Back to Overview

Fixed Income icon
  • December 2020

2020 Geopolitics & Fixed Income Outlook

  • Global Macro and Global Fixed Income teams

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. FOR PROFESSIONAL OR INSTITUTIONAL INVESTORS ONLY

Drawing on our marketplace of ideas

Wellington has no “house view” — the perspectives of our investment professionals can vary, sometimes significantly. We believe this diversity of thought strengthens our investment processes by creating a robust “marketplace of ideas.”

Let’s get fiscal

Key points

  1. The global cycle seems to be bottoming — Europe and China are stabilizing, while the US remains resilient.
  2. Decreased efficacy of monetary policy and a shift toward populism suggest global governments will increase fiscal support for 2020.
  3. Globally coordinated fiscal spending could help stabilize global growth and extend the current reflation cycle.
  4. Globally coordinated fiscal spending could help stabilize global growth and extend the current reflation cycle.
  5. Ahead of the 2020 US elections, rising populism and political uncertainty pose structural challenges to the US dollar and greater risk of market-unfriendly policy outcomes for certain industries.

The past few decades have been characterized by rising globalization and central bank independence.

Globalization has reduced the bargaining power of labor and promoted free flow in global trade, capital flows, and human capital. Meanwhile, the world’s central bankers have been less influenced by politics when exercising their policy tools to counter cycle downturns and meet their growth-inflation mandates. We believe these trends are set to reverse now.

A shift toward populism, both in the US and globally, will likely affect government behaviors in 2020. Most major economies are planning to increase levels of fiscal support. Fiscal policy is expected to play a greater role because most countries have limited monetary ammunition to combat the next economic slowdown, given the starting point of low and even negative interest rates. Also, there is a growing consensus that monetary policy has lost its efficacy in generating demand-side inflation. Given persistently low inflation, far below central banks’ own targets, policymakers could redefine their inflation targets and still influence inflation expectations. Nevertheless, the challenge of monetary policy normalization in the context of a sluggish global economy will be daunting. As a result, the real policy responses to the next downturn would need to come from the fiscal side.

Fiscal policy: Room for more?

Most of the current fiscal policy proposals revolve around:

  • Social redistribution (income inequality)
  • Climate change (“Green New Deal”)
  • A rethinking of free-market capitalism, including private-property rights (accountable capitalism)
  • An entitlement versus human-rights balanced approach toward health care and education

These fiscal policy proposals have the potential consequences of higher taxes, more regulation, and increased entitlement spending. The case for fiscal spending is especially compelling in Europe, where there is significant budget capacity in countries like Germany, while the European Central Bank (ECB) has limited room for further monetary stimulus. Japan is an example of a country taking big steps on the fiscal front — including structural reforms like loosening immigration rules, as deepening labor shortages and close to record-low unemployment in Japan have made it difficult to effectively launch public works programs.

Globally coordinated fiscal spending could help stabilize global growth and extend the current reflation cycle. However, political constraints coupled with institutional and ideological rigidities may result in suboptimal timing and reduced effectiveness.

Globally coordinated fiscal spending could help stabilize global growth and extend the current reflation cycle. However, political constraints coupled with institutional and ideological rigidities may result in suboptimal timing and reduced effectiveness.

Figure 1

Global governments plan to add fiscal stimulus in 2020

Global fiscal stance (% GDP)
Figure 1

Source: Wellington Management; based on national budgets of various countries | Chart data: 2005 – 2020

Political and geopolitical wildcards

Major upcoming political events — the 2020 US presidential election, the UK elections, and an eventual Brexit — and geopolitical developments will likely influence the ebb and flow in credit sectors, sovereign rates, and the US dollar. US tariffs on imports from China have probably peaked, and there could even be a partial rollback of tariffs as part of a phase one “mini deal.” However, the longer-term US-China bilateral relationship has clearly deteriorated. Countries will be incented to appease their domestic populace and promote protectionism over globalism. This de-globalization and decoupling dynamic should continue to manifest itself in declining business confidence across multinational corporations that have global integrated supply chains, with most having to deal with a growing US-China duopoly. The negative impacts of economic and political uncertainty could spill over into weakening consumer sentiment.

