Despite a relatively strong to last year for markets and a broadly positive outlook for 2020, there are still several key macroeconomic themes that investors should be aware of, according to asset manager PIMCO’s Joachim Fels and Andrew Balls.
Fels – a global economic adviser – and Balls – chief investment officer for global fixed income – have identified seven macro themes that everybody should be paying attention to in 2020.
1. ‘Time to recession’ has increased
Recession risks that were heightened during the middle part of the year have receded in recent months, said Balls and Fels, as a result of greater monetary easing, a trade truce between the US and China, better prospects of an orderly Brexit and a rebound in economic data.
“As a consequence, we are now more confident in our baseline forecast that the current window of weakness for global growth will give way to a moderate recovery during 2020,” they said.
“With fiscal and monetary policy now working in the same direction –further easing – in almost all major economies, the outlook for a sustained economic expansion over our cyclical horizon has improved.”
2. But ‘loss given recession’ has likely increased, too
Further easing is likely to have increased the loss in the event of a recession too, said Balls and Fels.
“Whenever the next economic downturn or major risk market drawdown hits, policy makers will have even less policy capacity to manoeuvre, thus limiting their ability to fight future recessionary forces,” the PIMCO pair explained.
As such, while ‘time to recession’ has increased, so too has ‘loss given recession’.
3. Potential cracks in the corporate credit cycle
Caution towards corporate credit market stems from concerns about the riskier segments, which could be vulnerable to any economic slowdown.
“Private credit, leveraged lending, and high yield debt have been concentrated in businesses that are highly cyclical and have riskier credit profiles,” they noted. “Moreover, despite solid bank equity positions, post-crisis regulation creates incentives for banks to ration credit when heading into a downturn.
“With speculative grade lending currently around 35 per cent of GDP, stress across these sectors would be more than enough to contribute to recession.”
4. Home sweet home
The housing market should be an area of strength for the US economy in 2020 and beyond, argued Balls and Fels, as the decline in mortgage rates has brought affordability levels back to November 2016 levels and excess homes built pre-crisis have been absorbed.
“We are now entering a period of overall scarcity across the US,” they noted. “Housing vacancy and inventories are at their lowest levels since 2000, while household formations are once again picking up, arguing for an increase in investment needed to grow the housing stock.”
5. The world leads, the US lags
Balls and Fels are anticipating that global growth will likely trough and rebound earlier than US growth this year, as has been seen in previous cycles.
“US growth momentum may lag global growth momentum at least for some time during the first half of 2020,” they said, highlighting a rebound in global manufacturing data and a slowdown in US economic growth ahead of the presidential elections.
6. Inflation: The devil they prefer
Although the PIMCO strategists are forecasting benign inflation for advanced economies, medium-term upside risks should outweigh downside risks “especially given how little inflation is priced into markets”.
Labour markets have continued tightening and wage pressures – although moderate – have started to pick up.
“If unemployment falls further as economic growth recovers this year, wage pressures are likely to intensify over time, and firms will find it easier to pass on cost increases as demand improves,” they said.
“After many years of missing their inflation targets on the downside, virtually all major central banks seem to prefer inflation – the devil they know – over deflation – the devil they don’t know.”
They added: “Against this backdrop, and despite the expected global growth recovery this year, we see the major central banks largely on hold this year and expect the bar for tighter policy to be generally higher than the bar for further easing.”
7. Dealing with disruption
Despite the expectations of a pick-up in global growth and supportive monetary and fiscal policy, there potential for “significant bouts of volatility caused by geopolitics and national politics around the world”.
Relations between the US and China are likely to remain fragile, while the US presidential election will also be worth keeping an eye on, said Balls and Fels.
Recent protests against the political establishments in several emerging market economies have added to the potential for further volatility.
As such, investors may have ‘deal with disruption’ and make sure they are positioned accordingly.
“While the baseline outlook for 2020 looks positive, we also recognise risk premia has been compressed by central bank action, leaving little cushion in the event of disruption,” they said.
“We see a range of political and geopolitical risks in addition to the potential for macro surprises, central bank exhaustion, and rising volatility.”
Balls and Fels added: “As well as a close focus on liquidity management, careful scaling of investment positions, and caution on generic credit, we will look to have somewhat lower weight on top-down macro trades, to keep powder dry and potentially of on the offensive in a more difficult investment environment.”