The world economy enters 2015 at an intersection. One track leads to the self-sustaining good recovery that central bankers and policy makers have sought in vain ever since the financial crisis started in 2007.
Lower oil prices should get consumers spending and businesses investing. Memories of the biggest recession since the 1930s can finally be banished. And so the rest of the world starts to look like a revitalised US.
The other track leads back towards recession. Problems that have been stored up since 2008-09 can be contained no longer. A financial crisis erupts in the emerging markets. China has a hard landing and can not keep growth above 7%. Greece sparks off a fresh phase to the eurozone’s struggle for survival. Deflation sets in. The rest of the world starts to look like Japan.
These challenges can be summarised in five issues that will determine how 2015 will look like economically.
Russia and the Ukraine
The Russian economy will go into deep recession in 2015. Even before the dramatic plunge in the rouble in the weeks running up to Christmas, the central bank was predicting a fall in output of 4.5%. Pushing up interest rates from 10.5% to 17% in one move may well help to stabilise the rouble and prevent further capital flight – but at a cost. In many ways history is about to repeat itself; just as after the debt default of 1998, Russia is staring down the barrel of a deep recession. The depth of that slump and how long it will last will depend on what happens to the price of oil and whether the west lead by the United States lifts the economic sanctions that it has gradually been intensifying since the spring of 2014.
Two other things are also unclear. Firstly, how Vladimir Putin will respond. The Russian president offered the people a bargain: accept a strong man in the Kremlin in return for rising living standards. That deal will be broken in 2015, and there is no guarantee that it will encourage the Kremlin to take a softer line over Ukraine. On the contrary, a failing economy could push Putin into acts of nationalist defiance. That would not just intensify the recession; it would also have knock-on effects for Russia’s neighbours and for the Eurozone specially the Eurozone’s biggest economy, Germany.
The second unknown is whether Russia will be a special case. The fear is that it will set off a chain reaction across other emerging markets that have attracted the copious amounts of footloose capital generated by the quantitative-easing programmes of the world’s central banks. Turkey, South Africa and Indonesia and are the big countries to look out for.
In the summer of 2014, a barrel of Brent crude was trading at $115 a barrel. By late December it was half that price. The big drop in the oil price is positive for global growth: it puts more spending power in the hands of consumers and it cuts costs for businesses. The link between the cost of crude and the world economy is well established in history: the long booms of 1948-1973 and the 15-year period that preceded the great recession of 2008-09 were both built on cheap oil. The four recessions of the postwar era (1974-75, 1981-82, 1990-91 and 2008-09) have all been associated with rising oil prices.
A low oil price is a stimulus for consumers. Global growth should pick up over 2015 and there are as yet few signs of the kind of inflation that would necessitate meaningful monetary tightening.
But there is a risk, the plunging oil price could prompt “credit stress”. This would affect governments, such as Russia, Venezuela and Iran, that can only balance their books if the oil price is at $100 a barrel or more. And it would affect the shale gas sector in the US, where much of the investment has been financed by high-yielding but risky junk bonds. As the Bank of England points out in its recent Financial Stability Review: “As US oil and gas exploration firms account for 13% of outstanding debt in US high-yield bond markets, an increase in the preceived or realised credit risk in this sector could lead to sales by investors and potentially illiquidity in the broader high-yield market”. In other words, shale oil could be the next sub-prime.
China will be crucial to the performance of the global economy in 2015. Depending on the yardstick used, it is now the world’s biggest economy. It is also a net exporter of foreign direct investment. China could soon join the select club of countries with a reserve currency.
But 2014 has been an uneasy year, as Beijing has tried to mop up the credit excesses left behind after the growth-at-all-costs approach adopted during the deep downturn of late 2008. Policy makers have been running a tight ship and the constraints on credit have started to bite. Growth will be lower in 2015: the question is how much lower. 7% is the crucial number to remain above in terms of growth,
A marked slowdown would affect the rest of the world in two big ways. First, exports to China would weaken. This would affect countries such as Germany, which sell the machine tools needed for China’s industrial expansion, and those, such as Australia, that provide China with its raw materials. A sluggish Chinese economy in 2015 will compound a low oil price.
