uncertainty on the Horizon
How Infrastructure Is Evolving
Royce Investment Partners
Positive Signs for Small-Caps
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.
Nominal gross domestic product (GDP) is a GDP figure that has not been adjusted for inflation.
Investment-grade bonds are those rated Aaa, Aa, A and Baa by Moody’s Investors Service and AAA, AA, A and BBB by Standard & Poor’s Ratings Service, or that have an equivalent rating by a nationally recognized statistical rating organization or are determined by the manager to be of equivalent quality.
Real yields are calculated by adjusting stated yields to compensate for inflation expectations over the time period during which the yields are expected to be paid.
The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) is an indicator of the overall economic condition for the non-manufacturing sector. Levels greater than 50 indicate expansion; below 50, contraction.
The European Central Bank (ECB) is responsible for the monetary system of the European Union (EU) and the euro currency.
"Brexit" is a shorthand term referring to the UK vote to exit the European Union.
The Reserve Bank of Australia (RBA) is the central bank of Australia.
The JPMorgan Government Bond Index (Emerging Markets Asia) is an unmanaged index that tracks local currency bonds issued by Emerging Markets countries in Asia.
The Citi World Government Bond Index measures the performance of fixed-rate, local currency, investment-grade sovereign bonds in 20 countries.
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.
USDCNY is a shorthand term for the currency exchange rate between the U.S. dollar and Chinese yuan.
CNY is a shorthand term for the Chinese yuan.
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