Economic outlook for 2020: entering a new era of uncertainty

news-single-imgcaption" style="width:240px">Alexis Gray.

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As geopolitical uncertainty plays out and the unpredictability of economic policies becomes the new norm, we believe that these influences will negatively affect demand in 2020 and supply in the long term. The continued contraction of world trade relative to GDP combined with the persistence of a high level of uncertainty tends to reduce the production potential. This type of phenomenon occurs when investment is restricted and the diffusion of technologies and ideas that stimulate productivity growth is prevented. That’s why we’re expecting moderate growth for most of the year.
According to our forecasts, American growth will fall below the trend of around 1.3% in 2020, with the risk of recession remaining high. In China, too, growth was below the target set this year and should continue to slow down at a rate below the trend of 5.8% for fiscal year 2020. The economy in the euro area continued to slow due to its sensitivity to industrial trade as well as the retarding effects stemming from the uncertainty linked to Brexit. Growth in the euro area is expected to remain weak at around 1%. Emerging markets will remain exposed to the challenges posed by trade disputes in 2020, particularly in Asia.

Central banks struggle to inspire confidence

In recent years, the major central banks have shown a persistent inability to meet their inflation targets. This may be explained in part by the interaction of several persistent structural factors, including technological progress and globalization, which are driving down prices, as well as by the fact that the goods and labor markets are apparently unable to respond to the fall in unemployment and the intensification of capacity utilization.
As long as these secular forces continue and output gaps widen in the context of the current contraction, inflation is likely to remain low. The credibility of policies is a determining factor in inflation. For several years, inflation expectations of consumers and the financial markets have, for the most part, always fallen short of the objectives set by policies, a sign of the growing doubts as to the effectiveness of monetary policy, and this , for a variety of reasons, including technical or political. These expectations of low inflation confirm our forecasts of moderate inflationary trends.

Monetary easing remains the central pivot

The Fed having so far cut its rates by 75 bp in 2019, we expect further reductions in federal funds rates from 25 to 50 bp before the end of 2020. The ECB has once again lowered its key rate in negative territory, by 10 bp, bringing it to -0.5%. In 2020, we believe that the ECB will keep its policy broadly unchanged, with the risks pointing to further easing.
Despite doubts about the effectiveness of further monetary policy stimulus, we do not believe that the fiscal measures will be enough to stimulate activity significantly. China, for example, has already stopped its policy of active support for debt reduction and will probably intensify its monetary and fiscal stimulus in the face of growing headwinds. These efforts would be calibrated so as to more allow a soft landing rather than a strong rebound in growth, given the concern of political decision-makers around the issues of financial stability.
The heightened risks to growth and the low level of inflation could lead the Bank of Japan to slightly reorient its policy, through compensatory measures in order to cushion the negative impacts for financial institutions. Emerging countries are likely to follow in the footsteps of the Federal Reserve in its trend to soften its policy.

Towards persistent low yields worldwide

In a context of continued slowdown in global growth in 2020, investors will have to expect periodic episodes of volatility in the financial markets, given the heightened uncertainty about monetary policies, the risks linked to the end of the cycle and the tense level of assessments. The short-term outlook for the global equity markets remains reserved, and the likelihood of a significant decline in stocks and other high beta assets remains high and significantly higher than it would be under normal market conditions. High quality fixed income assets, whose expected returns are only positive in nominal terms, remain an essential component of diversification within a portfolio.
Yields are expected to remain modest at best over the next decade. Expected returns on fixed income securities fell due to lower key rates, lower yields across all maturities and tighter corporate spreads. Annualized bond market returns are expected to range between 2% and 3% over the next decade, up from 2.5% to 4.5% last year. The outlook for global fixed income securities outside the US is in the range of 1.5% -2.5%, on an annualized basis. Regarding the US equity market, the outlook for annualized returns over the next ten years is between 3.5% and 5.5%, while that of returns for global equity markets outside the United States are expected to be between 6.5 % and 8.5% for American investors, due to the more reasonable level of valuations.
In the medium term, it can be expected that central banks will eventually embark on the normalization of their monetary policies, namely raising risk-free rates from the low levels currently observed. This will provide more attractive valuations for financial assets. However, the outlook for returns is expected to remain well below that of previous decades and the post-crisis years, as global equities have risen more than 10% per year on average since the market collapse. Given the prospects for slowing global economic growth and moderate inflation, risk-free rates and asset yields are expected to remain below historical levels for an extended period of time.

* Senior economist, Vanguard

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