Investors in recent months have been busy “Dealing With Disruption” (Secular Outlook, May 2019) – such as the escalating trade war between the U.S. and China, changes in government in the U.K. and Italy, the U.S. president criticizing the Federal Reserve, and the vertiginous plunge in bond yields in August.
As we discuss in our latest Cyclical Outlook, the global economy is about to enter a low-growth “window of weakness,” which we expect to persist going into 2020 with heightened uncertainty about whether it is a window to recovery or recession.
Recession or recovery?
In our baseline forecast, the low-growth period of vulnerability over the next several quarters gives way to a moderate recovery in U.S. and global growth in the course of 2020 in response to generally supportive fiscal policies and further monetary easing in both developed and emerging markets.
However, our conviction in this baseline economic narrative is lower than usual, given the environment of elevated political uncertainty and fat left and right tail risks. We see two main catalysts that could produce either better or worse economic outcomes than in our baseline.
The first major swing factor for the outlook is trade policy. On one hand, a further escalation of the trade war could easily tip an already slowing global economy into recession. On the other hand, a comprehensive trade deal between the U.S. and China that removes a significant portion of the already imposed and prospective tariff increases could produce a synchronized reacceleration of global growth in 2020. Our base case is that while a limited trade deal is possible, the tensions between the U.S. and China are likely to remain on a low boil rather than cooling down permanently.
Monetary and fiscal policies are the other main swing factor that could push the economy and markets into left and right tail scenarios. Our base case is that the Fed, following the two rate cuts in July and September, delivers additional easing over the next several quarters, thus dis-inverting the U.S. Treasury yield curve and reducing recession risks. However, there is a risk that the Fed under-delivers relative to market expectations, which could lead to a significant sell-off in risk assets and a tightening of financial conditions.
Conversely, the main upside risk to economic growth, apart from a comprehensive trade deal, is that fiscal policy in major economies becomes more expansionary.
During this window of weakness, we think it prudent to focus on capital preservation, to be relatively light in taking top-down macro risk in portfolios, to be cautious on corporate credit and equities, to wait for more clarity, and to take advantage of opportunities as they present themselves.
Read PIMCO’s latest Cyclical Outlook, “Window of Weakness," for further insights into the 2020 outlook for the global economy along with takeaways for investors, including additional information and discussion on the risks.
Joachim Fels is PIMCO’s global economic advisor and a regular contributor to the PIMCO Blog.