2020: A Look Ahead

As the first full week of 2020 gets underway, today's Daily Market View takes a look at the themes set to dominate in the year ahead

Previous Day's Market Highlights

Trade War - Phase Two

Keen observers will note that ever-changing Sino-US trade relations were the primary driver of risk appetite throughout the previous year, with talks eventually concluding with the agreement of a 'Phase One' agreement just before the year drew to a close. Unfortunately, this narrative isn't going away any time soon.

The 'Phase One' deal is set to be signed in Washington DC on 15th January, with attention then set to shift quickly towards negotiations over a 'Phase Two' deal between the two superpowers.

However, despite markets seemingly pricing the agreement of 'Phase One' as a simple stepping-stone to a broader, more comprehensive trade deal, such an outcome is far from certain

Thus far, the numerous US-China discussions have largely covered the 'easier' issues - such as Chinese purchases of US agriculture - and haven't yet tackled more complex aspects of the trading relationship such as intellectual property rights and forced technology transfer. These two issues in particular reflect the fact that negotiations are no longer purely discussions over trade, but are talks centred largely on matters of national security.

No matter the subject of the talks, they are likely to follow a similar pattern to the negotiations seen last year, hence the below trade cycle is likely to prevail once again.

 

 

Furthermore, the trading playbook that applied to trade discussions in 2019 is likely to play out once again, namely optimism will see equities rally and safe-haven bonds decline, while trade pessimism will likely be greeted with the opposite market reaction. In G10 FX, the antipodeans stand to benefit if markets are swept by trade optimism, while the safe-havens of the Japanese yen and Swiss franc should strike a firm tone if markets are spooked by the direction that trade talks are taking.

It is, however, important to look at the next stage of trade discussions in the context of November's presidential election, for two reasons.

Firstly, with President Trump keen on using the performance of equity markets as a gauge of his administration's success, there is extra incentive to push out positive trade headlines and move quickly towards a deal to support risk appetite, and thus boost equity markets. Secondly, bearing in mind the tight timeframes between the signing of 'Phase One' and the election, as well as the prolonged nature of the first stage of negotiations, any meaningful progress could be limited.

 

Bye Bye Brexit Talks, Hello Trade Negotiations

Trade talks are also set to be the order of the day on this side of the pond, as the UK and EU begin negotiations over the post-Brexit trading relationship that is due to take effect from the beginning of next year.

However, before trade talks begin, both the UK and European Parliaments must ratify the Withdrawal Agreement before the UK's departure on 31st January. This will, though, be little more than a formality, with the Conservatives' 80 seat Commons majority meaning the days of late night, knife-edge votes are now over.

Once trade discussions get underway, politics will assume its now normal place as the primary factor influencing sterling, with investors set to pay close attention to the progress of discussions as the two economies work towards securing a free trade agreement (FTA).

With only 11 months until the scheduled end of the transition period, the timings for agreement of a full FTA appear to be incredibly tight. Therefore, initially, focus will likely fall on whether the transition period will be extended beyond the end of the year, a decision which must be taken by June at the latest.

Of course, the UK will not only be seeking to secure an FTA with the EU, but also to agree trade deals with a host of other major economies. Progress of these talks will also be closely monitored, particularly discussions over a potential UK-US deal.

The full timeline of this year's events is as follows;

 

 

 

For sterling, the above may result in a year of two distinct halves. The first 6 months of the year should see the pound perform relatively well, buoyed by the release of pent-up investment due to increased political certainty, and potentially pro-business policy announcements in the Tories' first budget.

However, the second half of 2020 may bring increasing headwinds for sterling. Increased uncertainty over whether the transition period will be extended, along with potentially lingering doubts over whether a cliff-edge reversion to WTO trading terms will occur at the end of the year.

 

Presidential Election - A Second Term for Trump?

Away from trade, the primary political event of 2020 will be November's presidential election.

Americans will head to the polls on 3rd November, choosing either to re-elect President Trump to a second four-year term, or to elect the Democratic nominee.

This nominee will become clear in the first half of the year, with the Caucuses and Primaries set to see the party choose between a progressive candidate such as Bernie Sanders or Elizabeth Warren, and a more centre-left candidate such as Joe Biden or Michael Bloomberg. Biden currently leads national polling on around 29%, ahead of Sanders on 19%.

Once the nominee is known, attention will shift to November's poll. For markets, the re-election of President Trump would represent the status-quo outcome, and would be positive for the dollar and for risk assets. However, not having to worry about re-election, Trump has the potential to become increasingly hawkish and unpredictable in his second term.

