The global market outlook for 2014 will most likely be comprised of three main themes:
- Modest growth;
- Continued low inflation;
- Weakening potential.
Meanwhile, the Organization for Economic Cooperation and Development (OECD) anticipates and/or recommends:
- Revised 2013 and 2014 global growth projections (2.7% and 3.6% versus 3.1% and 4%);
- A frustratingly vulnerable global recovery more than five years after the Lehman Brothers collapse;
- Despite the Eurozone exiting a recession, the ECB should be looking at policies to further reduce interest rates;
- That the Fed should keep its accommodative stance intact rather than considering the beginning of tapering.
The upside risks remain centered on capital investment – a global
problem in 2013, where many corporations were long “cash” and repeatedly
caught behind the investment curve.
More than five years after the onset of the Great Recession, consistent
global growth remains elusive, prompting central banks to stick with
artificially low interest rates while pumping an unprecedented infusion
of cash into the financial system.
As they search for new ways to stimulate liquidity to augment the
stimulus measures they’ve enacted, central bank policymakers must also
fight deflation, and as expected, these are the themes that will
continue to dominate the European Central Bank’s (ECB) train of thought
as it has at the Bank of Japan (BoJ). Many foreign exchange (forex)
participants and analysts are anticipating fiscal policy to be less of
an impediment to U.S. growth in 2014. If so, it should allow the Federal
Reserve to carefully navigate away from making asset purchases and
reduce its massive $85-billion-a-month bond-buying program.
In 2013, the forex asset class managed to loiter within a contrived
trading range policed by various central bank policies that, at times,
led to a drop in both currency volume and volatility for painfully long
stretches. The post-Lehman Brothers storm has now been replaced by a
calmer period that continues to lack a badly needed injection of global
corporate investment to help spur growth (think Japanese Prime Minister
Shinzo Abe’s third arrow problems, high unemployment in the Eurozone,
and tentative U.S. growth).
There is great expectation that the U.S. and Europe will lead any
rebound in the developed market. Next year, the U.S. is expected to
reduce the fiscal drag (increased taxes and spending seizures) that the
American economy has endured in the last few years. Hopefully, this will
lead to a consensus of a real growth rate of approximately +3%. That’s a
far better prospect than what’s unfolding across the Atlantic. Recent
hard and soft European data would suggest a more muted and gradual
recovery for the 17-member single currency bloc. In Japan where
Abenomics reigns, additional monetary easing, and stimulus from Abe’s
third arrow, should be capable of compensating the fiscal tightening
(sales tax) Tokyo will initiate at the end of the first quarter in 2014.
Japan is an export driven economy, a country that requires a weaker yen
to further boost exports and economic growth. Critics of Abe’s three
arrow policies are certainly wary of the fact that increasing the
inflation rate to 2% may not necessarily increase consumption and
economic activity. Even changes in the structure of Japan’s economy, do
not necessarily mean that a lower currency may have the same effect on
exports and growth. The short-yen trade has dominated many forex
portfolios this past year. It has certainly been a trade of “patience,” a
trade that’s expected to continue to dominate in the coming year.
In general, any stabilization in developed markets will eventually aid
emerging markets, as increased demand in developed economies will soften
the blow to any export deficits felt in the emerging world.
If this is what unfolds, it would be somewhat safe to assume that any
improvement within the U.S., Eurozone, and Japan will complement the
stabilization of China’s economy, and it should support emerging market
growth next year. However, even if the cyclical outlook for emerging
economies growth is pegged to improve, structural weakness is likely to
persist. As a result, the spread between emerging and developed markets
will probably narrow. Regarding China’s “reform package”, the focus is
on how quickly China might allow productivity to rebound, as well as how
it alters the orientation of growth. By any measure, China is faring
best as it adjusts policy to confront the changing global outlook. The
market expects steady growth to be maintained between +7.5% and +8%.
