Ignacio de la Torre. Professor. Business School
27 January 2015
While the eurozone, led by Spain, will exceed forecasts, the US will raise interest rates earlier than expected and China will give the world an unpleasant surprise, pushing the price of raw materials down even further.
People say that we economists are lucky because we get paid twice; once for making a mistake, and then a second time to explain why we were wrong. As is now a Christmas tradition in this column, I’m going to make my predictions and thus earn the first part of my salary:
One: the Fed will raise interest rates faster than the market anticipates. The reason will be wage inflation in the US, which will accelerate, with this acceleration being passed on to the CPI. The Fed will have no choice but to mitigate the inflationary impact of this trend by raising rates more than the market expects as otherwise all the credibility it has would go straight out the window.
Two: the eurozone will surprise the market not only by not going into recession but instead by achieving GDP growth over and above what is forecast (0.8%). The reasons behind this prediction are threefold: firstly, an improvement in credit flows to the private sector, boosting investment and, in turn, creating jobs and by extension inducing consumption; secondly, a weak euro, which will lead to higher levels of exports, a key factor in the European economy (for every 10% the euro falls, GDP rises 0.6% and the CPI 0.4%); and thirdly, falling oil prices, directly benefiting the eurozone.
Three: China will have a hard landing as it grows less than the required 7% (the official target which has already been trimmed from the original 8%) in an increasingly worrying scenario of depressed activity, a credit crunch and recession in the housing market. As a result, commodity prices will continue to be very weak.
Four: emerging countries will have a tough time in 2015, having their worst year since 2009. Firstly, countries exposed to commodity trading will suffer as a result of the Chinese contagion (i.e. Argentina, Brazil, Chile, Peru, Russia, sub-Saharan Africa, etc.). Some of these countries will go into recession while others will experience feeble growth. Secondly, countries with a large current account deficit will undergo significant production adjustments due to the repatriation of capital resulting from the Fed’s higher interest rates (South Africa, Turkey and Indonesia). Finally, many emerging countries will see the beginning of a downward adjustment of their property bubbles, which will lead to a gradual credit squeeze. As a result, 2015 will mark a milestone. The growth differential between developed and emerging countries will be the smallest in a long time. India will be an honourable exception in this scenario and will grow by over 5%.
Five: the Fed’s higher interest rates will lead to a readjustment in the portfolios of many American retail investors who will take money out of credit positions (investment grade and high yield bonds). The paradox of liquidity explains why, despite being in a world awash with liquidity from central banks, many bond markets have become extremely illiquid due to the regulator banning investment banks from trading, which has led to a 75% fall in banks’ bond inventories over recent years. This will mean that when retailers try to sell, they will find no takers on the demand side resulting in highly dangerous downward swings in the price of many bonds, something that will lead to greater volatility and greater discussion about financial instability.
Six and last: the Spanish economy will grow by more than 2% in 2015, the government’s official target, which in turn is two tenths higher than the consensus forecast. The government’s target is based on two key assumptions for 2015: a) oil at 103 (it is at 65) and b) the euro at 1.37 to the dollar (it is at 1.22). The logical consequence is that we will export more and import less, and what we save on energy we will spend or invest, leading to the potential rise in GDP. Furthermore, the consensus GDP estimate is based on a forecast of stable credit, but new data shows that credit is, in fact, gaining momentum, resulting in higher production levels. The upshot will be that some 400,000 new jobs will be created and some 500,000 people will come off the dole. Spain’s recovery is gradually reaching the people in the street, and that is certainly good news for everybody.