The economy is in a different place entering 2020 than it was entering 2019, when the Federal Reserve was in a tightening cycle, yield curves were inverting, and the markets expected a recession.
Early in 2019 “the Fed had overplayed its tightening hand and would pivot toward a new easing cycle,” according to Markus Schomer, chief economist at PineBridge Investments.
And while the economy slowed in 2019, the combination of strong labor market and consumer spending and three rate cuts helped boost the economy and right the yield curves, for the most part.
“Economic analysis suggests average growth at best” in 2020 but no recession, he added. “In a world where central banks are missing inflation targets everywhere around the world, the pressure to keep easing policy will just intensify and the result of the [quantitative easing] program the ECB is starting will be an ever greater downward pull on bond yields around the world.”
And while business sentiment remains weak, that could rebound with “a truce in the U.S.-China trade war,” or “a stronger signal that the Fed understands this isn’t a moment for ‘fine-tuning,’” Schomer said. “The central bank needs to do whatever it takes to prevent a more serious slowdown. The three rate cuts in 2019 ought to help. Yet we expect further easing steps in 2020 and more supportive rhetoric to generate a modest rebound in business investment that should keep overall U.S. GDP growth just above the 2% potential growth rate.”
The Fed is on hold and the bar is high for a rate hike. How will that affect the yield curve? “Initially, we expect the curve to continue to trade directionally to rates, with the front end staying relatively pegged and the belly and long end reacting more strongly to economic data surprises,” he added. “Ultimately, however, muted inflation and growing downside risk to growth argue for a modest bull-steepening bias, which is our baseline view for 2020.”
PineBridge expects rate cuts around the world next year “no matter what the economic fundamentals show,” Schomer said. “If bond yields don’t rebound, or to say it differently, if the macro cycle doesn’t reestablish its traditional dominance, the Fed will have to cut rates much deeper to regain control of the yield curve.”
Keefe, Bruyette & Woods Director of Research Fred Cannon expects gross domestic product “to run just below 2%, one more Fed cut and bond yields in a trading range of 1.5-2.0%.”
The markets will expect “a Goldilocks economy: not too hot, not too cold, not much movement up in rates, not much movement down.”
And while growth will be slow through 2021, Cannon doesn’t expect recession. Inflation will remain below the Fed’s 2% target rate, he said, keeping the 10-year Treasury rate averaging below 2% for both 2020 and 2021. This will force the Fed to cut rates once in 2020.
The yield curve should continue to steepen through 2021 and the unemployment rate will rise, while staying low.
Stifel Chief Economist Lindsey Piegza is “cautiously optimistic” about the outlook, given that consumers have fueled the economy. Online sales on Black Friday up almost 20% to $7.4 billion, “the day's largest revenue grab ever,” backs “the thesis the consumer remains solid heading into the key holiday shopping season despite some preliminary reports of weakness.”
For the past six months, she said, consumers have “been the sole organic support to the economy,” and a strong Black Friday “suggests the consumer may actually have enough ammunition to carry the economy at least into next year.”
Rates will remain volatile next year, according to Subadra Rajappa, head of U.S. Rates Strategy at Societe Generale, as “U.S.-China trade deal uncertainties (beyond Phase 1), recession concerns and election/impeachment risks” remain.
“A U.S.-led economic slowdown and Fed rate cuts should keep yields close to bottom, or drive them there, in 2020,” she said. “Curves will be mixed with the U.S. steepening on Fed rate cuts while the EUR curve will remain directional.”
Rajappa believes, “With the Fed’s accommodative stance, U.S. markets are underpricing the risk of further policy easing in 2020.”
The economy should continue growing next year, according to John Lynch, executive vice president and chief investment strategist, LPL Financial, “which we believe will support stock market gains, but we are increasingly mindful of the advanced age of the economic expansion and bull market.”
Uncertainty will remain, but the likelihood of recession in 2020 is “low.”
For growth to surge, “progress on U.S.-China trade discussions needs to come sooner rather than later.” LPL sees GDP up 1.75%, reflecting the trade war “dragging into the first part of 2020 and increased odds of recession in the latter months of 2020 or early 2021.”
Long-term bond yields should increase modestly, according to LPL.
Economic data
Business conditions in the New York are improved in November, showing expansion after two months of contraction, the Institute for Supply Management-New York reported Tuesday.
The current business conditions index rebounded to 50.4 in November from 47.7 in October. The index has been below 50.0 four times since May, above twice, and at 50.0 once.
The six-month outlook rose to 62.8 from 53.6.
