Feature Stories | Jan 15 2015
This story was originally published on 11 December 2014. It has now been republished to make it available beyond paying subscribers at FNArena.
By Greg Peel
The past several quarters have featured global divergence, notes Danske Bank, as the US economy has strode ahead while the economies of Europe, Japan and China have slowed. The first half of 2015 should nevertheless feature a return to convergence, the analysts believe, albeit under divergent policies.
The second and third quarters in the US saw a very strong rebound out of the heavily weather-impacted first quarter. While the rebound has faded somewhat in the fourth quarter, underlying momentum continues to improve in Danske’s view. The job market is strong, wealth increases have been significant and lower oil prices will provide an extra boost for consumers. The “fiscal drag”, so much of a headwind in previous years as Congress bickered and blocked, slashed and slowed, has eased in 2014. A rising US dollar provides a headwind, but not enough to derail the recovery.
The Ukraine crisis could not have come at a worse time for the eurozone, the gradual recovery of which looked like it might be the story for 2014 as 2013 came to an end, alongside great expectations for a stimulus-driven Japan. Danske expects the effects of the Russian sanction shock to gradually fade, while fresh tailwinds will be provided by a sharp weakening of the euro, the fall in oil prices and significant easing of monetary and fiscal policy. Easing lending standards should also begin to support credit availability next year.
The sales tax hike imposed in Japan in April clearly hit the Japanese economy very hard. The pre-tax hike first quarter economic surge was cancelled out by the inevitable post-tax hike second quarter plunge, but of concern was a failure to begin turning around in the third quarter. Prime Minister Abe has now postponed his intended second tax hike in 2016, and Danske notes fourth quarter industrial production and retail sales numbers have already recovered. The analysts expect continued moderate improvement over the coming year.
Danske also expects improvement in China, now that the central bank has shown its determination to lift growth by cutting interest rates. With inflation clearly below target, the People’s Bank can ease enough to ensure a return to Beijing’s 7.5% growth target, Danske suggests.
A feature of 2015 will be divergent policy. The Fed will implement its first rate hike in almost ten years in June, Danske forecasts, as unemployment nears the Fed’s long-term estimate of 5.4%. Further hikes thereafter will nevertheless only be gradual. The analysts expect the ECB to announce new asset purchases (QE) in early 2015, beginning with corporate bonds, as “the first line of defence”, and later government bonds, as “the last resort”. The decision to purchase government bonds will not likely be a unanimous one (Germany remains opposed), but Danske expects Mario Draghi to use a majority vote to push the decision through.
The Bank of Japan also began easing aggressively in the first half of 2014 and additional measures were announced in October. Despite the pall overhanging Japan’s September quarter GDP contraction, Danske believes the BoJ will already be talking about an exit strategy from QE as early as the second half of next year. The output gap has now almost closed in Japan, Danske attests, thus it should not take much more growth and a much weaker yen to hit the 2% inflation target.
Throw in Chinese easing, and global liquidity is going to see a significant boost in 2015 which, combined with a gradual recovery, should underpin risk assets, Danske suggests. The capacity to ease will be supported by persistently low global inflation in the short term, given headline disinflation. This disinflation is not of the “dangerous” kind, the analysts are quick to point out, which would result from falling demand, falling wages and a general recessionary spiral. Rather we have seen a positive “supply shock”, as not only the price of oil but the price of food has fallen, supporting growth in all countries bar the big commodity exporters.
In terms of risks to their expectations, the Danske analysts cite an escalation of tensions in the Ukraine, and thus the imposition of further sanctions, as being an obvious potential threat for Europe. Were oil prices to decline further, the benefits for energy importing countries would begin to be offset by financial distress in the likes of Russia, which could spread to other markets. A tumultuous response to the first Fed rate hike remains a threat, although it’s not as if the market will not have had time to prepare, and Ebola remains an issue, although the outbreak appears now to have been contained.
Credit Suisse agrees that geopolitical uncertainties and volatile oil prices are risks that could see global growth remain sluggish in 2015. Otherwise most regions should see a moderation in growth headwinds, although the analysts remain concerned over China.
2015 is set to be a “controversial” year, Credit Suisse suggests. Policymakers acting on domestic objectives alone tend to disrupt markets, growth, and policies oceans away. Sometime next year the Fed is set to raise rates, which for some newer faces in the market will actually be a first-time experience, the analysts note. Extremely easy policy is no longer obviously necessary from a US perspective, although things look a little different when viewed from other parts of the world.
