The combat against lowflation, or possibly deflation, will be by far the greatest economic challenge of 2015. The world economy is now deflation-prone, and in almost all developed economies, inflation is below target. If inflation expectations were to ease further due to an adverse shock (e.g. China slowing far faster or politics playing havoc in Europe), the world economy might fall victim to a self-fulfilling prophecy where lowflation becomes entrenched or even turns into deflation. As we’ve repeatedly argued, no model can predict this, as deflation is essentially a psychological phenomenon.
China constitutes the greatest global deflationary risk. Last month, its core price inflation rose by just 1.4% (on a yearly basis – its lowest level in 60 months) while the producer price index dropped 2.7% – the 33rd consecutive month of decline. This reflects overcapacity and is structural in nature. China’s mammoth size and economic significance mean that these deflationary pressures are bound to impact the rest of the world.
In high-income countries, subdued consumer demand is the defining feature of the sub-par, brittle, tepid post-crisis recovery. In most cases, workers earn less today than they did in 2007. According to the ILO, average real wages rose just 0.1% in 2012 and 0.2% last year. Real wages is the indicator to watch: if it doesn’t go up, the global economy will not improve.
In the US, the impressive revision for GDP growth in Q3-from 3.9 to 5% (on the back of 4.6% in Q2)- indicates that its economic revival is stronger than we thought. The ability (or otherwise) of the US consumer to sustain this momentum will ultimately determine whether the US economy has reached an inflection point or not. What else might derail this impressive lift-off? (1) The reality of an interdependent world with weak or non-existent (in Japan and the Eurozone) global growth; (2) A policy mistake / market miscalculation caused from the divergent monetary policy response (how much tightening in the US vs. how much loosening elsewhere) and an appreciating USD; (3) An exogenous adverse shock (see below).
The consensus says that falling oil prices have a net positive effect on the world economy. But in a global deflationary environment, we should beware of the mechanistic transmission mechanism according to which a 20$ drop in oil prices triggers a 0.4% boost in global GDP growth. This time, things may be different: the causality is reversed since lower oil prices partly reflect subdued global growth. If households (say in the Eurozone, China and Japan) don’t spend but save this equivalent of a tax windfall, the boost in global demand will be less than expected.
In 2015, the inevitable dollar appreciation will expose currency and funding mismatches in many emerging markets. According to the BIS – “the central bank of central banks” -, EMs have an aggregate of USD2.6 trillion in outstanding debt securities, three quarters of which is issued in US dollars. A substantial portion of the total will have to be serviced by revenues earned in domestic currencies, so trouble in the high- yield bond markets is a quasi-certainty.
To distill the essence of 2015 into just one word we choose “fragmentation”. Economically, growth and policies will diverge in a “free-for-all” international monetary system where every country pursues its own short-term interests and where trade multilateralism gives way to bilateral deals. From a (geo)political standpoint, growing disorder / messiness will continue to prevail, as the tectonic plates of multi-polarity collide in a world beset by sectarian / identity conflicts, but also riddled with rising nationalism and inequalities.
In 2015, the Uber model–the“posterchild”for disruption – will multiply into a “million” different services, ranging from laundry (Washio) to shopping (Instacart), from chores (Task Rabbit) to parking (Luxe Valet) and so on. As a result, everybody is at risk of being “Ubered”, having to trade more freedom for more risks. Self-employment comes at the expense of a steady income and a decent social safety net, both progressively becoming a “thing of the past”.
2015 will also see an inflection point for service and manufacturing industries. Major technological innovations are on the brink of wreaking momentous change throughout the world. Privately, a senior executive from a top consultancy reckons that, over the next 5 years, 60% of all CEOs will not be able to cope with disruption. In the words of one pundit, “new trillion $ industries will wipe out existing trillion $ industries”. This is good news for some countries (the US, Europe) and bad news for others (notably China). Our next annual Get-Together (September 19-21) will focus on how to prepare for the next wave of tech disruption.
2015 will harbour both nice and nasty surprises.We can’t know what they will be, but we can try to guess… The good ones: (1) the US economy continuing to improve, (2) the Eurozone proving again more resilient than assumed, (3) the reformists in large developing countries like India and Indonesia delivering on their commitments. And some bad ones, all too plausible: (1) China decelerating much too fast, (2) an oil or commodity-country collapsing, (3) Putin mishandling Russia’s economic decline, (4) a devastating cyber- attack, (5) a catastrophic epidemic or climate disaster.
In a world that is so inherently uncertain, here are jus ta few “non-economic” forces sure to be at play in 2015: (1) our professional and personal lives will progressively become fully monitored; (2) the more digital the world becomes, the greater the need for businesses based on face-to-face interaction: they’ll benefit from scarcity value – hospitality services, personal care, physical events etc. will thrive; (3) the democratic malaise will grow in intensity – with elected leaders largely confined to the role of managing disappointment; (4) issues of immigration will be at the forefront – this year, 3,400 people died crossing the Mediterranean Sea, and 68,361 unaccompanied children were apprehended in the US…
The list of major “must-watch” issues for investors and decision-makers has elongated… Over the next month(s), they must pay particular attention to: (1) growth deceleration in China and its inevitable knock- on effect; (2) deflationary pressures and rising political risk in the Eurozone (with a general election due in Greece on January 25th); (3) currencies’ shifts – falling commodity prices; (4) a possible “distress loop” in the high-yield bond markets, with a particular focus on $ risk in EM corporate debt; (5) rise in populism and geo- political turmoil, with a focus on Ukraine / Russia. For real-time or in-depth analysis on any of these, and if you are interested in prediction markets to better forecast some of the risks, please contact us.