Second, China will export deflation to the rest of the world. The prices of goods leaving China are already falling and that trend will continue. The US and Europe will be flooded with cheap Chinese goods, driving down inflation. In the case of the eurozone, it may result in deflation. Central banks, faced with inflation being well below target, will be cautious about raising interest rates even if their economies are growing at a healthy rate, risking the recreation of the conditions that led to the pre-2007 asset bubbles.
2015 will be hugely significant year for Janet Yellen and her colleagues at the Federal Reserve, and for global markets. A focus for investors in the new year will be the timing of the first rise in interest rates. Rates have been in a record low range of between zero and 0.25% since December 2008, but the economy has been gaining momentum in recent months. The Fed has already called time on its $4.5tn bond-buying programme, completing its final purchases in October. Winding the clock back to May 2013, then chairman Ben Bernanke triggered a so-called “taper tantrum” when he suggested the Fed might start slowing the rate of its bond-buying sooner than markets were expecting. Investors – hooked on ultra-loose monetary policy since the crisis fully erupted in 2008 – took fright and triggered a fresh wave of volatility.
Given we’re talking about the world’s largest economy, speculation on the first rate rise will have repercussions around the world. Investors will scrutinise Fed statements for any change in tone that might indicate when the first increase will come. Until it does come, uncertainty – despised by markets – will reign. At its latest policy meeting last December, the Fed dropped its insistence that rates would be kept on hold for a “considerable period”, replacing it with the message that it could be “patient” about policy changes. Within minutes of the statement, New York’s Dow Jones Industrial Average shot up 1.5%, as investors interpreted it as a signal that there would be no mad rush to raise rates. However, if the economic data in the coming weeks and months continues to reflect a strengthening US economy, the Fed’s patience may wear thin. Expect market volatility when the central bank drops its cautious tone as it paves the way for the first rate rise since the great recession.
The eurozone is the crisis that keeps on giving, and there is every reason to believe this will remain the case in 2015. Mario Draghi, the eloquent president of the European Central Bank, lifted the single currency bloc out of the worst phase of the crisis in the summer of 2012 simply by saying that he would do “whatever it takes” to save the euro. But he now faces one of his biggest challenges yet.
In 2014, the story in the eurozone was one of a recovery that failed to get off the ground and of the mounting threat of deflation. Neither of those problems has gone away, with growth of just 0.2% in the third quarter of 2014 and an annual inflation rate of 0.3% at last count in November. Greece and Spain are already stuck in a deflationary rut and there is concern that a dangerous deflationary spiral will spread to the rest of the region. The fear is that as prices continue to fall, businesses and consumers will delay spending plans as they expect prices to fall further. With a backdrop of weak growth, low oil prices and general lack of inflationary pressures, the ECB’s battle against deflation will continue well into 2015.
Measures announced in 2014 – including charging banks to park cash with the central bank in a bid to encourage more lending – have failed to provide a silver bullet. The bank has one weapon left up its sleeve: full-blown quantitative easing.
So far the eurozone’s policymakers have failed to take the plunge with QE, largely as a result of forceful opposition from Germany. But 2015 could be the year to abandon the hints and throw full blown QE at the problem.
More weak data from the eurozone will make investors nervy. Failure to press the QE button in the face of weakness could trigger outright panic.
The relevance for the UK is huge: policymakers at the Bank of England and within government have repeatedly warned that fragility in the eurozone is one of the biggest threats to the UK recovery, not least because it is Britain’s biggest trading partner. Also not forgetting that this year the UK will see a general election in May, so markets generally don’t like uncertainty so we might see some volatility in UK stocks and Sterling over the next few months – By Ali Hamoudi
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