We head into 2020 with a generally robust risk market globally, with sentiment at elevated levels led by optimism on the US-China “Phase 1” trade deal and encouragement from US and Chinese economic data. We remain concerned over how the start to 2020 will play out for developed markets. Traditionally in January, we would expect year-end tax harvesting and rebalancing to lead to positive returns. However, given the rally in risk assets that took place towards the end of 2019, the typical "January effect" perhaps will not come to fruition in the new year because returns have been pulled forward. Geopolitics will remain a key focus, especially in the latter half of the year when the November US presidential elections take place. We certainly think US President Donald Trump has the incentive to reach a trade deal with China before the campaign picks up. A favourable market and a well-performing economy will support the president’s chances for re-election, especially with a fragmented Democratic party, in our view. We also think President Trump’s impeachment trial will serve as a campaign platform and ultimately benefit his re-election chances.

Moving on to US rates, we think the Federal Reserve (Fed) and President Trump will remain dominant factors throughout 2020. While we have a bias for higher rates considering the strength of US fundamentals, we think this will be balanced by potential political risks and the Fed's easing bias. Regarding the Fed, we expect it to remain on hold for at least the first half of the year after it aggressively rate cuts in 2019 and nearly reversed all of its 2018 hikes. This also increases the likelihood of potential changes taking place only after the November election, as any moves prior to that could lead to the Fed being tagged with further political bias. Regarding political bias, we note President Trump's negative public commentary towards Fed Chairman Jerome Powell. We think that if President Trump is re-elected, he will try to appoint a new, likely more dovish Fed chair when Powell’s term ends in February 2022. We do not expect any activity on the policy rate. But we do see the Fed remaining quite influential through open market operations with the continued expansion of its balance sheet to restore reserve balances; the Fed had increased its balance sheet size to USD 4.1 trillion as of the first week of December. At its current pace, it is on track to completely reverse the quantitative tightening reduction of the balance sheet some time in the first quarter. We think it quite possible that the Fed may have to resort to QE4 in order to offer a more permanent solution than the current stop gap measures via their term repo facilities. A deficit exceeding USD 1 trillion, based on the net increase in supply, will also remain a headwind for any sustained bond rally in the US. The dollar will remain supported by US rates at relatively higher levels, in our view. However, we do not expect any significant gap higher given current relative valuation levels. The 2019 inversion of the yield curve raises the risk of a US recession based on historical precedents, but we believe that the Fed's aggressive action will head off future weakness.

For the UK, fortunately the political direction has become more transparent as the December 2019 election resulted in a clear mandate for the UK to withdraw from the EU on 31 January 2020. But we still have a no-deal overhang with UK Prime Minister Boris Johnson set to create a new cliff date of 31 December 2020 that could continue to hamper the British pound’s recovery. On the positive side, we think that the 80-seat Tory parliamentary majority will put the UK in a much stronger negotiating position with the EU, and the pound should benefit from more constructive discussions. UK risk asset classes from equities to credit appear cheap on a relative valuation basis compared to US and European markets.

Lastly, onto Europe, we think our lower-for-longer view on rates will continue to hold throughout 2020 as industrial production data and PMI survey figures point to weakness in the European economy. Based on recent weakening trends, we think that Germany will enter a technical recession in the first half of the year following its recently weak GDP growth data. The European Central Bank (ECB) will continue to expand its balance sheet to the tune of EUR 20 billion per month. But discourse is growing regarding the damaging impact of the negative rate environment and we do not see the ECB adjusting its policy rate for the next several years. We think ECB President Christine Lagarde will continue to push for fiscal stimulus and German resistance to this idea will likely wane as its economy moves towards recession. The prospect of below-average growth combined with balance sheet expansion in "perpetuity" will likely serve to hold interest rates at low levels for much longer than expected. Japan's experience with low to negative rates over the past several decades demonstrates the difficulty for low growth economies to move out of low rate environments.