Figure 2

US: The last tranche of tariffs are consumer-heavy

Net fiscal stimulus after tariffs (% GDP)
Figure 2

Sources: Haver Analytics, Wellington Management | Chart data as of 31 August 2019

The Fed has the most room among major central banks to further cut rates, especially if the domestic US cycle slows and growth leadership rotates to Europe and Asia.

Tracking the resilient US economy

The US economy has been resilient, outperforming most of its global counterparts. The Federal Reserve (Fed) has the most room among major central banks to further cut rates, especially if the domestic US cycle slows and growth leadership rotates to Europe and Asia. In the US, tension remains between loose financial conditions and still elevated, but improving, policy uncertainty. The persistent weakness in US manufacturing activity indicators and capex intentions suggests, at the margin, that the heightened level of policy uncertainty is still dominating. Despite better rhetoric between both the US and China, many companies likely require not only a trade truce, but one that includes a rollback of some existing tariffs to encourage greater corporate confidence for future capex investments. Until that occurs, a gap between uncertainty and financial conditions is likely to persist. Thus far, measures of business and consumer confidence and the broader cycle have responded more to the levels of uncertainty.

Our baseline is for a small improvement in US growth activity over the next few months, but one that still leaves growth below trend into the first half of 2020. Also, in contrast to the rest of the world, fiscal support is fading in the US and major spending initiatives are unlikely to be passed by a divided Congress as the nation heads into an election year.

A new paradigm in the US?

To date, the division of roles between the Fed and the Treasury has been that the Fed develops and conducts monetary policy, while the Treasury is tasked with tax collection along with regular and predictable issuance of fiscal debt. Recent liquidity tightness in the US funding markets contributed to the establishment of standing repo facilities and an unwinding of the Fed’s quantitative tightening. Also, a significant amount of net new marketable US sovereign issuance has come at the front end of the yield curve over the past year or so.

The shift in the composition of US debt is pretty dramatic and likely has been distorting the recent inversion of the yield curve to some degree. Recent developments in the US repo markets and the resulting Fed-Treasury “co-independence” could be heralding a new alternative framework of monetary-fiscal coordination in the US.

Figure 3

US Treasury: Highest front-end issuance in a decade!

Treasury net marketable borrowing (%)
Figure 3

Source: US Treasury | Chart data: 1 January 2015 – 31 December 2018

The long-term US-China decoupling dynamic should continue to manifest itself in declining business confidence across multinationals that have global integrated supply chains.

Market implications

  • Decreasing efficacy of monetary policy and a shift toward populism suggest global governments will increase fiscal support in 2020. The global cycle seems to be bottoming — Europe and China are stabilizing, while the US remains resilient. Against this backdrop, we favor gradually reducing aggregate duration exposures as rates could gradually move higher. We still favor duration exposure in select countries where central banks are considering unconventional policy-easing measures (such as Australia and New Zealand).
  • Ahead of the 2020 US presidential election, rising political uncertainty and populism from the left present structural challenges to the US dollar and an increasing risk of market-unfriendly policy outcomes for industries such as tech and pharma. The potential for a domestic US cycle slowdown and a rotation in growth leadership to Europe and Asia would also increase the probability of the USD peaking.
  • The long-term US-China decoupling dynamic should continue to manifest itself in declining business confidence across multinationals that have global integrated supply chains. Supply-chain disruptions are forcing many companies to diversify suppliers, incurring greater costs and adding pressure to corporate margins. If margin pressures continue, that could translate into equity-market volatility, which should help push corporate credit spreads higher.
Market participants are struggling to grasp the implications of global economic and political uncertainty.

Navigating tail risks

Market participants are struggling to grasp the implications of global economic and political uncertainty. These uncertainties leave many investors exposed to two key tail risks:

  • The downside risk of entering a prolonged economic slowdown
  • The upside risk of a continued economic expansion and fiscal policy-induced reflation

We believe navigating these tail risks has become an increasingly important factor in managing client fixed income portfolios. We recommend that clients consider developing a barbell approach that includes:

  • A global core allocation that focuses on capital preservation to help mitigate the potential effects of increasing market volatility and an extended market sell-off
  • A return-enhancing, dynamic fixed income allocation to provide excess returns in a pro-cyclical environment
  • Market-neutral, absolute return-oriented strategies that seek to provide stable and consistent total returns over various market environments
Back to Overview
Equity Outlook