Which view is correct? That the US economy is strong enough to warrant a rate hike or that the global economy is so weak all central banks should remain in easy-policy concert, in order to fight disinflation? The answer might be that both are true, Credit Suisse suggests. Even if the Fed were to lift its cash rate quickly from the current 0.00-0.25% range to 1.00% or 1.25% by the end of next year, “real” rates will still be negative (when adjusted for inflation) and well below GDP growth rates. Thus the Fed could hike by 100 basis points within the year, and still remain “accommodative”.
If global growth does improve next year, those economies with the biggest output gaps, such as the eurozone, could see sharp asset price bounces. The yawning gap between US and European corporate earnings suggests massive room for improvement at the European end. Improving confidence in Europe would cause credit demand to pick up, meaning any level of ECB stimulus would be more effective. This dynamic has already occurred in the US and UK, Credit Suisse believes.
On the other hand, Credit Suisse also worries about the excesses caused by years of zero interest rates. The analysts are particularly concerned over the behaviour of investment managers in recent years whose mandates have forced them to target unrealistically high returns in a zero rate environment. Abundant liquidity can hide a lot of credit risk. A key risk, in years to come, is that the rest of the world does not see the sort of growth hoped for and rising US rates suck capital away, only to expose risks that had previously been ignored, the analysts warn.
It is therefore imperative, Credit Suisse believes, that the first Fed rate rise occurs in an environment of improving global growth. One might assume Janet Yellen is of a similar mind. Many an American patriot’s nose was out of joint earlier this year when it was disclosed FOMC discussions had included acknowledgement of this risk.
In a similar vein, Germany’s persistence with tight fiscal policy, while all about are easing away from post-GFC austerity, is proving damaging to its neighbours, Credit Suisse notes, yet a fragile eurozone economy ultimately threatens Germany.
The answer, the analysts declare, lies in growth.
ANZ’s economists believe the global economy will indeed grow in 2015. The US will lead the way, offset by some moderation in Chinese growth and supported by only subdued growth in Europe. ANZ does not believe global interest rates will move a lot from current levels, meaning liquidity will remain abundant and asset markets will remain supported.
Such growth should prevent a fall into global disinflation, including deflation in Europe and possibly Japan, given inflation growth lags economic growth, ANZ points out. And the disinflationary impact of lower oil prices on headline CPI should ultimately be stimulatory for economic growth, and thus inflation down the track (greater household spending power, for one, but also lower operating costs for almost all businesses).
That said, ANZ will not rule out a more severe financial event in China than that which has played out in recent years, but the economists remain confident Beijing can manage the fallout. The government may nevertheless need to slow growth further in order to deal effectively with those problems which are currently impeding China’s economy.
ANZ is forecasting a gradual rise to 3% global growth and on to 4% by 2016. But that doesn’t mean the global economy won’t remain problematic. Prior to the GFC, the world was imbalanced between too much saving in some parts of the world (China in particular) and over-consumption in the US and the “Anglo-bloc”. The GFC snuffed out over-consumption overnight but still-high savings rates in the likes of China and Germany continue to constrain global consumer demand, the analysts note. The “heavy lifting” of demand growth in the post-GFC era has been done by investment, for example in Chinese infrastructure.
Beijing has become very frustrated in its failure to really kick-start China’s domestic consumer economy, as is partly evident in November’s PBoC rate cut. For the world to return to sustained strong growth, the high savings rates in China and Europe will need to ease, ANZ believes, and consumption lift. Household balance sheets in the likes of the US, UK and Australia have improved over the past five years, but this does not mean a return to the debt-fuelled spending frenzy of the pre-GFC years. Consumption in these economies can support global demand, but not drive it.
It is not hard to see room for improvement in China, where savings rates are running at 40-45% of income (Australia currently about 9%). But to release this potential spending wave, Beijing must persist with its difficult reforms and thus provide support to new industry and employment, particularly in the area of a social safety net.
Improvement is more difficult to envisage in Japan and Europe. Both face the demographic problem of an ageing population, particularly Japan, which naturally leads to higher savings rates, albeit at some point the money saved for a rainy day has to be spent. In Europe, profligate government financial positions have driven Europeans to put their own money away safely, ageing or not.
Investment will thus continue to be the key driver for growth over coming years, ANZ believes. Infrastructure investment should continue to be a focus of governments across the global economy and a lift is needed in economies outside China. Nevertheless the “clock may be turning back”, ANZ suggests, to the days when the US economy led the world and consumption growth spilled over into imports, thus dragging along other economies. Outside of oil, US imports have indeed being showing signs of strong recovery.
