Global Macro View – 2013Q4 – Ten Big Questions for 2014

by: Nick Kounis , Aline Schuiling , Maritza Cabezas

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We expect global growth to accelerate noticeably: We shine some light on ten big questions that are often put to us that are critical for the outlook for the global economy and financial markets. We have also extended our forecasting horizon to 2015. Our core conviction is that stronger global economic growth lies ahead, though the pace of recovery will be uneven between economies, while plenty of risks remain. The easing of fiscal consolidation and uncertainty, the renewed health of private sector balance sheets and easing credit conditions in some economies, point to stronger growth in developed markets. This should feed through to stronger exports in Asia and through the emerging markets more widely. As such, we expect global growth to reach almost 4% in 2014 and 2015. In terms of developed markets, the US and UK will outperform the eurozone and Japan, while China will remain the fastest growing emerging market. Germany will once again be a star performer next year within the eurozone, but Greece might take a lead in the fast growers group in 2015.

There is no shortage of risks: Threats to the outlook include the Fed’s exit, eurozone deflation, a re-escalation of the euro debt crisis and a hard landing in China. On balance we think policymakers can and will manage benign outcomes. The low inflation outlook, stronger growth and the dry run earlier this year is likely to allow the Federal Reserve to start to wind down its asset purchases next year without creating too much of a stir. Meanwhile, the ECB has the tools to push down the euro and ease financial conditions to get inflation up from the danger zone in the coming years and it is finally taking its symmetrical price stability goal seriously. The central bank’s last big innovation – the OMT – has stood the test of time as a credible sovereign safety net. So although problems in the eurozone remain, we do not expect the euro debt crisis to re-escalate. Finally, we also think that China’s policymakers have the policy levers and financial firepower to allow investment to ease gradually, despite the high leverage in the corporate and local government sectors.

A new wave of forward guidance: We think that the Fed will likely sugar the tapering pill by lowering its unemployment threshold, signalling that it expects an even later start of interest rate hikes. Meanwhile, the ECB is likely to take the next step against uncomfortably low inflation by indicating that rates are unlikely to go up this year or next, which should push down short rate expectations. If deflationary risks rise, another refi rate cut, a negative deposit rate or QE look to be the next steps. The likely shift of the Fed’s guidance will keep Treasury yields close to current levels over the next few months, but we expect a significant rise later in 2014 and 2015. This reflects our above-consensus call on US economic growth, and our related view that unemployment will continue to fall at a faster rate than the Fed expects. Given the likelihood of highly accommodative ECB policy, very low inflation and a slow recovery, euro long rates are likely to remain very low. All this points to a considerable widening in the US-Germany bond yield spread next year, which should finally bring down the EUR/USD.