The 2015 Economic Outlook: Opportunities and Risks
First a word on oil
As of this writing, the oil price has fallen by more than 50% since the peak in June. We believe there are several reasons for this decline. As we have stated in the past, a strong dollar typically results in a decline in commodity prices, including oil. Also, weaker growth in emerging markets is likely leading to less demand for oil. Adding to the overhang is Saudi Arabia’s reluctance to reduce supply. We view this reluctance as more of a geopolitical decision, which makes it difficult to determine how low oil can go. In general, we believe that the oil price is a net positive for global growth, as oil-consuming nations typically spend more than oil producing nations. However, there are some risks to the oil price move, which we will discuss below.
U.S.
We believe that growth in the U.S. economy is poised to step up to roughly +3-3.5% in 2015 after rising by roughly +2.5% in 2014. With wage growth beginning to pick up and employment growth remaining relatively strong, we expect consumer income to improve, which should lead to an improvement in consumer spending. Lower gasoline prices should provide a further boost to consumer spending in the first half of the year. A continuation of less fiscal austerity should result in a boost to business confidence. In addition, we believe that it is increasingly necessary for the U.S. government to upgrade the country’s infrastructure. We believe that both sides of the political spectrum have come to this conclusion, which if implemented, would be a further boost to growth. Capital spending has seen improvement over the past two years, and we expect that to continue. However, any increase in U.S. capital spending is likely to be tempered by a drag on energy-related capital spending due to the dramatic decline in oil prices. Inflation is likely to come down further on the back of lower oil prices. While we believe the Federal Reserve (Fed) will begin to hike rates in 2015, the low inflation environment and global risks mean the hikes will likely take place later rather than sooner. We believe any hikes will be limited and gradual.
We still believe that the U.S. dollar will see further appreciation in 2015. We expect U.S. economic growth to outpace much of the world. Also, interest rates in the U.S. remain higher than most of the developed world and the Fed will likely be the first major central bank to hike rates, contrary to the European Central Bank (ECB) and the Bank of Japan (BOJ) continuing to ease.
Europe
We see the Eurozone economy in 2015 growing at a similar pace as in 2014, roughly +1%. This annual growth rate hides a gradual improvement in the pace of growth throughout the year, as lower oil prices and less fiscal austerity filter through to the economy. Inflation in the Eurozone looks to remain well below the central bank’s 2% target, and will likely show declining prices in the first half on the back of lower oil prices. We expect the ECB to expand its asset-purchase program, likely adding both corporate and sovereign bonds to the mix. This should weaken the value of the euro relative to other trading partners, which would be marginally positive for growth.
Economic growth in the U.K. will likely remain relatively firm as wage growth is finally firming. This coupled with much lower inflation means the purchasing-power of the consumer has improved. While the U.K. is a slight net importer of oil, we believe that the weight of lower oil prices on North Sea oil production will be a drag on capital spending. Given lower inflation concerns around U.K. elections, we believe the Bank of England (BoE) will only hike rates towards the end of the year, at the earliest.
Japan
Japanese economic growth surprised to the downside in 2014 as the shock from the value-added tax (VAT) hike was larger than expected. We expect growth to accelerate to roughly +1% in 2015 after rising roughly +0.5% in 2014. As the economy drifts further away from the VAT shock, consumer spending should recover further, which will likely result in a further modest improvement in wage growth, in part due to government prodding. The BOJ is expected to continue to ease aggressively on the back of inflation remaining well below target. Recent elections should allow Prime Minister Abe to continue to push for reforms and further fiscal spending, which should be positive for economic growth. We continue to be skeptical that transformational reforms are unlikely, the biggest of which would be immigration reform.
Emerging Markets
In general, we continue to be concerned about emerging market economies. In recent years, many countries experienced large increases in credit growth on the back of foreign capital inflows and low interest rates globally, which boosted global liquidity. With the U.S. dollar strengthening, those capital flows are likely reversing, and the Fed is contemplating an increase in interest rates. Credit growth in emerging market countries should slow. Furthermore, periods of U.S. dollar strength and Fed rate hikes have not been favorable for emerging market economies, many times leading crises in some countries.
Regarding China, we believe that economic growth will continue to slow. A weak housing market coupled with overcapacity in the manufacturing sector should result in a continued slowdown in the growth rate for fixed-asset investment (FAI). Growth in FAI would slow even further were it not for government efforts to continue to accelerate infrastructure spending. China’s demographic profile also points to slower growth, not only for 2015 but for years to come, as the working-age population declines. Reported GDP growth in China was +7.0-7.5% in 2014, and we expect reported growth to be +6.5-7.0% in 2015.
We are still optimistic on India. Prime Minister Narendra Modi is continuing his reformist agenda. While some believe the pace of reforms to be slow, we believe that over time he will be successful in laying the groundwork for stronger sustainable growth. Furthermore, India should benefit from the drop in oil prices. In 2015, we see GDP growth of roughly +6.5% after roughly +5.5% in 2014.
Risks
There are a number of risks. We are fearful that the magnitude and pace of the decline in the price of oil could cause some dislocations in the global economy. We could see a rise in defaults for oil-related debt. Financial crises in some oil-producing countries cannot be ruled out. In particular, we worry about Russia. With the oil price collapse and the U.S./EU sanctions, we worry that President Putin may respond with more aggression in the region. We are also concerned that a weak oil price could perpetuate the rise of terrorism and conflict in the Middle East and elsewhere. In addition, we worry about a policy mistake. What if the Fed tightens too aggressively? What if the ECB can’t come to an agreement to ease as aggressively as needed? While we believe that emerging market economies are slowing, we also worry that less U.S. dollar liquidity could cause a more severe slowdown than we expect.
Past performance is no guarantee of future results. The opinions expressed in this article are those of Mr. Hamilton and are not meant to predict or project the future performance of any investment product. The opinions are current through Jan. 15, 2015. Mr. Hamilton’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
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