Thus ANZ sees 2015 as the year not when Europe, Japan and China hold the US back, but when the US drags Europe, Japan and China along. Global liquidity will remain abundant despite the end of Fed QE, given QE from the ECB and Bank of Japan and rate cuts from the PBoC. Thus higher US interest rates should not cause major market disruption, ANZ suggests.
Slower global growth has forced Citi’s economists to push back their expectation for the first Fed, and Bank of England, rate hikes. (Again evidence of an assumption the Fed will pay heed to the global picture.) But shrinking slack in both economies should mean hikes in late 2015, Citi suggests. Conversely, persistent low inflation in Europe and Japan should prompt the ECB to follow the BoJ and launch a major QE program soon. Widespread monetary easing is also expected across emerging markets.
The boost consumers will receive from lower energy prices provides key upside risk to their view, the Citi economists note, alongside loose monetary policies, particularly in advanced economies.
JP Morgan expects the 2014 global growth rate to come in at 2.6%, below beginning of the year forecasts of 2.9%. Therein lies quantification of growth slowing more than most expected. But for 2015, JP Morgan sees 3.0% growth, fuelled by reduced fiscal tightening, increased monetary stimulus, and a rise in confidence as the post-GFC recovery enters its sixth year.
Global inflation is set to end the year at 2.1%, JP Morgan estimates. Aforementioned, lower growth, and falling oil prices, should drive a fall to 1.8% by mid-2015 (remembering that inflation lags GDP) before a year-end pick up to 2.1% once more.
JP Morgan is forecasting a 12% return on developed market equities in US dollar terms in 2015, slightly less for emerging market equities.
BTIG is forecasting the US S&P500 stock index to rise to 2200 in 2015, a fairly modest increase from an end-2014 target of 2100. One reason for a muted forecast relates to the Fed’s efforts to raise interest rates. History suggests the first rate hike in a tightening cycle is invariably greeted poorly by stock markets. The S&P is currently trading around 17.5x 2014 earnings forecasts and 16.4x 2015, which is elevated compared to recent history, BTIG notes, but not as elevated as in other periods.
BTIG expects US GDP growth of around 3.0% in 2015, retail sales growth of 4% and earnings growth of close to 7%. This forecast assumes there will be some contraction in PE multiples as a reaction to the first Fed rate hike. The US economic expansion is broadening and improving, BTIG suggests, which should help support stock prices over time. Given current levels of operating margins, even a modest increase in top-line sales will flow through more quickly to earnings growth.
The prospect of US tightening provides a challenge for emerging markets in 2015, Citi suggests, albeit not an insurmountable one. China’s slowdown and falling oil prices are the other themes impacting on EMs. Ex-China EM economies are also suffering as Beijing has sought to manage excess leverage in the Chinese economy, flowing through to lower income growth and declines in imports.
Declines in commodity imports have led to lower commodity prices, which is splitting EMs into two economic groups, Citi notes, being manufacturing-based commodity consumers and commodity producers. Citi believes China is entering a new seven-year cycle of lower GDP growth (6-7%) but better growth quality supported by incremental reforms.
For more views on China in 2015 and beyond, see China: The Decline Of The Dragon.
Global oil prices are clearly a swing factor for 2015, as their rapid collapse has caught out just about everyone in the market. Brent crude is down 36% in six months. Given the fall is mostly supply-side driven, Citi’s analysts believe Brent could find a new US$70-90/bbl equilibrium range in the years ahead. Near-term downside risk remains, nonetheless, in the wake of OPEC’s decision not to curb production.
The macro impact of lower oil prices is that global economic growth enjoys a boost but inflation falls, thus monetary policy remains looser for longer, Citi suggests. The combination of stronger economic growth but low rates should support equities and risk assets in general.
In terms of metals and minerals, Citi prefers base metals over bulks and precious metals in 2015. The stronger greenback, lower oil prices and oversupplied markets will continue to place pressure on the bulk commodities (iron ore, coal) while in contrast, base metals are looking more resilient given higher global demand, more muted supply growth and issues with declining global grades.
The single most significant influence on commodity prices is, of course, the Chinese economy. Citi expects Chinese commodity demand to weaken further into the first half of 2015 after a difficult 2014. The second half should nevertheless see a boost from the Chinese property market, following Beijing’s efforts to lower mortgage rates, provide government funds for home buyers and accelerate social housing construction, among other policies.
In summary, Citi holds relatively bullish calls on nickel, copper, palladium and platinum, an in-line view on silver, gold, zinc and aluminium and a bearish view on iron ore.
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