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THE turn of the year is a time for reflecting on the year past and what the forthcoming year might entail. For the finance industry, it is also the time for crystal ball gazing and lists of predictions for the year ahead.
Of course, New Year’s predictions tend to be about as successful as New Year’s resolutions – and with this in mind we put an alternative spin on the exercise: what seven events, despite being predicted by highly respected forecasters, we think won’t happen this year.
1. The Fed cuts rates back to zero
Who says it will happen?
Thomas Costerg, US Economist at Standard Chartered Bank, although the majority of economists in a Bloomberg survey thought rates would be back at zero within five years.
What’s their thinking?
Cyclical tailwinds are fading and the hike at the end of last year will prove to be a mistake.
Why don’t we think it will happen?
We believe there are a lot of headwinds to US growth in 2015: US dollar strength (which has hurt manufacturing exports) and the asymmetric impact from the oil price collapse (energy capex and sentiment in oil-producing areas have been hit, whereas consumers have yet to adjust their behaviour) will moderate, and gross domestic product growth will broadly be in line with this year’s 2.5%
What’s our base case?
We believe that the Fed rate hiking cycle will be a slow one, but nonetheless will be in one direction. The US economy ended 2015 strongly: not only did it produce 292 000 jobs in December, but data for the previous two months were revised up.
We believe there is sufficient momentum in the US economy for the labour market to continue tightening. This will help underpin continued wage inflation, which means that not only will consumer inflation reaccelerate, but consumption will remain strong.
2. Plant and machinery capex boom in the US
Who says it will happen?
Janet Henry, global chief economist at HSBC.
What’s the thinking?
Plant and machinery capex has been very poor in the recovery since 2009, whereas historically this component has driven recoveries. They believe some catch-up is due.
Why don’t we think it will happen?
Even going into the great recession, plant and machinery expenditure as a proportion of GDP had been on a secular downward trend, suggesting that there are more fundamental forces at work than just the economic cycle. The reasons for this are varied and complex.
A continued shift towards services and outsourcing is part of the story but doesn’t explain everything. We have identified that equity markets don’t reward companies that increase capex and consequently reduce free cash flow.
What’s our base case?
While we believe the US economy will be one of the faster growing major economies out there, it will be the consumer who will drive demand.
3. China financial collapse
Who says it will happen?
David Cui, China strategist, Bank of America Merrill Lynch.
What’s the thinking?
China has had an extraordinary increase in debt to GDP of 75 ppts since the Global Financial Crisis – similar increases in other countries have preceded major financial crises.
Why don’t we think it will happen?
Over the last two decades China has had more than its fair share of Cassandras. Cassandra, a mythical princess of Troy, was granted the gift of prophecy but was also cursed so that she would never be believed. China Cassandras by contrast have been readily listened to but unlike the Cassandra of Troy, their prophecies have yet to come true. Why is this?
For much of the last 20 years, the Chinese financial system has had many of the ingredients of a potential classic financial crisis: very high levels of (often disguised) non-performing assets; poor or non-existent credit processes within banks, focused if anything on collateral rather than cash flows; and widespread cronyism.
Despite this, the financial system has been able to muddle along. Rapid GDP growth has meant that the problem has become smaller versus GDP. Depositors and markets have therefore been confident in the ability of the Chinese government to stand behind the banking system. Capital injections in the middle of the last decade, an artificially high net interest margin and transfers of bad assets out of the system have meant that institutions, at least superficially, look well capitalised.
The part of the lending book that has received the most attention over the last five years is lending to local government financing vehicles, which are responsible for the increase. This lending was largely dictated by central government and, as it is lending to the public sector, we believe that central government will effectively nationalise those debts which can’t be serviced. As the banking system is largely state-owned, there is little to be gained from robbing Peter to pay Paul by defaulting.
Could the Chinese government find that its fiscal capacity is insufficient to service the debts? Possibly - but although public debt to GDP is high on a consolidated basis, there are also plenty of public sector assets on the other side of the balance sheet too.
What’s our base case?
It is our view that China will continue to muddle through, with GDP increasingly being driven by services and consumption.
4. Oil will blow past $80 a barrel in 2016
Who says it will happen?
Andy Critchlow, resources associate editor, Reuters BreakingViews.
What’s the thinking?
OPEC will succeed in driving out high cost production in the North Sea and US shale areas. OPEC’s pricing power will come back.
Why don’t we think it will happen?
While you should never rule out tail events such as a major war in the Middle East disrupting global supplies, for the moment geopolitical stability is reducing cooperation between members and is leading to more production. Shale oil producers are reacting by slashing costs.
While output is falling, productivity has also been improved in the Permian - new oil production per new rig has nearly doubled over the last year, slowing down the impact that lower prices might be anticipated to have on production. While Critchlow may eventually be proved right, for it to happen in 2016 is a big ask.
What’s our base case?
The steepness in the oil futures curve should incentivise oil to be increasingly stored offshore in tankers if we continue to get production running in excess of consumption, and hence provide a degree of downside protection. Instability in the Middle East makes predicting the oil price even trickier than normal.
5. Worldwide recession
Who says it will happen?
Ruchir Sharma, head of emerging markets and global macro, Morgan Stanley Investment Management.
What’s the thinking?
Emerging market stress - and China in particular - tips the world over into recession.
Why don’t we think it will happen?
Predicting recessions, particularly global ones, is tricky, partly because economists will often spend years debating whether a recession had occurred many years after the event.
Emerging markets certainly face challenges: Brazil’s recession is likely to extend into a third calendar year. However, as we explain above, we think that China will continue to grow and this should keep the global economy expanding even if it is not super-buoyant. Of course, if there is a China hard landing - as China is now the largest economy in the world in purchasing power parity terms - then a world recession is almost inevitable.
What’s our base case?
2015 saw global growth decelerate to 3.1% from 3.4% in 2014. We think that 2016 should reaccelerate back to 2014 levels.
6. US dollar depreciates
Who says it will happen?
David Bloom, global head of FX Strategy, HSBC.
What’s the thinking?
Historically there is little correlation between US Fed hiking cycles and dollar appreciation. Bloom argues that the European Central Bank won’t be able to get the euro weaker and the Bank of Japan won’t expand quantitative easing, and that the dollar will therefore depreciate.
Why don’t we think it will happen?
Since the global financial crisis, the US economy has been one of the strongest of the major economies. Yet despite this, the US trade-weighted dollar in real terms only appreciated above its long-term mean back in July 2015. Although the USD is no longer glaringly cheap, we think that it could get more expensive. The US economy has one of the highest levels of return on capital and this should continue to attract inflows.
What’s our base case?
We believe that the USD will appreciate against the other major currencies such as the euro, Chinese yuan and the British pound.
7. England wins the European Championship
Who says it will happen?
Arsene Wenger, manager arsenal FC.
What’s the thinking?
An injured, largely English Arsenal midfield will be fit by the summer and return to lead Roy Hodgson’s men to triumph.
Why don’t we think it will happen?
How long have you got?
* Derry Pickford is a macro analyst at Ashburton Investments. Opinions expressed are his own.