Speaking in Tongues
Monetary policy will continue to deliver effective stimulus everywhere,
but nowhere is that urgency greater than in Japan and Europe. It is
widely expected that Japan’s prime minister will implement new
quantitative measures in 2014, while the threat of deflation may
pressure the ECB to introduce negative interest rates for the first time
in its tenure. The Fed is expected to begin tapering while keeping
short-term interest rates low for the foreseeable future. Any central
bank policy divergences will provide investment opportunities in
equities, forex, and to a certain extent, in fixed-income. Central banks
must continue to improve communication with the market and speak with
plain language. As witnessed on a few occasions in 2013, incoherent
dialogue leads to market risk.
Looking Ahead
Central banks’ monetary policies are expected to remain highly
simulative and somewhat innovative in 2014. The Fed (soon-to-be under
new leadership) will provide stronger forward guidance and it will
reduce its monthly asset-purchase program. Other central banks will have
to adapt to any move the Fed makes. With global rates remaining “lower
for longer”, it would suggest more market opportunities in other asset
classes like equities. However, investors have yet to experience how a
Fed taper will play out.
The Fed requires the “terrible twos” to be constant before tapering will be seriously considered:
- U.S. growth more than +2%;
- Inflation greater than +2%;
- Nonfarm payrolls to print employment numbers in the +200k’s.
The forex market is under the impression that any notion of Fed
tapering is data-dependent. This may not be wholly accurate. Reading
between the “transparent” lines, it’s been suggested that U.S.
policymakers are increasingly keen to pullback on liquidity and reduce
the Fed’s monthly bond-buying program, with or without any noticeable
improvement on the jobs front. If one digs deeper, it becomes obvious
that the Fed is already discussing “concerns about the efficacy or costs
of future asset purchases.” The main hurdle for the Fed to overcome has
to do with communicating its intentions concisely. The steepness of the
U.S. Treasury yield curve suggests that it so far has succeeded in
getting its message across clearly to investors – front rates remain
low, while the long-end has backed up. The Fed is required to partake in
a fine balancing act – too much tightening too fast could cause an
unsightly global domino effect.
Are improving fundamentals fueling an imminent withdrawal of the Fed’s
loose monetary policy? Whether the Fed begins to taper its asset
purchases in December or in the first quarter of 2014 doesn’t matter all
that much. Many in the market do not expect the various asset classes
to perform as wildly as they had when the Fed first floated the idea
back in May 2013. Regardless, equities remain the global investors’
asset of choice despite assurances that stock returns will not
necessarily carry-over smoothly into 2014. Others believe that the
“mighty” dollar is on edge and about to wake from a two-month slumber of
tightly contained range trading. Improvement in U.S. growth and the
orderly move higher in Treasury yields is sure to support the dollar.
This is in stark contrast to what the forex market was exposed to during
the summer of 2013’s emerging market flight. During that period,
investors were wide-open to volatile spikes and the relentless selling
of emerging economic assets, firm in the belief that the Fed was on the
cusp of reducing its quantitative easing program. The USD should be
highly favored, especially against a dovish yen and Aussie next year.
On the other side of the planet, the jury remains out on Abenomics. Of
the three arrows in Abe’s quiver – bold monetary easing, flexible fiscal
policy, and a growth strategy aimed at bolstering the economy’s supply
capacity – only the first arrow has hit the bull’s eye. Despite the yen
underperforming across the board, and Tokyo distancing itself from any
suggestion of currency manipulation, the market believes that another
“arrow” aimed at devaluing the yen to an even greater degree will most
likely need to be drawn and released in the first quarter of 2014 – if
not sooner. There is a concern that directly devaluing the yen may not
provide the intended impetus. A weaker domestic currency is advantageous
for an export-driven economy. However, relying on a weak yen to expand
economic growth can be easily and quickly trumped by Japan’s territorial
and political disputes with China, an increasingly important trading
partner for the island nation.
