Next year will bring mixed fortunes for global markets as the US and UK race ahead of struggling nations, but government moves could quickly change all that, Capital Economics says.
Japan and Europe could easily reverse the rankings through monetary stimulus, and emerging markets in the gun from future US Fed’s monetary tightening can boost their performances through reform, Capital Economics chief global economist Julian Jessop explains.
Fed to float like a dove, swoop like a hawk
Despite chairman Janet Yellen’s dovish demeanour, the Federal Reserve is likely to boost rates higher and faster than most expect, Jessop says.
Fed officials say they are in “no hurry” to tighten policy, but they have also said they will be driven by the data, which appear to be turning.
“In our view, labour market conditions are now improving at a rapid pace and wage pressures are building,” Jessop says.
“We therefore believe that both the Fed and the markets are under-estimating how rapidly rates will need to rise over the next few years.
“This should not only provide additional support for the dollar, but also drive Treasury yields higher and, alongside a squeeze on profit margins, help to limit any gains in US equities.”
Eurozone QE but with less effect
“Full-blown QE” is almost certainly on the cards for the eurozone early next year, Jessop predicts.
This should raise asset prices, but with yield levels suppressed and bankers wary about taking on more risk, the unconventional move may have less an impact on the real economy than hoped.
“The new norm for the euro-zone could look like Japan, with growth of 1 per cent or less and a significant risk of a damaging deflationary spiral, implying a further depreciation of the euro and a long period of rock-bottom German bond yields,” he explains.
“The renewed uncertainty in Greece is also a timely reminder that the economic and financial crisis in the periphery is not over yet.”
UK economy’s bull run to continue
The UK’s dream run will keep apace in 2015 as faster real wages expand faster than any time in the past 12 years, Jessop says.
Investment levels are also set to rise along with productivity, while energy bills sink further. That will keep inflation relegated to the shadows and the pressure to raise briskly rates off the Bank of England, he says.
“This should facilitate some partial decoupling of UK gilts from US treasuries,” he adds.
“However, market sentiment and the pound in particular will be vulnerable to heightened political uncertainty surrounding the May General Election and the prospect of a referendum on EU membership.”
Yen will sink to 1998 level
The yen will slump to at least 140 cents as the Federal Reserve and the Bank of Japan find themselves on opposites ends of the monetary see-saw.
It has not slipped to that level since the 1998 currency crisis when it hit 144.75c, it stands at 120.65c.
“In any event, it is hard to see any solution to Japan’s economic and fiscal problems that does not involve a significantly weaker currency,” Jessops says.
Rebound or hard landing in China equally unlikely
A hard landing in China is overstated, but growth in the Middle Kingdom will slow further as a “rebound” is unlikely.
“GDP growth will continue to slow, rather than rebound – as some expect,” Jessop predicts.
“In particular, the property sector has not yet bottomed out. Nonetheless,
policy-makers still have plenty of tools to prevent a crash, and reforms are proceeding well.”
Indian reform will disappoint
Rockstar Indian prime minister Narendra Modi’s May election has added 25 per cent to the nation’s stock market, but Jessop is less optimistic about the extent of reform next year.
Jessop believes the subcontinent’s reform programme will “disappoint” in 2015, with the political agenda overtaking the nation’s current account deficit as the biggest threat to growth.
“[Growth] is likely to undershoot most expectations in both the near and medium term,” he says.
“But with the right reforms, the longer-term prospects would be much brighter.
“And in the meantime, monetary policy is set to be loosened further than most anticipate.”
The MSCI India index had a heady run in 2014, however it remains below its peak of November 2010.
Russia will struggle with or without sanctions
Russian GDP could crumble by up to 5 per cent next year, as inflation grinds higher and energy prices remain depressed.
“Consensus forecasts for Russian growth are still too optimistic and inflation is likely to rise much further than most expect to,” Jessop says.
“Indeed, the economy is likely to struggle even if oil prices stabilise and the conflict in Ukraine eases, allowing sanctions to be lifted.
Without a new wave of reform “structural constraints” will keep long-term growth in a 2 per cent straitjacket, he adds.
Support for oil at $60 but no chance of upside
Oil prices to will stay in the doldrums, but industrial and precious metals are likely to recover.
There is support for Brent at about $60 a barrel, which is what Capital Economics had expected, he explains.
“But ample supply will prevent a strong rebound.
“Nonetheless, the boost to global activity should lift metals prices in 2015, so many commodity exporters could still be better off, as well as emerging economies who are large net energy importers.”