2015 was a year with two faces, economically and in the financial markets.
But while unrest concerning Greece did not shake the financial markets, the fear of Chinese economic growth relapsing did
Ben Steinebach Head of Investment Strategy
Despite the attack on the French satirical weekly Charlie Hebdo in early January, which shook the world, the economic start to the year was promising.
Expectations for the global economy were positive, and were raised further – in particular in the eurozone – by the European Central Bank’s announcement in January of an extensive bond-buying programme. In Germany, the 10-year yield dipped to an unprecedented level of less than 0.1% in April. The country’s federal bonds with maturities of up to seven years even posted negative returns in the past year. The same applied to other euro countries, although interest rates were slightly different.
Since interest rates in the United States remained at a higher level, the euro dropped against the dollar, from over USD 1.20 to less than USD 1.10, giving the eurozone’s economy an extra boost. The outlook for the US was also positive, despite the strong dollar. The economy appeared to be sufficiently robust thanks in part to the Federal Reserve’s earlier bond-buying programmes. Yet, as in 2014, the fierce winter weather negatively impacted economic growth in 2015. American manufacturing companies were particularly hard hit by the strong dollar.
2015: a tough year for emerging countries
The emerging markets also felt the sting of the strong US dollar given that it led to a capital outflow from these countries and exchange rate losses. Many emerging countries decided to devalue their currencies. At first, lower exchange rates result in less income from exports and more expensive imports; only after some time does the improved competitive position boost the volume of exports and slow down import volumes.
In China, the exchange rate now plays only a minor role. The country is in a phase of transition, with the influence of exports and investments waning and private consumption becoming more important. While still considerably higher than in more mature markets, at 6% to 7%, the rate of economic growth has dropped somewhat.
Where Greece failed, China succeeded
In the financial markets, the fear of a further slowdown in economic growth in China explained the difference between the positive first six months of 2015 and a less rosy second half of the year. During the first half year, both bond markets and equity markets were positively affected by the ECB’s accommodative policy. The Bank of Japan, too, extended its own bond-buying programme, which contributed to the weakening yen against the dollar. This resulted in significantly higher prices in the equity markets of the eurozone and Japan, narrowing the gap with the US markets that had grown in previous years.
This favourable development took place despite renewed problems in Greece. The new government led by Alexis Tsipras, leader of a coalition of parties known as Syriza, was not keen to implement previously agreed reforms. What’s more, the new Finance Minister Yanis Varoufakis was unable to establish a trusting relationship with his European colleagues, including Eurogroup chairman Jeroen Dijsselbloem. Agreement was reached after all when Varoufakis was succeeded by Euclid Tsakalotos, and calm returned – for a while at least.
But while unrest concerning Greece did not shake the financial markets, the fear of Chinese economic growth relapsing did. Investors lost faith and equity prices plummeted below levels recorded early 2015.
Bond yields did not hit the record lows we saw in April, but they did come under pressure in both the United States and Europe, reaching a climax in mid-August when the Chinese authorities unexpectedly devalued the yuan by 2%. This sparked speculation about a weaker than expected Chinese economy. In our view this was an incorrect interpretation as we believe pegging the currency to the stronger dollar had become untenable.
A turbulent end to 2015 and renewed activity by central banks
The year ended on a turbulent note, with fresh attacks in Paris and terrorist threats in Brussels but also a positive outcome of the climate summit in the French capital. The ECB and the Fed regained the limelight as year-end approached. At the beginning of December, the ECB did not do what the financial markets expected, namely to intensify its bond-buying programme. It merely extended its duration until April 2017 and further lowered the deposit rate to -0.3%.
The Fed, on the other hand, did meet expectations by raising the Fed funds rate by 0.25 percentage points to a bandwidth of 0.25%-0.5%. And so the two central banks’ policies were moving in different directions at the beginning of 2016 and the upward pressure on the US dollar is set to continue.
2016: positive economic outlook, but also great uncertainties
The economic outlook for 2016 is more favourable than 2015 turned out to be, but many uncertainties remain. Economic growth in Europe will pick up in breadth and depth, supported by consistently low interest rates, low raw material prices, including energy, and a low and presumably further weakening euro.
In the United States, it remains to be seen what the effect will be of the interest rate increase, but the economy seems to be sufficiently robust to cope. In the emerging economies – especially in Asia – the positive exchange rate effect is expected to stimulate growth in 2016. There are differences between the emerging countries, though. Exporters of raw materials will continue to suffer from low prices, although a slight recovery appears to lie ahead. And quite a few emerging countries are in debt; if their debts are dollar-denominated, they will weigh particularly heavily on the economy. What lies ahead for Japan remains uncertain. Large-scale incentive programmes, introduced both by the government and by the central bank, have not succeeded in accelerating structural economic growth.
Uncertainties across the board
What else may we expect in the coming year? A key issue will be how Europe addresses the refugee problem. The European countries have so far failed to agree on a concerted approach and – as is often the case – this makes for a thorny decision-making process. But while decisions could often be postponed in other cases, there’s no escaping this time. In that respect, the refugee problem could possibly contribute to the accelerated improvement of Europe’s institutions.
This could, additionally, help solve a number of other problems, one of which is the position of the United Kingdom within the EU. If decision-making in Europe improves, one of Prime Minister David Cameron’s most fervent wishes will have been met and he will probably advise the British people to vote against a ‘Brexit’ in the referendum that is expected to be held later this year.
But the position of Europe – and how things will unfold there in 2016 – remains a major uncertainty for the coming year. In addition to the refugee problem and the outcome of the British referendum, the issue of Greece is also likely to again feature on the agenda of Europe’s policy makers.
US presidential elections on 8 November
In the United States, the focus will be on the presidential elections on 8 November. A series of Republican candidates, with Donald Trump receiving most attention, are vying to win the Republican nomination. But first all candidates – including those for the Democrats – will run in the primaries. As for Donald Trump, it remains to be seen whether the Republican party will support his nomination. If they don’t, this will boost the chances of Democratic candidate Hillary Clinton. It will be interesting to see who gains a majority in Congress and the Senate.
If – as is the case now – a Democratic president is saddled with a Republican majority, or vice versa, governing the United States will be difficult. Here, too, we face uncertainties in the run-up to the elections on 8 November.
But despite the many insecurities, there are also favourable economic prospects. Let’s hope that these two forces bring harmony, resulting in a positive year.
On behalf of all the editors and contributors to Investment News, I would like to wish you and your loved ones a prosperous and enriching 2016, both personally and professionally!