China’s Uncertain Reform Blueprint
The world’s second-largest economy is faring best as it adjusts policy
to confront the changing global outlook. China’s growth prospects will
be less of a concern in 2014. The reform package reportedly proposed by
Communist Party General-Secretary, Xi Jinping, following the Third
Plenary Session last November, will surely dominate most analysts’
thoughts next year. The success of the plan will be determined by how
these policies will be executed. After decades of rapid expansion, the
Chinese economy is entering a period of slower growth, and Beijing is
under growing pressure to address issues that threaten further economic
development and social stability. Now that the Chinese manufacturing
sector has become somewhat unprofitable, it has led to less private
investment – a global problem. Though the document focuses on improving
China’s capacity to carry out economic and financial reforms, it remains
light on details.
According to the OECD, China’s 2013 gross domestic product (GDP) was
7.7%, and the OECD expects it to achieve 8.2% next year. While Chinese
economic recovery of the last 12 months is subdued when compared to
recent history, money and credit growth needs to be reined in. The OECD
suggests Beijing should increase social benefits, financial
liberalization, and tax reform.
Nevertheless, China’s economy remains strong. What sets China apart is
that it has been growing because of structural change as the government
addresses its economic weakness quickly – a by-product of its political
ideology. It will continue on its trajectory to become more of a
middle-income country.
Emerging Markets Outlook
Aggregate emerging market growth has slowed to less than +4% in only
three years. Emerging markets are predominately pressured by the
slowdown in fixed-investment spending, which accounts for approximately
+50% of that pullback. That said analysts believe the cyclical outlook
for emerging market growth is steadily improving. Stronger growth from
developed markets is expected to boost external demand, and when coupled
with still-low real interest rates in most emerging countries, it
should also continue to support domestic demand. Based on the
International Monetary Fund’s real GDP growth forecast for 2014-15,
Turkey, Mexico, Poland, the Czech Republic, Hungry, and China should be
the biggest net benefiters. Of course, a stronger U.S. economy should be
capable of pushing emerging markets’ real GDP growth even higher. Last
summer’s intense pressure on the emerging forex market was brought about
by the possibility of Fed tapering. The tightening of a loose U.S.
monetary policy caused a massive backlash that saw investors and
speculators dumping emerging market assets, with many seeking shelter in
American assets. During this period of intense pressure, the Fed
surprised the market and delayed the much anticipated tapering, in turn
giving emerging markets a second life that allowed these economies to
experience a relief rally. In reality, the challenges unstable emerging
economies face has merely been delayed, not averted. Any emerging market
countries and currencies with weak growth, structural issues, high
debt, and other funding concerns will experience the pain of renewed
capital market pressure when the Fed does begin to reduce its
bond-buying program.
All that Glitters is Not Gold
In recent years, commodity prices have been competitively correlated
with growth in emerging market industrial production. As growth slowed
in these regions, so too have commodity prices, especially gold. The
yellow metal will close-out 2013 in the red for the first time in 13
years. It’s no wonder that this long-time bull story will top many
analysts’ 2013 financial stories of the year. With emerging market
growth lagging, this has led to muted growth in overall commodity
prices. This is not expected to change in 2014 – emerging market
structural concerns combined with excess supply of commodities will lead
to further stagnation of commodity prices. Many investors who brought
gold as an inflation hedge have fared poorly. The market is losing faith
in the metal as a store of value due to concerns that the Fed will
reduce its asset purchases and ease the risk of accelerating inflation.
What may have caught many gold bugs off-guard is India. The world’s
second-most populous country is to be dethroned as the biggest purchaser
of the yellow metal on the planet. China will assume that status in
2014 with a consistent appetite. China has imported more than 100 tons
of gold per month in the second half of 2013. For some, the Chinese
demand is a case of too little, too late. John Paulson, the best-known
gold bull since he started wagering on bullion more than three years
ago, is backing away from his bet. Paulson made it clear to investors
that he would not be adding to his gold fund because of inflation
uncertainty. To date, Paulson’s fund has lost -63%. The market expects
Chinese gold demand to continue to pick-up before the lunar New Year at
the end of January 2014 due to a lack of alternative investment
opportunities. With equities under pressure, and Chinese authorities
dissuading real estate investment, gold remains a solid alternative.
However, spot gold prices continue to be dictated by U.S. economic data
and monetary policy. Global investors need solid clues on what to expect
on American policy direction for trade vindication.
