These key global macroeconomic themes are set to shape markets in 2020

Abhishek Goenka

Global macroeconomic themes track in 2020

As 2019 draws to an end, we are seeing some positive traction on two key risk themes that have kept the global markets on tenterhooks over the last couple of years: US-China trade tensions and Brexit.

The US-China phase one trade deal has finally seen the light of the day. In the UK, Conservatives have emerged victorious in the general elections and with a majority in the parliament; it would be easier for Prime Minister Boris Johnson to deliver on his core campaign promise i.e. to "Get Brexit Done". Unfortunately, given how complex both the underlying issues are, the way forward is likely to be convoluted and we expect developments on these themes to certainly drive the global risk sentiment in 2020 also. Below are the key themes to track in 2020 and our expectations under various scenarios:

2020 US Presidential Elections: A test of 'Trumponomics'

The central plot for 2020, where we expect a lot of drama to unfold, is the US presidential elections. The Democrats charges for impeachment in the House of Representatives on December 18 was passed. Although the president is impeached, he may not be removed from office as that would require a two-thirds majority in the Senate, which at the moment, is controlled by the Republicans. If the Democrats succeed in getting the allegations against the president to resonate with the voters, it would further lower Trump's approval ratings. President Trump,on the other hand, would want to showcase the health of the US economy, pointing to unemployment rate, which is at a multi-decade low, and stock indices, which are at record highs, as a testimony to his economic policies. Generally, no incumbent president has lost a re-election bid with the economy doing well. Also, no president has won a re-election bid with an approval rating below 50 percent. In Trump's case, both these statistics cannot hold at the same time, and it will be interesting to see which one gives way.

Any development that tilts the scales in favour of President Trump would be Dollar positive and risk positive and vice versa. The top three Democrat contenders (in order of their current chances) are Joe Biden, Bernie Sanders, and Elizabeth Warren. Markets would keenly follow who emerges on top to challenge Trump in the race to become the next US president. If Warren turns out to be the one then one can expect a massive sell-off in US equities, bonds and the US Dollar on account of her left-leaning ideology, which is not seen as being business and market-friendly.

US-China trade tensions: Patches of agreement, swathes of disagreement

Phase one of the US-China trade deal is more like the tip of the iceberg. What we have got now seems like a temporary truce. Both sides were desperate to show some progress and closure to their constituents. While the deal may benefit a section of Trump's voter base and help him lift his approval ratings, more contentious issues continue to remain unresolved. Even the commitment on the part of China to purchase $40-50 billion of US farm goods seems too ambitious given that prior to the start of the trade war, China had bought $24 billion of US farm goods in 2017 and the most it has ever bought so far was worth $29 billion in 2013.

President Trump has said phase two negotiations would commence immediately, but he has not specified any timeline on the same. Phase 2 negotiations are expected to cover issues such as the Chinese government subsidies to state-owned enterprises, digital trade, data localization, cross border data flows and cyber intrusions. The extent of hardball president Trump plays in phase two would depend on the state of the economy and markets heading into the elections, his approval ratings and on who the Democrat challenger is. Just like in 2019, we expect a lot of comments and statements coming in from both sides. We expect some patches of an agreement, but large swathes of disagreement.

Brexit: A tumultuous transition period lies ahead

With a majority, the Conservatives will be able to push through the Withdrawal Agreement Bill (agreed by Boris Johnson with the EU) through the UK parliament, legally taking the UK out of the EU. Thereafter there shall be a short window of 11 months, until December 31, 2020, by when the UK and EU would have to hammer out a trade deal that would establish the future of their trading relationship. This could be a tall order, especially if the UK wants to differ significantly from current EU standards and tariffs. The more closely aligned the UK is with European standards, the smoother the transition would be.

Given the health of the UK economy, there is a possibility the Bank of England could cut rates in Q2 after considering the progress made on future trading relations during the transition period.

We expect the Pound to trade 1.2750-1.40 during 2020 with a risk of breaking lower if downside risks to the UK economy emerge from a tumultuous transition period.

Health of the Chinese economy: A dragon on its knees

The global engine of growth has been slowing. Deleveraging has taken its toll on the Chinese economy. China’s auto sales have contracted in 17 out of the past 18 months. The third-quarter GDP growth was at 6 percent, its lowest in nearly three decades. Growth in Q4 is expected to slow down further. While the government has taken small steps to boost infrastructure growth, no large scale stimulus measures have been announced so far. The response from the People's Bank of China has also been measured. It has cut the loan prime rate by merely 5bps to 4.15 percent from 4.20 percent. This indicates that China wants to tread cautiously, striking a balance between debt and growth. Considering that China has accounted for one-third of global growth in recent years, lack of immediate revival in Chinese demand could keep global growth suppressed.
EURUSD and USDJPY 3M ATM vols

The question on everybody’s mind is whether we will see the low volatility environment of 2019 continue into 2020. The volatility in EUR/USD and USD/JPY is at, or close to, its historic lows. This does not come as a surprise given that there is little policy divergence between the major global central banks; the Fed, the ECB and the BoJ. All three are accommodative and stand ready to ease more if their respective economies worsen. All three are currently engaged in some kind of asset purchases (Though the Fed is doing more so to manage liquidity). For volatility to return, we need policy divergence to reappear. Therefore it would be very important to track the incoming data, especially from the US and Eurozone.

The Fed is better placed than the ECB, and the BoJ as the US economy is relatively stronger. The median dot plot indicates that the next action of the Fed could be a hike (though far ahead in 2021). The Fed is expected to pause and watch the effects of its midcycle policy adjustment play out. We expect the Fed to remain on hold through 2020. However, the pillar holding the US economy so far is consumption and if that falters we could be looking at an even more dovish Fed and that could be negative for the US Dollar. We see EUR/USD trading in 1.07-1.16 and USD/JPY in 104.50-112.50 during 2020.

On the geopolitical front, anti-government protests in Hong Kong, France, South America, and Iran need to be monitored closely. Other outside risks could emanate from the impact of negative rates on European banks, the impact of a quick turnaround in yields on fund portfolios having sizeable exposure to negative-yielding debt, overstretched valuations of Fintech unicorns, prolonged phase of low growth resulting in earnings not meeting expectations, making current valuations unsustainable and resulting in a steep equity market correction.

(The author is Founder and CEO at IFA Global.)

Disclaimer: The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.