Andrew Scott surveys the outlook for the US, Europe and the UK at the start of the new year.
From a financial markets perspective, 2019 was a year very much dominated by politics. The pound and UK government bonds both had a particularly volatile year as MPs fought over Brexit. Sterling fell to below 1.20 versus the US dollar for the first time since 2016 and the yield on the 10-year UK gilt hit a record low of just 0.34%, as Brexit caused a second UK prime minister to resign amid a deadlocked Parliament.
The pound subsequently reversed its losses and rallied to 1.35 versus the dollar, rising 13% in three months as Boris Johnson managed to renegotiate the withdrawal agreement and clinch a historic general election victory for the Conservatives.
Sterling ended the year at 1.3260, representing a near 4% gain for the currency, during a year where some forecasters were predicting fresh record lows owing to Brexit.
The Trump effect
In the US, President Donald Trump began 2019 with the government in partial shutdown over funding for his Mexican border wall and under the shadow of the Robert Mueller investigation. The year ended with the president being impeached.
Not one for the quiet life, Trump doubled down on his trade war with China by ramping up tariffs on Chinese goods from 10% to 25%, as well as introducing several anti-Chinese trade measures.
While the market has adjusted to the president’s never-ending domestic controversies, his actions on the global scene were clearly influential.
Investors grew increasingly worried that trade tensions would tip the global economy into recession, so sought the safety of government bonds, causing the yield curve between the 10-year and the two-year US Treasuries to invert (historically a reliable predictor of economic recession). The US dollar and typical safe-haven currencies (Japanese yen and Swiss Franc) also strengthened.
An optimistic start
The year started with reasons to be optimistic that these two major headwinds for the global economy will be less of a drag on economic growth and investor risk appetite this year. The market reaction was to sell the US dollar and safe-haven assets and to buy yet more stocks.
However, Donald Trump’s decision to kill Iran’s top military commander quickly reminded investors that while he is in power, the world will remain a more volatile and unpredictable place to invest.
Despite a possible escalation in the US-Iran situation, the signing of a phase one trade deal between China and the US, along with Brexit progress, should help lift business sentiment and unlock some of the billions being held in cash rather than invested, particularly among manufacturers.
It is also an election year in the US, and Mr Trump - assuming that he isn’t removed from office - is likely to push for further tax cuts (yes, more short-term gains for long-term pain).
Equally, the conversation in Europe is moving away from austerity and towards fiscal stimulus, with the realisation that monetary policy can only do so much. Germany is critical to such measures, both from a political and monetary point of view.
In the UK, Boris Johnson has pledged to spend billions on infrastructure, raise the minimum wage, and aims to lower personal income tax.
With only a few trading days of the new year complete, there is little certainty of where different asset classes will end the year. What we can say at this point is that the two main reasons to hedge financial risk - volatility and unpredictability – are certain to be dominant features of financial markets this year, particularly as the fight for the US presidency reaches a crescendo and we head towards another Brexit date.
Andrew Scott is associate director at JCRA, an independent financial risk advisor specialising in hedging and debt advice.