Econosights - The global economy in 2020

In this Econosights we outline our view for the global economy, central banks and financial markets in 2020. Our key forecasts across the major economies are in included in the table below:

Global growth

Global economic growth, as measured by GDP, disappointed expectations in 2019, rising by 2.9%, compared to estimates in 2018 closer to 4%. We expect world GDP growth to improve to 3.2% in 2020 and 3.3% in 2021, slightly below the long-run average of 3.5%. The International Monetary Fund (IMF) are only slightly more optimistic on growth but have been known to consistently revise down their forecasts (see below chart).

Global manufacturing versus services industries

Global manufacturing had its steepest slowdown in 2019 since the Euro debt crisis in 2012/13 driven by weakness in the auto sector, particularly in Germany. Auto production was hit from changes in new emissions standards and a deteriorating global economy. Lower technological innovation, inventory accumulation and uncertainty created by the US/China trade spat also contributed to broader manufacturing weakness. The manufacturing sector tends to run in three-year cycles (18 months upturn and 18 months downturn) with the current downturn starting since in early-mid 2018 which means that activity should start to lift soon. Some stabilisation in global manufacturing PMI’s is already evident. In contrast to the weakness in manufacturing, the global services sector held up relatively well (see chart below).

The services sector is holding up thanks to strong employment growth and a decline in global unemployment rates over the past decade (apart from Australia – see chart below). While falling unemployment rates is positive for reducing spare capacity, more needs to be done to reduce total labour underutilisation which includes the unemployment and underemployment rate. Labour underutilisation still has room to fall (it is 6.7% of labour market in the US, 15.9% in Eurozone and 13.4% in Australia). We expect unemployment rates to remain low in 2020 but further significant declines are unlikely which means that wages growth needs to rise to see a pick up in consumer spending.

Lower labour market spare capacity is required to lift wages growth. Other factors holding back wages growth including automation and a rise in non-standard “gig” employment, but these are less important. While low wages growth is a hindrance to consumer spending and risks keeping inflation expectations too low, low wages growth keeps employment growth stronger than otherwise because it contains business labour costs.

Inflation

The persistence of the low inflation environment is likely to remain an issue in 2020. Stronger economic growth and higher inflation expectations are required to lift inflation. Other well known forces like technological improvements, globalisation and competition resulting in easy transportation of goods, are keeping down the prices for goods (although it could be argued that the world has reached “peak globalisation” given the rise in protectionist policies recently).

Volatility in commodity prices can often make unexpected impacts to inflation, especially in petrol price changes. Better global growth could see metals prices move higher in 2020 and contribute to higher goods prices. Tensions between the US/Iran may also contribute to heightened volatility in oil prices, which has already begun in 2020. However, the US now appears less susceptible to changes in oil prices as less oil in consumed given the growth in the services sector.

US – strong consumer, poor capex and political risks

The US economy remains in good shape thanks to the strength of the consumer. The unemployment rate is low but is unlikely to fall much further and US employment growth is expected to moderate with signs that job openings are now declining. Business investment growth remains disappointing for this stage of the economic cycle. Unfortunately, election years are not particularly favourable for business investment growth.

While US economic growth is solid, inflation (at 1.6%) is still persistently below the Federal Reserve’s target of 2%. Less US growth outperformance in 2020 probably means a lower US dollar which could lift inflation. The US Fed is undergoing a review of its inflation target (it concludes mid-year) with the likely outcome that the Fed should adopt a more flexible and average inflation target which will allow the central bank to let inflation run hot before it worries about lifting interest rates.

There are plenty of political risks on the US calendar this year. US/China trade tensions have cooled after “Phase One” talks were signed last week. Further trade talks will continue in 2020 that address broader issues like Chinese hacking of US businesses and Chinese state subsidies for firms, so there is still room for disappointment and further disruption to growth.

The impeachment trial of President Trump is currently in the hands of the Senate. It is very unlikely the Republican-controlled Senate would vote to impeach Trump. The more important issue is the Presidential Election in November. Vice President Joe Biden has been the front-runner for the Democratic nomination but has recently been overtaken by Bernie Sanders. However, polling will remain very fluid as there are numerous candidates in the running (primary voting begins in Iowa on 3 February). If the Democratic Party nominate a far-left leaning candidates like Bernie Sanders or Elizabeth Warren, share markets may get hit due to concerns about more regulation on big companies, compliance and higher taxes. For now, our base case is that a Trump victory is the most likely outcomes, as long as the US economy remains strong and with a low unemployment rate.

Europe – a stronger position in 2020

An improvement in German manufacturing, diminished Brexit risks, an improving Chinese economy and easy monetary conditions should see higher Eurozone growth in 2020. The European Central Bank (ECB) restarted quantitative easing in late 2019 at a pace of €20bn/month (well below the peak at €80bn/month) and this is likely to continue for the majority of the year with interest rates remaining unchanged. The Eurozone would benefit more from fiscal stimulus, but there are no signs of the major economies undertaking extra spending. The ECB is also doing a strategic review on monetary policy; but a change to the inflation target is not expected.

China – less deleveraging, more policy stimulus

Chinese GDP growth is expected to be somewhere around 6% in 2020. More economic stimulus is expected in the form of government spending via infrastructure spending, further interest rate cuts and freeing up cash requirements for banks to lift lending. But, more focus from policymakers on deleveraging and sustainable growth mean that the level of stimulus is unlikely to be on the same scale as that over recent years (like in 2015-16).

Implications for investors

Global central banks are expected to keep monetary conditions easy in 2020 which is positive for money supply growth and liquidity. Along with an improvement in the global economy, no signs of a recession and low bond yields, this environment is positive for equities and we expect global shares to have decent returns around 9-10% in 2020. Bond yields are likely rise marginally but without large interest rate rises, bond yields will still remain at the low end of their historical range.

Political risks could de-rail the economic recovery including Iran/US tensions and its impacts on oil, a setback in China/US trade, another round of Brexit risks as the future free trade deal is negotiated, as well as the latest concern about a new strand of Coronavirus in China.