Market overview Markets experienced a volatile month, but sentiment is improving

Market optimism following the completed US-China ‘phase 1' trade deal was short-lived. The coronavirus outbreak in China dealt a blow to risk sentiment in late January, and prompted fears about a global pandemic. China's decision to quarantine whole cities and extend its New Year holiday raised the spectre of a derailed global recovery, weighing heavily on commodities, global bond yields, Scandies and EM FX. Over the last two weeks, however, signs of containment have begun to emerge. This has fuelled a rebound in risk sentiment and provided some relief to Scandi FX, especially versus the EUR. Moreover, decent US Q4 earning reports supported US equities and the USD throughout the month, and there continue to be tentative signs that the global manufacturing sector may rebound somewhat in the months to come.

Across the board, central banks reaffirmed their wait-and-see approach in January. The Federal Reserve, ECB, Bank of England and Bank of Japan all kept their policy stances unchanged, with few changes to their communication. Overall, this was in line with the view ofyu0 further economic recovery. Yet, we still expect a cut by the Bank of England in 2020 as economic momentum runs out of steam and Brexit fears resurface.


The dollar is likely to strengthen further

The euro area remains burdened by low growth, weak inflation dynamics and underperforming financial assets. In contrast, a host of tailwinds continue to support USD denominated assets, and the USD has been gaining ground since early January. Fundamental models suggest EUR/USD fair value is around 1.20, but we see no trigger in favour of such a correction. Rather, it seems likely US assets will continue to outperform their European peers, and for this to be reflected in downward pressure on EUR/USD. We expect a downward sloping profile for EUR/USD, with the spot edging lower toward 1.07 over a 12M horizon. Although there are several events that could change this view significantly, such as a US recession or expansive fiscal policy in Europe, we find these unlikely given current economic conditions.


Near-term growth outlook looks shaky, but a quick recovery seems likely

In light of the coronavirus outbreak, we expect a v-shaped recovery during H1 2020. Chinese Q1 growth and February growth indicators are set to take a significant hit, followed by a sharp rebound in Q2. While the hit to global demand is likely to be smaller than initially feared, we expect lower Chinese demand and supply-chain disruptions will strain the short-term global growth outlook. This is particularly true for Asia and Australia, given their export exposure to China and the negative impact of virus fears on tourism. That said, we continue to be optimistic about the prospect for a modest global recovery in the mediumterm.


Coronavirus fall-out, political risks and constrained policy space remain key global uncertainties

A failure to contain the coronavirus could force other countries to take the same drastic public health measures as China, pausing the global recovery. Moreover, political risks remain in play. This is particularly the case for the euro area, as outspoken differences in view in the trade talks between EU and UK, a possible breakdown in Germany's grand coalition and the lingering threat of US tariffs on the European auto sector all pose a risk to its recovery. Finally, a lack of monetary policy space in many countries/regions means central banks will be constrained when reacting to any downturn in economic growth.


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