Trade, geopolitics, and emerging markets were top of mind at the recent annual meetings of the International Monetary Fund (IMF) and the World Bank Group in Washington D.C. Here are 10 key takeaways from the talks with global central bankers, finance ministers, and public and private sector leaders.
- Spending time in Washington D.C. was a reminder that the next 12 months will be heavily influenced by the rhetoric on the U.S. campaign trail. Throw in the threat of impeachment and U.S. sabre-rattling in the Middle East, and one is reminded that politics and geopolitics will be a key driver of markets and risk sentiment in 2020.
- Consistent with PIMCO’s Secular Outlook, “Dealing With Disruption,” there was a sense that the U.S.–China conflict is a secular theme, even if mini-deals may happen along the way. Political analysts and inside-the-beltway experts were much more bearish on prospects of a real détente than what markets seem to be pricing in.
- Conviction on the direction of risk assets was low given the combination of weak growth globally, the ebb and flow of U.S.–China trade tensions, and uncertainty about central bank policy effectiveness in a world with increasing negative real yields. Despite this, a J.P. Morgan survey found that 75% of investors were looking to either increase or keep unchanged their emerging market (EM) allocations next year – not surprising given the attractive yields on offer in EM. Within EM, we at PIMCO favor local duration and external bonds, and are waiting for a more constructive global backdrop to revisit EM foreign exchange (FX) long positions.
- The IMF revised lower its projections for global growth, a theme highlighted in our Cyclical Outlook, “Window of Weakness,” which foresees additional slowing over the coming quarters, leaving the economy vulnerable to shocks. The IMF’s discussions focused on U.S. recession risks, with market participants and policymakers both seeing a relatively low likelihood of a recession in 2020 given expectations the Fed will continue to ease. There was also uncertainty around Chinese growth forecasts and China’s reaction function, with limited monetary and fiscal responses thus far. Instead, Chinese yuan (CNY) depreciation was seen as a likely policy choice to buffer future shocks.
- Weak growth, muted inflation, and negative real rates are prompting a discussion on the scope for policy stimulus and its effectiveness. While the narrative in developed markets (DM) is around limits to additional monetary policy accommodation, EM central banks still have scope to cut rates given muted inflation and still-negative output gaps. Candidates to loosen rates further include Brazil, India, Mexico, and Russia.
- Lack of growth, rising youth unemployment, the spread of social media, and austerity fatigue have served as tinder for protests across the globe, including in Egypt, Ecuador, Chile, Lebanon, and Spain. This may limit governments’ appetite for further fiscal consolidation and create upward pressure on fiscal deficits, debt ratios, and sovereign credit ratings.
- The IMF has been increasingly vocal about the need to protect the most vulnerable populations. This has meant a focus on social safety nets and progressive taxation policies that we believe will become even more important under the new leadership of IMF Managing Director Kristalina Georgieva. A key factor to monitor will be whether a more progressive stance on fiscal consolidation makes the IMF more tolerant of missed fiscal targets for countries under existing IMF funding programs and whether there is a shift toward lighter conditionality in structural measures.
- With several EM “high-yielders” suffering a rough ride in 2019 (Venezuela, Argentina), investors have focused on countries pursuing reforms, such as Egypt and Ukraine. While the fundamental rationale of investing in such countries may be credible, concentrated positions in a small subset of countries create risk.
- Brazil’s milestone pension reform and recovering economic activity give it a chance to differentiate itself from an uncertain outlook for EM and the global economy. A minimally stable domestic political environment is needed to allow the business cycle to develop and for reforms to bear fruit.
- ESG (environmental, social, governance) investing has come into focus as a new theme for the IMF meetings. Central bankers are leading the assessment of financial sector risks from climate change. However, as discussed at the recent UN Climate Action Summit, there was general agreement that central bankers cannot tackle the problem alone and that governments need to do more. Meanwhile, the private sector, led by asset owners and asset managers, is increasingly integrating ESG solutions into their investment processes. In addition to environmental risks, social risks such as refugee flows will continue to shape economics and politics in many countries. For example, refugees from Syria have created social pressures in Turkey, Lebanon, and Jordan – and changed these countries’ relationships with Europe, where political opinion has turned against further immigration.
For more of our views on the long-term outlook for the global economy and markets, please read our Secular Outlook, “Dealing With Disruption.”
Yacov Arnopolin, Lupin Rahman, and Vinicius Silva are portfolio managers on the emerging markets team.