The incumbent has history on their side in presidential elections, winning a second term on 70% of occasions since the Second World War. However, predicting elections is never an easy business, and with Trump having the lowest post-war approval rating of any President, November's poll will be unpredictable.

 

 

 

On the Democrat side, the impact on markets is a little more difficult to call, and will depend largely on the nominee. The election of a more progressive nominee, such as Warren or Sanders, would likely spook market participants, particularly with policy proposals such as wealth taxes and increased federal spending. A more centre-left nominee, such as Biden, may result in little immediate reaction.

It is, however, important to note that for any Democrat nominee to enact any of their major policies, they will need to flip control of the GOP-held Senate, otherwise 2 years of political deadlock will likely ensue until the midterms.

 

Central Banks - Taking a Backseat

Turning to the world of monetary policy, 2020 is set to see central banks largely take a backseat, a sharp contrast from 2019's global, dovish, policy U-turn.

Added to last year's policy loosening - with the Fed, ECB, RBA and RBNZ all cutting rates in 2019 - was the resumption of balance sheet expansion from both the Fed, in order to calm jitters in the repo market, and the ECB, through the introduction of an 'open-ended' quantitative easing programme.

It is balance sheets, rather than interest rates, that are likely to take centre stage throughout the coming year, with the majority of G10 central banks set to leave rates on hold throughout the year ahead, remaining in 'wait and see' mode. This will either be through choice, for example the Fed evaluating the impact of last year's insurance cuts, or through lack of ammunition, such as the BoJ who will find it difficult to take rates deeper into negative territory.

Only the ECB and RBA appear likely to consider loosening policy further, though the former is seemingly approaching the reversal rate, and the latter is rapidly approaching the effective lower bound.

Meanwhile, back to balance sheets. As a result of the resumption of asset purchases, G3 central banks now hold almost 15tln USD worth of assets on their balance sheets.

 

 

This is only likely to trend higher throughout the coming year, a situation which will once again ensure plentiful liquidity through a continued supply of 'easy money' from central banks. As a result, 2019's scenario of extremely muted G10 FX may play out once again.

 

Global Growth - Slowing Further

Finally, 2020 is likely to see global growth slow further, however my base case is that recession will once again be avoided.

The continued slowdown is set to come as business investment remains relatively sluggish, along with the potential spill-over effects of the deepening manufacturing slowdown in several major economies. As such, and as in 2019, consumer spending will remain key, with consumption set to remain the primary factor underpinning the present economic expansion.

Drilling down to a region specific level, and starting with the US, 2020 is likely to be another year where US economic growth 'catches down' to the pace of other developed economies. The impact of 2017's tax cuts and fiscal stimulus has now almost totally faded, however last year's 75bps of policy easing from the Fed should see the economic expansion - now the longest on record - continue for some time yet. The consumer remains key to this outlook, however with the labour market healthy and inflation low, spending should be well-supported.

 

 

 

Meanwhile, in Europe, the 'Japanification' of the eurozone is set to continue, with the present low yield, low growth, low inflation environment set to continue for some time to come. The present slowdown in the manufacturing sector appears to be deepening, which is likely to, eventually, have a spill-over impact on other areas of the economy.

On the inflation side, despite unemployment hitting a post-crisis low, there has been scant upward pressure on wages or on prices, perhaps indicative of deeper, structural issues in the labour market. Furthermore, there is little sign of inflation stemming from other sources, with the ECB projecting inflation to be at just 1.6% in three years' time.

 

 

Speaking of the ECB, policymakers continue to require assistance from looser fiscal policies when it comes to stimulating the bloc's economy. However, such fiscal stimulus appears unlikely at present, with particularly strong opposition to such policies coming from Germany. While it is not inconceivable to see the ECB delivering a 10bps deposit rate cut within the next 12 months, the efficacy of such a cut has to be called into question, with policy rapidly approaching the reversal rate.

Currency Pairing 08:00 Today Vs 08:00 Yesterday Four-Week High Four-Week Low % Change
GBP/EUR 1.1720 1.2081 1.1628 3.75%
GBP/USD 1.3080 1.3514 1.2903 4.52%
EUR/USD 1.1160 1.1239 1.1066 1.54%
GBP/AUD 1.8855 1.9523 1.8635 4.55%
GBP/NZD 1.9670 2.0417 1.9415 4.91%
GBP/CAD 1.6970 1.7794 1.6963 4.67%

Today's Market Highlights



Today's Economic Calendar

Time Currency Release Consensus Previous
9.00am EUR Services PMI (Dec F) 52.4 52.4
9.00am EUR Composite PMI (Dec F) 50.6 50.6
9.30am GBP Services PMI (Dec F) 49.2 49.0